Announcements Midterm is approaching… less than 2 weeks –Midterm review sheet on website soon (probably tomorrow) Midterm review session: –During section on Tues-Friday next week, & following Monday Agenda Midterm info More on economic globalization –Currencies & financial crises –Trade & trade agreements
Midterm Info Exam Format: Closed book / closed notes Mix of short answer/multiple choice, medium length, and perhaps one short essay question No bluebook needed Topic coverage: All class lecture material –Lecture notes on course website All readings up through Week 5 Commanding Heights video, Episodes 1 & 3 –Available via course web page…
Review: Economic Globalization What do you need to have a global economy? –1. Inexpensive transportation & communication –2. International financial (money) system –3. Countries that are willing to participate Absence of legal or regulatory “barriers” History of the international financial system Gold Standard: Money equivalent to gold Bretton Woods: US dollar based on gold, used for trade Floating exchange rates: supply/demand affect currencies
Currency Value Examples CountryCurrencyNumber per US$ EuropeEuro0.736 CanadaDollar1.004 ChinaYuan/RMB6.22 IndiaRupee53.25 JapanYen91.32 MexicoPeso12.71 South KoreaWon1088 ThailandBaht29.86 United KingdomPound.63 As of Jan 31, 2013
Trade & Exchange Rates Currency values affect trade: Example: Suppose the Euro becomes more valuable relative to the dollar: Value of dollar drops from.70 Euros to.10 Euros –Euro worth 1.44 US$, goes up to 10 US$ How much would a US$ 1,000 computer cost to a European? Answer: Only 100 Euros! When your currency goes up relative to others, it becomes cheaper to import If currency value drops, imports become expensive.
Trade & Exchange Rates Who benefits if the US dollar goes up relative to the Euro? 1. American consumers – they can buy European products cheaply 2. European exporters – they can sell lots to the U.S. Who Loses? 1. European consumers – American imports become expensive 2. American companies – can’t compete with cheap imports from Europe
Floating Exchange Rates Why do currency values “float” (change in value relative to others)? Answer: Changes in supply/demand But: What forces affect supply and demand? 1. Asymmetric trade If a country imports lots more than it exports (“current accounts deficit”), its currency drops –Ex: If US has a current accounts deficit with Japan To purchase Japanese goods, Americans must sell dollars, buy Japanese Yen –Demand drives up value of Yen relative to the dollar Converse is also true… lots of exports cause a currency to float up…
Floating Exchange Rates Example: The effects of asymmetric trade on currency values Suppose I sell 10,000,000 computers Europeans will sell 7.5 billion Euros to banks in order to purchase 10 billion US$… –If banks (currency markets) are flooded with Euros, supply increases, value drops… Currency markets don’t want more Euros –Changing currency values often result in a trade equilibrium Drop in currency limits subsequent imports But, we’ll discuss exceptions… (ex: China & US)
Floating Exchange Rates What forces affect currency values? 2. Asymmetric capital flows –If capital moves into a country, currency goes up Ex: In early 1990s, global investors moved money into Thailand, Mexico… raising the value of currency –If capital moves out of a country, its currency goes down Investors feared problems in Mexico, Thailand… pulled money out Thai Baht and Mexican Peso dropped in value.
Floating Exchange Rates What causes asymmetric capital flows? 2. a. Changes in interest rates If a country raises interest rates, its currency goes up –Reason: Foreign investors prefer high rates –The “electronic herd” is attracted to high rates… If a country cuts interest rates, its currency drops –Investors would prefer moving money into countries where banks pay higher interest… –Important issue: Globalization limits the ability of governments to control their own monetary policy Sometimes countries want to lower interest rates to boost the economy… –But doing so might cause adverse effects on currency…
Floating Exchange Rates What causes asymmetric capital flows? 2. b. Anything that “scares” investors –Concern that an economy may have problems Ex: Fears that Thailand was going “bust” –Policy changes that investors don’t like Ex: big increase in taxes Shift away from free-market policies (“golden straightjacket”) –Government instability –All of these things can cause investors to pull their money out of a country quickly, harming currency values.
Floating Exchange Rates What forces affect currency values? 3. Countries can intervene strategically to alter their currency values –Sometimes keeping it at a “fixed” value with the dollar or other major currency Governments can sell their currency to lower its value –They buy other currencies on global markets Governments can buy their own currency to raise its value –They spend reserves of gold or other currencies on global markets –Of course, this requires lots of money Mainly, big / wealthy countries do this (ex: China) Small countries sometimes fail (ex: Thailand).
Financial Flows & Exchange Rates Issue: Asymmetric trade & capital flows cause currencies to shift But remember: Investment flows are larger than trade flows, and they can happen much faster Elwood: “pinball capital” Result: global investors can cause currency values to change rapidly Called: market volatility (rapid change in value).
Exchange Rates & Volatility Capital flows and resulting currency volatility can produce severe crises Example: Mexico in 1994 Global investors bought lots of stock, investments in Mexico over several years… –This caused a slow rise in the peso. Not a problem. A minor political crisis led to panic selling in 1994 –The stock market began to plummet Global investors rushed to sell stocks, converted pesos to dollars Result: Selling of pesos made the value of pesos plummet!
Video Commanding Heights, Ep 3, chapter 7 Time: 27:50 – 32:45. Mexican Peso Crisis (also called the “Tequila Crisis”)
Exchange Rates & Volatility Why was it bad for the value of pesos to drop severely, rapidly? –1. Suddenly, imports were very expensive Price of gas shot up Businesses dependent on imports couldn’t afford costs; potential for bankruptcies –2. Mexican companies & government had borrowed money from US banks US banks must paid in $, not pesos If pesos are worth less, suddenly you can’t afford to pay loans Result: More bankruptcies, economic recession.
Exchange Rates & Volatility In the case of the 1994 peso crisis, the US government stepped in Provided emergency loans, etc., to prevent massive bankruptcy –After panic, currency stabilized But, that was just a small crisis… It is clear that crises could occur that are too large to stop so easily.
Asian Financial Crisis Commanding Heights Video: In the 1990s, foreign investors moved capital into Asia And, foreign banks lent money to Asian companies at very low interest rates –Consequence: Rapid economic growth Economies “heated up” But, capitalism is prone to boom-bust cycles… Companies built more factories and housing than needed –The “boom” ended But – global dynamics made the “bust” much worse!
Asian Financial Crisis How did globalization prompt a crisis for Asian economies in the 1990s? –1. Investors pulled out quickly – affecting currencies Asian currency valued dropped… Imports became expensive Companies could no longer pay off loans to foreign banks –Bankruptcies, unemployment…
Asian Financial Crisis How did globalization prompt a crisis for Asian economies in the 1990s? –2. Contagion Worries about Thailand spread to other Asian countries –Self-fulfilling prophecy: fear of problems caused investors to pull out, creating real problems Also, many US companies were invested in Asia (or had made loans)… Now they were losing money –Lesson: Integrated economies mean that crises tend to spread… Example: US financial crisis caused economic disruption around the globe.
More Video: Commanding Heights Topic: Asian financial crisis, spillover to other regions… Video: 40:48 to 48:10 (8 minutes) –Asian economic miracle Video: 48:10-1:14:30 (36 minutes) –Asian financial crisis and contagion
Commanding Heights Asian financial crisis wrap-up –Long Term Capital Management (LTCM) A US-based hedge fund; assets $130 billion in 1998 –Controlled much more Used leverage (borrowed funds) to invest globally Crisis in Asia/Russia caused LTCM to take huge losses –LTCM was bankrupt (owed more than it had to US banks) »US banks were threatened with huge losses (like 2008) –AND: If LTCM was forced to sell remaining assets, markets would fall further – making things worse! Strategy: US engineered a private bailout –Banks lent LTCM a huge amount of money to keep going until markets recovered –IMF and other lenders also bailed out countries (e.g., Brazil) to end financial crisis.
Asian financial crisis Wrap-up Remarks: –The 1998 crisis was ended… but nearly brought down major US banks And, caused massive suffering in many countries –The 2008 crisis DID bring down major US banks Only government intervention saved the financial system from a TOTAL disaster Again, massive suffering –Recession, 10% unemployment –Lack of funds for government services (including cuts to UC) –Contagion in Europe –Issue: Is this acceptable? Do we need to regulate markets more aggressively? If so, how?
Participation in Globalization Question: Given the dangers, why do some countries want to participate in globalization? What are the benefits? And for whom? International trade and capital flows can increase economic growth Corporations often stand to benefit most... So business elites tend to support globalization BUT, other groups in society may also benefit –Investment can create new jobs, employment –Consumers can have access to wider array of goods, cheaper goods –… the “golden” part of the “golden straightjacket”
Benefits of Trade / Investment Without trade, every country must produce all kinds of goods – cars, coffee, computers, etc. Issue: Countries vary in their ability to produce goods efficiently Example: Coffee can be grown in America, but not very efficiently due to climate Example: Computers can be built in Columbia, but not very efficiently due to lack of technology, infrastructure Result: Without trade, production is less efficient.
Benefits of Trade / Investment Economists Adam Smith and David Ricardo argued: Trade allows nations to specialize in what they do best… their comparative advantage… –See Stiglitz Ch 3, p –Countries can focus on things they produce efficiently And, trade for things they don’t produce efficiently –Result: Greater efficiency & economic growth This can produce a win/win situation, where both countries are better off –Not counting environmental consequences, etc.
Benefits of Trade / Investment Also, economists predict that foreign capital will benefit economic growth –Recall: Investment is a major ingredient in long- term economic growth Allowing foreigners to invest in a country results in more overall investment Example: If Sony builds a TV factory in a country, the economy will grow –And, intangible capital flows can have benefits Example: Foreign banks may lend money at low rates –Access to capital allows domestic companies to invest Lower rates and investment help economic growth.
Benefits of Trade / Investment Many people – including sociologists – have criticized the Smith/Ricardo model of trade Critics have shown lots of bad side-effects from globalization: –Increasing inequality, crises, environmental problems, etc… –BUT, research evidence doesn’t typically find disastrous economic effects of trade/investment Extreme fears about the dangers of trade/investment do not seem warranted…
Reading: Rodrik The benefits: analogy: Trade = technology Trade, like new technology, allows nations to convert some products (e.g., raw materials) into something else Example: We can magically turn wheat into electronics… by trading with Japan Yes, new technologies cause people to lose jobs… but who wants to go back to a world of manual labor? Likewise, we shouldn’t resist free trade…
Reading: Rodrik Question: So why doesn’t everyone love free trade? –1. benefits of trade involve large shifts in production To reap benefits, we have to shift production toward things we produce efficiently (e.g., wheat) and away from other stuff Lots of transitional (and permanent) unemployment Rodrik: Ratio = $50 shifted to gain $51 in GDP.
Reading: Rodrik So why doesn’t everyone love free trade? –2. Benefits of trade aren’t quite like technology For one thing, they repeatedly put the same people out of work –Namely, those without high levels of education/skills –3. Benefits of trade don’t always work out in practice Example: Merchandise trade between Europe/United States & poor countries in Asia may be harming US economic growth (Krugman) Some poor countries fare badly in trade with rich countries (more on this later).
Benefits of Trade / Investment Who benefits from global trade/investment? –1. Many benefit from greater economic growth The wealthy usually benefit a great deal… –2. Consumers benefit from cheap imports –3. Multi-national corporations, because they can move operations to wherever is cheapest –4. Highly competitive export-oriented companies benefit from access to new markets –And, workers in those industries tend to benefit –5. Investors can invest where profits are big Ex: pension funds CalPERS, LTCM –6. Companies that can get cheap credit from foreign banks
Problems of Trade / Investment Who might oppose global trade & investment? –1. Corporations in industries that will face greater international competition Example: steel & auto industries in the US –2. Workers in industries that will face competition And labor unions more generally… –3. People & governments concerned about: Potential for economic crises Loss of state autonomy –Pressure to please foreign capital; loss of domestic ownership Difficulty regulating global capitalism –Environmental problems, sweatshops, etc.
Barriers to Trade / Investment Definition: Protectionism = blocking foreign imports or capital flows Opposite: “Liberalization” or “opening up markets” Note: different from typical use of “liberal” in US Reasons to pursue protectionism: –1. Protect domestic companies or industries from foreign competition Prevent bankruptcies, job loss in inefficient industries –2. To reduce risk of financial crises. –3. Prevent foreign ownership and/or control of the companies or the economy Example: People get nervous when Chinese companies buy major US oil or computer companies
Barriers to Trade Strategies for protectionism 1. Tariffs – taxes on imported goods and services Example: The US government can impose a $2,000 tax on Japanese cars Fewer people will buy Japanese cars, imports will decrease 2. Quotas – a government-imposed numeric limit on imports Example: The US may allow only 500,000 Japanese cars to be imported in any given year.
Barriers to Trade Strategies for protectionism (continued) 3. “Non-tariff” barriers – A government regulation that indirectly limits trade or makes it more expensive –Example: Strong agricultural subsidies make it impossible for foreign imports to compete NOTE: Subsidies block imports, just like tariffs… –Example: The US may impose complex agricultural inspections that delay or discourage imported fruit Could be legitimate, or simply a way of stopping imports.
Barriers to Investment Strategies for protectionism (continued) 4. “Foreign ownership” laws – laws that limit the ability of foreigners to buy companies Example: US government could require owners of corporations to be US citizens 5. “Capital controls” – laws designed to prevent the rapid withdrawal of capital/investment Example: Law requiring invested capital to remain in the country for one year –Thus, preventing rapid flows in and out.
Removal of Barriers How do trade/capital barriers get removed? “Liberalization” or “opening markets” Answer: When governments agree to remove them… In direct negotiation with other countries Or, via international treaties & organizations –GATT; NAFTA; WTO.
Removal of Barriers Bi-lateral negotiations & treaties: When two countries negotiate trade & investment barriers Ex: The US negotiates with China, haggling over barriers –“You reduce tariffs on American cars, and we’ll reduce import quotas on Chinese textiles” –Note: Barriers can also be raised as coercion Example: US threatens to impose quotas on Chinese steel products, if China doesn’t lower tariff –China might respond by threatening to raise tariffs on the US Escalation of this is called a “trade war.”
Example: Bi-Lateral Trade Negotiations South Korea, U.S. May Hold Farm Trade Talks in March SEOUL (Reuters) - The United States and its seventh-largest trading partner began talks on a free trade agreement in June It would be the biggest free trade deal for the United States since the North American Free Trade Agreement was signed in Agriculture has been one of the toughest sectors to negotiate in a free trade deal between two countries, especially because of intense opposition from South Korean farmers to market liberalization. South Korea's farm ministry repeated Seoul's position that it would continue to insist on exempting rice under a bilateral free trade deal. ``Rice should be excluded." South Korea and the United States recently failed to resolve the dispute over U.S. beef imports, which Washington said could threaten the free trade pact. –Exceprt: New York Times 2/21/07
Free Trade Agreements Multilateral agreements When groups of countries negotiate together to reduce barriers Ex: NAFTA; also negotiations under GATT, WTO Quick review of NAFTA consequences: –Schaeffer, p. 242; also Stiglitz Ch 3 –US: Slight increase in exports; ,000 added jobs; 140,000 textile jobs lost to Mexico –Canada Lost 500,000 jobs –Given the size of Canada, this was huge Canada imports heavily from US; currency devalued.
Free Trade Agreements Impact of NAFTA (cont’d) –Mexico 600,000 new textile jobs; offset by other job losses Imports from US increase –This was one factor leading up to the crisis in 1994 –Other losers? Organized labor (Unions) –From commanding heights video: –Other winners? Consumers Multi-national corporations Possible long-term increase in efficiency, growth.
Problems With Trade Agreements Rich/powerful countries have numerous advantages in negotiating trade agreements –See: Stiglitz, Chapter 3 Some points to consider: 1. Advantages of Rich/powerful countries are biggest in bi-lateral trade negotiations Example: US vs. a small Latin American country US can bully, bring great pressure… Often, those turn out worse for poor countries than large multilateral agreements.
Problems With Trade Agreements 2. Rich/powerful countries disproportionately control the agenda of agreements “The United States and Europe have perfected the art of arguing for free trade, while simultaneously working for trade agreements that protect themselves against imports from developing countries.” Stiglitz Ch 3 p. 78. Topics addressed by FTAs benefit rich countries –Ex: focus has been on removing barriers for high-value goods & investment, not farm products or low-tech stuff And, rich countries are savvy at using dispute resolution procedures –They have lots of lawyers, using technicalities to block imports.
Problems With Trade Agreements 3. Government trade negotiators are often influenced by powerful groups Rather than negotiating for terms that will benefit everyone in a country, negotiators may cater to big corporations Example: Suppose Guatemala is negotiating over a tariff that limits big business, but protects jobs? –Companies may push the government to get rid of the tariff, even if many workers will be harmed…
Stiglitz: Making Trade Fair Stiglitz, Chapter 3: Recommendations –1. Developing countries should be treated differently from wealthy countries Previously, most trade agreements focused on equal treatment, but poor countries can’t really compete… –1. A. So, rich countries should simply open their economies to the poorest countries –This would have a much bigger effect than providing direct aid –NOTE: Europe has started moving in this direction –1. B. Poor countries should be allowed to use subsidies to support “infant industries” Rich countries have little to lose… but benefits are big.
Stiglitz: Recommendations: 2. Rich countries should stop MASSIVE agricultural subsidies –Rich countries give huge amounts of money to (mainly) industrial farms –Norway: two-thirds of farm income is from subsidies –EU spends 80 billion US$; US spends –Consequences: Farmers in rich countries can sell food at LOW prices and still make a profit –Often below the cost of farmers in poor countries Farmers in poor countries can’t compete… go broke.
Stiglitz: Recommendations 3. Escalating tariffs should be ended Escalating tariffs: taxing manufactured products at higher rates than raw materials –Ex: Having no tariffs on raw agricultural goods, but high tariffs on higher-value processed goods –No tax on apples; high tax on applesauce Issue: This prevents poor countries from industrializing –They are stuck farming –While rich countries have cheap source of produce for their high-value industries.
Stiglitz: Recommendations 4. Remove barriers to unskilled services & migration Rich countries have pushed to remove barriers for high- tech services (banking, accounting, software) Barriers remain in low-skill services –Example: Shipping/trucking. Foreign companies aren’t allowed This is one area that poor countries could actually compete… Also, allowing more labor flows would provide a huge benefit to poor countries.
Stiglitz: Recommendations 5. Restrict the use of non-tariff barriers There are legitimate reasons for having them… BUT, more often they are used by rich countries to protect their own markets –Despite claims of supporting free trade 6. Restrict bi-lateral agreements They are rarely advantageous to poor countries –Due to asymmetry in power between negotiators And, they tend to undermine multilateral agreements
Stiglitz: Recommendations 7. Reform governance Change the rules of organizations like the WTO Issues (p. 97): –How decisions get made –What gets put on the agenda –How disagreements are resolved –How rules are enforced Currently, rules sometimes favor rich countries System should be more open/transparent, more democratic, with better enforcement for small countries.