GE 319 - The Contemporary World - Lesson 1: The Global Economy PDF

**GE 319 - The Contemporary World** Lesson 1: The Global Economy ============================ - **Globalization** involves the \"broadening and deepening of interdependence among peoples and states". - It leads to an extension of geographic linkages, encompassing societies and states...

**GE 319 - The Contemporary World** Lesson 1: The Global Economy ============================ - **Globalization** involves the \"broadening and deepening of interdependence among peoples and states". - It leads to an extension of geographic linkages, encompassing societies and states and deepens interaction among them such that policies and events of one state also affect distant ones. - **Globalization** is a multidimensional phenomenon comprised of political, economic and cultural features. Szentes (2003) defines **economic globalization** as \"a process making the world economy an ***\"organic system***\" by extending transnational economic processes and economic relations to more and more countries and by deepening the economic interdependencies among them\". Benczes (2014) follows this definition and emphasizes that interpretation of the current trends in the world economy must be understood in the global context of an integrated world economy. Non-state actors such as international organizations, non-governmental organizations, and multinational transnational or corporations play significant roles in the international economic processes. In today's borderless economy, the workings of the **"invisible hand**" have a reach and strength beyond anything Adam Smith ever could have imagined. The **global economy** is the result of the development of an economy that rises above borders and is free moving between the different nation states of the world. But why do countries trade? Countries trade with each other when, on their own, they do not have the resources, or capacity to satisfy their own needs and wants. **The production of goods and services in countries that need to trade is based on two fundamental principles:** 1. Division of labor -------------------- - a division of labor means breaking down production into small, interconnected tasks, and then allocating these tasks to different workers based on their suitability to undertake the task efficiently. - a division of labor means that countries produce just a small range of goods or services and may contribute only a small part to finished products sold in global markets. 2. Specialization ----------------- - is the second fundamental principle associated with trade, and results from the division of labor. Given that each worker, or each producer, is given a specialist role, they are likely to become efficient contributors to the overall process of production, and to the finished product. - can generate further benefits in terms of efficiency and productivity. - can be applied to individuals, firms, machinery and technology, and to whole countries. - **International specialization** is increased when countries use their scarce resources to produce just a small range of products in high volume. - **Mass production** allows a surplus of goods to be produced, which can then A. Principle of Absolute Advantage (Adam Smith) ----------------------------------------------- - refers to the capability to produce more of a good or service than competitors using the same/abundant resources. - We can say that a country has absolute advantage in one commodity over another country if that country can produce the commodity more efficiently than the other country can. B. Principle of Comparative Advantage (David Ricardo) ----------------------------------------------------- - refers to producing a good or service at a lower opportunity cost. - the basis, therefore, for specialization and trade, in general, is comparative advantage and not absolute advantage. - countries specialize in and export those goods and services where they have comparative advantage and import those commodities where they do not have comparative advantage. - **Producing a narrow range of goods and services for the domestic and export market** means that a country can produce in at higher volumes, which provides further cost benefits in terms of economies of scale. - **Trade increases competition and lowers world prices**, which provides benefits to consumers by raising the purchasing power of their own income and leads a rise in consumer surplus. - **Trade also breaks down domestic monopolies**, which face competition from more efficient foreign firms. - **The quality of goods and services is likely to increases** as competition encourages innovation, design and the application of new technologies. Trade will also encourage the transfer of technology between countries. - **Trade is also likely to increase employment**, given that employment is closely related to production. Trade means that more will be employed in the export sector, and, through the multiplier process, more jobs will be created across the whole economy. **The disadvantages of trade:** - **Trade can lead to overspecialization**, with workers at risk of losing their jobs should world demand fall or when goods for domestic consumption can be produced more cheaply abroad. Jobs lost through such changes cause severe structural unemployment. - **Certain industries do not get a chance to grow because they face competition** from more established foreign firms, such as new infant industries which may find it difficult to establish themselves. - Local producers, who may supply a unique product tailored to meet the needs of the **domestic market, may suffer because cheaper imports may destroy their market**. Over time, the diversity of output in an economy may diminish as local producers leave the market. The Pattern of International Trade ---------------------------------- Heckscher--Ohlin Theory ----------------------- Product life-cycle Theory ------------------------- - Proposed by *Raymond Vernon*, this theory suggests that early in their life cycle, most new products are produced in and exported from the country in which they were developed. - As a new product becomes widely accepted internationally, however, production starts in other countries. As a result, the theory suggests, the product may ultimately be exported back to the country of its original innovation. New Trade Theory ---------------- Theory of National Competitive Advantage ---------------------------------------- - Developed by **Michael Porter**, attempts to explain why particular nations achieve international success in particular industries. - In addition to factor endowments, Porter points out the importance of country factors such as domestic demand and domestic rivalry in explaining a nation's dominance in the production and export of products. Free Trade Vs Protectionism --------------------------- ### Free trade \- Advocates for minimal restrictions on the movement of goods and services between countries, aiming to maximize wealth through increased trade. ### Protectionism - Supports restricting trade to protect domestic industries and jobs, especially in strategic sectors like food or steel production. - Protectionism may also be used to prevent imports from countries with lower labor or environmental standards from undercutting local industries. Economists often agree that some restrictions may be necessary but caution that excessive protectionism can lead to higher prices and reduced overall wealth. ### Arguments for Free Trade - **Free trade increases the size of the economy as a whole**. It allows goods and services to be produced more efficiently. That's because it encourages goods or services to be produced where natural resources, infrastructure, or skills and expertise are best suited to them. It increases productivity, which can lead to higher wages in the long term. There is widespread agreement that rising global trade in recent decades has increased economic growth. - **Free trade is good for consumers.** It reduces prices by eliminating tariffs and increasing competition. Greater competition is also likely to improve quality and choice. Some things, such as tropical fruit, would not be available in the UK without trade. - **Reducing non-tariff barriers can remove red tape, thus reducing the cost of trading**. If companies that trade in several countries must work with only one set of regulations, their costs of 'compliance' come down. In principle, this will make goods and services cheaper. - In contrast, protectionism can result in destructive trade wars that increase costs and uncertainty as each side attempts to protect its own economy. Protectionist rules can tend to favor big business and vested interests, as they have the resources to lobby most effectively. ### Arguments for Protectionism - **As more countries experience industrial development, traditional domestic industries can decline.** In the UK, for example, the shipbuilding industry has declined in the face of international competition since the 1950s and currently steel production faces increasing competition. Protectionism can help preserve jobs in these sectors, or at least slow the process of change. - **Protectionism can also help build up new industries.** In sectors with high start-up costs, new firms might find it difficult to compete if there is not support from government in the form of tariffs or subsidies. Once they have become competitive, such barriers can be removed. - **Protectionism can be used to safeguard 'strategic' industries such as energy, water, steel, armaments and food.** For example, 'food security' may be seen as important so that we can feed ourselves if something terrible happens to disrupt the system of world trade. - Some people worry that free trade deals can lead to a lowering of standards. Such deals might require us to let in goods and services even though they don't meet our standards, which might then be cheaper than those made by domestic industries. For example, some people have been worried recently that a free trade deal with the US might let in imports of chlorine-washed chicken. There might also be pressure to reduce our standards for workers' rights or environmental protection so that our companies can compete with companies in countries that have lower standards. Lesson 2: Market Integration ============================ Economic systems vary from one society to another. But in any given economy, production typically splits into three sectors. Primary sector -------------- Secondary sector ---------------- Tertiary sector --------------- - involves providing services rather than producing goods. - this sector focuses on doing tasks rather than making physical products. The Post-World War II Economic System and The Role of International Financial Institutions in the Creation of a Global Economy ------------------------------------------------------------------------------------------------------------------------------ **Bretton Woods Conference (July 1944)**: - Also known as the United Nations Monetary and Financial Conference, held in Bretton Woods, New - Delegates from 44 countries established a new international economic framework. **Creation of International Institutions**: Two key institutions were formed: - International Monetary Fund (IMF) - World Bank (International Bank for Reconstruction and Development) These are collectively known as the Bretton Woods Institutions. **General Agreement on Tariffs and Trade (GATT)**: - Created in 1947 after the Bretton Woods Conference. - A more informal institution compared to the IMF and World Bank but served as the primary global trade organization. - Designed to address the issues from the interwar period, such as **trade protectionism** and **exchange controls**. - These issues were believed to have contributed to the **Great Depression** and **World War II**. Keystone International Economic ------------------------------- **Organizations (KIEOs)**: International Monetary Fund (IMF) --------------------------------- - Established in 1945 to promote global monetary cooperation and international financial stability. - Initially designed to monitor a system of pegged or fixed exchange rates where currencies were linked to gold and the U.S. dollar. - was designed to provide short-term loans to aid countries facing balanceof-payments deficits. ### IMF Role in Preventing Trade Wars - The IMF aimed to prevent trade wars caused by competitive currency devaluations, which were common during the interwar period. - Countries with balance-of-payments deficits often devalued their currencies to boost exports and reduce imports. ### Balance-of-Payments Deficits - Occurs when a country spends more than it earns. - The IMF provides short-term loans to countries with temporary deficits to prevent devaluation and maintain fixed exchange rates. ### Shift to Floating Exchange Rates - In 1971, the fixed-exchange-rate system collapsed, leading to the adoption of floating exchange rates. - The IMF\'s role shifted to providing liquidity to countries linked to major currencies. ### Quota System ### Criticism and Western Dominance ### Global Financial Crisis and IMF Reform The Global Financial Crisis (2007-2009) prompted IMF reforms to improve its capacity for crisis management. Two key elements of the reform: 1. **IMF Resource Expansion**: To enhance the institution's financial crisis management capabilities. 2. **Quota and Voting Power Adjustments**: Increase the quota and voting shares of emerging economies. ### 2010 Reform - Involved doubling the IMF quota and shifting quota shares from overrepresented to under-represented countries. - Increased representation of developing and emerging market economies. - Redistributed seats in the Executive Board to restore legitimacy and improve crisis management. - More than 6% of the quota was shifted to under-represented countries, including emerging markets. ### Trade-off in Reform Negotiations - The reform resulted in a trade-off between money and power, especially involving **the BRIC countries (Brazil, Russia, India, China).** - The BRIC nations contributed more to IMF resources in exchange for greater quota shares and representation on the Executive Board. - Despite reforms, the changes did not fully meet expectations for IMF restructuring and strengthening. International Bank for Reconstruction and Development (World Bank) ------------------------------------------------------------------ **Two Institutions of the World Bank**: 1. **IBRD (International Bank for Reconstruction and Development)**: Focuses on providing loans to middleincome and creditworthy low-income countries. 2. **IDA (International Development Association)**: Grants credits and loans to the lowest-income countries. **World Bank Group**: The World Bank is part of the larger **World Bank Group**, which includes three other institutions: ### 1. International Finance Corporation (IFC) 2. Multilateral Investment Guarantee Agency (MIGA) 3\. **International Centre for Settlement of Investment Disputes (ICSID)** **Modern Role of the World Bank**: - Focuses on reducing extreme poverty and addressing imperfections in global capital markets. - **Policy Influence**: Rooted in its legitimacy and credibility, the World Bank impacts global economic policy, particularly in donor and recipient countries. - Its technocratic staff and multilateral status enhance its effectiveness General Agreement on Tariffs and Trade (GATT) --------------------------------------------- - Purpose: Avoid trade wars by raising protectionist barriers, especially after the interwar period. - Created post-Bretton Woods, after the - The U.S. agricultural sector feared the potential losses brought by the ITO, leading to its failure. - GATT was created as an informal, provisional treaty where participating states were **\"contracting parties**\" rather than formal members. - Focus: Liberalize trade but was limited in addressing the expansion of trade in services, investment, and intellectual property. - It also lacked a strong dispute settlement system. - More formal and capable of addressing issues such as trade in services, investment, and intellectual property. - Developed a stronger, more efficient system for dispute settlement. - The global economic order shaped by the WTO was heavily influenced by Western developed countries. Organization for Economic Cooperation and Development (OECD) ------------------------------------------------------------ - The OECD is an influential organization with 35 member states as of 2016, with Latvia being the most recent member. - The organization wields influence due to the resources and economic power of its member countries, despite lacking formal power. Organization of Petroleum Exporting Countries (OPEC) ---------------------------------------------------- - OPEC was formed in 1960 by Saudi Arabia, Iraq, Kuwait, Iran, and - The current OPEC members also include the United Arab Emirates, Algeria, Libya, Qatar, Nigeria, and Indonesia. - OPEC remains one of the major oilexporting groups in the world today. - Most members within the Eurozone use the euro as their currency, but some, like Great Britain, Sweden, and Denmark, have not adopted it. - Critics argue that the euro increased prices in Eurozone countries and contributed to depressed economic growth rates, particularly in Greece, Spain, and Portugal. - The European Central Bank\'s policies are seen as playing a role in these economic challenges. NAFTA (North American Free Trade Agreement) ------------------------------------------- - Formed on January 1, 1994, between the United States, Mexico, and Canada. - Initially created in 1989 as a trade pact between the United States and Canada before Mexico joined. - Aims to develop and expand world trade by increasing international cooperation. - Focuses on improving working conditions in North America and reducing barriers to trade. - Helps expand markets among the three countries. ### Effects of NAFTA on Mexico - Manufacturing jobs moved from developed nations (U.S. and Canada) to Mexico due to lower costs. - Producer prices in Mexico dropped, causing about 2 million farmers to leave their farms. - Consumer food prices increased, pushing 20 million Mexicans (25% of the population) into \"food poverty.\" ### Impact of NAFTA on the United States - NAFTA contributed to U.S. GDP growth, adding \$127 billion annually through increased trade. - Job losses and wage stagnation were partly attributed to outsourcing to Mexico. - About 791,000 U.S. jobs were outsourced to Mexico by 2010 due to cheaper labor and fewer government regulations. ### Impact of NAFTA on Canada - 76% of Canadian exports go to the United States. - A quarter of jobs in Canada are dependent on trade with the United States. - Changes or elimination of NAFTA could severely impact Canada\'s economy. ### Positive Consequences of NAFTA - Lowered prices by removing tariffs. - Opened opportunities for small- and medium-sized businesses. - Quadrupled trade between the three countries. - Created 5 million U.S. jobs. ### Negative Consequences of NAFTA - Excessive pollution due to increased industrial activities. - Loss of more than 682,000 manufacturing jobs in the U.S. - Exploitation of workers in Mexico. - Displacement of Mexican farmers from their businesses. **International Monetary System:** A set of general rules, legal norms, instruments, and institutions shaping payment conditions in foreign trade, brought by multilateral international agreements facilitated by international financial organizations. **Gold Standard (Adopted by England, 1816)**: - The first international monetary system, later joined by European countries and the U.S. - A fixed exchange rate regime where countries determined the gold content of their currencies, defining fixed exchange rates. **Features**: - Unlimited convertibility of currencies into gold. - Stability in trade, eliminating exchange rate fluctuations. - Automatic equilibrium of the trade balance. - Non-inflationary since money issuance was dependent on a state\'s gold reserves. **Weaknesses**: - Limited cash flow. - Curbed economic development. - Dissolution marked by World War I due to military spending demands. **Gold Bullion Standard (Genoa, 1922)**: - A modified gold standard involving the exchange of large sums of money for gold bullion of fixed weight. - Failed to ensure free convertibility of currencies into gold. - Collapsed in 1931 with the outbreak of the Great Depression (1929), which triggered bankruptcies, a decrease in trade and production, and unemployment. **Bretton Woods System (1944)**: - **44** countries agreed in creating a new international system that would prevent the chaos that occurred during the interwar period. - Known as the **dollar-gold standard or gold-exchange standard**: - U.S. dollar as the only convertible currency, backed by gold at US\$35 per ounce. - Effective stability period: 1959 to 1968. **1960s and 1970s**: - Introduced interventions like the ***Gold Pool and Special Drawing Rights*** to expand resources and means of payment. - Despite these efforts, issues like U.S. deficit, currency speculation, and inflation led to the abandonment of the gold-exchange standard. - The Bretton Woods System collapsed in 1973, leading to fluctuating exchange rates determined by market forces. **Post-Bretton Woods Era**: - Countries moved to floating exchange rates. - The IMF allows flexibility for member states to determine exchange rates or peg them to major currencies like the U.S. dollar or SDR. - Managed float systems permit central bank interventions to address exchange rate fluctuations. - Countries are prohibited from manipulating their currencies for shortterm gains at the expense of others.