International Economics

1. International Economics Prof. Dr. Stefan Kooths BiTS Berlin(winter term 2014/2015) www.kooths.de/bits-ie

2. Contact data Prof. Dr. Stefan Kooths Deputy Head of the Forecasting Center Kiel Institute for the World Economy Office Berlin In den Ministergärten 8 10117 Berlin 030/2067-9664 stefan.kooths@bits-hochschule.de www.kooths.de

3. The Kiel Institute for the World Economy

4. Outline • Introduction and Overview • Recording Cross-border Economic Activity • The Pure Theory of International Trade • Trade Policy: Free Trade vs. Protectionism • Foreign Exchange Markets and the Open Macroeconomy • Case Study: The Euro Area Crisis • Summary: The Key Lessons Learnt

5. Outline • Introduction and Overview • Motivation, key questions, and methodology • Course scheme • Systemizing and Recording Cross-border Economic Activity • The Pure Theory of International Trade • Trade Policy: Free Trade vs. Protectionism • Foreign Exchange Markets and the Open Macroeconomy • Case Study: The Euro Area Crisis • Summary: The Key Lessons Learnt

6. Global production and international trade Average growth:GDP: 3.4 percent Trade: 5.6 percent

7. Drivers of Globalization (overview) • Liberalization of world trade • Liberalization of cross-border capital flows • Collapse of centrally-planned economies • Increased political/social stability • Improved transportation infrastructure • Progress in telecommunication systems/internet technologies • Creation of economic blocs (e.g. EEC/EU, NAFTA, MERCOSUR) • Spread of technological know-how via FDI • Better education for more people

8. Effects of Globalization (overview) • Generally: More choices (deeper markets) • More competition on world markets • Increased number of tradable goods and services • More alternatives for production sites (globally integrated value-added chains) • Accelerated structural change/more innovations(pressure on domestic labor markets) • Regulatory arbitrage, pressure on tax and transfer systems(less latitude for national policies) • Intensified international dependencies • Net gains, but domestic winners and losers (preview)

9. Why „International Economics“ is different (and why it is not) • Key economic questions (not specific to IE) • (International) division of labor • (International) allocation of production factors • Uniform microeconomic foundations and macroeconomic analysis • Country borders and the nation state • Factor mobility (labor, capital) • Legal frameworks, fiscal policy • National money and exchange rate systems

10. Economics:Analysis of economic activity (= coping with scarcities)

11. International Economics:Analysis of cross-border economic activity

12. BUT: Do country borders always matter?

13. Methodological individualism • General method • Individuals as point of departure for economic analysis • Explaining social processes via actions of involved persons • Individuals … • … are diverse • … have exogenous preferences • … are capable of acting on their own • … follow their vested interest • Subjectivism • Individual preferences • No scientific inter-subjective comparisons of utility

14. Key first insights from methodological individualism • Trade = exchange of goods or services • Two-sided human interaction (social cooperation) • Based on voluntary contracts (implies mutual benefits) • Net gains from trade for both parties (no zero-sum game) • Pitfalls from aggregation/collectivist perspectives • Countries do not trade with each other, only individuals/firms do • Countries do not compete with each other, only individuals/firms do • Competitiveness is a relative concept • Countries (economic areas) consist of multiple markets • Each market comprises both the supply side and the demand side • „Competitiveness“ not applicable to country level

15. Outline • Introduction and Overview • Motivation, key questions, and methodology • Course scheme • Recording Cross-border Economic Activity • The Pure Theory of International Trade • Trade Policy: Free Trade vs. Protectionism • Foreign Exchange Markets and the Open Macroeconomy • Case Study: The Euro Area Crisis • Summary: The Key Lessons Learnt

16. Reading • Literature • Dieckheuer, G. (2001): “InternationaleWirtschaftsbeziehungen”, 5. Aufl., München/Wien. • Eibner, W. (2006): “Understanding International Trade: Theory & Policy/AnwendungsorientierteAußenwirtschaft: Theorie & Politik”, OldenbourgVerlag: München/Wien. • Hazlitt, H. (2008): “Economics in One Lesson”, Ludwig von Mises Institute: Auburn/Alabama.[https://mises.org/books/economics_in_one_lesson_hazlitt.pdf] • Kooths, S. and B. van Roye (2012): “Euro Area: Single Currency – National Money Creation”, Kiel Working Papers, No. 1787, Kiel. • Pugel, T, A. (2012): “International Economics”, 15th Edition, McGraw-Hill: New York. • Snower, D., J. Boysen-Hogrefe, K.-J. Gern, H. Klodt, S. Kooths, C.-F. Laaser, C. Reicher, B. van Roye, J. Scheide and K. Schrader (2013): “The Kiel Policy Package to Address the Crisis in the Euro Area”, Kiel Policy Brief, No. 58a, Kiel. • Course website: www.kooths-de/bits-ie

17. Outline • Introduction and Overview • Recording Cross-border Economic Activity • The Balance of Payments (BoP) • The International Investment Position (IIP) • The Pure Theory of International Trade • Trade Policy: Free Trade vs. Protectionism • Foreign Exchange Markets and the Open Macroeconomy • Case Study: The Euro Area Crisis • Summary: The Key Lessons Learnt

18. Types of cross-border transactions CURRENT ACCOUNT • Trade flows • Goods (merchandise) • Services • Cross-border incomes(compensation for use of production factors) • Labor: Compensation of employees • Capital: Investment income • Transfers • Current transfers (regularly) • Capital transfers (one-off) • Financial transactions • Nonofficial: Direct/Portfolio/Other investment • Central bank: Changes in official international reserves CAPITAL AND FINANCIAL ACCOUNT

19. Accounting principles:Credit and debit items (double-entry bookkeeping) • Credit item (measured with a positive sign/entry on the left side) … • … results from a transaction for which the country must be paid. It sets up the basis for a payment by a foreigner into the country – that is, it creates a monetary claim on a foreigner. • Debit item(measures with a negative sign/entry on the right side) … • … results from a transaction for which the country must pay. It sets up the basis for a payment by the country to a foreigner – that is, it creates a monetary liability against a foreigner. • Double-entry system(sum of all credit entries = sum of all debit entries) • BUT: Statistical discrepancies („errors and omissions“)

20. Valuation: cif vs. fob

21. Key “Balance of Payments” concepts • Flow-oriented framework for cross-border transactions • Specific time period (year, quarter, month) • NOT: Stocks (“balance sheet”) • Time of recording • Accrual principle • NOT: Actual Payment • People • Residents vs. Non-Residents • NOT: Nationals vs. foreigners (nationality does not matter) • Focus: Reporting country vs. RoW (= rest of the world)

22. The consolidated BoP account

23. Current account vs. Capital and financial account

24. More detailed BoP subaccounts

25. The detailed BoP structure (IMF BoP Manual) • IMF Balance of Payments Manualhttp://www.imf.org/external/pubs/ft/bopman/bopman.pdf

26. Official reserve assets and the role of the central bank

27. Real-life BoPs Statistical Discrepancies = Net Errors and Omissions = Balance on Unclassified Transactions

28. Example: US Balance of Payments (2010, $ billions)

29. Interpreting BoP balances (BoP and National Accounts) • Goods and services balance / trade balance (NX) • Net exports of both goods and services • Current account balance (CA) • Net credits on the flows of goods, services, income, current transfers • Financial account balance, exl. official reserves (FA) • Net credits involving changes in nonofficial foreign financial assets and liabilities • Overall balance / official settlements balance (B) • Current account balance + (nonofficial) financial account balance [+ statistical discrepancy] = Increase of official reserve assets • Link to National Accounts • NX  GDP • CA  GNI • CA + net capital transfers  Net external lending

30. Does a trade deficit reduce GDP?

31. Accounting exercise (Reporting country: USA) • At the end of the year, Northern Illinois (a U.S. utility company) buys $34 million in natural gas from a Canadian firm. It does not pay in cash immediately, but instead issues a promissory note saying it will pay the bill (plus interest that will accrue over time) one year later. • Brazilian soccer fans spend $6 million as tourists in the U. S. during a soccer tournament, and they pay for their hotels, meals, and transportation by using the deposits that they have at a New York bank. • The U.S. Treasury pays $25 million in interest on its past borrowing from Swiss investors, paying with checks on a New York bank. • The U.S. monetary authority (Fed) in its official role becomes concerned that the exchange rate value of the dollar may appreciate against the Japanese yen. It decides to purchase yen-denominated bank deposits from a major Tokyo bank and pay by transferring $15 million of its New York bank deposits to this Tokyo bank. • The U.S. government gives $8 million in foreign aid to the government of Egypt in the form of wheat from U.S. government stockpiles. • Mexican immigrant workers in the U.S. send $2 million from their bank accounts at a Phoenix-based bank as remittances to their families in Mexico.

32. Outline • Introduction and Overview • Recording Cross-border Economic Activity • The Balance of Payments (BoP) • The International Investment Position (IIP) • The Pure Theory of International Trade • Trade Policy: Free Trade vs. Protectionism • Foreign Exchange Markets and the Open Macroeconomy • Case Study: The Euro Area Crisis • Summary: The Key Lessons Learnt

33. Linking BoP and IIP • Stocks (IIP) vs. flows (BoP • Transaction-based flows vs. revaluations of stocks

34. Germany: Current account, capital transfers, and IIP

35. Outline • Introduction and Overview • Recording Cross-border Economic Activity • The Pure Theory of International Trade • General analysis of cross-border trade • Reasons for inter-industry trade:Absolute and comparative advantage • Causes and consequences of cost differences:The role of factor endowments and factor proportions • “Imperfect” competition and intra-industry trade • Trade Policy: Free Trade vs. Protectionism • Foreign Exchange Markets and the Open Macroeconomy • Case Study: The Euro Area Crisis • Summary: The Key Lessons Learnt

36. Four basic questions about cross-border trade • Causes:What determines which products are exported and imported? • Impact:How does trade affect production and consumption in each country? • National gains:How does trade affect the economic well-being of each country? • Intra-national winners and losers :How does trade affect the distribution of economic well-being among various groups within a country?

37. Categories of trade • Non-availability (trade in commodities) • Inter-industry trade (specialization) • Intra-industry trade

38. Product markets: General assumptions, demand and supply, consumer and producer surplus, elasticities

39. Opening of trade: National and international markets

40. Arbitrage and free-trade equilibrium

41. Terms of trade

42. Four basic answers to trade

43. Outline • Introduction and Overview • Recording Cross-border Economic Activity • The Pure Theory of International Trade • General analysis of cross-border trade • Reasons for inter-industry trade:Absolute and comparative advantage • Causes and consequences of cost differences:The role of factor endowments and factor proportions • “Imperfect” competition and intra-industry trade • Trade Policy: Free Trade vs. Protectionism • Foreign Exchange Markets and the Open Macroeconomy • Case Study: The Euro Area Crisis • Summary: The Key Lessons Learnt

44. Adam Smith: Theory of absolute advantage • Maximum number of working hours: 10 (millions, billions, …) • Production and consumption possibilities without trade(self-sufficiency)? • Consumption possibilities with trade and specialization(division of labor)? Adam Smith (1723—1790) An Inquiry into the Nature and Causesof the Wealth of Nations, 1776

45. David Ricardo:Opportunity cost and theorem of comparative advantage • Maximum number of working hours: 10 (millions, billions, …) • Production and consumption possibilities without trade(self-sufficiency)? • Any chance for mutually beneficial trade (division of labor)? David Ricardo (1772—1823) On the Principles of Political Economy and Taxation, 1817

46. Production-possibility curve

47. Exchange rate and terms of trade

48. Mercantilism and unbalanced trade

49. Complete vs. incomplete specialization: Constant vs. increasing marginal cost

50. Production conditions, preferences and trade patterns