MSc in International Management: Global Scenarios, Module 2 Report

This report analyzes key aspects of economic globalization, focusing on international trade in goods and services. It explores the main drivers of globalization, including transportation and communication cost declines, and the impact of trade liberalization through organizations like the WTO. The report delves into the theory of comparative advantage, economies of scale, and the new trade theory, along with the gains and costs associated with free trade. It also examines trade policies, particularly the impact of import tariffs, and discusses offshoring, outsourcing, and the role of global value chains. The analysis includes the location of production, internalization versus outsourcing decisions, and concludes with a discussion of the pandemic's impact on GVCs, providing a comprehensive overview of macroeconomic concepts related to globalization and international trade.

MSc in International Management
«Global Scenarios: Module 2 (Macroeconomics)»
Lectures 10 & 11
Globalization

Economic Globalization
• International exchange of:
– Goods
– Services
– Factors of production
• Capital (FDI)
• Labor (Migration)

Agenda
• Trade in goods and services
– Main drivers
– Gains from trade
– Debate over globalization
– Trade policy: impact of import tariffs
• Trade liberalization
– WTO: main principles
• Offshoring and outsourcing
– Location
– Internalization
– The pandemic and GVCs

TRADE IN GOODS AND SERVICES

World trade over GDP
Source: World Bank

Main drivers of economic globalization
• Decline in
transportation &
communication costs
• Decline in
tariffs/quotas & other
barriers to trade
– WTO
– Regional/Bilateral
trade agreements
(NAFTA, EU,
Mercosur, ASEAN, …)

Why do countries trade?
• Comparative advantage
– Trade among different countries (North – South trade)
• Economies of scale
– Trade among similar countries (North – North or South
– South trade)
Gains from trade

Comparative advantage
2 key elements
8
Countries are
different
if resources are used to produce units of one good,
the same resources cannot be used to produce
another good…
Scarcity of
resources
Opportunity cost

Comparative advantage
• comparative advantage in the production of a
good if opportunity cost lower compared to
other countries
– A country is relatively more efficient in the
production of that good
• Even a country with an absolute disadvantage in
the production of both goods always has a
comparative advantage!!!
9

Absolute and comparative advantage
• Absolute advantage:
– One economy can produce a particular good more
cheaply than another country
– Even if a country has an absolute advantage in
producing all goods, gains from trade may still be
realized
• Comparative advantage:
– The relative price of a good is lower than in another
economy
10

Gains from trade
• Trade is welfare improving:
– Makes people better off: buy where goods are
cheaper
– Countries specialize in the productions in which
they are relatively more efficient compared to the
rest of the world
– Improves efficiency and welfare:
gains from specialization!!!
→ Growth!
11

Sources of comparative advantage
• Different technologies (Ricardian model)
• Different factor endowments (Heckscher-Ohlin
model)
– Idea
• China and US produce textile products and airplanes
• Textile industry is more labor intensive
• Airplanes industry is more capital intensive
• China has more labor than the US, while the US has
more capital than China (in relative terms!!!)
• China will specialize in textiles, while the US in
airplanes
12

Question
• Why does lots of trade occur between relatively
similar countries producing relatively similar
goods?
• Example: cars among developed countries
13

New Trade Theory
Paul Krugman (Nobel Prize, 2008)
Idea
1. Although similar, the products have distinct
characteristics (differentiation)
2. If citizens of all the countries like to consume
many types of similar products and
3. if there are increasing returns to scale of
producing these goods it is convenient to
concentrate production on a limited number of
varieties
→ Intra-industry trade
14

New Trade Theory – New Gains from Trade
Additional gains from trade
• Firms take advantage of economies of scale →
they are more productive
• Love of variety: more differentiated varieties for
consumers
• More competition → lower prices
• Adoption from the frontier + diffusion of
knowledge
15

New New Trade Theory
Marc Melitz
• Observation: only few firms export
– These firms are more productive than domestic
ones
– Intuition: trade is costly, hence only more efficient
firms can pay for those costs and get profits on
foreign markets
– Positive selection through trade (gains from trade):
only more productive firms survive → industries
become more productive on average
16

Is free trade good or bad?
17

Gains
• Specialization → expansion of production and
consumption possibilities → growth!!!
• More competition → lower prices for consumers →
more efficiency → growth!!!
• More variety
• Higher productivity:
– Economies of scale
– Positive selection of firms → growth!!!
• Diffusion of knowledge and technology !!!
– Spillovers
– Incentives from increased competition
→ growth!!!
18

Costs
• Adjustment costs: short run costs
– Creation vs. Destruction of Jobs
– Retraining, relocating is difficult and costly
• Winners and losers:
– Impact on inequality
– Losses concentrated; gains spread thinly
– Structural change → structural unemployment
• BUT…
– Trade or technology? …
19

TRADE POLICY
20

Trade policy
A policy with an impact on the international trade of
goods and services
• Tariff barriers:
– Import tariffs/Export subsidies
• Non-tariff barriers:
– Quotas
– Regulations
– …
21

A tariff in a small country
• A tariff is a tax on imported units
– drives a wedge between the price paid and the
price received
Price buyer – price seller = tax
• unlike sales tax, tariffs discriminate between
products based on where they are made
22

A tariff in a small country
• Distortions ⇒ lower productivity
• Small vs. large country
– Impact on the international market
– Who pays the tariffs?
23

A tariff in a small country
• Consumers are worse off
– They pay more and can consume a lower amount
• Domestic producers are better off
– They face less competition
• The Government gets tariff revenues
24

A tariff in a small country
• Net impact on the economy is negative:
Lower total welfare
– inefficient allocation of resources
• distortions in consumption decisions
• distortions in production decisions
– Reduction in trade
– Retaliation and trade wars
25

Summary
• Drivers of economic globalization
– Reduction in transport and communication costs
– Trade liberalization
• Why countries trade:
– Comparative advantage
– Economies of scale
• Heterogeneity across firms
• Trade policy
– Impact of an import tariff
26

TRADE LIBERALIZATION
27

Trade liberalization
• Unilateral
• Multilateral: World Trade Organization
• Preferential trade agreements
28

Prisoner dilemma in trade policy
• The allocation of resources is more efficient
when tariffs are zero
• If a country (large) imposes a tariff, the foreign
country is negatively affected
• Risk of retaliation
• In case of retaliation, both countries are worse
off
29

Prisoner dilemma in trade policy
Nation A’s
choices:
Protect
Liberalise
Protect Liberalise
Nation B’s choices:
A’s welfare B’s welfare A’s welfare B’s welfare
A’s welfare B’s welfare A’s welfare B’s welfare
2 2
1 4
4 1
3 3
unless they can coordinate policies
internationally, they will be stuck at the
inefficient northwest box
30

Prisoner dilemma
Prisoner dilemma
Both countries would be better off without tariffs,
but no one has the incentive to reduce them
Bad equilibrium!!!
Multilateral negotiation can help in solving the prisoner
dilemma
31

World Trade Organization
• Main purpose:
– Make trade as free as possible…
– … so long as there are no undesirable effects …
– because this is important for economic
development and well being
• Main agreements:
– GATT (Goods)
– GATS (Services)
– TRIPS (Property rights)
– …
www.wto.org 32

WTO – basic principles
• Trade without discrimination
– Most-favored-nation (MFN): treating other people
equally
• Grant someone a favor and you have to do the same
for all other WTO members
• Exceptions allowed
– National treatment:
• Imported and locally-produced goods should be treated
equally — at least after the foreign goods have entered
the market
www.wto.org 33

WTO – basic principles
• Freer trade: gradually, through negotiation
• Predictability:
– Tariff binding
• promising not to raise a trade barrier can be as
important as lowering one
– Transparency
• Promoting fair competition
– In limited circumstances, forms of protection are
allowed (countervailing duties)
• Encouraging development and economic reform
www.wto.org 34

WTO: Exceptions
Important exceptions
– Safeguard measures:
protect a specific domestic industry from an increase in imports
which is causing or threatening to cause serious injury to the
industry
– Article XXI: security exceptions
Member can take “any action which it considers necessary for
the protection of its essential security interests” in times of
“emergency in international relations”
– Article XXIV GATT:
• preferential trade agreements are allowed
• Countries have to notify them to the WTO
• Risk of creating contraposed trade blocks
35

WTO – Dispute settlement
Dispute settlement is the central pillar of the
multilateral trading system
• Role: Enforcing the rules
– secure and predictable trading system
– clearly-defined rules and timetables
36

WTO – Dispute settlement
• Principles:
– Equitable
– Fast
– Effective
– Mutually acceptable
37

WTO – Dispute Settlement: Timing
60 days Consultations, mediation,
etc
45 days Panel set up and panellists
appointed
6 months Final panel report to parties
3 weeks Final panel report to WTO
members
60 days Dispute Settlement Body
adopts report (if no appeal)
Total = 1 year (without appeal)
60-90 days Appeals report
30 days Dispute Settlement Body
adopts appeals report
Total = 1y 3m (with appeal)
38

WTO – Dispute Settlement
• First stage: consultation (up to 60 days)
• Second stage: the panel (up to 45 days for a
panel to be appointed, 6 months to conclude)
– If the panel decides that the disputed measure does
break an agreement or an obligation, it
recommends that the measure be modified
according to WTO rules
– Both sides can appeal the report
39

WTO – Dispute Settlement
• The case has been decided: and now?
• If the country loses, it must follow the
recommendations of the panel report
– If complying proves impractical, the member will be
given a “reasonable period of time” to do so
40

WTO – Dispute Settlement
• If it does not comply:
→ negotiations with the complaining country to
determine mutually-acceptable compensation
• If after 20 days, no satisfactory compensation is
agreed, the complaining side may ask for
permission to retaliate
– Temporary!
41

OFFSHORING AND OUTSOURCING
42

Definitions
• Outsourcing = Movement of an activity
outside the firm
• Offshoring = Movement of an activity to a
different country
– Could be
• Subsidiary abroad (FDI → MNE)
• Subcontracting with another firm (Arm’s-length
trade)
43

Global fragmentation of production
• Production abroad: Location and Internalization
Offshoring:
production abroad
Outsourcing:
externalization of
production
44

Offshoring
– Horizontal offshoring: same tasks performed
abroad and domestically
– Vertical offshoring: different tasks performed at
home and abroad
• Global value chains
– Mixed strategies
45

Global Value Chains
• Measures of GVCs
– Trade in value added
• FVA – Foreign value added (Backward)
– Value added by foreign countries in a country’s
exports
– Imported goods and services incorporated into
country’s exports
• DVA – Domestic value added (Forward)
– Value added produced by the country in the exports
of another one
46

Global Value Chains
𝐹𝑉𝐴 + 𝐷𝑉𝐴
𝐸𝑥𝑝𝑜𝑟𝑡𝑠
World Bank, World Development Report 2020, https://www.worldbank.org/en/publication/wdr2020 47

GVC participation and productivity
World Bank, World Development Report 2020, https://www.worldbank.org/en/publication/wdr2020 48

Determinants of FDI
World Bank, World Development Report 2020, https://www.worldbank.org/en/publication/wdr2020 49

LOCATION: WHERE?
50

Location: where?
• Once a firm decides to produce abroad, where
it is producing???
– Product characteristics
• Economies of scale
• Disintegration costs
• Customization
51

Location: where?
• Once a firm decides to produce abroad, where
it is producing???
– Countries’ characteristics
• Distance
• Trade barriers
• Resources
• Human capital
• Skills
• Quality of institutions
• Local economic conditions
52

Trade in components shows three interrelated production hubs
World Bank. 2017, Measuring and analyzing the impact of GVCs on economic development, Washington, D.C. : World Bank Group. 53

Low wages vs. low production costs
Developing countries deeply involved in GVCs have low unit labor costs but no low
wages, 2010 (Unit labor costs: ratio of average wages to GDP per capita).
wages
Unit labor
costs
Developing countries
deeply involved in
GVCs
Other developing
countries
World Bank. 2017, Measuring and analyzing the impact of GVCs on economic development, Washington, D.C. : World Bank Group. 54

INTERNALIZATION VS OUTSOURCING
55

Internalization
In-house vs. outsourcing
– Full control → higher costs, but full control on
quality and technology
– Outsourcing (contract) → lower costs, but lower
control on quality and technology (contracts)
• Relevant factors:
– Incomplete contracts
– Countries’ structure: quality of institutions
56

Internalization
• The configuration of the GVC is determined by:
– Complexity of the input needed
• Standardized vs. customized input
– Ability to codify transactions
• Need of specific investment to produce the input
– Capabilities in the supply base
• Specific skills vs. generic skills
57

HEALTH SHOCKS AND GLOBAL VALUE
CHAINS
58

Health shocks and GVCs: previous evidence
• Reshoring: a rise in domestic production
• geographical diversification: less imports from
affected areas
• GVC widening: rise in number of suppliers for
each product imported
• Near-shoring: more import from suppliers in the
geographical neighbourhood
• GVC resilience: short-run disruptions
Anirudh Shingal, Prachi Agarwal, “Global value chain responses to previous health shocks: Lessons for Covid-19”
VoxEU, Dec 8, 2020.
59