“Tell me and I forget. Teach me and I remember.

Involve me
and I learn.”
Benjamin Franklin

Module 1: Introduction: An Overview of the

World Economy
FA 2025

1
Econ 4321 International Trade
 Introduction
“One of the most impressive and persistent trends of the last
several decades is the expansion of international trade. Trade
across national borders has increased far faster than world
GDP. As a consequence, imports of goods and services as a
percentage of gross domestic products worldwide, on average,
have risen from approximately 12 percent forty years ago to 24
percent today.
To most economists, the evidence is impressively persuasive that
the dramatic increase in world competition--a consequence of
broadening trade flows--has fostered markedly higher standards
of living for almost all countries that have participated in cross-
border trade. I include most especially the United States.”
(Testimony of Chairman Alan Greenspan, Trade policy, Before
the Committee on Finance, U.S. Senate, April 4, 2001).
[Link]
200104042/[Link] 2
Econ 4321 International Trade
 Introduction 2
International Economics helps us to explain the patterns of
international transactions.
Nations are more closely linked through product
transactions (trade in goods and services) and asset
transactions (portfolio investment and /or direct
investment) than ever before (IMF)
Video
International Trade and Supply Chains
[Link]
64750874001

3
Econ 4321 International Trade
The Scope of International Economics
International Economics
Analysis of the production, distribution, and consumption of goods,
services, and the movement of capital and labor across nations

International Economics requires Micro and Macroeconomic

analysis.

There are two subfields of international economics:

International Trade
International Finance

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Econ 4321 International Trade
The Scope of International Economics 2
International trade analysis focuses mainly on the real
transactions in the international economy
Why does trade takes place between nations?
What goods and services does the trade between
countries include?
What is the impact of trade on economic outcomes (e.g.,
income, jobs, wages, productivity?
Why do capital and labor move across nations?
What is the impact of the international movement of
capital and labor on economic outcomes?
Note that international trade utilizes microeconomic models to
help understand international issues.

5
Econ 4321 International Trade
 The Scope of International Economics 3
International finance focuses mainly on the monetary side of the
international economy
That is, transactions that involve financial assets such as foreign
purchases of U.S. dollars, or equity/direct investment (when an
investor owns less than 10% of the shares)
Note that International finance applies macroeconomic models to
help understand the aggregate international issues:
Level of employment and output
Changes in the price level, the balance of payments, and
exchange rates
The relationship between prices, exchange rates, and interest
rates
The link between domestic goals/policies and international
ones

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Econ 4321 International Trade
 The Output of the World Economy
Gross National Product (GNP)
Value of final goods and services produced by home inputs
anywhere (home and foreign countries)
Gross Domestic Product (GDP)
The market value of final goods and services produced within a
country during a given year
It is a commonly used measure of output.
The world economy is measured as the sum of GDP (World
Bank national accounts data and OECD National Accounts data
files)
About $1.35 trillion in 1960 (current US$)
$11.356 trillion in 1960 (constant 2010 US$)
About $87.752 trillion in 2019 (current US)
$84.991 trillion in 2019 (GDP constant 2010 US$)
[Link] 7
 The Output of the World Economy 2
Gross Domestic Product (GDP)
The market value of final goods and services produced
within a country during a given year
It is a commonly used measure of output
GDP = C + I + G + (EXP-IMP)
C – Household consumption of new goods and services
I – Investment in assets (e.g., machinery, equipment,
inventory, software purchases of businesses, new houses)
G- Government expenditures on new goods and services
EXP- Exports
IMP – Imports
GDP=expenditures on first four categories –imports
Note that income=outcome (GDP)
Income is computed by adding up the payments for inputs
(e.g., capital, labor) used for output production. 8
 World GDP (constant 2010 US$) from 1960 2019

Source: [Link]
Econ 4321 International Trade 9
The Output of the World Economy 3
Value added = sales-cost of material (intermediate inputs)
If you buy a table for $500, purchase some material for
$100 to paint and polish it, and then sell it to someone else
for $750, your contribution to the output is $150

10
Econ 4321 International Trade
The Output of the World Economy 4
Weaknesses in the GDP measure
Does not include the economic activities that are not
sold in a market
Homemaker services
Food is grown in the backyard
Some economic activities are not reported
Taxation or regulation escape efforts
Underground or black market economies
Capital Quality

11
Econ 4321 International Trade
 The Output of the World Economy 5
World Bank
A multi-lateral institution, which provides loans to some
countries for their development projects, classifies nations into
low-income, middle-income, and high-income economies based
on their GDP per capita.
See
[Link]
locations=XM for more current data.

12
Econ 4321 International Trade
 The Output of the World Economy 6
Table 1.1 Distribution of World Population and Economic, 2012

Source: Sawyer and Sprinkle (2016)

See [Link] for
more current data
There are significant variations in the production of goods and income
Human capital
Institutions
Capital Investments, Innovation 13
Other Resources, Climate Econ 4321 International Trade
Imports and Exports of Goods in the World
Economy
Exports
Goods (tangible products/merchandise) and services
(intangible products such as consulting) produced in the
home country and sold to foreign countries
Imports
Goods and services purchased from foreign countries
and consumed in the home market
Trade Deficit / Surplus
Deficit if imports > exports
Surplus if exports>imports
Trade balance/net exports = exports - imports
[Link]
14
[Link] Econ 4321 International Trade
Imports and Exports of Goods in the World
Economy 2
Table 1.2 Distribution of Imports and Exports of Merchandise in the
World Economy 2012

Source: Sawyer and Sprinkle (2016)

See [Link] for more current
data
15
Econ 4321 International Trade
Imports and Exports of Goods in the World
Economy 3
Figure 1.3 Real World Exports of Goods and Real GDP, 1975–2012

Source: Sawyer and Sprinkle (2016)

See [Link] for more
16
current data Econ 4321 International Trade
Imports and Exports of Goods in the World
Economy 4
Figure 1.3(a) US exports as a percentage of US output

Source: Sawyer and Sprinkle (2016)

See [Link] for more
current data
17
Econ 4321 International Trade
 International Trade in Services
Types of international trade
Trade in goods
Visible trade
Service trade
Business services – transportation and insurance
Individual services – tourism
Invisible trade
It is more difficult to measure
Until recently, a small portion of international trade.

18
Econ 4321 International Trade
 International Transactions
Trade (product transactions): exports and imports of
goods and services (IMF)
Merchandise goods: Moveable goods or tangible products
Manufacturing, mining, and agricultural products
Service (intangible products) exports :
Transportation, communication, advertising, accounting, research,
entertainment, travel, banking, consulting, insurance, education,
insurance
Royalties and license fees (payments for the right to use patents,
trademarks, and copyrights)
Trade involves product transactions where the products can be
tangible (e.g., goods or merchandise) or intangible (e.g.,
services).
See the IMF Balance of Payment Manual for various
transactions
([Link] 19
 International Transactions 2
In total trade (goods + services), the U.S. is the world’s largest
exporter, followed by Germany and China.
The U.S. is the world’s largest exporter of services
Visit
[Link]
[Link] for interesting examples

20
Econ 4321 International Trade
 International Trade in Services 2
Table 1.3 Distribution of International Trade in Services in the World Economy 2012

Source: Sawyer and Sprinkle (2016)

See [Link] for more
current data

21
Econ 4321 International Trade
Trends in International Production and Trade
Table 1.5 Rates of Growth of GDP, Exports, and Population

Source: Sawyer and Sprinkle (2016)

See [Link] for more
current data
22
Econ 4321 International Trade
Trends in International Production and Trade 2
Table 1.5 Rates of Growth of GDP, Exports, and Population

Source: Sawyer and Sprinkle (2016)

See [Link] for more
current data
23
Econ 4321 International Trade
 Globalization
The common measure of globalization is the ratio of exports to
GDP
Countries with a high ratio of exports to GDP or a high ratio
of exports plus imports to GDP are generally more open to
the world economy than countries with a low ratio
[Link]
2b_e.pdf
[Link]
[Link]
4a498/Popular-Indicators#
A proxy for how much a country engages in international trade
Open Country: high ratio of exports to GDP or high ratio of
exports plus imports to GDP
Closed Economy: low ratio of exports to GDP or low ratio of
exports plus imports to GDP 24
Econ 4321 International Trade
 Globalization 2
Table 1.6 Exports Plus Imports as a Percentage of GDP for Selected Countries

25
Econ 4321 International Trade
 Globalization 3
Table 1.6 Exports Plus Imports as a Percentage of GDP for Selected Countries (cont.)

26
Econ 4321 International Trade
 Globalization 4

Table 1.6 Exports Plus Imports as a Percentage of GDP for Selected Countries (cont.)

Source: Sawyer and Sprinkle (2016)

See [Link] for
more current data 27
Econ 4321 International Trade
Exports of goods and services (% of GDP)

Source: [Link]

28
Econ 4321 International Trade
 VIDEO
Dani Rodrik
Future of globalization after the COVID crisis
[Link]
directory/covid19_13/

29
Econ 4321 International Trade
 Why do countries trade?
Why do countries trade?
They can obtain products and services from abroad at a
lower cost or of higher quality than those made or
served domestically.
Germany produces high-quality manufactured goods,
on average
China and/or Vietnam produce cheaper goods, on
average

30
Econ 4321 International Trade
 Gains from Trade
Studies show that trade benefits nations as a whole in
various ways, but it may harm some groups within a
country (e.g., the owners of resources that are used
intensively in industries that compete with imports)
Trade may therefore have effects on the distribution of
income within a country.
Trade conflicts are likely to occur between groups
within countries rather than between countries (See
Feenstra and Taylor, 2008)
Static gains
Dynamic Gains
31
Econ 4321 International Trade
 The Effects of Government Policies
on Trade
Policies are likely to affect the trade between countries
tariffs: a tax on imports
quotas: a quantity restriction on imports
export subsidies: a payment to producers that export
or through other regulations (ex., labor, environment,
product safety)
Transportation costs
Wars, sanctions, etc.
Trade barriers vary over time as policies, technology, etc.,
change (Feenstra and Taylor, 2008)
[Link] 32
Econ 4321 International Trade
 The Basics of World Trade
The problems with bilateral trade data (Feenstra and
Taylor, 2008)
If some inputs are imported into a country, then the
value-added is likely to be lower than the value of
exports
Barbie Doll
Oil from Saudi Arabia, plastic from Taiwan, hair from
Japan, and assembly in China

The doll’s value is $2 when it leaves China

but 35 cents is value-added from Chinese workers
33
Econ 4321 International Trade
 The Basics of World Trade 2
The problem is that $2 is counted as an export from
China to the U.S., but only 35 cents of the value
originates from China via labor contribution.
Thus, the bilateral trade deficit or surplus is
complicated, leading to controversy.
There have been some recent measures of value-added
exports, which are more reliable.
This example also shows that the value-added can be much
lower than the total value of exports.
This is why we often see that trade is greater than GDP.

34
Econ 4321 International Trade
 Another Example
Fragmentation of production / complex supply chains
iPod price: $299
Country contribution to value added is:
US: $163 ($80 Apple's intellectual property right + $75
distribution and retail + $8 various domestic components)
Japan: $26 ($19 Toshiba's IPR in hard drive + $7 other
components)
China, Korea, and other countries: $110 (for labor and other
components)
(Source: Varian, NYTimes June 28, 2007, Economic Scene)

35
Econ 4321 International Trade
 Video 2
Pinelopi Goldberg on international trade and supply chains
after COVID-19
[Link]

36
Econ 4321 International Trade
 Flow of Labor and Capital
Migration is the flow of individuals across countries.

Foreign Direct Investment is the flow of capital

across countries; a firm owns a permanent
establishment in another country.

37
Econ 4321 International Trade
 Migration
Many immigrants move to countries due to
Push factors
Pull factors
There is a concern that immigrants from low-wage
countries are likely to reduce the wages for lower-
skilled workers in the high-wage country.
But, studies show that international trade can serve
as a substitute for movements of capital and labor
across borders (Feenstra and Taylor, 2008)
Trade can raise workers' living standards in low-wage
countries, and thus they would choose to stay home.
38
Econ 4321 International Trade
 Foreign Direct Investment
Foreign direct investment (FDI)- a firm from country j owns a
permanent establishment (factory, plant, subsidiary, office) in
a foreign country or more than one foreign country.
Unlike migration, FDI mainly occurs between OECD or
industrialized countries.
Why?
[Link]
[Link]?source=world-development-indicators
[Link]
[Link]
[Link]

39
Econ 4321 International Trade
 Capital Flows in the World Economy
Multinational Firms (MNFs) or Transnational corporations (TNCs)
Firms that own, control, or manage permanent establishments in
more than one nation
Direct investment in foreign countries by the parent firm
Exxon, GM, Ford, GE, Tesla (recent)
Portfolio Capital/Investment
Cross-border purchases of financial assets (e.g., stocks, bonds)
Transactions involve debt securities (e.g., bonds, notes, options) and
equity securities (e.g., an investor owns less than 10% of the shares of
an entity) – called “hot money” as it can enter and exit easily (IMF)
Foreign Direct Investment (FDI)
A domestic corporation’s establishment or purchase of real assets
(investor owns more than 10% or more of an establishment)
Foreign Exchange Market
The market where currencies are bought and sold
Exchange Rate 40
The value of currencies in terms of other currencies Econ 4321 International Trade
Capital Flows in the World Economy 2
IMF defines direct investment as
“An incorporated or unincorporated enterprise in which a direct investor,
who is resident in another economy, owns 10 percent or more of the
ordinary shares or voting power (for an incorporated enterprise) or the
equivalent (for an unincorporated enterprise)”
Direct transactions (IMF)
Equity capital (purchase of shares of an enterprise by a foreign investor)
Reinvested earnings (the foreign investor’s share of enterprise earnings that
are not distributed as dividends but reinvested )
Inter-firm transactions or other direct capital (e.g., borrowing and lending
funds between parent enterprise and affiliate enterprises) (WIR, 2007)
Equity capital (direct investments in foreign affiliates)
Subsidiaries: investor owns more than 50% of the incorporated business
enterprise (also defined as “majority-owned affiliates”)
Associates: investor owns 10-50% of the equity in the incorporated
enterprise
Branches: unincorporated enterprises which are wholly or jointly owned 41
Econ 4321 International Trade
Capital Flows in the World Economy 3
The following definitions are in more detail.
The United Nations Conference on Trade and Development (UNCTAD),
World Investment Report (WIR), 2007, defines multinational corporations as
follows.
“Transnational corporations (TNCs) are incorporated or unincorporated
enterprises comprising parent enterprises and their foreign affiliates.
A parent enterprise is defined as an enterprise that controls assets of other
entities in countries other than its home country, usually by owning a certain
equity capital stake. An equity capital stake of 10% or more of the ordinary
shares or voting power for an incorporated enterprise, or its equivalent for
an unincorporated enterprise…
A foreign affiliate is an incorporated or unincorporated enterprise in which
an investor, who is a resident in another economy, owns a stake that permits
a lasting interest in the management of that enterprise (an equity stake of
10% for an incorporated enterprise or its equivalent for an unincorporated
enterprise). UNCTAD WIR (2007, page 245).
[Link]
Foreign affiliates or direct investments in foreign affiliates are defined as
follows in World Investment Report IWIR). 42
Econ 4321 International Trade
Capital Flows in the World Economy 4
UNCTAD WIR (2007), [Link]
defines direct investment (foreign affiliates, affiliates, or direct
investments in foreign affiliates) as:
“A subsidiary is an incorporated enterprise in the host country in which
another entity directly owns more than half of the shareholder’s voting power
and has the right to appoint or remove a majority of the members of the
administrative, management, or supervisory body.
An associate is an incorporated enterprise in the host country in which an
investor owns a total of at least 10%, but not more than half, of the
shareholders’ voting power.
A branch is a wholly or jointly owned unincorporated enterprise in the host
country which is one of the following: (i) a permanent establishment or office
of the foreign investor; (ii) an unincorporated partnership or joint venture
between the foreign direct investor and one or more third parties; (iii) land,
structures (except structures owned by government entities), and /or
immovable equipment and objects directly owned by a foreign resident; or
(iv) mobile equipment (such as ships, aircraft, gas- or oil-drilling rigs)
operating within a country, other than that of the foreign investor, for at least
one year.” UNCTAD WIR (2007, page 245).
43
Econ 4321 International Trade
Capital Flows in the World Economy 5
UNCTAD WIR (2007), [Link]
defines foreign direct investment (FDI)
“as an investment involving a long-term relationship and reflecting a
lasting interest and control by a resident entity in one economy (foreign
direct investor or parent enterprise) in an enterprise resident in an
economy other than that of the foreign direct investor (FDI enterprise or
affiliate enterprise or foreign affiliate)… FDI has three components:
equity capital, reinvested earnings and intra-company loans.
Equity capital is the foreign direct investor’s purchase of shares of an
enterprise in a country other than its own.
Reinvested earnings comprise the direct investor’s share (in
proportion to direct equity participation) of earnings not distributed
as dividends by affiliates, or earnings not remitted to the direct
investor. Such retained profits by affiliates are reinvested.
Intra-company loans or intra-company debt transactions refer to
short- or long-term borrowing and lending of funds between direct
investors (parent enterprises) and affiliate enterprises” UNCTAD
WIR (2007, page 245).
44
Econ 4321 International Trade
Capital Flows in the World Economy 6
UNCTAD WIR (2007), [Link]
defines non-equity investments as follows:
“Foreign direct investors may also obtain an effective voice in the
management of another business entity through means other than
acquiring an equity stake. These are non-equity forms of investment,
and they include, inter alia, subcontracting, management contracts,
turnkey arrangements, franchising, licensing and product-sharing.
Data on these forms of transnational corporate activity are usually
not separately identified in the balance-of-payments statistics. These
statistics, however, usually present data on royalties and licensing
fees, defined as receipts and payments of residents and non-residents
for: (i) the authorized use of intangible non-produced, non-financial
assets and proprietary rights such as trademarks, copyrights, patents,
processes, techniques, designs, manufacturing rights, franchises, etc.,
and (ii) the use, through licensing agreements, of produced originals
or prototypes, such as manuscripts, films, etc” UNCTAD WIR (2007,
page 245).
45
Econ 4321 International Trade
Capital Flows in the World Economy 7
UNCTAD WIR (2007),
[Link] defines
inward and outward activities as follows:
“Inward operations refer to the activities of foreign
affiliates in the host economy (business enterprises in
which there is an FDI relationship in the host country).
Outward operations refer to the activities of foreign
affiliates of home-based TNCs abroad (business
enterprises located abroad in which the home-based TNC
has an FDI relationship).” UNCTAD WIR (2007, page
249).

46
Econ 4321 International Trade
 Capital Flows in the World Economy 8

Table 1.4 Distribution of International Capital Flows in the World Economy 2012

Source: Sawyer and Sprinkle (2016)

See [Link] for more current
data

47
Econ 4321 International Trade
The Balance of Payment Account (BoP) and
International Positions
Let’s look at the Balance of Payment Account (BoP) and
International Positions data for U.S. at
[Link]
CA473CA1FD52&sId=1542635306163
BOB includes cross-border transactions

48
Econ 4321 International Trade
 Productivity
Productivity: A rise in value added (or output) that does
not stem from labor or capital
The efficiency with which inputs are converted into
output
Labor Productivity
Quantity of output divided by the number of hours
worked by labor (or by the number of workers),
ceteris paribus
Total factor productivity
The measure of the change in output resulting from a
change in all inputs
More output from the same inputs or the same output
from fewer inputs 49
Econ 4321 International Trade
 Productivity 2
The productivity change for a firm can stem from
Technical change
Better production processes or the shift in the production frontier over
time
Changes in output over time that are not attributable to changes in inputs
(changes in the maximum output obtained from a given level of inputs)
Technical Efficiency Change or Catching-up
Changes in the use of existing production methods over time (use of
existing technology more efficiently regardless of whether the technology
improves)
Change in the firm ability to ensure that they get the most out of
existing technologies (training, absorptive capacity)
Scale Efficiency Change
The changes in the scale at which the current production methods are
utilized
Allocative efficiency
The changes in the level of inputs or proportions such that input price ratios equal
to the ratios of the marginal products
Econ 4321 International Trade 50
 Productivity 3
The growth of output is a function of
The growth of inputs (capital, labor)
The growth in total factor productivity
Improvements in productive efficiency
The growth of output when the inputs are held constant
The residual is “a measure of our ignorance.”

Productivity growth is extremely important.

Watch the minutes 45+ in the video at
[Link]
kin
“When I think about the economy, all roads lead to productivity
growth.”
51
Econ 4321 International Trade
 Sources
Robert C. Feenstra and Alan M. Taylor, International Economics,
2008, New York: Worth Publishers.
Paul R. Krugman and Maurice Obstfeld, International Economics:
Theory and Policy, 8th edition, 2009, New York: Pearson/Addison-
Wesley.
W. Charles Sawyer and Richard L. Sprinkle, Applied International
Economics, 4th edition, 2015, Routledge.
International Monetary Fund Balance of Payment Manual.
[Link]
World Investment Report 2007 - Transnational Corporations,
Extractive Industries and development (UNCTAD/WIR/2007) 15 Oct
2007, 323 pages. [Link]
Other sources are cited throughout the slides. 52
Econ 4321 International Trade