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Chapter 14
Case Studies in International
Trade
Germany: From Economic
"Miracle" to Stagnation
• Growth rates in most of the industrialized world
decreased sharply after 1973, but while some countries
recovered, Germany did not.
• Labor costs were too high, both because of high wage
rates and fringe benefits and an overvalued currency
• Generous welfare state and Eurosclerosis
• German companies invested outside their country
• Unification handled very poorly because of the political
decision to set Ostmark at the same value as the
Deutschemark
United Kingdom: Rebirth After
Thatcher
• From the end of World War II through the late 1970s, growth in the
U.K. sharply lagged growth in other major industrialized countries.
• Thatcher was widely praised – or castigated – for severe cutbacks in
government spending, but in fact government spending as a % of
GDP declined only from 43% to 42% during her tenure in office. The
growth spurt occurred after she stepped down for the following
reasons
End of overvalued pound
End of union stranglehold on wages and productivity gains
Lower marginal tax rates and end of brain drain
Resurgence of venture capital
Less regulation and more deregulation
. Many of these changes were started by Thatcher, but because of the
severe and prolonged deterioration of the economy, it took much
longer than usual for these changes to benefit the economy.
France: the Case of Failed
Socialism
• French politicians were determined to show the
world that the so-called “Third Way” –
democratic socialism – could produce better
economic conditions than either “pure”
capitalism or totalitarianism.
• It didn’t. Growth was much lower, and inflation
much higher, than in most of Western Europe
• Only when France jettisoned that approach and
adopted more of the trappings of capitalism did
the growth rate pick up and surpass that of
Germany
The Economic Impact of the
European Community
• On balance, a system that eliminates tariffs and
currency differentials and encourages free trade
among countries is almost certain to boost real
growth and productivity.
• However, these gains will be limited if other
forces are interfering to reduce the overall
growth rate of the region.
• In recent years, the dead hand of Eurosclerosis
has outweighed the benefits of the Common
Market and the Eurocurrency.
How the Huge Japanese Trade
Surplus Backfired
• The demise of the Japanese economy has been
even more stunning than in Germany. And they
did not have the excuse of unification to explain
their slump
• Like the Germans, the Japanese economy
eventually suffered from an overvalued currency.
But that is not the only reason.
• Oddly enough, the trouble started in 1986, when
oil prices decreased. On the surface, that would
appear to be a plus for an economy that imports
virtually all of its energy.
Japan, Slide 2
• That decline created a huge trade surplus. The
sensible thing would have been to liberalize
import restrictions, but Japan declined to take
that move. As a result, the trade surplus
boosted the yen to unsustainable levels. It was
also accompanied by a huge bubble in stock
prices and land values.
• The Japanese financial system suffered from
lack of transparency, cronyism, and corruption.
Many companies were losing money and were
kept afloat only by inappropriate bank loans.
Japan, Slide 3
• Finally, the stock market and land price bubbles
burst, reducing consumption and investment.
Also, exports declined in volume terms because
of the overvalued yen. But because of a series
of J-curves, the current-value net export balance
kept rising, driving the yen even higher.
• As a result, Japanese companies decided to
invest overseas, and the economy never
recovered. Real growth has averaged less than
1% per year since 1991.
The Collapse of the Growth Tigers
• The massive decline in many Southeast Asian
economies in 1997 and 1998 shocked many investors.
But in retrospect, 10% annual growth was clearly
unsustainable.
• Most of these countries were torpedoed by an additional
factor, which was the dependence on foreign loans –
which was not the case for Japan. The debt on these
loans could only be serviced by ever-increasing exports.
• Exports fell in 1996 for two reasons. First, in many of
these countries, labor costs had risen sharply. Second,
prices of high-tech components declined sharply, which
meant net exports in current prices fell even though the
volume kept rising. Many firms could not repay their
loans.
Growth Tigers, Slide 2
• When the current account balance fell, the currencies
started to decline. As a result, even more firms could not
repay their debts because they were denominated in
dollars.
• The value of many Southeast Asian currencies dropped
by at least half, and production ground to a halt until the
IMF created a payback mechanism. Once that
happened, real growth picked up again, but the halcyon
days never returned.
• Some decline in the growth rate was inevitable, but the
sharp recession could have been avoided if these
countries had moved earlier to flexible exchange rates.
Growth in China: Miracle or
Mirage?
• Any comment about the recent economic performance of
China must be prefaced by the comment that the
economic data released by the government is extremely
untrustworthy. Thus while official statistics continue to
proclaim growth rates of 7% to 8%, many private
economists think the actual growth rate is only about 3%.
• There is no question that Chinese exports to the U.S.
have been growing dramatically in recent years, with the
U.S. trade deficit which China now exceeding $100
billion per year, far larger than any other country. The
question is whether any other sector of the Chinese
economy is growing, or whether millions of unreported
Chinese are still starving to death
China, Slide 2
• For the foreseeable future, the Chinese
economy can grow rapidly only if foreign
investment remains at high levels. Unlike
Japan, there is not nearly enough domestic
saving to generate above average growth rates.
• The orderly transition of power in China,
combined with the confession of some of its past
sins, have been designed to convince foreign
investors that Chinese investments will now
generate satisfactory returns. The response has
been positive, but the results remain unclear.
NAFTA and its Effect on the
Mexican Economy
• Both the U.S. and Mexican politicians
were eager for NAFTA to pass. The U.S.
wanted the opportunity to sell Mexicans
more goods, and also to open more plants
in Mexico without facing tariff barriers.
The Mexicans wanted to stop the outflow
of skilled and motivated workers by
providing better jobs.
Mexico, Slide 2
• However, since the U.S. had low tariffs but
Mexico had high tariffs, their removal would
boost Mexican imports more than exports,
reducing real growth and causing the currency
to decline. That is indeed what happened, aided
by the revolution in Chiapas that worried many
foreign investors.
• Thus the Mexican economy suffered a serious
setback before it began to recover. While the
benefits of free trade in the long run are
substantial, it is sometimes the case that the
transition should be more gradual.
The Brazilian and Argentinean
Devaluations
• Brazil experimented with a “floating peg” that
was designed to offset the differential rate of
inflation with the U.S.
• Argentina apparently did everything right by
pegging its currency to the dollar and backed it
by gold.
• These moves should have generated stable
currencies, but neither worked. Both countries
were forced to devalue, leading to severe
recessions.
Brazil and Argentina, Slide 2
• Brazil originally set the value of the real too high.
Also, it refused to bring its enormous
government deficit under control.
• Argentina’s main trading partner and competitor
is Brazil. When that country devalued, Argentine
goods were no longer competitive, so it too
went into recession. The decline in net exports
eventually forced the peso to fall to lower levels.
Pros and Cons of Free Trade in an
Imperfect World
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Retaliate Against Dumping
Countervailing Duties to Offset Subsidies
Worldwide Monopolies
Infant Industry Argument
Terms of Trade for Commodities
Peril-Point Tariffs
Free Trade, Slide 2
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National Defense
Diversification
Lower Real Wages
Tariffs for Revenues
Optimal Tariff
Political Unrest
Factors Boosting Growth
• Currency correctly valued in terms of PPP
• Minimal import restrictions on trade
• Few restrictions on international flows of
labor and capital
• Government that functions by rule of law
• Political freedom and encouragement of
entrepreneurship and innovation
• Tolerable level of bureaucracy and
minimal corruption
Growth Criteria, Slide 2
• Independent, credible monetary policy
committed to low, stable inflation
• Full-employment balanced budget
• Relatively low marginal tax rates, especially on
capital
• Less regulation and more deregulation
• High domestic saving and investment ratio
• Ability to attract foreign capital, including
repatriation of foreign earnings