International Economics and Trade 2024 Lecture Notes PDF

WELCOME to the class of INTERNATIONAL ECONOMICS AND TRADE 2024.11.07 Asist. Dr. Julija Gavėnaitė-Sirvydienė [email protected] 866204092 1  Getting to know each other...

WELCOME to the class of INTERNATIONAL ECONOMICS AND TRADE 2024.11.07 Asist. Dr. Julija Gavėnaitė-Sirvydienė [email protected] 866204092 1  Getting to know each other Julija Gavėnaitė Sirvydienė PhD in Economics Field of scientific research: risk management; cyber security issues in financial sector Also working in business, area of expertise: customer experience management Travel lover Former electric guitar player in rock band 11/7/2024 2  Getting to know each other THIS or THAT UNLIMITED ICE CREAM FOR LIFE UNLIMITED FRIES FOR LIFE SUPER STRENGHT SUPER SPEED BE INVISIBLE BE ABLE TO FLY BATMAN SPIDER MAN NEVER BRUSH YOUR HAIR NEVER BRUSH YOUR TEETH STUDY EVERY DAY STUDY ON LAST NIGHT 11/7/2024 3 Internation economics and trade Topics of the course 1. International economics and trade- introduction 2024.11.07 2. The theory of comparative advantage 2024.11.07 3. The Heckscher – Ohlin model 2024.11.20 4. Alternative theories of trade 2024.11.20 BUSINESS 2024.11.28 CHALLENGE 5. Tariffs PRESENTATION 6. Balance of payments 2024.11.28 2025.01.09 7. The foreign exchange determination 2024.11.28 8. International lending and financial crises 2024.12.05 9. TEST 2024.12.05 11/7/2024 4 Setting ground rules for IET lectures Attendance matters (compulsory attendance of lectures and seminars - 50%) Ask questions, there are no stupid ones All material will be available in Moodle course “Sustainable Economy” 11/7/2024 5 1. International economics and trade Introduction International Economics is the branch of economics that studies how countries interact through trade, investment, finance, and policies. It seeks to understand the effects of economic activity that crosses international borders, examining the factors that influence trade flows, the movement of resources, and how policies impact global markets. 11/7/2024 6 1. International economics and trade Introduction INTERNATIONAL ECONOMICS INTERNATIONAL TRADE INTERNATIONAL FINANCE exchange of goods and services across how capital flows between countries borders how exchange rates, balance of payments, why nations trade, what determines the and international investments influence goods they export and import economies how trade impacts economic welfare studies currency markets, exchange rate Trade theories: comparative advantage; systems absolute advantage how financial institutions like the IMF trade policies, tariffs, quotas, and the roles of manage economic crises that cross national global trade institutions like the WTO boundaries * WTO – World Trade organization * IMF – International Monetary fund 11/7/2024 7 1. International economics and trade Introduction Together, international economics and trade help explain: 1. how and why nations benefit from economic interdependence 2. the impact of globalization on national economies 3. how countries can balance the challenges and benefits of participating in a global economy. 11/7/2024 8 1. International economics and trade Introduction As long as countries exist, international economics will be a body of analysis distinct from the rest of economics. The special nature of international economics makes it fascinating and sometimes difficult. Let’s look at four controversial developments that frame the scope of nowadays international economics and trade environment. The trade war China’s Immigration Brexit of 2018 Exchange Rate 11/7/2024 9  1. International economics and trade Introduction The trade war of 2018 The Trade War of 2018, initiated by President Donald Trump, marked a significant shift in U.S. trade policy, primarily targeting China. The conflict arose from long-standing grievances regarding China's trade practices, which the Trump administration characterized as unfair. Key issues included allegations of intellectual property theft, currency manipulation, and barriers to U.S. companies accessing Chinese markets. Objectives: The main objectives of the trade war were to reduce the U.S. trade deficit with China, protect American jobs, and force China to change its trade policies. Trump argued that these tariffs were necessary to level the playing field for U.S. businesses Economic Impact: The trade war had various economic ramifications, including increased costs for U.S. consumers and businesses reliant on Chinese imports. Economists have debated the effectiveness of tariffs in achieving their intended goals, with many arguing that they ultimately hurt American industries and consumers more than they helped. 11/7/2024 10  1. International economics and trade Introduction Immigration Approximately 260 million people, or 3% of the world's population, reside outside their country of birth. Countries like the U.S., Canada, and Australia have significant percentages of foreign-born residents, which are on the rise. While opponents of immigration raise concerns about economic impacts, cultural integration, and crime, international economic analysis suggests that immigration generally brings net economic benefits. Immigrants often fill labor shortages, contribute to economic growth, and support the firms that employ them, even though there may be negative impacts on certain low-skilled workers competing for jobs. Overall, immigration remains a complex topic, with ongoing debates about its benefits and challenges shaping policies across the globe. The net economic benefits of immigration are significant, but they come with political and social complexities that vary by region and over time. 11/7/2024 11  1. International economics and trade Introduction Brexit The Brexit referendum held on June 23, 2016, resulted in a narrow decision to leave the European Union (EU), with 52% voting for "leave" and 48% for "remain." This vote marked a significant turning point in the UK's relationship with the EU, which it had been a part of since 1973. Reasons for Voting to Leave: 1.Sovereignty: Many voters felt that leaving the EU would allow the UK to reclaim control over its laws and policies, particularly regarding immigration. 2.Immigration Concerns: fears about cultural integration and job competition. 3.Economic Arguments: UK could save money on EU contributions and negotiate its own trade agreements. Consequences: 1.Political and Economic Uncertainty: Brexit created a host of questions about the future relationship between the UK and the EU, including tariffs, trade agreements, and immigration policies. 2.Northern Ireland Border Issues: The need to maintain an open border between Northern Ireland and the Republic of Ireland posed significant challenges, threatening the peace established by previous agreements. 3.Transition Period: The formal exit was set for March 2019, but ongoing negotiations would determine the specifics of the UK’s new status, complicating the landscape for businesses and individuals alike. 11/7/2024 12  1. International economics and trade Introduction China’s Exchange Rate An exchange rate represents the value of one country's currency relative to another, playing a crucial role in international economics. The controversy surrounding China's yuan has been particularly intense over the past few decades, with debates primarily focusing on whether China's currency manipulation has given it an unfair trade advantage. China has employed a strategy of controlling its currency, the yuan (or renminbi), which has significant effects on its economy and international trade relations. Effects of These Actions: 1.Trade Surpluses: China’s currency manipulation helped maintain a trade surplus, making Chinese exports cheaper and more competitive internationally. This led to large trade deficits for countries like the U.S. and the EU 2.Inflation and Economic Control: Keeping the yuan undervalued initially helped manage inflation in China by keeping import prices lower. However, as domestic economic conditions changed, a stronger yuan became necessary to control excessive money supply and inflation 3.Global Tensions: China’s currency practices have led to tensions with other countries, particularly the U.S., which has accused China of unfair trade practices. This has resulted in calls for tariffs and other trade restrictions against Chinese goods 4.Investment Flows: The manipulation of the yuan has also influenced capital flows. Speculators often move money into China, expecting currency appreciation, leading to volatility and pressure on China’s 11/7/2024 foreign reserves 13 2. Demand and Supply Four main questions about trade to answer: 1.Why do countries trade? More precisely, what determines which products a country exports and which products it imports? 2.How does trade affect production and consumption in each country? 3.How does trade affect the economic well-being of each country? In what sense can we say that a country gains or loses from trade? 4.How does trade affect the distribution of economic well-being or income among various groups within the country? Can we identify specific groups that gain from trade and other groups that lose because of trade? 11/7/2024 14 2. Demand and Supply The demand-supply relationship is a fundamental concept in economics that describes how the price and quantity of goods in a market are determined by the interaction of demand and supply. 11/7/2024 15  2. Demand and Supply DEMAND SUPPLY Refers to the quantity of a product or service Represents the quantity of a product or that consumers are willing and able to service that producers are willing and purchase at various prices. able to sell at different price levels. Generally, as the price of a good decreases, Typically, as the price increases, supply demand increases (and vice versa), increases (and vice versa), demonstrating the law of supply. illustrating the law of demand MARKET EQUILIBRIUM The point where the quantity demanded equals the quantity supplied, resulting in a stable market price. Changes in demand or supply can shift this equilibrium, leading to price adjustments. For example, an increase in demand with unchanged supply will lead to higher prices and potentially a new equilibrium point. 11/7/2024 16 2. Demand and Supply Four main questions about trade to answer: 1.Why do countries trade? More precisely, what determines which products a country exports and which products it imports? ANSWER: Demand and supply conditions differ between countries, so prices differ between countries if there is no international trade. Trade begins as someone conducts arbitrage to earn profits from the price difference between previously separated markets. A product will be exported from countries where its price was lower without trade to countries where its price was higher. 11/7/2024 17 2. Demand and Supply Four main questions about trade to answer: 2. How does trade affect production and consumption in each country? ANSWER: The move from no trade to a free-trade equilibrium changes the product price from its no- trade value to the free-trade equilibrium international price or world price. The price change in each country results in changes in quantities consumed and produced. In the country importing the product, trade raises the quantity consumed and lowers the quantity produced of that product. In the exporting country, trade raises the quantity produced and lowers the quantity consumed of the product. 11/7/2024 18 2. Demand and Supply Four main questions about trade to answer: 3. How does trade affect the economic well-being of each country? In what sense can we say that a country gains or loses from trade? ANSWER: If we use the one-dollar, one-vote metric, then both do. Each country’s net national gains from trade are proportional to the change in its price that occurs in the shift from no trade to free trade. The country whose prices are disrupted more by trade gains more. 11/7/2024 19 2. Demand and Supply Four main questions about trade to answer: 4. How does trade affect the distribution of economic well-being or income among various groups within the country? Can we identify specific groups that gain from trade and other groups that lose because of trade? ANSWER: The gainers are the consumers of imported products and the producers of exportable products. Those who lose are the producers of import- competing products and the consumers of exportable products. 11/7/2024 20 3. Theory of comparative advantage David Ricardo’s theory of comparative advantage, developed in the early 19th century, is foundational in understanding international trade. Ricardo's insight was that trade between nations is beneficial even when one country has no absolute advantage in producing any goods. Comparative advantage emphasizes relative efficiency or opportunity cost, which is the cost of forgoing the production of one good to produce another. 11/7/2024 21 3. Theory of comparative advantage Explaining the theory of COMPARATIVE ADVANTAGE Explaining the theory of COMPARATIVE ADVANTAGE 11/7/2024 22 3. Theory of comparative advantage Key Points of Ricardo’s Comparative Advantage Theory Relative Opportunity Costs Trade Without Absolute Double Comparison Each country has different Advantage Comparing productivity not only opportunity costs for producing Even if one country is less efficient in between two countries but also goods. A country should producing all goods, both countries across different goods within each specialize in producing and can benefit from trade. The less country, identifying where each has exporting goods it can make at a efficient country should focus on a comparative advantage or lower opportunity cost than products where its relative disadvantage. other countries inefficiency is smallest. Absolute Advantage and Numerical Example Equilibrium Price in Trade Comparative Advantage As example: despite the United States The interaction of international While absolute advantage reflects a country’s having lower productivity in producing demand and supply creates a overall productivity and can influence living both cloth and wheat, it still has a global equilibrium price for goods. standards, comparative advantage explains comparative advantage in wheat if its relative productivity loss is less than in This price falls between each trade benefits. High-productivity countries country’s domestic price ratios, often have high wages, whereas low- cloth. Thus, the United States would allowing mutually beneficial trade. productivity countries with fewer absolute export wheat and import cloth. advantages may have lower wages 11/7/2024 23 3. Theory of comparative advantage If free trade is so good, why do so many people fear it? Activists and protesters have recently been complaining loudly that trade has bad effects on Workers in developing countries. Workers in the industrialized countries. The natural environment. Analysis of absolute advantage and comparative advantage focuses on a resource called labor, so let’s focus on trade and workers…..? 11/7/2024 24 3. Theory of comparative advantage If free trade is so good, why do so many people fear it? The classical trade theory by Ricardo sheds light on why and how trade can benefit different countries. Imagine two countries – NORTH and SOUTH. NORTH SOUTH high-productivity low-productivity high wages low wages has an absolute advantage in all products— has an absolute disadvantage in all it can produce everything more efficiently products—it cannot produce anything more than South efficiently than North However, trade between them remains beneficial because of their comparative advantages, which focus on relative costs rather than absolute productivity levels. Here’s a closer look at what’s happening in each region: 11/7/2024 25  3. Theory of comparative advantage Impact on the South (Low Productivity, Low Wages) Comparative Advantage despite Absolute Disadvantage: The South, though less productive across the board, still has a comparative advantage in producing some goods—those where its productivity disadvantage is least severe compared to North. These are often labour-intensive products, like textiles or certain agricultural goods, where production doesn’t require highly skilled labor or advanced technology. Export-Driven Growth and Industry Shifts: By specializing in its comparative-advantage goods, the South develops export-oriented industries, which can boost income and employment in these sectors. However, as trade grows, South may lose jobs in sectors where it cannot compete with North’s high productivity (e.g., certain high-tech products or capital-intensive industries), prompting a shift of resources toward competitive industries. While this transition can create temporary job losses, overall, the South’s economy grows as it reorients around its strengths. Wages and Cost Competitiveness: Low wages in the South allow it to maintain low production costs despite lower productivity, enabling it to compete on the global market. This comparative advantage makes its exports affordable and attractive to North’s markets. The low wages, however, reflect South’s limited productivity rather than an effect of trade exploitation. 11/7/2024 26  3. Theory of comparative advantage Impact on the North (High Productivity, High Wages) High Productivity as a Buffer for High Wages: North’s high wages are a result of its advanced productivity, from better technology, more skilled labor, and efficient industries. This allows North to produce high-value goods at a low unit cost despite the high wages paid to workers. For instance, products like advanced machinery, pharmaceuticals, are highly competitive globally because North can produce them efficiently, maintaining a comparative advantage in these high-value sectors. Export Strength and Economic Gains: North benefits from trade by exporting products where it has the greatest productivity advantage. High productivity reduces costs enough to offset high wages, so these goods remain competitive even when sold internationally. Trade enables North to focus on and expand industries where it excels, while importing goods from South that would be costlier to produce domestically. Protection against Lower-Wage Competition: Although the North competes with low-wage producers in South, it remains competitive due to its focus on high-value goods and innovation-driven industries. Thus, instead of being harmed, North continues to gain from trade as it imports goods that would otherwise cost more to produce domestically, thus lowering costs for consumers and freeing resources for more competitive sectors. 11/7/2024 27  3. Theory of comparative advantage Addressing the Fairness Question: Low Wages in the South Why North-South Wage Differences Exist: The wage gap reflects productivity differences rather than exploitation by trade. Workers in North earn more because their productivity is much higher, driven by access to better technology, higher education levels, and efficient business practices. In contrast, the South has lower productivity due to limited resources, infrastructure, and investment, which keeps wages lower. Path to Higher Wages and Living Standards in the South: The solution lies in boosting South’s productivity, which involves building a skilled workforce, enhancing technology, and improving governance. As productivity rises, wages can increase, and living standards improve. However, this is a gradual process that depends on internal and external investments and strategic reforms, rather than merely engaging in trade alone. 11/7/2024 28 4. Producer surplus Producer surplus is the difference between what producers are paid for a good and the minimum amount they would be willing to accept to produce it. Essentially, it’s the profit producers make above their costs. On a supply and demand graph, it’s represented as the area above the supply curve and below the price level. Producer surplus increases when market prices rise, benefiting producers with greater earnings above their production costs. 11/7/2024 29 4. Consumer surplus The difference between the highest price consumers are willing to pay for a good or service and the actual price they pay. It represents the extra value or benefit consumers receive when they purchase a product at a price lower than what they were prepared to pay. 11/7/2024 30 5. Protectionism and free trade Protectionism refers to government policies aimed at restricting or limiting international trade to protect domestic industries from foreign competition. These measures are often justified as a way to preserve local jobs, support emerging industries, and ensure national security. Common forms of protectionism include tariffs, quotas, subsidies, and import restrictions. 11/7/2024 31  5. Key Types of Protectionist Policies Tariffs Quotas Subsidies Import Restrictions and Taxes on imported goods Limits on the amount of Financial support to Standards that make them more specific goods that can be domestic industries from Regulations or high expensive, discouraging imported, which restricts the government, allowing standards on imported consumers from buying supply and can raise the them to produce goods goods (such as strict health foreign products. For price of foreign goods. more cheaply and or safety standards) can example, a 10% tariff on For instance, a quota may compete with foreign serve as trade barriers by imported cars raises their limit the number of foreign- companies. Agriculture is making it harder for foreign price, making made textiles allowed into a commonly subsidized, companies to enter the domestically country. where governments help market. manufactured cars more local farmers to keep competitive. prices lower than foreign imports. 11/7/2024 32 5. Arguments in Favor of Protectionism Protecting Domestic National Security Infant Industry Preventing "Dumping Jobs Protectionism can help Argument Sometimes foreign Shielding local industries secure essential industries, Emerging industries may companies sell products at from international such as defence or initially lack the scale or very low prices (even competition can prevent agriculture, so that a country efficiency to compete below cost) to drive out job losses, particularly in is not overly dependent on internationally. domestic competitors, a industries that would imports for crucial goods. Protectionist measures practice known as struggle to compete with can give them the time dumping. Protectionist lower-cost foreign labor. and support needed to policies can prevent this, grow and eventually ensuring fair competition. compete globally. 11/7/2024 33 5. Criticisms of Protectionism Higher Prices for Reduced Efficiency and Retaliation and Trade Distorted Resource Consumers Innovation Wars Allocation By limiting cheaper Without competition, Protectionist policies can Protectionism can prevent imports, protectionism domestic industries may lack lead to retaliation from resources from flowing to can raise prices on goods, the incentive to innovate or other countries, escalating the most efficient forcing consumers to pay improve efficiency, into trade wars that harm producers, leading to less more for locally made potentially harming long- global trade and economic optimal economic products. term economic growth. stability. For example, if outcomes and slower one country imposes growth. tariffs, the affected country might respond with tariffs of its own, reducing overall trade. 11/7/2024 34 5. Imposition of a Tariff The US imposed tariffs of 25% on imported steel and 10% on imported aluminium in 2018, citing national security concerns and a desire to support domestic steel and aluminium producers. The tariffs made imported steel and aluminium more expensive for American consumers, reducing their demand for these imports and encouraging them to purchase from domestic producers instead. The implementation of a tariff increases the price from P w to P+t. At the higher price level, more domestic producers are able to supply the good and hence domestic production increases from Q1 to Q3. 11/7/2024 35 5. So, what is protectionism? Protectionism aims to protect domestic industries from foreign competition but can come at a cost to consumers, efficiency, and international relations. While it can provide short-term benefits, economists often argue that free trade leads to greater long- term benefits by encouraging competition, efficiency, and innovation. 11/7/2024 36  That’s all for today. Thank You, any questions? What’s next? 2024.11.14 14:40 - 16:10 Practice Subgroup 2 16:20 – 17:50 Practice Subgroup 1 11/7/2024 37