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WORLD ECONOMY

Introduction.

As a member of the government of a nation on the periphery of


Europe currently considering the benefits that European Union (EU)
membership may provide for my nation. I will take into account 15
elements and with the best of my knowledge I will outline the
advantages and disadvantages of joining the EU.

First of all, I will explain in short about EU, The EU currently consists
of 27 members (independent countries).
The EU was formed through many steps the process started in late
50’s whereby it was set up with the aim of ending the frequent and
bloody wars between neighbours, which culminated in the Second
World War.

The EU of today was formed in 1992 with different aims and


objectives such as to promote peace, its values and the well-being of
its peoples, offer its citizens an area of freedom, security and justice
without internal frontiers, and an internal market where competition is
free and undistorted and promote economic, social and territorial
cohesion and solidarity among member states.

Main body.

The following are the 15 elements and their explanations that I will
consider as a member of a government of a nation currently
considering the benefits that EU membership may provide for my
nation.

1. Three gains from trading internationally

International trade involves the exchange of goods and services


across international boundaries.
As a member of the government I advice my country to be a member
of EU as through it the country will be able to trade internationally and
gain the following: -
Access to larger markets (economies of scale), as soon as our
country join the EU we will have the access to trade with different
countries in the EU and be able to buy and sale in a wider market.

Through international trade a country can purchase cheap goods: -


goods which are expensive in country A can be bought cheaply from
country B and from this country a can enjoy the value of goods
through international trade.

Another gain of international trade is that a country can get goods


which are not available in the country, for example through
international trade UK’s residents can purchase Mercedes from
Germany or cars from Japan.

2. Free trade

Free trade is a situation in which there are no artificial barriers to


trade, such as tariffs and NTBs.
It refers to the unrestricted or unimpeded process of conducting
business or transactions. It can also be defined as a system of trade
policy that allows traders to act and transact without the interference
from the government.

A recent example of free trade is when ‘’Barack Obama backed a


return to the Doha free trade talks at the G20 summit’’ quoted from
the guardian.
3. Absolute and Comparative advantage

In case of absolute advantage it exists when a country is able to


produce a good more cheaply in absolute terms than another country.
It is assumed that each country is more efficient than the other in the
production of one of the commodities.

• Country A can produce 1000 parts per hour with 200 workers.
• Country B can produce 2500 parts per hour with 200 workers.
• Country C can produce 10000 parts per hour with 200 workers.

Considering that labor and material costs are all equivalent, Country
C has the absolute advantage over both Country B and Country A
because it can produce the most parts per hour at the same cost as
other nations. Country B has an absolute advantage over Country A
because it can produce more parts per hour with the same number of
employees. Country A has no absolute advantage because it can't
produce more goods than either Country B or Country C given the
same input

Comparative advantage exists when a country is able to produce a


good more cheaply relative to other goods produced domestically
than another country.
In this case one country is more efficient than the other in the
production of both commodities. It is assumed that country A is the
more efficient country; it has an absolute advantage over country B in
both industries.

Assume that there are only two goods, cars and computers, and one
productive resource which is some composite of land, labor, and
capital. Assume also that producing 100 cars requires two units of the
productive resource (PR) in the United Kingdom and four units in
Brazil, and producing 1,000 computers requires three units of PR in
the United Kingdom and four in Brazil.
Thus: U.K BRAZIL
100 cars 2 4
1000 computers 3 4

UK has an absolute advantage in producing both cars and


computers. It may seem that UK can realize no gain by trading with
Brazilians. Why not produce both cars and computers here? Because
it costs more to produce computers in the UK than in Brazil. All costs
are opportunity costs. The cost of producing computers is the cars
that could have been produced. Using the three units of PR required
to produce 1,000 computers in the United Kingdom requires
sacrificing the production of 150 cars. Using the four units of PR
required to produce 1,000 computers in Brazil requires sacrificing
only 100 cars. So even though UK has an absolute advantage in
producing computers, Brazilians have a comparative advantage.
Compared to what has to be sacrificed, Brazil produces computers
for only two-thirds as much as it costs in the United States. The
United Kingdom, of course, has a comparative advantage over Brazil
in the production of cars. Producing 100 cars here costs 666
computers, while producing 100 cars in Brazil costs 1,000 computers.
Clearly the UK benefits from specializing in cars, which it produces
more cheaply than Brazil, and trading with Brazil for some of the
computers it produces more cheaply. If, for example, the UK
produced both cars and computers it might devote 70 units of PR to
car production and 30 units to computer production, yielding 3,500
cars and 10,000 computers. If Brazil produced both products, it might
devote 56 units of PR to car production and 24 to computer
production, yielding 1,400 cars and 6,000 computers. On the other
hand, by specializing in their comparative advantages, the UK can
produce 5,000 cars and Brazil can produce 20,000 computers, or a
total of 100 additional cars and 4,000 additional computers. The UK
could trade 1,450 cars to Brazil for 12,500 computers and have 50
additional cars (3,550) and 2,500 more computers (12,500), while
Brazil would have 50 more cars (1,450) and 1,500 more computers
(7,500). Trade is productive since it generates more output of both
products.
4. Protectionism

Protectionism is the restriction of international trade. It prevents


consumers and producers reaching the equilibrium price and quantity
that would prevail in a free market. Every country operates some form
of restriction on its trade with the rest of the world.

An example of protectionism is the way the cotton farmers in the USA


are protected by a quota system. The US government tries to ensure
that these farmers receive a stable income. If the price of raw cotton
in the USA falls below a certain level, then the government will begin
to limit the amount of cotton imported into the country.

This makes life difficult for cotton farmers in poorer countries because
they are uncertain from year to year how much of their cotton will be
bought.

5. Barriers to trade

Tariffs, these can also be called customs duties and are the most well
know barrier. They act in exactly the same way as tax by artificially
raising the price of foreign products as they enter the country.
For example in China complete vehicles attract tariffs of 25% of the
price of car imported so if manufactures want to avoid the tariff, they
have to buy parts locally.

Product standard regulations, this is where a country can use health


and safety regulations to limit imports.
For example in UK the country uses this method to prevent some of
Japanese cars such as Balloon.
6. The role of World trading organization in the
development of free trade.

A key rule to multilateral trade system is that reductions in trade


barriers should be applied, on a most-favoured nation basis, to all
WTO members.
The role of WTO is to ensure that no member is discriminated against
by another member’s trade regime. However, regional trade
agreements (RTAs) are an important exception to this rule. Under
RTAs reductions in trade barriers apply only to parties to the
agreement.

Another role of WTO is facilitating the implementation, administration


and operation and furthering the objectives of the agreement
establishing it and other Multilateral trade agreements and providing
the framework for the implementation, administration and operation of
the Plurality trade agreements.

7. The role of EU in promoting trade

Recently the EU has launched its strategy of promoting trade and the
strategy has targeted, inter alia,
• Smart and green growth (in particular in terms of limiting
greenhouse emission and encouraging renewable
energies and energy efficiency)
• Job creation (employment rate should increase from the
current 69% to at least 75% by 2020
• Boosting innovation and the digital economy (investing
3% of GDP in R&D)
• Higher education, training and lifelong learning, and
• Poverty reduction in Europe ( lifting over 20 million people
out of poverty)
8. Balance of payment

It is a record of all transactions made between one particular country


and all other countries during a specified period of time. Balance of
payment compares the dollar difference of the amount of exports and
imports.
A negative balance of payments means that more money is flowing
out of the country than coming in, and vice versa.
It may be used as an indicator of economic and political stability.
For example, if a country has consistently positive BOP, this could
mean that there is significant foreign investment within that country. It
may also mean that the country does not export much of its currency.
It is just another economic indicator of a country’s relative value and,
along with all other indicators, should be used with caution. The BOP
includes trade balance, foreign investments and investments by
foreigners.

This is a measure of the extent of trade between one country and the
rest of the world. This trade is referred to as imports and exports,
which in balance of payments accounting is looked at in terms of the
change of ownership of resources linked to the payment for the
change of ownership.

• Imports represent the purchase of items from abroad that result


in sterling being sold to acquire the foreign currency used to
purchase the item. This is recorded as an outflow of funds.
• Exports are the sale of items to other countries leading to
sterling being purchased by foreign buyers to complete the
transaction. This is recorded as an inflow of funds.

It is important to think of imports and exports in terms of the flow of


funds as it helps to avoid the confusion that can arise when thinking
of goods and services being traded. For example, a foreign tourist
coming to visit Britain represents export earnings to the UK as they
are changing their currency to spend sterling whilst on their visit. In
summary, exports lead to a demand for sterling on the foreign
exchange markets and imports lead to an increase in supply of
sterling on the foreign exchange markets.
The trade is divided into different categories.

• Trade in goods records the import and export of items such as


cars, animals, timber, minerals, chemicals, food, textiles, glass,
leather products, paper products, fuels, plastics, metal products,
machinery, weapons, electrical goods, transport equipment,
sports goods, watches and waste products amongst others! The
difference between the value of imports and the value of exports
is called the 'Balance of Trade' or the 'Trade in Goods'.
• Trade in services records transactions in what used to be
referred to as 'invisible trade' - the 'invisible' term aiming to
describe the non-physical nature of the trade. Such transactions
may include transportation - payments made to a haulage
contractor to deliver goods abroad; the hire by a UK company of
a freight ship to transport items; the payments made to use an
aircraft for transporting items; payments to use pipelines or
cables; travel by foreign visitors or by UK residents to other
countries; the purchase and sale of communication services,
insurance, financial and banking services; royalty payments;
government services, license fees, payments for the use of TV
programmes and so on.
• Income flows measure the payments and receipts of dividends
and interest and financial flows measure the payment and receipt
of funds associated with investments in shares, loans and other
securities.
Together all these inflows and outflows comprise the balance of
payments on Current Account. It is this figure that comprises the
major bulk of the balance of payments but often the trade figures
highlighted will relate just to the trade in goods and services as this
serves to illustrate the key trends in our trading patterns.

Figures for the Balance of Payments on Current Account for the UK:
2001 - 2003.
Source: http://www.statistics.gov.uk/pdfdir/bop0903.pdf
Reproduced under license from HMSO

The final part of the balance of payments is the capital account. This
records the transfers of funds. They might include foreign aid, funds
brought by migrants to the UK, money received from the EU Regional
Fund and funds from the purchase and sale of assets and liabilities
including so called 'debt forgiveness'.

9. General trends in UK trade over the last 30 years

Current account

The UK has recorded a current account deficit in every year since


1984. Prior to 1984, the current account recorded a surplus in 1980 to
1983. Since the last surplus was recorded in 1983, there have been
four main phases in the development of the current account. In the
first phase, from 1984 to 1989, the current account deficit increased
steadily to reach a high of £25.5 billion in 1989, equivalent to -4.9 per
cent of Gross Domestic Product (GDP). During the second phase,
from 1990 until 1997, the current account deficit declined to a low of
£1.0 billion in 1997. In the third phase, between 1998 and 2006, the
current account deficit widened sharply, peaking at £44.9 billion in
2006. This was the highest recorded in cash terms but only equated
to -3.4 per cent of GDP. In the past two years there has been a
reduction in the current account deficit – in 2009 it currently stands at
£15.5 billion, equivalent to -1.1 per cent of GDP. The profile for the
current account has historically followed that of trade in goods, its
biggest and most cyclical component. That pattern was broadly
followed until it changed in 2001. The pattern re-emerged in 2004 to
2006 with an increasing deficit on trade in goods being mirrored by an
increase in the current account deficit. In 2007 and 2008, once more
there was a change in direction of the movements of trade in goods
to the movements in the overall current account balance. In 2009
however, the decrease in the trade in goods deficit once again
broadly matched the fall in the current account deficit.

The last trade in goods surplus, recorded in 1982, contributed to a


current account surplus. Following 1982, the goods balance went into
deficit and this increased to a peak of £24.7 billion in 1989, while the
current balance deteriorated to a deficit of £25.5 billion. From 1989
until the late 1990s, both the trade in goods and current account
deficits broadly fell and then subsequently rose. From 2001 to 2003,
while the goods deficit continued to grow, the current account deficit
narrowed due to a widening income surplus. From 2004 the deficit on
trade in goods increased, matched by a rise in the current account
deficit. In 2007 and 2008 however, the increasing deficit on trade in
goods was more than offset by increasing surpluses on both trade in
services and income. This reduced the current account deficit by £8.5
billion in 2007 and by a further £12.7 billion in 2008. In 2009 the
£11.2 billion decrease in the deficit for Trade in Goods drove the £8.3
billion decline in the current account deficit.

Source the pink book 2010

10. How balance of payments is affected by exchange


rates

The Exchange Rate is the value of one currency expressed in terms


of another - for example, £1 = $1.60. The exchange rates are
determined by the demand for and supply of sterling on the foreign
exchange markets. Note, it is NOT the same as the supply of money
in circulation! The foreign exchange market exists to enable those
who wish to buy foreign currency to 'meet' with those who wish to sell
it. Currency exchange markets are truly global; in any one-day
around $1.5 trillion worth of currencies are traded. A trillion is one
thousand billion! So that is $1,500,000,000,000 or £900,000,000,000
traded every day world wide! This is almost as much as UK Gross
Domestic Product (GDP) in a year. A large proportion - possibly as
much as 70 - 80% of this trade is for speculative purposes rather than
to finance trade; brokers simply moving funds from one financial
centre to another in search of the best return on behalf of clients.
Increases in the demand for GBP leads to an appreciation of sterling
- each £1 will buy more of the foreign currency than previously
whereas if the supply of GBP exceeds the demand, sterling will
depreciate - each £1 will buy less of a foreign currency than before.
Changes in the exchange rate have an effect on the apparent prices
of imports and exports. The term 'apparent' is used because the price
in the originating country may not have changed but for the buyer or
seller the fact that they may have to give up more of their own
currency to acquire the same amount of pounds, or if they can get the
same amount of the foreign currency by giving up less pounds, then
prices will appear to change. An appreciation or strengthening of a
currency will have the effect of reducing import prices, but increasing
export prices, whereas a depreciation of the currency (a weakening)
will lead to import prices rising but export prices appearing to fall. The
impact on the economy as a whole and of individual businesses
therefore depends on the amount of trade they carry out with the rest
of the world and the proportion of that trade that is accounted for by
exports and imports. A firm may, for example, buy in some
component parts from China but sell the vast majority of its output in
Europe. What is happening to the exchange rate between the Yuan
and the Euro will have a significant effect on its overall position.

• Appreciation of the £ - buys more of a foreign currency; Import


prices fall; Export prices rise.
• Depreciation of the £ - buys less of a foreign currency; Import
prices rise; Export prices fall.
The value of the £ sterling (GBP) against the United States dollar ($)
2000 - 2003.
Source:http://www.statistics.gov.uk/
Because the UK is a relatively small island, we do tend to rely on
importing raw materials and component parts for business. If the
exchange rate weakens, this means that import prices rise and, other
things being equal, could lead to an increase in business costs. This
could have inflationary consequences if firms pass on the increased
costs in the form of higher prices to customers. Alternatively,
businesses may resist putting prices up but may have to accept lower
profit margins or find ways of reducing costs elsewhere.
There is also a close link between the trade deficit and the state of
the economy. In times of economic growth, there is a relatively high
level of demand - some of which will be demand for goods from
abroad. At the same time, exporters may recognise that there is a
buoyant demand in the UK and switch sales from export markets to
those in the domestic market. The net effect is for exports to fall and
imports to rise thus contributing to the widening of the deficit. The
issue is made all the more complex because the traditional theoretical
explanation can be rendered inaccurate because of the impact of the
price elasticity of demand for imports and exports.
In theory, if the exchange rate weakens, this would be a boost to UK
exports whereas import prices rising would dampen demand for
imports. As a result the trade deficit would narrow. But we need to
distinguish between the amount traded (volume) and the payments or
earnings from trade. If the price elasticity of demand for imports was
inelastic, then an apparent rise in the price of imports of, say 10%,
would lead to a fall in demand of less than 10%, total expenditure on
imports would actually rise, and assuming other things remained
equal, the trade deficit would get worse not better! The activity will try
to help you make sense of some of these relationships

11. ADVANTAGES AND DIADVANTAGES OF THE


SINGLE CURRENCY FOR THE UK.

ADVANTAGES

Rival to the "Big Two".


If we look out in the world today we can see strong currencies such
as the Japanese Yen and The American $. America and Japan both
have strong economies and have millions of inhabitants. A newly
found monetary union and a new currency in Europe could be a rival
to the "BIG TWO".
EMU can be self-supporting and so they could survive without trading
with anyone outside the EMU area.
This fact makes the Euro very strong already, and even George
Soros couldn't affect it (well, hopefully!!!!).
The situation that EMU is in is good as it seems that it can survive on
its own, with or without the help of Japan and U.S.A.

Transaction costs will be eliminated.


For instance, Uk firms currently spend about £1.5 billion a year
buying and selling foreign currencies to do business in the EU.
With the EMU this is eliminated, so increasing profitability of EU firms.

Advice to young people: You can go on holiday and not have to worry
about getting your money changed, therefore avoiding high
conversion charges

DISADVANTAGES

The instability of the system.


Throughout most of the 1980s the UK refused to join the ERM
(Exchange rate mechanism). It argued that it would be impossible to
maintain exchange rate stability within the ERM, especially in the
early 1980s when the pound was a petro-currency and when the UK
inflation rate was consistently above that of Germany. When the UK
joined the ERM in 1990 there had been three years of relative
currency stability in Europe and it looked as though the system had
become relatively robust. The events of Sept. 1992, when the UK and
Italy were forced to leave the system, showed that the system was
much less robust than had been thought.

Loss of Sovereignty.
On the political side, it is argued that an independent central bank is
undemocratic. Governments must be able to control the actions of the
central banks because Governments have been democratically
elected by the people, whereas an independent central bank would
be controlled by a non elected body. Moreover, there would be a
considerable loss of sovereignty. Power would be transferred from
London to Brussels. This would be highly undesirable because
national governments would lose the ability to control policy. It would
be one more step down the road towards a Europe where Brussels
was akin to Westminster and Westminster akin to a local authority.
12.EFFECTS OF SINGLE CURRENCY ON
INDIVIDUALS AND ON BUSINESS

It makes firms wary when investing in other countries because of the


uncertainty caused by the fluctuating currencies in the EU.
Investment would rise in the EMU area as the currency is universal
within the area; therefore the anxiety that was previously apparent is
there no more

Since that trade and everything else should operate more effectively
and efficiently with the Euro. Single currency in a single market
seems to be the way forward.
It provides simplicity to the firms/business as they do not have to
worry about the drop of value of money due to exchange as they can
trade using the single currency.

13. CHARACTERISTICS OF LESS DEVELOPED


COUNTRIES (LDCs).

Less developed countries are also called 3rd world countries.


There are many characteristics of less developed countries; the
following are just the two of many: -

Poor infrastructures and social services, in less developed countries it


is very often to find a good school and education, hospital, roads,
railways and other social services and infrastructures.
Most of these important services are in very poor condition if not
there at all.
For example in Tanzania when a person is sick and can not afford the
private hospitals then he/she will go and suffer in the government
hospitals which do not offer good treatment and most of the times in
order for the patient to be well taken care of bribery must work
effectively.
Another characteristic of less developed countries is poor standard of
living which results to low age life expectancy and high mortality rate
due to diseases and lack of food and clean water.
Since that people are poor they do not eat well and clean food and
water and this result to cholera and other diseases and it kills many
people.
And this increases poverty each day because many of the youths
who could have help the development of the country later die.

14.AN ANALYSIS OF TWO CURRENT ISSUES THAT


FACE LDCs.

Currently one of the issues facing LDCs is civil wars.


In many less developed countries civil wars are exploding each day.
For example the civil wars in Somalia and DRC.
And this is mainly caused by the corrupted system and the corrupted
leaders.

Another issue that faces LDCs currently is hunger.


Due to low standard of living, poverty, civil wars and lack of food
production many LDCs face a problem of hunger and many people
die.
For example Darfur in Sudan where by it is unexplained how people
die because of hunger while help can reach them but due to the
corrupted system and leaders people die everyday.

15. IMPACTS OF MULTINATIONAL COMPANIES ON


NEWLY INDUSTRALISING COUNTRIES AND LDCs.

The presence and activities of multinational corporations in the


developing world have been the subject of controversy in discussions
on development policy. The theoretical background for the negative
verdict is largely from the ideological left (for example, the theory of
peripheral capitalism and Latin American dependency theories). The
skepticism shown is often partly based on negative experiences in
the late 1960s and early 1970s, with blatant examples of incorrect
behavior - e.g. inappropriate influence of political decisions,
exploitative wages and poor social conditions. In recent years the
impact on developing countries of multinational corporations has
been judged more favorably.

Comparative surveys by the International Labor Organization (ILO) of


social conditions, effects on employment, choice of technology and
training by multinationals and local companies paint a positive picture
for multinationals - certainly in comparison with local companies. This
view is confirmed by studies from the UN Center for Transnational
Corporations (UNCTC) since the early eighties.

Positive contribution to development


Most multinationals make a positive contribution to the economic
growth of developing countries through their investments, products
and services. This is primarily through:

• translating theoretical knowledge into practical results by the correct


use of their products and services, for example in agriculture, health
and industry;

• providing access to modern technological and management know-


how (e.g. research, development, marketing, finance);

• investment and employment

• training in all areas, on all hierarchical levels.

The benefits for host countries from a multinational's presence vary


according to its structure, product range, services and sphere of
activity. Suitable regulatory and financial conditions, a dependable
legal system, an adequate infrastructure and a well-functioning
government help reinforce such potentially positive effects, while their
absence prevents or hinders them.

As is the case with any economic or social activity, multinationals in


developing countries can also generate conflicts of interest.

Conflicts of interest
A commercial enterprise seeking profit optimization pursues its own
corporate objectives such as achieving an acceptable rate of return
on invested capital, gaining market share, or ensuring its long term
competitiveness, rather than supporting the host country's economic
and social development objectives. The result is that corporations
and host country authorities have diverging opinions on very
fundamental issues:

• Repatriation of profits to the parent company is in most cases


essential in order to contribute to overhead costs incurred at
headquarters (e.g. for research and development) as well as to
corporate profits as repayment for financial risks. Host countries often
consider this a regrettable drain on limited foreign exchange and a
burden on the balance of payments.

• Patents which safeguard the results of a company's research and


the associated transfer of patent and licensing fees may lead to
conflicts because developing countries prefer the lower priced
product imitations (e.g. generics).

• A corporation's research policy and its strategic direction may also


not coincide with the developing country's interests and needs.

• A company's location policy, for example of production facilities, is


largely determined by economic criteria (e.g. volume of production,
market size, availability of high quality raw materials and technical
skills), and not by a government's need to become self-sufficient
through the local production of specific goods.

There are other potential areas of conflict that differ from company to
company and country to country. Solving such conflicts requires a
serious evaluation of the interests of and benefits to both parties,
taking the overall social and economic benefit of a company and
product concerned into consideration. There are no universally valid
answers.

Ethical behavior
Corporations that act responsibly in a number of obvious areas
reduce the potential for conflict between a socially and economically
viable development policy and the impact of a corporation's
involvement in a developing country. In this context these are the
minimum requirements for good business practices:
• As far as the consumer is concerned, there should be no
fundamental difference between industrialized and developing
countries in the quality of products and services, their safety and
information for their use (e.g. indications and side-effects of drugs).

• The same objectives and principles must be adopted in the safety of


production and environmental protection all over the world. Double
standards in areas which affect the lives and health of people are
unacceptable.

• If better information or greater insight reveals problem areas which


fall within the responsibility of a company, it must take corrective
action, regardless of existing regulations.

• Multinationals should set an example in their wage and social


policies. Applying the standards of local industry or simply observing
the legal minimum is, in many cases, inappropriate for the social
conditions in poor countries.

A multinational corporation which operates in different legal and


social frameworks, and which strives for uniform ethical standards, is
well advised to develop corporate policies for sensitive activities in
the developing world - whether in marketing, environmental protection
or other areas. Not everything legal is morally acceptable.