Nova workboard

a blog from young economists at Nova SBE

Buying Cheap

Over the last years, we became used to “buy cheap”. Worse, we became used to think that buying cheap was an amazing progress of industry. And it would be, maybe, if we lived in a world where Central Bank emitted money every time a firm opened. Otherwise, how could firms still increasing their output and selling almost everything?

Let us firstly understand where these cheap products came from. When countries with cheap labor started to join the World Trade Organization, many companies decided to transfer their production departments in order to get a cheaper production and then higher profits. That was the original idea. Nevertheless, when a company transfers its department to somewhere else, it spreads information about its know-how. So, they were teaching others how to produce their products. Thus, when these countries with cheap labor such as China or Taiwan started to know how to manufacture, they started to make their own companies copying the model of other brands.

With the increase of competition, prices went even lower and were set more closely to the international price. Hence consumers were better off because they had their opportunities of consumption increased.

But, what about the other companies all around the world? Was this good to the supply side too? Unfortunately we cannot say it was. Many countries have seen their companies going bankrupt and unemployment have increased a lot in manufacturing industries. We can see this in the USA case: today USA has a trade deficit with China that represents almost one quarter of the total trade balance. This is the results of importing too much or exporting to little. Between 1990 and 2000, China exportations to the USA increased 880% and USA exportations to China increased almost 230%. We can see the difference. This was exactly the problem, as China started to rise in international trade becoming specialist in what other countries used to be, the world faced an disequilibrium because the other countries have not reallocate resources.

David Ricardo, a classical economist, in his principle of comparative advantage explained how trade can benefit all parties such as individuals, companies, and countries involved in it, as long as good as are produced with different relative costs. So, we can have gains from international trade as long as we became specialised in product in which we have comparative advantages. Thus, if another country appears in the scenario and It can produce in a more competitive way, we have to reallocate our resources in order to produce the thing where we are competitive. This is what countries should have done. Otherwise unemployment would rise. And it did. For example,in Portugal. From 1988 to 2006, manufacturing industries, mainly textile and footwear industries, left 250 000 unemployed people.

Besides, reallocation is a very costly process and cannot be done overnight. It has many difficulties. For example, sometimes, people work in a sector all their lives and they cannot do anything else, ei, they are specialised in that job. Finding a new one in such conditions is much more difficult. We could think that people that can not get a job in one place just go to another but people rarely change place (Peter Huber, 2004)

What I mean is that countries have to find other ways to survive, they have to innovate or this will happen every time an under developed country becomes a developing country. Portugal could have become specialised in producing cotton or wool because China needs these commodities to produce textile. And USA could have specialised in producing machinery that is also necessary for that type of industry.

Notice that last years we have been assisting to a change in textile industries in most developed countries: they change their target. They now produce high quality products in order to reach people with higher power purchase, i.e., success through differentiation. One can see that this have been happening in Portugal and nowadays there are lot of companies that have committed to vertical differentiation producing products with much higher quality. Even when this type of trade could not survive with just Portuguese consumers, most of these companies have a website where consumers all around the world can choose and import products.

 

Maria João Sá de Azevedo #639

    

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Author: studentnovasbe

Master student in Nova Sbe

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