Lectures 3&4 Flashcards
What was the result of the pre-industrial period?
“The Great Stagnation”
When did the great stagnation cease?
With the first unbundling (1820)
What are A7 countries?
China, India/Pakistan, Iraq, Iran, Turkey, Italy/Greece, Egypt
What are G7 countries?
Germany, France, US, Canada, UK, Italy, Japan
Phase 1: _______ moves to _________.
Consumption moves to production
Phase 2: ________ moves to __________.
Production moves to consumption.
What is the first unbundling reversal caused by?
It’s caused by lower trade costs driving the “unbundling” of production and consumption
True or False?
In the first unbundling, production no longer needs to be near consumption: beginning of “made here, sold there” and vice versa.
True
Who are the drivers of the first unbundling?
Steam revolution and trade liberalization
Define economic globalization
Integration of markets across space
What was the estimated start of the first unbundling? How do we know this?
1815-1820.
A good indicator of integration of markets across space is the convergence of international prices.
A good indicator of integration of markets across space is the ____________.
Convergence of international prices
Define demand
Demand is the quantity of a good consumers are willing to purchase for a given price. It results from consumers maximizing their utility (=happiness) subject to their given restraint
Define the supply
The supply is the quantity of a good producers are willing to sell for a given price. It results from producers maximizing their profits (=sales - costs)
When does the equilibrium occur?
When demand=supply: at the equilibrium price, producers are willing to sell the same quantity that consumers want to buy, the equilibrium quantity
Changes in the supply or demand will have an effect on the ________.
Equilibrium
Price variations will also depend on whether the market is ______________.
Local or not
If the market for a good is _______, the price and quantity will typically be more stable than if it is local
Global
Stable prices over time and across regions are a sign of a __________ market. _________ of prices is even more so.
Globalized
Convergence
Why 1815-1820?
The convergence of prices was permitted by changes in the political landscape:
- 1815 marks the end of the Napoleonic wars with his defeat in Waterloo
- The congress of Vienna in 1820 stabilized intra-European and international relations
- “Pax Britannica”: British empire is becoming the first superpower through trade and industrialization
- This power was not based on Mercantilism (piling up gold)
- Trade and industrialization rose together and industrialization led to economic and military power
First trigger of the start: the Steam Revolution
The industrial revolution is a revolution in __________. It led to a huge reduction in _____________ (in particular transportation) both __________________ as railroad spread from the 1840s. The electric telegraph (using Morse code) transformed ___________, and the first permanent telegraph cable was successfully laid across the Atlantic Ocean in the year _______.
- Energy conversion
- Trade costs
- Nationally and internationally
- Communication
- 1866
Railroads spread from the ______.
1840s
By ________, oceanic travel is transformed
1850
Second trigger of the start: Trade liberalization
_____________: trade costs fluctuate with war and peace
_____________: trade costs came down from between 40% and 60%
_____________: spikes due to wars
_____________: steady decline resumes
- 1750-1820
- 1820-1905
- 1905-1945
- 1945-1990
With lower trade costs (in the first unbundling), ____________ no longer needs to be near _____________.
Production no longer needs to be near consumption
The first unbundling unfolded in 3 separate acts:
- Pre-WW1 (1815-1820), where trade flourished globally (5 main changes)
- Rebundling (1914-1950), where countries close borders, tariffs increase, production and consumption are rebundled
- Post-WW2 unbundling (1950-1990), where tariffs decrease, and bilateral trade agreements increase: more unbundling
Name the 5 main changes of the pre-WW1 unbundling (1820-1914)
- Trade boomed
- Northern and G7 industrialization
- Southern and A7 de-industrialization
- Urbanization
- “The great divergence”
(These 5 steps apply all the way to 1990, but they appeared strongly in the period 1820-1914.)
Booming trade is triggered by ______________.
Britain’s move towards free trade
When did free trade policies spread to continental Europe?
1846-1879
Pro-industrialization protectionism rises in the continent from 1879-1914, in the name of the ___________.
“Infant-industry argument”
What’s another name for the “Infant-industry argument”?
The “Import-substitution industrialization”
What does the “Infant-industry argument” policy aim to do?
This policy aims at protecting domestic industries until they get competitive on the world market
Until then, tariffs are imposed on imports
Ad valorem tariff: tax expressed as _______________.
Expressed as a % of the purchasing price
Specific tariff: tax expressed _________________.
Expressed in $ per unit (per lb, piece, gallon, etc.)
Why was the concept of “Infant-industry argument” criticized?
- Why not target directly the source of the problem? (Financing? Lack of entrepreneurship? Training?)
For tariffs in the 19th century, independent nations in America tended to have high ________.
Tariffs
For tariffs in the 19th century, __________________ had intermediate tariffs.
British dominions (Australia, Canada, New Zealand)
For tariffs in the 19th century, UK and the big Asian countries tended to have _________ tariffs.
Low
“Northern industrialization”
- The UK industrializes first (Napoleonic wars make it difficult for Europe to industrialize)
- Industrialization spreads to Europe and North America post-Napoleon
- The US, Germany and France around 1850
- Canada, Italy and Japan industrialize later (late 1800s)
“Southern de-industrialization”
- In 1750, the Ancient 7 (A7) accounted for 73% of world manufacturing output (50% in 1830, 7.5% by 1913!)
- Mainly China and India are de-industrializing
Why did “Northern” industrialization and “Southern” de-industrialization occur?
- Transportation is easier but production remains “clustered” as it is costly to move ideas (high communication costs)
- Factories benefit from economies of scale
- Clustering of manufacturing ignites innovation and growth
Northern innovations stay in _________ due to high communication costs
North
What is the virtuous cycle for the north, but vicious for the south?
Comparative advantage -> Industrial exports -> Industrial clustering -> Industrial competency (process repeats)
Concept: Comparative advantage
(Proposed by David Ricardo)
A firm/country has a comparative advantage in the production of a good over another firm/country if its opportunity cost of producing that good is lower
What kinds of sources can a comparative advantage come from?
Multiple sources: abundance in natural resources, endowment in inputs (land, labor, physical and human capital), increasing returns to scale, institutions, etc.
Concept: Opportunity cost
The opportunity cost of choosing an alternative is the value of the next best alternative that was given up
Concept: Economies of scale
A firm/industry experiences economies of scale if the average cost of production, AC(q) = (Cq/q), decreases as q increases.
- New firms typically experience economies of scale: with few employees, any extra employee is very productive and the average cost of producing more unit decreases
What are the 2 cases of economies of scale?
- Internal economies of scale (occur when the quantity is produced by one firm)
- External economies of scale (occur when the quantity is produced by all the firms in a given area)
Concept: Internal economies of scale
Internal economies of scale occur when the average cost of the firm level decreases when quantity produced increases
Concept: External economies of scale
External economies of scale occur when the average cost of production of all the firms in a country/region/city decreases on the quantity produced in the area increases
Lower trade costs can lead to _____________ for a product
A greater demand (production will therefore increase to satisfy the expanded demand)
Urbanization after the first unbundling was heavily based towards the _____________.
Atlantic economies
Strong correlation between urbanization and _________. Why? ___________: returns to “being smart” increases thanks to globalization and technological change, and humans get smart by hanging around smart people.
- Incomes
- Ed Glaeser
Growth and “the Great Divergence”
G7 countries (within each nation) have a _________ innovation and growth, which leads to __________ and ________ wages.
Developing nations (including A7) (within each nation) have a _________ innovation and growth, which leads to __________ and ________ wages.
- High
- Knowhow/Labour
- High wages
- Low
- Knowhow/Labour
- Low wages
“The Great Divergence”
- The growth take-offs in G7 economies created the “great divergence”
- It was a consequence of the reduction of costs of moving goods and a high cost of moving ideas (high communication costs)
- Freer trade led to specialization and micro-clustering which yielded faster innovation in the North, and stayed in the North due to the high communication costs
- High growth in the North (G7) and low growth in the South (A7)
For the first unbundling, countries specialize in the production of goods for which they have a ___________.
Comparative advantage
- Rebundling (1914-1945)
- World wars and the Great Depression (international trade is reduced as a consequence, inter-wars tariffs are driven by backlash against globalization, fascism pushes protectionism, the UK is not willing to support world trading as it used to)
- Period of nationalism and protectionism
- A need for global institutions, practices and cooperation among nations arises
- Post-WW2 unbundling (1945-1990)
- Trade is institutionalized and liberalized with the General Agreement on Tariffs and Trade (GATT) in 1947, succeeded by the WTO in 1994
- Colonies became nations
- Advances made in transportation (containerization, refrigerated ships and trucks, air cargo)
Containers
- The shipping container has transformed global trade
- The first container trip (April 1956) from Newark to Houston
- Containers allow to save time and money
- Containers are used in all modes of transportation: ships, trucks, trains
- International trade is now standardized, making it faster and cheaper
What are the 3 main waves of liberalization?
- Wave 1: 1945-1985
- Wave 2: 1986-2000
- Wave 3: 2001-2018
Wave 1: 1945-1985
Multilateralism and regionalism advance together
What does GATT mean?
General Agreement on Tariffs and Trade
1947-1958
- GATT starts: mostly a “club” of WW2 winners
- US leadership
- Germany joins GATT in 1950
- Japan joins GATT in 1955
- Trade liberalization is mainly for manufacturing goods, not so much for agriculture or services
Role 1 of the GATT (now WTO) (5 in total)
- It is a multilateral forum aimed at negotiating freer trade and avoid/restrict the use of non-tariff barriers. It also requires to declare export subsidies
Role 2 of the GATT (now WTO) (5 in total)
- It is based on the fundamental principle of “non-discrimination”:
- The “most favoured nation”: every country belonging to GATT/WTO must be treated the same. If a country benefits from a lower tariff, all members should benefit too (exceptions allowed if the goal is free trade)
- “National treatment”: once a product has crossed the border, it should be treated “no less favourably” than a domestic product
Role 3 of the GATT (now WTO) (5 in total)
- Binding tariff schedules: once tariffs have been negotiated, they should not be increased
Role 4 of the GATT (now WTO) (5 in total)
- Tariffs can be temporarily raised for specific products in particular situations
- In a reaction to foreign subsidies creating injuries in a domestic industry
- When a surge of imports creates serious injury to domestic products
- If the GATT/WTO judges this as being inconsistent with the GATT charter, countries can impose retaliatory tariffs
Role 5 of the GATT (now WTO) (5 in total)
- Dispute resolution mechanism (under threat since Jan 2020)
1958-1965
- EEC (European Economic Community) comes into force; customs union implemented (1958-1968). Triggers a domino effect
- EFTA (European Free Trade Association) is formed by the UK in reaction (still exists with non EU countries like Switzerland, Norway, Iceland and Lichtenstein)
- The UK applies to the European Union in 1961 (joins in 1973)
- 1962: US trade Act that allows formula tariff cuts
- Important GATT round of negotiations: Kennedy Round (1962-1967)
Concept: Formula tariff cuts
Instead of negotiating each tariff rate, a formula is negotiated and applies to all tariff rates under consideration:
- Linear tariff cut: A percentage cut is negotiated, and the cut is applied to all existing rates
- Nonlinear tariff cut: More than one tariff cut is negotiated
The “Swiss Formula”
t-new = (A * t-old)/(A + t-old)
and A is negotiated (Main advantage: only A needs to be negotiated!)
Eg. Assume A = 30%. If t-old = 45%, then t-new = 18%
Concept: Regional agreements
- A RTA (Regional Trade Agreement) is a treaty between 2 or more governments that define the rules of trade for all signatories. There are 2 types of regional agreements:
1. Free trade area (free trade among members. Every members keeps its own tariff schedule with respect to non members - EG. NAFTA)
2. Custom union (free trade almond members with common tariff schedule with respect to non members - Eg. EEC, now EU) - Regional agreements are discriminating: free among members, costly to non members
- Can be costly to members too if there is trade diversion or no trade creation
Concept: Trade creation
Trade creation: creation of new flows of international trade between members for goods/services:
- New imports benefiting domestic consumers and new exports benefiting domestic firms
- Both members gain from new trade and the volume of trade increases
Concept: Trade diversion
Trade diversion: trade increases between 2 members but at the expense of trade with a non members
Big year: 1965
- Regionalism spreads beyond Europe (US-Canada Auto Pact (1965), Australia-New Zealand FTA (1965), First postwar Latin American FTAs (1960 and 1961))
- Unilateral preferences to developing nations (special and differential treatment): Low tariffs are set on goods coming from countries designed as developing countries
What does FTA mean?
Free Trade Agreement
1962-1973: South-South regional trade agreements
- Decolonization led to GATT memberships
- GATT’s Kennedy Round tariff cuts phased in
- Non-tariff barriers rise (which partly offsets tariff liberalization)
Concept: Non-Tariff Barriers (NTB)
NTB are barriers to trade other than tariff such as:
- Quotas (quantitative restrictions - cannot import more than a specific number of units/tons per year)
- Anti-dumping (process through which domestic firms ask governments to investigate whether specific foreign firms “dump” (i.e. Sell below “fair price”))
- Domestic procurement policies (purchases by governments restricted to domestic firms)
- Other (subsidies, technical barriers, import licensing procedures, etc)
Concept: Countervailing measures
They’re used to offset the effect of a country subsidizing a good it exports:
- If an exported good is subsidized by its country, foreign countries have a right to impose a tariff on that good equal to the rate at which it is subsidized. It is called a countervailing duty
Big year: 1973
- EEC first enlargement (UK, DK and IRL join) that triggers FTAs
- GATT’s Tokyo’s round launched
1973-1985
- Tokyo round (1973-1979) is launched and completed (1st round to tackle beyond tariff issues; subsidies and countervailing measures, technical barriers to trade, import licensing procedures, government procurement, anti-dumping)
- Regionalism advances in Africa and Asia
- Oil shocks and stagflation make liberalization difficult, and non-tariff barriers continue to rise through quotas in particular
Wave 2: 1986-2000
Big year: 1986
- Single European Act establish plain to form Single Market by 1992
- Canada and US launch FTA talks to deepen and widen the 1965 Auto Pact
- Uruguay round launch
- 1986-1990: deepening of North-North RTA (Regional Trade Agreement)
1990-2001: North-South regionalism is launched
- 1990: US-Mexico became NAFTA
- Mercosur in 1991
- The fall of Berlin’s wall (1989) triggers RTAs between the EU and Eastern European countries
- GATT deepens to WTO with the end of the Uruguay round in 1994 (effective 1995)
Concept: Effect of a tariff on domestic country
- A tariff raises domestic prices to P^W + t where P^W is the initial world price. P* is the autarky equilibrium price
- It helps import-competing industries
- Harms consumers as demand is downward sloping
- The government earns a revenue equal to the tariff * import levels
Concept: tariff properties
- The level of a tariff balances supply and demand for protection
- Demand for protection = marginal benefit to special interests (domestic producers)
- Supply of protection = government’s willingness to harm consumers and national welfare for political gains (votes, lobbies push, campaign contributions, etc)
- The level of tariff depends upon the relative political strength of special interest groups (mostly the import-competing domestic industry)
Why is liberalization mostly bilateral or multilateral?
- Countries are stick in a prisoner’s dilemma if they don’t negotiate a joint binding agreement
- Each country can decide on free trade or protectionism (with tariffs, for instance)
- When Canada chooses “Free trade”, the US prefers “Protectionism” to “Free trade”
- When Canada chooses “Protectionism”, the US also prefers “Protectionism” to “Free trade”
Concept: Prisoner’s dilemma
- The US prefers “Protectionism” no matter what Canada chooses - “Protectionism” is a dominant strategy for the US in this example (and vice versa for Canada)
- Consequence: US and Canada end up choosing “Protectionism”, where payoffs (general surplus) are lower
- Only way to break the dilemma: cooperate and agree and a binding agreement (hence NAFTA, EU, GATT/WTO, etc.)
- Countries making decisions unilaterally leads to the least desirable outcome
Why does liberalization encourage further liberalization?
- Reciprocal trade talks re-align political economy forces inside each participating nation
- Tariff cuts become politically optimal (governments find it politically optimal to remove tariffs they previously found optimal to impose since multilateral negotiations “politically activate” a new special interest group: exporters)
- Multilateral negotiation makes exporters into anti-protectionists
- As export sectors strengthen with each tariff cut, they gain in political influence, calling for more tariff cuts
- The bigger the trade blocks, the stronger the incentives for non-members to join to avoid trade diversion and foster trade creation (network effect)
Concept: Domino effect
- Formation or deepening of a trade block realigns the political economy forces inside non member nations
- Pro-membership forces want to prevent trade diversion and foster trade creation
- Non members join in if the export sector is politically larger than the import competing sectors
- If a new member joins, “forces for inclusion” get stronger for non members
Why do tariff liberalization through GATT/WTO and FTAs have a tendency to bring more NTB?
- Lobbies in import-competing industries find other ways to influence the government
- These new ways are more specific/targeted
- It decreases the magnitude of trade liberalization
