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International Economics - Appleyard, Field and Cobb
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INTERNATIONALECONOMICS
SEVENTH EDITION
DENNIS R. APPLEYARDDAVIDSON COLLEGE
ALFRED J. FIELD, JR.UNIVERSITY OF NORTH CAROLINA
AT CHAPEL HILL
STEVEN L. COBBUNIVERSITY OF NORTH TEXAS
I McGraw-HillI Irwln
BRIEF CONTENTS
CHAPTER 1The World of International Economics, 1
PARTI
PART 3
THE CLASSICAL THEORY OF TRADE 15
CHAPTER 2Early Trade Theories: Mercantilism and theTransition to the Classical World of David Ricardo, 17
CHAPTER 3The Classical World of David Ricardo andComparative Advantage, 28
CHAPTER 4Extensions and Tests of the Classical Modelof Trade, 42
PART 2
NEOCLASSICAL TRADE THEORY 63
CHAPTER 5Introduction to Neoclassical Trade Theory: Tools toBe Employed, 65
CHAPTER 6Gains from Trade in Neoclassical Theory, 87
CHAPTER 7Offer Curves and the Terms of Trade, 103
CHAPTER 8The Basis for Trade: Factor Endowments and theHeckscher-Ohlin Model, 125
CHAPTER 9Empirical Tests of the Factor EndowmentsApproach, 153
ADDITIONAL THEORIESAND EXTENSIONS 173
CHAPTER 10Post-Heckscher-Ohlin Theories of Trade and Intra-Industry Trade, 175
CHAPTER 11Economic Growth and International Trade, 204
CHAPTER 12International Factor Movements, 226
PART 4
TRADE POLICY 257
CHAPTER 13The Instruments of Trade Policy, 259
CHAPTER 14The Impact of Trade Policies, 280
CHAPTER 15Arguments for Interventionist Trade Policies, 319
CHAPTER 16Political Economy and U.S. Trade Policy, 358
CHAPTER 17Economic Integration, 392
CHAPTER 18International Trade and the DevelopingCountries, 418
xv
XVI BRIEF CONTENTS
PART 5
FUNDAMENTALS OF INTERNATIONALMONETARY ECONOMICS 451
CHAPTER 19The Balance-of-Payments Accounts, 453
CHAPTER20The Foreign Exchange Market, 476
CHAPTER21International Financial Markets and Instruments:An Introduction, 507
CHAPTER 22The Monetary and Portfolio Balance Approaches toExternal Balance, 541
CHAPTER 23Price Adjustments and Balance-of-PaymentsDisequilibrium, 573
CHAPTER 24National Income and the Current Account, 602
PART 6to)
MACROECONOMIC POLICY IN THEOPEN ECONOMY 629
CHAPTER25Economic Policy in the Open Economy under FixedExchange Rates, 631
CHAPTER26Economic Policy in the Open Economy underFlexible Exchange Rates, 662
CHAPTER 27Prices and Output in the Open Economy: AggregateSupply and Demand, 683
PART 7
ISSUES IN WORLD MONETARYARRANGEMENTS 711
CHAPTER28Fixed or Flexible Exchange Rates? 713
CHAPTER 29The International Monetary System: Past, Present,
and Future, 739
References for Further Reading, 775
Photo Credits, 794
Index, 795
CONTENTS
CHAPTER 1
The World of International Economics, 1 jINTRODUCTION, 1 v
THE NATURE OF MERCHANDISE TRADE, 3
The Geographical Composition of Trade, 3The Commodity Composition of Trade, 6U.S. International Trade, 7
WORLD TRADE IN SERVICES, 9
THE CHANGING DEGREE OF ECONOMIC
INTERDEPENDENCE, 11
SUMMARY, 12
Appendix: A General Reference List in InternationalEconomics, 12
PARTI
THE CLASSICAL THEORY OF TRADE 15
CHAPTER 2
Early Trade Theories: Mercantilism and the Transitionto the Classical World of David Ricardo, 17
INTRODUCTION, 18
The Oracle in the 21st Century, 18MERCANTILISM, 18
The Mercantilist Economic System, 18The Role of Government, 19Mercantilism and Domestic Economic Policy, 20
IN THE REAL WORLD: MERCANTILISM IS STILL
ALIVE 21
THE CHALLENGE TO MERCANTILISM BY EARLY
CLASSICAL WRITERS, 22
David Hume—The Price-Specie-FlowMechanism, 22
CONCEPT BOX 1: CAPSULE SUMMARY OF THE
PRICE-SPECIE-FLOW MECHANISM, 22
CONCEPT BOX 2: CONCEPT REVIEW—PRICE
ELASTICITY AND TOTAL EXPENDITURES, 23
Adam Smith and the Invisible Hand, 24TITANS OF INTERNATIONAL ECONOMICS:
ADAM SMITH (1723-1790), 25SUMMARY, 26
CHAPTER 3The Classical World of David Ricardo andComparative Advantage, 28
INTRODUCTION, 29
Some Common Myths, 29ASSUMPTIONS OF THE BASIC RICARDIAN
MODEL, 29
TITANS OF INTERNATIONAL ECONOMICS: DAVID
RICARDO (1772-1823), 30RICARDIAN COMPARATIVE ADVANTAGE, 30
IN THE REAL WORLD: EXPORT CONCENTRATION
OF SELECTED COUNTRIES, 33
COMPARATIVE ADVANTAGE AND THE TOTAL GAINS
FROM TRADE, 34
Resource Constraints, 34Complete Specialization, 35
REPRESENTING THE RICARDIAN MODEL WITH
PRODUCTION-POSSIBILITIES FRONTIERS, 36
Production Possibilities—An Example, 36Maximum Gains from Trade, 38
COMPARATIVE ADVANTAGE—SOME CONCLUDING
OBSERVATIONS, 39
SUMMARY, 40
CHAPTER4Extensions and Tests of the Classical Modelof Trade, 42
INTRODUCTION, 43
Trade Complexities in the Real World, 43THE CLASSICAL MODEL IN MONEY TERMS, 43
WAGE RATE LIMITS AND EXCHANGE RATE
LIMITS, 44
CONCEPT BOX 1: WAGE RATE LIMITS AND
EXCHANGE RATE LIMITS IN THE MONETIZED
RICARDIAN FRAMEWORK, 46
MULTIPLE COMMODITIES, 47
The Effect of Wage Rate Changes, 48The Effect of Exchange Rate Changes, 49
TRANSPORTATION COSTS, 50
IN THE REAL WORLD: THE SIZE OF
TRANSPORTATION COSTS, 51
MULTIPLE COUNTRIES, 52
xvii
XV111 CONTENTS
EVALUATING THE CLASSICAL MODEL, 53
IN THE REAL WORLD: LABOR PRODUCTIVITY AND
IMPORT PENETRATION IN THE U.S. STEEL
INDUSTRY, 55
SUMMARY, 57
Appendix: The Dornbusch, Fischer, and SamuelsonModel, 59
PART 2
NEOCLASSICAL TRADE THEORY 63
CHAPTER 5Introduction to Neoclassical Trade Theory: Tools toBe Employed, 65
INTRODUCTION, 66
THE THEORY OF CONSUMER BEHAVIOR, 66
Consumer Indifference Curves, 66TITANS OF INTERNATIONAL ECONOMICS:
FRANCIS YSIDRO EDGEWORTH (1845-1926), 67
The Budget Constraint, 71Consumer Equilibrium, 72
PRODUCTION THEORY, 73
Isoquants, 73IN THE REAL WORLD: CONSUMER EXPENDITURE
PATTERNS IN THE UNITED STATES, 74
Isocost Lines, 76Producer Equilibrium, 78
THE EDGEWORTH BOX DIAGRAM AND THE
PRODUCTION-POSSIBILITIES FRONTIER, 78
The Edgeworth Box Diagram, 78The Production-Possibilities Frontier, 81
SUMMARY, 85
CHAPTER 6Gains from Trade in Neoclassical Theory, 87
INTRODUCTION, 88
The Effects of Restrictions on U.S. Trade, 88AUTARKY EQUILIBRIUM, 88
INTRODUCTION OF INTERNATIONAL TRADE, 90
The Consumption and Production Gains fromTrade, 92
Trade in the Partner Country, 94MINIMUM CONDITIONS FOR TRADE, 95
Trade between Countries with Identical PPFs, 95Trade between Countries with Identical Demand
Conditions, 97Conclusions, 98
SOME IMPORTANT ASSUMPTIONS IN THE
ANALYSIS, 98
Costless Factor Mobility, 98Full Employment of Factors of Production, 99The Indifference Curve Map Can Show Welfare
Changes, 99IN THE REAL WORLD: CHANGES IN INCOME
DISTRIBUTION WITH INCREASED TRADE, 100
SUMMARY, 101
Appendix: "Actual" versus "Potential" Gains fromTrade, 102
CHAPTER 7Offer Curves and the Terms of Trade, 103
INTRODUCTION, 104
Terms-of-Trade Shocks, 104A COUNTRY'S OFFER CURVE, 104
CONCEPT BOX 1: THE TABULAR APPROACH TO
DERIVING AN OFFER CURVE, 107
TRADING EQUILIBRIUM, 108
SHIFTS OF OFFER CURVES, 110
CONCEPT BOX 2: MEASUREMENT OF THE TERMS
OF TRADE, 113
ELASTICITY AND THE OFFER CURVE, 114
IN THE REAL WORLD: TERMS OF TRADE FOR
MAJOR GROUPS OF COUNTRIES, 1973-2007, 115OTHER CONCEPTS OF THE TERMS OF TRADE, 119
Income Terms of Trade, 119Single Factoral Terms of Trade, 119
IN THE REAL WORLD: INCOME TERMS OF
TRADE OF MAJOR GROUPS OF COUNTRIES,
1973-2007, 120Double Factoral Terms of Trade, 120
SUMMARY, 121
Appendix A: Derivation of Import-Demand Elasticityon an Offer Curve, 122
Appendix B: Elasticity and Instability of Offer CurveEquilibria, 123
CHAPTER 8The Basis for Trade: Factor Endowments and theHeckscher-Ohlin Model, 125
INTRODUCTION, 126
Do Labor Standards Affect ComparativeAdvantage? 126
SUPPLY, DEMAND, AND AUTARKY PRICES, 127
FACTOR ENDOWMENTS AND THE HECKSCHER-
OHLIN THEOREM, 127
Factor Abundance and Heckscher-Ohlin, 128
CONTENTS XIX
Commodity Factor Intensity and Heckscher-Ohlin, 128
IN THE REAL WORLD: RELATIVE FACTOR
ENDOWMENTS IN SELECTED COUNTRIES, 129
IN THE REAL WORLD: RELATIVE FACTOR
INTENSITIES IN SELECTED INDUSTRIES, 2006, 131
The Heckscher-Ohlin Theorem, 131TITANS OF INTERNATIONAL ECONOMICS: PAUL
ANTHONY SAM UELSON (BORN 1915), 134The Factor Price Equalization Theorem, 135 {The Stolper-Samuelson Theorem and Income
Distribution Effects of Trade in theHeckscher-Ohlin Model, 138
Conclusions, 139THEORETICAL QUALIFICATIONS
TO HECKSCHER-OHLIN, 139
Demand Reversal, 140Factor-Intensity Reversal, 141Transportation Costs, 142Imperfect Competition, 144Immobile or Commodity-Specific Factors, 145
IN THE REAL WORLD: THE EFFECTS OF
INTERNATIONAL CARTELS, 146
Other Considerations, 149CONCEPT BOX 1: THE SPECIFIC-FACTORS MODEL
AND THE REAL WAGE OF WORKERS, 149
SUMMARY, 151
CHAPTER 9Empirical Tests of the Factor EndowmentsApproach, 153
INTRODUCTION, 154
Theories, Assumptions, and the Role of EmpiricalWork, 154
THE LEONTIEF PARADOX, 154
SUGGESTED EXPLANATIONS FOR THE LEONTIEF
PARADOX, 155
Demand Reversal, 155Factor-Intensity Reversal, 156
IN THE REAL WORLD: CAPITAL/LABOR RATIOS IN
LEADING EXPORT AND IMPORT
INDUSTRIES—LEONTIEF TEST, 157
U.S. Tariff Structure, 158Different Skill Levels of Labor, 159The Role of Natural Resources, 159
OTHER TESTS OF THE HECKSCHER-OHLIN
THEOREM, 160
Factor Content Approach with Many Factors, 161Comparisons of Calculated and Actual
Abundances, 163
Productivity Differences and "Home Bias," 163IN THE REAL WORLD: CASE OF THE MISSING
TRADE AND OTHER MYSTERIES, 166
HECKSCHER-OHLIN AND INCOME INEQUALITY, 166
IN THE REAL WORLD: TRADE AND INCOME
INEQUALITY IN A LESS DEVELOPED COUNTRY:
THE CASE OF MOZAMBIQUE, 169
IN THE REAL WORLD: OUTSOURCING AND WAGE
INEQUALITY IN THE UNITED STATES, 171
SUMMARY, 172 ,
PART 3
ADDITIONAL THEORIES ANDEXTENSIONS 173
CHAPTER 10
Post-Heckscher-Ohlin Theories of Trade andIntra-Industry Trade, 175
INTRODUCTION, 176
A Trade Myth, 176POST-HECKSCHER-OHLIN THEORIES OF TRADE, 176
The Imitation Lag Hypothesis, 176The Product Cycle Theory, 177Vertical Specialization-Based Trade, 181Firm-Focused Theories, 181The Linder Theory, 182
IN THE REAL WORLD: NEW VENTURE
INTERNATIONALIZATION, 184
IN THE REAL WORLD: A REEXAMINATION OF THE
LINDER HYPOTHESIS, 185
Economies of Scale, 186The Krugman Model, 187Other Post-Heckscher-Ohlin Theories, 190Concluding Comments on Post-Heckscher-Ohlin
Trade Theories, 192INTRA-INDUSTRY TRADE, 192
IN THE REAL WORLD: GEOGRAPHY AND TRADE, 193Reasons for Intra-Industry Trade in a Product
Category, 194The Level of a Country's Intra-Industry Trade, 196
SUMMARY, 198
Appendix A: Economies of Scale, 199Appendix B: Monopolistic Competition and Price
Elasticity of Demand in the Krugman Model, 201Appendix C: Differentiating among Alternative Trade
Theories Using the Gravity Equation, 202Appendix D: Measurement of Intra-Industry Trade, 203
XX CONTENTS
CHAPTER 11Economic Growth and International Trade, 204
INTRODUCTION, 205
China—A Regional Growth Pole, 205CLASSIFYING THE TRADE EFFECTS OF ECONOMIC
GROWTH, 205
Trade Effects of Production Growth, 206Trade Effects of Consumption Growth, 207
SOURCES OF GROWTH AND THE PRODUCTION-
POSSIBILITIES FRONTIER, 209
The Effects of Technological Change, 209 s -IN THE REAL WORLD: LABOR AND CAPITAL
REQUIREMENTS PER UNIT OF OUTPUT, 210
IN THE REAL WORLD: "SPILLOVERS " AS A
CONTRIBUTOR TO ECONOMIC GROWTH, 213
The Effects of Factor Growth, 213FACTOR GROWTH, TRADE, AND WELFARE IN THE
SMALL-COUNTRY CASE, 216
GROWTH, TRADE, AND WELFARE: THE LARGE-
COUNTRY CASE, 217
CONCEPT BOX 1: LABOR FORCE GROWTH AND PER
CAPITA INCOME, 218
CONCEPT BOX 2: ECONOMIC GROWTH AND THE
OFFER CURVE, 220
GROWTH AND THE TERMS OF TRADE: A
DEVELOPING-COUNTRY PERSPECTIVE, 222
IN THE REAL WORLD: TERMS OF TRADE OF
BRAZIL, JORDAN, MOROCCO, AND THAILAND,
1980-2007, 223SUMMARY, 224
CHAPTER 12International Factor Movements, 226
INTRODUCTION, 227
INTERNATIONAL CAPITAL MOVEMENTS THROUGH
FOREIGN DIRECT INVESTMENT AND
MULTINATIONAL CORPORATIONS, 227
Foreign Investors in China: "Good" or "Bad" fromthe Chinese Perspective? 227
Definitions, 229Some Data on Foreign Direct Investment and
Multinational Corporations, 229Reasons for International Movement of Capital, 232
IN THE REAL WORLD: DETERMINANTS OF
FOREIGN DIRECT INVESTMENT, 234
Analytical Effects of International CapitalMovements, 235
IN THE REAL WORLD: HOST-COUNTRY
DETERMINANTS OF FOREIGN DIRECT INVESTMENT
INFLOWS, 237
Potential Benefits and Costs of Foreign DirectInvestment to a Host Country, 239
LABOR MOVEMENTS BETWEEN COUNTRIES, 242
Seasonal Workers in Germany, 242Permanent Migration: A Greek in Germany, 242
IN THE REAL WORLD: MIGRATION FLOWS INTO THE
UNITED STATES, 1986 AND 2006, 244
Economic Effects of Labor Movements, 245Additional Considerations Pertaining to
International Migration, 248IN THE REAL WORLD: IMMIGRANT REMITTANCES, 249
Immigration and the United States—RecentPerspectives, 252
IN THE REAL WORLD: Is THERE A LICENSING BIAS
AGAINST FOREIGN MEDICAL GRADUATES? 253
IN THE REAL WORLD: IMMIGRATION INTO THE
UNITED STATES AND THE BRAIN DRAIN FROM
DEVELOPING COUNTRIES, 254
SUMMARY, 255
PART 4
TRADE POLICY 257
CHAPTER 13The Instruments of Trade Policy, 259
INTRODUCTION, 260
In What Ways Can I Interfere with Trade? 260IMPORT TARIFFS, 261
Specific Tariffs, 261Ad Valorem Tariffs, 261Other Features of Tariff Schedules, 261
IN THE REAL WORLD: U.S. TARIFF RATES, 263IN THE REAL WORLD: THE U.S. GENERALIZED
SYSTEM OF PREFERENCES, 265
Measurement of Tariffs, 266IN THE REAL WORLD: NOMINAL AND EFFECTIVE
TARIFFS IN THE UNITED STATES AND JAPAN, 269
IN THE REAL WORLD: EFFECTIVE TARIFF RATES IN
BANGLADESH, 270
EXPORT TAXES AND SUBSIDIES, 271
NONTARIFF BARRIERS TO FREE TRADE, 272
Import Quotas, 272"Voluntary" Export Restraints (VERs), 272Government Procurement Provisions, 272Domestic Content Provisions, 273European Border Taxes, 273Administrative Classification, 274Restrictions on Services Trade, 274
CONTENTS xxi
Trade-Related Investment Measures, 274Additional Restrictions, 274
IN THE REAL WORLD: Is IT A CAR? IS IT
A TRUCK?275
Additional Domestic Policies That AffectTrade, 275
IN THE REAL WORLD: EXAMPLES OF CONTROL
OVER TRADE, 276
IN THE REAL WORLD: THE EFFECT OF
PROTECTION INSTRUMENTS ON DOMESTIC ':
PRICES, 277 —
SUMMARY, 278
CHAPTER 14The Impact of Trade Policies, 280
INTRODUCTION, 281
Gainers and Losers from Steel Tariffs, 281TRADE RESTRICTIONS IN A PARTIAL EQUILIBRIUM
SETTING: THE SMALL-COUNTRY CASE, 282
The Impact of an Import Tariff, 282The Impact of an Import Quota and a Subsidy to
Import-Competing Production, 285The Impact of Export Policies, 288
IN THE REAL WORLD: REAL INCOME GAINS FROM
TRADE LIBERALIZATION IN AGRICULTURE, 289
TRADE RESTRICTIONS IN A PARTIAL
EQUILIBRIUM SETTING: THE LARGE-COUNTRY
CASE, 291
Framework for Analysis, 291The Impact of an Import Tariff, 294The Impact of an Import Quota, 297The Impact of an Export Tax, 299
IN THE REAL WORLD: WELFARE COSTS OF U.S.IMPORT QUOTAS AND VERS, 301
The Impact of an Export Subsidy, 302TRADE RESTRICTIONS IN A GENERAL EQUILIBRIUM
SETTING, 303
Protection in the Small-Country Case, 303IN THE REAL WORLD: THE U. S. EXPORT
ENHANCEMENT PROGRAM FOR WHEAT, 304
Protection in the Large-Country Case, 306OTHER EFFECTS OF PROTECTION, 309
IN THE REAL WORLD: DOMESTIC EFFECTS OF THE
SUGAR QUOTA SYSTEM, 310
SUMMARY, 311
Appendix A: The Impact of Protection in a Marketwith Nonhomogeneous Goods, 312
Appendix B: The Impact of Trade Policy in theLarge-Country Setting Using Export Supply andImport Demand Curves, 314
CHAPTER 15
Arguments for Interventionist Trade Policies, 319INTRODUCTION, 320
TRADE POLICY AS A PART OF BROADER SOCIAL
POLICY OBJECTIVES FOR A NATION, 320
Trade Taxes as a Source of GovernmentRevenue, 321
National Defense Argument for a Tariff, 321IN THE REAL WORLD: THE RELATIVE IMPORTANCE
OF TRADE TAXES AS A SOURCE OF GOVERNMENT
REVENUE, 322
Tariff to Improve the Balance of Trade, 323The Terms-of-Trade Argument for Protection, 324Tariff to Reduce Aggregate Unemployment, 326Tariff to Increase Employment in a Particular
Industry, 327IN THE REAL WORLD: INDUSTRY EMPLOYMENT
EFFECTS OF TRADE LIBERALIZATION, 327
IN THE REAL WORLD: COSTS OF PROTECTING
INDUSTRY EMPLOYMENT, 328
Tariff to Benefit a Scarce Factor ofProduction, 328
Fostering "National Pride" in Key Industries, 329Differential Protection as a Component of a
Foreign Policy/Aid Package, 329PROTECTION TO OFFSET MARKET
IMPERFECTIONS, 330
The Presence of Externalities as an Argument forProtection, 330
Tariff to Extract Foreign Monopoly Profit, 332The Use of an Export Tax to Redistribute Profit
from a Domestic Monopolist, 333PROTECTION AS A RESPONSE TO INTERNATIONAL
POLICY DISTORTIONS, 334
Tariff to Offset Foreign Dumping, 334Tariff to Offset a Foreign Subsidy, 335
IN THE REAL WORLD: ANTIDUMPING ACTIONS IN
THE UNITED STATES, 336
IN THE REAL WORLD: COUNTERVAILING DUTIES IN
THE UNITED STATES, 338
MISCELLANEOUS, INVALID ARGUMENTS, 340
STRATEGIC TRADE POLICY: FOSTERING
COMPARATIVE ADVANTAGE, 340
The Infant Industry Argument for Protection, 341IN THE REAL WORLD: U.S. MOTORCYCLES—A
SUCCESSFUL INFANT INDUSTRY? 342
Economies of Scale in a Duopoly Framework, 343Research and Development and Sales of a Home
Firm, 346Export Subsidy in Duopoly, 348
xxn CONTENTS
Strategic Government Interaction and WorldWelfare, 351
IN THE REAL WORLD: AIRBUS INDUSTRIE, 352Concluding Observations on Strategic Trade
Policy, 354SUMMARY, 355
CHAPTER 16Political Economy and U.S. Trade Policy, 358
INTRODUCTION, 359
Contrasting Vignettes on Trade Policy, 359THE POLITICAL ECONOMY OF TRADE POLICY, 359
The Self-interest Approach to Trade Policy, 360IN THE REAL WORLD: WORLD ATTITUDES TOWARD
FOREIGN TRADE, 361
IN THE REAL WORLD: CHANGING U.S. ATTITUDES
TOWARD INTERNATIONAL TRADE, 1992-2009, 362IN THE REAL WORLD: POLITICS PUTS THE
SQUEEZE ON TOMATO IMPORTS, 364
The Social Objectives Approach, 364An Overview of the Political Science Take on
Trade Policy, 366Baldwin's Integrative Framework for Analyzing
Trade Policy, 366A REVIEW OF U.S. TRADE POLICY, 367
Reciprocal Trade Agreements and Early GATTRounds, 367
The Kennedy Round of Trade Negotiations, 368The Tokyo Round of Trade Negotiations, 368
IN THE REAL WORLD: THE DETERMINANTS OF
TRADE ADJUSTMENT ASSISTANCE, 370
The Uruguay Round of Trade Negotiations, 371Trade Policy Issues after the Uruguay Round, 373
IN THE REAL WORLD: TARIFF REDUCTIONS
RESULTING FROM THE URUGUAY ROUND, 374
IN THE REAL WORLD: NATIONAL SOVEREIGNTY
AND THE WORLD TRADE ORGANIZATION, 377
The Doha Development Agenda, 377Recent U.S. Actions, 380
IN THE REAL WORLD: HEALTH, SAFETY, OR
PROTECTIONISM?, 385
CONCLUDING OBSERVATIONS ON TRADE POLICY, 386The Conduct of Trade Policy, 387Empirical Work on Political Economy, 387
SUMMARY, 389Appendix: A WTO Statement on Its Aims and
Functions, 390
CHAPTER 17Economic Integration, 392
INTRODUCTION, 393
An Expanded European Union, 393TYPES OF ECONOMIC INTEGRATION, 393
Free-Trade Area, 393Customs Union, 394Common Market, 394Economic Union, 394
THE STATIC AND DYNAMIC EFFECTS OF ECONOMIC
INTEGRATION, 394
Static Effects of Economic Integration, 394IN THE REAL WORLD: ECONOMIC INTEGRATION
UNITS, 396
IN THE REAL WORLD: TRADE CREATION AND
TRADE DIVERSION IN THE EARLY STAGES OF
EUROPEAN ECONOMIC INTEGRATION, 397
General Conclusions on Trade Creation/TradeDiversion, 400
CONCEPT BOX 1: TRADE DIVERSION IN GENERAL
EQUILIBRIUM, 401
Dynamic Effects of Economic Integration, 402Summary of Economic Integration, 402
THE EUROPEAN UNION, 403
History and Structure, 403IN THE REAL WORLD: THE EAST AFRICAN
COMMUNITY, 404
Growth and Disappointments, 405Completing the Internal Market, 406Prospects, 406
IN THE REAL WORLD: CANADIAN REGIONAL TRADE
AGREEMENTS—Is THE EU NEXT?, 408
NORTH AMERICAN ECONOMIC INTEGRATION, 409
Greater Integration, 409Worries over NAFTA, 410NAFTA and Recent U.S. Free-Trade Agreements, 411
IN THE REAL WORLD: NAFTA—MYTHS VERSUS
FACTS, 412
OTHER MAJOR ECONOMIC INTEGRATION
EFFORTS, 413
MERCOSUR, 413CAFTA-DR, 414FTAA,414Chilean Trade Agreements, 414
IN THE REAL WORLD: ASIAN ECONOMIC
INTERDEPENDENCE LEADS TO GREATER
INTEGRATION, 415
APEC, 416SUMMARY, 416
CHAPTER 18International Trade and the Developing Countries, 418
INTRODUCTION, 419
Strong Recovery in East Asia, 419AN OVERVIEW OF THE DEVELOPING COUNTRIES, 419
A Closer Look at the Least Developed Countries, 420
CONTENTS XXI11
THE ROLE OF TRADE IN FOSTERING ECONOMIC
DEVELOPMENT, 421
The Static Effects of Trade on EconomicDevelopment, 421
The Dynamic Effects of Trade on EconomicDevelopment, 423
Export Instability, 424Potential Causes of Export Instability, 424Long-Run Terms-of-Trade Deterioration, 426
TITANS OF INTERNATIONAL ECONOMICS: RAULPREBISCH (1901-1986) AND HANS WOLFGANG" -SINGER (1910-2006), 427
TRADE, ECONOMIC GROWTH, AND DEVELOPMENT:
THE EMPIRICAL EVIDENCE, 429
TRADE POLICY AND THE DEVELOPING
COUNTRIES, 430
Policies to Stabilize Export Prices or Earnings, 430Problems with International Commodity
Agreements, 431IN THE REAL WORLD: MANAGING PRICE
INSTABILITY, 432
Suggested Policies to Combat a Long-RunDeterioration in the Terms of Trade, 433
IN THE REAL WORLD: THE LENGTH OF
COMMODITY PRICE SHOCKS, 433
IN THE REAL WORLD: COMECON FOREIGN TRADE
PRICING STRATEGIES, 435
Inward-Looking versus Outward-Looking TradeStrategies, 436
IN THE REAL WORLD: TERRORISM AND ITS EFFECT
ON DEVELOPING COUNTRIES, 439
IN THE REAL WORLD: EMERGING CONNECTIONS
BETWEEN ASIA AND AFRICA, 441
THE EXTERNAL DEBT PROBLEM OF THE
DEVELOPING COUNTRIES, 441
Causes of the Developing Countries' DebtProblem, 442
Possible Solutions to the Debt Problem, 444IN THE REAL WORLD: THE MULTILATERAL DEBT
RELIEF INITIATIVE, 446
SUMMARY, 450
PARTS
FUNDAMENTALS OF INTERNATIONALMONETARY ECONOMICS 451
CHAPTER 19The Balance-of-Payments Accounts, 453
INTRODUCTION, 454
China's Trade Surpluses and Deficits, 454
RECENT GROWTH OF TRADE AND CAPITAL
MOVEMENTS, 455
CREDITS AND DEBITS IN BALANCE-OF-PAYMENTS
ACCOUNTING, 457
SAMPLE ENTRIES IN THE BALANCE-OF-PAYMENTS
ACCOUNTS, 458
ASSEMBLING A BALANCE-OF-PAYMENTS
SUMMARY STATEMENT, 460
IN THE REAL WORLD: CURRENT ACCOUNT
DEFICITS, 464
BALANCE-OF-PAYMENTS SUMMARY STATEMENT
FOR THE UNITED STATES, 466
IN THE REAL WORLD: U.S. TRADE DEFICITS WITH
JAPAN, CHINA, OPEC, AND CANADA, 467
INTERNATIONAL INVESTMENT POSITION OF THE
UNITED STATES, 471
IN THE REAL WORLD: TRENDS IN THE U.S.INTERNATIONAL INVESTMENT POSITION, 473
SUMMARY, 475
CHAPTER20The Foreign Exchange Market, 476
INTRODUCTION, 477
The Case of the Wayward U.S. Dollar, 477THE FOREIGN EXCHANGE RATE AND THE MARKET
FOR FOREIGN EXCHANGE, 477
Demand Side, 478Supply Side, 478The Market, 479
THE SPOT MARKET, 481
Principal Actors, 481The Role of Arbitrage, 481Different Measures of the Spot Rate, 482
IN THE REAL WORLD: NOMINAL AND REAL
EXCHANGE RATES OF THE U.S. DOLLAR, 486
THE FORWARD MARKET, 489
IN THE REAL WORLD: SPOT AND PPP EXCHANGE
RATES, 490
CONCEPT BOX 1: CURRENCY FUTURES
QUOTATIONS, 495
CONCEPT BOX 2: CURRENCY FUTURES OPTION
QUOTATIONS, 496
THE LINK BETWEEN THE FOREIGN EXCHANGE
MARKETS AND THE FINANCIAL MARKETS, 497
The Basis for International FinancialFlows, 497
Covered Interest Parity and Financial MarketEquilibrium, 499
Simultaneous Adjustment of the Foreign ExchangeMarkets and the Financial Markets, 503
SUMMARY, 505
XXIV CONTENTS
CHAPTER 21International Financial Markets and Instruments:An Introduction, 507
INTRODUCTION, 508
Financial Globalization: A Recent Phenomenon? 508INTERNATIONAL BANK LENDING, 508
THE INTERNATIONAL BOND MARKET (DEBT
SECURITIES), 514
IN THE REAL WORLD: INTEREST RATES ACROSS
COUNTRIES, 517 }
INTERNATIONAL STOCK MARKETS, 519
FINANCIAL LINKAGES AND EUROCURRENCY
DERIVATIVES, 521
Basic International Financial Linkages:A Review, 521
International Financial Linkages and theEurodollar Market, 523
IN THE REAL WORLD: U.S. DOMESTIC AND
EURODOLLAR DEPOSIT AND LENDING RATES,
1989-2008, 525Hedging Eurodollar Interest Rate Risk, 528
CONCEPT BOX 1: EURODOLLAR INTEREST RATE
FUTURES MARKET QUOTATIONS, 532
CONCEPT BOX 2: EURODOLLAR INTEREST OPTION
QUOTATIONS, 534
THE CURRENT GLOBAL DERIVATIVES MARKET, 536
SUMMARY, 539
CHAPTER 22The Monetary and Portfolio Balance Approaches toExternal Balance, 541
INTRODUCTION, 542
The New Globalized Capital, 542THE MONETARY APPROACH TO THE BALANCE OF
PAYMENTS, 542
The Supply of Money, 543The Demand for Money, 544
IN THE REAL WORLD: RELATIONSHIPS BETWEEN
MONETARY CONCEPTS IN THE UNITED STATES, 545
Monetary Equilibrium and the Balance ofPayments, 548
THE MONETARY APPROACH TO THE EXCHANGE
RATE, 551
IN THE REAL WORLD: MONEY GROWTH AND
EXCHANGE RATES IN THE RUSSIAN TRANSITION, 552
A Two-Country Framework, 553THE PORTFOLIO BALANCE APPROACH TO THE
BALANCE OF PAYMENTS AND THE EXCHANGE
RATE, 554
Asset Demands, 555
Portfolio Balance, 556Portfolio Adjustments, 557
EXCHANGE RATE OVERSHOOTING, 560
TITANS OF INTERNATIONAL ECONOMICS:RUDIGER DORNBUSCH (1942-2002), 561
SUMMARY, 567
Appendix: A Brief Look at Empirical Work on theMonetary and Portfolio Balance Approaches, 568
CHAPTER 23Price Adjustments and Balance-of-PaymentsDisequilibrium, 573
INTRODUCTION, 574
Price Adjustment: The Exchange Rate Question, 574THE PRICE ADJUSTMENT PROCESS AND THE
CURRENT ACCOUNT UNDER A FLEXIBLE-RATE
SYSTEM, 574
The Demand for Foreign Goods and Services andthe Foreign Exchange Market, 575
Market Stability and the Price AdjustmentMechanism, 578
CONCEPT BOX 1: ELASTICITY OF IMPORT DEMAND
AND THE SUPPLY CURVE OF FOREIGN EXCHANGE
WHEN DEMAND IS LINEAR, 582
The Price Adjustment Process: Short Run versusLong Run, 585
IN THE REAL WORLD: ESTIMATES OF IMPORT AND
EXPORT DEMAND ELASTICITIES, 586
IN THE REAL WORLD: EXCHANGE RATE PASS-
THROUGH OF FOREIGN EXPORTS TO THE UNITED
STATES, 588
IN THE REAL WORLD: JAPANESE EXPORT PRICING
AND PASS-THROUGH IN THE 1990S, 589
IN THE REAL WORLD: U.S. AGRICULTURAL
EXPORTS AND EXCHANGE RATE CHANGES, 593
THE PRICE ADJUSTMENT MECHANISM IN A FIXED
EXCHANGE RATE SYSTEM, 593
Gold Standard, 593The Price Adjustment Mechanism and the Pegged
Rate System, 596IN THE REAL WORLD: EXCHANGE RATE REGIMES
IN TRANSITION ECONOMIES, 596
SUMMARY, 598
Appendix: Derivation of the Marshall-LernerCondition, 599
CHAPTER 24National Income and the Current Account, 602
INTRODUCTION, 603
Does GDP Growth Cause Trade Deficits? 603
CONTENTS XXV
THE CURRENT ACCOUNT AND NATIONAL
INCOME, 603
The Keynesian Income Model, 603TITANS OF INTERNATIONAL ECONOMICS: JOHN
MAYNARD KEYNES (1883-1946), 604
Determining the Equilibrium Level of NationalIncome, 609
IN THE REAL WORLD: AVERAGE PROPENSITIES TO
IMPORT, SELECTED COUNTRIES, 610
The Autonomous Spending Multiplier, 615 !IN THE REAL WORLD: MULTIPLIER ESTIMATES FOR
INDIA, 617
The Current Account and the Multiplier, 618Foreign Repercussions and the Multiplier
Process, 619IN THE REAL WORLD: CORRELATIONS OF
MACROECONOMIC VARIABLES ACROSS
COUNTRIES, 620
IN THE REAL WORLD: SYNCHRONIZATION OF GDPMOVEMENTS ACROSS COUNTRIES, 621
AN OVERVIEW OF PRICE AND INCOME
ADJUSTMENTS AND SIMULTANEOUS EXTERNAL
AND INTERNAL BALANCE, 622
SUMMARY, 623
Appendix A: The Multiplier When Taxes Depend onIncome, 625
Appendix B: Derivation of the Multiplier withForeign Repercussions, 626
PART 6
MACROECONOMIC POLICY IN THE OPENECONOMY 629
CHAPTER 25
Economic Policy in the Open Economy under FixedExchange Rates, 631
INTRODUCTION, 632
The Case of the Chinese Renminbi Yuan, 632TARGETS, INSTRUMENTS, AND ECONOMIC POLICY IN
A TWO-INSTRUMENT, TWO-TARGET MODEL, 632
7JV THE REAL WORLD: EXCHANGE RATE
ARRANGEMENTS, 633
TITANS OF INTERNATIONAL ECONOMICS:ROBERTA. MUNDELL (BORN 1932), 634
GENERAL EQUILIBRIUM IN THE OPEN ECONOMY
MODEL: THE IS/LM/BP MODEL, 637
General Equilibrium in the Money Market: TheLM Curve, 637
General Equilibrium in the Real Sector: The ISCurve, 640
Simultaneous Equilibrium in the Monetary andReal Sectors, 642
Equilibrium in the Balance of Payments: The BPCurve, 642
IN THE REAL WORLD: THE PRESENCE OF
EXCHANGE CONTROLS IN THE CURRENT
FINANCIAL SYSTEM, 647
Equilibrium in the Open Economy: TheSimultaneous Use of the LM, IS, and BPCurves, 649
THE EFFECTS OF FISCAL POLICY UNDER FIXED
EXCHANGE RATES, 651
THE EFFECTS OF MONETARY POLICY UNDER FIXED
EXCHANGE RATES, 654
THE EFFECTS OF OFFICIAL CHANGES IN THE
EXCHANGE RATE, 655
IN THE REAL WORLD: THE RISE AND FALL OF A
CURRENCY BOARD—THE CASE
OF ARGENTINA, 657
SUMMARY, 659
Appendix: The Relationship between the ExchangeRate and Income in Equilibrium, 660
CHAPTER 26Economic Policy in the Open Economy underFlexible Exchange Rates, 662
INTRODUCTION, 663
Is There a Case for Flexible Rates? 663THE EFFECTS OF FISCAL AND MONETARY POLICY
UNDER FLEXIBLE EXCHANGE RATES WITH
DIFFERENT CAPITAL MOBILITY
ASSUMPTIONS, 663
CONCEPT BOX 1: REAL AND FINANCIAL
FACTORS THAT INFLUENCE THE BP
CURVE, 665
The Effects of Fiscal Policy under DifferentCapital Mobility Assumptions, 665
The Effects of Monetary Policy under DifferentCapital Mobility Assumptions, 668
Policy Coordination under Flexible ExchangeRates, 670
THE EFFECTS OF EXOGENOUS SHOCKS IN THE
IS/LM/BP MODEL WITH IMPERFECT MOBILITY
OF CAPITAL, 672
IN THE REAL WORLD: COMMODITY PRICES AND
U.S. REAL GDP, 1972-2008, 673IN THE REAL WORLD: POLICY FRICTIONS IN AN
INTERDEPENDENT WORLD, 677
XXVI CONTENTS
IN THE REAL WORLD: MACROECONOMIC
POLICY COORDINATION, THE IMF,
AND THE G-7, 678SUMMARY, 680
Appendix: Policy Effects, Open-EconomyEquilibrium, and the Exchange Rate underFlexible Rates, 680
CHAPTER 27Prices and Output in the Open Economy: AggregateSupply and Demand, 683 v
INTRODUCTION, 684
Crisis in Argentina, 684AGGREGATE DEMAND AND SUPPLY IN THE CLOSED
ECONOMY, 685
Aggregate Demand in the ClosedEconomy, 685
Aggregate Supply in the Closed Economy, 686Equilibrium in the Closed Economy, 690
IN THE REAL WORLD: U.S. ACTUAL AND NATURAL
INCOME AND UNEMPLOYMENT, 691
AGGREGATE DEMAND AND SUPPLY IN THE OPEN
ECONOMY, 692
Aggregate Demand in the Open Economy underFixed Rates, 692
Aggregate Demand in the Open Economy underFlexible Rates, 694
THE NATURE OF ECONOMIC ADJUSTMENT AND
MACROECONOMIC POLICY IN THE
OPEN-ECONOMY AGGREGATE SUPPLY AND
DEMAND FRAMEWORK, 694
The Effect of Exogenous Shocks on the AggregateDemand Curve under Fixed and FlexibleRates, 694
The Effect of Monetary and Fiscal Policy on theAggregate Demand Curve under Fixed andFlexible Rates, 696
Summary, 697MONETARY AND FISCAL POLICY IN THE OPEN
ECONOMY WITH FLEXIBLE PRICES, 697
Monetary Policy, 697Currency Adjustments under Fixed Rates, 701Fiscal Policy, 701Economic Policy and Supply
Considerations, 702IN THE REAL WORLD: ECONOMIC PROGRESS IN
SUB-SAHARAN AFRICA, 704
EXTERNAL SHOCKS AND THE OPEN
ECONOMY, 704
IN THE REAL WORLD: INFLATION AND
UNEMPLOYMENT IN THE UNITED STATES,
1970-2007, 706SUMMARY, 709
PART 7
ISSUES IN WORLD MONETARYARRANGEMENTS 711
CHAPTER 28
Fixed or Flexible Exchange Rates? 713INTRODUCTION, 714
Slovenia's Changeover to the Euro—A ClearSuccess, 714
CENTRAL ISSUES IN THE FIXED-FLEXIBLE
EXCHANGE RATE DEBATE, 714
Do Fixed or Flexible Exchange Rates Provide forGreater "Discipline" on the Part ofPolicymakers? 714
Would Fixed or Flexible Exchange Rates Providefor Greater Growth in International Trade andInvestment? 716
IN THE REAL WORLD: EXCHANGE RISK AND
INTERNATIONAL TRADE, 717
Would Fixed or Flexible Exchange Rates Provide forGreater Efficiency in Resource Allocation? 718
Is Macroeconomic Policy More Effective inInfluencing National Income under Fixed orFlexible Exchange Rates? 720
Will Destabilizing Speculation in ExchangeMarkets Be Greater under Fixed or FlexibleExchange Rates? 721
IN THE REAL WORLD: RESERVE HOLDINGS
UNDER FIXED AND FLEXIBLE EXCHANGE
RATES, 721
TITANS OF INTERNATIONAL ECONOMICS:MILTON FRIEDMAN (1912-2006), 725Will Countries Be Better Protected from External
Shocks under a Fixed or a Flexible ExchangeRate System? 726
IN THE REAL WORLD: "INSULATION" WITH
FLEXIBLE RATES—THE CASE OF JAPAN, 727
CURRENCY BOARDS, 728
Advantages of a Currency Board, 728IN THE REAL WORLD: CURRENCY BOARDS IN
ESTONIA AND LITHUANIA, 729
Disadvantages of a Currency Board, 730
CONTENTS XXV11
OPTIMUM CURRENCY AREAS, 731
HYBRID SYSTEMS COMBINING FIXED AND
FLEXIBLE EXCHANGE RATES, 733
Wider Bands, 733Crawling Pegs, 734Managed Floating, 735
IN THE REAL WORLD: A CRAWLING PEG IN
COLOMBIA, 736
SUMMARY, 737
CHAPTER 29 v - -The International Monetary System: Past, Present,and Future, 739
INTRODUCTION, 740
Global Crisis Requires a Global Solution, 740IN THE REAL WORLD: FLEXIBLE EXCHANGE RATES
IN POST-WORLD WAR I EUROPE: THE UNITED
KINGDOM, FRANCE, AND NORWAY, 741
THE BRETTON WOODS SYSTEM, 743
The Goals of the IMF, 743The Bretton Woods System in Retrospect, 746
GRADUAL EVOLUTION OF A NEW INTERNATIONAL
MONETARY SYSTEM, 747
Early Disruptions, 747Special Drawing Rights, 748The Breaking of the Gold-Dollar Link and the
Smithsonian Agreement, 749The Jamaica Accords, 750The European Monetary System, 750
Exchange Rate Variations, 754Short-Run Fluctuations in the 1990s and 2000s, 754
IN THE REAL WORLD: ADOPTING THE EURO IN
THE NEW MEMBER STATES, 755
CURRENT EXCHANGE RATE ARRANGEMENTS, 756
EXPERIENCE UNDER THE CURRENT
INTERNATIONAL MONETARY SYSTEM, 759
The Global Financial Crisis and Recession of2007-, 763
SUGGESTIONS FOR REFORM OF THE
INTERNATIONAL MONETARY SYSTEM, 764
A Return to the Gold Standard, 764A World Central Bank, 765
CONCEPT BOX 1: A WORLD CENTRAL BANK WITHIN
A THREE-CURRENCY MONETARY UNION, 766
The Target Zone Proposal, 767Controls on Capital Flows, 768Greater Stability and Coordination of
Macroeconomic Policies across Countries, 770IN THE REAL WORLD: POLICY COORDINATION AND
THE G-20, 771THE INTERNATIONAL MONETARY SYSTEM
AND THE DEVELOPING COUNTRIES, 772
SUMMARY, 773
References for Further Reading, 775Photo Credits, 794Index, 795
