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Summary International Economics
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- Katholieke Universiteit Leuven (KU Leuven)
This document provides you with a summary of "International Economics" in the course "Macro & International Economics".
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Chapter 1: IntroductionWhat is international economics about?
International economics studies economic interactions between countries and the problems that
may arise. Trade in goods and services (International Trade) + Trade in financial flows and
investments (International Finance).
Why is it important? At the beginning of the 21st century, countries are more interconnected than
ever, through trade in goods and services, through capital flows and through investments.
Figure 1.1: Export and import as a percentage of US national income.
International Trade International Finance
- International trade has How does Us pay for this
tripled since 1960. import?
- Both imports and - Influx of foreign
exports fell in 2009 due capital.
to the recession. - Growing links between
- import increase > national capital
export increase markets.
Figure 1.2: Average of Exports and Import as Percentage of National
Income (2015)
In comparison to the US, other countries depend more on international
trade.
Why has international trade risen to sharply?
- A decrease in trade barriers, such as tariffs and quotas, …
- A reduction in transport costs (decrease in air fares, costs of tanker transport, costs for the use of
information technology).
- The creation of free trade areas (EU, NAFTA, CETA, etc.).
Advantages and disadvantages of international trade?
- The following advantages and disadvantages will be covered throughout this course.
- Some seem logical, others not.
- By the end of this course these advantages and disadvantages should be clear to everyone.
Advantages/gains
1. When a buyer and a seller engage in a voluntary transaction, both can be made better off.
- Norwegian consumers import lemons that they would have a hard time producing.
- The producers of lemons receive an income that they can use to buy other things.
2. Even if a country is the most (or least) efficient in the production of ALL goods, it wins from free
trade.
- Even when producers in the less efficient country can only compete by paying lower wages.
- The efficient country concentrates on producing that good it is relatively the best in and imports the
rest.
• Countries use finite resources to produce what they are most productive at (compared to their
other production choices), then trade those products for goods and services that they want to
consume.
• Countries can specialize in production, while consuming many goods and services through trade.
, So, the idea that trade is harmful when there are major productivity and wage inequalities between
countries is wrong.
3. Trade will be beneficial to a country when it exports (imports) goods that make use of abundant
(scarce) production factors.
4. If countries specialize, they can be more efficient through production on a larger scale.
5. Countries can also win by trading current production factors, goods, etc. against future production
factors, goods, etc. (Example: When the world was in a crisis, African countries turned to their former
rulers and asked for money. Nobody would give them except for China but they made the deal that if
they give money (current production factor), they can use their souls (future production factor) for x
years.)
Disadvantages/Losses
Trade is beneficial to individual countries but may be detrimental to certain groups of economic
agents within countries (the distribution of benefits may vary).
1. International trade can harm the owners of resources that are used relatively intensively in industries
that compete with imports. (Example: Trade w Asian countries (cheap clothes, …) brings problems
since they can’t make it as cheap here in Europe.)
2. Trade may therefore affect the distribution of income within a country.
3. Rather than between countries, trade conflicts should occur between groups within a given country.
Pattern of Trade (Who sells what to whom?)
Trade can be explained by:
- Differences in climate and production factors (inter-industrial trade).
o Example: Brazil exports coffee and Australia exports iron ore.
o Not always: Example: why does Japan export cars and US aircraft?
- Differences in labour productivity (inter-industrial trade).
- Differences in availability and use of production factors (inter-industrial trade = Trade between 2
different products. Example: cloths against food.)
- Economies of scale: intra-industrial trade: Trade between 2 similar products (Ferrari vs Volvo).
How much trade? Is there a need for government policy? (How much trade is allowed without
damage?)
- On the one hand, since WW II, industrialized countries have tried to remove obstacles to
international trade through all kinds of “agreements” between a few countries or on a ‘world scale
(Examples: NAFTA, GATT, …)
- On the other hand, governments are concerned about the impact of international trade on the
prosperity of domestic industries. They have regularly tried to counteract trade.
o Example: mercantilism, protectionism
o Think of the statements of Trump!
- At the same time, the anti-globalist movement has gained a lot of influence (° 1999 in Seattle).
Policy makers may affect the amount of trade through:
- tariffs: a tax on imports or exports,
- quotas: a quantity restriction on imports or exports,
- export subsidies: a payment to producers that export,
- etc.
International Finance (International capital market)
Not only trade has increased, but also international financial flows (capital flows): why?
- To finance trade.
- To finance deficits in the balance of payments.
,- For foreign investments (direct control).
- To buy stocks, bonds, etc. (no direct control).
, Chapter 2: World Trade (an overview)
Who trades with whom?
The Gravity model: size and distance
= What determines the intensity of trade relationships between two countries or regions?
What do the empirics tell us?
Figure 1: Total U.S Trade with 10 Major Partners (2015)
- The 5 biggest trading partners: China, Canada, Mexico, Japan and
Germany.
- 3 of the top 10 trading partners were also the 3 largest
European economies: Germany, UK and France.
- Although Mexico and Canada are relatively small economies, they
belong to the major trading partners of the United States.
Why does the US trade a lot with large European economies, but also with
small economies such as those of Canada and Mexico?
A. Why does the US trade more with these European countries than with other
European countries?
Figure: The size of European Economies and the value of their trade with the
US (2012). Explanation of figure: Precent of EU GDP (Germany has around
20% of the full GDP of the EU), Percent of US trade w EU (Germany is
responsible for about 25% of the complete trade between the US and the
EU).
The trade between the US and countries that are all at the same distance of the US. This means
that the distance does not (really) play a role.
The more to the right on the horizontal axis, the more up on vertical axis. So, the size of an economy
plays a role. Why is the size of the economy important?
- The size of an economy is directly related to the volume of imports and exports.
- Larger economies produce more goods and services, so they have more to sell in the export market.
- Larger economies generate more income from the goods and services sold, so they can buy more
imports.
B. Why does the US trade a lot with Canada and Mexico, two relatively small
economies?
Figure: Economic size and Trade with the United States (2012)
The Canadian economy is only a little larger than the Spanish economy.
The trade of the US with Canada alone is almost as large as the US trade with
the EU. So, the US trades more with its neighbors than with European
economies of about the same size.
Why does distance matter?
- Distance affects transportation costs and hence the cost of import and export.
- Distance affects personal contacts and communication, which in turn can affect trade.
What does the theory tell us?
The “Gravity Model” (1962?): The gravity model assumes that size (+) and distance (-) are important
Ax Y i x Y j
for trade in the following way: T ij = .
D ij
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