4.1 International Economics Flashcards
What are the characteristics of globalisation
- Growth in free trade + movement of labour and capital across national borders.
- Increased importance of global financial systems.
- Growth in trading blocs (groups of countries, like EU).
- Growth of TNC’s
What are the factors contributing to globalisation
- Growth of free trade; made countries more closely integrated.
- Multinational companies.
- Technology: internet has improved communications
- Transport: containerisation + shipping
-
WTO: helped reduce barriers to trade and
provide a forum for discussing global issues. - Trading blocs.
-
Opening up of China and Eastern Block.
e.g. China investment in Africa to benefit from raw materials.
What is the impact of globalisation on the government
- Global trade cycles: dependence on others
- International co-operation.
-
Interdependence.
China has become reliant on Africa for raw materials. Africa is reliant on China for inward investment. -
Higher taxes but TNC’s lobby and ‘race to the bottom’
apple 0.005%
What is the impact of globalisation on workers
-
New opportunities
e.g. finding new opportunities to work abroad, like workers from Eastern Europe coming to work in Western Europe –> but problems of housing shortages -
Wages helped equalise wages across the world.
For example, self-employed computer programmers in India can work for US firms through the internet. - FDI has created manufacturing jobs in developing countries e.g. clothing retailers setting up in Asia.
–> but sweatshops; 36 hr shifts Indonesia - Encourage Skilled labour.
What is the impact of globalisation on firms
- Domestic firms uncompetitive. Some local firms may be pushed out
-
Lower costs for multinationals. outsourcing labour.
but costs to outsourcing (e.g. bad potential
publicity from ‘sweat shop’ factories) and possibly harder to
maintain quality of production. -
Economies of scale. significant for industries with
high fixed costs, like cars and aeroplanes; mainly benefits TNC - Impact on firms in developing world; reliance on primary prod.
o But new opportunities to firms in developing countries, e.g. computer software firms in India - Cheaper imports + lower risk from dependency on one country
What is the impact of globalisation on the enviroment
- Environmental costs. goods are increasingly imported from; higher carbon foorprint
- firms switch production to countries with weaker environmental legislation.
- But greater cooperation
What is the impact of globalisation on economic growth
- Investment by TNC, increase in LRAS
- TNC’s bring human capital through knowledge
- Increased trade
- Compartivie adv. change over time
What are the limitations of MNE’s
Footloose-MNE’s can and will relocate for more favourable tax and or cheap labour
e.g. Rust Belt (700,000 jobs lost) in USA
Repatriated profit
How does globalisation affect cultural identity
- Cultural globalisation is a key part of globalisation
- Communication and media transmits cultural ideas and has a large effect
- Communication technology allows acculturation through the internet
How did Covid ‘kill’ globalisation
- Clothing sales fell by 73.56% and bangladhes lost out on 2.6 billion dollars, millions of low income workers were laid off
- 2008 caused slowbilisation, opposition to the system grew in response to the movement of labour to China
- Desire to bring back maufacturing brought Populist leaders to ban immigrants ‘the future does not belong to Patriots, it belongs to Globalists’
According to the Economist how much has containerisation impacted bilateral trade over 20 years
over 790%
How much of the world’s outsouring businesss does India control
controls 44 percent of world outsourcing business
How much of the world’s wealtth does the top 1% of income earners control
43% of the world’s wealth
What is slowbalisation
The stagnation of the rate of globalisation after 2008
- Cost of moving goods has fallen
- the average tariff rate on all American imports will rise to 3.4%, its highest for 40 years
- Asian firms made more foreign sales within Asia than in America in 2017
How can it be argued that globalisation isn’t dying but changing
Figures in physical goods doesn’t take into explosion of digital economy
Cross border data flows have increased from 1 terabit per second in 2005 to 1,400 in 2017
What did Hal Varian say if trade flows recorded the true value of US-made operating systems installed on smartphones assembled in Asia
It would reduce the U.S.’s $500 billion trade deficit with the world by more than $120 billion in one fell swoop.
What is absolute advantage
This occurs when one country can produce a good with fewer resources than another.
What is comparative advantage
A country has a comparative advantage if it can produce a good at a lower opportunity cost i.e. it has to forego less of other goods in order to produce it.
What is the law of comparative advantage
This states that trade can benefit all countries, if they specialise in the goods in which they have a comparative advantage.
According to the law of comparative advanatage, what should happen in this scenario
Clothes:
For the UK to produce 1 unit of clothes, it has an opportunity cost of 4
computers.
* For India to produce 1 unit of clothes, it has an opportunity cost of 1.5
computers.
* Therefore, India has a comparative advantage in producing clothes
because it has a lower opportunity cost.
Computers
* If the UK produces a computer, the opportunity cost is 1/4 (0.25).
* If India produces a computer, the opportunity cost is 2/3 (0.66).
* Therefore, the UK has a comparative advantage in producing computers.
After Specialisation, total output increases by 2
What are the limitations of the theory of comparative advantage
- Increased specialisation –> diseconomies of scale
- Trade may be restricted through tariffs.
- Comparative advantage measures static advantage but not any dynamic
advantage. - Assumes constant cost, homogenous goods, perfect knowledge, no transport costs, constant return to scale
- Ignores exchange rate
Portray absolute advantage diagramatically
in the context of the PPF. Country 1 has an absolute advantage in both as they can produce more of both. However, trade is not worthwhile because they have the same opportunity cost since the gradients of the lines are the same.
Portray comparaitive advantage diagramatically
Country 1 has an absolute advantage in producing good B and country 2 has absolute advantage in good A. Specialisation is worthwhile since the opportunity cost is different.
This creates the new green PPF, since they maximum they can produce is 200 and 1600. If they produce at a rate of 1:1, they produce on the line but they can produce anywhere in the area between all three lines, A.
Both countries are able to produce beyond their PFF, which shows both have benefitted from specialisation.
Why do manufactured goods tend to be non-homogenous and what does Preference Similarity Theory suggest
Preferance similarity theory suggests that some goods are imported simply because consumers want choice.
What is the Hecksher Olin principle
Countries export what they can most easily and abundantly produce
What is the pattern of trade
The pattern of trade refers to how a country trades with other countries and in which direction.
Trade flows refer to where the countries exports and imports go
What are the factors influencing the pattern of trade
-
Comparative Advantage
e.g. deindustrilisation in UK led to moving to other places such as Poland -
Emerging Economies
As countries grow, likely to need more imports such as China
International trade contributes 20% of LIC’s economies compared to 8% of US - Trading blocs and bilateral trading agreements Leaving EU meant that the UK had a 14% fall in trade w them
-
Relative exchange rate
UK’s trade deficit with Europe is due to the strength of the pound.
China have kept their currency weak in order to increase their trade surplus by making exports more competitive.
What is the pattern of trade between the UK/USA + China/Germany
- UK/USA run a persistent current account deficit
- China and Germany run a consistent surpluss
What is the reason for the nature of the pattern of trade between the UK/USA + China/Germany
China lower labour costs –> gives a omparative advantage in manufactured goods.
* Chinese currency relatively undervalued. China has often sought to
maintain an undervalued currency to make exports cheaper.
* In the Euro, German exports become relatively cheaper because in the
Euro, there is no appreciation within the Eurozone
* It also reflects a higher marginal propensity to consume in the UK and the
US. This means more willing to spend income.
What is the terms of trade
the quantity of exports that need to be sold in order to purchase a given level of imports.
an improvement if buy more imports with the same level of exports.
Detoriation if converse
What are the factors influencing the terms of trade
-
Exchange rate. depreciation cause a deterioration in the
terms of trade. - Commodity prices. If a country produces mainly primary products, then falling commodity prices worsens their terms of trade.
-
Higher inflation. A relatively higher inflation rate will increase the price
of exports relative to imports and improve the terms of trade- but depreciation on FX -
Demand for products. rising export demand will push
up export prices, causing an improvement in the terms of trade.
Long-run:
* Improvement in productivity will decrease terms of trade
* changing incomes - Prebish Singer Hypothesis –> primary goods decline in price propotionately so those dependent on them will see fall in terms of trade
What is the effect of a detoriation in the terms of trade
countries will need to export more goods to finance the
same quantity of imports.
* A deterioration in the terms of trade could mean higher import prices and
cost-push inflation.
* A long-term decline in the terms of trade can lead to lower living
standards, because the country can afford relatively fewer imports
- Beneficial if caused by depreciation; if demand elastic then increase in exports
How does elasticity affect the terms of trade and the current account
If PED of exports and imports is inelastic, a favourable movement in terms of trade would improve the current account on the balance of payments
if it is elastic, a favourable movement would worsen the current account
Why is an improvement in the terms of trade likely to lead to a fall in GDP and a rise in unemployment
, since if it is caused by a rise in export prices, exports will fall and if it is caused by a fall in import prices, imports will rise. Both of these causes a reduction in production within the country and so a fall in jobs and output
What is the issue with a long-term decline in the terms of trade
suggests a long term decline in living standards as less imports can be bought.
What are the stages of economic integration between countries
- Free Trade Area
- Customs Union
- Single/Common Market
- Economic Union
- Monetary Union
- Fiscal Union
What is a PTA and FTA
● Preferential trading areas (PTA): These are where tariff and other trade barriers are reduced on some but not all goods traded between member countries.
● Free trade areas (FTA): These occur when two or more countries in a region agree to reduce or eliminate trade barriers on all goods coming from other members. Each member is** able to impose its own tariffs and quotas on goods it imports from outside the trading bloc. **
What is a customs union
A customs union involves the removal of tariff barriers between members and the acceptance of a common external tariff against non-members.
members may negotiate as a single bloc with third parties such as other trading blocs or countries.
(FTA + Common External Tariff)
What is a single/common market
hen members trade freely in all economic resources so barriers to trade in goods, services, capital and labour are removed.
They impose a common external tariff on imported goods from outside the market
significant level of harmonisation of micro-economic policies
‘aim to create a single market’
What is an economic union
A common market as well as a common external tariff but free to pursue independent macro economic policy
What is a Monetary Union
– Economic Union plus common currency and common
monetary policy. (e.g. Eurozone).
What is a fiscal union
A fiscal union is an agreement to harmonise tax rates, to establish common levels of public sector spending and borrowing, and jointly agree national budget deficits or surpluses.
The majority of EU states agreed a fiscal compact in early 2012, which is a less binding version of a full fiscal union.
What are the conditions necessary for the success of a monetary union
- there should be free movement of labour, capital mobility and wage and price flexibility, fiscal transfers from one country to another when a country is performing poorly, and countries should share the same business cycle.
The main problem for the EU is the** lack of automatic fiscal transfers**, for example these would have helped Greece, Spain and Portugal following the financial crisis of 2007-08.
What are the costs and benefits of a monetary union
- prices are fixed as all currencies are the same and there are reduced exchange rate costs.
- It becomes easier for prices to be compared across the union and so MNCs are less able to price discriminate.
- There are financial costs in starting a new currency and with one breaking them
- Loss of policy independence can be bad for countries e.g. black wednesday, greece
What are the advantages of a customs union
Without a unified external tariff, trade flows would become distorted
A common external tariff effectively removes the possibility of arbitrage
What are the disadvantages of a customs union
Union members must negotiate collectively with non-members or organisations like the WTO as a single group of countries. While this is essential to maintain the customs union, it means that members are not free to negotiate individual trade deals.
Also, it makes little sense for a particular member to impose a tariff on the import of a good that is not produced at all within a that country.
e.g. banana tariff 10.9%
Members that trade relatively more with countries outside the union, such as the UK, may not get their ‘fair share’ of tariff revenue.
What are regional trade agreements
- These are agreements between neighbouring countries e.g. South-East
Asia, Latin America, Africa and the EU. - The WTO often calls these regional trade agreements preferential trade
agreements, because they are exclusive to a certain number of countries.
What are the advantages of regional trade agreements
- Most trade is with neighbours so large effect
- enable more free trade –> trade –> increase economic growth
- They are a potential stepping stone to more inclusive trade agreements.
What are the costs of regional trade agreements
- WTO argues they should be preferable since FTA should involve all countries
- PTA can conflict with WTO global trade treaties
- Leads to conflict between other trading blocs
- Increasesd complexity –> NTB
What are the benefits of general economic integration
- Greater trade and gains from comparative adv. –> EoS
- Increased FDI
- Clout for international negotiations
- More flexible labour markets
What are the potential costs of economic integration
- Regional inequality due to geographical immobilities e.g. difficult to move from Spain to Germany to get a job.
- Increased specialisation –> structural unemployment
- The UK experienced trade diversion when joining the EU, because
agricultural tariffs to Commonwealth countries increased. - Free movement of labour may cause friction over housing and
overpopulation.
What is trade diversion
when tariff agreements cause imports to shift from low-cost countries to higher-cost countries; concentrates production in countries with a higher opportunity cost and lower comparative advantage.
typically occurs w a common external tariff
Draw the trade diversion diagram
- decline in consumer surplus
- DWL
- Loss of EU efficiency in net loss area
- also net loss to society
What is trade creation
increase in economic welfare from joining a free trade area, such as a customs union due to a reduction in tariffs allowing for lower prices
- increase in consumer surplus, equal to area 1+2+3+4
- Domestic producers will sell less as consumers buy cheaper imports (decline in producer surplus is shown by area 1)
- Government lose tax revenue (from import tariffs) (shown by area 3)
How can the impact of trade creation and trade diversion be lessened
If demand and supply are inelastic, the effect will be much lower.
How does trade creation benefit exports
If you cut import tariffs, other countries are likely to reciprocate and reduce tariffs on your exports. Therefore, there will also be an extra benefit from increased exports.
What are the potential issues with trade creation
Often domestic job losses are more visible, than the gains from cheaper prices.
e.g. nafta caused rust belt 700k america and 2 million agricultural mexico
What is the WTO
- responsible for trying to promote and regulate free trade and trade agreements between countries.
- Forum for agreeing and resolving conflict
- Help trade flow except when conflicts with other objectives
How has world exports as a % of GDP changed from 1970
World Bank stats show how world exports as a % of GDP have increased from 13% in 1970 to 30% just before the financial crisis of 2008.
In the past decade, world exports as a share of GDP have flatlined, with no rise since the peak of 2008.
What are the benefits of free + international trade
- Use of abdundant resources - e.g. oil in UAE
- Comparative Advantage
- Greater Choice for Consumers - Preference Similarity Theory e.g. Primark and Gucci
- Economies of Scale - Apple designs their computers in the US but contract the production Asian factories
- Global economic development - reduction in absolute poverty (90 million raised from poverty in India)
- Encourage FDI - Poland
- Increased competition to increase efficiency + stop domestic monopoly
- Engine of Growth - World Trade has increased by avg. of 7% since 1945
9.
What are the costs of free + international trade
- Infant industry argument - free trade leads to primary sector dependence/dumping so need to diversify
- Cultural homogenisation - local brands have a cultural niche and expertise
- Displacement effects - cause uncompetitive domestic industries to close down –> structural UE
eval: creative destruction + new jobs in diff. industry to supplement TNC
- Enviromental Costs
What are the principles of the WTO
- Promote free trade through gradual reduction of tariffs
- Provide** legal framework for negotiation of trade disputes**. This aims to provide greater stability and predictability in trade.
- Trade without discrimination - avoiding preferential trade agreements.
- WTO is not a completely free trade body. It allows tariffs and trade restrictions under certain conditions, e.g. protection against ‘dumping’ of cheap surplus goods.
- WTO is committed to protecting fair competition. There are rules on subsidies, dumping
- WTO is committed to economic development. For example, recent rounds have put pressure on developed countries to accelerate restrictions on imports from the least-developing countries.
What are the successes of the WTO
The WTO has over 160 members representing 98 per cent of world trade. Over 20 countries are seeking to join the WTO.
- Prevent trade war, according to (Bagwell and Staiger 2002) the average tariff in 1930s was 50%. In 2000s, average tariff is 9%
the value of WTO in preventing trade wars could be estimated at up to $340 billion per year according to Ralph Ossa
the value of WTO in preventing trade wars could be estimated at up to $340 billion per year
What are the disadvantages of the WTO
- Free Trade policies unfavourable to developing countries, Ha Joon chang argues it is ‘ pulling away the ladder they used themselves to climb up
- Preventing development of infant industries
- WTO still have lots of protectionism in areas such as agriculture that favour developed countries
- ‘Most favoured nation’ principle - mean developing countires cannot give preference to local contractors over footloose TNCs (favour developed)
- Damage to enviroment, cultural diversity
- WTO structure is undemocratic +enbales rich countries to win what they desire
Evaluate the WTO
- free trade has been an important engine of growth for developing countries in Asia. Although there may be some short term pain, it is worth it in the long run.
- Also the WTO has sought to give exemptions for developing countries; enabling in principle the idea developing countries should be allowed to limit imports more than developed countries.
- Growth of world trade has reduced absolute poverty - 90 million India
What can protectionism involve
- **Higher tariffs **(type of tax on imports).
- Non-tariff barriers e.g. diff uk + eu regulation
- Voluntary export restraint is effectively a type of quota where voluntary limits are placed on imports of goods.
- Embargo .
- Government subsidy e.g. Chaebols
- Distorted exchange rate e.g. international yuan
- Weakest environmental law. A way to attract certain types of business.
- Administrative barriers
What are reasons for protectionism
- Infant Industry
- Job Protection
- Protection from dumping/unfair competition
- Improve the terms of trade
- Prevent over-dependence
- Stop dangerous goods
- Protecting senile industries
- Reducing a deficit
What is economic dumping
· Monopoly from another country sells a good/service at or below costs temporarily, to increase market share and force out domestic firms to form a monopoly in a foreign market.
· They will then increase price and exploit consumers as those firms gain a monopoly foothold.
or
Selling excess stock at a price that injures domestic comp e.g. chinese steel 9-14% tariff
What is the infant industry argument
- Prevent economic dumping
- Need to diversify from a reliance on primary products:
1) Low YED in LR
2) Price Volatility
What are the criticism of the infant industry argument
- May encourage firms to be inefficient –> X-inefficiency
- Retaliation
- Political pressure group, may become politically difficult to remove because of vested interests.
- Which industries to choose?
- **Welfare loss **of tariff protection
- May be a stronger case for subsidies
How does protectionism decrease a current account deficit
· By protecting against imports and promoting exports the value of M should fall and X should rise current account deficit, ceteris paribus
· Makes it easier to finance an equilibrium
A large C/account deficit will also likely mean that domestic multipliers are weaker, and growth can be restricted.
How does protectionism protect domestic employment
· As M decreases and X increases and as labour is a derived demand, protectionism would help to control cyclical unemployment and in the long run prevent structural unemployment.
- The US uses steel tariffs as a method to protect domestic jobs in steel.
What are strategic reasons for protectionism
· Domestic control over key strategic industries is seen as favourable, for example nuclear power, and armaments.
· Protects against importation of demerit goods, e.g. through embargo/law.
Helps prevent over specialisation
e.g. Banning Huawei
How does protectionism help senile industries
· Industries which may have had national significance – Jingoistic
Culture/heritage E.g. Sunset industries in decline due to foreign comp/changing demand then there may be an argument to slow that decline, protect employment etc. This tends to be a weaker argument.
Draw the effect of a tariff
S world shifts up
tariff of size (Pw + t – Pw) is introduced. That raises the price of chicken wings in the UK to Pw + t. Quantity supplied by domestic producers increases Q1 -> Q2 (extension of S domestic).
· Quantity demanded contracts Q4 -> Q3.
· Hence, imports shrink to (Q3 – Q2).
What is the effect of tariffs on: consumers, government, domestic producers, foreign producers, DWL
· Consumers: consumer surplus lost by area (Area 1 + Area 2 + Area 3 + Area 4) lost.
· Government: gain in revenue of Area 3
· Domestic producers: domestic producers gain surplus Area 1.
· Foreign producers: they lose revenue as tariff decreases the quantity of chicken wings imported.
Deadweight welfare loss: due to tariff there is social surplus lost to nobody which is the DWL: Area 2 + Area 4.
Draw the effect of subsidy on trade
the domestic supply curve shifts downwards by the size of the subsidy per unit: (Pw + subsidy – Pw).
Domestic production increases Q1 → Q2 and the quantity imported shrinks to Q4-Q2
What is the effect of a subsidy on governments, consumers, domestic producers, foreign producers, DWL
· Government: paying the subsidy of the green-marked area.
· Consumers: loss of the consumer surplus does not occur, as the price of the rice does not change.
· Domestic Producers: the price that they receive increases to Pw+subsidy. Their revenue increase from (Area 1 + Area 2) to (Area 1 + Area 2 + green-marked area).
· Foreign Producers: their revenue decreases from (Area 2 + Area 3 + Area 4) to (Area 3 + Area 4) as rice imports shrank.
Deadweight welfare loss: due to increased production by the inefficient domestic producers (over allocation of resources to those producers), Deadweight Welfare Loss (DWL) marked triangle Area 5 emerges.
The green area is the size of the subsidy, everything in the green area apart from Area 5 goes to producers to increase their revenue. Hence, what is left in the green are goes to no one – that is why Area 5 is said to be a DWL
What are the advantages for using a subsidy for protectionism
· Helps achieve government objective.
· Can reduce imports and boost X
· Tends to be more well tolerated than a tax on M from foreign countries (less likely to cause retaliation)
More effective if PED’s are elastic
What are the disasdvantages of the effect of a subsidy on protectionism
· Welfare loss
· Helps to create inefficiency amongst domestic producers
· PED may be inelastic of M therefore policy does not achieve objectives just harms domestic consumers.
· Can lead to retaliation
e.g. UK is a member of the WTO committed to free trade. There may also be sanctions for protectionism.
What is the evaluation of use of a subsidy for protectionism
· This trade protection could be said to be more favourable than tariff as it does not lead to possible loss of living standards.
but tariffs better for demerit goods
However, consumers are affected by the government subsidising producers rather than funding more socially desirable projects.
Also, to fund the subsidy, the government might have to increase taxes.
What are the 2 diagrams for quotas
Same as tariff and just shifting
or
This leads to a fall in imports to just Q3-Q2
Domestic suppliers gain more revenue. The price rises to P quota and domestic suppliers, supply more Q1 to Q2. It can create domestic jobs.
What is the welfare loss of quotas
Consumers pay a higher price and also total quantity falls from Q4 to Q3.
Governments are not affected directly, as there is no income.
There is a net welfare loss to society because the increase in producer surplus is outweighed by the decline in consumer surplus.
World exporters will make less revenue – unless demand is very inelastic, meaning increase in price is greater than fall in quantity.
Quotas or Tariffs
- Quotas cause a bigger fall in economic welfare because the government don’t gain any tax revenue
- Quotas may be harder to enforce if it is difficult to count the amount of the good coming into the country.
- Quotas could be more unfair; distribution political
Quota better:
* Quotas allow the country to be certain on the number of imports coming in, while tariffs depend on elasticity
What is a non-tariff barrier
a way to restrict trade using trade barriers in a form other than a tariff such as licenses or administrative barriers
What is a VER - Voluntary Export Restraint
A voluntary export restraint (VER) is a trade restriction on the quantity of a good that an exporting country is allowed to export to another country. This limit is self-imposed by the exporting country.
Exporting countries often wish to impose their own restrictions than risk sustaining worse terms from tariffs or quotas
How do you avoid a VER
the exporting country’s company can always build a manufacturing plant in the country to which exports would be directed.
By doing so, the company will no longer need to export goods, and should not be bound by the country’s VER.
What is VIE - Voluntary Import Expansion
a change in a country’s economic and trade policy to allow for more imports, by lowering tariffs or dropping quotas. Often VIEs are part of trade agreements with another country or the result of international pressure.
What are the advantages and disadvantages of VER
ADV:
Producers in the importing country experience an increase in well-being, though, as there is decreased competition, increased price, profits, and employment
Disadv:
VERs reduce national welfare, by creating negative trade effects, negative consumption distortions, and negative production distortions.
What is a good example of a VER
Japan imposed a VER on its auto exports into the U.S. as a result of American pressure in the 1980s.
The VER subsequently gave the U.S. auto industry some protection against a flood of foreign competition.
This relief was short-lived though, as it ultimately resulted in a rise in exports of higher-priced Japanese vehicles and a proliferation of Japanese assembly plants in North America.
What has been the effect of structural adjustment policies on Latin America compared to protectionism
During Protectionism per capita income in Latin America grew at an impressive 3.1 per cent per year.
Since structural adjustment, it has been growing at a paltry 0.5 per cent
What are the reasons for a current account deficit
- Overvalued exchange rate; worsens X-M
- Declining competitiveness,
- Fast economic growth; higher income means greater income consumption
-
Low savings ratio. Lower savings tends to cause higher consumer
spending on imports. -
Capital inflows. Large inflows of foreign capital enable the country to
afford more imports and run a current account deficit.
Capital inflows also
increase the value of the exchange rate making exports less competitive
How is a current account deficit financed
- Attracting FDI and hot money flows
What are potential problems of a current account deficit
- Potentially unsustainable. borrowing can be unsustainable in the long term and countries will be burdened with high interest payments.
- Foreign claim on UK assets. foreigners will have an increasing claim on UK assets, which they could require return of at any time.
- Depreciation likely to cause depreciation in the exchange rate, leading to higher import prices and lower living standards.
- **Reflection of economic weakness. **:
Declining competitiveness, due to higher labour costs or declining
productivity.
* Lack of productive capacity/ infrastructure in the UK.
* Declining comparative advantage in many manufactured goods.
Why is a current account deficit not necessarily harmful
- Used to finance investment
-
Inward investment can be beneficial for the economy. If a current
account deficit is financed by long-term capital flows, it can create jobs
and more output -
Floating exchange rate will restore balance. With a floating exchange
rate, a large current account deficit should be reduced over time by a depreciation to restore competitiveness. - Size of deficit. .
What are measure to reduce a current account deficit
-
Devaluation / depreciation
lead to an improvement in net exports (X-M) and therefore
improve the current account on the balance of payments. -
Reduce consumer spending. Higher taxes and/or higher interest rates will
reduce disposable income and cause lower spending on imports. This will
improve the current account deficit. - Supply Side Policies:
○ Policies to raise labour productivity
○ Investment in human capital to boost productive capacity and competitiveness
What is the Marshall Lerner Condition
- If (PED x + PED m > 1), then a devaluation will improve the current
account while an appreciation will worsen it
Essentially, if demand for exports and imports is elastic, then a depreciation will
improve the current account.
What is the J Curve Effect
In the** short term**, demand for imports and exports tends to be inelastic
Therefore, after a devaluation, the current account can get worse before it gets
better. However, over time, demand becomes more price elastic and the current
account improves.
Evaluate devaluation leading to inflation
- can lead to imported inflation, because imports will be more expensive and
we will get higher AD. Relatively higher inflation can reduce the country’s
competitiveness. - Therefore, if we do get inflation, the improvement in the current account
might only be temporary.
What are potential problems of a large current account surplus
- It represents an unbalanced economy – dominated by exports and
showing less consumer spending. - it means other countries will have a similar deficit.
- In the Eurozone, current account imbalances are more of a problem
because countries can’t rely on a depreciation to solve the imbalance
How could a government reduce a current account surplus
- Allowing the exchange rate to appreciate, reducing competitiveness.
- Encouraging consumer spending (e.g. lower income tax), leading to higher
import spending.
What is the export multiplier effect
Many industries rely heavily on key export industries remaining competitive – these include:
* Transportation / freight / logistics businesses
* Trade finance businesses e.g. Insurance and trade credit
* Service businesses that operate in ports and airports
Exports particularly important for regional economic performance
What is a sovereign wealth fund
state-owned investment fund that is used to benefit the country’s economy and citizens
The money typically comes from a nation’s budgetary surplus to funnel it into investments rather than simply keeping it in the central bank or channeling it back into the economy.
to stabilize the country’s economy through diversification and to generate wealth for future generations.
Can be funded through commodities or non-commodities, financed by fx reserves
What is the international debate about
Following the mortgage crisis of 2006-2008, sovereign wealth funds helped rescue struggling Western banks CitiGroup, Merrill Lynch, UBS, and Morgan Stanley.
This led critics to worry that foreign nations were gaining too much control over domestic financial institutions and that these nations could use that control for political reasons.
projects that if sovereign wealth funds continue to grow at their current pace, they will exceed the annual economic output of the U.S. by 2015 and that of the European Union by 2016.
What is a floating exchange rate
When the value of the currency is determined by market forces i.e. the supply and demand for currency
What is a fixed exchange rate
Where the value of a currency is set at a certain peg, compared to other countries e.g. fixing the Pound at £1 = €1.1
What is a managed exchange rate
‘Semi fixed exchange rate’. This is a situation where there is no set exchange rate level but the Central Bank (or government) intervene, to try and influence the exchange rate.
For example, if the value of the currency is falling, the Central Bank may use foreign exchange reserves to buy currency
What is an exchange rate index
This gives a measure of a currency against a tradeweighted basket of currencies. It is expressed as an index, where the value of the index will be 100 in the base year.
weight given to each currency depends upon the proportion of
transactions done with the country
What is the real exchange rate
This is the exchange rate after being adjusted for the effects of inflation, which more accurately reflects purchasing power.
What is a devaluation
This occurs when the government reduces the set level of the currency in a fixed exchange rate.
What is a depreciation
This occurs when the value of an exchange rate in a floating exchange falls.
Caused by an increase in supply or fall in demand for the pound on the forex.
What is revaluation
When the government increases the set level of the currency in a fixed exchange rate.
What is an appreciation
When the value of the currency in a floating exchange rate
rises.
Caused by an increase in supply or fall in demand for the pound on the forex.
Evaluate the J Curve
· The current account will **depend on consumer spending **and the rate of economic growth.
· It also depends on consumer spending in foreign countries (hence demand for exports)
· It depends on Inflation (e.g. depreciation can cause imported inflation which reduces the competitiveness of exports)
Firms may engage in insurance policies to hedge against exchange rate movements.
What is the **inverse J curve effect **
When an appreciation of the exchange rate initially causes the current account or trade balance to improve.
What are factors influencing the exchange rate
- Interest rates will attract hot money
- **Inflation. ** affects competitiveness
- Speculation. If speculators believe the value of sterling will rise in the future, they will demand more, causing an appreciation.
- Economic growth interest rates are likely to rise, to keep inflation low. This will encourage investors to buy Pounds, in anticipation of better returns.
-
Current account. A large deficit on the current account is likely to cause a
depreciation in the value of the exchange rate. - Open Market Operations - Central Bank uses FX reserves to buy domestic currency on the forex
How can governments intervene in the currency markets
- Use foreign currency reserves
2.** Change interest rates** -
Change money supply. If a country wanted to depreciate its currency, it
could print more money -
Fiscal / monetary policy. If the government used tight fiscal policy
(higher taxes), it could reduce inflation
Evaluate the effectiveness of government intervention in currency markets
- A government has only limited foreign exchange reserves
e.g. In 1992, the UK government failed to protect the value of the Pound, because foreign currency markets had more buying power than the government.
- The Central Bank could use interest rates to protect the currency but it would be at the cost of lower growth and higher unemployment.
- To manage the exchange rate in the long-term requires efforts to tackle
long-term competitiveness.
Evaluate the effectiveness of government intervention in currency markets
- A government has only limited foreign exchange reserves
e.g. In 1992, the UK government failed to protect the value of the Pound, because foreign currency markets had more buying power than the government.
- The Central Bank could use interest rates to protect the currency but it would be at the cost of lower growth and higher unemployment.
- To manage the exchange rate in the long-term requires efforts to tackle
long-term competitiveness.
What are the effects of an appreciation in the exchange rate
- Export quantity falls, Import quantity increases
- Lower AD –> cyclical UE esp in manufacturing and higher NRU if appreciation is sustaianed
- Lower inflation, from cheaper imports and lower AD
- Worsening of current account i.e. bigger deficit, because of decline in
exports and rise in quantity of imports. - Foreign direct investment may fall. A rise in the exchange rate may
discourage FDI (foreign direct investment), because it is now more
expensive for foreign firms to invest.
Evaluate the effects of an appreciation
- Marshall Lerner condition states an appreciation will only worsen current
account, if PEDX + PEDM >1. - It depends on other components of AD, consumer bigger impact
- Inverse J Curve
- It depends on productivity growth. If the exchange rate appreciates
because firms are becoming more productive, then they will remain
competitive. - Capital Equipment + tech becomes cheaper –> inc productivity and LRAS
- It depends on the state of the economy. If the economy is growing
strongly and is near full capacity, a rise in the exchange rate could help
reduce inflationary pressure and keep growth sustainable.
What is a competitive devaluation
This is a situation where a government actively tries to reduce the value of its
currency, to gain a competitive advantage by:
- Selling its own foreign currency and buying foreign assets
e.g. China has bought US$3.12 trillion to keep the Chinese currency undervalued
against the dollar.
- Pursue loose monetary policy e.g. low interest rates and quantitative
easing (increasing money supply).
What is the impact of competitive devaluation
- increase exports, create employment and reduce its current account deficit, but may be at the expense of other countries
- It may cause inflation: a rise in import prices + require printing money,
which also causes inflation. - It doesn’t deal with the fundamental economic issues. A depreciation
gives a ‘relatively easy’ improvement in competiveness but this may
prove short-lived.
It can avoid firms dealing with the long-term issues of
productivity and competitiveness.
What does joining the Euro involve
- Replacing domestic currency with Euros.
- No possibility of fluctuating exchange rates within the Euro area.
- A common monetary policy. Interest rates are set by the ECB for the
whole Eurozone area. -
Rules about size of budget deficits (3% of GDP). Fiscal stability pact
though, in practice, this is often broken.
What are the advantages of joining the Euro
-
Lower transaction costs; Lower costs have been estimated to be worth 1% of
GDP. - Eliminate exchange rate fluctuations more confidence about future export prices.
- Increased inward investment.
-
Greater price transparency/comparibility. should hopefully lead to
greater price competition and easier for firms to identify the cheapest suppliers. -
Lower Inflation. The ECB has a strong tradition of keeping inflation low.
Joining the Euro will help reduce inflation expectations. - Incentive for greater competitiveness as can’t rely on devaluation
What are the problems of the Euro
- Countries will lose the ability to set interest rates.
-
Lack of exchange rate flexibility.
e.g. detoriation in competitiveness 2000-07 in EU countries - Low inflation may conflict with other objectives.
-
Loss of independence over fiscal policy.
e.g. growth and stability pact limits government borrowing to no more than 3% of GDP. - Bond Yields in the Eurozone, there is no Central Bank willing to print money and act as lender of last resort
Evaluate what is needed for a succesful monetary union
1.** Convergence of economic cycle**, to deal with common interest rate and
monetary policy.
2. Similar inflation rates. If inflation is much higher, a country will become
uncompetitive
3. **Mobility of labour and capital **
e.g. will unemployed workers find it easy to move to other areas in the monetary union?
4. Fiscal union. Similar levels of budget deficits and fiscal union to be able to
offer help to depressed economies.
What is a reserve currency
anchor currency, a currency that national governments and other instuitons are happy to hold as a key part of their foreign exchange reserves
reserve currency of choice has been the US dollar
What is an adjustable and crawling peg system
- An adjustable peg system is where currencies are fixed against another but
the level at which they are fixed can be changed.
o Crawling peg systems are a form of this but have a mechanism which allows
the value to change.
What are the arguments for a floating exchange rate
- Central bank doesn’t need to maintain a particular rate ot use reserves
- Interest rates are reserved for domestic monetary policy
- Partly able to auto-correct a trade deficit
- Reduced risk of cuurrency speculation
What are the arguments for and against a fixed exchange rate
For:
* Avoids currency fluctuations –> encourage trade + investment
* Reduces costs of currency hedging
* Gives incentive to keep inflaiton low + helps if fixed to strong currency
Against:
* Govt has to intervene by rasising IR which has negative effects
* Information failure; easy to set the wrong exchange rate, if too high wiill make goods uncompetitive + if too low it could cause inflation from high imports
* Less flexibility to respond to temporary shocks
* Cause current account imbalance
* Dificult to keep at correct level; target of speculators
How much did Soros make and Treasury spend on Black Wednesday
Soros made a £1 billion profit from Black Wednesday.
The UK Treasury spent £27bn in buying sterling on the foreign exchange markets.
What did the 18% fall in value of the Sterling Black Friday cause for UK exports from 1992-7
Uk exports to increase in value by 53% from 92-97
After 2008, the sterling depreciated but what happened to the trade balance
trade balance did not recover
Why did the trade balance not recover after the 20% depreciation in the sterling in 2008
Sheffield Political Economy research suggested that it was due to ‘deep-rooted economic imbalances’ and needs a rebalance towards maanufacturing and diversification of the export base
1) Much greater reliance on global supply chains so **higher import costs can offset impact **
2) Impact of protectionism e.g. US tarifs of 11.2 billion on EU imports such as Land Rover
3) Demand for imports are price inelastic while exports more price elastic;UK is a net importer of Oil e.g. 2008 in dollar terms the oil price increased by 14% but in Sterling terms it rose by 42%
4) Depressed economic growth in EU
What is a foreign currency gap
when currency outflows persistently exceed currency inflows
Normally needs capital flight too and a fall in the value of inflows
What is import cover
the number of months of imports the currency could finance
What does a foreign currency crisis imply for imports
a nation does not have enough currency to pay for essential imports like medicine, foodstuffs, raw materials and replacement components for machinery; hamper sr economic growth
e.g. Sri Lanka in 2020 ran out of fx reserves
How do you measure international competitiveness
-
Relative export prices. The relative cost of UK exports to other
countries. -
Relative unit labour costs. Unit labour costs are the cost of employing
workers to produce one unit labour costs.
what factors influence international competitiveness
- Labour productivity – (output per worker)
- Relative inflation rates- experincing lower inflation means lower costs and prices
- Levels of infastructure- if a country experiences transport bottlenecks, it will lead to higher costs and higher export prices
e.g. Malwai/Zimbabwe through a single railway to Mozambique
- Cost of business- levels of regulation and taxes reduce competition
- Exchange Rate - undervalued exchange rate will make exports more competitive
What are measures to increase international competitiveness
- Education and training - increase labour productivity
- Investment in Infastructure- but susceptible to time lag +govt. failure
- Privatisation and Deregulation - aim to increase efficiency
- Devaluation in Exchange - but doesn’t deal with issues of competitiveness
- Limiting Wage Growth - reduces growth of unit labour costs
- Flexible Labour Markets - help reduce labour costs
What are the benefits of international competitiveness
-
Rising Exports - lead to job creation + economic growth
e.g. China rapid growth - Improved CA
- Low inflation- competiitive exports lead to appreciation which helps with inflation
- Higher living standards - with low import prices and higher export revenues
- Lower unemployment
What are the problems of international competitiveness
- ** Appreciation in exchange rate could damage growth** and make
exports less competitive - Economy may become too reliant on exports. and it will be more vulnerable to a downturn in the global economy.
What are factors that make a place a competitive location for FDI
- Variations in coporation tax rates
- Low RULC
- Non-wage costs such as regulation
- Quality of infastructure
- Avaliability of skilled labour
- Ease of doing business
- Macroecnomic stability
What is the UK competitiveness ranking sin 2022
What are supply side poliicies to increase investment in Britain
- Super-deduction tax relief (130%) for encouraging small business investment
- Creation of Free Ports
- New UK Infastructure Bank- Bank of British Businesss
What are some current examples of UK infastructure projects
- HS2
- Thames Tideway Tunnel
- Hinkley + Sizewell Point C
- 400 million investment in Scottish Rail
What are UK pro-competitiveness policies Post-Brexit
- Points-Based immigration system; allow a more competitive labour market for highly inelastic skilled labour markets
- 5 billion Levelling Up Fund
- Agreed trade deals with 70 countries plus the EU trade and cooperation agreement
What has the effect of Brexit been on competitiveness
- Big rise in NTBs which add costs
- Employees struggling to hire workers, vacancies>UE. Uk migration has reached new levels
- High budget deficit, rising tax burden
- Loss of talent + R+D funding such as Erasmus funding
- Real investment has stalled since referendum
