WORLD POLITICS, TRADE & INVESTMENT

Trade

Introduction  As no nation is entirely self-sufficient, all states engage in trade.

 Even when states can produce the same goods and services, they often have to trade with other states in order to overcome their different allocation of resources.

 Because nations have different allocations of resources:  Land,  Labor, or  Capital  Each enjoys a comparative advantage in producing those goods that use its abundant resources.

 When a country is more efficient than others in producing a certain good, it is said to have an absolute advantage in that good’s production.

Ricardo’s Model of Trade  David Ricardo’s model of trade demonstrates how mutual gains from trade are still possible even if one party has an absolute advantage in all goods.  Each country gains by exporting the good in which it has a comparative advantage and by  Importing the good in which it has a comparative disadvantage.  Mutual gains will lead to specialization within each country, making goods less expensive and production more efficient for both.  David Ricardo

Trade Barriers  Given that states are better off trading with countries that produces certain goods more efficiently, why do states still implement barriers to free trade?  Foreign competition may drive domestic producers out of business prompting government to intervene on behalf of those individuals who have lost jobs or declared bankruptcy;  This is particularly true if these individuals and groups are politically connected and exert tremendous political influence.

 Trade barriers, a form of protectionism, are often a result of a conflict of domestic interests, specifically consumers (who want inexpensive goods) versus industries (who want to stay in business) along with workers in those industries (who want to stay employed).

 Political support for protectionism can generally penetrate even the most ardent free- trade governments as this type of protection benefits a small, concentrated, politically powerful group and hurts an unorganized and disparate group of consumers.  Most common form of protectionism is the tariff, or a tax on imports.

 States also implement non-tariff barriers (NTBs) such as:  Import quotas;  Voluntary Export Restrictions (VERs);  Regulations to protect labor, the environment, and domestic consumers; and  Subsidies.

Balance of Payments  States keep “balance sheets” that reflect a country’s trade balance,  How much money locals earned overseas,  Amount of foreign currency invested in the domestic economy,  Level of official foreign aid given to other countries, and  Amount of foreign currency held by the central bank.

 The current-account balance refers to the sum total of a nation’s:  Imports,  Exports,  Foreign aid  Other government transactions, and  Investment income and payment;  A positive current-account balance indicates that the country enjoys a trade surplus whereas a negative balance indicates a trade deficit.

Money Makes the World Go Round  Prior to the development of money, trade was conducted by barter, or the mutual exchange of goods and services.  Money as a medium of exchange, helped overcome the inefficiencies of the barter system. That each state has its own currency necessitated the need for an international system of currency exchange.

Exchange Rates  A fixed exchange rate system sets all currencies at fixed rates against one another,  Preventing currency fluctuations, eliminating an element of risk from trade;  However, a disadvantage is that when recessions occur, states must either preserve or “defend” the value of their currency or renege on agreements made with other states in the fixed system.

 A floating exchange rate system (the current world monetary system, which began in 1973) allows currencies to fluctuate, which accurately reflects a country’s economic health, provides for the manipulation of exchange rate to improve balance of trade, and allows states more freedom to use monetary policy in attempts to alleviate inflation and unemployment; conversely, a floating system introduces an element of risk and uncertainty into trade and manipulating exchange rates can create international tensions, as between the United States and Japan in the 1980s and 1990s.

Capital Markets and Investments

Capital Markets  Capital markets include:  Banks,  Securities firms,  Stock markets, and  Foreign exchange markets,  All of which are part of international economic forces that are beyond states’ control.

 The currency market is inherently unstable and unpredictable;  However, traders find it attractive for these very reasons, hoping to cash in on a quick trade. Speculation in currency markets is associated with economic irrationality due to the lack of complete information on the part of currency traders.

 One attempt at confronting currency speculation and foreign exchange market instability is the Tobin tax,  Taxing global financial flows and using the money for development; Although the concept has received support in national legislations, it has never been instituted due to obstacles inherent in the international system.

 Due to the lack of a concerted international response to currency speculation, states have instituted protection against capital flight in the form of capital and exchange controls.  Capital controls are viewed by many as important for developing countries, Which tend to suffer disproportionately at the hands of the international capital market.

 Beyond currency trading, capital markets also include nongovernmental financial institutions such as:  Banks,  Stocks and bond exchanges,  Commodities exchanges, and  Government securities markets.

 A bond is a debt security whereby the buyer is essentially lending money to an issuer  Who in turn promises to pay a specified rate of interest for the life of the bond and to then repay the face value of the bond at maturity.

Foreign Direct Investment  Foreign direct investment (FDI) is private corporate investment in foreign countries, including greenfield investments and mergers and acquisitions (M&As), with most FDI taking place between developed countries.

 Developing countries are beginning to amend domestic practices in order to attract more FDI;  Ex. Indonesia created a special office with an Internet Web site providing a list of advantages (fertile land, strategic location, large population of potential workers and consumers, market-oriented economy, and democratic government) of direct investment in the country.

 There is a debate whether this competition to attract FDI to developing countries is beneficial  Incentives tend to be costly,  May be harmful to the domestic economy,  May lead to corruption,  Might contribute to xenophobic responses to foreign efforts to invest.

Economic Power

Introduction  A state’s raw materials contribute to its strategic strengths and vulnerabilities;  Population,  Industrial Capacity,  Technology,  Geography

 Some elements of power are more easily quantifiable  Oil Reserves and  Balance of Trade  With other components more difficult to quantify  Skills of a nation’s labor force.

 The territorial aspect is based on a state’s:  Geography and  Natural Resources  Whereas a state’s population or demographic endowments focuses on the:  Age,  Health,  Education, and  Degree of homogeneity of the population.

Trade and Industry  Gross national income (GNI) is a crude but useful measure of economic strength;  It measures the market value of goods and services produced in a given period (usually annually). GNI is a good indicator of rankings and changes in overall economic strength.  Per capita income is an indicator that takes into account population because a small country with the same GNI as a large country will have more wealth per person.

Technology  Technology creates efficiencies and spawns entire new industries,  Leads countries to spend a great deal of money on research and development (R&D); United States is the world’s R&D powerhouse primarily due to the enormity of the U.S. economy.  However, technological advantages can dissipate quickly as new technologies are rapidly disseminated, reengineered, and reproduced worldwide.

 Much of R&D spending reflects a recognition that the ability to move and use information promises to be one of the most important determinants of economic power  Many countries, including the United States, have thus made significant efforts to develop their technological and communications infrastructure.

 Globalization and fragmentation both can act as :  Intervening factors capable of stripping ostensible economic power from a country or  Enhancing it.

Economics and Politics

Realism  Wars are fought with:  Guns and  Rockets;  Economic battles are fought with:  Tariffs and  Subsidies, Weapons that are often more destructive than their military counterparts.

 Economic policy is a tool of power politics  Any economic decision should enhance a state’s level of security and influence; Such policies include maintaining a favorable balance of trade (mercantilism).

Liberalism  Liberalism theorizes that states should allow the free market to function unhindered by trade barriers,  Thereby serving the greater good while also  Benefiting each of the states within the international system.

 Although beneficial, there are several caveats.  There is no pure free trade;  There are certain costs, particularly social, political, and short-term economic costs, to those associated with industries that have been cast off for more productive and competitive ones.  Some government oversight is necessary for: The protection of intellectual property and Defenses against predatory trade and investment practices.

 Beyond the benefits associated with free trade, liberals also believe in the possibility and benefits of cooperation;  Trade is viewed as a positive-sum game with both trading partners benefiting.  Liberals argue that the problem is not self-interest; rather it is the difficulty of coordination and enforcement of cooperative agreements.

 Liberals offer several options for overcoming the problems of cheating and the issue of relative gains. Reciprocity Mutual trust illustrated by a tit-for-tat strategy One side is willing to cooperate if the other does but is also ready to cheat if it acts dishonestly. International regimes establish general rules and principles, or norms, of state behavior that facilitate cooperation and are generally developed in specific issue areas like trade; These norms are usually formalized in treaties, Establish institutions and organizations that help states overcome the problems of cheating International law discourages states from selfishly acting against the common good, Urge states to forgo short-term advantages gained through cheating.

Hegemonic Stability Theory  Many argue that the best method of guaranteeing international economic stability is through a hegemon  Sets and enforces the rules of the global economy;  Promotes trade because increased trade and economic stability are in its own best interest.  Hegemony is ultimately self-defeating;  As the cost of keeping trade and markets open grows, other states may become richer and challenge the hegemon.  The hegemon may demand that its allies “share the burden” of enforcing security and stability.

 Trade liberals and realists generally agree that as long as the United States remains the hegemon, the international economy will remain relatively stable;  However, it is also agreed that the position of the United States will likely be challenged.

Constructivism  Constructivists argue that when states lose faith in free trade, it breaks down;  When they believe in its benefits, they uphold it.

Conclusion  International trade continues to grow annually, and  Markets and investments opportunities expand (cooperation) Despite the best efforts of governments to erect trade barriers (conflict).  Greater economic interdependence is likely to increase both the incentives and the risks of cooperation among states.