HSC Economics Topic 1

HSC Economics Notes

The Global Economy
1. INTERNATIONAL ECONOMIC INTEGRATION
2. TRADE, FINANCIAL FLOWS AND FOREIGN INVESTMENT
3. PROTECTION
4. GLOBALISATION AND ECONOMIC DEVELOPMENT
5. CASE STUDY

International Economic Integration

Global economy: refers to the sum of the interactions between the economies of individual
countries that are now increasingly linked together into one economic unit.

Gross world product (GWP): refers to the sum of total output of goods and services by all
economies in the world over a period of time.

Globalisation: refers to the integration between different countries and economies and the
increased impact of international influences on all aspects of life and economic activity.

Main aspects of globalisation:

-Trade in goods and services
-Financial flows
-Investment and transnational corporations
-Technology, transport and communication
-International division of labour and migration

Trade in Goods and Services

Trade: the buying of goods and services between international economies

Trade has grown rapidly in recent decades:

- 1990: USD $8.7 trillion (38% of global output)
- 1012: USD $53 trillion (73% of global output)
The size of global trade reflects that economies do not produce all the goods and services they
need because other economies can produce these goods and services more efficiently (meaning
that they have a comparative advantage in this production area)
Global trade has increased for a number of reasons:
- Increased dependance on imports
- Increased transport and communications
- Removal of trade barriers
- Introduction of international organisations
Composition of global trade:
- Dominated by manufactured goods
- Recent growth in trade of fuels and minerals (from 17% in 1970 to 50% in 2014)
- Decrease in trade of rural goods (from 42% in 1970 to 12% in 2014)
Asia has seen a rapidly growing share of GWP while Europe and the USAs shares have
declinedbetween 1995-2009 high-income economies saw their share of global trade fall from
80% to 72% of world exports

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Financial Flows
Foreign exchange market (FOREX): refers to the market in which currencies are traded.

Portfolio investment: refers to the short-term movement of funds between economies for loans or
speculative reasons (less than 10% of a company).

Speculators: are investors who buy or sell financial assets with the aim of making profits from
short term price fluctuations (i.e. portfolio investment).

International financial flows have expanded substantially following financial deregulation around
the world, which in most countries occurred in the 1970s and 1980s
New technological advancement and global communication networking have increased financial
flows by linking financial markets through the world and have reduced the cost of world trade
Foreign exchange markets (FOREX) have experienced exponential growth in recent years, with
average daily turnover reaching USD $5.5 trillion in 2014
95% of FOREX transactions are related to short-term speculative portfolio investments rather
than long term direct investment and trade
Greater global financial flows allow countries to obtain funds for domestic investment

Investment and Transnational Corporations

Foreign direct investment (FDI): refers to the long-term movement of funds between economies
for the purpose of buying over 10% of an existing company or establishing a new market position.

Transnational corporations (TCNs): are global companies that have production facilities in at
least two countries and are owned by residents of all least two countries

Foreign direct investment is strongly affected by the global business cycle, for example, the GFC
saw a huge drop in FDI as it meant there was far greater risk for investors
Traditionally FDI has been more attracted to high income economies, however, for the first time
in history in 2010, emerging economies received more FDI than developed economies
TCNs play a vital role in global investment because they utilise the benefits of global integration,
and since the 1990s the number of TCNs grew from 37,000 to 10,4000
Because TCNs often bring capital and job opportunities, governments sometimes encourage
them to set up in their countries by providing subsidies and tax concessions
International mergers and takeovers have further increased global investment, however mergers
and takeovers are strongly influenced by economic growth and in 2012, mergers fell 45% due to
instability and subdued growth in developing economies

Technology, Transport and Communication

Technological development has facilitated the global integration of economies by increasing the
capabilities of international transport and communication:
Advancements in freight technology such as standardised shipping containers (containerisation),
cargo tracking and efficient logistics systems
Advancements in transportation such as aircraft and high-speed rail networks have allowed
greater labour mobility between economies and increased accessibility of tourists
Cheaper and more reliable international communications, such as broad-band networks, have
allowed easier connection between global consumers and producers
Powerful computer and communications networks have allowed money to move more rapidly
around the world, encouraging increased trade and investment
Social media has allowed for greater cultural globalisation, for example Google's advertising
revenue has grown from $51 billion in 2013 to $60 billion in 2014

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International Division of Labour and Migration

Migration: refers to the movement of people between countries on a permanent or long-term
basis, usually for 12 months or longer.

Brain Drain: refers to the emigration of highly trained or qualified people from a particular country.

International division of labour: refers to how the tasks in the production process are allocated
to different people in different countries around the world.

In 2014, there were 232 million international migrants in the world, 60% of whom resided in
developed economies
Since 2010, migration has slowed down due to the aftermath of the GFC, however, rising
pressure from labour supply and income equality could increase migration again
Migration to advanced economies is concentrated at the top and bottom end:
- Highly-skilled labourers migrate for better pay and opportunities, known as brain drain
- Unskilled workers migrate to advanced economies to receive relatively better pay than for
the same job in their country of origin
Globalisation and the international division of labour mean people migrate to where their skills
are most needed as countries specialise in areas where they have comparative advantage
- Developing economies large population of workers with basic labour skills/education levels
leads to comparative advantage in labour intensive manufacturing (and many TCNs move
their production facilities to developing countries to reduce costs, known as offshoring)
- Advanced economies focus on specialised service aspects which take advantage of the
abundance of highly skilled/educated workers available
However, worker and business mobility is restricted by barriers such as migration restrictions,
language, cultural factors and incompatible education qualifications

International Business Cycle

Business cycle: refers to fluctuations in the level of economic growth due to changes in aggregate
supply and aggregate demand (usually measured in GDP).

International business cycle: refers to fluctuations in the level of economic activity in the global
economy over time (usually measured in GWP).

Upswing: rising GWP, consumption, investment

and decreased unemployment
Boom: high GWP, businesses operating at near full
capacity, rising inflation, demand and interest rates
Downswing: falling GWP, consumption,
investment and increased unemployment
Trough: low GWP, businesses not working at full
capacity, falling inflation, demand and interest rates

Although economic growth differs between countries, for most nations, economic growth is
stronger when there is an upswing in the international business cycle and weaker when the there is
a downswing. This highlights how highly integrated the global economy is, and how how quickly
the transmission of economic conditions from one economy to another is.

TRADE FLOWS
If there is a boom or recession in one country will affect the demand for exports and therefore
affect the aggregate demand of other nations. It was estimated that during the GFC more than
25% of the decline in US growth was transmitted to other countries.
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INVESTMENT FLOWS
Strong economic conditions in one country will make it more likely that businesses in that country
will invest in new operations in other nations, which will then add to their economic activity. In early
2010 there was limited FDI from developed economies due to weak growth in the US and Europe.

TRANSNATIONAL CORPORATIONS
The actions of TCNs have had an increasingly significant effect on the international business cycle.
For example, in 2011, Toyota temporarily reduced its manufacturing operations in Australia due to
the impact the earthquake and tsunami had on the companys headquarters in Japan.

FINANCIAL FLOWS
The global integration of financial markets means that 70% of financial market vulnerability in
advanced economies is transmitted to emerging countries, which takes about one to two months.

FINANCIAL MARKET AND CONFIDENCE

The confidence of investors in financial markets is constantly influenced by fluctuations in growth
from all around the international economy. This is evident in that usually share prices in the worlds
major stock exchanges experience synchronised fluctuations with the international business cycle.

GLOBAL INTEREST RATES

Monetary policy decisions in individual economies are increasing influencing exchange rate
changes in other economies. For example, if the US reduces interest rates due to subdued growth,
this places pressure on central banks in other countries to also lower interest rates.

INTERNATIONAL ORGANISATIONS
International forums such as the G8 or G20 can play an important role in influencing the global
business cycle by influencing macroeconomic changes in the worlds major economies.

COMMODITY PRICES
Higher commodity prices will generally cause a contraction in GWP, however, some individual
economies will benefit from this while others will suffer. The decrease in oil prices in 2015 when the
Middle East flooded the market benefitted oil importers such as China but was detrimental to the
economic growth of oil producing economies such as Russia.

STRUCTURAL FACTORS
Different economies have different comparative advantages, resources, financial systems and
attitudes towards consumption and saving. Structural changes in one economy may affect
economic growth in other economies, for example, in 2015, Brazil decreased capacity constraints
by building large scale ocean liners to increase international competitiveness in the commodity
export sector, thereby decreasing the demand for Australian iron ore.

REGIONAL FACTORS
Economies are highly influenced by the economic growth of their neighbours as neighbouring
economies tend to be highly integrated, such as the European Union or ASEAN.

Regional Business Cycle

Regional business cycle: refers to the fluctuations in the level of economic activity in a
geographical region of the global economy over time.

Gross Domestic Product (GDP): is the total market value of all final goods and services
produced in an economy over a period of time.

In the same way that countrys economic activity can be influenced by global changes they can
also be influenced by regional factors.

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While changes in the American business cycle will affect countries all around the world, the
effects will be most profound on Canada and Mexico due to the North America Free Trade
Agreement (NAFTA), which integrates these economies
Similarly, the East Asia region is highly influenced by economic activity in China and Japan, who
are the second and third largest economies in the world, respectively
Fluctuations in Germany, the UK and France influence the other 28 members of the EU
Some regions containing a high proportion of developing economies such as Sub-Saharan Africa
can be dependent on high income economies for more than 80% of exports, and therefore, these
economies are increasingly influenced by international factors rather than regional factors
While regional conditions are dominated by the larger economies in that region it is important to
recognise that small economies can also have significant influence on regional economic growth:
- In the late 1990s the East Asia Financial Crisis was triggered by a depreciation of the Thai
Baht, even though Thailand is a relatively small economy compared to the rest of Asia
- In the early 2000s problems in Argentina affected all of Latin America
- In 2010 financial turmoil in Greece affected the whole European Union
- in 2014 political conflict in the Ukraine reduced economic growth across Asia and Europe
It is important to note that the regional business cycle can by quite different to patterns in global
economic growth and while the international business cycle may be in recession some regions
may still be prospering during this time

Trade, Financial Flows and Foreign Investment

Free Trade
Free trade: refers to a situation where governments impose no artificial barriers on trade for the
purpose of shielding domestic producers from foreign competitors.

Comparative advantage: is when an economy has an advantage over other nations in a certain
area of production because they have the lowest opportunity cost, possibly due to an abundance of
natural resources, low wages or the presence of highly-skilled labour.

Specialisation: occurs when an economy concentrates on producing a particular set of goods and
services in which it has a comparative advantage.

Opportunity cost: is the cost of the forgone alternative andrepresents the alternative use of
resourcesthat is, the cost of satisfying one want over an alternative want.

Free trade allows countries to specialise in areas where they have a comparative advantage,
thereby reducing their opportunity cost and making themselves more efficient. The reduction of
tariffs and other artificial barriers involved with free trade will eventually increase a countrys
standards of living as it imports goods in sectors from sectors where it has a comparative
disadvantage from countries that have a comparative advantage in this sector and vice versa.

Dumping: is the practise of exporting goods to a country at a price lower than their selling price in
their country of originusually a way of disposing of production surpluses.

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Advantages of Free Trade Disadvantages of Free Trade

Wider variety of goods: countries are able to Increased short term unemployment: as
obtain goods and services they can not some domestic businesses find it harder to
produce themselves in an efficient manner compete with tariff free imports and are force
(such as ETMs in Australia because we have a out of business leading to a decrease in the
comparative disadvantage in manufacturing). demand for labour in the short term. However,
in the long term as the economy reallocates its
resources unemployment will decrease.
Specialisation: Allows countries to specialise Decreased demand for domestic goods and
in the production of goods and services where services: local producers may experienced
they are most efficient leading to a better reduced demand due to increased demand for
allocation of resources and higher production. now cheaper tariff free importsthis implies an
increase in leakages via the export sector.
Allocative efficiency: free trade encourages Entrepreneurial difficulties: it may be difficult
efficient allocation of resources by countries for new businesses and industries to establish
who specialise. themselves if they are not protected from larger
already established international competitors.
Economies of scale: Specialisation leads to Decreased government revenue: the
economies of scale, which will lower average government produces less revenue by
costs and lead to increased productivity. decreasing tariffs, however, the government
may also be able to cut spending by reducing
subsidies and export incentives.

International competitiveness: due to lower Product dumping: production surpluses from

export prices from the reduction or complete other countries may be 'dumped' on the
abolition of tariffs. domestic market, which may hurt efficient
domestic industries.
Innovation and technology: encourages Environmental degradation: free trade may
innovation and the spread of new technology encourage environmentally irresponsible
and production processes. practises because producers may move to
countries engaging in free trade to take
advantage of low levels of environmental
regulation in order to decrease costs.
Increased investment: the increased Exploitation of human rights: free trade will
competitiveness and efficiency created by free cause TCNs to use economies where there are
trade will encourage investors to invest in reduced human rights regulations in order to
economies engaging in free trade practises. decrease costs along with the reduction of
costs from having reduced tariffs on exports.
Higher living standards: the benefits of
economic growth and increased real incomes
will lead to higher living standards.

Role of International Organisations

World Trade Organisation (WTO)

The WTOs role is to implement and advance global trade agreements and resolve trade
disputes between economies around the world
Formed in 1995 to replace the General Agreements on Tariffs and Trade (GATT)
The process used by the WTO to settle trade disputes is as follows:
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- An economy will lodge a complaint with the WTO
- A process of dispute resolution occurs
- WTO panel issues a decision
- If an economy disagrees with the WTOs decision it may experience higher tariffs as a
consequence of its non-compliance

Successes of the WTO:

- Resolves trade disputes between smaller countries
- Has over 160 members
- The WTO has had some success in freeing up world trade by encouraging members to
voluntarily reduce artificial trade barriers
Shortcomings of the WTO:
- The WTO has had less success in resolving disputes between the United States and the
European Union due to lodged appeals and delays
- Since its establishment in 1995 it hasnt single-handedly administered any major agreement
- The WTO has had much difficulty reducing agricultural protection because many wealthy
nations such as the US and EU do not agree to reduce primary sector protection. In 2005
alone, the US and EU spent almost USD $800 billion in subsiding agricultural protection. As
a response, Australia joined with New Zealand and Brazilall major agricultural exporters
to place pressure on the WTO to reduce agricultural protection

International Monetary Fund (IMF)

The main role of the IMF is to maintain financial stability, particularly in regards to the FOREX
It plays a critical role in managing and minimising the effects of global financial crises
The IMF is funded by a quota system where each member state is required to place a certain
amount of money in the fund, determined by their relative size in the global economy
The IMFs main strategy to achieve this is to develop a rescue package to help stabilise an
economy that may be experiencing financial crisis:
- In 2014 a USD $17 billion emergency loan was given to the Ukraine
During the GFC of 2008-09 the IMF played a huge role in supporting economic recovery:
- USD $250 billion was injected into the global economy to promote liquidity and provide
specific support for countries especially affected by the crisis
- The IMFs lending reached USD $157 billion in 2009
- Interest payments on loans to developing countries were suspended
- The IMF advised economies to adopt expansionary macroeconomic policy
Two more long term roles of the IMF are to support the free trade of goods and services and to
encourage the movement of finance and capital in world markets
The IMF uses structural adjustment policies whereby client countries are required to adopt IMF
policies before they are willing to lend to them
The IMF encourages economies to embrace globalisation and deregulation:
- Cut the size of government
- Privatise government owned industries
- Deregulate market policies that inhibit business practises
- Open domestic markets to foreign competition

World Bank
Soft loans: refer to loans that have very little or no interest.

The role of the world bank is to help poorer countries with their economic development by
funding infrastructure, reducing poverty and helping countries embrace globalisation
The world bank has a number of sub-organisations that provide specific assistance to lower
income countries:
- International development association: provides soft loans to developing countries
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- International finance corporation: attracts private sector investment to the bank
- Multilateral insurance guarantee agency: provides risk insurance to private investors
The World Bank funds its projects from member countries and from its own borrowings in global
financial markets
The bank makes loans to developing nations at rates that are below standard commercial rates
to fund infrastructure projects, and thereby promote economic development
In response to the GFC in 2008 the world bank provided USD $280 billion to assist developing
countries with their recovery from the crisis
In 2014 the world bank made USD $39.6 billion in new lending commitments for programs to
reduce global poverty and encourage economic development internationally

United Nations (UN)

The UN has a very broad agenda which covers the global economy, international security, the
environment, poverty, economic development, international law and global health issues
It was established in 1954 and currently has 193 member states
The UN has historically played an important role in promoting globalisation and supporting
greater economic linkages between its member states

Organisation for Economic Cooperation and Development

(OECD)
The OECD plays a number of major roles in the global economy:
- Promotes highest possible levels of sustainable growth, employment and living standards
- Maintains financial stability in international markets
- Contributes to world economic development
The OECD has 34 members, 23 of whom are industrialised nations
During the GFC the OECD proposed an internationally coordinated macroeconomic stimulus

Government Economic Forums

Group of Eight Nations (G8)

The G8 includes most of the largest industrialised nations including the US, UK, Germany,
France, Canada, Japan, Italy and most recently, Russia
It is essentially a forum for global economic policy which aims for global prosperity and
maintenance of economic growth by focusing on the discussion of issues such as global
unemployment, nuclear safety and security
However, the significance of the G8 is declining as it does not represent all the powerful
economic forces in the worldlacking both China and Brazil as membersand its membership
covers only 14% of the worlds population

Group of Twenty Nations (G20)

The G20 includes 19 of the worlds largest economies and the European Union
Its members cover 80% of GWP and include 2/3 of the worlds population
The meetings seek to improve coordination of fiscal stimulus being implemented by different
countries around the world, as well as improving supervision of global financial institutions
- Post-GFC the G20 emerged as the leading forum for coordinating a global response to the
crisis by providing macroeconomic consultation and encouraging fiscal stimulus

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Trading Blocs, Monetary Unions and Free Trade Agreements

Trade bloc: occurs when a number of countries join together in a formal preferential trading
agreement to the exclusion of other countries.

Monetary union: refers to where two or more countries share a common country.

Free trade agreement: refers to when a number of countries agree to reduce imposed trade
barriers that are designed to give to give domestic producers an artificial advantage.

There are two types of agreements between countries:

Bilateral: involving two countries
Unilateral/multilateral: involving more than two countries

European Union (EU)

Function: the EU is a free trade agreement that function as a trade bloc to protect European
producers from the rest of the world. 18 of the 28 members share the currency of the Euro and
together, these countries form the monetary union of the Eurozone
Members: there are 28 members of the EU; the main members include Germany, France, Italy,
Belgium, Luxembourg, Netherlands, United Kingdom, Ireland, Greece, Spain and others
Multilateral or Bilateral: multilateral
Focus Area: Europe
Development: founded in 1959, largest and most important trading bloc in the world
Importance: the agreement increases trade and integration between European nations and has
a specific focus on using protecting to shield Europes agricultural industry

Asia-Pacific Economic Cooperation (APEC)

Function: APEC is a free trade agreement that supports the WTO and globalisation by
encouraging free trade and open investmentin is intended to be a non-discriminatory group
which means it doesnt serve as a trading bloc for one specific geographical area
Members: Australia, Brunel, Canada, Chile, Hong Kong, Indonesia, Japan
Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, The Philippines, Russia,
Singapore, South Korea, Taiwan, Thailand, USA and Vietnam
Multilateral or Bilateral: multilateral
Focus Area: Asia-Pacific
Development: formed in 1989
Importance: APEC meetings are no longer focused around their original goal of free trade, and
have increasingly served simply as an opportunity for political leaders to meet and address
whatever issues were the priority of the day (e.g. financial crises, terrorism, climate change)

North American Free Trade Agreement (NAFTA)

Function: NAFTA, as the name suggests, is a free trade agreement that acts as a trading bloc to
protect North America from the rest of the world, and increase trade within the region
Members: United States, Mexico, Canada
Multilateral or Bilateral: multilateral (trilateral)
Focus Area: North America
Development: signed in 1994
Importance: NAFTA has played a large role in increasing trade between the three nations, and,
like the EU, has had a particular focus on protecting the North American agriculture industry

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Association of South East Asian Nations (ASEAN)

Function: ASEAN is a free trade agreement that aims to support the smaller emerging
economies in South East Asia by protecting them against larger economies such as the US,
China and EU via a trading bloc
Members: Indonesia, Thailand, Malaysia, Singapore, The Philippines, Vietnam, Brunei, Burma,
Cambodia and Laos
Multilateral or Bilateral: multilateral
Focus Area: South East Asia
Development: founded in 1967 as a counterweight to the APEC forum
Importance: ASEAN was formed in response to a number of other free trade agreements
dominated by the larger economies such as the US, EU and China, and aims to protect smaller
emerging economies in South East Asia via a trading bloc

Protection

Reasons for Protection

Protection: refers to government policies that give domestic producers an artificial advantage over
foreign competitors, such as tariffs on imported goods.

INFANT INDUSTRY ARGUMENT

New and emerging or sunrise industries may face difficulties in establishment before they are
able to gain economies of scale and become competitive
However, protection should only be temporary in order to help the industry establish itself, and
should be gradually removed as the industry becomes more efficient and less reliant on the
government shielding it from already established international competitors

DOMESTIC EMPLOYMENT
When local producers are protected from more competitive international imports, there will be an
increase in demand for the now relatively cheaper domestic goods and services, in turn, this
means firms will increase the demand for labour and thereby decrease domestic unemployment
However, protection tends to distort the allocation of resources away from efficient areas to less
efficient areas, and in the long run, this may lead to higher levels of unemployment
By phasing out protection it is hoped that better and more long lasting jobs will be created in
sectors of the economy that have comparative advantage and are internationally competitive

DUMPING
Dumping is used by foreign countries to dispose of large production surpluses and put domestic
competitors out of business in order to establish market position in another country
In the short run domestic consumers will enjoy cheaper prices from the dumped goods, however
once the international competitors have got a foothold in the market and eliminated domestic
competitors from the market they will raise their prices again
Because the act of dumping can force domestic producer out of business and thereby lead to
loss of productive capacity and higher unemployment, governments will often choose to protect
certain industries against dumping

DEFENCE
Many powerful countries want to retain their own defence industries to be confident that in time of
war they can supply their own defence equipment and wont be reliant on other countries for their
national security (America is a prime example of this)

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SELF-SUFFICIENCY
Some countries use protection to ensure that they are not too heavily reliant on international
economies for vital imports such as food
Although Japan is highly inefficient in producing its own food supplies, it retains very high tariffs
on rice imports as it wants to retain self-sufficiency in supplying its own food because it
experienced famines twice in the 20th Century due to wartime blockades that prevented imports
When a country adopts this approach, it must accept that it is gaining self-sufficiency at the
expense of higher living standards that accompany specialisation and free trade

OTHER ARGUMENTS
Countries may use protection to block goods coming from countries that have inadequate
environmental regulations and use unsavoury production processes
Similarly, protection can be used to block goods from countries with inadequate human rights
regulations, where human rights may be abused in the production process

Methods of Protection

Tariffs
Tariffs: are taxes on imported goods imposed for the purpose of protecting domestic industries.

The curves SS and DD represent domestic

supply and domestic demand respectively
Where the supply and demand curves
intersect is where the equilibrium price would
be if the economy was completely closed to
the international market
0P represents the world price or rather, the
price before the tariff is imposed
Before the introduction of the tariff the
quantity of imports is Q1 - Q
0P1 represents the price after the tariff and
the distance P1 - P is the size of the tariff
This price rise causes an expansion in
supply from 0Q to 0Q2 and a contraction in
demand from 0Q1 to 0Q3
The quantity of imports after the tariff is
therefore reduced to Q3 - Q2
Government revenue is given by the price of
the tariff (P1 - P) multiplied by the quantity of
imports after the tariff (Q3 - Q2)

Tariffs are a favourable form of protection for governments because they generate more revenue
for the government than other forms of protection
Tariffs are the most likely form of protection to result in the retaliation effect, whereby in response
to higher tariffs placed on imports, other countries will also place tariffs on exports

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Subsidies
Subsidies: are cash payments from the government to businesses to encourage production of a
good or service and help businesses compete with overseas producers of that good or service.

The supply curve SS represents domestic supply before the subsidy and the demand curve DD
represents domestic demand
After the subsidy is introduced, the industry becomes more appealing for entrepreneurs as the
potential for profit is greater now that operating costs have been reduced
This causes an increase in supply from SS to S1S1, causing quantity to rise from 0Q to 0Q1 and
price to decrease from 0P to 0P1
Because the price has now been decreased, the domestic producers become more
internationally competitive
The size of the subsidy can be found by looking at the vertical distance between the supply
curves SS and S1S1 at the original quantity 0Q, which in this case is the distance P - P2

Both producers and consumers gain from subsidies, as consumers enjoy lower prices and
producers enjoy cheaper costs
However, this comes at the cost of increased government spending to the government and a
distorted allocation of resources moving the economy away from its PPF

Quotas
Quotas: refer to restrictions on the amounts or
values of various kinds of imported goods.

The curves SS and DD represent domestic

supply and demand respectively
Where the supply and demand curves
intersect is where the equilibrium price would
be if the economy was completely closed to
the international market
0P represents the world price before the
quota is introduced, and the distance Q1 - Q
is the quantity of importers before the tariff
Once the quota is introduced, the quantity of
imports is restricted to Q3 - Q2 and hence,
to maximise profits, importers and domestic
producers increase the price from 0P to 0P1
This will result in an expansion in domestic
supply and a contraction in demand
As a result, domestic producers are now
creating a larger quantity of the good

Quotas are far more effective at limiting the imported quantity of a good with inelastic demand
because they set a clearly defined limit on the quantity of that good that can be imported
Quotas are inflexible and do not fluctuate with the supply and demand of the market
Quotas do not raise any revenue for the government

Local Content Rules

Local content rules: specify that goods must contain a minimum percentage of locally made parts
to qualify for trade protection assistance.

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In return for guaranteeing that a minimum percentage of locally made parts are used the
government will provide trade protection assistance which may include the abolition of tariffs on
secondary goods that producer is importing to create their product
The Australian domestic car industry had an 85% local content rule for many years, meaning that
only 15% of their production components could be imported
To protect Australian culture, there are local content rules on Australian Television stations that
specify that a minimum number of hours of Australian content must be broadcast
Local content rules are limited in their effectiveness because they are complex to implement

Export Incentives
Export Incentives: refers to the provision of assistance to domestic producers in the form of
grants, loans or technical advice (such as marketing or legal advice) to encourage businesses to
enter global markets and expand their market share.

The popularity of export incentives has grown considerably in recent years as nations have
moved to a greater focus on capturing foreign markets for export-led growth, rather than
protecting domestic import-competing businesses
Export incentives are limited in their effectiveness because they do not protect domestic
businesses who are competing against importers and WTO agreements limit the scope of export
incentives that governments are permitted to use

Effects of Protection
Trade effect: causes domestic producers to generate a greater quantity of the good, and
therefore, protection increases output and employment
Reallocation effect: the economys resources are reallocated to less efficient protected
industries, leading to a decrease in efficiency, and in the long term, slower growth
Redistribution effect: consumers pay a higher price for locally manufactured goods, and hence,
income in the economy is redistributed from consumers to producers
Revenue effect: some forms of protection (such as tariffs) raise revenue for the government
Retaliation effect: protectionist policies may cause other governments to retaliate by protecting
their own domestic markets

OVERALL ECONOMIC EFFECTS OF PROTECTION:

Global protectionist policies have the effect of reducing global tradethe WTO estimates that the
global economy loses up to USD $520 billion in exports yearly due to protection
Overall reduction in global living standards and GWP as protection shields inefficient producers
Protection reduces businesses ability to specialise, achieve economies of scale and reduce
prices, and therefore consumers pay higher prices
The negative impacts of trading blocs are greatest on developing countries and it is estimated
that trade liberalisation would lift 140 million people out of poverty

Globalisation and Economic Development

Differences Between Economic Growth and Development

It is important to distinguish between economic growth and economic development and to note that
a country may have high levels of growth but low levels of economic development.

Economic growth: occurs when there is a sustained increase in a country's productive capacity
over time. This is commonly measured by the percentage increase in real GDP.

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Economic development: is a broad measure of welfare in a nation that includes indicators of
health, education and environmental quality as well as material living standards.

Structural changes to increase economic development in developing countries:

Redistribution of employment from agriculture to other sectors
Increase in the manufacturing, services and tertiary sectors
Significant rises in labour productivity
Expansion of tertiary and technical education
Significant and continuous growth in domestic and foreign investment

Distribution of Income and Wealth

Purchasing power parity (PPP): is a theory that states that exchange rates should adjust to
equalise the price of identical goods and services in different economies in the world.

Gross national income (GNI): is the total income earned by domestically owned factors of
production over a given period of time.

DISTRIBUTION OF INCOME:
High income economies receive over half the worlds GNI (PPP)
While the richer nations are far better off than the poorer nations, this inequality gap is shrinking,
however, this process is happening extremely slowly
Technological changes have meant that there is less demand for low-skilled labour and more
demand for highly-educated labour (which tends to be more abundant in developed nations),
meaning that for low-skilled workers unemployment is far higher

DISTRIBUTION OF WEALTH:
Wealth in the global economy is more inequitable than income
Global wealth is concentrated around households in North America (34% of global wealth),
Europe (30%) and rich Asia-Pacific countries like Japan and Australia (24%) while the remaining
countries share only a little over 10% of the worlds wealth

Income and Quality of Life Indicators

Gross National Income (GNI)

Gross national income (GNI): is the total income earned by domestically owned factors of
production over a given period of time.

Gross national income is a measure of income and not a direct measure of quality of life, meaning
that it is indicative of the economic growth of a country rather than its economic development.

The GNI is a popular measure of comparing living standards between nations because it
represents the ease with which a nations citizens can satisfy their material wants
To overcome differences in population the usual measurement used is GNI per capita
To overcome differences in exchange rates when measuring GNI the PPP system is used
However economic growth and GNI alone are unable to give a well-rounded and accurate
measurement of the living standards in a nation

Human Development Index (HDI)

Human development index (HDI): is a measure of economic development devised by the United
Nations which takes into account life expectancy at birth, levels of educational attainment and
material living standards (as measured by gross national income per capita)
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The HDI is a measurement of both income and economic development as it takes into account
health, education and material living standards by including the GNI.

The HDI takes into account three primary measurements

- Life expectancy at birth: indicative of health and nutrition standards in a country
- Levels of educational attainment: measures the average number of years for which
adults aged 25 attended school and the expected years of total school attendance for
school-age children as this indicates workforce skills and future potential of the economy
- Gross national income per capita: measures material standard of living
This is calculated into a score between zero (minimum human development) and one (maximum
human development)Australia is currently ranked second in the world with an HDI of 0.933

Developing, Emerging and Advanced Economies

Advanced Economies
Advanced economies: are developed or industrialised economies who have high levels of
economic development, close ties with each other and generally liberal-democratic politics.

DEFINING CHARACTERISTICS OF ADVANCED ECONOMIES:

High levels of economic development (implying health, education and GNI)
Large service industries and advanced technology manufacturing
Highly educated and skilled workforce
Strong ties with each other
High productivity and efficiency
Stable government fostering economic growth
Adequate infrastructure

Emerging Economies
Emerging economies: are in the process of industrialisation and experiencing sustained high
levels of economic growth (usually around 5-10%) with positive economic prospects.

DEFINING CHARACTERISTICS OF EMERGING ECONOMIES:

Lower levels of economic development than developed economies (implying somewhat lower
health, education and GNI levels)
Large manufacturing sectors, often with a focus on exports
Privatisation of state enterprises
Includes newly industrialised countries and economies transitioning from socialist regimes
- Note that transition economies refers to economies that are moving from a socialist
planned economy to a more capitalist market-based economy. This implies that the
economy is undergoing deregulation, microeconomic reform leading to structural change
and a reduction in the size of the government

Developing Economies
Developing economies: have low living standards, low education levels and generally have
agriculture based economies with poor infrastructure and unstable political institutions.

DEFINING CHARACTERISTICS OF DEVELOPING ECONOMIES:

Low levels of economic development (implying low education, health and GNI levels, often with
around half the population below the absolute poverty line of USD $1.25 a day)
Narrow export base focused on agriculture and mining
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Often corruption at the government level
Low investment and technology levels
Low productivity and efficiency
Largely unskilled workforce
Inadequate infrastructure
High inequality
Reliance on foreign aid

Reasons for Differences Between Economies

This section can also be called causes of global inequality.

Global Factors
GLOBAL TRADE SYSTEM
Protectionism and global trading blocs keep wealth in the developed nations, especially in terms
of agriculture, where developed nations are extremely inefficient, however high levels of
protection cause wealthy nations to maintain domestic agriculture industries
Agreements from the WTO usually benefit advanced economies over developing nations
The administrative costs for developing countries to develop and implement free trade
agreements with other countries is too high

GLOBAL FINANCE ARCHITECTURE

Historically, FDI was far more attracted to developed nations because of the security and
potential profits of those investments
However, more recently FDI has been attracted to emerging nations with high growth rates who
show lots of potential such as China and India
Meanwhile, lower income countries receive close to no FDIin 2010, the worlds 48 least
developed countries received only 2% of global FDI inflows
Because developing economies often have large debt problems investors are deterred

GLOBAL AID AND ASSISTANCE

The flow of aid from developed nations to developing nations is extremely small
Furthermore, much of this aid is temporary of conditional, meaning its effectiveness is limited

GLOBAL TECHNOLOGY FLOWS

Many new technologies are geared towards the needs of advanced economies (who developed
them using R&D) and are of little use to developing nations
Developing nations find it difficult to access new technologies due to intellectual property rights
restriction and poor infrastructure

Domestic Factors
NATURAL RESOURCES
Economies with an abundance of reliable natural resources are far better suited to take
advantage of international export markets and produce higher GNI

LABOUR SUPPLY AND QUALITY

Economies with a large supply of highly educated workers have greater ease in developing high-
tech manufacturing and services sectors, which are typical of advanced economies

ACCESS TO CAPITAL AND TECHNOLOGY

Poorly developed financial systems, low national savings and low FDI make it difficult for
developing nations to gain access to capital and technology, both of which are key for an
economy to broaden its production base and increase economic development
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ENTREPRENEURIAL CULTURE
Strong work ethic and an entrepreneurial drive within an economy can assist in the process of
developing new markets and industrialising

POLITICAL INSTITUTIONS
Political instability, corruption and a lack of economic support from government institutions can
make it far more difficult for industries to develop so that they are competitive on an international
scale and can operate sustainably in the country

GOVERNMENT RESPONSE TO GLOBALISATION

Policies relating to trade, financial flows, investment flows, transnational corporations and the
countrys participation in regional and global economic organisations will influence an economys
ability to take advantage of the benefits of integration, such as economic restructuring, efficient,
access to foreign capital and technology and access to overseas goods markets

Effects of Globalisation
Globalisation has a plethora of effects on individual nations and the world as a whole. By and
large, globalisation has been extremely beneficial to the global economy, however there have been
both advantages and disadvantages in terms of growth and development, trade, investment,
TCNs, environmental sustainability, income equality and the international business cycle.

Economic Growth and Development

Globalisation gives developing nations a greater opportunity to increase growth by producing
exports for the global consumer market and increases access to technologies and FDI
In recent decades, some emerging countries such as China and India have achieved extremely
high growth rates by embracing globalisation and export-led growth
However, while globalisation can lead to increased growth and development through trade,
investment and the sharing of technologies, there are also risks to such significant globalisation,
as fluctuations in one economys growth can very quickly spread to the rest of the world:
- The GFC in the late 2000s displayed how the global integration of trade and financial
markets means global recession can be caused by conditions in just a handful of nations
- Integration of financial markets has led to large foreign debt problems in Africa
- In Latin America, globalisation caused exchange rate volatility
Hence, it is evident that while Globalisation can boost economic growth it also has the potential
to hamper growth
Economic growth caused by globalisation will increase GNI, R&D, technological advancement
and investment, and can lead to increased health, education and material living standards which
will contribute positively to economic development
However, at the same time, globalisation-led economic growth can lead to degradation of the
environment, abuse of human rights and income inequality

Trade, Investment and Transnational Corporations

Globalisation has largely increased trade flows and FDI, which, coupled with the benefits of free
trade, have allowed economies to specialise in sectors where they have a comparative
advantage in order to become more efficient and achieve economies of scale
The global integration of financial markets has meant that FDI can flows far easier throughout the
world, and TCNs are able to position different parts of the production process around the world
However, growth in short term portfolio investment flows have greatly increased volatility

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Income Equality
Increased trade in the global economy as increased the income of agricultural workers in
developing countries and has lifted many out of poverty
The reduction in tariffs resulting from free trade has reduced the price of imports and has made
consumer goods cheaper, improving standards of living for the poor
Growth resulting from increased FDI and trade has created many employment opportunities
The IMF estimates that one fifth of the increase in world income equality is due to globalisation

Environmental Sustainability
TCNs may take advantage of countries will low levels of environmental regulation in order to
reduce costs, or advanced economies may import goods that were manufactured using
environmentally unsavoury practises
The growth in global trade has increased consumption of non-renewable fuels used for
transportation vehicles travelling by air, road, rail and sea

International Business Cycle

The close integration of the international business cycle means that many countries in the global
economy will tend to experience upswings and booms at the same time
Conversely, this also means that downswings will be shared across the global economy
As global integration continues to increase, it is likely that there will be greater synchronisation of
the international business cycle as downturns and upturns are shared across many economies,
meaning their effect on the global business cycle is intensified

Globalisation Case Study: China

Influence of Globalisation on China

China is arguably the economy that has been most affected by globalisation in the last few
decades as it moved from a planned socialist economy centred around agriculture to an
emerging market capitalist economy centred around industrial manufacturing and exports
China is currently the second largest economy in the world
Has experienced rapid economic growth with mean GDP growth of 10.1% between 1978-2014
Experienced rapid economic development with HDI increase from 0.423 in 1980 to 0.719 in 2013
The influences of globalisation on China have generally been as a result of policies that promote
international integration, and hence, the influences of globalisation on China will be discussed
under the policies that led to those specific influences

Strategies Used to Promote Economic Growth in China

OPEN DOOR POLICY
Open Door Policy introduced in 1978 involved deregulation to open China to the global
economy, involving the creation of Special Economic Zones to attract foreign direct investment
and trade by offering low tax rates, cheap labor and less regulation
Open Door Policys effects on Chinas Trade:
- Since the open door policy was introduced, Chinas export levels have increased an
average of 17% every year
- In 1990 Chinas trade accounted for 2% of global trade compared to 9% of global trade in
2013, making China the worlds largest exporter and importer
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- BOGS has been in surplus for the majority of the last few decades
Open Door Policys effects on investment and the presence of TCNs:
- In 2002, China surpassed the USA, to become the top recipient of FDI in the global
economy
- In 1997, China received $45 billion in FDI
- Due to this investment, since the mid 1980s, labour productivity has increased annually by
an average of 3.35%

TARRIF RESTRUCTURES
Chinas average tariff rate was reduced from 32% to 19% by 1996 and had fallen to 15% by 2000
This contributed to the aforementioned increases in trade
These tariff reductions have been heightened further by the governments negotiations of 12
FTAs with a number of its major trading partners:
- Most notable is the ASEAN-China FTA which reduces the tariff on 90% of imports to zero
and reduced the tariff on over 99% of exports to zero
- This FTA has the third largest trade volume in the world after the EU and NAFTA

ENTRANCE TO WTO
China became a member of the World Trade Organisation (WTO) in 2001
This gave China trade access to more countries, thereby widening its export base as it now
produced more ETMs, which were being demanded in large quantities by the main developed
economies in the WTO
As a result, Chinese exports grew by 27.9% of GDP from 2001-2006

Strategies Used to Promote Economic Development in China

ENVIRONMENTAL IMPACTS
China is the worlds largest polluter, producing about the same amount of emissions as the
United States, the European Union and Japan combined
Chinas attempts to increase environmental sustainability have had minimal effects
By offering incentives to encourage renewable energy use, the government increased energy
capacity from wind power more than 100% between 2005 and 2009
The government has also subsidised a lot of R&D into renewable energy

DISTRIBUTION OF INCOME AND POVERTY

Chinas GINI coefficient rose from below 0.3 in the mid 1980s to 0.473 in 2013
In 1990, 60.7% of the population was below the international poverty line of USD $1.25, down to
6.3% in 2011 partially due to the social welfare reform of 1998 (i.e. fiscal redistribution)

HEALTH AND EDUCATION

Revised 1980 Cooperative Medical Scheme that increased medical accessibility and hence life
expectancy from 67 in 1980 to 75 in 2012
1985 Education reform that made basic education compulsory and free which increased literacy
rates from 68% in 1983 to 95% in 2010

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