Chapter 35 - Globalisation

Question 1

What is globalisation?

Answer 1

A process by which the world’s economies are becoming more closely integrated.

Question 2

How is transportation and communication costs a cause of globalisation?

Answer 2

One of the contributory factors to the spread of globalisation was undoubtedly the rapid advances in the technology of transportation and communications.

Improvements in transportation enabled firms to fragment their production process to take advantage of varying cost conditions in different parts of the world. For example, it is possible to site labour- intensive parts of a production process in areas of the world where labour is relatively plentiful, and therefore relatively cheap.

Furthermore, communications technology developed rapidly with the growth of the internet and e-commerce, enabling firms to compete more easily in global markets. The importance of email and other forms of communication such as video-conferencing and Skype should not be underestimated. It is now taken for granted that there can be instant communication across the globe. This has made it very much easier for firms to communicate within their organisations and with other firms, and has certainly fuelled the closer integration of firms and economies. The emergence of a global media presence enables the rapid sharing of information and ideas, keeping consumers well informed about new products coming to the market.

These technological changes augmented existing economies of scale
and scope, enabling firms to grow. In the countries in which they operate,
the sheer size of some multinational corporations gives them political as
well as economic power.

Question 3

How is a reduction of trade barriers a cause of globalisation?

Answer 3

In addition to these trade-liberalising measures, there has been a trend towards the establishment of free trade areas and customs unions in various parts of the world, with the EU being just one example. By facilitating the process of international trade, such developments have encouraged firms to become more active in trade, and so have added to the impetus towards globalisation.

Question 4

What is the World Trade Organisation (WTO)?

Answer 4

A multilateral body now responsible for overseeing the conduct of international trade

Question 5

How is deregulation of financial markets cause of globalisation?

Answer 5

Hand in hand with these developments, there were moves towards removing restrictions on the movement of financial capital between countries, thereby making it much easier for firms to operate globally. This has been reinforced by developments in technology that enable financial transactions to be undertaken more quickly and efficiently.

This whole process has led to changes in the pattern of trade between countries - for example, as the UK became more closely integrated with the rest of Europe, there has been an increase in the share of UK trade that is with the rest of Europe, although the USA also remains a significant trading partner.

Question 6

How is migration cause of globalisation?

Answer 6

In Europe, the formation of the Single European Market enabled freer movement of people within Europe. The effects of this were reinforced by the ending of the Cold War, which affected global labour supply.

Question 7

What is absolute advantage?

Answer 7

A country’s ability to produce a good using fewer resources than another country

Question 8

What is comparative advantage?

Answer 8

A country’s ability to produce a good relatively more efficiently (i.e. at lower opportunity cost) than another country

Question 9

What is the trading possibilities curve?

Answer 9

Shows the consumption possibilities under conditions of free trade

Question 10

What is the law of comparative advantage?

Answer 10

A theory arguing that there may be gains from trade arising when countries specialise in the production of goods or services in which they have a comparative advantage

Question 11

What are terms of trade?

Answer 11

The ratio of exports prices to import prices

Question 12

What is the formula for terms of trade?

Answer 12

(Price index of exports / Price index of imports) x 100

Question 13

What is the net barter terms of trade?

Answer 13

The terms of trade described in the text are known more formally as the net barter terms of trade. As noted, the net barter terms of trade relate solely to the relative prices of exports and imports, so do not take into account changes in the volume of exports and imports. The income terms of trade take the volume of trade into account, being defined as the value of a country’s exports divided by the price of imports.

In other words, this measures the purchasing power of a country’s exports in terms of the price of its imports. It is possible for all countries to experience an increase in the income terms of trade simultaneously.

Question 14

How does the terms of trade in developing countries work?

Answer 14

Movements in the terms of trade have been especially important for developing countries, which tend to rely on exporting primary products. Problems have arisen in both the short run and the long run. In the short run, primary product prices have tended to be highly volatile. Developing countries are typically too small in the market to be able to influence prices, so have experienced volatility in export revenues.

In the long run, there has been a tendency for non- fuel primary product prices to fall relative to prices of manufactured goods, so that many developing countries have experienced a long-term deterioration in the terms of trade, reducing the value of their exports.

Question 15

What is the J-curve effect?

Answer 15

A situation following a devaluation, in which the current account deficit moves further into deficit before improving.

Question 16

How does the J-effect work?

Answer 16

Under a fixed exchange rate system, it may be tempting to use devaluation to improve competitiveness. At a lower value of the pound, you would expect an increase in the demand for exports and a fall in the demand for imports, ceteris paribus.

However, this does not necessarily mean that there will be an immediate improvement in the current account. One reason for this concerns the elasticity of supply of exports and import substitutes. If domestic producers do not have spare capacity, or if there are time lags before production for export can be increased, then exports will not expand quickly in the short run, and so the impact of this action on exports will be limited. Furthermore, similar arguments apply to producers of goods that are potential substitutes for imported products, which reinforces the sluggishness of adjustment. In the short run, therefore, it may be that the current account will worsen rather than improve, in spite of the change in the competitiveness of domestic firms.

A second consideration relates to the elasticity of demand for exports and imports. Again, if competitiveness improves but demand does not respond strongly, there may be a negative impact on the current account. If the demand for exports is price inelastic, a fall in price will lead to a fall in revenue. There is reason to expect that the demand for exports is relatively inelastic in the short run. In many cases, exports may be supplied under contracts that cannot be immediately renegotiated. Furthermore, people and firms may wait to see whether the devaluation is permanent or temporary, and so not revise their spending plans in the short run.

Question 17

What is the Marshall-Lerner condition?

Answer 17

The condition that devaluation will have a positive effect on the current account only if the sum of the elasticities of demand for exports and imports is negative and numerically greater than 1

Question 18

How does comparative advantage work?

Answer 18

The law of comparative advantage helps to explain the pattern of international trade. Indeed, globalisation may be seen as a process that enables countries to enhance the way in which their comparative advantage can be exploited. In some cases, it may enable some countries to develop new specialisations, and so alter the pattern of their comparative advantage.

From the point of view of economic analysis, it would seem likely that this process of globalisation, and the increasing use of comparative advantage, would be welcomed by countries around the world. However, it seems that this is not a universal view. Countries often seem reluctant to open their economies fully to international trade, and have tended to intervene to try to protect their domestic producers from what is perceived as excessive and possibly unfair competition from foreign firms.

In the light of these twin problems, it is perhaps no surprise that many LDCs see themselves as trapped by their pattern of comparative advantage, rather than being in a position to exploit it. They have therefore been reluctant to continue in such a state of dependency on primary products, but the process of diversification into a wide range of products has been difficult to achieve.

A potential change in this pattern was seen in 2007 and 2008, with food prices rising rapidly. These included the prices of some staple commodities such as maize and rice. The net effect of this on LDCs was mixed. Countries in a position to export these commodities benefited from the rise in prices - that is, an increase in their terms of trade. However, there are many LDCs that need to import these staple commodities and for them the terms of trade deteriorated. These trends were interrupted by the onset of recession in many developed countries in 2008.

The degree to which a country or region engages in trade depends upon several factors. One important influence is the extent to which a country has the resources needed to trade - in other words, whether it can produce the sorts of goods that other countries wish to buy. However, it also depends upon the policy stance adopted by a country. Some countries have been very open to international trade. For example, a number of countries in Southeast Asia built success in economic growth on the basis of promoting exports. In contrast, there are countries such as India that in the past were less eager to trade, and introduced policies that hindered their engagement with trade.

Question 19

What is the Hecksher-Ohlin model?

Answer 19

Two Swedish economists, Eli Heckscher and Bertil Ohlin, argued that a country’s comparative advantage would depend crucially on its relative endowments of factors of production. They argued that the optimal techniques for producing different commodities varied. Some commodities are most efficiently produced using labour-intensive techniques, whereas others could be more efficiently produced using relatively capital-intensive methods.

This then suggests that if a country has abundant labour but scarce capital, its natural comparative advantage would lie in the production of goods that require little capital but lots of labour. In contrast, a country with access to capital but facing a labour shortage would tend to have a comparative advantage in capital-intensive goods or services.

Question 20

How is standards of living a consequence of globalisation?

Answer 20

By enabling increased specialisation and trade, globalisation has allowed economic growth to take place. This has enabled an increase in standards of living for people in many countries.

In developed countries, globalisation has allowed more consumer choice, as a wider range of products has become accessible. The emerging economies have benefited by being able to enjoy economic growth in supplying the demands of consumers in the developed countries. Developing countries have not always benefited as strongly, partly because of low incomes that mean many products remain out of reach. There is also the danger that inappropriate products and lifestyles may spread at the expense of local cultures.

Question 21

How is structural change a consequence of globalisation?

Answer 21

Increased specialisation comes with a transitional cost. Countries have had to adjust to new patterns of economic activity. For example, many developed countries have seen their economies go through a transition in which traditional sectors such as manufacturing have declined in the face of competition from LDCs. This process is known as deindustrialisation.

The service sectors have expanded, but workers displaced from manufacturing occupations do not always find it easy to retrain for service sector jobs. Some producers have been unable to compete with lower-cost producers from elsewhere in the world, but others have flourished as service activity has expanded. In theory, there should be long-term benefits from making this transition, but sometimes the short- term costs are more evident.

The emerging economies have again benefited by being able to move into areas of economic activity vacated by the developed countries. This has helped to fuel their rapid and persistent economic growth. Developing countries are beginning to benefit also, but many lack the resources and skills to be able to compete with the developed and emerging economies.

Question 22

What is foreign direct investment (FDI)?

Answer 22

Investment undertaken in one country by companies based in other countries

Question 23

What is a multinational corporation (MNC)?

Answer 23

A company whose production activities are carried out in more than one country

Question 24

How is FDI a consequence of globalisation?

Answer 24

The UN Conference on Trade and Development has identified three main reasons for FDI:

• market seeking
• resource seeking
• efficiency seeking

First, some MNCs may engage in FDI because they want to sell their products within a particular market, and find it preferable to produce within the market rather than elsewhere: such FDI is market seeking. Second, MNCs may undertake investment in a country in order to take advantage of some key resource. This might be a natural resource such as oil or natural gas, or a labour force with certain skills, or simply cheap unskilled labour: such FDI is resource seeking. Third, MNCs may simply review their options globally, and decide that they can produce most efficiently in a particular location. This might entail locating just part of their production chain in a certain country. Such FDI is efficiency seeking.

Developed and emerging economies have benefited from FDI, partly because most began life in those economies, so the profits tend to flow to them. The spread of technology through the actions of MNCs has been beneficial to developed countries, and to the emerging economies that have been able to use the enterprise and physical capital now located in their countries. For example, the opening up of China to foreign investment proved a magnet for MNCs wanting to gain access to this large and growing market.

For developing countries, FDI can have positive and negative effects. On the positive side, it is hoped that FDI will bring potential gains in employment, tax revenue, capital and technology, with consequent beneficial impact on economic growth. This may be seen as especially important for countries that especially lack capital and technology or the ability to raise tax revenue. However, there is a downside, as these potential benefits may not always be as strong as had been hoped. In particular, if profits are repatriated to shareholders elsewhere in the world, the long-term impact of FDI may be diluted, rather than feeding back into economic growth. For LDCs, the tax concessions negotiated by foreign transnational firms may reduce the benefits, and the technology may not be appropriate, or not disseminated.

Question 25

How is interdependence of economies a consequence of globalisation?

Answer 25

One of the issues concerning a more closely integrated global economy is the question of how robust the global economy will be to shocks. In other words, globalisation may be fine when the world economy is booming, as all nations may be able to share in the success. But if the global economy goes into recession, will all nations suffer the consequences? There are a number of situations that might cause the global economy to take a downturn, which then affects countries and their governments around the world.

Question 26

How does oil prices affect interdependence of economies?

Answer 26

Oil prices seem to provide one possible threat. Historically, sudden changes in oil prices have caused widespread disruption: for example, in 1973-74 and in 1979-80. Arguably, national economies in the twenty- first century are less vulnerable to changes in the price of oil than they were in 1973. However, volatility in the price of such a key commodity is significant. The price of oil is significant because of its importance to so many businesses as an energy source, so fluctuations in its price can have knock-on effects across the global economy. Higher oil prices have highlighted awareness of environmental issues, and stimulated the search for new sources of energy.

Question 27

How does financial crises affect interdependence of economies?

Answer 27

Given the increasing integration of financial markets, a further concern is whether globalisation increases the chances that a financial crisis will spread rapidly between countries, rather than being contained within a country or region. An example of the dangers of close interdependence began to unfold in 2007-08, when the financial crisis began to bite, and commercial banks in several countries found themselves in financial crisis. This followed a period in which relatively low interest rates had allowed a bubble of borrowing. When house prices began to slide, many banks in several countries found that they had overextended themselves, and had to cut back on lending, in some cases threatening their viability. This affected a number of countries simultaneously, and there was a danger that the financial crisis would affect the real economy, leading to a recession. This was a recession that would affect countries all around the globe because of the new interconnectedness of economies. It became apparent that no single country could tackle the problem alone, as measures taken to support the banks in one economy had rapid knock-on effects elsewhere. Once this was realised, coordinated action was taken, and in October 2008 the central banks of several countries reduced their bank rates together. This was followed by action aiming to salvage the situation and avoid a full-blooded recession. By early 2009, the UK economy was officially in recession, bank rate had been driven down to an unprecedented 0.5%, and the Bank of England was introducing quantitative easing to try to stimulate the economy. One of the problems was that the commercial banks had become reluctant to lend, so firms that wanted to invest were finding it difficult to obtain funds. Attempts were made to coordinate the efforts of governments of key countries around the world - for example, at the G20 Summit held in London in April 2009. As time went by and the recession deepened, a number of countries in the Eurozone faced crises with the level of public debt. This affected Ireland, Greece and Portugal in particular, all of which needed bailouts. Some emerging economies, notably India and China, were able to continue to enjoy economic growth through the period of the crisis, although subsequently, they too experienced something of a slowdown. The experience of developing countries was mixed, some of them continuing to grow through the period.

Question 28

How does the environment affect interdependence of economies?

Answer 28

Critics of globalisation have pointed to the impact that the increase in trade associated with globalisation may be having on the environment, especially in the context of climate change and global warming. This is bound up with the notion of sustainable development, which refers to the effect that economic growth and increased trade may have on future generations.

Question 29

How does globalisation impact emerging economies?

Answer 29

Industrialisation and economic growth began in Britain and other countries in Western Europe and North America, and by the 1960s there was a divide between those countries that had gone through the development and growth process and those that had not. Since the 1960s, relatively few countries have managed to bridge the gap in living standards. There was a group of countries that became known as the newly industrialised countries (NICs) that made the transition. These included some countries in Southeast Asia, such as Singapore, South Korea, Taiwan and Hong Kong, and some Latin American countries, although the latter group fell foul of hyperinflation, which interrupted their progress. More recently, some other countries have accelerated in terms of economic growth and human development: namely, the emerging economies. This group has included the so-called BRICS countries, and a less-defined group including Thailand, Malaysia and Turkey, among others. The success of these countries has had a significant impact on the performance of other countries. The initial impact of the NICs was mainly positive. They were producing goods that the developed countries had been accustomed to produce. However, the expansion of service sector activity and hi-tech products meant that the NICs were filling a gap left by the developed countries. The rise of China as an economic superpower produced rather different responses, and the developed countries began to see a possible threat to their dominance.

Question 30

How does China and the USA link to globalisation?

Answer 30

In the early to mid-2000s, the global economy was faced with two seemingly distinct but related phenomena: the rapid growth of the Chinese economy, and the deficit on the US current account of the balance of payments. The US current account deficit arose partly from the heavy public expenditure programme of the Bush administration. However, the deficit grew to unprecedented levels partly through the actions of China and other East Asian economies that had chosen to peg their currencies to the US dollar. Effectively, this meant that those economies were buying US government securities as a way of maintaining their currencies against the dollar, thereby keeping US interest rates relatively low and allowing the American public to borrow to finance high consumer spending. Who gained from this situation? The USA was able to spend, and China was able to sell, fuelling its rapid rate of economic growth. In due course, China agreed to allow its currency to adjust towards its true equilibrium - albeit rather slowly. The events left a legacy of distrust between the USA and China. In 2018, President Trump imposed heavy tariffs on imports from China, initially on goods such as solar panels and washing machines, later on steel and aluminium. Further tariffs were announced as the year went by, not only affecting China but other countries as well. There were also threats that Trump tariffs would be imposed on imported cars from Europe. China retaliated by imposing its own tariffs on goods from the USA. Such a trade war would have a major impact on world trade.