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Although most economists support free trade, in the 1970s a growing number of them became increasingly puzzled by the large differences between the predictions of free trade theory and real-world trade flows. Their solution to this puzzle is known as new trade theory. One mystery was that trade was growing fastest between industrial countries with similar economies and endowments of the factors of production. In many new industries, there was no clear comparative advantage for any country. Patterns of production and trade often seemed matters of chance. Trade between two countries would often consist mostly of similar goods, for example, one country would sell cars to another country from which it would import different models of cars. One explanation, associated in particular with Paul Krugman of the Massachusetts Institute of Technology, drew on Adam Smith’s idea that the division of labor lowers unit costs. Economies of scale within firms are incompatible with the perfect competition assumed by traditional trade theory. A more realistic assumption is that many markets have monopolistic competition. When a monopolistically competitive market expands, it does so through a mixture of more firms (greater product variety) and bigger firms, with bigger-scale economies. Free trade expands market size beyond national borders and so allows firms to reap bigger economies of scale, to the benefit of consumers, workers and shareholders. The upside may be greater the more similar are the trading economies. This may explain why trade liberalization is easier to achieve between similar countries. Thus, for example, the free-trade agreement between the United States and Canada produced only minor local complaints, whereas its subsequent expansion to include the very different economy of Mexico was much more controversial (see NAFTA).
Industry:Economy
In 1993, the United States, Mexico and Canada agreed to lower the barriers to trade among the three economies. The formation of this regional trade area was opposed by many politicians in all three countries. In the United States and Canada, in particular, there were fears that NAFTA would result in domestic job losses to cheaper locations in Mexico. In the early years of the agreement, however, most studies found that the economic gains far outweighed any costs.
Industry:Economy
A controversial phrase, which actually means little more than the lowest rate of unemployment at which the jobs market can be in stable equilibrium. Keynesians, encouraged by the Phillips curve, assumed that a government could lower the rate of unemployment if it was willing to accept a little more inflation. However, economists such as Milton Friedman argued that this supposed inflation-for-jobs trade-off was in fact a trap. Governments that tolerated higher inflation in the hope of lowering unemployment would find that joblessness dipped only briefly before returning to its previous level, while inflation would rise and stay high. Instead, they argued, unemployment has an equilibrium or natural rate, determined not by the amount of demand in an economy but by the structure of the labor market. This is the lowest level of unemployment at which inflation will remain stable. When unemployment is above the natural rate demand can potentially be increased to bring it to the natural rate, but attempting to lower it even further will only cause inflation to accelerate. Hence the natural rate is also known as the non-accelerating-inflation rate of unemployment, or NAIRU. At first, the NAIRU became synonymous with the view that macroeconomic policy could not conquer unemployment. It was often used to justify policy inaction even when unemployment rose to more than 10% of workers in industrialized countries during the 1980s and 1990s, even though economists’ estimates of the NAIRU differed hugely. More recently, economists looking for ways to reduce unemployment have started to ask whether, and under what circumstances, the natural rate might change. Most solutions have stressed the need to make more people employable at the prevailing level of wages, in particular by increasing labor market flexibility. Economists still disagree over what jobless rate at any particular point in time is the NAIRU, but nobody any longer thinks that the natural rate is fixed. Indeed, some think the concept has no meaning at all.
Industry:Economy
When a monopoly occurs because it is more efficient for one firm to serve an entire market than for two or more firms to do so, because of the sort of economies of scale available in that market. A common example is water distribution, in which the main cost is laying a network of pipes to deliver water. One firm can do the job at a lower average cost per customer than two firms with competing networks of pipes. Monopolies can arise unnaturally by a firm acquiring sole ownership of a resource that is essential to the production of a good or service, or by a government granting a firm the legal right to be the sole producer. Other unnatural monopolies occur when a firm is much more efficient than its rivals for reasons other than economies of scale. Unlike some other sorts of monopoly, natural monopolies have little chance of being driven out of a market by more efficient new entrants. Thus regulation of natural monopolies may be needed to protect their captive consumers.
Industry:Economy
When a government takes ownership of a private-sector business. Nationalization was a fashionable part of the mix in countries with a mixed economy between 1945 and 1980, after which the privatization of state-owned firms became increasingly popular. The amount of public ownership in different countries has always varied considerably. Nationalization has taken place for various reasons, ranging from socialist ideology to attempts to remedy examples of market failure. The performance of nationalized firms has often, but not always, been poor compared with their private-sector counterparts. State-owned businesses often enjoy a legally protected monopoly, and the lack of competition means the firms face little pressure to be efficient. Politicians often interfere in important management decisions, making it harder to take unpopular actions on pay, factory closures and job cuts, particularly when there are strong public-sector trade unions and a union-friendly government. Politically imposed financial constraints may also force public-sector firms to underinvest. Although privatization has not been universally beneficial, on balance it has increased economic efficiency.
Industry:Economy
A Paris-based club for industrialized countries and the best of the rest. It was formed in 1961, building on the Organization for European Economic Co-operation (OEEC), which had been established under the Marshall plan. By 2003, its membership had risen to 30 countries, from an original 20. Together, OECD countries produce two-thirds of the world’s goods and services. The OECD provides a policy talking shop for governments. It produces forests-worth of documents discussing public policy ideas, as well as detailed empirical analysis. It also publishes reports on the economic performance of individual countries, which usually contain lots of valuable information even if they are rarely very critical of the policies implemented by a member government.
Industry:Economy
As good as it gets, given the constraints you are operating within. For the concept of optimum to mean anything, there must be both a goal, say, to maximize economic welfare, and a set of constraints, such as an available stock of scarce economic resources. Optimizing is the process of doing the best you can in the circumstances.
Industry:Economy
The name given to the arrangements through which countries reschedule their official debt; that is, money borrowed from other governments rather than banks or private firms. The club is based on Avenue Kléber in Paris. Its members are the 19 founders of the OECD as well as Russia. Other institutions such as the World Bank attend in an informal role. Rescheduling requires the consensus agreement of members and must not favor one creditor nation over another. Private debt re¬scheduling takes place through the London Club.
Industry:Economy
A measure of the value of money that removes the effect of inflation. Contrast with nominal value.
Industry:Economy
Although economists say that rationing is what the price mechanism does, what most people think of as rationing is an alternative to letting prices determine how scarce economic resources, goods and services are distributed (see also queuing). Non-price rationing is often used when the distribution decided by market forces is perceived to be unfair. Rationing may lead to the creation of a black market, as people sell their rations to those willing to pay a high price (see black economy).
Industry:Economy
