Econoland International Trade and Creative Destruction

Solution Preview

Econoland runs a current account deficit of $100 billion in a given year. Explain what must have happened to the financial account and Econoland's international investment position. Specifically explain how the financial account and Econoland's international investment position are related.
Econoland must have fared low on the financial account. Usually such countries have a large deficit because they must spend a lot on developmental costs. However, this must have led to a fall in the currency of Econoland that would reduce the real repatriation made from investments in the country. This leads to lower investments in the country as well as movement of capital away from the country leading to a further increase in the current account.
The deficit in the financial account of Econoland leads to the devaluation of the currency and this leads to lower investments in that country as well as reductions in investments. Even ongoing investments are delayed and the result is that the international investment in that country goes down. In addition, there are further fears of devaluation and this could lead to further delays and stoppages in investment.

Whys does most of the worlds' international trade take place between similar developed countries?

The trading countries can be divided into the developing countries and the developed countries. The trade takes place between similar developed countries because of the barriers of trade that are in place and difficult to pull down because of the following reasons.
· Developing countries incur substantial problems from reducing their trade barriers. In many developing countries, tariff revenue accounts for 10-20 percent of government revenue, and in some cases considerably more. If tariffs are reduced or eliminated, these countries will have to impose large increases in other taxes in order to keep their budgets in line. The distortionary effect of these tax increases, as well as the costs and problems associated with collecting taxes from other sources, are generally ignored in economic models that project gains from eliminating trade barriers.
· The removal of trade barriers is also ...