World Trading System In The 20th Century And Beyond

Introduction to International Economics

International economics refers to a study of international forces that influence the domestic conditions of an economy and shape the economic relationship between countries. It examines the interconnections between national economies and their interaction with the rest of the world.

International economics can be divided into two broad areas of study:

International Trade

International trade examines the real transactions between countries including exports, imports, and balance of payments. It focuses on topics like comparative advantage, patterns of trade, protectionism vs free trade, and the impact of trade policies. International trade theory aims to understand the gains from trade, interaction between countries, and trade flows.

International Finance

International finance deals with monetary interactions between countries including exchange rate policy, the balance of payments, international financial markets, and the effects of macroeconomic policies. It focuses on topics like exchange rate regimes, currency crises, global capital markets, and the role of international financial institutions. International finance examines how macroeconomic variables like GDP, unemployment, inflation, and interest rates are affected by international forces.

The two main branches of international economics are inherently linked as trade flows and exchange rates influence each other. However, international trade deals with the real economy while international finance centers around monetary and financial variables.

International Trade Theory

International trade theory explains how countries benefit from trade and the patterns of trade between countries. The main concepts include:

Benefits of Trade

Countries engage in international trade because they benefit from it. The benefits arise from specialization based on comparative advantage and economies of scale.

According to the principle of comparative advantage, even if a country has an absolute advantage in producing all goods, it can still benefit from specializing in and exporting those goods in which it has a comparative advantage. By exporting goods that it can produce relatively efficiently, and importing goods that it produces relatively less efficiently, a country can consume beyond its production possibilities.

Consumers benefit from trade through lower prices and access to a greater variety of goods. Producers benefit from access to broader markets. Resources flow from less efficient industries to more efficient export industries.

Trade also allows countries to take advantage of economies of scale. Larger scale production leads to lower average costs. A large international market allows firms to produce at an efficient scale.

Patterns of Trade

The patterns of trade are explained by differences between countries in terms of factor endowments, technology, and consumer preferences.

According to the Heckscher-Ohlin theory, a country will export goods that make intensive use of its relatively abundant factors of production, and import goods that make intensive use of its relatively scarce factors. For example, capital-abundant countries will export capital-intensive goods.

New trade theories emphasize the role of economies of scale and imperfect competition in shaping trade patterns. Industries where economies of scale are significant will tend to be located in large domestic markets. Firms in these industries may become exporters.

The Linder hypothesis states that countries with similar demand structures will have high levels of trade in similar types of goods. For example, high-income countries may trade differentiated consumer goods with each other.

Trade Policy

Governments use trade policy tools such as tariffs, quotas, export subsidies, and voluntary export restraints to influence trade flows. These policy tools have different economic effects.

Optimal tariff theory shows that under certain assumptions, a large country can use an import tariff to improve its welfare at the expense of its trading partner. However, such beggar-thy-neighbor policies lower global welfare if trading partners retaliate. Strategic trade policy involves government intervention to help domestic firms compete with foreign rivals.

International Finance

International finance deals with the macroeconomic, economy-wide aspects of international economics. It examines how global financial flows and exchange rates affects domestic economic variables like GDP, unemployment, inflation, trade balances, and more.

Some key aspects of international finance include:

• Gross Domestic Product (GDP) - The monetary value of all finished goods and services made within a country during a specific period. International finance examines how global trade and financial flows impact a country’s GDP growth and business cycles.
• Unemployment - The number of people unemployed and actively seeking work. International finance looks at how exchange rates, capital flows, and trade balances affect employment rates. For example, some argue that countries with trade surpluses tend to have lower unemployment.
• Inflation - The rate of increase in prices over time. Global factors like energy and commodity prices can drive domestic inflation rates. Central banks also manage inflation using interest rates and exchange rates.
• Trade Balance - The difference between a country’s exports and imports over time. Persistent trade deficits and surpluses impact currency exchange rates and economic growth trends.
• Exchange Rates - The price of one currency in terms of another currency. Exchange rates fluctuate constantly based on trade flows, relative interest rates, speculation, central bank intervention and more. They impact inflation, exports, FDI flows and more.
• Interest Rates - The cost of borrowing money. High interest rates tend to attract foreign capital and drive currency appreciation. Central banks influence domestic interest rates and use them to manage economic growth, inflation and exchange rates.

In summary, international finance focuses on how global economic forces shape critical macroeconomic variables. This includes the impact of trade balances, currency valuations, capital flows, and commodity prices on GDP, unemployment, inflation, interest rates and broader financial stability.

International Trade Organizations

International trade organizations play an important role in facilitating global trade, maintaining standards, helping developing countries, and establishing norms for trade agreements and conflict resolution between nations.

Some key international trade organizations include:

• World Trade Organization (WTO) - The WTO deals with the global rules of trade between nations. Its main function is to ensure that trade flows as smoothly, predictably and freely as possible.
• World Customs Organization (WCO) - The WCO sets standards for customs procedures, promotes legitimate trade facilitation, and helps build customs capacity in developing countries.
• International Chamber of Commerce (ICC) - The ICC provides rules and standards to facilitate cross-border trade and resolve trade disputes. It also issues certificates for trade finance instruments.
• UN Conference on Trade and Development (UNCTAD) - UNCTAD assists developing countries integrate into the global economy. It provides research, policy advice, and technical assistance on trade, investment, finance and technology.
• International Maritime Organization (IMO) - The IMO regulates shipping to ensure safety, security and environmental performance. It also facilitates maritime traffic and efficiency.
• International Air Transport Association (IATA) - IATA develops commercial standards for airlines, and helps airlines navigate regulations. It promotes safety, security and cost-efficiency.
• International Organization for Standardization (ISO) - The ISO develops voluntary international standards for products, services and systems. This ensures quality, safety and efficiency.
• United Nations Commission on International Trade Law (UNCITRAL) - UNCITRAL works to modernize and harmonize international trade. It formulates model laws, rules, and legal texts for international commerce.

WTO History and Functions

The World Trade Organization (WTO) is an intergovernmental organization that regulates and facilitates international trade between nations. The WTO officially began operations on January 1, 1995 under the Marrakech Agreement, replacing the General Agreement on Tariffs and Trade (GATT) which had been in effect since 1948.

The WTO was created to provide an institutional foundation for the multilateral trading system. It evolved from negotiations aimed at progressively reducing tariffs and other barriers to trade and providing a rules-based system to govern the international trading system.

Some key historical milestones in the creation of the WTO:

• 1930s – Efforts begin to establish an International Trade Organization (ITO).
• 1947 – 23 countries sign the General Agreement on Tariffs and Trade (GATT) in Geneva.
• 1986-1994 – The Uruguay Round negotiations reduce tariffs and establish new rules covering services, intellectual property, dispute settlement, and creation of the WTO.
• 1995 – The WTO is established to administer the trading rules, agreements, and principles governing world trade.

Today, the WTO has 164 member countries and oversees about 97% of world trade. The WTO’s core functions include:

• Administering WTO trade agreements - The WTO oversees the implementation, administration and operation of the covered agreements.
• Providing a forum for trade negotiations - The WTO provides a forum for negotiating trade agreements and settling disputes. Members can raise issues, hold consultations and resolve problems.
• Settling trade disputes - The WTO’s dispute settlement system is vital for enforcing rules and agreements. Member countries can resolve disputes in a rule-based system through consultation, mediation, panels and appeals.
• Monitoring national trade policies – The WTO conducts regular reviews of members’ trade policies to improve transparency and facilitate multilateral surveillance.
• Cooperating with other international organizations – The WTO works closely with the IMF and World Bank to achieve greater policy coherence in global economic policymaking.

The WTO aims to support economic reform, development and growth by establishing an open, fair, equitable and non-discriminatory multilateral trading system with agreed rules. Its history and evolution demonstrate the long effort to reduce barriers to trade and provide an institutional forum for international cooperation.

International Trade Terminology

There are several key terms used when discussing international trade policy:

Trade liberalization refers to policies that reduce barriers to trade and make it easier for goods, services, and factors of production to move across borders. This includes reducing tariffs, quotas, and other trade restrictions. Trade liberalization increases international competition and market openness. Proponents argue it raises efficiency and wealth.

Protectionism involves policies that shield domestic industries from foreign competition through methods like tariffs, quotas, subsidies, etc. Protectionism reduces international competition in an attempt to give domestic firms an advantage. However, it risks decreasing efficiency.

Autarky represents a completely closed economy with no international trade or finance. Under autarky, a country aims to be fully self-sufficient through import substitution and limited exports. Autarky eliminates international competition but is rarely feasible long-term.

Free trade refers to unrestricted international trade free from any barriers, subsidies, or other intervention. Free trade relies on market forces and the invisible hand to determine trade patterns. Many economists argue free trade increases competition and economic efficiency. However, some trade barriers may benefit countries in certain cases.

The main debate around international trade policy often centers on finding the right balance between free trade and selective protectionism. Countries must weigh the costs and benefits of openness versus regulating trade to achieve particular economic and political objectives.

Economic Efficiency

Economic efficiency refers to the optimal production and allocation of resources in an economy. It consists of two main components:

Production Efficiency

Production efficiency means producing goods and services at the lowest possible cost. This occurs when a country specializes in producing goods for which it has a comparative advantage.

Comparative advantage refers to the ability of a country to produce specific goods at a lower opportunity cost compared to other countries. By specializing in products which it can produce most efficiently, a country makes the best use of its available resources.

Greater efficiency is achieved when a country increases its factor endowments related to a product, such as machinery, infrastructure, and other inputs besides primary resources. Specialization as per comparative advantage raises production efficiency.

Consumption Efficiency

Consumption efficiency occurs when consumers find a product optimally satisfying given its price and quality. Free trade enables countries to import products at lower prices and/or higher quality. Consumers can then maximize utility via optimal consumption choices.

By specializing per comparative advantage and trading with other nations, countries can achieve higher economic efficiency both in production and consumption.

Debate Over Free Trade

The liberal doctrine of free trade is based on principles of the market system formulated by classical economists such as Smith and Ricardo. Proponents emphasize the benefits of free trade:

• Increased competition in the domestic market which increases national efficiency.
• Increased national and global wealth.
• Encouraging the spread of technology and know-how around the world.
• Increasing the prospects of world peace.

However, critics of the liberal doctrine support some degree of trade protection, particularly for infant industries.

Trade theory acknowledges that some groups will suffer losses from free trade. In the long run, once resources can fully adjust, the Ricardian model shows everyone would benefit. But in the Heckscher-Ohlin model, some groups may continue losing even in the long run. John Maynard Keynes famously quipped “in the long run, we are all dead.” The compensation principle suggests some gains could be redistributed from winners to losers.

When considering free trade, the costs beyond those in Ricardian models must be weighed, such as transaction costs. A country can benefit from free trade even if it has no absolute advantage in any industry. And domestic firms can lose out to more efficient foreign rivals.

Some economists argue protection can benefit a country under certain conditions, such as the presence of infant industries, foreign monopolies, unemployment concerns, or national security interests. While so-called “beggar-thy-neighbor” policies may benefit the enacting country at a trading partner’s expense, strategic trade policy could raise domestic welfare without reducing world welfare.

However, the case for free trade remains strong overall. The merits and drawbacks of both free trade and protectionism must be weighed carefully. Limited protectionism may benefit some groups but can also cause harm.

Compensation Principle

The compensation principle states that while free trade creates overall net benefits for countries as a whole, some groups may lose out from free trade even if net national welfare rises. The gains that winners receive from free trade could potentially be redistributed to compensate the losers, while still leaving some net gain for the winners.

In other words, free trade leads to an increase in total economic surplus for countries, but the surplus is not necessarily evenly distributed. Some industries and workers may suffer losses from increased foreign competition. However, the economic gains from free trade are enough such that the winners could hypothetically compensate the losers for their losses and still be better off.

For example, when a country opens up to trade in an industry where it does not have a comparative advantage, domestic firms and workers in that industry are likely to experience falling incomes as cheaper imports flood in. The consumers in the country and industries gaining a comparative advantage would benefit from free trade. The government could tax some of those gains from trade and provide subsidies or compensation packages to the displaced workers that suffered losses. This would allow the winners to share some of their gains while still being better off overall.

While theoretically possible, in practice such redistribution of gains rarely occurs to fully compensate trade losers. There are challenges in redistributing the diffuse benefits among consumers and efficiently targeting affected groups. There is also resistance from those benefiting from trade opening. Still, trade adjustment programs can provide partial compensation to mitigate the inequality impacts of trade.

The core insight is that trade potentially raises total welfare for a nation, but the distribution of these welfare gains can be very uneven. Some groups such as import-competing industries can experience losses even if the national net welfare impact is positive. Policymakers face trade-offs between pursuing efficiencies from trade versus mitigating adverse distributional consequences on some groups through redistributive policies.

Political Economy of Trade

The political economy of trade examines how political pressures and institutions influence trade policy. Specifically, it looks at how democratic pressures affect the trade policies pursued by governments. Some key aspects include:

Government Trade Policies and Political Motivations

• Governments may impose trade barriers or subsidies to protect politically influential domestic industries. This can be motivated by lobbying from domestic firms or desire to gain political support.
• Governments may negotiate free trade agreements or join trade blocs to gain geopolitical influence and allies.
• Politicians may use trade policy to signal their positions to voters and donors. For example, a leader may adopt a tough stance on trade with a rival nation to appear strong or nationalist.

Democratic Pressures on Trade Policy

• Mass opinion and public pressures can constrain leaders from adopting more economically efficient policies. For example, protecting declining industries may be politically popular but economically inefficient.
• Special interest groups that will gain from protectionism often have more concentrated interests in trade policy outcomes than the general public. They may successfully lobby for tariffs or subsidies.
• Politicians from districts that benefit from trade will tend to support liberalization, while those from import-competing districts will favor protectionism.
• Around elections, politicians may feel greater pressure to appeal to protectionist sentiment among voters and workers who feel threatened by trade liberalization.
• Divided government and multiple veto points in democratic systems can enable small protectionist lobbies to block or delay trade agreements.

In summary, the political economy of trade examines how political factors like lobbying, public opinion, and democratic institutions shape trade policy and outcomes. It provides insights into trends like protectionism and fluctuations in support for liberalization.