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

2. 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.

3. 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

6. 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

7. 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

8. TABLE 20.1 United States Balance of Payments, 2011
37.7
(11) Net capital account transactions and financial derivatives
(13) Balance of payments ( )
−89.2
(12) Statistical discrepancy
517.4
(10) Balance on capital account ( )
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 ( )
−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 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

9. In the Current Account…
−465.9
(5) Balance on current account ( )
−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 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.

10. TABLE 20.1 United States Balance of Payments, 2011
37.7
(11) Net capital account transactions and financial derivatives
(13) Balance of payments ( )
−89.2
(12) Statistical discrepancy
517.4
(10) Balance on capital account ( )
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 ( )
−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 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

11. TABLE 20.1 United States Balance of Payments, 2011
37.7
(11) Net capital account transactions and financial derivatives
(13) Balance of payments ( )
−89.2
(12) Statistical discrepancy
517.4
(10) Balance on capital account ( )
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 ( )
−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 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

12. TABLE 20.1 United States Balance of Payments, 2011
37.7
(11) Net capital account transactions and financial derivatives
(13) Balance of payments ( )
−89.2
(12) Statistical discrepancy
517.4
(10) Balance on capital account ( )
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 ( )
−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 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

13. TABLE 20.1 United States Balance of Payments, 2011
37.7
(11) Net capital account transactions and financial derivatives
(13) Balance of payments ( )
−89.2
(12) Statistical discrepancy
517.4
(10) Balance on capital account ( )
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 ( )
−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 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

14. TABLE 20.1 United States Balance of Payments, 2011
37.7
(11) Net capital account transactions and financial derivatives
(13) Balance of payments ( )
−89.2
(12) Statistical discrepancy
517.4
(10) Balance on capital account ( )
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 ( )
−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 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

15. 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:
The Wissinks are importing goods and services.
There will be 2 entries in the Balance of Payments.

16. 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.

17. 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

18. 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.

19. 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.