4.1 International Economics

Question 1

What is globalisation ?

Answer 1

• a process by which economies and cultures have been drawn deeper together and have become more inter-connected through global networks of trade, capital flows, and rapid spread of technology and global media

Question 2

What is the key benefit of globalisation ?

Answer 2

✅ allows businesses and countries to specialise in producing goods/services where they have a comparative advantage (ie. produce at a lower opportunity cost)
✅ gain in economic welfare ➡️ lower prices for consumers (increases real incomes) + greater range of goods/services

Question 3

What are the characteristics of globalisation ?

Answer 3

• trade to GDP ratios are ⬆️ for many countries
• expansion of financial capital flows across international borders
• increasing FDI and cross border acquisitions
• more global brands (a rising no. from emerging countries)
• deeper specialisation of labour (eg. making specific components of parts)
• global supply chains + new trade and investment routes
• higher levels if cross border labour migration
• increasing connectivity of people + businesses through networks

Question 4

Factors contributing to globalisation in the last 50 years ?

Answer 4

• Containerisation: real prices + costs of ocean & air shipping have decreased due to widespread use of standardised containers + economies of scale (lower unit cost of transporting)
• Technological advances: cuts the cost of transmitting + communicating info ➡️ key factor behind trade
• Differences in tax systems: some nations have cut down corporation taxes to attract inflows of FDI (deliberate strategy to drive growth)
• Less protectionism: average import tariffs have fallen (recently a rise in non tariff barriers eg. quotas, domestic subsidies etc)

Question 5

Advantages of globalisation on individual countries/governments/producers/consumers/workers/environment ?

Answer 5

• ✅ encourages both producers + consumers to reap benefits from deeper division of labour in global supply chains ➡️ economies of scale + gains in economic welfare
• ✅ more competitive markets ➡️ reduces the level of monopoly supernormal profits + can incentivise businesses to seek cost-reducing innovations
• ✅ trade can help drive faster economic growth ➡️ higher per capita incomes (reduced extent of extreme poverty)
• ✅ freer movement of labour ➡️ relieving labour shortages + promoting the sharing of ideas from diverse workforces
• ✅ opening of capital markets eg. bond & stock markets ➡️ increases the opportunities for developing countries to borrow money to overcome a domestic savings gap
• ✅ increased awareness among people around the world of the systemic challenges from climate change + the effects of wealth/income inequality
• ✅ competitive pressures of globalisation ➡️ prompt improve standards of govt + better labour protection through improved monitoring by international organisations

Question 6

Drawbacks of globalisation on individual countries/governments/producers/consumers/workers/environment ?

Answer 6

• ❌ rising inequality/relative poverty: unequal gains from globalisation ➡️ growing political + social tensions
• ❌ threats to the global commons eg. irreversible damage to ecosystems, deforestation, severe water scarcity etc
• ❌ greater exploitation of the environment eg. increased production of raw materials, trading toxic waste to countries with weaker environment laws
• ❌ macroeconomic fragility: inter-connected world economy ➡️ external shocks in one region can rapidly spread to other centres ie. systemic risk
• ❌ trade imbalances: increasing imbalances ➡️ protectionist tensions, wider use of tariffs, quotas + move towards managed exchange rates
• ❌ structural employment ➡️ direct result of out-sourcing of manufacturing to lower cost countries + rise in the share of imports in a nation’s GDP
• ❌ dominant global brands: businesses with dominant brands + superior technologies may squeeze out smaller local producers ➡️ reduction in choice for consumers + some job losses

Question 7

What does the overall impact of globalisation depend on ?

Answer 7

• effectiveness of policies eg. environmental interventions & labour market policies designed to help compensate those affected in a harmful way + give people/communities the skills and opportunities required to adjust to a fast changing world economy

Question 8

Impact of globalisation on the UK economy ?

Answer 8

• expanded choice + higher consumer surplus
• effects on retail prices + rate of inflation ➡️ likely to rise due to increased imports/cosumerism?
• UK firms relocating to lower-wage economies ➡️ less available jobs ?
• impact of net inward migration on real wages + on UK govt spending/tax revenues
• impact of inward investment into UK on employment ➡️ more jobs?
• impact on share prices + profits on UK companies ➡️ may decrease as more people importing goods from foreign markets but can also increase

Question 9

What are external shocks ?

Answer 9

• events that come from outside a domestic economic system ➡️ biggest external shock in recent times was the Global Financial Crisis (GFC) from 2007 onwards

Question 10

Examples of external shocks ?

Answer 10

• Global Financial Crisis (2007-2009)
• Euro Zone Economic Crisis
• Volatile World Commodity Prices
• Growth slowdowns in emerging nations
• International & Regional Trade & Investment Deals
• Currency volatility and policy changes e.g. devaluation
• Extreme weather events (drought, flooding etc)
• Geo-political uncertainty & risks from terrorism

Question 11

What is meant by absolute advantage ?

Answer 11

• occurs when a country can supply a product using fewer resources than another nation ➡️ if a country using the same factors of production can produce more of a product, then it has an absolute advantage

Question 12

What is meant by comparative advantage ?

Answer 12

• an economy’s ability to produce a particular good or service at a lower opportunity cost than its trading partners

Question 13

When does a comparative advantage occur ?

Answer 13

• the relative opportunity cost of production for a good/service is lower in one nation than another country ➡️ relatively more productively efficient
• basic rule is to specialise your scarce resources in the goods/services that you are relatively best at
• this opens up gains from specialisation + trade ➡️ more efficient allocation of resources

Question 14

What are the assumptions behind comparative advantage ?

Answer 14

• constant returns to scale: ie. no economies of scale (might amplify the gains from trade)
• perfect factor mobility: between industries (eg. geographical + occupational of labour)
• no trade barriers: eg. tariffs & quotas ➡️ artificially change the prices at which trade occurs
• low transport costs: high logistics costs may erode comparative advantage
• no significant externalities: from production/consumption of the products being traded

Question 15

Advantages of specialisation and trade ?

Answer 15

• ✅ free trade allows for deeper specialisation & benefits from economies of scale (increasing returns)
• ✅ free trade increases market competition & choice + drives up product quality + innovation
• ✅ increased market contestability reduces prices from consumers ➡️ higher real incomes
• ✅ trade can lead to a better use of scarce resources (eg. from trade in sustainable technologies)

Question 16

Drawbacks of specialisation and trade ?

Answer 16

• ❌ transport costs e.g. carbon emissions from
  increased food miles
• ❌ negative externalities from both production & consumption
• ❌ risk of rising structural unemployment as trade patterns change (demand/output/jobs change)
• ❌ inequality ➡️ benefits from globalisation unequally shared
• ❌ pressure on real wages to fall in advanced & emerging countries
• ❌ risks from global shocks eg. the Global Financial Crisis
• ❌ countries that specialise in only a few primary commodities may suffer from the natural resources trap ➡️ may make them poorer than countries less dependent on exporting primary commodities
• ❌ volatile global prices affecting export revenues + profits for producers + tax revenues for govt

Question 17

What is the geographical pattern of trade ?

Answer 17

• the countries with whom business and people trade
• intra-regional trade is trade between countries in the same region eg. EU, Africa
• inter-regional trade is trade between different regions ie. Europe and N America

Question 18

What is the gravity theory in trade ?

Answer 18

• 🔔 countries tend to trade most with other nations in closest proximity (neighbouring countries)
• shared borders help to facilitate high levels of trade + labour mobility
• shared language + a single currency cuts the costs of trade contracts + market transactions
• similar consumer preferences encourage firms to compete on the basis of strength of their product brands
• countries at similar stages of development will have over lapping capabilities ➡️ allowing business to trade a range of connected products

Question 19

What is the geographical pattern of trade for the UK ?

Answer 19

• the EU, is the UK’s largest trading partner ➡️ 2018 46% of all UK exports + 54% of all UK imports
• EU’s share of UK exports has fallen in recent years ➡️ UK’s biggest single trade partner is the US
• China now accounts for over 7% of UK imports (UK’s 4th largest source of imports)

Question 20

What is the commodity pattern of trade ?

Answer 20

• the type of products that are traded internationally ➡️ a country has a dependance on primary v manufactured v service exports
• many less economically developed countries rely heavily on primary product exports

Question 21

How does the pattern of trade change as countries move through different stages of development ?

Answer 21

• as a nation develops increasing complexity and more capabilities, then they become capable of supply and then exporting a broader range of products
• often the transition to a different pattern of trade comes from switching from growing and extracting to processing & refining primary products through to final assembly & manufacturing
• patterns of trade also adjust as countries
  develop a new comparative advantage in industries such as financial services, transportation & tourism.

Question 22

What is meant by the trade in goods ?

Answer 22

• goods exported and imported ➡️ incl. tangible manufactured products eg. cars, components for aircrafts, processed food/drink, chemicals, steel etc
• over 70% of merchandise exports globally are manufactured goods

Question 23

What is meant by the trade in services ?

Answer 23

• heavily traded services incl. transportation (freight & passengers), tourism, health & education services, financial services eg. foreign exchange dealing, business services eg. accountancy, consultancy, marketing
• other services incl. computer & info services, royalties & license fees
• huge growth in international trade in services ➡️ many now export TV series, film rights etc

Question 24

What factors affect comparative advantage ?

Answer 24

• natural resources: quantity & quality available
• unit wage costs
• demographics: ageing population, net migration, women’s participation in the labour force etc
• rates of new capital investment: incl. infrastructure spending
• non-price factors: eg. product design, innovation, product reliability, branding etc
• import controls: eg. tariffs, export subsidies + quotas ➡️ used to create an artificial comparative advantage
• exchange rate: fluctuations can affect the relative prices of exports/imports
• investment in R&D: can drive business innovation

Question 25

What is the problem with the comparative advantage model ?

Answer 25

• it is simplistic + may not reflect the real world eg. only two countries taken into account ➡️ most exports contain inputs from many different countries + products can travel across borders many times before a finished good/service is made available for sale to consumers
• general rule: business rather than countries trade

Question 26

What is the impact of emerging economies on trade patterns ?

Answer 26

• rising income: they start to purchase more goods/services from elsewhere in the world + above basic necessities (incl. increasing imports of commodities ➡️ push up prices of commodities for others)
• attract MNC activity + grow their own large companies: which start to operate elsewhere in the world eg. Lukoil from Russia
• selling more medium to high value exports: eg. manufactured items & electronics rather than commodities
• currency volatility in emerging markets: can have a large impact on commodity prices + raw material prices in other countries
• rising tension: between developed economies eg. US and emerging economies ➡️ trade wars/protectionist measures

Question 27

What are trade blocs ?

Answer 27

• consists of a number of countries that agree to trade with each other with reduced or no trade barriers ➡️ varying degrees of integration & types of trade blocs

Question 28

What are the different types of trade blocs ?

Answer 28

• preferential trade area: reduced protectionism on a no. of select goods/services amongst the countries involved ➡️ can be between two countries (bilateral)
• free trade area: completely free trade between the countries involved, but each country can set their own trade restrictions on countries outside of the agreement eg. EFTA
• custom union: completely free trade between the countries involved & they all agree to impose the same trade restrictions on other countries as each other eg. MERCOSUR (S America)

Question 29

What is the impact of trade blocs and bilateral trading agreement on trade patterns ?

Answer 29

• often lead to more intra-regional trade (within the trade bloc itself) + less inter-regional trade (trade between region/blocs) ➡️ may mean that countries do not always gain the benefits from specialising according to their comparative advantage
• 🔔 there may be trade creation at the expense of trade diversion

Question 30

What is the impact of changes in relative exchange rates on trade patterns ?

Answer 30

• a strong currency make exports appear relatively more expensive + imports relatively cheaper
• a weak currency makes exports appear relatively cheap + imports relatively expensive
  🔔 a currency can be weak against another but strong against others ➡️ important to consider relative exchange rates

Question 31

What are the terms of trade ?

Answer 31

• ToT measures the relative prices of a country’s exports compared to that cost (prices) of imported goods/services
• the ratio of the weighted price index for exports to the price index for imports ➡️ the amount of imported goods & services an economy can purchase per unit of exported goods & services

Question 32

Formula for calculating ToT ?

Answer 32

ToT index = (price index for exports) / (price index for imports) x100

Question 33

What is ToT a measure of ?

Answer 33

• a measure of a country’s trade competitiveness ➡️ another in relative unit labour cost
• a rise in the price index for exports of goods/services improves the tot ➡️ meaning a country can buy more imports for any given level of exports

Question 34

What does an improvement in the TOT mean ?

Answer 34

• export prices are rising relative to import prices (good because fewer goods have to be exported to buy a certain amount of imports)

Question 35

How can the ToT improve ?

Answer 35

• a fall in relative prices of imported technology : gives country the chance to import capital goods more cheaply ➡️ will then help to increase labour productivity + their long run competitiveness
• a rise in the unity export prices of a country’s exports: rising export price ➡️ cause an increase in revenues from exports (injection into the circular flow + improves the bofp on current account + increases the stock of foreign exchange reserves)

Question 36

What are regional trade blocs ?

Answer 36

• groups of countries that have formed a regional economic alliance in order to promote trade and economic cooperation within the region
• the WTO permits trade blocs, provided that they result in lower import protection against outside countries than existed before the the creation of the trade bloc

Question 37

Examples of regional trade blocs ?

Answer 37

• USMCA: US, Mexico, Canada agreement
• Mercosur: Brazil, Argentina, Uruguay, Paraguay + Venezuela
• ASEAN: association of Southeast Asian Nations free trade area
• Common Market of Eastern + Southern Africa: Zambia, Rwanda, Swaziland, Ethiopia + Kenya
• Trans-Pacific Partnership: an agreement negotiated between Australia, Brunei, Chile….

Question 38

What are free trade areas ?

Answer 38

• is when there are little/no import tariffs or quotas on products from one country entering another in the area
• eg. EFTA: European free trade association of Norway, Iceland, Switzerland, Iceland, Liechtenstein
• South Asian Free Trade Area
• Pacific Alliance

Question 39

What are bi-lateral trading agreement ?

Answer 39

• is the exchange of goods between two economies/groups of economies promoting trade in goods/services + flows of foreign investment ➡️ the two countries will reduce/eliminate import tariffs/import quotas/export restraints to encourage trade + investment
• eg. EU & Japan, US and Morocco

Question 40

What is a custom union ?

Answer 40

• comprises a group of countries that agree to: abolish tariffs & quotas between member nations + adopt a common external tariff on imports from non-member countries (same external trade policy)

Question 41

Examples of Customs unions ?

Answer 41

• EU is a customs union, it also has custom union agreements with Turkey, Andorra & San Marino
• South African Customs Union (Botswana, Lesotho, Namibia, South Africa & Swaziland)
• Eurasian Custom Union (Armenia, Belarus, Kazakhstan…)

Question 42

Difference between a trading bloc & a customs union ?

Answer 42

• trading bloc ➡️ an agreement between countries to LOWER import tariffs + perhaps extend this to reducing the use of non-tariff barriers to trade (in a free trade area, each country continues to be able to set their own distinct external tariff on goods imported from the rest of the world)
• customs union ➡️ NO tariffs are charged on goods/services moving within the area + adds on a common external tariff (CET) on all products flowing from countries outside the union (unless specific trade deal have been established) + revenues from import tariffs are combined for all member states

Question 43

What are common (single) markets ?

Answer 43

• represent a deeper integration between participating countries ➡️ usually go beyond free trade in goods/services to incl. free movement of labour across borders & capital + some common policies on product regulation
• eg. European Union

Question 44

Difference between a custom unions & a single market ?

Answer 44

• single market is a stronger + deeper form of integration
• a single market involves the free movement of goods/services, capital & labour
• as well as a common external tariff, a single market also tries to cut back on the use of non-tariff barriers eg. different rules on product safety & environmental standards ➡️ replacing them with a common set of rules governing trade in products within the common market

Question 45

What are the four key freedoms of a common market ?

Answer 45

1. free trade in goods ➡️ businesses can sell their products anywhere in EU member states + consumers can buy where they want with no penalty
2. mobility of labour ➡️ citizens of EU states can live, study & work in any other EU country
3. free movement of capital: financial capital can flow freely between member states & EU citizens can use financial services eg. insurance in any EU state
4. free trade in services ➡️ eg. pensions, architectural services, telecoms & advertising can be offered in any EU member state

Question 46

Potential economic benefits from countries joining the EU single market ?

Answer 46

• ✅ import: tariff free access to a single market of nearly 500 mill people ➡️ opportunity to exploit economies of scale
• ✅ easier to access FDI from inside/outside the EU ➡️ inward FDI can lift trend growth + raise factor productivity
• ✅ Access to EU structural funds (made available for poorer EU nations) ➡️ investment helps to improve infrastructure + potential output
• ✅ better access to EU capital markets ➡️ EU companies can raise investment funds from bond & capital markets
• ✅ Discipline of intense competition from being inside the EU single market ➡️ businesses must become more cost efficient + improve dynamic efficiency

Question 47

What is a monetary union ?

Answer 47

• a form of economic integration beyond participation in a single market ➡️ share the same currency
• eg. single European currency introduced in 1999 + came into common circulation in Jan 2002
• no country yet left the Euro Area despite the problems
• as of Aug 2019, 19 member nations ➡️ out of 27

Question 48

Possible advantages from joining a single currency ?

Answer 48

• ✅ currency risk: euro more stable than smaller currencies ➡️ easier for smaller countries to borrow money
• ✅ trade: euro enhances the gains from being in a single market ➡️ eg. encourages more cross border trade
• ✅ investment: likely to stimulate inward investment ➡️ eg. industries such as tourism, financial services, car-making
• ✅ competition: euro increases price transparency + market competition ➡️ helps consumers to find products at better prices
• ✅ transactions: shared currency eliminates the costly conversion of money + may also improve labour mobility within the single market

Question 49

Risks/drawbacks from committing to joining a single currency ?

Answer 49

• ❌ a country’s central bank loses the freedom to set monetary policy interest rates solely to meet macro objectives ➡️ eg. lower inflation or preventing a recession
• ❌ the option of a managed depreciation/ devaluation of the exchange rate to improve price competitiveness in overseas market is lost ➡️ govts may have to maintain deflationary fiscal policies to achieve an inter devaluation of the price level instead
• ❌ adjustment costs when switching currencies ➡️ incl. menu costs + risk that some retailers will increase prices when the currency is switched to make extra short term profits

Question 50

What conditions are necessary for the success of a monetary union (optimal currency area) ?

Answer 50

• countries are highly integrated ➡️ high % of trade is with fellow currency union nations
• each economy has a flexible labour market to cope with external shocks ➡️ incl. flexibility in real wages during an economic cycle, workers w/adaptable skills to reduce risk of structural unemployment, high geographical mobility within/between countries, flexible employment contracts incl. short term job contract
• when effects of interest rate changes or movement in the exchange rate have a broadly similar effect on businesses + households from country to country
• countries willing to makes fiscal transfers between each other + provide financial support during difficult economic times

Question 51

Benefits of regional trade agreements ?

Answer 51

• ✅ lower/abolished tariffs/quotas/other trade barriers ➡️ can lead to trade creations
• ✅ trade creation: occurs when countries agree to a trade deal that lower tariffs between them ➡️ consumers can now source imports from a lower cost country ➡️ lower prices + rise in real incomes

Question 52

Costs of regional trade agreements ?

Answer 52

• ❌ threat to globalisation: some of the worlds poorest countries may not be able to negotiate favourable tariff or quota free access to many of the markets of rich & advanced countries
• ❌may be costly: rules of origin used to prevent the roundabout export from non-member countries under preferential status ➡️ firms must comply & obtain certificates of origin to utilise preferential tariff rates under an RTA
• the WTO had noted a trend towards regionalisation of trade eg. within East Asia or the EU ➡️ WTO would prefer a global trade deal covering many goods/services rather than a complex a patchwork quilt of having over 4,000 separate free trade deal across the global economy

Question 53

What is the role of the WTO in trade liberalisation ?

Answer 53

• founded 1995
• key principle is that of multilateral trade
• describes itself as having 4 roles: conductor, tribunal, monitor and trainer

Question 54

What are the four roles of the WTO ?

Answer 54

1. conductor role: members of the WTO come up with a set of rules that apply to international trade ➡️ the WTO ensures that these rules are followed + rounds up negotiations to be able to develop new rules
2. tribunal role: settling disputes between members ➡️ members are encourage to sort out disputes itself but occasionally the WTO needs to convene a panel of experts
3. monitor role: the WTO reviews the trade policies of its members to make sure that WTO riles are being applied fairly + consistently
4. training role: the WTO provides training to govt official in mostly developing countries, to help them engage in trade with other WTO members

Question 55

What possible conflicts are there between trade blocs and the WTO ?

Answer 55

• trade blocs engage in free trade with their member (in line with WTO aims) but often put up trade restrictions against non-members (against WTO aims)
• The formation of RTA, eg. free trade areas, customs unions, and common markets, may conflict with the roles and aims of the World Trade Organization (WTO) in several ways:
  1. Non-discrimination: member countries to provide equal treatment to all WTO members in terms of trade & access to markets ➡️ trading blocs, on the other hand, discriminate against non-member countries by providing preferential treatment to member countries.
  2. Fair competition: WTO aims to promote fair competition among countries by reducing trade barriers & promoting trade liberalisation ➡️ trading blocs may lead to increased competition among member countries but also create new trade barriers between member and non-member countries, leading to unequal competition.
  3. Transparency: WTO operates on the principle of transparency, which requires members to make their trade policies & agreements public ➡️ formation of trading blocs may make it more difficult for the WTO to monitor trade policies and agreements among its member countries, leading to increased uncertainty and reduced transparency.
  4. Dispute resolution: WTO provides a forum for resolving trade disputes between member countries ➡️ the formation of trading blocs may make it more difficult for the WTO to resolve disputes between members and non-members, as disputes may arise between the bloc and non-member countries, creating a new layer of complexity in dispute resolution.
• the WTO allows regional trade agreements provided that certain criteria are met ➡️ in particular, trade should flow more freely within the RTA w/o barriers being raised on countries external to the RTA + developed countries are allowed to give special trade treatment to developing counties
• 🔔 “regional integration should complement the multilateral trading system and not threaten it” ➡️ if this principle is not upheld, the WTO believes that RTA’s violates its key principle of the most favoured nation

Question 56

Reasons for restrictions on free trade ?

Answer 56

• response to allegations of export “dumping”
• response to a persistently large trade deficit
• employment protection in key (strategic) industries
• protect “fledgling” or infant sectors until they are competitive
• raise tax revenues to help lower a budget (fiscal) deficit
• response to the impact of an economic recession

Question 57

What are the main reasons for protectionism ?

Answer 57

1. infant industry argument ➡️ protecting emerging industries until they have achieved economies of scale
2. sunset industry argument ➡️ use tariffs to slow the decline of old sectors + limit structural unemployment
3. diversify an economy thought to be too dependent on one product
4. raise tax revenues ➡️ important for many developing countries with a limited domestic tax base
5. improve the trade balance + preserve jobs in key industries
6. prevention of unfair trade practices eg. import dumping ➡️ where excess output is sold in another country at a price below cost of production
7. protect strategic industries eg. might include national defence, electricity generation, supply of basic foodstuffs

Question 58

What is import dumping ?

Answer 58

• dumping occurs when firms sell exports at below costs or below normal prices in the home market ➡️ implies predatory pricing (illegal) + price discrimination (not illegal)
• if sold below normal prices to other countries it makes it harder for domestic producers to compete
• anti-dumping duties (tariffs) raise the price of a product to help protect local producers

Question 59

What are anti-dumping tariffs ?

Answer 59

• allowed under WTO rules when cases of dumping have been established ➡️ 3 main options when introducing them:
  1. an ad valorem duty: % of the net EU frontier price (most common import duty)
  2. a specific duty: a fixed value/ a set amount per unit imported
  3. a variable duty: a min import price (MIP) ➡️ importers do not have to pay an anti-dumping duty if the foreign exporter’s export price is higher than the MIP ➡️ the lesser-duty rule is that duties can’t exceed the level needed to repair the harm done to European industry by the unfair dumping practices

Question 60

What are the types of trade restriction ?

Answer 60

• import tariffs
• import quotas
• domestic subsidy: reduce costs ➡️ increase the supply & therefore reduce the market equilibrium price
• non-tariff barrier: trade barriers such as import quotas, environmental regulations, trade embargoes & export subsidies
• rules of origin: rules on the national source of a product eg. a country may set a min % for locally sourced components
• migration controls
• managed currencies

Question 61

What are import tariffs + their impact ?

Answer 61

• taxes on imports (may be ad valorem % or a specific tax)
• aim: to protect domestic suppliers from overseas competition by increasing the relative price of imports ➡️ switch of spending towards domestic producers + generate tax revenues for govt
• impact: expansion of domestic output, contraction of domestic demand (reduces real incomes of consumers), fall in volume of imports, increases govt tax revenues, increase domestic producer revenue, fall in foreign producer revenue, fall in consumer surplus, fall in overall economic welfare (deadweight loss of welfare + loss of economic efficiency)

Question 62

What are import quotas + their impact ?

Answer 62

• a physical limit on the quantity of a good that can be imported into a country/market
• aim: restrict supply of an imported product ➡️ increasing price of imported products
• impact: increase in domestic output, contraction of domestic demand, contraction in import volumes, no direct effect on tax revenues, increase in domestic producer revenue, fall in foreign producer revenue, fall in consumer surplus, fall in overall welfare (restricts free trade + leads to deadweight loss of economic welfare) + black markets may develop with agents trading at unofficial prices

Question 63

Impact of an import quota on different stakeholders ?

Answer 63

• domestic producers:
  ✅ benefit from cap on imports (increases the market price + makes it more profitable for them to stay in the market)
  ❌ might encourage domestic firms to become less productively efficient + some producers hampered by scare supply of higher quality overseas imports (hurts their competitiveness)
• consumers:
  ❌ higher prices likely bcs of limit + less competition may also effect the quality of products available
  ✅ consumers who work for domestic firms may benefit from higher employment + wages + may stimulate increased investment
• govt:
  ✅ improved external balance from reduction in imports + expansion of GDP from increase in domestic production
  ❌ no immediate tax revenues

Question 64

What is a domestic subsidy + their impact ?

Answer 64

• any form of govt financial help to domestic businesses (financial incentives)
• aim: help firms to lower their costs, thus become more competitive in home & overseas markets
• domestic producers:
  ✅ higher revenues will lift profits + may lead to a higher share price
  ❌ risk of dependancy emerging (lack of competitiveness, productivity)
• consumers:
  ✅❌ no direct effect on prices assuming that the subsidy is not large enough to change the world price
  ❌ may face higher taxes if expensive subsidies take up more of govt spending
• govt:
  ✅ can be an effective non-tariff barrier to reduce the volume of imports by encourage domestic production
  ❌ does not generate tax revenues directly + increase spending on subsidies may then cause a growing budget deficit

Question 65

Wha are non-tariff barriers (NTBs) ?

Answer 65

1. intellectual property: laws eg. patents + copyright protection
2. technical barriers: incl. labelling rules + stringent sanitary standards ➡️ rules/regulations increase product compliance costs + act as a friction cost for importers
3. preferential state procurement policies: where govts favour local producers when finalising contracts for state spending
4. domestic subsidies: aid for domestic businesses facing financial problems eg. subsidies for car manufactures
5. financial protectionism: eg. when a govt instructs banks to give priority when making loans to domestic businesses
6. murky/hidden protectionism: eg. state measures that indirectly discriminate against foreign workers, investors + traders
7. managed exchange rates: govt intervention in currency markets to affect relative prices of imports + exports

Question 66

What are the main arguments against protectionism ?

Answer 66

• conventional view ➡️ import tariffs nearly always lead to a deadweight loss of economic welfare eg. from distorting effects on market competition
  1. resource misallocation: leading to a loss of economic efficiency
  2. dangers of retaliation: risks of a persistent trade war as a response
  3. potential for more corruption: tariffs are higher in less democratic countries (revenues can be appropriated)
  4. higher prices for domestic consumers: has a regressive impact on poorer people/ communities
  5. increased input costs for home producers: damages competitiveness for businesses that require key imported component parts/raw materials
  6. barrier to entry: protectionism reduces market contestability ➡️ increases monopoly power

Question 67

What is the current account of the BoP ?

Answer 67

made up four separate balances:
- net balance of trade in goods
- net balance of trade in services eg. banking, insurance, transport, tourism, education
- net primary income (includes interest, profits, dividends and migrant remittances)
- net secondary income (includes transfers i.e. contributions to EU, military aid, overseas aid)

Question 68

What is the capital account of the BoP ?

Answer 68

• used to record international transfers between the residents in one country & those in other countries ➡️ can reflect a country’s financial health + stability
• sale/transfer of patents, copyrights, franchises, leases & other transferable contracts (example would be
  international buying and selling of land by businesses)
• debt forgiveness/cancellation (forgiving debt is counted as a negative in this account)
• capital transfers of ownership of fixed assets (i.e. international death duties)

Question 69

What is the financial account of the BoP ?

Answer 69

• includes transactions that result in a change of ownership of financial assets & liabilities between UK residents and non-residents
• net balance of foreign direct investment flows (FDI)
• net balance of portfolio investment flows (e.g. inflows/outflows of debt and equity)
• balance of banking flows (e.g. hot money flowing in/out of banking system)
• changes to the value of reserves of gold and foreign currency

Question 70

What is FDI ?

Answer 70

• foreign direct investment ➡️ investment from one country into another (normally by companies rather than govts) that
  involves establishing operations or acquiring tangible assets, including stakes in other businesses
• FDI flows:
• inward investment is a positive for the UK accounts eg. an overseas business decides to build a manufacturing factory in the UK or a foreign retail firm invests to open new stores in the UK
• outward investment is a negative for the UK financial account of the balance of payments eg. investment made overseas by UK businesses

Question 71

What are portfolio investment flows ?

Answer 71

• happens when people/businesses from one country buy shares or other securities such as bonds in other nations.
• eg. a UK investor buys some shares in Google (this is a portfolio investment outflow for the UK accounts)
• eg. a German investment bank might buy some of the sovereign debt issued by the UK government (this counts as a portfolio investment inflow for the UK)

Question 72

What is a current account deficit (external deficit) ?

Answer 72

• involves a net outflow of income from the economy’s circular flow ➡️ value of the goods/services imported > value of the products exported
• deficit countries need to run a financial account surplus to achieve balance on their external accounts ➡️ might be achieved for example by attracting inflows of financial capital (e.g. FDI) from other countries
• current account deficit nations are debtor countries

Question 73

Causes of a current account deficit ?

Answer 73

• poor price & non-price competitiveness: due to high inflation, low levels of capital investment & R&D spending, weaknesses in design, branding and product performance
• strong exchange rate: high currency value increases overseas prices of exports ➡️ fall in demand (appreciating currency also makes imports cheaper)
• strong domestic economic growth: rising demand + spending on imported products (luxury, raw materials used by industries, imported capital equipment & technologies)
• recession in one or more major trade partner countries: cuts value of exports to these countries
• volatile global prices: exporters of primary commodities may be hit by a fall in global prices ➡️ direct fall in the value of their export earnings, importing nations may be hit by higher world prices for oil/gas/raw materials

Question 74

Structural causes of a current account deficit ?

Answer 74

• relatively low productivity/high unit labour costs
• insufficient investment in capital ➡️ limits a nation’s export capacity
• low levels of national saving
• long term declines in the real prices of a country’s major exports

Question 75

Consequences of a current account deficit ?

Answer 75

• loss of AD if there is a trade deficit ➡️ causes weaker real GDP growth + may lead to reduced standard of living + higher unemployment
• big deficit usually will cause the currency to depreciate ➡️ higher cost-push inflation + deterioration in the ToT
• some countries running a deficit may chose to borrow to achieve a financial account surplus ➡️ increases external debt carries risks
• unsustainable deficits can lead to a loss of investor consequence ➡️ capital flights + possible currency/BoP crisis

Question 76

What is a current account surplus ?

Answer 76

• means that there is a net injection of income into a country’s circular flow ➡️ exports > imports
• surplus nations are also known as creditor countries
• a surplus will lead to an accumulation of
  foreign exchange e.g. from rising export sales or an increase in net primary and secondary income.

Question 77

Main causes of a current account surplus ?

Answer 77

• large & persistent surplus of savings (S) over investment (I) for households, firms and the government ➡️ in these countries, consumption could be higher, and this would help to rebalance trade
• a large positive gap between exports & imports, when net income balance and net transfers are small
• an export surplus may be the result of high world prices for exports of commodities such as oil and gas.
• a surplus on the current account would allow a deficit to be run on the financial account eg. surplus foreign currency can be used to fund investment in assets located overseas or some current account surplus countries have large sovereign wealth funds
• current account surplus countries nearly always have a strong exchange rate as a result

Question 78

What are expenditure switching policies ?

Answer 78

• policies designed to change the relative price of exports and imports ➡️ to help reduce the size of a country’s external deficit
• eg. an exchange rate depreciation ought to improve the price competitiveness of exports + also make imports more expensive when priced in a domestic currency
• import tariffs are also designed to create expenditure-switching effects + low rate of inflation

Question 79

What are expenditure reducing policies ?

Answer 79

• policies designed to lower real incomes + AD ➡️ thereby cut demand for imports
• eg. higher direct taxes, cuts in government spending or an increase in monetary policy interest rates, increase in income taxes, cuts in real level of govt spending (lowers AD)

Question 80

Measures to reduce a country’s imbalance on the current account ?

Answer 80

• expenditure switching policies
• expenditure reducing policies
• supply-side policies ➡️ can increase output + reduce the domestic price levels (exports more competitive)

Question 81

What effect does changes in the exchange rate have on the current account ?

Answer 81

• a large current account deficit leads to an outflow of currency from the circular flow which then causes an exchange rate depreciation (within a floating currency system)
• a weaker currency (in theory) helps bring about an adjustment of the trade balance ➡️ exports become more competitive in overseas markets + imported goods/services appear more expensive in domestic markets.
• in reality, the extent to which a current depreciation helps to improve the trade balance depends on a number of factors ➡️ J Curve effect and the associated Marshall-Lerner condition.

Question 82

What is the J Curve effect ?

Answer 82

• in the short term, a currency depreciation may not improve the current account of the BoP ➡️ bcs the price elasticities of demand for exports & imports are likely to be inelastic in the short term
• initially the qnty of imports bought will remain steady bcs contacts for imported goods are already signed + export demand will be inelastic in response ➡️ takes time for export businesses to increase their sales after a fall in prices
• earnings for selling more exports may be insufficient to compensate for higher total spending on imports, therefore the balance of trade may initially worsen ➡️ ‘J curve’ effect
• providing the price elasticity of demand for imports & exports are greater than one, then the trade balance will improve over time
• known as the Marshall Lerner condition

Question 83

What is the Marshall Lerner condition ?

Answer 83

• states that a depreciation/devaluation of the exchange rate will lead to a net improvement in the trade balance provided that the sum of the price elasticity of demand for exports & imports > 1

Question 84

What are global trade imbalances ?

Answer 84

• refer to persistent current account surpluses for some countries contrasted with deficits in other nations
• theory suggests that in a freely-floating exchange rate system, trade imbalances will self-correct ➡️ because if a country has a trade deficit, then demand for exports will be low which in turn causes reduced demand for the
  currency ➡️ leads to a depreciation of the currency, thus making exports more price competitive & stimulating
  demand for them. However, imbalances often tend to persist, because:
  a) not every country operates a freely-floating exchange rate
  b) there may be structural reasons why some countries run persistent trade deficits or surpluses

Question 85

Why do current account deficits & surpluses matter ?

Answer 85

• the BoP will balance overall ➡️ a deficit on the current account must be matched by surpluses on the capital/financial accounts (in reality, it is very difficult to carry out accurate accounting & so there is always a ‘net errors and omissions’ term which allows the BoP to balance).
• for there to be a persistent deficit on the
  current account, there must be a corresponding persistent surplus on the financial account ➡️ the economy must be
  able to attract inflows of capital (either long-term capital such as FDI…desirable…or short-term capital in the form of hot money…less desirable)

Question 86

Characteristic of current account deficit countries ?

Answer 86

• run up large external debts + are reliant on foreign capital
• may reflect low levels of savings or high levels of investment
• may decide to switch towards using protectionist policies
• deficits can lead to a fall in relative living standards over time if economic growth slows down

Question 87

Characteristics of current account surplus countries ?

Answer 87

• are saving more than they spend ➡️ depressing global economic demand & growth
• may be adopting a policy to keep their currency deliberately under-valued
• might be under-consuming (thus affecting living standards) + allocating domestic scarce resources to exporting overseas rather than allowing higher levels of domestic consumer spending