session1intro & comp adv
TRANSCRIPT
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Comparative AdvantageInternational Trade Session 1
Daniel TRAA
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Globalization I:Increased trade in goods and services
Trade has grown faster than GDP
10
15
20
25
30
35
40
1980 1985 1990 1995
T r a
d e
( % G
D P )
World High income Low & middle income
mostly for East Asia; it has fallen for Africa
0
15
30
45
E-Asia &Pac.
Lat. Am. &Carib.
Mid East, N Af
South Asia Sub-S. Africa
E x p o r t s
( % G
D P )
1960 1970 1980 1990 1998
International Trade involves mostly exchanges among high income
countries.
Developing countries have increased their relevance, particularly East Asia,
but are still a small part.
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Trade in services and merchandise
Most of world trade is in goods(merchandise) 82%.
Services trail behind, but arethe fastest growingcomponent. Outsourcing is the latest trend
Share of goods and commercial services in total trade
(Percentages, based on balance of payments data)
Export Shares Import Shares
GoodsCommercial
Services GoodsCommercial
Services
World 81.4 18.6 81.4 18.6
North America 77.2 22.8 85.9 14.1
Latin America 86.0 14.0 84.1 15.9
Western Europe 78.8 21.2 79.4 20.6
Africa 81.5 18.5 76.8 23.2
Egypt 42.5 57.8 68.2 31.8
Nigeria 93.8 6.2 71.1 28.9
Asia 85.7 14.3 81.3 18.7
India 71.4 28.6 73.4 26.6
Indonesia 92.8 7.2 72.3 27.7
Japan 87.1 12.9 74.8 25.2
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Globalization II:Foreign Investment - complex strategies of multinationals
Global FDI Flows 2000 1995 1990 1985 1980 1975 1970FDI in millions of dollars 1,270,764 331,068 202,297 56,583 54,725 25,850 12,542FDI per capita (dollars) 210.3 58.8 41.4 12.8 13.6 9.8 5.3FDI as percentage of GDP 3.12 1.13 0.96 0.48 0.52 0.49 0.48FDI as percentage of exports 19.99 6.45 6.05 3.10 2.95 3.33 4.56
Gross foreign direct investment (% of GDP)
0
2
4
6
8
1976 1981 1986 1991 1996
World High income Low & middle income
Share of FDI flows, by group
0%
25%
50%
75%
100%
1980 1985 1990 1995
Low income
Middle income
High income
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Drivers of Modern Globalization
Lower transport and
communication costs
Development of international
institutions
The WTO
Regional Trade Agreements
Political decisions toward de-regulation and liberalization of
trade and FDI regulations
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Theory and practice of international tradeand foreign investmentWHAT WE WILL LEARN
Why do countries export certain goods and imports others?
What do countries and populations gain and loose from trade?
Why do multinationals exist and what are their effects?
Why do governments protect their industries and what are the costs andbenefits?
What are the effects of different protectionist instruments?
How do the institutions that regulate global trade work?
What have been the economic and social consequences of the rise in tradeand foreign investment with developing nations?
What has globalization brought to developing countries?
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Organization of the course
Theories of international trade Comparative advantage Gains from trade: static and
dynamic
Losers and winners
Trade policy Policy Instruments The case for free-trade and
exceptions Policies for Strategic sectors Political economy and the realist
view
The effects of modernglobalization Trade and the developing
countries
Multinationals and FDI The effects in industrialized
countries
Institutions of global trade The W.T.O Regional agreements
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Materials and exams
course website: www.danieltraca.com
Download class slides before class from website Also available at GES
Practice exams and answer keys available at website.
List of required sections available from website
Recommended textbook International Economics, 7 th edby Krugman P. and Obstfeld M., Addison -Wesley
Available in French
Additional readings available at website
http://www.danieltraca.com/http://www.danieltraca.com/ -
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The theory of Comparative Advantage
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Absolute Advantage
It is the maxim of every prudent master of thefamily, never attempt to make at home what it willcost him more to make than buy What is prudentin the conduct of every family can scarce be folly inthat of a great kingdom If a foreign country cansupply us with a commodity cheaper than weourselves can make it, better buy it of them Adam Smith 1776
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Absolute Advantage
Output per worker (productivity)
93SOUTH
8 10NORTH
Food(bushels)
Manufacturing(pieces)
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Gains from specialization
Output
before after
1 northerner(FOOD toMANUF)
8 Food 10 Manuf
1 southerner(MANUF toFOOD)
3 Manuf 9 Food
North specializes inManufacturing and South inFood
There is more of both goods, if specialization follows absoluteadvantage
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Comparative Advantage
"A country enabled to manufacturecommodities with much less labour that herneighbours may, in return for such commodities,import a fraction of the corn required for itsconsumption, even if corn could be grownwith much less labour than in the country fromwhich it was imported." David Ricardo
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Output per worker (Productivity)
Manuf (pieces)
Food(bushels)
NORTH 10 10
SOUTH 3 9
Comparative AdvantageNorth is MORE productive in both goods
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Even so, there are gains fromspecialization
2 x 9 18 Food
2 x 3 6 Manuf
2 southerners(Manuf toFood)
10Manuf 10 Food
1 northerner(Food toManuf)
afterbefore
Output A country has Comparative Advantage in a given good if its relative productivity inthat good is higher than in
other goods
Specialization according toComparative Advantage creates value , by increasingoutput.
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How does the market work?
Does the decentralized international market achieve this pattern of specialization? How?
Who benefits and who looses from international trade in the free-market?
Among individuals within a country? Among countries?
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In Autarky...
Food
Manuf
North
Northern workerThey work in bothsectors, and tradeamong them at theautarky relative price
The relative price
P= pManuf /p Food In equilibrium, workers
must be indifferentbetween the twosectors.They must get thesame wage
S o u t h
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The prices in autarky (closedeconomy)
The relative price of Manuf (P) denotes how many bushels of Food for one piece of Manuf.
9
10
Food(bushels)
9/3 = 33SOUTH
10/10 = 110NORTH
PManuf (pieces)
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Relative prices, relative supply,relative demand
1
Manuf/Agro
Relative demand (RDW)It is the same in both countriesif preferences are the same
P
Relative Supply (RS N)NorthP N=
3Relative Supply (RS s )SouthP S=
[Manuf/Agro] S [Manuf/Agro] N
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In Autarky...
Food
Manuf
North
Northern worker Southern worker
The Northernerstrade among themat the autarky priceP N = 1
Food
Manuf
South
The Southernerstrade among themat the autarky priceP S= 3
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Wages and productivity
Are the wages the same in both sectors? Why? If not, where are they higher? Why?
Are they the same in both countries? Why? If not, where are they higher? Why?
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The Production Possibility Frontierand Welfare
NorthManuf
+1
-1
UN
10
10 Agro
The choice of consumersdetermines the allocation of labor
MRS =MUFood / MU Manuf = 1/P =1
ProductionPossibilityFrontier
-1/P N = -1
Equilibrium P=1 ,So that bothgoods areproduced
Slope =-Prod F / Prod M
NorthernWorkers in Agro
N
o r t
h e r n
W o r k e r s
i n
M a n u
f
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The beginnings of Trade
Manuf is relatively cheaper in the North. An enterprising Northerner takes 1 Manuf to the South and
exchange it for 3 Foods. Back in the North, she could sell 1 Foods for 1 Manuf with a net
gain of 1 Food.
There are gains from exchange because prices aredifferent: Trade occurs! What happens to the relative price of Manuf in North? And in the South?
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Openness in the Short Run...
Food Food
Manuf Manuf
1 . Tradestarts due to
arbitrage
2 . Prices adjust tonew scarcity
P rises in the North andfalls in the South
SouthNorthP S < 9/3P N >10/10
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In the Long-Run, there is re-allocation
Food Food
Manuf Manuf
North SouthEach country specializes
completely in, and exports, thegood in which it has
comparative advantage
There is one world price,which is between the
initial prices10/10 < P W 10/10
3 . Factors (workers) respond to new prices and profitability -- specialization
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How to determine the world price?
1
3
Manuf/Food
Relative Supply (RS W)World
South produces Food onlyNorth produces both
North produces Manuf onlySouth produces both
N o r t
h a n
d S o u
t h s p e c
i a l i z e
c o m p
l e t e l y
N o r t
h a n
d S o u
t h p r o d u c e
o n
l y M a n u
f
North andSouth
produceonly Food
Relative Demand (RD W)World
1
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The Gains from Trade according toComparative Advantage
North South
10
10 Food
Manuf
Food
Manuf
9
3
UN
US
US (Food)
UN(Manuf)-1/P N
-1/P S
-1/P W
-1/P W
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Some unrealistic features of themodel, so far
What if there are transport costs?
What if there are more than two goods?
What if factors cannot adjust to other sectors?
What if there are more than one factor?
Why is there always complete specialization?
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Transport Costs and Non-tradedgoods
If there are transport costs, the competitiveness edge of a country
must more than make up for this transport cost.
Otherwise, the good will not be traded, even if it is cheaper to
produce in one country. This good is called non-tradable.
In reality, economies spend large proportions of their income in these
type of goods.
It can become tradable, if transport costs fall or the productivity
advantages widen (globalization).
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Global markets vs. local marketsTRADABLES and NON-TRADABLES
Tradable goods can travelacross borders and haveinternational markets that setprices.
Non-tradable goods have theirprices set by supply anddemand in local markets. Often, the same good exists in
different countries because itis produced locally.
With globalization, many goodsand services have becometradable.
Consulting
Banking Telecoms Tourism
Hairdressers
Governmentservices Auto-repair Almost allservices
Services
Textiles Machinery Almost allgoods
Cement Housing McDonaldsHamburger
Goods
TradablesNon-tradables
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Summary
Comparative advantage: Consumers react to price differences and buy from lower price
foreign producers the goods in which their country does not havecomparative advantage (gains from exchange).
Producers react to price differences and allocate resources toindustries where relative productivity is higher, exporting thosegoods (gains from specialization).
Every country always has an industry in which it hasComparative Advantage and it is competitive in worldmarkets for that industry.