2. Adam Smiths
Theory of Absolute Advantage
Country should specialize in the production of commodities
which it can produce most efficiently – Lower Cost of Production.
A country tends to specialize in production of commodities in which
it has Absolute Advantage
Per Quintal Labour Cost (Man- hour)
Country
Rice
Jute
India
30
60
Bangladesh
50
20
3. Adam Smiths
Theory of Absolute Advantage
Would should country’s be doing?
India
India should specialise in Rice production.
As India has to sacrifice 2 Qtl of Rice for 1 Qtl of Jute.
It can import jute from Bangladesh
1Qtl of Rice = 1.5 Qtl of Jute (30/20)
Bangladesh
Should specialise in Jute
Import Rice from India
As in domestic trade they get 0.4 Qtl of Rice (20/50) for Jute
If they trade they get 0.67 Qtl of Rice (20/30) for 1 Qtl of jute.
4. Ricardo's Insight
What if one country has absolute advantage in both the
commodities?
Is trade possible?
As long as countries have comparative advantage in the production
of both the commodities specialisation and trade would always be
possible.
Per Quintal Labour Cost (Man- hour)
Country
Rice
Jute
India
30
60
Bangladesh
50
80
5. Ricardo's Insight
India
It can produce both the goods efficiently.
It has comparative advantage in rice production.
It can produce Rice at 60% (30/50) cost then Bangladesh.
It has comparative disadvantage in jute because cost of jute
production is twice the cost of rice production.
Bangladesh
It has comparative advantage in jute production
Relative cost of jute production ( 80/50 = 1.6 Qtl of rice) is
less than India’s(60/30= 2Qtl of rice).
7. Who Gains from Trade?
Who Gains India or Bangladesh?
It depends upon the determination of commodity exchange rate
between two countries.
India’s exchange rate ranges between 500Kg to 625 kg of Jute
for 1 Qtl of Rice.
Bangladesh it ranges between 1.6 to 2 Qtl of Rice for 1 Qtl of
Jute.
If Exchange rate in foreign trade are same as internal rates then
both the country gain.
8. Heckscher-Ohlin Theory of Trade
The comparative advantage in the cost of production is due to the difference
s in the factor endowment of the nations.
It refers to the overall availability of usable resources in the country.
A country tends to specialise in the export of a commodity whose
production requires intensive use of its abundant resources and
imports a commodity whose production requires intensive use of its
scarce resources.
10. The Gold Standard
The earliest form of International Monetary system
In use for 4 decades before the onset of World War I
The principles
Domestic currency system (coins or paper) – fully repayable in
Gold
Gold could be freely imported or exported in unlimited quantities
between countries
The exchange rates were fixed on the basis of their gold parity at
fixed par values
11. The Gold Standard
The mechanism
The flow of Gold from trade deficit countries to trade surplus
Gold losing countries experienced reduction in money supply, money income
& fall in prices
Gold receiving countries experienced increase in money supplies, income &
prices
These conditions made goods & services flow from trade deficit countries to
surplus ones.
Thus gold standard system automatically restored equilibrium
12. The Gold Standard
The breakdown
World War I rudely shattered the economic order
Because of hyper Inflation – gold payments were suspended
Consequently convertibility of currencies broke down
It was expected that freely fluctuating exchange rates would restore
competitive price and cost system which would automatically restore stability
However, it stimulated speculation in hot currencies
Over valuation of Pound Sterling
Undervaluation of French & Belgium Francs
Collapse of German Mark
Due to war – free trade & flexible exchange rate gave way to restrictions &
exchange control
And the world went into complete disarray leading to
collapse of the gold standard
13. What Happened Next…
Restoration attempts were not very successful.
And in 1931 with Britain going off gold standard – it finally collapsed
Emergence of currency blocs
Formal & Informal arrangements between members
4 prominent blocs
Sterling area, French Bloc, COMECON (Soviet Bloc), Dollar area
It was a chaotic monetary system
With multiple exchange rates
Exchange rate fluctuations were frequent
Import restrictions & exchange controls were widespread
Competitive devaluation had become order of the day.
All this lead to serious economic erosion of super powers – USA, UK,
& France
The order was finally restored with establishment of IMF.
14. International Monetary Fund
IMF – came into existence in 1945 & started functioning in 1947
Started with 7 members and had 180 members in 2000.
It combined the characteristics of both
Gold standard;
Fluctuating exchange rate
Gold remained the universally accepted medium payment.
Dollar & Pound Sterling emerged as reserve currencies supplementing Gold
as internationally acceptable assets.
Exchange rates were fixed in Gold and also linked to Dollar or Pound
With fixation of exchange rates – convertibility of currencies was
restored.
15. International Monetary Fund
IMF also restored multilateral payment system with following
conditions.
No country is supposed to impose new exchange controls without IMF’s
approval.
To ensure flexibility in exchange rates within prescribed limits – the
members were not permitted to vary spot exchange rates more
than 1 % beyond upper & lower limits.
To deal with short run payment difficulties a member will be allowed to
borrow 25% of the quota in a year – though total borrowing can be
125% of the quota across 5 years.
To overcome fundamental disequilibrium – IMF may permit devaluation of
currency by 10%. Beyond that only through negotiations
16. International Monetary Fund
With the establishment of IMF:
Within 5 years multilateral payment system was fully restored
By 1958 most major currencies had become convertible, restrictions
on payment had disappeared and a free payment system was
universally established
17. International Monetary Fund
Purpose of IMF
To promote international monetary cooperation
To facilitate expansion and balanced growth of international trade
To maintain exchange rate stability
To assist members in establishment of multilateral system of
payments and elimination of foreign exchange restrictions
To give confidence to members by making fund’s resources available
to them to correct balance of payments
To shorten the duration and lessen the degree of disequilibrium in the
international balance of payments of members
18. Collapse of IMF System
In 1960s – there was serious inadequacy of international liquidity
Shortage of gold & foreign exchange reserves to remove in
deficit in BOP because world trade was growing faster than world
reserves
For instance during 1950-71 world trade grew at 8 % per annum
– where as Reserve increased by 2-3% per annum during this
period
The smaller stock of gold and fixed exchange rate system created
instability.
Led to severe BOP Deficit in USA
19. Special Drawing Rights
This necessitated the search for a new kind of reserve asset to
supplement gold stock & create additional international liquidity
SDR
20. Special Drawing Rights
SDR – is a kind of ‘reserve asset’ – created through amendment
of IMF system.
It is nick-named ‘paper gold’ – since it performs the functions of
gold in international payment system
It is not
A paper currency
Nor a coin
Nor a credit note
Nor a treasury bill
SDRs are simply entries in SDR-account of participating countries.
Though SDRs figure in the published reserves of a nation.
21. Special Drawing Rights
SDRs serve as ‘means of payment’ between the participating
nations for the purpose of legitimate purchase of foreign exchanges
and for making up for the deficit in balance of payment.
In SDR transactions participating nations are not required to transfer
their currency or any other asset against SDRs received in allocation.
They are simply credited to the participants’ accounts and are then
available for use.
SDRs are defined in terms of a basket of major currencies used in
international trade and finance. The amounts of each currency making
up one SDR are chosen in accordance with the relative importance of
the currency in international trade and finance
22. Special Drawing Rights
3 ways to transact in SDRs
Receive foreign exchange from a participant designated by the fund
Through mutual agreements between the participants to redeem their
own currency held by another nation
For transaction with the Fund’s General Account.
SDR Quota
Quota subscriptions generate most of the IMF's financial resources.
Each member country of the IMF is assigned a quota, based broadly
on its relative size in the world economy.
A member's quota determines its maximum financial commitment to
the IMF and its voting power, and has a bearing on its access to IMF
financing. Total quotas at end-March 2008 were SDR 217.3 billion
(about $357.3 billion).
23. Special Drawing Rights
What are the functions of quotas?
Subscriptions.
A member's quota subscription determines the maximum amount of financial
resources the member is obliged to provide to the IMF.
A member must pay its subscription in full upon joining the Fund: up to
25 percent must be paid in SDRs or widely accepted currencies (such as the
U.S. dollar, the euro, the yen, or the pound sterling), while the rest is paid in the
member's own currency.
Access to financing.
The amount of financing a member can obtain from the IMF (its access limit) is
based on its quota, a member can borrow up to 100 percent of its quota annually
and 300 percent cumulatively.
24. Composition of SDR
• The largest member of the IMF is the United States, with a quota of
SDR 37.1 billion (about $61.0 billion),
• The smallest member is Palau, with a quota of SDR 3.1 million
(about $5.1 million).
25. The Present IMF System
The present IMF is on MANAGED FLOATING SYSYTEM
It allows member nations the choice of foreign exchange as long as it
does not injure the interest of their trade partners.
Most of the nations pegged their currencies to the US Dollar, SDR and
basket of currencies.
27. Need for Trade Agreements
Helps in overcoming trade barriers
Promotes trade amongst member countries
Increases efficiency – through economies of scale (spreading fixed
cost over larger regional markets)
Increased economic growth from foreign direct investment
Promotes regional infant industries through protected regional
market
Increased security of market access for smaller countries.
Improves members bargaining strength in multilateral trade
negotiations.
Strengthens political ties and managing migration flows.
29. Trade Agreements
Bi-Lateral Agreement
Trade agreements between two countries.
Regional Trade Agreements (RTAs) :
Trade agreements between group of countries – may or may not
belong to same geographical region
Multi-lateral Agreements
Trade agreements between multiple countries – GATT/WTO
30. Multilateral Trade
GATT ( General Agreement of Trade and Tariff)
Formed in 1948 to liberalize Trade.
Till 1994 this was the forum for negotiating lower customs duty
rates and reducing other trade barriers.
Provided a framework for trade expansion vis-à-vis removing
barriers on free movement of goods and services.
‘Rounds’ the West, negotiated trade deals with themselves in
mind.
The developing world were forgotten as backward and without
any clout.
31. GATT v/s WTO
GATT
WTO
It is Adhoc and provisional.
Its agreement are permanent.
It had contracting parties.
It has members.
It allowed existing domestic
legislation to continue even if it
violated the agreement.
WTO does not permit it.
It was less powerful, dispute
system settlement system was
slow and less efficient and its
ruling could be blocked.
WTO is more powerful,
mechanism faster and more
efficient and difficult to block the
rulings.
32. WTO IMPACT
GATT / GATS
TRIMS
TRIPS
Liberalisation of trade
in
goods and services
Liberalisation of
international
investment
Provides monopoly
power to owners
of intellectual
33. Multilateral Trade
The WTO (World Trade Organisation) is an international organization
dealing with the rules of trade between countries.
The WTO can be said to be made up of different entities:
Laws governing international commerce and are contracts by which
governments agree to trade policies that would be beneficial to all the
WTO member nations.
Countries can negotiate these agreements, settle disputes arising from
the agreements and help other countries join the negotiations .
WTO is GATT plus – GATS (General agreement on trade in services)
and TRIPS (Trade related intellectual property rights).
Helping countries, especially developing countries, develop and review
national trade policies.
37. Preferential Trade Agreement:
A grouping of countries where partial preference to trading
partners are given.
Central American Common Market (CACM)
Free Trade Area:
A grouping of countries to bring free trade between them.
North American Free Trade Area (NAFTA)
ASEAN Free Trade Area (AFTA)
EFTA ( European Free Trade Association)
LAFTA ( Latin america Free trade association)
Custom Union:
Eliminates all restrictions on Trade members but also adopts a
uniform commercial policy against the non-member.
European Economic Community (EEC)
38.
Common Market:
It allows free movement of labour and capital in addition to
having free movements of goods and having common
commercial policy for non-members.
ECM ( European Common Market)
CACM ( Central American Common Market)
Economic Union:
Members countries have same economic policies, including
monetary and fiscal policy.
EU ( European Union)
39. “What should be India’s focus –
bilateral/ regional or
multilateral trade agreement?”
40. Multilateral Trade
Overwhelming dominance of developed countries in the WTO.
The developing countries have not gained any meaningful increase
in market access in the key areas where they have comparative
advantage (textiles and agriculture).
Liberalization of services or trade has occurred only in sectors which
are of primary interest to developed countries like IT, ITES,
automobile and some manufactured goods.
Declining industrial tariff and removal of all quantitative restrictions
has the potential to harm the industrial sector of developing
countries.
Free trade is more suitable to the advanced countries which have
already established their industrial base.
41. Bilateral/ Regional Trade
Help the developing countries to expand market access without
compromising on national policies and interests
Lead to lower dependence on developed country markets and help
in resisting the pressures of economic superpowers
Helps to forge and foster stronger alliances at the multilateral trade
negotiations.
Allows infant industry protection
42. Thus, India is :
Focussing on BLT/RTAs first. So that it can balance differences and
build capabilities at par with developed countries and then move
towards a multilateral trade regime.
Some of the recent alignments
Free trade area (FTA) agreements with Sri Lanka and Thailand
Advance stages of free trade area agreement with Singapore
Signed a framework agreement for a free trade area with the
members of the Association of South East Asian Nations
(ASEAN)
An agreement to create a South Asian Free Trade Area
(SAFTA).
Approached distant trading partners such as South Africa and
Brazil