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Economic Development

Economic Growth

Global Trade

 

 

ECON MARGIN NOTES

 

Economic Development

 

The essential issue of development economics is why some countries grow and develop and others do not and the policies that might help developing countries get richer.

  1. Putting World Poverty into Perspective: At least one-third of the world’s population lives at subsistence level. The official poverty level in the United States exceeds the average income of at least one-half of the world’s population.

  2. The Relationship Between Population and Economic Development: World population is expected to reach approximately 9.3 billion by the year 2050, up from 7 billion today. Excessive population growth has been a concern ever since Malthus’ day (1798).

  1. Malthus Was Proved Wrong: As population has grown, the amount of food produced as measured by calories per person has increased. Also, the relativeExamples of nations' primary, secondary and tertiary sectors as a percent of GDP price of food has fallen for more than a century.

  2. Growth Leads to Smaller Families: As nations get richer, the average family size declines.

  1. The Stages of Development: Agriculture to Industry to Services: Modern rich nations went through three stages as they developed. From the dominance of agriculture (primary) to that of manufacturing (secondary) and finally to the dominance of services (tertiary). [Note: You may find less developed nations with a larger than expected tertiary sector. That's almost always due to a reliance on tourism.] It is important that nations that wish to develop specialize in those products in which they have comparative advantage.

ReadEconomic Sectors (PDF)

 

  1. Are developing countries a homogenous group?

Common Characteristics:

mass poverty - low standard of living levels and per capita income

highly skewed income distribution

substantial dependence on agriculture: 30-60% of GDP

importance of primary products in trade: food and raw materials make up half or higher of the value of exports

high rates of population growth

dependency and vulnerability in international relations

Differences:

country size

historical background

physical and human resources

ethnicity and religion

importance of public and private sectors

importance of primary, secondary and tertiary sectors

external economic, political and cultural dependence

interests and power of different groups

  1. Which is the most relevant theory of development?

The International-Dependence Revolution

Developing countries face institutional, political and economic rigidities, both on the domestic and the international front and are caught in a dependence and dominance relationship with rich countries. Three major streams of thought can be sorted out:

o   Neo-Colonial Dependence

o   The False-Paradigm Model

o   The Neo-Classical Counterrevolution

Neo-Colonial Dependence

This is an indirect outgrowth of Marxist thinking that attributes the existence and continuance of underdevelopment between rich and poor countries primarily to the historical evolution of a highly unequal international capitalist system. In this system, rich countries are intentionally exploitative or unintentionally neglectful, and the international system is dominated by unequal power relationship between the center and the periphery. This makes it difficult for poor nations to develop. The situation is perpetuated by power groups (landlords, entrepreneurs, military leaders, merchants, public officials, trade union leaders, etc). These groups enjoy high incomes, social status and political power, and constitute an elite ruling class whose principle interest lies in the perpetuation of the international capitalist system, for which they are rewarded. Therefore underdevelopment is seen as an externally induced phenomenon.

The False-Paradigm Model

This model attributes underdevelopment to faulty and inappropriate advice provided by well-meaning but often uninformed ethnocentric international experts from developed countries or multinational organizations, Western-trained university faculty, bureaucrats and technocrats. This set of theories emphasizes the removal of international and domestic imbalances as the most effective way to deal with diverse social problems. Acceleration of the pace of economic growth can be accomplished through domestic and international reforms,  accompanied by a judicious mixture of both public and private economic activity. However, these theories offer little formal or informal explanation on how countries initiate and sustain development. More importantly, the actual economic experiences of less developed countries that have pursued revolutionary campaigns of industrial nationalization and state-run production has been mostly negative. Also according to these theories countries pursuing policies of autarky, or inwardly directed development, should be doing well, for example, China and to a certain extent India. However, both these countries experienced stagnant growths until they opened up their economies in 1978 and 1990.

The Neo-Classical Counterrevolution

These theories advocate freer markets and the dismantling of public ownership, central planning by the state and government regulation of economic activity. Underdevelopment results from poor resource allocation due to incorrect pricing policies and too much state intervention by overly active developing country governments … thus, slowing the pace of economic growth. The Free Market approach argues that markets alone are efficient, prices of products and factors reflect the accurate scarcity values of goods and resources, competition is effective if not perfect, technology is freely available and nearly costless to absorb, and information is also perfect and nearly costless to obtain. Under these conditions any intervention by the government is a distortion. However, this has not really been the case in the developing countries. The Public Choice approach – and also the new political economy approach – argues that politicians, bureaucrats, citizens and states use their power and authority to act solely from a self-interested perspective, resulting in corruption and misallocation of resources. The Market Friendly approach recognizes that there are many imperfections in a developing country’s product and factor markets and that governments do have a key role to play in facilitating the operation of markets through non-selective (market friendly) interventions … for example, investing in physical and social infrastructure, health care facilities and educational institutions, and providing a suitable climate for private enterprise.

Structural Change Models of Development

Structural change models focus on the mechanism by which underdeveloped economies transform their domestic economic structures from a heavy emphasis on traditional subsistence agriculture to a more modern, more urbanized and more industrially diverse manufacturing and service economy. Important examples of such models are:

o   Lewis’s Structural Change Model

o   Chenery’s Patterns of Development

o   Rostow’s Linear Stages of Growth Model

o   The Harrod-Domar Model

Lewis' Structural Change Model of GrowthLewis’s Structural Change Model

Nobel Laureate Arthur Lewis said that an underdeveloped economy consists of two sectors: (1) a traditional, overpopulated rural subsistence sector with surplus labor and (2) a high productivity modern sector to which surplus labor is transferred. The focus of the model is on the process of surplus labor transfer from the traditional sector which leads to the growth of output and employment in the modern sector.

Lewis calculated that with an increase of 30% or more in urban wages, workers will migrate from the rural areas to the urban areas, leading to growth in output and employment through the modern sector. Lewis’ model reflects the historical experience of economic growth in the West. It assumes that the faster the rate of capital accumulation, the higher the growth rate of the modern sector and the faster the rate of new job creation. It does not take into account that capitalist profits may be re-invested in sophisticated labor-saving technologies or that there may be capital flight.

The model assumes surplus labor exists in the rural areas while there is full employment in the urban areas. This is not supported by empirical literature and is generally not valid. It also assumes the existence of a competitive modern-sector labor market that guarantees the existence of  constant real urban wages up to the point where the supply of rural surplus labor is exhausted. However, urban wages continue to rise even in the presence of rising levels of open modern sector unemployment and the existence of surplus labor in the rural sector due to the presence of unions, civil services wage scales and multinational corporations’ own hiring practices that tend to negate competitive forces in the modern sector. Finally, evidence suggests that increasing returns prevail in the modern sector instead of diminishing returns, which means that the modern sector might continue to use more and more capital instead of labor.

Chenery’s Patterns of Development

According to Hollis Chenery’s work, in addition to the accumulation of capital, both physical and human, a set of interrelated changes in the economic structure of a country are required for the transition from a traditional economic system to a modern one. These structural changes involve all economic functions – including the transformation of production and changes in the composition of consumer demand, international trade and resource use as well as changes in socioeconomic factors such as urbanization and the growth and distribution of a country’s population. Development shows certain patterns, for instance, a shift away from agriculture to industrial production, the steady accumulation of physical and human capital, the change in consumer demands from emphasis on food and basic necessities to manufactured goods and services. This leads to the growth of cities and urban industries as people migrate from the rural to the urban regions with a decline in overall family size and rate of population growth.

Rostow's Model of DevelopmentRostow’s Linear Stages of Growth Model

In the 1950s and the early 1960s, the process of development was viewed as a series of successive stages through which all countries must pass. With the right mix of savings, investment and foreign aid, these countries could be put on the path to development, thereby making development synonymous with aggregate economic growth. Walt Rostow became the most influential advocate of the stages of growth model of development. Rostow argued that the advanced countries had all passed through a series of steps leading to development and growth. The developing countries were still in either the traditional society or the preconditions stage and had to follow a set of rules to take-off into self-sustaining economic growth. The principal strategy to help this takeoff was the mobilization of domestic and foreign savings in order to generate sufficient investment to accelerate economic growth.

 

The Harrod-Domar ModelThe Harrod-Domar Model

The Harrod-Domar Model describes the economic mechanism through which more investment leads to more growth. The theory states that the rate of growth of GNP is determined jointly by the national savings ratio and the national capital-output ratio. Therefore, an economy’s most fundamental growth strategy is to save and invest a certain proportion of its GNP. However, the actual rate at which an economy can grow for any level of saving and investment depends on how much additional output can be had from an additional unit of investment. According to this theory the major obstacle to growth is capital constraint, which became the reason for the transfer of capital and technical assistance to developing countries. Stages theory did not always work because, although savings and investment is a necessary condition for accelerated rates of growth, it is not a sufficient condition. Economies also need to possess certain structural, institutional and attitudinal conditions, such as well-integrated commodity and money markets, highly developed transport facilities, a well-trained and educated work-force and an efficient government.

  1. How relevant are the lessons learned from the historical growth process?

    Due to differences between the initial conditions of the current developing countries and the initial conditions of the developed countries when they started their economic growth, the lessons we have learned are of limited relevance.

physical and human resource endowments: Many developing countries are less well endowed with natural resources. Asia where half of the world’s population lives is poorly endowed. Even though Africa and Latin America are better endowed they need heavy capital investment to exploit these resources.

per capita incomes and levels of GDP in relation to the rest of the world: Four-fifths of the world has a real per capita income that is on average lower than their counterparts in the 19th century. Today’s developed countries were in advance of the rest of the world and hence could take advantage of the strong income gaps between themselves and other nations.

climate: Most developed countries are located in temperate climatic zones as opposed to the developing countries that are located in the tropical zone. Heat and humidity result in a decline in soil quality and depreciation of natural goods, lower agricultural  productivity, weakened regenerative growth of forests and poor health of animals. Too, diseases, such as malaria, are concentrated in tropical areas.

population size, distribution and growth: In the earlier growth years developed countries experienced a slow population growth rate and, as industrialization proceeded, population growth was due mostly to falling death rates. The natural birth rate of Europe and North America was always low. For today’s developing countries, however, population growth rates have been and remain high.

historical role of migration: During the 19th and early 20th centuries, there was a major outlet for excess rural populations in international migration, which was both large scale and wide-spread. For instance, three major contributions to labor-scarce areas of North America and Australia came from the Irish, Germans and Scandinavians. International migration until WWI was both distant and permanent, whereas after WWII it was mostly within Europe, over short distances and essentially temporary. The same type of migration is not possible today because of large distances involved and the very restrictive nature of immigration laws in modern developed countries.

international trade benefits: During the 19th and 20th centuries, international free trade was called the engine of growth. Today developing countries cannot expand as rapidly because the terms of trade have declined. That is, the price that they receive for their exports is much less than the price that they have to pay for their imports. The developed countries are so far ahead in terms of producing more competitive and new products that the developing countries cannot compete. Developing countries of today also face various tariff and non-tariff barriers such as import quotas, sanitary requirements and special licensing arrangements.

basic scientific and technological research and development capabilities: 90% of research and development is concentrated in the developed countries and is focused on solving their problems. The technological requirements of developing countries are very different and require simple solutions.

stability and flexibility of political and social institutions: The developed countries in their pre-industrial time were independent consolidated nation-states able to pursue national policies on the basis of consensus towards modernization with ideals embodied in the notions of rationalism. In contrast many of the developing countries have only recently gained independence and have yet to gain political and social stability, to become consolidated states.

There is no strong empirical evidence of convergence between the living standards of developed and developing countries. The most important lesson may be the significance of technological, social and institutional changes that are essential for long-term economic growth.

  1. Keys to Economic Development

  1. An Educated Population: Developing countries can advance more rapidly if they invest more heavily in secondary education.

  2. Establishing a System of Property Rights: The more certain property rights are, the more capital accumulation and economic growth there will be, other things being equal.

  3. Letting “Creative Destruction” Take Its Course: “Creative destruction” occurs when new businesses ultimately create new jobs and economic growth after first destroying old jobs, old companies and old industries.

  4. Limiting Protectionism: Open economies experience faster economic development than do economies that are closed to international trade.

World map of GDP sectors

 

 

 

 

WORLD DEVELOPMENT INDICATORS

 

 

CHARACTERISTICS OF LDCs & MDCs

 

 

 

 

 

 

 
Less Economically Developed Country Policies for Promoting Growth
  1. Establish and strengthen the rule of law. Clearly defined and enforced property rights bolster economic growth by ensuring that individuals get and keep the fruits of their labor.

  2. Open economies to international trade.

  3. Control population growth.

  4. Encourage foreign direct investment.

  5. Build human capital. Programs which increase basic literacy, education and labor-market skills help enhance economic growth.

  6. Make peace with neighboring countries.

  7. Establish independent central banks.

  8. Establish realistic international exchange rate policies.

  9. Privatize state-run industries.

More Economically Developed Country Policies for Fostering Developing Country Growth
  1. Direct foreign aid to the poorest developing countries. Much of foreign aid from developed countries is strongly influenced by potential and military considerations. Only of foreign aid goes to those 10 countries whose population constitutes 70% of the world’s poorest people.

  2. Reduce tariffs and import quotas.

  3. Provide debt relief to developing countries.

  4. Admit temporary workers but discourage brain drains.

  5. Discourage arms sales to developing countries.

ReadEconomic Development (PDF)

Dig Deeper

 

What is the Meaning of the So-Called “Resource Curse” and How Does It Affect Current International Trade?

Test Yourself

 

Test Yourself: Economic Development

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ECON MARGIN NOTES

 

Economic Growth

 

I. How do we define economic growth? Increases in per capita real GDP over time. It is measured by the rate of change of real GDP per capita per year. If there is economic growth, the production possibilities curve will shift outward.MIKE KEEFE 04/04/2008

  1. Problems in Definition: Real standards of living can go up without any positive economic growth when individuals are, on average, enjoying more leisure by working fewer hours, but producing as much as before. Growth tells us nothing about the distribution of output and income.

  2. Is economic growth bad? Anti-growth proponents suggest that economic growth is bad because it raises expectations faster than income. Our measures of growth allow us to make comparisons across countries and time and provide a serviceable measure of productivity.

 

II. Determinants of Economic Growth

  1. Productivity Increases: The Heart of Economic Growth: Labor productivity is real GDP divided by the number of workers (output per worker). Increases in labor productivity lead to increases in the standard of living. If all resources are divided up into labor and capital, then the growth of per capita GDP is the cumulative contribution of the growth of capital, the growth of labor, and the rate of growth of capital and labor productivity.

  2. Saving: A Fundamental Determinant of the Rate of Economic Growth: Higher savings rates lead to higher living standards in the long run, other things equal, because investment and the capital stock will increase.

  3. New Growth Theory and the Determinants of Growth: New Growth Theory examines factors that determine why technology, research, innovation, and the like are undertaken and how they interact.

1. Growth in Technology: The growth of the power of the personal computer is an example of technological change.

  1. Technology: A Separate Factor of Production: One of the major foundations of new growth theory is that the greater the rewards, the more technological advances we will get.

  2. Research and Development: Technological advance can come from R&D that develops new materials, products, and processes. Thus, some technological advance depends on the rate of spending on R&D and business spending on R&D depends on expected profits. The greater the reward, the more technological advances we will get.

  3. Patents: A 20–year monopoly on a new product or technique granted by the federal government to an inventor.

  4. Positive Externalities and R&D: Some of the results of R&D spending accrue to others who benefit without paying. An estimated 25 percent of R&D spending in the top 7 industrialized countries accrues to foreigners.

GRAPHIC SHOWING THE SLOW GDP GROWTH IN THE WORLD'S LARGEST ECONOMIES

2. The Open Economy and Economic Growth: Open economies can experience higher rates of growth than closed economies, because free trade encourages a more rapid spread of technology and industrial ideas and may give domestic industries access to a bigger market.

3. Innovation and Knowledge: Innovation involves transforming an invention into something that benefits the economy. Much innovation involves small improvements in the use of an existing technology.

a. The Importance of Ideas and Knowledge: Past investment in capital may make it more profitable to acquire more knowledge. There exists the possibility of an investment-knowledge cycle where investment spurs knowledge and knowledge spurs investment. Therefore knowledge, like capital, has to be paid for by forgoing current consumption. Knowledge can be viewed as a store of ideas. Thus, economic growth can continue as long as we keep coming up with new ideas.

b.  The Importance of Human Capital: Increases in the productivity of the labor force are a function of increases in human capital. Human capital is at least as important as physical capital.

  1. Population and Immigration as They Affect Economic Growth: Population growth implies that more workers are entering the labor force, which the evidence shows can increase technological progress, which increases the rate of economic growth.

D. Property Rights and Entrepreneurship: The more certain private property rights are, the more capital accumulation there will be. If people have property rights in their wealth that are sanctioned and enforced by the government, they will save and invest more.

 

III. Labor Resources and Economic Growth: Important determinants of economic growth are growth of labor and capital and the rate of increase of labor and capital productivity. This section examines the conditions necessary for population growth to be translated into economic growth.

  1. Association Between Average Annual World Population Growth Rates & GDP per Capita Growth Rates, 1975-2004Population Growth and Economic Growth: The growth rate of per capita real GDP is equal to the rate of growth of real GDP minus the population growth rate.

  1. How Population Growth Can Contribute to Economic Growth: Immigration can increase real GDP faster than population if they increase the labor force participation rate. It is possible for higher birth rates to lead to an increase in the labor force and an increase real GDP per capita.

  2. Whether Population Growth Hinders or Contributes to Economic Growth Depends on Where You Live: There are countries such as Saudi Arabia where rapidly increasing population leads to lower per capita real GDP and others such as Hong Kong that have experienced high rates of growth of per capita real GDP.

  1. The Role of Economic Freedom: Economic freedom is expressed as the rights to own private property and to exchange goods, services, and financial assets with minimal government interference. In general the higher is the level of economic freedom, the higher is per capita real GDP and growth rates.

  2. The Role of Political Freedom: Political freedom is the right to openly support and democratically select national leaders. It seems less important than economic freedom in explaining economic growth. In fact there is some evidence that greater democracy in a nation reduces economic growth rates because of successful attempts to restrict competition by producers. In general though as countries achieve high standards of living through consistent growth they tend to become more democratic over time. This suggests that there is a positive relationship between economic freedom and economic growth.

 

IV. Capital Goods and Economic Growth: In general capital is necessary for economic growth. In many developing countries one of the most significant problems they face that retards economic growth is dead capital, which is any capital resource that lacks clear title of ownership. Because people have difficulties exchanging, insuring, and legally protecting their rights to it, it is not readily allocated to its most productive use.

  1. Dead Capital and Inefficient Production: Because people who unofficially own capital goods are commonly constrained in using them efficiently, large amounts of capital goods are used inefficiently.

  2. Dead Capital and Economic Growth: In developing countries the existence of dead capital reduces the rate of return on investment thus reducing the incentive to invest in new capital goods. This reduces investment. Since economic growth depends in part on investment, the result is a decrease in the rate of economic growth.

  1. Government Inefficiencies, Investment, and Growth: A major factor that contributes to dead capital and resulting lower rates of investment in less developed countries is inefficient government regulation. Economies of countries with less efficient governments tend to grow more slowly. The reason is that capital is difficult to direct to its most efficient uses.

  2. Corruption and Growth: The more widespread is corruption, the greater is the problem of dead capital and the higher is the cost of investment. Greater corruption leads to lower economic growth.

 

V. Private International Financial Flows as a Source of Global Growth: One approach to promoting greater economic growth in developing countries is to rely on private markets to direct capital goods to their best uses.GLOBAL ECONOMIC GROWTH RATES

  1. Private Investment in Developing Nations: Net private international flows of funds to developing countries have averaged over $100 billion per year since 1995 (equal to about 10 percent of annual net investment in the U.S.).

  1. Source of Foreign Funding for Capital Goods: There are three sources of foreign funds for capital goods. These are bank loans, portfolio investment—the purchase of less than 10% of the shares of ownership in a company in another nation—and direct foreign investment. Direct foreign investment is the acquisition of a more than 10 percent share of a firm’s ownership.

  2. How International Financial Flows Can Contribute to Global Growth: International investors live in countries where there are fewer barriers to proof of capital ownership. There is a greater likelihood that international investors will be able to prevent the capital they own from becoming dead capital and thus it will remain productive.

  1. Obstacles to International Investment: The major problems of financial markets in developing countries are related to the problem of asymmetric information.

  1. Asymmetric Information as a Barrier to Financing Global Growth: The problem here is that institutions that make loans or investors who hold stocks and bonds have less information than those who seek to use the funds. Adverse selection arises when those who wish to obtain funds for the least worthy projects are among those who wish to borrow or issue bonds or stocks. If lenders and investors have trouble identifying these higher-risk persons, they may be less willing to channel funds to even creditworthy borrowers. Moral hazard exists when recipients of funds engage in riskier behavior after getting the funds. These asymmetric information problems are great enough in some countries as to form a significant obstacle to economic growth.

  2. Incomplete Information and International Financial Crises: An international financial crisis exists when there is a rapid withdrawal of foreign investments and loans from a nation. These happen because less sophisticated investors and banks follow the example of larger, more sophisticated investors and institutions in withdrawing funds when risks in a foreign country or group of foreign countries exist.

 

VI. International Institutions and Policies for Global Growth: Since 1945 the world’s governments have taken an active role in supplementing private markets through the World Bank and the International monetary Fund.

  1. The World Bank: A multinational agency that specializes in making loans to about 100 developing nations in an effort to promote their long-term growth and development. The bank mainly finances projects such as irrigation systems and road improvements.

  2. The International Monetary Fund: The IMF is an international organization that aims to promote world economic growth through more financial stability. Each nation that joins the IMF deposits funds to an account called its quota subscription and these are measured in special drawing rights from a pool of funds held by the IMF. The IMF currently makes both short-term and long-term loans to help finance growth or to provide assistance to countries that are having trouble paying off their debts.ECONOMIC GROWTH WORD CLOUD

  3. The World Bank and the IMF: Part of the Solution or Part of the Problem? In recent years economists have questioned IMF and World Bank policy making.
  1. Does the World Bank Really Have a Mission Anymore?: While the World Bank’s mission is to make loans to developing nations that fund projects incapable of attracting private investors for funding, it makes many of its loans to countries that have little trouble attracting private investment. Some countries such as China are inappropriate recipients for World Bank loans.

  2. Asymmetric Information, the World Bank and the IMF: Lending policies of both organizations can make the adverse selection problem worse.

  3. Rethinking Long-Term Development Lending: Many economists argue that promoting market reforms by governments in developing countries would have much higher payoffs in promoting development. The major issue is whether the lending should be for specific projects or more for financing the market reforms by government.

  4. Alternative Institutional Structures for Limiting Financial Crises: Proposals range from eliminating the IMF and the World Bank and replacing them with alternative organizational forms to simply having the IMF and World Bank more carefully monitor borrowers. Almost all economists agree that improved accounting standards for international borrowers are needed.

Similarities between the IMF and The World Bank

Dig DeeperMedian Household Income: Life in the Middle from the Federal Reserve Bank of San Francisco

No Middle Class Means No Economic Growth

ECON 2302 Margin Notes on Global Finance

Test Yourself

 

Test Yourself: Economic Growth

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ECON MARGIN NOTES

 

Global Trade

 

I.  Why We Trade

Countries trade with each other when, on their own, they do not have the resources or capacity to satisfy their own needs and wants. By developing and exploiting their domestic resources, countries can produce a surplus and trade this for the resources they need.

MAP OF WORLD CURRENCIES

Clear evidence of trading over long distances dates back at least 9,000 years, though long distance trade probably goes back much further to the domestication of pack animals and the invention of ships. Today, international trade is at the heart of the global economy and is responsible for much of the development and prosperity of the modern industrialized world.

Goods and services are likely to be imported from abroad for several reasons. Imports may be cheaper or of better quality. They may also be more easily available or simply more appealing than locally produced goods. In many instances, no local alternatives exist and importing is essential. This is highlighted today in the case of Japan, which has no oil reserves of its own, yet it is the world’s fourth largest consumer of oil and must import all it requires.GARY VARVEL 04/02/2006

The production of goods and services in countries that need to trade is based on two fundamental principles, first analyzed by Adam Smith in the late 18th century (in The Wealth of Nations, 1776), these being the division of labor and specialization.

  1. The Output Gains from Specialization: If specialization and trade occurs along lines of comparative advantage, then production increases above what would be possible without specialization and trade.

  2. Specialization Among Nations: Comparative advantage is the ability to produce a good or service at a lower opportunity cost than can other producers. Comparative advantage always exists as long as the opportunity cost of doing the same job varies for different individuals or countries. Absolute advantage is the ability to produce more output from given inputs of resources than another can.

  3. Transmission of Ideas: Ideas are transmitted through international trade. These ideas may be in the form of intellectual property, new goods and services, and new processes.

 

Watch

 

Explaining Comparative Advantage (2:02)

Specialization and Trade (9:03)

 

 

II. The Relationship Between Imports and Exports: In the long run, imports are paid for by exports. This is because foreigners want something in exchange for the goods that are shipped to the US. Any restriction of imports ultimately reduces exports, because restrictions on imports lead to a reduction in employment in the export industries.

Watch

 

The Balance Of Trade (1:52)

 

 

III. International Competitiveness: This term is hard to define precisely because countries do not compete. Businesses within each country compete with businesses in other countries. Based on an international study, the US leads the world in measures of competitiveness.

ReadThe Magic Bean Shop and The Fries that Bind Us

Trade Patterns: US Imports from the Federal Reserve Bank of San Francisco

 

IV. Arguments Against Free Trade: The arguments against free trade do not consider the benefits of the possible alternatives for reducing costs while still reaping benefits.

Trade Flowchart

A. The Infant Industry Argument: The argument that tariffs should be imposed to protect an industry that is trying to get started from import competition. After the industry becomes technologically efficient, the tariff can be lifted.

B Foreign Subsidies and Dumping: When a foreign government subsidizes its producers, ours claim they cannot compete fairly with subsidized foreigners. To the extent that such subsidies fluctuate, one can argue that unrestricted free trade will seriously disrupt domestic producers. Occasionally, dumping takes place — selling a good or service abroad at a price below its cost of production or below the price charged in the home market. This disrupts international trade and may impair commercial well being at home.

  1. Protecting Domestic Jobs: The most often used argument against free trade is that unrestrained competition from other countries will eliminate U.S. jobs because other countries have lower-cost labor and less restrictive environmental standards.

  2. Emerging Arguments Against Free Trade: environmental concerns, undesirable effects (genetic engineering), certain technologies should not be exported

V. Ways to Restrict Foreign Trade:

  1. Quotas: Quotas are government-imposed restrictions on the quantity of a specific good that another country is allowed to sell in the US. Quotas restrict imports. These restrictions are usually applied to a specific country or countries. With a voluntary restraint agreement (VRA) a country agrees to voluntarily restrict its exports to the US. The opposite is a voluntary import expansion agreement (VIE) in which a foreign country agrees to voluntarily increase its imports from the US. Neither a VRA nor a VIE has the force of law.

  2. Tariffs: A tariff is a tax on imported goods. A protective tariff is such that no similar tax is applied to identical domestic goods.IMPOSING A TARIFF: SEQUENCE OF EVENTS

1.   Tariffs in the US: Tariffs on all imported goods have varied widely. The highest tariff rates in 20th century occurred with passage of the Smoot-Hawley tariff in 1930.

2.   Current Tariff Laws: The Trade Expansion Act of 1962 permitted the president to reduce tariffs by up to 50%. The Trade Reform Act of 1974 and the Trade and Tariff Act of 1984 allowed the president to reduce tariffs further and resulted in the lowest tariff rates ever. All of these trade agreement obligations of the US are carried out under General Agreement on Tariffs and Trade (GATT), an international agreement formed in 1947 to further world trade by reducing barriers and tariffs.

 

VI. International Trade Organizations: Widespread efforts to reduce tariffs around the world have led to a growth of international trade organizations.

  1. World Trade Organization (WTO): The successor organization to GATT handles all trade disputes among its 117 member nations. In addition, the WTO agreement will lead to a 40 percent reduction in tariffs worldwide, protection of intellectual property rights, local content laws will be eliminated, and US service suppliers will be subject to the same rules as foreign suppliers in their countries.NAFTA INFOGRAPHIC

  2. Regional Trade Agreements: Other international trade organizations such as the EU and NAFTA known as regional trade blocs also exist. These trade blocs are groups of nations that grant members special trade privileges.

ReadThe Three Faces of Globalization (PDF)

Costs and Benefits of Globalization (PDF)

Dig Deeper
We, the Economy Films: Chapter 4: What is globalization?

WORLD FLAGS CUBE

What is the global trade system? What does it mean to have a globalized economy? And is it good for us? Seven experts break it all down as a troupe of comedic actors enliven the commentary.

What happens when jobs disappear? Detroit has been the poster child for the loss of well-paid manufacturing jobs, but this trend impacts communities all over the country. How does a great American city bounce back?

Is China's boom good for our economy? China is often portrayed as America’s greatest economic competitor and even accused of not playing fair. But is it possible they could be a key ally in US economic development?

What do human rights have to do with the economy? As consumers in a rapidly growing world economy, we have an insatiable appetite for the next greatest electronic gadget, like smart phones and TVs. But can we consume cheap imported products without exploiting someone in the supply chain?

 

VII. The Balance of Payments and International Capital Movements: The balance of payments is a system of accounts that measures transactions of goods, services, income, and financial assets between domestic households, businesses, and governments and between governments and residents of the rest of the world during a specific time period. Balance of payments transactions are normally grouped into three categories: current transactions, capital account transactions and official reserve account transactions.BALANCE OF PAYMENTS

  1. Accounting Identities: Accounting identities are definitions of equivalent values.

  1. Disequilibrium: Disequilibrium exists when the item that brings about a balance in an accounting identity cannot continue indefinitely.

  2. Equilibrium: The accounting identity does not contain a balancing item that cannot go on indefinitely.

  3. An Accounting Identity Among Nations: If a nation interacts with other nations, an accounting identity insures a balance, but not necessarily an equilibrium.

  1. Current Account Transactions: All payments and gifts that are related to the purchase or sale of both goods and services constitute the current account in international trade.

1.   Merchandise Trade Exports and Imports: The largest portion of any nation’s balance of payments current accounts is typically the importing and exporting of merchandise goods. The balance of trade is defined as the difference between the value of merchandise exports and the value of merchandise imports.

2.   Service Exports and Imports: The services exports and imports have to do with invisible or intangible items that are bought and sold, such as shipping, insurance, tourist expenditures, and banking services. Also, income earned by foreigners on U.S. investments and income earned by Americans on foreign investments is part of service imports and exports.

3.   Unilateral Transfers: Americans give gifts to relatives and others abroad. The federal government grants gifts to foreign nations. Foreigners give gifts to Americans and some foreign governments have even granted money to the U.S. government. Net unilateral transfers are the total amount of gifts given by Americans minus the total amount received by Americans from abroad.

4.   Balancing the Current Account: If the sum of net exports plus unilateral transfers plus net investment income exceeds zero, a current account surplus is said to exist; if the sum of net exports plus unilateral transfers plus net investment income is negative, there is a current account deficit.

  1. Capital Account Transactions: Capital account transactions concern the buying and selling of real and financial assets in international transactions. They occur when foreigners invest in the US or Americans invest in other countries. In the absence of interventions by finance ministries or central banks, the current account and capital account must sum to zero. Thus any nation running a current account deficit must also be running a capital account surplus.

  2. Official Reserve Account Transactions: The third type of balance-of-payments transaction concerns official reserve assets:

  1. Foreign currencies

  2. Gold

  3. Special drawing rights (SDRs): These are reserve assets that the International Monetary Fund created to be used by countries to settle international payment obligations.

  4. The reserve position in the International Monetary Fund.

  5. Financial assets held by an official agency, such as the US Treasury Department. This balance added to the sum of the Current and Capital Account balance makes the Balance of Payments equal to zero.

  1. What Affects the Balance of Payments?: The balance of payments is affected by a country’s domestic rate of inflation relative to that its trading partners and relative political stability. Political instability in other countries causes “capital flight,” moving assets to countries that are stable.

ReadBalance of Payments: Fundamental Concepts

Balance of Payments: Categories and Definitions

Watch

 

The Balance Of Payments (2:00)

 

VIII. The Advantages of Trade: International trade brings a number of valuable benefits to a country, including:

Coca Cola in Asia
  1. The exploitation of a country's comparative advantage, which means that trade encourages a country to specialize in producing only those goods and services which it can produce more effectively and efficiently, and at the lowest opportunity cost.

  2. Producing a narrow range of goods and services for the domestic and export market means that a country can produce at higher volumes, which provides further cost benefits in terms of economies of scale.

  3. Trade increases competition and lowers world prices, which provides benefits to consumers by raising the purchasing power of their own income, and leads to a rise in consumer surplus.

  4. Trade also breaks down domestic monopolies, which face competition from more efficient foreign firms.

  1. The quality of goods and services is likely to increase as competition encourages innovation, design and the application of new technologies. Trade will also encourage the transfer of technology between countries.Changes from Trade

  2. Trade is also likely to increase employment, given that employment is closely related to production. Trade means that more will be employed in the export sector and, through the multiplier process, more jobs will be created across the whole economy.

 

IX. The Disadvantages of Trade: Despite the benefits, trade can also have some disadvantages, including:

  1. Trade can lead to over-specialization with workers at risk of losing their jobs should world demand fall or when goods for domestic consumption can be produced more cheaply abroad. Jobs lost through such changes cause severe structural unemployment.

  2. Certain industries do not get a chance to grow because they face competition from more established foreign firms, such as new infant industries which may find it difficult to establish themselves.

  3. Local producers, who may supply a unique product tailored to meet the needs of the domestic market, may suffer because cheaper imports may destroy their market. Over time, the diversity of output in an economy may diminish as local producers leave the market.

 

 Challenges of Globalization

X. Globalization

Globalization is the process of increased interconnectedness among countries most notably in the areas of economics, politics and culture. McDonalds in Japan, French films played in Minneapolis and the United Nations are all representations of globalization.Who's winning and who's losing?

Over many centuries, human societies across the globe have established progressively closer contacts. Recently, the pace of global integration has dramatically increased. Unprecedented changes in communications, transportation and computer technology have given the process new impetus and made the world more interdependent than ever. Multinational corporations manufacture products in many countries and sell to consumers around the world. Money, technology and raw materials move ever more swiftly across national borders. Along with products and finances, ideas and cultures circulate more freely. As a result, laws, economies and social movements are forming at the international level.

The globalized world sweeps away regulation and undermines local and national politics, just as the consolidation of the nation-state swept away local economies, dialects, cultures and political forms. Globalization creates new markets and wealth, even as it causes widespread suffering, disorder and unrest. It is both a source of repression and a catalyst for global movements of social justice and emancipation. The great financial crisis of 2008-09 revealed the dangers of an unstable, deregulated, global economy but it also gave rise to important global initiatives for change.

The idea of globalization may be simplified by identifying several key characteristics.Tecnology and Trade

  1. Improved Technology in Transportation and Telecommunications

    What makes the rest of this list possible is the ever-increasing capacity for and efficiency of how people and things move and communicate. In years past, people across the globe did not have the ability to communicate and could not interact without difficulty. Today, a phone, instant message, fax or video conference call is easily available to connect people. Additionally, anyone with the funds can book a plane flight and show up half way across the world in a matter of hours. In short, the "friction of distance" is lessened and the world begins to metaphorically shrink.

  2. Movement of People and Capital

A general increase in awareness, opportunity and transportation technology has allowed people to move about the world in search of a new home, a new job or to flee a place of danger. Most migration takes place within or between developing countries, possibly because lower standards of living and lower wages push individuals to places with a greater chance for economic success.

Additionally, we move capital (money) globally with the ease of electronic transference and a rise in perceived investment opportunities. Developing countries are a popular place for investors to place their capital because of the enormous room for growth.

  1. Diffusion of Knowledge

The word 'diffusion' simply means to spread out, and that is exactly what any new-found knowledge does. When a new invention or way of doing something pops up, it does not stay secret for long.

A good example of this is the appearance of automotive farming machines in Southeast Asia, an area long home to manual agricultural labor.

  1. Non-Governmental Organizations (NGOs) and Multinational Corporations (MNCs)

MNCs: Kentucky Fried Chicken and McDonalds

As global awareness of certain issues has risen, so too has the number of organizations that aim to deal with them. So called non-governmental organizations, nationally- or globally-focused, bring together people unaffiliated with the government. Many international NGOs deal with issues that do not stop at borders, such as global climate change, energy use or child labor regulations. Examples of NGOs include Amnesty International, the International Red Cross or Doctors without Borders.

As countries connect to the rest of the world (through increased communication and transportation), they immediately form what a business would call a market. A particular population represents more people to buy a particular product or service. As more and more markets open up, business people from around the globe come together to form multinational corporations in order to access these new markets. Another reason that businesses are going global is outsourcing, meaning that some jobs can be done by foreign workers for a much cheaper cost than by domestic workers.

At its core globalization is an easing of borders, making them less important as countries become dependent on each other to thrive. Some scholars claim that governments are becoming less influential in the face of an increasingly economic world. Others contest this, insisting that governments are becoming more important because of the need for regulation and order in such a complex world system.

  1. Is Globalization a Good Thing?Globalized Wal-Mart

    The advantages and disadvantages of globalization have been heavily scrutinized and debated in recent years. Proponents of globalization say that it helps developing nations "catch up" to industrialized nations much faster through increased employment and technological advances. Critics of globalization say that it weakens national sovereignty and allows rich nations to ship domestic jobs overseas where labor is much cheaper. Good or bad, though, there isn't much argument as to whether or not it is happening. Look at the positives and negatives of globalization, and decide for yourself whether or not it is the best thing for the world.

1.   Positive Aspects of Globalization

a. As more money is poured in to developing countries, there is a greater chance for the people in those countries to economically succeed and increase their standard of living.

b. Global competition encourages creativity and innovation and keeps prices for commodities/services in check.

c. Developing countries are able to reap the benefits of current technology without undergoing many of the growing pains associated with development of these technologies.

d. Governments are able to better work together towards common goals now that there is an advantage in cooperation, an improved ability to interact and coordinate and a global awareness of issues.

e. There is a greater access to foreign culture in the form of movies, music, food, clothing and more. In short, the world has more choices.

 

Watch

 

Globalization I - The Upside: Crash Course World History #41 (11:51)

 

 

MNCs

2.   Negative Aspects of Globalization

a. Outsourcing, while it provides jobs to a population in one country, takes away those jobs from another country, leaving many without opportunities.

b. Although different cultures from around the world are able to interact, they begin to meld, and the contours and individuality of each begin to fade.

c. There may be a greater chance of disease spreading worldwide, as well as invasive species that could prove devastating in non-native ecosystems.

d. There is little international regulation, an unfortunate fact that could have dire consequences for the safety of people and the environment.

e. Large Western-driven organizations such as the International Monetary Fund and the World Bank make it easy for a developing country to obtain a loan. However, a Western-focus is often applied to a non-Western situation, resulting in failed progress.

 

Watch

 

Globalization II - Good or Bad?: Crash Course in World History #42 (13:54)

 

ReadSectors of the Economy

What is the Impact of Globalization? (1st screen only)

Globalization cartoon

Dig DeeperGlobalization - Global Policy Forum

Globalization | Center for Global Development

The Globalization Website - Emory University

infed.org | Globalization: Theory and Experience

What Is International Economics?

Making the Case for a Global Brand

Introduction to Outsourcing

Investopedia: Globalization

Gap between Economic Elite and General Public Created Not by Differences in Expertise but in Priorities

 

Just for fun: The Great Drama that is Globalization (Animation 2:36)

Test Yourself

 

Test Yourself: Global Trade

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Copyright 1996 Amy S Glenn
Last updated:   10/19/2017   2200

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