Globalisation: causes and effects

Globalisation is the increasing integration of national economies through trade, capital flows, migration and technology.

Causes: falling transport costs (containerisation); the ICT revolution; trade liberalisation (the WTO, trading blocs); deregulation of financial markets; the growth of multinational corporations (MNCs); and the entry of China and the former Soviet bloc into the world trading system.

• Benefits: greater specialisation and comparative advantage → lower prices and more choice; economies of scale from larger markets; competition drives efficiency and innovation; technology transfer and FDI raise LRAS in developing economies; hundreds of millions lifted out of absolute poverty.
• Costs: structural unemployment in the deindustrialised regions of rich countries; widening inequality; a race to the bottom in wages, tax and environmental standards; MNCs exploiting labour and avoiding tax; loss of national sovereignty; environmental damage; and much greater interdependence, so shocks (2008, COVID) spread instantly.

Absolute and comparative advantage

• Absolute advantage — a country can produce a good using fewer resources than another.
• Comparative advantage (Ricardo) — a country can produce a good at a lower opportunity cost. This, not absolute advantage, determines the pattern of trade.

Ricardo's astonishing result: even if a country is worse at making everything, both countries still gain by specialising in the good in which they have the lower opportunity cost and then trading. Total world output rises.

Assumptions (and hence the evaluation): the model assumes no transport costs, constant returns to scale, perfect factor mobility within a country, and no barriers. In reality transport costs can wipe out the gain; specialisation causes painful structural unemployment because workers cannot switch instantly; over-specialisation leaves a country dangerously exposed to a demand shock or a bad harvest; and comparative advantage can be created (South Korea) rather than being a fact of nature.

Your turn — comparative advantage

Ricardo's insight

Trade barriers and the arguments for and against

• Tariff — a tax on imports. Raises the domestic price, cuts imports, raises domestic output, and generates government revenue.
• Quota — a physical limit on the quantity imported. Same price effect, but the extra revenue goes to the importer or foreign supplier, not to the government.
• Export subsidies — payments to domestic producers, making their goods artificially competitive abroad.
• Non-tariff barriers — the modern weapon of choice: standards and regulations, mountains of paperwork, licences, deliberate delays at customs, government procurement rules.

Arguments FOR protection: the infant industry argument (a new industry needs temporary shelter to reach MES); the sunset industry argument (managing decline to avoid mass structural unemployment); preventing dumping (selling below cost to destroy rivals); national security (food, steel, defence); correcting a persistent current account deficit; and raising revenue.

Arguments AGAINST: higher prices and less choice for consumers (regressive — the poor spend more of their income on traded goods); loss of the gains from comparative advantage; protected domestic firms become X-inefficient; the risk of retaliation and a trade war; and a net welfare loss.

Government failure lurks here: infant industries have a habit of never growing up, because the protection creates a permanent, well-organised lobby to keep it. Any temporary protection needs a hard sunset clause — and rarely gets one.

Your turn — tariff revenue

Trading blocs, the EU and the WTO

Degrees of integration:

• Free trade area — no internal tariffs; each member keeps its own external tariff.
• Customs union — no internal tariffs plus a common external tariff (so members cannot strike independent trade deals).
• Single market — a customs union plus free movement of goods, services, capital and labour, with harmonised regulation (the EU).
• Monetary union — a single currency and a single central bank (the eurozone). Members surrender monetary policy and the exchange rate as adjustment tools — brutal for a member hit by an asymmetric shock (Greece).

Trade creation vs trade diversion — the key analytical distinction:

• Trade creation — joining the bloc shifts production from a high-cost domestic producer to a lower-cost bloc member. Welfare rises. Good.
• Trade diversion — the common external tariff shifts imports away from a low-cost non-member to a higher-cost member. Welfare falls. Bad.

Whether a customs union raises welfare depends on which effect dominates — a genuinely open question, and the reason economists are not automatically enthusiastic about trading blocs.

The WTO promotes multilateral trade liberalisation, administers trade rules and settles disputes. Criticisms: it is slow (the Doha round stalled for two decades), it is accused of favouring rich countries (rich-country agricultural subsidies survive), and its dispute settlement body has been effectively paralysed.

Exchange rate systems and determination

• Floating — set by demand for and supply of the currency. Appreciation = the currency rises in value; depreciation = it falls. Advantages: automatic adjustment of the current account, and monetary policy is free to target domestic inflation. Disadvantages: volatility and uncertainty deter trade and investment; speculation can drive the rate away from fundamentals.
• Fixed — pegged to another currency, defended by the central bank buying/selling reserves and changing interest rates. (A deliberate reduction of a fixed rate is a devaluation, a rise a revaluation.) Advantages: certainty for traders, and discipline on inflation. Disadvantages: requires huge reserves, monetary policy becomes hostage to the peg, and the peg is a sitting target for speculators (Black Wednesday, 1992).
• Managed float — mostly market-determined, with occasional intervention.

What raises the demand for pounds (appreciation): more UK exports; higher UK interest rates (attracting hot money); inward FDI; speculation that sterling will rise. What raises the supply of pounds (depreciation): more UK imports; lower UK interest rates or QE; UK investment abroad; higher relative UK inflation.

Effects of a DEPRECIATION — remember WPIDEC: Weaker Pound → Imports Dearer, Exports Cheaper. So net exports and AD tend to rise, boosting growth and jobs — but dearer imported raw materials cause cost-push inflation (SRAS shifts left), and there is less pressure on firms to control costs.

Your turn — an exchange rate conversion

Appreciation or depreciation?

Tap an event, then tap its likely effect on the value of the pound.

Correcting a current account deficit

Causes of a persistent UK current account deficit: poor non-price competitiveness (quality, design, reliability); high relative unit labour costs and weak productivity; a strong pound; a high marginal propensity to import as UK incomes grow; and the long decline of manufacturing.

Policies to correct it:

• Expenditure reducing — deflationary fiscal or monetary policy cuts AD, so incomes and therefore imports fall. It works, but at the cost of lower growth and higher unemployment. A cure worse than the disease.
• Expenditure switching — make imports less attractive and exports more so: a depreciation, or protectionist barriers (risking retaliation).
• Supply-side policy — the only real long-term answer: raise productivity and non-price competitiveness through education, training, infrastructure and R&D. Slow, but it fixes the cause rather than the symptom.

The Marshall–Lerner condition: a depreciation only improves the current account if PEDx + PEDm > 1 — the combined elasticity of demand for exports and imports must exceed one. If demand is very inelastic, buying the same volume of imports at a higher price makes the deficit worse.

The J-curve: in the short run elasticities are low (contracts are already signed, habits are sticky), so Marshall–Lerner initially fails and the deficit worsens. Over time demand adjusts, elasticities rise, and the balance improves — tracing out a J shape.

Your turn — the current account balance

What a depreciation does

Economic development

Growth is a rise in real GDP; development is broader — a sustained improvement in living standards, health, education, and freedom of choice. The HDI (income, life expectancy, education) is the standard composite measure.

Barriers to development: the savings gap (low incomes → low saving → low investment: the Harrod–Domar trap); poor infrastructure; weak institutions, corruption and insecure property rights; over-dependence on a few primary commodities with volatile prices and low income elasticity (the Prebisch–Singer thesis on declining terms of trade); the resource curse; capital flight and brain drain; debt burdens; conflict; and poor health and education (low human capital).

Strategies:

• Trade-led (outward-looking) — export-led growth, attracting FDI, joining the world trading system. The East Asian tigers and China are the great successes. Risks: exploitation, over-dependence, volatile capital.
• Aid — humanitarian and development. Can fill the savings gap and fund infrastructure, but risks dependency, corruption and distortion. Tied aid is often just an export subsidy in disguise.
• Microfinance, debt relief, industrialisation, investment in human capital, and above all better institutions.

Trade vs aid is the classic evaluation debate. Trade is sustainable and self-financing but requires rich countries to actually open their markets (and drop farm subsidies). Aid can help fastest where institutions are weak and markets absent — but only if it is well governed. The honest answer names the preconditions under which each works.

Match the trade term

Tap a description on the left, then the term it defines.

Creation or diversion?

Marshall-Lerner

The big ideas to know

You have covered the whole of AQA 4.2.6 — and with it, the whole A-level. Press Finish to see your score.