The meaning of globalisation
There is no precise definition of the term globalisation, and it is used to refer to a variety of ways in which countries are becoming more and more closely integrated, not just in the economic sense, but also culturally and politically.
However, one of the best definitions of globalisation in the economic sense is by Peter Jay, the BBC’s economics corrospondent in 1996: ‘The ability to produce any good or service anywhere in the world, using raw materials, components, capital and technology from anywhere, sell the resulting output anywhere and place the profits anywhere’.
It should be understood that globalisation is not a new phenomenon because there have been many period in history when there was considerable integration between countries: for example, during the height of the Roman empire. However, the pace of global integration has increased considerably over the last 30 years.
Characteristics of globalisation
- An increase in trade as a proportion of GDP
- Increased movements of financial capital between countries
- Increased international specialism and division of labour. It is increasingly common for parts and components of products to be made in different countries and for assembly to occur in another country
- The growing importance of MNCs and TNCs – multinational and transnational companies – and foreign direct investment (FDI)
A variety of factors have contributed to increased economic integration if countries.
One of the most significant is the fall in transport costs. In real terms, the price of transporting goods has fallen significantly, enabling good to be imported and exported more cheaply. Coupled with this has been a decline in the cost of communications. In particular, the cost of using the internet has fallen greatly over the last 20 years, and its availability has increased.
The lowering of trade barriers since the Second World War has been a major factor in the growth of world trade. The World Trade Organisation (WTO), formerly the General Agreement on Tariffs and Trade, has been responsible for negotiating reductions in tariffs and other barriers to trade in rounds of talks, the most recent of which was the Doha round.
Both the collapse of communism and the opening of China to world trade have contributed to globalisation. Countries which were previously not open to FDI became much more integrated into the world trading system. TNCs have taken advantage of the reduction in trade barriers and the development of the internet to organise trade on a global scale.
Benefits and disadvantages of globalisation
Free trade enables the application of the law of comparative advantage, which suggests that, when countries specialise in goods in which they have a comparative advantage (i.e. goods can be produced at a lower opportunity cost) then world output and living standards will increase. It is evident that the growth in world trade in both goods and services has been associated with increased growth in real GDP.
- For consumers, globalisation may mean a wider choice of goods at a lower price
- For producers, there are likely to be benefits in terms of lower production costs as a result of offshoring and also economies of scale
The external costs associated with trade are becoming increasingly apparent, especially in relation to environmental degradation which results in global warming. Consumers are also becoming more aware of ‘food miles’. It mat be argued, therefore, that increased trade is not sustainable in terms of the environment.
Globalisation has also been associated with increased inequality. For example, rich countries have much greater access to the internet than poor countries. Given that much wealth creation is dependant on readily available information the poorest developing countries are at a severe disadvantage.
Some argue that the liberalisation of financial markets has been associated with global instability, as evidenced by the financial crisis in Asia at the end of the 1990s, and more recently the global credit crunch following the collapse of confidence in the banking system. It is also argued that the global imbalances currently experienced (i.e. the current account deficits in the USA and surpluses in China) are unsustainable.
The global financial crisis that became particularly evident in 2008 has led to a development sometimes described as deglobalisation, in which countries adopt protectionist policies in an attempt to protect domestic employment. Obviously thi leads to the decline in specialisation and trade. Examples of protectionism in 2009 include the subsidies given to the car industry in the USA; the increased tariffs on imported cars in Russia, and the EU raising duties on imported Vietnamese shoes
Globalisation has led to a phenomenal increase in world trade. One measure is to consider exports as a proportion of world GDP.
The pattern of world trade has also been greatly affected by the entry of China as a major manufacturer.
The basis of free trade law: the law of comparative advantage
The law states that, even if one country has an absolute advantage in the production of all goods, it can still benefit from specialisation and trade, if it specialises in the production of goods in which it has a comparative advantage.
A country has a comparative advantage in producing a product if the opportunity cost of producing it is less than its potential trading partner.
Say the UK take 5 hours to make cheese, and China 1. Also, the UK takes 15 hours to make cars, but China 2. China clearly has an absolute advantage in producing both cars and cheese.
However, look at the opportunity cost. The UK gives up 3 cars if it producing 1 cheese. China gives up 2 cars if its producing 1 cheese. Therefore China has a comparative advantage in cheese production.
The UK gives up 1/3 a car if it produces one cheese, and China gives up 1/2. So, the UK has a comparative advantage in car production.
Therefore, the UK should specialise in producing cars, and China should produce cheese.
For trade to be beneficial, the terms of trade must lie between opportunity cost ratios. In other words, the UK will only trade for cheese with china if the price is above 1/3 of a car, and China will only trade if it is below 1/2 of a car.
Terms of trade = (index of export prices / index of import prices) x 100
You should note that, if opportunity costs were the same, then there would be no benefit from specialisation and trade.
However, widespread acceptance of the law of comparative advantage amount economists and the benefits of free trade, various criticisms can be made:
- Free trade is not fair trade i.e. the rich countries might exert their monopsony power to force producers in developing countries to accept low prices.
- The law of comparative advantage is based on unrealistic assumptions such as constant costs of production, zero transport costs, and no barriers to trade.
Limits of free trade: the case for protectionism
The term protectionism refers to measures designed to limit free trade. Arguments supporting the need for protectionism might include the following:
- To protect infant industries: this argument might be particularly relevant to developing countries that are in the process of industrialisation. Without protection, infant industries might be unable to compete because they have yet to establish themselves and are too small to benefit from economies of scale.
- To protect geriatric industries: these are industries that might demand protection so that they have time to restructure and rationalise production so that they can become competitive again. Typically, these occur in developed economies that are loosing their comparative advantage.
- To ensure employment protection: cheap imports might threaten jobs in the domestic economy and workers might demand that the government takes action to limit imports.
- To prevent dumping: the term dumping refers to goods exported to another country below at a price below the average cost of production. It is a form of predatory pricing and, if it can be proved, it is illegal under WTO rules. This is one of the few arguments in favour of protectionism that can be justified under economic theory because it unfairly distorts comparative advantage
- To correct a balance of payments deficit on current account: restrictions on imports might help to reduce the imbalance of between the value of import and the value of exports. However, under the floating exchange rates system, it is possible that this correction will happen automatically
- To restrict imports fro counties whose health and safety regulations and environmental regulations are less stringent: some argue that developing countries have an unfair comparative advantage because production is not under the same laws and regulations as developed countries, so enabling them to produce at lower average cost
- For strategic reasons: a country might introduce protectionist policies on goods of strategic importance in time of war so that it is not dependant on imports. Food, defence equipment and energy are items frequently used as examples of such goods.
- To raise tax revenues: tariffs may be an important source of tax revenue for developing countries.
- In retaliation: barriers to trade may be imposed by a country because another country has restricted the imports of its goods.
There are numerous ways by which free trade can be prevented. The most common are tariffs, quotas and subsidies to domestic producers and administrative regulations. In countries where the exchange rate is not freely floating, the authorities might also hold down the value of the currency artificially to give their good a competitive advantage. e.g. China.
Before the tarrif is imposed:
- the price paid by consumers is P1, domestic output is Q1, imports are Q1 to Q2.
- the price paid by the consumer increases to P2, reducing consumer surplus
- domestic output rises to Q4, increasing producer surplus
- imports fall to Q4Q3
- tax revenue collected by the government is KLMN
- net deadweight welfare loss is the loss in consumer welfare that is not made up for by producer welfare or government revenue – X and Y
Import quotas place a physical restriction on the amount of goods that can be imported. They have a similar effect as tarrifs, in that the price of imported goods will rise and domestic producers should gain more business. However, unlike tariffs, the government does not gain any extra revenue.
Subsidies to domestic producers
Grants given to domestic producers artificially lower their production costs, so enabling their goods to become more competitive. Subsidies therefore act as a barrier to trade
These take a variety of forms, including labelling, heath and safety regulations, environmental standards and documentation on country of origin. In effect, such regulations increase the costs of foreign producers and so act as a barrier to trade.
The case against protectionism
There are several problems with protectionism including:
- Inefficient resource allocation: trade barriers distort comparative advantage and reduce specialisation, which will result in lower world output and therefore reduce living standards
- Higher prices and less choice for consumers
- Less incentive for domestic producers to become more efficient in order to compete on a global scale
- Difficulty of removing trade barriers. Once such barriers are introduced, it might prove to be difficult to remove them because of the adverse effect on domestic producers
The World Trade Organisation
The primary aim of the World Trade Organisation (WTO) is to liberalise trade i.e. to lower trade barriers. It does this by providing governments with a forum for negotiating trade agreements. Since the creation of the General Agreement of Tariffs and Trade (GATT), which was the forerunner of the WTO, there have been eight rounds of talks, with the ninth round – the Doha Development Agenda – still being negotiated (since 2001).
In addition to promoting free trade, the WTO performs other functions including:
- Most favoured nation principle: which implies that counties cannot discriminate between trading partners. For example, a reduction in tariff for one country must be enacted for all countries
- National treatment: imported and locally produced goods must be treated equally once the foreign goods have entered the market.
While the WTO has been successful at bringing about substantial reductions in tariffs on manufactured goods e.g. industrialised country’s tariffs averaged around 4% by the mid 1990s, it has been less successful in reducing barriers to the trade in services. Further, there has been a growth in the use of non-tariff barriers, especially administrative regulations, which has, to some extent, offset the gains from the reduction in tariffs.
Regional trading blocs are intergovernmental associations that manage and promote trade activities for specific regions of the world. Trading blocs may take several forms:
- Free trade areas. Trade barriers are removed between member countries, but individual countries can still impose tariffs and quotas on countries outside of an area. An example is in the North Atlantic Free Trade Area.
- Customs unions. The characteristics of customs unions include free trade between member states and a common external tariff on all goods imported from outside the bloc. An example is the European Union
- Common market. These are customs unions but with the added dimension that it is not only goods and services that can be moved freely within the area, but also factors of productions (especially labour). For example, the European Economic Area.
- Monetary unions. These are customs unions that adopt a common currency. For example, the Eurozone
Trading blocs and the WTO
The existence of trading blocs has two significant consiquences:
- trade creation – trade occurs that otherwise wouldn’t have happened. This is a result of the removal of trade barriers and therefore increased specialisation and trade according the the law of comparative advantage
- trade diversion – trade changes from with members from outside of the union to inside of the union. This is due to the tariffs imposed on countries outside of the union, and the removal of tariffs inside of the union – from the lower-cost to the higher cost countries. Therefore this is an inefficient allocation of resources.
Nevertheless, it may be argues that the growth in both the number and size of trading blocs has contributed to the WTO goal of promoting free trade.