McConnell Campbell R., Brue Stanley L., Barbiero Thomas P. Microeconomics. Ninth Edition

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of the CA’s time). By using the CA to prepare

his tax return, the painter lowers his cost of get-

ting the tax return prepared.

What is true for our CA and house painter

is also true for nations. Specializing enables

nations to reduce the cost of obtaining the

goods and services they desire.

Comparative Costs

Our simple example shows that specialization

is economically desirable because it results in

more efﬁcient production. Let’s now put spe-

cialization in the context of trading nations,

using the familiar concept of the production

possibilities table for our analysis. Suppose pro-

duction possibilities for two products in Mexico

and Canada are as shown in Tables 5-3 and 5-4.

In these tables we assume constant costs. Each

country must give up a constant amount of one

product to secure a particular increment of the

other product. (This assumption simpliﬁes our

discussion without impairing the validity of

our conclusions.)

Specialization and trade are mutually beneﬁcial

or “proﬁtable” to the two nations if the comparative costs of the two products within

the two nations differ. What are the comparative costs of corn and soybeans in Mex-

ico? By comparing production alternatives A and B in Table 5-4, we see that ﬁve tonnes

of soybeans (= 15 – 10) must be sacriﬁced to produce 20 tonnes of corn (= 20 – 0). Or

more simply, in Mexico it costs one tonne of soybeans (S) to produce four tonnes of

corn (C); that is, 1S ≡ 4C. Because we assumed constant costs, this domestic compara-

tive-cost ratio will not change as Mexico expands the output of either product. This is

evident from looking at production possibilities B and C, where we see that four more

tonnes of corn (= 24 – 20) cost one unit of soybeans (= 10 – 9).

Similarly, in Table 5-5, comparing Canadian production alternatives R and S

reveals that in Canada it costs 10 tonnes of soybeans (= 30 – 20) to obtain 30 tonnes

of corn (= 30 – 0). That is, the domestic comparative-cost ratio for the two products

in Canada is 1S ≡ 3C. Comparing production alternative S and T reinforces this; an

extra three tonnes of corn (= 33 – 30) comes at the direct sacriﬁce of one tonne of soy-

beans (= 20 – 19).

The comparative costs, or internal terms of trade, of the two products within the

two nations are clearly different. Economists say that Canada has a domestic com-

parative advantage or, simply, a comparative advantage over Mexico in soybeans.

Canada must forgo only three tonnes of corn to get one tonne of soybeans, but Mex-

ico must forgo four tonnes of corn to get one tonne of soybeans. In terms of domes-

tic opportunity costs, soybeans are relatively cheaper in Canada. A nation has a

comparative advantage in some product when it can produce that product at a lower domes-

tic opportunity cost than can a potential trading partner. Mexico, in contrast, has a com-

parative advantage in corn. While one tonne of corn costs one-third tonne of soybeans

in Canada, it costs only one-quarter tonne of soybeans in Mexico. Comparatively

speaking, corn is cheaper in Mexico. We summarize the situation in Table 5-5.

chapter ﬁve • canada in the global economy 109

TABLE 5-3 MEXICO’S

PRODUCTION

POSSIBILITIES

TABLE (IN TONNES)

PRODUCTION ALTERNATIVES

Product A B C D E

Corn 0 20 24 40 60

Soybeans 15 10 9 5 0

TABLE 5-4 CANADA’S

PRODUCTION

POSSIBILITIES

TABLE (IN TONNES)

PRODUCTION ALTERNATIVES

Product R S T U V

Corn 0 30 33 60 90

Soybeans 30 20 19 10 0

comparative

advantage

When a region or

nation can produce

a good at a lower

domestic opportu-

nity cost compared

to a potential trad-

ing partner.

Because of these differences in domestic

comparative costs, if both nations specialize,

each according to its comparative advantage,

each can achieve a larger total output with the

same total input of resources. Together they will

be using their scarce resources more efﬁciently.

Terms of Trade

Canada can shift production between soybeans

and corn at the rate of 1S for 3C. Thus, Canadi-

ans would specialize in soybeans only if they

could obtain more than three tonnes of corn for

one tonne of soybeans by trading with Mexico.

Similarly, Mexico can shift production at the

rate of 4C for 1S. So it would be advantageous

to Mexico to specialize in corn if it could get one

tonne of soybeans for less than four tonnes of corn.

Suppose that through negotiation the two nations agree on an exchange rate of

one tonne of soybeans for three-and-a-half tonnes of corn. These terms of trade are

mutually beneﬁcial to both countries since each can “do better” through such trade

than via domestic production alone. Canadians can get three-and-a-half tonnes of

corn by sending one tonne of soybeans to Mexico, while they can get only three

tonnes of corn by shifting resources domestically from soybeans to corn. Mexicans

can obtain one tonne of soybeans at a lower cost of three-and-a-half tonnes of corn

through trade with Canada, compared to the cost of four tonnes if Mexicans pro-

duce one tonne of corn themselves.

Gains from Specialization and Trade

Let’s pinpoint the size of the gains in total output from specialization and trade.

Suppose that before specialization and trade, production alternative C in Table 5-3

and alternative T in Table 5-4 were the optimal product mixes for the two countries.

These outputs are shown in column 1 of Table 5-6. That is, Mexicans preferred 24

tonnes of corn and 9 tonnes of soybeans (Table 5-3) and Canadians preferred 33

tonnes of corn and 19 tonnes of soybeans (Table 5-4) to all other alternatives.

110 Part One • An Introduction to Economics and the Economy

TABLE 5-6 SPECIALIZATION ACCORDING TO COMPARATIVE

ADVANTAGE AND THE GAINS FROM TRADE

(IN TONNES)

(1) (2) (3) (4) (5)

Outputs before Outputs after Amounts Outputs available Gains from specialization

Country specialization specialization traded after trade and trade (4) – (1)

Mexico 24 corn 60 corn –35 corn 25 corn 1 corn

9 soybeans 0 soybeans +10 soybeans 10 soybeans 1 soybeans

Canada 33 corn 0 corn +35 corn 35 corn 2 corn

19 soybeans 30 soybeans –10 soybeans 20 soybeans 1 soybeans

terms of

trade

The

amount of one

good or service

that must be given

up to obtain one

unit of another

good or service.

TABLE 5-5 COMPARATIVE

ADVANTAGE

EXAMPLE: A

SUMMARY

Soybeans Corn

Mexico: Must give up Mexico: Must give up

4 tonnes of corn to get

⁄4 tonne of soybeans to

1 tonne of soybeans get 1 tonne of corn

Canada: Must give up Canada: Must give up

3 tonnes of corn to get

⁄3 tonne of soybeans to

1 tonne of soybeans get 1 tonne of corn

Comparative advantage: Comparative advantage:

Canada Mexico

Now assume both nations specialize according to comparative advantage, Mex-

ico producing 60 tonnes of corn and no soybeans (alternative E) and Canada pro-

ducing no corn and 30 tonnes of soybeans (alternative R). These outputs are

reﬂected in column 2 of Table 5-6. Using our 1S = 3

⁄2C terms of trade, assume Mex-

ico exchanges 35 tonnes of corn for 10 tonnes of Canadian soybeans. Column 3 of

Table 5-6 shows the quantities exchanged in this trade. As indicated in Column 4,

after trade Mexicans have 25 tonnes of corn and 10 tonnes of soybeans, while Cana-

dians have 35 tonnes of corn and 20 tonnes of soybeans. Compared with their opti-

mum product mixes before specialization and trade (column 1), both nations now

enjoy more corn and more soybeans! Speciﬁcally, Mexico has gained one tonne of

corn and one tonne of soybeans. Canada has gained two tonnes of corn and one

tonne of soybeans. These gains are shown in column 5.

Specialization based on comparative advantage improves resource allocation. The same

total inputs of world resources result in a larger global output. If Mexico and Canada allo-

cate all their resources to corn and soybeans respectively, the same total inputs of

resources can produce more output between them, indicating that resources are

being used or allocated more efﬁciently.

We noted in Chapter 2 that through specialization and international trade a nation

can overcome the production constraints imposed by its domestic production possi-

bilities table and curve. Table 5-6 and its discussion show just how this is done. The

domestic production possibilities data of the two countries have not changed, mean-

ing that neither nation’s production possibilities curve has shifted. But specialization

and trade mean that citizens of both countries have enjoyed increased consumption.

Thus, specialization and trade have the same effect as an increase in resources or tech-

nological progress: they make more goods available to an economy. (Key Question 5)

Buyers and sellers, whether individuals, ﬁrms, or nations, use money to buy prod-

ucts or to pay for the use of resources. Within the economy, prices are stated in the

domestic currency and buyers use that currency to purchase domestic products. In

Mexico, for example, buyers possess pesos, exactly the currency that sellers want.

International markets are different. How many dollars does it take to buy a truck-

load of Mexican corn selling for 3000 pesos, a German automobile selling for 90,000

euros, or a Japanese motorcycle priced at 300,000 yen? Producers in Mexico, Germany,

and Japan want payment in pesos, euros, and yen, respectively, so they can pay their

wages, rent, interest, dividends, and taxes. A foreign exchange market, a market in

which various national currencies are exchanged for one another, serves this need. The equi-

librium prices in these markets are called exchange rates—the rate at which the currency

of one nation is exchanged for the currency of another nation. (See Global Perspective 5.3.)

Two points about the foreign exchange market are particularly noteworthy:

1. A Competitive Market Real-world foreign exchange markets conform closely

to the markets discussed in Chapter 3. They are competitive markets character-

ized by large numbers of buyers and sellers dealing in standardized products

such as the Canadian dollar, the European euro, the British pound, the Swedish

krona, and the Japanese yen.

2. Linkages to all Domestic and Foreign Prices The market price or exchange rate

of a nation’s currency is an unusual price; it links all domestic (say, Canadian)

prices with all foreign (say, Japanese or German) prices. Exchange rates enable

consumers in one country to translate prices of foreign goods into units of their

chapter ﬁve • canada in the global economy 111

Foreign Exchange Market

foreign

exchange

market

market in which the

money (currency)

of one nation can

be used to purchase

(can be exchanged

for) the money of

another nation.

exchange

rate

The rate at

which the currency

of one nation is

exchanged for the

currency of another

nation.

own currency: They need only multiply the foreign product price by the

exchange rate. If the dollar-yen exchange rate is $.01 (1 cent) per yen, a Sony tel-

evision set priced at ¥20,000 will cost a Canadian $200 (= 20,000 × $.01). If the

exchange rate is $.02 (2 cents) per yen, it will cost a Canadian $400 (= 20,000 ×

$.02). Similarly, all other Japanese products would double in price to Canadian

buyers. As you will see, a change in exchange rates has important implications

for a nation’s level of domestic production and employment.

Dollar-Yen Market

How does the foreign exchange market work? Let’s look brieﬂy at the market for dol-

lars and yen, leaving details to a later chapter. Canadian ﬁrms exporting to Japan

want payment in dollars, not yen; but Japanese importers of Canadian goods possess

yen, not dollars. So the Japanese importers are willing to supply their yen in

exchange for dollars in the foreign exchange market. At the same time, there are

Canadian importers of Japanese goods who need to pay Japanese exporters with yen,

not dollars. These Canadians go to the foreign exchange market as demanders of yen.

We then have a market in which the “price” is in dollars and the “product” is yen.

Figure 5-4 shows the supply of yen (by Japanese importers) and the demand for

yen (by Canadian importers). The intersection of demand curve D

and supply

curve S

establishes the equilibrium dollar price of yen. Here the equilibrium price

of 1 yen—the dollar-yen exchange rate—is 1 cent per yen, or $.01 = ¥1. At this price,

the market for yen clears; there is neither a shortage nor a surplus of yen. The equi-

librium $.01 price of 1 yen means that $1 will buy 100 yen or ¥100 worth of Japan-

ese goods. Conversely, 100 yen will buy $1 worth of Canadian goods.

Changing Rates: Depreciation and Appreciation

What might cause the exchange rate to change? The determinants of the demand for

and supply of yen are similar to the determinants of demand and supply for almost

any product. In Canada, several things might increase the demand for—and there-

fore the dollar price of—yen. Incomes might rise in Canada, enabling Canadians to

buy not only more domestic goods but also more Sony televisions, Nikon cameras,

112 Part One • An Introduction to Economics and the Economy

Exchange rates: foreign

currency per Canadian dollar

The amount of foreign currency

which a dollar will buy varies

greatly from nation to nation. These

amounts are for April 2001 and

ﬂuctuate in response to supply

and demand changes in the foreign

exchange market.

5.3

$1 Will Buy

1.39 German marks

.44 British pounds

.57 U.S. dollars

5.97 Mexican pesos

1.08 Swiss francs

4.67 French francs

80 Japanese yen

855 South Korean won

1380 Italian lira

and Nissan automobiles from Japan. So Canadians would need more yen and the

demand for yen would increase. Or a change in Canadian tastes might enhance their

preferences for Japanese goods. When gas prices soared in the 1970s, many Cana-

dian auto buyers shifted their demands from gas-guzzling domestic cars to gas-

efﬁcient Japanese compact cars. The result was an increased demand for yen.

The point is that an increase in the Canadian demand for Japanese goods will

increase the demand for yen and raise the dollar price of yen. Suppose the dollar

price of yen rises from $.01 = ¥1 to $.02 = ¥1. When the dollar price of yen increases,

we say a depreciation of the dollar relative to the yen has occurred: It then takes

more dollars (pennies in this case) to buy a single unit of the foreign currency (a

yen). Alternatively stated, the international value of the dollar has declined. A depre-

ciated dollar buys fewer yen and therefore fewer Japanese goods; the yen and all

Japanese goods have become more expensive to Canadians. Result: Canadian con-

sumers shift their expenditures from Japanese goods to now less expensive Cana-

dian goods. The Ford Taurus becomes relatively more attractive than the Honda

Accord to Canadian consumers. Conversely, because each yen buys more dollars—

that is, because the international value of the yen has increased—Canadian goods

become cheaper to people in Japan and Canadian exports to Japan rise.

If the opposite event occurred—if the Japanese demanded more Canadian

goods—then they would supply more yen to pay for these goods. The increase in the

supply of yen relative to the demand for yen would decrease the equilibrium price

of yen in the foreign exchange market. For example, the dollar price of yen might

decline from $.01 = ¥1 to $.005 = ¥1. A decrease in the dollar price of yen is called an

appreciation of the dollar relative to the yen. It means that the international value

of the dollar has increased. It then takes fewer dollars (or pennies) to buy a single

yen; the dollar is worth more because it can purchase more yen and therefore more

Japanese goods. Each Sony Walkman becomes less expensive in terms of dollars, so

Canadians purchase more of them. In general, Canadian imports rise. Meanwhile,

because it takes more yen to get a dollar, Canadian exports to Japan fall.

Figure 5-5 summarizes these currency relationships. (Key Question 7)

chapter ﬁve • canada in the global economy 113

FIGURE 5-4 THE MARKET FOR YEN

Exchange

rate :$.01 = ¥1

.01

Dollar price of 1 yen

Quantity of yen

Canadian imports

from Japan create a

demand D

for yen,

while Canadian

exports to Japan

create a supply S

yen. The dollar price

of one yen—the

exchange rate—is

determined at the

intersection of the

supply and demand

curves. In this case

the equilibrium price

is $.01, meaning that

1 cent will buy 1 yen.

depreciation

(of the dol-

lar)

A decrease

in the value of the

dollar relative to

another currency so

that a dollar buys a

smaller amount of

the foreign currency.

appreciation

(of the dol-

lar)

An increase

in the value of the

dollar relative to the

currency of another

nation so that a dol-

lar buys a larger

amount of the for-

eign currency.

If people and nations beneﬁt from specialization and international exchange, why do

governments sometimes try to restrict the free ﬂow of imports or encourage exports?

What kinds of world trade barriers can governments erect, and why would they do so?

Trade Impediments and Subsidies

There are four means by which governments commonly interfere with free trade:

● Protective tariffs are excise taxes or duties placed on imported goods. Protec-

tive tariffs are designed to shield domestic producers from foreign competi-

114 Part One • An Introduction to Economics and the Economy

FIGURE 5-5 CURRENCY APPRECIATION AND DEPRECIATION

Equals

Equals Equals

International

value of dollar

falls (dollar

depreciates)

Dollar price

of foreign

currency

rises

International

value of foreign

currency rises

(foreign

currency

appreciates)

Foreign

currency

price of

dollar falls

Suppose the dollar

price of a certain for-

eign currency rises

(as illustrated by the

upper left arrow).

That means the inter-

national value of the

dollar depreciates

(upper right arrow).

It also means that

the foreign currency

price of the dollar has

declined (lower left

arrow) and that the

international value of

the foreign currency

has appreciated

(lower right arrow).

●

A country has a comparative advantage when it

can produce a product at a lower domestic oppor-

tunity cost than can a potential trading partner.

● Specialization based on comparative advantage

increases the total output available for nations

that trade with one another.

● The foreign exchange market is the market in

which the currencies of nations are exchanged

for each other.

● An appreciation of the dollar is an increase in

the international value of the dollar relative to

the currency of some other nation; a dollar

now buys more units of that currency. A depre-

ciation of the dollar is a decrease in the inter-

national value of the dollar relative to another

currency; a dollar now buys fewer units of that

currency.

Government and Trade

protective

tariff

A tariff

designed to shield

domestic producers

of a good or service

from the competi-

tion of foreign

producers.

tion. They impede free trade by causing a rise in the prices of imported goods,

thereby shifting demand toward domestic products. An excise tax on imported

shoes, for example, would make domestically produced shoes relatively less

expensive to consumers.

● Import quotas are limits on the quantities or total value of speciﬁc items that

may be imported. Once a quota is “ﬁlled,” further imports of that product are

choked off. Import quotas are more effective than tariffs in retarding interna-

tional commerce. With a tariff, a product can go on being imported in large

quantities; with an import quota, however, all imports are prohibited once the

quota is ﬁlled.

● Non-tariff barriers (and, implicitly, non-quota barriers) include onerous licens-

ing requirements, unreasonable standards pertaining to product quality, or

simply bureaucratic red tape in customs procedures. Some nations require that

importers of foreign goods obtain licenses and then restrict the number of

licenses issued. Although many nations carefully inspect imported agricul-

tural products to prevent the introduction of potentially harmful insects, some

countries use lengthy inspections to impede imports.

● Export subsidies consist of government payments to domestic producers of

export goods. By reducing production costs, the subsidies enable producers to

charge lower prices and thus to sell more exports in world markets. Two exam-

ples: Some European governments have heavily subsidized Airbus Industries,

a European ﬁrm that produces commercial aircraft, to help Airbus to compete

against the U.S. ﬁrm Boeing. Canada, the United States, and other nations have

subsidized domestic farmers to boost the domestic food supply. Such subsidies

have lowered the market price of food, and have artiﬁcially lowered export

prices on agricultural produce.

Why Government Trade Interventions?

What accounts for the impulse to impede imports, boost exports, and create trade

surpluses through government policy when free trade is beneﬁcial to a nation? Why

would a nation want to send more output abroad for consumption there than it gains

as imported output in return? There are several reasons—some legitimate, most not.

MISUNDERSTANDING OF THE GAINS FROM TRADE

It is a commonly accepted myth that the greatest beneﬁt to be derived from inter-

national trade is greater domestic employment in the export sector. This suggests

that exports are “good” because they increase domestic employment, whereas

imports are “bad” because they deprive people of jobs at home. Actually, the true

beneﬁt created by international trade is the overall increase in output obtained

through specialization and exchange. A nation can fully employ its resources,

including labour, with or without international trade. International trade, however,

enables society to use its resources in ways that increases its total output and there-

fore its overall well-being.

A nation does not need international trade to operate on its production possibil-

ities curve. A closed (non-trading) national economy can have full employment

without international trade. However, through world trade an economy can reach

a point beyond its domestic production possibilities curve. The gain from trade is the

extra output obtained from abroad—the imports obtained for less cost than if they

were produced at home.

chapter ﬁve • canada in the global economy 115

import

quota

A limit

imposed by a

nation on the

quantity (or total

value) of a good

that may be

imported during

some period of

time.

non-tariff

barriers

All

barriers other than

protective tariffs

that nations erect

to impede interna-

tional trade.

export sub-

sidies

Govern-

ment payments to

domestic producers

to enable them to

reduce the price of

a good or service

to foreign buyers.

POLITICAL CONSIDERATIONS

While a nation as a whole gains from trade, trade may harm particular domestic

industries and particular groups of resource suppliers. In our earlier comparative-

advantage example, specialization and trade adversely affected the Canadian corn

industry and the Mexican soybean industry. Those industries might seek to preserve

their economic positions by persuading their respective governments to protect

them from imports—perhaps through tariffs or import quotas.

Those who directly beneﬁt from import protection are few in number but have

much at stake. Thus, they have a strong incentive to pursue political activity to

achieve their aims. However, the overall cost of tariffs and quotas typically greatly

exceed the beneﬁts. It is not uncommon to ﬁnd that it costs the public $100,000 or

more a year to protect a domestic job that pays less than half that amount. Moreover,

because these costs are buried in the price of goods and spread out over millions of

citizens, the costs born by each individual citizen is quite small. In the political

arena, the voice of the relatively few producers demand protectionism is loud and

constant, whereas the voice of those footing the bill is soft or non-existent.

Indeed, the public may be won over by the apparent plausibility (“Cut imports

and prevent domestic unemployment”) and the patriotic ring (“Buy Canadian!”) of

the protectionist arguments. The alleged beneﬁts of tariffs are immediate and clear-

cut to the public, but the adverse effects cited by economists are obscure and dis-

persed over the entire economy. When political deal-making is added in—“You

back tariffs for the apparel industry in my province, and I’ll back tariffs on the auto

industry in your province”—the outcome can be a network of protective tariffs,

import quotas, and export subsidies.

Costs to Society

Tariffs and quotas beneﬁt domestic producers of the protected products, but they

harm domestic consumers, who must pay higher than world prices for the protected

goods. They also hurt domestic ﬁrms that use the protected goods as inputs in their

production processes. For example, a tariff on imported steel would boost the price

of steel girders, thus hurting ﬁrms that construct large buildings. Also, tariffs and

quotas reduce competition in the protected industries. With less competition from

foreign producers, domestic ﬁrms may be slow to design and implement cost-

saving production methods and introduce new or improved products.

When one nation enacts barriers against imports, the nations whose exports

suffer may retaliate with trade barriers of their own. In such a trade war, escalating

tariffs choke world trade and reduce everyone’s economic well-being. Economic

historians generally agree that high tariffs were a contributing cause of the Great

Depression. Aware of that fact, nations have worked to lower tariffs worldwide.

Their pursuit of free trade has been added by powerful domestic interest groups:

Exporters of goods and services, importers of foreign components used in “domes-

tic” products, and domestic sellers of imported products all strongly support

lower tariffs.

Figure 5-6 makes clear that while Canada has been a high-tariff nation over much

of its history, Canadian tariffs have declined during the past half-century.

116 Part One • An Introduction to Economics and the Economy

Multilateral Trade Agreements

and Free-Trade Zones

Reciprocal Trade Agreements

The speciﬁc tariff reductions negotiated between Canada and any particular nation

were generalized through most-favoured-nation clauses, which often accompany

reciprocal trade agreements. These clauses stipulate that any subsequently reduced

Canadian tariffs, resulting from negotiation with any other nation, would apply

equally to any nation that signed the original agreement. So if Canada negotiates a

reduction in tariffs on wristwatches with, say, France, the lower Canadian tariff on

imported French watches also applies to the imports of the other nations having

most-favoured-nation status, say, Japan and Switzerland. This way, the reductions

in Canadian tariffs automatically applies to many nations.

General Agreement on Tariffs and Trade (GATT)

In 1947, 23 nations, including Canada, signed the General Agreement on Tariffs and

Trade (GATT). GATT was based on three principles: (1) equal, non-discriminatory

trade treatment for all member nations; (2) the reduction of tariffs by multilateral

negotiation; and (3) the elimination of import quotas. Basically, GATT provided a

forum for the negotiation of reduced trade barriers on a multilateral basis among

nations.

Since World War II, member nations have completed eight “rounds” of GATT

negotiations to reduce trade barriers. The eighth and last “round” of negotiations

began in Uruguay in 1986. After seven years of wrangling, in 1993 the 128 member

nations reached a new agreement. The Uruguay Round agreement took effect on Jan-

uary 1, 1995, and its provisions are to be phased in through 2005.

Under this agreement, tariffs on thousands of products have been eliminated or

reduced, with overall tariffs eventually dropping by 33 percent. The agreement also

liberalized government rules that in the past impeded the global market for such

services as advertising, legal services, tourist services, and ﬁnancial services. Quo-

tas on imported textiles and apparel were phased out and replaced with tariffs.

chapter ﬁve • canada in the global economy 117

FIGURE 5-6 CANADIAN TARIFF RATES, 1930–2000

Year

Import duty (percentage of total imports)

1930 40 50 60 70 80 90 2000

GATT (1947)

Kennedy Round

of GATT (1967)

Tokyo Round

of GATT (1979)

Uruguay

Round

of GATT

(1993)

Historically, Canadian

tariff rates have ﬂuc-

tuated. But beginning

with the mid-1930s,

the trend has been

downward. (Source:

Adapted from Statis-

tics Canada, “Histori-

cal Statistics of

Canada,” Catalogue

No. 11-516, and Stat-

can: CANSIM Disc,

March 2000.)

most-

favoured-

nation

clause

agreement by

Canada to allow

some other nation’s

exports into Canada

at the lowest tariff

levied by Canada.

general

agreement

on tariffs

and trade

(gatt)

The inter-

national agreement

reached in 1947 in

which 23 nations

agreed to give

equal and non-

discriminatory

treatment to the

other nations, to

reduce tariff rates

by multinational

negotiations, and

to eliminate export

quotas.

Other provisions reduced agricultural subsidies paid to farmers and protected intel-

lectual property (patents, trademarks, copyrights) against piracy.

When fully implemented, the Uruguay Round agreement will boost the world’s

GDP by an estimated $6 trillion, or 8 percent. Consumers in Canada will save more

than $3 billion annually.

World Trade Organization (WTO)

The Uruguay Round agreement established the World Trade Organization (WTO)

as GATT’s successor. Some 135 nations belong to the WTO, with China being the last

entrant. The WTO oversees trade agreements reached by the member nations and

rules on trade disputes among them. It also provides forums for further rounds of

trade negotiations.

GATT and the WTO have been positive forces in the trend toward liberalized

world trade. The trade rules agreed upon by the member nations provide a strong

and necessary bulwark against the protectionism called for by the special-interest

groups in the various nations.

For that reason and others, the WTO is highly controversial. Critics are concerned

that rules crafted to expand international trade and investment enable ﬁrms to cir-

cumvent national laws that protect workers and the environment. What good are

minimum-wage laws, worker safety laws, collective bargaining rights, and envi-

ronmental laws, if ﬁrms can easily shift their production to nations that have weaker

laws or consumers can buy goods produced in those countries?

Proponents of the WTO respond that labour and environmental protections

should be pursued directly in nations that have low standards and via international

organizations other than the WTO. These issues should not be linked to the process

of trade liberalization, which confers widespread economic beneﬁts across nations.

Moreover, say proponents of the WTO, many environmental and labour concerns

are greatly overblown. Most world trade is among advanced industrial countries,

not between them and countries that have lower environmental and labour stan-

dards. Moreover, the free ﬂow of goods and resources raises output and income in

the developing nations. Historically, such increases in living standards have engen-

dered stronger, not weaker, protections for the environment and for workers.

The European Union (EU)

Countries have also sought to reduce tariffs by creating regional free-trade zones—

also called trade blocs. The most dramatic example is the European Union (EU), for-

merly called the European Economic Community. Initiated as the Common Market

in 1958, the EU now comprises 15 Western European nations—France, Germany,

Italy, Belgium, the Netherlands, Luxembourg, Denmark, Ireland, the United King-

dom, Greece, Spain, Portugal, Austria, Finland, and Sweden.

THE EU TRADE BLOC

The EU has abolished tariffs and import quotas on nearly all products traded

among the participating nations and established a common system of tariffs appli-

cable to all goods received from nations outside the EU. It has also liberalized the

movement of capital and labour within the EU and has created common policies in

other economic matters of joint concern, such as agriculture, transportation, and

business practices. The EU is now a strong trade bloc: a group of countries having

common identity, economic interests, and trade rules.

118 Part One • An Introduction to Economics and the Economy

world trade

organiza-

tion (wto)

An organization

established in 1994,

replacing GATT, to

oversee the provi-

sions of the Uruguay

Round and resolve

any disputes stem-

ming from it.

european

union (eu)

An association of

European nations

that has eliminated

tariffs among them,

established com-

mon tariffs for

goods imported

from outside the

member nations,

and allowed the

free movement of

labour and capital

among them.

trade bloc

A group of nations

that lower or

abolish trade barri-

ers among mem-

bers. Examples

include the Euro-

pean Union and the

nations of the North

American Free

Trade Agreement.

www.wto.org

World Trade

Organization