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In Figure 32.1 we note that when the US was dominant during the Keynesian era that the total of trade (exports about 5% net exports about 1%) was only 10% of GDP (when exports and imports are added together). American wealth was grown domestically virtually independent of trade. Recall the link between budget deficits and trade imbalances from Chapter 14 (pg 306) This is what one would expect from unilateral free trade as opposed to fair trade. Chapter 32 Comparative advantage and the open economy
The textbook has oversimplified the idea of gains from specialization. The example given is one in which there are no monetary transactions. The two individuals appear to be working cooperatively to maximize productivity. A similar simplification is offered where India and the US appear to work cooperatively to increase world production. Where these examples fail to bear any resemblance to reality is that individuals, businesses, and countries trade goods through markets for currency. Output gains from specialization
The textbook offers an example that seems to suggest that one country will tell another country “Provide us with all of the sugar cane, pineapples, and bananas that you can produce and we will provide you with all of the computers, medicines, and appliances you need.” This focusing on comparative advantage has kept poor countries poor for centuries. If Hamilton had listened, we would still be farmers deep in debt to Europe. If Park had listened Korea would still be a nation of impoverished subsistence farmers. International trade
The IMF and the World Bank as a part of their SAPs insist on the “expansion of the export of natural resources and agricultural products.” (Clarke, 1996) Emphasis on low-value added goods provide Western corporations with cheap raw materials. By focusing on agricultural products and natural resources these poor countries will remain poor as they will always have a trade deficit, and therefore, a budget deficit, producing low cost goods and importing high cost goods. When all you produce are commodities, producing more only serves to bring the price down. Keeping the poor poor
“…poor countries in the South that were once self-sufficient in food but are now desperate for foreign exchange to pay down their debts are forced to turn over valuable agricultural lands to transnational agribusinesses and to convert to cash-crop production while importing food products to feed their own peoples. ‘Export or die,’ is the message, but ‘export and die’ is the reality.” (Clarke, 1996) Comparative advantage?
Today, US wood products are shipped to China, used to build furniture, then shipped back to the United States for sale. This is similar to colonial times when cotton was shipped from the US to Britain then sold back (at substantially higher cost of course) as textiles. During colonial times this relationship was largely forced upon us under British mercantilism and the Navigation Acts. Now, however, we have done this voluntarily in the name of globalization and the faith that all trade is good. In reality, a Chinese worker who had been living on less than $2.00 a day is better off living in dorms and making $80.00 a month. Corporations make profits on manufacturing in a poor economy and selling in a wealthy economy and also through the Chinese currency manipulation by paying workers in undervalued Chinese currency. Who benefits?
David Ricardo was a classical economist whose name is frequently thrown around in discussions of free trade and comparative advantage. As with other classical economists, he based his ideas on the perfectly competitive market. At the center of his argument regarding free trade was the “iron law of wages.” Ricardo argued that wages above subsistence levels (paying workers more than the bare minimum to keep them alive) are futile as it would cause unemployment (based on the idea that profits are zero). Other firms would pay their workers the subsistence wage, be able to sell at a lower price level, and put this firm out of business. The iron law of wages
“…transnational manufacturing firms can quickly move their operations around the world, in search of cheap labor, more profitable investment opportunities, and freedom from the demands of unionized workers…there is a very real danger that the forces of global competition will drag workers everywhere down to the lowest common wage standards.” (Clarke, 1996) Wage rates
A 17 year patent made sense in the times of Edison and Bell when these inventors spent their own time and money creating inventions that would not likely exist for decades without their endeavors. It does not make sense in the context of tens of thousands of researchers working on the same projects, often with some form of taxpayer funding. Not only would another researcher make the same discovery within weeks or months, but the new technology is now often obsolete in less than 10 years. Patents were 17 years. Industry could not get Congress to extend them. Industry lobbied and received an extension to 20 years through the WTO. Patents and innovation
The patent system was developed to encourage innovation, however, its abuses are now achieving the opposite effect. Processes that have been used routinely in research have been patented and their use prevented by competing firms and researchers. Pharmaceutical companies spend taxpayer research dollars to investigate new drugs for patent on proven opportunities for sales even when there are already plenty of treatments available. (IE high blood pressure medications and ED treatments) Little research is done on medical conditions that are relatively rare or are limited to poor countries. Minor changes are added to existing products to extend the period of the patent. Patents are about profits
The neem tree of India has been recognized for its startling chemical properties for centuries, yet several extracts from the tree have been patented by US firms. If a cure for AIDS were found its patent would likely be bought up and hidden as AIDS maintenance drugs are a multi-billion dollar industry. Pharmaceutical companies are incentivized to develop maintenance drugs over cures. The NiMH battery is considered by many to be the answer to electric cars, but the patent is owned by Chevron who prevents its usage in vehicles. This is known as a patent encumberance. Innovation???
Entrepreneurs patent business processes and technologies already in use in order to earn royalties from its usage. They are not innovators or manufacturers, only opportunists. Patent trolls
“any restrictions of imports ultimately reduces exports.” For a country like South Korea, exports are a necessity as they lack natural resources in any great measure. The United States, however, has been most successful when we have focused on the domestic market at the expense of trade. During most of the Keynesian era exports only accounted for about 5% of GDP. As discussed in Chapter 14 (pg 307) trade deficits and budget deficits go hand in hand. US and exports
There is some debate regarding the argument about how American worker productivity compares to our European counterparts. Americans frequently work off the clock, providing labor for free by working from home or while on vacation, while in some areas of Europe it is customary to leave work after lunch on Fridays. There are some discrepancies on the counting of actual hours worked. US worker productivity If we were really worried about American competitiveness we would have a universal, government-run healthcare system. By keeping it as something provided by employers our businesses face a cost that is not borne by businesses in other countries.
Africa is the closest continent to Europe, yet it was the last to be colonized (even after Australia). The rough terrain and dense jungle make transportation dangerous and in some cases impossible. It wasn’t until steamboats were invented that Europeans started to venture into the interior to exploit resources. These same problems still exist today. African competitiveness
Know these from the textbook The infant industry argument Countering foreign subsidies and dumping Protecting domestic jobs Emerging arguments against free trade Arguments against free trade
Quotas and tariffs: Below are the effects on the prices of consumer goods in the presence of tariffs and quotas. The emphasis in the discussion is on who is harmed (foreign producers and US consumers) and who benefits (US producers) We are concerned with the macroeconomy of the United States. The effect on GDP is to increase domestic production, to increase investment, and to reduce imports. If in the long run it increases worker’s wages they can afford a higher price for the laptop computer, bicycle, or widget. If we continue buying imports we won’t be able to afford these items whatever the price. Quotas and tariffs
The graphs for quotas and tariffs are read in the same manner. With no imports the quantity and price is determined where domestic supply intersects with domestic demand. In the graph below this position is not marked on the axes. With no limitations to imports, we have a price of $300 and domestic producers produce and sell quantity S0 while sales of imported bikes will be the quantity from S0 to D0 With a quota or a tariff in place, the price to consumers will be $330. Domestic producers will produce and sell quantity S1 while sales of imported bikes will be reduced to the quantity from S1 to D1. The increase to GDP is the quantity S0 to S1 The reduction of leakages due to imports is the quantities S0 to S1 and D0 to D1 Understanding the graph below
The United States has numerous free trade agreements, many of which are practiced unilaterally. Our markets are open to foreign goods while protectionist policies still keep us out of the foreign markets. This is tantamount to unilateral disarmament. The reason corporations want free trade is to sell goods manufactured in a low wage environment to be sold in a high wage environment. Free trade vs fair trade
Intended to provide a fair and equitable system of trade, international trade organizations and agreements are becoming corporate tools for the extraction of wealth worldwide. By lobbying at the international level, corporations are able to get countries to sign on to legislation that they would be unable to get passed in the legislations of the home countries. Extending patents to 20 years, financial deregulation, and the patenting of medical supplies are all things that were achieved through the WTO that many countries would have resisted at the national level. International trade organizations
Regional trade agreements make sense when surrounding nations have similar standards of living and business practices. By expanding a trade area, these trade regions can become more self-sufficient and independent, much like the United States. When richer countries with higher wage rates join with countries with lower wage rates the inclination is to bring the wage rates down. Mexico in NAFTA. Eastern Europe in the EU. Regional trade agreements
In political science, this is what is called framing. This term is consistently used to describe the effects of trade. When you google “losses from trade” you find news on losses on Wall Street or a sports story regarding a really bad trade by a sports team. Just as the Washington Consensus believes that markets fix themselves, all savings are invested, and government cannot do anything right, they also adhere to the idea that all trade, regardless of the terms or conditions, is good. Gains from trade
Again, the textbook focuses on the workers who are benefitted (truck drivers) and the workers who are harmed (Paper product manufacturer). The federal government has to take into consideration the sum total of effects. How many truck drivers versus how many paper products workers. Are the Mexican drivers safe and would they continue to be safe on American roads or will they be tempted to drive with little sleep in order to increase their income. It is most likely that lower shipping costs will affect the consumer price. Neo-classical economists would suggest that this is the government picking the winners and the losers. The Keynesian would say that is the wrong emphasis, that it is about astute management of the macroeconomy. You are there union workers
Subsidizing exports: It would appear to be a knee-jerk response by corporations to suggest the government giving them money to solve any problem. Not surprising that a private-sector advisory board would come up with this suggestion. Exports and imported tires: Free trade vs fair trade. China manipulates its exchange rates and workers are paid less than $1.50/hr. Chinese tires were flooding the American market. The International Trade Commission recommended the tariff and it was approved by the WTO. Issues and applications
The dollar as reserve currency. China has been working toward making the Chinese yuan the world’s reserve currency. As I was writing this, a few hours earlier it was announced that the yuan had surpassed the euro as the world’s second most traded currency. It would be devastating to the US economy if we lost the position of being the world’s currency. We have gotten away with sloppy macroeconomic policy because of this position. This would force us to get our house in order. Chapter 33
What does that have to do with the price of blue jeans in Canada? Note that when the value of the dollar dropped, the price of the jeans did not drop in Canada. The price was set to be affordable at the prevailing wage rate in Canada. Again, it has nothing to do with cost. Exchange rates
Balance of trade: The difference between exports and imports of physical goods Balance of payments: The transactions of goods, services, income, and financial assets between domestic households, businesses, and governments and residents of the rest of the world during a specific time period. Terms to know and differentiate
4. Receiving public transfers from a government, which obtained the funds by taxing others (a transfer is a payment, in money or in goods or services, made without receiving goods or services in return) I would like to point out that unemployment insurance and social security are transfer payments that individuals paid into throughout their working lives. I am taxed today to pay your UI and you are taxed tomorrow to pay my UI. Just a note
Current account transactions Capital account transactions Official reserve account transactions As shown, these figures need to balance. Balance of payments
In the discussion of distribution of account balances. The textbook is confusing inflation and exchange rates. Both are a measure of the value of a dollar but in different markets. Inflation measures the price of goods in the domestic markets relative to dollars. The exchange rate measures the value of the dollar as a means of exchange relative to other currencies. Lately, the FED has been basically printing money to keep the US out of deflation (we have discussed its ill effects). By doing so we have driven down the exchange rate of the US dollar. However, we still suffer from maldistribution of income, so the money created is largely being distributed on the world markets and not in our domestic market. The result is that while our inflation rate appears to be quite similar to that of Canada, the dollar has been devalued. It would be more appropriate for the textbook to talk about this distribution in terms of exchange rates, not inflation. Distribution of account balances
Political instability tends to go hand in hand with economic instability. As the US becomes even more polarized and our government becomes more dysfunctional we will become a riskier bet for investments. Another major economic or political crisis could set off capital flight. Political instability and capital flight
As with anything else, the value of the dollar is based on supply and demand. As the world’s reserve currency, central banks and market-shy investors are sitting on a frightening number of trillions of dollars. Should all of these dollars be dumped on the market at once it would start an economic crisis like the world has never seen. Doing so would be like dropping a nuclear weapon on New York and DC at the same time. Supply and demand of dollars
The book assumes no currency speculators. Consider the case of George Soros. In 1992 he made a $10 billion bet and shorted the British pound. It is estimated he made as much as $2 billion on this bet. The UK Treasury spent $27 billion pounds to prop up the currency ultimately costing the UK over 3 billion pounds. He was also involved in currency speculation in the East Asian crisis. “nobody who has read a business magazine in the last few years can be unaware that these days there really are investors who not only move money in anticipation of a currency crisis, but actually do their best to trigger that crisis for fun and profit. These new actors on the scene do not yet have a standard name; my proposed term is 'Soroi'.“ Paul Krugman Equilibrium foreign exchange rate
Currency appreciation and depreciation and understand the models on 734 to 738. One problem with this scenario. It assumes that as the exchange rate fluctuates that prices will change for goods in the US, yet prices are set at what the market will bear. What will change is the cost benefit analysis of whether a company will manufacture in the US or abroad. You need to know
If the US were to decide to manipulate the exchange rate to increase exports, China has much more available in reserves to outmanipulate the currency. We try to put more dollars on the market and China buys them up. Encourage exports by devaluing dollar
“Central banks can keep exchange rates fixed as long as they have enough foreign exchange reserves to deal with potentially long-lasting changes in the demand for or supply of their nation’s currency.” Fixing the exchange rate
Advantage of fixed: good for countries in which the uses of foreign currencies are prevalent within their economy. Many countries with fixed exchange rates will peg them to the US dollar. Advantage of floating: good for countries who use mostly their own currency for exchange. As the currency goes up or down in value, their currency becomes more expensive or cheaper. In a world where all currencies are allowed to float, theoretically all trade (or nearly all) would be balanced. Floating vs fixed exchange rates
Markets for currency perform an important function for stabilizing the world economies and facilitating trade. Should there be currency speculation? We saw with George Soros that a $10 billion short sale was very profitable for Soros, but destabilizing to the British economy. When an individual can make a $10 billion dollar move in the market, they are capable with this move of causing a fall in the currency, not simply benefiting from a fall that would have occurred anyway. How would we be able to identify and prevent speculation instead of just someone seeking to exchange foreign currencies? currency speculation
It was surprising to me that a textbook published in 2012 chose to discuss the euro and not the yuan as the next world currency. China’s central bank holds $3.66 trillion in foreign reserves and China is the largest producer of gold by a substantial margin. With the US printing money to artificially keep the US out of deflation and the Chinese stockpiling currrency reserves and gold, the Chinese stand poised to destroy the US dollar and our economy along with it. The chineseyuan – the next world currency?
By having the world’s reserve currency we have been able to get away with poor policy choices, both fiscal and monetary. We have balance of payment problems that no other country would be able to get away with. Economic and political stability are the keys to holding a world currency. If the central banks, private banks, and corporations of the world were to suddenly divest themselves of US dollars, the hyperinflation that would ensue would be cataclysmic. What happens if?
