OCRALevelEconomicsCourseCompanionYear2MacroTopicsTheGlobalContext

Author:GeoffRiley

www.tutor2u.net

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TableofContentsGlobalisation......................................................................................................................................5KeyCausesofGlobalisation...........................................................................................................6ImpactofGlobalisation–KeyGains...............................................................................................6MainDisadvantages/CostsfromGlobalisation............................................................................6GlobalisationandExternalEconomicShocks.................................................................................7Impactofmultinationals(MNCs)...................................................................................................9ControllingGlobalCompanies(Transnationals)...........................................................................11

InternationalTrade..........................................................................................................................13AbsoluteandComparativeAdvantage.........................................................................................15TheBasicModelofComparativeAdvantage...............................................................................16AssumptionsbehindTheoryofComparativeAdvantage.............................................................18KeyFactorsDeterminingComparativeAdvantage......................................................................20

RoleofInternationalTradeforDevelopingCountries.....................................................................21PrimaryProductDependence......................................................................................................22PriceVolatilityforPrimaryProducts............................................................................................26

TermsofTrade.................................................................................................................................29RoleofForeignAidandMultilateralAssistance...............................................................................32ForeignAid...................................................................................................................................32EvaluationofForeignAid.............................................................................................................34FairTrade.....................................................................................................................................35TheIMF........................................................................................................................................37TheWorldBank............................................................................................................................37

InternationalCompetitiveness.........................................................................................................39TheBalanceofPayments.................................................................................................................46Thestructureofthebalanceofpayments...................................................................................46CurrentAccountDeficits..............................................................................................................49Policiestoreduceatrade(currentaccount)deficit.....................................................................50TheJCurveEffect.........................................................................................................................51TheMarshallLernerCondition.....................................................................................................52CurrentAccountSurpluses...........................................................................................................52SovereignWealthFunds...............................................................................................................53

ExchangeRatesandExchangeRateSystems...................................................................................55Freelyfloatingexchangerates.....................................................................................................57Causesofchangesintheexchangerate......................................................................................57Theeffectsofexchangeratechanges..........................................................................................59FixedExchangeRates...................................................................................................................61ManagedFloatingExchangeRates...............................................................................................61Evaluationofdifferentexchangeratesystems............................................................................62ImportTariffs................................................................................................................................66Non-TariffBarriers(NTBs)............................................................................................................71ImportQuotas..............................................................................................................................71DomesticSubsidies(&ExportSubsidies).....................................................................................73Argumentsforandagainsttradeprotectionism..........................................................................75ImportDumping...........................................................................................................................77TheWorldTradeOrganisation(WTO)..........................................................................................78StagesofEconomicIntegrationbetweenNations.......................................................................79

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PreferentialTradeAgreements/FreeTradeAreas.....................................................................79CustomsUnions............................................................................................................................80TheEuropeanUnion(EU)SingleMarket......................................................................................85EuropeanMonetaryUnion...........................................................................................................88

TheFinancialSectoroftheEconomy...............................................................................................94Money,CapitalandForeignExchangeMarkets...........................................................................94Roleoffinancialmarketsinthewidereconomy..........................................................................95Therelationshipbetweendebtandequityfinance.....................................................................95Bondpricesandinterestrates.....................................................................................................97

Banking.............................................................................................................................................99CommercialBanks........................................................................................................................99InvestmentBanks.........................................................................................................................99BanksandFacilitatingSaving.....................................................................................................101BanksandFacilitatingLending...................................................................................................101

CentralBanksandMonetaryPolicy...............................................................................................105Mainfunctionsofacentralbank...............................................................................................105WhatisMonetaryPolicy?..........................................................................................................106ExpansionaryandDeflationaryMonetaryPolicy.......................................................................107NegativePolicyInterestRates....................................................................................................108TheKeynesianLiquidityTrap......................................................................................................108QuantitativeEasing(QE)............................................................................................................109

RegulationoftheFinancialSystem................................................................................................109FinancialPolicyCommitteeoftheBankofEngland...................................................................109UKPrudentialRegulationAuthority(PRA).................................................................................110LiquidityRatiosandCapitalRatios.............................................................................................110MarketFailureintheFinancialSector........................................................................................112FinancialMarketFailureinFocus–FinancialInstabilityandthe2008GlobalFinancialCrisis..113WhatisaFinancialCrisis?..........................................................................................................116EconomicandSocialRisksfromFinancialInstability.................................................................118HymanMinsky'sFinancialInstabilityHypothesis.......................................................................1202007-2010GlobalBankingCrisisandAspectsofMarketFailure...............................................120EconomicPolicyResponsetotheGlobalCrisisin2008.............................................................121

Thefinancialsectorindevelopingandemergingeconomies........................................................122Theroleofsavingandinvestment–theHarrodDomarModel.................................................123FinancingGrowthandDevelopment.........................................................................................126Microfinance–GrowthandDevelopment.................................................................................127Foreigndebtanddevelopingcountries......................................................................................128Externaldebtrelief.....................................................................................................................129RemittancesandDevelopmentFinance.....................................................................................130TheForeignCurrencyGapandCapitalFlight.............................................................................132CapitalFlight...............................................................................................................................132

RecaponEconomicGrowthandDevelopment.............................................................................133Whatiseconomicdevelopment?...............................................................................................133TheDifferencebetweenGrowthandDevelopment..................................................................134MainCharacteristicsofEconomicallyLessDevelopedCountries..............................................137IndicatorsofHumanDevelopment............................................................................................141LimitationsoftheHumanDevelopmentIndex..........................................................................143

IncomeandWealthInequality.......................................................................................................146ForeignDirectInvestment(FDI)andDevelopingCountries...........................................................150

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PoliciestoAttractForeignDirectInvestment............................................................................152Evaluatingtheimpactofforeigndirectinvestmentfordevelopingcountries...........................154

Policiestopromoteeconomicgrowthanddevelopment..............................................................156Market-orientedpolicies............................................................................................................157TransitionEconomies.................................................................................................................161GrowthandDevelopmentinChile.............................................................................................162DannyQuah(LSE)onMarket-DrivenDevelopment...................................................................164HaJoonChang(UniversityofCambridge)onStateversustheMarket.....................................165InterventionistStrategies...........................................................................................................166GrowthandDevelopmentinSouthKorea.................................................................................167InterventionistPoliciesandGovernmentFailure.......................................................................169GrowthandDevelopmentinChina............................................................................................170GrowthandDevelopmentinMexico.........................................................................................182GrowthandDevelopmentinZambia.........................................................................................184

Recap:ObjectivesofGovernmentEconomicPolicy.......................................................................189PossibleConflictsbetweenMacroPolicyObjectives.................................................................189TheShortRunPhillipsCurve......................................................................................................190TheLongRunPhillipsCurve.......................................................................................................192PossibleConflictsbetweenGrowthandInflation......................................................................193EconomicGrowthandtheBalanceofPayments.......................................................................195ExternalShocksandMacroPolicyObjectives............................................................................196

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OCR–Year2Macro-TheGlobalContext

GlobalisationWhatisglobalisation?Globalisationisadynamicprocessinwhichnationaleconomieshavebecomeincreasinglyintegratedandinter-dependent.TheOECDdefinesglobalizationas“Thegeographicdispersionofindustrialandserviceactivities,forexampleresearchanddevelopment,sourcingofinputs,productionanddistribution,andthecross-bordernetworkingofcompanies,forexamplethroughjointventuresandthesharingofassets.”PercentageshareofthemainindustrializedandemergingcountriesinglobalGDP(adjustedforpurchasingpower)in2016,Source:IMFWorldOutlook

CharacteristicsofGlobalisation

17.65%15.71%

7.31%

4.15% 3.33% 3.12% 2.62% 2.33% 2.29%

0.0%2.0%4.0%6.0%8.0%

10.0%12.0%14.0%16.0%18.0%20.0%

China USA India Japan Germany Russia Brazil UnitedKingdom

France

ShareinglobalG

DP

TradetoGDPratiosareincreasingformost

countries

ExpansionofFinancialCapitalFlowsbetween

countries

ForeignDirectInvestmentandCross

BorderM&A

Rising number ofglobalbrands– including fromemergingcountries

Deeperspecializationoflabour– componentscome frommany

nations

Globalsupplychains&newtradeand

investmentroutese.g.South-Southtrade

Increasinglevelsofinternationallabour

migrationandmigrationwithincountries

Increasingconnectivityofpeopleand

businessesthroughmobileandWi-Fi

networks

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KeyCausesofGlobalisation1. Containerization–thecostsofoceanshippinghavecomedown,dueto

containerization,bulkshipping,andotherproductionefficiencies2. Technologicalchange–reducingthecostoftransmittingandcommunicating

information–sometimesknownas“thedeathofdistance”–akeyfactorbehindtradeinknowledgeproductsusingwebtechnology

3. Economiesofscale:Manyeconomistsbelievethattherehasbeenanincreaseintheminimumefficientscale(MES)associatedwithsomeindustries

4. Differencesintaxsystems:Manycountrieshaveadjustedtheirtaxsystemstoattractforeigndirectinvestment(FDI)

5. Lessprotectionism–inmanycountries,bordershaveopenedandaverageimporttarifflevelshavefallen–thatsaidinthelastfewyearstherehasbeenariseinnon-tariffbarrierssuchasimportquotas,productregulationsandcurrencymanipulation

ImpactofGlobalisation–KeyGainsSomeofthekeygainsfromglobalisationareasfollows:

1. Itencouragesproducersandconsumerstoreapthebenefitsfromdeeperdivisionoflabourandeconomiesofscale

2. Competitivemarketsreducethescaleofmonopolyprofitsandincentivizebusinessestoseekcost-reducinginnovations

3. Enhancedgrowthhasledtohigherpercapitaincomes–andhelpedmanyofpoorestcountriestoachievehighergrowthandreduceextremepovertytobelow10%oftheworld’spopulation(measuredusinganextremepovertylineof$1.90perdayPPP)

4. Advantagesfromthefreermovementoflabourbetweencountries5. Dynamicefficiencygainsflowingfromthesharing/diffusionofnew

ideas/skills/technologiesacrossnationalborders6. Openingupofcapitalmarketsincreasestheopportunitiesfordevelopingcountriesto

borrowmoneytohelpovercomethelimitsofadomesticsavingsgap7. Increasedawarenessamongpeoplearoundtheworldofthesubstantialchallenges

fromclimatechangeandwealth/incomeinequality8. Competitivepressuresofglobalisationmaypromptimprovedgovernanceandbetter

labourprotectionthroughimprovedbusinessstandardsMainDisadvantages/CostsfromGlobalisation

1. RisingInequality/RelativePoverty-leadingtopoliticalandsocialtensionsandinstabilityasabacklash.

2. ThreatstotheGlobalCommonse.g.threatsofirreversibledamagetoecosystems,landdegradation,deforestation,lossofbio-diversityandthefearsofpermanentshortagesofcleanwater

3. MacroeconomicFragility–inaninter-connectedworldeconomy,externalshocksinregioncanrapidlyspreadtoothercentres–thiscanleadtohighlyvolatilecapitalmovementsandswingsintradeflows

4. TradeImbalances:Increasingtradeimbalancesleadtoprotectionisttensionsandamovetowardsmanagedexchangerates

5. HigherStructuralUnemploymentespeciallyincountrieswheremanufacturingproductionhasshiftedtolowercostcentres,manypreviouslywell-paidwhite-collarjobsinadvancedeconomieshavebeenlostoverthelasttwodecades

6. DominantGlobalBrands–businesseswithdominantbrands,economiesofscaleandsuperiortechnologiesmaysqueezeoutlocalproducerswhohavelessmarketpower

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7. Poorbehaviourofsomeglobalmultinationals–exploitativeconditionsforlowwageworkers,taxavoidance,andfailurestoaddressenvironmentalissues.Taxavoidanceandtaxinversionhavebecomedominantissues.

ProfessorDianeCoyleontheImpactofGlobalisation“Globalisation,farfrommakingtheworldflat,hasthrownintosharperreliefeconomicinequalities.Ithasmadethegeographyofeconomicactivitymoreratherthanlesssalient.”“Thedistributionalconsequencesofglobalisation,drivenbythenewtechnologiesandmanifestedinflowsofgoodsandservices,capitalandpeople,havelongbeenforeseen.Unfortunately,ithastakenagenerationforanypolicyresponsetogetunderway.”

ProfessorDianeCoyle(July2016)ProfessorDaniRodrikontheImpactofGlobalisation“Opennesstotheworldeconomycanbethesourceofmanyeconomicbenefits….Buttheseareonlypotentialbenefits,toberealizedinfullonlywhenthecomplementarypoliciesandinstitutionsareinplacedomestically".“Theseinvolvebothsocialpolicies(especiallyeducation)andpoliciestoassistfirmsthatarebeingleftbehindintheincreasinglycompetitiveworld.”

ProfessorDaniRodrik

GlobalisationandExternalEconomicShocksMostcountriesarevulnerabletointernationalandorregionalexternalshocksthatcanaffectboththedemandandthesupply-sideoftheireconomies.Someofthesearesummarizedinthefollowinggraphic.

TopTenGlobalEconomicRisks2016(Source:EIU)

1. Chinaexperiencesahardlanding2. Russia'sinterventionsinUkraineandSyriaprecedeanew"coldwar"3. Currencyvolatilityculminatesinemergingmarketscorporatedebtcrisis4. "Grexit"isfollowedbyaeurozonebreak-up5. Besetbyexternalandinternalpressures,theEUbeginstofracture

GlobalFinancialCrisis(GFC)

EuroZoneEconomicCrisis

VolatileWorldCommodityPrices

ChinaSlowdown

International&Regional Trade&InvestmentDeals

Currencyvolatilityandpolicychangese.g.

devaluation

Extremeweatherevents Geo-politicaluncertainty&terrorism

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6. Therisingthreatofjihaditerrorismdestabilizestheglobaleconomy7. DonaldTrumpwinstheU.S.presidentialelection(Nov2016)8. TheUKvotestoleavetheEU9. ChineseexpansionismpromptsaclashofarmsintheSouthChinaSea10. Acollapseininvestmentintheoilsectorpromptsafutureoilpriceshock

De-globalisation:SlowdowningrowthofglobaltradeGlobalisationisnotinevitable–indeedsincetheGreatRecessionof2008-09therehasbeenasignificantlyslowergrowthofworldtrade.Itisnowwellbelowthepre-crisistrend.WhyisWorldTradeGrowingSlowlyattheMoment?

1. Weakeconomicgrowthinmanyoftheworld’srichestcountries–indeedsomeeconomistsbelievethatWesternnationsaresufferingfromsecularstagnation

2. Slowingpaceoftradeliberalization.Thebiggainstotradefromcuttingimporttariffsmayhavealreadyhappened.

3. Non-tariffbarriers(NTBs))havegrownandregionaltradeblocssuchasASEANhavebecomemorecommoninplaceofanewglobaltradeagreementwhichremainsalongwayfrombeingachieved

4. Risingprosperityitself.Aspeoplebecomerichertheyspendahigherproportionoftheirincomeonservices,suchaseducation,leisureandhealth–globaltradeinservicesisactuallylowerasashareofGDPthanmanufacturedproducts

5. Technologicalchange–e.g.3Dprintersarebeingusedtomanufactureasetoforderse.g.foraircraftequipmentorartificialjointsusedinmedicine–theynolongerhavetobeshippedaroundtheworld

5060708090

100110120130140150

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Pre-crisis trend

Index = 100 in 2008

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Impactofmultinationals(MNCs)WhatisaMultinationalCompany(MNC)?

• Amultinationalcompany(MNC)isabusinessthathasoperationsinmorethanonecountry.NotethatabusinessdoesnotbecomeanMNCsimplybecauseitsellsitsgoodsandservicesoverseas.ThekeytobeinganMNCisthatthebusinesshasbusinessoperationsintwoormorecountries.

• Around1,300companiescontrol80percentofglobaloperatingrevenues,with40percentofthiscontrolledbyonly147organisations

KeyReasonsfortheRapidGrowthofMNCs

• Globalbrandsseekingtodriverevenueandprofitgrowthinemergingeconomies(inparticularlyseekingrisingdemandfromincreasinglyaffluentconsumers)

• Thesearchforeconomiesofscale,toreduceunitcostsbyconcentratingproductioninafewkeyinternationallocations

• Theneedtosupplementrelativelyweakdemandinexisting,developedeconomies• Theneedtooperateinmanycountriestoavoidprotectionismsuchasimportquotas• Increasedtakeoveractivitythathasbuiltbusinesseswithinternationaloperations

PotentialBenefitsofMNCstotheCountriesinWhichTheyOperate

1. MNCsprovidesignificantemploymentandtrainingtothelabourforceinthehostcountryhelpingtoraiseemploymentandproductivity

2. Transferofskillsandexpertise,helpingtodevelopthequalityofthehostlabourforce3. MNCsaddtothehostcountryGDPthroughtheirspending,forexamplewithlocal

suppliersandthroughcapitalinvestment–theremightbelargemultipliereffects4. CompetitionfromMNCsactsasanincentivetodomesticfirmsinthehostcountryto

improvetheircompetitiveness,perhapsbyraisingqualityand/orefficiency5. MNCsextendconsumerandbusinesschoiceinthehostcountry6. ProfitableMNCsareasourceofsignificanttaxrevenuesforthehosteconomy(for

exampleonprofitsearnedaswellaspayrollandsales-relatedtaxes)PotentialDrawbacksofMNCActivityinTheCountriesinWhichTheyOperate

1. DomesticbusinessesmaynotbeabletocompetewithMNCsandsomewillfail–forexample,Uberisoneofthefastest-growingMNCsandhasfacedsignificantresistancefromnationalmarketsithasentered

2. MNCsmaynotfeelthattheyneedtomeetthehostcountryexpectationsforactingethicallyand/orinasocially-responsibleway

3. MNCsmaybeaccusedofimposingtheircultureonthehostcountry,perhapsattheexpenseoftherichnessoflocalculture.

4. ProfitsearnedbyMNCsmayberemittedbacktotheMNC'sbasecountryratherthanreinvestedinthehosteconomy.

5. SomeMNCsareaccusedofexploitationofworkingconditionsindevelopingeconomiesinsearchoflowproductioncosts-ThecomplexityofinternationalsupplychainsmakesithardforMNCstocontrol&monitorallaspectsoftheirproduction

6. MNCsmaymakeuseoftransferpricingandothertaxavoidancemeasurestosignificantreducetheprofitsonwhichtheypaytaxtothegovernmentinthehostcountry–highprofilecaseshaveincludedAmazon,Facebook,Google&Starbucks

Brandsthathavebeencaughtoutusingchildlabourorsweatshops

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Example:GlobalGrowthofGoogleasanMNCAnnualrevenueofGooglefrom2002to2015(inbillionU.S.dollars)

Example:GlobalRevenuesforIKEAIKEA'srevenueworldwidefrom2001to2015(inbillioneuros)

TotalnumberofNikeretailstoresworldwidefrom2009to2016

0.4 1.5 3.2 6.110.6

16.621.8 23.7

29.337.9

50.1855.51

65.6774.54

01020304050607080

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013* 2014 2015

Revenu

einbillionU.S.

dollars

10.4 11 11.4 12.915

17.520 21.5 21.8 23.5 25.2

27.6 28.5 29.332.7

05

101520253035

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Revenu

einbillioneu

ros

Year

674 689756

826753

858931

1,045

0

200

400

600

800

1000

1200

2009 2010 2011 2012 2013 2014 2015 2016

Totalnum

bero

fretailstores

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ControllingGlobalCompanies(Transnationals)CorporatetaxcompetitionIncreasinglytherearetrans-nationalcompanies(TNCs)operatinggloballywhilsttaxpolicyismostlyamatterofnationalgovernments.Foreigndirectinvestmenthasgrownrapidly-wellaheadoftheexpansionofworldGDP.Globalcompanieshavebecomemuchmoreimportantinthelastdecadesbutcorporateincometaxrates(paidonprofits)hasactuallydeclinedasmanycountriesreducetheirtaxratesinbidstoremaincompetitive.Thisissometimescalleda“racetothebottom.”SupportersoflowerbusinesstaxesoftenjustifytheirpoliciesusingtheideaoftheLafferCurve.Criticsofthedropincorporatetaxratesbelievethattaxrevenuesfrommultinationalsbecomeerodedandleavesnationalgovernmentswithlessincometospendonessentialpublicandmeritgoods.Multinationalbusinesseshave-byandlarge-becomemoreprofitable,andperhapstheyshouldbemakingabiggercontributiontonationaltaxreceipts?Corporatetaxisasubstituteforpersonaltaxation.Ifwedon’tcollecttaxesfrombusinesses,householdtaxeswouldhavetobehigherand/orgovernmentspendinglower.Taxavoidance(profitshifting)

• Taxavoidanceisknownasprofitshiftingandcanhappenthroughover-reportingofcostsandunder-reportingofaglobalcorporation’sproductionandrevenues.

• Thereisabigcurrentdebateabouttaxavoidancebymultinationalcompanies.NumerousnewspaperheadlineshavehighlightedallegationsoftaxavoidancebymultinationalssuchasApple,Amazon,Starbucks,IKEAandFiatamongothers.

• TheEUisproposinglegislationthatwillforcecompaniestodisclosetheirearningsandimprovethetransparencyoftheirbusinessmodels.

• GoogleCEOEricSchmidtwasquotedassayingthattaxavoidanceisanaturalfeatureofcapitalism.

The(estimated)scaleoftaxavoidance

• InOctober2015–WaronWantpublishedareportontaxavoidancefromtransnationalcompaniesoperatinginZambia.Accordingtothereport,Zambiaislosing$3billionayearfromcorporatetaxdodging.ThesumisequivalenttonearlytwiceZambia’sspendingonhealthandeducation.

• Oxfamestimatetheannualrevenuelossfordevelopingcountriesfromtaxavoidanceataround$50billion.Rememberhoweverthatalotoftaxavoidanceisdonebyindividualsoperatingintheshadoweconomy.

• TheEUestimatesthatcorporatetaxavoidancecostsmemberstates€50m-€70bnayearinlosttaxes

TaxEvasionTaxevasionisillegalwhereastaxavoidancehappenswhenindividualsandbusinessesfindtaxloopholesthatreducetheamountoftaxtheypay.AccordingtotheFinancialTimesin2013“Muchofthedevelopingworldisstrugglingtotaxgloballymobileprofitsandcapital.Africancountriesarehemorrhagingtensofbillionsofdollarsinpotentialrevenueseachyear.”Transferpricing

• Transferpricingisthepriceatwhichdivisionsofacompanytransactwitheachother.

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• Forexample,amultinationalminingcompanyoperatinginZambiaortheCentralAfricanRepublicmightinvoicetheirparentcompanyforthecostsofconsultancy/engineeringservicesorforloans.

• ThisreducestheirprofitsandthuslowerstheirliabilitytopaycorporationtaxKeyeconomiceffectsofcorporatetaxavoidance:

1. Distortionofmarketcompetitionbetweenmultinationalsanddomesticfirms2. Squeezingoftaxrevenuescanleadtohigherfiscaldeficitsandfewerresourcesforpublic

andmeritgoods3. Hugeexpensesgivenovertotaxplanningbybusinesses9andwealthyindividuals)isa

wasteofscarceresourcesLimitstogovernmentabilitytocontrolglobalcompaniesSomeoftheworld’sbiggesteconomiesarecorporations!

1. Capitalisincreasinglyfootloosemeaningthatforeigndirectinvestment(FDI)canflowtomanydifferentcountriesdependingonfactorssuchasunitlabourcosts,easeofdoingbusiness,capitalcontrolsandgovernmentregulationsonlabourmarketsandtheenvironment

2. Manycountriesrequireinflowsofexternalfinancetohelpsustaingrowthanddevelopment,thepowerrelationshipworksinfavourofmulti-nationalbusinesses

3. Manyoftheworld’sbiggestcorporationshavesignificantmonopsony(buying)powerindifferentcountries–forexamplethebuyingpoweroftheglobalcoffee,copperandrubberprocessingbusinesseswhentheypurchasefromlocalgrowersandminers.

4. Nationalgovernmentsmaybelimitedbytheinternationalagreementstheyhavesignedforexamplefull-membershipoftheWorldTradeOrganisationwhichmightcontrolfreedomtosetimportquotasandtariffs.Indeed,transnationalcorporationshaveusedtheirmoney,sizeandpowertoinfluenceinternationalnegotiationsincludingtradedeals

5. Corporationsoftenhavehugelobbyingbudgetswhichmightbeusedtolobbyagainstnewlegislationthataffectstheirmostprofitableindustries–considerforexamplethelobbyinginfluenceoftobaccoanddrinksbusinessesworldwide.Bigbusinessesmightalsolobbyforexampleagainstimmigrationreformsthatcouldaffecttheirabilitytohirethebestpeoplefromdifferentcountries.

Increasingly,oppositiontotheworstexcessesofcorporatepowercomesfromwell-organisedpressuregroupsandconsumerorganisationsmanyofwhommakeeffectiveuseofsocialmediatohighlighttheirconcernsandseekredress.Inthesummerof2016,theEuropeanCommission(whichisasupra-nationalbodywithresponsibilityforallEUmembernations)announceditwasrequestingAppletopayback$13bnlinkedtoitsIrishtaxscheme.Applehasfacedcriticismforpayinga2percentcorporatetaxrateinIreland,farlowerthantheheadline12.5percentrate.(TherateintheUKis19%).TheAustraliangovernmentisintroducinga“GoogleTax”toreducethescaleof(legal)taxavoidancebyforeignmultinationals.

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InternationalTradeWhatisinternationaltrade?

• Internationaltradeistheexchangeofproducts(goodsandservices)• Tradedoesn’ttakeplacebetweencountries,ittakesplacebetweentheeconomicagents

ofthatcountry,suchasbusinessesorstategovernmentsorevenconsumers• Whentheconditionsareright,externaltradebringsbenefitstoallcountriesinvolvedand

itcanalsobeapowerfuldriverforsustainedGDPgrowthandrisingaveragelivingstandards/improvedeconomicwelfare

WhatisFreeTrade?Thisisinternationaltradefreefromartificialbarrierssuchasimporttariffs,quotasandothertradebarriers.Tradereflectstheimpactofspecialisationandexchange

• Specialization:specialisationofscarceresources• Exchange:basedoncomparativeadvantageinsupplyingdifferentgoodsandservices

DavidRicardointhe19thcenturyproposedatheoryofcomparativeadvantageasakeyeconomicargumentforinternationaltrade.WhatarethemaingainsfromFreeTrade?Onewayofexpressingthegainsfromtradeingoodsandservicesistodistinguishbetween:

• Staticgains(i.e.improvementsinallocativeandproductiveefficiencyinmarkets)• Dynamicgains(i.e.thegainsinwelfarefromimprovedproductquality,increasedchoice

andfasterandmoreinnovativebehaviour).Gains:

• Trademakescountriesbetteroffbyallowingthemtospecialiseaccordingtotheircomparativeadvantage,providingaccesstonewandcheaperimportedgoods,andincreasingcompetitionbetweenproducers

• Dynamicgainsfromtrademakeadomesticeconomymoreproductive.Examplesofpotentialgainsfromtradeliberalizationthatfallintothiscategoryare:

• Diffusionofknowledgeandtechnologyacrossborders• Economiesofscaleinthelongrun(i.e.increasingreturnstoscale)• Increasedcompetitionandinnovationwithinmarkets• Awithin-countryselectionofmoreproductivefirmschallengingformarketshare• Accesstocheaperandmoreproductiveinputsintoacountry’ssupply-chain• Lessrent-seekingbehaviourbymonopolybusinessesandreducedincentivesforcorruption

whichthenaidslong-termdevelopmentSummaryofthekeygainsfromtrade

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SupplyandDemandAnalysistoIllustratesomeoftheGainsfromFreeTradeIntheanalysisdiagramwelookattheEuropeanmarketforcoal.

• TheEUpriceisthepriceiftheonlycoalavailableiscoalsuppliedfromEUcoalproducers• Weassumenon-EUcountriescanexportcoalintotheEUatalowerworldprice.This

causesdemandtoexpandandEUdomesticsupplytocontract• Consumersurplusbeforetrade=areaAED• Consumersurplusaftertrade=areaACB• Therefore,thereisanetgaininconsumerwelfare• Producersurplusbeforetrade=areaEFD• Producersurplusaftertrade=areaCFG• Therefore,thereisanetlossofproducersurplus

Exportrevenuesandjobshelptoreducethescaleofextremepoverty

Increasedmarketcontestabilityreducespricesforconsumers

Betteraccesstonewtechnologiesliftsproductivity

Inflowsofknowledgeacrossbordersraises

humancapital

Exploitingeconomiesofscale– causinglowerunit

costsandprices

Betteruseof scarceresourcesfromtradeinsustainabletechnologies

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AbsoluteandComparativeAdvantage

• Absoluteadvantage:o Thisoccurswhenacountycanproduceaproductusingfewerresourcesthan

anothernationo Ifacountryusingthesamefactorsofproductioncanproducemoreaproduct,then

ithasanabsoluteadvantage• Comparativeadvantage:

o Focusesonwhenacountryhaslowerrelativeopportunitycostwhenitdecidestospecialiseinaparticularproduct

o Opportunitycostisthesacrificeofalternativeproductsmadewhenyouspecialiseinanothergoodorservice

AbsoluteAdvantage–AnExampleOutputwithbothworkershaving10hoursoftimeavailable

BricksLaid CakesBakedHilary 80 20Donald 40 50Total 120 70Inthisexample,assumingbothpeoplehavethesamefactorresource(time)available:

• HilarycanlaymorebricksthanDonald(8-to40)• DonaldcanbakemorecakesthanHilary(50to20)• Hilaryhastheabsoluteadvantageinbrick-laying• Donaldhastheabsoluteadvantageinbakingcakes• Iftheybothbothspecialisefullythentotaloutputcanincrease

Price

Output

EU,Demand

EU,Supply

EU,price

Q,(EU)

Non,EU,SupplyGlobal,price

Q1 Q2

A

BC

DE

F

G