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International Economics 112

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Introduction What is International Economics About? International Economics: Trade and Money International economics theory

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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?

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The Gains from Trade Many people are skeptical about importing goods that a country could produce for itself. When countries sell goods and services 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. -International difference in labor productivity. -The relative supplies of national resources such as capital, labor, and land on one side and the relative use of these factors in the production of different goods on the other. -A substantial random component. 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?

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Protectionism? 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?

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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 (floating)exchange rates is at the center of international economics. What is International Economics About?

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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 Europes subsidized exports of agricultural products

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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

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International trade issues Part I: International Trade Theory Part II: International Trade Policy International monetary issues Part III: Exchange Rates and Open- Economy Macroeconomics Part IV: International Macroeconomic Policy International Economics: Trade and Money

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Two Basic Concepts balance of trade 1. Trade Surplus Exports Imports Favorable Balance of Trade 2. Trade Deficit Exports Imports Unfavorable Balance of Trade 3. Trade Balance Exports Imports Trade Structure 1. Commodity Structure 2. Geographical Structure Dependency of Trade 2004 2005 2004 2005 2004 70% 2005

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( Adam Smith :17231790 ---The Wealth of Nations) In a two-nation, two-product world, international trade and specialization will be beneficial when one nation had an absolute cost advantage in one good and the other nation has an absolute cost advantage in the other good. . Absolute advantage 11

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For the world to benefit from international division of labor, each nation must have a good that it is ablolutely more efficient in producing than its trading partner. A nation will import those goods in which it had an absolute cost disadvantage; it will export those goods in which it has an absolute cost advantage.

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Countries engage in international trade for two basic reasons: They are different from each other in terms of climate, land, capital, labor, and technology. For example, China and U.S. They try to achieve scale economies in production, such as Boeing and airbus.

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2 Comparative Cost David Ricardo 1817 Background Cultivation of wheat expands, land of grass shrinks, and price of wool goes up Labor is more expansive Food expend increases, end goods expend decreases Revenge from other countries, export of end products decrease

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Case of Ricardian Model Unit Cost Calculated in terms of labor Britain Portugal Carpet Wine 4848 6 10 Assumptions Two nations, two products, one factor, fixed productivity, sufficient employment, perfect competition, non-mobility of factor, barter, no technological improvement, no transportation cost Assumptions Two nations, two products, one factor, fixed productivity, sufficient employment, perfect competition, non-mobility of factor, barter, no technological improvement, no transportation cost The absolute costs of both products in Britain is lower than that in Portugal, why is there still trade between these two countries

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A necessary condition of international trade: Comparative cost difference A sufficient condition of international trade: international exchange rate is between domestic exchange rates in both countries. There is benefit from trade Limitation Why there is comparative cost

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Some failings of Ricardian model An extreme specialization is not in the real world, as we mentioned above. Without concern the distribution of income within countries in trade. It allows no role for differences in resources among countries as a cause of trade. It neglects the possible role of economies scale as a cause of trade.

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18 We have learned the Ricardian model, but there are so many wrong ideas about the international trade. We need to correct them. 1 Productivity and Competitiveness 2 The Pauper Labor Argument ( ) 3 Exploitation Misconceptions About Comparative Advantage

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19 1. Productivity and Competitiveness A well-known historian said: What if there is nothing you can produce more cheaply or efficiently than anywhere else? Myth 1: Free trade is beneficial only if a country is strong enough to withstand ( ) foreign competition. This argument fails to recognize that trade is based on comparative not absolute advantage. The competitive advantage of an industry depends not only on its productivity relative to the foreign industry, but also on the domestic wage rate relative to the foreign wage rate. In our numerical example, Foreign has competitive advantage with lower wages in wine production.

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20 2. The Pauper Labor Argument ( ) In 1993 Ross Perot warned that free trade between U.S. and Mexico was not beneficial to U. S. economy. Myth 2: Foreign competition is unfair and hurts other countries when it is based on low wages. It is favorite of labor unions to seeking protection from foreign competition. Again in our example Foreign has lower wages but home still benefits from trade. Because it is cheaper in term of its own labor for home to produce cheese and trade it for wine than to produce wine for itself.

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21 3. Exploitation One columnist contrasted the $2 million income of the chief executive officer of the clothing chain The Gap with the $0.56 per hour paid to the central American workers who produce the clothing. Myth 3: Trade makes the workers worse off in countries with lower wages. In the absence of trade these workers would be worse off. Again in our example, the purchasing power of a workers hourly wage would fall from 1/3 to 1/6 pound of cheese. Denying the opportunity to export is to condemn poor people to continue to be poor.