International Political Economy (PSC 2439):Fall 2011 Final Exam Study Guide

Short Case Studies (Define the concept and explain how it relates to the substantive example)1) Define the law of one price. Does the Economist’s Big Mac Index support or undermine this theoretical principle? Why or why not?2) What is trade diversion and how is this phenomenon related to the recent 2011 free-trade agreements that the United States signed with Colombia, Panama, and South Korea?3) Define balance of payments accounting, and why is this concept central to the future of US-Chinese bilateral relations?4) What is forward currency hedging and why did German-owned Volkswagon begin implementing this financial strategy in 2005?5) Why is the idea behind an optimum currency area, and what does this theory suggest about the future of the euro zone? Short Answers (Define each of the following concepts and explain how they are interrelated. Give an example that illustrates the theoretical, historical, or policy significance of each concept.) 1) Mundell-Fleming trilemma and gold standard2) Triffin paradox and Bretton Woods

3) Neo-realist institutionalism vs. neo-liberal institutionalism● Neo-liberal – Neo-liberal belief is that states should be most concerned about their

absolute gain rather than relative gains to other countries. Due to this, they are less focused on competition and outdoing others, and rather working cooperatively, if necessary, to achieve the greatest benefit for all. In terms of neo-liberal institutionalism, they believe that creating international institutions helps enhance international cooperation and gain mutual benefit for all involved.

● Neo-realist – Neo-realism is, contrary to neo-liberalism, the idea that states should work toward maximizing their personal gains in competition with other countries. They believe in working to become a leader and great power in the global economy. For this reason, neo-realists feel that institutions and the cooperation that they create, force states into a set economic standard that all countries involved follow. This means that one cannot out-perform the others.

4) Public vs. private goods5) Positive vs. negative selective incentives 6) GATT Article I and GATT Article IIIGATT Article I: Non-discrimination● The key aspect of Article I is the Most Favored Nation principle, which obliges all participating WTO countries to grant any trading partner with whom it has signed an agreement equal treatment to that of any other trading partner in the agreement.

● Any advantage granted to one participating country’s products shall be accorded to all other countries’ products as well.● This principle of non-discrimination relies on economics rather than political maneuvering to determine trade relationships.GATT Article III: National Treatment● Article III applies to goods already in the market. It states that a country must treat foreign products the same way it does national products once the products have been imported and the duties have been paid. Nations must provide an equal playing field to foreign goods, treating them no less favorably than domestic products with regard to taxes.● Example: In 2009, Europe brought a case to the WTO disputing the preferential tax treatment that Canada offered to its own beer and wine producers.Both of these measures deal with protectionism and promote trade liberalization, which should in turn lead to lower tariffs globally. They also encourage non-discrimination with regard to trading partners and imported goods. 7) Solow neoclassical vs. endogenous growth models8) Current account vs. capital account9) ‘The Original Sin’ and sudden stops10) Credible commitment and the time inconsistency problem 11) Interest rate parity vs. purchasing power parityInterest rate parity

● Has to do with the idea that money should (after adjusting for risk) earn an equal rate of return. Interest rate parity explains how foreign exchange assets are priced. Two major factors drive short-term capital and international cash flows: 1) whether the interest rate is better in one country versus another, and 2) the expected depreciation: whether or not you expect the currency to appreciate or depreciate. Taking these two factors into account you could decide, for example, whether you would get more by investing in Japan or in the US.

Purchasing power parity● (PPP) is a method of computing an appropriate exchange rate between currencies (rather

than that determined by the market or fixed by governments). This rests on determining domestic purchasing power by calculating the price of a basket of foods in the two countries in local currencies. To compute the PPP exchange rate between the two currencies, you take the ratio of the prices for the baskets of goods in local currencies. PPP exchange rates are often used as a means of presenting a more accurate comparison of standards of living across countries than those given by actual exchange rates.

PPP includes the idea of the Law of One Price, in which identical goods sold in different countries must sell at the same price when prices are expressed in terms of the same currency. This process must be consistent internationally, but quite frequently this doesn’t hold. The main difference between PPP and the Law of One Price is that the Law of One Price applies to individual commodities while PPP applies to the general price level. PPP is composed of all commodity prices that enter into the price reference basket (CPI). PPP theory predicts that a fall in a currency’s domestic purchasing power (as indicated by an increase in the domestic price level) will be associated with proportional currency depreciation in the foreign exchange market

(as demand for currency and products fall). While interest rate parity is a key determinant in short-term equilibrium, PPP is a key determinant of long-term equilibrium.[These concepts are present in the arguments in Oatley chapter 11, which gives policy proposals for currency adjustment in China. These proposals could result in a change in US purchasing power.] (Ravenhill, 486)(Oatley, Ch. 11) 12) Phillips curve tradeoff and inflation expectations13) Monetarism vs. Keynesianism14) Competitive advantage vs. comparative advantage15) Coase theorem and negative externalities16) Globalization and remittances17) Systemic risk vs. moral hazard18) Leverage and collateralized debt obligations19) Constructivism vs. structuralism

20) Fixed vs. mobile assets● Fixed - A fixed asset is a long-term asset owned by a firm that is used in the production

of income. These include investments such as buildings, physical infrastructure, real estate and machinery. This investment is harder to convert to cash, as it involves more concrete, physical assets.

● Mobile – A mobile asset is a financial asset such as a bond or bank claim. They move easily across borders and can be easily converted to cash. This means that it can be a more short-term investment, as it does not involve any physical assets. These “portfolio investments” can change quickly, and are very responsive to news and factors such as changing macroeconomic conditions, adjustments in exchange rates, of government policies. (Ravenhill page 104-105)

○ Once an investment in a fixed asset is made, it is more difficult to sell, and regain the money first invested, as it is harder to find someone who is looking to buy a physical property like a factory. This involves a more complicated process, and thus occurs less frequently. With a mobile asset, company shares, or securities, can be sold and traded between people with little effort, and becomes a potentially less risky investment.

21) Policy convergence vs. policy divergencePolicy convergence

● Policy convergence is the idea that as societies industrialize, globalization will occur, resulting in a convergence of traditionally national policies governing the environment, consumer health and safety, labor, and the ability to tax capital. Policies will grow more alike in the form of increasingly similar structures, processes and performances. Argues that states do not have an independent mediating role.

● As a result, globalization will also lead to a ‘race to the bottom’ or rollback of environmental, labor, tax and safety regulations in order to entice capital into a country.

● As this becomes the norm, globalization pressures such as capital mobility and perfect competition would produce a set of policy norms.

● Ex. Free trade that is enforced with very stiff penalties such that no country would put in place a protectionist policy is one example of policy convergence.

Policy divergence● Policy divergence is a goal of decentralized systems wherein competition between

governments is seen as inherently good and leading to a range of economic benefits such as FDI.

● Does not believe that there is a race to the bottom, but rather that FDI is positively correlated with levels of corporate taxation, union density and labor costs.

● Asserts that states have an independent mediating role. FDI is attracted to capital-intensive countries where there are highly skilled, reliable, and innovative work forces as well as countries with generous social welfare.

Both of these principles show the potential impacts of globalization on developed and developing countries and their policy approaches to attracting FDI. Policy convergence asserts that globalization will lead countries to deregulate their environmental and tax policies further to attract capital, which will lead to the tragedy of the commons. However, policy divergence states that this race to the bottom will not occur because FDI is positively correlated with an educated workforce, despite higher costs of labor. Thus, policies will not converge. 22) Arms length vs. hierarchical control

● Arms-length trade relationships are when buyers and sellers are independent entities. An arms-length trade relationship is an example of a governance option for global value chains that stresses pure market relations with foreign firms. With improvements in technology, it is increasingly possible to consider global organization of industry in the same terms as domestic. Relying on arms-length market relationships is one clear option.

● Hierarchical control of foreign operations is another governance option for global value chains that is coordination through the formation of an internal market. An example of hierarchical control is FDI. Firms decide to make rather than buy a particular product or service in the domestic context as a response to transaction costs. With the concepts of bounded rationality (rational decision-making in a context of incomplete knowledge) and opportunism (decision-makers pursuing their self-interest without regard for principles or the breaking of relationships with others based on trust) in mind, it is apparent that the costs of some market transactions are higher than others.A firm creates operations abroad when the net costs of hierarchical coordination are

lower than the net costs of using arm’s length relationship. Internalization might be attractive, because of transaction, legal and transportation costs. It may pay to internalize operations. These costs, including uncertainty about monitoring and negotiating contract relationship, compel firms to maintain its firm-specific advantages over local competitors while still attaining location specific advantages. Arms-length market relationships and hierarchical control of foreign operations are two concepts on opposite ends of the global value chain governance spectrum. Both are important when talking about firm governance, or how to coordinate independent activities in global value chains. There are plenty of middle-ground solutions between market and hierarchy. The governance of global value chains gives insight into the degree of leverage NGOs, governments, international organizations or other actors have to influence behavior in firms. This is important for essay 4 on conflict materials. (Ravenhill, 353-7)

23) Modular production revolution and outsourcing24) Value-added chain and industry upgrading25) Firm-specific vs. location-specific advantages26) Prebisch-Singer thesis and import substitution industrialization (ISI)27) Utilitarianism vs. Rawlsianism28) Tragedy of the commons and “greenwashing”29) GINI coefficient and microcredit30) Washington Consensus vs. Beijing Consensus

5) Why is the idea behind an optimum currency area, and what does this theory suggest about the future of the euro zone?

● The idea behind an optimum currency area (‘OCA’) is that an individual country does not always maximize economic efficiency to the degree that a larger geographic region would if it shared the same currency. The OCA theory involves evaluating the pros and cons of forming a monetary union among a select group of countries. The theory assumes that the union will produce microeconomic benefits in the form of lower transaction costs for cross-border commerce, and focuses attention to the potential macroeconomic costs associated with abandoning the exchange rate tool of macroeconomic adjustment. If these costs are low, the region can be seen as an OCA that should create a monetary union. If countries experience similar external shocks (that way they’ll have less need for an independent exchange rate)

● This theory has not always had predicative power as seen with the European Monetary Union. European countries gave up their commitment to domestic monetary policy autonomy in order to preserve financial liberalization and exchange-rate stability (The Mundell-Fleming Trilemma).

● However, there are tensions that arise within the Union from fixed exchange rates, which come from having an appreciated currency and attractive exports. Greece, along with other EMU countries, does not have monetary policy autonomy which would allow it to adjust its money supply in order to ease credit and promote growth. The tension between stability and competitiveness now plagues Greece as it gave up its monetary policy autonomy and is still not becoming more stable.

● The problems occurring with Greece suggests that the macroeconomic costs of joining the EMU and giving up monetary policy autonomy are greater than the benefits of stability. Thus, the EMU as it exists today may now be so large that it no longer maximizes economic efficiency.

1. Why has the Washington Consensus been widely discredited in the development field? Are there features of this policy approach that are still central to fostering sustainable growth today? Why or why not? Does the Beijing Consensus represent a viable alternative, development paradigm or is it simply a reformation of the East-Asian development model? Which features of the Beijing Consensus, if any, do you think can be successfully applied to other countries?

● Why has the Washington Consensus been widely discredited in the development field?○ It excludes important social and economic indicators in its analysis

○ Too much focus on infrastructure and not enough on closing the knowledge gap through open access to education and government promoted research in science and technology

○ Government expenditures in education, social safety nets, and R&D are essential. Trade liberalization won’t lead to growth without those factors.

○ Argentine Economic Crisis (1999-2002) occurred despite the country’s implementation of Consensus. Exacerbated income inequalities in the region, such as in Bolivia

○ ‘One size fits all treatment’ of economic policies○ Monitoring the GDP of a country does not reveal whether or not economic

development has benefited the country as a whole GDP could be growing, but it could be growing unequally between the rich and the poor and also cause health problems by limiting social services

○ Short term capital flows associated with foreign investment could be harmful and did not lead to sustainable growth

● Are there features of this policy approach that are still central to fostering sustainable growth today?

○ Prioritizing education and health care spending and securing property rights can be seen as the most ‘sustainable’ of the Washington Consensus policies; however, a strong, credible government is necessary to enforce these policies. Government investment in the education and health care sectors will lead to a healthier, more educated work force that will foster sustainable growth

● Why or why not?○ Most of the Washington Consensus policies will not lead to sustainable growth

because they place too much of an emphasis on trade and monetary liberalization policies in order to attract FDI, but not in a sustainable way.

● Does the Beijing Consensus represent a viable alternative, development paradigm or is it simply a reformation of the East-Asian development model?

○ The Beijing Consensus represents a viable alternative to the Washington Consensus; however, many tenets of this development model are a product of the environment and specific to East Asia, such as ‘flexible means to end’ or having one country with both Capitalism and Communism. Also, there are other tenets of Chinese society that have led to the country’s economic success, that are not accounted for in the development model, such as the country’s large population

● Which features of the Beijing Consensus, if any, do you think can be successfully applied to other countries?

○ Many features would be beneficial to other countries such as: localization of best practices borrowed, so that countries can adopt specific policies gradually and tailor them to their own economic situation (i.e. SEZs in China).

○ Particularly, the Beijing Consensus’ recommendations of constantly upgrading industry, encouraging indigenous innovation. This model encourages investing in R&D science and tech as well as education for the end goal of moving up the value-added chain.

Short Case Studies

3. Define balance of payments accounting, and why is this concept central to the future of US-Chinese bilateral relations?Balance of Payments accounting is an account of a country’s transactions with foreign countries and international institutions in a specific period. Transactions are divided into current account and capital account. The current account is savings minus investment, and consists of the balance of trade in goods and services plus profits and interest on overseas assets less those paid to foreign owners of domestic assets, plus net transfers such as worker remittances. The capital account consists of inflows and outflows of money investment, and for grants and loans (and their repayment). The balance of payments is an accounting identity: the current account plus the capital account equals zero, with for example, any imbalances on the current account being offset by net movements of capital.A current account deficit means a country is investing more than it’s saving. To fund this currency account deficit a country needs to have a corresponding capital account surplus. Since 2007 the US current account deficit has been increasing dramatically and in 2007 amounted to over $700 billion. China on the other hand has a very large current account surplus that in 2007 amounted to over $200 billion. The US has the largest bilateral trade deficit with China amounting to almost $300 billion in 2007. Balance of payments accounting is a central concept to the future of US-Chinese bilateral relations, as many blame the current US account deficit on its trade deficit with China and the depreciated Chinese currency relative the dollar. This has led to a policy debate as to whether or not the US should pressure China to revalue its currency.In addition there is debate as to whether currency revaluation will indeed correct the global trade imbalances. While the US has a trade deficit with China, China has a trade deficit with the rest of Asia. China also has a trade surplus with the US. One policy recommendation is that China become more integrated into the global economy. Deficit countries, i.e. the US, should take the lead in reducing their domestic spending relative to their domestic investment (fiscal tightening). Surplus countries, i.e. China, should reduce their uniquely high savings rates by increasing domestic consumption, i.e. through health care or education. (Ravenhill, 481)(Oatley Ch. 11) Essays 1. Why has the Washington Consensus been widely discredited in the development field? Are there features of this policy approach that are still central to fostering sustainable growth today? Why or why not? Does the Beijing Consensus represent a viable alternative, development paradigm or is it simply a reformation of the East-Asian development model? Which features of the Beijing Consensus, if any, do you think can be successfully applied to other countries?There are two main development theories, the Beijing Consensus and the Washington Consensus. The Washington Consensus:· Stresses fiscal discipline, i.e. making sure your macroeconomic policy is in order· Calls for elimination of large deficits that you can’t finance.· Prioritizes education and health care spending· Emphasizes how you spend the budget and create priorities within the budget· Calls for tax reform through increasing your tax base to have money to spend.

· Calls for liberalizing interest rates· Says the government shouldn’t intervene in interest rate markets, because to the extent that this occurs interest rates won’t appropriately reflect the risk in the systemComplete capital account liberalization was very controversial throughout the 1990s. Capital account liberalization refers to FDI (a long-term form of investment) and stocks and bonds (short-term forms of investment). The Western countries advocated countries to opening up to FDI and short-term hot-money flows, i.e. equity bonds, because this could bring wealth into a country to spur development. This has been discredited in the development field, because of the risk of sudden stop. Sudden stop refers to when countries are exposed to too much financial volatility and this overrides the wealth. In the 1990s there was also the problem of debt; in developing countries debt increased drastically during this time period. It was concluded from the lack of success of the Washington Consensus that the objectives of economic reform did not translate into a single and unique set of policy prescriptions, but rather could be achieved in a number of ways. China has not fully liberalized it capital account, but there are still features of this policy approach that are central to fostering sustainable growth today. In China privatization has occurred after an era of heavy state intervention and lots of state–owned enterprises. In Latin America, for example, phones throughout Latin American were expensive, but if you privative, it is cheaper and you will improve the efficiency in these areas and improve society. Deregulation is still important. If a country chooses to deregulate (get government out of it) things are be able to operate more efficiently, i.e. customs, businesses and permits all impede/slow economic growth. Securing property rights is also important. If the government guarantees property rights, political and economic stability increases. If these issues are approached incrementally they could be more successful. You can’t expect for all of these steps to be completed, it is better to work on some. The size of the Chinese population and its market makes the Beijing Consensus inapplicable to the other East Asian countries. China also has the unique benefit of where in the industrial process it started to institute these reforms. The Beijing Consensus is a viable alternative for China in that it borrows some of the best practices from the Washington Consensus. Under the Beijing Consensus:· China chose the features of liberalization that work best for it, i.e. special economic zones. Hong Kong was an area of free-market capitalism, and about to be taken over by China. In order to incorporate this idea of “one country, two systems” capitalism and socialism had to work together. China, a socialist country increasingly embraced capitalism.· Often conditionality is dependent on aid flows, i.e. from the IMF.· The Beijing Consensus offers a stable political environment, China doesn’t want to rush into economic changes and fail to maintain its political and economic stability.· China decided which industries it wanted to develop for exports and consumption. China has a desire to upgrade industry by opening it up to outside development. Poverty decreases in China as growth increases, but there is increasing income inequality. The policy of borrowing from the Washington Consensus could be applied to other countries, but specific aspects of the Beijing Consensus cannot really be applied to other East Asian countries, because it is a policy unique to China. (Ravenhill, 435)

Short Answer

Case Study #3Define balance of payments accounting, and why is this concept central to the future of US-Chinese bilateral relations?

● Balance of payments accounting is the concept of looking at savings-investment. In theory, a countries savings should be more than their investment, to ensure that they do not have an account deficit. With more spending than savings, the United States is currency in a deficit, in particular with large sums of debt to China. Manufacturing has increasingly begun to move to China as a major place production of goods. This means that the United States must import many of the goods in purchases from China, meaning that it is outputting a lot more money than it is actually bringing in. Ultimately, to correct the problem, the US needs to begin increasing domestic savings, and rebuilding domestic manufacturing bases. This would bring back jobs, as well as more locally purchased products. Correcting this debt and deficit is important to US-Chinese bilateral relations in that the large amount of debt could cause tension between the countries.

Essay #3What are the two major ideological approaches to governing the economy and how do they account for the 2008 global financial crisis?

Unsure, but I’m sure someone else that is working on this essay will have an answer.Does the crisis represent a flaw in free market ideology, government policy, or both?I personally believe that the crisis represents a combination of both flaws in free market ideology and government policy. On one hand, it is an example of the moral hazard, where an individual of institution does not take on the consequences of its risky behavior and thus doesn’t change it. On the other hand, the idea of systemic risk explains that flaws in the entire financial system and that instability cause a collapse of the economy, if there is no government intervention to relieve it.Should the government have a role in preventing future financial crises?The government should not control the entire financial system, as we still have a free market, however if the government sees that the country may enter an economic downturn, they should take the initiative to intervene and prevent the crisis from getting worse.In this regard, what is the likelihood that the 2010 Dodd-Frank financial reform bill will prevent future financial crises (Be sure to discuss the major tenets of the Dodd-Frank legislation within your essay)?

2010 Dodd-Frank Financial Reform Bill; signed July 21, 2010. The major tenets of the Dodd-Frank legislation include:

Increased capital to asset ratiosLimitation on financial leverageNew hedge fund regulations, formalize ‘shadow banking industry’‘volker rule’ limits banks from owning greated that 3% of hedge fund/private equity fundsmortgage originators have to hold at least 5% of mortgage loans on their bookscreates consumer financial protection bureauorderly funeral plans for large bank insolvencies

If the terms of the Dodd-Frank reform bill are followed carefully, it could have an impact in preventing future financial crises. Although other causes of financial crisis, not addressed in the bill, could occur and cause an economic downturn, it will help in preventing the same sort of crisis seen in 2008. With these concerns addressed in a bill, and the experience and knowledge gained from surviving a previous crisis will contribute to preventing it from repeating.

7. Solow neoclassical vs. endogenous growth models-------------The Solow neoclassical model built upon the Harrod-Domar model in several ways. It added labor as a factor of production, required diminishing returns to labor and capital, required constant returns to scale on the factors, and stated that capital-output and capital-labor ratios are not fixed. The lattermost point allow individuals using the model to understand the effects of increasing the level of capital intensity. The model places an emphasis on the role of technology. This allows policy makers to predict the effects technology will have in improving the productivity of capital and labor. Its limitations led to the creation of the endogenous growth model.The endogenous growth model states that economic growth is mostly derived from endogenous, not external factors. It is relevant because the model promotes investment in human capital and innovation as drivers of growth. Countries that invest heavily in education and/or research and development adhere to this model of growth.14) Competitive advantage vs. comparative advantageComparative advantage occurs on a macro level and competitive advantage occurs on a firm level. The two are interconnected. Comparative advantage encourages companies to specialize in the production of either capital-intensive or labor-intensive goods. While the countries do have an advantage relative to other countries in the production of certain goods, labor-intensive countries get trapped in labor-intensive production that leaves little potential for economic growth. This flaw led to the creation of competitive advantage. Competitive advantage is the advantage one firm has over other firms in its sector. The implication is that nations and businesses should focus on productivity growth rather than labor costs and natural resources. In competitive advantage, economies should produce high-cost goods and services.

Public vs. Private good (Ravenhill pg. 83) Private goods are goods and services that can be withheld from those who do not pay for them, and that cannot be used by others without additional production taking place. Private goods are based on two characteristics: the goods are generally excludable and are not joint in consumption. The concept of excludable means that goods can be withheld from those who do not pay for them; not joint in consumption means that when a consumer utilizes the good, it is exhausted and cannot be used by others without there being additional production. In addition to private goods, other goods may be desired, such as national defense or parks. These are public goods and cannot be withheld from consumers who do not pay for them, and whose consumption does not reduce their availability to other consumers.If a good is characterized by lack of exclusion and lack of jointness, then such a good is referred to as a common pool resource. Common pool resource are goods that cannot be withheld from those that do not pay for them, and whose consumption comes at the expense of other potential consumers. Examples of such goods include fish in the ocean, or even in a limiting case, a public park. Thus if the ocean is overfished, fish will cease to reproduce and die out. Similarly, while parks are often seen as a public good, too many users of a park create crowding, which impairs

the enjoyment of the good for others. Private actors will be particularly reluctant to produce such goods, and even governments will be concerned about the problem of too many users. Finally inclusive club goods are goods that may be excludable and yet be joint in consumption. These include goods such as software, music, and literature, which the private sector has a great incentive to produce.

Exclusion Possible?

Jointness in Production

YES NO

NO

Public Common Pool Resources

YES

Inclusive club good Private

What are some obstacles that states face in achieving co-operation?Free Rider Problem – when actors fail to contribute appropriately to the cost of the goods or services from which they benefit. Free riding is usually considered to be an economic problem only when it leads to the non-production or under-production of a public good or when it leads to the excessive use of a common property resource . The term free rider comes from the example of someone using public transportation without paying the fare . If too many people do this, the system will not have enough money to operate. Another example of a free rider is someone who does not pay his or her share of taxes, which help pay for public goods that all citizens benefit from, such as roads, water treatment plants, and fire services.Leverage and collateralized debt obligationsIn simple terms, a CDO is a promise to pay cash flows to investors in a prescribed sequence, based on how much cash flow the CDO collects from the pool of bonds or other assets it owns. If cash collected by the CDO is insufficient to pay all of its investors, those in the lower layers (riskier investments) suffer losses first.Leverage is a general term for any technique to multiply gains and losses. A common ways to attain leverage are borrowing money, buying fixed assets and using derivatives.Ex from notes November 8th:o A normal deal§ Best Buy has $10,000 on bank sheet§ Purchases 20 ipads for $500 each§ Sells them to consumers for $550 earning …o A leveraged Deal§ Best buy has $10,000§ Borrows another $90,000 at 1 percent§ Total money in hand is $100,000§ Purchases 200 ipads for $500 each

§ Sells them to consumers for $550 each earning $110,000§ Pays back $900 in interest§ Net profit of $9,100 CDO volume grew significantly between 2000 and 2006 as investment banks used leveraging to buy millions of dollars worth of mortgages. CDO then declined dramatically in the wake of the subprime mortgage crisis , which began in 2007. Many of the assets held by these CDOs had been subprime mortgage-backed bonds. Global investors began to stop funding CDOs in 2007, contributing to the collapse of certain structured investments held by major investment banks and the bankruptcy of several subprime lenders. Case Study #2Trade Diversion is where a preferential trade agreement leads to the displacement of goods previously imported from a non-preferred trading partner by imports from a party to the preferred agreement ( because these preferential imports now enter the local market at a reduced tariff). South Korea•How much we trade: $38.8 billion of U.S. exports to South Korea, $48.9 billion of U.S. imports from South Korea last year, according to the Census Bureau . Biggest sources of the trade deficit include cars, wireless communications equipment and appliances.•What it does: Cuts Korean tariffs on U.S. autos immediately, while more slowly phasing in cuts of U.S. levies on Korean-made cars and SUVs. Lets up to 100,000 U.S. cars into Korea annually that don't meet Korean safety or environmental standards, but do meet U.S. rules. Also opens up Korean markets for U.S.-based sellers of services such as accounting and banking.•Why business liked it: Companies with European-based competitors feared being left out after South Korea made a trade deal with the European Union .White House claims the pact will boost U.S. exports by $11 billion a year and add 70,000 jobs. Panama•How much we trade: $6 billion in exports last year, with a $5.7 billion trade surplus to the U.S. Biggest exports included construction equipment, refined petroleum products and telecom gear.•What the deal does: 88% of U.S. exports will see Panamanian duties eliminated. Agricultural duties would be cut immediately, and phased out completely in 10 years. The U.S. International Trade Commission declined to quantify its impact on U.S. jobs, citing the small size of Panama's economy. (aka Panama will choose US agricultural products over suppliers they already have.)•Why business liked it: It lets U.S. companies pursue lucrative deals linked to Panama's plan to upgrade its infrastructure.

Colombia•How much we trade: $12.1 billion in U.S. exports, $15.7 billion in U.S. imports. More than half of U.S. imports represent crude oil. The biggest exports are finished chemical and energy products.•What it does: The deal eliminates Colombian duties that average nearly 17% on most agricultural goods. Also eliminates duties on manufactured goods that range from 7% to 15%.

•Why business liked it: U.S. farmers who used to supply nearly half of Colombia's imported food have seen market share slip to 21% as other nations lowered trade barriers with Colombia. The U.S. International Trade Commission estimates the deal will boost exports by $1.1 billion and support thousands of jobs. Essay # 2“Liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate…Even a panic is not altogether a bad thing. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.” –Andrew Mellon, Secretary of Treasury for President Herbert Hoover (1930) For many economists, the Great Depression underscored the necessity of government intervention in forestalling economic crises and demonstrated the shortcomings of Mellon’s laissez-faire approach to governing the economy. Was the United States decision to inject $350 billion in capital into banking institutions to avoid a Great Depression 2.0 the most appropriate action? Would have allowing Wall Street firms to collapse been a better policy choice for the nation’s welfare? In evaluating these policy choices, examine the tradeoffs between creative destruction, systemic risk, and moral hazard. I. Introduction: Brief history of ’08 financial crisis. The late-2000s financial crisis (often called the global recession, global financial crisis or the credit crunch) is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s.[1] It resulted in the collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. In many areas, the housing market had also suffered, resulting in numerous evictions, foreclosures and prolonged unemployment. It contributed to the failure of key businesses, declines in consumer wealth estimated in the trillions of U . S . dollars , and a significant decline in economic activity, leading to a severe global economic recession in 2008 .[2]The financial crisis was triggered by a complex interplay of valuation and liquidity problems in the United States banking system in 2008.[3] The bursting of the U.S. housing bubble , which peaked in 2007, caused the values of securities tied to U.S. real estate pricing to plummet, damaging financial institutions globally.[4] Questions regarding bank solvency, declines in credit availability and damaged investor confidence had an impact on global stock markets , where securities suffered large losses during 2008 and early 2009. Economies worldwide slowed during this period, as credit tightened and international trade declined.[5] Governments and central banks responded with unprecedented fiscal stimulus , monetary policy expansion and institutional bailouts. Thesis: something along the lines of “if the government had not bailed out the capital banking institutions, a financial meltdown would have occurred and the collapse could have destroyed the entire US economy.” Was it the most appropriate course of action? What were the other options?II. Bailout or no bailout? Bailout – evades systemic risk - risk of collapse of an entire financial system or

entire market, as opposed to risk associated with any one individual entity, group or component of a system.

Bear Stearns stock in recess – led to a run – the people lost confidence. Invested in subprime mortgages – bundled into securities – sold to investors = toxic assets. Credit default swaps as forms of insurance – if bonds failed, they would pay. If Stearns went down, systemic risk – frighteningly interconnected with other banks on Wall Street. “Risk to the

system as a whole would be to great if Bear Stearns went under” – Ben Bernanke (Depression expert, chairman of Federal Reserve) Federal Reserve bailed using JP Morgan as a conduit. Had a reverse effect, singling Bear Stearns out confirmed that Bear Stearns was having issues, people continued to sell stocks. “1 – 2000 point drop in DOW expected.” – Paulson. Bernanke married Bear Stearns and JP MorganIf you bail out once, how do you know they’ve learned their lesson and that they won’t do it again?Moral Hazard point – Secretary of Treasury Paulson called JP Morgan CEO – this was not going to be a bailout they were going to like. The government does not have a safety net for you whenever you need it. Sold shares for $2 a share. Wanted to make sure that stock holders felt the pain so it would not happen again. In economic theory , moral hazard refers to a situation in which a party makes a decision about how much risk to take, while another party bears the costs if things go badly, and the party insulated from risk behaves differently from how it would if it were fully exposed to the risk.Moral hazard arises because an individual or institution does not take the full consequences and responsibilities of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to hold some responsibility for the consequences of those actions. FannieMae, FreddieMac – systemic risk – nationalized. No company too large not to fail from mortgage bubble.Paulson asked Fuld (CEO) to find a buyer for Lehman brothers. Paulson was dealing with another moral hazard dilemma. If Fuld does not, Paulson made the decision that he was going to let Lehman fail. Moral Hazard trumped systemic risk; the government would not intervene. No options left, bankruptcy was certainty. Systemic risk became reality when Lehman went down. Credit market froze. This one decision made all the difference. AIG gravely affected. AIG needed money, credit market froze. Bernacke and Paulson were the only options. Government bailed $85 billion. Government now controlled world’s largest insurance agency. In order to nip the problem before the pattern continued, Bernacke decided they needed to turn to Congress and initiate a bailout of the entire financial sector. “financial system will melt down in a matter of days” $700 billion to buy the toxic mortgage securities that were creating so many problems for the banks. Bill voted down first time around. Other option – capital injection. Put billions of dollars into banks to free up frozen markets. Did not like the idea of almost complete nationalization, however, revised bill with capital injection included passed. Systemic risk had gone global in the meantime.

Moral Hazard became a thing of the past. Had to take sizeable (regrettable) actions to save US economy, to restore confidence in the US financial system. Had to overcome an ideological aversion to the government taking a central role in the financial system. Intervention included 10’s of billions of dollars to 9 banks. Creative destruction is a term originally derived from Marxist economic theory which refers to the linked processes of the accumulation and annihilation of wealth under capitalism. It describes the way in which capitalist economic development arises out of the destruction of some prior economic order A time inconsistency problem occurs when decision makers’ preferences change over time. Political desires shift as the long run becomes the short run. An example would be if the Soviet premier intends to launch a counterstrike, but balks tomorrow when human lives are at stake. To resolve this problem, a mechanism must be put in place that acts as a credible commitment, something which ensures the original intentions are carried out. An example would be the doomsday machine which overcomes the time inconsistency problem by creating an automatic deterrent threat that removes the human element. A time-inconsistency problem in IPE would be when politicians promise low inflation to international investors, but when the time comes to do it, they are more concerned about unemployment and votes. Politicians signal a credible commitment to low inflation by implementing the gold standard or by handing control to independent central banks. A value-added chain is the sequence of activities through which technology is combined with material & labor inputs & then assembled, marketed, & distributed. An example would be a computer company like Apple or Dell, where the innovation takes place in Silicon Valley, but the labor and material inputs occur overseas, and everything is assembled in China. Competitive advantage provides the rational for a value-added chain, because it leads to industry uprgrading. Industry upgrading is when an industry increases competitiveness by capturing part of the value chain that involves higher-value added activities (e.g. improving process technology, product design, or distributional strategy). This process means that firms organize by function rather than geography, i.e. increased globalization. Define balance of payments accounting, and why is this concept central to the future of US-Chinese bilateral relations?Balance of payments accounting is recording all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfer. A positive balance of payments occurs when a country is exporting more than it imports and a negative balance of payments occurs when the opposite occurs. A balance of payments must sum up to zero, however, so when a deficit or surplus occurs, these imbalances will have to be counter-balanced by promises to repay the sum of the difference. Deficits or surpluses are problematic because a country runs the risk of defaulting on these promises to repay. This concept in central to US- Chinese bilateral relations because the US currently has a trade deficit with China and China has increasing shares

of US government bonds. This could eventually lead to a balance of payments crisis, which could lead to a rapid devaluation of US currency, making investors all over the world nervous, inspiring them to pull out their US government bonds, and further depressing the US economy. Recall the two short articles you read earlier in the semester about Congo’s conflict minerals.What does the growing grass-roots campaign against the electronics industry suggest about the governance structure of global supply chains? Is the “race to the bottom” an important policy concern, or is it merely a myth? Evaluate the competing claims of the two major schools of thought about foreign direct investment and outsourcing: policy convergence and policy divergence. Which pattern do you think exemplifies the supply chain links between Congo’s mines and cell phones, laptops, and video game consoles in the global electronics industry? Is there a compelling need to regulate multinational behavior? Why or why not? If so, who should create the regulatory rules? Governments? Non-government organizations? Industry associations? Grass-roots campaign= suggests that people are aware of global supply chain and do not want what is necessarily the cheapest, but also want ethical considerations to be taken into account.Policy convergence- race to the bottom- idea that capital flows to most deregulated destinations- places with low taxation, low union density, fewer environmental standards, residual welfare states, flexible markets= unregulated marketPeople feel that unless the gov. intervenes, firms will engage ina race to the bottom and will try and buy cheapest products despite other costs, ultimately lowering welfae overallPolicy divergence- Firms are not just driven by labor costs, also by government capacity, big states can help invest in education and R and d, infrastructure, customs, low corruptionEvidence shows that the race to the bottom is a myth, firms are not lowering their standards to be more competetivePattern= policy convergence- people buy products made with minerals from the congo that are funding conflict and genocide because they are cheapestNeed to regulate multinational behavior-Who should create regulatory rules- Government can impose labels which explain where products are coming from NGOs can raise awareness about possible human rights, environmental, etc. consequences of certain firms on the value added supply chain Industries should also act ethically and avoid investing in human rights violations

Globalization and RemittanceRemittance- Definition- Transfer of funds from a buyer to a a distant seller- Remittances are becoming an increasingly important part of the financial landscape- Have lifted entire countries out of poverty by creating new financial channels- In some countries, these flows are the single most important type of international capital inflow (public or private- Bear no cost on the country receiving them- Surge in remittance is the product of increased migration - 20 million Mexican immigrants sent home 10million in remittances

- Apprehension about the idea of remittance being used as a foreign aid in poor countries is the fear that money is being funneled to groups that are a threat to U.S national security such as Al Qaeda - The west monitors suspicious transactions through the Financial Action Task Force as wellas money laundering in order to monitor remittance flowGlobalization- Ellimination of trade barriers- increased communication- increased cultural exchange- promote inherent wealth of all nationsGlobalization and Remittance- Remittance is possible under Gobalization- Remittance is responsible for significant increase in migration- Remittances are increasingly attracting the attention of governments and the private sector- In many countries, the collection of remittances are invested in local community and development projectsBolivia- Bolivian migrant workers send remittances mostly from Argentina to Bolivia through informal channels (relatives or friends), the postal offices, and through Western Union which controlled 20% of the market.- Informal remittances are associated with considerable losses, because money disappeared, was stolen or transformed into bribes at the border. Firm-specific vs. location-specific advantages- Context: In Foreign Direct Investment, a firm will create operations abroad when the net costs of an internal market are lower than the net cost of using arms length market relationships. Firms want to stay competitive and• Firm-specific advantages are advantages that a firm has over local competition• examples of Firm-Specific Advantages:◦ Brand Management◦ Technological or manufacturing expertise◦ economies of scale◦ marketing power• Location Specific advantage is the ability of a firm or economy to conduct an activity or produce a good better than its competitors due to investment/access to resources in a specific geographic location. These advantages available only/primarily in that location give the firm an edge on the competition.• ex. of Location specific advantages (investing abroad allows firms to):◦ gain better access to market information◦ respond better to local market changes◦ acquire unique resources or capabilities◦ avoid protectionist barriers• When creating operations abroad, the costs of opportunism, bounded rationality, and Transaction costs compel firms to internalize and maintain its firm specific advantages over local competitors, while still attaining location specific advantages.

Case Study 3Define balance of payments accounting, and why is this concept central to the future of US-Chinese bilateral relations? Balance of payment accounting - Accounting statement that shows the commercial and financial operations between the residents of one country with the rest of the world. It is based on the accounting principle of double entry (any transaction enters as a credit and a debit).• Current Account + Capital Account =0• Current Account = Savings - Investment◦ A current account deficit means a country is investing more than its saving◦ to fund a current account deficit, a country needs to have a corresponding capital account surplus.• China’s purchase of US treasuries in recent years has fueled a relationship of dependency between the U.S. (who demand more Chinese imports and access to cheap credit) and China (who has lent to the US in order to boost its export industry).• currency and exchange rates also play a large role in US-Chinese relations.• China’s Yuan is argued to be largely undervalued and some argue that China manipulates its currency in order to gain a competitive advantage for its exporting sector.• The US’s increasing trade deficit, China’s investment in US debt and the US-China trade dependency are all actors in the global imbalance of China’s and US’s balance of payment statement. • The concept of balance of payments is central to the future of Chinese-US bilateral relations because it reflects the imbalances, dependency, exchange rate issues, and the need for cooperation between the two global financial powers to lessen the extreme surpluses and deficits. Essay 2“Liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate...Even a panic is not altogether a bad thing. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.”–Andrew Mellon, Secretary of Treasury for President Herbert Hoover (1930)For many economists, the Great Depression underscored the necessity of government intervention in forestalling economic crises and demonstrated the shortcomings of Mellon’s laissez-faire approach to governing the economy. Was the United States decision to inject $350 billion in capital into banking institutions to avoid a Great Depression 2.0 the most appropriate action? Would have allowing Wall Street firms to collapse been a better policy choice for the nation’s welfare? In evaluating these policy choices, examine the tradeoffs between creative destruction, systemic risk, and moral hazard. - Congress approved bailout for banks- Undoubtedly averted greater economic catastrophe and ultimately cost far less than expected.

- Secretary Paulson elected to spend the first $350 billion by directly injecting capital into banks- The nine largest banks, representing 75 percent of all American banking assets, were given $25 billion each in exchange for stock- This initial round of funding bolstered the banks’ capital reserves, but without any preconditions attached, failed to increase lending- Under heavy lobbying and with better-than-expected stress tests, the administration began to allow banks to repay their TARP funds- In the broadest sense, TARP and the bailout was a success- It halted the collapse of the US banking system and may have prevented a second Great Depression- The Congressional Oversight Panel wrote in its final report that TARP “provided critical support to markets at a moment of profound uncertainty.”- In September 2008, as the market was making three digit swings, TARP not only provided a mechanism for resolving the core of the crisis, but also served as a strong statement that the government would take extraordinary measures to ensure the survival of the financial system- The bailout also prevented an even deeper recession AlternativeDo Nothing - Many have suggested to just let the markets run their course. This is most likely to create a global depression, as businesses around the world shut down due to lack of credit. This would lead to large scale unemployment, and a downward economic spiral.Treasury Buys Preferred Shares of Banks - Preferred shares gives the government ownership of banks without voting rights, and also means the government gets paid before stockholders. This gives another method of transferring government cash to banks without owning the toxic debt The McCain Proposal - has proposed having the government buy $300 billion in mortgages from homeowners who are in danger of foreclosing. This would help reduce the amount of toxic mortgages on banks' balance sheets, and may even help stop falling housing prices by reducing foreclosures. However, it would not address the immediate credit crisis, which is caused by banks being afraid to lend to each other and therefore hoarding cash.

15) Coase theorem and negative externalities Negative externalities - instances where economic actions have consequences for others for which the actor does not pay.- environment: pollution – (i) affects on air quality (ii) greenhouse gases – local actions have a global effect -The free market perspective: markets will price externalities by themselvesCoase theorem- (E.g. Ecuador’s Amazonian oil fields) - Ecuadorian president and oil reserves in Amazon – opportunity cost in not digging them up, but environment groups say cost to environment, so they price it in. Fund through UN, those concerned with environment, so it’s worth it for Ecuador not to dig for oil.If someone cares about the environment, it can be priced into the market)

Externalities do not cause inefficiencies, notwithstanding who owns property rights, bargaining between parties leads to efficient outcomes -The market failure perspective:Markets are inefficient, and will not adequately price externalities; necessitating a role for government. (E.g. regulation against pollution) -The Middle Ground: 2010 Cap and Trade – government regulates a limit on overall emissions, but then within a market framework – can buy right to pollute from others, if you don’t want to pollute you can sell this right to others. 23) Modular production revolution and outsourcing Modular Production Revolution - Multinational firms in advanced capitalist countries break apart their value chains and locate the manufacturing of each component (module) according to competitive advantage

● Started by IBM in the 1960s.● Central office constructs architecture, or design rules to ensure compatibility of modules

(component parts).● Engineering teams work independently on individual modules that eventually function as

one, integrated system.● Modularity increases speed of design process and rate of innovation.● Globalization’s key technological enablers:

- Codifying design information (the interfaces linking modules) in digital form- New telecommunications infrastructure.Designers and production engineers can work separate not having to be in the same company or facility. Outsourcing – reallocation of a particular task from within one firm to another and the two are usually separated by having different ownership (Oatley, p.348)Distinction between FDI and outsourcing –Although FDI is a critical element of global production under foreign ownership, it neglects the outsourcing of productione.g. An American firm using a South Korean manufacturer in China is both outsourcing (from the perspective of the American firm) and reliant on FDI (from the perspective of the South Korean firm)Outsourcing need not be accompanied by transborder flows of capital – firms can be linked up simply by ‘arms-length’ purchase arrangements or the Outsourcing depends on POLITICS - trade liberalization (globalization of production). When trade barriers are high (protectionism), MNCs will invest in production facilities abroad (FDI) for access to foreign markets, but they will avoid relocating portions of the value added chain that need to be integrated

● Fragmentation of value chain requires low-tariff barriers

Measuring outsourcing – growth of trade in intermediate goods (neither raw nor finished products)e.g. Trade in telecommunications components increased from 3 billion in 1985 to 41 billion in 1996 (when components accounted for 72% of imports in the product group Modular production - the independency of different modules, allows for outsourcing when multinational firms break up their value chain. Multinational firms are now organized by function rather than product and geography Short case study 3) Define balance of payments accounting, and why is this concept central to the future of US-Chinese bilateral relations Balance of Payments AccountingCurrent Account + Capital Account = 0Current Account = Savings – InvestmentY = C+I+G+(X-M)

● Balance of payments is an accounting of a country’s international transactions - sales of U.S. goods or assets is positive (credit)

- purchases by U.S. citizens of foreign goods or assets is negative (debit)● Current account – all trade in goods & services

Capital account – all trade in assets (portfolio and direct investments)● Balance of payments always balances (sums to zero)● Thus a country with a current account deficit must have an off-setting capital account

surplus (if a country is buying more goods & services from the res of the world than it is selling, it must be selling more assets to the rest of the world than it is buying)

● Borrowing loans or selling existing financial assets will make up the difference (capital account surplus) – financing the trade deficit

Scott article – US-China bilateral trade deficit eliminated 2 million U.S. manufacturing jobs from 2001-2007US trade deficit with china risen from 84 billion in 2001 to 262 billion in 2007 an increase of 178 billion (see Scott article)Accusations: Institute for International Economics estimates that the Renminbi is 20-40 percent undervalued· currency manipulationo Pegs yuan to dollar at a rate that encourages a large bilateral surplus with the U.S. Maintaining this peg required purchase of $460 billion in U.S. treasury bills and securities in 2007o Artificially cheap yuan is a subsidy on Chinese exports· China suppressed labour rights, lowering manufacturing wages· Direct subsidization of export production in key industries· Maintains NTBs to importsIrwin article

Claim that imports destroy jobs is misleading because it ignores the creation of jobs elsewhere in the economy

● Dollars which U.S. consumers hand over to other countries to purchase imports do not accumulate overseas, but returns to purchase either U.S. goods (exports) or U.S. financial assets (foreign investment)

● Exports and foreign investment create new jobsà thus deficit does not eliminate jobs, but capital that finances trade deficits creates new businesses – these provide new jobsTrade deficit due to economic imbalances inside the U.S. (consumption boom in last 25 years with little saving). U.S. government has run large budget deficits which it must finance by borrowingU.S. policiesRyan-Murphy bill in Congress- Classifies undervalued currency as subsidy subject to countervailing duties (proposed in prelude to midterm elections- Congressional precedence – 2005 Schumer-Graham bill sought to impose a 27.5 percent tariff on all Chinese imports- Currency Exchange Rate Oversight Act of 2011 What are the risks of China’s exchange rate policyCompetitive currency devaluation globally (export)What are the risks to global currency realignment?· Political rigidities too severe (U.S. benefits from a low credit low interest facility, China benefits from depreciated currency)· Currency realignment not sufficient · China and the United States are not only two countries in the world· U.S. trade deficit with China is a negative 1.6 percent of GDP in 2005 compared …U.S. needs to boost domestic savings and rebuild manufacturing baseChina needs to rely less on exports and focus on domestic demand too

● Domestic macroeconomic measures are necessary to reduce savings-investment imbalances

Bad economics· opportunity cost in interest rate gains of holding reserves in low yielding assets· Risk of soaring inflation and asset bubbles· Hurts middle class incomes in China (more expensive imports PPP)Good politics – vital for economic growth, job creation and social stability Essay 4

•Policy Convergence (conjunctural explanation – strategic action and policy choices of governments to liberalize is important)§Race to the Bottom – capital will flow toward the most deregulated destinations:-Low rather than high taxation regimes.-Residual rather than comprehensive welfare states.-Flexible rather than highly regulated markets.-Low rather than high union density.-Law rather than strict environmental standards.§States do not have an independent mediating role.-Common globalization pressures (capital mobility and perfect competition) produce common economic outcomes. -Global financial markets prefer flexible labor markets, hawkish inflation policies, balanced budgets, and small welfare states. •Policy Divergence§Globalization’s ‘Race to the Bottom’– Don’t believe the hype! (constructivist argument)§Foreign direct investment (FDI) is positively correlated with:-Levels of corporate taxation.-Union density.-Labor costs.-Degree of labor market regulation.§States have an independent mediating role.-Generous welfare states can be attractive destinations for FDI.-Governments retain fiscal capacity to fund social services.-Capital intensive-FDI attracted to locations where there are highly skilled, reliable, and innovative work forces.States Boost Competitiveness§Globalization does not discriminate between states regarding the size of their expenditure but on effectiveness in promoting international competitiveness DOES CAPITAL MOBILITY LEAD TO STATE RETRENCHMENT? §There is a positive and strengthening relationship between public spending (as a percentage of GDP) and economic openness (Cameron, 1978 even shows that openness is linked to union power and regulation of the labour market; Katzenstein, 1985; Rodrik, 1996; 1997; Garrett 1998)

● Government expenditure (% of GDP) has continued to rise in Germany, UK and U.S. in graphical data since 1960 and is continuing even through the financial crisis) – lecture slide

“Societies that expose themselves to greater amounts of external risk demand (and receive) a larger government role as shelter from the vicissitudes of global markets. In the context of the advanced industrial economies specifically, this translates into more generous social programs. Hence, the conclusion that the social welfare state is the flip side of the open economy.” (Rodrik 1997) FDI determinants in developing countries•Geographical proximity and market access.

•Multinationals invest in countries with higher average education levels ((ENDOGENOUS GROWTH MODEL) and higher hourly compensation costs.•Skilled labour (not cost) and productivity attract inward investment (Germany receives $2.3 billion in US FDI per industry than the UK, high-skill – high wage countries attract investment)•Countries do not have to encourage wage restraint since high hourly compensation costs do no reduce foreign direct investment, provided the costs are matched by higher skills and productivity (Cooke and Noble 1998) OECD findings:-Positive association between globalization & size of state.-Positive association between FDI & education, skill, & productivityBUT Policy convergence vs. policy divergence debate is different for the case for developing countries:-Plagued by government and welfare state retrenchment (Rudra, 2008).-FDI in low-skilled, low-wage countries is often associated with lower work force education and limited skill requirements (Cooke and Noble, 1998).‘Race to the bottom’ pressures, including low levels of corporate taxation, may be more common in developing countries. Governance structure of global supply chainsThe ability of multinational firms to induce social standards in their suppliers increases going down the following the governance structure:-Spectrum for coordinating global value chain.

● Market relations- product specifications are complex; suppliers have capabilities to meet demands.

● Modular value chains- modules are codified easily; suppliers capable producing sophisticated modules (e.g. auto supply firms, electronics manufacturing).

● Relational value chains- product specifications are complex; suppliers have tacit knowledge & capabilities to meet demands.

○ Mutual dependence that is regulated by reputation, geographical proximity, or social, ethnic, and family ties (e.g. Nike’s long-term relationships with Korean and Taiwanese shoe suppliers).

● Captive value chains- product specifications are complex; suppliers have low capabilities.

○ Foreign investor does not provide key design elements; ensures small supplier remains reliant on large buyer firm. High monitoring and control.

● Hierarchical coordination- product specifications cannot be codified; suppliers are not capable of producing modules; firms rely on in-house capabilities.

Minerals and the electronics industry of the CongoGovernance structure of the cassiterite (used in laptops), coltan (mobile phones) and wolframite (light bulbs), and tantalum minerals approximates a market relation

● Clearly, there are other mineral sources e.g. Australian tantalum instead of Congolese tantalum (sourcing from the developed world could potentially be more expensive however)

● That said, the Enough Project, an anti-genocide organization that has been a leading force in the current campaign, estimates that only one-fifth of the world’s tantalum comes from Congo.

● But the Congo provides resources ONLY – the country is not involved in the production process (a higher-value added part of the supply chain)

Difficult for Apple, Intel etc. to directly control the practices of the Congolese suppliers – we don’t see the power the buying firm would have with its immediate supplying firm captive value chains or hierarchical co-ordination.NB the spectrum of governance listed above doesn’t apply exactly because of the length of the supply chain – there are many intermediary firms in between the Apple, Intel and the Congolese mineral suppliers There is a compelling need to regulate multinational behaviour if their supply practices have an impact (however small) on sustaining the different parties in a war or conflict. The current illegal trade means gains from selling the minerals aren’t accruing to the main government and the Congolese people.Regulatory rules:

● New Congressional legislation – ‘Companies that report to the American Securities and Exchange Commission now have to reveal whether they buy minerals from Congo or from any of its nine neighbours and, if so, from where. New regulations likely to be proposed by the State Department next year may follow guidelines being drafted by the UN and the OECD, a rich-country club, that will advise companies on how best to trace the origin of their materials.’

● NGOs can only operate at the level of shaming and encouraging MNCs to monitor their supply. NGOs are important however in raising public and customer awareness as to the supply chain issues in the everyday products they are buying à this public awareness can feed into supporting further government legislation

● Industry associations – ‘Some smelters, mostly based in Asia, as well as manufacturers such as Apple and Nokia, are sponsoring a pilot scheme to trace the ore coming out of two particular mines to prove they can regulate the trade. Each sack of ore is tagged with a label and has attached paperwork that can be checked at every transit point on its way from the mine to the end-user, though the scheme will need independent oversight to work.’

Companies are concerned that the new American law will stop any sourcing from the Congo – perhaps a better regulatory solution is one that is closer to the source

· Under another plan, backed by the UN and Congo's government, state officials will be stationed at five mineral-buying centres near mines where there is no military presence to check the provenance of the products.

· But armed groups may still be able to get contraband minerals into these centres. Conclusion: each actor has a role to play, though working alone they will be inefficient (NGOs) and unaccountable (industry) and possibly have a negative impact on trade (governments).

Case Study:

Law of One Price: is imbedded in the Purchasing Power Parity, a determinant of long-term equilibrium. The Law of One Price dictates that prices must be consistent internationally. It explains that if prices differ between countries, either the price needs to change or the exchange rate must. In the absence of transaction costs and trade barriers (i.e. tariffs), identical goods sold in different countries must sell at the same price when prices are expressed in terms of same currency. The main difference between PPP and the law of one price is that the law applies to individual commodities while PPP applies to the general price level (composed of all commodity prices that enter into the price reference basket, commonly known as CPI). PPP states the exchange rate between two countries’ currencies equals the ratio of countries’ price levels. PPP theory predicts that a fall in a currency’s domestic purchasing power (as indicated by an increase in the domestic price level) will be associated with proportional currency depreciation in the foreign exchange market (as demand for currency and products fall). This relationship also holds symmetrically.His example in class: D.C. Saturday at Eastern Market, Booth 1 sells apple cider for 1.5 US$ and another for one euro (1.4 US$), and an exchange broker is at another booth selling 1 euro at 1.4 US$. If goods are sold for different prices in different countries (or different booths), then either the prices of the goods or the exchange rate will change until the exchange-adjust prices are similar in the two countries (or in two booths).Big Mac Index: The Big Mac index undermines the theoretical principle because it took one commodity (Big Macs) and measured their domestic prices in multiple countries against the price in dollars. The result was a large range of prices for the Big Mac. I think this means that exchange rates must change between these countries since PPP dictates that if domestic purchasing power falls, meaning the price of the Big Mac is more, then that currency will depreciate internationally. The same should go vice versa. But since there is such a large difference in the prices of Big Macs compared to the US$, this law must not hold true.

Terms:

17) Systemic risk vs. moral hazard Systemic risk is defined as severe financial instability that jeopardizes the collapse of the entire financial system, as opposed to the instability limited to single entity, group, or component of system. Moral hazard occurs when an individual or institution does not bear the full consequences of its actions, and hence, does not change its behavior. During the financial crisis of 2008, systemic risk eventually trumped moral hazard to the policy makers since it was decided that the risk to the system was much greater than the need to “punish” the institutions for having made such terrible loans. US policymakers concerned about systemic risk orchestrated rescue packages for Bear Staerns and AIG and recapitalized banking institutions including Citibank, Bank of America, JP Morgan, etc. The tradeoff between these two terms is imperative in essay #2 in relation to how the financial crisis was or could have been dealt with: let Wall Street fail or come to the rescue, basically, chance the hazards of systemic risk or deal with the moral hazard of aiding institutions out of their own mess? It is also related to #3, which asks about the usefulness of the Dodd-Frank Reform bill. In relation to the bigger themes of class, the tradeoff between systemic risk and moral hazard in domestic policy has much greater implications globally with more countries being more exposed to international financial markets, meaning

that failures of the kind seen in the US has had repercussions across the globe. Additionally, the kind of investment and lending that caused the financial crisis in the first place is representative of the global shift to more and more risky, 24-7 “financial wizardry” behavior domestically and internationally.

29) GINI coefficient and microcredit The GINI coefficient is a number between zero and one that measures the degree of inequality in the distribution of income in a given society where closer to zero demarcates a more egalitarian society. The range is between 0.25 for historically egalitarian societies to 0.6 for countries with highly skewed income distributions. Microcredit is institution of a bank that lends small loans to those in poverty, sometimes to a group of people, in order to spur entrepreneurship amongst those who could not otherwise obtain the capital necessary. The relation between these two terms is the major theme of the class of inequality in developing countries. Microcredit is supposed to be a sustainable form of development to aid financial mobility amongst the poorest in a country, but often even the goals of microcredit are skewed and cause inequality, of which the GINI coefficient is a measurement. An example of where the GINI coefficient and microcredit come together is the Tanzanian bank discussed on page 326 of Oatley, where 60% of the loans are used to send children to school, and only 40% are used to create businesses. This shows the important factor that inequality plays, the loans only help those already well enough off to be able to utilize them for business as opposed to everyday expenses or emergencies. Two main theories were posed in class about inequality and development: inequality creates economic incentives, and inequality creates economic inefficiencies. The latter is better supported by international data that shows a widening rich-poor gap, where even where people are escaping $1/day poverty, they are only improving to $2/day. The GINI coefficient and microcredit are related to essay question #1 as well as the Prebisch-Singer thesis in that the idea of sustainable development and equality are intricately linked and necessary to any development theory.

Essay:

1. Why has the Washington Consensus been widely discredited in the development field? Are there features of this policy approach that are still central to fostering sustainable growth today? Why or why not? Does the Beijing Consensus represent a viable alternative, development paradigm or is it simply a reformation of the East-Asian development model? Which features of the Beijing Consensus, if any, do you think can be successfully applied to other countries? · BACKGROUNDo The Washington Consensus is a neoliberal adjustment policy that advocates global economic integration through free trade that is supported by economic stabilization, structural adjustment, and export-led growth. It includes the following policies:§ Fiscal discipline§ Prioritizing education and health care spending§ Tax Reform§ Liberalizing interest rates

§ Competitive exchange rate§ Trade liberalization§ Liberalization of inward foreign direct investment§ Privatization§ Deregulation§ Securing property rightso The Washington Consensus can be compared to the following models:§ Millennium Development goals· Sustainable development reflection of government and market· Benefits of globalization spread unevenly· Developed countries aid institutional building and state capacity in developing countries§ 2002 Monterrey Consensus· Recognizes that fundamental development challenges are both structural and domestic§ Beijing Consensus, which includes the following policies:· Localization of best practices borrowed· Combination of market and plan· Flexible means to a common end· Policy rights· Stable political environment· Self-reliance· Constantly upgrading industry· Indigenous innovation· Prudent financial liberalization· Economic growth for social harmony§ State-assisted capitalism· Newly industrialized Economies (NIEs) India, Chinao Promote industrial development with tariffs and subsidies for state-selected national championso Encourage exports when selected industries internationally competitive: Export processing zones promote foreign investment in domestic manufacturingo Governments negotiate technological transfer and favorable local content production in FDIo Invest in educational and technical trainingo Avoid financial volatility with capital controls· Why has the Washington Consensus been widely discredited in the development field?o The Washington consensus has held sway in the development field for years, relying heavily on a policy of relying strongly on markets at home and abroad in order to further development.o China’s huge development progress has veered away from this model, following a much more state-run and market-safe model.o The success of this model is largely responsible for discrediting the Washington Consensus, as well as the lack of proof that the Washington Consensus has been very successful.· Are there features of this policy approach that are still central to fostering sustainable growth today?o Yes. Some of the features of the Washington Consensus are even incorporated into the Beijing Consensus.

o I would say that all aspects of the Consensus could still aid a country in its development goals, but the entire proscription taken together might not always offer the best option for a developing country.o In my opinion some of the most important aspects of the Washington Consensus are: fiscal discipline and prioritizing education.· Does the Beijing Consensus represent a viable alternative, development paradigm or is it simply a reformation of the East-Asian development model?o Again, I think that the model could work for some countries. I think the entire reason there is doubt in the Washington Consensus is because something different worked for another country. I think it is very difficult to come up with a perfect plan that fits all countries.o Li et. al. argue for their Beijing consensus as a better alternative for development for the following reasons (Oatley chapter 15):§ China’s development was distinctive and successful (337)§ Their ten principles offer a broad and widely accepted (338)§ The principles offer a list of best practices for countries to adaptively use (338)o Kennedy explains that the Beijing Consensus is a myth:§ The Beijing consensus fails to accurately represent the actual growth model in China (353)§ The distinct aspects of China’s development cannot be easily translated to another country or copied by other governments (353)§ The development in China is not necessarily the best practices (not the most sustainable or equitable) and should therefore cannot be the best alternative (354)§ China essentially followed 8 of the ten WC policies (354-55)· Which features of the Beijing Consensus, if any, do you think can be successfully applied to other countries?o The following are the aspects of the Beijing Consensus that I think are the most flexible and broad in order to be applied to other countries§ Flexible means to a common end§ Stable political environment§ Localization of best practices borrowedo The other policies, I think were too specific to the experiences of China to be able to be exportedo The strengths of the Beijing consensus put forth by Li et. al. was the flexibility of the model, promoting changing policies and localization of the policies.

15) Coase theorem and negative externalities Coase theorem – The argument that economic efficiency will be optimized as long as property rights are fully allocated, and completely free trade in these rights is possible (Ravenhill, 481). Professor Kaplan discussed Coase theorem in the Oct. 25th lecture, where he discusses the following three approaches to solving the issue of negative externalities: one, free market perspective (Coase theorm and my notes say “Example: Ecuador’s oil”?); two, market failure perspective (government intervention); three, middle ground (example: cap and trade). The best example of Coase theorm is by Jason E. Bordoff in “International Trade Law and the Economics of Climate Policy” (Oatley, 139) He states that the ideal solution to negative externalities would

be an international cap-and-trade system, but falling short of that border adjustment taxes intended to offset leakages should be avoided, are ineffective, and likely not legal in the WTO. Negative externalities – From Oct. 25th lecture, “Instances where economic actions have consequences for which the actor does not pay.” Bordoff explains why negative externalities are an international issue, “a ton of carbon emitted in Beijing contributes to climate change just as much as a ton of carbon emitted in New York.” Solving issues concerning negative externalities is an ongoing debate in multilateral institutions like the WTO. The inherent issue is that regulation decreases competitiveness and creates a free rider problem. Another issue is that as the Environmental Kuznets Curve (Ravenhill, 463) illustrates that pollution will rise along with economic growth during the early stages of industrial development. When Western Europe and United States went through their early stages of industrial growth, there were no such environmental regulations and this is an argument often cited by the Chinese government. Coase theorm – pricing externalities – how to react – market or state intervention – the theory says that the market will fix for externalities 22) Arms length vs. hierarchical control Arms length – refers to a company contracting with companies abroad in their global supply chain rather than utilizing FDI. Ravenhill defines the approach as, “in the ideal world of a neoclassical economist, firms would not invest abroad. If markets are operating efficiently, information is costless, there are no barriers to trade or competition, and there are no advantages to be gained from economies of scale, there would be little reason for a firm to invest abroad because trade would be the logical means of reaching foreign markets and accessing inputs” (Ravenhill, 354) Hierarchical control – Rather than using the arms-length approach of contracting to other companies in a global supply chain, hierarchical control utilizes foreign investment (like FDI) and make vertical integration. This is a reaction to the possible transaction costs of the arms-length approach. One such transaction cost is bounded rationality that makes it impossible for actors to foresee every contingency that might affect an agreement between two actors. Another example is opportunism that is where each actor suspects that the other actor is not only acting for their own self-interest, but, potentially, with deceit and guile. Other advantages include brand management, technology or manufacturing expertise, economies of scale, and marketing power. Examples of industries that take on an hierarchical approach are IBM and Nike. 3) Define balance of payments accounting, and why is this concept central to the future of US-Chinese bilateral relations? Balance of payments accounting is the principle that the current account plus the capital account equals zero. The current account is the balance of trade in goods and services plus profits and interest on overseas assets less those paid to foreign owners of domestic assets, plus net transfers such as worker remittances (Ravenhill, 480) or more simply put by Professor Kaplan on class 17, “Current account = savings – investment.” The capital account consists of inflows and outflows of money for investment, and for grants and loans. A current account

deficit means that a country invests more than it saves, and to fund this deficit they must have a corresponding capital account surplus. The United States maintains a current account deficit and capital account surplus. Conversely, China maintains a current account surplus and capital account deficit. Politicians argue that punitive actions must be taken to compensate for China’s undervalued renminbi. However, David Hale and Lyric Hale argue in “Reconsidering Revaluation: The Wrong Approach to the US-Chinese Trade Imbalance” that trade relations are a product of each countries balance of payments accounts (Oatley, 264). In order to maintain low interest rates, the US relies on Chinese purchases of US treasury bonds. Reciprocally, the Chinese government has large savings but this comes at the opportunity cost of the other domestic investments they could make like healthcare and education. 1. Why has the Washington Consensus been widely discredited in the development field? Are there features of this policy approach that are still central to fostering sustainable growth today? Why or why not? Does the Beijing Consensus represent a viable alternative, development paradigm or is it simply a reformation of the East-Asian development model? Which features of the Beijing Consensus, if any, do you think can be successfully applied to other countries? There are five main sectors that the Washington Consensus has failed. First, growth, in many Latin American saw slower per-capita GDP growth in the 1990’s than during the period 1950 and 1980. Second, trade, trade liberalization is a one-way-street where the developed countries to pressure developing countries to liberalize while they refuse to eliminate their own agriculture subsidies. Third, finance and investment, increased portfolio investment (bonds and equities) mark decrease FDI and financial volatility is best highlighted by the peso crisis in Mexico, the Asian financial crisis, and the Argentine collapse in the early 2000s. Fourth, debt, heavily indebted developing countries had debt levels equivalent to 103% of total GDP between 1995 and 2000 (Ravenhill, 436). Fifth, poverty and inequality, ratio of GDP per capita relative to the developed world has fallen in Latin America, Eastern Europe, and Sub-Saharan Africa over the last two decades. The good news is that the number of people in poverty fell by 25% between 1981 – 2001. The bad news is that this was largely offset by a large decrease in poverty in China, rather than a global phenomenon credited to the WC (IPE class 23 ppt). Stiglitz best explains the reasons for the failure of the Washington Consensus in the following quote, “that consensus all too often confused means with ends: it took privatization and trade liberalization a ends in themselves, rather than as means to more sustainable, equitable, and democratic growth… It focused too much on price stability, rather than growth and stability of output. If failed to recognize that strengthening financial institutions is every bit as important to economic stability as controlling budget deficits an increasingly the money supply. If focused on privatization, but paid too little attention to the institutional infrastructure that is required to make markets work, and especially the importance of competition” (Ravenhill, 440). The tenants of the Washington consensus is still applicable today, but as emphasized above by Stiglitz, there needs to be more focus on ensuring the necessary institutions are in place. More emphasis should be placed on addressing inequality and governments should take a more rawlsian approach to fixing market failures in areas such as providing public goods, redressing distributional problems, and improving basic living standards (IPE class 23 ppt).

Some advocate that China’s economic success and WC’s failures make reason to shift to a new Beijing Consensus. The inherent issue is the very concept of a consensus, the idea that some shopping list of principals can be applied to any country and yield results is erroneous. The only principles outlined by Li, Brodsgaard, and Jacobsen in “Redefining Beijing Consensus: Ten Economic Principles” are localization of best practices borrowed and policy rights. These two principles embody the issues within the WC and that is given US’s power within the IMF. The conditionality of the loans given to the IMF will keep the creditors best interest in mind rather than the developing countries interests. A governments choice of development models is their choice alone and there should be less international pressure on such domestic choices. However, gradual implementation of the WC will yield best results, there should be less conditionality attached and the liberalization of capital markets should be a step taken with much caution and due diligence. As for Beijing versus Wshington Consensus, as stated by Kennedy in “Beijing Consensus: Myth or Reality?” China has already implemented seven of the ten tenants of the Washinton Consensus.

1) Mundell-Fleming Trilemma and Gold Standard: · The Mundell–Fleming Trilemma dictates that an economy cannot simultaneously maintain a fixed exchange rate (exchange rate stability), free capital movement (capital mobility), and an independent monetary policy (national policy autonomy). A country must pick two out of three. It can fix its exchange rate without emasculating (weakening) its central bank, but only by maintaining controls on capital flows (like China today); it can leave capital movement free but retain monetary autonomy, but only by letting the exchange rate fluctuate (like Britain – or Canada); or it can choose to leave capital free and stabilize the currency, but only by abandoning any ability to adjust interest rates to fight inflation or recession (like Argentina today, or for that matter most of Europe). The United States has capital monetary openness and national monetary policy autonomy, but not a fixed exchange rate.

· The gold standard is a monetary system in which money supply is linked to a country’s holdings of gold and the value of all currencies is set in terms of a unit of gold, and trade imbalances are settled through transfer of gold reserves. The gold standard as an international monetary system ended after WWII. Adhering to the gold standard means forgoing monetary policy autonomy because in the event of a trade imbalance between two countries, the country with the deficit is forced to transfer gold reserves to the other country and increase its domestic interest rates in order to decrease money supply. Because increasing interest rates worsen an already precarious economic situation, governments tempted to defect, would sell securities to reduce the gold circulating in the economy. One of the reasons the gold standard broke down in the interwar period was because governments rejected the idea of imposing economic pain on their citizens, especially as the working class increased in political importance. · Use for essay five. The Eurozone has chosen capital mobility and fixed exchange rate with a complete abandonment of national monetary sovereignty – meaning that the Eurozone cannot increase the money supply, thus lower interest rates, stimulate investment and improve the overall health of the European economies. Instead it has a fixed monetary policy, which is the responsibility of the European Central Bank (ECB). The principal task of the ECB is to keep inflation under control.

20) Fixed vs. mobile assets · Fixed assets are long-term assets owned by a firm, used in the production of income (e.g. buildings, physical infrastructure real estate, machinery, and personnel). These assets are not easily consumed or converted into cash; it’s also difficult to shift their geographic location across borders. Notwithstanding capital mobility, sunk costs mitigate foreign direct investor’s exit options.· Mobile assets are financial assets, such as bonds and bank claims. These are assets that move quite easily across borders and are readily converted to cash.· Fixed and mobile assets are discussed in describing globalization’s constraining structure:o In the post-world war financial liberalization period, this liberalization allowed for greater capital mobility. Capital can exit from national economic environments at minimum cost compared to capital immobility in the immediate post-war period (when most economies were closed). As a result of this world of capital mobility, states are thus forced to orient economic policies toward investor preferences to avoid capital outflows.· Use for Essay 2: Moral hazard, creative destruction, and systemic risk aside, The United States – like any other state, would not want to let Wall Street firms collapse, simply because in the world of capital mobility, the U.S. does not want to incur capital outflows due to the governments inability to prevent a financial meltdown. Fixed assets prove to be a long-term asset and are certainly more risk averse; mobile assets are short term and more risky due to their ability to move so easily between borders and traders. Short Case Study # 1.) Define the law of one price. Does the Economist’s Big Mac Index support or undermine this theoretical principle? Why or why not? The law of one price (LOOP) states that in the absence of trade frictions (such as transport costs and tariffs), and under conditions of free competition and price flexibility (where no individual sellers or buyers have power to manipulate prices and prices can freely adjust), identical goods sold in different locations must sell for the same price when prices are expressed in a common currency. In addition to LOOP, it is important to understand the principle of purchasing power parity (PPP), which is the macroeconomic counterpart to the microeconomic law of one price. The law of one price relates exchange rates to the relative prices of an individual good, while purchasing power parity relates exchange rates to the relative prices of a basket of goods. In studying international macroeconomics, purchasing power parity is the more relevant concept. The Economist’s Big Mac index is a guide to whether currencies are at their “correct” level. It is based on the theory of PPP, the notion that in the long run exchange rates should move towards the rate that would equalize the prices of a basket of goods and services around the world. To give an example, of how the Big Mac Index works: at market exchange rates, a burger is 44% cheaper in China than in America. In other words, the raw Big Mac index suggests that the yuan

is 44% undervalued against the dollar. The Economist’s index does warn that cheap burgers in China does not prove that the yuan is massively undervalued. Average prices should be lower in poor countries than in rich ones because labor costs are lower. PPP signals where exchange rates should move in the long run. To estimate the current fair value of a currency the index uses the “line of best fit” between Big Mac prices and GDP per person. The difference between the price predicted for each country, given its average income, and its actual price offers a better guide to currency under- and overvaluation than the “raw” index. (see graphs: http://www.economist.com/blogs/dailychart/2011/07/big-mac-index) While PPP and LOOP are different in micro and macro economic scope, they both compare the relationship of exchange rates to the relative price of a single goods (LOOP) and the relative prices of a basket of goods (PPP). While the index cites that it is based off of PPP, the index additionally supports the LOOP theory. The calculations for PPP and LOOP are the same except with PPP, the exchange rate will equal the ratio of the price of the basket of goods in two countries, versus LOOP, where the exchange rate will equal the ratio of the price of an individual good in two countries. In the Big Mac index it does just this. Hence it supports both LOOP and PPP. Essay # 5. Matthew Hellman, Michael Henn, Angela Woodhead, Bruce Tobin, Victor Ho-Chung Lam What does the current sovereign debt crisis in Europe suggest about the tensions between the domestic policy autonomy and international economic interdependence? In other words, what does political economy theory tell us about their compatibility under fixed and floating exchange rates? Drawing from your knowledge of historical fixed exchange rate systems, what’s your prognosis for the future of Europe’s monetary union? Under what conditions are the euro-zone countries likely to successfully navigate the current crisis. The establishment of the Eurozone was meant to reduce exchange rate variability and achieve monetary stability in Europe, through the introduction of a single currency, the euro. After the adoption of the euro in 1999, policy changed to linking currencies of countries outside the Eurozone to the euro (having the common currency as a central point). The goal was to improve stability of those currencies, as well as to gain an evaluation mechanism for potential Eurozone members. With the current debt crisis in Europe, the problem for the 17 countries that use the euro, along with several other currencies who have their own currency tied to the euro such as Denmark, is that there is significant international interconnectivity, so much so, that if the eurozone fails, not only will those countries within the eurozone be susceptible, but also those whose currencies are pegged to the euro, and those who have significant investments in Europe, i.e. U.S. A failure to solve the issue, means that the world will be substantially hurt by the failure.

To understand Europe’s system better: the Mundell–Fleming Trilemma dictates that an economy cannot simultaneously maintain a fixed exchange rate, free capital movement, and an independent monetary policy. The Eurozone system maintains capital mobility and a fixed exchange rate with a complete abandonment of independent monetary sovereignty. In lieu of the current sovereign debt crisis in Europe, what does this mean? Europe has chosen to leave capital free and stabilize the currency, but only by abandoning any ability to adjust monetary policy. The Eurozone and European Central Bank ECB (whose principle task is to keep inflation under control via keeping monetary policy fixed) cannot increase the money supply, which would thus lower interest rates, stimulate investment and improve the overall health of the European economy. In a floating exchange rate system, such as the United States, the Central Bank could increase the money supply as a way to help an ailing economy. Increasing the supply also reduces the interest rates, encouraging investment. It is much more challenging for an economy such as Europe, with a fixed exchange rate to do the same. In Europe in order to help a country with lethal debt such as Greece, the Euro-zone leaders have had to impose austerity measures on Greece, and put together a loan package from members of the ECB. The ability to increase the money supply is just simply not possible without creating disastrous inflation. The United States poses as a perfect example of a country that used to have a fixed exchange rate system, and moved to floating exchange rate system. During the Nixon Administration, President Nixon was trying to find a way to stimulate the U.S. economy. By switching to floating exchange rate system, it gave the U.S. Federal Reserve (central bank) the ability to raise and lower the money supply, enabling the central bank to determine interest rates. I believe that in the case of the Eurozone, the leaders will need to consider switching to capital monetary openness and national monetary policy autonomy, and eliminating their fixed exchange rate. It will ultimately help the leaders in the future to avoid financial crises such as the current ongoing one.

24) Value-added chain and industry upgrading-------------Rebecca Dauer, Allegra Chen-Carrel - Class: 11/15/2011 - Reading: Ravenhill, Chapter 10 - Powerpoint Class 21 Value Added Chains- The sequence of activities through which technology is combined with material & labor inputs & then assembled, marketed & distributedIndustry Upgrading:Chains important for upgrading prospects, longer-term development- Upgrading: increasing competitiveness by capturing part of the value chain that involves higher-value added activities (e.g. improving process technology, product design, or distributional strategy).

- FDI is beneficial if country is able to gain management, marketing, & technological skill.- Countries aim to have evolutionary industrial structures, so they can move up the value-added chain from labor-intensive to more capital-intensive production.- E.g. Infosys from India: one of the largest technology firms in the worldo Take timeo But can happeno Attract investment & simultaneously investing in local human and physical capitalà move up value-added chaino Government choices: Education, R & D In today’s global production, firm activities are fragmented and organized by function as opposed to geographic location. This allows outsourcing and modular production through FDI in other countries. Many developing countries seize the opportunity to participate in an area of production to hopefully “industry upgrade”. Drawbacks:· May become trapped in a dependent relationship with multinational firms conducting low value-added activities (doesn’t help grow, traps at the bottom)Benefits:· Local economies can capture higher value-added activities· FDI can pay dividends à Relates to essay #4: articles about Congo minerals & global supply chains- value-added production & industry upgrading show that an alternative to “race to the bottom” exists and may help developing countries achieve sustainable growth- FDI & outsourcing theory: divergence vs. convergenceo Divergence theory:o Undermines “race to the bottom” by explaining FDI is positively correlated with: levels of corporate taxation, union density, labor costs, the degree of labor market regulation and discusses the role of the state. The state can choose to build infrastructure, invest in education, assist in R & D, help ensure the rule of law. These choices by the state can help attract more FDI. FDI, according to divergence theory, is attracted to locations where there are highly skilled, reliable, and innovative workers. 30) Washington Consensus vs. Beijing Consensus-------------Tripp Corbett, Rebecca Dauer - 11/22/2011 - Ravenhill, Ch 13 & Oatley, Ch. 12 and 13 - 12/1/2011 - Oatley, Ch 15 & 16 Washington Consensus: model of economic growth for developing countries

o Neoliberal adjustment policieso Global economic integration through free trade§ Economic stabilization§ Structural adjustment§ Export-led growtho Elements outlined in Ravenhill, p. 433Beijing Consensus:· State-assisted capitalismo Newly Industrialized Economies (NIEs), India and China§ Promote industrialized development with tariffs and subsidies for state-selected national champions.§ Encourage exports when selected industries are internationally competitive· Export processing zones (EPZs) promote foreign investment in domestic manufacturing§ Governments negotiate technological transfer and favorable local content production in FDI.§ Invest in educational and technical training.§ Avoid financial volatility with capital controls. The Washington Consensus· Fiscal discipline· Prioritizing education and health care spending· Tax reform· Liberalizing interest rates· Competitive exchange rate· Trade liberalization· Liberalization of inward foreign direct investment· Privatizationo Prices will come down through efficiencies· Deregulationo Heavy previous government involvement in the economy. If you get government out, the economy/market will start to operate more efficiently. Permits & red tape impeded economic growth.· Securing property rightso Companies worry about local rule of law or legal contracts, increase political instability and ultimately economic instability. Companies won’t want to invest.Capital account liberalization- FDI, short-term investments (stocks, bonds, etc.)- WC : complete capital account liberalizationo Open to foreign investment & short-term (bonds, etc.), but controversial due to sudden stop and financial volatility (undermines available benefit from inward FDI)o Less clear in terms of benefits The Beijing Consensus- Localization of best practices borrowedo Operate under rule of law locals are used to, with more and more success (China- greater development on the coast and less efficient state-run enterprises).- Combination of market and plan

o Economic models were built on a premise that conditions are ‘perfect in society’.o Actors should all have access to all information.o Stiglitz- not this way, people are often acting with asymmetric information.o E.g. Healthcare: Insurance companies don’t have complete information about poor or elderly people (risk premium)- therefore, not a perfectly functioning marketà provides incentive for government to interveneo In wake of 2008 crisis in US, heavy government involvement (bail out), perhaps, everyone is moving towards more this market and plan - Flexible means to a common endo End: economic growth and developmento Means: countries unique§ China: One country, two systems§ Maybe market and communism can work together (communism once wouldn’t even accept private property, now accepting and allowing more and more)- Policy rightso “No strings attached”- Stable political environment- Self-reliance- Constantly upgrading industryo China picks their winners: which industries they want for exports or domestic consumption- Indigenous innovation- Prudent financial liberalizationo Wary of incoming FDIo China: open to uncertainty moving forward because there’s questions about banking system- Economic growth for social harmonyo Economic growth for social harmony- inclusive growtho Inequality between coasts remains Beijing Consensus Oatley: sequencing; China has had some benefit in where it is coming in in the many phases of development à relates to essay #1 (Why has Washingotn Consensus been discredited? Does the Beijing Consensus represent a viable alternative? Which features of the Beijing Consensus can be applied to other countries?) Short Case Study # 4. Angela Woodhead, Shane Logue, Rebecca Dauer, Se Ra Song, Spencer Frenchman What is forward currency hedging and why did German-owned Volkswagon begin implementing this financial strategy in 2005? - Powerpoint, class 14 - Notes 10/20/2011 -Oatley, Ch 11

à Forward transaction: The exchange of two currencies at a future settlement date, often used by multinational corporations to hedge foreign exchange risk.àForward currency hedging: entering into a forward exchange rate contract, which guarantees a certain rate of exchange at a specified point in the future- Currency risk poses a threat to a company’s profits if it is subject to change.- For Volkswagen, a currency mismatch between labor costs in Euro amounts and car sales in USD amounts eroded profits.o From 2002-2004, the euro appreciated considerably less against the USD, so, USD revenues were substantially lower in euro-terms.o To avoid currency risk, Volkswagen entered into euro forward contracts in 2005 to shield business operations from short-term foreign exchange volatility, ensuring figures for budgeting and balance sheet performance.§ The forward contracts provide a sort of insurance against foreign exchange volatility à Many countries and investors, particularly those in Asia, have chosen to invest in US Treasury securities for the safety and stability they offer. The US has essentially become a debtor to the rest of the world who are creditors to the US. If, however, foreign investors decided to rebalance their reserve portfolios (currently holding Treasury securities) and sell off US dollars, US interest rates would rise quickly. While US corporations are hedged against this risk, individuals are not. This would leave individuals exposed to the new high-interest rate market, which could drastically weaken the economy, terminating the ability for Americans to get low interest rate loans, refinance their debt, or pay off their current obligations. Must be wary of potential sudden and drastic change in foreign reserve holdings, because a sell off of T-securities would threaten the livelihood of all Americans. Essay # 2. Jordan Marlatt, Kelly Ryan, Joseph Maniscalco, Rebecca Dauer, Morgen Ellis Banking Crisis bailoutà assess tradeoffs:- Creative destruction- Systemic risk: risk for the entire system- Moral hazardReadings/Notes:- Class 11/8/2011- Ravenhill Ch 8, “Inside the Meltdown” video, Sumers. Eichengreen, DeLong, Johnson, & Oatley Ch 10 Systemic risk vs. Moral Hazard- Systemic risk : severe financial instability that jeopardizes the collapse of entire financial system, as opposed to the instability limited to a single entity, group, or component of the system.o Whole system at riskà need bail out (inside the meltdown)

- Moral hazard: occurs when an individual or institution does not bear the full consequences of its actions, and hence, does not change its behavior. Solution to Moral Hazard: Creative DestructionAllow market to destroy to create value.Allow inefficient companies to crash & new ones to come about (Schumpeter)- creative destructiono the essence of modern capitalismo national governments use bankruptcy to clear their economic systems (Ravenhill, 266)o national bankruptcy laws exist to guide the liquidation of a firm’s assets Banking Industry: changes in market & increase in information asymmetryà increased possibility of systemic risk- financial innovation & policy change- financial crises, especially banking crises, remain recurrent their only reliable predictor an increasingly shared sense that they will not recur because ‘this time is different’ (Ravenhill, 251)- when financial markets cross legal and political borders the probability of crisis increases as the information embedded in prices becomes less readily accessible for all market participants (Ravenhill, 251) Systemic vs. Moral Hazard- US policymakers concerned about systemic risk orchestrate rescuepackages for Bear Stearns and AIG and recapitalize banking institutions including Citibank, Bank of America, JP Morgan, etc.à prevented collapse, provided bail out so the nation (& world) wouldn’t suffer drastic reduction in credit and economic well-beingReactions to G intervention:- Johnson Critique: ‘Policy by Deal’ props up “too big to fail” banks, creating moral hazard problem: without nationalizations, financial management does not change and banks do not realize losses on security & loan portfolios: no change in management, no creative destruction, downsize, restructureà no conditionality that goes along with this- Government throws hundreds of billions of dollars of taxpayer money into ‘bailing out’ those institutions responsible for crisis- Banks should help restructure loans, get people out of the red; banks used the money, but didn’t help restructure, get people out of the red- And paying themselves HUGE bonuses!- Merill Lynch lost $27.6 billion in 2008 collapsed spectacularly, had to be brought by Bank of America, and was rescued with $10 billion in Federal money: yet, at the end of that disastrous year, its management approved bonuses …- Government should have added “strings” or requirements to bailout money to help limit/control future bank activities (like not providing huge bonuses to risky investors)

2) Triffin paradox and Bretton WoodsBretton Woods Order

The Order was created to reconcile liberal multilterialism with new domestically orientated priorities to combat unemployment and promote social welfare that had emerged with the new deal. Signatories of this order agreed to declare a par value of their currency in relation to the gold content of the US dollar in 1944. This created a gold exchange standard. Also countries were given the option of adjustment their countries par value whenever their country was in fundamental disequilibrium (adjustable peg). Countries could substitute exchange rate devaluation for harsh domestic deflation when they experienced sustained balance of payments deficit. Also countries agreed to make their currency covert-able for current account transactions (trade payments), but they were also given the right to control all capital movements. This provision was not intended to stop all private financial flows. Those that were equilibrating and designed for productive investment were still welcomed. Triffin Paradox Refers to the instability of the gold exchange standard during the collapse of the Bretton Woods order. In a system where the dollar was the central reserve currency, Triffin argued that international liquidity could be expanded only when the US provided the world with more dollars by running a balance of payments deficit. The more it did so, however, the more it risked undermining confidence in the dollar convertibility into gold. One potential solution, was to create a new international currency whose supply would not be tied to the balance of payments condition of any one country. The benefit of the Gold Exchange Standard was that the US was able to finance growing external deficits associated with domestic policies, which produced rising imports simply by printing the US dollar. This also led the US to be able to export inflation by flooding the world with dollars. But the country was becoming vulnerable to a confidence crisis, as if all the holders decided to covert their money to gold the US would not be able to meet its obligations. 8) Current account vs. capital accountAn account of a countries transactions with foreign countries and international institutions in a specific period. Transactions are divided into current account, which consist of the balance of trade in goods and services plus profits and interest overseas assists less those paid to foreign owners of domestic assists, plus net transfers such as worker remittance The capital account consist of inflows and outflows of money for investment, and for grants and loans ( and their repayment). The balance of payments is an accounting identity: the entries in the account should sum to zero with, for example, any imbalances on the current account being offset by net movements of capital. They have been manipulated differently over the course of each monetary regime (Gold Standard, Gold Exchange Standard, and Floating Exchange) (See Bretton Woods System too).26) Prebisch-Singer thesis and import substitution industrialization (ISI)Prebisch-Singer thesis Is the hypothesis that the terms of trade between primary products and manufactured goods tend to deteriorate over time. Developed independently by economists Raul Prebisch and Hans Singer in 1950, the thesis asserts that countries that export commodities (such as most developing countries ) would be able to import fewer and fewer manufactured goods for a given level of exports.

Singer and Prebisch examined data over a long period of time suggesting that the terms of trade for primary commodity exporters did have a tendency to decline. A common explanation for the phenomenon is the observation that the income elasticity of demand for manufactured goods is greater than that for primary products - especially food . Therefore, as incomes rise, the demand for manufactured goods increases more rapidly than demand for primary products.The theory implies that it is the very structure of the market which is responsible for the existence of inequality in the world system. This provides an interesting twist on Wallerstein 's neo - Marxist interpretation of the international order which faults differences in power relations between 'core' and 'periphery' states as the chief cause for economic and political inequality (However, the Singer-Prebisch thesis also works with different bargaining positions of labour in developed and developing countries). As a result, the Singer-Prebisch Thesis enjoyed a high degree of popularity in the 1960s and 1970s with neo-marxist developmental Economists and provided a justification for import substitution industrializing (ISI) policies and even an expansion of the role of the commodity futures exchange as a tool for development. Import substitution industrialization (ISI) Is a trade and economic policy based on the premise that a country should attempt to reduce its foreign dependency through the local production of industrialized products. The term primarily refers to 20th century development economics policies, though it was advocated since the 18th century.It has been applied to many countries in Latin America, where it was implemented with the intention of helping countries to become more self-sufficient and less vulnerable by creating jobs and relying less on other nations. The ISI is based primarily on the internal market. The ISI works by having the state lead economic development through nationalization, subsidization of vital industries (including agriculture, power generation, etc.), increased taxation to fund the above, and highly protectionist trade policy. Some of the positive effects of ISI included increased jobs and a more stable state. Ultimately, the ISI model was exhausted, because the size of internal markets were too small. As a result, there were fewer people buying products in the industrial market. Further, countries could not easily delink themselves with other countries and depended very much on exports, imports, and multinational corporations.Adopted in many Latin American countries from the 1930s until around the 1980s, and in some Asian and African countries from the 1950s on, ISI was theoretically organized in the works of Raúl Prebisch , Hans Singer ,Celso Furtado and other structural economic thinkers, and gained prominence with the creation of the United Nations Economic Commission for Latin America and the Caribbean (UNECLAC or CEPAL ). Insofar as its suggestion of state-induced industrialization through governmental spending, it is largely influenced by Keynesian thinking, as well as theinfant industry arguments adopted by some highly industrialized countries, such as the United States, until the 1940s. ISI is often associated withdependency theory , though the latter adopts a much broader sociological outlook which also addresses cultural elements thought to be linked withunderdevelopment. As a set of development policies, ISI policies are theoretically grounded on the Singer - Prebisch thesis, on the infant industry argument, and on Keynesian economics. From these postulates it derives a body of practices, which are commonly: an active industrial policy to subsidize and orchestrate production of strategic substitutes, protective barriers to trade (e.g. tariffs ), an

overvalued currency to help manufacturers import capital goods (heavy machinery), and discouragement of foreign direct investment . The major advantages claimed for ISI include: increases in domestic employment (reducing dependence on labour non-intensive industries such as raw resource extraction and export); resilience in the face of a global economic shocks (such as recessions and depressions); less long-distance transportation of goods (and concomitant fuel consumption and greenhouse gas and other emissions).The disadvantages claimed for ISI is that the industries that it creates are inefficient and obsolete as they aren't exposed to internationally competitive industries which constitute their rivals and that the focus on industrial development impoverishes local commodity producers who are primarily rural. Other disadvantages include unemployment increasing internationally as World GDP decreases through the promotion of inefficiency. 27) Utilitarianism vs. RawlsianismA utilitarian welfare function (also called a Benthamite welfare function) sums the utility of each individual in order to obtain society's overall welfare. All people are treated the same, regardless of their initial level of utility. One extra unit of utility for a starving person is not seen to be of any greater value than an extra unit of utility for a millionaire. At the other extreme is the Max-Min, or Rawlsian utility function (Stiglitz, 2000, p102). According to the Max-Min criterion, welfare is maximized when the utility of those society members that have the least is the greatest. No economic activity will increase social welfare unless it improves the position of the society member that is the worst off. Most economists specify social welfare functions that are intermediate between these two extremes. The social welfare function is typically translated into social indifference curves so that they can be used in the same graphic space as the other functions that they interact with. A utilitarian social indifference curve is linear and downward sloping to the right. The Max-Min social indifference curve takes the shape of two straight lines joined so as they form a 90 degree angle. A social indifference curve drawn from an intermediate social welfare function is a curve that slopes downward to the right. 28) Tragedy of the commons and “greenwashing”v Tragedy of commons Ø Because it’s commonly owned, no one takes the responsibility to do upkeepØ Whereas if someone owned it they’d upkeep it and it’d be better offSimilar to prisoner’s dilemmav The Kyoto Accords are an example of the world attempting to address a Tragedy of the Commons issue, i.e. the environmentØ 37 different industrialized nationsØ Between 2005 and 2012§ They’d reduce green house gas emissions back to 1990s levelsØ US didn’t sign onØ Canada just repealed their pledgeØ Notion of leakage is why it’s mentioned in the book

§ Competitiveness concern on the part of developing countries · Because these developing countries can defect, then the developed countries would be fucked as far as competitiveness goesØ The Frankel (pg 126) and Bordoff articles define this§ Leakage of emissions could come from several channels· Not just trade, but also investment competitiveness· People could reorient FDI to unregulated countriesv GreenwashingØ Greenwashing is a form of spin in which green PR or green marketing is deceptively used to promote the perception that a company's policies or products are environmentally friendly.Ø products shouldn’t be treated the same like the WTO regulates because they’re harmful to the environment, etc.Ø Unfair to treat goods the same when their inputs are different§ Looking at process· Does it pollute a lot· Does it kill dolphins, etc.Ø Important on the environmental note, because countries can be shunned or their products not bought because they’re not produced cleanlyv WTO mechanism Ø People come in with bias informationØ Frankel makes the case for a separate environmental mechanism§ Have a panel of environmental experts that could weigh in on border adjustments Ø Could be enforcement issues, both with this and currentlyv What does Frankel specifically propose in his piece?Ø Wants a multilateral regime that would be similar to the WTOØ How would it deal with the notion of leakage? § Developed countries are very worried about this, they’re using it as a policy excuseØ Border Adjustments § A tax on different companies or countries that potentially produced things in a dirty way · The problem with this tax is that it just goes to our government who give it to their domestic competitors§ Can be used as protectionist measures§ If you allow countries to have these border adjustments, will they take advantage of the system to further their non-protectionist measuresv How can we balance the change?Ø MNCs take the leadØ Invest in renewable energy 29) GINI coefficient and microcreditGini-coefficient

- A number between zero and one that measures the degree of inequality in the distribution of income in a given society.

- Range between 0.25 for historically egalitarian countries (e.g.

Bulgaria, Finland, Hungary, Japan, and Sweden). And 0.6 for countries

with highly skewed income distributions (e.g. Brazil, Central African Republic, Guatemala, Nicaragua, & Sierra Leone.

The Gini coefficient is usually defined mathematically based on the Lorenz curve , which plots the proportion of the total income of the population (y axis) that is cumulatively earned by the bottom x% of the population (see diagram). The line at 45 degrees thus represents perfect equality of incomes. The Gini coefficient can then be thought of as theratio of the area that lies between the line of equality and the Lorenz curve (marked 'A' in the diagram) over the total area under the line of equality (marked 'A' and 'B' in the diagram); i.e., G=A/(A+B). The Gini coefficient's main advantage is that it is a measure of inequality by means of a ratio analysis. This makes it easily interpretable, and avoids references to a statistical average or position unrepresentative of most of the population, such as per capita income or gross domestic product. The simplicity of Gini makes it easy to use for comparison across diverse countries and also allows comparison of income distributions across different groups as well as countries The weaknesses of Gini largely lie in its relative nature: It loses information about absolute national and personal incomes. Countries may have identical Gini coefficients, but differ greatly in wealth. Basic necessities may be equal (available to all) in a rich country, while in the poor country, even basic necessities are unequally available. In addition, Gini does not address causes: income equality may reflect differences in opportunity, or capability. For example, some countries may have a social class structure that presents barriers to upward mobility; some people may have more skills than others. By measuring inequality in income, the Gini ignores the differential efficiency of use of household income. By ignoring wealth (except as it contributes to income) the Gini can create the appearance of inequality when the people compared are at different stages in their life. MicrocreditAn extremely small loan given to impoverished people to help them become self employed. When the poor borrow, it indebts them into a cycle, so they want to continue borrowing so they can pay back their debt interests, so you have one loan after another. This is where microcredit comes in instead. The small loans with low interest rates allow impoverished people to make headway in starting their businesses and get out of the undeveloped trap. This concept represents the bottom up approach in policy that has become more popular with the turn of the century. 30) Washington Consensus vs. Beijing Consensus19) Washington Consensus Most commonly refers to an orientation towards neoliberal policies that from about 1980 - 2008 was influential among mainstream economists, politicians, journalists and global institutions like the International Monetary Fund and World Bank . The term can refer to market-friendly policies that were generally advised and implemented both for advanced and emerging economies. It is sometimes used in a narrower sense to refer to economic reforms that were prescribed just for developing countries , which included advice to reduce government deficits, to deregulate international trade and cross-border investment, and to pursue export-led growth. The term Washington Consensus is also sometimes used by economic historians to label

an era, which depending on the author can range from at most 1979 - 2009 to at least 1989 - 2000. The Washington Consensus§ Originated in the 1980s with the debt crisis§ Fiscal discipline· No large unfinancible deficit· Prudent financial policy§ Prioritize education and health care spending§ Tax reform· Tax bases are very shallow in developing countries¨ Grow the tax bases§ Liberalizing interest rates§ Competitive exchange rate· A boon to exports because the currency is competitive enough to compete· Williamson favors competitive exchange rate¨ IMF supports fixed exchange ratesØ Initially supported competitive but went towards fixed after Hong Kong and Argentina success stories§ Capital account liberalization· Short term stock and bond investments· FDI· Departure of Williamson from the others¨ Williamson supports internal direct investment but liberalization is too polemic¨ Opening yourself up to spur development¨ But controversial because countries are exposed to sudden stop§ Privatize· Make things more efficient· Make various utilities more affordable to the population§ Deregulation· Too many regulations prevent economic gains otherwise available because it hinders entrepreneurship§ Securing property rights· People are lethargic in doing things they think the government won’t honor§ Really one of the big things for the Washington Consensus is the pushback for timing and contextBeijing ConsensusØ Localization of best practices borrowed§ Tailor the laundry list of things to do to your context§ Picking of the features of liberalizing that will benefit you the mostØ Combination of market and plan§ Oatley book talks about the paper by Stiglitz· A lot of economic models assume everyone knows everything¨ Stiglitz pushes the envelope saying actors in society are working with less than perfect information, so markets fail¨ Justification by Stiglitz for government intervention in the marketØ Flexible means to a common end§ Capitalism and socialism can work together

§ Communist party can experiment and accept capitalist thingsØ Policy Rights§ Countries should respect other countries’ policies and shouldn’t attach strings to things· i.e. democracy and transparency aren’t things required by Chinese aid flows· Chimerica as Fergusson puts itØ Stable Political Environment§ You don’t rush into a political transitionØ Self reliance/constantly upgrading industry§ Government picks which industries it’s really going to push and champion and where to place industries, so it can help with growthØ Indigenous innovationØ Prudent financial liberalizationØ Economic growth for social harmony§ Schism from the coastal region that benefit from the growth§ And the interior that are operating far less efficiently and where people are losing jobs and stuff§ Rising income

13) Monetarism vs. Keynesianism-------------

Keynesianism: emphasizes the role that fiscal policy can play in stabilizing the economy - higher government spending can help the economy recover quicker by stimulating aggregate demand and real output through government borrowing (expansionary fiscal policy). In a recession people respond to unemployment by increasing saving and reducing spending, this reduces GDP and aggregate demandcompMonetarism emphasizes the importance of controlling the money supply to keep inflation low. Believe expansionary fiscal policy leads to crowding Out (government replaces businesses). Low inflation more important than low unemployment

21) Policy convergence vs. policy divergence-------------

Comes from the partisan nature of political forces in government. ultimately, political competition through compromise can drive candidates towards a converged policy that is benefit for broad segments of electorate. during elections, the candidate will espouse views that will get him elected with his voter base, leading to policy divergence

Short Case Study #1. 1) Define the law of one price. Does the Economist’s Big Mac Index support or undermine this theoretical principle? Why or why not

The Economist creates an index of real exchange rates using Big Mac prices. Theoretically equivalent goods should have equal real prices. The Economist's index does not account for the difference in demand for fast food, for example between the United States and India. In an efficient market, all identical goods must have only one price, however the Economist is

comparing goods across multiple markets. This would only work if the world was truly one globalized economy/market. This is why Purchasing Power Parities are different from market exchange rates over time. The relative cost of a product has as much to do with local capacity and willingness to pay (affecting demand) as much as it does relative currency values. In some markets, McDonalds utilizes a high-volume/low-profit margin (US) elsewhere low-volume/higher margin. For example, the difference in the price of a big mac in NYC vs rural area of NJ. Finally, the big mac is not an equivalent good across all markets. Beef burgers are not available in India.

Essay #3.

3. What are the two major ideological approaches to governing the economy and how do they account for the 2008 global financial crisis? Does the crisis represent a flaw in free market ideology, government policy, or both? Should the government have a role in preventing future financial crises? In this regard, what is the likelihood that the 2010 Dodd-Frank financial reform bill will prevent future financial crises (Be sure to discuss the major tenets of the Dodd-Frank legislation within your essay)

The 2008 Global Financial Crisis frames the debate between Liberalism vs Institutionalism, i.e. the role of the government in the economy. Primarily the crisis represented a flaw in government policy and inappropriate intervention.

Free market not appropriate - US government had to intervene in the market at least to add massive amounts of liquidity to ease credit crunch and stabilize the financial markets. As such, the government needs to be able to intervene to prevent future financial crisis.

1. Federal encouragement of housing loans arguably set up the market to fail by encouraging Fannie Mae/Freddie Mac to back mortgages in order to allow more Americans to buy houses - led to Housing Market collapse when people could not pay back loans2. Moral hazard problem "Johnson Critique - propping up banks as 'Too Big to Fail' essentially insures them against their mistakes and encourages them to take big risks if government will bail them out. Cost of avoiding systemic risk (system collapsing because of banks failing)

The 2010 Dodd-Frank Financial Reform Bill purports to provide rigorous standards and government supervision to protect the economy and end taxpayer funded bailouts of financial institutions. Greatly expanded federal oversight to include non-bank financial institutions

Leverage and collateralized debt obligations Leverage allows firms to borrow money and then pay back the interest while increasing their profit margin doing so. Collateralized debt obligations were created by investment banks from mortgages to market to institutional investors. They offer a higher rate of return than US treasuries. The financial market overextended themselves through schemes like leverage and collaterized debt obligations.

Tragedy of the commons and “greenwashing” Tragedy of the commons and greenwashing are connected through the economy’s impact on the environment. The tragedy of the commons is a theory that states that individuals acting in self-interest and have access freely to goods will inevitably act in a way that is collectively irrational. An example is the over-grazing of a pasture. Greenwashing is the act of “going green,” being environmentally conscious. It promotes firms to produce products in a way that is least harmful to the environment. It is not the most efficient way to produce. Case study 5 The optimum currency area provides import price stability, insulate countries from speculative financial flows and attract long-term foreign investment. Challenges such as deflation and maintaining economic competitiveness arise by joining a optimum currency area. In order for an optimum currency area to succeed participants must have similar business cycles and have domestic price and wage flexibility. Today, the Euro Zone is under a tremendous amount of stress do to the collapse of the financial system. Nations such as France and Germany are doing well while other nations in the zone like Italy, Greece, and Portugal are suffering. The leaders of the European Union nations are working together to straighten out the financial mess, but in such a large area encompassing so many different countries financial shocks like the one they are experiencing now is pushing the euro to the brink and showing the vulnerabilities of the system. Will the system stay in tact, yes, however it does raise serious concerns about the stability and success of an optimum currency area. Essay 5 • Theory of Optimum Currency Areas -The abandonment of national policy autonomy provides some clear policymaking benefits.§ Import price stability§ Insulate countries from speculative financial flows§ Attract long-term foreign investment. §E.g. Argentine convertibility (1-1 US$ currency peg) -Potential costs to abandoning exchange rate as a tool for economic adjustment. § Deflation (falling prices and wages) used for adjustment; maintain economic competitiveness. -Criteria for successful currency union.§ Participants have similar business cycles; exposed to similar economic shocks. Domestic price and wage flexibility Future Success The current financial crisis the Euro Zone is dealing with Comparison of France Germany-v-Italy, Greece, Portugal

5. Positive vs. negative selective incentives

These types of incentives are possible solutions to the free-rider problem, which refers to actors/countries defecting from cooperation on issues involving public goods and common pool resources – the environment, clean air, and liberal trade, etc. Positive selective incentives are one way to encourage countries to work toward cooperation by rewarding contributors. Examples include: the IMF providing funds that allow its policy recommendations or WTO members getting access to MFN level tariffs. Negative selective incentives involve punitive actions for non-contributors. Examples include: WTO dispute settlement mechanism sanctioning countries with policies that are not in accordance with WTO rules or IMF imposing fiscal and monetary targets to ensure countries do not free-ride (default) on loans. Positive and negative incentives are important because help incentivize (or enforce) collaboration, providing a solution the free-rider problem. 9. ‘The Original Sin’ and sudden stopsThe decentralized nature of bond markets, as well as the prevalence of short-term maturities (1 year or less), creates short-term incentives for investors. The original sinis that global emerging market bonds were typically denominated in USD, euro, or yen. This forced emerging market economies to deal with “two tiers of pain:” first, repaying initial debt, and then having to deal with the currency mismatch. Creditors to these countries faced with high information costs usually rely on assessments from IMF, rating agencies, and investment banks. These creditors, concerned about uncertainty and short term default risks, are quick to withdraw capital if they think said country’s economic policy is unsound or if speculation sparks a chain of financial turbulence. These situations create a herd mentality, causing a sudden, abrupt reduction (withdrawal) of investment from a country: a “sudden stop.” The original sin and sudden stop are economic issues, with potentially serious repercussions, for developing countries in particular. Specifically, they are consequences financial globalization – or pitfalls – of global economic integration. Short Case Study #5: Why is the idea behind an optimum currency area, and what does this theory suggest about the future of the euro zone?OCZs are geographical regions that share a common currency, in the hope of maximizing economic efficiency and development. Here, the abandonment of national policy autonomy provides clear policymaking benefits, such as: 1) stabilizing import price, 2) insulating countries from speculative financial flows, 3) attrmacting long-term foreign investment. To be successful, participating countries should have similar business cycles, be exposed to similar economic shocks, and have comparable domestic prices and wage flexibility. Abandoning national policy autonomy, however, has its costs – not being able to use the exchange rate as a tool for economic adjustment usually for deflation (falling wages and prices). Examples typically include the Eurozone and Argentina’s peg to the USD.The current Eurozone crisis is interesting example of a failing OCZ, though the degree to which the Eurozone was ever an OCZ is debatable. Proponents of this view emphasize Europe was not a natural labor market or an ideal candidate for a “one size fits” all interest rate. Also, it is virtually impossible to have a successful currency union – which requires monetary union –

without fiscal, and therefore, political union. In essence, this was the Eurozone’s main downfall, and therefore the systemic reason behind the Eurozone Sovereign crisis. The catalyst was Greece, a fast growing economy from 2000-2007 took a significant hit with the financial crisis of 2007. The government unable to pay back the interest on the large amount of debt it had incurred during this period of economic expansion, had its doubt downgraded which in turn increased interest rates and drove investors away. Greece unable 1) slash interest rates, 2) devaluate its currency, or 3) print more money because it was linked to the euro, had no choice but to turn to the other Eurozone countries and the IMF for help.This threat of default quickly spread to Portugal, Italy, Ireland and Spain, countries that also had crazy large deficits. The problem is that the Eurozone cannot let the countries in trouble default on their debt because this would lead to contagion.The theory of OCZ seems to suggest that perhaps it is true that the Eurozone was never really an ideal candidate for a currency union, because the crisis is the result a common currency between countries that do not share a sound fiscal policy. Seen this way, the OCZ theory suggests that the only choice the Eurozone faces is between much deeper macroeconomic (fiscal, monetary, and thus political) integration in the Eurozone or the collapse of the euro. There is no third way.Sources:http :// financialbanter . wordpress . com /2011/10/31/ greece - euro - till - debt - do - us - part / http :// www . forbes . com / sites / timworstall /2011/09/17/ yes - we - did - know - the - euro - was - going - to - fail / http :// www . economist . com / blogs / freeexchange /2011/11/ euro - crisis -21 Essay # 3 (used Oatly chapter 10)

The U.S. financial crisis of 2008 has sparked an ideological clash between those who favor a heavy role for government in regulation in the economy and those who do not – the two major approaches to governing the economy. When explaining the cause of the crisis, the “too little market regulation” band point to the fact that free market ideology makes unreasonable assumptions about human nature, the poor quality of information about risk, and market often inefficient outcomes. One such proponent is Joseph Stiglitz. He believes that the main protagonists in the crisis are banks and investors. These institutions (and people) did not manage risk, rather they created it. They engaged in excessive leverage (30-to-one ratio), and developed mortgage backed securities (MBS), which created a wide base of shared risks for risky mortgages. Securitization created risks, including those caused by information asymmetries because the originators of these mortgages did not keep up holding them, so they were not concerned if they failed. Advocates of this view also point to the fact that rating agencies contributed to the crisis by inappropriately rating these subprime mortgages (often F-rated) into A-rated securities; mortgage brokers and originators were focusing on short-term profits, not the quality of the loans; and regulators ignored systemic risks and had no legal basis to regulate derivatives. Additionally, the repeal of the Glass-Steagal Act transmitted the risk-taking culture of investment banking to commercial banks. Regulators should have also enforced antitrust laws better, as banks were allowed to grow to be “too big to fail.”

In short, the factors stated above and America’s political system (in which Wall Street has been able to exercise an increasing amount of influence through financial contributions) created a perfect storm for the housing bubble that served as a catalyst for the financial crisis. The cause,

therefore, was systemic as each actor was abiding by the rules of the game, acting its best interest.

The “too much government regulation” band argue that financial markets were not free of government intervention before the crisis and thus, arguing the contrary places the blame in the wrong place. Lawrence White a proponent of this ideology believes that it the housing bubbly and its aftermath arose from market distortions created by the Federal Reserve, government backing Fannie Mae and Freddie Mac, the Department of Housing and Urban Development, and Federal Housing. Two main policies had the capacity of producing industry wide effects that led to the crisis:1) The Fed’s credit expansion provided the means for unsustainable mortgage financing: during the recession of 2001, the Fed aggressively expanded U.S. money supply and lowered its interest rate to the point where the real rate was negative for two and a half years, which meant that essentially the borrower was gaining in proportion to what he borrowed. This created a massive demand bubble that went heavily into real estate. The Fed’s policy of short-term interest rates increased the dollar volume of mortgage lending but also had unintended consequences for the type of mortgages written, as it saw an increase in adjustable-rate mortgages (ARM). The short-term low interest rates in turn increased the feasibility of adjustable-rate mortgages, which caused mortgage quality problems.2) Congress and the executive branch encouraged the expansion in risky mortgages to under qualified borrowers by: loosening down payment standards on mortgages guaranteed by the Federal Housing Administration; strengthening the Community Reinvestment Act; pressure on lenders by the Department of Housing and Urban Development; most importantly, subsidizing through implicit taxpayer guarantees the dramatic expansion of government-sponsored mortgage busy Fannie Mae and Freddie Mac.

The Dodd-Frank bill: increased capital-to-asset ratios (initially to 3%, now to 7%); limited the use of financial leverage; placed regulations on the shadow bank industry; created the “Volckner Rule,” which limited banks from owning more than 3% of Hedge funds/private equity funds; Mortgage originators have to hold at least 5 percent of mortgage loans on their books; creates a consumer financial protection bureau; created orderly funeral plans for large bank insolvencies.

Interest Rate Parity vs. Purchasing Power ParityInterest Rate Parity: has to do with the pricing of foreign exchange assets.This is a no-arbitrage (i.e. you can’t take advantage of price differences in two different markets to make a profit) condition representing an equilibrium state under which investors will be indifferent to interest rates available on bank deposits in two countries. The interest rate parity condition implies that the expected return on domestic assets will equal the expected return on foreign currency assets, due to equilibrium in the foreign exchange market resulting from changes in the exchange rate between two countries. This has to do with the pricing of foreign exchange assets. Interest rate parity is a key determinant to the short-term equilibrium: if investments are leaving your country, your currency is devaluing, so in order to keep capital in the country, you have to lower interest rates. This theory accounts for why capital flows move from one country to another. Purchasing Power Parity: has to do with the pricing of foreign exchange assets.

This represents a condition between countries where an amount of money has the same purchasing power in different countries. The prices of the goods between the countries would only reflect the exchange rates. PPP is a key determinant to the long-term equilibrium. This concept is based on the law of one price, which stipulates that in the absence of transaction costs and trade barriers (i.e. tariffs), identical goods sold in different countries must sell at the same price when prices are expressed in terms of same currency. In other words, prices must be consistent internationally. If goods are sold for different prices in different countries, then either the prices of the goods or the exchange rate will change until the exchange-adjust prices are similar in the two countries. PPP, however, applies to the general price level (composed of all commodity prices that enter into the price reference basket, commonly known as CPI). It states the exchange rate between two countries’ currencies equals the ratio of countries’ price levels. Relation: the relation between these two concepts is that both attempt to overcome currency mismatches, as costs and revenues on multinational firms’ balance sheets are denominated in different currencies. In the end, exchange rate changes affect firms’ bottom line. So, these concepts are designed to help ease the intensity of this affect and to price foreign exchange assets equally across the globe. The difference between the two is that interest rate parity is designed for the short term, whereas PPP is designed for the long term.Example: the Big Mac index: shows PPP in different countries around the world by comparing prices of Big Macs – shows how much people can get for the value of their money in a certain country. Competitive Advantage vs. Comparative AdvantageCompetitive Advantage:The competitive strength of an economy that derives from the capacity of its firms in various sectors. Whether government intervention can enhance an economy’s competitive advantage remains a matter of considerable controversy. More simply, what you as a firm have to offer that makes you better than another firm. Several firm-level attributes that are necessary to outperform competitors include: competitive cost structure, highly trained labor, research and development, new technologies, distribution network, and brand management. This concept provides rationale for fragmenting value chains across the globe, and leads firms to organize by function rather than geography.Comparative Advantage:Where a country is relatively more efficient at producing at least one product than others, even though it may lack absolute advantage in producing that good or service. Production according to comparative advantage enables specialization in relatively more efficient production, thereby increasing welfare. Relation: both concepts are depicting advantages in production, but competitive advantage focuses more on the firm, whereas comparative advantage depicts a more holistic approach taken by an entire industry/sector. Example: Taiwan saw a huge investment in R & D, which led to tons of outsourcing to Taiwan by firms that focus on electronics. By investing heavily in R&D, Taiwan found its place in the global economic cycle, as firms are attracted to investing there due to the competitive advantage they gain by operating there.

Case Study #1: Define the law of one price. Does the Economist’s Big Mac Index support or undermine this principle? Why or why not? The law of one price stipulates that in the absence of transaction costs and trade barriers (i.e. tariffs), identical goods sold in different countries must sell at the same price when prices are expressed in terms of same currency. In other words, prices must be consistent internationally. If goods are sold for different prices in different countries, then either the prices of the goods or the exchange rate will change until the exchange-adjust prices are similar in the two countries. It is important to remember that the law of one price applies to individual commodities, such as the Big Mac.The Economist’s Big Mac Index undermines this principle, as it exhibits the enormous different in pricing of a Big Mac across the globe. If the law of one price held, then the Big Mac would be priced equally at the domestic currency in every country where it is sold in relation to the USD. Data shows that this is not the case; therefore, the principle is undermined by the BMI. In fact, The BMI illustrates the magnitude of the price variations that can occur and suggests how difficult it is to dismantle the international dimension in prices. Essay #4: Recall the two short articles you read earlier in the semester about Congo’s conflict minerals. What does the growing grass-roots campaign against the electronics industry suggest about the governance structure of global supply chains? Is the “race to the bottom” an important policy concern, or is it merely a myth? Evaluate the competing claims of the two major schools of thought about foreign direct investment and outsourcing: policy convergence and policy divergence. Which pattern do you think exemplifies the supply chain links between Congo’s mines and cell phones, laptops, and video game consoles in the global electronics industry? Is there a compelling need to regulate multinational behavior? Why or why not? If so, who should create the regulatory rules? Governments? Non-government organizations? Industry associations? What does the growing grass-roots campaign against the electronics industry suggest about the governance structure of global supply chains? Basically, the raw materials that form the bottom/beginning of the global supply chain are sold to bigger companies at the topmost end of the supply chain. This, however, is not a clean process. The groups selling the raw materials are often corrupt in various ways, as is the case in the Congo, where rebel groups fight, slaughter and rape their way across swathes of the DRC in order to gain control over certain mining sectors to profit from the precious minerals that are used in laptops, cell phones, and light bulbs all over the world. The grass-roots campaign against the electronics industry asserts that this structure is corrupt and exploitative, harming those native to the countries from where raw materials are extracted – they want to keep “conflict minerals” out of the global supply chain. Is the “race to the bottom” an important policy concern, or is it merely a myth? The race to the bottom – i.e. seeing capital flow to the most deregulated places – is not at all a myth. If it were, we wouldn’t be faced with the problem of having to lobby companies to stop using materials from the Congo, as it would be easier to persuade companies to get their

materials from a different, more regulated country. In other words, because the Congo is not as regulated and companies can therefore buy raw materials at cheaper prices due to cheap labor, etc., they are less inclined to buy materials from a more regulated place, where laborers are paid appropriately, raising the price of the material overall. The Congo is not the only place we have seen this phenomenon – recall blood diamonds, for example. Thus, the race to the bottom is an important policy concern. Evaluate the competing claims of the two major schools of thought about foreign direct investment and outsourcing: policy convergence and policy divergence. Which pattern do you think exemplifies the supply chain links between Congo’s mines and cell phones, laptops, and video game consoles in the global electronics industry? The policy convergence argument suggests that, as societies adopt a progressively more industrial infrastructure, certain determinate processes are set in motion that tend over time to shape social structures, political processes and public policies in the same mould. The race to the bottom is seen as a product of policy convergence, as the promise of the cheapest product in the most deregulated places attract numerous investors. In addition, policy convergence sets forth that states do not have an independent mediating role. Common globalization pressures, such as capital mobility and perfect competition, produce common economic outcomes, and global financial markets prefer flexible labor markets, hawkish inflation policies, balanced budgets, and a small welfare state. In light of all this, FDI and outsourcing directly correlate with the most deregulated markets and will be most prevalent in such areas. Policy divergence, on the other hand, asserts that the race to the bottom is a myth. FDI, in this case, is positively correlated with levels of corporate taxation, union density, labor costs, and degree of labor market regulation. States have an independent mediating role, in that (1) generous welfare states can be attractive destinations for FDI; (2) governments retain fiscal capacity to fund social services; and (3) capital intensive-FDI is attracted to locations where there are highly skilled, reliable, and innovative work forces.In the case of the Congo’s corrupt raw materials, I believe the pattern of policy convergence exemplifies the supply chain links, especially since huge, rich companies’ suppliers - such as Apple - are said to buy raw materials from the Congo. Is there a compelling need to regulate multinational behavior? Why or why not? If so, who should create the regulatory rules? Governments? Non-government organizations? Industry associations? In light of the atrocities related to the mining of raw materials in the Congo, as highlighted in the articles we read, there is definitely a compelling need to regulate multinational behavior. We have seen the detrimental effect on populations affected worst by the links in the global supply chain, and such extreme suffering must be eradicated. The attempt by the US government to create a law that contributes to this is a good start. I believe a mix of government intervention and industry association intervention could be the most beneficial plan of action in combating the issue. If governments set forth rules that force companies to evaluate their supply chains AND industry associations lobby for “clean” supply chains, the combined pressures could help positively affect the issue. Such actions by governments and industry associations would also significantly raise awareness throughout the

world about “bloody” supply chains, so that civil society could then also function as another actor fighting for change. As the authors of the two articles pointed out, these measures would not immediately resolve the conflict in the Congo, but they could very well contribute to the building of peace by taking a significant source of income away from the warlords. The Triffin Paradox: This paradox occurs when a country’s national currency also serves as the international reserve currency. This causes potential conflicts of interest between short-term national economic objectives, and long-term international ones. The country whose currency is the world reserve currency must be willing to supply the world with an additional supply of its currency, however this can cause trade deficits reflected in imbalances in the balance of payments. Bretton Woods Agreement: 44 countries met in July 1944 in Bretton Woods, NH to develop a system for monetary and exchange rate management. Outcomes of the conference included the formation of the International Monetary Fund (IMF), the International Bank of Reconstruction and Development, and the introduction of adjustable pegged foreign exchange rate system. Currencies were pegged to gold and the IMF was given authority to intervene when an imbalance of payments arose. The Bretton Woods agreement brought on a period of embedded liberalism emphasizing national policy autonomy while keeping fixed (thought adjustable)exchange rates and capital control. Utilitarianism: A philosophy proposed by Jeremy Bentham in 1789 which deems whether an action is moral by how many people it gives happiness or pleasure to. This makes it possible to make social and economic decisions based on the “utility” of the action with the end goal of bettering society. Taken to extremes, it can allow for some to suffer so that the masses can benefit. From a utilitarian view, markets, technological innovation, business investment, and economic growth improves average welfare. Rawlsianism: Philosophical school of thought laid out by John Rawls (1971) that states that one can only consider the morality of an issue when they do not know what role they will be assigned. From a rawlsian point of view, efficiency and distribution cannot be considered independently. Government should intervene in economy to address market failures. Case Study:The Law of one Price: The law of one price is a way of stating the concept of purchasing power parity. It states that the price of a given security, commodity, or asset will have the same price when exchange rates are taken into consideration. The Big Mac Index, popularized by the economist, compares the prices of Big Mac burgers from the fast food chain McDonald’s in order to compare purchasing power between countries. It works by taking the two prices from two countries, dividing those, and then comparing the result to the actual exchange rate between the two countries’ currencies. This allows to see whether a currency is overvalued compared to another. In a way, it is a test of the law of one price. If the law of one price holds, currencies would not be under or over-valued compared to one another, however in reality there are significant discrepancies. Thus, the Big Mac Index undermines the the law of one price.Essay:

Thesis: The government injection of $320 Billion in capital into banking institutions following the 2008 economic crisis was a realist decision made to avert a larger recession and greater systemic risk. Despite the potential to encourage moral hazard, the bailout is a better option than relying on the theory of creative destruction to “reboot” the economic system.

1. Saving flawed banking institutions is a better option than letting them collapsea. Destruction of financial system would adversely affect unemployment in the United

States as well as in other countries (domino effect of economic instability).b. $350 Billion is a small price to pay for stabilizing the economy and averting panic

compared to the possible losses which would be incurred by a collapse.2. Criticism in regard to moral hazarda. Bailout of banks could potentially encourage risky behavior which was the original cause

of the financial collapse.b. Bailout should be conducted with strict oversight and government regulation in order to

ensure that executives do not allocate funds towards unwarranted bonuses or other frivolous spending.

3. Creative destructiona. Definition: Marxist theory that describes the way in which capitalist economic

development arises out of the destruction of some prior economic order.b. Criticism: destruction of the current financial system would lead to extreme short-term

hardship which would threaten the economic system and economic US hegemony.

7. Solow neoclassical vs. endogenous growth modelsThe Solow neoclassical model built upon the Harrod-Domar model in several ways. It added labor as a factor of production, required diminishing returns to labor and capital, required constant returns to scale on the factors, and stated that capital-output and capital-labor ratios are not fixed. The lattermost point allow individuals using the model to understand the effects of increasing the level of capital intensity. The model places an emphasis on the role of technology. This allows policy makers to predict the effects technology will have in improving the productivity of capital and labor. Its limitations led to the creation of the endogenous growth model.The endogenous growth model states that economic growth is mostly derived from endogenous, not external factors. It is relevant because the model promotes investment in human capital and innovation as drivers of growth. Countries that invest heavily in education and/or research and development adhere to this model of growth.14) Competitive advantage vs. comparative advantageComparative advantage occurs on a macro level and competitive advantage occurs on a firm level. The two are interconnected. Comparative advantage encourages companies to specialize in the production of either capital-intensive or labor-intensive goods. While the countries do have an advantage relative to other countries in the production of certain goods, labor-intensive countries get trapped in labor-intensive production that leaves little potential for economic growth. This flaw led to the creation of competitive advantage. Competitive advantage is the advantage one firm has over other firms in its sector. The implication is that nations and businesses should focus on productivity growth rather than labor costs and natural resources. In competitive advantage, economies should produce high-cost goods and services.

Short Study #2 What is trade diversion and how is this phenomenon related to the recent 2011 free-tradeagreements that the United States signed with Colombia, Panama, and South Korea? Trade diversion occurs when countries sign preferential trade agreements that lower the cost of doing business between the nations but also divert trade from cost-efficient nonmember countries to the relatively inefficient member countries. Trade diversion is one of the main arguments against signing preferential trade agreements. The free trade agreement with South Korea is the most likely of the three to result in trade diversion. First of all, the South Korean economy is far larger than the other two. Second, South Korea is a major competitor in the production of high-tech goods. If it costs South Korea $100 to produce a good and there’s a $1 tariff, it will be cheaper than a good created for $90 with a $12 tariff. The margin of comparative advantage is so close between many countries, especially South Korea and its Asian neighbors, that a lower tariff is likely to shift trade to the less efficient South Korean economy. As the occurs across many countries, the efficiency of the global economy will fall. The downsides of trade diversion should be considered when policy makers weigh the importance of multilateral talks. In a global system in which the tariff rates are equal, trade diversion will not occur and the economy will work the most efficiently. Bilateral and regional talks may be easier than multilateral talks in the World Trade Organization but trade diversion is a negative phenomenon. Oatley p. 106

Essay 1Why has the Washington Consensus been widely discredited in the development field? Arethere features of this policy approach that are still central to fostering sustainable growth today? Why or why not? Does the Beijing Consensus represent a viable alternative, developmentparadigm or is it simply a reformation of the East-Asian development model? Which features of the Beijing Consensus, if any, do you think can be successfully applied to other countries? The Washington Consensus has been widely discredited because many countries that tried to implement the policies as prescribed have failed to sustain economic growth. Additionally, many people associate the Washington Consensus with the policies of the International Monetary Fund and the World Bank, institutions that are seen as slanted towards the developed world in their power structures. The following features are still central to fostering sustainable growth: fiscal discipline; public expenditure priorities; tax reform; trade liberalization; and increased FDI. Financial liberalization, exchange rate management, privatization, and deregulation have all faced challenges.The Beijing Consensus does not represent a viable alternative. China has seen a remarkable increase in technology and innovation yet this has occurred because other countries did the research and production. China has been able to borrow these technologies and use them to improve the productivity of their labor force that is unmatched in size anywhere in the world. As a whole, the strategy borrows eight of the ten elements in the Washington Consensus. It does use a unique mix of principles but that does not make it a stringent doctrine in and of itself. Rather, it

asserts the benefits of a highly customized development strategy. Several elements may be successfully applied to other countries, including: constantly upgrading industry; having a stable political environment, flexible means to a common end; localization of best practices borrowed; and a combination of market and plan.The Chinese government has not promoted this “Beijing Consensus” as a model for other countries but rather highlighted the point that countries can take a different route than that of the Washington Consensus. One of the principles of the BC, policy rights, states that governments should be allowed to choose its own strategies. While countries may adopt some of the principles of the Beijing Consensus, the Washington Consensus will likely remain the framework upon which development plans are built. Oatley p. 333

Short Case Study4. What is forward currency hedging and why did German-owned Volkswagen begin implementing this financial strategy in 2005?A company’s profits are easily eroded due to fluctuating foreign exchange rates. A numerical example of how this can happen is as follows (this isn’t part of the answer, but it may be helpful.) A Taiwanese company receives $400 for a good it sells to the United States. It converts this to TWD at a rate of $1 per 30 TWD. It therefore has ($400*30) 12,000 TWD. If the company pays all the employees a total of 10,000 TWD, it has made 2,000 profits. Say then the currency appreciates so now $1 can only buy 25 TWD, or the exchange rate is now $1 per 25 TWD. When the company receives $400 from the United States it now receives ($4000*25) or 10,000 TWD. Assuming nothing has changed as far as payments to workers, the company now makes 0 profits after it pays its workers. So foreign currency hedging is when, to continue the example, the Taiwanese firm develops expectations about their currency relative to the dollar, and locks in an exchange rate somewhere between current rates ($1 per 25) and expected rates ($1 per 30) so that the profits will shrink slightly but not completely. Multinational firms’ bottom lines can be affected by currency mismatching because costs and revenues on multinational firms balance sheets are denominated in different currencies. Volkswagen began hedging exchange risk in 2005 after decades of selling their cars internationally without this. Why did they suddenly decide to do this? For years the Bretton Woods system of fixed exchange rates made it so that people didn’t have to worry too much about volatility. Even when the system of exchange rates was broken in the 70’s, the deutchmark-dollar exchange rate remained stable throughout the 80s and 90s. If anything the dollar was appreciating too much and Volkswagen was earning dollar profits off of the exchange rate. But in 2002-2004 there was a major appreciation the euro, this was a major blow to their profitability (an appreciated exchange rate means their goods are more expensive and foreigners buy less of them, if the decrease in volume of sales outweighs the increase in the value of sales, Volkswagen looses money.) So Volkswagen decided to buy euro-forward contracts to shield business operations from short terms of foreign exchange volatility (in other worlds they locked in a more favorable rate through a forward contract. The main idea to take away from this is that they didn’t have to do this back in the day.Short Answers12. Phillips curve tradeoff and inflation expectations:The Phillips Curve shows the tradeoff, or inverse relationship, between inflation and unemployment. The extent to which you’re able to provide employment and growth in your economy, you’re also probably inducing inflation. However, a high inflation expectation deters

investment into your country because it lowers an investor’s real return. If an investor is supposed to get a 10% return on an investment but inflation during that period is 10% in the country, the inflation undermines/erodes the profitability of the investment. Inevitability there is a conflict when politicians want to create growth and jobs (and thus inflate the economy), but also want to attract foreign investment which seeks a low inflation environment. Political leaders often tell foreigners that they’ll keep inflation low, but in the long run they’re concerned with giving their constituents jobs. This ties into the issues of time inconsistency and credible commitments.

Essay5. What does the current sovereign debt crisis in Europe suggest about tensions between domestic policy autonomy and international economic interdependence? In other words, what does political economy theory tell us about their compatibility under fixed and floating exchange rates? Drawing from your knowledge of historical fixed exchange rate systems, what’s your prognosis for the future of Europe’s monetary union? Under what conditions are the euro-zone countries likely to successfully navigate the current crises?· The compatibility of domestic politics and economic interdependence:o Fixed versus floating exchange rates:

§ Fixed Exchange Rates: Countries will fix their exchange rates in order to appease investors. When a country fixes its exchange rate they’re making a credible commitment, “I’m going to permanently import someone else’s stable monetary policy and forgo my own monetary policy.” When a country pegs its exchange rate, there is an automated mechanism that adjusts to keep the exchange rate in place, money supply. Let’s say you have a large trade deficit, that means your money is being sent into the world in exchange for goods, so your currency will be under pressure to weaken (high supply of your money on the foreign exchange market means the value of your money falls.) Under flexible exchange rates, automatically, your deficit will heal itself some because this devalued currency means that more foreigners want to buy your (now cheaper) goods, and so as you export more your current account (trade) deficit lessens. Under a fixed exchange rate, however, you’re not able to adjust through these external prices (exchange rates.) You can’t automatically become more competitive due to a devalued currency, because the whole point of a fixed exchange rate is you can’t devalue your currency. In fact you work to keep it valued. When a country has a fixed exchange rate and is facing pressure from the foreign exchange market to devalue (again due to the fact that they’re pumping money into the markets because they’re buying foreign goods) that country must defend their peg by using foreign reserves (international currencies) to buy dollars. This in turn soaks up the money (dollar) supply, which causes an appreciation of the dollar to offset the pressure to devalue, but the decrease in the money supply also creates a fall in prices and thus in wages in a country (internal prices forced to adjust.) Thus, fixed versus floating exchange rates reflect a tradeoff between stabilizing domestic prices or stabilizing foreign prices.§ Given this, political economy theory tells us that political autonomy is more feasible under floating exchange rates because countries can use monetary policy to manage aggregate levels of economic activity and counter economic cycles. International economic interdependence in the form of a currency union, like the European Union, means that countries must all forgo their monetary policy to the European Central bank, therefore their political autonomy is limited.

Under fixed exchange rates political autonomy is limited, but international interdependence is strengthened. Under flexible exchange rates, political autonomy is strengthened, but international economic interdependence is weakened.§ Countries of the European Union joined the Euro because they wanted to import price stability (namely from anti-inflationary Germany) and to insulate themselves from speculative financial flows. Currently southern Europe is going throw a lot of speculation, which means money and investment is flowing in and out a lot, causing extreme volatility. At the same time there are costs to exchange rates, particularly domestically, deflation causes harm to works through drops in prices and wages. This is why people are protesting in Greece.§ Under the gold standard, too, Liberal governments embraced fixed exchange rates and capital mobility at the cost of political autonomy. Under Bretton Woods, there was an era of emphasizing national policy while keeping fixed (though adjustable) exchange rates and capital controls. In the Post-bretton Woods order (70’s to today) countries use monetary policy to curb inflation. Countries had to deal with deflation in order to maintain competitiveness. The United States ended the dollar standard because Nixon was under political pressure before his election to reinflate the economy. The United States was in a different place than the rest of the world economically.§ In order to have a successful currency union, participants must have similar buisness cycles and be exposed to similar economic shocks, so that when the area needs to defend the peg by either selling reserves and buying dollars to prop up the currency or vice versa, whatever instrument they choose affects all countries the same and should be to the benefit of all countries. Also, domestic prices and wages must be flexible in order for it to work. Participating countries need to know that this will make domestic prices fluxuate a lot, and they need to be prepared to handle the backlash that comes from that.§ The prognosis for the Euro is not very good. The economic situation of countries like Germany are way too different from countries like Greece and Ireland (and to an extent Spain and Portugal) for the Euro work. The Maastricht criteria was formed in order to have countries meet certain standards on low inflation, low interest rates, low budget deficits, etc, essentially to make their economies similar, but many of the countries falsified information and most haven’t made the targets since. Obviously not meeting these targets, having divergent economic situations, is not good for a currency union because each country has different economic needs. The idea behind the Euro is good, so long as countries actually meet their targets so their economies are similar and require similar political action.

ESSAY #4 The grass-roots campaign against the electronics industry suggests that electronic companies should not acquire the resources needed to produce their electronic devices - such as laptops, mobile phones, and light bulbs - from countries in which competition to supply these input resources contribute to domestic conflicts. For example, almost 80 % of minerals from Congo are smuggled and sold by manufacturing companies. The “race to the bottom” underlies the situation in Congo; private, profit-oriented international companies seek the cheapest resources for production regardless of the negative externalities their business activities may trigger. Thus, this global supply of chain provides incentives to suppliers to offer inexpensive inputs of production, sometimes at the cost of human rights or environment degradation. The “race” is reinforced by a prisoner’s dilemma: the optimal outcome of the discontinued use of conflict-

inducing materials from Congo by all electronics companies requires full coordination. However, there is an incentive for a single electronics company to defect and continuing procuring these cheap resources produced by unregulated countries in order to gain an advantageous position in the global supply chain. US firms could self-regulate and cooperate to stop utilizing cheap and ‘bloody’ minerals from Congo. Nonetheless, the success of halting this resource use would not necessarily translate into a resolution of the ongoing conflicts in Congo. According to estimates by the anti-genocide organization Enough Project, only one-fifth of the world’s tantalum comes from Congo. US consumers and firms should thereby be aware that lethal conflicts are likely to continue in Congo even if all US electronics companies suspend their trade, and that a suspension of trade will only help reduce one of the numerous factors causing the chaos in Congo.Two schools of thoughts - realism and liberalism - provide distinct arguments regarding this situation. Realists would argue that each government should regulate its own domestic market away from the control of international organizations. Specifically, they would see global cooperation as a hindrance on progress, causing slow and indecisive discussions and hence a lack of definitive enforcement mechanisms that would ensure nations’ adherence. On the other hand, liberalists would argue that an international institution or NGO should be employed to create an international agreement on the exclusive use of ‘clean’ minerals. In both cases, foreign direct investment (FDI) would be preferred to gain access to necessary inputs for electric devices to outsourcing. FDI would, for example, make Apple more accountable for what they use to produce iPads. In contrast, Apple would lose control over to suppliers if they purely outsourced their materials. SHORT CASE STUDY #2 Trade diversion is the transfer of trade from a more efficient exporter to a less efficient exporter as a result of the formation of a free trade agreement (FTA) or customs union. When a country applies common tariffs to its trade partners, it will import from the most efficient producer because this producer will have a competitive advantage in the good and thus be able to provide the good at the lowest price. In the case of a bilateral or regional free trade agreement, this may not be the case. It may well be that a less-efficient producer’s products become cheaper because of a lowering of tariffs within the agreement. Consequently, the importing country would acquire products from a higher-cost producer, instead of the original, low-cost producer leading to trade diversion. Ultimately, trade diversion decreases the output of a good or service traded by the nation with a comparative advantage. Economists believe that trade diversion is harmful to consumers; it works against creating efficient trade and hence is detrimental to overall trade surplus.In the case of the US and Colombia, goods from the US could replace Colombia’s lower-priced imports from other countries in Latin America if a new agreement were created. If this were to happen, the US would become the primary producer of that item, not because it produces the good more efficiently, but because it receives preferential access to the Colombian market. The IIE study assessed that a FTA would not likely cause trade diversion in the US, but that it would possibly cause some trade diversion in Colombia. It estimated that an FTA with the US would reduce Colombia’s exports to other countries by approximately 9%.

In the case of the United States and South Korea, there is an economic inefficiency triggered by trade diversion. The Taiwanese textile industry was one of the most efficient sectors in the world economy and a trading partner of the United States; however this relationship is likely to be affected by the South Korea-U.S. free trade agreement. The Taiwanese government and its textile industry should take precautionary measures to mitigate its impact on the industry. If the South Korea-US FTA did not exist, Taiwan could have maintained its comparative advantage in textiles (over South Korea) and continued to benefit from textile orders from the US. SHORT ANSWERS #10Credible commitment and the time inconsistency problem

Generally, the time inconsistency problem concerns making a choice that will eventuate in the future, but where that decision is no longer optimal at that later date. Decision makers’ preferences and political desires may shift over time, as the long run becomes the short-term. It demonstrates how the ‘human element’ can be a detrimental factor when it comes to these decisions. Politicians need to be able to signal a credible commitment to stick to low inflation. One such credible commitment to a stable exchange rate could be to peg a currency to a stronger more stable currency (a fixed exchange rate).In international finance, there is a trade-off between financial stability and domestic monetary policy autonomy (as illustrated by the Mundell-Flemming trilemma). Both instability of the exchange rate and inflation can erode the profitability and real returns of an investment; therefore international investors prefer a low inflation environment and exchange rate stability. Conversely, politicians want to demonstrate economic and job growth, even if it is at the cost of high inflation. Thus, even if politicians promise that they will deliver low inflation, they may be more inclined to implement short-term solutions to domestic issues. This is why independent central banks are believed to be advantageous; their independence allows them to focus on interest rate decisions for the greater good, not on making policy popular. SHORT ANSWERS #19Constructivism vs. structuralism

Constructivism is the claim that significant aspects of international relations are historically and socially contingent, rather than inevitable consequences of human nature or other essentialcharacteristics of world politics. Constructivism primarily seeks to demonstrate how core aspects of international relations are - contrary to the assumptions of neo-realism and neo-liberalism -socially constructed. That is, the international relations regime is created by ongoing social practices and interaction. This can be exemplified by the creation of state Science Bureaucracies because UNESCO influence, the role of the Red Cross in the Geneva Conventions and the World Bank's influence upon attitudes to poverty. Structuralism on the other hand, stresses the impact of world economic structures on the political, social, cultural and economic life in countries. For example, international regimes in trade and finance as dictated by organizations such as the WTO and the IMF, requires that ideals of liberal movement of goods and capital to be adopted by its members. This can alter how firms see themselves as producers in a wider market. Moreover, the common market of the EU has resulted in free flow of labor that has implications on migration and social and cultural boundaries of its members.

Terms:GATT Article I and Article III: Are trade policies that promote non-discrimination. Article I is known as the most-favored nation principle. Defined as countries need to extend the same trading privileges of one partner to all partners with MFN status. Article III requires nations to treat foreign products the same as domestic products with taxes and other requirements. Article III applies to environmental regulations and quality regulations that countries have in place. In historical context, the GATT was a 1947 contract that formalized the norm of reciprocity for multilateral tariffs, which led to reduction in tariffs. Both these articles created the standards the this reciprocity could be attained and the liberalization of trade.

Modular production revolution and outsourcing: Chapter 11 pg 351-352 Class notes lesson 21The Modular Production Revolution is the creation of the modular system. The modular system is composed of “modules”/units that are designed independently but still function together. The Modular production revolution codified modules from the main company allowing for interdependent work that increased the speed of the design process and increased innovations. This relates to outsourcing for outsourcing is the contracting out of a business function. In other words, it is the contracting of a module of a given good to a outside producer ie Brazil VW. Outsourcing is a possible outcome of the modular production revolution and are related due to the advancement of technology that made both a reality. They are both concepts that are a result of economic liberalization and the increase in global production. Short Case Study:What is Trade Diversion and how is this phenomenon related to the recent 2011 free-trade agreements that the United States signed with Columbia, Panama, and South Korea?Trade Diversion: When a preferential trade agreement leads to the replacement of domestic production by lower-cost imports from a party inside the trade agreement. Trade Diversion is one of the possible effects of the Spaghetti-bowl caused by PTAs between countries for trade with possibly lower cost producers is not possible if those producers are outside the agreement.In regards to the agreements between the US and Panama, Columbia, and South Korea the FTAs are suppose to increase jobs and exports. However, they could also lead to outsourcing and concerns with labor and tax laws. The issue is also that the government is sacrificing tariff revenue for slightly lower prices for consumers. Less efficient firms of countries within the agreement benefit compared to firms that are outside the agreement and who lose the ability to trade due to the FTAs signed by the US and the other three countries. Essay:What does the current sovereign debt crisis in Europe suggest about the tensions between domestic policy autonomy and international economic interdependence? In other words, what does political economy theory tell us about their compatibility under fixed and floating exchange rates? Drawing on your knowledge of historical fixed exchange rate systems, what’s your prognosis for the future of Europe’s monetary union? Under what conditions are the Euro-Zone likely to successfully navigate this crisis?

A. What does political economy theory tell us about their compatibility under fixed and floating exchange rates? (slides class 15)a. Domestic policy autonomy and international economic interdependence are on two sides of the issue. i. Under a fixed exchange rate system there is more support for international economic interdependence for the stability allows for greater international investment and trade thrive under a flexible and high fixed exchange rate ii. Under a floating exchange rate the domestic policy takes precedence to international economic interdependence for monetarism allows for countries to battle their own inflation and capital mobilityB. Drawing on your knowledge of historical fixed exchange rate systems, what’s your prognosis for the future of Europe’s monetary union?a. The fixed exchange rates of the Bretton Woods system were important for the rebuilding of Europe i. Due to the stability of investments and ability to repatriate profits for companies b. Nixon broke away from the gold standard so the government could spend more and not lose the value of the dollar. Thus floating exchange rates allow governments monetary policy flexibility not possible with fixed exchange ratesC. Under what conditions is the Euro-Zone likely to successfully navigate this crisis?a. Enforce austerity measures on struggling economies within the Euro-zoneb. Create sanctions on the countries unwilling to adjust to the requirements of the Euro-Zonec. Focus on a sustainable restructuring of the suffering economies instead of quick reliefd. Establishment of a rescue fund either by Germany or other outside sources to relieve the Euro

M-F Trilemma (Ravenhill p.220-226; powerpoint session 15)Basically, it refers an inevitable trade-off between the three policy goals of exchange rate stability, national monetary policy autonomy, and capital mobility. The government is only possible to realize two of these three goals at the same time. This term is important in explaining international finance in which the ability of government to deal more reactionary with increasing cross-border capital flow. It also explains why the governments decided to abandon the the gold standard system: they preferred greater autonomy in resolving domestic economic needs, such as unemployment and trade deficit, to exchange rate stability and support for the international regime. Today, the governments usually give up exchange rate stability in return of capital mobility which is essential to support domestic economies. It also indicates the case of the euro zone that its members chose more stable exchange rate, but could not respond rapidly due to restrictions of their monetary policy autonomy. Gold Standard (Ravenhill p. 217(-241))It refers the international monetary regime during the pre-WWI(1870-1914) and the post-WWI(1925-1931) periods, in which currency value and gold are supposed to have the equal value. Under the assumption that currencies circulating in the markets are made of gold, it expects the international monetary order to be self-regulatory because inflow and outflow of gold coins will affect to domestic wages and prices as well as national trade position. The governments which agreed with adopting gold stand at that time chose to embrace fixed

exchange rates and capital mobility at cost of monetary policy autonomy, among the three goals of impossible trinity. However, as the increase in capital flow and policy autonomy became important in domestic politics, the government decided to desert the fixed exchange rate, the pillar of the gold standard. Current accountthe current account is one of the two primary components of the balance of payments, the other being the capital account. The current account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid).The current account balance is one of two major measures of the nature of a country's foreign trade (the other being the net capital outflow). A current account surplus increases a country's net foreign assets by the corresponding amount, and a current account deficit does the reverse. Positive net sales abroad generally contributes to a current account surplus; negative net sales abroad generally contributes to a current account deficit.The United States, for example, gleans a substantially larger rate of return from foreign capital than foreigners do from owning United States capital. Capital accountWhereas the current account reflects a nation's net income, the capital account reflects net change in national ownership of assets.A surplus in the capital account means money is flowing into the country, but unlike a surplus in the current account, the inbound flows will effectively be borrowings or sales of assets rather than earnings. A deficit in the capital account means money is flowing out the country, but it also suggests the nation is increasing its claims on foreign assets. Why is the idea behind an optimum currency area , and what does this theory suggest about thefuture of the euro zone? (powerpoint session 15) The idea of an optimum currency area says that a geographical region can maximize economic efficiency to have the entire region share a single currency, a result of the merger of currencies of the creation of a new currency. This economic integration is closely related to the Mundell-Fleming trilemma which deals with the problem of choice among exchange rate stability, national monetary policy autonomy, and capital mobility. The optimum currency areas cannot avoid the abandonment of national policy autonomy. This choice will bring some clear policy making benefits, such as import price stability. Also, it will insulate countries from speculative financial flows and help the regional bloc to attract long-term foreign investment because the creation of a single currency of a large economic bloc seems more credible and stable compared to that of a single nation. Criterias for the optimum currency area include free capital mobility, flexibility of price and wage, and a risk sharing system (e.g. having the similar business cycle will allow the central bank to implement the measures which can work for all members). However, various cases related to the disadvantage of launching a unified currency raises suspicions about economic integration. For example, the Argentinean government, which pegged its currency to US1$, had to pay costs to abandon exchange rate as a tool for economic adjustment. Deflation(falling prices and wages) can be adopted as a tool for adjustment and

maintain economic competitiveness. As another example, Greece, a member of the euro-zone, failed to rapidly respond to its domestic economic crisis, because it did not have power to control its monetary policy. As a result, a state could not resolve the problem by itself, and the shock spread to the rest of the euro-zone. The optimum currency area theory suggests that in order to maintain a successful currency union, its members should try to have similar business cycle, an ability to take care a problem rapidly, and an ability to manage domestic price and wage flexibility. What does the current sovereign debt crisis in Europe suggest about the tensions betweendomestic policy autonomy and international economic interdependence? In other words, whatdoes political economy theory tell us about their compatibility under fixed and floatingexchange rates? Drawing from your knowledge of historical fixed exchange rate systems, what’s your prognosis for the future of Europe’s monetary union? Under what conditions are the euro-zone countries likely to successfully navigate the current crisis? (Oatley 367) In promoting international economic independence, especially through building a regional economic block like the euro-zone, a government benefit from better environment for foreign investors and stable exchange rate, but has to give up its monetary policy autonomy. The current sovereign debt crisis in Europe is about the lack of autonomous monetary policy and the failure of a nation-state to quell problem earlier. The Greek government, for example, could not use the policy like deflation because only the central bank of Europe can implement such measure. However, the problem outside Greece, such as the weakened European Central Bank increased the problem. As the divergence among the EU, especially by the three strongest EU nations, such as France, Germany, and the UK, arouse, disagreement among the group and refusal of the pleas for emergency assistance from eastern Europe made the European Central Bank powerless and delayed response to the crisis. According to historical precedents like the collapses of the gold standard system and the Bretton Woods system, it will be very difficult for each government to give up the benefit from autonomous monetary policy. In these previous systems, nations deserted the international monetary order in order to deal more efficiently with domestic economic problems like unemployment. If the European Union and especially the euro-zone fail to become more unified in resolving problems, its members will feel less necessity to maintain its membership within the group. Thus, they need to achieve the conditions that the optimum currency area theory already asserted, such as having similar business cycle and allowing more flexible price and wage change, and most of all, keeping the group’s unity stronger, and dealing rapidly with issues.

Solow Neo-classical Growth Model vs Endogenous GrowthConstructivist vs Structuralist Solow Neo-Classical Growth Model explains long-run growth as a result of increased capital and labor therefore technological progress improves worker productivity.The more developed you are, you will have diminishing return on capital (technology), whereas developing countries will have high returns because technology is new à economic convergence because of diminishing returns on capital. It’s relevant to policy as a framework to developing countries, suggesting that

they have a lot of potential for overall economic growth (as contrasted with developed countries) and also relevant because converging economies implies a greater interconnectedness. Solow neoclassical is a contrast to endogenous growth models, but can also be related to term pairs 23 and 24 when we consider the huge development leaps in countries like India as a result of increased technological capital. Apply this term in essay one, using the Asian tigers as an example of states that prioritized capital growth. As such, they can be considered adherants of the Beijing Consensus and less the Endogenous growth model. Endogenous growth models say that that differences in human capital determines domestic economic prosperity in different states. To thrive, countries should invest in research and development, education, and social capabilities. This is relevant to policy for developing economies, generally seen as a contrast to Solow Growth Model, though it can also inform terms microcredit, Washington Consensus and Beijing Consensus because all have viewpoint on the importance of human capital. (Related because microcredit builds microrelations Thus, apply this term especially to essay 1 as the normative idea informing the Washington Consensus—by emphasizing things like property rights, the W.C. sought to foster innovation and build human capital.. Constructivism is the idea that change is driven by norms and ideas; ideology can dominate political thinking. An example used in class was that, in the 1970s, many Latin America governments plagued by inflation who had believed in government-led decided to change to monetarism. This is relevant to policy because it suggests ideas driving policies may more permeable than we think—affected by our era and area. As a concept about policy, this term can be applied to the critique of a lot of different ideas; consider pairs 9, 13 and 15. Because it is easiest applied to development economics, this term would be suitable for essay 4.

Structuralismis the theory that development obstacles are reflected in the historical structuraleconomic differences between the north and south; southern economies exported primarycommodities and northern economies became rooted in industry. Structuralism hasvery real policy implications, for one, it was the basis for import-substitution-industrializationin Latin America and elsewhere. Naturally, that means that this term can belinked to pair 26; structuralism can be used to critique comparative advantage.Also, can be linked to concepts centered around outsourcing since this new flowindicates structural differences between north and south. The simplest place touse this term would be in essay number 4 perhaps evaluating the historicalinsecurities of the Congo.

CASE STUDY 2

What is trade diversion and how is this phenomenon relatedto the recent 2011 free-trade

agreements that the United States signed with Colombia,Panama, and South Korea?

Trade diversion occurs when imports from aregional partner displace imports from an international partner now excluded bya regional or free trade agreement. In other words, imports outside the agreementaren’t price-competitive when tariffs within the region are removed. High cost producer (imports) could displace a low costproducer because producers in the new FTA partner can import tariff free andtherefore may become cheaper than the low cost producer. In thissituation the government entering into an FTA with the high cost producerexperiences revenue losses. The government gains no tariff revenue andits citizens benefit little because of slightly lower prices. In effectthe importing country is subsidizing less efficient production in the partnercountry.

These agreements are related because

first, and most simply, we canidentify them as diversionary.

● NYT article calls agreem’ts “primarily political […] for foreign policy value in solidifying relations with stragetic allies

●

○ In other words, not primarily an economic move

● efficacy of the agreements is questioned

●

○ “The economic benefits are projected to be small. A federal agency estimated in 2007 that the impact on employment would be “negligible” and that the deals would increase gross domestic product by about $14.4 billion, or roughly 0.1 percent”

○ United States International Trade Commission, a federal agency that analyzed the deals in 2007, reported that that economic impact would be minimal because the three countries combined represent a relatively small market for American goods and services.

● Concerns over domestic well-being

●

○ Increased protections for American automakers in the South Korea deal won the support of traditional opponents of trade deals, including some Midwestern Democrats and the United Automobile Workers union.

○ Continued clamor that free-trade hurts American interest.

○ Are we just subsidizing foreign production for political purposes?

○

■ Domestic governments do not get the revenue benefit of tariffs

■ Further welfare effect on the external trade partner which experiences decline in export revenue

Solow Neo-classical Growth Model vs Endogenous GrowthConstructivist vs Structuralist Solow Neo-Classical Growth Model explains long-run growth as a result of increased capital and labor therefore technological progress improves worker productivity.The more developed you are, you will have diminishing return on capital (technology), whereas developing countries will have high returns because technology is new à economic convergence because of diminishing returns on capital. It’s relevant to policy as a framework to developing countries, suggesting that they have a lot of potential for overall economic growth (as contrasted with developed countries) and also relevant because converging economies implies a greater interconnectedness. Solow neoclassical is a contrast to endogenous growth models, but can also be related to term pairs 23 and 24 when we consider the huge development leaps in countries like India as a result of increased technological capital. Apply this term in essay one, using the Asian tigers as an example of states that prioritized capital growth. As such, they can be considered adherants of the Beijing Consensus and less the Endogenous growth model. Endogenous growth models say that that differences in human capital determines domestic economic prosperity in different states. To thrive, countries should invest in research and development, education, and social capabilities. This is relevant to policy for developing economies, generally seen as a contrast to Solow Growth Model, though it can also inform terms microcredit, Washington Consensus and Beijing Consensus because all have viewpoint on the importance of human capital. (Related because microcredit builds microrelations Thus, apply this term especially to essay 1 as the normative idea informing the Washington Consensus—by emphasizing things like property rights, the W.C. sought to foster innovation and build human capital.. Constructivism is the idea that change is driven by norms and ideas; ideology can dominate political thinking. An example used in class was that, in the 1970s, many Latin America governments plagued by inflation who had believed in government-led decided to change to monetarism. This is relevant to policy because it suggests ideas driving policies may more permeable than we think—affected by our era and area. As a concept about policy, this term can be applied to the critique of a lot of different ideas; consider pairs 9, 13 and 15. Because it is easiest applied to development economics, this term would be suitable for essay 4.

Structuralismis the theory that development obstacles are reflected in the historical structuraleconomic differences between the north and south; southern economies exported primarycommodities and northern economies became rooted in industry. Structuralism hasvery real policy implications, for one, it was the basis for import-substitution-industrialization

in Latin America and elsewhere. Naturally, that means that this term can belinked to pair 26; structuralism can be used to critique comparative advantage.Also, can be linked to concepts centered around outsourcing since this new flowindicates structural differences between north and south. The simplest place touse this term would be in essay number 4 perhaps evaluating the historicalinsecurities of the Congo.

CASE STUDY 2

What is trade diversion and how is this phenomenon relatedto the recent 2011 free-trade

agreements that the United States signed with Colombia,Panama, and South Korea?

Trade diversion occurs when imports from aregional partner displace imports from an international partner now excluded bya regional or free trade agreement. In other words, imports outside the agreementaren’t price-competitive when tariffs within the region are removed. High cost producer (imports) could displace a low costproducer because producers in the new FTA partner can import tariff free andtherefore may become cheaper than the low cost producer. In thissituation the government entering into an FTA with the high cost producerexperiences revenue losses. The government gains no tariff revenue andits citizens benefit little because of slightly lower prices. In effectthe importing country is subsidizing less efficient production in the partnercountry.

These agreements are related because

first, and most simply, we canidentify them as diversionary.

● NYT article calls agreem’ts “primarily political […] for foreign policy value in solidifying relations with stragetic allies

●

○ In other words, not primarily an economic move

● efficacy of the agreements is questioned

●

○ “The economic benefits are projected to be small. A federal agency estimated in 2007 that the impact on employment would be “negligible” and that the deals would increase gross domestic product by about $14.4 billion, or roughly 0.1 percent”

○ United States International Trade Commission, a federal agency that analyzed the deals in 2007, reported that that economic impact would be minimal because the three countries combined represent a relatively small market for American goods and services.

● Concerns over domestic well-being

●

○ Increased protections for American automakers in the South Korea deal won the support of traditional opponents of trade deals, including some Midwestern Democrats and the United Automobile Workers union.

○ Continued clamor that free-trade hurts American interest.

○ Are we just subsidizing foreign production for political purposes?

○

■ Domestic governments do not get the revenue benefit of tariffs

■ Further welfare effect on the external trade partner which experiences decline in export revenue

Case Study:

What is forward currency hedging and why did German-owned Volkswagonbegin implementingthis financial strategy in 2005?This is a method companies use to eliminate foreign exchange risk.When companies conduct business across borders they must deal inforeign currencies. Companies must exchange foreign currencies forhome currencies when dealing with receivables, and vice versa forpayables. This is done at the current exchange rate between the twocountries. Foreign exchange risk is the risk that the exchange ratewill change unfavorably before the currency is exchanged. This couldhave a serious effect on a company’s bottom line and devalue revenuesreceived in foreign currencies if the currency depreciates in value.A hedge locks in an exchange rate at which a transaction will occur inthe future, generally this is an exchange rate slightly below thecurrent exchange rate but trading at this rate will keep the company’sbottom line in the black. Therefore, a company ensures that it willmake a profit even if the exchange rate becomes very unfavorable.

Volkwagen had a currency mismatch where its labor costs were in eurosbut most of its car sales revenue was in US$. between 2002 and 2004the euro appreciated significantly against the dollar. Thus, therevenues in US$ lost substantial value compared with the euro causinga shrink in profits. In response, Volkswagen bought euro forwardcontracts to shield them from foreign exchange risk

Essay:Recall the two short articles you read earlier in the semester aboutCongo’s conflict minerals.

What does the growing grass-roots campaign against the electronicsindustry suggest about the governance structure of global supplychains? Is the “race to the bottom” an important policy concern, oris it merely a myth? Evaluate the competing claims of the two majorschools of thought about foreign direct investment and outsourcing:policy convergence and policy divergence. Which pattern do you thinkexemplifies the supply chain links between Congo’s mines and cellphones, laptops, and video game consoles in the global electronicsindustry? Is there a compelling need to regulate multinationalbehavior? Why or why not? If so, who should create the regulatoryrules? Governments? Non-government organizations? Industryassociations?

The growing grassroots campaign against the electronics industrysuggests that there is little industry led governance over the globalsupply chain and that it is largely open to market forces. Newlegislation regarding the Congo supply chain requires that companiesreveal whether they buy minerals from Congo or its neighbors, whichlikely have smuggled minerals from the Congo into their country.However, it falls short of actually regulating purchases from there.In addition, manufactures have thus far accepted supplier’s word thatthey do not get minerals from eastern Congo but these claims are notverified.

The race to the bottom is certainly an important policy concern. Therace to the bottom is the idea that capital will flow towards the mostde-regulated destinations. For example, it will be cheaper for acompany to produce goods in a country where the ruling regime levieslow levels of corporate taxes. Therefore, the regime will lower taxesin order to attract capital and investment even though this willdecrease the regime’s revenue. This is a prisoner’s dilemma ascountries will fight for the lowest corporate tax rate. Other factorsinclude lower environmental standards, residual welfare states,flexible markets, low union density. This certainly can describesituations where a company will outsource its low skilled labor tocountries where it is the cheapest to produce and they can pay workerslower wages.

The race to the bottom is the key component of policy convergence.Policy divergence conversely, says that Foreign Direct Investment ispositively correlated with levels of corporate taxation, uniondensity, labor costs, and degree of market regulation. The thinkingbehind this is that multinational companies will invest in countrieswith higher hourly wage compensation because they will have higheraverage education levels. Countries do not have to encourage wagerestraint since high hourly compensation costs do not reduce foreign

direct investment, provided the costs are matched by higher skills andproductivity.

In a comparison I believe that policy convergence is more common indeveloping countries, where the labor force will be largely un-skilledand un-educated. These countries will race to the bottom for thingslike lower corporate taxation levels in order to attract foreigndirect investment. Sweat shops could be seen as an example of thiswhere companies find cheap low skilled labor in developing countriesand outsource their manufacturing to these countries. On the otherhand, policy divergence plays a stronger role in developed countries.Companies needed skilled laborers will spend more money for those withhigher levels of education.

I think policy convergence better exemplifies supply chain linksbetween Congo’s mines and the electronics industry. As Australia ismore highly developed than the Congo, laborers mining similar mineralsthere likely have a higher level of education. However, electronicscompanies continue to purchase minerals originating in eastern Congopresumably because they are cheaper, which could owe to numerousfactors including probably lower wages for laborers, few environmentalstandards etc.

There is a compelling need to regulate multinational behavior becausethey are financing the perpetrators of war and genocide. Clearlymarket forces themselves do not stop companies from purchasing cheapconflict minerals. High levels of transparency in the supply chainhas begun to and should continue to make it clear which companies arepurchasing conflict minerals. Subsequently, as consumers discoverwhich companies do not purchase conflict minerals, they will buy fromthose that do not and market forces could then remedy the problem.However, such transparency or any other form of limits on conflictmineral purchases will not come without regulation.

Governments should have a hand in this regulation. This is becausefrom the industry standpoint, it is cheaper to buy conflict minerals,thus, there are incentives to continue to do so industry wide. Thegovernment can require transparency or put limits on conflict mineralsand are not subject to the same incentive to not do so but instead aresubject to political incentives of appeasing grassroots campaignmembers. Thus, this regulation should be government led since it issignificantly easier.

Terms:Public Good v. Private Good: A public good is one that is both

non-rival and non-excludable. Non-rival means that consumption of thegood by a person does not reduce its availability for consumptions byothers, while non-excludability means that no one can be excluded fromusing the good or exercise private ownership rights over it. Anexample would be breathing air and national defense. Private goodsare both excludable, meaning that the owner and rivalrous, examplesinclude food, clothing, and cars. Public goods create an inherentfree-rider problem and is an example of a market failure. Since thebenefits of providing a private good are diffused across a population,and the costs are localized, incentives to provide the public good arelowered and other people may free ride off others provision of such agood. For example, a country decreases their CO2 admissions,providing better air quality, each of their citizens get better airquality but they cannot exclude anybody in world from breathing theair and benefiting from this as well. Thus, the benefits of suchaction were diffused while the costs were localized on that country.On the other hand, public goods are those, which must be paid for asscarce economic resources, this causes competition for them.

Original Sin and Public Good: Both of these are aspects of debtfinance for developing countries that make debt finance difficult.Original sin refers to the situation where countries are not able toborrow in their own currency. Original sin makes debt riskier andmore volatile. A country affected by this is likely to have acurrency mismatch in its national balance sheet and large swings inthe real exchange rate will have an aggregate effect on wealth andaffect a country’s ability to service its debt. For example, when theU.S. housing market crashed it would have been significantly worse hadthe debt been in another currency and that currency had appreciated ordepreciated. If the borrowing country's domestic currency depreciates,the loan will become more difficult to pay back because their currencyis worth less relative to the loan. A sudden stop is defined as asudden slowdown in capital inflows to a country that had beenreceiving large volumes of foreign capital. When creditors becomeuncertain as to the likelihood of a country’s solvency, it can createan inhibiting fear game or bank run, where creditors will quicklyremove their capital to forgo the risk of losing their entireinvestment.

3) Neo-realist institutionalism vs. neo-liberal institutionalism Neo-liberal institutionalism is an IR school of thought that contends that nation-states should be concerned with absolute gains rather than relative gains to other states. This theory suggests that despite the anarchic nature of the international system, cooperation can occur through the construction of norms, regimes, and institutions. Neo-realist institutionalism is also grounded in the premise that the international order is anarchical, but differs from the former theory in that it

supports the notion of “balance of power” among nation-states, whereby nation-states potential for cooperation is bounded by their logical self-interest. Neo-liberal and neo-realist theory plays a crucial role in determining a state’s approach to the concept of foreign intervention and more importantly, in defining a country’s role in the development of international cooperation. International cooperation may take the form of energy accords, climate regulatory standards, humanitarian aid projects, or any other form of multilateral action. These theories come into play most directly in the fifth essay; international economic interdependence vs. domestic policy autonomy calls into question the viability of the neo-liberal order vs. the neo-realist order. Essay #5 also provides one with the chance to evaluate the norm/regime -sharing experiment of the European Union from the position of a neo-liberal or neo-realist policy analyst. 5) Positive vs. negative selective incentives Positive and negative selective incentives are often viewed within the context of Collective Action Theory. Positive selective incentives are either physical or immaterial items bestowed upon an actor to mobilize a latent group by distinguishing between contributing and non-contributing members. Examples of positive selective incentives would be the ability to gain prestige, a closer friendship with the incentivizing party, advantageous trading rights, or a cash sum. Obama’s “Race to the Top” education initiative offers a positive incentive by granting funds to the state with the largest achievement gains within a set period of time. Negative selective incentives are often used to coerce an actor into following a specific course of action, and can include international sanctions, threats of military intervention, and other means of forced cooperation with a standard. Incentives could play well into any argument made in Essay #3; positive incentives could be offered as a means of pushing banks to adopt more stringent credit policies, thus partially avoiding the foreclosure crisis of 2008. Essay #5 allows for the application of incentives to support/reject either theory. 12) Phillips curve tradeoff and inflation expectations The Phillips curve is explained as an inverse relationship between money wage changes and unemployment; when inflation is high, unemployment is low, and vice-versa. Belief in this tradeoff led governments to manipulate their monetary policy and/or fiscal policy to stimulate the economy by raising GDP and lowering the unemployment rate – this would lead to more employment at the cost of a higher inflation rate. Milton Friedman and Edmund Phelps contended that the Phillips curve did not hold up in the long term, arguing that lower unemployment could only be attained as long as wage inflation and inflation expectations lagged behind actual inflation. The Phillips curve and Friedman’s challenge to its predictive ability is especially applicable to Essay #2, where one could use Friedman’s criticisms of the Phillips curve to support an argument against bailing out Wall Street. 16) Globalization and remittances Globalization refers to the global distribution of public goods and services through reduction of barriers to international trade such as tariffs, import quotas and export fees. The advent of globalization has led to increased specialization of services and has expanded the theory of

comparative advantage to a larger context. Remittances are transfers of money from a foreign worker to someone in his or her own country. The proliferation of remittances are a positive consequence of globalization in that they contribute to economic growth and the livelihoods of less prosperous people in developing countries, while also spreading the use of financial services among people seeking remittances (i.e. A Honduran receiving remittances will likely open a bank account when they normally wouldn’t out of necessity). However, remittances have been criticized for fostering a further economic dependence on the global economy in receiving countries instead of building sustainable, local economies. Globalization and remittances can be best discussed in Essay #4, since outsourcing and foreign direct investment are tied to the concepts.

Essay #3 - Outline Two major ideological approaches to governing the economy:a.) Capitalism (laissez-faire, “invisible hand” – let market forces prevail unhindered)b.) Socialism (or some variant of socialism; measured by the degree of government intervention in the economy)What is to blame for the 2008 crisis? BOTH- Free market ideologyo Subprime mortgage crisis indicates that banks must be induced to responsibly lend- Government policyo The crisis suggests that the gov’t needs to take a more active role in the oversight of key financial institutions. Likelihood of Dodd-Frank Act preventing future financial crisis – good, if tenets of the act are preserved and addressed going forward.- The financial regulatory reforms introduced in the Dodd-Frank Act can prevent future breakdowns by:o Expanding the power of the Securities and Exchange Commission (SEC), the Federal Reserve (Fed) and the Federal Deposit Insurance Corporation.o Creation of the Financial Stability Oversight Council and the Office of Financial Research; the former will monitor systemic risk to the financial sector, while the latter will research the state of the economy.o The bill directly addresses the mortgage crisis in Title XIV, known as the Mortgage Reform and Anti-Predatory Lending Act. This focuses on standardizing data collection for underwriting and imposes obligations on mortgage originators to only lend to borrowers who are likely to repay their loans.- Effective prevention of a new financial crisis can only occur so long as the future iterations of the government maintains the precedent set with the Dodd-Frank bill.

Short Case Study #4 Forward Currency Hedging: agreeing to buy or sell an asset at an agreed price on a settled future date with various partners to spread out the potential losses an investment into its partners' businesses may cause: German-owned Volkswagon began implementing this strategy to reduce the possible increase in costs incurred by its Chinese suppliers, in the expectation of euro revaluation against RMB TermsMonetarism vs. Keynesianism

: in advocating a laissez-faire market approach, it believes inflation is due to an excess quantity of money in the economy [named after emphasizing the influence of money supply in relation to economy]: in supporting an active government intervention, it views tax cut and increased government spending as necessary to overcome recession [and, tax increases and spending cuts to fight inflation]-Relevance to policy:in the aftermaths of U.S subprime mortgage crisis, whether the government or the private market actors should be blamed, how much should the government regulate the economy and what course of actions are necessary to resolve situations became the concern-Relation to Other terms/concepts:Dodd-Frank financial reform bill, embedded liberalism, stagflation/deflation/inflation, fixed exchange rate anchors, Coase Theorem, market failure, Mundell-Fleming Trilemma, optimum currency area, systemic risk vs. moral hazard-Application to at least one of the essays:(essay #2, #4) can serve as founding concepts for discussing what position the government should take, (essay #3) requiredFirm-specific vs. location-specific advantages: advantages that firms already have by the way it is structured such as brand management, technological expertise, economies of scale, and marketing power: advantages that can incur from investing abroad such as gaining better access to market information, responding better to local market changes, and acquiring unique resources -Relevance to policy: ⁃ 'the race to the bottom' phenomena-- more wealthy northern countries bid the poor southern countries to throw their wastes into the latter's territory; while more women of northern countries are able to enjoy working outside of home and leisure, women of southern countries are often gaining less than a minimum wage received in southern countries to live their lives ⁃ THE CONCERN: whether western MNCs (multinational cooperations) should be regulated to take more responsibility in managing their outsourced factory ⁃ Opponents: raising cost of labor only gives the developing countries' citizens a harder times as their states do not have sufficient comparative advantage to guarantee substantial growth (foreign investment necessary for upgrading) ⁃ Proponents: MNCs will only increase, sweatshops can disappear only with sufficient government regulation and coordination on both home and host countries-Relation to Other terms/concepts:value added chains, outsourcing, hub-and-spoke model of international production, globalization, FDI, modular production revolution, internalization [hierarchical coordination], transaction costs, bounded rationality, opportunism-Application to at least one of the essays:(basically on every essay) if you are if running out of materials to write (because the questions do not really ask for these concepts) and want to say something about outsourcing and inevitable economic interdependenceEssays #3.What are the two major ideological approaches to governing the economy and how do they account for the 2008 global financial crisis? Does the crisis represent a flaw in free market ideology, government policy, or both? Should the government have a role in preventing future financial crises? In this regard, what is the likelihood that the 2010 Dodd-Frank financial reform bill will prevent future financial crises (Be sure to discuss the major tenets of the Dodd-Frank legislation within your essay)? • Two major ideological approaches to economy: Monetarism, Keynesianism.

• (M): Interest rates having been too low for virtually anyone to borrow the money, too much money were flowing in the economy. This led to inflation. (K): the government was too lax on its regulative functions; it should have increased taxes and reduced its expenditures. • The defaults of central banks combined with inflation led to economic disaster not simply for USA but global financial crisis. • Flaw in free market ideology ( its effect on the laypersons are significant) and government policy ( the beliefs in the banks' freedom leading to substantial economic growth made the government be lax on the regulative functions it should have performed) • The government must have a role in preventing future financial crises • The major tenets of the Dodd-Frank legislation 1. Government having public interests is (theoretically) in the best position and has a foremost duty to regulate the private financial industries 2. Government should be less dependent on the central banks by setting regulations, so that no further taxpayer-funded bailouts would occur 3. Transparency and accountability required for the central banks (led to the creation of CFPB (Consumer Financial Protection Bureau to distribute information for the consumers and to oversee the practices of central banks) and of FSOC (Financial Stability Oversight Council to resolve matters that affect financial industry in large) 4. Executive compensation plans should be regulated, so that the executives will not take unnecessary risks to increase short-term profits and stock prices. This is to influence the private interests of the financial insiders. • Dodd-Frank financial reform bill is insufficient to bring about the prevention of future financial crises. People need changes in their ideas for changes in their actions. In this sense, more