Trade and Globalization

Trends and Consequences

I. A Brief History of the World Economic System

A. Trade Before the World Trade System

1. Trade routes for all recorded history2. Evolution about 1000 years ago:

financial houses to underwrite trade expeditions, reliable permanent markets, etc (China and Italy)

3. About 500 years ago: Western Europe develops global reach (beginning of political-economic exploitation)

B. Origins of Per-Capita Growth

C. The World System to 1914

1. 16th-18th Centuries: a. Mercantilism (increase

capital/bullion through trade surpluses) – Trade at the point of a gun; exclusive deals

b. Problems: Uncontrolled inflation, deflation, and “Dutch disease,” emphasis on relative gains instead of absolute gains

2. 19th Century Trade

a. Emergence of modern banking (stockholders instead of families)

b. Emergence of modern paper currency (backed by silver/gold for public confidence)

c. 1846: Britain pushes for “free trade” – i.e. no tariffs. Unilaterally repeals “Corn Laws” 1860 British-French Treaty of Commerce

d. Interdependence "International finance has become so interdependent and so interwoven with trade and industry that ... political and military power can in reality do nothing.... These little recognized facts, mainly the outcome of purely modern conditions (rapidity of communication creating a greater complexity and delicacy of the credit system), have rendered the problems of modern international politics profoundly and essentially different from the ancient."

-- Norman Angell, 1910

Interdependence?Exports as % of GDP

1913: 13%1992: 14%

FDI as % of GDP1914: 11%1993: 11%

British-German trade was high before WW I

Lloyd’s insured Germany’s ships!

D. The Interwar Years1. Allied Debt to US, German Debt to Allies2. Return to Gold Standard (Example of an

international regime)a. Reason: early approach to the time inconsistency

problemb. US leads with easy domestic credit, allows UK to build

up trade surplus (gold reserves) UK and others begin adoption 1925

c. Key weakness of system: Gold adopted by core countries and others hold reserves of both gold and core currencies (designed to avoid gold price shock)i. Implication: World economic growth increases

demand for core currencies loss of competitiveness

ii. Implication: Non-core dependent on monetary policies of core

3. Reparations and the Credit Crunch

a. The 1920s:i. US invests/lends to Germany and Alliesii. Germany pays Alliesiii. Allies repay US

b. The Crunch:i. Late 1920s: US stock market boom

reduces willingness to lend/invest in Europe

ii. The Stock Market Crash

US stock market crash leads to business failures and bankruptcies banks find themselves without enough reserves to cover outstanding depositsUS banks call in loans international credit crunch

4. Collapse of the Gold Standarda. Decreased US demand exports

recession elsewhereb. Strong incentive to devalue currency:

devaluation boosts exports, lowers imports stimulates domestic demand

c. Trade deficits undermine gold standard (purchases made “in gold” so deficits drain gold reserves)

d. Prewar stabilization mechanism (borrowing from neighbors’ banks) unavailable due to credit crunch

e. Devaluation and domestic politics

i. Democratic governments more likely to devalue (domestic costs vs. international ones)

ii. Countries with large foreign investments less likely to devalue (would undermine own investments)

f. Cascade: Devaluation by Core States Spilled Over to Non-Core

Years on Gold Standard 1923-39

f. Cascade: Devaluation by Core States Spilled Over to Non-Core

Direct: Britain leaves system in 1931, immediately followed by all countries holding British pound as reserve currencyIndirect: Early-exit states able to moderate economic damage

Collapse of the Gold Standard

5. Collapse of the Trade System

a. “Beggar Thy Neighbor” – As complement to or substitute for devaluation, tariffs are used to shut out imports (US: Smoot-Hawley 1930)

5. Collapse of the Trade System

a. “Beggar Thy Neighbor” – As complement to or substitute for devaluation, tariffs are used to shut out imports (US: Smoot-Hawley 1930)

b. Other countries retaliate with tariffs

c. Trade spirals downward

E. The Rise and Fall of Bretton Woods

1. Goal: Avoid another Great Depression and World War III.

2. INSTITUTIONS:a. Rebuild industry and avoid another credit

crunch: International Bank for Reconstruction and Development

b. Avoid competitive devaluation: US pegs to gold, everyone else pegs to dollars. Stabilization to be provided by International Monetary Fund.

c. Avoid trade wars through the “MFN principle:” General Agreement on Tariffs and Trade

3. Evolution of the financial system

a. Europe and Japan rebuilt: IBRD turns to development of postcolonial states, becomes known as “World Bank” despite being only one agency in Group

b. 1950s-1060s: World Bank Group assumes role of mediating investment and international lending disputes

4. Evolution of the Trade Systema. GATT “Rounds” lower tariffs on manufactured goods trade expansion

b. The World Trade Organization

Created in 1995 by “Uruguay Round” of GATT Talks

Function = Resolve trade disputes, especially over “non-tariff barriers” (NTBs)Mechanism = Trade court with power to permit sanctions

Controversy: Many health, safety, environmental laws can be viewed as NTBs

Sample WTO CasesA government cannot ban a product based on the way it is produced

Child laborEuropean objections to U.S. hormone fed beefU.S. laws requiring shrimp boats to use nets that don’t entangle sea turtlesDolphin-safe tuna

U.S. Clean Air Act required stricter pollution standards for companies without reliable data (i.e. that already required to be collected by US regulations)

A government cannot ban a product based on the dealings of the company

c. The Doha Round: Key Issues

Services: Developed countries want to export services (banking, health, law, etc). Developing countries (except India) resist.Agriculture: Developing countries want end to subsidies. Developed countries resist.Industry (NAMA): Developed countries want further reduction in developing-country tariffs. Developing countries resist.

5. Evolution of the monetary system

a. The decline of the dollar: i. Vietnam + Great Society

Inflation. ii. Inflation + Economic Recovery

Outside America = Dollar overvalued (too easy to acquire dollars speculative attack on the dollar)

b. From fixed to floating exchange rates: The US abandons gold in 1971

II. Hegemons and Regimes

Explanations for the modern global economy (Post-18th Century: Per Capita Growth)

0–100

100200300400500600700800900

1,000%

11th 12th 13th 14th 15th 16thCentury

17th 18th 19th 20th 21st

A. Hegemonic Stability Theory

1. Assumptions: Primarily Economic Theory

a. Depressions Major Warsb. International Economic Cooperation

Prevents Depressions

Assumptionsc. Public Goods Theory:

i. World Economy as “Public Good:” Cannot exclude countries from existing in a prosperous world and stability is non-rivalrous

ii. Problem: World economic stability costs money (currency stability, free trade/lost jobs, military intervention, international law, etc.) – but no one wants to pay since their contributions won’t make a difference!

iii. Free Riding: Enjoying benefits of stable world economy without paying costs

d. Hegemony: When a single state…i. CAN pay the costs of world economic stabilityii. MUST pay those costs or stability won’t be providediii. is WILLING to pay those costs because the benefits

to itself outweigh the costs

e. “Law of Uneven Growth”

2. Evidencea. Free Trade

i. Napoleonic Wars: Challenge to British Hegemony (Continental System) – Consistent

ii. 1815-1840: Increased Protectionism: Corn Laws, etc – Inconsistent

iii. 1840s-1850s: Rise of free trade in Britain -- Consistent

iv. 1860s-1880s: Rise of free trade in Europe, i.e. Cobden-Chevalier Treaty (1860) -- Consistent

v. Free Trade and US Hegemony – Consistent?

AVERAGE AVERAGEUS TARIFF WORLD

YEAR RATE TARIFF-------- --------- ----------1940 36% 40%1946 25% --1950 13% 25%1960 12% 17%1970 10% 13%1975 6% --1984 5% 5%

b. American decline coincides with failure of Bretton Woods monetary system

B. Regime Theory1. Goal: Understand why economic system

didn’t collapse in 1970s2. Argument: Hegemons create regimes, which

persist after hegemony – “Principles, norms, rules, and decision-making procedures around which actor expectations converge in a given issue area”

3. Emphasis on nonstate actors: regimes perpetuate themselves

4. Problem: Regime theory adds little to predictive power

III. Contagion as a Cause of Regionalism and GlobalizationA. Processes of contagion in IR

1. Diffusion: Affinity, Agreements, or Spill-Over

2. Emulation: Modeling or Harmonization3. Opportunism: Altered decision calculus

B. Processes of Economic Contagion1. Diffusion

a. Affinity: Tourism, Remittances, Immigration

b. Alliances and Agreements: Incentive to trade more with allies / MFN countries than enemies

c. Spill-over: Alter economy of one state alter economies of neighbors

In Detail: East Asian CrisisMay – July 1997: “Bahtulism” in Thailand

Thai businesses begin to default on debts; government promises to “buy” the bad loans but reneges; Thai banks begin to go under; fear of recession leads to beliefs that baht will be devaluedAttack on the baht: Foreign speculators exchange baht for dollars, betting they will get more baht for their dollars later.June 19: “We will never devalue the baht.” Repeated June 30.July 2: Devaluation of the baht

July 1997: Devaluation Spreads• Investor fears (similar Investor fears (similar problems in neighbors’ problems in neighbors’ economies) and competitive economies) and competitive pressure (need to devalue pressure (need to devalue to save export industries)to save export industries)

• 22ndnd: Attack on the : Attack on the Philippine peso Philippine peso devaluation on 11devaluation on 11thth • 88thth: Attack on : Attack on Malaysian ringgit Malaysian ringgit devaluation on 14devaluation on 14thth • 1111thth: Attack on : Attack on Indonesian rupiah Indonesian rupiah devaluation August 14devaluation August 14thth • 1414thth: Singaporean : Singaporean dollar devalueddollar devalued

• 2424thth: Currency meltdown.: Currency meltdown.

Devaluation toRecession

• August-September 1997: Fears of recession Actual slowdowns• October: Vietnam, Taiwan devalue Hong Kong stock market crashes global plunge in stock markets (Dow Jones posts biggest single-day loss, trading suspended)• November: South Korean won and Japanese yen depreciate vs. US dollars new round of stock market crashes as investors pull out of South Korea and Japan• Crashes Banks call in loans Failing businesses, unemployment recessions in East Asia

2. Emulation

a. Institutions: Dollarization, Euros, WTO/IMF standards

b. Learning: Copy success stories (avoid socialism, sign on to neoliberalism or developmental state)

3. Opportunism

“Beggar Thy Neighbor” and the Great DepressionFree-Riding“Race to the Bottom”Trading Economics for Politics (Cold War)

C. Problems with Contagion

1. Why some regions rather than others?

2. Modeling, Opportunism or Diffusion?

3. Uncertain regional boundaries4. Few specific predictions

IV. Security Communities as a Cause of RegionalismA. Requirements

1. Expectation of Nonviolence: Trust, Predictability, Knowledge

2. “We-feeling”3. Shared long-term interests Reciprocity4. Security Communities Institutions, not

the other way around

B. Emergence

1. Democratic Peace? No democracy vs. democracy wars expectation of peaceful interaction

2. Interdependence? Creates common interests incentives for reciprocity

3. Regime stability? Creates predictability

4. Interaction? Creates “we-feeling”?

C. Assumption: Expectation of Cooperation

1. Promotes Absolute-Gains Concerns Over Relative-Gains Concerns

Why is this so important?

2. Absolute gains concerns = incentive to trade

Question becomes: Is this profitable for me? Rather than:

Is this more profitable for me than it is for you?

a. Absolute Advantage USA

Colombia

MissilesOR

20 5

Coffee 10 200

Given 100 resources, what can each country produce?

•Production possibilities without trade

•Trade Specialization. Coffee < 10 resources, Missiles < 20 resources

•Example: Coffee = 2, Missiles = 10.

US trades 5 missiles (50 resources) for 25 coffee (50 resources)

•Result: Both sides achieve levels of consumption outside of the original production possibilities!

200

20

Missiles

Coffee

10

10010

b. Comparative Advantage

USABritai

n

Wheat 100 20

Cars 10 5Given 100 resources, what can each country produce?

•US has absolute advantage in both goods!

•US has comparative advantage in…

•5:1 wheat, 2:1 cars wheat

•UK has comparative advantage in

•1:2 rather than 1:5 cars

•UK buys wheat at <5 resources, US buys cars at <10 resources

•Example: Wheat = 2, Cars = 8.

US sells 12 wheat (24 resources), buys 3 cars (24 resources)

50

10

100Wheat

Cars5

C. Evidence: Regional Economic Organizations and Cooperation

1. ASEAN: Only minimal political conflict

2. European Union: No war since WW II

3. US FTAs: Trade Policy or Security Policy?Year Country % US Exp % US Imp

1985 Israel 1 1

1989 Canada 23 18

1994 Mexico (NAFTA) + 14 + 12

2001 Jordan trivial trivial

2003 Chile < 1 < 1

2003 Singapore 2 1

2004 Morocco trivial trivial

2005 Australia 2 1

2006 Central America (DR-CAFTA)

2 1

2006 Bahrain trivial trivial

2007? South Korea, Colombia, Peru, Panama

varies varies

E. Problems with Security Communities

1. Causality not established2. Eurocentric: projects other

regions will follow path of Europe3. 19th-Century European Peace:

security community was absent4. Parsimony: The “Liberal Peace”

thesis (democracy/trade/IOs peace) explains war better, and peace trade

V. A final challenge to liberalism and globalization: commerce and coalitions

A. Heckscher-Ohlin Theorem: Relative factor abundance determines production. 1. Prediction: Countries with abundant labor

export labor-intensive goods, countries with abundant capital export capital-intensive goods

2. Expansion by Stolper-Samuelson theorem: Price rise in factor-intensive good increases price of factor

3. Implication: Tariff on capital-intensive goods raises price of capital relative to wages, Tariff on labor-intensive good raises wages relative to capital

B. Extending the factors

1. Capital: Banks and investors2. Labor: Workers3. Land: Farmers4. Free trade generally helps

industries using relatively abundant factors, hurts industries using relatively scarce factors

C. Predictions1. Obvious: Relative strength of

organized interest groups representing each factor determines trade policy

2. Less obvious: Trade policy selectively weakens or strengthens factors, altering domestic political balance!

3. Some evidence supports model, but most propositions too vague to test (real production uses all three factors)