International Economics

Roland Winkler
References
Krugman, Paul R., Maurice Obstfeld, and Marc Melitz
(2015). International Economics: Theory and Policy. Tenth
Edition or Eleventh Edition. Pearson.

Schmitt-Grohe, Stephanie, Martin Uribe, and Michael

Woodford (2016). International Macroeconomics.
http://www.columbia.edu/~mu2166/UIM/suw.pdf
Course organization
 Email: roland.winkler@uantwerpen.be
 Office: S.B.110 (make an appointment per email)
 Teaching Assistant:
 Patrick Allmis, patrick.allmis@uantwerpen.be
 Office: S.B.108 (make an appointment per email)
 Friday, 8.30-12.30, Room S.K.101
 Course consists of lectures and tutorials
 Timetable
Lecture: Tutorial:
15/02 : 08.30 – 10.00, 10.30 – 12.30 15/02 : no tutorial
22/02 : 08.30 – 10.00, 10.30 – 12.30 22/02 : no tutorial
01/03 : 10.30 – 12.30 01/03 : 08.30 – 10.00
08/03 : 10.30 – 12.30 08/03 : 08.30 – 10.00
15/03 : 10.30 – 12.30 15/03 : 08.30 – 10.00
29/03 : 10.30 – 12.30 29/03 : 08.30 – 10.00
05/04 : 08.30 – 10.30 05/04 : 11.00 – 12.30
26/04 : 08.30 – 10.00, 10.30 – 12.30 26/04 : no tutorial
03/05 : 10.30 – 12.30 03/05 : 08.30 – 10.00
10/05 : 10.30 – 12.30 10/05 : 08.30 – 10.00
17/05 : 10.30 – 12.30 17/05 : 08.30 – 10.00
24/05 : 10.30 – 12.30 24/05 : 08.30 – 10.00

4
Course information
The course is divided into two parts: international trade and
international macroeconomics.
• International trade covers the reasons for trade and
explanation of trade patterns.
• International macroeconomics covers the balance of
payments, global imbalances, and open economy
macroeconomics.
Course goal and prerequisites
Course goal
 Introduce students to main concepts in the domain of
international economics.
 Enable students to analyze developments in
international trade and international macroeconomics
 Enable students to critically evaluate policy options
and to analyze current international trade issues.

Prerequisites and requirements

 Introductory macro- and microeconomics.
Assessment criteria
(1) ASSIGNMENTS (10%): Two homework assignments
consisting of several exercises that need to be solved.
(2) Written FINAL EXAM WITHOUT oral presentation
(90%). The exam is a closed-book exam, consisting of
several exercises that need to be solved. Students need to
write down the answers including intuition and
interpretation of the results.

(3) AUGUST RESIT PERIOD

In the RESIT PERIOD, students do the resit exam without
oral presentation (closed-book exam 100%).
Chapter 1
Introduction
Preview
 What is international economics about?
 International trade topics
 Gains from trade, explaining patterns of trade, effects of
government policies on trade
 International macro topics
 Balance of payments, global imbalances, exchange rate
determination, international policy coordination and capital
markets
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 as countries become tied more to
the international economy.
 Nations are now more closely linked than ever before.
What Is International Economics About? (cont.)

U.S. exports and imports as shares of gross domestic

product have been on a long-term upward trend.
 International trade has roughly tripled in importance
compared to the economy as a whole in the past 50
years.
 Both imports and exports fell in 2009 due to the recession.
Fig. 1-1: Exports and Imports as a Percentage of U.S.
National Income

Source: U.S. Bureau of Economic Analysis

What Is International Economics About? (cont.)

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.
Fig. 1-2: Average of Exports and Imports as Percentage of
National Income in 2015

Source: World Bank

Gains from Trade
 That there are gains from trade is probably the most
important insight in international economics.

 Countries selling goods and services to each other

almost always generates 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.
Gains from Trade (cont.)
2. How could a country that is the most (least) efficient
producer of everything gain from trade?
• 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.
Gains from Trade (cont.)
3. Trade benefits countries by allowing them to export goods
made with relatively abundant resources and imports goods
made with relatively scarce resources.
4. When countries specialize, they may be more efficient due
to larger-scale production.
5. Countries may also gain by trading current resources for
future resources (international borrowing and lending) and
due to international migration.
Gains from Trade (cont.)
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.
Patterns 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 (ex., product specifications)
that exclude foreign products from the market, but still allow domestic
products.
 What are the costs and benefits of these policies?
The Effects of Government Policies
on Trade (cont.)
 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.
International Macro 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.
 how much 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 Macro
International trade focuses on transactions involving
movement of goods and services across nations.
 International trade theory

International macroeconomics focuses on financial or

monetary transactions across nations.
 International macroeconomics
 Chapter 2

World Trade:
An Overview
Preview
 Largest trading partners of the United States
 Gravity model:
 influence of an economy’s size on trade
 Distance, barriers, borders and other trade impediments

 Globalization: then and now

 Changing composition of trade
 Service outsourcing
Who Trades with Whom?

 More than 30% of world output is sold across national

borders.
 World trade in goods and services exceeded $21 trillion in
2015
 The 5 largest trading partners with the U.S. in 2015 were
China, Canada, Mexico, Japan, and Germany.
 The largest 15 trading partners with the U.S. accounted for
75% of the value of U.S. trade in 2015.
Fig. 2-1 : Total U.S. Trade with Major Partners, 2015

Source: U.S. Department of Commerce.

Fig. 2- a: Belgiu ’s Top Tradi g Part ers, 6

Source: BELGIAN FOREIGN TRADE AGENCY

Size Matters: The Gravity Model
 3 of the top 10 trading partners with the U.S.
in 2012 were also the 3 largest European economies:
Germany, the United Kingdom, and France.
 Why does the United States trade more with these European
countries than with others?
 These countries have the largest gross domestic product (GDP), the value of
goods and services produced in an economy, in Europe.
 Each European country’s share of U.S. trade with Europe is roughly equal to its
share of European GDP.
Fig. 2-2: The Size of European Economies, and the Value of
Their Trade with the United States
Size Matters: The Gravity Model (cont.)

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.
Trade between any two countries is larger, the larger is
either country.
Size Matters: The Gravity Model (cont.)

The gravity model assumes that size and distance are important
for trade in the following way:
Tij = A x Yi x Yj /Dij
where
Tij is the value of trade between country i and country j
A is a constant
Yi the GDP of country I, Yj is the GDP of country j
Dij is the distance between country i and country j
Or more generally
Tij = A x Yia x Yjb /Dijc
where a, b, and c are allowed to differ from 1.
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.
 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 (cont.)
 Estimates of the effect of distance from the gravity model
predict that a 1% increase in the distance between countries
is associated with a decrease in the volume of trade of 0.7% to
1%.
 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 (cont.)
 The U.S. signed a free trade agreement with Mexico and
Canada in 1994, the North American Free Trade Agreement
(NAFTA).
 Because of NAFTA and because Mexico and Canada are close
to the U.S., the amount of trade between the U.S. and its
northern and southern neighbors as a fraction of GDP is larger
than between the U.S. and European countries.
 Canada’s economy is roughly the same size as Spain’s (around 10% of EU GDP)
but Canada trades as much with the United States as does all of Europe.
Fig. 2-3: Economic Size and Trade
with the United States
Impediments to Trade: Distance, Barriers, and
Borders (cont.)
 Yet even with a free trade agreement between the U.S. and
Canada, which use a common language, the border between
these countries still seems to be associated with a reduction
in 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.
Fig. 2-4: Canadian Provinces and U.S. States that Trade with
British Columbia
Table 2-1: Trade with British Columbia, as Percent of
GDP, 2009
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 has grown smaller over time
due to modern transportation and communication.
 Technologies that have increased trade:
 Wheels, sails, compasses, railroads, telegraph, steam
power, automobiles, telephones, airplanes, computers, fax machines, Internet,
fi er opti s, personal digital assistants, GPS satellites…
The Changing Pattern of World Trade: Has the World
Gotten Smaller? (cont.)
 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.

 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.
Fig. 2-5: The Fall and Rise of World Trade
What Do We Trade?
 What kinds of products do nations trade now, and how does
this composition compare to trade in the past?
 Today, most (about 57%) of the volume of trade is in
manufactured products such as automobiles, computers, and
clothing.
 Services such as shipping, insurance, legal fees, and spending by tourists account
for about 24% of the volume of trade.
 Mineral products (ex., petroleum, coal, copper) remain an important part of
world trade at 12%
 Agricultural products are a relatively small (8%) part of trade.
Fig. 2-6: The Composition of World Trade, 2015

Source: World Trade Organization.

What Do We Trade? (cont.)

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 U.S. 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.
Table 2-2: Manufactured Goods as a Percent of
Merchandise Trade
What Do We Trade? (cont.)

 Low- and middle-income countries have also changed the

composition of their trade.
 In 2001, about 65% of exports from low- and middle-income countries were
manufactured products, and only 10% of exports were agricultural products.
 In 1960, about 58% of exports from low- and middle-income countries were
agricultural products and only 12% 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.
Fig. 2-7: The Changing Composition of Developing-
Country Exports
Service Outsourcing
Service outsourcing (or offshoring) 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 Outsourcing (cont.)
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%) need to be done close to the
customer, making them nontradable.
Fig. 2-8: Tradable Industries’ Share of Employment
Summary
1. The 5 largest trading partners with the U.S. are China,
Canada, Mexico, Japan, and Germany. The 5 largest trading
partners with Belgium are the Netherlands, France,
Germany, UK, and the U.S.
2. The largest economies in the EU undertake the largest
fraction of the total trade between the EU and the U.S.
3. The gravity model predicts that the volume of
trade is directly related to the GDP of each trading partner
and is inversely related to the distance between them.
Summary (cont.)
4. Besides size and distance, culture, geography, multinational
corporations, and the existence of borders influence trade.
5. Modern transportation and communication have increased
trade, but political factors have influenced trade more in
history.
6. Today, most trade is in manufactured goods, while
historically agricultural and mineral products made up most
of trade.