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A2 Economics: The Global Economy

The economics of globalisation Globalisation entails the processes that have resulted in the ever-closer links between the worlds economies e.g. trade, investment and production Globalisation manifests in two main different ways, global brands and global sourcing Global brands: Brands are increasing their penetration internationally. The quality of the product will be virtually identical but the price that you have to pay varies. Coca-Cola, McDonalds, and Snickers chocolate bars are available in all 5 continents Global sourcing: This refers to the ways in which MNCs now source their operations through worldwide production. Local domestic production has been replaced by manufacturing capacity on a global scale. This is a consequence of deindustrialisation. Toyota has set up manufacturing and assembly plants worldwide. These plants assemble vehicles from local as well as globally sourced parts International financial flows: These are becoming far greater. Countries such as China are financing a chunk of their fast economic growth from inward flows of international capital Cheap labour: For rich developed countries, goods are increasingly being manufactured abroad in developing countries such as India and China. This is because developing countries have a cost advantage in the form of cheap labour I.T and communications development: This has shrunk the time needed for economic agents to communicate with each other. Software programmers are effectively just as near as a clients office located in London or say India

Factors promoting globalisation Reduced protection in word economy: WTO has reduced the degree of protection in world trade. Tariffs and other trade-curbing factors are inconsistent with globalisation. The global economy is now has a number of regional trading blocs such as the EU, CARICOM which have established mutually beneficial links between one another Reduced capital movement restrictions: This is essential for business capital to move freely within the global economy. Exchange control has been gradually dismantled, allowing FDI to flow between developed economies and those that are emerging/developing Developments in IT: The technological change over the past generation has enabled firms to communicate via the Internet and has promoted global economic relations. Global supply chains that produce and sell their product can now be managed very effectively Liberalisation of domestic markets: In line with reduction in protection, many of the worlds economies, China especially, have been more receptive to FDI from developed economies and in forming

partnerships with MNCs enabling MNCs to directly purchase businesses in other parts of the world A fall in real transport costs: Unit transport costs particularly for sea transport have been falling increasing the viability for businesses to source on a global basis. Bulk distribution of products in containers by sea and to a much a lesser extent by air, has increased year on year. Economies of scale can be gained as vessels are aircraft have increased in size The impact of globalisation The world economy is now more integrated through the growth of trade and increasing dependency For developing economies globalisation has produced certain benefits: Higher living standards for more people Enjoyment of global brands Spreading best practice and technology faster Improved medical supplies that could increase life expectancy Increased liquidity of capital allowing investors in developing countries to invest in developed countries Increase flow of communications allow vital information to be shared by corporations across the globe Global mass media ties the world together Globalisation has its critics: Increased likelihood that an economic disruption in one nation will affect other nations due to increased dependency It is a new imperialism led that accentuates the gap between the poor and rich and leads to exploitation of works in developing countries Leads to environmental problems. A company may want to build factories abroad as environmental laws are weaker. Third world countries may cut down more trees to sell wood to richer countries

MNCs and FDI McDonalds and Coca-Cola are amongst the largest MNCs with manufacturing and retail outlets in many countries in the world MNCs provide FDI to the economies in which they operate This is investment that is necessary to produce or sell a good or service in a foreign country FDI involves capital flows between countries FDI should not be confused by portfolio investment which is the purchase of shares by foreign investors in businesses that are located in another country The activities of MNCs and the effects of FDI has been the subject of much debate and discussion by economist and politicians

Benefits and costs of FDI

Many benefits are obtained by the receiving economy of investment: Injection into circular flow of income: leads to the multiplier effect for the economy, in particular creating more total expenditure and important employment creation. Longer term, the injection of FDI increases the economys potential output Effects of the balance of payments: FDI is a credit item on the financial account of the BofP. This could be a short-term inflow, or a sustained one once the business is established. For example, the investment of multinational hotel in the Caribbean islands generates further income through the increase increased flows of tourists and payments received by local carriers An increase in tax revenue: the MNC contributes to tax receipts and expenditure taxes on their purchases of their goods and services. Also, MNCs provide additional tax revenue through purchase of local services and corporation/profit taxes Improved productivity: This may result from pressure on local suppliers to improve their efficiency Technology transfer and the acquisition of specialist equipment: Developing economies receive the benefit of up-todate technology and products that have been developed by MNCs in their home market There are various disadvantages and risks associated from FDI inflows: The employment created may be only short term and could be less than expected: The reason for that is that MNCs have little affinity to the overseas economies in which they have invested. Companies may pull out of a country transferring production to another location. The MNCs may employ workers from their own country in the top management lobs resulting in employees from the host country filling lower paid positions MNCs may invest in labour-saving technology: This may not seem appropriate in a recipient country with high unemployment and large amount of surplus labour Net effects on the balance of payments being less than anticipated: The profits earned in a host economy being repatriated and count as a debit item in the invisible section of the current account of that country. Over time, the outflows of such profits may well exceed the initial capital injection Taxes received by the government may be less that expected: as a result of fewer than expected new jobs. Account should also be taken of any government subsidies that might have been given to the MNCs in order to encourage them to set up in the first instance Productivity gains and technology transfer effects could be very limited depending on the type of FDI Environmental costs associated with certain types of FDI, especially mineral extraction and natural gas production

FDI in some respects is a mixed blessing thus not all governments welcome MNCs with open arms

Other financial flows Hot money flows around the world to take advantage of changes and expected changes in interest and exchange rates These movements can be disruptive as the money may only stay in the country for a short time before it is move to a more profitable opportunity elsewhere Portfolio investments are longer term. There are a number of factors that attract people to purchase the shares and government bonds of another country- relative interest rates and anticipated profit levels These are influenced by a government policies and changes in the level of economic activity Other investment includes loans made to other countries at commercial rates. Firms in other countries may seek loans from abroad if the interest rate charged are more favourable than can be obtained at home Developing countries may receive foreign aid in the form of loans at favourable rate. Most cases, foreign aid has led to the net outflow of funds. More is paid in servicing and repaying past debt than is received in aid For some developing countries, more money is now coming from remittances, the pay sent home from people working abroad, than from foreign aid, FDI or from sales of exports Remittances tend to be least volatile source of foreign currency for developing countries

World Trade Organisation WTO: a global organisation that regulates world trade It is established to promote free trade and provides a forum for discussing trade issues, established agreed rules and even assesses if these rules are broken WTOs mission is to help trade flow smooth, freely, fairly and predictable This should produce a trading system wit the following characteristics Non-Discrimination 1. Most favoured nation treatment- countries cannot grant a special favour (lower rate of duty or duty access free) to one WTO member over another i.e. all countries treated equal basis 2. National treatment- treating foreigners and locals equally. Under this, imported and locally produced goods should be treated equally after they have reached the domestic market. This does not prohibit a country imposing tariffs on imported goods, but it does mean that the goods compete on same basis thereafter. Principle applies to services- foreign firms trying to set up operations elsewhere should be treated in exactly the

same way as domestic firms wishing to expand their operations Free Trade: This can be done by lowering trade barriers, tariff and non-tariff barriers. This will enable goods/services to flow more openly and fairly between members, providing benefits of gains from trade Predictability: The will help provide a stable business environment whereby firms will feel secure that trade barriers will not be raised at some future date. This will create a business environment where investment is encouraged, jobs are created and consumer welfare is increased. This is relevant for businesses moving to developing economies, where there are likely to be concerns over future political stability and economic prospects Promoting fair competition: The WTO system allows tariffs and, in some circumstances, other forms of protection. Once a restriction has been imposed by a member, WTO agreements mean thereafter should be free and fair competition in the market. This must not be distorted by further constraints on foreign items Special provision for developing countries: WTO has sought to assist the development of developing countries. WTO has sought to give such countries time and flexibility to implement various agreements. The agreements build upon the principles special assistance and trade concessions for developing countries WTO agreements The Uruguay Round agreements are the basis of the current WTO system The Uruguay Round covered three main areas: Tariff Cuts: Developed country members agreed a 40% in their tariffs on industrial products, to be phased over 5 year period from 1995. This reduced the average tariff from 6.3% to 3.8%. They agreed that fewer imported products should be charged at higher duty rates More binding tariffs: This is a commitment by a member not to raise tariffs above the listed rate. Developed countries increase the no. of bound line products to 99%, while developing countries increased it to 73%. These agreements provide more security for traders and investors Agriculture: Substantial progress was med to remove all nontariff restrictions on agricultural world trade. Most of these restrictions were converted to tariffs (tariffication). Tariffs applying to products from developing countries have been progressively reduced and commitments have been received from developed countries to reduce export subsidies for agricultural products. The Uruguay Round represents the first time that such an agreement has been reached in principle

The Doha Round

The current round of talks, the Doha Round was launched in 1999 and completed in 2006. It covered a variety of areas: In manufacturing, further reduction in tariff barriers were negotiated In services, access to the markets was a key issue. In many service markets non tariff barriers were key to restricting trade First world countries were particularly concerned to tighten up intellectual property rights in face of widespread piracy. Whilst, third world countries wanted their rights over plant derived compounds and folklore protected There was an agreement to tighten up the role of WTO in settling trade disputes

International Monetary Fund IMF is a global organisation that aims to promote international monetary cooperation and international trade Set up 1945 at Bretton Woods Conference Helps promote the health of the world economy following World War Two. Non-members: Cuba and North Korea. Members: 184 The IMFs purposes and responsibilities are: To promote international monetary co-operation To facilitate the expansion and balanced growth of international trade To provide exchange stability To assist in the setting up a multilateral system of payments To make resources available to members experiencing BofP difficulties, provided adequate safeguards are provided IMF has three main functions known as surveillance, technical assistance and lending The first two have the aim of promoting global growth and economic stability by encouraging countries to adopt sound economic policies The third function is used where member countries experience difficulty in financing their balance of payments Technical assistance and training are offered by IMF to help members to design and implement effective economic policies This assistance provides advice on monetary, fiscal and exchange rate policies especially. This has been widely taken up my emerging transition economies Many IMF members have severe balance of payment problems. In this case, the IMF lends money to such countries to ease their immediate positions It is important that recipients work closely with the IMF to avoid similar problems in the future Anti-globalisation supporters condemn the IMF for favouring military dictatorships that are friendly towards the US and EU MNCs

Some economists are concerned about the pro Keynesian approach for dealing with the BofP disequilibria. They believe supply side polices rather than devaluation are the best way of alleviating structural imbalance The IMF has also been blame for some serious economic problems In 2001 in Argentina, it is generally believed that IMF induced budget restrictions and the privatisation of important natural resources were responsible for the economic crises that ensued World Bank World Bank is a global organisation that provides developing funding. This includes financial support for internal investment projects such as improving infrastructure and constructing new heal facilities Rose out of the Bretton Woods agreements It is best described as the World Bank Group as it has five constituent agencies: International Bank for Reconstruction and Development (IBRD) International Finance Corporation (IFC) Multilateral Investment Guarantee Agency (MIGA) International Centre for Settlement of Investment Disputes (ICSID) IBRD and IDA provide low- or no interest loans and grants that do not have favourable access to international credit markets Loans cover areas such as: Health and education- to enhance human development in a country- for improving sanitation and combating aids Agriculture and rural development- for irrigation programmes and water supply projects Environmental protection- for reducing pollution and for ensuring that there is compliance with pollution regulations Infrastructure- roads, railways, electricity Governance for anticorruption reasons It has been accused of being a US/EU dominated agency for supporting their own political and economic interests Though its advocacy for free market reforms, its policies have been criticised as being harmful to some countries, especially where shock therapy has been introduced too quickly In spite of this, World Bank has had a considerable impact in assiting the worlds poorest economies