Q.52 globalisation-developing-and-developed-economies

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Q.52 globalisation-developing-and-developed-economies

  1. 1. Discuss whether developing economies will benefit more from globalisation than developed economies. [25] Globalisation refers to the increase in flows of goods, services, investments and labour across international borders. The question on whether developing economies will benefit more from globalisation than developed economies can be discussed in terms of the effects on the balance of payments, national income, unemployment, the general price level and income equity. Globalisation may lead to an improvement in the balance of payments of developing economies. The balance of payments is a record of all the transactions between the residents of the economy and the rest of the world over a period of time and is made up of the current account and the capital and financial account. Due to their larger pool of low-skilled labour, developing economies have a comparative advantage over developed economies in producing low value-added goods, which include consumer, capital and intermediate goods. Therefore, globalisation will lead to a rise in the exports of low value-added goods of developing economies. Other things being equal, their current account and hence their balance of payments will improve. Further, globalisation will lead to a flow of foreign direct investments from developed economies to developing economies due to the lower labour cost in developing economies. Other things being equal, the capital and financial account of developing economies will improve. The aggregate demand and hence the national income of developing economies may rise due to globalisation. Aggregate demand is the total demand for the goods and services produced in the economy over a period of time and is comprised of consumption expenditure, investment expenditure, government expenditure on goods and services and net exports. Due to the increase in the investment expenditure and exports of developing economies, the aggregate demand and hence the national income will rise, other things being equal. © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  2. 2. In the above diagram, an increase in aggregate demand (AD) from AD0 to AD1 leads to an increase in national income (Y) from Y0 to Y1. When aggregate demand rises, firms will employ more factor inputs to produce more output and hence pay more factor income to households. Household income and hence consumption expenditure will increase. Due to the increase in consumption expenditure, firms will employ even more factor inputs to produce even more output and hence pay even more factor income to households. Household income and hence consumption expenditure will increase further. Therefore, the increase in the aggregate demand in developing economies will lead to a larger increase in the national income and this is commonly known as the multiplier effect. Since national income is equal to national output, the increase in the national income of developing economies due to the increase in the aggregate demand will lead to a rise in the demand for labour resulting in a fall in unemployment, assuming the size of the labour force remains the same. Globalisation may lead to a more rapid increase in the aggregate supply in developing economies in the long run. Aggregate supply is the total supply of goods and services in the economy over a period of time. The increase in the investment expenditure in developing economies will lead to a more rapid increase in the production capacity in the long run, assuming the net investment is initially positive. Therefore, the aggregate supply in developing economies will rise more rapidly in the long run. When this happens, assuming the aggregate demand in developing economies is rising, the national income will rise more rapidly, unemployment will be lower and the general price level will rise less rapidly. Due to the same reasons that may lead to an improvement in the balance of payments of developing economies, an increase in the aggregate demand and a more rapid increase in the aggregate supply in the long run, the balance of payments of © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  3. 3. developed economies may worsen, the aggregate demand may fall and the aggregate supply may rise less rapidly in the long run. Due to developing economies’ comparative advantage over developed economies in producing low value-added goods, globalisation will cause the labourintensive industries in developed economies to decline more rapidly which will lead to a rise in structural unemployment. The more rapid decline in the labour-intensive industries in developed economies will depress the demand for low-skilled labour and hence the wages which will cause income inequity to worsen. Globalisation may lead to an improvement in the balance of payments of developed economies. When developing economies grow, the people will become more affluent and hence their demand for high value-added consumer goods will rise. Further, to feed its economic growth, developing economies will need more high-value-added capital and intermediate goods. Due to their larger pool of high-skilled labour, developed economies have a comparative advantage over developing economies in producing high value-added goods, which include consumer, capital and intermediate goods. Therefore, the growth of developing economies will lead to a rise in developed economies’ exports of high value-added goods. The increase in outward foreign direct investments from developed economies to developing economies will also lead to an increase in inward income remittances in developed economies. Other things being equal, the current account and hence the balance of payments of developed economies will improve. When developing economies grow, some of the firms which will become larger will expand to other economies including developed economies. Other things being equal, the capital and financial account and hence the balance of payments of developed economies will improve. The increase in the investment expenditure and exports of developed economies will lead to an increase in the aggregate demand and hence the national income resulting in a fall in unemployment, other things being equal. The aggregate supply in developed economies may rise due to globalisation. When developing economies grow, they will produce more of the intermediate goods that developed economies need. Therefore, developed economies’ imports of intermediate goods from developing economies will rise. Due to the lower prices, the cost of production in developed economies will fall which will lead to an increase in the aggregate supply. The cost of production in developed economies will also fall due to an increase in inflow of cheaper labour from developing economies, both high-skilled and low-skilled. Globalisation may lead to a more rapid increase in the aggregate supply in developed economies in the long run. The increase in the investment expenditure in developed economies will lead to a more rapid increase in the production capacity in the © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  4. 4. long run, assuming the net investment is initially positive. Therefore, the aggregate supply in developed economies will rise more rapidly in the long run. Due to the same reasons that may lead to an improvement in the balance of payments of developed economies, the balance of payments of developing economies may worsen. The problem of brain drain in developing economies may make it difficult for them to move up the value-added chain which may lead to lower economic growth in the long run. If the entry of multinational corporations in developing economies leads to widespread closure of small firms, over-dependence on these footloose corporations may occur which may result in massive unemployment if they pull their operations out of the economies in the future due to more favourable market conditions in other economies. Due to the lax labour law and low environmental standards in developing economies, the entry of multinational corporations may lead to labour exploitation and environmental degradation which may lower the standard of living. In the final analysis, developing economies are likely to benefit more from globalisation than developed economies due to several reasons. Households in developing economies are poorer and hence have less purchasing power than households in developed economies. Therefore, developing economies are more export-driven than developed economies and hence an increase in exports due to globalisation is more beneficial to developing economies than to developed economies. Further, firms in developing economies are smaller and hence have less funds for investments than firms in developed economies. This problem in developing economies is exacerbated by the high interest rates due to the low supply of loanable funds. Therefore, an increase in inward foreign direct investments due to globalisation is more beneficial to developing economies than to developed economies. © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek

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