Topics in International Development, Trade, and Culture

1. Topics in International Development, Trade, and Culture Scott Wentland

2. Introduction • ESC Clermont: International Week • About your instructor: • Visiting Professor of Economics, Longwood University • Longwood University is located in Farmville, Virginia, US • PhD in Economics from George Mason University • GMU is located in Fairfax, Virginia…just outside of Washington DC • GMU hosts an outstanding economics department, with two Nobel Prize winning economists. • Originally from Ohio, U.S.A. • Born and raised in Toledo, Ohio • Attended Miami University of Ohio for Bachelors & Masters

3. Day 1: Lecture Outline • World poverty & institutions • Why do some countries grow rich while others stay poor? • Why do we trade? • Specialization & Absolute Advantage • Theory of Comparative Advantage

4. Assessing World Poverty • Looking at the world’s economies, we tend to ask three common questions: • Why are some nations wealthy while others are poor? • Why are some nations getting wealthier faster than others? • Can anything be done to help poor nations become wealthy?

5. Assessing World Poverty • Three Key Facts • Everyone Used to Be Poor • GDP per Capita Today Varies Enormously among Nations • Growth Miracles and Growth Disasters: some countries’ economies have grown at incredible rates while others stagnate. • How do we explain this?

6. All Countries Were Poor…

7. Most of the World is Still Poor

8. Growth Miracles & Disasters • Two Growth Miracles • Japan: • annual rate of real growth1950-70 = 8.5% • South Korea: • annual rate of real growth1950-70 = 7.2% • Two Growth Disasters • Argentina • 1900: one of the richest countries in the world • Now: per capita real GDP is 1/3 that of the U.S. • Nigeria • Has barely grown since 1950 • Poorer now than it was in 1974

9. Miracles and Resources • Do these “growth miracles” simply have more resources? • What do economists mean by “resources”? • Labor, land, & natural resources • Physical capital: the stock of tools, structures, and equipment. • Human capital:is the productive knowledge and skills that workers acquire through education, training and experience. • Technological knowledge: knowledge about how the world works that is used to produce goods and services.

10. Miracles and Resources • A country’s amount of available resources only tells part of the story. • Why do some countries have more physical and human capital and use more advanced technology? • Why do some countries obtain greater output from the resources they have than others? • The answers lie in the institutions and incentives that countries adopt.

11. Institutions: A Natural Experiment • A natural experiment - North and South Korea • Before division after WWII • Shared the same people and culture. • Had similar levels of physical capital. • Had access to the same technology. • North Korea became a communist state with a centrally planned economy. • South Korea adopted a capitalist free market model. • The result 50 years later is dramatic as seen in the following photo from outer space.

12. The Korean Peninsula at Night

13. Institutions and Incentives • Institutions are the “rules of the game” that structure economic incentives. • Institutions of Economic Growth • Property rights • Honest government • Political stability • A dependable legal system • Competitive and open markets

14. Institutions • Property rights: the right to benefit from one’s effort. • Provide incentives to work hard. • If you can keep/sell what you make, then you will make more. • Encourage investment in physical and human capital. • Property rights are also important for encouraging technological innovation. • Without property rights: • Effort is divorced from payment → ↓incentive to work • Free riders become a problem

15. Institutions • Honest Government • Property rights are meaningless unless government guarantees property rights. • Corruption bleeds resources away from productive entrepreneurs. • Corruption takes resources away from more productive government activity. • Next is a list of the 10 most and the 10 least corrupt countries. Are you surprised to see who is or who isn’t on these lists?

18. Institutions • Political Stability • Changing governments without the rule of law results in uncertainty which leads to less investment in physical and human capital. • If you are uncertain whether the next government will allow you keep your property, then you will have less incentive to produce goods now. • In many nations civil war, military dictatorship, and anarchy have destroyed the institutions necessary for economic growth.

19. Institutions • Dependable Legal System • A good legal system facilitates contracts and protects property from others including government. • Is property really yours if there is no legal system to defend it? • Poorly protected property rights can result from too much government or too little government. • The legal system in some governments is so poor that no one knows who owns what. • Example: In India, residents who purchase land have to do so more than once because of lack of proper record keeping.

20. Institutions • Competitive and Open Markets • Encourage the efficient organization of resources. • About half the differences in per capita income across countries is explained by a failure to use capital efficiently. • Competition drives people to do more with the same resources. • Example: One study found that if India used its physical and human capital as efficiently as the U.S., India would be four times richer than it is today.

21. Institutions: Conclusions and Questions • “Growth miracles” had relatively good institutions • “Growth disasters” had relatively bad institutions • Economic growth would become more common if more countries changed their institutions. • Where do institutions come from? • Culture? • History? • Geography? • Luck? • Key research question in economics: Understanding institutions, where they come from and how they can be changed?

22. Open Markets and Trade • Why are open markets important for economic growth and prosperity? • Doesn’t trade hurt us? • Trade causes us to lose jobs from foreign competitors. • Why pay foreigners for doing something we can do ourselves? • So, how that make us richer?

23. Specialization • Trade allows us to specialize • Specialization allows us to focus on the work we do well. The people with whom we trade can focus on the work they do well. • Collectively, the world produces more and the world is more prosperous. • Above summarizes the main insights from Adam Smith’s theory of trade (sometimes called the Theory of Absolute Advantage)

24. Trade Example: Absolute Advantage • Economists like to simplify examples, while maintaining the essence of the point. Suppose we are thinking about: • Two countries • France • Italy • Two goods • Wine • Cheese • Assumption: the goods are of equal quality and basically the exact same products across countries.

25. Trade Example: Absolute Advantage • No trade (suppose each has 36 work hours/week) • Italy: 18 hours  (18*1 = ) 18 wine 18 hours  (18*4 = ) 72 cheese Total: 36 hours  18 wine, 72 cheese • France: 18 hours  (18*2 = ) 36 wine 18 hours  (18*3 = )54 cheese Total: 36 hours  36 wine, 54 cheese

26. Trade Example: Absolute Advantage • France is best at producing wine • France produces more wine per hour of work than Italy. • France has an absolute advantage in wine production. • Italy is best at producing cheese • Italy produces more cheese per hour of work than France. • Italy has an absolute advantage in cheese production

27. Specialization and Trade • Specialization (again each still has 36 work hours) • Italy: 36 hours  144 cheese • France: 36 hours  72 wine • Trade (exchange 2 cheese for every 1 wine) • Italy:36 wine, 72 cheese • France: 36 wine, 72 cheese

28. Comparing No Trade with Trade No Trade Trade • Italy: 18 hours  18 wine 18 hours  72 cheese Total: 36 hours  18 wine, 72 cheese • France: 18 hours  36 wine 18 hours  54 cheese Total: 36 hours  36 wine, 54 cheese • Italy: 36 hours  144 cheese • Exchange: 2 cheese for 1 wine • Total: 36 hours  36 wine, 72 cheese • France: 36 hours  72 wine • Exchange: 1 wine for 2 cheese Total: 36 hours  36 wine, 72 cheese

29. Benefits of Trade & Specialization • Specialization and Trade make you richer • Why?  You can focus your time on what you do best • Should we allow Italians to steal French cheese jobs? • Yes! If it means that the French people are free to focus on what they do well. In this case, it is wine production. • Result: BOTH COUNTRIES BENEFIT FROM TRADE • What if we are not the best at anything? • What if other countries are more productive and less costly?

30. Trade Example: Comparative Advantage • Theory of Comparative Advantage • David Ricardo, British economist (1772-1823) • He explained that a country being “the best” or “good” at producing something was irrelevant. Both sides can benefit from trade even if one side is better at producing everything. • How do we know? • We look at what economists call opportunity costs.

31. Trade Example: Comparative Advantage • No trade (suppose each has 36 work hours) • U.S.: 23 hours  184 wine 13 hours  54 cheese Total: 36 hours  184 wine, 54 cheese • France: 18 hours  18 wine 18 hours  54 cheese Total: 36 hours  18 wine, 54 cheese

32. Trade Example: Comparative Advantage • Now, France produces cheese relatively well • France has no absolute advantage in either good. • But, for every unit of cheese it produces, it only has to sacrifice 1/3 of a bottle of wine (United States has to sacrifice more wine (2) to produce cheese) • France has a low opportunity cost for producing cheese (i.e. they have to sacrifice less wine production to produce cheese than United States).

33. Trade Example: Comparative Advantage • Now, United States produces wine relatively well. • United States has an absolute advantage in both cheese and wine production • But, for every bottle of wine it produces, it only has to sacrifice ½ unit of cheese. (France has to sacrifice more cheese, 3, to produce wine) • United States has a low opportunity cost for producing wine (i.e. they have to sacrifice less cheese production to produce wine than France).

34. Specialization and Trade • Specialization (again each still has 36 work hours) • United States: 36 hours  288 wine • France: 36 hours  108 cheese • Trade (exchange 1 wine for every 1 cheese) • United States:234 wine, 54 cheese • France: 54 wine, 54 cheese

35. Comparing No Trade with Trade No Trade Trade • U.S.: 13 hours  184 wine 23 hours  54 cheese Total: 36 hours  184 wine, 54 cheese • France: 18 hours  18 wine 18 hours  54 cheese Total: 36 hours  18 wine, 54 cheese • U.S.: 36 hours  288 wine • Exchange: 1 wine for 1 cheese • Total: 36 hours  234 wine, 54 cheese • France: 36 hours  108 cheese • Exchange: 1 cheese for 1 wine Total: 36 hours  54 wine, 54 cheese

36. Comparative Advantage • Both countries are richer! • It did not matter that U.S. was more productive in everything (or, that they could produce more stuff with the same resources). • Important: France does do something relatively well. • Does David Beckham mow his own lawn? • What if Beckham was great at mowing lawns AND soccer? • Beckham pays someone to mow his lawn because each hour that he’s mowing his lawn, he’s not spending that time playing soccer. • His time spent as an athlete is relatively more valuable.

37. Comparative Advantage • Benefits from trade • Trade allows us to use our time wisely. Our time is better spent doing jobs we do relatively well. • If France produces cheese relatively well, then more cheese production means more wine (if we trade cheese for wine). • Why do we care about relative costs and not absolute costs? • When you produce something, it means your time is spent not doing something else. • When they trade together, France allows the US to produce what they produce relatively well. And, as a result, the US pays France more for their cheese (leaving France with more wine too)

38. Protectionist Pressures • If trade is so good, why are so many against it? • Losers • French vineyards (in our last example) • American and French autoworkers and other manufacturing employees lose jobs to foreign competition • People think all of the above “could be me” • What to do? • Organize and pass laws limiting trade? • Tariffs: a tax imposed on imported goods • Quotas: a limit on the quantity of a good that may be imported in a given period of time

39. Protectionist Pressures • Tariffs/quotas makes some people richer • French wine industry (in our example) • Manufacturing and other trade-sensitive industries • Domestic industries would have limited competition due to higher prices of imports • Makes everyone else (i.e. consumers) poorer • Consumers must pay higher prices for goods • End up with less overall • Do the losers outweigh the winners?

40. Protectionist Pressures • How do we know we’re poorer on net? • Production (deadweight) losses • Higher cost domestic producers are unnecessarily using resources • With trade, some industries wouldn’t be wasting resources...so we would be producing more with less • Consumption (deadweight) losses • People pay more for goods and services • But, many mutually advantageous trades are not made • Consumers receive less and have fewer choices

41. Globalization, Wealth, and Trade Scott Wentland

42. Globalization, Wealth, & Trade • What do economists mean by “globalization”? • Is it here to stay? • Do countries actually become wealthier from trade?

43. What is Globalization? • Competition or Cooperation? • We tend to associate globalization with the increase in international trade and commerce. • “Globalization is the advance of human cooperation across national boundaries.” • Intentions vs. ends • Do we intend to cooperate with one another? • How do we achieve cooperation without intending to cooperate?

44. I, Pencil • by Leonard Read (1958) • No single person makes a pencil • Largely unplanned • People follow prices

45. Increasingly Global • Globalization Figure 1.1 • Similar story for the U.S. & France

46. Always an Increasingly Global World? • No. Late 19th and early 20th centuries were quite globalized for their time • England & France traded more once they stopped warring • Adam Smith & David Ricardo helped too • Back to war • Between WWI & WWII trade declined rapidly • Hawley-Smoot (1930) tariff in the US  increased tariff to very high rates • The rest of the world responded by passing their own tariffs

47. Can Globalization Take a Step Back? • Understanding globalization and international economics is key. • Political rhetoric (particularly economic fallacies) has the potential to reverse globalization • How do we reverse globalization? • Encourage policies of self-sufficiency • Make foreign products more expensive and reduce trade.

48. Do We Really Want Globalization? • Yes. But why? • Globalization & trade makes us: • Wealthier • More reliant on others (Yes, this is actually a good thing…) • More diversified

49. Wealth & Trade • Very tight link between the wealth & (freer) trade • Openness  Wealth (Boudreaux’s Figure 2.1) • Trade Openness Index: • Most open = highest real incomes, highest growth • Least open = lowest real incomes, lowest growth (The graphs in the proceeding slides are from the book Globalization by Donald Boudreaux.