trade

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Lecturer: Assoc. Prof. Bilgehan Karabay

E-mail: [email protected]

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Textbook:

By John McLaren “International Trade” Wiley 2012.

Main Lecture Slides are provided at the course webpage in Canvas.

Resources

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Assessment Final 2-hour Examination (plus 15 minutes

reading time): 50%

2 Assignments @ 25% each: 50%

– They are already posted. – Assignment-1: Due date is on Friday,

March 27th at 11.59pm Melbourne time – Assignment-2: Due date is on Friday, May

1st at 11.59pm Melbourne time – More information is on your course

webpage, Canvas.

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Provisional Topics 1. Globalization. What do we know? 2. The Ricardian Model 3. Increasing returns to scale (internal), Monopolistic Competition,

Heterogenous Firms 4. Oligopoly Models 5. Specific-Factors (Ricardo-Viner) Model 6. Heckscher-Ohlin Model 7. Tariffs and Quotas under Perfect Competition 8. Protectionism in Practice 9. Increasing returns to scale (external), Infant-industry protection 10. Tariffs and Quotas under Oligopoly 11. Offshoring 12. Immigration 4

1 A Second Wave of Globalization International Trade John McLaren

A ship loaded with cargo in standardized containers. Containerization has revolutionized ocean shipping since the 1960s.

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1.1 The First Wave

1.2 The Second Wave

1.3 Crisis, Peak Oil, Pirates—and

De-Globalization?

1.4 The Forces at Work

Define GLOBALIZATION • Anything that facilitates expanded

economic interaction across countries.

• Anything that lowers the costs of international transactions.

• Includes transactions in goods, services, factors of production, financial assets.

Key Forms of International Integration • Rise in trade flows.

• Convergence of international prices.

• Foreign portfolio investment.

• Foreign direct investment (FDI).

• Migrant labor

• Immigration

• Offshoring (aka “outsourcing”)

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In other words… • Integration of goods/services markets.

• Integration of financial markets

• Integration of factor markets (capital plus labor)

Two huge waves of globalization • 19th century (possibly centered on 1820’s)

• 20th century (after 1970)

19th Century Drivers of Globalization • Rise of steamship -- lowers cost of ocean shipping and

river shipping.

• Suez canal.

• Transatlantic cable -- improved communications.

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19th Century Evidence • E.g., O’Rourke and Williamson.

• Evidence on falling shipping costs around 1820’s (direct evidence).

• Evidence on convergence of product prices around 1820’s (indirect evidence).

The figure shows index of the cost of shipping coal from Britain to export destinations between 1741-1872, expressed in 1800 (year) shillings per ton. Both show dramatic reductions in shipping costs after 1820.

Evidence-1: Falling shipping costs (direct evidence).

Evidence-2: Convergence of product prices (indirect evidence).

All three commodities exported from Southeast Asia to Europe. The figure shows the ratio of price paid by the consumer in Amsterdam to the price received by the supplier in Southeast Asia between 1580 and 1939. These ratios fell dramatically after 1820.

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However, the first wave of globalization did not last long due to a wave of protectionist policies in the early twentieth century.

A tariff is a tax on imported good. The average tariff as recorded here is the total revenue collected from tariffs into the US in a given year divided by the total value of goods imported.

20th Century Drivers of Globalization • GATT/WTO multilateral reductions in trade barriers

beginning with end of WWII (undoing early-century tariffs).

• Loosening of immigration restrictions imposed early in century.

• Further improvements in communications; internet, etc.

Liberalization • The striking reduction in tariffs and other government-

imposed barriers to trade in the second half of the 20th

century is an example of liberalization.

• In general, liberalization denotes any reduction in barriers to international transactions that are created by government.

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Role of changes in transport technology

• Hummels (2007) studies trends in transport costs.

• 1970’s: Containerization revolution.

• Standardized containers can be shipped worldwide from truck to train to ship, then back to train and truck.

• However, this does not seem to have caused a consistent drop in ocean shipping rates: Fuel costs are still critical, and volatile.

• But air freight rates have dropped dramatically especially with the introduction of jet engines.

20th Century Evidence • Rising trade flows.

• Rising importance of FDI.

• Rising share of foreign-born in US labor force.

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Evidence-1: Rising Trade Flows.

Evidence-2: Rising Importance of FDI.

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1914 1929/30 1960 1996

US FDI abroad (% of US GDP) Inward FDI in the US (% of US GDP)

Source: Bordo, Irwin and Eichengreen (1999)

Evidence-3: Rising share of foreign-born in U.S. labor force.

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Overall message • First big globalization: 19th century: Seems to have

been driven mainly by technology.

• Second: Late 20th century: Seems to have been driven mainly by policy.

• Future: Economic crisis plus rising fuel costs could lead to another de-globalization. We’ll see.

Recent Trends • In the first quarter of 2009, world trade fell by a

startling 30% as the world economy entered a major downturn.

• Given the historical trends, it is worth asking what the future long-run trends in globalization may be, and whether or not the decades-long trend toward international integration may be reversed.

Some Key Factors • Trade may become more volatile.

• Peak Oil.

• A new rise of protectionism?

• Global warming.

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What is the reason for all of this international activity? The following questions come to mind:

• Why trade?

• Why build a company through investment abroad?

• Why offshore jobs?

• Why emigrate?

• What is the driving force behind all of these big economic changes described above?

• What are the effects of all of this globalization?

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Beyond the trends: Why do countries trade? • Answer that question and you have a theory of trade.

• Different answers to that question imply different theories of trade, with different policy implications.

• There are three main theories, and we’ll go through each.

Reasons for trade 1. Differences between countries (e.g., technology,

productivities): Comparative advantage.

2. Increasing returns to scale.

3. Imperfect competition.

These give rise to the three branches of the family tree of trade theory.

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Where we are

Comparative advantage:

Countries are different, and any difference between two countries – in technology, climate, culture, factor proportions, consumer preferences, for example – can lead to opportunities for mutual gains from trade. Theories based on this reasoning are called comparative advantage theories.

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Increasing Returns to Scale:

Many industries exhibit increasing returns to scale which can imply that it is most efficient and most profitable to concentrate production of a good in one location, serving all world markets from that location.

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Imperfect Competition:

Many industries are oligopolistic in nature, and trade can arise purely as a result of that, as oligopolists strive to grab oligopolistic rents from each other by invading each others’ markets.

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Some basic definitions Imports: the purchase of goods and services from another country.

Exports: the sale of goods and services to other countries.

Merchandise goods: includes manufacturing, mining and agricultural products.

Service exports: includes business services like eBay, travel and transportation.

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Migration: The flow of people across borders as they move from one country to another.

Foreign Direct Investment (FDI): The flow of capital across borders when a firm owns a company (at least 10% acc. to OECD definition) in another country. Two ways FDI can occur:

Horizontal FDI: When a firm from one industrial country owns a company in another industrial country, e.g., FDI between Europe and U.S.

Vertical FDI: When a firm from an industrial country owns a plant in a developing country, e.g., FDI in China by U.S. firms.

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Reasons for Horizontal FDI  Having a plant abroad allows the parent firm to avoid any

tariffs or quotas from exporting to a foreign market since it produces locally.

 Having a foreign subsidiary abroad also provides improved access to that economy because the local firms will have better facilities and information for marketing products.

 An alliance between the production divisions of firms allows technical expertise to be shared.

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Reasons for Vertical FDI • This usually occurs to take advantage of lower wages

in the developing country.

• Also to avoid tariffs and acquire local partners to sell there.

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There is also what we call as “Reverse-vertical FDI”.

Reverse-vertical FDI: Companies from developing countries buying firms in industrial countries, e.g., FDI in U.S. by Chinese firms.

Reason: They are acquiring the technological knowledge of those firms in industrial countries to combine with low wages in home country.

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Trade Balance: The difference between the total value of exports (of goods and services) and the total value of imports (of goods and services).

Trade Surplus: when exports > imports

Trade Deficit: when imports > exports

Bilateral Trade Balance: The difference between exports and imports between two countries.

In this course, for simplification we will assume that trade is balanced, i.e., exports = imports.

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What are the problems with bilateral trade data?

If some of the inputs are imported into the country, then the value-added is less than the value of exports.

Example: Barbie Doll. It is valued at $2 when it leaves China but only 35 cents is value-added from Chinese labor. The whole $2 is counted as an export from China to the U.S. even though only 35 cents of it really comes from China through their labor contribution. As a result, trade statistics can be misleading.

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Trade Barriers: All factors that influence the amount of goods and services shipped across international borders, such as:

Import Tariffs: Taxes that countries charge on imported goods.

Import Quotas: Limitations on the quantity of an imported good.

Transportation costs

Other events, such as wars.

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Some facts • Migration across countries is not as free as the

flow of goods and countries fear the effect of immigration on domestic labor markets.

• FDI is largely unrestricted in industrial countries but faces some restrictions in developing countries.

• A large portion of international trade is between industrial countries.

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• Larger countries tend to have smaller shares of trade relative to GDP since much of their trade is internal.

• The majority of world migration occurs into developing countries as a result of restrictions on migration into industrial countries.

• International trade in goods and services acts as a substitute for migration.

• The majority of world flows of FDI occurs between industrial countries.

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