International economy

# International economy
## Week 13
### Krisna Gupta
### 17 May 2021 (updated: 2021-05-17)

---

## Quick recap

- So far we've learned:
  - how to measure economic variables:
      + GDP, inflation, unemployment
  - How they interact:
      + AD-AS framework
      + Long run vs short run
      + fiscal policy
  - How financial market matters:
      + (central) banks and interest rate
  
---

## This week

- So far, we assume highly domestic market situation.

- It is highly not realistic especially for Indonesia, a small(-ish) country where international economies matter:
  + Indonesia relies a lot of international help from escaping 1966 and 1998 crises.
  + Exchange rate is highly depending on global capital market situation.
  + Two booms (1970s oil boom and 2000s commodity boom) elevate Indonesian economy hugely
  
---

## This week & next week

- Balance of Payment
  + Current account, capital account and financial account.

+ Trade in goods and services:
  + Comparative advantage theory
  + Global Value Chain

+ International finance:
  + exchange rate and international capital

+ International / External policy

---

## International economics

- Indonesia is largely an open economy:
  + It buys and sells goods and services to the rest of the world.
  + Also trade saving and investment abroad (stocks, currencies, debts, direct investment)
  
- Being an open economy offers advantage:
  + help building domestic capital (remember convergence theory?).
  + Enjoys spillover economic benefits.
  
---

- However, anything bad happens to the global market, will affect Indonesia as well.
  + Indonesian policy tool may be less effective.
  
- meanwhile, big economy's policy may be stronger:
  + When the US' central bank rise interest rate, lots of foreign capital fled Indonesia, tilting IDR valuation.
  
- We will learn more about these effect later on.

---

# Trade in goods

---

![](week13_files/figure-html/trade-1.png)

Indonesia's export jumps since the 1970s thanks to oil boom. Since then, Indonesia is generally running trade surplus.

The importance of trade is generally the same throughout.
---
.kiri[
![ww](export.png)
source: [OEM](https://oec.world/en/profile/country/idn#yearly-exports)
]

## Exported commodities

- Indonesia's main exports are natural resources: minerals, coal, palm oil, wood products, rubber.

- Also a bit on manufactures: iron and steel, vehicles, machine and electronics, food products.

]

---

## Imported commodities

- Indonesia's main imports are manufacturing inputs: capital goods, fuels, iron and steel, plastics and chemicals. Also a bit of food.

]

---

## Why nations trade

- You might have seen the news about what Indonesia trades with the world:

+ We imports many food stuff: beef, rice, wheat, soybeans
  
  + We also export many plantation and natural resources such as CPO and coal.
  
- But you might also hear that trade is like a competition: export is good, import is bad, and trade deficit means a country is "lost".

- Truthfully, it's much more complex than that.
  
- Generally, economists believe that international trade is better for both parties.

---

# Comparative advantage

---

## Comparative advantage

- **Comparative advantage** is the reason why trade is good for both parties.

- A country has a comparative advantage in producing a good or service if the opportunity cost of producing the good or service is lower for that country than for other countries.

- This concept relies heavily on **opportunity cost**, that is, when a country produce good `\(x\)`, it has to forgo resources capable of producing good `\(y\)`

- Think of it like this: if you spent 2 hours studying for economics, that means you forgo 2 hours you could have spent studying statistics.
  + How do you make decision on what to study?

---

## Production possibility frontier

- To understand this term better, we will use some simplified examples.

- Suppose there are two economies, Indonesia and United States (US), and two goods, textiles and soybean.

- Textiles and soybean requires different tech and labour / capital intensity.
  + Let's say Indonesia can either produce 200 ton of textiles and 0 soybean, 0 textile and 50 ton of soybean, or anything in between.
  + US can either produce 100 ton of textiles and 0 soybean, 0 textile and 100 ton of soybean, or anything in between.

- What if the two countries do not trade?

---

![](week13_files/figure-html/grafik1-1.png)
---

## 2 countries in autarky

- Suppose the two countries does not trade. Indonesia's production is (200,50), While in the US, it's (50,50).

| Produce | US opportunity cost | IDN opportunity cost |
| --- | --- | --- |
| 1 ton of textiles | 1 ton of soybean | 250 kg of soybean |
| 1 ton of soybean | 1 ton of textiles | 4 ton of soybean |

- Indonesia is comparatively better at making textiles, while US is better at producing soybean:
  + To make 1 ton of textiles, US needs to gave up resources which can be used to make 1 ton soybean, while Indonesians need only to give up 250 kg soybean.
  + To make 1 ton of  soybean, US needs to gave up resources which can be used to make 1 ton textiles, while Indonesians need only to give up 4 ton of textiles.

---

![](week13_files/figure-html/grafik2-1.png)

---

## Gains from trade

<table class="table" style="font-size: 18px; margin-left: auto; margin-right: auto;">
 <thead>
<tr>
<th style="empty-cells: hide;border-bottom:hidden;" colspan="1"></th>
<th style="empty-cells: hide;border-bottom:hidden;" colspan="1"></th>
<th style="border-bottom:hidden;padding-bottom:0; padding-left:3px;padding-right:3px;text-align: center; " colspan="2"><div style="border-bottom: 1px solid #ddd; padding-bottom: 5px; ">in autarky</div></th>
<th style="border-bottom:hidden;padding-bottom:0; padding-left:3px;padding-right:3px;text-align: center; " colspan="3"><div style="border-bottom: 1px solid #ddd; padding-bottom: 5px; ">with trade</div></th>
</tr>
  <tr>
   <th style="text-align:center;">   </th>
   <th style="text-align:center;">   </th>
   <th style="text-align:center;"> production </th>
   <th style="text-align:center;"> consumption </th>
   <th style="text-align:center;"> production </th>
   <th style="text-align:center;"> consumption </th>
   <th style="text-align:center;"> Gains from trade </th>
  </tr>
 </thead>
<tbody>
  <tr>
   <td style="text-align:center;font-weight: bold;"> USA </td>
   <td style="text-align:center;"> textiles (ton) </td>
   <td style="text-align:center;"> 50 </td>
   <td style="text-align:center;"> 50 </td>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;"> 75.0 </td>
   <td style="text-align:center;"> +25 </td>
  </tr>
  <tr>
   <td style="text-align:center;font-weight: bold;"> USA </td>
   <td style="text-align:center;"> soybean (ton) </td>
   <td style="text-align:center;"> 50 </td>
   <td style="text-align:center;"> 50 </td>
   <td style="text-align:center;"> 100 </td>
   <td style="text-align:center;"> 62.5 </td>
   <td style="text-align:center;"> +12.5 </td>
  </tr>
  <tr>
   <td style="text-align:center;font-weight: bold;"> IDN </td>
   <td style="text-align:center;"> textiles (ton) </td>
   <td style="text-align:center;"> 100 </td>
   <td style="text-align:center;"> 100 </td>
   <td style="text-align:center;"> 200 </td>
   <td style="text-align:center;"> 125.0 </td>
   <td style="text-align:center;"> +25 </td>
  </tr>
  <tr>
   <td style="text-align:center;font-weight: bold;"> IDN </td>
   <td style="text-align:center;"> soybean (ton) </td>
   <td style="text-align:center;"> 25 </td>
   <td style="text-align:center;"> 25 </td>
   <td style="text-align:center;"> 0 </td>
   <td style="text-align:center;"> 37.5 </td>
   <td style="text-align:center;"> +12.5 </td>
  </tr>
</tbody>
</table>

By concentrating production on one good and then trade, you can see that both ended up better-off:

- with autarky, total production {textiles,soybean} `\(=\{150,75\}\)`

- consumption=production, and `\(C_{USA} = \{50,50\},C_{IDN} = \{100,25\}\)`

---

## Gains from trade

- with trade, total production {textiles,soybean} `\(=\{200,100\}\)`

+ Production `\(\Rightarrow P_{USA}=\{0,100\}, P_{IDN}=\{200,0\}\)`
  + Consumption `\(\Rightarrow C_{USA}=\{75,62.5\}, C_{IDN}=\{125,37.5\}\)`

---

## Comparative advantage

- In reality, we will need country's preferences to establish proper equilibrium quantity and prices.

- In this model, we have no price. But from the opportunity cost, we can calculate the relative prices:
  + In the US, opportunity cost to produce 1 soybean is 1 textile. That means, `\(P^{soybean}_{USA} = P^{textile}_{USA}\)`
  + In Indonesia, opportunity cost to make 1 soybean is 4 textiles. That means, the price of soybean must be four times price of textile.
  
- Since in Indonesia, it is comparatively cheaper to produce textile, it's better for US to source its textile from Indonesia.

---

## Comparative VS Absolute advantage

- It's possible that a country is good at producing many things.
  + This is called absolute advantage.

- There's no reason why US can't be better at making clothes than Indonesia.
  + Hence, it's possible that in fact, US still better at making clothes

- But what matters is _relative_ opportunity cost:
  + as long as its better for US capital and labour to produce soybean, they will still buy clothes from Indonesia.
  + It may take lots of labor to produce textiles in Indonesia, but it'll take even more to produce soybean.

---

## Taking from the poor?

- In short, because Indonesians are less productive compared to the US, it's better to US to buy cheaper goods to Indonesia.

- This is not to say that US take advantage from Indonesians:
  + Since Indonesian labour is less productive anyway, they will still have low wage even if they sell domestically.
  + In fact, serving US market may give them higher wage.
  
- For example, if you feel ordering go-food is taking advantage from tukang ojeg, the alternative is even worse:
  + if you ended up stop ordering go-food, they won't have order.

---

## What determines comparative advantage?

1. **Differences in climate** is the reason why we're so good at producing CPO and rubber, but sucks at producing soybean and wheat.

1. **Differences in Factor Endowment**. Some countries are endowed with natural resource, some with cheap labour. Countries which has no both has to find something else, such as:

1. **Differences in technology**. Japan, South Korea and Taiwan are one good example. While technology can be transferred, opportunity cost of investing in high-tech things is more production of CPOs.

---

## Global Value Chain

- These days, trade have been moving to an even more extreme point. Hence **hyperglobalization**: countries rely on each other to produce one particular goods.

- The main enabler is advances in communications:
  + human-human: the internet.
  + human-machine: production software, production dashboard.
  + machine-machine: CAD-CAM.

- Countries able to specialize not only in a production of particular goods, but a particular process of production.

- This is called **Global Value Chain (GVC)**

---

Many products these days do not made by just 1 country

![image](sepeda.jpg)

source: [World Bank](https://twitter.com/BankDunia/status/1222002437411635200?s=20)

---

## Global Value Chain

Many products these days do not made by just 1 country

![image](semicon.png)

source: [Semiconductor Industry Association](https://www.semiconductors.org/strengthening-the-global-semiconductor-supply-chain-in-an-uncertain-era/)

---

## Global Value Chain

- GVC allows for a country that has very low technological prowess become one of the dominant exporter of high-tech goods like smartphone and laptops.

- In GVC situation, trade policy becomes very important: a poorly designed trade policy will leads to zero production in both.

- Imagine if Indonesia has to build its own semiconductor fab in order to produce a smartphone.
  + With GVC, Indonesia can import semiconductor and assemble a PCB and smartphone domestically.
  
- Indonesia also able to export textiles in varying qualities of raw materials.

---

# Trade policy and economic surplus

---

### Indonesian soybean market in autarky

![](week13_files/figure-html/market1-1.png)

---

### Indonesian soybean market with trade
.kiri[
![](week13_files/figure-html/market2-1.png)
]

- at `\(P_W\)`, demand increases `\(Q_A  \rightarrow Q_D\)`, while supply reduces `\(Q_A \rightarrow Q_S\)`

- This imbalance is solved via imports. Domestically produced soybean is `\(Q_S\)`, while imported soybean is `\(Q_D-Q_S\)`

]
]

---

### Change in surplus

- In trade:
  + PS = Y
  + CS = W + X + Z
  + TS = Y + W + X + Z
  
- CS is much higher, and trade gains area Z in total.

- However, domestic soybean producer lose area X.
]
]

---

### US soybean market with trade
.kiri[
![](week13_files/figure-html/market4-1.png)
]

- at `\(P_W\)`, demand reduces `\(Q_A  \rightarrow Q_D\)`, while supply increases `\(Q_A \rightarrow Q_S\)`

- This imbalance is solved via exports. Domestically consumed soybean is `\(Q_D\)`, while imported soybean is `\(Q_S-Q_D\)`

]
]

---

### Change in surplus

- In trade:
  + PS = Y + X + Z
  + CS = W
  + TS = Y + W + X + Z
  
- PS is much higher, and trade gains area Z in total which goes to producer.

- However, domestic soybean producer lose area X.
]
]

---

## Effect of trade

- Trade benefits **exporting industries** while hurting **import competing industries**.

- Factor of productions used for export sectors will have high demand, and priced highly:
  + Firms in natural resources exporting countries will compete to gain access to lands
  + Farmers move to manufacturing because Indonesia export a bit of manufactures, while net importing agricultural goods.
  
- If factors can't easily move, it will leads to inequality.
  
---

# Effect of trade policy

---

## Trade policy

- Trade leads to winner and losers:
  - import benefits consumers while hurt producers
  - export benefits producers while hurt consumers

- In the case of soybean:
  + import helps chicken breeders who benefit from cheap soybean, but hurt soybean farmers.
  
- If soybean farmers are more politically influencial, they can ask for protection from the government by using import tariff or import quota.

---

### Recall soybean import

![](week13_files/figure-html/tariff1-1.png)

---

### The effect of import tariff
.kiri[
![](week13_files/figure-html/tariff2-1.png)
]

.kanan[
.s[
- When the government impose tariff, the import price become more expensive. Local producer doesn't experience tariff so they become more competitive.

- Domestic parket becomes world price + tariff

- This push demand down to `\(Q_{DT}\)` and increase domestic supply to `\(Q_{ST}\)`

- Imports are lower `\(Q_{DT}-Q_{ST}\)`
]
]
---

### The effect of import quota
.kiri[
![](week13_files/figure-html/tariff4-1.png)
]

- buyers want to buy up to `\(Q_D\)` but cannot.

- This push price up to `\(P_T\)`.
]
]

---

### Surplus changes from trade policy

- In total, CS lost A+B+C+D

- PS gains = A

- Government gets tariff revenue, which is number of imports `\(\times\)` per-unit tariff, which is C

- B+D is DWL.
]
]

---

### Effect of trade policy

- in case of quota, B goes to quota rent.

- When quota rent is sold with a competitive auction, the rent can go to government, and thus have the same effect as tariff.

- However, when appointed quota is not transparent this can lead to a corruption.
  - [Beef](https://www.abc.net.au/news/rural/2013-02-01/beef-import-corruption-rocks-indonesian-political/6133612) and [garlic](https://en.tempo.co/read/1306850/layers-of-the-garlic-corruption-scandal) are the examples of import quota, while [lobster](https://www.abc.net.au/news/2020-11-27/rolex-watches-seized-as-indonesian-minister-arrested-corruption/12922796) was the example of export quota corruption.
  
---

## Conclusion

- In conclusion, trade is generally good for everyone

- Unfortunately, the gain from trade is not shared equally, and could potentially lead to higher inequality.
  + Donald Trump rust belt
  + Indonesian manufacturing suffer from commodity boom during the 2000s.
  
- Trade creates winners and losers, and the battle between winners and losers determine trade policy.

---

## Next up

- Next week we will see how international capital plays out.

- The role of exchange rate

- Balance of Payment.