International economies

Globalisation

Refers to the increased integration between countries economically, socially and culturally

Key characteristics of globalisation

• Increased trade as a proportion of GDP (world trade is growing faster than world GDP)

• Increased FDI (Foreign direct investment)

• Increased capital flows between countries

• Increased movement of people between countries

Foreign direct investment (FDI)

When a company establishes operations (e.g opening a factory) in another country or acquires physical assets or a stake in an overseas company.

Capital flows

Refers to all the money moving between countries as a consequence of investment flows into and out of countries around the world.

Causes of globalisation

• A decrease in transport costs (containerisation and economies of scale)

• A decrease in the cost of communications (the internet)

• A reduction in world trade barriers (tariffs etc.)

• Deregulation of many financial markets resulted in the expansion of global financial services

• The growth of trading blocs.

• The increased importance of global companies or TNC’s (TNC’S have undertaken FDI, which involves offshoring)

Offshoring

Companies transferring manufacturing to a different country.

Impact of globalisation on individual countries

With lower trade barriers and increased trade, countries can specialise in producing goods in which they have a comparative advantage.

This results in higher world output, and therefore an increase in living standards.

However, a country which doesn’t have a competitive advantage may rely increasingly on imports, causing a deterioration of the current account in it’s balance of payments

Also higher risk of contagion

Contagion

When economic shocks spread from one country to to others due to global interconnectedness.

Stakeholders impacted by Globalisation

• Individual countries

• Governments

• Firms

• Consumers

• Workers

• Environment

Impact of globalisation on Governments

Tax revenues will increase, which may be used on public services such as health and education, or for infrastructure.

However some TNCs engage in a form of tax avoidance known as transfer pricing.

Impact of globalisation on producers

Firms will be producing on a larger scale, and so benefit from economies of scale, and higher profits.

Impact of economies of scale on consumers

Consumers can expect lower prices (increased consumer surplus, and greater choice)

Impact of globalisation on workers

Increased employment opportunites

• However, TNC’s may exploit workers in developing countries by paying low wages for long working hours.

Impact of globalisation on the environment

There’ll be increased external costs, as increased trade means increased use of transport

Impact of international trade on prices and variety

Prices and variety would both rise

Absolute advantage

Occurs when a country is able to produce a product using fewer factors of production than another country

Comparative advantage

A theory that states a country should specialise in the goods and services that it can produce at the lowest opportunity cost

Assumptions of comparative advantage

• Transport costs are zero

  • No account taken for the moving of goods/services between the countries. The extent of this issue depends on a countries location

• There is perfect knowledge

  • Suggests each country knows what it has a comparative advantage in, and also the comparative advantage of other countries

• Constant costs of production

  • The theory doesn’t take into account economies of scale that can be achieved with greater output

• Assumes easy factor substitution

  • Assumes countries can easily switch between production factors to respond to global conditions

Constant returns to scale

When output rises in the same proportion to inputs

Limitations to the theory of comparative advantage

• Over dependence

  • Creates a dependence on other countries which generates vulnerability

  • e.g european countries relying on gas from russia before the war has cost them now

• Environmental damage

  • The impact of negative externalities of production are not considered

  • The theory assumes all costs of production are considered

  • In reality, there may be harmful society costs

• Distribution of income

  • GDP/Capita is likely to increase but the distribution of this is likely to be given to wealthier sections of the population (bc they own more resources)

• Structural unemployment

  • There may be a net increase in employment

  • But, when a country specialises, key industries shut down which leads to structural unemployment, as they may be unable to move into other occupations

Advantages of specialisation and trade

• Higher living standards and employment resulting from an increase in world output

• Lower prices, increased choice

• economies of scale

• reduction in power from domestic monopolies

Disadvantages of specialisation and trade

• A trade deficit if imports value more than exports, as a result of uncomp goods

• Increased unemployment as a result

• Increased risk of contagion

• TNCs may become global monopolies

Patterns of trade

The nature of trade between two countries and how this changes overtime

Factors influencing patterns of trade

• Comparative advantage

• The growth in exports of manufactured goods, especially from low wage countries to developed economies

• The growth of global supply chains

• The growth of trading blocs and bilateral agreements

• Changes in relative exchange rates

Terms of trade formula

(index of export prices/ index of import prices) x 100

Terms of trade

Measures the price of a countries exports relative to the price of it’s imports

Factors influencing a country’s terms of trade

• The country’s rate of inflation relative to other countries

• The country’s productivity rate relative to other countries

• Tariffs

• exchange rate

The effect of an increase in a country’s terms of trade

• Higher living standards- (the country can import more for a given quantity of exports)

• Deterioration in the current account for its balance of payments (the goods are less competitive)

Trading blocs

Groups of countries that agree to remove or reduce the trade barriers between themselves

Examples of trade blocs

• The EU

• USMCA (United States, Mexico and Canada)

• ASEAN (Association of South East Asian Nations)

Types of trading blocs

• Free trade areas

• Customs unions

• Common markets

• Monetary unions

Free trade areas

In these trade blocs, trade barriers are removed between members but each member can impose trade restrictions on non members

Customs union

There is free trade between countries, but they have a common external tariff to non members

Common markets

This has the same characteristics as a customs union, but it also involved the free movement of factors of production between countries

Monetary unions

These are custom unions which adapt a common currency, for example the Eurozone.

Trade diversion

When trade is diverted from a more efficient exporter to a less efficient producer

Costs of regional trade agreements

• Trade Diversion (Trade will switch from a low cost producer outside the trade bloc to a high cost producer inside the bloc)

• Distortion of comparative advantage, trade barriers against non members are likely to cause a decrease in specialisation and to a fall in world output.

Transition costs

These are one off costs associated with changing menus, price lists and slot machines when the new currency is introduced.

Costs of monetary unions

• Transition costs

• Loss of independent monetary policy (countries no longer have control over their own interest rates)

• Loss of exchange rate policy (countries no longer have their own currencies

Trade creation 

This occurs when trade is created as a result of the formation of a free trade agreement between a group of countries by the establishment of a trade bloc

Benefits of regional trade agreements

• Trade creation (as a result of a reduction in trade barriers.)

• Increase in FDI (TNC’s would have unrestricted access when selling goods to consumers within the bloc)

• Increase in economic power (A larger trading bloc might be in a better position to negotiate trade agreements with other countries and trading blocs

Benefits of monetary unions

• Elimination of transaction costs

• Price transparency

• Elimination of currency fluctuations between member countries.

Transaction costs

Costs involved in changing currencies when goods are imported or exported.

The role of the World Trade Organisation

• To promote free trade

• To settle disputes between member countries

Possible conflicts between regional trade agreements and the WTO

• Regional trade agreements restrict trade with non-member countries, which conflicts with the aim of the WTO

Reasons for restrictions on free trade

• To correct a deficit in the trade in goods and services balance

• To prevent dumping

• To reduce unemployment

• Reduce the risk of disruption from problems faced by the global economy

• To prevent sectoral imbalance

• To prevent the monopoly power of global companies.

Dumping

When a country or firm sells a product in a foreign market at a price lower than it charges in its home market, or even below the cost of production

Sectoral imbalance

International specialisation of trade means that those countries with the comparative advantage will be developed.

Particular reasons developing countries may restrict trade

• To protect infant industries (a developing industry that needs government protection to grow)

• To limit monopsony power of firms in developed economies

Protectionism

Methods of restricting free trade

Types of protectionism

• Tariffs

• Quotas

• Subsidies to domestic producers

• Non-tariff barriers

Tariffs

Taxes on imported goods

Quotas

Limits on the physical quantity of a product which may be imported

Subsidies to domestic producers

Grants given by the government to domestic firms

Non-tariff barriers

• Health and safety regulations

• Environmental regulations

• Labelling of products

• Bureaucracy (e.g require importers to complete forms)

All these may raise the cost of imports and/or deter importers from importing to the country.

The impact of protectionist policies on consumers

Tariffs and quotas result in higher prices, and a reduction in both consumer surplus and consumer choice.

The impact of protectionist policies on producers

They face less competition and have less incentive to produce at lowest average cost. Further, they may cause retaliation by other countries which might impose protectionist measures.

The impact of protectionist policies on Governments

The government would receive tax revenue

The impact of protectionist policies on living standards

Specialisation is reduced, lower output

The balance of payments

A record of all financial transactions between one country and those in the rest of the world.

Components of balance of payments accounts

• The current account

• The financial and capital account

The current account of balance of payments

Shows a country’s day to day transactions with other countries

The capital and financial accounts

Shows long term investments and short term capital flows

Elements of the current account

• Trade in goods balance

• Trade in services balance

• Investment income (now called primary balance)

• Current transfers (now called secondary balance)

Trade in goods balance

The value of goods exported - The value of goods imported

If the result is negative, then it’s a current account deficit and vice versa

Trade in services balance

The value of services exported - The value of services imported

If the result is negative, then it’s a current account deficit and vice versa

Investment income (primary balance)

Income earned from assets overseas - income paid to foreigners for assets owned in the UK

If the result is negative, then it’s a current account deficit and vice versa

Current transfers (Secondary balance)

Payments received from foreign institutions (e.g the EU) - Payments given abroad (e.g to the EU or aid to foreign countries)

If the result is negative, then it’s a current account deficit and vice versa

Current account deficit

When more money is flowing out the country than it is flowing in

Current account surplus 

When more money is flowing into the country than it is flowing out

Elements of the capital and financial account

• Foreign direct investment

• Portfolio investments in shares and bonds

• Short-term capital flows

• Changes in foreign currency reserves.

Foreign direct investment

Investment by foreign companies into the UK - investment by UK companies abroad

Portfolio investment in shares and bonds

Purchase of UK shares and bonds by foreigners minus purchase of foreign shares and bonds by UK citizens

Short term capital flows

Often referred to as hot money flows

Hot money flows into the UK minus flows out of the UK into other countries

Hot money

Money that moves between countries for short periods of time, usually less than a year

The balance of payments and ‘balancing’

Since the balance of payments is a set of accounts, it needs to balance.

For example, If there is a current account deficit, there needs to be a financial and capital account surplus.

Causes of deficits in the current account

• Relatively low productivity

• The relocation of many manufacturing industries from developed countries where labour costs are significantly lower, such as China.

• An increase in the country’s exchange rates against that of other countries

• Continuous economic growth, resulting in an increase in imports.

A cause of a surplus is the opposite of above.

Measures to reduce a country’s imbalance of the current account

• Expenditure reducing policies

• Expenditure switching policies

• Devaluation/depreciation

• Supply side policies

Expenditure reducing policies

Polices designed to reduce AD, e.g deflationary fiscal and monetary policy.

Expenditure switching polices

Policies designed to alter the pattern of a country’s expenditure between domestic and imported goods and services.

Supply-side policies

Often viewed as the most effective way of reducing current account deficits.

• These could include

  • Cut in corporation tax

  • Improved infrastructure

  • Provision of superfast broadband

  • Training and education

  • Reduction in regulation and red tape

  • Reduction in employers national insurance contributions

  • Improved/ subsidised childcare provision

A current account surplus could be reduced by reversing the above measures

Global trade imbalances

Occur when some countries have large current account deficits and others have large current account surpluses

Why a persistent current account deficit is undesirable

• It indicates that the country’s goods and services are uncompetitive.

• In turn, it may result in an increasing rate of unemployment.

• In a system of floating exchange rates, It could result in the depreciation of the exchange rate.

Why a current account deficit may not be seen as a major problem

• It’s caused by imports of capital goods

• It’s only a short run problem

• It can be financed easily if there’s inflows into the financial account.

Why a persistent current account surplus may be undesirable

• It could result in inflation, since AD is rising

• It may imply that living standards are falling, since there are fewer goods and services available for domestic consumption

• It could cause an appreciation in the value of the country’s currency.

• It might cause other countries to impose restrictions on imports.

Exchange rates

The rate at which one currency exchanges for another

Trade weighted index

When one currency is measured against a basket of other currencies, with each other currency weighted on it’s share of a country’s trade.

Exchange rate systems

• Floating

• Fixed

• Managed

Floating exchange rate

Under this system, the exchange rate is determined by market forces, i.e supply and demand.

Fixed exchange rate

When the country’s currency is fixed against those of other currencies.

Managed exchange rate

This is essentially a floating exchange rate, but one which the central bank is subject to intervene with in order to influence the exchange rate of a country’s currency.

Revaluation

When a country decides to increase the exchange rate of its currency under a system of fixed exchange rates

Appreciation

An increase in the exchange rate of a country’s currency under a system of floating exchange rates

Devaluation

When a country decides to decrease the exchange rate of it’s currency under a system of a fixed exchange rate.

Depreciation

A decrease in the exchange rate of a country’s currency in the system of a floating exchange rate.

Factors influencing a floating exchange rate

• Relative interest rates

• Relative inflation

• Speculation

• Current account balance

• FDI

Relative inflation’s influence on exc rate

If a country has a higher inflation rate than it’s competitors, then it’s purchasing power will fall, and in the long term, the value will fall.

This may be explained in terms of PPP

Current account balance’s influence on exc rates

The supply of a country’s money increasing relative to the demand for it, results in a depreciation in it’s currency.

Foreign direct investment

A country which is a net recipient of FDI, will see increased demand for it’s currency, so the value of it increases.

Speculation

This arises for a number of reasons, e.g the expected state of the economy. Greater pessimism about the future state of the economy will cause the country’s exchange rate to appreciate.