International Trade & Globalisation

Specialisation by country

Why does almost every country import goods it is perfectly capable of making at home? Because producing everything itself is rarely the cheapest way to get it.

The basis for specialisation

A country can specialise on two related grounds. The first is superior resource availability: a country with an unusually large or high-quality stock of a resource — fertile land, a mineral deposit, a particular climate — can either charge a premium for its quality or produce such a large quantity that it drives down the price and out-competes rivals. The second is lower-cost production: a country may produce more cheaply than others either through capital-intensive methods, such as advanced machinery and automation, or through an abundant, low-wage labour force suited to labour-intensive work. Either basis lets a country produce at a cost or quality other countries cannot easily match, which is what makes specialising — and then trading for everything else — worthwhile.

Advantages and disadvantages of specialisation

Specialising delivers real gains, but concentrating an economy on a narrow range of output also carries risk.

Free trade

Specialisation only pays off if a country can then sell the surplus abroad and buy in everything else — which is exactly what free trade allows.

What free trade removes

Under free trade, governments impose no tariffs, quotas, subsidies or embargoes on what crosses their borders, so goods and services move between countries purely on the basis of price and quality. This lets each country’s specialisation (previous page) translate directly into exports, and lets consumers buy whatever is produced most efficiently anywhere in the world, rather than only what is produced at home.

Advantages and disadvantages of free trade

These disadvantages are precisely why some governments choose to restrict free trade rather than practise it in full — the subject of the rest of this section.

Globalisation

Globalisation is not a new phenomenon, but the pace of global economic integration has sped up enormously over the last fifty years.

Causes of changes in globalisation

Four drivers explain most of the change. Falling trade restrictions — lower tariffs and quotas — make cross-border trade easier and cheaper. Falling transport costs, through larger container ships and cheaper air freight, make moving goods between countries more affordable. Falling communication costs — the internet and mobile networks — let firms coordinate production and place orders across the world almost instantly. And the movement of multinational companies into new countries spreads production, supply chains and economic activity more widely still.

Effects of globalisation

These drivers reshape an economy on several fronts at once. International trade expands and firms face competition from across the globe rather than only from domestic rivals, which can lower prices and raise quality, though smaller domestic firms may be pushed out of the market entirely. The environment gains from the shared spread of green technology but loses from rising transport emissions and resource overuse. Migration rises as workers move toward better opportunities, easing unemployment in the countries they leave but adding pressure on housing and public services where they arrive. Income distribution can shift in either direction — new jobs and higher export wages in some regions, a widening gap between skilled and unskilled workers in others. On balance, most economies gain in economic development through investment and export-led growth, at the cost of a greater dependence on multinational companies and global demand.

Multinational companies (MNCs)

Globalisation has made it easier for firms to operate across borders, and the number and scale of multinational companies keeps growing as a result.

Advantages and disadvantages of MNCs

An MNC’s effects differ for its home country and the countries that host its operations, which is why Cambridge questions usually ask for both sides of the argument rather than one.

Trade restrictions: types

Four tools let a government protect domestic industry from foreign competition, each working through a different mechanism.

Four methods of protection

A tariff is a tax on imports, which raises their price to consumers and makes domestically produced substitutes relatively more attractive. An import quota places a physical limit on the quantity of a good that may be imported, raising the market price by restricting supply directly rather than taxing it. A subsidy is a payment from the government to domestic producers, lowering their costs so they can sell more cheaply both at home and abroad. An embargo is a complete ban on trade with a particular country, usually imposed for political rather than purely economic reasons.

Diagram analysis — a tariff

A tariff raises the cost domestic importers must pay to bring a good into the country, which is equivalent to an increase in the cost of supplying that good to the domestic market.

Reasons for & consequences of trade restrictions

Governments restrict trade for several distinct reasons — each points to a different type of industry or problem.

Reasons for restricting trade

Restrictions can protect an infant (sunrise) industry that is too new to compete internationally yet, or a declining (sunset) industry, slowing job losses while it shrinks in an orderly way. They can protect strategic industries, such as food or energy, whose supply a country does not want to depend on in a crisis, or guard against dumping by foreign producers. A government may also restrict trade to reduce a current account deficit, to raise tax revenue through tariffs, to restrict demerit goods such as tobacco or alcohol, or to promote environmental sustainability by limiting imports produced in environmentally damaging ways.

Consequences of trade restrictions

Foreign exchange rate determination

Like any other product, a currency has a price — and that price is set, in a floating system, by its own demand and supply.

Reasons for buying and selling currencies

Currencies are bought and sold for trade in goods and services (importers need foreign currency to pay for what they buy; exporters convert what they earn back into their own), for speculation (traders buying a currency they expect to rise in value), through government intervention in the currency market, for profit, interest and dividend payments between countries, for workers’ remittances sent home from abroad, and for investment in capital goods bought from another country.

Determining the equilibrium exchange rate

The equilibrium rate is where the quantity of a currency demanded equals the quantity supplied — the same demand-and-supply logic already used for any other market. Demand for a currency comes mainly from foreigners buying the country’s exports, foreign investors buying its assets, and speculators expecting it to rise. Its supply comes mainly from the country’s own residents buying imports or foreign assets, and speculators expecting it to fall. If demand rises or supply falls, the currency appreciates; if demand falls or supply rises, it depreciates.

Causes & consequences of exchange rate changes

An exchange rate rarely sits still, and three causes explain almost every fluctuation examiners ask about.

Causes of exchange rate fluctuations

Changes in demand for exports and imports: rising exports raise demand for the currency and so appreciate it; rising imports raise the supply of the currency sold to buy foreign currency, and so depreciate it. Changes in interest rates: a higher interest rate attracts foreign savers seeking a better return, raising demand for the currency and appreciating it; a lower rate works in reverse. Speculation: if traders expect a currency to rise, buying it now increases demand and helps cause the rise they expected; if they expect it to fall, selling it increases supply and helps cause the fall.

Consequences of a change in the exchange rate

Current account of the balance of payments: structure

Every cross-border flow of goods, services or income ends up recorded in one of four boxes, shown on the chapter cover.

The four components

Trade in goods (visible trade) covers exports and imports of physical products. Trade in services (invisible trade) covers banking, tourism, insurance and similar non-physical trade. Primary income covers profit, interest, dividends and wages earned abroad, net of the same payments made to foreigners. Secondary income covers transfers where nothing is received in exchange, such as workers’ remittances and foreign aid. Money flowing into the country on any of these is a credit; money flowing out is a debit.

Current account balance = net goods + net services + net primary income + net secondary income — measured in $ · credits − debits.

Worked example: calculating the current account balance

In one year, a country recorded (all figures $m): exports of goods 420, imports of goods 500; exports of services 180, imports of services 110; net primary income +35; net secondary income −60. Calculate the current account balance.

Step 1. Net trade in goods = 420 − 500 = −$80m. Step 2. Net trade in services = 180 − 110 = +$70m. Step 3. Current account balance = −80 + 70 + 35 − 60 = −$35m — a deficit, driven mainly by the goods account. −$35m (deficit).

Causes, consequences & policies for the current account

A current account imbalance rarely has one single cause, and the right policy response depends on which cause is actually driving it.

Causes of deficits and surpluses

A deficit tends to arise from relatively low productivity (raising production costs and weakening export competitiveness), a relatively high exchange rate (making exports dearer and imports cheaper), relatively high inflation (raising export prices faster than rivals), or rapid economic growth (pulling in more imports as incomes rise). A surplus arises from the reverse of each: relatively high productivity, a relatively low exchange rate, and relatively low inflation.

Policies to achieve balance of payments stability

A government can do nothing and let a floating exchange rate self-correct — a deficit depreciates the currency over time, which eventually makes exports cheaper and imports dearer, though this can take time and cost domestic firms along the way. Expenditure-switching policies, such as tariffs or a managed depreciation, shift spending from imports toward domestic goods, though they risk retaliation from trading partners. Expenditure-reducing policies, such as higher taxes or interest rates, cut total spending (including on imports), at the cost of slower growth and higher unemployment. Supply-side policies, such as investment in education or infrastructure, raise productivity and competitiveness over the long run, improving the current account without first depressing domestic demand — but only slowly.