The Big U.S. Trade Deficit with China - Assignment Example

Review questions Name Institute Course Instructor Date Q1. What are these four scenarios, and how does each scenario influence: a) future aggregate supply and demand; b) price stability; c) unfolding competitiveness; d) standard of living? From your perspective, which of these four scenarios is the most desirable for the United States? Why? The four scenarios are embargos, tariffs, quotas and free trade I. Embargoes Embargoes specifically ban trade in a particular commodity or service, either imports or export or even both. In this scenario, domestic demand equals domestic consumption. Firms and consumers are forced to stick to the supply possibility curve and the consumption possibility curves. Currently, the US has imposed trade embargoes on North Korean, Iran, Cuba, Venezuela, and Zimbabwe among others. Such decisions are usually politically motivated rather than economically motivated. Future aggregate supply and demand The target countries in embargoes face a shortfall in the demand for their exports and there is no supply for their imports. This therefore means that these countries cannot obtain goods and services that they previously obtained though imports and they cannot export their products. Assuming that there are limited alternative markets, embargoes lead to collapse of export and import oriented industries in the affected countries. Prices stability Embargoes create a shortage of essential commodities in a market. This results to supplies shifting to the black market where prices are even higher. For instance, the price Cuban cigars can adequately capture the effect of embargoes on the prices stability. Given the social status associated with Cuban cigars in the American market, the demand has always been high. An embargo thus restricts supply forcing the prices to shoot upwards in line with the law of demand and supply. To satisfy the ever rising demand of Cuban cigars in the American market, the trade shifted into the black market where prices are easily manipulated. Competitiveness Trade embargoes limit competition from foreign players and protects local industries. A government may specifically place trade embargoes on particular products from specific country or countries to protect local industries. However, benefits gained by domestic players as a result of trade embargoes maybe added benefits. For instance in the case of Cuban embargo, the decreased competiveness in the American tobacco market benefited local producers though the main factors that the led to the embargo were political. Alternatively, the competitiveness in the Cuban tobacco market fell. The country was forced to seek alternative markets to their products or increase consumption to accommodate excess supply. However, limitations by population size and purchasing power dictate how much domestic demand can handle the excess supply. If the domestic demand or alternative markets cannot match, the export market, then prices fall and the industry declines drastically. Standard of living Embargoes are basically punishment to the people of the affected country. When the US or any other countries places embargoes especially on a developing country, the impact is astronomical. Embargoes deny given countries sources of foreign exchange and lead to collapse of export oriented industries that trigger a domino effect. This leads to unemployment in the affected industries and decline in the standard of living. Economies fall as a result of decreased purchasing power and falling aggregate demand. Unless a country can face an equally rewarding alternative, the people’s welfare and standard of living decline drastically. On the other, the standard of living in the countries enacting embargoes falls as a result of a shortage in an important service or commodity unless an alternate equally rewarding source is identified. In the American market, consumers cannot attain their desired utility from Cuban cigars due to lack of supply. The Cuban cigars supplied through the black market are exorbitantly priced. II. Tariffs Tariffs are taxes imposed on imported goods and services. They are enacted by governments to specifically collect government revenue and also protect local industries from competition from foreign players. Given that imported products and services have different levels of competitiveness in the domestic market, tariff rates are applied differently to different products. In the US for instance, the tariffs for wheat and wheat products are very high to deter imports that can compete with the local producers. Future aggregate supply and demand Tariffs affect future aggregate demand and supply in a number of ways. One of the ways is that tariffs give room to the domestic industry to grow by protecting it from foreign competition. The tariffs on one hand earn government revenue. Tariffs also affect aggregate demand and supply is by cutting down on demand of non-essential products. High prices of imports as result of tariffs are expected to lower demand on the affected products. This implies that consumption potential is restricted to the production potential. On the other hand, it minimizes the amount of resources or money exported to foreign countries. This in the long run enabled the country to maintain a healthy trade balance which in the long run promotes aggregate demand supply. Alternatively tariffs hurt future aggregate demand and supply. The ‘beggar thy neighbor’ theory claims that tariffs hurt the export business of other countries which are attempted to hit back through higher tariffs. Price stability Tariffs cause price instabilities in the market. They continually encourage increase in prices of affected products continuously. This happens as shown below as explained by Schiller. Tariffs increase the prices of imported commodities and thus allow the domestic producers to increase production. Prices also rise as a result of reduced imports. Governments, encouraged by higher revenues may be tempted to increase tariffs in the future thereby leading to more future price instability. Figure 1: tariff restricted trade Competitiveness Tariffs basically reduce competitiveness for domestic players. From the graph, it is clear that the quantity supplied by foreign players will drop from q2 to q3 as a result of high costs of doing business (tariffs) that is marked by change in price from p2 to p3. Standard of living Decreased competitiveness through tariffs leads to higher prices. Domestic players have better control of local market can even formulate cartels to regulate prices. Consumers are always on the losing end. They have smaller variety to choose from as a result reduced import quantities and also have to do with higher prices for commodities. III. Quotas Quotas are an alternative to tariffs. They refer to the restriction of international trade by setting limits on quantity of imports. Quotas are largely preferred as they do not cause price instabilities in the market as caused by tariffs Future aggregate demand The quota system has almost similar impact on aggregate demand and supply as tariffs. In the quota system, the domestic market operates in same way as a free trade scenario except that it is capped at a certain point. This allows the price to be set at two points: before the quota is reached and after. Before the quota is reached, price is determined by equilibrium of demand and supply. After the quota, the supply curve shifts to the right and a new higher price influenced by domestic demand is set. The foreign players are denied a chance to benefit from higher prices thus in the long run harms them. The effects on the aggregate demand and supply will almost be similar to an embargo in the long run unless the quota is raised gradually. Price stability Import quotas, whether imposed or the voluntary ones limit the quantity of commodities supplied to a given market. The effect is a decreased supply leading to a surge in prices. Therefore, quotas act as a direct threat to the stability of prices in the market. Competiveness Quotas prohibit the participation of foreign players at a certain point. Unlike tariffs, quotas limit the participation of foreign players in the domestic market at whatever price. Standard of living The public is the greatest loser in terms of utility and pricing where quotas are used. Quotas deny consumers access to imported goods at a lower price and expose them to higher prices from local suppliers. IV. Free trade This is the most desired scenario in international trade from a purely economic point of view. This scenario requires that there are no restrictions to trade whatsoever and moment of goods is unrestricted and pricing is determined by market forces. If this were to hold, countries would move towards specialization in areas they have comparative advantage. Competitiveness This scenario would increase competition globally to a level of perfectly competitive market. All buyers and supplies from all corners of the world would interact. Pricing Prices would be defined by purely market forces. This would mean that consumers can enjoy the most that suppliers have to offer at the best prices. Competiveness This scenario presents the perfectly competitive market. This is because there are no boundaries and barriers to trade. Consequently, all national markets would be combined into one global market. Standard of living The high competitive nature this scenario would force various countries to steer towards producing in areas that they have competitive advantage and specialize in that. As a result, consumption possibilities would increase almost in all product categories. Producers and consumers would equally benefits from higher utilities from better consumption possibilities and producers would operate optimally as a result of specialization. Desired scenario The most suitable scenario for the US would be the quota system. Currently, American firms face stiff competition from foreign firms in various industries. To ensure that fewer dollars are exported through purchase of imports, the country would be better off with quotas. Quotas are also more effective in curbing foreign competition as opposed to other measures. Embargoes would not be suitable as they are likely to be reciprocated by targeted countries which would hurt America’s ability to export. Alternatively, stringent quotas are likely to be reciprocated. 2. Identify the principal trends likely to influence the future of global markets. Why is the United States currently experiencing a major trade deficit? Why are some observers optimistic about the long-term trade position of the United States? Principal trends The major trends likely to define the near future are trends in the capital market, sustainable energy and trade agreements. The capital market has defines the trade deficit in terms of capital flow across borders. When a country invests more than it saves, such as the US, then there it is forced to import capital from foreign markets. The imported capital enables consumers to consumer goods and services produced locally and import the difference incurred as a trade deficit. The formula below simply explains this Savings - Investment = Exports – Imports This shows that the American trade deficit is a product of government borrowing rather than trade policies. Therefore future trends will be guided by how governments are able to encourage more savings to avert incurring deficits. The other defining future trend will be trade agreements. Trade agreements will allow countries address their trade deficits through help from trade partners. This can include removal of subsidies in foreign markets to ensure products compete equally. Therefore, the future will be highly influenced by trade agreements and alliances by countries keen on creating an acceptable balance of trade. The value of the American dollar vis a vis the Chinese currency has been attributed to the current trade deficit by some experts. China has been accused of currency manipulation. From the law of demand and supply, the Chines currency should have appreciated at a higher rate with the country having massive dollar reserves in excess of three trillion. On the contrary, the Chinese currency has not appreciated as would be expected. Some experts accuse China of current manipulation by buying extra dollars with local currency. This in short keeps the local products at a lower price compared to imports. Consequently, Chinese commodities are cheaper than American ones. How this is true remains to be verified. Unfortunately, it would be detrimental to the America economy to limit trade with China. The Smoot-Hawley Tariff act of 1930 serves as an important learning point for the US matters of international trade. The tariff, which was enacted despite pleas from over a thousand economists not sign to the act, worsened an already bad situation. The act was a self-preservation move that was intended to encourage Americans to buy Americans and create employment had very negative economic effects. The act led to US’s exporting following retaliatory acts by several countries impacted by the tariffs imposed on other countries imports. Among those that reacted were Italy, Canada and Australia. Currently, the US is facing a similar situation especially in light of the recent global financial crisis and American recession. Some sources blame the plight of the American economy to the rise of China. Americans complained that American were promoting Chinese manufacturers at the cost of their own. There is little the US can do in handling China’s products in the global market. China, courtesy of available energy, mineral and cheap skilled labor, has huge comparative advantages in many labor intensive industries. Therefore, the US cannot compete on that level. Enabling the Chinese to do what they do best not only protects American consumers from higher prices from domestic manufactures abut also improves product ranger and consumer utility. America on the other hand is quickly developing a comparative advantage courtesy of its highly skilled labor and better resources in research and development, producing hi-tech products for export to the rest of the world. Cutting edge technology is the new frontier. The growth being experienced by China and other manufacturing giants is not sustainable. Their growth is largely powered by relocation of western manufacturing firms into China. This rate of relocation will slow down in the near future. China is already facing growing labor wages and in the process eroding its comparative advantage. Previously, the American economy had the comparative advantage in manufacturing. However, with various suspects such as high labor wages eroding this comparative advantage, majority of manufacturing functions were relocated to China. The US is slowly but surely discovering another comparative advantage in services industry and cutting edge technology. In the near, the global economy will shift from a manufacturing oriented one to a service and cutting edge oriented one. This will place the US at a better position than now. The greatest issue facing the American is the huge trade deficit. The cutting technology exports will be key in boosting American exports and reduce the current trade deficit. Another area that the US is likely to excel in the future and boost its economy is green energy development. With major manufacturing activities now located in China, the US can concentrate on developing green energy technology for export. Furthermore, oil is one of the major imports that contribute toward widening the trade deficit. New discoveries in more conservative energy will address this trade deficit by about 40%. Works cited Schiller, Flannery, Russell. What Can Be Done About The Big U.S. Trade Deficit With China? Forbes Magazine. 2013 http://www.forbes.com/sites/russellflannery/2013/08/03/what-can-be-done-about-the-big-u-s-trade-deficit-with-china/ Read More