Chapter 11

Transcript Chapter 11

Chapter 11 GROWTH IN THE OPEN ECONOMY

Open economy = Globalization • • We live in a globally integrated world … More integrated than never Both in goods and financial markets But globalization is not a novel phenomenon (Victorian age, previous globalization period) Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley

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Growth in trade partly boosted by lower transport and communication costs, particularly in the first half of the century

Transport and Communication Costs (1930=100)

120 100 80 60 40 20 0 1930 1940 1950 1960 1970 1980 Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley 1990 Ocean Freight and port charges per ton of cargo Air transport cost per passenger mile Cost 3 minute phone call New York London

Moore’s Law as Seen in Intel Microprocessors – how the availability of a global technology ..

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.. Has driven down the price of computers, hence the cost of information and communication processing

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Globalization (especially in second half of century) also boosted by declining tariffs – hence role of policy 100 80 60 40 20 0 Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley

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Despite progress towards freer trade, globalization is still very incomplete

How do we know? Look at Law of One Price

Domestic price of bananas = (exchange rate) x (price of bananas abroad) • • Yet: Law of one price does not hold Neither statically: Price of similar goods more different across than within countries Nor dynamically: Not much evidence of decreasing price differentials over time • • • •

Also: persisting home bias in consumption

US share of world GDP = .25; rest of world GDP = .75

With same preferences and full integration, expect GDP share of imports = .75 Instead: =.12, one sixth of its frictionless value About the same for EU as a whole and Japan Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley

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Theory- Why are countries so eager to trade? The

comparative advantage

principle If countries trade so much and Governments are so eager to embrace free trade, there must be a reason. There must be GAINS FROM TRADE!

Why? Rationale from the principle of

comparative advantage (

David Ricardo first, Eli Heckscher and Bertil Ohlin then

). Comparative advantage

Even if the US is more productive than the rest of the world in producing

all

goods (“has an absolute advantage” in all productions), there may still be a case for the US to specialize in producing a subset of all goods and import the others This is because of

specialization gains:

if the US specializes in producing goods where its productivity advantage is relatively bigger, this generates welfare gains. Resources are therefore more efficiently allocated Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley

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Comparative advantage has huge implications The more different countries are as to resource endowments, the bigger the scope for specialization • Countries will benefit from trade even if they are not low cost producers • Even poor countries may benefit from trade (exchange is NOT unequal within a competitive environment) • Each country specializes in those goods where, given resource endowments, its comparative advantage is greater • L-abundant countries will export L-intensive goods (Chinese  toys) • K or technology abundant countries will export K-intensive tech intensive goods (US  aircraft) Being closed to trade (“autarkyc”) means being stuck producing goods that could be more efficiently imported from abroad Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley

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Is the Heckscher-Ohlin theory of comparative advantage a good theory?

Look at two pictures in the next slides. Then ask: Is comparative advantage a powerful theory?

• Yes, if goal is to explain trade between rich and poor countries, such as Japan vs. China or US vs. Mexico • No, if goal is to explain trade between similarly endowed rich countries – Italians and French similarly well equipped to produce and export wine. – Yet Italians keep drinking Champaigne and French (may) drink some Spumante. Why? Taste for variety and scale economies from specializing in intermediate goods So comparative advantage theory is useful to understand one half of world trade --- Subset of varieties in which each country specializes often follows resource endowments – Example: which cars do Germans and Italians sell to each other? Mercedes and Fiat Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley

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Chinese - U.S. trade consistent with Hecksher Ohlin

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Policy implications Under principle of comparative advantage: • Free trade  max permanent GDP through efficiency gains (higher TFP). These are

static

gains from trade • Trade restrictions = bad thing There may also be

dynamic

gains from trade • By trading with the world (multinationals, imports, learning-by-exporting), a country may import technical change, ability to reorganize production and the like Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley

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If trade so beneficial why do trade restrictions exist at all?

Examples of trade restrictions 

Tariffs

: taxes on imports 

Quotas

: quantity restrictions on foreign imports 

Voluntary Export Restrictions

(VER’s): Foreign producers “voluntarily” restrict quantities  Administrative and technical standards  Domestic Content Requirements (“buy Italian”)  Government Procurement • Why do they exist at all?

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Globalization and growth

• Look at trade of goods and services only • Is the degree of openness (= (exports + imports)/ Gdp) of a country related to its per capita income? Is it related to its rate of economic growth?

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Openness and GDP per Capita: a positive correlation – A proof of what?

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Remarks on the Solow model in the open economy In a closed economy: k ss would depend on domestic factors such as the saving rate In an open economy (with perfect capital mobility), domestic saving should be irrelevant • k ss would only depend on the world interest rate • So would y ss Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley

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How close is the real world to the open economy Solow model?

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No-global economics If trade according to comparative advantage is so beneficial and is laso conducive to growth why all this no-global fuss over immiserizing effects of trade, exploitation of the poor and the like?

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Why no-globals may have a point: international trade causes winners and losers Trade between countries with different resource endowments, though beneficial for the economy as a whole, causes winners and losers • Workers in exporting industries cash higher wages and employment -- winners – IT workers in the US, workers in mechanical industries in Italy • Workers in import-competing industries suffer wage and employment losses -- losers – Steel workers in the US, textile workers in Italy Comparative advantage theory says that winners gain enough to compensate losers. But

how

is unclear in practice. Government redistribution of part of the export proceeds implied in principle. Rarely carried out in practice … Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley

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.. Or simply a proof of labor productivity differentials?

Wages differ because labor productivity differs: high productivity countries can still pay higher wages and be competitive on unit costs (Source: Trefler, 1993,

Journal of Political Economy

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Who are the “trade winners” in poor countries ? In poor countries the winners from international trade are the owners of the resource available in abundant supply in the opening-up country (Stolper-Samuelson theorem – a consequence of Heckscher-Ohlin’s comparative advantage model) Who are these winners? Two categories of people • The owners of the land where natural resources are located and primary products are grown – This worsens income distribution for they are rich to start with • The plantation workers and small producers of primary products – This improves income distribution for they are the poor So effect of opening up on income distribution in poor countries not obvious (and may actually be positive) Copyright © 2009 Pearson Education, Inc. Publishing as Pearson Addison-Wesley

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Chapter 11

Transcript Chapter 11

Chapter 11

GROWTH IN THE OPEN ECONOMY

Globalization and growth

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