Ebook International economics (15th edition): Part 1

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International Economics

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International Economics
FIFTEENTH EDITION

ROBERT J. CARBAUGH
Professor of Economics, Central Washington University

Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States

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International Economics, Fifteenth Edition

© 2015, 2013 Cengage Learning

Robert J. Carbaugh

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Brief Contents

PREFACE

.......................................................................................................... xv

CHAPTER

1

PART 1

The International Economy and Globalization .............................. 1
International Trade Relations

27

CHAPTER

2

Foundations of Modern Trade Theory: Comparative
Advantage ........................................................................................ 29

CHAPTER

3

Sources of Comparative Advantage ............................................ 69

CHAPTER

4

Tariffs ............................................................................................. 107

CHAPTER

5

Nontariff Trade Barriers ............................................................... 149

CHAPTER

6

Trade Regulations and Industrial Policies ................................. 181

CHAPTER

7

Trade Policies for the Developing Nations ................................ 227

CHAPTER

8

Regional Trading Arrangements ................................................ 267

CHAPTER

9

International Factor Movements and Multinational
Enterprises ..................................................................................... 295

PART 2

International Monetary Relations

327

CHAPTER

10 The Balance-of-Payments ............................................................ 329

CHAPTER

11 Foreign Exchange ......................................................................... 357

CHAPTER

12 Exchange Rate Determination .................................................... 393

CHAPTER

13 Mechanisms of International Adjustment ................................. 419

CHAPTER

14 Exchange Rate Adjustments and the
Balance-of-Payments .................................................................... 427

CHAPTER

15 Exchange Rate Systems and Currency Crises .......................... 445

CHAPTER

16 Macroeconomic Policy in an Open Economy ........................... 479

CHAPTER

17 International Banking: Reserves, Debt, and Risk ...................... 495

GLOSSARY
INDEX

............................................................................................................. 513

.................................................................................................................... 527
v

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Contents
Preface ...................................................................................................................xv
CHAPTER 1

The International Economy and Globalization ....................................... 1
Globalization of Economic Activity ............................................ 2
Waves of Globalization .................................................................. 3

Federal Reserve Policy Incites
Global Backlash. . . . . . . . . . . . . . . . . . . . . . . . 4

First Wave of Globalization: 1870–1914............................. 4
Second Wave of Globalization: 1945–1980......................... 5
Latest Wave of Globalization ............................................... 5

Diesel Engines and Gas Turbines as
Movers of Globalization . . . . . . . . . . . . . . . . 8
The United States as an Open Economy................................... 9
Trade Patterns......................................................................... 9
Labor and Capital ................................................................ 11

Bicycle Imports Force Schwinn to Downshift ................... 16
Element Electronics Survives by Moving
TV Production to America............................................ 17
Common Fallacies of International Trade ..............................18

Is the United States Losing Its
Innovation Edge?. . . . . . . . . . . . . . . . . . . . . . 19
Does Free Trade Apply to Cigarettes? .....................................19
Is International Trade an Opportunity or a Threat

to Workers?............................................................................... 20
Backlash against Globalization ................................................... 22
The Plan of This Text .................................................................. 24

Why is Globalization Important? .............................................. 12

Summary.......................................................................................... 24

Globalization and Competition.................................................. 15
Kodak Reinvents Itself under Chapter 11 Bankruptcy .... 15

Key Concepts and Terms ............................................................ 25
Study Questions ............................................................................. 25

PART 1 International Trade Relations

27

CHAPTER 2

Foundations of Modern Trade Theory: Comparative Advantage ...... 29
Historical Development of Modern Trade Theory ...............29
The Mercantilists .................................................................. 29
Why Nations Trade: Absolute Advantage ........................ 30
Why Nations Trade: Comparative Advantage ................. 31

David Ricardo. . . . . . . . . . . . . . . . . . . . . . . . . 32
Production Possibilities Schedules............................................. 35
Trading under Constant-Cost Conditions...............................36
Basis for Trade and Direction of Trade ............................ 36

Production Gains from Specialization ............................... 37
Consumption Gains from Trade ........................................ 38

Babe Ruth and the Principle of
Comparative Advantage. . . . . . . . . . . . . . . 39

Distributing the Gains from Trade .................................... 40
Equilibrium Terms of Trade ............................................... 41
Terms of Trade Estimates.................................................... 42
Dynamic Gains from Trade........................................................ 43
How Global Competition Led to Productivity
Gains for U.S. Iron Ore Workers ................................. 44
Changing Comparative Advantage............................................ 45
Trading under Increasing-Cost Conditions ............................46

Natural Gas Boom Fuels Debate . . . . . . . 47
Increasing-Cost Trading Case ............................................. 48
Partial Specialization ........................................................... 50
The Impact of Trade on Jobs ..................................................... 51

vi
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Contents

Wooster, Ohio Bears the Brunt of Globalization ..................52

Comparative Advantage Extended to Many Products
and Countries ........................................................................... 53
More Than Two Products ................................................... 53
More Than Two Countries ................................................. 54
Exit Barriers .................................................................................... 55

vii

Outsourcing and the U.S. Automobile Industry............... 60
The iPhone Economy and Global Supply
Chains............................................................................... 60
Outsourcing Backfires for Boeing 787 Dreamliner .......... 61
Reshoring Production to the United States....................... 63
Summary.......................................................................................... 64

Empirical Evidence on Comparative Advantage ...................56

Key Concepts and Terms ............................................................ 65

Comparative Advantage and Global Supply Chains.............57
Advantages and Disadvantages of Outsourcing ............... 59

Exploring Further .......................................................................... 67

Study Questions ............................................................................. 65

CHAPTER 3

Sources of Comparative Advantage ...................................................... 69
Factor Endowments as a Source of Comparative

Advantage.................................................................................. 69
The Factor-Endowments Theory ........................................ 70
Visualizing the Factor-Endowment Theory ...................... 72
Applying the Factor-Endowment Theory to
U.S.–China Trade ........................................................... 73
Chinese Manufacturers Beset By Rising Wages and a
Rising Yuan ..................................................................... 74

Globalization Drives Changes for U.S.
Automakers. . . . . . . . . . . . . . . . . . . . . . . . . . . 75

Factor-Price Equalization .................................................... 76
Who Gains and Loses from Trade?
The Stolper–Samuelson Theorem ................................. 78
Is International Trade a Substitute
for Migration?.................................................................. 79
Specific Factors: Trade and the Distribution of
Income in the Short Run ............................................... 81
Does Trade Make the Poor Even Poorer? ......................... 81
Is the Factor-Endowment Theory a Good Predictor
of Trade Patterns? ................................................................... 83
Skill as a Source of Comparative Advantage..........................84
Economies of Scale and Comparative Advantage .................85
Internal Economies of Scale ................................................ 86
External Economies of Scale................................................ 87
Overlapping Demands as a Basis for Trade ...........................88

Does a “Flat World” Make
Ricardo Wrong?. . . . . . . . . . . . . . . . . . . . . . . 89
Intra-industry Trade ..................................................................... 90

Technology as a Source of Comparative Advantage:
The Product Cycle Theory.................................................... 92
Radios, Pocket Calculators, and the International
Product Cycle................................................................... 94
Japan Fades in the Electronics Industry............................ 95
Dynamic Comparative Advantage: Industrial Policy............96
WTO Rules that Illegal Government Subsidies Support
Boeing and Airbus................................................................... 97

Do Labor Unions Stifle
Competitiveness? . . . . . . . . . . . . . . . . . . . . . 99
Government Regulatory Policies
and Comparative Advantage ................................................ 99
Transportation Costs and Comparative Advantage............101
Trade Effects ........................................................................ 101
Falling Transportation Costs Foster Trade ..................... 103
Summary........................................................................................104
Key Concepts and Terms ..........................................................105
Study Questions ...........................................................................105
Exploring Further ........................................................................106

CHAPTER 4

Tariffs........................................................................................................ 107
The Tariff Concept......................................................................108
Types Of Tariffs...........................................................................109
Specific Tariff....................................................................... 109
Ad Valorem Tariff.............................................................. 110
Compound Tariff ................................................................ 111
Effective Rate of Protection.......................................................111

Trade Protectionism Intensifies As
Global Economy Falls Into the Great
Recession. . . . . . . . . . . . . . . . . . . . . . . . . . . . 112

Tariff Escalation ...........................................................................114
Outsourcing and Offshore Assembly Provision...................115
Dodging Import Tariffs: Tariff Avoidance
and Tariff Evasion.................................................................116
Ford Strips Its Wagons to Avoid High
Tariff............................................................................... 117
Smuggled Steel Evades U.S. Tariffs .................................. 117

Gains from Eliminating
Import Tariffs . . . . . . . . . . . . . . . . . . . . . . . . 118

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viii

Contents

Postponing Import Tariffs.........................................................119
Bonded Warehouse............................................................. 119
Foreign–Trade Zone ........................................................... 119
FTZ’s Benefit Motor Vehicle Importers ........................... 120

Tariff Effects: An Overview.......................................................121
Tariff Welfare Effects: Consumer Surplus
and Producer Surplus ...........................................................122
Tariff Welfare Effects: Small Nation Model..........................123
Tariff Welfare Effects: Large Nation Model..............................126
The Optimum Tariff and Retaliation.............................. 128

Tariffs and the Poor....................................................................134
Arguments for Trade Restrictions ...........................................135
Job Protection ...................................................................... 136
Protection against Cheap Foreign Labor......................... 136
Fairness in Trade: A Level Playing Field ........................ 139
Maintenance of the Domestic Standard of Living ......... 139
Equalization of Production Costs..................................... 140
Infant-Industry Argument ................................................. 140
Noneconomic Arguments................................................... 140

Petition of the Candle Makers. . . . . . . . . 142

Examples of U.S. Tariffs ............................................................130
Obama’s Tariffs on Chinese Tires .................................... 130
Should Footwear Tariffs Be Given
the Boot?......................................................................... 131

The Political Economy of Protectionism...............................142
A Supply and Demand View of Protectionism .............. 144

Could a Higher Tariff Put a Dent
in the Federal Debt?. . . . . . . . . . . . . . . . . . 132

Key Concepts and Terms ..........................................................146

How a Tariff Burdens Exporters .............................................132

Exploring Further ........................................................................148

Summary........................................................................................145
Study Questions ...........................................................................146

CHAPTER 5

Nontariff Trade Barriers ......................................................................... 149
Absolute Import Quota..............................................................149
Trade and Welfare Effects................................................. 150
Allocating Quota Licenses ................................................. 152
Quotas versus Tariffs ......................................................... 153

Whirlpool Agitates for Antidumping Tariffs
on Clothes Washers ...................................................... 168
Canadians Press Washington Apple Producers
for Level Playing Field.................................................. 169

Tariff–Rate Quota: A Two–Tier Tariff...................................154
Tariff–Rate Quota Bittersweet for
Sugar Consumers ................................................................. 156

Is Antidumping Law Unfair?....................................................169
Should Average Variable Cost Be the Yardstick
for Defining Dumping?................................................. 170
Should Antidumping Law Reflect Currency

Fluctuations?.................................................................. 171
Are Antidumping Duties Overused? ................................ 171

Export Quotas ..............................................................................156
Japanese Auto Restraints Put Brakes on
U.S. Motorists ................................................................ 157
Domestic Content Requirements.............................................158

How “Foreign” is Your Car? . . . . . . . . . . 160
Subsidies.........................................................................................161
Domestic Production Subsidy............................................ 161
Export Subsidy .................................................................... 162

Other Nontariff Trade Barriers ................................................172
Government Procurement Policies.................................... 172

U.S. Fiscal Stimulus and Buy
American Legislation. . . . . . . . . . . . . . . . . 173

Dumping........................................................................................163
Forms of Dumping ............................................................. 163
International Price Discrimination .................................. 164

Social Regulations ............................................................... 174
CAFÉ Standards ................................................................. 174
Europe Has a Cow over Hormone-Treated
U.S. Beef ......................................................................... 174
Sea Transport and Freight Regulations ........................... 175

Antidumping Regulations..........................................................166

Summary........................................................................................176

Swimming Upstream: The Case of
Vietnamese Catfish. . . . . . . . . . . . . . . . . . . 167

Key Concepts and Terms ..........................................................177
Study Questions ...........................................................................177

CHAPTER 6

Trade Regulations and Industrial Policies........................................... 181
U.S. Tariff Policies Before 1930 ...............................................181
Smoot–Hawley Act......................................................................183
Reciprocal Trade Agreements Act...........................................184

General Agreement on Tariffs and Trade .............................185
Trade without Discrimination .......................................... 185
Promoting Freer Trade ...................................................... 186

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Contents

Predictability: Through Binding and
Transparency ................................................................. 187

Multilateral Trade Negotiations ....................................... 187
World Trade Organization........................................................189

Avoiding Trade Barriers during
the Great Recession. . . . . . . . . . . . . . . . . . 190

Settling Trade Disputes ...................................................... 191
Does the WTO Reduce National Sovereignty?................ 192
Should Retaliatory Tariffs Be Used for
WTO Enforcement? ...................................................... 193
Does the WTO Harm the Environment? ........................ 194
Harming the Environment ................................................ 194
Improving the Environment .............................................. 195
WTO Rules against China’s Hoarding
of Rare Earth Metals.................................................... 195
Future of the World Trade Organization ....................... 197
Trade Promotion Authority (Fast Track Authority) ..........198
Safeguards (The Escape Clause): Emergency
Protection from Imports......................................................199
U.S. Safeguards Limit Surging Imports of
Textiles from China...................................................... 200
Countervailing Duties: Protection against
Foreign Export Subsidies .....................................................201
Lumber Duties Hammer Home Buyers........................... 202
Antidumping Duties: Protection against Foreign
Dumping..................................................................................202

Would a Carbon Tariff Help Solve
the Climate Problem? . . . . . . . . . . . . . . . . 203

ix

Remedies against Dumped and Subsidized
Imports ................................................................................... 204
U.S. Steel Companies Lose an Unfair Trade Case
and Still Win................................................................. 206
Section 301: Protection against Unfair
Trading Practices ...................................................................207
Protection of Intellectual Property Rights .............................208

The Globalization of Ideas and
Intellectual Property Rights. . . . . . . . . . . 210

Microsoft Scorns China’s Piracy
of Software ..................................................................... 210
Trade Adjustment Assistance ...................................................212
Industrial Policies of the United States..................................212
U.S. Airlines and Boeing Spar over Export–Import
Bank Credit.................................................................... 214
U.S. Solar Industry Dims as China’s Industrial
Policy Lights Up ............................................................ 215
Industrial Policies of Japan .......................................................216
Strategic Trade Policy.................................................................217
Economic Sanctions ....................................................................219
Factors Influencing the Success of Sanctions .................. 220
Economic Sanctions and Weapons of Mass
Destruction: North Korea and Iran ........................... 221
Summary........................................................................................223
Key Concepts and Terms ..........................................................224
Study Questions ...........................................................................224

Exploring Further ........................................................................225

CHAPTER 7

Trade Policies for the Developing Nations ......................................... 227
Developing-Nation Trade Characteristics..............................227
Tensions between Developing Nations
and Advanced Nations.........................................................229
Trade Problems of the Developing Nations .........................229
Unstable Export Markets................................................... 230
Falling Commodity Prices Threaten Growth
of Exporting Nations .................................................... 232
Worsening Terms of Trade ............................................... 232
Limited Market Access....................................................... 233
Agricultural Export Subsidies of Advanced
Nations ........................................................................... 235
Bangladesh’s Sweatshop Reputation................................. 235
Stabilizing Primary-Product Prices .........................................237
Production and Export Controls ...................................... 237
Buffer Stocks ........................................................................ 237
Multilateral Contracts........................................................ 239
Does the Fair Trade Movement Help Poor
Coffee Farmers? ............................................................. 239
The OPEC Oil Cartel .................................................................240

Maximizing Cartel Profits ................................................. 240
OPEC as a Cartel ............................................................... 242

Does Foreign Direct Investment
Hinder or Help Economic

Development?. . . . . . . . . . . . . . . . . . . . . . . . 244
Aiding the Developing Nations................................................244
The World Bank ................................................................. 245
International Monetary Fund........................................... 246
Generalized System of Preferences.................................... 247
Does Aid Promote Growth of Developing
Nations?.......................................................................... 248
How to Bring Developing Nations in from
the Cold.................................................................................. 248
Economic Growth Strategies: Import Substitution
versus Export Led Growth ..................................................250
Import Substitution ............................................................ 250
Import Substitution Laws Backfire on Brazil ................. 251
Export Led Growth............................................................. 252
Is Economic Growth Good for the Poor? ........................ 253

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x

Contents

Can All Developing Nations Achieve Export
Led Growth? .................................................................. 253

China’s Export Boom Comes at a Cost: How to

Make Factories Play Fair............................................. 260

East Asian Economies ................................................................254
Flying Geese Pattern of Growth........................................ 255

India: Breaking Out of the Third World...............................261

Is State Capitalism Winning? . . . . . . . . . 256

Summary........................................................................................264

China’s Great Leap Forward.....................................................257
Challenges for China’s Economy ...................................... 258

Key Concepts and Terms ..........................................................265

Brazil Takes off ............................................................................263

Study Questions ...........................................................................265

CHAPTER 8

Regional Trading Arrangements .......................................................... 267
Types of Regional Trading Arrangements ............................268

Optimum Currency Area................................................... 280
Eurozone’s Problems and Challenges............................... 281

Impetus for Regionalism............................................................270

European Monetary “Disunion”. . . . . . . 282

Regional Integration versus Multilateralism .........................267

Effects of a Regional Trading Arrangement .........................270
Static Effects......................................................................... 270
Dynamic Effects................................................................... 273

Is the U.S.–South Korea Free-Trade
Agreement Good for Americans? . . . . . 274
The European Union..................................................................274
Pursuing Economic Integration ........................................ 275
Agricultural Policy .............................................................. 276
Is the European Union Really a
Common Market? ......................................................... 278
Economic Costs and Benefits of a Common Currency:
The European Monetary Union ........................................280

Will the Eurozone Survive? ............................................... 283
North American Free Trade Agreement................................284
NAFTA’s Benefits and Costs for
Mexico and Canada............................................................ 285
NAFTA’s Benefits and Costs for the
United States.................................................................. 286
U.S.–Mexico Trucking Dispute ......................................... 288
U.S.–Mexico Tomato Dispute ........................................... 289
Is NAFTA an Optimum Currency Area?........................ 290
Summary........................................................................................291
Key Concepts and Terms ..........................................................292
Study Questions ...........................................................................292

Exploring Further ........................................................................293

CHAPTER 9

International Factor Movements and Multinational Enterprises..... 295
The Multinational Enterprise ...................................................295
Motives for Foreign Direct Investment..................................297
Demand Factors.................................................................. 298
Cost Factors ......................................................................... 298
Supplying Products to Foreign Buyers: Whether
to Produce Domestically or Abroad .................................299
Direct Exporting versus Foreign Direct
Investment/Licensing .................................................... 300
Foreign Direct Investment versus Licensing.................... 301
Country Risk Analysis................................................................302

Do U.S. Multinationals Exploit
Foreign Workers? . . . . . . . . . . . . . . . . . . . . 303
International Trade Theory and Multinational
Enterprise.................................................................................305
Japanese Transplants in the U.S. Automobile Industry.....305

Employment......................................................................... 310
Caterpillar Bulldozes Canadian Locomotive Workers ........ 311
Technology Transfer ........................................................... 312
National Sovereignty .......................................................... 314
Balance-of-Payments .......................................................... 315
Transfer Pricing .................................................................. 316
International Labor Mobility: Migration ...............................316

Apple Uses Tax Loopholes
to Dodge Taxes . . . . . . . . . . . . . . . . . . . . . . 317

The Effects of Migration .................................................... 318
Immigration as an Issue.................................................... 320
Does Canada’s Immigration Policy Provide
a Model for the United States? ................................... 322

Does U.S. Immigration Policy Harm
Domestic Workers?. . . . . . . . . . . . . . . . . . . 323

International Joint Ventures .....................................................307
Welfare Effects..................................................................... 308

Summary........................................................................................324

Multinational Enterprises as a Source of Conflict...............310

Study Questions ...........................................................................324

Key Concepts and Terms ..........................................................324

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Contents

PART 2 International Monetary Relations

xi

327

CHAPTER 10

The Balance-of-Payments ...................................................................... 329
Double Entry Accounting..........................................................329
Balance-of-Payments Structure ................................................331
Current Account ................................................................. 331
Capital and Financial Account......................................... 332

International Payments Process. . . . . . . 333

Official Settlements Transactions ..................................... 334
Special Drawing Rights ...................................................... 335
Statistical Discrepancy: Errors and Omissions ............... 336
U.S. Balance-of-Payments..........................................................337
What Does a Current Account Deficit (Surplus) Mean?........ 339
Net Foreign Investment and the Current
Account Balance............................................................ 340
Impact of Capital Flows on the Current Account ......... 340
Is a Current Account Deficit a Problem?........................ 341

The iPhone’s Complex Supply
Chain Depicts Limitations of
Trade Statistics . . . . . . . . . . . . . . . . . . . . . . 342

Business Cycles, Economic Growth, and the Current
Account........................................................................... 343
How the United States Has Borrowed at
Very Low Cost............................................................... 344
Do Current Account Deficits Cost
Americans Jobs? ............................................................ 345
Can the United States Continue to Run Current
Account Deficits Indefinitely?...................................... 346
Balance of International Indebtedness ...................................348
United States as a Debtor Nation .................................... 349

Global Imbalances. . . . . . . . . . . . . . . . . . . . 350
The Dollar as the World’s Reserve Currency.......................351
Benefits to the United States ............................................. 351
A New Reserve Currency?.................................................. 352
Summary........................................................................................353
Key Concepts and Terms ..........................................................354
Study Questions ...........................................................................354

CHAPTER 11

Foreign Exchange ................................................................................... 357
Foreign Exchange Market..........................................................357
Types of Foreign Exchange Transactions..............................359
Interbank Trading .......................................................................361
Reading Foreign Exchange Quotations ..................................363

Yen Depreciation Drives Toyota
Profits Upward. . . . . . . . . . . . . . . . . . . . . . . 366
Forward and Futures Markets ..................................................366

Foreign Currency Options.........................................................368
Exchange Rate Determination ..................................................369
Demand for Foreign Exchange ......................................... 369
Supply of Foreign Exchange .............................................. 369
Equilibrium Rate of Exchange .......................................... 370
Indexes of the Foreign-Exchange Value of the Dollar:
Nominal and Real Exchange Rates ...................................371
Arbitrage ........................................................................................373
The Forward Market...................................................................374
The Forward Rate............................................................... 375
Relation between the Forward
Rate and Spot Rate....................................................... 376
Managing Your Foreign Exchange Risk:
Forward Foreign Exchange Contract ......................... 377
Case 1................................................................................... 378
Case 2................................................................................... 378

How Markel, Volkswagen, and Nintendo
Manage Foreign Exchange Risk.................................. 379
Does Foreign Currency Hedging Pay Off?....................... 380

Currency Risk and the Hazards of
Investing Abroad. . . . . . . . . . . . . . . . . . . . . 381
Interest Arbitrage, Currency Risk, and Hedging .................382
Uncovered Interest Arbitrage ............................................ 382
Covered Interest Arbitrage (Reducing Currency Risk) ......383
Foreign Exchange Market Speculation ...................................384
Long and Short Positions .................................................. 385
Andy Krieger Shorts the New Zealand Dollar................ 385
George Soros Shorts the Yen ............................................. 385

People’s Bank of China Widens Trading Band
to Punish Currency Speculators.................................. 386
Stabilizing and Destabilizing Speculation ....................... 386
Foreign Exchange Trading as a Career ..................................387
Foreign Exchange Traders Hired by Commercial
Banks, Companies, and Central Banks ..................... 387

How to Play the Falling (Rising) Dollar. . . 388

Currency Markets Draw Day Traders............................. 389
Summary........................................................................................390
Key Concepts and Terms ..........................................................390
Study Questions ...........................................................................390
Exploring Further ........................................................................392

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xii Contents

CHAPTER 12

Exchange Rate Determination .............................................................. 393
What Determines Exchange Rates?.........................................393
Determining Long Run Exchange Rates................................395
Relative Price Levels ........................................................... 396
Relative Productivity Levels............................................... 396

Preferences for Domestic or Foreign Goods .................... 396
Trade Barriers ..................................................................... 398

Expected Change in the Exchange Rate .......................... 407
Diversification, Safe Havens,
and Investment Flows .................................................. 408

International Comparisons of GDP:
Purchasing-Power-Parity. . . . . . . . . . . . . . 409
Exchange Rate Overshooting....................................................410

Inflation Rates, Purchasing-Power-Parity,
and Long Run Exchange Rates ..........................................398
Law of One Price................................................................ 398
Burgeromics: The “Big Mac” Index and the
Law of One Price .......................................................... 399
Purchasing-Power-Parity ................................................... 400

Forecasting Foreign Exchange Rates.......................................411
Judgmental Forecasts.......................................................... 412
Technical Forecasts ............................................................. 413
Fundamental Analysis........................................................ 414

Inflation Differentials and the
Exchange Rate. . . . . . . . . . . . . . . . . . . . . . . 401

Summary........................................................................................416

Determining Short Run Exchange Rates:
The Asset Market Approach...............................................404

Relative Levels of Interest Rates........................................ 405

Study Questions ...........................................................................416

Commercial Mexicana Gets
Burned by Speculation . . . . . . . . . . . . . . . 415
Key Concepts and Terms ..........................................................416
Exploring Further ........................................................................418

CHAPTER 13

Mechanisms of International Adjustment........................................... 419
Price Adjustments........................................................................420

Disadvantages of Automatic Adjustment Mechanisms.........424

Gold Standard ..................................................................... 420

Monetary Adjustments...............................................................425

Quantity Theory of Money ............................................... 420
Current Account Adjustment............................................ 421
Financial Flows and Interest Rate Differentials ...................422
Income Adjustments...................................................................423

Summary........................................................................................425
Key Concepts and Terms ..........................................................426
Study Questions ...........................................................................426
Exploring Further ........................................................................426

CHAPTER 14

Exchange Rate Adjustments and the Balance-of-Payments ............ 427
Effects of Exchange Rate Changes
on Costs and Prices ..............................................................427
Case 1: No Foreign Sourcing—All Costs Are
Denominated in Dollars............................................... 428
Case 2: Foreign Sourcing—Some Costs Denominated
in Dollars and Some Costs Denominated
in Francs ........................................................................ 428
Cost Cutting Strategies of Manufacturers in
Response to Currency Appreciation .................................430
Appreciation of the Yen: Japanese
Manufacturers ............................................................... 430

Japanese Firms Send Work Abroad as
Rising Yen Makes Their Products Less
Competitive . . . . . . . . . . . . . . . . . . . . . . . . . 432
Appreciation of the Dollar:
U.S. Manufacturers....................................................... 432

Will Currency Depreciation Reduce a
Trade Deficit? The Elasticity Approach...........................433
J–Curve Effect: Time Path of Depreciation ..........................436
Exchange Rate Pass-Through ...................................................438
Partial Exchange Rate Pass-Through............................... 438

Does Currency Depreciation Give Weak
Countries a Way out of Crisis?. . . . . . . . 441
The Absorption Approach to Currency

Depreciation............................................................................441
The Monetary Approach to Currency Depreciation ..........442
Summary........................................................................................443
Key Concepts and Terms ..........................................................444
Study Questions ...........................................................................444
Exploring Further ........................................................................444

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xiii

CHAPTER 15

Exchange Rate Systems and Currency Crises.................................... 445
Exchange Rate Practices.............................................................445

The Crawling Peg ........................................................................462

Choosing an Exchange Rate System: Constraints
Imposed by Free Capital Flows..........................................447

Currency Manipulation and Currency Wars........................462
Is China a Currency Manipulator?.................................. 464

Fixed Exchange Rate System ....................................................448
Use of Fixed Exchange Rates ............................................ 448
Par Value and Official Exchange Rate............................ 450
Exchange Rate Stabilization.............................................. 450
Devaluation and Revaluation ........................................... 452
Bretton Woods System of Fixed Exchange Rates ........... 452
Floating Exchange Rates ............................................................453
Achieving Market Equilibrium ......................................... 454
Trade Restrictions, Jobs, and Floating
Exchange Rates.............................................................. 455
Arguments for and against Floating Rates ..................... 455
Managed Floating Rates.............................................................456
Managed Floating Rates in the Short
Run and Long Run....................................................... 457
Exchange Rate Stabilization and Monetary Policy........ 459
Is Exchange Rate Stabilization Effective? ........................ 461

Currency Crises............................................................................465

The Global Financial Crisis
of 2007–2009. . . . . . . . . . . . . . . . . . . . . . . . . 466

Sources of Currency Crises ................................................ 468
Speculators Attack East Asian Currencies....................... 469
Capital Controls ...........................................................................470
Should Foreign Exchange Transactions be Taxed? ........ 471
Increasing the Credibility of Fixed Exchange Rates ...........472
Currency Board................................................................... 472
For Argentina, No Panacea in a Currency Board......... 474
Dollarization........................................................................ 475

Summary........................................................................................477
Key Concepts and Terms ..........................................................478
Study Questions ...........................................................................478

CHAPTER 16

Macroeconomic Policy in an Open Economy ..................................... 479
Economic Objectives of Nations..............................................479
Policy Instruments.......................................................................480
Aggregate Demand and Aggregate Supply:
a Brief Review.........................................................................480
Monetary and Fiscal Policy in a Closed Economy .............481
Monetary and Fiscal Policy in an Open Economy .............483
Effect of Fiscal and Monetary Policy under
Fixed Exchange Rates................................................... 484
Effect of Fiscal and Monetary Policy under
Floating Exchange Rates .............................................. 486
Macroeconomic Stability and the Current Account:
Policy Agreement versus Policy Conflict.........................486

Monetary and Fiscal Policy Respond to
Financial Turmoil in the Economy. . . . . 487
Inflation with Unemployment..................................................488
International Economic Policy Coordination.......................488
Policy Coordination in Theory ......................................... 489
Does Policy Coordination Work? ..................................... 491

Does Crowding Occur in an
Open Economy?. . . . . . . . . . . . . . . . . . . . . . 492
Summary........................................................................................493

Key Concepts and Terms ..........................................................493
Study Questions ...........................................................................494

CHAPTER 17

International Banking: Reserves, Debt, and Risk ............................... 495
Nature of International Reserves .............................................495
Demand for International Reserves ........................................496
Exchange Rate Flexibility................................................... 496
Other Determinants............................................................ 498
Supply of International Reserves .............................................499
Foreign Currencies ......................................................................499
Gold ................................................................................................ 500
International Gold Standard............................................. 501
Gold Exchange Standard ................................................... 501

Demonetization of Gold..................................................... 502
Should the United States Return to the
Gold Standard?.............................................................. 503
Special Drawing Rights ..............................................................503
Facilities for Borrowing Reserves.............................................504
IMF Drawings ..................................................................... 504
General Arrangements to Borrow .................................... 504
Swap Arrangements............................................................ 505
International Lending Risk........................................................505

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Contents

The Problem of International Debt ........................................506
Dealing with Debt Servicing Difficulties.......................... 507
Reducing Bank Exposure to Developing
Nation Debt ............................................................................508
Debt Reduction and Debt Forgiveness...................................509

The Eurodollar Market...............................................................510
Summary........................................................................................511
Key Concepts and Terms ..........................................................511
Study Questions ...........................................................................511

Glossary ...............................................................................................................513
Index ....................................................................................................................527

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Preface
I believe the best way to motivate students to learn a subject is to demonstrate how it is
used in practice. The first fourteen editions of International Economics reflected this
belief and were written to provide a serious presentation of international economic theory with an emphasis on current applications. Adopters of these editions strongly supported the integration of economic theory with current events.

The fifteenth edition has been revised with an eye toward improving this presentation
and updating the applications as well as including the latest theoretical developments.
Like its predecessors, this edition is intended for use in a one-quarter or one-semester
course for students having no more background than principles of economics. This
book’s strengths are its clarity, organization, and applications that demonstrate the usefulness of theory to students. The revised and updated material in this edition emphasizes current applications of economic theory and incorporates recent theoretical and
policy developments in international trade and finance.

INTERNATIONAL ECONOMICS THEMES
This edition highlights five current themes that are at the forefront of international
economics:
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GLOBALIZATION OF ECONOMIC ACTIVITY
Wooster, Ohio bears brunt of globalization—Ch. 2
Japan fades in the global electronics industry—Ch. 3
Comparative advantage and global supply chains—Ch. 2
Caterpillar bulldozes Canadian locomotive workers—Ch. 9
Apple uses tax loopholes to dodge taxes—Ch. 9
Diesel engines and gas turbines as engines of growth—Ch. 1
Waves of globalization—Ch. 1
Has globalization gone too far?—Ch. 1
Putting the H-P Pavilion together—Ch. 1
Is the United States losing its innovation edge?—Ch. 1
Rising transportation costs hinder globalization—Ch. 3
iPhone’s complex supply chain highlights limitations of trade statistics—Ch. 10
Constraints imposed by capital flows on the choice of an exchange rate system—
Ch. 15
FREE TRADE AND PROTECTIONISM
Whirlpool wins dumping case—Ch. 5
Wage increases and China’s trade—Ch. 3
Should shoe tariffs be stomped out?—Ch. 4
Natural gas boom fuels trade debate—Ch.2
Element Electronics brings TV manufacturing back to the United States—Ch. 1
Carbon tariffs—Ch. 6
Averting trade barriers during the Great Recession—Ch. 6
Bangladesh’s sweatshop reputation—Ch. 7
xv

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xvi

Preface

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Does the principle of comparative advantage apply in the face of job
outsourcing?—Ch. 2
Boeing outsources work, but protects its secrets—Ch. 2
Does trade make the poor even poorer?—Ch. 3
WTO rules against subsidies to Boeing and Airbus—Ch. 3
Does wage insurance make free trade more acceptable to workers?—Ch. 6
China’s hoarding of rare earth metals declared illegal by WTO—Ch. 6
The environment and free trade—Ch. 6

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TRADE CONFLICTS BETWEEN DEVELOPING NATIONS
AND INDUSTRIAL NATIONS
U.S.-Mexico tomato dispute—Ch. 8
Is state capitalism winning?—Ch. 7
Canada’s immigration policy—Ch. 9
Is international trade a substitute for migration?—Ch. 3
Economic growth strategies–import substitution versus export led growth—Ch. 7
Does foreign aid promote the growth of developing countries?—Ch. 7
The globalization of intellectual property rights—Ch. 7
How to bring in developing countries from the cold—Ch. 7
Microsoft scorns China’s piracy of software—Ch. 6
The Doha Round of multilateral trade negotiations—Ch. 6
Wage increases work against China’s competitiveness—Ch. 7
China’s export boom comes at a cost: How to make factories play fair—Ch. 7
Will emerging economies soon outstrip the rich ones?—Ch. 7
Do U.S. multinationals exploit foreign workers?—Ch. 9

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LIBERALIZING TRADE: THE WTO VERSUS REGIONAL TRADING
ARRANGEMENTS
Does the WTO reduce national sovereignty?—Ch. 6
Regional integration versus multilateralism—Ch. 8
Is Europe really a common market?—Ch. 8
The U.S.-South Korea Free Trade Agreement—Ch. 8
NAFTA and the U.S.-Mexico trucking dispute—Ch. 8
Will the euro survive?—Ch. 8

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TURBULENCE IN THE GLOBAL FINANCIAL SYSTEM
Yen’s depreciation drives Toyota’s profits upward—Ch. 11
People’s Bank of China punishes speculators—Ch. 11

Can the euro survive?—Ch. 8
Does currency depreciation give weak countries a way out of crisis?—Ch. 14
Currency manipulation and currency wars—Ch. 15
Paradox of foreign debt: how the United states borrows at low cost—Ch. 10
Mistranslation of news story roils currency markets—Ch. 12
Why a dollar depreciation may not close the U.S. trade deficit—Ch. 14
Japanese firms send work abroad as yen makes its products less
competitive—Ch.14
Preventing currency crises: Currency boards versus dollarization—Ch. 15
Should Special Drawing Rights replace the dollar as the world’s reserve
currency?—Ch. 17
Should the United States return to the gold standard?—Ch. 17

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Preface

xvii

Besides emphasizing current economic themes, the fifteenth edition of this text contains many new topics such as outsourcing and the U.S. auto industry, U.S. safeguards
limiting imports of textiles from China, why Italian shoemakers strive to give the euro
the boot, bike imports that forced Schwinn to downshift, and how currency markets
draw day traders. Faculty and students will appreciate how this edition provides a contemporary approach to international economics.

ORGANIZATIONAL FRAMEWORK: EXPLORING
FURTHER SECTIONS

Although instructors generally agree on the basic content of the international economics
course, opinions vary widely about what arrangement of material is appropriate. This book
is structured to provide considerable organizational flexibility. The topic of international
trade relations is presented before international monetary relations, but the order can be
reversed by instructors choosing to start with monetary theory. Instructors can begin with
Chapters 10–17 and conclude with Chapters 2–9. Those who do not wish to cover all the
material in the book can easily omit all or parts of Chapters 6–9, and Chapters 15–17
without loss of continuity.
The fifteenth edition streamlines its presentation of theory to provide greater flexibility for instructors. This edition uses online Exploring Further sections to discuss more
advanced topics. By locating the Exploring Further sections online rather than in the
textbook, as occurred in previous editions, more textbook coverage can be devoted to
contemporary applications of theory. The Exploring Further sections consist of the
following:
Comparative advantage in money terms—Ch. 2
Indifference curves and trade—Ch. 2
Offer curves and the equilibrium terms of trade—Ch. 2
The specific-factors theory—Ch. 3
Offer curves and tariffs—Ch. 4
Tariff-rate quota welfare effects—Ch. 5
Export quota welfare effects—Ch. 5
Welfare effects of strategic trade policy—Ch. 6
Government procurement policy and the European Union—Ch. 8
Economies of scale and NAFTA—Ch. 8
Techniques of foreign-exchange market speculation—Ch. 11
A primer on foreign-exchange trading—Ch. 11
Fundamental forecasting–regression analysis—Ch. 12
Income adjustment mechanism—Ch. 13
Exchange-rate pass-through—Ch. 14
To access the Exploring Further sections, go to www.cengagebrain.com.

SUPPLEMENTARY MATERIALS
For Students
International Economics CourseMate (www.cengagebrain.com)
In this age of technology, no text package would be complete without Web-based
resources. An international economics CourseMate product is offered with the fifteenth
edition.
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Preface

Within the online study tool CourseMate, students will find a vast amount of
resources for self-study including access to the eBook, glossary, online quizzes, videos,
graphing workshop games, EconApps, and flashcards. Students can purchase CourseMate at www.cengagebrain.com.

Study Guide
To accompany the fifteenth edition of the International Economics text, Jim Hanson
(Professor Emeritus at Willlamette University) has prepared an online Study Guide for
students. This guide reinforces key concepts by providing a review of the text’s main
topics and offering practice problems, true–false, multiple choice, and short–answer
questions. The Study Guide is available online only and students can purchase it at
www.cengagebrain.com.

For Instructors
International Economics CourseMate (www.cengagebrain.com)

Through CourseMate, instructors have access to Engagement Tracker that is designed to
assess that students have read the material or viewed the resources that you’ve assigned.
Engagement Tracker assesses student preparation and engagement. Using the tracking
tools enables you to see progress for the class as a whole or for individual students, identify students at risk early in the course, and uncover which concepts are most difficult for
your class.

Aplia
Aplia is another feature of the fifteenth edition. With Aplia, international economics
students use interactive chapter assignments and tutorials to make economics relevant
and engaging. Students complete online assignments to improve their proficiency in
understanding economic theory and they receive immediate, detailed explanations for
every answer. Math and graphing tutorials help students overcome deficiencies in these
crucial areas.

PowerPoint Slides
The fifteenth edition also includes PowerPoint slides created by Syed H. Jafri of Tarleton
State University. These slides can be easily downloaded from the Carbaugh Website
available for instructors-only at . Slides may be edited to meet
individual needs. They also serve as a study tool for students.

Instructor’s Manual
To assist instructors in the teaching of international economics, there is an Instructor’s
Manual with Test Bank that accompanies the fifteenth edition. The manual contains:
(1) brief answers to end-of-chapter study questions; (2) multiple choice; and (3) true–
false questions for each chapter. The Instructor’s Manual with Test Bank is available for
download for qualified instructors from the Carbaugh Website for instructors-only at
www.cengagebrain.com.

Study Guide
To accompany the fifteenth edition of the International Economics, Jim Hanson (Professor Emeritus at Willlamette University) has prepared an online Study Guide for students.

This guide reinforces key concepts by providing a review of the text’s main topics and
offering practice problems, true–false, multiple choice and short–answer questions. The
Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
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Preface

xix

Study Guide is only available online and students can purchase it at www.cengagebrain.
com. Instructors can view the online Study Guide through .

Compose
Compose is the home of Cengage Learning’s online digital content. Compose provides
the fastest, easiest way for you to create your own learning materials. South–Western’s
Economic Issues and Activities content database includes a wide variety of highinterest, current event/policy applications as well as classroom activities designed specifically to enhance economics courses. Choose just one reading or many—even add your
own material—to create an accompaniment to the textbook that is perfectly customized
to your course. Contact your South–Western/Cengage Learning sales representative for
more information.

ACKNOWLEDGMENTS
I am pleased to acknowledge those who aided me in preparing the current and past editions of this textbook. Helpful suggestions and often detailed reviews were provided by:
Sofyan Azaizeh, University of New Haven
J. Bang, St. Ambrose University
Burton Abrams, University of Delaware
Abdullah Khan, Kennesaw State University
Richard Adkisson, New Mexico State University

Richard Anderson, Texas A&M
Brad Andrew, Juniata College
Richard Ault, Auburn University
Mohsen Bahmani-Oskooee, University of Wisconsin—Milwaukee
Kevin Balsam, Hunter College
Kelvin Bentley, Baker College Online
Robert Blecker, Stanford University
Scott Brunger, Maryville College
Jeff W. Bruns, Bacone College
Roman Cech, Longwood University
John Charalambakis, Asbury College
Mitch Charkiewicz, Central Connecticut State University
Xiujian Chen, California State University, Fullerton
Miao Chi, University of Wisconsin—Milwaukee
Howard Cochran, Jr., Belmont University
Charles Chittle, Bowling Green University
Christopher Cornell, Fordham University
Elanor Craig, University of Delaware
Manjira Datta, Arizona State University
Ann Davis, Marist College
Earl Davis, Nicholls State University
Juan De La Cruz, Fashion Institute of Technology
Firat Demir, University of Oklahoma
Gopal Dorai, William Paterson College
Veda Doss, Wingate University
Seymour Douglas, Emory University
Carolyn Fabian Stumph, Indiana University—Purdue University Fort Wayne
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xx

Preface

Farideh Farazmand, Lynn University
Daniel Falkowski, Canisius College
Patrice Franko, Colby College
Emanuel Frenkel, University of California—Davis
Norman Gharrity, Ohio Wesleyan University
Sucharita Ghosh, University of Akron
Jean-Ellen Giblin, Fashion Institute of Technology (SUNY)
Leka Gjolaj, Baker College
Thomas Grennes, North Carolina State University
Darrin Gulla, University of Kentucky
Li Guoqiang, University of Macau (China)
William Hallagan, Washington State University
Jim Hanson, Willamette University
Bassam Harik, Western Michigan University
Clifford Harris, Northwood University
John Harter, Eastern Kentucky University
Seid Hassan, Murray State University
Phyllis Herdendorf, Empire State College (SUNY)
Pershing Hill, University of Alaska—Anchorage
David Hudgins, University of Oklahoma
Ralph Husby, University of Illinois—Urbana/Champaign
Robert Jerome, James Madison University
Mohamad Khalil, Fairmont State College

Wahhab Khandker, University of Wisconsin—La Crosse
Robin Klay, Hope College
William Kleiner, Western Illinois University
Anthony Koo, Michigan State University
Faik Koray, Louisiana State University
Peter Karl Kresl, Bucknell University
Fyodor Kushnirsky, Temple University
Daniel Lee, Shippensburg University
Edhut Lehrer, Northwestern University
Jim Levinsohn, University of Michigan
Martin Lozano, University of Manchester, UK
Benjamin Liebman, St. Joseph’s University
Susan Linz, Michigan State University
Andy Liu, Youngstown State University
Alyson Ma, University of San Diego
Mike Marks, Georgia College School of Business
Michael McCully, High Point University
Neil Meredith, West Texas A&M University
John Muth, Regis University
Al Maury, Texas A&I University
Tony Mutsune, Iowa Wesleyan College
Jose Mendez, Arizona State University
Roger Morefield, University of St. Thomas
Mary Norris, Southern Illinois University
John Olienyk, Colorado State University
Shawn Osell, Minnesota State University—Mankato
Terutomo Ozawa, Colorado State University
Peter Petrick, University of Texas at Dallas
Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

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Preface

xxi

Gary Pickersgill, California State University, Fullerton
William Phillips, University of South Carolina
John Polimeni, Albany College of Pharmacy and Health Sciences
Rahim Quazi, Prairie View A&M University
Chuck Rambeck, St. John’s University
Elizabeth Rankin, Centenary College of Louisiana
Teresita Ramirez, College of Mount Saint Vincent
Surekha Rao, Indiana University Northwest
James Richard, Regis University
Suryadipta Roy, High Point University
Daniel Ryan, Temple University
Manabu Saeki, Jacksonville State University
Nindy Sandhu, California State University, Fullerton
Jeff Sarbaum, University of North Carolina, Greensboro
Anthony Scaperlanda, Northern Illinois University
Juha Seppälä, University of Illinois
Ben Slay, Middlebury College (now at PlanEcon)
Gordon Smith, Anderson University
Sylwia Starnawska, Empire State College (SUNY)
Steve Steib, University of Tulsa
Robert Stern, University of Michigan
Paul Stock, University of Mary Hardin—Baylor

Laurie Strangman, University of Wisconsin—La Crosse
Hamid Tabesh, University of Wisconsin–River Falls
Manjuri Talukdar, Northern Illinois University
Nalitra Thaiprasert, Ball State University
William Urban, University of South Florida
Jorge Vidal, The University of Texas Pan American
Adis M. Vila, Esq., Winter Park Institute Rollins College
Grace Wang, Marquette University
Jonathan Warshay, Baker College
Darwin Wassink, University of Wisconsin—Eau Claire
Peter Wilamoski, Seattle University
Harold Williams, Kent State University
Chong Xiang, Purdue University
Elisa Quennan, Taft College
Afia Yamoah, Hope College
Hamid Zangeneh, Widener University
I would like to thank my colleagues at Central Washington University—Tim Dittmer,
David Hedrick, Koushik Ghosh, Roy Savoian, Peter Saunders, Toni Sipic, and Chad
Wassell—for their advice and help while I was preparing the manuscript. I am also
indebted to Shirley Hood who provided advice in the manuscript’s preparation.
It has been a pleasure to work with the staff of Cengage Learning, especially Steven
Scoble, who provided many valuable suggestions and assistance in seeing this edition to
its completion. Thanks also to Jeffrey Hahn who orchestrated the development of this
book in conjunction with Tintu Thomas, project manager at Integra Software Services.
I also appreciate the meticulous efforts that Hyde Park Publishing Services did in the
copyediting of this textbook. Finally, I am grateful to my students, as well as faculty
and students at other universities, who provided helpful comments on the material contained in this new edition.
Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.