1. The Domestic Sources of Foreign Economic Policies
Week 5-6
The Domestic Sources of Foreign Economic Policies

2. Foreign economic policies(FEP) encompass:
International trade
International flows of investment and capital
Immigration and emigration
Exchange rate for national currency

3. 2 Key domestic explanations of different choices/decisions in FEPs
1) The policy preferences (Trade, Immigration, Foreign Investment, Exchange Rates) of different groups in the domestic economy
Requires economic analysis
Basic assumption: individuals and groups are concerned about how different policy choices affect their incomes
2) How domestic political institutions (Types of Political Systems, Legislatures and Policy-making Rules, Bureaucratic Agencies) determine the way these preferences are aggregated or converted into actual government decisions
Requires political analysis

4. 1) Policy Preferences: Trade (1)
Heckscher-Ohlin model
Differences in factor endowments (land, labour or capital) create differences in comparative advantage
Each country tends to export those items whose production requires intensive use of domestically abundant factors
Each country tends to import those items whose production requires intensive use of domestically scarce factors

6. Absolute Advantage vs. Comparative Advantage – Specialization
Absolute Advantage: One nation can produce more output with the same resources as the others. Comparative Advantage: One nation produces a good of a lower opportunity cost than the other.

9. Heckscher-Ohlin model – Simplest form

12. 1) Policy Preferences: Trade (2)
Stolper-Samuelson theorem
Outlining the likely effect of trade on the real incomes of different sets of individuals within an economy.
Assumption: factors of production are highly mobile between different industries (shifting industry is easy)
Trade benefits those who own the factors of production that are relatively abundant
Trade hurts those who own the factors of production that are relatively scarce
Trade creates winners and losers within each country:
Winners would support greater trade openness
Losers would be against greater trade openness

16. 1) Policy Preferences: Trade (3)
Specific factors model (now the most commonly accepted)
Accounts for coalitions between labour and capital in the same industry (interests assumed to be opposed in Stolper-Samuelson)
Relaxes the Stolper-Samuelson assumption that factors of production are highly mobile between different industries
Different types of factors of production have very limited or specific use
Trade benefits the factors of production that are employed in export-oriented industries
Trade hurts the factors of production that are employed in import-competing industries

19. 1) Policy Preferences: Immigration (1)
In principle, and at the aggregate level:
Freedom of movement for labour will lead to increases of total output of goods and services (at global and national levels)
Labour movement should respond to price signals to improve economic efficiency
International movement of labour (and other factors of production) is a substitute for movement of goods (within Heckshcer-Ohlin model)

21. 1) Policy Preferences: Immigration (2)
Who will oppose immigration? Why?
“Factor-proportions” analysis
Similar form of analysis to Heckscher-Ohlin endowments-based theory
Additional distinction is made between types of labour: e.g. high-skilled vs. low-skilled
Immigration harms local workers with similar skill levels to those of the arriving workers
Owners of land and capital are likely to be the strongest supporters of more immigration
Non-economic factors (culture, identity) are also very important

23. 1) Policy Preferences: Investment (1)
Portfolio investment: purchases of company shares and other forms of securities, including government bonds
Foreign Direct Investment (FDI): purchase of assets by foreigners that lead to ownership control of a firm
In general, it is reasonable to expect large flows of capital from industrial nations to the developing world (in line with Heckscher-Ohlin model)

26. 1) Policy Preferences: Investment (2)
Who will oppose inward investment? Why?
“Factor-proportions” analysis
Inflows of foreign capital will lower real returns for local owners of capital
NOTE: bulk of FDI in modern world economy occur between industrial economies alone
Firms gain advantages in “jumping borders” and trade barriers (e.g. access to foreign markets)
FDI allows firms to internalize transactions

30. 1) Policy Preferences: Exchange Rates (1)
Policy choices:
Allow the value of the currency to fluctuate freely
Fix the value of the currency
There is no consensus among economists on exchange rate policy
There is a trade-off between monetary policy and exchange rate policy
EITHER stable exchange rates but no control of monetary policy
OR fluctuating exchange rates and independent monetary policy

31. 1) Policy Preferences: Exchange Rates (2)
Difficult to form simple class- or industry-based analysis of policy preferences
Individual interests vary according to a range of considerations such as:
Ownership of factor of production (labour or capital)
Specificity of factors of production (fixed or mobile)
Destination of the output of production (export or domestic market)
Reliance on foreign markets (net purchases or net investments)

32. 2)Institutions: Political Systems
Autocratic regimes may support either trade liberalization or trade protection
In democracies, the balance of policy preferences can be affected by:
The extension of the electoral franchise
The voting system adopted
The cost of political action and lobbying
The design of electoral districts

35. 2) Institutions: Legislatures & Rules
Legislative rules determine the way policies are proposed, considered, amended and voted upon
Lobby groups’ ability to access lawmakers increases chances of protectionism
An institutional ability to link domestic tariff reductions with reciprocal reductions abroad can facilitate trade liberalization

39. 2) Institutions: Bureaucratic Agencies
How bureaucratic agencies implement or administer foreign economic policies can have important effects
The danger of “bureaucratic capture” by partisan groups

43. Complications: Information (1)
Standard political economy approach assumes that individuals know
what they want
what others want
what types of policies will have what effects
More recent research has emphasized
Uncertainty
Asymmetry of information among actors
Changes in knowledge due to learning and the impact of new ideas

45. Complications: Information (2)
New ideas and knowledge can have a large impact on policy-making
Many individuals have incomplete information about foreign economic policies and are susceptible to issue-framing or manipulation
Governments may choose to “tie their hands” in order to demonstrate credible commitment to certain policies

50. Complications: Issue Linkages
The effects of different policy instruments depend on how other policies are set
Linkages can be made with both economic and non-economic policies (e.g. national security, environmental policies, human rights issues)
Interesting coalitions may emerge
Issues may be “hijacked” by powerful groups
Non-economic goals may trump economic goals or outcomes

54. Complications: Int’l Bargaining
Putnam’s (1988) “two-level game”
Governments engaged in international economic negotiations are involved in two different political games simultaneously
International level: relative size and strength can be important
Domestic level: preferences of domestic groups and legislative processes are important