Macroeconomics and the Global
Economic Environment
International Trade and Financial Flows
Professor Tim Landvoigt
TRADE IN THE DATA
2
1/1/2020
1/1/2018
1/1/2016
1/1/2014
1/1/2012
1/1/2010
1/1/2008
1/1/2006
1/1/2004
1/1/2002
1/1/2000
1/1/1998
1/1/1996
1/1/1994
1/1/1992
1/1/1990
1/1/1988
1/1/1986
1/1/1984
1/1/1982
1/1/1980
1/1/1978
1/1/1976
1/1/1974
1/1/1972
1/1/1970
Global Trade as % of World GDP
65
60
55
50
45
40
35
30
25
20
Source: World Bank, OECD
3
Exports and Imports for U.S.
4
Index of Openness
(imports plus exports as percent of GDP)
120
100
80
1990
60
2000
40
2010
20
2015
0
5
WHY DO COUNTRIES TRADE?
6
Why does anyone trade?
• Two important theories for the benefits / motives for trade
1. Specialization
– Is at the heart of any modern economy. Without specialization, TFP would be abysmal
– Much trade between developed economies is in intermediate, not final, goods
– Intra-industry trade as extreme form of specialization in widgets and gadgets
2. Variety
– Why does Germany import Korean cars and Korea import German cars?
– Clearly, this is not specialization, but taste for variety of the modern consumer
• Important lesson: international trade is really no different from trade within
a country.
7
Specialization and comparative advantage
• Trade allows us (countries) to specialize in what we are good at.
– What does Lionel Messi do when he plays professional soccer?
– He trades in his amazing abilities on the pitch for money. Then he uses the money to buy food,
clothes, cars, mansions, yachts, …
– Without trade, Lionel would live “off the grid” on a farm, make his own food, build his own
cars, perform his own dental surgery, …
• Specialization brings gains from trade even if someone (a country) is better at
everything because it allows us (countries) to focus resources on what we are
relatively good at.
– This is the notion of comparative advantage.
– Allows most efficient use of resources.
• International trade – by increasing overall production – can be viewed as a better
technology to combine capital and labor into output.
8
Comparative advantage – an example
• Two regions – North and South – produce apples and computers.
– Note: North is better at producing both goods; i.e. it has an absolute advantage.
• Each region prefers to spend half of its income on apples and half if its
income on computers.
9
Outcome under no trade (“Autarky”)
• Suppose that each worker supplies one unit of labor so that the wage 𝑤𝑤 is the
worker’s income.
• Workers want to spend half the income on apples and half on computers. We have:
Let’s normalize the
price of apples to
1. So the price of
computers, p,
denotes the cost
of a computer in
numbers of apples.
10
• Computers are relatively cheap in the North – i.e. the North has a comparative advantage
in producing computers. Similarly, South has comparative advantage in apples.
• If there was free trade, this would represent an arbitrage opportunity.
11
How to compute free trade solution?
1. Figure out comparative advantage
–
North has comp.adv. in computers, because computers cheaper there
2. Compute each region’s output under full specialization
–
South only makes apples, North only makes computers
3. Calculate wage in each country and world market prices of both goods
– There is no money in the model, so one good functions as numeraire – let’s use apples
4. Compute how much of each good a worker in each region consumes
• Details are in appendix slides and chapter 19.4 in Jones textbook
• Spreadsheet with example on Canvas that allows you to play around with numbers
12
Autarky: 80
Autarky: 1
• By specializing, global supply of apples and computers increases and
both regions are better off.
• Trade occurs even though the North has an absolute advantage in
both apples and computer production.
13
Is international trade a good thing?
• Gains from trade
– Specialization and comparative advantage
– Trade, in addition, often brings new technologies
• Costs from trade
– Relatively unskilled workers in high-productivity countries may lose their jobs and
retraining / relocation is difficult and costly
– Specialization can lock low-productivity countries into poverty trap
• Big issue: how to share gains from trade.
14
Who are the winners and losers of globalization?
• Winners
– Consumers – as trade increases overall productivity, consumers can afford more goods and
services with a given income.
– Workers in industries in which the country has a comparative advantage.
– Workers in regions of the country benefitting from trade.
• Losers
– Workers in industries in which the country does not have a comparative advantage.
– Workers in regions of the country not benefitting from trade.
• These effects are not particular to globalization but apply to increased
automation as well.
15
Manufacturing Employment and Globalization
16
Manufacturing Employment and Globalization
• Manufacturing employment declined by about 6 million from 2000 to 2010.
– Between 10 and 35% of this decline is estimated to be due to increased import competition after
China’s accession to WTO in 2000.
– This estimate does not take into account positive employment effects of the U.S. having access to
cheaper manufacturing goods.
• At the same time, manufacturing output increased substantially, due to a large increase in
labor productivity
– Manufacturing sector mostly shed low-productivity / low-skill jobs.
– High-skill / high productivity jobs have become more productive due to better technology and imports
of cheaper intermediates.
⇒ The manufacturing sector as a whole is not a loser of globalization but lower-skill workers
are; and much of the employment losses are not directly due to globalization but increased
automation.
17
Trade for Variety
• Not all trade is well characterized by comparative advantage
• Recall my initial example: South Korea imports some German cars and Germany
imports South Korean cars
• Lots of trade especially between advanced countries best understood as consumers’
desire to have a large set of product choices
• Little downside to this kind of trade
18
NATIONAL INCOME ACCOUNTING WITH NET
EXPORTS
19
Savings, investment and net exports
• National income accounting revisited
Y = C + I + G + (X − M )
(𝑌𝑌 − 𝐶𝐶 − 𝐺𝐺) + (𝑀𝑀 − 𝑋𝑋) = 𝐼𝐼
Domestic savings 𝑺𝑺 Foreign savings
NX = ( X − M ) = S − I
Net exports=
Trade balance
Net capital outflow
• If a country saves more than it invests domestically, its citizens invest some of
their savings abroad
• Then simple accounting implies the country is a net exporter
• Let’s take a look at the data and the official statistics
20
Current Account and Financial Account
• Current Account (CA) measures
– Trade in goods and services: exports (+) and imports (-)
– Direct factor payments
• corporate profits, dividends
• salaries, other labor compensation
• Financial Account (FA) measures
– Acquisition (+) of foreign financial assets by U.S. based entities
– Incurrence (-) of financial liabilities of U.S. based entities with foreign creditor
• Accounting identity: CA = FA
– Recall our simplified model: NX = S - I
21
International trade transactions settlement
• Trade implies payments
• Example: U.S. car dealership imports car from abroad. Price of car is $50k
• Consider two scenarios:
1. Transaction settled in kind: car dealer not only imports foreign cars, but also
exports U.S. cars. Pays for import of foreign car through equivalent-value export of
domestic car. Import and export offset each other, no net impact on CA or FA.
2. Transaction settled in dollars: foreign car manufacturer maintains U.S. dollar
account at U.S. bank. Gains 50k dollars, a liability of the U.S. bank. CA declines by
50k, and FA declines 50k.
• By the way, if you are not a U.S. resident, then I am exporting educational services to
you right now
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Financial Transactions
• Financial Account Loss (FAL) occurs when a foreign entity gains ownership of U.S.
assets or a U.S. entity loses ownership of foreign asset. Examples:
– A foreigner buys U.S. stocks  foreigner gains U.S. asset
– An American tourists spends foreign currency while on vacation  U.S. entity loses foreign asset
(NOTE: when you vacation abroad that counts as an “import”)
• Financial Account Gain (FAG) occurs when a U.S. entity gains ownership of foreign
assets or foreign entity loses ownership of U.S. asset. Examples
– U.S. corporation sets up factory abroad  U.S. entity gains foreign asset
– Foreign tourist spends dollars while vacationing in U.S.  foreigner loses U.S. asset
(NOTE: when a foreigner vacations here that’s an “export”)
23
Currency Exchange And Other Financial Transactions
• Currency exchange is neutral for financial account
• Example: U.S. bank uses U.S. dollars to buy Yen from Japanese bank
• Japanese bank gains U.S. dollars: FAL
• U.S. bank gains Yen: FAG
• These transactions perfectly cancel in Financial Account
• Many other examples of purely financial transactions that balance out within
Financial Account
24
Summary: Four Possibilities
• Thinking about cross border transactions can be confusing
• Big picture: there can be 4 types of transactions
1. Purely non-financial: export and import of equal value offset each other
 no effect on CA or FA
– Example: “pay” for import of car with export of equivalent-value car
2. Purely financial: FAG and FAL offset each other  no effect on CA or FA
– Example: currency exchange
3. Export: receive financial asset from foreigner as payment for export  CA up, FA up
– Example: export car and grant trade credit (accounts receivable)  Export + FAG
4. Import: pay for import by giving financial asset to foreigner  CA down, FA down
– Example: import car and incur trade credit (accounts payable)  Import + FAL
25
Line
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
Current Account from bea.gov
Current account (millions of USD)
Exports of goods and services and income receipts (credits) $
Exports of goods and services
$
Goods
$
Secondary income: receipts and
Services
$
Primary income receipts remittances of earnings across border$
Investment income
$
Compensation of employees
$
Secondary income (current transfer) receipts /1/
$
Imports of goods and services and income payments (debits) $
Imports of goods and services
$
Goods
$
Services
$
Primary income payments
$
Investment income
$
Compensation of employees
$
Secondary income (current transfer) payments /1/
$
2021
3,780,154.00
2,556,638.00
1,761,364.00
795,273.00
1,052,080.00
1,045,181.00
6,899.00
171,436.00
4,626,508.00
3,401,685.00
2,851,660.00
550,025.00
912,587.00
895,030.00
17,557.00
312,236.00
26
When confused about the
terminology, remind yourself of this
definition
19
Financial account (millions of USD)
Net U.S. acquisition of financial assets excluding financial
derivatives (net increase in assets / financial outflow (+))
$
1,278,599.00
20
Direct investment assets
$
421,749.00
21
Portfolio investment assets
$
719,095.00
22
Other investment assets
$
23,763.00
$
113,993.00
$
1,977,294.00
23
24
Reserve assets
Net U.S. incurrence of liabilities excluding financial derivatives
(net increase in liabilities / financial inflow (+))
25
Direct investment liabilities
$
448,325.00
26
Portfolio investment liabilities
$
676,112.00
27
Other investment liabilities
$
852,857.00
$
(41,902.00)
28
Financial derivatives other than reserves, net transactions /2/
27
How CA and FA net out … or not
Statistical discrepancy
29
Statistical discrepancy /3/
Balances
30
31
Balance on current account (line 1 less line 9) /4/
Balance on goods and services (line 2 less line 10)
If we had properly recorded all
transactions, these would be
equal, but some slippage in reality
“Trade deficit”
$
108,231.00
$
(846,354.00)
$
(845,047.00)
32
Balance on goods (line 3 less line 11)
$
(1,090,296.00)
33
Balance on services (line 4 less line 12)
$
245,248.00
34
Balance on primary income (line 5 less line 13)
$
139,493.00
35
Balance on secondary income (line 8 less line 16)
$
(140,800.00)
Balance on capital account (line 17 less line 18) /4/
$
Net lending (+) or net borrowing (-) from current- and capital-account
transactions (line 30 plus line 36) /5/
$
Net lending (+) or net borrowing (-) from financial-account transactions (line 19
less line 24 plus line 28) /5/
$
“Net borrowing”
(2,474.00)
36
37
38
(848,828.00)
(740,597.00)
28
US Net Debt Position Relative to GDP
The large trade deficits of recent decades have
made the U.S. a net debtor to the rest of the world.
The net debt exceeded 70 percent of GDP in 2021.
29
Is a persistent trade deficit a problem?
• As with any borrowing, the net debt has to repaid at some point and it implies
interest payments.
• Warren Buffet (2005)
“As time passes, and as claims against us grow, we own less and less of what we produce.
…Should we continue to run current account deficits comparable to those now prevailing,…our
U.S. ‘family’ will be delivering [a substantial fraction of] its annual output to the rest of the
world simply as a tribute for the overindulgences of the past.”
• Yet, so far, net income on foreign assets has been positive!
– How can that be?
• Under what circumstances does a negative net foreign asset position become a
problem?
30
Back to our simplified model
• National income accounting revisited
𝑌𝑌 = 𝐶𝐶 + 𝐼𝐼 + 𝐺𝐺 + 𝑋𝑋 − 𝑀𝑀
(𝑌𝑌 − 𝐶𝐶 − 𝐺𝐺) + (𝑀𝑀 − 𝑋𝑋) = 𝐼𝐼
Domestic savings 𝑺𝑺
Foreign savings
Current Account =
Trade Surplus
Financial Account =
Net Lending
𝑋𝑋 − 𝑀𝑀 = 𝑆𝑆 − 𝐼𝐼
31
PRACTICE QUESTIONS
32
Q1
Labor Force
Fish Production per Person
Chip Production per Person
West
100
200 kilos
100 kilos
East
400
60 kilos
20 kilos
Which of the following statements is true?
A. The West has an absolute advantage in the production of both fish and chips and
has a comparative advantage in the production of chips.
B. The East has an absolute advantage in the production of both fish and chips and
has a comparative advantage in the production of fish.
C. The West has an absolute advantage in the production of chips and the East has an
absolute advantage in the production of fish.
D. The East has a comparative advantage in chip production and the West has a
comparative advantage in the production of fish.
33
Q2
If a U.S. firm buys machines from a Japanese firm and the Japanese firm
uses the dollars it gets to buy French stocks, the U.S. current account
________ and the Japanese financial account ________.
A. Falls; falls
B. Rises; rises
C. Falls; rises
D. Rises; falls
34
APPENDIX
35
Autarky Solution
• Steps for North (same for South):
1. Quote all numbers in units of apples (price of apple normalized to 1)
2. Wage equal to number of apples a worker can produce:
𝑤𝑤𝑁𝑁 = 160 apples (wage = MPL !)
160
= 10 apples (why?)
3. Price of computer 𝑝𝑝𝑁𝑁 =
16
4. Consumption of apples 𝑐𝑐𝑁𝑁,𝐴𝐴 =
𝑤𝑤𝑁𝑁
2
5. Consumption of computers 𝑐𝑐𝑁𝑁,𝐶𝐶 =
= 80
𝑤𝑤𝑁𝑁
/𝑝𝑝𝑁𝑁
2
=8
36
Free Trade Solution (1/4)
• First determine comparative advantage: what is the ratio of
apples/computers that can be produced?
• North: 10, South: 50
→ South has comparative advantage for apples
• That means that North must have comparative advantage for computers!
(note: by definition, it is impossible to have the comparative advantage
for both goods)
37
Free Trade Solution (2/4)
• World production:
𝐴𝐴 = 400 × 100 = 40,000,
𝐶𝐶 = 100 × 16 = 1,600
• Key step: what is the world price of computers?
• World price of computers: 𝑝𝑝 =
40,000
1,600
= 25 apples
• Can verify that at this price world markets clear
• Intuition see next slide
38
Free Trade Solution (3/4)
• World price of computers: 𝑝𝑝 =
40,000
1,600
= 25 apples
• Wage equal to revenue per worker (=MPL):
• 𝑤𝑤𝑁𝑁 = 25
𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎
𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐
× 16 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = 400 apples
• 𝑤𝑤𝑆𝑆 = 100 apples
• Why do markets clear? At price of 25, North workers can trade in half of their
production of computers for apples, and apple market exactly clears
• If price of computers was >25, there would “too much income” relative to supply of
apples: excess demand, apple price rises (=computer price drops)
39
Free Trade Solution (4/4)
• Consumption North
• 𝑐𝑐𝑁𝑁,𝐴𝐴 =
• 𝑐𝑐𝑁𝑁,𝐶𝐶 =
• South:
• 𝑐𝑐𝑆𝑆,𝐴𝐴 =
• 𝑐𝑐𝑆𝑆,𝐶𝐶 =
𝑤𝑤𝑁𝑁
2
𝑤𝑤𝑁𝑁
2 𝑝𝑝
𝑤𝑤𝑆𝑆
2
𝑤𝑤𝑆𝑆
2 𝑝𝑝
=
=
=
=
400
= 200
2
400
=8
2×25
100
= 50
2
100
=2
2×25
Does the world market for both goods clear?
• Computers: 8 x 100 + 2 x 400 = 1,600
• Apples: 200 x 100 + 50 x 400 = 40,000
40