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IR 292 FALL 2017 EXAM 2 REVIEW SHEET CHAPTER 8: ENVIRONMENTAL AND LABOR STANDARDS 

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When it comes to setting standards, be able to define the following options. What are the pros and cons of each option? (Most regional trade agreements and the WTO agreements practice a combination of the three) o Harmonization: Two or more countries share a common set of standards in an area of concern, such as product safety, labor, environment, or fair competition  Pros  Harmonization of technical standards having to do with product design or performance is useful since it leads to a larger, more unified market with greater efficiency (firms have to consider only one set of standards)  Makes a great deal of sense if it widens the market and lowers prices  Cons  Harmonization can freeze into a set of inferior standards  For labor/environmental standards it is often unclear which country has the “best” rules  Failure to account for differences between countries (the lower a country’s average income, the less administrative, scientific, and technical capacity it has to design and enforce standards)  National priorities change as income levels change, and there is no reason why the priorities of one group of countries should dominate o Mutual Recognition: Countries keep their own product and process standards, but accept the standards of others as equally valid and sufficient (ex: allowing certified physicians to practice in either country)  Pros  Helpful when countries vary significantly in income levels  Cons  Race to the Bottom: in the absence of a common set of labor and environmental standards, low standards abroad create competitive pressures for domestic firms to lower their standards or move to a foreign location in order to reduce their costs o Separate Standards: Countries keep their own standards and refuse to recognize those of anyone else (ex: prohibiting imports of vegetables grown using unsafe pesticides)  Pros  Helpful when countries vary significantly in income levels AND safety standards Pollution Havens: countries that compete by offering foreign firms a reduced set of environmental compliance requirements o It is impossible to identify any country that successfully competes for new investment on the basis of low environmental standards (there are NO pollution havens in existence) o Individual firms may still relocate to escape the environmental regulations of a high-standards country, but this is NOT a pollution haven and the overall importance of these individual decisions are uncertain What do we mean when we talk about a “Race to the Bottom” in Labor and Environmental Standards? How might this be used as a justification for imposing trade barriers? o Debate: Do low standards reflect a deliberate policy to capture markets and foreign investment (countries repress labor standards to reduce costs of producing goods)? It is UNLIKELY that countries use low labor/environmental standards to attract foreign investment o Why is the Race to the Bottom issue not considered to be a big problem by most economists?  While a country can reduce production costs via repressive practices (i.e. outlawing unions), there is no evidence that this type of policy has given any country a comparative advantage that did not already exist  Low standards can reduce production costs, but do not change a country’s comparative advantage (does not affect competition between countries with the same or similar comparative advantages)  Low standards have harmful competitive effects on other countries with low standards, not on countries with high standards and an entirely different comparative advantage o Why are lower labor standards usually associated with lower foreign investment?  Low labor standards are highly correlated with a labor force that has an abundance of unskilled workers

Sign that the nation’s infrastructure of roads, ports, power supply, telecommunications, schools, and sanitation are undeveloped, HENCE the labor cost savings of lower labor standards is more than likely to be offset by higher costs everywhere else in production o Why might domestic firms operating abroad actually find it beneficial to adopt environmentally friendly standards?  GAIN foreign COMPARATIVE advantage (labor-abundance & low wages) while MAINTAINING COMPETITIVE advantage & EFFICIENCY (more sustainable If foreign countries have lower standards than you, what are some ways to address this issue without resorting to trade barriers or sanctions? o Economists are skeptical about using trade barriers to enforce labor standards because they are an expensive and inefficient means for protecting labor or jobs at home  Deadweight losses  Limited effectiveness in creating change in an exporting country because…  The effectiveness of trade barriers increase as more/larger countries join to impose them  Trade barriers can make conditions worse by causing producers inside a country to move their facilities into the informal, unregulated economy out of sight of domestic inspectors and regulators (untaxed, employees earn less, harsher working conditions)  Hazy borderline between protectionism and concern over standards  A mechanism for high-income countries to undermine the comparative advantage of low-income countries  Lack of agreement over the specific content of standards  Child labor varies by income, and even the definition of child varies across countries  Lack of agreement can undermine international economic relations  Potential to start a trade war (country out of compliance with WTO) o As long as there are large income gaps between rich and poor countries, it seems unlikely that differences in standards will disappear. o Efficient policies (as opposed to trade barriers) go directly to the root of the problem they are designed to correct. In the cases of environmental degradation and exploitation of labor, the root of the problem lies in the PRODUCTION and/or CONSUMPTION of particular goods, NOT in their TRADE o Alternatives to trade barriers include…  Labels for Exports: Certification process producing a label that is attached to the good when it is exported; the label tells consumers that the good was produced under conditions that are humane or environmentally sustainable  Cons: o Countries resist what they consider an infringement on their sovereignty when foreign inspectors are allowed to probe into the details of labor and environmental conditions o Consumers have to be convinced that the label provides reliable information  Requiring Home Country Standards: Require home country firms to follow home country standards whenever they open foreign operations  Includes: Minimum wages, some benefits, workplace health & safety standards  Does NOT Include: wages and benefits (cost of labor varies)  Pros: o Addresses the issue of a race to the bottom by making it impossible for a home-based company to exploit low labor or environmental standards WHILE SIMULTANEOUSLY preserving access to the low-wage labor of labor-abundant countries o Shifts the costs of improved standards to firms and consumers in high-income countries, where much of the concern originates  Cons: o Addresses only the problem of firms in high-standards countries that go abroad, not that of foreign-owned and foreign-operated firms that export into the domestic market (firms based in countries with low standards are untouched by this rule) o Manufacturers in high-standards countries might OUTSOURCE their production to foreignowned firms in low-standards countries, putting part of the production at arm’s length and making it more difficult to ensure that working conditions are satisfactory 

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Increasing International Negotiations: Increase the level of international negotiations, either using existing international organizations such as the ILO (labor) or WTO (environment) or creating new agreements and organizations for the environment  Ex: ILO publicizes examples of countries that are out of compliance with core labor rights o What are some advantages of adopting “Home Country Standards” for domestic firms that operate overseas?  Address fears of a race to the bottom  Remove the threat by domestic firms to relocate abroad if standards are not reduced at home  Ensure that the attraction of foreign-based production is the foreign comparative advantage NOT the ability to lower labor standards or ignore the environment  Avoid the problems created when high-income countries appear to be dictating labor and environmental standards for LMICs What are Trans-border Environmental Impacts? o Some, but not all environmental impacts are tansboundary (low standards in one country can degrade the environment in other countries)  One country’s pollution spills over into a second country (ex: shared watershed is polluted by and upstream user, industrial production in once country creates acid rain in another country, heavy truck traffic between two countries creates air pollution in both, global warming & ozone depletion) o Environmental standards in most countries have gotten tougher over time, not more lax… why?  Environmental standards reduce industrial competitiveness (environmental race to the bottom where countries are forced to rescind standards to stay competitive)  BUT… if standards are correctly implemented, they raise national well-being and lead to an economically optimal level of production  Standards in high-income countries cause them to “export pollution” to low- and middle- income countries by relocating their dirty industries there Where geographically is child labor most common (both in absolute and percentage terms)? Which economic sector is it most common in? o Opposition to child labor becomes more complicated when schools do not exist and impoverished families depend on the few cents their children can bring home – children and their work may contribute to family survival o Child labor appears to be in decline worldwide, but is still common in some pars of the world  Children in employment: a working child who has access to schooling and is not subjected to long hours or dangerous work  Child laborers: does not count children who work within legal frameworks agreed by most nations (child labor disproportionately affects boys more than girls) o Geography  Absolute: most numerous in the Asia-Pacific Region (60000 million), largely because there are more children (followed by Sub-Saharan Africa)  Percentage: Sub-Saharan Africa o Industries  #1 = Agriculture (58.6%)  #2 = Services (32.3%)  #3 = Industry (7%)  Very few children work in export-oriented sectors o Patterns  Child labor declines as GDP increases  Child labor declines as educational opportunities increase (ILO argues that child labor is most effectively combated by supporting the expansion of schooling) 

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CHAPTER 9: BALANCE OF PAYMENTS Calculating Balance of Payments 

Know the basic components of the current and financial accounts o Current Account: Tracks the FLOW OF GOODS AND SERVICES into and out of the country

Goods & Services 

Primary Income 

Secondary Income

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Components of the Current Account Credit Debit Exports Imports Investment earnings income  Investment earnings income paid received from foreigners to foreigners (NOTE: initial stock market  Compensation of FOREIGN investment is financial, while employees paid by DOMESTIC dividends received on stock are firms current) Compensation of DOMESTIC employees paid by FOREIGN firms Transfers received from abroad Transfers made to foreigners  Foreign aid Foreign aid Remittances (transfer of wages  Remittances earned in one country to residents of another)

Financial Account: Record of FINANCIAL TRANSACTIONS between one country and the rest of the world  Foreign investment  Purchases/sales of foreign stocks and bonds  International bank lending  IMPORTANT NOTES  Positive net acquisition of financial assets: country’s residents are buying more foreign assets than they are selling (DEBIT)  Positive net incurrence of liabilities: foreigners are purchasing more of the home country’s assets than they are selling (CREDIT)  (1) Financial account presents the flow of assets during the year, not the stock of assets that have accumulated over time  (2) All flows are “net” changes rather than “gross” changes

Net US acquisition of financial assets (Net increase in assets/financial outflow)  Direct investment assets (businesses, real estate, other physical assets)  Portfolio investment assets (stocks & bonds)  Other investment assets (international bank loans)  Reserve assets

Net change in financial derivatives (Assets with a value that is derived from the value of some other asset)  Commodity prices  Exchange rates

Capital Account: Transfers of specialized types of capital (smallest of the three)  Gift of an embassy building/land it is on or gifts sent between residents in different countries  Similar to secondary income but measures TRANSFERS OF CAPITAL NOT TRANSFERS OF INCOME Be able to determine whether a payment should be categorized into the current or financial account, and whether it should be counted as a credit or a debit o

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Components of the Financial Account Net US incurrence of liabilities (Net increase in liabilities/financial inflows)  Direct investment liabilities  Portfolio investment liabilities  Other investment liabilities

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o Credit: Money entering the country o Debit: Money leaving the country Why can’t a country run both current account deficits and financial account deficits at the same time? o Because each element in the current account must include a financial transaction (payment or receipt), the current account (plus capital account) must equal the financial account  Negative value in the current account (plus capital account) implies net borrowing in the financial account by the home country (financial account funds the current account)  +(Capital Account + Financial Account) = -(Current Account)

Current Account Deficits 

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Trade Balance: Difference between exports and imports of goods and services o Can be decomposed into the balance on goods and the balance on services o US negative trade balance = overall trade deficit  Although the US trade balance for services is in surplus, total trade in services is still too small a share of overall trade to counteract the very large deficit in the merchandise goods trade balance o Merchandise goods trade balance is the most commonly cited measurement of a nation’s transaction with the rest of the world (most familiar concept to most people) o Current Account Balance: measures all current, nonfinancial transactions between a nation and the rest of the world What is a Current Account Deficit? Value of goods and services a country imports exceeds exports (INCLUDES income – interest & dividends – and transfers) o How is it different from a trade deficit?  Trade deficit is the LARGEST COMPONENT of the current account deficit  Current account also includes primary & secondary income while trade deficit does not o How is it different from a budget deficit?  Budget deficit is when overall expenditures (government spending, etc.) exceeds revenues  Includes flow of money within the nation Under what situations might a Current Account deficit be nothing to worry about? o A current account deficit can occur because saving is too low or investment is too high o Current account deficits enable more investment than would be possible otherwise, and since higher investment is correlated with higher living standards, the current account deficit might be interpreted as beneficial  Rapid economic growth raises incomes and increases appetite for imports – sign of economic strength (surplus means people aren’t spending their income which can slow economic growth) o Capital inflows associated with current account deficits are an implicit vote of confidence by foreigners  If foreign investors continue to pour in capital during a deficit, countries can raise their level of investment and increase productivity in spite of a declining savings rate  US current account deficits are financed by capital inflows in its financial account  Allows US to maintain a low level of public and private savings despite high spending On the other hand, what are the dangers associated with running a large Current Account deficit? o It is not sustainable in the long run o The capital inflows that occur with a current account deficit increase the stock of foreign-owned assets inside the home country, raising the possibility that a change in investor expectation about the economy’s future can lead to a sudden surge in capital outflows  More vulnerable to capital flight

Sudden Stops, Capital Flight, and Capital Controls 

What is the difference between FDI and foreign portfolio investment? Which is more vulnerable to capital flight? o Foreign Direct Investment: The purchase of physical assets such as real estate or businesses by a foreign company or individual  LESS LIQUID (more long-term) o Foreign Portfolio Investment: The purchase of paper assets/liabilities such as stocks, bonds, bank accounts, loans  MORE LIQUID: easier to dispose of in the event of a sudden change in he economy or in investor expectations  MORE VULNERABLE TO CAPITAL FLIGHT

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What are capital controls? How can they be used to stop a financial crisis? What are the possible dangers of imposing capital controls? o Capital Controls: National controls on the inflow and/or outflow of funds  Imposed by limiting transactions that are part of the FINANCIAL ACCOUNT o Dangers of capital controls:  Undermine investor confidence  Cut countries off from international capital markets  Long-term damage to the economy  Firms can over-invoice imports, under-invoice exports, or resort to corruption to get around capital controls Which is generally a safer option: inflow or outflow capital controls? o Restriction on INFLOWS are more workable than restrictions on OUTFLOWS  Reduce the inflow of volatile, short-run capital, which may add to the stock of liquid assets ready to flee the country (preventative)  DOESN’T UPSET INVESTORS WHO HAVE ALREADY INVESTED IN YOUR COUNTRY  BUT restrictions on inflows cannot stop a crisis once it begins o Temporary limits on capital OUTFLOWS could help stop a crisis by artificially reducing the demand for foreign exchange (props up the value of domestic currency and eliminates expectations of a large decline in its value) BUT more controversial  CAN RUIN REPUTATION WITHIN THE FINANCIAL COMMUNITY

Other Chapter 9 Material 

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What is the most important determinant of private investment in an economy? o Amount of domestic savings o S + (T - G) = I + CA, so savings (both private & government) are equal to investment International Investment Position: the total of all domestic assets owned by foreigners subtracted from the total of all foreign assets owned by residents o Formula: DOMESTICALLY OWNED FOREIGN ASSETS – FOREIGN OWNED DOMESTIC ASSETS o Positive IIP: Home country could sell all its foreign assets and have more than enough revenue to purchase all the domestic assets owned by foreigners o Negative IIP: Selling all foreign assets would not provide enough revenue to buy all the domestic assets owned by foreigners (US is here – largely due to ongoing current account deficits) Roughly when did the Current Account Balance of the US start to deteriorate (become negative)? o EARLY 1980s: Neoliberalism, Reagan spending on weapons/military buildup, Prosperity o 1990s: Birth of the internet  THEN 2007… US economy crashes

CHAPTER 10: EXCHANGE RATES Basic Info 

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What is an exchange rate and what ratio is used to calculate “R”? DOMESTIC CURRENCY/FOREIGN CURRENCY o Exchange Rate: The price of one currency stated in terms of a second currency  The strength or weakness o...