ECO 615

Unit 1 Lecture

Unit Learning Outcomes

Unit 1

ULO 1. Articulate measurements of international economic integration by analyzing the

differences in international economic integration from the end of the nineteenth century
to the present.
ULO 2. Appraise and classify the major themes of international economics and the main types of
international economic organizations.
ULO 3. Analyze the roles of international economic organizations .
The goal of this unit is to examine international economic integration in historical perspective.
Most features of globalization are not new, and international economic integration is described
as re-emerging after a period of disruption during World War I, the Great Depression, and World
War II. This unit adds a brief discussion of new features in the current wave of globalization,
including regional trade agreements and multilateral organizations. It also briefly discusses
three types of evidence to support the idea of gains from trade: historical experiences of similar
countries such as North and South Korea; economic theory; and large statistical comparisons of
countries.

This unit also introduces the major international governmental organizations of the global
economy. This background material is designed to remove some of the mystery early in the
course about the IMF, World Bank, WTO, and the GATT. Unit also addresses the need for
these organizations and the criticisms against them. Institutions are supposed to reduce
uncertainty and increase stability. Drawing on material from the new institutionalisms, such as
Doug North, the unit introduces international institutions as organizations that set the rules,
which govern behavior and potentially constrain or limit a nation’s actions.

CHAPTER ONE

The United States in a Global Economy

What You Will Learn

The goal of Chapter One is to examine international economic integration in historical

perspective. Most features of globalization aren’t new, and international economic integration is
described as re-emerging after a period of disruption during World War I, the Great Depression,
and World War II. The chapter adds a brief discussion of new features in the current wave of
globalization, including regional trade agreements and multilateral organizations. It also briefly
discusses three types of evidence to support the idea of gains from trade: historical experiences
of similar countries such as North and South Korea; economic theory; and large statistical
comparisons of countries.

INTRODUCTION: INTERNATIONAL ECONOMIC INTEGRATION

International integration of national economies has brought many benefits to many nations

• Technological innovation

• Less expensive products

• Greater investments in scarce resource regions

ELEMENTS OF INTERNATIONAL ECONOMIC INTEGRATION

Today’s major economies are more integrated than they’ve been at any time in history.

• Instantaneous communications

• Modern transportation
• Relatively open trading systems

This allows most goods to move across boundaries without major obstacles and low relative
costs.

There are four criteria or measure for judging the degree of integration:

1. Trade flows

2. Capital flows

3. People flows

4. Similarity of prices in separate markets

The Growth of World Trade

Since the end of World War II, world trade has grown much faster than world output. In 1950,
total world exports were estimated to be 5.5% of world gross domestic product (GDP). By 2005,
total world exports were 20.5% of world GDP.

The index of openness is the ratio of trade to GDP.

Index of Openness = (Exports + Imports)/GDP

This index does not tell us about a nation’s trade policies. Nations with higher figures for the
index of openness do not necessarily have lower trade barriers. Large economies are less
dependent on international trade and often have lower measures of openness than small
countries.

Figure 1.1 shows the openness index for six nations at different points in time. It shows the drop

in trade from 1913 to 1950 and its growth (even above 1913 levels) for most nations by 2000. A
trend obscured in the overall trade data is that in 1890 most U.S. trade was in agricultural
products and raw materials, while today most is manufactured goods. The relative importance of
capital goods has increased dramatically.

Ask yourself: What is “openness”? How is it measured? Does a low openness indicator indicate
that country is closed to trade with the outside world?

Capital and Labor Mobility

Factor movements are indicators of economic integration. As national economies become more
interdependent, labor and capital generally move more easily across international b orders.

Two important points regarding international capital flows:

1. Savings and investment are highly correlated

2. Technology improvements increase capital

Ask yourself: What are the two key points to keep in mind when comparing international capital
flows today as compared to a century ago?

Three Features of Contemporary International Economic Relations

There are three features of contemporary international economic relations:

1. Deeper integration

2. Multilateral organizations

3. Regional trade agreements

Trade and Economic Growth

More trade may give consumers lower prices and greater choices, but it also means more
competition for firms and workers. Capital flows make more funds available for investment
purposes, but they also increase the risk of spreading financial crises internationally. Rising
immigration means higher incomes for migrants and lower labor costs for firms, but also it
means more competition in labor markets and, inevitably, greater social tensions.

Ask yourself: What is the stance of economists on the benefits of trade and what are the three
kinds of evidence that support their stance.

The statistical evidence of the benefits of more open economies comes from comparisons of
large samples of countries over different periods. While the statistical tests of the relationship
between trade policy and economic growth suffer from their own technical shortcomings (usually
problems of measuring trade policy), the results consistently show that more open economies
grow faster. These results cannot be viewed as absolutely conclusive, but together with trade
theory and the casual empirical evidence drawn from historical experiences, the available
statistical analysis provides additional support for the notion that trade is usually beneficial.

Ask yourself: What are the differences between East Asia and Latin America in their stance on
integration into the world economy?

TWELVE THEMES IN INTERNATIONAL ECONOMICS

There are twelve themes that will be examined in the chapters that follow. These themes are
overlapping, multidimensional, and often go beyond pure economics. The twelve themes to be
discussed in the following chapters are:

1. The Gains from Trade (Chapters 3, 4, and 5)

2. Wages, Jobs, and Protection (Chapters 3, 6, 7, and 8)

3. Trade Deficits (Chapters 9, 11, and 12)

4. Regional Trade Agreements (Chapters 2, 13, and 14)

5. The Resolution of Trade Conflicts (Chapters 2, 7, and 8)

6. The Role of International Institutions (Chapters 2 and 12)

7. Exchange Rates and the Macroeconomy ( Chapters 10 and 11)

8. Financial Crises and Global Contagion (Chapter 12)

9. Capital Flows and the Debt of Developing Countries (Chapters 2, 9, and 12)

10. Latin American and the World Economy (Chapter 15)

11. Export-Led Growth in east Asia (Chapter 16)

12. The Integration of India and China into the World Economy (Chapter 17)

CHAPTER TWO
International Economic Institutions since
World War II
What You Will Learn
Chapter 2 introduces the major international governmental organizations of the global economy. This
background material is designed to remove some of the mystery early in the course about the IMF,
World Bank, WTO, and the GATT. Chapter 2 also addresses the need for these organizations and the
criticisms against them. Institutions are supposed to reduce uncertainty and increase stability. Drawing
on material from the new institutionalists, such as Doug North, the chapter introduces international
institutions as organizations that set the rules which govern behavior and potentially constrain or limit a
nation’s actions.

INTRODUCTION: INTERNATIONAL INSTITUTIONS AND ISSUES SINCE WORLD WAR

As World War II was drawing to a close, representatives from the United States, Great Britain, and other
Allied nations met in the small New Hampshire town of Bretton Woods. The outcome of these meetings
was a series of agreements that created an exchange rate system, the International Bank for
Reconstruction and Development (IBRD) (World Bank), and the International Monetary Fund (IMF).

• Formal institutions: Written sets of rules that explicitly state what is and is not allowed
• Informal institutions: Customs or traditions that define appropriate behavior, but without legal
enforcement
International Institutions
International economic institutions are an important feature of the world economy. Institutions can be
formal or informal. A formal institution is a written set of rules that explicitly state what is and is not
allowed. The rules may be embodied in a club, an association, or a legal system. An informal institution
is a custom or tradition that tells people how to act in the same way that a law does, but without legal
enforcement.

Ask yourself: How do you define the word institution? Can you distinguish between formal and informal
institutions?

A Taxonomy of International Economic Institutions

International economic institutions come in many shapes and sizes. They can be lobbying groups for a
particular commodity or an international producer’s association, the joint management by several
nations of a common resource, trade agreements or development funds for a select group of nations, or
even global associations.

Examine Table 2.1 titled “A Taxonomy of International Economic Institutions” for the five main types of
international economic institutions.

THE IMF, THE WORLD BANK, AND THE WTO

Three global organizations play a major role in international economic relations and are central to this
book: the International Monetary Fund (IMF), the World Bank, and the World Trade Organization
(WTO).

The IMF and World Bank

The International Monetary Fund (IMF)

The IMF was founded by 29 nations (1945) at the Bretton Woods meeting between the Allies in July
1944.

The 184 member (2006) IMF is the central monetary institution in today’s international economy.
Funding for the IMF comes from its membership fee, or quota (the price of membership). The quota
depends on the member’s size and status and determines the member’s voting weight.

Functions of the IMF include:

Prevents crisis in a financial system by promoting sound macroeconomic policy, which includes:

• Balanced expansion of trade

• Stable exchange rates
• Avoidance of competitive devaluations
• Orderly corrections of Balance of Payments problems
A financial crisis occurs when a country runs out of foreign exchange reserves, which are a major
currency or gold that can be used to p ay for imports and international borrowings.
In the event of a financial crisis, members may borrow against IMF quotas.

IMF conditionality: Requirement for borrowing member to carry out economic reforms in exchange for a
loan.

The World Bank

The World Bank was founded in 1944 as the International Bank for Reconstruction and Development
(IBRD).

The IBRD and the International Development Association (IDA) comprise the World Bank.

The World Bank has the same membership and similar structure to the IMF. Member’s voting rights are
proportional to the number of shares owned.

The original purpose of the World Bank was to provide financing mechanisms to rebuild Europe after
World War II. The main function today is assisting development in non-industrial economies.

Ask yourself: What is the purpose of the IMF and the World Bank? Who are the members?

The GATT, the Uruguay Round, and the WTO

The “Big 3” of international economic organizations are the International Monetary Fund, the World
Bank, and the World Trade Organization. The latter grew out of the General Agreement on Tariffs and
Trade. The IMF, World Bank, and the GATT were created at the end of World War II with the purpose of
avoiding a return to the destructive economic conditions of the interwar years.

The GATT functions through a series of trade rounds in which countries periodically negotiate a set of
incremental tariff reductions.

The foundations of all WTO and GATT agreements are the principles of national treatment and
nondiscrimination. National treatment is the requirement that foreign goods are treated similarly to the
same domestic goods once they enter a nation’s markets. Nondiscrimination is embodied in the concept
of most-favored nation (MFN) status.

Ask yourself: What does the MFN require all WTO members to do? What is the intention of this?

Read the Case analysis, “The GATT Rounds” regarding the rounds of negotiations in the GATT forum. The
list of the various rounds of negotiations can be found in Table 2.2 “The GATT Rounds” (page 23).

REGIONAL TRADE AGREEMENTS

Besides economic organizations, regional trade agreements form a key part of the institutional structure
of the world economy. Regional trade agreements are bilateral (two countries) or plurilateral (several
countries)
Five Types of Regional Trade Agreements

1. Partial trade agreement: Two or more countries liberalize trade in a selected group of product
categories such as steel or autos
2. Free trade area (FTA): Trade in goods and services are fully liberalized between two or more
countries.
a. North American Free Trade Agreement (NAFTA)
3. Customs union (CU): An FTA plus a common external tariff (CET).
a. European Union in the 1970s and 1980s
b. MERCOSUR in South America
4. Common market: A CU plus free mobility of factors of production
a. European Union in the 1990s
5. Economic Union: A common market with coordination of macroeconomic policies (including
common currency, harmonization of standards and regulations)
a. United States
b. Canada
c. European Union members participating in the Euro currency zone
Table 2.3 titled “Five Types of Regional Trade Agreements” lists five types of trade agreements and their
characteristics.

Read the Case analysis, “Prominent Regional Trade Agreements” .

Examine Table 2.4 which lists some of the RTAs currently in force.

Regional Trade Agreements and the WTO

Since 1948, over 400 agreements have been listed with the WTO; 75% of those since 1995. Of these
agreements, 225 are still active (2008).

The WTO and GATT allow RTAs, assuming they create more new trade than they destroy.

Trade Creation > Trade Diversion

Ask yourself: How does the above concept apply to the incident that occurred in 1995 regarding the
Caribbean Basin and Central America?

For and Against RTAs

• Are RTAs supportive of gradual, long run increases in world trade (building blocks) or,
• Do they tend to become obstacles to further relaxation of trade barriers (stumbling blocks).
Proponents of RTAs view them as building blocks toward freer, more open, world trade. Opponents view
RTAs as undermining progress toward multilateral (worldwide) agreements.
Ask yourself: What do of opponents of RTAs say is happening to poor and less-developed countries?

THE ROLE OF INTERNATIONAL ECONOMIC INSTITUTIONS

People rely on institutions to create order and reduce uncertainty. By defining the constraints or limits
on economic, political, and social interactions, institutions define the incentive system of a society and
help to create stability.

The establishment of rules for international trade and international macroeconomic relations are
dependent on the voluntary associations of nations in international economic organizations.

International institutions help provide order and reduce uncertainty. Order and certainty are public
intangibles that are different from most goods and services.

Ask yourself: What is the primary difference between international economic organizations and the
government of a single nation?

The Definition of Public Goods

Public goods are:

• Nonexcludable: The normal price mechanism does not work as a way of regulating access to
them
• Nonrival (undiminishable): They are not diminished or reduced by consumption
Private markets fail to supply public goods because of free riding: Peoplple have no incentive to pay for
a public good because they cannot be excluded from its consumption even if they don’t pay.

Maintaining Order and Reducing Uncertainty

Two of the most important functions of international economic institutions are to maintain order in
international economic relations and to reduce uncertainty. Together, these functions are often
instrumental in the avoidance of a global economic crisis.

Table 2.5 (page 30) illustrates “Four Examples of International Public Goods”.

Read the Case analysis, “Bretton Woods” regarding the founding principles of the institutions.

CRITICISM OF INTERNATIONAL INSTITUTIONS

The World Bank, IMF, WTO, and various regional trade agreements have provided financial resources for
development, technical assistance for crisis management, and mechanisms for opening markets. Not
everyone agrees that these efforts are positive on balance, however, and even those who view their
actions favorably would agree that there is room for improvement. The range of criticism covers a wide
spectrum, from public demonstrations against trade ministers meeting under the auspices of the WTO
to the well-informed criticisms by leading economists such as Nobel Laureate Joseph Stiglitz. The
underlying question is whether the IMF, World Bank, and WTO are fostering development and economic
security, or generating greater economic inequality and compounding the risks to vulnerable groups.

Sovereignty and Transparency

Sovereignty covers the rights of nations to be free from unwanted foreign interference in their affairs.
One of the strongest complaints about international institutions is that they violate national sovereignty
by imposing unwanted domestic economic policies.

Closely related to the issue of sovereignty is the issue of transparency. Transparency concerns are based
on questions about the decision making that occurs within international institutions.

Ask yourself: What is the governing structure of the WTO based on?

Ideology

Issues of sovereignty and transparency are compounded by questions about the value of the technical
economic advice given by the IMF and other institutions. Some of the sharpest criticisms come from
economists who strongly favor international economic integration but argue that the advice and
technical assistance provided to developing countries are a reflection of the biases and wishes of
developed country interests.

Privatization of publicly owned enterprises can have a number of benefits, but it can also impose high
costs. When countries lack regulatory structures or when local institutions are easily captured by
powerful economic interests, privatization may trade a public monopoly for a much more predatory
private one.

Implementation and Adjustment Costs

Trade agreements and the WTO are a major focus of complaints by the critics of economic integration.
In particular, when agreements combine developing and developed countries, asymmetries in
negotiating skills and the ability to absorb the costs of implementation and adjustment are singled out
for criticism.

Once in place, trade agreements always impose costs in the form of adjustments to the new
opportunities and challenges. Some markets will expand while others will contract. In general, the costs
of adjusting to the new incentives are less significant than the benefits, but for some developing
countries the adjustment costs may be quite large.

The author notes that issues of sovereignty and transparency, ideological biases, and the costs of
implementation and adjustment are only a partial catalog of the concerns raised by the critics of
international institutions. In general, however, there is widespread agreement among professional
economists that there are theoretical and practical reasons for their existence. Nevertheless, beyond a
basic consensus about need, many issues remain subject to debate, particularly issues of governance
and the amount of authority that should be vested in international organizations. Still, in spite of these
uncertainties, it is safe to say that if these international institutions did not exist, we would create them.

Ask yourself: What are the arguments in favor of international organizations? What are the arguments
against? Which do you think are stronger?

SUMMARY

• Institutions are the “rules of the game.” They can be formal, as in a nation’s constitution, or
informal, as in a custom or tradition. In both cases, we depend on institutions as mechanisms for
creating order and reducing uncertainty. Global institutions have played an important role in
fostering the growth of international trade and investment during the last fifty years. They have
defined a set of rules that have helped avoid trade wars and the problems of the 1930s.
• Most analysts agree that some forms of international institutions are necessary as a precaution
against crises and to promote growth, but there is significant disagreement over the design of
governance structures and the scope of their responsibilities.
• Primary areas of criticism are in sovereignty, transparency, ideological bias, and implementation
and adjustment costs.