International Finance

THE WORLD OF INTERNATIONAL FINANCEtrade can make a broader range of inputs and technology available and thereby increase economicgrowth. 15 Therefore, the gain from exploiting comparative advantages is only part of the total gain fromfree trade. 16Some costs of international tradeWhile most economists believe that international trade is beneficial, there are possible costs to be weighed against thegains. One possible costof freeinternational trade occurs whena country finds its own firmsput out of business and therebyexposesitselftoexploitationby a foreign monopoly. Thisisthe flipsidetothe gainfrom competition described earlier,andislikelytooccuronlyinoligopolisticmarketswithveryfewproducers. 17 Forexample,ithasbeenarguedthatitcanbeadvantageous for governments to subsidize aircraft production in Europe so as to reduce prices faced on importedaircraft. 18 Another possible drawback of trade is the reduction ineconomic diversity a country might face. This is the flipside of the gain from specialization. Finally, some people have decried international trade because of the homogenizationof culture and possible political domination it has brought to the planet, while others have questioned trade becauseof possible impacts on the environment. 19 It is clear that as in most things in economics, there is no free lunch.APPENDIX BThe gains from the international flow of capitalIn Appendix A we showed that everybody can simultaneously benefit from international trade in goods and services.In this appendix we show that everybody can also simultaneously gain from the international flow of financialcapital. Between them, the international flow of goods and services and the international flow of capital constitutethe sum total of reasons for the supply of and demand for foreign exchange. Indeed, as we shall show in Chapter 5,the two major subdivisions of the balance-of-payments account – the current account and the capital account –report respectively the demand for and supply of a country’s currency due to trade in goods and services, and thesupply of and demand for the currency due to the flow of capital. Therefore, what this and Appendix A do is showthat the very bases of the study of international finance – transactions due to the flow of goods and services and theflow of capital – are both important contributors to our well-being. It is not, as is often thought, just the freeinternational flow of goods and services from which we benefit.15 See Gene M. Grossman and Elhanan Helpman, ‘‘Product Development and International Trade,’’ Journal of Political Economy,December 1989, pp. 1261–83, and ‘‘Growth and Welfare in a Small Open Economy,’’ National Bureau of Economic Research,Working Paper 2970, May 1989. For an alternative view, see Meir G. Kohn and Nancy P. Marion, ‘‘The Implicationsof Knowledge-Based Growth for the Optimality of Open Capital Markets,’’ Canadian Journal of Economics, November 1992,pp. 865–83.16 An account of the numerous sources of gains from trade can be found in Cletus C. Coughlin, K. Alec Chrystal, and GeoffreyE. Wood, ‘‘Protectionist Trade Policies: A Survey of Theory, Evidence and Rationale,’’ Review, Federal Reserve Bank ofSt. Louis, January/February 1988, pp. 12–26.17 See Elhanan Helpman and Paul R. Krugman, Trade Policy and Market Structure, MIT Press, Cambridge MA, 1989.18 See James A. Brander and Barbara Spencer, ‘‘Export Subsidies and International Market Share Rivalry,’’ Journal of InternationalEconomics, February 1985, pp. 83–100.19 On the effects on culture and political domination, see J. J. Servain-Schreiber, The American Challenge, Hamish Hamilton,London, 1968. On trade and the environment, see Alison Butler, ‘‘Environmental Protection and Free Trade: Are TheyMutually Exclusive?’’ Review, Federal Reserve Bank of St. Louis, May/June 1992, pp. 3–16.& 22