Economics Questions and Answers:
International Economic Issues

Copyright 2001-2008 by Scott Palmer.

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What is comparative advantage and how does it work?

Question: I am unclear of what this statement is saying: "Two countries, US and France, produce two goods, textiles and machinery. In a given time period, a typical worker in the US can make 10 textiles or machines, while a typical French worker can make 6 textiles or 1 machine."

Then who has the comparative advantage in makign machines and who has the compartative advantage in making textiles? Overall, what I'm really trying to ask is: If free trade opens up between these two nations, what is the possible price range of the textiles? How do I go about solving this?

Answer: This is obviously a homework question, so I can't simply answer it for you. But I'll help you think it through.

Comparative advantage is one of the toughest ideas in economics because it seems to go against common sense. So let's examine it one step at a time.

Simpler than comparative advantage is "absolute advantage." If you go back to Adam Smith's defense of free trade in "The Wealth of Nations," that's the kind of advantage he talks about. Suppose that country A can produce 30 widgets per hour or 10 doobles per hour, while country B can produce 10 widgets per hour or 25 doobles per hour. Then country A has an absolute advantage in producing widgets, while country B has an absolute advantage in producing doobles. If the countries trade, it's almost certain that country A will specialize in widgets and country B will specialize in doobles.

But what if country A is more efficient than B at producing both goods?

The best way for you to see the "big picture" is to forget about trade for a moment and just think about production. Imagine that producing goods is like dragging a big rock up a hill. You've got a rope tied around the rock, and you're pulling on the rope. A friend comes along and offers to help pull on the rope. Now, suppose that you are much stronger than your friend: does that mean you should turn down the help?

Of course not. No matter how weak your friend is, as long as he or she can pull on the rope a little, it will help you get the rock up the hill. And comparative advantage is just like that. No matter how inefficient another country is, as long as it makes a positive contribution to production, trading with that country can increase total output: the more people you have pulling on the rope, the more you can accomplish.

That's the first basic idea behind comparative advantage. There's one other idea, and it shows you the smartest way to divide up work between trading partners. Suppose that you and your friend have finished pulling the rock up the hill, and now want to sculpt it into a statue. Making a statue involves two jobs: sculpting the rock, and keeping track of the chisels. You are much better than your friend at sculpting the rock, but you're only a little better than your friend at keeping track of the chisels. Compared to the difference in your abilities at sculpting, your friend has less of a disadvantage at keeping track of the chisels -- in other words, he has a comparative advantage at that task. So when you make the statue, you do the sculpting and he manages the chisels.

Now, let's get back to country A and country B. Suppose that A can produce 10 widgets per hour or 5 doobles per hour, but that B can produce only 1 widget per hour or 3 doobles per hour. Thus, A is better than B at producing both items.

Suppose further that each country divides its 8-hour work day so that half (4 hours) is spent producing each item.

With no trade, A will produce 40 widgets and 20 doobles. To produce one more dooble, A must give up 2 widgets: that's the opportunity cost of a dooble for A. And as for B, with no trade, B will produce 4 widgets and 12 doobles. To produce one more widget, B must give up 3 doobles: that's the opportunity cost of a widget for B.

Now, observe two things. First, the opportunity costs for A and B determine the maximum price they will pay for each good. A will not pay B more than 2 widgets for a dooble because it would be paying B more than it costs A to make a dooble at home. The same applies to B buying widgets: B won't pay more than 3 doobles for a widget.

Second, the total production of both A and B together, with no trade, is 44 widgets and 32 doobles. With trade, we will see that this total goes up.

Now, let's see what happens when A and B trade with each other. We will look at a specific situation, but you would find that all situations along each country's production possibility frontier would be similar.

Suppose that A devotes 6 hours per day to making widgets and 2 hours per day to making doobles. It will then produce 60 widgets and 10 doobles. B, on the other hand, spends all 8 hours per day making doobles, so it makes 0 widgets and 24 doobles. The total production of A and B together has increased from its no-trade level of 44 widgets and 32 doobles to a new level of 60 widgets and 34 doobles.

The specific amounts of trade between A and B depend on the relative demand for widgets and doobles, but here's a possible outcome:

Remember that A will pay any price up to 2 widgets per dooble, while B will pay any price up to 3 doobles per widget. That determines the price range within which widgets and doobles will exchange. So if the price is 1 widget per dooble, both A and B are getting what they want for less than the maximum they'd be willing to pay.

If A pays 11 widgets for 11 doobles, then it has increased its wealth from the no-trade level of 40 widgets and 20 doobles to 49 widgets and 21 doobles. At the same time, B has increased its wealth from the no-trade level of 4 widgets and 12 doobles to 11 widgets and 13 doobles. So the trade benefits both countries.

Just remember the analogy with pulling a rock up a hill: the more people who help, the more you can accomplish. And each person should do what he/she is best (or least bad) at doing. Those two ideas are all that comparative advantage is really about.

Here are some additional information sources for you:

Books:

Web links:

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Does comparative advantage predict how countries will specialize?

Question: I am studying international economics and need clarification on something. I understand that the classical model predicts that countries will completely specialize in the production of their comparative adavantage goods. However, why does the opportunity to participate in international trade lead to this? Is it simply the advantage you have is so strong that you produce your goods that you have the C.A. in and essentially stop making those goods that other countries are more efficient at?

Answer: I'm not sure which textbook you're using, but the classical model of comparative advantage does not predict that countries will completely specialize in the production of goods for which they have a comparative advantage. As M.I.T.'s Paul Krugman puts it in his own international economics textbook (p.13), comparative advantage "is a statement about possibilities, not about what will actually happen."

Comparative advantage simply states that from that standpoint of producing the "largest number of beans" (etc.), it's best for each country to export goods for which it has a comparative advantage and import goods for which it does not. What it actually ends up doing can depend on many other factors besides comparative advantage.

Here are some additional sources of information for you:

Books:

Web links:

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What does it mean when the dollar depreciates?

Question: How does a depreciating dollar affect employment, inflation and growth?

Answer: When the dollar depreciates, that means it decreases in value relative to money issued by other countries or monetary authorities (e.g., the European Union).

Suppose that a country named Flobovia uses a monetary unit called the "flob." At the start, one flob exactly equals one US dollar. Suppose further that a consumer in Flobovia wants to buy a US-made automobile that lists for US $10,000. Then the consumer knows he/she will have to pay 10,000 flobs for the car. (For the sake of simplicity, we're leaving out transportation costs and red tape associated with international trade.)

Now, suppose that the dollar depreciates relative to the flob so that each flob is now worth $2.00 instead of $1.00. The consumer in Flobovia can now buy the same car for only 5,000 flobs, which makes it a more attractive purchase. Apply this same process to all other goods and services that the US exports, and you can see that a depreciating dollar tends to improve business for sectors of the economy that export. They tend to grow and have increased levels of employment.

What about imports to the US from other countries? A depreciating dollar makes them more expensive. As a result, US businesses that import from other countries will suffer. However, US businesses that compete with imported goods will benefit.

A depreciating dollar is often associated with an increase in the supply of money and credit, which can lead to price inflation (rising prices). The effects of a depreciating dollar on growth are mixed: depending on the circumstances, it might help in some cases and hurt in others.

Long term, the best situation is one in which the value of money is stable -- neither appreciating nor depreciating. Because the economy continues to grow and the demand for money increases apace, this leads some economists to propose that central banks keep a slow, steady growth in the money supply.

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What does it mean when one currency is pegged to another? When it's overvalued?

Question: Perhaps my question is really three questions, perhaps they are linked - I hope I am not being too cheeky:

    1. What does it mean when one currency is linked (pegged?) to another?
    2. Overvalued?
    3. What does going into the Euro at the right rate mean?

Please help. Many thanks in anticipation.. You are probably over qualified for me. Recommend a good book?

Answer: First, let me tell you something that my grandfather used to say: "Every person you meet knows something that you don't know." No matter how young or old a person is, no matter how high or humble his station in life, he knows things that no one else knows. So don't worry about being "cheeky."

In the field of economics, I know a few things that you don't know, and I'm happy to share that knowledge. I hope that in cases when you know things that someone else needs to know, you will do the same for that person.

Here endeth the sermon. :-) Now, on to your questions.

<< 1. What does it mean when one currency is pegged to another? >>

If currency B is pegged to currency A, it means that the value of B is defined as a certain quantity of A, and that a country's central bank will try to maintain that value. For example, under something called the Bretton Woods agreement, the pound used to be pegged to the U.S. dollar at $2.80 per pound. Both the U.S. and British governments, with their central banks, were committed to exchanging pounds for dollars at that rate.

Now, if you've had a bit of economics, you might recognize this as a case of price control: the price of pounds in terms of dollars is fixed, and vice versa. And it suffers from all the same problems as price control of any other commodity.

For example, suppose that the British central bank expanded the money supply by increasing the number of pounds in circulation, but the U.S. central bank did not. Then the value of the pound would tend to decline, because an increase in supply of any good tends to lower the value of each unit of the good. However, the price of pounds would still be fixed at $2.80 per pound, so people could exchange pounds for dollars and get more dollars than the pounds were really worth.

As people rush to sell pounds for dollars, this floods foreign-exchange markets with pounds, and tends to push down the equilibrium exchange rate between pounds and dollars. Instead of exchanging at the officially pegged rate of $2.80 per pound, a pound might bring only $2.70 or $2.50. However, the British government and central bank are committed to maintaining an exchange rate of $2.80 per pound, so they must step into the foreign-exchange markets and start buying pounds to prop up the price. Where do they get the money to buy all those pounds? They must either take it from tax revenues or borrow it: neither is a very sensible alternative.

The Nobel prize-winning economist Milton Friedman has written some very good articles about this, and they are reprinted in two books I've listed at the end of this email.

For the most part, national currencies are no longer pegged to each other. Their values fluctuate more or less freely on foreign-exchange markets. Sometimes, governments still try to prop up the values of their currencies, but it's for more general economic reasons.

It's worth mentioning that the issue of fluctuating exchange rates only arises in a system of "fiat money," that is, paper money not backed by any valuable commodity such as gold or silver. Originally, a pound sterling was defined as a pound of silver. The U.S. dollar was defined as an ounce of silver, that being the amount of silver in a popular European coin called a "thaler," the name of which was slurred over time to "dollar."

If a British pound is a pound of silver, and a U.S. dollar is an ounce of silver, there's no problem about what the exchange rate should be: it's simple arithmetic. It's only when governments and central banks stop redeeming their currencies in valuable and universally-accepted commodities that exchange rates become a problem.

<< 2. Overvalued? >>

When someone says that a currency is over-valued, it means that he has his own idea of what the value should be, but it doesn't match what people are paying for the currency in foreign-exchange markets. The key issue is this: On what basis does the person believe that some other value is correct? Usually, it's something like this: If the currency were lower in value, it would make exports cheaper and make imports more expensive. If one believes (erroneously) that the path to prosperity is to export more than you import, then this line of reasoning might seem convincing.

<< 3. What does going into the Euro at the right rate mean? >>

It's another case of knowing what the "correct exchange rate" should be. However, adopting the Euro has significant drawbacks because it prevents each country from following monetary policies best-suited to its own situation. The British economy has recently been quite strong compared to countries on the continent, and requires different policies to stay that way. Personally, I think that Britain's reluctance to adopt the Euro shows great wisdom.

Here are some additional information sources for you:

Books:

Web links:

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What is a country's balance of payments account?

Question: can you give me a quick overview on what the balance of payments account is? When you read it is it like a bank statement where credits are money coming in and debits money going out. Or is it like a revenue statement debits money in credit is money out.

Answer: The balance of payments account gives the details of a country's payments to foreigners and payments received from foreigners. Payments to foreigners are recorded as debits (as negative amounts), while payments from foreigners are recorded as credits (as positive amounts).

The balance of payments account is divided into two parts, each of which records a different type of transaction. The first part, the current account, records export or import of goods and services, while the second part, the capital account, records purchases and sales of capital assets, such as factories, bonds, and so forth. It looks something like this:

  Credits Debits
Current Account    
1. Exports    

(categories of exports)

    
2. Imports    

(categories of imports)

    
3. Net unilateral transfers    
     
Capital Account    
4. Country's assets held abroad    

(categories of assets)

    
5. Foreign assets held in the country    

(categories of assets)

    

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How far can interest rates fall before foreign investors abandon a country's debt?

Question: How far can rates fall before foreigners abandon our debt and how will we maintain the value of the dollar? Interest rates cannot be as arbitrary as we would like. Interest rates have approached zero in Japan. Where has that gotten them?

Answer: Remember that the interest rate includes two factors. First, it includes the market rate of time preference between now and the future: other things being equal, people prefer to have money now, and they discount the value of future money by their rate of time preference. Second, interest includes a risk premium based on the chance that if people invest money now, they might not get the expected future return on their investment, or might even lose their money altogether.

Depending on the market rate of time preference and especially on investors' perception of risk, a low or even zero nominal interest rate might not be sufficient to attract their money. I believe that was part of the problem in Japan.

Foreign investors buy US stocks and bonds not merely because of the nominal interest rate, but because they see the US as a large, stable, and therefore relatively safe place to put their money. That hasn't changed, though the recent terrorist attack and the looming war have introduced a slight element of uncertainty and, hence, increased risk.

Even now, however, the risk is much lower than investors would face in most other countries. Therefore, I don't expect foreign investors to withdraw en masse from US bond or stock markets. Some will, but most won't: the arguments of stability and relatively low risk are too powerful. Remember that investors are going to put their money somewhere: their question is not "Do I wish that conditions in the US were better?" Instead, their question is, "Do I have investment alternatives better than the US?"

The value of the dollar on foreign exchange markets will undoubtedly fall as a result of recent (September 2001) interest rate cuts, but unless it falls at a catastrophic rate -- which is very, very improbable -- it shouldn't cause any long-term problems.

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What are the advantages and disadvantages of protectionism?

Question: I am a law student at the University of Melbourne. My question is: (i) What is protectionism, and (ii) What are the advantages/disadvantages of protectionism for a country?

Answer: Protectionism is the belief that a country's government should limit trade between the country's citizens and people in other countries. It has a long pedigree, going all the way back to Plato and Aristotle, though it is mainly associated with the mercantilist writers of the seventeenth century.

Advocates of protectionism have used two main arguments to justify it. The first argument is that trade with foreigners exposes people to foreign ideas and ways of acting. If you believe that this exposure is undesirable because it tends to weaken people's attachment to their own culture, then you will, as Aristotle did in his Politics, argue that the government should restrict trade to protect people from being corrupted by foreigners. This argument depends on how much value you assign to your country's culture, and therefore, it is not an economic argument even though it has economic consequences.

The second argument contends that a country is analogous to a household, and that it becomes wealthy by selling more than it buys -- that is, by accumulating money, by which mercantilists meant "gold." Unlike the first argument, which suggests that all trade should be restricted, this argument leads people to think that only imports should be restricted, while exports should be encouraged. Remember that if country A imports goods from country B, that means people in country A are buying goods from country B -- in other words, there's an inflow of goods and an outflow of money. Conversely, if country A exports goods to country B, there's an inflow of money and an outflow of goods. If you believe, as did the mercantilists, that the key to national wealth and power is to accumulate money, then you might want to follow their prescription.

On balance, protectionism has no economic advantages for the country that practices it. That's a strong statement, but it's pretty much the universal consensus of economists. The plausibility of protectionism comes largely from what French economist Fredric Bastiat called "the fallacy of the seen and the unseen." Suppose that America imports lots of product X from Japan because Japanese companies offer it for a low price. What you see on the TV news are stories about American workers in the X industry who've lost their jobs because of imports. What you don't see are the new jobs created because, having paid lower prices for X, consumers have more money left over to buy other things, thereby stimulating demand in other areas of the economy.

There are circumstances in which protectionism might be justified, and even Adam Smith, the patron saint of free trade, thought that there were a few. For non-economic reasons, a country might want to be self-sufficient in certain strategic industries in case of war or disputes that could cut off its foreign supplies of key products, such as steel or oil. Moreover, there is an argument -- not a particularly good argument, but not completely insane -- that temporary, limited protection can cushion an industry's adjustment to import competition. However, every industry says that it's strategic, and "temporary" protectionist measures almost always end up being permanent, so it's good to view such arguments with skepticism.

If you want to read more about protectionism, I suggest the following:

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Is globalization an opportunity or a threat?

Question: I have to write an essay on whether globalization is a threat or an opportunity to the United States. I'm supposed to use only the sources given to me by the professor; however, they are all from the viewpoint that it's a threat and I believe that it is an opportunity. I don't know much about it though, so I'd appreciate any insight you could give.

Answer: Globalization is both a threat and an opportunity for the US: it mainly depends on where you sit. But let's define terms first. Globalization means a process by which products, capital, and labor all become freer to move across national borders. As a result, business becomes more tightly integrated between countries.

For example, consider the imaginary "Acme Widgets" in Boise, Idaho, and suppose that widgets require factory labor to assemble three parts, A, B, and C. Globalization makes it easier for Acme to own branch facilities anywhere in the world, and buy or sell from other companies anywhere in the world. It can manufacture part A in Singapore, buy parts B and C from a company in China, assemble the widgets in Acme's factory in Mexico, and then ship the widgets back to the US for sale. The only limiting factors are the time and cost of shipping parts and products around the world. But if the cost savings on labor and parts are enough, it will be worth the effort.

Now, since Adam Smith, it's been understood that this widening of the market and increased division of labor increase the total wealth of the societies that do it. In that sense, globalization is a great opportunity for the US: it means producing (and consuming) more total output at lower cost. Paul Krugman has a lot of good essays on this, and his book International Economics (a textbook he wrote with Maurice Obstfeld) discusses the theory at length.

But total output isn't the whole story, and here's where your professor has probably focused. For Americans, globalization means both (a) a world-wide market buying their products, which tends to increase the income of all Americans; and (b) a world-wide labor market competing for their jobs, which tends to decrease the income of wage-earning Americans. Global competition is most intense for unskilled or low-skilled jobs, so these US workers are the hardest hit; but even high-tech workers must sometimes take pay cuts or see their jobs exported to computer centers in, e.g., India or Taiwan.

Business owners and investors, on the other hand, tend to see lower costs and higher profits as a result of globalization.

So there are two opposing forces in globalization: one that tends to improve the living standard of all Americans, and another that tends to hurt some Americans and benefit others.

One non-economic note: You can never have an economic or social system in which nobody loses. You just have to try to set up institutions to benefit the greatest number of people, and then take additional steps to help those who fall through the cracks.

If you want to read more about globalization, I recommend the following:

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What are trade liberalization and deregulation?

Question: In the context of international trade, (i) What is trade liberalization? (ii) What is deregulation?

Answer: In the context of international trade, liberalization and deregulation are synonymous, and both refer to the removal of legal restrictions on trade between different countries.

Governments of many countries pass laws that restrict the ability of people in those countries to do business with people in other countries. These laws take many forms, including:

Liberalization and deregulation refer to the removal of these and other barriers to international trade. If you want to learn more about liberalization and deregulation, you might look at the following:

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How is globalization related to trade liberalization and deregulation?

Question: I am a law student at the University of Melbourne. My question is: How does globalization relate to trade liberalization and deregulation?

Answer: Globalization is a process in which products, capital, and labor become increasingly able to move between countries. It faces three main obstacles:

1. Legal barriers between countries include import quotas, tariffs, immigration restrictions, and restrictions on the movement of capital.

2. Physical barriers are the time and cost of moving products, labor, and productive resources.

3. Cultural barriers include different business practices and different languages.

Trade liberalization and deregulation address only the first category of obstacles. Eliminating these obstacles is an important step, but not the only one.

A recent study by the U.S. National Bureau of Economic Research -- I'm afraid that I don't have the citation at hand, but you could find it by searching the NBER Web site -- found that the costs of doing business internationally have dropped a lot in recent years, and this contributes to the globalization process.

Also, of course, all developed countries have faced massive immigration from poor nations, while English has become the standard language of the Web and international business -- if not of the American Southwest. :-) Therefore, obstacles in categories (2) and (3) are falling as well.

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What are the benefits and costs of globalization?

Question: Further to my previous question, I am also interested to know your opinion on globalization, trade liberalization and deregulation.

Answer: There is no question that globalization, trade liberalization, and deregulation tend to increase the total production and wealth of the countries that participate. That's a good thing.

Like all good things in this world, however, it comes at a cost. In the global marketplace, labor is more plentiful than capital, and unskilled labor is more plentiful than skilled labor. Therefore, globalization tends to shift income from wage earners to investors, and from unskilled workers to skilled workers. That doesn't mean it's bad: if globalization gives an unskilled worker in a poor country a chance to earn five cents a day, and the alternative is to starve, that's still an improvement. But over the short term, globalization leads to increased inequality of wealth, even though the cartoon version of the process ("the rich get richer and the poor get poorer") does not apply. With globalization, the rich get richer and the poor get richer -- but the rich get richer much faster than the poor do. It widens the gap between the very wealthy, the middle class, and the dirt-poor who barely get enough to eat. That troubles me.

Globalization also tends to destroy the national, regional, and local cultures of the countries that participate in it. The market acts as a global "melting pot" that tends to obliterate all cultural differences that are not economically useful. That, too, troubles me.

On balance, I favor globalization, but I hope that we can find a way to mitigate its less-desirable effects.

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How does globalization affect less-developed and developed countries?

Question: In simple terms, What is Globalization and how will it effect 3rd world countries and 1st world countries?

Answer: Globalization is a process in which products, capital, and labor become increasingly able to move between countries. It faces three main obstacles:

  1. Legal barriers between countries include import quotas, tariffs, immigration restrictions, and restrictions on the movement of capital.
  2. Physical barriers are the time and cost of moving products, labor, and productive resources.
  3. Cultural barriers include different business practices and different languages.

Over the last 50 years, and especially the last 30 years, these obstacles have become less and less significant. That's why globalization has accelerated.

The principal economic problem of third-world countries (which are usually called less-developed countries, or LDCs) is lack of capital -- in productive equipment, investment funds, and human skills. Globalization helps LDCs raise their living standards by encouraging foreign businesses to invest and create jobs; in the course of doing so, businesses find it in their self-interest to help develop the skills of the local workforce. It can also give local governments an incentive to adopt more modern systems of law and to respect property rights, because if they don't, foreign business won't want to come into their countries.

Thus, globalization is a tremendous benefit to LDCs because it helps them in a short time to acquire capital and skills that otherwise might require generations to accumulate.

First-world countries (usually called developed countries) also benefit from globalization, though not quite as much as LDCs. The benefit comes from a widening of markets and a widening of the division of labor; this effect has been known at least as far back as Adam Smith's book The Wealth of Nations, which was published in 1776 and is still a good read.

Some people worry about the fact that workers in LDCs don't yet make wages at the same levels as workers in developed countries, and that LDCs might have lower environmental and labor standards than developed countries. Over time, these differences tend to diminish, and even now, studies of environmental practices have found little difference between how businesses operate in developed countries and how they operate in LDCs. It just doesn't make sense for a company that's designed an environmentally-safe factory for use in developed countries to design a whole new, less-safe factory to use in LDCs.

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How much globalization has occurred, and what are its effects?

Question: As a requirement for my 12th grade research paper I need to use information from an interview. I have done research about pros and cons of globalisation and I am about to write my final draft. Because of the interview requirement I thought quoting an experts view on the degree of the world's globalisation. It would be very helpful if you could give me your perspective on how much the world is globalised. I would really appreciate your answer and I will be quoting you for my paper.

The student's interview:

Question: How much is the world globalized?

Answer: Before we can say how much the world is globalized, we have to define what globalization is. And for a word that's thrown around so much, it's surprisingly hard to get people to agree on a definition.

For example, Dani Rodrik at Harvard University, in his book Has Globalization Gone Too Far?, says that globalization is "the international integration of markets for goods, services, and capital." That's a strictly economic definition.

However, Paul Hirst at the University of London wants to go further. He says that globalization implies "the greater part of social life is determined by global processes, in which national cultures, national economies, and national borders are disappearing." That's in his book Globalization in Question, which he co-authored with Grahame Thompson of the UK's Open University.

Finally, James Mittelman at American University in Washington DC makes the definition even broader. He says that globalization requires "spatial reorganization of production, the interpenetration of industries across borders, the diffusions of identical consumer goods to distant countries, massive transfers of population, resultant conflicts between immigrant and established communities ... and emerging worldwide (though not universal) preference for democracy." That's in his book The Globalization Syndrome.

Question: So which definition is right?

Answer: I think that they're all right as far as they go. Certainly, globalization does involve international integration of markets, as Rodrik says. And we see national cultures being submerged in a global marketplace, as Hirst says, with the process spurred by massive immigration from poor countries to developed ones.

You don't see people emigrating from London to Bangladesh, or from New York to Nairobi; it's all in the other direction. That makes perfect sense for the people in poor countries, who face poverty, oppression, and disease that we would find almost beyond imagining; but it has definite costs for people in developed countries, whose cultures are being buried under a tidal wave of immigrants, and whose government and other social services are strained to the breaking point by the same phenomenon. But I digress.

I'm an economist, not a sociologist, so I personally define globalization in economic terms. I see globalization is a process in which products, capital, and labor become increasingly able to move between countries.

Question: So, is globalization increasing, or not?

Answer: Yes, in most areas. The quantitative evidence consists of things like the increase in foreign direct investment in almost all countries, though as with most statistics, you can turn the numbers around a different way and say that globalization hasn't increased at all.

But apart from statistics, the evidence of globalization is all around us. My shirt was made in China. My pen was assembled in Canada from parts that were manufactured in Mexico and Indonesia. Today at the office, I was at a meeting attended by three people in the US and five people in the UK, all via a videoconference hookup. Earlier tonight, on a television that was made in Japan and a DVD player made in the US, I watched a DVD that I ordered over the Web from Amazon.de in Germany: it was a German-language version of an episode of "The X-Files," originally taped in Canada with American actors. Anyone who thinks that those things could have happened in the 1950s is crazy. It would have been science fiction.

One question you haven't asked me, by the way, is why globalization is happening now. There has been international trade for hundreds, even thousands, of years. Why is it only in the late 20th and early 21st century that international trade has expanded into what we call globalization?

Question: That's a good question, I agree. How about it?

Answer: If you look at international trade, and at globalization, you can see that they face three main obstacles. First, there are legal barriers between countries, such as import quotas, tariffs, immigration restrictions, and restrictions on the movement of capital. Second, there are physical barriers, such as the time and cost required to move products, labor, and productive resources between countries. And third, there are cultural barriers, such as different business practices and different languages.

Over the last 50 years, and especially the last 30 years, these obstacles have become less and less significant. Economists are almost unanimous in their support for free trade, so government leaders have been hearing from all sides that the way to increase national wealth is to open up their countries to foreign trade and investment. As a result, many legal barriers to globalization have been eliminated. In addition, the time and cost of communicating and shipping between countries have dropped dramatically -- largely because of new technology. And business practices have become internationalized. That's why globalization has accelerated.

The Internet is just one example of how technology has made globalization easier. A recent study from the (US) National Bureau of Economic Research looked at how the Internet reduces the cost of doing business. The study observed that "The Internet potentially reduces a buyer's cost of finding suppliers because it is less expensive to search for products and compare prices over the Internet that it is to read catalogs and make phone calls. Conversely, sellers can reach buyers at lower cost." (Luis Garicano and Steven N. Kaplan, "The Effects of Business-to-Business E-Commerce on Transaction Costs," NBER working paper #8017. National Bureau of Economic Research, Cambridge, Massachusetts, USA, 2000.)

The NBER study found that businesses using the Internet reduced their transaction costs by anywhere from 37-52 percent. Apply that saving to international trade, and you can see at least one reason why globalization is happening now. Thirty or 40 years ago, it was too expensive and difficult to have as much international trade and integration as we do now. Today, it's easy.

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Will European integration increase competition between regions of Europe?

Question: Why may European integration increase competition between Europe's cities and regions? Is such competition likely to increase or reduce regional disparities? Basically what I have thought about is mainly the creation of a Single Market where all parties are effectively in competition with each other. Of course in Europe there are additional factors that have to be taken into consideration, like the core and periphery and their inability to compete effectively with each other, input from the EU, and Member States tendancies to encourage inward investment at the expense of other Member States. However, I'm not really getting anywhere, and I feel like there's a big question that I'm missing somewhere. Have you got any ideas?

Answer: This is a fascinating and difficult question because it goes beyond economics alone. That is no surprise, I suppose, inasmuch as your professor (as you said in a separate email) is mainly a lecturer in geography. Because of the latter fact, however, I fear that I have no special insights into his thinking, as I would if he were an economist; and geography was never a strong subject of mine in any event.

Nonetheless, I think that I can give you at least some advice, with the proviso that since you're taking the class, you probably know many more details of the subject than I do.

First, although their activities will have economic effects, cities and regions are not going to compete in the economic sense of the term. They do not have marginal costs, are not trying to make a profit, and do not charge a monetary price for their "product." Their product is principally an attractive environment for doing business, and that consists of things they completely control (such as regulatory exemptions), things they partly control (such as tax rates), and things over which they have almost no control (such as the literacy and work ethic of the population, or shipping costs in and out of their location).

Now, I agree with you that the cities and regions are going to compete in some sense -- just not the economic sense. In your paper, it would be worthwhile for you to point out that fact, and to contrast the type of competition you're discussing with the economic sense of competition. A good way to do that would be to respond to one of Paul Krugman's essays in his book Pop Internationalism, which I listed below.

Krugman is an economist at the Massachusetts Institute of Technology and is also a very good writer, so his ideas are easy to follow. He argues that it's nonsense to believe countries or regions can compete, but it's very clear that he means economic competition. By answering him -- conceding his point about economic competition, but arguing that there are other kinds of competition -- you can demonstrate that you've done your homework and that you've thought out the issues involved.

As far as competition between cities and regions goes, it's not economic competition, so we can't analyze the process using traditional economic concepts. I would suggest that you apply some very simple game theory to the situation. It won't be a perfect fit, but you can draw out some interesting insights by doing so. Try the Cournot and Bertrand models: they're quite easy and you don't need any math to understand the basic ideas. At the end of this email, I've listed a couple of game theory books that you can find at the library.

As for the question "Does competition increase as a result of EU integration?", this is another place we can dip into economics for a concept that applies. Although the process of city and regional competition doesn't fit in the economic paradigm, the start and end states of the process do fit (awkwardly) into the neoclassical concept of competition. In the beginning, before integration, there is a smaller number of "sellers" (cities/regions) in each country's marketplace, competing for the capital in that country. After integration, there's a larger number of sellers competing against all other sellers in the EU for all the capital in the EU: this latter situation is closer to the neoclassical ideal of a competitive market. (I think that's an incorrect view, but it's a useful one for your paper.)

As for disparities, it's clear that the competitive process would tend gradually to reduce regional disparities. Each city or region has some advantage, at least a comparative advantage. If (other things being equal) one region has a scarcity of capital relative to other regions, the returns to capital will tend to be higher in that region until the returns equalize with those in other regions. More capital investment will tend to increase the productivity of labor in capital-scarce areas until wages in those areas are on a par with the other areas.

Here are some additional sources of information that you might find helpful:

Books:

Web links:

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Should the United Kingdom adopt the Euro? What are the arguments?

Question: For A-level Economics, I have the following question: Discuss whether or not the UK should join the single currency. Can you help?

Answer: This is obviously a homework question, so I can't simply answer it for you. But I'll be happy to get you started. I assume that the "single currency" is the Euro.

It's worth noting that until the 20th century, the UK and other countries did have what amounted to a single currency, because their paper money was defined in terms of gold and silver, and it was readily convertible into those metals. For example, if a pound sterling is a pound of silver and a US dollar is an ounce of silver -- as those two moneys were historically defined -- then it matters little what each country calls its monetary unit: a pound exchanges for 16 dollars, and so forth. It's only when countries divorced their currencies from a commodity standard such as gold that problems arose about the relative value of different countries' monetary units.

The basic advantage of a single currency is that it makes transactions easier across national borders. For example, if you buy things regularly from a country that uses the Euro (or any non-British money), you can't predict exactly how much things will cost because the value of the foreign money might change relative to the pound. Likewise, for example, if you sell things in a foreign country, you will be paid in that country's monetary units, and until you convert them back into pounds, you won't know exactly how much UK money you are going to get. That kind of unpredictability makes it very difficult to run a business.

On the other hand, a single currency has significant drawbacks if it's used over an area that is too large. There's a whole program of economic research into what are called "optimal currency areas." What I've read of that research is skeptical that Europe is an optimal currency area: it's too large and diverse. For example, if the British economy is booming and the French economy is in recession, a single currency administered by the EU limits each country's ability to adapt to its own circumstances. In effect, each country that adopts the Euro loses the ability to chart its own economic destiny and gives that power to the EU. And even if it has the best intentions, the EU will have to follow a "one size fits all" economic policy that won't exactly suit any of the individual EU countries.

For similar reasons, many people in the UK and other countries are suspicious of the Euro because they see it (correctly, in my opinion) as an attempt to weaken their national sovereignty in preparation for a European super-state ruled by unelected bureaucrats of the EU. The history of the United States is instructive in this regard.

The US was founded by 13 sovereign states, and the US Constitution guaranteed that they would retain their sovereign status. Over the years, however, the national government inexorably destroyed the individual identities and freedom of the states. The same might well happen to European countries, with adoption of the Euro as the first step.

Here are some more sources of information for you:

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Why do the British resist adopting the Euro?

Question: I am currently doing a project on the single european currency and am not very clear on the reasons as to why Britain isn't joining. I am having difficulty in finding precise answers in any of my research. Could you possibly outline the reasons for me?

Answer: As I understand the debate, the main issue is political rather than economic.

Many people in Britain see the EU as the beginning of a super-state that would obliterate the independence and cultural identities of its member nations -- much as the U.S. national government, over the last 200 years, has obliterated the independence and cultural identities of the states that originally formed it.

On the British Conservative Party's Web site, for example, I found the following statement by a party leader:

"Under Labour's plans, the British pound, the currency that for centuries has been both the symbol and reality of our national independence, has two years left to live."

I think that pretty much sums up the argument against the Euro.

If you want to read more about these issues, you might look at Peter Hitchens's recent book, The Abolition of Britain.

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What countries does the U.N. list as less-developed?

Question: I am looking for the complete list of the 26 (or so) "developed countries" as defined by the UNCTAD. Can you provide me with a web site address where I could find this information?

Answer: You can find the list at www.unctad.org, and in particular, check the UNCTAD Handbook of Statistics at www.unctad.org/en/pub/ps1tdstatd25.en.htm: only excerpts are on the Web site, but they might contain all the information you need. I'm sure
that the book itself is available at your university library.

The countries are as follows:

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