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, you have chosen not to join international institutions. Given that you have embraced the global economy, this is a tricky decision. You have jumped into the international economic community without joining the institutions that guide it. International partners are hesitant to trade with or invest in Abkhazia, and your international economic action is constrained. If you are going to maintain an open economy, you will likely want to move toward membership in international institutions soon.