free trade

absence of government imposed barriers (ex: quotas, duties) that impede free flow of goods and services between countries

new trade theory

1. specialization of production
2. realization of economies of scale
3. production of greater variety of products
4. lower prices

mercantilism

economic philosophy advocating that countries should simultaneously encourage exports and discourage imports

gold & silver = power

zero-sum game

absolute advantage

nations should never produce what it can buy cheaper abroad

factor endowments

extent to which a country is endowed with such resources as land, labor and capital

economies of scale

cost advantages associated with large-scale production

first mover advantages

advantages accruing to the first to enter a market

ability to capture economies of scale ahead of later entrants = lower cost structure

benefits of trade

1. specialization of production
2. realization of economies of scale
3. production of greater varieties of products
4. lower prices

comparative advantage

nation should specialize in production of those goods it produces most efficiently and buy goods it produces less efficiently from other countries

Samuelson Critique

lower prices for US consumers may not be enough to produce net gain for US economy if it lowers real wage rates

Hecksher-Olin Theory

shows that is beneficial for a country to engage in foreign trade even for products it is able to produce for itself

Leontief Paradox

US relatively abundant in capital but US exports less capital intensive than US imports

Porter's Diamond

1. firm strategy, structure and rivalry
2. demand conditions
3. related and supp. industries
4. factor endowments

tariffs

tax levied on imports that effectively raises the cost of imported products relative to domestic products

specific tariffs = fixed charge

ad valorem = proportionate charge

subsidy

government payment to a domestic producer

helps domestic producers...

compete against low-cost foreign markets

gain export markets

import/export quota

direct restriction on the quantity of some good that may be imported/exported into a country

voluntary export restraints

quotas on trade imposed by the exporting country, typically at the request of the importing country's government

local content requirement

demands that some specific fraction of a good be produced domestically (can be physical or value)

dumping

selling a product at an "unfairly" low price

• unload excess production in foreign markets
• can be predatory

administrative policies

bureaucratic rules that are designed to make it difficult for imports to enter a country

embargo

complete ban on trade (imports and exports) in one of more products with a particular country

Smoot-Hawley Act

1930

created significant import tariffs on foreign goods -- led to greater depression, low world trade

GATT

General Agreement on Tariffs and Trade (1947)

multilateral agreement to liberalize trade

WTO

World Trade Organization

Liberalize trade

Negotiate trade agreements

Settle trade disputes

System of trade rules

History of GATT/WTO

1947: GATT

1986: WTO

1995-2006: 340 trade disputes

1999: WTO -- free trade = mainstream

2010: 135 members

foreign exchange

market

market for converting currency of one country into that of another country's

currency speculation

short-term movement of funds from one currency to another in hopes of profiting from shifts in exchange rates

transaction exposure

extent to which the income from individual transactions is affected by fluctuations in foreign exchange values

ex: being held to a previously contract price

economic exposure

extent to which a firm's future international earning power is affected by changes in exchange rates.

concerned w/ long term effect of changes in exchange rates on future prices, sales and costs

translation exposure

impact of currency exchange rate changes on the reported financial statements of a company

ex: value of foreign subsidiary

spot exchange rate

rate at which foreign exchange dealer converts one currency into another currency on a particular day

determined by interaction of supply & demand -- changes continually

forward exchange rate

occurs when two parties agree to exchange currency and execute the deal at some specific date in the future

currency swap

simultaneous purchase and sale of a given amount of foreign exchange for two different value dates

used when it is desirable to move out of one currency into another for a limited period w/o incurring foreign exchange rate risk

regional economic integration

agreements among countries in a geo region to reduce and ultimately remove tariff and nontariff barriers to free flow of goods and services and factors of production

free trade area

no barriers between goods and services trade

common market

no trade barriers; common external trade policy, factors of production can move freely -- labor/capital move freely

economic union

free flow of products, factors of production; requires common currency, harmonization of members' tax rates, common monetary/fiscal policy

political union

central political apparatus coordinates economic, social and foreign policy

NAFTA

abolition of tariffs

removal of most barriers

protection of intellectual property

removal of most restrictions

app of ntl enviro standards

establishment of 2 commissions

Andean Community

unites Bolivia, Chile, Ecuador, Columbia and Peru in free trade, unsuccessful

low economic growth, hyperinflation, high unemployment, political unrest, crushing debt burdens

MERCOSUR

free trade pact b/w Brazil, Argentina, Paraguay, Urugua and  Venezuela 1988

modest reduction in tariffs/quotas -- 80% increase in trade

CAFTA

ASEAN

attempt at regional economic integration between Brunei, Cambodia, Indonesia,  Load, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam

foreign exchange risk

possibility that unpredicted changes in future exchange rates will have adverse consequences for firm

Avoid by:

using spot exchange rates, forward exchange rates, currency swaps

law of one price

purchasing power parity (PPP) theory

argues that given relatively efficient markets (few impediments to intl trade and investment exist) the price of a "basket of goods" should be roughly equivalent in each country

exchange rate = price of good in country1/price of good in country2

currency convertability:

freely convertible

both residents and non-residents can purchase unlimited amounts of foreign currency with the domestic currency

currency convertibility:

externally convertible

when only non-residents can convert their holdings of domestic currency into a foreign currency

currency convertibility:

nonconvertibile

when both residents and non-residents are prohibited from converting their holdings of domestic currency into a foreign currency

levels of economic integration

political union

economic union

common market

customs union

free trade area

case for political integration

connecting countries through trade decreases likelihood of violent conflict/war

linked economic power leads to more political power on world stage

case against political integration

national soverignty issues

may cause problems with relations with other countries/blocks of countries

case for economic integration

unrestricted free trade and FDI -- economic growth

trade creation : resources shift from least to most efficient producers

economies of scale

increase competition leads to increased efficiency

case against economic integration

trade diversion : discrimination against outside producers, diverts trade less-efficient producers within the country or group

some may benefit more than others

economic integration in Europe

1. European Commission - proposes EU legislation, implements it, monitors compliance

2. European Council - ultimate controlling authority within EU

3. European Parliament - debates legislation proposed by commission and forwarded it to council

4. Court of Justice - supreme appeals court for EU law

European Union

product of:

devastation of western europe from wwii, desire for lasting piece

european nations desire to hold their own in political/economic scene

Treaty of Rome -- 1957

establishment of the Euro

Maastricht Treaty (1991) EU members must adopt single currency by 1992

Arguments for

NAFTA

• enlarged, more efficient productive base
• increased labor in Mexico -- comp adv -- lower prices for consumers
• greater ability to compete w/asia, europe rivals

Arguments against

NAFTA

• mass exodus of jobs for us, canada to mexico
• environment standards of mexico could degrade clean air, toxic waste across US
• loss of national soverignty

international monetary system

international arrangements countries adopt to govern exchange rates

floating exchange rate

a system under which the exchange rate for converting one currency into another is continually adjusted depending on the laws of supply and demand

pegged exchange rate

currency value is fixed relative to a reference currency

dirty float

fixed exchange rate

a system under which the exchange rate for converting one currency into another is fixed

currency crisis

banking crisis

a loss of confidence in the banking system that leads to a run on banks, as individuals and companies withdraw their deposits

moral hazard

arises when people behave recklessly because they know that they will be saved if things go wrong

triggers of

great recession

• legal fraud - giving mortgages to unworthy lenders
• securitization of bad mortgages

ways in which financial systems of different countries are linked together

capital inflow -- huge debt/money supplies

ex: China's huge capital outflow into US, recession caused huge debt

Bretton Woods

system of rules and procedures to regulate the intl monetary system, drawn up in 1944 after the Great Depression by worldwide delegates

IMF

international monetary fund

international institution set up to maintain order in the international monetary system