Dr. P.V. Viswanath



Economics/Finance on the Web
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Some Answers to Questions on International Finance Articles


Why Trade is Good for You

  1. What are the advantages of free trade, according to economists?

  2. Ans: One, world production will increase; furthermore, all countries participating in free trade can consume more.
    Two, opening up markets to foreign suppliers increases competition.
    Three, free trade means that firms are not limited by the size of their home markets. This means that they can take advantage of economies of scale. Four, freer trade can mean faster economic growth. This happens in several ways: a) bigger markets create more scope for "learning by doing." Firms become more efficient by doing things on a larger scale. b) There are also greater incentives to invest in R&D. c) Trade also disseminates knowledge and technology.
  3. How does the possibility of factor mobility affect the theory of comparative advantage?

  4. Ans: Factor mobility allows previously inefficent countries to become more efficient through the acquisition of factors. This also means that comparative advantage by itself may not be able to explain trade since countries' differences in production efficiency can be erased through factor mobility.
    On the other hand, factor mobility might cause countries to specialize even further because of the increased migration of factors specializing in a given activity to the country which originally had a comparative advantage in that activity. This might be beneficial because of economies of scale.
  5. How does the advent of the multinational corporation impact the theory of comparative advantage? Is it possible to reconcile the theory with multinational corporations?

  6. Ans: Multinational corporations can simply be seen as the conduit through which trade is conducted. In this sense, there is no conflict between the theory of comparative advantage and the advent of the multinational corporation. However, to the extent that capital is moved across countries and technology is moved across frontiers by the multinational corporation, differences in comparative advantage can be erased.

 Trade Theory vs. Used Clothes in Africa

  1. Wouldn't permitting the import of used clothes reduce local employment in the garment industry? Isn't it therefore better to ban the import of used clothes?

  2. Ans: Permitting the import of used clothes may indeed reduce employment in the clothing industry, at least in the new clothes segment. However, this will be offset by employment in the used clothing sector. Furthermore, the lower price paid by consumers should be offset against the loss to workers who are specialized in making new clothes, and would not be able to easily switch to other employments.
  3. What other arguments could be used to ban importing used clothes?

  4. Ans: It's difficult to think of arguments in favor of a ban. Perhaps it could be argued that the import of used clothes prevents the development of an efficient new clothes manufacturing industry over time. Patriotic arguments are also sometimes used.
  5. What do you think of Mr. Sirak's point that the import of used clothes has lead to a reduction in the quality of garments?

  6. Ans: That might very well be true; however, if so, it just means that there is not as much demand for quality new clothes, if consumers can substitute for them with cheaper used clothes.

Dollar Firms, Stocks Slip

  1. What caused the dollar to firm up? Relate your answer to theories of exchange rate determination.
    Ans: The dollar firmed up against the euro because of expectations that the Fed would increase nominal interest rates. Apparently the market felt that this would also increase real interest rates. This would cause marginal investors to move their funds from the euro and other currencies to the dollar, which would cause the dollar to firm up. However, since this is widely expected to happen, the dollar is firming up right away, in expectations of the impending dollar run-up.

Outsourcing 101

  1. Explain why losing business processing and other IT jobs to India can turn out to be good (or at least not bad) for the US? (Do not copy any sentences from the article; try and use your own examples.)
    Ans: First of all, outsourcing production/services to lower-cost providers to firms outside the US should lower prices for goods.
    Second, this might be an added source of flexibility compared to the alternative of allowing temporary or permanent immigration of the required workers to the US. If there are public costs of having these workers in the US, such as public health costs, and it is not possible to have the workers leave as soon as the need for them dries up, there would be deadweight costs on US taxpayers.
    Third, this could provide additional competition for US firms that compete with these foreign firms -- this can have the result of improving US productivity, as well as of increasing innovation.
    Fourth, there could be complementarity effects. There may be new job creation in the US related to the products that US firms can sell because of outsourcing. Such job creation may be, for example, in auditing, which US firms may want to have done by other US firms.
    (Example from a student -- Citigroup recently outsourced the Global Deployment Services to India, a group that is responsible for packaging applications. This is a mechanical process, which seems to be working well. The GDS group has redeployed their US staff to work on re-engineering the process. They had hired 7 additional people to work on improving processes. The end result proved to be beneficial to all. )

Foreign investment in China's banks

  1. This should cause us to rethink Vernon's theory. These foreign banks are willing to bring in capital into China. If this is so, then local availability of capital is no longer a necessity for a country to be in the first list of countries that Vernon gives us, viz. the new product stage.
    Another way to relate Vernon's theory to the article is to treat the banks themselves as engaging in FDI -- in the banking industry. However, this is much more difficult to do, since it's not clear whether the "product" in question can be exported, in the first place!
  2. According to the first part of the article, China seems to be a textbook example of Porter's Theory of the Competitive Advantage of Nations, since China's nationalized banking industry seems to have been prodded by the government into reforming itself and attracting foreign capital. However, in the second half, we are told that the Chinese banks haven't really reformed; yet, they are attracting foreign capital, thus seemingly refuting Porter's theory.
  3. Germany seems to have done much more in making its labor laws more business-friendly and flexible (one example). Hence Germany seems more of a Porter example than China.