Transcript International Economic Integration

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International
Economic Integration
Implications for National
Economic Policies
Thorvaldur Gylfason
Outline
1. Globalization and its implications for
 National incomes
 Prices and inflation
 Interest rates
2. Policy coordination
 Monetary policies and institutions
 Fiscal policies
3. Agricultural policy
Import Tariffs 1980-2000
25
20
1980
15
2000
10
5
0
Tariffs (% of Tariffs (% of
tax revenue)
imports)
Export Duties 1980-2000
5
4
1980
3
2000
2
1
0
Duties (% of
exports)
Duties (% of
tax revenue)
Imports and Exports
1960-2000 (% of GDP)
50
40
1960
1980
2000
30
20
10
0
Imports
Exports
FDI 1980-2000 (% of GDP)
10
1980
1990
2000
8
6
4
2
0
FDI (net)
FDI (gross)
Further Evidence of
Globalization
Economic integration followed by
political integration
Widening and deepening integration
Europe’s common currency rests, in part,
on political arguments (Austria vs. Sweden)
Even in North America, there is an ongoing
debate about the pros and cons of
adopting a common currency
Is NAFTA not enough?
But political and historical impetus is absent
International Linkages
National incomes of trading partners tend
to move in tandem
Suppose country A exports to country B, so A’s
exports are B’s imports
Then a boom in B increases demand for
imports in B which means that exports – and
output! – in A must also rise
Likewise, a slump in A can lead to a slump in B
International business cycles, through trade
GDP in US
The Foreign Multiplier
Extra boost
in US
C
EU
US’
Demand
boom in US
US
B
A
Imported
boost in EU
GDP in EU
Other Linkages: Inflation
Prices move together
Inflation in country A increases the real
exchange rate (i.e., makes the home
currency appreciate in real terms), thus
hurting exports which, in turn, diverts
demand from imports to home
production in country B, hence
increasing aggregate demand and
inflation in country B
Imported inflation, through trade
Price level in US
Other Linkages: Inflation
Extra inflation
in US
C
EU
US’
Demand
boom in US
US
B
A
Imported
inflation in EU
Price level in EU
Two Cases
Fixed exchange rate
P = P*/e
As P* rises, so does P
With fixed e, a rise in P* leads to real
depreciation, so BOP improves and M rises
Hence, P rises: Imported inflation
Flexible exchange rate
As P* rises, e rises (nominal appreciation)
Real depreciation is partly reversed
Hence, M and P rise less than otherwise
Still Other Linkages:
Interest Rates
Interest rates move together
An increase in interest rates in country A
attracts capital inflows from country B,
thus reducing the supply of capital in
country B, and thereby driving up
interest rates in country B
Interest parity, through capital
movements
Still Other Linkages:
Interest Rates
r = real interest rate
S = saving
I = investment
Home country
r
B
S
Rise in I
A
I’
I
S, I
Still Other Linkages:
Interest Rates
Foreign country
Home country
r
B
r
S
Rise in I
S’
S
B
Fall in S
A
I’
A
I
S, I
I
S, I
Implications of Linkages
Economic integration means that
economic policy in one country,
especially if the country is large,
influences economic developments in
other countries, through international
trade and investment
Economic integration calls for political
integration, to some extent at least
Important driving force behind
European integration
Example of
Environmental Policy
Pollution respects no national
boundaries
Therefore, need international
cooperation on environmental
protection and pollution control
Case in point: Kyoto protocol
Same general principle applies to some
aspects of economic policy
Also: Law enforcement
Exchange Rate Policy
Cannot be conducted in a vacuum
Unless your country is very small
Country A’s decision to devalue its
currency causes country B’s currency
to appreciate, through trade
Therefore, countries may wish or need
to cooperate on exchange rates
Currency unions
Case in point: Europe’s single currency
Or they may want to be alone
The Impossible Trinity
Free
capital movements
Currency union
Fixed
exchange rate
Floating
exchange rate
Independent
monetary policy
1945-1972
Fiscal Policy
Globalization also presents a challenge to
fiscal policy through impending tax erosion
E-commerce and electronic money
Offshore activities and foreign shopping
Financial capital
Globalization may, however, facilitate new and
more efficient ways to collect revenue
Tax harmonization
Pollution fees
Monetary Policy
Main objective is price stability
Because high inflation hurts economic growth as
well as the external position
Monetary restraint requires fiscal discipline
Monetary policy under floating exchange
rates and perfect capital mobility
Increased independence of central banks, and
increased accountability
Banking supervision
Inflation targeting
Global Economic Performance
since 1990: Four Features
I.
World inflation has been brought
down to its lowest level in 40 years

Inflation dispersion has also diminished
II. International integration and
liberalization of financial markets
III. More complex financial linkages and
policy transmission mechanisms
IV. Flexible exchange rates have become
more prevalent
Agricultural Subsidies per
Farmer 1999-2000 (USD)
35000
30000
25000
20000
15000
10000
5000
0
Iceland
Norway
EU
US
New
Zealand
Agricultural Subsidies per
Farmer 1999-2000 (USD)
35000
30000
25000
20000
15000
10000
5000
0
Iceland
Norway
EU
US
New
Zealand
Agriculture
Slope = -PI/PA
D
Domestic
price ratio
H
E
Agricultural
output (A)
As PI rises, I rises and A falls
As PA rises, A rises and I falls
C
O
Industrial output (I)
G
Agriculture
E = mc2
World price ratio
D
H
If output gain = E
and price distortion
= c, then E = mc2
Agricultural
output
E
Price
distortion
Output
gain
OC = industrial output
CA = agricultural output
OA = total output
O
Domestic,
distorted
price ratio
F
C
Industrial output
G
A
B
Agriculture
Implication:
The output gain varies directly with
1. The magnitude of the transfer of
resources between sectors (m)
2. The extent of the original price
distortion (c)
The greater the transfer of resources
and the greater the distortion, the
greater is the output gain
Numerical Example
E is the output gain from liberalization
m is a constant equal to ½ times the share
of the industrial sector in output after
liberalization times the price elasticity of
industrial output
c is a measure of the price distortion in
percent
The greater the initial distortion, the more
ambitious the liberalization, and the more
elastic the output, the greater the gain
The CAP: An Application
Suppose
Farm protection keeps domestic agricultural
prices 80% above world prices, so that
c = 0.8/(1 + 0.8) = 0.44
Industrial sector’s share in GDP will rise to
95% following farm policy liberalization
Price elasticity of industrial output is 0.2
Accords with price elasticity of farm output of 4
Output gain from liberalization is then
E = 0.5*0.95*0.2*0.442 = 0.02, or 2%
Larger effect if productivity gain is included
The CAP: An Application
When productivity gain is included, the
total cost of the CAP rises to perhaps
3% of the EU’s GDP
Yet these cost estimates do not include
Environmental damage in agriculture
Effects on CEECs
Effects on LDCs
Agriculture:
Static Gains
World price ratio
Welfare
gain
Exports
D
K
J
H
E
Price
distortion
Output
gain
Agricultural
output
Domestic,
distorted
price ratio
Imports
F
C
O
Industrial output
G
A
B
Agriculture:
Transitional Pains
Transition
takes time:
From E to F
via M, N,
and Q
Welfare
gain
D
J
H
E
M
Agricultural
output
N
Q
Price
distortion
F
C
O
Industrial output
G
A
B
Agriculture:
AB = static gain
Dynamic Gains BC = dynamic gain
AC = AB + BC = total gain
Welfare
gain
D
World price
ratio
K
J
Productivity
gain
E
Price
distortion
Agricultural
output
H
F
G
O
Industrial output
A
B
C
Conclusion
Globalization means interdependence
Policies influence not only those who
make them
Need to find ways to share
responsibility without giving up too
much sovereignty
Not easy, but we must try