INTERNATIONAL TRADE: An Introduction Prepared by Iordanis Petsas (and adapted by Paul Black) To Accompany International Economics: Theory and Policy International Economics: Theory and Policy, Sixth Edition by Paul R. Krugman and Maurice Obstfeld

Overview of Unit 8  Introduction  What is International Economics About?  International Economics: Trade and Money

What is International Economics About?  International Policy Coordination A fundamental problem in international economics is how to produce an acceptable degree of harmony among the international trade and monetary policies of different countries without a world government that tells countries what to do.  The International Capital Market There are risks associated with international capital markets: –Currency depreciation –National default

 The Balance of Payments Some countries run large trade surpluses. –For example, in 1998 both China and South Korea ran trade surpluses of about $40 billion each. Is it good to run a trade surplus and bad to run a trade deficit?  Exchange Rate Determination The role of changing exchange rates is at the center of international economics. What is International Economics About?

 International economics deals with economic interactions that occur between independent nations. The role of governments in regulating international trade and investment is substantial. Analytically, international markets allow governments to discriminate against a subgroup of companies. Governments also control the supply of currency.  There are several issues that recur throughout the study of international economics. What is International Economics About?

 The Gains from Trade Many people are skeptical about importing goods that a country could produce for itself. When countries sell goods to one another, all countries benefit. Trade and income distribution –International trade might hurt some groups within nations. –Trade, technology, and wages of high and low-skilled workers. What is International Economics About?

 The Pattern of Trade (who sells what to whom?) Climate and resources determine the trade pattern of several goods. In manufacturing and services the pattern of trade is more subtle. There are two types of trade: –Interindustry trade depends on differences across countries. –Intraindustry trade depends on market size and occurs among similar countries. What is International Economics About?

 How Much Trade? Many governments are trying to shield certain industries from international competition. This has created the debate dealing with the costs and benefits of protection relative to free trade. –Advanced countries’ policies engage in industrial targeting. –Developing countries’ policies promote industrialization: –Import substitution versus export promotion industrialization. What is International Economics About?

International Economics: Trade and Money  International trade analysis focuses primarily on the real transactions in the international economy. These transactions involve a physical movement of goods or a tangible commitment of economic resources. – Example: The conflict between the United States and Europe over Europe’s subsidized exports of agricultural products

 International monetary analysis focuses on the monetary side of the international economy. That is, financial transactions such as foreign purchases of U.S. dollars. –Example: The dispute over whether the foreign exchange value of the dollar should be allowed to float freely or be stabilized by government action International Economics: Trade and Money

Types of Economic Systems (A Review)  traditional economy (subsistence): Means of making a living has changed very little over time. Usually favors the status quo over innovation.  command economy (central planning): state ownership and control of major industries (energy, transportation, healthcare, etc.)  market economy: individuals and private companies make the vast majority of decisions about what is bought and sold  mixed economy (market economies with some governmental planning and regulation).

Absolute and Comparative Advantage  Absolute advantage: the ability to produce a good at a lower cost than another producer. (“Anything you can do, I can do better…”)  Comparative advantage: being able to produce a good at a lower opportunity cost (i.e., having to give up LESS) than other producers. (“Specialize in what you do best, trade for the rest.”)  Even if a country can’t produce anything at a lower cost than other countries, it is still said to have a comparative advantage if it has to give up less of one product to get more of another (i.e., the opportunity costs are smaller).

Protectionism = Any effort to protect domestic businesses through the use of tariffs or quotas on imports, subsidies to domestic businesses/farmers. Advanced countries’ policies engage in industrial targeting (i.e., US tariffs on imported cars.) Developing countries’ policies promote industrialization: import substitution versus export promotion industrialization. NOTE: Too many protectionist measures lead to a trade war: an escalating pattern of trade barriers erected in retribution for those imposed against one’s own country.

Two Common Arguments/Reasons for Protectionism  National security argument: Military goods (and food) should be made domestically so that the supply is not cut off in the event of a war.  Infant industry argument: industries that are just beginning to develop in a country must be protected.

Multi-Lateral Trade Agreements:  Protectionist policies are DECREASING throughout the world today. In other words, nations are making it easier to trade freely with one another by forming multi-lateral trade groups:  NAFTA: North American Free Trade Agreement (Canada, Mexico, and the US)  FTAA: Free Trade Area of the Americas  CAFTA: Central American Free Trade Area  APEC: Asia-Pacific Economic Cooperation  WTO: World Trade Organization: dedicated to reducing protectionism across the globe.

Most Favored Nation/ “Normal Trade Relations” = Used to designate countries with whom the US has good trade relations. China currently has MFN status, which means that we charge them lower tariffs  Advantage: We get access to inexpensively-made goods.  One disadvantage of granting MFN status: it weakens our ability to criticize the political practices of another country (such as China’s extensive record of human rights abuses.)

The Capital Account  The capital account tracks the movement of funds for investments and loans into and out of a country.  The capital account includes foreign direct investment, plus changes in holdings of stocks, bonds, loans, bank accounts, and currencies.  The capital account only keeps track of the money being transferred (i.e., the worth of stocks is not taken into account as money when calculating figures for the capital account).

The Current Account = Imports and exports items of goods and services, as well as transfer payments (money from the US to other countries or vice versa).

Trends in Capital and Current Accounts  Q: What are the trends in the U.S. for capital accounts? Current accounts?  A: The US has long had a capital account SURPLUS (other countries invest more in the US than vice-versa), and a current account DEFICIT (because the US imports much more than it exports.)

At the beginning of the 21 st century, nations are more closely linked through trade in goods and services, through flows of money, and through investment in each others’ economies than ever before. Figure 1-1 shows that international trade for the United States has roughly tripled in importance compared with the U.S. economy as a whole. Explanation of Graphs/Evidence

Figure 1-1: Exports and Imports As A Percentage of U.S. National Income

Figure 1-2: Exports and Imports As Percentages of National Income in 1994

Exchange Rates: A Brief Explanation  Exchange rate: price at which one currency can be used to purchase another. There are three ways in which nations manage their exchange rate:  Fixed/ “Pegged” rate: When the price of a currency is tied to the stable currency of a developed nation (such as the US dollar, a “hard currency”.) Usually adopted by developing nations who fear that fear volatile (wildly changing) currency may discourage foreigners from investing.  “Floating” rate: value of exchange is determined by the supply of and demand for that currency. (NB: the demand for dollars is largely the same thing as the demand for US products- such as Jeeps or Chevrolets- because foreigners mainly purchase dollars in order to buy US goods.)  “Managed floating” rate: A combination of the first two. Exchange rate floats within an agreed-upon band, but if the value gets above or below this range, then the central bank intervenes.

Currency Appreciation and Depreciation  Currency appreciation: An appreciating currency buys MORE units of foreign currency than it would previously.  Currency depreciation: A depreciating currency buys FEWER units of foreign currency than it would previously. Questions: 1. How does the strength of the U.S. dollar affect how much we import? How much we export? 2. What is the impact of a strong dollar on our national balance of trade (trade deficit or trade surplus?)