Lecture Notes

Lecture Notes
 

Lecture  Notes
The Global Economy

Lecture Two

Lecture Three

Lecture Four

=============================
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

Other Concerns
Global Care Chain
Sisters taking care of brothers and sisters
Costs to migrant women and their families
Are the costs taken into account?
The state of the economy at home and its effect of migrant workers
Are migrant workers better off in the end?
Unpaid work

Globalization and Democracy:

What do our experiences suggests?
How globalization promotes democracy What should come first, economic growth or political reforms? Leftist Movements in a Globalized World Why do many politicians in democratic countries support globalization while people of those countries oppose it?
    The case of NAFTA
    Is WTO antidemocratic?
 



Old Notes
What is wrong with this simple analysis?
The presumption that the market is perfectly competitive and efficient
The level of economic activities does not change, keeping the demand at the same level.
All the producers of the import competing good who cease production would switch to other products, possibly exportable ones.
All displaced workers will placed in other industries, possibly export oriented ones.
The social net gain from trade is always positive
Production Possibilities Curve: An Abstract Picture of the Economy
Given economic resources
Given technology
Full employment
Opportunity costs: No free lunch
The principle of increasing opportunity costs
Relative price: the trade off rate
Absolute advantage
Comparative advantage

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
 
 



Lecture 1
The Global Economy, An Overview
  (Holly See, Switzerland, and Palestine have permanent observers to the UN.) 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

Capital Infrastructure Capital stock and labor productivity

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

                           "In 1945, representatives of 50 countries met in San Francisco at the United Nations
                           Conference on International Organization to draw up the United Nations Charter. Those
                           delegates deliberated on the basis of proposals worked out by the representatives of China,
                           the Soviet Union, the United Kingdom and the United States at Dumbarton Oaks, United
                           States in August-October 1944. The Charter was signed on 26 June 1945 by the
                           representatives of the 50 countries. Poland, which was not represented at the Conference,
                           signed it later and became one of the original 51 Member States.

                           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:

Important political developments: Questions to be asked? Gilpin: No! The news about globalization has been exagerated. For nation states, still  their national interests (security, political power) are the primary determining factors when formulation their international economic and political strategies.                         Inequalities within and among countries
                        Exploitation of workers
                        Declining real wages in developed countries
                        Environmental degradations

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
 

Norms and values
      Constructivism: International politics is  “socially constructed”  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

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?
 
 



Global Political Economy
Economics versus Political Economy

National Interests

 The realities of the world  today
  Political Economy Definitions:
Smith: Political economy
    The science of a statesman or legislator
J.S. Mill: Political economy
  teaches a nation how to become rich
A. Marshall: Economics
    studies human behavior relative to the use of scarce resources in alternative uses

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:

Economic acts and actors
    Economic acts:
            Consumption
            Production
            Saving
            Investment
            Trade/exchange
    Economic actors:
            Owners of resources
            Consumers
            Firms
            Governments
The setting: The market

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



International Political Economy
IPE versus Economics

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?



Questions to be asked:
    · How does the economy work?
    · What makes an economy grow?
    · How does international economic relations (globalization) affect economic growth and development in different countries?
    · Can neoclassical economics explain the dynamics of economic development within and among the economies of the world?
 

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 reality of imperfect competition


The role of government

Economic Growth in Neoclassical Economics

· 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
 

Economies of Scale and Economic Growth Trade and Government Imperfectly Competitive Markets


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