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Universiteit Leiden: Aantekeningen Trade and Finance in the Global Economy
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Collegeaantekeningen voor het vak Trade and Finance in the Global Economy voor Rechtsgeleerdheid aan de Universiteit Leiden.
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Notes on Trade and Finance inthe Global Economy
Week I:
Video I: Globalisation
Globalisation is often defined in terms of culture, environment, politics and technology. For
this course, emphasis is placed on trade, production and finance: the economical
interdependencies of countries.
This economic integration across borders is driven by three developments: advances in
technology, establishment of institutions that promote cross-border trade, and domestic
policies like opening markets and freeing capital flows as argued by Wolf.
Baldwin argues that if there are high trade costs, high communication costs, and high face-to-
face costs, production and consumption will take place in close vicinity to each other. As
these costs fall, trade increases. Production can be located elsewhere as well, which allows
firms that do so to integrate into the global value chain.
Economies are more integrated, but mainly concentrated around a few locations, being mostly
between NA and EU, and between EU and East Asia. Trade within these areas also increases.
Video II: Benefits of trade
1
,Trade is done to obtain something that one does not have or cannot productive (but still want
or need), or to obtain something cheaper elsewhere than one can make it itself.
The graph above shows that demand in both countries are equal, and that Vietnamese
companies are able to produce a given good at a cheaper price, which is shown by the lower
p-value (pV as opposed to pJ). If they are allowed to export these goods, they will receive a
higher price, which is shown by pH. Here, the law of one price kicks in: if markets are joined,
the price will be equal everywhere, unrelated to the location of the buyer. Additionally, the
following effects occur as result of a rising price:
o Consumption within Vietnam drops.
o Production by Vietnamese companies increases.
The difference between a lower consumption and a higher production can be exported, which
shown by the gap notated as EV. These exported goods are then consumed in Japan; the
amount of which is shown by the gap between a higher supply and higher consumption in
Japan, displayed by ZJ. This occurs due to the lower price on the global market.
Due to the changing price, welfare effects occur. Vietnamese producers will benefit as result
of a higher quantity of goods sold at a higher price. Contrary, Vietnamese consumers are
harmed as they experience a higher price and as the quantity demanded decreases. The gain of
producers however exceeds the loss of consumers, and hence a net welfare increase occurs
for Vietnam, shown by the triangle under EV.
In Japan, producers will be harmed as result of the dropping price, whilst consumers will
benefit due to an increase in demand and the lower price. There will also be a net gain for
Japan, displayed by the triangle above ZJ.
Concluding, trading leads to benefits for both the exporter and the importer. Trade thus
leads to an increase in welfare. However, imports will need to be paid for, which requires
exports of other goods.
2
,Week II:
Video I: Comparative Advantage argument by Ricardo
Adam Smith argued that the division of labour and exchange is economically beneficial, and
allows for higher income. He saw import not as a loss as seen by mercantilism, the dominant
paradigm in his time, as it frees resources, which can be put to better use. Consequently, an
additional argument for international trade was born besides the unavailability of products:
the absolute cost advantages.
Comparative advantage also presents itself as an argument for international trade. Even if a
given country produces a product more than another country, it should still opt to specialise in
another product as the trading country can produce this given good against fewer opportunity
costs.
Due to trade, the possibilities of production and consumption can be heighted. Thus, a
Pareto-improvement occurs: more of a given good can be obtained without having to
sacrifice another good.
3
,Video II: Comparative Advantage with diminishing returns
Ricardo’s argument is based on the following assumptions:
o Constant returns.
o Labour as the only factor of production.
o Countries use different techniques to produce a given good.
o The non-existence of transport or other costs.
The assumption of constant returns can be dropped as there are diminishing returns: the
costs to produce a given good increase per good produced. Consequently, the line of
production possibilities turns into a curve as opposed to a straight line. This has the following
consequences:
o Neither country completely specialises in the production of a given good. Complete
specialisation is an outgrowth of constant opportunity costs, but since they do not
hold, complete specialisation will be unlikely to be seen.
o Thus: part of the gains of specialisation are nullified as countries move towards less
efficient production.
In the standard model, the exports of one country are matched by the imports of another
country. Reinert uses the model of demand diagonals that assume a fixed, constant relation
between the consumption of both products (which is an assumption of the preferences of
consumers). The higher up this demand curve, the more of both products one will have. These
demand diagonals are crossed with the production possibility curves.
In the figure hereabove, trade occurs between Vietnam and Japan. At point A, consumption is
maximised given the production possibilities. The line crossing this point reflects the relative
prices. Due to differences in opportunity costs, both countries move towards point B. Here,
the price ratio between countries is identical: it is no more profitable to further specialise.
Consequently, countries move alongside the demand diagonals to get to point C as to increase
their consumption (everything above point A shows the increase in welfare).
4
, Critique: Reinert assumes consumers’ preferences (marked by point C), whilst the lecturer
allows for different preferences, reflected by any point in the area above point A.
Video III: Comparative Advantage Heckscher
Ricardo’s assumption of different techniques used per country (that allow for a comparative
(dis)advantage) can also be contested. Heckscher and Ohlin argue that difference in
technology does not matter for countries, but it does for sectors. These are labour intensive
sectors vs. capital intensive sectors being the two different factors of productions.
The costs of these production resources (being labour, capital) is based on their availability,
which results in different factor prices (being wages, or rent). Par example, a labour abundant
country will likely have low wages as result of its high supply. This affects the costs of
production, and thus a comparative (dis)advantage is still present.
Production possibility curves can change by policy, par example if the supply of labour
changes through migration (lower labour costs) or foreign investment (more capital
resources).
Heckscher and Ohlin assume trade between a relatively labour abundant country that makes a
product (like food) which is labour intensive, and a relatively capital abundant country that
makes another product (ex. clothing) that is capital intensive: polar opposites.
Because of trade, the demand of food in the first country increases, and as of such the prices
for food rise as well. There will also go more labour and capital into food, so workers will
benefit (higher wages), but capital owner will lose (lower rents).
In the other country there will be lower prices for food as result of trade with a more efficient
producing country, and higher prices for clothing due to increased demand. Here, it is shown
that not everyone benefits from trading, as workers in this country lose (due to lower
wages) and capital owners gain (higher rents due to increased export).
Concluding, countries that are different initiate in trading. Ricardo argues that this is on the
basis of different technologies, whilst Heckscher and Ohlin argue that this is because of
different compositions of resources.
5
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