Seminars,

Globalisation SoSe 2021 Definitions

Why it is interesting:
 Highly dynamic: cannot be avoided – should be understood etc.
 Brings economic opportunities & risks: Globalisation
o Gains for all/some groups; losers can be compensated? Growing interdependence
o Dependencies on specific global producers and value chains? of markets and
 Certain globalisation dynamics could run counter to political/ voters production in various
interests countries through trade,
 How to open countries up to global markets capital, and technology
transfer.
 Effectiveness and efficiency of International Organisations
But also: International
 Impact of the global Internet
(labour) migration,
General understandings about Globalisation increasing
interdependence &
 Countries selling goods and services to each other almost always
specialisation, diminishing
generate mutual benefits importance of national
1. When a buyer and a seller engage in a voluntary transaction, both can borders, universal canon
be made better off of values (disappearing
2. Trade benefits countries by allowing them to export abundant cultural identities),
resources and import scarce goods convergence of economic
3. Specialised countries may get more efficient due to larger-scale models, power shift
production between state and
4. Countries may also gain by trading current resources for future individual (favouring
individual)
resources (international borrowing and lending)
Voc.: Tariff  Zoll
Criticism
 Trade may benefit countries as a whole but may harm particular
groups within a country
 Ecological, cultural, political, and social issues can arise through
globalisation

History
 Beginnings: Colonial powers
 19th century: decreasing transportation costs
 Phase of protectionism between WW1 and WW2  magnification of
impact of great depression  founding of international organisations
such as IMF, World Bank, WTO to foster trade
 Fall of “Iron Curtain”
 Regional integration: EU, NAFTA (US, CDN, MEX) etc.
 Digital revolution  know-how transfer
 Increasing importance of China as a dominant country
 Global Financial Crisis 2007/2008: slower pace integration, increased
protectionism; increased production directly in export regions
 Trade offers limited potential for additional integration, service sector
and non-tariff restrictions are underdeveloped
Size Matters: The Gravity Model Seminars,
 Size of an economy is directly related to the volume of imports and Definitions
exports.
o Larger economies produce more goods and services, so they etc.
have more to sell in the export market.
o Larger economies generate more income from
o the goods and services sold, so they are able to buy more
imports.
 Trade between any two countries is larger, the larger is either
country.
 Anomalies: Cultural affinities (common language, history of
migration) & transport cost advantages due to location
 Disproportionately large trade volume due to these reasons,
even when countries/economies small

Impediments to Trade
 Distance between markets influences transportation costs and
therefore the cost of imports and exports.
 1% increase in distance is associated with decrease in volume
of trade of 0.7% - 1%
 Trade agreements: reduction of formalities and tariffs 
increasement in trade
 NAFTA: Mexico and Canada as neighbours of US  amount
of trade as a fraction of GDP is larger than between US and
European countries
 Canada-US-Border: despite trade agreement and
common language still obstacle
 Cultural affinity: close cultural ties, such as a common language,
usually lead to strong economic ties
 Geography: ocean harbours and a lack of mountain barriers make
transportation and trade easier.
 Multinational corporations: corporations spread across different
nations import and export many goods between their divisions.
 Borders: crossing borders involves formalities that take time, often
different currencies need to be exchanged, and perhaps monetary
costs like tariffs reduce trade

Composition of World Trade

 Past: mainly trade of
agricultural and mineral
products
 Today: manufactured
products
 Low- and middle-
income countries
have changed the
composition of
 their trade  Past mainly agricultural, today manufactured Seminars,
products  1980s onwards
Definitions
International Trade Theory etc.
Ricardian Model (on Labour Productivity)
 Uses concepts of opportunity costs and comparative advantage
 A country has a comparative advantage in producing a good if
the opportunity cost of producing that good is lower in the
country than in the other countries.
 When countries specialize in production in which they have a
comparative advantage, more goods and services can be
produced and consumed.
 Construction of a one-factor Ricardian model using the following
assumptions:
 Labour is the only factor of production.
 Labour productivity varies across countries due to differences in
technology, but labour productivity in each country is constant.
 The supply of labour in each country
is constant.
 Two goods: wine and cheese.
 Competition allows workers to be
paid a wage equal to the value of
what they produce and allows them
to work in the industry that pays the
highest wage.
 Two countries: home and foreign.
 With trade, a country can specialize its production and exchange for the
mix of goods that it wants to consume.
 Consumption possibilities expand beyond the production possibility
frontier when trade is allowed
 Predicts complete specialisation, but rarely ever happens
 More than one factor of production reduces the tendency of
specialization
 Protectionism
 Transportation costs reduce or prevent trade
 Nontraded goods and services exist due to high transport costs
 large fraction of national income spend on nontraded goods
and services

Two‐Factor Heckscher‐Ohlin Model

 Trade occurs due to differences in labour productivity AND differences in
resources across countries
 Production processes use factors of production with different relative
intensity
Assumptions Seminars,
1. Two countries: Home and Foreign.
2. 2. Two factors of production: labour and capital. Definitions
3. Two goods: cloth and food  Cloth  labour intensive; Food 
capital intensive
etc.
4. The mix of labour and capital used varies across goods. Heckscher-Ohlin
5. The supply of labour and capital in each country is constant and varies theorem
across countries. The country that is
6. In the long run, both labour and capital can move across sectors, abundant in a factor
equalizing their returns (wage and rental rate) across sectors exports the good whose
7. The countries are assumed to have the same technology and the same production is intensive
in that factor.
tastes.
a. Same technology  comparative advantage in producing goods
that use relatively abundant factors of production
b. With the same tastes, the two countries will consume cloth to
food in the same ratio when faced with the same relative price
of cloth under free trade.

Trade in the Heckscher‐Ohlin Model

 Predicts specialisation of countries
 Trade increases the demand of goods produced by relatively abundant
factors  increasing the demand of these factors  raising prices of the
relatively abundant factors

Empirical Evidence on the Heckscher‐Ohlin Model

 According to model US should specialize in high-skilled, capital intensive
goods and export those
 Leontief-Paradox: U.S. exports were less capital-intensive than
U.S. imports, even though the U.S. is the most capital-abundant
country in the world  confirmed on global level in other study
 Difficulty finding support for the predictions of the “pure” Heckscher-
Ohlin model  some of the assumptions made (i.e., same technology)

Standard Trade Model (Krugman) Isovalue lines

 Differences in labor services, labor skills, physical capital, land, and Isovalue lines
technology between countries cause differences in production possibility represent different
frontiers (PPF). budget constraint, V V
 A countryʼs PPF determines its = PCQC + PF QF, value
relative supply function. of the total
 National relative supply functions production, also the
determine a world relative supply maximum an
function, which along with world economy can afford
relative demand determines the to consume. Produce
equilibrium under international at point where PPF is
trade. tangent to Isovalue
 Standard trade model is a general line. Isovalue line
model that includes Ricardian steeper when price of
and Heckscher-Ohlin models as one good rises.
special cases.
 Output & Consumption without trade Seminars,
 The relative price of cloth to food is determined by the
intersection of relative demand and relative supply for that
Definitions
country. etc.
 Consume and produce at point D where the indifference
curve is tangent to the production possibilities frontier

Output & Consumption with trade

 Consumption and production no longer need to be the same
 The relative supply is determined
by the tangent point of the highest
isovalue line.
 Consumption choice is based on
preferences and relative price of
goods: Consume at point D where
the isovalue line is tangent to the
same indifference curve (no longer
the PPF).
  terms of trade refers to the price of exports relative to the price of imports  higher relative
price for exports means that the country can afford to buy more imports, an increase in the
terms of trade increases a country’s welfare.
 Equilibrium Relative Price with Trade and Associated Trade Flows:

International Trade Policy

Types of Tariffs
 Specific Tariff: fixed charge for each unit of imported goods
 Ad valorem tariff: fraction of the value of imported goods.

Supply, Demand, and Trade in a Single Industry

 In absence of trade price is higher in home than in foreign
 With trade, wheat will be shipped from Foreign to Home until the price difference is
eliminated
 Import demand curve is the difference between the quantity
that home consumers demand minus the quantity that home
producers supply, at each price  MD = D – S  intercepts
the price axis at PA and is downward sloping
 Export supply curve is the difference between the quantity
that foreign producers supply minus
the quantity that Foreign consumers
demand, at each price  XS* = S* – D*
intersects the price axis at PA and is upward
sloping
World equilibrium Seminars,
 import demand = export supply,
 home demand – home supply = foreign supply – Definitions
foreign demand
 home demand + foreign demand = home supply + foreign
etc.
supply
 world demand = world supply

Effects of a Tariff
 A tariff acts like a transportation cost, making sellers unwilling to ship
goods unless the Home price
exceeds the Foreign price by the
amount of the tariff: PT – t = PT*
 price rise in the Home market
(excess demand) and fall in the
Foreign market (excess supply)
 price in the Home market rises
from PW under free trade to PT with
 the tariff
 Home producers supply more, and Home consumers demand less
 the quantity of imports falls from QW under free trade to QT with
the tariff.
 Prices in foreign fall
 Foreign producers supply less, and Foreign consumers demand
more, quantity of exports falls from QW to QT
 The quantity of Home imports demanded equals the quantity of Foreign
exports supplied when PT – PT* = t
 The increase in the price in Home can be less than the amount of the tariff
 export prices in foreign decline, but effect small

…in a small country

 No effect on the foreign (world) price because demand is
insignificant part of world demand  foreign price does
not fall, remains at Pw  price of home rises by full amount
of tariff PT = PW + t
Costs and Benefits of Tariffs Seminars,
 A tariff raises the price of a good in the importing country, so it hurts
consumers (decreasing consumer surplus) and benefits Definitions
producers there (increasing producer surplus) etc.
 Government gains tariff revenue  the government collects
tariff revenue equal to the tariff rate times the quantity of Consumer surplus
imports with the tariff. T QT = (PT –PT*) (D2 – S2 ) measures the
 Measured with concepts of consumer/ producer surplus amount that
consumers gain
 Large country welfare effect ambiguous
from purchases by
 b and d represent the efficiency loss  tariff distorts
computing the
production and consumption decisions difference in the
 e represents the terms of trade gain  foreign lowers price  price actually paid
imports cheaper from the maximum
 If the terms of trade gain exceed the efficiency loss, then national welfare will price they would be
increase under a tariff, at the expense of foreign countries  foreign free to willing to pay for
retaliate  danger of trade war each unit consumed
 Tariffs can be hard to remove, and large tariffs may induce producers to Producer surplus
engage in wasteful activities to avoid paying tariffs measures the
amount that
Export Subsidy producers gain
 Can be specific or ad valorem from sales by
 raises the price in the exporting country, decreasing its computing the
consumer surplus (consumers worse off) and increasing its difference in the
producer surplus (producers better off) price received from
 Also, government revenue falls due to paying sX S* for the the minimum price
export subsidy. at which they
would be willing to
 lowers the price paid in importing countries P S* = PS – s.
sell
 subsidy worsens the terms of trade by lowering the price of exports in world
markets.
 damages national welfare  b + c + d + f + g represents the cost of the subsidy
 b and d represent the efficiency loss  producers produce too much, consumers
demand less

Export Subsidy in Europe

 EU sets high prices for agricultural products and subsidizes exports to dispose
of excess output
 The cost of this policy for European taxpayers is almost $30 billion more than
its benefits (in 2007). Subsidy payments are about 22% of the value of farm
output

Other Trade Policies

 local content requirement is a regulation that requires a specified fraction of a
final good to be produced domestically
 Export credit subsidies  subsidized loan to exporters
 Government procurement: Government agencies are obligated to purchase
from home suppliers, even when they charge higher prices (or have inferior
quality) compared to foreign suppliers.
 Bureaucratic regulations (red tape): Safety, health, quality, or customs
regulations
 Current Debates On Trade Seminars,
Trading Agreements Definitions
World Trade Organisation
 average tariff rate has decreased substantially from the mid-1930s to etc.
1998  General Agreement of Tariffs and Trade in 1947, later World
Trade creation
Trade Organisation 1995
Occurs when high-cost
 covers 90% of global trading volume domestic production is
 Their goals: replaced by low-cost
 generate gains from trade  lower trade barriers across imports from other
countries & regions members.
 multilateral agreements for all members
Trade diversion
 settle trade disputes among members Occurs when low-cost
Multilateral vs. bilateral/preferential trade agreements imports from non-
members are diverted
 Preferential trading agreements are trade agreements between countries
to high-cost imports
in which they lower tariffs for each other but not for the rest of the world
from member nations
 WTO generally does not allow discriminatory agreements, except when
tariff rate is zero  WTO promises that all countries will pay tariffs no
higher than the nation that pays the lowest: called the “most favoured
nation” (MFN) principle
 Preferential trade agreements do not necessarily increase national
welfare  prices at world market might be inexpensive + tariff revenue,
but country imports expensive product from member country
 National welfare is increased when new trade is created, but not when
existing trade from the outside world is diverted to trade with member
countries.

Free Trade Area Customs Union

Allows free trade among members, Agreement that allows free trade
but each member can have its own among members and requires a
trade policy towards non-member common external trade policy towards
countries. non-member countries.
Trade and Low‐Wage Labour
Issues

Manufactured exports from low- and middle- income countries have been increasing, causing two potential
issues:
Compared to rich-country standards, workers who produce these goods are paid low wages and may work
under poor conditions.
labour standards imposed by foreign countries are opposed by governments of low- and middle-income
countries
International standards used as protectionist policy or basis for lawsuits when domestic producers violate
Standards set by high-income countries expensive for low- and middle-income producers.
Solution: system that monitors wages and working conditions  information available to consumers
Low-income/skilled workers lose their jobs in rich countries

Model Predictions

Ricardian Model predicts that while wages in Mexico should remain lower than those in the U.S. due to low
productivity in Mexico, they will rise relative to their pretrade level
Heckscher-Ohlin model does predict that unskilled workers in the U.S. will lose from NAFTA, but it also
predicts that unskilled workers in Mexico will gain
Trade and the Environment Seminars,
 environmental standards in low- and middle- income countries are less strict Definitions
than in high-income
 Inclusion of environmental standards in trade negotiations: etc.
 Same arguments used as in labour standards (see above)
The applicability of
 Poor countries grow richer (partly due to trade)
the EKC is debatable
 rising production and consumption when it comes to
 Further increase in income  able to afford non-air pollutants,
stringent environment protection. some natural
 pollution haven: place where an economic resource use, and
activity that is subject to strict environmental biodiversity
controls in some countries is moved to (sold to) conservation. For
other countries with less strict regulation. example, energy,
land-and resource
 Pollution in some countries may cause a negative
use (sometimes
externality for other countries  Co2 emissions included in international
called the
negotiations "ecological
footprint") may not
Open-Economy Macroeconomics fall with rising
income. While the
The National Income Accounts
ratio of energy per
 Gross national product: value of all final goods real GDP has fallen,
and services produced by a nation’s factors of total energy use is
production in a given time period still rising in most
 GNP (Y) is calculated by adding the value of expenditure on final goods and developed countries
services produced: as are total
1. Consumption (C): expenditure by domestic consumers emission of many
2. Investment (I): expenditure by firms on buildings & equipment greenhouse gases.
3. Government purchases (G): expenditure by governments on goods and
services
4. Current account balance (exports (EX) minus imports (IM) = CA): net
expenditure by foreigners on domestic goods and services

Net foreign wealth

 CA = EX - IM = Y- (C + I + G)
 net foreign wealth is increasing, when production > domestic expenditure,
exports > imports: current account > 0 and trade balance > 0
 A country exports more, than it imports, it earns more income from
exports than it spends on imports
 Germany
 net foreign wealth is decreasing, when production < domestic expenditure,
exports < imports: current account < 0 and trade balance < 0
 A country exports less, than it imports, it
earns less income from exports than it
spends on imports
 USA
 National saving (S) = national income (Y) that is
not spent on consumption (C) or government
purchases (G).
 S=Y–C–G=I
  An open economy can save by building up its capital stock or by Seminars,
acquiring foreign wealth  S = I + CA
Definitions
Balance of Payments Accounts
Current Account Financial Account Capital Account
etc.
accounts for flows of - accounts for flows of financial flows of special categories Strategies to narrow the
goods and services assets (financial capital) of assets (capital): typically US trade deficit
(imports and - the difference between sales of nonmarket, non-produced, - Recession: US
exports) domestic assets to foreigners or intangible assets like consumer will spend
(inflow) and purchases of foreign debt forgiveness, less on imports
assets by domestic citizens (outflow) copyrights and trademarks. - Increase savings: US
consumer (and the
Causes and Backgrounds for Current account surpluses (in Germany)
government) spend less
 Wage restraint of the past years and increase in productivity  on imports and start to
increased competitiveness, exports, and employment finance their exports
 Demographic chances force older generation to save up for retirement (surpluses)
 Basis for export surplus and financing of credit of foreign -Impose tariffs on
imports: US consumers
Consequences of current account Consequences of current account deficits in EU will buy less foreign
surpluses in D and World goods & services
- Accumulation of foreign - Temporarily living above own means
exchange reserves - Increasing dept  possibly not able to pay
- Position of creditor to the back
rest of the world - Decline of foreign exchange reserves,
- Export of capital leads to less pressure to devaluate currency (not
investment in home country possible in euro-zone because of
Germany)

Exchange Rates
Foreign Exchange Markets
 Set of markets where foreign currencies and other assets are exchanged
for domestic ones  Institutions buy and sell deposits of
currencies/other assets for investment purposes
 Characteristics:
 High volumes, 24h books
 Vanilla & structured products
 small or no arbitrage  computer and telecommunications
technology transmit information rapidly and have integrated
markets
 USD, EUR & JPY as vehicle currency

Motives & dangers for international financial transactions/investments

Motives Dangers

Trade of goods & service across borders FX risks: Home investors whohold foreign
Differences in return between domestic and financial investments may suffer losses,
foreign investments when the foreign currency depreciates
Expansion of investment opportunities in This risk adds to regular valuation risks
global markets Country / transfer risk: Foreign borrower
Risk diversification of the portfolio through may not meet his obligations (economic or
exploitation political instability)
different economic cycles To limit such risks:
different economic policies Country ratings
Knowledge about FX markets
 Characteristics of different FX Markets
Spot Markets: Participants
Exchange rates for currency exchanges executed in the present
on Foreign
On the spot or within 2 days Exchange
Markets
Forward Markets:

30-, 60- or 90-day

Rates are negotiated between two parties in the present, but the exchange occurs in the future.
hedging, but no trading possible

Future Markets:

specified amount will be delivered on a specific date in the future

possible to trade the contract

Option Markets

owner has the right to sell or buy a specified amount at a specified price
no obligation to make the deal as owner of option, tradable
  Commercial banks and other depository institutions: transactions involve Seminars,
Seminars,
buying/selling of deposits in different currencies for investment
purposes
Definitions
Definitions
 Non-bank financial institutions (mutual funds, hedge funds, securities etc.
etc.
firms, insurance companies, pension funds) may buy/sell foreign assets
for investment. Law of One Price
 Non-financial businesses conduct foreign currency transactions to Due to the price
difference,
buy/sell goods, services and assets.
entrepreneurs would
 Central banks: conduct official international reserves transactions have an incentive to buy
products and services
(Supply and) Demand of Currency Deposits
etc. at the cheap
Supply: location and sell it at the
 Special case because of national/supranational stately monopoly (EZB expensive location for
etc.) an easy profit. People
would have an incentive
Demand (Based on fundamentals  FX markets very
to adjust their
complex)
behaviour and prices
 Rate of return: would tend to adjust
 the percentage change in value that until one price is
an asset offers during a time period. achieved across markets
 Real rate of return: inflation-adjusted
rate of return  represents the
additional amount of goods & services that can be purchased
with earnings from the asset.
 Interest rate:
 amount of a currency that an individual or institution can earn
by lending a unit of the currency for a year
 To compare the rate of return on a deposit in domestic currency
with one in foreign currency, consider:
 the interest rate for the foreign currency deposit
 Model in equilibrium when deposits of all currencies offer the
same expected rate of return: interest parity  deposits in all
currencies are equally desirable assets, no arbitrage possible

Depreciation and Appreciation of Currencies

 Depreciation is a decrease in the value of a currency relative to another
currency.
 Less valuable (less expensive) and therefore can be exchanged
for (can buy) a smaller amount of foreign currency
 Imports more expensive and
domestically produced goods
and exports are less expensive
 Depreciation of the domestic
currency today lowers the
expected rate of return on
foreign currency deposits 
initial cost of investing in foreign
currency deposits increases 
lowering expected rate of return
  Appreciation is an increase in the value of a currency relative to another currency.
 An appreciated currency is more valuable (more expensive) and therefore can be
exchanged for (can buy) a larger amount of foreign currency
 Imports are less expensive and domestically produced goods and exports are more
expensive
Determination of
the Equilibrium  Appreciation of the domestic currency today raises the expected return of deposits
Dollar/Euro on foreign currency deposits  initial cost of investing in foreign currency deposits
Exchange Rate decreases  raising expected rate of return

Model of Foreign Exchange Markets

 An increase in the interest rate paid on deposits denominated in a particular
currency will increase the rate of return on those deposits  Appreciation of the
currency.
 Higher interest rates on dollar-denominated
assets cause the dollar to appreciate.
 Higher interest rates on euro-denominated
assets cause the dollar to depreciate.

Effect of a Rise in the Dollar Interest Rate vs. Effect of Rise

in the Euro Interest Rate
 Seminars,
Financial Globalisation
International Capital Markets Definitions
 Group of markets (financial cities) trading different types of financial and etc.
physical assets:
o Stocks
o bonds (government and private
sector)
o deposits denominated in
different currencies
o commodities (like petroleum,
wheat, bauxite, gold)
o forward contracts, futures
contracts, swaps, options
contracts
o real estate and land
o factories and equipment
 When buyer and seller engage in a voluntary transaction, both receive
something that they want, and both can be made better off
 Intertemporal Trade Theory:
o gains from trade of goods and services for assets, of goods and
services today for claims to goods and services in the future
(today’s assets).
o Savers want to buy assets (claims to future goods and services)
and borrowers want to use assets to consume or invest in more
goods and services than they can buy with current income.
o Savers earn a rate of return on their assets, while borrowers are
able to use goods and services when they want to use them: they
both can be made better off.

Portfolio Diversification
 Portfolio diversification: gains from trade of assets for assets, of assets
with one type of risks for assets with another type of risk
o Goal: Risk reduction or aversion
 International assets: prices are often less correlated and determined by
different fundamental economic factors
 diversify the portfolios of assets so that both countries always achieve the
portfolios’ expected (average) values  always enjoy moderate yield 
both better off if risk averse

Menu of International Assets

Debt instruments Equity instruments
- bonds and deposits - Stocks and title to real estate
- Specification: issuer must - Specification: ownership of
repay fixed amount variable profits or returns, can
regardless of economic vary according to economic
conditions conditions
Specialised Institutions for International Assets: Offshore Banks Seminars,
Definitions
etc.
Agency office Subsidiary Bank Foreign Branch Offshore
(Tochergesellschaft) (Niederlassung) Currency Trading
as a driving force
- Loans and transfers, - Follows the - often subject to both
does not accept regulations domestic and foreign for growth of
deposits of the regulations, but offshore banking
- Not subject to foreign Offshore
sometimes may 
depository regulations country, not currency
choose the more
in either domestic or domestic in lenient regulations of
deposit:
foreign home the two.
bank
country deposit
denominated in a currency other than the currency that circulates where the bank resides
 Reasons for Offshore Currency Trading:
o Growth in international trade and international business
o Avoidance of domestic regulations and taxes  in many countries not subject to
reserve requirement earn interest on the full amount of the deposit.
o Political factors  avoid confiscation by a government because of political events
 Banks fail because they do not have enough or the right kind of assets to pay for their
liabilities
o If the value of assets decline (many loans go into default)  liabilities > value of
assets and bankruptcy could result

Government Safeguards against Financial Instability

Deposit Insurance

Prevents bank panics due to lack of information: depositors cannot determine financial health of a bank --> redraw funds, if
unsure that banks pay
creates moral hazard for banks to take excessive risk --> no longer fully responsible for failure

Reserve Requirements

banks required to maintain some deposits on reserve at the central bank in case they need cash

Capital Requirements and Asset Restrictions

higher bank capital (net worth) --> more funds available to cover cost of failed assets
Asset restriction: reduces risky investments by preventing banks from holding too many risky assets and encourage
diversification (prevention of holding too much of one asset)

Bank examination

Regular examination prevents banks from engaging in risky activities

Lender of Last Resort

Federal Reserve System (US) lends to banks with inadequate reserves (cash)
prevents bank panics
Addition to deposit insureance
creates moral hazard for banks

Government-Organised Bailouts

Failing all else --> central bank/ fiscal authorities organize the purchase of a failing bank by healthier institutions, sometimes
aiding with own money
bankruptcy avoided thanks to govt. intervention as crisis manager, but at public's expense
safeguards not nearly sufficient to prevent financial crisis of 2007-2009
Is the EU an optimum currency area? Seminars,
 Expectations:
o large trade volumes as a fraction of GDP Definitions
o a large amount of foreign financial investment and foreign direct
investment relative to total investment
etc.
o a large amount of migration across borders as a fraction of total
labour force
 Reality:
o Regional migration is not extensive in the EU.
 Europe has many languages and cultures, which hinder
migration and labour mobility.
 Unions and regulations also impede labour movements
between industries and countries.
 Differences of U.S. unemployment rates across regions
are smaller and less persistent than differences of
national unemployment rates in the EU, indicating a lack
of EU labour mobility
 Financial assets able to move freely but labour is stuck 
reduction of aggregate demand in a particular EU country
 disinvestment  The loss of financial assets could
further reduce production and employment
o Deviations from the law of one price also occur in many EU
markets  each member state has own taxes etc.
o Immense disparity in Ten-year government bond interest rates
(especially since financial crisis 2008)
o Real appreciation: Prices develop differently in member countries
 different inflation rates  higher appreciation results in loss in
competitiveness
 Conclusion:
o Not an optimum currency area
o Plenty of structural problems  labour markets must become
more flexible

Role of the financial

channeling
System savings into
 Reality: not investment

everything working
according to these
requirements! effecting transferring
payments risk
role of
financial
system

making
Maturity
markets &
transformati
providing
on
liquidity
 Financial Bubbles Seminars,
 period in which prices exceed fundamental
valuation  Any valuation depends on a model of
Definitions
fundamentals etc.
 Asset price bubbles:
o Coincide with increasing trade volume Alternative policy to
import-substituting
o Implosions seem to coincide with
industrialization:
increases in asset supply Trade Liberalisation
o coincide with financial or technological innovations (decrease in tariffs,
promotion of exports
Theories on bubbles
in targeted
 Rational Bubbles (Santos and Woodford, 1997) industries)  very
o Prices exceed fundamental value because they are expected to successful in Asia
exceed fundamental value by even more tomorrow (feedback loop) because of
o Difficulty dealing with finite-lived assets. investment in
o Does not generate correlation with trading volume efficient education
 A positive shock is amplified by extrapolation of past returns (Shiller, 2000) system, but fosters a
greater income
 Limited arbitrage
disparity (only few
o Asymmetry between costs of going short vs. long.
industries favoured)
o Heterogeneous beliefs
o Absence of common knowledge that bubble exists

Globalisation & Developing Countries

Development & Trade: Import‐Substituting Industrialization
 trade policy adopted by many low- and middle-income countries before the
1980s  encourage domestic industries by limiting competing imports

Infant industry argument:

 Potential comparative advantage in some industries (still too weak to
compete internationally)  until industries established, governments
support them  protectionism  high tariffs
 Problems with the Infant Industry Argument:
o Wasteful policy  comparative advantage only (maybe) in the future
o Protected industries may never become competitive
o no justification for government intervention unless market failure
prevents the private sector from investing in the infant industry

How market failures prevent infant industries from becoming competitive:

 Imperfect financial asset mar* kets:
o Poorly working financial laws and markets (lack of property rights) 
firms cannot or do not save and borrow to invest sufficiently in their
production processes
o High tariffs only second-best policy to increase profits in new
industries  rapider growth
 The problem of appropriability
o The knowledge created when starting an industry may not be
appropriable (may be a public good) because of a lack of property
rights.
 o If establishing a system of property rights is not feasible, then high Seminars,
tariffs second-best policy to encourage growth in new industries.
Definitions
Development & Financial Markets: LDCs Borrowing and Debt
 Another common characteristic for many low- and middle-income etc.
countries: traditionally borrowed from foreign countries
o able to finance investment projects, eventually leading to higher
production and consumption
 Countries with national saving less than domestic investment will have
financial asset inflows and a negative current account (trade deficit)

A financial crisis may involve

 debt crisis: an inability to repay sovereign (government) or private sector
debt.
o Fear of default reduces financial asset inflows and increases
financial asset outflows (capital flight), decreasing investment and
increasing interest rates, leading to low aggregate demand,
output, and income
o Must be matched with increase in export or reduction in
international reserves  pay those who want to remove their
funds
o causes low income and high interest rates, which make
government and private sector debts even harder to repay
 balance of payments crisis under a fixed exchange rate system.
o Official international reserves may quickly be depleted because
governments and private institutions need to pay for their debts
with foreign funds, forcing the central bank to abandon the fixed
exchange rate
 banking crisis: bankruptcy and other problems for private sector banks
o High default rates on loans made by banks reduce their income to
pay for liabilities and may increase bankruptcy.
o If depositors fear bankruptcy due to possible devaluation of the
currency or default on government debt (assets for banks), then
they will quickly withdraw funds from banks (and possibly
purchase foreign assets), leading to actual bankruptcy.

The Problem of “Original Sin”

 refers to the fact that poor and middle- income countries often cannot
borrow in their domestic currencies
 Problem: loss of control due to liabilities denominated in foreign
currencies  if domestic currency depreciates, foreign net wealth
decreases too
 Seminars,
Case Study: Brexit
Definitions
etc.
Conclusions:
- Loss of welfare for
both UK and EU, UK
worse off
- EU27 weaker position
in the world
 Post-Brexit
Hopes on Brexit – UK views Consequences from Brexit – Continental
European View
Scenarios for
- No EU membership fee + fiscal, - Access to Single Market while Trade and
monetary and exchange rate policy remaining completely Growth
instruments  Fund infrastructure, independent unlikely: other EU
promote reindustrialization, foster members demand the same
low unemployment, support lower - More attractive agreements for
inflation UK against current agreements:
- New trade deals, new conditions o Exports to non-EU states
- Termination of EU “constraints” on is small (around 40% of
UK economic development Exports goes to the EU)
- Own regulation could be designed o Creating trade with non-
for firms not trading with EU EU countries could go
- Alternative economic policies could along with a diversion of
be developed trade with EU
- Thatcher years of deindustrialization - UK less capable to specialise in
and dominant role of UK could be most effective activities
reinvented