1. Why do countries trade? Economic theory states that trade occurs because it is mutually enriching . It is asserted that it has a positive economic effect like that caused by technological change, whereby economic efficiency is increased, allowing greater output from the same amount of scarce productive resources. By allowing each participant to specialize in producing what it is relatively more efficient at and trading for what it is relatively less efficient at, trade (according to economic theory) can increase economic well-being above what would be possible without trade. The benefit of trade is attached to the product received (the import), not in the product given (the export). Hence, countries export in order to pay for imports. There is a broad consensus among economists that trade expansion has a favorable effect on overall economic well-being, but the gains will not necessarily be distributed equitably. Although most economists hold that the benefits to the overall economy exceed the costs incurred by workers who lose their jobs to increased trade, others argue that the benefits are often overestimated and the costs are often underestimated. Some goods that are imported into the United States, such as bananas, cannot be produced economically in sufficient quantities to satisfy domestic demand. Many other products (including intermediate goods) and services are imported because they can be produced less expensively or more efficiently by firms in other countries. Many imports into the United States contain U.S.-made components (such as semiconductors inside a computer) or U.S.-grown raw materials (such as cotton used to make t-shirts). Consumers can benefit through access to a wider variety of goods at lower costs. This raises consumer welfare (i.e., consumers have more money to spend on other goods and services) and helps control the rate of U.S. inflation. Producers can benefit through access to lower priced components or inputs that can be utilized in the production process. Longer term, import competition can also pressure companies to reduce costs through innovation, research, and development, leading to growth in economic output and productivity. 2. What is comparative advantage? The idea of comparative advantage was developed by David Ricardo early in the 19 th century and its insight remains relevant today. Ricardo argued that specialization and trade are mutually beneficial even if a country finds that it is more efficient at producing everything than its trading partners. If one country produces a given good at a lower resource cost than another country, it has an absolute advantage in its production. (The other country has an absolute disadvantage in its production.) If all productive resources were highly mobile between countries, absolute advantage would be the criterion governing what a country produces and the pattern of any trade between countries. But Ricardo demonstrated that because resources, particularly labor and the skills and knowledge it embodies, are highly immobile, a comparison of a good's absolute cost of production in each country is not relevant for determining whether specialization and trade should occur. Rather, the critical comparison within each country is the opportunity cost of producing any good— how much output of good Y must be forgone to produce one more unit of good X . If the opportunity costs of producing X and Y are different in each economy, then each country has a comparative advantage in the production of one of the goods. In this circumstance, Ricardo predicts that each country can realize gains from trade by specializing in producing what it does relatively well and in which it has a comparative advantage and trading for what it does relatively less well and in which it has a comparative disadvantage. 3. What determines comparative advantage? Most often, differences in comparative advantage between countries occur because of differences in the relative abundance of the factors of production: land, labor, physical capital (plant and equipment), human capital (skills and knowledge including entrepreneurial talent), and technology. Standard economic theory predicts that comparative advantage will be in activities that make intensive use of the country's relatively abundant factor(s) of production. For example, the United States has a relative abundance of high-skilled labor and a relative scarcity of low-skilled labor. Therefore, the United States' comparative advantage will be in goods produced using high-skilled labor intensively, such as aircraft, and comparative disadvantage will be in goods produced using low-skilled labor intensively, such as apparel. In addition to differences in factor endowments, differences in productive technology among countries create differences in relative efficiency and may be a basis for comparative advantage. Nevertheless, some high-skilled services jobs, such as computer programming and graphic design, can today be easily done in a country such as India because of the revolution in telecommunications. 4. Can governments shape or distort comparative advantage? Government actions to influence comparative advantage can be grouped in two broad categories: policies that indirectly nurture comparative advantage, most often by compensating for some form of market failure, but not targeted at any specific industry or activity; and policies that aim to directly create and nurture comparative advantage in particular industries. Indirect influence on comparative advantage can emanate from government policies that eliminate corruption, enforce property rights, remove unnecessary impediments to domestic market transactions, liberalize trade and foreign investment barriers, assure macroeconomic stability, build transport and communication infrastructure, support mass education, and assist technological advance. Policies that try to exert a direct influence on comparative advantage may include policies to promote and protect certain industries (such as through subsidies or trade protection) that are thought to have significant economic potential. In this view, realizing that potential requires initial government support to help a country obtain its economic targets. Some economists contend that direct government policies may often distort a country's trade and investment flows, reduce economic efficiency, undermine more economically competitive industries that do not receive government help, and diminish potential economic growth. 5. What is the terms of trade ? A nation's terms of trade— the ratio of an index of export prices to an index of import prices—is a measure of the export cost of acquiring desired imports. Increases and decreases in its terms of trade indicate whether a nation's gains from trade are rising or falling. A sustained improvement in the terms of trade expands what a nation's income will buy on the world market and can make a significant contribution to the long-term growth of its economic welfare. When that occurs, a nation's economy as a whole is often said to have become more globally competitive. Similarly, a falling terms of trade raises the export cost of acquiring imports, which reduces real income and the domestic living standard. Although trade is considered a process of mutual benefit, each trading partner's share of those benefits can change over time, and movement of the terms of trade is an indicator of that changing share. 6. What are the costs of trade expansion? Like technological change and other market forces, international trade creates wealth by inducing a reallocation of the economy's scarce resources (capital and labor) into relatively more efficient industries that have a comparative advantage and away from less efficient activities that have a comparative disadvantage. This reallocation of economic resources is often characterized as a process of "creative destruction," generating a net economic gain to the overall economy, but also being disruptive and costly to workers in adversely affected industries that compete with imports. Many of these displaced workers bear significant adjustment costs and may find work only at a lower wage. Although economic analysis almost always indicates that the economy-wide gains from trade exceed the costs, the perennially tough policy issue is how or whether to secure those gains for the wider community while dealing equitably with those who are hurt by the process. Economists generally argue that facilitating the adjustment and compensating for the losses of those harmed by market forces, including trade, is economically less costly than policies to protect workers and industries from the negative impacts of trade. While it is debatable how well existing worker assistance policies have worked, funding is also a long-standing issue. A 2008 study by the Peterson Institute for International Economics, for example, estimated the lifetime costs of worker displacement that were triggered by expanded trade in 2003 to be as high as $54 billion, but calculated that the United States spent less than $2 billion that year to address the costs for workers connected to that displacement. 7. Does trade " destroy " jobs? Trade "creates" and "destroys" jobs in the economy just as other market forces do. Economy-wide, trade creates jobs in industries that have a growing comparative advantage and destroys jobs in industries that have a growing comparative disadvantage. In the process, the economy's composition of employment changes, but there may not be a net loss of jobs due to trade. Consider that over the course of the rapid economic expansion that occurred from 1992 to 2000, U.S. imports increased nearly 240%, but total employment grew by 22 million jobs and the unemployment rate fell from 7.5% to 4.0% (the lowest unemployment rate in more than 30 years). From 2001 to 2007 (before the global financial crisis), U.S. employment grew by 7.1 million jobs and the unemployment rate dropped from 4.7% to 4.6%, while U.S. imports over the period increased by 70.8%. From 2007 to 2010, the U.S. unemployment rate rose to 9.6% and employment fell by 7 million, but U.S. imports declined by 2.0%. In times of economic hardship, when unemployment is high, governments will sometimes try to stimulate some domestic industries by protecting them from foreign competition. However, such measures are unlikely to increase total employment and could be costly. The near-term cost can be an exacerbation of weakness in the economy as foreign governments may retaliate with their own protective measures, causing a decline in exports. In the long run, trade protection may tend to reallocate employment from unprotected domestic industries toward protected domestic industries, but not increase total employment. However, more than just a transfer of well-being between sectors occurs, as there will be a permanent cost to the whole economy arising from the less efficient allocation of these resources. 8. Does trade reduce the wages of U.S. workers?