ECS 3702: International Trade
Salvatore D, 2014, International Economics: Trade and finance: 11th Edition
Learning unit:1
Introduction
1.2 International economic theories and policies
The purpose of economic theory in general is to predict and explain. That is, economic
theory abstracts from the details surrounding an economic event in order to isolate the few
variables and relationships deemed most important in predicting and explaining the event.
Along these lines, international economic theory usually assumes a two-nation, two-
commodity, and two-factor world. It further assumes no trade restrictions to begin with,
perfect mobility of factors within the nations but no international mobility, perfect
competition in all commodity and factor markets, and no transportation costs.
International economic theory examines the basis for and the gains from trade, the
reasons for and the effects of trade restrictions, policies directed at regulating the flows of
international payments and receipts, and the effects of these policies on a nation’s welfare
and on the welfare of other nations. International economic theory also examines the
effectiveness of macroeconomic policies under different types of international monetary
arrangements or monetary systems.
International trade theory analyzes the basis and the gains from trade. International trade
policy examines the reasons for and the effects of trade restrictions. The balance of
payments measures a nation’s total receipts from and the total payments to the rest of the
world, while foreign exchange markets are the institutional framework for the exchange of
one national currency for others. Finally, open-economy macroeconomics deals with the
mechanisms of adjustment in balance-of-payments disequilibria (deficits and surpluses).
More importantly, it analyzes the relationship between the internal and the exter- nal
sectors of the economy of a nation, and how they are interrelated or interdependent with
the rest of the world economy under different international monetary systems.
International trade theory and policies are the microeconomic aspects of international
economics because they deal with individual nations treated as single units and with the
(relative) price of individual commodities. On the other hand, since the balance of
payments deals with total receipts and payments, as well as with adjustment and other
economic policies that affect the level of national income and the general price level of the
nation as a whole, they represent the macroeconomic aspects of international economics.
These are often referred to as open-economy macroeconomics or international finance.
International economic relations differ from interregional economic relations (i.e., the
economic relations among different parts of the same nation)
,1.3 The globalisation of the world economy
We live in a globalized world. We can connect instantly with any corner of the world by
cellular phone, e-mail, instant messaging, and teleconferencing, and we can travel
anywhere incredibly fast. Tastes are converging (i.e., more and more people all over the
world generally like the same things) and many goods we consume are either made
abroad or have many imported parts and components. Many of the services we use are
increasingly provided by foreigners as, for example, when a radiography taken in a New
York hospital is evaluated across the world in Bangalore (India) and when H & R Block
sends our tax returns abroad for processing. Even small companies that until a few
decades ago faced only local or regional competition now must compete with firms from
across the globe.
Although not as free as the flow of international trade in goods and services, millions of
workers at all skill levels have migrated around the world, and thousands of jobs have
moved from advanced countries to such emerging markets as India and China.
Finance has also globalized: We can invest in companies anywhere in the world and
purchase financial instruments (stocks and bonds) from any company from almost
anywhere in the world. Many pension funds are in fact invested abroad and a financial
crisis in one financial center quickly spreads across the world at the click of a mouse. We
can exchange dollars for euros and most other currencies easily and quickly, but the rates
at which we exchange our currency often change frequently and drastically. In short,
tastes, production, competition, labor markets, and financial markets are rapidly
globalizing, and this affects all of us deeply as consumers, workers, investors, and voters.
Although labor migration generally leads to the more efficient utilization of labor, it also
leads to job losses and lower wages for less-skilled labor in advanced nations and harms
(i.e., it is a “brain drain” for) the nations of emigration. Similarly, financial globalization and
unrestricted capital flows lead to the more efficient use of capital throughout the world, as
well as provide opportunities for higher returns and risk diversification for individuals and
corporations. But they also seem to lead to periodic international financial crises.
Antiglobalization movement, which blames globalization for many human and
environmental problems throughout the world, and for sacrificing human and
environmental well-being to the corporate profits of multinationals. Globalization is being
blamed for world poverty and child labor in poor countries, job losses and lower wages in
rich countries, as well as environmental pollution and climate change throughout the world.
Globalization is important because it increases efficiency in the production of material
things; it is inevitable because we cannot hide or run away from it. But we would like
globalization also to be sustainable and humanizing.
,1.4 International trade and the nations standard of living
A rough measure of the economic relationship among nations, or their interdependence, is
given by the ratio of their imports and exports of goods and services to their gross
domestic product (GDP). The GDP refers to the total value of all goods and services
produced in the nation in a year.
The economic interdependence among nations has been increasing over the years, as
measured by the more rapid growth of world trade than world production.
But there are many other crucial ways in which nations are interdependent, so that
economic events and policies in one nation significantly affect other nations (and vice
versa). For example, if the United States stimulates its economy, part of the increased
demand for goods and services by its citizens spills into imports, which stimulate the
economies of other nations that export those commodities. On the other hand, an increase
in interest rates in the United States is likely to attract funds (capital) from abroad and
increase the international value of the dollar. This stimulates U.S. imports and discourages
U.S. exports, thus dampening economic activity in the United States and stimulating it
abroad.
Finally, trade negotiations that reduce trade barriers across nations may lead to an
increase in the exports of high-technology goods (such as computers) and thus to an
increase in employment and wages in those industries in the United States, but also to an
increase in imports of shoes and textiles, thereby reducing employment and wages in
those sectors.
1.5 South Africa in world trade
The Gravity model postulates that (other things equal), the bilateral trade between two
countries is proportional, or at least positively related, to the product of the two countries’
GDPs and to be smaller the greater the distance between the two countries (just like in
Newton’s law of gravity in physics). That is, the larger (and the more equal in size) and the
closer the two countries are, the larger the volume of trade between them is expected to
be.
Besides trade in goods and services, the international flow of people (migration) and
capital across national boundaries is another measure or indicator of economic integration
and globalization in the world economy.
Migration is generally more restricted and regulated than the international flow of goods,
services, and capital. (International labor migration is examined in detail in Section 12.6.)
In general, capital flows more freely across national boundaries than people. Financial or
portfolio capital (bank loans and bonds) generally move to nations and markets where
interest rates are higher, and foreign direct investments in plants and firms flows to nations
where expected profits are higher. This leads to the more efficient use of capital and
generally benefits both lenders and borrowers.
, 1.6 Current international economic problems and challenges
The most serious economic problem in the world today is the slow growth and high
unemployment facing the United States and most other advanced countries. On the trade
side, the most serious problem is rising protectionism in advanced countries in the context
of a rapidly globalizing world. On the monetary side are the excessive volatility of
exchange rates (i.e., the very large fluctuations in the international value of national
currencies) and their large and persistent misalignments (i.e., the fact that exchange rates
can be far out of equilibrium for long periods of time). Other serious international economic
problems are the deep structural imbalances in the United States, slow growth in Europe
and Japan, and insufficient restructuring in the transition economies of Central and
Eastern Europe; the deep poverty in many developing countries; and resource scarcity,
environmental degradation, and climate change, and the danger they pose for continued
growth and sustainable world development. A brief description of these problems and
challenges follows.
1. Slow Growth and High Unemployment in Advanced Economies after “the Great
Recession”
2.Trade Protectionism in Advanced Countries in a Rapidly Globalizing World
3.Excessive Fluctuations and Misalignment in Exchange Rates and Financial Crises
4.Structural Imbalances in Advanced Economies and Insufficient Restructuring in
Transition Economies
5.Deep Poverty in Many Developing Countries
6.Resource Scarcity, Environmental Degradation, Climate Change, and Unsustainable
Development
Learning unit: 2
Why nations trade: the classical theory
2.1 Introduction
2.2 Mercantilists view on trade
During the seventeenth and eighteenth centuries a group of men (merchants, bankers,
government officials, and even philosophers) wrote essays and pamphlets on international
trade that advocated an economic philosophy known as mercantilism. Briefly, the
mercantilists maintained that the way for a nation to become rich and powerful was to
export more than it imported. The resulting export surplus would then be settled by an
Salvatore D, 2014, International Economics: Trade and finance: 11th Edition
Learning unit:1
Introduction
1.2 International economic theories and policies
The purpose of economic theory in general is to predict and explain. That is, economic
theory abstracts from the details surrounding an economic event in order to isolate the few
variables and relationships deemed most important in predicting and explaining the event.
Along these lines, international economic theory usually assumes a two-nation, two-
commodity, and two-factor world. It further assumes no trade restrictions to begin with,
perfect mobility of factors within the nations but no international mobility, perfect
competition in all commodity and factor markets, and no transportation costs.
International economic theory examines the basis for and the gains from trade, the
reasons for and the effects of trade restrictions, policies directed at regulating the flows of
international payments and receipts, and the effects of these policies on a nation’s welfare
and on the welfare of other nations. International economic theory also examines the
effectiveness of macroeconomic policies under different types of international monetary
arrangements or monetary systems.
International trade theory analyzes the basis and the gains from trade. International trade
policy examines the reasons for and the effects of trade restrictions. The balance of
payments measures a nation’s total receipts from and the total payments to the rest of the
world, while foreign exchange markets are the institutional framework for the exchange of
one national currency for others. Finally, open-economy macroeconomics deals with the
mechanisms of adjustment in balance-of-payments disequilibria (deficits and surpluses).
More importantly, it analyzes the relationship between the internal and the exter- nal
sectors of the economy of a nation, and how they are interrelated or interdependent with
the rest of the world economy under different international monetary systems.
International trade theory and policies are the microeconomic aspects of international
economics because they deal with individual nations treated as single units and with the
(relative) price of individual commodities. On the other hand, since the balance of
payments deals with total receipts and payments, as well as with adjustment and other
economic policies that affect the level of national income and the general price level of the
nation as a whole, they represent the macroeconomic aspects of international economics.
These are often referred to as open-economy macroeconomics or international finance.
International economic relations differ from interregional economic relations (i.e., the
economic relations among different parts of the same nation)
,1.3 The globalisation of the world economy
We live in a globalized world. We can connect instantly with any corner of the world by
cellular phone, e-mail, instant messaging, and teleconferencing, and we can travel
anywhere incredibly fast. Tastes are converging (i.e., more and more people all over the
world generally like the same things) and many goods we consume are either made
abroad or have many imported parts and components. Many of the services we use are
increasingly provided by foreigners as, for example, when a radiography taken in a New
York hospital is evaluated across the world in Bangalore (India) and when H & R Block
sends our tax returns abroad for processing. Even small companies that until a few
decades ago faced only local or regional competition now must compete with firms from
across the globe.
Although not as free as the flow of international trade in goods and services, millions of
workers at all skill levels have migrated around the world, and thousands of jobs have
moved from advanced countries to such emerging markets as India and China.
Finance has also globalized: We can invest in companies anywhere in the world and
purchase financial instruments (stocks and bonds) from any company from almost
anywhere in the world. Many pension funds are in fact invested abroad and a financial
crisis in one financial center quickly spreads across the world at the click of a mouse. We
can exchange dollars for euros and most other currencies easily and quickly, but the rates
at which we exchange our currency often change frequently and drastically. In short,
tastes, production, competition, labor markets, and financial markets are rapidly
globalizing, and this affects all of us deeply as consumers, workers, investors, and voters.
Although labor migration generally leads to the more efficient utilization of labor, it also
leads to job losses and lower wages for less-skilled labor in advanced nations and harms
(i.e., it is a “brain drain” for) the nations of emigration. Similarly, financial globalization and
unrestricted capital flows lead to the more efficient use of capital throughout the world, as
well as provide opportunities for higher returns and risk diversification for individuals and
corporations. But they also seem to lead to periodic international financial crises.
Antiglobalization movement, which blames globalization for many human and
environmental problems throughout the world, and for sacrificing human and
environmental well-being to the corporate profits of multinationals. Globalization is being
blamed for world poverty and child labor in poor countries, job losses and lower wages in
rich countries, as well as environmental pollution and climate change throughout the world.
Globalization is important because it increases efficiency in the production of material
things; it is inevitable because we cannot hide or run away from it. But we would like
globalization also to be sustainable and humanizing.
,1.4 International trade and the nations standard of living
A rough measure of the economic relationship among nations, or their interdependence, is
given by the ratio of their imports and exports of goods and services to their gross
domestic product (GDP). The GDP refers to the total value of all goods and services
produced in the nation in a year.
The economic interdependence among nations has been increasing over the years, as
measured by the more rapid growth of world trade than world production.
But there are many other crucial ways in which nations are interdependent, so that
economic events and policies in one nation significantly affect other nations (and vice
versa). For example, if the United States stimulates its economy, part of the increased
demand for goods and services by its citizens spills into imports, which stimulate the
economies of other nations that export those commodities. On the other hand, an increase
in interest rates in the United States is likely to attract funds (capital) from abroad and
increase the international value of the dollar. This stimulates U.S. imports and discourages
U.S. exports, thus dampening economic activity in the United States and stimulating it
abroad.
Finally, trade negotiations that reduce trade barriers across nations may lead to an
increase in the exports of high-technology goods (such as computers) and thus to an
increase in employment and wages in those industries in the United States, but also to an
increase in imports of shoes and textiles, thereby reducing employment and wages in
those sectors.
1.5 South Africa in world trade
The Gravity model postulates that (other things equal), the bilateral trade between two
countries is proportional, or at least positively related, to the product of the two countries’
GDPs and to be smaller the greater the distance between the two countries (just like in
Newton’s law of gravity in physics). That is, the larger (and the more equal in size) and the
closer the two countries are, the larger the volume of trade between them is expected to
be.
Besides trade in goods and services, the international flow of people (migration) and
capital across national boundaries is another measure or indicator of economic integration
and globalization in the world economy.
Migration is generally more restricted and regulated than the international flow of goods,
services, and capital. (International labor migration is examined in detail in Section 12.6.)
In general, capital flows more freely across national boundaries than people. Financial or
portfolio capital (bank loans and bonds) generally move to nations and markets where
interest rates are higher, and foreign direct investments in plants and firms flows to nations
where expected profits are higher. This leads to the more efficient use of capital and
generally benefits both lenders and borrowers.
, 1.6 Current international economic problems and challenges
The most serious economic problem in the world today is the slow growth and high
unemployment facing the United States and most other advanced countries. On the trade
side, the most serious problem is rising protectionism in advanced countries in the context
of a rapidly globalizing world. On the monetary side are the excessive volatility of
exchange rates (i.e., the very large fluctuations in the international value of national
currencies) and their large and persistent misalignments (i.e., the fact that exchange rates
can be far out of equilibrium for long periods of time). Other serious international economic
problems are the deep structural imbalances in the United States, slow growth in Europe
and Japan, and insufficient restructuring in the transition economies of Central and
Eastern Europe; the deep poverty in many developing countries; and resource scarcity,
environmental degradation, and climate change, and the danger they pose for continued
growth and sustainable world development. A brief description of these problems and
challenges follows.
1. Slow Growth and High Unemployment in Advanced Economies after “the Great
Recession”
2.Trade Protectionism in Advanced Countries in a Rapidly Globalizing World
3.Excessive Fluctuations and Misalignment in Exchange Rates and Financial Crises
4.Structural Imbalances in Advanced Economies and Insufficient Restructuring in
Transition Economies
5.Deep Poverty in Many Developing Countries
6.Resource Scarcity, Environmental Degradation, Climate Change, and Unsustainable
Development
Learning unit: 2
Why nations trade: the classical theory
2.1 Introduction
2.2 Mercantilists view on trade
During the seventeenth and eighteenth centuries a group of men (merchants, bankers,
government officials, and even philosophers) wrote essays and pamphlets on international
trade that advocated an economic philosophy known as mercantilism. Briefly, the
mercantilists maintained that the way for a nation to become rich and powerful was to
export more than it imported. The resulting export surplus would then be settled by an
