theme 4- 4.1 international economics Flashcards
globalisation
the increased economic integration between countries
the pace of globalisation increased up to the GFC 2008
the pace slowed after Trump’s election in 2016 due to rise in protectionism, the covid-19 pandemic will increase pace of deglobalisation
key characteristics of globalisation
- increased trade as a proportion of GDP, trade growth > GDP growth
- increased FDI- indication of integration between economies
- increased capital flows between countries- due to mergers and acquisitions across borders
- increased movement of people between countries
causes of globalisation
- decrease in transport costs- e.g. containerisation -> economies of scale
- decrease in the cost of communication
- reduction in world trade barriers- engineered by WTO
- the opening up of China and the collapse of the USSR
- growth of trading blocs
- increased importance of global and transnational companies (TNCs)- partake in FDI and offshoring labour and production to cheaper countries
impact of globalisation on living standards
countries can specialise in producing goods that they have a comparative advantage for
-> results in higher world output and therefore increased living standards
impact of globalisation on a country’s trade balance
a country that lacks comparative advantage may rely on imports
-> cause a deterioration in the trade balance
impact of globalisation on inequality
evidence it has led to increased inequality in some countries
due to:
- decreased demand for unskilled labour in developing countries = increased gap in earnings
BUT inequality between countries has fallen over the last 40 yrs
impact of globalisation on public finances and governments
tax revenues will increase which can be used for public services
BUT some global countries avoid tax through transfer pricing
transfer pricing
the price one part of a company charges for the products and services it provides to another part of the same company
enables TNCs to declare profits in the country where corporation tax is lowest
impact of globalisation on producers
benefit from economies of scale and higher profits
tech transfer is likely to occur
TNCs can bring in modern management techniques designed to increase productivity
BUT local producers who are less competitive are likely to go out of business
impact of globalisation on consumers
can expect:
- lower prices
- increased consumer surplus
- greater choice
impact of globalisation on workers
can expect:
- increased employment opportunities
BUT
- TNCs may exploit workers in developing countries by paying low wages for long hours
- if migration of low skilled workers to developed countries, existing workers may face little increase in real wages
impact of globalisation on the environment
increased external costs
e.g. air and noise pollution
FDI by countries in search of raw materials may lead to exploitation and depletion of resources
impact of globalisation on supply chains
made supply chains lengthier and more complex
-> covid-19 exposed weaknesses of this so some are trying to shorten them by increasing domestic production
absolute advantage
implies that a country can produce more of one product than another country can with the same amount of resources
comparative advantage
when a country can produce a good with a lower opportunity cost than another country
ricardo and comparative advantage
demonstrated that trade is advantageous to both countries if each specialises in the production of a good in which it had the comparative advantage- must be a difference in the opportunity cost of producing the products
law of comparative advantage assumptions
- constant returns to scale (implies PPF = straight line)
- no transport costs
- no trade barriers
- perfect mobility of factors of production
- externalities are ignored
comparative advantage on a graph
a country has comparative/absolute advantage when 1/both its points are at a higher quantity of production
limitations of the law of comparative advantage
- free trade is not = to fair trade (may exert monopsony power to coerce developing countries to accept very low prices)
- based on unrealistic assumptions
- if opportunity costs are =, there would be no benefit from specialising
advantages of specialisation and trade
- higher living standards and increased employment from increased world output
- lower prices = consumer surplus and choice
- transfer of management expertise and tech
- economies of scale
- reduction in the power of domestic monopolies
disadvantages of specialisation and trade
- deficit in the trade balance if uncompetitive
- danger of dumping
- increased unemployment in some countries
- increased risk of contagion and disruption from problems in the global economy
- TNCs may become global monopolies and exploit consumers
- unbalanced development
disadvantages of specialisation and trade for developing countries
- infant industries may be unable to compete and go out of business
- may exert monopsony power to coerce developing countries to accept very low prices
- declining in terms of trade occur for countries dependent on primary products
key factors influencing the patterns of trade between countries
- changes in comparative advantage
- growth in exports, especially from low wage countries to developed
- growth of global supply chains
- increased importance of emerging economies as trading partners
- growth of trading blocs and bilateral trade agreements
- changes in relative exchange rates
changes in the share of world exports
asia’s share grew from 28% in 2008 to 34% in 2018
terms of trade
measure the price of a country’s exports relative to the price of its imports
= index of export prices /
index of import prices x 100
factors influencing terms of trade
- rate of inflation relative to other countries
- productivity relative to other countries
- exchange rate
effect of an increase in the terms of trade
- higher living standards- can import more for a given quantity of exports
- deterioration in the current account of the balance of payments- causes a decline in the competitiveness of its goods and services
decrease = vice versa
trading blocs
groups of countries that agree to reduce or eliminate trade barriers between themselves- most in specific geographical locations
e.g. the Common Market for Eastern and Southern Africa (COMESA)
free trade areas
type of trading bloc where trade barriers and removed between members but each can impose trade restrictions on non-members
customs unions
type of trading bloc where there is free trade between members combined with a common external tariff on goods outside of the union
common markets
type of trading bloc that is like a customs union but includes free movement of factors of production between members
monetary unions
type of trading bloc that is like a customs union that adopts a common currency e.g. the Eurozone
costs of regional trade agreements (trading blocs)
- trade diversion (may be diverted from low cost producers to high cost ones in the member states)
- distortion of comparative advantage- trade barriers with non-members is likely to decrease specialisation and world output
costs of monetary unions
- transition costs resulting from changing the currency
- loss of independent monetary policy e.g. no control over interest rate
- loss of exchange rate flexibility
benefits of regional trade agreements (trading blocs)
- trade creation
- increase in FDI
- increase in economic power
benefits of monetary unions
- elimination of transaction costs between currencies
- price transparency- consumers can compare prices across borders
- elimination of currency fluctuations between member countries- can encourage investment
role of the WTO in trade liberalisation
- to promote free trade
- to settle trade disputes between member countries
188 members
possible conflicts between trading blocs and the WTO
they restrict trade from non-member countries, conflicting with the aims of the WTO
BUT both the number and size of trading blocs is increasing, playing an important role in promoting free trade
reasons for restrictions on free trade
- correct a trade deficit
- prevent dumping
- reduce unemployment
- reduce risk of disruption from the global economy
- prevent sectoral imbalance
- limit monopoly power of global companies
reasons to restrict free trade in developing countries
- to protect infant industries
- to limit monopsony power of firms in developed economies
types of restrictions in free trade- tariffs
taxes on imported goods that artificially raise its price
also decreases demand for the product to protect domestic industry
types of restrictions in free trade- quotas
limits on the quantity of a product imported
price to domestic consumers will increase as the good is more scarce, protecting domestic output
types of restrictions in free trade- subsidies to domestic producers
govt grants to a firm which reduce cost of production
causes supply curve to shift to the right
effect is similar to that of tariffs, but public expenditure is used to finance this
types of restrictions in free trade- non-tariff barriers
WTO agreements have reduced tariffs
range of alt methods to reduce imports:
- health and safety regulations
- environmental regulations
- labelling of products
- bureaucracy
-> may raise the cost of imports / deter companies from attempting to import
impact of protectionist policies on consumers
tariffs and quotas -> higher prices and a reduction in consumer surplus and choice
impact of protectionist policies on producers
domestic firms= less competition and less incentive to produce at lowest AC
may cause retaliation from other countries , who might put tariffs on their imports as well
impact of protectionist policies on govts
tariffs = tax revenue
may reduce a fiscal deficit or increase a fiscal surplus
impact of protectionist policies on living standards
protectionism distorts comparative advantage -> specialisation = reduced, resulting in lower output
impact of protectionist policies on equality
tariffs = indirect taxes, may cause increase in income inequality as they don’t take into account a person’s income
balance of payments definition
a record of all financial transactions between one country and the rest of the world
2 main components:
1. current account
2. capital and financial account
current account definition
a country’s day to day transactions with other countries
elements inc:
- trade in goods balance (exports - imports)
- trade in services balance (exports - imports)
- primary balance (investment income earned from overseas - income paid to foreign investors)
- secondary balance (current transfers received from foreigners - payments paid abroad)
current account balance
trade in goods balance + trade in services balance + primary balance + secondary balance = current account
if result = -ve = deficit
if result = +ve = surplus
capital and financial account definition
shows long-term investments and short term capital flows
concerned with changes in ownership of the UK’s foreign financial assets and liabilities
elements of the capital and financial account
- FDI (investment by foreign companies into the UK - investment by UK abroad)
- portfolio investment in shares abroad (purchase of UK shares and bonds by foreigners - purchase of foreign shares and bonds by UK citizens)
- short term capital flows (flows in - flows out)
- changes in foreign currency reserves
causes of deficits on the current account
- relatively low productivity
- relocation of manufacturing to other countries with lower labour costs
- increase in exchange rate against that of other countries
- continuous economic growth, resulting in an increase in imports
current account deficit = capital and financial account surplus
opposite of above = a current account surplus
measures to reduce a current account deficit
- expenditure reducing policies to reduce AD e.g. deflationary fiscal and monetary policy
- expenditure switching policies e.g. restrictions on free trade
- devaluation/depreciation of currency
supply side policies = most effective e.g.: - less corp tax
- infrastructure
- training in education
surplus = opposite
global trade imbalances
occur when some countries have large current account deficits (USA, UK) while others have large current account surpluses (China, Germany, oil exporters)
differences in current accounts are often associated with differences in savings ratios
reasons why a persistent current account deficit may be undesirable
- could indicate country’s goods and services are uncompetitive
- could lead to unemployment
- may be forced to borrow currency from other countries or the IMF
- under floating exchange rates, could lead to a depreciation in exchange rate
reasons why a deficit may not be regarded as a major problem
if:
- it is caused by imports of capital goods
- it is only a short run problem
- can be financed easily by inflows into the financial account
reasons why a persistent current account surplus may be undesirable
- could result in inflation as AD increases
- may imply that living standards are falling as there are less goods available for domestic consumption
- could cause an appreciation in value of currency, making goods less competitive
- might cause other countries to impose restrictions on imports
exchange rate definition
the rate at which one currency exchanges for another (value of one currency in relation to other currency)
trade-weighted index definition
a currency may also by valued against a basket of other currencies weighted according to their relative importance in world trade
floating exchange rate system definition
exchange rate = determined by market forces i.e. supply and demand
fixed exchange rate system definition
where a country’s currency is fixed against those of other currencies
managed exchange rate system definition
essentially a floating exchange rate but 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
revaluation definition
when a country decides to increase the exchange rate of its currency under a system of fixed exchange rates
devaluation = opposite
appreciation definition
refers to an increase in the exchange rate of a country’s currency under a system of floating exchange rates
depreciation = opposite
factors influencing floating exchange rates
- relative inflation rates- higher = value will fall in the longer term
- relative interest rates- higher = value will rise as more demand for the currency
- current account balance- deficit = value will fall
- FDI- net recipient of FDI = increased demand for its currency = value will rise
- speculation- more pessimism = value will fall
govt intervention in currency markets- foreign currency transactions
if aim is to reduce the exchange rate then the central bank would sell its currency on the foreign exchange market
this increase in supply of the domestic currency would cause a fall in its value
govt intervention in currency markets- interest rates
to reduce the exchange rate, the central bank can reduce the base interest rate
this would make it less attractive for foreigners with cash balances to leave them in that country
-> causes an increase in the supply of the currency in the foreign exchange market, causing a reduction in its value
govt intervention in currency markets- quantitative easing
although the intended effect is to stimulate the domestic economy, there is evidence that QE has had an indirect affect of causing a depreciation of the exchange rates of countries using this policy
currency war definition
occurs when nations seek to deliberately depreciate the value of their domestic currencies in order to stimulate their economies
e.g. to improve its net trade balance
-> lead to increased protectionism s a means of gaining competitive advantage
impact of changes in exchange rates- the current account of the balance of payment
devaluation/depreciation would cause:
- decrease in the foreign currency price of the country’s exports
- increase in the domestic price of imports
-> cause an increase in competitiveness of the country’s goods and services, and an improvement in the BoP
BUT will only happen if the Marshall-Lerner condition holds
Marshall-Lerner condition
states that a depreciation/devaluation of a currency will only lead to an improvement of the trade balance if the sum of the price elasticities of demand for imports and exports is less than -1
J-curve effect
when a country’s trade balance initially worsens following a devaluation or depreciation of its currency and only improves in the long run
reasons why a depreciation/devaluation might causes a deterioration in the current account of the BoP in the short run
- demand for imports may be price inelastic if firms have stocks or if they are tied into contracts
- demand for exports may be price inelastic because consumers take time to adjust to new lower prices
impact of changes in exchange rates- economic growth and employment/unemployment
a depreciation/devaluation should lead to an increase in AD as:
- net exports should rise, causing real output
-> increase in employment and decrease in unemployment
impact of changes in exchange rates- rate of inflation
increased price of imports would cause an increase in the cost of production, leading to cost-push inflation
increase in AD could increase rate of inflation
impact of changes in exchange rates- FDI flows
depreciation of a currency would make it cheaper for stronger currencies to invest in the country
international competitiveness
measures the cost of a country’s goods and services exports relative to those of other countries
2 types of competitiveness:
1. price competitiveness
2. non-price competitiveness
measures of international competitiveness
- relative unit labour costs- AC of labour per unit of output
- relative export prices vs its competitors
- global competitive index (GCI)
factors influencing international competitiveness
- unit labour costs
- productivity
- real exchange rate (nominal exchange rate x domestic price level / foreign price level)
- labour taxes or subsidies
- government laws and regulations
- R&D
benefits of being internationally competitive
- improvement in the current account of the balance of payments
- reduction in unemployment
- increase in economic growth as an increase in net exports will increase AD and have a multiplier effect on national income
problems of being internationally competitive
- a deficit on the current account of the balance of payments
- increase in unemployment
- depreciation in the country’s exchange rate (floating), leading to an imported inflation
