Nontariff Barriers to Imports

The figure below shows the market for MP3 players in a small country. Dd and Sd are the domestic demand and domestic supply curves of the MP3 players. QQ is the quota quantity. How many MP3 players can be imported from abroad after the quota is imposed?


Nontariff Barriers to Imports

The figure below shows the market for MP3 players in a small country. Dd and Sd are the domestic demand and domestic supply curves of the MP3 players. QQ is the quota quantity. The quota on MP3 players will cause domestic producers to


Nontariff Barriers to Imports

The figure below shows the market for MP3 players in a small country. Dd and Sd are the domestic demand and domestic supply curves of the MP3 players. QQ is the quota quantity. The quota on MP3 players will cause domestic consumers to


Nontariff Barriers to Imports

The figure below shows the market for MP3 players in a small country. Dd and Sd are the domestic demand and domestic supply curves of the MP3 players. QQ is the quota quantity. According to the figure, how much revenue can the government expect to receive if the import licenses are auctioned?


Nontariff Barriers to Imports

The figure below shows the market for MP3 players in a small country. Dd and Sd are the domestic demand and domestic supply curves of the MP3 players. QQ is the quota quantity. If the government auctions the import licenses, the quota on MP3 players will result in a(n) ________ in the national well-being by


Arguments for and against Protection

The Ideal World of First Best
The framework allows us to look at situations in which the free market may not result in economic efficiency, because of distortions that result from market failures or from efficiency-reducing government policies. In the “first-best” world with no distortions, private marginal benefits (MB) to consumers who make buying decisions equal social marginal benefits (SMB), because there are no positive externalities or spillovers, private marginal costs (MC) recognized by sellers equal social marginal costs (SMC), because there are no negative externalities or spillovers, and all of these are equal to market price, because the market is perfectly competitive and there are no distorting government policies like a tax or a subsidy.

” world, all private incentives are aligned with benefits and costs to society as a whole.


Arguments for and against Protection

The Realistic World of Second Best
In situations in which the free-market outcome is second-best because of a market failure, there is a potential role for government policy to contribute to economic efficiency. We mention the approach of creating new property rights, but we focus in this chapter on the tax-or-subsidy approach to eliminate distortions in private incentives.

Private actions will not lead to the best possible outcomes for society.

Two major sources of distortions in an economy:

Market failures (externalities, monopoly, monopsony)


Arguments for and against Protection

Promoting Domestic Production or Employment
The specificity rule is powerful in its applications. Consider the situation in which there is too little domestic production in an import-competing industry, because of marginal external benefits from this production. What is the best government policy to address the distortion? A tariff can be used to increase domestic production, so it may be better than doing nothing, but it is not the direct policy, because it acts on imports directly, not on domestic production.

Local production produces spillover benefits.


Arguments for and against Protection

The Infant Industry Argument
The infant industry argument leads to another application of the specificity rule, as well as raising a set of other interesting issues. The argument is that import competition prevents an initially uncompetitive domestic industry from starting production. But, if the industry is shielded from foreign competition, it can begin production, and over time it will be able to lower its production costs, so that it becomes competitive.

A temporary tariff is justified because it cuts down on imports while the infant domestic industry learns how to produce at low enough costs.

Eventually the domestic industry will  be able to compete without the help of a tariff.


Arguments for and against Protection

The Dying Industry Argument and Adjustment Assistance
Another argument in favor of protection is assistance to industries that are declining because of rising import competition. Moving resources out of an industry is costly. People who lose their jobs because of increased imports often have a difficult time finding new jobs and often suffer substantial declines in earnings.

Should government intervene to save a dying industry? If we are in a “first-best” world, the answer is no. Since the social value of anything is already included in private incentives, ordinary demand and supply curves already lead us to the socially optimal choice.

Trade adjustment assistance to workers and firms in import-threatened industries is a better policy, using the specificity rule, than, for example, a tariff, because adjustment assistance focuses on income losses, training, and worker mobility.


Arguments for and against Protection

The Developing Government (Public Revenue) Argument
3.One such set of conditions described in this chapter is the developing government argument. If the government is so underdeveloped that the gains from starting or expanding public programs exceed the costs of taxing imports, then the import tariff brings net national gains by providing the revenue so badly needed for those programs.

According to this argument, in poor, developing  countries the import tariff becomes an important source of not just protection but also government revenue.

The government revenue can be spent on otherwise underprovided public investments like education, health, and infrastructure.


Arguments for and against Protection

The Politics of Protection
Arguments for and against Protection

The size of the gains for winners from protection, and how many individuals are in the group of winners.


Arguments for and against Protection

Government Policies toward Externalities
This chapter has three purposes: To present a framework and a rule for evaluating arguments offered in favor of limiting imports, to apply the framework and rule to several prominent arguments for protection, and to examine the political processes that result in government policies toward imports.

Tax-or-subsidy approach
Property-rights approach


Arguments for and against Protection

Role playing can be used to bring the issues raised in the chapter to life. For instance, the class can be divided in half, with each half taking the opposite side in a debate about an actual trade problem. One possible topic: To protect U.S. jobs and raise the low U.S. wages in the clothing manufacturing sector, the U.S. government should impose quotas or raise tariffs on imported clothing drastically. Another possible topic: The Japanese government should sell its scarce rights to land international flights at its airports to the highest bidders, even if this means that some Japanese airlines go out of business. Yet another: Brazil should limit its imports of personal computers, in order to foster the development of its own personal computer industry. Current events (including Trump’s trade policies) can offer other topics. After playing the assigned roles in the debate, the students c


Arguments for and against Protection

The chapter then examines several arguments in favor of protection that involve national pursuit of “noneconomic objectives.” First, national pride gained by production of a product calls for a production subsidy as the least-cost way to achieve the objective. National pride in self-sufficiency calls for a tariff or other import limit, because in this case the objective is specifically to reduce or eliminate imports. Second, providing for the national defense is usually least costly using a subsidy to domestic production capacity, leaving depletable resources in the ground, or building stockpiles. The U.S. tariffs on steel and aluminum imports imposed by President Trump in 2018 are an example of an excessively costly policy—in this case, the first of these three alternative policies, a subsidy to production or production capacity, would be less costly. For the latter two alternative poli


Arguments for and against Protection

Another argument in favor of protection is assistance to industries that are declining because of rising import competition. Moving resources out of an industry is costly. People who lose their jobs because of increased imports often have a difficult time finding new jobs and often suffer substantial declines in earnings. For example, research on the rapid increase in imports from China from the early 1990s to 2007 (the “China shock”) shows the large and enduring harm to U.S. workers and local communities. The marginal external benefit of continuing domestic production in a declining industry is avoiding these costs of moving resources to other uses. Again, a tariff can be used to maintain domestic production, and it may be better than doing nothing (so that the industry shrinks). But again the specificity rule says to attack the externality directly. A subsidy to domestic production wil


Arguments for and against Protection

How Sweet It Is (or Isn’t): For a U.S. company that makes jelly beans in the United States, U.S. policies that limit sugar imports increase sugar prices and raise the cost of obtaining the key input into its production. The U.S. firm would like to change US. policy, to lower the domestic price of sugar, for instance, by moving to or toward free trade in sugar. On its own, the firm probably cannot have much impact politically, because anything it can do would be too small. The firm could join the Coalition for Sugar Reform and contribute to the Coalition’s efforts to oppose protectionist U.S. policies that limit sugar imports. However, this group’s efforts have had little effect, because the sugar producers are better organized and willing to spend more (campaign contributions and lobbying) to maintain the existing import-limiting policies. The U.S. firm does have some other options. Firs


Arguments for and against Protection

Which of the following is an expected effect of a tariff or a nontariff barrier (NTB) on a product?

A decrease in the domestic production of the product

An increase in the employment of labor and other resources used in the import-competing industry in the tariff-imposing country

An increase in domestic consumption of the imported product


Arguments for and against Protection

If there is something extra bad about local consumption of a product, then a tariff can be good for the country because

the tariff brings down the domestic price of the product.

the tariff leads to higher domestic price for the product.

the tariff revenue is invested in the production of substitute products.


Arguments for and against Protection

In a "first-best" world

each economy is self-sufficient enough not to indulge in free trade.

free trade benefits only the consumers of the importing country.

free trade benefits only the exporting nations.


Arguments for and against Protection

Which of the following is valid for a "first-best" world?

Social Marginal Benefit (SMB) > Price (P) = Buyer's Private Marginal Benefit (MB) = Seller's Private Marginal Cost (MC) = Social Marginal Cost (SMC)

Social Marginal Cost (SMC) > Price (P) = Buyer's Private Marginal Benefit (MB) = Seller's Private Marginal Cost (MC) = Social Marginal Benefit (SMB)

Price (P) = Buyer's Private Marginal Benefit (MB) = Seller's Private Marginal Cost (MC) = Social Marginal Cost (SMC) = Social Marginal Benefit (SMB)

Social Marginal Benefit (SMB) > Social Marginal Cost (SMC)


Arguments for and against Protection

If Social Marginal Cost (SMC) > Price (P) = Buyer's Private Marginal Benefit (MB) = Seller's Private Marginal Cost (MC) = Social Marginal Benefit (SMB), it implies that

there is an excess demand for the product.

the socially optimal amount of the product is supplied.


Arguments for and against Protection

If Social Marginal Benefit (SMB) > Price (P) = Buyer's Private Marginal Benefit (MB) = Seller's Private Marginal Cost (MC) = Social Marginal Cost (SMC), it implies that

the socially optimal amount is supplied.


Arguments for and against Protection

In a "second-best" world

private actions are dictated by government agencies.

social marginal cost of a transaction equals social marginal benefit.

private actions do not lead to the best possible outcomes for society.


Arguments for and against Protection

Which of the following refers to the positive or negative effect on parties who are not directly involved in a transaction?


Arguments for and against Protection

Which of the following statements reflects a situation in which there are external benefits?

John paints his house and cleans his paintbrushes in the nearby stream.

John pays 5 percent of his income as taxes.

John's decision to get vaccinated for smallpox reduces the chances that his neighbor Pete will get smallpox.

John sells his car to his neighbor Pete at half the first-hand price.


Arguments for and against Protection

Which of the following statements reflects a situation in which there are external costs?

Suzanne invites her neighbors to a party on her birthday.

Suzanne paints her house and landscapes her yard. Her newly beautified house and yard help her neighbors to sell their house for more than the asking price.

Suzanne pays for a professional fireworks show for her family. Her neighbors also enjoy the show.

Suzanne dumps her household garbage around the corner of the street.


Arguments for and against Protection

Which of the following is a plausible solution to a distortion?

Centralizing the privately owned enterprises

Shutting down any industry which is contributing to atmospheric pollution

Imposing a tax or subsidy on the activity if the social marginal cost or the social marginal benefit exceeds the market price

Imposing an importation ban on manufactured goods


Arguments for and against Protection

Suppose manufacturing of paper results in substantial ground-water pollution. One possible policy that can be used to reduce the inefficiency caused by this externality is

to subsidize the production of paper by the domestic firms.

to impose a tax on the production of paper.

to raise tariff barriers on paper imports.

to provide tax benefits to the firms exporting paper.


Pushing Exports

Dumping
Chapters 8 through 10 focused on government policies toward imports, with little attention to government policies and business practices in the exporting countries. This chapter shifts to looking at various practices and policies that can increase exports, as well as the effects of these export-promoting activities on importing countries.

According to the World Trade Organization (WTO):

occurs when goods are exported at a price less than their


Pushing Exports

Proposals for Reform
Actual importing-country government policies toward dumping generally do not make these economically sensible distinctions. The policy usually investigates alleged dumping by looking at whether the export price is too low, by either standard, and looking at whether there is injury to domestic industry. If both are found, then the importing country imposes antidumping duties equal to the difference between the low export price and the “normal price” or “fair market value.” The policy does not look at the overall effect of alleged dumping on the national well-being of the importing country, because it does not examine the effects on domestic consumers, and it does not attempt to determine the reason for the dumping.

Limit antidumping actions to situations in which predatory dumping is plausible. Focus on the type of dumping that is most likely to be bad for the world and for the importing country.

Expand the injury standards to require that full weight be given to consumers and users of the product. Shift to injury to net national well-being.


Pushing Exports

Export Subsidies
Chapters 8 through 10 focused on government policies toward imports, with little attention to government policies and business practices in the exporting countries. This chapter shifts to looking at various practices and policies that can increase exports, as well as the effects of these export-promoting activities on importing countries.

Governments promote or subsidize exports more often than they restrict or tax exports.

is controversial because it violates international norms about fair trade.


Pushing Exports

Should the Importing Country Impose Countervailing Duties?
WTO rules generally prohibit export subsidies and permit importing countries to impose countervailing duties in response. We examine the peculiar economics of all of this, using the case in which the export subsidy lowers the price of exports, and the market is otherwise competitive. Because of the lower import price, the importing country gains well-being in the shift from free trade with no subsidy to free trade with the foreign export subsidy (and no countervailing duty).

If the exporting country is large enough to influence the world price of the exports, then the export subsidy lowers the price that the importing country pays for these exports. The importing country benefits from improved terms of trade.


Pushing Exports

WTO Rules on Subsidies
WTO rules generally prohibit export subsidies and permit importing countries to impose countervailing duties in response. We examine the peculiar economics of all of this, using the case in which the export subsidy lowers the price of exports, and the market is otherwise competitive. Because of the lower import price, the importing country gains well-being in the shift from free trade with no subsidy to free trade with the foreign export subsidy (and no countervailing duty).

The WTO rules divide subsidies into two types:

Subsidies linked directly to exporting are prohibited, except export subsidies used by the lowest-income developing countries.

Subsidies that are not linked directly to exporting but still have an impact on exports are


Pushing Exports

The economics of an export subsidy are rather different if the market is not perfectly competitive—a major insight of strategic trade policy. The text shows the example of competition between Boeing and Airbus for the world market for a new type of airplane. With no government support, it is possible that neither firm will enter the new market, because both will lose if both enter. But if one government offers a suitable subsidy, its firm will enter. If the other government does not offer support, then the other firm will not enter, and the first firm will earn high profits, bringing a benefit to its country and possibly to the entire world. But, if the other government also offers a subsidy, both firms produce. The world’s consumers gain, but each of the producing countries can end up with lower well-being because of its firm’s loss net of the government subsidy (the subsidy is a transf


Pushing Exports

Agriculture is Amazing: A high tariff or a zero quota can reduce imports of butter to zero. But, the high tariff or zero quota cannot turn butter into an EU export product, because production costs behind the import barrier will be too high to export successfully into foreign markets. Instead, the country will be at the no-trade national equilibrium, with a no-trade domestic price that is well above the world price. A price support in which the government purchases any production that is not sold to private buyers can turn butter into an EU export product. If the price support is set above the no-trade national equilibrium price, then there will be excess domestic supply at that price (domestic quantity supplied at the high support price is greater than domestic quantity demanded at that high price). The government then must decide what to do with the butter that it has purchased. It may


Pushing Exports

The United States would lose. The U.S. government pays a subsidy of $5 for each pair of blue jeans to Canada. The export price is lower, but the quantity exported is the same as with free trade. Canada would gain the $5 on each pair. The gain would be collected as government revenue from the countervailing duty. Otherwise, the domestic price in Canada and all quantities are the same as with free trade. Because Canada’s gain equals the U.S.’s loss, this is another way to see that the well-being of the world as a whole is the same as it would be with free trade.


Pushing Exports

Antidumping in Action: American steel firms reacted to increasing steel imports in 2013 by filing a number of new dumping cases. Two of these cases did not lead to the imposition of antidumping duties because the U.S. government determined that, for the specific products in these two cases, American steel firms were not injured sufficiently by the rising imports. A challenge for steel dumping cases filed in 2013 was that U.S. demand for steel was strong. The U.S. International Trade Commission (ITC), the government body that examines injury, is reasonably strict in the standards that it imposes for this determination. Even with rising imports, American firms were selling a lot of steel. For steel products that were in strong demand, it may not have been possible for American steel firms to show sufficient injury from the dumped imports. But, why did the American firms file these two case


Pushing Exports

Which of the following refers to dumping?

Selling domestic goods in the international market at much lower prices.

Selling domestic goods of inferior quality in the international markets at higher prices.

Restricting the sale of domestic goods within the geographic boundary of the country.

Selling domestic goods at discounted prices to local consumers and selling the same at much higher prices to foreign consumers.


Pushing Exports

________ occurs when a firm temporarily charges a low price in the foreign export market, with the purpose of driving its foreign competitors out of business.


Pushing Exports

Which of the following is said to occur when a firm lowers its price to limit the decline in the quantity sold during a period of recession?


Pushing Exports

Which of the following is said to occur when a firm lowers its price to sell off excess inventories of a product?


Pushing Exports

Which of the following is said to occur when a firm with market power uses price discrimination between markets to increase its total profit?


Pushing Exports

A firm maximizes profits by charging a lower price to foreign buyers if

it has a greater monopoly power in the foreign market than it has in its home market.

the foreign demand for its good is more elastic than the domestic demand.

the buyers in the home country have access to cheaper imports from the rest of the world.

the size of the foreign market is much larger than the home market.

Reacting to Dumping: What Should a Dumpee Think?


Pushing Exports

Persistent dumping can occur if a profit-maximizing firm faces a ________ demand in the home market and sells its good in a ________ international market.

relatively inelastic; highly competitive


Pushing Exports

Which country had no antidumping cases until the early 1990s, but became the top initiator of antidumping cases for the time period 2012-2016?

Actual Antidumping Policies: What is Unfair?


Pushing Exports

In early 2018, nearly half of all antidumping duties in effect in the United States were on


Pushing Exports

Which of the following statements about dumping is true?

Consumers and import-competing producers in the importing country are both hurt by dumping.

Logically, an import country should never allow seasonal and introductory-price dumping.

Dumping helps to improve the importing country's terms of trade.

Predatory dumping occurs quite frequently in modern markets.


Pushing Exports

Which of the following is NOT a way in which a safeguard policy is better than antidumping policies?

Firms and governments do not need to show that foreign exporters have done anything unfair.

There is pressure for import-competing firms to adjust their production to be more competitive with foreign exporters.

The interests of consumers can be disregarded since they do not play a role in determining whether to invoke a safeguard policy.

The protection provided to the import-competing sector is explicitly temporary.


Pushing Exports

Which of the following statements about an export subsidy on a particular product is accurate?

An export subsidy can switch the product from being exported to being imported.

An export subsidy reduces the amount available in the domestic market of the exporting country and increases the amount imported by the foreign country.

An export subsidy increases the price paid by foreign buyers, relative to the price that local consumers pay for the product.

An export subsidy increases the net national well-being of a large exporting country.


Trade Blocs and Trade Blocks

Types of Economic Blocs
There are four major types of trade or economic blocs: free-trade area, customs union, common market, and economic union. WTO rules generally call for equal trade barriers against all other countries (at least those that are also members of the WTO)—the most-favored-nation principle. But the WTO rules also have a few exceptions, including an exception for a trade bloc that achieves substantially free trade among its members.

: Members remove trade barriers among themselves but keep their separate national barriers against trade with the outside world.


Trade Blocs and Trade Blocks

Is Trade Discrimination Good or Bad?
In 2016 the United Kingdom voted to leave the EU (Brexit). A key issue for the separation will be how to avoid border checks that would limit movement of people and goods along the land border between Ireland and Northern Ireland. The overarching decision is whether the separation will be a “soft Brexit” or a “hard Brexit,” with the latter being more assertive of British sovereignty over laws, regulations and rules, but also more disruptive of industries and business activities.

It depends, first, on what you compare it to.


Trade Blocs and Trade Blocks

The Basic Theory of Trade Blocs: Trade Creation and Trade Diversion
A trade bloc can have several effects on the well-being of its member countries and the world overall. We usually analyze trade blocs by comparing them to countries maintaining barriers against all other countries. To the extent that forming or joining the trade bloc results in lower prices in an importing member country, the country and the world gain as additional trade is created.

is a source of gains. It occurs whenever economic integration leads to an increase in the total volume of trade. Total trade increases because:

Consumption of high-cost domestically produced goods in a member country is replaced by imports of these same goods produced at lower cost in some other member country.


Trade Blocs and Trade Blocks

Other Possible Gains from a Trade Bloc
A trade bloc can have several effects on the well-being of its member countries and the world overall. We usually analyze trade blocs by comparing them to countries maintaining barriers against all other countries. To the extent that forming or joining the trade bloc results in lower prices in an importing member country, the country and the world gain as additional trade is created.

Increased competition within the bloc can lower prices.

Increased competition within the bloc can lower production costs.

Expanded production within the bloc can lead to achieving economies of scale.


Trade Blocs and Trade Blocks

The EU Experience
This chapter examines two types of trade barriers that are intended to discriminate between foreign countries. A trade bloc has lower or no barriers for trade between its members, while they maintain higher barriers for trade with outside countries. A trade embargo or trade block places extra barriers against trade with a specific foreign country, usually because of a broader policy disagreement.

When is a trade embargo more likely to work?  Actual experience:

Embargoes have more chance of success if they are sudden and comprehensive when first imposed.


Trade Blocs and Trade Blocks

North America Becomes a Bloc
The North American Free Trade Area (NAFTA) began in 1994, subsuming the previous Canada-U.S. Free Trade Area. NAFTA has eliminated tariffs, reduced some nontariff barriers, and liberalized trade in services and cross-border business investments. The formation of NAFTA was controversial. In Mexico there were fears of jobs lost to more productive U.S.

The formation of the North American Free Trade Area (NAFTA) went through two steps:

The Canada-U.S. Free Trade Area (CUSFTA) was created in January 1989.

In 1990 the U.S. and Mexico began negotiations on a free-trade agreement, and Canada joined the talks in 1991. The NAFTA treaty replaced CUSFTA in January 1994.


Trade Blocs and Trade Blocks

Trade Embargoes
9.Trade embargoes are usually imposed by large countries that are important in the trade of the target country. An embargo has a better chance to succeed if it is imposed suddenly rather than gradually because a sudden interruption of economic flows damages the target country by a large amount for some time before it can develop alternatives.

Each member country can import from other member countries freely, or at least with lower tariffs or nontariff barriers.


Trade Blocs and Trade Blocks

Trade Barriers Designed to Discriminate
This chapter examines two types of trade barriers that are intended to discriminate between foreign countries. A trade bloc has lower or no barriers for trade between its members, while they maintain higher barriers for trade with outside countries. A trade embargo or trade block places extra barriers against trade with a specific foreign country, usually because of a broader policy disagreement.


Trade Blocs and Trade Blocks

For the European Union, most estimates are that the EU gains from its internal free trade in manufactures, because trade creation has been larger than trade diversion, and because there are probably also dynamic gains, although these are harder to measure. Additional gains came as the move toward a true common market in 1992 removed nontariff barriers and freed resource movements. However, the EU also incurs substantial losses from its protectionist common agricultural policy. In 2004, 10 additional countries joined the EU, in 2007 two more, and in 2013 one more (Croatia), bringing the total number of members to 28. Integration of the new members has been relatively smooth, though some features of EU policies have been phased in slowly for them.


Trade Blocs and Trade Blocks

The North American Free Trade Area (NAFTA) began in 1994, subsuming the previous Canada-U.S. Free Trade Area. NAFTA has eliminated tariffs, reduced some nontariff barriers, and liberalized trade in services and cross-border business investments. The formation of NAFTA was controversial. In Mexico there were fears of jobs lost to more productive U.S. and Canadian firms, as well as the loss of political sovereignty as NAFTA committed Mexico to change a number of its government policies. In the United States there were fears of job losses to low-wage Mexico, as well as complaints about linking with a country that has a corrupt political system and poor environmental protection. Proponents in both Mexico and the United States hoped that NAFTA would commit the Mexican government to maintain and extend its market-oriented reforms.


Trade Blocs and Trade Blocks

6.The standard estimates are that Mexico has probably gained from NAFTA, as trade creation is likely to have been larger than trade diversion, and Mexican firms also gain from better access to selling to the large U.S. market. In Mexico, the gains are largest for those sectors tied to exports and for those resources (including less-skilled labor) that are relatively abundant in Mexico. The standard estimates are that the United States and Canada also probably have gained, with gains to those export sectors that can increase their sales to Mexico and to resources that are relatively abundant in these countries, including skilled labor. (There is also some research that suggests that trade diversion has been larger than the standard estimates, so that the net gains from trade creation and trade diversion for the member countries are close to zero.) Outside countries are hurt by trade diver


Trade Blocs and Trade Blocks

NAFTA has resulted in substantial increases in trade among the three members. The standard view is that trade creation has been larger than trade diversion, with substantial net gains for Mexico. However, there is also some research that suggests that trade diversion has been large, so that the net gains are close to zero. Studies of Canada indicate that it gained from increased competition that forced high-cost plants to close down, from the achievement of scale economies through longer production runs as access to the large U.S. market became assured, and from increased innovation driven by increased competition and assured market access. In addition to the trade effects, Mexico has also gained from the substantially increased inflows of direct investment by foreign firms that have located production in Mexico to serve the NAFTA area. NAFTA has not caused massive shifting of total empl


Trade Blocs and Trade Blocks

Which of the following allows member countries to import from other member countries freely, but imposes trade barriers against imports from outside countries?


Trade Blocs and Trade Blocks

Which of the following features does a free-trade area necessarily have?

Absence of trade barriers among the member nations

Free movement of factors of production across the member nations


Trade Blocs and Trade Blocks

Which of the following is true of a common market?

The member countries export similar products to the non-member countries.

The member countries do not import goods from the non-member countries.

The member countries have identical monetary and fiscal policies.

There is free movement of capital and labor among the member countries.


Trade Blocs and Trade Blocks

Which of the following is true of an economic union?

Free movement of resources, but restricted movement of goods among the member countries

The members have a common set of tariffs among themselves but the external tariff rates are determined independently.

Free movement of goods, but restricted movement of resources across the member countries

Harmonization of all economic policies in the member countries


Trade Blocs and Trade Blocks

Which of the following features does a customs union have?

Free trade among those members with similar economic policies


Trade Blocs and Trade Blocks

The Southern Common Market (MERCOSUR) is actually a


Trade Blocs and Trade Blocks

The North American Free Trade Agreement (NAFTA) is an example of a(n)


Trade Blocs and Trade Blocks

Which of the following is closest to being a full economic union?

The North American Free Trade Agreement (NAFTA)


Trade Blocs and Trade Blocks

Formation of trade blocs can be considered beneficial because it

encourages purchases from higher-cost producers.

causes international friction when certain countries are let in the bloc and others are left out.

diverts world trade from low-cost producers to high-cost producers by encouraging too much trade within blocs.

encourages increased total trade by each member country.


Trade Blocs and Trade Blocks

Which of the following states that any trade concession given to any foreign country must be given to all other countries having the same status?


Trade Blocs and Trade Blocks

Which of the following refers to trade creation?

The net increase in exports when the currency of a country depreciates with respect to a foreign currency

The net increase in imports when foreign firms lower the prices of their exports

The net volume of new trade that results from the formation of a trade bloc

The net change in the volume of trade among member countries when they form a trade bloc

The Basic Theory of Trade Blocs: Trade Creation and Trade Diversion


Trade Blocs and Trade Blocks

Which of the following refers to trade diversion?

The volume of trade that is redirected from low-cost exporters to higher-cost domestic firms when the domestic government imposes import restrictions

The volume of trade redirected from low-cost exporters to higher-cost trade bloc member countries

The amount of the imported goods that is replaced by domestically produced goods

The change in the trade pattern such that the good which was formerly imported is now exported as the government subsidizes its production


Trade and the Environment

Is Free Trade Anti-Environment?
We begin the chapter with two provocative questions. First, is free trade anti-environment? We argue that it is not. There is no reason to think that trade generally promotes production or consumption of products that cause large harm to the environment. Surprisingly, the incentive to relocate production into “pollution havens” is usually small.

There are several effects of increasing international trade on pollution and the environment.


Trade and the Environment

Is the WTO Anti-Environment?
Second, is the World Trade Organization anti-environment? WTO rules recognize environmental-protection exceptions to its general thrust toward free trade, but the WTO also worries that restrictions that governments claim to be necessary to protect the environment are pretexts for common protectionism. A country can impose product standards to protect the environment, but the standards must apply to all consumption, not just imports, and the standards must be based on scientific evidence.

Three important types of policies that may qualify for environmental exception by the WTO:

1.   When consumption of products can cause damage

WTO position: A country generally can impose product standards or other limits on consumption to protect the country’s health, its safety, or the environment, even though such a policy may limit imports.


Trade and the Environment

The Specificity Rule Again
Adverse environmental effects like pollution are negative externalities, distortions that lead to failures of the market to be fully efficient. The specificity rule introduced in Chapter 10 is a handy guide to government policy to address negative environmental externalities. In fact, there are two types of government policy that can directly attack the distortion—imposing taxes and subsidies, or changing property rights.

exists when somebody’s actions bring direct costs or benefits to anybody who is not part of the marketplace decisions to undertake the activity.

Pollution is an externality that imposes an external cost on people who do not have any say over the pollution. This distortion leads to market failure.


Trade and the Environment

A Review of Policy Prescriptions
The Paris agreement, signed by almost all the world’s countries, came into effect in 2016. Each country agreed to make a voluntary pledge of actions that it would take to reduce its greenhouse gas emissions, and these pledges are to be reviewed and upgraded every five years. The agreement relies on exchanges of information and peer pressure.

When we have to choose between doing nothing and intervening in the product markets related to externalities, as a substitute for controlling the externality directly, we should follow the guidelines summarized in the following table:


Trade and the Environment

Global Environmental Challenges
Second, is the World Trade Organization anti-environment? WTO rules recognize environmental-protection exceptions to its general thrust toward free trade, but the WTO also worries that restrictions that governments claim to be necessary to protect the environment are pretexts for common protectionism. A country can impose product standards to protect the environment, but the standards must apply to all consumption, not just imports, and the standards must be based on scientific evidence.

Global warming as a result of greenhouse gases

When an environmental problem causes only domestic costs, it is up to the government of the country to address it.


Trade and the Environment

Trade and Domestic Pollution
In our formal analysis we begin with the case in which pollution caused by an activity within the country has effects only on this country. We use tools similar to those that we developed in Chapter 10. If the country simply allows the pollution to occur, with no government policy to limit the negative externality, we show that free trade can make the country worse off, and that the country can export the wrong products.

Economic activities sometime produce significant amounts of domestic pollution. That is, the costs of the pollution fall only on people within the country.

If there are no policies that force market decision-makers to internalize these external costs:

Free trade can reduce the well-being of the country.


Trade and the Environment

The Size and Income Effects
We begin the chapter with two provocative questions. First, is free trade anti-environment? We argue that it is not. There is no reason to think that trade generally promotes production or consumption of products that cause large harm to the environment. Surprisingly, the incentive to relocate production into “pollution havens” is usually small.

have two different effects on the economy:


Trade and the Environment

Environmental Problems by Income Level
We begin the chapter with two provocative questions. First, is free trade anti-environment? We argue that it is not. There is no reason to think that trade generally promotes production or consumption of products that cause large harm to the environment. Surprisingly, the incentive to relocate production into “pollution havens” is usually small.


Trade and the Environment

The material of this chapter lends itself to additional examples. The instructor can introduce extra material in lecture, in class handouts, or in additional readings. Some examples include the threat to the marine population of the Galapagos, water quality and air quality along the Rio Grande, the U.S. diversion of water in the Colorado River before it gets to Mexico, the paper mills in Uruguay that have been opposed by Argentina, dams on the Mekong River, the drift of air pollution from China to South Korea and Japan, overfishing of tuna (especially bluefin tuna), and the role of deforestation in contributing to global warming.


Trade and the Environment

The analysis of transborder pollution raises new issues. We use the example of production activity in one country that pollutes a river flowing into a neighboring country. The best solution would balance the gains to the polluting country from dumping waste into the river with the costs of pollution to the receiving country. Generally, this best solution is less pollution than the amount that occurs with no government policy, but more than zero pollution. However, the government in the polluting country may resist imposing a pollution tax (or some other way to limit pollution by its firms), because it bears the national costs while the other country gets the national benefits. If international negotiations fail, what should the receiving country do? It cannot tax the foreign pollution or even the foreign production that causes pollution. If the receiving country imports the product from


Trade and the Environment

In our formal analysis we begin with the case in which pollution caused by an activity within the country has effects only on this country. We use tools similar to those that we developed in Chapter 10. If the country simply allows the pollution to occur, with no government policy to limit the negative externality, we show that free trade can make the country worse off, and that the country can export the wrong products. This occurs because of the marginal external costs, in our example resulting from pollution that accompanies domestic production of the export good. A government policy that taxes pollution or production that causes pollution (or that establishes suitable property rights) can reverse these effects, assuring that the country exports and imports the appropriate products and gains from free international trade.


Trade and the Environment

Actual global negotiations to reach agreements to reduce greenhouse gas emissions have been challenging. In the Kyoto Protocol, many industrialized countries made commitments to reduce their greenhouse gas emissions, but developing countries refused to do so. The Protocol came into effect in 2005, but the United States and Australia decided not to ratify it. (Australia ratified in 2007.) The Protocol did not accomplish much. Some industrialized countries did not meet their emissions targets. Emissions increased in the United States and in many developing countries.


Trade and the Environment

Which of the following is likely to be the least important factor for firms in determining production location?

Costs of environmental protection standards


Trade and the Environment

Free trade may lead to less pollution because

it results in increased production and consumption of goods and services.

competition among nations leads to stricter pollution standards.

higher income can lead to political pressure on governments to enact tougher environmental protection policies.

imported products are produced using cleaner production techniques than domestic products.


Trade and the Environment

Free trade may lead to more pollution because

with free trade, the size of the economy increases resulting in higher production and consumption.

competition among nations invariably leads to less restrictive pollution standards.

the countries may not specialize in the production of goods in which they have comparative advantage.


Trade and the Environment

Identify the correct statement.

There is sufficient evidence to prove that free trade simply promotes production and consumption of products that tend to cause large amounts of pollution.

It is not easy to find cases where government policies that limit or distort trade result in environmental damage.

Freer trade in environmental services actually lowers environmental quality, especially in the developing countries.

Environmentalists often fear that free trade permits production to be shifted to countries that have lax environmental standards.


Trade and the Environment

Environmental harm declines with rising income per person when

the consumption of environment-friendly goods decline with an increase in income.

with rise in income the increase in demand for better environment quality is larger than any adverse effects from rising production scale.

the government imposes restrictions on the import of environment-friendly technologies from abroad.

the adverse effect of any increase in nominal Gross Domestic Product (GDP) dominates any modest improvements from better production techniques.


Trade and the Environment

Which of the following would you expect to lead to improved environmental quality?

An export or production subsidy from the French government to French wheat producers

A voluntary export restraint on the part of Japanese auto producers

An export subsidy for producers of clean technology for producing paper

Freer trade that promotes production of manufactured goods in developing countries where environmental laws are lax


Trade and the Environment

Which of the following would you expect to lead to worsening environmental quality?

An export or production subsidy from the Chinese government to Chinese steel manufacturers

Freer trade in capital equipment that incorporates environmentally friendly technologies

Freer trade that promotes production of manufactured goods in developing countries where environmental laws are strict


Trade and the Environment

Which of the following statements is true?

Evidence shows that measures to keep the environment clean represent a large percentage of the total costs of production for a firm in a country with strict environmental laws.

There are large incentives for firms to relocate from countries with strict environmental laws to countries with lax environmental regulation.

Firms are unlikely to relocate their high-pollution production to countries with lax environmental laws because they fear that such moves will result in adverse effects on their reputations.

Imposition of a tax on the production of a particular high-pollution product typically has a greater impact on consumer surplus than on producer surplus.


Trade and the Environment

For which of the following types of environmental pollution can we expect that the level of environmental harm would increase as per capita income increases?


Trade and the Environment

For which of the following environmental pollutions would we expect that an inverted-U relationship would exist between environmental harm and per capita income?


Trade and the Environment

The relationship between environmental harm and national income per person for arsenic water pollution exhibits a(n)


Trade and the Environment

As the world moves toward freer trade, the composition of production shifts so that more environmentally "dirty" products are produced in ________ and more environmentally "clean" products are produced in

industrialized countries; developing countries.

developing countries; industrialized countries.

both industrialized and developing countries; only industrialized countries.

developing countries; neither industrialized nor developing countries.


Trade Policies for Developing Countries

Which Trade Policy for Developing Countries?
2.The four arguments in favor of ISI are the infant-industry argument, the developing-government argument, the chance to improve the terms of trade for a large importing country, and economizing on market information. The conditions under which ISI is likely to be better than alternative strategies include the following.

Exports of goods and services are about 37 percent of GDP in developing countries, vs. 28 percent for developed countries.

Developing countries are the source of about 46 percent of all world exports.

About 42 percent of exports by developing countries go to industrialized countries, but these are only about 38 percent of industrial-country imports.


Trade Policies for Developing Countries

Are the Long-Run Price Trends Against Primary Producers?
The comparative advantages of developing countries (relative to industrialized countries) derive from abundance of unskilled labor and, for many, abundance of natural resources, as well as a tropical climate for agriculture. Furthermore, financial capital markets and labor markets are less efficient in developing countries.

Many developing countries have exports concentrated in one or a few primary products such as petroleum, coffee, cotton, gold, sugar, timber, diamond, and bauxite/aluminum.

Raul Prebisch and others have argued that  adverse price trends for primary products trap these developing countries into declining incomes relative to incomes in industrialized countries.


Trade Policies for Developing Countries

International Cartels to Raise Primary-Product Prices
The comparative advantages of developing countries (relative to industrialized countries) derive from abundance of unskilled labor and, for many, abundance of natural resources, as well as a tropical climate for agriculture. Furthermore, financial capital markets and labor markets are less efficient in developing countries.

How big could the cartel opportunity be? That is, if a group of nations or firms were to form a cartel, as OPEC did, what is the greatest amount of gain they could reap at the expense of their buyers and world efficiency?

If all the cartel members could agree on simply maximizing their collective gain, they would behave as though they were a perfectly unified profit-maximizing monopolist.


Trade Policies for Developing Countries

Import-Substituting Industrialization (ISI)
Import-substituting industrialization (ISI) was the dominant policy in the 1950s and 1960s, and it is still important today. At its best, it is an application of the infant-industry argument, guided by the existence of a market for the goods produced by the new domestic producers, with tariff revenues that may be justified by the developing-government argument, and it can also improve the country’s terms of trade by reducing demand for imports.

at Its Best
The infant industry argument:
Places


Trade Policies for Developing Countries

Trade Policy Alternatives for a Developing Country
Trade Policies for Developing Countries

Attempt to raise the world prices of primary products that are exported.

Protect and encourage new industries that produce products sold into the local market.


Trade Policies for Developing Countries

Challenges Faced by Developing Countries
The comparative advantages of developing countries (relative to industrialized countries) derive from abundance of unskilled labor and, for many, abundance of natural resources, as well as a tropical climate for agriculture. Furthermore, financial capital markets and labor markets are less efficient in developing countries.

Another difference is in factor input markets.

work less efficiently in many developing countries in channeling money to the most productive uses.


Trade Policies for Developing Countries

The Relative Price of Primary Products, 1900-2017
The comparative advantages of developing countries (relative to industrialized countries) derive from abundance of unskilled labor and, for many, abundance of natural resources, as well as a tropical climate for agriculture. Furthermore, financial capital markets and labor markets are less efficient in developing countries.


Trade Policies for Developing Countries

Classic Monopoly as an Extreme Model for Cartels
One possible approach to the problem of declining primary product prices is to form international cartels to raise their prices. OPEC did this for oil in the 1970s. The analysis of a cartel as a group that has monopoly power because it controls a large part of the world’s production indicates the limits to this power and why cartels usually erode over time.

The cartel members acting as a monopoly would try to find the price level that would maximize the gap between their total export sales revenues and their total costs of producing exports.


Trade Policies for Developing Countries

Special Challenges of Transition: The international economics of the situation probably favor a country like Ukraine reorienting itself toward the European Union. Ukrainian export producers will benefit from better access to buyers in high-income European countries. Competition with productive firms and demanding buyers in these European countries will force Ukrainian firms to improve product quality and control costs. Ukrainian buyers (both households and firms that need production inputs) will benefit from better access to products produced by European firms. In contrast, the main advantage to a country like Ukraine from strengthening its orientation toward Russia and its customs union with several other CIS countries is that Russia is the main supplier of fuels to Ukraine. In addition, to the extent that strengthening Ukraine’s legal system (including contract laws and enforcement and


Trade Policies for Developing Countries

One possible approach to the problem of declining primary product prices is to form international cartels to raise their prices. OPEC did this for oil in the 1970s. The analysis of a cartel as a group that has monopoly power because it controls a large part of the world’s production indicates the limits to this power and why cartels usually erode over time. Demand becomes more elastic over time, new competing supplies from outside the cartel enter the market, increasing the noncartel supply elasticity and decreasing the cartel’s market share, and cheating by cartel members often increases over time. The large decrease of oil prices during 2014-2016 shows the importance of the new noncartel supply (increased U.S. production of crude oil using hydraulic fracturing and horizontal drilling). The ability of OPEC to work with Russia and several other non-OPEC oil-producing countries to reduce


Trade Policies for Developing Countries

Import-substituting industrialization (ISI) was the dominant policy in the 1950s and 1960s, and it is still important today. At its best, it is an application of the infant-industry argument, guided by the existence of a market for the goods produced by the new domestic producers, with tariff revenues that may be justified by the developing-government argument, and it can also improve the country’s terms of trade by reducing demand for imports. However, because the terms of trade effects are usually small, it imposes substantial economic costs through deadweight losses—it often results in domestic industries that have high costs, domestic monopoly power, and low-quality products. Countries like Taiwan and South Korea that have shifted from a policy of ISI to a more outward-oriented policy that encourages development through exporting usually grow faster with the outward-oriented policy,


Trade Policies for Developing Countries

8.The prediction is that the shift to an outward oriented policy will result in an increase in India’s growth rate, so that it is higher than India’s growth rate was before the shift, and probably also that it is among the higher growth rates for developing countries. The data shown in Figure 14.1 are consistent with the prediction. India’s rate of growth of per capita GDP was 4.9 percent during 1990-2016, which is substantially faster growth than the 2 percent India achieved during 1970-1990. India’s 4.9 percent growth rate is also among the higher growth rates shown for developing countries.


Trade Policies for Developing Countries

While developing countries have about ________ of the world's population, they produce less than ________ of the world's output.

Which Trade Policy for Developing Countries?


Trade Policies for Developing Countries

Identify the correct statement.

In many of the industrialized countries, the income per person declined between 1990 and 2016.

Most of the developing countries have been growing at the same rate since 1990.

The average product per person has grown faster in the developing countries than in the industrialized countries since 1990.

The developing countries are expected to catch up with the average per capita income in the industrialized countries in the near future.


Trade Policies for Developing Countries

Which of the following is true of developing countries?

More than 40 percent of the exports by developing countries go to the industrialized countries.

Exports of goods and services on average are about only 10 percent of gross domestic product in developing countries.

Exports from the developing countries comprise about three-quarters of industrial-country imports.

Developing countries are the source of about 60 percent of all world exports.


Trade Policies for Developing Countries

Which of the following has been observed in the developing countries during 1990-2016?

The dispersion in the growth rates of the developing countries has been negligible during 1990-2016.

The East Asian countries like South Korea, Singapore, and Taiwan reported negative growth rates.

Countries like China and Vietnam reported positive but low growth rates.

Several of the countries in Eastern Europe and Central Asia that were making a transition from a centrally planned economy to a market-based economy reported a decline in the per capita income.


Trade Policies for Developing Countries

In comparing growth rates of per capita gross domestic product (GDP) in developing countries over the period of 1990-2016, the highest growth rates were reported in the ________ countries while the lowest growth rates have been reported in the ________ countries.

European and Central Asian; Latin America and the Caribbean

East Asian and the Pacific; Sub-Saharan African

Latin America and the Caribbean; East Asian and the Pacific


Trade Policies for Developing Countries

Developing countries tend to have comparative advantages in

land-intensive and unskilled-labor-intensive goods.

both skilled-labor and capital-intensive goods.


Trade Policies for Developing Countries

According to comparative advantage theory, the developing countries are expected to export


Trade Policies for Developing Countries

Countries having comparative advantages based on land and in various natural resources are most likely to

experience rapid accumulation of capital.

export products like gold, coffee, or cocoa.


Trade Policies for Developing Countries

Suppose Country A is a major exporter of limestone in the world market. Which of the following policies can be taken by the government of Country A to enhance the gains from exporting limestone by raising its world price?

Setting a price ceiling on the limestone sold in the domestic market


Trade Policies for Developing Countries

An example of policies designed to encourage new local industries serving the domestic market would be

subsidizing imports to the domestic market.

imposing import tariffs or otherwise restricting imports.

removing all trade restrictions and price supports.


Trade Policies for Developing Countries

An example of policies designed to encourage the development of new industries whose products can be readily exported would be

taxing exports of skilled-labor-intensive goods.

providing subsidies to domestic industries that exploit the country's comparative advantage.

imposing tariffs on imports of skilled-labor-intensive goods.


Trade Policies for Developing Countries

Which of the following was a main economic policy goal of the Soviet Union?


Multinationals and Migration: International Factor Movements

Foreign Direct Investment
This chapter provides a survey of the economics of foreign direct investment (FDI) and the economics of labor migration.

FDI is funding provided by investors (usually firms) to establish or acquire foreign companies or to expand or finance existing foreign companies that the investors own.

Key is sufficient ownership to control or influence the management of the foreign company. The agreed international standard is at least 10 percent ownership.


Multinational Enterprises
Multinationals and Migration: International Factor Movements

A MNE is a firm that owns and controls operations in more than one country.


FDI: History and Current Patterns
Are Immigrants a Fiscal Burden?: These characteristics matter for the (current) fiscal effects of the immigrants. Because they are young, immigrants will pay relatively large amounts of social security taxes while drawing few social security (pension) benefits. Because they have low wage rates, they will tend to pay low income taxes (and similar taxes like sales or value added taxes).


MNEs and International Trade
What explains why MNEs exist? Purely financial theories cannot explain MNEs because they cannot explain why managerial control over the foreign affiliates, with its focus on production and marketing, is necessary if the goal is only to move capital from one country to another in pursuit of higher returns or diversification of risk.


Should the Host Country Restrict FDI Inflows?
Economic analysis suggests that the host country gains from inward FDI, even if the profits of the local affiliates do not belong to the host country, and even though some local competitors may be harmed by the competition from the affiliates. There is some case for the host-country government to tax or restrict inward FDI, because of fear of the local political power of the foreign multinationals, or to impose an optimal tax on the affiliate’s profits.

Workers in the host country gain from increased demand for their services, as do other suppliers of inputs to the affiliates of foreign multinationals.

The host country government gains from taxes collected on affiliate profits, as long as these exceed the extra costs of any additional government services provided to the affiliates.


Migration
Multinationals and Migration: International Factor Movements


The latter part of the chapter examines international migration, including the benefits and the costs to the migrants, the effects of migration on other groups and on the sending and receiving countries overall, the fiscal effects of migration, and government policies toward migration. For the United States and Canada, immigration was relatively large until the 1920s, was low in the 1930s, and has been higher since the 1950s. For the shorter history of the European Union, immigration was curtailed in the mid-1970s and early 1980s, but has increased again since the late 1980s.


10.Agree or disagree, depending on whether you think the import-reducing effects or the import-increasing effects are larger. As Chinese companies expand their FDI into the United States, the growing operations of Chinese companies in the United States are likely to have several effects on U.S. imports from China. On the one hand, U.S. imports would tend to decrease, because U.S. production in the U.S. affiliates of Chinese companies could replace some products that otherwise would have been imported from China. On the other hand, two effects would tend to increase U.S. imports from China. U.S. production in the affiliates of Chinese companies could lead to importing machinery, components, and materials from China. And, the U.S. affiliates of Chinese companies could improve the marketing of the Chinese companies’ products in the United States. If some of these products are not made in th


11.First, in 1924, the United States passed a law that severely restricted immigration, using a system of quotas by national origin. Second, the Great Depression, with its very high rates of labor unemployment, probably reduced the economic incentive to immigrate because potential immigrants would expect that it would be very difficult to find employment.


The analysis has implications for the policies used by receiving countries to limit immigration. First, the types of immigrant admitted have an impact on which native group suffers loss. Second, the types of immigrants admitted have an impact on the net fiscal effects. To gain greater fiscal benefits (and to minimize the negative impact on low-skilled native workers who already have low earnings), the receiving country should skew its immigration policies to favor young adults with some college education. However, for countries like the United States, this would mean shifting away from other worthy goals pursued by their current immigration policies, including family reunification and assisting refugees.
Tips


Multinationals and Migration: International Factor Movements

Which of the following is an example of foreign direct investment?

Ford motor company puts $10 million from its pension fund into a mutual fund containing shares of foreign companies.

Dr. Gareau, a French biologist, buys $5,000 worth of shares of Toyota.

Wells Fargo Bank buys $10 million worth of Bank of England T-Bills.

Ford buys a controlling interest in Peugeot Citroën, a French automobile company.


Multinationals and Migration: International Factor Movements

Foreign direct investment (FDI) refers to

the flow of funding provided by an investor or lender to establish or acquire a foreign company or to expand or finance an existing foreign company that the investor owns and controls.

the hot money that an investor needs to get registered in a foreign stock exchange to make investments and have the liberty to sell stocks purchased earlier.

a method of funding business adopted by a foreign investor by participating directly in the secondary markets of a country, through investments in the country's stocks or bonds.

the passive holding of securities such as foreign stocks, bonds, or other financial assets, none of which entails active management or control of the securities issued by the investor.


Multinationals and Migration: International Factor Movements

A firm that owns and controls operations in more than one country is a(n)


Multinationals and Migration: International Factor Movements

Which of the following is true for a multinational enterprise (MNE)?

Its affiliates usually get nearly all of their financing from the direct investment flows.

It usually transfers its liabilities to its foreign subsidiaries.

Its home-country tax burden is mostly borne by its foreign affiliates.

It usually provides intangible assets to its affiliates for their usage.


Multinationals and Migration: International Factor Movements

Financing from the parent company to its foreign affiliates is generally a small percentage of total funding because

the returns on such investment are taxed at very high rates.

the parent firm wants to reduce the risks to which its foreign activities are exposed.

most foreign governments have imposed quotas of foreign investment in their domestic economy.

most major home-country governments limit investment in foreign firms by their domestic firms.


Multinationals and Migration: International Factor Movements

Which of the following ways can a multinational enterprise (MNE) adopt to reduce its exposure to political risks in its host country?

By threatening to cease all exports of its products to the host country

By establishing more than one affiliate in the host country

By equating its physical assets in the host country with its local borrowings

By negotiating with the host country's government to clear off its debts


Multinationals and Migration: International Factor Movements

At the end of 2016, most of the United States' foreign direct investment was in

the other North American Free Trade Agreement (NAFTA) countries.


Multinationals and Migration: International Factor Movements

Most foreign direct investment is in


Multinationals and Migration: International Factor Movements

Which of the following statements is true concerning the global flow of foreign direct investment (FDI) since 1990?

The proportion of global FDI that flowed into developing countries increased.

Mexico has received more FDI inflows than has the United States.

The proportion of global FDI that flowed into the United States increased.

FDI flows into and within the European Union fell.


Multinationals and Migration: International Factor Movements

Which of the following provides a good explanation of why multinational firms exist?

Location factors that favor exporting over foreign production

The need to shift financial capital between countries

Internalization advantages that favor direct investment over contracting with independent foreign firms

Firms lack inherent knowledge of foreign laws, procedures, and practices.


Multinationals and Migration: International Factor Movements

Which of the following is an inherent disadvantage to being a multinational enterprise (MNE)?

An MNE does not initially have the native understanding of local laws, customs, procedures, practices, and relationships.

An MNE does not have the same assets as those held by its local competitors in the host market.

An MNE does not enjoy comparative advantages in the same goods as those of its local competitors in the host market.

An MNE's profits are doubly taxed by two governments.


Multinationals and Migration: International Factor Movements

How can an MNE overcome its inherent disadvantages?

By borrowing funds from the host country rather than transferring funds from the parent firm

By producing more than two products in which it has comparative advantage

By expanding its operation in more than two host countries

By owning one or more assets that are not owned by its local competitors in the host country


Payments among Nations

A Country's Balance of Payments
A country's balance of payments records all economic transactions between the residents of the country and residents of the rest of the world. Each transaction or exchange results in two opposite flows of value. By convention, a credit or positive item is the flow for which the country is paid—it is the item that the country gives up in the transaction, and it sets up a claim on the foreign resident, so that funds (or "money") flow into the country.

The balance of payments (BOP) is an accounting of a country's international transactions for a particular time period.

In double-entry accounting, each transaction has two items.

An item that would cause funds or money to flow into a country is a


Payments among Nations

The Macro Meaning of the Current Account Balance
The current account balance (CA) has several meanings. First, CA equals the value of the country's net flow (If) of foreign investments (both private and official). Second, CA equals the difference between national saving and domestic real investment (S Id). Third, because CA is approximately equal to the difference (X M) between the value of the country's exports of goods and services and the value of its imports of goods and services, CA is (approximately) equal to the difference between domestic production of goods and services and national expenditures on goods and services (Y E).

The country’s current account balance must equal

, the increase in the country’s foreign financial assets minus the increase in the country’s foreign financial liabilities.


Payments among Nations

The Macro Meaning of the Overall Balance
This chapter begins the discussion of international finance and macroeconomics—the subject of the rest of the book. Its major purpose is to show how the balance of payments accounts for international transactions and how the different balances (or sub-balances) can be interpreted. It also presents the international investment position.

should indicate whether a country’s balance of payments has achieved an overall pattern that is sustainable over time. No single indicator represents overall balance perfectly.


Payments among Nations

The International Investment Position
This chapter begins the discussion of international finance and macroeconomics—the subject of the rest of the book. Its major purpose is to show how the balance of payments accounts for international transactions and how the different balances (or sub-balances) can be interpreted. It also presents the international investment position.

is a statement of the stocks of a nation’s international assets and foreign liabilities at a point in time, usually the end of a year.


Payments among Nations

Accounting Principles
This chapter begins the discussion of international finance and macroeconomics—the subject of the rest of the book. Its major purpose is to show how the balance of payments accounts for international transactions and how the different balances (or sub-balances) can be interpreted. It also presents the international investment position.


Payments among Nations

Financial Account
Typically, the first categories we examine are items that are international flows of goods (or merchandise), services, income, and gifts—the current account. Services include flows of transportation, financial services, education, consulting, and so forth. Income includes flows of payments such as interest, dividends, and profits.

Net change in official international reserves


Payments among Nations

The current account balance (CA) has several meanings. First, CA equals the value of the country's net flow (If) of foreign investments (both private and official). Second, CA equals the difference between national saving and domestic real investment (S Id). Third, because CA is approximately equal to the difference (X M) between the value of the country's exports of goods and services and the value of its imports of goods and services, CA is (approximately) equal to the difference between domestic production of goods and services and national expenditures on goods and services (Y E). The text shows how the current account and goods and services balances have changed over time for four countries—the United States, Canada, Japan, and Mexico.


Payments among Nations

A good source of up-to-date information on many countries is Balance of Payments Statistics from the International Monetary Fund (IMF). The format for the current account is similar to the presentation used in the text. What we call the financial account in the text is actually the combination of the Financial Account and the Capital Account in the IMF presentation method. In addition, the official reserves account shown by the IMF includes only changes in official reserve assets held by the country’s own central bank or monetary authority. The omission of changes in foreign official holdings of the country’s liabilities is not a major issue for most countries, but it is important for a country like the United States, whose own liabilities are held in large amounts by foreign central banks.


Payments among Nations

5.Transaction c contributes to a surplus in the current account because it is an export of merchandise that is paid for through an item in the financial account. (Transaction a leaves the current account unchanged because it is both an export and an import. Transaction b contributes to a deficit in the current account because it is an import. Transaction d affects no items in the current account.)


Payments among Nations

10. a.The current account balance is exports of goods and services, minus imports of goods and services, plus income received from foreigners, minus income paid to foreigners, plus net unilateral transfers. For this country the current account balance is $60 million (= 200 – 160 + 60 + (−40)) minus income paid to foreigners. For the country to have a current account surplus, the income paid to foreigners must be less than $60 million.


Payments among Nations

A country's balance of payments records

the prices that a country pays for its imports and the prices that the country receives for its imports.

the flows of value between that country's residents and residents of the rest of the world during a period of time.

capital gains and losses on a country's international assets.

the value of a country's holdings of foreign assets, minus the value of foreign holdings of the country's assets.


Payments among Nations

A credit item in the balance of payments is

an item for which the country must be paid.

an item that creates a monetary claim owed to a foreigner.


Payments among Nations

A debit item in the balance of payments is

any foreign aid received by the country.

an item that creates a monetary claim on a foreigner.


Payments among Nations

In a nation's balance of payments, which one of the following items is always recorded as a positive entry?

Military foreign aid supplied to allied nations

Purchases by foreign travelers visiting the country


Payments among Nations

Every international exchange of value is entered into the balance-of-payments accounts ________ time(s).


Payments among Nations

The sum of all of debit items in the balance of payments


Payments among Nations

Which of the following financial transaction items is entered as a debit in the U.S. balance of payments?

A U.S. resident transfers $100 from his account at Credit Suisse in Basel (Switzerland) to his account at a San Francisco branch of Wells Fargo Bank.

A French resident transfers $100 from his account at Wells Fargo Bank in San Francisco to his Credit Suisse account in Basel.

A U.S. resident sells his IBM stock to a French resident.

A U.S. resident sells his Credit Suisse stock to a French resident.


Payments among Nations

An increase in a nation's financial liabilities to foreign residents is a


Payments among Nations

________ are money-like assets that are held by governments and that are recognized by governments as fully acceptable for payments between them.


Payments among Nations

Which of the following is considered a capital inflow?

A sale of U.S. financial assets to a foreign buyer

A loan from a U.S. bank to a foreign borrower

A purchase of foreign financial assets by a U.S. buyer

A U.S. citizen's repayment of a loan from a foreign bank


Payments among Nations

In a country's balance of payments, which of the following items will be recorded as a debit entry?

Domestic bank balances owned by foreigners are reduced

Foreign bank balances owned by domestic residents are reduced

Assets owned by domestic residents are sold to nonresidents

Securities are sold by domestic residents to nonresidents


Payments among Nations

The role of international ________ is to direct one nation's savings into another nation's investments.


The Foreign Exchange Market

The Basics of Currency Trading
The purpose of this chapter is to present the foreign exchange market and exchange rates, with an emphasis on spot exchange rates. Foreign exchange is the act of trading different countries' moneys. An exchange rate is the price of one money in terms of another. The spot exchange rate is the price for "immediate" exchange.

is the act of trading different nations’ moneys.


The Foreign Exchange Market

Demand and Supply for Foreign Exchange
We can picture the foreign exchange market by using demand and supply curves. Exports of goods and services and capital outflows (as well as income payments to foreigners) create a demand for foreign currency, as payments for these items typically require that at some point in the payment process the home currency is exchanged for the foreign currency to pay for the items that the home residents are buying.

Within the foreign exchange market, people want to trade moneys by trading in goods, services, and financial assets.

A nation’s export of goods, services, and financial assets typically causes foreign moneys to be sold to buy that nation’s money.

Thus, U.S. exports of goods, services, and financial assets create a supply of foreign currency and a demand for U.S. dollars.


The Foreign Exchange Market

Arbitrage Within the Spot Exchange Market
The chapter concludes by introducing the two different kinds of arbitrage that can occur using the spot foreign exchange market. The simpler form is arbitrage of the same exchange rate between two locations. This arbitrage assures that, at a particular time, the same exchange rate is essentially the same value in different locations (at least within a small range that reflects transactions costs).

The process of buying and selling to make a (nearly) riskless pure profit

Ensures that exchange rate values in different locations are essentially the same.


The Foreign Exchange Market

Using the Foreign Exchange Market
The purpose of this chapter is to present the foreign exchange market and exchange rates, with an emphasis on spot exchange rates. Foreign exchange is the act of trading different countries' moneys. An exchange rate is the price of one money in terms of another. The spot exchange rate is the price for "immediate" exchange.


The Foreign Exchange Market

Interbank Foreign Exchange Trading
At the center of the foreign exchange market are a group of banks that use computers and telecommunications to conduct trades with their customers (the retail part of the market) and with each other (the interbank part of the market). Most foreign exchange trades are conducted by exchanging ownership of demand deposits denominated in different currencies.

Participation in the interbank (or interdealer) part of the market provides a bank with a continuous stream of information on conditions in the foreign exchange market through communications with traders at other banks and through observing quoted prices.

Interbank trading allows a bank to readjust its own position quickly and at a low cost.

It also permits a bank to take on a position in a foreign currency quickly if the bank and its traders want to speculate on exchange-rate movements in the near future.


The Foreign Exchange Market

Floating Exchange Rates
The purpose of this chapter is to present the foreign exchange market and exchange rates, with an emphasis on spot exchange rates. Foreign exchange is the act of trading different countries' moneys. An exchange rate is the price of one money in terms of another. The spot exchange rate is the price for "immediate" exchange.

system, the spot price of foreign currency is market-determined by the interaction of private demand and supply for that currency. The market clears itself through the price mechanism.


The Foreign Exchange Market

Fixed Exchange Rates
The purpose of this chapter is to present the foreign exchange market and exchange rates, with an emphasis on spot exchange rates. Foreign exchange is the act of trading different countries' moneys. An exchange rate is the price of one money in terms of another. The spot exchange rate is the price for "immediate" exchange.

government monetary authorities keep the exchange-rate value fixed (or pegged), even if the rate they choose differs from the current market equilibrium rate.


The Foreign Exchange Market

4.The U.S. firm obtains a quotation from its bank on the spot exchange rate for buying yen with dollars. If the rate is acceptable, the firm instructs its bank that it wants to use dollars from its dollar checking account to buy 1 million yen at this spot exchange rate. It also instructs its bank to send the yen to the bank account of the Japanese firm. To carry out this instruction, the U.S. bank instructs its correspondent bank in Japan to take 1 million yen from its account at the correspondent bank and transfer the yen to the bank account of the Japanese firm. (The U.S. bank could also use yen at its own branch if it has a branch in Japan.)


The Foreign Exchange Market

The text explains the downward slope of the demand curve for foreign currency through changes in the dollar price of products that the home country might buy from the foreign country, as the going spot exchange rate would be one or another value. (The text assumes that the supply curve slopes upward, without much discussion at this point. The details of how values of exports and imports respond to changes in the exchange rate are deferred until the last part of Chapter 23.)


The Foreign Exchange Market

Suggested answers to case study discussion question
Foreign Exchange Trading: In Europe there is one major location for foreign exchange trading, London. In North America (really, the Americas, or the Western Hemisphere) there is one major location, New York. Asia is different, it has three locations that are all about equal in size—Tokyo (Japan), Singapore, and Hong Kong. Foreign exchange trading is a business that seems to benefit from external scale economies (discussed in Chapter 6), as shown by the clustering of trading in banks in each of London and New York. London dominates foreign exchange trading in Europe, with its time zones of overlapping banking hours, and New York dominates foreign exchange trading in the Western Hemisphere, with its time zones of overlapping banking hours. Because external scale economies seem to be important in this industry, it is surprising that no one


The Foreign Exchange Market

b.Demand for yen. The U.S. import company probably begins with dollars, and the Japanese producer probably wants to receive payments in yen. Dollars must be sold to obtain yen.


The Foreign Exchange Market

Which of the following refers to foreign exchange?

The act of trading different nations' moneys

The act of exchanging goods and services internationally


The Foreign Exchange Market

If the price of British pounds in terms of U.S. dollars is $1.80 per pound, then the price of U.S. dollars in terms of British pounds is


The Foreign Exchange Market

The exchange rate set for an immediate trade is often referred to as a


The Foreign Exchange Market

The exchange rate that is set now for a currency trade that will take place sometime more than a few days in the future is often referred to as a


The Foreign Exchange Market

The retail part of the foreign exchange market does not include traders at banks trading with

stock brokers who trade in the assets of the firms in different nations.

nonfinancial companies that sometimes want to buy and sell different currencies.


The Foreign Exchange Market

Which of the following is true of foreign exchange markets?

The foreign exchange market is a single gathering place where traders shout buy-and-sell orders at each other.

Individuals' exchanges of currencies comprise the largest portion of overall foreign exchange trading.

The laws of demand and supply are not applicable in a foreign exchange market.

Most foreign exchange trading involves the exchange of U.S. dollars for other currencies.


The Foreign Exchange Market

The U.S. dollar is called a ________ because it is often used as an intermediary to accomplish trading between two other currencies.


The Foreign Exchange Market

Suppose the dollar per pound exchange rate is $2 per pound while the dollar per Swiss franc exchange rate is 50 cents per franc. From the given information we can conclude that the Swiss franc per pound exchange rate is


The Foreign Exchange Market

Which of the following is NOT a function of the interbank part of the foreign exchange market?

Provides a bank with a continuous stream of information on conditions in the foreign exchange market

Provides a bank the means to readjust its own position quickly and at low cost when it separately conducts a large trade with a customer

Permits a bank to take on a position in a foreign currency quickly if the bank and its traders want to speculate on exchange-rate movements in the near future

Provides clearing services for organizations that prefer to use different currencies


The Foreign Exchange Market

The 2004-2013 rapid growth in global foreign exchange trading can be explained by

large increases in trading by hedge funds, pension funds, and other financial institutions.

increases in the volume of global trade in the recent years.

volatility in U.S. long-term government bond yields.

an increase in the number of nations adopting the floating exchange rate system.


The Foreign Exchange Market

Interbank trading is conducted directly between ________ or through the use of ________ that provide anonymity until the trade is complete.


The Foreign Exchange Market

A country's demand for foreign currency is derived from

international transactions entering the debit side of its balance-of-payments accounts.

international transactions entering the credit column of its balance-of-payments accounts.

the government's attempt to revalue domestic currency.

an increase in foreign capital inflows into the domestic country.


Forward Exchange and International Financial Investment

Exchange Rate Risk
This chapter presents the uses of forward foreign exchange rates and the returns and risks of international financial investments, both covered and uncovered. It begins by noting that in many situations people or organizations are exposed to exchange rate risk, because the value of the individual's income, wealth, or net worth changes when exchange rates change unexpectedly in the future.

You are exposed to exchange-rate risk if the value of your income or wealth or net worth changes when exchange rates change unpredictably in the future.

is taking an action to reduce your exposure to exchange-rate risk.


International Financial Investment
Forward Exchange and International Financial Investment


International Investment With Cover
This chapter presents the uses of forward foreign exchange rates and the returns and risks of international financial investments, both covered and uncovered. It begins by noting that in many situations people or organizations are exposed to exchange rate risk, because the value of the individual's income, wealth, or net worth changes when exchange rates change unexpectedly in the future.

Decisions about international investments are based on the returns and risks of the available investment alternatives.

is hedged exposure to exchange-rate risk.


International Investment Without Cover
This chapter presents the uses of forward foreign exchange rates and the returns and risks of international financial investments, both covered and uncovered. It begins by noting that in many situations people or organizations are exposed to exchange rate risk, because the value of the individual's income, wealth, or net worth changes when exchange rates change unexpectedly in the future.

The investor is exposed to exchange-rate risk, because the actual return depends on the actual value of the future spot exchange rate, which is uncertain at the time the investment is made.

At the time the investment is made, the investor can use the expected future spot rate (


Does Interest Parity Really Hold? Empirical Evidence
It is more difficult to test uncovered interest parity, because we cannot observe the expected future spot exchange rate in the market. (If we use the forward rate as an indicator of the expected future spot exchange rate, then we are really just testing covered interest parity.) Indirect tests of uncovered interest parity suggest that it does not hold as tightly as covered interest parity.

Four rates are needed to test for covered interest parity: the current spot exchange rate, the current forward exchange rate, and the current interest rates in the two countries.

All of these rates can be seen in the foreign exchange markets and the short-term financial markets.

Covered interest parity holds very well, except:


The Market Basics of Forward Foreign Exchange
An investor can compare the return on a covered international investment to the return on a home investment using the covered interest differential (CD). The exact expression is CD = (1 + if) f/e − (1 + i), where the i's are the foreign (subscript f) and domestic interest rates, e is the spot exchange rate, and f is the forward exchange rate.

In the forward market, deals are transacted for foreign exchange deliveries to be made at some specified future date (e.g. 30 days, 60 days, 90 days, etc.) Banks provide forward foreign exchange on all currency pairs.

The forward exchange market is convenient for large customers and corporations that are viewed by banks as acceptable credit risks.

Don’t confuse the forward rate with the future spot rate, the spot rate that will exist at a date in the future.


Hedging Using Foreign Exchange
This chapter presents the uses of forward foreign exchange rates and the returns and risks of international financial investments, both covered and uncovered. It begins by noting that in many situations people or organizations are exposed to exchange rate risk, because the value of the individual's income, wealth, or net worth changes when exchange rates change unexpectedly in the future.

means reducing both kinds of “open” positions in a foreign currency—both


Eurocurrencies: Not (Just) Euros and Not Regulated: The beginning and early growth of the Eurocurrency market included deposits from the government of the Soviet Union and the governments of Arab oil-exporting countries. These governments did not trust the U.S. government, but they still wanted to hold dollar bank deposits. So, they found banks outside the United States that were willing to take dollar deposits. Even if the Soviet Union and the Arab countries had not played such a role, the Eurocurrency market probably would still have developed into a large market. Other depositors were looking to get a better return on their deposits. Banks in some countries found that they could take dollar deposits (and make dollar loans) while avoiding both U.S. bank regulations and the bank regulations of their own countries. By avoiding some of the costs of these regulations, the banks could pay a


The final section of the chapter presents some evidence on whether the various parity conditions actually hold. For several decades up to 2007, covered interest parity holds well between currencies of countries whose governments permit free movements of international capital. Larger deviations from covered interest parity arose during the global financial and economic crisis and then for the euro during the euro crisis. While it is not surprising that such deviations arose during the turmoil of these crises, it has been surprising that larger deviations of up to a full percentage point from parity arose at times during 2015, 2016, and 2017, as shown in the new Figure 18.3. Research indicates that stricter bank regulation imposed since the global crisis has limited the willingness of banks to commit funds to covered interest arbitrage.


11. a.For the expected future value of the euro, the future spot exchange rate expected in 90 days is U.S.$1.408/euro (= 1/0.71). This value is larger than the current spot rate, $1.400/euro, so investors are expecting the euro to appreciate.


A forward foreign exchange contract is an agreement to exchange a certain amount of one currency for a certain amount of another currency on some date in the future, with the amounts based on the price (forward exchange rate) set when the contract is entered. A forward foreign exchange contract is a kind of derivative contract based on exchange rates. A box in the text discusses other foreign-exchange derivative contracts—currency futures, options, and swaps.


Forward Exchange and International Financial Investment

Company X is a perfume manufacturer and one of its popular products involves rosewood. It is deeply concerned with the market price fluctuations of rosewood. To protect this, it enters into a contract which would allow the company to buy rosewood at a specific price at a given future date. This is an example of


Forward Exchange and International Financial Investment

The act of taking a net asset position or a net liability position in some asset class is referred to as


Forward Exchange and International Financial Investment

Which of the following is true for forward foreign exchange contracts?

Common dates for future exchange are 50, 100, and 150 days forward.

The actual currency exchange occurs after one week from the stated time period.

They are used mostly to offset net asset positions held in the foreign currencies.

They can be used for both speculation and hedging.


Forward Exchange and International Financial Investment

________ means committing oneself to an uncertain future value of one's net worth in terms of home currency.


Forward Exchange and International Financial Investment

Assume you are a Chinese exporter and expect to receive $250,000 at the end of 60 days. You can remove the risk of loss due to a devaluation of the dollar by

selling dollars in the 60-day forward exchange market.

buying dollars now and selling these dollars at the end of 60 days.

selling the yuan equivalent in the forward exchange market for 60-day delivery.

keeping the dollars in the United States after they are delivered to you.