08 Growth in the Open Economy

Question 1

International linkages

Answer 1

• Trade in goods and services
• Capital flows
• People flows
• Transfer of technology and ideas

Question 2

Immigrant share of population (2013)

Answer 2

Norway 13.8%, U.S. 14.3%, Sweden 15.9%, Canada 20.7%, New Zealand 25.1%, Switzerland 28.9%, Hong Kong 38.9%, UAE 83.7%

Question 3

Two common ways of measuring trade openness

Answer 3

• Trade relative to GDP.
  
  • 􏰀But trade can be free even if no trade occurs.
  • 􏰀Small vs large countries.
• Relative prices. If free trade, then law of one price should hold.
  
  • Pros and cons?

Question 4

GDP vs GNP

Answer 4

Gross Domestic Product (GDP) measures the income earned by all factors of production located in a country.

Gross National Product (GNP) measures the income earned by the factors of production owned by residents of a given country.

Makes a difference if e.g. large share of capital stock owned by foreigners.

Question 5

Two waves of globalization

Answer 5

• Mid 1800s to WW1
• (Inter-war period: Protecionism)
• WW2 to today

Question 6

World exports as a percentage of world GDP (1870 - 2010)

Answer 6

Openness in 1950 at same level as 1880!

Question 7

Foreign Direct Investment (FDI)

Answer 7

A Foreign Direct Investment (FDI) is a controlling ownership in a business enterprise in one country by an entity based in another country.[

Question 8

Causes of globalization

Answer 8

• Lower transport costs
• Freer flow of information
• Trade liberalization

Question 9

Causes of globalization: Transportation costs

Answer 9

New technologies:

• Railroads and steamship (1800s).
• Opening of Suez canal in 1869, Panama canal in 1914.
  
  • Latest expansion of Suez in 2014-15 and Panama 2007-
• Container shipping (1950s-).
  
  • 20-fold increase in the speed of loading.
  • Containers can be shipped from truck → train → ship and back.
• Air freight (1950s-). Cost/ton fell by factor of 10 between 1955 and 2004.

→ Dramatic reduction in shipping costs. From $95 to $29/ton between 1920 and 1990 according to IMF (1990 dollars).

Question 10

Causes of globalization: Information costs

Answer 10

New technologies:

• Transatlantic telegraph (1866)
• Transatlantic telephone (1927)
• The internet.

→ Dramatic reduction in communication costs. 3 minute phone call London-NYC $300 in 1930, $50 in 1960, $1 in 1996, $0 today (1996 dollars).

−→ enables trade in services.

Question 11

Causes of globalization: Trade policy

Answer 11

• Average tariff rates in industrial countries fell from 40% after WW2 to 6% in 2000.
• Large reductions negotiated under the GATT and WTO.
• Tariffs still high today in many poor countries.
• .. as well as in agricultural trade:
  
  • 250% tariff on wheat in Japan.
  • x% tariff on beef in Norway
  • x% tariff on milk in Norway

Question 12

Empirics: Are open economies richer than closed ones?

Answer 12

(Sachs and Warner, 1995) Countries assigned 0 or 1 each year from 1965 to 2000 based on tariffs, exchange rate manipulation, government monopolies on exports etc.

Question 13

Empirics: Does openness cause higher growth?

Answer 13

Case studies:

• Japan autarky ended in 1858 → Trade rose by 70x & rapid GDP growth & catch-up with Europe.
• South Korea 1960s: Sweeping liberalization → GDP doubled in 11 years
• China’s integration in world economy and joining the WTO in Dec 2001.
• U.S. protectionism in 1930s → contributing to the severity of the Great Depression

Other studies:

• Suez canal closed 1967-1975 in response to Egypt-Israel conflict => Increased shipping distance => Large effects
• The rise of air freight (1950 - 2000) meant that country-pairs with very long sea shipping distance would benefit more than other country pairs.

Question 14

How does openness affect income?

Answer 14

• Factor accumulation
• Productivity

Question 15

How can we extend the Solow model to study the relationship between openness and factor accumulation?

Answer 15

Extend the Solow model with perfect capital mobility.

Question 16

Solow model with perfect capital mobility.

Answer 16

Solow model with perfect capital mobility.

→ Saving != Investment.
→ Price of capital same everywhere.

Assume small open economy: Price of goods and factors fixed. For now, ignore human capital.

y = Ak^α

r_w = MPK = αAk^α-1

k* = …

y* = …

Question 17

Solow model with perfect capital mobility: Implications

Answer 17

• Capital and output per worker determined by the price of capital r_w
• The savings rate does not affect GDP per worker
• But higher savings rate will boost GNP per worker

Question 18

Answer 18

Hm… (Perfect capital mobility : An empirical test)

Question 19

____ is the main source of growth coming from openness.

Answer 19

Productivity is the main source of growth coming from openness.

Question 20

Openness and productivity

Answer 20

• Specialization
• Technology transfer
  
  • Foreign direct investment: Foreign firm brings technology and capital.
  • Imports of inputs/capital that embody new technology.
  • Transfer of soft technologies such as management techniques.
• Incentives for R&D and knowledge creation (Market size!)
• Efficiency
  
  • Exploting economies of scale
  • Weakens monopoly power of domestic firms => raising efficiency / reducing mark-ups

Question 21

Economic costs from openness

Answer 21

• Workers with obsolete skills.
  
  • The scarce factor typically loses.
  • E.g. low-education workers in Norway / U.S.
  • Need for adjustment assistance.
• Income inequality.
• Environmental concerns. “Food miles”.
• Exploitation of workers - Apple/Foxconn working conditions.
• Loss of national sovereignty - inability to raise taxes.