Unit 4: The Global Economy: International Trade and Development

Unit 4: The Global Economy:

International Trade and Development

Chapter 12: Trade Theory, Agreements, and PatternsChapter 13: Financing International TradeChapter 14: International Economic Issues

Chapter 14: International Economic Issues

• Over the years, Canadians have taken to the streets to voice their opinions on many social movements, including civil rights, women’s right to vote, nuclear disarmament, and protection of the environment

• In recent years, as global organizations have met behind closed doors, activist groups from around the world have reacted with persistent, sometimes violent, protests

Chapter 14: International Economic Issues

• Globalization, in its present form, is perceived by many to promote the exploitation of the poor by the rich, through the spread of capitalism

• In this chapter, we’ll investigate many issues arising from the globalization movement

What is Globalization?• Globalization is the process of creating a global economy• Driven by three forces• Technology• Removal of trade barriers• International finance system

What is Globalization?

• Technology• Improvements in telecommunications,

computer technology, and transportation infrastructure allows large companies to produce goods and services on a global basis and market them around the world


• Removal of trade barriers• Many nations have removed, or are removing,

various barriers to cross-border trade, resulting in a huge increase in the volume of international trade


• International finance system• A vast international financial system is

facilitating trade and financing international business activity


• Each of these three forces have been promoted by globalization’s defenders as beneficial for national economies and their citizens

• They have also been just as strongly attacked by globalization’s detractors as damaging to people

• Let’s examine each in greater detail

The Multinational Corporation

• As introduced in Chapter 6, the multinational corporation (MNC) is fundamental to globalization• Remember that an MNC is a firm that operates in

several countries• Also called transnational corporations

• These large businesses can now…• Set up production in any number of companies• Communicate orders and production plans by

computer and satellite links• Sell their products and services


• Consider the example of Caterpillar, a Canadian tractor manufacturer located near Toronto

• The various parts for the tractor are manufactured in several countries• Engines in Japan• Transmission in the US• Winches in Brazil• Axles in Belgium


• The parts are all shipped to an Ontario plant, where they are assembled into tractors

• The completed tractors are sold to Japan, the US, Brazil, Belgium, and other countries

• Computer and satellite links enable companies such as Caterpillar to…• Send their specifications for parts from the home

office to their foreign parts manufacturers quickly• To test a finished part while it is still on the factory

floor on another continent


• The business arrangement of hiring outside contractors to produce either parts or finished products is called outsourcing• Using this strategy, multinationals can “shop

around” in many countries for the subcontractor that will produce the good for the least amount of money

• The business arrangement of setting up a subsidiary, or branch plant, in another country, is another way of conducting an international operation


• In the case of multinationals that sell services, arrangements usually depend on the transfer of data via computers and satellite links

• For example, Ireland has become a major centre for the processing of US insurance claims• A US insurance company, New York Life, sends the day’s claims

to an Irish branch office at the end of the business day in the US• Because of the 5-6 hour time difference, Irish employees can

spend their workday processing the claims before their US counterparts even wake up

• They then relay the processed claims back to the US, where American employees can begin their day by sending out processed claims to the company’s insurance claimants


• With this international arrangement, the US company takes advantage of:• Lower labour costs in Ireland• Favourable tax levels offered

to foreign companies by the Irish government

• The fact that the Irish employees speak English

• The time difference between the two countries to create a comparative advantage for itself


• Caterpillar and New York Life give us what appear to be positive examples of the global economy

• If the manufacturer or service company opens a branch plant…• It builds, buys, or leases a plant for its operations in the

host country• It hires and trains local people, sometimes introducing

them to new technology• Pays wages to these employees• Pays taxes to the host government• May use local suppliers for component parts needed in its

production process

Foreign Multinationals in Canada

• The debate today over foreign multinationals in Canada has shifted…• From concern over their presence…• To concern when they shift their operations to other

countries and eliminate jobs for Canadians

• On the one hand, many foreign multinationals moved operations from Canada while they continued to sell products here

• On the other hand, many Canadian firms have expanded their operations to export products and services to markets in other countries

Foreign Multinationals in Canada

• Over the last 30 years, larger and larger companies have been expanding their operations to larger and larger markets in their quest for profit

• According to Fortune magazine, by 2000, the list of world’s top 30 economies included 5 multinationals:• General Motors• Wal-mart• Exxon Mobil• Ford• DaimlerChrysler

• The multinationals, therefore, are a fundamental force driving globalization

Removing the Barriers to International Trade

• The second major force that’s driving globalization is the removal of numerous barriers to international trade• As a consequence on this, trade

among countries is now much more important than it was in the past

• Figure 19.2 illustrates that international trade has been increasing far more quickly than world output since the 1970s• Increasing at a rate of about 7%

per year• Trade now constitutes 21% of total

world income and is likely to keep increasing


• The major reason for the dramatic increase in the volume of world trade over the last 30 years or so stems directly from absolute and comparative advantage• These theories promise great gains from trade if it’s open

and free from trade barriers such as tariffs

• Industrialized countries made a determined effort among themselves to lower barriers to trade• A series of international agreements, first negotiated under

the General Agreement on Tariffs and Trade )GATT) and later under the World Trade Organization (WTO) steadily lowered tariff barriers from as high as 40% to an average of 5% today


• Other international changes contributed to a worldwide trade expansion

• The Cold War ended in the late 1980s when communism fell in Russia and Eastern Europe• Russia, East Germany, Poland, and other

Eastern European countries replaced their command economies with capitalist economies

• Central to this process, they opened up their economies to trade and investment


• In another major shift in East Asia, the “Asian tigers” of South Korea, Singapore, Taiwan, and Hong Kong flourished under capitalism• Became industrial powers and major trading

nations

• China, though still technically communist, opened its doors to international investment• Many subsidiaries of foreign multinationals are

now located in China• Recently joined the WTO

The World Trade Organization (WTO)

• The one organization most responsible for removing trade barriers is the WTO

• The WTO is the focus of much of the debate and protest surrounding globalization• Most governments, economists,

and businesspeople support the WTO

• Most labour organizations, environmentalists, and social activists oppose it

• The general population holds mixed opinions


• As of 2002, the WTO had 144 members• The large numbers of members makes governing the

organization somewhat unwieldy

• Trade rules are set by a simple majority vote of the members

• Trade disputes that arise between members are brought before special tribunals of trade experts and lawyers• The tribunals decide who is at fault, and the country found

at fault might be asked to change its law to conform to the WTO rule, face economic sanctions, or pay compensation to the wronged country


• The WTO has had to deal with newer kinds of international trade items and issues than the GATT, which dealt mostly with trade in goods

• At present, trade in services such as telecommunications, insurance, finances, health, and education, accounts for over 60% of world GDP


• Another area of concern for the WTO is the issue of intellectual property rights• Patents for such products as technology,

recorded music, and pharmaceutical drugs

• Rules regarding foreign investment by multinationals are another area in which the WTO tries to achieve consensus among its members


• Proponents of the WTO claim that these negotiations lead to a “level playing field” for all nations that want to participate

• Opponents claim that only the most powerful nations can finance the permanent lobbyists who can sway WTO rulings to their benefit

Globalized Financial Markets

• The third force driving the creation of a global economy is the global financial market• A network of 100 or so of the world’s banks and large

brokerages linked by computers

• Enables traders to buy or sell foreign currencies, along with government and corporate bonds or stocks, exceedingly quickly, using specialized computer technology

• The amounts traded are vast• It’s estimated that $2.5 trillion is traded daily on these

global money markets


• The traders who work for major financial institutions specialize in performing one of several functions

• First, they may carry out currency conversions for individuals or businesses buying or selling with foreign countries• The buyer (importer) contacts a bank trader,

who purchases the exporter’s currency in the world money market and arranges payment to the seller


• Second, another groups of traders specializes in bonds sold worldwide by corporations and businesses• To finance deficits, governments sell these bonds to

investors abroad through the global market• The bond market alone trades over $300 billion per day

• A third group of traders buys and sells shares for multinationals• This global stock exchange buys and sells about $40

billion per day, but this figure is likely to increase quickly


• The traders in these global markets make money by charging their clients for the service of buying currencies, bonds, or stocks

• Also profit by taking advantage of small differences in prices of currencies or assets between different countries• If a currency, bond, or share sells for a lower price in one

country, the trader will buy it there and then sell it in another country where the price is slightly higher

• A trader can make these transactions from a computer terminal using computer technology that acts at lightning speed

Concerns about Global Finance

• The very speed and efficiency of the global markets that allow sellers and buyers to transact business have become an issue of concern

• In 1997, the countries of East Asia suffered a devastating financial crisis that spread to many countries around the world

• Exact causes are still disputed• Some say the governments and banking systems in

these countries were inefficient• Most experts agree that the responses of the global

money markets intensified and spread the financial crisis


• Thailand, South Korea, Malaysia, and Indonesia had been economic success stories before 1997• Their economies boomed, and the markets pumped in billions

of dollars into real estate, new factories, and financial assets

• In 1997, the markets grew pessimistic about these countries• Their currencies appeared to be overvalued• Their exports had fallen• It seemed their comparative advantage in production was

slipping away to China with its lower wages

• Investors pulled out of these countries, businesses closed, and the currencies were devalued


• The crisis soon spread to:• Hong Kong, where the stock market fell 25% in 4 days• South Korea, the world’s 11th largest economy, where the

currency collapsed

• The International Monetary Fund attempted to fix the situation by engineering a large loan to South Korea, but that only resulted in the crisis spreading to economies with no connection to East Asia• Brazil’s currency was sold, driving its value down by 33%• Russia’s government defaulted on its debt• The US stock market fell by 2000 points• The Canadian dollar depreciated due to a drop in demand from

Asia for natural resources


• In human terms, this financial crisis…• Plunged 10 million people into “extreme

poverty” (income of $1 or less a day)• Threw 24 million into “poverty” (2$ a day)• Left an estimated 27 million workers without

jobs in the 5 countries most severely hit


• At present, the global financial system has no mechanism to regulate international flows of capital

• Regulations to prevent sudden withdrawals of capital have been proposed to reform the global financial system

Underdevelopment: The Status Quo?

• Although the proportion of poor Canadians continues to increase statistically, most Canadians live a relatively comfortable lifestyle in contrast to the majority of Earth’s people

• To help recognize the disparities that exist between rich and poor nations, the World Bank classifies national economies into 3 groups based on annual per capita GDP data:• High-income• Middle-income• Low-income


• High-income economies (also called industrially advanced countries or IACs) are nations with per capita GDPs high enough to provide a substantial majority of citizens with prosperity

• In its 2000/2001 report, the World Bank set US$9266 (about Can$15,000) as the minimum GNP per capita for this group• In this report, 52 nations qualified for this

distinction, representing 903 million people


• Middle-income economies are those in which a sizable minority of the population avoids living in acute poverty

• In the 2000/2001 report, 92 nations, representing 2.7 billion people, were classified in this group• Included China, Russia, the Eastern European

countries formerly under Soviet domination, several Central and South American nations, the Middle East, the extreme northern and southern regions of Africa, and the newly industrializing countries of Southeast Asia


• Low-income economies (also called less developed countries or LDCs) include the poorest nations of the world

• In the 2000/2001 report, the maximum GNP per capita was set at $755• 63 nations were placed in this category,

representing 2.5 billion people


• Many of these low-income nations share a common history as former colonies, at one time under the control of other nations• In many cases, the economies developed

under colonialism were designed to benefit the home country and exploit the colonies for their natural resources

• Consequently, colonialism crippled healthy economic development in these nations


• Many contemporary economists have concluded that the gap between high- and low-income nations continues to widen

• It has been stated by various economists, relief workers, and religious leaders that in order for the world to experience lasting peace, it must first do away with existing injustices that serve to keep low-income nations from achieving sustained economic process


• Unfortunately the 80/20 rule appears to be a permanent economic fixture in the world economy• More than 80% of the world’s productive

resources are effectively controlled by 20% of the world’s people

• Conversely, the 80% of the world’s people control only 20% of the resources

• Under these circumstances, it seems like a more equitable distribution of global wealth is virtually impossible


• Some of the more radical voices suggest that the rich are rich precisely because of their advantageous position over the poor and vulnerable

• Famines, as the arguments go, are not as much a case of insufficient food production to meet global needs as they are of distribution breakdowns between the :”have” and “have-not” nations

Barriers to Economic Development

• Economists judge the economic success of a country by noting whether living standards are growing

• An economy shows economic development when a nation’s living standards have increased• We can easily see this when there is a measurable increase

in per capita GDP that is shared by the bulk of its population

• To achieve this, a country requires both economic growth and a widespread distribution of the benefits of this economic growth

• In attempting to facilitate economic growth, low-income nations generally face a series of obstacles


Lack of economic freedom and stability

• Many low-income countries have politico-economic systems in place that limit economic freedom and the individual pursuit of self-interest• Some of these nations, such as Afghanistan, Angola, Cambodia,

and Somalia, have experienced long civil wars that have further devastated their already fragile economies

• In some low-income countries, military and other forms of dictatorship control the governments• The stability present in a strong dictatorship comes at the price

of lost personal and economic freedom• In these “controlled” economies, national wealth rarely manages

to trickle down to the majority of citizens


Malnutrition

• Nations with a low GDP per capita usually have insufficient food supplies to distribute, resulting in a malnourished population• Other goods and services that contribute to improved health

standards are also in short supply

• To complicate matters, available food and productive resources may be controlled by a small minority of the population and used only for their benefit• For example, many low-income countries grow cash crops intended

for export• Usually grown on huge plantations owned by a small minority• The majority may be powerless to do anything about this

imbalance


Low levels of investment

• Because individuals, households, and firms must use most of their income to purchase essential goods and services, only a minor portion of income can be saved

• Without substantial savings in banks, the financing of investment projects and the development of a capital-goods infrastructure are very difficult to achieve

• Further, when foreign interests supply money or real capital, their interests (profit maximization) may not always be in the best interests of the host nation, so they may be unwelcome

• Finally, traditions that discourage self-interest, competition, and profit may inhibit local entrepreneurship


• Without high levels of investment capital, production tends to rely on labour• Labour is relatively cheap and offers the only means of

achieving profitability

• Labour-intensive industries provide many people with jobs• As long as people receive a wage they can live on, often

referred to as a living wage, this situation is not problematic

• However, in many low-income nations, the earnings of the majority of workers are not sufficient to provide the necessities of a healthy life


Population growth

• Population growth in most low-income economies tends to be too high to be sustained by the existing levels of production growth• Consequently, living standards decline steadily over time

• Rapid population growth and low incomes are linked• Large families are seen as an economic necessity in low-GDP

nations, especially in areas where the child mortality rate is high• In economies with limited social security programs in place (such as

retirement pensions) children provide labour to help the family survive

• Later, they provide security for aging parents


Dependence on child labour

• According to the International Labour Organization, by the end of the 20th century, the number of working children had climbed to more than 250 million

• In many low-income countries, children are required to work in factories or at home sewing garments, stitching baseballs, weaving rugs, making bricks, treating leather, hawking wares in markets, and serving as domestics for wealthy families• One of the most dangerous activities involves scavenging

through refuse dumps in order to find materials that can be sold


• Many families run home businesses in which all family members must work in order to put food on the table

• In other cases, businesses hire children because they can be paid very low wages and are easier to control than adults• In the case of rug weaving, the agility of tiny fingers is an asset• Often, the parents must stay at home unemployed because the

local factory will not hire them, preferring to employ children

• As a result, millions of ch8ildren miss the chance to go to school, and most never learn to read or write• High levels of illiteracy are always associated with high levels of

poverty


Natural-resource-intensive production

• For many of the world’s less developed countries, economic enterprise is limited largely to primary industrial activity• Their economic revenue is based on the exportation of limited natural

resources such as bauxite, latex rubber, coffee, bananas, and sugar cane

• Exporting relatively inexpensive natural resources, while importing expensive manufactured goods, usually results in a steady drain of money out of an economy• This imbalance serves to limit the economy’s ability to grow

• If discounted prices (whether as a result of market forces or exploitation) are being paid for the resources purchased from less developed countries, than economic growth potential can be even more adversely affected


• In Figure 19.5, you can see that banana growers receive very little of their product

• This situation is made worse if foreign interests control the natural resources, taking potential profits out of the country• An example would be a

foreign company that owns agricultural land in a less-developed nation, where it grows flowers for export to developed nations


Debt burden

• Many less developed nations have borrowed money from foreign banks, governments, and international institutions such as the World Bank and the International Monetary Fund

• Monies were borrowed to:• Finance infrastructure projects (to build roads, schools, and

water works)• Feed hungry citizens• Prevent the collapse of the domestic currency and banking

system• Pay for import


• Debt repayment can happen only when the nation that owes the debt has a surplus of exports over imports• Results in a positive flow of money into the country and, ultimately, in

economic growth

• In order to achieve this, industrialized nations must open their markets to exports from less developed nations• Few low-income economies have ever managed to achieve this

situation, particularly as many more developed countries maintain trade barriers to protect their own industries

• As a result, many less-developed nations fall deeper and deeper into debt, and the interest payments get larger• Having to pay the interest on the incurred debt becomes a further

burden for debtor economies and serves to limit their ability to invest and grow

Development Strategies: Breaking the Cycles of Poverty

• While it would be a difficult task, it is not impossible to break the cumulative downward cycles presented in the previous section and shown in Figure 19.6

• Breaking the cycle involves the efforts of many individuals and organizations, working on many different fronts

Political and Economic Stability

• A stable politico-economic system is a prerequisite for lasting development• Political and economic stability discourages the flight of

investment funds and profits out of a less developed economy to safer markets

• Political stability permits long-term planning and promotes capital investment• If investors are confident that their investments will not be

seized by government, they are more likely to invest

• Political stability is usually not assured until a country experiences a substantial period of rule by a democratically elected government

Population Control• In many nations experiencing rapid population growth

(relative to GDP) great effort is expended on state-sponsored birth-control programs• For example, in India birth-control programs have been in

place for decades• Nonetheless, the national birth rate remains relatively high

• In another example, China’s severe “one-child” policy has reduced that country’s birth rate substantially• The success of the program depends on the state-imposed

limits on the number of children allowed to each couple• There are certainly drawbacks to China’s approach, such as

the extreme measures families go to to ensure they have a male child

Population Control• In another approach, population-control programs

focusing on raising income and education levels have proven to be both effective and respectful of human dignity and life

• Government programs that improve basic social services (health care, nutrition, and education) and provide programs that improve income distribution and employment opportunities also tend to encourage people to have fewer children• Evidence of this result appears in almost all

industrialized nations, where birth rates are extremely low

Investing in Productive Resources

• For many low-income economies, natural resource endowment is limited

• In the absence of these resources, governments can instead work toward the development of human resources by focusing on education, health care, and nutrition• Education and training increase the supply of skilled labour, which in

turn increases productivity and living standards

• Government programs can also work toward the development of capital resources by encouraging savings• Financial institutions then have capital that they can use to lend to

entrepreneurs

• Developing “intermediate technology” that makes good use of plentiful, low-cost labour is an effective strategy for less developed countries

Freer Trade• Lasting and healthy development for many low-income economies

requires the efficient use of whatever productive resources the economy has, especially labour• For example, by offering efficiency, in the form of low production

costs, the economy has something to trade internationally

• When industrially advanced countries open their markets to the goods (especially labour-intensive manufactured goods) produced by low-income economies, in the long and in fair trade arrangement, both parties share the benefits of the law of comparative advantage

• In the last two decades, a considerable number of manufacturing jobs have shifted from industrially developed countries to less developed nations• Many people in low-income nations have gained employment

Foreign Aid• Direct aid from developed nations is needed to help break

the vicious circles of poverty at work in less developed nations

• Relief programs are needed to deal immediately with crises resulting from drought, famine, civil war, earthquakes, and other natural disasters

• Structural programs are necessary to help build the infrastructure, education systems, and capital resources necessary to provide a foundation for lasting economic development

• In Canada, government aid is administered by the Canadian International Development Agency (CIDA)

Debt Reduction• During the 1990s, actions were taken to help debtor

nations• Negotiations with bankers helped to reduce some debts• The World Bank provided low-interest loans and technical

assistance for large-scale development projects• The International Monetary Fund provided loans to

governments in return for specific corrections to the economy, such as reductions in government spending

• These tactics did little to help• Money infusions do not address the cycle of exploitation• In time, the money flows back to wealthy nations

Debt Reduction• By 1998, Brazil, the most indebted less-developed nation,

owed $374 billion to other nations• Mexico owed $258 billion• China owed $250 billion• Argentina owed $232 billion• India owed $158 billion

• By 2000, it had become clear that the debt crisis continued to be an insupportable burden for many debtor nations

• Led by Pope John Paul II, many concerned world leaders began to advocate an international debt forgiveness plan to free less-developed countries from the burden of paralyzing debt

Debt Reduction

• In 2001, Argentina defaulted on its loan payments because it was unable to pay• This plunged the bankrupt nation into a

political, economic, and financial crisis• When Argentine banks closed their doors,

people were unable to get their money out• Street riots led to several changes in

government

Unit 4: The Global Economy: International Trade and Development

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Transcript of Unit 4: The Global Economy: International Trade and Development