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- If there is a specialization a country can keep the good that it has not
exported and can import the good it is not good at producing – gain both
at lower costs – and vice versa
- Countries are able to consumer at a point beyond their PPCs – amount
of gain depends on exchange rates
Does the theory of comparative advantage always work (HL)
- Only works when there are different opportunity costs – if they are the
same there are no gains to be made from trade
What gives a country a comparative advantage (HL)
- Based on abundance of certain factors – land agriculture, unskilled
labour production of manufactured goods, educated labour
financial services, beaches tourism – price of factor is lower than the
price of other factors – making opportunity cost pf things using that
factor be lower than in other countries
Limitations of comparative advantage (HL)
- Assumption of perfect knowledge of where the least expensive goods
may be purchased
- Assumption that there are no transport costs – those costs may erode the comparative
advantage and eliminate its competitiveness
- Normally assumes that there are two economies producing two goods – this however
can be overcome with technology and simulations – comparative advantage may be
found in multiple countries
- Assumption that costs do not change – economies of scale, however, do exist – costs
fall
- Non-identical goods – consumer durables – are harder to compare and see if a country
has a comparative advantage or not
o E.g., Japan’s Toshiba television vs Phillips television
- Factors of production do not necessarily remain in the country that has the advantage
– capital may be moved to developing countries instead
- Free trade might not necessarily be present – government trade barriers may be placed
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o Works in the short-run and the issue is not fixed + other countries may also
impose similar measures
Arguments against trade protection
- Raised prices to consumers and producers of imports
- Less choice for consumers
- Reduced competition, firms become inefficient, innovation is reduced, export
competitiveness may be reduced
- Comparative advantage is distorted – inefficient use of resources; specialization is
reduced
- Trade war
- Economic growth may be hindered (see previous reasons)
Main types of protectionism
Tariffs
- Tax charged on import goods – supply shift upward by amount of
tax (World Supply curve)
o When supply is shifted domestic producers receive more
revenue – from g to g+a+b+c+h and foreign producers
receive less, from h+i+j+k to i+j and government receives
d+e
o Dead-weight loss – loss of consumer surplus at point f
o Dead-weight loss – loss of producer surplus at h+c – inefficiency of the firms
against the export producers – more resources are used than necessary
- Importers pay higher prices – it would thus increase costs of production, forcing
consumers to pay more, and thus reducing international competitiveness
o E.g., Car production
- Can be used as an anti-dumping measure
International trade subsidies
- Subsidy to domestic producers to make them competitive – S shifts to the right
o Producers produce at point Q3, revenue increases from a
to a+b+e+f+g, Exporters Q3Q2 revenue falls from b+c+d
to c+d, government pays at points e+f+g
o Dead-weight lost at points b+g – inefficient production
and allocation of resources – other producers would
produce at point b
o No consumer loss however in long-term they might have
to pay higher taxes to fund those subsidies
Quotas
- Physical limit on number/value of imported goods
o A quota is imposed on Q1Q3 point – therefore all imports at points Q3Q2 are
not allowed to be imported
o As price at point Q3 is higher at Pquota domestic producers begin increasing
production shifting it – demand falls to point Q4
o Domestic producers’ revenue = from a to a+c+d+f+i+j
o Foreign producers’ revenue = from b+c+d+e to b+g+h
o Dead weight loss – consumer surplus loss at k
o Dead weight loss – domestic producers produce at c+d+j – inefficient
allocation of resources
Administrative barriers
- Red tape: administrative process for imported goods – ports that are hard to reach,
lengthy paperwork, legal work = slows down imports
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2. Portfolio investment:
a. Measure of stock/bond purchases, treasury bills buying/selling + savings
account
b. Investor is putting money expecting that interest will be paid on investment
and money will be repaid
3. Reserve assets:
a. Reserves of gold/foreign currencies – movements in and out of financial
account ensure that balance of payments balance to zero
b. If there is a surplus – reserve increases, deficit – decreases
c. Net changes in official reserve account that balances the accounts
Does balance of payments balance
- Too many transactions are taking place to be sure – net errors and
omissions/statistical discrepancy is used in order to balance the accounts
Relationship between current account and exchange rate (HL)
- Deficit in current account results in downward pressure on exchange rate – fixed
exchange system – too high of a value has been set
o The government could increase capital and financial account or use reserve
assets however these could run out and the rate would have to be devalued
o If there is a surplus – the rate is too low and will result in revaluation of the
currency
- Floating exchange rate system – deficit implies that there is an excess supply of
currency – demand for exports fell/demand for imports increased = exchange rate
falls, improving country’s competitiveness
o If there is a surplus – the rate will rise – decreasing competitiveness of
exports and lowering price of imports
Consequences of current account imbalances (HL)
Consequences of a current account deficit (HL)
1. To increase capital account the country may use its reserves – written as a positive
entry in a capital account; HOWEVER, in long-term those reserves could run out
2. FDI can be financing the deficit, it is also believed that too much ownership of
domestic assets can be a threat to economic sovereignty; MOREOVER, if there is a
drop in confidence then FDI could be pulled out and the currency value will fall
3. The deficit could be financed by high levels of lending – high interest rates have to be
paid which drains the economy and creates a further level of debt
4. High levels of debt leads to lower credit ranking, which creates uncertainty to invest
and makes it harder to borrow because of the risk to invest
a. E.g., UK credit ranking was downgraded from AA1 to AA2 in 2017 following
Brexit decision
5. Central bank might lower interest rates to lower exchange rates; however, this creates
an inflationary pressure in the economy
6. AD shifts to the left = reduced economic growth and causes unemployment
Consequences of current account surpluses (HL)
A country can have structural and cyclical (short-term) factors for having an account surplus.
- Structural factors include:
o Long-run competitive advantage in certain goods production – low prices and
high export demands
E.g., South Korea and electronics
o High savings ratio in households which makes imports and overall
consumption levels lower
E.g., Germany has an 11% savings ratio from disposable income
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o E.g., if both are inelastic that expenditure increases and revenues decrease,
making the current account deficit worse
- It should be noted that over time elasticity increases and in the long-run countries
could meet the Marshall-Lerner condition
J-Curve (HL)
- In the short-run the current account deficit gets worse before it gets better – J-curve
effect
- As the rate is devalued/depreciated the price will fall
but because communication is not perfect other
countries need time to realise that prices have fallen +
those who have contracts cannot change suppliers
quickly
- PED is inelastic in short run for both imports and
exports = increasing current account deficit
- In the long run PED increases, making exports and
imports PED satisfy the M-L condition, improving the
current account balance
- Created in 2012 to set goals that meet urgent challenges that the worlds faces –
extension of MDGs (Millennium Development Goals) and are helping to shift the
world onto a sustainable path
Relationship between sustainability and poverty (HL)
- Poor rely on environment for food, fuel, sanitation – creates more environmental
problems – deforestation and the need of wood by poor results in poverty traps
- Poor don’t own land, don’t have sufficient agricultural knowledge and productivity =
pushes them into a deeper poverty cycle and threatens sustainability of land as a
source
- Poor are more affected by floods and catastrophes, while being the least likely
contributors to it – developing countries cannot afford climate crisis aversion
Do developing countries have common characteristics
- Common characteristics include:
1. Low standards of living due to low incomes, inequality, poor health and poor
education: low standards of loving are experienced by majority because of the
factors above
2. Low levels of productivity: low education standards and health as well as
access to technology and physical capital investments results in lower amount of
output per person
3. High rates of population growth and dependency burdens: crude birth rates
that are double the ones in developed countries (annual number of births/1000)
World average – 18.2 but some countries have over 40
E.g., Niger 44.2 in 201; Spain 9.2
• High crude rates mean that there are a lot of young people that have
to support more children than there is workforce in developed
countries
• Child dependency ratio: nonproductive as a percentage of those in the
working force:
Health Measures
1. Life expectancy at birth
- Average #years person is expected to live from the time they are born
- Used in HDI
- Factors that can lead to high numbers:
o Good level of health care and services
o Good water supplies and sanitation
o Education
o Food
o Diets
o Low levels of poverty
o Lack of conflict
2. Infant mortality rate:
- Number of deaths under the age of one/per 1k births
- Affected by
o Level of health care
o Clean water
o Food
o Level of poverty
Education measures
1. Expected years of schooling
2. Mean years of schooling
- Includes University – mean average of schooling by people who are 25 and older
Single indicators
1. Economic/social inequality
- Income and wealth distribution
- Pay inequality
- Asset ownership
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- Access to credit
2. Energy
- Inability to maintain the home at an adequate temperature/provide energy services
to ensure decent living conditions
- Access to electricity
- Impact of energy bills on household
- Maintain home at an adequate temperature
3. Environment
- Air pollution
- Climate change
- Biodiversity
- Waste
- Ocean temperatures
- Gas emissions
Overall: are too specific to highlight progress, therefore are most likely used in a composite
indicator
HDI
- Long and healthy life
o Life expectancy at birth
o Education by mean years of schooling
o Standard of living (ability to meet basic needs)
- Measured by
o GNI per capita at PPP
- Value between 0 and 1 (1 being high level of development)
- HDI = success in translating the benefits of national income into economic
development
- Example: South Africa – 90th GNI per capita, 113th for HDI
- HDI = assess development of the country, not economic growth
- More effective than GDP
- Average = masks inequalities = rural and urban areas, men and women, ethnic
groups
- Example: Iceland HDI – 6th, IHDI – 1st, Hong Kong – 7th HDI, 21st IHDI – more
problems in inequality
Summary
- GNI is not a good indicator of living standards - says nothing about whether
people in a country have a good quality of life
- GPI (Genuine Progress Indicator) – measures country’s growth, adds a measure of
non-monetary benefits
- Includes
o Environmental costs - water and noise pollution, loss of farmland
o Social costs – family breakdown, crime
o Commuting costs
o Costs of automobile accidents
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Capital flight: movement of money out of the country, due to political and economic
instabilities
- Risks in holding domestic assets – hyperinflation, government compulsory purchase
of assets, devaluation of the currency, security of banking
- Restricts growth – capital could have been used in the country, depreciates currency –
increased demand for foreign
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Indebtedness:
- Countries borrow debt and then repay interest on a loan (debt servicing) – when
paying for it the funds leave the country – funds that could have been spent on growth
- Loans are at market interest rates and are in hard currencies – harder for developing
countries to borrow and repay
- Third World Debt Crisis – prices of commodities fell – cannot repay
- Example: Increase in debt repayment by 60% between 2014 and 2017
- Fall in commodity prices – fall in exchange rates – increases size of debt repayments
– most debts are settled in US dollars
- Example: Angola – 55.4% government debt as a proportion of revenue
Geographical factors:
- Landlocked: pay more and wait more for imports to be delivered, transport costs,
bribery, border delays
- Climates and diseases: tropical countries – slow development – agriculture and health
issues – lower production rates
- Due to soil formation and erosion low productivity – poor nutrition and poor health
- Diseases that are hard to control – malaria
Gender inequality
= economic development if women are empowered
- Well-being of family, children health = more educated about health and
hygiene
- Education of children
- = Quality of workforce improves
- Women earn more money
- Lower birth rates = better use of contraception
Good governance:
- Eight elements
o Participatory
o Equitable
o Accountable
o Transparent
o Responsive
o Consensus oriented
o Effective and efficient
o Lawful
Corruption – exploitation of power for personal gain
Include: bribery, extortion, fraud, patronage, peddling and nepotism
Occurs where there are:
- Large amount on investment projects
- Accounting problems
- Officials are not well paid
- Elections not controlled
- Legal structure is weak
- No freedom of speech
o Electoral corruption – people’s needs are not met
o Effectiveness of the legal system – not met because people can buy
their way out
o Market failure – highest bidder > efficient producer
o Cost of business are increased
o Reduced trust in an economy – low FDI
o Contracts not being honored – low FDI
o Blind eye to regulations
o Capital flight
o Corruption = barrier for women to gain access to their rights
o Example: Transparency International: Somalia 10/100 corruptness
scale – low economically developed country – Denmark – 88/100
Political instability
When there is stability:
- FDI attracted - economic growth + access to aid – development
- Good government planning – long term
- Citizens have an input into the running of the country = higher living
standards
When there is instability:
- No FDI
- High levels of poverty
- Low standards of living
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Poverty trap
Low economic growth – low income – low saving – low investment = econ. Growth
Low level of education and health rate – low level of human capital – low productivity – low
income = Development
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Goal: growth will only lead to development if the benefits of the growth are shared equitably
- Priority to achieve inclusive growth and pro-poor strategies – confront problem of
poverty
3. Economic integration
o Access schemes and regional free trade agreements – offer opportunities to
achieve economic growth and development
o Opportunities and challenges depend on extend of integration – whether it is
preferential access for particular goods, free trade area, customs union or
common market
- Advantages:
o Larger export markets = economies of scale
o Encouragement of diversification, reduce dependence on a range of
commodities
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Diversification:
o Countries face problems in exporting only one or possibly two commodities
o Many are using export diversification to gain economic growth – to move
from production and exports of manufactured and semi manufactured products
– hope to protect themselves from changes in primary product prices –
stabilize, ↑ export revenue and to stabilize or ↑ employment
o There will be an ↑ use of technology and an ↑ demand for highly skilled
workers
- Barriers:
o Practice of tariff escalation – rate of import tariffs on good rises the more the
goods are processed
Importing country protects its industries = puts lower tariffs on imports
of raw materials and high tariffs on processed and finished products
Little incentive for developing countries to diversify from producing
raw materials to processing them – high prices will make processed
good uncompetitive
o Need for highly qualified workforce – produce sophisticated products
Developing countries: low educational standards, difficult to fund
education
Country = poverty trap
Low education -> production of low profit commodities and
components -> low incomes for governments and individuals –
explains the low ability to fund education
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o Low costs of labour are low in developing countries – low costs, low prices,
more profit
o Less severe regulations – easier to set up and reduce cost of production + tax
concessions = policies to attract FDI
Leads to reducing corporate tax rates
- Advantages:
o FDI helps fill savings gap that may lead to economic growth
o MNCs provide employment, education and training = improves skill and work
force
o MNCs – allows for R&D, tech and marketing expertise = enhance
industrialization
o ↑ employment and earnings = multiplier effect
o Tax revenues from MNCs can be used to invest in infrastructure, education
o MNCs buying companies = increases AD (injection)
o MNCs may improve infrastructure of economy or help the government
o MNCs = more choice and low prices + essential goods provisions
o Lib. Trade + MNCs = efficient allocation of resources
o Example: China attracted FDI since 1978 = exports are produced by foreign
firms, which allowed for growth and success. China now has FDI abroad for
natural resources
- Disadvantages:
o MNCs may bring their own teams and hire low skilled workers = no education
provided
o MNCs have too much power = subsidies and tax advantages + internationally
have an influence on policy decisions
o Transfer pricing: goods are sold from one division to the next in a different
country = countries lose on tax revenue. This is normally regulated to
minimize however hard to monitor
o MNCs set up where pollution laws are weak = reduce private costs and create
external costs
The same is done with low wages
o MNCs use the country for resources and they leave
o MNCs use capital intensive production instead of labour intensive, which is
available in developing countries
o MNCs buy firms and pay in shares which might not be used in the economy
o MNCs’ profits are sent back to the country of origin
- Extent to which FDI is helpful depends on type of investment of the host country to
regulate the behaviour of the MNCs and use benefits of that investment to achieve
development objectives
- OECD Guidelines for MNEs – code of responsible business, agencies – National
Contact Point serve as a mediator. These guidelines include:
o Contribute to econ, environ. Social progress to achieve sustainable
development
o Respect human rights
o Encourage local capacity building
o Encourage human capital formation = employment and training
o Fill finance and operations information
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- Firms are worried about possible allegations – child labour, exploitation of workers =
difficult to conceal information, therefore promote CSR through reports to encourage
development
- Example: OBOR (one belt one road) – Chinese plan of investment - 78 different
countries – big infrastructure projects = new markets, better connection and transport
= market leader
Social enterprise
- Organizations that have specifical objectives – for profit or NPOs = aim for creation
of social wealth + env. Responsible operation ``
- Goal: Overcome an issue = poverty, education, health care = financial figures must be
capable to provide a long-term existence
o S.E.s are gender sensitive and env. Conscious
o Example: Sunny Money – solar powered products to rural communities in
Africa = are sold at low prices, done through agents, which creates
employment in areas where are sold
o Believe that through creation of a market the needs of customers are made =
charities ruin the market – how will you earn money if someone if giving it
out for free
Interventionist strategies
- Ensure that economic growth is inclusive – ensure that the assets of poor people are
improved. They should be aimed at:
o Sectors where poor work
o Where poor live
o Factors of production which poor possess
o Products which poor consume
Fiscal policies
- Using money from taxes for transfer payments, where developing countries do not
have enough revenue to invest
- Challenges and strategies:
o Large informal sector = strat. To mobilize informal workers into formal sector
o Reliance on indirect (regressive) taxes, as they are easy to set, but low revenue
= imposing higher taxes on demerit goods
o Loops in taxes – higher don’t pay = improve the structure to make sure that
there are no loops
o High tax rates on high levels of income – incentive to evade = lower rates
o Avoiding taxes because of: corruption and lack of trust, lack of transparency,
weak sense of national identity = reduce corruption, access to budgets
(accountability), public awareness campaigns – role of taxes, discussions
about taxes
Transfer payments
- Hard for government to invest and spend money on transfer payments due to low
revenue
- Conditional cash transfer (CCT) – transfer payments for low-income people with
behavioral conditions (e.g., school attendance) = CCTs provide income and can
alleviate poverty and improve quality of human capital
- CCTs provide more access to education, however only adds onto the received income
and provides compensation
Foreign aid
- Any assistance to a country that would not have been provided by market forces.
Reasons include:
o Help natural disaster or war survivors
o Help achieve economic development
o Fill savings gap
o Improve quality of human resources
o Strengthen institutions
o Improve technology
o Fund development projects
o Increase capacity to benefit from international trade opportunities (Aid for
trade)
o Help meet SDG
Humanitarian aid
- Given to save lives and alleviate suffering in response to emergencies or human made
crises or medical crisis
- Short term but can be prolonged if the situation is not under control
Development aid
- Given by governments, multilateral organizations and NGOs to alleviate poverty and
promote economic, social, environmental, political development in other countries
- Long term assistance in response to systematic problems
Official development assistance
- ODA – government aid targeting economic development and welfare of developing
countries
- Given by a government through aid agencies or multilateral international institutions
– Example: UN, World Bank, IMF
- Aid given directly = bilateral aid, Aid through agencies – multilateral aid
- SDG 17 – partnership for the goals – developed countries need to assist other
countries – 0.7% of GNI spent on the goal (requirement)
- ODA = to be eligible = must be provided by official agencies and must be
concessional = grant or soft loan, must promote economic development and welfare
as main objective
o Soft loan – interest-free or below market interest rate and is repaid over long
period than commercial loans
- Military aid is not included as it aims to strengthen security, military interests
o Example: UK – Lebanese Armed Forces – non-ODA; Austria – Transitional
Crime Units in 5 West African countries – eligible as it helps domestic
institutions in a way that benefits the population
o Example: Syria top 1 recipient of ODA = 10,361 million, USA top 1st donor –
30,006 million (2017)
Concerns about aid
- Concerns about nature uses and disbursement of aid:
o If the government does not use the welfare for the majority, then the aid
received goes to a particular sector of the economy that does not need support
o Aid given for political and economic reasons rather than in need – poor
receive less, middle income – more
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o Given based on political views of the government – if that changes aid will
change too
o Tied aid (form of bilateral aid) – given for development project where the
recipient must buy goods from the donor country
Minimizes trade between developing countries
Money is lost
Questions motivation = tied aid is subsidy for domestic industries
Example: Tied aid has fallen, UK made it illegal in 2002
o Long term provision of food may affect domestic producers, due to low prices
o Dependence on aid can limit economic development and incentive to develop
– damaging if donors send less aid
o Focus on modern sector may create a gap in incomes and standards between
that and agriculture
o Aid given when policies are adopted = liberalization, deregulation and
privatization – more interest to developed and MNCs rather than developing
o Aid needs to be repaid which can lead to debt
- IBRD: originally lent money to re-build war-torn countries, now: loans to worthy
developing countries
- Funds generated by World Bank bonds issue and repaid by member states and
borrowing country government – offer at lower rates than other sources
- IDA (1960) – provides grants and zero to low interest loans to poorest countries for
economic growth, reduction of inequalities and improvement of living conditions
- WB: provided loans for infrastructure, now: small project that target poorest
- Example: 27 development topics: forests, health, trade, nutrition
International Money Fund (1944)
- Organization of 189 countries to foster global monetary cooperation, secure financial
stability, facilitate international trade, promote high employment and sustainable
economic growth and reduce poverty
- Stability of international monetary system: exchange rates and payments,
responsibilities being:
o Promotion international monetary cooperation
o Expansion and balanced growth of international trade
o Promotion of exchange stability
o Help in establishment of a multilateral system of payments
o Resources available to members experiencing balance of payments issues
- 3 Practices: surveillance, financial assistance, capacity development
o Surveillance: analysis of member countries and performance and then
discussion of policies to achieve stable exchange rates and growth – reports
published for transparency
o Capacity development: training and tech assistance – free of charge – fiscal
monetary policies, exchange rates, banking
o Financial assistance: loans when countries cannot finance balance of
payments – quotas that each country deposits to IMF – IMF gives out loans
only if polices are implemented
- IMF provides lending and debt relief and assists those battling natural and health
disasters
o Example: Liberia, Guinea, Sierra Leone – Ebola afflicted – $100 million
assistance
- Both are essential for support and assistances well as achievement of SDGs; however,
problems include:
o Both established in US, have been accused of free market and business
friendly promotions that help developed countries and high income in
developing
o President chooses the head of WB – policies that are in interest to US may be
implemented
o IMF’s conditions on loans – reducing fiscal deficits and encouraging
economic growth – Structural Adjustment Policies – free market school of
thought and included:
Trade liberalization
Encouragement of primary commodities
Devaluing currency
Liberalization of capital flows
FDI encouragement
Privatization of nationalized industries
Elimination of subsidies and price controls
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You’re done with the syllabus!!! Good luck with all the content and
revising for your exams! :D