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Reading 17: International trade and Capital Flows (Trade agreements …
Reading 17: International trade and Capital Flows
GDP vs. GNP
GDP
Total value of G&S produced within a country border.
GNP
Total value of G&S produce by the labor and capital supplied by a country's citizens.
International Trade
Benefits
Increase overall economic wellfare.
Countries can specialize production and enjoy economies of scale.
More product variety, competition & efficient allocation of resources.
Costs
Losses of domestic industries that lose business to foreign competition.
Unemployment increase when workers are retrained for jobs in expanding industries.
Income inequality
Comparative Vs. Absolute Advantages
Absolute Advantages
lower cost in term of resource
Comparative Advantage
Lower opportunity cost in term of other goods (that could be produced instead)
Law
Trade can make all countries better off
Each country can specialize in goods that they produce most efficiently and trades for other goods
Outcome
: increase worldwide output and wealth with no country being worse off
Best trade term: trade at partner's comparative advantage ratio (partner's autarkic price)
Comparative advatange for goods A: = \(\frac{Output_{B}}{Output_{A}}\)
The lower the better
Example
Country X can produce 1Product A or 3 product B
Country Y can produce 1Product A or 2 product B
X has comparative advantage over Y in producing product B (1/3 < 1/2)
Y has comparative advantage over X in producing product A (2 < 3)
X can focus on producing B
Y can focus on producing A
then Trade
Trade ratio and utility capture
B/A = 2/1 (Point where Y Comparative advantage for A)
X captures all utility gains
B/A=3/1(Point where X Comparative advantage for B)
Y Capture all utility gains
2/1 < B/A < 3/1(between 2 comparative advantage ratio)
X and Y share utility gains
B/A < 2/1 (lower than Y's autarkic price)
No trade, Y rather make A by itself.
If trade, X has unfair gains, while Y has unfair loss
B/A > 3 (lower than X'S autarkic price)
No trade, X rather make B by it self
If trade, Y has unfair gains, while X has unfair loss
Ricardian Vs. Heckscher-Ohlin Model of trade
Ricardian
:
Only one factor of production: Labor.
The source of difference in production costs (and thus comparative advantage) is the
difference in labor productivity due to technology
Trade gains
Country A capture more gains if
Trade price is closed to PARTNER'S autarkic price (price of closed economy) than to its own
Heckscher-Ohlin
2 factors of production: Capital & Labor
Source of comparative advantage: differences in relative amount of each factor that each country has.
A country with larger labor force will have comparative advantage in labor-intensive industry; A country with larger capital capacity will have comparative advantage in capital-intensive industry.
Each country can specialize in the good that requires more of the more abundant resource, increasing total output
Owners of the more abundant resource in each country gain wealth while owners of the less-available resource lose wealth
Price of the more abundant resource will increase in each country
Trade & capital restrictions
Trade restrictions
Types
Quotas
Limits on the amount of imports
Domestic Consumer: LOSS
Domestic Producer: GAIN
Domestic Government: MAY GAIN
Foreign Exporter: MAY GAIN
Minimum Domestic Content
Requirement that some % of product content must be domestic.
Voluntary export restraints
A country voluntarily restricts the amount of exported goods, in order to avoid tariffs or quotas imposed by trading partner.
Domestic Consumer: LOSS
Domestic Producer: GAINS
Domestic Government: NONE
Foreign Exporter: LOSS
Tariffs
Taxes on imported goods
Domestic Consumer: LOSS
Domestic Producer: GAINS
Domestic Government: GAIN
Foreign exporter: LOSS
Export subsidy
:
Payments by government to domestic exporters
Domestic Consumer: LOSS
Domestic Producer: GAIN
Domestic Government: LOSS
Foreign Exporter: NA
Effects of restrictions
Increase prices & decrease quantity of imported goods
Increase demand and quantity supplied of domestic goods
Increase producer surplus and decrease consumer's surplus
Capital restriction
Types
Prohibition or taxes on income earned on foreign investment by domestic citizens
Prohibition of foreign investment over certain industries
Restriction on repatriation (sending back earned money) of earnings of foreign entities operating in a country.
Outright prohibition of foreigner investment
Reasons/ objectives
Reducing volatilities of domestic asset prices
However, in the long-term will isolate from global market
Maintaining fixed exchange rate
More independence regarding monetary policy
Protecting strategic industry from foreign ownership.
Revenue from tariffs, quota rents
Trade agreements
Reduce trade restriction --> improve economic welfare
Free Trade Area
:
All barriers to the import/export of G&S among members are removed. Ex: NAFTA
Custom Unions
:
(Plus) Members also adopt a common set of trade restriction with nonmember.
Common Market
(Plus) Members also remove all barriers to the movement of labor and capital goods among members.
Economic Union
(Plus) Members also establish common institution and economic policy for the union.
Monetary Union
(Plus) Members also adopt a single currency (Ex: Eurozone)
Regional trading agreements are quicker to establish than multilateral trade negotiations
Quicker and easier policy coordination.
Balance of payment
Composition
Current Account
Import / Export of G&S
Service includes patent or legal fees
Foreign earnings from stock dividend or debt interest
Unilateral transfers (Money from domestic citizen working abroad, direct foreign aid)
To calculate Current Account Balance
Determine each transaction is inflow (+) or outflow (-)
Net all the transactions
Capital Account
Debt forgiveness
Migrant's assets
Purchase/ sale of fixed assets
Purchase/ sale of non-financial assets (Rights to natural resource, copyrights, trademark, lease, etc.)
Financial Account
Foreign-owned asset in the country, domestic government and corporate securities, direct investment in the country and domestic currency.
Government-owned foreign assets, direct investment in foreign country and claim against foreign banks.
Balance of Trade
Export - Import = Private savings + Government savings - Domestic investment - Transfer
X-M = S-I + T-G-R
When total savings < domestic investment, export must be less than import
Lower private savings, larger Gov deficit and high-rate of domestic investment --> increase current account deficit.
Any surplus (deficit) in current account must be offset by a deficit (surplus) in the capital and financial accounts.
World Bank, IMF and WTO
World Bank
Provide low-interest-rate loans, interest-free credits and grants to developing countries
Provide resources and knowledge and help forming private/ public partnerships with overall goals of fighting poverty
IMF
International monetary cooperation
International payment systems
Help with balance of payment problems
Exchange rate stability
Growth of trade
WTO
Ensure that trade flows freely and works smoothly
Instituting, interpreting and enforcing multilateral trade agreements that detail global trade policies.