Royal institute of Technology (KTH) Course name: Macroeconomics for Business Course code: AH2020 Teacher: Hans LÜÜf Date of submission: 04.05.2011
Globalization and International Trade Elena Alexejenko, Vivian van der Burgt
Content
1. Introduction
2. The History of Globalization
3. Comparative Advantage as a basis for trade
4. Production and consumption possibilities
5. International Trade and its impacts on Economy 5.1 Advantages of Globalization 5.2 Disadvantages of globalization 5.3 Social impacts of Globalization
6. Conclusion
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Globalization and International Trade 1.
Introduction
Globalization of the world economy denotes a process based on the formation of a single market for goods, services and factors of production, including capital, labour, technology and natural resources, covering all countries and economic regions.1 National and international markets are combined to a single complex market. From a theoretical point of view, globalization means an unlimited access to these markets for all interested businesses regardless of country of origin and economic region.2 Globalization is the economic trend of the last century. The value of international trade has constantly increased since mid 1980s and is nearly twice the rate of world GDP today. And according to Robert H. Frank, and Ben S. Bernanke and their book “Principles of Macro Economics” the volume of international financial transactions has expanded at many times that rate. This development is the result of several simultaneous trends that intensified in the world. This primarily was true of technological process indicated by production automation and computerization, accompanied by global access to information. The international division of labour deepened, leading to a rapid growth of commodity trade. Trade in finished products began to be accompanied by growth in production and investment cooperation and also the importance of international and transnational corporations. This report will expose the historical development of globalization, its advantages and disadvantages for an economy of a nation, and also show the greater possibilities in consumption and production in a globalized world. 2.
The History of Globalization
1498, six years after Columbus discovered America, Vasco da Gamma found the sea rout to India. The corn stone for international trade was set up. The traded goods at this time were high value added items, mostly simple goods as such as raw materials and agricultural goods, for further processing. These played a relatively small role in the economy. With new technological developments, as such as larger, faster and more reliable ships, the introduction of refrigeration for agricultural trade, the opening of the Suez and Panama Canals, improvements in navigation, finance, and insurance. The whole process took place in two waves. The first wave started in the early nineteenth century and ended in with the twentieth century with the World War I. According to David Miles and Andrew Scott the world trade grew before 1914 at an average of 5% per year, because of the decreasing transport cost, although it fluctuated widely depending on the business cycle. The dramatically declining of the transport cost was caused by the shift from sail to steam, improvements in the infrastructure and other inventions and improvements. After the end of WWI in 1918, trade resumed but collapsed dramatically during the early 1930s. The Great Depression caused the shutting USA, and other countries, off from the world trade. The main goal was to prevent imports from capturing domestic demand. Other countries retaliated to this protectionisticall measure, and trade declined. The consequence was the creation of international institutions, such as International Monetary Fund, the World Bank, and General Agreement on Trade and Tariffs (later WTO), to avoid a return to the isolationism of the years between the WW1 and WW2, and to reduce the possibility of future conflict, and help to raise the income standards. The second wave of globalization was in the 1980s and 1990s as increasing numbers of emerging markets adopted trade orientated policies, with the aim of boosting their GDP growth. 3.
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Comparative Advantage as a basis for trade
P.Bo yk, J.Misala, M. Pulawski, Mi dzunarodowoe stosunki ekonomiczne, 2nd edn, p. 395 Pawel‐Bozyk, Globalization and the Transformation of Foreign Economic Policy, p. 1 3
Everyone can enjoy more goods and services if nations specialize in those products in which they have a comparative advantage. Furthermore, if trade is unrestricted, market forces will ensure that countries produce those goods in which they have a comparative advantage. States and nations benefit from specialization and exchange. Countries engage in international trade to reap the gain that arises from specialization. The law of comparative advantage says that the individual with the lowest opportunity cost of producing a particular good should specialize in that good. Trade based on comparative advantage is usually prompted by differences in the quantity and quality of recourses across countries. These recourses include labour and capital, soil and mineral deposits, climate, technology and education. For example the large number of leading research universities in the United States gives that nation a comparative advantage in the design of technologically sophisticated computer hardware and software. Similar, France’s climate and topography, together with the accumulated knowledge of generations of vintners, provide that country a comparative advantage in producing fine wines. Specialization, combined with trade between producers of different goods and services, allows a society to achieve a higher level of productivity and standard of living than one in which each person is essentially self-sufficient. 4.
Production and consumption possibilities
Trade lend to a technological upgrading and associated learning process. It can promote productivity and this increase in productivity can in turn support the incomes of citizens of a country. The relationship between a country’s consumption possibilities and its production possibilities depends on whether or not the country is open to international trade. Consumption possibilities are the combinations of goods and services that a country’s citizens consume. Therefore production possibilities are the combinations of goods and services an economy can produce. In a closed economy with no trade, people can consume only the goods, which are produced within their own country. In such case consumption and production possibilities are equal. In case of an open economy people are not restricted to consuming what is produced in their own country, because part of what they produce can be sent abroad in exchange for other goods and services. In this situation a society’s consumption possibilities are typically greater than its production possibilities. The conclusion is that citizens of a country can consume more of every good by opening itself to trade than if it relied solely on its own production. Also the amount and variety of consumed goods increase by trade. 5.
International Trade and its impacts on Economy
International trade is a means of expanding markets, and market expansion can generate employment and incomes for an economy. According to David Miles and Andrew Scott, around three quarters of countries, with approximately half of the world population have open trade policies. This increasing interconnection has impacts on trade in goods and services, on the capital market, and the labour market. International trade is potentially a powerful force to reduce poverty in the world and to increase the productivity of countries. It can contribute to poverty reduction by expanding markets, creating jobs, promoting competition, rising productivity, and providing new technologies. All this can increase the real incomes and living economic status of an economy.
5.1. Advantages of Globalization Technological innovation (TFP) The world is one big network, interacting with each other from great distances. This interacting is only possible through technological innovation, as such as in telecommunication technology. But not only international trade benefits from TFP. Also TFP growth is only possible through free good exchange
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and free trade. Knowledge and growth in technological innovation (TFP) have become the most important factors of standard of living of a country, more important than labour and capital, especially for industrial nations. Economical growth is only possible if TFP grows. The most advanced technological economies have a lot of knowledge and skills. Through free trade countries can spread and import knowledge, and technological innovation. Import and export innovations and knowledge are the source of the TFP growth, for industrial nations as well as for developing countries. Import process can lead to the imports of new machinery that embody more advanced technologies than the machinery they replace in the importing country. Foreign direct investment (FDI) The main effect of globalization is the increased investment in foreign countries. Corporations try to reduce their costs through outsourcing to developing countries. With the outsourcing developing countries get access to technological innovations, skills, and capital. This will lead to a closer and integrated economy all over the world and to higher income rates in developing countries. A renunciation of foreign direct investments and relying on the countries own resources will limit the development of the country. But the flows of the investments and the businesses relationships in foreign countries have to be controlled and regulated by international supervision to ensure an optimal and justified use of a country’s resources. Such international supervision are for example World Bank, GATT and WTO, which have set up rules to make globalization work. Stability in foreign policy As globalization integrates countries into one global system, everyone is treated the same and everyone has benefits from each other. When all these economic systems are hanging together, it is less likely that countries want to start a war with each other. Because of this benefit countries do rely and trust trade partners more than before. Political stabilization and interaction increase the positive long-run effects of globalization. 5.2. Disadvantages of globalization However, there are some disadvantages of globalization that should not be overlooked. Globalization brings a growth in knowledge and technological innovation, which leads to an economical growth of a nation. A big network interacting through technological systems results. But because of this, risks can also be globalized really fast. Infant Industries Some less developed countries cannot compete with the global markets, as their market is too poor on capital. They have to build up their own markets first, to become part of the trade system. To give these countries for the development necessary time and to protect their domestic markets from the intervention from outside for a certain time, a protective trade barrier is important instrument. This will give developing countries the opportunity to build up their markets to a higher level that they can compete at a global market. This is known as the infant industry justification for trade protection. In general, domestic consumers of imported goods benefit from free trade. But free trade can also be a disadvantage because it negative effect on domestic prices. Through the open market access the competition for domestic producers increases. If a country does not have an equal equipment and equal skilled and trained labour force, it won’t be able to produce to the same low costs as its competitor. That’s why some governments often restrict their trade policies to protect their domestic market Unemployment Globalization is good for business leaders as they can have cheaper labour and production facilities in foreign developing countries. With the low wages and low healthcare costs in developing countries, they can sell their goods in countries where wages are higher for a better price. Having this labour in a
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foreign country will help this country to bring it towards industrialization and the possibility of increasing the standard of living. But not only the availability of labour and capital is important, but also the quality of these resources. Newer technology level demands relatively more skilled workers than the old technology that had been used before. Consequently, the unskilled workers lost in terms of relative wages, while workers who were more highly skilled gained. The unemployment of unskilled workers rises thorough the globalization. Therefore upgrading skills is crucial for trade and for foreign direct investment. Poverty & inequality A criticism on globalization and trade openness is the increased poverty that will occur especially in nations that are already poor. However, it is stated that globalization increases productivity and standard of living. Trade liberalization boosts GDP in long run and reduces poverty. But, the way poverty is occurring, is when there is a bigger inequality. When there is inequality the most of the GDP will go to the more wealthy people in the country. This is the same case with comparative advantage. However, when countries trade more, some areas will grow and others will contract. If poor people work in the area that is growing, then there will be less poverty and inequality. If poor people work in the area that contract, poverty and inequality will rise. But, the gap between the richest countries and the poorest countries has increased. As globalization states one global world where everyone benefits from free trade, in reality this is not the case. As we want globalization to be fair, this is in a lot of situations not true. Multinational enterprises Multinational enterprises (MNEs) are companies that have a productive capacity in several countries. These companies are larger than economies. Globalization has improved communication between less developed countries and more developed countries. MNEs that position themselves in less developed countries benefit from low wages, cheaper labour force, cheaper land and taxes. They are not thinking about the citizens of that country, they are only benefiting from them. They take the profit back home and leave the less developed country behind with a polluted environment, and politically they are paying bribes to the local government to reduce costs. When there are companies being larger than economies, there is a danger that trading rules will be set up to benefit corporations rather than citizens. Further, as MNEs can locate anywhere in the world, countries will reduce their taxes and will offer subsidies to attract the MNEs. The governments of less developed countries want to compete with others to get benefits from the MNEs. But when reducing taxes the government will not have enough money to finance other aspects of the economy and country. This will lead to losses and a decrease in standard of living and welfare. Therefore, globalization may remove the ability to protect workers at the same time as it increases the need for this protection. Furthermore, some critics say that globalization is about the United States who are dominating the world affairs and that they are exploiting developing countries.
5.3. Social impacts of Globalization Environmental damage As multinational enterprises have a lot of power on influencing the policies in a country and in big organizations such as the European Union and World Bank, national governments are losing their power. Due to the power of MNEs, governments will not put effort in protecting the environment through legislation. This will lead to environmental damage. Furthermore, the increase in trade and growing economies will lead to more fuel and more environmental damage. Global warming is one of the main topics nowadays and there is a huge debate going on. As national governments provide support to their citizens they have to keep their power, as multinational enterprises are only interested in their business demands rather than public needs. Legitimacy
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Globalization also means that more goods are being imported from abroad and that countries are relying on other markets and economies. Because of this governments are losing their national power to influence their own economy. Negative shocks and changes in other economies are influencing the whole world. This will limit the freedom of actions of national governments. Globalization is influencing the relationships in countries and governments have to shape their social relationships and economies. Furthermore, countries have no control over the imported goods. Some imported goods are imported by markets, which can lack legitimacy. For instance, a country that has forbidden child labour can import goods that are made by child labour in another country. The country has not made any decision on the imported goods. Here the country is losing its sovereignty. Countries will have more attention for prices and labour wages, and less for ethic responsibility. Cultures Due to globalization the world is integrating and the world is becoming one big country. Because of this also cultures become one and the values of cultures will slowly disappear. People from all over the world are able to communicate with each other and sharing their traditional behaviours. This exchanging of cultures is good, but it also tends to make them more similar to one another. All over the world you can find the same stores and brands. A lot of brands are known all over the world and have become a part of many people’s life and culture. This branding is one aspect of globalization. Multinational enterprises are contributing the most to this branding. They outsource their products and services on a large scale so that every product can be integrated and sold all over the world. Another issue that brands bring with them is the brand management. A brand has to have a good image and this can easily be damaged, which will affect sales. Because of this economies can switch very fast and profits can go up and down. While the globalization is going on, people are less interested in social, ethical, values of their own culture. Globalization can be seen as an advantage of easy communication, but also as a loss of culture differences and values. 6.
Conclusion
Globalization is the great exchange of goods and services all around the world. Globalizations has brought freedom and free trade where everyone benefits from, a great communication system, exchange of goods and capital, sharing knowledge and technological innovation, which will increase the standard of living in countries. But, globalization also increases the gap between wealthy countries and poor countries, environmental damage, unemployment, exploitation and inequality. This shows that not everyone benefits from globalization. Despite the organisations like GATT, WTO and World Bank, who have set up rules to make globalization happen, the system is still lacks some legitimacy. Supporter of globalization indicate that globalization is a form of global capitalism, with a high level of freedom and free trade where everyone can benefit from. But, the government gets less power and the economic systems and corporations are getting more power. As we want globalization to be fair, this is in a lot of situations not true.
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