International Economics

The goal of this book is to make economic reasoning about the international economy accessible to a diverse group of students, including both economics majors and non majors.

James Gerber

500 Pages

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  • James Gerber   
  • 500 Pages   
  • 18 Feb 2015
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    International Economics SIXTH EDITION read more..

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    Abel/Bernanke/Croushore Macroeconomics* Bade/Parkin Foundations of Economics* Berck/Helfand The Economics of the Environment Bierman/Fernandez Game Theory with Economic Applications Blanchard Macroeconomics* Blau/Ferber/Winkler The Economics of Women, Men and Work read more..

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    Leeds/von Allmen The Economics of Sports Leeds/von Allmen/Schiming Economics* Lipsey/Ragan/Storer Economics* Lynn Economic Development: Theory and Practice for a Divided World Miller Economics Today* Understanding Modern Economics Miller/Benjamin The Economics of Macro Issues read more..

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    International Economics SIXTH EDITION James Gerber San Diego State University Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo read more..

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    Copyright © 2014, 2011, 2008 by Pearson Education, Inc. All rights reserved. Manufactured in the United States of America. This publication is protected by Copyright, and permission should be obtained from the publisher prior to any prohibited reproduction, storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or read more..

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    Preface xix PART 1 Introduction and Institutions 1 Chapter 1 The United States in a Global Economy 2 Chapter 2 International Economic Institutions Since World War II 17 PART 2 International Trade 39 Chapter 3 Comparative Advantage and the Gains from Trade 40 Chapter 4 read more..

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    ix Preface xix PART 1 Introduction and Institutions 1 Chapter 1 The United States in a Global Economy 2 Introduction: International Economic Integration 2 Elements of International Economic Integration 3 The Growth of World Trade 4 Capital and Labor Mobility 6 Features read more..

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    x Contents Regional Trade Agreements 23 Five Types of Regional Trade Agreements 23 CASE STUDY: Prominent Regional Trade Agreements 24 Regional Trade Agreements and the WTO 26 For and Against RTAs 27 The Role of International Economic Institutions 28 The Definition of Public read more..

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    xi Contents Chapter 4 Comparative Advantage and Factor Endowments 63 Introduction: The Determinants of Comparative Advantage 63 Modern Trade Theory 63 The Heckscher-Ohlin (HO) Trade Model 64 Gains from Trade in the HO Model 65 Trade and Income Distribution 68 The Stolper-Samuelson read more..

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    xii Industrial Policy Tools 106 Problems with Industrial Policies 107 CASE STUDY: Do the WTO Rules Against Industrial Policies Hurt Developing Countries? 109 Summary 111 • Vocabulary 112 • Study Questions 112 Chapter 6 The Theory of Tariffs and Quotas read more..

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    xiii Contents Escape Clause Relief 151 Section 301 and Special 301 152 CASE STUDY: Economic Sanctions 152 Summary 154 • Vocabulary 154 • Study Questions 155 Chapter 8 International Trade and Labor and Environmental Standards 156 Introduction: read more..

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    xiv The International Investment Position 203 Summary 204 • Vocabulary 205 • Study Questions 206 APPENDIX A: Measuring the International Investment Position 207 APPENDIX B: Balance of Payments Data 208 Chapter 10 Exchange Rates and Exchange Rate Systems 209 read more..

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    xv Contents Fiscal and Monetary Policy and the Current Account 258 The Long Run 260 CASE STUDY: Argentina and the Limits to Macroeconomic Policy 260 Macro Policies for Current Account Imbalances 262 The Adjustment Process 263 CASE STUDY: The Adjustment Process in the United read more..

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    xvi The North American Free Trade Agreement 311 Two NAFTA-Specific Issues 313 CASE STUDY: Ejidos, Agriculture, and NAFTA in Mexico 314 New and Old Agreements 316 Labor and Environmental Standards 317 Investor-State Relations 319 Job Loss Due to Trade 320 read more..

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    xvii Contents Import Substitution Industrialization 360 Origins and Goals of Import Substitution Industrialization 360 Criticisms of Import Substitution Industrialization 363 CASE STUDY: ISI in Mexico 364 Macroeconomic Instability and Economic Populism 366 Populism in Latin America 367 read more..

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    xviii Is Export Promotion a Good Model for Other Regions? 405 CASE STUDY: Asian Trade Blocs 406 Is There an Asian Model of Economic Growth? 407 Summary 409 • Vocabulary 410 • Study Questions 411 Chapter 17 The BRIC Countries in the World Economy read more..

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    xix International Economics is designed for a one-semester course covering both the micro and macro components of international economics. The Sixth Edition continues the approach of the first five editions by offering a principles-level introduction to the core theories, together with policy analysis and the institutional and historical contexts of international economic read more..

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    xx Preface ■ Chapter 14 has less material on EU institutions and more on the gains from the Single Market Program, together with a new case study on the current problems in the euro area and the costs of monetary union. ■ Chapter 17 examines the BRIC economies; the emphasis on China remains, but new material read more..

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    xxi Preface economy. Some instructors prefer to delve into the theory chapters immediately, reserving this material for later in the course. There is no loss of continuity with this approach. Part 2 presents the micro side of international economics, while Part 3 covers the macro side. These two parts can easily be reversed in sequence if desired. read more..

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    xxii Preface also available online as an additional resource. Finally, the CourseSmart eTextbook for the text is available through . Course- Smart goes beyond traditional expectations, providing instant, online access to the textbooks and course materials you need at a lower cost to students. And, even as students save money, you can save time and hassle read more..

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    xxiii Preface ■ Customization options provide new and enhanced ways to share documents, add content, and rename menu items. ■ Temporary access for students who are awaiting financial aid; a seventeen- day grace period of temporary access. ■ One place for students to access all of their MyLab courses . Students and read more..

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    xxiv Preface Alan Deardorff University of Michigan Craig Depken II University of North Carolina, Charlotte John Devereaux University of Miami K. Doroodian Ohio University Carolyn Evans, Santa Clara University Noel J. J. Farley Bryn Mawr College Ora Freedman read more..

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    xxv Preface Leonie Stone State University of New York at Geneseo Carolyn Fabian Stumph Indiana University, Purdue University, Fort Wayne Rebecca Summary Southeast Missouri State University Jack Suyderhoud University of Hawaii Kishor Thanawala Villanova University Henry Thompson Auburn read more..

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    Introduction and Institutions 1 PA R T read more..

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    2 Introduction: International Economic Integration In August of 2007, a crisis erupted in the housing sector of the United States. At the time, few people realized that the subprime mortgage crisis would become a demon- stration of international economic integration or that it would push the world econ- omy to the brink of collapse. The crisis grew through the read more..

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    Chapter 1 The United States in a Global Economy 3 and greater investment in regions where local capital is scarce, to name a few. But it has also made countries vulnerable to economic problems that have become more easily transmitted from one place to another. Given that the ben- efits and costs of international economic integration are surrounded by contro- versy, it is read more..

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    4 PART 1 Introduction and Institutions By comparison, in 1890 the United States made about 92 percent of its goods and services, a larger share than today, but not radically different. The question as to whether we are more economically integrated today or in some period in the past is not only academic. Between the onset of World War I in 1914 and the read more..

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    Chapter 1 The United States in a Global Economy 5 to sell to foreign markets. Consequently, smaller countries tend to have higher ratios of trade-to-GDP. Figure 1.1 shows the trade-to-GDP ratio for six countries between 1913 and 2010. The decline in trade between the onset of World War I and 1950 is clearly visible in each country, as is the read more..

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    6 PART 1 Introduction and Institutions petition than was the case in 1900. In addition, much of the growth of world trade since 1950 has been accomplished by multinational corporations. With production sites in multiple countries and inputs that pass back and forth between affiliates, multinational corporations have become dramatically important. This trend has been supported read more..

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    Chapter 1 The United States in a Global Economy 7 mentioned, but capital flows also increased in the late 1800s because there were new investment opportunities such as national railroad networks and other infra- structure, both at home and abroad. If we compare the size of capital flows today to the previous era of globaliza- tion, flows today are much larger but mainly read more..

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    8 PART 1 Introduction and Institutions probably earlier. U.S. and world history show a number of such cases. Financial crises are not a new phenomenon, nor have we learned how to avoid them—a fact driven home by the recent subprime mortgage crisis. Features of Contemporary International Economic Relations While international economic integration has been rapid, it read more..

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    Chapter 1 The United States in a Global Economy 9 “Made in China” or “Made in the USA” are less and less meaningful. Low tariffs along with innovations in transportation and communication technolo- gies have enabled firms to locate production of the different components of a sophisticated product in different countries. For example, the hardware for a 3G iPhone is read more..

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    10 PART 1 Introduction and Institutions existed throughout history. What is new is the significant increase in the num- ber of regional trade agreements (RTAs) that have been signed in the last twenty years. The formation of preferential trade agreements is controversial. Trade opponents dislike the provisions that expose more of the national economy to read more..

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    Chapter 1 The United States in a Global Economy 11 Depression of the 1930s, but it did worsen it, and ultimately it led to the misery and tragedy of World War II. There are also the parallel experiences of countries that were divided by war, with one side becoming closed to the world economy, and the other side open. Germany (East versus West), Korea (North versus read more..

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    12 PART 1 Introduction and Institutions Wages, Jobs, and Protection ( Chapters 3 , 6 , 7 , and 8 ) International trade raises national welfare, but it does not benefit every mem- ber of society. Workers in firms that cannot compete may be forced to find new jobs or take pay cuts. The fact that consumers pay read more..

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    Chapter 1 The United States in a Global Economy 13 The Resolution of Trade Conflicts ( Chapters 2 , 7 , and 8 ) Commercial conflicts between nations cover a wide variety of issues and com- plaints. In one sense these conflicts are routine, as the WTO provides a formal dispute resolution procedure that has the assent of most read more..

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    14 PART 1 Introduction and Institutions Financial Crises and Global Contagion ( Chapter 12 ) As international trade and investment barriers declined, and as new communica- tions and transportation systems developed, increasing quantities of capital flowed across national borders. These flows were encouraged by financial inno- vation and a general spirit of read more..

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    Chapter 1 The United States in a Global Economy 15 Export-Led Growth in East Asia ( Chapter 16 ) Throughout the late 1980s and into the 1990s, it was hard to ignore the East Asian “miracle.” While some economists point out that it was not really a miracle—just a lot of hard work and sound economic policies—the growth rates of the read more..

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    16 PART 1 Introduction and Institutions Study Questions All problems are assignable in MyEconLab. 1. How can globalization and international economic integration be measured? 2. In what ways is the U.S. economy more integrated with the world today than it was a century ago? In what ways is it less integrated? 3. read more..

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    17 Learning Objectives After studying Chapter 2 , students will be able to: ■ Classify and give examples of the main types of international economic organi- zations. ■ Compare and give examples of the different levels of integration found in regional trade agreements. ■ Analyze the roles of international read more..

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    18 PART 1 Introduction and Institutions When most people hear the word institution , they probably think of a formal organization. However, economists tend to define institutions more abstractly. For example, the “New Institutionalists,” led by economist Douglas North, have argued that organizations are not institutions in themselves, but are rather the rules that govern read more..

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    Chapter 2 International Economic Institutions Since World War II 19 The IMF, the World Bank, and the WTO Three global organizations play a major role in international economic relations and are central to this book : the International Monetary Fund (IMF), the World Bank, and the World Trade Organization (WTO) . The IMF and the World Bank date from the end read more..

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    20 PART 1 Introduction and Institutions owes on its international borrowings. This is one scenario that warrants a call to the IMF. The IMF makes loans to its members, but it usually extracts a price above and beyond the interest it charges. The price is an agreement by the bor- rower to change its policies so that the problem cannot recur. If simple eco- nomic read more..

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    Chapter 2 International Economic Institutions Since World War II 21 agreements on tariffs and trade rules remained in force as a separate agreement, known as the General Agreement on Tariffs and Trade (GATT). The GATT has been very successful in bringing down trade barriers gradually. One indicator is that international trade has grown over the last fifty years from 5 read more..

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    22 PART 1 Introduction and Institutions discriminate in favor of each other and implicitly against nonmembers. In theory, the WTO permits such agreements as long as they do not harm the overall level of international trade, and in practice, the WTO has never challenged the validity of a trade agreement between member countries. CASE STUDY The GATT Rounds read more..

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    Chapter 2 International Economic Institutions Since World War II 23 tive advantage, since the national government pays part of the cost of pro- duction, either through direct payment or indirectly through subsidized interest rates, artificially cheap access to foreign currency, or some other way. The Tokyo Round began the laborious process of creating rules in this area, one read more..

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    24 PART 1 Introduction and Institutions CASE STUDY Prominent Regional Trade Agreements Each of the fi ve levels of integration is an example of a different kind of regional trade agreement (RTA) , or trade bloc . The question naturally arises as to how many agreements there are and whether they are benefi cial or harm- ful for the world economy. read more..

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    Chapter 2 International Economic Institutions Since World War II 25 other countries, including Chile, Japan, Israel, and Costa Rica, among others. Table 2.4 lists some of the RTAs currently in force. Among the best known are the EU, the EFTA, the NAFTA, MERCOSUR in South America, the ASEAN Free Trade Area in Southeast Asia, and COMESA in eastern and southern read more..

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    26 PART 1 Introduction and Institutions A partial trade agreement is the least comprehensive RTA. It occurs when two or more countries agree to drop trade barriers in one or a few economic sec- tors, such as steel, autos, or any other line of production. Partial trade agree- ments are used when countries are reluctant to open all sectors, but they desire free read more..

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    Chapter 2 International Economic Institutions Since World War II 27 notifications having occurred since 1990. Not all of these agreements are still active, but 338 were considered active at the start of 2012. RTAs are inherently discriminatory since countries in an RTA discriminate in favor of each other and thereby deny most-favored nation treatment to non- RTA members. read more..

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    28 PART 1 Introduction and Institutions domestic effects of a reduction of trade barriers are less dramatic since an RTA covers less than the world economy, and thereby limits the sudden surge of com- petition that might occur if all the WTO nations adopted the same policies. This also allows members to go further and to potentially open more than they would under a read more..

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    Chapter 2 International Economic Institutions Since World War II 29 Bank can withdraw lines of credit to developing countries. The withdrawal of IMF credit raises a red flag for private lenders and makes it more costly for unco- operative nations to gain access to private capital markets. Likewise, the WTO can legitimize retaliatory sanctions against nations that fail to honor read more..

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    30 PART 1 Introduction and Institutions The maintenance of order and the reduction of uncertainty are general tasks that require specific rules in a number of areas of international economic interac- tion, although economists do not completely agree on the specific rules or the specific types of cooperation that should be provided. Nevertheless, the propo- nents of international read more..

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    Chapter 2 International Economic Institutions Since World War II 31 importance of international institutions. The lack of a lender of last resort was particularly critical because a number of countries with temporary financial problems soon passed into full-blown financial collapse. As it became impossible for countries to pay their foreign debts, the crisis spread from the read more..

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    32 PART 1 Introduction and Institutions All parties agreed that in any postwar order the United States would have to be the political, military, and economic leader. The United States had sur- passed Great Britain in wealth and size several decades earlier, and its leader- ship during the war gave it prestige and credibility. In addition, the physical infrastructure of the read more..

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    Chapter 2 International Economic Institutions Since World War II 33 Criticism of International Institutions The World Bank, IMF, WTO, and various regional trade agreements have pro- vided financial resources for development, technical assistance for crisis manage- ment, and mechanisms for opening markets. Not everyone agrees that these efforts are positive on balance, however, read more..

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    34 PART 1 Introduction and Institutions the issue of how hard international institutions should be allowed to push coun- tries to change their policies is an open debate. Closely related to the issue of sovereignty is the issue of transparency. Transparency concerns are based on questions about the decision making that occurs within international institutions. As noted read more..

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    Chapter 2 International Economic Institutions Since World War II 35 the proponents of more controls on capital flows, with more regulations and less open capital markets, will become more influential. This means that the position of the IMF over the last few decades has begun to shift away from completely open capital markets and toward more regulation. As always, the read more..

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    36 PART 1 Introduction and Institutions by the lack of social safety nets to protect unemployed workers and their fami- lies. In order to take advantage of the opportunities presented by greater access to foreign markets, countries may need to construct new infrastructures, for example, roads and ports for moving fresh produce. The ability of developing countries to build read more..

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    Chapter 2 International Economic Institutions Since World War II 37 and are discriminatory. In general, the WTO allows RTAs as long as they create more trade than they divert. ■ International economic institutions are an attempt to overcome the problem of free riding by individual nations in the sphere of providing international public goods. The most read more..

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    38 PART 1 Introduction and Institutions Study Questions All problems are assignable in MyEconLab. 1. What is an institution? Give examples of formal and informal institutions. Explain how they differ from organizations. 2. What are the arguments in favor of international organizations? What are the arguments against them? Which do you read more..

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    International Trade 2 PA R T read more..

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    40 Learning Objectives After studying Chapter 3 , students will be able to: ■ Analyze numerical examples of absolute and comparative advantage. ■ Draw a diagram showing gains from trade. ■ Define and state the differences between the concepts of absolute advantage, comparative advantage, and competitiveness. read more..

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    Chapter 3 Comparative Advantage and the Gains from Trade 41 reflection should be enough to see the mistake in this belief, at least as it applies to voluntary exchange. When a grocery store sells a gallon of milk or a loaf of bread, both the store and the consumer are better off. If that were not the case, the store would not sell or the consumer would not read more..

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    42 PART 2 International Trade well-being. Later, we will examine some of the cases where real-world condi- tions do not conform to the assumptions of the model and where the optimality of free trade is questionable. The basic model is often referred to as a Ricardian model, since it first took form in the analysis of David Ricardo. The model begins by read more..

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    Chapter 3 Comparative Advantage and the Gains from Trade 43 The values in Table 3.2 show that productivity in the making of bread is greater in Canada than in the United States, and that productivity in steel is greater in the United States. Canada has an absolute productivity advantage in bread because it produces more loaves per hour worked read more..

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    44 PART 2 International Trade where Psw the world price of steel (the trade price). Without knowing more details about the demand side of the market, it is impossible to say whether the price will settle closer to 3.0 (the Canadian opportunity cost of steel) or 0.67 (the U.S. opportunity cost). The closer the price is to 0.67, the more Canada read more..

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    Chapter 3 Comparative Advantage and the Gains from Trade 45 Admiral Matthew Perry to accomplish the task. Perry made first contact with Japanese officials in 1853 and signed a limited agreement in 1854. The United States continued to request further opening until a full commercial treaty was signed in 1858 and took effect on July 4, 1859. Following close on the read more..

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    46 PART 2 International Trade The Production Possibilities Curve The production possibilities curve (PPC) shows the trade-offs a country faces when it chooses its combination of bread and steel output. Figure 3.1 illus- trates a hypothetical PPC for the United States. Point B on the PPC is an effi- cient point of production because it utilizes read more..

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    Chapter 3 Comparative Advantage and the Gains from Trade 47 steel. This trade-off is called the relative price of steel or the opportunity cost of steel. The term relative price follows from the fact that it is not in monetary units, but rather in units of the other good. If no trade takes place, then the relative price of a good must be equal to its read more..

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    48 PART 2 International Trade possibilities for the United States are illustrated by the consumption possibilities curve (CPC) . The slope of the CPC is 2, which is the relative price of steel, or the rate at which bread and steel can be traded for each other. The CPC passes through point A because this is the combination of steel and bread that is avail- able read more..

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    Chapter 3 Comparative Advantage and the Gains from Trade 49 The most important thing to note about production point B is that it maxi- mizes U.S. income. This follows from the fact that it makes available the greatest combinations of bread and steel. To see this, consider that no other point of pro- duction puts the United States on a price line that lies farther read more..

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    50 PART 2 International Trade Domestic Prices and the Trade Price Now we know that as long as the trade price is between the pre-trade domes- tic prices in Canada and the United States, both countries can gain from trade. What ensures that the trade price actually settles within this range, 3.0 (loaves >ton) Psw 0.67 (loaves >ton)? What read more..

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    Chapter 3 Comparative Advantage and the Gains from Trade 51 the range we specified earlier, between the opportunity costs in the two coun- tries. In our case, this is between 0.67 and 3.0 loaves per ton. At the extreme, the trade price could be equal to the opportunity cost in one country; for example, if the trade price of steel is 0.67 loaves per ton, then the read more..

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    52 PART 2 International Trade Gains from Trade with No Absolute Advantage Consider the case shown in Table 3.3 . Japan has an absolute advantage in both cars (2 0.5) and steel (2 1) , yet it can still gain from trade, as can Malaysia, even though it lacks an absolute advantage in either good. If Japan does not read more..

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    Chapter 3 Comparative Advantage and the Gains from Trade 53 CASE STUDY Changing Comparative Advantage in the Republic of Korea, 1960–2007 Few countries began life with a more limited set of possibilities than the Republic of Korea (South Korea). Liberated from its forty years of colonial status (1905–1945) by the defeat of Japan in World War II, Korea was read more..

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    54 PART 2 International Trade Comparative Advantage and “Competitiveness” The rhetoric of “competitiveness” is so common in our public discourse that it is useful to consider its relationship to comparative advantage. In the analysis so far, comparative advantage resulted from productivity differences between nations in autarky. In our simple model of a barter economy, read more..

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    Chapter 3 Comparative Advantage and the Gains from Trade 55 In general, by ignoring money wages, money prices, and exchange rates, we assumed that all goods and labor were correctly priced. In other words, we assumed that the prices of outputs and inputs are an accurate indication of their relative scarcity. In this case, there is no difference between a nation’s read more..

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    56 PART 2 International Trade nation’s overall standard of living to be lower than it would be otherwise. Businesses are not designed to ensure that resources are efficiently allocated at the national level. If they can legally tip the playing field in their direction, they will not hesitate. Another important distinction between nations and business enterprises is read more..

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    Chapter 3 Comparative Advantage and the Gains from Trade 57 another branch of economic analysis, such as labor economics, and from outside economics. It is widely recognized, however, that changes in trade patterns, whether they are due to trade agreements, a unilateral reduction in trade barri- ers, technological breakthroughs, or any other cause, will result in some disloca- read more..

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    58 PART 2 International Trade CASE STUDY Losing Comparative Advantage The case study on Korea shows that comparative advantage is not fi xed in time but changes as countries develop their economies. Changing comparative advantage cuts two ways, however, and some production stops being an effi - cient use of a country’s capital and labor. In the Korean case, read more..

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    Chapter 3 Comparative Advantage and the Gains from Trade 59 low-cost and high-cost producers. As shown, low-cost countries produce less but depend more on cotton exports, as their very low levels of income put them close to the edge of survival and they have fewer goods to export. High-cost producers depend much less on their cotton exports and have much higher read more..

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    60 PART 2 International Trade Summary ■ The single most important determinant of trade patterns is the opportunity cost of producing traded goods. Countries that sacrifice the least amount of alternative production when producing a particular good have the lowest opportunity cost, or a comparative advantage. The idea of comparative advantage has been one read more..

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    Chapter 3 Comparative Advantage and the Gains from Trade 61 Study Questions All problems are assignable in MyEconLab. 1. Use the information in the following table on labor productivities in France and Germany to answer questions a through f. Output per Hour Worked France Germany Cheese 2 kilograms 1 kilogram Cars 0.25 read more..

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    62 PART 2 International Trade e. What are the upper and lower bounds for the trade price of cheese? f. Draw a hypothetical PPC for France and label its slope. Suppose that France follows its comparative advantage in deciding where to produce on its PPC. Label its production point. If the trade price of cars is 5 kilo- grams of cheese per car, read more..

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    63 Learning Objectives After studying Chapter 4 , students will be able to: ■ Explain the Heckscher-Ohlin Trade Model. ■ Diagram the changes in production and show gains from trade after a country begins to trade. ■ Predict the impacts on different factors of production of trade-opening. ■ read more..

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    64 PART 2 International Trade and its own resources, and that differences among nations would give rise to productivity differences. In the twentieth century, several economists devel- oped a more detailed explanation of trade in which the comparative advan- tage of a country depends on its endowments of the inputs (called factors of production, or simply, factors read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 65 The Heckscher-Ohlin (HO) trade theory makes this point exactly. It asserts that a country’s comparative advantage lies in the production of goods that inten- sively use relatively abundant factors. To clarify, consider the United States. It is richly endowed with a wide variety of factors. It has natural resources read more..

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    66 PART 2 International Trade one before. The reason is straightforward: If more bread is wanted, resources must be taken out of steel. The optimal strategy is to move resources that are relatively good at bread production, but poor at steel production. This leads to the greatest gain in bread with the smallest loss of steel. The next shift in produc- tion, toward read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 67 curve, trading steel for bread. As before, line CPC is both the trade line showing the rate at which bread and steel exchange for each other, and it is the consumption possibilities curve (CPC) since it shows the possible consumption bundles when production is at A and trade occurs. In Figure 4.3 read more..

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    68 PART 2 International Trade At point B, the opportunity cost of steel equals its trade price. Since the model is symmetric and the opportunity cost and trade price of bread are the inverse of the steel, the same equivalency holds for bread. To the left of B, the opportunity cost of steel (bread) is less (greater) than the trade price, so more (less) produc- read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 69 losers adds an important and necessary element of realism. We are all aware that not everyone favors increased trade, and without an analysis of trade’s income distribution effects, we have no basis for understanding the opposition to increased trade. The Stolper-Samuelson Theorem Everyone’s income depends on the read more..

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    70 PART 2 International Trade According to the HO theory, the United States will have a comparative advan- tage in steel, which it will export in return for Canadian bread. In Figure 4.4 , after trade begins, the United States moves along its PPC toward the steel axis from point A to point B. As the United States shifts along its PPC, the change read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 71 move to the steel sector, it could be hurt much worse than if it were completely flexible to move. Another example illustrates this point: Within the debate over U.S.-Mexico free trade, there was a small, but intense, controversy surrounding avocado production. Mexico has a comparative advantage in avocados because it is read more..

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    72 PART 2 International Trade goods. The specific factors (land and capital) are immobile and cannot move between bread and steel, while the variable factor (labor) is completely mobile between industries. The determinants of comparative advantage with a specific factors model are similar to the analysis with an HO model. As with HO, comparative advan- tage depends on read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 73 CASE STUDY Comparative Advantage in a Single Natural Resource Natural resources are a source of comparative advantage in many countries. Chile has copper, Botswana has diamonds, and Saudi Arabia has oil. Crude oil is probably the most important geopolitical resource today, and it is cer- tainly the largest read more..

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    74 PART 2 International Trade Empirical Tests of the Theory of Comparative Advantage All the popular theories of trade are variations on the idea of comparative advan- tage, and each theory makes predictions about the goods that a country will export and import. Therefore, it should be relatively straightforward to test each theory by holding its predictions up to read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 75 The trade theories presented here and in Chapter 3 are the two most widely accepted by economists—the Ricardian theory of trade, based on relative produc- tivities, and the Heckscher-Ohlin theory, based on factor endowments. In the Ricardian theory discussed in Chapter 3 , read more..

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    76 PART 2 International Trade In Chapter 5 we will leave the comparative advantage framework and look at cases where trade is not determined by productivity differences or factor endowments. The Product Cycle The product cycle model of trade was developed by Raymond Vernon. The model is an insightful analysis that incorporates ideas about read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 77 manufacturing processes become standardized, they can be performed by rela- tively unskilled labor. In effect, the blend of inputs changes over time, from highly skilled scientific, engineering, and marketing elements to basic unskilled and semiskilled labor. Consequently, the opportunity cost of production in devel- oping countries read more..

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    78 PART 2 International Trade CASE STUDY United States–China Trade According to the World Bank, China is the world’s most populous country, with more than 1.34 billion people, and it has the second largest economy after the United States, with GDP equivalent to 5.9 trillion U.S. dollars in 2010. China’s economy was substantially closed to the outside until read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 79 Foreign Trade versus Foreign Investment In the product cycle, firms invest abroad instead of exporting, and some of the output may be imported back into the home country. This pattern is very differ- ent from the simple Heckscher-Ohlin model where countries export one good and import another. First, it implies read more..

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    80 PART 2 International Trade the financial crisis, they have received “only” 65 percent of foreign investment (while making over 80 percent), which is down from a more normal 75 percent received before the crisis, but is still nearly two-thirds of all FDI. Research into the trade-offs between investing abroad versus exporting from a home base acknowledges the importance of read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 81 mobile and will use the comparative advantages they find in different locations. In this sense, it demonstrates how those advantages motivate individual firms to adapt their own behavior. Off-Shoring and Outsourcing Off-shoring and outsourcing are frequently used terms, but with varying defini- tions. In read more..

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    82 PART 2 International Trade The main focus of debate about off-shoring, whether in services or manufac- turing, is the effect that it has on the home country, and in particular, the issue of job loss. Off-shoring is particularly unsettling for workers who felt immune from international trade, such as service workers, and it seems to be another instance of creeping read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 83 Migration and Trade According to the World Bank, in 2010 there were more than 215 million interna- tional migrants spread across the globe. Nearly 80 percent were in high-income countries, and almost 20 percent were in the United States alone. International migration is not considered a possibility in the HO model. read more..

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    84 PART 2 International Trade terms of the individual migrant and the underlying incentives to migrate. In this view, economic incentives play a major role by determining the factors that cause migrants to leave and the factors that attract them to a particular destination. Economists refer to supply-push factors as the forces inside a country that cause people to read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 85 1997 (a growth of almost 50 percent), largely based on the availability of low- wage, unskilled immigrant workers. Given that apparel is a declining sector in the United States, immigrant labor appears to have postponed the decline of the industry in California for about a decade. Other U.S. examples of where immi- read more..

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    86 PART 2 International Trade The second issue concerns the impact of trade with less-developed countries (LDCs) on the wages of workers in the advanced industrial economies. This question has been studied by many economists, and the general consensus is that trade may have caused some of the decline in wages for the less skilled (and, hence, some of the increase read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 87 other country is likely to have components from a wide range of countries. Mod- ern production processes span the globe, particularly when we examine sophis- ticated high technology products. Firms fi nd it advantageous to off-shore and to out-source different pieces of the production process, and then bring the parts read more..

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    88 PART 2 International Trade Summary ■ The Heckscher-Ohlin (HO) model hypothesizes that comparative advan- tage is based on national differences in factor endowments. Countries export goods that have production requirements that are intensive in the nation’s relatively abundant factors. They import goods that require inten- sive input from the nation’s read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 89 Vocabulary demand-pull factors derived demand factor abundance factor scarcity foreign affiliate Heckscher-Ohlin (HO) trade theory intrafirm trade magnification effect off-shoring OLI theory outsourcing read more..

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    90 PART 2 International Trade Study Questions All problems are assignable in MyEconLab. 1. According to the following table, which country is relatively more labor- abundant? Explain your answer. Which country is relatively more capital- abundant? United States Canada Capital 40 machines 10 machines Labor 200 workers 60 workers read more..

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    Chapter 4 Comparative Advantage and Factor Endowments 91 OLI theory explain the trade-offs GM faced as it decided whether to export to those two markets or to produce in them? 9. Many domestically owned apparel manufacturers buy their garments over- seas, sew their labels into them, and then sell them abroad or back into the home market. What are some read more..

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    92 Introduction: More Reasons to Trade Comparative advantage is the foundation of our understanding of the gains from trade and the potential income distribution effects of trade. Unfortunately, trade models built exclusively on the idea of comparative advantage have a mixed record when it comes to predicting a country’s trade patterns. This is an important read more..

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    Chapter 5 Beyond Comparative Advantage 93 odds with the bread-for-steel examples shown in Chapters 3 and 4 . In the second section of the chapter, we examine industrial clustering. Many traded goods and services that are essential parts of a country’s exports are produced in regional clusters. For example, the U.S. advantage in entertainment products read more..

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    94 PART 2 International Trade and a country that exports computers and imports pencil sharpeners would engage in intraindustry trade. In general, the more broadly an industry is defined, the more trade appears to be intraindustry. Conversely, the more detailed the definition, the less trade is defined as intraindustry. Evidence suggests that intraindustry trade is greater in read more..

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    Chapter 5 Beyond Comparative Advantage 95 Often, internal economies lead to the relatively common market structure called monopolistic competition . Recall that in a pure monopoly, one firm pro- duces the entire industry output. In monopolistic competition, there is competi- tion among many firms, but their competition is attenuated by the practice of product differentiation read more..

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    96 PART 2 International Trade the total number of firms in the market. It slopes upward because as more firms enter the market, the quantity each existing firm sells is reduced and the average cost of production increases. At prices above P 1 , new firms have an incentive to enter the market since price exceeds average cost. At prices below P 1 , just read more..

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    Chapter 5 Beyond Comparative Advantage 97 firms to produce for a larger market and at a higher level of efficiency. That raises everyone’s real income through the reduction in prices. The expansion of the market that occurs with trade ultimately leads to an increase in the number of firms. This follows from the fact that exports costs are below the selling price, read more..

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    98 PART 2 International Trade CASE STUDY United States and Canada Trade In 1965, the United States and Canada implemented a free-trade policy that covered autos and auto parts. The results were dramatic, particularly on the Canadian side of the border. Before the Auto Pact, Canada required most cars sold domestically to be made inside the country. The relatively read more..

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    Chapter 5 Beyond Comparative Advantage 99 Trade and Geography Paul Krugman, winner of the 2008 Nobel Prize in Economics, has stated that international trade is really about geography and the decision every firm must make about the location of its activities. Produce at home or abroad? If abroad, then in which country? If at home, in what part of the country? read more..

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    100 PART 2 International Trade it was noted in Chapter 4 that most foreign investment in the world today is directed toward high-income countries, not toward developing countries. Largely this is because high-income countries have larger markets, and firms find it con- venient to locate next to the market. All other factors being equal, the lower read more..

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    Chapter 5 Beyond Comparative Advantage 101 External Economies of Scale External economies of scale occur when firms become more productive as the number of firms in the industry increases, but individual firms may or may not have an economic incentive to increase in size. External economies may occur for several reasons. First, if the firms in a region produce similar read more..

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    102 PART 2 International Trade spillovers are particularly important in frontier industries undergoing rapid tech- nological change, and they seem to be very sensitive to the face-to-face contact that is impaired by geographical distance. A second form of external economies of scale occurs when the presence of a large number of producers in one area helps to create a deep read more..

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    Chapter 5 Beyond Comparative Advantage 103 a consortium of European governments used large subsidies and other interven- tions to foster a European competitor, Airbus. Once the U.S. lead was established, other countries with essentially the same technological ability as the United States could never catch up, even though in theory they had the capacity to achieve the same level read more..

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    104 PART 2 International Trade activity explicitly. As the name and example imply, industrial policies are govern- ment policies designed to create new industries or to support existing ones. Not surprisingly, industrial policies are controversial; so much so, that recent international agreements limit the scope of action that countries can take to sup- port their industries. In read more..

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    Chapter 5 Beyond Comparative Advantage 105 children. Note that externalized costs or benefits do not mean that they disap- pear and are of no consequence. From an economic viewpoint, they are as impor- tant as any other costs or benefits even though they do not fall on the individuals or firms that created them. There are two simple rules for analyzing cases of market read more..

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    106 PART 2 International Trade As can be seen in Figure 5.3 , private markets lead to output Q 1 at price P 1 . From the standpoint of the social optimum, however, the price is too high and the quantity is too low. The social optimum, at P 2 and Q 2 , takes into account the costs and benefits that are external to the producing read more..

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    Chapter 5 Beyond Comparative Advantage 107 products. Nevertheless, the rules generally allow governments to subsidize “precompetitive” activities such as research, and the distinction between the two can be blurry at times. It is not necessary, however, to provide direct subsidies to targeted industries in order to support them. Governments have a wide range of options, ranging from read more..

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    108 PART 2 International Trade benefits, particularly if they are spread throughout the economy and if they are only realized over a long period of time. Without the advantage of hard numbers, it is easy to imagine a situation where a government program spends $100 million to capture $50 million of external benefits. A second problem is determining which industry read more..

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    Chapter 5 Beyond Comparative Advantage 109 CASE STUDY Do the WTO Rules Against Industrial Policies Hurt Developing Countries? The Uruguay Round of the General Agreement on Tariffs and Trade (GATT) accomplished more than the creation of the WTO and the lowering of tariffs. It created new agreements in a range of areas, including trade in services, investment read more..

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    110 PART 2 International Trade grant to foreign investment on the use of local inputs or on export perfor- mance. Historically, many countries used performance requirements to link foreign investors with local manufacturers. For example, they required a cer- tain percentage of domestic content to be used in the plants built by foreign investors in order to increase domestic read more..

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    Chapter 5 Beyond Comparative Advantage 111 Summary ■ Comparative advantage cannot account for a significant part of world trade. In many countries, well over 50 percent of the merchandise trade is intrain- dustry, and for the United States and a number of other large economies, it is over two-thirds. ■ Intraindustry trade is not based on read more..

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    112 PART 2 International Trade Vocabulary export processing zone (EPZ) external economies of scale externality industrial policy interindustry trade internal economies of scale intraindustry trade maquiladora market failure monopolistic competition New Trade read more..

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    Chapter 5 Beyond Comparative Advantage 113 4. What are three key incentives for firms in a particular industry to cluster together in a geographical region? 5. How might trade hurt a country if it imports goods that are produced under conditions of external economies of scale? 6. When the United States signed a read more..

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    114 Introduction: Tariffs and Quotas Chapters 6 and 7 are an introduction to the theory and policy of tariffs and quotas. In the economics literature, this analysis is called commercial policy . Chapter 6 is an introduction to tariff theory and Chapter 7 focuses on an empirical estimate of the read more..

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    Chapter 6 The Theory of Tariffs and Quotas 115 the analysis in Chapter 6 is known as partial equilibrium analysis because it considers the effects of tariffs and quotas on only a part of the economy—the market in which the trade barrier is erected. Before we turn to tariff analysis, however, we must introduce two important concepts: read more..

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    116 PART 2 International Trade goods. The easiest strategy for most firms is simply to charge everyone the same price, so consumer surplus is a real savings for most consumers in most markets. On the production side, the analogous concept is called producer surplus . In our hypothetical milk example, if you owned a dairy farm and were willing and able to produce read more..

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    Chapter 6 The Theory of Tariffs and Quotas 117 however, we must begin with a description of the effects of tariffs on prices, domestic output, and domestic consumption. Figure 6.2 shows the domestic or national supply and demand for an imported good. We are assuming that there is one price for the good, which we will call the world price, or P w read more..

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    118 PART 2 International Trade increasing costs while remaining competitive with foreign firms. Finally, imports decrease from Q 1 Q 2 to Q 1 *Q 2 *. To summarize, tariffs cause the domestic price to rise by the amount of the tariff, domestic consumption falls, domestic produc- tion rises, and imports fall. Resource Allocation and Income Distribution read more..

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    Chapter 6 The Theory of Tariffs and Quotas 119 worse off, it makes producers better off by the same amount. Therefore, the nation as a whole is neither better nor worse off unless it can be established that giving the resources to producers somehow benefits or harms national welfare. This part of the lost consumer surplus is an income distribution effect of the tar- read more..

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    120 PART 2 International Trade TABLE 6.1 Economic Effects of the Tariff in Figure 6.3 Variable Free Trade Post-Tariff Price to consumers P w P t Domestic consumption Q 2 Q 2 * Domestic production Q 1 Q 1 * Imports Q 1 Q 2 Q 1 *Q 2 * Consumer surplus a b read more..

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    Chapter 6 The Theory of Tariffs and Quotas 121 Because it is difficult to gather information on tariff rates for a large num- ber of countries, we must interpret the data in Figure 6.4 with caution. The year-to-year data in each group of countries varies in the number of countries included in the group average. Furthermore, tariffs are only one form of read more..

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    122 PART 2 International Trade Other Potential Costs These effects of tariffs are the ones that are most predictable and quantifiable. In Chapter 7 there are some actual estimates of the production and income distribu- tion effects of tariffs and quotas for a number of industries in the United States, Europe, and Japan. These are not the only read more..

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    Chapter 6 The Theory of Tariffs and Quotas 123 The Large Country Case Economists distinguish between large and small countries when it comes to tariff analysis. As a practical matter there may not be much difference between the two, but in theory it is possible for large countries to actually improve their national welfare with a tariff as long as their trading read more..

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    124 PART 2 International Trade As long as g b d , a large country can improve its welfare by imposing a tariff. This outcome, however, assumes that there is no retaliation, rent seeking, or harmful effects on innovation. Effective versus Nominal Rates of Protection One of the ironies of tariff protection is that often it is not what it read more..

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    Chapter 6 The Theory of Tariffs and Quotas 125 the United States ($1,000 $600 $400) . If the United States imposes a 20 per- cent tariff, then the price rises to $1,200. Value added in the United States is now $600 ($1,200 $600), and the effective rate of protection is 50 percent (($600 $400)/$400). That is, a 20 percent tariff provides 50 read more..

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    126 PART 2 International Trade One of the biggest potential changes in world trade patterns coming out of the Uruguay Round was the negotiation of a separate Agreement on Textiles and Clothing (ATC). Until 1994, textiles and clothing had a separate interna- tional agreement, called the Multi-Fiber Arrangement, which was a system of quotas and tariffs. Under the ATC, read more..

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    Chapter 6 The Theory of Tariffs and Quotas 127 Analysis of Quotas The economic analysis of quotas is nearly identical to that of tariffs. Quotas are quantitative restrictions that specify a limit on the quantity of imports rather than a tax. The net result is much the same: tariffs and quotas lead to a reduction in imports, a fall in total domestic consumption, read more..

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    128 PART 2 International Trade further divided by country; so, for example, Hong Kong and Haiti had different limits on each type of apparel that they could export to the United States. Another type of quota is an import licensing requirement. The United States uses this form infrequently, but many other nations have relied on these quotas for the bulk of their read more..

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    Chapter 6 The Theory of Tariffs and Quotas 129 D S Price Pw Q1 Q2* Q2 Quantity FIGURE 6.6 Analysis of a Quota: 1 A quota restricts imports to line segment Q 1 Q 2 * and creates excess demand equal to Q*Q 2 . S D c Price Pq P w Q 1 Q 1 * Q 2 * Q 2 Quantity FIGURE 6.7 Analysis of a Quota: 2 The quota read more..

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    130 PART 2 International Trade assumes that the country is relatively small and the increase in its demand does not alter the world (pre-tariff) price. Given this difference, it is not sur- prising that domestic firms prefer quotas over tariffs as a form of protection for their industry. Two circumstances can mitigate or limit the ability of foreign suppliers to read more..

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    Chapter 6 The Theory of Tariffs and Quotas 131 the United States and the EU have a long-running disagreement over the EU’s prohibition of imports of beef and pork from livestock that is fed growth hormones. The EU claims that this is to protect the health of its consumers, while the United States argues that there is no scientific evidence to support the ban. read more..

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    132 PART 2 International Trade enforcement of protections for intellectual property. Since the implementa- tion of the Uruguay Round in 1995, there have been thirty-one intellectual property complaints brought to the WTO, most having to do with patents, and a large share of those related to pharmaceuticals. It is probably impossible to prevent copyright infringements that read more..

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    Chapter 6 The Theory of Tariffs and Quotas 133 Summary ■ Tariffs increase domestic production and employment at the cost of greater inefficiency and higher prices. Production and distribution effects are measured by estimating the changes in producer surplus and consumer surplus. ■ In addition to short-run welfare and efficiency effects, read more..

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    134 PART 2 International Trade Study Questions All problems are assignable in MyEconLab. 1. Graph the supply and demand of a good that is produced domestically and imported. Assume that the country is not large enough to affect the world price. Illustrate the effects that a tariff on imports has. Discuss the following: a. Income read more..

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    Chapter 6 The Theory of Tariffs and Quotas 135 7. Suppose that in the United States bikes are built from a combination of domestic and foreign parts. a. If a bike sells for $500 but requires $300 of imported parts, what is the domestic value added? b. If a 20 percent tariff is levied on bikes of the same quality and with read more..

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    136 Introduction: Commercial Policy, Tariffs, and Arguments for Protection Tariffs around the world have come down significantly in the last few decades, leading to rapid increases in the volume of world trade. Countries have converted many of their quotas into tariff-equivalents, and new agreements on subsidies, foreign invest- ment, and intellectual property, have been read more..

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    Chapter 7 Commercial Policy 137 due to further tariff reductions are also relatively small in terms of world GDP. Chapter 7 looks at these numbers and asks why economists still favor further reductions in trade barriers if the gains are not great. There are several reasons to pursue further market openings, not the least of which is that the read more..

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    138 PART 2 International Trade high-income countries. If tariff cuts have diminishing marginal returns, so that each successive round of cuts leads to a smaller gain than the cuts before, it is reasonable to guess that future cuts are not likely to have a large impact on world trade and income. Large is relative, but thinking back to the case study of Japan in read more..

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    Chapter 7 Commercial Policy 139 The Costs of Protectionism There are several reasons why further trade opening is beneficial even if the dol- lar values of the gains are not that high. Some economists argue that the failure of the Doha Round of negotiations will undermine the legitimacy of the world trading system and have potentially severe consequences in the read more..

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    140 PART 2 International Trade This exercise does not discuss the desirability of maintaining a strong and vibrant clothing sector, nor does it explain whether societies are better or worse off if they have larger employment in each of the three sectors. It is not an exer- cise that is useful for understanding the role of agriculture in national culture, nor the read more..

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    Chapter 7 Commercial Policy 141 are in the form of higher prices on candy bars, soft drinks, and other products containing sugar. Few of us work in the sugar industry, so the argument that our jobs depend on it is weak at best. In a surprising way, however, we probably permit our tariffs and quotas because of a version of the jobs argument. The economist Mancur read more..

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    142 PART 2 International Trade made in the rules for agricultural trade. Many quotas were converted to tar- iffs, and industrial countries agreed to reduce their direct support for the farm sector by 20 percent. Indirect supports such as research and develop- ment and infrastructure construction were recognized as necessary, desir- able, and permissible. While direct-support read more..

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    Chapter 7 Commercial Policy 143 Why Nations Protect Their Industries Trade protectionism is used in different times and places to achieve a variety of potential goals. Very few countries have zero tariffs across all industries (Hong Kong is the only country, although some others such as Singapore have very few and very low tariffs), but many countries have low read more..

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    144 PART 2 International Trade each region. The takeaway from Table 7.4 is that poorer regions (Africa, South Asia, parts of the Middle East) rely more on tariffs as a source of government revenue. Tariffs may still be used for other purposes, but for some countries, the primary goal is to generate income for the operation of government services. read more..

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    Chapter 7 Commercial Policy 145 workers and incentives for employers to hire them are far less expensive than trade policy for this purpose. If the goal is to keep a particular sector alive, then direct subsidies to the producers are preferable because they do not have the distortions that result from forcing consumers out of the market. The Infant Industry read more..

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    146 PART 2 International Trade The National Security Argument Every nation protects some industries as a way to guard its national security. The most obvious examples include weapons industries, and somewhat more broadly, strategic technologies. Most countries refuse to trade military technologies or weapons with potential adversaries, and some nations also include strategic read more..

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    Chapter 7 Commercial Policy 147 Economic analysis is of limited utility in understanding this situation, since the outcome depends on political processes that determine how nations respond to pressure, their willingness to negotiate, and the outcome of negotiations. There are three camps of economists on this issue. One camp argues that free trade is beneficial regardless of the read more..

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    148 PART 2 International Trade used for over four thousand years in Indian traditional medicine. Never- theless, Patent No. 5,401,504 was granted by the U.S. Patent Office to the University of Mississippi for its use as a healing agent. As a practical mat- ter, the patent probably would have been unenforceable, but it might have imposed a legal requirement on traditional read more..

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    Chapter 7 Commercial Policy 149 The Politics of Protection in the United States Although U.S. trade with the rest of the world has grown, political pressures to protect domestic industries have frequently been intense. One reason for this is that Congressional reforms removed some of the insulation from industry lobby- ists that Congress enjoyed in the 1950s and 1960s. read more..

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    150 PART 2 International Trade Antidumping Duties An antidumping duty (ADD) is a tariff levied on an import that is selling at a price below the product’s fair value . The determination of fair value introduces an element of subjectivity into the process of justifying an antidumping duty, as does the fact that the legal analysis and the economic read more..

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    Chapter 7 Commercial Policy 151 Second, within the scope of normal commercial operations, firms often sell below cost. The most obvious case is that of goods that are likely to spoil. A fresh fish exporter with a load sitting on a dock is likely to lower the price progres- sively as time passes. In this case, the cost of producing the shipment of fish rep- read more..

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    152 PART 2 International Trade Section 301 and Special 301 Section 301 of the U.S. Trade Act of 1974 requires the president’s chief trade negotiator, the United States Trade Representative (USTR), to take action against any nation that persistently engages in unfair trade practices. The action usually begins with a request for negotiations with the targeted read more..

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    Chapter 7 Commercial Policy 153 are often accompanied by additional measures, ranging from diplomatic pressure to military invasion. The logical question to ask about sanctions is “Do they work?” In an impor- tant two-volume study of this question, three economists analyzed 120 episodes of economic sanctions throughout the world since World War I. Table 7.5 read more..

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    154 PART 2 International Trade Summary ■ Regardless of their cost or their ability to achieve a desired objective, every nation uses trade barriers. In most industrial nations, they are not used to develop comparative advantage in new industries, but rather to protect old industries that can no longer compete or to temporarily pro- tect industries read more..

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    Chapter 7 Commercial Policy 155 Study Questions All problems are assignable in MyEconLab. 1. Which industries are more heavily protected in the United States and Japan? Are high-income or low-income nations more affected by American and Japanese trade barriers? Explain. 2. What new areas of trade and investment received coverage under the read more..

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    156 Introduction: Income and Standards Since the end of World War II, many of the formal barriers to international trade have been removed. This was accomplished through the sustained efforts of the world’s trading nations, often working through the negotiating frameworks pro- vided by the General Agreement on Tariffs and Trade (GATT), the World Trade read more..

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    Chapter 8 International Trade and Labor and Environmental Standards 157 these areas for various reasons. For example, the adoption of a common set of product standards gives a significant commercial advantage to firms already producing to the standard, and hence, each country would like to see wider application of its own standards. Another reason behind many of the conflicts read more..

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    158 PART 2 International Trade practice in either country. A third option is separate standards . In this case, countries keep their own standards and refuse to recognize those of anyone else. For example, if the home country has a more stringent rule for pesticide residue on vegetables after harvest, then with separate standards it prohibits imports that are read more..

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    Chapter 8 International Trade and Labor and Environmental Standards 159 CASE STUDY Income, Environment, and Society The World Bank uses four categories to classify the countries of the world according to their income levels. High-income countries have per capita incomes (2010, U.S. dollars) of $12,276 or more, upper-middle-income coun- tries range between $3,976 read more..

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    160 PART 2 International Trade Labor Standards Recently, the United States and other countries have demanded that labor and environmental standards be included in all future trade negotiations. This is a politically charged issue that is likely to come and go over time, depending in part on the political party in power, but it also reflects rising worldwide read more..

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    Chapter 8 International Trade and Labor and Environmental Standards 161 ment mechanism, both in existing agreements and in future agreements, including those reached by the WTO. The complaints against trade by labor and environmental interests are rela- tively similar. In both cases, it is alleged that trade with countries that have lower standards creates a race to the read more..

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    162 PART 2 International Trade CASE STUDY Child Labor The most common defi nition of a child is a person under 18 years of age. This is the defi nition set forth by the United Nations and the International Labour Organization (ILO; see the next case study) and accepted by most countries. Many children are economically active without falling into the read more..

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    Chapter 8 International Trade and Labor and Environmental Standards 163 causes. Agriculture is the primary user of children’s labor (60 percent of all child labor), with services second (25.6 percent) and industry (manufacturing, construction, mining, and utilities) third (7 percent of all child laborers). Very few children work in export-oriented sectors and, in general, the read more..

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    164 PART 2 International Trade demand. That is, if a small country such as the Netherlands decides that garment producers in Haiti are exploiting children, no trade barrier that the Netherlands erects against imports from Haiti is likely to reduce demand enough to stop the offending Haitian practice. Only countries that constitute a significant share of the Haitian market read more..

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    Chapter 8 International Trade and Labor and Environmental Standards 165 The Specific Content of Labor Standards The problem of reaching agreement on the specific content of standards has yet to be resolved. We have seen how child labor varies by income, and that even the definition of a child varies across coun- tries. For example, disputes over the minimum age read more..

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    166 PART 2 International Trade Low labor standards are highly correlated with a labor force that has an abun- dance of illiterate and unskilled workers. Furthermore, it is a sign that the nation’s infrastructure of roads, ports, power supply, telecommunications, schools, and sanitation are also undeveloped. Hence, the labor cost savings of low labor standards is more than read more..

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    Chapter 8 International Trade and Labor and Environmental Standards 167 Trade and the Environment Over the last forty years, the realization has grown that our activities profoundly affect the natural environment. Unfortunately, our production and consumption choices do not always reflect the environmental costs of our decisions, and in the short run, our economies too often read more..

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    168 PART 2 International Trade into trade agreements believe that trade sanctions—tariffs, quotas, prohibitions on imports—should be used as enforcement mechanisms, while the critics of trade sanctions have the same concerns raised earlier: They are relatively ineffec- tive, there is a hazy borderline between protectionism and concern for the envi- ronment, there is a lack of read more..

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    Chapter 8 International Trade and Labor and Environmental Standards 169 losing theirs. Regardless, there is strong evidence showing that the idea of pollu- tion havens is invalid; that is, it is impossible to identify any country that success- fully competes for new investment on the basis of low environmental standards. The fact that there are no pollution havens is good news, read more..

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    170 PART 2 International Trade imports that were not certifi ed as “dolphin-safe.” Mexico lodged a complaint, and the outcome of the investigation was a GATT ruling that countries cannot prohibit imports based on the method of production, as long as the goods are legal. Because the United States allowed tuna to be sold in its market, it could not keep out tuna read more..

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    Chapter 8 International Trade and Labor and Environmental Standards 171 Alternatives to Trade Measures Currently, it is impossible to predict how, or even if, trade rules might eventually change to accommodate labor and environmental standards. These are new issues for the world trading system, and it is possible that they will become a per- manent source of tension read more..

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    172 PART 2 International Trade Labels for Exports The idea of labeling is widespread and has been implemented with mixed suc- cess. This idea is a certification process producing a label that is attached to the good when it is exported. The label tells consumers that the good was produced under conditions that are humane or environmentally sustainable. This method read more..

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    Chapter 8 International Trade and Labor and Environmental Standards 173 The advantage of this approach is that it addresses the issue of a race to the bottom by making it impossible for a home-based company to exploit low labor or environmental standards abroad, while, at the same time, preserving access to the low-wage labor of labor-abundant countries. Furthermore, this read more..

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    174 PART 2 International Trade CASE STUDY Global Climate Change A consensus of climate scientists tell us that global warming is happening and that it is caused by human activity. There are some scientists that dis- agree, and consultants hired by energy companies and others with a fi nancial stake in fossil fuels sometimes try to create doubt, but most read more..

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    Chapter 8 International Trade and Labor and Environmental Standards 175 Economics does lead to a set of tools and analysis that helps society under- stand the net value of remediation efforts, however, and is essential for evaluating the different policy proposals for addressing the problems of cli- mate change. Economics can evaluate the costs and benefits along the entire read more..

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    176 PART 2 International Trade Summary ■ The increase in world trade over the last fifty years has reduced tariffs and eliminated quotas, but as a result, many domestic policies have become unintentional barriers to trade. Examples include competition policies, product standards, health and safety standards, and labor and environ- mental standards. read more..

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    Chapter 8 International Trade and Labor and Environmental Standards 177 Vocabulary core labor standards harmonization of standards high-income, upper-middle- income, lower-middle-income, and low-income countries informal economy International Labour Organization (ILO) mutual recognition of standards pollution havens read more..

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    178 PART 2 International Trade 3. When high-definition television (HDTV) was first considered a possibility in the United States, the U.S. government held a competition to select the tech- nical standards that would be used nationwide. Why would the government see an advantage to setting one standard, and what are the pros and cons for the private businesses read more..

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    International Finance 3 PA R T read more..

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    180 Introduction: The Current Account The international transactions of a nation are divided into three separate accounts: the current account , the capital account , and the financial account . For most countries, the capital account is relatively minor, and the two most important accounts are the current and financial accounts. The current read more..

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    Chapter 9 Trade and the Balance of Payments 181 billion worth of aircraft, software, grains, trips to Disneyworld, and other goods and services. The difference between exports and imports of goods and services is called the trade balance . For the United States, the 2011 trade balance was $2,105 billion minus $2,655 billion, or −$560 billion. Because the number is read more..

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    182 PART 3 International Finance The investment income items in Table 9.1 are not movements of investment capital but the income received or income paid on previous flows of financial capital. For example, financial capital sent to Germany to buy a bond would not be included, but the interest received on the bond would be. (The funds that leave the read more..

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    Chapter 9 Trade and the Balance of Payments 183 Figure 9.1 . Large deficits in the current account began around 1982, and have been more or less a constant feature of the U.S. economy since then. Although the deficit turned into a small surplus of $6.6 billion in 1991 (partly due to large unilateral transfers received by the United States as payment for read more..

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    184 PART 3 International Finance other fixed assets, such as transfer of ownership of a military base or an embassy. The annual total of these flows is relatively small for most countries. The financial account is divided into three categories: (1) net changes in U.S.- owned assets abroad, (2) net changes in foreign-owned assets in the United States, and (3) net read more..

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    Chapter 9 Trade and the Balance of Payments 185 A large share of a nation’s financial account transactions, however, is not in response to the current account flows of goods and services. For example, a London- based investment company may buy stock in a Chilean firm, lend money to the government of Thailand, and engage in any number of financial transactions that read more..

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    186 PART 3 International Finance shares in the Mexican stock market (capital outflow), he or she must sell Cana- dian dollars or some other asset (capital inflow). (If he or she pays for the shares by writing a check drawn on a Mexican bank, then it does not enter the financial account since it is a change of one foreign asset for another.) As a result, the read more..

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    Chapter 9 Trade and the Balance of Payments 187 country such as Chile purchases a shipload of goods from Europe, payment may be in dollars, euros, or pounds, but the supplier probably would not accept Chil- ean pesos from the purchaser. The importer must convert some pesos into a reserve currency, such as U.S. dollars, and use them to pay for its imports. If the read more..

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    188 PART 3 International Finance States and a liability for the borrowing government), the rescheduling of past loans made to foreign governments, payments received on outstanding loans, and changes in nonreserve currency holdings, such as Mexican pesos or Israeli shekels. Line 2.A of Table 9.4 is symmetrical with 1.A. When the federal government needs to borrow read more..

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    Chapter 9 Trade and the Balance of Payments 189 between FDI and foreign portfolio investment is that they both give their hold- ers a claim on the future output of the foreign economy. They are very different, however, in their time horizons, and this can have dramatic effects on the host country, where assets are located. Direct investments usually involve a longer read more..

  • Page - 217

    190 PART 3 International Finance such onerous terms and conditions that it was undesirable. These types of restric- tions on financial flows were a normal part of the international economic land- scape, even in industrial economies, until the 1980s and 1990s. For example, the members of the European Union did not completely liberalize financial flows between member countries read more..

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    Chapter 9 Trade and the Balance of Payments 191 into 2008 and then intensifi ed with the bankruptcy of several large fi nancial services fi rms that had signifi cant international business. Throughout late 2007 and into 2008, banks and other fi nancial services fi rms such as insurance com- panies and securities dealers reassessed their portfolios and tried to read more..

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    192 PART 3 International Finance assets altogether, or greatly reduced their purchases. In 2007, U.S. private interests purchased $1.449 trillion (millions of millions) of foreign assets (line 1.B), but in 2008 they sold over one-half trillion dollars ($534 billion) of foreign assets. The primary source of the change was in the form of reductions in loans to foreigners read more..

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    Chapter 9 Trade and the Balance of Payments 193 The National Income and Product Accounts The internal, domestic accounting systems that countries use to keep track of total production and total income are called the national income and product accounts (NIPA) . These accounts are very detailed presentations of income, out- put, and other measures of a nation’s read more..

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    194 PART 3 International Finance is apparent when we look at the definition of GDP based on its four main components. Table 9.7 defines the necessary variables. GDP is equal to the sum of consumer expenditures plus investment expenditures plus govern- ment expenditures on goods and services plus exports of goods and services minus imports of goods and read more..

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    Chapter 9 Trade and the Balance of Payments 195 From the point of view of the income recipients, there are three choices or obli- gations: They may consume their income (C), save it (S), or use it to pay taxes (T). In reality, all of us do a combination of the three. This permits us to rewrite the definition of GNP in terms of income and its uses as follows: read more..

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    196 PART 3 International Finance Conversely, a surplus in government budgets will augment private savings and increase the funds available for investment, all else being equal. The second use for national savings is as a source of funds for foreign invest- ment. If the current account is in surplus, national savings finances the purchase of domestic goods by foreign users read more..

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    Chapter 9 Trade and the Balance of Payments 197 savings and investment levels that are roughly similar. This is not true for every country, however, and in recent years it has been less and less true overall. For example, developing countries with relatively low savings such as Honduras, Ethiopia, and Kenya have managed to invest much larger shares of their GDP than read more..

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    198 PART 3 International Finance the left and right sides are equal by definition. Consequently, we cannot say that the current account is in deficit because saving is too low any more than we can say it is because investment is too high. There is a general tendency in the media and the public to interpret a current account deficit as a sign of weakness and read more..

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    Chapter 9 Trade and the Balance of Payments 199 deficit, and that there are no absolute thresholds between safe and dangerous levels of a deficit. While deficits of 3 to 4 percent of GDP begin to raise red flags, and deficits of 7 to 9 percent are considered extremely risky, too many other factors must be taken into consideration before the probability of a read more..

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    200 PART 3 International Finance Before the crisis that began in 2007, a central concern of some observers was whether or not the U.S. current account deficit posed a danger to the U.S. econ- omy. After the crisis began, a separate set of questions surfaced about the role of the deficit in creating the crisis itself. While no one argued that the current account read more..

  • Page - 228

    Chapter 9 Trade and the Balance of Payments 201 International Debt Current account deficits must be financed through inflows of financial capital. Recall from Table 9.5 and the previous discussion that capital inflows take differ- ent forms, from direct investment to purchases of stocks, bonds, and currency, to loans. Loans from abroad add to a country’s read more..

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    202 PART 3 International Finance may also intensify and spread an economic crisis, such as occurred with the East Asian Crisis of 1997–1998. Debt problems of developing countries have received considerable attention in recent years from multilateral organizations such as the World Bank, from governments of high-income governments, and from private organizations that have argued read more..

  • Page - 230

    Chapter 9 Trade and the Balance of Payments 203 The International Investment Position Each year that a nation runs a current account deficit, it borrows from abroad and adds to its indebtedness to foreigners. Each year that it runs a current account surplus, it lends to foreigners and reduces its overall indebtedness. If the total of all domestic assets owned by read more..

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    204 PART 3 International Finance stock, bonds, foreign currency, and bank loans. At the same time, the market value of assets located in the United States and owned by governments, busi- nesses, and residents abroad was $22,772 billion. As a result, the international investment position of the United States at the end of 2010 was −$2,474 billion. To summarize: read more..

  • Page - 232

    Chapter 9 Trade and the Balance of Payments 205 ■ The financial account is a record of financial capital flows between a coun- try and the rest of the world. The financial account is equal to the current account plus the capital account, with the sign reversed. This follows from the accounting principle that every purchase or sale of a good or service read more..

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    206 PART 3 International Finance goods and services gross domestic product (GDP) gross national product (GNP) international investment position investment income national income and product accounts (NIPA) odious debt official reserve assets statistical discrepancy sudden stop read more..

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    Chapter 9 Trade and the Balance of Payments 207 e. An American church donates fi ve tons of rice to the Sudan to help with famine relief. f. An American retired couple fl ies from Seattle to Tokyo on Japan Airlines. g. The Mexican government sells pesos to the United States Treasury and buys dollars. 3. read more..

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    208 PART 3 International Finance APPENDIX B Balance of Payments Data Current account and international investment data are readily available for most nations of the world. Bureau of Economic Analysis The Bureau of Economic Analysis is the official source of national income and product and international accounts data for the United States. It has an easy-to- use read more..

  • Page - 236

    209 Introduction: Fixed, Flexible, or In-Between? Every country must choose an exchange rate system to determine how prices in the home country currency are converted into prices in another country’s currency. Some countries peg their exchange rate at a fixed level while others let market forces deter- mine the value of their currency. Both approaches have read more..

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    210 PART 3 International Finance Exchange Rates and Currency Trading The exchange rate is the price of one currency stated in terms of a second cur- rency. An exchange rate can be given in one of two ways, either as units of domestic currency per unit of foreign currency or vice versa. For example, we might give the U.S.-Mexico exchange rate as read more..

  • Page - 238

    Chapter 10 Exchange Rates and Exchange Rate Systems 211 between one-third and one-half between their maximum and minimum values. Considering that the changes in the real economies of each country were not nearly as large, Figure 10.1 gives an idea of the variability of exchange rates. At the end of the series, the Japanese yen is at a level equal to read more..

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    212 PART 3 International Finance be destabilizing in the sense that it does not always push an exchange rate to its equilibrium value, but instead sometimes leads to a grossly over- or undervalued currency, which is a major problem for the country involved. Institutions There are four main participants in foreign currency markets: retail customers, com- mercial read more..

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    Chapter 10 Exchange Rates and Exchange Rate Systems 213 Suppose, for example, that a U.S. semiconductor manufacturer signs a con- tract to send a British computer manufacturer a shipment of microprocessors in six months. If the U.S. manufacturer agrees on a price in British pounds, it must know the value of the pound six months from now in order to know the dollar read more..

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    214 PART 3 International Finance its value), while an increase in its supply will lower its price (cause a deprecia- tion ). Under a fixed exchange rate system, the value of the dollar is held constant through the actions of the central bank that counteract the market forces of sup- ply and demand. Consequently, supply and demand analysis is a useful tool for read more..

  • Page - 242

    Chapter 10 Exchange Rates and Exchange Rate Systems 215 The supply curve in Figure 10.2 slopes up because British firms and consum- ers are willing to buy a greater quantity of American goods as the dollar becomes cheaper. That is, they receive more dollars per pound. However, before British customers can buy American goods, first they must convert read more..

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    216 PART 3 International Finance The causal factors behind the shifts in the supply and demand are easier to conceptualize if we divide the determinants of exchange rates into three periods: long run, medium run, and short run. This seems to be accurate empirically, as not all the factors that determine an exchange rate show up instantaneously. In fact, some causal read more..

  • Page - 244

    Chapter 10 Exchange Rates and Exchange Rate Systems 217 In Table 10.1 , a hypothetical basket of goods costs $1,000 or £500, depending on the country where it is purchased. Accordingly, the long-run tendency is for the exchange rate to move to $2 per pound. If it is above that, the pound is over- valued and the dollar is undervalued. An overvalued pound read more..

  • Page - 245

    218 PART 3 International Finance flow costlessly across international borders and that all goods and services can be traded. In reality, there are transportation costs involved with moving goods. This means that our merchant who buys £571.43 of goods in Britain and sells them for $1,142.86 in the United States loses some of his or her $142.86 profit to shipping, insurance, and read more..

  • Page - 246

    Chapter 10 Exchange Rates and Exchange Rate Systems 219 The effect of growth is symmetrical, both with respect to slower growth at home, and with respect to the rate of economic growth abroad. Slower growth, such as a recession during which output declines (negative economic growth), raises consumer uncertainty about jobs and reduces many people’s incomes. For the read more..

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    220 PART 3 International Finance then exchange rate movements must be taken into account during the investment period. To protect against unanticipated losses due to currency fluctuations, cross border investors can sign a forward contract to sell the foreign exchange from their future earnings. This is known as covered interest arbitrage and is a common way to take advantage read more..

  • Page - 248

    Chapter 10 Exchange Rates and Exchange Rate Systems 221 The utility of the interest parity condition is that it brings together capital flows, domestic interest rate policy, and exchange rate expectations. Suppose, for example, that domestic interest rates are above foreign rates, so that i > i*. In that case, investors expect a discount in the forward market, so that F read more..

  • Page - 249

    222 PART 3 International Finance This can create a sudden exodus of financial capital and put enormous pressure on the country’s supply of foreign exchange reserves. To a significant extent, epi- sodes of capital flight can be self-fulfilling in their expectations about an exchange rate. If investors expect depreciation, they try to convert their assets to another currency. read more..

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    Chapter 10 Exchange Rates and Exchange Rate Systems 223 may use Chilean pesos to buy dollars and use the dollars to buy Mexican pesos. It is unlikely that the Mexican exporter would accept Chilean pesos, so one way or another the importer has to come up with dollars. Currency trading is concentrated in just a few financial centers. London is by far the largest read more..

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    224 PART 3 International Finance The mechanisms from inconsistent policy to exchange rate crisis and collapse are fairly well understood, but this begs the question about the cause of a sudden shift in expectations. Many recent episodes of sudden exchange rate shifts have occurred when investors lost confidence in a particular currency. Yet why the sudden change in read more..

  • Page - 252

    Chapter 10 Exchange Rates and Exchange Rate Systems 225 convert their dollars, not the number of units of a foreign currency. An American importer trying to decide between Malaysian and Chinese textiles does not really care if he or she gets four ringgits per dollar or eight Chinese yuan per dollar. The biggest concern is the volume of textiles that can be purchased in read more..

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    226 PART 3 International Finance The real rate equals the nominal rate when the purchasing power is the same in both countries. Note that purchasing power parity indicates that this is the long-run equilibrium. Over time, however, if inflation is higher at home than in the foreign country, P rises more than P*, and R r falls, meaning the domestic cur- rency read more..

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    Chapter 10 Exchange Rates and Exchange Rate Systems 227 currency in terms of a fixed amount of gold. After World War II, many nations shifted away from gold and pegged the value of their currencies to the U.S. dollar or to the currency of another country with which they had strong historical ties. For example, a number of former French colonies in sub-Saharan Africa read more..

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    228 PART 3 International Finance (the dollar, the pound, the yen, and so on) in terms of gold. This fixes the exchange rate. For example, under the modified gold standard of the Bretton Woods exchange rate system, the U.S. dollar was fixed at $35 per ounce and the British pound was set at £12.5 per ounce. Since both currencies were fixed in terms of gold, they were read more..

  • Page - 256

    Chapter 10 Exchange Rates and Exchange Rate Systems 229 government when it wishes to keep its currency fixed. Suppose that the United States and the United Kingdom are both on the gold standard and the U.S. demand for British pounds increases. In the short run or medium run, a rise in demand for pounds from D 1 to D 2 is caused by one of the read more..

  • Page - 257

    230 PART 3 International Finance Pure gold standards have been rare since the 1930s. More commonly, countries have adopted modified gold standards, such as the Bretton Woods system (see the Case Study), or fixed exchange rate systems called pegged exchange rates. Pegged exchange rate systems operate similarly to a gold standard except that instead of gold, another read more..

  • Page - 258

    Chapter 10 Exchange Rates and Exchange Rate Systems 231 remains constant and the impact of inflation differences never shows up as a change in competitiveness. There are several other variations on the theme of fixed exchange rates. One of the key points to keep in mind is that purely fixed or purely flexible exchange rate arrangements are rare. When a currency is read more..

  • Page - 259

    232 PART 3 International Finance 1960s, the United States deepened its involvement in the Vietnam War while it simultaneously created the “War on Poverty” at home. Both policies gener- ated large fiscal expenditures that stimulated the economy. While U.S. expan- sion raced ahead of expansion elsewhere, Europeans found themselves accumulating dollars more rapidly than they read more..

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    Chapter 10 Exchange Rates and Exchange Rate Systems 233 Choosing the Right Exchange Rate System Given the menu of choices for exchange rate systems, an active area of economic research has focused on the performance characteristics of systems under differ- ent economic conditions and institutional arrangements. For many years, econo- mists debated the pros and cons of read more..

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    234 PART 3 International Finance hand, if the shocks to an economy originate in the external environment—for example, a sudden change in the price of imported oil—then relatively more flexibility in the exchange rate enables the country to adapt to the changes more easily. The general argument here is that individual country characteris- tics matter a great deal. The read more..

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    Chapter 10 Exchange Rates and Exchange Rate Systems 235 CASE STUDY Monetary Unions Some countries prefer not to have their own currency. Seventeen of the twenty-seven countries of the EU use a common currency, the euro, and more are expected to join. Panama adopted the dollar as a legal tender alongside its own currency, called the cordoba , in the early read more..

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    236 PART 3 International Finance This particularly affected the WAEMU, which mainly exports cotton and other agricultural products. All of the monetary unions are also economic unions (EU), common markets (ECCU is the basis for the Caribbean Common Market), or cus- toms unions (WAEMU and CEMAC). Monetary union implies a high level of integration and coordination and is read more..

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    Chapter 10 Exchange Rates and Exchange Rate Systems 237 accurately. Each of these advantages provides some gain in efficiency and a reduction in business costs. Second, a single currency eliminates price fluctua- tions caused by changes in the exchange rate. When speculators move their money into or out of a country, or when temporary interest rate changes in one country read more..

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    238 PART 3 International Finance The first condition is that the business cycle must be synchronized and national economies must enter recessions and expansions at more or less the same time. In this case, a single monetary policy is appropriate since each country is indi- vidually at the same point in the business cycle and there is no cost associated with the loss read more..

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    Chapter 10 Exchange Rates and Exchange Rate Systems 239 CASE STUDY Is the NAFTA Region an Optimal Currency Area? The EU is one model for the creation of a single currency. In the EU model, an entirely new currency is created, and each country gives up its national money. The discussion of a single currency in the NAFTA countries has favored a different read more..

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    240 PART 3 International Finance Summary ■ People hold foreign currency to buy goods and services, to take advan- tage of interest rate differentials, and to speculate. The primary institu- tions in the exchange-rate market are commercial banks and foreign exchange brokers. ■ Exchange rates can be analyzed with supply and demand analysis, read more..

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    Chapter 10 Exchange Rates and Exchange Rate Systems 241 Vocabulary appreciation Bretton Woods exchange rate system covered interest arbitrage crawling peg depreciation dollarization exchange rate exchange rate risk fixed exchange rate system flexible (floating) exchange rate read more..

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    242 PART 3 International Finance 4. Which of the three motives for holding foreign exchange are applicable to each of the following? a. A tourist b. A bond trader c. A portfolio manager d. A manufacturer 5. If U.S. visitors to Mexico can buy more goods in Mexico than they can in the read more..

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    Chapter 10 Exchange Rates and Exchange Rate Systems 243 An investor has a choice between i and i*. Letting the dollar be the home cur- rency, $1 invested today will return $1(1 i) next period if invested at home. To make the comparison with a foreign investment, the dollar first has to be con- verted into the foreign currency, then invested, and the earnings must read more..

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    244 Introduction: The Macroeconomy in a Global Setting Chapters 9 and 10 introduced the concepts of the balance of payments and the exchange rate. In this chapter we look more closely at their relationship to each other and to the overall national economy . After a brief review of a few key macroeconomic concepts, read more..

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    Chapter 11 An Introduction to Open Economy Macroeconomics 245 national product and as a consequence, their normal, day-to-day operating deci- sions affect exchange rates and the current account. The same is true for consum- ers and businesses, both of which have significant macroeconomic impacts and can alter exchange rates, current account balances, and capital flows through their read more..

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    246 PART 3 International Finance wages, rent, interest, and dividends, as well as its suppliers. We can keep fol- lowing the flow of payments through the suppliers to the glass firms, or more simply, we can recognize that all of the payments are incorporated into the value of the car. That is, the purchase price of the car ultimately generates an equivalent amount read more..

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    Chapter 11 An Introduction to Open Economy Macroeconomics 247 The shape of the aggregate supply curve is designed to call attention to three regions of GDP. On the horizontal part of the AS curve, the economy is operating below full employment. Theoretically, the availability of unemployed workers and other idle resources allows an increase in output to occur without read more..

  • Page - 275

    248 PART 3 International Finance Although the simple relationships between AD, AS, P, and GDP portrayed in Figures 11.1 and 11.2 are a useful way to conceptualize the interactions of a num- ber of key macroeconomic variables, the graphs and the description hide a great deal of complexity. For example, the graphs illustrate only one point in read more..

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    Chapter 11 An Introduction to Open Economy Macroeconomics 249 firms increase their own expenditures as well. They buy houses, furniture, cars, college education, medical care, and all the other things that households spend money on, thus creating another round of income increases and expenditures. In effect, the original increase in investment spending causes an increase in read more..

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    250 PART 3 International Finance Fiscal and Monetary Policies The discussion of aggregate demand, aggregate supply, and the multiplier is background for the analysis of the effects of fiscal and monetary policies on GDP and prices. Fiscal policy includes government taxation and expenditures, while monetary policy covers the money supply and interest rates. read more..

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    Chapter 11 An Introduction to Open Economy Macroeconomics 251 most economists today are much more cautious about the use of fiscal policy. The reasons are not hard to understand. First, expansionary policies tend to cause inflation, which offsets some of the increased consumer spending by absorbing it into higher prices instead of higher output. Second, there is a sub- read more..

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    252 PART 3 International Finance As cash reserves in the financial system increase, there is likely to be more investment. That is, financial institutions such as banks need to generate revenue by making loans. Money sitting in the vaults earns the bank no revenue, so an increase in bank reserves leads banks to make more loans. To encourage busi- nesses to borrow read more..

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    Chapter 11 An Introduction to Open Economy Macroeconomics 253 production-income-spending cycle is set in motion. Hence, an increase in the money supply will expand the economy and increase incomes. Not surpris- ingly, monetary policy is also symmetrical with respect to its contractionary and expansionary impacts, so a decrease in the money supply will result in a decline in read more..

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    254 PART 3 International Finance downturns in economic activity, there was a strong recovery, and by 1936, real GDP was above where it had been in 1929, the last year of overall positive growth until 1934. Figure 11.4 illustrates the annual rate of growth, 1930–1941. In hindsight, it is easy to see the policy mistakes that prolonged the reces- sion read more..

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    Chapter 11 An Introduction to Open Economy Macroeconomics 255 time, most dramatically with the beginning of social security taxes in 1937. Given the contractionary impact of tax increases, it is not surprising that 1932 was the worst year of the depression, nor that the economy slipped back into recession in 1938 after the implementation of the new social security tax. read more..

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    256 PART 3 International Finance It is no coincidence that the first countries to leave the gold standard (the United Kingdom and the countries that followed it in September 1931) were the first to experience recovery. Once their policies were freed from the con- straint of supporting a fixed rate of exchange, they could turn them toward economic expansion. In the read more..

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    Chapter 11 An Introduction to Open Economy Macroeconomics 257 are present in both cases as well, since home country interest arbitrageurs have the same motivation to move their capital in and out of the country. The exchange rate effects of monetary policy are easily identified. We have already seen how an expansion of the money supply increases bank reserves and pushes read more..

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    258 PART 3 International Finance Why do households increase their demand for money when their incomes increase? The reasons are straightforward. First, at higher levels of income, they consume more. That is, they need a higher level of money holdings to pay for their purchases. Second, the opportunity cost of the interest they lose on holding money instead of an read more..

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    Chapter 11 An Introduction to Open Economy Macroeconomics 259 To summarize, the impact of monetary policy on income is magnified by its exchange rate effects. We cannot definitely say, however, what the effects are on the current account balance since the income effect of monetary policy on the current account is the opposite of the exchange rate effect. The current read more..

  • Page - 287

    260 PART 3 International Finance The Long Run How permanent are the effects? Economists more or less agree that in the long run, the level of output in an economy tends to fluctuate around a level that is consistent with full employment. Note that full employment does not mean that everyone has a job. No matter how strong the economy is, there is always read more..

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    Chapter 11 An Introduction to Open Economy Macroeconomics 261 and it was not getting smaller when it was hit by the Latin American debt crisis and the Lost Decade of the 1980s (see Chapter 15 ) . The debt crisis was vicious and hard to shake off. In 1989, seven years after it began, Argentina was still caught in it, and its GDP fell 7 percent read more..

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    262 PART 3 International Finance The debate over policy was intense: Should Argentina devalue and increase the debt burden, or maintain the exchange rate and continue to watch the current account deficit grow and the economy shrink? Cut govern- ment spending to create confidence in the fiscal soundness of the govern- ment, or use expansionary fiscal policy to address the read more..

  • Page - 290

    Chapter 11 An Introduction to Open Economy Macroeconomics 263 partners, but they rarely threaten a national economy the way that large defi- cits sometimes do. The macro policies for addressing a current account deficit are a combination of fiscal, monetary, and exchange rate policies, often collec- tively called expenditure switching policies and expenditure reducing policies read more..

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    264 PART 3 International Finance After a depreciation, there is usually a short period of no noticeable impact on the flow of goods and services. When imports and exports begin to respond, the immediate change is an increase in the value of imports, pushing the current account balance deeper into deficit. The size of the deterioration and the length of time before read more..

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    Chapter 11 An Introduction to Open Economy Macroeconomics 265 While the dollar was falling, the trade deficit continued to widen. This was unsettling to a number of politicians, economists, and others, who had pre- dicted a significant decline in the U.S. trade deficit as a result of the deprecia- tion. Some journalists and politicians began to argue that the trade deficit read more..

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    266 PART 3 International Finance Consequently, when the dollar began to fall, foreign producers were initially able to keep dollar prices constant and absorb the decline in its value by real- izing lower profits in terms of their domestic currency. Another possible reason for the long lag is that there were still impacts from earlier appreciations working through the read more..

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    Chapter 11 An Introduction to Open Economy Macroeconomics 267 or countries using expansionary policy will probably experience a deterioration in their current accounts since their trading partners are not growing at the same rate. If expansionary fiscal policies cause interest rates to rise, then a further deterioration in the current account is likely due to the appreciation of read more..

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    268 PART 3 International Finance ■ Both fiscal and monetary policy influence exchange rates and the current account balance. In each case, the effect is through a change in interest rates brought on by the fiscal or monetary policy. Neither policy is likely to have long-run effects on income. ■ To reduce or eliminate a current account deficit, read more..

  • Page - 296

    Chapter 11 An Introduction to Open Economy Macroeconomics 269 2. Explain the concepts of fiscal and monetary policy. Who conducts them and how do they work their way through the economy? 3. What are some of the problems in trying to use fiscal and monetary policies? Why can’t economists and politicians make precise predictions about the read more..

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    270 Introduction: The Challenge to Financial Integration Increasing international economic integration has created opportunities for growth and development, but it has also made it easier for crises to spread from one country to another. The worldwide recession that began in 2008 was triggered by a financial crisis that started in 2007, and while it is perhaps the read more..

  • Page - 298

    Chapter 12 International Financial Crises 271 indicators. The contagion effects of a crisis do not conform to a single pattern, and they reinforce the idea that there are different types of crises with their own rules of behavior. Financial crises have brought down governments, ruined economies, and destroyed individual lives. Their enormous costs have created an intense read more..

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    272 PART 3 International Finance When a bank, insurance company, or securities firm fails, the investors that purchased its financial products lose some or all of their savings. Bank depositors in many countries are covered by deposit insurance, but holders of insurance annuities or securities purchased through a brokerage house rarely are. The loss of savings causes read more..

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    Chapter 12 International Financial Crises 273 liabilities and the lender becomes insolvent. Debt crises can spread economic stagnation in other ways as well. In the 1990s, for example, Japanese firms and banks focused on paying off debt after the collapse of their real estate bubble in the late 1980s and early 1990s. This caused them to cut back on normal business read more..

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    274 PART 3 International Finance prices to unsustainable levels. Investment was facilitated by global imbalances in which countries with high savings rates and large current account surpluses lent to countries with large current account deficits and significant demand for invest- ment. When the housing bubble collapsed, the crisis began. Banks were unable to lend as they became read more..

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    Chapter 12 International Financial Crises 275 The fundamental cause of this type of crisis is that financial capital is highly volatile, and technological advances have reinforced this volatility. The discovery of large emerging markets and the drive by financial investors in high-income countries to diversify their portfolios caused hundreds of billions of dollars to be invested read more..

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    276 PART 3 International Finance supervision and regulation on the part of the banking authorities. International lenders, for their part, must be more informed about the activities of their bor- rowers. This requires greater information flows, the use of standard accounting practices, and overall greater transparency in domestic and international finan- cial systems. Finally, once a read more..

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    Chapter 12 International Financial Crises 277 between Canada, the United States, and Mexico took effect on January 1, 1994, and throughout the year U.S.-Mexican trade expanded by almost one- fourth (23.7 percent). NAFTA inspired confidence in Mexico’s institutional stability and guaranteed access to the wealthy U.S. market for any goods made in Mexico. During 1994, the world read more..

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    278 PART 3 International Finance The medium- and long-run problems were addressed with a package of austerity measures that cut government spending, increased taxes (T up, G down), and reduced consumption. The large current account deficit at the end of 1994 increased the vulnerability of Mexico’s financial system to capital flight and had been partly responsible read more..

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    Chapter 12 International Financial Crises 279 Domestic Issues in Crisis Avoidance Not all crises are avoidable. Nevertheless, there are steps that countries can take to try to minimize the likelihood of crises and the damage they cause when they happen. In addition to the need to maintain credible and sustainable fiscal and monetary policies, governments must engage in read more..

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    280 PART 3 International Finance capital levels, known collectively as the Basel Accords , have been signed, including Basel III, which was signed in 2010. In addition to tackling the prob- lem of moral hazard, the Basel Accords also try to make banking systems more robust by setting new standards for bank supervision, information disclosure, and stress tests. The read more..

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    Chapter 12 International Financial Crises 281 Capital Controls Many economists hold that the free movement of capital is a desirable objective because it allows investors to send their financial capital wherever the return is highest, which raises world welfare by putting financial capital to its most valu- able use. At the same time, capital mobility allows countries to read more..

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    282 PART 3 International Finance Restrictions on capital inflows cannot stop a crisis once it begins, however. Consequently, there is an ongoing debate over the utility of imposing restrictions on capital outflows once a crisis starts. Since many crises include a speculative attack against the home country currency, some argue that a temporary limita- tion on capital outflows read more..

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    Chapter 12 International Financial Crises 283 reason to believe that would change anytime soon. Furthermore, slow growth in Japan and Europe during much of the 1990s caused many inter- national investors to scour the globe looking for higher returns, and the stable and dynamic economies of Southeast Asia stood out prominently. Low inflation, small budget deficits or consistent read more..

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    284 PART 3 International Finance Financial Sector Problems The downturn in export revenues exposed several other weaknesses, includ- ing those in regulatory systems, corporate structures, and financial systems. Many countries in East Asia rely on corporate structures built around fam- ily ties and personal networks. This can have significant advantages for small and read more..

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    Chapter 12 International Financial Crises 285 The rapid recoveries shown in Table 12.2 caught most analysts by surprise, yet the flexibility and fundamental soundness of macroeconomic policies throughout East Asia facilitated swift recovery. Still, Table 12.2 does not tell the whole story since poverty rose significantly throughout the region. In read more..

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    286 PART 3 International Finance international reserves, defense of the domestic economy through lower interest rates seems feasible. The real question applies to the five countries with large current account deficits. Some critics of the IMF blame it for turn- ing financial panics in those countries into full-blown depressions by coun- seling them to raise their interest read more..

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    Chapter 12 International Financial Crises 287 last bit of restraint over money creation and lead to hyperinflation. Governments may not be able to cut expenditures easily, since government employees may be unionized with multiyear contracts, may provide essential domestic services, or other elements of the budget may support powerful domestic interests. The case of a crisis read more..

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    288 PART 3 International Finance reforming the international financial architecture. In particular, a lot of atten- tion is focused on the role of the IMF and the conditions it imposes as part of its loan packages. A number of ideas for reforming the international financial architecture have been advanced in recent years. Private think tanks such as the Council on read more..

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    Chapter 12 International Financial Crises 289 much a country can borrow in a “normal” crisis, as well as how many votes the country has in setting IMF policy. Generally, countries can borrow up to 300 per- cent of their quota, but in extraordinary circumstances such as the Mexican peso crisis, the Asian crisis, or other crises with the potential to spread, the limits on read more..

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    290 PART 3 International Finance effects of conditionality on the vulnerable members of societies forced a closer look at the social impacts of policies, and the IMF has tried to make adjust- ments. Even so, there are still widespread complaints that IMF conditionality is too punitive and too contractionary, and a few countries in crisis have refused IMF assistance. read more..

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    Chapter 12 International Financial Crises 291 Reform Urgency In the aftermath of the Asian crisis, many reform proposals were circulated among academics, government officials, and the staff of multilateral organiza- tions. The crisis drove home the points that international financial flows had grown dramatically over the previous decades, that many developing countries are now read more..

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    292 PART 3 International Finance products. The financial services industry of 2007 did not look at all like the industry it was in the 1960s or 1970s. Second, financial markets had become much more integrated. Open capital markets and flexible exchange rates created new global flows of financial capital that were not possible in earlier decades. These larger and more read more..

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    Chapter 12 International Financial Crises 293 number of other markets experienced increases as large or larger. These increases fed on themselves as they pulled more finance into the housing market. The growing international integration of financial services meant that capital for home loans could be moved from one country to another, and that the United States, Spain, read more..

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    294 PART 3 International Finance the sheer size of these accumulations, they began to play an important role in international finance. The savings held by governments are called sovereign wealth funds , but private entities also increased their savings. Globally, current account balances must total to zero. If China and other countries run large current account surpluses read more..

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    Chapter 12 International Financial Crises 295 the United Kingdom, Spain, and elsewhere would have been much more expensive countries to live in, and the bubble in housing markets would have been less likely. As a result, we probably would not have seen the boom in house prices, low interest rates, and the easy lending that took place in the high-deficit countries. read more..

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    296 PART 3 International Finance may encourage future risky behavior. The problem of moral hazard is par- ticularly acute if the government has directed credit to specific enterprises for political or developmental purposes because directed credit either explicitly or implicitly includes a government guarantee. ■ The Basel Accords, including Basel III, are a set of read more..

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    Chapter 12 International Financial Crises 297 Vocabulary austerity banking crisis Basel Accords capital controls capital requirements collective action clauses conditionality contagion effects data dissemination standards debt crisis disintermediation read more..

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    298 PART 3 International Finance 5. What type of exchange rate is associated with a higher probability of experi- encing a crisis? Why? 6. In a crisis not caused by macroeconomic imbalances, economists are uncer- tain whether a country should try to guard against recession or try to defend its currency. Why are these mutually exclusive, and read more..

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    Regional Issues in the Global Economy 4 PA R T read more..

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    300 Introduction: A New World Economy The relationship of the United States to the global economy is shaped by its size, its wealth, and its role as a military super power. It is endowed with a wide range of resources, including abundant and fertile farmland, a relatively well educated popula- tion, and a disproportionate share of the world’s top research read more..

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    Chapter 13 The United States in the World Economy 301 shift towards more open trade policies around the world. The transition to capi- talism of formerly socialist economies; the worldwide preference for more open trade relations; and the economic success of countries from Botswana in Africa, to Chile in Latin America, to China in Asia are reshaping the world economy and the read more..

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    302 PART 4 Regional Issues in the Global Economy the eighteenth most important market for U.S. exports. By 2010, it was the num- ber one source of imports and the third most important export market. If the European Union is treated as one entity, then it moves into the second spot for both imports and exports, behind Canada (exports) and China (imports). The read more..

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    Chapter 13 The United States in the World Economy 303 and continue to show strength, not the least of which is that they are an area in which the United States has a trade surplus. About 40 percent of service exports are travel and transportation services, while the remaining 60 percent are royal- ties, education, financial and insurance services, and business and read more..

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    304 PART 4 Regional Issues in the Global Economy The left scale shows manufacturing employment. Employment peaked in 1979 at 19,426,000 and began a long-run decline after that. In 1980 the United States entered a mild recession and then a more severe one in 1981–1982. Manufacturing employment recovered some of its losses in 1984 but contin- ued its trend downwards, read more..

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    Chapter 13 The United States in the World Economy 305 trade negotiations in the Doha Round are focused on much more difficult issues such as agricultural support systems, intellectual property, services trade, govern- ment procurement, and assistance for developing countries. These areas pose significant challenges, in part because they are not easily represented as recipro- cal read more..

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    306 PART 4 Regional Issues in the Global Economy 2010. As can be seen in the table, most of the agreements, other than NAFTA, cover very small shares of U.S. trade, although the FTAs with Australia, Israel, South Korea, Singapore, and the DR-CAFTA agreement each cover more than $20 billion in exports or imports. The United States is by no means alone in shifting read more..

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    Chapter 13 The United States in the World Economy 307 blocks” that create more trade than they divert and that enable countries to try new types of agreements. The WTO has concluded that in practice, most are complementary to the multilateral trading system and not substitutes for it. The NAFTA Model Table 13.3 shows clearly that the NAFTA read more..

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    308 PART 4 Regional Issues in the Global Economy The PPP adjustment is necessary in order to compare actual living standards, while the market exchange rates income is useful to know something about the ability of people to buy goods and services in the world economy. The two num- bers are not equal because exchange rates are rarely in long-run equilibrium and because read more..

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    Chapter 13 The United States in the World Economy 309 quotas in limiting foreign imports to a set level. The most important affected industry was the Japanese car market. From the perspective of Canada’s leadership, growing U.S. protectionism and rising Asian manufacturing competitiveness were troubling signs since Canada is very dependent on the United States as an read more..

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    310 PART 4 Regional Issues in the Global Economy The final and most contentious issue from the Canadian point of view was the possibility of U.S. cultural domination. A very wide spectrum of opinion, includ- ing both opponents and proponents of expanded free trade, argues that the com- bination of Canada’s smaller population and its proximity to the United States will read more..

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    Chapter 13 The United States in the World Economy 311 The debt crisis that began in Mexico in August 1982 was the result of a series of factors. From Mexico, the debt crisis quickly spread to the rest of Latin America, where similar policies had resulted in poor macroeconomic manage- ment and the accumulation of a large amount of debt. This period came to read more..

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    312 PART 4 Regional Issues in the Global Economy For example, between 1993 and 1996, average U.S. tariffs on Mexican goods fell from 2.07 to 0.65 percent. By contrast, Mexican tariffs on U.S. goods fell from 10 to 2.9 percent. These reductions in tariffs under NAFTA were a con- tinuation of the reduction in trade barriers that began in the mid-1980s. Between 1982 read more..

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    Chapter 13 The United States in the World Economy 313 FTAs negotiated by the United States. Each of these has its supporters and its detractors and will be considered in more detail in the following discussion of the new trade agreements signed by the United States. Two NAFTA-Specific Issues A number of highly contentious issues arose during the NAFTA debate, as read more..

  • Page - 341

    314 PART 4 Regional Issues in the Global Economy A second issue of grave concern in the NAFTA region is the rise in drug vio- lence in Mexico. This is a very contentious and tragic issue with no clear way forward at the moment, but a continuing loss of life, mostly in Mexico and mostly related to the violence of transporting and selling illegal drugs. This read more..

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    Chapter 13 The United States in the World Economy 315 excess land. The 1992 reforms stopped the creation of new ejidos and created a process for breaking up existing ones by turning them into private land- holdings. The reforms do not require change, and most ejidos continue to operate the same as they did before the reforms, although some have been privatized and read more..

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    316 PART 4 Regional Issues in the Global Economy increased imports from the United States, in part to lower the price of corn for animal feed, increase the size of the country’s livestock herds, and expand the amount of animal protein in the diet of the average Mexican citizen. Mexico’s larger and more commercial farmers expanded their corn production along with the read more..

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    Chapter 13 The United States in the World Economy 317 In these two trade agreements and in the agreements already in place ( Table 13.3 ), including NAFTA, a similar set of issues arise over and over again. These include labor and environmental standards, investment, and job loss. Labor and Environmental Standards In nearly all the trade agreements signed read more..

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    318 PART 4 Regional Issues in the Global Economy These four basic rights are built into conventions drafted by the ILO that coun- tries are encouraged to sign. They are as follows: 1. Freedom of association and the effective recognition of the right to col- lective bargaining. 2. The elimination of all forms of forced or compulsory labor. read more..

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    Chapter 13 The United States in the World Economy 319 identical in countries with different income levels. Whereas some countries may prioritize the reduction of greenhouse gases, others may still be struggling to pro- vide access to clean drinking water. The marginal benefits of one priority over another depend on the level of income and the state of the environment in each read more..

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    320 PART 4 Regional Issues in the Global Economy agreements is to create a higher level of certainty for investors with respect to their property rights if they invest in a country that has an agreement with the United States. Secure property rights encourages investment and, presumably, leads to more rapid economic growth, particularly in developing countries. Again, NAFTA read more..

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    Chapter 13 The United States in the World Economy 321 these conceptual difficulties, actual estimates of the number of jobs gained or lost are closer to guesses. In addition, pro-trade think-tanks and scholars usually show job gains, while anti-trade think-tanks show job losses. In either case, however, neither side of the debate can show large job gains or losses in the read more..

  • Page - 349

    322 PART 4 Regional Issues in the Global Economy growth of trade as a result of NAFTA and other trade agreements is a positive indicator of increasing specialization, economies of scale, and efficiency. A second often overlooked point in the jobs debate is that most of the coun- tries that have signed FTAs with the United States are not very big relative to the read more..

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    Chapter 13 The United States in the World Economy 323 $20.4 billion to $71.7 billion in 2011. While this is a small percentage of U.S. total imports, it represents a significant increase in exports to the United States from the beneficiary countries. The forty beneficiary countries of the AGOA have a combined 2010 GDP of slightly over US $1 trillion, when measured at read more..

  • Page - 351

    324 PART 4 Regional Issues in the Global Economy ■ Mexico is the third most important trading partner with the United States, after Canada and China. Mexico’s President Salinas proposed a free trade agreement with the United States as a way to lock in his economic reforms and as a way to attract foreign capital for investment. ■ NAFTA is the read more..

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    Chapter 13 The United States in the World Economy 325 Study Questions All problems are assignable in MyEconLab . 1. What factors caused the United States to shift its focus from a more multilat- eral approach to a more bilateral and plurilateral one? 2. How has the trade-to-GDP ratio changed for the United States over the last read more..

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    326 14 Introduction: The European Union The European Union (EU) is an economic union of twenty-seven nations with over 500 million citizens and $17,577 billion in output. It is the largest, oldest, and most integrated of regional agreements. It helped put an end to over a century of wars on the European continent, and its incorporation of new members read more..

  • Page - 354

    Chapter 14 The European Union: Many Markets into One 327 the foundation for the Single Market Program (SMP) and turned the EC into a common market that allows free movement of labor and capital as complements to the already free movement of goods and services. In 1992 the members signed the Treaty on European Union , which led directly to the creation of the read more..

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    328 PART 4 Regional Issues in the Global Economy None of these changes have been easy, and the problems of the single cur- rency threaten to unravel many of the economic and political gains. In imple- menting the various integration initiatives, the member states have been forced to act pragmatically as internal and external events forced changes. The shift from fixed read more..

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    Chapter 14 The European Union: Many Markets into One 329 TABLE 14.1 Population and Income in the European Union, 2011 Country Population (Millions) GDP (US$, Billions) GDP per Capita (US$ PPP) Original Members Belgium 10.9 513 37,737 France 63.1 2,776 35,156 Germany 81.8 3,577 37,896 Italy read more..

  • Page - 357

    330 PART 4 Regional Issues in the Global Economy than comparisons at purchasing power parity rates, but they are a more accurate indicator of each market’s size in terms of its ability to buy goods and services that are imported. Several features of Table 14.1 are worth highlighting. First, not all west European nations are members. Norway, which voted read more..

  • Page - 358

    Chapter 14 The European Union: Many Markets into One 331 six foreign ministers of the ECSC countries launched a round of talks to discuss the creation of the European Economic Community and European Atomic Energy Community (EAEC or Euratom) . The goal of the former was to create a single, integrated market for goods, services, labor, and capital. The latter sought read more..

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    332 PART 4 Regional Issues in the Global Economy responsibility is to act as the guardian of the treaties, ensuring that they are faith- fully and legally enforced. This role includes responsibility for creating the rules for implementing treaty articles and for EU budget appropriations. As the exec- utive branch, the Commission has the sole right to initiate EU laws and read more..

  • Page - 360

    Chapter 14 The European Union: Many Markets into One 333 Deepening and Widening the Community in the 1970s and 1980s When Europeans speak of increasing the level of cooperation between member countries, they use the term deepening . Deepening refers to economic and non- economic activities that cause increased levels of integration of the national econo- mies. For read more..

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    334 PART 4 Regional Issues in the Global Economy to prop it up, or by selling currency to push it down. In September 1992, for example, the United Kingdom spent an estimated $30 billion in just a few days of buying British pounds in a failed attempt to protect the currency from market speculators convinced that it was going to fall in value. Given the read more..

  • Page - 362

    Chapter 14 The European Union: Many Markets into One 335 the EC, and, at a time when many of the members wanted expansionary mone- tary policy, they were forced to adopt contractionary policies. The 1992 episode illustrates the recurrent tension between the appropriate external policies (exchange rate management) and the appropriate internal policies (full employ- ment, reasonable read more..

  • Page - 363

    336 PART 4 Regional Issues in the Global Economy The Delors Report Reshaping the EC got under way with the selection of the former French finance minister, Jacques Delors, to serve a five-year term as president. Delors was a compromise candidate, and no one expected unusual or dramatic changes in the EC under his stewardship. Delors’s vision of the EC, however, read more..

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    Chapter 14 The European Union: Many Markets into One 337 It laid out a timetable for completing the changes and removed the need for unanimous voting in the Council of Ministers. Delors proposed that most mea- sures be allowed to pass with a “qualified majority” and that unanimity be reserved for only the most momentous issues, such as taxes. Although the quali- read more..

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    338 PART 4 Regional Issues in the Global Economy prices are above marginal costs, the mark-up charged by firms would come down as more competitive pressures are applied. Economies of scale can have similar effects as firms find it easier to operate across national boundaries, expand pro- duction, and reduce their costs by taking advantage of internal scale economies. The read more..

  • Page - 366

    Chapter 14 The European Union: Many Markets into One 339 was a direct result of the SMP, but there is strong evidence that it played a sig- nificant role. Problems in the Implementation of the SEA One of the most interesting lessons of the Single Market Program is that it is still difficult to reduce barriers to trade and investment even when the read more..

  • Page - 367

    340 PART 4 Regional Issues in the Global Economy estimated that there were more than 100,000 technical standards that required harmonization in order to realize the benefits of a completely integrated market. Many of the technical standards involved rules that directly touch upon cultural identities. Nowhere was this more true than in the case of food processing. For example, read more..

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    Chapter 14 The European Union: Many Markets into One 341 maximum rates that were set at 15 and 25 percent. Since the difference still exceeds the 5 percent differential that is the threshold at which high-tax countries lose revenue and sales, a number of controls were established to prevent revenue loss, even though these controls prevent the complete realization of the read more..

  • Page - 369

    342 PART 4 Regional Issues in the Global Economy The Third Wave of Deepening: The Maastricht Treaty By 1989, planning for the implementation of the SMP was well under way. Europe had seen several years of economic expansion, and the excitement of the SMP seemed to signal that the time was right to consider some of the directives proposed in the Delors read more..

  • Page - 370

    Chapter 14 The European Union: Many Markets into One 343 recessions. If, for example, Germany is booming, but Spain is in an economic slump, there is no common monetary policy that will be suitable to both coun- tries. Germany would need a contractionary policy to cool off the economy and to prevent the ignition of inflation, while Spain would need an expansionary pol- read more..

  • Page - 371

    344 PART 4 Regional Issues in the Global Economy why these particular criteria were chosen in the first place, since a country that can maintain its interest rates, debts, deficits, inflation, and exchange rates in the target range is already doing what the EU hopes to achieve with monetary union. In other words, meeting the convergence criteria was an indicator that read more..

  • Page - 372

    Chapter 14 The European Union: Many Markets into One 345 means that there is a single monetary policy—expansionary, neutral, or contrac- tionary—that is appropriate for everybody. A mobile labor force guarantees that if some regions are not well synchronized, labor will move from the shrinking region to the expanding one, making the business cycles move together. If, how- read more..

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    346 PART 4 Regional Issues in the Global Economy anxiety in some European capitals and this was a strategy to tie Germany ever more deeply into a pan-European project. All of these explanations have their adherents, but one of the most widely voiced explanations is that the single currency became necessary after the removal of capital controls that took place under read more..

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    Chapter 14 The European Union: Many Markets into One 347 CASE STUDY The Financial Crisis of 2007–2009 and the Euro In their masterful work on the economics of fi nancial crises, This Time Is Dif- ferent, Carmen Reinhart and Kenneth Rogoff defi ne four types of fi nancial crises: banking crises, debt crises, currency crises, and infl ation read more..

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    348 PART 4 Regional Issues in the Global Economy –14 –12 –10 –6 –8 –4 –2 0 2 4 Greece Germany France Ireland Italy Portugal Spain 2000–2006 2007–2011 Percent of GDP With the exception of Greece, none of the euro-crisis countries had large budget defi cits before the fi nancial crisis of 2007–2009. Source: IMF, World Economic Outlook Database. read more..

  • Page - 376

    Chapter 14 The European Union: Many Markets into One 349 The problem for the euro-crisis countries is straightforward. First, the col- lapse of a real estate bubble led to a banking crisis, which, in turn, led to a recession. The recession depressed tax revenue and expanded social spending, causing an increase in government budget deficits. At this point, fiscal and read more..

  • Page - 377

    350 PART 4 Regional Issues in the Global Economy Widening the European Union After the achievement of monetary union, one of the most pressing problems facing the EU was the timetable and conditions under which new members would be added. New Members Ten countries joined the EU in 2004 and two more in 2007. Croatia is scheduled to become a member on read more..

  • Page - 378

    Chapter 14 The European Union: Many Markets into One 351 First, the EU budget contains a shrinking but still extensive set of farm support programs. Direct payments to farmers were about 30 percent of the EU budget in 2011, with another 11 percent for rural development. Much of this amount is administered under the Common Agricultural Program (CAP) , which read more..

  • Page - 379

    352 PART 4 Regional Issues in the Global Economy Emigration was slowed by the world depression of the 1930s and World War II, but it began again in earnest after 1950. Unlike the earlier migrations, when the majority of migrants went to the Americas, increasing numbers headed for other countries in central and western Europe. In particular, France, Germany, and read more..

  • Page - 380

    Chapter 14 The European Union: Many Markets into One 353 The Demographic Challenge of the Future As the EU looks toward the future, a number of challenges are visible. In the short to medium run, it must continue to create convergence in income and living standards between its poorest and its most well-off members. Over the medium run, it must also prepare for read more..

  • Page - 381

    354 PART 4 Regional Issues in the Global Economy Table 14.4 . Fewer workers means that the rate of economic growth will fall, and that new resources for supporting an aging population will be harder to acquire. At the same time, the number of available workers to support the production of social services needed by the aging population will be both read more..

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    Chapter 14 The European Union: Many Markets into One 355 ■ The Treaty of Rome was signed in 1957 and was put into effect in 1958, creating a six-country, free-trade area that was phased in gradually over the next ten years. ■ The next wave of deepening was the creation of the European Monetary System and the Exchange Rate Mechanism in 1979, read more..

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    356 PART 4 Regional Issues in the Global Economy Study Questions All problems are assignable in MyEconLab. 1. What were the three main stages of deepening that occurred in the European Community after the Treaty of Rome was passed? 2. What are the three main institutions of the European Union, and what are their responsibilities? read more..

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    357 Introduction: Defining a “Latin American” Economy Latin America stretches from Tijuana on the U.S.-Mexico border to Cape Horn at the southern tip of South America. Within this vast geographic area lies such a diversity of languages and cultures that any definition of Latin America must have exceptions and contradictions. For example, Merriam-Webster’s read more..

  • Page - 385

    358 PART 4 Regional Issues in the Global Economy many of these nations share a heritage of Spanish and Portuguese colonization and a common linguistic base. In some countries, however, the languages of indigenous people are important as well. A second part of their shared histories is that many Latin American countries gained their national independence from Spain and read more..

  • Page - 386

    Chapter 15 Trade and Policy Reform in Latin America 359 TABLE 15.1 Population and GDP for Latin America and the Caribbean, 2010 Population (Millions) GDP (US$, Billions) GDP per Capita (US$, PPP) Andean Community Bolivia 10.4 19.8 4,549 Colombia 45.5 287.2 9,585 Ecuador 14.8 read more..

  • Page - 387

    360 PART 4 Regional Issues in the Global Economy the Debt Crisis brought an end to nearly fifty years of economic policy, as one country after another tried bold new experiments in their search for a way to restore economic growth. Import Substitution Industrialization Economic policy reform in Latin America brought the demise of the economic development strategy read more..

  • Page - 388

    Chapter 15 Trade and Policy Reform in Latin America 361 Latin America exported raw materials and imported finished goods, so the Prebisch-Singer prediction was that the terms of trade for the region would decline. For obvious reasons, this view was labeled export pessimism . The reasoning behind export pessimism included both statistical studies and economic theory. read more..

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    362 PART 4 Regional Issues in the Global Economy read more..

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    Chapter 15 Trade and Policy Reform in Latin America 363 Criticisms of Import Substitution Industrialization The economic tools for implementing ISI are the same as those for industrial policies discussed in Chapter 5 . These include a variety of different types of gov- ernment support, from subsidies of all kinds to trade protection and monopoly power read more..

  • Page - 391

    364 PART 4 Regional Issues in the Global Economy in rural areas to remain low and stagnant. Overvalued exchange rates also hurt industries that did not produce substitutes for imports because it was less profitable to export. They also made foreign machinery less expensive and caused industrial investment to be too capital intensive and insufficiently labor intensive. Conse- read more..

  • Page - 392

    Chapter 15 Trade and Policy Reform in Latin America 365 Cárdenas, whose son was a leading opponent of the dismantling of ISI during the reforms of the 1980s and 1990s. In order to lead and direct economic growth, government could legitimately claim the need to be powerful—otherwise, powerful social classes could resist the government’s directives and initiatives, particularly those with read more..

  • Page - 393

    366 PART 4 Regional Issues in the Global Economy Macroeconomic Instability and Economic Populism Many economists are convinced that while ISI policies are suboptimal, they had less of a direct effect in creating the economic crisis of the 1980s than did misguided macroeconomic policies. The reasons are relatively straightforward. ISI policies involve trade barriers and read more..

  • Page - 394

    Chapter 15 Trade and Policy Reform in Latin America 367 policies, on the other hand, often lead to hyperinflation, depression, and balance of payments crises. In addition, while most of Latin America used ISI policies from the 1950s through the 1980s, economic growth remained at fairly high levels for most countries until the early 1980s when growth turned negative in nearly read more..

  • Page - 395

    368 PART 4 Regional Issues in the Global Economy develop. The flight of capital out of the country depresses investment and further depresses real wages. In the end, real wages are often lower than before the cycle began, and there is an international intervention under the sponsorship of the IMF, which is designed to stop the high inflation and end a balance of read more..

  • Page - 396

    Chapter 15 Trade and Policy Reform in Latin America 369 By 1990, the economy reached the deepest point in its recession. In July, a new government took office and implemented a relatively orthodox stabiliza- tion program of fiscal and monetary austerity to end inflation and curb the budget deficit. By then, however, real wages were well below the level they had attained read more..

  • Page - 397

    370 PART 4 Regional Issues in the Global Economy The price decline for Latin America’s exports and the rise in interest rates were significant parts of the mix of events that led up to the debt crisis. These external economic shocks probably would not have caused a generalized debt crisis without some additional factors, however. Historically, debt crises are often read more..

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    Chapter 15 Trade and Policy Reform in Latin America 371 Responses to the Debt Crisis Initially, most analysts in the United States and in international financial institu- tions such as the IMF perceived the debt crisis to be a temporary, short-run liquidity problem. Under this assumption, the reasonable response is to increase capital flows to Latin America and other read more..

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    372 PART 4 Regional Issues in the Global Economy recessions throughout the region. Between 1982 and 1986, the average rate of growth of real per capita GDP was −1.8 percent per year in Latin America and the Caribbean. By 1987 it was apparent to analysts throughout the world that restoring cap- ital flows was not enough. There was a need for deep reform in read more..

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    Chapter 15 Trade and Policy Reform in Latin America 373 Neoliberal Policy Reform and the Washington Consensus By the late 1980s most countries in Latin America had started a series of eco- nomic policy reforms that began to alter the fundamental relationships between business and government and between their national economy and the world. After 1989 the reforms read more..

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    374 PART 4 Regional Issues in the Global Economy A further complication was the lack of agreement over the causes of inflation. Some argued that it was caused by inertia since everyone expected future inflation to be high. This caused producers to raise prices in anticipation of higher future input costs. The problem of inflation developing a momentum of its own, read more..

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    Chapter 15 Trade and Policy Reform in Latin America 375 on imports of U.S.-made capital goods, which were essential to Mexican industry, thereby helping to hold down Mexican prices for finished manufactured goods. Since Mexico’s inflation was still slightly higher than U.S. inflation, the peso became overvalued over a period of time. Ultimately, this contributed to a seri- ous read more..

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    376 PART 4 Regional Issues in the Global Economy better off by lowering the real cost of traded goods. In response to the changes in trade policy, the growth rate of exports picked up in most countries, while nontra- ditional exports increased dramatically. Furthermore, productivity rose in a major- ity of countries for which there is data. The productivity increase is at read more..

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    Chapter 15 Trade and Policy Reform in Latin America 377 With the onset of trade reforms in the mid-to-late 1980s, regional trade agreements once again became popular. Mexico took the lead with its announcement in 1989 that it was pursuing a free-trade agreement with the United States. In addition to economies of scale, trade agreements seemed to hold the promise of read more..

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    378 PART 4 Regional Issues in the Global Economy The Next Generation of Reforms The Washington Consensus overlaps with stabilization policies and structural reforms, and they are commonly mixed together under the label of neoliberalism. Neoliberalism and the Washington Consensus are negative terms throughout most of Latin America, primarily because the reforms of the last read more..

  • Page - 406

    Chapter 15 Trade and Policy Reform in Latin America 379 emphasis on primary education and health care for children, as well as a set of social policies called conditional cash transfers (CCT). CCT began in Brazil and Mexico and have been adopted in more than seventeen countries. These programs vary somewhat in their size and administration, but in each case, read more..

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    380 PART 4 Regional Issues in the Global Economy been in crisis, began to grow two years after Pinochet gained power and after a disastrous recession in 1975. But the growth was illusory, and when a world- wide recession started in the early 1980s, Chile’s economy collapsed. Banks were renationalized, and many of the trade reforms were turned back. After two more read more..

  • Page - 408

    Chapter 15 Trade and Policy Reform in Latin America 381 Summary ■ Latin America was one of the fastest-growing regions of the world throughout most of the twentieth century. Growth came crashing to a halt in the 1980s, however, and only began to return in the late 1980s and early 1990s. ■ Until the recent reforms, Latin American read more..

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    382 PART 4 Regional Issues in the Global Economy ■ From the mid-1980s through the present, the governments of Latin Amer- ica have engaged in serious reforms of economic policy. The reforms have first tried to create macroeconomic stability through controlling inflation and reducing budget deficits. Stabilization policies have been followed by structural reforms that read more..

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    Chapter 15 Trade and Policy Reform in Latin America 383 5. Explain how economic populist policies usually lead to overvalued exchange rates and large trade deficits. 6. What were the proximate causes of the debt crisis? How did the United States and other industrial countries respond? 7. Why did the Latin American debt read more..

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    384 16 Introduction: The High-Performance Asian Economies One of the most interesting and important economic stories of the last fifty years is the success of several Asian economies. In Chapter 17 we will look more closely at China, India, and other emerging markets, but in this chapter the focus is on the group of countries that read more..

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    Chapter 16 Export-Oriented Growth in East Asia 385 read more..

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    386 PART 4 Regional Issues in the Global Economy NIE in the HPAE are Indonesia, Malaysia, and Thailand. China may also be con- sidered a NIE, but it is usually placed in its own category due to its size and the legacy of communism. All of the NIE began their high rates of economic growth after the economies of the Four Tigers took off. Economists agree read more..

  • Page - 414

    Chapter 16 Export-Oriented Growth in East Asia 387 TABLE 16.1 Population and GDP for the HPAE, 2011 Population (Millions) GDP (US$, Billions) GDP per Capita (US$, PPP) HPAE Hong Kong, China 7.1 243.3 49,137 Japan 127.8 5,869.4 34,740 Indonesia 241.0 845.7 read more..

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    388 PART 4 Regional Issues in the Global Economy also shows the rate of growth of GDP per person for the high-income countries. As shown in the table, growth rates for each of the HPAE exceed the high- income average, except in the case of Japan, which had a decade of no growth in the 1990s. General Characteristics of Growth in the HPAE Recall read more..

  • Page - 416

    Chapter 16 Export-Oriented Growth in East Asia 389 Shared Growth One of the most remarkable features of growth in the HPAE is that it was accom- panied by rising economic equality. This feature is even more remarkable when it is realized that inequality in income and wealth was already relatively low at the start of the period of high growth. Since the work of read more..

  • Page - 417

    390 PART 4 Regional Issues in the Global Economy to high rates of investment, which fed back into a second round of income growth and high savings. Investment in people was as important as the accumulation of physical capital. One of the key features of the HPAE’s educational policy is that public investment in education was focused on the primary and secondary read more..

  • Page - 418

    Chapter 16 Export-Oriented Growth in East Asia 391 The connection between export promotion and high rates of growth is an area of some controversy in economics. Several possible connections are explored in greater detail later in the chapter. A second controversy is the possibility of other nations using similar export promotion strategies. In many cases, these policies generate read more..

  • Page - 419

    392 PART 4 Regional Issues in the Global Economy Several components of the institutional environment are critical insofar as they help to make government policy credible. In particular, property rights are relatively secure and free from the threat of nationalization. Bureaucracies are generally competent, individuals and businesses are free to make contracts that will be read more..

  • Page - 420

    Chapter 16 Export-Oriented Growth in East Asia 393 De Soto’s work found its way onto a larger stage at the World Bank where his ideas were built into an ongoing research project and an online database comparing the ease of doing business in 183 countries. The Doing Business Web site ( ) issues an annual report on the degree of read more..

  • Page - 421

    394 PART 4 Regional Issues in the Global Economy Fiscal Discipline and Business-Government Relations Democratic or not, governments must create a stable macroeconomic environ- ment in order for economic growth to succeed. The characteristic of macroeco- nomic stability has already been discussed, but it is worth revisiting because of its central importance. The maintenance of read more..

  • Page - 422

    Chapter 16 Export-Oriented Growth in East Asia 395 largest bureaucracies in Japan, and because it has more control over Japanese economic policy than any other bureaucracy—with the exception of the Min- istry of Finance—it has numerous deliberation councils. Councils in METI are of two basic types. They are industry specifi c, such as the Automobile Division or the Textile read more..

  • Page - 423

    396 PART 4 Regional Issues in the Global Economy Avoiding Rent Seeking Economic policy in the HPAE has been relatively interventionist. That is, the laissez-faire ideology of letting markets determine outcomes has not been fol- lowed. Hong Kong is an exception, but even there, the government has directed and actively participated in the creation of extensive public read more..

  • Page - 424

    Chapter 16 Export-Oriented Growth in East Asia 397 ity, their insulation from the political process gives them the room to make deci- sions based on merit rather than on the basis of special interests. A final explanation for the relative lack of rent seeking is the commitment to shared growth that we saw at the beginning of the chapter. The fact that business elites read more..

  • Page - 425

    398 PART 4 Regional Issues in the Global Economy income. If mercantilism is the key to their success, it would be an important empir- ical case against the paradigm of comparative advantage and the gains from trade. Table 16.5 contrasts imports and exports for high-growth East Asian coun- tries with those of the main Latin American economies. Imports and read more..

  • Page - 426

    Chapter 16 Export-Oriented Growth in East Asia 399 East Asian economies apparently did not close their import sectors, but rather imported quite a large amount of goods and services. They still may have used selective protection for targeted industries, but in general the data do not support the idea that they were relatively closed to imports. This is entirely read more..

  • Page - 427

    400 PART 4 Regional Issues in the Global Economy Korea, Taiwan’s programs have provided research institutes, science parks, and basic infrastructure for a variety of industries and seem to have targeted the development of import substitutes. Malaysian policies took off in the early 1980s with the Look East policy, which emulated Korea’s and Japan’s industrial development. read more..

  • Page - 428

    Chapter 16 Export-Oriented Growth in East Asia 401 forced financial institutions to make unsound loans. In turn, the failure to apply business criteria led to a mountain of bad debt, which ultimately sank many banks and whole financial sectors. Did Industrial Policies Work? The role of industrial policies in the story of HPAE growth is controversial. Ide- ally, we read more..

  • Page - 429

    402 PART 4 Regional Issues in the Global Economy Critiques of the World Bank’s findings usually rest on two points. First, the fact that productivity growth was generally no faster in promoted sectors is irrelevant, according to the critics. The important issue is what the growth rates would have been without promotion. It is conceivable that without industrial policies, read more..

  • Page - 430

    Chapter 16 Export-Oriented Growth in East Asia 403 equipment and autos)—for export. The tools used to promote these industries were the same as previously described but with a different emphasis. By the mid-1970s, trade policy had become somewhat more liberal, although most industries still received significant protection. Greater emphasis was placed on subsidies, directed credit read more..

  • Page - 431

    404 PART 4 Regional Issues in the Global Economy The Connections between Growth and Exports It is true by definition that exports are part of the GDP, so growth in exports would seem to be simply a part of overall GDP growth. Export growth may not add to GDP growth, however, if it crowds out growth in the output of goods for domestic consumption, such read more..

  • Page - 432

    Chapter 16 Export-Oriented Growth in East Asia 405 the HPAE to policies that openly encouraged inward foreign direct investment (FDI) and the acquisition of new technology. One way to overcome the back- wardness of domestic manufacturing is to encourage foreign firms to invest. Most of the HPAE welcomed FDI; Singapore went so far as to build its industrial poli- cies around read more..

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    406 PART 4 Regional Issues in the Global Economy CASE STUDY Asian Trade Blocs The fi rst edition of this text (1994) began this case study as follows: “Asia is the one region of the world without signifi cant trade blocs.” Since then, and more particularly since 2000, that has changed dramatically. Table 16.6 shows the read more..

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    Chapter 16 Export-Oriented Growth in East Asia 407 Is There an Asian Model of Economic Growth? The East Asian “miracle” has given rise to a large number of studies that seek to explain rapid growth in the HPAE and China. While the issue may superficially appear academic, it has become one of the more interesting and heated debates in recent popular read more..

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    408 PART 4 Regional Issues in the Global Economy To describe some interesting recent studies, we must briefly review the idea of growth accounting. Recall that labor productivity is a measurement defined as output per worker. The growth in labor productivity is highly correlated with the growth in income (or output) per member of the population, but they are not the read more..

  • Page - 436

    Chapter 16 Export-Oriented Growth in East Asia 409 ilar growth accounting exercises and have reached the same conclusions. The growth accounts for East Asia are important because they paint a consistent, if surprising, picture of the East Asian “miracle.” They tell us that there may be no miracle at all, just the hard work and sacrifice that comes from forgoing today’s read more..

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    410 PART 4 Regional Issues in the Global Economy ■ The institutional environment is instrumental in creating confidence in policymakers. The policymaking bureaucracy tends to be insulated from the push and pull of the political system. This leads some to decry the lack of representation of the population in policy decisions, but it allows decisions to be read more..

  • Page - 438

    Chapter 16 Export-Oriented Growth in East Asia 411 Study Questions All problems are assignable in MyEconLab. 1. Contrast the characteristics of economic growth in the HPAE with those characteristics of Latin America. 2. How can passage through a demographic transition lead to high savings and investment rates? 3. What read more..

  • Page - 439

    17 Introduction: The BRICs In November, 2001, James O’Neill, director of Global Economic Research at the investment bank Goldman Sachs, wrote a paper he titled “Building Better Global Economic BRICs.” The BRICs acronym in the title referred to Brazil, Russia, India, and China, and his thesis was that these four countries were dramatically reshaping read more..

  • Page - 440

    Chapter 17 The BRIC Countries in the World Economy 413 this group—Mexico, perhaps, or Turkey, South Africa, or Korea if it were not already among the high-income group. Others have written about more compre- hensive groups of dynamic countries with a lot of potential, and O’Neill himself wrote about another set of countries, called the N-11, that have the size and read more..

  • Page - 441

    414 PART 4 Regional Issues in the Global Economy see it is as a return to a pre-industrial balance of power that was disrupted by indus- trial development in the West, imperial ambitions of Western leaders, and institu- tional weaknesses in other parts of the world. These two views of Figure 17.1 are not mutually exclusive, so both may be correct. read more..

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    Chapter 17 The BRIC Countries in the World Economy 415 Russia’s economy was less than half of China’s and was significantly less than India’s. Brazil experienced rapid rates of growth in the 1950s and 1960s, and again from the mid-1990s to the present, after dealing with the Latin American Debt Crisis of the 1980s. By 2010, as shown in Table 17.1 , read more..

  • Page - 443

    416 PART 4 Regional Issues in the Global Economy and 2050. As can be seen, the share nearly doubles, or increases by more, in all cases, and in China it almost triples. Russia starts with a much older population in 2010, so its near-doubling will give it one of the oldest populations by 2050, but not as old as China’s. An aging population will mean read more..

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    Chapter 17 The BRIC Countries in the World Economy 417 Undoubtedly, retirement in China will not be as it is in the West, since fewer people have pensions and families are not large enough to support elderly peo- ple. Many seniors will keep working; but as people grow older, their ability to do certain tasks decreases or disappears altogether, and their productivity read more..

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    418 PART 4 Regional Issues in the Global Economy High rates of growth are not new to Brazil. Brazil’s economy boomed in the 1950s and again in the late 1960s through much of the 1970s. Economic policy in Brazil was based on the traditional Latin American policy of import substitution industrialization, but Brazil’s large domestic market enabled many of its firms read more..

  • Page - 446

    Chapter 17 The BRIC Countries in the World Economy 419 imports went through the FTC and were strictly regulated with no consideration given to comparative advantage. The reforms gradually opened trade, first through the creation of additional FTC and then through a series of steps that removed price controls and ended export subsidies. To limit the initial impact of reforms read more..

  • Page - 447

    420 PART 4 Regional Issues in the Global Economy The changes in economic policy that followed touched on a number of areas, including the permitting process. India’s regulation of its economy was based on a system of permits that stifled innovation and creativity with their extensive, complicated, and inefficient rules. Permits were intended to prevent the creation of read more..

  • Page - 448

    Chapter 17 The BRIC Countries in the World Economy 421 controversies was over the speed of the transition. “You cannot cross a chasm in two leaps” (go fast) was one view. The other view was that of Deng Xiaoping, the Chinese leader who likened reform to “feeling the stones to cross the river.” The International Monetary Fund (IMF) and the U.S. government favored read more..

  • Page - 449

    422 PART 4 Regional Issues in the Global Economy The Brazilian government’s attempt to finance itself in the 1980s and early 1990s by printing money was not unique in Latin America. When tax systems do not provide sufficient revenue to support government spending, and domestic and foreign lenders are wary of new loans, money creation is a way for govern- ments to read more..

  • Page - 450

    Chapter 17 The BRIC Countries in the World Economy 423 role, each of them use the power and authority of their national governments to direct and control a significant share of industry. This model has been labeled state capitalism to distinguish it from the market capitalism of the United States and Western Europe. In state capitalism, the national government uses read more..

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    424 PART 4 Regional Issues in the Global Economy production, and individual incentives began to rule the efforts and decision making of producers. In the mid-1980s, China extended its market-based reforms to a num- ber of Special Economic Zones (SEZ), Economic and Technology Development Zones (ETDZ), High Technology Development Zones (HTDZ), and other special developmental read more..

  • Page - 452

    Chapter 17 The BRIC Countries in the World Economy 425 The BRICs in the World Economy The BRICs have profoundly influenced the direction of world trade and invest- ment. As they have become more integrated with the rest of the world, multina- tional businesses have quickly moved to establish production and distribution networks inside the BRICs, and BRIC firms have read more..

  • Page - 453

    426 PART 4 Regional Issues in the Global Economy a loss of exports and somewhat fewer imports, as shown by the sudden decline in the ratio in the last few years. At the end of the crisis, there was the beginning of a recovery in 2010. Brazil is the least trade dependent of the four countries, while Russia’s trade-to-GDP ratio is tightly linked to the status of read more..

  • Page - 454

    Chapter 17 The BRIC Countries in the World Economy 427 Chapter 4 ’s case study on Chinese exports to the United States illustrates this point. Table 4.4 lists the top ten exports of China to the United States . Among them are low-technology items, such as apparel, footwear, toys, and furniture, and a few read more..

  • Page - 455

    428 PART 4 Regional Issues in the Global Economy (Brazil). Russia has the world’s eighth largest reserves of oil, and its economy is reliant on exports of oil and gas to the European Union, Ukraine, and other regional economies. Brazil’s trade, on the other hand, is nearly equally divided between manufactured goods, agricultural products, and minerals and oil. In part read more..

  • Page - 456

    Chapter 17 The BRIC Countries in the World Economy 429 U.S. Bureau of Labor Statistics projects significant job growth in the United States in IT-related occupations. These new workers and many already in the IT services sector will not continue to do the same thing, however, as the compara- tive advantage of the United States is shifting within the IT field. While read more..

  • Page - 457

    430 PART 4 Regional Issues in the Global Economy engineer products, produce a knock-off at a fraction of the price of the imported good since no royalties are paid, and expand across the domestic market. Many observers believe that China’s enforcement will not become effective until China itself has significant intellectual property to protect. Resources China’s read more..

  • Page - 458

    Chapter 17 The BRIC Countries in the World Economy 431 weakened beginning in 2002, the renminbi weakened with it. In many quarters this was seen as an unfair trade advantage for China. In 2005, China announced that it was adopting a narrow exchange rate band and that it would use a trade-weighted index instead of a dollar peg. In other words, the People’s Bank read more..

  • Page - 459

    432 PART 4 Regional Issues in the Global Economy Sterilization is controversial because it is seen by some as currency manipula- tion to keep the value of the renminbi low. This has undoubtedly given China an advantage in export markets and raised tensions with its trading partners. Never- theless, current estimates put the renminbi at or near its equilibrium value (mid- read more..

  • Page - 460

    Chapter 17 The BRIC Countries in the World Economy 433 tensions with the United States and the European Union, where it is viewed as an unfair trade practice. The United States has reacted by levying both anti-dumping duties and countervailing duties on Chinese products. This issue overlaps the issue of unbalanced trade since subsidized industries are potentially more read more..

  • Page - 461

    434 PART 4 Regional Issues in the Global Economy have not been proposed for India, although the outsourcing by firms of their IT work has led to calls for the re-examination of policies that may be encouraging firms to go abroad. In the end, however, measures against China and India become difficult to enforce because for every firm hurt by Chinese or Indian read more..

  • Page - 462

    Chapter 17 The BRIC Countries in the World Economy 435 ■ All four BRIC countries score low on the Doing Business Index of the World Bank, indicating that a number of institutional changes are yet to be made. ■ China and India have had a very rapid growth of imports and exports. China’s manufacturing sector is extremely competitive but read more..

  • Page - 463

    436 PART 4 Regional Issues in the Global Economy 4. Why did economic reform in Russia and most other transition economies lead to large declines in their GDP? 5. Why did Brazil begin its reforms when it did? What were its main challenges? 6. What are the sources of China’s comparative advantage and how does that read more..

  • Page - 464

    GLOSSARY Absolute productivity advantage, or absolute advan- tage. A country has an absolute productivity advantage in a good if its labor productivity is higher; that is, it is able to produce more output with an hour of labor than its trading partner can. Acquis communautaire. The European Union rules governing technical standards, read more..

  • Page - 465

    438 Glossary Monetary Fund and the World Bank emerged from the Bretton Woods Conference. Bretton Woods exchange rate system. The exchange rate system that emerged from the Bretton Woods Conference at the end of World War II. See also Smithsonian Agreement. BRICs. Brazil, Russia, India, and China. The term was first used by Jim read more..

  • Page - 466

    Glossary 439 Countervailing duty (CVD). A tariff on imports that is levied in retaliation against foreign subsi- dies. See also Subsidy. Covered interest arbitrage. Interest rate arbitrage that includes the signing of a forward currency contract to sell the foreign currency when the foreign assets mature. See also Interest rate arbitrage. read more..

  • Page - 467

    440 Glossary while having the same or substantially similar fis- cal and monetary policies. Economic unions may include a common currency. Economies of scale. A decline in average cost while the number of units produced increases. Effective rate of protection. Effective rates of pro- tection consider levels of protection on interme- diate inputs as read more..

  • Page - 468

    Glossary 441 External economies of scale. Scale economies that are external to a firm, but internal to an industry. Consequently, all the firms in an industry experi- ence declining average costs as the size of the industry increases. Externality. A divergence between social and pri- vate returns. Factor abundance, factor scarcity. These read more..

  • Page - 469

    442 Glossary provides low income countries with preferential access at reduced tariff rates to high-income markets. Gold standard. A fixed exchange rate system that uses gold as its standard of value. Goods and services. Goods and services are the components of international trade and the two main components of the current account. read more..

  • Page - 470

    Glossary 443 Intermediation. The role of banks as institutions that concentrate savings from many sources and lend the money to investors. Internal economies of scale. The idea that an indi- vidual firm experiences a decline in its average cost of production as it increases the number of units produced. International financial architecture. read more..

  • Page - 471

    444 Glossary Moral hazard. A financial incentive to withhold information, take on excessive risk, or behave in a manner that generates significant social costs. Most-favored nation (MFN) status. The idea that every member of the World Trade Organization (WTO) is required to treat each of its trading partners as well as it treats its most favored read more..

  • Page - 472

    Glossary 445 OLI theory. A model of the determinants of foreign direct investment that is based on the key vari- ables Ownership-Location-Internalization. Oligopoly. A market with so few producers that each firm can influence the market price. Open market operations. The main tool of mone- tary policy, consisting of the buying and selling read more..

  • Page - 473

    446 Glossary resources (labor and capital) but do not add to national output. For this reason, rent seeking is a net loss to the nation. Resource curse. The economic and/or political problems caused by an abundance of one valu- able natural resource such as petroleum. Revaluation. An increase in the value of a currency under a fixed read more..

  • Page - 474

    Glossary 447 Structural adjustment policies. Policies that are designed to increase the role of market forces in a national economy. Structural adjustment poli- cies are mainly microeconomic in nature and include privatization, deregulation, and trade reform. See also Stabilization policies. Structural reform policies. A set of reform policies designed read more..

  • Page - 475

    448 Glossary adopted socialist or communist ideologies during the twentieth century. Transparent. Describes any trade barrier that is clearly defined as a barrier. Tariffs have the most transparency (are the most transparent) because they are usually clearly specified and published in each country’s tariff code. Any disguised or hid- den trade barriers cause a read more..

  • Page - 476

    INDEX Absolute productivity advantage comparative advantage versus, 51 defined, 43 , 51 gains from trade and, 42 – 44 no, gains from trade with, 52 – 54 Acquis communautaire , 350 ADD (antidumping duty), 150 – 151 Adjustment costs, international economic institutions, 35 – 36 read more..

  • Page - 477

    450 Index Australia agricultural sector, 138 , 142 borrowing patterns, 7 comparative advantage, 142 Autarky , 47 Auto Pact , 308 Baker plan , 371 – 372 Balance of payments. See also Capital account; Current account; Financial account crisis of 2007–2009 and, 190 – 192 read more..

  • Page - 478

    Index 451 Capital flows comparison of, 6 – 7 inflow controls, 282 inflow costs, 204 as international economic issue, 14 outflow controls, 281 quantity of, 7 short run, 219 size comparison, 7 trade and, 10 volatile movement, 7 – 8 , 274 – 276 Capital requirements , 279 read more..

  • Page - 479

    452 Index Climate change (case study), 174 – 176 CMI (Chiang Mai Initiative) , 407 Cohesion funds , 332 Cold War, 305 Collective action clauses , 290 Collective action, logic of, 140 – 141 Commercial policy, 136 – 155 defined, 114 introduction to, 136 – 137 read more..

  • Page - 480

    Index 453 Data dissemination standards , 290 Deadweight loss , 119 , 139 Debt of developing countries, 14 external, 201 odious, 202 – 203 problems, 201 – 202 service, 201 unsustainable, 201 Debt crisis , 272 – 273 Debt crisis of 1980s (Latin America) read more..

  • Page - 481

    454 Index Eastern Caribbean Currency Union (ECCU), 235 , 236 ECB (European Central Bank) , 342 , 349 Economic Commission on Latin America, 361 Economic growth East Asia, 386 – 388 exchange rates and trading, 233 exchange rates in medium run and, 218 Latin America, 358 – 360 symmetrical, 219 read more..

  • Page - 482

    Index 455 migration role, 354 monetary union, 343 – 345 new members, 350 – 351 political economy and the euro, 345 – 346 population, 329 population forecast, 354 as regional trade agreement, 10 Single European Act (SEA), 335 – 341 Spain’s switch from emigration to immigration (case study), 351 – 353 read more..

  • Page - 483

    456 Index Fair value , 150 FDI. See Foreign direct investment Financial account Asian Crisis of 1997–1998, 282 – 283 components of, 187 credit and debit tabulation, 184 defined, 184 interdependency, 184 in relation to current account, 184 , 185 transactions, 185 – 186 U.S., 191 read more..

  • Page - 484

    Index 457 internal economies of scale, 99 – 100 Mexico’s manufacturing case study, 100 – 102 trade and, 99 – 103 trade and external economies, 102 – 103 transportation costs and, 99 – 100 Germany reunification, 334 trade-to-GDP ratio, 5 GHG (greenhouse gases), 174 – 176 Global climate change, read more..

  • Page - 485

    458 Index High-performance Asian economies (HPAE) (Contd.) deliberation councils in METI (case study), 394 – 395 doing business in (case study), 392 – 394 ease of doing business index rankings, 393 economic policy as interventionist, 396 educational policy, 390 enforceability role, 396 export promotion model, 405 export read more..

  • Page - 486

    Index 459 Infant industry argument , 145 Inflation, Latin America, 373 – 375 Informal economy , 164 Informal institutions, 18 Inputs availability of, 64 Heckscher-Ohlin (HO) trade model, 65 intermediate, 245 – 246 Institutions . See also International economic institutions defined, read more..

  • Page - 487

    460 Index International financial crises (Contd.) frequency of, 287 global crisis of 2007 (case study), 291 – 295 as international economic issue, 14 introduction to, 270 – 271 from macroeconomic imbalances, 287 moral hazard and financial sector regulation, 279 – 280 reform of international financial architecture, 287 – 291 read more..

  • Page - 488

    Index 461 Labor standards. See also Standards child, 162 – 163 core, 166 daily work hours, 161 defining, 161 effectiveness, 163 – 164 health and safety issues, 161 ILO, 161 lack of agreement on, 165 low, as predatory practice, 165 – 166 minimum wage, 161 protectionism and, 164 read more..

  • Page - 489

    462 Index Mercado Común del Sur (MERCOSUR), 10 , 377 Mercantilism , 40 METI (Ministry of Economy, Trade, and Industry), 394 – 395 Mexican Peso Crisis of 1994–1995, 2 , 31 austerity measures, 278 case study, 276 – 278 defined, 276 devaluation, 277 lessons, 278 pesos per dollar, read more..

  • Page - 490

    Index 463 Negotiations, 173 – 174 Neoliberal model , 373 Net foreign investment, 196 Net national welfare loss, 139 Netherlands, 5 New Trade Theory defined, 11 , 94 economies of scale, 94 Newly industrializing economies (NIEs) , 384 – 386 NIPA. See National read more..

  • Page - 491

    464 Index Productivity differences availability of inputs and, 64 labor argument and, 144 Profits, effects on foreign producers, 128 – 130 Protection arguments for, 136 – 137 effective rate of, 124 – 125 hidden forms of, 130 – 131 intellectual property, lack of, 131 – 132 as international economic issue, read more..

  • Page - 492

    Index 465 Regional trade blocs. See Trade blocs Relative prices , 47 – 48 Renminbi, 431 Rent seeking defined, 108 HPAE avoidance, 396 – 397 import substitution industrialization (ISI) and, 363 tariffs and, 122 Research and development (R&D), industrial policy problems, 108 read more..

  • Page - 493

    466 Index Spain (Contd.) housing market, 292 – 293 switch from emigration to immigration (case study), 351 – 353 Special 301 , 152 Special drawing rights (SDRs) , 19 Special Economic Zones (SEZ) , 419 Specific factors model defined, 71 determinants of comparative advantage with, 72 read more..

  • Page - 494

    Index 467 summary, 133 Uruguay Round, 125 – 127 vocabulary, 133 zero, 143 Technology transfer , 204 TEDs (turtle excluder devices), 170 Terms of trade (TOT) , 360 Thailand currency loss, 198 pegged exchange rates, 230 Tokyo Round, 22 – 23 Total factor productivity read more..

  • Page - 495

    468 Index Transportation costs geography and, 99 – 100 manufacturing, 99 Treaty of Rome , 330 – 331 Treaty on European Union , 327 TRIMs. See Trade-Related Investment Measures TRIPS. See Trade-Related Aspects of Intellectual Property Rights Turtle excluder devices (TEDs), 170 read more..

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    Index 469 World Trade Organization (WTO) creation of, 9 , 13 , 19 criticisms of, 33 – 36 Dispute Settlement Body, 170 dumping, 150 environment agreements, 174 governing structure, 34 member treatment, 165 national treatment and nondiscrimination, 21 regional trade agreements and, 26 – 27 rules read more..

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