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The Theory of International Trade
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Globalization versus Inter-Regional IntegrationEconomic AlliancesNAFTAUSA, Canada, MexicoEuropean UnionCurrently 25 members10 new members joined in May of 20043 more countries are being consideredAssociation of Southeast Asian Nations10 member countriesOngoing negotiations between ASEAN, China, Japan, India WTO provides the following note of caution on Regional Trade Agreements: RTAs can complement the multilateral trading system, help to build and strengthen it. But by their very nature RTAs are discriminatory: they are a departure from the MFN principle, a cornerstone of the multilateral trading system. Their effects on global trade liberalization and economic growth are not clear given that the regional economic impact of RTAs is ex ante inherently ambiguous. Though RTAs are designed to the advantage of signatory countries, expected benefits may be undercut if distortions in resource allocation, as well as trade and investment diversion, potentially present in any RTA process, are not minimized, if not eliminated altogether. Source: WTO Website: http://www.wto.org
All members of WTO (previously parties to GATT) are required to notify WTO of any trade agreement. (See the handout)1948-1994, GATT received 124 notifications.1995-2002 WTO (established in 1995) received 130 notifications MERCOSURSouthern Common MarketOriginal members: Argentina, Brazil, Uruguay, ParaguayAndean CommunityBolivia, Colombia,Ecuador, Peru, Venezuela
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Growth in International Trade
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Trade Specialization. The TheoryAbsolute advantage principleWhy specialize in the production of something that is cheaper to purchase from abroad?Comparative advantage principleSpecialize in the production of those products in which you have the lowest relative (opportunity) cost of production
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SpecializationSources for Comparative AdvantageResource EndowmentHeckscher-Ohlin TheoremPast economic development/planning is responsible for current comparative advantageLeontief ParadoxFactor Price equalizationStopler-Samuelson Theorem and H-O theoremIncrease in the earnings of relatively abandoned factor, decrease in the earnings of relatively scarce factor
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US exampleUS trade balance (available on BEA website)http://www.bea.gov/bea/di/home/trade.htmHow does the US afford to run this large trade deficit continuously?Demand for the US dollarBoP (available through the BEA website)http://www.bea.gov/bea/di/home/bop.htm
- Current Account Balance (~Trade balance) as % of GDP, 2001Less than 8.2-8.2 < . < - 4.8-4.8 < /
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Forms of Common Trade RestrictionsQuotaTariff
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Arguments against free trade-strategic industry-infant industry-cultural or social values-job preservation
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Forms of Trade AgreementsPreferential trade arrangement (one sided or reciprocal)Free trade area (reciprocal)Customs UnionCommon market factors mobilityEconomic union policy coordination
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International ArrangementsGATT General Agreement on Tariffs and Trade. Instituted in 1947. In 1945, the USpresented the IMF with a draft charter for an International Trade Organization,but that failed to materialize in part due to the US congress lack of approval.Instead, an agreement (GATT) under the Reciprocal Trade Agreements Actwas introduced.
GATS General Agreement on Trade in Services.
General Agreement on Trade-Related Aspects of Intellectual Property Rights.
Under GATT (Article 1) all countries signing the treaty must extend the Most-Favored Status (treat all countries equally) to all other countries that ratified GATT. There aretwo exceptions to Article 1: customs unions and free-trade areas, and countries arePermitted to apply lower import tariffs to goods coming from developing countries.
Movement away from quotas towards tariffs, and subsequent reduction in tariffs
Some famous rounds of negotiations: The Uruguay Round 1986-1993 lead to the Establishment of WTO in 1995.The Kyoto Round: The Kyoto Protocol of 1997 set targets for reductions of greenhouse gas emissions for industrialized countries from the 1990 level by 2012: 8% in Europe, 7% in US, 6% in Japan, and stabilization of emissions in Russia.
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WTOMonitors and administers all WTO trade agreements (GATT)
Presents a forum for future trade negotiations
Provides arbitrage in trade disputes between nations (WTO has a nice case study example on their website at: http://www.wto.org/english/thewto_e/whatis_e/tif_e/disp3_e.htm)
Provides technical assistance, policy recommendations forDeveloping countries.Established January 1, 1995Located in Geneva SwitzerlandCurrently 146 member nations
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EU1948 Benelux the custom union of Belgium, Luxemburg, the Netherlands1950 proposition of forming a larger of six countries: Belgium, Luxemburg, the Netherlands, France, Germany, and Italy (European Economic Community, 1957)1968 Customs union with common external tariffs is established1973Denmark, Ireland, United Kingdom join the European Community1979 Establishment of European Monetary System1981 Greece becomes a member1986 Spain and Portugal enter1995 Austria, Sweden and Finland1993 Maastricht Treaty is ratified (plans to establish a common currency in 1999). Three step approach: free capital movement and close policy coordination, then establishment of central European banks to control the currencies followed by the establishment of fixed exchange rate and transfer of monetary authority. January 1 1999 Euro is launchedMay 2004 Massive expansion into Eastern EuropePerspective members: Bulgaria, Romania, Turkey
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Can Euro be a problem for the Dollar?Price of oilInternational reserve currencyCompetition for investment funding
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Foreign Exchange
Foreign exchange (Nominal) simply the price of one currency in terms of another (1 dollar = 30 roubles , 1 dollar = 0.85 euros)
The currency appreciates when the number of units of foreign currency required to purchase it increases (1 dollar = 36 roubles would be an example of a 20% appreciation in the value of the dollar). Depreciation is just the opposite of appreciation.
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Why should we be concerned about the exchange rate of the dollar?
Effect of the currency on trade: If a US firm sells a product in Russia that is priced at 300 roubles, then given the exchange rate of 1USD=30R, the US firm receives 10 dollars per unit sold, but what if during the time between shipping the product to Russia and actually selling it and converting the proceeds into dollars the value of the dollar changes to 1USD=40 R, then the US firm will receive only 7.5 dollars per unit sold => 25% loss in revenues!
Investment is similarly effected by the exchange rate fluctuations.
These fluctuations in the exchange rate create uncertainty for export/import firms and international investors causing those agents to hedge against foreign exchange fluctuations.
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In addition, currency conversion has a cost, that can play a significantrole. Every time you convert currencies you are charged conversion fees by the bank. It was estimated that in Europe these fees, because of large volume of trade ran near 1% point of the GDP a strong reason for creating a common currency.
Sheet1
Myanmar0
French Polynesia5
Rwanda6
Marshall Islands8
Sudan8
Burundi9
Palau9
Argentina10
Eritrea10
Japan10
Brazil11
Central African Republic11
Mozambique11
Uganda11
United States11
Burkina Faso12
India12
Lebanon12
Bangladesh13
Haiti13
New Caledonia13
Ethiopia14
Sierra Leone14
Tanzania14
Chad15
Egypt, Arab Rep.15
Pakistan15
Peru15
West Bank and Gaza15
Albania16
Cuba16
Niger16
Benin17
Bolivia17
Suriname18
Uruguay18
Cape Verde19
Colombia19
Guatemala19
Australia20
Greece20
Armenia21
Guinea21
China22
Venezuela, RB22
Comoros23
Iran, Islamic Rep.23
Nepal23
Paraguay23
Turkey23
Zambia23
Cameroon24
Lesotho24
El Salvador25
Guinea-Bissau25
Madagascar25
Mali25
Bosnia and Herzegovina26
France26
Georgia26
Italy26
Kenya26
Poland26
South Africa26
United Kingdom26
Malawi27
Spain27
Algeria28
Azerbaijan28
Botswana28
Bhutan29
Chile29
Germany29
Romania29
Dominican Republic30
Morocco30
Portugal30
Senegal30
Mexico31
Ghana32
New Zealand32
Syrian Arab Republic32
Togo32
Panama33
Iceland34
Samoa34
Indonesia35
Nicaragua35
Sao Tome and Principe35
Israel36
Sri Lanka36
Uzbekistan36
Yemen, Rep.36
Cambodia37
Denmark37
Ecuador37
Nigeria37
Finland38
Mauritania39
Norway39
Lithuania40
Croatia41
Saudi Arabia41
Jamaica42
Kazakhstan42
Korea, Rep.42
Kyrgyz Republic42
Macedonia, FYR42
Switzerland42
Tunisia42
Turkmenistan42
Honduras43
Bulgaria44
Canada44
Cote d'Ivoire44
Jordan44
Latvia44
Russian Federation44
Sweden44
Austria45
Cyprus45
Gabon45
Papua New Guinea45
Gambia, The46
Kuwait46
Zimbabwe46
Djibouti47
St. Kitts and Nevis48
Namibia49
Barbados50
Belize51
Philippines51
Trinidad and Tobago51
Costa Rica52
Moldova52
St. Vincent and the Grenadines52
Hungary53
Slovenia53
Ukraine54
St. Lucia56
Dominica58
Thailand58
Belarus59
Czech Republic61
Mongolia61
Netherlands61
Grenada62
Slovak Republic62
Tajikistan62
Mauritius65
Fiji68
Congo, Rep.72
Bahrain74
Seychelles74
Swaziland74
Antigua and Barbuda76Exports as % of GDP in 1999
Belgium77Singapore166Estonia77
Estonia77Hong Kong, China133United States11
Macao, China80Malaysia122Slovak Republic62
Angola86Luxembourg113Czech Republic61
Ireland88Ireland88Austria45
Malta91Malta91Russian Federation44
Maldives93Angola86Netherlands61
Equatorial Guinea94Belgium77Sweden44
Guyana99
Luxembourg113
Malaysia122
Hong Kong, China133
Singapore166
American Samoa..
Andorra..
Aruba..
Bahamas, The..
Bermuda..
Brunei..
Cayman Islands..
Channel Islands..
Congo, Dem. Rep...
Faeroe Islands..
Greenland..
Guam..
Iraq..
Isle of Man..
Kiribati..
Korea, Dem. Rep...
Lao PDR..
Liberia..
Libya..
Liechtenstein..
Mayotte..
Micronesia, Fed. Sts...
Monaco..
Netherlands Antilles..
Northern Mariana Islands..
Oman..
Puerto Rico..
Qatar..
San Marino..
Solomon Islands..
Somalia..
Tonga..
United Arab Emirates..
Vanuatu..
Vietnam..
Virgin Islands (U.S.)..
Yugoslavia, Fed. Rep...
Sheet2
Sheet3
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Hedging works like an insurance against currency fluctuations:there are several mechanisms that exist in currency markets for thispurpose: futures, forwards, options, swaps. Perhaps options should bemost familiar, since those are also used in the stock market as well. Options can be of two setups: European (like stock index options), and American, like stock options. More importantly, options are done in two types: calls and puts.Consider the following simple example:You intend to sell your product in Russia at 300 roubles per unit, but you are not sure what the exchange rate between the rouble and the dollar will be when you complete your sale, you can protect yourself by purchasing a put option on the rouble with a given strike price today and an expiration period that is sufficient for your sale. (use stock example here)
Clearly, options like any risk shifting instrument will have premiums, and hence may be quite expensive, especially on volatile currencies.
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What if the demand for the dollar suddenly drops?Can the government do anything to stop the value of the dollar from falling?
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The preceding discussion concentrated on the floating exchange rate regime, but that wasnt always the case.
Alternative regimes:
Gold Standard 1880s-1914. Gold standard made the exchange rates fixed, removing all the complexities of the floating exchange rate that we previously mentioned. Gold acted as international money! Humes correction mechanism and the balance of payments.
1944 Bretton Woods conference and the birth of WB and IMF, the Gold Exchange Standard. Fixed exchange rate system under a fixed exchange rate system the government specifies the exchange rate. In many places this system lead to parallel markets, as the government regulations expended in order to protect the government reserves of forex.
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Fixed exchange rate continued: many countries fix their currencies to the currency of their major trading partner to insure stability in trade (Bulgaria, Estonia and the Deutsche mark in the late 1990s, Argentina and the USD)
Although, fixing the exchange rate has its benefits, it may also be quite costly. What if my currency is overvalued, like the Mexican Peso in 1994, prior to the December crisis, then my economy will experience growing trade deficit. The currency crisis doesnt need to come from the trade side, in the case of Russia in 1998, and in the earlier currency crisis, one of the larger contributors was the capital flight (Financial account instead of the current account, know this distinction, as I may put it on the exam)
Relatively recent solution the currency board!
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Policy and exchange rate regimeFLOATstrong open economy effect, thus weak fiscal policy. Monetary expansion causes depreciation in the value of the currency, thus strong monetary policy
FIXEDno open economy effect, weak indirect crowding out effect, thus strong fiscal policyno currency depreciation, inability to change domestic interest rate due to international capital mobility
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Economic DevelopmentEstablishment of World Bank/Bank for Reconstruction and DevelopmentCapital growth and productionTargeted developmentDebt
Role of Human Capital
Institutions and their development
Political Stability and Economic Prosperity
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Multinational firmExchange rate and translation impactPolitical and institutional changesTransfer pricingwindow dressingProfit transfer
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