Chapter 9: International Economics: Basic Theory and Core Institutions

Outcome:

You have opted for a fairly open economy, which will allow you to take advantage of the global market. Each of your decisions comes with some pros and some cons. Let's look at them briefly, one by one.

A fixed exchange rate will provide you with two major advantages. In the first place, by tacking your exchange rate to a slow-inflation currency, you can fight inflationary expectations and avoid inflation for your fledgling economy. Additionally, a fixed exchange rate below the free-market rate will give your domestic exporters an advantage in the global market. However, there are also a handful of risks with this strategy. First, it could actually spur inflation as Abkhazians take in surpluses of foreign currency, trade them in at the central bank for Abkhazian currency, and then circulate Abkhazian currency in the domestic economy. If supply of goods in the domestic economy cannot keep up, inflation will occur. Second, Abkhazian holdings of foreign currencies are susceptible to the rises and falls of those foreign economies and the value of those currencies. Third and finally, the edge you gain in exports could prompt your trade partners to take retaliatory action, potentially leading to barriers to trade and a blow to the Abkhazian economy.

Next, you have chosen not to allow multinational enterprises into Abkhazia. On the positive side, forbidding the entry of MNEs will allow the growth of domestic firms, as national champions can thrive without international competition, and Abkhazia can pursue infant industry protection. However, MNEs could bring an influx of capital to the Abkhazian economy and provide jobs to Abkhazians, bolstering the economy and growing both imports and exports. By keeping them out, you are losing out on these potential benefits.

Lastly, your decision to join international institutions will likely help Abkhazia. Foreign aid will boost your economy (for more on the benefits and risks of foreign aid, see Chapter 10), and you will have a forum to solve any international disputes. Additionally, your willingness to embrace the international community is a boon to your international trade, as regional trade blocs and international trade organizations provide you with trade partners, further boosting your nascent economy. Overall, you have taken bold steps to embrace the global economy, and will now enjoy the benefits and weather the costs of that decision.