Public Benefits of Free Trade

Eurodollar market

Market in which banks outside the United States accept deposits and make loans denominated in dollars

International trade has grown much faster than world production during recent years. The rapid recent increase in world trade is, in part, the result of the General Agreement on Tariffs and Trade (GATT), which was created after World War II to reduce tariffs and remove other non-tariff barriers to international trade. Expanding opportunities for international trade have effects similar to those of technological improvements: For the same amount of input, more output will be produced.

In the United States, expanding world trade has created new employment opportunities in high-wage industries. As shown in Figure 16.7, trade in capital goods industries grew especially fast during the late 1990s. Open trade is also beneficial to developing economies that have less competitive markets and need modern capital goods. By creating new competition, providing domestic producers with access to large international markets, and improving the environment for investment, international trade can make a vital contribution to global economic development.

An important counterpart to an integrated global trade system is a well-functioning international financial system. The international financial system serves several important functions. It provides traders with access to foreign exchange and credit, thereby expanding the scope for commercial transactions. It also allows nations to finance trade imbalances through private capital flows, government borrowing and lending, or changes in reserves. The international financial system also encourages capital to move to countries where it is more productive. Capital inflows can finance domestic investment and thereby enable a country to invest more than it saves. Finally, international finance allows investors to diversify investment portfolios and reduce the risk of loss due to poor economic performance or political upheaval in any single country.

The growth in international finance is the result not only of the increase in international trade but also of improvements in technology, financial innovations, and changes in regulation. As an important example, the removal of external capital restrictions in Europe contributed to the creation in the 1950s and 1960s of Eurodollar markets, in which banks outside the United States accept deposits and make loans denominated in dollars. More recently, Eurodollar markets have

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