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Week 1

LECTURE NOTES/RECITATION QUESTIONS/W ANSWERS for DISCUSSION

1. What is globalization? It is the result of the increased economic integration of nationsthat follows the opening of nations to trade in goods, services, financial assets and - to a

lesser extent - labor.

2. What are the driving forces underlying globalization? Declining transportation costs,innovations in communication technology, liberalization policies of national governmentsand well-established international "rules of the game" such as those established by theBretton Woods Agreement (signed July, 1944 in Bretton Woods New Hampshire) in thepost WW II period.

3. What are the benefits of a nation's economic integration into a global trading system?Increased opportunities to trade, increased access to technology and to new markets,improved efficiency and hence productivity, better health of its citizens, and participationin an active, global, civil society.

4. How are these benefits achieved? Through intensified competition, which leadsinefficient industries to either innovate or exit the market, thereby freeing scarceresources for allocation to more efficient industries. On a national scale, this processleads competitive firms to use a nation's relatively cheap, abundant resources intensively(e.g., China's labor supply, which leads to labor-intensive production, vs. America'sabundant supply of technology, which leads to skill-intensive production methods). As anation's industries specialize in the production of output that uses its abundant resourcesintensively, it exports those goods to its trading partners and imports goods, which it nolonger produces efficiently.

This market dynamic generates increased joint output (more goods, services, etc.), for

the global economy, than could have been achieved if each nation had continued toproduce output that is more efficiently produced by its trading partners.

The 19th century classical political economist David Ricardo described this globalmarket dynamic as the "law of comparative advantage." In essence, Ricardo's seminalinsight was that international trade promotes greater efficiency and productivity (outputper unit of input, which was labor at that point in history) of a nation's industries if theindustry specializes in the production of output, which is less costly to produce, relativeto its trading partners.

5. What are the detriments of globalization? As industries and even entire sectors of aneconomy fail to remain competitive, they contract and possibly even fail, leading to

significant job losses and declining incomes of newly unemployed workers. Thefundamental policy choice of every nation that opens its economy to international trade,then, is whether the increased global output that results from increased economicopenness outweighs the costs of lost jobs, lost skill sets, and uprooted individuals andfamilies. This is an empirical question and cannot be answered a priori. The point, here,is that international trade creates winners and losers.

6. Is globalization inevitable? Is it irreversible? As history has demonstrated (e.g., theend of the first wave of globalization in 1914), the process of increased economic

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openness of national economies may be reversed as a result of the decline of a nation sGDP, exports or protectionist/isolationist policies.

7. Identify some of the major challenges confronting the international trading system.Among the major challenges facing the international trading system today aremaintaining cooperation, and avoiding destructive "tit-for-tat" behavior by the system's

many participants; establishing and enforcing international standards for fair laborpractices and establishing standards that promote environmental quality.

8. How does an international trading system create "winners and losers"? Why shouldgovernments care? The inherent dynamic of market competition, in Josef Schumpeter'sfamous words, is one of "creative destruction." Perfect competition rewards firms thatpursue innovation, specialization, increased productivity and thereby achieve cost-savings and improved quality of production. Firms unable to achieve these objectivesfail and exit the market. As a result of this dynamic, income is re-distributed and hencecreates "winners and losers." Economists, (as practitioners of theories embodying the

central ethical, political and economic tenets of 18th century Liberalism), cherish thislogic and its outcomes. Government policy-makers, by contrast, seeking to promote thepower of their states and or the welfare of their citizens (as embodiments of the centraltenets of Mercantilism), want to resist it. Governments in countries (both low- and high -income) with struggling industries and low GDP growth rates seek to mitigate the costsof intensified international competition to protect economically significant domesticindustries and their owners and workers.

9. In what ways is protectionism similar to the logic and outcome of the famous"Prisoners' Dilemma"? Like the zero-sum outcome of this game when two prisoners,exercising rational self-interest, "rat" on each other, and as a result, both end up in jail,

two trading nations, pursuing rational self-interest through the imposition of tradebarriers, end up reducing national and global income, which is equally self-defeating. Inother words, while protectionism appears rational from the individual nation's short-termperspective, when pursued collectively by all trading nations, it is terribly destructive inthe long-term.