Lecture 1.
Introduction
Introduction to Global Economics
By Bakhtier Tukhtaev
About the subject
Students examine the historical development of
the global economy and the increasing
interdependence of economies, governments,
and public policy. Economic theories in
international trade, finance and monetary policy
are explored within the context of globalization.
Contemporary global economic issues such as the
environment, income distribution, and
development are analyzed using case studies
from various nations.
Core textbook
Paul R. Krugman (2022) International Economics;
Theory and Policy, Global Edition, 12th edition.
Pearson Publishing
Assessment
Mid-term Final exam Attendance Assignments
30 % 40 % 10 % 20 %
International Economics: Theory and Policy
Twelfth Edition, Global Edition
Introduction
Lecture 1
What Is International Economics About?
• International economics is about how nations interact
through trade of goods and services, flows of money,
and investment.
• International economics is an old subject, but continues
to grow in importance.
• Nations are now more closely linked than ever before.
What Is International Economics About?
• U.S. exports and imports as shares of gross domestic product have been
on an upward trend.
• International trade has roughly tripled in importance compared to the
economy as a whole in the past 60 years.
• Both imports and exports fell substantially in 2009 due to the
recession.
• Both imports and exports fell again in 2020 due to the COVID-19
pandemic.
Figure 1.1 Exports and Imports as a Percentage of U.S. National Income
(Shaded areas indicate U.S. recessions.) Both imports and exports have risen as
a share of the U.S. economy, but imports have risen more.
Source: U.S. Bureau of Economic Analysis, [Link]
What Is International Economics About?
• Compared to the United States, other countries are even more tied to
international trade.
• Their imports and exports as a share of GDP are substantially higher.
• The United States, due to its size and diversity of resources, relies less
on international trade than almost any other country.
Figure 1.2 Average of Exports and Imports as Percentages of
National Income in 2018
International trade is even more important to most other countries than it is
to the United States.
Source: World Bank
The Gains from Trade
• The most important insight of all international economics is
that there are gains from trade.
• Countries selling goods and services to each other almost
always generate mutual benefits.
1. When a buyer and a seller engage in a voluntary
transaction, both can be made better off.
▪ Norwegian consumers import oranges that they would
have a hard time producing.
The Gains from Trade
• How could a country that is the most (least) efficient producer of everything gain
from trade?
▪ Countries use finite resources to produce what most productive at (compared
to their other production choices), then trade those products for what they
want to consume.
▪ Countries can specialize in production, while consuming many goods and
services through trade.
The Gains from Trade
• Trade benefits countries by allowing them to export goods made with
relatively abundant resources and imports goods made with relatively
scarce resources.
• When countries specialize, they may be more efficient due to large-
scale production.
• Countries may also gain by trading current resources for future
resources (international borrowing and lending) and due to
international migration.
The Gains from Trade
• Trade is predicted to benefit countries as a whole in several ways, but
trade may harm particular groups within a country.
• International trade can harm the owners of resources that are used
relatively intensively in industries that compete with imports.
• Trade may therefore affect the distribution of income within a
country.
The Pattern of Trade
• The pattern of trade describes who sells what to whom.
• Differences in climate and resources explain why Brazil exports coffee, and Saudi
Arabia exports oil.
• But why does Japan export automobiles, while the U.S. exports aircraft?
• Why some countries export certain products can stem from differences in:
• Labor productivity
• Relative supplies of capital, labor, and land and their use in the production of
different goods and services
Effects of Government Policies on Trade
• Policy makers 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, or
• Through other regulations (e.g., product specifications)
that exclude foreign products from the market, but still allow domestic products.
• What are the costs and benefits of these policies?
Effects of Government Policies on Trade
• If a government restricts trade, what are the costs if foreign governments respond
likewise?
• Trade policies are often chosen to cater to special interest groups, rather than to
maximize national welfare.
• Governments tend to adopt tariffs, then negotiate them down in exchange for
reduction in trade barriers of other countries.
Tarrifs
International Finance Topics
• Exchanging risky assets such as stocks and bonds can benefit all
countries by diversification that reduces the variability of income—
another source of gains from trade.
• Most international trade involves monetary transactions.
• Many monetary events have important consequences for international
trade.
Balance of Payments
• Governments measure the value of exports and imports, as well as the
value of financial assets that flow into and out of their countries.
• Trade deficits, where countries import more than they export in
value, may be offset by net inflows of financial assets.
• The official settlements balance, or the balance of payments,
measures the balance of funds that central banks use for official
international payments.
• All three values are measured in the government’s national income
accounts.
Exchange Rate Determination
• Exchange rates are an important financial issue for most governments.
• Exchange rates measure how much domestic currency can be exchanged for
foreign currency and thus affect how much:
• Goods denominated in foreign currency (imports) cost in the domestic
country.
• Goods denominated in domestic currency (exports) cost in foreign markets.
• Some exchange rates change continually (float) while others are fixed for
periods of time.
International Policy Coordination
• In an integrated economy, one country’s economic policies usually affect other
countries as well, leading to the need for some degree of policy coordination.
• Depends on type of exchange rate regime.
• Capital markets, where money is exchanged for promises to pay in the future, have
special concerns in an international setting:
• Currency fluctuations can alter the value paid.
• Countries, especially developing ones, might default on debt.
The International Capital Market
• Capital markets are arrangements by which individuals and firms exchange money
now for promises to pay in the future.
• International capital markets cope with special regulations that countries impose on
foreign investments.
• Special risks of currency fluctuations and national default
• Sometimes offer opportunities to evade regulations placed on domestic markets.
International Trade Versus Finance
• International trade focuses on transactions involving movement of goods and
services across nations.
• International finance focuses on financial or monetary transactions across
nations.
Who Trades with Whom?
• More than 30 percent of world output is sold across national borders.
• World trade in goods and services exceeded $25 trillion in 2019.
• Figure 2-1 shows the total value of trade in goods—exports plus imports—between the
United States and its top 15 trading partners in 2019.
• The largest 15 trading partners with the United States accounted for 75 percent of the
value of U.S. trade.
• The five largest trading partners with the United States in 2019 were Mexico, Canada, China,
Japan, and Germany.
Figure 2.1 Total U.S. Trade with Major Partners, 2019
U.S. trade—measured as the sum of imports and exports—is mostly with 15
major partners.
Source: U.S. Department of Commerce.
Size Matters: The Gravity Model
• Three of the top 15 U.S. trading partners are European nations: Germany, the United
Kingdom, and France.
• Why does the United States trade more with these European countries than with
others?
• These three countries have the largest gross domestic product (GDP), the value
of goods and services produced in an economy, in Europe.
• Figure 2-2 shows that each European country’s share of U.S. trade with Europe is
roughly equal to its share of European GDP.
Figure 2.2 The Size of European Economies and the Value of Their Trade with the
United States
Shows the correspondence between the size of different European
economies and those countries’ trade with the United States.
Source: U.S. Department of Commerce, European Commission.
Size Matters: The Gravity Model
• 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 are able to buy more imports.
Using the Gravity Model: Looking for Anomalies
• A gravity model fits the data on U.S. trade with European countries well but not
perfectly.
• The Netherlands, Belgium, and Ireland trade much more with the United States than
predicted by a gravity model.
• Ireland has strong cultural affinity due to common language and history of
migration. Ireland also hosts many U.S.-based multinational corporations.
• The Netherlands and Belgium have transport cost advantages due to their
location.
Impediments to Trade: Distance, Barriers, and Borders
Other things besides size matter for trade:
1. Distance between markets influences transportation costs and therefore the cost of
imports and exports.
2. Cultural affinity: close cultural ties, such as a common language, usually lead to
strong economic ties.
3. Geography: ocean harbors and a lack of mountain barriers make transportation and
trade easier.
4. Multinational corporations: corporations spread across different nations import
and export many goods between their divisions.
5. Borders: crossing borders involves formalities that take time, often different
currencies need to be exchanged, and perhaps monetary costs like tariffs reduce
trade.
Impediments to Trade: Distance, Barriers, and Borders
• Estimates of the effect of distance from the gravity model predict that a
1 percent increase in the distance between countries is associated with
a decrease in the volume of trade of 0.7 percent to 1 percent.
• Besides distance, borders increase the cost and time needed to trade.
• Trade agreements between countries are intended to reduce the
formalities and tariffs needed to cross borders and, therefore, to
increase trade.
Impediments to Trade: Distance, Barriers, and Borders
• The United States signed a free trade agreement with Mexico and Canada in 1994,
the North American Free Trade Agreement (NAFTA), which was replaced in 2020
with a slightly modified agreement, the U.S.-Mexico-Canada agreement (USMCA).
• Due to NAF TA and because Mexico and Canada are close to the United States, the
3 .
amount of trade between the United States and its northern and southern neighbors
as a fraction of GDP is much larger than between the United States and European
countries.
• Canada’s economy is roughly the same size as Spain’s (around 10 percent of EU G
DP) but Canada trades as much with the United States as does all of Europe.
Figure 2.3 Economic Size and Trade with the United States
The United States does markedly more trade with its neighbors than it does
with European economies of the same size.
Source: U.S. Department of Commerce, European Commission.
Impediments to Trade: Distance, Barriers, and Borders
• Yet even with a free trade agreement between the United States and Canada, which
mostly use a common language, the border between these countries still reduces
trade.
• Data shows that there is much more trade between pairs of Canadian provinces than
between Canadian provinces and U.S. states, even when holding distance constant.
• Estimates indicate that the U.S.-Canadian border deters trade as much as if the
countries were 1,500–2,500 miles apart.
Figure 2.4 Canadian Provinces and U.S. States that Trade with British
Columbia
Source: Statistics Canada, U.S. Department of Commerce.
Table 2.1 Trade with British Columbia, as Percent of
GDP, 2009
U.S. State at Similar
Canadian Trade as Percent Trade as Percent of Distance From British
Province of GDP GDP Columbia
Alberta 6.9 2.6 Washington
Saskatchewan 2.4 1.0 Montana
Manitoba 2.0 0.3 California
Ontario 1.9 0.2 Ohio
Quebec 1.4 0.1 New York
New Brunswick 2.3 0.2 Maine
Source: Statistics Canada, U.S. Department of Commerce.
The Changing Pattern of World Trade: Has the World Gotten Smaller?
• The negative effect of distance on trade according to the gravity models is
significant, but it has grown smaller over time due to modern transportation and
communication.
• A global economy, with strong economic linkages between even distant nations, is
not new.
• There have been two great waves of globalization with the first wave relying not
on jets and the Internet but on railroads, steamships, and the telegraph.
The Changing Pattern of World Trade: Has the World Gotten Smaller?
• Political factors, such as wars, can change trade patterns much more than
innovations in transportation and communication.
• World trade grew rapidly from 1870 to 1913.
• Then it suffered a sharp decline due to the two world wars and the Great
Depression.
• It started to recover around 1945 but did not recover fully until around 1970.
The Changing Pattern of World Trade: Has the World Gotten Smaller?
• Since 1970, world trade as a fraction of world GDP has achieved unprecedented
heights.
• Vertical disintegration of production has contributed to the rise in the value of world
trade through extensive cross-shipping of components.
• A $100 product can give rise to $200 or $300 worth of international trade flows.
Figure 2.5 The Fall and Rise of World Trade
The ratio of world exports to world GDP rose in the decades before World War !
but fell sharply in the face of wars and protectionism. It didn’t return to 1913 levels until
the 1970s but has since reached new heights.
Source: Michel Fouquin and Jules Hugot, “Trade Globalisation in the Last Two Centuries,” Voxeu
(September 2016).
What Do We Trade?
• What kinds of products do nations trade now, and how does this composition
compare to the past?
• Most (about 70 percent) of the volume of trade today is in manufactured products
such as automobiles, computers, and clothing.
• Fuels and mining products (e.g., petroleum, coal, and copper) remain an
important part of world trade at 15 percent.
• Agricultural products are a relatively small part of trade at 10 percent.
Figure 2.6 The Composition of World Trade, 2017
Most world trade is in manufactured goods, but minerals—mainly oil—
remain important.
Source: World Trade Organization.
What Do We Trade?
• In the past, a large fraction of the volume of trade came from agricultural and
mineral products.
• In 1910, Britain mainly imported agricultural and mineral products, although
manufactured products still represented most of the volume of exports.
• In 1910, the United States mainly imported and exported agricultural products
and mineral products.
• In 2002, manufactured products made up most of the volume of imports and
exports for both countries.
What Do We Trade?
• Low- and middle-income countries have also changed the composition of their
trade.
• In 2001, about 65 percent of exports from low- and middle-income countries
were manufactured products, and only 10 percent of exports were agricultural
products.
• In 1960, about 58 percent of exports from low- and middle-income countries
were agricultural products and only 12 percent of exports were manufactured
products.
• More than 90 percent of the exports of China, the largest developing country and a
rapidly growing force in world trade, consist of manufactured goods.
Figure 2.7 The Changing Composition of Developing-Country Exports
Over the past 50 years, the exports of developing countries have shifted
toward manufactures.
Source: United Nations Council on Trade and Development.
Service Offshoring
• Service offshoring (or outsourcing) occurs when a firm that provides services
moves its operations to a foreign location.
• Service outsourcing can occur for services that can be transmitted
electronically.
▪ A firm may move its customer service centers whose telephone calls can
be transmitted electronically to a foreign location.
• Other services may not lend themselves to being performed remotely.
Service Offshoring
• Service outsourcing is currently not a significant part of trade.
• Some jobs are “tradable” and thus have the potential to be outsourced.
• Most jobs (about 60 percent) need to be done close to the customer, making
them nontradable.
Do Old Rules Still Apply?
• The sources of modern trade are more subtle than before.
• Human resources and human-created resources (in the form of machinery and other
types of capital) are more important than natural resources.
• Political battles over trade typically involve workers whose skills are made less valuable
by imports, such as clothing workers who face competition from imported apparel, and
tech workers who now face competition from Bangalore.
• Even though much about international trade has changed, the fundamental principles
discovered by economists at the dawn of a global economy still apply, as we shall see in the
upcoming chapters about why international trade occurs.
Questions?