Economics Exam Paper

Name: Sherman Yau Heng Fatt OUID: 149579 Location & Group number: KL29 E-mail add: [email protected]

1.

How has an open trading system helped Malaysia? How has it hurt Malaysia? Proponents of an open trading system contend that international trade results in higher levels of consumption and investment, lower prices of commodities, and a wide range of products choices for consumers. Under an open trading system, Malaysia has showed a positive sign of growth in all sectors according to Malaysia trade 2004. Domestic demand, particularly private consumption, continues sustaining growth for five consecutive years, while private investment, which began to pick up last year, has become more entrenched, resulting in a private sector-led growth. The government has also generated new source of growth, resulting in manufacturing, which has become more diversified with high-end, value-added and new emerging industries and products. However, arguments against this trade system tend to be voiced during period of excess production capacity and high unemployment. This may led to many Malaysians fear getting laid off, especially at those firms operating in importcompeting industries. Also, workers face demands of wages concessions from their employees, which often threaten to export jobs abroad if wages concessions are not agreed to.

2.

What do you think Malaysia’s competitive advantage is? Has it changed? What was it before? Will it change in the future? What will it be? Malaysia is an investor-friendly country and has been successful in attracting investment. Under the Malaysia external trade policy, the government tend to present a strong and stable government with efficient infrastructure and sound economic policies. Investors find these even more important than merely having a set of global rules and regulations on investment. Like other developing countries, Malaysia is concerned that having global rules on investments will hinder the ability of the

1

International Economics

ECO 40963

government to screen the type of investments that we want to promote in the country given scarce resources. Moreover, Malaysia has adopted long and medium term development plans that call for the effective use of scarce resources through promoting investments in appropriate and strategic industries. Multilateral rules could restrict the country's ability to provide special incentives and privileges to local investors for social and strategic reasons, as members may not be able to discriminate between local and foreign investors once they are allowed into the host country. Malaysia attracts foreign investment, in other words, she has a healthy economy, will tend to have a net capital inflow and this will be associated with a trade deficit. There is every reason to see the benefits of such a situation. Both the acquisition of imports and the foreign investment are good for the country. 3.

What is a product largely imported to Malaysia? What happens to Malaysian terms of trade if demand for this product increases? Malaysia trade statistics recorded a new high of RM34.66 billion, expanding 9.6% from RM31.63 billion in May 2004. Import growth was mainly led by increase in imports of intermediate and capital goods to sustain manufacturing activities to meet external demand. As we noted, demand and supply condition determine the basis for trade and the direction of the trade. Demand also helps establish the international terms of trade, that is, the relative prices at which commodities are exchanged between nations. If demand for imports of intermediate and capital goods increases, the price for this particular product will rise; thus it will show a deterioration in a Malaysia terms of trade that the prices of its exports fall relative to the prices of its imports over the given time period. This may lead to reduced export sales and less revenue earned from exports, and we could hardly say that Malaysia welfare has improved.

2

International Economics 4.

ECO 40963

What is Malaysia’s industrial policy? What has the government tried to create a comparative advantage in? Has it worked? Why or why not? Malaysia industrial policies emphasize specialization and reallocation of existing resources found domestically. It overlooks the fact that additional resources can be made available to the trading nation because they can be created or imported. However, these policies has also suffered from being increasing costs, in which additional use of limited resources results in rising their units costs as resources become fully used. Although these policies hold in the short run, empirical evidence suggests that unit costs may decrease over time – partly because firms learn to be more efficient and partly because of economies of large-scale production.

5.

Which of the arguments for tariffs do you feel are most relevant in today’s Malaysia? Why? Malaysia feel that developed nations tend to insist that developing nations open their markets to industrial products from the developed world, yet refuse to open their markets to agriculture goods from the developing world. For example, United States have used aggressive antidumping and countervailing duties to limit access to their markets. Furthermore, the current concept of free trade supports the free movement of products and employers, which favors the developed nations, but not the free movement of employees (i.e., labor), which would favor the people of developing nations.

6.

Does Malaysia’s government provide any subsidies? If so, what kind and are they effective? If not, should they? Why or why not? Malaysia’s government grants subsidies to their producers to help improve their trade position. By providing domestic firms a cost advantage, a subsidy allows them to market their products at prices lower than warranted by their actual cost or profit considerations. Governmental subsidies assume a variety of form, including out right

3

International Economics

ECO 40963

cash disbursements, tax concessions, insurance arrangements, and loans at belowmarket interest rates. Two types of subsidies can be distinguished: a domestic subsidy, which is sometimes granted to producers of import-competing goods, and an export subsidy, which goes to producers of goods that are to be sold overseas. In both cases, the government adds an amount to the price the purchaser pays rather than subtracting from it. The net price actually received by the producer equals the price paid by the purchaser plus the subsidy. The subsidized producer is thus able to supply a greater quantity at each consumer’s price. Moreover, when a subsidy is given to an industry, it is often in return for accepting government conditions on key matters such as wage and salary levels. 7.

Concerning intellectual property, what is Malaysia’s policy (official and unofficial)? What do you actually do (buy pirated music or videos)? Intellectual property is an invention, idea, product, or process that has been registered with the government and that awards the inventor (or author) exclusive rights to use the invention for a given time period. Malaysia governments use several policies to protect intellectual property such as copyrights are awarded to protect works of original authorship (for example, music compositions, textbooks); trademark are awarded to manufacturers and provide exclusive rights to a distinguishing name or symbol (for example, “Coca-Cola”); patents secure to an inventor to a term, usually 15 years or more, the exclusive right to make, use, or sell the invention. Furthermore, the government enforcement personnel always carry a raid to certain shopping areas to strike at pirated goods such as automobile parts, jewelry, sporting goods and watches, piracy of audio and videotapes, computer software, and printed materials. To protect and respect the intellectual property, I will surely support the original version, no matter music or video CD, or computer software and etc. I also do agree with the government steps in protecting the intellectual property and give my full cooperation by providing the useful information to the related authorities regarding the illegal selling of counterfeit products.

4

International Economics 8.

ECO 40963

Why are less-developed nations concerned with commodity-price stabilization? Is Malaysia concerned with this? For what materials? The composition of less developed nations’ exports emphasis on primary products and these nations concentrated in only one or a few primary products. Thus, a poor harvest or a decrease in market demand for that product can significantly reduce export revenues and seriously disrupt domestic income and employment levels. In addition, export prices and receipts can be very volatile when supply and demand conditions are price-inelastic. Therefore, it is vital important for them to enact commodity price stabilization policies to increase their level of income and standard of living. Malaysia has also concerns with commodity-price stabilization for its commodity products such as palm oil and rubber; however, Malaysia has recently generated new source of growth, resulting in manufacturing, which has become more diversified with high-end, value-added and new emerging industries and products.

9.

Is Malaysia a member of any economic integration agreements (i.e. free trade areas, customs union, common market, economic union, monetary union)? If so, how is it working? If not, should it be? What kind and with whom? Malaysia is a member of the ASEAN Free Trade Area (AFTA). AFTA is a collective effort by ASEAN member countries to reduce/eliminate tariffs on intraASEAN trade in the goods sector. The target is to achieve tariff between 0-5% in 2003 for the six original member countries, Vietnam by 2006, Lao PDR and Myanmar by 2008 and Cambodia by 2010, and eliminate quantitative restrictions and other non-tariff barriers. The reduction/elimination of tariff is undertaken through the Common Effective Preferential Tariff Scheme.

5

International Economics

ECO 40963

The primary objective of AFTA is to enhance ASEAN’s position as a competitive production base producing for both the regional and global markets. This is to be achieved through: •

Promotion of intra-ASEAN trade and industrial linkages, specialization and economies of scale; and

•

Promoting the region as an efficient and competitive production base for investments.

Malaysian companies will be able to benefit from: •

Preferential access into the larger market of ASEAN with a population of 530 million.

•

A wider base for competitive sourcing of raw materials from countries in the region.

•

Opportunity to cooperate and collaborate with ASEAN partners to tap both the regional and global markets.

10. What are the major industries in Malaysia in which foreigners place direct investments? What are the major foreign industries in which Malaysian businesses have chosen to place direct investments? To aid the economic growth, Malaysia aims to make the region a competitive base to attract foreign direct investment through the implementation of programs and activities on investment liberalization, facilitation and promotion. The agreement covers direct investment related to manufacturing, agriculture, fisheries, forestry and mining, and services activities related to these sectors. On the other hand, ASEAN as a group continues to be Malaysia’s largest trading partner. In 2002, total trade with ASEAN was RM161.8 billion, accounting for 24.6 per cent of Malaysia’s global trade. For Malaysia, pineapple canning, palm oil industry and refinery, sugar refinery, sawn timber, veneer and plywood, petroleum refinery, batik, extraction of timber, fisheries, cement and oleo-chemicals have been those businesses chosen to place direct investments.

6

International Economics

ECO 40963

11. What is meant by the balance of payments? Why does the balance-of-payments statement “balance”? Is Malaysia’s current account in deficit or in surplus? Is this a good thing? Why or why not? The balance of payments is the government's attempt to measure all international trade activity. The major accounts in the balance of payments are exports, imports, capital inflows, and capital outflows. Exports and imports are goods and services sold to and purchased from foreign interests, respectively. In addition to exports and imports, much of the trade in the world involves situations where no assets leave or enter a country. These exchanges are called capital flows. Capital inflows occur when foreign interests acquire assets in this country. Examples include the purchase of stocks, bonds, real estate, and businesses. Conversely, capital outflows occur when domestic interests acquire assets in another country. When the dollar value of a country's imports exceeds the dollar value of its exports, the country has a trade deficit. If the country is exporting more than it imports, it has a trade surplus. A trade deficit implies that due to the trade of goods and services, more currency is flowing out of the country than into the country. This net currency outflow is generally associated with a net capital inflow. Similarly, a trade surplus is associated with a net capital outflow. From Malaysia external trade report, a trade surplus of RM 5.09 billion was recorded in June 2004. This was the eightieth consecutive month of trade surplus since November 1997. Trade figures for June show that Malaysia's total trade had grown significantly by 29.2% to RM 74.41 billion compared with RM 57.57 billion the previous year. From a quarterly perspective, total trade for the second quarter of 2004 was 10.8% higher than that of the first quarter of 2004 and trade in June was 6.1% higher than that in May. Thus, this would either benefit exporting industries or it would benefit the domestic competitors of foreign imports

7

International Economics

ECO 40963

12. Why are exchange rate quotations stated in different financial centers consistent with one another? Is it better to have a strong or weak/dollar (and Ringgit)? Why? The Wall Street Journal’s foreign-exchange quotations include those of the New York foreign-exchange market and the International Market located in Chicago. Both spot quotations and forward quotations are provided. The exchange rate is the price of one unit of foreign currency in terms of the domestic currency. A dollar depreciation is an increase in the number of dollars required to buy a unit of foreign exchange. In the foreign-exchange market, currencies are traded around the clock and throughout the world. Most foreign exchange trading is in the inter-bank market. Banks typically engage in three types of foreign-exchange transaction: spot, forward, and swap. The equilibrium rate of exchange in a free market is determined by the intersection of the supply and demand schedules of foreign exchange. These schedules are derived from the credit and debit items in a nation’s balance of payments. Also, exchange arbitrage permits the rates of exchange in different parts of the world to be kept the same. This is achieved by selling a currency when its price is high, and purchasing when the price is low. Thus, exchange rate quotations stated in different financial centers consistent with one another. In my opinion, it is better to have a dollar (and ringgit) stabilized, and the foreign trader and investor are advised to deal in the forward market for protection from possible exchange rate fluctuation to ensure the steadily economic growth of the world.

8

International Economics

ECO 40963

13. Explain how the following factors affect the Dollar’s (and Ringgit’s) exchange rates: a) a rise in the US price level compared to foreign prices b) tariffs and quotas placed in US imports c)

increased demand for Us exports

d) rising productivity in the US relative to other countries e)

rising deal interest rates overseas relative to US rate

f)

an increase in US money growth

g) an increase in US money demand Like other prices, the exchange rate in a free market is determined by both supply and demand conditions. A nation’s demand for foreign exchange is derived from, or corresponds to, the debit items on its balance of payments. The supply of foreign exchange refers to the amount of foreign exchange that will be offered to the market at various exchange rates, all other factors held constant. As long as monetary authorities do not attempt to stabilize exchange rates or moderate their movements, the equilibrium exchange rate is determined by the market forces of supply and demand. •

A rise in the US price level compared to foreign prices will depreciate the effect on the Dollar’s exchange value

•

tariffs and quotas placed in US imports will appreciate the effect on the Dollar’s exchange value

•

increased demand for Us exports will appreciate the effect on the Dollar’s exchange value

•

rising productivity in the US relative to other countries will appreciate the effect on the Dollar’s exchange value

•

rising deal interest rates overseas relative to US rate will appreciate the effect on the Dollar’s exchange value

•

an increase in US money growth will appreciate the effect on the Dollar’s exchange value

9

International Economics •

ECO 40963

an increase in US money demand will depreciate the effect on the Dollar’s exchange value.

14. How can adjustments in Malaysian domestic interest rates help promote payments balance? Malaysian domestic interest rates aim to restore equilibrium in the balance of payment. For example, assume that Malaysia enjoying a surplus, and Singapore, facing a deficit. The inflow of gold from the deficit to the surplus nations automatically results in an increase in Malaysia’s money supply and a decline in the money supply of Singapore. Given a constant demand for money, the increase in Malaysia’s money supply would lower domestic interest rates. At the same time, Singapore’s gold outflow and declining money supply would bid up interest rates. In response to falling domestic interest rates and rising foreign interest rates, the investors of Malaysia would find it attractive to send additional investment funds abroad. Conversely, Singapore investors would not only be discouraged from sending money overseas, but might find it beneficial to liquidate foreign investment holdings and put the funds into domestic assets. This process facilitates the automatic restoration of payments equilibrium in Malaysia and Singapore. Because of the induced changes in interest rates, stabilizing capital movements automatically flow from the surplus to the deficit nation, thereby reducing the payment imbalances of both nations.

10

International Economics

ECO 40963

15. Suppose ABC Inc. a US auto manufacturer building cars in Mexico sales, obtains all of its auto components from the US and these costs are denominated in dollars. Assume the dollar’s exchange rate appreciates against the Mexican Peso. What happens to ABC’s costs and to the price of their cars in Mexico? Changes in relative costs because of exchange–rate fluctuation also influence relative prices and the volume of goods traded among nations. By increasing relative U.S. production costs, a dollar appreciation tends to raise U.S. export prices in foreigncurrency terms, which induces a decrease in the quantity of U.S. goods sold abroad; similarly, the dollar appreciation leads to an increase in U.S. imports. By decreasing relative U.S. production costs, dollar depreciation tends to lower U.S. export prices in foreign-currency terms, which induces an increase in the quantity of U.S. goods sold abroad; similarly, the dollar depreciation leads to a decrease in U.S. imports. Thus, ABC’s costs and the price of their cars in Mexico will increase and the cost will surely be transferred and spread to the consumers. 16. What factors underlie a nation’s decision to adopt floating or fixed exchange rates? Why is the Ringgit pegged to the US dollar? Should Malaysia’s currency be allowed to float? In choosing an exchange-rate system, a nation must decide whether to allow its currency to be determined by free-market forces (floating rate) or to be fixed (pegged) against some standard of value. If a nation adopts floating rates, it must decide whether to float independently, to float in unison with a group of other currencies, or to crawl according to a predetermined formula such as relative inflation rates. The decision to peg a currency includes the options of pegging to a single currency, to a basket of currencies, or to gold. Instead of utilizing fixed exchange rates, some nations allow their currencies float in the foreign-exchange market. By floating (or flexible) exchange rates, means currency prices that are established daily in the foreign-exchange market, without

11

International Economics

ECO 40963

restrictions imposed by government policy on the extent to which the prices can move. With floating rates, there is an equilibrium exchange rate that equates the demand for and supply of the home currency. Changes in the exchange rate will ideally correct a payments imbalance by bringing about shifts in imports and exports of goods, services, and short-term capital movements. Malaysia’s currency should float as it provides several benefits. First, the prices of the traded products of many developing nations are determined primarily in the markets of industrialized nations such as the United States; by pegging, say, to the dollar, Malaysia can stabilize the domestic-currency prices of their imports and exports. Second, many nations with high inflation have pegged to the dollar (the United States has relatively low inflation) in order to exert restraint on domestic policies and reduce inflation. Pegging the exchange rate may thus lessen inflationary expectations, leading to lower interest rates, a lessening of the loss of output due to disinflation, and a moderation of price pressures.

17. Distinguish among external balance, internal balance, and overall balance. Which does Malaysia’s government strive for? Give some examples? When a nation experience inflation with unemployment, achieving overall balance involves three separate targets: BOP equilibrium, full employment, and price stability. Three policy instruments may be needed to achieve these targets. Expenditure-switching policies can help a nation attain overall balance. Although these measures are designed primarily to influence the nation’s external sector, they have secondary impacts on its internal sector. Given a fixed exchange-rate system, for monetary policy the disequilibrium zones of employment-with-BOP-surplus and inflation-with-BOP-deficit are zones of policy agreement. The disequilibrium zones of employment-with-BOP-deficit and inflationwith-BOP-surplus are zones of policy conflict; a dilemma exists for monetary

12

International Economics

ECO 40963

authorities concerning which objective to pursue. A combination of policies may be needed to resolve these economic problems. Additional export sales provide an injection of spending into the economy, which encourages additional production and thus reduces the level of unemployment. In terms of the figure, the currency depreciation induces movement in a northeasterly direction, promoting both internal balance and external balance.

18. A nation’s need for international reserves is similar to your personal desire to hold a cash balance. Explain. Just as an individual desires to hold cash balances, national governments have a need for international reserves. The chief purpose of international reserves is to enable nation to finance disequilibrium in their balance-of-payments positions. When a nation finds its monetary receipts falling short of its monetary payments, the deficit is settled with international reserves. Eventually, the deficit must be eliminated, because central banks end to have limited stocks of reserves. From a policy perspective, the advantage of international reserves is that they enable nations to sustain temporary balance-of-payments deficits until acceptable adjustment measures can operate to correct the disequilibrium. Holdings of international reserves facilitate effective policy formation because corrective adjustment measures need not be implemented prematurely. Should a deficit nation posses abundant stocks of reserves balances, however, it may be able to resist unpopular adjustment measures, making eventual adjustments even more troublesome.

13