International Trade and International Finance

Malabika Roy · Saikat Sinha Roy Editors

International

Trade and

International

Finance

Explorations of Contemporary Issues

International Trade and International Finance

Malabika Roy • Saikat Sinha Roy

Editors

International Trade

and International Finance

Explorations of Contemporary Issues

123

Editors

Malabika Roy

Department of Economics

Jadavpur University

Jadavpur, Kolkata, West Bengal

India

Saikat Sinha Roy

Department of Economics

Jadavpur University

Jadavpur, Kolkata, West Bengal

India

ISBN 978-81-322-2795-3 ISBN 978-81-322-2797-7 (eBook)

DOI 10.1007/978-81-322-2797-7

Library of Congress Control Number: 2016937967

© Springer India 2016

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Foreword

The present volume is a collection of articles on various aspects of international

trade and international finance, written by a selected group of researchers who have

specialized in the respective fields. The planning of this volume was mooted at the

meeting of advisory committee of the Centre for Advanced Studies (CAS) of the

Department of Economics, Jadavpur University. Since CAS has sponsored a variety

of workshops and seminars and hosted visiting fellows, the external experts of the

CAS, Profs. Dilip Nachane (former Director, Indira Gandhi Institute of

Development Research, Mumbai) and Ramprasad Sengupta (formerly of Jawaharlal

Nehru University, New Delhi) suggested that we collate important papers in two

volumes to be contributed by the visitors as well as Jadavpur’s own faculty. The

reason for planning two volumes is to accommodate the five thrust areas we have in

the CAS, namely International Trade, Finance, Resource and Environment, West

Bengal Economy and Public Policy related to social sector. The idea is to produce a

monograph which will help the readers with some survey papers along with some

state-of-the-art research in relevant fields. The present volume International Trade

and International Finance: Explorations of Contemporary Issues edited by my two

junior colleagues, Malabika Roy and Saikat Sinha Roy, who are themselves spe￾cialists in the subject matters included in the book, has a very well-thought col￾lection of topics covered under the purview of the book. The papers selected will be

of great help for the teachers and researchers in the subject on the one hand and on

the other, it would certainly be a handy reference for policy planners and practi￾tioners. I must thank the efforts of the editors who spared their valuable time to

make the volume useful and interesting. I have faith that the purpose of publishing

this volume will be totally fulfilled and we will be having increasing returns to

knowledge after reading the volume.

Ajitava Raychaudhuri

Professor and Coordinator, Centre for Advanced Studies

Department of Economics, Jadavpur University, Kolkata, India

v

Contents

Part I Recent Developments in Trade Theory and Empirics

The “New-New” Trade Theory: A Review of the Literature ......... 3

Priya Ranjan and Jibonayan Raychaudhuri

Time Zones and FDI with Heterogeneous Firms. . . . . . . . . . . . . . . . . . 23

Toru Kikuchi, Sugata Marjit and Biswajit Mandal

MNEs and Export Spillovers: A Firm-Level Analysis of Indian

Manufacturing Industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Maitri Ghosh

IPR Regulatory Policy, Commercial Piracy, and Entry Modes

of MNC: A Theoretical Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49

Nilanjana Biswas Mitra and Tanmoyee Banerjee Chatterjee

Part II International Trade and Institutions

International Trade and the Size of the Government . . . . . . . . . . . . . . 77

Rajat Acharyya

The Effects of Corruption on Trade Flows:

A Disaggregated Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

Subhayu Bandyopadhyay and Suryadipta Roy

Enlargement Decisions of Regional Trading Blocs . . . . . . . . . . . . . . . . 117

Sunandan Ghosh

Deal Breaker or the Protector of Interests of Developing Countries?

India’s Negotiating Stance in WTO . . . . . . . . . . . . . . . . . . . . . . . . . . . 159

Parthapratim Pal

Is WTO Governed Trade Regime Sufficient for Export Growth? . . . . . 179

Saikat Sinha Roy and Pradyut Kumar Pyne

vii

Part III Issues in Trade, Trade Policy and Development

Export Performance in Textile and Garments with China

as a Competitor: An Analysis of India’s Situation from the Perspective

of Structure-Conduct-Performance Paradigm. . . . . . . . . . . . . . . . . . . . 201

Sarmila Banerjee, Sudeshna Chattopadhyay and Kausik Lahiri

Impact of Trade Liberalization on Indian Textile Firms:

A Panel Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229

Subhadip Mukherjee and Rupa Chanda

Trade, Infrastructure and Income Inequality in Selected Asian

Countries: An Empirical Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . 257

Ajitava Raychaudhuri and Prabir De

A Theoretical Model of Trade, Quality of Health Services

and Signalling. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279

Kausik Gupta and Tonmoy Chatterjee

Smuggling and Trafficking of Workers: A Brief Review

and Analysis of the Economics of Illegal Migration . . . . . . . . . . . . . . . 295

Saibal Kar

Impact of Trade Restriction on Child Labour Supply

and the Role of Parents’ Utility Function: A Two Sector

General Equilibrium Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315

Biswajit Chatterjee and Runa Ray

Part IV Issues Related to Foreign Investment Flows

The Determinants of Foreign Direct Investment:

An Analytical Survey . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 333

Chaitali Sinha and Kunal Sen

Foreign Direct Investment, Capital Formation, and Growth . . . . . . . . . 363

Prabirjit Sarkar

Foreign Direct Investment and Macroeconomic Indicators in India:

A Causality Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 373

Basabi Bhattacharya and Jaydeep Mukherjee

Part V Issues Relating to Globalization, Financial Markets

and Financial Instruments

Exploratory Study of Select Commodity and Equity Indices

Around the Meltdown of 2008. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 387

Diganta Mukherjee and Arnab Mallick

viii Contents

An Empirical Investigation of Volatility Clustering, Volatility

Spillover and Persistence from USA to Two Emerging Economies

India and China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405

Ayanangshu Sarkar and Malabika Roy

Imbalances, Local and Global, and Policy Challenges

in the Post-Crisis World . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 429

Soumyen Sikdar

Testing Non-linearity in Emerging and Developed Markets. . . . . . . . . . 437

Kousik Guhathakurta, Basabi Bhattacharya and A. Roy Chowdhury

Part VI Issues Related to Foreign Exchange Market

Foreign Exchange Markets, Intervention, and Exchange

Rate Regimes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 469

Ashima Goyal

Global Foreign Exchange Market: A Crisis Analysis . . . . . . . . . . . . . . 493

Gagari Chakrabarti

The Impossible Trinity: Where Does India Stand? . . . . . . . . . . . . . . . . 511

Rajeswari Sengupta

Part VII Issues Related to Financial Institutions

Guaranty Funds and Moral Hazard in the Insurance Industry:

A Theoretical Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 527

C. William Sealey, John M. Gandar and Sumon C. Mazumdar

Performance of Aggregate Portfolios of Equity Mutual Funds:

Skill or Luck? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 547

Rama Seth and Kamran Quddus

Foreign Bank Presence and Financial Development in Emerging

Market and Developing Economies: An Empirical Investigation . . . . . . 565

Sasidaran Gopalan

Banks, Financial Derivatives, and Crises:

A Fourth-Generation Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 585

Romar Correa

Contents ix

Introduction

International trade and international finance have always been important areas of

research in economics. With globalization, the nature, importance, and scope of the

subjects have changed and the horizon has expanded manifold. Instead of treating

international trade and international finance as two disjoint areas of study, the

present volume brings together a collection of essays from both the fields, some￾times overlapping across the two areas. The volume, while focusing on the recent

developments and frontiers of research in international trade and international

finance, also emphasizes the inherent integrated nature of the two subjects.

Theory and empirics in international trade is founded on microeconomic prin￾ciples highlighting the gains from trade through specialization and exchange as a

country moves from autarky to free trade. The traditional theoretical notion of

comparative advantage evolved to include nuances of imperfect competition and

product differentiation. This has again recently given way to “New-New Trade

Theory”, which centres on the concept of heterogeneity of firms. This latest

development in trade theory is an important direction of trade research especially

during globalization. With globalization, new sectors have emerged important and

the modes of trade considerably vary from that in the past. Further, new institutions,

both global and domestic, have emerged and have significant implications for trade.

In this volume, the theoretical and empirical papers included deal with recent

advances in the subject, emergence of new sectors and institutions in shaping up

trade during globalization.

International finance primarily developed from macroeconomics to address the

same issues about equilibrium level of income, growth of output and employment

and effects of monetary and fiscal policies—but in an international context, when

more than one economy are interacting with each other in the sphere of trade and

finance involving more than one currencies. It is not surprising that traditionally, the

issues addressed in international finance were balance of payments and related

policies, foreign exchange market and foreign exchange management, global capital

markets and cross-border flow of funds, international financial systems and their

management. However, globalization brought about not only an integration of

financial markets but also an integration of financial institutions. So in the present

xi

volume we have included essays that address issues related to international financial

institutions along with essays dealing with traditional issues on foreign exchange

markets and international financial markets.

The present volume contains 28 essays divided into seven thematic parts. Rather

than dividing the parts in line of international trade and international finance, we

have divided the parts according to thematic uniformity thus establishing a close

link between international trade and international finance. However, the chapters

included in Parts I–V focus more on issues related to international trade, whereas

chapters included in Parts V–VII lean more towards issues related to international

finance.

Part I covers works on recent developments in international trade theory and

empirics. Chapter “The “New-New” Trade Theory: A Review of the Literature” by

Priya Ranjan and Jibonayan Raychaudhuri is an account of the developments and

progress in “New-new” trade theory models and empirical research centred on the

seminal work of Melitz (2003). This chapter also discusses the policy implications

and welfare implications of trade liberalization in this context. In Chapter “Time

Zones and FDI with Heterogeneous Firms”, Toru Kikuchi, Sugata Marjit and

Biswajit Mandal develop a model on the role of FDI in the context of heteroge￾neous firms situated in different time zones. It is shown that firms undertaking FDI

have higher productivity than non-FDI firms, and the foreign subsidiaries of

high-productivity firms serve the home market. In Chapter “MNEs and Export

Spillovers: A Firm-Level Analysis of Indian Manufacturing Industries”, in an

empirical analysis, Maitri Ghosh looks into the role of firm heterogeneity in export

spillovers in the presence of FDI. It is found that firm heterogeneity, measured in

terms of productivity and sunk cost, is critical to explaining export spillovers in the

presence of multinationals. In contrast to the other chapters in this part, Chapter

“IPR Regulatory Policy, Commercial Piracy and Entry Modes of MNC: A

Theoretical Analysis” by Nilanjana Biswas (Mitra) and Tanmoyee Banerjee

(Chatterjee), relates IPR regulation regime chosen by LDC government to the mode

of entry of the MNC: fragmentation or full technology transfer, in the presence of

commercial piracy. It is found that entry in this case depends on the transport cost

and monitoring.

The second part on international trade and institutions covers issues like trade

openness and the size of government, issues related to bilateral, regional and

multilateral trade. In Chapter “International Trade and the Size of the Government”,

using a theoretical framework Rajat Acharyya shows that under certain conditions

pertaining to the non-traded public good, trade liberalization in terms of tariff

reduction necessarily increases absolute size of the government. The relative size

of the government expands when the value of the price elasticity of the public good

is small though not less than unity. Corruption in trading countries at the importer

level as well as exporter level plays an important role in bilateral trade. In Chapter

“The Effects of Corruption on Trade Flows: A Disaggregated Analysis”, Subhayu

Bandopadhyay and Suryadipta Roy investigate the impact of importer level and

exporter level corruption on bilateral exports for 27 sectors of 100 countries during

1984–2004. The other chapters in this part deal with regional trading blocs or issues

xii Introduction

related to WTO. Using an oligopolistic framework in Chapter “Enlargement

Decisions of Regional Trading Blocs”, Sunandan Ghosh shows the possibilities of

and nature of equilibrium in the expansion or consolidation of regional trading

blocs in the presence of technology and market asymmetries between countries. The

conclusions are of importance for emerging market economies, which are a part of

an existing regional trading arrangement seeking expansion or consolidation. In

Chapter “Deal Breaker or the Protector of Interests of Developing Countries?

India’s Negotiating Stance in WTO”, Parthapratim Pal, delineates India’s engage￾ments in Doha Round of trade talks in the light of the experience with the WTO

regime and changes in global trade including proliferation of RTAs along with

rising global commodity prices. The last chapter in this part, an empirical paper by

Saikat Sinha Roy and Pradyut Kumar Pyne on “Is WTO Governed Trade Regime

Sufficient for Export Growth?”, highlights that a WTO-governed trade regime is not

sufficient for export growth across countries.

In the third part, which focuses on trade and development, there are theoretical as

well as empirical papers. Chapters “Export Performance in Textile and Garments

with China as a Competitor: An Analysis of India’s Situation from the Perspective of

Structure-Conduct-Performance Paradigm” and “Impact of Trade Liberalization on

Indian Textile Firms: A Panel Analysis” both deal with different aspects of trade in

India’s textiles sector, a very important sector in terms of output, wide range of

technology used, foreign exchange earnings and employment. In Chapter “Export

Performance in Textile and Garments with China as a Competitor: An Analysis of

India’s Situation from the Perspective of Structure-Conduct-Performance Paradigm”,

Sarmila Banerjee, Sudeshna Chattopadhyay and Kausik Lahiri analyse textiles

exports from India as compared to that from China, which followed a more aggressive

approach in terms product and market diversification. The chapter relates such

international price and non-price competitiveness to policies adopted in these

countries. On the other hand, in Chapter “Impact of Trade Liberalization on Indian

Textile Firms: A Panel Analysis” Subhadip Mukherjee and Rupa Chanda show the

impact of trade liberalization on improvements in profitability, sales and import of

raw materials. In this chapter, the effect of trade liberalization is found to be stronger

through the import sourcing channel. The impact of merchandise trade on income

inequality has been significant. In Chapter “Trade, Infrastructure and Income

Inequality in Selected Asian Countries: An Empirical Analysis”, Ajitava

Raychaudhuri and Prabir De show that trade openness and infrastructure have sig￾nificant impact on income inequality across countries in the Asia-Pacific region, and

country-specific factors turn out to be important determinants of trade openness and

income inequality. The chapter also establishes persistence in trade openness and

income inequality across these countries.

The other chapters in this part deal with issues related to services trade, labour

movements and development. Chapter “A Theoretical Model of Trade, Quality of

Health Services and Signalling” by Kausik Gupta and Tonmoy Chatterjee build a

theoretical model of services trade, health services in particular, and the role of

quality signalling therein with respect to southern countries. The chapter arrives at

optimum values of health quality and prices of health quality through a two-stage

Introduction xiii

dynamic game. In Chapter “Smuggling and Trafficking of Workers: A Brief

Review and Analysis of the Economics of Illegal Migration” Saibal Kar surveys the

issue of economics of illegal international migration in general and smuggling or

trafficking of workers. The chapter discusses a policy to lower exploitation from

illegal labour migration. The last two chapters in this part deal with the incidence of

child labour in the context of an open developing economy. Chapter “Impact of

Trade Restriction on Child Labour Supply and The Role of Parents’ Utility

Function: A Two Sector General Equilibrium Analysis” by Biswajit Chatterjee and

Runa Ray shows that non-trade policies are effective to deal with the incidence of

child labour and trade policies remain ineffective.

In Part IV the main focus is on flow of foreign investment, i.e. FDI and FII and

the role of multinationals. Chapter “The Determinants of Foreign Direct

Investment: An Analytical Survey” by Kunal Sen and Chaitali Sinha surveys the

literature on the factors determining the location decision of FDI. It is found that

economies of scale, management skill and innovative product technologies are the

major determinants of location decision of MNCs along with regulatory policies

of the government. The chapter analyses the locational decisions of the southern

MNCs as against those in the advanced market economies in the context of

changing FDI flows in recent years. Both Chapters “Foreign Direct Investment,

Capital Formation and Growth” and “Foreign Direct Investment and

Macroeconomic Indicators in India: A Causality Analysis” concentrate on foreign

direct investment. In Chapter “Foreign Direct Investment, Capital Formation, and

Growth” Prabirjit Sarkar examines the relationship between growth of fixed capital

formation and direct foreign investment (as % of GDP) in a panel of 61 countries

covering a time period of 1980–2006 using alternative methodologies. In Chapter

“Foreign Direct Investment and Macroeconomic Indicators in India: A Causality

Analysis”, Jaydip Mukherjee and Basabi Bhattacharya analyse the pattern of

movement of external capital flows to Indian economy in terms of foreign direct

investment (FDI) and the probable impact of macroeconomic indicators, viz. real

GDP growth, call money rate, US dollar exchange rate, inflation, T-bill rate, trade

openness and Dow Jones Index value on the financial and overall performance

of the economy from the period 1997–1998 to 2013–2014.

Part V contains four papers each focusing on different aspects of globalization

and functioning of financial markets. In Chapter “Exploratory Study of Select

Commodity and Equity Indices Around the Meltdown of 2008” Diganta Mukherjee

and Arnab Mallik conduct an exploratory study of commodity market performance

in and around 2007–2008, when the world was hit by the meltdown resulting from

subprime crisis. Their primary focus is to look into the nature of price movement

and volatility some of the key base metals have been showing, mainly on the

London Metal Exchange and MCX. They also attempt to establish patterns of

movement in some of the popular equity indices and establish which one between

the equity commodities fared well during the period of negative market sentiment in

the years of subprime crisis. In Chapter “An Empirical Investigation of Volatility

Clustering, Volatility Spillover and Persistence From USA to Two Emerging

Economies India and China”, Ayanangshu Sarkar and Malabika Roy examine the

xiv Introduction

pattern of volatility in the Indian and Chinese stock market during 2006–2011 in

terms of its time-varying nature, presence of certain characteristics such as volatility

clustering and whether there exists any ‘spillover effect’ between the domestic and

the US stock markets. They also estimate the persistence of shock in terms of

half-life in each subperiod of study. In Chapter “Imbalances, Local and Global, and

Policy Challenges in the Post Crisis World”, Soumyen Sikdar addresses some

interesting questions on correct policy choices in the face of the economic slow￾down that India and China have experienced as a result of subprime crisis. Some

very pertinent questions are: What are the major policy failures that allowed the

catastrophe to happen? What type of reforms will prevent a recurrence? Should

China, India and other developing economies of Asia and Africa make systematic

efforts to ‘decouple’ from the developed countries and work towards greater inte￾gration among them? If yes, then how? The chapter attempts to suggest answers to

these questions, after examining the impact on the Indian economy and the role

of the Indian policymakers during the time of trouble. Future prospects of India and

China, the two Asian giants, receive particular attention. In Chapter “Testing Non￾linearity in Emerging and Developed Markets” Basabi Bhattacharya and Koushik

Guhathakurata explore the possibility of non-linearity in selected stock markets

of the world.

In Part VI we have included three papers all dealing with foreign exchange

market, which is a major area of study in international finance. Chapter “Foreign

Exchange Markets, Intervention and Exchange Rate Regimes” is a survey of

structure of foreign exchange market. In this chapter Ashima Goyal describes the

institutional features of FX markets, with special emphasis on the process of lib￾eralization and deepening in Indian FX markets, in the context of integration of

currency markets with financial markets and of large international capital flows.

Chapter “Global Foreign Exchange Market: A Crisis Analysis” is an exploration

of the global foreign exchange market dynamics around the significant financial

meltdowns in the past. In this chapter Gagari Chakraborty studies the factors

influencing the forex market movements over the last 20 years. She further enquires

whether and how the sensitivity of forex market changes, following the changes in

the chosen real and financial variables in times of such crises. Finally, in Chapter

“The Impossible Trinity: Where Does India stand?”, Rajeswari Sengupta addresses

the dilemma of “impossible trinity”. This chapter again is basically a survey

chapter. In this chapter, she presents a comprehensive overview of a few empirical

studies that have explored the issue of trilemma in the Indian context. Based on

these studies she analyses how Indian policymakers have dealt with the various

trade-offs while managing the trilemma over the last two decades and also draw

relevant policy conclusions.

Part VII brings together four studies on financial institutions. In Chapter

“Guaranty Funds and Moral Hazard in The Insurance Industry: A Theoretical

Perspective”, J.M. Gandar, Sumon Mazumdar and C.W. Sealey develop a model

of the guaranty fund insurance company relationship under moral hazard, and

examine the nature of adverse incentives in this setting. They also devise workable

mechanisms that alleviate the moral hazard problem. Rama Seth and Kamran

Introduction xv

Quddus, in Chapter “Performance of Aggregate Portfolios of Equity Mutual Funds:

Skill or Luck?” present some descriptive statistics on mutual funds contrasting the

two countries: USA and India. Then they evaluate the performance of mutual funds

in an emerging market such as India, borrowing a methodology extensively used in

asset pricing literature. Next using bootstrap simulations, they analyse the persis￾tence of fund returns, distinguishing skill from luck. The next two chapters both

deal with different aspects of international banking. Chapter “Foreign Bank

Presence and Financial Development in Emerging Market and Developing

Economies: An Empirical Investigation” by Sasidaran G. sets out to explore the

empirical determinants of foreign bank entry in emerging and developing econo￾mies (EMDEs). Using panel data for over 100 EMDEs, this chapter contributes to

the literature by throwing light on understanding the motives of foreign bank entry

to EMDEs which remains a relatively under-researched topic in the literature. In

Chapter “Banks, Financial Derivatives, and Crises: A Fourth-Generation Model”,

taking off from the third generation open economy model of financial crisis, Romar

Correa examines the investment plans of domestic entrepreneurs supported by

banks. He models outcomes consequent on changes in capital movements and the

possibility of multiple equilibria.

A unique feature of the proposed volume is that it unravels some new issues in

addition to re-examining certain old issues in a new perspective and it covers wide

ranging issues with an emphasis on policy. The book covers issues mostly related to

emerging market economies, which has increasingly assumed importance in the

context of globalization. The book contains some survey papers covering the

frontiers of current knowledge on important themes like recent developments in

trade theory and empirics, foreign exchange market, interrelation and interaction

between international trade and international finance. The book, thus, will be of

immense use for advanced undergraduate and graduate teaching as well as for

research. We expect the book to substantially contribute to the growing literature on

issues related to trade and international finance in emerging market economies and

extend the frontiers of knowledge. The editors are grateful to the Centre for

Advanced Studies, Department of Economics, Jadavpur University, Kolkata, and in

particular to Ajitava Raychaudhuri and Basabi Bhattacharyy for entrusting them

with the job. The editors are extremely grateful to the authors as well as the

reviewers of the papers for their carrying out their respective duty with responsi￾bility. The volume would not have seen the light of the day without the extreme

cooperation of the editorial team of Sringer India.

xvi Introduction

Part I

Recent Developments in Trade

Theory and Empirics