ఇంటర్నేషనల్ ఎకనోమిస్ ఇంత్రోడుచ్షన్

he International Economy

International economics is growing in importance as a field of study because of the rapid integration of international economic markets. More and more, businesses, consumers and governments realize that their lives are increasingly affected, not just by what goes on in their own town, state or country, but by what is happening around the world. Consumers can buy goods and services from all over the world in their local shops. Local businesses must compete with these foreign products. However, these same businesses also have new opportunities to expand their markets by selling in a multitude of other countries. The advance of telecommunications is rapidly reducing the cost of providing services internationally and the internet will assuredly change the nature of many products and services as it expands markets even further than today.

Markets have been going global, and everyone knows it.

One simple way to see this is to look at the growth of exports in the world during the past 50+ years. The following figure shows overall annual exports measured in billions of US dollars from 1948 to 2005. Recognizing that one country's exports are another country's imports, one can see the exponential growth in trade during the past 50 years.

However, rapid growth in the value of exports does not necessarily indicate that trade is becoming more important. Instead, one needs to look at the share of traded goods in relation to the size of the world economy. The adjoining figure shows world exports as a percentage of world GDP for the years 1970 to 2005. It shows a steady increase in trade as a share of the size of the world economy. World exports grew from just over 10% of GDP in 1970 to almost 30% by 2005. Thus, trade is not only rising rapidly in absolute terms, it is becoming relatively more important too.

One other indicator of world interconnectedness can be seen in changes in the amount of foreign direct investment (FDI). FDI is foreign ownership of productive activities and thus is another way in which foreign economic influence can affect a country. The adjoining figure shows the stock, or the sum total value, of FDI around the world taken as a percentage of world GDP between 1980 and 2004. It gives an indication of the importance of foreign ownership and influence around the world. As can be seen, the share of FDI has grown dramatically from around 5% of world GDP in 1980 to over 20% of GDP just 25 years later.

The growth of international trade and investment has been stimulated partly by the steady decline of trade barriers since the Great Depression of the 1930s. In the post World War II era the General Agreement on Tariffs and Trade, or GATT, was an agreement that prompted regular negotiations among a growing body of members to reduce tariffs (import taxes) on imported goods on a reciprocal basis. During each of these regular negotiations, (eight of these rounds were completed between 1948 and 1994), countries promised to reduce their tariffs on imports in exchange for concessions, or tariffs reductions, by other GATT members. When the most recent completed round was finished in 1994, the member countries succeeded in extending the agreement to include liberalization promises in a much larger sphere of influence. Now countries would not only lower tariffs on goods trade, but would begin to liberalize agriculture and services market. They would eliminate the many quota systems - like the multi-fiber agreement in clothing - that had sprouted up in previous decades. And they would agree to adhere to certain minimum standards to protect intellectual property rights such as patents, trademarks and copyrights. The WTO was created to manage this system of new agreements, to provide a forum for regular discussion of trade matters and to implement a well-defined process for settling trade disputes that might arise among countries.

As of 2006, 149 countries were members of the WTO "trade liberalization club" and many more countries were still negotiating entry. As the club grows to include more members, and if the latest round of trade liberalization discussion called the Doha round concludes with an agreement, world markets will become increasingly open to trade and investment. [Note: the Doha round of discussions was begun in 2001 and remains uncompleted as of 2006]

Another international push for trade liberalization has come in the form of regional free trade agreements. Over 200 regional trade agreements around the world have been notified, or announced, to the WTO. Many countries have negotiated these with neighboring countries or major trading partners, to promote even faster trade liberalization. In part these have arisen because of the slow, plodding pace of liberalization under the GATT/WTO. In part it has occurred because countries have wished to promote interdependence and connectedness with important economic or strategic trade partners. In any case, the phenomenon serves to open international markets even further than achieved in the WTO.

These changes in economic patterns and the trend towards ever increasing openness are an important aspect of the more exhaustive phenomenon known as globalization. Globalization more formally refers to the economic, social, cultural or environmental changes that tend to interconnect peoples around the world. Since the economic aspects of globalization are certainly one of the most pervasive of these changes, it is increasingly important to understand the implications of a global marketplace on consumers, businesses and governments. That is where the study of international economics begins. What is International Economics?

International economics is a field of study which assesses the implications of international trade in goods and services and international investment.

There are two broad sub-fields within international economics: international trade and international finance.

International trade is a field in economics that applies microeconomic models to help understand the international economy. Its content includes the same tools that are introduced in microeconomics courses, including supply and demand analysis, firm and consumer behavior, perfectly competitive, oligopolistic and monopolistic market structures, and the effects of market distortions. The typical course describes economic relationships between consumers, firms, factor owners, and the government.

The objective of an international trade course is to understand the effects on individuals and businesses because of international trade itself, because of changes in trade policies and due to changes in other economic conditions. The course will develop arguments that support a free trade policy as well as arguments that support various types of protectionist policies. By the end of the course, students should better understand the centuries-old controversy between free trade and protectionism.

International finance applies macroeconomic models to help understand the international economy. Its focus is on the interrelationships between aggregate economic variables such as GDP, unemployment rates, inflation rates, trade balances, exchange rates, interest rates, etc. This field expands macroeconomics to include international exchanges. Its focus is on the significance of trade imbalances, the determinants of exchange rates and the aggregate effects of government monetary and fiscal policies. Among the most important issues addressed are the pros and cons of fixed versus floating exchange rate systems. [Note: A separate collection of web materials on international finance is available at The International Finance Webtext]. he course is divided into four distinct sections.

1. International Trade History and Current Issues

* The Terminology of International Trade

* Trade Policy Instruments

* Trade History

* Current Trade Issues



2. The Effects of International Trade

In this section a variety of models are developed which highlight the following five basic reasons that trade occurs.

* differences in technology

* differences in resource endowments

* differences in consumer demand

* existence of economics of scale in production

* existence of government policies



The models address the effects that trade has on the prices of goods and services, the profits of firms, the well-being of consumers, the wages of workers, and the return to other factors of production.



3. The Effects of Trade Policies

These models address the effects that trade policies have on the prices of goods and services, the profits of firms, the well-being of consumers, the wages of workers, the return to other factors of production and the implications for the government budget. This section is divided according to the following assumptions on market structure.

1. Perfect Competition
2. Market Imperfections and Distortions



4. Evaluating the Controversy: Free Trade or Protectionism?

This final section reviews the results of the course by applying them to the premier controversy in international trade: whether to follow a policy of free trade or selected protectionism. Using trade theory results, we develop the arguments that support a policy of free trade and the arguments that support a policy of selected protectionism. We also provide the counter-arguments or caveats that can be used against each of the arguments supporting a particular position. In the end, the section does not reach a definitive conclusion. It is left to the reader to decide which arguments carry the greatest validity. However, the argument does "tilt" in the direction of free trade. Some Trade Terminology

In trade policy discussions terms such as protectionism, free trade, and trade liberalization are used repeatedly. It is worthwhile to define these terms at the beginning. One other term is commonly used in the analysis of trade models, namely national autarky, or just autarky.

Two extreme states or conditions could potentially be created by national government policies. At one extreme, a government could pursue a "laissez faire" policy with respect to trade and thus impose no regulation whatsoever that would impede (or encourage) the free voluntary exchange of goods between nations. We define this condition as free trade. At the other extreme, a government could impose such restrictive regulations on trade as to eliminate all incentive for international trade. We define this condition in which no international trade occurs as national autarky. Autarky represents a state of isolationism. (See Figure).

Probably, a pure state of free trade or autarky has never existed in the real world. All nations impose some form of trade policies. And probably no government has ever had such complete control over economic activity as to eliminate cross-border trade entirely. The real world, instead, consists of countries that fall somewhere between these two extremes. Some countries, such as Singapore and (formerly) Hong Kong, are considered to be highly free trade oriented. Others, like North Korea and Cuba, have long been relatively closed economies and thus are closer to the state of autarky. The rest of the world lies somewhere in between.

Most policy discussions are not about whether governments should pursue one of these two extremes. Instead, discussions focus on which direction a country should move along the trade spectrum. Since every country today is somewhere in the middle, discussions focus on whether policies should move the nation in the direction of free trade or in the direction of autarky.

A movement in the direction of autarky occurs whenever a new trade policy is implemented if it further restricts the free flow of goods and services between countries. Since new trade policies invariably benefit domestic industries by reducing international competition, it is also referred to as protectionism.

A movement in the direction of free trade occurs when regulations on trade are removed. Since the elimination of trade policies will generally increase the amount of international trade, it is referred to as trade liberalization.

Trade policy discussions typically focus, then, on whether the country should increase protectionism or whether it should pursue trade liberalization.

Note that, according to this definition of protectionism, even policies that encourage trade, such as export subsidies, are considered protectionist since they alter the pattern of trade that would have prevailed in the absence of government intervention. This implies that protectionism is much more complex than can be represented along a single dimension (as suggested in the above diagram) since protection can both increase and decrease trade flows. Nevertheless, the representation of the trade spectrum is useful in a number of ways. Valuable Lessons of International Trade Theory

In this section some of the most important lessons in international trade theory are briefly presented. Often, the lessons that are most interesting and valuable are those that teach something either counterintuitive, or at least contrary to popular opinions. A number of these are represented below. Each explanation also provides links to the pages where the arguments are more fully explained. (Note: For most students, following the links initially may be more confusing than helpful. However, once reading through many of the chapters, review of these lessons may help reinforce them).

1. The main support for free trade arises because free trade can raise aggregate economic efficiency.

2. Trade theory shows that some people will suffer losses in free trade.

3. A country may benefit from free trade even if it is less efficient than all other countries in every industry.

4. A domestic firm may lose out in international competition even if it is the lowest-cost producer in the world.

5. Protection may be beneficial for a country.

6.

Although protection can be beneficial, the case for free trade remains strong. The main support for free trade arises because free trade can raise aggregate economic efficiency.

In most models of trade there is an improvement in aggregate efficiency when an economy moves from autarky to free trade. This is the same as an increase in national welfare. Efficiency improvements can be decomposed into two separate effects: production efficiency and consumption efficiency. An improvement in production efficiency means that countries can produce more goods and services with the same amount of resources. In other words, productivity rises for the given resource endowments available for use in production. Consumption efficiency improvements mean, in essence, that consumers will have a more satisfying collection of goods and services from which to choose.

Many economists define the objective of the economics discipline as seeking to identify the best way to use scarce resources to satisfy the needs and wants of the people of a country. Economic efficiency is the term economists use to formally measure this objective. Since free trade tends to promote economic efficiency is so many models, this is one of the strongest arguments in support of free trade.

This result is formally demonstrated in the Ricardian model (see page 40-9b), the Immobile Factor model (see page 70-15), the Specific Factor model, the Heckscher-Ohlin model (see page 60-10), the Demand Difference model, the simple Economies of Scale model, (see page 80-3) and the Monopolistic Competition model (see page 80-5e). It can also be demonstrated when a small country reduces barriers to trade (Consider the analysis on page 90-11 in reverse). Each of these models shows that a country can have a larger national output (i.e. GDP) and superior choices available in consumption as a result of free trade.Lesson 5B

Trade theory shows that some people will suffer losses in free trade.

A common misperception about international economics is that it teaches that everyone will benefit from free trade. One often hears that voluntary exchange, whether between individuals or between nations, must benefit both parties to the transaction, otherwise the transaction would not occur. Although this argument is valid for exchange between two people, the conclusion changes when one considers two countries made up of multiple individuals. (See pages 30-3 through 30-5)

Economists themselves often espouse the position that free trade is beneficial to all, albeit often with the caveat, "... at least in the long run". In the short run, factors of production may be relatively immobile across industries (see pages 70-1 and 70-2). In the presence of immobility, it can be shown that while export industries would gain from free trade, import-competing industries would lose (see page 70-17). Thus, in the short run, resource adjustment problems can explain losses to some groups.

In the long run, once all resources can move to alternative industries, some models (e.g. Ricardian) suggest that everyone in the economy would benefit from free trade (See page 40-9a). Other models (e.g. Heckscher-Ohlin), however, suggest that some groups may continue to lose even in the long run (See page 60-12).

Another complication is that not everyone will make it to the long run. As John Maynard Keynes once remarked, "In the long run, we are all dead." If not dead, it is surely true that some individuals will retire from the labor force before the long run arrives. These individuals may be unfortunate enough to experience only the negative short-run losses to an industry. Upon retirement, their short-term losses may carry over to long-run losses.

Economists will often dismiss concerns about potential losses from trade liberalization by proposing that compensation be provided. The "compensation principle" suggests that some of the gains could be taken away from the winners and given to the losers such that everyone becomes better off as a result of free trade. Although the principle is valid conceptually, effective implementation of it seems unlikely (See discussion on page 60-13). Lesson 5C

A country may benefit from free trade even if it is less efficient than all other countries in every industry.

It makes sense that one firm would be more successful than another firm in a local market if it could produce its output more efficiently - that is at lower cost - than the second firm. If the two firms produce identical products, then the less efficient firm is likely to be driven out of business, generating losses. If we extend this example to an international market then it would also make sense that a more efficient foreign firm would absorb business from a less efficient domestic firm. Finally, suppose all firms in all industries domestically were less efficient than all firms in all industries in the foreign countries. It would then seem logically impossible for any domestic firms to succeed in competition in the international market with the foreign firms. International competition would seemingly have only negative effects upon the less efficient domestic firms and the domestic country.

This seemingly logical conclusion is refuted by the Ricardian model of comparative advantage. Ricardo demonstrated the surprising result that less efficient firms in a country can indeed compete with foreign firms in international markets. In addition, by moving to free trade, the less efficient country can generate welfare improvements for everybody in the country. Free trade can even benefit a country that is less efficient at producing everything (See page 40-9).

What's more, in a free market system, differences in prices and profit-seeking behavior are all that is needed to induce countries to produce and export the "right" goods and trade to their national benefit. (see especially 40-8)Lesson 5D

A domestic firm may lose out in international competition even if it is the lowest-cost producer in the world.

This result is a corollary of Lesson 3. As argued there, it seems reasonable to think that a more efficient firm (i.e., one who produces at lower cost) would drive its less efficient competitors out of business. The same would seem to follow if the two firms are domestic and foreign and the two firms compete in international markets.

However, the Ricardian model of comparative advantage argues that a firm in one country, even if it is the lowest-cost producer in the world, may be forced out of business once the country liberalizes trade with the rest of the world. Even more surprising, despite the decline of this industry, the move to free trade can generate welfare improvements for everybody in the country. In other words, losing production in a highly efficient industry can be consistent with an improvement in welfare for everyone. This contradicts the logic above which would suggest that more efficient (lower-cost) firms should always win (See page 40-9).

It is important to note that this result does not imply that every decline of an efficient industry will improve welfare. Instead, the model merely suggests that one should not jump to the conclusion that the loss of an efficient industry will have negative effects for the country as a whole. Lesson 5E

Protection may be beneficial for a country.

Sometimes the support for free trade by economists seems so strong that one might think there is very little evidence to suggest that protection could be beneficial. In actuality, there are numerous examples in the trade literature which show that protection can be beneficial for a country. The examples fall into two categories.

The first category contains trade policies which raise domestic national welfare, but which reduce aggregate world welfare at the same time. These type of policies are sometimes called "beggar-thy-neighbor" policies since benefits to one country can only arise by forcing losses upon its trading partners. The most notable example is the terms of trade argument for protection which is valid whenever a country is either a large importer or a large exporter of a product in international markets (See page 90-9). A second type of beggar-thy-neighbor policy is strategic trade policy. These policies benefit the domestic country by shifting profit away from either foreign firms or foreign consumers (See pages 100-5).

The second category of beneficial trade policies are those which not only raise domestic welfare but raise world welfare as well. Some trade policies may act to correct prevailing market imperfections or distortions. If the welfare improvement caused by correcting the imperfection or distortion exceeds any additional distortion caused by the trade policy, then world welfare may rise. Many well-known justifications for protection, including the potential for unemployment (see page 100-3), infant industries (see page 100-4), the presence of foreign monopolies, (see page 100-5) and concern for national security (see page 100-7), arise because of the assumption of market imperfections or distortions.
Lesson 5F

Athough protection can be beneficial, the case for free trade remains strong.

The argument in support of free trade is often different depending on whether the speaker is in a political setting or an academic setting. In a political setting, political realities will often force the speaker to emphasize all of the positive aspects of free trade and to hardly even mention any negative aspects. The reason for this is thattalking of the negative effects of free trade will offer up ammunition to one's opponents who may then use these statements against him in future debates.

Since most people will have learned the argument for free trade by listening to political and public policy debates in the news media, they are likely to believe that economics teaches that free trade is good for all people, in all countries, at all times. This belief may lead people, especially those obviously hurt by freer trade policies, to doubt whether economics has anything useful to say about the real world.

However, the academic argument for free trade, is much more sophisticated than the typical political argument. As readers of this site will learn, free trade will cause harm to some (see 5-5b), as well as good to others. Furthermore, certain selected protectionist policies can be good for individuals, and for the nation (see 5-5e), but they will also cause harm as well.

Thus, the choice between free trade and selected protection is not as simple as typically presented by political advocates on one side or the other. In essence, one must choose between the good and bad that comes with free trade, and the good and bad that comes with selected protectionism. In weighing the alternatives, economists often conclude that free trade is the more pragmatic choice, dominating, for a variety of reasons, selected protectionist policies.

This more sophisticated argument for free trade is the topic of Chapter 120. The chapter highlights both the positive and negative aspects of free trade policies and refers readers back via hyperlinks to many sections in the main text to support each argument. Chapter 120 is useful to read at the beginning of your studies to see where the course is going. It is even more important to read at the end, to see how everything covered in the text fits into the argument supporting free trade. During this second reading, the hyperlinks will become especially useful.