exam 2
1.Encouraging Outward FDI •government-backed insurance programs •special funds or government banks to firms investing in developing countries •eliminated double taxation of foreign income • 2.Restricting Outward FDI •tax rules favoring investment at home •restrict investing in certain nations for political reasons
. Encouraging Inward FDI to: •Gain from the resource-transfer and employment effects of FDI •Capture FDI away from other potential host countries • 2.Restricting Inward FDI •Ownership restraints: •national security or competition •maximize the resource transfer and employment benefits of FDI •Performance requirements: •maximize the benefits, and •minimize the costs of FDI for the host country
Regional economic integration has been on the rise in the last two decades. Regional economic integration occurs through agreements between countries in a geographic region to promote free trade between those countries participating Depending in how it is organized, this regional agreements can be a good thing (increasing overall trade) or a bad thing (decreasing overall trade by creating barriers to out-bloc producers)
There are 5 levels of economic integration, Free Trade Zone, Customs Unions, Common Market, Economic Union, Political Union, with increasing integration from Free Trade Zone to Political Union. The economic arguments for regional integration claim that it can increase trade beyond what global agreements can achieve and is easier to achieve; the political arguments claim that deeper regional integration creates political stability, diminishes risk of war, and improves the bargaining position of the members in the world stage. Still implementation is difficult because as any free trade agreement there are winners and losers, and many of them have political clout. The case against Regional integration is that it may have negative impact on overall trade if the amount diverted is larger than the amount created
Free trade
refers to a situation where a government does not attempt to restrict what its citizens can buy from another country or what they can sell to another country Many nations are nominally committed to free trade Nations tend to intervene in international trade to protect the interests of politically important groups Even countries and economic unions at the front of free trade promotion have their own protectionist measures, for example: •US Chicken tax, Sugar tax •EU quotas to agricultural products.
3.Advantages of Foreign Direct Investment: ● • FDI will be favored over exporting when: •Transportation costs are high •Trade barriers are high • • FDI will be favored over licensing when: •The firm wants control over its technological know-how •The firm wants control over its operations and business strategy •The firm's capabilities are not amenable to licensing
1. Strategic Behavior •In oligopolistic industries (few large competitors) firms match their closest rivals' FDI (Knickerbocker, 1963) •Firms that experience multipoint competition match their multipoint competitors' FDI (when two or more enterprises encounter each other in different regional markets, national markets, or industries) 2.Eclectic Paradigm in addition, other factors that drive FDI are: •location-specific advantages (resources, endowments) •externalities, (knowledge spillovers, supporting industries)
There are seven main instruments of trade policy:
1. Tariffs 2. Subsidies 3. Import quotas 4. Voluntary export restraints 5. Local content requirements 6. Antidumping policies 7. Administrative policies
•Between 1992 and 1995, value of ruble fell from R 125/$ to R 5130/$ •Money supply too large, resulting in very high inflation •Used up all their international reserves trying to keep the ruble stable •IMF bailout, 1996 ($10B), 1998 ($11.2B) in exchange for concessions -1998 bailout comes in the wake of the Asian financial crisis and the sudden drop in oil prices •1999. Russian economy more stable since then
1.Anything that causes a collapse of investor's confidence in the currency Examples: -Sudden increase on inflation -current account deficit -excessive domestic borrowing - - 2.Leads to a capital flight -Argentinism: Capital golondrina (swallow capital) - 3.This results in a government inability to uphold the currency via its international reserves
•Historically, most FDI has been directed at the developed nations of the world •The United States is a favorite target as is the European Union • •More recently, developing nations have been the recipients of FDI •South, East, and Southeast Asia, and particularly China have received significant inflows •Latin America is also emerging as an important region for FDI
1.Limitations of Exporting: an exporting strategy can be limited by transportation costs and trade barriers •Is Exporting affected by high transportation costs? •Is Exporting affected by trade barriers (actual or threatened, import tariffs or quotas) ? • 2. Limitations of Licensing: internalization theory (aka market imperfections) suggests: •Does Licensing gives away firm's valuable technological know-how to a potential foreign competitor? •Does Licensing give a firm the tight control in the foreign country required to maximize its profitability? (over manufacturing, marketing, and strategy) •Is the firm's competitive advantage amendable to Licensing?
1.Resource Transfer Effects FDI can bring capital, technology, and management resources 2.Employment Effects FDI can bring jobs 3.Balance-of-Payments Effects •country's payments to and receipts from other countries •FDI can help achieve a current account surplus • 4.Positive effects on Competition and Economic Growth •Greenfield investment •Increased competition in a market •Overall, it may: •lead to lower price, product innovation, productivity growth, economic growth
1.Negative Effects on Competition •MNEs subsidiary use of superior economic power to diminish competition •The MNE subsidize costs in the local market to create a monopoly position 2.Adverse Effects on the Balance of Payments •Repatriation of earnings to the parent country •Imports of input products by the foreign subsidiary (opaque transfer pricing) 3.National Sovereignty and Autonomy •FDI can mean some loss of economic independence •foreign parent that has no real commitment to the host country, and •host country's government has no real control over foreign parent
1.The effect on the capital account of the home country's balance of payments from the inward flow of foreign earnings 2.The employment effects that arise from outward FDI • (High paid jobs) 3.The gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country
1.The balance-of-payments •Initial capital outflow required to finance the FDI •Negative if offshoring to low-cost production location •Negative if the FDI is a substitute for direct exports 2.Employment effects of outward FDI •Transfer of jobs to low-cost production location •Lost on jobs in supporting industries
1. Spot exchange rate: the rate at which a foreign exchange dealer converts one currency into another currency on a particular day Determined by the interaction between supply and demand Changes continually
2. Forward exchange rates - the exchange rate governing a forward exchange A forward exchange occurs when two parties agree to exchange currency and execute the deal at some specific date in the future Forward rates are typically quoted for 30, 90, or 180 days into the future
A firm's bargaining power with the host government is highest when: •The host government places a high value on what the firm has to offer •When there are few comparable alternatives available •When the firm has a long time to negotiate
A firm engage in Foreign Direct Investment when it invests directly in new facilities to produce or market in a foreign country Both the flow and stock of FDI in the world economy have increased over the last 35 years This has been driven by firms fears of protectionist policies, shift toward democratic institutions and free market policies, and increased globalization While historically developed countries were the dominant actors, in recent years developing countries became larger targets and increasingly sources of FDI flows.
Mexico: • •Pegged to the dollar since early 1980s, according to IMF prescription •1994 NAFTA and Government engage in selling bonds in dollars to finance its expansionary policies in an presidential election year •December 1994. Confidence in the currency evaporated, investors started converting pesos into dollars, causing a run on the banks and investments to leave •New IMF prescriptions caused deep recession for two years, recovery in 1997
Asian Crisis: •1980s unprecedented growth in SE Asia, based on exports •1990s developments -investment boom in property -banks engaged in excessive lending -excessive government involvement in economy -expanding imports •Local currencies pegged to the dollar •1997 Overvalued assets/currencies lead to bankruptcies. Foreign investors get worried and capital leaves the countries. •Global crises, with global production contraction and drop in oil prices
Political Union independent states are combined into a single union
Central political apparatus coordinate economic, social, and foreign policy for member states
Free Trade Area Free Trade among members, but members determine their own trade policies with nonmembers
Customs Union Free trade between member countries and Common External Trade Policy
Import Quotas impose limits to quantity imported (EU quotas to agricultural products) Tariff rate quota is a tax levied to imported products above a quota (US beef quotas system) VER (Voluntary Export Restraints) impose limits to exports from one country. •Why would a country do that? (80s Japan vs. US car dispute) Import Quotas and VER benefit domestic producers by limiting competition from abroad (also increasing prices for consumers)
Demands that some fraction of the product to be produced domestically Originally implemented to promote development of local industries. •They tend to favor the local industry and creates jobs • •NOTE: With the increased globalization of production and expansion of international trade agreements, Local Content Requirements have been imposed by members of international trade agreements to avoid loopholes. (Mexican cars export to US - NAFTA)
A tax levied on imports that effectively raises the cost of imported products relative to domestic products pt2
Detractions (a rarity, sister of Tariffs) Tax levied on exports that effectively drops the price of the product sold in the country. As tariffs, they increase government revenues (I have seen levied on raw materials), protect domestic consumers, but may make producers not competitive in the world. Detractions are unambiguously pro-consumer and anti-producer
Spot Market: exchange rates quoted for transactions that require immediate delivery or within two days Two quotes given by the FX trader: the bid (buy) and the offer (sell) rates The spread in the spot market is the difference between the bid and offer rates
Direct quote: number of units of the domestic currency needed to acquire one unit of the foreign currency •Ex: If we are in the U.S., a direct quote= US $/foreign currency •Ex: If we are in Japan, a direct quote = ¥/foreign currency • Indirect Quote: number of units of the foreign currency needed to acquire one unit of the domestic currency •Ex: If we are in the U.S., foreign currency/US $ •Ex: If we are in Japan, foreign currency/¥
Bureaucratic rules that are designed to make it difficult for imports to enter a country (Non-tariffs barriers) •They tend to hurt consumers by denying access to foreign products (or increasing their cost) • •Environmental requirements, labor requirements, etc.
Dumping: selling goods in a foreign market below their cost of production, or selling goods in a foreign market at below their "fair" market value •Predatory behavior (Using local profits to wipe out foreign industries, to later raise prices) •Sell excess production abroad below cost to sustain production level locally (European Union export of subsidized agricultural products during the 70s) • Antidumping polices: designed to punish foreign firms that engage in dumping •Goal: protect domestic producers from "unfair" foreign competition •U.S. firms that believe a foreign firm is dumping can file a complaint with the government •If the complaint has merit, antidumping duties, also known as countervailing duties may be imposed
Common Market Free trade between member countries and common external trade policy and Free Movement of Production Factors
Economic Union Free trade between member countries and common external trade policy, free movement of production factors, and Common Currency, Tax Policy Harmonization, Common Monetary and Fiscal Policy
A tax levied on imports that effectively raises the cost of imported products relative to domestic products
Effects: •Increase government revenues •Provide protection to domestic producers against foreign competitors by increasing the cost of imported foreign goods •Force consumers to pay more for certain imports They are unambiguously pro-producer and anti-consumer
International firms use foreign exchange markets: •To convert and repatriate foreign income •export receipts, •income received from foreign investments, or •income received from licensing agreements •To pay a foreign company for products or services •Importing bills, •Foreign debt •To invest spare cash for short term's benefits in money markets •For currency speculation •the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates
Foreign exchange risk: the possibility that unpredicted changes in future exchange rates Consider this scenario. On 1/1/2015 you exported 1 widget from US to Germany under a contract promising you will receive 1 euro on 4/1/2015 The market performs this function (Insuring against FX Risk) using: 1.Spot exchange rates 2.Forward exchange rates 3.Currency swaps
1.While tariffs on imports protect producers and hurt consumers, tariffs on exports (detractions) protect consumers and hurt producers. 2.Subsidies affect international trade by reducing producer's cost with direct payments from the government, cost that falls on consumers through increased prices or taxes. 3.Import quotas and VER (2 instruments) favor producers (less competition) and hurt consumers (higher prices or less variety). 4.Local contain requirements protect local industries and tend to create jobs. 5.Antidumping policies try to stop the damage cause by firms trading products below cost of production or fair value (dumping) 6.Administrative policies interfere with international trade by imposing onerous requirements. •We can fairly say that except for detractions, all the other measures favor producers over consumers.
Governments intervene in international trade in general to protect the interests of certain groups (usually producers) at the expense of other groups (usually consumers) Political arguments: •Protection of jobs and industries •To protect industries important for national security •Retaliation to stop unfair practices •Protect consumers from unsafe products •Advance foreign policy objectives •Protect human rights Economic arguments: •Infant Industry argument: •Strategic trade policy
Interest Rate Parity •Real interest rates become equal through arbitrage •If the nominal interest rate in one country is lower than that in another, the first country's inflation rate is expected to be lower so that real interest rates are equal • International Fisher Effect •Combines interest rates, inflation, exchange rates •The currency of the country with the lower nominal interest rate is expected to strengthen in the future
How should exchange rate forecasts be prepared? There are two approaches to exchange rate forecasting 1.Fundamental analysis •draws upon economic factors like interest rates, monetary policy, inflation rates, or balance of payments information to predict exchange rates 2.Technical analysis •Focuses on trends and believes that past trends and waves are reasonable predictors of future trends and waves
Political arguments: To protect the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers) • •Protection of jobs and industries •Driven by political pressure (unions, industries) •Favors those with more political clout •Consumers tend to lack organization to lobby •To protect industries important for national security (Boeing subsidies) •Retaliation to stop unfair practices (Chicken tax) •Protect consumers from unsafe products (US vs EU hormone free beef) •Advance foreign policy objectives •Protect human rights
In a dispute for unfair treatment of US poultry exports to France and Germany, Johnson's administration (1963) levied punitive 25% tax to Light Trucks imported from those countries. This tariff was still in effect on 2012.
Cross Rate: an exchange rate computed from two other exchange rates Suppose we want the following exchange rate: Argentina Peso/Brazil Real Calculate as follows:
In the form of contracts Forward contracts allow firms to lock in a rate of exchange on funds required in the future Forward Rate: rate quoted for transactions that call for delivery at some future date Maturities of 30, 60 90, 120, 180, and 360 days A discount exists when the forward rate is less than the spot rate A premium exists when the forward rate exceeds the spot rate
Informal in structure: No central place or floor where trading takes place Thousands of telecommunications links between financial institutions around the globe Open 24 hours a day Trading concentrated in UK, US & Japan US $ involved in 89 % of transactions Astronomical growth in FX transactions
Interbank Market: Banks dealing with other banks in large volumes, usually involving transactions exceeding $1 M Brokers: Professionals who assist in the transfer of funds between banks and find most favorable currency prices Central Banks: National banks that implement govt. policies regarding currency values
3. Currency swap - the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates Swaps are used when it is desirable to move out of one currency into another for a limited period without incurring foreign exchange rate risk
Law of One Price •Under completely free trade, prices of comparable goods should be equivalent across countries • Purchasing Power Parity •A basket of good should be equivalent across countries. •If we know inflation differential across countries we can predict future exchange rate (depreciation)
Integration is not easy to achieve or maintain There are two main impediments to integration: 1.It can be costly - while a nation as a whole may benefit from a regional free trade agreement, certain groups may lose 2.It can result in a loss of national sovereignty
Regional economic integration only makes sense when the amount of trade it creates exceeds the amount it diverts Trade creation occurs when low cost producers within the free trade area replace high cost domestic producers Trade diversion occurs when higher cost suppliers within the free trade area replace lower cost external suppliers
Is regional economic integration a good thing? It depends: the world is moving toward a situation in which a number of regional trade blocks compete against each other • • gains from free trade within blocs could be offset by a decline in trade between blocs
Regional economic integration: agreements between countries in a geographic region to reduce tariff and non-tariff barriers to the free flow of goods, services, and factors of production between each other Over the last two decades, the number of regional trade agreements has been on the rise •More than 500 agreements are currently in place
The number of regional blocks is around 500 today The largest blocs are NAFTA and the EU NAFTA is the agreement between USA, Canada and Mexico (1994). It's impact was smaller than what proponents and detractors claimed at the time of its creation. It has increased trade between the 3 members (250%), have a very small effect on job creation, and productivity has increased The UE evolved into what it is today (with 27 members) from a free trade agreement on the coal and steel industries between France Germany, Belgium, Italy and the Netherlands in 1957. It is in the process of perfecting its economic integration and achieving political integration.
Regional integration in the Americas has been searched for more than 50 years. Today's blocs are descendant of efforts started in the 60s. Similar stories are found in Asia and Africa. The final goal of most of these agreements is to establish economic unions.
How successful has NAFTA been? Answer: Studies of NAFTA's early impact suggest that both advocates and detractors may have been guilty of exaggeration •Trade between the three countries increased by 250% •The members have become more integrated •Productivity has increased in member nations •Employment effects have been small •Mexico initially became more politically stable, but drug related violence remains a problem
Should NAFTA accept new members? Answer: •Several other Latin American countries have indicated their desire to eventually join NAFTA •Currently both Canada and the U.S. are adopting a wait and see attitude with regard to most countries
post bretton woods era •Increasing frequency and depth of financial crises in countries •Caused by rapid decline in currency value •188 member countries, more than 60 with IMF programs in place •The current role of the IMF has greatly expanded beyond its original role •The IMF has become an extremely important and powerful organization in the world
Since the Jamaica Agreement, global financial crises started appearing with great frequency. Latin-America (82), Mexico (94), Asia (97), Russia (98), Brazil (99), Argentina (2001), Global Financial Crisis (2008) I will give you 20-year snapshots of 4 of these crises to highlight what causes a financial crisis
The Single European Act (1987) committed EC countries to work toward establishment of a single market by 1992 The Act proposed to: •Remove all frontier controls between EC countries •Apply the principle of mutual recognition to product standards •Institute open procurement to non-national suppliers •Lift barriers to competition in retail banking and insurance •Remove all restrictions on foreign exchange transactions between member countries •Abolish restrictions on cabotage
Since when do we have the idea of economic integration of the Americas? • •JFK's Alliance for Progress (1961, Inter-American Conference, Punta del Este) •ALALC (Latinamerican Free Trade Association, 1961, Montevideo Treaty) Argentina, Brazil, Chile, Mexico, Paraguay, Peru, Uruguay (Expanded to Colombia, Ecuador, Venezuela, Bolivia) •ALADI (Latinamerican Integration Association, 1980, Montevideo Treaty) All South America, Panama and Mexico
Mercosur (1988): a free trade pact (Brazil and Argentina) •Expanded to include Paraguay and Uruguay in 1990 •Has been successful at reducing trade barriers between member states Critics worry that Mercosur may be diverting trade rather than creating trade, and local firms are investing in industries that are not competitive on a worldwide basis Venezuela joined in 2006, but is not yet a full member (and was suspended in 2016)
The Andean Community (1969) was based on the EU model (Colombia, Ecuador, Peru, Bolivia) •The agreement had more or less failed by the mid-1980s •In the late 1980s, Latin American governments began to adopt free market economic policies •In the 1990s, the Andean Pact was re-launched, and now operates as a customs union •In 2003, it signed an agreement with Mercosur to restart negotiations towards the creation of a free trade area •Current members include Bolivia, Ecuador, Peru, and Columbia
•Smith to Great Depression (1800-1947) •Every country had some degree of protectionism • •Geneve GATT (1947) •Eliminate tariffs, subsidies, import quotas • •1980-1993 •Increased protectionism (work around GATT) • •Uruguay round GATT (1986) •Services and Intellectual Property •Trade liberation •Doha round WTO (2001) •Recommendations for trade disputes •Global police •Expand trade agreements
The WTO is currently focusing on: •Cutting tariffs on industrial goods and services •Phasing out subsidies to agricultural producers •Reducing barriers to cross-border investment •Limiting the use of anti-dumping laws • •TRIPS impose WTO members enforcement of patents lasting 20 years and copyrights lasting 50 years
Currencies are: •Freely convertible: for both residents and non-residents •Externally convertible: only for non-residents •Nonconvertible: both residents and non-residents are banned • Why to limit convertibility: preserve foreign exchange reserves and prevent capital flight For nonconvertible currency, firms may turn to countertrade (barter like agreements by which goods and services can be traded for other goods and services) to facilitate international trade Countries may limit convertibility of the currency for specific purposes (travel, import of essential goods, etc)
The foreign exchange market facilitates international trade. Without it international trade would be limited to barter and countertrade. The foreign exchange market allows firms to repatriate foreign income, pay for foreign services and products, invest excess cash in foreign markets and speculate on the fluctuation of currencies. Spot rate change is the exchange rate you got from foreign exchange dealer "on the spot". At the current time and date. This is defined by the supply and demand of the currencies exchanged. World currencies constantly fluctuate in their value, so firms are expose to currency fluctuation when payments and receipts happen at different times.
Europe has two trade blocs: •The European Free Trade Association (Switzerland, Norway Liechtenstein, Iceland) •The European Union with 28 members • •The European Union (EU) is the result of: •The devastation of two world wars on Western Europe and the desire for a lasting peace •The desire by the European nations to hold their own on the world's political and economic stage •The forerunner of the EU was the European Coal and Steel Community •Free Trade agreement on Coal and Steel industries (1951) •Germany, France, Belgium, Italy, Luxemburg, the Netherlands •The Treaty of Rome established the European Economic Community •Common Market (1957) •Specifically Included to establish common policies in agriculture and transportation •The Treaty of Maastricht (1992) committed the EC members to an economic union •The name was changed to the EU in 1994
The four main institutions of the EU are: 1.The European Commission: proposes EU legislation, implements it, and monitors compliance 2.The European Council: the ultimate controlling authority within the EU 3.The European Parliament: debates legislation proposed by the commission and forwarded to it by the council 4.The Court of Justice: the supreme appeals court for EU law
The ideological position ranged from total opposition (radical view) to non-intervention (free market view). There are also positions in between (national pragmatisms) 1.The radical view: the MNE is an instrument of imperialist domination and a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries ● •The radical view has been in retreat because of: • •The collapse of communism in Eastern Europe •The poor economic performance of those countries that had embraced the policy •The strong economic performance of developing countries that had embraced capitalism
The ideological position ranged from total opposition (radical view) to non-intervention (free market view). There are also positions in between (national pragmatisms) 2.The free market view: international production should be distributed among countries according to the theory of comparative advantage •Countries should specialize in the production of goods and services they can produce most efficiently •The MNE increases the overall efficiency of the world economy • 3.The pragmatic nationalist view: FDI has benefits and costs •Benefits: inflows of capital, technology, skills and jobs •Costs: repatriation of profits to the home country and a negative balance of payments effect FDI should be allowed only if the benefits outweigh the costs
The foreign exchange market allow firms to erase the risk by providing forward exchange contracts (transactions at a predetermine rate occurring on a defined date in the future). Firms use this because they are not in the business of making money of currency fluctuations. The foreign exchange market is a decentralize market, without one central physical location. It operates 24/7 all around the world. Its players are banks, brokers and central banks. Spot markets are based on 2 rates (bid and offer). The difference is the spread, which varies depending on the client (usually form .5 to 4%). Not all currencies are fully convertible. Some are convertible for non-residents, some are not convertible at all. Some government limit the convertibility of their currency at specific rates for specific purposes.
The law of one price tells us that under free trade, price of comparable good should be the same across countries. PPP tells us that the prices of a basket of comparable products should be the same across countries. This can help us estimate the exchange rate of two currencies. In the long run both laws hold reasonably well. In the short run, prices may depart from them. The interest rate parity tells us that real interest rates differences should be equal to the difference in inflation between both economies. If those differences were not equal, arbitrage opportunities are available.
Talks began in 1998 to establish a Free Trade of The Americas (FTAA) by 2005 •The FTAA was not established as planned •Current support for the agreement by the U.S. and Brazil is limited •If the FTAA is established, it would create a free trade area of 850 million people
There have been various attempts at regional economic integration throughout Asia and Africa The success of these attempts have been limited The most significant efforts are the Association of Southeast Asian Nations and the Asia-Pacific Economic Cooperation Don't miss those regional economic integration efforts, check the textbook: ASEAN (1967) and ASEAN Free Trade Area (2003) (Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand, Vietnam, Myanmar, Laos, and Cambodia; later Vietnam, Laos, and Myanmar) Asian Pacific Economic Cooperation (APEC) (1990) (21 members including USA, Japan and China) Nine Trade Blocs in Africa
Government payment to domestic producers (subsidies)
They help domestic producers: •Compete against low-cost foreign imports (difficult to control) •Gain export markets (difficult to implement without retaliation) • Consumers typically absorb the costs
Economic arguments: • •Infant Industry argument: an industry should be protected until it can develop and be viable and competitive internationally (accepted at temporary restriction by WTO) • •Latin-American's Import Substitution policies 60s and 70s, • •Strategic trade policy Argument from New trade theory
This feature describes the trade battle between the United States and the European Union over beef from cattle that have been given growth hormones. It outlines the basic issues that led to the dispute, and shows how the World Trade Organization has treated the case. Discussion 1. Why is the European Union so concerned about beef from cattle that have been given growth hormones? Some may argue that the European Union's ban on growth hormones in cattle was little more than a thinly veiled form of protectionism. Australia, New Zealand, and Canada, which also use the hormones in their cattle industry, were also affected by the ban. The European Union claimed that it was merely protecting the health of its citizens, however studies showed that the hormones posed no health issues for people. 2. Why did the WTO rule against the European Union? The World Trade Organization ruled against the European Union stating that the European Union's ban on imported hormone treated beef had no scientific justification. Even so, the European Union refused to lift the ban, which had strong public support, and in the end, the European Union was assessed punitive tariffs. The European Union held on to its principles though, and as of 2008, continued to maintain its restrictions on hormone treated beef despite the resulting punitive tariffs.
•The European Monetary Union (EMU) created in 1995 through Maastricht Treaty •Euro launched at governmental level in 1999 -11 countries •Euro launched into participating economies in 2002 -12 countries •Not all EU members can (or want to) join the EMU •Today 19 members have adopted euro -Not G. Britain, Denmark or Sweden
To adopt the Euro, a country must: •Keep government deficit low (< 3%) •Have low government debt/GDP ratio (60%) •Low inflation rates (<1.5% above EU minimum) •Long-term interest rates (<2% of EU minimum ) •Participate in EMS in good standing •However, not always abided by eurozone countries, for example: -Greece -Spain -Italy -(Psst, don't tell anybody but since 95 you can include in the list: Germany, France, the Netherlands, etc., etc...)
What are the benefits of NAFTA? Answer: •Mexico: •Increased jobs as low cost production moves south and more rapid economic growth • •The U.S. and Canada: •Access to a large and increasingly prosperous market •Lower prices for consumers from goods produced in Mexico •Increased competitiveness in world markets (U.S. and Canadian firms with production sites in Mexico) •Increased the neighbor's stability (political and economic)
What are the drawbacks of NAFTA? Answer: •Jobs could be lost and wage levels could decline in the U.S. and Canada •Mexican workers could emigrate north •Pollution could increase due to Mexico's more lax standards •Mexico would lose its sovereignty
A firm engage in Foreign Direct Investment when it invests directly in new facilities to produce or market in a foreign country MNC engage in FDI. For example, when: •Walmart opens a supermarket in China, •Ford opens a assembly line in Mexico, or •Santander Bank buys Sovereign Bank in the US. FDI forms: •Greenfield investment, establishment of a wholly owned new operation in a foreign country •Acquisition of or merging with (M&A) an firm in a foreign country. • Measuring FDI in the World Economy: •Outflows of FDI: Investments originated in a country over a period of time •Inflows of FDI: Investments received by a country over a period of time •Stock of FDI: Total accumulated value of Foreign-owned assets at a given time.
trends of fdi •Both the flow and stock of FDI in the world economy have increased over the last 35 years • •FDI has grown more rapidly than world trade and world output because: • •Firms still fear protectionist policies •The shift toward democratic political institutions and free market economies encourages FDI •Globalization is prompting firms to ensure they have a significant presence in many regions of the world
There are several instruments of trade policy utilized by governments They may constraint international trade.
•They may increase the cost of foreign products to protect producers or manufactures (reducing imports) •The may decrease the cost of local products to protect consumers (Impeding exports) •Imposing non-trade barriers (prohibitively expensive standards) They may facilitate international trade in unfair ways: •increasing competitiveness not on efficiency grounds (promoting exports).
•A government buys and sells its currency in the open market as a means of influencing the currency's price • •Governments maintain reserves of foreign currencies to do this (called international reserves) • •Devaluation: when a government reduces the value of its currency relative to that of a foreign currency -contrast with "depreciation" • •Revaluation: when government increases the value of its currency relative to that of a foreign currency -contrast with "appreciation"
•A Central Bank of each country intervenes in money supply issues in order to further the government's economic/political objectives •Black markets an indication of true supply and demand for a currency Argentinisms: •dolar paralelo, dolar Blue = black market rate •Arbolito (little tree) = black market broker •The less flexible an XR, the more likely there will be a black market
•Many countries are moving towards adopting the dollar as their primary currency •Response to continual currency crises: -Ecuador, -El Salvador, -Panama, -Argentina (convertibility plan) •Quasi-dollarization: Many more countries including Israel, other Latin American countries
•Conditions for receiving IMF funding: Increase taxes, privatize, cut public spending, raise interest rates, more exports, less imports, foreign direct investment, etc. (Washington Consensus) •Criticisms: -One-size-fits-all prescription -too powerful, lack of accountability -moral hazard problem •New initiatives to counteract IMF: •BRICS Development Bank •AIIB, BID
•By end of WWII, European and Japanese economies devastated •Former colonies (Asia, Africa, Middle East) very poor •Industrial infrastructure around the world in poor shape •Only the U.S. was in a good position economically •U.S. needed to sell to the rest of the world • à All this sets the stage for the Bretton Woods Agreement of 1944
•Created two organizations: the International Monetary Fund (IMF) and the World Bank •The job of the IMF: -To promote XR stability and facilitate int'l flow of currencies -To upheld system of fixed XRs with par values for each currency (benchmark value quoted in terms of US $) -Only US $ convertible to gold at $35/ounce -Currencies could vary by 1% up or down but no more
•Each member country pays a quota to the IMF, creating a fund that is used to help countries maintain exchange rates at par value • •Also created Special Drawing Rights (SDRs): used to help countries maintain BOPs and increase international reserves (based on basket of currencies) • •The job of the World Bank: to provide low-cost loans to help countries develop economies
•Europe had largely recovered from WWII •The United States began to register huge trade deficits •The US went off the gold standard in 1971 and 1976 • •Smithsonian Agreement (1971): widened XR flexibility from 1 to 2.25 % from par •Jamaica Agreement (1976) led to floating exchange rates for many countries -Floating rates were declared acceptable -Gold was abandoned as a reserve asset -Total annual IMF quotas - the amount member countries contribute to the IMF - were increased to $41 billion (today, this number is $767 billion)
•Over time the global monetary system evolved from non-existent (trade based on barter and countertrading), to the gold standard, to the Bretton Woods convertibility with the dollar as the unit, to the current global monetary system (without standard and currencies that are allowed to float) •The World Bank and the IMF are institutions created in the Bretton Woods agreement, to provide financial stability to and support the international system in which currencies had a fix exchange rate against the dollar, which was the only currency convertible into gold.
•In Fixed exchange rate systems the government of the country established an exchange rate against a currency of choice and promise to maintain it. In floating exchange rate systems, the government does not participate in the foreign exchange market and the exchange rate is determined by supply and demand. There are pros and cons for both systems and both are at the whim of the currency market forces. •Floating exchange rate systems limit the ability of governments to utilize monetary policy to affect domestic economic activity. It is also argued that it automatically adjusts trade imbalances, and that in times of financial crisis, it provides a less painful path to recovery (because devaluation increase exports competitiveness) •Fixed exchange rate systems impose strict discipline on a government monetary policy, are more expose to speculation, reduced uncertainty (which favors international trade and growth).
•There are both economic and political arguments supporting regional economic integration •Generally, many groups within a country oppose the notion of economic integration •Economic Argument: •achieve additional gains from the free flow of trade and investment between countries beyond those attainable under international agreements such as the WTO •easier to form an agreement with a few countries than across all nations •Political Argument: •likelihood of violent conflict and war will decrease •Due to increase interdependency and interactions •As a group they have greater clout and are politically much stronger in dealing with other nations.
•There are both economic and political arguments supporting regional economic integration •Generally, many groups within a country oppose the notion of economic integration •Economic Argument: •achieve additional gains from the free flow of trade and investment between countries beyond those attainable under international agreements such as the WTO •easier to form an agreement with a few countries than across all nations •Political Argument: •likelihood of violent conflict and war will decrease •Due to increase interdependency and interactions •As a group they have greater clout and are politically much stronger in dealing with other nations.
•The location-specific advantages argument associated with Dunning help explain the direction of FDI •However, internalization theory is needed to explain why firms prefer FDI to licensing or exporting •Exporting is preferable to licensing and FDI as long as transportation costs and trade barriers are low •Licensing is unattractive when: •The firm's proprietary knowledge cannot be protected by a licensing agreement •The firm needs tight control over a foreign entity in order to maximize its market share and earnings in that country •The firm's skills and capabilities are not amenable to licensing
•There are three ideological views of FDI: • •Radical view, in retreat. MNE are instruments of imperial domination and for that reason FDI avoided by developing countries. • •Free Market view. International trade should be based on Comparative Advantage Theory, and MNE through their FDI are the instruments to achieve efficiency and increase the economic welfare around the world • •National Pragmatic view. There are benefits and costs of FDI, and host countries should allow FDI if benefits outweigh the costs. • •FDI has benefits and costs for both host and home countries: • •Job creation, market competition, balance of payments, economic growth, and national sovereignty. •Depending on this balance, host and home countries may incentivate or restrict FDI flows.
What is the international monetary system? •The international monetary system: the institutional arrangements that govern exchange rates • •Why should I care about the international monetary system or even any monetary system at all? "I am thankful to Martinez de Oz [Past-minister of economy]. If it were not for him I would have never visited Europe, USA, the rest of Latin-America" 19 year old Argentinean college student. April 1982 • In a globalized economy, what you can buy and enjoy depends in your ability to buy... and that is closely tied, at any point in time, to the monetary system implemented by your country government. Here is why...
•Up to 1800s: Mostly barter or countertrade •1880s: the Gold Standard became prevalent -Paper currency started to be used -currency backed by gold -Worked reasonably well until early 20th c. -More currency printed than reserves of gold •1914-1944: U.S. accumulated much of the gold -Sold needed goods to warring nations -Paid in gold -Economy grew 400% in 30 years
What is the foreign exchange market? The foreign exchange market is a market for converting the currency of one country into that of another country What is an exchange rate? An exchange rate is the rate at which one currency is converted into another Why do we have foreign exchange markets and exchange rates?
•Without a currency we were force into barter. •It makes trade easy •Currency is an instrument: •Easy to carry, •We all agree its valuable, and •Fungible (you can transform it on what you need) •It is an efficient way to trade.
