Introduction
Trade between the United States and the rest of the world has played a significant role in the growth and development of the US economy over the past years. The growth of foreign trade in the US grew much faster after the Second World War. The trade between the US and the rest of the world is vital because the US is a superpower nation.
There are a number of benefits that arise from the trade relationship between the US and the rest of the world. First, the exports and imports of goods and services results in an improvement in the standards of livings of the citizens. This comes about because exports generate revenue to the economy while imports increase the amount of commodities available for consumption.
This further leads to a reduction in the prices of goods and services. On the other hand, foreign trade has a negative impact on the economy in a number of ways. A major drawback is the risk of survival of the domestic industries. Economists argue that foreign trade results in the reduction of job opportunities and wages.
This can be attributed to the fact that an increase in import leads to a reduction in the amount of goods and services produced by local firms. On the contrary, surveys show that the imposition of restrictions on trade does not favor both consumers and the producers (McTeer 1).
Background
Economic globalization
The contemporary economies of the world are characterized by economic globalization. These economies experience a rapid growth of foreign trade and cross border investments. This has resulted in a transfer of international labor across various states and a change in the industrial structure of the economies. There are certain variables that have grown significantly due to economic globalization.
To start with, studies show that there is rapid growth of foreign trade. According to the statistics provided by the World Trade Organization’s (WTO), the volume of world trade increased by 15% to reach a value of $11.76 trillion. The increase is equivalent to a growth of world trade by 8% (McTeer 1).
Secondly, the statistics provided by the United Nations Conference on Trade and Development (UNCTAD) indicate that there is a significant growth in the volume of foreign direct investment (McTeer 1). For instance, the statistics show that the amount of international direct investment inflows amounted to $1.271 trillion. The value in the current year has grown tremendously (McTeer 1).
An increase in foreign direct investment has resulted in growth and development of several economies. Thirdly economic globalization has resulted in rapid flow of resources across the world. Rapid reorganization of factors of production has been observed in various sectors across the globe.
This can be attributed to high – end and high – tech transfer in the manufacturing sector. Further, foreign direct investment has resulted in the exchange of resources (capital mobility) and knowledge. The transfer of knowledge leads to an accumulation of knowledgeable human capital in a country (Tianzhu, Sun and Cui Riming 1).
Foreign trade policy
Various countries have come up with a number of policies to govern trade with their trading partners. Such policies have a significant effect on trade with other nations. The foreign trade and trade policy of the United States is quite contentious because the country has continued to maintain an open market policy. The international trade policy of the country has undergone various amendments (Irwin 1b).
These changes occur as the political leadership changes. Thus, it can be noted that the international trade policies depend on the political regime. For instance, during the Clinton administration significant adjustments were made to the foreign trade policy (Irwin 1b). For instance, the administration altered the traditional adherence to the free trade strategy and introduced a more practical fair trade strategy.
Further, the management concentrated on the development of international trade. They treated this expansion as a priority to the development goal of the country. Further, the administration also actively implemented strategic trade policies that resulted in an increase the competitive advantage of domestic firms both in the domestic and foreign markets.
Specifically, the government of the US came up with the new policy orientation ad strategy choice. This foreign trade policy aimed at promoting economic safety within the United States. It also enabled the country to acquire large international market. The policy was geared towards improving the economic security of the country.
In the process of participating international trade, the country needs to protect the strategic high-tech companies (Irwin 1b). This can achieved by coming up with the trade policies and tariffs that will protect the domestic industries. In addition, the country should ensure that in the process of implementing the open market and open trade policy, the quality of goods and services brought into the country is not compromised.
Thus, the quality of goods and services must be similar to the goods and services traded in the open market. This can be achieved by coming up with standards for measurement of quality. The same concept is being practiced in Japan and Germany (Irwin 1b).
The favorable trade policy in the US has resulted in tremendous growth of export of goods and services within the US. For instance, between 1992 and 1996, the value of exports increased from $736.7 billion to $1,032.4 billion. The change is equivalent to a 40% increase (McTeer 1). During the same period, the export became the key factor that contributed to the expansion of the US economy.
Even though the country has experienced a deficit in the balance of trade, that is, the value of imports often exceeded the value of exports. The tremendous increase in the volume of export has resulted in a trade surplus. This has led to the positive growth of the value of gross domestic product (GDP) of the country.
For instance, the in the first quarter of the year 2007, the value of exports was 12 percent while the value of imports was 17 percent of the GDP (McTeer 1). Thus, the resulting trade deficit was approximately 5 percent of the GDP. However, in the third quarter of the same year, the value of exports was 13 percent while the value of imports was 16 percent of the GDP (McTeer 1).
Thus, the resulting trade deficit was approximately 3 percent of the GDP. The resulting trade deficit declined by approximately 2 percent of the GDP (McTeer 1). It can be observed that there has been a continuous increase in the volume of export with a corresponding decline in the proportion of imports. This has narrowed down the gap between exports and imports (McTeer 1).
Aim of the paper
The paper seeks to analyze the impact of foreign trade in the economy of the US. Specifically, the paper will analyze the impact of foreign trade on GDP, standard of living (measured using per capita income), and other variables.
Literature review
There are a number of studies that have been carried out to analyze the impact of foreign trade on the US economy. Besides, there has been continuous debate on the trade-off between the positive and negative impact of trade on the US economy. This has called for the needs to come up with policies that create a balance between the negative and positive impact of trade.
An example of such study was carried out by Robert Krol in the year 2008 (Krol 1). In the study, “the author carried out a review of the empirical studies that evaluate the impact of foreign trade on the US economy” (Krol 3). Specifically, the author focused on the factors that cause an increase in foreign trade, the positive impact of foreign trade, the effect of foreign trade on employment and wages, and the cost of restrictions on foreign trade.
Krol reviewed the work of various scholars and came up with a number of observations (Krol 4). To start with, Krol observed that the concept of comparative advantage was a key motivator for international trade. This implies that countries still engage in trade on the basis of their comparative advantage (Krol 4). Further, Krol observed that there are a number of factors that explain the growth of foreign trade.
The study showed that the growth of income explains about sixty six percent of growth in foreign trade, trade freedom accounts for twenty five percentage of the growth of foreign trade and a decline in the transportation cost explains the rest of the expansion of foreign trade (Krol 4). Thus, it can be observed that the three factors explain the growth in foreign trade.
The study also pointed out that a change in government policies on foreign trade had a significant impact on the expansion of foreign trade. A change in any of the factors will result in a change of the volume of international trade. The research further indicated that an expansion of foreign trade has contributed to a high rate of growth in the economy. It also contributed to the growth of income in economies that are open.
The author has indicated that a unit growth of trade results in a unit growth of per capita income (Krol 4). Further, removal of trade barriers across the world will result in an increase in the growth of world income by approximately $2 trillion. Such action will result in the growth of income of the US economy by about $500 billion.
Therefore, the results of the research show that free trade between nations results in significant economic benefits. Further, Krol observed that competition that arises as a result of free trade results in lower prices of goods and services. Besides, such competitions lead to an increase in the variety of goods and services that are being offered to the consumers (Krol 4).
On the contrary, Krol observed that loss of jobs occurs in sectors of the economy that are not open to foreign trade. Statistics in the study show that foreign trade affects only fifteen percent of the work force. Further, the study shows that there is a positive correlation between an increase in imports and an increase in job creation in the US economy.
This can only be explained by the fact that a loss in jobs in the production sector of the economy is counterbalanced by gain in employment in other sectors of the economy. Therefore, it can be stated that foreign trade has lead to a decline in the growth of the manufacturing sector with a corresponding growth in other sectors of the US economy (Krol 4).
Apart from loss of jobs, Krol also established that expansion of foreign trade does not explain the wage differentials between the skilled and semi skilled. Krol established that the difference in wages between these two groups is explained by technological differences and not trade (Krol 4).
Finally, Krol observed that the free trade is beneficial to the economy. The economic benefits (both measurable and non-measurable) exceed the wages paid to workers (Krol 4).
A separate research was carried out by James Jackson in the year 2013 (Jackson 6b). In the study, Jackson used the computable general equilibrium model that integrates data on foreign trade and other economic variables for about 100 countries. He also made use of the Michigan Model and Estimates as an extension of the computable general equilibrium model in his study (Jackson 16b).
The study was based on cross sectional secondary data. Jackson observed that foreign trade enables countries to use their resource endowment more proficiently. This enables them to maximize the variety of goods and services they provide to their citizens thus increasing their standard of living (Jackson 11b). The author further stated that the economies of the world engage in trade with an aim of maximizing their national interest.
Jackson further pointed out that nations engage in trade on the basis of comparative advantage. The author stated that individuals within a nation will tend to focus on areas they have strong skills. Based on this, the citizens will focus on the production of goods and services in the areas they have comparative advantage and exchange with countries that produces other goods and services (Jackson 14b).
This creates the concept of exports and imports in international trade. In the paper, Jackson stated that foreign trade alone does not account for the economic expansion or contraction of key variables in the economy such as income level, output level, wage rate, and distribution of income because exports accounted for only about 14 percent (in the year 2012) of the GDP of the country (Jackson 11b).
However, the author stated that from the production point of view, foreign trade leads to movement of both labor and capital from productive sectors of the economy to less productive sectors. This strengthens specialization and improves efficiency in the economy.
The research conducted by Jackson further reveals that the movement of capital and labor from one sector of the economy to the other results in an adjustment of costs and improvement of efficiency. Further, research conducted by Jackson showed that foreign trade results in consumption gains for the citizens in the form of increase in the variety of goods and services, improved quality and a decline in prices.
The research also pointed out that engagement in trade results in economic growth of a country. This can be observed when the impact is measured over a long period of time. The economic growth is strengthened by trade liberalization. Jackson had the same findings in the earlier research paper that was published in the year 2008 (Jackson 27a).
Another research was conducted by Oscar Afonso in the year 2001 (Afonso 1). In the paper, the author attempted to explain the economic theories that explain the impact of international trade on economic growth. In the study, Afonso focused on “the impact of international trade (from a commercial and technological aspect) on physical accumulation and quality of productive factors” (Afonso 1).
The author observed that during the classical period, international trade had a positive impact on economic growth. The research further shows that during the neoclassical period, foreign trade did not have an impact on the economic growth of the nations that were being analyzed.
This situation was experienced until the 1960’s (Afonso 27). Further, the author stated that the recent theories have explained better the positive relationship between foreign trade and economic growth. Afonso also pointed out that there is significant empirical evidence to show that trade liberalization tends to impact positively on economic growth.
The author pointed that in developed economies, trade liberalization increases the domestic rates of innovation (Afonso 27). Finally, Afonso pointed out that the effect of foreign trade varies depending on the level of growth and development of the trade partners, the level of technological development, and level of human capital development (Afonso 27).
Thus, the author stated that countries cannot achieve equal results from foreign trade (Afonso 27). Based on the literature review above, it is evident that engagement in foreign trade generates positive results on an economy. Thus, data for the US economy will be collected to verify the above findings
Methodology and Data
Data collection
A comprehensive internet research will be carried out as part of secondary research on the available data about the impacts of foreign trade on the economy of the US. The data will comprise of GDP per capita, population growth rate, capital formation, investment, import, exports, and foreign direct investment (US Department of Commerce 1). These are proxies that will be used to estimate the Cobb-Douglas production function.
The weakness in this data is that the proxies might not give a true representation of variables being measured. Specifically, the data will be retrieved from the US Bureau of Commerce website (US Department of Commerce 1). The source is reliable because it is updated by the US Department of Commerce on a periodic basis. The data will cover a period of 33 years, that is, between 1980 and 2012.
Scope of the methodology
The scope of the methodology is a systematic and a comprehensive method of data collection, grouping, and analysis in order to scientifically apply reasoning from the analyzed data. As a matter of fact, the result of this process combines outcome and the purpose of the research.
As stated by Kothari (2004), a blueprint is transformed into a research design through a series of operational study aimed at drawing a factual outcome comprising of evidence backed claims. The chapter focuses on research design, data collection methods, data processing and analysis.
According to Kothari (2004), research design resonates on the facets of research project blueprint that comprise of study of operations to create an efficient outcome that yield the desired information at minimal cost (Kothari 10).
In order to achieve the desired outcome, a quality research should assimilate systematic investigation characterized by the phenomenon approach of a scenario through statistical and mathematical computations (Kothari 10).
Quantitative research in Secondary data
This study will use a systematic quantitative research method in collecting data. Reflectively, non-experimental quantitative research design determines existing or perceived relationship between dependent and independent variables of any given study population (Mugenda and Mugenda 23). In collective quantitative data, past survey instruments will be employed across the study.
The study opts for quantitative data collection method since it is economical on time, finance, and energy unlike qualitative method which may not be economical especially when the sample size is put into the picture. However, this method limits natural expression of ideas and attitude towards the study and objective especially in responding to questions asked or reflecting on a secondary thought (US Department of Commerce 1).
The researcher will carry out comprehensive internet research as part of secondary research on the available data about the impacts of foreign trade on the economy of the US. The data will comprise of GDP per capita, population growth rate, capital formation, investment, import, exports, and foreign direct investment. The data will be analyzed at all levels to present a comprehensive result.
Reflectively, the context of secondary data will depend on online research on present, past, and projected future data on the state of foreign trade in the US. Holistic inquiry requires a method for choosing among models that is congruent with holistic philosophy. A comprehensive approach to model design and interpretation will provide a general holistic framework to guide the study.
To analyze the data, comparisons with previous studies will be conducted. A summary of the articles and journals will be used to model the solution to the problem. In the analysis phase, the paper examines the impact of foreign trade on the economy of the US as identified in the literature (US Department of Commerce 1).
Hypothesis
The null hypothesis (Ho): Foreign trade does not have an impact on the US economy
Alternative hypothesis (H1): Foreign trade has an impact on the US economy
Variable models
Regression analysis is a statistical tool that is used to develop and approximate linear relationships among various variables. When coming up with the model, it is necessary to separate between dependent and independent variables.
GDP per capita
The dependent variable in this analysis is the GDP per capita. This will be used as a proxy for the output level in the Cobb-Douglas production function. It represents Y in the regression model.
Population growth
The first explanatory variable that will be used in the analysis is the population growth rate. Economic theory suggests that there is negative relationship between population growth rate and GDP per capita.
Physical capital stock
The second explanatory variable is investment in physical capital stock. In the analysis, capital formation and investment expressed as the percentage of GDP is used as proxies for investment in capital stock. Economic theory suggests that there is positive relationship between investment and physical stock and GDP per capita income.
Trade
The third explanatory variable in the regression analysis is trade. In this analysis, trade is measured using the ratio of the sum of total exports and total imports divided by the amount of GDP. The literature review above suggests that there is positive relationship between international trade and improvement of standards of living (measured using the GDP per capita).
Knowledge
The final variable is knowledge. The value of foreign direct investment is used as a proxy for knowledge transfer. Economic theory suggests that there is positive relationship between between knowledge transfer and per capita income.
Model specification
To estimate the impact of international trade on the US economy, the Cobb-Douglas production function is used. The production function takes the form Y = Kα * (A * L) β; α + β = 1. The equation can be transformed into linear form by converting the variables into logarithmic form. When using the ordinary least squares method, the regression line takes the form
The regression equation can be simplified to take the form Y = b0 + b1X1 + b2X2 + b3X3 + b4X4. Thus, from the variables discussed above, the regression line takes the form presented below.
YGDP per capita = b0 + b1X (pop + 5)+ b2Xinvest+ b3Xcapital + b4Xtrade + b5Xknow.
Analysis and findings
Correlation analysis
Correlation coefficient measures the degree of association between two variables. The table in appendix 1 gives a summary of the correlation analysis. The results of correlation coefficient indicate that there is a weak negative relationship between the GDP per capita, and population growth rate (35.02%) and investment (42.65%).
Also, indicates that there is a positive negative relationship between the GDP per capita and trade (43.34%). On the other hand, there is a strong negative relationship between GDP per capital and capital (65.36%). Finally, there is a strong positive relationship between GDP per capita and knowledge (84.25%) (US Department of Commerce 1).
Regression results
The results of the coefficient of regression analysis are presented in appendix 2. From the regression results, the regression equation can be written as shown below.
YGDP per capita = 4.4771 + 0.1995X (pop )– 0.7927Xinvest+ 0.2721Xcapital – 0.0356Xtrade + 0.1576Xknow.
The negative coefficients on investment and trade imply that a unit change in the value of each variable result in a decline in the value of GDP per capita. The positive coefficients on population, investment and knowledge imply that a unit change in the value of the each variable result in an increase in the value of GDP per capita.
Evaluation of the model
A t – test is used to evaluate the statistical significance of the explanatory variables. A two tailed t- test is carried out at 5% significance level.
Null hypothesis: Ho: bi = 0
Alternative hypothesis: H1: bi ≠ 0
The null hypothesis implies that the variables are not significant determinants of GDP per capita. The alternative hypothesis implies that variables are significant determinants of GDP per capita. The results of t – test are presented in appendix 3.
From the results of the t – test, it can be observed that population growth rate, capital and knowledge are the only significant determinants of GDP per capita. However, trade and investment are not significant determinants of GDP per capita at the 5% level of significance.
F–test of the regression models
The overall significance of the regression model can be evaluated using an F-test. The test is carried out 5% significance level.
Null hypothesis H0: β0 = β1
Alternative hypothesis H1: βj ≠ 0, for at least one value of j
The null hypothesis implies that the overall regression line is not significant. The alternative hypothesis implies that overall regression line is significant. The value of F-calculated is 44.95 while the value of F-tabulated is 2.0495. Thus, the null hypothesis is rejected. This implies that the overall linear regression line is significant and can be used in further analysis and predictions.
How the results support the competing hypothesis
The discussion above shows that there are a number of variables that significantly determine GDP per capita. Also, the discussion shows that the overall regression line is significant. Further, the value of R-square is 89.28%.
This implies the explanatory variables explain 89.28% of the variations in the dependent variable. It is an indication of a strong variable. Therefore, the null hypothesis will be rejected and conclude that foreign trade has an impact on the US economy.
Conclusions
The paper carried out an analysis of the impact of foreign trade on the economy of the US. The Cobb-Douglas production function was used to evaluate the impact of foreign trade on GDP per capita. Various variables were used as proxies for foreign trade.
The study shows that indeed foreign trade has an impact on the economy of the US. Specifically, foreign trade has a positive impact on efficiency, accumulation of physical capital stock, and knowledge transfer. The results are consistent with the observations in the literature review section.
Works Cited
Afonso, Oscar 2001, The Impact of International Trade on Economic Growth. PDF. 06 Nov. 2013.
Irwin, Douglas 2006, Historical Aspects of US Trade Policy. Web.
Jackson, James 2008a, Trade Agreements: Impact on The US Economy. PDF. 06 Nov. 2013.
Jackson, James 2013b, Trade Agreements: Impact on The US Economy. PDF. 06 Nov. 2013.
Kothari, Jaipur. Research Methodology: Methods and Techniques, New Delhi: New Age International (P) Limited Publishers, 2004. Print.
Krol, Robert 2008, Trade, Protectionism ad the US Economy. PDF. 06 Nov. 2013.
McTeer, Bob 2008, The Impact of Foreign Trade on the Economy. PDF. 06 Nov. 2013.
Mugenda, Olive, and A. Mugenda. Research Methods: Quantitative and Qualitative Approaches, Nairobi: Acts Press, 2003. Print.
Tianzhu, Sun and Cui Riming. “Exploration on U.S Foreign Trade Deficit Promote Economic Growth.” China Academic Journal Press, (2007): 1003-6547.
US Department of Commerce 2013, US Economic Accounts. Web. 06 Nov. 2013.