世 界 经 济 概 论
(双语课程)
厦门大学经济学院国际经济与贸易系
林季红 编
厦门银禾软件公司 制作
The World Economy
Dr Lin Jihong
Professor of Economics
Xiamen University
Contents
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Lecture 1
Lecture 2
Lecture 3
Lecture 4
Lecture 5
Lecture 6
Lecture 7
Lecture 8
Globalization
Regional Economic Integration
MNCs and FDI
American Economy
Japanese Economy
German Economy
Developing Economies
Transitional Economies
Lecture 1
Globalization
Some Simple Facts About the
Global Economy
In 2000:
• World Trade Totaled $7.6 Trillion.
• About 63,000 Multi-National Corporations
(MNCs) Operate in the Global Economy
– Controlling About 690,000 Foreign Affiliates
– Employing About 86 Million People.
• Foreign Direct Investment Totaled $1.3 Trillion.
• About 30 Countries in Western Europe, North
America, and Asia Account for About 75% of this
International Economic Activity.
The Definition of Globalization
An increasingly interconnected world:
As a result of very rapid increases in
telecommunications and computer-based
technologies and products, a dramatic expansion
in cross-border financial flows and within
countries has emerged. The pace has become
truly remarkable. These technology-based
developments have so expanded the breadth and
depth of markets that governments, even reluctant
ones, increasingly have felt they have had little
alternative but to deregulate and free up internal
credit and financial markets.”
------Alan Greenspan, keynote address at the Cato
Institute's 15th Annual Monetary Conference,
October 14, 1997.
“Drivers” of Globalization:
Declining Trade and Investment Barriers
• Globalization of markets and production
– the result of lowering of trade barriers
– enabled by technological change
• Telecommunications & microprocessors
– High power/low cost computing
– Increase in information processing capacity
• The internet and the world-wide web
• Transportation technology
• Deregulation of Capital Control
International Trade
Growth of World Trade
600
500
400
300
200
Industrial Revolution
100
0
18
50
18
96
19
13
19
24
19
30
19
35
19
48
19
53
19
63
19
68
19
71
Volume
GATT-Based System
World Trade, 1968-1997
6000
$US Billions
5000
4000
3000
2000
1000
0
1968
1973
1978
1983
1988
1993
World Trade Growth
Growth of World Output and Trade
15.0
5.0
0.0
19
51
19
54
19
57
19
60
19
63
19
66
19
69
19
72
19
75
19
78
19
81
19
84
19
87
19
90
19
93
19
96
19
99
Percent Change
10.0
-5.0
-10.0
GDP Growth
Trade Growth
Distribution of World Trade
EU
21.2%
6.0%
6.3%
17%
Asia/Pacific
North America
9.6%
10.7%
5.3%
6.2%
Rest of the World
4.4%
12.8%
60% of All Trade Among the Advanced Industrialized Countries
The Multilateral Trade System:
GATT and the WTO
• GATT: General Agreement on Tariffs and Trade:
Created in 1947.
• Average Tariff Rates on Manufactured Products
(% value)
•
•
•
•
•
•
•
•
France
Germany
Italy
Japan
Holland
Sweden
Britain
USA
1913
21
20
18
30
5
20
–
21
1950
18
26
25
–
11
9
23
18
1990
5.9
5.9
5.9
5.3
5.9
4.4
5.9
5.9
2000
3.9
3.9
3.9
3.9
3.9
3.9
3.9
3.9
WTO: Promotion of Trade
Liberalization
• WTO: World Trade Organization:
Established in 1994
– An International Organization Charged with:
• Monitoring Compliance with rules (including GATT)
• Resolving Trade Disputes
• Facilitating Trade Negotiations
Growth rates of world industrial production，world trade and
foreign direct investments,1985---2000
Year
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
world industrial
production
2.4
1.2
4.1
5.0
3.6
1.6
-0.8
-0.7
-1.0
3.9
3.7
2.4
4.5
0.7
2.4
5.2
world trade
0.9
13.1
15.1
10.4
3. 6
9.6
2.0
5.6
-1.2
12.2
15.0
2.8
3.2
0. 7
2.0
5.5
foreign direct
investment
3.8
60.6
56.2
12.0
17.7
-0.6
- 24.5
7.4
28.3
10.8
32.7
12.8
23.7
48.2
32.4
n. a.
Periods of protectionism and free trade
• In the international division of labor, periods of liberalization and of
protectionism have alternated in economic history. The beginning of
the 19th century, with the Napoleonic Continental Blockade against
Great Britain, was protectionist. In 1815, the British Corn Laws took
effect. Intensely discussed in the literature, these laws aimed at
ensuring self-sufficiency in agricultural goods in case of another
conflict. The remaining part of the first half of the century was then
marked by the intention of reducing trade barriers; the Corn Laws were
abolished in 1846. A phase of liberalization began. Until the First
World War broke ort in 1914, there was a time of free trade , especially
in the exchange between Great Britain and its colonies and its former
colonies; important capital flows went into the newly independent
states and the colonies. But the continental countries also reduced their
trade barriers, e, g. in the German Tariff Union (1834). This phase of
liberalization was accompanied by largely stable currency conditions
in the framework of the gold standard.
Periods of protectionism and free
trade
• With the First World War, the phase of integration in the world
economy came to an end. The hyper-inflation that hit Germany and
other European countries in 1923 and the Great Depression starting in
1929 seriously disrupted the economy. Tariffs and other trade barriers
increased; the 1930s saw devaluation races in which states tried to
stimulate their exports by devaluing their currencies and thus
improving their employment possibilities (‘beggar-thy-neighbor
policy ’).After the Second World War, a framework for the world
economy was created with the GATT (General Agreement on Tariffs
and Trade) in 1948. Based on this framework, the international
division of labor could develop beneficially, without trade barriers.
Until 1971, the currency system of Bretton Woods succeeded in
keeping foreign currency rates relatively stable. The World Bank and
the International Monetary Fund, international organizations that
aimed at a stronger integration of all countries into the world economy,
were created.
Trade policy instruments
• Import duties
– The tariff on imports protects the domestic import substitutes
sector, but the opportunity costs are considerable:
• The export sector shrinks as the import substitutes sector attracts
production factors. In a dynamic economy, import protection hampers
the development of export opportunities.
• If production of import substitutes is concentrated in particular region of
a country, protection against imports hampers the development prospects
of this region or of other regions in a number of ways. Furthermore, the
incentives to increase efficiency are weaker.
• Consumers reach a lower welfare level in the consumption point c’.
Trade policy instruments
• Subsidies
• Quotas
• Voluntary export restraints
– With an agreement on restraints for exports,
governments agree on a maximum import quantity
(from the point of view of the importing country) or a
maximum export quantity (seen from the exporting
country). Exporting countries enter export restraints
under the threat of facing even harder entry barriers
for their exports.
Arguments for trade policy interventions:
protection of domestic production
• Autarky
• Protection of established industries
• Stretching structural change
• Protecting infant industries
Arguments for political interventions
in trade
• Anti-dumping
– It can not be denied that an explicit dumping represents a distortion
to the international division of labor; consequently, it is prohibited
according to Article VI of GATT. It is equally true, however, that
in many anti-dumping cases, protectionist goals gain the upper
hand, Anti-dumping then, can easily develop into a protectionist
division .Unfortunately, retaliation entails the danger that a trade
war develops. This would bring a less favorable welfare situation
for both countries.
Arguments for intervention in trade:
creating a level playing field
• Industry and trade unions of the industrialized demand
a worldwide equalization of conditions under which
firms (and labor) compete (a level playing field),
focusing often on equal social and environmental
standards. As an example, demands are voiced that
employees in newly industrializing countries should
have the same social conditions as their counterparts in
the industrialized countries.
• Just as wages in China cannot be raised to the German
level, a rich industrialized nation does not have the
right to impose its social standards on a newly
industrializing country.
• More powerful are the arguments in favor of free trade.
Arguments for intervention in trade:
creating a level playing field
• Welfare gains for the world
– Free trade overcomes national restrictions: the more
restrictions are overcome, the more leeway for
economic decisions results, and this causes
efficiency gains.
• Welfare gains for a particular country:
allocation-driven gains
1.Allocation-driven gains (or static gains)
Arguments for intervention in trade:
creating a level playing field
The scale effect--------Average costs fall with rising output. Factor and
resource input per unit of output decrease.
The profit effect --------Firms have higher profits; national welfare rises.
However, trade can make markets contestable; this reduces market
segmentation.
2. Dynamic welfare gains
In the long run, the dynamic effects of free trade can be considered to be more
important than the effects that can be expected in a comparative-static context.
– The competition effect
• Free external trade ensures intensified competition between suppliers. The
domestic producers have to face up to the foreign supply. This triggers a
tendency to cut cost. Competition controls cost and ensures efficiency. It
also forces economic actors to find new economic solutions and to discover
new products. Free trade is the best competition policy.
Arguments for intervention in trade:
creating a level playing field
– The innovation effect
• External trade stimulates technological progress, as the
strengthened international competition induces a search for
cheaper production possibilities and for new products.
– The accumulation effect
• Trade is also incentive for accumulating a larger factor stock.
This accumulation effect holds for physical capital (including
infrastructure capital) and human capital. For instance, the
import of capital goods allows a larger stock of capital. The
innovation effect is another form of the accumulation effect
because a larger knowledge is accumulated, enabling producers
to use the given production factors more effectively.
A little bit history of GATT
• The GATT (General Agreement on Tariffs and Trade) was
founded in 1948 by 23 countries. In 1995 it was followed
by the WTO. At the time when the GATT was established,
after the protectionist experiences of the 1930s, the goal
was to create a stable framework for international trade in
order to provide the preconditions for growth and an
increase of prosperity.
• As of November 2001, the WTO has 144 members, and 30
states are applying for membership among them Russia,
China and Taiwan have been members since the Doha
meeting.
From GATT to WTO
• Rounds of liberalization
– GATT succeeded in the course of eight liberalization rounds in
significantly cutting tariffs and reducing other barriers.
– In the years before the Geneva Round of 1947, the tariffs of the
industrialized countries were as high as about 40 percent of the
import value (on average). After the Uruguay Round, they were
brought down to about 4.3 percent.
– The first five GATT rounds were concentrated on tariff cuts. The
last rounds, all of them lasting several years, embraced new themes.
– The Kennedy Round, for example, developed an anti-dumping
code, although this was not ratified by the US.
– In the Tokyo Round, a proposal for a new anti-dumping code saw
daylight, but an improved code on subsidies was left aside.
– Finally, the Uruguay Round extended the agenda with new rules on
services, intellectual property and property rights, and dispute
settlement procedure.
The WTO : how it works
• Decision structure of the WTO
– The central decision-making body, the ministerial conference, is
responsible for general questions. The WTO Council, the General
Director and the General Secretary are the operative bodies.
– The WTO is different from GATT in several respects. First ,
member states have formally ratified the WTO agreements,
whereas GATT was simply signed by governments. Second, GATT
dealt only with trade in goods; in addition, the WTO covers
services and intellectual property as well. Third, the dispute
settlement mechanism is more effective.
The basic principles of WTO
• The basic principles
– liberalization
• The simple idea of GATT/WTO is to reduce trade barriers.
Nations have to abstain from raising existing tariffs or from
levying new ones. In addition, quantitative restrictions or nontariff barriers are forbidden.
– Non-discrimination
• Trade policy measures should not differentiate between
countries, countries should be treated equally. In particular,
there must be not discrimination between domestic and foreign
products.
• It should not discriminate against imports.
– Most-favored nation
• The most-favored-nation principle is an expression of
the non-discrimination principle (favor one, favor all) .
• The obligation towards a general, positive and
unconditional most-favored treatment, which is
included in Article I of the GATT treaty, implies that a
tariff reduction that is granted to one country has to be
granted to all countries.
• In this way bilateral tariff reductions are multilateralized.
The basic principles of WTO
---Reciprocity
The principle of reciprocity requires that concessions have to be
granted mutually. This means that a tariff cut in one country has
to correspond to an equivalent cut in another country.
---Bound tariffs
When countries agree on reduced tariffs, they bind their
commitments. Changing the bindings requires negotiating with
the trading partners and compensating them for loss of trade.
The basic principles of WTO
– Single undertaking
• The single-undertaking nature of the WTO reflects the
concept of packaging the benefits arising in different
areas of the international division of labor.
• In principle, it can be expected that the singleundertaking nature of WTO will strengthen the rule
system because it forces countries to swallow less
favorable rules in one area if they are compensated by
rules allowing higher benefits in other areas.
The WTO : how it works
• Further rules of the WTO
– Country-of-origin versus country-of-destination
• The country-of-origin principle accepts the rule of the
country of origin whereas the country-of –destination
principle leaves it to the importing country to set the
domestic standard as the yardstick for its imports.
• Moreover, such regulations can easily be captured by
interest groups.
• The goal of the world trade order is therefore that
countries mutually accept the regulations of the country
of origin for product quality and production processes
in order to minimize transaction costs.
The WTO : how it works
– National treatment
• For services , the principle of national treatment is applied. Foreign
suppliers have to be treated in the same way as domestic suppliers. For
services, the country-of-origin principle has not been acceptable so far.
• Dispute settlement
– The member countries of the WTO have voluntarily agreed to a
dispute-settlement system. If a country violates the rules, the
WTO is allowed to demand a change in the trade policy decisions
and to impose sanctions.
– Whereas the ruling of a Dispute Panel can be appealed before the
Appellate Body, the decision of the Appellate Body is binding
unless all parties are against its adoption.
The WTO : how it works
• Trade policy review mechanism
– The trade policy review mechanism scrutinizes the
trade policy of each member state on a regular
basis. The report on the four major trading partners
( US, EU ,Japan and Canada) are provided more
frequently. This review is expected to exercise
discipline on the trade policy of member stats.
New areas for the world trade order
•
•
•
•
•
•
Strategic trade policy and subsidies
Free market access and national regulation
Open services markets
National treatment in the case of person-embodied services
International competition policy
Aggressive trade policy versus the multilateral order
– With its powerful instrument ‘Super 301’
– Import restrictions can be imposed and bilateral export-restriction agreements
can be pursued.
• Protecting health and conserving natural resources
• Consistency between the international environmental order and the
international trade order
The Withering Away of the
State
• Assault on state sovereignty from above –
supranational organizations:
– NATO
– EU
– WTO
– IMF
The Major Financial Crises of
Our Times:
•
•
•
•
•
•
Latin American Debt Crisis of 1982
ERM Crisis of 1992
Mexican Peso Devaluation of 1994
East Asian Crisis of 1997
Russian Crisis of August 1998
Brazil Crisis of 1999
Global Inequality
“Some 3 billion people, half of the world's
population live on the margin of subsistence, and
the gap between the average incomes of the richest
and poorest countries has widened to 70:1.”
------Secretary-General Kofi Annan in a message
to the International Conference on Development,
June 24, 1999
Global Inequality is widening
• Global inequality is widening :
• “If we do not have the capacity to deal with social
emergencies, if we do not have longer-term plans for solid
institutions, if we do not have greater equity and social
justice, there will be no political stability. And without
political stability, no amount of money will put together
packages which will give us financial stability."
• - James Wolfensohn, President, The World Bank Group, to
the IMF-World Bank Meeting in Washington, 1997
Globalization: Does it cause
Prosperity or Impoverishment?
• Impact of barrier removal on jobs and incomes
– Do jobs move away from wealthy advanced economies
in search of lower wage rates?
• Impact of trade liberalization on labor policies and
the environment
– Do manufacturing facilities move to developing
countries with weaker labor laws and environmental
protection?
• Its impact on national sovereignty
– WTO, EU, UN: supplanting national governments?
Who is against globalization?
Those politicians who want blame “external causes”
for internal failures of their own policies,
The “political left” which needs new enemies to
exist
Those trade unions which cannot cope with
increasingly unforgiving and competitive world of
technology, education and resource crunch.
The most common demands of Antiglobalists
No child labor
No pollution
No deforestation
No McWorlds
No Hormone Food
No American mass sub-culture
Pay Fair Wages in Asia Protect Dolphins
Protect Turtles
Not Exploit Workers
Globalization fears
• An overriding concern is that welfare is not enhanced, but
seriously impaired. One line of argument is that developing
countries will lose by the international division of labor.
• Another concern is that jobs will be destroyed in the
industrialized countries. However, wages for human capital
will rise the industrial countries. Wages also will rise
because of the benefit from trade.
• It is feared that countries face additional constraints
through trade and lose maneuvering space.
• The deterioration of environmental quality. If countries
produce more for the international division of labor. They
also produce more pollutants and harm their environment.
• Possible subsidization of multinationals to drive
out domestic competitors
• Attack on infant firms
• Repatriated profits show up as debits to capital
account
• Potential unfavorable impact (on trade/current
account balance) of multinationals imports
• Threat to national sovereignty
Class Topics
• To what extent is a global market integrated worldwide and
to what extent is it segmented?
• Where does production take place?
• Do we have a vertical structure of production ?
• Is the valued-added chain of production sliced up?
• What are the backward and forward linkages of production?
• To what extent is production separated spatially from
demand?
• Is the industry vertically integrated? Or do markets
perform the allocation of production and investment
decisions?
• What are future trends of an industry? And which major
factors influence these trends?
Lecture 2
Regional Economic
Integration
Major Types of Regional
Economic Integration
• Free trade area
– Eliminates tariffs within the area only. Each country
retains its own policy towards non-members.
• Custom union
– Add a common external policy to the free trade area.
• Common market
– Factors of production can flow freely within a custom
union.
• Economic union
– Common market with common determination of some
structural and macroeconomic policies.
Elementary theory of integration
• Static Effects：Trade-creating and trade-diverting
Germans love to eat fatty ducks which they could import from France for 20
DM, or from Hungary for 17 DM.When a Common Market in agricultural
produce (CAP) was introduced they had adopted Common External Tariff
(CET) of 20 % which raised the price of Hungarian ducks to 20.5 DM. They
diverted their import from Hungary (nonmember) and created trade with
France (member state).
• Dynamic effects
– The exploitation of economies of scale and increased specialization,
intensified intra-industry trade and- in a more general sense- a high
mobility of both capital and labor . dynamic effects also stemming from
an improved competitiveness of firms, from innovation, from the
accumulation of capital and from higher growth. These gains in efficiency
also have positive effects on third countries because a higher GDP implies
an increased import demand.
– Empirical studies have emphasized the relative importance of dynamic
effects in comparison with comparative- static effects.
• In addition, the member states are enable to conclude an
agreement much more easily. For that reason, regional
integration might be realized faster. Further barriers can be
dismantled in the long run, when the regional integration
opens itself to additional members.
• The advantage of the multilateral approach consists in
creating a set of rules that are legally binding nearly all
over the world.
• For instance, the world economy could be subdivided into
the triad Europe, North America and Japan. Up to now,
however, regional integration has not led to important
forms of separation.
Elementary theory of integration
Does a multilateral approach to liberalization represent a
faster and more secure track towards free trade than a
regional approach?
The advantage of the regional approach is that barriers to
trade are more or less totally abolished within a partial area
of the world?
Elementary theory of integration
• In East Asia, APEC has the goal of market integration with
no tendency towards protectionism.
• European integration has proved to be open to new
members, and despite some protectionist measures tradediverting effects unfavorable to the rest of salt, overcompensated by its growth.
• Indeed, the danger of an escalating trade war between the
regional blocs is still a matter of importance. Therefore, it is
necessary to find mechanisms which allow a multilateralization of regional integration.
Regional integration
The Americas The Northern American Free
Trade Agreement (NAFTA) between the US,
Canada and Mexico started in 1994. Its aim is
to remove tariffs and substantially reduce nontariff barriers over a period of 10-15 years. By
liberalizing the trade of goods and services,
facilitating foreign investment and establishing
an effective dispute settlement mechanism,
NAFT is expected to become an important area
of regional integration in the world.
Regional integration
• A Trans-Atlantic Free Trade Area (TAFTA) is
proposed to integrate the European Union and
NAFTA. But instead of a free-trade area it may be
attempted to first create a common economic
area ,in which production standards creating nontariff barriers would lose their significance, e. g. by
mutual recognition of standards.
• In the long run, the creation of a so-called Free
Trade Area of the America (FTAA), which would
require an integration of both NAFTA and
MERCOSUR and other Latin American countries, is
aimed at reducing barriers to trade in the western
hemislphere.
Regional integration
Asia
• In 1989, the Asia-Pacific Economic Cooperation
(APEC) was founded in order to encourage free
trade among its member states, now comprising
Japan, China ,Australia, New Zealand, South Korea
and Taiwan as well as some other fast-growing
economies of South-East Asia, the NAFTA members
and Chile. In accordance with the WTO principles,
APEC wants to reduce barriers to the trade of goods
and services, but there is no desire to establish a
common external tariff (open regionalism) .
EEC
• European Coal and Steel Community(ECSC)
1952: The basis of the EU began with the signing of the
Treaty of Paris, establishing the European Coal and Steel
Community (ECSC), to regulate European industry &
improve commerce, post WWII.The six founding states
were Belgium, France, Germany, Italy, Luxembourg, and
The Netherlands.
• Treaty of Rome
1957: the Treaties of Rome were signed by the six member
states, forming: The European Economic Community
(EEC);The European Atomic Energy Community
(Euroatom);1967: ECSC, EEC, and Euroatom merged to
form the basis of the EC.
The EEC as a Custom Union
•
•
•
•
Elimination of internal tariffs.
Common external tariffs of 15 percent (members’average).
Institutionalize the virtuous circle of export-led growth.
The elimination of tariffs would create trade (trade
creation).
• The imposition of external tariffs would reduce
dependence from the United States, Soviet Union, etc.
(trade diversion).
The Development of EEC
• 1973: the United Kingdom, Denmark, and
Ireland joined the EC.
• 1981: Greece joined.
• 1986: Spain and Portugal joined.
• 1995: Finland, Sweden, and Austria joined.
Goals of EU
• To continue to improve Europe’s economy by regulating
trade and commerce.
• To form a single market for Europe's economic resources.
• As these goals were accomplished, other goals were
developed:
• Environmental movements
• Regulatory acts
• Human rights concerns.
• 1992: the Maastricht Treaty was ratified, which rechartered
the EC as the European Union.
Principal Objects of the EU
•
•
•
•
Establish European Citizenship
Ensure freedom, security, and justice
Promote economic and social progress
Assert Europe’s role in the world
The EU is run by five institutions
• European Parliament
– elected by the peoples of the Member States
• Council of the Union
– composed of the governments of the Member States
• European Commission
– driving force and executive body
• Court of Justice
– compliance with the law
• Court of Auditors
– sound and lawful management of the EU budget
Decision making in the European
Union
• Giving up some national sovereignty
– European integration relies on the method of
intergovernmental cooperation where most of the decisions
are taken in the European Council by reaching agreements
between the ministers of specific portfolios .
– Its basis is the treaty as a multilateral arrangement by
which sovereignty in favor of joint decision making on the
European level.
– The EU treaty is not a constitution. If the EU had a
constitution, the fundamental decisions would not be made
by the Council but by the sovereign; that is, by the people
or by a parliament representing the people.
Decision making in the European
Union
• Types of legal rules
– Community law, adopted by the Council –or in the case of
co-decision procedure by Parliament and Council –can only
be established in those areas which have been defined for
joint decisions. Where unanimity is required, the power to
legislate still rests with the individual member state.
– Community law may take different forms. Regulation are
directly applied; there is no need for national measures to
implement them. Directives bind member states with
respect to the objectives to be achieved. It is up to the
national authorities to choose the appropriate means to
implement the directives. Decisions are addressed to any or
all member stats and are binding.
Decision making in the European
Union
Different types of majorities
For a qualified majority in the EU-15, 62 of 87 votes (71.26
percent) are needed. This holds for decisions which are taken by
the European Council with respect to proposals of the European
Commission. In all other cases, it is additionally required that 62
votes represent the approval of at least 10 member states (Article
205). The blocking majority is 26 votes. The Treaty of Nice
changes these numbers for the case of enlargement: the EU of 27
will have 345 votes. Then a qualified majority , now at 68 of 87
votes or 71.26 percent, requires 258 votes (or 74.79 percent) and
the majority of members. The blocking minority is 88 votes. If not
all candidates have joined the European Union when the new
weighting becomes effectively by 1 January 2005, the threshold
for the qualified majority will be moved up from a value below the
actual level of 71.26 percent to a maximum of 73.40 percent.
Single market
• Single European White Paper (1985)
• The European White Paper was a proposal of legislation to
eliminate the existing non-tariff barriers.
• Single European Act (1987)
• The Single European Act (SEA) formally approved most
of the legislation proposed in the White Paper and other
legislation promoting the liberalization of capital.
• Government procurement
The SEA requires member governments to open up their
purchases from firms of other member countries.
• Technical standard
• The SEA adopts the principle of Mutual Recognition: if a
product is legal in one country, it can access all other
countries’ markets, given no security or safety problems.
• Physical barriers
• Simplification of export-import documentation and custom
checkpoints procedures.
• Fiscal barriers
• Homogenization of VAT and corporate taxation. Countries
could choose, for each product, to eliminate the VAT or
impose a minimum VAT of 15 percent.
The Four Freedoms in the Single
Market
• Free movement of goods
– The common market requires the dismantling of all obstacles to
the free movement of goods. Barriers to trade include not only
tariffs and quantitative restrictions but also national regulations.
• Free movement of persons
– Workers have the right to work anywhere in the European Union
(right of free movement). Individuals have the right to establish
businesses everywhere in the European Union (right of
establishment). Discrimination based on nationality is to be
abolished.
The Four Freedoms in the Single
Market
• Free movement of services
– Services offered in one member country can also be supplied in
the other member countries.
• Free movement of capital
– Until the 1980s, capital flows were still controlled in
some countries . With monetary union in the making,
national controls of capital movements could no longer
be justified.
The Four Freedoms and the Single
Market
Trade policy
Since the European Union is also a customs union, it has a common
external tariff which now is at 2.7 percent for all trade in industrial
products. Other trade policy instruments are applied uniformly.
Competition policy
In a single market, competition policy (anti-trust policy) has to
apply to the market as a whole. Competition policy has to prevent
cartels and to ensure that dominant positions within the common
market do not arise. Thus , the abuse of market power in the EU
and the creation of new dominating positions (monopolies) by
mergers have to be controlled on the European level, where the
Commission has taken a lead position.
EU expenditures
EU expenditures amounted to 96 billion euros in 2001. Of this ,46
percent was spent on agricultural policy, 34 percent on structural
and regional funds.
Liberalization of factors of
production
• Labor mobility
Workers move from areas with low wages to areas
of high wages.
• The movement of workers to areas with high
wages tends to reduce the wages of existing
workers.
• The redistribution effects motivates conservative
resistance.
• However, intrinsic labor immobility prevented this
mechanism from working in the EU.
Capital mobility
• Capital moves from areas where the return on capital
(interest rate) is low to areas where the return is high.
• The movement of capital to areas with high interest rate
tends to reduce the interest rate in these areas and increases
the interest rate in the areas with law rates.
• As for labor there are significant redistribution effects that
motivate conservative resistance.
• During 1980s there were extensive capital controls in the
EU. Individuals and firms were not allow to open bank
deposits in other EU countries.
• In July 1990 these controls were eliminated and it was one
of the causes of the 1992 collapse of EMS.
• In 1993 there has been a major liberalization of the
banking system
• In anticipation of the SEA, there has been an increase in
merger and acquisition activities. In particular in the
service and banking sectors.
The Evolution of the European
Single Currency
THE EURO
• The euro – Europe's new single currency - represents the consolidation
and culmination of European economic integration.
• During the floating exchange rate period EU countries tried to reduce
the fluctuations of their currencies against each other. These efforts
resulted in the birth of euro on January 1, 1999. The existing national
currencies are withdrawn from circulation by 2002. Currently all
monetary policy actions and most large-denomination private
payments within Europe and most foreign exchange transactions are
carried out in euros.
• Its introduction on January 1, 1999, marked the final phase of
Economic and Monetary Union (EMU), a three-stage process that was
launched in 1990 as EU member states prepared for the 1992 single
market.
• European Payment Union (1950-1958)
• Facilitated multilateral clearing of payment imbalances.
The Bank of International Settlements acted as a clearing
house.
• European Monetary Agreement (1958-1972)
• Many European currencies became convertible. The
Agreements facilitated central banks in making settlements
in gold and dollars.
• Bretton Woods Agreement (1959-1971)
• Currencies were allowed to fluctuate by 1% with respect
to the dollar.
• European currencies could fluctuate as much as 4% with
each other.
• With the Smithsonian Agreement on December 1971, the
band was enlarged to 2.25%
• European Currency Reform Initiatives, 1969-1978
• The evolution of euro can be traced to the Hague meeting
in December 1969.
• A committee headed by Pierre Werner, prime minister and
finance minister of Luxembourg proposed a program that
would result in locked EU exchange rates and the
establishment of a federated system of European central
banks.
• Snake in the Tunnel (1972)
• EC currencies jointly moving within a dollar tunnel.
– Bilateral exchange rates with respect the dollar 2.25%.
– Bilateral exchange rates among European currencies
1%.
• Intervention mechanism and monetary support for member
countries.
• The European Monetary System, 1979-1993
• European Monetary System (1979)
• Currencies were allowed to fluctuate by 2.25% with each other (Italy
and UK 6%).
• Possibility of realignments allowed within the EMS.
• Financing facilities were provided.
• Creation of the European Currency Unit (ECU)
• The eight original participants in the EMS’s exchange rate mechanism
- France Germany, Italy, Belgium, Denmark, Ireland, Luxembourg,
and the Netherlands began operating a formal network of mutually
pegged exchange rates in March 1979. Most exchange rates fixed by
the EMS until August 1979 could fluctuate up or down as much as
2.25% relative to an assigned par value. Between March 1979 and
January 1987 11 currency alignments occurred. The fiscal expansion
during the German unification and the policies followed after that led
to speculative attacks on on the EMS exchange parities starting in
September 1992. In August 1993 all EMS bands, except the DM and
the Dutch guilder were widened to +/-15%.
• European Economic and Monetary Union
• The early EMS characterized by frequent currency
realignments and widespread capital controls allowed a lot
of room for national monetary policies. In 1989 a
committee headed by Jacques Delors, president of the EC,
set the goal of economic and monetary union (EMU), a
European Union in which national currencies are replaced
by a single EU currency managed by a sole central bank.
This road map was approved by the Maastricht Treaty.
The result was the introduction of euro in January 1999.
Delors Report (1989): Plan for the
realization of EMU
• Stage 1 (July 1990)
• Free movement of capital. Member states undertake programs
that make possible fixed exchange rates.
• Stage 2 (January 1994)
• Creation of the European Monetary Institute (EMI) to:
• Coordinate monetary policies and ensure price stability.
• Prepare the establishment of the European System of Central
Banks (ESCB) overseen by the European Central Bank (ECB).
• Prepare the introduction of a single currency in stage 3.
• Examine the achievement of economic convergence among EU
states as established by the Maastricht Treaty (1992).
• Stage 3 (January 1999)
• Introduction of the single currency “EURO”.
• Establishment of the European Central Bank in charge of the
European monetary policy.
Maastricht Treaty (1992)
• Price stability
• For the preceding year the average inflation rate must not exceed that
of the best three states by more than 1.5%.
• Interest rate convergence
• For the preceding year the average long-term interest rate must not
exceed that of the best three states (in term of inflation) by more than
2%.
• Budget discipline
• Government budget deficit must be less than 3% of GDP.
• Government debt cannot exceed 60% of GDP.
• Exchange rate stability
• For the preceding two years no exchange rate realignments.
• The EURO (Early 1990’s)
• 1990: Aimed at boosting cross-border business activity, the first stage
of EMU lifted restrictions on movements of capital across internal EU
borders.
• 1994: The European Monetary Institute was established in Frankfurt to
pave the way for the European Central Bank.
• 1999: the Euro was introduced as the single currency for eleven EU
member states: Austria, Belgium, Finland, France, Germany, Ireland,
Italy, Luxembourg, the Netherlands, Portugal, and Spain.
• The EURO (1999-Present)
• 1999-2002: The Euro and the previous national currencies were
concurrently used in participating states.
• 2002: The participating countries had their previous national
currencies withdrawn permanently as legal tender.
• EU member states not yet using the Euro as currency: Denmark,
Greece, Sweden, United Kingdom
Benefits and Costs of EURO
Benefits:
• Reduction in transaction costs.
• Elimination of the exchange rate risk.
• Greater competition leading to greater efficiency.
• Greater integration among the European financial markets
and greater investment efficiency.
• Inflation discipline guaranteed by the independence of the
European Central Bank.
• Fiscal discipline as a requirement to enter and stay in the
system.
• Increase the urgency of structural reforms in Europe.
Costs:
• The system of fixed exchange rates eliminate the possibility of using
exchange rate adjustments as a policy tool in the presence of
asymmetric shocks.
• Individual countries cannot use monetary policy to face countryspecific shocks.
• Europe may not be an optimal currency area due to:
• Likelihood of asymmetric or country-specific shocks.
• Limited labor mobility.
• Structural labor market rigidities.
• Limited ability to use fiscal policy as a stabilization tool in absence of
monetary independence.
• Absence of a system of fiscal redistribution to insure against
regional/national shocks.
East Enlargement:
•
•
•
•
•
•
•
•
•
•
•
•
10 more countries to become EU Member States in 2004
Country - date of EU application
Cyprus - 3 July 1990
Malta - 16 July 1990
Hungary - 31 March 1994
Poland - 5 April 1994
Slovakia - 27 June 1995
Latvia - 13 October 1995
Estonia - 24 November 1995
Lithuania - 8 December 1995
Czech Republic - 17 January 1996
Slovenia - 10 June 1996
East Enlargement
• On average , the EU candidate countries export 65 percent
of their exports to the EU as existing EU members do.
• Trade between these countries and the EU is not only intersectoral trade, but also already to a large extent intrasectoral trade, albeit with some vertical structure.
• Poland reaches 39 percent of the EU per capital level of
GDP when purchasing power parity is used. For Hungary
the relative level is at 52 percent , for the Czech Republic
at 58 percent and for Slovenia 72 percent.
• In regional policy, regions of the EU are actually subsidize
with 33 billion euros in the structural funds accounting for
34 percent of the EU budget (2001). The transfers are
intended for areas where GDP per capital is below 75
percent of the EU average.
Lecture 3
MNCs
and
FDI
Definition of MNCs
• An MNC is an enterprise that engages in foreign direct
investment (FDI) and that owns or controls value-added
activities in more than one country. MNCs are concerned
about securing the least costly production of goods for
world markets, making profits, increasing market share,
and corporate growth This goal may be achieved through
acquiring the most efficient locations for production
facilities or obtaining taxation concessions from host
government. Key decisions involving foreign activities,
such as the location of production facilities, distribution of
markets, location of R&D, capital investement, etc are
made by the parent company. MNCs have a large pool of
managerial talent, financial assets, and technical resources,
and they run their gigantic operations with a coordinated
global strategy.
Characteristics of MNCs
• An MNC is among the world’s largest firms.
• The sales of each of the top ten MNC in 1992 were over
$59 billion, more than the GDP of at least 100 countries;
• General Motors’ 1992 sales ($134 billion) were well ahead
of Denmark ($124 billion), Norway ($113 billion), Saudi
Arabia ($111 billion)
• MNCs tend to be oligopolistic corporations in which
ownership, management, production, and sales activities
extend over several countries.
• By 2003, there were 63,000 firms with business activities
in foreign countries, controlling over 800,000 subsidiaries
or foreign affiliates.
Ways of assessing the degree of
multinationality of a firm
• they have many foreign affiliates or subsidiaries in foreign
countries.
• they operate in a wide variety of countries around the
globe.
• the proportion of assets, revenues, or profits accounted for
by overseas operations relative to total assets, revenues or
profits is high.
• their employees, stockholders, owners, and managers are
from many different countries.
• their overseas operations are much more ambitious than
just sales offices, including a full range of manufacturing
and research and development (R&D) activities.
•
Why Do Firms Invest Overseas?
Trade Barriers
• - Government action leads to market imperfections.
• - Tariffs, quotas, and other restrictions on the free flow of
goods, services and people.
• - Trade Barriers can also arise naturally due to high
transportation costs, particularly for low value-to-weight
goods.
Labour Market Imperfections
• Among all factor markets, the labor market is the least
perfect.
• - Recall that the factors of production are land, labor,
capital, and entrepreneurial ability.
Why Do Firms Invest Overseas?
• If there exist restrictions on the flow of workers
across borders, then labor services can be
underpriced relative to productivity.
• The restrictions may be immigration barriers or
simply social preferences.
• Persistent wage differentials across countries exist.
This is one on the main reasons MNCs are making
substantial FDIs in less developed nations.
Why Do Firms Invest Overseas?
Intangible Assets
• Coca-Cola has a very valuable asset in its
closely guarded “secret formula”.
• To protect that proprietary information,
Coca-Cola has chosen FDI over licensing.
• Since intangible assets are difficult to
package and sell to foreigners, MNCs often
enjoy a comparative advantage with FDI.
Vertical Integration
• MNCs may undertake FDI in countries where
inputs are available in order to secure the supply
of inputs at a stable accounting price.
• Vertical integration may be backward or forward:
• Backward: e.g. a furniture maker buying a logging
company.
• Forward: e.g. a U.S. auto maker buying a Japanese
auto dealership.
Product Life Cycle
• U.S. firms develop new products in the developed world
for the domestic market, and then markets expand overseas.
• FDI takes place when product maturity hits and cost
becomes an increasingly important consideration for the
MNC.
• It should be noted that the Product Life Cycle theory was
developed in the 1960s when the U.S. was the
unquestioned leader in R&D and product innovation.
• Increasingly product innovations are taking place outside
the United States as well, and new products are being
introduced simultaneously in many advanced countries.
• Production facilities may be located in multiple countries
from product inception.
Shareholder Diversification
• Firms may be able to provide indirect
diversification to their shareholders if there exists
significant barriers to the cross-border flow of
capital.
• Capital Market imperfections are of decreasing
importance, however.
• Managers can therefore probably not add value by
diversifying for their shareholders as the
shareholders can do so themselves at lower cost.
J. H. Dunning’s OLI Paradigm
• The OLI paradigm offers an analytical framework for
incorporating a variety of operationally testable
economic theories of the determinants of FDI and the
international activities of MNEs.
• It sets out to explain the MNE in terms of three sets of
advantages:
– ownership (O) advantage: MNEs’capacity to engage competitively
in the foreign value-added activities against competitors.
– locational (L) advantage: MNEs’wish to locate those foreign
value-added activities and/or those relating to the creation of
ownership advantage in a host country.
– internalisation (I) advantage: MNEs’desire and opportunity to
internalise the market for the ownership advantage.
• According to Dunning (2000), the paradigm asserts the
precise configuration of the OLI parameters facing any
particular firm. It also reflects the economic, political,
geographical and cultural features of the country or region
of the investing firms and of the country or region in which
they are seeking to invest, and the industry and the nature
of the value added activity in which the firms are engaged.
• In the literature, there is a view that internalisation is in
itself a general theory of MNEs. It is considered that the
concept of O advantage is irrelevant in explaining MNEs.
However, the empirical work demonstrates the importance
of O advantages. In addition, Dunning dismisses the
capacity of internalisation approach to explain the level,
structure and location of all international production. He
argues the internalisation theory not as an alternative but as
a very important contribution to his own approach.
Motives of MNEs
• Broadly speaking, the motives for firms to
engage in international production can be
classified in four groups:
–
–
–
–
Resources Seeking
Markets Seeking
Efficiency Seeking
Strategic-Assets Seeking
Resource-Seeking MNEs
• Firms gain access to resources which tend to be
location specific.
– Natural resources (The traditional form of resourceseeking): Firms seek new supplies of raw materials.
– Cost, skills and productivity of local labour force:
Firms extend the international division of labour by
seeking appropriate labour force in manufacturing
and/or services.
– Expertise and technology: Firms seek foreign
technological capability, management and operational
expertise and organisational know-how which are
unavailable or too costly to obtain at home.
Market-Seeking MNEs
• Firms seek to improve market access via proximity to
demand.
• Transaction Cost-Reducing: High transportation costs and
transaction costs mean that proximity to the market may be
crucial to supplying the market competitively.
• Adapting to Local Preferences: Firms may need to be
‘close’ to the market so as to adapt their products
effectively to strong differences in culture and tastes.
• Strategic Presence-Seeking:
• MNEs need to have a physical presence in markets,
especially those served or threatened by key
competitors.
• Firms often follow existing suppliers or customers
which move overseas.
Efficiency-Seeking MNEs
• Firms attempt to rationalise the
operations of their value added activities
and exploit advantages due to
internationalisation
– International differences in product and factor
prices
– Economies of scale and scope
– Global sourcing
Strategic Asset-Seeking MNEs
• Firms increasingly use FDI to obtain strategic
assets (tangible or intangible) that may be critical
to their long-term strategy but are not available or
costly at home.
• In contrast to the other motives for MNCs,
strategic assets seeking investment does not imply
the exploitation of an existing ownership
advantage of the firm. Instead, FDI may be a
vehicle for the firm to build the ownership
advantages that will support its long-term
expansion at home and abroad.
Organizational Forms
• Vertically integrated MNCs -----in manufacturing, they
place the various stages of production in different locations
throughout the world; in minerals, they are involved in the
extractive and smelting stages; in petroleum, they are often
involved in the distributive stages, owning many petrol
stations.
• Horizontally integrated MNCs-----have the same sort of
plant in many countries (plants to make the same or similar
goods everywhere)Union Carbide which has many
chemical subsidiaries around the globe.
• Conglomerate firms have interests in many sectors.
Organizational Forms
• Joint ventures
- the various partners own less than 100% of the equity of the joint
venture firm
- Collaborative arrangements exist in automobile industry,
- While these kind of arrangements reduce risks and realize economies of
scale in research, they also promote tendencies towards concentration
and oligopoly
• Strategic alliances
are partnerships between separate, sometimes competing
companies.They are drawn together because each needs the
complementary technology, skills or facilities of the other; but the
scope of the relationship is strictly defined, leaving the companies free
to compete outside the relationship.MNCs are engaged either in
extraction (extract raw material), or in manufacturing (manufacture
consumer goods, high technology), or more recently in services (such
as insurance or banking)
Mergers & Acquisitions
• Greenfield Investment
• Building new facilities from the ground up.
•
•
•
•
Cross-Border Acquisition
Purchase of existing business.
Cross-Border Acquisition represents 40-50% of FDI flows.
Cross-border acquisitions are a politically sensitive issue:
• Greenfield investment is usually welcome.
• Cross-border acquisition is often unwelcome.
Strategic alliances
Benefits
•
•
•
•
•
Economies of scale
Technology development
Risk reduction
Shaping competition
New market opportunities
Risks
•
•
•
•
Imbalance of benefits
Imbalance in commitment & motivation
Communication problems
Conflict between partners
Class topics
1. The main strands of analysis in the international
business literature.
2. The market power approach.
3. The internalization approach.
4. The eclectic paradigm.
5. Competitive international industry and resource-based
approaches.
6. Macroeconomic and developmental approaches.
7. Distinguishing types of foreign direct investment and
locational issues.
8. Strategy and organization of the multinational
corporation.
9. Subsidiary level analysis.
10. Strategic alliances and international mergers and
acquisitions.
Lecture 4
American Economy
Definition of the New Economy
 the productivity revival that occurred in the
United States mostly in the second half of
the 1990s,
 knowledge becomes a factor of production,
and information and communications
technologies are developed to an extent that
makes all sectors of the economy more
productive.
 the institutional changes that were necessary
for the firm’s accommodation to the digital
economy, the organization of the firm, the
nature of industrial competition, etc., which
are transforming commerce, the economy,
and society.
The Key New Economy Issues
• “…to reduce costs, to coordinate large-scale
operations, and to provide new or enhanced
services, American firms have been investing in
information technology at a furious pace. Indeed,
business investment in computers and peripheral
equipment, measured in real terms, jumped more
than four-fold between 1995 and 1999(p.3).” That
corresponded with rebounded labor productivity
and a growth of output per labor hour at roughly a
2.5% annual rate between 1995 and 1999.”
Sichel and Oliner, 2000.
• “Capital input has been the most important
source of U.S. economic growth throughout
the postwar period…The contribution of
capital input since 1995 has boosted growth
by nearly a full percentage point. The
contribution of IT accounts for more than
half of this increase…..” (Jorgenson, 2001,
p. 2)
Other Factors
• Deregulation of financial and other
industries probably added stability.
• Greater competition in airlines, banking,
etc., likely enhanced productivity growth.
• Improved macro policies always help
stability.
Globalization may well reduce instability as
healthy foreign markets reduce our dependence on
domestic consumers. Imported resources and
products reduce inflationary pressure in domestic
markets.
• Globalized capital markets are broader and more
liquid.
• Why did the US economy shift from
noncompetitive in the 1980s to a model of a “new
economy” in the 1990s ?
• The New Economy is also worthy of attention for the right
things it did and remains capable of doing. Computers add
value not only in the area of numerical calculation. It is
their symbol processing capacity, as opposed to their
number crunching capacity, that will cause computer
applications to produce complementary innovations far
into the future. IT encourages complementary
organizational investments in business processes, enabling
cost reductions and increased output quality. Brynjolfsson
and Hitt (2000)
How IT Added to Productivity
Growth in the Nineties
• – A robust conclusion was that IT only contributes
to productivity growth when accompanied by
business process innovation
• – The way IT contributes to productivity is very
different across industries and even sub sectors
• – This means IT applications must address
sector-specific business processes and be linked to
performance measures
The Internet’s Growing Contribution
The Internet
• reduces transactions costs in the distribution of
commodities and consumers,
• increases management efficiency, especially in
facilitating more effective communications and
supply chain management, and
• increases competition, especially by rendering
prices more transparent.
Characteristics of the New Economy
• Heavy investment in IT (investments rose 28% per year in
1995-2000 in U.S.; since IT prices fell, the real (priceadjusted) IT investments rose from $15 billion in 1990 to
$300 billion in 2000, an increase of 20 times)
• Global economy (global communications and global
capital markets, global supply chains and global standards)
• Innovations in engineering and manufacturing, as well as
in banking and finance and business operations.
• Accelerated productivity growth (in U.S., 1.4% p.a.
increase in 1973-95 and 3.1% increase in 1995-2000)
Conclusion
1990s: American Economic Boom
• Deregulation of markets (airlines, banking and finance)
• Leap-frogging IT technology (computers, semiconductors,
telecom equipment)
• Accelerating productivity growth (matching of IT and
computer software with business processes)
• Global supply chains (outsourcing of services and
manufacturing)
• Fiscal restraints (reduced budget deficits in US and EU)
• Increased credibility of central banks
U.S. Private Investment in IT, 1960-99
•
•
•
Year
•
•
•
•
•
•
•
•
•
•
•
•
1960
1970
1975
1980
1982
1984
1986
1988
1990
1994
1998
1999
•
Source: Table B-16, Economic Report of the President, 2000, p. 326
and own calculations.
PFI*
IPE*
IPE/PFI
(Private
(Information
(IPE as
Fixed
Processing
% PFI)
Investment) Equipment
and Software
75.7
4.9
6.47
150.4
16.7
11.10
236.5
28.2
11.92
484.2
69.6
14.37
531.0
88.9
16.74
670.1
121.7
18.16
740.7
137.6
18.58
802.7
155.9
19.42
847.2
176.1
20.79
1034.6
233.7
22.59
1460.0
356.9
24.45
1577.4
407.2
25.81
IE*
(Industrial
Equipment)
9.3
20.2
31.1
60.4
62.3
67.6
74.8
83.5
91.5
113.3
150.2
151.4
IE/PFI
(IE as %
of PFI)
12.3
13.4
13.2
12.5
11.7
10.1
10.1
10.4
10.8
11.0
10.3
9.6
1980s Investments and 1990s Boom
• In 1970, total private gross fixed investment below
15% of GDP.
• It increased to 16.4% in 1974, to 18.8% in 1979,
then stayed around 17 or 18% until the mid-1980s.
• By 1989 it was back down to 15.3 and by 1994 to
14.6% of GDP. So these expenditures were
substantial from about the mid-1970s into the
1990s.
• Although perceptions as to the drivers of
productivity growth differ, Baily interprets the
literature to anticipate a near term productivity
trend which will likely run from 2 to 2.7 percent
per year. That level of productivity growth would
permit GDP expansion at a rate of 3.0 to 3.7
percent a year. The important shift in the U.S.
economy of the 1990s can be expected to continue
with productivity growth remaining strong.
• Downsizing and rationalizing would
improve stability, as would other
characteristics of the new economy, e.g.,
• Improved inventory control
• The service economy is more stabile than
the declining manufacturing and
construction industries
• Intensive competition increases static efficiency
by driving out slack management practices.
• It promotes the entrance of high productivity
enterprises and the exiting of low productivity
enterprises from the market.
• It encourages innovation on the part of companies
competing to survive.
The “New Economy” ICT Boom
Didn’t Happen in Isolation
The “triangle approach”
– Why the ICT investment boom and bust?
– Stock market: causes and effects
– Economic factors: productivity growth,
inflation, monetary policy
Component 1: Innovation and Hitech Investment
• Virtuous Circle, Positive Feedback Loops
– Acceleration of Hi-Tech Innovation, e.g.Internet, WWW,
Mobile telephones, telecom infrastructure
– Investment boom fed GDP Growth
– Investment boom and GDP growth together generated stock
market boom and bubble
• the economy has changed in terms of its fundamental structure
and, of less significance
• changes have produced a boom
– The boom has recently been approaching either a new phase or
an end.
• So, have fundamental changes permanently altered the nature of
and prospects for growth and change?
Component 2: Stock Market Boom
and Consumption
• Fast GDP Growth stimulated growth in
income and consumption
• Fast GDP Growth and hi-tech “bubble”
caused stock market to triple 1995-2000
• Stock market boom created “wealth effect”
that allowed consumption to grow faster
than income
Stock Market reduced Saving and
Boosted Consumption
Household Savings Rate and the Ratio of the S&P 500 to Nominal GDP
12
180
160
Household savings rate
10
Household Savings Rate
8
120
100
6
S&P 500 / Nominal GDP
80
4
60
40
2
20
0
1970
1975
1980
1985
1990
1995
2000
0
2005
S&P 500 to Nominal GDP Ratio (1972=100)
140
Component 3: Productivity Revival
and Low Inflation
• Productivity Growth Doubled, 1973-95 to
1995-2000
• Fast Productivity Growth Held Down
Inflation
– Real wage growth fell behind
– Growth in unit labor costs was minimal
Causes of Low Inflation despite Fast Output
Growth and Low Unemployment
• Positive “Demand Shock” should have
pushed inflation up
• But offset by beneficial “Supply Shocks”
–
–
–
–
Productivity revival
Strong dollar, falling real import prices
Low oil prices before 1999
Medical care “Managed Revolution”
Effects of Low Inflation
• Normally low unemployment would create
faster inflation, cause Fed to tighten
monetary policy
• With low inflation, no need to tighten
• No change in interest rates, 6.0 percent in
late 1994, 6.5 percent in mid-2000
The New Economy in the US
• Development of the internet economy is the most
important feature of the 1990s boom.
• The service sector provides the largest number of
jobs and generates nearly two-thirds of GDP in the
United States.
• Knowledge-based industries, e.g., finance,
insurance, business, legal and other professional
services have led the growth of the services sector.
• High tech industries have been the leading growth
sector recently.
Key elements of the “new business models”
of the 1990s
•
•
•
•
Vertical specialization
Outsourcing of more & more functions, esp. production.
High rates of new-firm formation.
R&D collaboration among firms; between firms and
universities; between firms and public labs.
• IP protection and strategy are more important.
– Markets for technology often underpin R&D collaboration, vertical
specialization.
• “Science-intensity” of innovation has increased in some
sectors (biotech, IT).
– Fed R&D investment an important complement.
Economists on the US economy in
1980s & 1990s
• “…American industry is not producing as well as it
ought to produce, or as well as it used to produce, or
as well as the industries of some other nations have
learned to produce…if the trend cannot be reversed,
then sooner or later the American standard of living
must fall.” (MIT Commission, 1989)
• “In recent years, the US economy has grown at a
surprisingly fast pace, in a phase of expansion that
started nine years ago and constitutes its longest-ever
recorded period of sustained growth…US per capita
income is now moving even further ahead of other
OECD countries.” (OECD, 2000)
What happened in the US?
• In high-tech in particular, US firms improved performance,
but did not move ahead of performance of foreign firms in
semiconductors, other products.
• Instead, US firms succeeded in developing new products,
new services, and new business models in software,
Internet, hardware, biotech, genomics.
– Much of the production of new products handled by other, often
Asian, firms.
• Sources of “weakness” during the 1980s were cited as
sources of competitive revival during the 1990s:
– Venture capital
– New-firm formation.
Capital Market and IT
• In the first half of 1999, the venture capital
industry raised $25 billion at an annual rate.
– Over $16 billion, went to the IT sector,
– $12 billion went into Internet companies. In terms of
market capitalization.
– the IT hardware sector now accounts for about 14
percent of the US total. (A decade ago only six percent.)
– Software component c. 9 percent was only two percent
in 1989. Of total value of U.S. stocks, internet sector
stocks represent about 4 percent.
Computers and Technical Change
• Diffusion of computer-based technologies
due to rapid decline in computer prices.
• Jorgenson and Stiroh: this resulted not in
economy-wide technical change (creating
greater output from the same inputs), but in
massive substitution of computers for labor
and other inputs in home and business
sector use.
Computers and Technical Change
• Since 1990, computers responsible for c. one sixth of
annual 2.4 percent output growth.
• Computers represent c. 20 percent of the capital inputs
contribution to growth,
• They represent 14 percent of the services contribution of
consumer durables.
• Computer-related gains are fundamentally changing the
economy
– not by producing general growth spillover effects
– but returns to IT investments are captured by computer
users themselves as they substitute equipment for other
inputs.
Trade’s Role in the 1990s Boom
• The US economy increasingly open
– The ratio of exported and imported goods and
services to the GDP, the US reached 29.3% in 1998
(Japan’s at 18.1%). Heilemann et al indicate the
openness ratio of the Euro-Zone, calculated
exclusive of intra-EU trade, would not be much
higher.
– U.S. trade with the developing countries (40% of the
total) significantly larger than Germany’s (16%);
– American trade with transition countries only about
one percent, Germany’s about 10 percent.
Trade’s Role in the 1990s Boom
• U.S. exports in recent years a prime driver of
economic growth, but exports have not increased
as rapidly as imports.
• Huge, long-standing trade deficits due to
– modest prices of petroleum imports before 1999 OPEC
rejuvenation, and
– more than robust consumer demand.
– Dollar appreciation on foreign currency markets
Stock Prices, “Wealth Effect ”and Savings
• The ”wealth effect” comes from increasing
share prices. It encourages consumption by
providing an alternative form of wealth
accumulation. Why would one need normal
savings when the value of one‘s stock
holdings increases continually. Thus, private
savings in the U.S. even became negative
towards the end of the boom.
Stock Prices, “Wealth Effect” and
Savings
• Beginning in 1990, U.S. households’
real net worth increased by $15
trillion, or by more than 50 percent.
Of total wealth creation in the 1990s,
more than 60 percent came from
rising stock values
Foundations of Economic
Reorganization: Strategic Investments
in the U.S
• Excess capacity generation into the 1970s,
• Stock prices depressed with underutilization of the
capital stock;
• little demand for products of obsolete
technologies.
• Nevertheless, managers refused to downsize,
continued to invest. The result was share prices
remained low and unproductive assets
accumulated.
Growing Need for Restructuring
• In the 1960s, large conglomerates formed.
• Separate and disparate businesses under single
management, but information dispersed in
separate corporate divisions.
• Competitive managerial outsiders noted low ratio
of share prices to corporate assets in excessively
large and unmanageable firms
• With prices low and assets large, they could
leverage takeovers, produce greater profits and
higher share prices.
1980s Mergers and Acquisitions
• This was not merely an expression of corporate
greed, but a preparatory period of industrial
restructuring.
• Many inefficiently managed firms forced to exit
the industrial scene. The effect?
– The value of public equity more than doubled (from
$1.4 to $3 trillion in a decade),
– a decline in productivity was reversed,
– real income was increased over the period by about a
third,
– record levels established for R&D
Do factors promoting growth
also promote stability?
• Zarnowitz (1999) evaluates whether certain
factors promoting productivity growth also
promote greater economic stability.
– Downsizing and rationalization stabilize the economy.
But through cost-cutting and more effective production,
effective downsizing leads to growth and, ultimately, to
subsequent opportunities for ”upsizing.” Inflationary
pressure may also return with recovery, with upward
wage adjustments and associated inflationary pressure
following.
Do factors promoting growth
also promote stability?
• Breakthroughs in information technologies are
thought to stabilize the economy. They induce
increased investments and increase business
profits.
• But these productivity-enhancing effects have yet
to be documented quantitatively, any specific link
between information technologies and the stability
of economic growth remains unclear.
Do factors promoting growth
also promote stability?
• Improved inventory control, especially
through just-in-time management
techniques, helps to stabilize the economy.
• But Zarnowitz finds that constant dollar
inventory investments in the 1990s
remained about as ”volatile and as cyclical”
as in the past.
Do factors promoting growth
also promote stability?
• The growth of the service economy adds
stability, since the more volatile
manufacturing and construction sectors
have declined in significance.
• This is probably true, but with growing
international competition in services, they
are also becoming more cyclical.
Do factors promoting growth
also promote stability?
• Deregulation of financial and other industries
is believed to have added stability. More
competition in airlines, trucking, banking, etc.,
has enhanced productivity growth
• But it is unlikely that further deregulation will
promote further stability.
Do factors promoting growth
also promote stability?
• Discretionary macro policies could also be the
source of greater cyclical stability. Macroeconomic control through interest-rate adjustments
has been quite effective in recent years as
compared to the earlier effort to manage money
growth.
• But policy agents cannot always anticipate and
avert business recessions or financial crises, and
policies can still be ”wrong, mistimed, or bungled”
Do factors promoting growth
also promote stability?
• Finally, globalization has reduced instability
– Importing many resources and products reduces
domestic inflationary pressure. Foreign markets
reduce dependence on domestic demand for
prosperity.
– Globalized capital markets are broader and more
liquid, reducing the risk of bubbles and crashes.
• At the same time, added stock market volatility
and the economy’s vulnerability to financial and
currency market instability is greater (Asian crisis).
Weaknesses AND
Potential Problems
• Savings Rates low due to wealth effect
• High consumption, high imports and high levels of
personal indebtedness. When will expectations
change.
• Increasing energy prices spill over and drive up
the prices of numerous other products
• Increasing tightness in labor markets prompted
interest rate increases by the Fed after mid-1999
Complementary developments in the
broader economy & policy
• US gov’t policy:
– Macroeconomic policy & budget surpluses support lower interest
rates, in contrast to the 1980s.
– Trade & investment liberalization in global markets.
– Domestic & international IPR strengthened.
– Sectoral policies (SEMATECH): Limited in scope and effect.
• Huge investment boom through the 1990s propelled IT
industry, contributed to a “bubble.”
• Restructuring of US R&D system: Roles of universities,
industry, gov’t all change in size, scope.
IT and all nonresidential fixed investment, 1987-2001
1400
1200
billions of 1996$$
1000
800
Nonresidential fixed investment
IT investment
600
400
200
0
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
year
IT investment share of total nonresidential fixed
investment, 1987-2000
0.9
0.8
0.7
shar e
0.6
0.5
0.4
0.3
0.2
0.1
0
1987
1988
1989
1990
1991
1992
1993
1994
year
1995
1996
1997
1998
1999
2000
US research univ. patents % of all domestic-assignee US patents, 1963 - 99
0.04
0.035
0.03
0.02
0.015
0.01
0.005
year
19
99
19
97
19
95
19
93
19
91
19
89
19
87
19
85
19
83
19
81
19
79
19
77
19
75
19
73
19
71
19
69
19
67
19
65
0
19
63
share
0.025
federal & nonfederal shares of national R&D spending, 1953-2000
80.0
70.0
60.0
nonfederal share
40.0
federal share
30.0
20.0
10.0
0.0
19
53
19
56
19
59
19
62
19
65
19
68
19
71
19
74
19
77
19
80
19
83
19
86
19
89
19
92
19
95
19
98
share
50.0
year
Industry-funded basic/Total industry-funded R&D, 1953-2000
0.1
0.09
0.08
0.07
0.05
0.04
0.03
0.02
0.01
0
19
53
19
55
19
57
19
59
19
61
19
63
19
65
19
67
19
69
19
71
19
73
19
75
19
77
19
79
19
81
19
83
19
85
19
87
19
89
19
91
19
93
19
95
19
97
19
99
share
0.06
year
Venture capital disbursements, 1980-2000
16,000.0
14,000.0
10,000.0
8,000.0
biotechnology
6,000.0
communications
computer hardw are
4,000.0
2,000.0
0.0
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
nominal $$
12,000.0
year
The post-2000 US economy: “new” or
“old”?
• 2000-200? US recession is driven largely by a collapse in
business investment, which in turn reflects IT investment
downturn.
– Differs from previous post-1945 recessions, most of which were
caused by downturns in consumer spending.
– This “new economy” recession resembles the business cycles of
the 19th century.
• Other “new” elements remain:
– US productivity growth remains higher than during 1980s/1970s.
– Other elements of the new business models (vertical specialization,
IPR, collaboration) remain important.
– Relatively high levels of income inequality.
Annual growth rate, US business-sector labor
productivity, 1899-2001
3.5
annual % gr owth
3
2.5
2
1.5
1
0.5
0
1899-1948
1948-73
1973-90
years
1990-99
2000-01
I. Current Productivity
and Economic Performance
The American Decade
• Porter (1990) wrote that a government’s role
in generating international competitiveness
was a vital ”if not the most important
influence in national economic performance.
The policies of the Japanese and Korean
governments were ”associated with the
success these nations’ firms have enjoyed”
The Boom of the Nineties
• Fiscal policy restrictive, monetary policy
accommodative.
• The longest period of economic expansion in U.S.
history,
– declining unemployment
– wage and price stability,
– rising productivity, and
– strong economic growth.
– Productivity growth in the U.S., reports
Krugman ,has accelerated, perhaps from 1 percent
per annum to 2 percent or more.
The Boom that Followed
• The boom of the 1990s was fundamentally
different from preceding ones. The long
expansions of the 1960s and 1980s had been
flawed by
– inflationary tendencies when employment levels
were high, or
– had high levels of both inflation and unemployment.
– 1980s boom had huge federal budget deficits (expansionary fiscal policy)
– tight monetary policy response to the inflationary
seventies.
Looking ahead
• Post – 9/11 US federal R&D budget may shift toward
defense.
• US macroeconomic policy is reverting to high-deficit,
(potentially) higher interest rates, reversing posture of the
90s.
• US firms have demonstrated consistent strength in
pioneering new technologies & business models, much less
strength in maintaining strength against strong competition
from other nations.
• Many elements of these new business models can be
imitated by non-US firms.
– What elements of competitiveness are less mobile?
Again, what is a “new economy”?
• The use of the expression “New Economy,” when
limited to a few, glamorous high-tech sectors, is
misleading.
• We have in fact only one economy. If the new
sectors of the economy do not interact with and
change economic processes in the old sectors,
creating a whole new economic structure, we
should not talk of a New Economy.
What is its future?
• Even if the New Economy is not recession proof,
it will not disappear in a slowdown. The internet
economy and its companion, the relentless process
of globalization, are here to stay. They will be the
basis of recovery, of expansion, and of future wellbeing.
• The benefits of the service and internet economy
will continue to spread, affecting partners and
competitors of the US globally.
What is its future?
• Even if the New Economy is not recession proof,
it will not disappear in a slowdown. The internet
economy and its companion, the relentless process
of globalization, are here to stay. They will be the
basis of recovery, of expansion, and of future wellbeing.
• The benefits of the service and internet economy
will continue to spread, affecting partners and
competitors of the US globally.
What is its future?
• New technologies and the ratio of IT and high- tech
products to the BIP is lower in the EU than in the US, and
the contribution of these new sectors to EU national
growth is also smaller.
• But internal European market growth, with continuing
liberalization and deregulation, will increase
competitiveness and dynamism.
– Note the European Commission’s initiative ”eEurope 2002" to
use the internet as a more integral part of education and ecommerce.
• A parallel development is the Euro
Semiconductors
• Why did the structure of the US industry differ so
markedly from those of other nations’ semiconductor
industries?
• Why & how did US semiconductor firms regain global
dominance during the 1990s?
• What are the strengths and weaknesses of the “fablessfoundry” model of competition that is emerging in the
global semiconductor industry?
• What does the “fabless-foundry” model mean for the
geographic location of production, design, and R&D?
• Why has the 2000-03 downturn been so severe?
Lecture 5
Japanese economy
Japan GDP
High Growth of 1955-62
• Large investment in heavy industry
• Imports of energy and raw materials
• Government’s economic goals:
–
–
–
–
achieve economic self-sufficiency
achieve full employment
improve export competitiveness
keep domestic demand high
High Growth of 1963-73
• Government’s “doubling income” plan
– Large-scale infrastructure construction
• Shinkansen (bullet train)
• Labor-intensive to capital-intensive
– Technological improvement and facility modernization
under government protection
• Aggressive export strategy
– Businesses compete with foreign counterparts under
government protection
Japan and USA
Appreciation of yen
More shocks in 1990s
• Large and rising government deficit and
debt (~150% of GDP)
• Aging population
• Banking crises and non-performing loans
• Asian financial crisis (1997-8)
• ``Hollowing out” of industry
Japanese Model of Economic
Development
State guides economy and growth
State allocates resources
Export led growth
Banking Systems
High Levels of Corruption
Investment Boom
Japanese slowdown
The poor performance of Japan
during the 1990s
• Post-bubble collapse exacerbated by policy failures in
Japan.
– Monetary policy failed to prevent deflation.
– Failure to restructure banking system remains a drag on larger
economy, preventing restructuring of firms.
• Japanese firms failed to exploit new business models.
– Entry by new firms much less common than in US.
– Vertical specialization much less developed.
– Sectoral initiatives (ASET, SELETE): little effect.
• Manufacturing competition from China & elsewhere in
Asia has intensified.
Japanese economy and FDI
• The globalization spurt of the Japanese economy in the
second half of the 1980s was not driven by trade but by
internationalization of production. FDI by Japanese
companies in foreign countries increased twenty-fold (in
nominalterms) from 1980 to 1990. Its share of worldwide
FDI outflows increased from 5.1% in 1980 to 20.2% in
1990. Certainly, these numbers overstate the increase,since
FDI flows are very volatile and 1990 was the peak year of
Japanese companies’ foreign investment.
However,comparing five year averages for Japanese
outward FDI of the first and the second half of the 1980s,
outward FDI flows in the second half were still 7.7 times
higher than FDI flows in the first half.
• In the second half of the1980s, the first heyday of
globalization, Japanese companieswere the largest source
of FDI worldwide.The 1990s have seen a relative and an
absolut decline of Japanese outward FDI activities in the
first half of the decade,and a strong increase since 1997
(METI, 2001). Inward FDI remained very low over the
whole period. It didnot show an increase until very recently.
But the advent of the international cross-border merger
activity has almost doubled Japanese FDI inflows in 1999
and in 2000.
• Like Japanese trade structure, regional and
sectoralcompositions of FDI have become similar
to structuresof FDI flows and stocks of other
developed countries.Starting with high shares of
FDIstocks in Asia, the 1980s brought about a
change in the direction of activities towards
developed countries. Their share has increased
from about a third to about 70%.The shares of
outward FDI flows which have been directed
towards the EU and Nafta were even higher,
peaking at 71.5% in 1990.
• The largest share was invested in the United States
but European countries received a large amount of
FDI as well. Among the European countries, the
United Kingdom has attracted most Japanese FDI.
The NIEs’ share4 has remained stable, but
ASEAN countries5 and others have lost shares to
the EU and NAFTA.6 The change in the regional
distribution came along with changes in the
sectoral composition of FDI flows of Japanese
companies.
• In the 1990s, China received more Japanese
FDI than before, in absolute terms and
relatively to other countries. NIEs’ share has
fallen slightly in the 1990s, ASEAN’s share
was stable over the whole decade, after a
spurt in the early 1990s up to the Asian
crisis, when these countries attracted about
10% of Japanese FDI outflows.
• Besides the smaller share ASEAN countries received after
the crisis, the revaluation of invested capital stocks due to
the strong devaluation of the currencies in some of these
countries contributed to falling shares of ASEAN in total
Japanese outward FDI stocks in the late 1990s.European
countries and the United States further gained shares in
Japanese outward FDI, although not at the same high speed
as in the 1980s and not at the speed expected (and feared in
Europe and the United States) at the beginning of the last
decade. In 1999, Japan showed the same regional pattern
as other OECD countries, 70% of FDI stocks are intraOECD positions.
• Japanese outward FDI stocks had grown tenfold in the 80s
from 16.9 billion US$ in 1980 to 201.4 billion US$ in
1990. Until 1999, the stock rose to 249.1 billion US$, an
increase of about 25%, which is less than the growth of
total FDI worldwide in the 1990s (UNCTAD, 2000).
Furthermore, inward FDI remained very low. Truly global
competition takes place on all markets including the home
market. But foreign companies have invested less than a
fifth of the amount in Japan that Japanese companies have
invested in foreign countries. This gap emerged in the
1980s and could be closed only partially in the 1990s in
spite of efforts to stimulate inward FDI. Over the whole
period, the ratio of inward to outward FDI stocks was
much lower than in other developed countries.
Ratio of inward direct investment to
outward direct investment 1999 (%)
•
•
•
•
•
Japan 18.5
United States 102.5
United Kingdom 70.3
Germany 35.7
France 84.5
Source: Bank of Japan (2000)
Lecture 6
German Economy
Output growth in Germany has been
lacklustre in 1990s
• Since the mid-1990s, output growth in Germany has been
lacklustre: between 1995 and 2001 growth averaged 1.6%
per year. This is almost 1 percentage point below that of its
partner countries in the EMU/EU area, even if the faster
growing countries (i.e. Spain, Ireland, Portugal and Greece)
are excluded from the comparison. The only year where
this gap was notably smaller was 2000 when an
unprecedented export boom propelled output expansion
close to the European average. But the growth momentum
faltered again in 2001 as the international economy slowed.
With the German economy relapsing into slow motion the
growth gap re-emerged and there are little signs that this
would change in 2002.
• … and the economy has proven highly vulnerable to
external shocks.Subdued economic activity has been
accompanied by a strong volatility of output growth. The
most recent downturn in 2001-02 completes already the
third full cycle since the recession of 1993. For each of
these three cycles the downward movement was triggered
by an international crises, in particular the Mexican crisis
in 1994, the Asian crisis in 1997/98 and the oil price hike
in 1999/2000. Although Germany’s European partners
were also adversely affected by these shocks to the world
economy, output growth of these economies proved much
more resilient.
This is due partly to long-lasting
effects of re-unification, …
• Slow growth of domestic demand, essentially of private
consumption and construction investment, is the key factor
behind the weakness of GDP growth in Germany. On the
supply side, this weakness is reflected by a very low
contribution from employment to output growth. Longlasting effects of re-unification seem to play a pivotal role
in the twin phenomenon of sluggish domestic demand and
job growth. Indeed, re-unification brought together one of
the most advanced economic areas of the world with an
area of low productivity, state-protected companies,
artificial exchange rates and an almost obsolete capital
stock. 1:1 was the conversion rate of the East German
mark into the DM, while the exchange rate applicable for
East German exports had been at 1 to 4.3.
In addition, in the initial years eastern wages
rose far beyond productivity gains.
• This was due partly to the specific wage
bargaining situation, where labor unions and
employers’ associations from the West oversaw
the negotiations in the New Länder, but also to
political reasons such as equality consideration
and the attempt to prevent a massive outward
migration. The consequence was a near collapse of
those sectors of the economy that were exposed to
West-German and international competition,
particularly the manufacturing sector, with a
dramatic labor layoff and skyrocketing
unemployment as a result.
with the construction sector in
the East particularly affected
• In spite of this, in the initial years after reunification output growth in the New Länder was
higher than in the West. In part this is explained by
a catching-up effect following the drastic fall in
output at the start of re-unification. But even more
so it was the result of the effect, with the building
sector giving a disproportional contribution to
growth in the New Länder in the first half of the
1990s.
Reconstruction needs related in
particular to the area of infrastructure
• This was partly due to reconstruction needs related
in particular to the area of infrastructure, but it
also resulted from very generous fiscal incentives
for both business and housing construction. When
in the mid-1990s infrastructure investment
levelled off and fiscal incentives were reduced,
construction investment in the New Länder
decreased, imparting very negative contributions
to growth ever since. As a consequence, growth
rates in the East have fallen short of those in the
West from the mid-1990s onwards.
Sharp tax increases to finance huge
transfers to the East …
• Economic growth has also been affected by the large
financial burden re-unification imposed on the country.
These transfers have been used to finance the
reconstruction of the eastern economy and, even more
importantly, to pay for the large deficits in the social
security systems of the New Länder which resulted mainly
from very high unemployment levels. These transfers have
amounted to some 4% of GDP per year in net terms ever
since re-unification. Initially, they were mostly financed by
allowing budget deficits to increase, but when the
budgetary situation risked to become unsustainable taxes
raised and social security contributions cut sharply.
Although most other European countries also witnessed a
rise in the tax burden in the early 1990s, in Germany this
increase was particularly strong.
Cost-competitiveness suffered in
the first half of the 1990s …
• Re-unification also contributed to the deterioration
of Germany’s external competitiveness in the first
half of the 1990s. Although the overall
competitiveness of a country is a complex notion,
which is difficult to measure, it is evident that the
cost competitiveness of Germany as measured by
relative unit labour costs declined strongly in the
first half of the 1990s.
wage increases much above productivity
• This was due to wage increases much above productivity
increases, especially but not exclusively in the East,
coupled with a strong appreciation of the D-Mark. The
decline in Germany’s competitiveness can be detected, for
instance, in the relative loss of export market shares
witnessed since re-unification. In particular, East German
firms are virtually absent from world markets, causing the
New Länder to run a trade deficit of enormous proportions.
Other indicators, such as a relatively low inflow of foreign
direct investment also point to a comparatively low
attractiveness of Germany as a business location.
while budgetary consolidation proceeded in
step with Germany’s European partners.
On the fiscal side, Germany had to follow a rather
restrictive budgetary stance in order to qualify for EMU
and comply with the provisions of the Stability and
Growth Pact. The budgetary strategy chosen in Germany
might have been more harmful to growth than in other
Member States as, in order to make up for the sharp rise in
social transfers, expenditure was drastically cut at the level
of government employment and investment. In conclusion,
in the second half of the 1990s the German policy-mix
followed a path similar to the one followed by its European
partners. If macro-economic policies were to be held
responsible for a differential impact on growth, it was
probably through the specific composition of the budgetary
consolidation process rather than the overall macroeconomic policy stance.
Structural factors may explain a significant
part of the growth gap …
• A significant part of the growth gap between Germany and
its partners is, therefore, left unexplained. The labour
market behaviour is an important factor behind a lower
than average growth rate in Germany after the mid-1990s.
According to DG ECFIN estimates, German potential
growth during the second half of the 1990s could have
been around 0.5 percentage points higher per year than the
Euro-area average. Most of this difference can be
explained by developments in the labour market. Two
factors, in particular, stand out, each explaining about one
half of the overall difference in potential growth. First, the
labour market participation rate has seen a more subdued
development in Germany than in other countries. On the
other hand, the estimated equilibrium unemployment rate
has remained rather stable in Germany, while it has trended
down in most other EMU/EU countries.
with rigidities in the labour market standing
out as a key factor
• It is a difficult task to pinpoint the exact
underlying factors, which account for the
different labour market experience of
Germany in comparison with other
European countries. Nevertheless, it seems
likely that a lack in labour market reform in
Germany lies at the root of these
differences..
Several impediments in the
German labour market
• Several impediments in the German labour market could
be identified which might have a dampening effect on
labour market participation and the unemployment rate: (i)
wages out of line with productivity due to the nature of the
wage bargaining process in Germany, especially for the
unskilled segment of the labour market, with the East-West
wage differentiation remaining a particular problem; (ii)
high marginal tax rates which, in combination with a long
benefit duration and high benefit rates for certain groups,
lead to significant unemployment traps; and (iii) a general
lack of flexibility and mobility
In general, however, labour market regulations in
Germany are not much higher than in most other
continental European countries. Differences in
outcomes are, therefore, most likely due to
differences in the evolution of structural labour
market impediments during recent years rather
than their level. In particular, while many
European countries made efforts to render their
labour markets more flexible, similar effort have
been largely missing in Germany.
While continuous reforms of product
and capital markets will be important…
• Although, in general, the growth potential of an economy
may be seriously constrained by product and capital
market rigidities, in comparative terms they seem to be of
lesser importance in explaining the specific growth
performance of Germany. Indeed, Germany has made
substantial progress during the 1990s in liberalising its
network industries. While state aid, which is mostly geared
towards large industrial companies and based on
subsidizing capital inputs, continues to act in a
distortionary way in various markets. On the other hand,
outdated regulations tend to limit the creation of jobs in
new types of activities, thereby reducing potential
employment. Indeed, this gap is exclusively explained by
the labour contribution to potential growth.
Labour market reform will be key to bring
Germany back onto a robust growth path.
Looking ahead, according to DG ECFIN estimates,
Germany is likely to have a medium-term growth
path of some 2% which compares with a potential
growth rate of close to 2½ % for Germany’s
EMU/EU partners. Germany would need to
undertake labour market reforms . Without a new
round of labour market reforms the German
medium term growth outlook is likely to remain
bleak.
Lecture 7
Developing Economies
Characteristics of developing
countries
• Characteristics are malnutrition, diseases, high
infant mortality, low life expectancy, and an
inefficient supply of public goods in, for examples,
the public health sector, schools and universities.
• Further characteristics are illiteracy, few
opportunities to earn a sufficient income, and
insufficient living and housing conditions.
Characteristics of developing
countries
• On the production side of gross national product, a
developing country is characterized by a primary sector
(agriculture , exploitation of natural resources) contributing
a relatively highly proportion of total national income and
of employment.
• Agriculture has a relatively low productivity and is often
economically discriminated against in favor of other
sectors like manufacturing .
• The manufacturing sector accounts for only a small share
of national income and of employment.
• Most of the population is characterized by a low income
per capital. There is no middle class, so that there is a big
gap between rich and poor.
Reasons for underdevelopment
• Excessive population growth
• Missing institutions
– the lack of efficient tax systems
• Lack of capital information
• No entrepreneurship
• National debt
– Latin America, have accumulated a high foreign debt.
• Vicious circle
Newly industrialized countries: a
broad spectrum
The term ‘newly industrialized countries’ is
becoming more accepted- such as Argentina,
Brazil, Chile , Mexico, Korea, Hong Kong,
Singapore and Taiwan.
Development strategies
• Import substitution
– Latin American development policy followed the
strategy of import substitution.
– This policy was directed at replacing imports by
domestic goods. The domestic sectors were supported
in their development and shielded against foreign
suppliers.
– Typical instruments of such a policy were protectionist
instruments like import licenses or import duties.
– This development strategy, which was predominant in
the 1950s and 1960s, at first seemed to be successful in
Latin America ,but from the mid-1960s onwards, the
problems became visible.
Development strategies
– Above all, the industrial sector developed very poorly.
• One reason was that the policy of import
substitution was associated with considerable
distortions. Intermediate goods became more
expensive because of import protection, and this
reduced the competitiveness of the export sector.
• Because of the protection from international
competition, the domestic producers did not feel the
necessary pressure to cut costs and to innovate.
– The system of import licenses opened the doors for
corruption.
Development strategies
• Export-oriented strategy
– The strategy was pursued by some Asian countries, can
be seen as an outward-oriented development strategy.
the objective is to expose the export sectors to
international between the export sector and the sector of
the import substitutes.
– In short, it tried to enhance domestic production by
intensive competition and by this to develop a
sustainable economic basis. The predominant
philosophy was that the world markets would offer
interesting opportunities to the domestic producers. The
exchange rate policy could prevent massive
overvaluations.
– The exports were an enormous stimulus for the process
of industrialization and economic development. They
provided the countries with high gains from trade and
made considerable real growth rates possible.
Institutional infrastructure
• The right of ownership
• A stable tax system
• The independence of the central
bank
Lecture 8
The Transitional Economies
Rebuilding a centrally planned
economy into market economy
• In the process of rebuilding a centrally
planned economy into a market economy,
there are three main areas of reform which
can be distinguished:
– the creation of a new institutional framework,
– macroeconomic stabilization
– the real adjustment of the firms and sectors on
the microeconomic.
Rebuilding a centrally planned
economy into a market economy
• The institutional framework
–
–
–
–
–
Law of contract
Law of enterprises
Property rights
Autonomy of the central bank
Creation of a tax system
Rebuilding a centrally planned
economy into a market economy
• Macroeconomic stabilization
– Monetary stabilization
• Inflation
• Currency reform and convertibility
• Tight budget restraint
• Reduction of government budget deficits
Rebuilding a centrally planned
economy into a market economy
• Real adjustment of firms
– Start of micro-reforms
•
•
•
•
Autonomy of firms
Abolition of the government export monopoly
Markets instead of central planning
Free market entry
– Implementation of micro-reforms
•
•
•
•
•
Freeing of prices (commodity and factor markets)
Free trade, no subsidies for tradable goods
Commercialization of firms
Privatization of enterprises
New enterprises
Change in central and eastern
Europe
• The fall of the Berlin Wall in November 1989
symbolically marked the beginning of a process of
radical transformation in CEE
• This process entailed different types of transition
– Political transition: From one-party states to democratic regimes
– Economic transition: From centrally planned socialist economies
to capitalist systems
– Identity transition: Represented by changes in national
allegiances
– Diplomatic transition: Integration or reintegration into a
‘Western-dominated’ international system
Political transition:
– From communist one-party states to democratic
regimes
• Successful in the Czech Republic, Hungary, Poland, Slovenia,
and, increasingly, Slovakia
• Baltic states close to that stage (question marks about the
treatment of minorities)
• Right track, but early stages: Bulgaria, Romania, and,
increasingly, Croatia
• Still far away: Russia, the Ukraine, Yugoslavia, Albania
• Plain dictatorships: Belarus
Economic transition (I):
– Serious difficulties in the passage from centrallyplanned to free-market systems
• Wholesale reform of how the economy is run
• Change in the attitudes and habits of economic agents
• End of central planning, of state support and subsidies to basic
industries
• Introduction of market institutions such as competition and
profit
• End of full employment and employment for life
• Introduction of ‘real’ trade
Economic transition(II):
– Two alternative approaches to economic transition:
• Shock therapy: Rapid demise of socialist economic institutions
and their replacement by market institutions (Poland and
Hungary, to a lesser extent)
• Gradual and incremental transition: step by step change of
institutions (Czech Republic)
– No system has yielded magical results
• Loss of economic weight of most CEECs
– Severe recession in the early 1990s
– Steep rise in unemployment
• Transition to capitalism has often implied the loss of one
generation’s worth of income (Fischer, Sahay, and Végh, 1997)
Economic transition (III):
– Weak economic situation across CEECs
• The republics of the former USSR have been especially hard
hit
• Although candidate countries, Turkey and the European
republics of the former USSR together have a population
which is similar to that of the EU-15, the size of their
economies put together represents less than the joint size of the
Dutch and Spanish economies
• The GDP per capita of candidate countries is lower than that of
the poorest member states in EU-15
– Economic transition is proving more complicated that
political transition
• Few CEECs have managed to achieve a full transition to a
market economy
The sequence of reform steps
• At the beginning of reforms, the creation of an institutional
framework is required. Central planning is replaced by
market allocation. The export monopoly of the state is
abolished, firms decide autonomously.
• In a second step these micro-reforms are implemented. The
pries on the commodity markets are liberalized.
Additionally, scarcity prices on the factor markets ate
established. The wage structure has to be adapted to the
new situation. After commercialization of enterprises,
privation has to start.
The sequence of reform steps
• Monetary stabilization must be tackled. This includes a
currency reform and an (at least partial) independence of
the central bank with the appropriate institutional
arrangement. In this phase, it is important to tighten the
budget constraint. Centrally planned economies were
characterized by ‘soft budget constraints’ for state
enterprises and for the state itself (Kornai 1980).
Enterprises received cheap credits and direct subsidies
from the national budget. This practice has to be given up.
As the government should be not be allowed to cover its
deficits with the help of the central bank any longer, a tax
system must be developed that allows government
expenditures to be financed by taxes.
The sequence of reform steps
• Finally, the economy has to adjust in real terms.
This means that the factor allocation within the
firms must be changed. The set of goods that is
produced and the sectoral structure have to adjust.
In principal, it is reasonable to carry out as many
reform steps as possible in a short period of time.
There is a bundle of essentials that has to be
introduced at once.
– The creation of an institutional framework, the
decontrol of prices, the opening of commodity
markets to foreign countries, the privatization of
enterprises and monetary stabilization must be put into
effect simultaneously.
Big Bang or Gradual Adjustment?
• Real wages in Poland (1990) and in the Czech Republic
(1991) fell by more than 30 percent within one year. The
quicker the necessary and painful steps of adjustment are
carried out of the ‘vale of tears’.
• As an alternative, a gradual approach was discussed in the
early literature on the transformation. The argument in
favor of the gradual approach was that the transformation
process would turn out to be less hard if the steps of reform
were stretched over a longer period of time.
Some central issues of economic
policy
• Privatization
– In the Czech Republic, the problem was solved by means of coupon
privatization: citizens received coupons which allowed them to buy
company shares at an auction.
– In Russia, coupons were used as well, but insiders of the enterprises got
preferential treatment.
– In addition, they could acquire shares under preferential conditions.
– Coupons were also used in most other transformation countries. In East
Germany, the trustee approach was applied : the enterprises were sold to
investors by a government agency.
– Privatization has probably reached the most advanced level in the Czech
Republic, where 80 percent of the gross domestic product originates from
the private enterprise sector. Poland (65 percent) and Hungary(80 percent)
are at a similar level.
Some central issues of economic
policy
• The tightening of the budget restraint
– The government cannot give the remaining staterun enterprises cheap credits through the banks any
longer, or only to a limited extent.
• Current account deficits
– In the Czech Republic and the Slovak Republic,
large current account deficits have been recorded
since 1996.
Some central issues of economic
policy
• Inflation
– The transformation process is often linked to a high
rate of inflation, not least due to the lack of an
institutional framework for the monetary system
and a loose monetary policy (Russia 1992-1994).
– The annual rate of inflation must be lower than 50
percent if a growth process is to begin.
Foreign trade aspects of
transformation
• Efficiency gains of foreign trade
– The opening up to foreign trade involves efficiency
gains from international exchange. The domestic
enterprises are exposed to international competition.
– Inefficient enterprises come under pressure from
imports.
– With the gains from trade, higher growth rates become
possible.
Foreign trade aspects of
transformation
• Capital inflow
– The opening up to foreign trade improves the prospects for
attracting foreign capital that can give significant new
growth momentum. Thanks to their liberal foreign trade
policies, Poland ,the Czech Republic and Hungary have
attracted considerable foreign direct investment,
comparable to that of Latin America and Asia. The share
of foreign direct investments in total gross investment, for
example, amounted to 20 percent in Hungary and
significantly more than 10 percent in Poland in 1992-1996.
Foreign trade aspects of
transformation
• Exchange rate policy
– Poland and the Czech Republic also underwent massive nominal
devaluations early in the transformation process.
– The excessive money supply in Poland was significantly larger
than in the Czech Republic, therefore the devaluation had to be
strong as well. In the Czech Republic, the macroeconomic
imbalance and foreign debt were relatively low at the start of the
transformation process and the country pursued a
consistently restrictive fiscal policy after its independence in 1993.
moreover, a wage restraint was prevalent at first, and capital inflow
from abroad increased quickly.
– Owing to a growing current account deficit, however, the Czech
crown had to be devalued in 1997.
Case study: the Transformation of
East Germany
• East Germany is a special case in the transformation process.
The creation of an institutional infrastructure, macroeconomic
stabilization and the economic adjustment in real term-were
realized practically overnight: by joining the Federal Republic,
the constitution and all other legal arrangements of West
Germany were taken over. The real economic adaptation is
therefore at the core of the transformation process in East
Germany.
• The population pressed for similar living wages and a quick
wage alignment. In this way, a wide gap opened up between
wages and productivity. This involved high unemployment and,
moreover, hampered investment. East Germany is also a special
case in the sense that, quite differently from the usual
transformation process, significant transfers were made. They
amounted to 5 percent of the gross domestic product of
Germany as a whole per year (‘big bang with a big brother’) .
Case study: the Transformation of
East Germany
• East Germany experienced a dramatic collapse of production.
Gross industrial production, fell to less than less than one third
of its of its former level. The low level of industrial production
after 1990, is partly due to a lack of comparable data. Starting
with 1992, an increase in net industrial production can be
decreased from 10 million by almost 5 million
• East Germany (including West Berlin) reached approximately 72
percent of the West German labor productivity level in 2000,
after approximately 30 percent in the new länder (without West
Berlin) in 1991. The gross wage and salary sum per employee
(including West Berlin) reached approximately 80 percent in
2000. An export basis is still being built up. If the results
concerning catching-up processes are analogously applied, we
have to conclude that a complete alignment will still take some
time.