Globalization, Trade and Finance

1. Globalization, Trade and Finance Macroeconomics

2. Absolute and Comparative Advantage absolute advantage: when one country can use fewer resources to produce a good compared to another country; when a country is more productive compared to another country comparative advantage:when a country can produce a good at a lower cost in terms of other goods; or, when a country has a lower opportunity cost of production

3. Production Possibilities Frontier and Trade

4. Calculating Comparative and Absolute Advantage • To calculate absolute advantage, look at the larger of the numbers for each product. Which country can produce more? • To calculate comparative advantage, find the opportunity cost of producing one barrel of oil in both countries. The country with the lowest opportunity cost has the comparative advantage

5. Benefits of International Trade • workers with different characteristics can specialize in the types of production where they have a comparative advantage • firms and workers who specialize in a certain product become more productive with learning and practice • economies of scale • Promotes growth (International trade is about $20 Trillion) • Helps lower income countries more than wealthy countries • Increases total surplus

6. Specialization in the Value Chain Splitting up the value chain is when different elements of a finished good are produced in stages in different countries

7. Total Surplus and International Trade Free trade results in gains from trade. Total surplus increases in both countries. However, there are clear income distribution effects.

8. Distributional Effects Sugar consumers in Brazil and producers in the US are worse-off. Overall, both the United States and Brazil are better off than they would be without trade.

9. Trade Restrictions Trade restrictions are typically undertaken in an effort to protect companies and workers in the home economy from competition by foreign firms. A protectionist policy is one in which a country restricts the importation of goods and services produced in foreign countries

10. Consequences of Protectionism Protectionist policies imposed for a particular good: • reduce its supply • raise its price • reduce the equilibrium quantity

11. Types of Trade Restrictions • Tariffs: taxes that governments place on imported goods • import quotas: numerical limits on the quantity of products that can be imported • nontariff barriers: ways a nation can draw up rules, regulations, inspections, and paperwork to make it more costly or difficult to import products

12. Regional Trade • free trade agreement: economic agreement between countries to allow free trade between members • common market: economic agreement between countries to allow free trade in goods, services, labor, and financial capital between members while having a common external trade policy • economic union: economic agreement between countries to allow free trade between members, a common external trade policy, and coordinated monetary and fiscal policies

13. International Free Trade • General Agreement on Tariffs and Trade (GATT): forum in which nations could come together to negotiate reductions in tariffs and other barriers to trade; the precursor to the World Trade Organization • World Trade Organization (WTO): organization that seeks to negotiate reductions in barriers to trade and to adjudicate complaints about violations of international trade policy; successor to the General Agreement on Tariffs and Trade (GATT)

14. Currency Exchange Rates An exchange rate is the price of one currency in terms of another currency

15. Impact of Exchange Rates on:

16. How do Exchange Rates Affect International Trade? • Every nation would prefer a stable exchange rate to facilitate international trade and reduce the degree of risk and uncertainty in the economy. • A weaker exchange rate can stimulate aggregate demand and reduce a recession • A stronger exchange rate can fight inflation. • Rapid movements from a weak to a strong exchange rate may cripple export industries • Rapid movements from a strong to a weak exchange rate can cripple the banking sector In short, every choice of an exchange rate—whether it should be stronger or weaker, or fixed or changing—represents potential tradeoffs

17. Expectations of Future Value Drive Currency Markets

18. Demand and Supply in Foreign Exchange Markets

19. Exchange Rates and Balance of Trade A strong currency will increase imports and decrease exports which may lead to a trade deficit

20. What is a trade deficit? A trade deficit means that a nation is consuming beyond its income, in other words, it is borrowing from the rest of the world. This implies short term benefits and long term costs as those debts must repaid

21. Is this always a bad idea? • Borrowing to invest in the future, say for example by building railroads as the U.S. did in the late 1800s, raises the nation’s future GDP and enhances their ability to pay back their loans • Borrowing to raise the current standard of living or to allow citizens to retire early, as Greece did in the early 2000s, has the opposite effect

22. Globalization Globalization is the process by which the world, previously isolated through physical and technological distance, becomes increasingly interconnected. It is manifested by the increase in interaction between peoples around the world that involves the sharing of: • Ideas • Cultures • Goods and services (international trade) • Investment (international finance)

23. Fear of Globalization • “Race to the Bottom” loss of jobs and income • Loss of culture • Loss of national sovereignty

24. Practice Question In 2016 the United Kingdom voted to leave the European Union. Right wing parties in Europe are gaining ground on anti-EU platforms. Donald Trump won the electoral college to become the president of the United States on a protectionist platform. Using what you learned about international trade and globalization, how do you explain these trends?

25. Quick Review • What are comparative and absolute advantage? How are they calculated? • How does international trade affect a nation’s workers and consumers? • How do government trade regulations affect business, consumers and workers in the economy? • What are alternative international trade regimes and how do they impact global trade? • What are currency exchange rates? How do they influence trade balances? • How does the balance of trade (surplus or deficit) affect the domestic economy? How does the domestic economy affect the balance of trade? • How are globalization, international trade, and international finance connected?