Globalization: Trade Creation and Trade Diversion

This document provides detailed notes on the concepts of trade creation and trade diversion, key aspects of globalization for Cambridge A-Level Economics (9708).

What is Globalization?

Globalization refers to the increasing interconnectedness and interdependence of countries through the flow of goods, services, capital, information, and people. It is driven by factors such as technological advancements, reduced trade barriers, and the growth of multinational corporations.

Trade Creation

Definition

Trade creation occurs when a country specializes in the production of goods and services in which it has a comparative advantage and exports these goods. This leads to increased trade volume and economic efficiency for both the exporting and importing countries.

Explanation

When a country specializes in producing goods it is good at (comparative advantage), it can produce those goods at a lower opportunity cost than other countries. This makes its exports more competitive, leading to increased demand and trade. Importing countries benefit from access to goods at lower prices.

Example

Consider Country A, which has a comparative advantage in producing wheat. If it specializes in wheat production and exports it to Country B, both countries benefit. Country A gains from increased export revenue, and Country B gains from access to a cheaper supply of wheat.

Diagram

Factors Contributing to Trade Creation

• Comparative Advantage: A country's ability to produce a good or service at a lower opportunity cost.
• Specialization: Focusing production on goods where a country has a comparative advantage.
• Reduced Trade Barriers: Lower tariffs, quotas, and other trade restrictions.
• Technological Advancements: Improvements in transportation and communication reduce the cost of trade.

Trade Diversion

Definition

Trade diversion occurs when a country switches from importing a good from a more efficient producer (often a trading partner) to a less efficient producer within a trading bloc or due to protectionist measures. This can lead to a loss of economic efficiency.

Explanation

Trade diversion happens when protectionist policies (like tariffs) are used to favor domestic producers over foreign producers. Even if a domestic producer is less efficient than a foreign producer, the protectionist policy forces the country to buy from the domestic producer. This results in higher prices and less efficient allocation of resources.

Example

Suppose Country A and Country B trade wheat. Country A has a comparative advantage in wheat production. However, Country C imposes a tariff on wheat imports from Country A to protect its own domestic wheat farmers. Country C then imports wheat from Country D, which is less efficient. This is trade diversion.

Diagram

Factors Contributing to Trade Diversion

• Protectionist Policies: Tariffs, quotas, and other measures that favor domestic producers.
• Formation of Trade Blocs: Joining a trade bloc can lead to trade diversion if the bloc's members are not all equally efficient producers.
• Political Pressure: Lobbying by domestic industries to protect them from foreign competition.

Key Differences Summarized

Feature	Trade Creation	Trade Diversion
Definition	Increased trade volume and efficiency	Shift from efficient to less efficient producers
Impact on Consumers	Lower prices, wider variety of goods	Higher prices, limited variety
Impact on Producers	Increased export opportunities, higher profits	Reduced export opportunities, lower profits for some
Overall Economic Efficiency	Increases economic efficiency	Decreases economic efficiency

Conclusion

Understanding trade creation and trade diversion is crucial for analyzing the effects of globalization. While globalization can lead to significant economic benefits through trade creation, protectionist policies can result in trade diversion, which reduces economic efficiency. The overall impact of globalization depends on the balance between these two forces.