1. Economic Globalization
Sociology 2, Class 8
Copyright © 2013 by Evan Schofer
Do not copy or distribute without permission

2. Announcements Announcements Agenda
Midterm is approaching… less than 2 weeks
Midterm review sheet on website soon (probably tomorrow)
Midterm review session:
During section on Tues-Friday next week, & following Monday
Agenda
Midterm info
More on economic globalization
Currencies & financial crises
Trade & trade agreements

3. Midterm Info Exam Format: Topic coverage: Closed book / closed notes
Mix of short answer/multiple choice, medium length, and perhaps one short essay question
No bluebook needed
Topic coverage:
All class lecture material
Lecture notes on course website
All readings up through Week 5
Commanding Heights video, Episodes 1 & 3
Available via course web page…

4. Review: Economic Globalization
What do you need to have a global economy?
1. Inexpensive transportation & communication
2. International financial (money) system
3. Countries that are willing to participate
Absence of legal or regulatory “barriers”
History of the international financial system
Gold Standard: Money equivalent to gold
Bretton Woods: US dollar based on gold, used for trade
Floating exchange rates: supply/demand affect currencies

5. Currency Value Examples
Country
Currency
Number per US$
Europe
Euro
0.736
Canada
Dollar
1.004
China
Yuan/RMB
6.22
India
Rupee
53.25
Japan
Yen
91.32
Mexico
Peso
12.71
South Korea
Won
1088
Thailand
Baht
29.86
United Kingdom
Pound
.63
As of Jan 31, 2013

6. Trade & Exchange Rates Currency values affect trade:
Example: Suppose the Euro becomes more valuable relative to the dollar:
Value of dollar drops from .70 Euros to .10 Euros
Euro worth 1.44 US$, goes up to 10 US$
How much would a US$ 1,000 computer cost to a European?
Answer: Only 100 Euros!
When your currency goes up relative to others, it becomes cheaper to import
If currency value drops, imports become expensive.

7. Trade & Exchange Rates
Who benefits if the US dollar goes up relative to the Euro?
1. American consumers – they can buy European products cheaply
2. European exporters – they can sell lots to the U.S.
Who Loses?
1. European consumers – American imports become expensive
2. American companies – can’t compete with cheap imports from Europe

8. Floating Exchange Rates
Why do currency values “float” (change in value relative to others)?
Answer: Changes in supply/demand
But: What forces affect supply and demand?
1. Asymmetric trade
If a country imports lots more than it exports (“current accounts deficit”), its currency drops
Ex: If US has a current accounts deficit with Japan
To purchase Japanese goods, Americans must sell dollars, buy Japanese Yen
Demand drives up value of Yen relative to the dollar
Converse is also true… lots of exports cause a currency to float up…

9. Floating Exchange Rates
Example: The effects of asymmetric trade on currency values
Suppose I sell 10,000,000 computers
Europeans will sell 7.5 billion Euros to banks in order to purchase 10 billion US$…
If banks (currency markets) are flooded with Euros, supply increases, value drops…
Currency markets don’t want more Euros
Changing currency values often result in a trade equilibrium
Drop in currency limits subsequent imports
But, we’ll discuss exceptions… (ex: China & US)

10. Floating Exchange Rates
What forces affect currency values?
2. Asymmetric capital flows
If capital moves into a country, currency goes up
Ex: In early 1990s, global investors moved money into Thailand, Mexico… raising the value of currency
If capital moves out of a country, its currency goes down
Investors feared problems in Mexico, Thailand… pulled money out
Thai Baht and Mexican Peso dropped in value.

11. Floating Exchange Rates
What causes asymmetric capital flows?
2. a. Changes in interest rates
If a country raises interest rates, its currency goes up
Reason: Foreign investors prefer high rates
The “electronic herd” is attracted to high rates…
If a country cuts interest rates, its currency drops
Investors would prefer moving money into countries where banks pay higher interest…
Important issue: Globalization limits the ability of governments to control their own monetary policy
Sometimes countries want to lower interest rates to boost the economy…
But doing so might cause adverse effects on currency…

12. Floating Exchange Rates
What causes asymmetric capital flows?
2. b. Anything that “scares” investors
Concern that an economy may have problems
Ex: Fears that Thailand was going “bust”
Policy changes that investors don’t like
Ex: big increase in taxes
Shift away from free-market policies (“golden straightjacket”)
Government instability
All of these things can cause investors to pull their money out of a country quickly, harming currency values.

13. Floating Exchange Rates
What forces affect currency values?
3. Countries can intervene strategically to alter their currency values
Sometimes keeping it at a “fixed” value with the dollar or other major currency
Governments can sell their currency to lower its value
They buy other currencies on global markets
Governments can buy their own currency to raise its value
They spend reserves of gold or other currencies on global markets
Of course, this requires lots of money
Mainly, big / wealthy countries do this (ex: China)
Small countries sometimes fail (ex: Thailand).

14. Financial Flows & Exchange Rates
Issue: Asymmetric trade & capital flows cause currencies to shift
But remember: Investment flows are larger than trade flows, and they can happen much faster
Elwood: “pinball capital”
Result: global investors can cause currency values to change rapidly
Called: market volatility (rapid change in value).

15. Exchange Rates & Volatility
Capital flows and resulting currency volatility can produce severe crises
Example: Mexico in 1994
Global investors bought lots of stock, investments in Mexico over several years…
This caused a slow rise in the peso. Not a problem.
A minor political crisis led to panic selling in 1994
The stock market began to plummet
Global investors rushed to sell stocks, converted pesos to dollars
Result: Selling of pesos made the value of pesos plummet!

16. Video Commanding Heights, Ep 3, chapter 7 Time: 27:50 – 32:45.
Mexican Peso Crisis (also called the “Tequila Crisis”)

17. Exchange Rates & Volatility
Why was it bad for the value of pesos to drop severely, rapidly?
1. Suddenly, imports were very expensive
Price of gas shot up
Businesses dependent on imports couldn’t afford costs; potential for bankruptcies
2. Mexican companies & government had borrowed money from US banks
US banks must paid in $, not pesos
If pesos are worth less, suddenly you can’t afford to pay loans
Result: More bankruptcies, economic recession.

18. Exchange Rates & Volatility
In the case of the 1994 peso crisis, the US government stepped in
Provided emergency loans, etc., to prevent massive bankruptcy
After panic, currency stabilized
But, that was just a small crisis… It is clear that crises could occur that are too large to stop so easily.

19. Asian Financial Crisis
Commanding Heights Video:
In the 1990s, foreign investors moved capital into Asia
And, foreign banks lent money to Asian companies at very low interest rates
Consequence: Rapid economic growth
Economies “heated up”
But, capitalism is prone to boom-bust cycles…
Companies built more factories and housing than needed
The “boom” ended
But – global dynamics made the “bust” much worse!

20. Asian Financial Crisis
How did globalization prompt a crisis for Asian economies in the 1990s?
1. Investors pulled out quickly – affecting currencies
Asian currency valued dropped…
Imports became expensive
Companies could no longer pay off loans to foreign banks
Bankruptcies, unemployment…

21. Asian Financial Crisis
How did globalization prompt a crisis for Asian economies in the 1990s?
2. Contagion
Worries about Thailand spread to other Asian countries
Self-fulfilling prophecy: fear of problems caused investors to pull out, creating real problems
Also, many US companies were invested in Asia (or had made loans)… Now they were losing money
Lesson: Integrated economies mean that crises tend to spread…
Example: US financial crisis caused economic disruption around the globe.

22. More Video: Commanding Heights
Topic: Asian financial crisis, spillover to other regions…
Video: 40:48 to 48:10 (8 minutes)
Asian economic miracle
Video: 48:10-1:14:30 (36 minutes)
Asian financial crisis and contagion

23. Commanding Heights Asian financial crisis wrap-up
Long Term Capital Management (LTCM)
A US-based hedge fund; assets $130 billion in 1998
Controlled much more
Used leverage (borrowed funds) to invest globally
Crisis in Asia/Russia caused LTCM to take huge losses
LTCM was bankrupt (owed more than it had to US banks)
US banks were threatened with huge losses (like 2008)
AND: If LTCM was forced to sell remaining assets, markets would fall further – making things worse!
Strategy: US engineered a private bailout
Banks lent LTCM a huge amount of money to keep going until markets recovered
IMF and other lenders also bailed out countries (e.g., Brazil) to end financial crisis.

24. Asian financial crisis Wrap-up
Remarks:
The 1998 crisis was ended… but nearly brought down major US banks
And, caused massive suffering in many countries
The 2008 crisis DID bring down major US banks
Only government intervention saved the financial system from a TOTAL disaster
Again, massive suffering
Recession, 10% unemployment
Lack of funds for government services (including cuts to UC)
Contagion in Europe
Issue: Is this acceptable? Do we need to regulate markets more aggressively? If so, how?

25. Participation in Globalization
Question: Given the dangers, why do some countries want to participate in globalization?
What are the benefits? And for whom?
International trade and capital flows can increase economic growth
Corporations often stand to benefit most... So business elites tend to support globalization
BUT, other groups in society may also benefit
Investment can create new jobs, employment
Consumers can have access to wider array of goods, cheaper goods
… the “golden” part of the “golden straightjacket”

26. Benefits of Trade / Investment
Without trade, every country must produce all kinds of goods – cars, coffee, computers, etc.
Issue: Countries vary in their ability to produce goods efficiently
Example: Coffee can be grown in America, but not very efficiently due to climate
Example: Computers can be built in Columbia, but not very efficiently due to lack of technology, infrastructure
Result: Without trade, production is less efficient.

27. Benefits of Trade / Investment
Economists Adam Smith and David Ricardo argued:
Trade allows nations to specialize in what they do best… their comparative advantage…
See Stiglitz Ch 3, p
Countries can focus on things they produce efficiently
And, trade for things they don’t produce efficiently
Result: Greater efficiency & economic growth
This can produce a win/win situation, where both countries are better off
Not counting environmental consequences, etc.

28. Benefits of Trade / Investment
Also, economists predict that foreign capital will benefit economic growth
Recall: Investment is a major ingredient in long-term economic growth
Allowing foreigners to invest in a country results in more overall investment
Example: If Sony builds a TV factory in a country, the economy will grow
And, intangible capital flows can have benefits
Example: Foreign banks may lend money at low rates
Access to capital allows domestic companies to invest
Lower rates and investment help economic growth.

29. Benefits of Trade / Investment
Many people – including sociologists – have criticized the Smith/Ricardo model of trade
Critics have shown lots of bad side-effects from globalization:
Increasing inequality, crises, environmental problems, etc…
BUT, research evidence doesn’t typically find disastrous economic effects of trade/investment
Extreme fears about the dangers of trade/investment do not seem warranted…

30. Reading: Rodrik The benefits: analogy: Trade = technology
Trade, like new technology, allows nations to convert some products (e.g., raw materials) into something else
Example: We can magically turn wheat into electronics… by trading with Japan
Yes, new technologies cause people to lose jobs… but who wants to go back to a world of manual labor?
Likewise, we shouldn’t resist free trade…

31. Reading: Rodrik Question: So why doesn’t everyone love free trade?
1. benefits of trade involve large shifts in production
To reap benefits, we have to shift production toward things we produce efficiently (e.g., wheat) and away from other stuff
Lots of transitional (and permanent) unemployment
Rodrik: Ratio = $50 shifted to gain $51 in GDP.

32. Reading: Rodrik So why doesn’t everyone love free trade?
2. Benefits of trade aren’t quite like technology
For one thing, they repeatedly put the same people out of work
Namely, those without high levels of education/skills
3. Benefits of trade don’t always work out in practice
Example: Merchandise trade between Europe/United States & poor countries in Asia may be harming US economic growth (Krugman)
Some poor countries fare badly in trade with rich countries (more on this later).

33. Benefits of Trade / Investment
Who benefits from global trade/investment?
1. Many benefit from greater economic growth
The wealthy usually benefit a great deal…
2. Consumers benefit from cheap imports
3. Multi-national corporations, because they can move operations to wherever is cheapest
4. Highly competitive export-oriented companies benefit from access to new markets
And, workers in those industries tend to benefit
5. Investors can invest where profits are big
Ex: pension funds CalPERS, LTCM
6. Companies that can get cheap credit from foreign banks

34. Problems of Trade / Investment
Who might oppose global trade & investment?
1. Corporations in industries that will face greater international competition
Example: steel & auto industries in the US
2. Workers in industries that will face competition
And labor unions more generally…
3. People & governments concerned about:
Potential for economic crises
Loss of state autonomy
Pressure to please foreign capital; loss of domestic ownership
Difficulty regulating global capitalism
Environmental problems, sweatshops, etc.

35. Barriers to Trade / Investment
Definition: Protectionism = blocking foreign imports or capital flows
Opposite: “Liberalization” or “opening up markets”
Note: different from typical use of “liberal” in US
Reasons to pursue protectionism:
1. Protect domestic companies or industries from foreign competition
Prevent bankruptcies, job loss in inefficient industries
2. To reduce risk of financial crises.
3. Prevent foreign ownership and/or control of the companies or the economy
Example: People get nervous when Chinese companies buy major US oil or computer companies

36. Barriers to Trade Strategies for protectionism
1. Tariffs – taxes on imported goods and services
Example: The US government can impose a $2,000 tax on Japanese cars
Fewer people will buy Japanese cars, imports will decrease
2. Quotas – a government-imposed numeric limit on imports
Example: The US may allow only 500,000 Japanese cars to be imported in any given year.

37. Barriers to Trade Strategies for protectionism (continued)
3. “Non-tariff” barriers – A government regulation that indirectly limits trade or makes it more expensive
Example: Strong agricultural subsidies make it impossible for foreign imports to compete
NOTE: Subsidies block imports, just like tariffs…
Example: The US may impose complex agricultural inspections that delay or discourage imported fruit
Could be legitimate, or simply a way of stopping imports.

38. Barriers to Investment
Strategies for protectionism (continued)
4. “Foreign ownership” laws – laws that limit the ability of foreigners to buy companies
Example: US government could require owners of corporations to be US citizens
5. “Capital controls” – laws designed to prevent the rapid withdrawal of capital/investment
Example: Law requiring invested capital to remain in the country for one year
Thus, preventing rapid flows in and out.

39. Removal of Barriers How do trade/capital barriers get removed?
“Liberalization” or “opening markets”
Answer: When governments agree to remove them…
In direct negotiation with other countries
Or, via international treaties & organizations
GATT; NAFTA; WTO.

40. Removal of Barriers Bi-lateral negotiations & treaties:
When two countries negotiate trade & investment barriers
Ex: The US negotiates with China, haggling over barriers
“You reduce tariffs on American cars, and we’ll reduce import quotas on Chinese textiles”
Note: Barriers can also be raised as coercion
Example: US threatens to impose quotas on Chinese steel products, if China doesn’t lower tariff
China might respond by threatening to raise tariffs on the US
Escalation of this is called a “trade war.”

41. Example: Bi-Lateral Trade Negotiations
South Korea, U.S. May Hold Farm Trade Talks in March
SEOUL (Reuters) - The United States and its seventh-largest trading partner began talks on a free trade agreement in June It would be the biggest free trade deal for the United States since the North American Free Trade Agreement was signed in 1992.
Agriculture has been one of the toughest sectors to negotiate in a free trade deal between two countries, especially because of intense opposition from South Korean farmers to market liberalization. South Korea's farm ministry repeated Seoul's position that it would continue to insist on exempting rice under a bilateral free trade deal. ``Rice should be excluded."
South Korea and the United States recently failed to resolve the dispute over U.S. beef imports, which Washington said could threaten the free trade pact.
Exceprt: New York Times 2/21/07

42. Free Trade Agreements Multilateral agreements
When groups of countries negotiate together to reduce barriers
Ex: NAFTA; also negotiations under GATT, WTO
Quick review of NAFTA consequences:
Schaeffer, p. 242; also Stiglitz Ch 3
US:
Slight increase in exports; ,000 added jobs;
140,000 textile jobs lost to Mexico
Canada
Lost 500,000 jobs
Given the size of Canada, this was huge
Canada imports heavily from US; currency devalued.

43. Free Trade Agreements Impact of NAFTA (cont’d) Mexico Other losers?
600,000 new textile jobs; offset by other job losses
Imports from US increase
This was one factor leading up to the crisis in 1994
Other losers?
Organized labor (Unions)
From commanding heights video:
Other winners?
Consumers
Multi-national corporations
Possible long-term increase in efficiency, growth.

44. Problems With Trade Agreements
Rich/powerful countries have numerous advantages in negotiating trade agreements
See: Stiglitz, Chapter 3
Some points to consider:
1. Advantages of Rich/powerful countries are biggest in bi-lateral trade negotiations
Example: US vs. a small Latin American country
US can bully, bring great pressure…
Often, those turn out worse for poor countries than large multilateral agreements.

45. Problems With Trade Agreements
2. Rich/powerful countries disproportionately control the agenda of agreements
“The United States and Europe have perfected the art of arguing for free trade, while simultaneously working for trade agreements that protect themselves against imports from developing countries.” Stiglitz Ch 3 p. 78.
Topics addressed by FTAs benefit rich countries
Ex: focus has been on removing barriers for high-value goods & investment, not farm products or low-tech stuff
And, rich countries are savvy at using dispute resolution procedures
They have lots of lawyers, using technicalities to block imports.

46. Problems With Trade Agreements
3. Government trade negotiators are often influenced by powerful groups
Rather than negotiating for terms that will benefit everyone in a country, negotiators may cater to big corporations
Example: Suppose Guatemala is negotiating over a tariff that limits big business, but protects jobs?
Companies may push the government to get rid of the tariff, even if many workers will be harmed…

47. Stiglitz: Making Trade Fair
Stiglitz, Chapter 3: Recommendations
1. Developing countries should be treated differently from wealthy countries
Previously, most trade agreements focused on equal treatment, but poor countries can’t really compete…
1. A. So, rich countries should simply open their economies to the poorest countries
This would have a much bigger effect than providing direct aid
NOTE: Europe has started moving in this direction
1. B. Poor countries should be allowed to use subsidies to support “infant industries”
Rich countries have little to lose… but benefits are big.

48. Stiglitz: Recommendations:
2. Rich countries should stop MASSIVE agricultural subsidies
Rich countries give huge amounts of money to (mainly) industrial farms
Norway: two-thirds of farm income is from subsidies
EU spends 80 billion US$; US spends
Consequences:
Farmers in rich countries can sell food at LOW prices and still make a profit
Often below the cost of farmers in poor countries
Farmers in poor countries can’t compete… go broke.

49. Stiglitz: Recommendations
3. Escalating tariffs should be ended
Escalating tariffs: taxing manufactured products at higher rates than raw materials
Ex: Having no tariffs on raw agricultural goods, but high tariffs on higher-value processed goods
No tax on apples; high tax on applesauce
Issue: This prevents poor countries from industrializing
They are stuck farming
While rich countries have cheap source of produce for their high-value industries.

50. Stiglitz: Recommendations
4. Remove barriers to unskilled services & migration
Rich countries have pushed to remove barriers for high-tech services (banking, accounting, software)
Barriers remain in low-skill services
Example: Shipping/trucking. Foreign companies aren’t allowed
This is one area that poor countries could actually compete…
Also, allowing more labor flows would provide a huge benefit to poor countries.

51. Stiglitz: Recommendations
5. Restrict the use of non-tariff barriers
There are legitimate reasons for having them…
BUT, more often they are used by rich countries to protect their own markets
Despite claims of supporting free trade
6. Restrict bi-lateral agreements
They are rarely advantageous to poor countries
Due to asymmetry in power between negotiators
And, they tend to undermine multilateral agreements

52. Stiglitz: Recommendations
7. Reform governance
Change the rules of organizations like the WTO
Issues (p. 97):
How decisions get made
What gets put on the agenda
How disagreements are resolved
How rules are enforced
Currently, rules sometimes favor rich countries
System should be more open/transparent, more democratic, with better enforcement for small countries.