INTERNATIONAL

ECONOMICS
Prepared by
MSc. Chan Bonnivoit
for NU & HRU
20010-2011
Table of Contents
1. Introduction
2. The classical models of international trade
3. The Hecksher-Ohline (HO) theorem
4. The tariffs
5. Non-tariff barriers and arguments for protection
6. Other commercial policy
7. The international trade and economic growth
8. The commercial policy (Cambodia)
9. The foreign exchange market
10. The exchange rate & PPP
11. The balance of payment
12. The interest rate and the exchange rate
13. The dollarization
1. Introduction
1. Terminology
§ GNP : the value of new goods and services produced
by domestic factors of productions.
§ GDP : the value of new goods and services produced
within a Country.
§ Export goods are goods that are sold by economic
agents located in one Country to economic agents
located in another Countries.
§ Import goods are goods that are purchased by
economic agents located in one Country from
economic agents located in another Countries.
Σ:··..· «. .··· - Σ:··..·.«···· = .....·.····· = Σ.:.:«·
370 – 220 = GDP = 150
The Flow of Currencies:
Whisky sold to Italian hotel
€ changed to £
Export earnings for UK
(Credit on Balance
of Payments)
The Flow of Currencies:
Oil
Oil from Russia
£ changed into Roubles Export earnings for Russia
Import expenditure for the UK
(Debit on balance of payments)
1. Introduction
1. Terminology (con’t)
§ Trade deficit: The Country has a trade deficit if
merchandise imports exceed its merchandise
exports.
§ Trade surplus: The Country has a trade surplus if the
merchandise exports exceed its merchandise
imports.
§ Balance of trade: The value of merchandise exports
minus imports.
§ Balance of payments equilibrium: Credits equal
debits for a particular account.
1. Introduction
Imports (Debits)
§ Current Account: (M)
§ Goods and services
§ Factor- and assets income
§ Assets transfer (= transfer
account)
§ Aids, gifts etc. (= unilateral
transfer)
§ Capital Account: (CM)
§ Direct investments
§ Security purchase
§ Bank claims, liabilities,
obligations, etc.
§ Government assets abroad
Exports (Credits)
§ Current Account: (X)
§ Goods and services
§ Factor- and assets income
§ Assets transfer (= transfer
account)
§ Aids, gifts etc. (= unilateral
transfer)
§ Capital Account: (CX)
§ Direct investments
§ Security purchase
§ Bank claims, liabilities,
obligations, etc.
§ Government assets abroad
1. Introduction
1. Terminology (con’t)
§ Balance of payments equilibrium:
§ X + CM = M + CX
§ => X –M = CX –CM
§ If X > M (trade surplus) => CX > CM => The Country
exports capital.
§ If X < M (trade deficit) => CX < CM => The Country
imports capital.
Balance of Payments
The UK Balance of Payments on Current Account 1998 - 2004
Source: ONS (http://www.statistics.gov.uk/cci/nugget.asp?id=194) (Crown copyright material is
reproduced with the permission of the Controller of HMSO and the Queen's Printer for Scotland.)
1. Introduction
2. Structure of the world trade
§ The range of goods that are internationally traded
§ Direction of the international trade
§ Volume or value of international trade
§ Trend of the international trade
Basic Facts About World
Trade
— About a quarter of world trade is in primary products,
the remaining three-quarters in manufactures.
— World trade centers on the industrialized countries.
— Value of $2.4 trillion in 2006 (about 25% of
international trade)
World Trade in Services
— Most traded services: transportation, travel, other
services (banking, medicine, consulting, insurance
& education)
— U.S is largest exporter and importer of services
— Trade has been growing more quickly than world
income, and is increasingly important.
Value of World Merchandise Exports
($ Billion)
Sources: League of Nations, Europe’s Trade, WTO
0
2000
4000
6000
8000
10000
12000
1928 1935 1950 1980 1990 2000 2005
$

B
i
l
l
i
o
n
Growth in World Exports and GDP
Source: The WEO Database (IMF),
http://www.imf.org/external/pubs/ft/weo/2004/02/data/index.htm
-4
-2
0
2
4
6
8
10
12
14
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
World Merchandise Exports World GDP
Leading Importers in World Merchandise
Trade, 2006
Rank Importer Value (B$) Share (%)
Annual
change (%)
1
United States
1919 15,5 11
2
Germany
909 7,3 17
3
China
791 6,4 20
4
United Kingdom
619 5,0 21
5
Japan
580 4,7 13
6
France
535 4,3 6
7
Italy
437 3,5 14
8
Netherlands
416 3,4 14
9
Canada
358 2,9 11
10
Belgium
354 2,9 11
25
Sweden
127 1,0 14
35
Finland
69 0,6 17
World 12413 100,0 14
Leading Exporters in World
Merchandise Trade, 2006
Rank Exporter Value (B$) Share (%)
Annual
change (%)
1
Germany
1112 9,2 15
2
United States
1038 8,6 15
3
China
969 8,0 27
4
Japan
650 5,4 9
5
France
490 4,1 6
6
Netherlands
462 3,8 14
7
United Kingdom
448 3,7 17
8
Italy
411 3,4 10
9
Canada
390 3,2 8
10
Belgium
369 3,1 10
21
Sweden
147 1,2 13
35
Finland
77 0,6 17
World
12083 100,0 15
International Monetary Fund
(IMF)
— The IMF describes itself as "an organization of 186
countries (as of June 29, 2009),working to foster
global monetary cooperation, secure financial
stability, facilitate international trade, promote high
employment and sustainable economic growth, and
reduce poverty".
— With the exception of Taiwan (expelled in 1980),
North Korea, Cuba (left in 1964), Andorra, Monaco,
Liechtenstein, Tuvalu and Nauru, all UN member
states participate directly in the IMF.
1. Introduction
3. Conditions of international trade
§ Absolute price advantage
§ P
1
Country A < P
1
of Country B, in this case A exports good 1
to B. (only with the stable exchange rate)
§ Comparative price advantage
§ P
1
/P
2
of Country A < P
1
/P
2
of Country B, in this case A
exports good 1 to B, and B exports good 2 to A (only with
the stable exchange rate)
§ Exchange rate and inflation (interest rate)
§ The rates varied occur the change of the price of goods
trading and can change the direction of trade. (One
example : if S($/pound) = 1, the good (price in England 20
pound und in USA 30 US$) is exported to US, but if the
S($/pound) = 2, then can the trade change the direction)
• Price absolute advantage
P
A
P
W
X
W
P
B
X
A
X
B
Country A has comparative
advantage in product X.
Country B World Market
D
B
S
A
D
A
D
B
S
A
S
B
Factors that Shift R
F
and R
D
It present only
return, not relating
to exchange rate
presented in the
ordinal axe
Factors that Shift R
F
and R
D
1. Introduction
3. Conditions of international trade (con’t)
§ Domestic demand for the product.
§ Profit and cost variation
§ It depends on variation of production condition like
production factor, technology, salary, state policy (tax
and expenditure for infrastructure) and money supply.
§ Tariffs and non-tariff barriers
§ Ad valorem, specific tax, compound tariff, MFN and GSP.
§ Quota, voluntary export restriction, dumping price,
subsidies, SPS, TBT, safeguard and government
procurement.
§ Location of export Country
§ Production diversifying in different areas can provide the
difference factor allocation as well salary.
The quantity equation is an identity: the definitions of the four
variables make it true. If one variable changes, one or more of the
others must also change to maintain the identity. The quantity equation
we will use from now on is the money supply (M) times the velocity of
money (V) which equals price (P) times output (Y):
Money ´ Velocity = Price ´ Output
M ´ V = P ´ Y
Because Y is also total income, V in the quantity equations is called the
income velocity of money. This tells us the number of times a dollar
bill changes hands in a given period of time.
2. The classical model of international
trade
2. 1 AdamSmith theory (The wealth of nation, 1776)
§ His theoremis absolute advantage as a basic for trade.
§ He argued that the Countries specialized in the
production of goods in which they have an absolute
advantage.
§ In this case, rather than producing both goods, as they
would do in autarky, Country A should concentrate on
the production of soybean and Country B on the
production of textile.
2. The classical model of international
trade
§ The table below will be illustrated Adam Smith
theorem before the Countries take the measures to
specialize the production.
Items Country A Country B The world
production
Soybean 3 h for producing 1
unit of soybean
12 h for producing
1 unit of soybean
2 units of
soybean
Textile 6 h for producing 1
unit of textile
4 h for producing 1
unit of textile
2 units of textile
2. The classical model of international
trade
§ If Country A reduce 1 unit for textile in order to
produce soybean, then the Country A gets 2 units of
soybean.
§ In similar fashion, let the output of soybean in
Country B fall by 1 unit. In this case, 12 hours of
input factor are released to the textile industry.
§ With 12 more hours of input factor, 3 additional
unit of textile can be produced.
2. The classical model of international
trade
Items Soybean Textile
Country A + 2 units of soybean
(as 6H/3H=2)
- 1 unit of textile (as 6H
took to produce soybean)
Country B - 1 unit of soybean (as 12H
took to produce textile)
+ 3 unit of textile
(as 12H/4H=3)
The world
production
+ 1 unit of soybean + 2 units of textile
§ The table below will be illustrated Adam Smith
theorem after the Countries took the measures to
specialize the production.
2. The classical model of international
trade
Items Country A Country B The world
production
Soybean 1 unit + 2 units =
3 units
0 unit 3 units of soybean
Textile 0 unit 1 unit + 3 units =
4 units
4 units of textile
§ The table below will be illustrated the gain of the
world production after the both Countries have a
specialization.
2. The classical model of international
trade
2. 2 Comparative advantage as a basic for trade (David
Ricado’s model in the principle of political
economic 1819 )
§ Ricado first pointed out, is that, in this case, the
Country should specialize where they have their
greatest absolute advantage (if they have an absolute
advantage in both goods) or in their least absolute
disadvantage (if they have an absolute advantage in
neither goods).
§ This rule is known as the law of comparative advantage.
2. The classical model of international
trade
§ The table below will be illustrated David Ricado
theorem before the Countries take the measures to
specialize the production.
Items Country A Country B The world
production
Soybean 3 h for producing 1
unit of soybean
12 h for producing
1 unit of soybean
2 units of
soybean
Textile 6 h for producing 1
unit of textile
8 h for producing 1
unit of textile
2 units of textile
2. The classical model of international
trade
§ In the table above Country A is 4 times (12/3) more
efficient in the production of soybean relative to
Country B.
§ However, Country A is only 4/3 times (8/6) more
efficient in the production of textile relative to Country
B.
§ Because Country A’s greatest absolute advantage is in
the production of soybean, it is said to have a
comparative advantage in soybean.
§ Likewise, because Country B’ s least absolute
disadvantage is in the production of textile, it is said to
have a comparative advantage in textile.
2. The classical model of international
trade
§ The table below will be illustrated the per unit gain
after the both Countries have a specialization (the
general equilibriumsolution of the Ricado model .
Items Soybean Textile
Country A + 2 units of soybean
(as 6H/3H=2)
- 1 unit of textile (as 6H
took to produce soybean)
Country B - 1 unit of soybean (as 12H
took to produce textile)
+ 1.5 unit of textile
(as 12H/8H=1.5)
The world
production
+ 1 unit of soybean + 0.5 units of textile
2. The classical model of international
trade
§ The table below will be illustrated Ricado theorem
after the Countries took the measures to specialize
the production.
Items Country A Country B The world
production
Soybean 1 unit + 2 units =
3 units
0 unit 3 units of soybean
Textile 0 unit 1 unit + 1.5 units
= 2.5 units
2.5 units of textile
2. The classical model of international
trade
§ As you can see table above, we have the remarkable
result that even though there are no new resources in
the World and even though Country A has an absolute
advantage in both goods, by following the law of
comparative advantage, and the result is that:
§ The output of both goods rises
§ The world production of both goods increases
§ Both Country can be trading better than they would
be in autarky.
2. 3 An Evaluation of the classical models
• The important notion of the classical model:
§ The international trade occurs along the line of
comparative advantage.
§ The international trade is a phenomenon (··. . .)
which aids in increasing the productivity
capacity of our planet,
§ The international trade leads to higher standard
of living for the Countries involved, and
§ The international trade occurs as a direct
consequence of the free market activities.
2. The classical model of international trade
• The problem of the classical model:
§ The model is seriously incomplete in many way.
§ Nowhere does it explain why exist the differences in
the productivity level between Countries which can
occur the trade.
§ It is not borne out in the real world.
§ It seems clear that the Countries often continue to
produce import-competing products.
§ The Countries will not completely specialize in
production of exportable and get out of the business
wholly of producing import-competing goods.
2. 3 An Evaluation of the classical models
2. The classical model of international trade
3. The Hecksher-Ohline Theory
• Eli Hecksher laid out the basic fundamentals of the
model of the patterns and determinants of international
trade in a paper first published in 1919.
• This paper was written in Swedish and was not
translated into English for almost 30 years.
• An English translation of this paper entitled “ the Effect
of Foreign Trade on the Distribution of Income”
appears in Howard S. Ellies and Lloyd A. Metzler,
“Reading in International Trade, Philadelphia: The
Blakiston Co., 1949”.
3. The Hecksher-Ohlin (HO) Theory
• Hecksher’s pupil, Ohlin, elaborated on the ideas
of Hecksher in his 1924 doctoral dissertation (also
in Swedish) and later in a book published in
English by Harward University in 1933.
• Ohlin’s book is titled “Interregional und
international trade”, in Boston: Harward
University Press, 1933.
• Ohlin has got the Nobel Price of Economic in
1977.
3. The Hecksher-Ohlin (HO) Theory
• Hecksher and Ohlin built their theory around two basic
characteristics of Countries and products.
• Countries differ from each other according to the factors of
the production they possess.
• Goods differ fromeach other according to the factors that are
required in their production.
• Given these features of the world, HO argued that a Country
will be able to produce at lower cost those products whose
production requires relatively large amounts of the factors of
production with which that Country is relatively well
endowed.
3. The Hecksher-Ohlin (HO) Theory
3. 1 Assumption of HO Theory
• Having 2 Countries, each Country produce 2
goods, soybean (S) and textile (T).
• Using intensively Capital (C) for S and
intensively labor (L) for T.
• Having constant return of scale.
• Having uncompleted specialization.
• Having identical taste for both goods.
• Having identical technology of both Countries.
3. The Hecksher-Ohlin (HO) Theory
3. 1 Assumption of HO Theory (con’t)
• Having transparently competition of both products.
• Full movement of domestic factor inputs in the Country, but
not for international factor inputs.
• Transport cost, tax, etc. were exempted, if the both goods
flow out or in fromor to the both Countries.
• Full using all domestic resources relatively endowed.
• Balance Payment of both Countries has the balance situation
(BP=X-M=0)
3. The Hecksher-Ohlin (HO) Theory
Factor intensity, and factor abundance
L
C
Country A
2
2
4
4
C/L in T = 1
8
C/L in S = 4
C
2
2
4
4
C/L in T = 1/4
8
Country B
8
1
C/L in S = 1
L
3. The Hecksher-Ohlin (HO) Theory
PPF of both Countries base on assumption
T T
S S
Country A (a) Country B (b)
Z
Y
E
D
3. The Hecksher-Ohlin (HO) Theory
3. 2 HO Theory
• HOtheory is summary in 2 form
• Solving and predicting the trade model.
• Factor price equilibriumtheorem.
• HO theorem (hypothesized) said a Country will have
comparative advantage and should therefore export that
good those production is required relatively intensive factor
with which that Country is relatively well endowed.
• If we simplify the theory, then the theorem states that a
Country, that is relatively capital abundance compared with
the other Country, will have a comparative advantage in the
good that requires more capital per labor to produce.
3. The Hecksher-Ohlin (HO) Theory
3. 2 HO Theory (con’t)
• In the example (or hypothesis):
• Country A (B) will have a comparative advantage in soybean
(textile), since we assumed that Country A (B) is relatively
capital (labor) abundant and soybean (textile) production is
required relatively capital (labor) intensive.
• Let trying to prove the HO theoremgraphically
• Our goal is to find the autarky (pre-trade price ratio) for the 2
Countries to determine the direction of comparative advantage.
• To do that we employ the simple trick.
§ The Equilibrium in the autarky situation of the Country A and B
T
T
S S
Country A Country B
Slope=1/2
or
P
S
/P
T
=1/2 2000
4000
1200
800
Slope=3/2
or
P
S
/P
T
=3/2
K
L
We assume that the
Country B has 9,600
hours in producing
soybean and textile.
3. The Hecksher-Ohlin (HO) Theory
3. 2 HO Theory (con t)
§ We take the data in the table below to illustrated
the theorem of HO and to find the price in autarky
situation.
Items Country A Country B The world
production
Soybean 3 h for producing 1
unit of soybean
12 h for producing
1 unit of soybean
2 units of
soybean
Textile 6 h for producing 1
unit of textile
8 h for producing 1
unit of textile
2 units of textile
3. The Hecksher-Ohlin (HO) Theory
3. 2 HO Theory (con’t)
• PPF of both Countries base on assumption
T T
S S
Country A (a) Country B (b)
Z
Y
E
D
3. The Hecksher-Ohlin (HO) Theory
3. 2 HO Theory (con’t)
• Taking PPF of both Countries into one panel
T
S
PPF of Country A
PPF of B
Z
Y
E
D
I
J
CIC
0
(c)
(P
S
/P
T
) of B
(P
S
/P
T
) of A
3. The Hecksher-Ohlin (HO) Theory
3. 3 HO Theory (con’t)
• Taking the panel (a) and (b) on the panel (c).
• We introduce the consumption of identical taste in the two
Countries by drawing in one Community indifference curve
(CIC) which reflects the common taste of either population.
• In this case the curve is labeled CIC
0
(see the figure above)
• (P
S
/P
T
) of Country A and (P
S
/P
T
) of Country B are a tangency
point between CIC
0
with both PPFs and occur a different
points (point I for Country A and point J for Country B)
3. The Hecksher-Ohlin (HO) Theory
3. 3 HO Theory (con’t)
• I and J present the autarky equilibrium production and
consumption points for the respective Countries.
• As we knew the tangency or slope of PPFs at the
production point define the relative price (or price
ratios or termof trade) for the Country.
• Consequently, fromthe diagramit is clear that:
• P
S
/P
T
of Country A < P
S
/P
T
of Country B or
• P
T
/P
S
of Country B < P
T
/P
S
of Country A
3. The Hecksher-Ohlin (HO) Theory
3. 3 HO Theory (con’t)
• This established that Country A (B) has a comparative
advantage in the production of good S (T)
• It recalls that a Country has a comparative advantage in
a good if the good has a lower autarky price in that
Country.
• Now, let go back to our assumption that S was assumed
to be the capital intensive good, and that Country A was
assumed to be the capital abundant Country.
3. The Hecksher-Ohlin (HO) Theory
3. 3 HO Theory (con’t)
• This explanation proves the theorem of HO.
• Here we have not only prove the theorem of Country A,
but we have established that is true for Country B as
well.
• The answer to this question here is the same of classical
model that namely in a comparative environment the
trade flows are determined by profit-seeking activities
of economic agents, and
3. The Hecksher-Ohlin (HO) Theory
3. 3 HO Theory (con’t)
• If a product is cheap in one Country, it will tend to be
exported to those place where it is relatively expensive.
• Consequently, we would expect to see Country A export
good S to Country B.
• Likely, exporters in Country B should want to export T
to Country A
3. The Hecksher-Ohlin (HO) Theory
3. 4 Equilibriumof HO
• 2 steps will be analyzed for this case.
• Considering the effect of the introduction of international
trade on the production and consumption decision of a
single Country.
• After we analyze this question, we turn to an examination
of the world trade equilibriumin the HO model.
3. The Hecksher-Ohlin (HO) Theory
3. 4 Equilibriumof HO (con’t)
• Again, we know for previous chapter that one trade is
allowed between two Countries.
• Consequently, the price of S will begin to rise in
Country A (where it was initially low) and fall in
Country B (where it was initially high).
• Let to focus our attention on the Country A in figure
below. If one trade is begun, the price of S will start to
rise in Country A. This is illustrated by the price lines
(P
S
/P
T
)0, (P
S
/P
T
)1 and (P
S
/P
T
)2.
3. The Hecksher-Ohlin (HO) Theory
T
S
(P
S
/P
T
)
1
(P
S
/P
T
)
2
(P
S
/P
T
)
0
CIC
0
CIC
1
CIC
2
X
0
=C
0
C
1
C
2
V
1
V
2
X
1
X
2
Country A
3. The Hecksher-Ohlin (HO) Theory
3. 4 Equilibriumof HO (con’t)
• (P
S
/P
T
)
0
is tangent to Country A’s PPF at autarky point
x
0
(=c
0
).
• As the price rises to (P
S
/P
T
)
1
and (P
S
/P
T
)
2
the production
of textile declines and the factors are released to the
soybean industry allowing Country A’s production point
to move to point x
1
and x
2
.
• At that point, the supply of soybean exceeds the local
demand for it, and some can be exported to Country B
in exchange for textile.
3. The Hecksher-Ohlin (HO) Theory
3. 4 Equilibriumof HO (con’t)
• This allows consumption to move of Country A’s PPF to
point C
1
and C
2
.
• How much is traded at price (P
S
/P
T
)
1
and (P
S
/P
T
)
2
. This
is given in the figure by the triangle v
1
c
1
x
1
and v
2
c
2
x
2
.
• The base of the triangle, v
1
x
1
and v
2
x
2
represent export
while the side, v
1
c
1
and v
2
c
2
is Country A’ s desired
imports.
3. The Hecksher-Ohlin (HO) Theory
3. 4 Equilibriumof HO (con’t)
• At this point, A is almost completely specialized in the
production of soybean.
• Country A’s consumption point moves from c
1
to c
2
.
Thus, Country A relies more and more on Country B for
the textile it consumes.
• Country A’s trade triangle has grown in size to v
2
c
2
x
2
.
3. The Hecksher-Ohlin (HO) Theory
3. 4 Equilibriumof HO (con’t)
• Diagrammatically, the condition for international
equilibrium is that the trade triangles of the two countries
are similar.
• Example of international trade equilibrium is given in figure
below.
• The Country A’s desired export (V
A
X
A
) so long as the price
(P
S
/P
T
) of Country A is equally price (P
S
/P
T
) of Country B. It
means that Country A’s desired export so long as the Country
B desired import V
A
X
A
= V
B
C
B
as well V
A
C
A
= V
B
X
B
.
3. The Hecksher-Ohlin (HO) Theory
T
S
(P
S
/P
T
)
1
(P
S
/P
T
)
2
(P
S
/P
T
)
0
CIC
0
CIC
1
CIC
2
X
0
=C
0
C
1
C
2
V
1
V
2
X
1
X
2
Country A
3. The Hecksher-Ohlin (HO) Theory
3. 4 Equilibriumof HO (con’t)
T
S
Country A
E
D
C
A
V
A
X
A
(P
S
/P
T
)
As imports
As exports
Country A
• Production in X
A
• Consumption in C
A
• A’s export V
A
X
A
• A’s import V
A
C
A
3. The Hecksher-Ohlin (HO) Theory
3. 4 Equilibriumof HO (con’t)
T
S
Country B
E
D
X
B
V
B
C
B
(P
s
/P
T
)
B s exports
B s imports
Country B
• Production in X
B
• Consumption in C
B
• B’s export V
B
X
B
• B’s import V
B
C
B
3. The Hecksher-Ohlin (HO) Theory
3. 4 Equilibriumof HO (con’t)
• If the international market for product soybean is in
equilibrium, we know that is also in the equilibrium for
product textile
• Hence, we know that the sides of the two triangles are
also equal in length.
• Like our studied in the classical models note first that
neither Country completely specialize in the production
of its comparative advantage good. It means that it
continues to produce some of the good it imports.
3. The Hecksher-Ohlin (HO) Theory
3. 5 Some new HO theorem
• In addition to HO theorem, which predict the direction
of comparative advantage, the HO model offers several
other important theorem about economic behavior in
economic engaged in international trade.
• These theorem refers to issue such as the effect of
economic growth on trade, and the impact trade has on
the distribution of income in a society.
• The first of these is known as the Rybczyusky theorem.
3. The Hecksher-Ohlin (HO) Theory
3. 5 Some new HO theorem(con’t)
• Rybczyusky theorem: At constant world price, if a
Country experiences an increase in the supply of one
factor, it will produce more of the product intensive in
that factor and less of the other.
• The effect of an increase in Country A’s capital: Country
A were increasing capital above its initial endowment,
every things else constant. The Country will produce
more soybean than before and less textile.
3. The Hecksher-Ohlin (HO) Theory
3. 5 Some new HO theorem(con’t)
S
S
0
T
X
0
X
1
T
1
S
1
T
0
3. The Hecksher-Ohlin (HO) Theory
3. 5 Some new HO theorem(con’t)
L
C
C
S
/L
S
C
T
/L
T
H
1
G
0
H
0
G
1
E E
D
F
To suppose
• E: Economic factor
(Capital) endowed
• E’: Economic factor
(Capital) endowed rises
3. The Hecksher-Ohlin (HO) Theory
3. 5 Some new HO theorem(con’t)
• In figure above capital were increasing. This occurs that
PPF shifts outward along the soybean axis, because
soybean is capital intensively.
• Then we have the new production point is X
1
.
• The factor price equalization theorem: Given all the
assumptions of the HO model, free international trade
will lead to the international equalization of individual
factor prices.
3. The Hecksher-Ohlin (HO) Theory
3. 5 Some new HO theorem(con’t)
• The Stolper Samuelson Theorem: Free international
trade benefits the abundant factor and harms the scarce
factor.
• Country A that the labor is scarce has declining the cost
of labor, because Country A uses intensively capital.
• Country B that the capital is scarce has declining the
cost of capital, because Country B uses intensively
labor.
4. The Tariff
• Action take by a government to influence the volume
and composition of trade flows (into or out of a
Country) are known as commercial policy.
• A government has a varieties of options in conducting
commercial policy. These options include tariffs and
non-tariff barriers.
• Non-tariff barriers include a variety of government
policies or regulations, such as wealth and safety
standard or government procurement policies.
4. The Tariff
• So far we have focused our discussion on the causes and
the consequences of international trade.
• We have seen that international trade lead to the
redistribution of production in the economy and also
affects the returns paid to the factors of production.
• For both of these reasons, some individuals in every
society favor government policies aimed at affecting the
volume and composition of international trade.
• Now we turn our attention in this section to the role of
government in the area of international trade.
4. The Tariff
4. 1 The gain fromfree trade
• When a Country opens its market to free international
trade, it benefits in several different ways.
• First the Country enjoys (1) static gain fromtrade. These
gain are illustrated in figure above.
• One resource are allowed to move away from point A,
the Economy accrues (adds) further economic gains.
• These gain are reflected in the movement of the
consumption point from B to C and, in term of
community welfare, fromCIC
1
to CIC
2
.
4. The Tariff
4. 1 The gain fromfree trade (con’t)
• These gains come about because productive resources
are channeled into the economy’s comparative
advantage industries, and
• Because of this redistribution of resource, overall
output GNP rises.
• Hence, this second increase in welfare is known as the
static production gain fromtrade.
4. The Tariff
4. 1 The gain fromfree trade (con’t)
• Free trade also leads to (2) dynamic gains. These refer
to the relationship between trade and economic
growth.
• A economy grows over time either because it
experiences increases in its stock of productive factors
or because of technological innovation that a Country’s
existing stock of factor become more efficient.
4. The Tariff
4. 1 The gain fromfree trade (con’t)
• In term of our model economic growth refers to
outward shift in a nation’s PPF.
• Trade effects positive on productive capacity.
• Trade effects enhancing diffusion of technology.
• Trade effects increasing saving.
4. The Tariff
4. 1 The gain fromfree trade (con’t)
• In addition to economic gain from trade, a Nation that
trades may enjoy (3) political benefits.
• These come about because of the probability that the
Countries become more economically interdependent.
• They are less likely to revert to aggressive (hostile)
action among themselves.
4. The Tariff
4. 2 The tariff
• Ad valorem tariff: a trade tax is equally to a given
percentage of selling price.
• Ex: 13%for imported knit cotton headwear in US$.
• Specific tariff: a trade tax is equally to a fixed amount of
money per unit sold.
• Ex: 14 cents on each pound of imported fertilizer.
• Compound tariff: a trade tax that has both a specific
and an ad valorem.
• Ex: 19 cents per pound plus 18.5 percent ad valorem on
imported cashmere sweaters (.··.··. .····.).
4. The Tariff
4. 2 The tariff (con’t)
• Tariff has several effects on the economy
• Revenue effect: The amount of revenue increasing to the
Government comes fromtariff.
• Protective effect: The amount by which domestic
producers are able to expand their output, because the
tariff is in place.
• Generally, both the revenue and the protective effects of
the tariff will operate at the same time.
4. The Tariff
4. 2 The tariff (con’t)
• However, there are special case when only one of these
effects is present.
• For instance, a tariff that is imposed on a import
when no domestic producer exists would be a pure
revenue tariff.
• A prohibit tariff is one that is so high that no goods
are imported. A prohibitive tariff is a example of a
purely protection tariff – in such circumstance no
government revenue is collected.
4. The Tariff
4. 2 The tariff (con’t)
• MFN (most favored nation):
• If any other Country grants another Country MFN status,
it agrees to charge tariffs against that Country’s good that
are no higher than those imposed against the goods of any
other Country.
• GSP (general system of preference)
• Which was instituted by the United States in the early
1970.
• Other industrialized Countries, including Canada, EC and
Japan have their own GSP programs.
• The idea behind the GSP is that by charging lower tariffs
on goods fromDeveloping Countries
4. The Tariff
4. 2 The tariff (con’t)
• GSP (general system of preference) (con’t)
• Importers in the preference granting Countries such a the
United States will have an incentive to expand their
purchases fromthe preference receiving Countries.
• In turn, expanded exports should improve the standards
of living for the Countries ( and raise demand for imports
fromindustrialized Countries such as the United States).
4. The Tariff
4. 3 Economic Analysis (con’t)
• Consumer surplus: The difference between the
amount consumers are willing to pay to purchase a
given quantity of goods and the amount they have to
pay to purchase those goods
• That is, if the market price of grapes were to rise to P’,
consumer surplus would fall. Lower market price
increase the amount of consumer surplus.
4. The Tariff
4. 3 Economic Analysis:
Consumer Surplus
P
P
2
P
1
P
P
X
A
Consumer Surplus
Consumer Surplus
Copyright©2003 Southwestern/Thomson Learning
Price of
Album
0 Quantity of
Albums
Demand
1 2 3 4
$100
John s willingness to pay
80 Paul s willingness to pay
70 George s willingness to pay
50 Ringo s willingness to pay
Consumer Surplus
Copyright©2003 Southwestern/Thomson Learning
(a) Price = $80
Price of
Album
50
70
80
0
$100
Demand
1 2 3 4 Quantity of
Albums
John s consumer surplus ($20)
Measuring Consumer Surplus with the Demand
Curve
Copyright©2003 Southwestern/Thomson Learning
(b) Price = $70
Price of
Album
50
70
80
0
$100
Demand
1 2 3 4
Total
consumer
surplus ($40)
Quantity of
Albums
John s consumer surplus ($30)
Paul s consumer
surplus ($10)
How the Price Affects Consumer Surplus
Copyright©2003 Southwestern/Thomson Learning
Initial
consumer
surplus
Quantity
(b) Consumer Surplus at Price P
Price
0
Demand
A
B
C
D E
F
P
1
Q
1
P
2
Q
2
Consumer surplus
to new consumers
Additional consumer
surplus to initial
consumers
How the Price Affects Consumer Surplus
Copyright©2003 Southwestern/Thomson Learning
Consumer
surplus
Quantity
(a) Consumer Surplus at Price P
Price
0
Demand
P
1
Q
1
B
A
C
4. The Tariff
4. 3 Economic Analysis (con’t)
• Producer surplus: The difference between the price
paid in the market for a good and the minimum price
required by an industry to produce and market that
unit.
• That is, if the market price of grapes were to rise to P,
producer surplus would increase. Higher market price
increase the amount of producer surplus.
4. The Tariff
4. 3 Economic Analysis (con’t)
Producer Surplus
P
P
X Q
1 0
S
P
The Costs of Four Possible Sellers
Copyright©2004 South-Western
The Supply Schedule and the
Supply Curve
The Supply Schedule and the Supply Curve
Measuring Producer Surplus with the Supply
Curve
Copyright©2003 Southwestern/Thomson Learning
Quantity of
Houses Painted
Price of
House
Painting
500
800
$900
0
600
1 2 3 4
(a) Price = $600
Supply
Grandma s producer
surplus ($100)
Measuring Producer Surplus with the Supply
Curve
Copyright©2003 Southwestern/Thomson Learning
Quantity of
Houses Painted
Price of
House
Painting
500
800
$900
0
600
1 2 3 4
(b) Price = $800
Georgia s producer
surplus ($200)
Total
producer
surplus ($500)
Grandma s producer
surplus ($300)
Supply
How the Price Affects Producer Surplus
Copyright©2003 Southwestern/Thomson Learning
Quantity
(b) Producer Surplus at Price P
Price
0
P
1
B
C
Supply
A
Initial
producer
surplus
Q
1
P
2
Q
2
Producer surplus
to new producers
Additional producer
surplus to initial
producers
D
E
F
How the Price Affects Producer Surplus
Copyright©2003 Southwestern/Thomson Learning
Producer
surplus
Quantity
(a) Producer Surplus at Price P
Price
0
Supply
B
A
C
Q
1
P
1
4. The Tariff
• The gain fromthe free trade: one more time
P
A
P
W
X
W
P
B
X
A
X
B
Country A has comparative
advantage in product X.
Country B World Market
D
B
S
A
D
A
D
B
S
A
S
B
4. The Tariff
• The welfare lost of the tariffs imposed by small Country
P
P
W
X
a
0
S
P
W+T
D
Tariff (T)
Q
3
Q
4
Q
2
b c d
4. The Tariff
• The welfare lost of a tariff imposed by a small Country
base on the above figure.
• Change in consumer surplus: - a$ - b$ - c$ - d$
• Change in producer surplus : + a$
• Change in government revenue: + c$
• Net welfare change: - b$ - d$
4. The Tariff
• The welfare lost of a tariff imposed by a large Country
• Country A imposes the tariff T like in the graphic center
of the figure below
• Imposing the tariff T occurs increasing the price in
Country A
• It can be effected to reduce the demand in the foreign
trade quadrant fromL
0
to L
1
.
4. The Tariff
• The welfare lost of the tariffs imposed by large Country
P
P
W
X
0
S
P = P
W+T
D
Tariff (T)
Q
3
Q
4
Q
2
P
4. The Tariff
• The welfare lost of the tariffs by the large Country
P
A
P
W
X
W
P
B
X
A
X
B
Country A: Market large
Country
Country B: Market small
Country
World Market
D
A
S
B
D
A
D
B
S
A
S
B
P
W
P
P
S
B
+ Tariff
Tariff
L
0
L
1
a c
e
b d
P
W
P
W
P
4. The Tariff
• The welfare lost of a tariff imposed by a large Country
base on the above figure.
• Change in consumer surplus: - a$ - b$ - c$ - d$
• Change in producer surplus : + a$
• Change in government revenue: + c$ + e$
• Net welfare change: - b$ - d$ + e$
Tariffs
IA
Tariff Rate Quota
IB
Agricultural Products
Section I
Non-Agricultural products
Section II
Part I
Part II
Part III
Part IV
Preferential Tariffs
Non-tariff Concessions
Agricultural products:
Commitments limiting subsidization
Most Favored Nation Tariff
D
O
H
A

S
C
H
E
D
U
L
E
State A
Schedules of Concession on Goods
4. Tariff
(Schedules of concessions for WTO Members)
4. Tariff
(Schedules of concessions for WTO Members)
Schedule VI – SRI LANKA
This Schedule is authentic only in the English language
PART I MOST-FAVOURED NATION TARIFF
SECTION II Other Products
Tariff item
number
Description of products Base rate of duty
(U/B)
Bound rate of duty Initial negotiating
right
Other duties and
charges
1 2 6 4 5 6
0301 LIVE FISH
030110 - ornamental fish 66% (U) 50%
030191 -- trout (salmo trutta, salmo gairdneri, salmo
clarki, salmo agua bonita, salmo gilae)
66% (U) 50%
030192 -- eels (anguilla spp.) 66% (U) 50%
030193 -- carp 66% (U) 50%
030199 -- other: 66% (U) 50%
0302 FISH, FRESH OR CHILLED,
EXCLUDING FISH FILLETS AND
OTHER FISH MEAT OF HEADING NO.
0304
030211 -- trout (salmo trutta, salmo gairdneri, salmo
clarki, salmo agua bonita, salmo gilae)
66% (U) 50%
030212 -- pacific salmon (oncorhynus spp.), atlantic
salmon (salmo salar) and danube salmon
(hucho hucho)
66% (U) 50%
4. Tariff (Schedules of concessions for WTO Members)
4. Tariff (Schedules of concessions for WTO Members)
Bound and Applied MFN Tariffs
0.0%
20.0%
40.0%
60.0%
80.0%
100.0%
120.0%
140.0%
160.0%
180.0%
200.0%
2006 2006 2005 2006 2006 2006 2006 2006 2006 2006 2006 2006 2006
Bangladesh Norway India Korea Indonesia Brazil Philippines Japan Malaysia China EC United
States
Australia
Bound Tariff Applied Tariff
Bound Duty
Applied Duty
Source) World Trade Report 2004 13
Philippines
0.0
10.0
20.0
30.0
40.0
Wood, pulp, paper and
furniture
Textiles and clothing
Leather, rubber,
footwear
and travel goods
Metals
Chemicals and
photographic
supplies
Transport equipment
Non-electric machinery
Electric machinery
Mineral products
and precious stones
and precious metals
Manufactured
articles not
elsewhere
specified
Fish and
fish products
Petroleum
Binding coverage : 61.8%
Average of bound duties : 23.4%
Average of applied duties : 4.3%
Bound Rates and Applied Rates by Sector Bound Rates and Applied Rates by Sector
China
0.0
10.0
20.0
30.0
40.0
Wood, pulp, paper and
furniture
Textiles and clothing
Leather, rubber,
footwear
and travel goods
Metals
Chemicals and
photographic
supplies
Transport equipment
Non-electric machinery
Electric machinery
Mineral products
and precious stones
and precious metals
Manufactured
articles not
elsewhere
specified
Fish and
fish products
Petroleum
Binding coverage :100.0%
Average of bound duties : 9.1%
Average of applied duties : 11.3%
Bound Duty
Applied Duty
Source) World Trade Report 2004 17
India
0.0
10.0
20.0
30.0
40.0
Wood, pulp, paper and
f urniture
Textiles and clothing
Leather, rubber,
footwear
and travel goods
Metals
Chemicals and
photographic
supplies
Transport equipment
Non-electric machinery
Electric machinery
Mineral products
and precious stones
and precious metals
Manufactured
articles not
elsewhere
specified
Fish and
fish products
Petroleum
Brazil
0.0
10.0
20.0
30.0
40.0
Wood, pulp, paper and
furniture
Textiles and clothing
Leather, rubber,
footwear
and travel goods
Metals
Chemicals and
photographic
supplies
Transport equipment
Non-electric machinery
Electric machinery
Mineral products
and precious stones
and precious metals
Manufactured
articles not
elsewhere
specif ied
Fish and
fish products
Petroleum
Binding coverage : 69.8%
Average of bound duties : 34.3%
Average of applied duties : 27.7%
Binding coverage :100.0%
Average of bound duties : 30.8%
Average of applied duties : 14.1%
Bound Rates and Applied Rates by Sector Bound Rates and Applied Rates by Sector
Bound Duty
Applied Duty
Source) World Trade Report 2004 18
US
0.0
10.0
20.0
30.0
40.0
Wood, pulp, paper and
furniture
Textiles and clothing
Leather, rubber,
footwear
and travel goods
Metals
Chemicals and
photographic
supplies
Transport equipment
Non-electric machinery
Electric machinery
Mineral products
and precious stones
and precious metals
Manufactured
articles not
elsewhere
specified
Fish and
f ish products
Petroleum
EU
0.0
10.0
20.0
30.0
40.0
Wood, pulp, paper and
furniture
Textiles and clothing
Leather, rubber,
f ootwear
and travel goods
Metals
Chemicals and
photographic
supplies
Transport equipment
Non-electric machinery
Electric machinery
Mineral products
and precious stones
and precious metals
Manufactured
articles not
elsewhere
specified
Fish and
fish products
Petroleum
Binding coverage :100.0%
Average of bound duties : 3.2%
Average of applied duties : 3.7%
Binding coverage :100.0%
Average of bound duties : 3.9%
Average of applied duties : 4.0%
Bound Rates and Applied Rates by Sector Bound Rates and Applied Rates by Sector
Tariff peaks and high tariffs
— Generally used by IOs:
— National peaks: 3 times the national
average
— International peaks: >15%
— BUT, THERE IS NO AGREED WTO
DEFINITION
EC-15: bound AVG per HS Chap.
0
2
4
6
8
10
12
14
16
18
20
0
3
2
7
3
4
4
1
4
8
5
5
6
2
6
9
7
6
8
4
9
1
G
r
HS Chapter (Non Ag tariff lines only)
A
v
e
r
a
g
e

(
%
)
Bound Duty AV
Intern. Peak > 15%
Nat. AVG = 4%
Nation. Peak > 12%
3X
Nat.
AVG
Brazil: bound AVG per HS Chap.
0
10
20
30
40
50
60
70
80
90
0
3
2
8
2
8
3
2
3
1
3
6
4
4
4
3
4
8
6
8
5
1
5
6
6
1
6
6
7
1
7
2
7
8
8
4
8
5
8
6
8
8
9
1
9
6
HS Chapter (Non AG tariff lines only)
A
v
e
r
a
g
e

(
%
)
Bound duty AV
Intern. Peak > 15%
Nat. AVG = 30%
3X
Nat.
AVG
Nation. Peak > 90%
0
5
10
15
20
25
30
35
40
45
Raw material Semi-manufactured Finished product
Tariff
(%)
Tariff escalation: textiles and clothing
Tariff Peaks:
Japan
minimum tariff 0% maximum tariff 958%
Tariff Escalation:
cocoa imports into the EC
cocoa beans milk chocolate
0% 18.7%
Forms:
Specific duties and ad valorem duties
Seasonal duties
Matrix tariffs
Tariff only but problems still exist
5. Non-tariff barriers and argument for
protection
• Quota:
• Government imposed the limitation on the volume or
value of international trade.
• Quota rent: Profit that come about, because a quota has
artificially raised the price of imported products.
• Quota occurs the loss of the consumers
5. Non-tariff barriers and argument for
protection
• The welfare Effects of the Quota
P
P
W
X
0
S
M
P
M+Q
D
Quota (Q
1
+ Q
2
)
Q
1
Q
2
S
M
+ Quota
a b C
1
C
2
d
Remark: C = C
1
+ C
2
5. Non-tariff barriers and argument for
protection
• The welfare lost of a Quota.
• Change in consumer surplus: - a$ - b$ - c$ - d$
• Change in producer surplus : + a$
• Change in government revenue: + c$ (= C
1
+ C
2
)
• Net welfare change: - b$ - d$
• c$ is a Quota Rent.
Tariff Quotas or Tariff Rate Quotas
Imports (MT) Imports (MT) Quota volume Quota volume
Applied duty % Applied duty %
Out-of-quota
tariff
In-quota
tariff
Tariff Quotas or Tariff Rate Quotas
5. Non-tariff barriers and argument for
protection
• Embargo:
• Embargo is a complete ban on trade in product or
products.
• Voluntary export restraint (VER)
• Agreement between imported and exported Countries
whereby the export agree to limit the amount of their
export.
• Through this agreement these foreign industries are able
to raise their prices.
• In the case, the imported Country loss the revenue C= C +
C
2
(seen figure below).
5. Non-tariff barriers and argument for
protection
• The welfare Effects of voluntary export restraint
P
P
W
X
0
S
M
P
M+VER
D
VER (=C
1
+C
2
)
Q
1
Q
2
S
M
+ VER
a b C
1
C
2
d
Remark: C = C
1
+ C
2
5. Non-tariff barriers and argument for
protection
• The welfare lost by a voluntary export restraint.
• Change in consumer surplus: - a$ - b$ - c$ - d$
• Change in producer surplus : + a$
• Change in government revenue: + 0$
• Net welfare cost or change: - b$ - c$ - d$
§Financial contributions and kinds of contribution by
Government as Examples
— Grants
— Loans
— Loan guarantees
— Investment tax credits
— Tax exemptions
— Import duty exemptions
on capital equipment used
— Provision of goods or
services other than general
infrastructure
— Purchase of goods
— Income or price supports
— Gov’t entrusts or directs
private body to carry out
above functions
Export Subsidies
5. Non-tariff barriers and argument for
protection
Other Non-Tariff Barriers
§ Export subsidy:
§ A payment by a government to an industry that leads to
an expansion of exports by that industry.
§ Export subsidies Policy coverage - Article 9.1 (WTO)
(a) direct subsidies contingent on
export performance
(b) sale or disposal for export by
gov’t at price below domestic
market
(c) payments on exports financed
by gov’t action
(d) marketing subsidies, including
handling, upgrading, transport,
freight
(e) favourable internal transport
and freight charges for exports
(f ) subsidies on ag. Products
contingent on incorporation in
exported products
5. Non-tariff barriers and argument for
protection
Pillars of the Agreement on Agriculture
Market
Access
Domestic
Support
Export
Competition
Tariffication
Bindings
Reductions
Market Access
Tariff Rate Quotas
Special
Safeguard
Amber Box
AMS Reduction
Blue Box
Production Limiting
Programmes
Green Box
Non Trade Distorting
Volume
Reduction
Value Reduction
Roll-over
Amber box
Calculating the Current Total AMS
Annexes 3 and 4
Product-specific
support
l Market price support
l Compensatory payments
l Product-specific
subsidies +
= Current Total AMS
Non-product specific
support
l Fertilizers
l Irrigation, drainage
l Electricity
l Subsidized credits
Product Specific AMS
1. Market Price Supports
2. Non Exempt Direct Payments
3. Other product specific supports
Product Specific AMS
Non Product Specific AMS
Current Total Aggregate Measure of Support
But
If less than 5% (10% for
DC) of production
of product then zero
But
If less than 5% (10%
for DC) of total
production then zero
+
=
Current Total AMS
Note Reduction Commitments
Apply to Current Total AMS only
Domestic Support
Amber Box and De Minimis
Limits based on 1986-1988 average
Reductions 45% to 75% for developed, 30% for dev’g
§ Countervailing duty:
• A tax imposed by importing Country designed to offset
artificially low prices charged by exporters.
• This measures is to impose the tax in order to offset the
subsidized export goods.
Other Non-Tariff Barriers
5. Non-tariff barriers and argument for
protection
INJURY FACTORS (Article 3.4)
Include:
— Actual and potential decline in:
– Sales - Productivity
– Profits - Return on investment
– Output - Utilisation of capacity
– Market share
— Actual and potential negative effects on:
– Cash flow - Growth
– Inventories - Ability to raise capital
– Employment - Ability to raise investment
– Wages
— Factors affecting domestic prices
CALCULATION OF CVD RATE
— Domestic subsidies:
Amount of benefit allocated to POI
All products sales value for POI
— Export subsidies: (persistence of benefits over time (POI)
Amount of benefit allocated to POI
Exported products sales value for POI
— Subsidies tied to a market, products or producer:
Amount of benefit allocated to POI
Market, products or producer sales value for POI
§ Government procurement policies:
• Direct purchasing agents of state and local government to
purchase American product unless comparable foreign
good are substantially cheaper.
Other Non-Tariff Barriers
5. Non-tariff barriers and argument for
protection
§ Health and safety standard:
• Government often regulate the production and
distribution of products deemed (considered) to be
hazardous to the health and safety of their Citizens.
• Some time, however, such standard provide a mechanism
to protecting domestic products from the foreign
competition.
• In example Japan bans importing of skis, because of
unsafely.
• Regarding the WTO agreements these non-tariff barriers
are described in the SPS (sanitary and phyto-sanitary) and
TBT (technical barriers to trade) agreements.
Other Non-Tariff Barriers
5. Non-tariff barriers and argument for
protection
risks arising from additives,
contaminants, toxins or disease-causing
organisms
damage caused by the entry,
establishment or spread of pests
a country
human life
diseases carried by animals or plants
human or animal
life
pests, diseases or disease-causing
organisms
animal or plant
life
To protect :
from :
Definition of an SPS Measure in WTO
Agreement
— product criteria
— quarantine treatments
— production methods
— certification and approval
— inspection
— sampling procedures
— packaging and labelling
directly related to food
safety
All types of measures with SPS objectives,
including :
What type of SPS’s measures ?
The WTO’s TBT Agreement….
To start: some definitions
Technical Regulation
— "Document which lays down product characteristics or their
related processes and production methods...with which
compliance is mandatory.”
Standard
— Document, approved by a recognized body that provides, for common
and repeated use, rules, guidelines or characteristics for products or
related processes and production methods, with which compliance is not
mandatory
Conformity assessment procedure
— Any procedure used, directly or indirectly, to determine that relevant
requirements in technical regulations or standards are fulfilled
§ Protect intellectual property right:
• Defined as the innovative or creative ideas of inventors,
artists or authors.
• Patent, copyright and trademark laws exist to provide
incentive to create intellectual property by ensuring that
the owners of the intellectual property maintain exclusive
control over these ideas at least for a certain period of
time.
Other Non-Tariff Barriers
5. Non-tariff barriers and argument for
protection
§ Protect intellectual property right:
• Patent allows inventors the opportunity to recover their
investment and the cost of creating and marketing
inventions.
• Copyright give authors control over the reproduction,
dissemination and public performance of their work.
• Trademark assures consumers about the product
characteristics such as quality.
Other Non-Tariff Barriers
5. Non-tariff barriers and argument for
protection
§ Protect intellectual property right (con’t):
• Geographical Indication is any geo. sign (word or symbol)
used to indicate that a product originates in a given
country/region/place and its quality, reputation or other
characteristic are essentially due to its geographical
origin.
• Industrial design is aesthetic shape (ex. Model of shirt) of
mass-produced products.
• Neigbouring right is Performers, Phonogram Producers
and Broadcasting Organizations
Other Non-Tariff Barriers
5. Non-tariff barriers and argument for
protection
§ Disclosure
DEFINITION
§ Patentable subject matter
§ Industrial applicability
§ Novelty
§ Inventive Step
Patents
Non-tariff barriers
Fields Protected:
§ Literary Works
§Musical Works
§Artistic Works
§Photographic Works
§Cinematographic Works
§Maps
§Computer Programs
§Works of Applied Art
Copyright
Non-tariff barriers
§ NO if dictated purely by the function
§ NO if contrary to public order and morality
§ Industrial
§ New (Worldwide)
Main Characteristics of Industrial
Design
6. Other commercial policy
• Dumping:
• Defined a selling a product in a foreign Country at a price
that is lower than the price charged by the same firm in
its home market or at a price below cost of production.
• Many reasons for “dumping”:
• May be predatory pricing policy
• May be result of custom production
• May be unintentional / technical dumping
• May be conscious economic decision relating to profits from
increased marginal production.
— Break-Even analysis :
Profit = (P x Q) – [(C
V
x Q) + C
F
]
— For Break-Even analysis the profit is 0
=> 0 = (P x Q) – [(C
V
x Q) + C
F
]
= Q (P – C
V
) – C
F
=> Q = C
F
/(P – C
V
)
Volume
Q
Fixed Cost
Total Cost
Revenue
Break-Even Point
C
o
s
t

a
n
d

R
e
v
e
n
u
e
Variable Cost
Profit
Loss
Definition of Dumping base on WTO agreement
§ Dumping = when a product is sold for export to another
country at less than its “normal value”.
§ Normal Value is
§ the price in the home market when the good is sold at a
price above the cost of production
§ the price charged for the good when sold at a price above
cost in third-country markets
§ “constructed normal value” calculated as the total costs of
producing the product plus a reasonable amount for
selling, general and administrative expenses and profit.
6. Other commercial policy
6. Other commercial policy
§ Antidumping law:
• Dumping margin: The difference between the normal
value of a product and its dumped price.
• Injury test: Investigation to determine the cause of the
foreign trade practice to harma domestic producer.
INJURY FACTORS (Article 3.4)
Include:
— Actual and potential decline in:
– Sales - Productivity
– Profits - Return on investment
– Output - Utilisation of capacity
– Market share
— Actual and potential negative effects on:
– Cash flow - Growth
– Inventories - Ability to raise capital
– Employment - Ability to raise investment
– Wages
— Factors affecting domestic prices
— The magnitude of the margin of dumping
6. Other commercial policy
§ Safeguard:
• A measure trade law that allows for temporary
protection (5 years) against fairly trade foreign
import.
• Reason for using this measure is trade adjustment in
the domestic producers.
• But for using this measure it should be investigated
the injury of the domestic industry through the
foreign products.
SAFEGUARDS (WTO): BASIC REQUIREMENTS
§ A determination that,
§ As a result of (i) unforeseen developments and (ii) the
effect of a Member’s obligations under GATT 1994
§ A product is being imported in such increased quantities
§ As to cause or threaten to cause
§ Serious injury to the domestic industry
§ Producing “like products” or directly competitive
products
6. Other commercial policy
… serious injury …
(threat of)
= significant overall impairment in the position of a
domestic industry
— Relevant factors:
— Increased imports (value and volume)
— Market penetration of imports
— Changes in sales
— Production
— Productivity
— Capacity utilization
— Profits / losses
— Employment
“New” Safeguard Measures
— Maximum duration
— 4 years
— Extension (max. + 4 years)
— Compensation
— In principle (agreement on compensation)
— If no agreement :
— “retaliation”
— not within the first 3 years (if absolute increase in
imports)
Rule of Origin (ASEAN case):
• Agriculture products (chapter 01-24) and
agricultural products commit to WTO, such
as cotton chapter 52, silk chapter 50.
• Non-agricultural products
Other non-tariff barriers and argument
for protection
Rule of Origin (ASEAN Case) (con’t):
Agricultural Products
• Apply the rule of wholly produced or obtained applicable for
goods which are made wholly from domestic raw material.
• The value of raw materials from exporting country and
ASEAN Country is not less than 60% of total production cost.
Other non-tariff barriers and argument
for protection
Rule of Origin (ASEAN Case) (con’t):
Non-agricultural Products
• Apply the rule of wholly produced or obtained
• The value of raw materials from exporting
country and ASEAN Coutry is not less than 40%
of total production cost.
Other non-tariff barriers and argument
for protection
— The local ASEAN content can be cumulative, that
is, the value of inputs from various ASEAN
members can be combined to meet the 60% or 40%
requirement. The following formula is applied:
— (Raw material cost + Direct labor cost + Direct
overhead cost + Profit + Inland transport cost) x
100/ FOB value
Other non-tariff barriers and argument
for protection
The formula for calculating the RCV shall be:
A- Build-Up Method
RVC = (VOM / FOB) x 100%
B- Build-Down Method
RVC = [(FOB – VNM) / FOB] x 100%
- RVC: Regional Value Content
- VOM: Value of originating materials used by the producer in
the production of good
- VNM: Value of non-originating materials used by the
producer in the production of good
Other non-tariff barriers and argument
for protection
HOW DO YOU DETERMINE THE “LIKE PRODUCT” ?
§ Consider on:
§ Characteristics of product
§ Uses of product
§ Raw materials used
§ Manufacturing process
§ Tariff classification
§ Consumer preference and end-use
§ Quality
6. Other commercial policy
6. Other commercial policy
§ Preferential trading arrangement
• FTA (free trade area): Agreement between several
Countries to eliminate internal barriers to trade, but
to maintain existing barriers against non-member
Countries.
• Custom Union (CU): Agreement between several
Countries to eliminate internal barrier to trade, but
to erect common barrier against the non-member
Countries.
ASEAN Vision 2020
AEC
— At the 12th ASEAN Summit in January 2007, the Leaders affirmed
their strong commitment to accelerate the establishment of an
ASEAN Community by 2015 as envisioned in the ASEAN Vision
2020 and the ASEAN Concord II, and signed the Cebu Declaration
on the Acceleration of the Establishment of an ASEAN Community
by 2015.
— In particular, the Leaders agreed to hasten the establishment of the
ASEAN Economic Community by 2015 and to transform ASEAN
into a region with free movement of goods, services, investment,
skilled labour, and freer flow of capital
— ASEAN ECONOMIC COMMUNITY BLUEPRINT.
ASEAN Trade Cooperation
• Agreement on the common effective preferential
tariff (CEPT) scheme for AFTA
— Ultimate Goal : 0% tariff rate in 2010 for ASEAN- and
2015 (2018) for new members Countries.
ASEAN Trade Cooperation
The common effective preferential tariff (CEPT) is a
mechanism to achieve the AFTA’s target by reducing
import tariff rates and eliminating quantitative
restriction and non-tariff barriers among ASEAN
member states.
ASEAN Cooperation in Services
Main Provisions Governing Market Access and
National Treatment
— Market Access
— No limitations on the numbers of service suppliers,*
— No limitations on the value of service transactions,*
— No limitations on the number of service operations,*
— No limitations on the number of natural persons in a sector,*
— No restrictions on types of legal entity,
— No limitations on foreign capital participation
* Includes limitations in the form of economic needs tests.
— National Treatment (non-discrimination de facto)
— No measures which modify the conditions of competition in favour of
domestic services or service suppliers
ASEAN Cooperation in Services
Modes of supply: 1) Cross-Border supply 2) Consumption abroad 3) Commercial presence 4) Presence of natural persons
Sector or sub-sector Limitations on market access Limitations on national treatment Additional commitments
B. SECTOR-SPECIFIC COMMITMENTS
I. BUSINESS SERVICES
1. Professional Services
(a) Legal services
(CPC 861):
(1) None
(2) None
(3) In commercial association with
Cambodian law firms
[1]
, and may not
directly represent clients in courts.
(4) Unbound, except as indicated in
the horizontal section.
(1) None
(2) None
(3) None
(4) Unbound, except as indicated
in the horizontal section.
Foreign legal consultancy
on law of jurisdiction where
service supplier is qualified as a
lawyer (including home country
law, third country law, and
international law)
(1) None
(2) None
(3) None
(4) Unbound, except as indicated in
the horizontal section.
(1) None
(2) None
(3) None
(4) Unbound, except as indicated
in the horizontal section.
(b) Accounting, auditing,
bookkeeping
(CPC 86211, 86212, 86220)
(1) None, except must have
commercial presence in Cambodia for
auditingservices.
(2) None
(3) None
(4) Unbound, except as indicated in
the horizontal section
(1) None
(2) None
(3) None
(4) Unbound, except as indicated
in the horizontal section.
Other ASEAN Cooperation
• Cooperation in Investment
• Industrial Cooperation
• Cooperation in Transport
6. Other commercial policy
§ Economic Analysis of FTA (CU)
• Assumption:
• 3 Countries A, B and C.
• Country B and C export Beer to A.
• Country B has 2 $ per 1 bottle and Country C has 1.5 $
per bottle in case of autarky.
• A charge the ad valorem100%.
• Country A and B make the agreement to build up the
FTA.
• According the assumption consumers of Country A
shift their consumed product to Country B, because
product from Country B don’t impose tariff.
6. Other commercial policy
§ Economic Analysis of FTA (CU) (con’t)
1.5$
X
0
S
2$
D
S
C
+ T
X
C
1
S
B
+ T
a b c
g
d
3$
4$
h f e i
S
B
S
c
X
B
1
X
C
1+T
X
C
2+T
X
C
2
X
B
2
X
B
1+T
X
B
2+T
6. Other commercial policy
• The welfare effect on the Country A of an FTA
between Countries A and B
• Change in consumer surplus: +a$ +b$ +c$ +d$
• Change in producer surplus : -a$
• Change in government revenue: -c$ -g$
• Net welfare cost or change: +b$ +d$ -g$
6. Other commercial policy
§ Economic Analysis of FTA (CU) (con’t)
• The source moves from C to B that means the trade
will move from low cost world producer to high
cost world producer or lowest cost FTA member (=
trade diversion).
• Trade expands in the Country A, their importing
Beer is increased (trade creation).
• Why: FTA exists only with Country A and B, not
with C, it has the following reasons:
• Being the economic policy in the region
• Not being calculation of the dynamic gain, only
considering the static gain.
Comparative advantage in trade
§ A country can have a relatively lower opportunity cost
and potentially a comparative advantage over another
country based on the supply and price of labour, on
technology, on environmental and climatic factors or
it could be due to an abundance of natural resources.
7. International Trade and
Economic Growth
Comparative advantage in trade
— A country has a comparative advantage in producing a
good if the opportunity cost of producing that good in
terms of other goods is lower in that country than it is in
other countries.
— So China has a comparative advantage in the production
of textiles and clothing because the (opportunity) cost of
producing clothing (due to cheaper labour) is lower in
China than in most other countries.
— Trade between two countries can benefit both economies
if each country exports the goods and services in which it
has a comparative advantage.
7. International Trade and
Economic Growth
The Terms of Trade
— The Terms of Trade looks at the relationship
between the price received for exports and the
amount of imports we are able to buy with that
money.
Average Price of Exports
Terms of Trade = ------------------------------
Average Price of Imports
7. International Trade and
Economic Growth
Costs of Protection
§ to the economy
§ inefficiency & lower productivity
§ hidden tax on consumers
§ higher prices on imports & domestic goods & services
§ reduced choice & quality
§ to efficient producers/exporters
§ higher input prices
§ higher-cost economy - competition for resources
from less efficient activities
7. International Trade and
Economic Growth
7. International Trade and
Economic Growth
— In a poor country, labour-intensive activities will often have a
comparative advantage
— Expansion of such activities will usually help the poor
— Policy - focus on constraints to the poor participating in economic
activities
— Empirical evidence mixed, but provides strong presumption in favour
— problems with empirical studies (cross-country regression analysis,
country case studies)
— Difficulty in taking account of institutional differences between
countries
— Causality in dispute (economic growth leads to higher trade vs
higher trade leads to higher economic growth)
— DCs open to trade grow faster & higher income countries are more
open to trade (see following charts)
Trade policy, economic growth, and poverty
Chart: DCs Open to Trade Grow Faster
-1
0
1
2
3
4
5
6
7
8
1963-73 1974-85 1986-92
A
v
e
r
a
g
e

A
n
n
u
a
l

G
r
o
w
t
h

i
n

G
N
P

p
e
r

P
e
r
s
o
n

(
%
)
Open Moderately Open Moderately Closed Closed
7. International Trade and
Economic Growth
Chart: Higher Income Countries are Much More Open
0
5
10
15
20
25
30
35
40
Low Income Lower Middle Income Upper Middle Income High Income
%

o
f

G
D
P
,

1
9
9
9

(
P
P
P
)
Trade in Goods Gross Private Capital Flows Gross Foreign Direct Investment
7. International Trade and
Economic Growth
Trade liberalization ÛGrowth ÛPoverty Alleviation
§ No evidence that
§ trade liberalization harms growth or raises poverty
§ import substitution policies generate sustained rapid growth
§ Agriculture and labour-intensive activities (e.g., textiles)
will often have a comparative advantage in poor countries
§ agricultural development essential in developing countries with
large land and rural labour endowments
§ non-farm rural & urban income & employment opportunities
also
7. International Trade and
Economic Growth
7. International Trade and
Economic Growth
Designing Trade Liberalization & Poverty Reduction
Strategies
§ There is no evidence to support the idea that trade
liberalization can be designed to reduce poverty (evidence
that agricultural investment reduces poverty is because
this sector has a comparative advantage)
§ Remember Tinbergen’s rule “One policy instrument for
each policy objective”
§ Best to regard trade policy as part of growth-enhancing
package
7. International Trade and
Economic Growth
Prioritizing Trade Liberalization & Poverty Reduction
Strategies
§ begin with poverty analysis that identifies the poor
§ identify constraints faced by the poor to earning income
§ focus policy on alleviating the constraints
§ note reasons for the status quo
§ poor have little political influence
§ vested interests against change
§ need to build coalition of interests in support of change
§ empower poor to participate in the benefits of economic
growth
7. International Trade and
Economic Growth
Trade Liberalization
§ identify constraints to reform
§ property rights / security of contracts
§ credibility of reforms; ‘package of reforms’
§ stable macroeconomic environment
§ mobilization of factor markets
§ investment/competition policies
§ trade liberalization itself is good competition policy
§ open investment policies promote trade in services
7. International Trade and
Economic Growth
Gains From Trade Liberalization
§ Static gains
§ allocate efficiency
§ specialization on activities with comparative advantage
(economies of scale), more efficient input and output markets
§ governments cannot ‘create’ comparative advantage
§ Access to a larger variety of products and services
§ Note that smaller countries tend to trade more. Why?
§ Access to new technologies
§ Access to new ideas
§ Result:
§ Usually Leads to Higher Level of GDP
7. International Trade and
Economic Growth
Gains From Trade Liberalization
§ dynamic gains
§ more competitive markets
§ improved efficiency over time
§ removes rent seeking/”X-inefficiencies”
§ better technology/production methods
§ difficult to measure
§ thought to exceed static gains of 1-2% of GDP
7. International Trade and
Economic Growth
§ Raising Standards of living
§ Ensuring full employment
§ Ensuring large and steadily growing volume of real
income and effective demand
§ Expanding the production of and trade in goods and
services, while allowing for the optimal use of the
world’s resources (sustainable development)
§ … seeking both to protect and preserve the
environment […] in a manner consistent with [the
Member’s needs]
WTO - General Objectives
7. International Trade and
Economic Growth
§ Implementation, administration and operation of
WTO Agreements
§ Framework to further the objectives of the WTO
Agreements
§ Forum for trade negotiations
§ Framework to administer the Understanding on
Rules and Procedures Governing the Settlement
of Dispute (DSU)
§ Framework to administer the Trade Policy Review
Mechanism (TPRM)
WTO - Main Functions
7. International Trade and
Economic Growth
Integrated Framework
§ Integrated Framework (IF) for LDCs
§ coordinated delivery of trade-related technical
assistance
§ run by 6 institutions; WB, WTO, ITC, UNCTAD, UNDP,IMF
§ formed in 1997, revamped in 2000; endorsed at
Doha
§ based on principles of
§ country ownership
§ partnership & policy coherence
7. International Trade and
Economic Growth
Integrated Framework (con’t)
§ LDCs to mainstream trade policy priorities into
national development plans & Poverty Reduction
Strategies
§ Diagnostic Trade Integration Study (DTIS) & Action Plan
§ program designed in consultation with governments and
stakeholders
§ funded by donors (multilateral, bilateral)
§ success depends on making basic policy changes
§ problems well known, but poor implementation record
7. International Trade and
Economic Growth
Rectangular strategy of RGC
8. Commercial Policy of Cambodia
1. The rectangular Strategy of RGC
§ The core of the rectangular strategy is good governance focused at
four reform areas:
§ Anti-Corruption
§ Legal and judicial reform,
§ Public administration reform, including decentralization and de-
concentration, and
§ Reform of the armed forces, especially demobilization
§ The integration of Cambodia into the region and the world is a
significant part of the rectangular strategy of RGC.
8. Commercial Policy of Cambodia
2. The Integrate Framework of RGC
§ The Integrated Framework (IF) is the outcome of a commitment made by six multilateral
Agencies (IMF, ITC, UNCTAD, UNDP, World Bank, and WTO) to coordinate their
assistance in the area of trade and investment integration into the global economy among
themselves and with other multilateral and bilateral donors.
§ IF came about as a result of the High Level Meeting (HLM) for LDCs organized by the
WTO in October 1997 in Geneva.
§ The IF’s strategy must be fully “mainstreamed” in the country’s national strategy for
poverty reduction. In other words, the country’s trade sector strategy must be fully support
and coherent with national objectives of poverty reduction.
§ In the donor community based in Cambodia, UNDP has taken the lead to ensure effective
implementation of IF and coordination among local donors. UNDP-Phnom Penh and the
International Trade Center (Geneva) are cooperating and working directly with RGC and
others to backstop work in this area.
8. Commercial Policy of Cambodia
2. The Integrate Framework of RGC (con’t)
§ The IF was undergoing some restructuring that include the creation of an
Integrated Framework Trust Fund (IFTF) and the adoption of a Pilot Phase
Work Program during the Second IFTF Steering Committee Meeting held in
New York in late March 2001
§ The Pilot Phase Work Program is to be implemented by the IF Agencies under
the leadership of the World Bank in a small number of Pilot Countries using
IFTF and other resources.
§ Cambodia has been designated as one of the Pilot Countries.
§ The IF “Pilot Phase Work Program” seeks to provide financial and technical
support to the selected pilot countries for the formulation of a full-fledged pro-
poor trade sector strategy that is fully mainstreamed into the PRSP
8. Commercial Policy of Cambodia
3. The Pro-Poor Trade Strategy of RGC
§ Preliminary evidence examined suggests that trade is making a significant
positive contribution to economic growth and poverty reduction and that such
contribution can be further enhanced and provided Cambodia to become
proactive in promoting trade for poverty reduction.
§ Regarding this issue RGC established a Pro-Poor Trade Strategy organized
around tree basic concepts:
§ Shifting the balance of policy emphasis from issues of market access and macro-
reforms for trade to micro and meso-level issues of supply capacity
§ Focusing strongly on the delivery of capacity-building support at the export
enterprise and export sector level; and
§ Stressing the regionalization and geographical decentralization of export
business within Cambodia
8. Commercial Policy of Cambodia
3. The Pro-Poor Trade Strategy of RGC (con’t)
§ The early efforts of the RGC to formulate a pro-poor trade sector strategy – initially
under the umbrella and with the support of the Integrated Framework (IF) for Trade –
coincides closely with the PRSP effort.
§ The pro-poor trade integration strategy will include:
§ (1) policy and institutional reforms to target key bottlenecks and constraints that
emerge from the analysis;
§ (2) several action plans at the product-sector level including project proposals to
capitalize on major opportunities identified in the strategy;
§ (3) assessment of technical assistance and capacity-building priorities to support
implementation of the trade strategy as well as recommended actions that might
be taken by high-income and regional partner countries to improve access to
their markets.
8. Commercial Policy of Cambodia
3. The Pro-Poor Trade Strategy of RGC (con’t)
§ The RGC has identified eight sectors with current or potential
opportunities for expanding, diversifying, and developing exports
under the Pro-Poor Trade Strategy. These are:
§ Specialty crops and agro-processing
§ Rice
§ Fresh water fish and seafood
§ Handicraft (including furniture making)
§ Tourism
§ Labor services
§ Garment and shoe manufacturing
§ Rubber, sawn timber and processed wood
8. Commercial Policy of Cambodia
4. Trade Sector wide Approach (SWAp)
§ SWAp is an instrument for better management, coordination
and effectiveness of resources. Now RGC is willing to utilize
SWAp in the Trade Sector.
§ The Ministry of Commerce stands ready to develop SWAp in
order :
§ To include all initiatives, strategies, measures and actions,
§ To strengthen partnerships for consensus building and
coordination with the private sector, civil society and donors, and
§ To improve implementation and delivery.
8. Commercial Policy of Cambodia
4. Trade Sector wide Approach (SWAp) (con’t)
§ The Trade SWAp is lead by the Ministry of Commerce in
close cooperation with other line Ministries, Cambodian
Trade Stakeholders and Development Partners.
§ The Trade SWAp is to be guided and monitored by the Sub-
Steering Committee on Trade Development and Trade-
Related Investment chaired by the Ministry of Commerce.
8. Commercial Policy of Cambodia
4. Trade Sector wide Approach (SWAp) (con’t)
§ The Sub-Steering Committee on Trade Development and Trade-
Related Investment has endorsed the creation of three teams
responsible for formulating the three “pillars” of the program
aimed at implementing the broad objectives of the Cambodia’s
2007 Trade Integration Strategy.
§ The three pillars are:
§ Legal Reform and Cross-Cutting Issues
§ Product and Service Export Sectors Development
§ Capacity Development for Trade
8. Commercial Policy of Cambodia
5. Integrating Cambodia into the international Community
§ Cambodia’s membership in ASEAN (30-04-1999) and WTO
(13-10-2004), as well as cooperation within the framework of
the ASEM.
§ Cambodia’s membership in Great Mekong Sub-Region, the
Ayeyawadee-Chao Phraya-Mekong Economic Cooperation
Strategy (ACMECS) and other Triangular Developments at
sub-regional level.
§ Integrating Cambodia into the international Community will
provide great opportunities to reform the investment and
foreign trade regime.
8. Commercial Policy of Cambodia
Country Industrial and Agro-
Industrial Products
Agricultural Products
IL TEL IL TEL SL
ASEAN-6 1993-2003 1996-2003 1996-2003 1997-2003 2001-2010
Vietnam 1996-2006 1999-2006 1999-2006 2000-2006 2004-2013
Laos & Myanmar 1998-2008 2001-2008 2001-2008 2002-2008 2008-2015
Cambodia 2000-2010 2003-2010 2003-2010 2004-2010 2008-2017
Schedules of Tariff Rate of Cambodia in Schedules of Tariff Rate of Cambodia in
ASEAN ASEAN
Cambodia’s Tariffs by Product Groups for
Accession into WTO
Cambodia’s Service Commitments for Accession into WTO
§ Undertaken market access and national treatment commitments in at least one sub-sector
under each of 11 different service which are communications services, construction and
related engineering services, distribution services, education services, environmental
services, financial services, health-related services, tourism and travel services, recreational
services and transport services.
§ Allowing foreign firm to operate in the areas of legal services (with some exceptions),
accounting, auditing, bookkeeping, banking, management consulting, telecommunication and
transport, but some conditions were attached to market access in areas of financial services
(banking and insurance) and telecommunication services.
§ Allowing foreign firms to provide higher education and adult education services.
§ Reserving part of a market for Cambodian small and medium sized enterprise in areas such
as banking, tourism and courier service (tourist guides services; opening hotel market only
for hotels of three stars or higher; and allowing foreign supply of retailing services only a
small number of specific items or for very large supermarkets or department stores.
8. Commercial Policy of Cambodia
Modes of supply: 1) Cross-Border supply 2) Consumption abroad 3) Commercial presence 4) Presence of natural persons
Sector or sub-sector Limitations on market access Limitations on national treatment Additional commitments
B. SECTOR-SPECIFIC COMMITMENTS
I. BUSINESS SERVICES
1. Professional Services
(a) Legal services
(CPC 861):
(1) None
(2) None
(3) In commercial association with
Cambodian law firms
[1]
, and may not
directly represent clients in courts.
(4) Unbound, except as indicated in
the horizontal section.
(1) None
(2) None
(3) None
(4) Unbound, except as indicated
in the horizontal section.
Foreign legal consultancy
on law of jurisdiction where
service supplier is qualified as a
lawyer (including home country
law, third country law, and
international law)
(1) None
(2) None
(3) None
(4) Unbound, except as indicated in
the horizontal section.
(1) None
(2) None
(3) None
(4) Unbound, except as indicated
in the horizontal section.
(b) Accounting, auditing,
bookkeeping
(CPC 86211, 86212, 86220)
(1) None, except must have
commercial presence in Cambodia for
auditingservices.
(2) None
(3) None
(4) Unbound, except as indicated in
the horizontal section
(1) None
(2) None
(3) None
(4) Unbound, except as indicated
in the horizontal section.
8. Commercial Policy of Cambodia
6. Trade related to Investment: Investment Protection
§ Equal treatment of all investors
§ No nationalization adversely affecting the property of
investors
§ No price controls on products or service
§ No restriction on foreign equity participation
§ No restriction on foreign convertibility
§ Remittance of foreign currencies abroad
8. Commercial Policy of Cambodia
§ In a typical foreign exchange transaction a party
purchases a quantity of one currency by paying a
quantity of another currency.
§ The modern foreign exchange market started forming
during the 1970s when countries gradually switched to
floating exchange rates from the previous exchange rate
regime, which remained fixed as per the Bretton Woods
system.
§ The foreign exchange market, as we usually think of it,
refers to large commercial banks in financial centers
such as New York or London trading foreign-currency-
dominated deposits with each other.
9. The Foreign Exchange
Market
International Monetary Arrangements
in Theory and Practice
— The Bimetallism, 1791-1879
— The International Gold Standard, 1879-1913
— The Spirit of the Bretton Woods Agreement, 1945
— The Fixed-Rate Dollar Standard, 1950-1970
— The Floating-Rate Dollar Standard, 1973-1984
— The Plaza-Louvre Intervention Accords and the Floating-
Rate Dollar Standard, 1985-1999
— For example, if the dollar is pegged to silver at
U.S.$1.293 = 1 ounce of silver, and if the dollar is
pegged to gold at U.S.$19.395 = 1 ounce of gold
(28.35g gold).
— The “mint ratio” was 15 to 1. In other word, the mint
price of gold was 15 times that of silver.
— Reestablishment in 1834, the dollar is pegged to gold
at U.S.$20.67 = 1 ounce of gold.
— Then, the “mint ratio was 16 to 1 in USA, while in
Abroad 15½ to 1.
The Bimetallism, 1791-1879
The Spirit of the Bretton Woods
Agreement, 1945
The Role of International Reserves in
Exchange Rate Determination
Price of
Sterling
Quantity of sterling/Time
$2.82
$2.78
D
D
S
S
a
The Spirit of the Bretton Woods Agreement,
1945
The Role of International Reserves in
Exchange Rate Determination
Price of
Sterling
Quantity of sterling/Time
$2.82
$2.78
D
D
S
S
a
D’
D’
e
f
g
The Bank of
England uses
its US$
reserves to
buy up fg £
each period.
D”
D”
b
c d
The Bank
must supply
cd £ each
period.
The Fixed-Rate Dollar Standard,
1945-1972
— In practice, the Bretton Woods system evolved into a
fixed-rate dollar standard.
Industrial countries other than the United States :
Fix an official par value for domestic currency in terms
of the US$, and keep the exchange rate within 1% of
this par value indefinitely.
United States : Remain passive in the foreign
exchange market; practice free trade without a
balance of payments or exchange rate target.
Bretton Woods System: 1945-
1972
German
mark
British
pound
French
franc
U.S. dollar
Gold
Pegged at $35/oz.
Par
Value
§ The purpose of the foreign exchange market
is to assist international trade and
investment.
§ The foreign exchange market allows
businesses to convert one currency to
another.
§ For example, it permits a U.S. business to
import European goods and pay Euros, even
though the business's income is in U.S.
dollars.
9. The foreign exchange market
The purpose of FX
9. The Foreign Exchange Market
Market participants
— Banks: The interbank market caters for both the majority of
commercial turnover and large amounts of speculative trading every
day. A large bank may trade billions of dollars daily.
— Commercial companies: An important part of this market comes from
the financial activities of companies seeking foreign exchange to pay
for goods or services. Commercial companies often trade fairly small
amounts compared to those of banks or speculators
— Central Bank: National central banks play an important role in the
foreign exchange markets. They try to control the money supply,
inflation, and/or interest rates and often have official or unofficial
target rates for their currencies. They can use their often substantial
foreign exchange reserves to stabilize the market.
9. The Foreign Exchange Market
— Hedge funds as speculators: About 70% to 90% of the foreign exchange
transactions are speculative. In other words, the person or institution
that bought or sold the currency has no plan to actually take delivery
of the currency in the end; rather, they were solely speculating on the
movement of that particular currency.
— Investment management firms: Investment management firms (who
typically manage large accounts on behalf of customers such as
pension funds and mutual funds) use the foreign exchange market to
facilitate transactions in foreign securities.
— Retail foreign exchange brokers: There are two types of retail brokers
offering the opportunity for speculative trading: retail foreign
exchange brokers and market makers. Retail traders (individuals) are
a small fraction of this market and may only participate indirectly
through brokers or banks.
9. The Foreign Exchange Market
— Non-bank foreign exchange companies: Non-bank foreign
exchange companies offer currency exchange and international
payments to private individuals and companies. These are also
known as foreign exchange brokers but are distinct in that they
do not offer speculative trading but currency exchange with
payments.
— Money transfer/remittance companies: Money transfer
companies/remittance companies perform high-volume low-
value transfers generally by economic migrants back to their
home country. In 2007, the estimated that there were $369
billion of remittances (an increase of 8% on the previous year).
The largest and best known provider is Western Union with
345,000 agents globally.
9. The Foreign Exchange Market Setting
The foreign exchange market is unique because of
— its trading volumes,
— the extreme liquidity of the market,
— its long trading hours: 24 hours a day except on weekends
(from 22:00 UTC on Sunday until 22:00 UTC Friday),
— the variety of factors that affect exchange rates.
— the low margins of profit compared with other markets of
fixed income (but profits can be high due to very large
trading volumes)
— The foreign exchange market is a geographical dispersion,
broker-dealer market, and hence lacks transparency.
— Dealers can trade in a number of ways:
— direct telephone contact with a dealer at another bank (direct
dealing)
— telephone contact with a voice broker
— electronic direct trading and broking systems
9. The foreign exchange market
9. The foreign exchange market
9. The foreign exchange market
9. The foreign exchange market
Determinants of FX rates
— International parity conditions: purchasing power parity, interest rate
parity, Domestic Fisher effect, International Fisher effect. Though to some
extent the above theories provide logical explanation for the fluctuations in
exchange rates, yet these theories falter as they are based on challengeable
assumptions [e.g., free flow of goods, services and capital] which seldom
hold true in the real world.
— Balance of payments: This model, however, focuses largely on tradable
goods and services, ignoring the increasing role of global capital flows. It
failed to provide any explanation for continuous appreciation of dollar
during 1980s and most part of 1990s in face of soaring US current account
deficit.
— Asset market: It views currencies as an important asset class for
constructing investment portfolios. Assets prices are influenced mostly by
people’s willingness to hold the existing quantities of assets, which in turn
depends on their expectations on the future worth of these assets. The asset
market model of exchange rate determination states that “the exchange rate
between two currencies represents the price that just balances the relative
supplies of, and demand for, assets denominated in those currencies.”
9. The foreign exchange market
The spread
— The difference between selling and buying rates
called the spread. E.g. Bank bid to buy foreign
exchange rate at lower rates than the exchange
rate quoted to sell.
Spot market
— Spot market is where currencies are traded for
current delivery (actually, deposits traded in the
foreign exchange market generally take 2 working
days to clear).
9. The foreign exchange market
Foreign Exchange Market Products and Activities
Spot Rate Quotations
— Direct quotation
— the U.S. dollar equivalent
— e.g. “a Japanese Yen is worth about a penny”
— Indirect Quotation
— the price of a U.S. dollar in the foreign currency
— e.g. “you get 100 yen to the dollar”
9. The foreign exchange market
Country USD
equiv
Friday
USD equiv
Thursday
Currency per
USD Friday
Currency per
USD Thursday
Argentina (Peso) 0.3309 0.3292 3.0221 3.0377
Australia (Dollar) 0.5906 0.5934 1.6932 1.6852
Brazil (Real) 0.2939 0.2879 3.4025 3.4734
Britain (Pound) 1.5627 1.5669 0.6399 0.6386
1 Month Forward 1.5596 1.5629 0.6412 0.6398
3 Months Forward 1.5535 1.5568 0.6437 0.6423
6 Months Forward 1.5445 1.5477 0.6475 0.6461
Canada (Dollar) 0.6692 0.6751 1.4943 1.4813
1 Month Forward 0.6681 0.6741 1.4968 1.4835
3 Months Forward 0.6658 0.6717 1.502 1.4888
6 Months Forward 0.662 0.6678 1.5106 1.4975
Spot Rate Quotations
The direct quote
for British pound
is: £1 = $1.5627
Spot Rate Quotations
The indirect
quote for
British pound
is:
£0.6399 = $1
1.4975 1.5106 0.6678 0.662 6 Months Forward
1.4888 1.502 0.6717 0.6658 3 Months Forward
1.4835 1.4968 0.6741 0.6681 1 Month Forward
1.4813 1.4943 0.6751 0.6692 Canada (Dollar)
0.6461 0.6475 1.5477 1.5445 6 Months Forward
0.6423 0.6437 1.5568 1.5535 3 Months Forward
0.6398 0.6412 1.5629 1.5596 1 Month Forward
0.6386 0.6399 1.566 1.5627 Britain (Pound)
3.4734 3.4025 0.2879 0.2939 Brazil (Real)
1.6852 1.6932 0.5934 0.5906 Australia (Dollar)
3.0377 3.0221 0.3292 0.3309 Argentina (Peso)
Currency per
USD Thursday
Currency per
USD Friday
USD equiv
Thursday
USD equiv
Friday Country
Spot Rate Quotations
Note that the
direct quote is
the reciprocal of
the indirect
quote:
1
1.5627
0.6399
=
1.4975 1.5106 0.6678 0.662 6 Months Forward
1.4888 1.502 0.6717 0.6658 3 Months Forward
1.4835 1.4968 0.6741 0.6681 1 Month Forward
1.4813 1.4943 0.6751 0.6692 Canada (Dollar)
0.6461 0.6475 1.5477 1.5445 6 Months Forward
0.6423 0.6437 1.5568 1.5535 3 Months Forward
0.6398 0.6412 1.5629 1.5596 1 Month Forward
0.6386 0.6399 1.566 1.5627 Britain (Pound)
3.4734 3.4025 0.2879 0.2939 Brazil (Real)
1.6852 1.6932 0.5934 0.5906 Australia (Dollar)
3.0377 3.0221 0.3292 0.3309 Argentina (Peso)
Currency per
USD Thursday
Currency per
USD Friday
USD equiv
Thursday
USD equiv
Friday Country
Settlement and Settlement Risk
Settlement and Settlement Risk
Forward exchange market
— Forward exchange market is where currencies may
be bought and sold for delivery in future period.
— Forward premium means that the forward
exchange rate exceeds the current spot rate.
— Forward discount means that the forward
exchange rate is less than the current spot rate.
9. The foreign exchange market
Forward Rate Quotations
— Consider the example from above:
For British pound, the spot rate is
£1.00 = $1.5627
While the 180-day forward rate is
£1.00 = $1.5445
— What’s up with that?
9. The foreign exchange market
Forward Rate Quotations
Clearly the
market
participants
expect that
the pound
will be
worth less
in dollars in
six months.
1.4975 1.5106 0.6678 0.662 6 Months Forward
1.4888 1.502 0.6717 0.6658 3 Months Forward
1.4835 1.4968 0.6741 0.6681 1 Month Forward
1.4813 1.4943 0.6751 0.6692 Canada (Dollar)
0.6461 0.6475 1.5477 1.5445 6 Months Forward
0.6423 0.6437 1.5568 1.5535 3 Months Forward
0.6398 0.6412 1.5629 1.5596 1 Month Forward
0.6386 0.6399 1.566 1.5627 Britain (Pound)
3.4734 3.4025 0.2879 0.2939 Brazil (Real)
1.6852 1.6932 0.5934 0.5906 Australia (Dollar)
3.0377 3.0221 0.3292 0.3309 Argentina (Peso)
Currency per
USD Thursday
Currency per
USD Friday
USD equiv
Thursday
USD equiv
Friday Country
— Forward Exchange Market: where currencies may be bought and sold
for delivery in a future period.
— For 1 month S(£/$) = forward rate F(£/$) for £:
— if for 1 month S(£/$) < F(£/$)! forward premium
— if for 1 month S(£/$) > F(£/$)! forward discount
— Used to avoid the risk of exchange rate changes
— Suppose I need to pay my supplier of US-cars in dollar (10,000$) in 1
month:
— S(£/$) = 0.69; for 1 month F(£/$) = 0.70 but in one month S(£/$) = 0.71
— If I sign the forward contract I would need £7,000 instead of £7,100.
9. The foreign exchange market
Forward Premium or discount
Forward Premium
— The percentage difference (annualized) between the current forward rate
and spot rate is the forward premium (if positive) or discount (if negative).
— For example, suppose the € is appreciating from S($/€) = 0.5235 to
F
180
($/€) = 0.5307
— The forward premium or the percentage return (annualized) is given by:
— We may approximate this using natural logarithms as:
180
180, /$
($/ ) ($/ ) 360 .5307 .5235
.01375
($/ ) 180 .5235
F S
FP
S
- -
= ´ = =
, / $ ,
($/ ) 360 360
ln ( )
($/ )
n
n n t t
F
fp f s
S n n
é ù
= ´ = - ´
ê ú
ë û
Í2 = .02750
Foreign Exchange Swap
— an agreement to trade currencies at one date and
reverse the trade at a later trade.
— Citibanks wants pounds now and arranges a swap
with Barclays.
— Citibanks trades dollars for pounds now and pounds
for dollars in one month.
— Swap is like borrowing on one currency while
lending another currency for the duration of the
swap period
9. The foreign exchange market
Foreign Exchange Market Products and Activities
9. The Foreign Exchange Market
S(£/$) = 0.69; for 1 month F(£/$) = 0.70
Annual % return of pound : 0.014 x 12 = 0.17
— Speculation entails more than the assumption of a
risky position. It implies financial transactions
undertaken when an individual’s expectations differ
from the market’s expectation.
9. The foreign exchange market
Simple Hedging Strategies
Activity to Hedge Strategy
Payable in domestic currency Nothing, no FX risk.
Payable in foreign currency Accelerate payment if foreign currency
expected to appreciate.
Delay payment if foreign currency
expected to depreciate.
Receivable in domestic
currency
No FX risk.
Receivable in foreign currency Accelerate payment if foreign currency
expected to depreciate.
Delay payment if foreign currency
expected to appreciate.
— Arbitrage is the simultaneous, or nearly
simultaneous, purchase of securities in one market
for sale in another market with the expectation of a
risk-free profit.
— Cross rates arbitrage condition:
— $/£ = x$, ¥/£ = y¥ => $/¥ = ($/£)/(¥/£)
— Cross rate means that the third exchange rate
implied by any two exchange rates involving three
currencies.
9. The foreign exchange market
Cross Rates
— Suppose that S($/£) = .50
— i.e. $1 = 2 £
— and that S(¥/£) = 50
— i.e. £1 = ¥50
— What must the $/¥ cross rate be?
$ $
since ,
¥ ¥
= ´
£
£
$1 1 $1
($/ ¥) .01 or $1 ¥100
2 ¥50 ¥100
S ´ = Þ = =
£ 2
£ 1
Triangular Arbitrage
$
£
¥
Credit
Lyonnais
S(£/$)=1.50
Credit Agricole
S(¥/£)=85
Barclays
S(¥/$)=120
Suppose we
observe these
banks posting
these exchange
rates.
First calculate the
implied cross
rates to see if an
arbitrage exists.
Government intervention & factors
influenced
— Supply and demand for any given currency, and
thus its value, are not influenced by any single
element, but rather by several. These elements
generally fall into three categories:
— Economic factors,
— Political conditions and
— Market psychology.
9. The foreign exchange market
Economic factors
These include:
1. Economic policy comprises:
Government fiscal policy (budget/spending practices) and
monetary policy (the means by which a government's
central bank influences the supply and "cost" of money,
which is reflected by the level of interest rates).
2. Economic conditions include:
• Government budget deficits or surpluses
• Balance of trade levels and trends
• Inflation levels and trends
• Economic growth and health
• Productivity of an economy
The Effect of a Government Budget Deficit
Loanable Funds
(in billions of dollars)
0
Interest
Rate
3. . . . and reduces the equilibrium
quantity of loanable funds.
S
2
2. . . . which
raises the
equilibrium
interest rate . . .
Supply, S
1
Demand
$1,200
5%
$800
6%
1. A budget deficit
decreases the
supply of loanable
funds . . .
Copyright©2004 South-Western
e
Income, Output, Y
LM*
IS*
e
Income, Output, Y
LM*
IS*
IS*'
LM*'
When income rises in a small open economy, due to
the fiscal expansion, the interest rate tries to rise but
capital inflows from abroad put downward pressure
on the interest rate.This inflow causes an increase in
the demand for the currency pushing up its value
and thus making domestic goods more expensive
to foreigners (causing a DNX). The DNX offsets
the expansionary fiscal policy and the effect on Y.
When the increase in the money supply puts downward
pressure on the domestic interest rate, capital flows out
as investors seek a higher return elsewhere. The capital
outflow prevents the interest rate from falling. The
outflow also causes the exchange rate to depreciate
making domestic goods less expensive relative to
foreign goods, and stimulates NX. Hence, monetary
policy influences the e rather than r.
+DG, or –DT Þ
+De, no DY
+DM Þ
-De, +DY
The Mundell-Fleming Model
Under Floating Exchange Rates
Political conditions
• Internal, regional, and international political conditions and events can
have a profound effect on currency markets.
• All exchange rates are susceptible to political instability and
anticipations about the new ruling party. Political turmoil and
instability can have a negative impact on a nation's economy. For
example, destabilization of coalition governments in Pakistan and
Thailand can negatively affect the value of their currencies.
• Similarly, in a country experiencing financial difficulties, the rise of a
political faction that is seeming to be fiscally responsible can have the
opposite effect.
• Also, events in one country in a region may spur positive or negative
interest in a neighbouring country and, in the process, affect its
currency.
Market psychology
Market psychology and trader perceptions influence the
foreign exchange market in a variety of ways:
• Flights to quality
• Long-term trends
• "Buy the rumor, sell the fact"
• Economic numbers
• Technical trading considerations
Daily Trading Volumes by Hour
FX Turnover (2002)
FX Turnover (2008)
This approximately $3.21 trillion in main
foreign exchange market turnover was
broken down as follows:
• $1.005 trillion in spot transactions
• $362 billion in outright forwards
• $1.714 trillion in foreign exchange swaps
• $129 billion estimated gaps in reporting
— The rate at which one currency can be exchanged
for another e.g.
— £1 = $1.90
— £1 = €1.50
— Important in trade and investments
10. The exchange rate
Converting currencies:
— To convert £ into (e.g.) $ - Multiply the sterling
amount by the $ rate
— To convert $ into £ - divide by the $ rate: e.g.
— To convert £5.70 to $ at a rate of 1£ = $1.90,
multiply 5.70 x 1.90 = $10.83
— To convert $3.45 to £ at the same rate, divide 3.45 by 1.90
= £1.82
10. The exchange rate
Determinants of Exchange Rates :
— Exchange rates are determined by the demand for
and the supply of currencies on the foreign
exchange market
— The demand and supply of currencies is in turn
determined by:
10. The exchange rate
— Relative interest rates
— Changes in relative inflation rates
— The demand for imports
— The demand for exports
— Investment opportunities
— Speculative sentiments
— Global trading patterns
10. The exchange rate
Factors affecting R
D
R
D
shifts right when:
i
D
, because R
D
at each S
t
Note: This assumes that
domestic π
e is
unchanged, so
domestic real rate
Factors affecting R
F
R
F
curve shifts right when:
i
F
because R
F
at each S
t
E(S
t+1
) because expected
appreciation of Foreign Deposits
causes R
F
Other factors that will shift R
F
rightward:
1. Domestic P
2. Imports
3. Exports
4. Productivity
Factors that Shift R
F
and R
D
Factors that Shift R
F
and R
D
Appreciation of the exchange rate:
— A rise in the value of £ in relation to other
currencies – each £ buys more of the other
currency e.g.
— £1 = $1.85 £1 = $1.91
— UK exports appear to be more expensive
( Xp)
— Imports to the UK appear to be cheaper
( Mp)
10. The exchange rate
Exchange Rates
$ per £
Quantity on
Foreign Ex. Markets


1.85
Q1

1
Q2
Shortage
1.90
Q3
Assume an initial
exchange rate of
£1 = $1.85. There
are rumours that
the UK is going to
increase interest
rates
Investing in the
UK would now be
more attractive
and demand for £
would rise
The rise in demand
creates a shortage
in the relationship
between demand
for £ and supply –
the price (exchange
rate) would rise
10. The exchange rate
Depreciation of the Exchange Rate
— A fall in the value of the £ in relation to other
currencies - each £ buys less of the foreign
currency e.g.
— £1 = € 1.50 £1 = € 1.45
— UK exports appear to be cheaper
( Xp)
— Imports to the UK appear more expensive
( Mp)
10. The exchange rate
Exchange Rates
$ per £
(£ per $)
Quantity on
Foreign Ex. Markets
D£ (D$)
S£ (S$)
1.85 (0.54)
Q1 Q2
Surplus
1.70 (0.58)
Q3
Assume an initial
exchange rate of £1
= $1.85. There are
rumours that the
UK is going to
decrease interest
rates
Investing in the UK
would now be not
more attractive and
supply for £ would
rise

1
The rise in supply
creates a surplus in
the relationship
between supply for
£ and demand – the
price (exchange
rate) would decline
10. The exchange rate
S’£ (S$)
— A depreciation in exchange rate should lead to a rise
in demand for exports, a fall in demand for imports –
the balance of payments should ‘improve’
— An appreciation of the exchange rate should lead to a
fall in demand for exports and a rise in demand for
imports – the balance of payments should get ‘worse’
BUT
10. The exchange rate
What is the government debt
and the annual budget deficit?
Annual Deficit (2002)
Annual Deficit (2001)
Annual Deficit (2000)
Annual Deficit (1999)
Annual Deficit (1998)
Annual Deficit (1997)
The government debt
is an accumulation
of all past annual
deficits. In 2001, the
debt of the U.S. federal
government was $3.2
trillion.
When a government spends more than it collects in taxes, it borrows
from the private sector to finance the budget deficit.
What Does the Trade Balance
Really Mean?
— So in spite of its name, and it’s definition, the
trade balance
— Is not really about trade, which is just the symptom
— It is about whether we are living within our means
— When is a trade deficit good?
— When the country (like a young person) is investing
for the future (like a successful developing country)
— Not when it is going into debt just to finance current
consumption (like the US)
Imports (Debits)
§ Current Account: (M)
§ Goods and services
§ Factor- and assets income
§ Assets transfer (= transfer
account)
§ Aids, gifts etc. (= unilateral
transfer)
§ Capital Account: (CM)
§ Direct investments
§ Security purchase
§ Bank claims, liabilities,
obligations, etc.
§ Government assets abroad
Exports (Credits)
§ Current Account: (X)
§ Goods and services
§ Factor- and assets income
§ Assets transfer (= transfer
account)
§ Aids, gifts etc. (= unilateral
transfer)
§ Capital Account: (CX)
§ Direct investments
§ Security purchase
§ Bank claims, liabilities,
obligations, etc.
§ Government assets abroad
International Transactions: Data
279
The U.S. Balance of Payments, 2005 (Millions of Dollars)
International Transactions: Data
Exchange Rates
— The volumes and the actual amount of income
and expenditure will depend on the relative price
elasticity of demand for imports and exports.
— Elasticity of M = %ΔQ
M
/% ΔP
M
— Elasticity of X = %ΔQ
X
/% ΔP
X
10. The exchange rate
Exchange Rates
— Floating Exchange Rates:
— Price determined only by demand and supply of the
currency – no government intervention
— Fixed Exchange Rates:
— The value of a currency fixed in relation to an
anchor currency – not allowed to fluctuate
— Dirty Floating or Managed Exchange Rate:
– rate influenced by government via central bank
around a preferred rate
10. The exchange rate
Fixed vs Flexible Exchange Rate
Regimes
Pro & Cons for Floating Exchange Rate
— Arguments in favor of flexible exchange rates:
— Easier external adjustments.
— National policy autonomy.
— Arguments against flexible exchange rates:
— Exchange rate uncertainty may hamper
international trade.
— No safeguards to prevent crises.
Fixed vs Flexible Exchange Rate
Regimes
— Suppose the exchange rate is $1.40/£ today.
— In the next slide, we see that demand for British
pounds far exceed supply at this exchange rate.
— The U.S. experiences trade deficits.
Fixed vs Flexible Exchange Rate
Regimes
S D
Q of £
D
o
l
l
a
r

p
r
i
c
e

p
e
r

£

(
e
x
c
h
a
n
g
e

r
a
t
e
)
$1.40
Trade deficit
Demand
(D)
Supply
(S)
Flexible Exchange Rate
Regimes
— Under a flexible exchange rate regime, the dollar will
simply depreciate to $1.60/£, the price at which supply
equals demand and the trade deficit disappears.
Fixed vs Flexible Exchange Rate
Regimes
Supply
(S)
Demand
(D)
Demand (D*)
D = S
Dollar depreciates
(flexible regime)
Q of £
D
o
l
l
a
r

p
r
i
c
e

p
e
r

£

(
e
x
c
h
a
n
g
e

r
a
t
e
)
$1.60
$1.40
Fixed vs Flexible Exchange Rate
Regimes
— Instead, suppose the exchange rate is “fixed” at
$1.40/£, and thus the imbalance between supply and
demand cannot be eliminated by a price change.
— The government would have to shift the demand
curve from D to D*
— In this example this corresponds to contractionary
monetary and fiscal policies.
Fixed vs Flexible Exchange Rate
Regimes
Supply
(S)
Demand
(D)
Demand (D*)
D* = S
Contractionary
policies
(fixed regime)
Q of £
D
o
l
l
a
r

p
r
i
c
e

p
e
r

£

(
e
x
c
h
a
n
g
e

r
a
t
e
)
$1.40
Purchasing Power Parity (PPP)
— The nominal exchange rate e is the price in foreign
currency of one unit of a domestic currency.
— The real exchange rate (RER) is defined as
RER = e(P/P
f
), where P
f
is the foreign price level
(price index) and P the domestic price level (price
index).
10. The exchange rate
Purchasing Power Parity
in a Perfect Capital Market
— Purchasing power parity (PPP) is built on the notion
of arbitrage across goods markets and the Law of One
Price. P and P
f
must have the same arbitrary value in
some chosen base year. Hence in the base year, RER =
e.
— The Law of One Price is the principle that in a PCM
setting, homogeneous goods will sell for the same
price in two markets, taking into account the
exchange rate.
£ / $ wheat UK, wheat US,
S P P ´ =
— The RER is only a theoretical ideal. In practice, there
are many foreign currencies and price level values to
take into consideration.
— Correspondingly, the model calculations become
increasingly more complex. Furthermore, the model
is based on purchasing power parity (PPP), which
implies a constant RER.
— The empirical determination of a constant RER value
could never be realized, due to limitations on data
collection.
10. The exchange rate
Purchasing Power Parity (PPP)
Purchasing Power Parity and Exchange Rate
Determination
— The exchange rate between two currencies should equal the
ratio of the countries’ price levels:
S($/£) =
P
£
P
$
S($/£) =
P
£
P
$
£150
$300
= = $2/£
For example, if an ounce of gold costs $300 in the U.S. and £150
in the U.K., then the price of one pound in terms of dollars
should be:
— The exchange rate would be a proper reflection of the
purchasing power in each country if the relative values
bought the same amount of goods in each country.
— E.g. if the price of a pint of Stella in the UK was £3.00
and in Europe €4.50, the exchange rate between the
two countries should be £1 = €1.50
— If any lower than this value, the £ would be
undervalued and if any higher, the £ would be
overvalued.
10. The exchange rate
Purchasing Power Parity and Exchange Rate Determination
Purchasing Power Parity and Overvalued
or Undervalued Currencies
— Nominal exchange rates greater than the PPP implied
exchange rate represent foreign currency overvaluation,
— while nominal exchange rates less than the PPP implied
exchange rate represent domestic overvaluation (or
foreign undervaluation).
The Big Mac PPP Standard
— PPP exchange rates are especially useful when
official exchange rates are artificially manipulated
by governments.
— Countries with strong government control of the
economy sometimes enforce official exchange
rates that make their own currency artificially
strong.
— By contrast, the currency's black market exchange
rate is artificially weak. In such cases a PPP
exchange rate is likely the most realistic basis for
economic comparison.
10. The exchange rate
Purchasing Power Parity and Exchange Rate
Determination
11. The Balance of Payments
— A record of the trade between one Country
(UK) and the rest of the world.
— Trade in goods
— Trade in services
— Income flows
= Current Account
— Transfer of funds and sale of assets and liabilities
= Capital Account
Imports (Debits)
§ Current Account: (M)
§ Goods and services
§ Factor- and assets income
§ Assets transfer (= transfer
account)
§ Aids, gifts etc. (= unilateral
transfer)
§ Capital Account: (CM)
§ Direct investments
§ Security purchase
§ Bank claims, liabilities,
obligations, etc.
§ Government assets abroad
Exports (Credits)
§ Current Account: (X)
§ Goods and services
§ Factor- and assets income
§ Assets transfer (= transfer
account)
§ Aids, gifts etc. (= unilateral
transfer)
§ Capital Account: (CX)
§ Direct investments
§ Security purchase
§ Bank claims, liabilities,
obligations, etc.
§ Government assets abroad
11. The Balance of Payments
U.S. Balance of Payments Data
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account
($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account
$444.26
7 Statistical Discrepancies
Overall Balance
$0.30
Official Reserve Account
($0.30)
0.73
§ Balance of payments equilibrium:
§ X + CM = M + CX
§ => X – M = CX – CM
§ If X > M => CX > CM => The Country exports
capital.
§ If X < M => CX < CM => The Country imports
capital.
11. The Balance of Payments
§ Balance of trade (BT) is the value of
merchandise exports minus import:
§ BT = X - M
§ Basic Balance is the current account plus long
term capital.
11. The Balance of Payments
The Balance of Payments Identity
BCA + BKA + BRA = 0
where
BCA = balance on current account
BKA = balance on capital account
BRA = balance on the reserves account
Under a pure flexible exchange rate regime,
BCA + BKA = 0
Because BRA = 0
U.S. Balance of Payments Data
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account
($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account
$444.26
7 Statistical Discrepancies
Overall Balance
$0.30
Official Reserve Account
($0.30)
0.73
U.S. Balance of Payments Data
In 2000, the
U.S. imported
more than it
exported, thus
running a
current account
deficit of
$444.69
billion.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account
($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account
$444.26
7 Statistical Discrepancies
Overall Balance
$0.30
Official Reserve Account
($0.30)
0.73
U.S. Balance of Payments Data
During the
same year, the
U.S. attracted
net investment
of $444.26
billion clearly
the rest of the
world found the
U.S. to be a
good place to
invest.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account
($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account
$444.26
7 Statistical Discrepancies
Overall Balance
$0.30
Official Reserve Account
($0.30)
0.73
U.S. Balance of Payments Data
Under a pure
flexible
exchange rate
regime, these
numbers would
balance each
other out.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account
($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account
$444.26
7 Statistical Discrepancies
Overall Balance
$0.30
Official Reserve Account
($0.30)
0.73
U.S. Balance of Payments Data
In the real
world, there
is a statistical
discrepancy.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account
($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account
$444.26
7 Statistical Discrepancies
Overall Balance
$0.30
Official Reserve Account
($0.30)
0.73
U.S. Balance of Payments Data
Including that,
the balance of
payments
identity should
hold:
BCA + BKA = BRA
-($444.69) + $444.26 + $0.73 = $0.30= ($0.30)
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account
($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account
$444.26
7 Statistical Discrepancies
Overall Balance
$0.30
Official Reserve Account
($0.30)
0.73
Balance of Payments and the Exchange
Rate
Q
P
Exchange rate $
Credits Debits
Current Account
1 Exports
$1,418.64
2 Imports
($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account
($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account
$444.26
7 Statistical Discrepancies
Overall Balance
$0.30
Official Reserve Account
($0.30)
0.73
S
D
Q
P
As U.S. citizens import, they supply dollars to the FOREX market.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account
($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account
$444.26
7 Statistical Discrepancies
Overall Balance
$0.30
Official Reserve Account
($0.30)
0.73
Exchange rate $
S
D
Balance of Payments and the Exchange
Rate
Q
P
As U.S. citizens export, others demand dollars in the FOREX market.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account
($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account
$444.26
7 Statistical Discrepancies
Overall Balance
$0.30
Official Reserve Account
($0.30)
0.73
Exchange rate $
S
D
Balance of Payments and the Exchange
Rate
Q
P S
D
As the U.S. government sells dollars, the supply of dollars increases.
S
1
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account
($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account
$444.26
7 Statistical Discrepancies
Overall Balance
$0.30
Official Reserve Account
($0.30)
0.73
Exchange rate $
Balance of Payments and the Exchange
Rate
Statistical Discrepancy
What is the government debt
and the annual budget deficit?
Annual Deficit (2002)
Annual Deficit (2001)
Annual Deficit (2000)
Annual Deficit (1999)
Annual Deficit (1998)
Annual Deficit (1997)
The government debt
is an accumulation
of all past annual
deficits. In 2001, the
debt of the U.S. federal
government was $3.2
trillion.
When a government spends more than it collects in taxes, it borrows
from the private sector to finance the budget deficit.
What Does the Trade Balance
Really Mean?
— So in spite of its name, and it’s definition, the
trade balance
— Is not really about trade, which is just the symptom
— It is about whether we are living within our means
— When is a trade deficit good?
— When the country (like a young person) is investing
for the future (like a successful developing country)
— Not when it is going into debt just to finance current
consumption (like the US)
Balances on the Current (BCA) and Capital (BKA)
Accounts of the United States
-500
-400
-300
-200
-100
0
100
200
300
400
500
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
U.S. BCA
U.S. BKA
Balances on the Current (BCA) and Capital (BKA)
Accounts of United Kingdom
-50
-40
-30
-20
-10
0
10
20
30
40
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
UK BCA
UK BKA
Balances on the Current (BCA) and Capital (BKA)
Accounts of Japan
-150
-100
-50
0
50
100
150
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
Japan BCA
Japan BKA
Balances on the Current (BCA) and Capital (BKA)
Accounts of Germany
-80
-60
-40
-20
0
20
40
60
80
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
Germany BCA
Germany BKA
Balances on the Current (BCA) and Capital (BKA)
Accounts of China
-15
-10
-5
0
5
10
15
20
25
30
35
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
China BCA
China BKA
11. Interest Rates & Exchange Rates
—What is the interest rate?
—What is its relationship to exchange
rates?
Four Types of Credit Instruments
1. Simple loan
2. Fixed-payment loan
3. Coupon bond
4. Discount (zero coupon) bond
Concept of Present Value
Simple loan of $1 at 10% interest
Year 1 2 3 n
$1.10 $1.21 $1.33 $1 x (1 + i)
n
$FV
PV of future $1 =
(1 + i)
n
Present Value
Yield to Maturity: Loans
1. Simple Loan (i = 10%)
$100 = $110/(1 + i) Þ
$110 – $100 $10
i = = = 0.10 = 10%
$100 $100
2. Fixed Payment Loan (i = 12%)
$126 $126 $126 $126
$1000 = + + + ... +
(1+i) (1+i)
2
(1+i)
3
(1+i)
25
FP FP FP FP
LV = + + + ... +
(1+i) (1+i)
2
(1+i)
3
(1+i)
n
Yield to Maturity: Bonds
Þ
4. Discount Bond (P = $900, F = $1000), one year
$1000
$900 =
(1+i)
$1000 $900
i = = 0.111 = 11.1%
$900
F P
i =
P
3. Coupon Bond (Coupon rate = 10% = C/F)
$100 $100 $100 $100 $1000
P = + + + ... + +
(1+i) (1+i)
2
(1+i)
3
(1+i)
10
(1+i)
10
C C C C F
P = + + + ... + +
(1+i) (1+i)
2
(1+i)
3
(1+i)
n
(1+i)
n
Consol: Fixed coupon payments of $C forever
C C
P = i =
i P
Yield to Maturity: Bonds
Current Price or (Current Price + Par Value)/2
Yield to Maturity: Bonds
Distinction Between Interest
Rates and Returns
Rate of Return
C + P
t+1
– P
t
RET = = i
c
+ g
P
t
C
where: i
c
= = current yield
P
t
P
t+1
P
t
g = = capital gain
P
t
Relationship Between Price
and Yield to Maturity
Real Interest Rate (the Fisher hypothesis (sometimes Fisher
parity)
—Interest rate that is adjusted for expected changes in the
price level
— i
r
= i
n
– π
e
— Real interest rate (i
r
) more accurately reflects true cost of
borrowing
— When real rate is low, greater incentives to borrow and less
to lend
—if i
n
= 5% and π
e
= 3% then:
i
r
= 5% – 3% = 2%
—if i
n
= 8% and π
e
= 10% then
i
r
= 8% – 10% = –2%
Distinction Between Real & Nominal
Interest Rates
U.S. Real and Nominal
Interest Rates
The Fisher hypothesis says that the real interest rate
in an economy is independent of monetary variables.
If we add to this the assumption that real interest
rates are equated across countries, then the country
with the lower nominal interest rate would also have a
lower rate of inflation and hence the real value of its
currency would rise over time.
The International Fisher Effect
—Suppose that the current spot exchange rate for U.S.
Dollars into British Pounds is $1.4339 per pound. If the
current interest rate is 5 percent in the U.S. and 7 percent
in Britain, what is the expected spot exchange per pound
rate 12 months from now according to the International
Fisher Effect?
—The International Fisher Effect estimates future exchange
rates based on the relationship in nominal interest rates.
Multiplying the current spot exchange rate by the nominal
annual U.S. interest rate and dividing by the nominal
annual British interest rate yields the estimate of the spot
exchange rate 12 months from now ($1.4339 * 1.05) / 1.07 =
$1.4071.
The International Fisher Effect
Covered Interest Parity (CIP)
Suppose you have $100,000 to invest for one year.
You can either
1. invest in the U.S. at i
$
. Future value = $100,000(1 + i
$
)
or
2. trade your dollars for pounds at the spot rate, invest in England at i
£
and be cautious your exchange rate risk by selling the future value of
the British investment forward.
The future value = $100,000(F/S)(1 + i
£
)
Since both of these investments have the same risk, they must have
the same future value—otherwise an arbitrage would exist, therefore
(F/S)(1 + i
£
) = (1 + i
$
)
Covered Interest Parity (CIP)
Formally,
(F/S)(1 + i
£
) = (1 + i
$
)
or if you prefer,
IRP is sometimes approximated as
1 + i
£
1 + i
$
=
S
F
i
$
i
£ =
S
F – S
Covered Interest Parity (CIP)
— Depending upon how you quote the exchange rate ($ per £
or £ per $) we have:
1 + i
$
1 + i
£
S
£/$
F
£/$
=
1 + i
$
1 + i
£
S
$/£
F
$/£
=
or
CIP and Covered Interest
Arbitrage
A trader with $1,000 to invest could invest in the U.S., in one year
his investment will be worth $1,071 = $1,000´(1+ i
$
) =
$1,000´(1.071)
Alternatively, this trader could exchange $1,000 for £800 at the
prevailing spot rate, (note that £800 = $1,000÷$1.25/£) invest £800
at i
£
= 11.56% for one year to achieve £892.48. Translate £892.48
back into dollars at F
360
($/£) = $1.20/£, the £892.48 will be exactly
$1,071.
Interest Rate Parity
According to IRP only one 360-day forward rate,
F
360
($/£), can exist. It must be the case that
F
360
($/£) = $1.20/£
Why?
If F
360
($/£) ¹ $1.20/£, an smart trader could make money
with one of the following strategies:
Arbitrage Strategy I
If F
360
($/£) > $1.20/£
i. Borrow $1,000 at t = 0 at i
$
= 7.1%.
ii. Exchange $1,000 for £800 at the prevailing spot
rate, (note that £800 = $1,000÷$1.25/£) invest £800
at 11.56% (i
£
) for one year to achieve £892.48
iii. Translate £892.48 back into dollars, if
F
360
($/£) > $1.20/£ , £892.48 will be more than enough
to repay your dollar obligation of $1,071.
Arbitrage Strategy II
If F
360
($/£) < $1.20/£
i. Borrow £800 at t = 0 at i
£
= 11.56% .
ii. Exchange £800 for $1,000 at the prevailing spot
rate $1.20/£, invest $1,000 at 7.1% for one year to
achieve $1,071.
iii. Translate $1,071 back into pounds, if
F
360
($/£) < $1.20/£ , $1,071 will be more than enough
to repay your £ obligation of £892.48.
Dollarization
— Dollarization: occurs when residents of a
country extensively use a foreign currency
alongside or instead of the domestic
currency.
— Official dollarization occurs when the
government adopts the foreign currency as
a legal tender.
12. Dollarization
— Unofficial dollarization: there is no legal element.
(different stages: asset substitution (holding foreign
bonds and deposits abroad), currency substitution
(holding foreign currency deposits in domestic
banking system).
— Panama is an example of official dollarization;
— Andorra had two currencies as legal tender: French
franc and Spanish Peseta.
— Difficult to assess the performance of dollarized
economy: not much evidence.
12. Dollarization
How does dollarization work?
— An officially dollarized country is part of a unified
currency zone with the country whose currency it
uses, otherwise called issuing country.
— An officially dollarized country relinquish (giving up)
independent monetary policy and imports monetary
policy of the country whose currency it uses.
12. Dollarization
— Within the currency zones, arbitrage tends to keep
prices of similar goods within a narrow range =>
inflation rates tend to be similar throughout the zone.
— Interest rates tend also to be equalized across the
currency zone (still country risk element might
contributing in creating a wedge between interest
rates).
— Supplied of money is determined by the balance of
payment: the monetary base is determined by the
issuing country and if people want to acquire more
foreign currency notes they have to spend less.
12. Dollarization
Cost of dollarization for officially dollarized
Countries:
— Lost of seigniorage (profit by government);
— One time cost of converting prices;
— Losing central bank as a lender of last resort;
— Losing flexibility in monetary and exchange rate
policy;
12. Dollarization
Benefits of dollarization for officially dollarized
Countries:
— Lower transaction costs;
— Reducing the country risk premium on foreign
borrowing;
— Lower inflation and lower risk of future inflation;
— Greater economic openness and transparency;
12. Dollarization
When should countries adopt an official
Dollarization regime?
— History of poor monetary performance;
— Many economists have proposed the theory of
optimum currency area to judge where official
dollarization is desirable.
— Critical role of major trading partners;
— Political considerations;
12. Dollarization
· ·.·. .
THANKS YOU

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