TRADE POLICY

PROF. ISIDRO APOLLO G. VALENSOY, JR.

 What is TRADE?
• The exchange of goods and services
• INTERNATIONAL TRADE refers to exchange of
goods and services between one country and
other countries.
 Why do countries trade?
• Professor Paul Samuelson said, “Even if you
are the best lawyer and the best typist in
town, it is better to engage only in legal
practice and let the secretary do the job of
typing.”
 Bases of International Trade
• Distribution of economic resources vary
among countries.
• “When a top Japanese government official
saw the United States, he said, God has not
been fair in the distribution of natural
resources.”
• Japan has only 15% arable land;
• During winter, half of it is covered with snow.
What factor serves as basis for profitable trade?

• Technological efficiency
• Assuming all other things being equal, a
country which has the most efficient
technology can produce goods at the lowest
price, with the best quality, and the highest
quantity.
The importance of International Trade
• Fundamental Principle: One should buy goods
and services from a country which has the
LOWEST PRICE, and sell his goods and services to
a country which has the HIGHEST PRICE.
• With FREE TRADE, a developing country could
increase the pace of its development by
importing equipment and technologies.
• People with money can acquire goods and
services which are not available in their own
country.
 MERCANTILIST IDEAS
• Mercantilist Doctrine: believed that the power and prestige of any nation
depended on the accumulation of gold and silver.
• Policies: the State regulated foreign trade and even actively participated in
the exports business.
• Niccolo Machiavelli: supported the idea of supremacy of the State over all
other sources of power, including the church. He was in favor of a
benevolent dictator who could achieve material prosperity for his national
state in order to maintain order and facilitate the creation and
accumulation of wealth.
• Antonio Serra: wrote a treatise on THE CAUSES WHICH CAN MAKE GOLD
AND SILVER PLENTIFUL IN KINGDOMS WHERE THERE ARE NO MINES. He
maintained the superiority of industrial products over those of agriculture
as far as exports and profits were concerned.
• Thomas Mun: He argued that the ORDINARY WAY to increase wealth and
treasure is TO SELL MORE to foreigners THAN BUY FROM THEM. This is his
idea of favorable foreign trade – encourage exports and at the same time
discourage imports.
 Rise of Mercantilism
• France, England, and Spain became aggressive
in searching for new colonies.
• In England, the government was busy building
highways and canals.
• New industries were given abundant
incentives (subsidies).
• Workers were given low wages.
 Rise of Economic Liberalism
• Workers’ exploitation, the granting of subsidies
which bred favoritism and corruption, state
regulations and restrictions of economic activities led
to the collapse of the mercantilist system.
• The rising class of businessmen opposed the
mercantilist doctrine and promoted instead the idea
of economic individualism - which espoused
economic freedom, dignity of man, absence of
restrictions in production, consumption, and
marketing.
 Theory of Comparative Advantage
• Adam Smith: pointed out the defects of mercantilism and
stressed the benefits of free trade, that is, if it is cheaper
to buy a product than to produce it, then do not produce
it.
• David Ricardo’s Theory of Value: the value of any product
is determined by its labor cost (which is determined by the
number of days in producing it).
• Ricardo’s Theory of Comparative Advantage states that a
country should export those goods in which it has the
greatest advantage, and import those goods in which it
has the greatest disadvantage.
 Some illustration…
RICE CLOTH
JAPAN 60 DAYS 80 DAYS
VIETNAM 90 DAYS 70 DAYS

On which product has Japan a comparative advantage?

Vietnam?
If Japan exchanges its rice with Vietnam’s cloth, how many days
would it save?
If Vietnam exchanges its cloth with Japan’s rice, how many days
would it save?
 Some limitations of the theory…
• Does the theory consider transportation cost
and quality?
• Does it consider land, capital, and managerial
ability?
 Free trade as viewed in the
classical theory…
• Buyers and sellers can readily communicate
with one another;
• There is free mobility of labor and capital
• There are no direct quantitative restrictions
• There is free convertibility of currencies
 Revival of economic nationalism…
• Birth of Trade Protectionism in continental
Europe as a result of the failures of economic
liberalism.
• In the Philippines, many believed that the
cause of our poverty is our COLONIAL
ECONOMY, COLONIAL MENTALITY, and
COLONIAL EDUCATION.
• Does WB have anything to do with it?
 Is free trade only possible in
theory?
• Can it still operate in today’s realities?
• How can one country enter into a free trade if it needs
to protect its own interests?
• If competition is the order of the day, would there be
fair trade agreements?
• If free trade dictates that countries should specialize in
producing goods that it has the greatest advantage,
would it be beneficial for the Philippines to continue
producing agricultural products and leave production
of industrial products to other countries?
 Trade Barriers
• Tariff – an excise tax on imported products
• Import Quota – limits on the number of goods
to be imported

• Why do countries impose high tariffs and

import quotas? What are the pros and cons of
this kind of trade policy?
 Arguments for Trade Barriers
• Military self-sufficiency: Should manufacturers of
military goods be allowed to sell to enemies?
• Infant industry: Should the government tolerate
foreign competition with products produced by
emerging industries?
• Local standard of living: Should cheap imported
products be allowed to lower local goods?
• Local employment: Should imports be promoted and
let local employment suffer?
 BALANCE OF PAYMENTS
• What exchange transactions are involved between
two countries?
• What facilitates these exchange transactions?
What systematically records them?
• Transactions – goods, services, loans, foreign
investments, and monetary reserves (including
IMF SDRs)
• A BOP, therefore, is a summary of all economic
transactions of a country with the other countries.
 Hypothetical BOP of Philippines
ITEM CREDIT DEBIT
(Inflows) (Outflows)
CURRENT ACCOUNT
Goods Exports Imports
Services Japanese Tourists Filipino students in the US

CAPITAL ACCOUNT Private foreign investment Debt payments to WB-IMF

United Nations grants Financial contributions to
WB loans other countries

CASH ACCOUNT (Monetary Monetization of gold

Reserves) Allocation of SDRs

What happens when there are deficits in the current and capital account?
What’s the difference between BOP and Balance of Trade?
Where do we “record” the values of smuggled goods?
 EXCHANGE RATE
• It is the price of a foreign money relative to
the local money (E.g. the price of $1 is P42)
• Floating Exchange Rate – the rate is
dependent upon the forces of supply and
demand
• A foreign currency’s value may appreciate
(increase) or depreciate (decrease). It may
also be overvalued or undervalued.
 Determinants of Exchange Rate
• Relative income changes: What happens if
there is increase in imports of US products by
Filipino residents?
• Relative price changes: What happens if prices
of local goods are higher than US-made
products in the local market?
• Relative interest rates: What happens if interest
rates in the Philippines are higher than in the
US?
 Exchange Rates Policies
• Pegged Exchange Rates – the government
through its central bank fixes the rate.
• Free-floating or flexible exchange rate –
forces of supply and demand determines the
rate.
• Managed floating exchange rates – forces of
supply and demand determines the rate but
with the intervention of the government.
World trade, world per capita
income, and world BCI compared…
• Countries with basic BCI level are those providing
essential social services required to ensure a
minimum dignity level and are thus able to further
improve the well-being of its people.
• Basic: 98 and over
• Medium: from 91 to 97
• Low: from 81 to 90
• Very Low: from 71 to 80
• Critical: below 70
• Economic performance and well being of the
people do not go hand in hand;
• Progress on education, health and nutrition
was already too slow when gross income was
growing fast;
• The vulnerable did not benefit from the
accelerated growth in the economy.
What our HDI says…