International political economy - Module 2

International political economy mod.2 08/11/21

International trade and trade policies

The first main topic is international trade and trade policies. As long as there is comparative advantage, then international trade can be beneficial for all the countries. In the first module, we have seen ideas, different schools, and different points of view in international political economy. Here we are going to try to formalise them, and then we are going to back to ideas with the help of mathematical formalisation.

Open macroeconomics and international macro policies

The second set of topics are topics in open macroeconomics and international macropolicies, topics that we have already seen in descriptive terms, such as national income accounting, balance of payments, exchange rates, and the international monetary system, but trying to give a bit of formalisation.

We are going to look at political economy in an international dimension. Political economy is an approach that looks not only at an economic factor but also at the political and social dimension and we are going to be into these particular phenomena that have either an international or a transnational aspect - for example, trade relationships between sovereign states or the role of transnational companies that have different activities in different countries. The important aspect of political economy is that we are going to use economics, but we are going to try to keep on board some elements of politics and society. Towards the end of the first part of this module, we will see that we can go back to the political economy using these tools.

What is international political economy?

• It is essentially the study of Political Economy with particular attention to the international dimension: i.e., focusing on actors/phenomena that are either international (between nation-states, such as trade relations) or transnational (i.e., the role of transnational corporations).
• PE - here IPE - includes an economic dimension (how scarce resources are distributed among individuals, groups, states, and the role of markets), the political dimension (use of power by different actors: individuals, groups, states, international organizations), the social dimension (attention to different groups/classes within states).

There is not much difference about the topics between module 1 and module 2; it is more about the approach: in the first one, it was more about understanding the different schools and a different way to approach the topic of importance of this subject. Instead, in this second module, we are going to focus more on the most popular approaches, which are the neoclassical and neo-Keynesian approaches to international economics and try to use it to understand something a bit deeper about what we want to do.

Introduction

The study of international economics has never been as important as it is now. Nations are more closely linked through trade in goods and services, through flows of money, and through investment in each other's economies than ever before. This is clear when looking at some basic statistics. As last time, we introduced the importance of studying international economics and international economic relations in a broad way. Now we are going to see some topics in purely economic terms. You can think that these last decades have been the most important time in history to study international economics because most regions of the world are now incredibly interlinked. So, understanding how the relationship of trade, monetary relationships across countries is crucial to understanding the wellbeing and the economic dynamics of the world. And a lot of other aspects, as we have seen in the first module, such as aspects of development for developing countries, given that the world is so strongly interlinked in order to understand any of these aspects is crucial to understand how some basic aspects of international economic relations work.

This is something very similar to what I showed you at the beginning of the first module, and it is more important now because this part is going to be about international trade. These were looking at the percentage of exports and imports on GDP as a percent of US national income, and you can see how this is growing and the shaded areas represent crises, so you can see that typically openness tends to go down in crises. For example, the one of 2010 is a particularly severe one, it is the 2008-2010 mortgage crisis in the US. There are moments in which this openness goes down since imports and exports go down, but the trend is very clear, it has been growing up over time.

This is more interesting: this is a comparison across countries. You can see that openness depends on the size of the country, apart from many other factors, but if we look at the percentage of exports or imports as a percentage of the national income, clearly it depends on the size: small countries, like Belgium, which need to import a lot of products that they need and export a lot of what they do, while big countries, like the US, in absolute terms are exporting and importing much more than Belgium but, relative to their GDP, not as much because they are producing internally a lot of the things they need, so they do not need international trade so much.

In particular, one reason to start thinking about understanding and modelling international trade is that in recent years it has been an incredibly hot topic and I think about it from a political economy perspective. For a long time, since the mid-80s until the late 90s, the political economy of trade has been dominated by a sort of neoclassical view. There was this very strong dominant idea, according to which trade is good. If we remove all those distortions like tariffs and other within-country negative aspects and we can reach something that is close to an ideal world, then trade is very good and we should promote it. The 90s have been an age in which all the international institutions have been pushing very strongly for countries to reduce tariffs, to make international agreements to keep tariffs low, to promote bilateral and multilateral agreements to cut tariffs and promote trade. It was the spirit of that time but you must have seen that in the last ten years the feeling was much different.

In particular, this feeling of distrust and aversion to globalization, to economic openness was progressively going hand in hand with the rise of populism. One of the main arguments of populist leaders that have been successful around the world was to push in the opposite direction, it was to try to convince people that trade is not necessarily good and that it is good to run trade wars, that it is good to put tariffs, and this idea that international trade is unfair and needs to be curbed one way or another, either by putting tariffs or by putting heavy regulations. On the other hand, you can see that economic newspapers and other kinds of information outlets that were heavily informed by economic theory did not agree with this view very much. If we see what Bloomberg said at that time, he said “Trump said that...” and what Bloomberg says is that “Asia’s up in arms...”.

"In the Spirit of Achieving Fair Trade," Trump Raises Tariffs on Hundreds of Billions of Chinese Imports" - there is this discussion in economic theory. We think that in ideal conditions trade is always good and we will see this today more formally. You can claim that sometimes ideal conditions are not met but, if we analyze specific case studies, my feeling is that when things do not work, it is possible that perhaps trade does not work so well, but those who do not achieve free trade are typically the poor. Instead, the leading rhetoric in the US was that the US was hit by unfair trade, they were like the weak guys that everybody was exploiting for some reasons. This rhetoric had a lot of success there. So, they started for example to raise tariffs on Chinese imports and, given that in economics expectations are very important, they got to a point in which Trump was tweeting stuff and this was affecting expectations, so there were immediately dramatic consequences in the market. There is strong evidence that his trade affected the market’s expectations of policy.

So, these anecdotal elements were used to deliver two things:

• This is an important topic for policy. There was a lot of feeling in Europe and the US that, whether trade is fair and whether trade should be opened and promoted across countries or not, it was an important policy debate element. In the election of Trump five years ago, it was one of the key topics.
• In a way, this kind of economic finding, that in economics has been challenging since the 60s and 70s, fundamentally has been there since Ricardo, and now there is little disagreement in economics that international trade is good.

Despite this very clear prescription of economic theory, you can see that people do not seem to be very on board with this idea and populist leaders that come to elections with a platform saying that we should put tariffs and curb international trade seem to be quite popular. In Italy, there were equivalent populist leaders that have very strongly pushed on the idea that Chinese stuff was unfair competition and that being part of the EU is damaging because we are forced to have free trade with other countries. One of the characteristics of populism (it is not part of this course) is the strong anti-elite rhetoric but also the other characteristic, that is to propose policies that are meant to please the voters in the short run but they disregard the long-run effect of it. If trade is good or bad, a person that has a view grounded in neoclassical economic theory thinks that it is always better to have better cars, so if there is a place that there is a place that is better in producing cars it would be the place where cars are produced and sold to other countries which is better in doing something else.

What is international economics about?

International economics deals with economic interactions that occur between independent nations. The role of governments is regulating international trade and investment is substantial. Governments also control the supply of currency.

Same method of analysis as other branches of economics. There are several issues that recur throughout the study of international economics:

• The Gains from Trade: Many people are skeptical about importing goods that a country could produce for itself. When countries sell goods to one another, all countries benefit.
• Trade and income distribution: International trade might hurt some groups within nations. Real wages of low-skilled workers in the US have been declining even though the country as a whole has been growing richer.
• The Pattern of Trade (who sells what to whom?): Theory should be good enough to explain the international trade that is actually observed. Climate and resources determine the trade pattern of several goods. In manufacturing and services, the pattern of trade is more subtle.

This part of the course is gonna try to keep a little bit of the approach of Political Economy but a lot of the elements are gonna be from a course of International Economics, which means that we are gonna be a bit far away from the political and social perspective and starting from the economic model of international economics. The aim is that of dealing with economic interactions that occur between independent nations, the role of governments both in terms of trade policy and in terms of exchange rates because governments decide the supply of currency, so they are very important players. And we are gonna see a few issues: the first one is trying to give a formalisation of that long-lasting theory of Ricardo, which is about the gains from trade.

Once we have some very simple mathematical formalisation, you'll see how gains from trade emerge very naturally and if there is somebody that does not gain from trade, it's either a distributional aspect (a certain country has gained but all the gains were to one and the others didn't get anything) or there is something else that is not working and it should. Of course, even if trade is beneficial, international trade has an effect on income distribution and once we see the specific factors model, it will be clear how economic forces generate these aspects but that is why, even if international trade is good, it may still hurt some specific groups within a nation. The typical examples are the real wages of low-skilled workers in the US that have been declining even though the country as a whole has been growing richer. So, those many years of international trade after the GATT and the WTO the US incredibly benefited from trade in aggregate, but the problem is that within the US some categories have gained dramatically and some have lost a bit. And if you are part of the category that lost a bit, you don't particularly care about what in aggregate is happening, you're just upset.

So, when we will come back on this module also the political economy side is an important aspect and a bit of the story that political economy is trying to formalise about the rise of populism in the US for example and the Trump phenomenon. It is very interlinked to this because Trump was talking a lot about international trade five years ago, and one way to interpret it is exactly that.

If you look at the pattern of voting for republican parties or for a particular republican candidate in a presidential election, traditionally the US has been a country where the income pattern has been the strongest. If you look at the probability of voting for the republican candidate in an election relative to income, there will be a very strong correlation. The first time in which this situation was not so clear anymore was the election of Trump. It was the first time in the after-war history in which, if you look at the pattern of the probability of voting for Trump and the income of the voters, you will see that it was the first time in which this clear pattern that in the US politics has always been there was not clear anymore. There was probably still some correlation, but almost poorly significant, which means that a lot of the switch that brought Trump to be supported was the fact that it was not a traditional republican anymore, it was a populist right-wing leader, which means that he was voted by a lot of working class and one of the interpretations was exactly this: that his rhetoric against trade was very appealing for those people that were hit negatively by these years of international trade because there were some categories that lost.

You can imagine that, as we have seen Adam Smith and Ricardo, one of the typical characteristics of international trade is specialisation: each country with international trade can specialise in the sectors of the stuff that it can do better but it has consequences in a multisector economy. If the US have a very strong comparative advantage in producing Apple computers but perhaps they don't have so much comparative advantage in producing cars, this means that if you are a worker in the manufacturing sector instead of in the IT, you may find yourself in a much less fine position. This explains partially how the working class is supportive of right-wing populist parties and not only the US. If you see the pattern of the Northern League in Italy, it is a right-wing party in many dimensions but it gains a lot of support from the working class. A lot of the rhetoric of the Northern League is very much in line with the same points: international trade is bad for Italy, we need to consume Italian. The propaganda of these parties has a clear aim, which is that of delivering the idea that international trade is bad and therefore we should curb it one way or another.

So, the first aspect is to try to understand the pattern of trade, so who is selling what to whom? and you should already have an idea, that is that certain countries specialise in certain goods and export them, and other countries specialise in others. For a lot of goods this is trivial: if you think about the trade pattern of certain products, such as stuff for mining or certain natural and agricultural products, these are just determined by climate and resources.

Part 2

If you look at the export of bananas, they are going to be exported by countries that have the right climate to cultivate them. Manufacturing and service are a bit simpler: it is about economic efficiency, without cast and growing, it is not like bananas, you don’t have to look at the climate.

The second one is to try to understand how much trade you have. For structuralists, you have to trade with tariffs, especially in certain sectors: the government has to actually shield certain sectors with import-substitution for example. Of course, this generated debates about costs and benefits on free trade. If you think about globalization, about Brexit, about Trump and other populist leaders all around the World, pretty much have cast in a topic that initially it was a topic of the Left, but for the Left, it has always been a topic about the fact: in rich countries, the manufacture work has lost a bit of the process, but the financial sector has gained, so how do we redistribute the income? In more recent years this became a topic of the Right: the right populism. A very interesting phenomenon, characterized by a lot of rhetoric, but in terms of policy, it is characterized by some old arguments of the left, which have dropped anti-trade, high tariffs, and high taxes on distribution.

Balance of payments

In the first part of the course, we have seen what it is and how it works. For some countries, it is not a problem to run a consistent deficit or surplus.

Exchange rates

The role of exchange rates is at the center of international economics, it affects how much:

• Goods denominated in foreign currency (imports) cost in the domestic country.
• Goods denominated in domestic currency (exports) cost in foreign markets.

Now we are going to try to see how they are determined and how they affect international trade, international transactions. They change the price of the importing goods inside the country and the price of exporting goods outside the country. We are going to make a distinction between inte...