Chapter 1 Introduction

Chapter 1 Introduction Prepared by Iordanis Petsas To Accompany International Economics: Theory and Policy, Sixth Edition by Paul R. Krugman and Maurice Obstfeld

What is International Economics About? • International economics deals with economic interactions that occur between independent nations. • There are several issues that recur throughout the study of international economics: - • Gains from trade, The Pattern of Trade, Protectionism, How Much Trade?, The Balance of Payments, Exchange Rate Determination, International Policy Coordination, and the International Capital Market. • The most important themes for this academic year (2011-2012) are: • Gains from trade • Protectionism • The International Capital Market

The Gains from Trade • What exactly do people gain when they trade with one another? • Comparative advantages and specialization. As the theory of comparative advantage states, a country can increase its standard of living by specializing in what it can make at low opportunity cost and trading for what it can make only at high price. The theory of comparative advantage also shows that total production in both countries increases with specialization. • Increased variety of goods. Free trade gives consumers in all countries greater variety from which to choose (German car versus American car).

The gains from trade • Lower costs through economies of scale. Some goods can be produced at low cost only if they are produced in large quantities—a phenomenon called economies of scale. Free trade gives firms access to larger world markets and allows them to realize economies of scale more fully. • Increased competition. Opening up trade fosters competition and gives the invisible hand a better chance to work its magic. It restricts the ability of domestic companies to have market power, which in turn gives it the ability to raise prices above competitive levels.

The Gains from Trade • Enhanced flow of ideas. With specialization and trade, the total sum of knowledge used in an economy increases tremendously and far exceeds that of any one brain. Without trade, the knowledge used by an entire economy is approximately equal to the knowledge used by one brain.

THE WINNERS AND LOSERS FROM TRADE • The Gains and Losses of An Exporting country. • The main two conclusions: • When a country allows trade and becomes an exporter of a good, domestic producers of the good are better off, and domestic consumers of the good are worse off. • Trade raises the economic well-being of a nation in the sense that the gains of the winners exceed the losses of the losers.

What is International Economics About?

The Gains and Losses of an Importing Country. • • When a country allows trade and becomes an importer of a good, domestic consumers of the good are better off, and domestic producers of the good are worse off. • • Trade raises the economic well-being of a nation in the sense that the gains of thewinners exceed the losses of the losers.

The Lessons for Trade Policy in Isoland country • Question (1):If the government allows a Isolandians to import and export textiles, what will happen to the price of textiles and the quantity of textiles sold in the domestic textile market? • Answer:Once trade is allowed, the Isolandian price of textiles will be driven to equal the price prevailing around the world. If the world price is now higher than the Isolandian price, our price will rise. The higher price will reduce the amount of textiles Isolandians consume and raise the amount of textiles that Isolandians produce. Isoland will, therefore, become a textile exporter. This occurs because, in this case, Isoland has a comparative advantage in producing textiles. • Conversely, if the world price is now lower than the Isolandian price, our price will fall. The lower price will raise the amount of textiles that Isolandians consume and lower the amount of textiles that Isolandians produce. Isoland will, therefore, become a textile importer. This occurs because, in this case, other countries have a comparative advantage in producing textiles.

Question:Who will gain from free trade in textiles and who will lose, and will the gains exceed the losses? • Answer:The answer depends on whether the price rises or falls when trade is allowed. If the price rises, producers of textiles gain, and consumers of textiles lose. If the price falls, consumers gain, and producers lose. In both cases, the gains are larger than the losses. Thus, free trade raises the total welfare of Isolandians.

Question:Should a tariff be part of the new trade policy? • Answer:A tariff has an impact only if Isoland becomes a textile importer. In this case, a tariff moves the economy closer to the no-trade equilibrium and, like most taxes, has deadweight losses. Although a tariff improves the welfare of domestic producers and raises revenue for the government, these gains are more than offset by the losses suffered by consumers. The best policy, from the standpoint of economic efficiency, would be to allow trade without a tariff. We hope you find these answers helpful as you decide on your new policy.

Key terms • Comparative advantage • Absolute advantage • Child labor • Export • Import • Domestic producers • Foreign producers • Specialization • Knowledge • Information

Chapter 2: Arguments against International Trade (Protectionism) • Trade and jobs. Trade does eliminate jobs, Because domestic factories cannot compete with foreign industries. • Child labor . Another justification of restricting trade is that some companies in the exported country have employed child workers to produce its products. Thus, some claim that importing any goods that made by children under the age of 15 must be prohibited.

Trade and National Security. some argue that restrictions are necessary to avoid any imported goods which may badly affect the health of people (In 1918, more than a quarter of the U.S. population got sick with flu and more than 500,000 died). • Key Industries. Another argument is the "it is better to produce computer chips than potato chips" argument. The idea is that the production of computer chips is a key industry because it generates spillovers, benefits that go beyond the computer chips themselves.

Strategic Trade Protectionism. • Sometimes, the government use tariffs and quotas to help domestic firms to act like a cartel when they sell to international buyers. Oddly, the way to do this is to limit or tax exports. A tax or limit on exports reduces exports but can drive up price enough so that net revenues increase.

The Instruments of Trade Policy • The tariff. A tariff is simply a tax (duty) levied on a product when it crosses national boundaries. • The most widespread tariff is the import tariff, which is a tax levied on an imported product. A less common tariff is an export tariff, which is a tax imposed on an exported product. Export tariffs have often been used by developing nations. • Two purposes of tariff: • A protective tariff: it is designed to reduce the amount of imports entering a country, thus insulating import-competing producers from foreign competition. • A revenue tariff: it is imposed for the purpose of generating tax revenues and may be placed on either exports or imports.

Other Instruments of Trade Policy • Export Subsidies. An export subsidy is a payment to a firm or individual that ships a good abroad. • Import Quotas. An import quota is a direct restriction on the quantity of some good that may be imported. The restriction is usually enforced by issuing licenses to some group of individuals or firms. • For example, the United States has a quota on imports of foreign cheese. The only firms allowed to import cheese are certain trading companies; the size of each firm's quota is based on the amount of cheese it imported in the past.

KEY TERMS • protection. • export restraint. • export subsidy. • import quota. • specific tariff.

Trade Policy in Developing Countries Prepared by Iordanis Petsas To Accompany International Economics: Theory and Policy, Sixth Edition by Paul R. Krugman and Maurice Obstfeld

Infant Industry argument • 1- According to the infant industry argument, developing countries have a potential comparative advantage in manufacturing, but new manufacturing industries in developing countries cannot initially compete with well-established manufacturing in developed countries. Thus, it makes sense, according to this argument, to use tariffs or import quotas as temporary measures to get industrialization started. بةثيَي ئةم ئارطيوميَنتة ولاتاني تازة ثيَطةيشتو ميزةي نسبيان Comparative advantage هةية لة مانيفاكتؤرةدا (Manufacture) بةلام ثيشةسازي مانيفاكتؤرة لةم ولاتانةدا تواناي كيَبركيَي نيية لةطةل ثيشةسازية بةهيَزةكاني ولاتاني ثيَشكةوتو. بؤية مةعقوليةتي تيَداية، جيَطاي باوةرثيَهيَنان و قبولكردنة (Make sense) كة حكومةت لةم قؤناغةدا طومرط (tariffs) يان ثشكي هاوردة (Import qoutas) (حصص) دابنيَت بؤ ئةوةي بةثيشةسازيكردن دةست ثيَبكات.

2- Another reason why infant industry protection may be a good idea is imperfect capital markets: developing countries do not have a set of financial institutions that would allow savings from traditional sectors to be used to finance investment in new sectors. • هؤكاريَكي تر كة بؤضي ثاريَزطاريكردن لة ثيشةسازي ساوا رةنطة ئايديايةكي باش بيَت بريتية لة ناتةواوي بازاري سةرماية: ولاتاني تازة ثيَطةيشتو دامةزراوةي داراييان نيية بة شيَوةيةك هاني ثاشةكةوت بدات لة سيَكتةري تةقليدييدا تا بؤ دارايي وةبةرهيَنان لة سيَكتةري نويَدا بةركاريهيَنريَت. Thus the first-best policy is to create a better capital market, the second-best policy is to protect new industries, which would raise profits and thus allow more rapid growth بؤية يةكةم-باشترين سياسةت بريتية لة دروستكردني بازارييَكي سةرمايةي باشتر، دووةم-باشترين سياسةت بريتية لة ثاريَزطاريكردن لة ثيشةسازي نويَ، كة قازانج زياد دةكات و ريَطادةدات طةشة خيَراتر بيَت.

3- The problem of spillover: The idea is firms in a new industry generate social benefits for which they are not compensated. Pioneering firms may, in addition to producing physical output, create intangible benefits (such as knowledge or new markets) in which they are unable to establish property rights. In some cases the social benefits from creation of a new industry will exceed its costs, yet because of the problem of spillover no private entrepreneurs will be willing to enter. • طرفتي سثيلؤظةر دةكريَ بة هؤكاريَكي تري ثشتطيري ئةم ئايدياية دابنريَت. ئايدياكة بريتية لةوةي كؤمثانياكان (ثرؤذةكان) لة ثيشةسازييةكي نويَدا هةنديَك كةلك يان سودي كؤمةلايةتي بةرهةمدةهيَنن كة قةرةبوناكريَنةوة لةسةري. ثرؤذة ثيَشةنطةكان رةنطة، سةرباري ئةوةي بةرهةمي مادي دروست دةكةن، سودي نةبينراو دروست بكةن (وةك زانين يان بازاري نويَ) بةشيَوةيةك كة ناتوانن مافي خاوةنداريَتي بثاريَزن. هةنديَجار سودي كؤمةلايةتي دروستكردني ثيشةسازي نويَ تيَضونةكةي تيَدةثةريَنيَت، بةلاَم بةهؤي طرفتي سثيلؤظةوة هيض ثيَشةنطيَط لة كةرتي تايبةت ئامادة نيية بضيَـتة ناو ئةم بازارةوة.

Problems with the Infant Industry argument ِ • Economists have pointed out many pitfalls in the argument, suggesting that it must be used cautiously. (What are the main problems with Infant Industry argument?) هةنديَك لة ئابوريناسان ئاماذة بة ضةندين مةترسي شاراوة Pitfalls دةكةن كة ناضارمان دةكات زؤر بة ورياييةوة مامةلة لةطةل ئةم سياسةتة بكةين، لةبةر ئةم هؤيانة: • 1- First, it is not always good to try to move today into the industries that will have a comparative advantage in the future. • يةكةم، مةرج نيية هةميشة ئةوة باش بيَت كة هةولبدريَت روبكريَتة ثيشةسازييةك كة لة داهاتودا ئةطةري ئةوة هةية ميزةي نسبي هةبيَت. • بؤ نمونة: لة 1980 كاندا كؤرياي باشور دةستي كرد بة هةناردةكردني ئؤتؤمبيَل. بةلام خؤ نةدةكرا لة 1960 ةكاندا روبكاتة هةناردةكردني سةيارة و واز لةو ثيشةسازيانة بهيَنيَت كة ثشتي بة كار دةبةست لة كاتيَكدا ئةو كاتة دةستي كاري شارةزاي و سةرمايةي كةمبوو. بةم ماناية، مةترسيةك لةم ئارطيوميَنتة ئةوةية كة دةشيَت هانمان بدات واز لة هةنديَ ثيشةسازي بهيَنين و ذيانمان بخاتة ضاوةروانييةوة بة ئوميَدي ئةوةي لة ئايندةدا ثيشةسازييةكانمان دةطةنة بازارةكاني جيهان و خؤشبةختي بؤ ولات دةنيَرنةوة.

Example 2- protecting manufacturing does no good unless the protection itself helps make industry competitive. • دووةم، ثاراستني مانيفاكتؤرةكة مايةي دلخؤشي نيية مةطةر unless خودي ثاريَزطاريكردنةكة ببيَتة هؤي بةهيَزبوني تواناي كيَبركيَ. نمونة: ثاكستان و هيند بؤ ضةند دةيةيةك قةلغانيان بة دةوري هةنديَك لة مانيفاكتؤرةكانيان دروست كرد، و بةم دواييةش زؤر لة بةرهةمةكاني ئةو مانيفاكتؤرانة طةيشتنة بازارةكاني جيهان. لةطةلَ ئةمةشدا (however)، ئةم بةرهةمانةي ئةوان دةيانناردة دةرةوة مانيفاكتؤرةي سوك بون Light manufactures وةكو نةسيج، نةك بةرهةمي ئةو مانيفاكتؤرانةي كة قورس بون heavy manufactures و ثاريَزطارييان ليَدةكرا. ئةم جياوازيية بة ئةندازةيةك بوو كة هةر دةتوت ئةوان دةيانتواني ئةو شمةكانة بنيَرنة دةرةوة بيَ ئةوةي ثيَويست بكات هةنديَك لة مانيفاكتؤرةكانيان هةرطيز بثاريَزن if they had never protected manufacturing.

3- More generally, the fact that it is costly and time-consuming to build up an industry is not an argument for government intervention unless there is some domestic market failure. • لة سةرو ئةمانةشةوة، ئارطيوميَنتي ”بيناكردني ثيشةسازي نويَ ثيَويستي بة كاتي زؤر و تيَضوني زؤر هةية و ئةمةش لة تواناي كةرتي تايبةتدا نيية“ بةس نيية بؤ ئةوةي حكومةت دةستوةربداتة ئابورييةوة مةطةر بازاري ناوخؤيي لةو بوارةدا شكستي هيَنا بيَت unless there is some domestic market failure. • ئةطةر ثيشةسازييةك دةستكةوتي زؤر دروست بكات و بطيَريَتةوة بؤ هةر يةك لة كار و سةرماية و فاكتةرةكاني ديكة، بؤضي كةرتي تايبةتي ئةم ضالاكية نةكات بيَ هاوكاري حكومةت without government help؟ بيَطومان داخلَي ئةم جؤرة ثيشةسازيانةش دةبيَت، وةك ثيشةسازي دةرمان لة ئةمةريكا

4- Both the imperfect capital markets argument and the spillover case are clearly special cases of the market failures justification for interfering with free trade. The difference is that in this case the arguments apply specifically to new industries rather than to any industry. • هةردوو ئارطيوميَنتي ناتةواوي بازاري سةرماية و سثيلؤظة بة روني بريتين لة كةيسي تايبةتي شكستي بازار كة بونةتة ثاساو بؤ دةستوةردان لة بازرطاني ئازاد. جياوازيةكة ئةوةية كة ئةم ئارطيوميَنتة بةسةر ثيشةسازي نويَدا دةسةثيَت و بةس نةك بؤ هةر ثيشةسازييةك. • However, in practice it is difficult to evaluate which industries really warrant special treatment, and there are many stories of infant industries that have never grown up and remain dependent on protection. • لةطةل ئةمةشدا، لة ثراكتيكدا هةلسةنطاندني ئةو ثيشةسازيانةي ثيَويستيان بة بايةخيَكي تايبةتي هةية ئاسان نيية، و زؤر ضيرؤكيش هةية دةربارةي ثيشةسازي ساوا كة هةرطيز طةشةيان نةكرد و تا ئيَستاش ثشت بة ثاريَزيَطاريكردن دةبةستن.

import-substituting industrialization. • It is the strategy of encouraging domestic industry by limiting imports of manufactured goods through trade restrictions (e.g. tariffs and quotas). • The 1950s and 1960s saw the high tide of import-substituting industrialization. In the early 1970s, India's supports other than oil were only about 3 percent of GDP.

One might ask why a choice needs to be made. Why not encourage both import substitution and exports? • The answer is a tariff that reduces imports also necessarily reduces exports. By protecting import-substituting industries, countries draw resources away from actual or potential export sectors.

Why to choose import-substituting strategy? • Many developing countries believed that industrialization was necessarily based on a substitution of domestic industry for imports rather than on a growth of manufactured exports. • In many cases, import-substituting industrialization policies dovetailed (come together) naturally with existing political bases (e.g. the Great Depression and the wartime disruption of trade in 1940s).

Converse to export substitution, import substitution directly benefited powerful, established interest groups. • Some argued that the international economic system systematically works against the interests of developing countries. • These arguments remained common until the 1980s.

DEVELOPING-NATION TRADE CHARACTERISTICS 1- Trade among developing nations is relatively minor, although it has increased in recent years 2- Developing nations are highly dependent on advanced nations. A majority of developing-nation exports go to the advanced nations. 3- Another characteristic is the composition of developing-nations’ exports, with its emphasis on primary products (agricultural goods, raw materials, and fuels). Of the manufactured goods that are exported by developing nations, many (such as textiles) are labor intensive and include only modest amounts of technology in their production. 4- Finally, developing-nation imports originate in advanced nations

Chapter 1 Introduction