Chapter 5: Does Openness Mean That Domestic Prices are Determined Abroad?
* Harry Bloch and Michael Olive INTRODUCTION Globalization is reflected in the growth of world trade outstripping world production in both commodities and manufactures. International Monetary Fund statistics indicate that from 1971 to 1991, imports/GDP increased by 104 per cent in the US, 51 per cent in Germany and 18 per cent in the UK (notably, imports/GDP fell by two per cent in the period for Japan).1 This raises a question of the degree to which prices of individual products in one country can move differently from those in its trading partners. Put differently, do separate national markets still exist or is there only a global market in which prices are determined for all countries? Prices in world markets may not dominate the domestic economy due to a tension that exists in the influence of globalization on the integration of markets. On the one hand, domestic producers face competition from global markets that squeeze the price differentials between domestic and foreign product. On the other hand, domestic producers are able to differentiate their product from that of their foreign competitors through quality level, product sophistication, marketing, and so on, allowing price differentials to persist (Carlin et al., 2001). The tendency toward differentiation and fragmentation of markets is encouraged by the economies of agglomeration in modern industry, which are examined by Cohen and Morrison Paul (Chapter 4). Neoclassical international trade theory predicts that the price of tradable goods equalizes across countries. In the empirical literature, this is the law of one...
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