Globalisation

Question 1

What are the characteristics of globalisation? (4)

Answer 1

1) Free trade of goods and services across national boundaries.
2) Free movement of labour between countries.
3) Free movement of capital between countries.
4) Free interchange of technology and intellectual capital across national borders.

Question 2

What are the causes of globalisation? (7)

Answer 2

1) Trade in goods increasing between the developed and developing world.
2) Trade in services across the world growing.
3) Growth of TNCs who operate in many countries across the globe.
4) Trade liberalisation leading to growth in trade of goods and services.
5) International financial flows making it easier to trade and invest across the world.
6) Foreign ownership of firms and FDI.
7) Communications and IT have made it easier for economic agents to trade internationally.

Question 3

Impact of globalisation on consumers. (3)

Answer 3

1) Increased consumer choice.
2) Globalisation has led to a fall in the price of most goods and services.
3) Globalisation has raised incomes around the world.

Question 4

Impact of globalisation on workers. (4)

Answer 4

1) Employment and unemployment - increasing unemployment in manufacturing industries in the developed world. Increased employment opportunities in the developing world.
2) Migration - this can help to fill skills shortages, but may cause hostility from native workers.
3) Wages - depression of wages of unskilled and low-skilled workers in the developed world.
4) TNCs create jobs in the countries they invest in.

Question 5

Impact of globalisation on producers. (3)

Answer 5

1) Greater interdependence between countries and firms leads to greater risk if trade links break down.
2) Wide supplier networks have led to lower prices.
3) Domestic firms have suffered from international competition.

Question 6

Impact of globalisation on governments. (5)

Answer 6

Relocation of firms from the developed world will create the following problems for the governments of these countries:
1) Fewer jobs
2) Less tax revenue
3) Fewer exports
Governments across the world have also become victims of:
1) Tax avoidance
2) Corruption

Question 7

Impact of globalisation on the environment. (3)

Answer 7

1) Increased deforestation.
2) Increased exploitation of finite resources such as oil and iron ore.
3) Increased emissions - negative impact on global warming and climate change.

Question 8

Impact of globalisation on individual countries.

Positive (4) and negative (3)

Answer 8

Positive:

1) Rising incomes
2) More jobs
3) Lower prices
4) Increased consumer choice

Negative:
1) Loss of industries
2) Loss of jobs
3Lower incomes

Question 9

What is absolute advantage?

Answer 9

Absolute advantage implies that one country is able to make more of a product than another country from the same amount of resources.

Question 10

What is comparative advantage?

Answer 10

Comparative advantage is where one country can produce a good with a lower opportunity cost than that of another country.

Question 11

When can trade between two countries be beneficial to both countries?

Answer 11

Trade between two nations can be beneficial to both if each specialises in the production of a good in which it has a comparative advantage (even if one has an absolute advantage in both). The crucial requirement is that there must be a difference in the opportunity cost of producing the products.

Question 12

What assumptions are made in the law of comparative advantage? (5)

Answer 12

1) Constant returns to scale. This would imply that the production possibility frontiers are drawn as straight lines.
2) No transport costs.
3) No trade barriers.
4) Perfect mobility of factors of production between uses.
5) Externalities are ignored.

Question 13

What are the limitations of the law of comparative advantage? (3)

Answer 13

1. Free trade is not necessarily fair trade; rich countries might use their monopsony powers to force producers in developing countries to accept very low prices.
2. The law of comparative advantage is based on unrealistic assumptions such as constant costs of production, zero transport costs and no barriers to trade.
3. If the opportunity costs were the same then there would be no benefit from specialisation and trade.

Question 14

What are the advantage of specialisation and trade? (5)

Answer 14

1) Higher living standards and increased employment resulting from an increase in world output.
2) Lower prices and increased choice.
3) Transfer of management expertise and technology transfer.
4) Economies of scale.
5) Reduction of the power of domestic monopolies.

Question 15

What are the disadvantages of specialisation and trade? (6)

Answer 15

1) A deficit on trade in goods and services balance if a country’s goods and services are uncompetitive.
2) Firms in countries with surpluses of goods might ‘dump’ them on other countries. This could cause local producers to go out of business and make the country dependent on imports in the long run.
3) Increased unemployment.
4) Increased risk of contagion and disruption resulting from problems in the global economy.
5) Unbalanced development – international specialisation based on free trade means that only those industries in which a country has a comparative advantage will be developed, while others will remain undeveloped. This could cause sectoral imbalance, which could limit economic growth.
6) TNCs may become global monopolies.

Question 16

Problems of specialisation and trade for countries in the developing world? (3)

Answer 16

1) Infant industries may be unable to compete and go out of business.
2) Monopsony power of firms in the developed world may mean that producers from developing countries are forced to accept low prices.
3) Declining terms of trade for countries dependent on primary products.

Question 17

What factors influence the pattern of trade between countries and changes in trade flows between countries? (6)

Answer 17

1. Comparative advantage
2. The growth in exports of manufactured goods, especially from low wage countries to developed economies.
3. The growth of global supply chains.
4. The increased importance of emerging economies as trading partners.
5. The growth of trading blocs and bilateral agreements.
6. Changes in relative exchange rates.

Question 18

How is terms of trade calculated?

Answer 18

Terms of trade = (index of export prices/index of import prices) x100

Question 19

What factors influence a country’s terms of trade? (4)

Answer 19

1. The country’s rate of inflation.
2. The country’s productivity relative to that of other countries.
3. Tariffs.
4. The country’s exchange rate.

Question 20

What are the possible effects of an increase in a country’s terms of trade? (2)

Answer 20

1. Higher living standards – the country can import more for a given quantity of exports.
2. Deterioration in the current account balance of payments – although an increase in the terms of trade is referred to as an ‘improvement’ because of its implications for living standards, such an increase would cause a decline in the competitiveness of its goods and services.

Question 21

What is trading bloc?

Give three examples.

Answer 21

A trading bloc is a group of countries usually within a geographical region designed to significantly reduce or remove trade barriers between member countries. The world is now increasingly divided into trade blocs, most of which are specific geographical regions. For example, the East African Community (EAC), the Common Market for Eastern and Southern Africa (COMSEA), and the Southern African Development Community (SADC).

Question 22

What are free trade areas?

Answer 22

Free trade areas – in these trading blocs trade barriers are removed between member states but each member can impose trade restrictions on non-members.

Question 23

What are customs unions?

Answer 23

Customs unions – there is free trade between member countries combined with a common external tariff on goods from countries outside the customs union.

Question 24

What are common markets?

Answer 24

Common markets – these have the same characteristics as customs unions but include the free movement of factors of production (e.g. labour) between member countries.

Question 25

What are monetary unions?

Answer 25

Monetary unions – these are customs union which adopt a common currency. The Eurozone is an example of such a monetary union.

Question 26

What are the costs of regional trade agreements/trading blocs? (2)

What are the costs in monetary unions? (3)

Answer 26

1. Trade diversion from low-cost producers outside of the bloc to high-cost producers within the bloc.
2. Distortion of comparative advantage – Trade barriers against non-members are likely to lead to a decrease in specialisation and to a fall in world output.

In monetary unions:

1. Transition costs – these are one off costs associated with introducing the new currency.
2. Loss of independent monetary policy – Countries no longer have control of their own interest rates. In the Eurozone, the European Central Bank (ECB) controls monetary policy.
3. Loss of exchange rate flexibility – Individual members of monetary unions no longer have their own currencies.

Question 27

What are the benefits of regional trade agreements/trading blocs? (3)

What are the benefits of monetary unions? (3)

Answer 27

1. Trade creation – The removal of trade barriers between member states will result in increased trade between them.
2. Increase in foreign direct investment (FDI) – TNCs would have unrestricted access in selling goods to consumers in the bloc.
3. Increase in economic power – A large trading bloc might be in a better position to negotiate trade agreements with other countries and trading blocs.

In monetary unions:

1. Elimination of transaction costs – These are costs involved in changing currencies when goods are imported or exported.
2. Price transparency – Consumers have the ability to compare prices more easily across national borders.
3. Elimination of currency fluctuations between member nations – This may encourage increased investment by businesses.

Question 28

What are the key roles of the WTO? (2)

Answer 28

The WTO has two key roles:

1) To promote free trade - this achieved through various rounds of talks.
2) To settle trade disputes between member countries.

Question 29

What are the reasons for restrictions on free trade? (6)

Answer 29

1) To correct a deficit in the trade in goods and services balance.
2) To prevent dumping
3) To reduce unemployment
4) To reduce the risk of disruption resulting from problems in the global economy.
5) To prevent sectoral imbalance: international specialisation based on free trade means that only those industries in which the country has a comparative advantage, are focused on.
6) To limit the monopoly power of global companies

Question 30

For what two main reasons would developing countries restrict trade?

Answer 30

1) To protect infant industries

2) To limit monopsony power of firms in developed economies.

Question 31

Give four types of restriction on free trade.

Answer 31

1. Tariffs
2. Quotas
3. Subsidies to domestic producers.
4. Non-tariff barriers

Question 32

What are tariffs and what is their impact?

Answer 32

Tariffs and customs duties are taxes placed on imports that artificially raise the price of imported goods. Tariffs lead to a rise in price which causes contraction of world supply as well as an extension of domestic supply and a contraction of demand.

Question 33

What are quotas and what is their impact?

Answer 33

Quotas are limits on the physical quantity of a product which may be imported. As with tariffs, the price to domestic consumers will increase and domestic output will rise.

Question 34

What are subsidies to domestic producers and what is their impact?

Answer 34

Subsidies are government grants to firms which reduce costs of production, so causing the supply curve of domestic producers to shift to the right. The effect on imports is similar to that of a tariff but in this case the price of imports does not change and the government does not receive tax revenue. Instead this method involves public expenditure to finance the subsidies to domestic producers.

Question 35

Give four examples of non-tariff barriers that countries impose on imports to restrict free trade.

Answer 35

1) Health and safety regulations
2) Environmental regulations
3) Labelling of products
4) Bureaucracy – requiring importers to complete a vast number of forms.
All these may raise the costs of imports and deter foreign companies from attempting to import goods to the country imposing the restriction.

Question 36

What is the impact of protectionist policies on producers and consumers?

Answer 36

On Consumers:
Tariffs and quotas raise the price of goods and services and may lead to a reduction in both consumer surplus and consumer choice.

On producers:
Domestic firms face less competition and have less incentive to produce at lowest average cost. Further, they may cause retaliation by other countries who may also impose protectionist measures.

Question 37

What is the impact of protectionist policies on governments and on living standards?

Answer 37

On governments:
If tariffs are imposed, the government would receive tax revenue, on the other hand subsidies are costly for both the government and the taxpayer.

On living standards:
Protectionism distorts comparative advantage. This means that specialisation is reduced, resulting in lower output.

Question 38

What is the balance of payments?

Answer 38

The balance of payments is a record of all financial transactions between one country and those in the rest of the world.

Question 39

What is the current account?

Answer 39

The current account of the balance of payments shows a country’s day-to-day transactions with other countries.

Question 40

What are the capital and financial accounts?

Answer 40

The capital and financial accounts of the balance of payments show long-term investments and short-term capital flows.

Question 41

What are the most important elements of the current account? (4)

Answer 41

1) The trade in goods balance – value of goods exported minus the value of imports.
2) The trade in services balance – the value of services exported minus the value of services imported.
3) Investment income (the primary balance) – income earned from assets owned overseas minus income paid to foreigners for assets owned in the UK.
4) Current transfers (secondary balance) – payments received from foreign institutions (e.g. EU) minus payments paid abroad (e.g. to the EU)

Question 42

What are the four main elements of the capital and financial account?

Answer 42

1) Foreign direct investment – investment by foreign companies into the UK minus investment by UK companies abroad.
2) Portfolio investment in shares and bonds – purchase of UK shares and bonds by foreigners minus purchase of foreign shares and bonds by UK citizens.
3) Short-term capital flows – often referred to as hot money flows – hot money flows into the UK minus flows out of the UK to other countries.
4) Changes in foreign currency reserves.

Question 43

What are the possible causes of a current account deficit? (7)

Answer 43

1. Overvalued exchange rate – This makes exports more expensive and imports cheaper.
2. Declining competitiveness – If prices rise in the UK relatively more than in the Eurozone, these higher UK prices will lead to lower demand for UK exports.
3. Low savings ratio – lower savings tends to cause higher consumer spending on imports.
4. Fast economic growth – If there is a rapid growth in consumer spending, this will lead to higher import spending. In the UK, we tend to have a high marginal propensity to import, which means growth leads to a big rise in imports.
5. Capital inflows – Large inflows of foreign capital enable the country to afford more imports and run a current account deficit.
6. Recession in one or more major trade partner countries – recession cuts value of exports to these countries.
7. Volatile global prices – Exporters of primary commodities might be hit hard by a fall in world prices. Importing nations could be hit by higher prices for oil and gas, raw materials, etc.

Question 44

What are the possible consequences of a current account deficit? (6)

Answer 44

1. Loss of aggregate demand if there is a trade deficit (M>X) which causes weaker real GDP growth and reduced living standards and rising unemployment.
2. Big current account deficits will cause the currency to depreciate, leading to higher cost-push inflation and a deterioration in the terms of trade.
3. Can lead to currency weaknesses and higher inflation and a country may run short of vital foreign currency reserves.
4. Trade deficit might be a reflection of lack of competitiveness/ supply-side weaknesses in the economy.
5. Some countries running current account deficits may choose to borrow to achieve a financial account surplus – increases risks.
6. Unsustainable current account deficits can ultimately lead to a loss of investor consequence, leading to capital flight and a currency/ balance of payments crisis.

Question 45

What are the potential causes of a current account surplus? (3)

Answer 45

1. A large and 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.
2. A large gap between exports (X) and imports (M), when net income balance and net transfers are small.
3. An export surplus may be the result of very high prices for exports of commodities such as oil and gas.

Question 46

What measures could be imposed to reduce a country’s imbalance of the current account? (4)

Give examples of supply side policies.

Answer 46

1. Expenditure-reducing policies - These include deflationary fiscal and monetary policy, which would reduce aggregate demand and, in turn, lead to a reduction in imports.
2. Expenditure-switching policies – These include tariffs, quotas and export subsidies.
3. Devaluation/ depreciation of the country’s currency.
4. Supply side policies are often viewed as the most effective way of reducing current account deficits for some countries. These could include:
   • Cut in corporation tax
   • Improved infrastructure
   • Provision of superfast broadband
   • Training and education
   • Reduction in regulation and red tape
   • Reduction in employers’ national insurance contributions
   • Improved/subsidised childcare provision

Question 47

Why might a persistent current account deficit be undesirable? (4)

Answer 47

1. It could indicate that the country’s goods and services are uncompetitive.
2. In turn, this may result in an increasing rate of unemployment.
3. Ultimately, the country may be forced to borrow money from other countries or the International Monetary Fund (IMF).
4. Under a system of floating exchange rates, it could result in a depreciation of the exchange rate.

Question 48

Why may a current account deficit not be regarded as a major problem? (3)

Answer 48

On the other hand, a current account deficit may not be regarded as a major problem if:

1. It is caused by import of capital goods.
2. It is only a short run problem.
3. It can be financed easily by inflows into the financial account.

Question 49

Why may a persistent current account surplus be undesirable? (4)

Answer 49

1. It could result in inflation, since aggregate demand will be increasing.
2. It may imply that living standards are falling because there are fewer goods and services available for domestic consumption.
3. It could cause an appreciation in the value of the currency.
4. It might cause other countries to impose restrictions on imports.

Question 50

What is an exchange
rate?

What is an effective exchange rate?

Answer 50

An exchange rate:
The rate at which one country’s currency can be exchanged for other currencies in the foreign exchange market (FX).

Effective exchange rate:
This is a weighted index of sterling’s value against a basket of currencies the weights are based on the importance of trade between the UK and each country.

Question 51

What is a fixed exchange rate?

What is a floating exchange rate?

What is a managed exchange rate?

Answer 51

A fixed exchange rate is where the country’s currency is fixed against those of other currencies.

A floating exchange rate is where the exchange rate is determined by market forces, i.e. by the forces of supply and demand.

A managed exchange rate is essentially a floating exchange rate but one which is subject to intervention by the central bank in the foreign exchange market in order to influence the exchange rate of the country’s currency.

Question 52

What is the distinction between revaluation and appreciation?

Answer 52

A revaluation is when a country decides to increase the exchange rate of its currency under a system of fixed exchange rates.

An appreciation refers to an increase in the exchange rate of a country’s currency under a system of floating exchange rates.

Question 53

What is the distinction between a devaluation and a depreciation of a currency?

Answer 53

A devaluation is when a country decides to decrease the exchange rate of its currency under a system of fixed exchange rates.

A depreciation refers to a decrease in the exchange rate of a country’s currency under a system of floating exchange rates.

Question 54

What factors determine a currency’s value? (4)

Answer 54

1. Trade balances – countries that have strong trade and current account surpluses tend (other factors remaining the same) to see their currencies appreciate as money flows into the circular flow from exports of goods and services and from investment income.
2. Foreign direct investment (FDI) – an economy that attracts high net inflows of capital investment from overseas will see an increase in currency demand and a rising exchange rate.
3. Portfolio investment – strong inflows of portfolio investment into equities and bonds from overseas can cause a currency to appreciate.
4. Interest rate differentials – countries with relatively high interest rates can expect to see ‘hot money’ flowing across the currency markets and causing an appreciation of the exchange rates. The high interest rates in a country will attract money into its banks from abroad, causing increased demand for the currency and so causing its value to rise.

Question 55

In what two ways can governments intervene in currency markets?

Answer 55

1. Foreign currency transactions – If the aim is to reduce the exchange rate of the country’s currency, then the central bank would sell its currency on the foreign exchange market. This increase in supply of domestic currency would cause a fall in its value.
2. Interest rates – To reduce the exchange rate of the country’s currency, the central bank would reduce the base interest rate. This would make it less attractive for foreigners with cash balances to leave them in that country, so causing an increase in supply of the currency on the foreign exchange market and a reduction in its value.

Question 56

What is the impact of changes in exchange rates on the current account of the balance of payments?

Answer 56

A devaluation/ depreciation would cause:

1. A decrease in the foreign currency price of a country’s exports.
2. An increase in the domestic price of its imports

These two factors would lead to an increase in the competitiveness of the country’s goods and services and to an improvement in its balance of payments on the current account.
However, this will only happen if the Marshall-Lerner condition holds.
This states that the current account of the balance of payments will only improve if the sum of the price elasticities of demand for exports and imports is greater than 1. There may also be different effects in the short run and long run.

Question 57

Why might a devaluation /depreciation cause a deterioration in the current account balance of payments in the short run?

Answer 57

In the short run, a devaluation/depreciation might cause a deterioration in the current account balance of payments because:
1. The demand for imports might be price inelastic if firms have stocks or if they they are tied into contracts.
2. The demand for exports might be price inelastic because consumers take time to adjust to the new, lower prices.
Consequently, it will only be in the long run, when these factors are no longer relevant, that there would be an improvement in the current account balance of payments.

Question 58

How does a change in the exchange rate affect the rate of change of consumer and producer prices? (3)

Answer 58

1. Changes in the prices of imported goods and services – this has a direct effect on the consumer price index. For example, an appreciation of the exchange rate usually reduces the price of imported consumer goods and durables, raw materials and capital goods.
2. Commodity prices – Many commodities are priced in dollars – so a change in the sterling-dollar exchange rate has a direct impact on the UK price of commodities such as oil and foodstuffs. A stronger dollar makes it more expensive for Britain to import these items.
3. Changes in the growth of exports: A higher exchange rate makes it harder to sell overseas because of a rise in relative prices. If exports slow down, then exporters may choose to cut their prices, reduce output and cut-back employment levels.

Question 59

How can the exchange rate affect unemployment?

Answer 59

An exchange rate appreciation causes a slower growth of real GDP because of a fall in net exports (reduced injection) and a rise in the demand for imports (an increased leakage in the circular flow).

A reduction in demand may cause job losses as businesses seek to control costs. Some job losses are temporary – reflecting short-term changes in export demand and import penetration. Others are permanent if imports take up a permanently higher share of the domestic market. Thus a higher exchange rate can have a negative multiplier effect on the economy.
Some industries are more exposed than others to currency fluctuations – e.g. sectors where a high percentage of total output is exported and where demand is highly price elastic.

Question 60

How can the exchange rate affect FDI?

Answer 60

When a currency weakens, i.e. it depreciates, this may lead to an increase in FDI, e.g. if a US company is considering taking over a UK company for £100 million, then it is obviously much cheaper for the US company when the exchange rate is at £1 = $1.50, than if it were £1 = $1.80. However, if the exchange rate were to continue to fall then this may be an indication that the economy is in serious difficulty and may well discourage future FDI.

Question 61

What is international competitiveness?

What two types of competitiveness may be distinguished?

Answer 61

International competitiveness is a measure of a country’s advantage or disadvantage in selling its products in international markets at a price and quality that is attractive in those markets.

1. Price competitiveness
2. Non-price competitiveness

Question 62

In what ways can international competitiveness be measured? (3)

Answer 62

1) Relative unit labour costs – according to the OECD, unit labour costs (ULC) measure the average cost of labour per unit of output and are calculated as the ratio of total labour costs to real output. A rise in labour costs higher then the rise in labour productivity may result in a fall in the economy’s cost competitiveness.
2) Relative export prices – A country’s export prices relative to those of its major competitors are significant for competitiveness.
3) The Global Competitive Index (GCI) – A composite index based on a range of indicators including macroeconomic stability, labour market efficiency, infrastructure, health and primary education.

Question 63

What factors influence international competitiveness? (6)

How is the real exchange rate calculated? What will cause a depreciation in the real exchange rate?

Answer 63

1. Unit labour costs
2. Productivity
3. The real exchange rate – this is the nominal exchange rate adjusted for changes in price levels between countries. It may be calculated as follows:
   Real exchange rate = (Nominal exchange rate x domestic price level)/foreign price level
   There will be a depreciation in the real exchange rate if the nominal exchange rate falls or if the prices of goods abroad rise relative to prices in this country.
4. Labour taxes or subsidies – Employers’ national insurance contributions are regarded as a tax on jobs and so could reduce the competitiveness of a country’s goods and services.
5. Government laws and regulations – these include environmental and health and safety regulations; employment protection, and a national minimum wage.
6. Research and development (R&D) – this might result in technological advancement and increased productivity.

Question 64

What are the benefits of being internationally competitive? (3)

Answer 64

1. An improvement in the current account of the balance of payments
2. A reduction in unemployment
3. An increase in economic growth because an increase in net exports will cause an increase in aggregate demand and have a multiplier effect on national income.

Question 65

What are the problems of being internationally uncompetitive? (3)

Answer 65

1. An increase in unemployment
2. A deficit on the current account balance of payments
3. A depreciation in the country’s exchange rate (under a system of floating exchange rates), leading to an imported inflation.