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OCR F585 Economics - Extract 1 - Globalisation and Trade


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These are the slides from my revision presentation on Extract 1 for the OCR F585 A2 Global Economy

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OCR F585 Economics - Extract 1 - Globalisation and Trade

  1. 1. Extract 1 Economics of Globalisation and World Trade Remember to refer clearly to the pre-release data in your final exam answers!
  2. 2. OCR F585 Economics – For June 2016 Pre-Release A2 Economics Case Study Toolkit from Tutor2u
  3. 3. Extract 1: Key Term Glossary Key term Brief definition Globalisation A process of deeper economic integration and interdependence between countries Capital markets Markets for bonds (debt) and equities (shares) Foreign direct investment (FDI) Inflows of capital from overseas including takeovers Specialisation Specializing factor inputs in a certain task Division of labour Breaking down production into smaller individual tasks Comparative advantage Comparative advantage refers to the relative cost advantage that one country has over another Economic efficiency Making optimum use of scarce factor inputs Import tariffs Ad valorem taxes on the value of imported products Absolute advantage The ability to produce a product (good or service) at a lower absolute unit cost
  4. 4. Globalisation is a process in which national economies have become increasingly integrated and inter-dependent
  5. 5. The OECD defines globalization as “The geographic dispersion of industrial and service activities, for example research and development, sourcing of inputs, production and distribution, and the cross-border networking of companies, for example through joint ventures and the sharing of assets.”
  6. 6. Trade to GDP ratios are rising for most countries Expansion of Financial Capital Flows between countries Rising Foreign Direct Investment and Cross Border M&A Rise of global brands – including many from emerging countries Deeper specialization of labour – i.e. components from many nations Global supply chains & new trade and investment routes Selection of Important Aspects of Globalisation
  7. 7. Extract 1: Text and Commentary • The closer links between the world’s economies are seen in a number of indicators. • These include: 1. The value of trade in goods and services as a percentage of world GDP is increasing 2. Foreign Direct Investment (FDI) as a percentage of world GDP has increased six-fold since 1980 3. The number of migrant workers has trebled since the 1960s. • Merchandise trade as a share of GDP is the sum of exports and imports divided by the value of GDP, all expressed in current US$. • This trade-to-global GDP ratio has risen in the long term but has actually been stable or declining gently in recent years. (Source IMF) • World trade-to-GDP ratio since 2006 • 2006: 47% • 2008: 53% • 2009: 43% • 2011: 51% • 2014: 48% • The growth of world trade is currently slowing down casting doubt on the points made in this extract – has the current phase of Globalisation stalled? Sharp drop in world trade in recession year
  8. 8. Extract 1: Text and Commentary • It is argued that globalisation brings significant benefits both to individual economies and to the global economy as a whole. • It opens up markets throughout the world, promoting specialisation and division of labour as economies focus production according to their comparative advantage. Comparative advantage • First introduced by David Ricardo in 1817, comparative advantage exists when a country has a ‘margin of superiority’ in the supply of a good or service i.e. where the marginal cost of production is lower • Countries will generally specialise in and export products which use intensively the factor inputs which they are most abundantly endowed
  9. 9. Comparative Advantage and Economic Welfare • If each country specializes, total output increases leading to better allocative efficiency and economic welfare • As a country develops more capabilities it can produce a wider range of closely-linked goods and services – it can diversify • Countries such as South Korea, Japan, Germany, the USA and UK all have a highly diversified pattern of exports • Nations at a lower stage of development (e.g. Zambia and Malawi) have fewer capabilities and export a narrower range of products
  10. 10. Vertical Specialisation and Global Value Chains • The last 20 years has seen more countries contributing to global value chains • Many nations specialize in particular stages of production (this is vertical specialization) e.g. the components, design & branding that go into making an iPad or iPhone • For many developing countries, foreign direct investment in manufacturing has led to a rise in vertical specialisation. Examples include: • “Factory Asia” in China, South Korea, Vietnam and others • Specialisation in chemicals, glass, electrical in Poland and Czech Republic – both countries are inside the EU • Light manufacturing in sub Saharan African countries such as Ethiopia and Kenya
  11. 11. New Global Value Chains – The iPad and Added Value! “An Apple iPad is "Made in China" (it says so on the box) but only around 5% of the price paid for an Apple iPad is actually paid for Chinese economic activity. About 45% goes to Apple in the US, Korea takes around 8% for components, and so forth. China has to import all those things, package them together, and then export the finished product.” (Source: WTO Report published in 2015)
  12. 12. Overview of the Wider Gains from Trade Export revenues and jobs help to reduce the scale of extreme poverty Increased market contestability reduces prices for consumers Better access to new technologies lifts productivity Inflows of knowledge across borders raises human capital Exploiting economies of scale – causing lower unit costs and prices Better use of scarce resources from trade in sustainable technologies
  13. 13. Rising Developing Country Share of Global Trade • “Developing economies have increased their participation in international trade over the last 20 years. • The share of exports to developing economies increased from 26 per cent in 1995 to 39 per cent in 2014 ” • (Source WTO, 2015)
  14. 14. Why is Trade important for Developing Countries? • Successful trade provides for developing nations: 1. A source of foreign currency to help a nation’s balance of payments (trade surplus countries build up US$ reserves) 2. An important way of financing imports of essential imports of capital equipment / technologies and energy supplies 3. An injection of demand into the circular flow of income and spending + creating positive export multiplier effects 4. Increased employment in export industries and related industries and rising per capita incomes and strong HDI scores 5. Falling prices for consumers helps to increase real incomes e.g. by opening up monopoly suppliers of energy to new competition The share of the least-developed countries (LDCs) in world exports increased from 0.5% of total trade in 1995 to 1.1% in 2014 (Source: WTO)
  15. 15. Risks of Trade & Investment for Developing Countries • Overseas trade and investment also carries risks 1. Volatile global prices affecting export revenues and profits and tax revenues for governments 2. There are risks that exports will be affected by geo- political uncertainties and cyclical shifts in demand 3. Capital flows into developing nations are highly volatile 4. Opening up to trade and investment may actually cause rising structural unemployment in some industries as the pattern of demand, output and jobs changes – poorer countries may opt for rapid industrialisation aided by import protectionism before they open up 5. Countries that specialise in only a few natural resources may suffer from the “natural resource trap”
  16. 16. Summary of Main Gains from Globalisation 1. Encourages producers and consumers to reap benefits from deeper division of labour and economies of scale 2. Competitive markets reduce the scale of monopoly profits and incentivize businesses to seek cost-reducing innovations 3. Enhanced growth has led to higher per capita incomes – and helped many of poorest countries to achieve higher growth and reduce extreme poverty 4. Advantages from the freer movement of labour between countries 5. Dynamic efficiency gains from the sharing of ideas / skills / technologies across national borders 6. Opening up of capital markets increases the opportunities for developing countries to borrow money to help overcome a domestic savings gap 7. Increased awareness among people around the world of the substantial challenges from climate change and wealth/income inequality 8. Competitive pressures of globalisation may prompt improved governance and better labour protection through improved business standards
  17. 17. Summary of 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
  18. 18. Examples of Regional Trade Agreements • The number of RTAs has risen from 70 in 1990 to over 300 now • The World Trade Organisation 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 • 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) free trade area that includes Zambia, Rwanda, Swaziland, Ethiopia and Kenya • Pacific Alliance – 2013 – a regional trade agreement between Chile, Colombia, Mexico and Peru • Trans-Pacific Partnership (TPP) 2015 – this is a major new free trade agreement negotiated between Australia, Brunei, Chile, Canada, Malaysia, Mexico, New Zealand, Peru, Singapore, the United States, and Vietnam
  19. 19. Extract 1: Text and Commentary • Economies can access larger markets than would be the case without globalisation. • They can access more capital goods and more advanced technology, as well as larger markets for their exports. • At the same time they can benefit from cheaper imports. • Economic theory provides strong support for the process of globalisation in terms of the benefits of increased economic efficiency. • Larger markets: • For most developing / emerging countries this means accessing markets of countries with a higher GNI per capita and larger GDP (i.e. a bigger market size) • The United States and China are now officially the two biggest countries in the world • For advanced countries, growing consumer markets in emerging countries offer rich potential for trade in goods and services and investment
  20. 20. Economic Efficiency in Markets For the exam make sure you are confident on each type of economic efficiency. Then become confident in handling economic efficiency concepts and apply them to the effects of trade, investment and the effects of successful supply-side policies
  21. 21. What is Economic Efficiency? • Economic efficiency is achieved when optimum use is made of scarce productive resources • Allocative efficiency: • Occurs when Price = Marginal Cost (or when the sum of consumer and producer surplus is maximized) • Allocative inefficiency: when P>MC; i.e. a deadweight loss exists • Productive efficiency: • When MC=ATC, when ATC is at its minimum; when producing at the minimum efficient scale • Dynamic efficiency: • This occurs when a firm constantly updates its product offering/range to reflect changing consumer preferences and wants • X-inefficiency: • This is the inefficiency that arises from complacency / lack of motivation/morale existing from a lack of competition in an industry
  22. 22. Extract 1: Falling Tariffs – Average Tariffs in 2011-15 • Extract: “One of the many factors promoting globalisation has been a reduction of trade barriers, including import tariffs.” Source: WTO, 2015
  23. 23. Extract 1: Trade to GDP Ratios for 4 Countries Malawi – a low income economy Zambia – a lower-middle income economy Brazil – an upper-middle income economy Australia – a high income economy. Malawi Zambia Australia Brazil
  24. 24. Extract 1: Trade to GDP Ratios for 4 Countries Malawi has seen a sharp rise in the ratio of trade to GDP (from 69% to 111%) whereas the trade-ratio for Zambia has actually declined from 66% to 63%. Malawi Zambia
  25. 25. Extract 1: Trade to GDP Ratios for 4 Countries Australian trade/GDP rose in 2009 whereas it fell for the other 3 countries. Australia avoided recession partly because of continued economic growth in China Australia
  26. 26. Trade to GDP Ratios for 4 Countries – The Long View This chart provides long-run data on trade as % of GDP for the four selected countries. Zambia’s trade to GDP ratio has declined since 1960 whereas it has risen for the other 3 countries. Malawi stands out in terms of the steep rise in the trade-to-GDP ratio to over 100% in 2011.
  27. 27. Explaining Trade to GDP Ratios in Excess of 100% • The ratio of trade in goods and services to a nation’s GDP can be above 100% How can this happen? • Many much smaller countries specialise in a few profitable industries in which they have a clear comparative advantage. • These industries may produce more money from exports than the entire domestic economy! • Export revenues then allows them to purchase imports in excess of what their domestic economy could otherwise support. • This leads to a high trade-to-GDP ratio perhaps in excess of 100% • A country might also import intermediate products (e.g. essential components) and then simply assemble for re-export. Again this causes the value of trade to exceed measured GDP 1. Export-driven or import-dependent countries nearly always have a high trade to GDP ratio. 2. Larger countries with more sophisticated production capabilities such as the United States tend to have lower trade ratios 3. Small poor countries highly reliant on world trade have a high trade-to- GDP ratio – it does not mean that these countries must remain poor
  28. 28. Focus on Malawi • Malawi is landlocked (Zambia is one border) • It is one of the poorest countries in the world • National Income • GDP per capita, PPP (constant 2011 international $): $756 • GNI per capita, PPP (constant 2011 international $): $726 • Exports and Imports • Exports of goods and services (% of GDP): 47.6% • Imports of goods and services (% of GDP): 60.5% Malawi’s currency is the Kwacha and has been the official currency since 1970
  29. 29. Malawi – Trade in a Global Context • Malawi is a tiny economy in a global context • It is the 147th largest export economy in the world and it’s exports are 0.01% of the world total • It is the 96th most complex economy according to the Economic Complexity Index (ECI) • GDP (million current US$, 2013) 3 705 • Merchandise exports (million US$) 1 208 • Merchandise imports (million US$) 2 845 • Total value of merchandise trade 4 053 • Merchandise trade as a % of GDP 109%
  30. 30. Malawi – Low Complexity / High Primary Dependence Over 90% of Malawi’s exports of goods are agriculture or mining/extractive products. Only 8% of their exports are manufactured goods
  31. 31. Malawi – Pattern of Imports of Goods Malawi is dependent on final manufactured products and components for imports. The biggest single import is fertilizer. South Africa is the key source of imports.
  32. 32. Explaining the Rise in Malawi Trade to GDP • Malawi’s economy is very narrowly based. • Agriculture represents approximately 37% of her GDP. The rising value of their food exports has contributed to an increase in their trade to GDP ratio • So too has a surge in spending on imports due to a weakening exchange rate (the demand for imports is price inelastic so a weaker currency means that more money must be spent on buying these imported products) • Wholesale and retail trade, including hotel industry and restaurants is the second largest contributor to GDP at 24% • The growth of tourism into Malawi is another factor behind the steep climb in the trade-to-GDP ratio – this could be good news for future growth and development prospects • Malawi has also joined a number of regional trade agreements – leading to some trade creation effects
  33. 33. 2015 Global Competitiveness Index for Malawi Indicator Malawi ranking out of 140 countries Overall competitiveness 135/140 Institutions 92/140 Infrastructure 135/140 Macroeconomic environment 140/140 Labour market efficiency 29/140 Technological readiness 133/140 Highlighted problems for business • Access to financing • Endemic corruption • Crime and theft
  34. 34. Extract 1: Text and Commentary • In 2007–08, financial and economic crises in high income developed economies reduced the growth in world trade as their effects spread to the global economy. • There was a fear that the sharp increase in unemployment, particularly in developed economies, would lead to protectionist measures. • However, fears of global trade wars quickly subsided and the growth in world trade recovered in 2010. • Why did the crisis lead to a slowdown in world trade? 1. The credit crunch led to a steep fall in the availability of trade credit and trade insurance 2. Falling real incomes and rising unemployment caused consumption to drop – leading to weaker demand for imports 3. Fiscal austerity measures also weakened global aggregate demand 4. There was a rise in non- tariff trade barriers and managed exchange rates
  35. 35. WTO Report (2015) Annual Growth of World Trade Source: The biggest drop in trade over the past 20 years
  36. 36. Volume of world merchandise exports and gross domestic product, 1950-2014 (Annual percentage change) Trade Global GDP 1995-00 7.0 3.4 2000-05 4.9 2.9 2005-10 3.4 2.3 2010-14 3.3 2.5 2006 8.7 4.1 2007 6.5 3.9 2008 2.0 1.5 2009 -12.2 -2.1 2010 14.1 4.1 2011 5.5 2.8 2012 2.3 2.2 2013 2.9 2.4 2014 2.5 2.5 The Slowing Growth of World Trade since 2010 Source: WTO, 2015
  37. 37. Why is World Trade Growing Slowly at the Moment? 1. Weak economic growth in many of the world’s richest countries – indeed some economists believe that Western nations are suffering from secular stagnation 2. Impetus to global trade from the industrialization of Asia seems to be fading. As Asian industrialization has slowed so capital investment spending has declined in importance and Asian demand for goods and services has softened. 3. Slowing pace of trade liberalization. The big gains to trade from cutting tariffs may have already happened. 4. Non-tariff barriers have grown and regional trade blocs such as ASEAN have become more common in place of a new global trade agreement which seems a long way from being achieved 5. Rising prosperity itself. As people become richer they spend a higher proportion of their income on services, such as education, leisure and health – global trade in services is actually lower as a share of GDP than manufactured products
  38. 38. Q3 Analysis: Diagram showing Import Tariffs Q4Q1 Price Domestic Demand OutputQ2 Domestic Supply World supply pre-tariffP1 Supply after tariff Volume of imports after tariff P2 Import tariffs have economic welfare consequences, one of which is that the welfare of consumers who must now purchase imports at a higher price has fallen – there is a deadweight loss of consumer surplus. The effects of an import tariff on quantities depend on the price elasticity of demand and price elasticity of supply of domestic businesses who are given a cushion of increased competitiveness by the tariff.
  39. 39. 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.
  40. 40. Understanding: Motivations for Protectionism Response to export “dumping” e.g. steel Response to a chronic trade gap Employment protection Protect “fledgling” - infant sectors Protect key /politically strategic industries Raise tax revenues for the government Response to a recession / low aggregate demand
  41. 41. Arguments against Trade Barriers / Protectionism Risk of Retaliation Market Distortions Higher prices for consumers Regressive effect on income inequality By-passing import controls Higher costs for exporters
  42. 42. Extract 1 Economics of Globalisation and World Trade Remember to refer clearly to the pre-release data in your final exam answers!
  43. 43. For more revision resources Twitter: @tutor2ugeoff