1. 1 Introduction to International Trade and Investment Theory 1

2. ■ Aims of the course  To understand reasons for international trade  Traditional trade theory  Modern trade theory  To understand benefits and costs of international trade  To understand international trade policy  Effects of tariffs and non-tariff barriers, etc. Introduction to the course 2

3. 3  International trade focuses on transactions of real goods and services across nations.  These transactions usually involve a physical movement of goods or tangible resources like labor.  International Economics is traditionally divided into international trade t heory and international finance.  International trade theory is the microeconomics of international transactions. The focus of international trade theory is on:  why countries trade  the effect of trade on nations and  the effect of policies adopted by nations towards trade.  International finance is the study of the balance of payments, foreign exchange markets and the macroeconomics of international transactions. The macroeconomics of international transactions is also known as open- economy macroeconomics. What is International Trade

4. 4  Whether from daily consumed goods (cheese) and use of c onsumer durables (TV/Microwave), daily news reports on print or electronic media, or an ever expanding list of new TV channels, we are always reminded of the importance of globalization.  In the U.S. (also in Bangladesh) many, if not most, consumer durables, including CD players, AC, computers, televisions and auto mobiles, are imported.  Moreover, goods that are produced domestically often have significant imported contents in them. Ford automobiles may be manufactured in the U.S. but are produced using foreign steel. Walton produces consumer durables in Bangladesh with foreign parts. Most of RFL plastic and other appliances are made in China.  The issue of whether a product is domestic or foreign becomes e ven murkier when considering the issue of ownership for firms w hose stock is traded on international markets. The Globalization of the World Economy

5. 5  Globalization generally defined as the increased integration of markets, including goods’ markets, financial markets, and the market for factors of production (land, labor, and physical capital).  The movement of goods (exports plus imports) across national b orders is a significant and increasing part of economic activity in nearly every country of the world.  International movement of goods and resources affects nations’ standards of living in many ways. Perhaps the most important effect is to increase the average standard of living by lowering the cost of producing goods.  With international trade, goods can be produced where they have the lowest cost of production and shipped to where people value them the most (i.e. buys at higher price like readymade garments made in Bangladesh for brands like Zara, Marks & Spencer).

6. 6  With the increased integration of economies comes not only increased s hipments of goods, but also increased movement of people across national borders. In 2015, the US immigrants have accounted for 13.5% of the total U.S. population of 321.4 million.  Less apparent than the movement of goods and people, but equally i mportant, are the effects of the movement of financial capital. If, for example, interest rates increase in Asia, then funds will flow out of Europe and the U.S. towards the higher rate of return. The reduction in lending in Europe and the U.S. increases the cost of borrowing on both continents. The financial linkages between nations were very apparent in the recent global financial crisis in which mortgage delinquencies in the U.S. led to tougher credit standards around the world. The Globalization of the World Economy

7. 7  The flow of funds between nations also affects currency exchange rates on the foreign exchange markets. If funds flow out of the U.S., then the d ollar depreciates against foreign currency, which is equivalent to a higher dollar cost for foreign currency. Tourists from the U.S. will find traveling ab road more expensive in dollar terms, so undertake fewer trips abroad. Forei gn tourists will find trips to the U.S. relatively cheaper. The dollar’s cheap er value will also have important effects on industry. U.S. exports will i ncrease as foreigners take advantage of the cheap dollar by buying U.S goo ds. The higher cost of foreign currency will decrease U.S. imports from ab road as U.S. citizens buy relatively cheaper U.S. produced goods. The Globalization of the World Economy Gross Domestic Product (GDP) is an indicator of the size of an economy. It measures the monetary value of all final goods and services (i.e. those that are bought by the final user) produced within a country regardless of who owns the means of production, in a given period of time Gross National Product (GNP) is the market value of all products and services produced in a given period of time by labor and property supplied by the citizens of a country. GNP is equal to GDP plus income earned by residents from overseas minus income earned within the domestic economy by overseas residents

8. Trend of World Trade Source: WTO, World Trade Report 2013. ■ Growth of World trade International trade as a (%) of the World GDP has doubled in the past 30 years. 8

9. Trend of World Trade Source: Bank of Korea ■ Growth of US’s and Bangladesh’s trade Import as a (%) of GDP for Bangladesh has doubled in the past 30 years. Compared to the US, Bangladesh and also other countries are even more tied to international trade. 9

10. Trend of World Trade Source: Bank of Korea ■ Growth of US’s and Bangladesh’s trade Export as a (%) of GDP for Bangladesh has tripled in the past 30 years. 10

11.  Liberalization of Trade  GATT/WTO [WTO deals with the global rules of trade between nations. Its main function is to ensure that trade flows as smoothly, predictably and freely as possible. GATT is a legal agreement between many countries, whose overall purpose was to promote international trade by reducing or eliminating trade barriers such as tariffs or quotas.]  Economic Integration [an agreement among countries in a geographic region to reduce and ultimately remove, tariff and non tariff barriers to the free flow of goods or services and factors of production among each others; any type of arrangement in which countries agree to coordinate their trade, fiscal, and/or monetary policies are referred to as economic integration.]  Development of Transport  Sea Transport  Air Transport  Development of Telecommunication  Telephone  Internet Reasons for Fast Expansion of International Trade 11

12. Container shipping dramatically reduced shipping costs making it much easier and cost effective to ship world-wide. 12

13.  Comparative advantage  Difference in technology - David Ricardo [The theory of comparative advantage is about the gains from trade for individuals, firms, or nations that arise from differences in their factor endowments or technological progress]  Difference in factor endowments – Heckscher-Ohlin (builds on David Ricardo's theory of comparative advantage by predicting patterns of commerce and production based on the factor endowments of a trading region. The model essentially says that countries will export products that use their abundant and cheap factor(s) of production and import products that use the countries' scarce factor(s))  Inter-industry trade [Inter-industry trade is a trade of products that belong to different industries. For instance, the trade of agricultural products produced in one country with technological equipment produced in another country. Countries usually engage in inter-industry trade according to their competitive advantages] Fundamental Reasons for International Trade 13

14.  Economies of scale and product differentiation  Economies of scale [Economies of scale means a larger scale (more output) can be achieved at a lower cost (i.e. with economies or savings). When production within an industry has this characteristic, thus specialization and trade can result in improvements in world productive efficiency and welfare benefits that accrue to all trading countries. Economies-of-scale models are used to explain trade between countries with similar characteristics, like the United States and Canada.]  Product differentiation [international trade is also caused by consumers’ taste for variety. product differentiation is a cause of the substantial amount of intra- industry trade among industrialized countries Intra-industry trade [Intra-industry trade, is a trade of products that belong to the same industry. US imports and exports automobiles, machine tools, steel, etc. To some extent intra- industry trade arises because many different types of products are aggregated into one category] Fundamental Reasons for International Trade 14

15. ■ Benefits of International Trade  Individuals  Consumption of better quality products with lower prices  Consumption of diverse products  Firms  Greater business opportunities  Greater profit  Nation  Fast economic growth  Job creation What are the Consequences (Benefits and Costs) of International Trade? 15

16. ■ Costs of International Trade  Individuals  Loss of jobs employed in the less competitive industries  Firms  Face stronger competition and may lose competitive edge  Nation  Greater income disparity  Possibility of environmental degradation in developing countries  Greater vulnerability to foreign shocks What are the Consequences (Benefits and Costs) of International Trade? 16

17. ■ Net Benefit of International Trade  Firms  Greater business opportunity but may lose competitive edge  Individuals  As consumers, individuals become better off, but as workers, individuals may become worse off.  Nation  Overall national welfare becomes greater, but the nation may face the problems of income disparity, environmental degradation, etc. What are the Consequences (Benefits and Costs) of International Trade? 17

18.  Gravity Model  The volume of trade increases with the size and proximity of trading partners. This relatively simple observation is called gravity model because of the obvious similarity to the gravitational pull between planets. This means that we would expect the volume of trade to be higher with large nations and higher with geographically close nations  Other things equal, the bilateral trade between two countries is proportional, and the greater the distance between the two countries, the smaller is their bilateral trade. That is, the larger (and more equal in size) and the closer two countries are, the larger the volume of trade between them is expected to be. Who are the major trade partners of a nation? 18