ECS3702 SUMMARISED STUDY NOTES 2022

ECS3702 SUMMARISED STUDY NOTES 2022.WORLD TRADE AND THE NATIONAL ECONOMY International Economics It is concerned with the exchange of goods, services, factors of production and capital across national boundaries. International Trade The reasons for and the benefits/gains from international trade are no different from those associated with domestic transactions - as with domestic transactions, international transactions offer the benefits of specialisation, allowing us to gain increased output from a given amount of inputs. Voluntary trade is therefore held to be mutually beneficial, increasing the economic welfare of all parties involved in such. It is the conduct of trade, rather than the benefits that flow from it, that distinguish international transactions from domestic transactions. Differences in the way in which international trade is conducted arise as a result of influences such as:  Exchange rates: transactions within a country are financed by that country's own currency. International transactions, on the other hand, require, for example, that importers convert their own currency into the currency of the country from which they are purchasing the imported goods. Such conversion takes place via exchange rates, which are subject to change, and therefore introduce an element of risk into such transactions that does not occur with domestic transactions;  Commercial policies: a national government may impose a variety of restrictions upon international transactions that cannot be imposed upon domestic transactions. Examples may include tariffs, import quotas, export subsidies and exchange controls;  Different domestic policies: national governments have differing views as to the aims of fiscal/monetary policy. This can result in varying levels of inflation between trading partners, affecting their competitive positions;  Statistical data: the detailed tracking of all transactions between a country and its trading partners means that statistics regarding international transactions tend to be of a greater depth than those relating to domestic transactions;  Relative immobility of factors of production: It is far easier for production factors to move around within the borders of a country than to move between countries; Created by Achievers Tutorial Centre (Pretoria Campus) - 078 628 2401  Marketing considerations: Companies cannot always apply the same marketing techniques that have proven to be successful in one country to other international markets. Different countries often have different demand patterns and market requirements. These necessitate the formulation of sales techniques appropriate to such. Created by Achievers Tutorial Centre (Pretoria Campus) - 078 628 2401 International Transactions - An Empirical Glimpse Some Interesting Statistics:  Between 1958 and 2004, the value of world exports increased from $108 billion to $8.8 trillion, as measured at constant dollars ;  In 2004, the US generated nearly 10% of the value of world exports, and consumed nearly 17% of the value of world imports;  In 2004, Germany also generated 10% of the value of world exports, and consumed nearly 8% of the value of world imports;  In 2004, China replaced Japan as the world's third largest exporter;  In 2003, more than a quarter of world trade was conducted between Western European countries;  The US is the leading exporter and importer of commercial services (shipping, banking, communications, etc);  Direct foreign investment (e.g. the setting up by domestic companies of manufacturing plants in foreign countries) is growing rapidly. As a result of the above, a global marketplace for the production and distribution of goods is emerging. This process is referred to as globalisation. Globalisation has led to a situation where international trade and direct foreign investment are expanding faster than global output. Over the last 45 years or so, the volume of world exports has increased by an annual average compound rate of 6.2%, while world output increased by 3.8% per annum over the same period. Indicators of International Trade Much of the growth in trade has been not only in commodities, but also in services (tourism, shipping, banking communications etc), the latter accounting for a fifth of world exports in 2003. A further indicator of growing globalisation, as mentioned above, is the increasing extent of direct foreign investment, the US being the main recipient of such, with the EU being one of the largest sources of DFI. Table 1.1A (P. 4, P.T.) indicates global merchandise trade. A glance quickly reveals the dominant position of Germany as the world's leading exporter of merchandise, and that of the US as the dominant importer of merchandise. Due to its commercial links with member countries of the Commonwealth, the UK is second only to the US in the exporting of services, and behind only the US and Germany in the importing of such (see Table 1.1C, P.5 P.T.) Table 1.1B (P. 5, P.T.) also indicates the growing importance of Asia as a contributor to world trade, especially the increasing influence of China as it moves from a command to a market-oriented economy. Created by Achievers Tutorial Centre (Pretoria Campus) - 078 628 2401 FOREIGN TRADE IN THE US NATIONAL ECONOMY The importance of the US economy with regard to world trade should not be underestimated. It is the leading trading nation, being the largest importer and exporter of goods and services. It therefore goes without saying that changes in the level of demand in the US have profound implications for the rest of the world - a recession in the US will have a recessionary effect upon all trading nations who export goods/services to the US. Although the US is the world's largest exporter and importer of goods and services, it remains a relatively closed economy. This is indicated by the fact that, as a percentage of the GDP of the US, the value of its exports and imports is relatively small (10% and 15% respectively in 2004). The ratio of exports or imports to a country's GDP is called its index of openness:  Developing countries tend to have higher indices of openness, as they themselves cannot produce the wide variety of goods and services required by their populations. They are often heavily reliant upon the primary sector of their economy, and therefore need to export goods/services in order to be able to pay for the more sophisticated goods/services that they cannot produce themselves;  Developed countries, on the other hand, are more able to meet the needs of their populations, due to the more diversified nature of the more modern type of economy. It is important for students to be wary of over-interpreting the value obtained for the index of openness. A substantial part of the value of those goods exported by a country may actually consist of inputs that were imported into the country to facilitate production. With specific reference to goods in transit, the domestic component of output contributed by the exporting country to the value of the good may be virtually negligible, being little more than trans-shipment and transport activities. Such goods are generally referred to as re-exported goods. Furthermore, as not all value added to exports takes place domestically, the export ratio (value of exports as proportion of GDP) can exceed 100% (for example, Singapore). Geographical size can also distort the openness measure, as can the question of whether we are referring to average or marginal entities. For example, if a country has a relatively small import sector, but new economic growth in a particular industry requires the use of a substantial volume of imported goods, then the marginal import ratio (change in imports in relation to a unit increase in domestic product) will be high. However, the average import ratio (total imports to total domestic product) may not be so high. Degree of openness may also differ greatly between industries within the same economy. If the domestic industry has to deal with a high degree of competition from foreign manufacturers, then the import ratio (ratio of imports to domestic output) will tend to be high. Such an industry is referred to as an import-competing industry. Created by Achievers Tutorial Centre (Pretoria Campus) - 078 628 2401 On the other hand, if the industry sells most of its output on foreign markets, then the export ratio (ratio of exports to domestic output) will be high. Such an industry is referred to as an export-competing industry. Created by Achievers Tutorial Centre (Pretoria Campus) - 078 628 2401 From Table 1.3, P. 8, P.T.:  The US is a large exporter of both manufactured goods and primary sector products (the latter due to its substantial agricultural sector);  Japan is heavily reliant upon the import of food, oil and other raw materials, exporting mainly manufactured goods (99% of exports). The increasing importance of India, Japan and other Asian countries in the world economy, and the economic integration of much of Europe via the European Union (EU), have all served to decrease the dominance of the US in global trade, creating a tripolar trading system between the US, Asia and the EU. Despite the US being, for the most part, economically self-sufficient, there are certain strategic areas where it is heavily reliant upon imports e.g. oil, platinum. SOUTH AFRICA IN WORLD TRADE SA has an index of openness value of more than 20%, and is therefore a relatively open economy. The value of the index decreased between 1985 and 1994. This was not, as might have been expected, due to a drop in the value of exports as a result of trade sanctions - the strategic value of SA precious/base metals and minerals to the US and the rest of the world ensured that trade in such continued. However, financial sanctions did result in large-scale capital flight. To compensate for such, and to reduce imports, the government then imposed tight monetary and fiscal policies, which slowed the level of economic growth in SA. Thus exports remained high as a percentage of GDP, giving a high index of openness value. This was pushed even higher after 1994, when the removal of sanctions, combined with continued export growth and sluggish GDP growth, pushed the index value higher, to around 27% in 2001, where it has hovered ever since. Table 1.1, P. 5, UNISA Study Guide, indicates the division of SA imports and exports between SA's main trading partners: Germany, the US, the UK, Japan, and the newcomer, China. In recent years, the US has diminished while the EU has increased in importance as a trading partner with SA. SA is also increasingly used by many countries as a port of entry into the rest of Africa, particularly with regard to trade in electronic products. As previously mentioned, China is also becoming an increasingly important trading partner. SA exports remain reliant, for the most part, on primary sector products, although the contribution of manufactured and semi-processed products has increased significantly. SA is no longer totally dependent upon the export of a few primary products, and may therefore now be classified as a semi-industrialised country, the contribution of the industrial sector to exports steadily increasing (e.g. motor vehicles). Created by Achievers Tutorial Centre (Pretoria Campus) - 078 628 2401 However, we remain heavily reliant upon imported oil and capital machinery. A FINAL WORD Despite the potential drawbacks of international trade (e.g. cheaper imports taking market share from domestic firms):  Consumer choice is widened;  Producers can market their products beyond national borders;  Producers can open manufacturing plants in foreign countries;  Increased competition can curb domestic monopoly power and provide impetus for technological innovation;  Foreign imports can be used to curb inflationary pressures (by, perhaps, relaxing import restrictions in order to increase supply in the domestic economy). Created by Achievers Tutorial Centre (Pretoria Campus) - 078 628 2401 CHAPTER TWO WHY NATIONS TRADE: THE CLASSICAL THEORY INTRODUCTION Any discussion of international trade must first consider the following:  Why do countries trade?  Why do some nations export some goods and import others?  What determines the terms of trade (what determines the relative prices of goods traded between countries)?  What gains are made by nations as a result of participating in trade? To answer these questions, we first consider a brief history of the development of "trade theory", and then apply theoretical principles to explain the results of international trade. EARLY THEORIES ON TRADE The first theoretical explanations of international trade include those of the mercantilists, and that of the classical theorists. MERCANTILISM International trade can be viewed as either a:  Zero sum game: a situation or interaction in which one participant's gains result only from another's equivalent losses; or as a  Positive sum game: a situation where the outcomes are such that the sum of winnings and losses is greater than zero. This becomes possible when the size of the pie is somehow enlarged so that there is more wealth to distribute between the parties than there was originally, or some other way is devised so everyone gets what they want or need. The mercantilists, a group of writers during the period 1500 to 1800, believed that trade was a zero sum game. They held that the motivation for trade was self-interest, and that the gains of the "winners" from trade were only obtained as a result of the "losses" of the losers. The mercantilists measured the economic welfare of a country in part by the size of its foreign trade surplus. If a country exported more than it imported, then it would have a favourable balance of trade, which would result in an inflow of gold and silver from its trading partners. The latter would encourage demand within the domestic economy, increasing economic activity (output, employment etc). Created by Achievers Tutorial Centre (Pretoria Campus) - 078 628 2401 To achieve such, the mercantilists argued in favour of government imposition of tariffs, etc. on imports, accompanied by simultaneous implementation of policies to encourage exports. Such strategies obviously reflect the self-interest that tended to motivate trade at the time. However, the mercantilist approach failed to fully explain the welfare benefits of trade, while they themselves remained unaware as to the further effects of a trade surplus on the domestic economy. With regard to the latter, the classical theorist David Hume showed that a favourable trade balance tends to be a temporary phenomenon, as it can lead to higher domestic inflation (more money chasing the same quantity of goods). The resultant higher prices for domestically produced goods tends to adversely affect the international competitiveness of the economy's exports, thereby encouraging more imports into the country. Another classical theorist, Adam Smith, also refuted the mercantilists belief that "the size of the world's economic pie is constant", and therefore a nation may only gain from trade at the expense of its trading partners. Smith argued that world output was not a fixed amount, but rather that trade between countries afforded the possibility for the latter to specialise in the production of particular goods, improving productivity through the division of labour, and ultimately leading to an increase in world output. Furthermore, both Smith and another classical theorist, David Ricardo, argued that countries who are partners in trade can simultaneously achieve higher output levels of production and consumption as a result of free trade. CLASSICAL THEORISTS ABSOLUTE ADVANTAGE (ADAM SMITH) In "The Wealth of Nations" (1776), Adam Smith argued for the benefits of free trade between countries. Smith was writing at a time when factory-based production was becoming an increasingly important part of the total output of the UK economy, due in large part to the implementation of "division of labour"-based production practices. Output over and above that which was required for the domestic economy could be exported. Smith argued that nations should concentrate on the production of those goods that they could produce most cheaply. Students should note that the cost of production would also be affected by factors other than simply the production method used - the cost of labour in each country, for instance. Indeed, Smith argued that the main determinant of production costs would be the productivity of labour. His argument regarding the determination of absolute advantage and trade was therefore primarily based upon a consideration of "supply-side factors". He tended to ignore the effect of changes in demand, which he held to be of a temporary nature. Created by Achievers Tutorial Centre (Pretoria Campus) - 078 628 2401 From Smith's perspective, the principle of absolute advantage provides an explanation both of:  the pattern of trade; and  the gains from trade...