EXCHANGE RATES, ECONOMIC INTEGRATION AND THE INTERNATIONAL ECONOMY Studies in Economic Transformation and Public Policy in association with the Athenian Policy Forum, Inc. Global Financial Markets and Economic Development Edited by C. Paraskevopoulos, A. Kintis and T. Georgakopoulos The Macroeconomics of Exchange Rate Policies, Tariff Protection and the Current Account: A Dynamic Framework Simon Neaime Globalization and the Political Economy of Trade Policy Edited by C. Paraskevopoulos , A. Kintis and A. Kondonassis The Asymmetric Global Economy: Growth, Investment and Public Policy Edited by C. Paraskevopoulos, T. Georgakopoulos and L. Michelis An Introduction to Economic Evaluation in Health Care: Methods and Case Studies M. Marzouk Asymmetries in Financial Globalization Edited by B. Batavia, N. Lash and A. Malliaris Globalization and Economic Growth: A Critical Evaluation Edited by T. Georgakopoulos, C. Paraskevopoulos and J. Smithin Money and Finance in the Global Economy: Challenges and Opportunities for the 21st Century Edited by A. Kintis, P. Koveos, C. Paraskevopoulos and N. Baltas The Global Economy: Financial, Monetary, Trade and Knowledge Asymmetries Edited by M. Hayford, A. Malliaris and M. Malliaris Trade, Competitiveness and Social Protection Edited by J. Pacolet and E. Claessens The State of Welfare State Anno 1992 and Beyond Edited by J. Pacolet Exchange Rates, Economic Integration and the International Economy Edited By L. Michelis and M. Lovewell EXCHANGE RATES, ECONOMIC INTEGRATION AND THE INTERNATIONAL ECONOMY Edited by Leo Michelis Ryerson University Mark Lovewell Ryerson University STUDIES IN ECONOMIC TRANSFORMATION AND PUBLIC POLICY APF Press Toronto, CANADA © L. Michelis and M. Lovewell 2004 All rights reserved. No part of this book may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic or mechanical, or photocopying, recording, or otherwise without the prior permission of the publisher. Published by APF Press 51 Havenbrook Blvd. Toronto, Ontario M2J 1A7 CANADA National Library of Canada Cataloguing in Publication Data Main entry under title: Exchange rates, economic integration and the international economy / edited by Leo Michelis, Mark Lovewell. (Studies in economic transformation and public policy) "... collection of papers presented at an international conference... that took place at Ryerson University, Toronto, May 17-19, 2002."--cf. Intro. Includes bibliographical references and index. ISBN 1-894490-18-5 1. Monetary policy. 2. Monetary unions. 3. Foreign exchange rates. 4. Investments, Foreign. 5. Developing countries--Economic integration. I. Michelis, Leo II. Lovewell, Mark A. III. Series. HF1352.E93 2004 332.4'6 C2004-900438-7 Printed in Canada by Brown Book Company (BBC) Limited Acknowledgements The collected papers of this volume were originally presented at the international conference on “Exchange Rates, Economic Integration and the International Economy”, held at Ryerson University, Toronto, May 17-19, 2002. Our primary debt is to all the conference participants, especially those who traveled long distances to come and make this conference a huge success. The organization of the conference benefited from the support and involvement of many people. We are most grateful to our colleague Thomas Barbiero, who along with Leo Michelis co-organized the conference, and the Department Chair Ingrid Bryan, whose support and active participation added great value to the conference. We also owe debts of gratitude to the University President Claude Lajeunesse, the Provost and Vice-President Academic Errol Aspevig, and the Dean of Arts Carla Cassidy for their participation and material support, to our departmental assistant Leah Espineda for her tireless and professional work, and to the volunteer students at the conference for their help and enthusiasm. In addition, we are most thankful to Brennan Thompson and Susan Szekely for their invaluable editorial assistance. Brennan’s skill, efficiency and judgement in manipulating the text, the graphs and the tables of the original papers are reflected in the quality of this volume. The conference could not have been realized without generous financial sponsorship. We are most grateful for the support of our internal sponsors – the Offices of the President, the Provost and VP Academic, and the Dean of Arts – and our major external sponsors, McGraw-Hill Ryerson and CIBC World Markets. Table of Contents FOREWORD David Laidler........................................................................................ ix PREFACE Sven Arndt ............................................................................................ xi INTRODUCTION Leo Michelis and Mark Lovewell........................................................... xiii PART I: GLOBALIZATION AND MONETARY INTEGRATION The World Dollar Standard and Globalization: New Rules for the Game? Ronald I. McKinnon.............................................................................. 3 The Case for Monetary Union Reexamined with the Benefit of the Single Monetary Policy George M. von Furstenberg .................................................................. 29 The Merit of Hard Currency Fixes and Argentina’s Experience with a Currency Board Herbert G. Grubel................................................................................. 49 Some Aspects of the Subsidiarity Principle in the EU Massimo Di Matteo............................................................................... 63 PART II: MONETARY ISSUES IN NORTH AMERICA Revisiting the Case for Flexible Exchange Rates in North America John Murray, Lawrence Schembri and Pierre St-Amant ........................ 77 Prospects of a Monetary Union in North America: An Empirical Investigation Leo Michelis ......................................................................................... 114 Dollarization in Canada: Where Does the Buck Stop? John Murray and James Powell............................................................. 136 PART III: EXCHANGE RATES, FDI AND THE DOMESTIC ECONOMY Exchange Rate Regimes and Foreign Direct Investment Katheryn Niles Russ.............................................................................. 169 The Impact of the Single Market and of the Single Currency on Foreign Direct Investment in the European Union Olivia Galgau and Khalid Sekkat .......................................................... 199 Real Exchange Rates and Productivity Shocks in a Small Open Economy Simon Neaime ....................................................................................... 214 Exchange Rate, Price Level and Output: A Structural Cointegrating VAR Approach for Malaysia Kamal Uddin Ahmed ............................................................................. 229 PART IV: ECONOMIC INTEGRATION IN EMERGING ECONOMIES Exchange Rate Movements, Trade Links and Labor Markets in Latin America Ansgar Belke and Kai Geisslreither....................................................... 251 A Review of the Role and Impact of Export Processing Zones in World Trade: The Case of Mexico Mustapha Sadni-Jallab and Enrique Blanco de Armas..........................271 Monetary Integration in Beautiful Places: Prospects for the Caribbean Lester Henry ......................................................................................... 293 INDEX ...............................................................................................................311 Foreword This book presents a generous sampling of the papers presented at a conference which addressed monetary issues of considerable theoretical and practical interest, not just to Canadian economists, but to the profession in general. That is enough to commend it to any reader, but even more important, the conference from which it has grown also marked the appearance on the Canadian academic landscape of the economics department of a new university. To launch a new university is challenging under any circumstances, but when, as in the case of Ryerson, it was a matter of converting an already going concern into something different, the task must have been especially daunting. After all, had a certain polytechnic institute not already been doing outstanding work, no one would have thought of granting it university status in the first place; but the job descriptions of the two types of institution are not quite the same, and Ryerson’s very success in its old role required that the qualities that marked its earlier endeavours had to be blended into its new activities rather than superseded. No one was free to start from scratch in this case. Furthermore, Ryerson is Toronto’s third university, and it faces a considerable amount of friendly competition from its already established neighbours. The contribution of Ryerson’s economics department to the new university’s success in meeting these challenges is epitomised by this book, and the conference that generated it. The department has chosen to carve out for itself a particular niche in the Canadian profession, specializing in international economics. Given the openness of the Canadian economy, the decision is a shrewd one. International economics is of great practical relevance, and always will be in this country, but an old fashioned academic cannot help but notice another, perhaps even more important, virtue in this particular selection. It is impossible to study and contribute to international economics without a thorough grounding in general economic theory and