4.1 International economies

Question 1

Globalisation

Answer 1

The integration of the world’s markets in goods and services, as well as flows of investment (both Portfolio Investment and Direct Investment) and people across national boundaries

Question 2

Key economic actors in the process of globalisation

Answer 2

States and multinational corporations

Question 3

Benefits of globalisation

Answer 3

• International trade increases specialisation between countries. This may lead to exploitation of comparative advantage as each country can produce the most of each good - higher productivity + output - more consumption + consumer surplus
• Reducing barriers to trade allows firms to access larger markets so can make more profits - leads to decreased unemployment, increased product quality, increased efficiency (EOS) + more export led growth
• Globalisation increases competition between firms, which benefits consumers as prices will be lower + quality may be higher due to more non-price competition eg R+D
• Globalisation may help an economy achieve its macroeconomic objectives - decreased unemployment, increased growth (larger market for firms), decreased inflation (lower prices - imported deflation), improved trade balance (more exports)

Question 4

Costs of globalisation

Answer 4

• Increased specialisation may lead to unemployment, specifically structural unemployment - lack of diversification of industries, people not employed in dominant industry struggle
• Globalisation may generate negative externalities from transport (emissions), environmental degradation, raw material extraction
• Globalisation ay stifle competition due to the emergence of a global monopoly (e.g. Apple)
• Globalisation may not help a country meet its macroeconomic objective because current account deficit may get worse + unemployment may increase

Question 5

People who have benefitted the most and least from globalisation

Answer 5

People living in countries integrated into supply chain (e.g. China/India) - higher incomes + more employment (cheaper labour for TNCs
Very richest people - firms benefit + shareholders - employees benefit from higher revenue for firms
Very poor nations from which people have been lifted out of poverty
Working and middle classes - lost jobs abroad + to automation
Poorest 5% - countries are too violent, unstable or remote to gain benefits

Question 6

When has globalisation been the most effective

Answer 6

When it has been controlled e.g. in China/India
Better to focus on individual needs of countries

Question 7

Autarky

Answer 7

The absence of trade

Question 8

Reciprocal absolute advatage

Answer 8

When the gains from specialisation are clear since each country has an absolute advantage in one of the outputs

Question 9

Free trade diagram

Answer 9

Question 10

Benefits of free trade for consumers

Answer 10

Higher quantity
Welfare gain
Lower prices

Question 11

Absolute advantage

Answer 11

When one county is able to produce more of a g/s than another country per unit of resources

Question 12

Comparative advantage

Answer 12

When one country produces a good or service at a lower relative opportunity cost than another country

Question 13

Terms of trade formula

Answer 13

(Index of export prices/index of import prices) x 100

Question 14

Meaning of improved terms of trade

Answer 14

For every unit of exports sold it can buy more units of imported goods

Question 15

Meaning of worsened terms of trade

Answer 15

A country has to export more to purchase a given quantity of imports

Question 16

Factors affecting terms of trade

Answer 16

Prices of exports - higher export prices, higher TOT
Inflation - UK experiencing higher inflation relative to trading partners - higher TOT
Changes in exchange rates - increased value of pound leads to increased TOT
Relative productivity - UK is less productive relative to trading partners - increased price of exports, decreased price of imports, increased terms of trade

Question 17

Counter arguments against TOT

Answer 17

Globalisation has tended to reduce the price of manufactured goods over the past 15 years, so the advantage that industrialised countries had over developing countries ma be falling. The impact of globalisation has tended to halt the decline in the TOT of developing countries

Commodity prices cannot keep falling,. even if this is the historical long-run trend recently; and due to the (often) finite nature of them, as we increasingly use them up we will start to run out of them - pushing prices back up and improving commodity exporting countries’ terms of trade

Question 18

Effect of an improving terms of trade

Answer 18

For every unit of exports sold it can buy more units of imported goods

A rise in the terms of trade may create a benefit in terms of how many goods need to be exported to buy a given amount of imports. it can also have a beneficial effect on domestic cost-push inflation as an improvement indicates falling import prices relative to export prices
However, countries may suffer in terms of falling export volumes and a worsening BOP if their TOT improves (depends on PED for these traded goods)

Question 19

Trading bloc definition

Answer 19

An agreement between several countries where barriers to trade are reduced or eliminated among the participating states

Question 20

Free trade area

Answer 20

A grouping of countries within which barriers are abolished but no common trade policy toward non-members

Question 21

Free trade areas examples

Answer 21

US-Mexico-Canada Agreement (USMCA)
European Free Trade Association (EFTA)

Question 22

Customs union

Answer 22

A group of states that have agreed to charge the same import duties as each other and usually to allow freed trade between themselves

Question 23

Common external tariff (CET)

Answer 23

A tariff applied to imported goods by a group of countries that have formed a customs union

Question 24

Single Market

Answer 24

A group of countries imposing few or no duties on trade with one another and a common tariff on trade with other countries + freedom of movement of FOP

Question 25

Economic + Social Unions

Answer 25

Composed of a common market with a customs union. Includes common policies on product regulation, freedom of movement of goods, services + FOPs and a CET

Question 26

Monetary Union

Answer 26

Sharing a common currency and common monetary policy

Question 27

Trade Creation

Answer 27

The replacement of more expensive domestic production or imports with cheaper output from a partner within the trading bloc

Question 28

Trade Diversion

Answer 28

The replacement of cheaper imported goods by goods from a less efficient trading partner within a bloc

Question 29

Positive impacts of trading blocs (5)

Answer 29

Cheaper + more imports due to removed trade barriers and producer effect
Access to wider markets for firms - more consumers + higher profits
Economies of scale due to larger market (depends on homogeneity of tastes)
Opportunity to exploit comparative advantage, increasing output and efficiency due to specialisation
Increased investment - more likely to recieve investment from other countries in the trading bloc

Question 30

Negative impacts of trading blocs (4)

Answer 30

Globally inefficient allocation of resources
Trade deflection due to switch from more competitive trading partners outside of the bloc
Possible WTO intervention
Slows long term global process of free trade

Question 31

WTO conflicts with trading blocs

Answer 31

WTO main aim - free trade everywhere and the removal of trade barriers

Trading blocs may allow members to increase output, however there will be trade diversion
Trade agreements may restrict smaller domestic industries from growing

Question 32

Example of a monetary/currency union

Answer 32

Economic and Monetary Union (EMU) of the European Union

Question 33

Advantages of Monetary/Currency Union (3)

Answer 33

Easier for transnational transactions within the bloc so trade Creation
Greater certainty/stability
Greater ease of price comparisons

Question 34

Disadvantages of Monetary/Currency Union (4)

Answer 34

Limitations to fiscal policy tools when dealing with asymmetric shocks
Lack of exchange rate mobility
Initial costs when joining
Loss of monetary sovereignety

Question 35

Mundell-Fleming Trilemma

Answer 35

Capital mobility
Exchange rate management
Monetary Sovereignty

Question 36

Optimum currency area

Answer 36

An area where efficiency would be maximised by sharing a common currency rather than having separate currencies

Question 37

US vs EU Optimal currency area

Answer 37

Wage flexibility - ability of firms to change wages in order to respond to asymmetric shocks without being able to use monetary policy
US - Low trade union power
EU - Lots of wage rigidity due to strong trade unions (eg in France and Germany) with lots of bargaining power

Labour mobility - unemployed workers should be able to migrate from recession hit areas to economic hot spots
US - every year more than 7 million Americans move across US state borders for the purpose of taking up new employment
EU - language and cultural barriers discourage labour mobility from taking place

Efficient fiscal transfer - perhaps the most important characteristic of an OCA is an area-wide fiscal transfer mechanism where individual member states would have to relinquish some of their power of taxation and submit to a federal tax system. The federal authority would tax all states, to redistribute money away from the overheating regions and towards the slowing regions, to correct any cyclical imbalances caused y the single interest rate.
US - the Federal Government levies income taxes on the whole country collecting a large proportion of its revenues from a handful of rich and booming states like New York and California. As a result, the interest rates can be set to meet the needs of the booming states, knowing that fiscal policy will iron out the differences in the business cycles across the US
EU - Wealthier countries are not willing to give up the revenues so easily for the benefit of foreign countries

Question 38

Trade creation diagram

Answer 38

Question 39

Trade diversion diagram

Answer 39

Question 40

Trading bloc conclusions

Answer 40

Second best option compared to overall free trade
Distort global trade patterns
Time frame is important
Depends on the type of trading bloc

Question 41

Protectionism definition

Answer 41

Government intervention in international trade through the imposition of trade barriers

Question 42

Tariff diagram

Answer 42

Question 43

Tariff definition

Answer 43

A tax imposed on imported goods and services

Question 44

Quota definition

Answer 44

A limit of the quantity of goods and services that can be imported

Question 45

Quota diagram

Answer 45

Question 46

Subsidy definition

Answer 46

A payment that the government pays to the producers for each unit of output

Question 47

Why subsidies are considered protectionist policies

Answer 47

Domestically produced goods have an unfair competitive advantage over foreign produced goods

Question 48

Subsidy diagram

Answer 48

Question 49

Protectionism positives (8)

Answer 49

Protect infant/sunrise industries:
Barriers to trade can be used to protect sunrise industries, also known as infant industries, such as those involving new technologies. This gives new firms the chance to develop, grow, and become globally competitive.
Protection of domestic industries may allow them to develop a comparative advantage. For example, domestic firms may expand when protected from competition and benefit from economies of scale. As firms grow they may invest in real and human capital and develop new capabilities and skills. Once these skills and capabilities are developed there is less need for trade protection, and barriers may be eventually removed.

Protect sunset/senile industries:
At the other end of scale are sunset industries, also known as declining or senile industries, which might need some support to enable them to decline slowly, and avoid some of the negative effects of such decline. For the UK, each generation throws up its own declining industries, such as ship building in the 1950s, car production in the 1970s, and steel production in the 1990s. This is not a long run argument for protectionism, but a means of guiding a declining industry to its death in a managed fashion, to try and prevent excessive impacts of structural unemployment and allow for development of other industries and retraining opportunities.

Protect strategic industries:
Barriers may also be erected to protect strategic industries, such as energy, water, steel, armaments, and food. These are industries which a country perhaps wouldn’t want to be reliant on imports for, in case of a change in trade relations. For example, although the EUs Common Agricultural Policy has come under a lot of fire recently, the implicit aim of it is to create food security for Europe (as a collective entity) by protecting its agricultural sector from lower priced imports, so that Europe is never wholly reliant on foreign countries.

Protect non-renewable resources:
Non-renewable resources, including oil, are regarded as a special case where the normal rules of free trade are often abandoned. For countries aiming to rely on oil exports lasting into the long term, such as the oil-rich Middle Eastern economies, limiting output in the short term through production quotas is one method employed to conserve resources (done through OPEC)

Deter unfair competition:
Barriers may be erected to deter unfair competition, such as dumping by foreign firms at prices below cost. This form of protectionism ensures that trade is ‘fair’ across international boundaries. Barriers might also be erected to protect a country from imports from a country which has relaxed carbon standards, allowing them to produce at a lower cost which the domestic country can’t compete at due to their high carbon standards. This is another example of trying to protect against unfair competition using protectionist policies.

Protecting domestic jobs:
Protecting an industry may, in the short run, protect jobs and stave off unemployment in that sector, though in the long run it is unlikely that jobs can be protected indefinitely (or rather the cost of doing so will far outweigh the benefits of doing so). Again, this is more of a short-run argument, and if an economy is struggling with unemployment it might make sense to protect some industries from further losses until the economy has recovered.

Help the environment:
Some countries may protect themselves from trade to help limit damage to their environment, such as that arising from CO2 emissions caused by increased production and transportation. However, if these external costs of trade are less than the reduced welfare from adopting protectionist policies, then technically this argument starts to break down, and there are further issues with how to measure the costs to the environment in a way which can be compared to the potential welfare losses of closing up to free trade.

Limit over-specialisation:
Many economists point to the dangers of over-specialisation, which might occur as a result of taking the theory of comparative advantage to its extreme. Retaining some self-sufficiency is seen as a sensible economic strategy given the risks of global downturns, and an over-reliance on international trade.

Question 50

Protectionism negatives

Answer 50

Protectionism increases prices for domestic consumers

Can reduce quality of goods being produced/consumed:

Protectionism moves against specialisation and towards self-sufficiency (comparative advantage link)

Global frictions / international relations harmed (diplomacy issues) – more a POLITICAL argument than economic, but could have economic impacts over time.

Downward multiplier effect: protectionism lowers export led growth for those nations exporting to us, leading to a fall in national incomes in those exporting nations, which might affect their appetite for importing from us. Therefore protecting against imports might have the undesired effect of damaging our own export markets.

Retaliation: protectionism might lead to retaliatory protectionism (tit-for-tat) from those countries affected (counter-productive).

Could be deemed regressive (proportionately a larger impact on lower income households) as a policy: the price increases affect lower income households to a greater extent than higher income households.

Bureaucracy and government failure: government might incorrectly set tariffs / other barriers to trade at incorrect levels or on incorrect markets (e.g. protecting a market for infant industry reasons when in reality it was never going to grow to become competitive internationally).

Could result in X-inefficiency due to the lack of competitive pressures.
 

Question 51

Name A+B+C

Answer 51

A: Surplus gained by domestic consumers
B: Deadweight welfare loss from change from more to less efficient producers
C: Surplus gained by government

Question 52

Name A+B+C+D

Answer 52

A: Gain in domestic producer surplus
B: Producer effect (DWL)
C: Quota revenue transferred aboard
D: Consumer effect (DWL)

Question 53

Free trade definition

Answer 53

Free trade refers to the absence of government intervention of any kind in international trade, so that trade can take place without any trade barriers (restrictions) between individuals or firms in different countries.

Question 54

Effects of a tariff on different groups

Answer 54

Domestic consumers: Less choice + higher prices, lower unemployment

Domestic producers: Higher revenue, less competition, more investment
Dynamic efficiency - more internationally competitive

Domestic government: Higher tax revenue, lower unemployment, higher growth + AD

Foreign producers: Smaller market + more long run competition

Foreign consumers and government: Less export tax imports, more unemployment

Question 55

Tariff effect eval

Answer 55

Effectiveness of the tariff will depend on producer ability to increase production - (PES + PED)
Domestic unemployment might not fall in the industry due to increased investment and less need for human workers - capital (depends on industry)
Other countries may introduce tariffs too/stop trading with them

Question 56

Exchange rate manipulation

Answer 56

In order to boost exports and reduce imports, a country can also opt to manipulate its exchange rates so that its currency is undervalued (i.e. one whose value is too low relative to its free-market equilibrium value). When a currency is undervalued, exports becomes comparatively cheaper in the international market, allowing the country to expand its export industries, grow its economy and increase its domestic employment levels.

Currency undervaluation is considered as a kind of ‘cheating’ as it creates unfair disadvantages for countries which do not undervalue its currency. A good example of exchange rate manipulation is the persistent undervaluation of the Chinese yuan.

Question 57

Administrative barriers

Answer 57

Whenever a good is imported from another country, it must go through a number of customs procedures, checks and inspections. Furthermore the good must fulfil the regulatory requirements imposed, such as certain technical, health, safety and environmental standards. All these administrative barriers can be costly and time-consuming; the effect is to reduce the quantity of imports.

An example of administrative barriers is the Section 8e requirement the US imposes on imported Mexican tomatoes during the US growing season, to protect US domestic farmers. It stipulates that all imported tomatoes must be at least 29/32 inches in diameter with the quality of at least US No.2 grade (similar varietal characteristics, mature, not overripe or soft, clean, well developed, reasonably well-formed, and not more than slightly rough). Each shipment of tomatoes from Mexico will be inspected at the border.

Another good example is EU’s ban on prepared meat from third countries, which became a flashpoint as part of the Northern Ireland Protocol negotiations. British sausages were not allowed to be imported to (Northern) Ireland following the UK’s departure from the European Union.

Question 58

Exchange rate definition

Answer 58

The value of one currency in terms of another

Question 59

Main reasons why currencies are traded (3)

Answer 59

To allow international trade to occur
To allow for investment in other countries
For speculative reasons: foreign exchange traders who try to make money by buying and selling foreign exchange based on their predictions about exchange rates

Question 60

Exchange rates diagram

Answer 60

Question 61

Effect on s/d for currency of change in demand for exports

Answer 61

• If foreigners wish to buy a country’s goods and services, they first need to purchase the currency
• A rise in demand for exports leads to increased demand for the currency
• A fall in exports leads to decreased demand for the currency

Question 62

Effect on s/d for currency of change in demand for imports

Answer 62

• When domestic citizens wish to buy foreign imports, they first need to purchase the foreign currency. They do this by selling their own currency
• A rise in demand for imports leads to increased supply of the home currency
• A fall in demand for imports leads to decreased supply of the home currency.

Question 63

Effect on s/d for currency of change in interest rates

Answer 63

• Interest rates are the reward for saving. If one country’s interest rates go up relative to another country, there is an incentive for savers to covert to that currency so that they can take advantage of the high interest rate.
• If interest rates rise, demand for the currency increases and vice-versa

Question 64

Effect on s/d for currency of change in foreign investment

Answer 64

• If foreigners wish to invest in a country, they first need to exchange their money for that country’s currency.
• Increased investment from foreigners leads to an increase in demand for the currency
• Increased investment from home investors in foreign markets leads to an increase in supply of the home currency

Question 65

Effect on s/d for currency of speculation

Answer 65

• If speculators believe the value of a currency is likely to fall, they will stop buying that currency and try to sell what they currently have
• If speculators believe a currency will increase in value, they will try to buy that currency.

Question 66

Floating exchange rates

Answer 66

• In a floating exchange rate system, the government does not intervene in the foreign exchange markets.
• The value of a currency is determined entirely by the forces of supply and demand.
• There are no controls over how much currency can be bought and sold.
• The government/central bank does not undertake its own buying and selling of currencies to try to manipulate the exchange rate.

Question 67

Fixed exchange rates

Answer 67

• In a fixed exchange rate system, governments actively intervene in the foreign exchange markets to maintain a fixed exchange rate with another currency.
• The government first decides on a desirable exchange rate with another currency which becomes its ‘peg’.
• When market forces change (shifting supply or demand) and put upwards or downwards pressure on the exchange rate, the government will intervene to counteract those forces and maintain the peg.

Question 68

Tools used to manipulate exchange rates by governments

Answer 68

• Buying and selling of reserve assets
• Adjusting interest rates
• Import controls
• Currency controls

Question 69

Buying and selling of reserve assets explanation + evaluation

Answer 69

• Where the central bank buys or sells foreign exchange currencies to counteract the market
• Reserve assets are a finite reserve, so can be a battle of ‘wills’ if trying to battle speculators

Question 70

Adjusting interest rates explanation + evaluation

Answer 70

• Higher relative interest rates will attract foreign savers to save in the currency, and thus increase demand for the currency. Vice versa.
• May lead to undesirable outcomes for the domestic economy, e.g. low interest rates during a boom etc.

Question 71

Import controls explanation + evaluation

Answer 71

• Physical limits to importing goods could reduce demand for foreign currency and the supply of the domestic currency
• Or contractionary fiscal and monetary policies

 - Protectionism could have drawbacks…

Question 72

Currency controls explanation + evaluation

Answer 72

Limits of movement of capital into / out of a country (e.g. China with RMB)

 
But… huge issues with confidence of foreign investors if they could not move capital/profits out of the country in an easy way

 
Or Borrow money from abroad, e.g. the IMF

But… could be conditioned to impose onerous policies that are contrary to macroeconomic goals of the country

Question 73

Managed systems

Answer 73

• Adjustable peg systems
• In the short term, currencies are fixed against each other, but in the longer term the value can be changed.
• Crawling peg systems
• A country fixes its currency against another currency within a band, which is reviewed every few months. This allows depreciation or appreciation to happen gradually.
• Dirty float
• Exchange rates are freely floating, but governments and central banks occasionally intervene to change the value of the currency. This is the most common type of system used today – USD, GBP, EUR, JPY…

Question 74

Advantages of floating exchange rate

Answer 74

• Automatic adjustment mechanism to achieve trade balance: A country with a large deficit on the current account will find its currency depreciating. As its exchange rate falls its export prices fall which improves their international price competitiveness.
• Meanwhile imports are becoming more expensive for domestic consumers and firms so less will be purchased. This automatic adjustment can lead to a balanced current account in the long run.
• Less need for central bank to hold sufficient foreign exchange reserve to counteract speculations etc.
• Frees up fiscal and monetary policies for other objectives than to defend the currency.
• Could prevent speculation

Question 75

Disadvantages of a floating exchange rate

Answer 75

• No guarantees
• There still is need for open market operations for the central bank/govt to maintain what is deemed an ‘optimal’ rate of a currency.
• Can lead to uncertainty

Question 76

Advantages of a fixed exchange rate

Answer 76

Increased certainty: Firms know the price that they are going to receive for their exports and they know the cost of their raw materials. This increased certainty facilitates greater investment.

Reduces inflationary pressure that could be driven by a weakening currency – rather, firms have more of an incentive to keep costs down in order to remain competitive on the international market

(If exchange rates artificially low…) can make exports more price competitive

Question 77

Disadvantages of fixed exchange rate

Answer 77

Mundell-Fleming Trilemma: a fixed exchange rate means that the govt would have to give up monetary autonomy, i.e. use monetary policy to actively maintain a fixed exchange rate

Central Banks have to maintain a good level of FOREX

Can attract speculation (investors know that the central bank is committed, to an extent, to defend the currency)

Question 78

Mundell-Fleming illustration

Answer 78

Question 79

Why might a government over or undervalue their currency?

Answer 79

• In a fixed exchange rate system, the peg is overvalued if there is consistently downwards pressure on the currency and the central bank is always intervening to keep it high
• An economy may do this in order to make imports cheaper. This has historically been done by many developing countries.
• This could be because they wish to promote development by encouraging imports of foreign capital and technology or because they lack their own domestic industries for consumer goods so rely on imported consumer goods
• This has the obvious drawback that it makes exports less competitive so can damage the opportunity for export led growth.
• Continuous intervention to prop up the value of the currency is also problematic:
• Eventually foreign exchange reserves will run out, so this cannot be done indefinitely
• High interest rates are contractionary and harmful to borrowing and growth
• In a fixed exchange rate system, the peg is undervalued if there is consistently upwards pressure on the currency and the central bank is always intervening to keep it low
• An economy may do this to make their exports cheap and relatively competitive and to boost export markets (China!)
• Economies which do this may find themselves accused of trying to attain an unfair competitive advantage over other countries in trade – may trigger a currency war or competitive devaluations
• This has the obvious drawback that it makes imports more expensive which can cause cost-push inflation
• Continuous intervention to lower the value of the currency is also problematic:
• Low interest rates or continual expansions of the money supply (printing money to buy up reserve assets) are expansionary and can lead to demand-pull inflation

Question 80

International competitiveness

Answer 80

Competitiveness refers to the ability of a country to sell its goods and/or services abroad. Competitiveness is usually determined by the price and/or quality of the good or service.

Question 81

Factors determining international competitiveness:

Answer 81

Relative unit labour costs which are heavily dependent on productivity:
These are the labour costs of supplying goods and services per unit of output – in simple terms, how expensive it is to make something.
Unit labour costs are determined by:
- The costs of employing people (wage rates, salaries, employment taxes like NICs)
- The productivity of those people employed
- Data on unit labour costs is normally expressed in relative terms i.e. we compare unit labour costs in one country relative to another
- Unit labour costs will rise when wages rise faster than the annual improvement in productivity

Wages and non-wage costs relative to those of competitors
- Costs (both wage and non-wage) will feed into prices, and thus have an impact on a country’s goods price competitiveness.
- Wage costs might be constrained through minimum wage laws and powerful trade unions – impacting price competitiveness.
- Non-wage costs (such as raw material costs or capital machinery costs) will be affected by the supply and demand of these input in factor markets.

Rate of inflation relative to competitors
- This will have an impact on a country’s price competitiveness
- If caused by cost-push factors this is arguably more a concern (as it isn’t accompanied with rising incomes / falling unemployment.
- However, cost-push inflation might be felt by all exporters (e.g. if oil prices rise, they rise for everyone) – whereas demand-pull might be unique to your country, thus more likely to affect your relative rates of inflation.

Regulation relative to that of competitors
- Regulations deter investment, thus might affect a country’s non-price competitiveness over time.
- Furthermore, these regulations might represent additional costs for businesses – thus feeding into cost-push pressures and price rises.

Non-price competitiveness (e.g. product quality)

Question 82

Policies to improve international competitiveness:

Answer 82

• Firms can:
  o Boost productivity through ‘capital deepening’
  o Relocate the production of components or ancillary services overseas
  o ‘Move upmarket’ – i.e. improve the quality and image of their g/s
  o Invest in R&D to develop a new technology or design
  o Empowering employees – e.g. give more flexibility over hours
  o Improve management / chains of command (organisation/communication)
• UK Government can:
  o In the product markets
   Offer R&D tax credits
   Offer investment subsidies
   Privatise inefficient state-owned industries
   Deregulate monopoly markets (add competition)
   Ease the burden of ‘red tape’
   Improve infrastructure (e.g. transport / telecoms)

o In the labour markets
 Pursue trade union reform
 Invest in education & training
 Reduce both income taxes and benefits (incentives)
 Retraining schemes to boost labour mobility

Question 83

International competitiveness evaluation

Answer 83

Evaluation:
Good evaluation will be specific per policy you choose, so you need to consider possible weaknesses of the policy and why the policy wouldn’t necessarily improve competitiveness. Ideas might include:
* Are there time lags between implementation and impact?

• Is the cost of the policy relative to alternative uses of these funds justifiable?
• Does the policy address the issues that are causing a lack of competitiveness? Think of the context.
• Are the policies appropriate given the impact they might have elsewhere in the economy? Will there be ‘unintended consequences’ of the policy? Is the economy’s point in the business cycle relevant to whether this policy is appropriate?

Question 84

Reasons for UK lack of international competitiveness

Answer 84

High govt debt: crowding out; less credit available for private-sector investment

Rate of return for investment not attractive to investors:
- Brexit: UK no longer a base from which to export to the rest of the EU
- Investors turning to rapidly emerging economies in search of higher rate of return
- Short-term thinking by managers (not actively seeking long-term investment/projects etc.)
- Govt red-tape; huge paperwork involved in getting planning permission

Restrictive immigration law: less access to labour (lower supply of labour)

Question 85

Measures of International Competitiveness

Answer 85

Relative Unit Labor Costs:
Relative unit labor costs compare the cost of labor in one country to another.
It is calculated by dividing the average wage in one country by the productivity of labor in that country, then comparing it to the same ratio in another country.
A lower relative unit labor cost indicates greater competitiveness, as it suggests that a country can produce goods and services at a lower labor cost.
Relative Export Prices:
Relative export prices compare the prices of a country’s exports to those of its competitors.
It involves analyzing the price levels of similar products produced in different countries.
Lower relative export prices indicate greater competitiveness, as it means a country’s products are more attractively priced in international markets.

Question 86

Benefits of Being Internationally Competitive

Answer 86

Increased Exports: Competitive countries can sell more goods and services abroad, boosting economic growth.
Job Creation: Export-oriented industries often create jobs, reducing unemployment.
Higher Standards of Living: International competitiveness can lead to higher incomes and improved living standards for citizens.
Foreign Direct Investment (FDI): Competitive environments attract foreign investment, leading to economic development.

Question 87

Problems of Being Internationally Uncompetitive

Answer 87

Trade Deficits: Uncompetitive countries may import more than they export, leading to trade imbalances.
Economic Decline: A lack of competitiveness can result in declining industries and economic stagnation.
Unemployment: Uncompetitive industries may shed jobs, leading to high unemployment rates.
Income Inequality: A lack of competitiveness can exacerbate income inequality as some industries decline while others thrive.

Question 88

Current account, Financial account + Capital account

Answer 88

Current account: Exports of goods, imports of goods, exports of services, imports of services, net income and current transfers

Financial account: Net direct investment, portfolio investment and reserve assets

Capital account: Net capital transfers and transactions in non-produced, non-financial assets

Question 89

Elements of the currents account

Answer 89

*Trade in Goods
(Visibles) Exports are the sale of goods to other countries, for which payment is received in home currency; therefore, exports are a credit item (inflow). Imports of goods are the purchase of goods from other countries, for which payment is made in foreign currencies (generating a supply of home currency); imports are therefore a debit and represent money flowing out.

*Trade in Services (Invisibles) Services include a variety of activities, such as insurance, tourism, transportation and consulting. When foreigners visit as tourists, the country is exporting tourism services; similarly, when foreigners buy insurance from home companies, this represents exports of insurance services. When home citizens visit other countries as tourists, or buy insurance from other countries, they are importing tourism and insurance.

Current Transfers Refers to inflows into a country due to transfers from abroad like gifts, foreign aid and pensions, minus outflows of such transfers to other countries.

Income All inflows of wages, rents, interest and profits from abroad minus all outflows of wages, rents, interest and profits.
* Citizens may earn income abroad, such as from wages if they work abroad and send their wages home,
* or if they own rental property abroad that earns rental income,
* or have bank accounts abroad that earn interest,
* or if they own stocks in another country that earn dividends
This income is ‘repatriated’ to the home country of the person who earned it.

Question 90

Trade deficit + causes

Answer 90

With a trade deficit, a country imports more than it exports. (M>X) and outflows are greater than inflows. This means it is consuming outside of its production possibility frontier. The deficit has to be balanced by a surplus elsewhere on the balance of payments, namely on the financial account.

This could be caused by or suggests a number of things:

• Overspending (either by consumers or governments), and a preference for borrowing over saving to fund current consumption. This is good for living standards but financed by borrowing
• An underlying lack of competitiveness which limits exports. This is indicative of underlying supply-side problems and the need for increased productivity
• The country attracting large inflows of FDI, creating a surplus on the financial account allowing for a current account deficit
• Rapid economic growth requiring imports of capital - capital costs more than consumer goods
• An overvalued exchange rate

Question 91

Trade surplus causes

Answer 91

• Competitiveness
• A high savings rate - MPC low so MPM low
• An undervalued exchange rate - imports expensive, exports cheap

Question 92

Measures to Reduce a Country’s Imbalance on the Current Account

Answer 92

Exchange Rate Adjustments: A depreciating currency can make exports cheaper and imports more expensive, improving the trade balance.

Fiscal Policy: Governments can reduce budget deficits to increase national savings and reduce reliance on foreign borrowing.

Trade Policy: Promoting exports through trade agreements or incentives can boost export revenues.

Structural Reforms: Encouraging innovation and productivity improvements can enhance competitiveness in global markets.
Foreign Investment: Attracting FDI and portfolio investments can offset deficits by bringing in foreign capital.

Macroeconomic Policy Coordination: Coordinating monetary and fiscal policies to maintain economic stability.

Question 93

Significance of Global Trade Imbalances

Answer 93

Economic Stability: Persistent imbalances can lead to financial instability, as countries may accumulate unsustainable levels of debt.

Exchange Rate Volatility: Imbalances can contribute to currency fluctuations, affecting trade and investment.

Political Tensions: Trade imbalances can lead to disputes and protectionist measures, straining international relations.

Global Economic Health: Imbalances in one country can affect the overall health of the global economy.

Resource Allocation: Persistent deficits may indicate inefficiencies or resource misallocation, hindering economic growth.

Diversification of Risks: Some countries rely on trade surpluses to offset vulnerabilities in other areas of their economies.

Question 94

Marshall-lerner condition

Answer 94

As previously explained, an economy may opt to deliberately undervalue / devalue its currency in order to boost its exports, as a weaker currency means that the price of exports is relatively cheaper to the rest of the world.

However, the extent to which currency devaluation will boost exports can be evaluated by the Marshall-Lerner condition.

For a currency devaluation to have a positive impact on the trade balance the sum of price elasticity of exports and imports (in absolute value) must be greater than 1.

The original exchange rate is £1 to $1
* The UK imports 1000 units at a price of $1 per unit, meaning £1000 is spent on imports
* The UK exports 1000 units at a price of £1 per unit, meaning the UK receives £1000 for its exports
* The value of imports = the value of exports (£1000) so X=M and there is a trade balance

Question 95

J-Curve

Answer 95

In the short-run, there may be a problem with currency depreciation as a policy to improve the current account whereby the balance of trade initially worsens.

This J-curve effect occurs due to the relatively inelastic price elasticities of demand for imports and exports immediately following a depreciation arising from difficulties in altering order contracts.