GROWTH IN THE OPEN ECONOMY

Transcription

1 Chapter 11 GROWTH IN THE OPEN ECONOMY Modified for EC 375 by Bob Murphy

2 Growth and the Open Economy Three Main Ques.ons: How does openness affect growth? What are the channels by which this occurs? Why do some people oppose openness? But before answering these ques.ons, need to define openness and describe how it has increased in recent years. 2

3 Autarky versus Openness Globaliza.on is a process elimina.ng economic relevance of na.onal borders: Autarky- - closed to world. Trade in goods and services. Flow of factors of producaon. Measuring openness: Value of trade and factor flows- - but could be open and sall have low flow if no incenave to trade. Law of one price- - the closer prices are across countries, the more integrated are the markets. 3

4 Measuring Output in an Open Economy GDP: sum of all income earned by factors of produc.on located in a given country. GNP: sum of all income earned by factors of produc.on owned by residents of a given country. Flows of factors across borders will lead to differences between GDP and GNP. GNP- GDP = Net Factor Income Can be large for some countries. 4

5 Globalization: The Facts Globaliza.on is not new: First period of globalizaaon was from mid- 19th century to witnessed a reducaon in global integraaon. Since 1950 have seen a return to earlier level of globalizaaon (and surpassing it in some cases). Trade (world exports/world GDP) only reaches previous peak in 1960s. 5

6 Figure 11.1 Growth of World Trade, Sources: Maddison (2001), World Bank (2007a). 6

7 Globalization: The Facts Flows of physical capital have only recently returned to levels of earlier period. Britain accounted for 50% of cross- border investment across in the two decades prior to WWI, serving as bankers to the world. In 1911 alone, it invested over half of savings, represenang almost 9% of GDP. Between 1870 and 1910, foreigners financed almost 40% of investment in Canada. Half of the physical capital in ArgenAna and 20% in Australia was owned by foreigners on the eve of WWI. In 2010, China, Japan, and Germany were the largest capital exporters, while the United States was the largest capital importer. Private capital flows to developing countries have risen from $92 billion in late 1990s to $659 billion in But these were more than matched by government accumulaaon of foreign exchange reserves, so net capital actually flowed out of these countries. 7

8 Globalization: The Facts ImmigraAon flows among countries have not reached the level of integraaon seen in the earlier period. From about 100 million people changed countries- - 10% of the world s populaaon in About 50 million lec Europe for Americas and Australia. End of colonialism, rise of naaonalism, and poliacal changes in receiving countries reduced flows in post- WWII period. U.S. is only one of the receiving countries of the earlier period to have immigraaon near the earlier rate- - in % of populaaon was foreign born, in %. 8

9 Globalization: The Causes Technological Advances: Transport costs decline making it cheaper to ship goods abroad- - RR, steamship, canals. Costs of informaaon transmission decline allowing easier coordinaaon of economic acavity over long distances- - telegraph and telephone. Changes in Economic Policies: Trade policy- - GATT/WTO lead to sharp reducaons in tariffs and other barriers to trade. 9

10 Effect of Openness on Growth Measure Openness Using Several Criteria Sachs- Warner (1995) measure which includes tariff level, manipulaaon of exchange rate, government monopolies over exports. Look at relaaonship to GDP per capita. But quesaon of causality- - perhaps rich can afford to be open or maybe a third factor drives both. 10

11 Figure 11.2 Relationship between Economic Openness and GDP per Capita Sources: Sachs and Warner (1995), Wacziarg and Welch (2008). 11

12 Effect of Openness on Growth Three Approaches: Openness on growth across countries. Openness on growth in a given country over Ame. Geographic factors and growth- - ahempt to control for endogeneity of policy. 12

13 Effect of Openness on Growth Growth in Open versus Closed Economies Use Sachs- Warner measure to form two groups (closed for some or all years versus open for all years). Look at relaaonship to iniaal GDP per capita. Average growth 1.5% in closed group versus 3.1% in open group. Evidence of convergence in open group but not closed group. 13

14 Figure 11.3 Growth in Closed Economies Sources: Sachs and Warner (1995), Wacziarg and Welch (2008), Heston et al. (2011). 14

15 Figure 11.4 Growth in Open Economies Sources: Sachs and Warner (1995), Wacziarg and Welch (2008), Heston et al. (2011). 15

16 Effect of Openness on Growth Changes in Openness and Growth: Japan in 1858 opens up and trade rises by 70 Ames over next 12 years, with real income up 65% over next two decades. South Korea liberalizes in and income doubles in next 11 years. Uganda and Vietnam grow rapidly in 1990s following integraaon into world economy embargo in U.S. leads to prolonged downturn. Smoot- Hawley Tariff of 1930s- - Great Depression. 16

17 Effect of Openness on Growth Geographical Barriers and Trade: Frankel and Romer (1995) use geographically determined trade to get at effect of trade on growth. First look at how much trade one would expect given geography. Use this geographically- determined level of trade to explain income per capita. Find that raising raao of trade to GDP by one percentage point would increase income by between 0.5 and 2.0 percent. 17

18 Effect of Openness on Growth Geographical Barriers and Trade: Feyrer looked at situaaons where barriers do change to get look at how changes in openness affect growth Suez Canal closed from : Significant reducaon in trade volumes for countries that had their effecave trade distances increased. Drop in cost of air freight relaave to cost of shipping by sea- - fell by factor of 10 from 1955 to Look at country pairs and measure drop in effecave distance. Finds increase in trade volume for country pairs where effecave distance fell as a result of the decline in the cost of air freight. 18

19 How Does Openness Make a Country Richer? Openness and Factor Accumula.on Factor accumulaaon might be enhanced by openness as capital can flow across borders. Adapt Solow growth model to include capital mobility. Assume that law of one price holds so that rental rate on capital is same everywhere. Also assume country is small so that it has no effect on prices of factors in the rest of the world. Ignore human capital to simplify model. 19

20 Solow Model With Capital Mobility Growth with Capital Mobility: y = Ak α MPK = αak 1 α r = MPK = αak 1 α r = r w r w = αak 1 α Solve for k to obtain: k = αa r w 1/1 α 20

21 Solow Model With Capital Mobility Plug into production function to obtain: α /1 α α y = Ak α = A 1/1 α r w Investment is driven by A but unrelated to saving rate, since saving need not equal investment in the open economy. Implies that there will be a difference in GDP versus GNP for a country. But is this true in the real world? 21

22 Figure 11.5 Saving and Investment Rates of Industrialized Countries, Sources: Feldstein and Horioka (1980). 22

23 Solow Model with Capital Mobility Test for Capital Mobility: Measure the saving retenaon coefficient cross- country data for industrialized countries gives coefficient of Conclusion is that capital is not very mobile. More recent analysis shows coefficient has fallen to around 0.6 for , indicaang some increase in capital mobility. ImplicaAon is that physical capital may not be highly mobile internaaonally, and FDI data indicate that poor countries may be even less open than rich. 23

24 How Does Openness Make a Country Richer? Openness and Produc.vity: Trade as a form of technology. ComparaAve advantage allows trade to act as a form of technology. Endowments of natural resources, relaave abundance of factors of producaon, specializaaon. Openness and technological progress. Import technologies directly. Increased incenaves for creaaon of new technologies. Openness and efficiency. CompeAAon from abroad leads to greater efficiency. 24

25 Table 11.1 Prices in Japan before and after Opening to Trade 25

26 Figure 11.6 Quality of U.S.- and Japanese-made Automobiles Source: Are Today s Cars More Reliable? Consumer Reports 66(4) (April 2001), p

27 Opposition to Openness Being open makes a country richer, so why do people ouen oppose it? Trade is like technology: On average country benefits, but not necessarily every person or industry. Benefits dispersed but costs are concentrated: Sugar quotas raise price to twice world level, but only cost $7 per year per person. Luggage industry tariff in 1990 protected 226 jobs at cost to consumers of $211 million or $934,000 per job! DifferenAal effects on returns to factors of producaon: When a country opens up to trade, factors that were trade lose and abundant factors gain. scarce before 27

28 Opposition to Openness Globaliza.on and Developing Countries: ExploitaAon of workers: OpportuniAes elsewhere are inferior. Inability of poor countries to compete: Exchange vs. compeaaons, adjustment assistance. Environmental exploitaaon: LocaAon of polluang industries, demand for goods produced with negaave externaliaes. Loss of naaonal sovereignty: Race to the bohom in regulaaons, less ability to tax capital compared to labor leads to greater income inequality. 28

29 Globalization and Openness Globaliza.on and Developing Countries: Hidden price of foreign capital: Short- term capital flees quickly in crisis, access to borrowing allows countries to run up large naaonal debts. Hypocrisy on part of rich countries: ProtecAonism in rich countries is not a good reason for poor countries to also adopt restricaons. 29