Econ 102 --- The World Economy

Topic 2: Institutions
Simon Fraser University
Summer 2015
Instructor: Yang Wang

Outline:

Definition of intl institutions

The three main institutions
RTAs
The role of Intl institutions
Criticism of intl institutions

The World Economy

International Institutions:
Definition of institution: Rules and organizations that govern
and constrain behavior

Formal institutions: Written sets of rules that explicitly

state what is and is not allowed (embodied in a club, an
association, or a legal system)
Informal institutions: Customs or traditions that define
appropriate behavior, but without legal enforcement (e.g.
the rules of socializing, gift exchange, table manners, email etiquette)

The World Economy

TABLE 2.1 A Taxonomy of International Economic

Institutions, with Examples

The World Economy

The Three Main Institutions:

IMF (International Monetary Fund): Financial
Assistance
World Bank: Development Assistance
WTO (World Trade Organization): Trade Policy
Regulation and Negotiation

The World Economy

IMF:
IMF is the central monetary institution in todays international economy
Founded by 29 countries at the Bretton Woods conference in July 1944 and
began operation in 1945
Currently (in 2012), 188 members
Original purpose: to strengthen intl cooperation
Originally enforced pegged exchange rate to prevent beggar-thy-neighbor
exchange rate policies

Main function: provides financial assistance (loans) to its members.

Major currencies switched to floating in 1970s
Funding for the IMF comes from its membership fee, or quota
the size of quota depends on:
size of the economy
Importance of its currency in world trade

Important decision are made by vote, the weight of vote is proportional to

quota, so high-income countries have higher voting power
The World Economy

IMF (contd)
The most visible role for the IMF is to intercede, by invitation, whenever a
nation experiences a crisis in its international payments.
if a country imports more than it exports, then it may run out of
foreign exchange reserves.
Foreign exchange reserves are dollars, yen, pounds, euros, or another
currency (or gold) that is accepted internationally.
IMF has its own currency, called an SDR, or special drawing right. SDRs
are based on a countrys quota and are a part of its international
reserves.
In the event of a financial crisis,

Members borrow against IMF quotas

Subject to IMF conditionality: Requirement for the borrowing
member to carry out economic reforms in exchange for a loan, e.g. a
cut in currency value, limits on the central banks creation of credits.

The World Economy

World Bank:
Original purpose

To provide financing mechanisms to rebuild Europe after World War II

Main function today

Assisting development in non-industrial economies

Has same membership and similar structure to IMF

Members voting rights are proportional to number of shares
owned

The World Economy

The GATT, the Uruguay Round, and the WTO:

Began with 23 nations in 1946 when the International Trade Organization (ITO)
was established
The General Agreement on Trade and Tariffs (GATT) followed in 1950
The GATT functioned through trade rounds: countries periodically negotiate a set
of incremental tariff reductions
During the Kennedy Round in the mid-1960s, and the Tokyo Round in the 1970s,
other issues included:
- Problems with dumping
- Subsidies to industry
- Nontariff barriers to trade

The Uruguay Round established the WTO (1995)

The Doha Round/Doha Development Agenda (2001-2006)
Focused on trade issues of importance to developing countries

The General Agreement on Trade and Tariffs (GATT) followed the following
principles:

National treatment: Imports must be given similar treatment on the domestic market as
domestically produced goods
Nondiscrimination: Enshrined in the concept of most favored nation (MFN); a
prohibition against discrimination
The World Economy

Regional Trade Agreements (RTA):

RTA is another important institution in the world economy.
between two (bilateral) or Several countries (plurilateral)
Called multilateral agreement because it includes, potentially, all the
countries of the world.
The WTO is not an RTA because it is worldwide in scope

Five types of RTAs

The World Economy

10

Regional Trade Agreements (RTA):

Five types of RTAs:
1.

Partial trade agreement: Two or more countries agree to drop trade barriers in a selected
group of product categories such as steel or autos (the least comprehensive RTA)

The U.S.-Canada Auto Pact

2.

Free-trade area (FTA): Nations trade goods and services across international boundaries
without paying a tariff and without the limitations imposed by quotas.

NAFTA (North America free trade area),

EFA (European free trade area)

3.

Customs union (CU): An FTA plus a common external tariff (CET)

4.

European Union in the 1970s and 1980s

MERCOSUR in South America

Common market: A CU plus an agreement to allow the free mobility of inputs, such as
labor and capital.
The European Union in the 1990s

5.

Economic Union: A common market with coordination of macroeconomic policies

(including common currency, harmonization of standards and regulations)

The states of the United States

The provinces of Canada
The 12 European Union members participating in the Euro currency zone
The World Economy

11

Other Institutions:
G-7, G-8, G-20: Groups of countries

G-7 = US, Canada, Japan, Britain, France, Germany, Italy

G-8 = G-7 + Russia (1998-2014)

Finance ministers meet regularly

Heads of state meet annually
Heads of state met annually

G-20 = G-8 + Australia & EU, + 10 major EMEs (Emerging Market

Economies)=19 countries + EU

meet regularly, but only the finance ministers

UN (United Nations)
Founded in 1945, currently 193 members
Promote international cooperation

OECD (Organization for Economic Cooperation and Development)

Club of mostly high-income countries

Does research, collects data, drafts policies
Does not have any direct power

The World Economy

12

RTA and the WTO:

When a WTO member signs an RTA, it is obligated to
notify the WTO.
Since 1948, over 500 agreements have been listed with
the WTO; with majority of the notifications since 1990
338 of these agreements are still active (2012)
The WTO and GATT allow RTAs, assuming they create
more new trade than they destroy
trade creation > trade diversion

The World Economy

13

For and Against RTAs:

The central economic question:

Are RTAs supportive of gradual, long run increases in world trade (building
blocks),

or
Do they tend to become obstacles to further relaxation of trade barriers
(stumbling blocks)?

Proponents view RTAs as building blocks toward freer, more open world
trade.
1. Easier for a few countries to reach agreement than it is for all the countries in
the WTO.
2. The domestic effects of a reduction of trade barriers are less dramatic.
3. RTA member countries can experiment with new agreements.
4. RTAs can be used as a political and economic threat to encourage agreements
in the WTO.

Opponents criticism:
1. RTAs undermine progress toward multilateral (worldwide) agreements.
2. Pro-trade opponents do not believe that they encourage agreements through
the WTO
3. RTAs are often discriminatory against poor and less-developed countries
The World Economy

14

The Role of International Economic Institutions:

The primary difference between international institutions and national

governments is that the former have limited enforcement power

Two important functions of international economic institutions:

Maintaining order in international economic relations

Reducing uncertainty

Order and certainty are intangibles that are different from most goods and
services

Order and certainty are public goods.

Public goods are:

Nonexcludable: The normal price mechanism does not work as a way of regulating access to
them
Nonrival (or nondiminishable): They are not diminished or reduced by consumption
Private markets fail to supply public goods because of free riding: People have no incentive to
pay for a public good because they cannot be excluded from its consumption even if they
dont pay

Two important functions of international economic institutions reduce free riding.

The World Economy

15

Criticism of International Institutions:

Sovereignty and Transparency

Sovereignty refers to the rights of nations to be free from

unwanted foreign interference in their affairs.
International institutions can violate national sovereignty by
imposing unwanted domestic economic policies
Transparency concerns are based on questions about the
mechanism with which decisions are made within an
international institution

Ideology
the advise and technical assistance provided to developing
countries are often a reflection of the biases and wishes of
developed country wishes.

Implementation and adjustment costs

When agreements are reached that combine developed and
developing countries, there are often asymmetries in the ability
to absorb the costs associated with them that favor developed
nations.
The World Economy

16