Chapter Two The Global Economy

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 2 I started the day early having set my alarm clock (MADE IN JAPAN) for 6 a.m. While my coffeepot (MADE IN CHINA) was perking, I shaved with my electric razor (MADE IN HONG KONG). I put on a dress shirt (MADE IN SRI LANKA), designer jeans (MADE IN SINGAPORE) and tennis shoes (MADE IN KOREA). After cooking my breakfast in my new electric skillet (MADE IN INDIA) I sat down with my calculator (MADE IN MEXICO) to see how much I could spend today. The Global Economy

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 3 After setting my watch (MADE IN TAIWAN) to the radio (MADE IN INDIA) I got in my car (MADE IN JAPAN) and continued my search for a good paying (!) American job. At the end of yet another discouraging and fruitless day, I decided to relax for a while. I put on my sandals (MADE IN BRAZIL) poured myself a glass of wine (MADE IN FRANCE) and turned on my TV (MADE IN INDONESIA), and then wondered why I can't find a good paying job in.....AMERICA! The Global Economy (cont.)

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 4 Imports and Exports as a Percentage of GDP (in Billions of Dollars)

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 5 Stock Market Crash 1929 US Isolationism, Protectionism Other Countries Retaliate with Similar Measures Global Depression – Germany and Japan Hit Particularly Hard World War II Historical Development

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 6 Bretton Woods Conference GATT, WTO   Import Tariffs Decrease from 40% in 1947 to 4% Today   World Trade Increases 22-fold Since 1950   Foreign Direct Investment Increased Over 100% in a Single Decade! Historical Development (cont’d)

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 7 Absolute advantage Trade is based on each country selling what it is best at producing Comparative advantage Trade can occur between twocountries even if one of the countries has no absolute advantage in any product Make the product you have a comparative advantage in Basic Theories of World Trade

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 8 VietnamGermany Yearly output per worker Machinery200 machines500 machines Tomatoes800 tons1000 tons Opportunity cost of production 1 machine costs 4 tons of tomatoes or 1 ton tomatoes cost 0.25 machines 1 machine costs 2 tons of tomatoes or 1 ton tomatoes costs 0.5 machines Absolute advantage NoneMachinery, tomatoes Comparative advantage TomatoesMachinery

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 9 1 (Vietnamese) machine = 4 tons (Vietnamese) tomatoes 1 (German) machine = 2 tons (German) tomatoes If Germany trades 1 machine to Vietnamese for 3 tons of tomatoes…both countries win!

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 10 Any trading ratio between: 1 machine = 2 tons of tomatoes and 1 machine = 4 tons of tomatoes will be a mutually advantageous trading ratio

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide Land 2. 2.Labor 3. 3.Natural resources 4. 4.Capital Competitive Advantage (Adam Smith) Comparative advantage is limited by its focus on the elements of production, including:

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 12 Porter’s Revised Theory of Competitive Advantage Elements of production Nature of domestic demand Presence of appropriate suppliers or related industries The conditions in the country that govern how companies are created, organized, and managed Nature of domestic rivalry

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 13 An exchange rate measures the value of one currency in terms of another currency 1 US $ = 0.5 £ One currency can appreciate or depreciate against another 1 US $ = 0.75 £ 1 US $ = 0.30 £ Exchange Rates

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 14 Balance of Payments An accounting record of the transactions between one country’s economy and the rest of the world’s collective economy at a point in time. Functions like a statement of cash flows.

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 15 Add table 2.5, p. 26 here Balance of Payments

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 16 Supply and Demand and FOREX The foreign exchange market reflects the supply and demand for one currency versus another D S q p DM Pounds

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 17 Rates Determining Factors (besides Supply & Demand) Imports/exports drive need for currencies Inflation Investors and speculators - ROI Government actions

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 18 Is a strong currency good or bad?

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 19 “Soft” Currencies Currencies of smaller, less developed countries Rates can be artificially “determined” by the governments of these countries Pegging of rates to more stable currencies Governments must eventually respect FOREX supply and demand Currencies often face significant devaluations

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 20 Panama adopted the U.S. dollar as its currency in 1904 Ecuador adopts U.S. dollar in 2000 Good idea? + Monetary stability - Lack of flexibility in monetary or foreign exchange policy to respond to economic downturn or external shocks (i.e. what if dollar depreciates?) Dollarization

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 21 Agencies Promoting Economic and Monetary Stability International Monetary Fund –Prevention of economic instability in emerging markets World Bank –Long-term loans to developing countries Group of 7(8) –Finance ministers/Central Bank governors of USA, Japan, Germany, France, Britain, Italy, Canada (Russia)

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 22 Protectionism and Trade Restrictions Tariffs Quotas Orderly marketing arrangements (voluntary export restrictions) Non-tariff barriers (regulations, stringent standards, bribes, etc.)

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 23 General Agreement on Tariffs and Trade (GATT) – Key Principles Reciprocity Non discrimination –Most favored nation (MFN) status Transparency

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 24 World Trade Organization Created as final act of GATT Unlike GATT, WTO decisions can only be overturned by consensus and not by unilateral veto Challenges –Continued liberalization of trade –Establish trade policy for foreign investment, competition and labor standards –Promote regional trade agreements

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 25 Unfair to developing countries? Threat to national sovereignty and culture? Protectionist agendas still remain in some countries Opposition to WTO Agendas

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 26 Different Types of Regional Economic Integration –Free Trade Area (i.e. NAFTA) Liberal external trading policy –Customs Union supranational trade policy-making body Common external trade barrier adopted by all member nations –Common Market Customs Union characteristics + mobile labor and capital among member nations –Monetary Unions (example: European Union and the “Euro”)

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 27 Geographic Proximity Often Contributes to Economic Integration Distances are short – lower cost of trading Similar consumer tastes Common history or interests

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 28 Benefits Trade Creation Bigger Markets Greater Consensus Political Cooperation & Good Will Drawbacks Trade Diversion Shifts in Employment and Loss of Jobs Loss of National Sovereignty The Effects of Economic Integration

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 29 European Integration…. ''When I need to get in touch with the Kremlin, I know who to call. When I need to get in touch with Europe, who do I call?'' --Henry Kissinger

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 30 European Union - Characteristics Founded on International Treaties among sovereign nations rather than a Supra-national Constitution Power to enact laws that are binding on all EU citizens throughout EU territory Common Currency established – the “Euro”

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 31 EU Objectives 1.Promote economic and social progress 2.Assert the identity of the European Union on the international scene 3.Introduce European citizenship 4.Develop an area of freedom 5.Maintain and build an established EU law

Copyright © Houghton Mifflin Company. All rights reserved.Chapter 2 | Slide 32 History of the EU European Coal and Steel Community 1957 – Treaties of Rome: EEC (later EC) European Free Trade Association 1967 – Internal Tariffs Eliminated in EC; Common External Tariff Imposed 1992 – European Union Signed in Maastricht 1999 – Most Countries Adopt the Euro