Globalisation: causes and impacts

Globalisation is the increasing integration of national economies into a single world economy — through trade in goods and services, flows of capital and labour, and the transfer of technology.

Causes over the last 50 years: containerisation and falling transport costs; the collapse in communication costs (the internet); trade liberalisation (the WTO and the growth of trading blocs); the deregulation of financial markets and the removal of capital controls; the growth of transnational corporations (TNCs) and global supply chains; and the entry of China and the former Soviet bloc into the world trading system.

Impacts — the balance sheet:

• Consumers: lower prices, more choice. But a loss of cultural diversity.
• Producers: bigger markets, economies of scale, cheaper inputs. But fiercer competition.
• Workers: jobs and rising real incomes in emerging economies — over a billion people lifted out of extreme poverty since 1990. But structural unemployment in the deindustrialised regions of advanced economies, and downward pressure on low-skill wages.
• Governments: higher tax revenue from growth. But a loss of sovereignty, and TNCs can shift profits to low-tax jurisdictions through transfer pricing.
• The environment: higher output ⟹ more emissions, resource depletion, and a "race to the bottom" in environmental standards. A large negative externality.

Who loses from globalisation?

Absolute vs comparative advantage

• Absolute advantage — a country can produce more of a good with the same resources (or the same amount with fewer resources).
• Comparative advantage (Ricardo) — a country can produce a good at a lower opportunity cost than another country.

Ricardo's astonishing result: mutually beneficial trade is possible even if one country is absolutely better at making everything. What matters is not who is better, but who gives up less to make it.

Read the absolute advantages straight off the table: A produces more wheat (10 > 6), B produces more cloth (6 > 5). Each has an absolute advantage in one good. But absolute advantage is not what determines the pattern of trade — the real question is opportunity cost.

Opportunity cost ratio

Working out who specialises in what

The terms of trade must lie between the two opportunity-cost ratios. Here, 1 wheat must trade for between 0.5 and 1.0 rolls of cloth. Inside that range both countries gain; outside it, one country would rather produce the good itself. Examiners love this.

Assumptions and limitations of the theory: it assumes no transport costs, constant returns to scale (in reality, specialising may bring economies of scale, which strengthens the case for trade), perfect factor mobility within a country (in reality, structural unemployment), no trade barriers, and homogeneous goods. It also ignores the risk of over-specialisation — a country dependent on one product is horribly exposed to a demand or price shock (see 4.3, primary product dependency).

Ricardo's point

The pattern of trade and the terms of trade

What changes the pattern of trade? Shifts in comparative advantage (as skills, technology and capital accumulate); the rise of emerging economies (China's entry to the WTO in 2001 reshaped world manufacturing); the growth of trading blocs and bilateral agreements, which divert trade towards members; and changes in relative exchange rates.

• An improvement (the index rises) means each unit of exports buys more imports — a given volume of exports commands more foreign goods.
• A deterioration (the index falls) means the opposite.

The trap: an "improvement" in the terms of trade is not automatically good. If export prices rise because the currency appreciated, export volumes may collapse — so the current account can worsen even as the terms of trade "improve". Whether it helps depends on the PED of exports and imports. Say so, and you are into the top band.

Terms of trade index

What does 88 mean?

Trading blocs and the WTO

The ladder of integration — each rung adds one thing:

• Free trade area — no tariffs between members; each keeps its own external tariff (e.g. NAFTA/USMCA).
• Customs union — a free trade area plus a common external tariff. Members can no longer negotiate their own trade deals.
• Common (single) market — a customs union plus the free movement of capital and labour and common standards.
• Monetary union — a single market plus a single currency and a single central bank (the Eurozone).

Conditions for a successful monetary union (optimal currency area theory): similar business cycles (otherwise one interest rate cannot suit all); labour and capital mobility between members; wage and price flexibility; and ideally fiscal transfers from strong to weak regions. The Eurozone crisis exposed all four weaknesses: Greece needed a devaluation and low rates while Germany needed the opposite, and neither could have both.

Trade creation vs trade diversion: a bloc creates trade when consumption shifts from a high-cost domestic producer to a lower-cost member — a welfare gain. It diverts trade when consumption shifts from a low-cost non-member (now facing the common external tariff) to a higher-cost member — a welfare loss. The net effect determines whether the bloc is beneficial.

The WTO promotes trade liberalisation, administers trade rules, and settles disputes. Its core principle is non-discrimination ("most favoured nation"). Conflict: regional trade agreements are, by design, discriminatory — they give members preferences denied to outsiders — which sits awkwardly with the WTO's founding principle.

Protectionism and the tariff diagram

Reasons given for protection: the infant industry argument; protecting against dumping (selling below cost); saving jobs in declining/strategic industries; correcting a current account deficit; raising government revenue; and national security.

Types: tariffs (a tax on imports), quotas (a physical limit on import volume — note these raise no government revenue; the gain goes to whoever holds the import licence), subsidies to domestic producers (shifting domestic supply right), and non-tariff barriers (product standards, licensing, complex customs procedures, "buy national" rules).

Tariff revenue

Tariff vs quota

Who wins and who loses?

• Domestic producers WIN — higher price, more output, more jobs in that industry.
• Government WINS (tariff only) — tax revenue.
• Consumers LOSE — higher prices, less choice, a fall in consumer surplus. Because tariffs fall heavily on food and clothing, they are effectively regressive and worsen equality.
• Living standards fall — resources are pulled into industries where the country has no comparative advantage: a global welfare loss.
• Retaliation — the biggest danger. Other countries impose their own tariffs; exporters lose; a trade war shrinks world trade. This is what turned the 1930 Smoot–Hawley tariff into a catastrophe.
• Producers using imported inputs LOSE — a steel tariff protects steelmakers but raises costs for every car maker, and there are far more workers downstream than upstream.

Evaluation of the infant-industry argument: it is theoretically respectable (temporary protection lets a young industry reach minimum efficient scale). But in practice protection is rarely temporary — the industry lobbies to keep it, never faces competitive pressure, and stays inefficient. Government failure, again.

The balance of payments

A record of all financial transactions between one country and the rest of the world. It has two halves that must, in principle, sum to zero.

• The current account — four parts: trade in goods; trade in services (the UK's great strength — finance, insurance, education); primary income (interest, profits and dividends flowing across borders); and secondary income (transfers: remittances, foreign aid).
• The capital and financial accounts — flows of investment: FDI, portfolio flows, and changes in reserves.

Causes of a current account deficit: poor international competitiveness (high relative unit labour costs); a strong exchange rate; strong domestic economic growth sucking in imports; a high marginal propensity to import; and structural decline in manufacturing.

Measures to reduce a deficit: expenditure-switching (depreciation, tariffs) to switch demand from imports to domestic goods; expenditure-reducing (contractionary fiscal or monetary policy) to cut demand for all goods, including imports; and — best of all in the long run — supply-side policies to raise productivity and competitiveness.

Is a deficit necessarily bad? Not automatically. It means the country is consuming more than it produces, financed by a surplus on the financial account — foreigners buying UK assets. That may be fine if the inflow is long-term FDI building factories. It is dangerous if it is hot money that can leave overnight, and it means selling assets (and the future income they generate) to fund current consumption. Global imbalances — large persistent surpluses in China and Germany against deficits in the US and UK — are a source of systemic instability.

Exchange rate systems and movements

• Floating — the rate is set by demand and supply of the currency. Automatic adjustment; the central bank keeps monetary policy free for domestic goals. But volatile, which deters trade and investment.
• Fixed — pegged to another currency or a basket, defended by buying/selling reserves and changing interest rates. Certainty for traders and a discipline against inflation. But requires huge reserves, and monetary policy is surrendered to defending the peg.
• Managed float — mostly market-determined, but the central bank intervenes to smooth movements. The commonest system in practice.

What moves a floating rate? Relative interest rates (higher rates attract hot money ⟹ appreciation); relative inflation; the current account position; speculation; FDI flows; and central bank intervention.

SPICED — Strong Pound, Imports Cheap, Exports Dear. An appreciation therefore tends to reduce inflation (cheaper imported inputs) but worsen the current account and slow growth.

Exchange rate conversion

After an appreciation

Will a depreciation fix the deficit?

A depreciation makes exports cheaper abroad and imports dearer at home. But whether the current account improves depends on how much volumes respond.

If demand is highly inelastic (the sum is less than 1), the volume gains are too small to offset the fact that we now pay more per unit for our imports — and the current account gets worse.

Why the J-shape? In the short run, contracts are already signed and consumers are slow to switch, so PEDs are low and Marshall–Lerner fails. Over time demand becomes more elastic (buyers find alternatives, exporters win new orders), the condition is satisfied, and the current account improves.

Marshall–Lerner

International competitiveness

Measures: relative unit labour costs (the wage cost per unit of output, compared with rivals — this is the key one, since it captures both wages and productivity) and relative export prices.

Factors influencing competitiveness: productivity (the fundamental driver), wage costs, the exchange rate, regulation and taxation, investment in infrastructure and skills, innovation and R&D, and inflation relative to competitors.

Benefits of being competitive: higher export-led growth, a stronger current account, more FDI, higher employment and living standards. Problems of being uncompetitive: a persistent current account deficit, deindustrialisation, structural unemployment, and reliance on capital inflows to finance consumption.

The essential contrast: a depreciation improves price competitiveness instantly but temporarily — and it makes imported inputs dearer, which feeds through into costs and inflation, eroding the advantage. Only supply-side improvement in productivity raises competitiveness permanently. That is the closing line of many a 25-mark essay.

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The big ideas to know

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