The Nation and the

World Economy
Based on CORE’s The Economy: Unit 18 and Unit 1.8
Overview

Part 1
Exchange rates and Balance of Payments
From Begg et al Ch 24 and 25
Part 2
What is Globalisation?
Specialisation and gains from trade
Winners and losers from trade specialisation
(From Core Unit 18 and Unit 1.8)
Part 3
Globalisation and anti-globalisation
Trade and Growth
Conclusions
(From Core Unit 18)
Exchange Rates

• The domestic price of foreign exchange it the

quantity of domestic currency per unit of the foreign
currency.
• The foreign exchange market (forex) exchanges one
national currency for another at a price called the
exchange rate.
• The foreign exchange market is the international
market in which one national currency can be
exchanged for another.
• The exchange rate is the price at which two
currencies exchange.
Market for foreign exchange

§DD shows the demand for

pounds by Americans wanting
to buy British goods/ assets.
§SS shows the supply of pounds
by UK residents wishing to buy
American goods/assets.
§Equilibrium exchange rate is e0
(eg $1.50/ UK £)
§If UK residents increase the
supply of pounds as they wish to
import more from US, the supply
of £ moves to SS1
§New equilibrium at e1 (e.g.
$1.40/ UK £) (US Dollar has got
stronger against the UK £)
Flexible vs fixed exchange rates

§ In a flexible exchange rate regime

– the exchange rate is allowed to attain its
free market equilibrium level without any
government intervention using exchange
reserves.
§ In a fixed exchange rate regime
– the national governments agree to maintain
the convertibility of their currency at a fixed
exchange rate.
§ For fixed exchange rate: Suppose the
government is committed to maintaining the
exchange rate at e1
§ If the demand for pounds is DD1 there is excess
demand AC. The Central Bank must supply AC
£s to buy $ which are added to reserves
§ The reverse occurs if there is not sufficient
demand for pounds at DD2 then central bank
must use up its finite reserves of $ to buy pounds
and keep its value at e1
§ When demand is DD, no intervention is needed.
There is a balance in transactions between the
countries.
Monetary policy under fixed exchange
rates

§An increase in nominal money supply

–tends to reduce interest rates
–leads to a capital outflow
–reducing money supply as the government seeks
to maintain the exchange rate
§so monetary policy is powerless
–the government cannot fix independent targets
for both money supply and the exchange rate
–domestic and foreign interest rates cannot diverge
Fiscal policy under fixed exchange rates

§An increase in government expenditure, in the short

run,
–stimulates output
–money supply expands
–there is no crowding-out as the pressure for higher
interest rates (increased demand for local currency)
is met with increased supply of local currency so
interest rates do not rise
§In the long run,
–wages and prices adjust, affecting competitiveness
and
–the economy returns to potential output
Monetary and Fiscal policy under
floating exchange rates
§Monetary policy with floating exchange rates
is highly effective in the short run but the
effect is only transitional
§Fiscal policy is less effective under floating
exchange rates as following an increase in
government expenditure, the crowding-out
effect of higher interest rates is enhanced by
appreciation of the exchange rate, which
dampens export demand.

©McGraw-Hill Education, 2014

Balance of payments (BoP)

§ The BoP is a systematic record of all transactions

between residents of one country and the rest of the
world
§ Current account
– records international flows of goods, services, income
and transfer payments
§ Capital account / Financial account
– records transactions involving capital (savings) and
the purchases and sales of financial assets
 What is globalisation?

§ Globalisation refers to the integration of:

– the world trade in goods and services

– flows of investment, savings and asset markets

– flows of people across national boundaries

§ Globalisation has led to the prices of goods converging across countries

§ But the global convergence of wages has been much less than the
convergence of goods and asset prices

§ Globalisation is partly a policy choice and partly a technological necessity

Key policy instruments of nation states

§ Policies associated with globalisation

– Tariffs and other barriers to trade: taxes on imports to protect local
producers by making goods produced in other countries more costly
(tariffs are a key instrument in “trade wars” related to the rise in
“protectionism”)
– Immigration policies: the regulation of movement of people between
countries
– Capital controls: Limits on the ability to transfer financial assets among
countries
– Monetary and exchange rate policies: Affect the exchange rate, and
so alter the relative prices of imported and exported goods
§ Nation-states enter into multilateral agreements to regulate trade and
other elements of globalisation
Arbitrage

§ By buying at a low price in export markets and selling at a higher price in import
markets, traders can make a profit as long as the price gap is higher than the total
cost of trade
§ The practice of buying a good at a low price in one market (or country) to
sell it at a higher price in another.
§ Through the process of buying cheap and selling dear – the price rises in the low
price market and falls in the high price market leading one price in both markets
§ Arbitrage explains why the price gap equals trade costs: Arbitrage continues until
the price gap has been driven down to the trade cost, and further arbitrage is
unprofitable
Price gap

§ Greater openness to trade in goods and services, open capital markets,

and open migration of labor should lead to convergence in prices

§ Even so, for most goods and factors there will be some gap

§ What is the gap between the price of a (tradeable) commodity in one

country and another.

§ A low price gap reflects a much more globalised world in which trade is
cheap

§ A high price gap reflects a world in which trade is expensive and

globalisation is limited

§ The price gap is a function of policy choices about globalisation (tariff

and non-tariff barriers to trade) and technological factors (e.g. speed and
cheapness of shipping)
Japan selling cars to the USA
Trade cost (t) is the cost of shipping a car from Japan
to the US (including transportation costs, tariffs, Falling trade costs (including falling tariffs)
insurance etc). If the market is competitive, then the imply a decline in the price gap between
total cost of obtaining a car in the US will be the cost the import price and the export price
of buying it in Japan, plus the trade cost t (from t to t’) this increases the number of
cars traded from 4,000 to 6,000

PRICE

price in Japan

price in the US

QUANTITY
Trade costs have declined over time
§ As trade costs fall (and the price gap falls) – the volume of trade rises

§ The wheat price gap between the UK and the US started to decline at about the same time
that shipping costs started to fall (due to the introduction of steamships on long-distance
routes). The volume of wheat shipped across the Atlantic rose dramatically
§ The transatlantic trade in wheat is not an isolated example. International price gaps fell
sharply on many routes and for many commodities between 1815 and 1914
History of trade in mechandise
Protectionist policies and deglobalisation

§ Transatlantic shipments of wheat fell after 1914, and price gaps rose, suggesting a
rise in trade costs and therefore deglobalisation

§ When a country undertakes protectionist policies, its government is taking steps

to limit trade, by reducing the amount of imports coming into the economy

§ This is often done to protect domestic industries and jobs against foreign
competition

§ it also means consumers must pay more for imports

§ Protectionist measures include taxes to raise the domestic price of imports (a

tariff) and quantitative restrictions on imports (a quota)
Specialisation
and gains from trade
David Ricardo
19

§ In his book “On Principles of Political Economy

and Taxation”, Ricardo laid out the principle of
comparative advantage, recognizing that two
countries could trade to the mutual advantage of
each, even if one of them was absolutely better at
producing all goods
§ Ricardo was also known for successfully lobbying
the British government to repeal the Corn Laws
in the early 1800’s to allow the importation of
corn into the UK from the USA and Europe
§ This was opposed by vested land-owning and
farming interests
§ Once corn could be imported then food prices
fell, workers wages were moderated by lower
food prices
§ this allowed the UK to be more competitive in
producing and exporting goods, helped the UK
to be the world’s leading economy at the time
What are the key policy issues?
20

§ The integration of national economies into a global economic system provides:

– Opportunities for mutual gains
– Conflicts over the distribution of the gains

§ When evaluating government policy we must assess whether policies:

– fully exploit the mutual gains made possible,
– distribute those gains fairly, and
– reduce the economic insecurities involved in the globalisation process
Specialisation and gains from trade

§ Specialisation : when a country produces a more narrow range of goods and

services than it consumes

§ This requires trade you must engage in trade to acquire the goods you do not
produce

§ Nations specialise in the production of the goods and services in which they are
relatively low-cost producers

§ International trade is the outcome of specialization among countries

§ Specialisation and trade allows for mutual gains for the people of trading
countries

§ Specialisation and trade may benefit some groups within a country while harming
others for example, those producing goods that compete with imports
Reasons for specialization

§ Two important economic concepts are important in explaining specialisation

§ Economies of scale, agglomeration and other positive feedbacks

– The production of aircraft is subject to economies of scale. The Boeing Plant in Everett,
Washington is the largest building in the world.

– Writing computer code is not subject to economies of scale, but good software is produced in
areas in which a very large number of people are working on similar tasks, sharing information
and innovating.

– There is an accidental quality to this aspect.

§ Differences between regions (comparative advantage)

– The production of clothing requires a lot of labour but not an extensive amount of capital
goods, this suits Mauritius.

– Parts of Canada’s climate and land suites the production and export of wheat.

– This aspect is more closely linked to differential factor endowments.

Economies of scale/Increasing returns

§ Economies of scale: doubling all the inputs to a production process more than
doubles the output.
§ Bigger volumes of output can be produced at lower cost per unit
§ For instance: doubling the amount of land and time used for production would
more than double output

§ Imagine that we all need wheat and apples to survive

§ Two island-nations have 100 hectares each (and are the same in every respect)
– They can be self-sufficient if they both devote half of their land to wheat and
half to apples, total output will be 500 tonnes of wheat and 5,000 apples
– It they both specialize, one in wheat and one in apples, and open to trade,
total output will be 1000 tonnes of wheat and 10 000 tonnes of apples
Different factor endowments

§ Greta lives on Wheat Island and Carlos lives on Apple Island.

– Both islands have 100 hectares of land
– The land on each island is suitable for growing both wheat and apples
– They consume both wheat and apples in order to survive
§ Imagine now that the two producers have different factor endowments:

Production if 100% of time is spent on one good, per hectare of land

Greta (Wheat island) 1,250 apples or 100 tonnes of wheat
Carlos (Apple Island) 1,000 apples or 40 tonnes of wheat

§ Greta is lucky: Wheat Island has better soil (for both crops)
– Greta has an absolute advantage in both crops
– Although Carlos’ land is worse overall for producing both crops, his disadvantage
is less (relative to Greta) in apples than in wheat.
– To see this note that for apples 1250/1000 = 1.25; for wheat 100/40 =2.5
Carlos’ feasible production

Feasible production frontier: The Carlos’ feasible set: He can produce anywhere between the
red line that joins points A and B is origin and the feasible production frontier.
the feasible production frontier for
Carlos. It shows all the combinations
of wheat and apples that can be
produced by Carlos in a year Carlos’s choice: He can choose to produce any
combination on (or inside) the frontier. For
example, he could produce 2,000 tonnes of
wheat and 5,000 apples, as shown by point C.

The slope of the production frontier shows

the marginal rate of transformation
between wheat and apples.

In this example the MRT is 2.5 (10000/4000):

If Carlos wants to product one extra

(marginal) ton of wheat, he will have to
produce 2.5 fewer apples. Therefore a ton of
wheat costs 2.5 apples; the relative price of
wheat to apples will be 2.5.

The relative price of apples to wheat will be

1/2.5 =0.4
Wheat island has an absolute advantage

§ Wheat Island has an advantage in producing both goods

§ Greta’s feasible set includes Carlos’ within it

Greta can produce more of

both goods than Carlos can.
If she only produces a single
good, she can produce
either 12,500 apples or
10,000 tonnes of wheat

Carlos
 Without trade PRODUCTION = CONSUMPTION
§ In the absence of trade, the feasible production frontier is also the feasible consumption
frontier. This is because each person spends time producing only wheat and apples, and can
consume only the amount they produce

§ The shape of the indifference curves represents Carlos’ preferences over wheat and apples.

§ In the absence of trade, Carlos and Greta do best by selecting a point on the highest indifference
curve possible, given the constraint of their feasible production frontier

Greta can consume more of both goods than Carlos because of her superior productivity. We assume her
preferences are the same as Carlos’ (the indifference curves are the same shape). She consumes 6,000 tonnes
of wheat a year and 5,000 apples, as shown by point E.
Relative prices and comparative advantage (without trade)
§ An island has a comparative advantage in producing a good when it is relatively cheaper in their
economy (in the absence of trade).

§ While Greta has an absolute advantage in producing both products, Carlos has a comparative
advantage in producing Apples

§ For Carlos, the marginal rate of transformation between wheat and apples is 2.5: it takes the same
amount of land and labour to produce one tonne of wheat as it does to produce 2.5 apples.

§ For Greta the relative price of wheat to apples on Wheat Island is 1.25. Greta has a comparative
advantage in producing wheat. Her relative price of wheat is lower than on Apple island. If you
were to vising Greta, you would notice that her wheat is cheaper.

§ The relative price of apples is the reciprocal or inverse of the relative price of wheat, so if Wheat
Island has a comparative advantage in producing wheat, then Apple Island must have a
comparative advantage in producing apples.

Apple Island (Carlos) Wheat Island (Greta)

Tons of wheat 4,000 10,000
Number of apples 10,000 12,500
Relative price of wheat 10,000/4,000 = 2.5 12,500/10,000 = 1.25
Relative price of apples 4,000/10,000 = 0.4 10,000/12,500 = 0.8
 Potential gains from trade

§ With autarky: The feasible production frontier is § If they specialise

also the feasible consumption frontier
– Greta can produce 10,000 tonnes of wheat and
§ Total production between the two islands is
– Carlos can produce 10,000 apples
– 2,500 + 6,000 = 8,500 tonnes of wheat
§ So there would more of both goods overall
– 3,750 + 5,000 = 8,750 apples
§ If they can trade, both countries can consume
more of each good
Price convergence

§ Assume no trade costs so the price gap is zero

§ With trade relative prices of wheat and apples will converge
§ What will the new price be? We don’t know exactly with the information we have, but we
can make a general deduction:

§ From Carlos’ point of view

– The (potential) supply of wheat has increased MORE than the supply of apples
– Why? Because Greta has a comparative advantage in wheat, while Carlos has a
comparative advantage of apples
– so the price of wheat relative to apples will go DOWN to below 2.5
§ From Greta’s point of view
– the supply of wheat has increased by LESS than the supply of apples
– The relative price of wheat will go UP for her to something higher than 1.25
§ The price will lie between the prices experienced by the two economies when they are
closed
(Let's assume that price of wheat relative to apples converges at 2)
Without trade
Effect of specialisation and trade

The production frontier But the dotted lines show the

of each economy has not shift of the feasible
changed (solid lines) consumption frontiers due to
specialization and trade.

We assume that the relative price

of wheat after specialization and
trade is 2 (an arbitrary price in
between 1.25 and 2.5)
With trade consumption can diverge from production

§ Specialisation has enlarged the feasible consumption set for both Carlos and
Greta

§ Because both countries are now specializing in the good in which they have a
comparative advantage, the new consumption frontiers are above their
production frontiers

§ For each country, the two frontiers meet at the point at which they do not
trade (at the axis)

§ We can see that specialisation and international trade have led to an increase
in the size of the feasible consumption set for both countries.

§ Note, Greta cannot consume more than the maximum amount of apples Carlos
can produce (10,000), which is why her feasible consumption frontier does not
extend beyond 10,000 apples.

§ The expansion of their feasible consumption sets makes it possible for both
Carlos and Greta to reach a higher level of utility (a higher indifference curve)

§ Trade has been mutually beneficial: the welfare of both has improved
 Consumption after specialization and trade

He then trades with

Greta along the new
relative price line Carlos specializes in apples,
producing 10,000

…. in exchange
for imports
2000 tons of
wheat

He now exports 4,000

apples to Greta …
With bargaining power

§ Suppose that Greta can determine the price of wheat because has more bargaining power
§ Since she is specializing in wheat (her comparative advantage) this means keeping apples cheap: she will
choose a price that increases the amount of apples she receives for each tonne of wheat she sells to
Carlos.
§ Here, we assume Greta has chosen a price of 2.25 apples for a tonne of wheat
§ This means trade and specialisation will increase the utility of both Carlos and Greta, but will increase
Greta’s utility by more

§ At a price of 2,5 apples for a ton of

wheat she would eliminate Carlos’ gains
from trade entirely.
§ At this price Carlos would be equally well
off if he produced his own wheat and
would have no reason to engage in
trade with Greta.
Winners and losers
within and between
Winners and losers from trade specialisation

§ Nations are composed of people with differing economic interests:

workers and capitalists in different sectors

§ They are not like islands with only one person

§ Typically, when countries trade, there are winners and losers within each
country

§ For example when South Africa imports cheap clothes from Bangladesh:

– Workers in South African clothes factories lose

– Consumers of clothes would benefit

US-China Trade War

§ President’s Xi and Trump – negotiating trade issues in Argentina in December

2018
§ Trump agreed that he would leave the tariffs on $200 billion worth of Chinese
products at the 10 percent rate, and not raise tariffs to 25 percent
Assumptions in the US-China model

§ To think about winners and losers from trade we begin with a model of two stylized
countries USA and China, where specialisation is based on factor endowments
§ Only two goods are produced (under constant returns to scale):
– Aircraft (relatively capital intensive)
– Consumer electronics (relatively labour intensive)
§ USA
– An advanced economy with a long tradition of manufacturing
– Capital is relatively abundant
– Has absolute advantage in producing both goods
– Has comparative advantage in producing aircraft
§ China
– Less developed, but has become the world’s second-largest economy by exporting
manufactured goods
– Has an abundance of labour relative to capital
– Has a comparative advantage in consumer electronics production
Conflicts of interest

§ Given these assumptions, when the economies begin to trade

– the US will specialise in aircraft

– China will specialise in consumer electronics

§ Opening trade between the US and China in aircraft and consumer

electronics has the following effects:

– It increases the consumption possibility set for both countries.

– Conflicts of interest emerge between the countries.

– Conflicts of interest emerge within each country.

Conflict of interest between countries

§ The relative price of the two goods affects how the gains from trade are
divided between the countries

§ The usual forces of demand and supply affect the relative price

§ The balance of bargaining power between the two affects the price too

§ Between countries:

– USA will benefit if the relative price of aircraft rises

– China will benefit if the relative price of consumer electronics rises

Conflict of interest within the country

§ Within a country, the beneficiaries of a rise in relative price are those that specialises in producing that
product

§ Trade and specialisation mean that resources shift from one industry to another.

§ In the US
– the increase in production of aircraft means that the US increases the demand for capital, the factor of
production used intensively in that industry
– The owners of capital benefit more from trade than workers, because capital becomes relatively scarce
as production of aircraft rises
– Workers previously employed in electronics in the US must try to find work in the expanding aircraft
manufacturing businesses
– Since the wealthy tend to hold proportionally more of their wealth in capital than the poor, we would
predict a rise in inequality

§ In China
– The demand for labour (used intensively in producing consumer electronics) will rise
– employment will expand in consumer electronics production
– Workers are in higher demand as consumer electronics production expands
– Wages rise as firms compete for workers. Lower unemployment lowers the cost of job loss, and firms
raise wages
– Workers benefit more from trade than the owners of capital, hence we would expect inequality to fall
Impact on employment

§ Trade and specialisation in the US involves transferring labour and capital

from electronics production to aircraft production.
§ In the US, when capital shifts from electronics production to aircraft
production there is a net loss of jobs
– An electronics factory closes, laying off X workers, and an aircraft
factory opens, hiring Y workers. Which is bigger, X or Y?
– The answer: X is bigger than Y, since one unit of capital provides the
tools and equipment necessary to employ more workers in electronics
than in aircraft production (since electronics is relatively labour-
intensive).
§ In China the shift to electronics production means that there is a net gain
in jobs
Net effect

§ Overall net effect depends on growth in size of the economy from

specialisation and trade
§ First Effect
– in the US workers are initially relatively scarce and lose from trade, while
employers gain
– in China workers are initially relatively abundant and gain from trade, while
employers lose.
§ Second effect
– if the overall economy increases in size as a result of trade this could
benefit everyone in the economy and could therefore offset the losses
experienced by the disadvantaged group
 The pie grows and shares of the pie change

US and Chinese
economies with limited With greater
specialisation and specialisation and trade,
trade. the total size of each
To make comparison economy is larger: The
easy, the economies are size of the US economy
normalized to a size of has increased by 30% and
one the size of the Chinese
economy has increased
the numbers in the pies
by 40%.
show both the
proportion and size (in The prices at which they
brackets) of the slice of have traded (as
the economic pie that determined by
accrue to workers (red) bargaining) have resulted,
and the owners of in this case, in China
capital (blue) securing more of the
gains from trade.
 The pie grows and shares of the pie change

US employers, In the USA the owners of

Chinese employers, capital goods (employers)
and Chinese workers now have a larger slice of
are all winners. the US’s larger pie

US workers are US workers’ slice is not only

losers. proportionally smaller (75%
> 55%), but also smaller in
absolute size (0.75 > 0.715)
So even after we take the
growth of the economy into
account, US workers are the
China’s shift into labour-
losers.
intensive electronics has
raised labour’s share of
China’s larger pie, and
reduced the share of profits.
Both capital and labour in
China are, however, better
off with higher specialisation
and trade
the absolute size of the
slices going to workers and
the owners of capital have
both increased (0.5 < 0.84
and 0.5 < 0.56).
Capital flows
International investment flows
48

§ If countries existed in isolation, they would have to finance their

investment needs using their own savings
§ This would mean that they could not spend more than they earn in a
given year
§ In reality, capital flows across borders creating obligations between
countries by individuals, financial institutions, companies, and
governments
§ These obligations can take the form of debt or equity
§ So a country the earns more than it spends will have a surplus of
savings that it can export and earn a return on this investment (e.g.
China)
§ A country that spends more than it earns can finance itself from
foreign savings, but will have to pay interest on these investments (e.g.
South Africa)
Balance of Payments
49

§ Imports must be paid for with foreign exchange

§ Exports generate foreign exchange

§ Balance of Payments records the sources and uses of foreign exchange:

– the flow of goods across borders “the current account”

– The flow of finance across borders “the financial account”

§ Typically SA has:

– A deficit on its current account (the value of imports > the value of exports)

– A trade deficit implies that a country is “borrowing”, accumulating obligations to other

countries

– This would have to be met by a net inflow of finance

– A surplus on its financial account (the value of financial inflows > the value of financial
outflows)

§ In addition to trade finance, savings flow in order to purchase assets – this take the form of
portfolio investment and foreign direct investment.
 South Africa’s Balance of Payments (1985-2018)
50
Net direct investment Net portfolio investment Net other investment
Balance on the financial account Balance on the current account
10%

8%

6%

4%
Percent of GDP

2%

0%

-2%

-4%

-6%

-8%

-10%
1985

1990

1995

2000

2005

2010

2015
 Trends in international asset holdings
51
§ For the rich countries that dominated international lending, the share of foreign assets divided by
GDP was high in the early part of the century, but declined after the great depression and in the
inter-war period

§ After 1945, New York took over from London as the global financial centre and the US eclipsed
Britain as the dominant international asset holder
Migration of people
Migration to the “new world”
53
§ When Europe was experiencing its population boom, as death rates fell sharply and birth rates fell
only with a lag, it was able to ship its surplus population to America and other parts of the world
(e.g. South Africa, Australia)
§ In the late nineteenth century, declining transport costs and rising wages made passage to America
and other parts of the world affordable for millions: immigrants accounted for more than half of
the increase in the US population
Migration has been heavily restricted
54

§ Labour migration is probably the dimension of globalisation along which

international economic integration has advanced the least

§ Immigration barriers became much stricter during and after the First
World War, and rich countries retain strict immigration barriers

§ Labour into and out of some countries is less mobile internationally

today than it was in 1913

§ The movement of goods and finance between countries is easier, and

greater in magnitude, than the movement of people

§ In addition to policy choices, movement in people is complicated by

language and culture.

§ There is no tendency of wages in different countries around the world to

become more similar
Manufacturing wages as a ratio to US manufacturing wages (1975-2012)
55

Norway

Sweden

Germany France

USA

UK
Italy
Japan South
Korea

Portugal
Taiwan

Mexico

Sri Lanka
Immigration and workers
56

§ When new people arrive in a nation they are unemployed, so we might

expect the first impact of immigration to be that it increases
unemployment.
§ This means that immigration also increases the cost of job loss for
residents, because the worker who loses a job is now in a larger pool of
unemployed workers.
§ Workers have more to fear from losing their jobs, and firms will be able
to make employees work effectively at a lower wage.
§ This is not the end of the story.
Short-run and long-run effects of immigration
57

§ Firms are now getting work at lower wages, and so are more profitable. As a
result they will seek to expand production. To do this, they will invest in new
machinery. This will increase labour demand in the rest of the economy, and when
the new capacity is ready, firms will hire more workers.
§ In the short-run impact of immigration could be bad for existing workers in that
country: wages fall and the expected duration of unemployment increases. The
short run may last for years or even decades.
§ In the longer run, the increased profitability of firms leads to expanded
employment that eventually will restore the real wage and return the economy to
its initial rate of unemployment (if no further changes in the situation take place,
like another wave of immigration).
§ As a result, incumbent workers are no worse off. Immigrants are likely to be
economically better off too—especially if they left their home country because it
was difficult to make a living.
The politics of globalisation
Political backlash against globalisation
59

§ In the 1800’s European landowners in countries such as France and

Germany they succeeded in getting governments to impose tariffs on
agricultural imports (Corn laws opposed by David Ricardo)

§ In 2016-19, in the USA, UK and Europe there is a backlash against

globalisation because workers have been losers as China and other
countries have specialised in labour intensive exports

§ Workers losing in developed countries (and antipathy towards migration)

have been the underlying causes of the populist political movements
behind Trump, Brexit, and other European countries

§ There is survey evidence that unskilled workers in rich countries are more
protectionist than skilled workers, but unskilled workers in poor countries
are more in favour of trade than skilled workers.
Glabalisation and anti-globalisation
60

§ Globalisation can undermine itself.

§ Freer movement of capital around the world in search of profit-making

opportunities also allows businesses to seek countries with lax environmental
regulation and low taxation or where workers do not have rights to organize in
trade unions

§ If the losers, whether from the mobility of goods, investment or people, are
ignored, globalisation may turn out to be politically unsustainable in a democracy

§ These concerns have been analysed by Dani Rodrik, an economist, who

developed what he calls the fundamental political trilemma of the world
economy
Rodrick’s trilemma of the world economy
61

A world in which there are virtually

no political or cultural barriers to the
location of goods and investment

Rodrick’s trilemma
three things
all of which are
valued but which
cannot all occur at
the same time

National government that respect Each national government can pursue

both individual liberty and policies that it chooses without any
political equality significant limits imposed on it by other
nations or global institutions
Example: Hyper-globalisation vs democracy
62

§ hyperglobalisation means that countries have to compete with each other for
investment, with the result that wealth owners will seek locations for their
investments in which labour has fewer rights and the environment is less
protected.

§ This makes it difficult for national governments to adopt regulatory standards or

other policies, or raise taxes on mobile capital or highly paid workers, even when
citizens think that fairness requires this.

§ Therefore, implementing hyperglobalisation may be impossible in a democratic

society.

§ The outcome may therefore either be the demise of hyperglobalisation or the

demise of democracy
63
Example of Rodrick’s trilemma in EU
64

§ the political integration of Europe over the last few decades happened, in
part, so that governments could obtain the benefits of free trade, plus
the free movement of capital and labour,
§ while retaining some ability at the supranational EU-wide level to
regulate profit-making in the interests of fairness and economic stability.
§ The obvious problem is how to make sure that this EU-wide or global
governance is democratic as well as technocratic, and to allow voters to
change the system if they don’t like it
Example of Rodrick’s trilemma in South Africa
65

§ Democratic and globalisation, but limit on degree of policy sovereignty?

§ Exacerbated by dependence on foreign savings (capital flows)
§ SA cannot simply nationalize foreign owned companies or SARB without
major negative economic consequences
Trade and growth
Trade and Growth
67

§ What are the best policies for governments to adopt if they seek to promote
long-run growth in living standards?
§ Some argue that it is a choice between two policy extremes:
– Seal the national borders and withdraw from the world economy!
– Let trade, immigration, and investment across national boundaries take place in
the absence of government regulation of any kind!
§ The reality is likely to be more complex
§ The question is how to exploit the contributions of the global economy to a
nation’s wellbeing, while minimizing the ways in which integration into the global
economy may retard it.
Growth-enhancing aspects of greater global economic integration
68

§ Among the growth-enhancing aspects of greater global eco-nomic integration are:

§ Competition:

– Limiting the impediments to trade in goods and services among nations increases the
degree of competition faced by firms in the local economy.

– This means that firms that fail to adopt new technologies and other cost-cutting methods
are more likely to fail and to be replaced by more dynamic firms.

§ The size of the market:

– A firm that can export to the world market has the opportunity (if it can meet the
competition) of selling far more than it could were it restricted to the domestic market.

– This allows lower-cost production, which benefits home-economy buyers, employees, and
owners of these successful firms, as well as external buyers.
Government and integration
69
§ Ways that greater integration into the global economy might require greater government intervention

§ Learning by doing in infant industries

– In addition to economies of scale, another factor contributing to cost reductions is termed learning
by doing.

– Even if the firm never achieves large-scale production, costs of production typically fall over time.

– Tariffs protecting infant industries can give firms the time and possibly the scale of operation
necessary to become competitive.

§ Disadvantageous specialisation

– For reasons of history, some countries may specialise in sectors where there is a lot of potential for
innovation, whereas others specialise in sectors with little such potential.

– Many Latin American countries, for example, slowed growth by specializing in low-innovation sectors
such as natural resource extraction.

– Developing new specialisations may require direct government intervention, including infant
industry protection.

§ Redistribution

– Where global integration creates winners and losers, government is need to redistribution incomes
and balance this process

– Displaced workers need retraining for new employment opportunities created by globalisation
Different routes to development
70

§ There has not been a unique route to economic success during the past 150 years.

§ Early protectionism in Germany and the US:

– These countries developed modern manufacturing sectors behind high tariff barriers that
sheltered them from British competition.

– In the late nineteenth century, the correlation between tariffs and economic growth across
relatively rich countries was positive.

– In particular, higher manufacturing tariffs were associated with higher growth.

– During the interwar period, tariffs were also positively correlated with growth.

§ Scandinavian prosperity through openness:

– These countries have been very open to trade for more than 100 years and have prospered.

– So as to mitigate the fluctuations in household income associated with changes in international

prices, they also have high tax rates to support generous social insurance and subsidies for
retraining.
Different routes to development
71

§ Picking national winners:

– Many East Asian governments have promoted trade while influencing its pattern by favouring
certain industries, or even certain firms, and by directing firms to compete in export markets
whilst providing some protection from import competition.

§ Two directions after 1945:

– On the one hand, countries in East Asia that encouraged their firms to compete in international
markets grew faster than Latin American countries that were more closed to international trade.

– On the other hand, after those Latin American countries reduced their tariffs in the early 1990s,
their subsequent economic growth rates were lower than during the more closed period 1945
to 1980.
Conclusion
72

§ If there is a lesson, it is that success does not depend on whether a country is more or less
integrated into the world economic system

§ Or on more or fewer exports and imports or on a greater amount of international investment

by its firms

§ Success depends on how well economic integration is managed by policies that promote
growth

§ What is the role of economics?

– Economics can help to design and evaluate policies that secure the greatest possible
mutual gains among the world’s people participating in this new dynamic and
cosmopolitan economy.

– Economics can also identify groups whose livelihoods are under threat from the
globalisation process and propose policies to ensure that the gains made possible from
worldwide investment and exchange are fairly shared.