International trade I Flashcards
Explain the concept of opportunity costs.
Opportunity cost is the highest valued alternative that must be given up
Opportunity costs = cost of the good in terms of another good - how many units of one good we have to give up to produce one unit more of the other good
What is the distinction between absolute and comparative advantage
Absolute advantage: more efficient in all industries
Absolute advantage is determined by absolute costs, whereas comparative advantage is determined by opportunity costs (which are in turn determined by relative costs)
What is gains from trade and why does it occur?
When countries sell goods and services to each other, this exchange is almost always to their mutual benefit
Does not imply that all members of a country benefit equally
Basic reasons for Gains from Trade
1. Comparative Advantage
› Countries differ either in their resources or in their technology
› Countries gain from specialization in things they have a comparative advantage in
- Economies of scale
› Countries produce only a limited range of goods
› They can produce each of these goods at a larger scale and hence more efficiently than if they tried to produce everything
Explain the Ricardo model
Ricardo model: comparative advantage arises from differences in labour productivity
Potential reason: technology
A country may be less efficient in all sectors (absolute disadvantage) -> what matters is comparative advantage: relative costs rather than absolute costs!
Countries specialize in the good in which they have a comparative advantage (CA)
Export the CA good, import the other good
What are the gains from specialization according to the Ricardo model?
Reallocate resources towards the relatively most efficiently produced good
Overall production and consumption increase
Distribution of gains among countries unclear, at least one country gains, but for sure no country loses
What is autarky?
Both countries produce both goods (self-sufficient)
What are the shortcomings of the Ricardo model?
Predicts extreme specialization in a single good, which is not observable in the real world.
Ignores the effects on distribution of income within countries - workers in different sectors gain differently (or even lose) from trade despite overall gain
Describe the Heckscher-Ohlin model
In the Ricardo model, CA (comparative advantage) is due to differences in technology. There is only one factor of production (labour)
In the Heckscher-Ohlin model, CA is due to differences in endowments.
Two (or more) factors of production
Countries differ in their (relative) endowments with different factors
Countries tend to export goods whose production is intensive in factors with which the countries are abundantly endowed
› Capital abundant countries specialize in the production of capital-intensive goods
› Labour abundant countries specialize in the production of labour-intensive goods
Explain how specilization due to economies of scale can result in gains and name one factor that can influence what the country ends up specializing in
In the traditional view (Ricardo + Heckscher-Ohlin) gains derive from specialization in industries with comparative advantage
The more “modern view”: Gains derive from specialization due to economies of scale (increasing returns to scale).
Countries gain from producing a limited range of products efficiently, rather than trying to produce everything
Which products a country ends up producing can be a matter of chance and is less important
But often there is a relationship with natural factor endowments (e.g. design/furniture industry in Sweden)
What is the difference between inter and intra-industry trade?
Specialization in certain industries gives rise to inter-industry trade (trade between industries)
• Example: Germany exports cars to China; China exports apparel to Germany
But the majority of today’s trade is intra-industry trade (trade within industries)
• Example car industry: Germany exports BMW to France; France exports Peugeot to Germany
What are the reasons for intra-industry trade and what are the gains from intra-industry trade?
Reasons for intra-industry trade:
• Economies of scale at firm level: larger quantities can be produced more efficiently
• Trade enlarges the market: each firm can produce at a larger scale and thus at lower average cost + a larger number of firms can be supported
Gains from intra-industry trade:
• Larger product variety Example: Lego toys (Danish) vs. Playmobil toys (German) in Denmark
• Lower prices
Explain differences between smaller and larger countries in terms of intra- and inter-industry trade
Large countries (such as Germany) can sustain exports of products from large portfolio of industries - More intra-industry trade in large countries
Small countries (such as Denmark) need to specialize in exporting few products - More inter-industry trade in small countries
What are trade barriers and which countries do they have the largest effect on?
Trade barriers: all costs of getting a good to the final consumer other than the cost of producing the good itself
Moreover, trade barriers affect some countries more than others. Often hardest hit are less developed countries, whose exports are concentrated in low-skill, labor-intensive products that industrialized countries often protect
Name three types of trade barriers
Transportation costs (e.g. freight costs and time costs)
Internal trade and transaction costs (e.g. contract enforcement costs, legal and regulatory costs, local distribution, etc.)
Policy barriers (protectionist measures) • Tariffs: taxes on imports • Non-tariff barriers: e.g. bureaucratic rules concerning approval of products, national product standards, quotas on imports, subsidies to domestic products, ….
Policy barriers protect domestic industries from foreign competition, but costly to consumers (both individuals and firms)
When was the first age of globalization and what were the driving forces?
Early 19th century
Driven by invention of steam power (ships, railway) and telegraph - “death of distance”
What were two policies under the first age of globalization that were conducive to trade?
Gold standard: every country fixed value of its national currency in terms of gold, and fixed exchange rates with each other. This eliminated foreign exchange risk
Bilateral trade agreements kept tariffs low
What was the trade pattern during the first age of globalization?
First unbundling: separating consumers from factories
Great divergence: Industrializing North (Western Europe, North America). These countries export capital-intensive manufacture (especially textiles, clothes). The South (Americas, Asia and Africa) specializes in land-intensive agricultural products i.e. de-industrialization in the South, which falls behind economically
When was the de-globalization period and what caused it?
Global share of trade in GDP reached peak in 1913, just before World War I
Two World Wars and Great Depression (1930s) led to national/protectionist policies and reduction in trade
Recovery not until around 1970
How do we calculate trade openness?
Trade openness = (0.5(X+M))/GDP
X= total exports, M=total imports, the higher the index, the more open is the economy
What characterised the second age of globalization and when was it?
Re-globalization after World War II:
Further technological progress: Oil and diesel engines, air freight
Most importantly: multilateral economic cooperation (rather than uni-or bilateral decisions) under leadership of United States - Bretton Woods system
•World Bank, IMF, GATT
• Initially fixed exchange rates, emulating gold standard (abolished 1971)
What was the trade pattern during the second age of globalization?
Second unbundling: global value chains, various stages of production process at world’s most efficient places
• Great convergence: developing countries industrialize causing an increasing share in manufacture exports, resulting in economic catch-up and convergence
What is the relationship between GDP and international trade?
International trade has higher impact on GDP than in the past
And vice versa: Global trade is vulnerable to fluctuations in global GDP (e.g. financial crisis in 2008)
What are some recent developments in international trade?
The rise of Asia
New countries keep entering the global scene
• Eastern European Countries
• Asia, in particular: China and India
Increased globalisation is a vehicle for developing countries to attain higher growth
It is true that the increase in international trade for these countries is high, but it has started at a very low level
The increase tends to be largely balanced; Western countries import more from these countries, but we also export more to them
For many years, large immigration flows have also been part of the globalization process
Why would anyone oppose trade?
- Short-run costs of redeploying an economy’s resources out of the sector that shrinks under free trade
- Trade can worsen the income distribution, even making some people worse off in absolute terms
Suppose car and food production both rely on skilled and unskilled workers
Car production requires relatively more skilled workers and food sector employs mostly unskilled workers
Europe has relatively many skilled workers
Under free trade, food sector shrinks in Europe, newly unemployed unskilled workers from food sector have to find jobs in the expanding car sector
But there are relatively few low-skill jobs in the car sector!
Only way for unskilled workers to get reemployed is by accepting lower wages, so that car sector is willing to substitute unskilled for skilled workers
The redistributive effects of trade similar to technological progress
What is GATT and where did it come from?
International Trade Organization (ITO) supposed to become third pillar of multilateral economic system (in addition to IMF and the World Bank), but ratification failed in U.S.
Consequence: GATT - General Agreement on Tariffs and Trade established 1948
Agreement instead of organization
Basic principles:
• “binding” of existing barriers: existing tariffs may not be raised; export quotas forbidden (exception: agriculture) and new import quotas forbidden
• Further reduction of tariffs and trade liberalization through trade rounds (8 rounds since 1948)
What is WTO and how does it differ from GATT?
Establishment of WTO 1995:
GATT had focused on trade in goods - more attention to trade in services and protection of intellectual property
Dispute settlement procedures
How did EU become what it is today?
1952: European Coal and Steel Community (ECSC) - fear of another war led France, West Germany, Italy, Belgium, Luxembourg and the Netherlands to form common market for coal and steel
1957: European Economic Community (EEC) - “Rome Treaty” establish customs union and propose to progressively create a common market of goods, persons, services and capital (“four freedoms”)
1986: Single European Act (SEA) - remove any remaining barriers to trade and create the Single Market until 1992:” an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured”
1992: Maastricht Treaty - prepared for Euro and introduced elements of political union: citizenship, common foreign and internal affairs policy; renaming to European Union (EU)
Gradual expansion from economic to political union:
• More than a free trade agreement (specifically: customs union) from the very beginning
• Not all countries followed all steps of integration (e.g. Denmark and Great Britain opted out of Euro)
DK, Ireland and the UK joined in 1973
What does it mean that EU is a customs union?
EU is a customs union: member countries set tariffs with outside countries jointly
How does the EU generate income and what are the expenses of the EU?
EU revenue - tariffs contribute, a fee (90% of the revenue) that is based on the value added tax base and the GNP in member countries
EU expenses - administration, common agricultural policy, structural policies aiming at correcting for unequal areas within the union
What are trampoline policies and safety nets ?
Trampoline policies - active labour market policies that can help people get a new job
Social safety nets - e.g. unemployment benefits
Name three components of the primary income account
Dividends from owned companies abroad, interest payments to foreigners, wage income of residents working abroad
Name three components of the secondary income account
EU support for the country’s agriculture, transfer of state pensions to the country’s expatriates living abroad, membership of various international organisations
A current account surplus corresponds to a financial account …….?
A current account surplus corresponds to a financial account deficit and a current account deficit corresponds to a financial account surplus. Intuitively, a current account surplus (e.g. driven by strong exports) is equivalent to a savings surplus and positive net lending to foreigners, which is reflected in a negative financial account balance (net increase in foreign assets)
What is a comparative advantage?
Comparative advantage: country can perform the activity at a lower opportunity cost than other countries
Impossible to have a comparative advantage in both goods
The opportunity cost of one good is the inverse of the opportunity cost of the other
