ECON International Economics Chapter 2 Introduction to the World Economy

What is international economics about? Gains from trade Explaining patterns of trade The effects of government policies on trade International finance topics International trade versus international finance Profile of the World Economy 2

International economics is about how nations interact through trade of goods and services, through flows of money and through investment. International economics is an old subject, but it continues to grow in importance as countries become tied to the international economy. Nations are more closely linked through trade in goods and services, through flows of money, and through investment than ever before. In the popular media, this phenomena is known as “globalization” 4

International trade as a fraction of the national economy has tripled for the US in the past 40 years. Compared to the US, other countries are even more tied to international trade. What is happening here with the recent economic downturn? What are the longer term trends going to be? 5

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Better to look at X and M in terms of size of the economy. Replotting this:

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Several ideas underlie the gains from trade 1.When a buyer and a seller engage in a voluntary transaction, both receive something that they want and both can be made better off. Norwegian consumers could buy oranges through international trade that they otherwise would have a difficult time producing. The producer of the oranges receives income that it can use to buy the things that it desires. 11

2.How could a country that is the most (least) efficient producer of everything gain from trade? With a finite amount of resources, countries can use those resources to produce what they are most productive at (compared to their other production choices), then trade those products for goods and services that they want to consume. Countries can specialize in production, while consuming many goods and services through trade. 12

3.Trade is predicted to benefit a country by making it more efficient when it exports goods which use abundant resources and imports goods which use scarce resources. 4.When countries specialize, they may also be more efficient due to large scale production. 5.Countries may also gain by trading current resources for future resources (lending and borrowing). 13

Trade is predicted to benefit countries as a whole in several ways, but trade may harm particular groups within a country. International trade can adversely affect the owners of resources that are used intensively in industries that compete with imports. Trade may therefore have effects on the distribution of income within a country. Conflicts about trade should occur between groups within countries rather than between countries. 14

Differences in climate and resources can explain why Brazil exports coffee and Australia exports iron ore. But why does Japan export automobiles, while the US exports aircraft? Differences in labor productivity may explain why some countries export certain products. How relative supplies of capital, labor and land are used in the production of different goods may also explain why some countries export certain products. 15

Policy makers affect the amount of trade through tariffs: a tax on imports or exports, quotas: a quantity restriction on imports or exports, export subsidies: a payment to producers that export, or through other regulations (e.g., product specifications) that exclude foreign products from the market, but still allow domestic products. What are the costs and benefits of these policies? 16

Economists design models that try to measure the effects of different trade policies. If a government must restrict trade, which policy should it use? If a government must restrict trade, how much should it restrict trade? If a government restricts trade, what are the costs if foreign governments respond likewise? 17

Governments measure the value of exports and imports, as well as the value of international financial capital that flows into and out of their countries. Related to these two measures is the measure of official settlements balance, or the balance of payments: the balance of funds that central banks use for official international payments. All three values are measured in the government’s national income accounts. 18

Besides international financial capital flows and the official settlements balance, exchange rates are also an important financial issue for most governments. Exchange rates measure how much domestic currency can be exchanged for foreign currency. They also affect how much goods that are denominated in foreign currency (imports) cost. And they affect how much goods denominated in domestic currency (exports) cost in foreign markets. How are exchange rates determined? Partially a choice of government of country concerned as there are different exchange rate regimes 19

International trade focuses on transactions of real goods and services across nations. These transactions usually involve a physical movement of goods or a commitment of tangible resources like labor services. International finance focuses on financial or monetary transactions across nations. For example, purchases of US dollars or financial assets by Europeans. 20

In addition there are the institutional aspects of international economics e.g. WTO, IMF, World Bank, BIS and supranational institutions Also regional integration fosters new cooperation between countries e.g. NAFTA, EU, ASEAN, Mercosur

Also business aspects – how to compete in a global economy Business decisions that rely on international economic considerations e.g. international risk exposure, international production chains and foreign expansion decisionmaking

International trade topics International trade theory International trade policy International finance topics Exchange rates and open economy macroeconomics International macroeconomic policy International institutional topics International institutions Regional integration International business topics Global competition Foreign expansion and risk exposure 23

The more developed economies are still the largest economies in the world But now China and Brazil rank among the 10 largest economies in the world

GDP is a useful measure of the development of an economy, and then by extension GDP per capita is a good indicator of the standard of living of the country. NB US was 15th RankingCountryGDP per capita ( ) 1Luxembourg115,809 2Qatar98,144 3Norway97,607 4Switzerland83,073 5Australia66,371 6UAE63,626 7Denmark59,709 8Sweden57,638 9Canada50,496 10Netherlands50,216

China might have a large economy, but it’s GDP per capita is not large, although it is growing fast (so moving up rankings) 63Mexico10,146 72South Africa8,078 80Iran6,420 90China5, Ukraine3, Indonesia3, Morocco3, India1, Bangladesh Democratic Republic of Congo217 Other countries are not moving up the rankings. Most of these countries tend to be in Africa

This is clearly shown in figure below. North America, Western Europe, Japan and Australasia constitute the wealthiest countries African and Southern Asian countries are poorest, while E Europe and the rest of the Americas are middle income countries

Developed = high income countries Middle-income = “transition” or industrializing countries Developing = low income countries Give some examples of each of these…

Over a third of all trade is done by MNEs. Of this, most is done between developed countries, and not between developing and developed. Some examples of MNEs: Exxon SABC Mitsubishi Samsung Diageo

Intergovernmental organization – organization that has no internal structure and only exists when meetings occur. E.g. OPEC, G7, GATT International organization – organization that has internal structure (and personnel) and acts on behalf of it’s members. E.g. UN, IMF, WTO, EBRD

Outline of course International trade Interanational finance US trade Profile of world economy