Topic 1 - Convergence, Globalization and pre WWI Gold Standard
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(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
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)
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
Another measurement of convergence: Wage. i.e. Wage levels in poor & rich countries will
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,
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:
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
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
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.)
Industrialization in sending countries;
Chain migration (persistence)
Demographic factors 4. International Capital Flows (*)
Relatively large capital “exporters” (~2 – 2.5% of national income): England, Germany, etc.
Dated back to 19 century
By the end of 19 century, we see the presence of large multinational corporations
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
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
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