Globalization and the benefits of trade

THE FEDERAL RESERVE BANK           MARCH 2007

OF CHICAGO

Chicago Fed Letter

Globalization and the benefits of trade

by Robert L. Thompson, Gardner Chair in Agricultural Policy, University of Illinois at Urbana-Champaign, and
visiting scholar, Federal Reserve Bank of Chicago

Globalization involves increasing integration of economies around the world, from the
national to the most local levels, thereby promoting international trade in goods and
services and cross-border movement of information, technology, people, and investments.
This article examines the benefits and costs to the U.S. and other countries.

Since the conclusion of World War II
in 1945, international trade has been
greatly facilitated by agreement among
trading countries on a set of rules for in-
ternational trade, known as the General
Agreement on Tariffs and Trade (GATT).
These rules were developed through a
series of eight “rounds” of international
trade negotiations between 1947 and
1994. Through these negotiations, ex-
port subsidies were banned on every-
thing but agricultural products, and
import tariffs on manufactured goods
were reduced to inconsequential lev-
els. As a result, trade in manufactured
goods has grown rapidly, achieving an
unprecedented level of specialization
and exchange among countries.

Developments in ocean shipping have
also facilitated the latest wave of global-
ization, e.g., larger and faster vessels and
containerization of their cargoes. These
developments, combined with state-of-
the-art logistics, have significantly lowered
the cost of international transactions.
Multinational firms now engage in just-
in-time sourcing through global supply
chains. Deregulation and increasing
competition have further reduced costs
of international transportation and tele-
communications. Overbuilding of fiber
optics capacity among countries during
the dot-com boom in the 1990s also con-
tributed to today’s historically low prices
of international telecommunications.

At the end of World War II, most coun-
tries imposed barriers to free movement
of capital across their international bor-
ders. These barriers have been largely
eliminated among high-income coun-
tries and have been significantly low-
ered in middle-income countries, too.
Billions of dollars of funds can move in-
stantaneously among countries at the
touch of a computer key.

Why trade?

Why do countries engage in internation-
al trade anyway? The U.S., for instance,
engages in such trade to obtain goods
and services that some other countries
can produce at relatively lower cost than
it can in exchange for goods and ser-
vices that the U.S. can produce at lower
cost than the other countries can. If
everything cost the same to make in
every country, there would be no basis
for international trade.

When a country engages in interna-
tional trade, its households’ real pur-
chasing power rises. Their incomes
stretch further because they can obtain
at lower cost the goods and services
they have been buying. The country as
a whole benefits, too. When a country
engages in international trade, it can
produce more gross domestic product
(GDP) from its land, labor, and capital
because it is not using them to produce
things that other countries can produce

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