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This chapter extends the analysis of the previous chapter to an open economy by introducing exchange rate policy; analyzing the complex relationships between exchange rate, fiscal, and monetary policies; and examining the ways in which capital flows complicate traditional analyses. Despite the greater complexities associated with open economy macroeconomics, the policy conclusions for a closed economy remain remarkably unaffected. While Keynesians and heterodox economists believe that government should actively intervene, conservatives remain skeptical about the desirability of such interventions. The objective of this chapter is to shed some light on how economists can come to such diverse views on economic policy. The first section examines the macroeconomic effects of exchange rates on employment, trade, inflation, aggregate demand, growth, and balance sheets. The second section examines the complex interactions between fiscal, monetary, and exchange rate policies in open economies with either fixed or flexible exchange rate regimes. This section also examines the effects of interest rates and exchange rates on capital flows in both crisis and non-crisis situations.

The analytical issues raised by public-finance theorists who have looked at the issue of optimal income taxation when people can move out of a tax jurisdiction have addressed a great number of analytically interesting questions of tax design. This chapter provides an overview of the latest thinking among public-finance theorists. Skilled migration has the potential to drastically reduce and even reverse the use of income taxation to achieve an equitable distribution of income. To the extent that emigration does provide benefits for source countries, policies should be pursued that more fully realize their value. But a country's inability to tax emigrants can itself inhibit the use of such policies. While this chapter emphasizes the desirability of taxing foreign-source income, successfully collecting such taxes requires the aid of host countries, including the sharing of tax information.

An analysis is begun of the basic question of how the burden of financing economic development in less developed countries (LDCs) should be shared between those in the urban and rural sectors. An economy is considered that can trade at fixed international prices with the rest of the world, and in which there is a tax border between the urban and rural sectors. The latter assumption indicates that the government can impose different sets of taxes in the two sectors and, as a result, market prices in the two sectors can differ. In such an economy, the question posed above turns out to be equivalent to asking what the relationship should be among prices received by farmers, prices paid by city-dwellers, and international prices. The analysis presented is based on the simplest model that can highlight the central trade-offs involved in taxing or subsidizing the rural and urban sectors, and abstracts from intra-sectoral heterogeneity of individuals and goods, from inter-sectoral flows of factors such as labour and capital, and from the effects of prices and wages on productivity; the basic model has rural peasants selling their agricultural surplus in order to buy industrial goods.

The analysis of the preceding chapter assumed that the government in less developed countries (LDCs) has the ability to maintain separate sets of prices in the urban and rural sectors, but if transportation costs between the sectors are low, then the presence of large price differences between the two sectors would provide strong incentives for tax arbitrage and tax evasion. Rationing of food in the urban sector (if the price of food in that sector is lower than in the rural sector) may serve to alleviate this problem, but not without incurring significant administrative costs, and some tax evasion is inevitable. If it is very extensive, government revenues will be significantly less than what was intended, and the legitimacy of the government (or at least of its tax-pricing policies) may be called into question. In any event, it is clear that the problems associated with maintaining different sets of prices in rural and urban sectors imply that some LDC governments may be constrained to having the same set of prices in both sectors. In this chapter, the consequences of changes in the price scissors (the price of industrial goods relative to that of agricultural goods) are analysed by a simple modification to the open-economy model described in the previous chapter, and a simple formula is derived for characterizing the optimal price scissors.

This chapter assesses the impact of the quality of teachers on the growth process in a small open economy with a universal public education system. The teachers' salaries are shouldered by the government and financed by taxation, while education is provided free to all. Specifically, a tax is imposed on the labour income of current adults and on income from capital generated within the economy. The quality of workers including those joining the teaching profession is endogenously determined by their level of human capital. In this setup, the chapter demonstrates that the rate of economic growth is a function of the quality of teachers relative to the quality of all workers in the economy. The latter, in turn, is correlated with the taxation policy of the government. The chapter also shows that there is an optimal tax policy and an optimal value for the relative quality of teachers.

This chapter analyzes the extent to which openness to trade may influence the economy's response to domestic shocks. The analysis is conducted in terms of two models, that is, a medium-scale two-country model used at the Federal Reserve Board for policy simulations (known as SIGMA), and a two-country version of the Erceg-Henderson-Levin model. The effects of three domestic shocks in each of the models, that is, a permanent decline in the inflation target, a persistent increase in government spending, and a persistent technology shock are examined. The findings are summarized as any substantial differences observed in the volatility and persistence of output and domestic inflation between highly open and relatively closed (but otherwise similar) economies will hardly be attributable to differences in the propagation mechanisms of domestic shocks, but rather must be the consequence of their differential response to shocks in the rest of the world.

The chapter first examines the limitations of conventional open-economy macro models, such as the Mundell–Fleming model, when they are applied to developing countries. It discusses the Swan–Salter model and the three-sector dependent-economy model that better capture the reality of the external sector in poor countries. It then discusses the impact of devaluation under conditions of closed and open capital accounts and shows the limitation of a devaluation unaccompanied by structural measures in little diversified poor economies and in economies with large dollar liabilities. In this regard, it examines the results of the empirical literature on the contractionary or expansionary effect of devaluation in developing countries. Finally, it reviews the pros and cons of alternative exchange rate regimes, the impossible trinity theorem, and measures to control exchange rate volatility through capital controls.

Filmgoing in downtown Cairo had long taken place in the gap between official hopes for cinema as a vehicle for socially edifying purposes, and the unpredictable reality of audiences in movie theaters. Certainly by the late 1980s, movie theaters had lost favor in the eyes of cultural gatekeepers. Male youth had taken them over. Elites willfully mischaracterized these young men as a barbarian invasion of lower-class “tradesmen,” thereby obfuscating a phenomenon that was, in reality, connected to a broad downgrading of middle-class fortunes in the post-Nasser era. As open-market economies inexorably became the only policy choice on offer, promises made in an earlier era of social advancement through education began to ring hollow. The life stage of the “student” began to look like a prison sentence as it elongated into eternity, while marriage—traditionally the boundary between childhood and adulthood—receded into the distance.

This chapter examines the incidence of changes in the corporate income tax in a global economy in the context of a four-sector (tradable and non-tradable goods produced by both the corporate and the non-corporate sectors) general equilibrium model. It concludes that domestic labor often bears the full burden—or more than the full burden (overshifting)—of the corporate income tax and that a larger burden on capital understates the degree of international capital mobility as well as the degree of substitutability between domestic goods and competing imports. The chapter first considers the open economy vs. closed economy scenario for corporate income tax incidence before turning to the treatment of the corporate income tax as a “partial factor tax”.

This chapter discusses economic and environmental regulation in Mexico. First, it discusses the establishment of a new legal framework for a free market economy. Congress adopted a series of laws to regulate business activity in the new, open economy in which private investment was to play a much larger role. It then discusses environmental regulation, focusing on the adoption of the General Law of Ecological Equilibrium and Environmental Protection (Ley General del Equilibrio Ecológico y la Protección al Ambiente, or LGEEPA), which makes up the general regulatory framework pertaining to ecology and the environment.

This chapter proves the theory that a permanent increase in payroll taxes used to finance government purchases in a small open economy that takes the external rate of interest as given is neutral for employment in the long run. However, if the economy in question is large, in the sense that an increase in its borrowing in the world capital market pushes up the world interest rate, the neutrality breaks down. In the large open economy case, the higher world interest rate, in lowering the after-tax wage to unearned income ratio, reduces permanently the number of hours supplied. The chapter also addresses the Faggio–Nickell puzzle that despite higher labor taxes in both the group of Scandinavian countries (Denmark, Finland, and Sweden) and the Big Three continental countries, labor inputs fell far more in the latter than in the former over the past three decades.

This chapter investigates the optimal taxation treatment of the return to capital in a small open economy using the marginal cost of public funds concept. It uses a simple two-period life cycle model to examine one of the most hotly contested tax policy issues: whether governments should levy income taxes or consumption taxes. The optimal tax rule from the Corlett and Hague model—tax at a higher rate the good that is most complementary with leisure—implies that there should be a tax on the return on savings if future consumption is more complementary with leisure than current consumption. This insight, stemming from the work of Feldstein (1978) and Atkinson and Sandmo (1980), provides an alternative intuitive explanation of the optimal tax treatment of savings.

This chapter notes that the IFSL is obviously closely associated with neoliberal ideology. It is a membership organisation for financial service providers—the focus here is on its leadership and secretariat. IFSL is strongly committed to trade liberalisation and valorises an open global economy. The second section of this chapter looks at IFSL's understanding of development, trade rules and multilateralism. The third section looks directly at the concept of globalisation and asks what can be inferred from IFSL's use of the term in relation to various issues and policies, focusing in particular on spatial connotations. The discussion considers the implications of the financial crisis upon IFSL's discourse throughout.

This chapter provides an exposition of the synthetic model, highlighting how it enhances one's understanding of the effects of denomination and maturity of public debt more generally. The starting point is the experiment of Paul Krugman, Robert Flood, and Peter Garber in an economy with a fixed exchange rate and public debt (domestic- and foreign-currency, short- and long-term). The chapter postulates an exogenous disturbance that decreases the present value of government's real primary surpluses relative to its outstanding liabilities. It analyzes the dynamics of adjustment and models fiscal policy as non-Ricardian and monetary policy as pursuing an interest rate rule. The chapter summarizes the insights from the synthetic model: insufficient fiscal discipline can undermine currency stability independently of any need for seigniorage revenues. The chapter contributes a simple illustration of this point in the context of a small open-economy model with money introduced in a standard way.

This chapter focuses on an economy that was recently opened and which has been the subject of many of the empirical studies: Mexico's. Mexico substantially reduced its tariff and non-tariff barriers, starting in the mid-1980s, and later on, in the early 1990s, joined the North American Free Trade Agreement, effectively developing a very open economy. However, despite the fact that the Mexican economy was relatively closed in the early 1980s, it is not quite clear how long that had been the case. The chapter argues that, even though Mexican industry has been protected for a long period, which in some cases goes back to the late nineteenth century, the structure of protection that existed in the Mexican economy in the second half of the twentieth century came from an important modification to its commercial policy which took place around 1947.