Module 1 globalization

Globalization, Economic
Integration and International
Trade
Week 1 of a twelve-week survey course on the law
and policy of the global trading system

Outline
In this module (comprising 33 slides) we will cover a
number of topics:
 We will discuss several definitions of the term
“globalization” and what it essentially means for you
 We will discuss why countries trade and a few key
theoretical underpinnings of international trade
 Finally, we will discuss three simple principles of trade
policy that everyone would best be advised to
internalize
2

Part 1
Globalization
Why has it become a dirty word?
3

What’s all the fuss about
globalization?
4

Definitional issues
Wikipedia (itself arguably a product of globalization) defines “globalization” as
follows:
Globalization […] is the process of international integration arising from the interchange
of world views, products, ideas and other aspects of culture.
The New Shorter Oxford English Dictionary (which some at the WTO have an
almost reverent regard for) defines globalization in the following terms:
The action, process, or fact of making global; […] the process by which businesses or
other organizations develop international influence or start operating on an international
scale, widely considered to be at the expense of national identity.
In a figurative sense, globalization is about the world becoming smaller,
meaning that it is easier and cheaper for people, goods, services and ideas to
travel further and faster than at arguably any time in history - although some
posit that the so-called Golden Age of Globalization actually occurred in the
second half of the 1800s.
On the next slide we show a short video that should impart some
understanding of the factors and forces underpinning modern-day
globalization and why it is also a force that has attracted its fair share of
criticism
5

Video clip by Wissenswerte on
Globalization (8 minutes)
6

Over to you | your thoughts and
reflections
 In the 1960s, industrialized countries like the United States used to have
thriving steel sectors, now the towns that grew up around the steel mills are
mere shadows of themselves and the number of workers able to find
employment in this sector has dwindled dramatically.
 Explain how globalization has played a role in the the decline of the US steel
industry. Do you think this is ultimately a good or a bad thing? Who are the
winners and losers from this phenomenon?
 Some 30 years ago, Bangladesh started down the road towards becoming
what it is today, namely one of the world’s largest and most competitive
producers and exporters of clothing, apparel and textile products. This
industry has provided employment, livelihoods and a path out of poverty for
thousands of textile workers and their families, and has played an important
role in improving the social mobility and status of women in Bangladesh.
 Explain what role globalization has played in this process. Are there any
downsides to this phenomenon, either for the Bangladeshi textile workers
themselves or for other textile workers in other countries?
7

Want to do some more reading
on globalization?
8
World Bank, Globalization and
International Trade, 7 pages, click
on the thumbnail to download or
click here.
Federal Reserve Bank of Dallas,
Globalization, 16 pages, click on
the thumbnail to download or click
here.

Part 2
Why Countries
Trade
The theoretical underpinnings of
international trade
9

What’s the rationale behind
trade?
 Trade primarily happens thanks to one phenomenon, and that is
specialization!
 Most people don’t wake up in the morning and prepare breakfast from
food they have grown or cultivated in their own back gardens, or wear
clothes that they have designed and produced themselves. Most of us
live in societies characterized by various degrees of specialization,
meaning we buy food, clothing and other essentials from others.
 Thanks to specialization, most of the world’s population can lead lives
that are more productive, interesting and rewarding than they would be
if everyone had to do everything, and make everything they needed
themselves.
 It’s the same with countries. Countries could make almost everything
themselves (and some still do), but basically it’s better for countries to
focus a greater share of their limited resources making things they can
make better or more cheaply than many other countries.
10

Should Tiger Woods mow his own
lawn? [Care of Gregory Makiw, Principles of Economics]
11
Tiger Woods spends a lot of time walking around on grass. Formerly
one of the most talented golfers of his time, he used to be able to hit a
drive and sink a putt in a way that most casual golfers only dream of
doing. Most likely he is talented at other activities too. For example,
let’s imagine that Woods can mow his lawn faster than anyone else.
But just because he can mow his lawn fast, does that mean that he
should?
To answer this question, we can use the concepts of opportunity cost
and comparative advantage. Let’s say Woods can mow lawn in 2
hours. In that same 2 hours, he could film a television commercial for
Nike and earn $10,000. By contrast, Forrest Gump, the boy next door,
can mow Woods’ lawn in 4 hours. In the same 4 hours, he could work
at McDonalds and earn $ 20.
In this example, Woods has an absolute advantage in mowing lawns
because he can do the work with a lower input of time. Yet because
Woods’ opportunity cost of mowing the lawn is $10,000 and Forrest’s
opportunity cost is only $20, Forrest has a comparative advantage in
mowing laws.
The gains from trade in this example are tremendous. Rather than
mowing his own lawn, Woods should make the commercial and hire
Forrest to mow the lawn. As long as Woods pays Forrest more than $20
and less than $10,000, both of them are better off.

Adam Smith and the theory
of absolute advantage
“It is the maxim of every prudent master of a family,
never to attempt to make at home what it will cost
him more to make than to buy.
What is prudence in the conduct of every private
family, can scarce be folly in that of a great
kingdom.
If a foreign country can supply us with a commodity
cheaper than we ourselves can make it, better buy
it off them with some part of the produce of our
own industry, employed in a way which we have
some advantage.“
Adam Smith The Wealth of Nations, 1776
12

More thinking on absolute
advantage
 A country has an absolute advantage in the
production of a good if it can produce the
SAME amount of the good with LESS input
relative to other countries.
OR
 A country has an absolute advantage in the
production of a good if it can produce MORE
of the good with the SAME amount input
relative to other countries.
13

David Ricardo and the theory
of comparative advantage
 David Ricardo realised that Absolute Advantage is a
limited case of a more general theory called
Comparative Advantage.
 It can be seen between two countries that even when
one country has an absolute advantage in both
commodities, it could still be mutually beneficial for both
countries to specialise in 1 product and trade.
 According to the law of comparative cost advantage
two countries can gain from trade even if one of the
countries is more efficient in producing both products.
 A country specializes in producing and exporting goods
in which its comparative advantage is greatest, or
comparative disadvantage is the smallest.
 A country should import goods in which its comparative
advantage is smallest or comparative disadvantage is
greatest
14

Want to do more reading on absolute
and comparative advantage?
15
Reinhard Schumacher, Free Trade
and Absolute and
Comparative Advantage, 116
pages, click on the thumbnail to
download or click here.
Lynn Sha and Kent H. Hughes, New
Thinking in
International Trade:
Global Competition and
Comparative Advantage, 168 pages,
click on the thumbnail to download or
click here.

The gains from trade
 The example discussed above involving Tiger Woods and
his neighbor Forrest Gump highlights something
economists refer to as the “gains from trade”.
 Trade also provides benefits by allowing countries to
export goods whose production makes relatively heavy
use of resources that are locally abundant while
importing goods whose production makes heavy use of
resources that are locally scarce.
 International migration and international borrowing and
lending are also forms of mutually beneficial trade.
 The international exchange of risky assets, such as stocks
and bonds can benefit all countries by allowing each
country to diversify its wealth and reduce the variability of
its income.
16

More gains from trade
 International trade increases both the incentives for not
waging war and the costs of going to war.
 International trade intensifies cross border contacts and
exchange of ideas, which can contribute to better
mutual understanding, as well as spurring innovation.
 It has also been argued that open, international trade
may also promote a number of core values such as
liberty, human rights, and democracy
17

But its not all good news for
everyone | important caveat!
 While nations generally benefit from international
trade, however, it is quite possible that international
trade may hurt particular groups within nations (think
about the steelworkers of the North-eastern United
States we discussed earlier).
 This is because international trade has strong effects
on the distribution of income.
 International trade can adversely affect the owners
of resources that are “specific” to industries that
compete with imports and cannot find alternative
employment in other industries.
18

Over to you | your thoughts
and reflections
 What do you think are some of the benefits that a
developing country like Indonesia reaps from trading
with its partners both regionally and globally?
 Can you name some countries that have been more
successful in harnessing trade as an engine for
economic development, while pointing to others that
have had less success so far?
 Can you think of some groups within your own
country that have suffered from some of the adverse
distributional effects of trade liberalization? What do
you think can and should be done to help them?
19

Want to do some more reading on
the gains from trade?
20
Marc J. Melitz and Daniel Trefler,
Gains from Trade when Firms Matter,
28 pages, click on the thumbnail to
download or click here.
Mark Weisbrot and Jake Johnston, The Gains
From Trade: South American Economic
Integration and the Resolution of Conflict, 12
pages, click on the thumbnail to download or
click here.

Part 3
Three Simple Principles of
Trade Policy
Care of Doug Irwin Three Simple Principles of Trade Policy
21

First some recommended
reading
 This section draws heavily on a little-
known but very well written short
monograph written by renowned trade
economist Doug Irwin.
 If all policymakers and other officials
working in the area of trade policy, as
well as politicians were required to read
this before making any decisions in the
world of foreign economic policy, the
world trading system would function a lot
better than it does now.
 The American Enterprise Institute, who
published the work, has graciously
uploaded the entire text as a PDF. You
can download it by clicking on the
thumbnail or by clicking here.
22

1st Principle
A Tax on Imports is a Tax on Exports
 Any restrain on imports is equivalent to a tax on exports
 Any restraint on imports also acts, in effect, as a restraint
on exports.
 When a government undertakes polices to expand the
volume of exports, it cannot help but to expand the
volume of imports as well.
 This is because exports and imports are flip sides of the
same coin
 Exports are necessary to generate the earnings to pay for
imports
 Exports and imports are inherently interdependent, and
any policy that reduces one will also reduce the other.
 This truth has a long intellectual pedigree but is known
today as the Lerner Symmetry Theorem
23

1st Principle
 What mechanisms specifically link a country's exports and
imports to one another?
 The mechanisms can be complex and subtle, but focusing
on the foreign exchange market can perhaps illustrate
what is going on.
 If Indonesia unilaterally reduces its tariffs on goods from
Japan, for example, one would expect Indonesian
demand for Japanese goods to increase.
 In this case, consumers in Indonesia will (indirectly) have to
sell IDR on the foreign exchange market to purchase
Japanese Yen.
 This tends to depress the value of the IDR in terms of the
Japanese Yen, or conversely, to raise the value of the
Japanese Yen in terms of the IDR.
 The depreciation of the IDR tends to raise the price of
Japanese goods in Indonesia dampening demands for
those goods.
24

1st Principle
 But here is the flip side: even though Japan did not change
its tariff on Indonesian goods, Japan will now purchase
more goods from Indonesia because the depreciated IDR
will tend to lower the price of Indonesian goods.
 In other words, the foreign exchange market is one
mechanism that links exports and imports to ensure that
when a country unilaterally reduces its tariffs, its exports
increase as well.
 There is sufficient evidence of this symmetry to indicate that
exports and imports are unmistakably correlated: they rise
and fall in lockstep.
 If a government undertakes policies that systematically
reduce the volume of imports, it also systematically reduces
the volume of exports.
25

2nd Principle
Businesses are consumers too
 Economists since Adam Smith have always stressed the
costs to consumers of various trade restrictions.
 Examples of trade restrictive policies which imposed huge
costs on consumers were the Multi Fibre Arrangement
(MFA) in the textiles sector, and Vertical Export Restraints
(VERs) in the automobile sector.
 The consumer cost of protection argument is, however,
getting a bit worn out.
 Jobs are also viewed as very important in the political
arena.
 If it comes down to saving a few hundred jobs in some
industry or saving consumers a few hundred dollars in
income, the policy of import protection will win every
time.
 What’s more, producer interests are concentrated and
thus well represented politically, while consumers’ costs
are spread over millions of households.
26

2nd Principle
Businesses are consumers too
 But the producers versus consumers argument overlooks the fact
that businesses are consumers too.
 Business firms are, in fact, bigger consumers of imported products
than households.
 One can go down the list of trade policy interventions over the last
few decades and see that many of the commodities at issue
constitute intermediate goods.
 Any trade intervention that raises the price of an intermediate good
will at some point adversely affect most households as final
consumers.
 But the immediate adverse affect is on other downstream industries,
and, necessarily, employment in those industries.
 Example of US steel policy is an illustrative one. Other examples
include sugar, and Dynamic Random-Access Memories (DRAMs).
 By viewing imports not as final consumer goods but as inputs to
domestic production, policy makers can more clearly recognize that
the issue is not so much one of “saving” jobs but of “trading off” jobs
between sectors.
27

3rd Principle
Trade imbalances reflect capital flows
 Any analysis of trade imbalances must begin with the general
balance of payments.
 The balance of payments is simply an accounting of a country’s
international transactions.
 One important lesson to remember in the context of the balance
of payments is that it always balances – that is, sums to zero.
 Two broad categories of transactions enter into the balance of
payment:
– The current account , which records all trade in merchandise
goods and services; and
– The capital account, which records all trade in assets, either
portfolio or direct investments
 Because the balance of payments always balances, a country
running a current account deficit must also have a
counterbalancing capital account surplus.
 In other words, if a country is buying more goods and services
from the rest of the world than it is selling, the country must also be
selling more assets to the rest of the world than it is buying.
28

3rd Principle
Trade imbalances reflect capital
flows
 Countries with current account deficits are effectively borrowing from or selling
assets to the other countries.
 Countries with current account surpluses in contrast, are buying assets from the
rest of the world, or using their savings to act as net lenders to other countries.
 There is a fundamental equation of international finance that relates this net
borrowing and lending activity to the current account:
Exports minus Imports = Savings minus investment
 In other words, countries running trade surpluses (the value of their exports
exceeding the value of their imports) have domestic savings in excess of
domestic investment.
 This “excess” savings, which is invested or lent abroad, manifests itself in a
capital account deficit, the counterpart of which is a current account surplus.
 Countries with trade deficits can sustain greater domestic investment than
domestic savings because of the addition of foreign savings, which come in as
a capital account surplus or current account deficit.
29

3rd Principle
Trade imbalances reflect capital flows
 The powerful implication of this equation is that if a
country wishes to reduce its trade deficit, the gap
between its domestic investment and its domestic
savings must be reduced.
 Unless a country’s trade policies also affect its total
savings or investment, those policies will be ineffective
in altering its balance of trade.
 That is why simple observation shows us that some
countries with open markets run trade surpluses and
others run trade deficits, while some countries with
closed markets run trade surpluses and others run
trade deficits.
 Those imbalances have everything to do with
international borrowing and lending and virtually
nothing to do with commercial policies.
30

Over to you | your thoughts
and reflections
 Explain in your own words the mechanism that links
imports to exports.
 How does what you learned under the 2nd Principle
(Businesses are Consumers too) fit with what you
already know about global value chains or say, the
way a smart phone is manufactured in today’s
economy?
 Try and find some recent statements by the trade
minister or economic policymakers in your country
recently. To what extent to they reflect some level of
understanding of the these three simple principles of
trade policy? (hint: the answer may be “not very much at
all”)
31

33
University Pelita
Harapan – UPH
Founded in 1994 with the vision of
educating a new generation of
leaders for Indonesia and the wider
ASEAN region, University Pelita
Harapan is the number one private
university in Indonesia according to
the QS World University Ranking
2013. UPH was the first University in
Indonesia to introduce programs
entirely taught in English, the first to
offer a liberal arts curriculum, and
the first to introduce a multi-
disciplinary approach to its
programs. While consistently
underlining the vision of “knowledge,
faith and character”, UPH in
cooperation with overseas partner
universities, has developed a very
rich curriculum in many areas study,
ensuring that its graduates will be
respected globally and appreciated
by modern business and industries.
The Center for Trade and Investment - CITI
Established in September 2014, CITI’s objective is to raise awareness in Indonesia of the
importance of an outward-looking and liberal trade and investment policy so as to ensure
the country’s continued commercial competitiveness and to support its economic
development goals. CITI runs a number of research, education and outreach initiatives with
the generous support of both the Swiss State Secretariat for Economic Affairs (SECO) and the
WTO Secretariat (in the form of the WTO Chairs Program). This lecture is one of 12 we
designed to serve as an introduction to the law and policy of the global trading system. We
hope you have enjoyed it and also found it educational.
John Riady
WTO Chair Holder
John Riady is Director of
Lippo Group, Berita Satu.
Executive Dean at the
UPH Faculties of Law,
Business &Political
Science.

Module 1 globalization

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