Part 6. International Trade & Capital Flows

Question 1

Autarky/closed economy

Answer 1

A country that does not trade with other countries.

Question 2

Trade protection

Answer 2

A government places restrictions and limits or charges on X or M.

Question 3

World price

Answer 3

The price of g/s in world markets for those to whom trade is not restricted.

Question 4

Terms of trade:

Answer 4

The ratio of an index of the prices of country’s X to an index of the prices of its M expressed relative to a base value of 100.

If countries terms of trade are currently 102, the price of goods it exports have risen relative to prices of goods its M since the base period.

Question 5

FDI

Answer 5

Ownership of productive resources (land, factories, natural resources) in a foreign country.

Question 6

Multi national corporation

Answer 6

A firm that has made FDI in one or more foreign countries, operating production facilities and subsidiary companies in foreign countries.

Question 7

Gross national product (GNP)

Answer 7

• This measures the total value of g/s produced by labour and capital of countries citizens.
• Does not include the income to capital owned by foreigners invested within a country.
• The income of a countries citizens working abroad is included.

Question 8

Absolute advantage

Answer 8

The production of a good at a lower resource cost than another country.

Question 9

Comparative advantage

Answer 9

The production of a good if it has a lower OC in production of that good, expressed as the amount of another good that could have been produced instead.

Question 10

Ricardian model of trade

Answer 10

• Only has one FOP - labor; where differences in labor productivity due to differences in technology.

Question 11

Heckscher-Ohlin model

Answer 11

• There is a redistribution of wealth within each country between labor and owners of capital; with price relatively less scarce FOP in each country will increase so owners of capital will earn more in England, and workers in Portugal in comparison to without trade.
• Good country imports will fall in price, and exports will rise.
• The trade of more capital intensive good in cloth produced in England, demand and price for capital will increase in England.
• In Portugal, increasing production in wine (labor intensive) increases demand for price of labor, and workers gain at expense of owners capital.

Question 12

Reasons for trade restrictions support from economists:

Answer 12

1. Infant industry - protection from foreign competition given to new industries to give them an opportunity to grow on an international competitive scale and get up the learning curve in terms of efficient production methods.
2. National security - if imports are cheaper, it may be in the country’s best interest to protect producers of goods crucial to countries national defense, so those goods available domestically in event of conflict.

Question 13

Reasons for trade restrictions have little support:

Answer 13

1. Protecting domestic jobs - while some jobs are certainly lost, and some groups and regions negatively affected by free trade, other jobs (X or growth of domestic g/s) will be created and prices for domestic consumers less without import restrictions.
2. Protecting domestic industries - industry firms use potential influence to get protection from foreign competition, usually at the detriment of consumers paying higher prices.

Question 14

Types of trade restrictions:

Answer 14

• Tariffs - a tax on M collected by gov.
• Quotas - limits on the amount of M allowed over some period.
• X subsidies - gov. payments to a firm that X goods.
• Min. domestic content - a requirement some % of product content must be from domestic country.
• Voluntary X restraint - a country voluntarily restricts the amount a good can be X, in hope of avoiding tariffs or quotas imposed by trading partners.

Question 15

Economic implications of trade restrictions:

Answer 15

1. Tariff - placed on M increases the domestic price, decreases quantity imported, increases the quantity supplied domestically.
   i. e. dom. producers gain, foreign X lose, dom. gov gains via amount of tariff revenues.
2. Quota - dom. producers gain, dom. consumers lose from an increase in domestic price.
   - if import licenses are sold to foreign countries, the domestic gov. gains revenue.

Question 16

Quota rents

Answer 16

If the domestic government does not charge import licenses, this amount is a gain to those foreign exporters who receive the import licenses under the quota.

Question 17

Voluntary export restraint

Answer 17

The voluntary agreement by gov to limit the quantity of a good that can be exported; another way of protecting domestic producers in importing country.

They result in welfare loss to importing country equal to that of equivalent quota with no gov. charge for import licenses so no capture of quote rents.

Question 18

Export subsidies

Answer 18

Payments by gov. to countries exporters benefiting producers of good, bit increase price and reduce CS in exporting country.

Small country - price increase by amount of subsidy = world price plus subsidy.
Large exporter - world price decreases and some benefits from subsidy accrues for foreign consumers, while foreign producers get negatively affected.

Question 19

Effects of protectionist policies wrt importing country:

Answer 19

• reduce imports
• increase price
• reduce CS
• increase dom. qty supplied
• increase PS

all will reduce national welfare, but quotas and tariffs in the large country will increase national welfare under the assumption as large M would produce world price of goods.

Question 20

Capital restrictions

Answer 20

This includes:

• outright prohitibtion of investment in domestic countries by foreigners
• prohibition of or taxes on income earned on foreign investments by domestic citizens
• prohibition of foreign investment in certain domestic industries
• restrictions on repatriation of earnings of foreign entities operating in a country

Question 21

Effect of capital restrictions

Answer 21

• they are thought to decrease economic welfare.
• in the short term, they have helped developing countries avoid impact of great inflows of foreign capital during periods of optimistic expansion, and the impact of large outflows of foreign capital during periods of correction and market unease or outright panic.
• the short term benefits may not offset longer-term costs if the country is excluded from international markets for financial capital flows.

Question 22

Benefits of increased trade on economic welfare:

Answer 22

• Increased trade according to comparative advantage

- Increased competition among firms in member countries.

Question 23

Drawdowns of increased trade on economic welfare:

Answer 23

• Some firms/industeries/groups of workers will see their wealth and income decrease.
• Workers in affected industries may need to learn new skills to get new jobs

Question 24

Why is economic welfare improved by reducing/eliminating trade restrictions:

Answer 24

• the extent that a trade agreement increases trade restrictions on imports from non-member countries, economic welfare gains are reduced and could be outweighed by costs such restrictions impose.
• If restrictions on trade with non-members countries increases countries (unrestricted) imports from a member has higher prices than countries previous imports from a non-member.

Question 25

Regional trading agreements (RTA)

Answer 25

1. Free trade area
   - all barriers to M or X among members countries are removed.
2. Customs Union

• all above
• all countries adopt a common set of trade restrictions with non-members.

3. Common Market

• all above
• all barriers to movement of labor and capital goods among member countries are removed.

4. Economic Union

• all above
• member countries establish common institutions and economic policy for the union.

5. Monetary Union

• all above
• member countries adopt a single currency

Question 26

Objectives of capital flow restrictions:

Answer 26

1. Reduce the volatility of domestic asset prices;

• capital flows out of country can drive down asset prices drastically, especially prices of liquid assets such as stocks and bonds.
• no restrictions on out/inflows of foreign investment capital, asset markets of economies which are small relative to amount of foreign investment is volatile over country’s economic cycle.

2. maintain fixed exchange rates;
   - those with limiting flows of foreign investment capital makes it easier to meet exchange rate target, hence use monetary and fiscal policy to pursue economic goals for domestic economy.
3. keep domestic interest rates low
   - restricting outflow of investment capital, countries can keep domestic IR low, and manage domestic economy with monetary policy, as investors cannot pursue higher rates in foreign countries.
   e. g. China has fixed ER where restrictions on capital flows means policymakers can target ER to pursue MP independent of concerns of effect on currency ER.
4. protect strategic industries
   - gov. prohibit investment by foreign entities in industries considered important for national security, such as telecoms, and defense industries.

Question 27

Balance of payments

Answer 27

The current account which mainly measures the flows of goods and services.

The capital account which consists of capital transfers and acquisition and disposal of non-produced, non-financial assets.

The financial account which records investment flows.

Question 28

Current Account

Answer 28

Comprises of 3 sub-accounts:

1. Merchandise and services

• all raw material and manufactured goods bought, sold or given away.
• services include tourism, transportation, business and engineering services, fees from patents and copyrights on new technology, software, books and movies.

2. Income receipts
   - foreign income from dividends on stock holdings and interest on debt securities.
3. Unilateral transfers

• one-way transfers of assets such as money received for those working abroad, and direct foreign aid.
• In case of foreign aid and gifts, the capital account of donor nation is debited.

Question 29

Capital account

Answer 29

Comprises of 2 sub-accounts:

1. Capital transfers

• debt forgiveness and goods and financial assets migrants bring when they arrive or leave a country.
• transfer of title to fixed assets, of funds linked to purchase/sale of fixed assets, gift and inheritance tax, death duties, and uninsured damage to fixed assets.

2. Sales and purchases of non-financial goods
   - not produced assets include rights to natural resources and intangible assets, such as patents, copyrights, trademarks, franchises and leases.

Question 30

Financial account

Answer 30

Comprises of 2 sub-accounts:

1. Government-owned assets abroad
   - gold, foreign currencies, foreign securities, reserve position in IMF, credits and other LT assets, direct foreign investment, claims against foreign banks.
2. Foreign-owned assets in the country

• divided into foreign official assets and other foreign assets in domestic country.
• assets include domestic gov and corporate securities, direct investment in domestic country, domestic country currency, domestic liabilities to foreigners reported by domestic banks.

Question 31

IMF goals

Answer 31

• promoting international monetary cooperation
• facilitating expansion and balanced growth of international trade
• promoting exchange stability
• assisting establishment of multilateral system of payments
• making resources available (with adequate safeguards) to members experiencing BOP difficulties.

Question 32

World Bank

Answer 32

• vital source of financial and technical assistance to developing countries around the world.
• mission to fight poverty with passion and professionalism for lasting results, help people help themselves and environment through resources, share knowledge, building capacity, forging partnerships in public and private sector.
• Made up of International Bank of Reconstruction and Development (IBRD; reduces poverty in middle-income and creditworthy poorer countries), and International Development Association (IDA; focus on world’s poorest countries), owned by 187 countries.
• Provide low-interest loans, interest free credit, grants to developing nations such as investments in education, health, public admin, infrastructure, agriculture etc.

Question 33

World Trade Organisation (WTO)

Answer 33

• The only international organsiation dealing with global rules of trade between nations; to ensure trade flows smoothly, predictably and freely as possible.
• keep trade policies within agreed trade limits to everybody’s benefit.