Lecture Notes
The
Global Economy
=============================
Lecture Notes2006-2007
An overview
There are 189 countries belonging to UN with a diverse range of political
systems.
Holly See, Switzerland, and Palestine have permanent observers to the
UN.
The World Bank identifies over 200 countries/entities.
75% of the world’s population live in developing countries (including
some with transitional economies)
World Bank’s Classification
P/C Inc Pop% Output%
Low Income
$426 40%
3%
Lower Middle Income $1,146 34%
7%
Upper Middle Income $4,900 11%
10%
High Income
$27,609 15% 80%
Structural Differences
Labor
Labor force Participation
Female labor force participation
Skilled and semiskilled labor
Capital
Physical capital
Human Capital
Infrastructure
Physical infrastructure
Institutional Infrastructure
Social/Cultural Infrastructure
Capital stock and labor productivity
Capital Accumulation per Labor Unit
Some Important Post-WWII Developments
The formation of the United Nation : Oct 24, 1945
The Marshal Plan
The Bretton Woods System
The IMF and the World Bank
The formation of the European Common Market gradually evolving into
the European Union
The GATT Rounds
The division of the world into two/three blocks
The formation of NATO and the Warsaw Pact
The Cold War
Emergence of new independent nations as old colonies gained their independence
The end of the Cold War and the collapse of the Soviet regime
Emergence of the old soviet republics and the Eastern Block countries
as new “independent” nations
Economic liberalization (Marketization) in China
Emergence of newly industrialized countries
The global privatization movement/Deregulation in trade and finance
The formation of WTO
The growth of international investment/multinational business entities/the
globalization movement
Developments since the mid 1970s toward an economically more integrated
world:
Lower tariffs led to increased trade (GATT)
Regional economic agreements: free trade zones, the common market,
the European economic union, etc.
Financial deregulation within and among nation states leading to freer
movements of capital (portfolio investments as well as FDIs) and the creation
of new financial instruments
Technological evolution leading to better and more efficient communication
and higher productivity
What is globalization?
The removal of regulatory, economic and political barriers
to the movement of goods, services, capital, and labor across national
borders, and the establishment of international institutions (and norms
and regulations) to govern international economic activities.
Important political developments
The war in the Middle East and the Oil Embargo (1970s)
The US leaving Vietnam
Continued negotiations on disarmament
Emergence of new nuclear powers (China, Pakistan and India)
The UN becoming more involved/active in the affairs of the world
The political dimensions of the function of WTO, IMF and World Bank
The collapse of the Soviet Union and the US becoming the sole super
power of the world
Expansion of NATO
The formation of EU
Realignments in the alliances and movements toward a new political
order
Democratic movements in the developing world
The emergence of international NGOs and “advocate” groups
Radicalism and terrorism
Questions to be asked?
Are nation states disappearing?
Have most of the economic/political problems of the world been caused
by globalization and inadequate international checks and balances ?
Inequalities within and among countries
Exploitation of workers
Declining real wages in developed countries
Environmental degradation
How “globalized” have we become?
Export
Import
$B % Ch
$B %
Ch
Extra-EU 813.2
20.1 0
944.4 22.3
5
United States 682.5 16.8
-1 800.7 18.9
5
Japan
387.9 9.6
-8 280.5 6.6
-17
China
183.8 4.5
1 140.2 3.3
-2
Korea
132.3 3.3
-3 93.3
2.2 -35
Mexico
117.5 2.9
6 129.0 3.0
14
Singapore 109.9
2.7 -12
101.6 2.4 -23
Gilpin:
The technological changes that have taken place in recent
years aided by political changes are likely to have resulted in most of
these problems. Many of these problems would have occurred with or without
globalization. Besides, most of the developments identified as part of
the globalization movement have taken place among a handful of countries;
they include mostly developed countries, a few newly industrial countries
in Asia, China, and a few countries in Latin America.
Developing an approach to studying the global economy
Studying the global economy from a “purely” economic perspective: the
Neoclassical approach
The role and function of political systems as well social norms and
cultures in the formation of economic goals and the manners by which they
are pursued
Economic forces versus political forces
A Simple Economic Approach to Understanding Global Markets
What is a market?
Market participants: buyers and sellers
Supply and demand
Supply: the quantity of a good that producers
produce and offer to the market for sale under any given set of conditions
(price, factor prices, prices of alternative goods, etc.)
Demand: the quantity of a good that consumers (buyers) are willing
and able to buy under any given set of conditions ( price, income, price
of substitutes, etc.)
Supply and Demand Curves
Supply curve: A curve or line showing the quantities of a good producers
are willing to produce and offer for sale at different prices, ceteris
paribus: The higher the price the greater the quantity supplied
Demand curve: A curve or line showing the quantities of a good buyers
are willing and able to buy at various prices, ceteris paribus: the higher
the price the smaller the quantity demanded
Lec Two
Globalization
The removal of regulatory, economic and political barriers to
the movement of goods, services, capital, and labor across national borders,
and the establishment of international institutions (and norms and regulations)
to govern international economic activities
Bhagwati’s definition:
“Economic globalization constitutes integration of national economies
into the international economy through trade, direct foreign investment
(by corporations and multinationals), short-term capital fellows, international
flows of workers and humanity generally, and f lows of technology:……”
Who are against globalization?
First:
Those who are ideologically against capitalism and all
processes and developments that are based or driven by capitalistic principles
and sentiments. These people see globalization as nothing but the extension
of capitalism throughout the world with multinationals being at the forefront.
Second:
Those whose discontents are directed at what they see as social and
economic implications of globalization:
Increased poverty, especially in developing countries
Environmental deterioration
Poor working conditions in (host) developing countries
Displacement of workers/unemployment
Imposition of harsh conditions on poor nations by international organizations
(e.g., IMF and World Bank)
Imposition harsh terms on signatories to trade treaties (such as NAFTA
and EU)
Unfair trade (An argument used by both the poor and the rich)
Has free trade been good for America?
Economic Growth
Structural Changes
Economic Dependence on Foreign Resources
Employment
Income Distribution
Wages/Personal Income/Inflation
National Security
Structural Changes
Shrinking Manufacturing Sector
Growing Service Sector
Is less manufacturing bad for the economy?
New types of jobs
Skilled labor versus unskilled labor
International wage equalization
The widening gap?!
The narrowing gap?!
Protecting Domestic Industries
Tariffs
Quotas
Subsidies
Costs and benefits of protection
The feedback effects of protection:
economic
retaliatory
Do benefits of free trade really outweigh its costs?
Arguments for Protection
The case of optimal tariffs
National Security
Infant industries that can potentially become internationally viable
and competitive
Economies of scale
Monopolies and price discrimination
Dumping?
Unfair trade: subsidized exports
Foreign low wages
Trade Deficits
Are trade deficits bad for the country?
How can we reduce our trade deficits? Or, should we even try?
The relationship between trade and financial markets
Automatic market corrections
Lec Three
Globalization is Multi-dimensioned
Along with trade and investment come many other developments
change no only the economy but also social and political institutions under
which people run their lives. Many of these changes are positive and therefore
contribute to further economic development.
Exaggerations and Confusions
Have all the poor in all the countries that have liberalized (to some
measure) their economic relationships with some (or all ) other countries
really gotten poorer?
False generalization based on certain bad experiences: The Asian financial
Crisis
Globalization and “National Independence”
The North and South’s Position reversal
Globalization Today and Yesterday
Trade and investment during the colonial time
Technology and trade
Transportation
Communication
Security
The role of governments
Globalization and Information Technology
Technology can no longer be locked in!
Globalization and Capitalism
Socialistic tendencies of some anti-globalization groups
Changing rules
The old and the young
The North and the South
The Trilogy of Discontents: Anti-capitalism, Anti-corporation Sentiments,
and Anti-Globalization
Socialism as a viable alternative to capitalism: the Soviet case
Anti-capitalism sentiments among humanities majors
Technology and increased awareness about others
Reforms (economic liberalization movements) serve the goals of profit-driven
corporations
Politics of Globalization
Multinationals and domestic institutions/regulation
Social/political movements picking up “the cause”
A picking-and-choosing approach: accentuating the negative while
ignoring the positive (e.g., Gap, Nike, Starbucks)
Usury and multinationals
Other Sentiments
The right and the left: Michael Moore, Ralph Nader and Pat Buchanan
in the same bed!
Anti-immigration sentiments
Communitarianism: Limits to market: Kyoto and the pollution trading
Anti-Americanism: Globalization as an American-driven phenomenon
In Defense of Globalization
Parallels between capitalism and globalization
Stake wielding and stake asserting groups
>From an economic perspective
>From a social perspective
Poverty, child labor, etc.
The cause and effect issue
What is to be done?
There are downsides that need to be addressed (The shrimp farming problem,
lay-offs, etc.)
Wealth and income redistributions may not be equitable
Social goals that could be achieved through globalization should be
accelerated
Globalization should not be halted but it should be directed at a proper
pace
Globalization and Poverty
Are we making progress?
What is poverty?
• Causes of poverty in modern societies
• Types of poverty
• Dealing with the symptoms versus dealing with the causes
• Is globalization a cause or a cure?
• Varying perspectives: the good and the bad
There are those who based
on their observations and in some cases scientific analysis (Dennis Robertson)
argue that free trade (and globalization in general) help reduce poverty
There are others, on the
other hand, who point to the flaws of globalization movements and conclude
that while making the rich and multinationals richer, globalization has
not helped the poor and in many instances it has made them worse off.
The key answer: economic growth
• Trade as an engine of growth:
• Does trade reduce or increase poverty?
• Should we try to cut the pie differently or making the pie bigger?
• How do we grow the economy with so little capital?
Poor countries are often
capital poor.
If left on their own, their
savings are not enough to help them accumulate capital at a significant
rate. Rapid economic growth requires growing capital (both physical and
human).
Foreign investment could
play a very important role in accelerating capital accumulation in the
developing world.
Immiserizing growth
• Could growth be detrimental to the poor?
• Internally induced growth resulting in depressed prices
• Externally induced growth (the green revolution), also resulting
lower prices
• What is to be done?
Development Models
• Investing in heavy industry and infrastructure
• Investing in labor intensive industries
• The importance of capital reivisited
• Microcredit
• The de Soto model
Poverty and Democracy
• Participation in democratic processes by the poor
empowers them, making it possible for them to influence policy makers as
well as policies
• Improving market institutions and getting rid
of crippling bureaucracies and red tape
• Improving legal and economic institutions and
reducing corruption
• Improving social institutions (Improved economic
conditions could help social conditions. A child is more likely to be sent
to school if her parents are employed and enjoy some degree of economic
security. )
• Guiding the consumption when needed!
Increased incomes some times do lead to improved consumption if consumptions
habits are poor.
Trade and Growth
• Closed-economy (protected) growth
• Trade-based growth
• The Chinese model
• The Indian model
What do we do about inequalities?
Impressions versus facts
What do studies show?
Globalization and Women
Are women gaining from the process?
Japanese Women
Traditional Japanese women: centuries of oppression?
Japanese Women and Multinationals
Japanese studying abroad
The Gender Wage Gap
Globalization and Democracy:
Production/Consumption Possibilities of an Economy; The Case of
Autarky (150 units of labor)
Production Possibilities Frontier
Production possibilities frontier (or curve) is a line, drawn in a
two dimensional space with each axis measuring one of the two (groups of)
products, representing all possible combinations of the two goods the economy
can produce using all its (known) economic resources (full employment)
and its best technology (full efficiency).
Slope of PPF = Opportunity cost = MRT
Relative Price
Price of Good X / Price of Good Y
The Theory of Trade
Absolute Advantage in Production (Adam Smith)
A country that can produce a good (X) with fewer units of resources
(labor) than other countries can has an absolute advantage in the production
of that good (over other countries)
Comparative Advantage (David Ricardo)
A country has comparative advantage in production a good (X) over another
country if its opportunity cost of producing X (in terms of other goods
that it would have to forego) is lower than the other country’s opportunity
cost of producing the same good (X).
An Economy under Autarky
An Economy under Autarky
US and Mexico under Autarky 240 units of labor
Input Used Output
Total
Mexico
U.S.
Mexico U.S.
Tomatoes: 10 hrs 15 hrs 12 8 20
Corn:
8 hrs 4 hrs
15 30
45
------------------------------------------------------------------------------------------
After Specialization and trade based on the “absolute advantage principle
Mexico U.S.
Total
Tomatoes
24
0
24
Corn
0
60
60
Comparative Advantage
Res. Used Output
Mexico
U.S.
Mexico U.S.
Total
Rugs
10 hrs 8 hrs
12
15
27
Computers 40 hrs
10 hrs
3
12
15
------------------------------------------------------------------------------------------------------------
After Trade
Mexico U.S. Total
Rugs
24 0
24
Computers
0 24
24
Production Possibilities Curve: The of Case Increasing Cost
Food Clothes
Opp Cost of Clothes (MRT)
100 0
25 5/25 = .2
80
50
10/25 = .4
75
75 15/25 = .6
50
87
25/12 = 2.08
25
95 28/8 = 3.5
0
100 25/5 = 5
Factor Endowments
Factor endowments:
Capital abundant country
Labor abundant country
Production:
Labor- intensive good
Capital-intensive good
Heckscher-Ohlin Theorem
Two countries with identical technology and taste produce
(and consume) according to their factor endowments; each produces and (consumes)
relatively more of the good that uses its abundant factor more intensively.
Factor Endowments
Trade Between A and B
Factor Endowments
Factor endowments:
Capital abundant country
Labor abundant country
Production:
Labor- intensive good
Capital-intensive good
Heckscher-Ohlin Theorem
Two countries with identical technology and taste produce
(and consume) according to their factor endowments; each produces and (consumes)
relatively more of the good that uses its abundant factor more intensively.
The Leontief Paradox
Does the Heckscher-Ohlin theorem hold?
Capital/Labor ratio
US export goods had lower K/L ratios than the goods that were not exported.
Explanation:
The assumption of equal tastes?
Not accounting for human capital: labor differentials
Some factors (e.g, capital) may move across borders more easily
Inter-industry labor mobility?
The assumption of equal technologies
What Makes Countries Trade?
Relative Price Differentials
Factor Endowments Theorem
Different Tastes
Different Technology
A combination of some or all of
the above
Trade and Factor Prices
Factor Price Equalization Theory
Under H-O assumption free trade will lead to factor price equalization:
Under free trade wages as well as the prices of other factors of production
tend to equalize among trading partners.
The Welfare Effect of Globalization
From an economic standpoint the welfare effect of globalization
could be measured in terms of the changes in people’s real income (purchasing
power); that is how much they can buy and consume.
Real Income = Income / Price
Why do some nations hesitate in opening up their borders to free
trade?
Potential Comparative Advantage
Infant Industries
Economies of Scale
Strategic Trade policies
Other Concerns
Economic Dependence
Security concerns
Nationalistic Sentiments
Gilpin:
The technological changes that have taken place in recent
years aided by political changes are likely to have resulted in most of
these problems. Many of these problems would have occurred with or without
globalization. Besides, most of the developments identified as part of
the globalization movement have taken place among a handful of countries;
they include mostly developed countries, a few newly industrial countries
in Asia, China, and a few countries in Latin America.
Developing an approach to studying the global economy
Studying the global economy from a “purely” economic perspective: the
Neoclassical approach
The role and function of political systems as well as social norms
and cultures in the formation of economic goals and the manners by which
they are pursued
Economic forces versus political forces
Alternative Perspectives of the World
Nationalism: Nation states adopting policies and making decisions based
on the “national interests” of the country (security, political independence,
economic and political power)
Liberalism: The free market approach to the international relations
and letting things happen under the forces of the market
Communism: The belief that the unchecked market-based capitalism
is doomed to fail, both nationally and internationally, and the world would
eventually adopt a communistic regime
Realism: The recognition of the predominance of national interests
in the shaping of economic/political policies in international relations
What is global political economy?
A study of the interactions between market forces and political forces
in the relationship among nation states and international organizations
National interests play a dominant role
Who defines national interest? Political elites of the country
Do national interest supersede all norms and values?
Politics and Economy
While political forces (and conditions) help shape economic relations
(trade, etc.), economic forces affect political structures
What determines the political reality?
Constructivism
Realism
The recognition of the predominance of the state in and its nationalistic
sentiments (independence, political power, security) in shaping economic/political
structure of the international relations: state-centric decisions
(Morgenthau, Machiavelli and others)
The anarchic nature of international affair
A realist does not have to be a nationalist
A realist may be liberalist: promoting the free market principle in
international relations
National Interests
What are “national interests”?
Who determine national interests?
Does morality matter in state-centric nationalism?
Norms and values
Constructivism: International politics is “socially constructed”
Shared ideas
Forming interests based on shared ideas
A more humane world based on shared ideas rather than “realistic” (materialistic)
nationalistic interests
The importance of identity in determining international relations:
a democratic state as opposed to a autocratic state
The realities of the world today
The realities of the world today:
Globalization/liberalization trends
The US emerging as the only super power
Regionalization (as countervailing movement?!)
The widening gap between the rich and the poor
Financial liberalization and increasing financial interdependence
Increasing roles of international organizations
Emerging economies of Asia and Eastern Europe (including China
and India)
Political conflicts
Nationalism
Radicalism and terrorism
Globalization and Its Discontents
The Controversies
The Key Institutions
International Monetary Fund (IMF)
Word Bank
International Bank for Reconstruction and Development
International Development Association
International Finance Corp
Multilateral Investment Guarantee Agency
International Center for Settlement of Investment Disputes
World Trade Organization
The United Nations
Regional Pacts
European Union
NAFTA
Asian Free Trade Agreements in varied states of development: Most recent:
Mali Agreement
Latin America free trade policies/movements
Trade and Economic Development
Trade/economic liberalization has benefited millions of people around
the world in developed as well as developing countries.
Exports have been the engine of development in many small developing
countries.
Freer flow of information has raised expectations.
The freer spread of technology resulted improved productivity and reduced
costs
What are the problems?
Unequal distribution of benefits both within countries and across nations
The widening gaps between the poor and the rich
Too little attention to the downsides of globalizations by international
organizations led by developed countries, especially the US
Forcing market reforms on countries with inadequate functioning institutions
( economic, legal, social) that are necessary for an efficient market system
More Problems
Developed countries continuing to maintain certain protectionist policies
that are harmful to many poor developing countries
Increased poverty despite the steady growth in the world total income
(2.5% per annum)
Reduction in life expectancy among poor populations(partly caused by
AIDS)
Economic instabilities: the Asian crisis(1997)
Economic/political instabilities
More problems!
The unnecessary hardships caused by the chaos following the collapse
of the Soviet regime (still continuing in some countries)
Enforcement of intellectual property laws in some countries resulted
in further hardships for many poor people who lost access to certain drugs
The environmental costs of globalizations
Labor exploitation?
Still more problems
The behavior of the IMF and World Bank
Austerity measures imposed by the IMF focused on fiscal/monetary health
of the economy
Economic instabilities caused premature (capital) market liberalization
Increased unemployment due to restructuring was of little concern to
the IMF advisors
Sever recessions
Increased international debts
A More Balanced Approach to Globalization
Different countries might need to take different approaches to globalization:
Economic differences
Political differences
Social/cultural differences
“Development” differences
Sequencing the process
Comparing Wal-Mart expansion within the US and outside the US
World Bank and IMF
The IMF’s mission: economic stability
The WB’s mission: Economic Development and
eradication of poverty
Close one-half of the world’s population has per
capita incomes of less than $2 per day, over one million of them
less a dollar a day.
Management and Control
Representation and Perspectives
The Case of Ethiopia
Per capita income: $110
17 years of war
IMF’s approach: no deficits!
Foreign aids vs. tax revenues:Stability?
Early payment of high-interest loans (?)
Banking and financial liberalization: Ethiopia resisted and the IMF
relented
The Debt Problem
Most developing countries have accumulated significant foreign debts
Many countries also face domestic fiscal problems; large deficits
In most cases governments are directly or indirectly responsible for
foreign debts
The only ways to pay of or service foreign debts are using export revenues
or borrowing more!
Faulty Decision Making Process
Lack of transparency on the part of international organizations (IMF,
etc.)
The IMF’s unfamiliarity with the internal conditions of the less developed
countries.
An ideologically driven one-size-fits-all approach
A lack of trust between the IMF and its clients
Structural Differences
Labor
Chart: The distribution of the global output and consumption
Chart: Capital and labor distribution
Capital Accumulation per Labor Unit
Chart
Some Important Post-WWII Developments
The United Nations officially came into existence on 24 October 1945, when
the Charter had
been ratified by China, France, the Soviet Union, the United Kingdom, the
United States
and by a majority of other signatories. United Nations Day is celebrated
on 24 October
each year." Source: The UN web site
What is globalization?
Globalization refers to the actions and efforts aimed at the removal
of regulatory, economic and political barriers to the movement of goods,
services, capital, and other movable factors of production across national
borders, and the establishment of international institutions (and norms
and regulations) to promote and govern international economic activities.
Important economic developments toward a more integrated world:
Gilpin: The technological changes that have taken place in recent years aided by political changes are likely to have resulted in most of these problems. Many of these problems would have occurred with or without globalization. Besides most of the developments identified as part of the globalization movement have taken place among handful of countries; they include mostly developed countries, a few newly industrial countries in Asia, China, and a few countries in Latin America.
Finding an approach to studying the global economy:
Alternative Perspectives of the World
Nationalism: Nation states adopting policies and making decisions
based on the “national interests” of the country (security, political
independence, economic and political power)
Liberalism: The free market approach to the international relations
and letting things happen under the forces of the marketCommunism: The
belief that the unchecked market-based capitalism is doomed to fail
both national (and internationally) and the world would eventually adopt
a communistic regime
Realism: The recognition of the predominance of national interests in the shaping of economic/political policies in international relations
What is global political economy?
A study of the interactions between market forces and political forces
in the relationship among nation states and international organizations
National interests play a dominant role
Who defines national interest? Political elites of the country
Do national interest supersede all norms and values?
Politics and Economy
While political forces (and conditions) help shape economic relations
(trade, etc.), economic forces affect political structures
What determines the political reality?
National Interests
The Purpose of Economic Activity
In a purely economic (neoclassical) sense the purpose of economic activities is to put the earth's scarce resources to the most efficient use possible to maximize the welfare (pleasure) of individual consumers (or households), or the society.
Many economists believe that this objective can best be achieved through the market mechanism.
Economists may not concern themselves with issues such as wealth and income distribution or moral or political consequences of economic processes, as important as these issues may be.
In political economy, deciding on the purpose of economic activity and how it is to be pursued and the socioeconomic implications of the outcome as well the process by which it is achieved are subjects of inquiry.
Questions:
· Given our constraints, what mechanism should we use to
determine our objectives?
· Should the purpose of economic activity be to maximize individual consumers’ benefits, to achieve a certain social welfare objective, or to gain military superiority?
· To what degree should we rely on the market mechanism in
pursuing our goals?
National Interests
Today: From Chicago School, Public Choice to neoclassical institutionalists
Alternative approaches to defining economic goals in different
schools of thought :
Economic Efficiency
Individuals seek to build
institutions to promote economic efficiencies, e.g., D. North
Individuals are interested in rent seeking
Notes:
Normative and positive economics
Could economics be value free?
Exogenous and endogenous
Exogenous: non-economic factors
affecting our behavior (from without the economic framework of our
models)
Endogenous: economic motives behind
our actions (interacting within the economic framework of our models)
Economic Imperialism
All individual, social and political behaviors have underlying
economic motives and, thus, can be explained within the contexts of economic
models
Political economy as choice of economic system.
Universality of economic principles
Scarcity
The need for
making choices: economizing
The reality
of opportunity cost
"Rationality"
of individulas
Three approaches revisited:
Economy and Government
Free market: little or no government
Neoclassical views
Public Choice theory: Buchanan and Tullock
Market failures and the need for government
intervention
Some mainstream and more liberal economists: Tobin,
Samuelson,
Arrow,
Galbraith,
...............Heilbroner
Contemporary approaches (schools):
Neoclassical Institutionalism (North)
Economic and
other institutions can be explained by neoclassical economic principles
and tools of analysis; rational individuals pursuing their economic
interests: economic
efficiency or rent seeking
Public Choice (Buchanan)
Applying economic
tools of analysis to political matters; generally committed to the market
mechanism and against government intervention in the economy
“New Political Economy”
The self-serving
behavior of individuals and (interest) groups in determining public policies
and the welfare implications of such behavior
The Critics of Economic Imperialism (From Marxists to “liberal” economists)
Economics fails to take into account non-economic
factors and motives that could be as important in affecting people’s bahavior
Examples of events involving political elements as well as economic factors:
The European monetary crisis ( 1992)
German high interest rates/American low interest
rates
UK and Italy dropping out of the ERM
(the European Exchange Rate Mechanism)
The rejection of Maastricht
agreement by Denmark and German unification and ERM
Financial liberalization (as political development ) and its economic
implications
National sovereignty in danger?
1997 Asian Crisis (See Stiglitz on this.)
Was it a purely economic phenomenon?
Regionalization: Is Japan trying to form an Asian bloc rivaling
the West?
The Neoclassical Scenario
In an abstract free-information/no-transaction-cost world “rational”
homogeneous individual households pursue their economic objective of using
their scarce resources to (efficiently) satisfy their needs/wants.
The setting: The market
Economic Unints
Households engage in various economic activities wearing different
hats:
The Market
A place, a mechanism, or a system in or through which buyers and sellers
meet and interact
The market facilitates trade/barter
Trade is mutually beneficial: gains from trade and
the concept of comparative advantage: the relative price
The role of price and quantity: supply and demand
Market Equilibrium
Through a network of well functioning markets the interaction among
economic actors (particularly between consumers and specialized producers)
would lead to a set of equilibriums that brings about efficient allocation
of scarce economic resources.
What is an equilibrium?
A condition at which economic forces are in balance and,
thus, there is no tendency for change
What is efficiency?
Making the use of use of scarce economic resources
"Pareto optimal" efficient: a condition at which
no change can make one person better off without making another person
worse off.
"Equilibrium" revisited:
Equilibrium: a condition at which there is no tendency for change (in
the price or quantity)
Static equilibrium
Dynamics of the market and the market equilibrium
The role of competition: the survival of the fittest
Comparative statics and marginal analysis
Optimizing behavior of economic actors
Example: How does a consumer react to a change in the (relative) price?
Exogenously induced disequilibrium: non- economic factors? Example:
the oil embargo of 1973
Some of the shortcomings of the Neoclassical scenario:
The normative nature of some of the Neoclassical assumptions
Homogeneity of economic units
“Economic” rationality?
Perfect and free information?
Transaction costs?
Uncertainty?
Technological innovations and their uncertain outcomes?
The behavior of the state?
Flaws in empirical analysis and results
The controversy over the role of the government: market failure
What has been happening in the world?
The European monetary crisis ( 1992)
The rejection of Maastricht by Denmark and agreement and German
unification and ERM
Financial liberalization (as a political development ) and its economic
implications
National sovereignty in danger?
1997 Asian Crisis
Tight monetary policy in Germany/low interest rate
in US
Regionalization
Could regionaliztion be regarded as a countervailing
measure against globalization?
The evolution of World Bank and the IMF
Economics:
Trade and gains from trade
Efficient use of resources
International political economy:
How the gains from trade are distributed
The factors that affect the distribution of the gains
The effects of the distribution of gains on the power structure of
the world
The role of the state (as a influential player as well as a beneficiary)
The role of international institutions
The basic theory of trade:
The mercantilists` approach to trade
Hume and mercantilists: The self defeating outcome of gold accumulation
through maintaining a balance of trade surplus
Specialization and trade based on comparative advantage
Distribution problem from an economic standpoint: absolute gains versus
relative gains
Relative gains and political economy
International economic interdependence and national autonomy:
Balancing economic interests and political and cultural interests/autonomy
The clash between economic forces of the free market and the political
interests of the states as an important concern in IPE
Is mutually beneficial interdependence among states desirable?
Hirschman: Asymmetric interdependence as a tool of exploitation:
vulnerability of weaker (more dependent) countries
International Regimes
A set of rules, norms, and procedures governing international
relations
The need for rules in market setting?
Is a one-sided free trade regime desirable (or better than none)?
International "rules of the game"
The enforcement mechanism
The past: Pax Britannica
The present: IMF, WTO, etc.
The Origins of International Regimes
Spontaneous emergence and evolution of regimes
International agreements
Bretton Woods
IMF and World Bank
Bilateral and multilateral agreements
Politics of the regimes
The nature and the content of an international regime:
Could a regime be neutral?
Technological factors
Economic factors
Political factors: the role of dominant powers
Ideological factors
The Compliance Problem
The lack of international enforcement
The free rider problem
The game theory approach: The prisoner’s dilemma; iterative games
International cooperation: transaction costs and non-cooperative games
Hegemonic stability: a dominant power as an enforcer
Hegemonic Stability
Do we need a hegemon for estblishing order?
Does the hegemon have to be imperialistic?
Can a hegemon be altruistic?
Does a hegemons always pursue its self (national) interest?
A state-centric hegemon
Does a hegemon have to be committed to “liberal” economic principles
to succeed?
Comparing the role of a hegemon to the role of the government in providing
certain “public” goods
Hegemonic stability and Regionalism; e.g., NAFT, EU
Declining power and loss of the “leadership” position
Governance of The Global Economy
The effectiveness of a regime
Compliance needs to be enforced
Hegemony and regimes
Leadership ( by the hegemon ) and cooperation
Enforcing compliance through rewards (bribes) and punishments; e.g.,
the Marshal Plan, sanctions
Compliance and domestic goals/problems?
Who should be in charge of the management of the world economy? Is
there a need for a leader?
The fundamentals of the neoclassical approach:
· Individuals pursuing their self-interests
through economic activities involving production, consumption and trade
(based on the principle
of comparative advantage) with full
information under competitive market conditions with minimum government
intervention
· Comparative-static analysis of an equilibrium-bound
market economy with factors such as government, taste, technology being
treated
as exogenous
· Economic institutions (and other institutions)
necessary for the efficient functioning of the market emerge from individual
and
social rational choices consistent with
individuals’ economic objectives
· Government functions limited to correcting market failures and providing for public goods
· Technology assumed as given (a exogenous)
economic growth depends the growth of capital and labor but constrained
by diminishing
returns (to factor) and constant returns
to scale
The shortcomings of the neoclassical approach:
· The long-term dynamics of an economy involving
changes in taste, government structures, economic and social institutions,
etc. are not
adequately contained in neoclassical
models.
· Neoclassical models ignore the roles of
historical and geographical factors in economic development; geographical
diversities as the
cause of variations in economic conditions
(and the distribution of activities) are not recognized; the roles of historical
events and
developments in shaping the economic
environment/conditions of different economies are largely ignored.
· The cases of imperfect competition and incomplete
information (that may be interrelated) are not adequately addressed in
neoclassical
models.
· The geographical distribution of economic
activities (division of labor and specialization) around the world is decided
by the principle
of comparative advantage. The dynamic
shifts in the international distribution of labor and the contentious competition
among nations
over this distribution are hardly dealt
with in neoclassical economics.
· Technology and is considered a “public good”,
treated as an exogenous factor; perfect information implies that all individuals
have
equal and free access to technology.
The importance of innovation (the dynamics of technological changes) and
the fact knowledge
and technology can be privately owned
and monopolized is not recognized. Whereas innovations and access to technology
are
important determinants of economic growth.
· While recognizing the importance of economic
and social institutions for a well functioning market, neoclassical economics
sees them
as (natural) results individuals’ “utility”
maximizing behavior. The fact that historical events (and accidents) could
have had significant
roles in both formation and evolution
of economic and socio-political institutions is not adequately addressed.
The New Theories: The new economic theories incorporate some of the important element that are missing (or ignored) in neoclassical models:
Importance of time and space
The role of government
· The main engine of economic growth in neoclassical economics
is capital accumulation regulated by:
· Diminishing returns
· Technological limitations
· Households’ preference relative to present and future consumption
R&D as an Engine of Growth
National Economy and International Economic Affairs
Differences in National Economies
Fall 03 Lecture notes
PowerPoint Notes
(You must have
Power Point on your computer to open these two files.)
Economic
Integration
Balance
of Payments
The following is the text of the above two files.
Note: These notes are by no mean comprehensive.
They are just an outline of some of the topics covered in the lecture.
You must study the corresponding chapters in the textbook.
International Trade Policy
Economic Integration and Regionalism
Major Trade/Economic Agreements
NAFTA: The North American Free Trade Area
(1994)
EU: The European Union (1957)
Mercosur: Argentina, Brazil, Paraguay, Uruguay
(1991)
ASEAN: Association of Southeast Asian Nations
(1967)
Andean Community: Bolivia, Colombia, Ecuador,
Peru, Venezuela (1973)
What is a trade agreement?
A special agreed upon preferential arrangement
among a group of nations governing their trade/economic relationship:
Trade agreements cover matters related to:
Factor movements
Economic policies
Tariffs and other trade barriers
Trade with other countries
Types of Agreements
Preferential trade arrangements
Free trade area
Customs Union
Common Market
Economic Union
Regional agreement
Measuring Trade
International trade is commonly measured in terms
of the value of the goods (and services than cross borders: Value of exports
plus values of imports
About two-third of international trade take place
among industrial countries.
Countries that belong to established (functioning)
trade blocks (treaties) tend to do significant shares of their trade within
their blocks—e.g., EU, NAFTA, ASEAN
Measuring Trade Flows
A relative measure: World Trade Share
Regional share of trade relative to the total share
Share of the trade block relative to the world trade
Trade concentration ratio
of a trade block
Impacts of Trade Pacts on Trade
Trade creation:
Increases in trade among members of the
pack as a result of the lowering of removal of tariffs and other trade
barriers
Trade diversion:
Diversion of trade (imports)
from more efficient nonmembers (whose products are subject to higher tariffs)
to less efficient members (whose products) are subject to lower tariffs
or no tariffs)
Trade Creation
Multilateralism
Most Favored Nation (MNF)
GATT (General Agreement on Tariffs and Trade)
(From Tokyo to Uruguay1993)
WTO (World Trade Organization) 1995
GATS (General Agreement in Trade in Services);
the e-commerce dilemma
Countervailing Measures to correct unfair practices
Overlapping agreements: APEC (Asia and Pacific
Economic Cooperation
Balance of Payments
International Finance
Balance of Payments
Foreign Exchange Markets
Foreign Exchange Rates
Spot rates and forward rates
Foreign Exchange Systems
Risk Management in International Business
Other internationally traded financial instruments
Balance of Payments
The balance of payments is an accounting listing
(tabulation) of the values of economic (trade and financial) transactions
between the resident of a (home) country and residents of other countries.
Balance of payments entries are recorded based
on the double-entry bookkeeping principle.
The balance of payments entries are always balanced;
the entries add up to zero.
Balance of Payments Account Categories
Current Accounts
Merchandise Trade
Service Trade
Services of Capital: Interest Incomes,
Dividends
Unilateral Current Transfers
Capital Accounts
US private investments abroad
Foreign private investments
in the US
Other investments/capital transactions
Official Accounts
(Changes in) US official reserve
assets abraod: gold, SDRs, foreign currencies
(Changes in) foreign official assets
in the US
Double-Entry Principle
Each transaction affects at least two account
Debit entries balance credit entries
Imports are debit entries
The balancing (credit) entry(ies) for an import
take(s) place in one (or more) of the sections of capital the accounts
Exports are credit entries
The balancing (debit) entry(ies) for an export
take(s) place in one (or more) of the sections of the capital accounts
Capital inflows (increases in foreign assents)
are credit entries
Capital outflows (increases in US residents-owned
assets abroad) are debit entries
Increases in US claims against residents of other
countries are debit entries
Increases in foreign residents’ claims against
US are credit entries
Balance of Payments Balances
Balance of Merchandise Trade
Balance Merchandise and Services
Current Account Balance
Capital Account Balance
Official Settlement Balance
Statistical errors
Overall Balance = 0
How is the BOP balances?
Debit(-) Credit (+)
Export 100
Import 120
Current Account Balance -20
Reduction in US bank
Deposit claims abroad
10
Official Settlement Balance
-10
Reduction in official
reserves
10
Balance of Payments 00
Foreign Exchange Markets
Given that each nation state has its own currency
(with which domestic transactions are carried out), all international transactions
potentially generate either supply or demand for foreign exchange.
Generally, transactions resulting in debit entries
in the BOP generate demand for FX(e.g., imports, investments abroad); transaction
resulting in credit entries generate demand(e.g., exports, foreign investments
in the US)
Foreign exchange markets are places, systems,
or mechanisms through which currencies are exchanged or traded.
Today, most currency exchange rates are largely
determined by the forces of supply and demand
Foreign Exchange Markets
Prices and Exchange Rates
Exchange rate quotes:
The value of FX in domestic currency ($)
$1.5/pound $.0089/Y
$1.20/Euro
The value domestic currency ($) in terms of a
foreign currency
0.666 pound/$ Y112.36/$ E0.8333/$
$ P = e. YP
Foreign (FX)Exchange Rates and Inflation
Changes in FX rate and domestic prices
Appreciation of a currency
Depreciation of a currency
Nominal FX rate vs. real FX rate
The effect of a currency depreciation (on price) could be partly of totally off set by inflation in the prices denominated in that currency
FX Cross Rates and Arbitrage
Suppose
Y/$ rate = Y128/$
Y/E rate = Y150/E
Cross $/E
rate = (150/128) = $1.1718
If the market $ spot rate
for euro is quoted as $1.20/E, there is an arbitrage opportunity:
Buy 128 yen with a dollar,
convert it to euro at Y150/E. You’ll get 0.8533 euro. Then sell your euro
at $1.20/E. You’ll receive $1.024. You have made $.024 on each dollar.
Foreign Exchange Risk
Transaction Exposure
Accounting/Translation Exposure
Economic Exposure
FX Risk Management
FX Spot Markets
Buying or selling FX for immediate
delivery (on the spot)
FX Forward Markets
Buying or selling FX at a
predetermined (agreed upon) rate for future delivery
FX Futures
Buying or selling standardized
blocks of FX at (market determined) preset rates for future delivery
FX Options
Buying or selling options
to buy (call) or options to sell (put) standardized blocks of FX at preset
prices in the future for future delivery
Currency Swaps
A Forward Transaction
An American company is expecting
to receive 2.5 million euro from a German company in the first week of
March. Today’s euro spot rate is $1.17/euro.To avoid a loss from possible
depreciation of the euro, through it bank, the company sells its expected
euro receipt in the forward market at $1.16 per euro for March delivery.
According to this forward contract on March 3 the company will receive:
2,500,000 x 1.16 = $2,900,000
A Call Option Transaction
An American auto importer has purchased
1000 automobiles from Japan. On March 3, the importer is expected to pay
for these cars in yen:
1,320,000,000 yen
The importer purchases 105 blocks
of yen (call) options for March settlement at 92.5* cents per 100 yen at
1.25 per 100 yen.
Today the importer pays:
105x(12,500,000/100)x.0125 = $164,062.5
That is equivalent to 108.018 yen per dollar