Onyx Eco244 Full Notes 71khqv

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Macro Eco 2
Monetary Policy | International Trade | International Finance
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18
MONETARY POLICY
Ultimate objectives
Internal price level stability (a low inflation rate) should achieve low inflation
Financial stability (stability of the financial sector)
Balance of payments and exchange rate stability
Employment and income stability (stability in the business cycle)
Intermediate objectives/targets

because of long lag:
* choice of target is also determined
Inflation

monetary
by link between the target and the

policy agency identifies an
Money supply
ultimate objective
interest

the private sector
Credit extension to

objective/ target where
Interest

rate impact
Exchange rate of instrument will be visible
earlier: therefore shows how

effective instruments are
Operational variables
* choice of target is also determined
by link between the operational objective & the
ultimate objective

rate Well
Interest developed countries

Cash reserves

(cash base)

Policy instruments
Market oriented (indirect) policy instruments conventional
instrum.
Non-market oriented (direct) policy instruments
of monetary policy
Non-conventional policy instruments
are all available to a monetary policy maker/ the central bank & have
to decide between instruments
- how will the instruments help achieve low inflation.
- if a time lag between implementation of an instrument & the effect it
will have on the ultimate objectives: makes it difficult to determine if the
policy being implemented is effective

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Macro Eco 2
International Trade
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Economics 244
International Trade
Learning Outcomes
1. Understand the current economic conditions and the implications for economic growth
concepts
2. Gain insight from International trade theories that explain why international trade matters
3. Understand why, how and to what extent governments intervene in international trade
4. Understand the multilateral global trading system and how it advances trade amongst
countries
5. Understand regional integration, its purpose and possibilities and obstacles
6. Use the insight from theory to understand how the confluence of freer trade under the
World Trade Organization’s Trade Facilitation Agreement, the African Continental Free Trade
Agreement and the Fourth Industrial Revolution can propel Africa into economic prosperity
Growth During Covid-19

World Trade fell sharply in the first half of 2020 as the COVID-19 pandemic up ended the global
economy. However, rapid government responses helped temper the contraction, and WTO
economists believe that while trade volumes will register a steep decline in 2020, they are unlikely to
reach the worst-case scenario projected in April.
The WTO Set out two plausible paths: the optimistic scenario, in which the volume of the world
merchandise trade in 2020 would contract by 13%, and a pessimistic scenario in which it would fall
by 32%. Future trade expansion could fall short due to adverse developments [such as a second
wave of COVID-19].
Policy decisions have been critical in softening the ongoing blow to output and trade, and they will
continue to play an important role in determining the place of economic recovery. For output and
trade to rebound strongly in 2021, fiscal, monetary and trade policies will need to keep pulling in the
same direction. While many industries have shown strong rebounds in the past weeks, it is
important to note that these rebounds follow historic, or near historic declines, and will need to be
carefully monitored before drawing any definite conclusions about the recovery.
The outlook for the global economy over the next two years remains highly uncertain. This is
reflected in the range of GDP estimates from other international organizations, in some cases relying
on multiple scenarios. The World Bank, OECD, and IMF have all released forecasts showing
significant slowdowns in global trade and GDP; All are broadly consistent worth the World Trade
Organization's forecast for the current year. All the estimates imply a less negative trade response to
declining GDP growth than was observed in the global financial crisis of 2008 to 2009.
There are several reasons as to why trade would respond less to changes in GDP than it did during
the financial crisis in 2008. Firstly, fiscal and monetary policies have arguably been rolled out more
quickly and on a much larger scale in the current crisis than was done in 2008. The WTO forecast
scenarios did not include an attempt to model either set of policy responses, since, at the time, these
policies were just being introduced.
Secondly, income support to households and expectations that the pandemic would eventually ease
may have encouraged consumers to maintain consumption levels at a higher level than expected.
Lastly, much of the decline in output has been concentrated in non-tradable services, such as
hospitality, personal services and entertainment, which tend to be less import-intensive than
manufacturing.
Part 1:
Why does International Trade Matter?
Theory of international trade timeline:

international trade is the exchange of capital goods and services across international borders or
territories. International trade has led to significant economic prosperity, although unevenly spread
across the globe. Economic prosperity through trade arises from:
1. the exploitation of competitive advantage - trading partners reap mutual gains when each
nation specializes and goods for which it holds comparative advantage and then engages in
trade for other products
2. gains from specialization - higher production volumes provide further cost benefits in terms
of economies of scale
3. increased competition which lowers world process and promotes efficiency
4. the breakdown of domestic monopolies
5. the potential increase in the variety and quality of goods and services
6. employment, given that employment is closely related to production
Adam Smith, the father of economics, spent much of his time arguing against the Mercantilist
theory.
Mercantilism: 1500 – 1700

Mercantilism is the first theory of international trade and it underlies the desire to build a
prosperous and powerful state. Mercantilists believed that the wealth of the nation was measured
by how much currency, which was gold and silver in late on, the National Treasury had. Exports were
seen to be good because foreign nations would pay for their goods, bringing silver and gold into
their nation . However imports, on the other hand meant that gold and silver would leave their
country in order pay for goods coming in, and it was decided that imports should thus be limited.
The mercantilists we're very powerful class and we're able to influence government policies allowing
them to achieve their goal to restrict imports. This was done by imposing strict government controls
and regulations on trade, Commerce and economic activities. The restrictive economic policies
imposed included:
 high tariffs, especially on manufactured goods
 export subsidies
 limiting wagers
 exclusive trade with colonies
 maximizing the use of domestic resources
 government support of new industries through the provision of capital and tax benefits
 the establishment of monopolies with the local and colonial market.
The government would also provide grind titles and pensions to successful producers.
Features of a mercantilist economy

1. imports of certain goods were restricted through government policies
2. the government prioritized export industries through the provision of subsidies
3. policies of nationalism were imposed
4. wealth was measured in gold and silver, and private accumulation, use or export of precious
material was prohibited
5. promotion of one-way trade with colonies an importation of precious metals from a trading
partner
Assumptions about mercantilism
1. there's a finite amount of wealth in the world
2. a nation should have a positive balance of trade by exporting more than its imports
3. a nation can only grow rich at the expense of other nations, therefore trade is a zero-sum
game
The view of trade as a zero-sum game not only encouraged the adoption of complex government
trade restrictions, which raised prices and stunted the growth and freedom of businesses, but it also
ignited the conflict between trading parties and colonies in some instances. While the decline of
mercantilism can be linked to the rise of the laissez-faire doctrine of free market economics, it is the
publication of Adam Smith's “The Wealth of Nations” that was generally thought to mark the end of
the mercantilist era. Adam Smith coined the term “mercantile system” To describe the system of
political economy that sought to enrich the country by restraining imports and encouraging exports.
Adam’s Absolute Advantage: 1776

Adam Smith's “An inquiry into the nature and causes of the wealth of nations” installed him as one
of the most influential figures in the development of economic theory. Smith challenged the
mercantilist idea that national wealth was reflected in the countries Holdings of precious metals by
convincingly arguing that national wealth was reflected in a nation's productive capacity rather than
the stock of gold and silver (money).
Moreover, growth in productive capacity was fostered best in an environment where individuals are
free to pursue their self-interest. Self-interest, in tone, would lead individuals to specialize in and
exchange of goods and services based on their special abilities. Thus, gains are acquired through
division and specialization of Labor.
Adam Smith and the division of Labor

keep in mind that Adam Smith is from the 1770s. This was known as the beginning of the first
industrial revolution. Factory processes that, to us, or well-known were novelty in his day. One day
he visited a pin factory and what he saw there led him to formulate the concepts of division of Labor
and specialization that have stood the test of time for more than 200 years. He goes on to explain
how breaking a process up into smaller steps and learning to execute those steps very well through
learning, practice and specialization boost productivity. It is indisputable how this story plays today.
Smith advocated laissez-faire as he saw a little need for government control. He objected to the
merchant la system that enabled powerful merchants to enrich themselves through government
favor in the form of monopoly concessions and other privileges, while contributing nothing to the
general welfare society. Smith pointed out that government policies that favor one industry take
away resources from another industry who they might have been more gainfully employed. Smith
applied the principles of division of Labor and socialization to international trade where he explains
that in a setting where individuals can pursue their self-interest, countries would specialize in an
export goods in which they have an absolute advantage.
Absolute advantage theory

Adam Smith described absolute advantage as a particular country's capability to produce more of a
commodity at a lower cost (with less input) than its competitors could. Absolute advantage is
achieved through low-cost production , an in Adam Smith theory, there fish and see that leads to
lower costs is linked to the division of Labor and specialization. The theory is based on the following
assumptions:
1. A two-country and two commodity model are applied
2. labor is the only factor of production thus only input or production cost is taken into account
3. labor is homogeneous and mobile within a country but immobile between countries
4. free trade - no restrictions on imports or exports
5. perfect composition
6. the labor theory of value holds
7. no transport costs
The economic principle of absolute advantage implies that a country should specialize in and
produce commodities it is most efficient at making and which in turn will ensure that the price of
that commodity is competitive for all consumers. This makes trade mutually beneficial for all trading
countries, thus a positive-sum game as every country will export the commodities it has an absolute
advantage over and import the commodities it has an absolute disadvantage over. The pivot from
the mercantilist view on trade as a zero-sum game to Smith's view of trade as a positive-sum game
set the foundation for free trade and the elimination of government-imposed protectionist
measures. If a country has an absolute advantage and everything there would be no reason for them
to engage in trade with the country that has an absolute disadvantage because it produces both
goods at a lower cost.
David Ricardo’s Comparative Advantage Theory: 1800’s

This is also known as the Ricardian theory of trade. In 1817 David Ricardo expanded upon Smith
theory. Wall, in the context of a 2 country two commodity model, Adam Smith thought that a
country with an absolute advantage in both commodities would derive no benefits from trade.
Ricardo argued that gains from trade go beyond those advocated by himself.
Ricardo showed but even in the absence of a country's absolute advantage in any of the two
commodities, trade can still be favorable in a comparative advantage scenario. even if one country is
absolutely more cost efficient at producing both products, both will still gain from trade if each
produces the good in which they have a comparative advantage.
The Ricardian theory is based on comparative advantage and specialization. This classic model of
international trade attributes the basis for trade to differences in technology across nations. the
differences in technology give rise to differences in relative costs and are sources of comparative
advantage. Comparative advantage refers to the ability of a country to produce a good or service at
a relatively lower cost than another country.
Assumptions for the Ricardian model:

1. A two-country two-commodity model is applied
2. labor is the only factor of production, homogeneous and mobile within a country but
immobile between countries
3. technology does not change - there's no innovation
4. there is full employment in both countries before and after the trade
5. perfect competition prevails in all markets
6. constant returns to scale
7. free trade
8. no transport costs
David Ricardo predicts that a country will export goods in which it has the comparative advantage.
Where productivity, output per worker, is higher, Conversely, it will import the goods of its
comparative disadvantage, with productivity is lower.
A note on opportunity costs

David Ricardo explained the concept of comparative cost advantage with a simple arithmetic
example, comparing the relative cost of wine and cloth-making in England and Portugal. At the time,
the value of a product was very much dependent on the amount of Labor it took to produce it,
based on the labor theory of value. The problem was that this considered only one fact of
production. The advent of neoclassical economic theory and the toolbox of economics, especially the
introduction of opportunity cost in 1933, made it easier to explain comparative advantage.
Opportunity cost is simply the quantity of 1 good that must be given up to give one more of another.
A country has a comparative advantage if it can produce a good at a lower opportunity cost than
another country. Aloe opportunity cost means a nation has to forgo less of 1 good in order to
produce another.
Production possibilities
Recap: the production possibility frontier is a graph that shows all the different combinations of the
output of two commodities that can be produced using the total amount of available factors of
production, resources, and technology. It shows the maximum possible production level of 1
commodity for any production level of another, giving the existing levels of the factors of production
and the state of technology. The PPF captures the concept of scarcity, choice and tradeoffs.
The shape of the PPS depends on the cost structure. The usual PPF with increasing cost is jaune
concave from the origin . Conversely, APPF with decreasing cost bows inwards viewed from the origin
and one with constant cost is represented by a straight line. The slope of the PPF indicates the
opportunity cost of producing one commodity in terms of the other commodity. The opportunity cost
can be compared to the opportunity cost of another producer to determine the comparative
advantage.
An economy that is operating on the PPF is producing efficiently which means that it is impossible to
produce more of 1 good without reducing the production of the other good. Depending on a society's
preference, different combinations of products that full on the PPF curve can be chosen. If an
economy is operating below the curve, it is operating Inefficiently because resources could be
reallocated to produce more of one or of both goods without decreasing the quantity of either.
Points outside of the curve are unattainable with existing resources and technology.
The PDF will shift outwards if more inputs, such as capital or labor, become available or if
technological process is makes it possible to produce more output with the same level of inputs. If
this happens, more of one or both outputs can be produced without sacrificing the output of either
good. On the other hand, if the labor force shrinks comma the supply of raw materials is depleted
comma or natural disaster decreases the stock of A physical capital, the PPF will shift inward.
In the state of isolation without trade (autarky), each country consumes only what it produces. In this
case, the PPF also becomes the consumption possibility frontier. Trade enables consumption outside
of the PPF. The global PPF is made up of combining countries PPF's. When countries autarkic
Productions are added, the total quantity of each good produced and consumed as less than the
global PPF under free trade (when nations specialized according to their comparative advantage).
this shows that in a free trade system, the absolute quantity of goods available for consumption is
higher than the quantity available under autarky. Combining the notion of opportunity cost and the
well-known PPF as well as indifference curves, it becomes possible to illustrate the gains from trade
clearly. If we assume that we can horizontally sum these individual indifference curves, we can drive
a community indifference curve (CIC). the PPF represents the supply/production side and the CIC the
demand/consumption side of the economy for a country.
We can now use a graphical illustration to explain the gains from trade. Keep in mind that
comparative advantage is the advantage that one country has over another country if they can
produce a product at a lower opportunity cost than the other country. Opportunity cost is the value
of one product in terms of another. We start with a situation where there is no trade at all because
the country has a closed economy.
Before Trade:
possibilities for economic growth and isolation are limited and the best that a country can do is to
reach the PPF. A point beyond the PPF is unattainable and consumption would be equal to
production. The most efficient point occurs where there is a tangency between the PPF, the price
line/price ratio and the highest possible country indifference curves, ICi. an indifference curve is a
graph that shows a combination of two goods that give a consumer equal satisfaction a utility,
thereby making the consumer indifferent. Utility refers to the total satisfaction received from
consuming a good or service. Higher indifference curves represent greater levels of utility than lower
ones.
Now assume that international trade becomes an attractive option for this country.
After trade:
when markets open to trade, trading countries will determine their comparative advantage using
price ratios. On the graph, this means that we can draw a triangle under the PDF to see the price
ratio. If we have no figures, we look at the distances instead. The top graph on page 14 indicates that
the country has a comparative advantage in product X. Therefore this country will specialize in the
production of good X and which it has a comparative advantage common given favorable
international terms of trade (ITOT) indicated by the price line. The price line , now called ITOT,
should be better than the domestic price ratio (an autarky) to entire specialization and trade,
otherwise no trade will occur.
The country will begin to shift resources to the production of good X by moving along the PF to
produce X2. specialization splits the points of production and consumption. Production now shifts to
a point lower down on the PDF, producing more of X, the good of our competitive advantage and
less of Y, the good of our competitive disadvantage. if terms are favorable, the ITOT line will be
steeper and tangent to a higher country indifference curve ICii. We can now export more of X and
import Y in return. The in difference between X3 and X2 is exported. At the new price range,
consumption of Y increases to Y3 because of imports. Therefore the quantity consumed of good Y
increases from Y1 to Y3 and the quantity consumed of good X increases from X1 to X3. The quantity
produced of good Y decreases from Y1 to Y2,and the quantity produced of good X increases from X1
to X2.
It is important to note that mercantilism, Adam Smith's absolute advantage theory and David
Ricardo’s competitive advantage constitute the classical economic trade theories. Classical
economists simply accepted the fact that cost differences exist between countries, they made no
concerted attempt to explain the origin of the cost differences. For many decades the comparative
advantage theory and its predictions for trade patterns were accepted and no one thought to dig
deeper into the basis for the relative cost difference is crucial to the validity of the Ricardian theory ,
until Eli Heckscher and Bertil Ohlin.
Heckscher- Ohlin: 1900

In 1921, Ohlin began to write on the foundations of an approach to international trade theory that
was, to some extent knew and for which received the inspiration during a walk on a popular
promenade in Berlin. Ohlin Said that he was in part destined to become an economist, because at
the age of five he loved calculating the cost of the cookies his mom baked.
The Ricardian model with some mathematical improvements Remained the accepted theory of the
comparative advantage through the 19th century and into the early 20th century. And explanation
for the basis of relative cost differences across nations remained elusive until two Swedish
economists, Eli Heckscher and his student, Bertil Ohlin provided an answer that was so self-evident
that it remains a mystery why it was not articulated before.
Assumptions of the Heckscher- Ohlin model:
1. 2-country 2-commodity model
2. 2 two factors of production, capital and labor that are mobile across sectors
3. perfect competition prevails in all markets
4. free trade - no restrictions on imports or exports
5. constant return to scale
6. countries have identical production technologies
7. consumer tastes are the same across countries, preferences for commodities do not vary
with the countries level of income
The Heckscher- Ohlin Propositions

1. Relative availability (endowments) are factors of production differs between countries. We
can thus talk about capital-abundant or capital rich countries versus labor abundant or labor
rich countries
2. Technology determines different combinations of factors of production for different
products. a product could be produced in a capital, or labor-intensive way (factor intensity).
comparing the capital/labor ratios, we can tell which production processes or labor, and
which are capital intensive. Hence a process requiring relatively more labor would be
deemed labor intensive and vice versa for capital.
Applying the usual macro-economic reasoning, we can illustrate the logic of this model. Assume a
nation such as China or India that has more labor than capital. With labor being in abundant supply
and capital scarce, it follows that labor would be relatively cheap and capital more expensive. The
implication that we can derive is that a country should specialize in the production of a good that
uses its abundant factor most intensively, export that and import the good that uses its guess factor
of production most intensively.
Heckscher- Ohlin Theorem

Having explained that the basis for comparative advantage in their model would be relative cost
differences based on relative availability or factors of production, Heckscher- Ohlin serum predicts
that a capital abundant company will export capital intensive goods while the labor abundant
country will export labor intensive goods. The trade pattern that the Heckscher- Ohlin theory
explains is one of inter-industry trade. A trade pattern represents the composition of imports and
exports of the nation’s i.e. who imports and exports what? enter industry trade occurs between
different Industries. At the time of Heckscher- Ohlin’s writing , developed countries rich in capital
would have exported manufactured goods and developing countries with abandoned labor and
natural resources would have exported primary goods, such as agricultural and mining products.
In conclusion, free trade depicted in the Heckscher- Ohlin model produces winners and losers.
Owners of the abandoned factor will see an increase in real income and the owners of the scarce
factor will see a decrease in the real income. Given this, it is hardly surprising that owners of the
relatively abundant resources are usually pro free trade, and owners of the relatively scarce
resources are usually anti free trade. Generally however, the number of winners is greater than the
number of losers and international Trade is considered a positive-sum game, offering greater
efficiencies and wealth. The question that emerges here is what to do about the losers.
The Introduction of New Trade Theories

Theories sometimes become outdated or insufficiently useful, because the economic circumstances
that they applied to have changed. In the 20th century it became evident that some trade patterns
occurred that were not explained by the traditional trade theories. An example of this could be that
Germans were ardent beer producers and exporters, yet they still imported beer. While South Africa
produces cause , we still import cars. These exchanges happening in the same industry is called intra-
industry trade. While all the previously discussed theories were still capably explaining Inter-industry
trade, it became clear that knew explanations were required intra-industry trade. It is important to
remember that comparative advantage does not become less relevant under the new trade theories
dash they simply explain new bases for comparative advantage.
There were several new trade theories brought forward that all attempted to explain this intra-
industry trade. While classical theories were complete, the new attempts were each tackling the task
of explaining the new bases of comparative advantage underlying modern trade patterns from a
relatively narrow perspective. An example would be by relaxing some of the assumptions made
within the classical theories. While they all a lot of good modern trade theories, the following three
are important in intermediate international economics:
1. Linder’s overlapping demand theory
2. Economies of scale (Krugman)
3. The Technology gap and product lifecycle theories (Posner and Vernon)
Linder’s Overlapping Demand Theory: 1961

Up until the H-O model, comparative advantage was explained by always referring to the
production, thus the supply side with a direct link to costs as the differentiator. A Swedish
economist, Staffan B. Linder was the first economist who tried to explain the pattern of international
trade from the demand side, rather than the supply side, by looking mainly at the factors that
underlie the demand for products in exchange. While acknowledging that the traditional theories
still explain the Inter industry trade, Linder focus his attention to manufactured products in order to
explain modern trade patterns. His argument was that manufactured goods are initially produced to
meet domestic demand requirements, and it is only afterwards that the product is exported to other
countries (which usually happen to be in neighboring countries).
Linder’s Proposal was that international trade in manufactured goods will take place predominantly
between countries with similar income levels and demand patterns. This theory further states that
the countries with identical levels of income produced and consumed similar quality goods and
services and this should lead them to trade with each other. Linder’s Proposed hypothesis is known
as the demand-similarity hypothesis.
Assumptions of Linder’s theory:

1. The potential trade of a country is confined to goods that have domestic demand
2. Two trading countries are engaged in the trade of goods which demand exists within their
domestic market
3. The domestic demand for goods is determined by the level per capita income
4. Similar levels of income influence the potential trade between two countries
5. Similar tastes and preferences in the trading partners must be present
Linder suggested that his theory was only applicable to trade in differentiated manufactured goods
in which consumer preferences an economy of scale were deemed important and complex, and that
the H-O theory still applies to trade in primary products that are determined by factor endowments
(traditional theory). he stated this in order to support his hypothesis.
International trade is viewed as an extension of domestic trade with the prime condition being that
the countries will trade in those manufactured goods for which domestic demand is large and active
enough to allow for the exploitation of economies of scale so that the resulting lower costs would
help penetrate foreign markets. Since consumer preferences depend on income levels, the type of
products produced in a country or function of per capita income. Linder suggests the idea that low
income countries will produce low quality products, and heart income countries will produce high
quality products.
Given these patterns of production, international trade will occur in products that have overlapping
demands, implying that consumers in different countries with similar per capita incomes will
consume similar tops of manufactured goods. The more similar the demand structures of countries
the more they will trade with one another. It is important to make the connection on how trade
makes sense in this scenario, and how his hypothesis is linked to a cost base. Linder’s Theory asserts
that gains from trade derive not only from lower costs, as emphasized by the conventional theory of
comparative advantage, but also from affording the market the choice of being able to consume the
precise quality, brand or variety of product demand. This is thus an indirect route to comparative
cost competitiveness, but comparative advantage is still important and still matters.
Linder’s Siri by no means implies that no trade takes place between low income and high-income
countries. Given the prevalence of income inequality or disparities within societies, rich and poor
people reside in the same country and thus the possibility of overlapping demand and quality
between countries with different income levels should not be ruled out.
Paul Krugman: Economies of Scale: 1979

When international trade was thought about with the Ricardian framework of comparative
advantage, strict assumptions were taken into consideration, such as perfect competition, constant
returns to scale and homogeneous labor. All of these factors have become untenable in the modern
economy where pure perfect competition was rare an increasing return to scale powered many new
industries. After this, modern economists began to develop models of intra-industry trade based on
the relationship that occurs between economies of scale and trade. However, it wasn't until Paul
Krugman published his paper titled “increasing returns, monopolistic competition and international
trade” that there was a simple formal model which gave rise to trade in the absence of the classical
basis for comparative advantage. In this model trade is driven by internal economies of scale, a key
feature in Krugman’s approach, and this occurs when a firm's average cost per unit of output falls as
total output increases. The simplest reason for the existence of internal economies of scale is the
high fixed costs, meaning that more output will allow the firm to spread the fixed cost out. Krugman
illustrates that trade and gains from trade will occur between countries with identical performance,
technology and factor endowments. This implies that trade may simply be a way of extending the
market and allowing exploitation of economies of scale, and this model allows us to explain
observed patterns of intra industry trade.
Assumptions of the Model

1. All individuals in the economy have the same utility function - this implies that everyone has
the same taste in products
2. Countries have identical technology and factor in endowments
3. Labor is the only factor of production taken into consideration
4. Employment is at maximum capacity - full employment
5. The elasticity of demand rises as the price of a good increases
6. Internal economies of scale exist - this insinuates that a firm can reduce its own average
cost by expanding production
7. Monopolistic competition is evident - internal economies of scale induced markets are
imperfectly competitive and there will therefore be fewer firms so each firm will produce
more. in order to compete for profits, firms will also have an incentive to differentiate their
product from those of their competitors (if they are close or imperfect substitutes). in cases
as such , the total number of firms depends on the average cost and new entrants are most
likely only going to enter the market if the price of the product is higher than the average
cost. This being said, if the price is equal to the average cost, the profits will not be high
enough for new firms to recover their fixed cost investment, meaning that they are unlikely
to join the market.
Economies of Scale, Imperfect Competition and International Trade

Assume that there are two country is with a monopolistic competitive market. Will further assume
that these two countries have identical taste, technologies and factors of endowment. According to
traditional theories, these countries will have no reason to trade with each other due to the fact that
there are no potential gains from trading with each other. However, according to Krugman, these
two countries will trade and will gain from the trade.
Assuming that countries are identical, they would have the same wage rate and the prices of the
goods produced would be identical. If free trade between these countries was suddenly allowed, it
would be as though the market size of each firm has increased, so international trade increases the
market size of both trading partners.
This being said, the total firms when trade is allowed will be less than the total number of firms and
autarky. each surviving firm would then produce more goods, and in doing so exploit greater internal
economies of scale. This would ultimately lower prices, but all consumers in both countries would be
able to bar from a greater range of firms. While the prices are being reduced, the diversity of
products would also increase. Thus even in the absence of traditional comparative advantage, trade
would still occur to exploit the gains of internal economies of scale and from the increased variety,
except only economies of scale are now the basis for trade. We can call this an acquired comparative
advantage link to the size of the combined market under trade. In addition to this, under the
conditions of internal economies of scale, we will discover that countries will tend to export the
goods they produce more of due to the fact that the domestic demand for a product will induce
firms with the greatest internal economies of scale to specialize in that specific product. We will find
that the country with a larger domestic market for a specific good will be a net exporter of that good
due to the economies of scale. Krugman Argues that when there are barriers to trade the
specialization will become more limited because these costs reduce the profitability of exporting.
To summarize the above, the top of trade between two countries has much to do with differences in
factor endowments, the top of relatively abundant inputs, Krugman acknowledges. If the two
countries are endowed similarly, it will tend to be intra-industry type trade. The top of trade
predicted in the H-O model will prevail as factor in diamonds become more unique. Krugman’s
Formalized argument on the internal economies of scale allow economists to explain aspects of
international trade that could not be explained by the Ricardian comparative advantage. If they are
internal economies of scale present , firms are monopolistically competitive and markets will thus be
supplied by a certain number of firms , lessen the number of firms in perfectly competitive markets,
and each will produce a greater amount of output than they would in their perfectly competitive
equivalent. In cases such as these even if there are no different relative costs, tastes or technology,
the countries will always gain from trade in the form of lower prices and greater product diversity.
The standard Ricardian theory applies when they are differences between agents, economies of
scale explained trade when agents are similar.
Technological Gap Model of International Trade

All models up to this point that have been discussed assumed that the techniques or technologies of
production for a country was either given or fixed. This was done in order to simplify the models,
however, there can be no place for such assumptions in reality. Technical changes play a direct and
significant role in production and trade. A technological change may manifest in new methods of
producing existing goods or in the production of new varieties of goods. The last two prominent
models discussed attempt to explain international trade based on technological changes:
1. Technological gap or imitation gap model
2. Lifecycle model
Technological Gap or Imitation Gap Model: 1961

The theory of technological gap was developed by economist M.V. Posner. Posner argued that even
if countries have similar factor endowments and preferences , a technological change has the power
to give rise to trade. An example of a technological change would be continuous inventions and
innovations. According to this model, a firm will first introduce a new product into its domestic
market, and if it is successful here will then be released into the foreign market. this new firm will be
granted a temporary monopoly position in World Trade while the product is only available in the
domestic market. Patents and copyrights serve to protect this monopolistic position. The result of
this is that the exporting country enjoys a comparative advantage over the rest of the world until the
foreign producers either imitate new varieties of this product or learn new processes of production.
However this lag between the introduction of the new product and the introduction of the
substitutes by the foreign market creates the technology or imitation gap.

1. There are two countries (A and B)
2. The factor and almonds are similar in both countries
3. Both countries have similar demand structures
4. The cost of production, factor price, in the two countries are similar before trade
5. Countries have different production technologies
Posner split the technological gap into three categories:

1. The demand lag: this is the time taken by the domestic consumers to acquire a taste for the
new product
2. The foreign reaction lag: this signifies the time taken for the foreign firm to imitate a
produce the new product
3. the domestic reaction lag: this refers to the time that is required by the domestic producer
to keep innovating and introducing new varieties to maintain the upper hand in both the
domestic and foreign market
The combination of the innovation and imitation lag was referred to by Posner as “dynamism” and
According to him, a dynamic country in international trade is the one who innovate at a greater rate
and which imitates the foreign innovations at a greater speed. This means that a prosperous country
is one that has a greater degree of dynamism than the other. A country that lacks dynamism leads to
the erosion of their markets and a consequent trade deficit, where there are more imports than
exports.
Salvatore’s noted shortcomings:

1. This model, according to Salvatore, does not explain the size gap
2. It also does not discuss the reason why it arose in the first place
3. Nor does it discuss previously how it was eliminated overtime
Despite all of this, it is still important to note that the technology gap is a direct reason for trade.
This is a new basis for comparative advantage. However, it could still be temporary if the innovating
country does not continue to innovate. With introduction of changing technology, the static
comparative advantage of the traditional trade theory is expanded two dynamic comparative
advantage which has particular relevance for the discussions in part 4.
Product Life Cycle Theory: 1966
Raymond Vernon was the economist that developed this theory, and it is an extension of the
technology gap model. Vernon suggests that every product has a laugh span and they go through
various stages, from introduction up until decline. He goes on further to say that the innovating
country that initially produced and exported a good usually ends up being the country that imports
the same product or differentiated variety of the original product.

1. The Producers in capital-rich countries initially produce new products
2. The innovating firms have some real or monopolistic advantage
3. The need and opportunities of the domestic market stimulate the innovation of a new
product
4. The innovating firm has little information about the conditions existing in foreign markets
5. The domestic environment in the advanced countries which initially make the innovation is
different from that in other advanced countries
6. The market is competitive and rival producers can enter the market, prompting the turning
out of the product for export
The simple argument in this model states that the factor requirement of a product varies over the
product's laughed arm so that there exists a cycle in its production. The innovation of the product
includes risks that can be borne by relatively rich firms. These risks that are faced can be decreased
or reduced by adapting on the production side, which requires skilled Labour and easy access to
consumer insights. Vernon makes note that easy access to consumer insights is made possible by the
proximity to the market. With us, it is established that the production of new products is likely to be
concentrated in advanced countries. It is only when the product and manufacturing process is or
standardised that other countries can enter the market. This will only happen if the countries have a
cost advantage over the pioneering producers. an example of this would be a country that has
access to cheaper Labour. As a result, the pioneering country is overtaken by other developed or
developing countries in the production of these goods.
With this being said, the pioneering firm could also set up production facilities in other countries in
order to take advantage of the favourable factor prices. The result of this would be that the country
who originally produced the good will experience a decline in their exports and potentially may even
become an importer of either the same or differentiated variety of the product.
Stages of Product Lifecycle

Vernon makes reference to full distinct phases in the product classical theory that old products go
through. The time that different product spend in each phase will differ depending on the product,
but they all eventually progressed through the cycle from start to finish:
1. Introduction Stage: In this stage, a country Usually in the hot income, capital rich and
advanced part of the world with considerably rich firms, introduces a new product into their
domestic market. They are known as the inventor. This is because they are well equipped to
do the necessary research and development and manufacture the good. After they have
gained acceptance into the domestic market and seen the demand for the product grow, the
new product is then introduced into the foreign market through exports to other countries.
The innovating producers enjoy a virtual monopoly in both the domestic and foreign market
for some time.
2. Growth stage: yeah, the demand for the product increases to the point where the foreign
producers start manufacturing the product or a closed substitute. As a result of this, the
shares of the manufacturers of the innovating country start to decline but they still supply
meaningfully large quantities of the product.
3. Maturity stage: in this stage, the foreign country enjoys a greater competitive advantage
over the manufacturers in the pioneering country. At first, they enjoy the advantages of low
Labour costs, but as production continues, they start enjoying the advantages of economies
of scale, which were initially reaped by only the pioneering country.
4. Decline stage: in this stage the product becomes standardised and foreign producers
capture the market of the originally innovating country despite transport costs and tariffs
imposed by the advanced countries and the innovating countries become the net exporters
of the product. When this happens, the advanced countries have to produce new varieties of
the products which are consumed by relatively well-off sections of consumers both at home
and abroad.
In summary, an innovator establishes a technological breakthrough in the production of a

manufactured good. The product has a higher price and thus a higher return and market expands to
other foreign markets. The product begins to mature, and the price slowly starts to fall as low wage
Labour is used and domestic market enters the maturity stage. There is a rise in import competition
from foreign producers and innovating nations gradually lose their competitive advantage and their
exporting cycle enters the declining stage. This process becomes standardised enough to be used by
other nations completing the cycle. Technological breakthroughs are no longer beneficial to the
innovating nation alone. The innovating nation may even become an importer of the product as its
monopoly position is eliminated by foreign competition.
This theory proposed by Vernon does not contradict the traditional trade of comparative advantage
and factor endowment theory. It does however lend a dynamic element to comparative advantage
because the innovation of new products creates the comparative advantage, backed by the relative
abundance of scientific and technical skills in the capital-rich countries. This comparative advantage
is not forever, and the innovating country firms need to continue to produce an export new product
at a relatively lower cost to remain competitive.
Part 2:
Intervention in International Trade

In the first part we looked at the policy implications of all the international trade theories we have
studied. We notice that all of these suggest that free trade is the superior contributor to economic
welfare. Around the world, free trade implies the unrestricted flow of goods and services across
national borders. Free trade offers Significant economic benefits however these benefits are
unevenly spread across the globe. Trade theories have made it clear that restrictions impose
efficiency costs and depresses economic growth, however, we still see government implementing
trade barriers and intervening in other ways that restrict or alter free trade by applying protectionist
measures. Protectionism versus free trade is one of the most enduring debates and warrants careful
analysis to understand why, how and for whom of the arguments.
 Protectionism refers to trade and investment or subsidies applied to defend domestic

markets and industries. Protectionist measures include trade tariff, subsidies and other
similar payment practises
 A tariff is a tax imposed by the government on imported goods and they have fallen
overtime but remain hard in some countries.
 Subsidies are financial or other resources that a government provides to a firm or a group of
firms.
 Non-tariff trade barriers or government policy or measures that restrict trade without
imposing a direct tariff or duty. An example of this is quotas.
 quotas or government-imposed trade restrictions that limit the number or monetary value
of goods that a country can import or export during a particular.
2.1. Why do Governments Intervene in Free Trade?

Research has shown the governments undertake intervention to achieve several economic and non-
economic goals. Arguments in favour of economic goals are usually aimed at boosting overall
economic welfare whereas non-economic goals, politics and other considerations are concerned
with protecting certain interest groups in a country often at the expense of other groups. Interest
groups are usually producers who tend to be well organised with power while other groups are
usually consumers who happened to be more dispersed and not organised for powerful impact.
A. Economic Reasons
Preventing unemployment
To maintain existing jobs that are threatened by foreign competition is a Source of today's
protectionist policies that are found everywhere. Industries that at one time had a comparative
advantage and did not adapt to a changing competitive environment, struggle to stay afloat. This
leads to industries having to cut costs which usually lead to layoffs and ultimately to the demand for
protection. Governments believe that imposing tariffs will divert demand to domestic firms thus
improving the firm’s profitability and prevent factories from closing down in order to secure
employment. The model of international trade and perfect competition discussed before also
suggests that trade will challenge some industries. As countries specialise in activities in which they
have a comparative advantage, the sectors that do not have a comparative advantage will fall short
and contract. Preserving those sectors through trade barriers prevents a nation from enjoying gains
possible from free trade.
Another challenge that arises with the use of trade barriers to bolster employment in a particular
sector is that it can be an immensely expensive strategy. Estimates in the United States show that an
Obama-era Tara on Chinese tyres cost the economy more than USD$900000 per job temporarily
saved. Based on work done by Robertson and Wendelbo, it was discovered that governments could
save taxpayers and consumers money by giving each displaced worker the $100,000 to find and
move to a new job.
Protection of Infant Industries

A highly competitive landscape is created through free trade which can be harsh or even detrimental
to infant industries and firms. Because of this, the government argues that the infant industries
should be protected because they would not otherwise survive the competition from producers and
more advanced countries. For instance, developing countries have a potential comparative
advantage in manufacturing, however new manufacturing industries in developing countries cannot
compete with established manufacturing in developed countries. As the infants mature and become
more competitive the protective barriers could be lowered or eliminated. The theory on infant
protection articulates three requirements in order for this protection to be successful, known as the
Mill-Bastable test:
 The infant industry needs to have the potential to become competitive.
 The protection of infant industries should only be temporary.
 The beneficiaries of such protection should compensate the losers (who are usually the
consumers paying higher prices because of the restrictions) for their sacrifice which means
that the benefits from protection should exceed
Strategic Trade Policy Argument

Paul Krugman Introduced a new version of the infant industry argument which has been used in the
recent years as technological developments have spawned completely new industries and
transformed existing ones. The new version of the infant industry argument assumes an imperfectly
competitive market which is based on the new trade theory proposed by Krugman. the theory
argues that if an industry has economies of scale, the world would market will still only support a
few firms to the point where they are profitable. Countries may lead and export of certain product
simply because they had firms who were able to capture first mover advantages. The dominance of
Boeing in the commercial aircraft industry is attributed to such factors.
The strategic trade policy argument suggests that governments should use subsidies to support such
firms. this argument also suggests that it mark pay government to intervene in an industry if it helps
its domestic firm overcome the barriers it needs to in order to enter foreign firm that have already
reaped the first-mover advantages.
B. Political and Other Reasoning

To Prevent Dumping
Dumping occurs when firms export goods at a price below the production cost or below the price
charged in their domestic market. The low prices served to destroy rivals in the export market. The
World Trade Organisation permits countries to impose anti-dumping duties where there is genuine
material injury to the competing domestic industry. An act of dumping was seen in South Africa
when American exporters so an opportunity for market segmentation and price differentiation when
South Africans blocked different parts of the chicken.
National-Security
This is the security and defence from military and non-military threats of a nation state and includes
its citizens, economy and institutions which is regarded as a duty of the government. It can be
argued by government that the protection of industries that serve to promote, both directly and
indirectly, national securities should be protected through tariffs or other restrictive measures.
These industries would typically be those crucial for defence and related protection. However, this
argument may also be open to abuse oh very broad interpretation.
Fairtrade vs. Free Trade Argument
Read free trade focuses on reducing trade barriers while fair trade focuses on working conditions.
Governments tend to believe that tariffs and other restrictions can be imposed to promote fairness.
The rationale is that reducing competition and increasing prices could improve working conditions
and increased wages for workers.
Generation of government revenue

as tariffs for a tax, they raise revenue for the government. Allot of developing countries have
depended on customs and other duties on imports to boost the national budget. During the last few
decades of trade liberalisation, governments have had to find other and more sustainable sources of
government revenue. This is further discussed in part 4.
2.2. How Does the Government Intervene in Free Trade?

There are many different measures that a government can used intervene in trade. Due to the fact
that government has to make policy choices, it is important to understand the different measures of
intervention that can take place.
A. Tariffs
A tariff is a tax imposed on goods imported and are the most common measures implemented to
intervene in free trade. They influence trade patterns by making products more expensive to
consumers while at the same time hampering the demand for imports. As it increases the price, they
alter the relative price of products and can protect uncompetitive companies and they overpriced
products. Examples of import tariffs are plenty. Since the World Trade Organisation has established,
the general agreement on tariffs and trade (GATT), the tariff burden has been reduced steadily.
however, governments have turned to other restrictive measures collectively known as non-tariff
barriers. These methods allow government to put up barriers to trade overtly and covertly.
B. Non-tariff Barriers (NTB)

A non-tariff barrier refers to any obstacle in place in international trade that is not an import or
export duty.
 Import quotas are restrictions on the amount of product that can be imported into a
country.
 Export quotas are restrictions on the amount of product that can be exported within a given
period. This restraint is usually applied to prevent shortages or as a tool to moderate
domestic prices.
 Embargos are an unofficial ban on trade or other commercial activity with a particular
country. An example of this would be in 1977 when the UN ratified arms embargo on South
Africa after the Soweto uprising. Embargos can be political when liked to airspace and arms.
 Subsidies are resources (usually financial) that a government provides to a firm or to a group
of firms.
 Sanctions constitute a threatened penalty for disobeying laws, rules or actions.
 Trade levies are a tax/fee/fine other than normal tariffs that is imposed on trade. The
imposition of these levies and the safeguard measures is established in the World Trade
Organisation’s international agreement. The laws address three types of trade levies:
o Anti-dumping duty: this is a duty imposed on dumped imports that cause material
injury to a domestic industry
o Countervailing duty: a duty on export subsidised by a foreign government
o Safeguard measures in the event of a sudden ‘surge’ in imports that threaten to
destroy a sector or industry. The purpose of these being imposed is to protect that
country’s balance of payments and its foreign currency reserve, to protect the
agricultural industry and the country’s minded resources, or as an action against a
foreign country.
 Import Licenses: these are official government documents that authorize the importation of
certain goods into a country. Trade without the license is prohibited.
 Voluntary export restraints (also referred to as orderly marketing agreements) are
implemented to please a trading partner. It is a government-imposed limit on the quantity of
some category of goods that can be exported to a specified country during a specified period
of time.
 Government procurements: providing specifications that favour domestic firms
 Abuse of health and safety measures
 Marketing and packaging standards
 Abuse of customer procedures
 Exchange capital control
2.3. What is the Impact of Intervention in Free Trade?

The barriers imposed on trade, usually through tariffs, limit the growth of trade throughout the
world. Unnecessary costs imposed on exporters raise the prices for consumers, which will ultimately
decrease the consumer surplus. In addition to this, although domestic producers may benefit from
this, tariffs tend to encourage inefficiencies in the domestic market. They also undermine the
predictability of the trade regime, and reduce investment. This is especially true in developing
countries.
To illustrate the impact of barriers of trade, we use the example of chicken in South Africa. In march
2020, tariffs on chicken went up significantly to hopefully reduce chicken dumping. Chicken imports
have been a topic of debate in this country for a long time Chicken producers petition the
government for protection with regularity. In an economy such as South Africa’s, they must absorb
the whole tariff. In larger economies such as that of the US or China, the exported can be expected
to pay a portion of the tariff.
The graph below is the domestic market for chicken, with D and S representing demand and supply,
and Pe as the domestic equilibrium price. It is possible to import chicken at a lower price,
represented by Pw, from the world market. At that price, we can obtain as much as we want, as
evidenced by the perfectly elastic
world supply curve. South African
chicken producers have successfully
petitioned the government to impose
an import tariff on chicken. This tax
shifts the world supply curve up to
Sworld + tariff, and increases the
price that we will pay in South Africa
by the amount of the tariff to Pw + t.
The consumer surplus is the

difference between the price you have to pay and the price you are willing to pay as the consumer.
On the graph, this is the whole area above the price (Pw) and below the demand curve. The
producer surplus is the difference between the amount that a producer of a good receives and the
minimum amount the producer is willing to accept for the good. On the above graph, this is the area
below the price and above the domestic supply curve, S.
Effects of the Tariff on Consumers

Tariffs increase the cost of imports, which ultimately lead to higher price for consumers. Pw
becomes Pw + tariff. As the price increases, the quantity demanded will decrease from Q4 to Q3.
Imports will then decline, and fall to Q2-Q3. The consumer surplus will decrease by the addition of
areas 1 + 2 + 3 + 4. The consumers clearly lose because of the import tariffs.
The effect of the Tariff on Producers

Domestic producers will benefit from the introduction of tariffs, as domestic sales will rise from Q1
to Q2, and the producer surplus will increase by area (1). This is due to the fact that it makes their
domestic production relatively kore competitive in terms of price compared to imports.
The effect of Tariffs on Government

Tariffs yield government revenue that is equivalent to area (3). Having said this, the increase is
relatively small because it is subject to the quantity of imports, which now decline because of the
tariff.
Deadweight Losses to Society

We have seen that government and domestic producers benefit from the imposition of the tariff on
chicken. We are left with triangles 2 and 4 which constitute as deadweight losses to society. By
definition they mean that someone in society (in this case, the consumer) made a sacrifice, but
nobody else gains from it.
These occur because:
 Triangle 1 is a deadweight loss arising from the fact that resources have been reallocated to
inefficient domestic producers from efficient global producers.
 Triangle 2 is linked to the consumers. By increasing the price, tariffs decrease the real
income (the purchasing power) of consumers. This leads to a loss in economic welfare. The
net welfare loss is (1 + 2 + 3 + $) – (1 + 3) = (2 + 4). This may lead to less noticeable falls in tax
revenue elsewhere in the economy, such as in reduced indirect taxes, such as VAT on
consumption spending.
It is important to note that, depending on the product, the tariff will also hurt downstream
producers in addition to the end consumers.
We have explained the static (once-off) effects of an import tariff, but over time, it also leads to
dynamic negative outcomes. Producers are incentivised to compete for economic rents in wasteful
ways that does not improve economic efficiency. Firms may locate to places where they can enjoy
government patronage, though it may not be an advantageous location for their business. Since
protection cushions producers from competition, they may also not make the necessary changes,
such as investment in technology and skills to be competitive.
There is a broad consensus among economists that the impact of protectionism on economic growth
(and on economic welfare in general) is largely negative, although the impact on specific industries
and groups of people may be positive. The doctrine of protectionism contrasts with the doctrine of
free trade, where governments reduce barriers to trade as much as possible.
Diffuse Winners and Concentrated Losers

The benefits of free trade are diffuse while the harms are concentrated. Job losses from free trade
tend to come from loss of market share to cheaper imports that manifest in factory closings at the
companies that see greatly reduced sales. This means that the media can easily find hundreds or
thousands of people who are losing their jobs all at once.
In contrast, job gains are more spread out across the economy. Some job gains occur at exporting
companies that gain sales in the other countries who have opened up their market to our goods.
However, since these companies already exist, the job gains are usually incremental gains to their
current workforce. The remaining job gains are spread over the entire economy as consumers who
save money on cheaper imports spend those savings on a variety of other goods. These consumer-
spending driven gains materialize as a job here, a job there, so they are very difficult to see.
Economic theory suggests that job gains will outnumber the job losses – that the gains are bigger
than the losses. But there are a lot of winners who do not realise they are winners, such as new jobs
and restaurants, movie theatres, etc, that are fuelled by consumers with extra spending power
thanks to cheaper imports. Conversely, those who lose their jobs usually know exactly what
happened to them. That means that a bunch of winners have no idea that they should be praising
free trade while almost all the losers are very clear what is wrong with free trade.
Part 3:
Reducing Barriers to Trade

When a global economic system experiences big shocks, such as wars, the financial crisis of ’08 and
now the coronavirus pandemic, tend to lead governments to turn inwards. By doing so, the actually
exacerbate the damage to their economies. The onset of Covid-19 led to an immediate contraction
in global trade and it is expected that restrictive trade measures may make it worse. Global trade is
expected to decline 13-32% in 2020. Experts warn that protectionism may rise across the globe
after the pandemic.
It is essential that we do not repeat mistakes of the past periods of crises. This means that it is
imperial that we do not turn inwards, as this is the mistake that they’ve made in the past. Instead,
we must continue to explore the gains from out interconnectedness. There are significant global
attempts underway to try and remove the obstacles to trade an economic expansion. Barriers to
trade, which are often implemented in the form of tariffs, limit the growth of trade throughout the
world, and because of this, also limit economic growth.
The reduction of trade barriers is imperative for the realisation of gains through international trade.
There are two ways of doing this:
 This first way is multilateral, and is amongst the members of the rule-based trading system
under the auspices of the World Trade Organisation.
 Secondly, barriers to trade can be eliminated as a part of a process of regional integration.
We start with the global perspective (reducing barriers to trade as a multilateral effort).
Reducing Barriers to Trade: The Multilateral Way

The creation of the participatory global regulatory system was empirical for the world order after the
ravages of WW2.
Leaders of various countries realised that the world was going to be a very different place when the
war eventually ended. This means that it would need to take appropriate action and implement
strategies to recover the institutions to regulate the global economy in the post-war era. These ideas
lead to the Bretton Woods Conference (more commonly known as the United Nations Monetary and
Financial Conference) which is a gathering of delegates from 44 countries that met between July 1
and 22 1944, in Bretton Woods, New Hampshire. Their objective was to agree upon a series of rules
for the post-ww2 economic world order. South Africa was present at the conference, however at
this time, they were not completely independent of Britain.
John Maynard Keynes was also present at this conference, and was the chief negotiator in the British
side The American campaign was the brainchild of a Harvard-trained economist, Harry Dexter White,
who was also a senior US treasury official. After his death, it was confirmed that White was actually a
Soviet spy, and was passing information from the conference on to Moscow. While Keynes and
White disagreed for majority of the conference, the following terms were finally agreed to be
created:
 An institution that would provide financial assistance to economies destroyed by the war.
This was the International Bank for Reconstruction and Development.
 The International Monetary Fund
 The General Agreement on Tariffs and Trade (GATT), which members had to take back to
their governments to create the International Trade Organisation that would regulate global
trade.
However, this ratification did not happen and it was not until 1995 that the World Trade
Organisation (WTO) eventually came into being.
GATT
The objectives of the 1947 agreement were to establish an orderly and transparent framework
within which barriers to trade could be reduced gradually and through negotiation and in doing so,
would expand international trade for mutual gain. The GATT Was based on four principles:
1. there was to be no discrimination. There are two components to this principle: the Most-
Favoured-Nation (MFN) clause and the national treatment. The MFN is a bit confusing at
times because the name insinuates preferential treatment however, it means that all trading
patterns should be treated the same. If one trading partner extends a benefit to one partner,
it should extend this same benefit to all members. The national treatment clause requires
locals and foreigners to be treated equally.
2. Free a trade through negotiation. This principle found expression in the negotiation rounds
that took place under the GATT.
3. Reduction and binding of national tariffs. this was aimed at freeing trade but also improving
certainty in that once an offer of tariff reduction was accepted, members had to undertake
not to rise it again without the agreement of all members.
4. The elimination of non-tariff barriers, except an agriculture, regional agreements and for
countries with Balance of Payments problems.
These principles are subsumed and the agreement of the WTO and two more were later added:
5. Promoting Fair competition.
6. Encouraging development and economic reform.
there were eight negotiating rounds under the GATT which resulted in progressively reducing tariffs
initially and in the later rounds, also non-tariff barriers. the last round was the Uruguay round. this
round was important because it significantly expanded the scope of the negotiations and laid the
foundation for the creation of the World Trade Organisation on the 1st of January 1995. South Africa
was a member of the GATT and is also a member of the WTO. like all other members, South Africa
was required to reform its system of protection. the negotiating rounds can be found in the notes.
Although many the developing countries were members of the GATT, the issues remained mainly on
the margin. Those first changed with the Doha round, the first round under the WTO. this round
began in Qatar on November 2001, and its name indicates the intent to focus the negotiations
specifically on the needs of developing countries. The focus of negotiations has been on reforming
agricultural subsidies, improving access to global markets and ensuring that knew liberalisation in
the global economy does not jeopardise the need for sustainable economic growth in developing
countries.
In December 2013 in Bali, negotiating members achieved a breakthrough agreement which became
known as the Bali package. This agreement underlies the TWO’s trade facilitation agreement, which
is studied next.
The WTO’s Trade Facilitation Agreement (TFA)

Definition and Purpose
Trade facilitation is geared towards the simplification of import and export procedures with the
overarching aim of reducing transaction costs. The trade facilitation agreement also emphasise is
transparency of procedures, harmonisation and modernization of international trade procedures.
The TFA came into play on 22 February 2017 and it is an agreement designed to cut trading costs by
implementing processes that are more efficient and eliminating unnecessary obstacles before export
or import clearance at borders.
How the TFA Works

Facilitation works by removing barriers to trade and assisting in capacitating members to make
effective use of the opportunities that these fewer barriers opened up. The TFA Outlines extensive
provisions that define the roles and responsibilities of developing and less developed country
members on the one hand, and the donor members and the international and multilateral
organisations supporting trade facilitations on the other. In addition to this, it also sets out the
institutions and procedures to support the delivery of assistance.
The TFA Office implementation flexibility. Many of the technical measures are written in a
language that does not mandate, but rather requires the best effort to. Place developed countries
are required to implement the TFA’s provisions in three separate categories and accordance to
specified, and agreed upon timelines honouring the WTO’s Special ad Differential Treatment
(STDs) provisions:
1. Category A: This is those that a less developed country agrees to implement on the date of
the TFA’s entry to force (or within 1 year thereof)
2. Category B: This will be implemented by an LDC after a transitional period following the
TFA’s entry into force
3. Category C: These are those that will require technical assistance and capacity building
support, and which will be implemented after a transitional period following the TFA’s entry
into force.
Furthermore, the TFA is unique in the sense that it is linked directly to the capability of countries to
fulfil their requirements, and it provides for assistance to countries who need it. This assistance
includes funding, technical assistance and skills development for trade facilitation staff (e.g. customs
officials).
Participation: Ratification and Implementation

The details of this ratification and implementation of commitments under the TFA, as well as filing
for assistance gives insight into the priorities that trading partners have set for themselves.
Ratifications:
The TFA entered into force on 22 February 2017 when the WTO obtained the two-thirds
acceptance from its 164 members. Since its inception in 2017, the TFA have received 151
ratifications from its 164 members, meaning that just over 92% of the members thus far
have ratified the agreement. The rate of implementation commitment by all WTO members
has been encouraging, and to date, the implementation rate is at over 66%. This figure has
been calculated and based off of developing and less developed countries members’
notification as well as developed country member’s commitment.
Advantages of the TFA

1. The Reduction of Trade Costs: By improving trade facilitation, exports in developing
countries can be boosted due to the fact that they have a high trade cost, a large part of
which are due to their lack of trade facilitations. Delays at customs and cumbersome
procedures are far more frequently encountered in developing countries and less developed
countries.
The TFA is expected to reduce total trade costs by over 14% for low-income countries,
about 15% for lower-middle-income countries and by more than 13% for upper-middle-
income countries. For Southern Africa, the TFA has the benefit of removing regulatory trade
barriers, which have often had the unsatisfactory effect of delaying trade due to hours spent
on unnecessary checking and inspections at border posts. This allows for the promotion of
higher economic growth through facilitating trade and developing supporting infrastructure
in the country.
2. Increased Trade Flows and Gross Domestic Product: The TFA is expected to increase total
merchandise exports by about US$ 1 trillion per annum. With this, trade in developing
countries is expected to rise by US$ 569 billion, and by US$ 475 billion in developed
countries. South Africa’s chairperson of the International Chamber of Commerce, Pat Corbin,
says that the TFA is a vital new and insightful means of boosting trade, wealth creation, and
job opportunities worldwide. It promises Africa fast-tracking movements, release and
clearance of goods. This includes those in transit, and this promise is vital to Africa.
3. Induced Positive effects from Implementing Trade Facilitation: The implementation of the
TFA technical measures can lead to attraction of more foreign direct investment, better
collection of government revenues and the reduction in trade-related corruption, which is
positively affected by the time spent to clear customs.
4. Implementation Flexibility: Developing countries and less developed countries stand to

benefit from additional safeguards offered to them by the TFA. They can choose the period
for the implementation of their TFA commitments and articulate their needs for assistance
in reducing trade barriers and improving their capacity for trade efficiency, including
technology. Having explored the multilateral opportunities to improve trade flows and
capture the gains from trade, we can now focus on the opportunities that closer cooperation
in regional context may bring.
Reducing Barriers to Trade: The Regional Way

Economic integration occurs when a group of countries agrees to eliminate trade barriers only
amongst the members to the agreement. It is referred to as regional integration when geographical
proximity is key to the agreement. Although it never happens in linear fashion, it is customary to
depict economic integration in stages from least integrated, the FTA, to most integrated, the
Economic Union. The basic elements of the stages of economic integration are as follows:
 Free Trade Agreement: Zero tariffs among member countries and reduced non-tariff
barriers. An example of the is the North American free Trade Agreement (NAFTA) which is a
trilateral trade bloc between the United States, Canada and Mexico which came into effect
on 1 January 1994.
 Customs Union: This is the FTA along with common external tariff. An example would be the
South African Customs Union (SACU) and this is a regional trade agreement between South
Africa, Botswana, Lesotho, Swaziland and Namibia. It was established in 1910, making it the
world’s oldest custom union.
 Common Market: This is the custom union along with the free movement of capital and
labour, with some policies in harmonization. An example would be the Common market for
Eastern and Southern Africa (COMESA) which is a treaty entered by free independent
sovereign states which have agreed to co-operate in developing their nature and human
resources to enhance overall welfare. It’s primary focus is the formation of a large economic
and trading unit that is capable of overcoming trade barriers.
 Economic Union: This is the common market along with common economic policies and
institutions. An example of this the European Union, which is an economic and political
union compromising of 27 European countries that are subject to obligations and privileges
of the membership.
In trade theory, we make use of the custom unions to identify the effects of economic integration.
These effects can be either static (occurs in the short-term, is once off) or dynamic (Occur more than
once and are more durable). These two effects on economic integration of differentiated as follows:
Static Effects Dynamic Effects
Trade creation or trade diversion Increased competition enhances productivity,
improving allocation of resources and decrease
prices
Administration savings Economies of scale, scope and specialisation
enhance competitiveness
Improvements of collective terms of trade Access to new technology
Increased bargaining power in the international Growth in output increases welfare
community
Stabilisation of the economic neighbourhood Cohesion and convergence (following
and main trade patterns stabilisation) among member-states
Gaining initial resource allocation efficiency
Trade creation occurs when the members remove barriers on each other’s trade, while a negative
outcome (trade diversion) may occur when the customs union diverts trade from an efficient
exporter to an inefficient one. Specifically, if the country now imports from a member who is less
efficient and puts import tariffs on its former trade partner who is an efficient producer.
With this basic understanding of the WTO and the TFA along with the knowledge on economic
integration, we can now continue to consider what prospects it holds for Africa, and more
specifically, South Africa. More specifically, the above stated knowledge can be used to explore how
the TFA along with Africa’s latest attempts at regional integration and the technologies of the Fourth
Industrial Revolution can contribute to trade expansion, economic growth and development.
Part 4:
Africa and South Africa’s Through Trade
African and South Africa’s Prospects for Economic Prosperity through Trade
There has been significant progress in capitalising on the opportunities that arise from the
participation in the WTO’s TFA seen in African countries. These opportunities are facilitated by
technologies of the Fourth Industrial Revolution (FIR). African governments have, at the same
time, under the auspices of the African Union, embarked on an ambitious regional economic
integration plan, the African Continental Free Trade Agreement (AfCFTA).
As with the rest of the world, the Coronavirus pandemic has had devasting effects on Africa, and as
other countries did post WW2, African needs to prepare for a post-covid economy. Africa is
fortunate enough to have several factors that play in their favour for their post-corona recovery,
which will be explored in this subsection of international trade.
Regional Integration in Africa

Africa has a long history of attempts at regional integration, with their first attempt being the
Southern African Customs Union (SACU) which was established in 1910. The integration attempts
have, over time, been structured into Regional economic Communities (RECs), of which the
African Union recognises the following:
 Arab Maghreb Union (UMA)

 Common Market for Eastern and Southern Africa (COMESA)
 Community of Sahel–Saharan States (CEN–SAD)
 East African Community (EAC)
 Economic Community of Central African States (ECCAS)
 Economic Community of West African States (ECOWAS)
 Intergovernmental Authority on Development (IGAD)
 Southern African Development Community (SADC)
The Regional Economic Communities in Africa

The best way to think about this is to consider the existing RECs as pieces of a puzzle that will
eventually become the single African market. The ambition is that these communities will each in
their region do the work towards region integration, in co-operation with the AfCFTA.
WTO and TFA’s Role in Propelling Africa’s Growth Amid the Global Pandemic
The continent of Africa presents a narrative that oscillates between hope and despair as a
multiplicity of structural economic, fiscal and socio-economic woes contrast with its image as a land
of opportunity with a market of 1.2 billion people and a combined GDP of US$ 2.5 trillion. This
division has rendered it a fertile ground for trade-related economic interventions on an international
and regional level.
Over the past decade, the WTO’s TFA and the AfCFTA have made significant progress in the
implementation of the TFA to reduce trade barriers and deepen intra-continental trade and
integration. The TFA Facility have hosted multiple African workshops that have been a success, such
as the Border Agency Cooperation Workshop that was hosted in November of 2018, where there
were 13 South African countries represented by 77 participants, who considered ways to improve
border agency cooperation at national and regional levels.
By recognising the soft and hard infrastructure challenges that face the trade facilitation reforms in
Africa, the AfCFTA ultimately seeks to realise a prosperous Africa by placing inclusive growth and
sustainable development at the heart of its implementation. This year, AfCFTA’s secretory-general
announced that there is a plan in place to introduce inclusive measures designed to support young
Africans, women, and SMEs. In addition to this, AfCFTA is expected to boost intra-African trade from
18% to around 50% by 2030. This positive momentum could be tarnished by the coronavirus
pandemic. In the past, economic shocks have led to governments turning inwards, which
exacerbated the damage to their economies.
With this being said, as the worst economic downturn since the great depression looms and the FIR
accelerates, we contend that the covid-19 pandemic presents a critical juncture that requires the
continent of Africa to continue prioritising their implementation of the WTO’s TFA and the AfCFTA.
This is important because it would serve as a stimulus package to increase trade across the continent
in order to migrate the detrimental economic effects caused by the pandemic and potentially hasten
the economic recovery. In addition to this, to attain a prosperous Africa, the technologies provided
by the FIR should be employed carefully to supplement the trade intervention efforts to achieve this
goal both effectively and efficiently.
The World Trade Organisation’s Trade Facilitation Agreement

A brief Overview of the WTO and Their Purpose
Barriers of trade, imposed more often than not through tariffs, limit the growth of trade throughout
the world. The reduction of trade barriers is vital for the realisation of gains through international
trade and the promotion of free trade is the primary goal of the WTO. The WTO deals with the global
rules of trade between nations and according to the WTO as of 2020, its primary purpose is to ensure
that global trade flows smoothly. This can be achieved through the implementation of trade
facilitations measures.
The WTO’s TFA and Africa

Trade facilitation is geared towards the simplification of import and export procedures with the
overarching aim of reducing transaction costs. In addition to this, it emphasizes the transparency of
procedures, harmonisation and modernisation of international trade procedures. Most African
countries are less developed countries, and for African countries, the TFA could lead to a 35%
increase in exports from LDCs, a 20% improvement in the diversification of exports and a 3.5% boost
to economic growth across developing economies. This being said, for many African countries,
implementing trade facilitation reforms will require overcoming more considerable, cross-cutting
challenges.
Empirical studies have shown that trading across Africa boarders is an onerous process that is
characterised by excessive bureaucracy, corruption and inefficiency. African traders are confronted
with onerous bottlenecks, including the need for goods to go through many border agencies and
officials, completing numerous trade documents and spending several hours or days at borders. In
addition to this, traders are often expected to pay bribes to avoid confiscation of goods or refusal of
entry. According to the World Bank’s Ease of Doing Business, Southern Africa has implemented the
least trade reforms and remains one of the weaker performing regions with an average score of 51.8.
Similarly to this, the World Bank’s 2018 Logistics performance index indicated that Africa (along with
other regions) is lagging in infrastructure, customs, competence in trade-related logistics and
punctuality of exports and imports. Such bureaucratic measures impede the flow of goods, capital,
services or people across African borders and increase trade costs. These high trade costs result in
increased prices and less investment in Africa. In such a case, the AfCFTA (which recognises the soft
and hard infrastructure challenges hindering trade facilitation reforms on the continent)
complements the TFA.
The African Continental Free Trade Agreement
Towards the end of May in 2019, the AfCFTA took effect for 24 countries that ratified the agreement.
The AfCFTA signals the beginning of a new chapter for mega-regional trade relations on the African
continent and boosted efforts at regional integration. Regional integration helps countries to
overcome obstructions that impede the flow of goods, services, capital, people and ideas. The
objective of the agreement ranges from the economic to the political. The AfCFTA is the first
agreement of its kind to bring together all 54 African countries under a Free Trade Agreement.
The AfCFTA aspires to improve intra-African trade. Currently, trade within African countries is very
low and RECs have not made developing and enhancing regional trade a priority. The African Export-
Import Bank released their African Trade Report for 2018, and it found that Intra-Africa trade as a
share of GDP was at 15%. This compares unfavourably with Europe (which is at 67%), Asia (at 58%),
North America (at 48%) and Latin America (at 20%). The AfCFTA’s broad objective is to create a
single continental market for goods and services, with free movement of businesspersons and
investments, paving the way for accelerating the establishment of the customs union.
The full implementation of the TFA complemented by the AfCFTA can help tackle these issues and
increase trade across the continent subsequently, migrating the detrimental economic effects of the
pandemic and speeding up economic recovery across the continent. The overall positive impact on
the economy can be strengthened further by the technologies offered by the FIR.
The Fourth Industrial Revolution (FIR)

The Third Digital Revolution began in the 1960s, and was speed up/catalysed by the development of
mainframe computing, personal computing and the internet. Building onto this, the FIR represents
new ways in which technology can become embedded within our society and potentially with in the
human body as well. The development of digital, physical and biological technology are the three
drivers of the FIR. These technologies will alter many aspects of our everyday lives and will, in
addition to this, enable a higher living standard globally. The WEF has predicted that 60% of global
GDP will come from digital sources by 2022.
The African continent will face unprecedented possibilities as we work our way towards the FIR, and
the technologies will make real opportunities available to developing and less developed countries to
skip over many stages of development, and potentially accelerate their transition from developing to
developed. The FIR, unlike previous revolutions, will allow for the developing world to participate and
benefit from this revolution in a much easier manner, and with lower costs. For example, the internet
makes it possible for the technological fruits to be shared around the world easily, at a high speed,
while maintaining relatively low costs.
The technologies that will be found alongside the FIR will improve access to, while simultaneously
lowering costs of, products and services for basic needs (e.g. housing, education, food and finances).
This will both improve the wellbeing of citizens and free up finances to allocate to crucial
infrastructure investment.
Technological catalysts of the FIR include but is not limited to: Internet of Things (IoT); artificial
intelligence; autonomous vehicles; nanotechnology and blockchain. All of these present
opportunities for the AfCFTA. Blockchain technology is instrumental in the implementation of the
AfCFTA and can ensure that the benefits envisaged by the AfCFTA are fully realised in an effective
and efficient manner, while minimising room for leakage and/or corruption. Trading under the
AfCFTA agreement was expected to being on 1 July 2020, but has been postponed as a result of the
coronavirus pandemic. Efforts are currently being directed at addressing the technicalities of trade
facilitation.
The AfCFTA and FIR
There are seven focus areas that the AfCFTA consider: policy; infrastructure; information; market
integration; increased productivity; trade. The FIR offers technological solutions that span across all
seven areas and man assist Africa in smoothing, harmonisation and expediting the AfCFTA
implementation process. These technologies include blockchain technology and the automated
Border Control system, which can significantly reduce inefficiencies and accelerate the
implementation process.
Blockchain Technology
A blockchain is a decentralised distributed “ledger” or record of transactions in which transactions
are stored in a permanent and close to inalterable ways, using cryptographic methods. In a more
simple way, it is a database that is almost impossible to forge, and a simple way of transferring
information from A to B in a fully automated, secure and transparent manner.
Trust and co-operation are central to the successful implementation of the AfCFTA. Against the
backdrop of eroding trust between private and public institutions present on the African continent
which potentially risks lower rates of compliance with rules and regulations, blockchain technology,
called “the trust machine” by The Economist, has numerous potential trade-related applications fir
for Africa.
Blockchain ensures immediate, widespread transparency, as transactions added to the blockchain

are timestamped and are hard to tamper with. Blockchain allows products to be traced with ease
while smart contracts – self-executing contracts when specific terms are met supported by
blockchain technology – can be used to automate trade processes, further increasing efficiency and
reducing cost. In 2019 during AfricCom, the Eastern and Southern African Trade and development
Bank closed its first live, trade-finance transaction using smart contracts in a US$22 million sugar
deal.
Blockchain could help make trade processes from trade finance to customs clearance as well as
transportation and logistics become paperless, which reduces the implementation costs. Further,
blockchain and smart contracts could help orchestrate border procedures and sing nation windows (a
single point of entry through which trade stakeholders can submit documentation and other
information to complete customs procedures) in a more efficient, transparent and safe manner, and
improve the accuracy of trade data. Blockchain technology also enables efficient facilitation to
business-to-government and government-to-government processes at the national level, ensuring a
more frictionless implementation of the AfCFTA.
Automated Border Control System (ABC)

Beyond moving goods, the AfCFTA’s goal includes the free movement of business people (services) to
pave a way to the establishment of a custom union. The ABC system allows automated border
passages by electronically authenticating travel documents, establishing that the passenger is the
rightful holder of the document, querying border control records and automatically determining the
eligibility of border crossing. This is done according to pre-defined rules, and a self-service system
and an e-gate which can assist in increasing the efficiency of free movement of labour. ABC
incorporates various technologies such as infrared and facial recognition to operate.
Overall, the adoption of FIR technologies can enhance efficiency, security and trust across-the-board,
consequently expediting, harmonising and simplifying the implementation and facilitation of the
AfCFTA. The following sections apply the three main initiatives discussed above to highlight how the
opportunities offered by the WTO’s TFA, together with the FIR and AfCFTA, can be used to help
Africa increase trade and economic prospects and assist vulnerable groups, specifically the youth
and women.
Wamkele Mene has expressed his intention to take concrete steps to ensure that women and young
are at heart of the implementation of the AfCFTA and plans to announce specific measures that can
be put in place to enable women, young Africans and SMEs, to benefit from the AfCFTA to achieve
the objective of inclusive benefits of the AfCFTA.
1. How can the WTO’s TFA and the FIR together with the AfCFTA, help Africa increase trade and
economic prospects
The covid-19 pandemic has left Africa facing unpredictable times, with turbulent, uncertain and less
favourable economic conditions characterised by GDP contractions, increasing unemployment,
disrupted supply and weaker commodity prices. It has been predicted that global growth will shrink
sharply by -3%, which is 6% points less than the projections published before the outbreak. Given
Africa’s constrained monetary and fiscal space, the new AfCFTA secretary-general cited
implementing the AfCFTA as the best stimulus for posit-covid African economies. Moreover, the
covid-19 pandemic and its effect on commodity prices have underscored the growing need for Africa
to explore and transition to manufacturing to reduce its high dependency on commodities.
Mene highlighted the potential of the FIR to catalyse Africa’s industrial development, placing the
continent on a path to exporting value-added products, improving its local and global
competitiveness. The FIR offers technologies such as 3D printing that allows custom tools and
products to be produced in almost any location in the world. This is suitable for Africa’s many
infrastructure deprived regions.
Precision Agriculture for Africa with FIR Technologies

Further FIR solutions like robotics promise an ear of decreasing costs for goods as robotics replace
labour that is more expensive. Although thus undeniably threatens existing jobs, it has been
estimated that the continent may have a decade to boost manufacturing before the cost of robotics
is low enough to replace huma labour in some sectors.
Big data can also assist fostering a lean manufacturing landscape by providing more accurate
demand forecast which will reduce production waste. According to the Word Bank’s 2018 data,
manufacturing only accounts for 13% of GDP across Africa. Therefore, intesnly focusing on
manufacturing, while simultaneiously exploiting FIR solutions, can potentially improve economic
prospects. This can further be compounded positively by the AfCFTA increasing the market size and
enhancing competitiveness at the industry and enterprise level for manufactured goods while the
TFA ensures that global markets are more navigable than they currently are. A 2015 WTO study
argued that the LDCs, the majority of which are in Africa, would experience a 35 percent increase in
exports courtesy of the TFA if it is implemented fully. Infrastructure development is critical for
economic growth and regional economic integration. The provision of adequate infrastructure,
alongside macro-economic stability and long-term development strategy, are fundamental
conditions for sustainable economic and social development. The TFA is unique in that
implementation is directly linked to the capability of countries to fulfil their requirements, and it
offers technical and financial support for developing and LDCs who need it for infrastructure. African
countries can, therefore, leverage these resources to drive Africa’s regional integration agenda to
spur economic growth and development.
Moreover, the AfCFTA encourages pooled infrastructure investment, particularly transport and
logistics infrastructure. The lessened financial burden on each state could increase the willingness to
invest and ensure optimal resource allocation, subsequently reducing the cost of doing business
across the board, thus improving economic prospects.
Simulations by the United Nations Economic Commission for Africa, show that the implementation
of AfCFTA accompanied by trade facilitation measures would increase the share of intra-African
trade from 12 percent in 2012 to 22 percent by 2022, 7.5 percentage points higher than a scenario
without trade facilitation (15.5 percent).
The FIR requires entrepreneurship and innovation to thrive. Entrepreneurship, which spurs the
growth of Small and Medium Enterprises (SMEs), plays a vital role in improving economic prospects.
The technological changes brought by the FIR as well as the changes in consumer behaviour caused
by the Covid-19 pandemic such a consumer’s increased e-commerce migration provide new and
exciting business opportunities. One key feature of entrepreneurship is job creation. The 2030
National Development Plan expects SMEs to be a vital source of employment and drivers of growth
in the economy. The AfCFTA increases the talent pool of potential workers while trade facilitation
can increase start-ups’ success by increasing SMEs’ access to global markets and reducing their
administrative burdens through the employment of FIR technologies. These factors collectively
induce employment-rich economic growth for the African continent.
To sum up, for Africa to achieve increased trade and improved economic prospects within its own
region and globally, it needs to take a leap by implementing the FIR technologies carefully to
enhance its manufacturing sector. Furthermore, it needs to leverage the special benefits offered to
developing and LDCs by the TFA to spur infrastructure development. Lastly, Africa needs to create a
conducive environment that encourages entrepreneurship and innovation so that SMEs can create
employment opportunities for vulnerable groups, especially the youth.
2. How can the WTO’s TFA and the FIR TOGETHER with the AfCFTA, help reduce youth
unemployment?
Africa’s youth, aged 15-24, are both an asset and a minefield. The demographic represents future
promise but also present peril as the majority are currently in dire straits. The youth unemployment
rate in South Africa has averaged 53.06 percent from 2013 to 2020. Due to the Covid-19 pandemic,
the youth unemployment rate increased to a record-high 59 percent in the first quarter of 2020 from
58.10 percent in the first quarter of 2019.
The majority of the youth in Africa do not have stable economic opportunities. The absence of
existing economic opportunities calls for the creation of new ones. Fortunately, entrepreneurship
and innovation are the driving forces of the FIR and are in turn enabled by its technologies. The
continued promotion and support of these forces may increase job opportunities for the youth as
young entrepreneurs, and innovators will not only gain employment, but create jobs for others
through the incorporation of SMEs. In recent years, Africa has seen an increase in business
incubators that seek to support entrepreneurs across a diverse number of sectors to reduce the
chances of failure of start-ups.
In South Africa alone, there are over 55 business incubators. A number of business incubators are
initiatives of universities, which increases their accessibility to the youth. The LaunchLab, for
example, is an initiative of Stellenbosch University in partnership with Nedbank, which
encourages and supports various technological innovations. In this regard, the FIR creates a virtuous
cycle of sorts for the youth as its driving force creates opportunities in themselves but so do the
solutions offered by it. FIR-induced technologies like blockchain and ICT technologies simplify and
reduce the cost of starting and running businesses, which make entrepreneurship more accessible to
the youth. For example, the low operational costs incurred when social media platforms are used to
sell products online presents self-employment opportunities for the youth; this is compounded
by the proliferation and adoption of e-commerce by consumers spurred by Covid-19.
Moreover, the fast-growing online financial market makes paying taxes, making payments and
access to credit much easier, this is further enhanced by big data, where the collection of personal
data will give rise to safer and less discriminatory lending that can enable greater youth
participation.
The AfCFTA offers a continent-wide market size for all young entrepreneurs and innovators. Trade
facilitation serves to further increase opportunities for SME’s to access the global market whilst
simultaneously removing the red-tape they are susceptible to when engaging in trade across
borders. Furthermore, it can improve the profitability of these international ventures by reducing
transaction cost. This demographic dividend affords Africa greater flexibility and adaptability. The
government has an opportunity to redirect the youth into more favourable high-skilled service jobs
through education and training. In this sense, the youth can ride the wave of the fastest-growing
sector for job creation in most African economies. It is estimated that the service sector could grow
by 3.8 percentage each year until 2030, which contributes significantly to Africa’s growth trajectory.
The service sector is set to benefit most from the FIR through its modernisation and expansion.
More importantly, the free movement of labour (services) which would be enabled by the AfCFTA
increases the scope of job search for the youth by opening the doors to more lucrative continental
job opportunities.
However, in order for the youth to capitalise on these opportunities investment in quality education
for skills improvement and R&D is required by the government. Online learning, which Covid-19 has
made a new normal, will further assist by reducing the cost for youth to acquire important skills
needed to innovate and participate in the service industry. Online learning should, therefore, be
used to support this transitional effort. This should also be accompanied by the promotion of
frameworks that support SMEs, which are and will continue to be the engines of employment.
Nurturing SMEs, through increased development of incubators and implementing the AfCFTA
together with the TFA also transfers benefits to women, subsequently, reducing contribution
barriers and increasing their overall participation in the economy.
How can the WTO’s TFA and the FIR TOGETHER with the AfCFTA help women to participate more
in the economy?
Statistics confirm that women play a vital role in the economy. According to the Global
Entrepreneurship Monitor (GEM) 2018/19 women’s report, female entrepreneurship rates in Sub-
Saharan Africa are the highest in the world with a reported Total Entrepreneurial Activity (TEA) of
21.8 percent, the lowest TEA rates are found in Europe (6 percent). The majority of African women
indicated that they started a business because they were taking advantage of an opportunity, rather
than out of necessity.
Although this signals significant progress, overall women participation
in the global economy continues to
lag behind that of their men (male) counterparts. The global labour force participation rate for
women is close to 49% and for men, it is 75%. Women are subject to gender biases and societal
perceptions that hinder their entrance into the workforce, and their ability to start their own
businesses or own land and assets. According to the joint WTO/World Bank report, “The Role of
Trade in Ending Poverty”, published in 2015, “even when trade opportunities have delivered new
jobs for women, gender biases have sometimes resulted in greater risks, less protection and more
unfavourable working conditions for women”. Furthermore, women’s businesses are susceptible to
financing constraints. Women-owned SMEs have unmet credit needs that range between USD 260
billion and USD 320 billion a year. Women involved in trade compare unfavourably to men
concerning access to critical trade-related knowledge on cross-border regulations and procedures.
Moreover, women-owned businesses tend to be smaller than men-owned businesses, which make
women more susceptible to the downside of SMEs. SMEs tend to be affected disproportionately by
trade costs. SMEs often face higher export costs from delays in processing export permits, lack of
access to trade finance, and exclusion from distribution networks. SMEs also face greater risks when
trading internationally. These bottlenecks reduce their competitiveness, therefore, their rate of
survival.
From an economic perspective, it is important to optimise all available human resources. Otherwise,
the nation is producing below its PPF and not reaching its full potential. The economic and social
discrimination against women costs Africa US$ 105 billion a year or 6% of the continent’s GDP.
Eliminating barriers to accessing the labour market for women is therefore key.
The TFA has become an important reform agenda that can help empower women. Several trade
facilitation measures contained in the agreement directly contribute to meeting the UN’s Sustainable
Development Goals (SDGs), such as SDG 9.c on “access to the internet”, SDG 16.5 on
“reducing corruption and bribery” and SDGs 8.3 and 16.5 on “formalisation and growth of micro
small and medium-sized enterprises”. All of these can directly empower women.
The AfCFTA requires immense government investment, which translates in increased government
procurement. Government procurement is a powerful spending tool, which if used strategically, can
offer opportunities for women entrepreneurs to grow their businesses and create employment. The
International Trade Centre shows that public procurement accounts for over 30% of GDP in
developing countries and 10% to 15% in developed countries. The TFA implementation makes
provision for improvements in the capability of countries to fulfil their requirements, i.e. that
assistance be provided to countries who need it, which can increase the scope of investments. Smart
use of these opportunities could see government targeting women not only for entrepreneurship,
but also for skills development that puts them in crucial positions for the successful transition
to effective regional and global supply chains. In general, access to the internet allows women to
obtain information about markets, suppliers, as well as online education opportunities, which are
often free.
FIR-induced technologies like blockchain and ICT technologies simplify and reduce the cost of doing
business for all SMEs. Moreover, the fast-growing fintech sector makes access to credit much easier;
big data, and data analytics, will give rise to safer and less discriminatory lending, thus enabling
greater participation for women.
CONCLUSION
We have briefly discussed how the WTO’s TFA and the AfCFTA can propel Africa’s growth amid the
FIR and the Covid-19 global pandemic. This is a huge topic, which can take up many research hours.
We have, of course, limited our treatment to a level for Intermediate Economics students, but you
are encouraged to explore the topics further (since your future literally depends on its
development). Nevertheless, we believe that the Covid-19 pandemic presents a critical juncture that
requires the African continent to continue to prioritise the implementation of the WTO’s TFA and the
AfCFTA as a stimulus package to increase trade across the continent in order to mitigate the
detrimental economic effects caused by the pandemic and hasten economic recovery.
We applied these three concepts collectively to highlight how the opportunities offered by the
WTO’s TFA, together with the FIR and AfCFTA, can be used to help Africa increase trade
and economic prospects and assist vulnerable groups, specifically the youth and women. In
investigating the former, while simultaneously acknowledging the progress made thus far, we
conclude that:
1. for Africa to achieve increased trade and improved economic prospects within its own
region and globally, it needs to take a leap by implementing the technologies of the FIR to
enhance its manufacturing sector. Furthermore, it needs to leverage the special benefits
offered to developing and LDCs by the TFA to spur infrastructure development
2. From an economic perspective, it is important to optimise all available human resources.
Therefore, Africa must continue to create a conducive environment through the full
implementation of WTO’s TFA and AfCFTA in a manner that encourages entrepreneurship
and innovation so that SMEs, powered by the FIR, can create employment opportunities for
the youth and increase the participation of women in the economy.
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Macro Eco 2
International Finance
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ECONOMICS 244: INTERNATIONAL FINANCE
PROBLEM 1
What role does International Finance play in economic growth?
Prior knowledge
S
• What is economic growth? and How is economic growth measured? and What are the sources of
economic growth?
Please see the first portion of these summaries pertaining the International trade notes.
• The balance of payments and its accounts
The balance of payments refers to a periodic statement of the monetary value of all transactions
between the residents of one country and the residents of all other countries for a specific period, i.e. it
is a summary of all transactions that occur between the residents of a country and residents from other
countries.
Accounts in the balance of bayments
The balance of payments must always balance, i.e.
Current account balance
+ Capital transfer account
+ Financial account balance
+ Unrecorded transactions
= Reserve assets
The reason why the balance of payments will always balance is due to the fact that each transaction
contains a flow of goods, services or financial assets, as well as a flow of money as a payment.
Accordingly, each transaction will be recorded twice, once as a debit entry and once as a credit entry;
accordingly, the balance of payments will always balance.
• A debit transaction represents an inward flow of a valuable item or a payment that is made to
a non-resident, e.g. imports, because items flow in while payments flow to a non-resident
(money flows out). This will lead to a demand for a foreign currency and accordingly a supply
of the domestic currency on the foreign exchange market (commonly known as the forex
market, which refers to the market where all transactions involving currencies take place),
which will lead to a depreciation of the domestic currency.
• A credit transaction represents an outward flow of a valuable item or a payment that is received
from a non-resident, e.g. exports, because items flow out while payments flow from non-
residents (money flows in). This will lead to a demand for the domestic currency and
accordingly a supply of the foreign currency on the foreign exchange market, which will lead
to an appreciation of the domestic currency.
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Current account (acts as an expense/income (financial accounting terms) in terms of debits and credits)
The current account shows the net amount of a country's income if it is in surplus, or spending if it is
in deficit.
The current account consists of

• Merchandise exports,
• Net gold exports,
• Service receipts,
• Income receipts,
• Merchandise imports,
• Payments for services,
• Income payments, and
• Current transfers, which refers to an inflow of money in the form of gifts, donations and
remittances, i.e. money received without a glow of goods and/or services.
The most important item on the current account is the trade balance, which is given by the following
Trade balance = Merchandise exports (gold included) – Merchandise imports.

Capital transfer account
Capital transfers refer to the flow of money pertaining the transfer of ownership of fixed assets.
Financial account (acts as an asset/liability (financial accounting terms) in terms of debits and credits)
The financial account was previously called the capital account but was changed due to potential
ambiguity that arose with the capital transfers account.
The financial account consists of
• Direct investments, which refers to the flow of money with the purpose of obtaining a
controlling interest in an investment, which refers to when a country obtains more than 10% of
the voting rights in a company.
• Portfolio investments, which refers to the flow of money with the purpose of gaining a financial
return on an investment, which refers to when a country obtains less than 10% of the voting
rights in a company.
• Financial derivatives, which refers to financial instruments that is linked to another financial
instrument, which is generally used for risk management, hedging, speculation and arbitrage.
• Other investment, which refers to trade credits, trade loans (which is generally used when there
is no flow of money across country borders, e.g. South Africa obtains a trade loan in Germany
to fund imports from Germany – no money flows from South Africa to Germany when the
imports occur), currencies, deposits and any other assets and liabilities that do not fall under
the previously mentioned categories of the financial account.
• Reserve assets account, which refers to where all gold and foreign reserves are accounted for.
This is the most important account on the balance of payment as it will generally be the contra-
account in any international transaction, due to the increase or decrease in the foreign currency
(or gold) that the domestic country holds, which will affect the supply and demand of the local
currency.
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How to answer questions regarding the balance of payments?
1. Determine whether there is a flow of money across country borders, in which case reserve assets
will be affected, which is in the financial account. If not, trade loans are being used, which is a
part of “Other investments” in the financial account.
2. Determine whether payments are flowing to or from our country. If payments are flowing to
our country, “Reserve assets” will be debited, and if payments are flowing from our country,
“Reserve assets” will be credited.
3. Determine which specific parts of an account is being affected, e.g. merchandise exports or
portfolio investments.
4. Lastly, determine which main accounts are being affected, e.g. the current account or the
financial account.
5. Write the debit and credit transaction.
For example
An Indian investor purchases Pick n Pay, a South African firm, for R500 million.
1. Determine whether there is a flow of money across country borders, in which case “Reserve
assets” will be affected. If not, trade loans are being used, which appears under “Other
investments”.
Yes, money will flow across borders → Reserve Assets will be affected.
2. Determine whether payments are flowing to or from our country.
Payments are flowing to the country → Reserve assets will be debited.
3. Determine which specific parts of an account is being affected.
We have determined that Reserve assets will be affected.
But what is the other account? From this example we can determine that an outside country is
purchasing a South African firm, which means they will have 100% of the voting rights in the firm.
This is larger than 10% of the voting rights, and accordingly “Direct investments” will be affected; and,
it will be credited, as we have already determined that reserve assets have been debited.
4. Lastly, determine which main accounts are being affected.
Reserve assets, as well as direct investments are in the financial account.
Dr Financial account: Reserve assets
Cr Financial account: Direct investments
A South African imports goods from Germany and pays for the imports with a trade loan from Germany.
1. Determine whether there is a flow of money across country borders, in which case “Reserve
assets” will be affected. If not, trade loans are being used, which appears under “Other
investments”.
No, money will not flow across borders → Other investments will be affected.
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2. Determine whether payments are flowing to or from our country.
Payments are (technically) flowing from the country, because a loan will have to be repaid at some
point, in which case payments will flow from the country → Other investments will be credited.
3. Determine which specific parts of an account is being affected.
We have determined that Other investments will be affected.
But what is the other account? From this example we can determine that South African is importing
goods from another country, which means that merchandise imports will be affected.
4. Lastly, determine which main accounts are being affected.
Merchandise imports appear in the current account, while trade loans appear in other investments in the
financial account.
Dr Current account: Merchandise imports
Cr Financial account: Other investments
• The foreign exchange market – floating exchange rates and the current IMS
An exchange rate refers to the value of one currency in terms of the currency of other countries.
These exchange rates are determined by means of the foreign exchange markets, also called the forex
markets. If these exchange rates are purely determined through the interaction of the demand and the
supply of a specific currency, the country has a flexible exchange rate system, while if the exchange
rate is determined through the interaction of demand and supply, as well as some level of government
intervention, it is said that the currency has a fixed, or managed, floating exchange rate system,
depending on the level of government intervention.
A country’s International Monetary System (abbreviated as ISM) refers to the way that an exchange
rate is determined in the country.
South Africa’s official ISM is a managed floating exchange rate system, but the practice in South Africa
is not too use the reserves too much in order to affect the exchange rate system. South Africa is therefore
closer to having a free-floating exchange rate system than having a fixed floating exchange rate system.
For the aim of this part of the work, a floating exchange rate will be used, and we are therefore just
interested in the interaction between the demand and supply of a currency. It is important to understand
that these demands and supply are derived demand and supply curves, because individual do not directly
demand foreign currencies, but instead they demand goods and/or services from foreign currencies and
therefore require foreign currencies to make these transactions possible.
One thing that needs to be understood before approaching the foreign exchange market – the demand
of one currency is the reciprocal of the other currency’s supply, e.g. if the demand for Rand increases,
there will be a simultaneous increase in the supply of euros, because the Europeans need to supply euros
in order to receive Rands in return.
When we represent these exchange rates, a country can use one of two methods. These two methods
will be illustrated by means of an example in which case the South African Rand is the domestic
currency and the Euro (€) is the foreign currency.
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1. Direct quoting in which case the foreign exchange rate is quoted as the domestic currency per
unit of the foreign currency, e.g. R11 for 1€ given that the Rand (or abbreviated as the ZAR) is
the domestic currency.
When we graphically represent the direct quoting method, we will express the Quantity of the foreign
currency on the x-axis and the relationship between the domestic currency and the foreign currency
domestic currency
( ) on the y-axis.
foreign currency
This can therefore be graphically illustrated by the

figure to the right.
It is important to realise that the demand and the
supply that is given in the market for a specific
currency always relates to the foreign currency in
the case of an direct quoting graph, e.g. in the
figure that is given to the right, we are currently in
the Market for Euros and we also see that the
demand and the supply is given in terms of Euros,
which will always be the currency that is given on
the x-axis, as well.
2. Indirect quoting in which case the
foreign exchange rate is quoted as the
foreign currency per unit of the domestic
1
currency, e.g. R1 for € .
15
When we graphically represent the indirect quoting method, we will express the Quantity of the
domestic currency on the x-axis and the relationship between the foreign currency and the domestic
foreign currency
currency (domestic currency) on the y-axis.
This can therefore be graphically illustrated by

the figure to the right.
Again, it is important to realise that the demand
and the supply that is given in the market for a
specific currency always relates to the domestic
currency in the case of an indirect quoting graph,
e.g. in the figure that is given to the right, we are
currently in the Market for Rands, and we also see
that the demand and the supply is given in terms
of Rands, which will always be the currency that
is given on the x-axis, as well.
The last important aspect to note when dealing
with exchange rates is the concept of depreciation
and appreciation.
When a currency appreciates (and the other currency depreciates), it means that the currency becomes
stronger relative to another currency, e.g. R15 for 1€ changes to R14,50 for 1€. An appreciation of a
currency is characterised by the increase of the demand for that currency (and the other currency’s
5|Page
supply increases) and a decrease in the supply for that currency (and the other currency’s demand
decreases).
When a currency depreciates (and the other currency appreciates) it means that the currency becomes
weaker relative to another currency, e.g. R14,50 for 1€ changes to R15 for 1€. A depreciation of a
currency is characterised by the decrease of the demand for that currency (and the other currency’s
supply decreases) and an increase in the supply for that currency (and the other currency’s demand
increases).
The following factors will affect the supply and demand of a currency
• Investor confidence in a specific currency.
If the investors become more confident in a currency, investors will be willing to invest that country,
which means there will be an increase and the demand of the domestic currency and accordingly the
domestic currency will appreciate.
If investors become less confident in a currency, though, the domestic currency will depreciate.
• The global risk environment.
It is important to introduce the concept of risk-on and risk-off trade.
In a risk-on environment, the general attitude among investors is that it is advisable to take on more
risk. This means that investors will be willing to take on riskier investments and accordingly
investments in emerging economies, such as South Africa, will increase, which will lead to the
appreciation of the currency in these emerging economies.
In a risk-off environment, the general attitude among investors is that is not advisable to take on more
risk. This means that investors will not be willing to take on riskier investments and accordingly
investments in emerging economies, such as South Africa, will decrease, which will lead to the
deprecation of the currency in these emerging economies, because investors would rather move their
investments towards haven assets (assets that are considered to be “safe”), such as gold, the USD and
the Japanese Yen (¥).
• The differences in income growth rates between different countries.
If a country’s income rises, its citizens will have a greater demand for local and foreign goods, which
means there will be an increased demand for the foreign currency, which will lead to an appreciation of
the foreign currency.
If a country’s income decreases, however, we will see the opposite effect – the foreign currency will
depreciate.
• The differences in relative inflation rates between different countries.
If there is an increase in the inflation rate of a country, that country’s prices will be relatively more
expensive in comparison to another’s. This means that the domestic currency will be willing to import
more foreign goods and/or services. There will therefore be an increase in the demand for the foreign
currency, which will lead to an appreciation of the foreign currency.
If there is a decrease in the inflation rate of a country, we will see the opposite effect, because the
domestic currency’s goods and/or services will be relatively cheaper in comparison to another’s and
accordingly there will be a bigger demand for the domestic country currency and accordingly, the
domestic country will depreciate.
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• The changes in real interest rates in a country.
If there is an increase in the real interest rate of a country, foreign investments will flow towards the
country. There will therefore be an increase in the demand of the domestic currency, which will lead to
an appreciation of the domestic currency.
If there is a decrease in the real interest rate of a country, we will see the opposite effect – the domestic
currency will appreciate.
Additional question
Explain the USD as a dominant international currency.
A reserve currency is a stable currency that is expected to hold its value during business cycle and
asset volatility. These reserve currencies are therefore expected to appreciate during financial crises as
the demand for safe-haven assets increase during risk-off global environments.
The US dollar (abbreviated as USD) first became a reserve currency in 1944 under the Bretton Woods
System, when all currencies were fixed to the US dollar. By 1973, the exchange rate system was one of
managed flexibility and currencies were no longer required to be fixed to the USD. The USD, however,
remains the reserve currency of choice for most countries. The US Government enjoys greater liquidity
due to their issuing of reserve currencies, which allows them greater access to capital. About 90
countries in the world have a currency that is explicitly or implicitly pegged to the USD.
Certain estimates suggest that the US dollar zone may represent more than half of global GDP, i.e. the
invoices that are denoted in USD contribute to almost half of the global GDP. It is estimated that the
invoicing currency share of the US dollar is between four and five times higher than the United States’
share of world imports, and over three times higher than its share of exports.
The US dollar is used extensively in the trade of emerging market economies (EMEs) and for exports
from commodity producers. The rising share of EMEs in global trade has tended to push up the role of
the US dollar in international trade over time.
In 2017, approximately 40% of international financial transactions were done in USD. According to the
IMF, by the end of quarter 2 of 2018, USD 6,552 trillion of foreign reserves were held in US$. 62,5%
of the foreign reserves in the world are in USD, followed by 20,4% of global reserves in Euros and
4,8% of reserves in Yen.
According to a research report published by Moody's in September 2018, the transparency of the US
financial markets, as well as the stability and predictability of the monetary policy of the United States
reinforces the safe-haven legacy that the US dollar holds.
It will likely be several decades before the global status of the US dollar is challenged by any
currency.
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Question 1
How does economic growth in one country affect economic growth in another country? What are the
implications for the current account and the financial account in the balance of payments?
The transmission mechanism by which economic growth in one country leads to economic growth in
another country happens via the demand side.
Economic growth in one country will lead to domestic demand growth, which refers an increase in the
demand in the domestic market for international goods and services. The economic growth in the
country therefore relates to increased production and accordingly an increase in exports, but
simultaneously, the economic growth will lead to an increase in the level of wealth of the residents of
a country, which will lead to an increase in the imports of a country, as well. The economic growth in
one country therefore leads to increased trade among countries, which will lead to increased economic
growth in other countries, as well.
It is important to note that goods and/or services does not only refer to exports and imports between
countries, but it also refers to financial assets that are kept in other countries, as well as services that are
offered by a specific country, e.g. holidays in countries that are considered to be “nice”, which generally
relates to countries with higher economic growth.
The increase in the exports of the improved nations will lead to the current account deficit that will
narrow, as net exports become smaller, and it will also lead to the financial account surplus widening,
as money flow toward country, ceteris paribus.
Question 2
Briefly discuss how economic shocks in one country spill over to other countries. Provide specific
examples from 2016 and the first half of 2018.
Economic shocks are events that occur outside of an economy which produces a significant change
within an economy, whether it be a positive or negative change. These shocks occur in many different
forms, such as
• A supply shock refers to a shock that is due to a constrained supply, which is generally due to
the increase in prices of staple commodities, such as oil, which will make business activities
more expensive. Supply shocks are generally caused by accidents and disasters.
• Rapid devaluations in a country’s currency will produce shocks for the export/import industry,
which will bring across difficulties in the trade of foreign products.
• A technology shock refers to when technological advancements lead to significant changes in
productivity.
• An inflationary shock refers to when the prices of commodities go up, which is not
accompanied by immediate increases in the salaries of the society, which therefore leads to a
loss purchasing power.
• Demand shocks occur when there are sudden and significant changes in the patterns of private
spending, whether it be via consumption expenditure or investment expenditure.
• Monetary policy shocks refer to when central bank departs from an established pattern of
interest rate, or money supply, increase or decrease, without proper advance warning.
• Fiscal policy shocks refer to unexpected changes in government expenditure and/or levels of
taxation.
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These economic shocks spill over into other economies through international trade linkages in the global
value chain, which refers to all people and/or activities that are involved in the production and global
supply, distribution and post-sales activities of these people and/or activities. Furthermore, spillbacks
can also occur, which refers to when the adverse effects on a subsequent country, such as country B,
spills back over into the original country, i.e. country A, for example, when there is decreased domestic
demand in country A, country A will import less (i.e. a decreased demand for exports from country B),
which would decrease economic growth in country B and leads to an even more decreased demand for
country A’s exports.
Furthermore, global financial integration and international financial transactions will also cause the
growth to be transmitted among countries.
These spillovers are generally worsened by
• The extent to which a country’s borders are open to international trade. A country that has more
closed-off borders will be less affected by such spillovers, but if they have rather open trade
borders, they will be affected quite adversely.
• The strength of the linkages among trading partners in the global value chain, because the
greater the volume of trade that occurs between countries, the greater the effect these shocks
will have on other countries.
• Monetary policy that does not react in response to these effects will lead to the effect of the
spillovers being even worse.
Examples of shocks that plagued the global economic environment in 2016 includes
• In January 2016, the stock markets in China crash, which led to fear among investors an outflow
of capital from China and essentially leading to slowed growth in China.
• In June 2016, the United Kingdom voted to leave the world’s largest trading bloc, that we know
as Brexit. This added to global uncertainty (a risk-off environment), while decreasing investor’s
confidence in the currency and essentially demoted the Pound Sterling to not be considered a
haven asset anymore.
• In November 2016, Mr Trump won the election to become the president of the United States of
America, that increased the global uncertainty that investors face, due to the fact that Mr Trump
has some controversial opinions and implement actions that are questionable.
• In November 2016, the Organization of the Petroleum Exporting Countries decided to cut down
the global oil production, which led to an eventual increase in the oil prices, leading to a supply
shock.
And, shocks that plagued the global economic environment in the first half of 2018 includes
• The raging trade wars between the United States of America and China has led to increased
global uncertainty.
Question 3
Describe the global financial stability outlook for 2018.
Despite ongoing monetary policy normalisation in some advanced economies and some signs of firming
inflation, global financial conditions are still very accommodative relative to historical norms. Although
supportive of near-term growth, easy financial conditions could also facilitate a build-up of financial
fragilities, increasing risk to global financial stability and economic growth over the medium term.
The global economic outlook has continued to improve with the pace of economic growth picking up
and the recovery of economies are becoming more synchronised around the world. The key challenge
for central banks still remains – to maintain monetary accommodation which is required to support
economic recovery, while also addressing medium-term financial vulnerabilities.
Short-term risks that can affect the global financial stability outlook for the remained of 2018 have
increased somewhat, compared to historical norms, and include
• Inflation in the US may rise faster than expected, which is possible due to the recent fiscal
expansion. Central banks in response may tighten monetary policy more forcefully than
currently anticipated. In such a scenario, financial conditions could tighten sharply, generating
adverse (negative) spillovers to other advance and emerging market economies, i.e. safe-haven
assets become more widely advisable and according capital will flow from emerging market
economies.
• Trade tensions and greater protectionism could affect financial stability via increased
uncertainty and lower global growth. The increase in protectionist measures would also take its
toll on global output and welfare by raising geopolitical tension, which will have negative
implications for global financial stability.
• There may also be a decline in investors’ confidence, even before the impacts of protectionist
measures on trade, together with a tightening of financial conditions which might provide
substantial headwind for growth.
Medium-term risks have also become slightly elevated in comparison to recent years, and include the
following risks for the economy
• Substantial medium-term financial vulnerabilities have built up during the period of prolonged
monetary accommodation, which could amplify the impact of asset price movements on the
financial system, putting growth at risk in the medium term.
• A sharp tightening of global financial conditions could have negative repercussions of growth.
• A period of high credit growth is more likely to be followed by a severe downturn over the
medium term if it is accompanied by an increase in the riskiness of credit allocation.
• Policy-makers face a trade-off between supporting growth in the near term and putting future
growth at risk over the medium-term, i.e. they need to make a decision on whether they want
to focus on growth in the short term, rather than in the longer term.
• Managing the gradual process of monetary policy normalization will be tricky against this
backdrop of elevated medium-term risks and will require careful communication from central
banks and policymakers to reduce the risks from a sharp tightening of financial conditions.
• At present, crypto assets do not appear to pose macro-critical financial stability risks. A
potential financial stability should crypto assets be used more widely.
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Additional question
Differentiate between dovish and hawkish tones as pertained to monetary policy and what effect it could
have on the international finance component of an economy.
A dovish tone refers to the sentiment of the central bank when it is looking to stimulate the economy
and feels rates are too high for its policy, i.e. they are intending to decrease the policy interest rate. A
decrease in the policy interest rate will have a negative effect on the economy as the country’s currency
will depreciate. The depreciation of the currency will lead to an increase in the exports of the country
and a decrease in the imports of a country, which will lead to a decrease in the deficit on the current
account.
A hawkish tone refers to the sentiment of the central bank when they are intending to increase interest
rates. An increase in the policy interest rate will have a positive effect on the economy as the country’s
currency will appreciate. The appreciation of the currency will lead to a decrease in the exports of the
country and an increase in the imports of a country, which will lead to an increasein the deficit on the
current account.
Question 4
Describe the financial vulnerabilities currently facing emerging markets and low-income countries.
Emerging markets and low-income countries are very reliant on capital investments by foreign
investors. This means that they are very vulnerable to any changes in policy interest rates, whether it be
in response to other countries, or not. In the case that the policy interest rate increases in the emerging
markets and low-income countries, they will be faced with benefits of capital flowing into the country,
but the opposite also applies – if their interest rates decrease, capital will flow from these countries
towards less risky investment (the so-called “haven assets”), which could cause strain on the economic
growth prospects of the country.
Furthermore, emerging markets and low-income countries are very vulnerable towards changes in the
exchange rate, especially if they have debt that is denominated in dollars, especially with the uncertainty
that the world is facing regarding the questionable policy choices of Mr Trump. Accordingly, if the
dollar appreciates, the interest that is payable on these dollar-denominated debts, increases, and has
adverse effects on the economies of the emerging markets and the low-income countries.
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PROBLEM 2
Financial flows to and from African countries – strengths and challenges.
Prior knowledge
Please see the first few pages of this document for the prior knowledge required.
Question 1
Discuss the importance of remittances as financial flows to Africa.
Remittances refer to the financial flows to and from a country made by a migrant worker that sends
money back to their home country, e.g. a South African citizen that works in the United States and send
money home to his family in South Africa.
It is important to note that remittances are not financial flows to or from countries in payment of factors
of production utilised elsewhere. It is also not foreign direct investment. Remittances is mostly just
money that is transferred to someone in another country. It will be included under “Current transfers”
in the current account.
Remittances is an important financial flow to any country as it generally represents the largest
contribution of the country’s GDP. These remittances are generally much more stable than other sources
of income, such as foreign direct investment and/or private debt and portfolio equity, mainly because
most remittances refer to money that is sent to family.
Due to the fact that these remittances make such a large contribution to the GDP of many countries, it
is especially important to low- and middle-income countries, as they will be very dependent on
remittances as a form of income. This is therefore important to Africa, especially when Middle-East,
Northern and Sub-Saharan African countries are considered to be low- and middle-income countries.
The following table represents the total amount (forecasted where applicable) of remittances to specific
parts of Africa in billion USD.
2014 2015 2016 2017 2018 2019
Middle-East and Northern Africa 54 51 49 53 56 57
Sub-Saharan Africa 37 36 34 38 41 43
As can be seen from the table above, these countries generally receive a large sum of money in the form
of remittances, which can be used productively and is therefore a necessary form of income.
Remittances represents Africa’s main source of foreign exchange earnings since 2010, as it accounts
for about a third of total external financial inflows.
In 2017, Africa received a total of US$60 billion. A study done among countries in 2017, determined
that African countries such as Nigeria (US$22 billion) and Egypt (US$20 billion) is among the countries
that receive the most remittances. Furthermore, African countries such as Liberia (27%) and Gambia
(21%) is among the countries where remittances contribute the largest proportion of their GDP.
When we look at the trends regarding remittances in North Africa for the next few years, we see that
the remittances to Middle East and Northern Africa has increased by approximately 9% in 2017, after
two years of decline. This growth was driven by the rapid increase in remittances to Egypt.
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The improved economic and employment growth in Europe, as well as the depreciation of the dollar
against the euro, increased the remittances to Maghreb (which is a major region of North Africa that
consists primarily of the countries Algeria, Morocco, Tunisia, Libya and Mauritania), as well.
It is expected that the growth in remittances is expected to slow down, as the remittances from Saudi-
Arabia, the UAE and Kuwait to North Africa is expected to decrease.
The last thing that needs to be considered regarding remittances, is the fact that it is counter-cyclical
within the remittance-receiving country, which means that remittances moves in the opposite direction
as the business cycle (e.g. if there is an economic downturn in the country, remittances to that country
will increase), while being procyclical in remittance-sending countries, which means that remittances
moves in the same direction as the business cycle (e.g. if there is an economic downturn in the country,
remittances from that country will decrease).
Question 2
Briefly discuss the nature and impact of illicit financial flows to West Africa.
The licit and illicit are becoming increasingly interwoven in West Africa, partly due to the size of the
informal economy, which is approximated to be 60%-70% of the total economic activity in the region
due to the fact that the formal banking system is often out of reach for many. This low level of financial
inclusion facilities the environment for criminal economies and illicit financial flows (herein after
referred to as IFFs).
These IFFs refer to money that is illegally earned, transferred or used. IFFs include revenue and
proceeds generated by the following activities
• corruption due to the proceeds on theft, bribery and/or embezzlement of national wealth by
government officials; it also includes
• commerce, such as proceeds of tax evasion, misrepresentation, misreporting and misinvoicing
and also in the form of money laundering of criminal activities; and lastly it includes
• crime, such as the proceeds of illegal transactions, such as drag trafficking and prostitution.
West Africa is deeply affected by corruption and clientelism, i.e. the first two categories of IFFs.
Associated with these IFFs are criminal economies, which refers to activities that are clearly illegal,
but also to activities that are illicit, while including some subsistence component. Criminal economies
occur in three forms
1. Illegal activities, which refer to activities or transactions that are illegal in the context of the
law, such as drug trafficking, kidnapping for ransom money, human trafficking and smuggling.
2. Illicit trade in legal goods, which refer to activities that relate to resources sourced from
outside of the region, such as illicit tobacco and commodity smuggling.
3. Illicit resource extraction, which refer to resources that were sourced in the region, legally,
but never entered into the formal economy, or have moved into the illicit economy at some
point between the source and the market, such as illicit mining, oil bunkering and illegal,
unreported and unregulated fishing.
West Africa’s geography, demography and socio-economic conditions enable the existence of criminal
economies. The problem is then further exacerbated by weak states and governance. In West Africa,
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the low levels of financial inclusion are the biggest contributor to enabling environments for criminal
economies.
Common criminal economies that can be found in West Africa include ASGM (artisanal and small scale
gold mining), trading in counterfeit goods, drug trafficking, such as that of methamphetamines,
cybercrime, advance-fee fraud and the enabling of illicit extraction of the region’s natural resources.
These criminal economies and IFFs lead to harm revolving five specific areas that are crucial to
development
• Physical harm, which refers to harm to any persons, such as homicide or violent crimes, as
well as to physical infrastructure.
• Societal harm, which creates or exacerbates social tensions, such as gender-based or inter-
generational violence, as well as economic and/or social marginalisation of individuals.
• Economic harm, which can occur in a direct and indirect manner – directly, criminal
economies and IFFs withdraw money from the legitimate economy, which leads to a
misallocation of resources, and indirectly, because it damages the economic climate and the
level of competitiveness of firms in the company.
• Environmental harm, which is caused by unsustainable usage of resources, as well as the by-
products of criminal activities.
• Structural, or governmental, harm, which refers to any damage done to the quality of the
governance or rule-of-law system as a result of corruption, and through the erosion of the state’s
reputation, legitimacy and authority.
It is thus evident that criminal economies and IFFs can impede on the economic development of a
country through the harm that it can cause.
PROBLEM 3:
How can South Africa capitalise on the opportunities provided by the Fourth Industrial
Revolution and the World Trade Organisation’s Trade Facilitation Agreement to grow
the economy and create jobs, especially for the youth?
Prior knowledge
• IS-LM Analyses
The goods market and the IS relationship

Previously we assumed that equilibrium in the goods market exists when production, Y, is equal to the
total demand for goods, Z, i.e. Y = Z, which we referred to as the IS condition. This was based on the
assumption that the interest rate does not affect the demand for goods and that investment was a
constant. This gave us an equilibrium condition of Z = C(Y − T) + I̅ + G, by dropping the assumption
of linearity for the consumption function.
In this section we are dropping the assumption that interest rates do not affect the total demand for
goods, because investment will no longer be seen as a constant, but rather investment will become
endogenous to the model.
Investment, sales and the interest rate.

The two main factors that affect investment:
• If the level of sales (Y) of a company rises, firms will increase production to meet demand and
will thus require additional investments. Because level of sales is very difficult to measure, we
will be using a proxy variable, which is income (Y). There is a direct relationship between the
level of sales and investment – if the level of sales increases, so does investments; and if the
level of sales decrease, so will investments.
• If the interest rate (𝒾) increases, it is more expensive to borrow money. Borrowed money is
usually required for companies to acquire investments, which means if the cost to borrow
money increases, the company will have lower investments. This tells us that investments and
the interest rate is inversely related – if the interest rate increases, investments will decrease;
and if the interest rate decreases, investments will increase.
Regarding interest rates, we make the following assumptions:

• All firms are allowed to borrow money at the same interest rate, which is equal to the
interest rates on bonds, as determined in the previous chapter.
• Furthermore, we disregard the difference between the nominal interest rate (the interest rate
in terms of Rands) and the real interest rate (the interest rate in terms of goods).
The two abovementioned factors can be illustrated in terms of the behavioural equation given by the
formula as can be seen on the right. The positive sign under Y indicates the direct relationship between
the level of sales and investments, and the negative sign under 𝒾 indicates the inverse relationship
between the interest rate and investment.
15 | P a g e
This leads to a new equilibrium condition for the goods market, which can be expressed by the following
formula: Z = C(Y − T) + I(Y, 𝒾) + G.
This can again be graphed on an axis, together with the
production-income curve, which is a 45⁰-line, with a slope
of 1 due to production and income always being equal to
each other. Due to the fact that we dropped the assumption
of linearity for both consumption and investments, we see
that ZZ is now a curve, rather than a straight line, as before.
The ZZ curve’s shape can be seen in the figure to the right.
Demand is an increasing function of output, for a given
value of 𝒾, because:
• An increase in output leads to an increase in
disposable income, which leads to an increase in
consumption.
• An increase in output results in an increase in investment, which increases the level of sales
and accordingly the income, as discussed before.
Because the investment is now affected by the product, we will see that the sum of the increase in the
consumption and investment can be theoretically more than the increase in the output. We assume that
this is not the case, instead output leads to a less than one-to-one increase in demand
This will give rise to the ZZ curve being drawn flatter than the 45⁰-line.
Deriving the IS-curve
To derive the IS-curve, we need to evaluate what happens
to the graph above when the interest rate changes. An
increase in the interest rate will lead to a decrease in
investment and ultimately a decrease in total demand. The
total demand curve, ZZ, shifts down to ZZ′. The decrease in
the total demand will be equal to the decrease in investment,
which means the equilibrium point has moved from A to A′,
while the equilibrium level of output has decreased from Y
to Y′. Equilibrium in the goods market implies that an
increase in the interest rate leads to a decrease in output. The
IS-curve will therefore be downward sloping.
Firstly, we derive all possible demand curves for different
interest rates. We then plot the resulting equilibrium points’
interest rates (on the vertical axis) with the corresponding
output level (on the horizontal axis), and join these points,
we will end up with the IS-curve, as can be seen in the figure
to the right.
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Shifts of the IS-curve
When we drew the IS-curve above, we accepted that taxes
and government spending is fixed. However, any changes in
factors that decrease the demand for goods, given the interest
rate, will shift the IS-curve. Therefore, the following factors
will shift the IS-curve to the left, as can be seen in the figure
to the right:
S
• An increase in the tax rate, because consumers have

less disposable income to spend, which will
decrease consumption and accordingly decrease the
total demand for the good and accordingly the
output, as well.
• A decrease in government expenditure, because a decrease in government spending will lead
to a decrease in total demand.
• A decrease in consumer confidence, because it decreases consumption, given a specific level
of disposable income.
Symmetrically, any factors that would increase the total demand for goods, would shift the IS-curve to
the right. These factors would simply be the inverse of those mentioned above, i.e. a decrease in the tax
rate, an increase in government expenditure and an increase in consumer confidence.
Financial markets and the LM relationship
For this section, we are also removing that there is no financial market.
Nominal vs real value of a good
The nominal value of a good is its value in terms of money, while the real value is its value in terms of
some other good, service, or bundle of goods. Generally, the real value of something is obtained by
dividend the nominal value by the price level.
Due to these definitions, we can restate the equilibrium condition for the financial market in terms of
M
the real money supply, i.e. P
= YL(𝒾). This will now become the new LM relation. To formally define
it once again, if the financial market is in equilibrium, the real money supply is equal to the real money
demand, which depends on real income, Y, and the interest rate, 𝒾, as given in the formula above.
Deriving the LM-curve
Our financial market will now plot the
relationship between the interest rate and the
real money, while the LM-curve will plot the
relationship between interest rate (on the
vertical axis) and the income (on the
horizontal axis), as can be seen on the figure
at the right.
If we have an increase in the real income, we
know that the demand for money will
increase at every given interest rate, i.e. the
demand for money curve shifts to the right. If we have to derive the LM-curve, we plot all the possible
17 | P a g e
demand curves for the different levels of real income. If we join all the resulting equilibrium points and
plot the real income at that equilibrium point to the interest, we will obtain the LM-curve, as seen in the
figure at the far right.
It is important to note that there is a direct relationship between the interest rate and income, which
gives the LM-curve its upward sloping property.
Shifts of the LM-curve
An increase in the real money supply will shift the LM-curve
downward, as can be seen in the figure to the right; while a
decrease in the real money supply will shift the LM-curve
upward.
It is important to note that the real money supply can change due
to the following factors
• The nominal money stock; or
• The price level, which we assumed to be constant in the short-run.
The real money supply depends on these two factors, because the real money supply refers to the ratio
of the nominal money stock to the price level.
Putting the IS and the LM relations together
Quickly, a comparison: the IS-relation refers to the equilibrium condition in the goods and services
market, where the supply of goods must be equal to the demand for goods. This relation shows the
effect of interest rates on the output. The LM-relation refers to the equilibrium condition in the financial
market, where the supply of money must be equal to the demand of money. This relation shows the
effect of output on the interest rate.
The point where the IS-curve and the LM-curve intersect, both
the goods and services market and the financial market are in
equilibrium. This is called the overall equilibrium in the
economy. This can be graphically illustrated by the figure to
the right, at point A, where IS-curve and the LM-curve
intersects.
When used properly, this equilibrium point allows us to study
the what happens to the interest rate and the output level, if the
central bank increases the money supply, or the government
changes taxes, or consumers’ expectations change.
Fiscal policy, activity and interest rates
Contractionary fiscal policy, or fiscal consolidation, refers to fiscal policy that reduces the budget
deficit by decreasing government spending or increasing taxes, which will lead to a leftward shift of the
IS-curve. Expansionary fiscal policy, or fiscal expansion, refers to an increase in the budget deficit by
increasing government spending or decreasing taxes., which will lead to a rightward shift of the IS-
curve.
An increase in taxes shifts the IS-curve to the left because it changes the equilibrium level in the goods
and services market and leads to a decrease in the equilibrium level of output and the equilibrium
18 | P a g e
interest rate. The eventual result is therefore a shift of the IS-curve, but merely a movement along the
LM-curve in the economy.
The effect on the economy can be summarised as
follow: the increase in taxes, will decrease disposable
income and accordingly consumption will decrease. As
income decreases, the level of sales decrease, which
means investments will decrease. This will lead to a
decrease in the total demand for a good and eventually
the output level will move from point A to D (from the
figure to the right). But simultaneously, because income
has decreased, the demand for money will decrease,
which will result in a lower interest rate and accordingly
higher investments again. This will increase the output
level, but not with enough to offset the change in taxes, which will provide the movement from D to A′
(from the figure to the right).
A decrease in taxes would have the exact opposite effect!
Monetary policy, activity and interest rates
Monetary contraction, or monetary tightening, refers
to a decrease in the money supply, which will shift the
LM-curve to the left. Monetary expansion refers to an
increase in the money supply, which will shift the LM-
curve to the right.
An increase in the money supply will shift the LM-
curve down, because it changes the equilibrium level
in the financial market. Monetary policy affects only
the LM-curve and leads to an increase in output and a
decrease in the interest rate, as seen in the figure to the
right.
For a monetary expansion, an expansionary open-market transaction needed to take place, i.e. bonds
were bought back. This will increase the supply of money, increase the real money supply (as price
levels are constant) and therefore decrease the interest rate. The decreased interest rate will then lead to
an increase in investments, which means total demand will increase and will lead us to a higher output
level, as saw in the figure above. Finally, the increased output level will lead to increased investments
and consumption spending.
A method to answering policy-related questions

When you answer any question related to policies, you should always follow these three steps:
1. Characterise the shifts that will occur, for example “The IS-curve will shift right, because
of…” Remember to explain what effect the policy has on both markets – the goods and
services market and the financial market.
2. Show these shifts graphically and the effect that it has on the equilibrium level – both the
output and the interest rate.
3. Explain what happened in the graph in words.
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The implementation of different mixes of policy tend to result in a variety of different outcomes. The
general consensus is that it is better to understand effects that it will have, rather than to study, for all
practical measures the effects of different monetary and fiscal policies and the end results it causes can
be summarised by the table that appears at the top of the following page.
Movement of Movement in
Shift of IS Shift of LM
output interest rate
Increase in taxes left none down down
Decrease in taxes right none up up
Increase in spending right none up up
Decrease in spending left none down down
Increase in money supply none down up down
Decrease in money supply none up down up
Using a policy mix (some examples)

When we use fiscal policy and monetary policy together, we refer to it as the monetary-fiscal policy
mix, or simply the policy mix.
The Clinton-Greenspan Policy Mix
Given that the budget deficit has reduced over time, and so has the interest rate. With the knowledge
that both fiscal and monetary policy has been utilised, illustrate this policy mix in the IS-LM framework.
By following the steps that were previously mentioned we have:
1. Characterise the shifts
Because there is a reduction in the budget deficit, this has
to do with contractionary fiscal policy, which is achieved
by decreasing government spending or increasing taxes,
which will shift the IS-curve to the left. This leads to the
movement from point A to point B, in the figure to the
right. Because we know monetary policy was also used,
we can identify that it has to be expansionary monetary
policy through increasing the money supply, as to
decrease the interest rate and increase the output level,
because the LM curve shifts down. This leads to the shift
from point B to point A′ in the figure to the right.
2. Illustrate the shifts graphically
Notate all of the individual shifts and adjustments that were identified during the first step on the graph
until you find the final equilibrium point of A′.
3. Explain the effects in words
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This policy mix had the following effects
An increase in taxes, reduced disposable income, which led to decreased consumption
expenditure and ultimately a decreased total demand and output in the goods and services
market.
The increase in the supply of money decreased the interest rate in the financial market, which
increased investment in the goods and services market, which increased output.
German Unification and the German Monetary-Fiscal tug of war

Given that the budget deficit has increased over time, so has the interest rate and the output. With the
knowledge that both fiscal and monetary policy has been utilised, illustrate this policy mix in the IS-
LM framework.
By following the steps that were previously mentioned we have:
1. Characterise the shifts
Because there is an increase in the budget deficit, this
has to do with expansionary fiscal policy, which is
achieved by increasing government spending or
decreasing taxes, which will shift the IS-curve to the
right. Because we know monetary policy was also used,
we can identify that it has to be contractionary monetary
policy through decreasing the money supply, as to
increase the interest rate and increase the output level,
because the LM curve shifts up. This leads to the shift
from point A to point A′ in the figure to the right.
2. Illustrate the shifts graphically
Notate all of the individual shifts and adjustments that were identified during the first step on the graph
until you find the final equilibrium point of A′.
3. Explain the effects in words
This policy mix had the following effects
• A decrease in taxes, increased disposable income, which led to increased consumption
expenditure and ultimately an increased total demand and output in the goods and services
market.
• The decrease in the supply of money increased the interest rate in the financial market, which
decreased investment in the goods and services market, which decreased output slightly.
• The final equilibrium point, A′, experienced a definite increase in interest rates, as well as an
increase in the output level due to the increased output growth that the country experienced.
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Question 1
Would a return to the Gold Standard or Bretton Woods System be feasible today? Motivate.
The gold standard

a) Assumptions
The gold standard system is based on the following basic assumptions
• There are no constraints on the buying or selling side of gold within countries;
• Gold is allowed to move freely between countries;
• Prices and wages flexible, both up and down;
• National currencies was gold or they were completely (100%) backed by gold.
b) Basic Functioning
In a gold standard system, the domestic currency would be directly fixed to a specified amount of
gold, i.e. currencies are converted to gold by using unvarying rates. Thus, the domestic currency, and
other forms of money such as bank deposits and notes, would be redeemable for gold at a fixed price.
This standard sprang forth from the Mercantilist school of thought, due to their obsession with gold.
Under this system, almost everything was related to gold: the value of each currency was tied to
gold, as well as the fixed exchange rate.
The success of the gold standard system could be evaluated by the way in which it manages to
equilibrate balance of payment deficits.
c) How equilibrium on the balance of payments is reached
To understand the mechanism in which the gold standard system equilibrates balance of payment
deficits, we need to relook at the equation of exchange.
MV ≡ PQ
where M is the money supply, V is the velocity of money, P is the price level and Q refers to the real
GDP.
When we make some assumptions, such that the velocity of money and the real GDP remains constant,
we arrive at the simple (quantity) theory of money MV ̅ ≡ PQ̅ , which states that the money supply is
directly proportional to the price of money, i.e. if one increases, so does the other.
Now, if the balance of payments is currently in a deficit, it means that the imports exceed the exports
and accordingly gold is flowing out of the economy. This means that the money supply will decrease
and accordingly, due to the simple theory of money, the price level of the economy will also decrease.
Due to the price level that is decreasing, the country’s exports will also increase, and accordingly the
deficit on the balance of payments will decrease. This process will continue until the balance of
payments is in equilibrium.
d) Appropriateness today
The gold standard system relied heavily on the assumptions that were made. When people are not too
dedicated to follow these rules, the standard could easily fall apart, which would be the case as people
in an economy generally not follow the “rules of the game”.
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While the gold standard system was used, priority was given to exchange rate stability above all other
policy objectives. In current monetary policy, exchange rate stability does receive priority above policy
objectives anymore.
Furthermore, there is no longer enough gold reserves left for the gold standard to be effectively
implemented in South Africa.
Lastly, the reason for the breakdown of the gold standard proves to be a good reason as to why the gold
standard would no longer be appropriate today. Countries became very reluctant to let any gold flow
out of their countries, as they assumed their power and prestige to be determined by their gold reserves.
Furthermore, the gold standard and its mechanism of equilibrating the balance of payments requires
that the monetary supply must decline, as mentioned before. Most central banks were hesitant of this
due to the fact that it had deflationary effects on the economy, such as an increase in the unemployment.
Central banks would accordingly engage in expansionary open market transactions in order to offset
the decrease in the money supply.
The gold standard system generally assumed that central banks should have very limited involvement
in the process of equilibrating the balance of payments, but as it is necessary in order for economic
stability, the gold standard system would not be an appropriate exchange rate system to use today.
The Bretton Woods System
a) Assumptions
The Bretton Wood system is based on three basic assumptions.
1. The liberalisation of trade and the adoption of a free trade system would have positive economic
affects.
2. The US dollar was the strongest currency in the world.
3. The gold standard in the way it operated during 1880 to 1917 was a system that did not work.
b) Basic Functioning
The Bretton Wood system as a system of money that worked by using fixed exchange rates, as
established somewhere between 1944 and 1946.
The US agreed to maintain the convertibility of the dollar at a gold price of $35 per ounce of gold and
each country determined their parity value for their currency as quoted in USD. The governments then
agreed, and guaranteed, that their exchange rates would not deviate more than 1% from the par value
as agreed upon. Countries were then free to hold their reserves in US currency instead of gold. Under
the Bretton Wood system, a fixed exchange rate system was maintained in which each currency had a
value pegged to the price of gold, without the need to hold physical gold reserves.
The International Monetary Fund (herein after referred to as the IMF) was the central supervisory body
that oversaw that parities between countries were maintained, according to the IMFs Articles of
Agreement.
c) How equilibrium on the balance of payments is reached
Under the Bretton Wood system there was no one way to equilibrate the deficit on the balance of
payments. Instead, it depended on the nature of the deficit – whether it was temporary (short term) or
more permanent (long term).
• In the case of a temporary deficit, the IMF granted the currency with a conditional loan, given
that they would restructure the fiscal (and sometimes the monetary) side of the economy to be
23 | P a g e
more prudent in order to curtail imports and encourage exports to the country to try and reduce
the strain on the economy caused by the balance of payment deficit.
• In the case of a more permanent deficit, the IMF allowed the country to devalue their currency,
which meant that the currency would be artificially depreciated by government intervention.
d) Strengths
• Fixed exchange rates created a more stable trading environment and a more predictable macro-
economic framework in which governments were able to purse their objectives of full
employment, price stability and economic growth.
• Countries benefitted from free trade and a removal of a lot of the tariff barriers that had persisted
during the world wars. This allowed for the facilitation of trade to take place with ease, which
was especially beneficial for smaller economies who have generally open borders.
• The stability and predictability that was associated with this standard assisted many parties to
make long term decisions with more certainty, which resulted in better monetary and fiscal
policy, especially within struggling countries.
e) Weaknesses
• The system was too inflexible as it could not adapt rapidly enough to changing economic and
political circumstances.
• The IMF had very little control over countries with balance of payments surpluses, which acted
as a source of instability. The IMF could not force any country to revalue (or devalue) their
currencies.
• The Bretton Woods system was costly to administer due to the complications with holding and
transporting gold to and from the IMF, as well as the costs associated with the loans that the
IMF gave to countries that had balance of payment deficits.
f) Appropriateness today
The Bretton Woods system put a lot of emphasis on a single currency – the USD. This led to global
instability depending on the volatility of a single currency. This is exactly what happened and led to the
eventual breakdown of the Bretton Woods system. In the 1950s, the United States ran a balance of
payment deficit, especially due to the need to finance the Vietnam War. Eventually, the United States
opted to devaluate their currency by 10% and set a new gold price of $38 per price, according to the
Smithsonian Agreement. The speculation against the US dollar persisted and the US abandoned their
pledge to gold’s convertibility to dollars. This led to the major currencies becoming “managed” floating
exchange rate systems as by 1973 the world’s major currencies were all floating.
Accordingly, this system was rightfully disbanded, and its return would not be appropriate for the
current day and age.
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Question 2
Use IS/LM analyses to explain the South African fiscal and monetary policy options in an open
economy. Also, clearly describe the BP curve in your answer.
Just before we go to answering the question, the following underlying theory needs to be understood.
The BP curve represents the various combination of interest rates and income levels for which the
current account (denoted by CA) and the capital account (denoted by KA) offset each other completely,
i.e. points where the balance of payments is in equilibrium.
The following summary can be given regarding the shifts of the three different curves we are faced with
in open economies – the IS, LM and BP (only the case where the economy is operating under a floating
exchange rate system) curve.
Curve Increase (shifts right) Decrease (shifts left)
IS Expansionary fiscal policy, i.e. Contractionary fiscal policy, i.e.
government expenditure increases or the government expenditure decreases or the
level of taxation decreases. level of taxation increases.
When the exchange rate depreciates, When the exchange rate appreciates,
because net exports will increase. because net exports will decrease.
LM Expansionary monetary policy, i.e. the Contractionary monetary policy, i.e. the
money supply increases. money supply decreases.
BP When the exchange rate depreciates, When the exchange rate appreciates,
because net exports will increase. because net exports will decrease.
The table above only shows the case where capital is not perfectly mobile, i.e. when capital is mobile
or immobile, but never perfectly mobile. In the case that capital is perfectly mobile, the BP curve will
not shift.
Consider the case where the country utilises a
flexible exchange rate system, capital is mobile and
the central bank implements expansionary monetary
policy.
Firstly, our economy is currently in external
equilibrium at point A where IS0 = LM0 = BP0. In
drawing this equation we also need to ensure that
the BP curve is drawn flatter than the LM curve due
to the fact that capital is mobile.
Now, the central bank implements expansionary
monetary policy, which means that they increase the
money supply and accordingly, the LM curve will
shift right from LM0 to LM1, as denoted by shift (1), which means the external equilibrium at point A
moves to a temporary equilibrium at point B. But now, the internal equilibrium (the intersection of IS0
and LM1 at point B) lies below the BP curve, which means that the current level of capital flows is
insufficient to offset the incipient deficit (we call it an incipient deficit because we are working under a
floating exchange rate system and the change has not yet occurred, i.e. it is still going to happen) on the
current account. This incipient deficit means that the currency will depreciate, which will lead to a rise
in the exports of the currency.
This will lead to two effects happening simultaneously (and therefore no intermediate equilibriums)
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• Firstly, the increase in the exports of the country will lead to an increase in the net exports of
the country, which will lead to a rightward shift of the IS curve from IS0 to IS1 as denoted by
shift (2a).
• Secondly, the increase in the net exports will lead to a decrease in the current account deficit,
which will cause the BP curve to shift downward (or rightwards) from BP0 to BP1 as denoted
by shift (2b).
This will now leave our economy at external equilibrium again as IS1 = LM1 = BP1 at point C. The new
equilibrium occurs at a higher level of output (Y1 > Y0).
The conclusion that can therefore be drawn from this scenario, is that monetary policy is effective in
changing the level of domestic output (denoted by Y) under a floating exchange rate where capital is
mobile.
Consider the case where the country utilises a flexible
exchange rate system, capital is mobile and the
government implements expansionary fiscal policy.
Firstly, our economy is currently in external
equilibrium at point A where IS0 = LM = BP0. In
drawing this equation we also need to ensure that the
BP curve is drawn flatter than the LM curve due to
the fact that capital is mobile.
Now, the government implements expansionary
fiscal policy, which means that they increase their
government expenditures and accordingly, the IS
curve will shift right from IS0 to IS1, as denoted by shift (1), which means the external equilibrium at
point A moves to a temporary equilibrium at point B. But now, the internal equilibrium (the intersection
of IS1 and LM at point B) lies above the BP curve, which means that the current level of capital flows
is more than enough to offset the incipient surplus (we call it an incipient surplus because we are
working under a floating exchange rate system and the change has not yet occurred, i.e. it is still going
to happen) on the current account. This incipient surplus means that the currency will appreciate, which
will lead to a decrease in the exports of the currency.
This will lead to two effects happening simultaneously (and therefore no intermediate equilibriums)
• Firstly, the decrease in the exports of the country will lead to a decrease in the net exports of
the country, which will lead to a leftward shift of the IS curve from IS1 to IS2 as denoted by
shift (2a).
• Secondly, the decrease in the net exports will lead to an increase in the current account deficit,
which will cause the BP curve to shift upwards (or leftwards) from BP0 to BP1 as denoted by
shift (2b).
This will now leave our economy at external equilibrium again as IS2 = LM = BP1 at point C. The new
equilibrium occurs at a higher level of output (Y1 > Y0).
The conclusion that can therefore be drawn from this scenario, is that fiscal policy is effective in
changing the level of domestic output (denoted by Y) under a floating exchange rate where capital is
mobile. An additional conclusion that can be drawn is that fiscal policy is more effective in altering the
level of domestic output when capital is not perfectly mobile as opposed to when capital is in fact
perfectly mobile.
26 | P a g e
Question 3
Describe the different exchange rate systems and provide the advantages and disadvantages of each.
Fixed exchange rate system
A fixed exchange rate, sometimes called a pegged exchange rate, is an exchange rate regime in which
a currency's value is fixed against either the value of another single currency, such as the USD, to a
basket of other currencies or to another measure of value, such as gold.
It is suggested that small, open economies are best served by fixed exchange rates as it protects them
against the costs of currency fluctuations. Furthermore, developing countries with immature financial
markets require a fixed exchange rate system in order to protect the country against currency
fluctuations, as mentioned before. Lastly, if the reputation of a country’s central bank is not good, a
fixed exchange rate system would help to build confidence in the central bank to, among others, contain
inflation.
Under a fixed exchange rate system, the country’s monetary authority, i.e. the central bank, can pursue
balance of payment equilibrium by devaluing or revaluing the country’s currency.
Devaluing refers to when the home currency's exchange rate is artificially depreciated by counteracting
a payment deficit. Revaluing refers to when the home currency's exchange rate is artificially
appreciated by counteracting a payment surplus.
From the above definitions, it is clear that a devaluation and revaluation refers to when the currency’s
par value is legally redefined under a fixed exchange rate system, i.e. the value that the exchange rate
system is pegged at, is changed.
The process of devaluation, or revaluation, happens through the use of the relative prices, which will
be used to divert domestic expenditure to foreign goods or divert foreign expenditure to domestic goods.
1. By raising the price of foreign currency in the home country, devaluation will make the imports
more expensive for domestic citizens and exports will become cheaper for foreign citizens. This
will lead to a diversion of foreign expenditure to domestic goods.
2. This means that revaluations, on the other hand, discourages exports and encourages imports,
and therefore diverting domestic expenditure to foreign goods.
Before the implementation of a revaluation and devaluation, the monetary authority needs to decide on
certain things first, as the implementation of a revaluation and devaluation without having the answers
for the following first, could lead to the implementation of policy of the incorrect magnitude and timing.
The three things that the monetary authority needs to decide on is
1. Whether an adjustment of the exchange rate is necessary to correct payment disequilibrium,
2. When the adjustment will occur, and
3. How large the adjustment should be.
While the monetary authority is busy determining whether they will devalue, or revalue, their currency,
the process is veiled with secrecy in order to protect the economy against speculations as it could have
destabilizing effects on the economy.
27 | P a g e
The advantages of this system include
• The prices of goods are generally determined in the markets of industrialised nations, e.g. the
United States, and by anchoring the currency of a country to the currency of an industrialised
nation, it can provided added stability to the prices of the country’s imports and exports.
• By anchoring a country’s currency to country’s with relatively low inflation, such as the United
States, the country can exert restraint on domestic policies and reduce inflation (i.e. they lessen
inflationary expectations), which can reduce interest rates, lessen the loss of output caused by
disinflation and moderate price pressures.
• The system ensures that the exchange rate target is simple and clear.
• The system enables the use of an automatic rule for the conduct of monetary policy.
The disadvantages of this system includes
• The countries that make use of this system, make themselves vulnerable to speculative attacks
by investors, which can have adverse effects on their domestic markets.
• The countries that make use of this system will also experience a loss of independence regarding
their monetary policy.
• The fixed exchange rate system enables the persistence of prolonged balance of payment
disequilibrium.
Floating exchange rate system
A floating exchange rate system is an exchange rate regime in which case the currency prices are
determined on a daily basis within the forex market through the interaction of supply and demand,
without the restrictions that are imposed by government policy as to the flexibility of the currency price.
Flexible exchange rate systems are especially useful when a country is experiencing rapid growth in
their inflation rate, much higher than that of their trading partners. The fact that the exchange rate is
flexible protects the goods and/or services to become uncompetitive. Furthermore, when the labour
market wages are rigid, flexible exchange rate systems ensure that the economy is protected against
external shocks. Lastly, when a country is more open to flows of international capital, flexible exchange
rate systems are more useful to facilitate this process.
The advantages of this system includes
• This system is very simple due to the lack of government intervention.
• The floating exchange rate system allows for continuous balance of payment adjustments,
which eliminates the adverse effects involved with the prolonged balance of payment
disequilibrium that can persist under the fixed exchange rate system.
• This system is able to operate under simplified institutional arrangements.
• The government of a country that makes use of the floating exchange rate system has the
freedom to set independent monetary and fiscal policy.
• The use of the floating exchange rate system can be conducive to price inflation due to the
existence of an inflationary bias.
• Unregulated exchange markets can be disruptive towards trade and foreign investments. Even
though investors can help hedge the exchange rate risk by dealing the forward market, the cost
of hedging becomes prohibitively high.
28 | P a g e
• The use of floating exchange rate systems can also indirectly encourage reckless financial
policies from government.
Managed floating exchange rate systems
Managed floating exchange rate system is an exchange rate regime in which exchange rates are
allowed to fluctuate from day to day, but central banks still attempt to influence their countries'
exchange rates by buying and selling currencies to contain the fluctuations within a certain range.

• The intervention of the country’s government can be used to prevent the emergence of erratic
currency price fluctuations which enables investors to make long term economic forecasting
and for governments to use this in policy making.
• This system is very adaptable, as countries can decided to which degree they want to intervene
and effectively fall anywhere on a spectrum between a fixed exchange rate system and a floating
exchange rate system.
• Different countries will set exchange rates at levels which are inconsistent with one another, in
which case achieving purchasing power parity is difficult.
• Countries tend to become involved in continuous rounds of devaluations in order to achieve a
competitive advantage above other currencies.
• These wars that develop between countries (as mentioned above) usually happens at the cost of
other countries.
The crawling peg
The crawling peg system is a compromised approach between fixed and floating exchange rates in
which nations make small, frequent changes in the par value of the currency to correct balance of
payment disequilibrium. This system is generally used by countries that face rapid and persistent
inflation, such as Brazil, Costa Rica and Peru.
• It has the flexibility of the floating exchange rate, as well as the stability associated with the
fixed exchange rate system.
• This system is more responsive to changing competitive conditions.
• It also frustrates speculators with the regularity of the par value changes.
• It is hard to apply this system to industrialised nations whose currencies serve as international
liquidity, such as the United States and Germany.
29 | P a g e
Question 4
The South African government should implement capital controls to protect the external value of the
Rand. Do you agree? Motivate.
Capital controls (or exchange rate controls) refer to government-imposed barriers to foreign savers
investing in domestic assets or to domestic savers investing in foreign assets.
This is done in order to gain control over the payments that are made, which will circumvent the
sometimes disruptive effects of market forces. Furthermore, it also protects the country against
speculative attacks by limiting the number of transactions occurring on your foreign market, which is
done by setting different interest rates for different purposes in order to encourage and/or discourage
certain transactions from occuring. Speculative attacks generally mean that the country needs to
continuously use foreign currency to defend the country, which will no longer need to happen.
The above mentioned arguments for the use of capital controls can also be considered to be the
advantages of the use of capital controls. Capital controls also leads to stability in terms of foreign
market transactions which will make the process of policy planning easier as the fear of an unstable
balance of payment and its repercussions are minimised or eliminated.
The disadvantages of capital controls include the decrease in the confidence of investors in the
domestic government, it also leads to criminal activities such as legislation evasion, corruption among
government officials and bribery. Often times, the use of capital controls also provide governments with
a false sense of security regarding the need to reform the financial system in order to improve the current
conditions of economic crises.
Capital outflows are generally the source of importance for capital controls as the inflow does not cause
as much crises, but the sudden outflow of capital can lead to adverse effects for the government. Capital
inflows, however, can also cause certain problems, such as was seen in East Asia in 1997-98 when
capital inflows led to lending booms and excessive risk taking by commercial banks, which eventually
led to a financial crash.
Capital control on inflows is generally ineffective as private sector investors will always find ways to
evade the capital controls and capital will still move freely by for example bribing government officials,
or promising pay-outs, if they are allowed to let their capital flow freely.
Based on the lack of the confidence in the South African government, one might argue that capital
controls would have adverse effects on the economy as it will weaken the confidence in the government
even more. Furthermore, the use of capital controls will lead to an increase in illicit flows, as people
will find alternative, and often illegal, ways to let their capital flow across country borders. As seen
previously, illicit flows has adverse effects on the economy, which can be exacerbated by the use of
capital controls.
Contrary to what was mentioned above, South Africa is an emerging market and accordingly capital
inflows are essential to South Africa in order to finance certain investment projects, which is necessary
for the effective growth of the country.
Accordingly, it is very difficult to make a general consensus about capital controls in South Africa as
our economic conditions are very volatile and the extent of capital controls will depend on the current
economic conditions.
30 | P a g e
Question 5
Briefly discuss South Africa’s exchange rate policy options, with specific references to constraints faced
by the SARB in this regard.
The Impossible Trinity (also known as the Monetary Policy Trilemma) is a trilemma in international
economics which states that a country can have at most two, but never all three at the same time, of the
following
• A fixed exchange rate,
• Free capital movement, and/or
• An independent monetary policy.
Given that the South African Reserve Bank makes use of inflation targeting as the monetary policy
framework and that SA has capital mobility, it means that SA cannot have a fixed exchange rate system,
as well, based on the Impossible Trinity. This gives one explanation as to why South Africa is currently
making use of a flexible exchange rate system.
Under a flexible exchange rate system, ceteris paribus, an increase in the money supply will depreciate
the ZAR, while a decrease in the money supply will appreciate the ZAR.
Based on the Impossible Trinity, as well as the beforementioned fact regarding interest rates, it is
impossible for South Africa to follow a fixed exchange rate system, have capital mobility and make use
of inflation targeting as their monetary policy framework at the same time, as the changes in the interest
rate will lead to involuntary depreciations or appreciations of the ZAR, which is contrary to the
mechanism of the fixed exchange rate system.
Even if the SARB chose to abandon inflation targeting as a monetary policy framework in order to
favour a fixed exchange rate system, or exchange rate targeting as it is often called, the SARB will not
be able to sustain it as the SARB does not have enough foreign reserves to intervene in the exchange
rate market in order to facilitate the fixed exchange rate that is to be kept under this exchange rate
system. In terms of number, South Africa only had US$50,39 billion in foreign reserves at the end of
September 2018, while a country like China had US$3,087 trillion ($3 087 billion) in foreign reserves
at the end of September 2018.
China thus has the scope to intervene in the forex market, while South Africa does not, as their foreign
reserves are essentially minute towards bigger economic forces, like China.
In terms of desirability – even if South Africa had enough foreign reserves to be able to facilitate a fixed
exchange rate system, it would still be difficult for them to decide whether a weaker rand, in which case
exports and thus economic growth are favoured, or a stronger rand, in which case imports as well as
lower inflation are favoured, would be better for South Africa.
This means that the only viable exchange rate system for South Africa in their current economic
condition is to make use of the flexible exchange rate system as it currently is.
31 | P a g e

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Financial stability (stability of the financial sector)

Balance of payments and exchange rate stability

Employment and income stability (stability in the business cycle)

by link between the target and the

Exchange rate of instrument will be visible

earlier: therefore shows how

by link between the operational objective & the

Market oriented (indirect) policy instruments conventional

Non-market oriented (direct) policy instruments

to decide between instruments

- how will the instruments help achieve low inflation.

- if a time lag between implementation of an instrument & the effect it

will have on the ultimate objectives: makes it difficult to determine if the

policy being implemented is effective

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Growth During Covid-19

Why does International Trade Matter?

Theory of international trade timeline:

Mercantilism: 1500 – 1700

Features of a mercantilist economy

Adam’s Absolute Advantage: 1776

Adam Smith and the division of Labor

Absolute advantage theory

David Ricardo’s Comparative Advantage Theory: 1800’s

Assumptions for the Ricardian model:

A note on opportunity costs

Heckscher- Ohlin: 1900

The Heckscher- Ohlin Propositions