Theme 4 Macroeconomics Full textbook notes

Meaning of globalisation

Refers to a variety of ways in which countries are becoming more and more closely integrated, not just in the economic sense, but also culturally and politically.

Characteristics of globalisation (in the economic sense)

• An increase in trade as a proportion of world GDP

• Increased movements of financial capital and people between countries

• Increased international specialisation and division of labour

• The growing importance of global or transnational companies

• An increase in foreign direct investment

What factors have contributed to globalisation?

• Fall in transport costs

• Fall in communication costs

• Lowering of trade barriers since the Second World War

• Decline in communism and the opening up of China

• TNCs have taken advantage of the reduction of trade barriers to organise trade on a global scale

• Growth in the number and size of trading blocs

What is the law of comparative advantage?

When countries specialise in the goods in which they have comparative advantage (i.e. goods can be produced at lower opportunity cost) then world output and living standards will increase.

Impacts of globalisation on governments:

• Economic growth → higher incomes → higher tax revenues

• However, transfer pricing may result in lower tax revenue from corporation tax

  • When a global company manages its accounting of internal transactions within the company to show the highest profits in the country in which corporation tax is lowest

Benefits of globalisation for producers and consumer

Producers: Lower production costs as a result of offshoring and economies of scale

• The practice of moving business practices/operations to another country to benefit from lower labour costs, favourable regulations and access specialised skills

Consumers: A wider choice of goods and lower prices = increase in consumer surplus.

What assumptions underlie the theory of comparative advantage?

• No transport costs

• No trade barriers

• Constant returns to scale - averaage cost of production is constant

• Perfect mobility of resources between different uses

• Buyers/consumers have perfect knowledge

What are terms of trade and how are they measured

The relationship between the price of exports and the price of imports

Index of export prices

—————————— x 100 = TOT

Index of import prices

Limitations of the principle of comparative advantage:

• Transport costs might outweigh the benefits of comparative advantage

• Similarly, trade barriers might distort comparative advantage

• Increased specialisation and production might result in rising average costs caused by diseconomies of scale

Advantages of specialisation and trade

• Efficient resource allocation: specialisation and free trade based on comparative advantage result in an efficient allocation of resources

• Higher world output —> higher living standards

• Lower prices and more choice for consumers

• Incentive for domestic producers to become more efficient

• Larger markets for firms, enabling them to benefit from economies of scale

Disadvantages of specialisation and trade

• The law of comparative advantage is based on unrealistic assumptions

• For developing economies, specialisation in the production of primary products might prevent diversification into more productive manufacturing strategies

• A danger of overdependence on imports, especially those of strategic importance

• A country’s goods and services may be uncompetitive, resulting in a persistent trade deficit

What factors influence the pattern of world trade?

• Changes in comparative advantage

  • E.g. discovery of new natural resources, adoption of new technology, investment in infrastructure

• The growth of emerging and developing economies

• The growth since the Second W.W. in the number and size of trading blocs

• A long-term change in a country’s exchange rates against those of other countries will affect the relative competitiveness of that country’s goods and services

Factors influencing a country’s terms of trade

• Relative inflation rates

  • E.g. a higher inflation rate then export prices will be rising relative to import prices so a rise in the TOT

• Changes in raw material prices

  • A developed country that imports most of its raw materials, a rise in raw material prices would cause a fall in TOT

• Changes in exchange rates

  • Increase in exchange rate relative to other countries leads to export prices rising and import prices falling

• Tariffs

  • A tariff imposed on imported goods would cause an increase in import prices and so would lead to a fall in TOT

• Dependency on primary products (over long term)

Impact of changes in a country’s terms of trade

• Increase in TOT = Increase in living standards: A country has to export less to gain a given quantity of imports

• On the balance of payments on current account: Upward movement in a country’s terms of trade would decrease the competitiveness of its goods and services because its export prices would be rising relative to its import prices. So, BOP on CA likely to deteriorate

• Resource-rich developing countries: ownership of minerals and fuels causes an appreciation in the exchange rates of the currencies of these countries, so an increase in the TOT. However, this leads to a loss of competitiveness of their manufactured goods and services, leading to slower economic growth than may have otherwise happened

What are regional trade blocs?

Intergovernmental associations that manage and promote trade activities for specific regions of the world

What are Free Trade Areas

Trade barriers are removed betwen member countries, but individual members can still impose their own tariffs and quotas on countries outside the area.

Example: NAFTA

What are Customs Unions

When there is free trade between member states and a common external tariff on goods imported from outside the bloc

Example: EU

What are common markets

Customs unions, but with the addition that it is not only goods and services that can be moved freely within the area, but also factors of production (especially labour.)

Example: Mercosur, a south american customs union

What are monetary unions

Customs unions that adopt a common currency

Costs of regional trade agreements

• Trade diversion: trade may be diverted from low-cost producers outside the bloc to high-cost producers within the bloc

• Distortion of comparative advantage: Lead to less efficient allocation of resources, lowering global economic growth

• Loss of independent monetary policy: Countries would be unable to control their own interest rates and exchange rates

Benefits of regional trade agreements

• Trade creation and more specialisation between member countries

• Increase in FDI: Global companies may invest to be inside a trading bloc to avoid trade restrictions

————————————————— main ones

• Elimination of transaction costs: so no costs in changing currencies when goods imported or exported

• Price transparency makes it easier for consumers to compare prices across the whole bloc region

• Elimination of currency fluctuations between member countries may help to attract FDI

What are the two key functions of the WTO?

• Promote free trade among the 164 member countries through ‘rounds of talks’

• Settle trade disputes between members

What is protectionism

Measures designed to limit free trade

Arguments for protectionism / restrictions on free trade

• Protect infant industries - particularly for developing countries that are industrialising

• Protect geriatric industries - particularly for developed countries that are losing their comparative advantage: these industries gain time to restructure and rationalise production

• Employment protection by protecting industries

• Prevents ‘dumping’ - goods exported to another country at below the average cost of production, a form of predatory pricing

• Correct a balance of payments deficit on the current account

• Restrict imports from countries who have less stringent health and safety - e.g. america’s pink sludge chicken

• To raise tax revenue from tariffs for developing countries

• In retaliation because another country has restricted the imports of its goods

Types of restrictions on trade:

• Tariffs

• Quotas on how much can be imported

• Subsidies to domestic producers artificially lower domestic production costs = more competitive

• Non-tariff barriers: health regulations, labelling, environmental standards, documentation for goods

Impact of protectionist policy on consumers, producers, government, living standards, equality:

Consumers: Higher prices and less choice

Producers: Less incentive for domestic producers to become more efficient

Governments: Yay: Tax revenue from tariffs, Nay: Subsidies are a cost and once barriers are in place its hard to remove them bc they’ll have negative effects on domestic producers

Living standards: Less efficient world resource allocation bc distorted comparative advantage and less specialisation —> lower world output → lower living standards

Equality: trade barriers by developed countries onto developing countries could increase inequality between these countries

What is the balance of payments

A record of all financial transactions between one country and other countries

Causes of current account deficit

• Low productivity relative to other countries - not competitive internationally

• High inflation relative to other countries

• an overvalued exchange rate

• Dependence on highly priced imported raw materials

• Relocation of manufacturing industries to low-wage countries

• protectionism by other countries

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

• Supply side policies to increase productivity and competitiveness of countries exports

  • Market based: privatisation, deregulation

  • Interventionist: education to improve productivity, infrastructure investment

• Expenditure-reducing policy - e.g. deflationary fiscal policy = less imports

Define nominal exchange rate

The number of units of the domestic currency that can purchase a unit of a given foreign currency

Define real exchange rate

Calculated to measure the movements of the competitiveness of the country’s currency in relation to another country’s currency on the basis of inflation differential between the countries.

• The nominal exchange rate adjusted to reflect the different inflation rates inn the countries of the two currencies concerned

What are the 3 exchange rate systems?

• Floating exchange rates - market forces determine the value at which one currency exchanges for another

• Fixed exchange rates - the value at which one currency exchanges for another is fixed by the central bank or government against another currency or gold

• Managed exchange rates - market forces determine the value at which one currency exchanges for another but intervention by the central bank influences the exchange rate

Revaluation V.S. Appreciation of currency

Revaluation: Only occurs under a system of fixed exchange rates when gov decides to increase value of currency

Appreciation: Under a system of floating exchange rates due to market forces

Factors influencing floating exchange rates

• Relative inflation rates

• Relative interest rates - foreigners place money in UK banks w high interest, increasing demand for pound

• Political instability causing fall in confidence in the currency

What is a country’s international competitiveness

The ability to sell its goods and services in domestic and international markets at a price and quality that is attractive in those markets