Globalisation | 4.2.6 | AQA A-Level Economics Notes

4.2.6.1 Globalisation

• Globalisation is the growing integration of the world’s economies into a single, international market.
• Globalisation is caused by trade liberalisation, increasing presence of trading blocs, the growth of MNCs, technological advancement, and increased mobility of labour and capital.
• Globalisation involves free movement of capital and labour and free interchange of technology.
• Globalisation can lead to lower prices due to competition, greater employment, economies of scale, free movement of labour and capital, technological transfers and greater innovation.
• On the other hand, globalisation may cause greater inequality, structural unemployment, environmental problems, trade imbalances (e.g. US with China), and losses of identity/ cultural diversity.
• Multinational corporations are enterprises operating in several countries, with their headquarters in one country. They have played a great role in globalisation.
• Developed countries are able to benefit from the low manufacturing costs of developing countries, reducing the risk of cost-push inflation. Furthermore, the growth of developing countries can diversify the range of UK exports. Globalisation has allowed China to have export-led growth, and this leads to a growing Chinese consumer class, increasing demand for UK education and high valued services. There will also be greater competition worldwide leading to lower costs and prices. We will also benefit from greater competition and FDI, job creation and greater corporation and income tax revenue.
• On the other hand, we may become dependent on foreign manufactured goods and services, and we can be affected in the case of economic shocks or currency manipulation, trade imbalances and structural unemployment.
• Developing countries will benefit from a lot of foreign direct investment, increased demand for their goods, jobs are created and exports will increase. Comparative advantage is also exploited leading to trade benefits.
• On the other hand, globalisation can lead to environmental damage and overdependence on non-renewable resources, MNCs can gain monopoly power over local resources and this can hinder the growth of local industries. Lastly workers are exploited.

4.2.6.2 Trade

• Comparative advantage occurs when a country can produce a good or service at a lower opportunity cost than another.
• Absolute advantage occurs when a country can produce a good or service using fewer factors of production.
• The model shows that specialisation and trade can increase total output.
• The model of comparative advantage assumes each country’s factors of production are fixed and immobile, there are constant returns to scale whilst demand, inflation and transport costs are considered stable.
• These factors, including exchange rate changes, can distort the model.
• Free trade is the act of trading between nations without protectionist barriers.
• Free trade can lead to greater diversity, efficiency, increased competition, lower prices, and the ability to exploit economies of scale.
• Free trade can also allow production to move to countries with lower costs, causing structural unemployment and environmental costs such as pollution and transportation.
• Tariffs are a protectionist policy. They are taxes imposed on imports from another country, entering a country (import duties).
• Quotas are physical limits on the quantities of imported goods allowed into a country.
• Export subsidies are payments made to domestic firms to help sell their products abroad, by making their goods cheaper in export markets.
• Embargoes are complete bans on trade within a country.

• Countries may implement such protectionist policies in order to reduce trade deficits, stop the trade of demerit goods, allow its infant industries to grow, or to prevent dumping. Dumping is when high volumes of goods are exported at a price that is lower on the foreign market, than it is domestically.
• Protectionism can distort markets and reduce allocative efficiency. This can be seen by higher prices, lower quantities and losses in consumer surplus. Protectionism can protect domestic producers and revenue, but there is always a risk of government failure.
• A customs union is a trading bloc in which member countries can enjoy internal free trade in goods and possibly services. All member countries are protected by a common external tariff barrier.
• The Single European Market (SEM, 1993) aims to establish free movement of goods, services, workers and capital between EU member states. These are known as the four freedoms.
• The UK can benefit from jobs, higher GDP per capita, economic growth, increased FDI, and free movement of labour and capital.
• On the other hand, the UK is forced to follow laws and contribute to the EU budget. Accepting the Euro as a currency and other factors causes a loss of identity, and immigration has caused unemployment.
• The World Trade Organisation promotes trade by persuading countries to reduce barriers.

4.2.6.3 The Balance of Payments

• The current account comprises of trade in goods, trade in services, primary income flows and secondary income flows.
• Trade in goods and services is also known as the trade balance.
• Trade in goods is the exports and imports of tangible items.
• Trade in services is the exports and imports of financial services (e.g. tourism and shipping).
• Primary income refers to investment into a country, and income generated from UK owned capital assets which are located overseas.
• Primary and secondary income is also known as the income balance.
• Secondary income is also known as transfers, and it includes gifts, international aid and transfers.
• Trade in services is the only surplus on the current account.
• The capital account makes up a very small part of the Balance of Payments, and capital flows were moved into the financial account recently.
• The financial account records capital flows into and out of the economy.
• The financial account includes portfolio investment, foreign direct investment and reserve assets.
• FDI is investment in capital assets/ enterprises in a foreign country by a business with a headquarters in another country (e.g. UK firm setting up a manufacturing capacity in China).
• Portfolio investment is the purchase of one country’s securities (bonds and shares) by the residents/ financial institutions of another country.
• Overall, this makes up the Balance of Payments, which is the record of all money flows of transactions between the residents of a country and the rest of the world in a year.
• The current account balance is influenced by factors such as: productivity, inflation, exchange rate fluctuations.
• Investment flows such as FDI can help create employment, and also encourage innovation.
• Portfolio investments are solely done by individuals to make profits, whereas FDI involves some degree of management/ control of firms.
• A current account deficit can lead to a fall in aggregate demand, declines in economic growth, unemployment and large amounts of debt through borrowing. This can lead to loss of confidence from investors.
• Also, a deficit means there is a high volume of imports. This leads to an increase in the supply of pounds on the foreign exchange market, causing depreciation in its value.
• Expenditure switching policies aim to switch consumer spending towards domestic goods using protectionism.
• These can include tariffs, quotas, embargoes and domestic subsidies.
• This can lead to retaliation, where other countries begin to protect their imports from the UK (tariffs). It can also lead to domestic inflation, higher import prices, loss of consumer surplus and allocative inefficiency. Also, domestic industries are protected so there are fewer incentives to cut costs.
• Expenditure reducing policies aim to reduce the spending on imports in an economy by reducing aggregate demand, incomes and the marginal propensity to import.
• These can include contractionary fiscal policy and contractionary monetary policy.
• This can lead to problems as they may conflict with domestic objectives such as full employment and economic growth, it can lead to deflation and a loss of confidence and they won’t work if the country already has a positive output gap. Lastly, the marginal propensity to consume may already be low.
• Exchange rate policy involves increasing the money supply and lowering interest rates to cause depreciation in the exchange rate, with the aim of making imports more expensive and therefore disincentivising them.
• Alternatively, selling more pounds on the exchange market will lead to the same effect, as an increase in supply of currency reserves will cause the value of the pound to fall.
• This policy can lead to inflation (due to low interest rates), retaliation from other countries, and currency wars.
• Furthermore the Marshall-Lerner condition suggests that a currency devaluation will only lead to an improvement in the Balance of Payments if the sum of demand elasticity for imports plus exports is greater than one.
• The J-curve illustrates that, in the case the PED for imports is very low in the SR (often due to a lack of consumer knowledge of exchange rates), a current account deficit will usually worsen before improving.
• Supply-side policies can also be implemented to improve international competitiveness.
• Problems include time, costs and uncertainty of success.
• Lastly, you could argue that a current account deficit is less of a problem than other macroeconomic issues, as it can have benefits too.

4.2.6.4 Exchange Rate Systems

• A freely floating exchange rate system is where the value of a currency is determined by the forces of demand and supply. It can mean automatic correction of current account imbalances.
• For example, if imports are higher than exports, the supply of the pound rises, leading to depreciation of the pound, making imports more expensive.
• Pros: no need for currency reserves (no waste of resources/ money), freedom for domestic monetary policy (no conflicts), automatic correction of deficits, reduced risk of government failure, less risk of currency speculation.
• Cons: self correction can be unlikely (e.g. why was there a deficit in the first place?).
• A fixed exchange rate system has a value that is determined by the government, who hold large reserves of domestic and foreign currencies.
• For example, they can sell pounds to depreciate its value, or buy pounds to cause appreciation.
• Pros: certainty, still some degree of flexibility for speculators, governments can choose to re-adjust their exchange rates.
• Cons: interest rate is affected (conflicts of objectives), large reserves are needed (misallocated resources), and governments may have imperfect information (e.g. vulnerable to speculative attacks if they set currency too high).
• In a currency union such as the eurozone, members share the same currency, central bank and monetary policy.
• Pros: currency stability, no/ lower costs for currency conversion between members, helps business confidence, less speculative attacks, easy/ no comparison of currency prices.
• Cons: loss of monetary policy autonomy/ control (loss of member sovereignty), no degree of flexibility, costs of currency conversion very high outside of union, no fiscal union (so domestic fiscal policy could conflict).

4.2.6.5 Economic Growth and Development

• Economic growth is the increase in a country’s rate of growth of real GDP.
• Economic development refers to improvements in living standards, freedom and economic welfare and wellbeing (happiness).
• Growth is essential for development, but does not guarantee there will be development.
• High growth leads to higher employment, wages and a reduction in poverty. There will also be more profits, jobs and therefore better technology/ innovation. Governments are also likely to make more revenue/ fiscal dividend, and this can be used to make improvements on health, education and infrastructure.
• On the other hand, growth does not mean there will be income equality or general happiness. Also, growth can involve negative externalities such as pollution, and lastly growth can be unsustainable.
• Less-developed countries show poor standards of living, low productivity, low savings, high rates of population growth, incomplete markets, unemployment and primary sector (agriculture) dominance.
• The main indicator of development is the Human Development Index.
• HDI is made up of three components; health, education and living standards.
• Health is measured by life expectancy at birth.
• Education is measured by adult literacy levels.
• Living standards are measured by real gross national income at purchasing power parity.
• The PPP of a currency is the quantity of a currency needed to purchase a common basket of goods and services. It is helpful when making comparisons between countries and currencies.
• The HDI does not consider political freedom, environmental impact, or the distribution of income, however it arguably includes the most important factors of development and allows comparisons over time and between countries.
• The Human Poverty Index measures the ability for citizens to meet basic needs.
• The Gender Development Index measures the relative inequality between men and women in an economy.
• The Gini Coefficient and Lorenz curve are also used to measure inequality.
• The key factors that affect growth and development are investment, education and training.
• Investment on infrastructure can allow access to schools and hospitals, and lead to increases in FDI.
• Education and training leads to higher levels of productivity, jobs, higher incomes and also gender equality.
• Healthcare can lead to a greater, more productive working population, better living standards and happiness.
• Barriers to growth and development include:
o Corruption can lead to a misallocation of resources, instability, lack of investment and infrastructure. Aid will not be used efficiently so countries will not help.
o The poverty trap means that low incomes lead to low savings and a lack of investment, and this continues in a cycle.
o The development trap means that low incomes mean low levels of education and health, poor human capital and productivity, and this continues in a cycle.
o Overdependence on volatile, non-renewable primary commodities can make it difficult for countries to grow economically.
• Development is important for the global economy as it can allow developing countries to exploit their comparative advantage and natural resources. Consumer welfare and efficiencies improve, and these countries will also face the benefits of trade (mentioned before).
• Market based policies can include the promotion of FDI, deregulation, privatisation, trade liberalisation, reduced government spending and intervention. (FDI is promoted through low wages, low corporation tax, skilled work force/ productivity.
• Pros: more efficient resource allocation, incentives and FDI, export-led growth.
• Cons: government spending is essential to improve infrastructure, healthcare and education, income inequality remains. Also, the government needs to manage the economy against protectionism in advanced economies.
• Interventionist strategies can include protectionism, exchange rate policy, regulation, nationalisation, fiscal policy stimulus, and import substitution.
• Pros: benefits from infrastructure development, achievement of macroeconomic objectives such as economic growth, benefits from welfare spending.
• Cons: corruption can lead to inefficient outcomes, nationalised industries are inefficient, lack of incentives, government budget deficit and national debt.
• Aid is money, goods and services and ‘soft’ loans given by the government of one country/ multilateral institutions to help another country.
• Institutions such as the World Bank and non-government organisations such as Oxfam provide aid.
• Aid can provide governments money to finance fiscal stimulus, and lead to economic growth which is essential for development. It can also lead to higher incomes for those with large MPCs. This can lead to large multipliers.
• On the other hand, aid can go into the wrong hands, and corrupt governments can misallocate gifts. Also, governments of developing/ less developed nations may not be as efficient in using the money.