Unit 4 The Global Economy Flashcards
Globalisation
The growing integration and interdependence of the world economy I.e the increased international movement of output, financial capital, foreign direct investment (multinational production) and the harmonisation of consumer tastes.
Causes: improved transport and communications, reduction in trade barriers and removal of exchange controls.
Comparative advantage (C/A)
The producer with the lowest opportunity cost of production (or highest output per factor of production) for a particular product.
If persons or national economies specialise in production of a good they have a comparative advantage in, all can gain from trade.
Absolute advantage (A/A)
The producer with the ability to make the largest amount of a particular product using its factors of production.
Having absolute advantage in production of a product does not mean specialisation in it will lead to gains from trade; a producer can have absolute advantage in several products.
Multinational companies MNC)
Large company with production based in several different countries. E.g. General Motors.
Foreign direct investment (FDI)
Spending by firms on productive capacity in other countries.
E.g. the purchase of a foreign company or the setting up of a production plant abroad. It generates employment there and often involves technology transfer which has spin-off benefits for other local firms, boosting economic growth. FTI contrasts with portfolio investment (buying shares) because managerial control is exercised over the newly owned plant.
Protectionism
The raising of trade barriers against imports.
This protects domestic industry from more competitive foreign firms by the raising of tariffs, quotas or bureaucratic barriers; it is rational to respond to projectionist measures in kind, but it causes deadweight welfare losses (especially by raising consumer prices) compared to global free trade.
Infant industry argument
Rationale for protecting domestic firms from foreign competition until they have grown large enough to achieve the economies of scale to match rival foreign firms.
Tariff protection enables them to establish themselves through internal growth but foreign competition is needed later to help deliver the cost reductions to keep prices down or deadweight loss will arise.
Common external tariff
A tax on products imported into a customs union.
Method of protection used by a customs union to keep down imports from non-members; the tariff is designed to raise the import price to the same level in each member country.
(Import) Quota
A limit on the number of imported goods allowed into a country over a period of time.
A barrier to trade which leads to deadweight losses and higher consumer prices (but without a tariff’s advantage as a revenue raiser for government); their effect is more certain than tariffs, which depend on elasticities.
Non tariff barriers
Methods to prevent the sale of imports apart from tariffs or quotas.
E.g. product quality controls designed to favour domestic firms, preferential buying from domestic firms by public sector.
Dumping
Practice of selling exports in foreign markets at a low cost (or below selling price in domestic market).
A form of protectionism which damages foreign suppliers who cannot sell profitably in their domestic market; dumping firms may do this to keep up domestic prices (reducing supply at home e.g CAP) or to capture the foreign market before raising price. WTO allows a victim of dumping to retaliate (e.g. by raising tariffs) if it can prove damage to its domestic industry.
World trade organisation (WTO)
Organisation to promote free trade and coordinate (and police) reduction in barriers to trade.
Set up in 1995 to replace GATT (General Agreement on Tariffs and Trade).
Free trade area (FTA)
A group of countries which coordinate a reduction of trade barriers between themselves but do not erect a common external tariff.
Often progresses to customs union because each country has different tariff against non-members (hence lowest tariff forms gateway to goods from outside, benefiting import-export firms in that nation).
Customs union
A group of countries with reduced trade barriers (tariffs + quotas) between members but a common external tariff against imports from outside.
This leads to trade creation (benefits) but trade diversion (cost), the latter also imposing costs on non-members, who may respond with trade barriers against the customs union.
Common market
The stage of economic integration between states when barriers to capital (e.g. exchange controls) and labour mobility (e.g. visas) are removed.
Common market enables efficiency gains since firms can draw on labour supply from entire union (less labour shortages build up requiring increased wage rates) and firms can borrow money more cheaply, tapping into the savings of the entire union.
Economic and monetary union (EMU)
When a group of countries in a common market abolish national currencies to share a single currency (and therefore operate a single monetary policy for the whole union).
Arguments for: reduced costs, stable currency, anti-inflationary.
Arguments against: loss of macro policy independence (interest rates, fiscal constraints) to deal with asymmetric shocks – labour must be flexible to cope.
Convergence criteria
Macro economic conditions which must be met before a country is allowed to join an Economic and Monetary Union.
Covered: low inflation (below 2.7%), low government budget deficit (maximum 3% GDP), low national debt (maximum 60% GDP), low long-term interest rate (below 7.8%) and exchange rate stability (for two years) against other EMU currencies; meeting these criteria should indicate that an economy is ready for EMU membership e.g. it won’t need exchange rate depreciation to rescue its export sector due to excessive domestic inflation.
Stability and growth pact
Limit placed on government budget deficit for countries belonging to the European single currency.
Agreed by member countries, budget deficit should not exceed 3% GDP in any one year, or risk the imposition of fines; Its rationale? To prevent individual countries creating inflationary pressure by running a budget deficit (one governments fiscal laxity could raise EU inflation, bringing European Central bank interest rate rises which would slow down the entire EMU economy).
Trading bloc
A group of countries who form a free trade area, customs union or common market as a way to reduce trade barriers between them and raise barriers to non-members. E.g. European Union.
Trade creation
The welfare gains from joining a customs union.
These derive from having reduced trade barriers with customs union members e.g. lower tariffs will enable countries to specialise more in what they have a comparative advantage in, gaining the 2 triangles of deadweight loss in the standard textbook tariff diagram.
Trade diversion
The welfare losses to a country from joining a customs union.
These derive from having to adopt a common external tariff which may raise the price of imports from low-cost producers outside the customs union e.g. rise in price of New Zealand butter when UK joined EEC in 1973.
EU enlargement
Process whereby the established 15 members of the European Union is widening its membership to new European (accession) countries.
In May 2004, 10 new countries joined (Poland, Hungary, Czech Republic, Slovakia, Slovenia, Estonia, Latvia, Lithuania, Republic of Cyprus, Malta); in January 2007, Bulgaria and Romania joined; candidates for future enlargement include Croatia and, controversially, Turkey; EU membership requires a country to fulfil conditions of political and economic development before entry.
Competitiveness
The ability of domestic firms to sell their output in the global market (domestic + foreign).
Firms need to stay competitive to survive and contribute to GDP and preserve jobs; this implies being competitive on price or non-price (product quality, branding etc) former helped by fall in exchange rate, non-inflationary wage settlements, higher productivity (e.g. lower unit labour costs); the latter by supplied side policies (e.g. highly skilled).
Unit labour costs (ULC)
Labour costs per unit of output.
Crudely: wage bill divided by total output; this is a key indicator of a country’s competitiveness if output growth can outpace growth in the total wage bill then you unit labour cost (ULC) will fall; this should enable the goods to get more price competitive, provided the exchange rate does not strengthen; increased labour productivity won’t result in lower ULC if wages rise at a faster rate.
New deal (ND)
New Labour’s policy to combat the long-term unemployment: after a period of assisted job search, and unemployed person is guaranteed some form of paid work (involuntary work or subsidised employment) or training.
New Deal is a supply-side policy to make labour market more flexible.
Social chapter
Section of the Maastricht Treaty which commits European Union countries to guarantee certain legal rights of workers in the labour market.
Create a level playing field within EU where all workers get protection, helping labour mobility, and firms can’t relocate to source cheaper labour; but institutionalises higher labour costs, making workers less flexible.
Working time directive (WTD)
Regulation setting a maximum number of hours per week and employer can insist his employees work.
E.g. in UK 48 hours a week, although workers can sign away this right and not all workers are covered e.g. doctors.
Exchange rate system
The rules which determine how a country the exchange rate is set.
Either: floating, dirty (semi) floating, semi fixed (e.g. Exchange Rate Mechanism), fixed or EMU.
Floating exchange rate system
Exchange rate is freely determined by market forces (without government intervention targeting E.R).
Trade deficit causes depreciation of currency, this softens job losses in short run; despite being subject to fluctuation, in this system a currency should be in immune from major speculative attack (e.g. George Soros on Stirling 1992).
Fixed exchange rate system
Exchange rate is maintained at a target level by government interventions in the currency market.
Advantages: anti-inflationary (discipline on wages: devaluation cannot come to rescue of uncompetitive firms).
Devaluation
Fall in value of exchange rate, usually announced by the government when part of a fixed exchange rate system (notes: ‘appreciation’ fall in exchange rate when in floating regime).
Effects are to raise import prices and decrease export prices (for in terms of trade), which gives the initial impetus to export sector (though wage-price spirals can undo competitiveness); effect on balance of payments current account is only positive if Marshall Lerner condition holds.
Marshall Lerner Condition
The sum of elasticity of demand for exports and imports must exceed one.
This guarantees that a devaluation of currency will improve the trade balance on balance of payments current account. N.b. surprisingly, if each elasticity is 0.6 (inelastic) the trade balance still improves! In short run, J curve reflect low elasticities.
J curve Effect
The short term fall in balance of payments current account following a devaluation of the exchange rate before long run elastic demand for imports and exports leads to rise.
Measures balance of payments current account (vertical axis) against time; in short run firms don’t sell more exports because existing contracts reflect previous exchange rate therefore same volume of exports and earns less as price has fallen (same for imports, in reverse).
Hot money
Money in search of the highest short-term rates of return available internationally.
Such sums are moved by large financial investors into economies where rates of interest are increasing relative to others (so long as the nominal exchange rate is not depreciating at a greater rate); this adds volatility to exchange rate movements since e.g. rises in UK interest rate creates hot money inflows which drive up demand for Sterling… Until UK interest rates fall relatively, when the hot money flows out leading to sterling falls; unlike foreign direct investment, these flows are short term, like currency speculation.
Dutch Disease
Where the strength of one sector of the economy drives up the exchange rate to a point where its other sectors lose competitiveness.
Arguably one of the factors causing the UK Manufacturing recession in 1980-82, when North Sea oil created massive demand for sterling which drove up the currency so far that other export sectors, like steel and cars suffered a major loss of price competitiveness abroad.
Real exchange rate
The price of the country’s goods relative to those produced abroad when expressed in a common currency.
Measures international competitiveness (combines movements in normal exchange rate and relative information). When UK’s real exchange rate rises UK exports become more expensive for foreigners relative to bond produced substitutes: i.e. less price competitive; this can occur for 2 reasons: 1) U.K.’s inflation is relatively higher than abroad.
2) U.K.’s nominal exchange rate rises.
Effective exchange rate
The exchange rate of the country’s currency measured against a week on average of the currencies of its major trending partners.
This gives a general picture of whether the nominal exchange rate movements of, say, Sterling against or other currencies have made exports relatively more expensive for foreigners; the weights used reflect the percentage trade with each country; trend in effective exchange rate is given in index number form.
Balance of payments disequilibrium
Where balance of payments current account has a large, persistent and rising deficit (or surplus) over time.
In the long run such a deficit can only be supported by matching inflows on the capital/financial accounts (e.g. from sale of assets or borrowing) which is unsustainable.
Development
Broad notion of progress in social and economic conditions within a society covering improved material standards of living, self esteem and expanded opportunities for all individuals.
Normative concepts; implies that national income statistics are insufficient: development requires more than just improved material standards of living; measured by HDI.
Less economically developed countries (LEDC)
Term referring to those countries with relatively low per capita income. E.g poor countries.
Newly industrialised countries (NICs)
Countries which have rapidly industrialised since 1950.
