PUTTING PIECES TOGETHER WHAT IS INTERNATIONAL ECONOMICS

WHAT IS INTERNATIONAL ECONOMICS ABOUT?
International economics is about how nations interact through trade of goods and services, through flows of money and through investment.

INCOME GROUPS BY GDP PER CAPITA, 2009 (COUNTRIES):
low income, $995 or less;
lower middle income, $995 - $3,945;
upper middle income, $3,946 - $12,195;
high income, $12,196 or more. 25

2009 GDP PER CAPITA (PPP)

CAUSES OF DIFFERENCES IN ECONOMIC GROWTH OF COUNTRIES
Quantity and quality of resource endowments, particularly human capital
Investment in plant and equipment
Political and socioeconomic environment that is stable and conducive to competition

CHARACTERISTICS OF WORLD TRADE
Value and growth of world merchandise trade
Geographic patterns
Commodity composition
Largest exporters and importers

GROWTH OF WORLD EXPORTS
What has caused the explosion of world trade?
Reduction in trade barriers
Advances in transportation, communication and technology
Proliferation of trade agreements

GROWTH
OF WORLD EXPORTS

MERCANTILISM: MID-16TH CENTURY
A nation’s wealth depends on accumulated treasure
Gold and silver are the currency of trade.
Theory says you should have a trade surplus.
Maximize exports through subsidies.
Minimize imports through tariffs and quotas.
“Zero-sum game”?
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DAVID HUME - 1752
Increased exports leads to inflation and
higher prices.
Increased imports lead to lower prices.
Result: Country A sells less because of high prices and Country B sells more because of lower prices.
In the long run, no one can keep a trade surplus.
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THEORY OF ABSOLUTE ADVANTAGE
Adam Smith: Wealth of Nations (1776).
Capability of one country to produce more of a product with the same amount of input than another country.
Produce only goods where you are most efficient, trade for those where you are not efficient. The concept of specialization is introduced
Trade between countries is, therefore, beneficial.
Assumes there is an absolute advantage balance among nations.
© McGraw Hill Companies, Inc.,2000
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THEORY OF COMPARATIVE ADVANTAGE
David Ricardo: Principles of Political Economy (1817).
Extends free trade argument
Efficiency of resource utilization leads to more productivity.
Should import even if country is more efficient in the product’s production than country from which it is buying.
Look to see how much more efficient. If only comparatively efficient, than import.
Makes better use of resources
Trade is a positive-sum game.
© McGraw Hill Companies, Inc.,2000
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HECKSCHER (1919)-OLIN (1933) THEORY
Export goods that intensively use factor endowments which are locally abundant.
import goods made from locally scarce factors.
Patterns of trade are determined by differences in factor endowments - not productivity.
Remember, focus on relative advantage, not absolute advantage.
© McGraw Hill Companies, Inc.,2000
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© McGraw Hill Companies, Inc., 2000
PRODUCT LIFE CYCLE THEORY
Raymond Vernon, 1966
Article in the Quarterly Journal of Economics
Focus on the product, not its factor proportions
The New Product
Flexible production
Innovator Monopoly
Concentration
The Maturing Product
Intl market & competition
More standardized production
The Standardized Product
Low-margin cost-based production
Highly competitive

THE NEW TRADE THEORY
Began to be recognized in the 1970s.
Deals with the returns on specialization where substantial economies of scale are present.
Specialization increases output, ability to enhance economies of scale increase.
© McGraw Hill Companies, Inc.,2000
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© McGraw Hill Companies, Inc., 2000
PORTER’S DIAMOND
DETERMINANTS OF NATIONAL COMPETITIVE ADVANTAGE
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DEFINITION OF TRADE BARRIERS
Government laws, policies, or practices that either:
Protect domestic products from competition
Artificially stimulate exports of particular domestic products

PROTECTION:
INSTRUMENTS OF PUBLIC POLICY
Tariff (Taxes)
Quotas (quantity restrictions)
Non-tariff barriers (Product standards, voluntary restraints).

EFFECT OF TARIFF ON VALUE

Domestic Equilibrium Price and Quantity (No trade)
Domestic Supply
Domestic Demand
Quantity
Price

Once Imports are allowed there is infinite supply at the world price.
Domestic Supply
Domestic Demand
Quantity
Price
World Supply

Efficient domestic producers continue to produce.
Domestic Supply
Domestic Demand
Quantity
Price
World Supply
Supply
From
Local Firms

But there is an increase in supply from importers.
Domestic Supply
Domestic Demand
Quantity
Price
World Supply
Supply
From
Local Firms
Supply
From
Importers

Consumers’ value with trade:
Domestic Supply
Domestic Demand
Quantity
Price
World Supply

Local Producers’ value:
Domestic Supply
Domestic Demand
Quantity
Price
World Supply

THE GOVERNMENT IMPOSES A TAX/TARIFF

LOCAL PRODUCERS’ VALUE:
Domestic Supply
Domestic Demand
Quantity
Price
World Supply

LOCAL PRODUCERS’ VALUE:
Domestic Supply
Domestic Demand
Quantity
Price
World Supply
World Supply with Tariff

WHO GAINS WHO LOSES?
Domestic Supply
Domestic Demand
Quantity
Price
World Supply
Tariff

CONSUMERS LOSE THIS
Domestic Supply
Domestic Demand
Quantity
Price
World Supply
Tariff

PRODUCERS GAIN THIS
Domestic Supply
Domestic Demand
Quantity
Price
World Supply
Tariff

GOVERNMENT GAINS THIS MUCH TAX
Domestic Supply
Domestic Demand
Quantity
Price
World Supply
Tariff

TRADE POLICIES IN DEVELOPING COUNTRIES
Import-Substituting Industrialization
It states that developing countries have a potential comparative advantage in manufacturing and they can realize that potential through an initial period of protection.
Dual Economy
Countries with highly dualistic economies also seem to have a great deal of urban unemployment.
An increase in the number of manufacturing jobs will lead to a rural-urban migration so large that urban unemployment actually rises.
Export-Oriented Industrialization: The East Asian Miracle
The World Bank’s definition of HPAEs contains three groups of countries, whose “miracle” began at different times :
Japan (after World War II)
The four “tigers”: Hong Kong, Taiwan, South Korea, and Singapore (in the 1960s)
Malaysia, Thailand, Indonesia, and China (in the late 1970s and the 1980s)

GLOBALISATION
Definition:
An economic phenomenon?
A social phenomenon?
A cultural phenomenon?
The movement towards the expansion of economic and social ties between countries through the spread of corporate institutions and the capitalist philosophy that leads to the shrinking
of the world in economic terms.

INTEGRATION OF ECONOMIES
The increasing reliance of economies on each other
The opportunities to be able to buy and sell in any country in the world
The opportunities for labour and capital to locate anywhere in the world
The growth of global markets in finance
Stock Markets are now accessible from anywhere in the world!
Copyright: edrod, stock.xchng

INTEGRATION OF ECONOMIES
Made possible by:
Technology
Communication networks
Internet access
Growth of economic cooperation – trading blocs (EU, NAFTA, etc.)
Collapse of ‘communism’
Movement to free trade

CORPORATE EXPANSION
Characteristics:
Expanding revenue
Lowering costs
Sourcing raw materials
Controlling key supplies
Control of processing
Global economies
of scale
Controlling supplies may be one reason
for global expansion.
Copyright: rsvstks, stock.xchng

Movement of goods and services is one form of international integration.
Another form of integration is international movements of factors of production (factor movements).
Factor movements include:
Transfer of capital via international borrowing and lending
International linkages involved in the formation of multinational corporations
Labor migration

THERE ARE TWO MAIN TYPES OF FOREIGN INVESTMENTS:
Portfolio investments (bonds, stocks)
Direct investments (real investments in factories, capital goods, land, and inventories)
The basic motives are:
To earn higher returns abroad.
To reduce risks to account for the two-way capital flows.

REASONS FOR EXISTENCE OF MNCS
To achieve the competitive advantage of a global network of production and distribution.
MNCs can better protect and exploit their monopoly power, adapt their products to local conditions and tastes, and ensure consistent product quality.
The competitive advantage of MNCs also comes from economies of scale in production, financing, R&D, and the gathering of market information.
The large output of MNCs allows them to carry division of labor and specialization in production much further than smaller national firms.

MOTIVES FOR INTERNATIONAL LABOR MIGRATION
Migration takes place for: Economic Reasons and non-economic Reasons.
Economics Reasons: prospect of earning higher real wages and income abroad.
Non-economic Reasons: greater educational and job opportunities for children.
Costs:
Expenditures for transportation and the loss of wages;
Separation from relatives, friends, and familiar surroundings;
Need to learn new customs and often a new language;
Risks involved in finding a job, housing, and so on in a new land.

THE BALANCE OF PAYMENTS
A record of international transactions between a country and the rest of the world for a given period of time
Trade in goods
Trade in services
Income flows
= Current Account
Transfer of funds and sale of assets and liabilities
= Capital Account

Record of Payments to & Receipts from Foreign Entities
Double-entry bookkeeping system.
Every transaction has two entries – a credit (+) and a debit (-)!
Payment = Debit (-)
Receipt = Credit (+)
Multiple Accounts
Current Account (CA) and Capital/Financial Account (KA)
Is a summary (net) record of flows, not stocks

BALANCE OF PAYMENTS EQUATION
CA+K ≡ 0
CA is the current account (mostly trade)
K is a capital and financial account (investment and other payments)

STATISTICAL DISCREPANCY
CA + KA + Stat. Dis. = 0
Why Statistical Discrepancy?
Sampling Error
financial, services trades data inaccuracies
Unrecorded interest/dividends
Global BOP Deficit correlated with interest rates.
Timing Discrepancies
Black Markets

EXCHANGE RATES AND
INTERNATIONAL TRANSACTIONS
Two types of changes in exchange rates:
Depreciation of home country’s currency
A rise in the home currency prices of a foreign currency
It makes home goods cheaper for foreigners and foreign goods more expensive for domestic residents.
Appreciation of home country’s currency
A fall in the home price of a foreign currency
It makes home goods more expensive for foreigners and foreign goods cheaper for domestic residents.

EXCHANGE RATES AND
INTERNATIONAL TRANSACTIONS
Exchange Rates and Relative Prices
Import and export demands are influenced by relative prices.
Appreciation of a country’s currency:
Raises the relative price of its exports
Lowers the relative price of its imports
Depreciation of a country’s currency:
Lowers the relative price of its exports
Raises the relative price of its imports

EXCHANGE RATES AND
INTERNATIONAL TRANSACTIONS
Spot Rates and Forward Rates
Spot exchange rates
Apply to exchange currencies “on the spot”
Forward exchange rates
Apply to exchange currencies on some future date at a prenegotiated exchange rate
Forward and spot exchange rates, while not necessarily equal, do move closely together.

EXCHANGE RATES AND
INTERNATIONAL TRANSACTIONS
Foreign Exchange Swaps
Spot sales of a currency combined with a forward repurchase of the currency.
They make up a significant proportion of all foreign exchange trading.

EXCHANGE RATES AND
INTERNATIONAL TRANSACTIONS
Futures and Options
Futures contract
The buyer buys a promise that a specified amount of foreign currency will be delivered on a specified date in the future.
Foreign exchange option
The owner has the right to buy or sell a specified amount of foreign currency at a specified price at any time up to a specified expiration date.

EQUILIBRIUM IN THE
FOREIGN EXCHANGE MARKET
How Changes in the Current Exchange Rate Affect Expected Returns
Depreciation of a country’s currency today lowers the expected domestic currency return on foreign currency deposits.
Appreciation of the domestic currency today raises the domestic currency return expected of foreign currency deposits.

INTEREST RATES, EXPECTATIONS,
AND EQUILIBRIUM
The Effect of Changing Expectations on the Current Exchange Rate
A rise in the expected future exchange rate causes a rise in the current exchange rate.
A fall in the expected future exchange rate causes a fall in the current exchange rate.

INTERNATIONAL MONETARY SYSTEM
GOLD STANDARD PERIOD (1876-1914), exchange rates determined as ratio of nations’ own valuation of gold.
Economic uncertainty and government obligations changed nations’ willingness to pay more or less for gold reserves. F(x) rates changed accordingly.

THE YEARS 1914-1944.
The War interrupted the free movement of gold.
During the Wars and the inter-war years, The Years 1914-1944.
currencies fluctuated widely in terms of gold and one another.
Many countries attempted to return to the Gold Standard, without success
The banking crises of Austria in 1931 led most countries to abandon the Gold Standard once again.
Except for the dollar, many currencies lost their convertibilities into other currencies.
The volume of world trade decline significantly, as a share of GDP.

THE BRETTON WOODS FIXED EXCHANGE SYSTEM:
1945-1973.
Countries fixed the values of their currencies in terms of gold or a currency tied to gold.
Only the dollar was convertible into gold (at $35/ounce).
After the War, the US had accumulated 20,205 metric tons of gold (about 650 million ounces) or 2/3 of world’s reserves (today, the US has 8,200 metric tons with the EURO area holding 11,000 mt).
Countries set their exchange rates against the dollar.
Countries agreed to maintain their currency values within 1% of par, by buying or selling of foreign exchange or gold.
Countries agreed to have currency convertibility for current account transactions, but could impose capital controls.
Devaluation was not to be used as competitive trade policy, though a devaluation of up to 10% did not required IMF approval.
The BW Conference also led to the creation of the International Monetary Fund (IMF) and the World Bank.

MULTIPLE CURRENCY ARRANGEMENTS
FROM 1973 TO PRESENT.
Countries have opted for different currency systems, blessed by the IMF in the Jamaica Conference of 1976 (under “firm surveillance”, floating rates were accepted if consistent with "market" forces).
The only way to cope with international FX instability is to have greater economic policy coordination among the G-7 countries: A stable international monetary system has yet to emerge.
A number of currency events and crises have occurred since then that produced significant volatility in exchange rates

MACROECONOMIC POLICIES

MONETARY POLICY
Attempts to influence the level
of economic activity (the amount
of buying and selling in the economy) through changes to the amount of money in circulation and the price
of money – short-term interest rates.
Interest rates the key area
of Monetary Policy

SUPPLY SIDE POLICY
Intention is to shift the aggregate supply curve to the right, increasing
the long term productive capacity
of the economy
Tend to be long-term policies
Arguments about how effective they are – e.g. lowering taxes increases incentives, reducing welfare dependency increases the urge
to find work

SUPPLY SIDE POLICIES
Policies aim to influence productivity and efficiency
of the economy
Key feature – open up markets and de-regulate to improve efficiency in the working of markets and the allocation
of resources

FISCAL POLICY
Influencing the level of economic activity though manipulation
of government income and expenditure
Associated with Keynesian Demand Management Policies
Now seen in wider terms: