Trade, Economic Growth, and Fiscal Policy PDF

Trade, Economic Growth, Economic Development and Fiscal Policy Why Should Engineers Care? Abid Nahiyan Alam November 21, 2023 1 / 23 Content 1. Overvie...

Trade, Economic Growth, Economic Development and Fiscal Policy Why Should Engineers Care? Abid Nahiyan Alam November 21, 2023 1 / 23 Content 1. Overview 2. Economic Models of Trade 3. Why do Countries Trade? 4. Trade Barriers 5. Interesting Cases 6. Economic Growth 7. Fiscal Policy 8. Economic Development 2 / 23 Overview Now that we have some knowledge about how markets work, and what the different kinds of market are. It is a clear natural step forward to talk about international trade. Instead of individuals or firms, we can now think about countries who act like buyers or sellers. So what is international trade? Why do countries engage in trade with each other? What fosters international trade? What are trade barriers? Why should I care as an engineer? These are some of the questions we will try to answer today. 3 / 23 Production Possibility Frontier The Production Possibility Frontier (PPF) is a graphical representation of all the possible quantities (of two goods) that can be produced by a country given the resources that are available. It represents the opportunity cost of producing one good against the alternative. Points on the curve are efficient, points outside the curve are not attainable, and points inside are inefficient. 4 / 23 Production Function and Returns to Scale A production function, is a function that demonstrates the relationship between inputs and and outputs. An example of a very common production function is: 1 1 Y = L4 K 4 Here L refers to labor, K refers to capital, and Y refers to output. Can any of you tell me what happens to the output if I change both of the inputs at the same proportion for this particular production function? - Homogeneity Increasing Returns to Scale: it is a situation when increasing your inputs, leads to a more than proportional increase in output. Homogenenous of Degree (HOD) > 1. Constant Returns to Scale: it is when you increase inputs, and the output increases at the same proportion. HOD = 1 Decreasing Returns to Scale: it is when you increase your inputs, but your output increases by less than the proportion of increase, HOD < 1 5 / 23 Other Relevant Definitions Specialization: it is when an individual/entity/country focuses on producing one thing, or focuses on a particular task, and in doing so, gets better at it. It leads to increased efficiency and higher productivity. Comparative Advantage: It is a situation where an individual/entity/country can produce something at a lower opportunity cost compared to others. In the context of trade, we think about countries, who can produce a specific unit of output at a lower opportunity cost compared to others. It is basically what you do best, while giving up the least. Absolute Advantage: it is the ability of an individual/entity/country to produce more of some good/service using the same amount of inputs compared to a another. 6 / 23 A Bit More GDP or gross domestic product is the total value of all the final goods and services produced within the geographical area of a particular country within a given period of time. GNP or gross national product is the total value of all goods and services produced by the citizens of a particular country. How is GDP important? Why do we keep hearing about this? Is it related to national income? If so, how? Is the measure perfect? Can you find any flaws in the way it is defined? 7 / 23 Modelling International Trade International trade is the trade of goods and services between countries. Exports are the goods and services that a country sells to other countries.They add to the national income of a country. Imports are the goods and services that a country buys from another country. They add to the national expenditure of a country. When a country’s exports are greater than imports, then the country has a trade surplus, with more money coming into the country, than that is leaving. When a country’s imports are greater than exports, then the country has a trade deficit, with more money leaving the country, than that is coming into the country. 8 / 23 Models of international Trade There are many reasons that explain why a country engages in international trade, and thus, there are many economic models of trade which exist. Basic Ricardian Trade Model: usually a 2 country, 2 good model. Focuses on comparative advantage which arises due to differences in technology or natural resources. Hecksher-Ohlin Model: explains international trade is determined by differences in factor endowments. The basic idea is that a country will export goods that use a factor that it is generously endowed with intensively. Trade may be caused because of increasing returns to scale. Gravity models of trade explain international trade by the distance between countries and the realtive size of their economies 9 / 23 Trade Barriers Tariffs: these are taxes imposed by a government on goods imported from a foreign country. The arguments that support tariffs include - protection of domestic industries, increased revenue for the government, etc. Quotas: these are restrictions on the amount of a good or service that can be imported from a foreign country. Subsidies: when a country subsidies export-oriented industries to make them more competitive in the international market. Embargo: A complete or partial limit on trade with another country. Currency Devaluation: When a country intentionally devalues its currency to make its exports more appealing to foreign buyers, and imports from other countries less appealing to domestic buyers. 10 / 23 Are Trade Barriers Good? International trade allows consumers to enjoy commodities that they may not have able to in absence of trade. International trade can also allow consumers to enjoy goods and services at a lower price compared to what they would be able to without trade. However, trade can also be detrimental to new industries, and overall innovation in a country. So why do countries engage in protectionism? What are the arguments for and against protectionism? Is free trade the best solution? What are trade unions? Is EU a trade union? What about NAFTA? 11 / 23 United States and China China is one of the biggest trading partners of the USA and roughly $700 billion dollars worth of goods and services are exchanged each year, However, it is widely known that the value of US imports from China are far greater than the value of US exports. As such, can the US impose trade restrictions to improve the situation? That is precisely what the US administration may have thought. What happened afterwards? Did US companies suffer? Did US consumers suffer? What is a better approach? 12 / 23 Economic Growth Economic Growth is an increase in the production possibilities of an economy, which is followed by an increase in the quantity of goods and services produced in the economy. It is often measured as an increase in GDP per capita. GDP GDP Per Capita = Population Economic growth leads to an increase in the consumption of goods and services. The increase in both production and consumption is often of higher quality. 13 / 23 Economic Growth There are many kinds of growth models in economics: classical, neoclassical growth model, and endogenous growth models to name a few. Measuring economic growth is difficult, and GDP per capita is not a perfect measure. Why is that the case? Can anyone tell me the problems we discussed about GDP as a measure? Or about measuring GDP itself? Economic growth rates are used as an indicator to look at how fast a country is growing. Traditionally it was believed that developing countries grow at a faster rate, and can eventually catch up with developed countries. Do we see this in practice? Why? 14 / 23 Economic Growth Economic growth, however important, does not give us the full picture. Economic growth neglects important factors such as health, environmental quality, education, and other factors which are important for quality of life. Some of these factors include freedom of speech, institutions, crime rates, corruption, etc. For example, an increase in the production of electricity will contribute towards economic growth, regardless of whether it was generated in a clean way, or it polluted the environment in the production process. Therefore, measures such as the UN’s Development Index provides weights to life expectancy, education, and GDP per capita (instead of just economic growth). Moreover the benefits of economic growth are unevenly distributed. A country can experience very high levels of growth, yet the benefits may be felt much more acutely by only some segments of the population. → Trickle Down? So, can we find a better measure? 15 / 23 Aggregate Demand Aggregate demand in the most basic sense, is the total demand for final goods and services in an economy over a period of time. As such, it is also an indicator/measure of national income. It can be expressed as: Y = C + I + G + (X − M) Where C denotes consumption. I denotes investment. G denotes government expenditure. X denotes exports. M denotes imports. 16 / 23 Components of Aggregate Demand Consumption: it is the amount of money individuals spend on goods/services in the entire economy. What drives consumption? → disposable income (income after taxation)? Investment: it is the amount of money dedicated to acquiring assets, capital or in hopes of getting a return from a venture. What drives investment? → incentives (like what)? Government Expenditure: it is the amount of money the government spends in the economy. Increasing this boost or expand many different sections/sectors of the economy. → Subsidies? Transfers? Exports: the total amount of goods/services that are sold to consumers in foreign countries. It is considered an income for the domestic economy. What can boost exports? → Subsidies? Lower taxes? Incentives? Imports: the total amount of foreign goods bought by domestic consumers. Considered an expenditure for the economy. What can be done to reduce this? → Incentives? 17 / 23 Fiscal policy Economic growth can be achieved through boosting aggregate demand. Such policies are known as expansionary policies. Suppose that inflationary pressures are not severe in the economy. How can we use expansionary Fiscal Policy to achieve economic growth? Fiscal policy is the deliberate manipulation of government expenditure and taxation to achieve desired economic objectives. In order to do so, we need to understand how each of the tools of fiscal policy (taxation and government expenditure) can impact the components of aggregate demand. Let us have a look. 18 / 23 Expansionary Fiscal Policy - Economic Growth Increase Consumption – Consumption has a positive impact, so the goal is to increase consumption. But how can we do this? → increase government expenditure in terms of transfers to consumers and reduce the tax burden on consumers to increase the amount of disposable income people have. All else equal, this can boost consumption. Other examples? Increase Investment → increase government expenditure in terms of subsidies, to make investing more profitable for individuals, reduce tax rates to let individuals keep more of their investment earnings to boost incentives to invest. Other examples? Increase Government Expenditure → this has a direct effect. How so? Increase exports → provide subsidies and tax breaks to export oriented firms to provide incentives for them to produce more, and to be able to offer their products at a more competitive price in the international market. What about imports? 19 / 23 Other Effects? All else remaining equal, the equal, expansionary fiscal policy can lead to an increase in aggregate demand, and thus, can lead to an increase in economic growth. However, we know that the economy is dynamic, and things can have cascading effects. What are some of the other effects that can be caused by such policies? what happens to inflation in the economy? What happens to unemployment levels? Let us have a look. 20 / 23 Other Effects Inflation: expansionary fiscal policy can increase inflationary pressure. This is because as we saw in the aggregate demand and aggregate supply diagram, depending on where the economy is, there can be an increase in the price level (to various degrees). This can be especially acute in the short run, if other measures are not taken, and thus, it can be a cost of achieving economic growth. Unemployment: generally such policies, can lead to a fall in the unemployment rate. How so? → in a nutshell, if more is produced, more labor is needed. But is this always the case? What if production in the economy is mainly capital intensive (uses technology/machinery more)? Or investment is in labor reducing technology? Also, what if the economy does not have enough labor to begin with? → this would lead to an increase in the wage rate, and thus, mitigate some of the effects of the policy which were intended to reduce production costs. What about the environment? → If such policies are implemented without supporting regulation (that considers the environment), then it can be the case that this leads to an increase in pollution, and have a negative impact on the environment. 21 / 23 Economic Development Clearly economic growth is not the end all be all, and it does not paint a full picture. Economic development is the process by which the well-being, quality of life, and opportunities available to individuals gradually improves over time It is based on achieving targeted goals and objectives that go beyond just increasing economic output. One way to look at it is an expansion of human capabilities. Economic development in concerned with improving literacy rates, life expectancy, and reducing poverty rates among others. It is fundamentally different from economic growth as it is much more multi dimensional. It does not rely on “trickle down” ideas, and requires the implementation of specific policies that tend to different goals. 22 / 23 Thank you! Thank you for your attention. 23 / 23