OCR F585 June 2015

OCR Economics - June 2015
Revision Seminar

Summary of the Extracts in June 2015 Case Study
1/ UK enters recovery phase of the economic cycle
2/ UK trade and international competitiveness
3/ Regional integration in the global economy
4/ Trends in the pattern of global trade
5/ Characteristics and impact of globalisation

Some Key Themes in the June 2015 Case Study
• Causes, nature and pace of economic recovery in the UK
• Unemployment and real wages in the UK labour market
• Assessment of the impact of UK Coalition demand and
supply-side policies / reforms since 2010
• Trade and international competitiveness
• Changes in the pattern of global trade
• Comparative advantage and intra-industry trade
• Analysis and evaluation of regional integration
• Rise of trade and investment between developing nations
• Assessing the benefits and costs of globalization
• Is globalisation being replaced by regionalization?
• Growth, development and income/wealth inequality

Extract 1: The UK
Economic Recovery

Extract 1: Specification Topics Page 4
• Students should be able to
1. Show awareness of recent macroeconomic performance
of the UK and the different aims of macro policies
2. Distinguish between short-run and long-run growth
3. Describe & understand the different stages of the cycle
4. Analyse the nature and significance of output gaps
5. Define the national income multiplier and explain what
determines its size
6. Evaluate the consequences of economic growth for
employment and unemployment

Drawing out the key issues in Extract 1
• Why was economic recovery in the UK delayed?
• What are the main structural problems facing the UK?
• Has the economy achieved some re-balancing?
• Has UK manufacturing enjoyed a strong recovery?
• Will the recession have a damaging long-term effect?
• What are the consequences of falling real wages and
falling real per capita incomes?
• To what extent has the Coalition’s fiscal policy helped to
bring about or hindered the recovery?
• Will rising public and private sector debt harm prospects
for recovery beyond the next election?

• UK GDP grew 0.6% in the second
quarter of 2013. This was double
the growth in the first quarter of
the year and, at an annualised
rate, equivalent to a 2.4% growth
in GDP. This was the first time
since the middle of 2011 that UK
national output had increased for
two consecutive quarters. Some
economists claimed that the UK’s
long-awaited recovery had finally
begun. The Chancellor of the
Exchequer, George Osborne,
claimed that the economy was
“healing”.
Extract 1: Recovery in the UK Economy
Real GDP: Volume of national output of goods and services
Page 4
• Economic recovery is when real
national output rises in at least two
consecutive quarters
• The annual rate of growth is the rate
of change over a twelve month
period. Actual GDP follows a cyclical
pattern around a long-term trend
• 2.4% annualised growth
represented a return to trend
growth for the UK although some
economists believe this rate has
fallen because of the legacy effects
of the recession and the global
financial crisis (GFC).

UK Real GDP & The Economic Cycle
Peak
Recession
Fear of
double
dip
Real GDP
recovers to
previous
peak

Chart: Annual Rate of Growth of Real GDP for the UK
One of the
features of the
UK has been the
stronger growth
story since 2013
Latest data on UK growth
can be found here

• Positive signs that the UK had
entered the recovery phase of the
economic cycle included the broad
based nature of growth.
• Output had grown in all four
sectors – services, manufacturing,
construction and agriculture.
• Growth in services was 0.6% in the
second quarter of 2013 leaving its
total output only 0.2% below its
peak at the beginning of 2008.
Services make up around 80% of
UK GDP, so they provided the
largest contribution to growth.
Recovery phase: A recovery in real national output across sectors
Page 4
• The UK is an economy dominated by
business and consumer services:
• In 2012, the service sector
accounted for 79% of GDP
• Production sector was 15%
• Construction sector was 6%
• In the 10 years up to 2012,
agriculture’s contribution to the UK,
measured as a share of UK Gross
Value Added (GVA), has fallen from
0.7% to 0.6%.

Examples of Manufacturing and Service Industries
Food processing
Earth moving
equipment
Additive
manufacturing
(3D)
Hotels and
restaurants &
retail
Education, health
care, legal
services
Transport and
logistics

Apprenticeships – Manufacturing and Unemployment
• Extract 1 focuses heavily on manufacturing and unemployment issues
• The Coalition has expanded apprenticeship programmes
What role can government policy play in encouraging manufacturers to
offer apprenticeships – and encourage suitable people to apply?

• Unemployment also
moved in the right
direction, falling from
its peak of 2.56
million in January
2013 to 2.51 million
in May 2013.
• Update: UK
Unemployment has
continued to fall since
May 2013 – dipping
below 2 million in
summer of 2014
• Current rate = 5.5%
Extract 1: Changes in UK Unemployment
LFS Unemployment: This measures all those actively seeking and
available for work, whether or not they are claiming benefit
Page 4
Jan 2013
Latest data on UK unemployment can be found here

• “However, some economists
expressed concerns about the
strength of the UK economic
recovery and the extent to which
it could be sustained into the
future.”
• “John van Reenen, Professor of
Economics at the London School
of Economics, was concerned
about trends in the labour
market.”
Extract 1: John van Reenen
Sustainable: means 'enduring' and 'lasting' and 'to keep in being'
Page 4
• John van Reenen is one of the
leading economists at the LSE.
• He co-wrote a UKGrowth
Commission Report which was
published in 2013.
• The report recommended several
key issues that needed to be
addressed to achieve sustainable
growth in the future
• Their report emphasised the
importance of supply-side
competitiveness in driving
macroeconomic performance.

• His concerns focused on two
aspects in particular.
• Since the peak of the cycle in
2007 he noted:
1. The continued rise in long term
unemployment, with more than
900,000 unemployed for more
than a year – 36% of the total
number of people unemployed
2. A fall in the employment rate
from 73.1% at the end of 2007
to 71.4% in 2013, despite the
rise in employment.
Van Reenen identifies structural weaknesses in the UK labour market
Page 4
• The long term unemployed have been
out of work for at least a year
• Many face structural barriers and
structural disincentives to
successfully get back into paid work
• The employment rate is defined as
the percentage of the population of
working age that is in full-time or
part-time paid employment
• Reenen says long-term
unemployment is a lagging indicator
of the cycle.
• Changes in the size of the labour force
can cause total employment to rise
whilst the employment rate can fall

Long Term Unemployment Rates in the UK
Van Reenen is right to
point out that high
long-term
unemployment is a
serious problem for
the British economy.
However, since 2013
that rate has fallen a
little to less than 35%
- and it is lower than
in the recession of
the early 1990s when
it peaked at nearly
45%

UK Employment and Unemployment Rates
At the end of 2007
the UK employment
rate was close to
73% and the
unemployment rate
was 5.3%
After the end of the
recession, the
employment rate
had dropped to
70.1% with LFS
unemployment
peaking at 8.6%
Employment rate now
back at 73% although
unemployment remains
higher than in 2007

• Van Reenen warned that these
trends could adversely affect the
future potential growth rate of the
economy.
• This section of the extract focuses
on the concept of hysteresis
• Hysteresis effects happen when a
sustained period of low aggregate
demand can lead to permanent
damage to the supply side of the
economy
Unemployment and the Risk of Hysteresis Page 4
• The future potential growth rate is
measured by the estimated trend
growth of potential real GDP
• Potential national output is
determined largely by supply-side
factors including many linked to
the performance of the labour
market
• So a key analysis question is
• “How can high long-term
unemployment and a low
employment rate affect potential
GDP?”

Longer Term Economic & Social Effects of a Recession
The main effects of recession depend on causes and how long it lasts
Long Term
Economic Consequences
Rising structural long-term
unemployment rates
Low investment can reduce the
size of the capital stock
Persistent budget (fiscal) deficit
and rising national debt
Long Term
Social Consequences
Falling real wages hits median living
standards
Widening inequality of income and
wealth
Social costs / problems arising
from rising relative poverty

Recession and the Risk of Hysteresis
• The dictionary definition of hysteresis is “the lagging of an effect behind its
cause.” In macroeconomics it has become common to explain hysteresis as a
problem caused by a deep recession and persistently high unemployment.
1. Long-term unemployed workers can lose skills and motivation and may
become economically inactive by leaving the labour market
2. Businesses fail / closing down leaving depressed areas and regions with
much lower per capita incomes.
3. Other businesses make deep cuts in capital investment spending to a level
insufficient to replace worn out plant and machinery. As a result the capital
stock may decline – as a result, the growth of labour productivity suffers
4. Commercial banks that lose money in a recession become stricter with their
lending to businesses and households – leading to a contraction in loan
finance for the business sector – holding back much needed growth
5. A deep recession can cause lower government tax revenues which might
then result in less investment in and maintenance of public services and a
drop in the quality of infrastructure. It also makes it much harder for the
Chancellor to control the size of the fiscal deficit and the national debt

“Labour Scarring Effects” from Unemployment
Loss of work experience
• Reduced employability from a depreciation of skills
• Gaps in people’s CVs may influence potential employers
• Decline in the quality of human capital / motivation
Loss of current and future income
• Vulnerability to consumer debt at very high interest rates
• Decline in physical health and increase in psychological stress
– much less likely that someone will find work again
Changing pattern of jobs in the economy
• New jobs in the recovery stage often different from lost ones
• Structural unemployment – i.e. occupational immobility –
makes it significantly harder to get people into the new jobs

Policies to Reduce Unemployment – Labour Demand
Macro Stimulus Policies (+ Multiplier Effects)
• Low interest rates and policies to increase business lending
• Depreciation in the exchange rate (to help exports)
• Infrastructure investment projects (fiscal policy)
Cutting the cost of employing workers
• Reductions in national insurance contributions (tax)
• Financial support for apprenticeship programmes
• Extra funding for regional policy – business grants
Supply-side Competitiveness Policies
• Reductions in corporation tax (to increase investment)
• Tax incentives for research / innovation spending
• Enterprise policies to lift the rate of new business start-ups

Policies to Reduce Unemployment – Labour Supply
Reducing occupational mobility
• Better funding for and more effective training
• Teaching new skills e.g. Coding for gaming, languages
• An expansion of apprenticeship / internship programmes
Improving geographical mobility
• Rise in house-building will help to keep property prices
lower and encourage more affordable rents
• Active regional policy to create new jobs and businesses
Stimulate stronger work incentives
• Higher minimum wage or a living wage
• Reductions in income tax / national insurance
• Welfare reforms to reduce the risk of the poverty trap

• I see little prospect that this
growth rate will be sustained
into the future, despite what
George Osborne says.
• There is scant evidence that any
of the four components of
growth – investment,
consumption, net trade or
government expenditure – are
at ‘blast-off stage’ and net
business lending continues to
fall.
Extract 1: Views of David Blanchflower Page 4
• David Blanchflower is a Keynesian
economist who has been fiercely
critical of the economic policies of
the 2010-15 Coalition Government
• He was a member of the UK
Monetary Policy Committee for
three years and widely regarded
as a “doveish” member
• This meant that he feared the risks
of deflation and semi-permanent
recession and thus wanted to keep
monetary policy interest rates low
+ expand a programme of
quantitative easing (QE)
Explore: Read David Blanchflower in regular articles in the Independent newspaper

• “We need to remind
ourselves that the (UK)
economy has only grown
1.8% in total over the past
11 quarters and, of that,
0.7% is due to investment
in the Olympics.”
• “In contrast, over the same
period, both Canada and
the United States of
America grew by 5%.”
• “Most forecasters are not
expecting much, if any,
growth in the second half
of the year.”
• How might the 2012 London Olympics
have provided a boost to GDP growth?
1. Investment in constructing the
Olympic Park and other venues
2. Investment in extra traffic capacity
3. Injections into the circular flow from
extra tourist and business visitors
4. Legacy effects including post-
Olympics FDI projects attracted into
the UK
• The value of multiplier effects from
events such as the Olympic Games are
hotly contested
• There is also a continuing debate over
whether the Olympics has benefitted
regional balance in the British economy

• The economy that Osborne
inherited was also growing
at 0.6% per quarter, and
that continued for a couple
more quarters until his
reckless austerity policy
and talking down of the
economy took effect. Plus
he still has no growth plan.
• Moreover, the last time
there was growth of 0.6%
was in the third quarter of
2011 which was followed by
–0.1%, zero and –0.5%
growth in the following
three quarters.
“Talking down of the economy”
• This reflects a Keynesian view that
consumer and business confidence (or
Keynesian animal spirits) can have a
significant effect on household spending
and business investment.
“Reckless austerity policy”
• Ahead of the exam, be clear on some of
the key aspects of the Coalition’s fiscal
policy since they came into office in May
2010. Their main aim has been budget
deficit reduction through a mixture of
tax rises and cuts in the real level of
government spending in some areas.
• The last section on the left refers to risks
of a double-dip recession in 2011-12

• “We remain locked in the most feeble economic recovery in our history.”
Extract 1: Views of Liam Halligan Page 5
This chart from the National Institute of Economic and Social Research shows a profile of
recession and recovery in the months after previous recessions in our economic history. It
supports Liam Halligan’s view in that (as of May 2014), many months after the start of the
recession in 2008, real GDP was still lower than at the peak of the cycle. Recovery from
the 2008-2010 recession has been shallower than after the Great Depression:
Key discussion question: Why has UK economic recovery (until recently) been so slow?

• Beyond the headline numbers, real wages continue to fall as inflation
erodes purchasing power. Including population growth, UK real GDP per
head is actually some 7% below its 2007 peak.
• This has been a key
feature of the 2011-
2015 recovery.
• Consumer prices
have been rising
faster than wages
leading to lower real
wages.
• Weak recovery and
an expanding
population has seen
real GDP per capita
decline.

Understanding Real Incomes and Economic Activity
Year
Earnings
(Wages, Bonuses
and Overtime)
% annual change
Consumer
Price Index
% annual
change
Real
incomes
2008 4.7 3.0 Rising
2009 1.9 2.3 Falling Year of recession
2010 2.1 3.7 Falling
2011 0.4 4.5 Falling Almost a double dip
2012 1.6 3.0 Falling
2013 2.2 2.4 Falling Signs of recovery
Real income measures the purchasing power of a given amount of
nominal (money) income – i.e. nominal income adjusted for inflation
In recent years, the annual growth of earnings for people in work has
been less than inflation – causing real incomes to fall

Analysis: Why have real wages been falling in the UK?
• Real wages have been falling because the annual rate of change of
wages / earnings from jobs has been slower than the increase in
consumer prices
• Some reasons for slow wage growth:
1. Tough pay restraint in the public sector e.g. NHS workers have
seen a 10% decline in real wages since the start of the recession
2. Many private sector businesses have introduced pay freezes (and
in some cases, nominal pay cuts) as an alternative to bigger job
losses during the recession and weak economic recovery
3. Trade union bargaining power has been hit by economic
problems at home and forces of globalisation
4. For much of the last five years, consumer price inflation has been
above the 2% target measure, not least because of big increases
in fuel and energy prices.
5. Labour productivity has been disappointing – businesses find it
harder to fund wage rises if output per person employed is flat

What are the consequences of a fall in GDP per head?
• Average living standards decline (falling per capita incomes)
• More workers need a second job to supplement their
incomes – now more than 1 million people with second jobs
• Less consumer demand for goods & services
• Reduced incomes per capita may cause GDP growth to remain
slow – making the recovery more fragile
• Lower incomes and low net savings makes many more people
reliant on (expensive) consumer debt e.g. pay-day loans
• It becomes tough for people to reduce the debts
accumulated during the growth years including mortgages
• The government receives lower-than-expected tax revenues
– making it a lot harder to reduce the fiscal deficit
According to the Office for National Statistics: Nominal wage growth below the rate of price
inflation has resulted in real wages falling for the longest sustained period since at least 1964

• “In addition, there has been no sign of the ‘rebalancing’ away from
consumption and towards exports and investment that the
Coalition Government said it wanted.”
• “Back in 2010, Osborne declared his confidence in ‘a march of the
makers’, claiming that manufacturers would power growth via a
surge in exports. It hasn’t happened.”
1. What is meant by re-balancing?
2. Which policies might be effective in achieving this re-balancing?
3. To what extent has UK manufacturing output recovered?
4. Which UK manufacturing businesses and industries have done
well since the end of the recession?

What is meant by re-balancing of the economy?
• Re-balancing describes changing the balance of aggregate demand,
output, jobs and investment in an economy.
1. Re-balancing away from consumption and imports towards exports
and business capital investment
2. Re-balancing away from dependence on the housing market
towards manufacturing as a source of new wealth
3. Moving away from debt-fuelled consumption towards more private
saving including occupational pensions and other savings schemes
4. Re-balancing away from dependence on financial services towards a
greater role for manufacturing, life sciences and creative services
5. Improving regional balance i.e. more investment and jobs in areas /
regions with persistently higher unemployment and lower incomes
6. Re-balancing away from high levels of government spending,
taxation and borrowing towards a great share of national output
flowing from the private sector

Analysis: Which policies can re-balance the economy?
Currency depreciation (A fall in sterling)
• A boost to UK export price competitiveness
• Improved net trade balance (after time lags)
• Higher exports creates positive multiplier & accelerator effects
Supply-side support policies for industry
• Active regional growth policies, more infrastructure spending
• Establish many more technology innovation centres
• Increase graduates and apprentices in technical subjects
Improving the supply of credit
• Funding for Lending Scheme (especially if QE has not worked)
• Introducing stronger competition in retail banking system
• Green Investment Bank for renewable investment schemes

• “Despite the pound falling some 20% against our main trading
partners in recent years, UK exports have slumped, doing nothing
to foster growth, improve our national accounts, or tackle the
chronic job insecurity felt by millions. The UK’s external sector
remains a drag on growth, adding to our ever-deepening
indebtedness.”
1. Why did the pound fall by 20%?
2. How does a weaker pound help UK export industries?
3. Have UK exports of goods and services slumped?
4. What evidence is there of chronic job insecurity?
5. Analysie the likely economic effects of job insecurity
6. Why is the UK’s external sector a net drag on growth?
7. How is indebtedness measured?
8. What is the evidence on the scale of debt in the UK economy?

Selected components of UK demand, annual % change at constant 2011 prices
Consumer
Spending
Capital
Investment
Exports of
Goods and
Services
Imports of
Goods and
Services
Real GDP
2008 -0.5 -4.7 1.6 -1.8 -0.3
2009 -3.3 -14.4 -8.2 -9.8 -4.3
2010 0.5 5.9 6.2 8.7 1.9
2011 -0.1 2.3 5.6 1.0 1.6
2012 1.5 0.7 0.7 3.1 0.7
2013 1.7 3.4 1.5 1.4 1.7
Data: Have UK Exports “Slumped”?
1. Exports fell sharply in 2009 – they were hit hard by the effects of a
global economic recession and the slump in the EU economy
2. They recovered quite strongly in 2010 and 2011 (growing by more
than 5% in each year) but slowed down again in 2012 and 2013
3. Commentators puzzled over the causes of slow growth of exports

Analysis: Some reasons for slow growth of UK exports
The weaker pound caused higher import prices –
offsetting some of competitiveness gains from a
lower exchange rate
Many businesses reported that they were
finding it hard to get export finance / credit from
the big commercial banks
The UK’s major export market (the EU) was
experiencing it’s own financial and economic
crisis – causing falling overseas demand
Competitiveness is not just about cost and price
– innovation / design counts too – did the UK
have sufficient non-price advantages?
Read Robert Peston on the causes of the UK’s structural trade deficit

• “So, yes, the UK economy has grown for two consecutive quarters.
Yet, by 2015, Osborne will have borrowed more in five years than
Gordon Brown did in over a decade.”
• “The UK’s national debt is now £1100bn, up from £580bn in 2008
and set to soar above £1500bn over the next few years.”
1. Distinguish between government borrowing & the national debt
2. At what point will national debt as a share of GDP start to fall?
3. Why has government borrowing remained high during the early
years of the recovery?
4. To what extent is a high level of national (government) debt a
cause for concern?

Awareness: UK Coalition’s Fiscal Austerity Policies
• The UK coalition government has a deficit-reduction policy with the main
emphasis on cutting government spending in some areas in real terms
and a series of direct and indirect tax increases:
• Key policies for deficit reduction:
1. Rise in VAT to 20%
2. Rise in employee national insurance contributions
3. Deep cuts in real government spending e.g. for local authorities
4. Welfare caps including £26k pa cap on welfare for a family
Some taxes have been cut
1. A series of cuts to corporation tax (main rate is now 20%)
2. Freezing of fuel duties (meaning a cut in real terms)
3. Increases in the real value of the income tax free allowance
4. Freezing of council tax (so that council tax falls in real terms)
Government helped by lower market interest rates on newly issued debt

Selection of Suggested Questions for Extract 1
1. Describe two causes of an economic recovery
2. Describe two factors that affect the growth of exports
3. With the aid of a diagram, explain how a rise in real GDP can help to
reduce unemployment
4. Distinguish between the employment rate and the unemployment rate
5. Comment on the impact that job insecurity can have on the behaviour
of consumers
6. Comment on the argument that the Coalition’s fiscal austerity is
“reckless” for the health of the UK economic recovery
7. To what extent does the UK government have an effective economic
growth plan?
8. Comment on the policies likely to be most effective in reducing long
term unemployment
9. Evaluate the extent to which a lower exchange rate has helped to re-
balance the UK economy
10. Discuss the impact that falling real wages might have on economic
recovery in the UK

Extract 2: Net Trade and Competitiveness

1. Distinguish between absolute and comparative advantage
2. Analyse the effects of international trade
3. Outline the pattern of global trade
4. Analyse the causes of imbalances on the UK balance of
payments on current account
5. Define, measure and analyse the significance of the terms of
trade, and changes in the terms of trade over time
6. Evaluate comparative advantage as explanation of trade
patterns
7. Evaluate different economic policies to correct imbalances on
the balance of payments (current account)

Drawing Out Some Key Issues in Extract 2
• Why is competitiveness important for economic growth?
• What are the consequences of a structural trade deficit on a
country’s economic performance?
• To what extent has Coalition economic policy brought about
an improvement in UK external trade?
• What determines the terms of trade and how does this affect
competitiveness?
• What are the main drivers of global competitiveness?
• Which policies are most important in the long run in
sustaining competitiveness in the global economy?
• How can education & training reforms and investment affect
competitiveness and economic growth?
• Is a flexible labour market important for trade?

• A loss of comparative
advantage is an important
concern for future economic
growth in the UK.
• Net trade continues to be a
drag on such growth.
• As the UK economy enters the
recovery stage of the cycle, net
trade continues to be negative
Extract 2: UK Net Trade and Competitiveness Page 6
• Comparative advantage exists
when a country has a ‘margin
of superiority’ in supplying a
product i.e. where marginal
cost is lower
• Net trade measures a
country’s balance of trade i.e.
value of export – value of
imports
• If a country is running a trade
deficit, there is a net outflow
of demand from the circular
flow of income – hence a
“drag on growth”

Figure 2.1: UK Net Trade 2009-2013
The UK trade
deficit in 2011 Q1
was the smallest
since 1998
Page 6
Trade balance
in 2009 was
-£28bn
Trade balance
in 2010 was
-£37bn
Trade balance
in 2011 was
-£24bn
Trade balance
in 2012 was
-£35bn
Trade balance
in 2013 was
-£34bn
The net balance of trade in goods and services is shown in Figure 2.1

• The UK government stated in its
2011 Plan for Growth that it
would aim to ‘rebalance’ the
economy by encouraging growth
in UK exports and FDI.
• This was one of four priorities
for achieving growth. The others
were:
1. Reforms to the tax system
2. Measures intended to make the
UK a more attractive place to
start a business
3. Measures intended to create a
more educated and a more
flexible workforce.
• Read the 2013 Plan for
Growth implementation
update
• The Plan for Growth was
centered around supply-side
reforms and policy
interventions designed to
improve business
competitiveness and labour
market flexibility.
• You can find a summary of the
key measures on the next
slide

Extract 2: Plan for Growth – Policy Interventions Page 6
• Business taxation:
– Corporation tax cut to a new level of 20% from 2015
– Patent box (lower taxes on patented products) to stimulate innovation
– New tax reliefs for animation, high-end television and games industries
– Reductions in national insurance contributions for businesses employing
long-term unemployed / youth unemployed
• Business finance and red tape:
– Creation of Green Investment Bank for renewable energy investment
– Funding for Lending Scheme in association with the Bank of England
– 24 new Enterprise Zones established in areas of high unemployment
– Qualifying period for unfair dismissal increased from one year to two
• Education reforms:
– Expansion of free schools and academies
– Large rise in the number of apprenticeships available under Youth Contract
– 14 science and innovation capital projects

• As a result of the globalisation
of the world economy, the
long-run economic
performance of an individual
economy is increasingly
determined by its international
competitiveness.
• There is no single measure of
an economy’s competitiveness.
• Many measures, such as the
terms of trade and relative unit
labour costs, focus on price and
cost competitiveness.
Globalisation
Deepening of relationships
between countries of the
world reflected in an
increasing level of overseas
trade and investment.
International
competitiveness
The ability of a business or a
country to compete
effectively in international
markets.
Terms of trade
The terms of trade (also
known as the real exchange
rate) is the real value of
countries exports in terms of
their imports.
Relative unit
labour costs
(RULCs)
Wage costs per unit of output
– determined by wage and
productivity levels – relative
to those in other countries.

Global Competitiveness Index (WEF Measure)
The Global Competitiveness Index uses indicators which measure:
Indicator Brief comment on the indicator
Effectiveness of institutions Protection of property rights, rule of law, corruption
Quality of infrastructure Quality of transport, communications, energy etc.
Macroeconomic performance Inflation, fiscal balance, government debt, growth
Health and primary education Malaria incidence, prevalence of HIV, mortality rates
Higher education and training Quality of teaching and attainment e.g. in Maths
Efficiency of goods & labour markets Intensity of competition, tariffs, other barriers
Technological readiness Internet use, availability of latest technologies
Sophistication of business Supplier quality, business clusters,
Innovation Patent applications, research & development spend

Analysis: International (External) Competitiveness
External competitiveness is the ability to sell goods and services at
competitive prices in a foreign country
• Cost competitiveness
• Differences in unit labour costs – reflected in producer prices
• Non-price competitiveness
• Product quality, design, reliability and performance, choice,
after-sales services, marketing, branding and the availability
and cost of replacement parts
• Non-wage costs:
• Costs of meeting environmental / health regulations
• Environmental taxes e.g. carbon taxes and waste taxes
• Employment protection laws and health and safety laws
• Requirements to provide pensions for employees

Relative Unit Labour Costs
• Relative unit labour costs measure the labour cost per unit of output
expressed in a common currency and index number format
• Relative unit labour costs will rise when
1. A country’s exchange rate appreciates against other nations
2. Wage costs rise relatively faster
3. Labour productivity growth is slower than in other countries
Country Index of
Relative Unit
Labour Costs in
2010
Index of
Relative Unit
Labour Costs in
2014
Source: OECD World Economic Outlook
Comment
United Kingdom 100 103.4 No significant change in cost competitiveness
Switzerland 100 111.0 Appreciating currency
Japan 100 76.2 Depreciating currency and price deflation
Germany 100 102.6 Steady unit costs
Spain 100 88.6 Recession, wage cuts and some deflation
New Zealand 100 119.1 Strong currency has worsened competitiveness

The Terms of Trade
• Terms of trade measures the relative prices of products that we export
compared to the cost (prices) of imports goods
• The terms of trade are measured by ((Index of export prices / Index of
import prices) x 100)
– If the terms of trade index goes up, we say that the terms of trade have improved
– If the index falls, we say that the terms of trade have deteriorated
• The terms of trade affect the gains from overseas trade
• It also influences variables such as the balance of payments (current
account) and living standards
• The terms of trade is heavily influenced by changes in the exchange rate
• A rise in the value of a country domestic currency decreases prices for its
imports but also makes exports less competitive
• Thus a higher currency improves the terms of trade but might worsen the
balance of trade on the current account

Significance of Changes in the Terms of Trade
Changes in the prices of the items
we have to import
Standard of Living
Affects relative prices of capital
inputs needed to sustain growth
Prices of Imported Technology
Export and import prices affect the
value of trade flows
Balance of Payments
Improved terms of trade
might mean we are able
to import cheaper food
A weak exchange rate
increases the prices of
imports – worsens the
terms of trade – e.g.
makes imports of new
technology more
expensive
Important not to confuse
the terms of trade with
the balance of trade!

Extract 2: Focus on UK Competitiveness Policies
Policy Detail Click on the links to explore
further on each policy area
Investment in
infrastructure
• Public sector investment in infrastructure
worth over £100bn by 2020
• Government guarantees for lenders financing
infrastructure projects
• Background on the
Government’s National
Infrastructure Plan (2014
version)
Increasing access to
finance for business
• Funding for Lending Scheme
• Creation of a £1bn Business Bank to help
smaller businesses access finance and support
• Funding for Lending
• Business Bank
Encouraging
businesses to invest
• Increase in the tax allowance on investment
from £25 000 to £250 000
• Reduction in corporation tax from 23% to 20%
by 2015
• Corporation tax rate cut
in the UK (2013)
Simplifying business
regulation
• For every new regulation, the government has
committed to remove two regulations
• Red Tape Challenge
(Government website)
Creating an
educated
workforce
• Changes to the curriculum to improve literacy
and numeracy
• Improving training and apprenticeships
• Background on the
Government’s Youth
Contract
Page 7

Policies to Improve International Competitiveness
Improving functioning of Labour Markets
• Investment in all levels of education , management
• Encouraging inward migration of skilled workers
Infrastructure Investment
• Better motorways, ports, hi-speed rail,
• Communications e.g. super-fast broadband, 4G
Supporting Enterprise / Entrepreneurship
• Improved access to business finance e.g. for start-ups
• Incentives for business innovation and invention
Macroeconomic Stability
• Maintaining low inflation / price stability
• A sustainable and competitive banking system

1. Describe two causes of a trade deficit
2. Describe two factors that affect the terms of trade
3. Distinguish between the balance of trade & the terms of trade
4. Comment on the importance of higher education and training in
determining a country’s competitiveness
5. To what extent has the UK achieved an improvement in
competitiveness in recent years?
6. Evaluate the extent to which reductions in corporation tax may
improve a country’s economic performance
7. Discuss the impact that demand and supply-side policies can have
in improving the UK’s external trade figures
8. With the aid of a diagram, analyse how improvements in labour
market flexibility can aid competitiveness and economic growth

Extract 3: Regional Economic Integration

1. Understand & explain the stages of economic integration, such as:
– Free-trade areas
– Customs unions
– Single markets
– Economic unions
– Monetary unions
2. Be familiar with examples of economic integration, such as:
– EU (European Union)
– NAFTA (North American Free Trade Agreement)
– ASEAN (Association of South East Asian Nations)
3. Evaluate internal and external consequences of economic integration, such as:
– Short-run – trade creation and trade diversion
– Long-run – dynamic effects
4. Explain the roles of the WTO (World Trade Organisation)

• What factors are causing regionalization of global trade?
• Has EU enlargement accelerated EU intra-regional trade
• Why is intra-regional trade in the EU so high (>70%)?
• What are the welfare effects of the EU customs union?
• Comment on the effects of UK membership of the single market
• Does the free movement of labour within the EU single market bring
about gains in economic performance?
• What are the arguments for and against joining the fixed exchange
rate system against the Euro (ERM II)?
• What are the arguments for floating versus fixed exchange rates?
• Evaluate the case for smaller EU nations such as Lithuania to be a
member of the single currency
• Denmark is the sole remaining member inside ERM II. Comment on
the arguments for staying outside of the Euro Area

• The World Trade Organization
publishes an annual report on
world trade.
• Its 2013 report noted a trend
towards greater regionalisation
of trade, particularly in both
Asia and Europe.
• For example, EU intra-regional
trade accounted for 71% of
exports of EU member states in
2011.
Extract 3: Regional Integration in Global Economy Page 8
World Trade
Organisation
WTO polices free
trade agreements,
and decides on trade
disputes between
countries.
Regionalisation
of trade
An increase in the
intensity of trade
and investment
between countries
within the same
region
Intra-regional
trade
Exchange of virtually
identical products
between countries
within the same
region

• This is not surprising given the
widening and deepening of
regional economic integration in
Europe.
• Not only has the EU grown to
include more economies through
a series of enlargements
(widening) but the level of
economic integration has
deepened from the original
formation of a customs union.
• This customs union resulted in
both trade creation and trade
diversion.
Extract 3: Economic Integration in the EU Page 8
European
Union (EU)
Economically
integrated group of
28 member states
(newest: Croatia)
Customs union Countries that
operate free trade
with each other and
impose a common
external tariff
Trade creation Welfare gains from
lower import tariffs
from within the
customs union
Trade diversion Welfare loss from
higher import prices
from outside the
customs union

Extract 3: Enlargement of the EU – New States
Advantages for new EU countries (+ supporting comment)
Tariff free access to a single market >
500m people
Opportunity to exploit
economies of scale
Easier to access foreign direct
investment from inside/outside EU
FDI can lift trend growth and
raise factor productivity
Access to EU structural funds
Investment to improve
infrastructure / public goods
Better access to EU capital markets
EU companies can raise
investment funds from bond
and capital markets
Discipline of competition from being
inside the EU single market
Intra-EU trade already high for
many new EU countries

New Member States: Advantages from Joining the Euro
Boost to Trade and Investment
• Lower transactions costs for exporters and investors
• Eliminating currency conversion costs boosts tourism
• Fall in currency risk as the threat of devaluation is less
Financial support and political stability
• Access to the European Central Bank as a lender of last
resort in case of financial difficulty
• Euro membership is a confirmation of long-term political
alignment with the European Union
Reduced vulnerability to “external shocks”
• Many consumers and businesses in new member states can
now save, borrow, and take out mortgages in euros
• Joining the Euro reduces the risks of taking out these loans

New Member States: Risks from Joining the Euro
Exposure to Euro Zone economic problems
• Exposure to contributing to future fiscal bail-outs
• Exposure to continued weak growth in Euro Zone
• Risk that new member states will import deflation
Trade Patterns / Trade Diversion Effects
• Some of the main trade partners outside of Euro Zone
• Might involve switch of trade to higher cost countries
Structural Reforms and Jobs
• New Euro member countries will have to accelerate
process of structural reforms to improve
competitiveness inside the Euro – this may lead to a rise
in structural unemployment

Fixed versus Floating Exchange Rates
• Case for fixed exchange
rates
• Promotes trade and
Investment: because of less
currency risk
• Some adjustment to the
fixed currency parity is
possible
• Reductions in the costs of
currency hedging for
businesses
• Disciplines on domestic
producers to keep costs and
prices down
• Reinforcing gains in
comparative advantage if
unit costs can be reduced
• Case for floating exchange
rates
• Reduced need for foreign
currency reserves as no
exchange rate target
• Useful instrument of macro-
economic adjustment e.g.
after an external shock
• Partial automatic correction
for a trade deficit
• Less opportunity for
currency speculation
• Freedom (autonomy) for
domestic monetary policy –
interest rates can be set to
meet other macro
objectives

ERM II – The Danish Krone
Denmark has been inside the ERM II since the
launch of the Euro in 1999. Prior to the
introduction of the euro, the Danish fixed
exchange rate was vis-à-vis the German D-mark.
Under ERM II, the Danish krone is fixed against the
Euro – the central bank intervenes to keep the
currency within agreed limits when needed.
The Danish central bank’s sole mandate is to adjust
policy interest rates and currency reserves to defend
the krone’s peg to the euro

Euro against Norwegian and Swedish currencies
Sweden
Sweden operates a floating exchange rate
against the Euro. The Swedish currency
appreciated during the recession / euro crisis
– a factor behind the slower growth of
Sweden and the growing risk of price
deflation. Sweden has an opt out from the
single European currency.
Norway
Norway is not a member of the EU but does
have membership of the single market. The
commodity rich economy has a huge current
account surplus and high per capita income but
has been challenged by an appreciating
currency and a slowdown in GDP growth.
Appreciation v Euro

Extract 3: The EU as a Customs Union Page 8
• The European Union is a customs union. A customs union comprises
countries which agree to:
1. Abolish tariffs and quotas between member nations to encourage free
movement of goods and services. Goods and services that originate in
the EU circulate between Member States duty-free. However these
products might be subject to excise duty and VAT
2. Adopt a common external tariff (CET) on imports from non-members
countries. Thus, in the case of the EU, the tariff imposed on, say, imports
of Japanese TV sets will be the same in the UK as in any other EU
country
3. Preferential tariff rates apply to preferential or free trade agreements
that the EU has entered into with third countries or groupings of third
countries including many of the least developing countries
• Exam tip: Specific knowledge of the economics of a customs union is
needed for the exam. Apart from the European Union, another example
is that Kazakhstan and Belarus make up a customs union with Russia –
forming for the basis for a new Eurasian customs union system.

Extract 3 : Different Stages of Economic Integration
The table above provides a summary of economic integration
• A free trade agreement is the 1st stage of integration followed by a customs union
• The EU has deepened integration with the creation of a single European market
• As of January 2015, of the 28 member nations of the EU, 19 have entered the 4th stage of
integration – namely the single European currency.
• Progress towards full economic union including fiscal union has proved much harder to
achieve. Many countries want to retain autonomy (freedom) over their own tax systems.

Conventional Gains from Trade – Growth Enhancers
Helps to reduce
extreme poverty
Increased market
contestability
Better access to
new technologies
Knowledge
transfers
Exploiting
economies of scale
Better use of our
scarce resources

Understanding: Motivations for Protectionism
Response to import
“Dumping”
Response to chronic
trade gap / deficits
Employment
protection
Protect “fledgling” -
infant sectors
Protect key /
politically strategic
industries
Raise extra revenues
for governments with
budget deficits
Response to a
recession / stagnant
domestic demand
Protectionist tendencies have grown because of slow growth and widening trade imbalances
More countries have opted to “manage” their currencies – another form of protectionism

Arguments against Trade Barriers / Protectionism
Risk of Retaliation Market Distortion
Higher prices for
consumers
Regressive effect on
income inequality
By-passing import
controls
Higher costs for exporters
Protectionism invites a retaliatory response and countries can get locked into trade wars
The WTO has found it impossible to negotiate a wide ranging global trade agreement

Q3
Analysis: Import Tariffs
Q4Q1
Price
Domestic
Demand
OutputQ2
Domestic
Supply
World supply
pre-tariffP1
Supply after tariff
Volume of
imports
after tariff
P2
In October 2014, Kenya lost their tariff-free access to the European Union single
market for exports of cut flowers.

Customs Union: Trade Creation from Tariff Reduction
• Trade Creation effects
• Trade creation involves a shift in consumer spending from a higher cost
domestic source to a lower cost partner source for example - within the
EU - as a result of the abolition import tariffs on intra-union trade
– For example UK households may switch their spending on car and
home insurance away from a higher-priced UK supplier towards a
French insurance company operating in the UK market
– Similarly, Western European car manufacturers may be able to find
and then benefit from a cheaper source of glass or rubber for tyres
from other countries within the customs union than if they were
reliant on domestic supply sources with trade restrictions in place.
• Trade creation should stimulate an increase in trade between countries
that have signed trade agreements and should, in theory, lead to an
improvement in the allocative efficiency and gains in consumer and
producer welfare e.g. through lower prices and higher profits.

Analysis: Trade Creation and Welfare Gains
Price
Output (Q)
Domestic Demand
Domestic Supply
Supply price from EU Supply
Qd2Qs2
Supply price from outside the EU
Qd1Qs1
Trade creation – access to
cheaper supplies allows a
lower price – which benefits
consumers
P1
Lower price leads to an
expansion of demand and a
rise in consumer surplus + a
net improvement in
economic welfare
P2

Customs Union: Trade Diversion from External Tariff
• Trade Diversion effects
• Trade diversion is a shift in domestic consumer spending from a
lower cost world source to a higher cost partner source (e.g. from
another country within the EU) as a result of the elimination of
tariffs on imports from the partner
• The common external tariff on many goods and services coming
into the EU makes imports more expensive.
• This can lead to higher costs for producers and (eventually) higher
prices for consumers if previously they had access to a lower cost /
lower price supply from a non-EU country
• Trade diversion which leads to higher prices can have a regressive
effect on lower-income households.

Analysis: Import Quotas
Price
Import
Demand for a
product
OutputQ1
Export Supply
of a product
(no quota)
P1
Import
Quota
Quota
P2
Example of EU import quotas: The EU agreed a quota for imports of maize from all origins
into the customs union bloc in 2006. Special arrangements have been made to allow duty
free access for maize from Ukraine.

Analysis: Examples of Non-Tariff Barriers
1. Voluntary Export Restraint – where two countries make an
agreement to limit their exports to one another each year
2. Intellectual property laws e.g. patents and copyright protection
3. Technical barriers to trade including labeling rules and stringent
sanitary standards. These increase product compliance costs
4. Preferential state procurement policies – where government favour
local producers when finalizing contracts for state spending e.g.
infrastructure projects or purchasing new defence equipment
5. Domestic subsidies – government help (state aid) for domestic
businesses facing financial problems e.g. subsidies for car
manufacturers or loss-making airlines.
6. Financial protectionism – e.g. when a government instructs banks to
give priority when making loans to domestic businesses
7. Murky or hidden protectionism - e.g. state measures that indirectly
discriminate against foreign workers, investors and traders.

1. Describe two roles of the World Trade Organisation
2. Distinguish between trade creation and trade diversion for countries
inside a customs union
3. Distinguish between a customs union and a single market
4. With the aid of a diagram, analyse the effects of a reduction in import
tariffs for a developing country
5. Comment on the impact of the UK government cutting the main rate of
corporation tax from 28% in 2010 to to 20% from 2015
6. Comment on the argument that new member states of the EU are likely
to benefit from membership of the European single currency
7. To what extent does restricting the free flow of labour from new EU
states result in a worsening of economic performance?
8. Evaluate the case for the European customs union agreeing a new trade
deal with the United States
9. Discuss the impact of the enlargement of the EU to 28 countries for an
economy such as the UK
10. Discuss the policies likely to be most effective in reducing
unemployment rates within the EU

Extract 4: Trends in / Pattern of Global Trade

1. Distinguish between absolute and
comparative advantage
2. Analyse the effects of international
trade
3. Outline the pattern of global trade
4. Understand changes in the pattern
of trade within regions and
between countries
5. Evaluate comparative advantage as
an explanation of global trade
patterns

• How does the economic performance of EU countries and
the USA affect the rate of growth of world trade?
• What factors explain the divergences in real GDP growth
rates between Africa, China, the USA and EU countries?
• How can the rise of intra-industry trade be explained?
• Why is intra-industry trade in Africa so much lower than
other regions in the world, and with what consequences?
• Comment on the ways in which the African region can
achieve a rise in intra-industry trade
• What factors explain some of the changes in revealed
comparative advantage shown in Figure 4.4?
• To what extent can the UK economy restore
competitiveness in manufacturing industries?

Extract 4: Trends in World Growth and Trade Page 9
Extract 4 starts with this selection of real GDP growth rates for countries and
regions drawing on data for just one year - 2012.

Some of the Key Drivers of Economic Growth
Economic
growth
Expanding the capital stock
Increasing the active
labour supply
Extracting and
selling natural
resources
Improving factor
productivity
Driving innovation and
enterprise
Economic growth is a
sustained rise in a country’s
productive potential and real
national output
The main drivers of long run
economic growth are higher
productivity and gains from
innovation and rising real
incomes

Analysis: Key Growth Limiters in Developing Nations
Infrastructure
Gaps
Primary Export
Dependency
Macroeconomic
Instability
Conflict and
Corruption
Human Capital
Weaknesses
Insufficient
Savings
Natural Capital
Depleted
Rising Income
Inequality
Although many developing countries have enjoyed rapid growth in
recent years, for others there are crucial growth constraints

Analysing Reasons for Fast Economic Growth in Africa
• Many African countries feature in a league table of the world’s fastest
growing countries both in recent years and in the forecast
• What factors have contributed to rapid economic growth?

Analysis: Reasons for Fast Economic Growth in Africa
• What factors have contributed to rapid economic growth?
1. Improvement in the terms of trade – higher commodity prices have boosted
export revenues for many countries
2. Improved governance – wider spread of democratic governments allied to
improved institutions e.g. more countries are able to issue bonds
3. Strongly increasing foreign direct investment – especially in agriculture, mining,
oil and gas, infrastructure, hotels/restaurants
4. Increasing intra-regional trade including manufactured goods – emergence of
key African regional trade hubs bolstered by infrastructure spending
5. Improved macroeconomic management – lower inflation, more credible
central banks, improved fiscal balances
6. Rising per capita incomes – growth of consumer markets – poverty rates
continue to fall but social progress has been uneven
7. There is some evidence that a growing number of African countries are
becoming less dependent on primary commodities and building a more
diversified manufacturing / services base for their economy.

Why are many Developed Countries growing slowly?
• Secular stagnation theory
– Some economists argue that developed countries are experiencing a
sustained period of slower trend GDP growth caused by
• Weaker productivity growth
• A dip in the pace of innovation in markets
• The effects of an ageing population / rising dependency ratio
• Global shifts in investment and production towards emerging nations
• Debilitating effects of the global financial crisis including a shrinking of
finance available for business capital investment
• Persistently high unemployment in many advanced countries
• The negative effects of fiscal austerity policies especially in the EU/UK
• Damaging effects of deflation in countries such as Japan and Greece
• Weaker growth has brought about stagnant or declining real incomes
• Growth in developed countries may have been hit the the effects of rising
inequalities of income and wealth (IMF now shares this view)

Analysing Reasons for Recession in the Euro Area
• What factors have contributed to persistent recession in the Euro Area?
• Continued fall out from the global financial crisis
– Contractions in bank lending, many banks required bailouts / nationalization
– Sharp falls in real output and investment in industries such as construction
– Large declines in business confidence and investment
– Decline in property prices – asset price deflation
• Labour market failures
– High rates of structural unemployment and economic inactivity
– Low employment rates in many EU countries especially in southern Europe
– Low levels of labour mobility compared to the United States
• High exchange rate
– The Euro (a floating currency) has remained fairly strong against the US dollar
and other currencies despite the economic crisis (perhaps overvalued?)
• Fiscal crisis and resulting fiscal austerity programmes
• Increase in relative poverty – causing steep declines in consumption
• Policy inertia on behalf of the European Central Bank
– Reluctance to move beyond low interest rates
– Programme of quantitative easing only introduced in January 2015

Extract 4: Shares of Global Trade – North and South
Developed economies are customarily referred to as North and developing/emerging
economies as South, with trade between the developed and developing/ emerging groups,
for example, denoted by the term North-South trade.
56
33
8
50
36
12
36
38
24
The 2015 pre-release
extract does not
mention that the data
in this chart excludes
natural resources to
avoid having
fluctuations in
commodity prices skew
the % shares
“In the future,
South-South trade
will be norm not
novelty.”
HSBC economics,
June 2014

Shares of Global Trade – North and South
Share of South-South trade in total world exports has doubled over the last 20 years to over 25%

Extract 4: Explaining the Rise of South-South Trade
• Rising number of preferential trade agreements (PTAs)
– From 1990 to 2009, more than 500 preferential trading agreements
were formed by countries of all stripes
– These deals lead to lower tariffs and relaxations of quotas
– Many developing countries have agreed trade deals between each
other – leading to lower tariffs and other import barriers
• Developing countries are building extra manufacturing capacity and
complexity – allowing them to export products historically produced in
the North to other fast-growing emerging countries
– E.g. China has successfully diversified exports beyond the US and
Europe into Latin America, the Middle East and Africa.
• Investment in large-scale transport infrastructure is helping
• Trade deals are often linked to foreign direct investment. There has
been a large rise in FDI flows between developing countries e.g.
Chinese, Indian and Brazilian foreign direct investment into Africa

Examples of Regional Trade Agreements
• The number of RTAs has risen from around 70 in 1990 to over 300 now
• The World Trade Organisation (WTO) permits the existence of trade blocs,
provided that they result in lower protection against outside countries than
existed before the creation of the trade bloc
• EU– a customs union, a single market and now with a single currency
• European Free Trade Area (EFTA)
• North American Free Trade Agreement (NAFTA) (1994)
• Mercosur – Brazil, Argentina, Uruguay, Paraguay and Venezuela
• Association of Southeast Asian Nations (ASEAN) Free Trade Area (AFTA)
• Common Market of Eastern and Southern Africa (COMESA)
• Pacific Alliance – 2013 – a regional trade agreement between Chile,
Colombia, Mexico and Peru
• Trans-Pacific Partnership (TPP) - a proposed free trade agreement currently
being negotiated between Australia, Brunei, Chile, Canada, Malaysia, Mexico,
New Zealand, Peru, Singapore, the United States, and Vietnam

Analysis: Why is Trade important for Development?
• Successful international trade provides:
1. A source of foreign exchange to help a nation’s balance of payments
2. A way of financing imports of essential capital equipment /
technology and components
3. An injection of demand into the circular flow of income and
spending
4. Increased employment in export industries and multiplier effects in
other businesses and sectors helping to service export suppliers
• But trade also has risks
– Volatile global prices affecting export revenues and profits
– Risks that exports will be affected by geo-political uncertainty and
cyclical shifts in demand
– Opening up an economy to trade and investment may cause rising
structural unemployment in some industries as the pattern of
demand changes over time

A New Southern Silk Road? Focus on Africa
• Many economists believe we are seeing a new southern Silk Road, this is an
expanding network of new “South-South” trading routes connecting Asia, the
Middle East, Africa and Latin America. An example is the changing pattern of
African trade in goods and services. Consider the chart below:
0
200
400
600
800
1,000
2005 2012
USD 940bn
360 (38%)
China
USA
Intra-African
IND+BRA+KOR+TUR+RUS
80 (18%)
51 (11%)
Africa’s trade with main partners, 2005 and 2012
in billion USD (in share of total)
200 (21%)
EU 27
148 (16%)
132 (14%)
100 (11%)
231 (51%)
41 (9%)
49 (11%)
USD 450bn

Extract 4: Growth of Intra-Industry Trade
• The World Trade Report of 2013
also provided useful insights into
the pattern of global trade and
changes in comparative
advantage for selected economies
and industries.
• The extent of intra-industry trade
is measured using an index. The
closer this index is to 100, the
more significant intra-industry
trade is for a country. The closer
this index is to 0, the more a
country imports and exports goods
and services are produced by
different industries.
• What is intra-industry trade?
• Intra-industry trade means
trade within industries
• A measure of the intra-industry
trade that takes place between
countries is the Grubel-Lloyd
(GL) index.
• E.g. If a country only exports or
imports good X (e.g. sugar)
then the GL index for that
sector is equal to 0. On the
other hand, if a country
imports exactly as much of
good X as it exports, then its GL
score for sector would be 1.

Growth of Intra-Regional Trade
United States,
Canada and
Mexico (NAFTA)
Including many of
world’s biggest oil
and gas exporters
Note the small
share of Africa in
global trade
Inter

Figure 4.2: Growth of Intra-Regional Trade
% rise in total
value of trade
2000-11 = 86%
% rise in total
value of trade
2000-11 = 180%
% rise in total
value of trade
2000-11 = 385%
% rise in total
value of trade
2000-11 = 234%
% rise in total
value of trade
2000-11 = 299%
% rise in total
value of trade
2000-11 = 279% Inter

Africa’s intra-regional trade – a sleeping giant?
• Africa’s intra-regional trade share doubled
from 6% to 12% between 1990 and 2011
• But this remains very small compared to
more advanced regions
• Why is this?
1. Many African countries are highly
specialized in and dependent on extracting
and exporting primary commodities
2. Limited infrastructure like roads, energy
and physical networks to support
international trade – increasing the costs
of getting products to market.
3. Several overlapping trade blocs in Africa
4. Few significant import hub countries
5. Smaller size of consumer markets in Africa
– therefore less business profit incentive
6. Weaker governance, fraud, many non-
tariff barriers to trade such as cross border
restrictions that delay trade flows
Over 80% of Africa’s exports are shipped
overseas, mainly to the European Union
(EU), China and the US (Source: UN Report)
Accuracy of figures: Much trade across
borders in Africa may not be measured
e.g. a high level of informal trade
Inter

Figure 4.2: Rise of Intra-Asia Regional Trade
• One of the key features of Figure 4.2 is
• (a) The huge rise in the total value of Asian trade
• (b) The surge in intra-regional trade within many
Asian countries
• Share has grown from 42 per cent in 1990 to 52
per cent in 2011 – i.e. now a majority of trade
• Most of this change is due to a fall in the share of
North America in total Asian trade
• Many Asian countries have achieved fast progress
towards a highly diversified industrial base.
• Increasing capacities and competencies in
producing many different goods and services has
accelerated intra-industry trade e.g. as countries
supply different components to each other
• Asia is building complex and large supply chains
and trading more within the region – this is one of
the BIG changes in the world economy

Intra-Regional Trade for North America
• The high level of intra-regional
trade for North America is largely
explained by the impact of NAFTA
(North American Free Trade
Agreement) between Canada,
Mexico and the USA.
• NAFTA came into being in 1994 and
by 2000, intra-regional trade had
expanded to 56%.
• However this declined by 2011
suggesting that NAFTA had not led
to the further deepening of regional
integration forecast by supporters
• Read: Council for Foreign Relations
report on NAFTA (2014)
The United States trades more in goods
and services with Mexico and Canada
than it does with Japan, South Korea,
Brazil, Russia, India, and China combined

Extract 4: Intra-Industry Trade for Developing Countries
• Poorer countries, even if similar in terms of income, trade much
less with each other compared with rich countries
• Countries where labour and capital productivity is low have lower
wages and produce less differentiated goods and services
• Many of these countries are heavily reliant on a small number of
products – this gives rise to primary product dependency (PPD)
• Read: The Road Less Travelled – African Intra-Regional Trade – a 2013 article
from the Economist: www.economist.com/blogs/baobab/2013/04/intra-african-
trade
• Read: Why Africa is becoming less reliant on commodities (Economist magazine,
January 2015): www.economist.com/blogs/economist-
explains/2015/01/economist-explains-
5?fsrc=scn/tw_ec/why_africa_is_becoming_less_dependent_on_commodities

Extract 4: Intra-Industry Trade – Key points
• Developed economies and rapidly industrializing developing
economies (e.g. Hong Kong, China; Singapore; Malaysia and
Thailand) tend to engage in more intra-industry trade
• Resource-rich developing economies and Less Developed
Countries tend to have relatively little intra-industry trade
• Economies such as Malaysia and Thailand have more intra-industry
trade with other developing countries in the same region
• Japan has more intra-industry trade with developing economies – it
is net importer of commodities and it is also geographically close to
several emerging “industrialized” countries such as South Korea.
There is increasingly intense competition between Japanese and
South Korean manufacturing conglomerate businesses
• A major development theme in recent years has been for countries
to build a deeper level of complexity into their economy.

Index of Intra-Industry Trade for selected Countries
Country 1996 2011
World Developed Developing World Developed Developing
Hong Kong 70 29 65 66 30 61
Singapore 65 31 60 65 38 59
USA 61 65 47 62 68 51
EU (27) n/a n/a n/a 60 63 51
Zambia 18 8 18 17 4 18
Central
African
Republic
8 4 6 2 3 4

What might help to explain rising Intra-Industry Trade?
Demand-side explanations Supply-side explanations
Strong consumer preferences for variety
and choice from different countries
Advantages of economies of scale and
rising intra-firm trade within multi-
national businesses
Lower tariffs reduce prices of imported
goods and services thereby boosting
consumer demand
Falling transportation costs especially for
“smaller” high value manufactured
goods (effects of containerization)
Increasing openness of countries to
products from many different nations
Foreign direct investment and improving
human capital allows more countries to
produce similar intermediate and final
products (they have more “know-how”)

2014-15 Global Competitiveness Index (Hong Kong)
Indicator
HK ranking out of
144 countries
Overall
competitiveness
7/144
Institutions 8/144
Infrastructure 1/144
Macroeconomic
environment
14/144
Labour market
efficiency
3/144
Technological
readiness
5/144
Highlighted problems for = business
• Insufficient capacity to innovate
• Inefficient government bureaucracy

Central African Republic (CAR)
Source:
http://atlas.media.mit.edu/explore/tree_map/hs/export/caf/all/sh
ow/2012/
CAR Economic Background
1. Central African Republic is part of a
region of Africa that relies heavily
on output of primary commodities
and extractive industries – making
higher-paid job creation and
inclusive growth a major challenge
2. CAR has one of the lowest intra-
industry trade ratios in the world
according to the WTO research

Zambia – Low Intra-Industry Trade Ratio
Source:
http://atlas.media.mit.edu/explore/tree_map/hs/export/zmb/al
l/show/2012/
Zambian Economy Background
1. Low intra-industry trade largely
due to a lack of economic
diversification. Copper accounts
for 80% of Zambia’s exports and
mining is key to the economy
2. Agriculture accounts for 20% of
GDP, and 70% of employment) –
the economy is highly vulnerable
to external shocks.
3. Low human development. With a
GDP per capita of around USD
1,600, income levels are low and
uneven (Gini coefficient: 52% vs. a
SSA average of 45%).
4. Zambia scores low in terms of
health and education. Physical and
social infrastructure is weak, due
to many decades of under-
investment and human capital
deficiencies.
Pattern of Zambian Exports of Goods in 2012

2014-15 Global Competitiveness Index (Zambia)
Indicator
Zambia rank out
of 144 countries
Overall
competitiveness
96/144
Institutions 52/144
Infrastructure 118/144
Macroeconomic
environment
103/144
Labour market
efficiency
88/144
Technological
readiness
105/144
Highlighted problems for = business
• Access to financing
• Corruption

Extract 4: Changing Comparative Advantage
Comparative advantage is the ability of one country to produce a
particular good or service at a relatively lower cost over another

Long term Shifts in Comparative Advantage in Figure 4.5
• Figure 4.5 highlights long-term changes in
comparative advantage over a twenty year period
• Countries such as Chile, China, Poland and Mexico
highlighted as gaining advantage in manufacturing
industries
• Countries such as Australia, Brazil and the UK
viewed as losing comparative advantage in these
manufacturing sectors
• No data is provided to support the table in the
extract!

Analysis: Improving Long-Run Competitiveness
1. Domestic and foreign investment creating extra manufacturing capacity –
this leads to a supply surplus output available to export
2. Gains in relative labour productivity / efficiency helping to keep relative
unit labour costs low against that of competing nations
3. Effective macroeconomic policies to keep inflation low
4. Improvements in human capital geared to manufacturing industries and
increasingly to services e.g. health tourism and education
5. Exploitation of internal and external economies of scale
6. Advantages from having a competitive exchange rate over a number of
years – this keeps overseas exports prices relatively low
7. Successful adaptation and exploitation of new technologies
8. Competitive gains from supply-side structural economic reforms
9. Successful integration into regional trade agreements / single markets
building customer bases and using joint ventures between businesses
10. Countries successfully moving beyond an early dependence on a small
range of industries

Extract 4: Revealed Comparative Advantage
Comparative advantage is the ability of one country to produce a
particular good or service at a relatively lower cost over another
• Comparative advantage is a theoretical idea widely used in the
economics of international trade
• Revealed comparative advantage looks at actual trade data and
measures (for example) the ratio of a country’s exports of X in the
world market for X
• Nations building a growing comparative advantage in an industry
will tend to achieve a rising share of global exports
• For example, China, Mexico and Turkey have all gained
comparative advantage in manufacturing production and exports
• The table of countries in Figure 4.5 on page 11 of the pre-release
case study used revealed comparative advantage for the examples

Changing Comparative Advantage (Full WTO Table)

1. Distinguish between the pattern of trade and the balance of trade
2. Distinguish between comparative advantage and absolute advantage
3. Analyse two causes of a slowdown in world trade
4. With the the help of a diagram, analyse two causes of economic growth in Africa
5. Comment on the argument that an increase in intra-industry trade benefits both
producers and consumers
6. Comment on the policies a country might use to improve their competitiveness
7. Comment on the importance of trade for lower-income developing countries
8. To what extent does a depreciation of the exchange rate improve competitiveness?
9. Comment on the reasons why Australia is found to have lost competitiveness in the
products shown in Figure 4.5
10. Comment on the reasons for 71% of EU trade being within the EU
11. Discuss the policies that cause a rise in intra-regional trade for countries such as
Zambia and Central African Republic
12. To what extent does primary product dependency limit growth and development in
many African countries?
13. To what extent are the most integrated countries also the most competitive?

Extract 5: Characteristics & Impact of Globalisation

• Key characteristics of globalisation?
• What are the main factors driving globalisation?
• What factors affect competitiveness in the global economy?
• To what extent is globalisation currently under threat?
• Is the Human Development Index an appropriate measure of
measuring gains in development outcomes?
• Does globalisation benefit consumers in both developed and
developing countries in the long run?
• Why has globalisation created large economic imbalances?
• To what extent is rising inequality of income and wealth
damaging for economic growth and development?
• Which policies and strategies might be effective in addressing
the issues surrounding globalisation and widening income and
wealth inequality?

Extract 5: Characteristics of Globalisation Page 12
• Globalisation is a process through which national economies have
become increasingly integrated and inter-dependent.
• It has a number of characteristics, including:
1. Greater trade in goods and services between the world’s economies
2. Greater transfer of financial capital between the world’s economies and
greater FDI
3. Greater transfer of technology and information between the world’s
economies
4. Greater specialization in production, including outsourcing and
offshoring
5. Greater labour migration, both within and between the world’s
economies
6. Development of global brands
7. Inclusion of more economies in the global trading system, including
Central and Eastern European economies, China and other so-called
emerging economies.

Extract 5: Characteristics of Globalisation Page 12
Aspect of globalisation Links for further exploration
Transfer of financial capital and great FDI FDI – which countries get the most?
Transfers of technology and information Guardian article on technology transfer
Outsourcing and offshoring
Is the out-sourcing of jobs in cheaper
overseas countries now reversing?
Labour migration within and between
the world’s economies
Interview with economist Ken Rogoff –
Where will all of the workers go?
Development of global brands Top global brands in 2014

Distinction between Outsourcing and Offshoring
Outsourcing Offshoring
“Someone else does the work for us” “The work is done overseas”
A UK firm outsources IT and
consumer payments businesses to
other firms in the UK
A UK business sets up a call centre in
Bangalore, India
A car manufacturer contracts to have
component parts made overseas that
are then imported into the UK
A car manufacturer contracts to have
component parts made overseas that
are then imported into the UK

Advantages and Disadvantages of Offshoring
• Advantages:
• Access to lower unit
costs (productive
efficiency)
• Access to more
specialized suppliers and
services
• Economies of scale from
operating in larger
international markets
• Disadvantages / risks
• Hidden costs associated
with off-shoring
• Risks over uncertain
customer service,
component quality
• Protection of intellectual
property may be weaker
overseas
In November 2013, the Financial Times reported that “one in six UK manufacturers has
brought production back from overseas during the past year or is in the process of doing
so.” They cited increasing wage and shipping costs in countries such as China plus a desire
to bring manufacturing closer to consumer markets.

Reminder of the Importance of Competitiveness
Competitiveness
Innovation
Skills &
expertise
Quality
Efficiency
Energy
costs
“To ensure its survival in this country and in the global economy, UK manufacturing industry
has become flexible and leaner, focusing on the delivery of quality products”
Source: Engineering Employers’ Federation report (2014)

Economic & Social Advantages from Globalisation
1. Trade enhances division of labour as businesses and countries
specialize in areas of comparative / competitive advantage
2. Trade between markets across borders encourages producers and
consumers to reap the benefits of economies of scale
3. Competitive markets reduce monopoly profits and incentivize
businesses to seek cost-reducing innovations and improvements
4. Gains in efficiency should bring about an improvement in
economic growth and higher per capita incomes
5. Globalisation has helped many of the world’s poorest countries to
achieve higher rates of economic growth and reduce the number
of people living in extreme poverty
6. Increased awareness among consumers of economic, social and
political issues and challenges e.g. climate change and inequality

Risks / Disadvantages from Globalisation
1. More inequality / relative poverty leading to political and social
tensions and instability as a backlash.
2. Threats to the Global Commons e.g. threats of irreversible damage to
ecosystems, land degradation, deforestation, loss of bio-diversity and
the fears of a permanent shortage of water
3. Macroeconomic fragility – in an inter-connected world economy,
external shocks in region can rapidly spread to other centres – this can
lead to highly volatile capital movements and swings in trade flows
4. Trade Imbalances: Increasing trade imbalances lead to protectionist
tensions and a move towards managed exchange rates
5. Higher structural unemployment in countries where production has
shifted to lower cost centres
6. Standardization: Critics of globalisation point to less cultural diversity as
giant firms and global brands dominate domestic markets
7. Dominant Global Brands – businesses with dominant brands and
superior technologies may squeeze out local producers

Fig. 5.1 – IMF overview of globalisation
• There is substantial evidence, from countries of different sizes and
different regions, that as countries ‘globalize’ their citizens
experience benefits.
• The percentage of the developing world living in extreme poverty –
defined as living on less than US$1 per day – has been cut in half.
The IMF’s latest reports and briefings on
globalisation can be found here:
www.imf.org/external/np/exr/key/global.htm

Limited Progress in Extreme Poverty Reduction
The percentage of people living in extreme poverty has fallen across all regions but
progress in Sub-Saharan Africa has (until recently) been slower. The figure for the region as
a whole remains above 40% although many countries have achieved stronger gains
MENA: Middle East and North Africa

Causes of Extreme Poverty in Lower Income Countries
Absolute or
extreme poverty
is an inability to
meet basic
needs
In many
countries,
significant
progress has
been made in
reducing
absolute poverty
but each year the
Human
Development
Report makes
clear how much
progress remains
to be made
Population growing faster than GDP in low income countries
Savings gaps - families unable to save, live on less than $2 per day
Absence of basic government / public services
Effects of corruption and fraud at local, regional and national level
High levels of household debt and high interest rates
Damaging effects of civil wars and natural disasters
Low employment / participation rates, vulnerable jobs and poverty
wages. Low rates of female economic activity
Absence of basic property rights

Fig. 5.1 – IMF overview of globalisation
• Regional disparities persist: while poverty fell in East and South
Asia, it rose in sub-Saharan Africa. The United Nations Human
Development Report notes there are still around 1 billion people
surviving on less than US$1 per day and 2.6 billion living on less
than US$2 per day.
Access the 2014 edition of the Human Development Report:
http://hdr.undp.org/en/content/human-development-report-2014
Poverty headcount ratio at $2 a day (PPP) (% of population)

The Human Development Index (HDI)
• HDI focuses on longevity, basic education and minimal income
1. Knowledge: First an educational component made up of two
statistics – mean years of schooling and expected years of
schooling
2. Long and healthy life: Second a life expectancy component is
calculated using a minimum value for life expectancy of 25
years and maximum value of 85 years
3. A decent standard of living: The final element is gross
national income (GNI) per capita adjusted to purchasing
power parity standard (PPP)
• GNI (Gross National Income is now used because of growing size
of remittances sent across countries
• Log of income is used in the HDI calculation because income is
instrumental to human development but higher incomes are
assumed to have a declining extra contribution to human
development

Limitations of the Human Development Index (HDI)
1. HDI fails to take account of qualitative factors, such as cultural
identity and political freedoms (human security, gender
opportunities and human rights for example)
2. The GNI per capita figure – and consequently the HDI figure –
takes no account of income distribution. If income is unevenly
distributed, then GNI per capita will be an inaccurate measure of
the monetary well-being of the people. Inequitable development
is not human development
3. Purchasing power parity (PPP) values used to adjust GNI data
change quickly and can be inaccurate or misleading
4. 2010 saw launch of a new Inequality-adjusted HDI, a Gender
Inequality Index and a Multidimensional Poverty Index. The
average loss in the HDI due to inequality is about 23%

Inequality Adjusted Human Development Index (HDI)
Source: UNDP Human Development
Report, 2014
Inequality-adjusted HDI
The average loss in the HDI due to
inequality is about 23 percent—
that is, adjusted for inequality, the
global HDI of 0.682 in 2011 would
fall to 0.525

Extract 5: Views of Professor Joseph Stiglitz
• “The current process of globalization is generating unbalanced
outcomes, both between and within countries.”
• “Wealth is being created, but too many countries and people are
not sharing in its benefits.”
Imbalances between countries Imbalances within countries
Trade imbalances i.e. current
account surpluses and deficits
Rising income and wealth
inequalities
Unbalanced flows of foreign direct
investment between countries
Structural differences in
unemployment rates
Imbalances in access to global
markets, ideas, health & education
Imbalances between rural and
urban areas / different regions

Extract 5: Views of Professor Joseph Stiglitz
• World Commission on the Social Dimensions of Globalisation
found that 59% of the world’s people were living in countries with
growing inequality, with only 5% in countries with declining
inequality.
Measures of inequality
The Gini-Coefficient
The Gini coefficient condenses the entire income
distribution for a country into a single number
between 0 and 1: the higher the number, the
greater the degree of income inequality
Income ratios
The ratio of the income of the richest groups of
the population to the poorest
Note that this report was published in 2004 – and much has changed in the decade since

Analysis: Some of the Key Causes of Rising Inequality
Tax system in UK is
less progressive
than 20 years ago
High company
profits and surging
executive pay
Regressive effects
of high inflation
(especially food)
Widening urban-
rural income divide
Market failures in
education &
housing
Rising real incomes
for most skilled
workers
Root Causes Of

Key Economic and Social Costs of Rising Inequality
Social unrest and civil disobedience
• Strikes and demonstrations over poor pay and conditions
at Fox con in China which produces IPhones and IPads
Self-perpetuating poverty cycle
• Limited access to health care and education
• Volatile incomes, high debts
• Low savings
Misallocation of scarce resources
Capital investment skewed towards preferences of the rich
Low collateral – limits entrepreneurship
Capital flight by the rich

Some Strategies to Promote Inclusive Development
Human Capital Investment
• Improving school enrolment rates
• Improving the quality of teaching
Inclusive Pro-Poor Growth Policies
• Raising incomes for people
• Conditional cash transfers as welfare
• Productivity improvements in rural industries
Micro-Finance
• Small scale loans, gender empowerment
• Micro-insurance to help poorest farmers

Options for Government Spending to Reduce Inequality
Welfare state transfers
• Universal child benefits / unemployment assistance
• Public (state) pensions
• Conditional welfare transfers
• Targeted welfare payments rather than universal subsidies
State-provided services (in-kind benefits)
• Education - reduces inequality of market incomes
• Health care - overcoming market failures in health care
• Social housing
• Wage subsidies
• Employment training

1. Describe two features of globalisation
2. Describe two aspects of the measurement of the Human Development
Index
3. Describe two features of the informal economy in many countries
4. Distinguish between financial capital and foreign direct investment
5. Distinguish between off-shoring and out-sourcing
6. Comment on the argument that there has been too little globalisation
rather than too much
7. Comment on the policies that might reduce extreme poverty for
developing countries
8. Comment on the argument that the rise of global brands is damaging
for consumers in developing countries
9. To what extent does globalisation benefit the rich at the expense of the
poor?
10. Discuss the impact of rising income and wealth inequality on economic
growth in developed and developing countries
11. To what extent has globalisation benefitted the UK economy?

Brief Hints on OCR F585 Exam Technique

Advice on Exam Technique
1. The F585 exam paper last two hours and that there
are sixty marks available.
2. You have approximately 2 minutes per mark
3. You may be eligible to receive extra time in the exam
4. Read each question carefully and do not start
answering until you are clear what the question
requires! This will help you target a response
5. Make clear reference to the case study extracts and
figures in your answers especially when given a steer
to do so in the question!
6. Keep in mind that the higher marks are reserved for
analysis and evaluation, so please do not spend too
long on the shorter questions

Advice on Exam Technique
7. All questions are compulsory
8. Good quality diagrams can make a big difference to your
answers and marks – examiners like a clear analytical
framework such as AD/AS analysis, trade analysis
9. Recent examiners’ reports are worth reading – they say in
clear terms that they are looking for students to show an
ability to recognise how theoretical frameworks and the
toolkit of concepts can be applied to the case study
context. They want students to make reasoned judgements
on the issues raised.
10. In the final evaluation questions, always try to include a
final reasoned conclusion to support the evaluation “it is
the ability to reason through a judgement, rather than
simply paraphrase what has gone before, which makes the
best conclusions standout”

Mark Allocation on the F585 Paper
• Here is the mark allocation for individual
questions on the paper (part and sub part)
– 1 / a (I) 2 marks – e.g. define what is meant by /
distinguish between
– 1 / a (ii) 2 marks – e.g. with reference to the data,
state and explain
– 1 / b 6 marks – e.g. using a diagram, analyse why
– 1 / c 10 marks – e.g. comment on the case for
– 2 / a 4 marks – e.g. explain two possible reasons for
– 2 / b 6 marks – e.g. analyse the impact of
– 2 / c 10 marks – e.g. comment on the extent to which
– 3 / 20 marks – discuss / assess the view

OCR F585 June 2015

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OCR F585 June 2015