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The World Economy: Trade and Finance by Yarbrough & Yarbrough
Chapter One Introduction to The World Economy
1. Why study International Economic Issues? 2. International Interdependence and the Economic significance of political boundaries 3. Studying International Economics Chapter One Outline
Introduction • International Economic Issues • World Trade Organization (WTO) • Emerged as an international forum for trade discussions and conflict resolution. • North American Free Trade Agreement (NAFTA) • Trade bloc created in 1995 for USA, Canada, and Mexico. • Trade conflicts & upheavals continue • U.S./Japan (photo supplies) • U.S./European union “Banana War) • Asian financial crisis
Introduction • International Finance • The world’s stock markets have grown rapidly; and development of New technologies allowing fast transfer of funds. • Currencies • Most EU countries adopted common currency — the Euro.
Why Study International Economics? • More important than ever before. • Allows us to fully comprehend statements about international economic policies; evaluation of the influences on specific industries or companies, and analysis of the linkages between nations of the world. • Most top macroeconomic policy makers of the industrialized world have economic backgrounds.
International Interdependence • Rapid Increase in the volume of trade: • Demonstrated by effects of oil price increases during the 1970s. • In the early 1980s, oil prices declined in response to a policy-induced recession in the developed world.
Growth in World Merchandise Trade & Output, 1950-2000 (Percent) 12 10 8 6 4 2 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 World merchandise exports World merchandise output
Growth in World Merchandise Trade & Output, 1950-2000 (Percent) Trade 12 Output 10 8 6 4 2 1950-63 1963-73 1973-90 1990-2000
International Interdependence • Production Fragmentation has made it difficult to distinguish a product’s “nationality.” • John Deere tractors built in Japan…Komatsu builds in Illinois. • The Ford Escort is assembled in Germany. • Toyotas are built in Kentucky
International Interdependence • Increasing involvement of developing countries in the world economy. • Many nations attempted to isolate themselves for many years (China, Brazil, and India) • This trend is producing new patterns of international interdependence. For example, manufacturers produce in countries with lower wages.
See Figure 1.2 International Interdependence • Increased Interdependence in financial markets. • Has grown faster than that in markets for oil, steel, and cars. • 24-hour global trading in stocks, currencies, and bonds. • Over $1.5 trillion in currencies traded daily.
Daily Turnover in Foreign Exchange Markets, 1986-2001 1.75 $ Trillions 1.50 1.25 1.00 0.75 0.50 0.25 0 2001 1986 1989 1992 1995 1998 Year
International Interdependence • Increased opportunities for international investment (FDI). • Lenders fund projects regardless of the projects’ locations. • And the growth of global trade is resulting in a declines in the costs of transportation and communication.
Transport and Communication Cost, 1930-1990 (Index 1930 = 100) Index (1930 = 100) Average ocean freight and port charges per short ton of cargo 120 Average air-transport cost per passenger mile 100 80 Cost of a 3-minute phone call from New York to London 60 40 20 0 Year 1930 1940 1950 1960 1970 1980 1990
International Interdependence • Political Implications • Policy makers need to understand that their decisions in antitrust matters, regulations, and taxes have international ramifications.
International Interdependence • Despite Increased flow of goods and financial services, countries continue to differ significantly in the extent to which they engage in cross border trade. • Large countries like the U.S. tend to engage in less trade (as % of production), than do smaller ones. • E.g., The next Figure shows a marked increase in the U.S.’s global trade in recent years (yet it remains relatively small when compared to the GDP).
International Interdependence • Despite Increased flow of goods and financial services, countries continue to differ significantly in the extent to which they engage in cross border trade. • Large countries like the U.S. tend to engage in less trade (as % of production), than do smaller ones. • The figure shows marked increase in the U.S.’s global trade in recent years (yet it remains relatively small when compared to the GDP). • Reason? • The domestic markets can efficiently satisfy many needs.
International Interdependence • Global trade tends to cluster with certain trading partners. Why? • One reason…lower transportation costs; the other being regional integration.
International Interdependence • Synchronized changes in macroeconomic activity across countries. • Tendency toward simultaneous booms and recessions. • Cautionary note: perhaps mere coincidence produced these patterns.
Economic Significance of Political Boundaries • Major popular misconception about global trade policy is that policy choices pit the interests of one country against those of the other. • However, trade policy choices rarely take this form. • If U.S. steel producers win protection against Korean producers, then U.S. steel consumers (i.e., auto makers or car buyers) pay higher prices.
Economic Significance of Political Boundaries 2. Most economic transactions between individuals or companies from different U.S. states face a smaller set of barriers than those between a U.S. resident or company and that of a foreign country.
Studying International Economics • International economics has two parts: (I) International trade (theory): Extends microeconomic analysis to global questions. • Example: goods and services available to consumers are maximized when each country specializes in producing those goods that it can produce relatively efficiently.
Studying International Economics (II) International finance, balance-of-payments theory, or open-economy macroeconomics. • Applies macroeconomic analysis to aggregate international problems. • Level of employment and output • Changes in price level, balance of payments, and exchange rates (relative prices of different national currencies). • Interaction of international goals and influences with domestic ones in determining a nation’s macroeconomic performance and policy.
Studying International Economics • Does trade do less harm than good to residents of a country? • Two approaches to answer this
Studying International Economics • Normative Analysis: a judgment of what is and isn’t desirable. • If we think that trade is desirable because it maximizes the quantity of goods and services available to consumers, we might conclude that Japanese policy makers should pursue open trade policies in agriculture, even though their farmers strongly oppose them.
Studying International Economics • Positive Analysis: describe the way the world economy works in a simplified way. • Focus on explanation and prediction • “If event X happens, then event Y will follow.” • However, there may be disagreement about the way the world works. • One individual may think that “if event X happens, then event Z will follow.”