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Notes Topic 1 - Convergence, Globalization, pre WWI Gold Standard.docx

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Jon S.Cohen

Topic 1 - Convergence, Globalization and pre WWI Gold Standard th th st th (September 17 , 24 , Oct 1 , October 8 ) Pre WWI & post WWII (growth) vs. Interwar period (slow growth)  Opening of markets:  Closed down markets in the interwar period;  Return of this openness in the post WWII period (e.g. Bretton woods organization  Allows countries to have “dynamic comparative advantage”  Comparative advantage: even if one country dominates certain other country in terms of cost & production, there is still opportunity for these two countries to trade, with each country specializes in what they do the BEST, in terms of opportunity cost.  Dynamic: feedback from the specialization: you get better at doing it because you are doing it more – long run average cost goes down (“learning by doing”); As you cut off things you are not good at, you will be able to build bigger/more efficient production (“scale economy”)  When opening up the economy, there are opportunities associated with dynamic comparative advantage that could pay off in the long run (globally as well) – but sometimes it’s not politically popular  Pre WWI & Post WWII bought into this both by accident or by design  Interwar period NOT – restricted by human capital, resources, policy, etc. Globalization before 1914 (1879 – 1914)  Convergence:  Countries with lower GDP Per Capita will catch up to the countries with higher GDP Per Capita based on certain conditions that in the end, these countries will have the same level of GDP Per Capita)  Another measurement of convergence: Wage. i.e. Wage levels in poor & rich countries will converge. st  1 reason: much better data on real wage than on GDP per capita  2 reason: by looking at the real wage, it will help us understand the factors that are promoting converge. Just looking at GDP Per capita convergence may not provide us that insight. For example, if we just look at GDP Per capita, it could be because there is huge technological advances; if we look out real wage, we will be able to pick out factors we wouldn’t otherwise see.  E.g. the opening up of the prairies to western Europe has significant impact on the wheat price, which is good for consumers, but bad for producers thus had a huge push back – this can be picked up from looking at real wage but not GDP Per capita  Neoclassical Growth Model:  Predicts that convergence will occur;  Doesn’t say when & how;  What we know about economic growth is that it depends on the following: population growth, saving (investment) rate, technological change/progress.  Population growth affects labor inputs; saving/investment affects capital input; technological change helps putting inputs together to produce output.  ( ) ( )  Technological change affects the efficiency/way every input is put together and boost output without changing any of the inputs.  Rates of savings/investments & population growth rates  For all the Atlantic countries (western/northern Europe, new settlement), assuming certain similarities in rates of savings/investments & population growth rates, and assuming that everybody has access to technology, and assuming capital/labor/technology can move. Assuming the only difference is the starting point (some countries have higher capital/labor), then, the model argues that here will be forces put in place to push these countries towards GDP per capita/real wage convergence.  The model was not developed for this purpose – it was played around with and proposed.  Argument: several factors played a major role in convergence in this period.  1. Technological Change;  2. International Trade;  A period for rapid growth for international trade (both pre WWI and post WWII)  What is causing the trade? It is actually a function of technological change  Commodity market integration (how do you measure: commodity price differences)  Ocean freight rates fell by 2/3 during that period  Because of refrigeration, goods that are previously not shippable became shippable  Development of railroad (opens up the Great Plains, the prairies, Australia, Argentina, etc.)  Overall estimate transport cost went down 50%. (“cost of distance” starts to diminish)  Exploit markets in a way that was not possible before  Price gap between wheat on the Chicago market & wheat on the London market went from a 50% difference to a 17% difference. Price of meat (Cincinnati vs. London = 100%  ?)  Reaction: producers are not happy, agitation starts. Tariff starts. Some countries resist (Denmark), some countries don’t (Germany)  The idea of “The Most Favourite Nation”  Factors that put barriers in trade (lessen the effect of convergence) – trade cost model:  Politics  French resistance & protectionist policy (stronger than other countries)  Stronger agricultural lobby as a result of powerful landowners & large population in agriculture; easier/more natural for them to resist  Tariffs/non-tariff barriers  Wars  Quantifying trade cost  Roughly speaking, the decline in trade cost accounts for approximately half of the increase in international trade during the period. (so there are other factor that boosts trade)  Where is the other 50%? (expansion of economies themselves)  Not just international trade, also “internal trade” (e.g. when the Great Plains is opened up, not everything goes to Europe; some stays in Chicago, or Winnipeg, etc.)  3. Migration  Industrialization in sending countries;  Wage differentials  Chain migration (persistence)  Demographic factors  4. International Capital Flows (*)  Relatively large capital “exporters” (~2 – 2.5% of national income): England, Germany, etc.  Multinational Corporation  Dated back to 19 century th  By the end of 19 century, we see the presence of large multinational corporations  Royal Dutch  Coco cola;  Standard Oil  leman Brothers  1900 in the US, the largest flour manufactures, the largest mining equipment manufacturers, four top meat packers, are not American corporations. – US is a net importer of Capital at that time. US in general is a low saving, big borrower; countries willing to lend to US because it’s a good place to make money.  Capital Flow Theory  All else stays constant, we expect capital to flow to area with highest risk adjusted marginal product of capital – because that’s where you get the highest return on your capital.  In equilibrium, in the world with perfect information, the real marginal product of capital should be equal everywhere. (Capital will move until there is no incentive to move – pushing rate of return to be equal)  Everything else stays constant, we will expect the marginal product of capital should be the highest in areas where Labor/Capital ratio is the highest, or Land/Capital ratio is highest. Rational is that if you have abundant labor or land, then incremental increase of capital would produce more return. Capital would move here because there is most benefit moving here.  Refer to the graph, capital from the old world goes to the new world, increasing supply, driving down return that was previously higher.  It looks like capital follows the immigrants (workers, etc. go from Europe to America)  Young workers, male, no families, just started families, etc. little saving; abundant opportunities for external investors.  In relation to convergence:  Capital flow is a force of DIVERGENCE.  Recall that for convergence, new world wage goes down, old world wage goes up. But as capital flows to new world, making workers more productive, who then get paid more. It’s raising the return of labor. In theory this is increasing the wage, which is not promoting convergence  5. The Gold Standard  Argued that the Gold Standard also facilitated trade  The value of the currency is pegged to the value of gold; establish a certain ratio between your currencies to gold. (e.g. England: 1 ounce = 1.63 pounds) – just an arbitrary decision  These currencies are just a way of talking about different amounts of gold – as if there is only ONE currency – gold, and the paper currency is just different representation of gold.  Eliminated exchange rate fluctuation, reducing transaction cost of doing business (like Euro)  Consequence of convergence: Inter-country income distribution  W/R in the old world goes up; W/R in the new world goes down.  Assuming land owners are more
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