International Economics A European Focus Barbara Ingham This new international economics text reflects the unprecedented changes which have occurred in the world economy over the past quarter century. Rooted in classical analysis and the doctrine of comparative advantage, the book covers the central components of an international economics course in a stimulating and student-friendly way. This introductory, concise and non- technical approach to international economics deals with issues in the international environment which are of relevance to UK/European students, relating international economics to the European experience wherever it is appropriate to do so. International Economics is supported by a website at www.booksites.net/ingham The book is aimed at undergraduate students taking a course in international economics. As well as students specialising in economics, the book will be useful to students on business studies, management and social science programmes. Dr Barbara Ingham is Reader in Economics in the School of Management at the University of Salford, Greater Manchester, UK. International Economics A European Focus Barbara Ingham International Economics A European Focus an imprint of www.pearson-books.com Ingham www.booksites.net www.booksites.net Key features • Takes a European perspective and focuses on the issues which will affect the whole of Europe – transition economies, economic integration, WTO, etc. • An emphasis throughout on the dynamics of trade. • A comprehensive treatment of trade policy, including the political economy of trade protection, social objectives, fair trade and the role of the WTO. • Clear and simple models of exchange rate determination. • Explanations of first, second and third generation models of currency crises, as well as the potential role of ‘early warning systems’ and ‘safety zones’. • Full discussion of the principles of economic management in the euroarea. • A strong emphasis on the political and international relations context in which trade takes place. • Many case studies from the Financial Times. • An optional geometric appendix introduces students to the offer curve, the box diagram and the contract curve. www.booksites.net cyan magenta yellow black International Economics A European Focus We work with leading authors to develop the strongest educational materials in business and economics, bringing cutting-edge thinking and best learning practice to a global market. Under a range of well-known imprints, including Financial Times Prentice Hall, we craft high quality print and electronic publications which help readers to understand and apply their content, whether studying or at work. To find out more about the complete range of our publishing please visit us on the World Wide Web at: www.pearsoned.co.uk A European Focus Barbara Ingham Reader in Economics University of Salford International Economics Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: www.pearsoned.co.uk First published 2004 © Pearson Education Limited 2004 The right of Barbara Ingham to be identified as author of this work has been asserted by her in accordance with the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a licence permitting restricted copying in the united Kingdom issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London W1T 4LP. All trademarks used herein are the property of their respective owners. The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners. ISBN 0 273 65507 8 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library 10 9 8 7 6 5 4 3 2 1 08 07 06 05 04 Typeset in 10/13 pt Century Book by 68 Printed by Ashford Colour Press Ltd., Gosport The publisher’s policy is to use paper manufactured from sustainable forests. v Foreword xiii Preface xv Acknowledgements xix 1 Introduction and overview 1 Why international economics? 1 Why a European focus? 3 Overview 4 Part 1 Trade theory and policy 2 The theory of trade 7 Introduction 7 Objectives 8 Mercantilism 9 Adam Smith and absolute advantage 10 David Ricardo and comparative advantage 13 Opportunity cost and the pure theory of trade 15 Factor endowments 18 Testing the Ricardian and Heckscher–Ohlin models 22 The influence of the free trade doctrine 25 Summary 27 Key concepts 27 Questions for discussion 28 Suggested reading 28 3 Developments in the theory of trade 29 Introduction 29 Objectives 30 Technology and trade 30 Patterns of demand 32 Imperfect competition 33 Increasing returns 35 Spatial concentration and trade 37 Case study 3.1 38 Case study 3.2 39 Contents Contents vi Gravity trade models 40 Summary 43 Key concepts 43 Questions for discussion 43 Suggested reading 44 4 Theory of trade protection 45 Introduction 45 Objectives 47 Tariffs and non-tariff barriers 47 Exchange and capital controls as barriers to trade 50 Welfare effects of a tariff 51 ‘Old’ arguments for protection 54 External economies and research and development 57 Imperfect competition and the transfer of monopoly profit 59 Political economy of trade policy 61 Self-interest and the prisoner’s dilemma 63 Income distribution and social objectives 66 Case study 4.1 67 Case study 4.2 68 Summary 69 Key concepts 70 Questions for discussion 71 Suggested reading 71 5 International trade policy 72 Introduction 72 Objectives 73 Economic theory versus international political economy 74 From GATT to the WTO 75 The WTO 77 WTO and the environment 78 Social issues and the WTO 80 Market access 82 Case study 5.1 83 Trade blocs and the WTO 84 The EU and the WTO 85 Summary 87 Key concepts 88 Questions for discussion 88 Team project on the WTO 88 Suggested reading 89 Contents vii 6Trade and growth, past and present 90 Introduction 90 Objectives 92 Static and dynamic effects of trade 92 Vent for surplus and staples theory 95 Is trade an engine of growth? 98 Trade liberalisation 102 Trade policy reform in transition economies 104 Regional trade arrangements versus liberalisation 105 Case study 6.1 108 Growth, trade and de-industrialisation 110 Summary 111 Key concepts 112 Questions for discussion 112 Suggested reading 113 7 International factor mobility 114 Introduction 114 Objectives 115 Capital and labour flows in history 116 Theory of capital movements 118 Multinational enterprises and factor mobility 120 Europe’s foreign direct investment 123 Labour migration 125 Migration in Europe 129 Case study 7.1 130 Case study 7.2 132 Summary 133 Key concepts 133 Questions for discussion 134 Suggested reading 134 Part 2 International monetary economics 8 Balance of payments accounts 137 Introduction 137 Objectives 138 The UK balance of payments 138 The UK current account 140 The UK capital account 143 The UK financial account 144 Errors and omissions 146 Contents viii The UK international investment position 147 The euro area balance of payments 149 Summary 152 Key concepts 153 Questions for discussion 153 Suggested reading 154 9 Foreign exchange markets 155 Introduction 155 Objectives 156 The mechanism of international payments 156 Exchange rates, swaps, futures and options 158 The determination of the equilibrium exchange rate 162 Case study 9.1 164 Purchasing-power parities 167 Arbitrage 169 International financial flows 170 Financial markets and the foreign exchange market 173 Case study 9.2 175 Summary 176 Key concepts 177 Questions for discussion 177 Suggested reading 178 10 The exchange rate and economic policy 179 Introduction 179 Objectives 180 The gold standard (1880–1914) 180 The Bretton Woods system (1946–71) 184 Managed flexibility 187 Case study 10.1 189 Money supply, output, inflation and the exchange rate under managed flexibility 190 The volatility of exchange rates 192 Choice of exchange rate regime 193 Case study 10.2 195 The currency board system 196 Summary 198 Key concepts 199 Questions for discussion 199 Suggested reading 199 Contents ix 11 Capital flows and financial crises 201 Introduction 201 Objectives 202 Case study 11.1 202 Portfolio theory and diversification 204 Financial crises 206 The crisis in Asia 208 The 1998 Russian crisis 211 Contagion 212 Herd behaviour 213 Early warning systems 214 Safety zones for emerging markets 215 Summary 217 Key concepts 218 Questions for discussion 218 Suggested reading 218 Part 3 The global economy 12 The European Union in the global economy 221 Introduction 221 Objectives 222 Chronology of the European Union 223 The Treaty of Rome and the internal market 224 Case study 12.1 225 The European Monetary System and the Exchange Rate Mechanism 226 Case study 12.2 229 European Monetary Union 230 Case study 12.3 231 Economic management in the euro area 233 Case study 12.4 237 Case study 12.5 238 Accession countries and the euro 239 Summary 241 Key concepts 241 Questions for discussion 242 Suggested reading 242 [...]... ‘failing’ states and international terrorism Changes in the international economy require appropriate changes in the subject matter of international economics I have tried in this textbook to reflect recent developments in the world economy without in any way compromising the central components of an international economics course, which must remain rooted in classical analysis and the doctrine of comparative... xxi Chapter 1 Introduction and overview Why international economics? International Economics is the application of economic theory to situations in which countries are closely connected, through the exchange of goods and services, or through some other type of economic relationship, such as that between a creditor country and a debtor country International economics is concerned with the interrelationships... grounding in international economics International economics illuminates the interaction between domestic economic events, and important changes in the world economy Samuelson himself has made important theoretical contributions to the pure theory of trade He joins a long line of distinguished economists, going back to Adam Smith, the founder of modern economics, who believed that the international. .. economics, for which the prerequisite is an introductory course in micro- and macro -economics As well as students specialising in economics, the book is likely to be of interest to students on business studies, management and social science programmes Those intending to pursue postgraduate studies in international economics or international business should also find some useful foundation material, and there... the founder of modern economics, who believed that the international economy is where economics begins Does the international economy call for any special economic theory? Or can it be treated using the general principles of economics? Writing in the 1930s, the economist Gottfried Haberler stated that international economics requires only the application of general economic theory It is the individual... individual producers and consumers Why a European focus? Most international economics textbooks which have been published since the 1960s originate in the United States, and focus on the place of the US in the international economy These texts are almost without exception authoritative and stimulating, and some, such as Charles Kindleberger’s International Economics, are classics in their own right But none... book International economics texts customarily divide the subject into the ‘trade’ aspects, and the ‘monetary’ aspects of the subject Part I of this book covers material on trade theory and policy It is centred on the proposition that by participating in international trade, countries can increase the efficiency with which they utilise resources and can reap dynamic benefits such as scale economies International. .. Among the many individuals and institutions to whom I owe a debt, I would like to mention a long-standing colleague, Dr E.W Brasslof, and his work in international economics with Sidney J Wells The issues which they explored in an earlier international economics text, in particular the role of classical political economy, the significance of location decisions and the centrality of European integration... highly immobile If factors are immobile internationally 1 Chapter 1 ● Introduction and overview then international exchange will follow different economic ‘laws’ from purely domestic transactions Of course the classical writers did not believe that capital and labour were completely immobile between countries Factor mobility as a distinguishing feature of international economics is very much a matter of... of labour emigration And in today’s international environment factor mobility between countries is often very great Labour, capital, managerial skills and technology move freely between countries, often through the medium of the multinational company Factor mobility is not the only feature which distinguishes international economics A striking characteristic of international exchange in everyday life . to international economics deals with issues in the international environment which are of relevance to UK/European students, relating international economics. International Economics A European Focus Barbara Ingham This new international economics text reflects the unprecedented