MBA 34 Managerial Excellence 1 Term Globalization facts

MBA 34 Managerial Excellence – 1° Term Globalization: facts, theory and consequences The firm and its environment - Francesco Giavazzi Class 21 Copyright SDACopyright Bocconi 2004 SDA Bocconi 2006 1

We live in a globally integrated world … • • • More integrated than never Both in goods and financial markets But globalization is not a novel phenomenon (Victorian age, previous globalization period) Copyright SDA Bocconi 2004 2

Small countries are global, big countries are not Copyright SDA Bocconi 2004 3

Most international trades occur among rich countries which sell varieties of same goods to each other Copyright SDA Bocconi 2004 4

Leading exporters & importers: bullet points Germany world leading exporter, Usa world leading importer China quickly getting close to the top of the ladder. India & China with highest growth of exports. India with record growth of imports Germany (+200 bn$), China (+100), Japan (+80) and Russia (+120): countries with biggest trade surpluses. Their overall surplus of +500 bn$ is 60% of the US merchandise trade deficit (830 bn$). • Other countries with big merchandise trade deficits: UK ( -130 bn) and Spain (-90 bn) Merchandise trade balance partly offset by foreign account balance in services trade • UK, Spa and Usa show a “+” (Usa=+70) • Ger, Jap and, to lesser extent, Rus and Chi have a ”-”) Copyright SDA Bocconi 2004 5

The bulk of world trade is in manufactures • • • About 60% of the total, up from 50% in 1985 Declining shares of mining and other primary products (from 30% to 17%) Shares of services marginally up to 21% – Share of “Other services” (which includes IT services) almost doubled since 1985 Copyright SDA Bocconi 2004 6

Growth in trade partly boosted by lower transport costs, particularly in the first half of the century Copyright SDA Bocconi 2004 7

Trade (especially in second half of century) also boosted by declining tariffs Copyright SDA Bocconi 2004 8

Despite progress towards freer trade, globalization is still very incomplete Goods market Law of one price does not hold • • Price of similar goods more different across than within countries Not much evidence of decreasing price differentials over time Persisting home bias in consumption • • US share of world GDP =. 25; rest of world GDP =. 75 With same preferences and full integration, expect GDP share of imports =. 75 Instead: =. 12, one sixth of its frictionless value About the same for EU as a whole and Japan Copyright SDA Bocconi 2004 9

Theory- Why are countries so eager to trade? The comparative advantage principle If countries trade so much and Governments are so eager to embrace free trade, there must be a reason. There must be GAINS FROM TRADE! Why? Rationale from the principle of comparative advantage (David Ricardo first, Eli Heckscher and Bertil Ohlin then). Comparative advantage Even if the US is more productive than the rest of the world in producing all goods (“has an absolute advantage” in all productions), there may still be a case for the US to specialize in producing a subset of all goods and import the others This is because of specialization gains: if the US specializes in producing goods where its productivity advantage is relatively bigger, this generates welfare gains. Resources are therefore more efficiently allocated Copyright SDA Bocconi 2004 10

Comparative advantage has huge implications • The more different countries are as to resource endowments, the bigger the scope for specialization • Countries will benefit from trade even if they are not low cost producers • Even poor countries may benefit from trade • Each country specializes in those goods where, given resource endowments, its comparative advantage is greater • L-abundant countries will export L-intensive goods (Chinese toys) • K or technology abundant countries will export Kintensive tech-intensive goods (US aircraft) • Being closed to trade means being stuck producing goods that could be more efficiently imported from abroad Copyright SDA Bocconi 2004 11

High RELATIVE (not absolute) productivity means high exports Source: Leontief (1953) - reprinted in Caves and Johnson Copyright SDA Bocconi 2004 (1968) “Readings in International Economics” 12

Diagram shows how strong comparative advantage is US had absolute advantages in ALL industries (the ratio of US to UK productivity everywhere greater than one) However, still the case that in many industries the U. K. exported more than the US Consistent with theory of comparative advantage: The industries where UK exports are higher than US exports are in the low-productivity industries where the UK disadvantage is less sensible Copyright SDA Bocconi 2004 13

Is the Heckscher-Ohlin theory of comparative advantage a good theory? Look at two pictures: (Us. Chi) and (iit). Then ask: Is comparative advantage a powerful theory? • Yes, if goal is to explain trade between rich and poor countries, such as Japan vs. China or US vs. Mexico • No, at first sight, if goal is to explain trade between similarly endowed rich countries – Italians and French similarly well equipped to produce and export wine. Yet Italians keep drinking Champaigne and French (may) drink some Spumante. – Why? Taste for variety and scale economies from specializing in intermediate goods So: is comparative advantage useless for understanding about one half of world trade? Not really. Subset of varieties in which each country specializes often follows resource endowments – Example: which cars do Germans and Italians sell to each other? Mercedes and Fiat Copyright SDA Bocconi 2004 14

Policy implications Under principle of comparative advantage: • Free trade max permanent GDP through efficiency gains (higher TFP). These are static gains from trade • Trade restrictions = bad thing There may also be dynamic gains from trade • By trading with the world (multinationals, imports, learning-by-exporting), a country may import technical change, ability to reorganize production and the like Copyright SDA Bocconi 2004 15

If trade so beneficial why do trade restrictions exist at all? Examples of trade restrictions Tariffs: taxes on imports Quotas: quantity restrictions on foreign imports Voluntary Export Restrictions (VER’s): Foreign producers “voluntarily” restrict quantities Administrative and technical standards Domestic Content Requirements (“buy Italian”) Government Procurement • Why do they exist at all? • To minimise adverse distributional effects of trade • To raise revenue Copyright SDA Bocconi 2004 16

No-global economics If trade according to comparative advantage is so beneficial, why all this no-global fuss over immiserizing effects of trade, exploitation of the poor and the like? In a nutshell, there is something to discuss but evidence is not against trade. If anything, quite the opposite Copyright SDA Bocconi 2004 17

Why no-globals may have a point: international trade causes winners and losers Trade between countries with different resource endowments, though beneficial for the economy as a whole, causes winners and losers • Workers in exporting industries cash higher wages and employment -- winners – IT workers in the US, workers in mechanical industries in Italy • Workers in import-competing industries suffer wage and employment losses -- losers – Steel workers in the US, textile workers in Italy Comparative advantage theory says that winners gain enough to compensate losers. But how is unclear in practice. Government redistribution of part of the export proceeds implied in principle. Rarely carried out in practice … Copyright SDA Bocconi 2004 18

Cross-country wage differentials – a proof of exploitation? Copyright SDA Bocconi 2004 19

. . Or simply a proof of labor productivity differentials? Wages differ because labor productivity eventually differs: high-productivity countries can still pay higher wages and be competitive on unit costs. (Source: Trefler, 1993, Journal of Political Economy) Copyright SDA Bocconi 2004 20

Who are the “trade winners” in poor countries? In poor countries the winners from international trade are the owners of the resource available in abundant supply in the opening-up country (Stolper-Samuelson theorem – a consequence of Heckscher-Ohlin’s comparative advantage model) Who are these winners? Two categories of people • The owners of the land where natural resources are located and primary products are grown – This worsens income distribution for they are rich to start with • The plantation workers and small producers of primary products – This improves income distribution for they are the poor So effect of opening up on income distribution in poor countries not obvious (and may actually be positive) Copyright SDA Bocconi 2004 21

Chinese - U. S. trade consistent with Hecksher-Ohlin U. S. export capital intensive goods and import labor intensive ones (back) Copyright SDA Bocconi 2004 22

Extent of Intra-industry trade --more important for rich countries (back) Copyright SDA Bocconi 2004 23