Chapter Two The Global Economy. Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 2 I started the day early having set my alarm

Chapter Two

The Global Economy

Copyright © Houghton Mifflin Company. All rights reserved. Chapter 2 | Slide 2

I started the day early having set my alarm clock

(MADE IN JAPAN) for 6 a.m. While my coffeepot (MADE

IN CHINA) was perking, I shaved with my electric razor

(MADE IN HONG KONG). I put on a dress shirt (MADE IN

SRI LANKA), designer jeans (MADE IN SINGAPORE) and

tennis shoes (MADE IN KOREA). After cooking my

breakfast in my new electric skillet (MADE IN INDIA) I sat

down with my calculator (MADE IN MEXICO) to see how

much I could spend today.

The Global Economy


After setting my watch (MADE IN TAIWAN) to the radio

(MADE IN INDIA) I got in my car (MADE IN JAPAN) and

continued my search for a good paying (!) American

job. At the end of yet another discouraging and

fruitless day, I decided to relax for a while. I put on my

sandals (MADE IN BRAZIL) poured myself a glass of

wine (MADE IN FRANCE) and turned on my TV (MADE IN

INDONESIA), and then wondered why I can't find a good

paying job in.....AMERICA!

The Global Economy (cont.)


Imports and Exports as a Percentage of GDP (in Billions of Dollars)


Stock Market Crash 1929

US Isolationism, Protectionism

Other Countries Retaliate with Similar Measures

Global Depression – Germany and Japan Hit Particularly Hard

World War II

Historical Development


Bretton Woods Conference

GATT, WTO

Import Tariffs Decrease from 40% in 1947 to 4% Today

World Trade Increases 22-fold Since 1950

Foreign Direct Investment Increased Over 100% in a Single Decade!

Historical Development (cont’d)


Absolute advantage• Trade is based on each country selling

what it is best at producing

Comparative advantage• Trade can occur between two

countries even if one of the countries has no absolute advantage in any product• Make the product you have a comparative

advantage in

Basic Theories of World Trade


Vietnam Germany

Yearly output per worker

Machinery 200 machines 500 machines

Tomatoes 800 tons 1000 tons

Opportunity cost of production

1 machine costs 4 tons of tomatoes or 1 ton tomatoes cost 0.25 machines

1 machine costs 2 tons of tomatoes or 1 ton tomatoes costs 0.5 machines

Absolute advantage

None Machinery, tomatoes

Comparative advantage

Tomatoes Machinery


1 (Vietnamese) machine =

4 tons (Vietnamese) tomatoes

1 (German) machine =

2 tons (German) tomatoes

If Germany trades 1 machine to Vietnamese for 3 tons of tomatoes…both countries win!


Any trading ratio between:

1 machine = 2 tons of tomatoes and

1 machine = 4 tons of tomatoes

will be a mutually advantageous trading ratio


1. Land

2. Labor

3. Natural resources

4. Capital

Competitive Advantage (Adam Smith)

Comparative advantage is limited by its focus on the elements of production, including:


Porter’s Revised Theory of Competitive Advantage

• Elements of production• Nature of domestic demand• Presence of appropriate suppliers or

related industries• The conditions in the country that

govern how companies are created, organized, and managed

• Nature of domestic rivalry


An exchange rate measures the value of one currency in terms of another currency

1 US $ = 0.5 £

One currency can appreciate or depreciate against another

1 US $ = 0.75 £1 US $ = 0.30 £

Exchange Rates


Balance of Payments

An accounting record of the transactions

between one country’s economy and the rest of the world’s collective economy at a point

in time.

Functions like a statement of cash flows.


• Add table 2.5, p. 26 here

Balance of Payments


Supply and Demand and FOREX

• The foreign exchange market reflects the supply and demand for one currency versus another

D

S

q

p

DM

Pounds


Rates Determining Factors (besides Supply & Demand)

• Imports/exports drive need for currencies

• Inflation• Investors and speculators - ROI• Government actions


Is a strong currency good or bad?


“Soft” Currencies

• Currencies of smaller, less developed countries

• Rates can be artificially “determined” by the governments of these countries

• Pegging of rates to more stable currencies• Governments must eventually respect

FOREX supply and demand• Currencies often face significant

devaluations


• Panama adopted the U.S. dollar as its currency in 1904

• Ecuador adopts U.S. dollar in 2000• Good idea?

+ Monetary stability

- Lack of flexibility in monetary or foreign exchange policy to respond to economic downturn or external shocks (i.e. what if dollar depreciates?)

Dollarization


Agencies Promoting Economic and Monetary Stability

• International Monetary Fund– Prevention of economic instability in

emerging markets• World Bank

– Long-term loans to developing countries• Group of 7(8)

– Finance ministers/Central Bank governors of USA, Japan, Germany, France, Britain, Italy, Canada (Russia)


Protectionism and Trade Restrictions

• Tariffs• Quotas• Orderly marketing arrangements

(voluntary export restrictions)• Non-tariff barriers (regulations,

stringent standards, bribes, etc.)


General Agreement on Tariffs and Trade (GATT) – Key Principles

• Reciprocity• Non discrimination

– Most favored nation (MFN) status

• Transparency


World Trade Organization

• Created as final act of GATT• Unlike GATT, WTO decisions can only be

overturned by consensus and not by unilateral veto

• Challenges– Continued liberalization of trade – Establish trade policy for foreign investment,

competition and labor standards– Promote regional trade agreements


• Unfair to developing countries?• Threat to national sovereignty and culture?• Protectionist agendas still remain in some

countries

Opposition to WTO Agendas


Different Types of Regional Economic Integration

– Free Trade Area (i.e. NAFTA)• Liberal external trading policy

– Customs Union • supranational trade policy-making body• Common external trade barrier adopted by all member

nations

– Common Market • Customs Union characteristics + mobile labor and

capital among member nations

– Monetary Unions (example: European Union and the “Euro”)


Geographic Proximity Often Contributes to Economic Integration

• Distances are short – lower cost of trading

• Similar consumer tastes• Common history or interests


• BenefitsTrade CreationBigger MarketsGreater

ConsensusPolitical

Cooperation & Good Will

• DrawbacksTrade DiversionShifts in Employment

and Loss of JobsLoss of National

Sovereignty

The Effects of Economic Integration


European Integration….

''When I need to get in touch with the Kremlin, I know who to call. When I need to get in touch with Europe, who do I call?'' --Henry Kissinger


European Union - Characteristics

• Founded on International Treaties among sovereign nations rather than a Supra-national Constitution

• Power to enact laws that are binding on all EU citizens throughout EU territory

• Common Currency established – the “Euro”


EU Objectives

1. Promote economic and social progress

2. Assert the identity of the European Union on the international scene

3. Introduce European citizenship4. Develop an area of freedom5. Maintain and build an established EU

law


History of the EU

• 1951 - European Coal and Steel Community

• 1957 – Treaties of Rome: EEC (later EC)

• 1960 - European Free Trade Association

• 1967 – Internal Tariffs Eliminated in EC; Common External Tariff Imposed

• 1992 – European Union Signed in Maastricht

• 1999 – Most Countries Adopt the Euro

Documents

Chapter Two The Global Economy. Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 2 I started the day early having set my alarm