Week 4

Trade in the global economy. Theories, performance and institutional

structures

Corporations in the world economy

Free-trade v.protectionFree-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 free-trade 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, 1914-Free-trade and protectionism, 1914-19391939

• 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 protectionismLiberalism 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: New developments in international trade: inter-industry and intra-industry 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.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 Trade: is free trade better than protection?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 1945International 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 1980International 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 GATTLiberalizing 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 liberalizationGATT 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 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 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 WTOThe 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 WTOIssues 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 WTOIssues 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 WTOIssues 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 integrationRegional 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 integrationRegional 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 areaFree 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 UnionCustoms 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 MarketCommon MarketA 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 theoriesEconomic 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 theoriesPolitical theories

• Federalism

• Functionalism and neo-functionalism

• Liberal intergovernmentalism

• Realism

• Eclectic approaches.

Regionalization and globalizationRegionalization 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 2000 2005

Eu-25 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 intra-arearegion 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 Coca-Cola.

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 post-communist 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 foreign assets, 2001

Ranking by Foreign assets Millions of dollars and number of employees

Assets Sales EmploymentCorporation Country Foreign Total Foreign Total Foreign Total

1 Vodafone United Kingdom 187.792 207.458 24.602 32.744 56.430 67.1782 General Electric United States 180.031 495.210 39.914 125.913 152.000 310.0003 British Petroleum United Kingdom 111.207 141.158 141.225 175.389 90.500 110.1504 Vivendi Universal France 91.120 123.156 29.652 51.423 256.725 381.5045 Deutsche Telekom Germany 90.657 145.802 11.836 43.309 78.722 257.0586 ExxonMobil Corporation United States 89.426 143.174 145.814 209.417 61.148 97.9007 Ford Motor Co United States 81.169 276.543 52.983 162.412 188.919 354.4318 General Motors United States 75.379 323.969 45.256 177.260 148.000 365.0009 Royal Dutch/Shell Group UK/Nether 73.492 111.543 72.952 135.211 52.109 89.939

10 TotalFinaElf France 70.030 78.500 74.647 94.418 69.037 122.025

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?