The three parts of the session :

1. How to measure the wealth of a nation ? The concept of GNP. The four elements making up the GNP :
   • The household sector : total personal consumption expenditures
   • The private business sector : total private domestic investment output (mainly business plant and equipment, and new homes for families)
   • The government sector : total government purchases (consumption and investment : salaries of firemen as well as expenditures to maintain the road network)
   • The foreign sector : the export balance (all the goods and services that are sold abroad minus all the goods and services that are purchased from abroad)
2. David Ricardo and the Theory of the comparative advantage : an example
3. The balance of payments : an accounting document, recording all the exchanges (physical goods and financial assets) between a country and the rest of the world.

1. The GNP :

In all western countries, personal consumption expenditures, i.e. the Household sector,  is the largest element of the GNP.

Example : US   1980 and 2000 (billion current dollars)

(Exercise : find the same data for several european countries)

In the US the households save about 5% of their income. These savings go to finance the Business sector. It is one of the sources of finance for the Business sector.

In Germany or Japan, the percentages are much higher.

(Exercise : find the figures for the major european countries)

The Government sector gets its resources from two sources : taxation, and borrowings.

The pattern of consumption of the Household sector is very stable and predictable (in its large components). It is not an "active" force of the economy, it is a "passive" one.

The Business sector has a much more volatile behaviour. Investment decisions turnarounds (and increases or decreases in inventories) are quite rapid (relatively to the pattern of behaviour of the Household sector).

The Business sector is an "active" force of the economy. The course "Corporate Finance" will deal with this and all related  issues.

The Government sector, with the adjunction of  the Central banking system (in the US, "the Fed"), have several ways to influence the economy.

There is much debate as to whether they should intervene a lot or a little into the economy. The debate can still be schematically reduced to the opposition between the Keynesian economists (following J.M. Keynes (1883-1946)) versus the Monetarists economists. Some years ago the terms "demand side economists" vs "supply side economists" to represent the same distinction were in vogue.

According to Keynesian principles, the Government can and should compensate a sagging Business sector by launching large investments programs of its own.

That's what was done, in the second half of the thirties, in the US. But it is still a subject of debate as to whether it was of any real help, or if the economy would not have recovered by itself anyway. J.F. Kennedy declared (among other striking declarations that he made) "I am a Keynesian".

The Government sector can also dampen an overheated economy by increasing certain taxes (but it is difficult to apply, because of the time lag, and because, when it's an increase, it is very unpopular).

The Fed can regulate the access to money (the "Money supply", in short the cash and checking accounts - i.e. whatever can pay a debt) in three ways :

1. Changing the required reserves of money the banks must hold (between 15 and 20% usually)
2. Changing the discount rate, to borrow money, accessible to the member banks of the Federal Reserve System
3. Buying or selling governement bonds ("monetizing the debt"). Through a multiplier effect, if, say, the reserve requirement is 15%, injecting $100 million in cash (by buying government bonds - also called treasury bonds) will create about $600 million of new available money in the economy.

Monetarist economists, following Milton Friedman (born in 1912), are very strict regarding what the Fed should do. They do not encourage a "fine tuning" of the money supply by the Fed. The only thing they recommand is a steady and predictable increase in the money supply, in invariable proportion to the GNP.

In short, Monetarists say : "make the future more predictable (for the business world), not less", "government action - because of politics - makes the future even less predictable than no action at all", "the business sector needs to predict as much as possible the future", " let the smarter win, not the best in court with the government ; that'll make for a more efficient business sector - the engine of the economy (according to monetarist thinking)"

By the way, no Economic Theory will ever predict the future (therefore Economics will never be a Science, according to Carnap), because if it did the Business sector, in the western capitalistic societies, could not function. Indeed, the Business sector needs the competition over who is the best - or the luckiest - at forecasting the future. Otherwise, we are in some sort of a planned economy, and recent history has concluded that it is not adapted to human nature. Strangely enough, man needs uncertainty to live well ! (After all, is that such a discovery ? Would you really like to know the future, the entire future ?)

The fourth sector of the economy is the Foreign sector, this is the one this course will mostly deal with - and mostly in Europe.

Imports plus exports, of goods and services, used to be a small part of the GNP of the US : one twentieth of the economy just after WWII.

The figure was about 20% in 1980.

Now, in the year 2001, the figure is about 25% of the US GNP.

The percentages are much higher in Europe, particularly for small countries.

Besides this fact about trade of physical goods and services,  the flows of money through the boundaries of Western countries due to purchases and sales of porfolio value (shares or bonds of foreign entities) have "exploded" over the last 20 years.

In France, it was multiplied almost 100-fold between 1980 and 2000 ! (More on this in the section Balance of payments).

All these topics belong to the general topic called "Globalisation" : a hot topic, nowadays, with the viewpoint of Davos/New-York, and the viewpoint of Porto-Allegre.

2. David Ricardo and the Theory of the comparative advantage

David Ricardo (1772-1823), http://www.bized.ac.uk/virtual/economy/library/economists/ricardo.htm a Netherlands-born british economist, developped the Theory of the comparative advantage, to try and put on a sound theoretical basis the study of international commerce, and, in particular, to demonstrate the advantage of international trade between countries as opposed to autarcy.

Here it is, in its simplest model : let's consider two countries France (F) and Italy (I). Both produce corn and cars. There is only one production factor : labor.

Let's take a look at the productivity data : suppose that to produce one unit of corn France uses 2 units of labor, and Italy uses 5 units of labor. And suppose that to produce one car France uses 3 labor units, and Italy 4.

I.e. in France a car costs 1,5 units of corn. In Italy the cost of a car is 0,8 units of corn. We say that Italy has a comparative advantage in cars and France has a comparative advantage in corn (even though the absolute advantage is for both products on F side).

Secondly, suppose Fr. has a total of 6 000 units of labor at its disposal, and It. has 10 000.

If there is no trade between F and I, here are the production choices each country can make :

France

(For instance, if France chooses to produce 750 units of corn, it needs 1500 labor units for that. 4500 remain : that permits the production of 3000 cars.)

Italy

Still with no trade, assume french consumers spend 75% of their resources to corn, and 25% to cars. And assume the italian consumers have the exact opposite proportions.

That is in France (if we use corn as a money measurement) the demand for corn is 3000 (the total resources) x 75% = 2250 and the demand for cars is what's left : 500 cars.

In Italy, the demand for corn is 2000 x 25% = 500 units of corn, and the demand for cars is 1875 cars.

Now comes Ricardo's point : trade can improve the well-being of both countries !

Let's see how.

We saw that in Italy a car "costs" 0,8 units of corn, whereas in France a car "costs"1,5 units of corn.

Any price, between 0,8 and 1,5, to exchange cars for corn between Italy and France will improve the wealth of each country.

Without going into the (simple) details, let's look at the best price of exchange, some further calculations show that it is 1,2 : ie let Italy sell cars to France at a price of 1,2 units of corn for one car.

Obviously it's a good price for Italy; and it's also a good price for France.

Suppose that France specializes entirely into corn, and Italy entirely into cars.

France produces 3000 units of corn, consumes 2250 units (that's the internal demand), and therefore holds another 750 units of corn for sale to anyone. These will bring more cars to France, via trade, than if they were produced in autarcy.

Indeed a car is worth 1,5 units of corn in France, and we can  purchase them from Italy for 1,2 : that's better ! And indeed France will buy 625 cars from Italy (instead of producing itself only 500).

And Italy will produce 2500 cars. It will consume 1875 (as we saw) cars, and have 625 available for trade. These 625 cars will be exchanged for 750 units of corn (more than the 500 units of corn that Italy would have produced by itself).

So without trade, France had 2250 units of corn and 500 cars. And Italy had 500 units of corn and 1875 cars.

With trade, France has 2250 units of corn and 625 cars. And Italy has 750 units of corn and 1875 cars.

This is Ricardo's theory in its simplest form. It is somewhat simplistic.

It gave rise to works into two main directions : 1) try to extend it to many countries, many products, and several production factors (mostly labor AND capital), and 2) try to verify it in real life.

The first objective was undertaken by many economists (scholars). It lead to a theory named "the Heckscher, Ohlin, Samuelson" model.

Samuelson (born in 1915) received the Nobel Prize in Economics in 1970

(http://www.trinity.edu/departments/economics/nobel_files%5CSamuelson.htm)

The second objective - more ambitious - was undertaken by some more economists. More or less convincing results were achieved :

Dougall, Stern and Balassa, in a work published in 1963,  found some good empirical evidence of Ricardo's ideas in the study of the exchanges between the US and the UK in the early fifties.

Some other studies (eg. Kreinin : the study of the exports of Canada and of Australia to other countries) did not find as much evidence.

But, anyhow, Ricardo's ideas are useful. Economics by its very nature deals with extremely intricate phenomena. (It involves human behaviour, sociology, the attitude vis à vis anticipations, etc.) What Ricardo suggested, in a simple manner, is that trade is better than autarcy.

It is still the subject of a heated debate : "to which extent ?" (Here is the point of view of some people who warn against an uncontroled globalization of trade : http://attac.org/fra/asso/doc/doc1008en.htm )

3 . The balance of payments

The balance of payments is an "accounting" document measuring all the flows of goods, services and other exchanges between one country and the rest of the world.

It is organized as follows :

1. Trade balance = the difference between the exports and the imports measured in monetary terms (for France, in Euros)
2. Trade and services balance = the same thing were exports and imports of services are included
3. Current operations balance = same thing plus some minor transfers (foreigners working in France and sending money home, gifts)
4. Current operations balance + national gifts + patents
5. Balance to be financed = Current operations balance + minor things + direct investments (physical investments, into plants, by France abroad and by the rest of the world into France)
6. Global balance = Balance to be financed + all other non-bank non-monetary flows (mostly purchase and sale of share and bonds abroad)
7. The rest = what remains to be financed via the banking system and the central bank
8. The mistakes and corrections

The french balance of payments : http://www.finances.gouv.fr/indicateurs/economie_france/balance_des_paiements/

French exports and imports (by country and by products) : http://www.finances.gouv.fr/indicateurs/economie_france/commerce_exterieur/

(US data :

Bureau of Economic Analysis : http://www.bea.doc.gov/bea/dn/nipaweb/SelectTable.asp?Selected=Y

and also more generaly  http://www.bea.doc.gov/

Data since 1929 : Time series

Gross National Product : http://www.bea.doc.gov/bea/newsrel/gdp401a.xls

Miscellaneous data sources 1

Miscellaneous data sources 2

Data from Global Find

French data :

INSEE : http://www.insee.fr/fr/home/home_page.asp

Gross National Product : http://www.insee.fr/fr/indicateur/cnat_trim/tableaux/t_800_10_1.htm

Balance of payments : http://www.finances.gouv.fr/indicateurs/economie_france/balance_des_paiements/

Data from Les Echos : http://www.lesechos.fr/IDE/economie_france.htm)