1. Economics and Development International Trade Lecture 1
Giorgia Giovannetti
Professor of Economics, University of Firenze

2. Introduction The timetable
Course presentation, slides in Moodle after the lecture
What about this course? lectures, students’ involvement, choice of specific topics.
Important part of work is reading articles, commenting data, with the objective to understand, synthesize, discuss and judge articles, to get insights from data and link data and theory.

3. Plan of the course/lectures
International Trade, September 13th- December 7th 1 
Introduction: The main issues 2 
Introduction, 2 detailed presentation of the course 3 
Introduction, 3; Measuring globalization 4 
Measuring Globalization, 2  5
Overview trade models (Bernard et al 2007; 2011)  6
Exercises  7
The concept of Comparative advantage: the model of Ricardo  8
Ricardo and comparative advantage, 2 /H-O, intro  9
Trade models: H-O
 10
Trade models: H-O,2
 11
 12
Trade and Imperfect competition, 1
 13
Trade and imperfect competition, 2
 14
Geography models/gravity
 15
Hysteresis, Heterogeneous firms
 16
The Melitz model
 17
Exercises on the Melitz model
 18
Trade policy
 19
Trade Policy: TTIP
 20
FDI and Multinationals: OLI theory
 21
FDI and Multinationals Offshoring/trade in tasks
 22
China and India (BRICS)
 23
Granularity and aggregate shocks
 24
Brexit: discussion
 25
exercices
Plan of the
course/lectures

4. The first two weeks
Introduction to topics and issues (today). Data on globalization, world GDP and trade, answers to some basic Q, China and India (sketch)
Data & history; introduction to statistical indicators used to measure international integration, specialization and competitiveness
Overview of trade models

5. Main References (first two weeks)
FT chapter 1
Slides GG (in Moodle)
Further readings (if interested)
Badwin, 2006, the great unbundling(s)
Havik and Morrow, 2006, global trade integration and outsourcing, how well is EU coping with these challenges
OECD (2005)Handbook of Economic Globalisation Indicators
Love P. and Lattimore R. (2009) International Trade: Free, fair, open? OECD
Bernard A. J Bradford Jensen, Redding SA & P. Schott, 2007, Firms in International Trade, Journal of Economic Perspectives, vol 21 n.3
Andrew B. Bernard, J. Bradford Jensen, Stephen J. Redding and Peter K. Schott (2011) The Empirics of Firm Heterogeneity and International Trade, CEP Discussion Paper No 1084, October

6. Objectives Provide We deal with both theory and empirics
a picture of historical trends
some conceptual basis for understanding the major international economic questions
We deal with both theory and empirics
For data: IMF, Worldbank, WTO, ITC, Unctad, OECD, ILO i.e. international Organisations

7. Examples of questions we address
Are existing trade models (developed for the “North”) able to explain trade in the “South”?
Is globalization a new phenomenon? How do we measure it?
Is rising North-South trade responsible for rising inequalities in the North?
What are the causes and consequences of changes in terms of trade for developing countries?
What are the effects of quotas on textiles? Or other tariffs?
What is the EU development policy? Has it changed in the last 20 years? if so, how?
Where are we in the negotiation at WTO? And TTIP?
What is the effect of offshoring on employment?
How does migration fit into this picture?

8. Info, exams, participation etc etc
Exam: written exam (three random tests? Or final?)
Your role: ppt on two articles of your choice in a list that I provide or group work with theory and empirics?
Participation: important….you can volunteer to lead discussion on «hot topics» (EU crisis, TTIP etc)

9. Globalization: definition
(economists): increase in international trade of both financial assets and goods that comes from a decrease in transaction costs, increase of movement of workers and ideas
Two main point: Globalization is non an (entirely) new phenomenon and is not irreversible
Last 15 years (India): unbundling of the production process: production is split and diced into separate fragment, spread around the world
IMPORTANT: also services and high skill jobs
Trade of tasks rather than goods

10. Recap: Trade in the Global Economy
Imports are the purchase of goods or services from another country.
Exports are the sale of goods or services to other countries.
Germany had the largest exports of goods in 2008 with the U.S. and China coming in second and third. In 2009 China became first, Germany 2nd, US 3rd. In 2010, China first (10.4), US 2nd (8.4), Germany 3rd (8.3)

11. Recap: Trade in the Global Economy
Merchandise goods: includes manufacturing, mining, and agricultural products.
Service exports: includes business services like eBay, travel, insurance, and transportation.
In combining all goods and services, the U.S. is the world’s largest exporter followed by Germany and China.

13. Last ten years: world trade and GDP
2012 and 2013 well below 10 years average

14. Annual Growth of Merchandise Exports

15. Recap: Trade in the Global Economy
Migration is the flow of people across borders as they move from one country to another.
Foreign Direct Investment is the flow of capital across borders when a firm owns a company in another country (above 10%, a priori threshold).

16. Population in millions, 2011 EU-27 Population Pyramid, 2008, 2060

17. Foreign Direct Investments

18. Why do nations trade?
“You could say…that globalization, driven not by human goodness but by the profit motive, has done far more good for far more people than all the foreign aid and soft loans ever provided by well-intentioned governments and international agencies.”
Paul Krugman, “The Magic Mountain,” New York Times, January 23, 2001

19. Adam Smith, The Wealth of Nations (often called the Father of Modern Economics)
It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy. The taylor does not attempt to make his own shoes, but buys them of the shoemaker. The shoemaker does not attempt to make his own clothes, but employs a taylor. The farmer attempts to make neither the one nor the other…
What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we can make it, better buy it of them with some part of the produce of our own industry;…. (Book IV, Section ii, 12)

20. Why do nations trade?
Nearly all economic theories suggest that the benefits of international trade far exceed the costs.
“Specialization and international trade increase the productivity of a nation’s resources and allow for greater total output than would otherwise be possible. “
McConnell and Brue, 16th edition

21. Important Terms to Know, summary
Specialization: Division of labor into specific tasks and roles intended to increase the productivity of workers.
Globalization: Name for the process of increasing the connectivity and interdependence of the world's markets and businesses.
Imports: Goods and services purchased from other countries
Exports: Goods and services sold to other countries

22. Mercantilism
Not covered in the course (just for you to know what was before….)
Prevailed in
Export more to “strangers” than we import to amass treasure, expand kingdom
Zero-sum vs positive-sum game view of trade
Government intervenes to achieve a surplus in exports
Maximize exports through subsidies.
Minimize imports through tariffs and quotas
A country should always have a trade surplus.
Today neo-mercantilists = protectionists: some segments of society shielded short term

23. Adam Smith and the Attack on Mercantilism and Economic Nationalism
In 1776, Adam Smith published the first modern statement of economic theory, An Inquiry into the Nature and Causes of the Wealth of Nations
The Wealth of Nations attacked mercantilism—the system of which dominated economic thought in the 1700s
Smith proved wrong the belief that trade was a zero sum game—that the gain of one nation from trade was the loss of another
Voluntary exchange (trade) is a positive sum game —both nations can gain

24. Theory of absolute advantage
Adam Smith ideas based on…
The capability of one country to produce more of a product with the same amount of input than another country
(same thing) The ability of a country to produce a good using fewer resources than another country (lower opportunity cost)
Adam Smith argued:
A country should produce only goods where it is most efficient …. and trade for those goods where it is not efficient
Trade between countries is, therefore, beneficial

25. Theory of absolute advantage
… destroys the mercantilist idea since there are gains to be had by both countries party to an exchange
… questions the objective of national governments to acquire “wealth”: through restrictive trade policies
… also measures a nation’s wealth by the living standards of its people

26. TRADE BASED ON ABSOLUTE ADVANTAGE
One Person Per Day of Labor Produces
Country
Machines
Cloth EU
5 machines
10 yards of cloth
India
2 machines
15 yards of cloth

27. THE PRODUCTION POSSIBILITIES FRONTIER AND CONSTANT COSTS
The Production Possibilities Frontier (PPF) is a curve (line) showing the various combinations of two goods that a country can produce when all of a country’s resources are fully employed and used in their most efficient manner
One Person Per Day of Labor Produces
Country
Machines
Cloth EU
5 machines
10 yards of cloth
India
2 machines
15 yards of cloth

28. One Person Per Day of Labor Produces
Country
Machines
Cloth EU
5 machines
10 yards of cloth
India
2 machines
15 yards of cloth
Production Possibilities Curves for the UE and India
Machines 5 UE 2
INDIA
Cloth 10 15

29. EU Cloth Mach 10 0 8 1 6 2 4 3 2 4 0 5 India - Opportunity Costs
10 0
8 1
6 2
4 3
2 4
0 5
India Cloth Mach
“Opportunity Cost” also known as “Relative Price”
India - Opportunity Costs
Machine = cloth
Cloth = machine
EU - Opportunity Costs
Machine = 2 cloth
Cloth = machine

30. What Determines the Slope of the PPC?
Same graph, drawn more to scale!
What Determines the Slope of the PPC?
Slope = ∆Machines/∆Cloth = Opportunity Cost of Machines
This slope is also known as the …
Marginal Rate of Transformation
Machines
EU: Slope = Opportunity Cost = -0.5
India: Slope = Opportunity Cost = 5 2
Cloth 10 15

31. Absolute Advantage: Production Conditions When Each Country Is More Efficient in the Production of One Commodity
EU workers are more productive in producing machines
The EU has an absolute advantage in machine production
Indian workers are more productive in producing cloth
India has an absolute advantage in cloth production

32. One Person Per Day of Labor Produces
TRADE BASED ON ABSOLUTE ADVANTAGE … Yes, maybe that was obvious to you from the beginning…
One Person Per Day of Labor Produces
Country
Machines
Cloth EU
5 machines
10 yards of cloth
India
2 machines
15 yards of cloth
A country should produce only goods where it is most efficient, and trade for those goods where it is not efficient

33. Two Persons Per Day of Labor Produces
Assume TWO Persons per day, so that each product can be fully produced
Two Persons Per Day of Labor Produces
Country
Machines
Cloth EU
5 machines
10 yards of cloth
India
2 machines
15 yards of cloth
World Output
7 machines
25 yards of cloth
(and)
(and)
(and)
This is a condition under Autarky: (The complete absence of trade)
Under Autarky all nations can only consume the goods they produce at home

34. Two Persons Per Day of Labor Produces
Assume TWO Persons per day, so that each product can be fully produced
Two Persons Per Day of Labor Produces
Country
Machines
Cloth EU
5 machines
10 yards of cloth
India
2 machines
15 yards of cloth
World Output
7 machines
25 yards of cloth
(and)
(and)
(and)
However, if each country produces to their absolute adv.
Two Persons Per Day of Labor Produces
Country
Machines
Cloth EU
10 machines
0 yards of cloth
India
0 machines
30 yards of cloth
World Output .
(and) .

35. TRADE BASED ON ABSOLUTE ADVANTAGE
So there has obviously been an increase in World Output!!
Change in the Production of
Country
Machines
Cloth EU
+5 machines
–10 yards of cloth
India
–2 machines
+15 yards of cloth
Change in World Output
+3 machines
+5 yards of cloth
Both countries can benefit if trade occurs
EU produces machines and exports them to India
India produces cloth and exports it to the EU .

36. Implications of Adam Smith’s Theory
Access to foreign markets helps create wealth
If no nation imports, every company will be limited by the size of its home country market
Imports enable a country to obtain goods that it cannot make itself or can make only at very high costs
Trade barriers decrease the size of the potential market, hampering the prospects of specialization, technological progress, mutually beneficial exchange, and, ultimately, wealth creation

39. Now assume that UE has an Absolute Advantage in both goods.
One Person Per Day of Labor Produces
Country
Machines
Cloth UE
5 machines
15 yards of cloth
India
1 machine
5 yards of cloth

40. One Person Per Day of Labor Produces Comparative Advantage
Country
Machines
Cloth UE
5 machines
15 yards of cloth
India
1 machine
5 yards of cloth
Production Possibilities Curves for the UE and India
Graphically obvious …
UE has an Absolute Advantage in both goods.
Machines
To see the opportunity to trade, we need to introduce the concept of:
Comparative Advantage 5 1
Cloth 5 15

41. So… what If One Country Has Absolute Advantage in Both Goods?
David Ricardo’s Law of Comparative Advantage—countries should specialize where they have their greatest absolute advantage (if they have absolute advantage in both goods) or in their least absolute disadvantage (if they have absolute advantage in neither good).

42. Country A has absolute advantage in both goods S and T.

43. From Table 3.3
A is 4x more efficient than B in production of good S (compare 3 hours with 12 hours).
A is only (4/3)x more efficient than B in production of good T.
Thus, A has comparative advantage in S.
With trade, A will completely specialize in S.
Do likewise for country B!

44. Gains from Trade based on Comparative Advantage

45. Why countries trade, 2
Ricardo observed that trade was driven by comparative rather than absolute costs (of producing a good).
One country may be more productive than others in all goods: it can produce any good using fewer inputs (such as capital and labor) than other countries require to produce the same good.
Ricardo’s insight was that such a country would still benefit from trading according to its comparative advantage—exporting products in which its absolute advantage was greatest, and importing products in which its absolute advantage was comparatively less (even if still positive).
The notion of comparative advantage also extends beyond physical goods to trade in services—such as writing computer code or providing financial products.

46. Comparative advantage
Differences in comparative advantage may arise for several reasons.
Ricardo: different technologies
Heckscher and Ohlin identified the role of labor and capital, so-called factor endowments, as a determinant of advantage.
Economists today think that factor endowments matter, technology matters but that there are also other important influences on trade patterns (Baldwin, 2008).
Also now perfect competition (base of these models) is challenged (we shall go into details)

47. Comparative advantage
Episodes of trade opening are followed by adjustment not only across industries, but within them as well.
The increase in competition coming from foreign firms puts pressure on profits, forcing less efficient firms to contract (exit) and making room for more efficient firms.
Expansion and new entry bring with them better technologies and new product varieties. Trade enables greater selection across different types of goods. This explains why there is a lot of intra-industry trade something that the factor endowment approach does not encompass.

48. Absolute and Comparative Productivity Advantage Contrasted
Absolute productivity advantage: Held by a country that produces more of a certain good per hour worked than another
Comparative advantage: Held by a country that has lower opportunity costs of producing a good than its trading partners do
Comparative advantage allows a country that lacks absolute advantage to sell its products abroad

49. How do we empirically measure comparative advantage?
Let’s look at the trade balance
S = X – M
S = Balance. X = export. M = import
Difference between exports and imports
Global Balance, geographical balances sector balances
Same balance can have different economic meaning depending on level of trade.

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51. 17/09/2018

52. “Made in Italy” trade balance
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53. Better to look at Normalized trade balance
Zij = normalized trade balance of product j and country i
Value varies between –100% (country only imports) to +100% (country only exports). Equal to 0 if trade balances (=0)
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54. Normalized trade balance
Allows spatial and temporal comparisons
Is an indicator of a country's trade performance (upward trend if the rate of growth of exports is higher than that of imports)
Is an indicator of specialization and comparative advantage (specialization model)
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55. Interpretation
The normalization makes trade balances measures very useful in spatial and intertemporal comparisons.
Indicator of a country's trade performance, as it has an upward trend if the rate of growth of exports is higher than that of imports.
The normalized balances are widely used in disaggregated analysis to study specialization and comparative advantages of a country.
High and positive Normalized balances in specific industrial sectors reveal that those industries are highly competitive in international markets as well as on the domestic market.
The distribution of the normalized trade balances indicates areas in which a country has a comparative advantage wrt other countries, thus providing the first description of its specialization model.
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56. Ratio between trade balance and GDP
Is a basic indicator to measure the importance of foreign trade for a country.
This ratio is built as "normalized balance" but no longer wrt to x+m, but to GDP:
RSP = (X-M)/GDP
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