Trade Between China and the United States Essay

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Trade Between China and the United States

This paper discusses some theories about international trade, and why countries trade with one another. The first trade theory that warrants discussion is specialization, something that Adam Smith touched on. He used the analogy of specific professional to illustrate this theory -- nations do what they are best at. A quick look at the relationship between the U.S. And China illustrates this quite well. The United States is a world leader in innovation. A company like Wal-Mart is a leader at designing logistics and inventory management systems. It has no particular expertise in producing goods. China, on the other hand, has developed considerable expertise in recent years with respect to production. Thus, the arrangement between Wal-Mart and China, more or less, is that China makes the goods and Wal-Mart will then get those goods to market and sell them. This plays to the strengths of both of these entities. Wal-Mart has opened retail operations in China, again because it feels that it is superior at logistics and merchandising.

Wal-Mart -- and by extent the United States -- has an absolute competitive advantage is logistics and retailing. There are few countries and companies that do it better, as Wal-Mart has demonstrated in a number of international expansions. China, by contrast, has emerged as the world's manufacturer of choice. In this instance, both countries are playing t their strengths and the combination is compelling as a major driver of world trade. Apple and China is a similar story -- American innovation, design and retailing combines with Chinese production to create value that few if any in the world can match. Even Apple's major contractor, Foxconn, is an example of international trade at work, with Taiwanese management and Chinese laborers. So these are generally all examples of specialization in trade where nations do the things that they are the best in the world at.

David Ricardo developed one of the most influential theories about international trade, known as the theory of comparative advantage (WTO, 2013). This theory holds that nations do not necessarily trade only where there is absolute competitive advantage, but where there is comparative advantage. For example, there may be countries with lower cost structures than China with respect to manufacturing -- perhaps Vietnam, or Bangladesh -- but China has comparative advantage in that its costs are lower than those in the United States. Likewise, the U.S. may not have the world's best design, but it has very good designs and this alone is enough to provide it opportunity. Nations will trade where such comparative advantages exist -- China can learn how to sell things from many nations but it goes with the U.S.

Unrestricted free trade between nations seeks to foster greater economic efficiency in trade. In a nutshell, comparative advantage works better when there are fewer barriers to trade. For example, perhaps the U.S. buys Chinese manufactured goods not because Vietnam's are more expensive but because there are more trade barriers between Vietnam and the U.S. than there are between China and the U.S. All other things begin equal, trade barriers can govern the trade flows between nations. Where the influence of trade barriers takes trade between nations away from economic efficiency, this reduces the total wealth of each nation.

Thus, eliminating trade barriers will create truly free trade. Nations under free trade will be able to compete with each other on even terms. As Porter (1990) notes, these terms tend more to reflect innovation and improvement as forces driving competitive advantage, rather than factor endowments. When trade barriers are removed, nations are forced to compete with factors like innovation and education. Those nations with better capacity to invest in public infrastructure like education are going to be more innovative. There is a significant difference between how nations would trade under free trade conditions. When the world moves towards freer trade, this takes the world closer to economic efficiency, which should increase total global wealth.

For many countries, economic efficiency holds a lot of intellectual appeal, but is not necessarily pragmatic. The benefits of economic efficiency are clear. Resources are allocated more efficiently, more goods and services are produced, and in general there is improvement in living standards are total wealth increases. However, many nations must weigh the quest for economic efficiency. There are a few reasons for this. First, we do not exist in a world of stable nation-states. We exist in a world characterized by perpetual conflict Today's allies were yesterday's enemies and vice versa.

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Nations therefore have a vested interest in the long-run preservation of things like military power (so steelmaking, military R&D, automobiles) and food security. While economic efficiency might make a case for free trade in something like agriculture, there is no guarantee that today's trading partners will sell to us tomorrow. A nation faced with an existential threat from a lack of food security is likely to become a failed state, and this is something that governments prefer not to happen if the only benefits are a few cents off the price of milk.

Thus, governments play an active role in fostering the national competitiveness of certain industries. Governments also do this for other pragmatic reasons, such as the fact that governments are elected. For example, if there are not enough jobs for the people, there will be social unrest, and elected official risk losing office. Thus, there is strong incentive for politicians to promote certain industries even at the risk of economic inefficiency.

Governments should not play a role in fostering national competitive advantage, under economic orthodoxy, because this will reduce the overall economic efficiency of the global economic system. However, that efficiency is not ever going to be optimized. Remember that there is no efficiency in labor markets. If pure market forces demand that another 200 million people come to the United States, this will not happen because the country has immigration policies, there are costs associated with infrastructure that further constrain labor mobility and the total supply of labor in the world is not related to demand -- there is no natural equilibrium point. Thus, governments act in their own interests to foster competitive advantage in many industries in order ensure employment, food security, military security and other social goals that are important to the electorate but that detract from pure economic efficiency.

For managers dealing in the new economic trading system it is important to understand how this system affects their businesses. The trend was once towards greater trade freedom but in the past couple of years this trend has flatlined at its current level, according to libertarian think tank the Heritage Foundation, which tracks a trade freedom index (Riley & Miller, 2013). Trade activity is rising in the world, but moves to lower trade barriers have stalled. In this delicate geopolitical time, there is risk that trade barriers could even increase on aggregate. What this means is that managers need to constantly be aware of the shifting sands of world trade and how that affects their industry. Comparative advantage examples in school always use numbers, but in the real world those numbers are not static. China still has a comparative advantage vs. The U.S. In manufacturing, but this is not as significant as it once was. Other countries might have superseded China in this respect, with either low costs and better quality at the same cost, as China's costs continue to rise. Managers need to be alert to these trends. Furthermore, managers should be aware of other changes, such as trade agreements. If the U.S. signs a new agreement with, say, Vanuatu, then a manager should be aware of how that will affect his or her business. It might not, but if that business is in coconut milk, and the agreement removes tariffs on Vanuatu coconut milk, that matters. Managers need to always be aware of the changing dynamics of differential advantage in world trade, because these changes could be significant for its business.

Another recommendation for managers in this new trading system is to understand where the threats lie. For example, producers in another country could have a substantial advantage, but have their access to your country blocked by a tariff. If those tariffs change, your company could be exposed. When barriers on Japanese cars fell, they became more competitive on the American market and began to increase market share. Similar things happen in a number of industries. For many industries, it is better to pressure government to erect trade barriers than to compete on even footing. Likewise, competitors in foreign markets might put pressure on their governments to do the same. For managers, it is important to know where the company would stand if trade barriers were eliminated, because this will better inform strategy.

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