Chapter 13: International EconomicsFrancisco, Nicca MischelleSison, Joshua VerrArcangel,AlecxiemarOcana, CherryLomugda,Ricorde

INTERNATIONAL ECONOMICS• The rules of trade between nations at a global or near

global level are governed by the World Trade Organization. Its principles regarding multilateral trading system should be without discrimination. Freer, predictable, more competitive and more beneficial for less developed countries.

• International economics is concerned with the effects upon economic activity of international differences in productive resources and consumer preferences and the international institutions that affect them. It seeks to explain the patterns and consequences of transactions and interactions between the inhabitants of different countries, including trade, investment and migration.

• Regional Trade Agreements of the Philippines:To ensure free flow of trade by reducing trade barriers.(Tariff and non-tariff)

- Association of Southeast Asian Nation Free Trade Area- ASEAN-China Free Trade Area- Japan-Philippines Economic Partnership Agreement- ASEAN-Australia-New Zealand Free Trade Area

Selected Theoretical Bases of International Trade • Mercantilism

• Give more of your commodity to other follow trading countries, but, take little or none from others in return

 • Law of Absolute Advantage

• trade you have the most to the country that has the least of your commodity, that also has the most of the commodity of which your country lacks.

• In short it’s a “helping hand” or “fill in the gap” kind of trade.

 • Law of Comparative advantage

• even if country A is or has a less advantage in commodities compared to country B, mutual advantage trade is still possible. Country A should export the commodity which it has more and import from country B the commodity that country A lacks the most. While country B, despite having an advantage over A, will do the exact same thing as what country A is doing.

• In short, give what you at least have the most and take what you lack the most

• Heckscher-Oblin theory• each nation should give out what it has the most and the

cheapest. While each should take what it lacks & with an expensive price

• Heckscher-Oblin-Samuelson Theorem• international trade will cause the wages & interest rate to

be the same in all trading nations (factor price equalization theorem)

TYPES OF TRADE PROTECTIONS

• Tariff • A tax imposed on imported goods and services. Tariffs are used to restrict

trade, as they increase the price of imported goods and services, making them more expensive to consumers

• Governments may impose tariffs to raise revenue or to protect domestic industries from foreign competition, since consumers will generally purchase cheaper foreign produced goods

• Quota• A government-imposed trade restriction that limits the number, or in certain

cases the value, of goods and services that can be imported or exported during a particular time period.

• They are sometimes imposed on specific goods and services to reduce imports, thereby increasing domestic production.

• In theory, this helps protect domestic production by restricting foreign competition

• Quotas are different than tariffs, which places a tax on imports or exports in and out of a country. Both quotas and tariffs are protective measures imposed by governments to try to control trade between countries.

 • Government Regulations• These are forms of protections arising from health and

safety standards and preservation of the environment

• Exchange controls• Common exchange controls include banning the use of

foreign currency and restricting the amount of domestic currency that can be exchanged within the country.• Typically, countries that employ exchange controls are

those with weaker economies. These controls allow countries a greater degree of economic stability by limiting the amount of exchange rate volatility due to currency inflows/outflows.

The Need for Trade Protection of Developing Nations• Poorer countries dependent on the export of few

primary agricultural products are wary about the exploitative power of rich nations which have highly industrial bases.Trade policies being implemented in different trading blocks are influenced by developed countries such as U.S., European countries, and Japan.

• Without a certain level of protection from rich nations, these developing countries will find themselves trapped in being poor for a long period of time.

Types of Trade Protections• 1.) Tariff – Is a tax on imported products. It raises

the costs to foreign suppliers and reduces their revenues thereby reducing the import spending of the country.

• 2.) Quota – I s a fixed limit placed on the quantity of imports allowed into a country. Although the volume of imports is limited, their price may be forced upward because of the scarcity, thus, the spending on imports may not fall too much.

• 3.) Government Regulations – These are forms of protections arising from health and safety standards and preservation of the environment.

• 4.) Exchange Controls – The BSP ( Bangko Sentral ng Pilipinas ) restricts the sale of dollars ( and other forms of currency ) to importers. Only those importers who have permits are allowed to obtain dollars due to the necessity of the product they are importing.

Arguments for the Imposition of Tariff Protection• 1.) Infant Industry Argument -This argument asserts that a

temporary imposition of tariff will cut down imports while local industries will learn how to produce at low costs to compete without the help of a tariff. This is the most valid argument for an industrializing country.

They continue to be infants in spite of the opportunity afforded them to compete with foreign products.• 2.) Higher Standard of Living Argument -A tariff will

promote high wages because local industries cannot provide competition with foreign competitors and pay high wages at the same time. High wages and a large number of workers secure a high standard of living for most of the population.

But this argument lost its stream when it was observed that higher wages of a result of higher productivity.

• 3.) Increased Employment Argument -This arguments contents that tariff creates employment opportunities for labor. Goods that should have been imported can now be produced at home ( import substitution ) and therefore would increase the demand for labor.

The weakness of this argument lies in fact that imports decrease, exports will decrease also, and employment will decrease an outcome.• 4.) Self-sufficiency Argument -This argument

advocated to secure economic independence of national self-sufficiency. If war erupts, a country cannot depend upon other countries for a continuous supply of essential commodities.

Important industries should be strengthened to ensure self-sufficiency in case of conflicts.

Developing Nations

Foreign Exchange market

A foreign exchange market is the organizational framework wherein individuals, businesses, and banks buy and sell foreign exchange.

Ex. If an American wants to buy Philippine product, he has to sell his dollars in exchange for pesos in a foreign exchange market.

The main function of foreign exchange is to transfer funds of purchasing power from the Philippines to other countries or vice versa.

Foreign Exchange RateThe foreign exchange rate is the price if a unit of a

foreign currency in terms of domestic currency . the exchange rate is made the same in all markets by arbitrage . Foreign exchange arbitrage is the buying of a currency when its price is low and selling high.

On the other hand when the value of a currency declines/increases due to legislation. It is reffered to as currency devaluation/currency appraisal.

• Ex. US$1 = P43.36  means that P43.36 will be exchanged for each US$1 or that US$1 will be exchanged for each P43.36

Importance of Exchange Rate

The exchange rate is important for several reason:

1.It serves as the basic link between the local and overseas market for various goods, services and financial assets2. Exchange rate movements can affect actual inflation as well as expectations about future price movements.For Ex. A decrease in the value of the peso from US$1: P25 to US$1: 35 will increase the price of a $1 per litter gasoline from P25 (P25 x $1) to 35 (P35 x $1).

Importance of Exchange Rate

3.Exchange rate movements can affect the country’s external sector through their impact on foreign trade. the level of competitiveness of the Philippine exports will be greatly affected by the change in the peso exchange rates with other currencies.4.The exchange rate affects the cost of servicing (principal and interest of payments)

on the country’s foreign debt. a peso depreciation increase the amount of pesos needed to buy foreign exchange to pay interest and maturing obligations on foreign debts

DETERMINATION OF EXCHANGE RATEFLOATING EXCHANGE RATE• TYPE OF EXCHANGE RATE REGIME WHEREIN A

CURENCY’S VALUE IS ALLOWED TO FLUCTUATE ACCORDING TO THE FOREIGN EXCHANGE MARKET(SUPPLY)

2 TYPES OF FLOATING EXCHANGE RATE• MANAGE FLOAT • DIRTY FLOAT

FIXED EXCHANGE RATE SYSTEM• A CURRENCY SYSTEM IN WHICH GOVERNMENTS

TRY TO MAINTAIN THEIR CURRENCY VALUE CONSTANT AGAINST ONE ANOTHER

2 TYPES OF FIXED EXCHANGE RATE ADJUSTABLE PEG SYSTEM CRAWLING PEG SYSTEM

ADJUSTABLE PEG SYSTEM• THE CENTRAL BANK WILL SET UP A MAXIMUM AND

MINIMUM VALUE OF THE CURRENCY

CRAWLING PEG SYSTEM• THE PEGGED EXCHANGE RATE IS OFTEN ACCORDIMG

TO THE DISCRETION OF THE CENTRAL BANK OR SOME ECONOMIC INDICATION

MANAGE FLOAT• CURRENT INTERNATIONAL FINANCIAL ENVIRONMENT

IN WHICH EXCHANGE RATE FLUCTUATE FROM DAY TO DAY BUT CENTRAL BANKS ATTEMPT TO INFLUENCE THEIR COUNTRIES’ EXCHANGE RATE BY BUYING AND SELLING CURRENCIES

DIRTY FLOAT• THE COUNTRY WILL ARTIFICIALLY KEEP THEIR

CURRENCY LOW TO INDUCE ITS EXPORTS

POSITIVE AND NEGATIVE EFFECTS OF PESO APPRECIATION AND PESO DEPRECIATION

DEMAND AND SUPPLY IN FOREIGN EXCHANGE MARKET

A Case of an Increased Demand for U.S. DollarsWhat shifts the demand for dollars? Several factors, all relating to decisions of foreign countries to purchase U.S. goods and services or U.S. investments. Note that this is similar to the list of supply factors, only now we take of point-of-view of the foreign interests that demand dollars. Here are some factors that would INCREASE demand, causing the U.S. dollar to appreciate:

• An increase in the preference of foreign countries for U.S. goods. These foreign countries demand dollars to purchase these goods and services, and demand increases or shifts right .

• An increase in foreign GDP and income. With more income, foreign consumers will buy more of all types of goods and services, both foreign and domestic.

• An increase in the real interest rate on U.S. bonds relative to foreign bonds. The higher real interest rate makes the U.S. bonds more attractive and investors demand more dollars to purchase the U.S. bonds.

• A decrease in the riskiness of U.S. investments relative to foreign investments. Again, the U.S. investments become more attractive.

• An expected appreciation of the dollar. People will demand dollars now to benefit when they gain value against the foreign currency.

• If the supply for the U.S. dollar is constant while the demand for the U.S. dollar increased due to the brisk importance of U.S. goods and services, a huge effect on the movement of the exchange rate will occur.

• For example:1)When we export products or services, we create a demand for dollars because our customers need to pay for our goods and services in dollars and, therefore they will have to convert their local currency into dollars. Hence they sell their currency to buy dollars so that they can make the payment.2) Speculators• If an investor feels that the price of Mexican pesos will rise in

the future, she will demand more pesos today. This increased demand leads to an increased price for pesos.

A Case of an Increased Supply of U.S. DollarsWhat shifts the supply curve for dollars? Several factors, all relating to decisions in the U.S. to purchase foreign goods and services or foreign investments. Here are some factors that would INCREASE supply, causing the U.S. dollar to depreciate:

• An increase in the preference of Americans for foreign goods. When Americans desire more imports--French wine or German cars--then they supply more dollars to exchange for foreign currency, and supply increases or shifts right.

• An increase in U.S. GDP and income. With more income, U.S. consumers will buy more of all types of goods and services, both foreign and domestic. .

• An increase in the real interest rate on foreign bonds relative to U.S. bonds. The higher real interest rate makes the foreign bonds more attractive and investors supply more dollars to exchange for foreign currency and purchase the foreign bonds.

• A decrease in the riskiness of foreign investments relative to U.S. investments. Again, the foreign investments become more attractive.

• An expected depreciation of the dollar. People will supply dollars now to avoid holding dollars while they lose value against the foreign currency.

Central Bankers• A central bank might decide that its holdings of a particular currency are

too low, so they decide to buy that currency on the open market. They might also want to have the exchange rate for their currency decline relative to another currency. So they put their currency on the open market and use it to buy another currency. So Central Banks can play a role in the demand for currency.Supply and demand are often thought of as being two sides of the same coin. Here we see that this is the case, as in every transaction there is a buyer and a seller, or in other words, a demander and a supplier.

• Now we know what agents can cause price changes and for what reasons. We can use our knowledge to analyze what happens in the "real world". An interesting case is the Canadian-to-American exchange rate. Due to the geographical proximity and economic intergration of the two countries the Canadian-to-American exchange rate is often examined. The sharp decline in the value of the Canadian dollar relative to the American one is widely discussed in the news, so we'll discuss it now.

Exchange Rate MovementsFactor

Change in Factor

Change in US $

US real interest rate increase appreciate

Foreign real interest rate increase depreciate

expected US price level/inflation

increase depreciate

US investment risk increase depreciate

US relative tariffs and quotas

increase appreciate

demand for US goods increase appreciate

demand for foreign goods increase depreciate

US relative productivity increase appreciate

The Balance of Payments• Balance of Payments – (BOP) is a summary of the economic

transactions of a country with rest of the world, for a specific time period. The summary measure the performance of the Philippine’s external transactions is called the overall BOP position.

• A record of all transactions made between one particular country and all other countries during a specified period of time. BOP compares the dollar difference of the amount of exports and imports, including all financial exports and imports. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa.

• BOP is one of the most important tools for national and international policy formulation as countries have increasingly become independent.

Details of Balance of Payments• Economic transaction 2 major categories1.Current account-

a)Goods and Services - Exports, Imports, Servicesb)Income - Overseas Filipino earnings, Investment

income, Interest payments to foreign creditorsc)Current - Remittance of OFWs, Gifts grants and

donations2.Capital and Financial account-

a)Capital account - capital transfersb)Financial account - direct account, Portfolio

holdings, other investments.

Details of Balance of Payments

NET UNCLASSIFIED ITEMS• Overall BOP Position

a) Change in Reserve Assets (Gross International Income) – Foreign issued Securities, Monetary Gold, Foreign Exchange

b) Change in Reserve Liabilities – Use of fund credits, Short-term

The overall BOP position is a summary measure of the performance of the country’s external transaction.

Details of Balance of Payments

• Current account Balance + Capital and Financial Account; or

• Change in Net International Reserves due to transactions (change in reserve assets and change in reserve liabilities).

January- December 2009

Growth Rate (%) 2010

Current Account 8,465 9,358 -9.5

Capital and Financial Account

7,948 -1,627 588.5

Net Unclassified Items -2,010 -1,320 -53.4

Overall BOP 14,403 6,421 124.3

Details of Balance of Payments

Solution:

Year 2010Current Acc. 8,465 (Add) +Capital and Financial Acc. 7,948

------------------------ 16,413

(Less) -Net Unclassified Items 2,010

-------------------------OVER ALL BOP 14,403

Growth Rate:Present acc. – Past acc./Past acc.

X 100

Current Account:8465 – 9358 = -893 / 9358 = -9.5Capital and Financial Account:7948+1627= 9575 / 1627 = 588.5Net Unclassified Items:-2010+1320= -690 / 1320 = -52.27Overall BOP14403-6421=7982 / 6421 = 124.3

Year 2009Current Acc. 9,358(Less) -Capital and Financial Acc.1,627

------------------------7,731

(Less) -Net Unclassified Items 1,320

-------------------------OVER ALL BOP 6,411