UNIT 3

Madrid
Barcelona
INTERNATIONAL TRADE
Valencia
Sevilla
www.esic.edu

Zaragoza
Málaga
Galicia
Pamplona
Bilbao
Granada
 ÍNDICE 1. Why do we trade?
2. S

Dr. Beatriz Irún, PhD 2

 Is trade good?
Why do
we trade? No doubt that in some regions there is no
access to certain resources
Krugman
needed for the production of some
(2015) products. For example, Saudi Arabia may
International have some trouble if they want to
Economics. produce oak wood. However, it seems
Chap 1,3. less obvious that two countries can
benefit from trade if both can produce the
traded goods.
Dr. Beatriz Irún, PhD 3
 Gains from trade
We can see it from the Ricardian model, based on labor
productivity.
International trade relies on the fact that different countries
have different opportunity costs and, for that reason,
specializing in products in which
their production is more efficient than producing both
products for local consumption. That means that trade is
based on comparative advantages,
rather than absolute advantages.
Dr. Beatriz Irún, PhD 4
 Gains from trade
BUT: While theory is easy to support reality can be tricky.
What about specific resources or skills that are valuable only
for a certain industry. Resources are hard to
change in the short-term, and industries can have different
demand of factors of production. Reality is never as “fluid” as
the theoretical models.

What determines trade: Labor productivity? The interaction

between capital, labor and land? Is it partially random?
Dr. Beatriz Irún, PhD 5
 Look for the following information:

Volume of world merchandise exports and gross

domestic product, 1950-2020. (Annual
percentage change)
What happened in year 2020 (covid19 context).
Decoupling US - China?
https://www.linkedin.com/posts/beatrizirun_an%C3%A1lisis-del-
escenario-econ%C3%B3mico-internacional-
activity-6688855852058763264-1Drs

Dr. Beatriz Irún, PhD 6

 World Development
Reality is that the world has been evolving towards a more
liberalized global market, reducing protectionism and creating free
trade areas. Along the different treaties and meetings like the ones
celebrated by GATT (General Agreement on Tariffs and Trade), as of
1970s the world has reached a superlative level of international
trade.

It’s not only that tariffs and restrictions have been reduced, but as
well this same fact has led to the “vertical disintegration” of the
production. Nowadays, a products has
been “produced” in several countries. Some parts in China, others in
India, assembled in Spain but designed in Norway.
Dr. Beatriz Irún, PhD 7
 World Development
Not always has been like that, in the great depression, countries
were
closing borders to force consumption of national products. They
set up
tariffs and quotas. International trade plummeted.

After the WWII WB, IMF and GATT is created. At the same time
the
gold standard is eliminated and dollar standard is set up, until
last half of 20th century. Now fiat money.
Dr. Beatriz Irún, PhD 8
World Development
The idea of globalization with little restrictions to the movement
of goods and money has been celebrated by some and
criticized by others. To certain individuals within a country trade
can, indeed, make them worse off. Think about the farmers who
are producing vegetables, if we can import vegetables at lower
rates, what can they do? what are their legitimate expectations?
The country is better off by paying lower prices, but definitely
not them.

Has globalization helped the world as a whole? Has it lead to

exploitation? Is it fair for all the countries involved? How is the
situation when extraordinary situations such as covid19 9
World Development
According to Krugman, income distribution effects are not only
due to trade. These can happen because of technological
improvements, changes in customer preferences and so on.

Indeed according to this author is always better to allow trade

and compensate those who are hurt than prohibiting trade.

However, politics are not only based on rationality. Constant

strikes, or other social movements can undermine public
confidence and well-being.

What about developing industries? 10

 Working in teams
- Defend World Trade without restrictions

- Defend restrictions to World Trade

Dr. Beatriz Irún, PhD 11

 Look for definitions of Basic
elements in the World Trade you
should know about:

- GATT
- WTO
- “Dumping” - “antidumping”

Dr. Beatriz Irún, PhD 12

 Look for definitions of Basic
elements in the World Trade you
should know about:

- GATT
- Doha Deal
- WTO
- “Dumping” - “antidumping”
- Exchange rates
Dr. Beatriz Irún, PhD 13
 CURRENT SITUATION

We are now in the Doha round, the longest ever. While trying to keep on reducing
tariffs and quotas, there has been a collapse in the negotiations due to the agricultural
trade.

This is a really sensitive subject. On one side developing countries have comparative
advantages in this kind of products. On the other side, farmers and peasants of
developed countries claim the free trade to unfairly reduce prices, so they cannot
produce anymore. And it seems a good idea to have some national production of food
to ensure some self sufficiency.

EU is pretty restrictive on what agricultural products are imported, what leads to

tensions and discrimination with African countries but as well with United States that
have companies based in developing countries producing these products (eg.
Chiquitaor Del Monte)
Dr. Beatriz Irún, PhD 14
 CURRENT SITUATION

The countries eager to liberalize agricultural trade formed a coalition

called the Cairns Group. This is group’s aim is to press the WTO to
remove subsidies and tariffs.
!
“[…] deep cuts to all tariffs (including tariff peaks) and removal of tariff
escalation, the elimination of all trade-distorting domestic subsidies; the
elimination of export subsidies and clear rules to prevent circumvention
of export subsidy commitments.” (cairnsgroup.org

Dr. Beatriz Irún, PhD 15

 Exchange Rates
Aside from elements like tariffs, quotas or different legislations that
we had already covered and are treated by governments and
international organizations; international trade is tremendously
affected by the relative price of money. The exchange rate: the price
of a currency in terms of another currency.

Euros per Dollar, how many dollars can I buy with one euro?

The higher it gets, more dollars we can buy with the same euro.

Dr. Beatriz Irún, PhD 16

 CHECK EXCHANGE RATE TODAY/ YESTERDAY:

EURO - USD

CNY - USD

With one dollar today/ yesterday we can buy XXX US dollars. The euro
depreciated or appreciated?

Please explain reasons why.

Dr. Beatriz Irún, PhD 17

 Types of exchange rates:

- Flexible
- Fixed
- In between ( bands, EMS)

Dr. Beatriz Irún, PhD 18

Dr. Beatriz Irún, PhD 19
 Do you know which system
are we currently using?
A little bit of History…
Bretton Woods System. From gold standard to dollar standard, all currencies
linked to dollar. Dollar linked to gold. Fixed exchange rates - with +/-1
fluctuation bands - and the IMF is the safeguard of this equity. The idea was
to prevent competitive devaluations - remember protectionism…

That’s is why the role of the IMF has been related with cuts and fiscal control,
that gave the IMF a bad name. IMF would warn countries with a currency
depreciation to use foreign currency to buy their own currency. And if there
was a currency appreciation, buy foreign currency or print more money.

Dr. Beatriz Irún, PhD 20

 Rationale behind the IMF…
However if there was a sustained trend of currency depreciation,
IMF would investigate. It could happen that it was that the country
had to much public spending, that was financed either by:

- External Debt - Issues with future funding

- Internal Debt, selling bonds to citizens
- Crowding out
- Issuing money

Solutions to the problem:

- Cuts in public spending
- Privatization of public companies
- Austerity
- Lowering salaries - be competitive without devaluation
Dr. Beatriz Irún, PhD 21
 A little bit of History…

Despite this, the United States couldn’t stand the market pressure.
They were in charge of controlling, indirectly, the price for all the
currencies adhered to the treaty. In the 1970s, the system collapsed
and we got into a flexible exchange rate system.

However, central banks still look for stability. That’s why some
European Countries decided to set the EMS, and ultimately the Euro.

How is exchange rate affecting international

trade?
Dr. Beatriz Irún, PhD 22
 How is exchange rate affecting international trade?
An increase of the exchange rate of Euro/Foreign Currency, would
appreciate our currency. That would make cheaper our imports but more
expensive our exports, that could destabilize the current account.

Oppositely, if our currency depreciates, we can sell cheaper and thus our
exports would increase, but we would buy more expensively so our exports
would decrease. However, this depends not only on price but elasticity. If we
are energy dependent - we are - we would buy the same amount of oil and
gas but more expensive. Similarly if our exports have little elasticity even
with price reduction our goods would not have a great demand increase.
Dr. Beatriz Irún, PhD 23
 Why exchange rates move?
On one side we have the market forces. If our currency is demanded (for
example because our products are demanded) the price of our currency
would increase unless we increase money supply. Oppositely, if, for
example, people have assets in our currency but they want to sell them, this
would
bring a depreciation.

On the other side Central Banks have tools to modify this. As we have
explained they can buy own currency or sell foreign currency. They can as
well modify interest rates..

Dr. Beatriz Irún, PhD 24

 Why exchange rates move?
Interest rate is the price of our money, because we sell bonds that yield a
certain benefit. If we increase the interest rate, we are making the bond
more attractive, people would put money in the bonds and less money would
be in the economy. This internal use to control inflation has as well,
external consequences.

High interest rates make bonds more attractive as well for foreign investors
that would want to buy Euros to buy our bonds. That would appreciate our
currency. Oppositely, we can depreciate the currency with low interest rates

Dr. Beatriz Irún, PhD 25

 Why exchange rates move?

As well, governments can lead to movements in the exchange rate

with fiscal policies. If the public spending increases, the economy
heats,
demand increase and more money is demanded, if the central bank
is
not issuing more money - scarcity - the price of the money
increases.
What leads as we have seen to a currency appreciation.

Dr. Beatriz Irún, PhD 26

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 Economic Integration

Dr. Beatriz Irún, PhD 30

 Economic Integration
“Economic integration is the unification of economic policies
between different states through the partial or full abolition of tariff
and non-tariff restrictions on trade taking place among them prior
to their integration”. Not only about trade, but macro policies.
It is not a new idea. The Zollverein or German Customs Union of
1867 paved the way for German (partial) unification under
Prussian leadership in 1871.

Dr. Beatriz Irún, PhD 31

 Economic Integration
There are different types of integration ranging from
simple free or preferential trade areas to economic
unions. There are several classifications but we will
follow Lindert and Kindleberger:
1) Free Trade Area
2) Customs Union
3) Common Market
4) Full Economic Union
Dr. Beatriz Irún, PhD 32
 1) Free Trade Area
In such area the trade barriers amongst member countries are
removed but keep their own barrier with third countries. In this situation the
countries still new customs to check that no product from a third country is
passed as a product from the union.

Mexico and United States are in the NAFTA, but United States have higher
tariff on rice coming from India. It could go through Mexico if not customs
were between Mexico and United States.

Dr. Beatriz Irún, PhD 33

 2) Customs Union
Members not only remove trade barriers amongst them, but also
adopt a common set of external barriers. That way is not
necessary to have customs inspection at the borders.

Dr. Beatriz Irún, PhD 34

 3) Common market

Members not only removed trade barriers and have a common

external policy but also allow full freedom of factor flow (capital and
labor).

Dr. Beatriz Irún, PhD 35

 4) Economic Union
Member countries unify all their economic policies, including monetary,
fiscal and well-fare. We can find different stages ranges from having a
common policy on product regulation to currency or fiscal. In EU we
can find that we have an Economic and Monetary Union, and while we
aspire to have a complete Union fiscal policies are still dependent on
national governments. United States could be considered a full
economic union in their beginning.

Look for examples.

Dr. Beatriz Irún, PhD 36

 Outcomes

Using the same idea that we started with of international trade, economic
integrations searches higher productivity and the pursue of comparative
advantages that increase the benefit for the society. Again, while
theoretically is better for the countries as a whole, we can find some
individuals that are worse off.

The main advantages are:

- Higher competence.
- Higher achievement on economies of scale.
- Widening the range of available products.
- Possibility of new activities and development of the production structure.
- Elimination of custom procedures.
Dr. Beatriz Irún, PhD 37
Outcomes

We can find that there are two effects: Trade

Creation and Trade Diversion. Trade creation
since eliminating barriers increase trade
between member countries. Trade Diversion
because imports from third countries are
substituted by suppliers from the Union.
Dr. Beatriz Irún, PhD 38
 Outcomes

While complete free trade is supposed to bring all the benefits without the
losses of Trade Diversion (that demands on countries that are less efficient
but within our Union), still the countries are more prone to form this kind
of unions rather than opening their markets freely. Keep control on wellbeing
and economic development seems like a sensible reason to do so.

Bearing that in mind the greater effects on well-being will come the greater
number of countries, the larger their size, the more complementary their
economies are, the higher the tariffs were before.

Dr. Beatriz Irún, PhD 39

 Reviewing some concepts:

GNP/GDP
Monetary Policy
Fiscal Policy
WTO/GATT Rounds
Interest rate - What happens if…
Exchange rate
Impact of oil prices
Economic Integration
!
Dr. Beatriz Irún, PhD 40