International Trade and Tariff Revenue Loss Analysis Essay

User Generated

ivivinyragvabin

Economics

Description

I need you to use your own words to write it, a little bit more to type but not hard (since the standard answers can be searched online but I've attached the result book too), easy money. DO NOT copy the result answers, but rewrite it in your own words. No plagiarism please. Thank you. The question numbers are attached in the png file, the book and the result book is included.

Unformatted Attachment Preview

International Economics Sixteenth Edition The McGraw-Hill Series in Economics ESSENTIALS OF ECONOMICS Brue, McConnell, and Flynn Essentials of Economics Third Edition Mandel Economics: The Basics Second Edition Schiller Essentials of Economics Ninth Edition Slavin Economics, Microeconomics, and Macroeconomics Eleventh Edition ECONOMICS OF SOCIAL ISSUES Guell Issues in Economics Today Seventh Edition Sharp, Register, and Grimes Economics of Social Issues Twentieth Edition PRINCIPLES OF ECONOMICS Colander Economics, Microeconomics, and Macroeconomics Ninth Edition Frank and Bernanke Principles of Economics, Principles of Microeconomics, and Principles of Macroeconomics Fifth Edition Frank and Bernanke Brief Editions: Principles of Economics, Principles of Microeconomics, and Principles of Macroeconomics Second Edition Karlan and Morduch Economics, Microeconomics, and Macroeconomics First Edition McConnell, Brue, and Flynn Economics, Microeconomics, and Macroeconomics Twentieth Edition McConnell, Brue, and Flynn Brief Editions: Economics, Microeconomics, and Macroeconomics Second Edition Miller Principles of Microeconomics First Edition Samuelson and Nordhaus Economics, Microeconomics, and Macroeconomics Nineteenth Edition Schiller The Economy Today, The Micro Economy Today, and The Macro Economy Today Thirteenth Edition ECONOMETRICS Gujarati and Porter Basic Econometrics Fifth Edition Gujarati and Porter Essentials of Econometrics Fourth Edition MONEY AND BANKING Cecchetti and Schoenholtz Money, Banking, and Financial Markets Fourth Edition URBAN ECONOMICS O’Sullivan Urban Economics Eighth Edition LABOR ECONOMICS Borjas Labor Economics Seventh Edition McConnell, Brue, and Macpherson Contemporary Labor Economics Tenth Edition PUBLIC FINANCE Hilmer and Hilmer Practical Econometrics First Edition Rosen and Gayer Public Finance Tenth Edition MANAGERIAL ECONOMICS Seidman Public Finance First Edition Baye and Prince Managerial Economics and Business Strategy Eighth Edition Brickley, Smith, and Zimmerman Managerial Economics and Organizational Architecture Sixth Edition Thomas and Maurice Managerial Economics Eleventh Edition INTERMEDIATE ECONOMICS ENVIRONMENTAL ECONOMICS Field and Field Environmental Economics: An Introduction Sixth Edition INTERNATIONAL ECONOMICS Appleyard and Field International Economics Eighth Edition Bernheim and Whinston Microeconomics Second Edition King and King International Economics, Globalization, and Policy: A Reader Fifth Edition Dornbusch, Fischer, and Startz Macroeconomics Twelfth Edition Pugel International Economics Sixteenth Edition Frank Microeconomics and Behavior Ninth Edition ADVANCED ECONOMICS Romer Advanced Macroeconomics Fourth Edition International Economics Sixteenth Edition Thomas A. Pugel New York University INTERNATIONAL ECONOMICS: SIXTEENTH EDITION Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2016 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2012, 2009, and 2007. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 0 DOC/DOC 1 0 9 8 7 6 5 ISBN 978-0-07-802177-0 MHID 0-07-802177-4 Senior Vice President, Products & Markets: Kurt L. Strand Vice President, General Manager, Products & Markets: Marty Lange Vice President, Content Design & Delivery: Kimberly Meriwether David Managing Director: James Heine Lead Product Developer: Michele Janicek Senior Product Developer: Christina Kouvelis Director of Marketing: Lynn Breithaupt Director, Content Design & Delivery: Linda Avenarius Senior Content Project Manager: Lisa Bruflodt Buyer: Laura M. Fuller Cover Image: Design Pics/Ryan Briscall Compositor: Laserwords Private Limited Printer: R. R. Donnelley All credits appearing on page or at the end of the book are considered to be an extension of the copyright page. Library of Congress Cataloging-in-Publication Data Pugel, Thomas A. International economics/ Thomas A. Pugel.—Sixteenth edition. pages cm ISBN 978-0-07-802177-0 (alk. paper) 1. Commercial policy. 2. Foreign exchange. I. Title. HF1411.L536 2016 337—dc23 2014040055 The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites. www.mhhe.com In memory of my parents, Adele and Edmund, and my parents-in-law, Vivian and Freeman, with my deepest appreciation and gratitude for all that they did to benefit the generations that follow. About the Author Thomas A. Pugel Thomas A. Pugel is Professor of Economics and Global Business at the Stern School of Business, New York University, and a Fellow of the Teaching Excellence Program at the Stern School. His research and publications focus on international industrial competition and government policies toward international trade and industry. Professor Pugel has been Visiting Professor at Aoyama Gakuin University in Japan and a member of the U.S. faculty at the National Center for Industrial Science and Technology Management Development in China. He received the university-wide Distinguished Teaching Award at New York University in 1991, and twice he was voted Professor of the Year by the graduate students at the Stern School of Business. He studied economics as an undergraduate at Michigan State University and earned a PhD in economics from Harvard University. vi Preface International economics combines the excitement of world events and the incisiveness of economic analysis. We are now deeply into the second great wave of globalization, in which product, capital, and labor markets are becoming more integrated across countries. This second wave, which began in about 1950 and picked up steam in the 1980s, has now lasted longer than the first, which began in about 1870 and ended with World War I (or perhaps with the onset of the Great Depression in 1930). As indicators of the current process of globalization, we see that international trade, foreign direct investment, cross-border lending, and international portfolio investments have been growing faster than world production. Information, data, and rumors now spread around the world instantly through the Internet and other global electronic media. As the world becomes more integrated, countries become more interdependent. Increasingly, events and policy changes in one country affect many other countries. Also increasingly, companies make decisions about production and product development based on global markets. My goal in writing and revising this book is to provide the best blend of events and analysis, so that the reader builds the abilities to understand global economic developments and to evaluate proposals for changes in economic policies. The book is informed by current events and by the latest in applied international research. My job is to synthesize all of this to facilitate learning. The book Combines rigorous economic analysis with attention to the issues of economic policy that are alive and important today. Is written to be concise and readable. Uses economic terminology when it enhances the analysis but avoids jargon for jargon’s sake. I follow these principles when I teach international economics to undergraduates and master’s degree students. I believe that the book benefits as I bring into it what I learn from the classroom. THE SCHEME OF THE BOOK The examples presented in Chapter 1 show that international economics is exciting and sometimes controversial because there are both differences between countries and interconnections among countries. Still, international economics is like other economics in that we will be examining the fundamental challenge of scarcity of resources— how we can best use our scarce resources to create the most value and the most benefits. We will be able to draw on many standard tools and concepts of economics, such as supply and demand analysis, and extend their use to the international arena. We begin our in-depth exploration of international economics with international trade theory and policy. In Chapters 2–7 we look at why countries trade goods and services. In Chapters 8–15 we examine what government policies toward trade would bring benefits and to whom. This first half of the book might be called international microeconomics. vii viii Preface Our basic theory of trade, presented in Chapter 2, says that trade usually results from the interaction of competitive demand and supply. It shows how the gains that trade brings to some people and the losses it brings to others can sum to overall global and national gains from trade. Chapter 3 launches an exploration of what lies behind the demand and supply curves and discovers the concept of comparative advantage. Chapter 4 shows that countries have different comparative advantages for the fundamental reason that people, and therefore countries, differ from each other in the productive resources they own. Chapter 5 looks at the strong impacts of trade on people who own those productive resources—the human labor and skills, the capital, the land, and other resources. Some ways of making a living are definitely helped by trade, while others are hurt. Chapter 6 examines how actual trade may reflect forces calling for theories that go beyond our basic ideas of demand and supply and of comparative advantage. Chapter 7 explores some key links between trade and economic growth. Chapters 8–15 use the theories of the previous chapters to analyze a broad range of government policy issues. Chapters 8–10 set out on a journey to map the border between good trade barriers and bad ones. This journey turns out to be intellectually challenging, calling for careful reasoning. Chapter 11 explores how firms and governments sometimes push for more trade rather than less, promoting exports more than a competitive marketplace would. Chapter 12 switches to the economics of trade blocs like the European Union and the North American Free Trade Area. Chapter 13 faces the intense debate over how environmental concerns should affect trade policy. Chapter 14 looks at how trade creates challenges and opportunities for developing countries. Chapter 15 examines the economics of emigration and immigration and the roles of global companies in the transfer of resources, including technology, between countries. The focus of the second half of the book shifts to international finance and macroeconomics. In Chapters 16–21 we enter the world of different moneys, the exchange rates between these moneys, and international investors and speculators. Chapters 22–25 survey the effects of a national government’s choice of exchangerate policy on the country’s macroeconomic performance, especially unemployment and inflation. Chapter 16 presents the balance of payments, a way to keep track of all the economic transactions between a country and the rest of the world. In Chapter 17 we explore the basics of exchange rates between currencies and the functioning and enormous size of the foreign exchange market. Chapter 18 provides a tour of the returns to and risks of foreign financial investments. Exchange rates are prices, and in Chapter 19 we look behind basic supply and demand in the foreign exchange market, in search of fundamental economic determinants of exchange-rate values. Chapter 20 examines government policies toward the foreign-exchange market, first using description and analysis, and then presenting the history of exchange-rate regimes, starting with the gold standard and finishing with the current mash-up of different national policies. Well-behaved international lending and borrowing can create global gains, but Chapter 21 also examines financial crises that can arise from some kinds of foreign borrowing and that can spread across countries, a clear downside of globalization. Preface ix Chapter 22 begins our explication of international macroeconomics by developing a framework for analyzing a national economy that is linked to the rest of the world through international trade and international financial investing. We use this framework in the next two chapters to explore the macroeconomic performance of a country that maintains a fixed exchange-rate value for its currency (Chapter 23) and of a country that allows a floating, market-driven exchange-rate value for its currency (Chapter 24). Chapter 25 uses what we have learned throughout the second half of the book to examine the benefits and costs of alternatives for a country’s exchange-rate policy. While rather extreme versions of fixed exchange rates serve some countries well, the general trend is toward more flexible exchange rates. In a few places the book’s scheme (international trade first, international finance second) creates some momentary inconvenience, as when we look at the exchangerate link between cutting imports and reducing exports in Chapter 5 before we have discussed exchange rates in depth. Mostly the organization serves us well. The understanding we gain about earlier topics provides us with building blocks that allow us to explore broader issues later in the book. CURRENT EVENTS AND NEW EXAMPLES It is a challenge and a pleasure for me to incorporate the events and policy changes that continue to transform the global economy, and to find the new examples that show the effects of globalization (both its upside and its downside). Here are some of the current and recent events and issues that are included in this edition to provide new examples that show the practical use of our international economic analysis: • The euro crisis that began in Greece in 2010 spread to several other countries in the euro area and during 2011–2012 seemed to threaten the continued existence of the euro itself. Still, in the face of continued weak economic performance in the euro area, Latvia adopted the euro at the beginning of 2014, bringing the number of countries in the euro area to 18. • Beginning in 2007 the United States rapidly expanded its production of natural gas using horizontal drilling and hydraulic fracturing. A large number of U.S. firms sought approval to export natural gas, but a U.S. law prohibits export unless it is in the national interest. The U.S. government has been slow to act; as of mid-2014, only one U.S. facility had received full approval to export. • Immigration continues to be a hot issue. In 2014 Swiss voters approved limitations on immigration into the country. Prime Minister Cameron pledged to greatly reduce immigration into Britain by 2015. In 2013 the U.S. government again failed to pass a revision of its immigration laws. • Chinese government holdings of foreign exchange reserve assets reached $4 trillion in mid-2014, the result of continued official intervention to prevent the exchangerate value of China’s currency from rising too quickly. • Pressure from the growth of the countries’ exports led to rapidly rising wages for workers in China and in India. • After nearly two decades of negotiations, Russia joined the World Trade Organization (WTO) in 2012. x Preface • In 2013 the members of the WTO reached a new multilateral agreement on trade facilitation, but in 2014 its implementation was held up by a single country, India. • In response to rapidly growing imports, American steel producers sent a large number of new complaints to the U.S. government, alleging dumping by foreign producers and seeking hefty new antidumping duties. • The WTO ruled that European governments had violated WTO rules by offering massive subsidies to Airbus and that the U.S. government had violated WTO rules by offering massive subsidies to Boeing. But, then, the situation seemed to reach a stalemate. • After approval from the U.S. Congress, the United States implemented free-trade agreements with Colombia, South Korea, and Panama. • In 2012, Venezuela became a member of MERCOSUR, the South American regional trade area. • Croatia joined the European Union in 2013 as its 28th member country. • The first phase of the Kyoto Protocol was completed in 2012. For a number of reasons, the effects were minor, and global warming continues as a major global environmental challenge. • Led by increases in international financial investments and computer-driven trading, the size of the foreign exchange market continued to grow, with trading of one currency for another reaching $5 trillion per day in 2013. Foreign exchange trading has more than tripled since 2004. • The market-driven exchange-rate value of the Japanese yen increased during the week after a tsunami caused the nuclear disaster at Fukushima in 2011, prompting a large official intervention in the foreign exchange market. • Starting in 2008, the International Monetary Fund (IMF) rapidly expanded its lending to countries in crisis, with loans outstanding reaching $125 billion in mid-2014. Most of these IMF loans are to advanced countries—Iceland, Greece, Ireland, and Portugal—a sharp contrast to the lending to developing countries that had been predominant since 1980. • The United States pursued a third round of quantitative easing during 2012–2014 as a continuation of unconventional monetary policy for an economy stuck in a liquidity trap. In this third round, the Fed bought about $1.5 trillion of Treasury securities and mortgage-backed securities, but this round seemed to have less effect on the exchange-rate value of the U.S. dollar than did previous rounds. IMPROVING THE BOOK: TOPICS In this edition I introduce and extend a number of improvements to the pedagogical structure and topical coverage of the book. • The euro crisis that began in 2010 and intensified in 2011 and 2012 has had profound effects on the member countries of the euro area—the countries that have replaced their national currencies with the euro in a monetary union. Preface xi This edition interweaves the causes and impacts of the euro crisis across its chapters. The overview of the euro crisis in Chapter 1 shows that it began in different ways, as a fiscal crisis in Greece and as a burst housing-price bubble in Ireland that led to a banking crisis. Portugal then had a debt-driven crisis, and contagion spread the crisis pressures to Spain and Italy. The European Central Bank needed to play a key role, and a new program announced in July 2012 and adopted in September was the turning point in addressing the worst of the crisis. I then present discussions of important aspects of the crisis in a series of new shaded Euro Crisis boxes, which join the other six series of boxes: Global Crisis, Focus on China, Global Governance, Focus on Labor, Case Studies, and Extensions. For the Euro Crisis series, the new box in Chapter 16 shows how attention to current account balances and net international investment positions of the countries at the center of the crisis would have given signals of rising risk. Chapter 18 has a combination of a Global Crisis and Euro Crisis box, which shows how a key parity relationship among interest rates and exchange rates weakened under crisis conditions. The new box in Chapter 21 explains how the euro crisis was actually three interrelated crises that reinforced each other— sovereign debt or fiscal crisis, banking crisis, and macroeconomic crisis. While the sovereign debt and banking crises have calmed, the macroeconomic performance of the euro area remained very weak and Greece was in depression. The concluding section of Chapter 25 examines the benefits and costs of European monetary union, with special attention to fiscal policy. The euro area lacks areawide taxation and government spending, National fiscal policies have a double edge, as both the principal remaining tool for national governments to address their macroeconomic performance problems and a potential source of instability that can threaten the entire union. • The global financial and economic crisis that began in 2007 is the most important global trauma of the past 70 years, and it was a major contributor to the onset of the euro crisis. A new section of the text of Chapter 21 describes the global crisis, including the start of the crisis as the result of losses on sub-prime mortgages in the United States and on assets backed by these mortgages, and the terrible worsening of the crisis in 2008 with the failure of Lehman Brothers. This discussion of the global crisis also shows how the analysis of the series of financial crises that hit developing countries during 1982–2002 helps us to understand the causes and spread of the global crisis. The Global Crisis series of boxes examines other aspects of the crisis, including the collapse of international trade (Chapter 2), the avoidance of new protectionism (Chapter 9), the use of quantitative easing as nontraditional monetary policy once short-term interest rates are essentially zero (Chapter 24), and the increased use of currency swaps among central banks (Chapter 24). • China continues its rise as a force in the global economy. The presentation of China’s global role, including the series of boxes Focus on China, continues to be a strength of the text. Chapters 1 and 20 discuss the development of China’s controversial policies toward the exchange-rate value of its currency. In the box in Chapter 9, the presentation of China’s rising involvement in the dispute settlement xii Preface • • • • • • process at the World Trade Organization, both as a respondent (alleged violator) and as a complainant, has been updated and rewritten. Among other recent cases, the WTO ruled in 2014 that China’s restrictions on exports of rare earths were a violation of its WTO commitments. A major strength of the book remains in-depth analysis of a range of trade and trade-policy issues. The discussion of monopolistic competition and intraindustry trade in Chapter 6 has been expanded to incorporate the conclusions from research based on differences across firms in their cost levels. Opening to international trade favors the survival and expansion of lower-cost firms. This discussion also includes an estimate of the global gains from greater product variety. The section on trade embargoes in Chapter 12 has been revised, with a current case, Iran, being used as the example of the effects of international sanctions on the target country. Estimates of national factor endowments presented in Chapter 5 are completely updated and include better data on physical capital stocks and more countries in total. Data on national intra-industry trade shares in Chapter 6 include new estimates for 2012. Chapter 13 on trade and the environment continues as a unique and powerful treatment of issues of interest to many students. The discussion of global warming has been revised to incorporate data and projections from recent studies. The discussion of the Kyoto Protocol has been updated to include the outcomes from the first phase that ended in 2012 and the continued increase in global greenhouse gas emissions. The box on the fiscal effects of immigration in Chapter 15 has been substantially rewritten to incorporate the results of a recent Organization for Economic Cooperation and Development study of the effects of immigrants on government revenues and expenditures. In Chapter 18 a new section of text explains the definitions and uses of real exchange rates and effective exchange rates. The four ways to measure the exchange-rate value of a currency had previously been a box in the chapter, but the increasing importance of these concepts motivated the shift to a text section. Chapter 21 has been substantially revised. It incorporates the global financial and economic crisis into the text of the chapter and has a new box on the euro crisis. Some other aspects of the chapter have been streamlined. The short subsections on the Brazilian mini-crisis of 1999 and the Turkish crisis of 2001 have been removed, as has one of the two boxes on the International Monetary Fund. I used the latest available sources to update the wide range of data and information presented in the figures and text of the book. Among other updates, the book offers the latest information on international trade in specific products for the United States, China, and Japan; national average tariff rates; dumping and subsidy cases; levels and growth rates of national incomes per capita; trends in the relative prices of primary products; patterns of foreign direct investments broadly and by major home country; rates of immigration into the United States, Canada, and the European Union; the U.S. balance of payments and the U.S. international Preface xiii investment position; the sizes of foreign exchange trading and foreign exchange futures, swaps, and options; levels and trends for nominal exchange rates; effective exchange-rate values for the U.S. dollar; evidence about relative purchasing power parity; the exchange-rate policies chosen by national governments; the flows of international financing to and the outstanding foreign debt of developing countries; and gold prices. NEW QUESTIONS AND PROBLEMS In this edition I provide additional opportunities for students to engage with the book’s contents by adding new questions that students can use to build their facility in using the concepts and analysis of international economics. • Forty-eight new questions and problems have been added, two new questions and problems to each of the chapters that have end-of-chapter materials. These new questions and problems are targeted to cover chapter topics that were previously underrepresented. • A discussion question has been added at the end of each Case Study box, a total of 24 new questions that focus on the issues raised in the case studies. FORMAT AND STYLE I have been careful to retain the goals of clarity and honesty that have made International Economics an extraordinary success in classrooms and courses around the world. There are plenty of quick road signs at the start of and within chapters. The summaries at the ends of the chapters offer an integration of what has been discussed. Students get the signs, “Here’s where we are going; here’s where we have just been.” I use bullet-point and numbered lists to add to the visual appeal of the text and to emphasize sets of determinants or effects. I strive to keep paragraphs to reasonable lengths, and I have found ways to break up some long paragraphs to make the text easier to read. I am candid about ranking some tools or facts ahead of others. The undeniable power of some of the economist’s tools is applied repeatedly to events and issues without apology. Theories and concepts that fail to improve on common sense are not oversold. The format of the book is fine-tuned for better learning. Students need to master the language of international economics. Most exam-worthy terms appear in boldface in the text, with their definitions usually contiguous. The material at the end of each chapter includes a listing of these Key Terms, and an online Glossary has definitions of each term. Words and phrases that deserve special emphasis are in italics. Each chapter (except for the short introductory chapter) has at least 12 questions and problems. The answers to all odd-numbered questions and problems are included in the material at the end of the book. As a reminder, these odd-numbered questions are marked with a ✦ . xiv Preface Box Shaded boxes appear in different font with a different right-edge format and two columns per page, in contrast to the style of the main text. The boxes are labeled by type and provide discussions of the euro crisis that began in 2010, the global financial and economic crisis that began in 2007, the roles of the WTO and the IMF in global governance, China’s international trade and investment, labor issues, case studies, and extensions of the concepts presented in the text. SUPPLEMENTS The following ancillaries are available for quick download and convenient access via the Instructor Resource material available through McGraw-Hill Connect®. • PowerPoint Presentations: Revised by Farhad Saboori of Albright College, the PowerPoint slides now include a brief, detailed review of the important ideas covered in each chapter, accompanied by relevant tables and figures featured within the text. You can edit, print, or rearrange the slides to fit the needs of your course. • Test Bank: Updated by Robert Allen of Columbia Southern University, the test bank offers well over 1,500 questions categorized by level of difficulty, AACSB learning categories, Bloom’s taxonomy, and topic. • Computerized Test Bank: McGraw-Hill’s EZ Test is a flexible and easy-to-use electronic testing program that allows you to create tests from book-specific items. It accommodates a wide range of question types, and you can add your own questions. Multiple versions of the test can be created, and any test can be exported for use with course management systems. EZ Test Online gives you a place to administer your EZ Test–created exams and quizzes online. Additionally, you can access the test bank through McGraw-Hill Connect. • Instructor’s Manual: Written by the author, the instructor’s manual contains chapter overviews, teaching tips, and suggested answers to the discussion questions featured among the case studies as well as the end-of-chapter questions and problems. To increase flexibility, the Tips section in each chapter often provides the author’s thoughts and suggestions for customizing the coverage of certain sections and chapters. DIGITAL SOLUTIONS McGraw-Hill Connect® Economics Less Managing. More Teaching. Greater Learning. McGrawHill’s Connect® Economics is an online assessment solution that connects students with the tools and resources they’ll need to achieve success. Preface xv McGraw-Hill’s Connect Economics Features Connect Economics allows faculty to create and deliver exams easily with selectable test bank items. Instructors can also build their own questions into the system for homework or practice. Other features include: Instructor Library The Connect Economics Instructor Library is your repository for additional resources to improve student engagement in and out of class. You can select and use any asset that enhances your lecture. The Connect Economics Instructor Library includes all of the instructor supplements for this text. Student Resources Any supplemental resources that align with the text for student use will be available through Connect. Student Progress Tracking Connect Economics keeps instructors informed about how each student, section, and class is performing, allowing for more productive use of lecture and office hours. The progress-tracking function enables you to • View scored work immediately and track individual or group performance with assignment and grade reports. • Access an instant view of student or class performance relative to learning objectives. • Collect data and generate reports required by many accreditation organizations, such as AACSB. Diagnostic and Adaptive Learning of Concepts: LearnSmart and SmartBook offer the first and only adaptive reading experience designed to change the way students read and learn. Students want to make the best use of their study time. The LearnSmart adaptive self-study technology within Connect Economics provides students with a seamless combination of practice, assessment, and remediation for every concept in the textbook. LearnSmart’s intelligent software adapts to every student’s response and automatically delivers concepts that advance students’ understanding while reducing time devoted to the concepts already mastered. The result for every student is the fastest path to mastery of the chapter concepts. LearnSmart • Applies an intelligent concept engine to identify the relationships between concepts and to serve new concepts to each student only when he or she is ready. • Adapts automatically to each student, so students spend less time on the topics they understand and practice more those they have yet to master. • Provides continual reinforcement and remediation but gives only as much guidance as students need. • Integrates diagnostics as part of the learning experience. • Enables you to assess which concepts students have efficiently learned on their own, thus freeing class time for more applications and discussion. xvi Preface Smartbook is an extension of LearnSmart—an adaptive eBook that helps students focus their study time more effectively. As students read, Smartbook assesses comprehension and dynamically highlights where they need to study more. For more information about Connect, go to connect.mheducation.com, or contact your local McGraw-Hill sales representative. McGraw-Hill’s Customer Experience Group We understand that getting the most from your new technology can be challenging. That’s why our services don’t stop after you purchase our products. You can e-mail our Product Specialists 24 hours a day to get product-training online. Or you can search our knowledge bank of Frequently Asked Questions on our support website. For Customer Support, call 800-331-5094, or visit www.mhhe.com/support. Create McGraw-Hill Create™ is a self-service website that allows you to create customized course materials using McGraw-Hill’s comprehensive, cross-disciplinary content and digital products. You can even access third-party content such as readings, articles, cases, videos, and more. Arrange the content you’ve selected to match the scope and sequence of your course. Personalize your book with a cover design and choose the best format for your students—eBook, color print, or black-and-white print. And, when you are done, you’ll receive a PDF review copy in just minutes! CourseSmart Go paperless with eTextbooks from CourseSmart and move light-years beyond traditional print textbooks. Read online or offline anytime, anywhere. Access your eTextbook on multiple devices with or without an Internet connection. CourseSmart eBooks include convenient, built-in tools that let you search topics quickly, add notes and highlights, copy/paste passages, and print any page. Acknowledgments I offer my deepest thanks to the many people whose advice helped me to improve International Economics in its sixteenth edition. My first thanks are to Peter H. Lindert, my co author on several previous editions. I learned much from him about the art of writing for the community of students who want to deepen their knowledge and understanding of the global economy. I love teaching international economics, and I am grateful to my students for the many suggestions and insights that I have received from them. I thank my friends and colleagues from other colleges and universities who took the time to e-mail me with corrections and ideas for changes. I especially thank my faculty colleagues at the NYU Stern School for information and suggestions. I am indebted to Natalia Tamirisa of the International Monetary Fund for providing the data used in Figure 13.6, Carbon Tax to Stabilize Atmospheric Carbon Dioxide; to Richard M. Levich of the NYU Stern School of Business for providing data used in the box “Covered Interest Parity Breaks Down” in Chapter 18; and to Ravi Balakrishnan and Volodymyr Tulin of the International Monetary Fund for the data used in Figure 18.3, Uncovered Interest Differentials: The United States against Germany and Japan, 1991–2005. I also thank my brother, Michael Pugel, who shared with me his knowledge of technology issues from his perspective as a patent attorney and electrical engineer. I express my gratitude to the reviewers whose detailed and thoughtful comments and critiques provided guidance as I wrote the sixteenth edition: Adhip Chaudhuri, Georgetown University; Baizhu Chen, University of Southern California; Tran Dung, Wright State University; Wei Ge, Bucknell University; Pedro Gete, Georgetown University; Kirk Gifford, Brigham Young University; Nam Pham, George Washington University; Courtney Powell-Thomas, Virginia Tech University; Farhad Saboori, Albright College; George Sarraf, University of California–Irvine; Paul Wachtel, New York University; Lou Zaera, Fashion Institute of Technology. I remain grateful to the reviewers whose suggestions for improvements to the previous editions continued to redound to my benefit as I prepared the sixteenth: Vera Adamchik, University of Houston–Victoria; Gregory W. Arbum, The University of Findlay; Manoj Atolia, Florida State University; Mina Baliamoune, University of North Florida; Michael P. Barry, Mount St. Mary’s University; Trisha Bezmen, Old Dominion University; Frank Biggs, Principia College; Philip J. Bryson, Brigham Young University; Philip E. Burian, Colorado Technical University at Sioux Falls; James Butkiewicz, University of Delaware; Debasish Chakraborty, Central Michigan University; Roberto Chang, Rutgers University; Shah Dabirian, California State University Long Beach; Jamshid Damooei, California Lutheran University; Manjira Datta, Arizona State University; Dennis Debrecht, Carroll College; Carol Decker, Tennessee Wesleyan College; John R. Dominguez, University of Wisconsin–Whitewater; Eric Drabkin, Hawaii Pacific University; Robert Driskill, Vanderbilt University; Patrick M. Emerson, Oregon State University; Carole Endres, Wright State University; Nicolas Ernesto Magud, University of Oregon; Hisham Foad, San Diego State University; Yoshi Fukasawa, Midwestern State University; John Gilbert, Utah State University; Chris Gingrich, Eastern Mennonite University; xvii xviii Acknowledgments Amy Glass, Texas A&M University; Omer Gokcekus, Seton Hall University; William Hallagan, Washington State University; Tom Head, George Fox University; Barbara Heroy John, University of Dayton; Farid Islam, Woodbury School of Business; Brian Jacobsen, Wisconsin Lutheran College; Geoffrey Jehle, Vassar College and Columbia University; Jack Julian, Indiana University of Pennsylvania; Ghassan Karam, Pace University; Vani V. Kotcherlakota, University of Nebraska at Kearney; Quan Le, Seattle University; Kristina Lybecker, The Colorado College; John Marangos, Colorado State University; John Mukum Mbaku, Weber State University; John McLaren, University of Virginia; Michael A. McPherson, University of North Texas; Matthew McPherson, Gonzaga University; Norman C. Miller, Miami University; Karla Morgan, Whitworth College; Stefan Norrbin, Florida State University; Joseph Nowakowski, Muskingum College; Rose Marie Payan, California Polytechnic University; Harvey Poniachek, Rutgers University; Dan Powroznik, Chesapeake College; Ed Price, Oklahoma State University; Kamal Saggi, Southern Methodist University; Jawad Salimi, West Virginia University– Morgantown; Andreas Savvides, Oklahoma State University; Philip Sprunger, Lycoming College; John Stiver, University of Connecticut; William J. Streeter, Olin Business School–Washington University in St. Louis; Kay E. Strong, Bowling Green State University–Firelands; Kishor Thanawala, Villanova University; Victoria Umanskaya, University of California-Riverside; Doug Walker, Georgia College and State University; Dr. Evelyn Wamboye, University of Wisconsin–Stout; Dave Wharton, Washington College; Elizabeth M. Wheaton, Southern Methodist University; Jiawen Yang, George Washington University; Bassam Yousif, Indiana State University Hamid Zangeneh, Widener University; I offer my thanks and admiration to the great group at McGraw-Hill/Irwin who worked with me closely in preparing this edition, including Michele Janicek, lead product developer; Christina Kouvelis, senior product developer; Lisa Bruflodt, senior project manager; and Sourav Majumdar, project manager at SPi Global. My final acknowledgment is in remembrance of the late Charles P. Kindleberger, who was one of my teachers during my graduate studies. He started this book over 60 years ago, and I strive to meet the standards of excellence and relevance that he set for the book. Thomas A. Pugel Brief Contents 1 International Economics Is Different 1 21 International Lending and Financial Crises 502 2 The Basic Theory Using Demand and Supply 13 22 How Does the Open Macroeconomy Work? 539 3 Why Everybody Trades: Comparative Advantage 31 23 Internal and External Balance with Fixed Exchange Rates 565 4 Trade: Factor Availability and Factor Proportions Are Key 47 24 Floating Exchange Rates and Internal Balance 603 5 Who Gains and Who Loses from Trade? 66 6 Scale Economies, Imperfect Competition, and Trade 88 25 National and Global Choices: Floating Rates and the Alternatives 628 7 Growth and Trade 8 Analysis of a Tariff 9 Nontariff Barriers to Imports APPENDIXES 117 A The Web and the Library: International Numbers and Other Information 655 B 10 Arguments for and against Protection 192 Deriving Production-Possibility Curves 659 C Offer Curves 11 Pushing Exports D The Nationally Optimal Tariff E Accounting for International Payments 673 F Many Parities at Once G Aggregate Demand and Aggregate Supply in the Open Economy 680 H Devaluation and the Current Account Balance 690 137 160 222 12 Trade Blocs and Trade Blocks 13 Trade and the Environment 252 275 14 Trade Policies for Developing Countries 309 15 Multinationals and Migration: International Factor Movements 16 Payments among Nations 334 370 17 The Foreign Exchange Market 389 18 Forward Exchange and International Financial Investment 405 664 667 677 SUGGESTED ANSWERS TO ODD-NUMBERED QUESTIONS AND PROBLEMS 694 19 What Determines Exchange Rates? 433 REFERENCES 731 20 Government Policies toward the Foreign Exchange Market 464 INDEX 743 xix Contents Chapter 1 International Economics Is Different Four Controversies 1 U.S. Exports of Natural Gas Immigration 4 China’s Exchange Rate 5 Euro Crisis 7 1 Adam Smith’s Theory of Absolute Advantage 32 Case Study Mercantilism: Older Than Smith— and Alive Today Economics and the Nation-State Factor Mobility 11 Different Fiscal Policies Different Moneys 12 11 12 Chapter 2 The Basic Theory Using Demand and Supply 13 Four Questions about Trade Demand and Supply 14 14 Demand 14 Consumer Surplus 16 Case Study Trade Is Important 17 Supply 18 Producer Surplus 19 Global Crisis The Trade Mini-Collapse of 2009 20 A National Market with No Trade 22 Two National Markets and the Opening of Trade 22 Free-Trade Equilibrium 24 Effects in the Importing Country 25 Effects in the Exporting Country 27 Which Country Gains More? 27 Summary: Early Answers to the Four Trade Questions 28 Key Terms 28 Suggested Reading 29 Questions and Problems 29 xx 1 Chapter 3 Why Everybody Trades: Comparative Advantage 31 33 Ricardo’s Theory of Comparative Advantage 35 Ricardo’s Constant Costs and the Production-Possibility Curve 38 Focus on Labor Absolute Advantage Does Matter 40 Extension What If Trade Doesn’t Balance? 42 Summary 43 Key Terms 44 Suggested Reading 44 Questions and Problems 44 Chapter 4 Trade: Factor Availability and Factor Proportions Are Key 47 Production with Increasing Marginal Costs 48 What’s Behind the Bowed-Out Production-Possibility Curve? 48 What Production Combination Is Actually Chosen? 50 Community Indifference Curves 51 Production and Consumption Together 53 Without Trade 53 With Trade 54 Focus on China The Opening of Trade and China’s Shift Out of Agriculture 56 Demand and Supply Curves Again 58 The Gains from Trade 58 Contents Trade Affects Production and Consumption 59 What Determines the Trade Pattern? 60 The Heckscher–Ohlin (H–O) Theory 61 Summary 62 Key Terms 63 Suggested Reading 63 Questions and Problems 63 xxi Chapter 6 Scale Economies, Imperfect Competition, and Trade 88 Scale Economies 89 Internal Scale Economies 90 External Scale Economies 91 Intra-Industry Trade 92 How Important Is Intra-Industry Trade? 93 What Explains Intra-Industry Trade? 94 Chapter 5 Who Gains and Who Loses from Trade? 66 Monopolistic Competition and Trade Who Gains and Who Loses within a Country 66 Short-Run Effects of Opening Trade 67 The Long-Run Factor-Price Response 67 Three Implications of the H–O Theory 69 The Stolper–Samuelson Theorem 69 Extension A Factor-Ratio Paradox 70 The Specialized-Factor Pattern 72 The Factor-Price Equalization Theorem 72 Does Heckscher–Ohlin Explain Actual Trade Patterns? 73 Factor Endowments 74 Case Study The Leontief Paradox International Trade 76 What are the Export-Oriented and Import-Competing Factors? 75 78 The U.S. Pattern 78 The Canadian Pattern 79 Patterns in Other Countries 79 Focus on China China’s Exports and Imports 80 Do Factor Prices Equalize Internationally? 82 Focus on Labor U.S. Jobs and Foreign Trade 95 The Market with No Trade 97 Opening to Free Trade 98 Basis for Trade 99 Extension The Individual Firm in Monopolistic Competition 100 Gains from Trade 103 83 Summary: Fuller Answers to the Four Trade Questions 84 Key Terms 85 Suggested Reading 85 Questions and Problems 85 Oligopoly and Trade 104 Substantial Scale Economies 105 Oligopoly Pricing 105 Extension The Gravity Model of Trade 106 External Scale Economies and Trade Summary: How Does Trade Really Work? 111 Key Terms 114 Suggested Reading 114 Questions and Problems 114 Chapter 7 Growth and Trade 109 117 Balanced Versus Biased Growth 118 Growth in Only One Factor 120 Changes in the Country’s Willingness to Trade 121 Case Study The Dutch Disease and Deindustrialization 123 Effects on the Country’s Terms of Trade Small Country 124 Large Country 124 Immiserizing Growth Technology and Trade 124 126 128 Individual Products and the Product Cycle 129 xxii Contents Focus on Labor Trade, Technology, and U.S. Wages 130 Openness to Trade Affects Growth 131 Summary 132 Key Terms 133 Suggested Reading 134 Questions and Problems 134 Chapter 8 Analysis of a Tariff Case Study Carrots Are Fruit, Snails Are Fish, and X-Men Are Not Humans 178 Domestic Content Requirements 179 Government Procurement 180 How Big Are the Costs of Protection? 181 As a Percentage of GDP 181 As the Extra Cost of Helping Domestic Producers 182 International Trade Disputes 183 137 Global Governance WTO and GATT: Tariff Success 138 A Preview of Conclusions 140 The Effect of a Tariff on Domestic Producers 140 The Effect of a Tariff on Domestic Consumers 142 The Tariff as Government Revenue 145 The Net National Loss from a Tariff 145 Extension The Effective Rate of Protection 148 Case Study They Tax Exports, Too 150 The Terms-of-Trade Effect and a Nationally Optimal Tariff 152 Summary 156 Key Terms 157 Suggested Reading 157 Questions and Problems 157 Chapter 9 Nontariff Barriers to Imports 160 Types of Nontariff Barriers to Imports The Import Quota 162 160 Quota versus Tariff for a Small Country 162 Global Governance The WTO: Beyond Tariffs 164 Global Crisis Dodging Protectionism 167 Ways to Allocate Import Licenses 168 Extension A Domestic Monopoly Prefers a Quota 170 Quota versus Tariff for a Large Country 172 Voluntary Export Restraints (VERs) Other Nontariff Barriers 175 Product Standards 175 Case Study VERs: Two Examples 173 America’s “Section 301”: Unilateral Pressure 183 Focus on China China in the WTO 184 Dispute Settlement in the WTO 186 Summary 187 Key Terms 188 Suggested Reading 189 Questions and Problems 189 Chapter 10 Arguments for and against Protection 192 The Ideal World of First Best 193 The Realistic World of Second Best 196 Promoting Domestic Production or Employment 197 The Infant Industry Argument 201 How It Is Supposed to Work 201 How Valid Is It? 202 Focus on Labor How Much Does It Cost to Protect a Job? 204 The Dying Industry Argument and Adjustment Assistance 206 Should the Government Intervene? 206 Trade Adjustment Assistance 207 The Developing Government (Public Revenue) Argument 208 Other Arguments for Protection: Noneconomic Objectives 209 National Pride 209 National Defense 210 Income Redistribution 210 The Politics of Protection 176 194 Government Policies toward Externalities The Specificity Rule 196 211 The Basic Elements of the Political–Economic Analysis 211 Contents When Are Tariffs Unlikely? 212 When Are Tariffs Likely? 213 Applications to Other Trade-Policy Patterns 214 Case Study How Sweet It Is (or Isn’t) 215 Summary 217 Key Terms 219 Suggested Reading 219 Questions and Problems 219 Chapter 11 Pushing Exports 222 Dumping 222 Reacting to Dumping: What Should a Dumpee Think? 225 Actual Antidumping Policies: What Is Unfair? 226 Proposals for Reform 229 Case Study Antidumping in Action 230 Export Subsidies 233 Exportable Product, Small Exporting Country 234 Exportable Product, Large Exporting Country 236 Switching an Importable Product into an Exportable Product 237 WTO Rules on Subsidies 238 Should the Importing Country Impose Countervailing Duties? 239 Case Study Agriculture Is Amazing 242 Strategic Export Subsidies Could Be Good 244 Global Governance Dogfight at the WTO 246 Summary 248 Key Terms 249 Suggested Reading 249 Questions and Problems 250 Chapter 12 Trade Blocs and Trade Blocks 252 Types of Economic Blocs 252 Is Trade Discrimination Good or Bad? 253 The Basic Theory of Trade Blocs: Trade Creation and Trade Diversion 255 Other Possible Gains from a Trade Bloc 258 The EU Experience 259 Case Study Postwar Trade Integration in Europe 260 North America Becomes a Bloc 262 NAFTA: Provisions and Controversies NAFTA: Effects 264 Rules of Origin 265 263 Trade Blocs among Developing Countries Trade Embargoes 267 Summary 272 Key Terms 273 Suggested Reading 273 Questions and Problems 273 Chapter 13 Trade and the Environment 275 Is Free Trade Anti-Environment? 275 Is the WTO Anti-Environment? 280 Global Governance Dolphins, Turtles, and the WTO 282 The Specificity Rule Again 284 A Preview of Policy Prescriptions 285 Trade and Domestic Pollution 287 Transborder Pollution 290 The Right Solution 291 A Next-Best Solution 293 NAFTA and the Environment 294 Global Environmental Challenges 295 Global Problems Need Global Solutions 295 Extinction of Species 296 Overfishing 298 CFCs and Ozone 299 Greenhouse Gases and Global Warming 300 Summary 305 Key Terms 306 Suggested Reading 306 Questions and Problems 306 Chapter 14 Trade Policies for Developing Countries 309 Which Trade Policy for Developing Countries? 311 Are the Long-Run Price Trends Against Primary Producers? 313 Case Study Special Challenges of Transition 314 xxiii 266 xxiv Contents International Cartels to Raise Primary-Product Prices 319 The OPEC Victories 319 Classic Monopoly as an Extreme Model for Cartels 320 The Limits to and Erosion of Cartel Power 322 The Oil Price Increase since 1999 323 Other Primary Products 324 Import-Substituting Industrialization (ISI) 324 ISI at Its Best 325 Experience with ISI 326 370 Accounting Principles 370 A Country’s Balance of Payments Current Account 371 Financial Account 373 Official International Reserves Statistical Discrepancy 375 334 Foreign Direct Investment 335 Multinational Enterprises 337 FDI: History and Current Patterns 338 Why Do Multinational Enterprises Exist? 340 Inherent Disadvantages 341 Firm-Specific Advantages 341 Location Factors 342 Internalization Advantages 343 Oligopolistic Rivalry 344 Taxation of Multinational Enterprises’ Profits 344 Case Study CEMEX: A Model Multinational from an Unusual Place Summary 365 Key Terms 367 Suggested Reading 367 Questions and Problems 367 Chapter 16 Payments among Nations Exports of Manufactures to Industrial Countries 329 Summary 330 Key Terms 331 Suggested Reading 331 Questions and Problems 331 Chapter 15 Multinationals and Migration: International Factor Movements Effects on the Government Budget 361 External Costs and Benefits 361 Case Study Are Immigrants a Fiscal Burden? 362 What Policies to Select Immigrants? 364 345 MNEs and International Trade 347 Should the Home Country Restrict FDI Outflows? 349 Should the Host Country Restrict FDI Inflows? 350 Focus on China China as a Host Country 352 Migration 354 How Migration Affects Labor Markets 357 Should the Sending Country Restrict Emigration? 360 Should the Receiving Country Restrict Immigration? 361 371 374 The Macro Meaning of the Current Account Balance 375 The Macro Meaning of the Overall Balance 380 The International Investment Position 381 Euro Crisis International Indicators Lead the Crisis 383 Summary 385 Key Terms 386 Suggested Reading 386 Questions and Problems 386 Chapter 17 The Foreign Exchange Market 389 The Basics of Currency Trading 390 Case Study Brussels Sprouts a New Currency: € 392 Using the Foreign Exchange Market 393 Case Study Foreign Exchange Trading 394 Interbank Foreign Exchange Trading 395 Demand and Supply for Foreign Exchange Floating Exchange Rates 397 Fixed Exchange Rates 399 Current Arrangements 400 Arbitrage within the Spot Exchange Market 401 Summary 402 396 Contents Key Terms 402 Suggested Reading 402 Questions and Problems 403 Chapter 18 Forward Exchange and International Financial Investment 405 Exchange-Rate Risk 405 The Market Basics of Forward Foreign Exchange 406 Hedging Using Forward Foreign Exchange 407 Speculating Using Forward Foreign Exchange 408 Extension Futures, Options, and Swaps 410 International Financial Investment 412 International Investment with Cover 413 Covered Interest Arbitrage 415 Covered Interest Parity 416 International Investment without Cover 417 Case Study The World’s Greatest Investor 420 Does Interest Parity Really Hold? Empirical Evidence 422 Evidence on Covered Interest Parity 422 Evidence on Uncovered Interest Parity 423 Case Study Eurocurrencies: Not (Just) Euros and Not Regulated 424 Global Crisis and Euro Crisis Covered Interest Parity Breaks Down 426 Evidence on Forward Exchange Rates and Expected Future Spot Exchange Rates 428 Summary 428 Key Terms 430 Suggested Reading 430 Questions and Problems 430 A Road Map 435 Exchange Rates in the Short Run The Law of One Price 441 Absolute Purchasing Power Parity 441 Relative Purchasing Power Parity 442 Case Study PPP from Time to Time 443 Case Study Price Gaps and International Income Comparisons 444 Relative PPP: Evidence 446 The Long Run: The Monetary Approach Exchange-Rate Overshooting 452 How Well Can We Predict Exchange Rates? 455 Four Ways to Measure the Exchange Rate 457 Summary 459 Key Terms 460 Suggested Reading 461 Questions and Problems 461 Chapter 20 Government Policies toward the Foreign Exchange Market 464 Two Aspects: Rate Flexibility and Restrictions on Use 465 Floating Exchange Rate 466 Fixed Exchange Rate 466 Defense through Official Intervention 470 436 The Role of Interest Rates 437 The Role of the Expected Future Spot Exchange Rate 438 The Long Run: Purchasing Power Parity (PPP) 440 449 Money, Price Levels, and Inflation 449 Money and PPP Combined 450 The Effect of Money Supplies on an Exchange Rate 451 The Effect of Real Incomes on an Exchange Rate 451 What to Fix to? 467 When to Change the Fixed Rate? 467 Defending a Fixed Exchange Rate 469 Chapter 19 What Determines Exchange Rates? 433 xxv Defending against Depreciation 470 Defending against Appreciation 472 Temporary Disequilibrium 474 Disequilibrium That Is Not Temporary Exchange Control 477 International Currency Experience The Gold Standard Era, 1870–1914 (One Version of Fixed Rates) 481 Interwar Instability 484 475 480 xxvi Contents The Bretton Woods Era, 1944–1971 (Adjustable Pegged Rates) 486 Global Governance The International Monetary Fund 487 The Current System: Limited Anarchy 492 Summary 496 Key Terms 498 Suggested Reading 499 Questions and Problems 499 Chapter 21 International Lending and Financial Crises 502 Gains and Losses from Well-Behaved International Lending 503 Taxes on International Lending 506 International Lending to Developing Countries 506 The Surge in International Lending, 1974–1982 507 The Debt Crisis of 1982 508 The Resurgence of Capital Flows in the 1990s 509 The Mexican Crisis, 1994–1995 510 The Asian Crisis, 1997 512 The Russian Crisis, 1998 512 Global Governance Short of Reserves? Call 1-800-IMF-LOAN 513 Argentina’s Crisis, 2001–2002 516 Financial Crises: What Can and Does Go Wrong 517 Waves of Overlending and Overborrowing 517 Extension The Special Case of Sovereign Debt 518 Exogenous International Shocks 520 Exchange-Rate Risk 520 Fickle International Short-Term Lending 520 Global Contagion 521 Resolving Financial Crises 522 Rescue Packages 522 Debt Restructuring 523 Reducing the Frequency of Financial Crises 525 Bank Regulation and Supervision Capital Controls 527 How the Crisis Happened 528 Summary 534 Key Terms 536 Suggested Reading 536 Questions and Problems 536 Chapter 22 How Does the Open Macroeconomy Work? 539 The Performance of a National Economy 539 A Framework for Macroeconomic Analysis 540 Domestic Production Depends on Aggregate Demand 541 Trade Depends on Income 543 Equilibrium GDP and Spending Multipliers 543 Equilibrium GDP 543 The Spending Multiplier in a Small Open Economy 545 Foreign Spillovers and Foreign-Income Repercussions 547 A More Complete Framework: Three Markets 549 The Domestic Product Market 550 The Money Market 552 The Foreign Exchange Market (or Balance of Payments) 554 Three Markets Together 557 The Price Level Does Change 558 Trade Also Depends on Price Competitiveness 559 Summary 560 Key Terms 562 Suggested Reading 563 Questions and Problems 563 Chapter 23 Internal and External Balance with Fixed Exchange Rates 565 526 Global Financial and Economic Crisis Causes and Amplifiers 530 Euro Crisis National Crises, Contagion, and Resolution 532 528 From the Balance of Payments to the Money Supply 566 Contents From the Money Supply Back to the Balance of Payments 569 Sterilization 572 Monetary Policy with Fixed Exchange Rates 574 Fiscal Policy w ith Fixed Exchange Rates 575 Perfect Capital Mobility 578 Shocks to the Economy 580 Internal Shocks 580 International Capital-Flow Shocks International Trade Shocks 582 Imbalances and Policy Responses 580 584 Internal and External Imbalances 584 Case Study A Tale of Three Countries 586 A Short-Run Solution: Monetary–Fiscal Mix 589 Surrender: Changing the Exchange Rate 591 How Well Does the Trade Balance Respond to Changes in the Exchange Rate? 594 Global Crisis Liquidity Trap! 616 Case Study Can Governments Manage the Float? 619 Global Crisis Central Bank Liquidity Swaps 622 Summary 623 Key Terms 625 Suggested Reading 625 Questions and Problems 625 Chapter 25 National and Global Choices: Floating Rates and the Alternatives 628 Key Issues in the Choice of ExchangeRate Policy 629 Effects of Macroeconomic Shocks 629 Case Study What Role for Gold? 631 The Effectiveness of Government Policies 635 Differences in Macroeconomic Goals, Priorities, and Policies 636 Controlling Inflation 637 Real Effects of Exchange-Rate Variability 639 How the Response Could Be Unstable 595 Why the Response Is Probably Stable 596 Timing: The J Curve 597 Summary 598 Key Terms 600 Suggested Reading 601 Questions and Problems 601 National Choices 641 Extreme Fixes 643 Currency Board 643 “Dollarization” 644 The International Fix—Monetary Union Chapter 24 Floating Exchange Rates and Internal Balance Exchange Rate Mechanism 646 European Monetary Union 647 603 Monetary Policy with Floating Exchange Rates 604 Fiscal Policy with Floating Exchange Rates 607 Shocks to the Economy 609 Internal Shocks Case Study 609 Why Are U.S. Trade Deficits So Big? 610 International Capital-Flow Shocks International Trade Shocks 613 xxvii 612 Internal Imbalance and Policy Responses 614 International Macroeconomic Policy Coordination 615 Summary 652 Key Terms 653 Suggested Reading 653 Questions and Problems 654 APPENDIXES A The Web and the Library: International Numbers and Other Information 655 B Deriving Production-Possibility Curves 659 C Offer Curves 664 645 xxviii Contents D The Nationally Optimal Tariff E Accounting for International Payments 673 F Many Parities at Once 667 677 G Aggregate Demand and Aggregate Supply in the Open Economy 680 H Devaluation and the Current Account Balance 690 Suggested Answers to Odd-Numbered Questions and Problems 694 References Index 743 731 Chapter One International Economics Is Different Nations are not like regions or families. They are sovereign, meaning that no central court can enforce its will on them with a global police force. Being sovereign, nations can put all sorts of barriers between their residents and the outside world. A region or family must deal with the political reality that others within the same nation can outvote it and can therefore coerce it or tax it. A family or region has to compromise with others who have political voice. A nation feels less pressure to compromise and often ignores the interests of foreigners. A nation uses policy tools that are seldom available to a region and never available to a family. A nation can have its own currency, its own barriers to trading with foreigners, its own government taxing and spending, and its own laws of citizenship and residence. As long as countries exist, international economics will be a body of analysis distinct from the rest of economics. The special nature of international economics makes it fascinating and sometimes difficult. Let’s look at four controversial developments that frame the scope of this book. FOUR CONTROVERSIES U.S. Exports of Natural Gas Natural gas has wide-ranging uses as a source of energy, from heating homes and commercial buildings, to generating electricity, to the production of such products as steel, paper, cement, and glass, to providing the feedstock for the production of chemicals, fertilizers, and plastics. For the U.S. market for natural gas during the decade to 2006, several trends were clear. U.S. production of natural gas had been about flat since the mid-1990s. As U.S. consumption increased, imports rose from 13 percent of consumption in the mid-1990s to over 19 percent in 2006, with nearly all of the imports from Canada through pipelines. The cost of production from new wells in the United States (and in Canada) was rising, as the lowest-cost sources (using standard production technologies) were exhausted. The typical producer price of natural gas in the United States rose from $2 per million British thermal units (MMBtu) to $6 in the mid-2000s. The expectation was the United States would soon need to ramp up highcost imports of liquefied natural gas (LNG) to meet continued growth in consumption. 1 2 Chapter 1 International Economics Is Different Then a revolution in extraction technology hit and everything changed. U.S. producers used the combination of hydraulic fracturing and horizontal drilling (a process called “fracking”) to extract natural gas from shale deep underground. U.S. production of natural gas increased by 31 percent during 2006–2013, and imports fell to 11 percent of U.S. consumption. The typical producer price of natural gas hovered at about $4 during 2009–2013, and the price briefly fell below $2 in early 2012. As U.S. production continues to increase, U.S. firms should be looking for new customers. But, if the new customers are foreign, then expanding exports can be controversial, and the United States is a sovereign nation. A 1938 law prohibits exports unless the exporting firm can convince the government that the exports are in the “public interest.” The definition of public interest in the law is not precise but broadly includes adequate supply for domestic users and consumers, environmental impact, geopolitics, and energy security. (There is an exception for exports to 20 countries with which the United States has free trade agreements. However, with the exception of South Korea, the most promising potential foreign buyers of U.S. natural gas, including Japan, India, China, and some European countries, do not have free trade agreements with the United States.) Should the United States export more natural gas (than the very small amount it has been exporting by pipeline to Canada and Mexico)? That is, are larger amounts of natural gas exports in the U.S. public or national interest? Dow Chemical led a group of major U.S. users of natural gas that urged caution and limits on U.S. exports. In a Wall Street Journal article,1 Andrew N. Liveris, chairman and CEO of Dow Chemical, argued that plentiful low-cost U.S. production of natural gas should be used within the United States to produce general benefits rather than short-term profits to U.S. exporters that lead to long-run costs to the rest of the economy. He concluded that the United States must “consider what is in the nation’s best interest . . . before it exports all of its gas away.” How would exports work? The new large buyers would be in Asia and Europe, so U.S. firms could not send gas to them by low-cost pipelines. Instead, the gas would need to be liquefied and sent in special ships, an expensive process that costs about $4 to $5 per MMBtu. Could U.S. firms still make a profit? U.S. natural gas prices are about $4, so the combined cost of natural gas and getting it to, say Japan, is about $9. After the tsunami that caused the disaster at Fukushima in 2011, Japan shut down all of its nuclear generation of electricity and greatly increased its demand for natural gas, nearly all of which is met through LNG imports. Prices rose to $14 to $19. At these initial prices and cost, a U.S. firm that could export to Japan would earn a large profit from the arbitrage ($5 to $10 per MMBtu). The more typical price for Japan LNG imports has been about $10, so there would still be an arbitrage profit, but it would not be as large. What would happen if the U.S. government permitted substantial amounts of ongoing U.S. exports? Are the effects as dangerous as Dow Chemical suggests? Let’s preview some of the results from the economic analysis of international trade in Chapters 2 and 8. First, the United States will not “export all of its gas away.” Instead, 1 Andrew N. Liveris, “Wanted: A Balanced Approach to Shale Gas Exports,” The Wall Street Journal (February 25, 2013). Chapter 1 International Economics Is Different 3 the international natural gas market would reach an equilibrium. The extra foreign demand would increase the U.S. price somewhat. U.S. production of natural gas would increase somewhat, and U.S. consumption would decrease somewhat. (In an importing country like Japan, comparable effects would occur. For Japan, which has almost no domestic production, the price in Japan would fall and consumption would increase.) Second, there will be winners and losers, as Dow indicates. In the United States, natural gas producers and export distributors would benefit and U.S. consumers and users would be harmed. Third, what is the overall effect on the U.S. national interest? Economic analysis provides a clear answer. If we ignore environmental effects, as Dow does, the United States gains from the increased exports of natural gas. U.S. producers gain more than U.S. consumers lose. Interestingly, Dow Chemical will still get much of what it wants even in this freer trade situation. The large LNG transport costs will keep the U.S. price low, about $5 less than in importing countries like Japan. Chemical firms and other industrial users in the United States will still have an advantage internationally based on their access to relatively low-priced U.S. natural gas. What about environmental effects? First, noxious chemicals are used in the fracking process, and these can leak into groundwater supplies if the fracking is not done carefully. Second, burning natural gas releases carbon dioxide, a greenhouse gas that is contributing to global warming, and there is a risk of leaks of methane, another greenhouse gas, during the extraction process. A more subtle analysis of the effects on greenhouse gas emissions would also examine the alternative to increased natural gas use. For example, if natural gas replaces coal, then the net effect is to lower greenhouse gas emissions. Adverse environmental effects are actual or potential negative spillovers (a “negative externality”), and the full cost of producing and using natural gas increases. Chapter 13 provides economic analysis of the interplay between environmental issues and international trade. With external environmental costs, the country will export too much. Most observers think that the risks of chemical leaks are not large in the United States because government regulations and the threat of damage lawsuits impel producers generally to be careful. If the net effects on greenhouse gases are also not that large, then the over-exporting effect is not large. What has actually happened? As of mid-2014, the U.S. government had only provided full approval to one LNG export facility, and it was expected to begin exporting at about the end of 2015. Six other facilities had conditional approval that their exports would be in the public interest, but they had not yet received separate approval for compliance with environmental and safety norms. Another 26 applications were under review. National government officials have the power to enact policies that can limit international transactions like exporting. If the whole world were one country, the issue of shifts in selling would be left to the marketplace. Within a country, it is usually impermissible for one region to restrict commerce with another region. But the world is split into different countries, each with national policies. Overall, the U.S. economy is likely to benefit from increased exports of national gas. This is the essence of both comparative advantage as a basis for international trade and the gains from trading, topics examined in Chapters 2–7. The slow process of facility approval is a reflection of the controversy about allowing U.S. exports of natural gas. Powerful users like Dow 4 Chapter 1 International Economics Is Different Chemical can pursue their own benefits by seeking to limit exports through political action. Environmental groups can focus on their own interests. Economic analysis provides a sound way to add everything up to get to the national interest, but that does not make the controversy go away. Immigration About 230 million people, 3 percent of the world’s population, live outside the country of their birth. For most industrialized countries (an exception is Japan), the percentage of the country’s population that is foreign-born is rather high—14 percent for the United States and for Germany, 20 percent for Canada, 12 percent for Britain and for France, 15 percent for Sweden, and 27 percent for Switzerland and for Australia—and rising. Many of the foreign-born are illegal immigrants—over one-fourth of the total for the United States. The rising immigration has set off something of a backlash. In 2007 the U.S. Congress considered and rejected a bill to enact comprehensive reform of U.S. policies toward immigration. The bill, backed by President Bush and many congressional leaders, would have shifted U.S. policy toward favoring new immigrants with more education and skills, created a new temporary guest worker program, increased requirements for employers to verify the legal status of their employees, built new fences along the U.S. border with Mexico and added new border guards, and created a complex process for illegal immigrants to gain legal status. After different groups in the United States raised their objections, including conservatives who focused on the latter provision and labeled it an unacceptable amnesty, support for the bill unraveled. A renewed effort to pass a comprehensive reform of U.S. immigration laws failed to gain traction in Congress in 2013. In the absence of federal changes, individual states have enacted hundreds of state laws about immigrants in recent years, many of them tightening up against illegal immigrants. For instance, Arizona has passed a series of laws, beginning in 2004, that stop government assistance to illegal immigrants (unless federal law explicitly requires it), that can revoke a firm’s right to do business if it employs illegal immigrants, that make it a crime for an illegal immigrant to solicit work or hold a job, and that require police to check the immigration status of any person whom they suspect is an illegal immigrant. The latter requirement is likely to encourage racial profiling. The sheriff of Phoenix has been particularly outspoken and aggressive in arresting illegal immigrants. Anti-immigrant rhetoric and actions have been rising in other countries. Voters in France, the Netherlands, Austria, Denmark, and Norway have shifted toward candidates who promise to reduce and restrict immigration. In 2014, Swiss voters, driven by concerns that rising immigration was hurting employment of Swiss nationals, pushing up housing prices, and overburdening transportation systems, passed the Stop Mass Immigration referendum to impose numerical limits for foreign workers by 2017. In Britain, Prime Minister David Cameron pledged to achieve a large reduction in net migration into the country by 2015. Because Britain cannot do much to limit immigration from fellow European Union countries, the government has tightened immigration from other countries, including reductions in visas for college students. In the Australian election of 2010, the leader of one of the two major parties was an immigrant and the leader of the other was foreign-born to Australian parents. However, both were compelled by public opinion to promise to substantially reduce immigration by tightening policies. Chapter 1 International Economics Is Different 5 Opponents of immigration stress a range of problems that they believe arise from immigration, including general losses to the economy; the fiscal burden that may arise from immigrants’ use of government services (such as health care and schooling); slow integration of immigrants into the new national culture, values, and language; increased crime; and links of some immigrants to terrorism. What should one make of the claims of the opponents? Most immigrants move to obtain jobs at pay that is better than they can receive in their home countries, so it seems important to examine the economic effects. How much harm do immigrants do to the economies of the countries they move to? International economic analysis helps us to think through the issue objectively, without being diverted by emotional traps. The answer is perhaps surprising, given the heat from immigration’s opponents. As we will see in more depth in Chapter 15, such job-seeking immigration brings net economic benefits not only to the immigrants, but also to the receiving country overall. The basic analysis shows that there are winners and losers within the receiving country. The winners include the firms that employ the immigrants and the consumers who buy the products that the immigrants help to produce. The group that loses is the workers who compete with the immigrants for jobs. For instance, for the industrialized countries, the real wages of low-skilled workers have been depressed by the influx of lowskilled workers from developing countries. Putting all of this together, we find that the net effect for the receiving country is positive—the winners win more than the losers lose. It is important to recognize economic net benefits, but there will be fights over immigration as long as there are national borders. National governments have the ability to impose limits on immigration, and many do. If legal immigration is severely restricted by national policies, some immigrants move illegally. Migration, both legal and illegal, brings major gains in global economic well-being. But it remains socially and politically controversial. China’s Exchange Rate An exchange rate is the value of a country’s currency in terms of some other country’s currency. Exchange rates are often sources of controversy, with conflict over the exchange-rate value of China’s currency (the yuan, also called the renminbi) as the most intense in recent years. In 1994 the Chinese government switched from a system of having several different exchange rates, each applying to different kinds of international transactions, to an unofficial but unmistakable fixed rate to the U.S. dollar. In fact, the exchange rate was locked at about 8.28 yuan per U.S. dollar from 1997 to 2005. During the Asian crisis of 1997–1998, the U.S. government praised the Chinese government’s fixed exchange rate as a source of stability in an otherwise unstable region. However, by 2003 the U.S. government had begun to complain that China’s fixed-rate policy was actually unacceptable currency manipulation. In 2004 the U.S. trade deficit (the amount by which imports exceed exports) with China was $161 billion, a substantial part of the total U.S. trade deficit of $609 billion with the entire world. These deficits were headed even higher in 2005, and the pressure from the U.S. government intensified. Bills introduced in the U.S. Congress threatened reprisals, including large new tariffs on imports from China, unless the Chinese government implemented a large increase in the 6 Chapter 1 International Economics Is Different exchange-rate value of the yuan. The European Union also had a large trade deficit with China, and it was also pressuring China to revalue the yuan. Can keeping the exchange rate steady be manipulation? What this must mean is that the exchange-rate value should have changed but did not. What was the evidence? The bottom-line evidence was that, especially after 2001, the Chinese government continually had to go into the foreign exchange market to buy dollars and to sell yuan, to keep the market rate equal to the fixed-rate target. If it had not done so, the strong private demand for yuan would have led to a rise in the price (the exchange-rate value) of the yuan. (Equivalently, the large private supply of dollars that were being sold to get yuan would have led to a decline in the value of the dollar against the yuan.) There was evidence that the exchange-rate value of the Chinese currency was too low, but by how much? Various estimates of the degree of undervaluation were offered by economists, and most were in the range of 15 to 40 percent. Even for the experts, there are challenges in making this estimate. First, while China had substantial trade surpluses with the United States and the European Union, it had trade deficits with many other countries, including South Korea, Thailand, the Philippines, Australia, Russia, Japan, and Brazil. Overall China had a trade surplus. It was not that large in 2004, though it was increasing. Second, China has a remarkably high national saving rate. For a typical developing country, its low saving rate usually leads to a trade deficit, but China is not typical. So there is some economic sense for China to have a trade surplus. Third, as the official pressure built on the Chinese government to change the exchange rate, private speculators began to move “hot money” into the country in the hopes of profiting when the value of the yuan increased. A substantial part of the government’s purchase of dollars was buying this hot money, and the hot money flow will reverse once the speculators think that the play is done. For a few years, the Chinese government resisted the foreign pressure to change its exchange-rate policy. The fixed exchange rate to the U.S. dollar had served the Chinese economy well. The Chinese government did not want to appear to be giving in to the foreign pressure, and it stated repeatedly that it alone would make any decisions about its exchange-rate policy as it saw fit for the good of China’s economy. Then, on July 21, 2005, the Chinese government announced and implemented changes in its policy toward the exchange-rate value of the yuan. It increased the value from 8.28 yuan per U.S. dollar to 8.11 yuan per dollar, a revaluation of 2.1 percent. (Yes, that does look odd, but the lower number means a higher value for the yuan. Welcome to the sometimes confusing world of foreign exchange. As stated, the numbers show a decrease in the value of a dollar, which is the same as an increase in the value of the yuan.) Thereafter, the Chinese government followed a policy best described as a “crawling peg,” in which the government allows small daily changes that result in a slow, tightly controlled change over time in the exchange-rate value. By July 2008 the yuan had increased by a total of about 21 percent, to a value of about 6.83 yuan per dollar. But the Chinese government was worried about the worsening global financial and economic crisis. The government decided to return to a steady fixed rate to the U.S. dollar, and the yuan was kept at about 6.83 per dollar for nearly two years. China continued to run a trade surplus and foreign investment continued to flow into China. China continued to intervene in the foreign exchange market, buying dollars Chapter 1 International Economics Is Different 7 and selling yuan, to prevent the yuan from appreciating. China continued to add the dollars to its holdings of official international reserve assets. These government holdings of foreign-currency-denominated financial investments and similar assets had been $166 billion at the beginning of 2001, grew to $711 billion in mid-2005, and reached $2.45 trillion by mid-2010. As the world recovered from the worst of the global crisis, the United States and other countries resumed pressure on China to increase the exchange-rate value of the yuan. Although again there was a wide range of estimates, a number of credible analysts concluded that the yuan was still undervalued by perhaps 15 to 30 percent. On June 18, 2010, the Chinese government resumed allowing a slow increase in the exchange-rate value of the yuan, and by August 2014 it rose in value by another 11 percent. While foreign pressure may have had some effect, the most important reason that China’s government resumed yuan appreciation was that conditions in China’s national economy had changed. As the government intervened in the foreign exchange market to buy dollars, it was also selling yuan. The yuan money supply in China grew too rapidly, encouraging local borrowing and spending that created upward pressure on the inflation rate in China. Given these conditions, the increase in the exchange-rate value of the yuan can assist the Chinese government to manage its domestic economy better, through at least three channels. First, it lowers import prices in China, thereby reducing inflation pressures in China. Second, it slows the growth of China’s exports, removing some of the demand pressure on the prices of resources and products. Third, it reduces the amount of intervention needed, reducing the pressure for growth of China’s domestic money supply. The international controversy over China’s exchange rate was very much alive in mid-2014, as exchange market intervention continued and China’s official international reserves rose to a staggering $4 trillion in June 2014. As the conflict over China’s exchange-rate policy shows clearly, policy decisions by one country have effects that spill over onto other countries. The exchange rate is a key price that affects international trade flows of goods and services and international financial flows. In the second half of this book, we will examine in depth many of the issues raised in the description of this controversial situation. For example, in Chapter 16 we will examine trade surpluses and trade deficits in the context of a country’s balance of payments. In Chapter 18 we will explore foreign financial investments and the role of currency speculation. In Chapters 22–24 we will examine how exchange rates and official intervention in the foreign exchange market affect not only a country’s trade balance but also its national production, unemployment, and inflation rate. And in Chapters 20 and 25 we will look at why a country would or would not choose to have a fixed exchange rate. Euro Crisis The European Union (EU), founded in 1957–1958, is the most successful regional trade agreement. It has expanded from 6 countries to 28 and has largely eliminated barriers to trade in goods and services and movement of people and financial capital among its member countries. As a major step toward economic and monetary union, 11 EU countries established the euro as their common currency in 1999, with the European Central Bank (ECB) in charge of monetary policy for the new euro area. 8 Chapter 1 International Economics Is Different In its first decade the euro worked well. With national currencies replaced by the euro, the transactions costs of doing business across euro-area countries fell, risks of unexpected exchange-rate changes within the area were eliminated, international trade among the euro-area countries increased, and financial markets became more integrated. By 2009 the number of EU countries in the euro area had increased to 16 (and two more would join by 2014). The annual growth of real GDP for the euro area was a little more than 3 percent during 2006–2007, unemployment fell below 8 percent, and the annual inflation rate was a little above 2 percent. The global financial and economic crisis began in 2007. The United States had had a credit boom that increased debt generally, with a surge specifically in sub-prime mortgages, those made to high-risk borrowers, that were then packaged into debt securities and sold to investors. The credit boom had funded a housing bubble, with U.S. housing prices rising rapidly and peaking in April 2006. When sub-prime mortgages increasingly went into default, investors, including many financial institutions, that had purchased the mortgage-backed securities suffered losses. Short-term debt markets froze as financial institutions and other investors became wary of lending to other financial institutions. The global crisis intensified with the failure of Lehman Brothers in September 2008. Europe was involved in four major ways. First, some European countries had their own credit booms, with housing bubbles in Ireland, Spain, and several other countries. Second, many European banks bought mortgage-backed securities and suffered losses on their holdings. Third, the freezing of short-term funding markets hurt many European banks. Fourth, the recession that began in the United States spread to other countries. As U.S. production and income declined, the United States imported fewer foreign goods and services. That is, other countries exported less, and aggregate demand for their products fell. Along with the rest of the world, the euro area went into a deep recession, with real GDP falling by over 4 percent during 2009. Government policy responses, including aggressive actions by the U.S. Federal Reserve, had largely stabilized financial markets by late 2009. The recession in the euro area ended in mid-2009, and it looked like the euro area was on a steady path to recovery. Two festering problems were about to explode, causing several national crises that eventually threatened the euro’s existence. First, the recession drove increased fiscal deficits in most euro-area countries. Greece’s fiscal deficit was almost 16 percent of its GDP in 2009, and its outstanding government debt rose to 130 percent of its GDP. Second, burst housing bubbles in some countries led to rising defaults on mortgages, threatening the solvency of the banks that had made the loans. The Irish government addressed the weakness of its banking system by decreeing in 2008 that the government guaranteed all deposits and debts of large Irish banks. As bank losses mounted, the government provided massive assistance. Ireland’s fiscal deficit jumped to 30 percent of its GDP in 2010, and outstanding government debt rose from 25 percent of GDP in 2007 to over 100 percent by 2011. With the success of the euro in integrating financial markets across the euro area, and with generally strong economic performance, the interest rates on the government debts of different countries were very close to each other up to 2008. Essentially, the markets viewed the credit risk of the Greek government and other euro area Chapter 1 International Economics Is Different 9 governments to be nearly the same as the risk of the German government. In 2009, with the realization that the Greek deficit was much larger than the Greek government had previously indicated, the interest rates on Greek government debt began to rise well above those for Germany’s government debt, with the interest rate on 10-year Greek government bonds close to 5 percentage points higher by April 2010. The Greek government concluded that it could not take on such expensive financing, and the euro crisis began. In May 2010 the Greek government received a bailout package of €110 billion (equal to U.S. $138 billion at the exchange rate at that time of about $1.256 per euro), funded by the other euro-area countries through the newly formed European Financial Stability Facility (EFSF), the EU, and the International Monetary Fund. To access periodic loans to cover its fiscal deficits, the Greek government had to reduce its fiscal deficit over time by reducing government expenditures and raising taxes, and to enact structural reforms to loosen regulations on labor markets and product markets. Driven by concerns about the rising costs of the bank bailouts, the interest rates on Irish government debt spiked beginning in March 2010. In November the euro crisis spread, with the Irish government receiving a bailout package that totaled €85 billion. In Portugal a credit boom led to a mix of excessive government debt and excessive private debt. The interest rates on Portuguese government debt rose rapidly, and the Portuguese government received a bailout package of €78 billion in May 2011. Investors increasingly wondered about other euro countries, and the euro crisis expanded and intensified in mid-2011. Spain had its own housing bubble that had burst in late 2007, and a number of Spanish banks were shaky. The Spanish fiscal deficit was close to 10 percent in 2009 and 2010, and it was expected to continue at that high level. Yet, Spain began with a relatively low government debt, so that by 2010 its outstanding government debt was only about 60 percent of its GDP. Still, beginning in April 2011 nervous investors drove up interest rates on Spanish government debt. Italy had a large outstanding government debt, which had been above 100 percent of GDP since the euro began, but it had a relatively manageable fiscal deficit, below 5 percent in 2010 and falling. Nonetheless, interest rates on Italian government debt spiked beginning in June 2011. And, by July 2011, jitters in the debt markets increased generally as euro-area leaders began to discuss that Greece would have to default on it government debt, and as fears intensified that Greece would be forced to try to find a way to exit from the euro. Spain and Italy were too large—the EFSF and the International Monetary Fund did not have enough resources to provide Spain and Italy with bailout packages comparable to those provided to Greece, Ireland, and Portugal. The European Central Bank (ECB) had the resource capability to respond, but its role had been limited, and even somewhat perverse, to this point in the euro crisis. By statute the ECB’s primary objective is price stability (a low inflation rate, defined as less than but close to 2 percent), and the ECB is prohibited from direct lending to national governments or direct purchase of national government debt. Although not prohibited, the ECB was reluctant to purchase existing national government debt in secondary markets as this was viewed as too close to direct purchase. Through its new Securities Market Program, the ECB purchased modest amounts of existing Greek, Irish, and Portuguese government bonds during May 2010–March 2011, 10 Chapter 1 International Economics Is Different and modest amounts of Spanish and Italian government bonds during August 2011– February 2012, with total purchases of about €212 billion. Yet, in 2011, the ECB also became worried that the area’s inflation rate was rising above its target. In two steps (April and July) it raised its interest rate target (in the middle of the crisis) by half a percentage point, even as a new euro-area recession began in the middle of the year. The ECB reversed the interest rate increase in December. By November 2011 the interest rates on 10-year Spanish and Italian government bonds were 4–5 percentage points higher than the rates on comparable German bonds. In December the ECB finally swung into serious action, announcing a series of two large offerings (December 2011 and February 2012) of long-term loans to banks in the euro area. The banks, net new borrowing was about €520 billion in total. Banks used some of these funds to buy government bonds, and Spanish and Italian interest rates declined. The respite was short-lived. In March 2012 the Greek government received a second bailout program that added €130 billion to the first one, and the Greek government defaulted on its privately held bonds, decreasing its outstanding debt by €100 billion. Investors again became worried about risks in individual euro-area countries and risks to the continued existence of the euro. Interest rates on Spanish and Italian government bonds jumped again. On July 26, 2012, ECB President Mario Draghi delivered a speech that more fully addressed the crisis and began to wind it down. He stated that “the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” In September the ECB approved the new Outright Monetary Transactions program. To prevent distortions in financial markets, the ECB is willing to purchase potentially large amounts of national government bonds if the government also has a program with the European Stability Mechanism (ESM—the EU is fond of acronyms), which replaced the EFSF. The ECB insisted on a program with the ESM because the ESM imposes conditions for national adjustment (the ECB cannot do so). In July the interest rates on Italian, Spanish, Greek, Portuguese, and Irish bonds went into rapid decline, and by 2014 all 10-year bond rates except those of Greece were back to within 2 percentage points of the rates on German government bonds. The worst of the euro crisis was over, although in late 2012 Spain received a loan from the ESM to recapitalize its banks and in March 2013 Cyprus received a bailout program. Each country must choose a policy for the exchange rate (international value) of its currency, and the countries of the euro area have chosen monetary union, an extreme and controversial form of “fixed exchange rates” within the area. Monetary union is a step well beyond a regional trade bloc, and we discuss the euro and its crisis throughout the second half of the book. In Chapter 16 we examine current account balances and net international financial asset positions as indicators of potential problems in the countries at the center of the euro crisis. In Chapter 21 we describe and analyze financial crises that have occurred during the past 40 years, and we explicate the euro crisis as a set of three mutually reinforcing crises—sovereign (government) debt crisis, banking crisis, and macroeconomic performance crisis. In Chapter 25 we specifically analyze the benefits and costs of European Monetary Union. Two controversies emerge. First, what is the cost to a member country of giving up both national monetary policy and the ability to change its exchange rate with other member Chapter 1 International Economics Is Different 11 countries? Second, is it possible to manage the tension between national fiscal policy as an important tool for the government to improve the country’s macroeconomic performance and national fiscal policy as a source of instability (and even crisis) for the monetary union? ECONOMICS AND THE NATION-STATE It should be clear from the four controversies described above that international economics is a special field of study because nations are sovereign. Each nation has its own government policies. For each nation, these policies are almost always designed to serve some group(s) inside that nation. Countries almost never care as much about the interests of foreigners as they do about national interests. Think of the debate about U.S. exports of natural gas. How loudly have Americans spoken out about the harm to Japan because of the high cost of its natural gas imports? The fact that nations have their sovereignty, their separate self-interests, and their separate policies means that nobody is in charge of the whole world economy. The global economy has no global government, benevolent or otherwise. It is true that there are international organizations that try to manage aspects of the global economy, particularly the World Trade Organization, the International Monetary Fund, the United Nations, and the World Bank. But each country has the option to ignore or defy these global institutions if it really wants to. Among the most important policies that each country can manipulate separately are policies toward the international movement of productive resources (people and financial capital), policies toward government taxation and spending, and policies toward money and exchange rates. Factor Mobility In differentiating international from domestic economics, classical economists stressed the behavior of the factors of production. Labor, land, and capital were seen as mobile within a country, in the sense that these resources could be put to different productive uses within the country. For example, a country’s land could be used to grow wheat or to raise dairy cattle or as the site for a factory. But, the classical economists believed, these resources were not mobile across national borders. Outside of war land does not move from one country to another. They also downplayed the ability of workers or capital to move from one country to another. If true, this difference between intranational factor mobility and international factor immobility would have implications for many features of the global economy. For instance, the wages of French workers of a given training and skill would be more or less the same, regardless of which industry the workers happened to be part of. But this French wage level could be very different from the wage for comparable workers in Germany, Italy, Canada, or Australia. The same equality of return within a country, but differences internationally, was believed to be true for land and capital. This distinction of the classical economists is partly valid today. Land is th...
Purchase answer to see full attachment
User generated content is uploaded by users for the purposes of learning and should be used following Studypool's honor code & terms of service.

Explanation & Answer

Attached.

Running head: INTERNATIONAL TRADE

International Trade
Student’s Name
Institutional Affiliations

1

INTERNATIONAL TRADE

2

Chapter 8
(1)You can calculate the overall loss if the size of the tariff is well known as well as the amount in
which it would be required for the reduction of the imports.
(3) The imposition of tariff improves the production levels of a country since it shuts the rates of
importing products. It, therefore, increases production by reducing the levels of imported goods.
This can be basically be described from the perspective of the meaning of tariff. Though the use
of a diagram, the produced products' prices are drawn against the curve of the imported goods.
(5) a. The domestic consumers gain from removing the tariff
Consumers gain = consumption w/o tarifs – consumption w/ tarifs.
= (22 billion – 20 billion)
= 2 billion pounds per year.

b. the domestic producer's loss from removing the tariff
Domestic producers loss = domestic production w Tarif – domestic production w/o tariff
= (8 billion – 6 billion)
= 2 billion pounds per year

c. the government's tariff revenue loss
Tarif revenue loss = imports w/o tarifs – imports w/ tarifs
= (16 billion – 12 billion)
= 4 billion pounds per year

d. the net effect on national well-being

INTERNATIONAL TRADE

3

(2 billion - 2 billion – 4 billion) = -4 billion.
There is a net loss of 4 billion dollars per year.

(7) consumer gain from removing the duty
Gain = $5120000
b. producer loss from removing the duty
$1,875,000
c. the government revenue loss
$6,000,000
d. the net effect on the countries well being
$2,750,000
(9) $1.25 is made up to an added value of 60 cents, cotton payment of 35 cents, and payment for
the fibers amounting to 30 cents. Therefore the effective rate is equivalent to = (0.60-0.40)/0.4 =
50%
Chapter 10
(1)
a) Yes, there is an externality, which is the external benefits. This is a positive spillover effect.
This is generally the benefit to the entire country, generally large as compared to a single firm in
the technological innovation. The other firms paying nothing from the firm generally get benefits
in the process of learning and using the technology implemented for production.

INTERNATIONAL TRADE

4

b) An economist would most probably argue that the production subsidy is preferable to the tariff.
Both of them are useful in increasing domestic production rates, and tariff is made to distort
domestic consumpt...


Anonymous
Nice! Really impressed with the quality.

Studypool
4.7
Trustpilot
4.5
Sitejabber
4.4

Similar Content

Related Tags