Economics - Chapter 6: International Trade and Globalisation

Define *international trade*

Exchange of goods and services across international borders

Define *MNC*

A firm that owns production plants and other operating facilities all over the world and sells goods and services in global markets

Define *FDI, foreign direct investment*

Business investment undertaken by a firm in another country

* eg. Coke factory built in India → FDI into India

Define *globalisation*

The growing integration of the world’s economies

State three indicators of globalisation

* an increase in trade as a proportion of GDP
* increased importance of MNCs
* increased FDI

What factors have contributed to the recent increase in globalisation

* improvements in transportation and communication
* de-regulation of financial markets
* differences in tax systems
* lower labour and operating costs
* foreign markets and growth of MNCs
* lowering of trade barriers
* fall of Communism and emergence of China

State advantages of globalisation

* more efficient allocation of resources
* reduction of average cost
* wider choice of goods
* lower production costs
* lower prices and higher quality products
* sharing of knowledge

How are countries specialising in the production of goods an advantage of globalisation

Countries specialise in the production of goods they are most efficient at producing and trade

* leads to more efficient allocation of resources
* lower costs of production
* lower prices

How does globalisation lead to a reduction in average cost

Larger markets allow firms to grow bigger and develop economies of scale → this reduces their average cost

How does globalisation lead to lower production costs

Lower production costs for producers as a result of offshoring

* lower wages
* less regulation
* tax breaks

How does globalisation lead to lower prices and higher quality products

More intense competition drives efficiency and innovation

How does globalisation lead to more interrelationships between countries

Sharing of knowledge and experience between countries as well as increased cultural, diplomatic and economic integration

What are the disadvantages of globalisation

* external costs
* widening of trade imbalances
* loss of culture and identity
* increased domestic unemployment
* exploitation of workers
* domestic economies vulnerable to external shocks

How does globalisation lead to external costs

External costs associated with trade and transporting goods (e.g. environmental degradation)

How does globalisation widen global trade imbalances

Widening of global trade imbalances as countries continue to sustain deficits (USA) and surpluses (CHINA) → can cause instability between countries

How does globalisation lead to loss of culture and identity

Loss of culture and identity and increased social tension due to immigration

How does globalisation lead to increased domestic unemployment

Increased domestic unemployment (in DEVELOPED countries esp.) due to the inability t o compete with lower labour costs overseas

How does globalisation lead to the exploitation of workers

Exploitation of workers, children, farmers and the environment due to less demanding laws and regulations

How does globalisation lead to the vulnerability of domestic economies

Domestic economies are more vulnerable to external shocks due to specialisation and a higher dependence on imports and exports

Define *deglobalisation*

A decrease in trade as a proportion of GDP and decreased FDI

Define *free trade*

International trade without protectionist barriers such as quotas, tariffs (indirect taxes) or bans (embargoes)

What are the advantages of free trade

* lower prices
* lower prices and higher quality products
* wider choice for consumers
* lower average costs and prices
* increase in global awareness
* improved efficiency

How does free trade lead to lower prices for consumers

Some countries are more efficient at predicting certain goods and services → can produce at a lower cost per unit

* if countries specialise at what they are best at and trade

= lower prices for consumers

How does free trade lead to lower prices and higher quality products

More intense competition drives efficiency and innovation

= lower prices and higher quality products

How does free trade lead to wider choice for consumers

Wider choice for consumers as they have a larger variety of goods from different countries to choose from

How does free trade lead to lower average costs and prices

Larger markets for firms → allows them to grow and develop economies of scale

= leads to lower average costs and potentially lower prices

How does free trade lead to an increase in global awareness

Increase in global awareness as well as cultural, economic and diplomatic integration

How does free trade lead to improved efficiency

Sharing of knowledge and experience between countries

= improved efficiency in manufacturing processes worldwide

What are the disadvantages of free trade

* increased domestic unemployment
* increase In current account deficits
* increasing inequality in countries
* domestic economies becomes overspecialised in certain industries

How does free trade lead to an increased domestic unemployment

Increased domestic unemployment in some industry sectors due to inability to compete with more efficient industries overseas → could be related to lower labour costs

How does free trade lead to an increase in the current account deficits

Increase in the current account deficits of some countries (USA) as they import more and export less

How does free trade lead to an increasing inequality in countries

Could lead to increasing inequality in countries as benefits of trade flow more to the rich than the poor

How does free trade lead to domestic economies becoming overspecialised

Domestic economies may become overspecialised in particular industries (esp. primary products e.g. OIL) which makes them more prone to global downturns

How does a country have a comparative advantage

When a country can specialise into the goods and services that they are best at producing

What are the advantages of specialisation

* lower cost per unit
* increased productivity
* more units of output
* efficient allocation of resources
* lower prices for consumers
* higher standard of living

How does specialisation lead to a lower cost per unit

The labour force becomes skilled in certain industries leading to increased productivity and therefore a lower cost per unit

How does specialisation lead to an increase in productivity

Education and training schemes can be tailored to particular skills and industry areas to further increase productivity

How does specialisation lead to more units of output

Resources can be focused on particular industry areas. The cost of expensive capital machinery can be spread out of more units of output

How does specialisation lead to a more efficient allocation of resources

Specialisation leads to a more efficient allocation of resources as countries specialise in industries that they have a comparative advantage in (lowest OPP COST in terms of production)

How does specialisation lead to lower prices for consumers

Specialisation has led to lower costs of production and thus lower prices for consumers

How does specialisation lead to a higher standard of living

Wages for workers may increase as their productivity increases = higher standard of living

Define *protectionism*

An approach used by a government to protect domestic producers by limiting free trade

State the three main types of protectionism used by countries

* tariffs
* quotas
* embargoes
* subsidies

Define *tariffs*

An indirect tax on imports to make them more expensive

What are the effects of a tariff

Tariffs INCREASE costs for foreign producers which can lead to an INCREASE in the price of IMPORTS. If the prices of imports INCREASES, then domestic consumers may buy CHEAPER domestic substitutes

Define *quotas*

A physical limit on the quantity of imports allowed into a country → LOWER quota is MORE PROTECTIONIST

Define *subsidies*

A grant from the government to lower the production costs of domestic firms

What are the effects of a subsidy

Subsidies DECREASE costs for domestic firms which can lead to a DECREASE in the price of domestic goods. If the price of domestic goods DECREASE, then domestic consumers may buy these CHEAPER domestic substitutes instead of EXPENSIVE imports

Define *embargoes*

An official ban on trade or other commercial activity with a particular country

State an example of protectionism

CASE STUDY

CASE STUDY: CHINA VS USA


1. China heavily subsidised firms in solar panel industry

= lower production costs → competitive advantage


2. Chinese firms selling solar panels in international markets at prices lower than costs of production

= cheaper than other counties → “dumping”


3. US could not compete with low prices

= decrease in revenue and increase in unemployment

= WORSENING of USA CURRENT ACCOUNT


4. US implemented tariffs on Chinese imported solar panels → increased costs for producers

**US consumers bought cheaper domestic substitutes**

What are the advantages of protectionism

* prevent domestic job losses
* improving the current account
* raising revenue
* preventing dumping
* protect infant industries
* preventing entry of harmful/undesirable goods

How does protectionism protect jobs

Protect domestic industries from cheaper overseas competitors will help prevent domestic job losses

How does protectionism improve the current account

Protectionist measures will reduce the no. of important and/or increase the no. of exports. This would lead to an improvement in the current account

How does protectionism raise revenue

A government can raise tax revenue by implementing tariffs on imports

How does protectionism prevent dumping

Dumping is when a heavily-subsidised overseas firm sells large quantities of a product below cost in the domestic market → trade barriers can prevent this from happening

How does protectionism protect infant industries

Infant industries can be protected from strong overseas competition until they can grow, become established and exploit economies of scale

How does protectionism prevent entry of harmful/undesirable goods

Administrative barriers in particular can be used to prevent harmful goods being imported (e.g toys containing lead paint)

What are the disadvantages of protectionism

* retaliation
* cost-push inflation
* other more effective policies
* loss of free trade benefits

How does protectionism lead to retaliation

Protectionism may lead to a trade war where one country erects barriers and then those that are affected do exactly the same in retaliation

How does protectionism lead to cost-push inflation

The competitiveness of domestic firms may decrease if they are using protected goods that are now more expensive in their production process

How does protectionism become less effective than other policies

Other policies may be more effective than protectionism as supply side policies could be used to increase the productivity and therefore competitiveness of domestic firms

How does protectionism lead to a loss of free trade benefits

* competition between firms decreases
* price increases for consumers
* choice is restricted
* living standards fall
* less efficient allocation of resources

Define *exchange rates*

The value of one currency in terms of another

Define *freely floating exchange rate system*

The currency is free to change on the foreign exchange market using the price mechanism (supply and demand)

How do you gain another currency

Have to sell your money to buy another currency

What occurs to the economy when the demand for a currency increases (£ and $)

* appreciation in one currency = depreciation in another


1. Increase US tourists visiting UK = increase demand for £
2. £ APPRECIATES
3. Supply of $ INCREASES (buy £ using $)
4. $ DEPRECIATES

What happens to the economy when the government lowers the interest rate

DEPRECIATES = supply of money INCREASES

* hot money: investors invest for the biggest return → take money elsewhere

What is the increase in the value of a currency relative to others called?

APPRECIATION

What is the decrease in the value of a currency relative to others called?

DEPRECIATION

What is the effect of depreciation to:

* imports
* exports
* current account

Imports: MORE EXPENSIVE

Exports: LESS EXPENSIVE

Current Account: IMPROVES

What is the effect of appreciation:

* imports
* exports
* current account

Imports: **LESS** EXPENSIVE

Exports: **MORE** EXPENSIVE

Current Account: **WORSENS**

State the 5 factors that influence the value of a currency

* demand for exports
* demand for imports
* FDI
* Aid
* Relative interest rates

How does the demand for exports influence the value of a currency

Foreign countries demand for foreign goods increase

**= appreciation in domestic economy**

* more desirable
* more expensive

How does the demand for imports influence the value of a currency

Demand for imports INCREASES = **depreciation**

* sell domestic currency to buy foreign currency

How does the FDI influence the value of a currency

Increase in foreign aid

= **depreciate regional**/domestic economy

= **appreciate foreign** economy

How does aid influence the value of a currency

Increase in given aid = **DEPRECIATE** economy

Define *fixed exchange rate system*

The exchange rate is fixed against another currency by intervention from the government or central bank to maintain the chosen rate

Define *revaluation*

An increase in the pegged value of a currency relative to others

Define *devaluation*

A decrease in the pegged value of a currency relative to others

Define *managed float exchange rate system*

Exchange rates fluctuate from day to day, but central banks attempt to influence their country’s exchange rate by buying and selling currencies

Why do countries fix (peg) their exchange rate at a certain level against the currency of their main trading partner

* helps stabilise revenues for producers
* encourage FDI
* stabilise prices for consumers

Why will the government try to manipulate the exchange rate

* could be to fix the exchange
* create a competitive devaluation

Define *competitive devaluation*

When countries seek to reduce the value of their exchange rate to make their exports cheaper and gain a competitive advantage in world trade over other countries

How do governments create a competitive devaluation

MANIPULATE:

* foreign currency reserves
* interest rates

How is competitive devaluation created through foreign currency reserves

To devalue its currency, the central bank can **SELL** its own currency to increase foreign currency reserves. This INCREASES the **SUPPLY** of the **domestic** currency

= causes **DEPRECIATION**

How is competitive devaluation created through interest rates

To devalue its currency, the central bank can **DECREASE** interest rates. The return on saving in the country DECREASE. Hot money flows **OUT** the domestic currency as investors in the country begin earning less returns. This increases the **SUPPLY** of the **domestic** currency

= causes **DEPRECIATION**

Define *balance of payments*

A record of all transactions relating to international trade

INCLUDES: current account, financial account, capital account

What does the current account include

* visible trade
* invisible trade
* primary income
* secondary income

Define *visible trade*

the trade of physical goods (e.g. OIL, WHEAT)

Define *invisible trade*

the trade of services

Define *primary income*

Income received or paid in return for use of a factor of production (e.g. LAND, LABOUR)

Define *secondary income*

Payments made between government for co-operation and other transactions (e.g. WTO or EU membership, gifts of money for aid)

Define *current account deficit*

More money leaving the country than coming in

What are the benefits of a current account deficit

* may be importing important raw materials/capital
* short term: gives consumers more choice + lower prices

What are the disadvantages of a current account deficit

* increase in borrowing
* sign of lack of competitiveness
* loss of confidence by foreign investors
* reductions in assets owned domestically and overseas

What is the effect of long-term current account deficit

Fall in living standards over time

COUNTRIES: USA, FRANCE, UK

Define *current account surplus*

More money entering the country than going out

What are the benefits of a current account surplus

* can build up large reserves of foreign currency
* indicates the country is competitive internationally
* firms’ revenues will likely be increasing → allow growth

What are the disadvantages of a current account deficit

* exchange rate pressure may lead to appreciation
* goods could be consumed domestically but are not sold overseas
* lower standards of living

What does capital account include

* net capital transfers
* domestic people buying foreign assets
* transactions in non-produced, non-financial assets
* trademarks, brands, patents
* intangible assets
* buildings/capital