Macro & Micro economics - Essay Example

? Macro & Micro economics Contents Contents 2 Introduction 3 Causes and Mechanisms of the collapse of the world trade 3 Current Trade Policies in Response to the Global Recessions 7 Policy responses on negative impact on the trade balance were implemented in the UK 8 Effectiveness of the EU trade policies in the long run 9 Conclusion 11 References 12 Introduction The Great Depression was one of the most severe economic downturn that the world faced during the twentieth century in the pre-World War era. The phase which started from 1929 lasted for more than a decade and its effect was faced by most of the nations around the globe. The Great Recession of 2008 on the other hand took place due to a host of reasons including the subprime lending crisis, the burst of the US housing bubble, the drastic increase in the price of oil in the country and the devaluation of dollar. This report looks into the various aspects of the setbacks in the international trade caused by the collapse in US financial markets. The focus of this report is the main areas of the UK and EU which are in trade relations with the country of United States. Finally the changes in the trade policies in the post financial crisis period have been analysed. Causes and Mechanisms of the collapse of the world trade As during the time of the Great Depression when the phase saw increase in the rate of unemployment, lack of liquidity in the economy and various situations of bankruptcy, the great recession also witnessed the similar trouble. The economy faced a decline in the import and exports which in turn affected those countries which depended mostly on foreign trade during the 1930s (Bernard, Jensen, Redding and Schott, 2009, p. 491). Similar thing happened at the time of the US recession in 2008. The entire economy experienced a plunge in the global trade which accounted for about 30% decline compared to the GDP of the country. The trade figures for the country have been shown with the help of the export import trends of the country. Figure 1: Export of US Source: www.tradingeconomics.com It is clear that the exports of the country had been increasing from before 2004. However, trade faced a jolt in 2009 at the outset of the period of recession. The trade of US recovered from 2010 and it is exhibiting an upward trend at the present day. Similar situations can be noticed in the European Union. The export situation for this region also faced the similar consequences as that of the US (Velde, 2011, pp 1–28). Figure 2: Exports in European Union Source: www.tradingeconomics.com Economists have provided a host of reasons that would justify the trade collapse. First of all the supply chain linkages have caused a drop in the trade figures. The vertical linkage hypothesis believes that with a decrease in the demand for the final goods, the demands for the intermediate goods that add value to the final product are also at stake. With the advent of liberalisation, division of labour has taken place across countries and a lot of specialisation has occurred in the production process (Yi, 2003, p. 65). Thus if the aggregate demand in one country reduced it has an effect on the balance of trade of all the related countries. The compositional effect is a second reason why the international trade dropped during 2009. Trade of a country may take place in various sectors but there is a definite proportion in which it should take place. If inconsistent trade takes place in the sectors with the worse affected level of domestic absorption, then the trade to GDP ratio would be most adversely affected (Erceg, Guerrieri and Gust, 2008, p. 2637). The US data on industrial production would be able to support this hypothesis. It has been empirically tested that the drop in trade took place more in the sectors that reported decline in the domestic output the most. Figure 3: Trade across product categories Source: www.wto.org Finally the shortage of credit was the reason why trade could not take place at its full capacity. Any firm in order to carry on with the production processes need access to capital. The sectors that had proper access to credit could only carry on with trade. Since most of the sectors are finance dependent the lack of credit had hit the sectors hard (Chor, and Manova, 2012, p. 119). This also pressurised the suppliers of the companies who had overseas operations. The corporate buyers of the developed countries imposed a lot of restrictions in the process of delivery of the products and receivables and payments for the products. Current Trade Policies in Response to the Global Recessions The European Union recently in 2012 has formulated several policies which would prevent international trade through the formation of the trade barriers. Thus the threat due to protectionism had resulted in the diminution in the trade relations between countries that could have been formed. The choice of the European Union for making a more protected trade environment would have an effect on the entire world economy (Baldwin, 2009, p. 54). Most of the developing nations are into trade relations with the European Union and a lot of revenue of those countries comes through the export of goods and services (Centre for Aid and Public Expenditure, 2012, p. 1). With introduction of the strict trade barriers the production of the developing nations would face a decline. The policy adopted by the Union is much against the BRICS which intends to increase the trade relations among these nations (Ahn, Amiti and Weinstein, 2011. p. 300). The introduction of the Generalised System of Preferences would ensure that the EU imposes protectionism for the countries from which the nations are in no way getting benefitted. Thus the EU is slowly moving away from Multilateral trade and Earlier the countries of the European Union used to encourage trade by allowing concessions to the country that engage in trade. In the present scenario, the EU had decided to stop providing for the concessions. As a result of this the developing countries like Vietnam and India would suffer huge losses on concessions (Wakasugi, Ito and Tomiura, 2008, p. 113). However, studies on this aspect have revealed the fact that the richer countries like the United States would benefit out of the protectionist policies of the countries of the EU. The consumers of the EU would also be affected because the people previously would have access to the low cost imported products especially from the Chinese markets (Bernard, Redding and Schott, 2007, pp. 105-130). With the introduction of protectionism the people would have to buy the more expensive products from the domestic manufacturers. These protectionism policies are in form of tariffs mainly. However, the Union is also considering the prospects of instructing the associated governments to remove the government procurement policies. Several instances are there which shows that due to the change of business cycles the measures of trade protection has been taken (Bown, and Crowley, 2013, p. 57). The EU has been criticised on this ground for creating a differentiation among the developing nations. This is such an area of international trade where the age old principles of economics cannot be applied. The encouragement of tariffs as compared to free trade goes against the economic theory. For example the countries like Cuba would face differentiation and would be deprived of preferences in trade with the countries of the European Union. Thus there is lack of clarity in the strategies that the EU has taken for the differentiation (Braun and Larrain, 2005, p. 1102). The non trade policies that the EU formulated are also not in line with the development goals. Along with that the Union has taken a defensive position in the context of the problems that the entire world faces and seeks to address in a unified manner (World Trade Organisation. 2011, p. 5). The policies that the EU has taken has also very little connect with the growth. Thus the basic economic problem remains unaddressed in this form of protectionism. Policy responses on negative impact on the trade balance were implemented in the UK The collapse in the trade in the UK took place mainly due to the fall in the aggregate demand. The balance of trade for the country has been shown in the table below. The country faced a long period of trade deficit especially in the years 2008-09. Source: trading economics, 2013. This deficit took place mainly due to the decrease in the imports and stagnation in the exports of the nation. This is however not a very healthy situation for any economy. When the exports remain stagnant there is no inflow of fund into the economy (Evenett, 2012, p. 268). This means that there would be an adverse effect on the terms of trade of the country. This means that the relative price of exports compared to that of the imports would decline. It is unhealthy for any economy that is engaged in international trade with another country (Obstfeld and Rogoff, 1996, p. 199). Deterioration in the terms of trade of UK would imply that for a given level of exports it can buy fewer amounts of imports. In other words, the stagnation in the exports would also have an adverse effect on the currency of UK. Therefore the country needed to take the protectionism policy to increase the exports but keeping the imports low. Effectiveness of the EU trade policies in the long run The trade policies of the EU would be inclined towards the intensification of the protectionism policies. These policies would be more in the form of tariffs. The effect of the introduction of tariff on the social welfare of the countries would be adverse. This can be explained with the help of the following diagram. In absence of any protectionism the price would be at P. However, with the introduction of the tariff the prices would go up to Pw. However, the area shaded in red would be the deadweight loss of the economy because this part of the revenue cannot be procured by any one (Blanchard and Simon, 2001, pp. 135–74). On the other hand with the increase in the level of protectionism, the deadweight loss would increase and the amount would be the pink area as well as the red areas in the figure. Therefore the introduction of increased protectionism would result in net welfare loss for the countries. The policies taken by the EU would also have several other problems because trade is generally considered to be an economic activity in which both the parties gain. But the EU looked at liberalised trade as a possibility of loss for the member nations. Since the countries of the EU constitute about one third of the word trade, introduction of protective measures would hamper the economic conditions of the related nations (Eaton, Kortum, Neiman and Romalis, 2013, pp. 20-24). The consumer sovereignty gets hampered by the protectionist trade policies. This is because when the consumers would not have the access to the foreign products that they intend to buy (Singh, 2010, pp. 1517-1564). There might be domestic industries in the countries which would be need the intermediate products for the production of the final products in the Euro nations. For example in a particular country producing any consumer durable the intermediate product may be supplied by China or Vietnam. If Protectionism is introduced the country would have purchase the raw materials at a much higher rate and this would lead to an increase in the domestically produced goods (Rauch, J., 1999, pp. 7-14). The changes in the climatic conditions and the issues of global warming have become one of the major concerns of the nations at the present day. The Emissions Trading System has been a prudent step of the nations in the control of the emissions of the greenhouse gases. However, the policies that the EU has taken do not address the ways to mitigate such problems. The less developed countries have also not been considered in this case. The countries have faced various confrontations with the other nations of the world concerning the Kyoto Protocol. There are also uncertainties regarding the setting up of the Green Climate Fund. Conclusion The trade and development policies of the EU should aim at putting trade at a broader framework and opening up of the markets in future. Therefore protectionism would hamper the interests of the general people. The international laws encourage the introduction of free trade but some of the countries engage in the policy of protectionism. These decisions are often driven by the political agenda of the nation or the group of nations. Thus the international laws should be formulated in such a way that trade relationship is established and the world moves another step forward towards globalisation. References Eaton J, Kortum, S., Neiman, B. and Romalis, J., 2013. Trade and the Global Recession. [pdf] Available at http://faculty.chicagobooth.edu/brent.neiman/research/EKNR.pdf [Accessed on 19 November 2013] Singh, T., 2010. Does International Trade Cause Economic Growth? A Survey. The World Economy, Vol. 33(11), pp. 1517-1564. Yi, K., 2003. Can Vertical Specialization Explain the Growth of World Trade?. Journal of Political Economy, Vol. 111 (1), pp. 52-102. Erceg, C. J., Guerrieri, L. and Gust, C., 2008. Trade adjustment and the composition of trade. Journal of Economic Dynamics and Control, Vol.32 (8), pp. 2622-2650. World Trade Organisation, 2013. International Trade Statistics 2009. [Online] Available at http://www.wto.org/english/res_e/statis_e/its2009_e/its09_toc_e.htm [Accessed on 19 November 2013] Bown, C. and Crowley, M., 2013. Import protection, business cycles, and exchange rates: Evidence from the Great Recession. Journal of International Economics, Vol. 90, No 1, pp. 50-64. Braun, M. and Larrain, B., 2005. Finance and the Business Cycle: International, Inter-Industry Evidence. Journal of Finance, Vol. 60, No. 3, pp. 1097–1128. Obstfeld, M. and Rogoff, K., 1996. Foundations of International Macroeconomics. Cambridge, MA: MIT Press. Ahn, J., Amiti, M. and Weinstein, D. , 2011. Trade Finance and the Great Trade Collapse. American Economic Review: Papers and Proceedings, Vol. 101(3), pp. 298-302. Baldwin, R., 2009. The Great Trade Collapse: Causes, Consequences and Prospects. 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