World Economy

• Ad volarem tariff: a fixed percentage tax on the value (i.e. price) of a traded commoditiy
• Specific tariff: a fixed sum tax per unit of a traded commodity
• Compound tariff: a combination of an ad valorem and specific tariff

• Producers are effectively shielded
• Prices in the world market cannot be estimated (hard to set a quota limit)
• There is no ToT effect
• Part of quota rent (c) goes to license owner, part goes to domestic government
• Fiscal revenues cannot be predicted in general
• Policy damages home's welfare
• RETALIATION

• Domestic producers have an incentive to lobby for obtaining protection by quotas
• Since importers need a license they have an incentive to "take influence"
• Thus, import quota sets incentives for rent-seeking and corruption
• They lower competition and are a disincentive for innovation.

• Taxpayer's money is channelled to arbitrarily chosen industries and companies
• Domestic industry is massively distorted
• Negative welfare effect
• RETALIATION

• politicians don't have all the information to steer markets
• protected industries absorb money other industries cannot benefit from
• strategic trade policy damages other country's industries -> trade war - retaliation
• once a policy is in force, politicians will take advantage of it (rent-seeking)

While it is in the interests of the group as a whole to press for favourable policies, it is not in any individual's interest to do so. Therefore few companies which have a big gain will win through lobbying because many consumers with a tiny loss don't care.

1. Eliminating nontariff barriers
2. Reducing tariff rates
3. Binding tariff rates (having a country agree not to raise tariff in future)
4. most favoured nation (MFN) principle

Reducing works a lever and binding as ratchet.

Each GATT country promises that all countries will pay tariffs no higher than the nation that pays the lowest.

A country can give preference to other countries by allowing 0 tariff. There the MFN principle doesn't apply.

• Tariffs, general reduction of tariffs and increase of 0-tariff goods
• Quotas, quotas on agricultural goods and textiles were to be replaced by tariffs
• Antidumping, new dispute resolution mechanisms are put in place
• Subsidies, reduction of agricultural subsidies and limit to subsidised research
• Safeguards, health and safety standards are restricted to scientific proven ones
• Intellectual Property, agreement calls for 20 years protection (patent, TM, ©)
• Services, Banking and security markets in Japan and South Korea were opened
• Trade related investment measures, phases out the requirement that foreign investors buy supplies locally or export as much as they import.

• GATT, General Agreement on Tariffs and Trade: covers trade in goods.
• GATS, General Agreement on Tariffs and Services: covers trade in services.
• TRIPS, Agreement on Trade-Related Aspects of Intellectual Property

1.A free trade area: an agreement that allows free trade among members, but each member can have its own trade policy towards non-member countries.

e.g. the North America Free Trade Agreement (NAFTA).

2. A customs union: an agreement that allows free trade among members and requires a common external trade policy towards non-member countries.

e.g. the European Union

Preferential trading agreements increase national welfare when new trade is created, not when existing trade from outside is diverted to trade with member countries.

Trade creation occurs when high-cost domestic production is replaced by low-cost imports from other members.

Trade diversion occurs when low-cost imports from non-members are diverted to high-cost imports from member nations.

A “rule of thumb”

A free trading arrangements leads to a net trade creation, when a large number of countries join the arrangement and when tariffs to be removed are high otherwise it leads to a trade diversion.

The Official Reserve Settlement Balance (ORSB) measures the change in domestic official reserve assets and the change in foreign official reserve assets in the home country.

The ORSB accommodates for a deficit or surplus in autonomous transactions (transactions that occur for business or profit motives).

The ORSB are also called “accomodating transactions”

They balance the autonomous transactions

Interpretation: opposite signs of autonomous transactions

A nation’s international investment position measures total amount and distribution of assets abroad and foreign assets in the nation at the end of the year (Stock concept).

• also known as balance of international indebtedness.
• useful in projecting the future flow of income home-based foreign investments and payments on foreign investments in home country

spot exchange means on the spot -> within 2 business days

forward exchange calls for delivery of the foreign exchange in one, six, twelve, or thwenty-four months after the date the contract is signed. -> this is used as buffer to exchange rate fluctuations

The effective exchange rate is a weighted average of the exchange rates between domestic currency and the nation’s most important trading partners. This is not a real exchange rate but an index.. It shows, however, how the strength of the domestic currency develops over time.

Fixed exchange rates; must not leave a predefined corridor. They are often joint action of central banks.

Floating exchange rates; there is no central bank intervention on forex market.

Managed floating; officially, exchange rates may float. However, central banks may intervene if necessary. (Leaning against the wind).

Dirty floating; Similar to managed floating, but central bank intervenes systematically. This may do harm to trading partners.

The law of one price is the idea that in the absence of barriers to trade, the price of homogenously traded commodities will be identical in all markets.

If the law of one price holds for all goods, we have absolute purchasing power parity. This means that the exchange rate is equal to the ratio of price levels in the two nations.

Absolute PPP: e_$/€ = P_US / P_EU

Relative PPP postulates that the change in the exchange rate is equalt to the difference in the rates of inflation: ∆e_$/€ = Infl._US – Infl._EU

The interest parity approach says that forex markets are in equilibrium if and only if all financial assets have the same return in all currencies:

see graph