A Frugal Governed OPEN Economy Lecture 24 Dr. Jennifer P. Wissink ©2018 Jennifer P. Wissink, all rights reserved. November 15, 2018 1

Sources of Comparative Advantage A country with a great deal of good fertile land… California & Iowa in agriculture Brazil and coffee beans A country with a large amount of accumulated capital… New Jersey in oil refining South Korea and passenger cars A country well-endowed with human capital… New York in highly technical financial services US and advanced education Check out this site! Very interesting and oddly fun. http://www.worldsrichestcountries.com/top_us_exports.html

i>clicker questions Which country was the world’s richest in 2017 as measured by GDP? China United States Japan Germany Russia What is China’s rank when ranked by GDP per capita? 12th 22th 42th 62nd 82nd Which European country was the richest in 2017 as measured by GDP? France United Kingdom Germany Russia Italy

Other Suggested Explanations for Observed Trade Flows Product differentiation and competitive markets Acquired comparative advantage Economies of scale and scope However, because evidence suggests that economies of scale are exhausted at relatively small size in most industries, it seems unlikely that they constitute a valid explanation of world trade patterns. Trading Environments, Openness of Economy Free Trade Policy Protectionist Policy

Keeping Track of Trade: Foreign Exchange & The Balance of Payments Foreign exchange is simply all currencies other than the domestic currency of a given country. The balance of payments: it’s the record of a country’s transactions in goods, services, and assets with the rest of the world. It’s a record of the country’s sources (supply) and uses (demand) of foreign exchange. Note: it’s not a “balance sheet”. But: the overall account always balances. It’s broken into two pieces the Current Account the Capital Account

TABLE 20.1 United States Balance of Payments, 2011 37.7 (11) Net capital account transactions and financial derivatives (13) Balance of payments (5 + 10 + 11 + 12) −89.2 (12) Statistical discrepancy 517.4 (10) Balance on capital account (6 + 7 + 8 + 9) 211.8 (9) Change in foreign government assets in the United States −119.5 (8) Change in U.S. government assets abroad (increase is −) 789.2 (7) Change in foreign private assets in the United States −364.1 (6) Change in private U.S. assets abroad (increase is −) Capital Account −465.9 (5) Balance on current account (1 + 2 + 3 + 4) −133.1 (4) Net transfer payments 227.0 (3) Net investment income −517.6 Income payments on investments 744.6 Income received on investments 178.6 (2) Net export of services −427.4 Imports of services 606.0 Exports of services −738.4 (1) Net export of goods −2,235.8 Goods imports 1,497.4 Goods exports Current Account Billions of dollars TABLE 20.1 United States Balance of Payments, 2011 All transactions that bring foreign exchange into the United States are credited (+) to the current account; all transactions that cause the United States to lose foreign exchange are debited (−) to the current account

In the Current Account… −465.9 (5) Balance on current account (1 + 2 + 3 + 4) −133.1 (4) Net transfer payments 227.0 (3) Net investment income −517.6 Income payments on investments 744.6 Income received on investments 178.6 (2) Net export of services −427.4 Imports of services 606.0 Exports of services −738.4 (1) Net export of goods −2,235.8 Goods imports 1,497.4 Goods exports Current Account Billions of dollars TABLE 20.1 United States Balance of Payments, 2011 All transactions that bring foreign exchange into the United States are credited (+) to the current account; all transactions that cause the United States to lose foreign exchange are debited (−) to the current account In the Current Account… Debit items: any transaction that causes the US to loose foreign exchange. Imports use up foreign exchange and are a debit (–) item. Credit items: any transaction that provides the US with foreign exchange. Exports generate foreign exchange and are a credit (+) item on the current account.

TABLE 20.1 United States Balance of Payments, 2011 37.7 (11) Net capital account transactions and financial derivatives (13) Balance of payments (5 + 10 + 11 + 12) −89.2 (12) Statistical discrepancy 517.4 (10) Balance on capital account (6 + 7 + 8 + 9) 211.8 (9) Change in foreign government assets in the United States −119.5 (8) Change in U.S. government assets abroad (increase is −) 789.2 (7) Change in foreign private assets in the United States −364.1 (6) Change in private U.S. assets abroad (increase is −) Capital Account −465.9 (5) Balance on current account (1 + 2 + 3 + 4) −133.1 (4) Net transfer payments 227.0 (3) Net investment income −517.6 Income payments on investments 744.6 Income received on investments 178.6 (2) Net export of services −427.4 Imports of services 606.0 Exports of services −738.4 (1) Net export of goods −2,235.8 Goods imports 1,497.4 Goods exports Current Account Billions of dollars TABLE 20.1 United States Balance of Payments, 2011 All transactions that bring foreign exchange into the United States are credited (+) to the current account; all transactions that cause the United States to lose foreign exchange are debited (−) to the current account

TABLE 20.1 United States Balance of Payments, 2011 37.7 (11) Net capital account transactions and financial derivatives (13) Balance of payments (5 + 10 + 11 + 12) −89.2 (12) Statistical discrepancy 517.4 (10) Balance on capital account (6 + 7 + 8 + 9) 211.8 (9) Change in foreign government assets in the United States −119.5 (8) Change in U.S. government assets abroad (increase is −) 789.2 (7) Change in foreign private assets in the United States −364.1 (6) Change in private U.S. assets abroad (increase is −) Capital Account −465.9 (5) Balance on current account (1 + 2 + 3 + 4) −133.1 (4) Net transfer payments 227.0 (3) Net investment income −517.6 Income payments on investments 744.6 Income received on investments 178.6 (2) Net export of services −427.4 Imports of services 606.0 Exports of services −738.4 (1) Net export of goods −2,235.8 Goods imports 1,497.4 Goods exports Current Account Billions of dollars TABLE 20.1 United States Balance of Payments, 2011 All transactions that bring foreign exchange into the United States are credited (+) to the current account; all transactions that cause the United States to lose foreign exchange are debited (−) to the current account

TABLE 20.1 United States Balance of Payments, 2011 37.7 (11) Net capital account transactions and financial derivatives (13) Balance of payments (5 + 10 + 11 + 12) −89.2 (12) Statistical discrepancy 517.4 (10) Balance on capital account (6 + 7 + 8 + 9) 211.8 (9) Change in foreign government assets in the United States −119.5 (8) Change in U.S. government assets abroad (increase is −) 789.2 (7) Change in foreign private assets in the United States −364.1 (6) Change in private U.S. assets abroad (increase is −) Capital Account −465.9 (5) Balance on current account (1 + 2 + 3 + 4) −133.1 (4) Net transfer payments 227.0 (3) Net investment income −517.6 Income payments on investments 744.6 Income received on investments 178.6 (2) Net export of services −427.4 Imports of services 606.0 Exports of services −738.4 (1) Net export of goods −2,235.8 Goods imports 1,497.4 Goods exports Current Account Billions of dollars TABLE 20.1 United States Balance of Payments, 2011 All transactions that bring foreign exchange into the United States are credited (+) to the current account; all transactions that cause the United States to lose foreign exchange are debited (−) to the current account

TABLE 20.1 United States Balance of Payments, 2011 37.7 (11) Net capital account transactions and financial derivatives (13) Balance of payments (5 + 10 + 11 + 12) −89.2 (12) Statistical discrepancy 517.4 (10) Balance on capital account (6 + 7 + 8 + 9) 211.8 (9) Change in foreign government assets in the United States −119.5 (8) Change in U.S. government assets abroad (increase is −) 789.2 (7) Change in foreign private assets in the United States −364.1 (6) Change in private U.S. assets abroad (increase is −) Capital Account −465.9 (5) Balance on current account (1 + 2 + 3 + 4) −133.1 (4) Net transfer payments 227.0 (3) Net investment income −517.6 Income payments on investments 744.6 Income received on investments 178.6 (2) Net export of services −427.4 Imports of services 606.0 Exports of services −738.4 (1) Net export of goods −2,235.8 Goods imports 1,497.4 Goods exports Current Account Billions of dollars TABLE 20.1 United States Balance of Payments, 2011 All transactions that bring foreign exchange into the United States are credited (+) to the current account; all transactions that cause the United States to lose foreign exchange are debited (−) to the current account

TABLE 20.1 United States Balance of Payments, 2011 37.7 (11) Net capital account transactions and financial derivatives (13) Balance of payments (5 + 10 + 11 + 12) −89.2 (12) Statistical discrepancy 517.4 (10) Balance on capital account (6 + 7 + 8 + 9) 211.8 (9) Change in foreign government assets in the United States −119.5 (8) Change in U.S. government assets abroad (increase is −) 789.2 (7) Change in foreign private assets in the United States −364.1 (6) Change in private U.S. assets abroad (increase is −) Capital Account −465.9 (5) Balance on current account (1 + 2 + 3 + 4) −133.1 (4) Net transfer payments 227.0 (3) Net investment income −517.6 Income payments on investments 744.6 Income received on investments 178.6 (2) Net export of services −427.4 Imports of services 606.0 Exports of services −738.4 (1) Net export of goods −2,235.8 Goods imports 1,497.4 Goods exports Current Account Billions of dollars TABLE 20.1 United States Balance of Payments, 2011 All transactions that bring foreign exchange into the United States are credited (+) to the current account; all transactions that cause the United States to lose foreign exchange are debited (−) to the current account

Example 1: The Wissinks go to France. Hotel/food/train/gifts costs €5,000 Euros The Wissinks need to buy Euros € 1 Euro = $1.20 USD OR $1 USD = € 0.83 Euro So... it all costs $6,000 USD Cool currency converter site: http://www.xe.com/ucc/full/ The Wissinks are importing goods and services. There will be 2 entries in the Balance of Payments.

Example 1: The Wissinks going to France. In the Current Account, “Imports of goods and services” (lines 1&2) shows a - $6,000. Note: a debit item, since we use up foreign exchange! I take $6,000 US dollars and purchase € 5,000 Euros from a French private bank to pay the hotel/tour bill. In the Capital Account, (line 7) “Change in foreign private assets in the United States” (in this case, French holdings of US dollars) are increased by +$6,000. Note: this is a credit item! The net wealth position of the US vis-à-vis the rest of the world has decreased by $6,000.

Example 2: Prof. Wissink decides to buy a British bond from a non-government (private) British issuer. The bond costs £10,000. £1 GBP = $1.40 USD OR $1 USD = £0.72 GBP I take $14,000 USD and purchase the £10,000 GBP bond (which has a US dollar value of $14,000). The Wissinks are dealing with buying a foreign asset. There will be 2 entries in the Balance of Payments

Example 2: Wissink buys a British bond. “Change in foreign private assets in the US” (in this case, British holdings of US dollars) show a +$14,000 in the Capital Account. Reminder: increases in this item get recorded as a “+” item in line (7) of the Capital Account. But now I hold this bond so there is a “change in private U.S. assets abroad”, that is an increase in US assets abroad (the U.S.(me!) now holds more British bonds) and so we show this as a -$14,000 in the Capital Account. Reminder: increases in this item get recorded as a “–” item in line (6) of the Capital Account. So there is still “balance” in the Balance of Payments accounts.

Trade Policy: Free vs. Protection Free Trade - the practice of leaving the markets alone and letting the invisible hand of the price mechanism do its work. Protection - the practice of shielding a sector of the economy from foreign competition via various policies. So… Should we? (Protectionist Policies) Should we not? (Free Trade Policies) Common protectionist policies A tariff is a tax on imports. The average tariff on imports into the United States is about 5 percent. A quota is a limit on the quantity of imports. Export subsidies are government payments made to domestic firms to encourage exports. Dumping refers to when a firm or industry sells products on the world market at prices below the cost of production. The Comprehensive Trade Act of 1988 contains clauses that permit the president to impose trade sanctions when investigations reveal dumping by foreign companies or countries.