International Economics

International Economics Fourteenth Edition Thomas A. Pugel New York University McGraw-Hill Irwin Boston Burr Ridge, IL Dubuque, IA New York San Fran...
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International Economics Fourteenth Edition

Thomas A. Pugel New York University

McGraw-Hill Irwin Boston Burr Ridge, IL Dubuque, IA New York San Francisco St. Louis Bangkok Bogota Caracas Kuala Lumpur Lisbon London Madrid Mexico City Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto

Contents Preface

vi

c

About the Author

xv

Chapter 1 International Economics Is Different Four Controversies

1

1

/

Outsourcing 1 Immigration 3 China's Exchange Rate 5 Sovereign Wealth Funds 7

Economics and the Nation-State 9 Factor Mobility 9 Different Fiscal Policies 10 Different Moneys 10

The Scheme of This Book 11 PART ONE THE THEORY OF INTERNATIONAL TRADE 13 Chapter 2 The Basic Theory Using Demand and Supply 15 Four Questions about Trade 16 A Look Ahead 16 Demand and Supply 17 Demand 17 Consumer Surplus 18 Case Study Trade: Increasingly Important 20 Supply 22 Producer Surplus 22 A National Market with No Trade 23

Two National Markets and the Opening of Trade 24 Free-Trade Equilibrium 25 Effects in the Importing Country 27 Effects in the Exporting Country 29 Which Country Gains More? 29 xviii

Summary: Early Answers to the Four Trade Questions 30 Key Terms 30 Suggested Reading 31 Questions and Problems 31 Chapter 3 Why Everybody Trades: Comparative Advantage 33 Adam Smith's Theory of Absolute Advantage 34 Case Study Mercantilism: Older than Smith—and Alive Today 35

Ricardo's Theory of Comparative Advantage 37 Ricardo's Constant Costs and the Production-Possibility Curve 40 FOCUS on Labor Absolute Advantage Does Matter 42 Extension What If Trade Doesn't Balance? 44

Summary 45 Key Terms 46 Suggested Reading 46 Questions and Problems 46 Chapter 4 Trade: Factor Availability and Factor Proportions Are Key 49 Production with Increasing Marginal Costs 50 What's Behind the Bowed-Out Production-Possibility Curve? 50 What Production Combination Is Actually Chosen? 52

Community Indifference Curves 53 Production and Consumption Together 55 Without Trade 55 With Trade 56

Contents xix FOCUS on China The Opening of Trade and China's Shift Out of Agriculture 58 Demand and Supply Curves Again 60

The Gains from Trade 60 Trade Affects Production and Consumption 61 What Determines the Trade Pattern? The Heckscher-Ohlin (H-O) Theory 63 Summary 64 Key Terms 65 Suggested Reading 65 Questions and Problems 65

62

Internal Scale Economies 93 External Scale Economies 94

Intra-Industry Trade 95 Monopolistic Competition: The Basics

98

The Monopoly Element: Price Setting 99 The Competitive Element: Entry and Profit Erosion 101

Monopolistic Competition: Opening to Trade 101 Basis for Trade 105 Gains from Trade 106

Chapter 5 Who Gains and Who Loses from Trade? 69

Oligopoly and International Trade

107

Extension The Gravity Model of Trade 108 Substantial Scale Economies 110 Oligopoly Pricing 110

Who Gains and Who Loses Within a Country 69 Short-Run Effects of Opening Trade 70 Long-Run Factor-Price Response 70

Three Implications of the H - 0 Theory

Chapter 6 Scale Economies, Imperfect Competition, and Trade 91 Scale Economies 92

72

The Stolper-Samuelson Theorem 72 Extension A Factor-Ratio Paradox 73 The Specialized-Factor Pattern 75 The Factor-Price Equalization Theorem 75

Does Heckscher-Ohlin Explain Actual Trade Patterns? 76 Factor Endowments 77 Case Study The Leontief Paradox 78 International Trade 79

What Are the Export-Oriented and Import-Competing Factors? 81 The U.S. Pattern 81 The Canadian Pattern 81 FOCUS on China China s Exports and Imports 82 Patterns in Other Countries 84

Do Factor Prices Equalize Internationally? 84 FOCUS on Labor U.S. Jobs and Foreign Trade 86 Summary: Fuller Answers to the Four Trade Questions 87 Key Terms 88 Suggested Reading 88 Questions and Problems 88

External Scale Economies and Trade 112 Summary: How Does Trade Really Work? 114 Key Terms 117 Suggested Reading 117 Questions and Problems 117

Chapter 7 Growth and Trade 121 Balanced versus Biased Growth 122 Growth in Only One Factor 123 Changes in the Country's Willingness to Trade 124 Case Study The Dutch Disease and Deindustrialization

127

Effects on the Country's Terms of Trade

127

Small Country 128 Large Country 128 Immiserizing Growth 129

Technology and Trade

131

Individual Products and the Product Cycle 133 FOCUS on Labor Trade, Technology, and U.S. Wages 134 Openness to Trade Affects Growth 134

Summary 137 Key Terms 138

XX

Contents

Case Study Carrots Are Fruit, Snails Are Fish, and X-Men Are Not Humans 184 Government Procurement 185

Suggested Reading 138 Questions and Problems 139

PART TWO TRADE POLICY Chapter 8 Analysis of a Tariff Global Governance Success 144

How Big Are the Costs of Protection? As a Percentage of GDP 185 For Specific Products with High Protection

141

International Trade Disputes

143 WTO and GATT: Tariff

A Preview of Conclusions 146 The Effect of a Tariff on Domestic Producers 147 The Effect of a Tariff on Domestic Consumers 149 The Tariff as Government Revenue 151 The Net National Loss from a Tariff 151 Extension

The Effective Rate of Protection 154

The Terms-of-Trade Effect and a Nationally Optimal Tariff 156 Summary 160 Key Terms 161 Suggested Reading 162 Questions and Problems 162

Chapter 9 Nontariff Barriers to Imports

165

Types of Nontariff Barriers to Imports The Import Quota 167

165

Quota versus Tariff for a Small Country 167 Global Governance The WTO: Beyond Tariffs 168 Ways to Allocate Import Licenses 172 Extension A Domestic Monopoly Prefers a Quota 174 Quota versus Tariff for a Large Country 176 Voluntary Export Restraints (VERs) 178 Other Nontariff Barriers 179 Case Study VERs on Textiles and Clothing 180 Product Standards 180 Case Study Auto VER: Protection with Integrity? 182 Domestic Content Requirements 183

185 187

189

FOCUS on China China's First Years in the WTO 190 America s "Section 301": Unilateral Pressure 192 Dispute Settlement in the WTO 192

Summary 193 Key Terms 194 Suggested Reading 195 Questions and Problems 195

Chapter 10 Arguments for and against Protection 199 The Ideal World of First Best 200 The Realistic World of Second Best 201 Government Policies toward Externalities The Specificity Rule 203

203

Promoting Domestic Production or Employment 204 The Infant Industry Argument 208 How It Is Supposed to Work 208 •> How Valid Is It? 209 Focus on Labor How Much Does It Cost to Protect a Job? 210

The Dying Industry Argument and Adjustment Assistance 213 Should the Government Intervene? 213 Trade Adjustment Assistance 215

The Developing Government (Public Revenue) Argument 216 Other Arguments for Protection: Noneconomic Objectives 217 National Pride 217 National Defense 217 Income Redistribution 218

The Politics of Protection 218 The Basic Elements of the Political-Economic Analysis 219 When Are Tariffs Unlikely? 220

Contents

When Are Tariffs Likely? 220 Case Study How Sweet It Is (or Isn 't) 222 Applications to Other Trade-Policy Patterns 223

NAFTA: Provisions and Controversies 270 NAFTA: Effects 270 Rules of Origin 272

Summary 224 Key Terms 226 Suggested Reading 227 Questions and Problems 227

Trade Blocs among Developing Countries 272 Trade Embargoes 274 Summary 279 Key Terms 280 Suggested Reading 280 Questions and Problems 280

Chapter 11 Pushing Exports 229 Dumping 229 Reacting to Dumping: What Should a Dumpee Think? 232 Actual Antidumping Policies: What Is Unfair? 233 Case Study

Chapter 13

Trade and the Environment 283 v

Antidumping in Action 236

Proposals for Reform 239 Export Subsidies 241 Exportable Product, Small Exporting Country 242 Exportable Product, Large Exporting Country 243 Switching an Importable Product into an Exportable Product 244

WTO Rules on Subsidies 246 Should the Importing Country Impose Countervailing Duties? 246 Case Study

Agriculture Is Amazing 248

Strategic Export Subsidies Could Be Good 251 Global Governance

Dogfight at the WTO 252

Summary 256 Key Terms 256 Suggested Reading 257 Questions and Problems 257 Chapter 12

Trade Blocs and Trade Blocks 259 Types of Economic Blocs 259 Is Trade Discrimination Good or Bad? 260 The Basic Theory of Trade Blocs: Trade Creation and Trade Diversion 262 Other Possible Gains from a Trade Bloc 265 The EU Experience 266 Case Study Europe 268

Postwar Trade Integration in

North America Becomes a Bloc 269

xxi

Is Free Trade Anti-Environment? 283 Is the WTO Anti-Environment? 288 Global Governance and the WTO 290

Dolphins, Turtles,

The Specificity Rule Again 292 A Preview of Policy Prescriptions 293 Trade and Domestic Pollution 295 Transborder Pollution 298 The Right Solution 299 A Next-Best Solution 301 NAFTA and the Environment

302

Global Environmental Challenges 303 Global Problems Need Global Solutions Extinction of Species 305 Overfishing 306 CFCs and Ozone 307 Greenhouse Gases and Global Warming 308

Summary 313 Key Terms 314 Suggested Reading 314 Questions and Problems 315 Chapter 14

Trade Policies for Developing Countries 317 Which Trade Policy for Developing Countries? 319 Are the Long-Run Price Trends against Primary Producers? 321 Case Study Transition 322

Special Challenges of

303

XXii

Contents

International Cartels to Raise Primary-Product Prices 327 The OPEC Victories 32 7 Classic Monopoly as an Extreme Model for Cartels 328 The Limits to and Erosion of Cartel Power 330 The Oil Price Increase since 1999 331 Other Primary Products 332

Import-Substituting Industrialization (ISI) IS1at Its Best 333 Experience with ISI

332

334

Exports of Manufactures to Industrial Countries 337 Summary 338 Key Terms 339 Suggested Reading 339 Questions and Problems 340

Effects on the Government Budget 370 External Costs and Benefits 3 70 What Policies to Select Immigrants? 3 71 Case Study Are Immigrants a Fiscal Burden? 372

Summary 374 Key Terms 376 Suggested Reading 376 Questions and Problems 376

PART THREE UNDERSTANDING FOREIGN EXCHANGE 379 Chapter 16 Payments among Nations

Chapter 15

Multinationals and Migration: International Factor Movements 343 Foreign Direct Investment 344 Multinational Enterprises 346 FDI: History and Current Patterns 347 Why Do Multinational Enterprises Exist?

349

Inherent Disadvantages 350 Firm-Specific Advantages 350 Location Factors 351 Internalization Advantages 352 Oligopolistic Rivalry 353

381

Accounting Principles 381 A Country's Balance of Payments Current Account 382 Financial Account 384 Official International Reserves Statistical Discrepancy 386

382

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The Macro Meaning of the Current Account Balance 386 C a s e Study Planet Earth's Balance of Payments 387

Taxation of Multinational Enterprises' Profits 353 C a s e Study CEMEXA Model Multinational from an Unusual Place 354

MNEs and International Trade 356 Should the Home Country Restrict FDI Outflows? 358 Should the Host Country Restrict FDI Inflows? 359 FOCUS on China China as a Host

The Macro Meaning of the Overall Balance 392 The International Investment Position Summary 395 Key Terms 396 Suggested Reading 396 Questions and Problems 396

Chapter 17 The Foreign Exchange Market

393

399

The Basics Of Currency Trading 400

Country 360

Migration 363 How Migration Affects Labor Markets Should the Sending Country Restrict Emigration? 369

Should the Receiving Country Restrict Immigration? 370

366

Case Study Brussels Sprouts a New Currency: € 402 Using the Foreign Exchange Market 403 Case Study Foreign Exchange Trading 404

Contents

Interbank Foreign Exchange Trading 405

Exchange Rates in the Short Run 444

Demand and Supply for Foreign Exchange

406

Floating Exchange Rates 407 Fixed Exchange Rates 409 Current Arrangements 410

The Law of One Price 449 Absolute Purchasing Power Parity 449 Case Study Price Gaps and International Income Comparisons 450 Relative Purchasing Power Parity 452 Relative PPP: Evidence 453 Case Study PPPfrom Time to Time 455

Chapter 18 Forward Exchange and International Financial Investment 415

The Long Run: The Monetary Approach 457

Exchange Rate Risk 415 The Market Basics of Forward Foreign Exchange 416 Hedging Using Forward Foreign Exchange 417 Speculating Using Forward Foreign Exchange 418 Extension Futures, Options, and Swaps 420

International Financial Investment 422 International Investment with Cover 423 Covered Interest Arbitrage 425 Covered Interest Parity 426

International Investment without Cover 427 The World's Greatest Investor 430

Does Interest Parity Really Hold? Empirical Evidence 432 Evidence on Covered Interest Parity 432 Evidence on Uncovered Interest Parity 433 Case Study Eurocurrencies: Not (Just) Euros and Not Regulated 434 Evidence on Forward Exchange Rates and Expected Future Spot Exchange Rates 43 7

A Road Map 443

Money, Price Levels, and Inflation 457 Money and PPP Combined 458 The Effect of Money Supplies on an Exchange Rate 459 The Effect of Real Incomes on an Exchange Rate 459

Exchange Rate Overshooting 460 How Well Can We Predict Exchange Rates? 463 Extension Tracking the Exchange Rate Value of a Currency 464 Summary 467 Key Terms 468 Suggested Reading 469 Questions and Problems 469

Chapter 20 Government Policies toward the Foreign Exchange Market 473 Two Aspects: Rate Flexibility and Restrictions on Use 474 Floating Exchange Rate 475 Fixed Exchange Rate 475

Summary 438 Key Terms 439 Suggested Reading 439 Questions and Problems 439 Chapter 19 What Determines Exchange Rates?

The Role of Interest Rates 445 The Role of the Expected Future Spot Exchange Rate 446

The Long Run: Purchasing Power Parity (PPP) 448

Arbitrage within the Spot Exchange Market 411 Summary 412 Key Terms 412 Suggested Reading 412 Questions and Problems 413

Case Study

xxiii

What to Fix To? 476 When to Change the Fixed Rate? 476 Defending a Fixed Exchange Rate 4 78

441

Defense through Official Intervention 479 Defending against Depreciation 479 Defending against Appreciation 481

xxiv

Contents

Temporary Disequilibrium 483 Disequilibrium That Is Not Temporary 484

Exchange Control 486 International Currency Experience 489 The Gold Standard Era, 1870-1914 (One Version of Fixed Rates) 490 Interwar Instability 493 TheBretton Woods Era, 1944-1971 (Adjustable Pegged Rates) 495

Global Governance

The International

Monetary Fund 496 The Current System: Limited Anarchy

501

Summary 505 Key Terms 507 Suggested Reading 508 Questions and Problems 508

Chapter 21 International Lending and Financial Crises 511 Gains And Losses from Well-Behaved International Lending 512 Taxes on International Lending 514 International Lending to Developing Countries 515 The Surge in International Lending, 1974-1982 516 The Debt Crisis of 1982 517 The Resurgence of Capital Flows in the 1990s 517 The Mexican Crisis, 1994-1995 519 The Asian Crisis, 1997 520

Global Governance

Short of Reserves?

Call 1-800-IMF-LOAN 522 The Russian Crisis, 1998 524 The Brazilian Crisis, 1999 524 The Turkish Crisis, 2001 525 Argentina s Crisis, 2001-2002 525

Financial Crises: What Can and Does Go Wrong 526 Waves of Overlending and Overborrowing 527 Extension The Special Case of Sovereign Debt 528 Exogenous International Shocks 530 Exchange Rate Risk 530 Fickle International Short-Term Lending 530 Global Contagion 531

Resolving Financial Crises 532 Rescue Packages 532 Debt Restructuring 533

Reducing the Frequency of Financial Crises 535 Global Governance Mighty Joe Meets the Incredible Monetary Force 536 Bank Regulation and Supervision 536 Capital Controls 538

Summary 539 Key Terms 541 Suggested Reading 541 Questions and Problems 541

PART FOUR MACRO POLICIES FOR OPEN ECONOMIES 543 Chapter 22 How Does the Open Macroeconomy Work? 545 The Performance of a National Economy 545 A Framework for Macroeconomic Analysis 546 Domestic Production Depends on Aggregate Demand 547 Trade Depends on Income 549 Equilibrium GDP and Spending Multipliers 549 Equilibrium GDP 549 The Spending Multiplier in a Small Open Economy 551 Foreign Spillovers and Foreign-Income Repercussions 553

A More Complete Framework: Three Markets 555 The Domestic Product Market 556 The Money Market 558 The Foreign Exchange Market (or Balance of Payments) 560 Three Markets Together 563

The Price Level Does Change 564

Contents

Trade Also Depends on Price Competitiveness 565 Summary 566 Key Terms 568 Suggested Reading 569 Questions and Problems 569

Fiscal Policy with Floating Exchange Rates 613 Shocks to the Economy 615

Chapter 23 Internal and External Balance with Fixed Exchange Rates 571 From the Balance of Payments to the Money Supply 572 From the Money Supply Back to the Balance of Payments 575 Sterilization 578 Monetary Policy with Fixed Exchange Rates 580 Fiscal Policy with Fixed Exchange Rates 581 Perfect Capital Mobility 584 Shocks to The Economy 586 Internal Shocks 586 International Capital-Flow Shocks International Trade Shocks 588

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586

Imbalances and Policy Responses 590 Internal and External Imbalances 590 Case Study A Tale of Three Countries 592 A Short-Run Solution: Monetary-Fiscal Mix 595

Surrender: Changing the Exchange Rate 597 How Well Does the Trade Balance Respond to Changes in the Exchange Rate? 600 How the Response Could Be Unstable 601 Why the Response Is Probably Stable 602 Timing: The J Curve 603

Summary 604 Key Terms 606 Suggested Reading 607 Questions and Problems 607 Chapter 24 Floating Exchange Rates and Internal Balance 609 Monetary Policy with Floating Exchange Rates 610

Internal Shocks 615 Case Study Why Are US. Trade Deficits So Big? 616 International Capital-Flow Shocks 618 International Trade Shocks 619

Internal Imbalance and Policy Responses 620 International Macroeconomic Policy Coordination 621 Case Study Float? 622

Can Governments Manage the

Summary 626 Key Terms 627 Suggested Reading 628 Questions and Problems 628 Chapter 25 National and Global Choices: Floating Rates and the Alternatives 631 Key Issues in the Choice of Exchange Rate Policy 632 Effects of Macroeconomic Shocks 632 Case Study What Role for Gold? 634 The Effectiveness of Government Policies 638 Differences in Macroeconomic Goals, Priorities, and Policies 639 Controlling Inflation 640 Real Effects of Exchange Rate Variability 643

National Choices 644 Extreme Fixes 646 Currency Board "Dollarization"

646 647

The International Fix—Monetary Union 649 Exchange Rate Mechanism 649 European Monetary Union 650

Summary 654 Key Terms 656 Suggested Reading 656 Questions and Problems 656