Week 4
Trade in the global economy. Theories,
performance and institutional
structures
Corporations in the world economy
Free-trade v.protection
• Free trade doctrines dominate economic thought in the
19° c. The abrogation of the Corn Laws in the UK in
1846. The Cobden-Chevalier Treaty of 1860.
• In the last part of the 19° c. there was a revival of
protectionism. Great Britain remained committed to freetrade despite the pressures of protectionist lobbies.
• The rise of protectionism in the late 19° c. went together
with the rise of economic and military nationalism.
• Despite tariff barriers, international trade keeps on rising
consistently up to World War I.
Free-trade and protectionism, 19141939
• World War I carries with it a crisis in the liberal
international order.
• After WW1 there is a fragile attempt to restore the Gold
Standard, but tariff barriers continue to rise.
• As a result of the Great Depression, the US imposed the
Smoot-Hawley tariff, with rates of an average of 48%
on imports of manufactured goods. In 1931 Great
Britain abandoned free trade.
• In the1930s international trade is subjected to a variety
of restrictions and regulations.
Liberalism v protectionism
•
•
•
•
The free trade doctrine (Adam Smith)
Comparative advantage (Ricardo).
Each country needs to make only the
goods in which it is most productive
and import the rest.
The aim of exports is to facilitate
imports, not to bring privileges to
exporters or to the State.
H-O (Heckshner e Ohlin) model:
factor endowment is key to
comparative advantage.
•
•
•
•
Mercantilism (17° e 18°c): trade
surplus is desirable since it allows
military strength.
Industrial nationalism, (19° e 20°
c.) Friedrich List in Germany or
Alexander Hamilton in the USA:
infant industries need protection.
Strategic protectionism (20° and
21° centuries): countries need to
encourage high-tech industries to
gain a permanent comparative
advantage.
Noglobal protectionism– global
trade endangers employment,
labour standards and the
environment.
New developments in international trade:
inter-industry and intra-industry trade.
• Inter-industry trade consists of exchanging goods produced by
different economic sectors.
• Intra-industry trade exchanges similar goods (goods made in the
same sector). Two countries might exchange automobile parts for
finished automobiles, or small cars for larger cars. It partly
invalidates traditional theories based on comparative advantage as
a result of different factor endowments.
• Intra-firm trade. This is trade within large MNCs, vertically
integrated, with subsidiaries in different countries.
New trade theories.
• Competitive advantage (Porter). Firms are embedded
in national economies. Government policies, for
example in R&D, may help firms to acquire a
permanent advantage in certain industries, especially
high-tech ones. Path-dependency.
• Strategic trade theory. Development of high-tech
sectors brings benefit to the whole national economy.
These sectors, computers, semi-conductors,
biotechnologies, etc, are dominated by oligopolies
and benefit from economies of scale.
Trade: is free trade better than
protection?
• Protectionism, in its various forms, can work especially in the
short term. In the longer term, however, it is bound to produce
inefficiency, privileged positions and corruption.
• Liberalization entails a price in terms of structural adjustment.
Some sectors are bound to suffer and need restructuring or
closing down. Competition is good since it concentrates
productive resources where they are more efficiently used.
• A trade surplus or a trade deficit of a particular country depend
not so much on what goods are imported or exported but on the
aggregate level of demand of that country. A high-income
country that saves little and consumes a lot (see the USA in the
1990s) will inevitably incur a trade deficit.
International trade after 1945
• Since 1945 the volume of world trade has grown faster than world
GDP. Its growth rate has been 7% between 1945 and 1973 and
over 4.5% between 1973 and 2000.
• Trade as a share of World GDP has grown from 7% in 1945 to
21% in 1996. In 2004 the share had grown to 27 %.
• Trade in services, like banking, insurance, consultancy etc has
also grown, although it is still less important that trade in goods.
Many services are offered and consumed locally and are therefore
non-tradeable (see hairdressers, gyms, etc)
• As a result of international negotiations, there has been a fall in
tariff barriers. Tariff duties on imports in industrialised countries
have fallen from an average of 40% in 1945 to about 6% today.
International trade after 1980
• Privatization and deregulation have further opened the
economies of many countries around the world. Also
important have been improvements in transport and
telecommunications.
• Regionalization of trade has also been a factor. In the
three main areas of the world economy known as the
Triad (North America, the EU, and Japan and South
Asia) now a large fraction of trade is intra-area trade.
Liberalizing trade within GATT
• GATT was created in 1948, after the failure of the ITO.
The aim was to take steps to liberalize the world
economy, away from the extreme protectionism of the
1930s.
• GATT banned unilateral concession, bilateral exclusive
agreements and the creation of commercial blocs.
Transparency was mandatory. Waivers were allowed in
case countries created customs unions.
• GATT members were accorded Most Favoured Nation
clause. Any tariff reduction negotiated between two
GATT members was automatically extended to all the
other members.
GATT and trade liberalization
• Limits of GATT. It was not a true international
organization – it only had a secretariat based in Geneva.
Its decision making powers were limited.
• Kennedy Round (1964-1967). It was called by the US,
also with the intent of offering an answer to the creation
of the EEC. Key actors of the Kennedy Round were the
US and the EEC Commission, which acted on behalf of
the Six EEC members. It brought down tariffs on
manufactured goods by about one third.
• Tokyo Round. (1973-1979). The talks managed to reduce
several trade barriers in addition to $300 billion in tariffs.
The Uruguay Round (1986-1995)
• The GATT Uruguay Round began in 1986. It was the
most ambitious round to date, hoping to expand the
competence of the GATT to important new areas such
as services, capital, intellectual property, and
agriculture. Agreement on a package was only reached
in 1993. In 1995 the WTO replaced GATT as a new
organisation designed to implement the agreement.
• In terms of tariff reduction, it brought down tariffs in
industrialized countries to a few percentage points.
Quotas and subsidies were also cut. For example quotas
for textile and clothing were to disappear in ten years.
The Uruguay Round (1986-1993)
• The final agreement comprised 29 separate protocols
extending the rules of GATT to agriculture, services,
intellectual property, foreign direct investment.
• It contained agreements to enforce patents, trademarks
and copyrights (TRIPS), extending international trade
law to the service sector (GATS) and opening up foreign
investment. It also made major changes in the dispute
settlement mechanism of GATT.
• It was finally agreed to replace GATT with the WTO
(World Trade Organization).
The creation of the WTO
• Unlike GATT, the WTO has a substantial institutional
structure. Whereas GATT had been managed by a small
executive committee including all the main trading
powers, the WTO has a Ministerial Conference, in which
all member states participate.
• It has a much more binding dispute resolution mechanism.
Still there are many limitations to its powers. Its 150
members make it difficult to reach decisions.
Issues facing WTO
• Barriers to trade, visible and invisible, remain.
Industrialized countries subsidize agriculture,
developing countries protect their service and industrial
sectors.
• Exports of poor and developing countries face a host of
tariff barriers and other protectionist devices on the part
of industrialized countries as well as other developing
countries.
• Under the spotlight are subsidies to agriculture by the
EU, but also by Japan and the USA.
Issues facing WTO
• Social standards and social dumping have become
issues in trade negotiations. They often are used as
a cover for protectionist interests.
• The same is true for environmental standards.
• Competition policy has become enmeshed in trade
issues. With the development of MNCs rules on
mergers and acquisitions, anti-trust etc have
become part of trade issues.
Issues facing WTO
• The regionalization of trade has become a major
factor, especially with the EU, NAFTA,
Mercosur and others. Regional blocs trend to
develop their own standards, competition policies
etc, excluding outsiders, and putting a spanner in
the works or world trade liberalization.
• The WTO Doha Millennium Round has stalled
Regional integration
• Movement towards new regionalism
accellerated in the mid-1980s.
• See: European Single Market
– NAFTA (North American Free Trade
Agremeent)
– Mercosur
– APEC and ASEAN
– In the late 1990s there were 180 regional
agreements.
Regional integration
• Regional agreements are a mixture of economic
and political ties. Some are more market driven
(Pacific Asia), some are more political (EU), some
are a mixture of the two (NAFTA).
• Some have developed single markets with a
common external tariff, and common currency.
Others are merely free trade areas.
• Some have strong institutions, others have weak
institutions.
Free trade area
A free trade area exists when two or more states
(normally but not necessarly contiguous) agree
to remove all restrictions on trade between them,
but continue to make individual arrangements
for their trade with countries not party to the free
trade agreement.
Under World Trade Organization (WTO) rules,
a free trade area must cover at least 90 per cent
of participating states’ trade.
Customs Union
A customs union is a territory within which there are no
internal barriers to the free movement of goods and in
respect of which a single set of rules, tariff, quotas, etc. is
applied to goods entering the territory from outside.
The expression is normally used to denote a territory within
which two or more contiguous states have agreed to form
such a union.
A custom union is recognized as a “regional trading
arrangement” under the World Trade Organization
(WTO) Agreement, and the members of a customs union
are exempt from the requirement to accord “most
favoured nation” treatment to non-members.
Common Market
A common market is a customs union within which
the free movement of goods, service, capital and
labour is guaranted (also Single Market).
These broad distinctions serve to explain the
difference between,for example, the European
Free Trade Association (EFTA) and the European
Economic Community (EEC)
More comprenhensive forms of integration ARE
- ECONOMIC UNION
- ECONOMIC AND MONETARY UNION.
Economic theories
• Trade diversion and trade creation (Viner)
• Dynamic factors of economic integration.
• Regionalism is a step towards
multilateralism and free trade
OR
• Regionalism is a protectionist,
discriminatory arrangement.
Political theories
•
•
•
•
•
Federalism
Functionalism and neo-functionalism
Liberal intergovernmentalism
Realism
Eclectic approaches.
Regionalization and globalization
• Is regional integration the antechamber to broader
liberalization?
• Or is it a an attempt to shield member countries from the
effects of the global economy, i.e. Fortress Europe?
• No definite conclusions to these questions. The WTO
system is not working very well, especially it can not
match the results that regional arrangements have
attained in terms of deeper integration.
Share of Intra-area exports as a share of total area
exports
1990
1995
Eu-25
2000
2005
67,5
66,8
Nafta
42,6
46,0
55,6
55,8
Asean
20,1
25,5
24,0
24,9
Share of world trade
region
intra-area
1997
1983
1993
2006
2006
North America
17,3
16,8
18,0
14,2
53,9
Central and South America
4,7
4,4
3,0
3,6
25,9
Europe
45,4
43,5
45,4
42,1
73,6
Africa
4,8
4,5
2,5
3,1
9,0
Middle East
4,1
6,8
3,5
5,5
11,1
Asia
14,9
19,1
26,1
27,8
50,0
others
8,8
4,9
1,5
3,6
Regionalization and the EU
• The Single European Act and EMU were
launched and implemented as preparation
and response to the process of economic
globalization.
• Example:The wave of mergers within the
EU, starting from the end of the 1980s
onwards, resulted in the creation of large
MNCs which expanded also in the US.
Regionalization and globalization
• NAFTA (North American Free Trade Area, created in 1994 by the
USA/Canada and Mexico – between 1993 and 2000, US trade with
Nafta partners grew by more than double the rate of US trade with the
rest of the world, rising from $ 300 to 650 billion. Also very important
FDI flows from US and Canada into Mexico. The mexican economy
benefited (although Stiglitz observes that it was unable to match the
rise of exports to Usa by Asian economies). Manpower transfers are
not included in NAFTA
• Mercosur (Argentina, Brasi, with Uruguay and Paraguay created in
1994). During the 1990s intra-area trade rose by a factor of five,
increasing from 8% to 25% of total trade of member states. Mercosur
became a very promising area for inflows of FDI, with 20 billion
inflows every year.
Regionalization in Asia
• Asia has not seen the same kind of regional integration as
Europe or other areas of the world. There are various
regional bodies, such as APEC, ASEAN, but there is non
single direction. This is mainly because there are various
countries aspiring to regional or sub-regional leadership
such as India, China, Japan and the USA.
• A group of Asian countries belonging to ASEAN: Brunei,
Indonesia, Malaysia, the Philippines, Singapore, Thailand,
Vietnam, Laos, Cambodia, Myanmar have launched a
process of trade liberalization designed to create a Free
Trade Area, named AFTA. In 2002 China has pledged to
eliminate its reciprocal barriers with AFTA within ten
years..
Corporations in the Global Economy
Multinational Corporations
Definitions
• A Multinational Corporation is a company,
which produces goods or markets its
services in more than one country.
In a narrow sense it is a company that
through Foreign Direct Investment (FDI)
controls and manages subsidiaries in a
number of countries outside its home base.
Early history of MNCs
• The first multinationals were the big trading companies,
involved in colonial trade, and retaining a monopoly,
essentially on behalf of the mother country.
The East India Company is perhaps the best known.
• In the 19th c. overseas investment tended to be focused
on raw materials, mining and agriculture.
• FDI was unregulated – there were very few restrictions
on capital movements.
Early history of MNCs
• FDI grew very strongly during the Gold Standard period.
Composition of the stock of world FDI in 1913:
• Around 55% was in the primary product sector
(agriculture and mining);
• 15% in manufacturing;
• the rest in utilities and services, i.e. banking and trading
companies.
Britain was the largest sources of FDI, accounting for almost
half in 1914.
MNCs after WW2
• After the war the only real global players left were
American MNCs, mainly in oil, mining and agriculture.
• The first big rise in multinational investment took place
during the late 1960s. American MNCs were the
leaders.
• “horizontal investment”,
• One good example is IBM, which in the 1960s set up
production facilities in Europe in order to be able to sell
computers within the EEC (Common market). Tariff
Jumping.
MNCs in the 1970s and 1980s
• Starting in the 1970s there was a growth of the
Eurodollar market sustained by the overseas
expansion of US banks. This led to the emergence
of a global, closely integrated, financial market.
• Deregulation, removal of capital controls,
increased size and speed of financial flows.
• Financial markets facilitated reorganisation and
transformation of international business. A single
global market for corporate ownership and
corporate take-over emerged.
MNCs in the 1970s and 1980s
• A much more complex system of MNCs. Many
nations increased their FDI and the United
States became the world’s foremost host
economy.
• The service sector became a more important
field of MNCs investment, because of the
information revolution and the link between
services and manufacturing.
MNCs <vertical> strategies.
• In a vertical strategy production processes within an MNC are
integrated and rationalised worldwide.
• International outsourcing, components produced in one location
are assembled in other economies and exported throughout the
world economy.
• Vertical MNC investment affects flows of world trade as well
as the distribution of industrial and service capacity across
various countries and regions.
• Technological change advances in transportation and
communications, such as the Internet or teleconferences, have
made it possible for firms to globalise their organisation.
MNCs in the world economy.
• In the early 1970s MNCs invested abroad 10 billion $ a
year, 2 billions of which in the developing world. FDI
increased by 30% a year between 1985 and 1990, much
more rapidly than world trade and economic output. This
rise continued into the 1990s.
• By 2000 FDI was running at 1 trillion $ a year of which
about 250 billion was going to developing countries. The
greatest proportion of this investment has been in high-tech
industries, and the service sector.
• In 2001 and 2002 the flow of world wide FDI fell by 50%.
Between 2003 and 2007 it as picked up again to reach 1,2
trillion dollars $ a year.
• Intra-firm trade, i.e. trade between subsidiaries of the same
firm became a major portion of world trade.
MNCs in the world economy
• Mergers and acquisition (M&A) is another
important element of MNCs activity.
• In 2000 about one quarter of all merger activity
i.e. nearly 1 trillion $, was across borders.
• See for example acquisition of Mannesmann
Germany by Vodaphone (UK).
• M&A highest in finance (banks),
telecommunications and transport.
Geographical distribution of FDI
stock
• MNCs are still predominantly based in industrialized
countries.
• Despite strong growth since 1990, FDI in developing
nations is still a small share of the total. Among emerging
economies, only a few, such as China, Brasil Mexico,
attract sizeable flows of FDI.
In 2001 global stock of FDI was $ 6800 billion.
• Of this 66% was held in industrialized countries – 60% in
the EU e 30% in the USA.
• 32% was held by developing countries, of which 60% in
Asia (Hong-Kong, China, Singapore) and 30% in Central
and South America. Africa only accounted for a small
fraction.
Flows of incoming FDI (bn $) and outgoing FDI as a share of world
trade.
MNCs in the world economy
• European firms, Japanese firms and firms from
Taiwan and South-Asia have become major
international players.
• In 1998 there were 53,000 MNCs with 450,000
foreign subsidiaries. The 100 largest MNCs
controlled about 20% of foreign assets, employed 6
million workers.
• MNCs accounted for 2/3 of world trade, and 1/3 of
world trade is intra-firm trade between branches of
the same company.
MNCs and the world economy
• Financial liberalisation and improved investment
opportunities induced significant flows to East
Asia and Latin America.
• Privatisation programs accounted for a share of
investment into developing countries.
• Eastern Europe also became a destination for FDI
• MNCs do not account for more than a small
share of investment both in developing and
developed economies.
Other forms of business globalisation:
“global commodity chains
• Corporations increasingly enter into a variety of
arrangements on the global scale, for example
joint ventures, sub-contracting, interfirm
corporate alliances.
• In aerospace, electronics, automobiles,
companies need foreign partners to share
technology, to conduct R&D, to market good
across barriers and other protectionist devices.
Other forms of business globalisation:
“global commodity chains”.
• Slicing up the value chain has also increased trade
between industrialised and developing countries.
Companies locate segments of the production
process in lower wage countries or subcontract to
firms in Asia or Latin America.
• Small and medium sized enterprises have also
internationalised and are being integrated into
production and distribution networks.
Multinational or Transnationals?
• A 2000 survey of the 500 largest corporations
gave the following conclusions:
• 380 operated in various countries
• Only 9, however, had less than 50% of their sales
in one of the regions of the Triad (North America,
the EU, Asia and Japan) while conducting at least
20% of their business in the other two areas.
Among these nine: IBM, Sony, Intel and CocaCola.
Debate on Multinationals
• Pros – they are vital for access to technology,
to increase trade and investment
• Cons – they are a tool of US led cultural
domination, they stifle local economies and
undermine democracy.
• Negotiating with multinationals: is it possible?
• Should MNCs be regulated and how?
Arguments in favour
• Developing countries are more aware than in the
past that attracting FDI by MNCs may be the key
to acquiring technology, access to international
financial markets and trade.
• Many countries wish to become more attractive
sites for MNCs. One example is the new postcommunist E. European economies, which have
vied with each other to get EU and US MNCs.
Arguments against.
• Critics accuse them of harming national societies, and
even undermining democracy. They are accused of being
unanswerable except to themselves and to exploit national
economies and societies.
In the 1970s Third World dependency theory led many
countries in the developing world to nationalise MNC
subsidiaries or limit their investment.
• R&D facilities will tend to be located in the corporation’s
home country.
Negotiating with MNCs
• National governments are usually able to
negotiate, and regional supranational
organisations can do an even better job.
• Governments of poorer countries, are more
subject to corruption and economic blackmail.
Negotiating with MNCs
• MNCs may be asked to share technology with
the host country or apply local content rules,
whereby the MNC is required to purchase or
produce locally a certain percentage of the
component parts or intermediate goods used in
its products.
• The Chinese government refused to purchase
aircraft from Boeing unless Boeing agreed to
produce aircraft in China, in a co-production
agreement that gave the Chinese capabilities in
aircraft design and manufacturing.
The debate in the US and UK
• Advanced industrial countries act both as hosts and
home for MNCs.
• Critics have denounced the US MNCs for their
large-scale investment in cheap labour countries
such as Mexico, leading to job losses in the US.
• FDI by US corporations increased US exports to
the host country, by way of supplying parts and
components. Also the US as well as the UK were
able to benefit from Japanese investment, that
rejuvenated declining industrial sectors.
Global rules?
• Efforts have been made, with very limited success, to
establish global rules to govern their rights and their
conduct.
• The most important initiative was the MAI (Multilateral
Agreement on Investment) originally proposed by
President Clinton in the OECD. MNCs would be protected
from nationalisation and political instability, and there
would be an international procedure for settling disputes.
• This proposal generated strong opposition from labour,
environmentalists, and also from many developing
countries. It appeared to be one sided and eventually was
abandoned.
The World's top fifty nonfinancial multinationals, ranked by fo
Ranking by Foreign assets
Millions of dollars and number of employees
Assets
1
2
3
4
5
6
7
8
9
10
Corporation
Country
Vodafone
General Electric
British Petroleum
Vivendi Universal
Deutsche Telekom
ExxonMobil Corporation
Ford Motor Co
General Motors
Royal Dutch/Shell Group
TotalFinaElf
United Kingdom
United States
United Kingdom
France
Germany
United States
United States
United States
UK/Nether
France
Foreign
187.792
180.031
111.207
91.120
90.657
89.426
81.169
75.379
73.492
70.030
Total
207.458
495.210
141.158
123.156
145.802
143.174
276.543
323.969
111.543
78.500
Sales
Employment
Foreign Total Foreign
24.602
39.914
141.225
29.652
11.836
145.814
52.983
45.256
72.952
74.647
32.744
125.913
175.389
51.423
43.309
209.417
162.412
177.260
135.211
94.418
56.430
152.000
90.500
256.725
78.722
61.148
188.919
148.000
52.109
69.037
Total
67.178
310.000
110.150
381.504
257.058
97.900
354.431
365.000
89.939
122.025
Incoming FDI as %
of gross capital formation
World
1980
2,3
1990
4,7
1998
11,1
2006
12.6
Industrialised
Countries
1980
2,7
1990
4,9
1998
10,9
2006
11,8
Developing
Countries
1980
1,2
1990
4,0
1998
11,5
2006
13,8
Questions on financial crisis in the
global economy
• The East Asian Financial Crisis
– How did the crisis start, how did it develop and
what were its main effects?
– What are the main criticisms that J. Stiglitz makes
of the way the IMF handled the crisis?
– What are possible mechanisms to prevent or
alleviate future financial crises?
• Describe the financial crisis faced by Argentina
after 2000 and its outcome
The recent financial meltdown and
its consequences.
• The current world economic crisis
–
–
–
–
–
–
–
–
Getting into trouble
the housing bust
drama in the financial sector
the Fed
the currency crisis
Getting out of trouble
Parallels and differences with the Great Depression
Were the answers given correct? Is the Euro crisis a
second stage of the financial crisis?