The Big Ideas of Trade

Trade makes people better off, but how? In this video we discuss the importance of specialization and division of knowledge. Specialization leads to improvements in knowledge, which then lead to improvements in productivity. For instance, physicians who specialize are able to learn more about one specific area in medicine, and we benefit from better health care because of this.
What does specialization have to do with trade? What can we learn from Star Trek about the division of knowledge? Is globalization a good thing? We’ll answer these questions and others in this introductory video on the big ideas of trade.
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- [Tyler] In this section
of the course,

we're going to tackle trade,
one of my favorite topics

in economics and
one of the most fundamental parts

of economics.

First, we'll cover
the big ideas of trade.

Why do we trade?
What are the advantages of trade?

And what is comparative advantage?

Later in this section, we'll dive
into the micro-economics of trade.

How do we analyze trade
using supply and demand,

our usual tools?

Right now, we're going to look

at some of the big reasons
for trade.

Let's focus
on three benefits of trade.

First, trade makes people
better off

when their preferences differ.

Second, trade increases
productivity through specialization

and the division of knowledge.

Third, trade increases productivity
through specialization

according to comparative advantage.

We'll cover the first two
of these in this talk

and comparative advantage
in subsequent videos.

The first point, that trade
can make people better off

when preferences differ,

is simple and intuitive,
but still deep and fundamental.

Take a look at a company like eBay.

eBay is remarkable in that it took
low-valued goods

and transformed them
into higher valued goods,

simply by a better matching
of buyers and sellers.

Almost out of nothing,
eBay created value.

So, by taking goods which a seller
may regard as junk,

and have sitting around the attic,
and then by finding a buyer

who wants those goods
and transferring those goods

to that same buyer,
well that makes both the buyer

and the seller better off.

Again, we're transferring goods
from people who value them

a low amount, to people
who value them highly,

thereby, creating a net gain.

Both the buyer and the seller
are made better off.

The first point says that trade
allows us to get the most value

out of the goods
that we already have.

But the second point
is even more important

because it says that with trade,
we can create entirely new goods,

goods that without trade
would simply be impossible.

The idea here
is that specialization

leads to improvements
and increases in knowledge,

and that boosts productivity.

Think, for example,
about physicians.

Physicians specialize.

There's a specialist in the ear,
nose, and throat,

a specialist in heart-disease,
a specialist in breast cancer,

and so on.

If each one of these physicians
had to learn everything

that the other physicians know,
their total combined knowledge

would be much less.

By specializing,
each physician learns more,

and the total combination
of knowledge is much higher.

We get much better health care
by having these specialists.

In the same way,
if I were to try to grow

my own food
and tailor my own clothes

and have to make my own shoes,
I'd be starving, ill clothed,

and I wouldn't have
very good shoes.

I'd certainly wouldn't know
much about economics.

It simply is not possible
for one person

to know everything.

It's not even possible
for one person to know everything

about a single topic.

Specialization, however,
enables the combined knowledge

of a whole group of people,
to be much larger

than the knowledge
in any one brain.

Without trade,
specialization is impossible.

I couldn't specialize
in being an economist

if I didn't know that I could sell
the services of being an economist,

being a teacher of economics,
and in return for my salary,

buy food, clothing and shoes.

Again, it's trade which allows
this specialization to proceed.

Consider this picture
of farmers in Vietnam,

where 60% of the labor force
still works in agriculture.

These farmers, actually,
they know a lot about farming.

The problem is that the knowledge
in each one of the heads

of these farmers is very often
about the same as the knowledge

in the heads of the other farmers.

Now, one of the reasons
that developing economies are poor,

is that they are less specialized.

So, they are mobilizing
a smaller amount

of total combined knowledge.

That means, brain power
in those economies

is not being used
to its fullest extent.

Compare that to a more developed
economy where specialization

is much higher.

That means, the total amount
of combined knowledge

in the more developed economy,
is again higher.

So by specializing,
people become more productive

and they can learn more
and grow and produce more yet.

There's an episode
of the classic TV show "Star Trek",

where the space aliens
kidnap Mr. Spock,

to transplant his brain
and use it in the computer

to run their economy.

Now, that's terrible economics.

Even Vulcan brains are limited
and there's simply so much to know

about an economy.

It makes much more sense
to divide knowledge

across many brains
and then to have trade.

This division of tasks,
specialization, where each person

knows something different,
the combined brain power

of society is huge,
and it's much more

than could be fit
into a single brain,

even into Mr. Spock's brain.

So again, it's much, much better
to use all of the brains

in the society,
to divide knowledge up,

to specialize and then to trade.

The only reason that people
will specialize in this way,

is that they know they can trade
the results of their knowledge

for other goods.

I'm able to specialize
in teaching economics

and in learning about economics
and have to teach it.

Because I know, I can trade
my lessons for a salary

in turn to obtain food,
obtain shoes, and obtain clothes.

That specialization
is made possible by trade.

This is one reason
why globalization has benefits.

Globalization means
that the world as a whole

can become more specialized
and therefore,

our world knowledge increases.

We get more scientists
and engineers, for example,

and those scientists
and engineers know more.

Adam Smith,
the father of economics,

even made a fascinating argument
connecting trade, geography,

civilization, and growth.

Smith looked around the world,
and he noticed how often

civilization begins near sea coasts
or along big rivers.

Why is this?

Smith said it's because waterways
help make trade possible,

and that increases the division
of labor and specialization

and thus it boosts economic growth.

Smith said, quote, "As by means
of water carriage,"

by there he means ship and boat,
"a more extensive market

is opened to every sort of industry
than what land-carriage alone

can afford it,
so it is upon the sea-coast,

and along the banks
of navigable rivers,

that industry of every kind
naturally begins to subdivide

and improve," end quote.

People who live
along navigable rivers

and sea-coasts,
their markets are larger.

They have more people
to trade with,

they can trade more easily,
they can specialize more easily.

As they specialize,
they begin to learn.

Industry of every kind
naturally begins

to subdivide and improve.

Specialization increases knowledge.

This increases growth,
and it's the very foundation

of human civilization.

Next, we'll be looking
at comparative advantage,

one of the best known theories
of economics.

We'll start with a fun video
by my colleague, Don Boudreaux,

and then Alex will take you deeper
into comparative advantage

and give you some homework problems
to test yourself with.

- [Narrator] If you want
to test yourself,

click "Practice Questions,"

or if you're ready to move on,
just click "Next Video."

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