ec_km_globn

7/28/2019 ec_km_globn

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Globalization Notes © KMLI

Definition: growing economic interdependence of countries through increasing volume and varietyof cross-border transactions in gds, svs, free int’l capital, labour flows. These involve greater int’lmovement of commodities, $, info, people; dev of tech, org, legal sys, infrastruc allows it tohappen.

Globalization involves:1. ↑ int’l trade at faster rate > growth in world economy2. ↑ int’l flow of capital including FDI3. WTO, IMF deal with int’l transactions4. ↑ int’l outsourcing, offshoring by MNCs

closer integration of countries and people with reduction in costs of transportation andcommunications, and breaking down of artificial barriers to flow of gds, svs, capital,knowledge, labour.

Institutions that govern Globalization

IMF – provides funds if countries engage in policies e.g. cut deficits, raise taxes, raise interestrates that lead to contraction of economy.

World Bank – post-war reconstruction, development, develop developing countries.

WTO – govern int’l trade relations, forum for trade negotiation and arbitrates disputes &encourage free flow of goods and services.

Stages of Economic Integration- Process of eliminating restrictions on int’l trade, payments and factor mobility.

1. Free trade Area- assoc. of trading nations. Members agree to remove tariff/NT barriers among themselves- But members retains independence to establish trade policies with non-members- Scheme can apply to select group of goods, while other goods still protected

- Non-member ctries may find it profitable to export pdt with lowest level of outsideprotection, then through it to other ctries.

- Without Rules of Origin by members regarding source ctry of pdt, nothing to precludenon-member ctries from using transshipment strategy to escape trade restrictions

- E.g. NAFTA, Singapore-US FTA.

2. Customs Union- Agreement among ≥2 trading partners to remove T/NT barriers

- Each member imposes identical trade restrictions against non-members commonexternal trade policy

- Limitation: must give up independence of setting indiv. tariff rates- E.g. Benelux

3. Common Market- In addition to (2), free movement of labour and capital between members represent a

more complete stage of economic integration and further ↓ of ctrl of indiv members.

- EC 1958 EU 1993- Difficulties: member nations surrender sovereignty in immigration & capital flows, factor

integration

4. Economic Union- national, social, taxation, fiscal policies harmonized



- Each ctry remains separate political entities but economic sovereignty surrendered tosupranational instituition

5. Monetary Union- Ultimate Degree of economic integration- unification of national monetary policies and acceptance of common currency

administered by supranat. Monetary authority.

- EU requirements (Maastrict Treaty)o Price stability ≤1.5% inflation above lowest 3 ctries’ inflation rateo Low LT i/r ≤2% averageo Stable ER target bands of monetary uniono Sound public finances budget deficit ≤3% GDP, outstanding deficit ≤60% GDP

Regional Trading Arrangements

Regional trading agreements ↔ Globalization Regional trading agreements ≠ Globalization- When structured according to principles

of openness and inclusiveness, regionalblocs can aid global free trade andinvestment

- Regional agreements deeper economic integration among membersthan multilateral accords with greater common interests and simpler negotiating processes.

- As mkt encompassed by free trade area↑, opp. cost of remaining non-member ↑.

- ↑ in economic size of union = ↑bargaining power

- Regional liberalization encouragespartial adjustment of workers out of export competing industries wherecomparative adv. Is low political

support.

- Under WTO, trade liberalizationpolicies extends to all w/odiscrimination

- Regional trading blocs ↓discretion of

member nations to pursue tradeliberalizatn withoutsiders.

- Regional trade bloc members maynot enjoy addn EOS from further global trade liberalization.

- Interests: trade bloc members maywish to invest their time and energy inest. strong regional linkages rather than investing in global negotiations.

[ little incentive for regional trade blocmembers to work towards globalization.]

Effects of Globalisation

By forming a trade bloc, there is integration ( movement towards free trade for member countries), but there is also trade diversion (from lower-cost-non-member to member).

Trade creation – economic integration leads to shift in product origin from domestic producer whose resource costs are higher to a member country whose resource costs are lower. shift represents a movement in direction of principle of comparative advantage brings welfare gains from more efficient resource allocation.

Trade diversion – shift in production origin from non-member producer with lower resource costs

to member country producer where resource costs are higher. shift represents movement away from principle of CA, reducing overall welfare.



Benefits of economic integration depends on factors contributing to trade creation & diversionMember countries’prices nearer to low-cost world price

More likely effect of integration of markets will be positive. Nationswhose pre-union economies are quite competitive are likely to benefitfrom trade creation because forming union offers ↑ opportunity for production specialization.

Initial Tariff rate Effect more +ve if initial tariff rate is higher. Areas b and d will belarger.If tariff initially prohibitive (0 import from ctry A), no welfare loss

from trade diversion.Elasticity High elasticity of supply and demand curves = greater quantity response

by producers and consumers = larger areas b and d.Great number of participant countries

Integration more beneficial, since there is smaller group of countriesfrom which trade can be diverted. If entire world integrated, there will beonly trade creation; no trade diversion!

International movements of factors of productionEconomies of factor flows

- Productive factors move from nations where they are abundant (low productivity) towhere they are scarce (high productivity).

- Flow in response to differences in returns (wages/yields of capital). If returns > cost of moving, move!

- If labour is scarce import labour or labour-intensive products.- Int’l trade in g & s = substitutes for = productive factors.

International movement of capital- Foreign portfolio investment: does not involve ownership or control of foreign production

units. Just financial capital.- FDI involves movement of capital that involves ownership and control of production

facilities. By MNCs. E.g.:o Parent company obtains sufficient common stock in foreign companyo Parent company acquires/constructs new plant and equipment ovso Parent company shifts aborad to finance expansion of foreign subsidiary

- What affects capital flows:o

Expectation of higher rate of return – economic agents maximize their wellbeing• Economic determinants (How is the host country’s…)

o Market-Seeking FDI: Market size, per capital income,market growth, access to regional/global markets,specific consumer preferences, market structure

o Resource/asset-seeking FDI: raw materials, availabilityof skilled/unskilled labour, technology, innovation andother created assets, physical infrastructure

o Efficiency-seeking FDI: cost of physical humanresources, membership of country in regional networksto facilitate regional corporate networking

• Political Frameworko Eco/soc/pol stability, rules regarding entry/operations,

policies of market structure regarding competition,treatment of foreign firms, tax policies, trade policies

• Business Facilitationo Investment promotion (image-building)o “hassle costs” by corruption, admin inefficiencyo Social amenities (int’ schools, SOL)



Effects of International Capital Movements

Benefits CostsDONOR- more open economies enjoy higher

rates of private investment determinant of economic growth

and job creation- by participating in local labour mkt,

dd for labour ↑, ↑ wages for all workers

- SR: UE as production shiftsoverseas

- LR: foreign sales increaseovertime; foreign labour consumesand produces. As Investmentincreases, Employment andincome increases.

- LR: Investment abroad stimulates ↑export of machinery and other

capital goods- LR: FDI generate return flow of income e.g. interests and dividendsback to source country firmsstay competitive, supportemployment at home.

RECIPIENT- generates spillovers e.g. improved

management, better technology(knowledge as to production of goods)

- Tech spreads faster with personalcontact demonstration effect

- Competitive effect : other firmsinnovate and improve productionprocesses.

- Firms and sectors with intense FDIhave higher average productivityand pay higher wages.

- FDI ↑ total output/unit of input,↑employment and wages, ↑exportsand foreign exchange earnings

- ↑tax revenue for host govt- ↑ tech, managerial skills

improvement and new technology enhances recipient country’s

production possibilities

- foreign firms may stifle efforts to develophomegrown industry. SMEs have difficultycompeting with MNCs.

- Int’l firms drive out local competition to gain

monopoly power - During international crisis, MNCs maymove funds rapidly from one financialcentre to avoild losses /make profit fromchanges in exchange rates. does nothelp governments stabilize economies.

RECIPIENT- Dutch Disease: Inflow of capital leads to

appreciation of currency importsbecome cheap, exports expensive. Makesit difficult for host to export and groweconomy.

- Dual Economy: Small pockets of wealth

created, but domestic sector poor.- Decreased domestic Investment. Foreignfirms may partially finance investment,borrowing from host country’s capitalmarket. This increases interest rates andleads to crowding out effect.

- Instable BOP and ER: capital inflow, importof inputs, repatriation of profits to homecountry cause instability difficult for LRplanning

- Large foreign firm drive out domestic firmsand exist as monopoly.

Performance Requirements e.g. minimum % of local employees, max. % of profits repatriated tohome country, min. % of output that must beexported to earn ForEx, ban from key industries

Don’t forget to study International Labour Movements. Lecture Notes.



Overall Costs & Benefits of Globalization

Benefits Costs

- (static gain) trade creation- (static gain) greater world efficiency (allocative)- economic integration results in administrative

savings by eliminating need for govt officials tomonitor movement of g&s that cross country’sborders (less red tape etc)

- LR: (dynamic gains) creation of larger markets producers enjoy EOS

- Larger markets permit greater specialization of workers and machinery, use of efficientequipment, complete use of by-products

- Broader markets also promote greater competition among producers.

- Producers undertaking investments in newequipm and tech hold down costs and expandlevels of output.

- Integration can stimulate greater investmentsfrom i) structural changes, ii) IEOS, EEOS iii)increase in income and demand.

- Common market level: increased factor mobility.Moving to areas of scarcity will increaseeconomic efficiency and factor incomesincreases!

- Growing income dividereminds us rapid growth ≠↑SOL

- Labour market tensions(white-collar UE in developedcountries as result of outsourcing) govt mustensure retraining benefitsavailable some benefitsfrom trade must bechanneled to temporaryincome assistance &retraining for UEed. E.g.workfare scheme in S’pore

- Cost to developed country:closure of undustries that

relocate to low-wagecountries whereenvironmental regulationsless stringent (lower COP)and exports from developedcountry decreases too ):

- Environmental damage

Bottom Line

International trade helps economic development esp. when country’s exports driveeconomic growth. There is aggregate global improvement given (access to knowledge,asia’s rise as export-oriented region, declining infant mortality, increasing income (oops

and prices) and longevity)

Condition: Governments are able to improve education system, provide better infrastructure and investment incentives! A country (e.g. mexico) can benefit less fromNAFTA because of poor education, corruption, crumbling infrastructure, lack of credit and

small tax base) compared to another under the same agreement. Economic Integrationis actually providence for additional gains that govt may choose to allocate correctly. If bad government spends additional wealth wrongly, in LR, adv. of free trade erodes.

Improvements: Global institutions capable of securing greater stability in economicregulation, environmental security, containment of crime/terrorism and enhancing welfare.Climate for globalization must maintain/improve. The marriage of competition andproductivity will not last if conditions for globalization threatened. E.g. 40 yrs after WWI.

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