2 Announcements Announcements Agenda Midterm is approaching… less than 2 weeksMidterm review sheet on website soon (probably tomorrow)Midterm review session:During section on Tues-Friday next week, & following MondayAgendaMidterm infoMore on economic globalizationCurrencies & financial crisesTrade & trade agreements
3 Midterm Info Exam Format: Topic coverage: Closed book / closed notes Mix of short answer/multiple choice, medium length, and perhaps one short essay questionNo bluebook neededTopic coverage:All class lecture materialLecture notes on course websiteAll readings up through Week 5Commanding Heights video, Episodes 1 & 3Available via course web page…
4 Review: Economic Globalization What do you need to have a global economy?1. Inexpensive transportation & communication2. International financial (money) system3. Countries that are willing to participateAbsence of legal or regulatory “barriers”History of the international financial systemGold Standard: Money equivalent to goldBretton Woods: US dollar based on gold, used for tradeFloating exchange rates: supply/demand affect currencies
5 Currency Value Examples CountryCurrencyNumber per US$EuropeEuro0.736CanadaDollar1.004ChinaYuan/RMB6.22IndiaRupee53.25JapanYen91.32MexicoPeso12.71South KoreaWon1088ThailandBaht29.86United KingdomPound.63As of Jan 31, 2013
6 Trade & Exchange Rates Currency values affect trade: Example: Suppose the Euro becomes more valuable relative to the dollar:Value of dollar drops from .70 Euros to .10 EurosEuro worth 1.44 US$, 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 importIf currency value drops, imports become expensive.
7 Trade & Exchange RatesWho benefits if the US dollar goes up relative to the Euro?1. American consumers – they can buy European products cheaply2. European exporters – they can sell lots to the U.S.Who Loses?1. European consumers – American imports become expensive2. American companies – can’t compete with cheap imports from Europe
8 Floating Exchange Rates Why do currency values “float” (change in value relative to others)?Answer: Changes in supply/demandBut: What forces affect supply and demand?1. Asymmetric tradeIf a country imports lots more than it exports (“current accounts deficit”), its currency dropsEx: If US has a current accounts deficit with JapanTo purchase Japanese goods, Americans must sell dollars, buy Japanese YenDemand drives up value of Yen relative to the dollarConverse is also true… lots of exports cause a currency to float up…
9 Floating Exchange Rates Example: The effects of asymmetric trade on currency valuesSuppose I sell 10,000,000 computersEuropeans 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 EurosChanging currency values often result in a trade equilibriumDrop in currency limits subsequent importsBut, we’ll discuss exceptions… (ex: China & US)
10 Floating Exchange Rates What forces affect currency values?2. Asymmetric capital flowsIf capital moves into a country, currency goes upEx: In early 1990s, global investors moved money into Thailand, Mexico… raising the value of currencyIf capital moves out of a country, its currency goes downInvestors feared problems in Mexico, Thailand… pulled money outThai Baht and Mexican Peso dropped in value.
11 Floating Exchange Rates What causes asymmetric capital flows?2. a. Changes in interest ratesIf a country raises interest rates, its currency goes upReason: Foreign investors prefer high ratesThe “electronic herd” is attracted to high rates…If a country cuts interest rates, its currency dropsInvestors would prefer moving money into countries where banks pay higher interest…Important issue: Globalization limits the ability of governments to control their own monetary policySometimes countries want to lower interest rates to boost the economy…But doing so might cause adverse effects on currency…
12 Floating Exchange Rates What causes asymmetric capital flows?2. b. Anything that “scares” investorsConcern that an economy may have problemsEx: Fears that Thailand was going “bust”Policy changes that investors don’t likeEx: big increase in taxesShift away from free-market policies (“golden straightjacket”)Government instabilityAll of these things can cause investors to pull their money out of a country quickly, harming currency values.
13 Floating Exchange Rates What forces affect currency values?3. Countries can intervene strategically to alter their currency valuesSometimes keeping it at a “fixed” value with the dollar or other major currencyGovernments can sell their currency to lower its valueThey buy other currencies on global marketsGovernments can buy their own currency to raise its valueThey spend reserves of gold or other currencies on global marketsOf course, this requires lots of moneyMainly, big / wealthy countries do this (ex: China)Small countries sometimes fail (ex: Thailand).
14 Financial Flows & Exchange Rates Issue: Asymmetric trade & capital flows cause currencies to shiftBut remember: Investment flows are larger than trade flows, and they can happen much fasterElwood: “pinball capital”Result: global investors can cause currency values to change rapidlyCalled: market volatility (rapid change in value).
15 Exchange Rates & Volatility Capital flows and resulting currency volatility can produce severe crisesExample: Mexico in 1994Global 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 1994The stock market began to plummetGlobal investors rushed to sell stocks, converted pesos to dollarsResult: Selling of pesos made the value of pesos plummet!
16 Video Commanding Heights, Ep 3, chapter 7 Time: 27:50 – 32:45. Mexican Peso Crisis (also called the “Tequila Crisis”)
17 Exchange Rates & Volatility Why was it bad for the value of pesos to drop severely, rapidly?1. Suddenly, imports were very expensivePrice of gas shot upBusinesses dependent on imports couldn’t afford costs; potential for bankruptcies2. Mexican companies & government had borrowed money from US banksUS banks must paid in $, not pesosIf pesos are worth less, suddenly you can’t afford to pay loansResult: More bankruptcies, economic recession.
18 Exchange Rates & Volatility In the case of the 1994 peso crisis, the US government stepped inProvided emergency loans, etc., to prevent massive bankruptcyAfter panic, currency stabilizedBut, that was just a small crisis… It is clear that crises could occur that are too large to stop so easily.
19 Asian Financial Crisis Commanding Heights Video:In the 1990s, foreign investors moved capital into AsiaAnd, foreign banks lent money to Asian companies at very low interest ratesConsequence: Rapid economic growthEconomies “heated up”But, capitalism is prone to boom-bust cycles…Companies built more factories and housing than neededThe “boom” endedBut – global dynamics made the “bust” much worse!
20 Asian Financial Crisis How did globalization prompt a crisis for Asian economies in the 1990s?1. Investors pulled out quickly – affecting currenciesAsian currency valued dropped…Imports became expensiveCompanies could no longer pay off loans to foreign banksBankruptcies, unemployment…
21 Asian Financial Crisis How did globalization prompt a crisis for Asian economies in the 1990s?2. ContagionWorries about Thailand spread to other Asian countriesSelf-fulfilling prophecy: fear of problems caused investors to pull out, creating real problemsAlso, many US companies were invested in Asia (or had made loans)… Now they were losing moneyLesson: Integrated economies mean that crises tend to spread…Example: US financial crisis caused economic disruption around the globe.
22 More Video: Commanding Heights Topic: Asian financial crisis, spillover to other regions…Video: 40:48 to 48:10 (8 minutes)Asian economic miracleVideo: 48:10-1:14:30 (36 minutes)Asian financial crisis and contagion
23 Commanding Heights Asian financial crisis wrap-up Long Term Capital Management (LTCM)A US-based hedge fund; assets $130 billion in 1998Controlled much moreUsed leverage (borrowed funds) to invest globallyCrisis in Asia/Russia caused LTCM to take huge lossesLTCM 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 bailoutBanks lent LTCM a huge amount of money to keep going until markets recoveredIMF and other lenders also bailed out countries (e.g., Brazil) to end financial crisis.
24 Asian financial crisis Wrap-up Remarks:The 1998 crisis was ended… but nearly brought down major US banksAnd, caused massive suffering in many countriesThe 2008 crisis DID bring down major US banksOnly government intervention saved the financial system from a TOTAL disasterAgain, massive sufferingRecession, 10% unemploymentLack of funds for government services (including cuts to UC)Contagion in EuropeIssue: Is this acceptable? Do we need to regulate markets more aggressively? If so, how?
25 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 growthCorporations often stand to benefit most... So business elites tend to support globalizationBUT, other groups in society may also benefitInvestment can create new jobs, employmentConsumers can have access to wider array of goods, cheaper goods… the “golden” part of the “golden straightjacket”
26 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 efficientlyExample: Coffee can be grown in America, but not very efficiently due to climateExample: Computers can be built in Columbia, but not very efficiently due to lack of technology, infrastructureResult: Without trade, production is less efficient.
27 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, pCountries can focus on things they produce efficientlyAnd, trade for things they don’t produce efficientlyResult: Greater efficiency & economic growthThis can produce a win/win situation, where both countries are better offNot counting environmental consequences, etc.
28 Benefits of Trade / Investment Also, economists predict that foreign capital will benefit economic growthRecall: Investment is a major ingredient in long-term economic growthAllowing foreigners to invest in a country results in more overall investmentExample: If Sony builds a TV factory in a country, the economy will growAnd, intangible capital flows can have benefitsExample: Foreign banks may lend money at low ratesAccess to capital allows domestic companies to investLower rates and investment help economic growth.
29 Benefits of Trade / Investment Many people – including sociologists – have criticized the Smith/Ricardo model of tradeCritics 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/investmentExtreme fears about the dangers of trade/investment do not seem warranted…
30 Reading: Rodrik The benefits: analogy: Trade = technology Trade, like new technology, allows nations to convert some products (e.g., raw materials) into something elseExample: We can magically turn wheat into electronics… by trading with JapanYes, 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…
31 Reading: Rodrik Question: So why doesn’t everyone love free trade? 1. benefits of trade involve large shifts in productionTo reap benefits, we have to shift production toward things we produce efficiently (e.g., wheat) and away from other stuffLots of transitional (and permanent) unemploymentRodrik: Ratio = $50 shifted to gain $51 in GDP.
32 Reading: Rodrik So why doesn’t everyone love free trade? 2. Benefits of trade aren’t quite like technologyFor one thing, they repeatedly put the same people out of workNamely, those without high levels of education/skills3. Benefits of trade don’t always work out in practiceExample: 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).
33 Benefits of Trade / Investment Who benefits from global trade/investment?1. Many benefit from greater economic growthThe wealthy usually benefit a great deal…2. Consumers benefit from cheap imports3. Multi-national corporations, because they can move operations to wherever is cheapest4. Highly competitive export-oriented companies benefit from access to new marketsAnd, workers in those industries tend to benefit5. Investors can invest where profits are bigEx: pension funds CalPERS, LTCM6. Companies that can get cheap credit from foreign banks
34 Problems of Trade / Investment Who might oppose global trade & investment?1. Corporations in industries that will face greater international competitionExample: steel & auto industries in the US2. Workers in industries that will face competitionAnd labor unions more generally…3. People & governments concerned about:Potential for economic crisesLoss of state autonomyPressure to please foreign capital; loss of domestic ownershipDifficulty regulating global capitalismEnvironmental problems, sweatshops, etc.
35 Barriers to Trade / Investment Definition: Protectionism = blocking foreign imports or capital flowsOpposite: “Liberalization” or “opening up markets”Note: different from typical use of “liberal” in USReasons to pursue protectionism:1. Protect domestic companies or industries from foreign competitionPrevent bankruptcies, job loss in inefficient industries2. To reduce risk of financial crises.3. Prevent foreign ownership and/or control of the companies or the economyExample: People get nervous when Chinese companies buy major US oil or computer companies
36 Barriers to Trade Strategies for protectionism 1. Tariffs – taxes on imported goods and servicesExample: The US government can impose a $2,000 tax on Japanese carsFewer people will buy Japanese cars, imports will decrease2. Quotas – a government-imposed numeric limit on importsExample: The US may allow only 500,000 Japanese cars to be imported in any given year.
37 Barriers to Trade Strategies for protectionism (continued) 3. “Non-tariff” barriers – A government regulation that indirectly limits trade or makes it more expensiveExample: Strong agricultural subsidies make it impossible for foreign imports to competeNOTE: Subsidies block imports, just like tariffs…Example: The US may impose complex agricultural inspections that delay or discourage imported fruitCould be legitimate, or simply a way of stopping imports.
38 Barriers to Investment Strategies for protectionism (continued)4. “Foreign ownership” laws – laws that limit the ability of foreigners to buy companiesExample: US government could require owners of corporations to be US citizens5. “Capital controls” – laws designed to prevent the rapid withdrawal of capital/investmentExample: Law requiring invested capital to remain in the country for one yearThus, preventing rapid flows in and out.
39 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 countriesOr, via international treaties & organizationsGATT; NAFTA; WTO.
40 Removal of Barriers Bi-lateral negotiations & treaties: When two countries negotiate trade & investment barriersEx: 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 coercionExample: US threatens to impose quotas on Chinese steel products, if China doesn’t lower tariffChina might respond by threatening to raise tariffs on the USEscalation of this is called a “trade war.”
41 Example: Bi-Lateral Trade Negotiations South Korea, U.S. May Hold Farm Trade Talks in MarchSEOUL (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 1992.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
42 Free Trade Agreements Multilateral agreements When groups of countries negotiate together to reduce barriersEx: NAFTA; also negotiations under GATT, WTOQuick review of NAFTA consequences:Schaeffer, p. 242; also Stiglitz Ch 3US:Slight increase in exports; ,000 added jobs;140,000 textile jobs lost to MexicoCanadaLost 500,000 jobsGiven the size of Canada, this was hugeCanada imports heavily from US; currency devalued.
43 Free Trade Agreements Impact of NAFTA (cont’d) Mexico Other losers? 600,000 new textile jobs; offset by other job lossesImports from US increaseThis was one factor leading up to the crisis in 1994Other losers?Organized labor (Unions)From commanding heights video:Other winners?ConsumersMulti-national corporationsPossible long-term increase in efficiency, growth.
44 Problems With Trade Agreements Rich/powerful countries have numerous advantages in negotiating trade agreementsSee: Stiglitz, Chapter 3Some points to consider:1. Advantages of Rich/powerful countries are biggest in bi-lateral trade negotiationsExample: US vs. a small Latin American countryUS can bully, bring great pressure…Often, those turn out worse for poor countries than large multilateral agreements.
45 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 countriesEx: focus has been on removing barriers for high-value goods & investment, not farm products or low-tech stuffAnd, rich countries are savvy at using dispute resolution proceduresThey have lots of lawyers, using technicalities to block imports.
46 Problems With Trade Agreements 3. Government trade negotiators are often influenced by powerful groupsRather than negotiating for terms that will benefit everyone in a country, negotiators may cater to big corporationsExample: 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…
47 Stiglitz: Making Trade Fair Stiglitz, Chapter 3: Recommendations1. Developing countries should be treated differently from wealthy countriesPreviously, 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 countriesThis would have a much bigger effect than providing direct aidNOTE: Europe has started moving in this direction1. B. Poor countries should be allowed to use subsidies to support “infant industries”Rich countries have little to lose… but benefits are big.
48 Stiglitz: Recommendations: 2. Rich countries should stop MASSIVE agricultural subsidiesRich countries give huge amounts of money to (mainly) industrial farmsNorway: two-thirds of farm income is from subsidiesEU spends 80 billion US$; US spendsConsequences:Farmers in rich countries can sell food at LOW prices and still make a profitOften below the cost of farmers in poor countriesFarmers in poor countries can’t compete… go broke.
49 Stiglitz: Recommendations 3. Escalating tariffs should be endedEscalating tariffs: taxing manufactured products at higher rates than raw materialsEx: Having no tariffs on raw agricultural goods, but high tariffs on higher-value processed goodsNo tax on apples; high tax on applesauceIssue: This prevents poor countries from industrializingThey are stuck farmingWhile rich countries have cheap source of produce for their high-value industries.
50 Stiglitz: Recommendations 4. Remove barriers to unskilled services & migrationRich countries have pushed to remove barriers for high-tech services (banking, accounting, software)Barriers remain in low-skill servicesExample: Shipping/trucking. Foreign companies aren’t allowedThis is one area that poor countries could actually compete…Also, allowing more labor flows would provide a huge benefit to poor countries.
51 Stiglitz: Recommendations 5. Restrict the use of non-tariff barriersThere are legitimate reasons for having them…BUT, more often they are used by rich countries to protect their own marketsDespite claims of supporting free trade6. Restrict bi-lateral agreementsThey are rarely advantageous to poor countriesDue to asymmetry in power between negotiatorsAnd, they tend to undermine multilateral agreements
52 Stiglitz: Recommendations 7. Reform governanceChange the rules of organizations like the WTOIssues (p. 97):How decisions get madeWhat gets put on the agendaHow disagreements are resolvedHow rules are enforcedCurrently, rules sometimes favor rich countriesSystem should be more open/transparent, more democratic, with better enforcement for small countries.