Economics of Made in Italy, Appunti di Economia

Scarica Economics of Made in Italy e più Appunti in PDF di Economia solo su Docsity! 20/02/24 – Lecture 1 Globalization. When does globalization start? “a socio-economic system starts to take hold, which is increasingly based on the interaction of commercial and financial activities. An unprecedented growth of international exchanges takes place. Links with India and China become more secure. Trade is greatly facilitated.” (Intervento di Ignazio Visco Governatore della Banca d’Italia. Festival Dante 2021. Ravenna, 11 settembre 2021) Technical innovation driving globalization and disinflation: the steam engine (19th century). This is the time in which steam engine is created and get into place. Steam engine means that you can make more efficient the transportation system: locomotives, trains, steam ships. This allowed transportation costs to significantly decrease -> incentive international trade (you can go further at lower costs). This is the scale of the word trade in goods as a percentage of GDP when the spread of steam engine took place. Also inflation came down due to these technological innovations and because of trade (trade increase reduced prices, pushing down the level of inflation), STEAM ENGINE EFFECT. Another technological innovation that helped the facility of trade was the invention of the container shipping. The container was invented in 1960, very efficient way of transporting goods, developing a reduction of transportation costs (you can buy goods across the world at the lower price). Trade was able to pick up even further. So, globalization is a long-lasting process driven by significant technological innovation and by the reduction in trade barriers. The international openness to trade continues to be criticized by many economists. One book very popular is “Il Capitale nel XXI secolo” by Thomas Piketty: an extraordinary reconstruction of how the distribution of wealth capital and labor (production factors) has developed during globalization. 1 Many other kinds of criticisms to globalization: inequalities and social costs associated with globalization (there are many arguments with respect to globalization and its negative effects). The era of globalization was characterized by some unprecedented economic and social benefits:  Economic development and poverty reduction  Increase of life expectancy  Reduction in child mortality Prof. Maddison “hockey stick” graph of economic development: On this graph you see GDP per capita -> how much income is produced every each by each individual living at that time in that country. Economics grows dramatically at an exponential rate in almost all countries. In the last 200 years population increased a lot and despite of this GDP per capital has increased even more. Another important data is that economic growth was achieved while average working hours per workers declined (capital and labor are two important factors). Annual working hours per worker: 2 Goods in “credits” are made in Italy and sold abroad (total amount of exports), they are matched with a more or less amount of goods in “Debit” purchased in Italy. Imports are also many important because many products we export cannot be produced without element purchased abroad. Size of services < size of goods. Below the line we have the financial transactions (Financial account + Errors and Omissions). Financial account = the difference between acquisitions of assets from foreigners and build up of liabilities to them. Its main items are:  Direct investment (enabling control of the enterprise) -> the operation by which an Italian enterprise take control of an enterprise abroad. Many excellent Italian firms that started producing in Italy decided to go abroad and produce the same product with the same brand in a foreign country.  Portfolio investment (no control of the enterprise) -> it is a very large gross amount. a) Debt b) Equity  Changes in Official reserves -> the amount of reserves that Italy owns for safety reasons 5 Under financial account, we have “In Italy”, which are foreigners that buy Italian firms (Ex. Bulgari was acquired by the LVMH group as a direct investment still producing Italian made in Italy). Services -> refer to economic output of intangible commodities that may be produced, transferred, and consumed at the same time. Insurance policy is consumed when the contract is signed, you cannot slip production and consumption. A typical service activity is tourism (and also finance, transportation and insurance). Goods and services are connected, and it is important to have services that support the goods production. Main Service items in the Bop. Other business services include research and development (R&D), professional and management consultancy, technical and trade-related services, architectural, engineering and services, real estate. 6 Example: recording an important transaction in the Balance of Payment accounts. An Italian company Olivetti sells a machine in the U.S., so in the US bop you will register a debit (import) while in Italy it would be a credit in the Trade balance. Below the line: you will register a credit for the US (asset sale) and a debit for Italy. Another example: Official Reserves: definitions and functions. Every time we are selling something abroad, we are registering an inflow of dollars. Official reserves are important because they stabilize the exchange rates and the inflation (a harmful disease for export products). OFFICIAL RESERVES: a Central bank holding of • gold reserves, 7 NET EXPORT = EXPORT - IMPORT = CURRENT ACCOUNT (CA) Relationship between Current account and Savings -> the current account of a country is equal to the savings account of the country. A country with a current account surplus is exporting present savings, it is accumulating wealth abroad (it is spending less than it is earning, increasing welfare). A country with a current account deficit is importing present consumption, it is decumulating wealth abroad (increasing debt) US has been consuming more than what it has been earning, so it accumulated a very large debt with the rest of the world. It has been purchasing a lot from the rest of the world. US current account has been for a very long time in deficit. The US Current account and the Net foreign wealth (also Net International Investment Position NIIP): Countries that have accumulated wealth abroad (doing the opposite of US), running a positive current account: 10 Italy’s current account balance has been positive recently. The driving component is the Trade balance (goods). If we didn’t have made in Italy product the black line would have gone even below. Made in Italy helped to recover from the shocking increase in gas prices. 27/02/24 – lecture 3 TRADE THEORIES Evolution of Trade Theories (try to explain why international trade takes place):  Mercantilism  Absolute advantage (Classical)  Comparative advantage  Factor Proportions  International Product Cycle  National competitive advantage  New Trade Theory MERCANTILISM Mercantilism -> trade theory (policy) holding that nations should accumulate financial wealth, usually in the form of gold (forget things like living standards or human development) by encouraging exports and discouraging imports (protectionism). Very used until 18th centuries by Governments. If you increase exports and reduce imports you are improving the balance of trade (trade balance), so in the policies of this countries there was the idea of maximization of the trade balance.  A nation’s wealth depends on accumulated treasure - Gold and silver are the currency of trade  Theory says you should have a trade surplus 11 - Maximize export through subsidies - Minimize imports through tariffs and quotas (to prevent local consumers to buy from abroad)  Flaws: - Restrictions impaired growth - Incoherence: not all nations can have a trade surplus - Trade wars can ensue, as they actually did. Mercantilism theory would damage economies in the long run by giving rise to trade wars, an example: In the 30s the collapse of int.l trade brings about the collapse of per capita GDP. The two axis are an important piece of the US legislation to reduce imports (increasing taxes on imports). This is to say that mercantilism is still alive and kicking but the trade war it causes is dangerous. THEORY OF ABSOLUTE ADVANTAGE (Adam Smith) Adam Smith (an English philosopher) in the Wealth of Nations (1776) argued: the origin of wealth is in the capability of one country to produce more of a product than another country, with the same amount of input. “Why Nations are rich or poor? Because some of them are able to trade”. Adam smith is telling country: A country should produce only goods where it is most efficient and import those goods where it is not efficient. Trade between countries is, therefore, beneficial. Theory of absolute advantage destroys the mercantilist idea since there are gains to be made by both countries party to an exchange, questions the objective of national governments to acquire wealth through restrictive trade policies, measures a nation’s wealth by the living standards of its people. 12 Main conclusions of Ricardo’s theory of comparative advantages: • Trade allows countries to make better use of resources (optimization) • Trade is a positive-sum game (everyone gains from trade). It I not the mercantilism idea. Trade expands Consumption Possibilities (KUM, p.78): By opening up to trade I am able to consume more because the production possibility frontier moves forward (I can import what I cannot produce at home). 15 Empirical evidence of Ricardo’s theory by economist Bela Balassa,1963 (KUM p.78): Comparing US and British export-productivity relationship, across 25 productive sectors (each dot is a productive sector). The higher the US productivity compared to Britain’s, the higher US export compared to Britain’s. For each of these industries one country is more productive than the other and in the most cases US is better. How does the «Made in Italy» industry fits in Ricardo’s comparative advantage theory. Are excellent «Made in Italy» products the output of highly specialized enterprises (that focus on the production of one or two specialized goods)? Is their production facilitated by the possibility to sell them abroad (export)? YES. ASSUMPTIONS AND LIMITATIONS Every theory is a sort of simplified world.  Disregards transportation costs. (we can specialize and trade, but if the transportation costs are so high, no matter how specialized I am, I may be unable to trade).  Labor is the only major factor of production.  Labor is absolutely mobile between sectors within the domestic boundary; however immobile across countries. (you can move workers from one industry to another, not realistic). FACTOR PROPORTIONS THEORY OF INTERNATIONAL TRADE Completely different approach (this theory concentrates on factor endowments): Developed by Heckscher (1919) - Olin (1933): Patterns of trade are determined by differences in factor endowments - not productivity. Endowment -> resources that are naturally available to a country. According to the Factor proportion theory, countries produce and export those goods that require resources (factors) that are abundant (and thus cheapest) and import those goods that require resources that are in short supply. Examples: 16 - Australia – lot of land  Export: Iron ore, Gold, Meat, Wheat (it is rich in minerals, animals and gold). - Oil rich countries  Export: oil and oil-derivatives. - What about Italy? How does Italian export fit in the Factor proportion theory? - Italy endowed with art and beautiful landscapes -  Export: tourist services (“Made in Italy”) explained by Heckscher -Olin theory. The Leontief Paradox Leontief was an economist and he tried to apply Heckscher Olin finding out that the US (the country with the largest capital endowment) was importing these goods (a sort of contradiction). The Findings: The U.S. exported labor-intensive products and imported capital- intensive products, although the US is endowed with plenty of capital (Factories, technology, patents). The Controversy: Findings were the opposite of what was generally believed to be true! Leontief's paradox undermined the validity of the H–O theory? (Trade patterns would be based on countries' factors of production: capital and labor). The US has an advantage in highly skilled labor more so than capital. Using this definition, the exports of the United States are very (human) capital-intensive, and not particularly intensive in (unskilled) labor. PRODUCT LIFE-CYCLE THEORY OF INTERNATIONAL TRADE Developed by R. Vernon 1966. Here enters a new approach, you have to understand trade as a process by which products are created, developed, used and die. So the product has a life cycle, it starts from an idea, it is developed, it grows. According to the phase we are in, it sets the movements in the international market. The theory suggests three stages of a products life that affect international trade: 1. early in a product's life cycle all the parts and labor associated with that product come from the area where it was invented. (Steve Jobs computer was assembled in a garage in Cupertino) 2. after the product becomes adopted and used in the world markets, production gradually moves away from the point of origin. (the size of the supply grows) 3. in some situations, the product becomes an item that is imported by its original country of invention. 17 (foreign direct investment). Sometime firms have to take into account that if they remain local, they will lose a competitive advantage. First-mover implication = it is basically innovation, which means you have to experiment a lot, also to create new ways of producing. Made in Italy products have been highly innovative, so successful. According to NCA (Porter approach) institutions count! If you have to consider investing abroad, look at the country’s institutional set up (safety, health, education, judicial system). THE NEW TRADE THEORY (NTT) Why countries that are trade partners are trading similar goods and services? NTT was developed in the 1970s as a way to better predict international trade patterns. Main contribution by Paul Krugman, Nobel price for economics in 2008. This is especially true in key economic sectors like electronics, food, and automotive. The idea of new trade theory was developed by Paul Krugman and other contributors. If you look at comparative advantage theory, similar countries exchange similar products (what is the comparative advantage?). Especially in sectors most advanced (like motors) we buy similar goods. The basic idea is that demand factors are more important than comparative advantage -> countries that share similar demand structures (taste, values, income level) will be more likely to trade. There is not one country dominating the industry with comparative advantage. The US and Germany are developed countries with a significant demand for cars, so both have large automotive industries. Rather than one country dominating the industry with a comparative advantage, both countries trade different brands of cars between them. The critical factors determining international pattern of trade are: 1) Economies of scale 2) Network effect 3) First-mover advantages Economies of scale, network effects and first-mover advantages can be so significant that they outweigh the more traditional theory of comparative advantage. Two countries may have no discernible differences in comparative advantages at a particular point in time. But, if one country specializes in a particular industry then it may gain economies of scale and other network benefits from its specialization. 20 These 3 factors can explain globalization, extensive trade among similar nations and why some countries are poor (less industrialized). Economies of scale -> increasing outputs leads to lower long-run average costs. In production there are some inevitable fixed costs despite the size of production. Increasing the size of production can spread these fixed costs on a larger volume of production (the average cost will decrease). Economies of scale occur when increasing output leads to lower long-run average costs. Economies of scale descend from the existence of fixed costs i.e. costs that are incurred irrespective of the size of the firm. Example: administration, marketing, Research & Development, production facilities. As firms increase in size, they can spread fixed costs on a larger amount of final goods: hence average costs will decrease. Economies of scale imply that with the increase in production a firm becomes more efficient. Implications of economies of scale: it comes from specialization (a firm is able to generate economies of scale if it specializes), specialization also generates “learning effects” (cost savings that come from learning by doing). Economies of scale are particularly important in industries with high fixed costs (large initial capital investments: power plants, infrastructures), airports are an example. 21 Network effects -> it occurs when goods or servicer become more valuable as more people use it. Internet is an example: initially, there were few users on the internet since it was of little value to anyone outside of the military and some research scientists. The more people were connected the more valuable was the network for everybody. Different examples of network effects. Platforms -> everybody uses a specific platform (Wapp/FB/e-bay) not because of any intrinsic value, but because everybody else is using it. Branding -> companies invest in branding to create network effects. Firms competing in the model of monopolistic competition invest in branding to increase the value of their product (looks good to look as others «good lookers») Know-how spillovers. IT in Silicon Valley started with Hewlett and Packard. Success attracted more IT firms to that area because of the local environment filled with human and financial resources being around other IT setups. Italy’s industrial districts model of production is characterized by spillover effects. First mover advantage -> A first mover advantage derives from being the first to bring a new product or service to the market. First movers typically establish strong brand recognition and customer loyalty. First-mover is often connected to network effects: since you are the first mover every consumer naturally moves to you. Amazon and Ebay are firms very good at what they are doing, and they do it before everyone (first mover). Amazon started by selling book, then extended the same type of operation to other goods (same type of activity for different scopes) = Economies of scope. THE MONOPOLISTIC COMPETITION MODEL. Why nations with similar resources and technology (comparative advantages) trade among themselves? Answer: in the search for economies of scale firms will merge to increase in size (economies of scale) and access new markets (international trade) in what is known as the Monopolistic competition model of behavior. There is a domestic economy (one country with no trade) producing handbags in Italy. PP is the relationship between costs and the number of firms (the larger the number of firms the lower the costs). 22 This idea of government supporting new industries is controversial. Many economists say that it is likely to create other problems such as:  The government is likely to have poor information about which industry to support and how to go about it, the Gov makes mistakes. (It is the entrepreneurs that have the ideas)  It creates a tendency for powerful vested business interests (crony capitalism) which rely on state support. This state support may encourage inefficiency in the long-term (resources go to less useful initiatives). A tale of the «infant industry» argument. • In the sixties almost 90 % of motor vehicles in Italy were FIAT. (manufactured in Turin) • Import duties on foreign cars amounted to 40%. • In the seventies, Italy with a population of 53 million, was allowed to import only 500 Japanese cars. • In the eighties, the number of Japanese cars allowed into Italy was increased to 2.000. • In the nineties, with the opening of the European market to Japanese imports, Fiat almost went bankrupt. Other negative aspects of the “new trade theory” policy approach. Economies of scale allow a company to grow so that it will exert monopolistic tendencies. Monopolistic markets, in principle, tend to keep prices higher than competitive market structures. Established and powerful monopolies hamper growth of smaller companies, hence innovation and technological improvements. An early entrant to the trade has all the way and can create entry barriers for new entrants. Poorer countries may not be able to compete with developed nations as they lack economies of scale. China industrial policy (large state-owned manufacturers and banks, tariff protections) example of an NTT policy. Important distinction. Inter-industry trade is a trade of products that belong to different industries. For instance, exporting agricultural products produced in one country and importing technological equipment produced in another country can be classified to be an inter- industry trade. Countries usually engage in inter-industry trade according to their comparative advantages. Intra-industry trade is a trade of products that belong to the same industry. As it has been noted, “intra-industry trade (IIT), that is trade of similar products, has been a key factor in trade growth in recent decades. It is driven by economies of scale and network effects (New Trade Theory). 25 The importance of Intra-industry trade in some sectors of the US economy. Gravity theory is an element of ‘New trade theory’ as it emphasis factors which influence trade – other than traditional ‘comparative advantages’. Gravity theory holds that trade is influenced by countries geographical proximity and similarities in terms of culture and economic development. Neighboring countries are more likely to trade with each other (made in Italy exports close to home). It is difficult to sell made in Italy to Chinese people. 05/03/24 – Lecture 5 Foreign Direct Investment (FDI) FDI -> is a purchase of controlling interest in a company by a company or an investor located outside its borders. Some examples: Starbucks opened more than 10000 stores outside US (small companies), Samsung build a chip plant in the US managed and controlled by Samsung Korea. Why firms manufacture abroad instead of manufacturing at home and exporting? Starbucks cannot export cup of coffee, in other cases is more complex. Different reasons: - Different rates of return = capital should flow from lower returns (developed economies) to higher returns (underdeveloped economies) according to neoclassical model. It is a very logical explanation but it is not the only one and the one that best fits the reality (Luca highlighted the paradox) There is not this huge amount of capital flow in poor countries SLIDE Strategic arguments: - Lower production costs (efficiency seeking) -> labor cost is lower than the origin country - Cut transaction costs (market seeking) -> to reduce trade barriers, transportation, administrative procedures, to be closer to the final customer. Trying to ease market access 26 - Control of raw materials/inputs otherwise not available at home (resource seeking) -> China is being very aggressive in resource seeking - Acquire license and patent, access new technologies, through mergers and acquisitions (knowledge seeking) -> a firm purchases existing firms that have developed this intangible capital. FDI and export are complementary = FDIs located across the world generates huge trade flows of raw material, intermediate goods, final goods (it is very likely the company will re-exports the goods). FDIs very often are components of a Global Value Chain of production. In the case of Italy, many Italian firms are at the same time exporters and investors abroad combining made in Italy with made with Italy. Very often, Italian firms have established FDI for resources seeking. Another important reason is that Italian companies want to serve to local markets. Also, we have FDIs coming into Italy (Inbound FDIs) in order to exploit the strategic behavior of Italian firms (example, Bulgari has been acquired by a French enterprise). Total sales by Bulgari from 2011 to 2021: After the acquisition, Bulgari’s revenues doubled (revenues for made in Italy). Enterprise specific arguments. Each FDI decision comes from an enterprise an the reasons are: the firm is looking for a tradeoff between concentration and proximity. Staying at home increases economies of scale, invest abroad reduces trade barriers. This decision can only be taken at enterprise level because the managers can asses if it is more expensive one possibility or another. Small firms tend to stay domestic, big firms the opposite. Productivity explains trade off between export and FDI. - Enterprises less productive (usually smaller) only serve domestic market - Enterprises more productive, but not enough, produce domestic and export - Only highly productive enterprises invest abroad (FDI) There are basically 3 types of FDI investments: - Greenfield FDI - Brownfield FDI - Project finance FDI (usually energy or highways) FDIs are inflows for the recipient country and outflows for the originating countries. Italian balance of payments: 27 Brownfield FDI top 10 industries: Flows of Italian outward FDI: 30 The sum of all of this flows creates a stock and Italy’s stock reached 700 million. Sectorial distribution of Italy’s FDI: Italy’s stock of outbound FDIs in % of GDP in lower than our partners: 31 Italy accounts for only 5% of all EU FDIs, while its share in EU GDP’s is about SLIDE Why are Italian firms less prone to go abroad and set up operations? Because of the productive structure of Italy characterized by small and medium sized enterprises. Fixed costs and risk of setting up productive units abroad make decide not to go. Determinants of Italian outbound FDIs: Gravitational model: small firms tend to operate abroad operation closer to the origin country (distance factor) and the GDP of the country of destination is important when you are looking for markets (countries with big GDP are better). Large enterprises account for most of Italy’s outbound FDIs: Banks are important for outbound FDIs -> enterprises with longer relationship with a bank have higher probability of FDIs; probability is even higher if the bank has a network of foreign branches (Italian banks are less developed, limited presence). PROs and CONs of FDIs: 32 Example of bilateral trade policy measures. It is bilateral because all the EU members do not negotiate individually with non-EU countries (EU represents all the 27 members that negotiate With India). Example of multilateral trade policy measure. Asian Pacific Trade Agreement. Trade Policy Instruments. Tariff Barriers (most utilized): 1. Taxes 2. Subsidies (opposite of a tax, the Gov returns money to producers) Affecting international transactions. Non-Tariff barriers: 1. Legal limits on values or quantities of trade flows (No more than … imported form …)  Import quotas  Voluntary export restraints (apparently it is cooperative, but it is aggressive) 2. Regulations : health, safety, labeling, rules of origin, etc. (most subtle) To sum up, the tariff barriers are the most utilized because they are simple to apply and very transparent. Much less transparent and much more subtle are regulations. Level of tariff rates in percentage applied by US in the last century: 35 The story of the last 40 years, tariff rates have been coming down at world level and the value of exports (in Italy) has been growing: How tariff and other protectionist measures harm trade. We start from this situation: supply curve upward sloping and a demand curve downward sloped. 36 Introducing a tariff (tax on imports): drives a wedge between domestic price and world price. Trade declines. Japan price will increase, and world price will decrease to compensate. Foreign price will decrease. ERROR The quantity also has been reduced, so this is the explanation why imposing a tariff generates a reduction in the volume of trade. The situation by which a country like Italy can reduce the price is not possible if it is a small country. Tariff in a small country (price taker) is even more distortionary: 37 Tariff Net welfare effects. Effect of an Export subsidy (the Gov pays firms with a compensation to sell at a lower price products abroad): 40 EU Common Agricultural policy distortionary affects (EU gives money to EU agricultural producers to increase the price above the world price): US agricultural policy distortions: 41 Consumers of sugar in the US are unhappy because the domestic price is higher than the world price. Summing up the distortionary effects of trade policies: Non-Tariff barriers (NTMs) -> are any measures, other than a customs tariff, that act as a barrier to international trade. Anything excluded tariffs. These include:  Regulations : any rule which dictates how a product can be manufactured, handled, or advertised.  Rules of origin : rules which require proof of which country goods were produced in (case of embargo)  Quotas : rules that limit the amount of a certain product that can be sold in a market NTMs are most harmful to international trade, because more pervasive and less transparent. UNCTAD (United Nation Commission for Trade and Development) classification of NTMs. 42 It fluctuates: every time the line goes up with one euro you can buy more dollars (appreciation of euro) and every time the line goes down you can buy less dollars with one euro (depreciation of euro). Point of view of US citizens: The dollar has strengthened dramatically over the course of the year 2022, as the Federal Reserve hiked interest rate. It is affected by decisions taken from subject you cannot control. Durin the year, the price of the dollar has gone up or down? Up, you buy less dollars with one euro. Dollar – Euro exchange rate fluctuations in 2022-> the dollar appreciated by 20% which is a lot: 45 Determinants of foreign exchange rates:  Exchange rates are determined in the foreign exchange market  Like any other prices they are affected by relative demand/supply of both currencies  Deman/supply of a currencies are driven by: 1. Trade flows 2. Financial flows (most significantly) 3. Central bank interventions (purchase/sale) Since financial flows are more significant than trade flows, the main stream school of economic thought considers the exchange rate as the value of an asset. An asset is an instrument for transferring purchasing power from the present to the future; it’s a form of wealth (stocks, Italian treasure bonds and so on). The price an asset commands today is strongly influenced by the purchasing power it can deliver in the future. Hence todays value of the exchange rate is strongly influenced by its value «expected» in the future. If you buy a house and the market price of houses go up, you will get more money when you liquidate the house. Instead, for ordinary goods it is the opposite: I buy a bottle of wine because I want to drink wine today and not in the future. Factors that influence exchange rates: 46 These factors influence the expected amount of liquidity I will get in the future. When something happens like the Russian war, people buy the safest currency in the world (Ukrainian people save their money abroad).  Interest rates = the link between interest rates and the exchange rates is established in the Interest rate parity Theory (IRP)  Rate of growth = if a country experiences a high rate of growth it is a dynamic economy, people may want to buy goods (invest in this country) because they expect higher returns  Relative inflation rate = high inflation usually may fall the exchange rate  Competitiveness = if we are able to produce better products at lower costs, we are able to sell more abroad  Confidence/speculation = if a country is politically unstable, confidence is going to decline and people will sell currencies of this country The determinants of the exchange rate according to the IRP Theory = since the exchange rate is the relative price of two assets (i.e. Dollars and euros), the euro/dollar rate is strongly affected by any actual and expected changes in: 1. The dollar interest rate (actual and expected) 2. The euro interest rate (actual and expected) 3. The actual $/€ exchange rate 4. The expected future $/€ exchange rate -> tends to zero (market arbitrage conditions) IRP Theory links the rate of returns of two currencies and their exchange rate, actual and expected, so as to make investors indifferent to holding two currencies (market equilibrium) Effect of exchange rate changes:  Depreciation (currency becomes cheaper) -> lower export prices, higher import prices. A fall in the exchange rate, by lowering export prices and raising import prices, is likely to increase demand for domestic products by: - Foreigners (exports) 47 The real effective exchange rate (REER) -> The REER is the weighted average of one country’s currency with respect to the currencies and price indexes of other major currencies. The weightings reflect the relative trade balances between countries. The REER is used to compare changes in international price competitiveness of an economy.   Exchange rate regime: Government’s policy with respect to the exchange rate of its currency -> it is the policy to limit these fluctuations. We have private individuals intervening but also Central Banks. Central banks intervene in the Forex – buying and selling currencies – in addition to private operators. The scope and size of Central banks interventions defines the Exchange rate regimes that the country has chosen. In practice the central banks can: - LET THE EXCHANGE RATE FLOAT FREELY (Floating rate regime) or - DEFEND AN ESTABLISHED PARITY (Fixed rate regime - pegging) or - COMBINATION OF THE ABOVE The dollar exchange rate indifferent regimes since WWII: 50 There is a significant change in 1971 when the protectionist policy failed, and the exchange rate become flexible. Before 1971, the industrial countries decided cooperatively that their exchange rates were not going to fluctuate, and all the currencies were convertible into gold. The system collapsed and the US in agreement with other countries will have the exchange rates to fluctuate. The lira had depreciated, and dollar appreciated (really good for exports). Germans were good, being able to appreciate the Deutscher mark to appreciate. Italian exports are manufactured in Italy and require energy costs, energy cost went up (exports benefit, input costs go up and inflation goes up). Italy was able to increase the price, always a positive current account. FIXED EXCHANGE RATE REGIME Fixed exchange rate regime -> A fixed or pegged exchange rate is a rate the government (Central bank) sets and maintains as the official exchange rate. A set price will be determined against a major world currency (usually the U.S. dollar, but also other major currencies such as the euro, the yen, or a basket of currencies). In order to maintain the local exchange rate, the central bank buys and sells its own currency on the foreign exchange market in return for the currency to which it is pegged. The Eurozone is the «extreme form» of a fixed exchange rate regime, member countries having adopted a single currency. Fixed exchange rate regimes in reality. In reality, no currency is wholly fixed. In a fixed regime, market pressures can influence changes in the exchange rate, by forcing the country do devaluate the “official exchange rate”. Sometimes, when a local currency does not reflect its true value against the “official exchange rate”, an underground foreign exchange market may develop (so called Black currency market). 51 FLOATING EXCHANGE RATE REGIME Floating exchange rate regime -> In a floating regime the exchange rate is determined by the private market through supply and demand. A floating rate is often termed "self-correcting," as any differences in supply and demand will automatically be corrected in the market. If demand for a currency is low, its value will decrease, thus making imported goods more expensive and stimulating demand for local goods and services from abroad. This, in turn, will generate more jobs, causing an auto-correction in the market. A floating exchange rate is constantly changing. Floating exchange rates and Made in Italy. In a floating regime the exchange rate can undergo devaluation (i.e. the foreign currency becomes more dear) hence the country’s export become more attractive. Made in Italy is boosted when the Euro is devalued vis-à-vis the US$ and other currencies. Conversely, Made in Italy is hampered when the Euro strengthens vis-à-vis the US$ and other currencies. 14/03/24 – Lecture 8 EXCHANGE RATE REGIME: Government’s policy with respect to the exchange rate of its currency. From purely floating exchange rate (no rules, central banks do nothing) to the fixed exchange rate regime (or pegging system) by which the exchange rate is kept stable by the Gov. Historically we had these two regimes: 52 To conclude we have analyzed different forms of exchange rate regimes. Made in Italy flows are affected by exchange rate regimes of the country of destination. We have a eurozone exchange rate regime, the decisions are taken cooperatively by the euros counties. Now, the euro is floating freely, decision taken collectively by the euro zone countries through the European Central Bank. THE FOREIGN EXCHANGE MARKET (FOREX) This economic phenomenon (exchange rate fluctuation) take place in a market because the exchange rate is a price determined by the market. The foreign exchange market used to be a physical market made up of individuals exchanging coins, today all of this happens over high-tech equipment. Forex -> The modern foreign exchange market (FOREX) was born in the early ‘70, after the abandonment of the fixed exchange rate regime. With free floating exchange rates, the exchange of currencies quickly picked-up. London became, and still is, the largest market for currencies transactions. London market share is about 40%. After Brexit the volume of transactions in the London market continued to grow The forex exploded when the rate was let free to flow, London was the legal framework for the transactions. This market is ongoing 24h. How big is this market? According to the latest survey the daily forex transactions in April 2022 amounted to 7.5 trillion dollars. - daily FOREX transactions in April 2022 amounted to US$ 7.5 trillion ($ 6,6 Tr. in 2019). - Total world trade in goods in the year 2022 amounted to US$24 trillion. 55 The FOREX structure. The forex is made up of two levels: - Interbank market - Over the counter market (open to everyone) (OTC) The interbank market was very physical (banks’ representatives met in a certain place and physically traded) mainly in London, now everything is digitalized. It is where large banks trade currencies for purposes such as hedging, balance sheet adjustments, and on behalf of clients. Here brokers operate. The OTC market on the other hand, is where individuals/enterprises trade through online platforms and brokers. Here small and medium sized Italian enterprises can operate. There are a lot of Apps that would allow you to buy currencies, stocks, bonds. Today they are still distinguished, in the first only banks work. The FOREX currency pairs: 80% of all exchanges in the forex pertain to the following currencies pairs, called Majors. Each of them is setting the exchange rate on the euro vs the dollar, and so on. The British pound is another important pair, very popular today. Trades in these exchange 56 rates contracts are highly liquid (lot of people trading and low transaction costs) depending on the number of transactions done during a certain period of time. There are transactions of other smaller currencies, such as Albanian (this market is less liquidity). FOREX contracts. There are two types of Forex contract (legal instrument that binds 2 parties to deliver something): 1. Spot contracts, traded on the spot market (executed almost instantly) 2. Forward/Futures contracts, traded on the Forward/Future market (executed at the later day, unbounded) The spot market is the immediate exchange of currency between buyers and sellers at the current exchange rate. The spot market makes up much of the currency trading.  The key participants in the spot market include commercial, investment, and central banks, as well as dealers, brokers, and speculators. Large commercial and investment banks make up a major portion of spot trades, trading not only for themselves but also for their customers. Set of contracts in the spot market: In the future market is set the price today and we execute the contract one/two/three weeks from now (contract is signed, the price is fixed, but it is executed later). Forward and futures contracts are agreements between two parties to buy and sell an asset at a specified price by a certain date. Forward contract is a custom-made agreement, less liquid, and there is a counterparty risk if the other part will not deliver (because it is a transaction between only two party). It is very flexible, but costly. A forward contract is a private and customizable agreement that settles at the end of the agreement and is traded over the counter- 57 1) he can ask the buyer to pay him in euro, in this case the buyer bears the risk of changes in the €/$ X change rate; to do so you need substantial bargaining power which small exporter do not have. 2) he can sell dollars forward at the price that is defined today (forward contract). By doing so he eliminates the X change rate risk. So, in the moment you close the contract and you commit to deliver 6 months from now, you can go to your bank or broker and say “six months from now I will have 6000 dollars and I want you to commit today to give me a price for dollars 6 months from now”. Using forward contracts to protect Made in Italy exports from exchange rate risk (hedging). Hedging strategy: 1. Exporter sells $ today in exchange for €, with delivery in three months; the price is set today based on the €/$ Forward exchange rate available today. 2. Exchange rate risk is cancelled: he knows exactly how many euro he will collect three months from now. Notice: the importer has the exact opposite problem: the Forex market will match the two demands and both will be better off. This type of reasoning happens also for operators selling financial assets. 19/03/24 – Lecture 9 ITALY’S ECONOMIC HISTORY: “MIRACLE” AND “SLOWDOWN” GENERAL FEATURES OF ITALY’S EXPORT DRIVEN GROWTH MODEL. Italy is constrained by its physical conditions and its position (at the center of the mediterranean sea). It does not have lot of flat plants. It has always successfully transformed its natural resources into manufactured products, it is the 2nd most important manufacturing country in Europe (Germany first). First, agricultural 60 products, now mechanical products. The local market is constrained by the size of the population, so Italy needs to export. Some general features of Italy’s Export driven growth model (export are the main factor of growth). The most dynamic component in the Italian GDP has been exports: International trading with respect to Italian GDP. A ratio for every hundred euros of GDP Italy produces every year has been increasing constantly. Every time exports goes up GDP is positive, and the opposite occurs. The importance of international trade has been growing over the last 50 years. Story in terms of value: Here the importance of exports as a share of GDP. How large has been the export of goods for made in Italy? Constant growth of Italy’s export in value terms (€) only halted in 2009 recession and Pandemic years. Here exports are normalized in euro terms, and they have constantly been growing except for a recession after 2008 (US crisis) public debt crisis and the pandemic (lowering the amount of exports). 61 Germany has been showing extraordinary capacity in exports, a more internationalized country. Germany is one of the main destinations of Italy’s exports -> Germany success drives also Italian exports. USA is the largest economy in the world, but with respect to total GDP of the US the share of exports is inferior. Germany and Italy depend crucially on international trade (US is a much closer economy). The introduction of the euro at the end of the 90s increased shares of export in Germany more than in Italy (China enters the world market and Germany was able to benefit from it). Italy’s average tariff rate applied to total imports, an index of trade liberalization Italy was able to increase its exports activity because Italy is a manufacturing country so it has to imports (it has been able to benefit from a lower import tariff). The current account balance: 62 scooters (the Vespa and the Lambretta), and cars (from economical Fiats to luxury makes such as Maserati, Lamborghini, and Alfa Romeo). Italy became fully integrated into European trade. After WWII Italy enjoyed years of the economic miracle: in these years extraordinary phase of rapid growth (8% per year, now 0.6%). All industries were expanding. Some figures of the «miracle»: The export led growth model was driven by made in Italy. Autostrada the sole enabled firms to become exporters thanks to logistic.  The «redistribution policies» in the sixties. After 1963, when the Socialist party joined the government for the first time in Italian history, a policy of redistribution was initiated. Employment in government and the public sector was greatly expanded, increasing public expenditures. Labor rights were strengthened and Trade unions became more powerful. Wages and welfare expenditure were raised. Inflation began creeping up once again. Many firms had to be rescued at public expense, coming under the control of the State holding company (IRI). High costs, salaries inflation and slower productivity growth deteriorated the Current account of the Balance of Payments. Deterioration of economic conditions led to the “hot autumn” of 1969, a season of strikes, factory occupations, and mass demonstrations throughout northern Italy, with its epicenter at Fiat in Turin. The Seventies: social tensions and energy shocks increased inflation and Government spending and budget deficit. Labour unrest continued throughout most of the 1970s. Firms tended to restructure into smaller units employing part- time or unofficial workers, who could be dismissed easily and did not enjoy guaranteed wages. Unemployment rose sharply, especially among the young. Inflation continued, aggravated by the increases in the price of oil in 1973 and 1979. Italy was very much dependent on oil imports for the production of energy, an important component of the manufacturing activities. We were forced to buy oil at higher prices, and this put pressure on Italy’s prices and competitiveness. The budget deficit became permanent (Italian Gov was spending more and more) averaging about 10 percent of GDP, higher than any other industrial country. The lira fell steadily, from 560 lire to the U.S. dollar in 1973 to 1,400 lire in 1982. In the seventies the number of workers in the public sector tripled. Growing deficit = growing debt (more expenditures than revenues. 65 Story of oil price: This black line is the price of one barrel of oil. It has been almost flat for 30 years, helping countries like Italy who imported lot of oil. Then, in 1973 and 1979 the oil price sky rocked, and it was a shock for Italian manufacturer (it put pressure on Italian prices and competitiveness). In 2008 prices goes up again because of recession. Price of oil fluctuations are very harmful for countries like Italy (transformation economies). Government spending: Government spending was very low until the 60s. The higher the line, the higher the contribution of gov in the growing of GDP. The problem is that gov has to borrow to finance all this spending (debt goes up). Until ’98 it borrowed from central bank (generating inflation), and from the divorce it borrowed from the market. Italy has become a country with a large debt owned also by foreign investors (much more reactive and irrational) -> if they fear that the Italian gov will 66 perform bad they could stop investing. Italy has always been able to repay by raising taxes. We are the country with the largest promise to repay the debt.  Stabilization in the ‘80s . Economic growth revived in the mid-1980s, once terrorism had ended and the 1979 oil price shock had subsided. The long season of protest that began in 1969 was finally at an end. Labour unrest declined. Big industry rentrenchement , especially in the industrial northwest. Historic factories, linked to mass production and class struggle, closed or scaled down their operations. A 1985 referendum markedly reduced the indexation of wages to price inflation. Growth of Public expenditures and fiscal deficit were reined in. Structural reforms of Credit and Financial markets were completed. Very successful political stabilization, but larger firms had to reduce the size.  In the ‘80s transformation of the productive model: the Small and Medium Size Enterprises. The Italian economy began to develop along new lines. In central and northeastern Italy—collectively known as the “third Italy,” alongside the less-developed south and the northwest, with its older industries and financial centers—small businesses flourished. These firms dmainly produced quality goods for export and were often family-run. New industrial districts in these regions developed, specializing in particular productions. New industries, such as fashion, began to replace traditional businesses in the North. Milan became one of the world’s fashion capitals during the 1980s, bringing in billions of lire in business and advertising. However, fiscal policy remained loose: budget deficits remained large and by 1989 the stock of debt exceeded GDP.  The Nineties : the Lira’s devaluation (1992) and the inception of Privatizations. Economic problems increased sharply in the early nineties, as Italy felt the effects of a global recession that hit most of Europe. In 1990 the budget deficit rose to more than 10 percent of GDP, and industrial production fell by 4 percent from 1992 to 1993. In September 1992 the lira was heavily devaluated. To lower budget deficit, Government abolished wage indexation, cut spending, especially on health and pensions. Launching of the privatization program for leading state firms, to occur only very gradually. In the nineties the gov sold Telecom (it was privatized).  The Nineties: Italy adopts the Euro (1999). In 1992 the Treaty on the European Union (Maastricht Treaty) established a timeline for the creation of the European Economic and Monetary Union – with the introduction of the Euro – set for January 1 of 1999. Italy follows prudent financial policies to lower budget deficit and inflation. Interest rates fell significantly and a current account surplus is established. During the late 1990s the economy resumed strong export-led growth, driven by the flourishing design and manufacturing by small-business networks of the center and north-east (industrial districts). Italy’s was able to join the Euro at its inception on January 1 1999. Story of the budget deficit: 67 THE SLOWDOWN THAT TOOK PLACE SINCE THE NINETIES. Unfortunately, Italy has a structural problem in its growth model: every year Italy’s GDP grows of a certain percentage and this percentage declines every year (now 0.6%). We are still growing but as not fast as in the past (we are not successful as before). Italy: per-capita GDP. We are worst off in these terms. It has a social and political impact (we are poorer every year). Italy: per-capita GDP annual growth Italy’s growth of GDP and Total Factor Productivity (TFP). 70 Total Factor Productivity (TFP) -> to produce something you need capital (machinery) and labor. The growth of an economy depends on the rate of growth of how much capital and labor force you can have. Historically, in 70s Italy was able to increase its growth rate of 3.7% because physical capital was increasing (labor capital was constant). We had 2.6 of total factor productivity which is the residual of the growth that is not explained by increase in capital and increase in labor and it is the capacity of the system to organize production (the institutions, business environment, judicial system). An explanation of the slowdown in Italy’s productivity growth? Total factor productivity came down all over those years and dragged down the total growth of Italy despite the fact that capital and labor grow. According to Edmund Phelps, Nobel Price for Economics (2006), the cause is the loss of indigenous innovation: i.e. the capacity to autonomously generate new products and new productive processes (innovation). «It is striking that Italy, which had a high rate of «imported» innovation during the catch-up years of the ‘50s and the ‘60s, had only began building up a significant «indigenous» innovation around 1980; then lost all of that innovation by 1995 or so». DETERMINANTS OF EXPORTS: FIRM HETEROGENEITY AND LOCAL CONTEXT by Pietro de Matteis*, Filomena Pietrovito** and Alberto Franco Pozzolo** The geographical context in which firms operate can have a crucial impact on their propensity to internationalize. This paper, examines the determinants of export performance for a sample including more than 4,300 Italian manufacturing firms over the period 2000-2013, focusing on the role of provincial context, after controlling for firm-level characteristics. Each Italian province is classified in terms of context variables, such as: the distance to foreign markets, the level of human and social capital and the degree of efficiency of the public administration. The results show that context characteristics at the province level have an additional (statistically and economically) significant impact on the export performances of firms. 71