International Economics (Routledge Revivals)

David Gowland

• Publisher: Routledge
• Year: 2010
• ISBN:
  9781136820540
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Most of the existing textbooks on international economics - a widely taught and ighly popular subject - are long and too detailed and advanced for many students. This book, first published in 1983, and written by a respected leading authority, presents the essentials of the topic in a simple and straightforward way. The book contains the minimum of algebra and avoids detailed proofs. It incorporates the most recent theoretical advances and discusses current issues in comercial policy. Moreover, it puts less emphasis than other textbooks on trade theory and more on balance of payments theory and on questions of international finance and international finance anf international monetarism which are the areas of current concern.

1
THE CHANGING WORLD

1.1 International Economics

In international economic text books it is conventional to start by justifying the need for a separate branch of the subject. The reason for doing so is self-evident. The whole of economics should be ‘international’, for example all macroeconomic analysis must take account of overseas factors. In many ways international economics is the natural extension and complement to the other branches of economics. For example, the pure theory of international trade, Chapter 2, is an extension of the elementary analysis of the gains from exchange. Commercial policy, Chapters 3 and 4, is a complement to other analyses of government intervention. Balance of payments theory, Chapters 6 to 10, extends Keynesian and monetarist analysis to an open economy and analyses the exchange rate as another macroeconomic weapon. Chapters 11 to 13, international finance, similarly complement domestic financial economics.

However, to show the value of international economics does not explain why it should be studied as a separate branch of the subject. Hence some economists have tried to find a theoretical rationale for the existence of the subject. For example, it has been suggested that within an economy all the factors of production are (perfectly) mobile but that they are not mobile between economies. From this it is natural to derive a theory of international economics as the study of the relationship between these distinct economies. Unfortunately for this approach, however, factors are not very mobile within an economy and are not immobile between them. Even labour is quite mobile between countries in many cases, e.g. the ‘guest workers’ from Turkey, Portugal and Italy in Germany and Switzerland and between Canada and the USA. Indeed labour is far more mobile between Michigan (in the USA) and Ontario (in Canada) than between Ontario and Vancouver or Michigan and New York.

The justification for a separate and distinct international economics is, therefore, essentially a political one. Nation states, and groupings of them, are of fundamental importance in modern life irrespective of whether different countries do or do not represent distinct economies in any theoretical sense. Thus it is necessary to study the relationships between nations and to analyse them economically because of this underlying political reality. It is equally essential to be aware of the changing nature of the world which is being studied.

1.2 Some Developments

The major change in the world economy since 1950 has been the growing interdependence of economies, especially within the developed world. Underdeveloped countries have tried to reduce their dependence and perhaps thereby contributed to their continued lack of development. This interdependence has both caused and been caused by the very rapid growth of world trade which has risen six-fold since 1950, almost twice as fast as world output (see Table 1.1). The growing interdependence of economies is dramatically revealed in the US’s import ratio which was a mere 3 per cent in 1960 but nearly 11 per cent in 1980 (Table 1.1). In 1980 one new car in every four purchased in the US was an import.

This growing interdependence is in part the result of market forces. These always work to intergrate economies but their effects have been especially prominent since 1950. The most important and dramatic manifestation of market forces is the Eurocurrency market (see Chapter13). This has produced a massive degree of integration of world financial markets and consequent integration of real markets. Real transport costs have fallen substantially, mainly because of Japanese developments in shipbuilding and the ‘container revolution’ they faciliated. Communications have improved dramatically because of the impact of jet planes and electronics. Innovations of all sorts, whether dramatic, like television, or humdrum, like cheaper ships, have made the world in the popular, but accurate, cliché much smaller.

This growth in world trade and increasing interdependence has been encouraged by the movement towards the liberalisation of trade, i.e. the removal of restrictions on imports. This trend in particular has meant that most countries have reduced the discriminatory taxes on imports called tariffs (see p. 28 below). In the US, for example, the average tariff was reduced from over 60 per cent in 1932 to less than 10 per cent in 1970; although this is a very crude measure of the protective effect of tariffs, it reveals the very clear trend. The high tide of protectionism was in the mid-1930s, especially after the UK abandoned free trade in 1932. The sustained trend towards liberalisation began as part of post-war reconstruction programme which also remodelled the international financial system (see p. 163 below). The moves towards trade liberalisation were originally beset with difficulty, for example no nation ratified the Havana Charter (1947) which would have set up an International Trade Organisation, ITO. Such attempts were heavily criticised, e.g. Worswick and Ady (1952), p.31, but within a decade liberalisation had become unchallenged orthodoxy: in the US after Eisenhower’s Reciprocal Trade Act of 1954, in the UK after the Conservative victory in 1951. The formal framework for these developments was provided by the General Agreement on Trade and Tariffs, GATT, established in 1944 with a permanent secretariat (see Dam (1973)). In practice, barriers to trade were reduced by hard bargaining amongst national governments, e.g. in the much-vaunted Kennedy round, which was discussed from 1962–7 before implementation. The trend towards freer trade ended in the later 1970s when quasi-protectionist views became widespread in most countries.

Political developments greatly changed the environment in which world trade took place. In 1946 the British Empire and Commonwealth was still a tightly knit economic bloc comprising a quarter of the world’s population. By 1970 virtually all of this former empire was independent and, while the Commonwealth survived in name, it was of economic significance only in a few areas, notably the link between New Zealand and the UK. Successor states in Africa and Asia were usually protectionist. Less dramatic and slower, but almost equal in impact, was the demise of the French Empire. China became communist in 1949 with a consequent enormous reduction in its external trade. Trade between communist Eastern Europe and the rest of the world was much less important than had been trade with its predecessors.

All of these developments had a major effect upon the pattern of world trade. An ever-increasing proportion of world trade was between members of the developed world rather than between developed and underdeveloped countries. For example, as shown in Table 1.1, only one-third of UK exports in 1951 went to Western Europe and North America, whereas by 1980 two-thirds did. Trade in manufactured goods was also of ever-increasing importance, its growth rate being over twice that of food, raw materials and fuel and amounting to around two-thirds of world trade by 1970. Hence, whereas in 1950 the typical pattern of trade was that of an underdeveloped country exchanging raw materials for the manufactured products of a developed country, by 1970 it was of two developed countries exchanging their manufactured products. These trends were reinforced by the re-emergence of Germany as a major trading power in the 1950s. Its share of exports rose from 10 to 20 per cent of world trade in manufactured goods between 1950 and 1960. Japan also benefited. Its share of world trade rose by 50 per cent in the 1950s (from 4.1 to 6.9 per cent), nearly doubled in the 1960s and rose by over a quarter in the 1970s (see Table 1.1). The UK and USA both lost substantial shares of world trade, between them falling from nearly half of all manufactured trade in 1951 to only a quarter in 1980. This reflected many factors, some external, such as the end of the sterling area (Commonwealth) trading bloc, and some internal, especially an inability to produce cheaper reliable goods as quickly and as well as Japan.

The tendency for world trade to become ever more concentrated as trade in manufactured goods between developed countries was encouraged by the development of the EEC (European Economic Community). The origins of this were in the aftermath of World War II. On the one hand, there was a desire to ensure that France and Germany fought no more wars. On the other, there was a desire to create a strong anti-communist bloc, especially amongst the Christian Democrat politicians who were prominent in Germany, France (MRP), Italy and the Benelux countries. They were inspired by Pope Pius XII’s fervent anti-communism and by Catholic social philosophy to pursue (Western) European unity. Their schemes mixed political unity, military co-operation and economic policy, e.g. in the Western European Union, and sometimes were designed to facilitate co-operation with and sometimes to exclude the USA and UK. After the defeat of the European Defence Community in 1954 and the partial eclipse of the MRP in France after 1951, the schemes became entirely economic. The first major development was the European Coal and Steel Community, ratified in 1952. However, the main changes came after the Treaty of Rome (1957) which established the EEC, or Common Market. This was a customs union (see Chapter 5) linking the six countries of France, Germany, Italy, Belgium, Luxemburg and the Netherlands. Its major achievement was the growth in trade amongst its members which the EEC stimulated both directly, by reducing tariffs, and indirectly, by promoting a favourable climate. However, its major policy was the infamous Common Agricultural Policy, CAP. This was designed to increase farmers’ incomes and to reduce food imports. It utilised very high guaranteed prices and a variety of devices designed to exclude imports (see p. 66 below). The sky-high prices meant that supply of agricultural products exceeded the demand but the EEC bought up the difference and stored it, the famous butter, beef and apple mountains. The policy was enor

Table 1.1: World Trade Patterns 1950–80

mously expensive and seemed bizarre to observers, especially as it harmed relations with the USA, Third World producers of food and other efficient farmers who disliked being excluded from European markets. However, the policy was in line with both continental tradition and Catholic social philosophy. In addition, inefficient farmers were large marginal blocs of votes in France and Germany. The UK, Denmark and Ireland joined the EEC in 1973. The decision to join the EEC was bitterly contested in the UK. Moreover, few UK politicians shared the ideals of the CAP, so there was a long series of quarrels within the enlarged EEC. The EEC was further enlarged when Greece joined in 1982.

The final important change relevant to world trade concerned the oil market. In 1965 oil prices were controlled by a group of Western oil companies, often called the Seven Sisters (Shell, BP and five US companies). They ensured that oil prices were both low and falling. This economic control was reinforced by political muscle, e.g. the Gulf sheikhdoms were still largely ruled by UK political or resident agents supported by the Royal Navy. However, in 1968, the Wilson government withdrew from the Gulf. In 1969, the pro-Western regime was overthrown in Libya and King Feisal replaced his weak brother as King of Saudi Arabia. The oil-producing countries, who had formed an organisation called OPEC (Organisation of Petroleum Exporting Countries) in 1960, were now both willing and able to stand up to the Western governments and oil companies, which they did by blocking a price cut in 1970. In 1972 they forced a small increase in oil prices. The crucial change occurred in 1973 when the price of oil was quadrupled. A further rise followed in 1978. All in all, the price of a barrel of Saudi Arabian crude oil rose from $1.80 in 1970 to $34 in 1980. Energy prices rose 520 per cent in the decade, whereas other prices rose by about 150 per cent (see Table 1.1). In value terms fuel rose from 10 to 16 per cent of world trade, although it fell in volume terms. OPEC countries acquired enormous wealth with major effects on the world financial system. Oil production was stimulated elsewhere, e.g. in the North Sea.

Note

I would like to thank Brian Hillier who read the typescript of this book and made a number of helpful comments. I should also like to thank Janet Russell who helped in various ways, especially with the bibliography.

2
THE PURE THEORY OF INTERNATIONAL TRADE

2.1 Introduction

The purpose of the pure theory of international trade is to show why international trade exists and that it is beneficial. This might seem a redundant exercise, since there is no reason why the normal arguments used in elementary economics to demonstrate the existence of trade (internal or external) should not be applied at the international level. The argument in elementary theory is that trade will occur whenever it is profitable for two or more people to trade. If the price of a good is different in two places then it will pay someone to buy in the cheaper and sell in the dearer market. In addition to such arbitrage transactions, sellers will gravitate to the higher-priced market and buyers to the lower-priced until prices have been equalised. It is, in general, a sufficient condition for the existence of international trade of a good (in the absence of legal prohibitions or barriers) is that its price should be different in different countries. The gain to the participants may be regarded as self-evident or be proved using the familiar tools of welfare economics.

International trade theory, however, has set itself two slightly different and more precise goals:

1. to show that trade is beneficial to the nation as a whole, not just to exporters and importers.

This might be analysed using the ‘market failure’ framework to see whether international trade generates (negative) externalities but has usually been treated as a separate subject (for market failure, see Gowland (1982b), Chapter 8).

2. to show minimum conditions for the existence of trade.

It is easy to think of reasons for the existence of trade, such as different prices, but the theorists seek to show why prices differ and to find as many reasons as possible why they might differ. There are two principal approaches to these problems: the Ricardian and the Hecksher-Ohlin (p. 16), besides the alternative theories reviewed in section 2.9.

2.2 The Ricardian Theory

The Ricardian, or classical, theory of international trade argued that trade would occur and would be beneficial because of comparative advantage. This was simply a way of saying that beneficient trade would occur if marginal opportunity costs differed between countries. Given competitive assumptions, different marginal (opportunity) costs will be reflected in different prices, as it is, of course, a basic prediction of competitive analysis that price equals marginal cost; so the existence of trade is guaranteed. It is desirable because it will produce a potential pareto improvement compared to autarky (no trade), i.e. that more of all goods will be available for consumption so there must be a conceivable distribution of income that will make everyone better off, the definition of a potential pareto gain. This argument is best demonstrated by an example, which abstracts and simplifies by using only two countries and two goods. The two ...

Table of contents

• CONTENTS
• 1 THE CHANGING WORLD
• 2 THE PURE THEORY OF INTERNATIONAL TRADE
• 3 COMMERCIAL POLICY I: TARIFFS AND THE THEORY OF PROTECTION
• 4 COMMERCIAL POLICY II: THE EFFECTS OF PROTECTION
• 5 CUSTOMS UNIONS
• 6 THE TRADITIONAL BALANCE OF PAYMENTS THEORY
• 7 KEYNESIAN BALANCE OF PAYMENTS THEORIES
• 8 THE MONETARY THEORY OF THE BALANCE OF PAYMENTS
• 9 THE FOREIGN EXCHANGE MARKET
• 10 THE EXCHANGE RATE AND ECONOMIC POLICY
• 11 INTERNATIONAL FINANCE
• 12 THE INTERNATIONAL MONETARY SYSTEM
• 13 THE EUROCURRENCY MARKET
• A GUIDE TO FURTHER READING
• BIBLIOGRAPHY
• INDEX