International Economics

KOOTHS | BiTS: International Economics (winter term 2014/2015) 1

International Economics

Prof. Dr. Stefan KoothsBiTS Berlin

(winter term 2014/2015)www.kooths.de/bits-ie


Contact data

Prof. Dr. Stefan KoothsDeputy Head of the Forecasting CenterKiel Institute for the World Economy

Office BerlinIn den Ministergärten 810117 Berlin030/2067-9664

[email protected]

mailto:[email protected]


The Kiel Institute for the World Economy


Outline

1. Introduction and Overview

2. Recording Cross-border Economic Activity

3. The Pure Theory of International Trade

4. Trade Policy: Free Trade vs. Protectionism

5. Foreign Exchange Markets and the Open Macroeconomy

6. Case Study: The Euro Area Crisis

7. Summary: The Key Lessons Learnt


Outline

1. Introduction and Overview Motivation, key questions, and methodology Course scheme

2. Systemizing and Recording Cross-border Economic Activity







Global production and international trade

Average growth:GDP: 3.4 percentTrade: 5.6 percent


Drivers of Globalization (overview)

Liberalization of world trade Liberalization of cross-border capital flows Collapse of centrally-planned economies Increased political/social stability Improved transportation infrastructure Progress in telecommunication systems/internet technologies Creation of economic blocs (e.g. EEC/EU, NAFTA, MERCOSUR) Spread of technological know-how via FDI Better education for more people


Effects of Globalization (overview)

Generally: More choices (deeper markets) More competition on world markets Increased number of tradable goods and services More alternatives for production sites

(globally integrated value-added chains) Accelerated structural change/more innovations

(pressure on domestic labor markets) Regulatory arbitrage, pressure on tax and transfer systems

(less latitude for national policies) Intensified international dependencies

Net gains, but domestic winners and losers (preview)


Why „International Economics“ is different (and why it is not)

Key economic questions (not specific to IE)» (International) division of labor» (International) allocation of production factors» Uniform microeconomic foundations and macroeconomic analysis

Country borders and the nation state» Factor mobility (labor, capital)» Legal frameworks, fiscal policy» National money and exchange rate systems


Economics:Analysis of economic activity (= coping with scarcities)


International Economics:Analysis of cross-border economic activity


BUT: Do country borders always matter?


Methodological individualism

General method» Individuals as point of departure for economic analysis» Explaining social processes via actions of involved persons

Individuals …» … are diverse» … have exogenous preferences» … are capable of acting on their own» … follow their vested interest

Subjectivism» Individual preferences» No scientific inter-subjective comparisons of utility


Key first insights from methodological individualism

Trade = exchange of goods or services» Two-sided human interaction (social cooperation)» Based on voluntary contracts (implies mutual benefits)Net gains from trade for both parties (no zero-sum game)

Pitfalls from aggregation/collectivist perspectives» Countries do not trade with each other, only individuals/firms do» Countries do not compete with each other, only individuals/firms do

- Competitiveness is a relative concept- Countries (economic areas) consist of multiple markets- Each market comprises both the supply side and the demand side„Competitiveness“ not applicable to country level


Outline

1. Introduction and Overview Motivation, key questions, and methodology Course scheme

2. Recording Cross-border Economic Activity







Reading

Literature» Dieckheuer, G. (2001): “Internationale Wirtschaftsbeziehungen”, 5. Aufl., München/Wien.» Eibner, W. (2006): “Understanding International Trade: Theory & Policy/Anwendungsorientierte

Außenwirtschaft: Theorie & Politik”, Oldenbourg Verlag: München/Wien.» Hazlitt, H. (2008): “Economics in One Lesson”, Ludwig von Mises Institute: Auburn/Alabama.

[https://mises.org/books/economics_in_one_lesson_hazlitt.pdf]» Kooths, S. and B. van Roye (2012): “Euro Area: Single Currency – National Money Creation”, Kiel

Working Papers, No. 1787, Kiel.» Pugel, T, A. (2012): “International Economics”, 15th Edition, McGraw-Hill: New York.» Snower, D., J. Boysen-Hogrefe, K.-J. Gern, H. Klodt, S. Kooths, C.-F. Laaser, C. Reicher, B. van Roye, J.

Scheide and K. Schrader (2013): “The Kiel Policy Package to Address the Crisis in the Euro Area”, Kiel Policy Brief, No. 58a, Kiel.

Course website: www.kooths-de/bits-ie

http://www.kooths-de/bits-ie


Outline


2. Recording Cross-border Economic Activity The Balance of Payments (BoP) The International Investment Position (IIP)







CAPITAL AND FINANCIAL ACCOUNT

CURRENT ACCOUNT

Types of cross-border transactions

Trade flows» Goods (merchandise)» Services

Cross-border incomes(compensation for use of production factors)» Labor: Compensation of employees» Capital: Investment income

Transfers» Current transfers (regularly) » Capital transfers (one-off)

Financial transactions» Nonofficial: Direct/Portfolio/Other investment» Central bank: Changes in official international reserves


Accounting principles:Credit and debit items (double-entry bookkeeping)

Credit item (measured with a positive sign/entry on the left side) …» … results from a transaction for which the country must be paid. It sets

up the basis for a payment by a foreigner into the country – that is, it creates a monetary claim on a foreigner.

Debit item(measures with a negative sign/entry on the right side) …» … results from a transaction for which the country must pay. It sets up

the basis for a payment by the country to a foreigner – that is, it creates a monetary liability against a foreigner.

Double-entry system(sum of all credit entries = sum of all debit entries)» BUT: Statistical discrepancies („errors and omissions“)


Valuation: cif vs. fob


Key “Balance of Payments” concepts

Flow-oriented framework for cross-border transactions» Specific time period (year, quarter, month)» NOT: Stocks (“balance sheet”)

Time of recording» Accrual principle» NOT: Actual Payment

People» Residents vs. Non-Residents» NOT: Nationals vs. foreigners (nationality does not matter)

Focus: Reporting country vs. RoW (= rest of the world)


The consolidated BoP account


Current account vs. Capital and financial account


More detailed BoP subaccounts


The detailed BoP structure (IMF BoP Manual)

IMF Balance of Payments Manualhttp://www.imf.org/external/pubs/ft/bopman/bopman.pdf

http://www.imf.org/external/pubs/ft/bopman/bopman.pdf




Official reserve assets and the role of the central bank


Real-life BoPs

Statistical Discrepancies=Net Errors and Omissions=Balance on Unclassified Transactions


Example: US Balance of Payments (2010, $ billions)


Interpreting BoP balances (BoP and National Accounts)

Goods and services balance / trade balance (NX)» Net exports of both goods and services

Current account balance (CA)» Net credits on the flows of goods, services, income, current transfers

Financial account balance, exl. official reserves (FA)» Net credits involving changes in

nonofficial foreign financial assets and liabilities Overall balance / official settlements balance (B)

» Current account balance + (nonofficial) financial account balance [+ statistical discrepancy] = Increase of official reserve assets

Link to National Accounts» NX GDP» CA GNI» CA + net capital transfers Net external lending


Does a trade deficit reduce GDP?


Accounting exercise (Reporting country: USA)

(1) At the end of the year, Northern Illinois (a U.S. utility company) buys $34 million in natural gas from a Canadian firm. It does not pay in cash immediately, but instead issues a promissory note saying it will pay the bill (plus interest that will accrue over time) one year later.

(2) Brazilian soccer fans spend $6 million as tourists in the U. S. during a soccer tournament, and they pay for their hotels, meals, and transportation by using the deposits that they have at a New York bank.

(3) The U.S. Treasury pays $25 million in interest on its past borrowing from Swiss investors, paying with checks on a New York bank.

(4) The U.S. monetary authority (Fed) in its official role becomes concerned that the exchange rate value of the dollar may appreciate against the Japanese yen. It decides to purchase yen-denominated bank deposits from a major Tokyo bank and pay by transferring $15 million of its New York bank deposits to this Tokyo bank.

(5) The U.S. government gives $8 million in foreign aid to the government of Egypt in the form of wheat from U.S. government stockpiles.

(6) Mexican immigrant workers in the U.S. send $2 million from their bank accounts at a Phoenix-based bank as remittances to their families in Mexico.


Outline


2. Recording Cross-border Economic Activity The Balance of Payments (BoP) The International Investment Position (IIP)







Linking BoP and IIP

Stocks (IIP) vs. flows (BoP Transaction-based flows vs. revaluations of stocks


Germany: Current account, capital transfers, and IIP

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1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Balance on Current Account (rhs) Net Errors and Omissions (rhs) Net Capital Transfers

IIP Transaction-based IIP (1992 ff.)

Annual data.Source: Deutsche Bundesbank, IfW calculations.

Bn. Euro Bn. Euro


Outline

1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade

General analysis of cross-border trade Reasons for inter-industry trade:

Absolute and comparative advantage Causes and consequences of cost differences:

The role of factor endowments and factor proportions “Imperfect” competition and intra-industry trade

4. Trade Policy: Free Trade vs. Protectionism5. Foreign Exchange Markets and the Open

Macroeconomy6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt


Four basic questions about cross-border trade

Causes:What determines which products are exported and imported?

Impact:How does trade affect production and consumption in each country?

National gains:How does trade affect the economic well-being of each country?

Intra-national winners and losers :How does trade affect the distribution of economic well-being among various groups within a country?


Categories of trade

Non-availability (trade in commodities) Inter-industry trade (specialization) Intra-industry trade


Product markets: General assumptions, demand and supply, consumer and producer surplus, elasticities


Opening of trade: National and international markets


Arbitrage and free-trade equilibrium


Terms of trade


Four basic answers to trade


Outline








Adam Smith: Theory of absolute advantage

» Maximum number of working hours: 10 (millions, billions, …)» Production and consumption possibilities without trade

(self-sufficiency)?» Consumption possibilities with trade and specialization

(division of labor)?

Working hoursper ton of wheat

Working hoursper barrel of wine

Country A 2 5

Country B 2,5 4

Adam Smith (1723—1790)An Inquiry into the Nature and Causes

of the Wealth of Nations, 1776


David Ricardo:Opportunity cost and theorem of comparative advantage

» Maximum number of working hours: 10 (millions, billions, …)» Production and consumption possibilities without trade

(self-sufficiency)?» Any chance for mutually beneficial trade (division of labor)?

David Ricardo (1772—1823)On the Principles of Political Economy and Taxation, 1817

Working hoursper ton of wheat

Working hoursper barrel of wine

Country A 2 5

Country B 1 4


Production-possibility curve


Exchange rate and terms of trade


Mercantilism and unbalanced trade


Complete vs. incomplete specialization: Constant vs. increasing marginal cost


Production conditions, preferences and trade patterns


Trade effects and gains from trade


Country size and relative international winners


Outline




The role of factor endowments and factor proportions

“Imperfect” competition and intra-industry trade




Factor proportions and factor endowments

Factor proportions» Factor intensity used in production of goods» Labor-intensive good:

Ratio of labor to other factors is high relative to other goods(share of labor costs is high relative to other goods)

Factor endowments» Available factor resources within a country» Labor-abundant country:

Ratio of labor to other factors is high relative to the rest of the world


Shares of the world‘s factor endowments (2007/2010)


The Heckscher-Ohlin theory and income distribution

Two countries, two factors, two goods (2-2-2 model) Fixed and fully employed factor supplies

» Mobile between sectors within each country» Immobile between countries

Same consumption patters in both countries Same (constant-return-to-scale) production technologies in

both countriesTrade explanation by H-O

» Differences across countries in the relative availability of factors» Differences across products in the use of these factorsA country exports products that use its relatively abundant factor(s)

intensively and imports products that use its relatively scarce factors intensively


Short-run and long-run effects:National losers and winners (1/2)


Short-run and long-run effects:National losers and winners (2/2)


The Stolper-Samuelson theorem and factor price equalization


The Rybczynski-theorem


The Leontief-paradox and empirical evidence


Outline








Intra-industry trade (overview)

Intra-industry trade» Exports and imports in the same product category

Main drivers and explanations» Product differentiation (monopolistic competition)» Substantial internal scale economies (global oligopolies)» External scale economies (regional spill-overs, industry clusters)


Measuring intra-industry trade

United States, selected products (2009)

Average percentage IIT-shares in non-food manufactured products


Internal and external scale economiesand complete specialization


Monopolistic competition

Preferences for variety and product differentiation Some internal scale economies (decreasing average cost) Easy market entry and exit in the long runMild form of “imperfect” competition


Global oligopolies

Substantial internal scale economies (few large firms) Path-dependency for firm locations Oligopoly pricing (interdependence, game theory)Stronger form of “imperfect” competition


External scale economies: Industry clusters

Spill-overs and regional clusters:Size of the entire industry in one location matters» Home market» Path-dependency, luck» Government interventions


Summary: Gains and losses from international trade


Outline

1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism

Protectionism: Goals and instruments Tariffs Nontariff-barriers to trade Export subsidies (dumping) Economic integration and multilateral trade policy Free trade: Pros and cons


6. Case Study: The Euro Area Crisis7. Summary: The Key Lessons Learnt


Goals of protectionism


Mercantilism


Tariffs vs. nontariff barriers to trade


Outline






Tariff as a tax on imports


Types of custom duties

Specific tariff Ad valorem tariff


Effect on domestic producers


Effect on domestic consumers


Government revenues


Net national effect


Terms-of-trade effect: Small vs. large countries


Nationally „optimal“ tariffs


Outline






Types of nontariff barriers


Import quotas: Small country analysis


Allocating import licenses

Fixed favoritism Auction Resource-using procedures


Import quotas: Large country analysis


„Voluntary“ export restraints


Other nontariff barriers

Product standards Domestic content requirements Government procurement


Outline






Dumping vs. fair market value

„Normal“ value» Comparative (prices charged in domestic market)» Cost-based (selling below average cost)


Types of dumping

Predatory Cyclical Seasonal Persistent (price discrimination)


Small exporting country analysis


Large exporting country analysis


Retaliation


Strategic trade policy: Boing vs. Airbus (1/2)


Strategic trade policy: Boeing vs. Airbus (2/2)


Outline

1. Introduction and Overview2. Systemizing and Recording Cross-border

Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism

Protectionism: Goals and instruments Tariffs Nontariff-barriers to trade Export subsidies (dumping) Economic integration and multilateral trade

policy Free trade: Pros and cons




Stages of economic integration


Regional economic integration

Source: http://en.wikipedia.org/wiki/File:Economic_integration_stages_(World).png


Trade creation and trade diversion


Other effects of economic integration

Increase in competition (reducing monopoly power)» Lower prices (static efficiency)» Higher productivity/lower cost of production (dynamic efficiency)

Lower cost by expanding scales of production More opportunities for business investments (FDI)


Case study: The European Union


Trade embargoes


International trade disputes


GATT and WTO

GATT (1947)» General Agreement on Tariffs and Trade

WTO (1994)» World Trade Organization» www.wto.org


Outline






First best vs. second best


Costs of protection

Loss of welfare (deadweight losses) Foreign retaliation Enforcement costs Rent-seeking costs Rents to foreign producers (VERs) Dynamic inefficiencies (loss of dynamic efficiency)


Externalities


Promoting domestic production or employment


The infant industry/dying industry arguments


Public revenues


Noneconomic objectives

„National pride“ National defense Domestic income redistribution


Outline

1. Introduction and Overview2. Recording Cross-border Economic Activity3. The Pure Theory of International Trade4. Trade Policy: Free Trade vs. Protectionism5. Foreign Exchange Markets and the Open

Macroeconomy Foreign exchange markets and currency systems International financial investment Determination of exchange rate movements Open-economy macroeconomics



Exchange rates (spot vs. forward rate)

Exchange rate» Price of one nation‘s money (e.g. USD) …» … in terms of another nation‘s money (e.g. EUR)

Euro area view: 0,73 [€/$] United States view: 1,37 [$/€]

Time dimension» Spot rate: price for immediate exchange» Forward rate: price set now for an exchange in the future


Currency systems: Floating vs. fixed exchange-rate systems


Appreciation/revaluation and depreciation/devaluation

Floating exchange rate» Appreciation» Depreciation

Fixed exchange rate» Revaluation» Devaluation


Demand for and supply of foreign exchange

Demand-side» Imports of goods and services» Capital outflows

Supply-side» Exports of goods and services» Capital inflows


Arbitrage

Exploiting price differentials» Between trading centers (NY, London, Frankfurt, Tokyo, …)» Between multiple currencies

• 1,6 [USD/GBP]• 0,9 [USD/CHF]• 0,5625 [GBP/CHF]

• 1,6 [USD/GBP] 1,0227 GBP• 0,9 [USD/CHF] 1,6363 USD• 0,55 [GBP/CHF] 1 GBP = 1,8181 CHF


Pegged exchange rates


Defending the peg: Official interventions


Exchange control


International experience: From the Gold Standard until today


Outline





Exchange rate risk and speculation


Hedging and forward exchange contracts


Futures, Options, Swaps


The “Lake” model


Covered and uncovered transactions


Interest parity

Covered interest parity Uncovered interest parity


Outline





Short run vs. long run analysis

Short-run» Asset market approach to exchange rates

(capital flows)

Long-run» Low of one price Purchasing power parity

(trade in goods and services)


Asset market approach and interest rate parity


Purchasing Power Parity (PPP)


Absolute vs. relative PPP


Monetary approach


Exchange rate overshooting

International Economics

Documents

Transcript of International Economics