Global

Global economic
Benefits of international trade

Definition: [international trade] ——> the exchange of goods and services between
countries

Through exports and imports

“International trade” is free when there is no government intervention(e.g.

quotas, taxes etc) to reduce or limit trade

Greater choice: can access wider Ange of goods and services

Lower price: international competition ——> price fall giving households the
ability to buy more

International cooperation: trade helps countries build better relationships ——>

lower levels of hostilities

Flow of new ideas: innovative ideas and tech can shared between countries

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 Access to resources: output —> increase; COP—>fall ——> increase access to
raw materials

Efficiency: allows most efficient firms to emerge —> improve global resources

Economic growth: exports: key component of GDP of many countries ——

>increase in export ——> economic growth increase

Economic development: ↑output —> lower levels of unemployment ——> higher

incomes & standards of living

The Benefits of Free Trade When World Price is Above Domestic Price

a country where the world price for a good/service is above the domestic
price thus allowing for exports

Vietnamese rice producers are incentivised by the higher prices to produce a

higher level of output and domestic supply increases from Qe to Qs

Vietnamese consumers now have to pay the world price for rice (Pw) and the
domestic demand contracts from Qe to Qd

The excess domestic supply (Qs- Qd) is now available for export

The Benefits of Free Trade When World Price is Below Domestic Price

a country where the world price for a good/service is below the domestic
price thus allowing for imports

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 Some of Sri Lanka's firms cannot compete with the lower prices and domestic
supply contracts from Qe to Qs

Sri Lanka consumers benefit from the lower world price (Pw) and the domestic
demand extends from Qe to Qd

The excess domestic demand (Qd- Qs) is now met through imports

Trade protection
Protectionism:

Free trade aims to maximise global output through national specialisation

numerous reasons why countries would seek to limit free trade in order to
protect themselves from certain outcomes ——> This is called protectionism

Types: tariffs, export subsidies, quotas/embargoes

Tariffs （关税）
most commonly used forms of trade protectionism include tariffs, subsidies,
quotas and administrative barriers

A tariff is a tax on imported goods/services (customs duty)

The tax raises the selling price of the good/service within the country

higher price allows more——> inefficient domestic firm

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 After the tariff is imposed, the world price increases from Pw to Pw+ tariff

The new market equilibrium is seen at Pw+tariff and Q4

Following the law of demand, the quantity demanded contracts from

Q2 to Q4

Following the law of supply, the quantity supplied by domestic

firms extends from Q1 to Q3

The level of imports is reduced from Q1Q2 to Q3Q4

Evaluation

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 Quotas

A quota is a physical limit on imports

Real world example

e.g. in June 2022 the UK extended its quota on steel imports for a further two
years in order to protect employment in the domestic steel industry

As cheaper imports are limited, a quota raises the market price

As cheaper imports are limited a quota may create shortages

Some domestic firms benefit as they are able to supply more due to the lower
level of imports

This may increase the level of employment for domestic firms

The initial market equilibrium is at PwQ4

Domestic firms supply up to Q1 and Q4-Q1 is imported

The quota has raised prices and reduced total output from Q4→Q3

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 Domestic producers supply up to Q1 PLUS Q3-Q2

Foreign producers supply Q2-Q1 (the quota)

Evaluation

Export subsidies

Both subsidies and export subsidies lower the cost of production for domestic
firms

They can increase output and lower prices

With lower prices their goods/services are more competitive internationally

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 If firms are able to meet all of the domestic demand (Dd) then the excess
supply may be exported

Otherwise, the level of imports will decrease

The increased output may result in increased domestic employment

e.g.
Following the 2nd World War, the European Union subsidised food production and
this has continued ever since

Once food security had been established within Europe, countries were able
to start exporting the excess supply that subsidies generate

The domestic market for truffles in the EU was initially in equilibrium at PwQ3

Domestic firms supplied up to Q1, while Q2-Q1 was imported into the EU

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 The implementation of the subsidy lowered firms costs of production, shifting
the domestic supply curve from Sd to Sd + subsidy

Domestic firms increase output and market share from Q1→Q2

Imports reduce from Q1Q3 → Q2Q3

Evaluation

Administrative Barriers

Health and safety regulations

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 e.g. in 2017 the EU put a new health regulation in place regarding the
permitted level of aflotoxins in nuts. Aflotoxin levels are naturally higher in
southern hemisphere countries and it effectively blocked the import of
southern hemisphere nuts

Product specifications

e.g. Canada specified that all jam imported into Canada needed to be in a
certain size of the jar. Many countries do not usually manufacture jars in
the required size

Environmental regulations

e.g. in November 2021 new regulations were put in place in the EU and the
USA to limit the amount of imports of 'dirty steel' - predominantly this is
steel produced using coal-fired power stations which are prevalent in
China

Product labelling can be expensive for firms to apply and may limit their
desire to sell into certain markets

Inefficient administrative systems

e.g. many border crossings in Africa still require physical paper copies to
be submitted at each crossing with some companies claiming they have to
provide in excess of 10,000 documents for a single journey

Arguments for Trade Protection

Argument for protectionism:

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 The arguments against trade protection are evident from the impact that each
form of protection has on the stakeholders. These can be summarised in the
diagram below

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 1. Reduced choice
Protectionism reduces both the quantity and variety of goods/services
available to customers

2. Increased prices
Protectionism either reduces the supply of goods/services which leads to
higher prices - or in the case of tariffs, directly leads to higher prices

3. Increased costs
Manufacturers who rely on imported raw materials face higher costs of
production. If protectionism is widespread it may generate inflation in the
economy and/or lead to a loss of employment

4. Retaliation
Foreign producers are hurt by protectionism and it is common for their
governments to retaliate with their own measures which further harm free
trade

5. Reduction in export competitiveness

Protectionism reduces the need to be efficient or to innovate. Over time this
leads to higher prices and worse quality products which will reduce export
sales

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 6. Resource misallocation
Global welfare is reduced as protectionism shifts production away from more
efficient foreign producers to less efficient domestic producers

7. Domestic inefficiency increases

With a reduced level of competition, domestic firms will be less
productively efficient and will spend less on research, development and
innovation

Evaluation of Free Trade Versus Protectionism

Trade liberalisation[removing the barriers] has helped to generate significant

economic growth and economic development[sustainable increase in ….]

As an economy moves towards free trade, structural

unemployment[mismatch between job and skills] often develops as certain
industries move abroad

Without an intentional government program to retrain these workers, they

often fall through the cracks and their quality of life reduces significantly

It has been argued that structural unemployment is at the heart of

nationalism as angry workers seek to expel foreigners and get their jobs
back

Voters are able to influence the political agenda and protectionism goes
through periods of immense popularity

More economically developed countries (MEDCs) have the funds available to

provide significant export subsidies to their firms

The aim is usually not to protect these firms but to help them gain a global
monopoly

As monopolies develop they gain more revenue and generate more tax
revenue which may go back to their government (often it goes to off-shore
bank accounts)

Less economically developed countries (LEDCs) are often pushed into free
trade agreements by MEDCs with a focus on resource extraction

MEDCs frequently place tariffs on the import of manufactured

goods with added value from LEDCs

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 This prevents LEDCs from generating higher profits

e.g. cocoa beans are exported from Ghana to the USA at low prices
and without any import tariffs, however, there is a high tariff on the
import of Ghanaian chocolate to the USA

This argument is not as simple as free trade is better. The context of the trade
and the nature of the trading partners ultimately decides whether a path of
free trade or protectionism would serve a nation better

There is no doubt free trade generates higher output and income, but the
distribution of this income may be vastly unfair
这个论点并不像自由贸易更好那么简单。贸易背景和贸易伙伴的性质最终决定了
自由贸易还是保护主义的道路对一个国家更好。毫无疑问，自由贸易能产生更高
的产出和收入，但这种收入的分配可能非常不公平

Economic Integration

Economic integration occurs as countries reduce trading barriers between

themselves and become more interdependent [adj. 相互依赖的；互助的 ]

There are several ways in which economic integration can deepen

1. Through the development of trade agreements

2. Through the creation of trading blocs

3. Through the formation of a monetary union

1. Trade agreements

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 A preferential trade agreement (PTA) is an agreement between two or more
countries providing preferential (better)
terms and conditions of trade to member countries

E.g. Vietnam has preferential tariff rates with Australia

A bilateral trade agreement is a preferential trade agreement between two

countries and aims to reduce or eliminate barriers to trade

E.g. Vietnam signed a bilateral trade agreement with Korea in 2015

A regional trade agreement (RTA) is a preferential trade agreement usually

between more than two countries in the same geographical region

E.g. Armenia created an agreement with the EU in 2019 to create the EU-
Armenia RTA

A multilateral trade agreement is a legally binding preferential trade

agreement between more than two countries or trading blocs and is usually
negotiated and overseen by the World Trade Organisation (WTO)

E.g. The East African Community was created in 2005 between seven
African countries

2. Trading Blocs

There are generally three types of trading blocs - Free Trade Areas (FTAs),
Customs Unions, and Common Markets

Each successive bloc has a higher level of integration 结合

Advantages and Disadvantages of Trading Blocs

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 3. Monetary Unions

Monetary Unions often develop once there is integration at a Common Market

level

Nations in the Common Market may desire the creation of a common central
bank and convergence of monetary policy

Types of Trading Blocs

1. Free Trade Areas (FTAs)

A trading bloc is a group of countries who come together and agree to reduce
or eliminate any barriers to trade that exist between them

There are different levels of economic integration ranging from relatively low
integration in a bilateral agreement to high integration in a monetary
union e.g. the Eurozone

Globally, there were more than 420 regional trade agreements in effect in
2022

Each subsequent type of trading bloc has increased levels of economic

integration

A free trade area is a bloc in which countries agree to abolish trade

restrictions between themselves but maintain their own restrictions with
other countries e.g Canada–United States–Mexico Agreement (CUSMA)

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 Mexico, Canada and the USA have a free trade agreement but can deal
individually with Cuba as they see fit

In the diagram above, Mexico, Canada and the USA have reduced/eliminated
many trade restrictions between themselves

The USA refuses to trade with Cuba and has placed a complete ban on all
exports/imports to Cuba

Canada trades with Cuba but imposes tariffs on all imports

Mexico trades freely with Cuba

2. Customs Unions

A customs union is an agreement between countries in which all

goods/services produced by members are traded tariff free. Additionally,
countries agree on common tariff rates on imports from all external (third-
party) countries

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 Countries within the European Union
trade freely between themselves and
have common barriers with all third-
party countries e.g. UK

In the diagram above, countries in the European Union have eliminated all
tariff barriers between themselves but impose common tariff barriers on
third party countries such as the UK or China

3. Common Markets

Similarly, to a customs union, goods/services are traded tariff-free in common

markets

Additionally, the four factors of production flow freely between member

countries

The goal is to improve the allocation of resources between the common

market members and lower the costs of production

The European Union is a customs union and a common market

4. Monetary Union

A monetary union takes integration a step further. Members enjoy all of the
benefits of a customs union and common market, but then also establish
a common central bank which issues a common currency and controls the
monetary policy of member countries

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 Prior to Brexit, the UK was a member of the European Customs Union and
common market but never joined the Eurozone

At the start of 2023, 20 of the 27 countries in the EU are also members of

the Eurozone

WTO…….

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 Types of Exchange Rate Systems

Foreign Exchange Rates

An exchange rate is the price of one currency in terms of another e.g. £1 =

€1.18

International currencies are essentially products that can be bought & sold
on the foreign exchange market (forex)

The Central Bank of a country controls the exchange rate system that is used
in determining the value of a nation's currency

Three of the main exchange rate systems are

A floating exchange rate

A fixed exchange rate

A managed exchange rate

1. A Floating Exchange Rate System

Different currencies can be bought and sold, just like any other product

The forces of demand and supply determine the rate at which one currency
exchanges for another

As with any market, if there is excess demand for the currency on the forex
market, then prices rise (the currency appreciates)

If there is an excess supply of the currency on the forex market, then prices
fall (the currency depreciates)

The relationship between the US$

and the Euro shows that as
Europeans demand the $ it
appreciates but by supplying their
own currency it depreciates

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 Diagram Analysis

The Euro/US$ market is shown by two market diagrams one for the USD
market on the left and one for the Euro market on the right

The initial exchange rate equilibrium is found at P1Q1 in both markets

When Europeans visit the USA, they demand US$ and supply Euros

The increased demand for the US$ shifts the demand curve to the right
which results in the value of the $ appreciating from P1 → P2 in the USD
market and a new market equilibrium forms at P2Q2

The increased supply of the Euro shifts the supply curve to the right
which results in the value of the Euro depreciating from P1 → P2 and a
new market equilibrium forms at P2Q2

Floating Exchange Rate Calculations

As the value of a currency appreciates or depreciates, the value of any

international transaction changes

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 These changes can be significant
for firms during times of exchange
rate volatility

2. A Fixed Exchange Rate System

A system in which the country’s Central Bank intervenes in the currency

market to fix (peg) the exchange rate in relation to another currency e.g US$

When they want their currency to appreciate, they buy it on forex markets
using their foreign reserves, thus increasing its demand

When they want their currency to depreciate, they sell it on forex markets,
thus increasing its supply

Sometimes the peg is at parity e.g. 1 Brunei Dollar = 1 Singapore Dollar

Often the peg is not at parity e.g. Hong Kong has pegged its currency to the
US$ at a rate of HK$ 7.75 = US$ 1

A revaluation occurs if the Central Bank decides to change the peg and
increase the strength of its currency

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 A devaluation occurs if the Central Bank decides to change the peg and
decrease the strength of its currency

The Hong Kong Monetary Authority

intervenes to maintain the exchange
rate of HK$ 7.75 = US$ 1

Diagram Analysis

The HK$/US$ market is shown by two market diagrams one for the HK$
market on the left and one for the US$ market on the right

The initial exchange rate equilibrium is found at HK$ 7.75 = US$ 1 -

represented by point 1

When Hong Kong firms import goods from the USA, they demand US$ to pay
for them and supply HK$

This impacts the market for each currency - the US$ appreciates and the HK$
depreciates

To maintain the fixed exchange rate at HK$ 7.75 = US$ 1, the Hong Kong
Monetary Authority intervenes in the forex market by using US$ from its
foreign reserves to buy HK$

Left Diagram - HK$

The increased supply of the HK$ shifts the supply curve to the right which
results in the value of the HK$ depreciating from (HK$7.75 = $1) → (HK$7.75 =
$0.97) and a new market equilibrium forms at point 2

The Monetary Authority intervenes by buying HK$ which shifts the demand
curve right from D1 → D2

The HK$ has now been moved back to its target value of K$ 7.75 = US$ 1 -
point 3

Right Diagram - US$

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 The increased demand for the US$ shifts the demand curve to the right which
results in the value of the US$ appreciating from ($1 = HK$7.75) → ($1 =
HK$7.98) and a new market equilibrium forms at point 2

The Monetary Authority intervenes by buying HK$ using UD$ which increases
their supply shifting the supply curve right from S1 → S2

The HK$ has now been moved back to its target value of K$ 7.75 = US$ 1 -
point 3

3. A Managed Exchange Rate System

The exchange rate is allowed to fluctuate within a specified band around a

desired valuation. If it goes outside of this band then the Central Bank will
intervene to bring it back within the band

When they want their currency to appreciate to back within the band,
they buy it on forex markets using their foreign reserves, thus increasing
its demand

When they want their currency to depreciate back into the band, they sell
it on forex markets, thus increasing its supply

Currently, almost all currencies are managed currencies

The width of the band varies from country to country

These bands are not published as it would help currency speculators to

know when currency reversals would be initiated by the Central bank and
they would seek to profit from that knowledge

The Peoples Bank of China

intervenes to maintain the exchange
rate within a specified band of
trading and is in the region of 2%
around a value of 1US$ = 6.75 CNY

Diagram Analysis

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 China has not released their currency bands, however, the value seems to
fluctuate up to 2% around a value of 1US$ = 6.75 CNY

The initial market equilibrium is found at ER1 Q1

Action to correct currency appreciation

Increased demand for the Chinese Yuan leads to a rightward shift of demand
D1→D2 leading to an appreciation from ER1→ER2

The currency is approaching the upper band so the Peoples Bank of China
intervenes by selling their own currency (and buying foreign reserves)

This increases the supply of the Yuan causing a rightward shift from
S1→S2

A new equilibrium is established at ER1Q3, well within the band

Action to correct currency depreciation

Increased supply of the Chinese Yuan on world markets leads to a rightward

shift of supply from S1→S2 leading to a depreciation from ER1 towards the
bottom currency band

The currency is approaching the bottom band so the Peoples Bank of China
intervenes by buying their own currency (and selling foreign reserves)

This increases the demand of the Yuan causing a rightward shift from
D1→D2

A new equilibrium is established at ER1Q3, well within the band

Causes of Exchange Rate Fluctuations

Numerous factors influence floating exchange rates, resulting in

an appreciation or depreciation of a currency

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 Factors influencing floating
exchange rates

1. Relative interest rates: influence the flow of hot money between countries. If
the UK increases its interest rate, then demand for £'s by foreign investors
increases and the £ appreciates. If the UK decreases its interest rate, then the
supply of £'s increases as investors sell their £'s in favour of other currencies
and the £ depreciates

2. Relative inflation rates: as inflation in the UK rises relative to other countries,

its exports become more expensive so there is less demand for UK products
by foreigners, which means there is less demand for £s and so the £
depreciates

3. Net foreign direct investment (FDI): FDI into the UK creates a demand for the
£ which leads to the £ appreciating. FDI by UK firms abroad creates a supply
of £'s which leads to the £ depreciating

4. The current account: EU exports have to be paid for in €'s. EU imports have
to be paid for in local currencies, which requires €'s to be supplied to the forex
market. Due to this, an increasing net exports will result in an appreciation of
the € and falling net exports will result in a depreciation of the €

5. Changes in tastes/preferences: As global demand for quinoa increased as it

became fashionable, Bolivia's exports of quinoa increased dramatically which
put upward pressure on their currency. Foreigners demanded the Boliviano in
order to pay for the quinoa

6. Speculation: the vast majority of currency trades are speculative. Speculation

occurs when traders buy a currency in the expectation that it will be worth
more in the short to medium term, at which point they will sell it to realise a
profit

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 7. Net Portfolio Investment: Portfolio investment into the UK creates a demand
for the £ which leads to the £ appreciating. Portfolio investment by UK firms
abroad creates a supply of £'s which leads to the £ depreciating

8. Remittances: Some countries receive high levels of remittances which help to

keep the demand for their currency strong e.g. the Philippines

9. Relative growth rates: Countries with stronger economic growth rates will
attract higher levels of FDI resulting in an appreciation of their currency

10. Central Bank intervention: Any form of monetary policy is likely to influence
exchange rates e.g. higher interest rates will increase the hot money flows.
Direct intervention using foreign reserves will also influence the exchange rate

Consequences of Foreign Exchange Rate Fluctuations

Changes to exchange rates may have far-reaching impacts on an economy

1. Likely impact on the macro economy of a currency depreciation

A depreciation means that imports

are more expensive and exports are
cheaper. Net exports should rise
leading to an increase in AD from
AD1 → AD2

2. Likely impact on the macro economy of a currency appreciation

An appreciation means that imports

are cheaper and exports are more
expensive. Net exports should fall
leading to a decrease in AD from
AD1 → AD2

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 Impact of an Appreciation or Depreciation on the Economic Indicators
An Introduction to the Balance of Payments

The Balance of Payments (BoP) for a country is a record of all the financial
transactions that occur between it and the rest of the world

The BoP has two main sections:

The current account: all transactions related to goods/services along with

payments related to the transfer of income

The financial and capital account: all transactions related to savings,

investment and currency stabilisation

Money flowing into an account is recorded in the relevant account as a credit

(+) and money flowing out as a debit (-)

If more money flows into an account than out of it, there is a surplus in the
account

If more money flows out of an account than into it, there is a deficit in the
account

The Current Account

The Current Account is often considered to be the most important account in

the BoP

This account records the net income that an economy gains from
international transactions

An Example of the UK Current Account Balance for 2017

Component 2017

Balance of trade in goods (exports - imports) £-32.9bn

Balance of trade in services (exports - imports) £27.9bn

Sub-total trade in goods/services £-5bn

Net income (interest, profits and dividends) £-2.1bn

Current transfers £-3.6bn

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 Total Current Account Balance £-10.7bn

Current Account as a % of GDP 3.7%

• Goods are also referred to as visible exports/imports

Services are also referred to as invisible exports/imports

Net income consists of income transfers by citizens and corporations

Credits are received from UK citizens who are abroad and

send remittances home

Debits are sent by foreigners working in the UK back to their countries

Current transfers are typically payments at government level between

countries e.g. contributions to the World Bank

The Capital Account

The Capital Account records small capital flows between countries and is
relatively inconsequential

The capital account is made up of two sections:

1. Capital transfers
Smaller flows of money between countries
E.g.
Debt forgiveness payments by the government toward developing countries
E.g.
Capital transfers by migrants as they emigrate and immigrate

2. Transactions in non-produced, non-financial assets

Small payments are usually associated with royalties or copyright e.g. royalty
payments by record labels to foreign artists

The Financial Account

The Financial Account records the flow of all transactions associated with
changes of ownership of the country’s foreign financial assets and liabilities

It includes the following sub-sections

1. Foreign Direct Investment (FDI)

Flows of money to purchase a controlling interest (10% or more) in a foreign

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 firm. Money flowing in is recorded as a credit (+) and money flowing out is a
debit (-)

2. Portfolio Investment
Flows of money to purchase foreign company
shares and debt securities (government and corporate bonds). Money
flowing in is recorded as a credit (+) and money flowing out is a debit (-)

3. Official Borrowing
Government borrowing from other countries or institutions outside of their
own economy e.g. loans from the International Monetary Fund (IMF) or foreign
banks. When the money is received, it is recorded as a credit (+) and when the
money (or interest payments) are repaid, it is recorded as a debit (-)

4. Reserve Assets
These are assets controlled by the Central Bank and available for use in
achieving the goals of
monetary policy. They include gold, foreign currency positions at the
International Monetary Fund (IMF) and foreign exchange held by the Central
Bank (USD, Euros etc.)

Interdependence Between the Accounts

It is called the BoP as the current account should balance with the capital
and financial account and be equal to zero

If the current account balance is positive, then the capital/financial

account balance is negative (and vice versa)

In reality, it never balances perfectly and the difference is called 'net error
and omissions'

If there is a current account deficit, there must be a surplus in the capital and
financial account

The excess spending on imports (current account deficit) has to be

financed from money flowing into the country from the sale of
assets (financial account surplus)

If there is a current account surplus, there must be a deficit in the capital and
financial account

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 The excess income from exports (current account surplus) is financing
the purchase of assets (financial account deficit) in other countries

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