INTERNATIONAL TRADE

International Trade

International Trade

This paper is based on exam questions related to the topic of international trade.

Q1: Capital Flows

The surge in capital inflows to emerging market economies in the early part of each of the past two decades was attributed initially to domestic developments, such as sound policies and stronger economic performance, implying both the good use of such funds in the recipient country and the informed judgment of investors in the developed world (www.nber.org). The widespread nature of the phenomenon became clearer over time, though, as most developing countries -- whether they had improved, unchanged, or impaired macroeconomic fundamentals -- found themselves the destination of capital from global financial centers.

To some, the mystery of cross-border flows is not these recurrent cycles unanchored from country conditions but rather the restricted volume of these flows overall. Most famously, Robert Lucas argued that it was a puzzle that more capital does not flow from rich countries to poor countries, given back-of-the envelope calculations suggesting massive differences in physical rates of return in favor of capital poor countries. Lucas argued that the paucity of capital flows to poor countries must be rooted in fundamental economic forces, such as externalities in human capital formation favoring further investment in already capital rich countries (www.nber.org).

Various forms of controls on capital inflows--whether in the form of taxes, quantitative restrictions, or in the guise of "prudential measures"--have been imposed on the financial sector, usually with the aim of deterring short-term inflows. (Sometimes these controls take the form of prudential measures to curb the exposure of the domestic banking sector to the vagaries of real estate prices and equity markets.)

The fact that so many poor countries are in default on their debts, that so little funds are channeled through equity, and that overall private lending rises more than proportionally with wealth, all strongly support the view that credit markets and political risk are the main reasons why we do not see more capital flows to developing countries (www.nber.org).

Given this experience of wide swings in foreign funding, it is not surprising that policymakers in many emerging market economies have come to fear large current account deficits, irrespective of how they are financed, but particularly if they are financed by short-term debt. The capital inflow slowdown or reversal could push the country into insolvency or drastically lower the productivity of its existing capital stock. These multiple concerns have produced multiple responses to capital inflows (www.nber.org).

If credit market imperfections abate over time because of better institutions, then human capital externalities or other "new growth" elements may come to play a larger role. But as long as the odds of non-repayment are as high as 65 percent for some low-income countries, credit risk seems like a far more compelling reason for the paucity of rich-poor capital flows.

Q2: Euro System and Banks

Since the introduction of the euro in 1999, there has been growing demand for central counterparty clearing. Several central counterparty clearing houses already exist in the euro area and a number of mergers ...