International economics a heterodox approach 3rd edition

1.4.11.4.21.5 1.5.11.5.21.5.31.5.41.6 1.6.11.6.21.6.31.6.41.6.51.7 The Gains from Dealing with StrangersThe Three Benefits of Human Interaction Are IntertwinedDependence on Strangers Is

Now in its third edition, Hendrik Van den Berg’s International Economics: A Heterodox

Approach covers all of the standard topics taught in undergraduate international economics courses.Written in a friendly and approachable style, this new edition is unique in that it presents the keyorthodox neoclassical models of international trade and investment, while supplementing them with avariety of heterodox approaches This pluralist approach is intended to give economics students amore realistic understanding of the international economy than standard textbooks can provide

Changes to the new edition include:

updates throughout to reflect recent world events, including coverage of trade negotiations and theGreek crisis;

expanded discussion of pluralist approaches with more coverage of alternative schools of

thought;

discussions of the growing financialization of global economic activity;

additional real-world examples;

increased coverage of environmental issues; transnational corporations and their behavior in theinternational economy; the difference between international investment and international finance;and monetary history;

a consolidated and updated chapter on international banking

This book also maintains a broad perspective that links economic activity to the social and naturalspheres of human activity, with emphasis on the distributional and environmental effects of

international trade, investment, finance, and migration Chapter summaries, key terms and concepts,problems and questions, and a glossary are included in the book A Student Study Guide and an

Instructor’s Manual are available online

Hendrik Van den Berg is Professor Emeritus at the University of Nebraska, and he continues

teaching at Mount Holyoke College in Massachusetts, USA

Third edition published 2017

by Routledge

711 Third Avenue, New York, NY 10017

and by Routledge

2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN

Routledge is an imprint of the Taylor & Francis Group, an informa business

© 2017 Taylor & Francis

The right of Hendrik Van den Berg to be identified as author of this work has been asserted by him in accordance with sections 77 and

78 of the Copyright, Designs and Patents Act 1988.

All rights reserved No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers.

Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe.

First edition published by M.E Sharpe 2012

Second edition published by Routledge 2015

Library of Congress Cataloging in Publication Data

Names: Van den Berg, Hendrik, 1949- author.

Title: International economics : a heterodox approach / Hendrik van den Berg.

Description: 3rd edition | New York, NY : Routledge, 2017.

Identifiers: LCCN 2016022783| ISBN 9781138945043 (hardback) | ISBN 9781138945050 (pbk.) | ISBN 9781315671611 (ebook)

Subjects: LCSH: International trade | Protectionism | Investments, Foreign.| International finance | International economic relations | Emigration and immigration.

Typeset in 10/12pt Bembo MT Pro

by Cenveo Publisher Services

Visit the companion website: www.routledge.com/vandenberg

1.4.11.4.21.5

1.5.11.5.21.5.31.5.41.6

1.6.11.6.21.6.31.6.41.6.51.7

The Gains from Dealing with StrangersThe Three Benefits of Human Interaction Are IntertwinedDependence on Strangers Is Inherently Problematic

The Crucial Role of InstitutionsInstitutions Evolve Slowly and UnevenlyThe Evolution of International Economic Integration

The Growth of International TradeThe Growth of International Investment and FinanceInternational Migration

International Economic Integration Is Far from Complete

Economic Integration Is Not InevitableNew Concerns about International Economic IntegrationThe Field of International Economics

The Bias of Mainstream Economic AnalysisThe Spheres of Human Existence

The Natural EnvironmentSocial Stress

How Economists Deal with Complexity

Economic ModelsThe Dangers Lurking Behind Economic ModelsThe Tyranny of Models and Paradigms

The Pro-Globalization Culture of International EconomicsHeterodoxy

Summary and ConclusionsChapter Summary

Key Terms and Concepts

Problems and Questions

Notes

2

2.1

2.1.12.1.22.1.32.1.42.2

2.2.12.2.22.2.32.3

2.3.12.3.22.4

2.4.12.4.22.4.32.4.42.5

PART II

3

3.1

3.1.13.1.23.1.33.1.43.1.53.1.63.2

3.2.13.2.23.2.33.2.43.3

3.3.13.3.23.3.3

Introduction to Heterodoxy

Holism and Economics

The System Versus the Parts

Do Systems Move Toward Stable Equilibria?

Holism and ScienceCan the Scientific Method Ever Uncover Absolute Truth?

Economists and Complex Systems

Economists’ Embrace of Scientific ReductionismThe Neoclassical School

The Unbelievable Assumptions Behind Neoclassical ModelsThe Common Themes of Heterodoxy

Some Heterodox Ideas that Differ from Orthodox Economic ThinkingHeterodoxy and Economic Policy

A Sociological Justification for Heterodoxy

Institutions and CulturePierre Bourdieu’s Analysis of CulturesSymbolic Violence

A Sociology of International EconomicsConclusions and Further Thoughts

Key Terms and Concepts

Problems and Questions

Notes

INTERNATIONAL TRADE THEORY Orthodox International Trade Theory: Why Mainstream Economists Like Free Trade

A Simple Version of the Heckscher–Ohlin Model of International Trade

The Production Possibilities FrontierConsumer Demand and Indifference CurvesIndividual Indifference Curves and Society’s Indifference CurveCombining the Supply and Demand Sides

The Gain from International TradeThe Gain from International Specialization

Do All Nations Gain from Trade?

Why Production Possibilities Frontiers Differ from Country to Country

A Two-Country Model of TradeThe Principle of Comparative AdvantageDavid Ricardo’s Example of Comparative AdvantageInternational Trade and the Distribution of Income

International Trade and Factor ReturnsThe Heckscher–Ohlin Theorem

The Stolper–Samuelson Theorem

3.4.13.4.23.4.33.5

3.5.13.5.23.5.33.5.43.6

4

4.1

4.1.14.1.24.1.34.1.44.1.54.1.64.2

4.2.14.2.24.2.34.3

4.3.14.3.24.3.34.3.44.3.54.4

4.4.14.4.24.4.34.4.44.4.54.4.6

The Factor Price Equalization TheoremEstimating the Precise Distributional Effects of TradeEvaluating the Heckscher–Ohlin Model

Evaluating the HO Model and the Gains from TradeSome Especially Dangerous Assumptions of the HO ModelHow Important Is the Welfare Gain from Trade?

Supply and Demand Analysis of Trade

Producer and Consumer SurplusFrom the HO Model to the Partial Equilibrium ModelFrom the Supply and Demand Diagram to the Gains from TradeComparing the Partial and General Equilibrium Models

ConclusionsChapter Summary

Key Terms and Concepts

Problems and Questions

Notes

International Trade: Beyond the Neoclassical Perspective

Transport and Transactions Costs

Transport CostsThe History of Transport CostsCase Study: Afghan Warlords and Transport CostsNetwork Effects and Trade

Transactions Costs and the Gravity Model of TradeTentative Conclusions

The Costs of Adjusting to Free Trade

Costly Economic Adjustments to Free TradeThe Fixed-Factors Model

Trade and JobsInternational Trade, Income Inequality, and Welfare

A Simple Model of the Distribution of Trade’s Welfare Effects

In Search of a More Accurate Welfare FunctionPsychology and Life Satisfaction

Evidence from Neuroscientific ResearchHappiness Surveys

Externalities, Prices, and International Trade

Modeling ExternalitiesShifting GHG Emissions to Developing CountriesExternalities Associated with Transport

GHGs Embedded in U.K TradeAnother Example of Embedded GHGsPolicies for Adjusting Trade for Embedded GHGs

5

5.1

5.1.15.1.25.1.35.1.45.1.55.2

5.2.15.2.25.2.35.2.45.3

5.3.15.3.25.4

5.4.15.4.25.4.35.4.45.4.55.4.65.5

5.5.15.5.25.5.35.6

6

6.1

6.1.16.1.2

ConclusionsChapter Summary

Key Terms and Concepts

Problems and Questions

Notes

International Trade: Imperfect Competition and Transnational Corporations

Increasing Returns to Scale and International Trade

Intra-Industry TradeModeling Increasing Returns to Scale

An Example of Two Identical CountriesKrugman’s Model of Variety, Increasing Returns, and TradeSome Further Implications of the Model

Another Implication of Imperfect Competition: Transnational Corporations

Foreign Direct InvestmentVertical and Horizontal Foreign Direct Investment

A Brief History of Transnational CorporationsTNCs and International Trade

Explaining the Growth of Transnational Corporations

Why Transnational Corporations Dominate the Economic SphereTransnational Corporations Are Controversial

Comparative Advantage and International Marketing

Comparative Advantage and Competitive AdvantageMarketing and the Perceived Value of a ProductCustomers Are Not All the Same

Should the Product Look Local or Foreign?

Market SegmentationMarketing and Transnational CorporationsThe Implications of the Growth of Transnational Corporations

Managed TradeTransnational Corporations and Economic PolicyTransnational Corporations and National SovereigntyConclusions

Chapter Summary

Key Terms and Concepts

Problems and Questions

Notes

International Trade and Economic Development

The Growth of International Trade

Why Growth Matters: The Power of CompoundingStatistical Evidence on Trade and Growth

6.2.16.2.26.2.36.2.46.3

6.3.16.3.26.3.36.3.46.3.56.4

6.4.16.4.26.4.36.4.46.4.56.5

6.5.16.5.26.6

6.6.16.6.26.6.36.6.46.6.56.7

7

7.1

7.1.17.1.27.1.37.1.4

Cross-Section StudiesTime-Series StudiesThe Relationship between International Trade and InstitutionsThe Stolper–Samuelson Theorem and Long-Run Economic ChangeThe Solow Growth Model

Technological Progress and Factor AccumulationIncreased Investment Brings Only Medium-Run GrowthDoes International Trade Only Create Medium-Run Growth Too?Technological Change and Permanent Growth

Technology and Technological Progress

Human TechnologyTechnological Progress Is a Combinatorial ProcessTechnological Change Is Path Dependent

Not All New Technology Constitutes ProgressTechnological Change and AgglomerationJoseph Schumpeter’s Model of Creative Destruction

Fundamental Ideas Behind Schumpeter’s ModelRecent “Schumpeterian” Models of Technological ProgressThe Cost of Innovation

The Gains from Innovation Depend on the Speed of InnovationThe Equilibrium Rate of Technological Progress

International Trade and Economic Development

The Combinatorial Process and International TradeThe Geographic Diffusion of Technology

Economic Growth, Trade, and the Environment

The Clash Between Economic Growth and the EnvironmentAre There Limits to Growth?

Optimists, Skeptics, and Scientists

We Should Be ConcernedMust We Stop Economic Growth to Survive?

Conclusions and ImplicationsChapter Summary

Key Terms and Concepts

Problems and Questions

Notes

International Trade, Human Happiness, and Inequality

Income Inequality

Measuring InequalityThe Lorenz CurveThe Distribution of Income in Distant HistoryGlobal Measures of Income Inequality

7.2.17.2.27.2.37.2.47.3

7.3.17.3.27.3.37.3.47.3.57.3.67.3.77.4

7.4.17.4.27.4.37.4.47.5

PART III

8

8.1

8.1.18.1.28.1.38.1.48.1.58.1.68.1.78.1.88.2

8.2.18.2.28.2.38.2.48.2.5

The Distribution of Wealth

Is there an Optimal Level of Equality?

Elements of a Just SocietyRawls’s Veil of IgnoranceThe Psychological Basis for Economic EqualityThe Relationship between Social and Economic JusticeInternational Trade’s Effect on the Distribution of Income

Vernon’s Product Cycle ModelMore Leader–Follower ModelsInternational Trade and Technology DiffusionGeographic Concentration of Innovative ActivityThe Agglomeration of Innovative Activity

Changing Patterns of Economic ActivitySpecialized Agglomeration

Transnational Corporations, Agglomeration, and Technology

Foreign Direct Investment, Trade, and Technology FlowsReassessing the Gains from Trade When It Diffuses TechnologyImmiserizing Growth

The Long-Run Dynamics of International Investment and Knowledge TransfersTrade and the World Distribution of Income: A Conclusion

Chapter Summary

Key Terms and Concepts

Problems and Questions

A Numerical Example of a Specific Tariff

A Tariff in the Heckscher–Ohlin ModelThe Lerner Symmetry Theorem

Summarizing the Welfare Effects of a TariffHow Much Protection Does a Tariff Really Provide?

Average Tariff RatesQuotas

A Quota in the Supply and Demand Model of TradeThe Welfare Effects of a Quota

Who Gets to Import and Collect the Quota Rent?

A Numerical Example of a QuotaVoluntary Export Restraints (VERs)

8.3.18.3.28.3.38.3.48.4

8.4.18.4.28.4.38.4.48.5

8.5.18.5.28.5.38.5.48.5.58.5.68.6

9

9.1

9.1.19.1.29.1.39.1.49.1.59.1.69.2

9.2.19.2.29.2.39.2.49.2.59.2.69.3

Auction QuotasAre Tariffs and Quotas Equivalent?

Other Trade Barriers

Export Bans to Insure Against Domestic ShortagesUsing Bureaucratic Procedures to Impede International Trade

“Buy Domestic” RegulationsLocal Restrictions on Foreign TradeExport Taxes and Subsidies

Export TaxesPrice Elasticity and Export TaxesWhy Doesn’t the United States Tax Exports?

Export SubsidiesAntidumping Procedures, Surge Protection, and Sanctions

Defining DumpingHow the U.S Government “Proves” DumpingPrice Discrimination Does Not Necessarily Imply DumpingCountervailing Duties and Surge Protection

Trade SanctionsNational SecurityConclusions

Chapter Summary

Key Terms and Concepts

Problems and Questions

Notes

Appendix: The Complete Analysis of a Tariff in a General Equilibrium HO Model

The History of Trade Policy

The Political Economy of International Trade

The Median Voter ModelThe Uninformed Voter ModelCase Study: The U.S Sugar QuotaThe Endogenous Tariff ModelThe Adding Machine ModelRent-Seeking BehaviorTrade Policy Before the Twentieth Century

The Ups and Downs of Trade PolicyMercantilism

The Intellectual Attack on MercantilismU.S Trade Policy before World War IForced Trade Liberalization in the Far EastEurope Reverses Course in the Late 1800sDestroying Trade During the Interwar Period

9.4.19.4.29.4.39.4.49.4.59.4.69.4.79.4.89.5

9.5.19.5.29.5.39.6

9.6.19.6.29.7

9.7.19.7.29.7.39.8

10

10.1

10.1.110.1.210.1.310.1.410.1.510.1.610.1.710.2

10.2.110.2.210.2.3

The Treaty of VersaillesThe Smoot–Hawley TariffAnother Policy ReversalTrade Policy After World War II: The General Agreement on Tariffs and Trade

The Key Provisions of the General Agreement on Tariffs and TradeThe GATT Rounds

The U.S Reluctance to Open Its MarketTrade Without Injury: Further AnalysisThe Emergence of New Forms of Protection: Nontariff BarriersThe Kennedy and Tokyo Rounds

The Effectiveness of Trade Adjustment AssistanceEvaluating the GATT Rounds through Tokyo

The Uruguay Round

More Players and More IssuesIntellectual Property RightsReplacing the GATT with the World Trade OrganizationThe Doha Round

The Agenda of the Doha RoundThe Role of the Developing CountriesThe Shift to Trade Blocs

Defining Regional Economic IntegrationTrade Creation versus Trade DiversionRegional Free Trade Is Not Necessarily Welfare IncreasingConclusions and Comments

Chapter Summary

Key Terms and Concepts

Problems and Questions

Notes

International Trade Policy: A Holistic Perspective

Mercantilism and the Colonial System

Colonialism Is a Form of MercantilismThe Case of Colonial Brazil

Mercantilism after Brazil’s IndependenceThe Coffee Economy

From Accidental to Planned IndustrializationComparing the Law of Similars and the Infant Industry ArgumentInterpreting Brazil’s Colonial and Postcolonial ExperiencesImport Substitution Industrialization

ISI Gets a Life of Its OwnPrebisch’s Development Model

An Assessment of ISI Policies

10.3.110.3.210.3.310.3.410.4

10.4.110.4.210.5

PART IV

11

11.1

11.1.111.1.211.1.311.2

11.2.111.3

11.3.111.4

11.4.111.4.211.4.311.4.411.4.511.5

11.5.111.5.211.5.311.5.411.6

11.6.111.6.211.6.311.6.4

An Example of ISI FailureLessons from ISI

Mercantilism, Agglomeration, and the International Economy

Agglomeration and TNCsThe Reappearance of MercantilismTNCs and the Power to Set PolicyDramatic Examples of MercantilismStrategic Trade Policy

Strategic Competition: Boeing vs AirbusStrategic Trade Policy Can Reduce National WelfareConclusions

Chapter Summary

Key Terms and Concepts

Problems and Questions

Notes

INTERNATIONAL INVESTMENT AND FINANCE International Investment and International Finance

The Balance of Payments

The Circular Flow of Economic ActivityAdding the Financial Sector and Government to the Circular FlowThe Circular Flow in an Open Economy

The Design of the Balance of Payments Account

The BasicsThe Current Account and the Financial Account

The Current AccountFinance

The Financial Sector of the EconomyFinancial Instability

Why Financial Transactions Are Not Always Completed

An Example of Rampant Moral Hazard, Adverse Selection, and FraudWhat Does Finance Contribute to Human Provisioning?

Orthodox Models of International Investment

A Traditional Model of International InvestmentRisk and Diversification

The Dynamic Gains from International InvestmentThe Long-Run Welfare Effects of International Financial FlowsFinancialization

The Manifestations of FinancializationGrowing Influence of Finance on the Real EconomyThe Separation of Finance from Provisioning

Is Financialization a Necessary Evil in a Modern Complex Economy?

12

12.1

12.1.112.1.212.1.312.1.412.1.512.2

12.2.112.2.212.2.312.2.412.2.512.3

12.3.112.3.212.3.312.3.412.4

12.4.112.4.212.5

12.5.112.5.212.5.312.5.412.5.512.5.612.5.712.5.812.6

12.6.112.6.212.6.312.7

International Financial Flows: Some ConclusionsChapter Summary

Key Terms and Concepts

Problems and Questions

Notes

The Foreign Exchange Market

The Evolution of the Foreign Exchange Market

The Real History of MoneyThe Emergence of Finance Occurred Before the Emergence of MoneyThe Foreign Exchange Market in Ancient Times

The Development of Banking and Bankers’ Role in Money CreationFiat Money and Exchange Rates

Contemporary Foreign Exchange Markets

The Over-the-Counter Market

A Worldwide MarketOnline Trading

Centralization of the MarketRetail Currency ExchangeThe Supply and Demand Model of Foreign Exchange

A Simple Example of a Foreign Exchange MarketArbitrage Integrates Markets

Intertemporal Arbitrage

A Simple Example of Intertemporal ArbitrageThe Covered Interest Parity Condition

A More General Form of the Interest Parity Condition

An Exercise in Interest ParityFurther Evidence on Interest Parity

A Modern Case Study of Expectations: The Carry TradeExchange Rate Futures

Explaining the $4 Trillion Per Day Volume

Arbitrage TradesHot Potato ProcessExplaining the $5 Trillion Daily VolumeSummary and Conclusions

Chapter Summary

13.1

13.1.113.1.213.1.313.1.413.2

13.2.113.2.213.3

13.3.113.3.213.3.313.3.413.4

13.4.113.4.213.5

13.5.113.5.213.5.313.5.413.5.513.6

13.6.113.6.213.6.313.6.413.6.513.6.613.7

14

14.1

Key Terms and Concepts

Problems and Questions

Notes

International Banking and Financial Markets

Stocks and Flows in International Finance

The Net International Investment PositionFrom the Balance of Payments to the Net Investment PositionAsset Stocks and Asset Returns

Is the Growth of the Net Investment Deficit Sustainable?

The Growth of International Banking

Shifts in the Ranks of the Transnational Financial FirmsThe Eurocurrency Markets

Portfolio Investment

Defining Portfolio InvestmentInternational Equity MarketsAmerican Depository ReceiptsSome Unintended Consequences of the Globalization of Financial MarketsFinancial Innovation

The International Marketing of U.S Collateralized Debt ObligationsCredit Default Swaps Insured the CDOs

Deregulation and Financial Fraud

The Glass–Steagall ActGlobalization and Financial DeregulationThe Great Monetary Expansion

Financial Crisis to RecessionSummary

Chapter Summary

Key Terms and Concepts

Problems and Questions

Notes

Exchange Rate Crises

The Economics of Exchange Rate Crises

14.2.114.2.214.2.314.3

14.3.114.3.214.3.314.3.414.3.514.3.614.4

14.4.114.4.214.4.314.4.414.4.514.5

14.5.114.5.214.6

PART V

15

15.1

15.1.115.1.215.1.315.2

15.2.115.2.215.2.315.2.415.2.515.2.6

Fixing the Exchange Rate under Rational ExpectationsUsing Intervention to Stabilize the Exchange RateIntervention Is Not a Long-Run Tool

Fixed Exchange Rates and Economic Crises

Policy ChoicesThe Options When Policy Independence Is the PriorityTwo Dilemmas Equal One Trilemma

The 1982 Debt Crisis

Recycling PetrodollarsThe Macroeconomics of International Financial FlowsWhat Changed in 1982?

Dealing with the 1982 Debt CrisisThe Three Sides of the NegotiationsThe Role of the International Monetary FundFurther Foreign Exchange Crises

The Mexican Peso Crisis in 1994The Asian Crisis of 1997

The Russian CrisisCommon Threads in 1990s Exchange Rate CrisesExchange Rate Crises Are Very Damaging

Brazil’s 2004 Tightrope Walk

Sustainability of Public Sector DebtTracing Brazil’s Public Sector DebtConclusions

Chapter Summary

Key Terms and Concepts

Problems and Questions

Notes

THE HISTORY OF THE INTERNATIONAL MONETARY SYSTEM Early Monetary History: Ancient Times Through the End of the Gold Standard

The Emergence of Modern Money

Finance and Debt Came Before MoneyThe Development of Physical Representations of MoneyThe Growing Complexity of International Finance

The Origins of the Gold Standard

Why Britain Had a Gold Standard and Not a Silver StandardThe International Gold Standard

The Order of the International Gold StandardThe Gold Standard’s Fixed Exchange RatesHow the Gold Standard Really WorkedInternational Investment in the Late Nineteenth Century

15.3.115.3.215.3.315.3.415.4

15.4.115.4.215.4.315.4.415.4.515.5

15.5.115.5.215.5.315.5.415.6

15.6.115.6.215.6.315.7

15.7.115.7.2

16

16.1

16.1.116.1.216.1.316.1.416.1.516.1.616.1.716.1.816.1.916.2

The United States and the Gold Standard

Social Conflict and the Gold StandardBimetallism and William Jennings BryanThe United States Remains on the Gold StandardEvaluating the International Gold Standard

War War I Ended the Gold Standard

The Futile Attempt to Get Back to “Normal” after World War IThe Costs of the War

Reviving the Gold Standard Under Changed CircumstancesThe Treaty of Versailles

Isolationist Tendencies in the United StatesThe Failed Return to the Gold Standard

Not Quite a Gold StandardDid the Gold Standard Cause the Great Depression?

Exporting the U.S Financial ShockSome Further Consequences of the Economic Decline

A Change of Order

Reversing the Financial ChaosCompetitive DevaluationsThe Tripartite AgreementAssessing the Gold Standard During the Interwar Period

A Bad Report CardThe Trilemma Between the WarsChapter Summary

Key Terms and Concepts

Problems and Questions

Notes

Appendix: William Jennings Bryan’s “Cross of Gold” Speech, July 9, 1896

The International Monetary System: Bretton Woods to the End of the Twenty-First Century

The Bretton Woods Conference

A Holistic Perspective of Bretton WoodsHarry Dexter White and John Maynard KeynesAgreement on the IMF and the World BankThe Bretton Woods Order

The Marshall Plan and European Economic IntegrationThe Performance of the Bretton Woods System

The 1960s Reveal the System’s InconsistenciesThe Collapse of the Bretton Woods SystemEvaluating the Bretton Woods SystemAfter Bretton Woods

16.3.116.3.216.3.316.3.416.3.516.3.616.3.716.3.816.3.916.4

17

17.1

17.1.117.1.217.2

17.2.117.2.217.2.317.2.417.2.517.3

17.3.117.3.217.3.317.3.417.3.517.4

17.4.117.4.217.4.317.4.4

Many Meetings, No AgreementExchange Rate Volatility

The Plaza AccordThe Bretton Woods InstitutionsEvaluating the Post-Bretton Woods PeriodThe Euro

The Early Steps toward Economic UnionEnlarging the EEC

The EEC and the Collapse of Bretton WoodsThe Trilemma Again!

Establishing the Monetary UnionFurther Expansion of the European UnionTrade Effects of the European Monetary Union (EMU)Fiscal Policy in the European Union Countries: Some Potential ProblemsFinancial Instability in Europe: The Greek Crisis

Some Tentative ConclusionsChapter Summary

Key Terms and Concepts

Problems and Questions

Notes

Another Bretton Woods Conference?

Economic Instability

InflationDeveloping Countries’ Accumulation of Dollar Reserves

Why the Reluctant Fiscal Response?

Modern Money Theory

Personal Debt versus Aggregate Debt

A Simple Example of a Monetary Free LunchThe Fallacy of Composition

Summarizing Modern Money TheoryMMT and the Case for Flexible Exchange RatesRestoring Financial Regulation and Oversight

Do We Need a New Bretton Woods Conference?

Keynes’ Bancor

An International Bankruptcy Court?

Some New Proposals

PART VI

18

18.1

18.1.118.1.218.1.318.1.418.2

18.2.118.2.218.2.318.2.418.2.518.2.618.2.718.3

18.3.118.3.218.3.318.3.418.4

18.4.118.4.218.5

18.5.118.5.2

Key Terms and Concepts

Problems and Questions

Notes

IMMIGRATION Immigration: The International Movement of People

International Migration

Early MigrationsRecent ImmigrationWhy Do People Immigrate?

Many Types of Immigrants

A Labor Market Model of Immigration

Who Gains from Immigration?

The Effect of Immigration on Domestic Product DemandImmigrant Remittances

Externalities in the Destination CountryThe Costs of Government Services for ImmigrantsAre U.S Immigrants More Costly Today Than in the Past?

Tentative Conclusions from the Static Supply and Demand ModelImmigration’s Long-Run Effects on Economic Growth

Immigration’s Dynamic EffectsThe Brain Drain

Can Remittances Mitigate the Brain Drain?

Replacing the Brain Drain with Service Exports?

Unauthorized (Illegal) Immigration

Unauthorized Immigration as Labor Market SegmentationUnauthorized Immigration Can Be Deadly

Conclusions

The Economic Significance of Immigration

A More Holistic Perspective on ImmigrationChapter Summary

Key Terms and Concepts

Problems and Questions

Notes

Immigration Policy

The Purpose of Immigration Policy

Individual Rights and Community

19.2.119.2.219.2.319.2.419.2.519.2.619.3

19.3.119.3.219.3.319.4

19.4.119.4.219.4.319.5

19.5.119.5.219.5.319.5.419.5.519.6

19.6.119.6.219.6.319.6.419.6.519.6.619.7

19.7.119.7.219.7.319.7.419.7.519.8

Securing the BorderPro-Immigration Forces Kept Immigration OpenAssessing the Early Policies

The Shift in U.S Policy in the Early Twentieth Century

The Major Shift in U.S Immigration PolicySome Immigration Horror Stories During the Great DepressionImmigration Policy during World War II

Post-World War II Immigration Policy

Slow Shifts in Immigration Law

A New Immigration Law in 1965Unauthorized Immigration Has Grown RapidlyRecent United States Immigration Policy

The 1986 Immigration Reform and Control ActAfter IRCA

Temporary Work VisasU.S Policy at the Start of the Twenty-First CenturyImmigration Reform Stalls

Immigration Policy in Canada

The Early YearsCanada’s Treatment of Chinese ImmigrantsSummary of Nineteenth-Century PolicyThe Twentieth-Century Shift in PolicyCanadian Policy Shifts after World War IICanada’s Immigration Policy in the Twenty-first CenturyEuropean Immigration Policy

European Migration During the Colonial EraThe Nineteenth Century

European Emigration in the Twentieth CenturyThe Post-Soviet Era

Recent EU Immigration PolicyConclusions

Chapter Summary

Key Terms and Concepts

Problems and Questions

Notes

The Evolving International Economy in an Ecologically Constrained World

20.1.120.1.220.1.320.1.420.1.520.2

20.2.120.2.220.2.320.2.420.3

20.3.120.3.220.3.320.3.420.3.520.3.620.3.720.3.820.4

20.4.120.4.220.4.3

Economic Growth and the Ecosystem

Global WarmingScientific Evidence on Global WarmingBiodiversity

Nature’s Services Crucial to Human Existence

No Sense of Urgency among Policy MakersPolicy Making under Uncertainty

Risk vs UncertaintyThe Cost of Controlling Global WarmingThe Cost of Stopping Biodiversity LossWhy Is It So Hard to Insure Against Environmental Disaster?Economic Growth and the Environment

Nature as the Next Source of Diminishing Returns

A Two-Sector Solow Growth ModelThe Need for Technological Change in Both SpheresThe Two-Sector Model’s Insights

Environmental Costs and Economic GrowthPolicy Options

Taxes Versus Quantitative RestrictionsThe Political Economy of Environmental PolicyThe Case for Globalization Taking the Environment into Consideration

National Policies and Global ProblemsSupport Local Commerce

International Economics and Growth AgainChapter Summary

Key Terms and Concepts

Problems and Questions

A More Complex Relationship 2.1 Yin and Yang

Yin and Yang

The Production Possibilities Frontier: Scarcity Requires ChoicesIndiference Curves

Equilibrium in the Closed Economy

The Gain from Exchange

The Gains from Exchange and Specialization

The Two-Country Model: Equilibria with No Trade

The Two-Country Model: Equilibria with Free Trade

Trade and Factor Demand

Market Equilibrium

Producer Surplus

Consumer Surplus

Two-Country Model: Equilibria with Free Trade

National and World Markets for Guns with Free Trade

The Market without Transport Costs

Decreasing Transport Costs Permit Increased Trade

Decreasing Transport Costs Permit Increased Trade

Adjusting to Free Trade

The Short-Run PPF

Trade between Joe and Mary

Trade between José and María

Trade between Joe and María

Trade between José and Mary

Summary: The Gains from Trade

Happiness and Real Per Capita GDP in Japan, 1958–1991

Average Happiness for a Cross-Section of Countries

National and World Markets for Steel with Free Trade

GHG Emissions from National Production and ConsumptionThe Direction of Trade in 1998

The PPF with Increasing Returns

Decreasing Costs and Proft

Increasing Returns

Specialization with Increasing Returns

Unequal Gains from Specialization with Increasing Returns

Comparative Advantage, Marketing Activity, and Competitive Advantage

Price of Autos with Elastic and Inelastic Demand

The Similarity Between Trade and Growth

The Welfare Gain from Trade versus Economic Growth

World Economic Growth and Trade

Time Lines of Coefcient Values and Their Confdence Intervals from Cross-Section Studies

of International Trade and Economic Growth

A Production Function Subject to Returns to Capital

The Solow Equilibrium

Trade and the Solow Growth Model

The Efect of Increased Saving on the Steady State

Technological Progress

Technological Progress

The Lorenz Curve for Bolivia

The Lorenz Curve for Bolivia and South Korea

Inequality in Modern Korea and Eleventh-Century Ghana

Life Satisfaction: Relative versus Average Happiness

Vernon’s Product Cycle Model: Developed Country Perspective

Immiserizing Growth

The Two-Country Partial Equilibrium Model

An Import Tarif as Viewed by the Importing Country

Homeland’s Tarif as Viewed by Abroad’s Exporters

The Welfare Efects of a Tarif

The Welfare Efects of a Tarif

The Tarif-Inclusive Price Line Faced by Producers

Efective Tarif on Final Output

Efective Protection from Tarif on Inputs

An Import Quota as Viewed by Importing Economy

The Efect of Homeland’s Quota in Abroad

The Welfare Efects of a Quota

The Welfare Efects of a Quota

The Non-Equivalence of Tarifs and Quotas

Welfare-Diminishing Choices under a Quota

The Efect of an Export Tax by Homeland

The Efect of an Export Tax with Inelastic Foreign Demand

The Price of Shirts with Inelastic and Elastic Demand

Consumption Equilibrium with a Tarif

International Trade with a Tarif of t%

The Median Voter Model

The U.S Sugar Quota

Endogenous Tarifs

How Much Is a Quota Worth?

The Gain from Exchange without Specialization

The Gain from Exchange and Specialization

Levels of Regional Economic Integration

Trade Diversion versus Trade Creation

The Basic Circular Flow

Circular Flow with a Financial Sector

Circular Flow with Government Added

Circular Flow of an Open Economy

The Market for Loanable Funds

Two-Country Partial Equilibrium Investment Model

Two-Country Partial Equilibrium Investment Model with International InvestmentThe Foreign Exchange Market

The Foreign Exchange Market

Two Isolated Markets for Cucumbers

Arbitrage and Price Equalization

The Broad Index, 1974–2013

Trade Weighted U.S Dollar Major Currencies Index

Foreign Exchange Market Intervention

The Foreign Exchange Market Intervention

The Trilemma: Select Any Two Out of Three

Gold Parities and Exchange Rates

Price Levels U.S and Canada, 1870–1913

The Trilemma During the Gold Standard

The Trilemma During the Interwar Period

The Trilemma: The Bretton Woods Years

Real Exchange Rates, 1975–1989

The Trilemma since 1870

Infation since 1600

The Infow–Outfow Model of an Economy

The Three Defcits in the U.S since 1950

The Labor Markets after Immigration

Immigration and Demand for Labor

Immigration and Demand for Labor in the Source Country

The Labor Markets after Immigration and Remittances

The Gains and Losses from Immigration with Discrimination

Immigrant Departures as a Percent of Arrivals

The Economy’s Position in Society and the Natural Environment

A Standard Normal Distribution

A Distribution of Normal Distributions

Economic Growth in the Natural Sphere

Economic Growth in the Natural and Economic Spheres

Economic Growth When the Natural Sphere Is Stressed

From Economic Growth to Economic Decline

Technological Change in Both Spheres

Economic Growth with Investment in the Natural Sphere

Taxes versus Quantitative Restrictions

Cap and Trade

Gains from Trade without Internalizing Environmental Costs of TransportTransport Costs with Environmental Costs Fully Internalized

World Exports and Per Capita Gross Domestic Product, 1820–2014

Factor Endowments Relative to the World Mean for Selected Countries

Opportunity Costs Before Trade in Figure 3.6

Opportunity Costs in Ricardo’s Original Example

Life Satisfaction in Europe and the United States, 1975–1994

Marginal Infuences on Happiness, 1972–1998

CO2 Emissions Embedded in the U.K.’s International Trade

Estimated World FDI Stock, by Sector and Industry, 1990 and 2005

A Combinatoric Innovative Process Starting with 4 Combinations

A Slowing Combinatoric Growth Process

Income Distribution for Selected Countries

Gini Coefcients for 14 Historical Countries

Global Income Gini Coefcients, 1960–2000

Global Wealth Shares, 2000

A Sample of Average Tarif Rates

Tarif Reductions during the GATT Rounds

Tarif Escalation, 1994–2000

Merchandise Exports as Percentage of GDP

Hypothetical Profts or Losses for Boeing and Airbus

Hypothetical Profts or Losses for Boeing and Airbus: European Subsidy for Airbus

Hypothetical Profts or Losses for Boeing and Airbus: Subsidies for both Airbus and BoeingThe U.S Balance of Payments, 2000–2014

A Sample of Exchange Rates, May 9, 2009

Global Foreign Exchange Market Turnover, 1998–2013

Top Ten Dealer Banks Market Shares

Example: Four Countries and Four Currencies

Arbitrage with Incompatible Exchange Rates

Compatible Exchange Rates After Arbitrage

Broad Dollar Index: Trade Weights

Interest Parity on January 12, 2005

The International Investment Position of the United States, 1982–2014

The 25 Most Global Financial TNCs, Ranked by UNCTAD’s Spread Index, 2012

Foreign Debt of 30 Selected Developing Economies in 1982

Changes in Brazil’s Debt-to-GDP Ratio Under Alternative Assumptions

Report Card for the International Gold Standard, 1870–1914

World Merchandise Exports, 1929–1934

Report Card for the Interwar Gold-Reserve System

Report Card: Bretton Woods System

Report Card: Post-1973 Period

Realignments of EMS Exchange Rates

Shares of Foreign-Born Population and Labor Force, 2013

Summary of Gains and Losses from Figure 18.1

Immigrant Remittance Payments Received by Developing Countries, by Region, 2000–2014Major Government-Sponsored Programs and their Availability to Undocumented

Immigrants

Monthly Earnings by Occupation and by Country Ranking, 1998–2002

Immigration to the United States

Canadian Population Growth and Immigration

The Great European Migration, 1815–1930

Percentages of Foreign-Born Populations, 1870–2000

Net Migration, 1960–1999

The second edition of International Economics represented a paradigm shift from the first edition,published back in 2004 The book was given the subtitle “A Heterodox Approach” with the secondedition This third edition continues with the heterodox approach, adding even more material fromalternative perspectives and disciplines, and strengthening the book’s grounding in history and

empirical evidence

At the personal level, changing paradigms is not easy My experience is perhaps best captured bythe words of my favorite economist, John Maynard Keynes, in the Preface to his General Theory ofEmployment, Interest, and Money (1936, p viii):

The composition of this book has been for the author a long struggle of escape, and so must the reading of it be for most readers if the author’s assault upon them is to be successful, a struggle of escape from habitual modes of thought and expression The ideas which are here expressed so laboriously are extremely simple and should be obvious The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those of us brought up as most of us have been, into every corner of our minds.

The noted twentieth-century French sociologist Pierre Bourdieu provided a clear explanation forour reluctance to change our perspective and question the “knowledge” that we have accumulated: thepower of culture Mainstream economics, like every other field, has developed a strong culture sooverwhelming that few economists look outside the “box” that is the neoclassical paradigm Bourdieuexplained that adherence to the dominant culture permits us to navigate successfully within our fields.Cultural capital, which is the set of familiar behaviors, norms, beliefs, manners, and expressions that

we deem as “normal,” gives those who fit the culture an advantage over those not familiar with thefield’s culture Joseph Stiglitz (“Needed: A New Economic Paradigm,” Financial Times , August

20, 2011) wrote a critique of neoclassical economics in which he said that “[c]hanging paradigms isnot easy Too many have invested too much in the wrong models.” Indeed, the neoclassical modelsthat we all learn from day one in economics constitute a major portion of economists’ cultural capital

When speaking of paradigm changes, the historian of science Thomas Kuhn of course comes tomind Kuhn introduced the term paradigm shift into the scientific literature In his 1962 book TheStructure of Scientific Revolutions , Kuhn defined a paradigm as a set of practices that define ascientific discipline According to Kuhn, the paradigm tells practitioners what they should observeand study, the types of questions that they should seek answers to, how they should go about

answering those questions, and how they should interpret their findings

Kuhn argued that science did not progress according to the idealized scientific method, a processthat is designed to generate a continuous stream of new ideas that build on existing knowledge We alllike to quote Isaac Newton and his well-known claim that “If I have seen a little further it is by

standing on the shoulders of Giants.” But instead of a continual stream of new and better ideas inresponse to objective examinations and revisions of existing hypotheses and theories, Kuhn describedthe advancement of knowledge as an episodic process consisting of extended periods of normalscience interrupted by occasional spurts of revolutionary science Normal science consists ofrelatively routine activities that are closely controlled by the reigning paradigm that tells scientists,including economists, how they should conduct their research and how they should frame their

conclusions As a practical example of how a paradigm influences research, most economics graduateprograms are run by professors who instill in their students a specific culture that points them to whatquestions to ask, the methods with which to answer those questions, and how to present their answers.Graduate programs often explicitly state their mission as teaching their students “to think like

economists.” This phrase really instructs students to adhere to the currently dominant neoclassicalschool of economic thought Today, orthodox economics conducts what is sees as “normal science”tightly within the neoclassical paradigm

According to Kuhn, the restrictive nature of a paradigm eventually causes some of its practitioners

to run into anomalies , that is, real world findings that do not conform to the paradigm’s conclusions

In economics, for example, the statistical finding that many countries that opened their borders to freetrade did not grow faster, as neoclassical models of international trade suggest, is a clear anomalythat was nonchalantly explained away as exceptions caused by exceptional circumstances, poor data,

or some methodological failure Often, the anomalous results were simply ignored by the mainstream.And, as Kuhn and Bourdieu explain, practitioners who insist that anomalies point to an alternativeparadigm are often marginalized or banished, with the effect that most practitioners are cowed intoasking and answering questions within the parameters of the neoclassical paradigm It was whiledoing econometric studies of economic growth and international trade that I finally came to realizehow poorly economists follow the scientific method and how easily our culture causes us to ignorethe anomalies that are right there staring us in the face Of course, my early published econometricstudies helped to support my application for academic tenure, exactly as Bourdieu would predict.Once I broke with the mainstream in my later work, however, further promotions and pay raises camemuch more slowly

Kuhn argues that when a critical mass of practitioners in a discipline begins to deal with the

anomalies that their paradigm-restricted research cannot explain by embracing an alternative

paradigm that does seem to explain the anomalies, a new paradigm can take over from the failed

older paradigm The new paradigm is then celebrated as a “breakthrough” in knowledge At that

point, textbooks are rewritten and the history of thought is revised to position the new paradigm as thelogical result of objective researchers following the scientific method Kuhn warned, however, thatthe sharp discontinuous break between paradigms often results in a new paradigm being no moreaccurate or fruitful for the scientific advancement of knowledge than the older paradigm

I hope that this new edition provides enough of a revolution to keep knowledge moving forward,but not so much of a revolution that I have obscured other potential perspectives or paths of

knowledge accumulation I hope this textbook does not promote a new orthodoxy, as Kuhn warned.This edition of International Economics definitively rejects the orthodox neoclassical paradigm as

an exclusive framework within which economists should think At the same time, I also reject thesharp division between orthodoxy and heterodoxy that I often see in both the orthodox and heterodoxliteratures Instead, I have tried to interpret the true spirit of heterodoxy as pointing to a multi-

paradigmatic pluralistic approach that includes many useful neoclassical models along with the manymodels and ideas from elsewhere in economics, sociology, political science, ecology, psychology,neuroscience, history, and any other field that clarifies the causes and consequences of internationaleconomic integration If a paradigm is like a language, heterodoxy effectively enables economists tospeak many languages These multilingual abilities enable heterodox economists to understand manyviewpoints, discuss issues with many different interests, and uncover more information and evidence

to support or refute many more hypotheses As will hopefully become clear as you read this book,there is a compelling logic to heterodoxy that goes well beyond merely rejecting the generality of theneoclassical paradigm Its holistic approach also reduces the likelihood that we will replace it withsome other single dominant paradigm.

To further keep me from falling captive to some other paradigm, I hope readers and teachers willchallenge what I have done in this latest edition, as they did with my second edition I am certain that

as one person, I have not come close to capturing all the relevant knowledge related to the manyissues of international economics I look forward to your help to further the discussion of how

international economic integration can best further the well-being of humanity, our society, and ourecosystem

In closing, I would like to thank the many people that played a role in bringing this book about First

of all, I want to thank the editors at M.E Sharpe, who prepared the second edition for publication andthe editors at Routledge for this third edition They were also a pleasure to work with throughout thisproject I also want to thank my teachers At the State University of New York at Albany, I must

mention Fred Dickey, who taught me principles of economics and inspired me to major in economics,Helen Horowitz, who inspired me to become a teacher of economics, and Marvin Sternberg, FranklinWalker, and Pong Lee, who introduced me to the cutting edge of economic thinking at the time At theUniversity of Wisconsin–Madison, I owe special debts to Arthur Goldberger, who taught me to becritical of technical approaches to economics His courses in econometrics demanded critical

thinking and a heavy dose of methodological skepticism I must also thank the professors I workedwith most closely at Wisconsin, Robert Baldwin, J David Richardson, Rachel McCullough, andKenneth Rogoff While I have now embraced heterodoxy in place of the orthodox neoclassical

analysis they taught, they nevertheless showed me many broad perspectives that prepared me well for

my growth as an economist Their endless energy in research and teaching made it clear that we neverstop learning and revising our thinking

Among my colleagues at the University of Nebraska, I above all want to thank Greg Hayden andAnn Mari May, who never hesitated to challenge me as I struggled with the neoclassical paradigm.They also provided insight into heterodoxy, institutional economics, and feminist economics And, ofcourse, I thank all my students at the University of Nebraska for 26 years and now at Mount HolyokeCollege who asked difficult questions and wrote unconventional answers to my conventional

questions The insight I gain from students convinces me that academia’s focus on research is

overstated; we do not know how good a new idea is until we try to teach it to someone

My wife of 45 years, Barbara, provided the most comprehensive editing throughout the many, manystages of development of this new edition She added many ideas and perspectives from her readingand experience as a community activist I also want to thank our three sons, Paulo, Matthew, and

Tom, who continually challenged my reasoning Matthew, who now also teaches economics,

provided many detailed ideas, concepts, and additions that substantially expanded the book’s

heterodoxy Paulo has always provided timely advice that kept my feet on the ground And Tom andhis trombone provide the jazz that reminds us of the importance of improvisation and art Despitewhat orthodox neoclassical economics contends, we humans cannot survive on GDP alone

Hendrik Van den BergMount Holyoke CollegeSouth Hadley, Massachusetts

April 25, 2016

PART I

Introduction to International Economics

CHAPTER 1

Interdependence!

[T]he sea brought Greeks the vine from India, from Greece transmitted the use of grain across the sea, from

Phoenicia imported letters as a memorial against forgetfulness, thus preventing the greater part of mankind from being wineless, grainless, and unlettered

experienced improvements in their standards of living

The economic development of the Chinese economy cannot be fully described by the simple

compounding of annual growth rates of GDP, however The process of economic development is acomplex process that depends on the actions of many people individually and collectively, the

institutional framework that guides human activity, and the natural environment that supports humanactivity And as we will describe throughout this textbook, the performance of national economiesdepends on how it is linked to the other economies of the world The complexity of economic activity

is nicely illustrated by the recent experience of the town of Jinfeng, situated along the lower YangtzeRiver in China 1

A decade ago, at the start of the twenty-first century, every morning more than 30,000 of Jinfeng’sworkers walked or bicycled to an array of industries paying wages equal to about US$0.50 per hour.Compared to working on small farms in their villages, these wages constituted a substantial increase

in real family income, which is why so many workers flocked to cities like Jinfeng Among Jinfeng’smany industrial firms was the Shagang steel mill, which opened in 2002 after being transported, piece

by piece, from the Ruhr Valley of Germany The Ruhr Valley was until recently the center of

Germany’s steel industry

In the early 2000s, the German steel conglomerate ThyssenKrupp faced strong foreign competitionand new environmental regulations to combat climate change, health hazards, and other negative

consequences of pollution ThyssenKrupp therefore began selling off its ageing steel manufacturingplants But it did not sell the plants to new owners, who would continue operating them in Germany.Rather, it ended up selling the plants to Chinese entrepreneurs who sent work crews to dismantle theequipment and move it to China, where labor costs were a tiny fraction of Germany’s ThyssenKrupp

had estimated it would take three years to dismantle the plant, but the Chinese work crews sent toDortmund by Shagang finished the dismantling in just one year The Chinese workers labored sevendays a week for many more hours per day than German labor law allowed but, somehow, the Germangovernment looked the other way Today, the plant produces steel at much lower cost in Jinfeng, andthis steel is used to produce many Chinese products that are shipped all over the world, including tothe wealthy German market Because of the relocated steel plant in Jinfeng and dozens more like itthroughout the country, China is now the world’s biggest steel producer, well ahead of the once-

dominant German steel industry

The example of Jinfeng suggests that international trade and accompanying international investmentare an intimate part of Chinese economic development Indeed, many economists position

international trade as an important generator of economic growth But further information suggests thatthe Jinfeng plant is not necessarily a positive development for China or the world For one thing,China’s steel mills, and the coal-fired power plants that provide the electricity that powers the plants,

have also produced the massive greenhouse gas (GHG) emissions that pushed China past the United

States in 2007 as the largest emitter of the GHGs that cause global warming China was also releasinginto its air more than 26 million tons of sulfur, the pollutant that causes respiratory problems for

humans, and acid rain, which contaminates water supplies—about two and one-half times as muchsulfur as the United States emitted in 2005

Note that in the case of Jinfeng, German GHG and sulfur emissions were transferred to China whenthe ThyssenKrupp plant was moved So, while Germany proudly confirmed that it was on schedule toreduce its greenhouse gas emissions by 40 percent by 2020, its former steel mills were increasingChina’s (and global) emissions One study attributes 400,000 premature deaths in China to air

pollution Evidence shows that China’s sulfur emissions and other pollutants also travel across thePacific Ocean and now account for nearly 15 percent of California’s air particles allowable underU.S environmental laws 2

We clearly live in an integrated international economy, in which one country’s economic activityaffects the well-being of people in other countries in a variety of ways The $0.50-per-hour wagespaid in Shinfeng may be attractive for workers with few options in China’s rural communities, but inthe integrated global economy the low Chinese wages and poor working conditions have put severedownward pressure on wages and working conditions in other countries According to the British-based Catholic Agency for Overseas Development (CAFOD), the willingness of Chinese workersproducing high-tech computer products to work 16-hour days in factories with unclean air, high noiselevels, and dangerous machinery greatly reduces production costs on China Workers also often live

in company dormitories, and they do little more than work and sleep for months on end All firms inthe international market must compete with Chinese manufacturers and their low labor costs

For example, Mexican factories producing for the U.S market compete directly with Chinese

factories This is why, in the early 2000s, a Mexican labor activist complained that “[l]ast year, theaverage pay for production line workers was a not very generous 500 pesos [about US$45 a week].This year, most people are being offered 450 pesos.” 3 She claimed that Mexican working conditionswere deteriorating because workers were threatened with dismissal by firms that have the option of

outsourcing part or all of their manufacturing to subsidiary and third-party manufacturers in China.

The human cost of such competition can be devastating in many ways For example, a psychologistwho worked for one of the employment agencies used by manufacturers in the Guadalajara region of

Mexico wrote that firms intentionally sought workers with little self-esteem or aspiration The

applications of workers involved with labor unions, with relatives in government, or with work

experience in the United States were routinely rejected out of hand Prospective workers were

sometimes required to strip naked so they could be checked for tattoos (a sign of rebelliousness), andthey were often given pregnancy tests Such pre-employment tests were illegal under Mexican laborlaws, but the law was routinely ignored In practice, complaining immediately disqualified a jobapplicant Yet, having few or no other options for employment, Mexican workers continued to applyfor the available jobs Chinese competition meant there were many more workers than jobs in

Mexico

The situation is even more complex than we have so far described Most workers in Mexican

manufacturing plants come from small towns and villages, where agricultural jobs have been lost as a

result of the 1994 North American Free Trade Agreement (NAFTA) NAFTA opened the

Mexican market to subsidized U.S grain exports after its ratification in 1994, and because smallMexican farmers have neither the capital nor the technology to compete with the capital-intensive andsubsidized U.S agricultural producers, most ended up giving up farming Without local employmentopportunities in the traditional farming communities, unemployed workers from rural towns and

villages had to accept whatever Mexican manufacturers offer For many young Mexican workers, amore attractive alternative was to migrate illegally to the United States Thus, NAFTA not only

caused some jobs to be shifted within Mexico, but it encouraged immigrant workers to compete

directly with U.S workers in the U.S labor market The recently enacted Central American Free Trade Agreement (CAFTA) is having the same effect The vicious anti-immigrant rhetoric of

politicians in the United States conveniently ignores the role of U.S agricultural subsidies and

NAFTA in expanding illegal immigration to the United States, probably because it is more difficult tojust blame foreign immigrants when the complexity of interdependence is taken into consideration

The full costs and benefits of international trade such as the export of Chinese products made withJinfeng’s steel are difficult to assess once the social consequences are added to the standard

economic gains from trade that economists like to focus on For example, the social implications ofthe human migration from Mexico to the United States are substantial Mexican families are split up,children are not cared for, and rural communities have been reduced to populations consisting

disproportionately of children and the grandparents left behind to care for them In the United States,their illegal status subjects Mexican immigrants to abuse, exploitation, insecurity, and effectivelysecond-class social status not unlike the bottom rungs of a rigid caste system Many U.S employersexploit illegal workers because, similar to the desperate workers in Mexican plants, illegal workersare unlikely to complain or join a union Many people question whether such expansion of

international trade, investment, and migration really improves human welfare as some standard

economic models suggest

Even in China, growing income inequality threatens China’s social and political orders becauseChina’s rapid growth has not provided all 1.3 billion Chinese with comparable improvements inwell-being Some regions have grown faster than others, and some people in each region have

captured most of the income gains from economic growth China’s income is today much less equallydistributed than it was before the last three decades of rapid growth Remember, the willingness towork long hours in Jinfeng’s dirty industries for low wages reflects a lack of job opportunities in theChinese countryside

International interdependence also has macroeconomic consequences For example, China’s rapideconomic growth slowed in late 2008 and 2009 because the world economy, where the Jinfeng steelplant and all of China’s many industries sold their products, fell into a deep recession that seems tohave started in the United States, where a bubble in housing prices burst and sharply reduced thevalue of mortgage securities and other derivative securities based on those mortgages The collapse

of U.S housing prices affected the rest of the world because the derivative assets based on the

underlying mortgages had been acquired in other countries As the default rate on U.S mortgages shot

up and the mortgage securities proved to be worth much less than their inaccurate AAA ratings hadsuggested, balance sheets deteriorated and bankruptcies spread across the economies of Europe,Asia, and other continents At the start of 2009, it was estimated that 20 million workers in Jinfengand similar new industrial towns throughout China had lost their jobs and were returning to the

countryside The Chinese government quickly expanded domestic infrastructure expenditures to offsetthe drop in foreign demand for its products, and it appears that this fiscal stimulus may have sparedChina from being adversely affected by the rest of the world’s economic recession

In summary, the different international economic activities normally studied in the field of

international economics are interrelated and have broad economic, social, and environmental

consequences In fact, the interdependencies created among countries by trade, investment, finance,and migration imply that countries are no longer in complete control of their own destinies, and theeffects of economic change in one country inevitably spill over into other economies The purpose ofthis textbook is to not only present the traditional analysis of international economics, but also toextend that analysis in order to recognize the complexity of international economic activity We willprovide the broader perspectives from which we can make sense of the true complexity of

international economic activity As a result, we will arrive at more accurate and more realistic

assessments of how international economic activity affects human well-being

1.2 The Bigger Picture

Fundamentally, international economic integration implies an increase in human interactions overgreater distances, across more borders, and between more and different countries Humans, like allliving creatures, have struggled with the choice between expanding or limiting contact with othermembers of their species Throughout nearly all of their existence to date, humans lived in small

groups and dealt almost exclusively with people they knew well and interacted with on a regularbasis Humans evolved as social animals, but their societies were small

However, as the economic historian Paul Seabright (2010) describes in his aptly entitled book TheCompany of Strangers , 10,000 years ago humans transformed their existence with the invention ofagriculture:

[O]ne of the most aggressive and elusive bandit species in the entire animal kingdom began to settle down.… [N]ow, instead of ranging in search of food, it began to keep herds and grow crops, storing them in settlements that limited the ape’s mobility and exposed it to the attentions of the very strangers it had hitherto fought or fled Within a few hundred generations—barely a pause for breath in evolutionary time—it had formed social organizations of startling complexity Not just village settlements but cities, armies, empires, corporations, nation states, political movements, humanitarian organizations, even internet communities 4

inhabited by strangers, engaging strangers in trade, borrowing from them or lending to them, and

purchasing their property and assets

1.2.1 The Gains from Dealing with Strangers

There are many reasons why humans are better off when they cooperate with strangers than when theyisolate themselves into small groups Seabright (2010) points to three fundamental advantages ofexpanding the number of people that humans interact with:

higher levels of specialization

reduced uncertainty and risks from unpredictable adverse outcomes

faster accumulation of knowledge and technological change

Later chapters of this textbook will detail these, and many more, benefits of dealing with strangers.The gain from specialization that Seabright mentions was described long ago, in 1776, by AdamSmith in his An Inquiry into the Nature and Causes of the Wealth of Nations :

The greatest improvements in the productive powers of labour, and the greater part of the skill, dexterity, and judgement with which it

is any where directed, or applied, seem to have been the effects of the division of labour 5

That is, by splitting tasks among people within a society, the total product is increased In his

analysis of the Industrial Revolution, which was gaining momentum in Britain and his native Scotland

at the time of his writing, Smith also recognized the phenomenon that we now call economies of scale He observed large differences in productivity between the traditional cottage system of

production and the factory system that characterized the Industrial Revolution He explained that suchimprovements in productivity required large-scale factories; they could not be achieved by simplymultiplying the number of cottage industries He also noted that large-scale production requires

people to exchange products over greater distances with people engaged in other types of specializedlarge-scale production, people they almost certainly do not know personally Economies of scalerequired more impersonal transactions

Seabright’s second stated advantage of expanding economic interaction to more people is thatwider human interactions reduce individual risk and uncertainty What he means is that when peopleface risks and uncertain outcomes that are, at least in part, specific to them rather than to all of

society, cooperation with a variety of others can reduce the individual’s risks and uncertainty Forexample, if an isolated individual’s crops fail, starvation is the likely outcome It should be obviousthat people located over a larger geographic area can spread localized risks among more people Forexample, geographically dispersed groups of people could agree that when one group’s crops fail,others will feed them, and when the others’ crops fail, the former will help the latter People who

engage in such cooperation are likely to survive longer than they could in isolation.

Modern societies have developed a great variety of institutions, markets, and organizations thateffectively enable distrustful individuals to cooperate in order to deal with misfortune For example,

we have insurance companies that compensate people for a variety of disasters, bond markets whereaccumulated wealth can be quickly converted to cash when needed, private charities that extend

personal assistance beyond traditional family units, foreign trade networks that make goods and

services available anywhere on earth, and international organizations that directly assist people indealing with misfortune

Seabright’s third advantage of dealing with strangers is that the expansion of human interactionaccelerates technological progress Since the source of knowledge is the human capacity to think andreason, the rate of technological progress depends directly on the number of people who think,

experiment, and develop new ideas Two heads are better than one Or, according to the century writer William Petty, “it is more likely that one ingenious curious man may rather be foundamong 4 million than among 400 persons.” 6 Also, since new knowledge builds on existing

seventeenth-knowledge, the greater the diversity of the people who share their ideas, the more knowledge will becreated That is, interaction with different people is more likely to expand knowledge than interactionwith people who closely share your own experiences and knowledge

The accumulation of knowledge depends on how quickly new knowledge is passed from the

person(s) who originated it to others When people are willing to communicate and deal with

strangers, their accumulated knowledge can be passed on to many more people than just those whohappen to live close to those who originally developed the knowledge It is no coincidence that

throughout history the most advanced societies were those that had the most contact with other

societies, and the most backward regions have generally been those most isolated from the rest of theworld Isolated societies literally have to reinvent the wheel In an integrated world, only one personhas to invent something for the innovation to become available to everyone Plutarch’s nearly 2,000-year-old quote at the head of this chapter shows that this third gain from dealing with strangers hasbeen recognized for some time

1.2.2 The Three Benefits of Human Interaction Are Intertwined

The three benefits of human interdependence are related For example, Adam Smith saw a close

relationship between specialization, or what he referred to as the “division of labour,” and the

creation of knowledge:

[T]he invention of all those machines by which labour is so much facilitated and abridged, seems to have been originally owing to the division of labour Men are much more likely to discover easier and readier methods of attaining any object, when the whole attention

of their minds is directed toward the single object, than when it is dissipated among a great variety of things 7

Here Smith describes a concept that we now refer to as learning by doing That is, when people

concentrate on a specific task, they gain experience faster and have a stronger incentive to learn toperform the task more efficiently Thus, exchange among a greater number of strangers promotes

specialization, and specialization, in turn, promotes learning and the accumulation of knowledge.There is also, potentially, a positive relationship between knowledge creation and risk reduction

If people are less likely to die during any given year of their lives, as would happen if people

reduced the chance of starvation by expanding trade with strangers, they are likely to take a

longer-term view of life A longer time perspective enhances investment, innovation, and learning, all

activities that require some form of short-run sacrifice in exchange for potential future gains In short,Seabright’s three advantages of larger societies interact to enhance each of the advantages of dealingwith strangers

1.2.3 Dependence on Strangers Is Inherently Problematic

Interaction with strangers also has its costs and dangers, however First of all, cooperating withothers forces people to adjust their own behavior to that of others At the personal level, humans stillstruggle with the fact that working with someone else means that you cannot do everything exactly theway you are used to doing things At the national level, countries struggle with foreign affairs andrelations with other governments Economically, people become interdependent For example,

participating in an international monetary system imposes restrictions on national policy makers andimpacts a nation’s overall economic outcomes Also, international economic activity and frequentcontacts with foreigners may undermine the authority of national leaders International trade opensdomestic producers and consumers to foreign competition Interaction with foreigners may causecultural clashes and conflicts among institutions And historians have estimated that after Europeanexplorers arrived in the Western Hemisphere 500 years ago, as many as 80 percent of the originalWestern Hemisphere residents eventually died because of diseases carried by the European

explorers This health disaster came in addition to the blatant theft of resources on the part of theEuropean invaders and the introduction of African slaves to replace the deceased labor force In fact,the predominance of slavery and oppression throughout history suggests that it was often

advantageous to force others to do the least desirable work History shows that individuals, groups,and entire nations often have incentives to exploit, oppress, rob, pillage, and murder In short,

strangers may do more than just enable trade, reduce risk, and expand knowledge; they may take yourjob or they may even kill you Human survival has always depended on a careful balance betweencloser interaction and keeping one’s distance

1.2.4 The Crucial Role of Institutions

Because interaction with others was mostly limited to family, clan, and other small groupings duringnearly all of human history and the history of humans’ immediate ancestors, Seabright (2010)

interprets today’s growth of economic and social interaction between strangers as an indication thathumans have found ways to reduce their inherent propensity to exploit, steal, and kill when they arenot restricted to their immediate social circumstances: “To manage the hazards imposed on us by theactions of strangers has required us to deploy a different skill bequeathed to us by evolution for quitedifferent purposes, the capacity for abstract symbolic thought.” 8

This is a very important point: humans’ exceptional capacity to engage in abstract reasoning has

enabled them to design social and economic institutions that effectively enable strangers to behave in

a cooperative manner despite their instinctive fears of exploitation or personal harm

Institutions are the cultural norms, social customs, formal laws, and explicit government

regulations that shape individual human behavior Institutions are needed because hardwired humanbehavioral instincts, evolved when social and natural environments were different, are not