Chapter 6: International trade and globalization

6.1 International specialization

Globalisation is a process of interaction and integration among the people, companies,
and governments of different nations, a process driven by international trade and
investment and aided by information technology
Specialisation is when a nation concentrates its productive efforts on producing a limited
variety of goods and services in which they’re really efficient and productive at and have
an advantage over other economies in.
Advantages of international specialisation:
• Economies of scale and efficiency: just like specialisation by individuals,
countries can specialise in what they do best, and this leads to efficiency and
economies of scale. It can therefore increase output while reducing costs. When
more countries specialise, world output increases.
• Job creation: specialisation leads to increased output and therefore it could lead
to more investment and thus jobs are created. Moreover, it requires skilled labour
and thus earnings are higher.
• Allows more international trade to take place. Therefore goods and services
produced under the most efficient conditions can be traded and all countries can
benefit from them.
• Revenue to the government: as income increases and more trade takes place,
it can increase government revenue from taxes.
• Wider markets: specialisation and trade allow firms to sell their products to
international markets, helping them build international brands and increase
market shares and profits.
Disadvantages of international specialization:
• Structural unemployment: even though national level specialisation usually
creates more jobs, there is a risk that certain types of structural unemployment
might occur. As the country moves towards specialisation, the workers in the
declining industries will be put out of work.
• Over-exploitation of resources: output maybe increased by over-exploiting
Today, international specialization and trade is causing rapid depletion of non-
renewable resources like oil and coal. Middle Eastern countries are depleting
their oil resources so quickly, they are now building new industries to sustain
them in the future.
6.2 The role of multinational companies (MNCs)
Multinational Corporations (MNCs) → Businesses which have their operations,
factories and assembly plants in more than one country are known as multinational
businesses. Examples include Starbucks, IKEA, Toyota, Adidas etc. The country they
are based in is called the home country, and the countries they operate in are called
host countries.
Advantages to home country:
→ MNCs create opportunities for marketing the products produced in the home
country throughout the world.
→ They create employment opportunities to the people of home country, both at
home and abroad.
→ It aids and encourages the economic growth and development of the home
country.
→ MNCs help to maintain favourable balance of payments of the home country in
the long run as they export their products abroad.
Advantages to host country:
→ Provides significant employment and training to the labour force in the host
country.
→ Transfers of skills and expertise, helping to develop the quality of the host labour
force.
→ MNCs add to the host country’s GDP through their spending, for example with
local suppliers and through capital investment.
→ Competition from MNCs acts as an incentive for domestic firms in the host
country to improve their competitiveness and efficiency.
→ MNCs extend consumer and business choice in the host country.
→ MNCs bring with them efficient business practices, technologies and
standards from across the world, which can influence the industries in the home
country.
→ Profitable MNCs are a source of significant tax revenues for the host economy
(for example on profits earned as well as payroll and sales-related taxes).
Disadvantages to home country:
• MNCs transfer capital from the home country to various host countries causing
unfavourable balance of payments.
Disadvantages to host country
→ Domestic businesses may not be able to compete with MNC’s efficiency, low
costs, low prices and brand image, and may be forced to close shop.
→ MNCs may not act ethically or in a socially responsible way, especially by taking
advantage of weak countries who gain a lot from the MNCs presence in their
country. For example, exploiting workers with low wages and poor working
conditions in a country where labour laws are weak.
→ MNCs may be accused of imposing their culture on the host country, perhaps at
the expense of the richness of local culture.
→ Profits earned by MNCs may be remitted back to the MNC’s home country rather
than being reinvested in the host economy.
→ MNCs may make use of transfer pricing and other tax avoidance measures
to reduce the profits on which they pay tax to the government in the host country.
Free Trade and Protection
Free trade is when there are no restrictions for trade between economies.
The advantages of free trade:
→ Increases consumer choice: consumers can now enjoy a variety of products from
around the globe.
→ Increases competition and efficiency: international trade means that there will be
more competition among firms in different countries. This would help increase
efficiency.
→ Creates new business opportunities: free trade will allow businesses to produce
and sell goods for overseas consumers and expand and grow their operations by
doing so. Profits and revenue would rise.
→ Enables firms and economies to benefit from the best workforces, resources and
technologies from around the world.
→ Increases economic inter-dependency and thus fosters cooperation and reduces
potential for international conflicts.
The disadvantages of free trade:
→ Free trade may reduce opportunities for growth in less-developed economies and
threaten jobs in developed economies. Small businesses in developing countries
may not be able to compete with larger foreign firms. Established businesses in
developed countries may lose market share as new firms keep entering the
market. The US has seen considerable unemployment in manufacturing sectors
since China joined the WTO and flooded international markets with their cheap
products.
→ Causes rapid resource depletion and climate change as more resources are used
up by firms.
→ Exploitation of workers and the environment: free trade has allowed firms to
relocate to countries with lower costs (usually lower wages), where workers and
the environment can be exploited (as health, safety and environmental laws in
such countries are likely to be relaxed).
→ Income inequality worsens: multinational firms and consumers have dominated
the international supply and demand. This means that the rich keep getting richer
(by buying and selling more products) while the poor lose out on products and
resources.
Protection involves the use of trade barriers by governments to restrict
international market access and competition. Trade barriers include:
→ Tariffs: these are indirect taxes on imported (or exported) goods that make them
more expensive, imposed in order to discourage domestic consumers from
buying them.
→ Subsidies: government allows subsidies to domestic producers so that they can
increase their output and reduce costs and in turn reduce prices, in the hope that
consumers will be encouraged to buy inexpensive domestic goods rather than
imports.
→ Quotas: this is a limit on the number of imports allowed into a country in a given
period. Restricting supply will push up their market prices and discourage
consumption of those imports.
→ Embargo: this is a complete ban on imports of a good to a country.
→ Excessive quality standards: imports may only enter a country after extensive
quality checks which will be costly and so foreign producers will be discouraged
to sell their products in the country, reducing imports.

Reasons for protection:

 → To protect infant industries: trade barriers will help protect infant/sunrise
industries (industries that are new and are hoping to grow). Lesser competition
from foreign firms will increase their chances of survival and growth.
→ To protect sunset industries: sunset industries are those that are on their
declining stage. They would still employ many people and closure of firms in
that industry will result in high unemployment. Lesser competition from foreign
firms will decrease their rate of decline.
→ To protect strategic industries: strategic industries will include transport,
energy, defence etc. and governments will want to protect these so they are not
dependent on supplies from overseas. If foreign firms supplied these, they would
restrict output and raise prices.
→ To limit over-specialization: if a country specializes in the production of a
narrow range of products and there is a global fall in demand for one of them,
then the economy is at risk. Protectionism will ensure diversification into
producing more products and reduce this risk.
→ To protect domestic firms from dumping: dumping is a kind of predatory
pricing, that occurs when imports are sold at a price either below the price
charged in the home market or below its cost of production. As a result, domestic
firms will be unable to compete and be forced to go out of business. Once this
happens, the foreign firms will raise their prices and enjoy monopolistic power.
Trade barriers will eliminate the risk of dumping.
→ To correct a trade imbalance: protectionism can reduce the imports coming into
a country and thus reduce expenditure on imports by domestic consumers. If a
country is experiencing a deficit (imports exceeding exports), then protectionism
will correct this imbalance.
→ Because other countries use trade barriers.
Consequences of protection:
→ They restrict consumer choice.
→ They restrict new revenue and employment opportunities.
→ High levels of import tariffs and quotas will increase the costs of production at
home and drive up prices, causing cost-push inflation.
→ They protect inefficient domestic firms: when trade barriers are used to
protect domestic industries, it might include inefficient industries. Protectionism
means that even very inefficient industries are protected (when they are better off
being exposed to foreign competition and being forced to become more efficient).

6.3 Foreign exchange rates

 The foreign exchange rate is the value or price of a currency expressed in terms
of another currency, the foreign exchange rate of each currency is determined by the
market demand and supply of the currency.
→ The price at which demand and supply of the
currency equals is the equilibrium market foreign
exchange rate value of a currency against another
currency. An increased supply and decreased
demand causes the exchange rate to fall, while a
decreased supply and increased demand causes
the exchange rate to rise.
Causes of foreign exchange rates fluctuations:
→ Changes in the demand for exports and imports: when a country’s import
value is greater than its export value (which is a deficit), it means that more of
their currency is being supplied (going out) than being demanded. The exchange
rate for the country’s currency will fall. If there is a surplus in the current account,
the exchange rate will rise.
→ Inflation: if the inflation in a country is higher than that of other countries it trades
with, the price of that country’s goods in the international market will be higher
compared to goods from other countries. The demand for the country’s goods will
fall and the so the currency demand will also fall, causing a fall in exchange rate.
→ Changes in interest rate: if a country’s interest rate rises, overseas residents
may be keen to save or invest money in that country. The demand for the
currency will rise, and the exchange rate will rise. If interest rates fall below that
of other countries, the currency will fall in value as overseas demand falls.
→ Speculation: foreign exchange traders and investment companies move money
around the world to take advantage of higher interest rates and variations in
exchange rates to earn a profit. As huge sums of money are involved (known as
‘hot money’), this can cause exchange rate fluctuations, at least in the short run.
If speculators lack confidence in the economy they will withdraw their
investments in that country, thereby causing a fall in the value of the currency. In
contrast, high confidence in the economy will invite investments and raise the
foreign exchange value of the currency.

Consequences of foreign exchange rate fluctuations:

 → A fall in the foreign exchange rate causes import prices to rise and export prices
to fall.
→ A rise in the foreign exchange rate causes import prices to fall and export prices
to rise.
→ A fall in exchange rate will make imports expensive and exports cheap, so import
demand and spending will fall and export demand and spending will rise.
→ A rise in the exchange rate will make imports cheaper and exports expensive, so
import demand and spending will rise and export demand and spending will fall.

6.4 Current account of the balance of payments

Structure of the current account of the balanced payments
Imports = goods and services purchased by consumers in one country from suppliers
located in others
The purchase of imports therefore results in an outflow of foreign currency from a
country to make payments to overseas suppliers
Trade in goods → involves the exchange of physical products between countries, also
called visible trade
→The income received by selling exports will be recorded as credits in the national
accounts. However, if a country buys imported goods, this leads to a loss or a leakage
of income form an economy which will be recorded as debits in the national account
Trade in services → tourism (lo mismo que arriba)
Other incomes → it is important for a country to keep a record of all other flows of
income between its residents and residents of other countries
The current account of the balance of payments
Balance payments = monetary transactions with the rest of the world each period in an
account
Current account = key acocunt in the balance of payments of a country. The
government will use the current account to record all cross-border flows of incomes
between its residents and residents of other countries

The current account on the balance payments is split into 4 component parts
 1. Trade in goods → balance of trade in goods = credits (exports of goods) – debits
(imports of goods)
2. Trade in services → balance of trade in services = credits – debits
This 2 first sections are used to record the incomes received from the sale of exports
to overseas residents and payments made to overseas residents to buy imports which
represent a leakage of incomes from the country
→ Balance trade surplus = when the total value of credits from trade in goods and
services exceeds the total value of debits
→ Balance trade deficit = when the total value of credits from trade in goods and
services is leed than the total value of debits
Balance of trade = balance trade in goods + balance trade in services
3. Primary income (factor rewards exchanged between residents and non residents
for the use of each other’s factors of production) = wages, rent and investment
incomes received from non residents (credit) – “ paid to non residents (debit)
4. Secondary income (transfers of monet or benefits between residents and non
residents) = current transfers received from non residents (credits) – ‘’ to non
residents (debits)
Calculating the current account balance
→ Current account surplus = when total credits exceed total debits → increases the
gross national income of a country (has earned more than paid)
→ Current account deficit = when total credits are less than total debits → reduces
the gross national income of a country (has paid more than received/ earned)
Current Account Deficit
When the financial outflows in the current account exceed the financial inflows, the
current account is in deficit.
Causes:
→ Higher exchange rate: if the currency is overvalued, imports will be cheaper and
therefore there will be a higher quantity of imports. Exports will become
uncompetitive and therefore there will be a fall in the quantity of exports.
→ Economic growth: if there is an increase in aggregate demand and national
income increases, people will have more disposable income to consume goods.
If producers cannot meet the domestic demand, consumers will have to imports
goods from abroad. Thus faster economic growth enables the possibility of a
current account deficit developing.
→ Decline in competitiveness: if export industries are in decline and cannot
compete with foreign countries, the exports fall, ushering in a deficit. This is a
major reason for many countries today experiencing current account deficits.
 → Inflation: this makes exports less competitive and imports more competitive
(cheaper).
→ Recession in other countries: if the country’s main trading partners experience
negative economic growth then they will buy less of the country’s exports,
worsening the current account.
→ Borrowing money: if countries are borrowing money from other countries to
finance their expenditure and growth, current account deficits will develop.
Correcting a current account deficit
→ Do nothing because a floating exchange rate should correct it: if there is a
trade deficit, a depreciation will occur as more currency is being spent than
received. Depreciation will make imports more expensive and exports
cheaper. As a result, domestic demand for imports will fall and foreign demand
for exports will rise, reducing the deficit.
→ Use contractionary fiscal policy: a government can cut public expenditure and
increase taxes to reduce total demand in the economy, which will reduce demand
for imports and improve the trade balance. However, a fall in demand may affect
firms in the economy who may cut output and employment in response.
→ Use contractionary monetary policy: a higher interest rate will attract more
direct inward investments and nullify the trade deficit. Higher interest rates will
also make borrowing from banks more expensive and increase the incentive to
save, thus discouraging consumers from spending. The govt. can also devalue
the exchange rate to improve export competitiveness and demand.
Current Account Surplus
When the financial inflows in the current account exceed the financial outflows, the
current account is in surplus.
Causes:
• Improved competitiveness: exports may have become more price-competitive
in the international market, due to perhaps, better labour productivity or low
prices.
• Growth in foreign countries: export demand may have risen due to trading
partners experiencing growth and higher incomes.
• High foreign direct investment: strong export growth can be the result of a high
level of foreign direct investment.
• Depreciation: a trade surplus might result from a currency depreciation .
 • High domestic savings rates: high levels of domestic savings and low domestic
consumption of goods and services cause more products to be exported and
imports to fall.
• Closed economy: some countries have a low share of national income taken up
by imports, perhaps because of a range of tariff and non-tariff barriers.
Correcting a current account surplus:
• Do nothing because a floating exchange rate should correct it: if there is a
trade surplus, an appreciation will occur as more currency is being demanded.
An appreciation will make imports cheaper and exports expensive. As a result,
foreign demand for exports will fall and domestic demand for imports will rise,
reducing a trade surplus.
• Use expansionary fiscal policy: increasing public expenditure and cutting taxes
can boost total demand in an economy for imported goods and services.
• Use expansionary monetary policy: lower interest rates will make borrowing
from banks cheaper and increase the incentive to spend, thus encouraging
consumers to spend on imports and correct a trade surplus.
• Remove protectionist measures: reducing tariffs and quotas cause imports to
rise and close a surplus in the current account.