International Economics

A branch of economics that deals with the economic interdependence among nations, which involves international trade, international finance, and the effect of trade and finance on a nation's well being (development).

International trade theory deals with the reasons for trade and the consequences of trade. International trade theory has evolved over the years from mercantilism to globalization. Mercantilists generally believed that trade should be restricted for nations to acquire bullion (pre cious metals) in order to become wealthy and finance large armies and expansionary wars. By the 18th century, however, David Hume's price-specie-flow doctrine strongly discredited the mercantilist way of thinking. Hume showed that the mercantilist theory is self-defeating and futile because of the inflationary consequences of stock-piled bullion.

Subsequent theories of trade have focused on resource endowment and skill acquisition, absolute and compar ative costs, and globalization (integration due to techno logical breakthroughs). Absolute advantage is based on resource availability and skill acquisition, while compar ative cost is closely associated with the opportunity cost of production.

Nations trade for a variety of reasons, including differences in taste, climatic conditions, endowment, technological advancement, cost of production, and preferences; but nations also have a tendency to impose restrictions on trade in order to derive a competitive advantage or secure rational self-interest. They, therefore, frame an international trade policy.

As a result of international trade, nations must pay for the goods and services they consume. The items of the goods and services they consume are recorded in their balance of payments. Payments for goods and services consumed require foreign reserves or foreign currencies; as such, international economics deal with the mecha nisms of acquiring, managing, and spending financial resources (international finance). International finance includes the role of the International Monetary Fund (IMF) and depository institutions (banks) in the settle ment of payments.

Not all nations benefit equally from trade, but all nations obtain incremental benefits from trade. Consequently, trade is not a zero-sum game. Nations that benefit disproportionately from trade may encounter balance-of-payments or adjustment problems as they correct their deficits or salvage the value of their currencies. The IMF was instituted in the 1940s to deal with these kinds of problems in the short run. However, the policies of the IMF have not always been very suc cessful in correcting the balance-of-payments problems.

Stabilization policies have wider repercussions because they affect the economic interaction of nations, as a result of adjustments, and the movement of economic resources. International economics also deal with the adjustment mechanisms. Adjustments may take several forms, such as (a) international migration of labor to areas of higher-paying jobs, (b) tariffs, (c) movement of capital to areas of high return, (d) demand for political changes or a more equitable distribution of national income, (e) demand to reduce poverty, (f) solicitation of loans from depository institutions, and (g) reform of the exchange-rate regime. For more information, see Bhagwati (2004), Lowenfeld (2003), Perkins, Radlet, and Lindauer (2006), Stiglitz (2003), and Warburton (2005).