Question

Explain why converging economies may present a strong argument for limiting flows of capital but not for limiting trade.

a) Converging economies need to protect domestic industries from foreign competition. Trade promotes economic convergence, while unrestricted capital flows lead to financial instability.
b) Limiting trade encourages specialization, fostering economic convergence. Capital flows hinder convergence by creating financial imbalances.
c) Converging economies benefit from technological exchange through trade. Unrestricted capital flows accelerate economic convergence by facilitating investment.
d) Restricting capital flows allows for controlled economic convergence, while trade promotes diversity.

Answer 1

Converging economies might limit capital flows to prevent financial instability while encouraging trade to reap benefits such as technological exchange and market access.

Step-by-step explanation:

Converging economies may find strong reasons to limit flows of capital while still engaging in open trade. This approach can be justified as trade provides many benefits, including the exchange of technology and the opportunity for economic growth through specialization and market access.

On the other hand, unrestricted capital flows can lead to financial instability, as evidenced during events such as the Asian Financial Crisis in the late 1990s. Sudden and massive outflows of capital following excessive inflows can devastate an economy, leading to financial crises that undermine the overall economic growth and development. Therefore, converging economies may wish to manage or limit capital flows to ensure steady and controlled economic development, while simultaneously promoting trade to benefit from the diversification and efficiency it typically brings.