session 1 intro & comp adv (1)

8/6/2019 Session 1 Intro & Comp Adv (1)

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1

Comparative AdvantageInternational Trade Session 1

Daniel TRAA


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Globalization I:Increased trade in goods and services

Trade has grown faster than GDP

10

15

20

25

30

35

40

1980 1985 1990 1995

Trade(%G

DP)

World High income Low & middle income

mostly for East Asia; it has fallen for Africa

0

15

30

45

E-Asia &

Pac.

Lat. Am. &

Carib.

Mid East, N

Af

South Asia Sub-S.

Africa

Exports(%G

DP)

1960 1970 1980 1990 1998

International Trade involves mostly exchanges among high income

countries.

Developing countries have increased their relevance, particularly East

Asia, but are still a small part.


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Trade in services andmerchandise

Most of world trade is ingoods (merchandise) 82%.

Services trail behind, butare the fastest growingcomponent.

Outsourcing is the latesttrend

Share of goods and commercial services in total trade

(Percentages, based on balance of payments data)

Export Shares Import Shares

Goods CommercialServices

Goods CommercialServices

World 81.4 18.6 81.4 18.6

North America 77.2 22.8 85.9 14.1

Latin America 86.0 14.0 84.1 15.9

Western Europe 78.8 21.2 79.4 20.6

Africa 81.5 18.5 76.8 23.2

Egypt 42.5 57.8 68.2 31.8

Nigeria 93.8 6.2 71.1 28.9

Asia 85.7 14.3 81.3 18.7

India 71.4 28.6 73.4 26.6

Indonesia 92.8 7.2 72.3 27.7

Japan 87.1 12.9 74.8 25.2


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Globalization II:Foreign Investment - complexstrategies of multinationals

Global FDI Flows 2000 1995 1990 1985 1980 1975 1970

FDI in millions of dollars 1,270,764 331,068 202,297 56,583 54,725 25,850 12,542

FDI per capita (dollars) 210.3 58.8 41.4 12.8 13.6 9.8 5.3

FDI as percentage of GDP 3.12 1.13 0.96 0.48 0.52 0.49 0.48

FDI as percentage of exports 19.99 6.45 6.05 3.10 2.95 3.33 4.56

Gross foreign direct investment (% of GD

0

2

4

6

8

1976 1981 1986 1991 1996

World High income Low & middle incom

Share of FDI flows, by grou

0%

25%

50%

75%

100%

1980 1985 1990 1995

Low income

Middle income

High income


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Drivers of Modern Globalization

Lower transport and

communication costs

Development of international

institutions

The WTO

Regional Trade Agreements

Political decisions toward de-

regulation and liberalization oftrade and FDI regulations


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Theory and practice of internationaltrade and foreign investmentWHAT WE WILL LEARN

Why do countries export certain goods and imports others?

What do countries and populations gain and loose from trade?

Why do multinationals exist and what are their effects?

Why do governments protect their industries and what are the

costs and benefits?

What are the effects of different protectionist instruments?

How do the institutions that regulate global trade work?

What have been the economic and social consequences of the rise

in trade and foreign investment with developing nations?

What has globalization brought to developing countries?


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Organization of the course

Theories of international trade

Comparative advantage

Gains from trade: static anddynamic

Losers and winners

Trade policy

Policy Instruments

The case for free-trade and

exceptions

Policies for Strategic sectors

Political economy and therealist view

The effects of modernglobalization

Trade and thedeveloping countries

Multinationals and FDI The effects in

industrialized countries

Institutions of global

trade The W.T.O

Regional agreements


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Materials and exams

course website: www.danieltraca.com

Download class slides before class from website

Also available at GES

Practice exams and answer keys available at website.List of required sections available from website

Recommended textbook

International Economics, 7th edby Krugman P. and Obstfeld M., Addison-Wesley

Available in French

Additional readings available at website
http://www.danieltraca.com/http://www.danieltraca.com/


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The theory of ComparativeAdvantage


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Absolute Advantage

It is the maxim of every prudent master ofthe family, never attempt to make at homewhat it will cost him more to make than buy What is prudent in the conduct of every familycan scarce be folly in that of a great kingdomIf a foreign country can supply us with acommodity cheaper than we ourselves canmake it, better buy it of them

Adam Smith 1776


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Absolute Advantage

Output per worker(productivity)

93SOUTH

810NORTH

Food(bushels)

Manufacturing(pieces)


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Gains from specialization

Output

before after

1 northerner(FOOD toMANUF)

8 Food 10 Manuf

1 southerner

(MANUF toFOOD)

3 Manuf 9 Food

North specializes inManufacturing and South inFood

There is more of bothgoods, if specializationfollows absolute advantage


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Comparative Advantage

"A country enabled to manufacturecommodities with much less labour thather neighbours may, in return for suchcommodities, import a fraction of the cornrequired for its consumption, even if

corn could be grown with much less labourthan in the country from which it wasimported."

David Ricardo


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Output per worker(Productivity)

Manuf

(pieces)

Food

(bushels)

NORTH 10 10

SOUTH 3 9

Comparative AdvantageNorth is MORE productive in both goods


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Even so, there are gains fromspecialization

2 x 918 Food

2 x 36

Manuf

2 southerners(Manuf toFood)

10Manuf

10Food

1 northerner(Food toManuf)

afterbefore

Output A country hasComparative Advantagein a given good if itsrelative productivity in

that good is higher than inother goods

Specialization according

to ComparativeAdvantage createsvalue, by increasingoutput.


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How does the market work?

Does the decentralized international market achieve this patternof specialization? How?

Who benefits and who looses from international trade in the free-

market? Among individuals within a country?

Among countries?


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In Autarky...

Food

Manuf

North

Northern workerThey work in bothsectors, and tradeamong them at theautarky relative

price

The relative price

P=pManuf /pFoodIn equilibrium,workers must beindifferent betweenthe two sectors.They must get thesame wage

South


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The prices in autarky (closedeconomy)

The relative price of Manuf (P) denotes how manybushels of Food for one piece of Manuf.

9

10

Food(bushels)

9/3 = 33SOUTH

10/10 = 110NORTH

PManuf

(pieces)


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Relative prices, relative supply,relative demand

1

Manuf/Agro

Relative demand (RDW)It is the same in both countries

if preferences are the same

P

Relative Supply(RSN)NorthPN=

3Relative Supply (RSs)SouthPS=

[Manuf/Agro]S [Manuf/Agro]N


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In Autarky...

Food

Manuf

North

Northern worker Southern worker

The Northernerstrade amongthem at theautarky price PN= 1

Food

Manuf

South

The Southerners

trade amongthem at theautarky price PS=3


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Wages and productivity

Are the wages the same in both sectors? Why? If not, where are they higher? Why?

Are they the same in both countries? Why? If not, where are they higher? Why?


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The Production PossibilityFrontier and Welfare

NorthManuf

+1

-1

UN

10

10 Agro

The choice of consumersdetermines the allocation of labor

MRS=MUFood / MUManuf = 1/P =1

Production

Possibility

Frontier

-1/PN = -1

Equilibrium P=1,

So that both

goods are

produced

Slope =

-ProdF / ProdM

Northern

Workers in

Agro

N

orthernW

orkers

inManuf


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The beginnings of Trade

Manuf is relatively cheaper in the North. An enterprising Northerner takes 1 Manuf to the South

and exchange it for 3 Foods.

Back in the North, she could sell 1 Foods for 1 Manufwith a net gain of 1 Food.

There are gains from exchange because pricesare different: Trade occurs!

What happens to the relative price of Manuf in North? And in the South?


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Openness in the Short Run...

Food Food

Manuf Manuf

1 . Trade

starts due to

arbitrage

2 . Prices adjust to

new scarcityP rises in the North and

falls in the South

SouthNorth

PS < 9/3PN >10/10


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In the Long-Run, there is re-allocation

Food Food

Manuf Manuf

North SouthEach country specializes

completely in, and exports,the good in which it hascomparative advantage

There is one worldprice, which is between

the initial prices10/10 < PW 10/10

3 . Factors (workers) respond to new prices and profitability -- specialization


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In the Long-Run, there is re-allocation

Food Food

Manuf Manuf

North SouthEach country specializes

completely in, and exports,the good in which it hascomparative advantage

There is one worldprice, which is between

the initial prices10/10 < PW 10/10

3 . Factors (workers) respond to new prices and profitability -- specialization


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How to determine the worldprice?

1

3

Manuf/Food

Relative Supply (RSW)World

South produces Food only

North produces both

North produces Manuf only

South produces both

NorthandSo

uthspecialize

completely

NorthandSo

uthprod

uce

onlyManuf

North and

South

produce

only Food

Relative Demand (RDW)World

1


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The Gains from Trade accordingto Comparative Advantage

North South

10

10 Food

Manuf

Food

Manuf

9

3

UN

US

PN=1

PS=3

US(Food)

UN(Manuf)

1


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The Gains from Trade accordingto Comparative Advantage

North South

10

10 Food

Manuf

Food

Manuf

9

3

UN

US

PN=1

PS=3

US(Food)

UN(Manuf)

1


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Some unrealistic features of themodel, so far

What if there are transport costs?

What if there are more than two goods?

What if factors cannot adjust to other sectors?

What if there are more than one factor?

Why is there always complete specialization?


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Transport Costs and Non-tradedgoods

If there are transport costs, the competitiveness edge of a

country must more than make up for this transport cost.

Otherwise, the good will not be traded, even if it is cheaperto produce in one country. This good is called non-tradable.

In reality, economies spend large proportions of their income in

these type of goods.

It can become tradable, if transport costs fall or the

productivity advantages widen (globalization).


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Global markets vs. local marketsTRADABLES and NON-TRADABLES

Tradable goods can travelacross borders and haveinternational markets that setprices.

Non-tradable goods have their

prices set by supply anddemand in local markets. Often, the same good exists in

different countries because itis produced locally.

With globalization, manygoods and services havebecome tradable.

Consulting

Banking Telecoms

Tourism

Hairdressers

Government

services Auto-repair

Almost allservices

Services

Textiles

Machinery

Almost allgoods

Cement

Housing

McDonaldsHamburger

Goods

TradablesNon-

tradables


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Summary

Comparative advantage: Consumers react to price differences and buy from lower

price foreign producers the goods in which their countrydoes not have comparative advantage (gains from

exchange). Producers react to price differences and allocate

resources to industries where relative productivity ishigher, exporting those goods (gains from specialization).

Every country always has an industry in which ithas Comparative Advantage and it is competitivein world markets for that industry.

session 1 intro & comp adv (1)

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