Macroeconomics at the International Level

• The various economies that comprise the global economy are diverse. This can be quantified using GDP per capita. The diversity is due to a variety of reasons
  • Geographical differences
  • Differences in demography — most low-income countries are skewed towards young people.
  • Differences in Industry Structure
  • Differences in Economic Institutions (i.e., free market vs command economy).

Meeting Macroeconomic Goals §

• No nation intentionally aims for a low standard of living, high rates of unemployment and inflation, or an unsustainable trade imbalance. However, nations will differ in their priorities and in the situations in which they find themselves, and so their policy choices can reasonably vary, too

Economic Growth §

• For High income economies, the challenge of economic growth comes in innovation and shifting aggregate supply to the right.
  • This entails Fiscal policy focused on investment, and Monetary policy to keep inflation low.
  • These countries run expansionary monetary policies.
• For Middle-Income economies, the challenge comes in domestic savings, investments in human capital, technological R&D, and engaging with the world market.
  • In many of these countries, the government heavily regulates the financial sector and various industries.
• For Low-Income economies, they face extreme poverty and unemployment.
  • The main challenge is in establishing a stable economy with a stable legal backing. There is also a need to establish appropriate market forces.
  • The main obstacle is often political.
  • They must also cross a threshold of productivity considering income is invested into needs rather than capital that can boost productivity further.
  • Foreign aid does not necessarily work as it may only provide short-term benefits and may be politically motivated.

Unemployment §

• For High-Income economies, the challenge is either the cyclical unemployment during a recession or the natural rate of unemployment.

  • Solutions lie in either expansionary monetary policy or in automatic stabilizers. However, these are not perfect solutions due to time lag and the need to re-establish trust that the economy is growing.
  • Policies regarding the Labor Market could reduce the natural rate of unemployment, but this might also result in firms hiring less.

• For Low and Middle-Income economies, the problem of unemployment also extends to unstable jobs that has variable payoff.

  • These workers are also not subject to worker’s benefits and so are subject to harsh working conditions.
  • Another challenge is transitioning of labor. There is incentive towards manufacturing which requires low skilled workers and which pays a low but consistent wage.
  • The period of economic transition may cause the agricultural sector to suffer.

Inflation §

• High-Income economies operate on the following principles regarding inflation ¹

  • Monetary policy can prevent inflation from being entrenched in the economy in the medium and long term.
  • There is no long-run gain to letting inflation become established.

• Low and Middle-Income economies lack both the tools for addressing inflation and the consensus among policy makers that this is an appropriate goal

  • Inflation in these countries come from large budget deficits. Too much money chasing too few goods.
  • For other countries, especially those with converging economies, they can catch up to technology leaders at the cost of inflation rates that are “high” for high-income economies.

Trade §

• Low and Middle-Income economies previously shunned the idea of being open to international trade. However, evidence from successful economies that have “broken through” suggests that world trade is an imperative goal. No country exists that is isolated yet has a high standard of living

• There are concerns over foreign trade namely job loss, negative externalities to the environment, and unfair labor practices..

• Infant Industry Argument - subsidizing or protecting new industries for a time until they become established is good. ²

  • A country should block imports for a limited time to give infant industries time to mature and compete with other industries in the global market.

• There are concerns over international flows of capital. In particular, there may be trade imbalances.

  • High-income economies tend to run trade surpluses
  • Middle and low income economies tend to run trade deficits.

• Trade imbalances may not be sustainable in the long run which could mean budget deficits or sudden bursts of inflation as aggregate supply shifts left.

• Over-reliance on imports raises questions since this may make the country prone to bad loans and they may be stuck in debt to lenders of financial capital, which may lead to bankruptcy and recessions.

  • The challenge is in creating economic policy that can control or reduce foreign flows of capital.

Globalization §

• Protectionism - seeks to shield domestic producers from foreign competition. It manifests in three forms.

  • Tariffs.
  • Import Quotas - limitations in the quantity of products imported
  • Nontariff barriers - all other ways that a nation can draw up rules, regulations, inspections, and paperwork to make it more costly to import product.

• Protectionism is a matter of choosing between maximizing producer surplus or consumer surplus.

Arguments for Protectionism §

• Globalization can threaten national interests and security.

  • Trade policies can contribute to poverty in low-income countries because there is incentive for production in these countries to produce more at the expense of the laborers. High income countries can also drive out local businesses.
  • International trade can lead to fewer jobs, lower wages, or poor working conditions
  • In particular, globalization may disproportionately impose costs on low skilled low income workers because
    • They must compete with imported goods from trade
    • There is no incentive for their wages to rise since “labor is cheap abroad”.
    • They do not immediately benefit from physical capital.
  • It would also be bad for a nation to depend on imports for key products.

• The Infant Industry Argument (see here) applies. However, in order to hand it out properly: ³

  • Do not hand out protectionism and other subsidies to all industries, but focus on a few industries where your country has a realistic chance to be a world-class producer.
  • Do not use protectionist policies in industries that other industries rely on (i.e., tech). This imposes more costs on other industries.
  • Have clear guidelines for when the infant industry policy will end.

• The Anti-Dumping Argument means we block imports that are sold below the cost of production by imposing tariffs (the practice of selling goods below their cost of production is dumping).

  • Dumping cases are countercyclical. They increase during recessions and decrease during economic booms.
  • Dumping occurs either because of market forces which shift demand or because of strategizing in a similar manner to predatory pricing. Lower cost = More demand that can drive out local industry.

• Globalization affects the environment in a negative manner to the point that the social costs outweigh the social benefits. There is a gap between the environmental standards of high income and low income countries

  • The race to the bottom scenario goes as follows:
    • Profit seeking firms shift production abroad where environmental standards are lower
    • The shift in production means low income countries are incentivized to keep environmental standards low
    • Profit seeking firms continue to do this and environmental laws race to the bottom.
  • Blocking imports may allow low income countries to raise their environmental standards.

• The Unsafe Consumer Products Argument means that certain imported products are unsafe for consumers. For as long as the reason is founded in scientific evidence, this argument applies.

Arguments Against Protectionism §

• When a country sets a low or medium tariff or import quota, the equilibrium price and quantity will be somewhere between those that prevail with no trade and those with completely free trade.

  • Protectionism benefits local producers but imposes costs on local consumers since less of the good will be available, and the good will be sold at a higher price than if trade were allowed.
  • Protectionism may also protect some jobs but not others as costs are higher. It reshuffles jobs from industries without import protections to those that are protected from imports. However, this does not make new jobs,
  • Protectionism results in deadweight loss due to lost economic efficiency.
  • The key is how flexible workers are in finding jobs in different industries. The effect of trade on low-wage workers depends considerably on the structure of labor markets and indirect effects felt in other parts of the economy

• While eliminating trade barriers in one sector of the economy will likely result in some job loss in that sector, consumers will spend the resulting savings in other sectors of the economy and hence increase the number of jobs in those other sectors.

  • Promoting trade will also increase social surplus in both parties involved.
  • Trade will raise the average wages in the economy since workers operate on their comparative advantage. Trade barriers have the opposite effect.

• The Infant Industry Argument holds in theory, but in practice protectionist policy in place has restricted the industry too much that it could not compete with the global market.

• Anti-Dumping is difficult to find evidence for, and often it is founded in politics rather than economic principles.

• Environmental Costs to Trade may not be that big in practice

  • In the race to the bottom scenario, lax environmental laws are not the only factor for shifting production. Environmental costs, as well, are only a small fraction of total cost for starting up.
  • Even if the reason for moving production to foreign countries is environmentally motivated, the industry design will still follow the design in high-income (high environmental standard) countries. This applies unless the firm is willing to redesign its industry structure.
  • Firms are incentivized to follow high environmental standards since the cost of doing otherwise outweighs the benefits.
  • Protectionism is not the only approach to incentivizing environmental standards. For example, Taxes on pollution and emissions.

• It makes little sense to block imports for key economic goods since doing so only restricts possible sources of these goods.

• Products that are of “national interest” tend to be arbitrarily defined, usually motivated by politics.

Trade Policy §

• The General Agreement on Tariffs and Trade was signed to provide a forum where nations could negotiate trade restrictions. This would eventually become the World Trade Organization.

  • Negotiations on this level tend to be slow.
  • The general trend worldwide appears to be lower barriers of trade.

• Free Trade Agreement - participants allow each other imports without tariffs or quotas

• Common Markets - participants have a common external trade policy as well as free trade within the group

• Economic Unions - participants have a common market as well as coordinated monetary and fiscal policy.

• Regional Trade Agreements may conflict with the goals of the WTO since they may limit trade from anywhere else.

• On a national level, there is conflict between national protectionist laws, and international free trade agreements. This conflict is rooted in only allowing some imports — specifically those that benefit national interests.

• Trade benefits the average person, but not the “below average” person — producers who fail to compete with the global market, and consumers who cannot buy from the global market

  • However, it is better to embrace the gains from trade and deal with the costs with other policy tools, than it is to cut off trade to avoid both costs and benefits

• Trade can be viewed as a disruptive force on the economy.

Links §

• Shapiro, MacDonald and Greenlaw - Ch. 32, 34
• Macroeconomic Frameworks

Footnotes §

1. There is often a political consensus in these economies that these are the appropriate goals with regards to inflation. ↩

2. This is controversial since it falls under whether or not a country should adopt protectionist policies in the face of the global market. ↩

3. This is from the World Bank. In practice this is subject to politics ↩