Summary of International Economics (Theory and Policy) Chapter 1 PDF

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A summary of the first chapter (required reading for Lecture 1 of ECON3002)....

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Chapter 1. Introduction (Reading for Lecture 1) • •

Nations are more closely linked than ever before through trade in goods and services, investments in each other’s economies, and flows of money. Trade statistics:

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Imports and exports of the US roughly tripled in importance btw 1960 and 2015, as illustrated by the import/export as percentages of GDP à growing linkages btw national goods markets. The increased gap btw exports and imports à growing linkages btw national capital markets. The plunge in 2009 à close links btw world trade and the overall state of the global economy.

* The difference btw the exports and imports figure is financed by large inflows of capital into the US where money is invested by foreigners willing to take a stake in the US economy. •

The averages of exports and imports as % of GDP are much higher in other countries (e.g. South Korea, Belgium) than the US à countries limited by their size and diversity of its endowed resources rely more on international trade.

International economics involves new issues raised by different currencies, trade policies, and other special problems of economic interactions btw sovereign states. Seven themes: 1. 2. 3. 4. 5. 6. 7.

The gains from trade; The patterns of trade; Protectionism; The balance of payments; Exchange rate determination; International policy coordination; The international capital market.

The Gains from Trade • •

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Many are sceptical about the benefits of trading for goods that a country could produce for itself. However, there are almost always mutual gains from trade for both parties, and the range of circumstances under which international trade is beneficial is much wider than most ppl imagine. Trade provides mutual benefits: o By allowing countries to export goods whose production makes relatively heavy use of resources that are locally abundant while importing goods whose production makes heavy use of resources that are locally scarce (RESOURCES). o By allowing countries to specialize in producing narrower range of goods and hence letting them enjoy the higher efficiencies of large-scale production (SPECIALIZATION AND ECONOMIES OF SCALE). o Even when one country is more efficient in producing everything and the less efficient country can only compete by paying lower wages.

International trade of intangible goods: Migration Borrowing and lending Exchanges of risky assets (e.g. bonds and stocks) • •

Trade of labour for goods and services Trade of current goods for the promise of future goods, or vice versa Allowing countries to diversify their wealth and reduce the variability of their income

Although an economy overall generally benefit from trade, it is possible that trade may hurt particular groups within a country à alters the distribution of income. Examples: o Owners of resources that are specific to some industries (e.g. specialized machinery, workers with specialized and non-transferrable skills) are adversely affected by imports. o The real wages of less-skilled workers in the US are declining (probably) because of increased exports of manufactured goods from low-wage countries, even though the country as a whole is getting richer.

The Patterns of Trade: who sells what to whom? And in what volume? Possible determinants of the patterns of trade: • • • • •

Climate and resources (ENDOWMENTS); International dif in labour productivity (by David Ricardo); Interaction btw the relative supplies of national resources (e.g. K, L, land) on one side and the relative use of these factors in the production of dif goods on the other; A substantial random component; Economies of scale.

Protectionism: how much trade? •

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Protectionist policies: gov worried about the effect of international competition on the prosperity of domestic industries à placing limits on exports (e.g. quotas and tariffs) and/or helping domestic goods to compete in the global market (e.g. by subsidizing exports). The advanced democracies, led by the US, pursued a broad policy of removing barriers to international trade in the 1990s for the sake of economic prosperity and for world peace: o North America Free Trade Agreement (NAFTA) btw the US, Canada and Mexico in 1993; o Uruguay Round agreement established by the WTO (World Trade Organization) in 1994; Since then there has been considerable backlash against globalization: o Brexit: leaving the EU which guarantees free movement of goods and people among its members; o Claims that competition from imports and unfair trade deals have cost jobs made at the US presidential campaign in 2016; Key insight: it is the conflicts btw dif interest groups within a nation the main determining factor in gov policies toward international trade, rather than the conflict of interests btw nations.

Balance of Payments: context • • •

A trade surplus is not necessarily good and a deficit is not necessarily bad. A country’s balance of payments must be placed in the context of an economic analysis. The balance of payments has become a central issue for the US: it has been running huge trade deficits for each and every year since 1982.

Exchange Rate Determination Given that the modern exchange rates are determined by the marketplace, the relative values of currencies can change over time, and sometimes drastically à effects on trade. Before WW1 After WW2 Present

ER of major currencies are fixed in terms of gold (the gold standard) The values of most currencies are fixed in term of the US dollar Determined by the marketplace

International Policy Coordination • • • •

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In an integrated world economy, one country’s policies (trade and macroeconomic) can affect other countries. Dif in goals à conflicts of interest. Even countries with a common goal may suffer losses if they fail to coordinate their policies. Fundamental problem: how to produce an acceptable degree of harmony among the international trade and macroeconomic monetary policies of dif countries in the absence of a world gov? For almost 70 years, international trade policies have been governed by an international agreement known as the General Agreement on Tariffs and Trade (GATT). Since 1994, trade rules have been enforced by the WTO which can tell countries that their policies violate prior agreements. Although coordination on international trade policies is an established tradition, coordination on international macroeconomic policies is newer and remains controversial to this day.

Nonetheless, attempts at international macroeconomic policy coordination are occurring with growing frequency.

The International Capital Market • •

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The growing importance of international trade since the 1960s was accompanied by a growth in the international capital market, which links the capital markets of individual countries. Examples: o In the 1970s, oil-rich Middle East countries placed their oil revenues in banks in London and NY à those banks in turn lent money to gov and corporations in Asia and Latin America; o During the 1980s, Japan converted much of the money earned from booming exports into investments in the US, including establishments of US subsidiaries of JP corporations; o China funnelling its export earnings into a range of foreign assets, including a substantial amount of US dollars its gov holds as international reserves; Risks: o Currency fluctuations à create winners and losers; o Risk of national default: there is no effective way for the creditors of a defaulting country to bring the matter to court (fears of default by highly indebted Southern European countries has been a major concern in recent years).

International Economics

1. International Trade: physical movements of goods 2. International Money: financial transactions...