Globalisation and trade
Globalisation
Globalisation is the process by which countries become more interdependent on one another regarding trade, migration and flows.
Characteristics of globalisation
Globalisation has become more apparent towards the end of the 20th century and the 21st century. Some characteristics that show this has happened can include an increase in:
Net trade between countries: Increased interdependence between countries leads to more trade between them, thus making the amount of trade occurring greater.
Levels of labour migration: Increased interdependence between countries may lead to an increase in economic migrants seeking employment in other countries in pursuit of higher living standards.
Transfers of capital and technology: Countries that rely on each other may share capital or technology upon an agreed premium, leading to large amounts of goods such as machinery being transferred in and out of countries.
The development of global brands: If firms can easily set up operations in other countries due to increased globalisation, then their brands may be able to take off globally e.g. Coca-Cola.
Global living standards: If countries become increasingly reliant on each other, it may result in cheaper imported goods and services, which may also be of higher quality. Consumers being able to buy cheaper but better quality products is likely to increase their living standards.
Factors that contribute to increased globalisation
Globalisation is a process that can be accelerated by economic agents. Some ways in which they can do this include:
Improvements in transport infrastructure: The implementation or improvement in the quality of transport infrastructure will reduce commuting times when traveling from one country to another. This will make certain operations, such as trade much easier, thus accelerating globalisation.
Improvements in communication infrastructure: Improvements in communication infrastructure, such as increased access to the Internet, will allow countries to communicate much faster, accelerating the rate of globalisation.
Trade liberalisation: The reduction of trade barriers such as tariffs has incentivised firms and individuals to purchase imports or sell exports. This incentive accelerates globalisation by increasing trade and making countries more interdependent on one another.
Consequences of globalisation
Consumers
Increased choice: Globalisation allows consumers to access a broader range of goods and services from across the world. For instance, items that were once only available locally, such as tropical fruits or high-tech electronics, are now easily imported and sold in most markets, enhancing consumer satisfaction and meeting diverse preferences.
Lower prices: Increased competition among international producers often leads to reductions in production costs and retail prices. This is particularly evident in industries like clothing or electronics, where low-cost manufacturing in developing countries drives down costs for consumers in developed nations.
Higher prices: However, globalisation can also lead to higher prices for certain goods, especially when supply chains are disrupted or when tariffs and trade restrictions are imposed. Dependence on imports can expose consumers to exchange rate volatility, making foreign products more expensive.
Workers
Job losses: Many workers face unemployment as domestic firms struggle to compete with cheaper imports or relocate production abroad. This is especially common in industries such as manufacturing, where jobs are outsourced to countries with lower labour costs, leaving local workers without stable employment.
Lower wages: Increased competition from global labour markets often puts downward pressure on wages for low-skilled jobs. For example may move operations to countries with less stringent wage regulations, reducing bargaining power for workers in high-income nations.
Higher wages for skilled workers: On the other hand, globalisation can benefit highly skilled workers, particularly in sectors like technology or finance. These workers often find their expertise in demand across borders, allowing them to negotiate better pay and enjoy improved career opportunities.
Producers
Diversification: Globalisation enables firms to expand their operations and access international markets. This diversification reduces dependence on domestic demand and allows businesses to spread risks. For instance, a company facing a downturn in its home country might offset losses by exporting to growing economies.
Failure of domestic firms: Many smaller or less efficient businesses may struggle to survive in an increasingly competitive global market. Domestic firms that cannot adapt to new technologies or lower-cost competition often face bankruptcy, leading to job losses and reduced economic activity locally.
Lower labour costs: One major advantage for producers is the ability to outsource production to countries where labour is cheaper. This helps businesses reduce costs significantly, allowing them to compete more effectively in global markets. However, it often comes at the expense of domestic employment opportunities.
Specialisation
Absolute and comparative advantage
Absolute advantage: This occurs when a country can produce a particular good or service using fewer resources than another country. For example, if Country A can produce 100 units of a product with less labour or capital than Country B, it holds an absolute advantage. This efficiency is key to driving international trade.
Comparative advantage: A country has a comparative advantage when it can produce a opportunity cost than another country. For example, if Country A sacrifices less of Good Y to produce Good X than Country B does, it makes sense for Country A to specialise in Good X and trade for Good Y. This principle underpins much of modern trade theory.
Theory limitations
Perfectly mobile factors of production: The theory assumes that resources like labour and capital can easily move between industries or regions. In reality, retraining workers or reallocating capital often involves significant time and cost, limiting the flexibility of economies.
Homogeneous goods: Comparative advantage relies on the assumption that goods are identical regardless of their origin. In practice, differences in quality, branding, or consumer preferences mean that goods are rarely perfectly substitutable.
No economies of scale: The theory ignores the cost advantages that arise from large-scale production. Countries specialising in a narrow range of goods may fail to benefit from lower average costs that come with mass production.
Absence of transport costs: It is assumed that goods can be traded without incurring transport expenses. However, in reality, high transport costs can negate the benefits of specialisation, especially for bulky or perishable goods.
Depends on trade terms: The gains from trade are not guaranteed and depend heavily on the terms negotiated. Countries with less bargaining power may find themselves at a disadvantage, receiving fewer benefits from trade than their partners.
Advantages of specialisation in trade
Gain of economies of scale: By focusing on producing specific goods, per unit. This often leads to lower prices for consumers and higher profitability for businesses, as fixed costs are spread over a larger volume of production.
Increase in economic growth: Specialisation boosts productivity, enabling countries to produce more efficiently. This leads to higher levels of output, increased exports, and, ultimately, greater economic growth.
Increase in consumer choice: Specialisation and trade allow countries to import goods they do not produce, giving consumers access to a wider variety of products. For example, countries with no natural coffee production can still enjoy access to coffee through trade.
Increase in competition: Exposure to global markets encourages domestic producers to innovate and improve efficiency, as they face competition from international rivals. This can result in better quality goods and services for consumers.
Efficient use of resources: Specialisation ensures that resources are allocated to their most productive uses. Countries focus on what they can produce most efficiently, reducing waste and increasing overall output.
Disadvantages of specialisation in trade
Dependence: Relying heavily on specific industries or trading partners can make economies vulnerable to external shocks. For instance, a downturn in demand for a country's key export can severely impact its economy.
Unemployment: Workers in sectors that are not competitive on the global stage may lose their jobs as resources are shifted to specialised industries. This structural unemployment can be long-lasting, especially if workers lack the skills to transition to new roles.
Effect on the environment: Increased production and international trade often lead to higher carbon emissions and resource of specialisation, such as deforestation or pollution, can outweigh its economic benefits, particularly in developing countries.
Pattern of trade
The pattern of trade describes the flow of goods and services between countries, including what is traded, with whom, and in what volumes. It reflects the economic strengths of nations, such as resource availability or industrial capabilities, and evolves over time due to factors like technology and global demand shifts.
Factors affecting the pattern of trade
The level of comparative advantage: Countries specialise in producing goods where they have a comparative advantage, meaning lower opportunity costs relative to others. For instance, a nation with advanced technology may export high-value electronics, while importing basic agricultural goods it cannot produce efficiently.
Exchange rates: Fluctuations in currency values affect trade competitiveness. A weaker currency makes exports cheaper and imports more expensive, potentially increasing export volumes and shifting trade balances in favour of domestic producers.
Trading blocs: Membership in trading blocs reduces trade barriers, such as tariffs, among member countries. This fosters greater trade within the bloc and can divert trade away from non-member nations, reshaping traditional trade patterns.
Terms of trade
The terms of trade measure the ratio between a country's export prices and import prices. An improvement in terms of trade occurs when export prices rise relative to import prices, allowing a nation to purchase.
Calculation
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Factors affecting terms of trade
Exchange rates: A depreciation in the domestic currency makes imports more expensive and exports cheaper, potentially worsening the terms of trade. Conversely, currency appreciation may improve them by lowering import costs.
Changes in productivity: Increased productivity in export sectors can lower production costs, reducing export prices. While this may benefit global competitiveness, it can negatively affect a country's terms of trade if prices fall significantly.
Changes in real income: Rising real incomes often increase demand for imported goods, particularly luxury items. This heightened import demand can worsen the terms of trade if export prices do not increase correspondingly.
Consequences of changes in terms of trade
Balance of payments improvement: Improved terms of trade can enhance a country’s balance of payments, as higher export prices generate increased revenue, reducing trade deficits and supporting foreign exchange reserves.
Reduced economic growth: Worsening terms of trade may limit export revenues, reducing funds available for investment and slowing economic growth, especially in nations heavily reliant on trade.
Increased unemployment: When terms of trade deteriorate, industries producing exports may scale back production due to lower revenues, potentially leading to job losses and rising unemployment rates.
Trading Blocs
Types of trading blocs
Regional Trading Blocs: These are formed by neighbouring countries to promote trade within a specific geographic area, such as the European Union, enhancing economic cooperation and integration.
Customs Unions: Member countries remove trade barriers among themselves and adopt a common external tariff on non-member nations, ensuring uniform trade policies.
Common Market: A common market goes further than a free movement of goods, services, labour, and capital across member states, fostering deeper economic integration.
Economic Unions: These involve closer integration of economic policies, including harmonised taxation and monetary policies, alongside the free movement of goods, services, and factors of production.
Political Unions: Political unions represent the highest level of integration, combining economic unification with shared governance structures, often requiring significant sovereignty concessions from member states.
Monetary Unions: A monetary union entails member countries adopting a shared currency and central bank, such as the Eurozone, which facilitates trade and reduces exchange rate risks.
Free Trade Areas (FTAs): In FTAs, member countries eliminate tariffs and quotas on trade between themselves while maintaining independent trade policies with non-members.
Preferential Trading Areas (PTAs): PTAs reduce tariffs on specific goods traded between member nations but do not eliminate all barriers, offering a more limited scope of trade liberalisation.
Advantages of Trading Blocs
Gain of Economies of Scale
Firms in trading blocs can produce on a larger scale, lowering average costs and improving competitiveness through access to broader markets and reduced duplication of effort.
Larger Markets
Trading blocs create expansive markets, allowing firms to reach more consumers and diversify their revenue streams, supporting business growth and innovation.
Increased Competition
The removal of trade barriers fosters competition, pushing firms to improve efficiency, reduce costs, and innovate to maintain market share.
Increased Choice
Consumers benefit from a wider variety of goods and services, as trading blocs encourage the competitive prices.
Increased Employment
Expanded trade and investment within trading blocs often lead to job creation in export-oriented industries, boosting overall employment levels in member nations.
Disadvantages of Trading Blocs
Distortion of World Trade
Trading blocs may divert trade from efficient non-member producers to less efficient member producers, disrupting global trade patterns and reducing overall economic welfare.
Loss of Factors of Production
The free movement of labour and capital within blocs can result in resource imbalances, as skilled workers and investment gravitate towards wealthier member states.
Reduced Competition
Some firms within trading blocs may gain monopolistic power due to reduced external competition, potentially leading to higher prices and inefficiency.
Retaliations
Non-member countries may impose retaliatory tariffs or restrictions, escalating trade tensions and potentially harming global economic stability.
Trade Diversion
Trade blocs can divert trade from low-cost global producers to higher-cost bloc members, resulting in inefficiencies and higher prices for consumers.
World Trade Organisation (WTO)
The role of the WTO
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Conflicts of WTO
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Free trade restrictions
Reasoning for free trade restrictions
Infant industry argument:
Overdependency:
Terms of trade:
Types of free trade restrictions
Tariffs:
Quotas:
Non-tariff barriers:
Protectionism
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Consequences of protectionism
Consumers
Higher prices:
Decreased choice:
Producers
Increased revenue:
Higher cost of production:
Workers
Increased employment:
Governments
Increase in tax revenue:
Political advantage:
Balance of payments
Components of the balance of payments
Current account:
Capital and financial accounts:
Causes of deficits and surpluses
Short term
High demand:
Exchange rates:
Inflation:
Long term
Deindustrialisation:
Lack of productivity:
Corruption:
How to reduce balance of payments imbalances
Fiscal and monetary policies:
Supply side policies:
Importance of a current account balance
Important
Prevents foreign debt: A balanced current account helps avoid reliance on foreign countries, reducing vulnerability to foreign currency fluctuations.
Strengthens currency: Large current account deficits may drive down the price of a domestic currency because the supply of this currency on the foreign exchange market is likely to be high. Therefore, by keeping a balanced current account, the currency used by this country is expected to stay strong thus protecting economic agents from price spikes of imports and exports.
Protection against external shocks: Countries with a current account deficit tend to be more reliant on global capital flows, which in times of economic crises, slow down. By becoming less reliant on capital flows, a country is protected from external shocks.
Not important
Supports economic growth: Countries with a current account deficit may see long-term benefits, such as economic growth, if their borrowing is spent on supply side policies. Additionally, the use of supply side policies may reduce the imbalance in the future.
Debts are sustainable: Countries with huge national debts such as the US and UK have not had problems in financing current account deficits, thus meaning these debts are not unsustainable.
Prevents losses for citizens: If a country holds a current account surplus, it could imply that citizens are not fully enjoying the benefits of economic output, as resources are being directed outward instead of toward domestic consumption and investment.
International competitiveness
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Measurements of international competitiveness
Relative unit labour costs:
Relative export prices:
Factors that influence international competitiveness
Productivity:
Investment:
Taxation:
Exchange rates:
Inflation:
Economic stability:
Labour market flexibility:
Trade barriers:
Government regulation:
Advantages of competitiveness
Current account surplus:
Increased foreign direct investment (FDI):
Increased economic growth:
Disadvantages of competitiveness
Overdependency:
Pressure on wages:
Environmental effect: