Global Commerce and Currency Markets
International Trade
Trade vs. Protectionism
Trade is the exchange of goods and services between countries, driven by differences in resources, tastes, and climate. The principle of comparative advantage suggests that countries specialize in producing goods where they have a relative cost advantage, leading to increased overall production, competition, and expertise.
Protectionism involves barriers that impede international trade. Motives for protectionism include protecting emerging and strategic industries, national defense, and addressing unemployment.
Protectionist Measures
- Tariffs: Taxes on imported goods to increase their price and reduce competitiveness.
- Import Quotas: Quantitative restrictions on the number of foreign products allowed into a country.
- Export Subsidies: Government aid to domestic companies to make their exports more competitive.
- Dumping: Selling products below production cost in foreign markets.
- Non-Tariff Barriers: Administrative regulations that favor domestic products over foreign ones.
Free Trade and Globalization
Free trade promotes international trade without barriers. Globalization advocates for the expansion of free trade worldwide.
Forms of Trade Relations
- Global: Involving all countries. The GATT (General Agreement on Tariffs and Trade), established after World War II, and the WTO (World Trade Organization), formed in 1995, promote global trade and resolve trade disputes.
- Regional: Involving a group of countries. Examples include:
- Free Trade Areas: Free movement of goods and services within the area.
- Customs Unions: A free trade area with a common external tariff.
- Common Markets: A customs union with free movement of capital and labor, and a common economic policy.
Balance of Payments
The balance of payments is an accounting document that records all economic transactions between a country and the rest of the world. It includes:
- Current Account: Tracks the flow of goods and services.
- Trade Balance: Difference between exports and imports of goods.
- Service Balance: Difference between exports and imports of services.
- Income Balance: Net income from investments and other sources.
- Current Transfers: Unilateral transfers such as foreign aid.
- Capital Account: Includes capital transfers and the acquisition/disposal of non-produced, non-financial assets.
- Financial Account: Tracks investments, loans, and reserves.
- Direct Investment
- Portfolio Investment
- Other Investments
- Change in Reserves
Maastricht Treaty and the European Union
The Maastricht Treaty established the European Union, created European citizenship, and paved the way for economic and monetary union. It established community legislation, budget, institutions, and bodies.
Exchange Rates
Nominal vs. Real Exchange Rate
The nominal exchange rate is the price of one currency in terms of another. An increase in the nominal exchange rate means the currency is appreciating, while a decrease means it is depreciating.
The real exchange rate is the relative price of goods between two zones. It is calculated as: (National Price * Nominal Exchange Rate) / Foreign Price.
Currency Markets
The exchange rate is determined by supply and demand. Demand for a currency comes from exports, tourism, and foreign investment. Supply comes from imports, tourism by residents, and domestic investment abroad.
Exchange Rate Systems
- Fixed: The central bank sets the exchange rate.
- Flexible: The exchange rate is determined by market forces.
- Mixed (Adjustable): The central bank intervenes within a certain range.
Convergence Criteria (Maastricht Criteria)
- Inflation: No more than 1.5% above the average of the three lowest inflation countries.
- Interest Rates: No more than 2% above the average of the three lowest inflation countries.
- Exchange Rate Stability: Membership in the Exchange Rate Mechanism (ERM) for at least two years.
- Public Deficit: No more than 3% of GDP.
- Public Debt: No more than 60% of GDP.