International Economics & International Economic Organizations 2022-2023
1. Introduction: Global Public Goods (GPGs) and the Balance of Payments (BoP)
1. International Economics: a ‘global public goods’ approach:
Public Goods:
• Two basic characteristics of a pure public good:
1) Non-exclusion: people cannot be excluded from using this good once it is
produced.
2) Non-rivalry in consumption: all people can enjoy the good: one person’s
consumption does not reduce the ability of another person to enjoy the good.
Some goods diminish when someone consumes it, leaving less for others (like
food), this is not the case with pure public goods.
• Private goods/private market-produced goods (produced by the market mechanism):
to enjoy it you must pay for it often means that it is no longer available for others
to enjoy: because if you pay for the good, it is no longer available for others to use.
Quasi-Public Goods:
• In practice: very few public goods are pure public goods (do not possess both
characteristics), instead there are a lot of:
- Quasi-public goods: goods with some characteristics of pure public goods.
- Joint products: produced by the market mechanism but have some public
characteristics (public transport is not 100% pure public good).
Public goods cannot reliably be produced by the market mechanism
therefore the government has to intervene.
Free-rider problem: the basic problem of public goods
• Free-riding causes underprovision of public goods: Everyone has access to public
goods because they cannot be excluded from its consumption, therefore people do
not want to contribute to the public goods while still enjoying the benefits. This
creates the free-rider problem: due to the lack of contribution by some, the producer
of the public good cannot be sufficiently compensated, creating an underprovision of
the public good if it is not subsidized in some other way. To overcome underprovision
due to free-riding, the government produces it or regulates the market. The
government funds this through taxes.
• Overcoming underprovision by ‘rules’ & ‘institutions’: Due to globalization, public
goods have become Global Public Goods. Because of the cross-border transactions,
you need international agreements, institutions, and rules to resolve underprovision.
Global Public Goods: Application to global context
• Global Public Goods (GPGs): GPGs are public goods that transcend national
boundaries of a state, making these public goods global aka Global Public Goods. An
international action is required to provide the GPGs.
GPG = clean air, which transcends national borders (global public bad = pollution)
• Real world examples of GPGs:
- Rules on Trade: the WTO creates global rules on trade, making them available to
everyone and non-rivalrous.
- International financial stability: the IMF and WB’s mission statements promotes
international financial stability, which is non-excludable and non-rivalrous.
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Different technologies of provision production:
• GPGs are not all made the exact same way. There are 3 different technologies:
1) Summation: the total is a sum of the individual. The sum of the aggregate is what
we all do collectively. If one person does more, the sum of the aggregate is
higher. What you do is important, and the more you, do the better the results.
Everyone must pitch in to achieve the best result.
2) Weakest link: you are only as strong as your weakest link. The effect of
everyone’s contributions on the aggregate is not the sum of what we all do
together but only that of the smallest contribution.
If there is a convoy of ships that need protection, but one ship reduced its
speed due to engine problems, the weakest-link public good concept
suggests that protection can only be provided if all other ships in the
convoy similarly reduced their speed. So, the convoy becomes only as
strong as its weakest link (or ship).
3) Best shot: the aggregate effect is determined by the effort of the strongest. It is
much better to focus on the one with the highest contribution. For some policies
we need to direct our resources to the one with the highest contribution/the
highest chance/biggest capacity because resources are not infinite.
Vaccine production = focusing resources on the one with the most probable
success instead of giving every vaccine producer a bit of your resources
because this has a much higher chance of wasting a lot of your resources.
2. Concept of the Balance of Payments:
• Balance of Payments (BoP): the (annual) BoP of a country reflects all the cross-
border transactions of goods, services, income and financial assets between domestic
households, businesses, and government of a country and residents of the rest of the
world in monetary terms. So, the BoP is the sum of all cross-border transactions for a
particular period (not domestic transactions).
- Important indicator of an economy’s health as it looks at an economy’s
transactions with the rest of the globe.
Composition of BoP:
• BoP has three parts:
1) Current account: tracks flow of goods and services into and out of the country
2) Capital account: a record of transfers for nonfinancial assets and non-produced
assets, such as land or a mine used for diamond extraction. (Smallest account)
3) Financial account: record of financial cross-border transactions related to foreign
investment, real estate, bonds and stocks, international bank lending, and
government-owned assets (foreign reserves, gold, Special Drawing Rights (SDRs)
at the IMF), private assets abroad, and direct foreign investment.
• The current account measures goods and services and the capital and financial
accounts measure financial flows.
• BoP ‘identity’: current account + capital account (and financial account) = 0.
- Theoretically, the BoP should total zero, thus the assets (credits) and liabilities
(debits) should balance. This means that the current account should be balanced
against the combined capital and financial accounts, totaling zero. However, in
practice, this is rarely the case.
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- BoP tells the observer of a country if the country has a deficit or a surplus and
from which part of the economy the discrepancies come from.
• Account openness: a country is allowing cross-border transactions with other
countries. Closed means a country is not allowing cross-border transactions.
(Im)balances
• BoP must balance = sum must be zero: a surplus or deficit of the total BoP cannot
exist!! The current account should be balanced against the combined capital and
financial accounts to then equal zero. This is measured through:
• The system of double entry-bookkeeping:
- One entry explains the ‘nature’ of the transaction.
- Another one indicates the payment in foreign exchange and whether the money
goes into the country or goes out of the country (forex inflow or outflow).
All cross-border transactions are typically in foreign exchange (US Dollars or
Euros) because the currency of developing countries is not credit-worthy
enough for cross-border transactions.
• General rule in double-entry booking:
- Under this system, a transaction is represented in the BoP by two entries with
equal value but a different sign: either a credit (+) or a debit (-).
Credit (+): exports, income and transfers from abroad, increase in external
liabilities, and decrease in external assets.
Debit (-): imports, income and transfers to abroad, decrease in external
liabilities, and increase in external assets.
- Forex outflow and forex inflow:
Import causes foreign exchange outflow - (forex outflow), so forex outflow
itself is + in the BoP.
The country is losing foreign exchange (-) because it gains goods and
services due to import (+): so foreign exchange outflow itself is +
because there is an increase of foreign liabilities due to the decrease of
foreign assets, which was used to pay for the import.
Export causes foreign exchange inflow + (forex inflow), so forex inflow
itself is - in the BoP.
The country is gaining foreign exchange (+) because loses goods and
services due to export (-) so, forex inflow itself is - because there is a
decrease in foreign liabilities due to the increase of foreign assets.
Export transaction: Tanzania is exporting coffee (+), so USD comes into the
country (–) to pay for the export. Nature of the transaction and the incoming
payment of USD.
• Individual BoP components (current, capital, and financial) can be unbalanced
(surpluses/deficits): BUT the total BoP should always be balanced to zero! However,
the zero-sum concept does not hold up 100% as errors occur in practice, so a fourth
balancing item ‘errors and omissions’ has been added to the BOP to make it balance
in practice but theoretically it should always balance:
Registrations of forex inflow and outflow are being done by different agencies, so
small differences in amounts occur. The bigger the error, the more it says about the
quality of the system and the occurrence of informal transactions.
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I travel to Tanzania with a suitcase of dollars, which isn’t registered. I spent my
dollars in Tanzania, so the dollars end up registered at the bank of Tanzania. So,
Tanzania ends up registering more dollars. This suitcase will thus cause the
BoP to not balance due to human error, so errors and omissions exists.
• A trade balance is the difference between a country’s exports and imports of goods,
which can have surpluses or deficits.
When a country exports more goods than it is importing, a surplus occurs. When
a country imports more than it is exporting, a deficit occurs. The country is thus
not making enough from their exports to pay for their imports. The country
covers this by using its foreign reserves (foreign assets) from the past, specifically
there for trade balance deficits like this. If a country does not have foreign
reserve assets, it can only import as it exports.
Example of system:
Number 11: Change in reserve assets:
Reserve assets are financial capital held by
monetary authorities to finance trade
imbalances, check the impact of foreign
exchange fluctuations, and address other
issues under the purview of its Central
Bank.
The minus (-) sign means you have
accumulated additional foreign exchange.
Minus (-) is good, plus (+) is bad.
Economic perspective on BoP:
• Concept of overall/global balance:
Sum of current, capital, and financial
account except for number 11. Below the
line is number 11. The overall balance is
then +70 (is a surplus) -70 = 0
• There would be a problem if the overall
balance were a deficit (-) because that
would mean the country is depleting its
reserves.
When do you have a BOP problem?
1) When you have a (structural) overall/global deficit, indicating a loss of foreign
exchange reserves (over the period)
Our example: current account deficit (-250) overcompensated by net
financial account inflows leading to global surplus (+70), and reserve build-
up (-70): no problem.
2) When you do not have substantial foreign exchange reserve holdings to cover
the gap.
• Not necessarily when you have a (major) trade deficit or current account deficit.
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