International Economics

1
International Economics

• University of Helsinki
• September 24th October 19th, 2007

2
Practicalities

• Lecturer Matti Sarvimäki
• matti.sarvimaki_at_vatt.fi / [phone]
• Lectures Mondays 12-14, Wednesdays 14-16
• Fridays 10-12 at Economicum
• Wed 3rd cancelled, extra lecture TBA
• Exam 9.11.2007 at 12-14 U40 lecture room 1
• Retake 7.12.2007 at 12-14 Porthania III

3
Requirements

• Lectures
• Krugman (1993) What Do Undergrads Need to Know
  About Trade? The American Economic Review 83(2)
  2326 (available from JSTOR)
• There are two textbooks that are likely to be
  helpful (one by Krugman Obstfeld another by
  Appleyard Field). Both are called International
  Economics. The course covers most of the first
  half of the books (trade theory and policy) and
  the books cover most of the material I will
  present during the lectures.

4
Outline

• The course
• Basic Trade Models
• Introduction to Trade Policy
• Further Topics
• This lecture Introduction
• Stylised facts
• What models do
• Mercantilism and Adam Smith
• (introduction to comparative advantage)

5
World Trade 1820-1992
World Exports/GDP (in 1990 constant dollars,
percent)
Source Rodrik (2000), original data from
Maddison (1995)
6
Real GDP per capita (population weighted
averages, 1950-2000)
Source Calculations from Penn World Table, data
available at http//pwt.econ.upenn.edu/
7
World Inequality 1820-1992 (mean logarithmic
deviation)
Source Bourguignon Morrisson (2002). See also
Human Developments Trends in http//www.gapminder.
org/, in particular slides 1/15 and 2/11.
8
Change in the U.S. Real Wages(per percentile
between 1970 and 2002 )
Change in real wages 19702002
Percentile
Source Smith (2006)
9
Openness to Trade, GDP per capita and population
(2000)
Source Calculations from Penn World Table, data
available at http//pwt.econ.upenn.edu/
10
Openness to Trade, GDP per capita and population
(2000)
Source Calculations from Penn World Table, data
available at http//pwt.econ.upenn.edu/
11
Openness to Trade and GDP per capita over time
(Finland, 1950-2000)
Source Calculations from Penn World Table, data
available at http//pwt.econ.upenn.edu/
12
Openness to Trade and GDP per capita over time
(Selected countries, 1950-2000)
13
Changes in Openness to Trade and changes in GDP
per capita (1950/60 - 1990/00)
Source Calculations from Penn World Table, data
available at http//pwt.econ.upenn.edu/
14
Changes in Openness to Trade and GDP per capita
(1950/60 - 1990/00)
Source Calculations from Penn World Table, data
available at http//pwt.econ.upenn.edu/
15
Leading Merchandise Traders (2004, excluding
intra-EU trade)
Billions of dollars, Source WTO http//www.wto.or
g/english/res_e/statis_e/its2005_e/section1_e/i06.
xls
16
Structure of Trade (Finland, 2000)
Billons of dollars, Source Calculations from the
NBER-United Nations Trade Data. Data available at
http//cid.econ.ucdavis.edu/. Stata code
available by request (from me). In 2000,
Finlands GDP was about 130 billion dollars.
17
Finlands Top 6 Trading Partners, 2000
Billons of dollars, NBER-United Nations Trade Data
18
Structure of Bilateral Trade (Finland, 2000)
Billons of dollars, NBER-United Nations Trade Data
19
Structure of Trade (Finland 1962, 1989, 2000)
20
Economic Theory / Models

• . . . just talking plausibly about economics is
  not the same as having a real understanding for
  that you need crisp, tightly argued models.
• Paul Krugman (1996)
• Models reduce a complex problem to a few
  essentials and illustrate the relationships
  between them. A good model is one which is wide
  in scope and unexpected in implications.
• John Kay (2003)
• The ideas of economists and political
  philosophers, both when they are right and when
  they are wrong, are more powerful than is
  commonly understood. Indeed, the world is ruled
  by little else.
• John Maynard Keynes (1936)

21
Economic Models as Simplifications

• The point of economic models is to simplify the
  complex reality in order to understand it. A good
  model is such that
• it is easy to understand (simple)
• it increases the understanding of reality
• Mathematics is the language of economics. The
  point is to be consistent and to make assumptions
  transparent. In this course we use geometry to
  make the math more intuitive
• Gibbard Varian (1978) describe models as
  caricatures, approximations, stories with a
  specific structure etc. Models typically ask
  what would happen if this and this was the
  case? and exaggerate to make a point

22
Example London
23
A model of London
24
Another model of London
25
Economic Models as Imitations

• a "theory" is not a collection of
  assertions about the behavior of the actual
  economy but rather an explicit set of
  instructions for building a parallel or analogue
  system A "good" model, from this point of
  view, will not be exactly more "real" than a poor
  one, but will provide better imitations. Of
  course, what one means by a "better imitation"
  will depend on the particular questions to which
  one wishes answers. Lucas (1980)
• For an example of this kind of model in trade
  contest, visit www.gtap.agecon.purdue.edu
• However, in this course we will concentrate on
  models that are best described as caricatures.

26
International Economics

• What is different in comparison to ordinary
  economics? The institutional setting (national
  policies, currencies etc) nothing else, really.
• International economics typically divided
• international trade and international money.
• In this course we will concentrate on the former.
  HSE provides a similar course that concentrates
  on the latter.
• The study of international trade is often
  expanded to study international capital, labour
  flows and diffusion of technology.

27
Evolution of Trade Theory

• Mercantilism (1500)
• Classical Political Economy
• Price-Specie-Flow Mechanism (Hume, 1752)
• Absolute Advantage (Smith, 1776)
• Comparative Advantage (Ricardo, 1817)
• Neo-Classical Economics
• Heckscher-Ohlin Model (1919, 1933) and extensions
• Modern Economics
• Economies of scale, imperfect competition

28
Mercantilism

• Diffuse collection of economic thought
• Mostly written by merchants and businessmen
• Appears in economics virtually always as a target
  of critique. However, the mercantilist mindset
  has not vanished among many non-economists
• The word mercantilist is still used for a person
  opposing free trade based on traditional
  arguments
• For short discussion, see Appleyard Field
  (chapter 2). If youre more interested, see
  Landreth Colander (2002)

29
Mercantilist View of the Economy

• Nations wealth holdings of precious metals
• Zero-sum economy
• Favourable balance of trade
• i.e. exports good, imports bad
• Implicit assumption that the economy was
  operating at less than full employment
• Conclusion Economic activity should be
  regulated

30
Mercantilist Policy Recommendations

• International
• Tariffs Quotas on imports
• Subsidies on exports
• Exclusive trading rights
• Government control on exchange of precious metals
• Domestic
• Regulating production (exclusive product
  charters, tax exemptions, subsidies, special
  privileges)
• Regulating labour (crafts guilds, low wages,
  subsidies for children, financial incentives for
  marriage)

31
Adam Smith

• ... He generally, indeed, neither intends to
  promote the public interest, nor knows how much
  he is promoting it ... he intends only his own
  gain, and he is in this, as in many other cases,
  led by an invisible hand to promote an end which
  was no part of his intention.
• Smith (1776)
• Somehow all of the activities seem to get
  coordinated. Theres a taxi to get you to the
  airport. Theres butter and cheese for lunch on
  the airplane. There are refineries to make the
  airplane fuel and trucks to transport it, cement
  for the runways, electricity for the escalators,
  and most important of all, passengers who want to
  fly where the airplanes are going. if you are
  in a mood to be amazed, it can amaze you that the
  system works at all. Schelling (1978)

32
Smiths View of the Economic System

• Nations wealth Production capacity
• Positive-sum economy
• Self-interest combined with competition serves
  public interest
• Division of labour increases productivity
• Conclusion Policy of laissez faire promotes
  economic growth

33
Labour theory of value

• The amount of labour required to produce a good
  determines its value
• Lets assume that it takes two hours to produce A
  and an hour to produce B ? A is two times more
  valuable than B
• The prevailing value theory until 1870s
• Main problem Does not consider utility
• Other problems measurement, differing skills,
  how to deal with capital, land and profits

34
Smith on Trade Absolute Advantage
35
Absolute AdvantageRelative Prices in Autarky

• Autarky price of wine in terms of cloth
• England 1 bbl. wine 4 yd. cloth
• Portugal 1 bbl. wine 1,5 yd. cloth
• Autarky price of cloth in terms of wine
• England 1 yd. cloth 0,25 bbl. wine
• Portugal 1 yd. cloth 0,67 bbl. wine
• ? England has absolute advantage in cloth,
  Portugal in wine

36
Absolute AdvantageRationale for Trade

• If international trade is allowed
• England wants to buy wine if it costs less than 4
  yard of cloth per barrel of wine
• Portugal wants to sell wine if it gets more than
  1,5 yard of cloth per barrel of wine
• ? Both are willing to trade for any price
  between 1,5 - 4 yard per barrel

37
References

• Gibbard Varian (1978) Economic models. Journal
  of Philosophy 75664677
• Bourguignon Morrisson (2002) Inequality Among
  World Citizens 1820-1992. American Economic
  Review. Vol. 92, No. 4
• Heckscher (1919) The Effect of Foreign Trade on
  the Distribution of Income, Ekonomisk Tidskrift.
• Hume (1752) Of the Balance of Trade. Availabe at
  www.utilitarian.net/hume/
• Kay (2003) The Truth about Markets. Allan Lane.
  Published in the U.S. as Culture and Prosperity
  by HarperBusiness.
• Keynes (1936) The General Theory of Employment,
  Interest, and Money.
• Krugman (1993) What Do Undergrads Need to Know
  About Trade? The American Economic Review. Vol.
  83(2) 2326
• Krugman (1996) Pop Internationalism. MIT Press.
• Landreth Colander (2002) History of Economic
  Thought. Houghton Mifflin Company.
• Lucas (1980) Methods and Problems in Business
  Cycle Theory. Journal of Money, Credit and
  Banking 12 696-715
• Ohlin (1933) Interregional and International
  Trade.
• Ricardo (1817) On the Priciples of Political
  Economy.
• Schelling (1978) Micromotives and macrobehavior.
  W. W. Norton
• Smith, A. (1776) An Inquiry into the Nature and
  Causes of the Wealth of Nations.
• Smith, J. (2006) Immigrants and the Labor
  Market. Journal of Labor Economics 24(2)