International trade has been growing fast in the 21st century. In USA International trade has roughly tripled in importance compared with the economy as a whole

Imports and exports have both increased but imports have grown more. This has led to a large excess of imports over exports. How is this paid? The money is supplied by inflows of capital, foreign investments which want a stake in the U.S. economy. Earlier this amount of inflow of capital was inconceivable. This is a sign of growing international capital linkages in this example.

In 2009 both imports and exports plunged which reflected the global economic crisis which started in 2008. It is an example of the close link between world trade and the overall state of the world economy.

International economic relations are more crucial for other countries than USA, which as a result of its size and the diversity of its resources, relies less on international trade than almost any other country.

Average of exports and imports as a share of country GDP: Belgium 90%, USA 15%, Germany 45%

International Economics uses the same fundamental methods as domestic transactions. Individuals motives and behavior is the same regardless of the situation.

Seven themes recur throughout the study of international economics

the gains from trade
the pattern of trade
protectionism
the balance of payments
exchange rate determination
international policy coordination
international capital market

Beans from Hawaii and Mexico sold in Florida. Path same but different: Mexico imported, Hawaji internal trade.

International trade can be affected by government decisions and currency rates, such as quotas and as an example... if the value of the Mexican currency falls against the dollar--> Now Mexican coffee is cheaper for Americans.

Constitution forbids
restraints on interstate trade and all U.S. states use the same currency, so this kind of example can't occur with the beans from Hawaii.

The gains from trade

Remember! In international economics single insight important- there are gains from trade- meaning that when countries sell goods and services to each other, this exchange is almost always to their mutual benefit.

Common misconception- trade is harmful if there are large disparities between countries in productivity or wages. People in developing countries such as India fear that if international trade opened, they won't be able to compete against high technology countries. On the other hand, high technology countries fear of diminishing living standards if trading with less advanced lower wage countries occurs.

Chapter 3 shows in how all the parties benefit international trade are even in a situation where another country is more efficient than other, and producers in the less efficient country can only compete with price. We will also see that trade provides the possibility to export goods which use heavily resources that are locally rich and import goods which use heavily resources that are locally narrow. International trade also allows countries to specialize in a narrower range of goods, the potential for larger scale production.

Not only benefits limited to the trade in tangible goods, also migration, borrowing & lending.

International trade can hurt particular groups within the nation, in other words, international trade will have a strong effect on the distribution of income. The important theme is that the International trade can make people redundant with particular narrow skills and affect the distribution of capital ( workers vs owners of capital). it has become clear that real wages for low skilled workers in USA have been declining, as a result of imports from developing countries?

The Pattern of Trade

The main concern for economists is to understand the patterns of international trade- who sells to whom- and also how to observe these paths when discussing recommendations for governmental policies.

Climate and resources partly explain the patterns of trade, Brazil exports coffee and Saudi Arabia Oil.

Why does Japan export Automobiles while USA aircraft? David Riccardo in 19th Century explained that this is a result of international differences in labor productivity. Another theory developed in the 20th century suggests that differences occur as trade patterns are linked to an interaction between the relative supplies of national resources such as capital, labor, and land on one side and the relative use of these factors in the production of different goods on other hands. More in Chapter 5.--> Recent tests shown that this theory is less valid.

How Much Trade?

If Idea of gains from trade most important theoretical concept in International Trade, its most important policy theme is to debate how much trade to allow.

All time governments fear that international competition has a bad impact on the domestic industries. This has led to protectionistic regulations and subsidies, for example by setting limits to imports and subsidizing exports.

Important mission of International economics is to show the positive effects of free trade and analyze the effects of protectionist policies.

In the 90's international trade took one step further as advanced democratic countries led by the United States removed barriers for International trade, which was seen inevitable for future prosperity and world peace.

Major Free Trade Agreements were negotiated.

-North American Free Trade Agreement, NAFTA 1993. USA MEXICO CANADA

-Uruguay Round Agreement, WTO World Tread Organization formed 1994

The anti-globalization movement has been growing along. In Seattle 94, major international trade meeting was disturbed by demonstrators with traditional protectionists- and new ideologies.

Analytical framework has been developed to assess if the Government should interfere with policies regarding international trade, also cost-benefit analysis.

Trade policy disagreements usually within nations not between nations.

Balance of Payments

Trade surplus or trade deficit better? South Korea insists to have deficit while China has been blamed for not playing according to the rules with a surplus of 40 Billion Dollar.

Country's balance of payment must be put into context of an economic analysis to better understand each country's situation.

Specific contexts:

1.Foreign direct investment by foreign multi-national corporations

2. International transactions to national income accounting (Finnish people buying alcohol from Estonia, Estonia's drink the most alcohol/per inhabitant in the world?)

3. International monetary policy

The problem of protectionism, USA has had trade deficit since 83.

Exchange Rate Determination

Currency exchange rate new subject to the international trade, earlier rates were fixed by governments rather than determined in the marketplace. Euro- Dollar comparison. As Euro depreciates like in 2002, Eur= (0,82 Dollar), European exporters benefit.

More in the later chapters

1. working of a fixed rate systems 2. historical performance of alternative exchange rate systems 3. economics of currency areas. 4. floating exchange rates.

International Policy Coordination

In integrated system important for the countries to coordinate their policies. A fundamental problem in international trade is to produce an acceptable degree of harmony among the international trade and monetary policies of different countries.

Germany's Bundesbank raised interest in 1990 to control the possible inflationary impact of the reunification of West and East Germany. This helped building recession to other Western European countries.

International trade policies have been governed for 70 years by an International Treaty known as General Agreement on Tariffs and Trade (GATT). SInce 94 international trade rules have been enforced by WTO.

-Coordination of international macroeconomic policies more newer and also uncertain topic.

The International Capital Market

Examples from the past as advanced countries have lend money to developing countries, leading to financial crises.

1982 Mexico was unable to pay back money they owed-->Debt crisis persisted untill 90's.
Latin America and Asian countries got investments worth of hundreds of billions of dollars as emerging markets.
1994 Mexico
1997 Asia massive crisis
Argentina 2002

These show that there is a need for an international capital market.

Today in sophisticated economies there is an extensive capital market. A set of arrangements by which individuals and firms exchange money for promises to pay in the future.

International capital market examples:

70's Middle Eastern Oil companies placed oil revenues in banks in London and New York--> these corporations lend money to Latin America and Asia
80's Japan converted its export revenues into investments in the US, including many subsidiaries of Japanese corporations.
China invests its own exports into foreign assets, including dollar which is hold as international reserves.

International capital markets differ from domestic markets. They must cope with special regulations that are imposed on foreign investments. Possibilities also to evade regulations regarding domestic market

-London EuroDollar market. Billions of Dollars exchanges without it ever landing USA.

RISKS

Currency fluctuation-if Euro falls- USA Eur bond investors lose capital.

National defaults, one country simply could refuse to pay its debts.

International Economics: Trade and Money

The economics of International trade can be divided into two subfields:

Study of international trade

Study of international money

International trade: Focuses on the real transactions in the international economy, physical transactions of goods or tangible commitment of economic resources.

International money: Monetary analysis focuses on the financial transactions such as foreign purchases of U.S. Dollars.

World Trade Chapter 2

In 2008 around the world goods and services produced worth of about 50 Trillion Dollars at current prices. More than 30% were sold across borders.

Who trades with whom?

Empirical relationship known as the gravity model helps to understand the value of trade between any pair of countries and shows obstacles which limit international trade

..Changing the structure of world trade, towards Asia and types of goods that make up the trade...

USA main trade partners: Canada, China, Mexico, Japan, Germany, UK, South Korea

Gravity model

Three highest European countries in USA top 10..? list, Germany, UK and France. They have the highest GDP, which is the total value of all goods and services produced in an economy. A Strong empirical relationship is found between the large size of the economy and the volume of both imports and exports.

Looking at world trade as whole, the economists have found have found out that the following equation predicts the volume of trade between any two countries fairly accurately:

Tij= A x Yi x Yj/Dij

Tij= value of trade between two countries i and j

Yi= country i GDP

Yj= country j GDP

Dij= Distance between two countries

-Is trade proportional to the product?

ASK!!!! what is meant by the product???.....!!!

Why does gravity model work?

The larger the economy the larger the income. With the larger income comes the larger amount of imports. They also tend to get a share of other countries spending as they produce a wide range of products.

Actual trade flow between countries smaller than could think. The USA and Europe form 25% of Worlds GDP, but only attract 2% of the other's spending (Whole world or either of these areas? To make sense of actual trade flows, we need to consider factors limiting international trade.

Anomalies in gravity model make economists search deeper into the context. Belgium and Ireland larger share of US trade than gravity model suggests. Cultural reason for Ireland, same language, and the many USA descend from Irish people. Belgium's location is perfect at the entrance of River Rhine and West Europe. Antwerp together with Rotterdam one of the biggest harbors in EU...logistic costs cheaper.

Gravity model estimate to distance= 1 % increase to distance results in fall of 0-7-1% in trade between two countries

Also less tangible role with distance= the closer countries the closer usually shared culture and personal contact.

NAFTA trade agreement: no barriers or tariffs on trade among USA, Canada, and Mexico.

The Canada-USA border is reducing the potentiality of trade. Look closer at the study made between British Columbia and its trade calculated by the GDP rate of the USA and Canadian provinces surrounding it. More trade with Canadian provinces compared with USA provinces from an equal distance, border not efficient.

The changing Pattern of World Trade

Has the world become smaller? With technology and easier transportation access, the distance shouldn't be a too big problem. Gravity model still suggests that in international trade distance has a negative effect on trade.

Vertical disintegration- today a product can increase value already in the production phase as the product is produced and assembled in different countries and so affecting positive international trade flows. Estonia vs Finland... the benefit for Finland of Companies only moving production elsewhere?

2008 World trade= 54,73 % Manufacturers, 19.77% Services, 18,48 % Fuels and Mining, 7,02% Agricultural

Exotic new forms of trade can rise up and form a bigger part of services, like telecommunication from developing countries.

Service exports include transportation fees, insurance fees from foreigners and spending by foreign tourists.

From primary goods in the 70's to manufactured goods today. Primary= Agriculture, cloth Manufactured= Finished product like cloths

Service offshoring= outsourcing, which products are tradable at long distances. How big can outsourging become? Service jobs possible to outsource more than manufacturing. 2008 USA study 40% outsourcable, 60% not.

Labour Productivity and Comparative Advantage: The Ricardian Model Chapter 3

Two reasons why countries engage to International trade, both contribute to gains of trade.

The opportunity cost of producing one good from producing another. Roses and Computer example--> Rearrangement of production--> Same amount of roses produced but more computers.

The opportunity cost of producing: 10 million roses could be produced in USA, if this labour would be used for computers, amount of produced computers would be 100 000. The opportunity cost of producing 10 million roses is 100 000 computers. Another way round opportunity cost of producing 100 000 computers would be 10 million roses.

Roses could be instead produced in Columbia. The opportunity cost of those roses in terms of computers is less than it would be in the USA.

Columbian workes also less efficient in producing sophisticated goods such as computers, which means that with equal resources production of computers yields fewer computers in Columbia than in the US. Opportunity cost of producing 10 million roses in Columbia is propablt a lot smaller in terms of computers, maybe 30 000.

A country has a comparative advantage if the opportunity of producing a good in terms of other goods is lower in that country than it is in other countries, like roses in Colombia and computers in USA.

Trade between
two countries can benefit both countries if each country exports the goods in which it
has a comparative advantage.

Ricardion model: international trade is solely due to international differences in the productivity of labour.

COMPARAtIVE ADVANTAGE-IMPORTANT TOPIC!!

Production Possibility Frontie PPP

factors of production:number of h/per x amount

aLC Qc + aLW Qw =

aLC & aLW =labour requirements for goods

Qw=economy's production of wine

Qc=economu's production of cheese

Slope: aLC/ aLW =opportunity cost of cheese in terms of wine

Relative prices and supply

Production Possibility Frontier shows different mixes of goods the economy can produce.

To decide what goods to produce we need to know the relative prices- the price of one good in terms of other-

In a competitive economy:

1.supply decisions are determined by individuals attempts to maximize earnings.

2. In simplified economy, where Labour only factor of production

---> the supply of cheese and wine will be determined by the movements of workers to the sector which pays higher wages.

Next up

Previous

Lecture 3