Economic Growth 11 - Growth in the Open Economy Flashcards Preview

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Flashcards in Economic Growth 11 - Growth in the Open Economy Deck (88)
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1
Q

Which three things flow across borders in trade?

A
  • Goods and services
  • Factors of production
  • Labor and human capital
  • Technology
  • and more
2
Q

What is autarky?

A

The situation in which a country does not interact economically at all with the rest of the world.

3
Q

In a world of closed economies, what is the amount of output produced in each country a function of?

A

The stocks of factors of production (physical capital, human capital, and labor) that each country has accumulated, as well as the country’s level of productivity.

4
Q

Once we allow for an economy to interact with other countries, we must be precise about the form of the interaction. Economists distinguish between two forms of economic integration among countries. What are they?

A
  • Trade - The exchange of goods and services.

- Flows of factors of production across borders.

5
Q

Although trade and factor flows are often loosely tossed together into the category of “openness,” they differ in important ways. Explain and justify.

A

A country can be quite open to trade, for example, without allowing foreigners to own capital. Thus, in our analysis of the international aspects of economic growth, we must carefully distinguish between these two forms of openness.

6
Q

What is one approach to measuring how open an economy is?

A

Looking at trade and factor flows. Measure the quantities of goods or factors that flow among countries. If there is a large flow of goods into and out of a country, for example, then we can say confidently that it is open to trade. However, even if countries are open, goods or factors do not necessarily flow among those countries. Along with openness, there must also be a reason for economic interaction. If two countries produce the same goods or have the same factors of production, there might be no incentive for trade, even if trade is perfectly possible.

7
Q

Which different method can be used for testing openness in the absence of incentives for trade (reflected in low or no trade volumes)?

A

If two economies are open to trade with each other, then the law of one price, which says that the same good will sell for the same price in both markets, must hold true. We can measure the degree of interaction between two economies be measuring the differences in prices.

8
Q

Why must the law of one price be true in an open economy?

A

If the prices are not the same and trade is possible, the entrepreneurs will be able to buy goods or factors in one country and sell them in another, making an instant profit. Thus, if countries are open to trade in goods, the the same good will sell for the same price in both countries. Similarly, if countries are open to movements of factors of production, then the same factor should earn the same income in both markets.

9
Q

Why wouldn’t we expect the law of one price to hold perfectly?

A

It always costs something to transport the goods and factors from place to place.

10
Q

If the law of one price doesn’t hold perfectly, How does the degree of similarity of prices serve as a measure of integration

A

The closer the prices of the same goods in two countries, the more integrated are their markets for goods.
Likewise, the closer are prices of the same factors of production, the more integrated are the countries’ markets for factors of production.

11
Q

Allowing for trade in goods among countries does not require a fundamental alteration in the conceptual framework we have been using to analyze national income. Once we allow for the international movement of factors of production, however, the picture becomes more complicated. What do economists do to solve this difficulty?

A

They have 2 different ways of defining income.

  • GDP
  • GNP
12
Q

What is gross domestic product for our purposes here?

A

The sum of all income earned by the factors of production located in a given country.

13
Q

What is gross national product for our purposes here?

A

The sum of all income earned by the factors of production owned by the residents of a given country.

14
Q

What does whether GNP or GDP is a better measure depend on?

A

What we want to know. Most of the available data measure GDP because measuring the amount of output produced in a country is much easier than figuring out who owns what factors of production. But it is important to recognize that some of the international flows of factors we are considering can lead to a large discrepancy between GDP and GNP.

15
Q

Explain how economic historians have pointed out that the current wave of globalization is really the second such wave to sweep the world.

A

Much of the increase in integration that has taken place since WWII has simply been a return to the level of integration that existed before WWI.

16
Q

How has there actually been a net flow of capital out of the developing world over the past last decade?

A

Starting in the 1990s, there was a boon in investment in “emerging markets” in the developing world. However, these inflows of private capital have largely been matched by the accumulation of foreign reserves by developing country governments.

17
Q

In which respect has the current wave of globalization yet to reach the degree of integration seen in the surge that peaked in 1914?

A

The movement of people among countries. The end of colonialism, the rise of nationalism, and political changes in the receiving countries greatly reduces the importance of immigration after WWII.

18
Q

Which 2 forces have driven globalization?

A

Technological advances have eased the movement of goods and information, and changes in economic policies have lowered the barriers to trade.

19
Q

One of the driving forces in both waves of globalization has been a fall in the price of transportation. Elaborate.

A

Sailing ships, canal boats, and animal-drawn carts were slow and expensive means of transporting goods. As a result, international trade was profitable only when there was a large difference in the price of a good in the importing and exporting countries and when the goods to be transported had a high ratio of value to weight, as in the case of gold and spices.

20
Q

Which 2 key technologies vastly reduced the cost of transportation and propelled economic integration?

A

The railroad and the steamship.

21
Q

How else has the advance in transportation changed the economic landscape other than the lowering of transport costs?

A

The composition of countries’ output has shifted toward goods that are easier to transport.

22
Q

What has this change in the value/weight ratio of GDP in transportation resulted from?

A

A shift to lighter materials and from a movement in the composition of output away from physical goods toward “weightless” goods such as entertainment, communication, and specialized knowledge.

23
Q

A second driving forces in both waves of globalization has been a fall in the price of communication. Elaborate.

A

The steep reduction in communications cost has simplified the coordination of economic activity over long distances, allowing for freer flows of gods and factors of production.
Reductions in the cost of transmitting information have allowed the development of new types of trade. Trade was confined to gods, but increasingly, many information-based services have become subject to trade.

24
Q

As transportation costs have fallen, the legal barrier to trade that governments impose have become much more significant. What is one force propelling the current wave of globalization?

A

The series of reductions in trade restrictions negotiated under the General Agreement on Tariffs and Trade (GATT) and its successor, the WTO.

25
Q

Which sector is prone to the highest tariffs among industrial countries?

A

Agriculture.

26
Q

The two most important forms of trade restrictions are tariffs and quotas. But they are only the beginning when it comes to trade restrictions. what are 4 non-tariff barriers?

A
  • Voluntary export restraints (VERs)
  • Anti-dumping duties
  • Excessive standards
  • Bureaucratic creativity.
27
Q

What are VERs?

A

Voluntary export restraints are arrangements in which one country agree to put a limit on exports bound for another country.

28
Q

Why should VERs not be seen as truly voluntary?

A

Because VERs are usually instituted in response to the threat of more severe actions on the part of the importing nation.

29
Q

What are anti-dumping duties?

A

Dumping occurs when a firm charges a lower price in a market to which it is exporting than it does in its home market. Under the rules of the World Trade Organization (WTO), a country that is having products dumped in its markets is allowed to impose import duties (taxes) to offset the price differential. However, these anti-dumping duties are frequently abused.

30
Q

What are excessive standards with regard to barriers to trade?

A

Governments impose standards on all sorts of goods that are sold in their countries, ranging from regulations designed to protect public health to requirements that enable different pieces of equipment to work together. Often, however, standards are used to keep foreign products out of the domestic market.

31
Q

Why does measuring a country’s degree of openness require some judgment?

A

Because a country has many means of restricting trade and factor movements.

32
Q

Although the more open to the world economy countries are, the more they are to be rich, why doesn’t this prove that being open to the world economy makes a country rich?

A

Perhaps openness is a luxury that only rich countries can afford. Or similarly, maybe some third characteristic of countries tends to make them both rich and open.

33
Q

Which 3 approaches to we take to determine whether being open to the world economy will cause a country to be rick?

A

First, we look at how growth rates (rather than levels) of income compare in open and closed countries.
Second, we examine how growth rates change when countries become more open or less open.
Finally we consider the impact of geographical factors that affect a country’s openness but, unlike trade policies, are not themselves affected by other characteristics of the country.

34
Q

What are the results of study comparing the openness of trade to economic growth?

A

Poorer countries that are open tend to grow faster than richer countries. Poor countries that are open to trade grow faster than rich countries, and poor countries that are closed to trade grow more slowly than rich countries.

35
Q

According tot he evidence, how can changes in openness affect growth?

A

Increased openness leads to higher growth. Decreased openness leads to lower growth.

36
Q

What were the findings in the studying trying to determine the role that geographic factors play in determining trade?

A

They found that the volume of trade between any two countries was partially determined by how far apart the two countries were, whether one of the countries was landlocked, and how large the countries were.

37
Q

What does studying geography to determine trade volume imply?

A

Because geography - unlike trade policy - cannot itself be the result of differences in income or of some other factor, any relationship between geographically determined trade and income per capita must be the result of trade’s affecting income.

38
Q

What are the advantages and disadvantages of using geographic barriers between countries to measure the difficulty of trading?

A

Such barrier are clearly exogenous - that is, they are not determined by other country characteristics, such as income,. However, the geographical measure has a corresponding difficulty, which is that distances between countries never change.

39
Q

Freyer studied how effective distances between trading partners compared to trade levels. what did he find?

A

Changes in a country’s trade induced by changes in the effective distance to its trading partners resulted in corresponding changes in income; when trade rose, income rose, and when trade fell, income fell.

40
Q

a natural place to begin answering this question is to consider whether openness affects growth through the channel of factor accumulation or through the channel of productivity. In other words, are more open countries richer because they have more physical and human capital for each worker to work with, or are they richer because they use their factors of production more effectively?
Physical capital flows across nationalborder through several channels. What are the 2 largest such channels?

A

The largest is foreign direct investment.

The second largest is portfolio investment.

41
Q

What is FDI?

A

Foreign direct investment, by which foreign firms buys or builds a facility in another country..

42
Q

What is portfolio investments?

A

Portfolio investment, in which investors from a foreign country purchases stocks or bonds.

43
Q

Besides FDI and portfolio, what are the remaining sources of capital flows?

A

Government grants and lending from banks and multinational donor agencies such as the World Bank.

44
Q

When we first encountered this model, we examined an economy that was closed to capital flows, so that the level of investment was by necessity equal to the level of saving. What changes now that we look at the same model in the case of an economy that is fully open to capital flows from the rest of the world?

A

Investment can be financed by foreign savings and, similarly, domestic savings can be used to finance foreign investment.
Because the economy is open to capital flows, we can use the law of one price to conclude that prices of any mobile factor of production must be the same in the country we are considering and in the rest of the world.

45
Q

Recall from Chapter 3 that the way we measure the “price” of capital is by its rental rate. What will we therefore assume about an economy open to capital flows?

A

That the rental rate for capital will be the same as in the rest of the world. For analytic simplicity, we also make a second assumption: That the economy we are examining is small relative tot he rest of the world. Thus, what happens in this economy had so effect on the prices of factors int he rest of the world. A final simplifying assumption is that we ignore the effect of human capital in our analysis.

46
Q

y = Ak^α,

What is MPK?

A

MPK = αAk^(α-1)

47
Q

What does the equation MPK = αAk^(α-1) say about MPK?

A

That MPK depends negatively on the amount of capital per worker, k. If a country has a relatively high level of capital per worker, it will have a lower MPK.

48
Q

What is a consequence of firms maximizing their profits and what equations flows from it?

A

With perfect capital mobility, the capital/labor ratio depends on the world rental rate of capital.
r = r_world = MPK = αAk^(α-1)

49
Q

What is the equation for k?

A

k = (αA/r_world)^(1/(1-α))

50
Q

What’s a significant difference bettween our updated Solow model and our previous analysis of growth and capital accumulation in Ch.3, Ch.4?

A

We examined a situation in which the capital/labor ratio in a given country depends on domestic factors like the saving rate and the growth rate of the population.

51
Q

What’s the production function given our new Solow model?

A

y = Ak^α = A((αA/r_world)^(1/(1-α))^α

=A^(1/(1-α)) (α/r_world)^(α/(1-α)

52
Q

What does y = Ak^α = A((αA/r_world)^(1/(1-α))^α
=A^(1/(1-α)) (α/r_world)^(α/(1-α)
say about GDP and savings?

A

That GDP per worker will not be any higher in a country with a high saving rate than a country with a low saving rate.

53
Q

Does the fact that GDP per worker will not be any higher in a country with a high saving rate mean that, if the economy is open to factor flows, a country with a high saving rate will not be richer than a country with a low saving rate?

A

No, we must beyond GDP to GNP. In the closed-economy model of Chapter 3, this increase in saving would raise the level of domestic investment and thus raise the capital stock. But if the saving rate increased in an open economy, the increase in the capital stock would lower the marginal product of capital. At this point, owners of capital would find that they could earn higher returns abroad and would transfer their capital out of the country. This movement of capital abroad would continue until the marginal product of capital again equaled the world level; in this way, the capital stock would return to its former level. All of the rise in saving would result in increased ownership of capital in other countries.

54
Q

Although changes in the saving rate will not affect GDP, how will they have an impact on GNP?

A

GDP, they will have an impact on GNP because they will affect the quantity of capital owned abroad. A country that saves more will own more capital in total and consequently will earn more capital income, with the result that GNP will rise.

55
Q

What is an important implication of the free-capital-flow model with regard to saving rate?

A

For a country with a low saving rate, openness to capital flows should raise the GDP. Capital that is not supplied domestically can be supplied from abroad. The same would hold true for any country that has a low level of capital.

56
Q

What is an important implication of the free-capital-flow model with regard to growth rates per worker?

A

If the economy is open to capital flows, then investment flowing into the country from abroad can produce growth in GDP per worker that is much more rapid than the country could produce with its own savings.

57
Q

What is an important implication of the free-capital-flow model with regard to countries with high saving rates?

A

For a country with a high saving rate, openness to capital flows will lower the level of GDP per worker, as capital will flow abroad to countries where its marginal product is higher. Openness to capital flows will raise the level of GNP per worker in both high- and low-saving countries.

58
Q

In the model we just developed, investment in a given country has no relationship to that country’s level of saving. But investment does depend on the value of the productivity coefficient A. Which consequence flows from this fact?

A

A country with a high value of A will have a large capital stock, which implies a high level of investment. Saving, by contrast, might depend on factors such as how present- or future-oriented people in a country are. Having a high saving rate does not necessarily make a country a good place to invest.

59
Q

This difference in the implications that the closed- and open-economy models have for the correlation between saving and investment suggests a test of which model is more appropriate for the real world. What is the test?

A

Across a sample of countries, the more highly correlated are saving and investment rates, the less appropriate it is to think of capital flowing freely across international borders.

60
Q

What is the saving retention coefficient?

A

A numerical indicator of the degree of capital market openness which equals the slope of a line drawn to fit eh data points, measures what fraction of every dollars of additional saving ends up as additional domestic investment.

61
Q

What is the saving retention coefficient in a closed economy?

A

1, meaning that an additional dollar of saving saving would lead to an additional dollar of investment.

62
Q

What is the saving retention coefficient in a perfectly open economy?

A

0

63
Q

What do studies suggest about the openness throughout the world?

A

These results suggest that although the world has moved in the direction of capital market openness in recent years, economies remain closer to being closed to capital flows than they are to being perfectly open. There is also evidence that poorer countries—those most able to benefit from large foreign investment—are generally less open to capital flows than are rich countries.

64
Q

our examination of the data showed that capital flows were simply not large enough to justify this theoretical possibility. Thus, the primary channel through which openness raises income per capita must be elsewhere. Where must it come from?

A

Productivity.

65
Q

The most important effect of trade on productivity is so obvious that it is easy to overlook. what is it?

A

Trade makes a country more productive by allowing it to produce the things it is good at producing and then to sell them to other countries in return for things it is not as good at producing.

66
Q

From this perspective, trade is like a form of technology. How so?

A

Although trade does not literally convert one good into another in the way that a piece of technology such as a loom converts yarn into cloth, the effect is essentially the same.

67
Q

When do potential gains from trade arise?

A

whenever a country has a comparative advantage in producing some good relative to another country.

68
Q

What are some sources of comparative advantages?

A

A country may have natural endowments that make it easy to produce particular products.
Or a country may specialize in some products because they are well suited to the factors of production it has in abundance.
Finally, a country may be particularly good at producing certain items simply because it has already specialized in them so that it has developed expertise

69
Q

Openness can also affect technology in the more conventional sense. How so?

A

A country that is more open will have better technologies for producing output using its factors of production.

70
Q

What’s the first way in which economic openness contribute to higher level of technology?

A

Countries that are open to trade are more able to import existing technologies from abroad.

71
Q

By which channels do technology transfers takes place?

A

In the case of foreign direct investment, a firm building a factory in another country will transfer technology along with capital.
Another channel is a technologically
backward country’s purchase of key inputs or of capital goods that embody a new technology from abroad.
Finally, interactions among countries allow for the transfer of “softer” technologies such as innovative organizational techniques.

72
Q

The study found that ideas produced abroad were the dominant source of technological progress in all but one country.
Which Country?

A

The United States.

73
Q

In addition to facilitating technology transfer, what is a second way in which openness contributes to a higher level of technology?

A

By expanding the incentives for the creation of new technologies. Naturally, the larger the market in which a new invention will be used or a new product sold, the higher the profits accruing to the inventor. This lure of higher profits will give a greater incentive to R&D spending in an economy that is able to export its products.

74
Q

How does openness to trade improve efficiency?

A

An important effect of trade is that it weakens the monopoly power of domestic firms, thus raising efficiency. A similar effect of trade is to allow the firms in a country to take advantage of economies of scale by giving them access to a larger market for their output. In addition to these effects on efficiency, there is good evidence that foreign competition has a bracing effect on domestic firms.

75
Q

Where can much of the explanation for the opposition to openness, and to free trade in particular, be found?

A

Those who are hurt by a new technology will do their best to block its introduction. This same logic of technology blocking applies to trade. Workers and firms in the industries for which a country has a comparative disadvantage are natural supporters of trade protection. Similarly, domestic firms that will lose their monopoly positions with the opening of trade oppose openness. In both cases, what is good for a country on average is bad for a particular group.

76
Q

How can some industries can maintain trade restrictions? Think politics.

A

Because of the way the costs and benefits of trade policy are distributed, trade liberalization offers large benefits to an overall economy, but with only a small gain to each consumer. The costs of more open trade, by contrast, often fall on a small group of firms or workers. As a result, those who are hurt by trade liberalization tend to feel more strongly about it than those who benefit.

77
Q

Beyond the self-interest of firms or workers in a particular industry, where can opposition to openness also arise?

A

On the part of owners of factors of production that will become relatively less scarce if tariff protection is removed.

78
Q

Another example of how trade affects the returns to different factors of production is the case of human capital. Explain.

A

Having a comparative advantage in goods and services produced by high-skill workers, the United States has exported these and imported goods embodying low-skill foreign labor. In this way, trade has contributed to the increase in the skill differential (the gap in wages between low- and high-education workers) in the United States.

79
Q

What is the response to the anti-globalization claim that globalization leads to the exploitation of workers?

A

The willingness of workers to take jobs in factories—even sweatshops—to produce exports shows that such jobs are preferable to workers’ available alternatives. Put differently, if it were not for globalization, the same workers would have jobs with even lower wages or worse working conditions. Not only do exporting firms provide better jobs than are available in the local economy, but they also raise overall wages in the economy by increasing the demand for labor.

80
Q

What is the response to the anti-globalization claim that globalization leads to the inability of poor countries from competing?

A

This argument confuses competition, in which one party wins and one loses, with exchange, which is the essence of trade. When countries compete, as in sports or war, the weaker country loses out. When countries exchange, a country that is weak (in the sense of having lower productivity or fewer factors of production) stands to gain just as much as a country that is strong.

81
Q

What is the proper policy response to the dislocations that occur in both rich and poor countries when trade is opened up?

A

Adjustment assistance—helping workers relocate to sectors with comparative advantage and cushioning the temporary reduction in income while they do so—not trade restriction.

82
Q

What’s the first channel through which globalization can lead to environmental degradation?

A

rich countries can export their pollution, either literally by shipping their waste abroad or, more commonly, by allowing their high-pollution industries to migrate abroad and then importing the products of these industries.

83
Q

What’s the second channel through which globalization can lead to environmental degradation?

A

By opening up rich-country markets to poor-country exports that are produced in an environmentally harmful way.

84
Q

Openness to the world economy imposes constraints on how governments behave. In so-called footloose industries (industries that can easily relocate production from one place to another), firms will shop around for the most profitable country in which to operate. How can this lead to a loss of national sovereignty?

A

Countries’ attempts to attract or retain these firms will create a “race to the bottom” in which national governments compete to offer the fewest restrictions on environmental pollution, the weakest laws governing workers’ rights, and so on.

85
Q

What’s a second source of the loss of sovereignty associated with openness, particularly openness with regard to capital flows?

A

A government’s ability to levy taxes. More than workers, owners of capital can easily move their factor of production out of a country if they do not like the taxes they have to pay, so governments are constrained to keep capital taxes low. The burden of financing government expenditure thus shifts to taxes on labor or consumption goods. Because wealthy people tend to be the ones who own capital and earn capital income, the reduction in capital taxation induced by globalization exacerbates income inequality.

86
Q

What’s the first hidden price of foreign capital?

A

A country that imports capital from abroad becomes subject to the whims of international investors. Waves of speculation and herd behavior—the forces that create volatility in stock markets—can lead to wild swings of capital flows and exchange rates, a situation producing macroeconomic instability. The problem is particularly acute when the capital imports consist of short-term investments that can be withdrawn quickly.

87
Q

What’s the second hidden price of foreign capital?

A

it allows governments in developing countries to go irresponsibly into debt. Although government debt (e.g., to fund the construction of infrastructure) can be a useful development tool, rulers in poor countries all too often use borrowed money to maintain their hold on power or to enjoy a lavish lifestyle. When these rulers leave office, their former subjects are left with a crushing burden.

88
Q

What is the final anti-globalization claim not previously mentioned int he flashcards?

A

Many critics of globalization point out that rich-country governments that press developing countries to open their markets are themselves often engaged in protectionism.

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