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International
Economics
Sixteenth Edition
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International Economics
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International
Economics
Sixteenth Edition
Thomas A. Pugel
New York University
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INTERNATIONAL ECONOMICS: SIXTEENTH EDITION
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International economics/ Thomas A. Pugel.Sixteenth edition.
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In memory of my parents, Adele and Edmund, and my
parents-in-law, Vivian and Freeman, with my deepest
appreciation and gratitude for all that they did to benefit
the generations that follow.
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vi
About the Author
Thomas A. Pugel
Thomas A. Pugel is Professor of Economics and Global Business at
the Stern School of Business, New York University, and a Fellow of
the Teaching Excellence Program at the Stern School. His research
and publications focus on international industrial competition and
government policies toward international trade and industry. Professor
Pugel has been Visiting Professor at Aoyama Gakuin University in
Japan and a member of the U.S. faculty at the National Center for
Industrial Science and Technology Management Development in China.
He received the university-wide Distinguished Teaching Award at New
York University in 1991, and twice he was voted Professor of the Year
by the graduate students at the Stern School of Business. He studied economics as
an undergraduate at Michigan State University and earned a PhD in economics from
Harvard University.
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vii
Preface
International economics combines the excitement of world events and the incisiveness
of economic analysis. We are now deeply into the second great wave of globalization,
in which product, capital, and labor markets are becoming more integrated across
countries. This second wave, which began in about 1950 and picked up steam in the
1980s, has now lasted longer than the first, which began in about 1870 and ended with
World War I (or perhaps with the onset of the Great Depression in 1930).
As indicators of the current process of globalization, we see that international
trade, foreign direct investment, cross-border lending, and international portfolio
investments have been growing faster than world production. Information, data, and
rumors now spread around the world instantly through the Internet and other global
electronic media.
As the world becomes more integrated, countries become more interdependent.
Increasingly, events and policy changes in one country affect many other countries.
Also increasingly, companies make decisions about production and product develop-
ment based on global markets.
My goal in writing and revising this book is to provide the best blend of events
and analysis, so that the reader builds the abilities to understand global economic
developments and to evaluate proposals for changes in economic policies. The book
is informed by current events and by the latest in applied international research.
My job is to synthesize all of this to facilitate learning. The book
Combines rigorous economic analysis with attention to the issues of economic
policy that are alive and important today.
Is written to be concise and readable.
Uses economic terminology when it enhances the analysis but avoids jargon for
jargons sake.
I follow these principles when I teach international economics to undergraduates and
masters degree students. I believe that the book benefits as I bring into it what I learn
from the classroom.
THE SCHEME OF THE BOOK
The examples presented in Chapter 1 show that international economics is exciting
and sometimes controversial because there are both differences between countries and
interconnections among countries. Still, international economics is like other econom-
ics in that we will be examining the fundamental challenge of scarcity of resources
how we can best use our scarce resources to create the most value and the most
benefits. We will be able to draw on many standard tools and concepts of economics,
such as supply and demand analysis, and extend their use to the international arena.
We begin our in-depth exploration of international economics with international
trade theory and policy. In Chapters 27 we look at why countries trade goods and
services. In Chapters 815 we examine what government policies toward trade would
bring benefits and to whom. This first half of the book might be called international
microeconomics.
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viii Preface
Our basic theory of trade, presented in Chapter 2, says that trade usually results
from the interaction of competitive demand and supply. It shows how the gains that
trade brings to some people and the losses it brings to others can sum to overall
global and national gains from trade. Chapter 3 launches an exploration of what
lies behind the demand and supply curves and discovers the concept of comparative
advantage. Chapter 4 shows that countries have different comparative advantages for
the fundamental reason that people, and therefore countries, differ from each other
in the productive resources they own. Chapter 5 looks at the strong impacts of trade
on people who own those productive resourcesthe human labor and skills, the
capital, the land, and other resources. Some ways of making a living are definitely
helped by trade, while others are hurt. Chapter 6 examines how actual trade may
reflect forces calling for theories that go beyond our basic ideas of demand and sup-
ply and of comparative advantage. Chapter 7 explores some key links between trade
and economic growth.
Chapters 815 use the theories of the previous chapters to analyze a broad range
of government policy issues. Chapters 810 set out on a journey to map the border
between good trade barriers and bad ones. This journey turns out to be intellectu-
ally challenging, calling for careful reasoning. Chapter 11 explores how firms and
governments sometimes push for more trade rather than less, promoting exports
more than a competitive marketplace would. Chapter 12 switches to the economics
of trade blocs like the European Union and the North American Free Trade Area.
Chapter 13 faces the intense debate over how environmental concerns should affect
trade policy. Chapter 14 looks at how trade creates challenges and opportunities
for developing countries. Chapter 15 examines the economics of emigration and
immigration and the roles of global companies in the transfer of resources, including
technology, between countries.
The focus of the second half of the book shifts to international finance and
macroeconomics. In Chapters 1621 we enter the world of different moneys, the
exchange rates between these moneys, and international investors and speculators.
Chapters 2225 survey the effects of a national governments choice of exchange-
rate policy on the countrys macroeconomic performance, especially unemployment
and inflation.
Chapter 16 presents the balance of payments, a way to keep track of all the eco-
nomic transactions between a country and the rest of the world. In Chapter 17 we
explore the basics of exchange rates between currencies and the functioning and
enormous size of the foreign exchange market. Chapter 18 provides a tour of the
returns to and risks of foreign financial investments. Exchange rates are prices, and
in Chapter 19 we look behind basic supply and demand in the foreign exchange
market, in search of fundamental economic determinants of exchange-rate values.
Chapter 20 examines government policies toward the foreign-exchange market, first
using description and analysis, and then presenting the history of exchange-rate
regimes, starting with the gold standard and finishing with the current mash-up of
different national policies. Well-behaved international lending and borrowing can
create global gains, but Chapter 21 also examines financial crises that can arise
from some kinds of foreign borrowing and that can spread across countries, a clear
downside of globalization.
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Preface ix
Chapter 22 begins our explication of international macroeconomics by develop-
ing a framework for analyzing a national economy that is linked to the rest of the
world through international trade and international financial investing. We use this
framework in the next two chapters to explore the macroeconomic performance of a
country that maintains a fixed exchange-rate value for its currency (Chapter 23) and
of a country that allows a floating, market-driven exchange-rate value for its currency
(Chapter 24). Chapter 25 uses what we have learned throughout the second half of the
book to examine the benefits and costs of alternatives for a countrys exchange-rate
policy. While rather extreme versions of fixed exchange rates serve some countries
well, the general trend is toward more flexible exchange rates.
In a few places the books scheme (international trade first, international finance
second) creates some momentary inconvenience, as when we look at the exchange-
rate link between cutting imports and reducing exports in Chapter 5 before we have
discussed exchange rates in depth. Mostly the organization serves us well. The under-
standing we gain about earlier topics provides us with building blocks that allow us to
explore broader issues later in the book.
CURRENT EVENTS AND NEW EXAMPLES
It is a challenge and a pleasure for me to incorporate the events and policy changes that
continue to transform the global economy, and to find the new examples that show the
effects of globalization (both its upside and its downside). Here are some of the current
and recent events and issues that are included in this edition to provide new examples
that show the practical use of our international economic analysis:
The euro crisis that began in Greece in 2010 spread to several other countries in
the euro area and during 20112012 seemed to threaten the continued existence of
the euro itself. Still, in the face of continued weak economic performance in the
euro area, Latvia adopted the euro at the beginning of 2014, bringing the number
of countries in the euro area to 18.
Beginning in 2007 the United States rapidly expanded its production of natural gas
using horizontal drilling and hydraulic fracturing. A large number of U.S. firms
sought approval to export natural gas, but a U.S. law prohibits export unless it is in
the national interest. The U.S. government has been slow to act; as of mid-2014,
only one U.S. facility had received full approval to export.
Immigration continues to be a hot issue. In 2014 Swiss voters approved limitations
on immigration into the country. Prime Minister Cameron pledged to greatly reduce
immigration into Britain by 2015. In 2013 the U.S. government again failed to pass
a revision of its immigration laws.
Chinese government holdings of foreign exchange reserve assets reached $4 trillion
in mid-2014, the result of continued official intervention to prevent the exchange-
rate value of Chinas currency from rising too quickly.
Pressure from the growth of the countries exports led to rapidly rising wages for
workers in China and in India.
After nearly two decades of negotiations, Russia joined the World Trade
Organization (WTO) in 2012.
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x Preface
In 2013 the members of the WTO reached a new multilateral agreement on
trade facilitation, but in 2014 its implementation was held up by a single coun-
try, India.
In response to rapidly growing imports, American steel producers sent a large
number of new complaints to the U.S. government, alleging dumping by foreign
producers and seeking hefty new antidumping duties.
The WTO ruled that European governments had violated WTO rules by offering
massive subsidies to Airbus and that the U.S. government had violated WTO rules
by offering massive subsidies to Boeing. But, then, the situation seemed to reach
a stalemate.
After approval from the U.S. Congress, the United States implemented free-trade
agreements with Colombia, South Korea, and Panama.
In 2012, Venezuela became a member of MERCOSUR, the South American
regional trade area.
Croatia joined the European Union in 2013 as its 28th member country.
The first phase of the Kyoto Protocol was completed in 2012. For a number of
reasons, the effects were minor, and global warming continues as a major global
environmental challenge.
Led by increases in international financial investments and computer-driven trad-
ing, the size of the foreign exchange market continued to grow, with trading of one
currency for another reaching $5 trillion per day in 2013. Foreign exchange trading
has more than tripled since 2004.
The market-driven exchange-rate value of the Japanese yen increased during the
week after a tsunami caused the nuclear disaster at Fukushima in 2011, prompting
a large official intervention in the foreign exchange market.
Starting in 2008, the International Monetary Fund (IMF) rapidly expanded its lend-
ing to countries in crisis, with loans outstanding reaching $125 billion in mid-2014.
Most of these IMF loans are to advanced countriesIceland, Greece, Ireland, and
Portugala sharp contrast to the lending to developing countries that had been
predominant since 1980.
The United States pursued a third round of quantitative easing during 20122014 as
a continuation of unconventional monetary policy for an economy stuck in a liquid-
ity trap. In this third round, the Fed bought about $1.5 trillion of Treasury securities
and mortgage-backed securities, but this round seemed to have less effect on the
exchange-rate value of the U.S. dollar than did previous rounds.
IMPROVING THE BOOK: TOPICS
In this edition I introduce and extend a number of improvements to the pedagogical
structure and topical coverage of the book.
The euro crisis that began in 2010 and intensified in 2011 and 2012 has had
profound effects on the member countries of the euro areathe countries that
have replaced their national currencies with the euro in a monetary union.
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Preface xi
This edition interweaves the causes and impacts of the euro crisis across its
chapters. The overview of the euro crisis in Chapter 1 shows that it began in
different ways, as a fiscal crisis in Greece and as a burst housing-price bubble
in Ireland that led to a banking crisis. Portugal then had a debt-driven crisis, and
contagion spread the crisis pressures to Spain and Italy. The European Central
Bank needed to play a key role, and a new program announced in July 2012
and adopted in September was the turning point in addressing the worst of the
crisis. I then present discussions of important aspects of the crisis in a series of
new shaded Euro Crisis boxes, which join the other six series of boxes: Global
Crisis, Focus on China, Global Governance, Focus on Labor, Case Studies, and
Extensions. For the Euro Crisis series, the new box in Chapter 16 shows how
attention to current account balances and net international investment positions
of the countries at the center of the crisis would have given signals of rising risk.
Chapter 18 has a combination of a Global Crisis and Euro Crisis box, which
shows how a key parity relationship among interest rates and exchange rates
weakened under crisis conditions. The new box in Chapter 21 explains how the
euro crisis was actually three interrelated crises that reinforced each other
sovereign debt or fiscal crisis, banking crisis, and macroeconomic crisis. While
the sovereign debt and banking crises have calmed, the macroeconomic perfor-
mance of the euro area remained very weak and Greece was in depression. The
concluding section of Chapter 25 examines the benefits and costs of European
monetary union, with special attention to fiscal policy. The euro area lacks area-
wide taxation and government spending, National fiscal policies have a double
edge, as both the principal remaining tool for national governments to address
their macroeconomic performance problems and a potential source of instability
that can threaten the entire union.
The global financial and economic crisis that began in 2007 is the most important
global trauma of the past 70 years, and it was a major contributor to the onset of
the euro crisis. A new section of the text of Chapter 21 describes the global crisis,
including the start of the crisis as the result of losses on sub-prime mortgages in
the United States and on assets backed by these mortgages, and the terrible wors-
ening of the crisis in 2008 with the failure of Lehman Brothers. This discussion
of the global crisis also shows how the analysis of the series of financial crises
that hit developing countries during 19822002 helps us to understand the causes
and spread of the global crisis. The Global Crisis series of boxes examines other
aspects of the crisis, including the collapse of international trade (Chapter 2),
the avoidance of new protectionism (Chapter 9), the use of quantitative easing
as nontraditional monetary policy once short-term interest rates are essentially
zero (Chapter 24), and the increased use of currency swaps among central banks
(Chapter 24).
China continues its rise as a force in the global economy. The presentation of
Chinas global role, including the series of boxes Focus on China, continues to
be a strength of the text. Chapters 1 and 20 discuss the development of Chinas
controversial policies toward the exchange-rate value of its currency. In the box in
Chapter 9, the presentation of Chinas rising involvement in the dispute settlement
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xii Preface
process at the World Trade Organization, both as a respondent (alleged violator)
and as a complainant, has been updated and rewritten. Among other recent cases,
the WTO ruled in 2014 that Chinas restrictions on exports of rare earths were a
violation of its WTO commitments.
A major strength of the book remains in-depth analysis of a range of trade
and trade-policy issues. The discussion of monopolistic competition and intra-
industry trade in Chapter 6 has been expanded to incorporate the conclusions
from research based on differences across firms in their cost levels. Opening to
international trade favors the survival and expansion of lower-cost firms. This dis-
cussion also includes an estimate of the global gains from greater product variety.
The section on trade embargoes in Chapter 12 has been revised, with a current
case, Iran, being used as the example of the effects of international sanctions on
the target country. Estimates of national factor endowments presented in Chapter 5
are completely updated and include better data on physical capital stocks and
more countries in total. Data on national intra-industry trade shares in Chapter 6
include new estimates for 2012.
Chapter 13 on trade and the environment continues as a unique and powerful
treatment of issues of interest to many students. The discussion of global warm-
ing has been revised to incorporate data and projections from recent studies. The
discussion of the Kyoto Protocol has been updated to include the outcomes from
the first phase that ended in 2012 and the continued increase in global greenhouse
gas emissions.
The box on the fiscal effects of immigration in Chapter 15 has been substan-
tially rewritten to incorporate the results of a recent Organization for Economic
Cooperation and Development study of the effects of immigrants on government
revenues and expenditures.
In Chapter 18 a new section of text explains the definitions and uses of real
exchange rates and effective exchange rates. The four ways to measure the
exchange-rate value of a currency had previously been a box in the chapter, but the
increasing importance of these concepts motivated the shift to a text section.
Chapter 21 has been substantially revised. It incorporates the global financial and
economic crisis into the text of the chapter and has a new box on the euro crisis.
Some other aspects of the chapter have been streamlined. The short subsections on
the Brazilian mini-crisis of 1999 and the Turkish crisis of 2001 have been removed,
as has one of the two boxes on the International Monetary Fund.
I used the latest available sources to update the wide range of data and informa-
tion presented in the figures and text of the book. Among other updates, the book
offers the latest information on international trade in specific products for the
United States, China, and Japan; national average tariff rates; dumping and sub-
sidy cases; levels and growth rates of national incomes per capita; trends in the
relative prices of primary products; patterns of foreign direct investments broadly
and by major home country; rates of immigration into the United States, Canada,
and the European Union; the U.S. balance of payments and the U.S. international
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Preface xiii
investment position; the sizes of foreign exchange trading and foreign exchange
futures, swaps, and options; levels and trends for nominal exchange rates; effective
exchange-rate values for the U.S. dollar; evidence about relative purchasing power
parity; the exchange-rate policies chosen by national governments; the flows of
international financing to and the outstanding foreign debt of developing countries;
and gold prices.
NEW QUESTIONS AND PROBLEMS
In this edition I provide additional opportunities for students to engage with the books
contents by adding new questions that students can use to build their facility in using
the concepts and analysis of international economics.
Forty-eight new questions and problems have been added, two new questions and
problems to each of the chapters that have end-of-chapter materials. These new
questions and problems are targeted to cover chapter topics that were previously
underrepresented.
A discussion question has been added at the end of each Case Study box, a total of
24 new questions that focus on the issues raised in the case studies.
FORMAT AND STYLE
I have been careful to retain the goals of clarity and honesty that have made
International Economics an extraordinary success in classrooms and courses around
the world. There are plenty of quick road signs at the start of and within chapters. The
summaries at the ends of the chapters offer an integration of what has been discussed.
Students get the signs, Heres where we are going; heres where we have just been.
I use bullet-point and numbered lists to add to the visual appeal of the text and to
emphasize sets of determinants or effects. I strive to keep paragraphs to reasonable
lengths, and I have found ways to break up some long paragraphs to make the text
easier to read.
I am candid about ranking some tools or facts ahead of others. The undeniable
power of some of the economists tools is applied repeatedly to events and issues
without apology. Theories and concepts that fail to improve on common sense are not
oversold.
The format of the book is fine-tuned for better learning. Students need to master
the language of international economics. Most exam-worthy terms appear in boldface
in the text, with their definitions usually contiguous. The material at the end of each
chapter includes a listing of these Key Terms , and an online Glossary has definitions
of each term. Words and phrases that deserve special emphasis are in italics.
Each chapter (except for the short introductory chapter) has at least 12 questions
and problems. The answers to all odd-numbered questions and problems are included
in the material at the end of the book. As a reminder, these odd-numbered questions
are marked with a .
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xiv Preface
SUPPLEMENTS
The following ancillaries are available for quick download and convenient access via
the Instructor Resource material available through McGraw-Hill Connect.
PowerPoint Presentations: Revised by Farhad Saboori of Albright College, the
PowerPoint slides now include a brief, detailed review of the important ideas cov-
ered in each chapter, accompanied by relevant tables and figures featured within
the text. You can edit, print, or rearrange the slides to fit the needs of your course.
Test Bank: Updated by Robert Allen of Columbia Southern University, the test
bank offers well over 1,500 questions categorized by level of difficulty, AACSB
learning categories, Blooms taxonomy, and topic.
Computerized Test Bank: McGraw-Hills EZ Test is a flexible and easy-to-use
electronic testing program that allows you to create tests from book-specific items.
It accommodates a wide range of question types, and you can add your own ques-
tions. Multiple versions of the test can be created, and any test can be exported for
use with course management systems. EZ Test Online gives you a place to admin-
ister your EZ Testcreated exams and quizzes online. Additionally, you can access
the test bank through McGraw-Hill Connect.
Instructors Manual: Written by the author, the instructors manual contains
chapter overviews, teaching tips, and suggested answers to the discussion ques-
tions featured among the case studies as well as the end-of-chapter questions and
problems. To increase flexibility, the Tips section in each chapter often provides the
authors thoughts and suggestions for customizing the coverage of certain sections
and chapters.
DIGITAL SOLUTIONS
McGraw-Hill Connect Economics
Less Managing. More Teaching. Greater Learning. McGraw-
Hills Connect Economics is an online assessment solution that
connects students with the tools and resources theyll need to
achieve success.
Shaded boxes appear in different font with a
different right-edge format and two columns
per page, in contrast to the style of the main
text. The boxes are labeled by type and provide
discussions of the euro crisis that began in 2010,
the global financial and economic crisis that
began in 2007, the roles of the WTO and the IMF
in global governance, Chinas international trade
and investment, labor issues, case studies, and
extensions of the concepts presented in the text.
Box
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