Krugman Chapter 12 National Income Accounting and the Balance of Payments

Macroeconomic analyses emphasizes these 4 aspects:

o Unemployment, factors that cause it and steps, government needs to take to
prevent them.
o Saving, the world saving rate determines how quickly the world stock of
productive capital can grow.
o Trade imbalance, redistribute wealth among countries and are a main channel
through which one countrys macroeconomic policies affect their trading
partners.
o Money and price level, currency and monetary changes in one country can
have effects that spill across its borders to other countries.
National income accounting records all the expenditures that contribute to a
countrys income and output.
Balance of payments accounting helps to keep track of both changes in a countrys
indebtedness to foreigners and fortunes of its export- and import competing industries.
Gross National Product (GNP) = value of final goods and services produced by its
factors of production and sold on the market in a given time period. Calculated by
adding up the market value of all expenditures on final output.
o 4 output categories:
o Consumption = amount consumed by private domestic residents
o Investment = amount put aside by private firms to build new plant and
equipment for future production
o Government purchases= amount used by the government
o Current account balances = amount of net exports of goods and services to
foreigners
National income accounts = National outcome accounts.
GNP includes only sale of final goods and services, not intermediate ones.
o GNP doesnt take into account the economic loss due to the tendency of
machinery and structures to wear out as they are used.
o GNP-depreciation =net national product
o A countrys income may include gifts from residents of foreign countries =
unilateral transfers. = part of a countrys income, but not of its product => must
be added to NNP in calculations of national income.
National income = GNP - deprecation +net unilateral transfers
Gross domestic product (GDP) = measure of production within a countrys borders.
GNP = GDP + net receipts of factor income from the rest of the world
o Net receipts= the income domestic residents earn on wealth they hold in other
countries - the payments domestic residents make to foreign owners of wealth
that is located in the domestic country.
Open economy
Countries can save in form of foreign wealth by exporting more than they
import & dissave = reduce their foreign wealth by exporting less than they
import.
Y=C+I+G (Y=GDP, C= consumption, I= investment, G= government
purchases) <- closed economy
Y=C+I+G+Ex-Im (Y=GDP, C= consumption, I= investment, G= government
purchases, Ex= export, Im= import) <- open economy
Current account = difference between export & import ( CA=EX-IM)
o IM>EX => current account deficit
o IM<EX => current account surplus
o Measures size and direction of international borrowing.
Country with CA deficit is earning more from its exports than it spends on
imports => it finances CA deficit of its trading partners by lending to them.
Countrys CA balance = the change in its net foreign wealth
CA=Y-(C+I+G)= Ex-Im
National saving = portion of output, Y, that is not devoted to household
consumption, C or government purchases, G.
o Closed economy -> savings = investment => S=Y-C-G -> Y= C+G+I
=> S=I
o Open economy -> S=I+CA
An open economy can save either by building up its capital stock or by
acquiring foreign wealth => its possible to simultaneously raise investment
and foreign borrowing without changing saving
Because a countrys savings can be borrowed by a second country, a countrys
CA surplus is often referred to as its net foreign investment.
Private saving = part of disposable income that is saved rather than consumed.
Can take 3 forms:
o I= investment in domestic capital
o CA= purchasing wealth from foreighners
o G-T = purchases of the domestic governments newly issued debt
Disposable income = Y-T; (T=taxes from households and firms)->
government income
S
p
= Y-T-C; S
P
=I+CA-S
G
=I+CA-(T-G)= I+CA+(G-T)
S
G
= T-G
S=S
P
+S
G

Balance of Payments Accounts
3 accounts:
o Current account = Ex-Im
o Financial account = records all international transactions of financial assets
o Capital account= other activities resulting in transfers of wealth between
countries (e.g. Emigrants' money, forgiving of a national debt
CA+ FA+CapA=0 Due to the double entry principle
The balance payments accounts exports and imports into 3 categories:
o Goods, services, income (international investments and dividend payments &
earning of domestically owned firms abroad)
GNP refers to goods and services generated by a country's factors of production,
doesn't specify, that they must be within the borders of the country
Statistical Discrepancy= variation in final financial results because the information
about the offsetting debit and credit items associated with a given transaction may be
collected from different sources.
Official international reserves = foreign assets held by central banks as a cushion
against national economic misfortune.
Official foreign exchange intervention = transactions when central bank buys or
sells international reserves in private asset markets to affect macroeconomic
conditions.
o It's a way for the central bank to inject or withdraw it from circulation.

Task 4

GATT: (General Agreement on Tariffs and Trade)
A multilateral agreement regulating international trade.
in effect between 1947 and 1994. In 1995, it was replaced by WTO.
It aims for reduction in tariffs and other trade barriers.
The main difference between GATT and TWO is that while GATT was a set of rules
agreed upon by nations, WTO is an institutional body.
WTO: (World Trade Organization)
An organization whose goal is to supervise and liberalize international trade.
In general, deals with regulation of trade between participating countries and provides
a framework under which those countries negotiate and formalize trade agreements.
In contrast to GATT, WTO expanded its scope from traded goods to include trade
within the service sector and intellectual property rights.

The double life of Daniel Defoe
by Chang
Changs main argument is that nowadays top industrial countries, such as the US and
Britain, had acquired the position through not free market and trade liberalization but
by
o protectionism,
o subsidies,
o distribution of monopoly rights
o and other means of government intervention.
He gives the development of woollen manufacturing in Britain and the example of
infant industries of Hamilton in the US. He shows this trend of protectionism with
historical data.
For Britain
Chang gives account how Edward III increased tax on the export of raw wool (even
temporarily banned export) in order to encourage raw material processing at home.
His son, Henry VII, continues this policy until the English industry is mature enough.
Then he witdrew his ban on raw wool exports.
Furthermore, he gives the example of Walpoles 1721 legislation that aims to protect
manifacturing industries from foreign competition, subsidize them and encourage
them to export.
He asserts that until the mid-19
th
century, Britain was a highly protection country with
45-55% of average tariff rate.
Britain uses not only tariffs but to deprive colonies industries to advance for
protecting its own industry.
Ricardo
The economical framework of Ricardo is used by Chang. This framework basically
states that trade between two countries makes sense even when one country can
produce everything more cheaply than another.
That is to say, a country that has no cost advantage over its trading partner can gain
from trade through specialization in products in which it has least cost disadvantage.
For the US
Alexander Hamilton, who provided blueprint for US economic policy until the end of
WWII, developed the theory of infant industry.
He proposed a series of measures to achieve development of industry:
o protective tariffs and import bans,
o subsidies,
o export ban on key raw materials,
o development of financial and transportation infrastructures.
After WWII, the US liberalized its trade with its industrial supremacy unchallenged.
For other countries
Are the US and Britain more successful because they are less protectionist? Chang
says no.
France: Between 1821-1875, had lower tariffs than Britain. Between 1920s and 1950s,
Frances average industrial tariff rate was never over 30%, while Britain and the US
had 50-55%.
Germany: Relatively low (5-15%) throughout the 19th and early 20th century.
Japan: In its early days of industrial development, it practised free trade because of
unequal treaties with Western countries. After it gained some autonomy, it had
average tariff rate about 30%.
Lessons
In early stages of their development, all successful cotunries used some mixture of
protection, subsidies and regulation.
Kicking away the ladder already estabilished rich countries are forcing free-market,
free-trade policies on poor countries.


Task 6
The rise of middle kingdoms: Emerging economies in global trade
(Gordon H. Hanson)

- The growth rates of many emerging countries did not slow down during the last
recession
- China latent competitive advantage in labour intensive products over the recent years
- Middle income countries: Brazil, Korea, Russia, Argentina, Turkey. (GDP above
100 billion)
- 1992-2008: low and middle income share of global exports doubled (from 21%-43%)
- Trade mainly now between South-South and Nord-South
- Reason = urbanization and industrialization in those countries = strong demand raw
materials
- 1980: North-North trade was dominant: now shift away from theory of comparative
advantage
- New theory differences in national factors of supplies = product differentiation and
economies of scale
- North-South trade: low income countries produce narrow range of products
- Export growth higher than GDP growth = massive rise in low- (from 26% to 55%) and
middle income countries (from 25% to 55%)
- Low and middle income countries: exports exceeds the increase in economic size
- Gravity model of trade: expresses exports from one country to another (country size
and trade costs primary determinants of trade) = example share of low- and middle
income countries in global trade should increase in roughly the same proportion to
their share of global income
- But = Southern trade grows faster than Southern GDP
- WTO expands trade = weak demands on developing countries to liberalize trade
- Another theory for the growth Southern trade = multi stage global production
networks (offshoring) = individual production stages in the countries (each adds
value)
- Multi stage global production networks = need to be based on sequential
manufacturing
- Other strategy = all parts produced different countries and than combined in one
- Middle income countries = share of domestic value added in total exports (Malaysia
59% = manufacturing, Brazil 87% = commodities)
- Value added in China as a share of total exports only 36%
- Middle-income specialise on manufacturing of export goods
- Intermediate inputs imported from abroad to China to manufacture computers
- Hong Kong, Singapore = first global production networks and then expanded into
production and design
- Chinas goal is to have the same development

The Return to the Comparative Advantage
- Ricardian comparative advantage is consistent with the gravity model
- International specialization: follows comparative advantage
- Low income countries: positive net exports labour intensive products and negative in
others
- China is absorbing 40% of raw materials export growth of low income countries
(getting as trading partners more important)
- High income countries: positive net exports capital extensive sectors
- Trend deepening production networks among emerging countries
- High income countries absorb 70% of Chinas and Indias exports
- Foreign direct investment inflows rise from 2,1 to 3,4 low income countries

Dynamic Specialization
- After a while middle income countries change from labour intensive to capital
intensive goods (this can change rapidly)
- China = more technology advanced goods and accounts for a larger share of value
added (but still in the niche of low-priced goods perceived with inferior quality)

Hyper-specialized Exporters
- Hyper-specialized countries: Just export a very few goods (middle income countries)
= externality in production (lowers costs for other firms through knowledge spillovers,
or by making inputs available at a lower cost)
- Middle income countries invest more in education and machinery as the develop
therefore new products (microchips, cars, metals, boats)
- Striking fact is that smaller countries have positive exports of fewer goods
- Exports are concentrated within industries (with more productive firms doing the
lions share of the trade) but not between industries
- Eaton-Kortum model: A useful variant of the Ricardian Trade Model in which a
continuum of producers or industries have randomly chosen differences in
productivities
- Eaton-Kortum model links the gravity model of trade to the comparative advantage
one
- China changed along with its exports the supply of educated labour, attracted foreign
investment by MNEs, improved transportation and communication infrastructure
Still dominate primary commodity export (low and middle income countries)

Revisiting the terms of trade: Will China Make a Difference?
(Raphael Kaplinsky)


- Technological progress push down the relative prices of manufactures good exported
by high-income countries
- Imported products where inputs for the manufacturers of the high-income countries
- Price elasticity demand: less price sensitive lower technology goods
- Low income economies do not face strong barriers to entry for their products from
developed economies
- High income countries: labour unions strong, labour market tight
- Developing countries = army of labour (wages low)
- Less of 5% R&D in developing world (Sussex Manifesto)
- Fall in prices of manufactured goods from developing countries but not from high-
income ones
- Key determinants of relative price performance more country rather than product
specific
- Manufacturers prices have fallen in countries where China is exporting
- Falling prices: Growing concentration in global buying (Wal Markt)
- European food market: the largest 3 firms account for more than two-thirds of the
production in 9 countries
- Major buyers have halved their supply-base in Europe
- The de-commodification of some primary products
- De-commodification reflects a process whereby products benefit from rising barriers
to entry
- Nowadays often the prices for those primary products fall due to the huge supply
possibilities = except for niche primary products like special coffee = they can still
demand higher prices = because they have special characteristics
- Soft commodities and hard commodities
- Commodity made of metal or other raw materials. Hard commodities are often
materials mined versus soft commodities, which are usually grown
- The impact of Chinas increasing presence in the global economy = China alone
accounts for 11% of all US imports (worth $ 15 bn)
- Chinas per capita income rose by more than 9% during the 90s




- The demand for imports and exports had been so big that there was a shortage in
shipping capacity in 2001 because of China
- Rising prices of commodities but at the same time falling prices for manufactured
goods (due to concentrated buying power)
- As a rule the higher the per-capita income group of the exporter, the less likely unit
prices were to fall
- Products from China and developing countries get cheaper but not from EU countries
- Chinas high demand of raw materials (especially hard commodities) = 3 reasons =
rapid growth domestic market, substantial investment in infrastructure, a lot of exports
- Because of the growth in the world population there will be rising future demand for
commodities
- Innovation intensive against non-innovation intensive products
- If China gets enough commodities in the future there will be no constraint to further
growth because China has a lot of people who want to work (army of labour)
- Low unemployment rate = but 100 and 150 mio. people are currently working at very
low levels of productivity
- Recent developments = China increasingly has educated and skilled people = better
products = even cheaper then






Task 8
Fifty Years of Growth (and Lack Thereof): An Interpretation
(Dani Rodrik, 2007)
1) Introduction (pp. 1-4):*
1


- (1960-2004): Developing countries experience an
2
growth of their y
3
of
2, 1% per year. HIGH Growth rate (during their periods of most
important growth, US= 1, 8%, UK=1, 3%)
HOWEVER
- (1960-2004): Developed countries experience an growth of their y of
2, 5 % p.y.

Only the countries of East and Southeast Asia achieve
convergence with the developed world (3, 7 % growth rate, cf.
Fig.1.1)
Several patterns of economic performance: high-growth
countries vs. low-growth countries, and countries that took-off
around 1980 (China, India) vs. countries whose growth
collapsed around 1980 (Latin America, sub-Saharan Africa)

- Growth strategy: economic policies and institutional arrangements
aimed at achieving economic convergence with the developed countries.
- Leitmotiv: growth-promoting policies tend to be context specific. Two
arguments:
1
st
order economic principles (protection of property rights,
contract enforcement, market-based competition, appropriate
incentives, sound money, debt sustainability) do not map into
unique policy packages. Effective institutions achieve to
implement those principles in economic activity (function)
regardless from their form.
Igniting economic growth and sustaining it are [] different
enterprises. In the short-run, the former needs of a limited
array of reforms, while in the long-run (the latter) institutions
play a greater part.


1
All data taken from the World Development Indicators Database (WB, 2000 US $)
2
: average
3
y : Real per capita income
2) What we know that (possibly) aint so(pp. 16-21):

- The paradigm of Development policy has evolved. 60s: big push,
planning and import-substitution. / 70s: market-oriented development,
price system emphasis, outward orientation. / 80s(late)-nowadays:
The Washington Consensus
4
; this last policy framework emphasises
the role of fiscal discipline, competitive currencies, trade and financial
liberalization, privatization and deregulation.
BUT
- The list of the Consensus principles was augmented (late 90s) with
institutional reforms aiming for the governance problem (since the
authorities recognised the interdependence between policies and
institutions, and because of the fear of financial crises and critiques
about the original lists social effects).


- Though the growth record is consistent with some of the Consensus
principles, quite a lot of the regions which did best (South Korea,
Taiwan, Japan and later China, Vietnam and India) applied some
different policies from the ones preached, while the ones who did
(Latin American countries such as Mexico, Argentina, Brazil, Colombia,
Bolivia, Peru, and Africa) had a rather mediocre performance.




4
John Williamson coined the phrase in 1990.
3) Indeterminate mapping from economic principles to institutional arrangements
(pp. 22-35):

- In 1978, China could have applied every reform of the Washington
receipt, but instead a range of unorthodox measures were taken, in
the end they delivered the orthodox results expected of the former
(market-oriented incentives, property rights, macroeconomic stability).
For instance:
Dual-track reform in agriculture (later in industrial goods,
labour market) instead of liberalization of agricultural markets:
farmers allowed selling surpluses at market price after
delivering the quota fixed by the state => Allocative efficiency
+ funds for the state preserved.
Household responsibility system and TVEs
5
instead of land
and industrial assets privatization: land entrusted to
individual households according to their size, equity stakes
grants revenues to local governments.
=>Rise in investment and entrepreneurship, property rights
secured.

- Other anomalies (cf. Fig 1.4) at the service of sound principles exist, in
any way China is an exception: East Asian countries financial restraint
(vs. financial liberalization), South Koreas and Taiwans active industrial
policies (vs. arms length approach to public and private relationship),
Japans horizontal hierarchy (vs. free labour market), Mauritius EPZ
6

and protectionist barriers for domestic industries (vs. trade
liberalization), etc
Neoclassical economic analysis does not determine the shape
of institutional arrangements: a potentially wide variety of
measures fits one principles successful implementation.

The simplest of policy recommendations [] is contingent on
a large number of judgment calls about the economic and
social context in which it is to be implemented. Consensus
ambiguous effects are somehow related to policymakers not

5
Township and Village Enterprises. Ownership rights in the hands of local governments.
6
Export-Processing Zone.
taking into account the environment when designing the
reforms, not to the theoretical principles being flawed.
4) Back to the real world(pp.35-44):

- There are four stylized facts that can be deduced from growth
performance. First, growth spurts are associated with a narrow
range of policy reforms.
It takes rather little action to accelerate growth, as seen in
Fig.1.8: for example in Pakistan (1979) or Syria (1969) barely
anything can be said regarding undertaken policy reforms.
Sometimes, as in the cases of China(late 70s), South
Korea(early 60s) or India(early 80s), an attitudinal change of
the policymakers towards market-oriented/ private sector
policy framework created a take-off that played a part as
important as subsequent reforms array (during the 80s, 1964,
and 1991, respectively).

- Policy reforms [] associated with these growth transitions
typically combine elements of orthodoxy with unorthodox policy
practices (cf. 3 for examples). [Further ones: Taiwans and South
Koreas trade regimes reforms (selective subsidization of exports vs.
Consensus imports liberalization), Singapores opening to foreign
investment (via rise in I
g
7

+ tax incentives instead of reducing state
intervention), Botswanas management of diamonds industry (coupled
with greatest G
8
/GDP ratio in the world), and Chiles partial
interventionism (copper industry is state-owned, capital inflows controls
in the 90s, assistance to agro-industries).]
The only clear exception (success without unorthodox
elements) is Hong Kong (due to context of already high-
investment and high-entrepreneurship institutions in place,
guaranteeing results of laissez-faire approach). Also, not all
unorthodox remedies work, as proved by the Argentinian
example (currency board creation in the 90s later abandoned
during its failure in 1997-98 Asian crisis and 1999 Brazils
devaluation).


7
Ig: public investment
8
G: public expenditure
- Institutional innovations do not travel well.
For instance, Gorbachevs attempt to apply dual-track and
household responsibility reforms in the Soviet Union (late
80s) resulted in failure, EPZs havent been as successful as in
Mauritius, Brazil import-substitution growth strategy worked
(while it didnt in Argentina). Growth strategies require
extensive knowledge of local circumstances, thus some
experimentation (as in China, South Korea or Chile before
their take-off).

- Sustaining growth is more difficult than igniting it and it requires
more extensive institutional reform. (cf. Fig. 1.8)
Growth in the short/medium-run doesnt guarantee growth in
the long term. Institutions must be developed to increase
productive dynamism and protection from external shocks.
Latin America and Africa downfalls during mid-70s are related
to their vulnerability to terms-of-trade and interest-rate
shocks, Indonesia suffered way more than South Korea during
the 97-98 crisis due to its institutions weaknesses. China in
the future?

5) A two-pronged growth strategy (pp. 44-54):

- Successful growth strategies are based on a two-pronged effort: a
short-run strategy aimed at stimulating growth [whether it is based
upon a market/ government- failures approach], and a medium- to
long-run strategy aimed at sustaining growth [by emphasizing the
development of institutions].