Unit 9 - International Economics

International trade

A firm can grow and increase the size of its market by selling its products abroad. There are different kinds of international trade. - Trade between countries is known as international or external trade, as opposed to trade within a country, which is known as internal trade. - Trade within a trading bloc (such as EU countries among themselves) is known as intraregional trade, whereas trade outside these groupings, such as the US to UK, is interregional trade. (Note the slight but important difference in these prefixes - from Latin intra, inside, and inter, between or among). - Trade is also sometimes analysed as between high-income countries (HIC-HIC), such as Australia to France, between high- and low-income countries (HIC-LIC), such as the sale of Chinese railway equipment to African nations, or low-income countries trading among themselves (LIC-LIC) such as Fijian tourists in Vanuatu. (There is more on this in Topic 5.) Trading across national boundaries can involve extra costs and considerations. These may include the following: - Transport costs may be higher when trading between countries, although this is not always the case. For example, it is cheaper to send goods from Seattle, in the north-west of the USA, to Vancouver, in the south-west of Canada, than from Seattle to Miami, in the south-east of the USA.) - Governments and international organisations may restrict the free movement of products from one country to another, so limiting imports and, in some cases, exports. - Changing currencies to make and receive payments costs money. However, those countries which operate the single European currency do not experience these 'transaction costs' when trading with other members. - Researching developments in foreign markets can be more expensive than keeping up with home markets. Producers have to recognise and adapt to any differences in tastes and customs in foreign markets. - Advertising literature, guarantees and so on may have to be translated into different languages, and any differences in technical and legal requirements must be observed. -The advantages of international trade: Despite the costs of international trade, many firms do buy and sell abroad. This is because they believe that the rewards from international trade exceed its costs. The benefits firms can gain from engaging in international trade include: - access to larger markets, which enables firms to produce on a larger scale and so enjoy the benefits of economies of scale - contact with other countries, which brings information about new technology, product developments and management skills -referred to as technology transfer - access to raw materials that may be more readily or more cheaply available abroad - greater revenue and profit, and the possible reinvestment of those profits. There are advantages to consumers too. International trade brings them products that their own country is unable to produce. Contrary to popular belief, however, this accounts for only a very small proportion of international trade. Most countries import products that they could, and indeed often do, produce themselves. The UK imports and exports cars, for example. What international trade gives consumers is a greater variety of products. It also often gives them lower prices and better quality as a result of increased competition. The main advantage of specialisation and international trade, though, is higher world output and raised living standards.

Comparative advantage - a diagrammatic explanation

Comparative advantage can be illustrated by a production possibility frontier (your textbook calls this a 'trading possibilities curve'). Figure 2.1 shows that Country A has the absolute advantage in both computers and TVs. Its comparative advantage, however, is in producing TVs. The opportunity cost of producing one TV in Country A is two-thirds of a computer, whereas in Country B the opportunity cost of one TV is one computer. In contrast, Country B has the comparative advantage in producing computers. The opportunity cost of producing one computer in Country B is one TV whereas it is one and a half TVs in Country A. Notice that in this PPF diagram the lines are straight, unlike the convex ones you studied earlier in the course. Recall the assumption made above - that all workers are assumed to be equally competent in both areas; that's why the lines are straight. -Problems with the theory: In practice, the benefits of specialisation may be less than the theory of comparative advantage suggests, for several reasons: - The theory is often illustrated using a few countries and products. The real world is far more complex. In reality, comparative advantages are difficult to assess and in any case they are always changing. - The theory does not take into account transport costs. When these are added it may not be beneficial to import a product from a country that has a comparative advantage in that product. You may remember from Topic 1 how technological developments, such as dimension economies of scale, have greatly reduced transport costs; this is now much more significant than it was in Ricardo's day. - It is assumed that it is easy to switch resources from producing one product to producing another. As you saw in Figure 2.1, the lines in the PPF are straight. But, for example, workers may not find it is easy to pick up new skills. - When resources are switched, output may not rise by constant amounts. For example, 10 workers may produce 200 tables but this does not necessarily mean that 20 workers will produce 400 tables. As the best workers are likely to be used first, output may increase more slowly as extra workers are employed. Both the law of diminishing marginal returns in the short run, and the influence of economies and diseconomies of scale in the long run, have to be considered. - The existence of import restrictions may make it difficult for countries to export their products. Differences in countries' economic and bargaining power may mean that exchange rates will favour developed countries at the expense of developing countries. - The theory does not consider external costs and benefits. For example, a country which has a comparative advantage in disposing of toxic waste may decide that the risks involved to its own environment are too great, or countries may feel reluctant to trade with a country with a comparative advantage but a suspect environmental policy. In addition, a country may decide to produce a number of products in which it does not currently have a comparative advantage. This may be because it is supporting new industries which it believes will in the future develop comparative advantages. Some of its industries, including agriculture and armaments, may be considered to be strategic industries. A country may also be concerned about the risks attached to specialisation in a few products. A country that concentrates on the output of a narrow range of products will be vulnerable to any changes in demand or supply problems.

Wealth and income

Income is defined as a flow of money or money equivalent: the most prominent is a wage or salary, but the definition includes receipts from rent, dividends from shares, and interest from savings. Wealth, on the other hand, is a stock of assets owned by individuals and households. Wealth can be divided into marketable and non-marketable wealth. - Marketable wealth consists of those assets that can be bought or sold, such as houses and shares. - Non-marketable wealth covers assets that cannot be bought or sold, such as pension rights. Wealth is unequally distributed in the UK. Wealth can be a source of income; for example, land that is owned can be rented to earn income. So, the two concepts can be closely related. A high income can provide sufficient surplus, after living costs have been discharged, to allow the purchase of assets (wealth), which can then generate further income. It is common in economics to analyse income into subcategories: - Original income is income before government intervention (i.e. before taxation and benefits). - Gross income is original income plus state benefits. - Disposable income is gross income less direct tax and NICs (National Insurance Contributions). - Post-tax income is disposable income minus indirect taxes (such as VAT). - Final income is post-tax income plus notional values added for benefits in kind, e.g. NHS services and state education. In other words, you are assumed to have the income necessary to pay for these if they were chargeable. In this way income distribution and levels of poverty can be analysed in terms of original income, effects of benefits and taxation, and the existence of free-at-point-of-use public services. Additionally, the term discretionary income is used. This is what is left from disposable income after unavoidable living costs have been paid (mortgage or rent, utility bills, etc.). In a sense, it's what you have left to spend on yourself. Table 5.1 shows the distribution of marketable wealth and income in the UK for 2013/2015. It can be seen from this table that distributions of both income and wealth are unequal, and that inequalities in wealth are more pronounced than inequalities in income. - Measuring income and wealth distribution: A Lorenz curve (developed by the American economist Max Lorenz in 1905) can be used to measure the degree of inequality of income or wealth distribution. The horizontal (x) axis measures the cumulative percentage of the population, while the vertical (y) axis measures the cumulative percentage of income or wealth. It is possible to divide the population into decile groups or quintile groups. The bottom decile is the least wealthy 10 per cent of the population. A 45-degree line is drawn to show complete equality. This line would show that 25 per cent of the households own 25 per cent of wealth and 50 per cent own 50 per cent of the wealth. Then the actual distribution is plotted. The further the curve is below the 45-degree line, the greater the degree of inequality. Figure 5.1 plots the distribution of income and wealth in the UK in 2012. The precise extent of inequality can be measured using the Gini coefficient (named after its inventor, the Italian statistician Corrado Gini). This measures the ratio of the area between the Lorenz curve and the line of inequality to the total area below the line. For example, in Figure 10.1 above, the Gini coefficient for income would be the area between the black and green line divided by the triangle below the black line. A figure of 0 would indicate complete equality, while a figure of 1 would indicate complete inequality. The Gini coefficient is also sometimes expressed as a figure between 0 and 100 or as a percentage. A figure of 0 or 0 per cent would again mean complete equality and 100 or 100 per cent complete inequality. The nearer the figure is to 1, or in the second two cases 100 or 100 per cent, the greater the degree of inequality.

Types of trade restrictions

Tariffs, which can also be called customs duties, are the most well-known and common type of protectionist measure. Tariffs are taxes on imports. They can be levied on an ad valorem basis (as a percentage of the value of the product) or on a specific basis (a fixed amount per unit). Tariffs can be levied to protect domestic industries and/or to raise revenue. For instance, the EU's common external tariff is both revenue-raising and protective. However, most tariffs in developed countries are imposed for protectionist purposes. Figure 2.2 shows that the imposition of a tariff (i.e. P to P1) increases domestic output from A to B, reduces imports from AD to BC, but raises the price to domestic consumers from P to P1 and reduces the amount they consume from D to C. The tariff also reduces consumer surplus by WXYZ amount. Of this, W is converted into producer surplus and Y into tax revenue. However, X and Z are a deadweight loss: that is, a loss of consumer surplus that does not go to any other group - it just disappears. You may be wondering why the world supply curve is a straight line, i.e. perfectly elastic supply in economics terminology. The reasoning behind this is that as a world supply there are so many suppliers that the addition or subtraction of some suppliers is not enough to have any appreciable effect on the overall supply, so the link between supply and price ceases to exist. This may well not be the case in the real world. In 2016 supply problems with the core element of chocolate in Brazil - just one supplying economy - raised the prospect, terrifying to chocoholics, of a substantial rise in the price of chocolate. As you are aware by now, assumptions in economic models often do not reflect situations in the world around us. Tariffs can contribute to inflationary pressure since they raise the costs of foreign raw materials, increase the price of finished imported goods and lower pressure on domestic producers to keep their prices low. Another well-known type of protectionist measure is a quota. This is a limit on the quantity of a product that is allowed to enter a country. A quota is usually enforced by means of a licence. It does not earn revenue unless the licence is sold. Imposing a quota will raise prices if it means that imports are then in short supply. This is more likely to occur if domestic consumers and producers are reluctant to switch to home-made products and raw materials. (Figure 8.8 in your textbook provides a graphical representation of the effects of imposing a quota.) Exchange controls have also been used to reduce expenditure on imports, but this is now a less popular measure. Under a system of exchange control, the government restricts the availability of foreign currency in line with the level of imports that it thinks the country can afford. Importers have to apply for foreign currency to pay for their imports. A government may also use an import deposit scheme. This requires importers to deposit a sum of money with the central bank in order to import a product. Its aim is to make importing more time-consuming and expensive as it ties up importers' money. The most extreme form of import restriction is an embargo, which is a complete ban on the import of a product or of trade with a particular country. Domestic subsidies are currently widely used to promote exports and, indirectly, to reduce imports. By lowering the price of domestic products, subsidies make them more price-competitive in comparison with foreign-produced products. Other types of import restriction that have grown rapidly in recent years include voluntary export restraints (VERs), purchasing policies, administrative restrictions and technical standards. Countries can agree to set a limit on how much they sell to each other of a particular product. A country's government may also give preference to domestic firms when it makes purchases and awards contracts. Administrative procedures can be time-consuming, and artificially high health and safety standards may be set. For instance, foreign exporters and domestic importers may be required to fill in an unnecessarily large number of forms, or goods may be held up for long periods at customs points. Imports may also be expected to meet standards that are difficult and expensive to achieve, and that are not required of domestic producers.

The UK balance of payments

The UK's balance of payments consists of three accounts: - the current account - the financial account - the capital account. The current account is the most well-known and widely publicised account and consists of four elements: trade in goods, trade in services, income and current transfers. - Trade in goods is a record of income received from exported goods and income spent on imported goods (often known as visible trade). - Trade in services is a record of export income and import expenditure for services, or invisible trade. These two taken together constitute the balance of trade. - 'Income' is income from investment overseas, e.g. profits earned by a country's business activity in other countries (e.g. Tesco's profits from its supermarkets in Asia), less income generated in the country from businesses owned overseas, such as Nissan's profits from its car-making activity in the UK. - 'Current transfers', as its name suggests, refers to transfers of money into or out of a country, such as fees and contributions to supra-governmental organisations like the EU, and EU grants for projects in a member country. The financial account is much more important for the UK and involves much larger flows. It records the flows of direct and portfolio investments, such as the purchase of Italian shares by a UK national (debit item) and the purchase by a German car company of a UK car company (credit item). Remember: - a foreign direct investment (FDI) involves establishing a direct business interest in another country, e.g. buying a manufacturing business - a foreign portfolio investment (FPI) refers to investment in financial assets, e.g. stocks, in another country. Transactions in the financial account give rise to investment income in the form of interest, profits and dividends, which appear in the income section of the current account. As an example of a financial account inflow, if the construction of the Hinckley nuclear power plant goes ahead (it received government approval in September 2016), the substantial investment contribution from China which is part of the deal, will be a credit item in this account. The capital account is not of great significance to the UK's balance of payments. It includes transactions that involve the transfer of fixed assets, such as land, trade in non-financial assets such as copyrights, and funds brought into the country and taken out by migrants. The balance of payments is so called because it is, ideally, expected to balance. The sum of credit and debit items on the first three accounts should come to zero. A deficit in the current account (the usual situation in the UK economy) should be offset by a surplus in the financial account (as has usually been the case in the UK). One of the anxieties that arose as a result of the vote to leave the EU was that foreign direct investment into the UK (FDI) might fall, meaning that the current account deficit could not be financed, and so overall the balance of payments would not be a balance. In practice, in drawing up the national accounts mistakes are made and some items are not recorded. To cover this, an entry is made for net errors and omissions. -Trends in the UK balance of payments: Since 1982, the trade in goods account (the largest and most volatile component of the current account) has been consistently in deficit. The trend throughout the period was for the deficit to get larger, increasing from £13.7bn in 1996 to £96.2bn in 2015 (but note that these are nominal values, i.e. inflation isn't taken into account). Since 2011 the deficit has been on an increasing downward trend. Emerging economies have become more adept at producing goods efficiently, and so these imports have gained an advantage over UK domestic products as consumer choice. A further reason for the deterioration has been the relatively high value of the pound sterling against the US dollar and the euro, which made UK imports relatively cheap and UK exports relatively expensive. The pound, however, fell in value against these currencies after the EU referendum in June 2016. It seems that export sales increased, but at the time of writing (November 2016) it is too early to say if the deficit will become smaller as a result of the 'Brexit' vote. In contrast, the trade in services account has shown a surplus for every year since 1966. The surplus increased from £14.3bn in 1996 to £90.3bn in 2015. The UK has a good record in exporting services, and is the second largest earner in the world from the sale of services, after the USA.

The UK does not expect to record a trade in goods surplus. The size of the growth in the trade in goods deficit in recent years has alarmed some economists. It is, however, important to consider both the cause of the deficit and its impact on the current account position. For instance, a sharper slowdown in global growth than in the domestic economy would be expected to result in a growing trade deficit. 1. Explain what is meant by a 'trade in goods surplus'. 2. Why would 'a sharper slowdown in global growth than in the domestic economy' be likely to increase a trade deficit? 3. Does a trade in goods deficit necessarily mean a current account deficit?

1. A trade in goods surplus means that export revenue exceeds import expenditure. 2. A sharper slowdown in economic growth in other countries than in the UK may increase a trade deficit because it may result in a fall in UK exports relative to UK imports. If other countries' outputs and incomes are growing more slowly, their demand for finished products and raw materials from the UK will also tend to rise more slowly. In contrast, the more rapid growth in the UK will be likely to cause UK imports to rise more quickly. 3. The trade in goods account is the largest component of the current account and so has a major influence on the current account balance. However, while a deficit on the trade in goods account may result in a deficit on the current account balance, this is not necessarily the case. This is because the deficit may be offset by a surplus on the trade in services and income accounts.

In the last decade the cost of producing cotton in the USA was three times as great as in West Africa's four main cotton producers, Burkina Faso, Mali, Chad and Benin. Despite this difference in costs, US cotton sold on the world markets at a lower price than West African cotton because of subsidies given to US cotton farmers by the US government. Without the subsidies, US cotton farmers would have made a loss while West African farmers would have made a profit. The impact of the subsidies is a significant issue for West African farmers, as cotton production plays a key role in their economies. For example, it accounts for nearly 70 per cent of the exports of Burkina Faso and provides incomes for more than a quarter of its population. The World Trade Organisation has ruled that the subsidies are illegal, but the USA continues to provide them. 1. Explain one advantage and one disadvantage of Burkina Faso specialising in cotton production. 2. What action could the WTO take against the USA for subsidising its cotton farmers? Would this action be likely to be effective? 3. Discuss two benefits the US economy might experience as a result of the removal of its cotton subsidies.

1. One advantage of Burkina Faso specialising in cotton production is that its farmers could take advantage of external economies of scale. A large cotton-producing sector may make it worthwhile for ancillary industries to develop to provide cotton farmers with the equipment they need and for specialist markets to be created for the sale of cotton. Reaping economies of scale should help farmers to compete against cotton farmers from other countries.A disadvantage of Burkina Faso specialising in cotton production is that the country will become more vulnerable to adverse changes in demand and supply conditions. A sudden fall in demand, for instance, could reduce income and employment significantly and to a much greater extent than in a country with a more diversified industrial structure. This situation is sometimes called primary product dependency. 2. The WTO has already stated that the subsidies are illegal and could give permission for the West African countries to impose tariffs on US products. Such a move is unlikely to be effective. This is because West Africa is a very small market for US products and so US producers will not be concerned about losing sales there. 3. The removal of cotton subsidies should create a more efficient allocation of resources in the USA. Resources would move from cotton production, which the USA is not efficient at producing, towards other products which the USA is good at producing, such as film. This is a good example of a response that follows from economic theory, but which may have little value in reality because cotton producers may well have substantial geographical and occupational immobility. (In the 1980s the American film industry produced several telling movies about the increasing difficulties of agricultural life in a changing economic environment, such as Places in the Heart (about a cotton farm) and The River.)A more efficient allocation of resources would result in the USA exporting more and experiencing higher income and employment.Providing subsidies to cotton farmers involves an opportunity cost. If the subsidies are ended, the US government may spend more on education, healthcare and training, which could increase labour productivity, wages and living standards.

Growth, development and capitalism: effects on equality and poverty

A core feature of the theory of how economies grow and develop is 'trickledown' whereby the stimulus of increasing income (through improved terms of trade, overseas aid, MNC investment or shrewd government fiscal policies) should create employment opportunities; new economic activity in turn generates tax revenue. The rise in employment offers opportunities for people to escape from poverty, and this earned income will have a multiplier effect, so that prosperity gradually spreads throughout society. Similarly, the tax revenues generated can be used to enhance health and education infrastructures, and so alleviate poverty; in addition, benefit systems can be established. In this way, the wealth creation initiated by entrepreneurs reaches lower deciles and inequality is lessened. This is not just a theory applied to developing LICs: trickledown was quoted often as an intended feature of government policy in the UK in the 1980s, especially when the higher rate of taxation was reduced from 60 to 40 per cent, with no corresponding large cut in the basic rate. Supporters of this fiscal move argued that increasing the post-tax income of higher earners, who are more likely to be in managerial and entrepreneurial positions, would enable them to invest further in productive opportunities, and so create new businesses, innovative products, and new jobs; hence those with the appropriate skills are enabled to generate income-earning opportunities for others. However, capitalism as an economic system incorporates structures that are inherently opposed to this altruistic generation of equality. In essence capitalism holds that the means of production are created by financial capital provided by individuals, who therefore own those means of production. In return they expect profit as a compensation for their expenditure on this capital. There is nothing inherent in the system to regulate the extent to which that profit may be expropriated from the system. As David Ricardo pointed out, amplified as a fundamental criticism of capitalist labour by Karl Marx, the creation of wealth for the capitalist is the value produced by the labour employed. However, the return to labour need only be large enough to sustain that worker in employment, which, in terms of possible negative connotation, could be called a subsistence wage. However, this represents only a portion of the value of what is produced; the remainder, the 'surplus value' as the model is called, goes to the owner of the means of production. In terms of self-interest it would be reasonable to expect the owner of capital to seek to maintain this relationship. Since the time of Ricardo and Marx, capitalist economies have developed worker organisations, pressure groups and government policies to create a more balanced share of the value of production. The effect of this long-term process can be illustrated by a simple diagram, the Kuznets curve shown in your textbook, which was first drawn by the American economist Simon Kuznets. In a less developed income with low incomes overall, there is a high level of inequality (the Gini coefficient is a low number), as, according to an earlier quotation, nothing is easily distributed equally. If an economy develops using a capitalist base, greater income accrues to the entrepreneurial class than to those who are employed. As economies move toward middle-income status, inequality rises and the Gini coefficient Is a larger number. This may perhaps be seen in the case of South Africa, currently the country with the highest Gini coefficient (on one analysis, close to 7). South Africa has moved from being a low-income country to the middle-income bracket. However, as trickledown begins to take effect, as governments become sophisticated enough and rich enough to set up redistribution systems, and as labour representation gains strength, inequality falls. So, as a measure of inequality, the Kuznets curve rises, then falls.

Fixed exchange rate system

In contrast to a freely floating exchange rate, a fixed exchange rate is maintained at a certain level by a central bank buying and selling currencies as appropriate. For instance, if the supply of pounds were increasing, the Bank of England would buy pounds to keep the value of the pound stable. Figure 3.7 shows that the rate is fixed by the government at PX. However, free market demand (DD) and free market supply (SS) would establish an equilibrium price below the desired rate. The central bank would then intervene and buy pounds, so increasing demand to D1D1 and raising the price to the desired level. A fixed exchange rate, as its name suggests, does not alter from day to day. Any changes will be infrequent and will be the result of deliberate government action. For instance, a government may decide to revalue its currency and will announce that each unit of currency will exchange for fewer units of another or other currencies. A formal lowering of the exchange rate is called devaluation. The opposite process, by which the value is formally raised, is termed revaluation. Note that these are formal processes brought about by deliberate government action, unlike the appreciation and depreciation of the currency mentioned earlier. There are two main advantages to a fixed exchange rate: - It encourages trade, as traders will not be afraid of losing money because of exchange rate changes. - A country will have to take measures to solve an unacceptable level of inflation as it cannot rely on falls in the exchange rate to restore its competitiveness. However, there are also disadvantages: - If the rate is set above or below the long-run equilibrium position, pressures can build up. For instance, a government cannot indefinitely buy its own currency as it will run out of reserves of foreign currency. - When a government adjusts the exchange rate it may not make the right adjustment. For example, a revaluation may be to too high a level. - To maintain an exchange rate, a government may use trade restrictions or deflationary policies that could have an adverse effect on employment and growth. - Holding reserves involves an opportunity cost - they could be used instead to finance additional consumption or investment. A country operating a fixed exchange rate system has to decide at what level to set its exchange rate. As already noted, the rate cannot be significantly out of line with the equilibrium level. A well-known example of a fixed exchange rate is the £/$ agreement at the Bretton Woods conference in 1944. Initially the rate was $4 to £1, but in 1949 the British government devalued its currency, so that £1 = $2.80. A further devaluation occurred in 1967, taking the pound down to £1 = $2.40. This fixed rate system was abandoned in 1971. -The primary effects of changes in the exchange rate: A fall in the exchange rate is likely to improve the country's balance of payments position, provided that the Marshall-Lerner condition is met. The rise in demand for UK products is likely to raise employment and economic growth. However, the fall in the exchange rate may raise inflation as the price of imported finished products and raw materials will rise, and the pressure on domestic producers to keep prices low will be reduced. In contrast, a high exchange rate may reduce inflationary pressure as it will give low import prices and high export prices. (The latter might have the secondary effect of encouraging efficiency drives in domestic industry to counteract the higher export prices, i.e. supply-side reform.) Imports count in the calculation of a country's inflation rate, but its exports do not, so prices are reduced directly, and also possibly indirectly, by forcing domestic producers to cut costs in order to remain competitive. However, a high exchange rate may have an adverse effect on a country's balance of payments, inward direct foreign investment (FDI), employment and growth. There is a sentimental belief that a high-value currency is good for an economy, but this may not be the case. When, in September 1992, the value of the pound fell by 4.1% as a result of the UK leaving the Exchange Rate Mechanism of the EEC, Chancellor Norman Lamont announced publicly that on that evening he was singing in his bath.

Why may sending work abroad cause the wages of low-skilled workers to fall?

The type of work sent abroad from the UK is likely to be low-skilled work. If this is the case, there will be a reduction in demand for low-skilled workers which will result in downward pressure on their wages. The ability to carry out low-skill tasks abroad more cheaply may, however, free up domestic labour to be used in areas of greater value

What is globalisation?

The term globalisation refers to the development of a world market with the breakdown of national barriers to the movement of goods, services, finance, capital, and, to a lesser extent, labour. There is no single definition. Your textbook defines globalisation as: A process by which the world's economies are becoming more closely integrated. Another possible definition (Grant & Vidler, 2004) is: The development of the world into one marketplace. And a third: The processes that have resulted in ever closer links between the world's economies. Notice that two of these definitions refer to 'process' and 'link' or 'integration', i.e. an evolving phenomenon in which individual economies become less individual and more parts of a whole. However the second definition focuses on the product aspect of globalisation: the increasing harmonisation of products and of tastes. A potent image appeared in a British newspaper during the second Gulf War: a large film poster adorning the wall of a Baghdad cinema - for a Hollywood action movie. Trade in goods and services has grown rapidly, and multinational companies (MNCs) have been setting up production bases in foreign countries for many years. This increased integration of markets, featured in the definitions above, heightens the interdependence of economies. Many MNCs now not only have production bases in other countries, they also act transnationally. They are willing to break down their productive process and locate its stages in a number of countries, wherever they can be carried out at the lowest cost. This is called offshoring. For example, the Ford Motor Company manufactures in Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, India, Japan, Mexico, Romania, Russia, Slovakia, South Africa, Spain, Taiwan, Thailand, Turkey, the UK, the USA, Venezuela and Vietnam. However, the fact that production in Australia Is shortly to cease also shows that the global economic situation is in constant flux. As well as offshoring, MNCs are also now willing to engage in outsourcing abroad. This involves subcontracting part of the production process to a different firm operating in another country. In addition, MNCs seek out finance in the most efficient markets, try to place their profits in the lowest-taxed countries and market their products internationally. Consumers throughout the world are increasingly being exposed to international brands and are finding it easier to buy these brands from MNCs in their own countries and from abroad. Migration of workers, largely within regional trading blocs, has also increased. The increased integration of product, financial, capital and labour markets means that events in one economy can have repercussions throughout the world. The more significant the economy, the greater the effects are likely to be on other countries. The credit crunch which started in the USA in 2007 quickly developed into a global financial crisis which caused a downturn in world output. The chain of events seemed to confirm the old saying that when the US sneezes, the rest of the world catches a cold. The global effects of the withdrawal of the UK from the European Union are under consideration at the moment. For example, it was reported recently that Australia, about as far geographically as one can get from the UK, has made enquiries to the UK government about trading possibilities. -The causes of globalisation: The main factors contributing to globalisation are trade liberalisation, advances in technology, the growth of MNCs, increased capital mobility, increased skill levels throughout the world and reduced transport costs. In recent years there has been a move towards lowering tariff and non-tariff barriers on goods and services as more countries have been adopting free market policies, and the World Trade Organization (WTO) has been urging countries to reduce protectionist measures. This has made it easier for firms to sell products throughout the world. Advances in technology are thought to be a particularly significant force behind globalisation. Developments such as the internet and email are making it easier for consumers to obtain information and to order from firms throughout the world, and for firms to coordinate their production and to market on a world scale. As mentioned above, the growth of MNCs is also contributing to the increased integration of markets. These firms are not only operating in a greater number of countries, they are also increasingly prepared to shift their production to where their interests are best served, for example by changes in comparative advantage (a theory of trade determination that will be analysed later in this topic). The reduction in restrictions on the movement of portfolio and direct investment, such as the removal of exchange controls, has increased the ease with which firms can raise finance and operate transnationally. Rises in skills levels throughout the world, particularly ICT and English language skills, are enabling firms to consider more areas in both developing and developed countries in which to base their production and parts of their productive process. For example, many MNCs located their call centres and other back-office operations in India, the Philippines, Vietnam and a number of other relatively low-cost countries. (Those familiar with the film The Best Exotic Marigold Hotel or its source novel, These Foolish Things by Deborah Moggach, may recall this point.) However, in globalisation nothing seems permanent and some of these call centres have returned to their home country. Falling transport costs, resulting from the use of larger lorries, aeroplanes and ships, and more efficient handling, is making it easier for firms to operate transnationally and is making international trade more profitable. This is an example of technical economy of scale (Unit 6, Topic 3). An increase in the surface area of a container (that which involves a cost) produces a proportionally greater increase in volume (which generates the revenue). This is sometimes labelled as a dimension economy of scale. The causes of globalisation are interrelated. For example, increasing skill levels throughout the world and advances in information technology are making capital more mobile.

The World Economic Forum's Global Competitiveness Report rates 134 countries according to their international competitiveness. It assesses them in 12 categories, including the quality of their institutions, innovation, labour and product market flexibility and macroeconomic stability. Table 4.1 on the next page shows the top 16 in the 2016 rankings. China does not appear in the top 16 (it Is 28th) but its recent economic slowdown is mentioned in the report. India also did not make the top 16 but at position 39 is the highest in the South Asia group, and its progress, especially in infrastructure provision, is noted. The UK, 7th in this survey, is in 18th place in the IMD survey. 1. How many of the countries in the top 16 are: a) members of the EU? b) European economies? c) Asian economies? d) African economies? 2. Why does macroeconomic stability promote international competitiveness? 3. Apart from improving macroeconomic stability, explain one way a country could move up the table. 4. Why was the UK in different positions in the WEF and IMD tables in 2016?

a) Six: Netherlands, Germany, Sweden, UK, Finland Denmark b) Eight: the six EU countries plus Switzerland and Norway c) Four: Singapore, Japan, Hong Kong and Taipei. (Note that Hong Kong and Taipei are currently still being treated as a separate economy from China in some statistical returns.) d) None 2. Macroeconomic stability - a stable rate of economic growth and a stable inflation rate - creates reduced uncertainty, which in turn tends to promote investment. New capital goods often embody more advanced technology and may mean that the capital:labour ratio increases. Both factors may reduce firms' costs, which may lead to lower prices and raise the quality of the products produced.Lower prices and higher quality increase international competitiveness. 3. Increasing labour market flexibility would move a country up the table. A rise in the mobility of labour, a willingness of workers to work flexible hours, and the ease with which firms can hire and fire workers, should make firms more responsive to changes in demand and should reduce their costs. 4. The UK was in a different position because the two organisations use different criteria to assess the international competitiveness of countries.

Over the period 1998 to 2008 income inequality increased in a range of Asian countries including Cambodia, India and South Korea. The most noticeable rise was in China, a country which is trading increasingly with developed economies including the USA. Its Gini coefficient reached 47.6. (Table 5.3 shows the Gini coefficients for a number of Asian countries and other countries of the world.) The two key causes of this rise in inequality were a growing gap between the incomes earned in the primary sector and the other two sectors (secondary and tertiary) and between skilled and unskilled workers. Incomes were increasing more rapidly among those working in manufacturing and services than those working in agriculture. Some high-skilled workers are now earning very high wages. Although income has become very unevenly distributed, the number of people in China living on less than $1 a day fell from 26 per cent to 9 per cent in 2008. 1. Explain what is meant by the Gini coefficient. (2 marks) 2. Why may the wages of agricultural workers have risen more slowly than those in the other sectors? (3 marks) 3. Apart from the reasons given in the passage, explain another possible reason why China's coefficient may have increased. (2 marks) 4. Using Table 5.3, discuss whether Asian countries experience a greater degree of income inequality than the USA. (4 marks) 5. What does the passage suggest has happened to absolute and relative poverty in China in recent years? (3 marks) 6. Discuss what effect globalisation may have on absolute and relative poverty in developed countries. (6 marks)

1. The Gini coefficient is a measure of the extent of income inequality. It is often expressed as a figure between 0 (representing complete equality) and 100 (representing complete inequality with one person receiving all the income). 2. The wages of agricultural workers may have risen more slowly than those in the other sectors because the demand for the labour of agricultural workers may have increased more slowly than that for manufacturing and service workers. The lower demand, in turn, may have been the result of a smaller increase in the demand for some agricultural workers or a smaller increase in the demand for some agricultural products, and because of population growth in rural areas outstripping that in urban areas (for example, because of less access to and understanding of birth control techniques). 3. Another reason why China's Gini coefficient may have increased is that unemployment may have increased in China despite a higher growth rate in the economy. Higher unemployment in a relatively successful economy will widen the gap between the rich and the poor. 4. In 2008 three of the Asian countries shown (Malaysia, China and Cambodia) had a higher degree of income inequality and three others a lower degree of income inequality than the US (India, South Korea and Japan). It is interesting to note that the two Latin American economies had a higher degree of income inequality. The data only shows a small selection of countries and is only for one year. 5. The passage suggests that absolute poverty has fallen while relative poverty has risen. The passage mentions that the number of Chinese living on less than $1 a day has fallen while the Gini coefficient has increased. 6. The effects of globalisation on absolute and relative poverty are uncertain although it is generally thought that it reduces absolute poverty while increasing relative poverty in some countries. Globalisation should reduce absolute poverty as the forces which drive it, including advances in technology and increasing international trade, should raise world output and income. In a number of developed countries it is thought that globalisation is increasing the gap between the wages of skilled and unskilled workers. The skilled workers benefit from a larger market while the unskilled workers lose out as more products made by low-skilled workers are purchased from lower-cost countries and as more low-skilled workers are outsourced abroad. The tendency to increase income inequality will be reduced once more training can be given to the low skilled and the more occupationally and geographically mobile they become.

Explain why a government may want to keep its exchange rate 'artificially low'.

A government may want to keep its exchange rate 'artificially low' in order to prevent its export prices rising and its import prices falling. A low exchange rate can result in rapidly rising exports and hence in a current account surplus and high employment and growth in the short term and, if this is maintained, in the longer term.

Other effects

Globalisation can also result in environmental costs and some loss of national identities. MNCs may be attracted to locate in countries with inadequate environmental standards and, as with taxation, increased international competition can put downward pressure on environmental regulations. The increased spread of western culture through films, TV programmes, global brands, tourism and internet sites is posing a threat to some countries' native culture. It may be partly to counter this effect that the World Trade Organization allows member countries to restrict audiovisual imports and subsidise their own media industries. As markets become more integrated and economies more interdependent (we will look at this further after Activity 2), some economists are arguing for the need to develop global institutions that can regulate the behaviour of MNCs and national government and trade bloc macroeconomic policies, including taxation systems and trade policies. They claim that the World Trade Organization, the International Monetary Fund (IMF) and the World Bank were not designed to cope with a global economy and are not best suited to do so without significant reform as they are dominated by the US and, to a lesser extent, the European Union (EU).

Topic 3 - Balance of payments and the exchange rate

In Topic 2 you saw that one motive behind import restrictions may be to improve a country's balance of payments position. In this topic you will consider the components of, and trends in, the balance of payments, and examine three main policy remedies for a balance of payments disequilibrium. You will also explore exchange rate systems, the factors that influence exchange rates and the effects of changes in the exchange rates. Before starting this topic it would be useful to refresh your knowledge of the composition of the current account of the balance of payments, a current account deficit and the effects of a current account deficit (Unit 4 Topic 1), supply-side policies (Unit 5 Topic 3), fiscal policy (Unit 5 Topic 3) and the balance of payments (Unit 4 Topic 1 and Unit 5 Topic 3)

Topic 5 - Inequality and poverty

In this topic you will explore both income and wealth distribution, and the related issue of poverty. You will examine why wealth is often unevenly distributed, the causes of poverty, and government policies designed to influence income and wealth distribution and reduce poverty.

Summary for Why trade?

In this topic you have explored the nature of international trade and the advantages and disadvantages of countries specialising. You have also examined the different forms of trading blocs, the causes of conflicts between trading blocs, and the role of the WTO. In addition, you have considered the different types of trade restrictions and the arguments for imposing them. The key points are as follows: - International trade differs from internal trade in a number of respects, including dealing in different currencies and languages. - China is a becoming a major exporter and importer. The main benefit of free trade is higher world output, which generates higher world incomes. - Trade is explained by comparative advantage. A country has a comparative advantage in the production of a product if the product has a lower opportunity cost than it does for the country's trading partners. - Specialisation may not be beneficial as might be expected because of, for example, transport costs and the risks of adverse changes in demand and supply. - The four main forms of trading bloc are free trade areas, customs unions, common markets and economic unions. - The essential difference between a free trade area and a customs union is that members of a customs union impose a common external tariff on non-members, while members of a free trade area decide on their own policies towards trade with non-members. - Members of the eurozone, an example of monetary union, share the same currency, the euro, and have their interest rate set by the European Central Bank. - Participating in the single currency reduces a country's autonomy over monetary policy. The interest rate set by the ECB may not always be at an appropriate level for a particular country's economic needs. - Among the benefits claimed for a single currency are a reduction in transaction costs, transparency and an improved allocation of resources. - The WTO seeks to encourage trade liberalisation. It presides over rounds of trade negotiations and provides a dispute settlement procedure. - Measures used to protect domestic industries include tariffs, quotas, exchange control, subsidies, embargos, administrative restrictions, purchasing policies, import deposit schemes and voluntary export restraints. - Import restrictions may be used to help infant, declining or key industries, to prevent dumping and to protect industries from unfair competition. - General import controls may be used to raise revenue, improve the terms of trade, correct a balance of payments deficit, improve the industrial structure of a country, and thereby increase employment and growth, and to meet the conditions of membership of a trading bloc.

Identify three key features of globalisation.

Three key features of globalisation are the rapid growth of world trade, increased capital mobility and trade liberalisation.

Poverty

Poverty is an important aspect of inequality. Poverty can be discussed in terms of absolute poverty and relative poverty. - Absolute poverty arises when people lack basic necessities. Economists sometimes speak of the five basic needs: water, food, clothing, shelter, warmth (there are other lists). The current World Bank figure is less than $1.90 per day. - Relative poverty is when people are poor in relation to other people in the same country. In the UK, households are regarded to be living in poverty if they are receiving less than 60 per cent of the median household income. (Notice median, not average; the figure in 2016 for the UK is £25 700, so 60 per cent of this is £15 420.) The standard measure of poverty used in the UK is a relative one whereas the standard measure used globally is an absolute one. In the UK, some economists and politicians also refer to severe poverty as occurring when people are living on less than 40 per cent of median income. Both this and the standard measure are relative measures: as median income rises, the 'poverty line' also rises. Poverty becomes more of a problem the longer people experience it. The UK government defines persistent poverty as living on an income below 60 per cent of the median income for at least three out of the last four years. The status of countries is established by the World Bank. Countries are allocated into one of three bands according to annual per capita Gross National Income (GNI): - Low Income Countries (LIC): GNI of $1045 or less - Middle Income Countries (MIC): $1046-$12735 - High Income Countries (HIC): $12736 or over. The United Nations (UN) uses an indicator known as the Multidimensional Poverty Index (MPI), first issued in 2010. This is calculated on the basis of ten determinants of poverty, in three categories: education, health, living standard (e.g. sanitation, safe drinking water). In 2016, the region with the worst poverty is South Sudan, where 99% of the population are multi-dimensionally poor.

Topic 4 - International competitiveness

Topic 4 explores international competitiveness in more depth. In this short topic you will assess the competitiveness of UK industry in both home and overseas markets, explore the UK's changing international competitive situation, and consider how UK governments have taken measures to enhance competitiveness.

Arguments for selective import restrictions

Selective import restrictions are limits set on the import of particular products. A number of arguments are advanced for such restrictions. One fairly widely accepted argument is to support infant industries, also known as sunrise industries. The idea is that initially a new industry, especially a capital-intensive industry, may have high unit costs before it can grow large enough to take full advantage of economies of scale. While it is growing it may need protection from foreign competition. However, there is a risk that the industry will become reliant on the protection and will lack the incentive to become more efficient. If protection is given to an industry that will never be able to survive without it, resources will be wasted on propping it up. At the other end of the age cycle, declining industries, also known as sunset industries, may be protected. Again, the intention is not to protect the industry permanently but gradually to remove protection. In the case of a declining industry, protection would be reduced as the industry sheds its labour. Without initial protection, the industry might go out of business quickly, causing high unemployment. With protection, the industry could decline gradually with employment falling through natural wastage such as retirement and transfer to other industries. Another common argument for protecting some industries, and one accepted by the World Trade Organization, is to prevent dumping - the sale of products in foreign markets at prices below the cost of production. Initially, consumers in the home country may benefit from the lower prices dumping brings, but if a foreign producer gains a monopoly position by eliminating the home producer, it may later raise its prices. Both domestic producers and consumers would then lose out. China, in its rapid development as an emerging market, has come up against a number of accusations of dumping. Dumping is seen as a form of unfair competition. Another example of unfair competition is when a country gains a price-competitive advantage by operating lower labour and environmental standards than other countries. For example, a government may suggest that import restrictions should be imposed on the products produced by a foreign industry that makes widespread use of child labour. It is also argued that certain key, strategic industries should be protected in order to ensure the supply of products essential for the running of the economy or the defence of the country. An example is the EU's protection of its agricultural industry, designed to ensure adequate food supplies for the trading bloc. (This arises from the uncertainty and anxiety about food supply in Europe during World War II, when the idea of some kind of trading and economic organisation in Europe first emerged.)

Conflicts between trading blocs

Trading blocs can wield considerable power, and disputes can arise between powerful trading blocs. In recent years there have been a number of disputes between the EU and NAFTA. The EU has complained about America's system of tax subsidies for its exporters. In turn, NAFTA has protested about EU restrictions on imports of its genetically-modified crops and its beef. The USA objected to the Lomé Convention. There is always a risk that trade disputes can escalate into trade wars, with rival trading blocs raising their import restrictions in retaliation. Import restrictions may even be imposed in order to be used as bargaining tools in trade negotiations.

Terms of trade

Terms of trade is a ratio comparing the export prices paid by a country with the price it has to pay for its imports. The prices of exports and imports are averaged, as expressed as an Index number, with a base year. As a calculation, it's: average price of exports / average price of imports Note that terms of trade is a ratio of prices, not quantity - so positive terms of trade (i.e. where the price received for exports exceeds the price paid for imports) does not necessarily mean that a country has a positive balance of trade. A country may have high-priced exports, but sell relatively few of them, while importing large quantities of inexpensive goods. A country's terms of trade, in basic economic analysis, depends on the supply and demand conditions, which are the basic determinants of price. However, a number of other factors need to be considered, namely: - the country's ability to market its goods in the context of how much competition it faces - the price elasticity of demand - for example, until the recent collapse of oil prices, it would be reasonable to assume that the relative inelasticity of demand for petroleum-based products meant that a high price could be charged for them, helping oil-producing countries to have positive terms of trade - the possible effect of tariff measures. A country's state of development and its factor endowments will usually have a significant effect on this ratio. Less developed countries often rely for their foreign currency on primary product exports; if there is a global glut, their import price index will be low. However, such countries, without substantial industries of their own, have to import expensive machinery and technology, so often they will have negative terms of trade. One way to ameliorate this is to add value to primary products. Botswana is an exporter of diamonds, but in a raw state they fetch a lower price than if value is added by cutting and finishing. Botswana is therefore working to develop this industry so that they can earn higher export prices for their diamonds. Where export prices rise to exceed import prices, countries have an inflow of funds which may be used for domestic investment, either in capital infrastructure (enabling them to produce higher value-added goods and so improve the export quality even further), or in public infrastructure, raising quality of life (schools and hospitals) and improving productive efficiency (such as with better transport links). However, a deterioration of its terms of trade could mean that essential imports are less affordable. It would not be unreasonable to suggest that the poor safety record of some airlines in the least developed countries (LDCs) may be due to the inability to buy or lease new aeroplanes, while having to minimise safety maintenance of the existing fleets.

Topic 1 - Globalisation

The word ʼglobalisationʼ was introduced in the late 1970s and came into widespread use in the 1990s. It is used to describe a process that has existed for centuries: it would be fair to say that the economic circumstances of the Roman Empire were globalised, for example. In recent years the phenomenon has become more visible. It is changing the jobs we do and where we do them, the products we buy, where we buy them from and the way we buy them. It is also influencing government policy and the relationships between economies. The formation, growth, and policies of the European Union are part of globalisation, and it was felt by some that the result of the UK referendum on EU membership was in part a protest against the effects and reach of globalisation. There will be much to come about this, of course, and you are advised to follow these developments closely. In this topic you will examine how it is not only trade that is on a general upward trend but also other contributions to globalisation. You will explore the meaning, causes and effects of globalisation, including the growth of world trade and the increased interdependence of economies.

Explain three reasons why a multinational company may wish to produce abroad.

There are many reasons why a company may wish to produce abroad. One is to overcome trade barriers into a lucrative market: by setting up production in the country in question, the MNC will avoid paying any tariffs that are imposed on imports. Another motive is to take advantage of low costs of production in Asia. These may arise from higher productivity, low wages, factory rents and land prices. An MNC may decide to base just part of its production process in a country to take advantage of particular skills or raw materials, or other cost advantages. A third motive is to be in touch with the local market. Producing in a country enables a firm to monitor changes in consumer demand and to respond quickly to changes in competitive pressures such as the entry of new firms into the market. However, with advances in technology and communications this is becoming a less significant motive.

Summary for Inequality and poverty

This topic has examined the factors influencing the distribution of income and wealth, and the degree of poverty. The key points are as follows: - Wealth is more unevenly distributed than income in the UK. - Wealth can be gained through inheritance, marriage, enterprise, saving or chance. - The government influences the distribution of income through taxation and benefits. - The causes of poverty include unemployment, low wages and low benefit levels. - Possible measures a government might take to reduce poverty include increasing employment opportunities, raising benefits and cutting marginal tax rates.

Identify two ways that a central bank can keep the exchange rate 'artificially low'.

Two ways a central bank can keep the exchange rate 'artificially low' are by selling the country's currency and by lowering its interest rate.

Measures to correct a current account imbalance

A persistent current account deficit may cause a government to take action to remedy the situation. There are a number of measures it can implement. One is to improve or increase import restrictions in order to reduce expenditure on imports. However, membership of a trading bloc, such as a customs union, which takes away from individual economies the ability to set their own import restrictions, or an international institution such as the WTO, may limit a country's ability to use import restrictions. Import restrictions may also contribute to inflation by directly raising the prices of some of the products bought in the domestic market. They may also raise prices indirectly by pushing up the costs of production for firms that use imported raw materials, and by reducing the pressure on domestic producers to keep prices low. Another policy is to lower the value of the country's currency. This should have the effect of making imports more expensive, and so less attractive to buy, whereas exports will become cheaper and so more appealing to overseas purchasers. However, a fall in the value of the currency will only succeed in improving the trade balance if certain conditions are met. One of the most significant is covered by the Marshall-Lerner condition. This states that the combined price elasticities of demand for exports and imports must be greater than one. A fall in the price of exports will increase revenue if demand rises by a greater percentage than the fall in price, and a rise in the price of imports will reduce expenditure if demand falls by a greater percentage than the rise in price. It is also important that the supply of exports is elastic. These conditions are more likely to be met in the long run than in the short run. In the period immediately following a fall in the value of the exchange rate, the trade position may deteriorate. This is because it will take time to discover that relative prices have changed and to alter contracts. However, in the longer run, if demand and supply are elastic, the position will improve. This tendency for a trade position to worsen before it improves is known as the J curve effect and is illustrated in Figure 3.1. A reduction in the value of the currency may increase employment by stimulating demand for a country's exports. As with import restrictions, though, it may contribute to inflationary pressures by raising the price of imported products in the domestic market. A country that is a member of the eurozone (the group of countries that have adopted the euro as their currency) does not have an independent currency to lower but will be affected by a fall in the value of the euro. Greece has been unable to devalue its currency so as to make tourism (a major source of earnings for Greece) cheaper - remember that tourism into a country is an export - to alleviate its severe economic difficulties in the past few years. This has been an issue eagerly discussed by economists who are not in favour of monetary union. Import restrictions and devaluation are expenditure-switching measures. This means they encourage people to switch their spending from overseas products to domestically produced products. In contrast, expenditure-reducing measures try to improve the current account position by lowering expenditure on all products, whatever their source of origin. The thinking behind this approach is that spending on imports will fall and domestic producers, facing a smaller home market, will be forced to export more of their products. Deflationary policy measures are expenditure-reducing since they reduce aggregate demand. A rise in income tax, a cut in government spending or a rise in the rate of interest, for instance, are all likely to reduce expenditure on imports. However, deflationary measures may have an adverse effect on growth and employment. Using import restrictions, lowering the value of the currency or implementing deflationary measures may improve the current account position in the short run. However, if the deficit has arisen due to a lack of competitiveness, problems may arise again in the long run as these measures do not directly address problems like low productivity and poor marketing. For example, in the 1960s and 1970s British cars were difficult to export because they had a poor reputation for reliability and durability (they rusted easily). This is no longer the case owing to substantial structural changes in UK car manufacturing. However, the UK still finds it difficult to export its cinema product (but not its TV series), because of a cultural specificity in UK-made films which has limited appeal in other markets. Attempts to rectify this by producing US-style movies with a supposedly international appeal are rarely successful; the most infamous example was Raise the Titanic (1980), a British film which lost so much money that its producer exclaimed, 'Raise the Titanic - it would have been cheaper to lower the Atlantic!' This is why some economists favour using supply-side policies (Unit 5 Topic 3) to improve the current account position in the long run. For example, improved education and training will raise productivity, lower costs and prices and increase quality. This will be likely to result in a rise in demand for the country's products from both its own population and from abroad. Increased incentives, in the form of, say, lower income tax and lower corporation tax may also increase efficiency and improve the current account position. Changes in the exchange rate that are more than temporary may have effects on employment: what may be seen as a lasting lower rate may attract tourists into a country (this is noticeable in the UK at the time of writing) and so increase employment in this sector; a lasting high rate may have the opposite effect. Significant shifts to, or away from, imports will affect the (X-M) component of AD, and so the economic growth rate will be affected. Rising import prices, if they play a significant role in consumption or in terms of raw materials for domestically produced goods, will feed through into inflation rates. 'The Marmite effect' looks like becoming a new economic term. After the referendum result Unilever attempted to raise the price of Marmite supplied to Tesco because of more costly imported ingredients as a result of the fall in the pound. A falling or stubbornly low exchange rate may give the impression that a country is in economic difficulties, and so it becomes a less attractive target for foreign direct investment (FDI). This was a prominent feature of what is now being called 'project fear' in the EU referendum campaign.

Exchange rates

An exchange rate is the price of one currency in terms of another currency or currencies. As with prices in other markets, supply and demand play a crucial role. Households and firms demand currencies for a number of reasons. For example, households and firms in other countries demand pounds sterling in order to: - buy UK goods and services - buy shares in UK firms and - buy UK firms outright - place money in UK banks and other financial institutions - speculate on the future value of the pound. UK firms and households may also seek to buy pounds using foreign currency they have earned on trading abroad or have brought back from foreign holidays. Pounds may be sold by UK households and firms to obtain foreign currency in order to: - buy foreign goods and services - buy foreign shares and firms - place money in foreign banks and other financial institutions - speculate on the future value of foreign currencies. Again, foreign firms and households may sell pounds they have obtained from exporting to the UK and brought back from holidays in the UK. In terms of foreign exchange, remember: - Demand for a currency is an inflow: it means money coming in, for example dollars entering the UK to be changed into pounds to purchase UK goods. - The supply of a currency is an outflow: it means money going out, for example pounds leaving this country to France, to be converted into euros to buy French goods. Changes in demand and supply of currencies affect their price. For example, if UK interest rates rise, demand for pounds is likely to increase as foreign investors will wish to buy UK financial assets to gain a good return. Figure 3.2 shows that the increase in demand for pounds will raise the price of the pound. If UK goods and services decline in quality relative to other European products, demand for pounds is likely to fall and supply to rise. This is because overseas buyers will want fewer pounds as they will be buying fewer UK goods and services. UK households and firms will be buying more goods, services and raw materials from other European countries. So they will sell pounds to buy the necessary euros. Figure 3.3 shows the effect of this on the value of the pound. Notice that the fall in demand is greater than the rise in supply. It is worth remembering that such changes in the variables, even when simultaneous, will not normally be of the same degree. Considerable sums can be spent speculating on the value of currencies. Indeed, speculative flows of so-called hot money can greatly affect exchange rates. Changes in relative inflation rates and interest rates can affect all the motives for trading in a currency. A rise in a country's relative inflation will make that country's products less price-competitive, may reduce the return on direct and portfolio investment, and may lead speculators to believe that the value of the currency will fall in the future. All of these effects will lead to a depreciation in the exchange rate. A rise in inflation may lead a central bank to raise interest rates. Higher interest rates are likely to attract a capital inflow of footloose funds, which are sometimes referred to as hot money. These funds will be attracted by the higher rate of return and possibly also by the expectation that the higher interest rates will lead to an appreciation of the currency. All of these determinants are in constant operation, so that, technically at least, an exchange rate, unless it is fixed (see below), is in constant flux. If you stood by an exchange rate indicator board in a travel agent or bank for a while, you would see the changes happening.

Reasons to increase international competitiveness

Governments seek to raise international competitiveness as a rise in net exports can help them achieve their other macroeconomic objectives. Figure 4.1 shows that an increase in net exports raises aggregate demand from AD to AD1. Higher aggregate demand which raises the rate of short-run economic growth should help reduce unemployment and raise living standards. If international competitiveness has increased as a result of, for instance, rising labour productivity, then the long-run economic growth should be increased as both aggregate demand and aggregate supply will increase, as shown in Figure 4.2. However, these broad-stroke macroeconomic effects conceal a wide range of issues. International competitiveness is likely to increase an economy's inflow of foreign currency and this may help to redress a balance of payments disequilibrium. Financial inflows are particularly important to LDCs which suffer from primary product dependency, with negative terms of trade. If they improve the competitiveness of their exports, the improved terms of trade bringing in more foreign currency will enable these economies better to afford the purchase of capital equipment, and to finance infrastructural improvement, both of which are important steps in the development process. (Development economics is the subject of Section 10.) However, balance of payments status is, in international terms, regarded as a zero sum game: one country's surplus means another country's deficit. This section has, for example, covered the global balance problems currently exhibited by China, and formerly by petroleum-producing countries, in having economies which are highly competitive internationally and so draw in currencies from elsewhere in the world, to the detriment of the importer countries, such as the USA. (In the 1980s the culprit, so to speak, for the US economy was Japan. This situation is splendidly set out in the context of a murder drama in Michael Crichton's then very topical novel, Rising Sun, 1992). The diagrams above indicate that international competitiveness leads to rising national income but disguise the significant issue of how that income is distributed. Higher productivity, in basic terms of more output per worker, may mean that fewer workers are needed to produce the required output. Furthermore, capital substitution may well mean that some employment, especially among the lower skilled, disappears. (The 2004 movie I Robot, in which many low-skilled jobs, such as car park attendant and bar staff, are replaced by robots, signally failed to address the problem of how the workforce displaced by Isaac Asimov's imaginative androids are able to earn a living.) One of the main determinants of international competitiveness is the flexibility of the labour force, but flexibility has a cost in terms of the living standards of employees. Arguably the ultimate in labour flexibility is the zero-hour contract, yet there is currently much vexation in the UK, particularly from employee organisations like trade unions, and from the Labour Party, about the effect of such contracts on people's ability to sustain a living wage. In a general sense it could be stated that any economic development produces gains and losses, winners and losers, and international competitiveness is no exception.

The significance of current account imbalances

How significant a current account deficit or surplus is depends on its size, duration and cause. A small deficit or surplus which lasts for a short time will not have much impact on an economy. A cyclical deficit or surplus, i.e. one caused by booms or recessions as part of the economic cycle, will tend to move towards a balance as incomes change at home and abroad. In contrast, a structural deficit or surplus is likely to be longer lasting. This will be caused by features of the economy's structure itself. If, for example, a country's firms are producing products that are of low quality, then a deficit will continue unless the quality is raised. A country with few natural resources will have to import them, until at some stage technological advances make such resources less necessary - such as developing substitutes for oil, or improving the fuel efficiency of oil-consuming products. The significance of a deficit is also influenced by whether it can be financed by a surplus on the financial account. A government may not be too worried about a deficit if it is matched by a net inflow of portfolio investment and foreign direct investment. There is a risk that if a country experiences a large, persistent and structural deficit, economists from other countries may begin to question the strength of its economy. In such a case, foreign creditors may not want to lend to its firms and households, and foreign firms may not want to set up there. Even if the excess spending can be financed by borrowing from abroad, such borrowing will result in a net outflow of investment income in the longer run. -Global imbalances: Some countries, most noticeably the USA and the UK, have run current account deficits over a long period of time, whereas others, including China and the oil-exporting countries, have operated current account surpluses for some time. This was a major issue in the 1970s as several oil-producing countries hoarded their export earnings rather than returning them to the circular flow of the global income. There has recently been economic disquiet in the west owing to the current disposition of the Chinese economy to focus on exports while its citizens under-consume. A rebalance toward more domestic consumption and less reliance on export earnings is at the time of writing an objective of the Chinese economy. These imbalances have enabled some countries' citizens to spend more than they have produced while making use of the savings of other countries' citizens. In other words, savings in one country are channelled into portfolio investment in other countries (an inflow in the financial account), enabling a current account deficit, in which spending on imports is significant, to be maintained One reason why the Chinese and others in emerging economies have been prepared to buy US and UK financial assets is because of a lack of sophisticated and trustworthy domestic financial assets and institutions. Immature financial markets also help to explain why savings ratios, i.e. the proportion of income saved compared with that which is spent, are high in some emerging economies. Households feel they have to save for a rainy day as they cannot rely on a ready supply of credit. Governments have also been building up large reserves of foreign exchange. There are two major short-term and connected factors that could cause a global rebalancing. One would be a fall in the value of the US dollar, particularly, and a rise in the value of the Chinese renminbi. The other would be a redistribution of the components of aggregate demand within countries. A faster increase in consumer expenditure than exports in China, as mentioned above, and a faster growth of exports than consumer expenditure in the USA, would help to restore the international balance between spending and saving. In the longer term, another factor that would contribute to a global rebalancing is the development of more sophisticated financial institutions in the emerging economies.

The costs and benefits of monetary union

Participating in the single currency is thought to have a number of potential effects, some advantageous and some disadvantageous. A member country passes over control of monetary policy to the ECB. The ECB sets the interest rate for the eurozone, although governors of the central banks of member countries sit on the ECB council. There is a risk that the interest rate set may be more appropriate for some countries than others. For example, if a country has a higher rate of unemployment and a lower rate of inflation than the eurozone's average, it may be harmed by a rise in the area's interest rate. This is why convergence of economies is important. A member government also loses the ability to use devaluation as a policy tool to improve its international price- competitiveness, employment and growth, and to react to country-specific economic shocks. However, there are also potential benefits. An obvious one is reduction in transaction costs. Individuals and firms no longer have to spend time and money changing currencies. The allocation of resources is also likely to improve with increased transparency. Consumers and firms dealing in one currency are able to compare prices of products, raw materials and components, as well as investment opportunities throughout the eurozone. This is likely to make price discrimination more difficult to operate between member countries and to increase competitive pressure on firms to keep prices low and quality high. Inward foreign direct investment may also be attracted by the large market size. Some member countries may also enjoy a lower interest rate and a low inflation rate as a result of belonging to an area with a commitment to low inflation. The ECB's prime objective is the maintenance of price stability. Membership of a single currency, in terms of the benefits outlined above, should foster intraregional trade. At the time when the UK government was considering whether or not to join the eurozone, several multinational firms with plants in the UK threatened to leave if the UK did not join. This threat was not carried through. The UK was cautious about membership in part because of differences between the UK economy and the rest of the eurozone. These included greater use of variable interest rates, and hence greater vulnerability to an inappropriate interest rate, a greater proportion of its trade being with the USA, and being a major exporter of oil. The last two factors mean that UK has a greater susceptibility to changes in the value of the US dollar and US economic activity. - The effects of trading blocs: Establishing a trading bloc can result in both trade creation and trade diversion. - Trade creation occurs when the removal of tariffs between member countries enables those countries to move from buying products from high-cost countries to buying them from lower-cost countries. This change raises both trade and efficiency. - Trade diversion, however, can also occur, with trade being diverted away from the cheapest source of imports. This can arise if a common external tariff is imposed which makes imports from efficient producers outside the bloc more expensive. This was a source of contention during the UK's negotiations to join the European Community in the early 1970s, as Commonwealth producers, such as Australia and New Zealand, would find themselves subject to the common external tariff of the customs union, making their exports to the UK more expensive and less attractive (and thereby giving a significant advantage to EU farmers already enjoying significant benefits from the Common Agricultural Policy). The overall effect on efficiency depends mainly on the rate of any tariffs imposed on member and non-member countries before entry into the trading bloc. If there were initially relatively high tariffs on both, then the efficiency gained from trade creation should outweigh the efficiency loss from trade diversion. This is because products traded in the trading bloc will become significantly cheaper, while the price of imports from outside may not rise by very much. However, if the members initially had low tariff rates on imports from other member and non-member countries, there will be a net efficiency loss. This is because imports from and exports to member states will not fall much in price, but imports from non-member countries will rise significantly in price. As noted earlier, recent years have witnessed a growth in the number of countries that are members of trading blocs. This rise in 'regionalism' has been particularly noticeable in Europe with the EU, in North and South America with NAFTA, Mercosur and the Free Trade Area of the Americas (FTAA), and in the Asian Pacific area with ASEAN, the Association of South East Asian Nations. (ASEAN consists of Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar (formerly known as Burma), the Philippines, Singapore, Thailand and Vietnam.) Supporters of regional trading blocs argue that they can promote higher output due to trade creation, and that their existence makes it easier to reduce protectionism on a world scale because there are fewer parties to negotiate with. However, opponents claim that, at least in some cases, trade diversion effects can offset trade creation effects and can reduce the drive towards world trade liberalisation. Countries outside the major trading blocs, many of which are poor countries, find themselves unable to trade on equal terms and this can hinder their development. The EU response to this problem was the Lomé Convention, from 1976, by which a number of developing countries, many of them former colonies of EU members, are given preferential tariff arrangements.

Why might a large current account surplus indicate that a currency is undervalued?

A current account surplus indicates that the demand for a currency (in order, for example, to purchase exports from that country) is greater than the supply of that currency (i.e. less of it is leaving the country, to pay for imports, for example). This imbalance should cause an appreciation in the value of the currency (the demand for it will increase its value) until demand and supply are in equilibrium: then the exchange rate represents the true value of the currency.

Managed floating exchange rate

A managed exchange rate system - that is, deliberate action by governments to influence the movement of the currency in a desired direction - occurs when a government intervenes in the foreign exchange market to even out fluctuations or to move it in the direction it wants. The euro, the pound and the US dollar are currently floating exchange rates, which the European Central Bank, the Bank of England and the Federal Reserve occasionally seek to influence. This management of a floating exchange rate is sometimes described by the term 'dirty float' or 'managed flexibility'. (You might notice the ideological bias in that term: free-market economics means that the processes should be left to themselves, so it's distorting the market if there is intervention.)

Analyse why allowing the renminbi to float freely would increase China's 'ability to use its monetary policy to influence the internal economy and might enable it to cope better with external shocks'.

Allowing the renminbi to float freely would mean that the Chinese central bank could concentrate its interest rate policy on the internal economy. It would not, for example, be prevented from raising the interest rate to reduce demand-pull inflation for fear that such a rise would drive up the exchange rate. It would not have to consider that such a rise would increase the demand for the currency and, as its rate is fixed, Increase the problem of undervaluation. Allowing the exchange rate to move up and down in value can enable an economy to adjust more smoothly to sudden and unexpected changes in the external economic environment. If, for instance, there is major recession abroad, the country will export less. This would cause a fall in aggregate demand and, with a relatively fixed exchange rate, aggregate demand might remain low with an adverse effect on employment and economic growth. With a freely floating exchange rate, however, the value of the currency would fall, which would lower export prices and raise import prices. These changes in export and import prices may raise aggregate demand back to its previous level.

International trade and specialisation

Different factor endowments encourage countries to trade. Norway, for example, has the appropriate resources, including forests and labour expertise, to produce paper, while Spain has the climate and land to grow grapes to produce wine. Ireland has plenty of flat rural land, and ample rainfall, to maintain the growth of grass to support a large dairy industry International trade allows countries to make efficient use of their factor endowments and to specialise. This is because they can exchange some of what they make for those products they do not or cannot produce. It used to be thought that international trade was based on absolute advantage, but it is now recognised that most international trade can be explained by comparative, rather than absolute, advantage. These models originate from the work of the eminent English economist David Ricardo (1772-1823); although now over 200 years old, they are still at the forefront of analyses of trade determination. -Absolute advantage: A country has an absolute advantage when it can produce more of a product per resource unit than its competitors. This means that it is more efficient and can produce the product more cheaply. Table 2.1 shows the hypothetical output of oranges and paper in Norway and Spain that could be achieved if each country were to devote half of its resources to each product. You can see that Norway has the absolute advantage in the production of paper and Spain in the production of oranges. If each country specialises in the production of the product in which it has an absolute advantage, the total output of oranges would rise from 10 000 to 18 000 and the output of paper from 4500 to 8000. -Comparative advantage: If this basic model determined patterns of world trade, some countries, with an absolute advantage in nothing, would only import; these countries could not export because this would not be financially viable. This is not the case in the real world of international trade. Absolute advantage is a useful way of comparing the efficiency of resource use among countries, but it does not serve as a model of trade determination. As Ricardo saw, it is comparative advantage that is significant: countries with no absolute advantage in any good will most probably have a comparative advantage in something. A country has a comparative advantage if it can produce a product at a lower opportunity cost than its trading partners. This is the formal definition. The theory of comparative advantage suggests that international specialisation and trade increases world output. This is because international trade enables the more efficient countries to specialise in the products they are best at producing and the less efficient ones to specialise in the products they are not so bad at making. Table 2.2 gives an example of this. In this hypothetical case, the USA has the absolute advantage in producing both corn and tractors. This is because it can make more of both than Canada, with identical resource use. The USA's comparative advantage lies in producing tractors. This can be explained in two ways: - The USA can produce five times more tractors than Canada but only twice as much corn. - The opportunity cost of producing one tractor in the USA is four units of corn (20 ÷ 5) whereas in Canada the opportunity cost of one tractor is 10 units of corn (10 ÷ 1). Let's assume that all workers are equally adept at farming as at manufacturing. That's not likely, but the model operates on that assumption - you might like to consider that as one of its drawbacks. According to the data in Table 2.2 above, if we took the workers in the USA who made one tractor and asked them to grow corn instead, they'd produce four units. If we do the same in Canada, we'd lose one tractor but get ten units of corn. It therefore makes sense to have the US workers make tractors and let the Canadians make corn. The Canadians will sell corn to the USA, which in return will sell its tractors to the Canadians. So, Canada has the comparative advantage (or lesser disadvantage) in producing corn. It is not as efficient at producing corn as tractors, since it can produce half as much corn as the USA, but only a fifth as many tractors. The opportunity cost of producing corn is lower in Canada than in the USA. In Canada the opportunity cost of one unit of corn is one-tenth of a tractor. In the USA it is higher, at a quarter of a tractor. According to the theory of comparative advantage, if the USA specialises in producing tractors and Canada in producing corn, output will increase and, if they trade at a mutually beneficial exchange rate, living standards in both countries will rise. Comparative advantage is influenced by factor endowments so that countries with relatively large amounts of low-skilled labour would be expected to specialise in the production of products intensive in the use of this resource. This emphasis on factor endowments as the crucial element in comparative advantage was a development of Ricardo's model by two Norwegian economists Bertil Ohlin and Eli Hecksher, published in 1933.

Explain how direct and portfolio investment can affect the exchange rate.

Direct and portfolio investment can mean that the exchange rate moves in an opposite direction to that suggested by the current account position. If, for instance, there is a net inflow of FDI and portfolio investment, then the exchange rate may rise despite a current account deficit. Indeed, trade flows are now dwarfed by capital and financial flows which are recorded in the financial account. The opposite will be the case for a net outflow.

Firms

Firms are increasingly thinking globally in terms of marketing, where to base parts of their production and what resources to use. Products have been renamed in a number of countries to turn them into global brands. For example, in recent years in the UK Jif cleaning fluid has become Cif, and the chewy sweets, Opal Fruits, have been renamed Starburst, so that the same name can be used throughout the world - an example of marketing economies of scale (Unit 6, Topic 4). Tastes are becoming more uniform and less affected by national boundaries. Children from the USA, Moscow and Delhi alike drink Coca-Cola, wear Nike trainers and play with their PlayStations. The Tuaregs, an African nomadic people, delayed their migration to new pastures for 10 days so that they could watch a season finale of the US soap opera series Dallas (reported in The Story of English, by McCrum, MacNeill & Cran). Firms are also seeing the world as one place when deciding where to base their productive operations, where to raise finance and where to buy resources. As noted earlier, they are prepared to break down their production and place different parts in different areas of the world. They are also willing to buy raw materials and components and to recruit staff from anywhere in the world. The global labour market is not fully integrated, as most high-income countries operate relatively tight immigration controls; however, the shortage of labour resulting from ageing populations has encouraged the USA, Australia, countries in the European Union and a number of other countries to permit the immigration of skilled workers. The progressive transformation of the world into one market is also putting pressure on firms to increase their efficiency. They now face competition not only from other firms in their own countries, but also increasingly from foreign firms based abroad or, as MNCs, in their own countries. Their consumers are also more demanding and better informed. However, those firms that respond to competitive challenges can grow by producing for a world market and thereby take advantage of economies of scale, particularly in technology and marketing, as illustrated above.

The effects of globalisation

Globalisation is affecting consumers, firms, workers and governments. Consumers: Consumers are currently enjoying a wide range of products and low prices. For example, they are able to buy books, holidays and insurance over the internet, and more products that do not have tariffs imposed on them. In addition to increased information and access to foreign markets, advances in technology are also reducing costs of production and increasing the range of products available. However, the increasing access to foreign markets may result in a few large MNCs coming to dominate certain world markets. In this case, choice may be reduced and prices may rise. Certain world markets already exhibit a significant degree of market concentration, such as car production and sports equipment.

Protectionism

Protectionism refers to the restriction of international trade with the prime intention of protecting domestic industries from foreign competition. Restrictions on imports may be imposed to protect consumers from, for instance, what are regarded as unsafe toys. Exports of products, particularly food and fuel, which are in short supply in the country of production may be restricted to protect domestic consumers. In addition, limits on imports and exports are sometimes used to pursue political objectives, such as placing sanctions on trade with a hostile country. For example, from 1960 until 2016 the USA had a trade embargo with Cuba.

Explain how tariffs can distort comparative cost ratios.

Tariffs distort comparative cost ratios because they make products from abroad artificially expensive. For instance, if a home-produced product sells for £20 and a foreign product for £15, a tariff on the foreign product may put its price up to £22. Demand will switch from the foreign product to the domestically produced product and, as a result, resources will move away from their most efficient allocation. Figure 2.3 shows the effect that imposing a tariff will have. It shows that the price is initially P and the total quantity bought is QZ. Of this quantity, 0Q are home-produced products and Q-QZ are imports. After the imposition of the tariff, the price rises to P1 and the total quantity bought falls to 0QY. Of these, 0QX are home-produced and imports fall to QX-QY. It is not just tariffs that can affect comparative cost ratios. Other forms of import restriction may also distort the allocation of resources.

The World Trade Organization (WTO)

The driving force behind multilateral trade liberalisation is the World Trade Organisation (WTO), which in 2016 has 164 members. The WTO seeks to encourage governments to reduce existing trade barriers and to prevent the establishment of further trade barriers by getting governments to negotiate rather than take unilateral action. The WTO operates regular rounds of trade negotiations; these series of negotiations last a number of years. As well as seeking to reduce trade restrictions in general, they usually have specific objectives such as increasing intellectual property rights. (This is the right of someone who has created a product of the mind to be recognised as its creator and so to have similar rights over it to someone who has invented a physical product.) In addition to reducing trade barriers, the WTO operates dispute settlement tribunals. It checks that countries abide by the trade agreements they have signed and mediates on any trade disputes that occur between member countries. In September 2016, for example, the WTO ruled that the EU's financial assistance to Airbus broke the rules, giving Airbus an unfair advantage compared with the US aircraft manufacturer Boeing, on whose behalf the US government had appealed to the WTO. At the time of writing , the US response to this, in terms of what tariffs to impose as a retributory act, remains to be seen. If, as a more general example, the WTO finds that a member country's producers are engaging in dumping (the sale of products in foreign markets at prices below the cost of production, discussed later in this topic), it will order that country's government to stop its producers doing this. If the government fails to do this, the WTO will give the governments of the countries suffering from the dumping the right to impose punitive tariffs on the offending country's products. Some developing countries argue that the WTO is dominated by developed countries, particularly the USA, and argue that the trade rounds put more burden on developing countries than developed countries to cut their trade restrictions. The WTO is also criticised by a range of pressure groups which believe that it favours the interests of western MNCs at the expense of the environment and labour rights.

Summary for Balance of payments and the exchange rate

The key points are as follows: - The UK's balance of payments consists of the current account, the capital account and the financial account. - The current account is composed of the trade in goods account, the trade in services account, the income account and the current transfers account. - The UK usually has deficits on its trade in goods and current transfers accounts which are not always offset by surpluses on its trade in services and income accounts. The financial account exhibits considerable volatility. - To correct a current account deficit, a government may impose import restrictions, devalue the currency and introduce deflationary policies or supply-side policies. - A member of a trading bloc's ability to impose import restrictions is limited; import restrictions can be inflationary and do not directly improve international competitiveness. - For devaluation to improve the balance of payments position, the combined elasticities of demand for exports and imports must be greater than one (the Marshall-Lerner condition). - Deflationary policies can have an adverse effect on employment and growth. - Supply-side policies are long-term policies that, if successful, will raise a country's international competitiveness. - The exchange rate of a currency will rise if demand for the currency increases or the supply of the currency decreases. - A freely floating exchange rate is determined by demand and supply. - No reserves are needed if the price of a currency is determined by market forces, but its value may fluctuate and inflationary pressures may be created. - In a fixed exchange rate system, the price of a currency is set and maintained by the government. Its stability may encourage international trade, but policies may need to be implemented to maintain it. - Two key influences on the value of a currency are changes in relative inflation rates and interest rates. A rise in inflation or a fall in the rate of interest would be likely to reduce the exchange rate. - A rise in the exchange rate will be likely to reduce inflation but may also reduce employment and economic growth, and may discourage direct foreign investment.

Arguments for general import restrictions

There is some overlap in arguments for general import restrictions and for selective restrictions. Tariffs may be imposed on some or all products in order to raise revenue. This is one of the motives of the EU's common external tariff. Imposing a tariff on a wide range of products, or on all products, may improve the terms of trade. In measuring the terms of trade, import prices are taken as the prices foreigners charge for their products. Imposing a tariff will increase the price of the import, but not the price the foreign producer receives. Indeed, foreign producers may even reduce the price they charge so that they can remain competitive even with the tariff. If they do lower their prices, the terms of trade will improve and each export would exchange for more imports. One reason for general import restrictions is to avoid the risks of concentrating on a narrow range of products and so create a diversified industrial structure. A country may also seek to correct a balance of payments deficit by restricting imports. (The balance of payments, which is an account of money leaving and money entering an economy, is covered in Topic 3.) However, a high demand for imports may indicate some underlying weakness in the economy, such as low productivity. This will not be corrected just by import controls and, in the long run, other measures may be necessary. Import restrictions may be used to give an economy time to sort out its problems. A government may use them to protect the country's industrial base while it is being restructured. Protection will allow resources to be shifted from uncompetitive industries to competitive industries and will ensure that any injections of extra spending will not suck in too many imports. A government may also implement a system of import restrictions as part of the conditions needed to enter a trading bloc.

Topic 2 - Why trade?

This is a long topic; in it, you will examine the nature of international trade, the gains from international trade, the role of the World Trade Organization and the various types of trading bloc.

Despite the recent rapid growth of the Indian economy and the resulting rising prosperity among the country's middle and upper classes, poverty remains a problem for the country. It was estimated that in 2011 23.6 per cent of the 1.1 billion population were living in absolute poverty. Malnutrition is a particular problem in India and is not confined to the poor. 1. How many people were experiencing absolute poverty in India in 2011? 2. Apart from malnutrition, identify another indicator of absolute poverty. 3. Why might malnutrition not be restricted to the poor?

1. 259.6 million were experiencing absolute poverty. 2. Poor-quality housing or a lack of housing and lack of access to clean water are further indicators of absolute poverty. 3. Malnutrition might not be just the result of people being unable to afford enough calories. It may also be caused by people buying non-nutritious food or suffering from gastric diseases.

In 2016 there were estimated to be 14 million child slaves in India. Parents get into debt and agree to sell their children's labour in a bid to repay their loans. These bonded child workers often face no prospect of leaving their jobs as the interest charges, often set between 20 and 40 per cent, exceed their wages. Some of the children work 14-hour days on jobs that endanger their health. A significant number are employed producing clothes for the western market. 1. Identify two reasons why a firm may wish to employ child slaves. 2. Assess one argument for and against the EU imposing tariffs on imported Indian clothes made by producers who employ child labour.

1. A firm may wish to employ child labour because children are cheap to employ and they can be very manageable. For instance, children are unlikely to threaten to go on strike. 2. One argument for the EU imposing tariffs on imported Indian clothes made by producers who employ child labour is that such products represent unfair competition. The firms employing the child labour are likely to have lower costs as they will be paying the children less and are unlikely to be paying them when they are sick nor contributing to their pensions. This is a purely economic reason, but a tariff on such products could also be interpreted as a protest against the use of child labour (although whether ethical aspects of cultural relativity is an issue in economics is a debate that falls outside of the A level specification). An argument against imposing tariffs is that by not buying the products, the firms might go out of business. This may increase poverty in the country and worsen the living conditions of the children and their families. Those who support this line of argument suggest that the importers should require the Indian firms to phase out child labour.

Uruguay has received a number of benefits from membership of Mercosur. It has, however, complained about Mercosur's relatively high external tariffs, which make it expensive to import machinery from outside the trading bloc. It is also unhappy that it has to get the consent of its Mercosur partners to sign a free trade agreement with non-members. 1. What is the difference between a free trade area and a customs union? 2. Explain one factor which will influence whether Uruguay will receive a net benefit from being a member of Mercosur.

1. A free trade area removes tariffs on products from member states. A customs union goes a stage further by requiring member states to impose the same tariffs on products imported from outside the area. 2. A key factor that will influence whether Uruguay will receive a net benefit from being a member of Mercosur is the extent to which it trades with members relative to non-members. The more it trades with members and the less it trades with non-members, the more it will benefit.

Decide whether each of the following is an expenditure-reducing or expenditure-switching method of improving the UK's current account position, briefly stating the reason for your answer. 1. A rise in UK interest rates 2. A UK trade mission visiting China 3. A rise in income tax in the UK 4. A rise in VAT in the UK 5. The application of cheaper technology in the manufacture of UK washing machines 6. A significant depreciation of sterling

1. Expenditure-reducing: this will discourage borrowing and encourage saving. 2. Expenditure-switching: the mission will encourage some Chinese to switch their expenditure to UK products. 3. Expenditure-reducing: this will lower disposable income and demand for all products. 4. Expenditure-reducing: this will increase the price of foreign and domestically produced products on the home market. 5. Expenditure-switching: this will reduce the price of UK washing machines, and encourage both UK and foreign people to buy more of them. 6. Expenditure-switching: export prices will fall and import prices will rise, so UK and overseas consumers will buy more UK products and fewer foreign products.

Emerging economies and regional trading blocs

The development of air travel and containerisation, for instance, were features of globalisation in the past. Two features of this current period are the rise of the emerging economies and the growth of regional trading blocs. The so-called BRICs (Brazil, Russia, India and China) are becoming more powerful economies and were predicted to be among the most important economies by 2050, although at the time of writing (2016): - The Brazilian economy is in difficulty (growth rate -0.6) - Russia has been adversely affected by low oil prices (one of its main exports) - China's economic growth rate, although still high by western standards, is lower than it was in the previous decade (over 14 per cent in 2007, 6.7 per cent in late 2016). The increased global importance of the BRICs is recognised in their inclusion in the G20 group. A high growth rate of emerging economies increases global demand for food and energy. Rising skill levels in these countries is also gaining them a comparative cost advantage in the manufacture of a range of products. This, in turn, is leading to a relative decline in the role of manufacturing in the economies of the UK, USA and a number of other western countries. More countries are joining regional trading blocs. These have different degrees of integration. For example, the EU has a relatively high level of integration. Many barriers to the movement of products, workers and capital have been removed and a number of countries have adopted the same currency, the euro. In contrast, there is a lower degree of integration in the case of the three members (Canada, the USA and Mexico) of the North American Free Trade Agreement (NAFTA). This is what is called a free trade area, which means that the member countries only agree not to put tariffs on each other's products. In other words, unlike a customs union such as the EU, there is no common external tariff imposed around members. There is some debate as to the net effect regional trading blocs are having on globalisation. This is because, while integration is encouraged within the trading blocs, they can divert trade away from non-members.

The money which flowed into the USA from willing foreign savers in increasing amounts in the previous decade pushed up the price of US government bonds. The resulting lower interest rate raised house prices and encouraged more spending at the expense of saving. Since 2007 and the financial crisis, the net inflow of saving funds into the USA has slowed, but is still substantial. Some economists have argued that the US economy would benefit from a rise in the value of the renminbi but others argue that such a rise may not benefit the US economy. 1. Identify two reasons why a Chinese firm or household may have placed its savings in a US financial institution. 2. Explain why a rise in the value of the renminbi may not benefit the US economy.

1. A Chinese firm or household may have placed its savings in a US financial institution because the rate of interest was higher than in China and because it regarded US financial institutions as safer or providing more services than domestic alternatives. 2. There are two main reasons why a rise in the value of the renminbi may not benefit the US economy. One is that it may increase inflation in the USA as cheap Chinese imports have helped to keep down increases in the US price level. (Remember that if the value of a currency improves, then exports become more expensive.) The other reason is that there is not much overlap between Chinese and US production. If US consumers bought fewer Chinese products, they are likely to have to source them elsewhere, buying from other countries such as Vietnam and India, and so their current account position may not improve. Indeed, the US deficit may increase as some of the alternative sources of imports may be higher cost producers.

In 2016 the value of the pound sterling fell against the euro as a result of the 'leave' vote in the EU referendum. In the autumn the Bank of England cut the UK's interest rate to 0.25%. (This is also known as the bank rate - see Unit 10.) This depreciation of the pound benefited some groups in the country while harming others. There was nervousness at the time about the future health of the UK economy. Some expressed concern that this could lead the value of the pound to fall further. 1. Why might a fall in the rate of interest be expected to result in a fall in the exchange rate? 2. Identify two groups each which would: a) benefit from a fall in the pound b) suffer as a result of a fall in the pound. 3. Explain why a fall in confidence in an economy could cause the value of its currency to fall.

1. A fall in the rate of interest may reduce demand for pounds as foreign investors will want to put less money into UK financial institutions. As well as discouraging hot money flows into the country, the reduction in the rate of interest may result in hot money flows out of the country. Holders of sterling may sell pounds to gain the currency of countries offering higher interest rates. Figure 3.8 shows that a fall in the demand for and an increase in the supply of pounds sterling will push down its value. 2. Exporters and people from overseas who have borrowed from UK banks would benefit from a fall in the pound.Importers and people intending to holiday abroad would suffer from a fall in the pound. 3. A fall in confidence would lead to people and institutions selling the currency and fewer people and institutions wanting to buy the currency. This increase in supply and decrease in demand will result in a fall in the value of the currency. The currency could fall by a significant amount. This is because an initial fall may result in a further fall in confidence and hence more selling of the currency.

DeAnne Julius, an industrial economist and a former member of the Bank of England's monetary policy committee, calls workforce skills 'the biggest microeconomic challenge we face'. Other economists are agreed about the importance of training in improving productivity and international competitiveness. However, they disagree on whether decisions about training are best left to individuals and their employers or whether, due to the ʼmerit goodʼ nature of training, the government should promote it. 1. Explain why the 'merit good' nature of training may mean that training will be under-provided if left to market forces. 2. Will an increase in state spending on training necessarily increase productivity?

1. A merit good is one that is under-consumed if left to market forces because consumers lack information about the full benefits that can be gained. Merit goods also usually provide external benefits. In the case of training, some employers may not appreciate the gains they may achieve as a result of training their staff. They may dislike the short-term consequence of the opportunity cost: an employee in training may be producing less, or nothing. They may also fear that other firms will take advantage of the training they provide by poaching their staff. As a result, they may not devote sufficient resources to training. 2. An increase in state spending on training will not necessarily increase productivity. It will depend in large part on the quality of the training, the appropriateness of the training and whether lifelong training is provided. For example, it is important that workers are provided with the skills needed to carry out the functions they are required to perform and to operate any equipment they work with to its full potential. It is also important that workers keep up to date and flexible.

Singapore is considered to be one of the easiest places in the world to do business. The country benefits from excellent infrastructure and an international reputation for efficiency and friendliness. Two of Singapore's most competitive industries are its digital and interactive media industry and its healthcare industry. The first of these is expanding rapidly, creating more jobs and benefiting from a network of digital research and innovation centres. Singapore's healthcare system was ranked top in Asia and sixth out of 190 countries by the World Health Organization in 2014. It searches the world for the best doctors and other healthcare workers and is at the forefront of developments in cosmetic surgery, stem-cell and gene therapy research, organ transplants and brain surgery. The expertise and reputation the country is gaining is increasing medical tourism to the country. 1. Explain how 'excellent infrastructure' contributes to international competitiveness. 2. Why might firms in an expanding industry experience an increase in their international competitiveness? 3. Explain two factors that make Singapore's healthcare system internationally competitive.

1. An excellent infrastructure keeps firms' transport costs low. It enables firms to transport their raw materials and finished products quickly and means that workers do not get held up in traffic jams. You may recall that this is an external economy of scale (also relevant to the next answer). Low transport costs and high labour productivity, arising from workers arriving at work on time and unstressed, contribute to Singapore's firms' price competitiveness. 2. The firms in an expanding industry, such as Singapore's digital and interactive media industry, may be able to take greater advantage of internal economies of scale and also external economics of scale present in a growing market. If the firms grow in size, they may be able to make use of larger, more efficient equipment, borrow at a cheaper rate and employ specialist staff. Lower long-run average cost will increase an industry's price competitiveness. 3. Two factors that make Singapore's healthcare system internationally competitive are its skilled workers and its good reputation. Singapore recruits high-quality healthcare workers and has gained a reputation for advanced medical procedures and research. These factors are contributing to Singapore's quality competitiveness and encouraging people to travel to the country for medical treatment.

As a result of the global financial crisis, Chinese exports fell by 26 per cent in 2008. The collapse in global demand for Chinese products resulted in a rise in unemployment in the country of 20 million. The impact on the exports of other Asian countries, particularly South Korea and Taiwan, was more dramatic as importers traded down to cheaper made-in-China goods. A 1 per cent decline in US economic growth is associated with a 0.16 per cent decline in the real GDP of other countries. 1. Why might China still have experienced a rise in real GDP despite a fall in exports? 2. Why may the Chinese economy be more affected by changes in the US economy in the future?

1. China did experience economic growth in 2008 despite the fall in exports. This is because the other components of aggregate demand increased. 2. The Chinese government may be more affected by changes in the US economy in the future because the quality of its exports may increase. This would make demand more income-elastic and so more susceptible to changes in US income. As the Chinese economy grows, the country is also more likely to buy imports, including from the USA, and so will be affected by changes in the price, quality and availability of US products. Indeed, the more China engages in international trade, the more integrated it will become in the global economy.

In January 2007 the German Chancellor, Angela Merkel, announced an end to the government subsidies which had been given to the country's coal industry. At one time, the German coal industry was one of the most important and efficient industries in the country. The number of miners had declined gradually and state subsidies had declined from £2.94bn in 1998 to £1.65bn in 2006. The announcement of the removal of the subsidies, while expected to result in a loss of 37 000 jobs, was an acknowledgement that the country had lost its comparative advantage in coal production. 1. Explain one reason why Germany may have lost its comparative advantage in coal production. 2. Assess whether subsidies of Germany's coal industry should have been removed slowly or quickly.

1. Germany may have lost its comparative advantage in coal production because the cost of extracting coal may have risen relative to the cost in rival countries. The coal might have become more difficult to mine and the productivity of German miners might have fallen relative to miners in other countries. 2. An advantage of removing the subsidies slowly from an industry is that a large rise in unemployment is avoided. The industry can be allowed to decline gradually, with workers who retire or leave to find other jobs not being replaced. A basic assumption in economics of sectoral change is that as opportunities in one form of employment declines, new sectors emerge. This process, however, takes time. A slower deindustrialisation process in the coal mining sector would allow for a more gradual shift of labour from one sector to another, and create time for retraining - that is, to improve occupational mobility. Geographical mobility, however, may be harder to deal with. On the other hand, removing subsidies quickly can avoid resources which could be used for other purposes being kept in an inefficient industry.

Between 2000 and 2008, more than half the world's infrastructure investment was accounted for by the four emerging economies known as the BRICs. The BRICs' spending on electricity, railways, roads, telecommunications and other projects as as a percentage of GDP was twice that of developed countries. It also increased rapidly. The increase was greatest in China. Indeed, between 2003 and 2008 China's spending on infrastructure was greater than in the whole of the twentieth century. Infrastructure investment raises both short-run and long-run economic growth. It increases living standards which, in turn, further increases demand for infrastructure. As people's incomes rise and more people live in towns and cities, there is more demand for electricity, roads and housing. However, infrastructure investment can have a negative impact on the environment. More use of cars, for instance, and the generation of more electricity can worsen air pollution and contribute to global warming. 1. Explain why infrastructure investment may raise economic growth in both the short and long run. 2. What effect might increased infrastructure investment in emerging economies have on the growth of developed economies?

1. Infrastructure investment may increase short-run economic growth if the spending is on domestically produced capital goods and if there is initially spare capacity in the economy. The higher aggregate demand will result in an increase in real GDP, as shown in Figure 1.2. Spending on infrastructure projects such as electricity systems and transport links is also likely to increase the maximum output the country is capable of producing so will shift the aggregate supply curve to the right and result in long-run economic growth. 2. Increased infrastructure investment in emerging economies may increase growth in the developed countries in both the short run and the long run. In the short run, emerging economies may buy more imports of capital goods from the developed countries. In the longer run, the increase in growth of the emerging economies, which is likely to result from the extra and improved infrastructure, will mean that spending will rise among the population of these economies and some of this spending is likely to be on imports from developed economies. The rise in the quality of capital goods in emerging economies and their rising consumption may increase competitive pressure on some of the products produced by developed economies and may put upward pressure on commodity prices.

Look carefully at Table 2.3 below then answer the questions which follow. 1. Which country has the absolute advantage in producing both products? 2. In which product does the UK have the comparative advantage? 3. In which product does Japan have the comparative advantage?

1. Japan, since it can produce more of both products. 2. Cars. The UK can produce fewer of both products, but it is not as inefficient at producing cars as it is at producing TVs. It can make one-third as many cars as Japan but only one-quarter as many TVs. It also has a lower opportunity cost in producing cars than Japan. In the UK one car = two and a half TVs (10 ÷ 4) whereas in Japan it is three and a half (40 ÷ 12). 3. TVs. Japan is even better at producing TVs than producing cars. It can make four times as many TVs as the UK and only three times as many cars. It also has a lower opportunity cost in TVs than in the UK. In Japan, one TV equals three-tenths of a car whereas in the UK one TV equals four-tenths of a car.

Study Table 5.2 carefully and then answer the questions that follow. 1. Using the information in Table 5.2, compare the UK's and Sweden's Gini coefficients. 2. In 2000, Ireland's Gini coefficient was 34 and Belgium's was 33. What do the changes between 2000 and 2011/12 indicate?

1. The UK's Gini coefficient shows that income was more unevenly distributed than in Sweden in 2011/12. 2. Ireland's Gini coefficient fell slightly from 2000 to 20011/12. This meant that income became slightly more evenly distributed over the period. In contrast, Belgium's Gini coefficient also fell, by rather more, indicating a greater movement toward income inequality over the period. The coefficients of the countries in the table above are all relatively low - and these countries are all developed economies. We might infer from this that countries with low Gini coefficients, that is, with relatively equitable distribution, are developed. However, nine of the ten countries from the World Bank list with the highest coefficients are less developed countries. These may lack the government and financial infrastructure to redistribute income effectively, or their governments may lack the willingness to do so - it may be part of their ideology to prefer a particular élite. This is not invariable however: the Republic of Niger, with a coefficient of 34, is, on this measure, more equitable than Portugal. The explanation for such circumstances in a low-income country could be partly due to the fact that, in the words of one economist, 'It is easy to distribute nothing equally.'

For the 30 years from 1978 to 2008 international trade growth played an ever-increasing role in global economic growth, with export growth often outstripping increases in global output (see Figure 1.1). In 2009, however, there was a global downturn in both economic growth and international trade. 1. Does the data support the view that export growth often outstrips increases in global output'? 2. Explain why a global downturn in economic growth may be accompanied by a downturn in international trade

1. The data does largely support the view that export growth grows faster than global output. In the case of 10 out of the 11 years shown, the rate of growth of exports was greater than the growth of GDP. The exception is 2001, which witnessed a rise in GDP but a fall in exports. 2000 saw the greatest difference in growth rates and 2008 the smallest difference. 2. A global downturn in economic growth would be expected to reduce both imports and exports. If output, incomes and employment are falling, firms will demand fewer raw materials and capital goods, and households will demand fewer consumer goods. With less economic activity, fewer products will be traded internationally.

In recent years the eurozone (the group of countries that have adopted the euro) has been increasing in importance as a market for Chinese producers. Indeed, Chinese imports into the area increased by 31 per cent from 2009 to 2010; in 2007 China overtook the UK as the most important source of imports into the eurozone. Chinese producers are breaking into markets for not just consumer goods but also increasingly into markets for capital goods. The recently agreed deal with EDF for the Hinckley Point nuclear power station (September 2016), in which China's nuclear industry has a stake, shows a movement in high-technology capital investment. 1. Does the passage indicate that UK exports to the eurozone fell in 2007? Explain your answer. 2. Analyse two reasons why Chinese exports to the eurozone may have increased in 2010.

1. The passage does not necessarily indicate that UK exports to the eurozone fell in absolute terms. What it states is that China overtook the UK as the most important source of imports. What may have occurred is that both China and UK exports increased but Chinese exports increased more rapidly. 2. Two possible reasons why Chinese exports to the eurozone may have increased are a rise in the relative quality of Chinese exports and an increase in incomes in the eurozone. A rise in the relative quality of Chinese exports would have encouraged consumers in the eurozone to switch their purchases from products produced in their own countries towards Chinese products. If incomes increased in the eurozone, consumers may have purchased more products from a range of countries, including China.

Indonesian governments have used a variety of policy measures in a bid to reduce poverty in the country. These measures have included providing cash subsidies to the poor to help them cope with rising food and fuel prices and job creation schemes including those linked to infrastructure projects. Critics of Indonesian government policy argue that it would be more effective to increase the number of years' education the country's children receive. They argue that the national average education of less than seven years' schooling is a major cause of poverty. 1. Why are the poor more adversely affected than the rich by rises in food prices? 2. Discuss whether cash subsidies given to the poor to cope with rising prices or job creation schemes would be more likely to reduce poverty. 3. Explain why a lack of education may be a major cause of poverty.

1. The poor are more adversely affected than the rich by rises in food prices as they spend a higher proportion of their disposable income on food. Indeed, in Indonesia most poor people spend a quarter of their earnings on food. 2. Job creation schemes have the potential to be more effective in reducing poverty than cash subsidies given to poor people. The cash subsidies raise material living standards in the short term but they do not provide an opportunity for people to move out of poverty in the longer term. This is similar to the Oxfam TV advert in which it is said, 'Give a man a fish and you feed him for a day; teach him to fish and you feed him for a lifetime.'Unemployment is an important cause of poverty. Job creation schemes improve workers' chances of gaining long-term employment by providing them with work experience, training and confidence. A rise in employment is likely to have a knock-on effect. The people who gain jobs will spend more which, in turn, will create more jobs. 3. A lack of education can be a major cause of poverty as it reduces people's chances of gaining a job. If potential workers lack the necessary skills, they will find it harder to gain employment. The children of the unemployed tend to have their employment chances harmed. This is because their aspirations are likely to be lower, they may receive less education themselves, and may not enjoy very good health as they have been brought up in poverty. Even in LDCs opportunities for employment where few or no specific skills are required are diminishing.

In Asma in India there are approximately 300 000 weavers, most of whom work at home. They are poorly paid, earning on average $0.8 a day. Many of the workers lack basic education and are too poor to invest in power looms. The number of weavers has declined dramatically over the last 10 years. Some former weavers have found other jobs, but many are unemployed. The clothes made with the yarn the weavers produce are being replaced by western-style dress produced abroad and by clothes made in other parts of India using more advanced equipment. 1. Explain two possible costs of globalisation touched on above. 2. Discuss whether these costs are the result of globalisation.

1. Two costs of globalisation touched on in the passage are downward pressure on some wages and unemployment in some occupations. The passage mentions that the weavers in Asma are very low paid and that many weavers have lost their jobs. 2. Downward pressure on wages and higher unemployment in some industries may be the result of globalisation. Greater freedom of international trade, reduced transport costs and a greater taste for foreign products may mean that demand for certain products, and the jobs linked to those products, may flow from one country to another. The low wages and unemployment, however, are not necessarily entirely the result of globalisation. The passage mentions that the workers in Asma lack basic education and work with poor equipment, while workers in other parts of India work with better equipment. This is resulting in Asma losing out not only to foreign clothes producers but also to other Indian producers. Even without greater international trade, the weaving industry in Asma would be in decline.

Explain the factors that influence a country's international competitive position.

A country's international competitive position is influenced by a number of factors and a key one is the productivity of the labour force. If a country's labour force produces a high output per hour, unit labour costs will be low. High levels of capital investment can raise productivity and the quality of products produced, and increase the productive potential of the country. Indeed, investment in appropriate industries and in capital equipment that embodies advanced technology is likely to improve a country's price and quality competitiveness. To take full advantage of more advanced technology it is important that the workers are well trained and educated so that they can get the most out of the equipment they use. Good-quality education and training will make the labour force enterprising and adaptable, which may enable a country to retain or improve its international competitiveness. Increased spending on research and development is likely to improve methods of production, and thereby reduce unit costs and improve the quality and range of products. Unit labour costs will also be lowered by increased investment. Three further influences on international competitiveness are the inflation rate, the exchange rate, and marketing ability. A relatively high rate of inflation and a high exchange rate will tend to reduce a country's price competitiveness by making its products more expensive relative to its competitors' products. The fact that a product may be attractively priced and of good quality does not ipso facto guarantee sales - it has to be skilfully marketed.

Floating exchange rate system

An exchange rate system in which the value of the exchange rate is determined by market forces, without government intervention, is known as a floating exchange rate system. In such a system the value of a currency can alter constantly. -Advantages of a floating exchange rate system: There are two main advantages claimed for a floating exchange rate system, and they are linked: - A floating exchange rate system transforms the exchange rate from a target into a policy tool. Instead of adopting policies to maintain the exchange rate at a set level, a government can let the rate float down when the country's products are uncompetitive. - A floating exchange rate system should ensure a current account balance in the long run, and so a government would not have to hold reserves of foreign currency. For example, if the UK has high inflation, demand for pounds will be low as export sales will be low, but the supply of pounds will be high as UK nationals will be buying a large quantity of imports. The value of the pound will then fall, so the price of exports will increase, restoring a current account balance. In other words, a floating exchange rate should be self-correcting. The second of these works better in theory than in practice. Deficits can still arise because of capital movements and because a government is unlikely to allow sharp falls in the exchange rate as these can contribute to inflation. In practice, managed floating or flexibility is sometimes adopted.

The effects of poverty

Being poor reduces a household's educational opportunities and increases their risk of ill health. When households are poor they cannot afford to spend much on education and training. The children of the poor are less likely to have a PC at home, are likely to have fewer books at home, less likely to go on school trips, less likely to go to university and are likely to have lower aspirations. In this way poverty can breed poverty, becoming self-perpetuating and self-reinforcing. There is at the moment (October 2016) in the UK an acrimonious debate about the planned expansion of the grammar school system. The reason given for the decision is to widen access to a certain type of school education to a wider range of income groups, but it is regularly pointed out that existing grammar schools tend to attract few children from low-income families. Reductions in government subsidies for evening classes have led to fee rises and possibly taken this option out of range for some, and so reduced the range of provision. The poor also tend to suffer impaired mental and physical health. They have higher-than-average rates of suicide, depression, heart disease, respiratory problems and cancer, and they die younger. This is explained as the result of an income insufficient to buy healthy food, so low-income households rely on food that provides bulk but not so much nutritional value. Furthermore, the problems associated with poverty may be alleviated by the temporary comfort of tobacco, alcohol, sweets and cakes. As with the previous point, lack of education may mean that low-income households are less likely to seek access to information about sustaining healthy lifestyles. The poor also have more difficulty accessing a range of services. For example, people who cannot afford to run a car will find it difficult to visit various places of entertainment or go to the out-of-town superstores that often sell food more cheaply than supermarkets based in town, city and village centres.

Discuss why, despite the advantages of free international trade many countries impose tariffs and other forms of trade restrictions.

Countries impose import restrictions for a variety of reasons. One is to protect infant industries until they have grown large enough to compete with foreign firms on equal terms. Some countries also seek to protect industries at the other end of their lifespan to allow them to decline gradually and so avoid sudden unemployment. A government may also impose import restrictions in order to protect strategic industries, such as the arms industry and agriculture, or to protect an industry against unfair competition. One common form of unfair competition is dumping. This involves a country selling products in foreign countries at less than cost price. There are additional reasons for imposing import restrictions that do not relate to particular industries. One is to abide by the rules of a customs union, common market or economic union that imposes a common external tariff. A government may also seek to improve its balance of payments position (that is, the difference between money entering a country and money leaving it) by reducing demand for imports. However, this motive risks retaliation. If other countries do impose import restrictions, the country's exports will fall and its balance of payments position will not improve. Import restrictions may be imposed to ensure that a range of industries can survive and so the country will not be vulnerable to shifts in demand and supply. If a government believes that its resources have been misallocated it may think that it needs to impose import restrictions while it restructures its industrial base. Import restrictions can improve a country's terms of trade. This is because foreign firms may cut their prices after the imposition of tariffs in order to remain competitive. In this case the country will obtain its imports more cheaply. Tariffs may also be used by a country or trading bloc to raise revenue.

Factors affecting international competitiveness

Four key factors that affect international competitiveness are relative costs of production, inflation, the exchange rate and marketing skills. - Relative costs of production are in turn influenced by a number of factors. An important influence is the level of, and changes in, the productivity of the labour force. Countries with high and increasing output per worker hour will tend to have low unit costs and produce products of a high quality. High-quality education and training will lead to high labour productivity, more so if that education and training is directed at skills required by the structure of the economy. In the UK the frequent adjustments to the National Curriculum, and changes to the GCSE and A level examinations, lead in this direction, as UK employers often complain that job applicants, even if well-educated, lack the skills to become productive. A poor transport system will increase firms' costs and thereby reduce their price competitiveness. Indeed, many believe that one of the main ways by which UK international competitiveness could be improved would be by upgrading the country's transport infrastructure and so reducing transport costs. Defenders of the expensive HS2 railway in the UK argue that it will have a significant effect on the economy of the regions connected. - The price competitiveness of a country's firms will also be adversely affected by relatively high inflation. If the country's inflation rate is above that of its rivals, it will export less and import more. - The exchange rate also influences a country's international competitiveness. A rise in the exchange rate will influence the terms of trade by increasing export prices and lowering import prices. - How well a country can market its goods contributes to its competitiveness. It is often commented that in the UK the lack of interest in learning other languages holds back the UK's ability to sell its products abroad. Whereas it is largely true that many of the UK's potential customers are proficient in English as a second language, it is known that a deal is more likely if the customers are addressed in their own language. The increase in Mandarin lessons in school timetables lies not mainly in a desire to tap into China's cultural richness, but to be able to do business with a major emerging economy. There are many stories of British linguistic incompetence having an adverse effect on competitiveness. Some are probably apocryphal, but their very existence serves as a warning of a genuine problem. There is, for example, the case of a UK manufacturer of hairspray which attempted to market its brand in Germany, but did not bother to change the product's name, 'Silver Mist'. Dismayed by the product's failure to sell, they discovered only then that in German mist means cow dung.

Governments

Globalisation affects national governments' macroeconomic policies. A relatively high number of MNCs have revenues that are higher than the GDPs of many countries. The increased competition arising from globalisation is limiting all governments' ability to raise taxes in order to finance government spending, for instance on pensions and education. This is because some firms and some workers may leave the country if tax rates rise above those operating in other countries. This potential downward pressure on tax revenue can result in what is sometimes referred to as social dumping. This means that a reduction in a government's ability to raise revenue can result in a decrease in the quality of social services. The constraint on government spending is made more significant as a result of the need for workers to be as flexible and productive as possible in an increasingly competitive world. To enhance workers' educational levels and skills, and to help those who have difficulty coping with change, may require government spending. The ability of firms to move their production from one country to another can result in a sudden increase in employment in one country while there is a rise in unemployment in another country.

Factors influencing patterns of trade

In addition to changing relationships of comparative advantage, explained earlier in this topic, there are some other factors which can influence the pattern of trade: - The increasing ability of emerging economies to produce goods and services which are of a competitive quality and price leads to their gaining a larger share of world trade. There are also changing patterns within the emerging economies themselves. India is now playing a larger role in world trade, as China, becoming wealthier, faces rising production costs. Standard models of economic development assert that as countries develop economically, they move from primary (agricultural) to secondary (manufactures) to tertiary (services) goods. As emerging economies become adept at manufacturing and gain a comparative advantage, the long developed high-income countries place more emphasis on their service industries and so import, rather than export, secondary goods. - Since the formation of the European Community (since 1993 the EU), there has been a trend in world trade for countries to form trading blocs (see below), or make bilateral deals (i.e. a deal with one other country). The internal advantages enjoyed by such blocs, for instance no internal tariffs (a tariff is a tax imposed on imported good), has moved the pattern of trade more toward intraregional activity. - Variations in exchange rates may affect patterns of trade. Briefly, when a country's exchange rate falls (e.g. when the rate of sterling to dollars changes from £1 = $1.50 to £1 = $1.30, the kind of movement seen just after the UK EU referendum result in June 2016), that country's producers will find that its exports become cheaper and so should be easier to sell, and imports become more expensive. So, at the time of writing it is reasonable to expect to see a rise in UK exports but a fall in imports

Summary for International competitiveness

In this topic you have covered some of the measures of international competitiveness, examined the UK's international competitiveness, and considered some government policy measures to raise international competitiveness together with a consideration of the significance of international competitiveness. The key points are as follows: - Among the measures of international competitiveness are relative export and import prices, unit costs, share of world trade, relative profitability and composite measures. - A country's international competitiveness is influenced, among other factors, by the productivity of its labour force, capital investment, infrastructure investment, inflation rate, standard of its education, training, research and development, and the exchange rate. - Owing to changes in its competitive performance, the UK is producing fewer low-value manufactured goods and a greater number of high value-added manufactured goods and services. - Among the policies a government may use to increase its country's international competitiveness are privatisation, deregulation, cuts in direct taxes, improvements in transport infrastructure, education and training, and a reduction in the exchange rate. - A rise in international competitiveness should raise aggregate demand which, in turn, may result in lower unemployment and higher living standards.

Summary of Globalisation

In this topic you have examined the factors contributing to globalisation and the effects that globalisation is having. The key points are as follows: - A global market is developing due to the removal of trade barriers between countries, advances in technology, the growth of MNCs, a rise in skill levels in many countries, reduced transport costs and increased capital mobility. - Globalisation is increasing the information that consumers have and the choices available to them, and is putting downward pressure on the prices they face. - Globalisation is changing firms' marketing strategies, production methods, location decisions and the sources of their resources. The increased mobility of firms is putting pressure on workers to be flexible and mobile. - Globalisation is resulting in some tax competition, which limits governments' ability to raise tax revenue and so influences how much they can spend. - Economies are becoming more interdependent and so external shocks can have a significant effect on the global level of economic activity.

International competitiveness

International competitiveness refers to the ability of a country's firms to compete in the world market. Firms are internationally competitive when they produce the products that people in their domestic market and foreign markets want, in the quantities they want, and at prices they are willing to pay. So to be internationally competitive, firms have to keep their costs and prices relatively low and their quality high, and must keep in touch with consumer demand. If firms are not internationally competitive, they will go out of business or will need to be supported by subsidies or import restrictions. -Measures of international competitiveness: There are a number of measures of international competitiveness. These include relative export and import prices, and unit costs. - If export prices rise relative to import prices, this will reduce the price-competitiveness of the country's products. - Similarly, a rise in relative unit costs (i.e. the total cost/number of units produced), perhaps due to slower productivity growth than in other countries, will reduce price-competitiveness. Other measures of competitiveness include changes in a country's share of world trade and relative profitability. There are also composite measures based on a number of indicators. For example, the Institute for Management Development (IMD) and the World Economic Forum (WEF), both based in Switzerland, produce 'league tables' of international competitiveness.

Assess whether globalisation is 'good or bad for the poor'.

It is debatable whether globalisation is good or bad for the poor. Some economists argue that key features of globalisation, particularly advances in technology, trade liberalisation and the growth of MNCs, can benefit the poor in both developed and developing countries. The idea is that advances in technology and trade liberalisation will increase productivity, output and incomes. The resulting higher demand will increase employment opportunities and raise government tax revenue, some of which can be spent on measures which will reduce poverty, such as education and training. The growth and spread of MNCs may enable developing countries to pick up new technology and new working methods. However, other economists argue that the move towards global markets in products, capital and labour is benefiting some in developed economies at the expense of the low-skilled in developed economies and many in developing economies. The low-skilled workers in developed economies may lose their jobs and those that retain their employment may see their wages fall. Removing tariff barriers has resulted in some industries in developing economies contracting and has made some countries more vulnerable to economic shocks. Trade liberalisation and the use of floating exchange rates have also caused some developing countries' exchange rates to fall. This has caused the price of imported food to rise, which has hit the poor particularly hard. In addition, the presence of MNCs has not always been beneficial to the poor in developing countries. Many have failed to find well-paid jobs in MNCs because of their lack of skills. Some have suffered from the damage caused to the environment by MNCs. The emigration of skilled workers from developing countries may also have reduced the potential output of the countries they have left and made it more difficult for the poor there to increase their living standards.

Patterns of trade

The UK's main categories of exports and imports of goods are finished manufactured goods, semi-manufactured goods, fuels and food and drink. The country is also a major exporter of services and is, indeed, the second highest earner behind the USA. The UK's three main trading partners in terms of exports (2014 figures) are the USA, Germany, and the Netherlands, and in terms of imports, Germany, China, the Netherlands, and the USA. The main area the UK trades with is the EU: 44 per cent of its exports go to, and 53 per cent of its imports come from, other EU countries (2015). The UK is a relatively open economy, which means that it exports quite a high percentage of the products it produces and imports quite a high percentage of the products it consumes. Most international trade still takes place between developed economies, but recent years have seen a rise in the importance of China and India as global traders. China is selling more and more manufactured goods throughout the world, and India is becoming a major exporter of backroom and IT services. Table 2.4 shows that by 2008, China had become the third largest global importer and had overtaken the USA to become the second largest exporter.

Causes of poverty

The causes of poverty include the following: - Unemployment: This is a major cause of poverty throughout the world, especially in countries where the population of working age is greater than the level of economic activity can sustain. - Low wages: Not all countries have minimum wage legislation, and of those that do the levels in some cases are very low. As stated in the previous section, MNCs sometimes seek to establish themselves in countries where paying low wages remains possible - although increasing awareness of such practices among MNCs' affluent customers is putting pressure on this behaviour. In subsistence economies, households may produce very little surplus, so little is available for sale to generate income. - Low or no state benefits: If state benefits are low or non-existent, those sick, disabled and elderly who do not have relatives able or willing to support them will experience poverty. Even in countries with benefit systems, qualification criteria may exclude certain categories of the poor. - Poverty trap: This occurs when people's disposable income falls when they gain a higher wage or work more hours because they pay more tax and lose benefits. In the UK the poverty trap has lessened, especially since a substantial rise in the allowable amount of tax-free income (tax year 2016/17, £11 000). The employment trap is still a problem. This is where working becomes unviable because loss of benefits plus travel costs results in a lower overall income. The regular rise in public transport fares in the UK is seen as a discouragement to the mobility of people on low incomes. - Difficulty in accessing childcare facilities: Lone parents may find it difficult to enter the labour force because they cannot afford to pay to have their children looked after when they are working.

Disadvantages of a floating exchange rate system

The disadvantages of a floating exchange rate include the possibility of wide fluctuations in the exchange rate. The resulting uncertainty about the future value of the currency and other currencies may reduce trade and foreign direct investment. It is common for imports, especially raw materials, to be ordered some time in advance of their use (a chocolate manufacturer will not wait until just before Easter to arrange delivery of its cocoa to make chocolate bunnies). But when would be the best time to pay for it - when it's ordered, or when it's received? If the exchange rate is volatile, firms will not know when it would be most advantageous for them to settle their invoices. There are ways round this (forward trading, hedging - to be covered in Unit 10 Topic 3) but that involves guesswork and expense too. However, floating exchange rates do not always fluctuate widely and, under a managed float, a government may intervene to keep the exchange rate relatively stable. Risks and uncertainty are also not limited to a floating exchange rate. The value of a currency can change occasionally, even under a fixed exchange rate system, although this does not happen frequently. There are risks too under a fixed exchange rate system in that interest rates (see above) and tax rates may be changed to maintain the value of the currency. For example, corporation tax may be lowered to attract investment funds into the country; income tax may be raised to reduce overall consumption, which includes imports. It is sometimes argued that a floating exchange rate system removes the pressure on central banks to reduce inflation because, even if prices are higher than competitors' prices, a fall in the exchange rate will restore the country's competitiveness. However, a central bank is unlikely to allow a large fall in the exchange rate as this would itself have inflationary effects, and export sales would have to increase to pay for the same volume of imports. There may also be a 'ratchet' effect. A fall in the exchange rate tends to push up wage claims as the rise in import prices pushes up the cost of living. Workers do not, of course, agree to pay cuts when the exchange rate rises and import prices fall. Fluctuations in the exchange rate can therefore push up wages. These effects depend on the extent to which an economy is import-dependent. As you saw earlier in this topic, the UK regularly has a current account deficit, to a large extent due to importing. There was widespread economic anxiety that the fall of the exchange rate after the 'leave' vote in the EU referendum in June 2016 would lead to a rise in prices for domestic households. CPI inflation fell slightly in October 2016, but at the time of writing there is still a feeling among economists that an upward trend is inevitable.

Increased interdependence

The increased integration of economies makes them more susceptible to external shocks. A problem in one part of the world or in one significant economy can have a knock-on effect globally. In 1997 a financial crisis that started in Thailand spread throughout East Asia as banks and businesses collapsed and aggregate demand fell. In 1998 the crisis affected a number of Latin American and Eastern European countries as share prices fell and banks became more cautious in their lending. The EU and the USA avoided going into recession, but their economies did experience a decline in their rate of economic growth. Eleven years later the financial crisis which, as already noted, started in the USA, also resulted in the collapse of banks and other firms and a fall in share prices. This time, however, the effect was more serious, sending many countries into recession. External shocks are not solely economic in origin. The terrorist attacks in the eastern USA, known as 9/11, had economic repercussions. Many Americans became anxious about flying, so tourism industries throughout the world were affected. It remains to be seen whether the election of Donald Trump as US president - who in his campaign favoured a more protectionist approach to trade, and a more aggressive attitude to Iran - along with the continuing civil war in Syria will have widespread economic effects. The closer the connections between economies, the more vulnerable the whole system becomes to any downturn in a major economy. It has been estimated that a 1 per cent decline in US economic growth can cause a 0.16 per cent decline in other countries.

Evaluate three policies a government could implement to enhance its country's international competitiveness.

There are a number of policies a government could implement to enhance its country's international competitiveness. One is to encourage foreign direct investment. Multinational companies tend to use advanced technology, up-to-date management techniques, high-quality training and have low unit costs. They also contribute directly to the country's output and exports, and their presence may also stimulate domestic producers to increase their efficiency in order to remain competitive in their home market. Domestic firms may be encouraged to adopt some of the technology and methods of production they observe MNCs using. Technology transfer may also occur if MNCs demand higher standards from the country's component firms and help them to achieve these. However, MNC output and investment, or at least part of it, may just replace domestic output and investment. Some direct foreign investment may involve the takeover of existing assets, such as the purchase by a US car company of an existing UK car plant. MNCs may also seek to protect information about the technology and methods of production they use and may buy their components from firms outside the country. Another policy is to increase government spending on education and training. Improvements in education and training should raise labour productivity which, in turn, will reduce unit costs, improve the quality of what is produced and increase innovation. However, it is important that the spending is successful in raising education and training standards, and that education and training are available throughout a person's working life. Countries that have invested significantly in education and training do tend to be internationally competitive. For example, in recent decades Germany, which has a good record in vocational training, has had a good trade performance. A third policy is to increase the role of market forces by transferring assets from the public to the private sector. Supporters of privatisation argue that firms become more efficient when they are subject to market forces in both product and capital markets. If they do not produce what people want at the prices they are willing to pay, firms will go out of business. If, in contrast, they produce at a low cost high-quality products that are in high world demand, they will earn high profits. So the firms will have the pressure and the incentive to be efficient. In practice, though, market failure may occur. A privatised firm may gain a monopoly position at home, but may not keep its costs down and may not spend much on research and development. However, with the breaking down of the barriers on the movement of capital and products between countries, it is becoming increasingly more difficult for inefficient monopolies to survive.

Government policy measures to reduce poverty

There are a number of policy measures a government may use to reduce poverty: - Introduce employment-creating measures: As noted above, unemployment is a major cause of poverty. For instance, if there is cyclical unemployment, a government may try to stimulate aggregate demand by, for instance, increasing government spending. Present UK government thinking (2016) is to finance infrastructure improvement: this creates construction employment, and should spur further employment growth in other sectors. The contentious HS2 railway is supported on the presumption that it will create further growth and therefore job opportunities. - Improve education and training and create apprenticeship opportunities: This is a long-term measure but raising the skills and qualifications of the population should raise people's employment chances (occupational mobility), productivity and income. Regular changes to the National Curriculum and GCSE and A level examinations are, it could be argued, aimed less at developing personal intellectual satisfaction than at sharpening skills sought by employers and the changing structure of the economy. - Provide subsidised childcare places: This would enable lone parents to enter the labour force. - Give financial assistance to firms: This would enable them to adapt their premises to enable more disabled people to work. There have been various government schemes to reward firms financially who take on young workers or the long-term employed. - Cut the marginal rates of direct tax: The thinking behind this measure is that some unemployed people will be encouraged into work by the rise in net pay and that entrepreneurs will be encouraged to expand their businesses and take on more workers if income tax and corporation tax are reduced. However, there is no guarantee that unemployed people will have the necessary skills to fill any vacancies, nor that entrepreneurs will expand their activities. - Increase provision for those unable to work by redistributing income: The rich can be taxed in order to provide financial assistance to the sick, disabled and elderly. There is a kind of 'conservation of matter' thinking about taxation - that a reduction in one area is compensated for by a rise elsewhere - so the reduction in income tax for low-income earners can be paid for by raising the tax for those on high incomes. This was the thinking behind the much criticised 50 per cent tax rate introduced by the former Labour government. - Set a level of minimum wage sufficient to move people above the poverty line: current government policy is to raise the rate to £9 per hour by 2020.

Causes of wealth inequality

Wealth is unevenly distributed for a number of reasons including the following: - Inheritance: A number of wealthy people have inherited their wealth. Even for those who are not very wealthy, inheritance is becoming a more significant factor because the rise in house ownership is increasing the average amount that people inherit. - Marriage: Wealthy people usually marry other wealthy people, and this increases the concentration of wealth. - Saving: In practice, it is much easier for wealthy people to save and it is also more rewarding for them as large sums gain a better return per pound saved. - Enterprise: A number of people have accumulated fortunes through starting up a business, for example Bill Gates, or undertaking very well-paid employment, such as the chief executive of a large MNC. A number of people have quickly gone from obscurity to great wealth through the writing of novels that captured the public imagination, the best known instance being J K Rowling and the Harry Potter books - Chance: In practice, this is not a very significant factor, but a few people become wealthy as a result of winning money through gambling, doing the National Lottery or the football pools, or holding premium bonds.

Trading blocs

While in recent years there has been a general reduction in trade restrictions, this has occurred mainly between groups of countries formed into regional trading blocs. There are four main ways in which a number of countries may group themselves to allow free trade between members: they can operate a free trade area, a customs union, a common market or an economic union. - A free trade area is a group of countries which have no tariff barriers on trade with each other, but which allow each member country to decide on its own tariff policy towards non-members. An example of a free trade area is the North American Free Trade Agreement (NAFTA). This was signed between the USA, Canada and Mexico in August 1993 but its continuation may be in question, depending on the trade policies to be followed by the next US President Donald Trump. - A customs union has no tariff barriers between members but imposes a common external tariff on non-members. An example of a customs union is Mercosur (Mercado Comun del Sur). The current full members are Argentina, Brazil, Paraguay, Uruguay and Venezuela, with Bolivia, Chile, Colombia, Peru, Ecuador and Suriname as associate members. - A common market goes a stage further in integration. It has the same features as a customs union but, in addition to the free movement of products, it also has the free movement of factors of production. In January 1993, the implementation of the Single European Act created a single market in the EU by removing barriers to the movement of workers and capital and remaining trade restrictions, including exchange control, and gave authorised financial institutions the right to operate anywhere in the EU. - An economic union goes further still and is the ultimate stage in integration. In an economic union members pledge themselves toward having one overall economic policy - effectively a harmonisation of their monetary, fiscal and labour market policies - and agree to adopt a single currency. This feature, monetary union, is discussed below. -Monetary union: Monetary union is one important aspect of economic union. An economic union is the most integrated trading bloc, with members harmonising their economic policies, with emphases possibly on labour law and tax harmonisation. Monetary union involves a number of countries operating one currency and having a common monetary policy. The idea of a single currency was first conceived in the late 1960s but it only came into being on 1 January 1999 with the introduction of the single currency, the euro, and the transfer of the control of monetary policy to the European Central Bank (ECB). Initially, 11 member countries (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain) signed up to the EMU. The members of the single currency are collectively known as the eurozone. Since 1999 more countries have adopted the euro: Cyprus, Estonia, Greece, Latvia, Lithuania, Malta, Slovakia, and Slovenia. Now any country joining the EU has to agree to adopt the single currency as soon as possible.

The UK's changing international competitive situation

With increasing competition from the Asian tigers (the fast-growing economies of East Asia, including Indonesia, Malaysia, Singapore, South Korea and Thailand) and other emerging economies, such as China and India in low-valued manufacturing, the UK economy is moving more towards high value-added manufacturing and service activities. Indeed, the UK can claim to have a comparative advantage in a range of high-skilled, high-knowledge areas, including the design and production of Formula 1 racing cars and the development and production of pharmaceuticals, finance and insurance. However, this approach is providing a number of challenges for the UK economy. In the high value-added manufacturing and services area, it still has to maintain its advantage relative to other developed economies, including the USA, Germany and the Netherlands. In order to do this, the UK has to improve its education, training and infrastructure. -Government measures to improve international competitiveness: There are several measures a government can take to increase the international competitiveness of its producers. A number of governments throughout the world have introduced supply-side policies in a bid to raise price and quality competitiveness. These policies have included programmes of privatisation and deregulation, introduced in the belief that efficiency is higher in the private sector. Governments have also cut direct taxes. This measure is designed both to encourage domestic entrepreneurship, innovation and capital investment, and to attract MNCs. If MNCs do set up in the country, they may bring improved methods of production, new ideas and more competitive pressure, all of which can contribute to the country's output and exports. Other supply-side policies designed to raise international competitiveness include measures intended to improve transport infrastructure and to raise the standards of education and training. A government that operates a fixed or managed exchange rate may reduce the exchange rate in a bid to make its products more price-competitive both at home and abroad. Exchange rate manipulation is not a long-term way to promote international competitiveness, however. Some of the effects resulting from measures introduced to lower the exchange rate may also have an adverse effect on international competitiveness. For instance, a cut in the rate of interest designed to reduce demand for the currency may contribute to inflationary pressure.

Workers

Workers are facing new challenges, opportunities and, some would say, threats as a result of globalisation. With a reduction in national boundaries between the movement of products and firms themselves, workers have had to become more flexible and productive. They now have to be able to adapt to changes in demand, and changes in technology and working methods. Those who are flexible and have appropriate skills, such as IT skills, face increasing world demand for their services. However, concern has been expressed that globalisation may lower wages and adversely affect working conditions as firms move in search of the lowest unit labour costs. For example, in 1993 there was disquiet in France when the MNC Hoover announced that its factory in Dijon was to close, with production transferred to its plant in Scotland. There were strong suspicions that lower labour protection and wage rates in the UK at the time were behind the move. There is also the problem of de-skilling in less developed countries. The UK's National Health Service has been criticised for recruiting medical staff from low-income countries, where wage levels are lower, that can ill afford to lose scarce medical staff. Conversely, it was argued that the introduction of a top band of 50 per cent income tax in the UK would lead to the emigration of highly-skilled people to countries with lower income tax rates.