6. International trade and globalisation

Reasons for National Specialisation

• Specialisation occurs on several different levels

  • On an individual level where a worker specialises in a particular task

  • On a business level, e.g. one firm may only specialise in manufacturing drill bits for concrete work

  • On a regional level e.g. Silicon Valley has specialised in the tech industry

  • On a national level as countries seek to trade e.g. Bangladesh specialises in textiles and exports them to the world
     

• The two main factors which allow a country to specialise are:

1. Superior resource availability: If the quality of the resource is relatively better than other nations, the country will be able to charge higher prices for it. Alternatively, if a country has a higher quantity of the resource then it may be able to lower prices & drive competitors out of business by specialising in its extraction & sale

2. Cheaper production methods: If the country has lower costs of production, then it is very likely that they will be able to lower selling prices & gain a lead in the international market share. Some countries are able to produce cheaply using machinery or technological innovation, whilst others do so by providing large labour force which can perform manual tasks very cheaply

Advantages & Disadvantages of National Specialisation

Pros & Cons of National Specialisation

Globalisation

• Globalisation is the economic integration of different countries through increasing freedoms in the cross-border movement of people, goods/services, technology & finance

• This integration of global economies has impacted national cultures, spread ideas, speeded up industrialisation in developing nations & led to de-industrialisation in developed nations

• Globalisation has been increasing for thousands of years - it is not a new phenomenon

• Improvements in technology & the speed of global connections have exponentially increased the level of interdependence between nations in the past 50 years

• Consumers now source products globally recognising global brands wherever they travel  
  

The Four Main Characteristics of Globalisation

Multi National Corporations (MNCs)

• A multinational corporation is business that has production facilities in two or more countries e.g. Apple

• Globalisation has made it easier for firms to do business on a global scale & the number & size of MNCs continues to increase

• There are advantages & disadvantages linked to the economic activity of MNCs, both in their home country as well as in their host country

The Advantages & Disadvantages of MNCs

 
The Advantages of MNCs

1. Economies of scale: as they operate globally they are able to increase their output & benefit from lowered costs created by economies of scale

2. Increased profit: much of their profit is sent back to their home country. This point is debatable as many MNCs have offshore bank accounts & do not bring the profit back home

3. Create employment: new jobs are created in host countries each time a new facility is setup & this raises income which helps to improve the standard of living in that country

4. New markets: MNCs can identify potential markets & begin to sell there

5. Transportation costs: MNCs are able to setup facilities closer to their customers which reduces transportation costs

6. Risk management: By selling in many national markets, the risk of failure is reduced e.g. if Egypt goes through a recession (with sales falling there), then this could be less impactful due to rising sales in a strong German market

7. Tax incentives: MNCs are able to increase their profits by setting up in countries with low corporation tax - or countries that offer MNCs a tax break (no tax) for their first 5-10 years of operation

8. Avoidance of protectionism: MNCs can establish bases in countries that are operating protectionistmeasures & by doing so, they avoid the measures e.g. A Chinese MNC may setup in the USA & produce there, thus avoiding import tariffs on  their products exported from China to the USA

 
The Disadvantages of MNCs

The Benefits of Free Trade

• International trade refers to the exchange of goods & services between countries

• International trade involves the exchange of goods/service through exports & imports

• International trade is 'free' when there is no government intervention (quotas, taxes etc.) to reduce or limit trade
  

The benefits of free trade

• Greater choice: with access to a wider variety of goods/services, the standard of living improves

• Lower prices: with international competition prices fall giving households the ability to buy more

• International cooperation: required for trade helps countries to build better relationships which leads to lower levels of hostilities

• Flow of new ideas: innovative ideas & technology can be shared between countries

• Access to resources: output can increase & costs of production can fall with increased access to raw materials

• Increased efficiency: international competition allows the most efficient firms to emerge & this improves the use of global resources

• Economic growth: exports are a key component of the gross domestic product of many countries & an increase in exports can lead to economic growth

• Economic development: Increased output leads to lower levels of unemployment which leads to higher incomes & a higher standard of living

Reasons for Protection

• Free trade aims to maximise global output through national specialisation

• However, there are numerous reasons why countries would seek to limit free trade in order to protect themselves from certain outcomes

• This is called protectionism & may take the form of import tariffs, export subsidies, the use of quotas or embargoes

• Trading partners may retaliate to any methods of protectionism and they should be carefully considered before any implementation
   

Reasons for Protectionism

Methods of Protection

• The most commonly used forms of trade protectionism include tariffs, subsidies, quotas, embargoes & administrative barriers
  

1. Tariffs
 

• A tariff is a tax on imported goods/services (customs duty)

• With the price of imports higher, domestic firms find it easier to compete & increase their market share as consumers switch from buying imports to buying domestically produced goods/services

• Less efficient domestic firms are now producing at the expense of more efficient international firms

A tariff increases the costs of production for domestic firms, resulting in a shift of the supply curve from S₁ → S₂

Diagram Analysis

• The pre-tariff market equilibrium for plantains is seen at P₁Q₁

• After the tariff is imposed, costs of production for domestic firms increase (as they pay the tariff when the plantains enter the country) - the supply curve shifts from S₁ → S₂

• The new market equilibrium is seen at P₂Q₂ 

  • Following the law of demand, the quantity demanded contracts from Q₁ to Q₂
    

  • The price increases from P₁  → P₂
     

• Tariffs are one of the most widely used forms of protectionism & their impact on stakeholders can be evaluated as follows
   

An Evaluation Of The Use Of Tariffs To Protect Domestic Firms

Exam Tip

One of the most common misconceptions about tariffs is who pays them. The tariff is not paid by the foreign exporting firm. It is paid by any domestic firms that are importing. They pay the tariff to their own government when the goods cross the border. 

Quotas, Subsidies, Embargoes & Administrative Barriers

2. Quotas

• A quota is a physical limit on imports e.g. in June 2022 the UK extended their quota on steel imports for a further two years in order to protect employment in the domestic steel industry
  

• This limit is usually set below the free market level of imports
  

  • As cheaper imports are limited, a quota raises the market price

  • As cheaper imports are limited a quota may create shortages
    
    

• Some domestic firms benefit as they are able to supply more due to the lower level of imports

  • This may increase the level of employment for domestic firms
    

An Evaluation Of The Use of Quotas To Protect Domestic Firms

 
  
3. Subsidies to Domestic Producers

• A subsidy lowers the cost of production for domestic firms 

  • They can increase output & lower prices

  • With lower prices their goods/services are more competitive internationally

  • The level of exports increases

  • The increased output may result in increased domestic employment
    
    

An Evaluation Of The Use of Subsidies To Protect Domestic Firms

4. Embargoes

•  An embargo is a complete ban on trade with a certain country usually as the result of political fall out e.g. the USA ran an embargo for many decades on Cuban products 
  
  

An Evaluation Of The Use of Embargoes To Protect Domestic Firms

  
 5. Administrative Barriers

• There are many strategies that can be used to create barriers to trade using less obvious methods than tariffs, quotas & subsidies

  • Health & safety regulations e.g. in 2017 the EU put a new health regulation in place regarding the permitted level of aflotoxins in nuts. Aflotoxin levels are naturally higher in southern hemisphere countries & it effectively blocked the import of southern hemisphere nuts

  • Product specifications e.g. Canada specified that all jam imported into Canada needed to be in a certain size of jar. Many countries do not usually manufacture jars in the required size

  • Environmental regulations e.g. in November 2021 new regulations were put in place in the EU & the USA to limit the amount of imports of 'dirty steel' - predominantly this is steel produced using coal fired power stations which are prevalent in China

  • Product labelling can be expensive for firms to apply & may limit their desire to sell into certain markets

Foreign Exchange Rates (Forex)

• An exchange rate is the price of one currency in terms of another e.g. £1 = €1.18

  • International currencies are essentially products that can be bought & sold on the foreign exchange market (forex)
     

• The Central Bank of a country controls the exchange rate system that is used in determining the value of a nation's currency
   

• Two of the main exchange rate systems are

  • A floating exchange rate

  • A fixed exchange rate

1. A Floating Exchange Rate System

• Different currencies can be bought & sold, just like any other product

• The forces of demand & supply determine the rate at which one currency exchanges for another

• As with any market, if there is excess demand for the currency on the forex market, then prices rise (the currency appreciates)

• If there is an excess supply of the currency on the forex market, then prices fall (the currency depreciates)

The relationship between the US$ & the Euro shows that as Europeans demand the $ it appreciates but by supplying their own currency it depreciates

 
Diagram Analysis

• The Euro/US$ market is shown by two market diagrams - one for the USD market on the left & one for the Euro market on the right

• The initial exchange rate equilibrium is found at P₁Q₁ in both markets

• When Europeans visit the USA, they demand US$ & supply Euros

  • The increased demand for the US$ shifts the demand curve to the right which results in the value of the $ appreciating from P₁ → P₂ in the USD market & a new market equilibrium forms at P₂Q₂

  • The increased supply of the Euro shifts the supply curve to the right which results in the value of the Euro depreciating from P₁ → P₂  & a new market equilibrium forms at P₂Q₂

2. A Fixed Exchange Rate System

• A system in which the country’s Central Bank intervenes in the currency market to fix (peg) the exchange rate in relation to another currency e.g US$

  • When they want their currency to appreciate, they buy it on forex markets using their foreign reserves, thus increasing its demand

  • When they want their currency to depreciate, they sell it on forex markets, thus increasing its supply

• Sometimes the peg is at parity e.g. 1 Brunei Dollar = 1 Singapore Dollar

• Often the peg is not at parity e.g. Hong Kong has pegged its currency to the US$ at a rate of HK$ 7.75 = US$ 1

• A revaluation occurs if the Central Bank decides to change the peg & increase the strength of its currency

• A devaluation occurs if the Central Bank decides to change the peg & decrease the strength of its currency

Evaluating Exchange Rate Systems

• Each exchange rate system has advantages & disadvantages attached

An Evaluation of A Floating Exchange Rate Mechanism

An Evaluation of A Fixed Exchange Rate Mechanism

Causes of Exchange Rate Fluctuations

• Numerous factors influence floating exchange rates, resulting in an appreciation or depreciation of a currency

Factors influencing floating exchange rates

1. Relative interest rates: influence the flow of hot money between countries. If the UK increases its interest rate, then demand for £'s by foreign investors increases & the £ appreciates. If the UK decreases its interest rate, then the supply of £'s increases as investors sell their £'s in favour of other currencies & the £ depreciates
   
   

2. Relative inflation rates: as inflation in the UK rises relative to other countries, its exports become more expensive so there is less demand for UK products by foreigners, which means there is less demand for £s & so the £ depreciates
   
   

3. Net investment: foreign direct investment (FDI) into the UK creates a demand for the £ which leads to the £ appreciating. FDI by UK firms abroad creates a supply of £'s which leads to the £ depreciating
   
   

4. The current account: UK exports have to be paid for in £'s. UK imports have to be paid for in local currencies, which requires £'s to be supplied to the forex market. Due to this, an increasing net exports will result in an appreciation of the £ & falling net exports will result in a depreciation of the £
    

5. Changes in tastes/preferences: As global demand for quinoa increased as it became fashionable, Bolivia's exports of quinoa increased dramatically which put upward pressure on their currency. Foreigners demanded the Boliviano in order to pay for the quinoa
   

6. Speculation: the vast majority of currency trades are speculative. Speculation occurs when traders buy a currency in the expectation that it will be worth more in the short to medium term, at which point they will sell it to realise a profit
   

7. Quantitative easing: involves increasing the money supply & much of the new supply is used to buy back gilts. Many of these gilts are owned by foreigners who then exchange the £s received for their own currency. The increase in the supply of £'s depreciates the £
    

8. MNCs: An increase in the number of MNCs globally will result in more money flows between countries, each of which influences exchange rates

Consequences of Foreign Exchange Rate Fluctuations

• Changes to exchange rates may have far-reaching impacts on an economy

The impact of changes to exchange rates on an economy

The Current Account

• The Balance of Payments (BoP) for a country is a record of all the financial transactions that occur between it and the rest of the world
  

• The BoP has two main sections:

  • The current account: all transactions related to goods/services along with payments related to the transfer of income

  • The financial & capital account: which is not part of your syllabus
    

• Money flowing into the country is recorded in the relevant account as a credit (+) and money flowing out as a debit (-)

• A current account surplus occurs when the credits (money in) are higher than the debits (money out)

• A current account deficit occurs when the credits (money in) are less than the debits (money out)

The Current Account of the Balance of Payments

• The Current Account is often considered to be the most important account in the BoP

  • It records the net income that an economy gains from international transactions
    

An Example of the UK Current Account Balance For 2017

• Goods are also referred to as visible exports/imports

• Services are also referred to as invisible exports/imports

• Net income consists of income transfers by citizens and corporations

  • Credits are received from UK citizens who are abroad & send remittances home

  • Debits are sent by foreigners working in the UK back to their countries

  • (Income credits - Income debits) are often referred to as net primary income

• Current transfers are typically payments at government level between countries e.g. contributions to the World Bank

  • (Transfer credits - transfer debits) are often referred to as net secondary income
     

• The current account balance = net trade in goods + net trade in services + net primary income + net secondary income

Worked example

CURRENT ACCOUNT CALCULATIONS

The table shows a selection of economic data for a country

Calculate the current account balance of this country?

Step 1: Recall the formula for calculating the current account balance
 Net trade in goods + net trade in services + net income + net current transfers
 

Step 2: Substitute the appropriate values

Net trade in goods = (100-40) = 60

Net trade in services = (75-45) = 30

Net income transfers = 150

Net current transfers = -50
 

Step 3: Complete the calculation

60 + 30 + 150 -50 = 190
 

Step 4: Check the units and ensure your answer uses the correct units

€190,000m

Reasons for Deficits & Surpluses

• If there is a current account deficit, the value of imports must be greater than the value of exports

• If there is a current account surplus, the value of exports must be greater than the value of imports

 
Causes Of Current Account Deficits

Causes Of Current Account Surpluses

Consequences of Deficits & Surpluses

• As global trade is a net sum game where the value of global exports = global imports, it follows that if one country is running a current account surplus then another country is running a deficit
  
  

• Consequences of current account deficits include

1. Increasing unemployment: with falling demand for locally produced goods/services, fewer workers will be required & unemployment will rise

2. Slow down in economic growth or a recession: exports are a key component of the real GDP of many countries & a fall in exports may significantly reduce the level of economic growth

3. Lower standards of living: a fall in economic growth usually leads to a reduction in wages which leads to a decrease in the standards of living

4. Increased levels of borrowing: if the deficit is caused by continually increasing levels of imports, then it is likely that these imports are being paid for through higher levels of borrowing

5. Depreciating exchange rate: while this may ultimately help to increase exports again, it makes the cost of imported goods/raw materials more expensive and may cause cost push inflation
    

• Consequences of current account surpluses include

1. Increasing employment: with increasing demand for locally produced goods/services, more workers will be required & unemployment will fall

2. Economic growth: exports are a key component of the real GDP of many countries & a rise in exports may significantly increase the level of economic growth

3. Higher standards of living: a rise in economic growth usually leads to a rise in wages which leads to an increase in the standards of living

4. Demand pull inflation: economic growth caused by a rise in exports will lead to demand pull inflation

5. Appreciating exchange rate: rising exports will appreciate the exchange rate which leads to imports now being cheaper which causes the demand for imports to rise

Exam Tip

When answering questions on deficits, be absolutely clear if the question refers to a budget deficit or a current account deficit. Students often confuse these two!

A budget deficit refers to the government budget & occurs when the government spending > government tax revenue

A current account deficit occurs when the value of a nation's exports < value of a nation's imports

Policies Which Stabilise the Current Account Balance

• The Government has several policies (fiscal, monetary & supply-side policy) available to them in order to address a current account deficit or to stabilise the current account balance. Overall, their choices are:

1. They could do nothing, leaving it to market forces in the foreign exchange market to self-correct the deficit
    

2. They could use expenditure switching policies. These include:
   • Protectionist policies which raise the price of imports, so consumers switch to buying domestic goods
   • Currency devaluation which makes the price of imports more expensive & so consumers switch to buying domestic products
   

3. They could use expenditure reducing policies. These include:
   • Raising taxes which cause consumers to have lower disposable income & so they spend less on imports
   • Raising interest rates which reduces the level of borrowing resulting in a fall in the level of imports
   

4. They could use supply-side policies. These include
   • Investment in education which raises productivity making exports cheaper & more attractive
   • Investment in infrastructure which lowers costs for firms making exports cheaper & more attractive
    

• The use of any policy - or any combination of policies generates both advantages & disadvantages
  

Advantages & Disadvantages of Policies Used to Tackle Current Account Deficits

Exam Tip

The terms expenditure switching & expenditure reducing are not in your syllabus. They have been included as they clearly explain the intention of any fiscal, monetary or supply-side policy used to address imbalances in the current account. The policies aim to switch expenditure away from imports or to reduce expenditure on imports - both of which will help to lower any current account deficit.