Transcript International Capital Flows I

I. International Capital Mobility
1
a. Why international capital flows ?
(i) Capital flows as a counterpart of the
exchange of goods (see point b)
–
–
Trade balance = Net capital outflows
Exchange of goods results from differences
across countries: productivity, endowments,
time preference.
3
(ii) Capital flows as exchange of
assets to hedge risks
• Risks result from changes in prices
- raw materials: gold, oil…
- exchange rate: relative price of one
good between two countries
- assets
4
Example
€/$
• Imagine a US computer
maker firm (A) and a
European distribution firm
(B).
• B places an order with A
of 300 computers in
02/04. A will deliver these
300 computers with a
delay in 05/04.
• Computer’s Price:
1000USD
• 02/04: 1€->1.25 USD
5
• 05/04: 1€->1.2 USD
• B has to pay in USD so he will support this exchange
rate risk.
• If B pays when it orders in 02/04, the cost will be 240
000€
• If B pays at the delivery in 05/04, the cost will be 250
000€
• The spread between those payments (10 000 €) reflects
changes in USD/€ exchange rate.
• B can ask the bank to hedge this foreign exchange risk.
Otherwise, changes in exchange rates will be supported
by the buyers of B’s computers.
6
Price’s fluctuations
7
• These risks are more present because of
higher capital mobility.
• There is a risk when prices fluctuate.
• Risk on exchange rates were reduced in
the Bretton Woods system.
8
Hedge’s instruments (see Mishkin,
Chapter 13)
• Financial derivatives are used to eliminate the
price risk inherent in transactions that call for
future delivery of money, a security, or a
commodity.
• Buying an asset is taking a long position.
• Selling an asset for a future delivery is taking a
short position.
• Principle’s of hedging is to offset a long position
by taking an additional short position or offset a
short position by taking an additional long
position.
9
Hedge’s instruments
• Forward contracts are agreements by two
parties to engage in a financial transaction at a
future point in time.
• Futures contract are traded on organized
exchanges such as the Montreal Exchange in
Canada.
• Futures contracts are standardized (↑size of the
market -> ↑ liquidity) and parties are engaged
with an intermediate (the clearinghouse) to
prevent from the risk of default.
10
Example
• B has to buy USD in 2 months.
• He has to enter in a forward contract: he will
engage now to buy in 2 months 300 000 USD
against 240 000 € at the current exchange rate
(1€->1.25USD).
• Otherwise B could address to the Chicago
Mercantile Exchange for a euro contract
delivered in May. The amount is 1000€ by
contract with an exchange rate of 1.25USD. So
B needs 240 contracts to sell 240 000€ in May
against 300 000 USD.
11
Hedge’s instruments
• Options are contracts that give the
purchaser the right to buy or sell the
underlying financial instrument at a
specified price (exercise price) within a
specific period of time.
• The writer (seller) of the option is forced to
buy or sell the financial instrument to the
owner (buyer) but the owner does not
have to exercise the option.
12
Hedge’s instruments
• A call option is a contract that gives the
owner the right to buy a financial
instrument at the exercise price within a
specific period of time.
• A put option is a contract that gives the
owner the right to sell a financial
instrument at the exercise price within a
specific period of time.
13
Example
• 02/04 : 1€->1.25USD
• Imagine that 05/04 the €/USD has
appreciated (1€->1.3 USD) then B loses
with a forward contract but not with an
option because in this case he will not
exercise the option.
14
b. The reasons of exchange
(i) Static analysis: some aspects of
international trade (differences in productivity,
in endowments)
(ii) Dynamic analysis: intertemporal
choice
(i) Static analysis
• We assume here that trade balance is always
zero so that there are no capital flows.
• International trade exists because countries are
different (productivity, factors endowment)
• Trade implies price convergence
• To study the effects of trade, we distinguish:
– An autarky economy (AE)
– A trading economy (TE)
-> Countries have an advantage to exchange when
there exists a gap between prices in the AE and the
TE.
16
• This section:
-> why countries benefit from international trade?
->what are the consequences of international trade on
prices?
• Same answer around three different international trade
models:
-> Because countries are different
-> International trade leads to a price convergence
(i-a) the Ricardian model
(i-b) the Factor Specific model
(i-c) the Hecksher Olhin model
17
(i-a) The Ricardian Model
•
•
•
•
Introduction
The Concept of Comparative Advantage
A One-Factor Economy
Trade in a One-Factor World
18
Introduction
• Countries engage in international trade for
two basic reasons:
– They are different from each other in terms of
climate, land, capital, labor, and technology.
– They try to achieve scale economies in
production.
• The Ricardian model is based on
technological differences across countries.
– These technological differences are reflected in
19
differences in the productivity of labor.
The Concept of
Comparative Advantage
• If each country exports the goods in which it
has comparative advantage (lower opportunity
costs), then all countries can in principle gain
from trade.
• What determines comparative advantage?
– Answering this question would help us
understand how country differences determine
the pattern of trade (which goods a country
exports).
20
A One-Factor Economy
• Assume that we are dealing with an
economy (which we call Home). In this
economy:
– Labor is the only factor of production.
– Only two goods (say wine and cheese) are
produced.
– The supply of labor is fixed in each country.
– The productivity of labor in each good is
fixed.
– Perfect competition prevails in all markets.
21
A One-Factor Economy
• The constant labor productivity is modeled with
the specification of unit labor requirements:
– The unit labor requirement is the number of hours
of labor required to produce one unit of output.
• Denote with aLW the unit labor requirement for wine (e.g. if
aLW = 2, then one needs 2 hours of labor to produce one
gallon of wine).
• Denote with aLC the unit labor requirement for cheese (e.g.
if aLC = 1, then one needs 1 hour of labor to produce a
pound of cheese).
• The economy’s total resources are defined as L,
the total labor supply (e.g. if L = 120, then this
economy is endowed with 120 hours of labor 22or
120 workers).
A One-Factor Economy
• Production Possibilities
– The production possibility frontier (PPF) of
an economy shows the maximum amount of a
good (say wine) that can be produced for any
given amount of another (say cheese), and vice
versa.
– The PPF of our economy is given by the
following equation:
aLCQC + aLWQW = L
(2-1)
– From our previous example, we get:
QC + 2QW = 120
23
A One-Factor Economy
Figure 2-1: Home’s Production Possibility Frontier
Home wine
production, QW,
in gallons
L/aLW
Absolute value of slope equals
opportunity cost of cheese in
terms of wine
L/aLC Home cheese
production, QC,
in pounds
24
A One-Factor Economy
• Relative Prices and Supply
– The particular amounts of each good
produced are determined by prices.
– The relative price of good X (cheese) in
terms of good Y (wine) is the amount of
good Y (wine) that can be exchanged for
one unit of good X (cheese).
– Examples of relative prices:
• If a price of a can of Coke is $0.5, then the
relative price of Coke is the amount of $ that
can be exchanged for one unit of Coke, which
is 0.5.
• The relative price of a $ in terms of Coke is 2
cans of Coke per dollar.
25
A One-Factor Economy
• Denote with PC the dollar price of cheese and
with PW the dollar price of wine. Denote with
wW the dollar wage in the wine industry and
with wC the dollar wage in the cheese industry.
• Then under perfect competition, the nonnegative profit condition implies:
– If PW / aW < wW, then there is no production of QW.
– If PW / aW = wW, then there is production of QW.
– If PC / aC < wC, then there is no production of QC.
– If PC / aC = wC, then there is production of QC.
26
A One-Factor Economy
• The above relations imply that if the relative
price of cheese (PC / PW ) exceeds its
opportunity cost (aLC / aLW), then the
economy will specialize in the production of
cheese.
• In the absence of trade, both goods are
produced, and therefore PC / PW = aLC /aLW.27
Trade in a One-Factor World
• Assumptions of the model:
– There are two countries in the world (Home
and Foreign).
– Each of the two countries produces two goods
(say wine and cheese).
– Labor is the only factor of production.
– The supply of labor is fixed in each country.
– The productivity of labor in each good is fixed.
– Labor is not mobile across the two countries.
– Perfect competition prevails in all markets.
– All variables with an asterisk refer to the
28
Foreign country.
Trade in a One-Factor World
• Absolute Advantage
– A country has an absolute advantage in a
production of a good if it has a lower unit labor
requirement than the foreign country in this good.
– Assume that aLC < a*LC and aLW < a*LW
• This assumption implies that Home has an absolute
advantage in the production of both goods. Another way
to see this is to notice that Home is more productive in
the production of both goods than Foreign.
• Even if Home has an absolute advantage in both goods,
beneficial trade is possible.
• The pattern of trade will be determined by the
29
concept of comparative advantage.
Trade in a One-Factor World
• Comparative Advantage
– Assume that aLC /aLW < a*LC /a*LW
(2-2)
• This assumption implies that the opportunity cost
of cheese in terms of wine is lower in Home than it
is in Foreign.
• In other words, in the absence of trade, the relative
price of cheese at Home is lower than the relative
price of cheese at Foreign.
• Home has a comparative advantage in
cheese and will export it to Foreign in
exchange for wine.
30
Trade in a One-Factor World
Figure 2-2: Foreign’s Production Possibility Frontier
Foreign wine
production, Q*W,
in gallons
L*/a*LW
+1
L*/a*LC
Foreign cheese
production, Q*C ,
in pounds
31
Trade in a One-Factor World
• Determining the Relative Price After Trade
– What determines the relative price (e.g., PC /
PW) after trade?
• To answer this question we have to define the
relative supply and relative demand for cheese in
the world as a whole.
• The relative supply of cheese equals the total
quantity of cheese supplied by both countries at
each given relative price divided by the total
quantity of wine supplied, (QC + Q*C )/(QW + Q*W).
• The relative demand of cheese in the world is a
similar concept.
32
Trade in a One-Factor World
Figure 2-3: World Relative Supply and Demand
Relative price
of cheese, PC/PW
Foreign autarky
relative prices
a*LC/a*LW
RS
1
aLC/aLW
RD
2
RD'
Home autarky
relative prices
Q'
L/aLC
L*/a*LW
Relative quantity
of cheese, QC + Q*C
Q W + Q*W
33
Trade in a One-Factor World
• The Gains from Trade
– If countries specialize according to their
comparative advantage, they all gain from
this specialization and trade.
– We will demonstrate these gains from trade
in two ways.
– First, we can think of trade as a new way of
producing goods and services (that is, a
new technology).
34
Trade in a One-Factor World
– Another way to see the gains from trade is
to consider how trade affects the
consumption in each of the two countries.
– The consumption possibility frontier states
the maximum amount of consumption of a
good a country can obtain for any given
amount of the other commodity.
– In the absence of trade, the consumption
possibility curve is the same as the
production possibility curve.
– Trade enlarges the consumption possibility
for each of the two countries.
35
Trade in a One-Factor World
Figure 2-4: Trade Expands Consumption Possibilities
Quantity
of wine, Q*W
Quantity
of wine, QW
F*
T
P
F
Quantity
of cheese, QC
(a) Home
T*
P*
Quantity
of cheese, Q*C
(b) Foreign
36
Trade in a One-Factor World
 A Numerical Example
• The following table describes the technology of
the two counties:
Table 2-2: Unit Labor Requirements
37
Trade in a One-Factor World
• The previous numerical example implies
that:
aLC / aLW = 1/2 < a*LC / a*LW = 2
– In world equilibrium, the relative price of
cheese must lie between these values.
Assume that Pc/PW = 1 gallon of wine per
pound of cheese.
• Both countries will specialize and gain
from this specialization.
– Consider Home, which can transform wine to
cheese by either producing it internally or by
producing cheese and then trading the
38
cheese for wine.
Trade in a One-Factor World
– Home can use one hour of labor to
produce
1/aLW = 1/2 gallon of wine if it
does not trade.
– Alternatively, it can use one hour of labor to
produce 1/aLC = 1 pound of cheese, sell
this amount to Foreign, and obtain 1 gallon
of wine.
39
Trade in a One-Factor World
– In the absence of trade, Foreign can use
one unit of labor to produce 1/a*LC = 1/6
pound of cheese using the domestic
technology.
– Can it do better by specializing in wine and
trading wine with Home for cheese?
– In the presence of trade, Foreign can use
one unit of labor to produce 1/a*LW = 1/3
gallon of wine.
– Since the world price of wine is PW / PC = 1
pound of cheese per gallon, Foreign can
obtain 1/3 lb of cheese which is more than
1/6 lb.
40
Another Ex: If PC/PW=2,5
Opportunity
Specialization
Cost of Cheese Production
with 1h of
labor
Autarky
Home
2, aLC=2
aLW=1
½C
→1,25 W
½ C or 1W
Foreign
3, a*LC=6
a*LW=2
½W
→0,2 C
½ W or 1/6
C
Production
with 1h of
labor
41
(i-b) The Specific Factors Model
(SF)
• Model developed by Samuelson and
Jones (1971).
• Ricardian Model: differences in labor
productivity explain international trade
• SF model:
– 3 inputs (capital, land, labor) and two sectors:
capital and land are specific while labor is
mobile
42
(i-b) The Specific Factors Model
(SF)
Endowments
(land, capital)
International Trade
Prices in AE
Price Convergence
43
Autarky Equilibrium
• Assume that there are 2 countries
producing 2 goods (M and F) :
– Canada : TA, KA
– Japan : TJ,KJ
To simplify, consider that the demand for each
good is the same in the two countries but
countries have different endowments in inputs:
TA>TJ, KJ>KA
Canada: QF>QM,
Japan: QM>QF
PM/PF is higher in Canada
44
Trading Equilibrium
• International trade
leads to a change in
each country’s
relative price.
• The relative price
increases in Japan
and falls in Canada.
45
(i-c) The HO Model
• 2 sectors – 2 substitutable inputs (land and labor
for instance)
• Production can be obtained with different
combinations of inputs.
• Production structure depends on input’s prices
and hence on factor’s endowments.
• Main result: differences in productivity and
endowments lead to differences in AE prices.
International trade entails a relative price
convergence (goods, inputs).
46
Course Overview
I. International capital mobility
 a. Why international capital flows?
b. The reasons of exchange: some aspects of
international trade and intertemporal choice

(i) Static analysis

(ii) Dynamic Analysis
c. Recent evolutions of financial integration
d. The Balance of Payments
47
(ii) Dynamic analysis: intertemporal
choice
• The exchange of goods is a way of saving
or borrowing.
• Trade balance could be
– Positive: the home country saves and
accumulates net foreign assets
– Negative: the home country borrows to the
rest of the world
->International exchange of capital
48
• Why an international exchange of capital?
– Differences between countries (autarky
interest rates)
– Autarky interest rate depends on domestic
saving (time preference) and domestic
investment (capital productivity)
• International exchange leads to a price
convergence (r)
49
Intertemporal Production Possibility
Frontier and Exchange
• Economic agents face an intertemporal arbitrage
between present consumption and future
consumption.
• In a closed economy, the non consumed income
(Y-C-G) is invested to increase future
consumption.
• In an open economy, investment does not
systematically result from a renunciation to
present consumption. It can result from capital
inflows too.
50
• Assume a one good - Home economy
living two periods: present and future.
• All happens as if the country was
producing two goods:
– The good 1 designs the only good produced
at period 1
– The good 2 designs the only good produced
at period 2
– The relative price between good 1 and good 2
51
will be 1+r.
Two period equilibrium in a closed
Future good
economy
Isovalue line
Qp+Qf/(1+r)=Q
B
Q
Qf
Isoutility
Intertemporal
production
frontier
Investment
Qp
A
Present good
52
• At point A, the country produces only at
the first period and investment is zero.
• At point B, the country invests the all
income and present production is zero.
• At point Q, the country produces Qp in
present and Qf in the future. The spread
A-Qp represent the quantity of good not
consumed in the first period to be invested
in order to increase future production:
investment.
53
A two country world
• Home country: intertemporal PPF is
biased toward present production
• Foreign country: intertemporal PPF is
biased toward future production
• Since PPFs differ, countries have incentive
to trade.
• Differences in PPFs appear through the
relative price (opportunity cost) of present
consumption in terms of future
54
consumption.
• Since Home country production is biased
towards present, price of present
consumption will be lower in Home country
than in Foreign country.
55
• The relative price of future consumption in
terms of present consumption is:
– 1/(1+rA) for Home country (Autarky)
– 1/(1+rA*) for Foreign country (Autarky)
– 1/(1+r*) with international trade (price
convergence)
56
• Before international trade, we have:
rA<rA*
• International trade leads to a real interest
rate convergence: a rise in rA and a fall in
rA* such that: rA<r<rA*
• Home country saves whereas Foreign
country borrows at the first period.
57
A two country world
Future good
Both Isovalue line
and IBC:
Qp+Qf/(1+r)=Q=Dp+
Df/(1+r)
Future good
D
Df
Q
Qf
D
Q
Qf
Df
Qp
Dp
Present good
Qp
Dp Present good
58
• Home country exports present
consumption and imports future
consumption.
• Foreign country borrows to finance
present consumption and lend in the
future.
59
International trade leads to interest
rate convergence
• Foreign country
r
RS
Foreign
RS
world
rmonde
RS
Home
RD
world
wants to borrow on
world market
because the real
interest rate is lower
than in the autarky
situation.
• Home country wants
to lend on world
market because real
Qp/Qfinterest rate is higher
than in the autarky
60
situation.
Creditor or Debtor Country?
• A country with a PPF biased toward present (or
a patient country) will export present
consumption.
• A country with a PPF biased toward future (or an
impatient country) will import present
consumption.
• Patient country = High saving rate
• Impatient country = Low saving rate
• Age pyramid is a fundamental determinant of
savings.
61