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International Trade Policy
Terms in this set (69)
Advantages of international integration
1. Technological Innovation
2. Less expensive products
3. Greater investments in scarce resource regions
Disadvantages of international integration
makes nations more vulnerable for economic problems which have become more easily transmitted ==> Example: 'sub-prime mortgage crisis' within the housing sector in the US which lead to a recession of almost all world economies except China, India & major oil producer --> scarcity of credit; consumer but back spendings & businesses investments
How to measure intern. integration? (4 criteria)
1. Trade flows; 2. Capital flows; 3. People flow;
4. Similarity of prices in separate markets
Integration history visible with...
The Kondratiev Long Waves! Shows several waves of world integration which are centered around a different technology ==> textile, steam power, heavy industry, petrochemicals & aerospace, electronics & business services
Indicators of economic integration
1. Imports & Exports
2. Factor movement
Differentiation of capital flows today and in the past
Capital flow was in the past different compared with today
==> QUANTITATIVE: capital flows now larger because of bigger economies but relative to the economies size differences not that great (1870-1913 even larger than today)
==> QUALITATIVE: the transaction cost are cheaper now than before and more financial instruments available; but foreign exch. transactions were before easier because of fixed exch. rates episodes
Types of integration
a) Shallow integration at the border through elimination of tariffs & quotas => affects trade in goods & service
b) Deep integration through elimination or reduction of non-trade related domestic policies => affects trade in goods & services plus business-government relations
Rules & organizations that govern & constrain behavior for order & reduced uncertainty (formal/informal)
Taxonomy of int. institutions (5 types)
1. Lobbying groups for particular commodity or producers association
2. Joint Management of several nations that share a resource (Mississippi River Commission)
3. Development funds and banks
4. Int. Trade Agreements
5. Global organizations for trade, development and macroeconomic stability
- founded 1945 at Bretton Woods meetings
- is the central monetary institution which gives countries loans
- funding from membership fees/ quotas which depend on the nation size & that determines the voting weight => important decisions made by vote
- funtion: prevents crisis in financial system by promoting sound macroeconomic policy which incl., inter Alia, stable exchange rates and avoidance of competitive devaluation
When does a financial crisis occurs?
Financial crisis occurs when a country runs out of foreign exchange reserves (currency or gold) that can be used to pay int. borrowings & imports ==> in the event of financial crisis, members of IMF borrow against IMF quotas under the conditions to carry out reforms in exchange for loans
- founded 1944; consists of Int. Bank for Reconstruction & Development + Int. Development Association
- same membership & similar structure as IMF
- Members voting rights are proportional to the number of shares owned
- Original purpose: providing financial mechanism to rebuild Europe after WWII
- Function today: assisting development of non-industrial economies
- signed in 1947
- Principles which are prohibitions against discrimination: National Treatment (foreign goods have to receive same treat as domestic ones) & Non-discrimination/ Most-favored Nation (treat all members like your most favored one)
- GATT functioned through periodically rounds of negotiations which include decisions over tariff reductions (sector-specific discussions) ==> Example issues: dumping problems, export subsidies, non-tariff barriers
- so far 8 rounds, inter Alia, Kennedy round (60s) & Tokyo round (70s)
- most important round: Uruguay round which established the WTO ==> dealt with decrease of tariffs, elimination of textile & apparel quotas (by 2005), and elimination of agricultural export subsidies
- "multilateral trade agreement" which members are almost all countries of the world
- WTO based on agreements in trade of goods, service and Int. Property Rights
- monitors national trade practices & meets ever 2 years for negotiation rounds to set WTO policy objectives
- most important round is Doha round
- in general, WTO prohibits subsidies, quotas & tariffs but there are exceptions
- has an effective dispute settlement mechanism => panel of WTO experts decides if agreement was broken or not; every country that refuses the decision has trade restrictions from other countries as consequences
Doha Round - main issues & why is it still not a success?
- trade in service
- farm subsidies in high income countries
- issues of developing countries => the desire of developing countries for greater access to high income markets
- problems poor countries face in implementation
Still not a success because it focuses on trade issues of developing countries. Developing countries wish the elimination of trade barriers especially for agriculture, textile & apparel which are sector that are politically well organized in high income countries. Tariffs are already strong decreased but completely elimination is not possible => intensive negotiations
5 categories of RTA
1. Partial Trade Agreem. = liberalize trade for selected products
2. Free Trade Area = fully liberalized trade of goods & service
3. Custom Union = FTA + common external tariff towards non-member
4. Common Market = CU + free movement of production factors
5. Economic Union = Common market with substantial coordination of macroeconomic policies such as common currency & harmonization of standards & regulations
Are RTAs beneficial or harmful to the world economy?
In general, RTAs are inherently discriminatory because countries that sign the RTA deny the most-favored nation principle of the WTO. Most RTAs create trade diversion, but the reduction of trade barriers also create more trade between the countries. As long as, the RTAs create more trade than they divert, the WTO allows these agreements. Every country that plans to sign a RTA, is obliged to notify it to the WTO
==> trade creation/building blocks > trade diversion/stumbling blocks
==> RTAs increase national welfare when new trade is created, but not when existing cheap trade from the outside world is diverted to more costly trade with member countries
Costs of goods are decreasing because expensive domestic production or expensive imports will be replaced from a low-cost RTA member => these increases the efficiency of economic integration
Efficient producer is diverted to a less efficient one by the formation of a RTA or custom Union; or from low-cost imports to high-cost
Pro & contras of RTAs
- it is easier to reach an agreement between few countries than between all WTO members
- Reduction of trade barriers has a smaller domestic effect
- Experimentation of new agreements possible
- RTAs can be used as political & economic threats to encourage agreements in the WTO forum
- RTAs polarize countries & make it more difficult to reach agreements
- discriminatory against poor & less-developed countries
- low-income countries often lack on resources & infrastructure which is needed to take advantage of new market opening
By the Ricardo Model, how are the trade pattern defined?
The Ricardo Model assumes that the trade pattern are depending on the comparative advantage. Every country has their own technology which differentiate from the other country. Therefore, the productivity is different, as well as the comparative advantage. The country exports the product in which it has the comp. adv. in exchange with the other good on a relative price which lies between the opportunity costs of the both trading partners.
Ricardo Model assumes that comparative adv. is based on the difference of country's technology which leads to different productivity, and, therefore, different comp. adv.
Nations that produce according their comparative advantage (specialization), which depends on the opportunity cost of a produced good, are maximizing the benefits they receive from trade, and consequently, their national welfare (=gains from trade)
The amount of the exported good, where the country has the comp. adv., depends on the relative price which is between the opportunity costs of both trading partners.
HO model assumes that the comparative adv. is depending on the national differences in factors endowments (factor abundance & factor intensity).
A country will exports that good that intensively uses the production factor that is abundantly available & imports that good that intensively uses thee scarce production factor. Consequently, the income earned by the abundant factor rises, while it falls for the scarce factor (Stolper-Samuelson theorem)
Is the link between the factor prices & the prices of the goods. The SS theorem assumes that the amount of income earned per unit of input depends on both the input demand & supply ==> if a good is exported, it's income rises and the imported good's income is falling (demand falls, supply falls & income falls)
If the availability of a production factor changes, the output level will change, too.
Specific Factor Model
Model assumes that land & capital are specific factors which are not mobile between the sectors. Whereby, labor is mobile. When trade opens, each country follows its comp. adv. & moves toward greater specialization into 1 good. Industry which uses specific factor may disappear if the country does not has a comp. adv. for it. This causes labor movement.
3 primary factor of migration
1. Supply-Push factors => forces inside a nation that cause people to think about to leave the country, e.g. Wars, recessions or unemployment etc.
2. Demand-Pull factors => forces that pull migrates into a particular country, e.g. Immigration policies, work opportunities or wages
3. Social network => ability of migrants to gather their families or community more easily, e.g. Immigration policies
Effects of tariffs on national welfare
Tariffs are taxations on cross-border movements on imported goods. In general, small countries do not have influence on the TOT (term of trade), and, therefore, on the world price, as their demand is too small. If small countries put a tariff on imports, the price of goods is increasing means the nation has to pay the additional tariff costs on the world price (pw+t=pt). If a large country imposes a tariff, the increase of the price will be less than the tariff because a part of it will pay the foreign producer. This is because foreign producer are afraid that the price will get to high for the consumer and they will choose another cheaper product. Means, overall the world price is decreasing. A tariff in large countries may increase the national welfare if the gains of trade are larger then producers and consumers deadweight loss. But the importing countries gains are the exporting countries loss which means the overall world national welfare is decreasing from imposed tariffs. In both cases, the trading amounts are decreasing because of higher costs and in both countries deadweight losses are visible.
What are other potential costs of a tariff?
1. Retaliation of other countries ==> this way the net looks can be even bigger because tariffs can indirectly harm export markets of other domestic industries
2. Lack of innovation ==> lose of competitive pressure - loss of incentive to innovate and improve products
3. Rent seeking ==> any activity that uses resources in order to capture more income without actually producing a good or service ("mafia")
Effects of export subsidy on national welfare
Export subsidies are given from the government to firms to encourage them in the export of domestic goods. These subsidies increase the prices in the domestic market which leads to a consumer loss but producer gain. Within a large country the subsidies increase the the domestic price but decrease the foreign price, as foreign producers want to stay competitive. This further aggravates the TOT of the exporting country because the price of the export in the world market decreases. The decrease in the world price leads to a national welfare gain in foreign countries but national welfare loss in domestic ones. Furthermore, domestically, it leads to an income redistribution effect. Overall, subsidies in large countries lead to a decrease in national welfare on world level because it leads to a decrease of efficiency of the production and consumption.
Effects of import quota
Quotas are quantitative restrictions on imports where foreign firms receiving (or buying on auction) licenses to buy products and sell these on the domestic market at a higher price (gains quota rents). In this case, government is not gaining revenues (like tariff tax), means net loss may exceed that from the tariff. But, overall, the same as tariffs. Imports are reduced after imposing quota, fall in domestic consumption because of higher prices and therefore, increase in production. When a large country imposes quotas that limits the imports, the demand of the country is larger then the supply. The country is increases the product prices till there is an economic balance again.
Name example of hidden forms of protection
Non-tariff barriers (such as quotas):
- complicated customs procedure
- environment, health & safety regulations
- technical standards
- government procurement rules
- limits imposed by state trading companies
Why are trade policies efficient & inefficient mechanism to protect and create jobs?
Trade policies are efficient mechanism because they protect industries which would disappear under open trade. An example for that is the agricutural, textile & apparel industry in developed countries. High-income countries protect these industries because they are afraid that low-income countries and their significant comparative advantage in these sectors would take away & eliminate jobs for domestic workers. This issue is high debate at the negotiation rounds.
Trade policies are inefficient job creation mechanism because it is assumed that trade barriers in developed countries increase the poverty in developing countries (Doha Round). In general, trade policy is a non-transparent job-creation program which relies on too many intervening variables. It does not really go directly to the heart of the problem & is also very expensive (tariffs & quotas consequences of increased prices). So, overall, trade policies are inefficient. There are better ways to create jobs, Sachs as macroeconomic policies which support economic growth, or flexible labor markets with adjustment assistance for dislocated works.
Why do nations protect their industries?
1. Revenues => developing countries raise money with tariff because they can't earned it by collecting income & corporation taxes =, as the unemployment rate is high and there are only few large firms
2. Labor => protection from cheap imports from low wage countries - But! Productivity not considered
3. Infant industries => protection from strong competition, infant industries need time to develop - But! Risk of focus on wrong industries (Brazil computer industry)
4. National security => protection of industries that produce for crisis times (e.g. China agriculture & US steel industry)
5. Cultural protection => E.g. US television & journals influence Canadian culture
6. Retaliation => countries have to counter restriction from other country - But! Risk of trade war
Which 3 options exists in regard with setting standards within a trade agreement?
1. Harmonization of standards ==> Two or more countries adopt a common set of standards in an area of concerns (Problems are to decide which standards are best, further harmonization can slower development of new products, or low wage countries can't keep up with new standards)
2. Mutual recognition of standards ==> countries maintain their own standards, but accept standards of others as valid & sufficient
3. Separate standards ==> countries maintain their own standards & refuse to recognize the standards of others
There are no general rules which way of dealing with differences in standards is best or fairest for intern. trade - each has advantages & disadvantages.
Which 5 labor standards proposed the Intern. Labor Organization? (Why are they controversial & ambigious)
1. Prohibition of forced labor
2. Freedom of association
3. The right of organize & bargain collectively
4. End of exploitation of child labor (BUT what means exploitation)
5. Non-discrimination in employment (discrimination defined differently from country to country)
Does trade harm the employees in developing countries?
Assumed yes, because the export of manufactured goods from low to high wage countries increased in the last decade substantially even if there are such differences between the living standards & work conditions.. Means poor countries are supported in their bad standards. But according the trade models, the poor countries are better off with trade than without. Ricardo model shows that the wages increase in the poor countries with trade, as trade causes a price increase. And the HO model shows that after trade the low-skilled labor has the chance to specialize in the comp. adv. sector, which leads to higher income. Means overall without trade the poor countries would have worst standards.
Does trade harm the environment?
No, it does not as without trade the production & consumption of nations would still cause pollution. Research has shown that free trade can even boost growth & indirectly reduce pollution ==> Kuznets Curve
- When poor countries become rich - partly caused by trade - they will produce & consume more, what in first instance will lead to a degradation on the environment. However, when these countries become even more richer, they will be able to invest in stricter environmental rules ==> reversed U shaped relation between pollution & income per capita
4 big concerns over the use of labor & environmental rules in trade agreements
1. Effectiveness => only large countries & coalition of countries have big enough impact on global demand; use of sanction may cause firm to shift their production to unregulated & uninspected 'informal economy' (e.g. pollution haven)
2. Hazy borderline between protectionism & concerns => some countries use the issue of foreign labor standards in order to protect their self from competition
3. Which are the right labor & environment conditions? => there is no intern. agreement
4. Potential risk of trade war => sanction are discriminatory & infraction to WTO rules.. May cause retaliation & trade war
The developed & developing world are subject to different economic restrictions. Hence, a total leveling of labor & environmental conditions would be impossible.
3 ways of enforcing labor & envionment sanctions without hurting trade
1. Labeling exports to indicate that the products were produced in a humane & environmentally way; BUT, problem is that countries feel an infringement in their sovereignty as inspectors are probing their production procedures; further, people are not sure how accurate the information on the labels are & these labels are only for exporting sectors, but rest industries have still bad work conditions
2. Requiring home country standards abroad, which doesn't mean that wages & benefits has be the same, but that a minimum wage, health & safety standards, as well as child labor rules exists. This hinders the race to bottom. But, it only addresses high-standard countries
3. Increasing intern. negotiations by either existing organizations or by creating new agreements for the environment ==> as more countries agree as stronger the impact & important that the big economies sign the agreements such as Russia, US & China
3 political theories for trade policies
1. Median voter theorem ==> predicts that democratic politic parties choose policy which is in favor of the majority of the voters (I.e. Median voters) >> means parties will choose similar tariff (one minimal smaller/higher than the other) >> so a policy based on the majority interests.. A policy that inflicts large losses for minority (import-competing producers) but also large benefits for majority (consumers) >> BUT! Free trade helps everybody a little, while protection helps few people a lot ==> A trade policy will lead to large benefits for minority & small losses for majority (e.g. Sugar quota USA) ==> means in case of trade policies, this model leads to wrong predictions
2. Collective action theorem from Mancur Olson ==> describes political activity as a public good that leads to a collective action problem >> conflict between selfish individual interest & cooperative group interest >> consumer as a group have incentive to advocate free trade but each individual consumer has no incentive because his benefits are not high enough compared with time & costs; further policies that impose large losses for whole society are only small losses for each individual ==> Solution is when group is small enough that for each member gains are larger if the preferred policy is followed
3. Combination of both ==> actual trade policy based of combination of both theorems >> politicians win elections partly because they advocate popular policies in favor of median voters interests & because they advocate interests of fund sponsor groups who don't have collective action problem & exchange for money (to fund the campaigns) ==> this way, politicians will often deviate from the popular policy of the median & opt for the interests of their sponsors
International trade agreements: Brief history
- 1930, US passed Hawley-Smoot Tariff Act which increased tariff rates up to 60%
- other countries react with retaliation to this move which lead to a trade war => Great Depression, also called 'beggar-your-neighbor-policies' = competitive devaluations & high tariffs in order to shift econ. problems to other countries
- this lead to almost total collapse of intern. Trading system >> illustrated by spider web spiral that measures the size of the world import per month by looking at the distance to origin
- Solution for problem: bilateral trade negotiations which negotiate a lowering of tariffs
- but, multilateral negotiations better coordination mechanisms >> hence, since 1944 highest tariff reduction through multilateral rounds ==> 1947 GATT ==> 1994 Uruguay Round which replaced GATT its WTO
Why is the US focusing on bilateral & plurilateral trade agreements rather than to multilateral?
1. Multilateral negotiations became complicated with the new GATT/WTO members (1947 only 23 members & 2014 160)
2. Many quotas were converted to tariffs & tariffs have fallen substantially.. furthermore, new multilat. negotitaions in the Doha R. focusing on more difficult issues, such as trade in service & support of poor countries
3. the end of the Cold War removed one of the pressures that caused the US to offer trade concessions to other countries
The common history of US, Canada and Mexico
1. Auto Pact of 1965 betw. CAN & US on trade & investments in automotive products
2. CUSTA - CAN & US Trade agreement 1989, which helped CAN overcome the US protectionism & Asian competitiveness in manufacture industries
3. NAFTA - US, CAN & MEX.. both latter countries wanted to get its access to the US market
Mexico's economic history and it's crisis
Mexico's economic history is characterized by a shift from a closed and inward economic orientation To an open and outward set of policies which began from the mid-1980s.
Between the end of WW11 and 1980s, MEX followed inward-oriented import substitution industrialization (ISI) policies which targeting the development of manufacturing sectors that can compete against imported goods. With the ISI policies MEX supported the development of more sophisticated industrial goods by subsidies, tax breaks, low-interest loans & high protectionist trade barriers. This means ISI was using the 'infant industry' argument for its action. But, why protecting this industry if there are such a strong protectionist walls? MEX major weakness of that time was the poor macroeconomic management which included:
- governments misallocation of resources & overestimated technical ability to identify market failures & their solutions
- the overvaluation of exchange rates which raised foreign prices of domestic goods >> indirectly & unintentionally it made exports relatively less profitable
- the focus on urban areas which lead to income inequalities, rent-seeking & corruption
Overall, through the protection the industrial sectors never became competitive under ISI & MEX was never accomplishing its main goal - economic growth. Furthermore, it found itself deeply in debt & with limited capacity to export.
1982 the debt crisis of MEX began which was the result not just from the countries ISI policies but mostly caused by heavy borrowing from from foreign banks, weak tax systems, and rising interest rates that made debt service more expensive (whole Latin America >> "Lost decade"). MEX was heavily borrowing because it wanted to support its oil production. Unfortunately, the oil price decreased significantly and US interest rate grow rapidely. The weak export performance because of ISI policies & the low oil prices worsened the ability to pay off the foreign debt.
Summarized, MEX suffered a long period of crisis suffered by international trends & a series of domestic policy mistakes.
Solution for debt crisis required multiple policy changes, such as firm privatization, control of federal budget, reduced restrictions on trade & foreign investments, and open markets for more competition. With the new president (1988), the 'Brady Plan' for intern. debt relief was introduced (1989), which promised modest amount of debt relief in return for domestic policy reforms. Additionally, new president proposed the free trade agreement with the US ==> NAFTA
NAFTA (1994) Characteristics (3)
1. Reduction & elimination of trade barriers, especially with MEX.
2. NAFTS specified North American 'content requirements' for goods that are subject of free trade ==> in order to qualify for free trade or reduced tariff provisions, usually 50% of the value of the good must've made in North America
3. NAFTA established a system for dispute settlement consisting of bi-national panels that investigate & solve disputes
4 NAFTA Issues in the US
1. Labor issues ==> Blue collar labor unions feared jobs would migrate to Mexico workers as they are cheaper (BUT, productivity differences not considered) >> Attachment of labor-side agreement
2. Environmental issues ==> Environmental groups feared that US & CAN polluting firms would move to MEX & pollution on US-MEX border would increase >> Environmental-side agreement & establishment of the North American Development Bank which helps to finance border cleanup costs
3. Immigration ==> huge debated problem between US & MEX relation >> proponents say they support US immigration and monetary circulation, but opponents argue that the illegal behavior shouldn't be ignored
4. Rising drug violence in MEX
The economic impact of NAFTA
- The growth in trade between all three NAFTA members indicates increased specialization, economies of scales & efficiency
- Overall, CAN & US don't show a large effect coming from the agreement.. MEX benefits most from it with regard to trade, jobs and wages
- large and dramatic local effects are visible on the border between US & MEX, because MEX is a more export oriented policy, firms are locating as close as possible to foreign markets. That's why there is an extremely rapid population & manufacturing production growth to see >> large regional disparity in MEX
Can the NAFTA members become a real 'economic union' like the EU?
Relatively to the EU, NAFTA is still in its early stages of economic integration:
- free trade agreement is in place (free trade area)
- capitals flows freely, but there are restrictions in the movement from labor (only partial common market)
- no permanent NAFTA organizations yet & almost all policies are made independently by the three countries >> they choose separately their external tariffs (no customs union) & no common currency (no economic union)
Deeper integration requires permanent common government bodies, labor mobility & development to close economic gap between MEX & other members. Additionally, common external tariff & currency.
The European Union
Economic union of 28 independent nations/states, which has the largest totally integrated market in the world. The state's collaborate on transnational issues but maintain sovereign authorities. The EU is based on subsidiarity, which means, on one side, individual nations are independently, but from other side it tackles issues that are better handled through intern. action >> EU's responsibilities includes, inter Alia, trade, competition, environmental policies, regional development, R&D, as well as economic & monetary union.
Labor market, social safety and health care policies are unclear issues.
The EU institutions & programs are funded by tariffs & goods entering the EU, by taxes and by membership fees based on the side of the country. The two largest expenditures are the agricultural support (e.g. subsidies) & cohesion funds, which support less developed regions
Monetary Union & the convergence criteria
3 stages of monetary union >> 1990: stronger control of capital moving.. 1994: Europ. Monetary Institute in Frankfurt.. 1999: Phased-in introduction of common currency + Europ. Central Bank >> monetary union pushed ahead because potential gains were large & potential costs would lessen when countries integrated; further, single currency became necessary after the removal of capital control
5 convergence criteria (monetary & fiscal policies in preparation for the single currency):
1. Stabilize exchange rates ==> countries had to maintain currency within the exch.-rate mechanism (ERM) band & should not have devalued its currency during 2 years period
2. Control inflation ==> nations had to reduce it to less than 1.5 % above the average of the three lowest rates
3. Harmonize long-term interest rates ==> nominal long-term interest rate must not be more than 2% higher than in the 3 lowest inflation member states
4. Government deficits ==> reduce to less than 3% of national GDP
5. Government debt ==> reduce to less than 60% of national GDP
Nations had to meet all 5 goals, but besides Luxembourg, no other nation could consistently meet all of these targets & some countries would never meet.
Benefits & Costs of Monetary Union
- Eliminates costs of currency conversions
- Reduces the effects of exchange rate uncertainty on trade
& investments, especially when orders for goods are placed before the delivery occurs
- a single currency eliminates monetary independence, because there is "one fits all" monetary policy
- if labor is not fully mobile & business cycles are not synchronized between nations, the same monetary policy may not suit all nations
6 criteria to become member of EU
- having stable institutions
- be a stable, functioning democracy
- respect human rights
- have a market-based economy, that is competitive on the internal market
- adoption of EU wide rules in own nation (accumulated legislations, legal acts & court decisions)
- be a European country
The challenge of European future - 4 major problems with the planned expansion of the EU
In the short-to-medium run, the EU must continue to create convergence in income & living standards between its poorest & most-well-off members.
Widening the EU >> 4 major problems:
1. EU's Common Agricultural Policy >> it is impossible to support new member's agricultural sectors as the budge is not enough => more subsidizing is unfeassible
2. EU's governance structure were not designed for so many members.. New members would add pressure to change the voting system
3. The income gaps between existing EU members and new ones is much larger than with previous accessions >> budget will decrease even more for new members which can lead to conflicts between new and old members
4. Immigration and aging population base ==> more public spendings for health care as elder population increases and therefore, less budget for education & schools >> working age is declining
Latin America & it's economic history
1900-1960: Latin America was one of the fastest-growing regions of the world
1930/50-1980: inward-oriented Import substitution industrialization
> before: LA was depending on agricultural export sector, which were mostly developed & controlled by foreign capital > brought wealth to relatively small number of people => WWI & Great Depression disrupted export flow
> goal to achieve economic growth; government's role was to encourage & protect development of domestic rising industries that country don't need to rely on imports
> protection through high trade barriers & support through tax breaks, subsidies & low interest loan rates => government borrowed heavily from foreign banks to support these infant industries
> ISI series of stages > gradual leveling of production from simple consumer goods to complex industrial products
> Criticism for ISI the same as by MEX
> Many economists are convinced that ISI policies only partly created the economic crisis of the '80s.. Mostly caused by misguided macroeconomic policies which are blamed on populist political movements made by the governmental leaders >> movements using expansionary fiscal & monetary policies to reach specific goals without regard of inflation risks, budget deficits, and foreign exchange constraints
From 1982: Debt crisis/"Lost decade" began
>> main causes: a collapse of oil prices; this undermined ability to earn revenues it needed to service its debt (especially MEX); an increase in intern. interest rates (especially US) made it even more difficult because debt rose
> Solution: increase of capital flow to finance debts & attract new higher investments >> important policy proposal was the 'Baker Plan' (1985), which is renewed lending program by commercial banks (introduced through James Baker) >> BUT! Most banks involved, wanted to lower their exposure to the region, not increase it
>> Restoring capital was not enough, because of that introduction of 'Brady Plan' (1989) >> there was a need for deep reform in the economies of Latin America >> Idea by Nicolas Brady: countries required to reform their economies to obtain debt relief >> this plan didn't end the crisis but was significant step
> after that more open and market-oriented policies
1980s-1990s: the "neoliberal model" and the "Washington Consensus" of 1989 >> policy prescriptions for reform of the government finances & the management of the economy >> these reforms resulted in a return of growth to most countries; however, many problems still persisted: not stable economies, falling prices, poverty & high inequality in income ==> means 'Next generation of reforms' needed
1990s-2000s: Second reforms, which took into account the region's institutions & addressed problems of social & economic inequality (politically very difficult); thats why, they created opportunities for excluded groups >> greater emphasis on primary education & health care (parents which sent their kids to school were monetary granted, also for regular medical check-ups)
Today: recent economic crisis put many reforms 'on hold', but the Latin American countries developed to very open countries aimed at export orientation
Economic populism is usually triggered by three initial conditions...
Focus on economic growth & income redistribution
1. First, there is a deep dissatisfaction with the status quo (usually as a result of slow growth or recession)
2. Second, policy makers reject traditional constraints on macro policy
3. Policy makers promise to raise wages while freezing prices and restructuring the economy by expanding domestic production of imported goods, thereby lessening the need for foreign exchange
==> "reactivating, redistributing, and restructuring"
Stages of populist policies
1. Early in the populist regime, the leaders have justification for their policies >> to stimulate the economy the government spends money and prints money
2. Bottlenecks are created, e.g. construction firms run out of particular inputs
3. Increase in prices & budget deficits/debt
4. Acceleration of inflation
5. Shortages become pervasive
6. Capital flight because of fear of devaluation
7. The flight of capital out of the country depresses investments and further real wages
8. Resort to IMF help
The "neoliberal model" in Latin America
> favoring free markets & minimal government intervention in the economy
> follows 3 separate but interrelated aspects of Neoliberal Reforms (& also, of Washington Consensus):
1. Implementation of stabilization plan >> orthodox or heterodox model >> cutting government spending, reforming tax system, and limiting the creation of new money; later model, also included a freezing of wages & prices
2. Privatization of state-owned enterprises >> plus deregulation & redesign of the regulatory environment of over regulated industries (such as financial service)
3. Elimination of trade barriers >> trade reform had three goals: from ISI to a more export-oriented economy, raise the growth rate of productivity & make consumers better off by lowering the real costs of traded goods
==> with this model the export grew, new kind of products were produced & productivity rose
The "Washington consensus" of 1989 in Latin America
> set of economic policies that constitute a broad consensus among conservative and liberal economists
> 5 macroeconomic reform components:
1. Avoid large budget deficit
2. Spend public money on health, education & basic service
3. Cut taxes, but tax a wider range of activities and improve the collection system
4. Make certain that real interest rates are positive; limit the use of preferential rates
5. Make the exchange rate competitive & credible
> 5 microeconomic reform components:
1. Use tariffs instead of quotas, and gradually reduce them
2. Encourage foreign direct investments
3. Privatize state enterprises in activities where the markets work
4. Remove the barriers to firm entry and eliminate restrictions on competition
5. Guarantee the security of property rights
Brazil, Russia, India & China ==>> according to James O'Neill, these countries are dramatically reshaping the international economy with the potential to change global trade and capital flows
> all BRICs are large, ranking among the world's top 10 in population (41% of world population) & top 11 in GDP
> all have undergone reforms that changed them significant
> each has an abundance of 'unrealized potential' which conceivably have large impacts on the global economy
> in the last 15 years the BRICs countries experienced a big shift in the balance of world economic power (through hard work & careful policies) (A) & a return to a pre-industrial balance of power that was disrupted by 3 things (B): industrial development in the West, imperial ambitions of Western leaders & institutional weaknesses in other parts of the world
India & China historical development
(A) 1700-1950: Chinese cities were as rich as Western cities (e.g. America's) at the beginning of 1700; "Great Divergence" between East & West took place around 1820s >> resulted from several decades of military interventions & colonial rule; by 1870 China and India were losing ground rapidly; by 1950 only 10% of world GDP (1820 it were 50%); between 1820-1950: Both countries should extremely low growth rates
(B) 1950-2000: China & India grew more rapidly in the 1970s/80s and began to catch up and surpass Russia
Russia & Brazil historical development
(A) 1800-1950: Russia & Brazil shared same gains of industrialization Andy they grew 2% a year (no 'Great Divergence') >> By 1950: Russia's GDP was even more than twice the GDP of China & India
(B) 1950-2000: By 1992 Russia's economy was less than half that of China & significantly less than that of India (Break-up of USSR); Brazil showed rapid growth rates till 1960s and then came the Latin American debt crisis; Only mid 1990s rapid growth rates again; By 2010 Brazil's economy was larger than that of Russia and India
Shows population of developed vs. developing countries
Typical for developed countries >> Low death rate, lower birth rate & longer life expectancy (Easter egg shape)
Typical for developing countries >> high death rate, high birth rate & short life expectancy (Pyramid shape)
The reform process of China
Prior to the reform of 1978, private enterprises did not exist and all decisions were made by the government. The reform of the Communist system in China began in 1978. Leader gradual removed the controls exercised by the Communist Party; gradually because there was a lack of experience and information about how to proceed & further, there was a fear of a reaction from the hard-line, conservative anti-reformers. Before the new leader Xiaoping, foreign trade was controlled by 12 foreign trading corporations, with no consideration given to comparative advantage. After, he created Special economic zones that gave local provinces authority to establish economic and trade policy. This attracted foreign investments, and generated large flows of exports, which resulted in an economic growth. China applied to join the GATT in 1986 and gained WTO membership 2001.
The reform process of India
Prior to the reforms of the 1980s, India was characterized as socialist, where the heavy industry was state-owned & the private industries heavy regulated. India's reform began in 1980s and there were 3 forces that played significant roles in the move towards reforms:
> The USSR, India's primary trading partner, dissolved in 1991 (USSR system seemed not to work)
> Other South East Asian countries were having success with reforms (Reforms seemed to work)
> A financial crisis had developed in India as a result of heavy borrowing by the government
The reforms included:
> elimination of a regulatory permitting process that interfered with competition
> de-nationalization (privatization) of the state-owned enterprises (if a firm lost money, government covered the losses Ben if it could use the money for important public projects, such as safe drink water)
> Transition from ISI toward export lead growth policies
> Dismantling of restrictions on international trade and foreign investments
Four all 4 BRICs countries till now on big challenge is remaining: they are not easy places to do business (starting new ones &/or obtaining necessary business permits). These problems existing because of the role of the government & its relations to business, which is so-called: "State capitalism" >> that are capitalist economies with private ownership playing a dominant role, but these economies use the power and authority of their national governments to still control a significant share of the industry >> national government uses economy for national purposes
The BRICs in the World economy and their influences
> profoundly influenced the direction of world trade & investment, as they shifted from low growth, isolationist policies toward high growth & integration with the world economy
> multinational businesses have quickly moved to establish production and distribution networks inside the BRICs, and BRIC firms have begun to invest outside their home markets
> since August 2012, all 4 BRICs are members of the WTO
Trade characteristics of BRICs
In all BRICs rising shares of world trade & foreign direct investments. All four are moving towards the production of high-tech products in the future.
> famous for its software & sophisticated business services
The outsourcing of services from high-income industrial countries to India is huge
> fear is that all computer & IT trade will end up in developing countries (but seems highly unlikely, because, e.g. in US the job growth of IT-related occupations is rising)
> emphasis is on manufacturing >> aiming to become a major high-tech producer
> China's emergence as a manufacturing exporter and high-volume manufacturer of consumer goods (Alibaba) challenges existing trade patterns & manufacturing trends
> challenge to middle-income markets is to overcome the dependence to China's low wages (their comp. adv.)
> has several comp. adv. in manufacturing, such as, low-wage & low-skilled labor, scale economies, coastal are for logistic purposes for trading internationally
> has also institutional disadvantages that reduce China's competitiveness, such as, business climate is bad (copy of brands)
> China's rapid growth has increased it's demand for natural resources as it is scarce in them (except coal) >> world prices for these resources enormously increased (partly because of Chinese demand) >> resource producer, like Africa & Brazil, make lots of money with China >> long-term agreements
Unresolved Issues in China
1. Unbalanced trade
> competition created by the rapid growth of China's exports has generated pressures for protectionism in a number of countries
> China uses the process of "sterilization" to keep the Chinese currency (renminbi) from rising in value (keep it low) >> Central bank counteracts the money inflows so that they don't affect the exchange rate or domestic prices >> normally, the large export surplus & inflows of FDI create high demand for renminbi (drive value of currency up), but the central bank intervenes to supply the additional money demand & takes large portions of the newly created money off the market by selling bonds ==> "sterilize" the inflows of dollars > kind of currency manipulation
2. Environmental pressure
> China has 16 of the 20 most polluted cities in the world >> large coal deposits >> will become a major producer of carbon dioxide
> future economic success is likely to depend significantly on its ability to respond to the negative effect of environmental destruction created by growth
3. State capitalism
> market forces are used and relied on, but when a market outcome is thought to be harmful or less beneficial to the national interests, the state intervenes (e.g. Highly subsidizing certain industries)
> this has creates significant trade tensions with the US and the EU, where this method is viewed as unfair trade practice
4. Political reform &. Protest
> in China the communist party controls all political processes >> main goals: maintain stability
> however, with the rise in income & prosperity and the growth in independent, non-governmental sources of wealth and political influences, they have to take into account the impact of their decisions on these other, newer bases of power
> moreover, Chinese population has rising expectations
> in this respect, freer markets & access to information make it more challenging for the communist party to maintain social control
BRICs success (especially China's) will add pressures to limit their participation in the world markets >> bilateral agreements with voluntary export restraints (export quotas). Large populations in the BRICs countries still live in poverty >> losers & winners >> rising social protest & dissatisfaction in China >> China's growing inequality is seen as potential threat to the current system
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