Download A simple model of globalization and interdependence

1
Globalization and Interdependence: a simple
model
This is a simple model of globalization and interdependence. It demonstrates
the link between increased integration and interdependence between countries
in a way that is easy to understand, and that allows for the analysis of variety
of shocks.
1.1
Model
There are two countries in the global economy, the U S and the EU . Income in
the US, Y U S , depends on European income, Y EU , as follows (with a symmetric
relationship for the Europe)
Y US
=
US
+ Y EU
Y EU
=
EU
+ Y US
Each equation has an intercept ( i ) and a constant slope ( ), and there is a
simple economic intuition for the intercept, the slope, and the equation. The
parameter re‡ects the level of integration (a measure of globalization) between countries, with 2 [0; 1): A higher means a more globalized world
(e.g. higher share of trade in GDP, greater capital ‡ows) and therefore a more
interdependent world, as we shall see. The basic model is presented in Figure
1.
US
output
EU
US
Y1US
αUS
γ
1/γ
Y1EU
αEU
Figure 1: basic model
1
EU output
The term may be viewed as multiplied up components of aggregate expenditure, or a measure of domestic …scal and monetary policy settings e.g
i
= Gi + M i . The value of
can be in‡uenced by the level of technology, so that positive technology shock in one country increases (and this is
transmitted to the rest of the world via demand e¤ects - see diagram below).
Technological spillovers and technology transfer can be viewed as situations
where an increase in U S leads directly to an increase in EU which makes the
US even better o¤ than without spillovers/transfer.
The key point is that as economic integration increases, countries become
more interdependent. Your policies / shocks e¤ect me, and through me they
also e¤ect you. This is shown in the Figure 2 by an increase in , which steepers
the U S line and ‡atters the EU line, with the equilibrum moving from A1 to
A2 with higher income in both countries.
US
output
EU1`
Y2US
EU2
US2
A2`
US1
Y1US
A1`
α2US
α1US
αEU
Y1EU
Y2EU
EU output
Figure 2: Increase in integration
1.2
Shocks
i. increase in integration / globalization (increase in )
ii. …nancial crisis, or more generally a negative domestic demand shock
(fall in ). Note that this may have the additional e¤ect of reducing world
integration (fall in ), e.g. the Great Depression and to a lesser extent the
Great Recession, which makes both countries even worse o¤.
iii. a change in monetary or …scal policy (change in where = G + M )
iv. impact of innovation (increase in U S )
Figure 3 demonstrates the case of an increase in aU S .
2
Figure 3: Increase in
1.3
US
Other applications
i. International policy coordination games.
There are positive spillovers from from …scal and monetary policy (change
in ). For example, an increase in GU S (increase in U S ) increases income
in both countries, although to a lesser degree in the EU . This leads to the
possibility of free riding (why should I run an expansionary …scal policy when
your expansion will be expansionary for me) and a lack of …scal policy response.
This is certainly observed in the EU, and has also been observed at a global
level during the recent crisis.
ii. The European project (increase ) with the objective of stopping France
and Germany from going to war. Note that when = 0 there is no consequence
for you of attacking your neighbor, but as increases this changes.
1.4
Solution of Model
The model solves simply as follows
Y US
Y EU
US
=
2
1
EU
=
1
3
EU
+
US
+
2
and interdependence (which is multiplier e¤ect) is evident when examining the
e¤ects of changes to U S and EU on Y U S since
dY U S
d US
dY U S
d EU
Further
=
=
1
1
2
1
2
dY U S dY EU
;
>0
d
d
4