Thus, 179$ doesn t tell much about the economic structure of the trade.

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1 International Trade and Investment Policy 26 th July Lecture 1 Assessment - Midterm 14 th September 3-4pm - Final exam - Problem sets (only 6 will be graded only 5/6 handled in) How does trade look like between countries? What products are traded? How much is traded and for what price? Who is trading What are benefits and costs Which policies affect this? The basics of World Trade Countries buy and sell goods and services from one another constantly. An export is a product sold from one country to another. An import is a product bought by one country from another. They are the same thing in two different countries. Every transaction has two records (as import and export) A country s trade balance is the difference between its total value of exports and its total value of imports (usually including both goods and services à since import and exports include both). Countries that export more than they import, such as China recently, run a trade surplus. Countries that import more than they export, such as the United States, run a trade deficit. The bilateral trade balance is the difference of exports and imports between two countries. Nothing is implied with respect to welfare and utility if a country has a bilateral trade surplus or deficit! à for example, the U.S. bilateral trade balance with China, has been a trade deficit of more than $200 billion every year between 2005 and (i.e. for that amount they import from China more than they export to China) In 2010, the iphone 3GS was valued at about $179 when it was shipped from China (where it was produced) to the United States, and it sold for about $500 in the United States. However, only $6.50 of that amount reflects the value-added by Chinese labour (that puts together the components of the phone) used in the assembly. This is the cost of the wage; the rest is what Apple has to pay for the individual electronic components. This because of the value added concept, as in GDP. It doesn t really make sense to count the entire $179 iphone as a Chinese export to the United States, as is done in official trade statistics. $179 is the gross value of the phone, but we have to subtract the components (that may come from Indonesia, Vietnam etc.) Thus, 179$ doesn t tell much about the economic structure of the trade.

2 Lecture 2 27 th July Gross value v. Value added Although the iphone sold in the United States is assembled in China, most of its value comes from parts made in other countries. Apple Inc. s iphone one of the most iconic U.S. technology products actually added $19 billion to the U.S. trade deficit with China last year. How is this possible? What we call Made in China is indeed assembled in China, but what makes up the commercial value of the product comes from the numerous countries that preceded its assembly in China in the global value chain, Pascal Lamy, the director-general of the World Trade Organization According to Mr. Lamy, if trade statistics were adjusted to reflect the actual value contributed to a product by different countries, the size of the U.S. trade deficit with China $ billion, according to U.S. figures would be cut in half. GVC = global value chains. Some parts of the productions are done in different countries. The value added in different countries is lower because the import value has to be deducted. Thus, for a good, you should know the whole production history, or otherwise the bilateral balance deficit/surplus don t add much to the story. Map of world trade World Trade in Goods, 2010 ($ billions) This figure shows trade in merchandise goods between selected countries and regions of the world. - Relation between China & US => 668$b v. 301$b. - Within EU trade is the largest block because of vicinity of countries (easy transport, no border control, no custom regulations, no tariffs). It is an integrated single market - Europe also imports a lot from Asia (with which it has a bilateral trade deficit, as the US. - Asia has large internal trade - Same for Latin America - Trade agreement between US Canada Mexico (NAFTA). This because of Mexico s cheap labour to assemble goods [again, value added v. gross value because the US usually imports components from third countries and assembles them in Mexico] - Trade agreement between Australia & Japan

3 - US Australia trade agreement è easy thanks to same language: cultural differences can impact trade patterns - Africa has a small amount of trade (with respect to the other countries). There are free trade areas within Africa but they are not as strong as in EU or in other regions; also, the infrastructure is not as developed, i.e. there are less roads, political instability etc. and this diminishes the investment opportunities - EU & Africa => colonial past (France à Algeria). This helps creating trade ties. But these were absolute numbers. What about the relative numbers, i.e. the comparison of all the shares with the total trade in the world? è Australia and New Zealand don t have a large impact in the world s trade è African export is very small with respect to population, but this depends on the income European and U.S. Trade The largest amount of trade is the flow of goods within Europe, $3.9 trillion, or 23%, of world trade! Trade between European countries is high because import tariffs (taxes on international trade) are low (mainly non-existent thanks to the European Market. There are also large trade flows between the United States and Europe. The United States exported $303 billion of goods to Europe and imported $377 billion from Europe. This shows that a large amount of world trade occurs between countries that are similar in their levels of industrialization and great wealth. è There is large trade between countries with same/similar levels of incomes. Trade in the Americas There is also a large amount of trade recorded within the Americas, that is, between North America, Central America, South America, and the Caribbean. Trade within the Americas is about one-third of trade within Europe, and about 8% of world trade. The vast majority of that trade is within the North American Free Trade Area, consisting of Canada, the United States, and Mexico (NAFTA). Trade with Asia Exports from Asia totalled about $5.7 trillion in 2010, or about one-third (34%) of world trade, as shown in Table 1-1. This total includes only trade in goods and omits trade in services, which is becoming increasingly important. India, for example, performs a wide range of services (i.e. accounting, customer support, computer programming, and research and development tasks) for firms in the United States and Europe. Other Regions The exports of the Middle East and Russia combined (together with countries around Russia like Azerbaijan, Kazakhstan, etc.) total $2 trillion, or another 12% of world trade.

4 And then there is Africa. The European nations have the closest trade links with Africa, reflecting both their proximity and the former colonial status of some African countries. Europe exported $99 billion and imported $105 billion from Africa in Remember, the graph was only about goods, without considering the services such as education. However, services trade is becoming very important (many countries GDP, especially the ones with higher incomes, are strongly dependent on trade of services such as financial, engineering, architectural services). This is not observed; it is difficult to access this information, thus difficult to measure. Australia è mainly agricultural exports 1990s è halved the agricultural exports, minerals increased, manufactures stayed the same, gold doubled. The sum of mineral and gold almost doubles (from 21 to 35), services increased by 5% è agricultural almost halved again, while 50% is raw material. (remember => the share per sectors are given by quantity*prices, so if the mineral share increased is because of prices going up, but also because China is demanding steel and coal, and this increase in demand is translating in increase of prices). China sells so much because it can offer same goods for cheaper prices, thus we see Australian manufactures going down.

5 from 1901 Australia s most exported good was wool. Then, it changed from Wheat to Coal and Iron (especially minerals to China). This because relative prices have changed (i.e. price of coal has increased, becoming more attractive to export and more attractive for workers) Australia has diversified the share of the products. the mining industry makes every second dollar of Australian export, being the most important commodity. But in terms of value added (people employed in the sector i.e. Australia s GDP), we can see how the agricultural contribution to GDP went from 20% to 1%; for mining, we see that it stayed steady because of fixed prices of machines; manufactures went down because of China. The majority of value added is given by services! Not from mining and manufacturing. Australia s top 10 goods & services exports (2014) The 4 th is selling education! This includes not only fees but also living expenses of international students. Australia è exports many natural resources (despite being industrial country), despite not having resource curse. It exports a large amount of education.

6 Australia s top 10 goods & services imports (2014) there is a difference in basket of goods/services that are imported/exported to/from Australia, and this has to be beneficial for at least a portion of the population. Trade Compared with GDP (Trade/GDP => share of trade in GDP) So far, we have discussed the value of trade crossing international borders. There is a second way that trade is often reported, as a ratio of trade to a country s gross domestic product (GDP), the value of all final goods produced in a year. For the United States, the average value of imports and exports (for goods and services) expressed relative to GDP was 15% in Most other countries have a higher ratio of trade to GDP. Trade/GDP Ratio in 2015 for a cross-section of countries

7 This table shows the ratio of total trade to GDP for each country, where trade is calculated as (Imports + Exports)/2, including both merchandise goods and services. Countries with the highest ratios of trade to GDP tend to be small in economic size. Small countries have larger shares of trade/gdp (also called openness rate). Being small, less possibilities to produce, more relying on trade. Large countries like Australia, it is easier to produce. Evolution of trade Barriers to Trade The term trade barriers or trade costs refers to all factors that influence the amount of goods and services shipped across international borders. Two broad categories: - natural trade barriers - man-made trade barriers (trade policies, such as quarantines). Man-made trade barriers are actionable, i.e., they can be changed by politicians. Natural trade barriers may also be changed, e.g., Suez Canal

8 This diagram shows total trade in merchandise goods and services for each country divided by GDP. There was a considerable increase in the ratio of trade to GDP between 1890 and This trend was ended by World War I and the Great Depression. Most of the industrial countries shown did not reach the level of trade prevailing in 1913 until the 1970s. First Golden Age of Trade The period from 1890 until World War I ( ) is sometimes referred to as a golden age of international trade. Those years saw dramatic improvements in transportation, such as the steamship and the railroad, that allowed for a great increase in the amount of international trade. Interwar Period Signed into law in June 1930, the Smoot-Hawley Tariff Act raised tariffs to as high as 60% on many categories of imports. These tariffs were applied by the United States to protect farmers and other industries, but they backfired by causing other countries to retaliate. Canada retaliated by applying high tariffs of its own against the United States. France used import quotas, a limitation on the quantity of an imported good allowed into a country, to restrict imports from the United States.

9 This diagram shows the world average tariff for 35 countries. The average tariff fluctuated around 15% from 1860 to After World War I, however, the average tariff rose sharply because of the Smoot-Hawley Tariff Act in the United States and the reaction by other countries, reaching 25% by Since the end of World War II, tariffs have fallen. Second Golden Age of Trade In addition to the end of World War II and tariff reductions under the General Agreement on Tariffs and Trade, improved transportation costs contributed to the growth in trade. The shipping container, invented in 1956, allowed goods to be moved by ship, rail, and truck more cheaply than before. World trade grew steadily after 1950 in dollar terms and as a ratio to GDP. For this reason, the period after 1950 is called the second golden age of trade and globalization. [The world was quite integrated before WWI. During that, trade had fallen until the end of WWII. This because of economic recession and unemployment in all industrialized states. This is followed by increase of trade tariffs (US smooth-hawley acts). Then, there was trade war Everyone wanted to maximise their utilities but everyone was worse off (prisoner s dilemma). After WWII => idea not to repeat the same mistake. They created the GATT to reduce tariffs (predecessor of WTO). 2000s è technological improvements reduced transportation times.] Several factors have influenced the importance of world trade in Australia and in general Which factors are behind the changes in Australia s trade and world trade in general? 1. Higher income (due to population growth and general productivity increases across sectors). This brings to a higher level of trade. Australia has become richer, and since goods consumed are function of income, then also trade scales up. It is a linear relationship. Thus it regards population growth, that somehow replicates the economy. Even if there is no tech improvement, trade will increase. If technology increases as well, productivity will go up and exports will too. 2. Changes in relative prices (mining booms and busts), leading to changes in sectoral composition of trade. Some prices i.e. coal and iron have increased more than other; this will change the composition of trade.

10 3. Reduction in trade costs due to changes in technology è higher importance given to trade remember: trade cost = everything that makes difficult to export/import Introduction of steam ships since 1850s ( City of Adelaide last trip in 1887). Introduction of the telegraph (direct link between North America and Australia in 1903). Before that, was difficult to communicate the desired goods to import/export. This makes trade simpler. Other communication improvements (e.g. interoceanic telephone cable in 1956) Introduction of container trade since the 1950s (17 times faster than break-bulk shipping). This is very relevant è A Sea Change in Shipping 50 Years Ago Fifty years ago Malcom McLean, an entrepreneur from North Carolina, loaded a ship with foot containers and sailed from Newark, N.J., to Houston. A fully loaded container ship can carry thousands of containers. McLean was the first to design a transportation system around the packaging of cargo in huge metal boxes that could be loaded and unloaded by cranes. Replacing break-bulk with cargo containers dramatically reduced shipping costs, reinvigorating markets, and fuelling the world economy. 4. Reduction in trade costs due to changes in trade policy (trade liberalization)èhigher importance of trade Reduction of import tariffs à imports will be cheaper Reduction of non-tariff measures [non-tax] like import quotas (quantitative restrictions on imports), documents needed, etc. So not only payments but also the custom forms to fill up every time the goods pass from a country to another. Electronic forms are more efficient because they are streamlined between the countries (no need to re-fill it everytime). All these factors increased volumes but also importance of trade (in terms of GDP share) è remember: trade includes goods and services, but it is also important to understand how the factors of productions move around the world. With this, we include people (labour) and capital (in the form of FDI), whilst land cannot be traded because of its nature. Migration è PEOPLE = 1 ST FACTOR OF PRODUCTION The figure below shows Foreign-Born Migrants for 2005 (in millions of people) living in selected countries and regions of the world. This means people living in a country in which they are not born in. Remember: migration data is more difficult to access in regions such as EU where there is the free circulation of people, that leaves no traces while in countries like Australia where boarders are pretty controlled, this type of data is more accessible.

11 Australia receives but does not send many migrants Within Europe there is the is the 2 nd largest intra-region migration (second to Asia), since in the EU system you can live and grow in all EU member states. Lots of migration goes from the world into Africa (mainly Gulf Countries) Australia a country of immigrants this graph represents the share of population born overseas > we can see that it is quite high at the end of 19 th century, showing the colonial nature of Australia, then it declined until 1944 where only 10% of population were born overseas. This share increased after WWII and now it s up to 30%. There is hardly another country in the world with a similar share.

12 Australia s Foreign-born Population and its Changing Origins birthplace persons % birthplace persons % United Kingdom 495, England 991, Ireland 184, New Zealand 607, Germany 38, China (mainland) 526, China 29, India 468, New Zealand 25, Philippines 246, Sweden & Norway 9, Vietnam 236, India 7, Italy 194, USA 7, South Africa 181, Denmark 6, Malaysia 166, Italy 5, Scotland 140, Top ten total 810, Top ten total 3,758, Other 47, Other 3,114, total overseas born 857, total overseas born 6,873,140 total population 3,788,123 total population 24,127,160 % of Australian born overseas 22.6 % of Australian born overseas 28.5 This table compares the birthplace of foreign-born population in Australia, considering the changes in the sources of countries from where migrants come from. 1901: The largest share of migrants coming from Australia regards people coming from the UK and Ireland (altogether for ca 78%). This reflects a colonial type of migration, as well as one based on same language. We notice that the first ten countries total approximately the 94% of the Australian population born overseas. We can notice some differences after 100+ years. Immigration has become more diverse. Now the top 10 only makes 54% - the result is also a change of share with respect to origins (but also, more countries are represented), despite the most common is still England (with a reduced percentage). FDI è CAPITAL = 2 ST FACTOR OF PRODUCTION Another big flow (other than people i.e. migration) is the movement of capital in the form of FDIs. FDI occurs when a firm/investor in one country owns a significant part of a company or property in another country. à foreign ownership in a significant part. Significant part implies that the owner can influence the firm s decisions, i.e. the ownership is so large that the investor s opinion is taken into account for decision making. The share is difficult to define, however, the typical definitions of FDI assume that ownership of at least 10% is enough to fulfil this criterion. Investment below 10% is called (foreign) portfolio investment to diversify it. Two types of FDI different in motivations: Horizontal FDI ( market-seeking FDI ) The majority of foreign direct investment occurs between industrialized countries, when a firm from one industrial country owns a company in another industrial country. The central motive is to serve the foreign market via producing abroad instead of exporting. We refer to these flows between industrial countries as horizontal FDI. i.e. an Australian company building a Vegemite factory in Germany and selling it there, in order to be close to the German or European market, saving on shipping times and costs for this good. è Horizontal because happens between similar countries.

13 Vertical FDI ( cost-saving FDI ) The other form of foreign direct investment occurs when a firm from an industrial country owns a plant in a developing country, which we call vertical FDI. Low wages are the principal reasons that firms shift production abroad to developing countries. This is a rich country firm investing in a lower wage-cost, putting a factory there for exploiting the differences in factor prices (energy, labour, production etc.). Ex. Apple = assembles in China in order to not pay American wages. Often, there can be Complex FDIs, when there is a mix of both. Two waves of globalization in capital flows Foreign capital stocks; assets / world GDP Looking at statistics for FDIs, we see the values of capital invested in foreign countries has skyrocketed from the 1980s onwards. This is valid especially for multinational activity of firm, that is more present in the global scene (but also, more information is available, as well as it is easier to move from a country to another) source: chapter 1 in van Marrewijk, Charles (2012): International Economics. Theory, Application, and Policy. Second Edition. Oxford University Press. 45 Map of FDIs - Nafta è much horizontal investments btw Canada & US - Europe è horizontal types of FDI, not exploiting the differences of other countries but saving on transportation costs. However, wages in wester EU are more expensive than eastern Europe (that was the China of Western Europe). - Lots of investment across the Atlantic

14 - US does FDIs to China in form of vertical investments. Stocks of FDI 3 Foreign Direct Investment In which countries does Australia invest? (end of 2015, outward FDI stock) Rank Country A$b (10^9 $) % of total 1United States United Kingdom New Zealand Japan China Singapore Germany Hong Kong (SAR of China) Cayman Islands France Canada Netherlands Switzerland Papua New Guinea Luxembourg Republic of Korea Bermuda India Ireland Philippines Total outward FDI: $2.1 trillion A$ Australia s share of total world inward FDI stocks: 1.6% (rank 17) source: Department of Foreign Affairs and Trade website, accessed15/05/ stocks: Sum of all investments in a certain year minus depreciation. Australia invests in UK & US => Horizontal FDI. Despite what media says for offshoring and outsourcing of firms, the reality is different. Horizontal investment is more connected to management Australia is a market-seeker 3 Foreign Direct Investment Which countries invest in Australia? (end of 2015, inward FDI stock) Rank Country A$b (10^9 $) % of total 1United States United Kingdom Belgium Japan Singapore Hong Kong (SAR of China) China Netherlands Luxembourg Switzerland Germany New Zealand Canada Bermuda Republic of Korea Virgin Islands, British France Malaysia Ireland Cayman Islands Total inward FDI: $3.0 trillion A$ Australia s share of total world inward FDI stocks: 2.2% (rank 12) source: Department of Foreign Affairs and Trade website, accessed 15/05/2017 the same countries towards which Australia invests, they also invest into Australia. China is only 2,5% of share however media talk about it a lot 48

15 One can say that the majority of world flows of foreign direct investment occur between industrial countries. In 2010 the total value of FDI stocks located in the OECD countries or owned by those countries was $17 trillion (85% of the total world stock of FDI). The FDI stock in Africa ($570 billion) is just over one- third of the stock in Latin America ($1,450 billion) which in turn is less than one-half of the FDI into China and other Asian countries ($3,991b) Most of this FDI is from industrial countries, but Chinese firms have begun to acquire land in Africa and Latin America for agriculture and resource extraction. European and U.S. FDI: The largest stocks of FDI are within Europe; these stocks amounted to $5.6 trillion in 2006, or nearly one-half of the world total. FDI in the Americas: Brazil & Mexico are two of the largest recipients of FDI among developing countries, after China. FDI with Asia: China has become the largest recipient country for FDI in Asia and the fourth largest recipient of FDI in the world. this is the industry distribution of inward FDI è Mining is the most important Conclusions - Globalization means many things: the flow of goods and services across borders, the movement of people and firms, the spread of culture and ideas among countries, and the tight integration of financial markets around the world (capital). - Although it might seem as if such globalization is new, international trade and the integration of financial markets were also very strong in the period before World War I. it increased again only after WWII and now we are in an unprecedented level of globalization. - Migration across countries is not as free as international trade, and all countries have restrictions on immigration.