International EconomicsTHEORY & POLICY

NINTH EDITION

GLOBAL EDITION

Paul R. KrugmanPrinceton University

Maurice ObstfeldUniversity of California, Berkeley

Marc J. MelitzHarvard University

Boston Columbus Indianapolis New York San Francisco Upper Saddle River

Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto

Delhi Mexico City Sao Paulo Sydney Hong Kong -Seoul Singapore Taipei Tokyo

Brief ContentsContentsPreface

1 Introduction

Part 1 International Trade Theory

2

3

4

5

6

7

8

Part 2

9101112

Part 31314

15161718

Part 4

19202122

International Trade Policy

The Instruments of Trade PolicyThe Political Economy of Trade PolicyTrade Policy in Developing CountriesControversies in Trade Policy

Exchange Rates and Open-Economy Macroeconomics

National Income Accounting and the Balance of PaymentsExchange Rates and the Foreign Exchange Market:

An Asset ApproachMoney, Interest Rates, and Exchange RatesPrice Levels and the Exchange Rate in the Long RunOutput and the Exchange Rate in the Short RunFixed Exchange Rates and Foreign Exchange Intervention

International Macroeconomic Policy

International Monetary Systems: An Historical OverviewOptimum Currency Areas and the European ExperienceFinancial Globalization: Opportunity and CrisisDeveloping Countries: Growth, Crisis, and Reform

9

21

31

40

World TradeT An Overview 40Labor Productivity and Comparative Advantage:

The Ricardian Model 54Specific Factors and Income Distribution 80Resources and Trade: The Heckscher-Ohlin Model 110The Standard Trade Model 141External Economies of Scale and the International

Location of Production 167Firms in the Global Economy: Export Decisions, Outsourcing,

and Multinational Enterprises 185222

222

249

286

301

323

323

350

384

414

451

493

534

534

587

616

649

Brief Contents

Mathematical PostscriptsPostscript to Chapter 5: The Factor Proportions Model 691

Postscript to Chapter 6: The Trading World Economy 695

Postscript to Chapter 8: The Monopolistic Competition Model 703

Postscript to Chapter 21: Risk Aversion and International Portfolio Diversification 705

Credits 713

Index 715

Preface 21

Introduction 31

What Is International Economics About? 33The Gains from Trade 34The Pattern of Trade 35How Much Trade? 35Balance of Payments r.'. 36Exchange Rate Determination 36International Policy Coordination 37The International Capital Market 37

International Economics: Trade and Money 38

Part 1 International Trade Theory 40^

[g] World Trade: An Overview 40Who Trades with Whom? 40

Size Matters: The Gravity Model 41Using the Gravity Model: Looking for Anomalies : 43Impediments to Trade: Distance, Barriers, and Borders * 44

The Changing Pattern of World Trade 46Has the World Gotten Smaller? 46What Do We Trade? 47Service Outsourcing 49

Do Old Rules Still Apply? 51Summary 51

[£j Labor Productivity and Comparative Advantage: The Ricardian Model 54

The Concept of Comparative Advantage '. 55A One-Factor Economy 56

Production Possibilities 57Relative Prices and Supply 58

Trade in a One-Factor World 59Determining the Relative Price After Trade 60

BOX: Comparative Advantage in Practice: The Case of Babe Ruth 63The Gains from Trade 64A Note on Relative Wages 65

BOX: The Losses from Nontrade 66Misconceptions About Comparative Advantage 67

Productivity and Competitiveness 67The Pauper Labor Argument 67

BOX: DO Wages Reflect Productivity? 68Exploitation 69

Comparative Advantage with Many Goods 70Setting Up the Model 70.Relative Wages and Specialization '. 70Determining the Relative Wage in the Multigood Model 72

10 Contents

Adding Transport Costs and Nontraded Goods 73Empirical Evidence on the Ricardian Model 75Summary 77

Specific Factors and Income Distribution 80

The Specific Factors Model 81BOX: What Is a Specific Factor? 82

Assumptions of the Model 82Production Possibilities 83Prices, Wages, and Labor Allocation 86Relative Prices and the Distribution of Income 90

International Trade in the Specific Factors Model 92Income Distribution and the Gains from Trade 93The Political Economy of Trade: A Preliminary View 95CASE STUDY: Trade and Unemployment 96

Income Distribution and Trade Politics 98International Labor Mobility 99CASE STUDY: Wage Convergence in the Age of Mass Migration 100CASE STUDY: Foreign Workers: The Story of the GCC 101Summary 103Appendix: Further Details on Specific Factors 107

Marginal and Total Product 107Relative Prices and the Distribution of Income \ 108

Resources and Trade: The Heckscher-Ohlin Model 110

A Model of a Two-Factor Economy I l lPrices and Production I l lChoosing the Mix of Inputs 114Factor Prices and Goods Prices 116Resources and Output 118

Effects of International Trade Between Two-Factor Economies 119Relative Prices and the Pattern of Trade 120Trade and the Distribution of Income '. 121

CASE STUDY: North-South Trade and Income Inequality 122Factor-Price Equalization 127

Empirical Evidence on the Heckscher-Ohlin Model 128Trade in Goods as a Substitute for Trade in Factors 128Patterns of Exports Between Developed and Developing Countries 131Implications of the Tests 132

Summary 134Appendix: Factor Prices, Goods Prices, and Production Decisions 137

Choice of Technique 137Goods Prices and Factor Prices 138More on Resources and Output 139

@ | The Standard Trade Model 141

A Standard Model of a Trading Economy 142Production Possibilities and Relative Supply 142Relative Prices and Demand 143The Welfare Effect of Changes in the Terms of Trade '. 146Determining Relative Prices 147Economic Growth: A Shift of the RS curve 147

Contents 11

Growth and the Production Possibility Frontier 149World Relative Supply and the Terms of Trade 149International Effects of Growth 151

CASE STUDY: Has the Growth of Newly Industrializing CountriesHurt Advanced Nations? 152

Tariffs and Export Subsidies: Simultaneous Shifts in RS and RD 154Relative Demand and Supply Effects of a Tariff 155Effects of an Export Subsidy 156Implications of Terms of Trade Effects: Who Gains and Who Loses? 156

International Borrowing and Lending 157Intertemporaf Production Possibilities and Trade 158The Real Interest Rate 158Intertemporal Comparative Advantage 160

Summary 160Appendix: More on Intertemporal Trade 164

\¥] External Economies of Scale and the International Location of Production 167Economies of Scale and International Trade: An Overview 168Economies of Scale and Market Structure 169The Theory of External Economies 170

Specialized Suppliers 170Labor Market Pooling 171Knowledge Spillovers \ 172External Economies and Market Equilibrium 172

External Economies and International Trade 173External Economies, Output, and Prices 173External Economies and the Pattern of Trade 175

BOX: Holding the World Together 177Trade and Welfare with External Economies 177Dynamic Increasing Returns 179

Interregional Trade and Economic Geography 180BOX: Tinseltown Economics 181Summary 182

[©] Firms in the Global Economy: Export Decisions, Outsourcing,and Multinational Enterprises 185The Theory of Imperfect Competition 186

Monopoly: A Brief Review 187Monopolistic Competition 189

Monopolistic Competition and Trade 194The Effects of Increased Market Size 194Gains from an Integrated Market: A Numerical Example 196The Significance of Intra-Industry Trade 199

CASE STUDY: The Emergence of the Turkish Automotives Industry 201Firm Responses to Trade: Winners, Losers, and Industry

Performance 202Performance Differences Across Producers 202The Effects of Increased Market Size 204

Trade Costs and Export Decisions 206Dumping ".. .208CASE STUDY: Antidumping as Protectionism 209

Multinationals and Outsourcing 210

12 Contents

CASE STUDY: Patterns of Foreign Direct Investment Flows Around the World 210The Firm's Decision Regarding Foreign Direct Investment 213Outsourcing 215Consequences of Multinationals and Foreign Outsourcing 216

Summary 217Appendix: Determining Marginal Revenue 221

Part 2 International Trade Policy 222

The Instruments of Trade Policy 222

Basic Tariff Analysis 222Supply, Demand, and Trade in a Single Industry 223Effects of a Tariff 225Measuring the Amount of Protection 226

Costs and Benefits of a Tariff .228Consumer and Producer Surplus 228Measuring the Costs and Benefits 229

BOX: Tariffs for the Long Haul 232Other Instruments of Trade Policy 232

Export Subsidies: Theory 233CASE STUDY: Europe's Common Agricultural Policy 234

Import Quotas: Theory 235CASE STUDY: An Import Quota in Practice: U.S. Sugar 236

Voluntary Export Restraints \ 238CASE STUDY: A Voluntary Export Restraint in Practice: Japanese Autos 238

Local Content Requirements 239BOX: American Buses, Made in Hungary 240

Other Trade Policy Instruments 240The Effects of Trade Policy: A Summary ; 241Summary 241Appendix: Tariffs and Import Quotas in the Presence of Monopoly 245

The Model with Free Trade 245The Model with a Tariff 246The Model with an Import Quota 247Comparing a Tariff and a Quota 247

) The Political Economy of Trade Policy 249

The Case for Free Trade 250Free Trade and Efficiency 250Additional Gains from Free Trade 251Rent-Seeking 252Political Argument for Free Trade 252

CASE STUDY: The Gains from 1992 253National Welfare Arguments Against Free Trade 254

The Terms of Trade Argument for a Tariff 255The Domestic Market Failure Argument Against Free Trade 256How Convincing Is the Market Failure Argument? 257

Income Distribution and Trade Policy 259Electoral Competition 259Collective Action • 260

BOX: Politicians for Sale: Evidence from the 1990s 261Modeling the Political Process 262Who Gets Protected? 263

Contents 13

International Negotiations and Trade Policy 264The Advantages of Negotiation 265International Trade Agreements: A Brief History 266The Uruguay Round 268Trade Liberalization 268Administrative Reforms: From the GATT to the WTO 269Benefits and Costs 270

BOX: Settling a Dispute—and Creating One 271CASE STUDY: The Salmon War 272The Doha Disappointment 273BOX: DO Agricultural Subsidies Hurt the Third World? 274

Preferential Trading Agreements 275BOX: Free Trade Area versus Customs Union , 276BOX: DO Trade Preferences Have Appeal? 278CASE STUDY: Trade Diversion in South America 279Summary 279Appendix: Proving That the Optimum Tariff Is Positive 283

Demand and Supply 283The Tariff and Prices 283The Tariff and Domestic Welfare 284

JMl] Trade Policy in Developing Countries 286

Import-Substituting Industrialization 287The Infant Industry Argument " 288Promoting Manufacturing Through Protection 289

CASE STUDY: Mexico Abandons Import-SubstitutingIndustrialization 291

Results of Favoring Manufacturing: Problems of Import-SubstitutingIndustrialization 292

Trade Liberalization Since 1985 293Trade and Growth: Takeoff in Asia 295BOX: India's Boom 297Summary '. 298

p | Controversies in Trade Policy 301

Sophisticated Arguments for Activist Trade Policy 302Technology and Externalities 302Imperfect Competition and Strategic Trade Policy 304

BOX: A Warning from Intel's Founder 307CASE STUDY: When the Chips Were Up 308Globalization and Low-Wage Labor 309

The Anti-Globalization Movement 310Trade and Wages Revisited 310Labor Standards and Trade Negotiations 312Environmental and Cultural Issues 313The WTO and National Independence 314

CASE STUDY: Bare Feet, Hot Metal, and Globalization 315Globalization and the Environment 316

Globalization, Growth, and Pollution ,.. .316The Problem of "Pollution Havens" 317The Carbon Tariff Dispute 319

Summary 320

14 Contents

Part 3 Exchange Rates and Open-Economy Macroeconomics 323

[iJ©j National Income Accounting and the Balance of Payments 323

The National Income Accounts 325National Product and National Income 326Capital Depreciation and International Transfers 327Gross Domestic Product 327

National Income Accounting for an Open Economy 328Consumption 328Investment 328Government Purchases -r.- 329The National Income Identity for an Open Economy 329An Imaginary Open Economy 329The Current Account and Foreign Indebtedness 330Saving and the Current Account 332Private and Government Saving 333

CASE STUDY: Government Deficit Reduction May Not Increasethe Current Account Surplus 334

The Balance of Payments Accounts 336Examples of Paired Transactions 337The Fundamental Balance of Payments Identity 338The Current Account, Once Again 339The Capital Account 340The Financial Account .\ 340Net Errors and Omissions 341Official Reserve Transactions 342

CASE STUDY: The Assets and Liabilities of the World's Biggest Debtor 343Summary 346

[Ml Exchange Rates and the Foreign Exchange Market: An Asset Approach 350

Exchange Rates and International Transactions 351Domestic and Foreign Prices 351Exchange Rates and Relative Prices 353

The Foreign Exchange Market 354The Actors . .; 354Characteristics of the Market 355Spot Rates and Forward Rates 356Foreign Exchange Swaps 358Futures and Options 358

The Demand for Foreign Currency Assets 358Assets and Asset Returns 359

BOX: Nondeliverable Forward Exchange Trading in Asia 360Risk and Liquidity 362Interest Rates 362Exchange Rates and Asset Returns 364A Simple Rule 364Return, Risk, and Liquidity in the Foreign Exchange Market 366

Equilibrium in the Foreign Exchange Market 367Interest Parity: The Basic Equilibrium Condition 367How Changes in the Current Exchange Rate Affect Expected Returns 368The Equilibrium Exchange Rate " 369

Interest Rates, Expectations, and Equilibrium 371The Effect of Changing Interest Rates on the Current Exchange Rate 372The Effect of Changing Expectations on the Current Exchange Rate 373

Contents 15

CASE STUDY: What Explains the Carry Trade? 374Summary 376Appendix: Forward Exchange Rates and Covered

Interest Parity 381

Money, Interest Rates, and Exchange Rates 384

Money Defined: A Brief Review 385Money as a Medium of Exchange 385Money as a Unit of Account 385Money as a Store of Value 386What IfMoney? . . . , ::.'. 386How the Money Supply Is Determined 386

The Demand for Money by Individuals 387Expected Return 387Risk 388Liquidity 388

Aggregate Money Demand 388The Equilibrium Interest Rate: The Interaction of Money

Supply and Demand 390Equilibrium in the Money Market 390Interest Rates and the Money Supply 392Output and the Interest Rate : 393

The Money Supply and the Exchange Rate in the Short Run 393Linking Money, the Interest Rate, and the Exchange Rate .' 394U.S. Money Supply and the Dollar/Euro Exchange Rate 395Europe's Money Supply and the Dollar/Euro Exchange Rate 396

Money, the Price Level, and the Exchange Rate in the Long Run 398Money and Money Prices 399The Long-Run Effects of Money Supply Changes 399Empirical Evidence on Money Supplies and Price Levels 400Money and the Exchange Rate in the Long Run 401

Inflation and Exchange Rate Dynamics 402Short-Run Price Rigidity versus Long-Run Price Flexibility 402

BOX: Money Supply Growth and Hyperinflation in Bolivia 404Permanent Money Supply Changes and the Exchange Rate 404Exchange Rate Overshooting 407

CASE STUDY: Can Higher Inflation Lead to Currency Appreciation?The Implications of Inflation Targeting 408

Summary 411

Levels and the Exchange Slate in the Long Run 414

The Law of One Price 415Purchasing Power Parity 416

The Relationship Between PPP and the Law of One Price 416Absolute PPP and Relative PPP 417

A Long-Run Exchange Rate Model Based on PPP 418The Fundamental Equation of the Monetary Approach 418Ongoing Inflation, Interest Parity, and PPP 420The Fisher Effect 421

Empirical Evidence on PPP and the Law of One Price .424Explaining the Problems with PPP 425

Trade Barriers and Nontradables 426Departures from Free Competition 427Differences in Consumption Patterns and Price Level Measurement 427

16 Contents

BOX: Some Meaty Evidence on the Law of One Price 428PPP in the Short Run and in the Long Run 430

CASE STUDY: Why Price Levels Are Lower in Poorer Countries 431Beyond Purchasing Power Parity: A General Model of Long-Run

Exchange Rates 433The Real Exchange Rate 434Demand, Supply, and the Long-Run Real Exchange Rate 435

BOX: Sticky Prices and the Law of One Price: Evidencefrom Scandinavian Duty-Free Shops 436Nominal and Real Exchange Rates in Long-Run Equilibrium 438

International Interest Rate Differences and the Real Exchange Rate 440Real Interest Parity 442Summary 443Appendix: The Fisher Effect, the Interest Rate, and the Exchange Rate

Under the Flexible-Price Monetary Approach 448

Output and the Exchange Rate in the Short Run 451

Determinants of Aggregate Demand in an Open Economy 452Determinants of Consumption Demand 452Determinants of the Current Account 453How Real Exchange Rate Changes Affect the Current Account 454How Disposable Income Changes Affect the Current Account • 454

The Equation of Aggregate Demand 455The Real Exchange Rate and Aggregate Demand 455Real Income and Aggregate Demand 455

How Output Is Determined in the Short Run 456Output Market Equilibrium in the Short Run: The DD Schedule 458

Output, the Exchange Rate, and Output Market Equilibrium , 458Deriving the DD Schedule 459Factors That Shift the DD Schedule 459

Asset Market Equilibrium in the Short Run: The AA Schedule 462Output, the Exchange Rate, and Asset Market Equilibrium 462Deriving the AA Schedule '. 464Factors That Shift the AA Schedule 464

Short-Run Equilibrium for an Open Economy: Putting the DD and AASchedules Together 465

Temporary Changes in Monetary and Fiscal Policy 467Monetary Policy 468Fiscal Policy , 468Policies to Maintain Full Employment 469

Inflation Bias and Other Problems of Policy Formulation 471Permanent Shifts in Monetary and Fiscal Policy 472

A Permanent Increase in the Money Supply 472Adjustment to a Permanent Increase in the Money Supply 472A Permanent Fiscal Expansion 474

Macroeconomic Policies and the Current Account 476Gradual Trade Flow Adjustment and Current Account Dynamics 477

The J-Curve 477Exchange Rate Pass-Through and Inflation 479

BOX: Exchange Rates and the Current Account 480The Liquidity Trap 481Summary 484

Contents 17

Appendix 1: Intertemporal Trade and Consumption Demand 488Appendix 2: The Marshall-Lerner Condition and Empirical

Estimates of Trade Elasticities 490

[ | | Fixed Exchange Rates and Foreign Exchange Intervention 493

Why Study Fixed Exchange Rates? 494Central Bank Intervention and the Money Supply 495

The Central Bank Balance Sheet and the Money Supply 495Foreign Exchange Intervention and the Money Supply 497Sterilization .-.- , 497The Balance of Payments and the Money Supply 498

How the Central Bank Fixes the Exchange Rate 499Foreign Exchange Market Equilibrium Under a Fixed Exchange Rate 499Money Market Equilibrium Under a Fixed Exchange Rate 500A Diagrammatic Analysis 501

Stabilization Policies with a Fixed Exchange Rate 502Monetary Policy 502Fiscal Policy 503Changes in the Exchange Rate .l 504Adjustment to Fiscal Policy and Exchange Rate Changes 506

Balance of Payments Crises and Capital Flight 506Managed Floating and Sterilized Intervention 509

Perfect Asset Substitutability and the Ineffectiveness of Sterilized Intervention' 509BOX: Brazil's 1998-1999 Balance of Payments Crisis : 510

Foreign Exchange Market Equilibrium Under Imperfect Asset Substitutability 511The Effects of Sterilized Intervention with Imperfect Asset Substitutability 512Evidence on the Effects of Sterilized Intervention 513

Reserve Currencies in the World Monetary System. 514The Mechanics of a Reserve Currency Standard 515The Asymmetric Position of the Reserve Center 515

The Gold Standard 516The Mechanics of a Gold Standard 516Symmetric Monetary Adjustment Under a Gold Standard 517Benefits and Drawbacks of the Gold Standard .517The Bimetallic Standard 518The Gold Exchange Standard 519

CASE STUDY: The Demand for International Reserves 519Summary 523Appendix 1: Equilibrium in the Foreign Exchange Market

with Imperfect Asset Substitutability 528Demand 528Supply 529Equilibrium ; 529

Appendix 2: The Timing of Balance of Payments Crises 531

Part 4 International Macroeconomic Policy 534

jjOgj International Monetary Systems: An Historical Overview 534

Macroeconomic Policy Goals in an Open Economy 535Internal Balance: Full Employment and Price Level Stability 536External Balance: The Optimal Level of the Current Account 537

Classifying Monetary Systems: The Open-Economy Trilemma 539

18 Contents

International Macroeconomic Policy Underthe Gold Standard, 1870-1914 540Origins of the Gold Standard 541External Balance Under the Gold Standard 541The Price-Specie-Flow Mechanism 541The Gold Standard "Rules of the Game": Myth and Reality 542Internal Balance Under the Gold Standard 543

BOX: Hume versus the Mercantilists 544CASE STUDY: Gold Smuggling and the Birth of the UAE Dirham 544The Interwar Years, 1918-1939 546

The>Fleeting Return to Gold . . . . '"."....-.: 546

International Economic Disintegration 546

CASE STUDY: The International Gold Standard and the Great Depression 547The Bretton Woods System and the International Monetary Fund 548

Goals and Structure of the IMF 549Convertibility and the Expansion of Private Financial Flows 550Speculative Capital Flows and Crises 551

Analyzing Policy Options for Reaching Internal and External Balance 551Maintaining Internal Balance 552Maintaining External Balance 553Expenditure-Changing and Expenditure-Switching Policies 554

The External Balance Problem of the United States Under Bretton Woods 555CASE STUDY: The End of Bretton Woods, Worldwide Inflation,

and the Transition to Floating Rates V 556The Mechanics of Imported Inflation " 558

Assessment 559The Case for Floating Exchange Rates 559

Monetary Policy Autonomy. 560Symmetry 561Exchange Rates as Automatic Stabilizers 561Exchange Rates and External Balance 563

CASE STUDY: Monetary Regimes in Europe Post Bretton Woods 563Macroeconomic Interdependence Under a Floating Rate 567CASE STUDY: Transformation and Crisis in the World Economy' 568What Has Been Learned Since 1973? 574

Monetary Policy Autonomy 574Symmetry 575The Exchange Rate as an Automatic Stabilizer 576External Balance 576The Problem of Policy Coordination 577

Are Fixed Exchange Rates Even an Option for Most Countries? 577Summary 578Appendix: International Policy Coordination Failures 584

Optimum Currency Areas and the European Experience 587How the European Single Currency Evolved 589

What Has Driven European Monetary Cooperation? 589The European Monetary System, 1979-1998 590German Monetary Dominance and the Credibility Theory of the EMS 591Market Integration Initiatives • 592 ~European Economic and Monetary Union 593

The Euro and Economic Policy in the Euro Zone 594The Maastricht Convergence Criteria and the Stability and Growth Pact 594

Contents 19

The European System of Central Banks 595The Revised Exchange Rate Mechanism 596

The Theory of Optimum Currency Areas 596Economic Integration and the Benefits of a Fixed Exchange Rate Area: The GG Schedule 596Economic Integration and the Costs of a Fixed Exchange Rate Area: The LL Schedule 598The Decision to Join a Currency Area: Putting the GG and LL Schedules Together 600What Is an Optimum Currency Area? 602

CASE STUDY: IS Europe an Optimum Currency Area? 602The Future of EMU 608BOX: The Euro Zone Debt Crisis of 2010 610Summary.,-. .77 612

jlpjj Financial Globalization: Opportunity and Crisis 616The International Capital Market and the Gains from Trade 617

Three Types of Gain from Trade 617Risk Aversion . 618Portfolio Diversification as a Motive for International Asset Trade 619The Menu of International Assets: Debt versus Equity 620

International Banking and the International Capital Market 620The Structure of the International Capital Market 621Offshore Banking and Offshore Currency Trading 622The Growth of Eurocurrency Trading 623The Importance of Regulatory Asymmetries 624The Shadow Banking System .' 624

Regulating International Banking 625The Problem of Bank Failure 625

CASE STUDY: Moral Hazard 627Difficulties in Regulating International Banking 628

BOX: The Simple Algebra of Moral Hazard 629International Regulatory Cooperation 629

CASE STUDY: TWO Episodes of Market Turmoil: LTCM and the Global FinancialCrisis of 2007-2009 631

BOX: Foreign Exchange Instability and Central Bank Swap Lines 636How Well Have International Financial Markets Allocated Capital-and Risk? 638

The Extent of International Portfolio Diversification 638The Extent of Intertemporal Trade 640Onshore-Offshore Interest Differentials 641The Efficiency of the Foreign Exchange Market 641

Summary 645

| H Developing Countries: Growth, Crisis, and Reform 649Income, Wealth, and Growth in the World Economy 650

The Gap^Between Rich and Poor 650Has the World Income Gap Narrowed Over Time? 651

Structural Features of Developing Countries 653Developing-Country Borrowing and Debt 656

The Economics of Financial Inflows to Developing Countries 656The Problem of Default 657Alternative Forms of Financial Inflow 659The Problem of "Original Sin" 661The Debt Crisis of the 1980s , . . .662Reforms, Capital Inflows, and the Return of Crisis 663

East Asia: Success and Crisis 666The East Asian Economic Miracle 666

20 Contents

BOX: Why Have Developing Countries Accumulated Such High Levelsof International Reserves? 667Asian Weaknesses 669

BOX: What Did East Asia Do Right? 670The Asian Financial Crisis 671Spillover to Russia 672

CASE STUDY: Can Currency Boards Make Fixed Exchange Rates Credible? 674Lessons of Developing-Country Crises 676Reforming the World's Financial "Architecture" 677

Capital Mobility and the Trilemma of the Exchange Rate Regime 678"Prophylactic" Measures - 679Coping with Crisis u 680

CASE STUDY: China's Undervalued Currency 681Understanding Global Capital Flows and the Global Distribution of Income:

Is Geography Destiny? 683Summary 686

Mathematical Postscripts 691Postscript to Chapter 5: The Factor Proportions Model 691

Factor Prices and Costs 691Goods Prices and Factor Prices 693Factor Supplies and Outputs 694

Postscript to Chapter 6: The Trading World Economy 695Supply, Demand, and Equilibrium 695Supply, Demand, and the Stability of Equilibrium 697Effects of Changes in Supply and Demand 699Economic Growth 699A Transfer of Income 700A Tariff : 701

Postscript to Chapter 8: The Monopolistic Competition Model 703Postscript to Chapter 21: Risk Aversion and International Portfolio Diversification 705

An Analytical Derivation of the Optimal Portfolio 705A Diagrammatic Derivation of the Optimal Portfolio , 706The Effects of Changing Rates of Return 709

Credits 713

Index 715

Online Appendices (www.pearsonglobaleditions.com/krugman)

Appendix A to Chapter 6: International Transfers of Income and the Terms of TradeThe Transfer ProblemEffects of a Transfer on the Terms of TradePresumptions About the Terms of Trade Effects of Transfers

Appendix B to Chapter 6: Representing International Equilibrium with Offer CurvesDeriving a Country's Offer CurveInternational Equilibrium

Appendix A to Chapter 9: Tariff Analysis in General EquilibriumA Tariff in a Small CountryA Tariff in a Large Country

Appendix A to Chapter 17: The IS-LM Model and the DD-AA ModelAppendix A to Chapter 18: The Monetary Approach to the Balance of Payments