Can New Zealand blame distance for its economic woes alert: the global economic hub has been moving closer to us for at least 20 years
29 Aug 2014 Leave a comment
in applied price theory, economic growth, international economics Tags: burden of geography, New Zealand, New Zealand productivity performance, scapegoating
Comparative Advantage and the Tragedy of Tasmania | MRUniversity
02 Jul 2014 Leave a comment
in applied price theory, international economics Tags: comparative advantage, Don Boudreaux
The current-account deficit is a false problem
01 Jul 2014 1 Comment
in applied welfare economics, international economics Tags: capital account surpluses, current account deficits, foreign investment, international trade in savings, John Cowperthwaite
The current account balance equals net foreign investment. When net foreign investment is positive, the current account is in deficit. The current account balance is the result of the international trade in savings and the relative rewards and incentives of investing at home or abroad:
- The current account is in surplus when national saving is greater than net domestic investment; and
- The current account is in deficit when national saving is less than net domestic investment.
New Zealand can import more than it exports courtesy of this foreign investment.
- The difference between exports and imports, or net exports, is the trade balance.
- But for net foreign investment, the trade balance would have to always balance.
For most of the last 20-years, exports have been the same as imports, more or less, so the New Zealand current account deficit has little to do with the level of exports or imports.
A current account could be called a capital account surplus, but this label lacks that certain demonic ring the media laps up. Deficits are bad, surpluses are good. How can a surplus be bad? Who wants to cut a surplus?
John Cowperthwaite solved Hong Kong’s current account problems by not collecting trade statistics. His concern was:
If I let them compute those statistics, they’ll want to use them for planning.
Cowperthwaite refused to collect economic statistics
for fear that I might be forced to do something about them
If New Zealand did not collect trade statistics, would anyone be the worse off? How would we notice?
People knew that unemployment and inflation were a problem long before statistics agencies descended upon us.
The better solutions to unemployment and inflation are rules-based and were developed again long before statistics were collected.
Rules based policy regimes that attempt to stabilise unemployment and inflation often reject discretionary responses to the latest statistical releases.
Indeed, the main focus of rules based policy regimes is to prevent monetary and fiscal policy from becoming an independent source of instability. The secret of inflation targeting is to do as little as possible and not make things worse by doing much more that keeping monetary supply growth in check.
What is the welfare cost of a current account deficit and how does it compare?
- Welfare cost of inflation of 10% is maybe 1-2% of national income; and
- The annual welfare cost of the post-war business cycle is about 1% of national income.
People apparently fear the current account because it may lead to recessions and inflation. But the current account must be a small component of the factors contributing to the welfare cost of inflation and the annual welfare cost of the post-war business cycle.
There are a large number of other factors that cause recessions and and one factor that causes inflation. These must get their share of the 1-2% of national income that is the welfare cost of post-war business cycles and inflation of 10%. Adding up constraints mean that the welfare cost of the current account deficit, if there is such a welfare cost, must be small.
Scobie, Zhang and Makin (2008) found average income gains of $2,600 per New Zealand worker on a cumulative basis from capital inflows over the period 1996 – 2006. International capital mobility allows New Zealand to fund additional investment from external sources which raises wages in New Zealand because there is more technology and capital per worker in New Zealand. To the extent that foreign investment occurs, it raises the amount of capital in a country, driving wages up and profits down.
The current account reflects the relative returns of investing at home and abroad and any consumption smoothing. People save and borrow to smooth out consumption during any temporary ups and downs in their annual incomes.
The current-account balance typically gets worse—moves into deficit—in good times. Reason for this is in good times, people anticipate higher permanent incomes in the future and start spending now before the higher income actually arrives.
New Zealand and Australia based their prosperity on borrowing in anticipation of future increases in production based on exploiting the ample land and natural resources in New Zealand and Australia. This increase of wealth could be spread out over many periods including before it actually arrived because of the ability to borrow in the international credit markets in anticipation of permanently higher future incomes.
Paul Krugman on the nonsense thinking behind trade negotiations
01 Jul 2014 Leave a comment
in international economics Tags: mercantilism, Paul Krugman, preferential trade agreements, rent seeking, trade negotiations
HT: Alan Moran
Imports from countries where labour is cheap causes our unemployment to rise
25 Jun 2014 Leave a comment
in applied price theory, international economics, Murray Rothbard Tags: Murray Rothbard, tariffs
One of the many problems with this doctrine is that it ignores the question: why are wages low in a foreign country and high in the United States?…
Basically, they are high in the United States because labour productivity is high – because workers here are aided by large amounts of technologically advanced capital equipment.
Wage rates are low in many foreign countries because capital equipment is small and technologically primitive. Unaided by much capital, worker productivity is far lower than in the United States.
Wage rates in every country are determined by the productivity of the workers in that country. Hence, high wages in the United States are not a standing threat to American prosperity; they are the result of that prosperity…
we must realize that wages in each country are interconnected from one industry and occupation and region to another.
All workers compete with each other, and if wages in industry A are far lower than in other industries, workers – spearheaded by young workers starting their careers – would leave or refuse to enter industry A and move to other firms or industries where the wage rate is higher…
If the steel or textile industries in the United States find it difficult to compete with their counterparts abroad, it is not because foreign firms are paying low wages, but because other American industries have bid up American wage rates to such a high level that steel and textile cannot afford to pay.
In short, what’s really happening is that steel, textile, and other such firms are using labour inefficiently as compared to other American industries.
Tariffs or import quotas to keep inefficient firms or industries in operation hurt everyone, in every country, who is not in that industry. They injure all American consumers by keeping up prices, keeping down quality and competition, and distorting production. Tariffs and import quotas also injure other, efficient American industries by tying up resources that would otherwise move to more efficient uses.
The importance of bidding for the Olympics, losing that bid, but putting on a good show
18 Jun 2014 Leave a comment
in development economics, industrial organisation, international economics Tags: game theory, mega sports events, mega-events, Olympics, signalling
Both successful and unsuccessful bids to host the Olympics have a similar positive impact on exports according to Andrew Rose – no relation.
The Olympic effect on trade is from a signal that a country sends when bidding to host the games, rather than actually hosting the event.
A country that wishes to liberalise its trade may want to signal this by bidding to host a mega-event. It generates extra trade-related investment and creates a political atmosphere where back-sliding on trade liberalisation or the mega-event becomes difficult.
- Rome was awarded the 1960 games in 1955: the same year that Italy started to move towards currency convertibility, joined the UN, and began the negotiations that lead two years later to the Treaty of Rome and the creation of the European Economic Community.
- The Tokyo games of 1964 coincided with Japanese entry into the IMF and the OECD.
- Barcelona was awarded the 1992 games in 1986, the same year Spain joined the European economic community.
- The decision to award Korea the 1988 games coincided with Korea’s political liberalisation.
Many of the countries that are hosted the Olympic Games in recent years such as China have done so as part of showing to the world that they have made it and there’s no going back.
The trick then for the taxpayer is for your country’s bid to host the Olympics to come a close second without anyone knowing you really want to lose.
The trouble with treating the Olympic bid is all show to boost your image as an investment destination and a liberalising economy is your beard might actually win. Throwing a fight is never easy as many a boxer knows.
Jacob Viner and the ambiguous welfare effects of preferential trade agreements
17 Jun 2014 1 Comment
in applied price theory, applied welfare economics, international economic law, international economics Tags: Jacob Viner, Paul Krugman, preferential trade agreements, trade creation, trade diversion
The world trade system is a growing assortment of discriminatory trade agreements known as the ‘spaghetti bowl’ for reasons that the diagram of regional trade agreements (RTAs) in the Western Hemisphere makes clear.
Preferential trade agreements are the correct name for the political spin masters call free trade agreements or regional trade agreements.
- A preferential trade agreement is a trading bloc that gives preferential access to certain products from the participating countries. This is done by reducing or abolishing tariffs and other trade restrictions for the members of the trade bloc.
- A customs union is a type of trade bloc which is composed of a free trade area with a common external tariff.
Everything you need to know about trade blocs, preferential trading agreements, and customs union is in a book written by Jacob Viner in 1951. His book The Customs Union Issue introduced the distinction between the trade-creating and the trade-diverting effects of customs unions:
Trade diversion occurs if the common tariff around a customs union and the absence of tariffs within the union lead one of the members to purchase products from another member rather than from a “cheaper” producer in the outside world.
The classic example of this is the entry of Britain into the European Common market in 1973. It started sourcing dairy and wool imports from within the common market rather than from New Zealand as was the case for the past hundred years.
Assume the most efficient producer of lamb in the world is New Zealand. Before joining a customs union the UK will place an identical tariff on lamb imported from any country, this is shown on the diagram below. Before the customs union, French lamb is more expensive than New Zealand lamb once the tariff was paid. There are no imports from France. After joining the EU the tariff on French lamb will be removed.
The formation of the customs union between Britain and France reduces the price of lamb imports from PNZ+t to PFrance. Trade diversion now takes place as consumption switches from the low cost New Zealand farmers to the higher cost French lamb. Lower cost imports from outside the customs union have been replaced by high cost imports from within the customs union.
The welfare analysis analysis is tricky because consumer prices fall, but some of the tariff revenue is now converted into higher import prices because the lamb is sourced with the inefficient French farmers. This is shown in the multiple graphs below where some government tariff revenue is lost and is instead converted into payments to the higher-cost French farmers.
On the diagram below it is possible to highlight the gains and losses in welfare:
- There has been an increase in consumer surplus of areas 1 + 2 + 3 + 4.
- There has been a reduction in the producer surplus of UK lamb producers of area 1.
- There will be a loss of government tariff revenue of 3 + 5.
The will be a net loss in UK welfare if 2 + 4 < 5. It is possible that trade diversion will lead to an increase in UK welfare if 2 + 4 > 5. All in all this situation is full of ambiguity rather than the glories of straight out free trade were a country simply abolish the tariffs and buy from the cheapest supplier. As Paul Krugman explains:
If economists ruled the world, there would be no need for a World Trade Organization. The economist’s case for free trade is essentially a unilateral case – that is, it says that a country serves its own interests by pursuing free trade regardless of what other countries may do.
Or as Frederic Bastiat put it, it makes no more sense to be protectionist because other countries have tariffs than it would to block up our harbours because other countries have rocky coasts. So if our theories really held sway, there would be no need for trade treaties: global free trade would emerge spontaneously from the unrestricted pursuit of national interest.
Trade creation occurs if the abolition of tariffs between members of the customs union leads a member country to purchase products from another member country rather than producing it at higher cost itself.
Whether the trade creation of seats that trade to version requires very careful calculations such as those above . Whether there is a net loss or net gain will depend upon how the elasticity of domestic demand and the size of the initial tariff.
It doesn’t take much trade diversion to offset any trade creation. The trade diversion must be to a supplier within the trade bloc that is not much more expensive than the global cheapest price.
Source: http://www.mhhe.com/economics/pugel12e/keygraph/graphkey10h.html
Viner noted that the greater the similarity of the production mixes of the member countries, the greater the scope for trade creation relative to trade diversion; the more different the production mixes, the greater the scope for trade diversion!
Viner recognized that countries forming a customs union would in fact not be likely to permit the extensive relocation and reorganization of industry required to realize the potential benefits from the finer division of labour. This led him to regard customs unions as:
“unlikely to prove a practicable and suitable remedy for today’s economic ills” but rather “a psychological barrier to the realization of the more desirable but less desired objectives of … the balanced multilateral reduction of trade barriers on a non-discriminatory basis”
The expansion of trade after the signing of preferential trading agreements such as the common market and the many that followed including those signed by New Zealand, Australia and NAFTA are consistent with both trade creation and trade diversion.
The quality of arguments mounted against preferential trade agreements are surprisingly poor.There are good economic arguments against them based on the trade diversion cancelling out the trade creation.
By introducing discriminatory treatment into the trading system, the proliferation of preferential trade agreements promote costly trade diversion, interfere with the efficient operation of global business and allow great powers to extract unjustified concessions from weaker countries. These concessions can be in areas such as intellectual property rights, the purchasing pharmaceuticals by government agencies and social clauses on issues such as environmental and labour standards. Krugman again:
Fortunately or unfortunately, however, the world is not ruled by economists. The compelling economic case for unilateral free trade carries hardly any weight among people who really matter.
If we nonetheless have a fairly liberal world trading system, it is only because countries have been persuaded to open their markets in return for comparable market-opening on the part of their trading partners.
Never mind that the “concessions” trade negotiators are so proud of wresting from other nations are almost always actions these nations should have taken in their own interest anyway; in practice countries seem willing to do themselves good only if others promise to do the same.
The last time a world trade agreement was negotiated Clinton was President, cell phones were as heavy as a brick and no one had heard of email.
The market process picks unusual winners
10 Jun 2014 Leave a comment
in entrepreneurship, industrial organisation, international economics, Public Choice, rentseeking Tags: picking winners
What World Bank consultant would risk his fee and return business on advising Egypt to specialise in the export of toilets to Italy? But Egypt’s largest single manufacturing export is toilets to Italy where it captured 93% of the market.
Kenya has a booming export business in cut flowers for men to buy for their wives. Kenya has 40% of the European markets for cut flowers. Nigeria has 84% of the Norwegian market for floating docks. The Philippines has 71% of the global market for electronic integrated circuits.
What development expert would have picked these winners? They’re far too far away from the conventional wisdom and the safe bets that are behind picking winners in government circles.
Picking winners by governments requires heroic assumptions not only about the information politicians and bureaucrats have about the present and their ability to predict the future, but also about their motivations and their ability to resist capture by special interests. The Economist explains:
None of these studies addresses a deeper problem with the way industrial policy tends to develop over time.
Earlier efforts have tended to degenerate into rent-seeking, lobbying and cosy deals between incumbent firms and bureaucrats, stifling innovation and the process of creative destruction.
The problem, of course, is that … industrial policy requires disinterested, benevolent policymakers who can do it well. Unfortunately, they do not yet have a recipe for how such policymakers can be created.
Policy is made by real people with political and personal motivations. What they come up with is unlikely to be as well designed as the ones in the models.
In Praise of Cheap Labor | Paul Krugman (1997)
09 Jun 2014 Leave a comment
in development economics, growth miracles, international economics, labour economics, labour supply Tags: Paul Krugman, Sweatshop labour, The Great Enrichment, The Great Fact
The lofty moral tone of the opponents of globalization is possible only because they have chosen not to think their position through.
While fat-cat capitalists might benefit from globalization, the biggest beneficiaries are, yes, Third World workers.
After all, global poverty is not something recently invented for the benefit of multinational corporations…
wherever the new export industries have grown, there has been measurable improvement in the lives of ordinary people.
Partly this is because a growing industry must offer a somewhat higher wage than workers could get elsewhere in order to get them to move.
More importantly, however, the growth of manufacturing–and of the penumbra of other jobs that the new export sector creates–has a ripple effect throughout the economy. The pressure on the land becomes less intense, so rural wages rise; the pool of unemployed urban dwellers always anxious for work shrinks, so factories start to compete with each other for workers, and urban wages also begin to rise.
I found the best writer on global warming to be Thomas Schelling
09 Jun 2014 2 Comments
in applied welfare economics, environmental economics, global warming, international economics, Thomas Schelling Tags: game theory, global warming
Tom Schelling has been involved with the global warming debate since chairing a commission on the subject for President Carter in 1980.
Schelling is an economist who specialises in strategy so he focuses on climate change as a bargaining problem. Schelling drew in his experiences with the negotiation of the Marshall Plan and NATO.
International agreements rarely work if they talk in terms of results. They work better if signatories promise to supply specific inputs – to perform specific actions now.
Individual NATO members did not, for example, promise to slow the Soviet invasion by 90 minutes if it happened after 1962.
NATO members promised to raise and train troops, procure equipment and supplies, and deploy these assets geographically.
All of these actions can be observed, estimated and compared quickly. The NATO treaty was a few pages long.
The Kyoto Protocol commitments were made not about actions but to results that were to be measured after more than a decade and several elections.
Climate treaties should promise to do certain actions now such as invest in R&D and develop carbon taxes that return the revenue as tax cuts. If the carbon tax revenue is fully refunded as tax cuts, less reliable countries, in particular, have an additional incentive to collect the carbon tax properly to keep their budget deficits under control.
Schelling is a genius at problem definition when he asked this
Suppose the kind of climate change expected between now and, say, 2080 had already taken place, since 1900.
Ask a seventy-five-year-old farm couple living on the same farm where they were born: would the change in the climate be among the most dramatic changes in either their farming or their lifestyle?
The answer most likely would be no. Changes from horses to tractors and from kerosene to electricity would be much more important.
Climate change would have made a vastly greater difference to the way people lived and earned their living in 1900 than today.
Today, little of our gross domestic product is produced outdoors, and therefore, little is susceptible to climate. Agriculture and forestry are less than 3 per cent of total output, and little else is much affected.
Even if agricultural productivity declined by a third over the next half-century, the per capita GNP we might have achieved by 2050 we would still achieve in 2051.
Considering that agricultural productivity in most parts of the world continues to improve (and that many crops may benefit directly from enhanced photosynthesis due to increased carbon dioxide), it is not at all certain that the net impact on agriculture will be negative or much noticed in the developed world.
As for the chances of a global treaty, Schelling has said:
The Chinese, Indonesians, or Bangladeshis are not going to divert resources from their own development to reduce the greenhouse effect, which is caused by the presence of carbon-based gases in the earth’s atmosphere.
This is a prediction, but it is also sound advice.
Their best defence against climate change and vulnerability to weather in general is their own development, reducing their reliance on agriculture and other such outdoor livelihoods.
Furthermore, they have immediate environmental problems — air and water pollution, poor sanitation, disease — that demand earlier attention.
Utopia, you are standing in it! 
Recent Comments