International Economics

Chapter 1: Introduction
Globalization:
 refers to the trend towards a more integrated global economic system
 refers to the shift toward a more integrated and interdependent world economy
 is ongoing process that deepens and broadens the relationships and
interdependence among countries
We are living in the world which is rapidly globalizing.
There is an increasing international economic connection, particularly through:
 Goods and services flows
 Financial flows
 Movement of ideas, people, and jobs
There is an increasing role of International Organizations in constraining domestic
policies
Many people believe that globalization brings a lot good things (stimulating economic
growth, creating jobs, raise income level).
However, there are many critics, who demonstrate their opposition to globalization,
focusing on negative effects of globalization (loss of jobs, eenvironmental damage,
erosion of national sovereignty)
Current International Problems/Challenges
 Globalization & Inequality, Unemployment, Environment, Immigration
 Trade Protectionism and Trade Liberalization
 Excessive Fluctuations and Large Disequilibria in Exchange Rates
 Financial Crises/ Global Crises/ EU Public debt
 The US-China trade war
 Covid-19 epidemic
 Industry 4.0
 Russia and Ukraine war …
Chapter 2: International Trade Theory
Some famous theories:
Mercantilism Product Life Cycle Theory
Absolute Advantage Theory New Trade Theory
Comparative Advantage Theory Porter’s Diamond Theory for
Hecksher-Ohlin Factor Endowment Competitive Advantage
Theory
The Mercantilists’ Views on Trade
During 16th and 18th centuries, a group of men - Mercantilists (merchants, bankers,
government officials, and philosophers)
In Great Britain, Spain, France, Portugal and the Netherlands
Gold and silver were the currency of trade between countries

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Belief that nation could become rich and powerful only by exporting more than it
imported
Export surpluses brought inflow of gold and silver
Trade policy was to stimulate exports and restrict imports by:
 Maximize exports through subsidies
 Minimize imports through tariffs and quotas
One nation gained only at the expense of another “a zero-sum game”
Mercantilists measured wealth of a nation by stock of precious metals it possessed.
Today, we measure wealth of a nation by its stock of human, man-made and natural
resources available for producing goods and services. (The greater the stock of
resources, the greater the flow of goods and services to satisfy human wants, and the
higher the standard of living.)
The Wealth of Nations: Three types of wealth, measured in over 100 countries:
 Produced capital - buildings, machines and infrastructure
 Natural capital - cropland, pastureland forests, minerals and energy
 'Intangible capital' - human capital and quality of institutions
Adam Smith and Absolute Advantage
The Wealth of Nations, 1776
A. Smith challenged the mercantilist views on wealth and trade by arguing that trade
was not a zero-sum game, but rather as a positive-sum game.
A. Smith’s concept of absolute advantage was crucial in altering views on the nature of
and potential gains from trade
A nation has an absolute advantage in the production of a product when it is more
efficient than any other country producing it
When one nation has absolute advantage in production of a commodity, but an
absolute disadvantage with respect to the other nation in a second commodity, both
nations can gain by specializing in their absolute advantage good and exchanging part
of the output for the commodity of its absolute disadvantage.
Illustration on Absolute Advantage
Assumptions
 There are two countries A and B
 They produce two commodities X&Y
 Free trade exists between the countries
 The only element of cost of production is labour
Example: Because of climatic conditions:
Canada is efficient in growing wheat but inefficient in growing coffee.
Vietnam is efficient in growing coffee but inefficient in growing wheat.
Canada has an absolute advantage in wheat, Vietnam has an absolute advantage in
coffee.
=> Under these circumstances, mutually beneficial trade can take place if both
countries specialize in their absolute advantage.

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Adam Smith and other classical economists advocated policy of laissez-faire, or
minimal government interference with economic activity.
Free trade would cause world resources to be utilized most efficiently, maximizing
world welfare.
Absolute advantage can explain a very small portion of world trade
By nature, absolute advantage is a special case of the more general theory of
comparative advantage developed by David Ricardo
Trade Based on Comparative Advantage: David Ricardo
1817: Principles of Political Economy and Taxation
Law of Comparative Advantage
 Even if one nation is less efficient than (has absolute disadvantage with respect
to) the other nation in production of both commodities, there is still a basis for
mutually beneficial trade.
 Not possible for one country to have a comparative advantage in everything
Comparative Advantage and Opportunity Costs
The original idea of comparative advantage was based on the labor theory of value:
 The value or price of a commodity depends exclusively on the amount of labor
used to produce it.
Can use the opportunity cost theory to explain comparative advantage:
 The cost of a commodity is the amount of a second commodity that must be
given up to release just enough resources to produce one additional unit of the
first commodity.

Production Possibilities Frontier

 A curve that shows various combinations of the two commodities that a nation
can produce by fully using all resources with best available technology.

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  Constant opportunity costs arise when:
1. Resources are either perfect substitutes for each other or used in fixed
proportion in production of both commodities, and
2. All units of the same factor are homogeneous.
The Basis for and the
Gains from Trade
under Constant Costs
In the absence of
trade, a nation’s
production
possibilities
frontier also
represents its
consumption
frontier. US
produces and
consumes at A;
UK produces and
consumes at A’
Increased output resulting from specialization and trade represents nations’ gains from
trade, allowing nations to consume outside production possibilities frontier.
Under constant cost
conditions, nations will
completely specialize in
their comparative advantage.
With complete specialization
in both nations, the
equilibrium-relative
commodity price of each
commodity lies between the
pre-trade relative commodity
price in each nation.
BEC and B’E’C’ are called
trade triangles and they are

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identical, WHY?

Empirical Tests of the Ricardian Model

McDougall (1951 and 1952)
 Argued that costs of production would be lower in the U.S. in industries where
U.S. labor was more than twice as productive as U.K. labor.
 Found positive relationship between labor productivity and exports; industries
with relatively productive labor in U.S. have higher ratios of U.S. to U.K.
exports, supporting Ricardian theory of comparative advantage.
 Results supported by Balassa, Stern and Golub in later studies.
Absolute advantage: refer to a nation’s ability to produce a certain commodity more
efficiently than another nation
Comparative advantage: refer to a nation’s ability to produce a particular commodity
with a lower opportunity cost than another nation
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Chapter 3: The Standard Theory of International Trade
The Production Frontier with Increasing Costs
Increasing Opportunity Costs
 A nation must give up more
and more of one commodity
to release just enough
resources to produce each
additional unit of another
commodity.
i.e. The US must give up more
and more of cloth to release
just enough resources to
produce each additional unit of
cloth
 Increasing opportunity costs results in a production frontier that is concave from
the origin
The marginal rate of transformation (MRT) of X for Y refers to the amount of Y that a
nation must give up to produce each additional unit of X
MRT is another name for the opportunity cost of X
The value of MRT is given by the (absolute) slope of the PPF at point of production

Community Indifference Curves

A community indifference
curve shows
combinations of two
commodities that yield
equal satisfaction to the
community or nation.
 Represent measure
of taste and
preference.
 Characteristics of
community
indifference
curves.
The marginal rate of substitution (MRS) of X for Y in consumption refers to the
amount of Y that a nation could give up for one extra unit of X and still remain on the
same indifference curve.
This is given by the (absolute) slope of the community indifference curve at the point
of consumption and declines as the nation moves down the curve.
The decline in MRS (absolute slope of an indifference curve) is a reflection of the fact
that the more of X and less of Y a nation consumes, the more valuable to the nation is
a unit of Y at the margin compared with a unit of X.

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Equilibrium in Isolation
Declining MRS means that
community indifference curves are
convex from the origin.
Interaction of forces of demand
(community indifference curves)
and supply (production possibilities
frontier) determine equilibrium for
a nation in the absence of trade
(autarky).
Nations seek the highest possible
indifference curve, given its
production constraint.
The equilibrium-relative commodity price in isolation is given by the slope of
tangency between PPF and
indifference curve at autarky point of
production and consumption.
Relative prices are different in
Nation 1 and Nation 2 because of
different shape and location of PPF’s
and indifference curves.
Basis for and Gains from Trade
with Increasing Costs
Relative commodity price
differentials between two nations reflect comparative advantages, and form basis for
mutually beneficial trade.
Each nation should specialize in the commodity they can produce at the lowest relative
price.
Specialization will continue until relative prices equalize between nations.
Equilibrium-relative commodity
price with trade = common
relative price at which trade is
balanced.
Balanced trade: quantity of X
(Y) Nation 1(2) wants to export
= quantity of X(Y) Nation 2(1)
wants to import.
Any other relative price could
not persist because trade would
be unbalanced.
Under constant cost conditions, specialization is complete.
Under increasing cost conditions, specialization is incomplete:

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  As production moves along
PPF toward comparative
advantage good, relative costs
change, thus changing basis
and gains from trade.
Trade Based on Differences in
Taste
Even if two nations have identical
PPFs, basis for mutually beneficial
trade will still exist if tastes, or
demand preferences, differ.
Nation with relatively smaller
demand for X will have a lower
autarky relative price for, and
comparative advantage, in X.
Chapter 5: Factor Endownments and the H-O Theory
Developed by Eli Heckscher. Expanded by Bertil Ohlin
Assumptions of the Theory
Heckscher-Ohlin theory based on following assumptions:
1. Two nations, two commodities (X and Y), two factors of production (L and K) 2.
Technology in production same in both nations
3. Commodity X is labor intensive, commodity Y is capital intensive in both nations
4. Constant returns to scale for X and Y in both nations
5. Incomplete specialization in production in both nations
6. Tastes are equal in both nations
7. Both commodities and factors are traded in perfectly competitive markets
8. Perfect factor mobility within each nation, but not between nations
9. No transportation costs, tariffs or other barriers to free trade
10. All resources are fully employed in both nations
11. International trade between the nations is balanced.
Factor Intensity, Factor Abundance, and the Shape of the Production Frontier
Factor Intensity
 In a two-commodity, two factor world:
o Y is capital
intensive
commodity if the
capital-labor ratio
(K/L) used in the
production of Y is
greater than K/L
used in the
production of X.

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 o X is labor intensive commodity if the capital-labor ratio (K/L) used in
the production of X is less than K/L used in the production of Y.
 It is not the absolute amount of capital and labor used in production of X and Y,
but the amount of capital per unit of labor that determines capital intensity.
Factor Abundance
 In terms of physical units:
o Nation 2 is capital
abundant if the ratio of the
total amount of capital to the
total amount of labor
(TK/TL) available in Nation
2 is greater than that in
Nation 1.
o It is not the absolute amount
of capital and labor available
in each nation, but the ratio
of the total amount of capital
to the total amount of labor.
 In terms of relative factor prices:
o Nation 2 is capital abundant if the ratio of the rental price of capital to
the price of labor time (PK /PL) is lower in Nation 2 than in Nation 1.
o Rental price of capital is usually considered to be the interest rate (r),
while the price of labor time is the wage rate (w), so PK /PL = r/w.
o It is not the absolute level of r that determines whether a nation is K-
abundant, but r/w.
Factor Endowments and the Heckscher-Ohlin Theory
The H-O theorem:
 A nation will export the commodity whose production requires the intensive use
of the nation’s relatively abundant and cheap factor and import the commodity
whose production requires the intensive use of the nation’s relatively scarce and
expensive factor.
 In short, the relatively labor-rich nation exports the relatively labor-intensive
commodity and imports the relatively capital – intensive commodity.
 Explains comparative advantage rather than assuming it (as was the case for
classical economists).

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Factor-Price Equalization and Income Distribution
The factor price equalization theorem
 International trade will bring
about equalization in the relative
and absolute returns to
homogenous factors across
nations.
 In short, wages and other factor
returns will be the same after
specialization and trade has
occurred.
 Holds only if H-O theorem holds.
 International trade causes w to rise in Nation 1 (the low-wage nation) and fall in
Nation 2 (the high-wage nation), reducing the pre-trade difference in w between
nations.
 Similarly, trade causes r to fall in Nation 1 (the K-expensive nation) and rise in
Nation 2. (the K-cheap nation), reducing the pre-trade difference in r between
nations.
 Thus, international trade causes a redistribution of income from the relatively
expensive (scarce) factor to the relatively cheap (abundant) factor.
Specific Factors Model: Trade will:
 have an ambiguous effect on a nation’s mobile factors,
 benefit the immobile factors specific to a nation’s export commodities or
sectors, and
 harm the immobile factors specific to a nation’s import-competing commodities
or sectors.
Empirical Tests of the Heckscher-Ohlin Model
The Leontief Paradox
 A 1951 test of the H-O theory
 Leontief calculated amount of L and K in U.S exports and import substitutes for
year 1947
 Showed that the pattern of trade did not fit the conclusions of the H-O theorem.
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 o Exports in the U.S. seemed to be labor intensive when they should have
been capital intensive.
Source of the Leontief Paradox Bias
 Assumed a two-factor world which required assumptions about what is capital
and what is labor.
 Most heavily protected industries in U.S. were L- intensive, reduced imports
and increased domestic production of L-intensive goods.
 Only physical capital included as capital, ignoring human capital (education,
job training, skills).
Implications of the conflicting empirical results:
 The H-O model is useful in explaining international trade in raw materials and
agricultural products which represents a large component of trade between
developed and developing countries
 There should be other basis for international trade
Chapter 8: Trade Restrictions: Tariffs
Introduction – Defining Tariffs
A tariff is a tax or duty levied on the traded commodity as it crosses a national
boundary
 An import tariff is a duty on the imported commodity
 An export tariff is a duty on the exported commodity
Purposes:
 Protective tariff: designed to insulate domestic producers from competition
 Revenue tariff: intended to raise additional funds for domestic government
Introduction - Types of Tariffs
 Specific tariff is expressed as a fixed sum per physical unit of the traded
commodity
 Ad valorem tariff is expressed as a fixed percentage of the value of the traded
commodity
 Compound tariff: duty (tariff) is a combination of an ad valorem and a specific
tariff. Eg: A fixed $100 duty plus 10%
of the value of every imported car
Partial Equilibrium Analysis of a Tariff
Resulting Effects of Tariff
 Consumption effect: Reduction in
domestic consumption
o Decrease in consumer surplus
 Production effect: Expansion of
domestic production
o Increase in producer surplus
 Trade effect: Decline in imports
 Revenue effect: Revenue collected by the government

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  Protection cost, or deadweight loss

The Theory of Tariff Structure

The Rate of Effective Protection
 Nominal tariff rate: Based on tariff applied to value of final commodity
 Effective tariff rate: Based on tariff applied to final commodity and imported
inputs
 Indicates how much protection is actually provided to domestic producer of
import-competing commodity
 When a nation imposes a lower tariff on imported inputs than on the final
commodity produced with the inputs, the rate of effective protection exceeds
the nominal tariff rate.
 eg: the government imposes cotton duty free BUT, it imposes 20% tariff on
cloth
 Purposes: To encourage domestic processing and employment

Tariff Escalation
higher tariffs on intermediate & finished goods and,
lower tariffs on raw materials
 incentive for developing nations to expand production of raw materials
 disincentive for developing nations to compete in market for finished goods
Postponing Import Tariffs
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Bonded Warehouse:
 location maintained by importers ensuring that all customs obligations will be
satisfied
 goods may be stored for maximum of 5 years
 requires inspection by U.S. Customs Service
Foreign-Trade Zone:
 U.S/VN. site at which foreign merchandise can be imported without immediate
payment of duties or tariffs
 does not require inspection by U.S./VN Customs
Trade Restriction Arguments
1) job protection
 preserve jobs in some industries but decrease employment in others
 increased cost to consumer greater than average salary for worker whose job
was saved
2) cheap foreign labor
 productivity and cost relevant factors
 relevant to labor intensive production only
3) fairness in trade – level playing field
 other nations lack of environmental regulations
 response to trade barriers of other nations
4) domestic standard of living
 restrictions only improve standard of living at the expense of trading partners
5) equalized production costs
 scientific tariff – tariff to offset cost differentials
 subsidizes inefficient domestic production
6) infant industry
 short run protection for new domestic industries against developed foreign
competition
7) noneconomic arguments
 national defense and cultural considerations
General Equilibrium Analysis of a Tariff in a Small Country
Stolper-Samuelson Theorem
 An increase in the relative price of a commodity (for example, as the result of a
tariff) raises the return of the factor used intensively in production of the
commodity.
 Thus, the real return to the nation’s scarce factor of production will rise with the
imposition of a tariff.

Tariffs in a large economy

A large economy has an effect on world price:
 Lower imports lead to lower prices
 Larger imports lead to higher prices
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Upward-sloping export curve
Foreign supply curve is no longer “infinitely elastic”
Tariffs lead to an increase in the price of the good on domestic market, a decrease
imports and lower in the price in the rest of the world
General Equilibrium Analysis of a Tariff in a Large Country
Under these circumstances, when large Nation imposes a tariff:
 A reduction in trade volume will reduce welfare
 An improvement in terms of trade will increase welfare
Whether welfare actually rises or falls depends on net effect.
Chapter 9: Nontariff Barriers and the New Protectionism
Introduction - Instruments of Trade Policy
Non-Tariffs
Quota Local content requirements
Subsidies Others
Voluntary export restraints
Import Quotas
 Import quota is a direct quantitative restriction on the amount of a commodity
allowed to be imported during a specific period of time
o In year 2021, only 1,000 tons of sugar are allowed to be imported by the
Vietnamese Gov.
o In 2020, there were 2,000 tons of paddy rice allowed to be imported by
the Phillip. Gov.
 Export quota is a direct quantitative restriction on the amount of a commodity
allowed to be exported during a specific period of time
 Global quota: permits a specified number of goods to be imported each year
o Does not specify from where the product is shipped or who is permitted
to import
 Selective quota: import quota allocated to specific countries, Eg. It is banned
by the WTO but it still exists.
Effects of import quota on economy’s welfare:
 Higher domestic price than import tariff
 Higher domestic production than import tariff
 Lower consumption than import tariff
 Lower imports than import tariff
Import Quota vs. Equivalent Import Tariff
 Import quota involves distribution of import licenses, while tariff does not.
o If not auctioned by government in competitive markets, receiving firms
will reap monopoly profits.
o Allocation decision often based on arbitrary judgments rather than
efficiency concerns.

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 o Monopoly profits lead firms to lobby for licenses in rent-seeking
activities.
o Thus, import quotas replace market mechanism, resulting in waste, and
possible corruption.
 Import quota limits imports to specified levels with certainty, while the trade
effect of an import tariff may be uncertain.
o When elasticity of demand and supply are not known, it is difficult to
estimate the import tariff required to restrict imports to desired level.
o Foreign exporters cannot maintain export quantity simply adjust to
barrier by increasing efficiency or accepting lower profits, as with tariff
o Because import quota is less “visible”, domestic producers prefer them
over tariffs.
 Since import quotas are more restrictive than equivalent import tariffs, society
should resist domestic producers’ efforts to use quotas instead of tariffs.
Import quota and import tariff
 Import quota restrict quantity while import tariff works through prices
 The output effect, consumption effect and import restrictive effect of tariff and
quota are the same. The only difference is the area of revenue. If import licenses
are auctioned off the importers then government would earn revenue from the
auction
 The main advantage of a quota is that it keeps the volume of imports
unchanged. But a tariff permits imports to raise when demand increases,
particularly if the demand for imports becomes inelastic
 If officials charged with allocation of import licenses are likely to be exposed to
bribery. Under this situation, import tariff is preferable to import quota
 Import quotas have the tendency to distort international traded much more than
tariffs since its effects are more vigorous and arbitrary
Tariff – Rate Quotas
Two – tier tariff
 A quota that defines the maximum volume of imports (And charges the within –
quota tariff)
 Any imports above this level face a higher tariff rate (Over – quota tariff)
Other Nontariff Barriers and the New Protectionism
Voluntary Export Restraints (VERs)
 With VERs, an importing country induces another nation to reduce its exports
voluntarily, under threat of higher trade restrictions.
 Sometimes called orderly marketing arrangements, VERs allow industrial
nations to appear to support
the principle of free trade.
 Less effective in limiting
imports than import quotas

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 because exporters tend to fill the quota with higher quality, higher priced goods
over time.
A VER works like an import quota, except that the quota is imposed by the exporting
country rather than the importing country
These restraints are usually requested by the importing country
The profits or rents from this policy are earned by foreign governments or foreign
producers.
– Foreigners sell a restricted quantity at an
increased price.
Export Subsidies
The granting of tax relief to exporters or
subsidized loans to foreign buyers to
stimulate a nation’s exports.
Can be regarded as a form of dumping.
Export subsidies are illegal by
international agreement, but often used in
disguised form.
Technical barriers
Technical barriers are various types which restrict import:
 Health and safety regulations
 Sanitary regulations
 Labelling and packaging regulations
 Requirements for environmental performance, et.
Eg: all imports of food products into the US must meet Food and Drug
Administration's standards
Local content regulations
A specified amount of commodity must be supplied in the domestic market by the
producer.
It is to help local labour and domestic suppliers of goods
Government may state:
 Labour requirement
 Input requirement
 Component required at a local level
International Cartels
Organization of suppliers from different nations that agrees to restrict output and
exports of a commodity with the aim of maximizing or increasing total profits.
For example, OPEC (the Organization of Petroleum Exporting Countries) quadrupled
the price of crude oil between 1973 and 1974 by restricting production and exports.
Dumping
The export of a commodity at below cost, or the sale of a commodity at a lower price
abroad than domestically.
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Three types of dumping:
1. Persistent dumping is the continuous tendency of a domestic monopolist to
maximize total profits by selling the commodity at a higher price in the
domestic market.
2. Predatory dumping is the temporary sale of a commodity at below cost or a
lower price abroad to drive foreign producers out of business.
3. Sporadic dumping is the occasional sale of a commodity at below cost or lower
price abroad to unload surplus of the commodity without reducing domestic
prices.
Other Nontariff Barriers and the New Protectionism: Administration dealings,
Currency control, Embargo, …
The Political Economy of Protectionism Fallacious Arguments for Protection
1. Trade restrictions are needed to protect domestic labor against cheap foreign
labor.
 Even if domestic wages are higher than wages abroad, domestic labor costs
can still be lower if the productivity of labor is sufficiently higher
domestically than abroad.
 Mutually beneficial trade could be based on comparative advantage, with
cheap labor nation specializing in labor-intensive commodities.
2. Scientific tariffs are needed so that domestic producers can compete.
 A scientific tariff raises the price of imports to the domestic price.
 This would eliminate price differences and trade in all commodities subject
to such “scientific” tariffs.
Questionable Arguments for Protection
Protection is needed to:
1. Reduce domestic unemployment, and
2. To cure a deficit in the nation’s balance of payments
 Protection would lead to substitution of imports with domestic production.
 These are beggar-thy-neighbor arguments for protection because they come at
the expense of other nations.
 Other nations retaliate; all nations lose in the end.
A Qualified Argument for Protection
Infant-industry Argument
 Temporary trade protection is justified to establish and protect a domestic
industry during its “infancy” until it can meet foreign competition, achieve
economies of scale, and reflect the nation’s comparative advantage.
 To be valid, the return in the grown-up industry must be high enough to offset
the higher prices paid by domestic consumers of the commodity during infancy.
 Requires several qualifications which, together, take away most of its
significance:
1. More justified for developing nations than industrial nations.

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 2. May be difficult to identify which industry qualifies for protection, which, once
given, is difficult to remove.
3. What trade protection can do, an equivalent production subsidy to the infant
industry can do better.
Strategic Trade and Industrial Policies
According to the strategic trade policy argument, a nation can create a comparative
advantage in industries deemed crucial to future growth in the nation.
Nation may use temporary trade protection, subsidies, tax benefits and cooperative
government-industry programs.
Similar to infant-industry argument in developing nations.
Concerns
 Difficult to pick winners and devise appropriate policies to nurture them.
 Efforts largely neutralized when leading nations undertake strategic trade
policies at the same time.
 Retaliation in other markets may eliminate any gains.
The Uruguay Round, Outstanding Trade Problems, and the Doha Round
The Uruguay Round
 GATT’s eighth round of negotiations, with 123 countries participating.
 Began in September 1986 with completion scheduled for December 1990.
 Disagreements between United States and European Union, on reducing
agricultural subsidies, delayed conclusion for three years.
 Agreement took effect in July, 1995.
Aims of the Uruguay Round:
 Establish rules for monitoring protectionism and reversing the trend.
 Bring services, agriculture and foreign investments into negotiations.
 Negotiate international rules for protection of intellectual property rights.
 Ensure more timely decision and compliance with GATT rulings on dispute
settlements.
Major Provisions of Uruguay Accord:
Tariffs
 Tariffs on industrial products to be cut from an average of 4.7% to an average of
3%.
 The share of good with zero tariffs to increase from 20-22% to 40-45%.
 Tariffs removed on pharmaceuticals, constructions equipment, medical
equipment, paper products, and steel.
Quotas
 Quotas on agricultural products were to be replaced with less restrictive tariffs
by 1999
 Quotas on textiles were to be replaced with less restrictive tariffs by 2004

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Antidumping: Tougher and quicker resolution of disputes resulting from antidumping
laws, but not a ban on their use.
Subsidies: The volume of subsidized agricultural products was to be reduced by 21
percent, with government subsidies for industrial research limited to 50% of the
applied research cost.
Safeguards
 Countries barred from implementing health and safety standards that are not
based on scientific research.
 Temporary tariffs allowed to protect domestic industries from temporary
imports surges.
Intellectual property
 Twenty-year protection of patents, trademarks, and copyrights.
 A 10 year phase-in period for patents over pharmaceuticals in developing
countries.
Services
 United States failed to gain access to markets in Japan, Korea and many
developing nations for banks and security firms.
 United States did not succeed in having France and the European Union lift
restrictions on showing American films and TV programs in Europe.
Other Industry Provisions
 United States and Europe agreed to talks on limiting government subsidies to
civil aircraft makers, opening up distance telephone market, and limiting
European steel subsidies.
 United States expressed intention to negotiate opening Japanese computer chip
market.
Trade-Related Investment Measures: Phased out requirement that foreign investors
buy supplies locally or export as much as they import.
World Trade Organization (WTO)
 Established the WTO in place of the GATT Secretariat, with authority in
industrial and agricultural products and services.
 Trade disputes to be settled by vote of two-thirds or three-quarters of nations
rather than unanimously.
Outstanding Trade Problems
 Trade disputes between the United States and the European Union.
o EU subsidies to Airbus
o EU ban on US exports of hormone-raised beef and genetically modified
food
 High subsidies and tariffs on agricultural products, and frequently abused
antidumping laws.
 Tendency for world to divide into three major trade blocs:
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 o European Union (EU)
o North American Free Trade Area (NAFTA)
o Asian Bloc
 Call by some developed nations for labor and environmental standards, to
ensure “leveling of working conditions” and avoid “social dumping”
Doha Round
Launched in November, 2001, in Doha, Qatar.
Agenda included:
 Further liberalization of production and trade in agriculture, industrial products,
and services.
 Further tightening of antidumping regulations, investment and competition
policies.
Developing nations reluctant to make concessions because of feeling that Uruguay
Round failed to deliver on promises.
Developing nations insisted on making Doha Round a true “development round”.
Intended to conclude by end of 2004, all but collapsed in 2006 over disagreements
over agricultural subsidies between developed and developing nations.
As of beginning of 2009, still not concluded.
Chapter 10: Economic Integration
Introduction
Economic integration refers to the commercial policy of discriminatively reducing or
eliminating barriers only among the nations joining together.
Global economic integration & regional economic integration.
Global economic integration: efforts to reduce trade and investment barriers around the
globe: GATT/WTO
Regional economic integration refers to agreements between countries in a geographic
region to reduce tariff and non-tariff barriers to the free flow of goods, services, and
factors of production between each other: AFTA, ACFTA, NAFTA, EU, ….
Over the last two decades, the number of regional trade agreements has been on the
rise
What is the WTO (global integration)?
is the only international organization dealing with the global rules of trade between
nations.
its main function is to ensure that trade flows as smoothly, predictably and freely as
possible
is a forum for governments to negotiate trade agreements
is a rules- based, member –driven organization – all decision are made by the member
governments, and the rules are the outcome of negotiations among members.
History of WTO
The WTO was replaced the GATT (1948), WHY?
Before the WTO created:
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  ITO took place – an intellectual precursor of the WTO
 But the ITO failure, WHY?
It is created by Uruguay Round negotiations (1986- 94)
The WTO is currently working on new negotiations and agreements, known as the
Doha Development Agenda, started in 2001
The basic principles of the GATT
Non-discrimination (MFN clause-Article I)
National Treatment (Article III)
Reciprocity (Article XXWIII)
Transparent and foreseeable tariffs (Article X)
The impartial settlement of disputes (Article XXVIII); and Enforcement
WTO vs. GATT
GATT remained a “provisional” agreement and organization whereas WTO
commitments are permanent
GATT rules mainly applied to trade in goods whereas the WTO covers other areas,
such as services, intellectual property, etc.
GATT had contracting parties whereas the WTO has members
GATT was essentially a set of rules of the multilateral treaty with no institutional
foundation whereas the WTO is a permanent institution with its own Secretariat
GATT vs. WTO
A country could essentially follow domestic legislation even if it violated a provision
of the GATT agreement which is not allowed by the WTO
In WTO, almost all the agreements are multilateral in nature involving commitment of
the entire membership whereas a number of GATT provisions were plurilateral and
therefore selective
The WTO also covers certain grey areas, such as agriculture, textiles and clothing, not
covered under the GATT
The dispute settlement system under the WTO is much more efficient, speedy, and
transparent unlike the GATT system which was highly susceptible to blockages
WTO Objectives
Raising standards of living Expanding production and trade
Ensuring full employment Sustainable development
Ensuring growth of real income and Protection of the environment
demand
Functions of WTO
To facilitate the implementation, administration, and operation of trade agreements
To provide a forum for trade negotiations among member countries
To deal with trade disputes among its member countries
To carry out periodic reviews of its members' national trade policies
To assist developing countries in trade policy issues, through technical assistance and
training programs
To cooperate with other international organizations
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Facts about WTO
Intergovernmental Organization  Location: Geneva, Switzerland
Established: 1 January 1995 under the Marrakesh Agreement, signed by 123 nations
Created by: Uruguay Round negotiations (1986-1994)
Membership (2020): 164 members (98% of world trade value)
Budget (2019): 197 million Swiss francs ($209 million)
Secretariat staff: 625 (Director-General: Roberto Azevêdo from Brazil)
Website: www.wto.org
Levels of Economic Integration
Trading bloc: Trading blocs may take various forms:
preferential economic arrangement 1. Free trade area
among a group of countries 2. Customs union
3. Common market
4. Economic union
5. Political unio

Regional Economic Integration

Preferential trade arrangements
 Provide lower barriers to trade among participating nations than on trade with
non-member nations.
 The loosest form of economic integration.
 Example: British Commonwealth Preference Scheme, established in 1932
between the United Kingdom and members of the British Empire.
GATT/WTO prohibits such agreements:
 A group of countries can lower barriers to others in the group
 Bloc members do not raise their barriers against non-members
Free trade areas
 Removes all barriers to trade among members, but each nation retains its own
barriers to trade with non-members.
 Examples:
o European Free Trade Association (EFTA), 1960, between United
Kingdom, Austria, Denmark, Norway, Portugal, Sweden and Switzerland
o North American Free Trade Agreement (NAFTA), 1993, between the
United States, Canada and Mexico
Eg. Vietnam, Thailand, and Philippines join ASEAN/AFTA
Company A in Vietnam imports X from Bangladesh (non-member of AFTA)
=> Vietnamese Gov. imposes 10% tariff on X imported from Bangladesh
Company B in Thailand imports X from Bangladesh
=> Thailand Gov. imposes 15% tariff on X imported from Bangladesh.
Company C in Philippines imports X from Bangladesh
 Philipp. Gov. imposes 20% tariff on X imported from Bang. Vietnam

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Rules of Origin (ROO)
Not all products traded in an FTA are accorded the tariff preference.
An FTA extends preferential tariffs ONLY to products originating from the
country/area.
A good is considered to be originating if it meets the origin criteria (on) stipulated in
the Rules of Origin (ROO) chapter of an FTA.
ROO apply mostly to FTAs like AFTA, ACFTA, CPTPP, EVFTA, UKVFTA, …
ROO will determine which products are considered originating.
ROOs help to determine the “nationality” of a good.
ROOs vary from FTAs to FTAs  AFTA/ACFTA: Not less than 40% of its content
originates from any Party/member
ROO
Preferential ROO:
 Application of EPA (Economic Partnership Agreement)/ FTA tariff rates
 Application of GSP (Generalized System of Preferences) tariff rates
Non – preferential ROO (application of WTO tariff rates, trade statistics, etc.
ATIGA (ASEAN Trade In Goods Agreement): A Regional Value Content (RVC) of not
less than 40% of the Free on Board (FOB) value.
AIFTA: the AIFTA content is not less than 35 % of the FOB value
Regional Value Content (RVC)
Qualifying Value Content (QVC)/ Regional Value Content (RVC)
Goods are considered as originating if a certain value (%) is added through the
production undertaken in the territory of a party/country, and the value added exceeds
the prescribed threshold (%).
RVC of good can be calculated on the basis of the following method:

Eg. FTAs – Vietnam and Japan

AJEPA (ASEAN Japan Economic Partnership Agreement)- 2008
VJEPA (Vietnam Japan Economic Partnership Agreement) – 2008
CPTPP (The Comprehensive and Progressive Agreement for Trans-Pacific
Partnership) – 2018
Eg. On 10 March, 2020, company A in Vietnam exports USD 20,000 to Japan
VJEPA: Japan’s gov. imposes 2% import tariff on seafood imported from Vietnam
AJEPA (ASEAN Japan Economic partnership Agreement):...1%................
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CPTPP: ………………………..3%.........
Regional Economic Integration
Customs union
 Removes all barriers to trade among members and harmonizes trade policies
toward the rest of the world.
 Examples:
o Benelux (Belgium, the Netherlands, and Luxumberg, 1948)
o EU, or European Common Market, 1957, between West Germany,
France, Italy, Belgium, the Netherlands, and Luxembourg.
o The Customs Union of Belarus, Kazakhstan and Russia, 2010.
Customs union (FTA+)
 EU is a CU
 The EU also has CU agreement with Turkey, Andorra and San Marino
 EU adopt a common external tariff (CET) on imports from non-members
countries
 The tariff imposed on imports from South Korean TV screens will be the same
in the Germany as in any other EU country
 Preferential tariff rates apply to preferential of free trade agreements that EU
has entered into with third countries or groupings of third countries
Common market
 Removes all barriers to trade among members, harmonizes trade policies
toward the rest of the world, and allows free movement of labor and capital
among member nations.
 Examples:
o EU achieved common market status in 1993.
o MERCOSUR (between Brazil, Argentina, Paraguay, and Uruguay)
 CM is a Custom Union + allows free movement of labor and capital among
member nations
EU is a Common Market
EU is a single market/internal market:
 Most trade barriers are removed
 Free movement of goods, capital, services and labour
 Membership of the single market requires regulatory alignment for EU
members
No police or customs checks at borders between most EU countries
Economic union
 Removes all barriers to trade among members, harmonizes trade policies
towards the rest of the world, allows free movement of labor and capital among
member nations, and unifies monetary and fiscal policies of members.
 Examples:

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 o EU
o Benelux, formed after World War II between Belgium, the Netherlands
and Luxembourg
 EU is a common market + unifies monetary and fiscal policies of members =
An Economic Union
Political union - independent states are combined into a single union
 This requires that a central political apparatus coordinate economic, social, and
foreign policy for member states
 The EU is headed toward at least partial political union, and the United States is
an example of even closer political union
Duty free zones (free economic zones)
Duty free zones: Areas established to attract foreign investments by allowing raw
materials and intermediate products duty free.
Special economic zones: Is defined as “a specifically delineated duty free enclave and
shall be deemed to be foreign territory for the purposes of trade operation and duties
and tariffs”
What is a SEZ?
Is one or more areas of a country where the tariffs and quotas are eliminated and
bureaucratic requirements are lowered so that more companies are attracted to the area.
The companies establishing in the area also get extra incentives for doing business
Are an acknowledgement of the potential of export-led development strategy in
accelerating economic growth
Main objectives of the SEZ
Generation of additional economic activity
Promotion of exports of goods and services
Promotion of investment from domestic and foreign sources
Creation of employment opportunities
Development of infrastructure facilities
The theory of Customs Union
Jacob Viner, 1950
Discusses the benefits and cost of regional economic integration from two
perspectives:
 Static effects: Short–term effects
 Dynamic effects: Long-term effects
Combined, these static and dynamic effects determine the overall welfare gains or
losses associated with the formation of a regional trading agreement
Trade-Creating Customs Unions

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Trade creation occurs when
domestic production in a
member nation is replaced by
lower-cost imports from
another member nation.
 Leads to increased
welfare for members
as nations specialize
in comparative
advantages.
 Leads to increased
welfare for non-
members as increased
real income spills over into increased imports from rest of the world.
Trade-Diverting Customs Unions
Trade diversion occurs when
lower-cost imports from non-
members are replaced by higher
cost imports from members.
 By itself, trade diversion
lowers welfare as it shifts
resources away from
comparative advantages.
Trade diverting customs union also
results in trade creation. Change in
welfare depends on relative
magnitude of creation and
diversion.
The Theory of the Second Best and Other Static Welfare Effects of Customs
Unions
It was once believed that any movement toward freer trade would increase welfare, so
formation of a customs union would necessarily result in increased welfare for
members and non-members.
In 1950, Viner showed that formation of a customs union could increase or reduce
welfare, depending on the circumstances under which it takes place.
Theory of the Second Best: If all conditions required to maximize welfare cannot be
satisfied, trying to satisfy as many conditions as possible does not necessarily or
usually lead to the second-best position.
Conditions More Likely to Lead to Increased Welfare
1. Higher pre-union trade barriers of member nations.
2. Lower customs union’s trade barriers with non-members.
3. Greater number of nations forming customs union, and the larger their size.
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4. More competitive rather than complementary economies of member nations.
5. Closer geographical proximity of member nations.
6. Greater pre-union trade and economic relationship among potential member nations.
Other Static Effects of Customs Unions
1. Administration savings from elimination of customs officers, border patrols, and
others.
2. Reduction in demand for imports from and supply of exports to rest of the world
will likely lead to improvement in collective terms of trade of member nations.
3. By acting as a single unit, customs union will likely have more bargaining power
than members separately.
Dynamic Benefits of Customs Unions
1. Increased competition, leading to greater efficiencies and technological
improvements.
2. Economies of scale from the enlarged market.
3. Stimulus of investment to take advantage of enlarged market, and to meet increased
competition.
4. Better utilization of community resources as labor and capital move freely (assumes
common market).
EVFTA- EU – Vietnam Free Trade Agreement
The EVFTA is a new generation FTA between Vietnam and 27 EU member countries
On 26 June 2018, the EVFTA was divided into 2 agreements: EVFTA and EVIPA
In June 2019, EVFTA was signed
On August 1, 2020 EVFTA officially came into effect
The EVFTA is the first comprehensive and ambitious trade and investment agreements
that the EU has ever concluded with a developing countries in Asia
EVFTA - Trade Liberalization
Trade liberalization:
 99% of tariffs both value and number of tariff lines
 After 7 years for EU
 Vietnam 10 years
Coverage at entry into force:
 71% of value of Vietnamese exports/84% tariff lines
 65% value of EU exports/49% tariff lines
CPTPP & Vietnam
CPTPP: The Comprehensive and Progressive Agreement for Trans-Pacific Partnership
On March 2018, the CPTPP was finally signed in Chile, and entered into force on
December 30, 2018
The CPTPP:
 11 members
 495 million people
 13.5% of the world total economic output
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  15.2% total world trade turnover
Vietnam:
 CPTPP will lead to an increase of 1.32% in Vietnam’s GDP
 With CPTPP, VN is expected to gain export benefits by 4.2%
 Help VN reform domestic institutions, create transparent and open investment
and business environment
AEC
Population: 620 million (9% of
world population), 60% under the
age of 35
3.3 % of world GDP
AEC’s merchandise exports:
US$1.2 trillion (52% of total
ASEAN GDP and 7% of global
exports)
If ASEAN were one economy, it
would be the 7th largest in the world (4th largest by 2050 if growth trends continue)

History of Attempts at Economic Integration

The European Union (EU)
 1958 – established common external tariff
 1968 – Achieved free trade in industrial goods within EU, and common price
for agricultural goods
 1970 – Reduced restrictions on movement of labor and capital
 1993 – Removed all remaining restrictions on flow of goods, services and
resources, becoming largest trade bloc in the world
The European Free Trade Association (EFTA)
 1960 – formed by “outer seven” nations: United Kingdom, Austria, Denmark,
Norway, Portugal, Sweden and Switzerland
 1967 – Achieved free trade in industrial goods

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  1991 – Membership evolved to include Austria, Finland, Iceland, Liechtenstein,
Norway, Sweden, and Switzerland
 1994 – Joined EU to form European Economic Area (EEA)
The North American Free Trade Agreement (NAFTA)
 1994 – formed by United States, Canada and Mexico, to eventually lead to free
trade in goods and services over entire North American area.
o Also phased out many other barriers to trade and reduced barriers to
cross-border investments among the three member nations./.
Chapter 11: International Trade and Economic Development
The Importance of Trade to Development
Traditional trade theory:
 If each nation specializes in its comparative advantage good, world output
increases and both nations gain.
 This suggests that developing nations should continue to produce primary
goods (crude oil, coal, copper, coffee beans, tea, cotton, etc.) while developed
nations produce manufactured goods (steel, chemicals, paper, textiles,
machinery, clothing, vehicles, etc.).
 Developing nations believe this pattern keeps them from reaping the dynamic
benefits of industry and maximizing their welfare in the long run.
Developing nations view traditional trade theory as involving adjustments to existing
conditions, while development requires changing existing conditions.
However, traditional trade theory can be extended to incorporate changes in factor
supplies, technology, and tastes by using comparative statics.
A nation’s pattern of development is not determined once and for all but must be
recomputed as conditions change or are expected to change.
As a developing nation accumulates capital and improves technology, its comparative
advantage can shift from primary to manufactured goods.
Beneficial Effects of Trade on Economic Development:
 Can lead to full utilization of underemployed resources.
 Makes possible division of labor and economies of scale.
 Provides a vehicle for the transmission of new ideas, new technology, new
managerial, and other skills.
 Stimulates and facilitates the international flow of capital from developed to
developing nations.
 Stimulates domestic demand for new manufactured products until efficient
domestic production becomes feasible.
 Stimulates greater efficiency by domestic producers to meet foreign
competition.
Endogenous Growth Theory:

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  Lowering trade barriers will speed up the rate of economic growth and
development in the long run by:
o Allowing developing nations to absorb technology developed in
developed nations at a faster rate
o Increasing the benefits that flow from research and development
o Promoting larger economies of scale in production
o Reducing price distortions and leading to more efficient use of domestic
resources across sectors
 Encouraging greater specialization and more efficiency in the
production of intermediate inputs
 Leading to more rapid introduction of new goods and services.
The Terms of Trade and Economic Development
Terms of Trade (TOT):
TOT refers to the relationship between how much money a country pays for its
imports and how much it earns from exports.
It is expressed as a ratio of import prices to export prices:

A TOT over 100% or that shows improvement over time can be a positive economic
indicator as it can mean that export prices have risen as import prices have held steady
or declined.
Types of Terms of Trade:
Commodity terms of trade, or, net barter terms of trade (N)
Income terms of trade (I)
Single factoral terms of trade (S)
Commodity terms of
trade, or, net barter
terms of trade (N) is
defined as the ratio of
export prices to import
prices of a country:

Income terms of
trade (I) is the net
barter terms of trade
of a country multiplied
by its export volume
index (Measures the
nation’s export-based
capacity to import).

30
 Single factoral terms
of trade (S): Measures
the amount of imports
the nation gets per unit
of domestic factors of
production embodied
in its exports

Income terms of trade (I) and Single factoral terms of trade (S) can increase even if
commodity terms of trade (N) does not, increasing welfare.
Most favorable: increases in N, I, and S.
Deterioration in all three terms of trade may lead to immiserating growth
Commodity terms of trade in developing nations tend to deteriorate over time
because:
Most or all productivity increases in developed nations are passed on to workers with
higher wages and income, while increases in productivity in developing nations are
reflected in lower prices.
Developing nations’ demand for manufactured exports of developed nations grows
faster than developed nations’ demand for agricultural and raw material exports of
developing nations.
Export Instability and Economic Development
Developing world exports tend to face inelastic international demand.
Price fluctuations in these markets do not significantly change the quantity sold.
Thus, price fluctuations will generate large movements in revenues collected.
Fluctuating environmental conditions (weather, natural disasters, etc.) cause more and
larger supply shifts in the developing world than in the developed world.
Fluctuating export prices will result in export earnings that vary significantly from
year to year.
When export earnings rise, exporters increase consumption, investment, and bank
deposits, which multiply through the economy.
A subsequent fall in export earnings results in a multiple contraction of national
income, savings, and investment.
These boom-bust periods make development planning difficult.
Empirical Research (MacBean, 1966):
 While export instability is greater for developing nations, the degree of
instability is not very large in an absolute sense.
 Great fluctuation in export earnings of developing nations did not lead to
significant fluctuations in their national income, savings and investments, and
did not interfere with development efforts.
 MacBean concluded costly commodity agreements demanded by developing
nations are not warranted.

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Commodity Agreements:
 Buffer Stocks involve the purchase of the commodity when the commodity
price falls below an agreed minimum price, and the sale of the commodity out
of the stock when the commodity price rises above the maximum price.
o Example: International Tin Agreement, 1956
 Export controls regulate the quantity of a commodity exported by each nation in
order to stabilize commodity prices.
o Example: International Sugar Agreement, 1954
 Purchase contracts are long-term multilateral agreements that stipulate a
minimum price at which importing nations agree to purchase a specified
quantity of the commodity and a maximum price at which exporting nations
agree to sell specified amounts of the commodity.
o Example: International Wheat Agreement, 1949
Import Substitution versus Export Orientation
During the 1950s, 1960s, and 1970s developing nations made deliberate efforts to
move production away from primary goods towards more industrialized production.
Potential gains
Faster technological progress and growth
Creation of higher-paying jobs
Higher multipliers and accelerators through greater linkages in the production process
Improved terms of trade, price stability
Relief from balance of payments difficultie
Strategies for industrialization:
 Import substitution industrialization
 Export–oriented industrialization
Import substitution industrialization (ISI):
 Replace imports of industrial goods with domestic production by reducing
import access to the domestic economy.
 Advantages:
o The market for the product already exists
o It is easier to close the domestic market to imports than to establish new
industries in the face of foreign competition.
o Foreign firms will be encouraged to invest domestically to avoid the
barriers to trade.
 Disadvantages:
o Protected industries have reduced incentives to improve and become
competitive.
o The domestic economy may be too small to exploit available economies
of scale.
o Import substitution is difficult for more complex products.
Trade Liberalization and Growth in Developing Countries
32
  Many countries that had earlier followed import substitution strategies began to
liberalize, starting in the 1980s.
 Facilitated by the World Bank.
 Improvements in productivity and growth
Export-oriented industrialization:
 Expand industrialization through efforts to expand domestic exports of
industrialized products.
 Proven to be more effective than import substitution.
 Advantages:
o Allows for the exploitation of available economies of scale
o International competition spurs greater domestic efficiency
o Industrial expansion is not limited by the scale of the domestic economy.
 Disadvantages:
o May be difficult to set up export industries due to competition from more
established industries
o Developed nations often provide a high level of effective protection for
industries producing simple labor-intensive commodities in which
developing nations may have a comparative advantage.

33