International Economics

1
International Economics

• Lecture 1. Introduction. World Trade An Overview

2
Outline

• Practicalities
• What is international economics about?
• Main issues in international economics
• Gains from trade
• Patterns of trade
• Effects of trade policy
• Road map for the course
• Explaining who trades with whom and how much?
• The gravity model
• Borders and trade agreements
• Globalization, past and present
• Changing composition of trade
• Multinational corporations and outsourcing

3
Practicalities

• Literature
• Krugman and Obstfeld, 9th edition, chapter 1-11
• Difference compared to 8th edition explained in
  the Preface
• Requirements
• Mandatory individual assignment (handed in 15
  December)
• Final exam, 16 January (100 points)
• To pass need 40 points
• Office hours
• Tuesdays 15-17 (or by appointment)

4
Practicalities (cont.)

• Available on the web
• On the courses web site
• Outline
• Lecture notes
• Assignment
• On CourseCompass with student access kit
• Web resources related to the text book
• Course ID ekholm97627

5
What Is International Economics About?

• International economics is about how nations
  interact through trade of goods and services,
  through flows of capital and labor.
• This course will focus on interaction through
  trade in goods and services and through flows of
  real capital and labor.
• It will not deal with trade in financial assets.
• Old subject that continues to grow in importance
  as the world becomes more globalised.
• World trade has increased by ca 400 percent since
  1970 while world production has increased by ca
  150 percent.

6
What Is International Economics About? (cont.)
Source Barba Navaretti and Venables (2004)
7
Main Issues in International Economics

• Gains from trade
• Patterns of trade
• Who trades with whom and how much
• Which goods and services are exported/which are
  imported
• The effect of government policies on trade

8
Gains from Trade

• A fundamental proposition in economics is that
  there are gains from trade.
• Ideas underlying this proposition
• When a buyer and a seller engage in a voluntary
  transaction, both receive something that they
  want and both can be made better off.
• Swedes can buy tropical fruits and cut flowers
  through international trade that they otherwise
  would have a difficult time producing.
• The producers of the fruits and flowers receive
  income that they can use to buy the things they
  desire.

9
Gains from Trade (cont.)

• Even countries that are either the most or the
  least efficient producer of everything may gain
  from trade.
• With a finite amount of resources, countries can
  use resources to produce what they are most
  productive at (compared to their other production
  choices), then trade those products for goods and
  services that they want to consume.
• Countries can specialize in production, while
  consuming many goods and services through trade.
• Trade is predicted to benefit a country by making
  it more efficient when it exports goods which use
  abundant resources and imports goods which use
  scarce resources.
• When countries specialize, they may also be more
  efficient due to large scale production.

10
Gains from Trade (cont.)

• Trade is predicted to benefit countries as a
  whole in several ways, but trade may harm
  particular groups within a country.
• International trade can adversely affect the
  owners of resources that are used intensively in
  industries that compete with imports.
• Trade may therefore have effects on the
  distribution of income within a country.
• Conflicts about trade should occur between groups
  within countries rather than between countries.

11
Patterns of Trade

• Differences in climate and resources can explain
  why Brazil exports coffee and Australia exports
  iron ore.
• But why does Sweden export automobiles, while the
  US exports passenger aircraft?
• And why does Sweden import as well as export
  automobiles?
• Differences in productivity may explain why some
  countries export certain products.
• Differences in the availability of capital, labor
  and land and differences in the use of these
  resources in the production of different goods
  may also explain why some countries export
  certain products.
• Preferences for product variety and scale
  economies may explain why similar goods are both
  exported and imported.

12
The Effects of Trade Policies

• Policy makers affect the amount of trade through
• tariffs a tax on imports (or exports),
• quotas a quantity restriction on imports or
  exports,
• export subsidies a payment to producers that
  export,
• or through other regulations (e.g., product
  specifications) that exclude foreign products
  from the market, but still allow domestic
  products.
• What are the costs and benefits of these
  policies?
• If a government must restrict trade, which type
  of policy gives the highest benefits at the
  lowest costs?
• If a government must restrict trade, how much
  should it restrict trade?
• If a government restricts trade, what are the
  benefits and costs if foreign governments respond
  likewise (retaliate)?

13
A Road Map

• Lecture 2-6
• International trade theory (chapters 37)
• Gains from trade
• Patterns of trade
• Includes analysis of flows of real capital
  (foreign direct investment) and labor (migration)
• Lecture 7-8
• International trade policy (chapters 811)
• Effect of trade policy
• Determination of trade policy
• Controversies in trade policy
• Remaining part of lecture 1
• Who trades with whom and how much?
• Globalisation, past and present

14
Who Trades with Whom?

• The 5 largest trading partners with the US in
  2005 were Canada, China, Mexico Japan and
  Germany.
• The largest 10 trading partners accounted for 56
  of the value of US trade in 2005.
• The 4 largest trading partners with Sweden in
  2007 were Germany, Norway, Denmark and the UK
  (the fifth was the US for exports and Finland for
  imports).
• The largest 10 trading partners accounted for 66
  of Swedish exports and 71 of Swedish imports in
  2007.

15
Who Trades with Whom? (cont.)
Fig. 2-1 Total U.S. Trade with Major Partners,
2006
16
Who Trades with Whom? (cont.)
Source Statistics Sweden
17
Size Matters The Gravity Model

• The 3 largest European economies, Germany, UK and
  France, are among the top 10 trading partners for
  both the US and Sweden
• These countries are large in terms of GDP.
• The size of an economy is directly related to the
  volume of imports and exports.
• Larger economies produce more goods and services,
  so they have more to sell in the export market.
• Larger economies generate more income from the
  goods and services sold, so people are able to
  buy more imports.

18
Size Matters The Gravity Model (cont.)
Fig. 2-2 The Size of European Economies, and
the Value of Their Trade with the United States
Source U.S. Department of Commerce, European
Commission
19
The Gravity Model

• Other things besides size matter for trade
• Distance between markets influences
  transportation costs and therefore the cost of
  imports and exports.
• Distance may also influence personal contact and
  communication, which may influence trade.
• Cultural affinity if two countries have cultural
  ties, it is likely that they also have strong
  economic ties.
• Geography ocean harbors and a lack of mountain
  barriers make transportation and trade easier.
• Borders crossing borders involves formalities
  that take time and perhaps monetary costs like
  tariffs.
• These implicit and explicit costs reduce trade.
• The existence of borders may also indicate the
  existence of different languages (see 2) or
  different currencies, either of which may impede
  trade more.

20
The Gravity Model (cont.)

• In its basic form, the gravity model assumes that
  only size and distance are important for trade in
  the following way
• Tij (A Yi Yj)/Dij
• where
• Tij is the value of trade between country i and
  country j
• A is a constant
• Yi the GDP of country i
• Yj is the GDP of country j
• Dij is the distance between country i and country
  j
• In a slightly more general form, the gravity
  model that is commonly estimated is
• Tij (A Yia Yjb)/Dijc
• where a, b, and c are allowed to differ from 1.
• It works fairly well in predicting actual trade
  flows.

21
Distance and Borders

• Estimates of the effect of distance from the
  gravity model predict that a 1 increase in the
  distance between countries is associated with a
  decrease in the volume of trade of 0.7 to 1.
• Improved technology in transportation and
  communication along with trade liberalisation
  have reduced trade frictions and increased trade.
• However, it does not appear to have reduced the
  effect of distance on trade.
• Besides distance, borders increase the cost and
  time needed to trade.

22
Distance and Borders (cont.)

• Trade agreements between countries are intended
  to reduce the formalities and tariffs needed to
  cross borders, and therefore to increase trade.
• US trade with Mexico and Canada large because of
  proximity, but also because of the North American
  Free Trade Agreement (NAFTA) which was signed in
  1994.
• The gravity model can assess the effect of trade
  agreements on trade does a trade agreement lead
  to significantly more trade among its partners
  than one would otherwise predict given their GDPs
  and distances from one another?

23
Distance and Borders (cont.)
Fig. 2-3 Economic Size and Trade with the
United States
Source U.S. Deparment of Commerce, European
Commission
24
Distance and Borders (cont.)

• Yet even with a free trade agreement between the
  US and Canada, which use a common language, the
  border seems to be associated with a reduction in
  trade.
• Studying trade flows between British Columbia and
  other Canadian provinces, on the one hand, and US
  states at similar distances, on the other, shows
  that trade is substantially smaller in the latter
  case.

25
Distance and Borders (cont.)
26
Distance and Borders (cont.)
27
Globalisation, Past and Present

• Two waves of globalization
• 18401914 economies relied on steam power,
  railroads, telegraph, telephones.
• Globalization was interrupted and reversed by
  wars and depression.
• 1945present economies rely on telephones,
  airplanes, computers, internet, fiber optics,

28
Changing Composition of Trade

• In the past, a large fraction of the volume of
  trade came from agricultural and mineral
  products.
• Today, most of the volume of trade is in
  manufactured products such as automobiles,
  computers, clothing and machinery.
• Services such as shipping, insurance, legal fees
  and spending by tourists account for 20 of the
  volume of trade.
• Mineral products (e.g., petroleum, coal, copper)
  and agricultural products are a relatively small
  part of trade.

29
Fig. 2-6 The Composition of World Trade, 2005
Source World Trade Organization
30
Changing Composition of Trade (cont.)
31
Changing Composition of Trade (cont.)

• Low and middle-income countries have also changed
  the composition of their trade.
• In 1960, about 58 of exports from low and
  middle-income countries were agricultural
  products and only 12 of exports were
  manufactured products.
• In 2001, about 65 of exports were manufactured
  products, and only 10 agricultural products.

32
Changing Composition of Trade (cont.)
33
Service Outsourcing (Offshoring)

• Service outsourcing (offshoring) occurs when a
  firm that provides services moves its operations
  to a foreign location.
• It can occur for services that can be performed
  and transmitted electronically.
• For example, a firm may move its customer service
  centers whose telephone calls can be transmitted
  electronically to foreign location.
• The operations could be run by a subsidiary of a
  multinational corporation.
• Or they could be subcontracted to a foreign firm.
  
• Currently not a significant part of trade, but
  about 19 of service jobs estimated to be
  tradeable and thus have the potential to be
  outsourced.
• In comparison, about 12 of manufacturing jobs
  are tradeable and thus have the potential to be
  outsourced.
• Most jobs, however, are non-tradeable because
  they need to be done close to the customer.

34
Fig. 2-8 Tradable Industries Share of
Employment
Source J. Bradford Jensen and Lori G. Kletzer,
Tradable Services Understanding the Scope and
Impact of Services Outsourcing, Peterson
Institute of Economics Working Paper 5-09, May
2005
35
Summary

• Size and distance are important determinants of
  bilateral trade volumes
• This is captured by the gravity model, which
  predicts that the volume of trade is directly
  related to the GDP of each trading partner and is
  inversely related to the distance between them.
• Besides size and distance, borders have a strong
  effect on trade.
• Innovations in transportation and communication
  along with trade liberalisation have reduced
  trade costs, but the effect of distance and
  borders remain strong.
• Today, most trade is in manufactured goods, while
  historically agricultural and mineral products
  made up most of trade. In the future services
  trade may become the most important component of
  trade.