14 - The International Economy: Globalisation and International Trade Flashcards
(144 cards)
1
Q
What is globalisation?
A
The process of increasing economic integration of the world’s economies
2
Q
What are causes of globalisation?
A
- Improvements in information and communication technology (ICT)
- Developments in transport
- Other more traditional forms of technology
3
Q
What are examples of globalisation?
A
- Service industries in the UK dealing with customers through call centres in India
- Fashion companies designing their product in Europe, making them in southeast Asia and finally selling point of most of them in North America
4
Q
What are the main characteristics/factors contributing to globalisation?
A
- Trade in goods
- Trade in services
- Trade liberalisation
- Multinational Corporations (MNCs)
- International financial flows
- Communications and IT
- Containerisation
5
Q
How is ‘trade in goods’ a characteristic/factor contributing to globalisation?
A
- Developing countries have acquired the capital and knowledge to manufacture goods
- The efficient forms of transport make it easier and cheaper to transfer goods across international borders
- MNCs relocate production to developing nations due to cheaper labor costs, prompting trade between developed and developing countries for access to manufactured goods.
6
Q
How is ‘trade in services’ a characteristic/factor contributing to globalisation?
A
- E.g., the trade of tourism, call centre services, and software production has increased from developing countries to developed countries
7
Q
How is ‘trade liberalisation’ a characteristic/factor contributing to globalisation?
A
The growing strength and influence of organisations e.g. the World Trade Organisation (WTO)
8
Q
What is the World Trade Organisation (WTO)?
A
An international body which advocates free trade and has contributed to the decline in trade barriers
9
Q
How are ‘multinational corporations (MNCs)’ a characteristic/factor contributing to globalisation?
A
- They have used marketing to become global
- By growing, they have been able to take advantage of economies of scale, such as risk-bearing economies of scale has resulted in lower costs of production
10
Q
What are multinational corporations (MNCs)?
A
MNCs are organisations which own or control the production of goods and services in multiple countries
11
Q
What are the roles of multinational corporations (MNCs)?
A
-Economic integration and increased trade - led to global production platforms, enabling specialisation and leveraging the global division of labor.
- Investment and technology transfers - occur globally as firms seek optimal business opportunities, with technology flowing from developed to emerging economies.
- Changing employment patterns and global capitalism -involve the creation of millions of jobs, particularly in countries like China and India, coordinated by MNCs. These firms use their leverage to demand favourable business environments.
- The global marketplace and international brands - MNCs compete globally, operating on a large scale to benefit from economies of scale and reduce average production costs.
12
Q
How are ‘international financial flows’ a characteristic/factor contributing to globalisation?
A
- For example, the flow of capital and FDI across international borders has increased. China and Malaysia have financed their growth with capital flows
- The foreign ownership of firms has increased. There has been more investment in factories abroad
- The removal of capital controls has facilitated this increase
13
Q
How is ‘communications and IT’ a characteristic/factor contributing to globalisation?
A
- The spread of IT has resulted in it becoming easier and cheaper to communicate, which has led to the world being more interconnected
-There’re better transport links and the transfer of information has been made easier
14
Q
How is ‘containerisation’ a characteristic/factor contributing to globalisation?
A
- This has resulted in it becoming cheaper to ship goods across the world. This causes prices to fall, which helps make the market more competitive
- Containerisation helps to meet world demand as cargo can be moved 20x as fast as before
- However, it is mainly MNCs which have been able to exploit this, and it could result in some structural unemployment
15
Q
What is containerisation?
A
When goods are distributed in standard sized containers, so it is easier to load and cheaper to distribute using rail and seas transport
16
Q
What’re the consequences of globalisation?
A
- Individual countries
- Governments
- Producers and consumers
- Workers
- The environment
17
Q
What are the benefits of globalisation?
A
- Greater competition
- Increased investment
- Free movement of labour
18
Q
How is greater competition a benefit of globalisation?
A
- Domestic monopolies used to be protected by a lack of competition
- However, globalisation means that firms face greater competition from foreign firms
19
Q
How are workers/free movement of labour a benefit of globalisation?
A
- Workers can take advantage of job opportunities across the globe, rather than just in their home country
- However, structural unemployment may arise due to shifts in industries, as seen in the UK with the decline of shipbuilding and mining, leading to job losses
- It could be argued that countries would have had the change from agriculture to manufacturing to services anyway, and globalisation simply sped it up
- When production shifts to lower labour cost countries, the creation of jobs could be seen as either beneficial or harmful. On one hand, MNCs could be exploiting their labour and providing poor working conditions in e.g. sweetshops. On the other hand, working in a sweatshop might provide a higher, more stable income than any alternatives, such as agriculture
20
Q
How is Increased investment a benefit of globalisation?
A
- Globalisation has enabled increased levels of investment. It has made it easier for countries to attract short-term and long-term investment
- Investment by multinational companies can play a big role in improving the economies of developing countries
21
Q
How are producers and consumers a consequence of globalisation?
A
- Specialisation and economies of scale benefit consumers and producers as firms expand.
- Increased competition drives firms to lower average costs and enhance efficiency.
- Globalisation enables producers to lower costs by relocating to areas with cheaper labor and adopting advanced technology.
- While globalisation generally boosts world GDP, its exact contribution to growth is difficult to quantify.
- Rising consumer incomes, driven by increased demand from countries like China, can offset production cost reductions, especially in commodities.
- Globalisation has reduced extreme poverty globally, but not in regions like Sub-Saharan Africa, potentially exacerbating inequality.
- Consumers enjoy a wider range of goods and services due to globalisation, although some services may become standardised, such as hotels.
22
Q
What’re the costs of globalisation?
A
- Free trade
- The environment
- Tax competition and tax avoidance
- Labour drain
23
Q
How is tax competition and tax avoidance a cost of globalisation?
A
- MNCs like Amazon and Google, can set up offices in countries like Bermuda and etc with very low rates of corporation tax and then funnel their profits through these subsidiaries
- This means they pay very little tax in the countries where they do most of their business. This means governments have to increase taxes on VAT and income tax
- It is also seen as unfair competition for domestic firms who don’t use the same tax avoidance measures.
- The greater mobility of capital means that countries have sought to encourage inward investment by offering the lowest corporation tax. (e.g. Ireland offers very low tax rate)
- This has encouraged lower corporation tax, which leads to higher forms of other tax
24
Q
How is labour drain a cost of globalisation?
A
- Globalisation enables workers to move more freely
- Therefore, some countries find it difficult to hold onto their best-skilled workers, who are attracted by higher wages elsewhere.
25
How are individual countries/free trade a cost of globalisation?
- There could be trade imbalances between countries e.g. the US runs a large current account deficit with China
- There could be imbalances and inequalities in consumers' and countries' accesses to health, education and markets
- There could be income and wealth inequalities (within individual countries) if the benefits and costs of globalisation are not evenly spread e.g. China's rural-urban divide
- Culture could spread across the globe. Some might say this has weakened culture and that there's been a loss of cultural diversity due to global brands. However, others will argue that the spread of culture has been positive and helped to improve their quality of life
26
How are governments a cost of globalisation?
- Some governments might lose their sovereignty due to the increase in national treaties
- Individual states would find it hard to resist the force of them, they will have to abide by their rules
27
How is the environment a cost of globalisation?
- Consumers might show more concern towards the environment as their average income increase
- Negative impacts on the environment could include deforestation, water scarcity and land degradation
28
What is absolute advantage?
When a countries production of a good or service can produce them using fewer resources and at a lower cost than another country
29
Who has absolute advantage in this table? (table 14.1 pg501)
- Atlantis has an absolute advantage in producing guns as its 4x better in gun production than Pacifica
- Pacifica has an absolute advantage in butter production as its 3x better in butter production
30
What does production without specialisation mean and how is it shown in the table (table 14.2)?
- If both countries you're comparing devote half their total resources to each activity (country have 2 units available and use only 1 unit of resource)
- Without specialisation, Atlantis produces 4 guns and Pacifica produces 1 gun, which means that 5 guns are produced in total
- For butter production, without specialisation, total butter production is 8 tonnes. Atlantis produces 2 tonnes and Pacifica produces 6 tonnes
31
What does production with complete specialisation mean and how is it shown in the table (table14.3)?
- Each country produces only the good in which it has an absolute advantage
- Table shows that if Atlantis devotes both its resources units to guns, it produces 8 guns
- Table shows if Pacifica completely specialises, the country produces 12 tonnes of butter with its 2 units of resource
32
What does this diagram show (table 14.4)?
How when each country enjoys an absolute advantage in a different good, complete specialisation results in more of good being produced
33
Explain what is being shown within the diagram(table 14.4)?
- Specialisation produces net output gain of 3 guns and 4 tonnes of butter. Since more has been produced, more can be consumed, and it is possible to make people better off
- However, for output gains to translate into gains from trade, two further factors have to be taken into account
- First, Administration and transport costs are inherent in trade, reducing the net gains from specialisation and trade ((3 guns + 4 tonnes of butter) - transport and administration costs). Therefore, trade is only beneficial if the gains from specialisation exceed these costs.
- Second, For trade to translate into welfare gains for both countries, the traded goods must be in demand, and each country must export its surplus to satisfy the other country's demand after meeting its own inhabitants' needs for the specialised goods.
- The idea that based on circumstances, without suitable demand conditions, the case for specialisation and trade disappears
34
What is a comparative advantage?
Occurs when a country can produce a good or service at a lower opportunity cost than another country. This means they have to give up producing less of another good rather than another country, using the same resources
35
Explain how a comparative advantage is present within this table (table 14.5)
- Although Atlantis has an absolute advantage in producing both guns and butter, the country possesses a comparative advantage in the production of guns but has a comparative advantage in the production of butter
- The country that gives up least of the other commodity when increasing output of a particular commodity by 1 unit possesses a comparative advantage in that good
- Atlantis has to give up 2 guns to increase its output of butter by 1 tonne but Pacifica only has to give up 1 gun to produce an extra tonne of butter production even though it has an absolute disadvantage in both products
36
What is free trade?
The act of trading between nations without protectionist barriers, such as tariffs, quotas or regulations
37
What quality controls can import controls be divided into?
Import quotas (which put a maximum limit on imports), and tariffs or import/export duties (which raise the price of imports/ reduce the price of exports)
38
What are quotas?
Physical limits on the quantities of imported goods allowed into a country
39
What are tariffs?
Taxes imposed on imports from other countries entering a country
40
What are export subsidies?
Money given to domestic firms by the government to encourage firms to sell their products abroad and to help make their goods cheaper in exports markets
41
What benefits does free trade provide?
- Countries can exploit their comparative advantage, which leads to a higher output using fewer resources and increases world GDP. This improves living standards
- Free trade increases economic efficiency by establishing a competitive market. This lowers the cost of production and increases output
- By freely trading goods, there is trade creation because there are fewer barriers. This means there is more consumption and large increase in economic welfare
- More exports could lead to higher rates of economic growth
- Specialising means countries can exploit economies of scale, which will lower their average costs
42
What're the costs of free trade?
- Free trade has resulted in some job losses as countries with lower labour costs have entered the market
- Free trade might have contributed to some environmental damage, especially from the increase in manufacturing
43
What're the reasons for the changes in pattern of trade between the UK and the rest of the world?
- Comparative advantage
- Impact of emerging economies
- Growth of trading blocs and bilateral trading agreements
- Changes in relative exchange rates
44
How is 'comparative advantage' a reason for the changes in pattern of trade between the UK and the rest of the world?
- Developing countries have experienced a surge in manufactured goods exports to developed nations, driven by their competitive advantage in production stemming from lower labor costs, prompting production relocation
- The deindustrialisation of countries such as the UK has meant the manufacturing sector has declined. This means that production of manufactured goods has shifted to other countries, such as China, whilst the UK now focuses more on services, such as finance
- This has led to the industrialisation of China and India. Their share of world trade has and the volume of manufactured goods that they export has increased
- However, since China’s population is now ageing, their wage competitiveness has fallen. This is also due to the rise of the middle class in China, who demand higher wages and consume more
45
How is 'Impacts of emerging economies' a reason for the changes in pattern of trade between the UK and the rest of the world?
- The collapse of communism has meant that more countries, especially developing countries, are participating in world trade
- International trade is arguably more important for developing countries than developed countries
- For example, China and India are important for African infrastructure. They have invested in their infrastructure in exchange for natural resources.
46
How is 'growth of trading blocs and bilateral trading agreements' a reason for the changes in pattern of trade between the UK and the rest of the world?
- With more trading blocs, trade has been created between members, but diverted from elsewhere
- Trade creation occurs when a country consumes more imports from a low cost producer, and fewer from a high cost producer
- Trade diversion occurs when trade shifts to a less efficient producer
- Protectionist barriers are often imposed on countries who are not members, so trade is diverted from producers outside the bloc to producers within the trading bloc.
- The policies of developed countries have limited the ability of developing countries to export primary commodities. E.g. The EU Common Agricultural Policy (CAP)
47
How is 'changes in relative exchange rates' a reason for the changes in pattern of trade between the UK and the rest of the world?
- China has been running a trade surplus with the US and since 2006 the US trade deficit has narrowed with China, and China has reduced their trade surplus, too.
- China has planned this change from export-led growth to growth fuelled by domestic consumption.
- When running the trade surplus, China had kept their currency’s value low, in order to make their exports relatively cheap.
- Could be argued that one of the reasons for the UK’s current account deficit is the strength of the pound compared to the Euro. E.g. In 2015, it reached a seven year high against the Euro
48
What is protectionism?
The act of guarding a country's industries from foreign competition
49
What are the methods of protectionism?
- Tariffs
- Quotas
- Export subsidies
- Embargoes
- Excessive administrative burdens ('red tape')
50
What impact do tariffs have for protectionism?
- It could lead to retaliation, so exports might decrease
- Their impact is that the quantity demanded of domestic goods increases, whilst the quantity demanded of imports decreases
51
What does this tariff diagram show? (physics and maths)
- It illustrates the effects of imposing a tariff
- The original quantity of imports is Q2 – Q1, and the new quantity of imports is Q4 – Q3
- The purple rectangle shows the revenue the government gains from imposing the tariff. This could help finance government expenditure
- The blue triangles show the area of deadweight loss of welfare, as a result of the tariff
52
What impact do quotas have for protectionism?
Leads to a rise in the price of the good for domestic consumers, so they become worse off
53
What impact do export subsidies have for protectionism?
- Helps firms to make their goods cheaper in exports markets
- Government might use direct payments, tax relief, or provide cheap access to credit
54
What impact do embargoes have for protectionism?
- This is the complete ban on trade with a particular country
- Usually politically motivated
55
What impact do excessive administrative burdens ('red tapes') have for protectionism?
- Increases the cost of trading, and hence discourages imports
- It makes it difficult to trade with countries imposing red tape
- Particularly harmful for developing countries which are unable to access these markets
- (Harder to notice this type of protectionism, which is why it is favoured among some countries)
56
What're the potential benefits of countries adopting protectionist policies?
- Infant industries might need protecting. Protectionism is usually short term until the industry develops, at which point the industry can trade freely
- Could be used to correct market failure. It can deal with demerit goods and protect society from them
- Governments might employ protectionist measures to improve the current account deficit
- Governments might want to protect domestic jobs
- If a country employed multiple policies then a trade deficit would reduce as they will be importing less due to tariffs and quotas on imports
57
What're the potential costs/consequences of countries adopting protectionist policies?
- Protectionism could distort the market and lead to a loss of allocative efficiency.
- It prevents industries from competing in a competitive market and there is a loss of consumer welfare
- It imposes an extra cost on exporters, which could lower output and damage the economy.
- Tariffs are regressive and are most damaging to those on low and fixed incomes
- There is a risk of retaliation from other countries, so import and consumer prices might increase
- Protectionism could lead to government failure
58
What are custom unions?
Trading blocs in which member countries enjoy internal free trade in goods and possibly services, with all the member countries protected by a common external tariff barrier
59
What are the main features of a customs union?
- Common markets establish free trade in goods and services, a common external tariff and allow free movement of capital and labour across borders
- E.g. When the EU was established, it was a Common Market. EU citizens can work in any country in the EU
60
What are the additional (not main) features of a customs union
- Safety measures for imported goods, such as for food, are common across all members
- There are common customs rules and procedures
- There is a structure for the combined administration of the nations within the Customs Union
- There is a common trade policy. This helps to create and guide trading relationships with countries and blocs outside the Customs Union
61
What are the main characteristics of the Single European Market (SEM)?
- Free movement of goods, services, capital and labour between nations
- Administrative provisions, laws and regulators are approximated between number nations. This could mean some laws are better suited to some countries, and not so much for others
- Competition policy is common across the whole of the EU
- There are common external tariffs
62
What are the possible consequences for the UK of its membership of the EU?
- Trade creation and trade diversion
- Reduced transaction costs
- Economies of scale
- Enhanced competition
- Migration
63
How is trade creation and trade diversion a possible consequence for the UK of its membership of the EU?
- With more trading blocs, trade has been created between members, but diverted from elsewhere
- Usually, a country might stop importing from a cheaper producer outside a trading bloc to a more expensive one inside the trading bloc.
- Protectionist barriers are often imposed on countries who are not members, so trade is diverted from producers outside the bloc to producers within the trading bloc
- The UK trades mainly with the EU, at the expense of former trade links in the Commonwealth.
64
How is reduced transaction costs a possible consequence for the UK of its membership of the EU?
As there's no barriers to trade or no border controls, it is cheaper and simpler to trade
65
How is economies of scale a possible consequence for the UK of its membership of the EU?
- Firms can take advantage of a larger potential market in which to trade
- By specialising, firms and countries can exploit their comparative advantages, and the gains of efficiency and advanced technology can be reaped.
66
How is enhanced competition a possible consequence for the UK of its membership of the EU?
- As firms operate in a more competitive market, they become more efficient and there is a better allocation of resources
- There could be the long run benefits of dynamic efficiency too, although these benefits are not always spread evenly across each member.
67
How is migration a possible consequence for the UK of its membership of the EU?
- By being a member of a Customs Union, the supply of labour is increased, which could help fill labour shortages.
- However, this might mean some countries lose their best workers.
68
What is the role of The World Trade Organisation (WTO)?
- Promotes world trade through reducing trade barriers and policing existing agreements
- Settles trade disputes, by acting as the judge, and organises trade negotiations
- Every member of the WTO must follow the rules. Those who break the rules face trade sanctions
- To trade in goods, the WTO covers the trade in services and intellectual property rights.
69
What are the possible conflicts between regional trade agreements and the WTO?
- Trading blocs may distort global trade and harm non-members, such as through inefficient resource allocation like in the EU's Common Agricultural Policy (CAP)
- Bloc conflicts can increase protectionism, as seen with common external tariffs contradicting WTO principles by imposing barriers on non-members
- Some criticise the WTO for its perceived dominance and neglect of developing countries, with limited free trade hindering their growth
- Customs unions or free trade areas may seem discriminatory under WTO principles, especially with common external tariffs, but they can complement the trading system. The WTO aims to ensure non-members can freely trade with bloc members
70
What is the balance of payments?
The Balance of Payments is a record of a country’s transactions with the rest of the world. It shows the receipts from trade, exports and imports. It consists of the current and financial and capital account.
71
What are four main factors the balance of payments is broken down?
- the current account
- the financial account
- the capital account
- balancing item
72
How do you show exports and imports of goods and services in the balance of payments?
Exports are positive in the balance of payments, inflow of money.
Imports are negative in the balance of payments, outflow of money.
73
What is the current account? (Split into four sections)
This is a record of all payments for trade in goods and services plus income flow, divided into four parts:
- Balance of trade in goods (visibles)
- Balance of trade in services (invisibles) e.g. tourism, insurance.
- Net Primary income flows (wages and investment income)
- Net Secondary income flows (e.g. government transfers to UN, EU, military aid)
74
What is a financial accounts (in balance of payments) and what is its 3 sections it’s split into?
The part of the balance of payments which records capital flows in and out of the country.
- Net Balance of FDI Foreign Direct Investment
- Net Balance of Portfolio flows (e.g flows of debt, equity, savings)
- Short-term monetary flows, know as Hot Money
75
What is the capital account, in the balance of payments?
This refers to the transfer of funds associated with buying fixed assets such as land.
76
What does the balancing item mean, in the balance of payments?
The components of the balance of payments should balance. The sum should be zero. Where they are imbalances, a balancing item is used to cover the imbalances.
77
Why is the UK at a net current account deficit? And how does the UK account for this?
As the UK spends more on imports than earns on exports. This could lead the difficulties to finances this deficit.
The UK is able to allow this as it is in a Financial Account surplus.
78
What causes of balance of payments disequilibrium?
- Appreciation of the Currency
- Economic Growth
- More Competitive
- Deindustrialisation
- Membership of trade Union
- Attractiveness to foreign investors
79
By definition, where there is a current account surplus …
There is a capital and financial deficit.
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How does an appreciation of the currency, cause a disequilibrium in balance of payments?
a stronger currency means imports are cheaper
and exports are relatively more expensive, which means the current account
deficit would worsen.
83
How does economic growth, cause a disequilibrium in balance of payments?
when consumer incomes increase, demand increases. This could increase demand for imports. This is especially true of a country such as the UK, where consumers have a high propensity to import.
84
How does more competitive cause a disequilibrium in balance of payments?
If a country becomes more internationally competitive, such as with lower inflation or if there is economic growth in export markets, exports should increase. This also occurs when a country becomes more productive, since that causes average unit costs to fall. This could cause the current account deficit to improve, or increase the current account surplus.
85
How does Deindustrialisation, cause a disequilibrium in balance of payments?
In the UK, the manufacturing sector has been declining since the 1970s. The goods that the UK previously made domestically now have to be imported, which worsens the deficit.
86
How does membership of trade Union , cause a disequilibrium in balance of payments?
The UK has traditionally had negative current
transfers, since fees are paid for membership of the EU.
87
How does attractiveness to foreign investors, cause a disequilibrium in balance of payments?
A capital account surplus could be caused by
incoming finance from investors buying UK bonds, securities and financial derivatives. This could help fund a current account deficit.
88
What is an absolute advantage?
A country has an absolute advantage if it can produce more of a good with a given amount of resources than any other country.
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What is an absolute advantage?
A country has an absolute advantage if it can produce more of a good with a given amount of resources than any other country.
90
What is a competitive advantage?
This is measured in terms of opportunity cost. The country with the least opportunity cost when producing a good possesses a comparative advantage in that good.
91
What is a competitive advantage?
This is measured in terms of opportunity cost. The country with the least opportunity cost when producing a good possesses a comparative advantage in that good.
92
How does the state in the economic cycle affect the current account deficit?
In the UK, during periods of economic decline or recessions, the current account deficit falls. This is because consumer spending falls.
During periods of economic growth, when consumers have higher incomes and they can afford to consume more, there is a larger deficit on the current account.
93
What would cause a positive in the balance of payments?
By selling more exports to foreign countries, the UK will have a greater inflow of money into the circular flow of income. This will increase AD and improve the rate of economic growth.
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Draw the diagram you would use to describe how an increase in exports can affect the national economy.
95
Explain this diagram how an increase in exports can affect the national economy.
96
Use a part of the AD equation for where the is a current account deficit and surplus
X > M - current account surplus
(More exports than imports so more inflows of money than out flows of money)
X < M
(More imports than exports so more outflows of money than inflows of money)
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What is FDI?
FDI is the flow of capital from one country to another, in order to gain a lasting interest in an enterprise in the foreign country.
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How does Productivity influence a country’s current account balance?
Directly affects the success of supply side policies. And effecting the quality competitiveness of a country’s exports in international markets.
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How does Exchange Rate influence a country’s current account balance?
Effect the competitiveness of imports and exports, therefore effecting the amount of imports and exports which effect the current account.
100
How does Inflation influence a country’s current account balance?
101
What are the two types of policies to reduce balance of payments deficit?
1) Expenditure-reducing policy
2) Expenditure-switching policy
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What are expenditure-reducing policy?
A government policy which aims to eliminate a current account deficit by reducing the demand for imports by reducing the level of aggregate demand in the economy. Conversely, to reduce a current account surplus, aggregate demand would be increased and spending on imports would wise.
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What are expenditure-switching policy?
A government policy which aims to reduce a current account deficit by switching domestic demand away from imports to domestically produce goods. Conversely, to reduce a current account surplus, the policy would aim to switch domestic demand away from domestically produced goods toward imports.
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What are the expenditure-reducing policy?
Deflation
Contractionary monetary policy or fiscal policy which reduce aggregate demand.
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What are the expenditure-switching policy?
Direct Controls - import controls like tariffs
Devaluation - lowering the exchange rate, from a devaluation
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What are the policies used to reduce a current account deficit?
1. Devaluation
2. Monetary Policy (Deflationary Policy)
3. Deflationary fiscal policy
4. Supply Side Policies
5. Lower wages
6. Protectionism
107
What is the consequences of FDI?
Foreign multinationals might take advantage of weak laws on environmental protections
Multinationals (e.g. clothing companies) have been criticised for poor working conditions in foreign factories when outsourcing production
Profits from FDI are often repatriated to shareholders in the host country (an outflow from the circular flow)
Multinationals may only employ local labour in lower-skilled jobs rather than skilled, managerial roles
The share of locally sourced components for FDI projects is often relatively low – this reduces the multiplier effect of inward investment.
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What are the advantages of FDI
Capital inflows create higher output and jobs.
Capital inflows can help finance a current account deficit
Recipient country can benefit from improved knowledge and expertise of foreign multinational.
Investment from abroad could lead to higher wages and improved working conditions, especially if the MNCs are conscious of their public image of working conditions in developing economies.
Better transport.
109
How is Devaluation a policy to reduce a current account deficit?
This involves reducing the value of the currency against others. (e.g. selling pounds would cause the value of the Pound to fall)
If there is a devaluation of the currency, the price of imported goods increases and therefore the quantity demanded of imports falls.
Exports will become cheaper, and there will be an increase in the quantity of exports.
Therefore, assuming demand is relatively price elastic, we would expect a devaluation to lead to an improvement in (X-M) and therefore the current account on the balance of payments.
However, it does depend upon the elasticity of demand for exports and imports.
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Explain using a graph the drawback (evaluation( of using Devaluation as a policy to reduce current account deficit?
Depends upon the price elasticities of demand for exports and imports.
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How is Monetary Policy a policy to reduce a current account deficit?
Tight monetary policy involves increasing interest rates.
Higher interest rates will increase the cost of debt and mortgage repayments and leave people with less money to spend. Therefore, this will reduce their consumption of imports, improving the current account.
Also, higher interest rates will cause a fall in AD and therefore reduce economic growth. This will reduce inflation and help to make UK exports more competitive.
Deflationary policies will also put pressure on manufacturers to reduce costs, and this will lead to more competitive exports, and so exports may increase in the long run because of this effect.
112
What is the disadvantage of using monetary policy as a policy to reduce current account deficit?
(VERY GOOD POINT)
The main issue with using monetary policy to reduce a current account deficit is that an increase in interest rates will tend to cause HOT MONEY flows and therefore an appreciation in the exchange rate. This appreciation makes exports less competitive, and imports more attractive. Assuming demand is relatively elastic, this appreciation will worsen the current account.
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What is the evaluation of using monetary policy as a policy to reduce current account deficit?
Therefore, monetary policy has two conflicting effects.
Higher interest rates reduce spending on imports – improving the current account.
But, on the other hand, higher interest rates cause an appreciation in the exchange rate – worsening the current account.
Evaluation:
The overall effect is uncertain – it depends on which effect is bigger.
However, since the UK has a high marginal propensity to import, higher interest rates will tend to cause a reduction in AD and improve the current account significantly.
It depends on many other factors, for example, if the economy is growing strongly, a rise in interest rates may not actually reduce consumer spending – because income growth is high and confidence high.
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How is Fiscal Policy a policy to reduce a current account deficit?
An alternative to using monetary policy is to use fiscal policy. For example, the government could increase income tax. This would reduce consumer discretionary income and reduce spending on imports.
Governments could also reduce their spending. This would reduce AD and lead to less imports. It forces domestic firms into increasing exports, which helps improve the disequilibrium.
The advantage of fiscal policy is that it would not have an adverse effect on the exchange rate. Higher income tax would also improve government finances.
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What is the disadvantage of using Fiscal Policy a policy to reduce a current account deficit?
However this policy will conflict with other macroeconomic objectives – with lower aggregate demand (AD), growth is likely to fall causing higher unemployment. A government is unlikely to want to risk higher unemployment just to reduce a current account deficit.
Fiscal policy is effective in the short term, but not so much in the long term. As soon as the policy measures end, household are likely to revert their expenditure back on imports.
If taxes are imposed on trading partners, there is the risk of retaliation, which could reduce demand for exports, too.
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How is Supply Side policies a policy to reduce a current account deficit? And the disadvantages
Supply-side policies could help increase productivity with increased spending on education and training, which could result in the country becoming more internationally competitive. This could lead to a rise in exports. However, this incurs a significant time lag, so it is not effective as an immediate measure. In the long term, this can be an effective policy.
Supply-side policies could also help make the domestic economy attractive to investors.
The domestic economy could be made more competitive through deregulation and privatisation, which will force firms to lower their average costs. However, privatisation could result in monopolies being formed, which will not increase efficiency.
If governments provide subsidies to some industries to encourage production, there could be retaliation from foreign countries that see this as an unfair protectionist policy.
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How is Lower Wages a policy to reduce a current account deficit?
A policy used by many Eurozone economies facing a large current account deficit (but unable to devalue within single currency) is to reduce wages. Lower wages will reduce costs of production and improve competitiveness.
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What is the disadvantage of using Lower Wages a policy to reduce a current account deficit?
However, lower wages will also lead to lower aggregate demand and could lead to deflation and low growth.
If the government cut public sector wages, it may have limited impact on improving the competitiveness of exports.
Reducing wages is also known as internal devaluation.
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How is Protectionism a policy to reduce a current account deficit?
The government could increased tariffs on imports or even impose quotas. Both these measures would have the impact of reducing imports and therefore improve the current account.
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What is the disadvantage of using Protectionsim a policy to reduce a current account deficit?
Protectionism may lead to retaliation – with other countries placing tariffs on our exports – so exports could decrease.
Protected by tariffs – domestic industries may become uncompetitive because there is less incentive to cut costs.
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What are the policies to correct a balance of payments surplus?
Reflating demand, via expansionary monetary policy or fiscal policy. Increase a country’s demand for imports
Trade can be liberalised removing import controls
Re-value.
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What does a surplus or deficit on the current account indicate?
A surplus or deficit on the current account could indicate an unbalanced economy, and it could mean the country is too reliant on other economies for their own growth.
It could be difficult to attract sufficient financial flows in order to finance a current account deficit. This could make it unsustainable in the long run.
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What has international trade affect the current account surplus and deficit?
International trade has meant countries have become interdependent. Therefore, the economic conditions in one country affect another country, since the quantity they export or import will change.
If imported raw materials are expensive, there could be cost-push inflation in the domestic economy, since firms face higher production costs.
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What does an imbalance payments in the UK suggest?
An imbalance suggests that the UK is reliant on the performance of other countries. If export markets, such as the EU, become weak, UK economic performance will be affected. This was seen during the 2008 financial crisis.
125
Explain how the US current account works.
USA is the country which runs a large current account deficit importing far more than it exports. Most these imports from China. China enjoys this as they have a ready market for its exports. But American also benefit from cheaper components and consumer goods and labour is cheaper there so production cost is lower so total cost is lower.
However this could cause Americans to lose jobs as people will only relied on imports. To correct this deficit and save American jobs they could adopt a Protectionist policy. By subsidising its farmers or entrepreneurs to make their exports more competitive and therefore more exports and less imports needed. Also US have imposed tariffs on China.
126
Explain how it can be difficult to finance the deficit in the long run using the US as an example.
It could become difficult to finance the deficit in the long run. In the US, the current account deficit is financed by Chinese investors buying US securities at low interest rates. If they lose confidence in the US economy, they would stop buying US debt. The interest rates would then have to be increased to encourage investors to buy the debt. This would be damaging to US consumers who have a lot of debt, since repayments would increase, and they would have less disposable income as a result.
127
Explain how it can be difficult to finance the deficit in the long run using the US as an example.
It could become difficult to finance the deficit in the long run. In the US, the current account deficit is financed by Chinese investors buying US securities at low interest rates. If they lose confidence in the US economy, they would stop buying US debt. The interest rates would then have to be increased to encourage investors to buy the debt. This would be damaging to US consumers who have a lot of debt, since repayments would increase, and they would have less disposable income as a result.
128
What is an example of a Country undervaluing their currency?
China made their exports more competitive by undervaluing their currency. This makes their imports more expensive, however, so it could be inflationary and cause a boom or bust. A stronger Yuan causes lower growth, lower inflation and reduces the current account surplus. The US would prefer a stronger Yuan since it makes their domestic industries more competitive.
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130
Draw a diagram for a market closed to international trade, including the consumer and producer surplus.
131
Draw a diagram for a country with free trade.
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Explain this free trade economy diagram.
Consumer surplus is are of A+B+C, and producer surplus is area D. The domestic production has been contracted to QS1 and domestic consumption has increased to QD1
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What is the diagram for tariff’s on free trade?
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Explain this tariffs free trade diagram simply.
- More Domestic Supply and Less Imports
- In this case, the tariff is P1-P2.
- The tariff leads to a decline in imports. - Imports were Q4-Q1. After the tariff, imports fall to Q3-Q2.
- Consumer surplus falls by 1+2+3+4
- Government raises tariff revenue of area 3
- Domestic suppliers gain an increase in producer surplus of area 1
- The net welfare loss is (1+2+3+4) – (1+3) = 2+4
135
Explain this tarrif diagram.
136
What is the government revenue of this diagram?
Tariff revenue = tariff × q. of imports (£0.40 × 20 million) = £ 8 million
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How much is the consumer surplus reduced by in this diagram?
With no trade = (£3.20 – £1.80 × 40) /2 = (£1.40 ×40)/2 = £28 million
After tariff – (£3.20 – £1.60) × 50)/2 = £40 million
With no tariff (free trade)- £3.20 – £1.20 × 60)/2 = £60 million
Tariffs reduce consumer surplus by £20 million
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What is the increase in producer surplus in this diagram from the tariff?
With no trade (£1.80 – £0.5) × 40)/2 = £24 million
With tariff (£1.60-0.50) × 30)/2 = £16.5 million
With free trade and no tariff (£1.20-0.50 × 20)/2 = £6 million.
Tariffs increase producer surplus by £10.5 million
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What is the net welfare loss of this tariff in this diagram?
Welfare effect of tariffs = gain in producer surplus (£9 m) + gain in tariff revenue (£8m) – loss of consumer surplus £20m)
Therefore net welfare loss = £3 million
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Reasons for imposing tariffs:
1. Raise revenue. If a country produces no oil, levying a tax on oil imports will raise money as people have no alternative put to pay the import tariff.
2. Environmental. A tariff could be placed on goods who may have negative externalities. e.g.
3. Protectionism. The most common reason for a tariff. Imposing import tariffs makes domestic firms more competitive.
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Reasons for removing tariffs:
1. Lower prices for consumers
2. Increase specialisation and benefits from economies of scale.
3. Theory of comparative advantage states net welfare gain from free trade.
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Examples of tariffs.
US have 20% on vegetable imports
EU has many tariffs on food.
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How are the winners from tariffs?
- Government Tax Revenue
- Domestic industries, which are uncompetitive in the world market.
- Worker in these domestic industries that are uncompetitive globally.
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How are the loser from tariffs?
- Domestic consumers who pay higher prices
- Foreign exporters
- Domestic exporters who experience retaliatory tariffs.
