Notes on International Economics: by Chao Nan Chia

International Economics
Part I. International Trade Theory and policy
◎ The origin and evolution of the international trade theory
• Adam Smith published one of the most influential ten books in history, the “An
Inquiry into the Nature and Causes of the Wealth of Nations（國富論）” in
1776, pointing out that a nation’s wealth is completely determined by it’s
productivity of labor; while the rise of labor productivities is
accomplished through division of labor and specialization. This claim
overturned the popular thinking of that time, the Mercantilism (重商主義)
doctrine in which only gold hoardings represent wealth. In addition to
improving a nation’s welfare through the increase in production, international
trade, by allowing a nations to produce more than what are needed by their
people, contributed also in encouraging scientific researches and
technological advancements which in turn have deeply influenced the
development of civilization of human being.
• The pattern of labor division and specialization is determined by
individual’s absolute advantages(絕對優勢) in production.
• During the time when labor is the main factor of production, the values of
goods were completely determined by the hours required to produce one unit
of the goods. Labor force is thus the major source the wealth of nations.
• Dividing the labor force and specializing in the process of production raise the
productivity of labor and generates wealth as well.
• To extend the principle of labor division to across the border and to
form international specialization would improve furthermore the
welfare of the nations involved through international trade of the goods
produced. This the Classical economics doctrine.
• Industrial Revolution has brought in a new factor of production, the
capital, and the emergence of a new social and economic class called the
capitalist. How to distribute the outcomes of production between the
labor class and the capitalists became the major concern of economic
studies. This the main interest of the neo-classical economics doctrine.
• An appropriate allocation of labor and capital in various industries result in
more efficiency in production. Any changes in the economy would result in
redistribution of income.
• Under the assumption of factors immobility, differences in the endowments of
capital and labor affect the productivities of factors of production and become
an important element in determining the pattern of specialization and trade.

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國際經濟學講義：賈昭南編

• After getting richer and richer people are no longer satisfied with the
homogeneity of the products consumed, they began to pursue heterogeneity
in their demand since the 1950s. The adaptation of these changes in
demand patterns, the imperfectly competitive markets structure has been
evolved.
• Under imperfect competition, surplus capacity of production leads to waste
and inefficiency. However, the truth that the variety of goods produced which
has increased people’s utility or satisfaction should not be ignored.
• International trade by expanding market size allows firms to realize economy
of scale. The pursuing for economy of scale becomes an important factor for
international trade.
• The globalization movements initiated in the 1980s and stimulated by the
information and communication revolution in the 1990s have expanded the
scope of international trade from trading for purely physical goods to
intangible goods or services, covering the entire spectrum of products. This
is especially true for the service sector in general and for the financial
services in particular. The accompanying labor movements associated with
these new developments in providing services represent the ultimate
exploitation of the principle of specialization. Labors in the developed world
suffered from prolonged unemployment and frequent financial turmoil during
the transition period. However, the globalization movements are one way
drive meaning that there is no way to go back. What people can do is to
adapt it as soon as possible.

◎ Three elements for trade theory in market economy• Natural

law requires that a complete and effective trade theory should consist of the
following three elements:
1. to point out the different source of prices difference among nations.
2. to point out a specific pattern for specialization and trade based on 1.
3. to prove that the particular patterns of specialization and trade based on 2
can improve welfares of both trading countries.

◎ International trade policy

• Trade policy is the means or the measures that allows a nation to control over
and to regulate the international trade activities.
• From the historical point of view, a nation is a gathering of people with similar
life style, language and culture etc. aiming at protecting their achievements
from invasions of the outsiders. In order to achieve this goal a nation relies
on military forces and diplomatic efforts to fight or to negotiate to keep the

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Notes on International Economics: by Chao Nan Chia

people safer.
• The First World War of 1914 initiated the rise of nationalism and the
establishment of national countries. Separation and conflicts associated with
it between countries were deepened.
• The initiation of economic policy in general and the trade policies in
particular arises because of distrusting the operations of free market
activities are beneficial to the people and the nation involved. It
represents an attempt to turn the adverse situation around through some
artificially created measures.
• Economic policy depends on the use of taxations, subsidies and the direct
control over the quantities of transactions to fulfill the goal of the policy. Trade
policy tools can affect the trade flows indirectly through the institutes of tariffs,
subsidies and directly through quotas.
• The Great Depression of the 1930s, originated in the collapsing of the U.S.
stock market, leaded to the rise of protectionism which in turn had spilled
over throughout the rest of the world. Many people believed that the
protectionist policy was one of the major reasons that caused the break out
of the Second World War.
• Wars are always ignited by political affairs, however it the economic problems
or difficulties are the main reasons behind it. After WWII, leaded by the U.S.
government, economic cooperation movements were initiated aiming at
establishing an interdependent environment in the world economy to avoid
war from happening again.
• International economic cooperation programs were proposed and promoted
through the multilateral channel of regional agreements focusing on
eliminating trade barriers. Tariff reductions were the main topic for
negotiations.
• While tariffs are deducted gradually, the need for protection remains
unchanged and various form of non-tariff barriers emerged and became the
new areas of negotiation.
• Scientific developments not only shrank the world, it also created new trade
pattern. The rebirth of globalization movement in the 1990s has brought in
new problems and becomes the new focus of trade policy.

Part II. International finance and open economic

macroeconomics
◎ Foreign exchange market

• Money functioning as medium of exchange is used in every exchange

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國際經濟學講義：賈昭南編

activities. International trade involves with exchanging money for goods and
services and the exchange of different sovereign moneys.

• Foreign exchange market in every country provides the facilities for foreign
exchange transactions. The price of foreign exchange is called the exchange
rate.

◎ Determination of exchange rates

• During the gold standard era, exchange rates are fixed in terms of the gold
contents of the currency concerned. This is called a fixed exchange rate
regime. The gold standard regime (金本位制度)was terminated during and
immediately after the World War I, and failed to restore during the early
1930s.

• During the period between 1945~1973, under the monetary cooperation

program the Bretton Woods system which imitated the gold exchange system
was launched and was also denoted as the adjustable-pegged exchange
rate regime(可調整的釘住制度). The Bretton Woods system requires that
monetary authorities set the currency parity of their currencies against the
U.S. dollar and obliges to fix it through intervention, in the mean time the U.S.
government promises to fix the price of gold in terms of the U.S. dollar.
Therefore holding U.S. dollar is equivalent to hold gold essentially a
gold-exchange standard regime.

• Financial liberalization as well as several reasons that failed the promise

made by the U.S. government, has pushed the international monetary system
to abandon the Bretton Woods system. It was initially replaced by the freely
flexible exchange rate system (自由浮動匯率制度) within which the
exchange rates are determined completely by the market demand and
supply.

• The high frequency and large fluctuations of the exchange rates under the
freely flexible exchange rate system forced monetary authorities to intervene
heavily in the foreign exchange market. Without having any doctrine to
restrict their behaviors, the monetary authorities’ interventions are conducted
in a nonsystematic way, i.e. no regularity can be seen, hence, it is called a
system of no system or the managed floating system (管理式的浮動制動).

◎ The balance of payments account

• The balance of payments account (BOP) provides records of all transactions

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Notes on International Economics: by Chao Nan Chia

between a country’s residents and foreign residents using the double entry
principle.

• This is a standard form prepared by the International Monetary Fund, the

institution created to promote the Bretton Woods System, for the member
countries to compile for the international comparison purpose.

•Transactions are divided into four categories: the current account, capital
account, financial account and the change in the country’s foreign reserves
holding.

• What is the meaning of balance in BOP? How are the balances associated
with the various categories interpreted? What is a balance of payment
crisis?

◎ Open economy macroeconomics

• Money is essentially a macroeconomic phenomenon. The economic

behaviors in an open economy differ in many respects from that of a closed
economy because of the addition of foreign exchanges and the balance of
payments into the economy.

• What implications can be obtained with these addendum? More specifically,

what are the effects of government policies under different exchange rate
system?

◎ An overview of current world trade situation

• Factors affecting international trade can be formalized by examining the
actual trade data, In 2008 the 15 largest trade partners of the U.S. ranked in
descending order of amounts are Canada, China, Mexico, Japan, Germany,
United Kingdom, South Korea, France, Saudi Arabia, Venezuela, Brazil,
Taiwan, Netherlands, Italy, and Belgium (see Fig. 1 below)
• First of all, more than half of the trade partners are those with income level
close to that of the U.S. (see Fig. 2 and Fig. 3 below)
• Secondly, two of the largest three trade partners, Canada and Mexico are the
southern and the northern neighbors of the U.S. territory respectively.
• The share of the trade of the 15 countries counted for 69% of the total foreign
trade of the U.S..
• The size of the economy and the distance between U.S. and the partners
have played an essential role in determine the trade with which an empirical
trade model can thus be built.

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國際經濟學講義：賈昭南編

2006

2008

2012

Fig 1: The 15 largest trading partners of the U.S. in 2006, 2008 and 2012

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Notes on International Economics: by Chao Nan Chia

Fig. 2: Country’s economic size vs. trade with the U.S.

Fig. 3: Economic sizes of the European countries vs trade with the U.S.

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國際經濟學講義：賈昭南編

• The gravity model (重力模型) that follows the Newton’s Law of Universal
gravitation(萬有引力定律)（every point mass in the universe attracts every
other point mass with a force that is directly proportional to the product of
their masses and inversely proportional to the square of the distance
between them.(二物體間的引力與其質量成正比，與其距離的平方成反比）)
can be applied to interpret the cause of international trade by replacing the
economic size for the mass and applying the concept of distance directly,
where GDP level is used as a proxy for the economic size.

Tij  A  Yia  Y jb Dijc ,

Where T denotes the volumes of trade between country i and j; Y is the GDP
level and D denotes the distance between two trading countries. Estimates of
the effect of distance from the gravity model predict that a 1% increase in the
distance between countries is associated with a decrease in the volume of
trade of 0.7% to 1%.
• The gravity model has been widely used to identify anomalies in trade
as well as to analyze the effects of policy changes. The Netherlands,
Belgium and Ireland trade much more with the United States than predicted
by a gravity model.
- Ireland has strong cultural affinity due to common language and history of
migration.
- The Netherlands and Belgium have transport cost advantages due to their
location.
• Other things besides size matter for trade:
1. Distance between markets influences transportation costs and therefore
the cost of imports and exports.
2. Cultural affinity: close cultural ties, such as a common language, usually
lead to strong economic ties.
3. Geography: ocean harbors and a lack of mountain barriers make
transportation and trade easier.
4. Multinational corporations: corporations spread across different nations
import and export many goods between their divisions.
5. Borders: crossing borders involves formalities that take time, often
different currencies need to be exchanged, and perhaps monetary costs
like tariffs reduce trade.
• The gravity model can explain only a significant portion of international. It is
still not sufficient to ignore other factors. The study of international trade

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Notes on International Economics: by Chao Nan Chia

theory attempts to fulfill that goal. Furthermore, the world economy is

dynamic rather than static. In other words, trade pattern changes in a
historical perspective. The movements of capital and the associated rising of
multinational business play an important role in leading to the dynamics

◎ Change of Trade Pattern

• The transportation revolution occurred in the mid-20th century has increase
the speed of moving goods around the world and reduced dramatically the
cost of transportation, The importance of the distance factor declined
gradually thereafter..
• Communication revolution in the late 20th century, especially the
popularization of the World Wide Web system has brought about the wide
spread of trade in services.

2005 2008

2011

Fig. 4: Components of World trade in 2005, 2008 and 2011

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國際經濟學講義：賈昭南編

Fig. 5: Evolution of trade pattern of developing countries during the past 4

decades

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Notes on International Economics: by Chao Nan Chia

◎ Import and Export of Taiwan, R.O.C.

Export, Import and Trade Balance of Taiwan,

R.O.C.
350 45
export

Trade Balance in b. US$

40
Exporf and Import in b.

300
import 35
250 30
trade balance
200 25
US$

20
150 15
100 10
5
50
0
0 -5
1971
1974

1977
1980
1983

1986
1989

1992
1995
1998
2001
2004
2007
2010
2013
• Major exporting nations and regions of Taiwan’s products

Percentage of Export with different Areas:

selected years
Oceanic
2014
S. America
2010
Cntl. America 2000
N. America

Africa

Europe

Mid-East

Asia

0 10 20 30 40 50 60 70 80
%

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國際經濟學講義：賈昭南編

Ten Largest Exporting Nations of Taiwan, R.O.C. in 2000:

In Percentage of Total Exports
U.S.A

1.75
Hong Kong
2.63 2.43
2.89 Japan
3.02 U.S.A, 23.42
3.25 Sinpapore
3.71
Germany
U.K.
China
Japan, 11.11
S. Korea
Hong Kong, 21.55
Malaysia
Thailand

Ten Largest Exporting Nations of Taiwan, R.O.C. in 2014:

In Percentage of Total Exports
2.75 1.96 1.94 China
3.18
4.04 China, 26.18 Hong Kong
6.35 U.S.A
Sinpapore
Japan
6.55 S. Korea

U.S.A, 11.11 Hong Kong, 13.56 Vietnam

Malaysia
Germany
Thailand

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Notes on International Economics: by Chao Nan Chia

• Major importing nations and regions of Taiwan

Percentage of Import from different Areas:

Selected years
Oceanic
2014
S. America
2010
CntlAmerica 2000
N. America

Africa

Europe

Mid-East

Asia

0 10 20 30 40 50 60
%

Ten Largest Importing Nations of Taiwan, R.O.C. in 2000

In Percentage of Total Import
China
Japan
2.15 1.98
3.58 2.49 U.S.A
3.80 China, 27.44
3.96 S. Korea
Saudi Arab
S. Korea, 4.43 Germany
U.S.A, 6.41 Malaysia
Japan, 17.96 Singapore
Indonisia
Australia

Ten Largest Importing Nations of Taiwan, R.O.C in 2014:

In Percentage of Total Imports
China
Japan
U.S.A
2.67
3.06 2.70 China, 17.53 S. Korea
3.21
3.43 Saudi Arab
Germany
4.99
Malaysia
S. Korea, 5.40
Japan, 15.22 Singapore
U.S.A, 10.01
Indonisia
Australia

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國際經濟學講義：賈昭南編

• Evolution of Taiwan’s trade with Europe

Taiwan's Trade with Europe

35
export
30
import
25
balaqnce
20
US$ b.

15

10

0
1981

1983

1985
1987

1989

1991
1993

1995
1997

1999

2001
2003

2005

2007

2009
2011

2013
-5

Evolution of Taiwan’s trade with the U.S.

Taiwan's Trade with the U.S.

40
export
35
import
30
balaqnce
25
US$ b.

20
15
10
5
0
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013

• Evolution of Taiwan’s trade with Japan

Taiwan's Trade with Japan

60 0

-5
50
Trade balances in US$b.
Export, Imposr inUS$b.

export -10
40
import -15

30 balaqnce -20
-25
20
-30
10
-35

0 -40
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
11
13
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
20

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Notes on International Economics: by Chao Nan Chia

• Evolution of Taiwan’s trade with Mainland China

Taiwan's Trade with China

90
80 export
70 import
60 balaqnce
50
US$b.

40
30
20
10
0
1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014
-10

• Evolution of trade openness of Taiwan’s Economy

Openness of Goods Traded in Taiwan

1.30
1.21
1.20
1.10

1.00
0.90

0.80

0.70
0.68
0.60
1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

Openness of Services Traded in Taiwan

0.20

0.18

0.16

0.14

0.12

0.10
1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

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國際經濟學講義：賈昭南編

Openness of Goods and Services Traded in Taiwan

2 1.95

1.8

1.6

1.4

1.2
1.16
1
1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

2014

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Notes on International Economics: by Chao Nan Chia

Appendix: Economic openness of selected countries

Country Real Export Country Real Export

plus Imports plus Imports
as a Percent as a Percent
of GDP of GDP
Denmark 94.5 Turkey 71.2
Switzerland 90.7 Chile 71.1
Sweden 88.9 Poland 69.5
Canada 81.8 Mexico 66.8
Indonesia 81.7 Spain 65.1
Portugal 79.9 U.K. 59.9
Nicaragua 79.3 France 57.5
Iceland 78.9 Italy 54.5
Israel 78.3 China 54.4
Finland 77.9 South Africa 54.4
Ecuador 76.9 Greece 54.3
Germany 76.6 Australia 48.9
Norway 76.4 U.S. 26.6

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國際經濟學講義：賈昭南編

Major trade countries in 2012 US$billions

total value export import

rank
country amount country amount country amount
World 36,890 World 18,325 World 18,565
1 U.S.A. 3,882 China 2,049 U.S.A. 2,335
2 China 3,867 U.S.A. 1,547 China 1,818
3 German 2,574 German 1,407 German 1,167
4 Japan 1,685 Japan 799 Japan 886
5 Netherlands 1,247 Netherlands 656 U.K. 680
6 France 1,243 France 569 France 674
7 U.K. 1,148 S. Korea 548 Netherlands 591
8 S. Korea 1,068 Russia 529 Hong Kong 554
9 Hong Kong 1,047 Italy 500 S. Korea 520
10 Italy 986 Hong Kong 493 India 489
11 Canada 930 U.K. 468 Italy 486
12 Belgium 881 Canada 455 Canada 475
13 Russia 864 Belgium 446 Belgium 435
14 Singapore 788 Singapore 408 Mexico 380
15 India 782 Saudi Arabia 386 Singapore 380
16 Mexico 751 Mexico 371 Russia 335
17 Spain 624 Taiwan, ROC 301 Spain 332
18 Taiwan, ROC 572 U.A.E. 300 Taiwan, ROC 270
19 Saudi Arabia 530 India 293 Australia 261
20 U.A.E. 520 Spain 292 Thailand 248
21 Australia 518 Australia 257 Turkey 237
22 Thailand 478 Brazil 243 Brazil 233
23 Brazil 476 Thailand 230 U.A.E. 220
24 Malaysia 424 Malaysia 227 Swiss 198
25 Swiss 424 Swiss 226 Malaysia 197
26 Turkey 389 Indonesia 188 Poland 196
27 Poland 379 Poland 183 Indonesia 190
28 Indonesia 378 Sweden 172 Austria 178
29 Austria 344 Austria 166 Sweden 162
30 Sweden 334 Sweden 160 Saudi Arabia 144
Others 6,757 Others 3,456 Others 3,294
Source: WTO.

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