THE NATION IN THE WORLD ECONOMY
• The integration of national economies into a global system of trade and investment provides opportunities for mutual
gains but conflicts over how to distribute gains
• Globalisation includes the integration of markets in goods and services and investment, while labour markets remain
largely national. Prices in markets for goods and services have converged but wages have shown no tendency
towards convergence
• Nations tend to specialise in the production of the G&S in which they are relatively low-cost producers. This changes
over time due to public policies
• This specialisation allows for mutual gains for the people of trading countries but the distribution may favour those with
superior bargaining power
• Within nations some sectors of the economy, and the owners of some factors of production, benefit while others lose in
short run. In long run, exploiting mutual gains from international specialisation and investment, and distributing fairly
depend on the institutions and policies adopted.
• Transporting costs fell due to revolutions in transport such as Suez Canal, expansion of railway in USA, steam ships.
There was also a revolution in farming technology- in the US new types of wheat, better machinery which made
farming more capital intensive and productive.
• Governments imposed tariffs to protect the incomes of farmers in France and Germany. Other countries like Denmark
encouraged their farmers to product other crops instead.
• Drawing on a tradition of cooperation, farmers responded to the incentives to produce milk, cheese and other
commodities that could not be transported cheaply over long distances. In turn, cheaper grain meant families could
increase spending on these dairy products.
• The world’s grain was now grown in places where it could be produced most efficiently. But tariffs fully prevented this
reallocation of resources. Manufactures welcomed the expansion of trade with the US but farmers of grain did not
• Globalisation is a process by which economies of the world become increasingly integrated by freer flow across
national boundaries of goods, investment, finance and labour (lesser extent). We also apply term to culture and ideas
• Off shoring is an important aspect- can take place within a MNC or with other firms.
• Basic concepts for the global economy: exchange means the possibility of mutual gains but conflict over distribution.
Competition leads to a Nash equilibrium but it may not be Pareto efficient nor fair
• The government may impose tariffs, use immigration policies, use capital controls(limits of transferring fin assets) and
use monetary policy. But it cannot enforce contracts and protect property rights globally
16.1 GLOBALISATION AND DEGLOBALISATION IN THE LONG RUN
• Merchandise trade is the trade in goods that are physically shipped across borders by road, air etc. Services commonly
traded across borders are tourism, financial services and legal advice. Many traded services make merchandise trade
easier or cheaper—shipping services, insurance
• 19th Century, UK became leading provider of these services as it was the most advanced industrial economy and had
a strong navy.
• To measure the extent of globalisation for G&S, we could consider trade volumes i.e. consider share of imports/exports
in GDP so we consider the growth of GDP as well. This gives us an upward tend.
• A second method is to measure the reduction in trade costs. These are transport costs, tariffs or other factors incurred
in trading between markets in two countries that mean that, for affected goods, the Law of one price will not hold
across each market. Trading between markets in two countries is costly. Smaller trade costs mean more globalisation.
• We consider a good made in one country and exported to another. Assume only 2 countries and none of the good is
produced in the consuming country so everything produced is traded. We plot the supply curve for the
producing(exporting) country which is a function of the price in that country. Then plot demand curve in the in the
consuming (importing) country which is a function of the price in that country.
• Let t be the cost of shipping a unit of the good from the exporting to the importing country. It is a measure of the price
gap between the price the good in the exporting country and the price of the good in the importing country.
• If the market is competitive, then the total cost of obtaining a unit of the good in the importing country will be the cost of
buying it in the exporting country, plus the trade cost. Price gaps are entirely due to trade costs. E.g. if the trade cost is
4.5 then Q=4000
• Globalisation benefits exporters and importers by bringing them closer together and increasing trade volumes so more
surplus.
,• Arbitrage explains why the price gap should tend to equal the sum of
all trade costs. If the price gap was higher than the total costs of
trade, traders would buy at a low price in export markets and sell at
a higher price in import markets and make a profit. This lowers the
supply in the export market(price increases) and increases the
supply in the import market(price falls). This continues until the price
gap declines to the trade cost and further arbitrage is no longer
profitable. A low price gap indicates a globalised world where trade
is cheap.
• Globalisation should lead to falling import prices and rising export prices. But if we witness these, it doesn’t mean that
globalisation has occurred. It could be that demand or supply if changing and the price gap remains.
• Some price gaps fell less sharply in late 19th century due to tariffs
• Protectionist policies measures taken by a government to limit trade; in particular to reduce the amount of imports in
the economy. Policies are designed to protect local industries from external competition. E.g. tariff, quota.
• Economists calculate trade costs why looking at a pair of countries e.g. if trade between Germany and France
increased but it did not increase between them and their other trading partners then this suggests declining trade costs
for this pair of countries.
• If we sum total trade costs each year for all major economies, we have an indicator of the process of globalisation
• Two separate periods of increasing global economic integration: Globalisation I extended from before 1870 until the
outbreak of the first world war in 1914 Globalisation II extended from end of second world war into the 21st century
- Post 1945 period was re-globalisation, slow initially and then accelerating after 1990. But, agriculture was protected
- From 1970, re-liberalisation of trade and transport improvements, tariffs were higher in lower income countries
16.2 GLOBALISATION AND INVESTMENT
• International capital markets follow a similar pattern- 19th century globalisation, interwar de-globalisation and late 20th
century re-globalisation.
• A country can spend more than it earns by borrowing from abroad. Similarly a country can decide not to use its savings
to finance domestic investment, and instead lend it abroad and earn a return on these foreign loans. In this case its
savings will exceed domestic investment, or (equivalently) its income will be higher than expenditure.
• We use BOP to track lending and borrowing. Imports represent payments from the domestic economy to the rest of the
world, while exports represent payments from the rest of the world to the domestic economy.
• If the records of transactions were complete, the balance would sum to zero because the source and use of each dollar
crossing an international border could be accounted for.
• E.g. If the home country imports more than it exports, then its residents are making more international payments than
they are receiving. Country has to borrow from another to cover the difference. Conversely if exports exceed imports
then its nationals must be lending to trading partners so they can pay for the exports. These loans are a use of foreign
exchange for the home country, and a source of foreign exchange for its trade partners.Thus a trade deficit will imply
that the country is borrowing, while a trade surplus implies it is lending
• Another reason why people pay someone abroad is the purchasing of assets in another country. This is portfolio
investment. FDI involves ownership/substantial control over assets abroad. Doing this means you earn dividends from
portfolio and profits from FDI which are repatriated to home country and so are a source of foreign exchange.
• Remittances (payments back home by migrants) and aid flows from gov are other international payments.
• The Current account is the sum of all payments made to a country minus all payments made by the country.
- CA= X-M+NINV=exports-imports-net earnings from assets abroad
- CA deficit means the country is borrowing in order to cover the excess payments it is making to the rest of the world
- N.b. we can have a trade deficit (imports exceed exports) but still have a current account surplus.
• Borrowing and lending tracked by the CA are called net capital flows. A country that is borrowing to fund deficit is
receiving a net capital flow i.e. is being lent cash. This increases foreign debt for the country. This is sometimes good
as the country can finance good investments.
• When countries trade more, they tend to borrow and lend more. If we consider the volume of capital flows, we see
during the late 19th century that there were large capital flows from northwest Europe e.g. UK, France and Germany
who had CA surpluses. They lent to countries like the US who invested in railways and exploiting abundant natural
resources During war, capital flows fell due to limits . These controls persisted until the 1970-80s
, • Looking at price gaps, we see the late 19th century saw significant globalisation in capital flows. This is because
previously the speed of information was very slow so traders could not act successfully on a price gap by arbitrage.
Only a large price gap could enable speculation. Telegram solved this.
16.3 GLOBALISATION AND MIGRATION
• Later 19th century- migration to US due to lower transport costs and higher wages. Immigration curbed during the
wars. Labour migration has not improved much. There are now more strict barriers to immigration following WWI.
• Wages have not converged e.g. cultural and language barriers
16.4 COMPARATIVE ADVANTAGE, SPECIALISATION AND THE GAINS FROM TRADE
• Most nations are part of a global economy characterised by specialisation and trade
• trade and specialisation provide the conditions necessary for each other- without specialisation there would be nothing
to trade
• Specialisation occurs when an economy produces a more narrow range of g&s than it consumes, acquiring the g&s
that it does not produce by trade.
• There are 2 influences on specialisation: comparative advantage, Head starts, and economies of scale and external
economies from co-location.
- e.g. Ukraine and Kansas have best climate and soil for grain, Germany has distinctive institutions which ensure
high levels of productivity and has economies of scale in manufacturing. Manufacturing industry is highly
competitive and Germany has a head start
• Economies of agglomeration are an external economy and the cost reductions for the entire industry that occur when
similar firms are located in the same area
• So specialisation results from a combo of history, geography, institutions, population
Comparative advantage
• Greta lives on wheat island and Carlos lives of Apple Island. The islands do not trade. The land on each island can be
used to grow what and apples and the people consume these two goods.
• Wheat Island has better soil for both crops- a year of labour produces more apples and wheat.
• Although Great can produce more of either crop, she can produce much more wheat than Carlos but only a few more
apples. Apple Island is especially poor for producing wheat.
• Greta has an absolute advantage (produce more with same input e.g.labour) in both crops but only has a comparative
advantage in wheat. Carlos is relatively good at producing apples, Greta will buy apples off him.
• Even though Carlos lacks an absolute advantage, he specialises in what he is least bad at and gets the other good he
needs through exchange. Greta specialises in what she is comparatively best at. Both benefit from specialisation and
trade
Diversification in the absence of trade
• We plot the feasible frontier for both- shows all the combinations that can be
produced in a year.
• We assume that FF is straight i.e takes same time to make an apple regardless of
how many apples have already been made. There is constant MP of labour.
• The FF is the same for consumption and production as each person consume their
produce
• This graph shows the outcome without trade- assume preferences are same
(same shape of IC)
Trade and specialisation on Wheat and Apple Islands
• For mutually beneficial trade, the relative prices determines whether there are mutual gains.
• The relative prices depend on the cost of producing which depends on the productivity of worker
• For Carlos to produce one more wheat, he has produce 2.5 fewer apples so the MRT between wheat and apples is 2.5.
• Since it takes the same amount of inputs to produce 1 wheat than 2.5 apples, relative price of wheat to apples is 2.5
• For Carlos, the relative price of apples to wheat is 400/1,000 = 0.4. For Greta, the relative price of wheat is 1.25 and
relative price of apples is 0.8
• Wheat Island has a comparative advantage in producing wheat as it can produce wheat relatively more cheaply than
Apple Island. Greta only has to give up 1.25 apples for 1 extra wheat whereas Carlos must give up 2.5
• Apple Island has a comparative advantage in apples
Gains from trade
• If there is no trade, the economies are closed so the feasible production frontier equals the feasible consumption
frontier. Total production was 8500 what and 8750 apples
• When specialising, Greta produces 10000 wheat and Carlos produces 10000 apples
• through trade, they can consume both goods
• The integration of national economies into a global system of trade and investment provides opportunities for mutual
gains but conflicts over how to distribute gains
• Globalisation includes the integration of markets in goods and services and investment, while labour markets remain
largely national. Prices in markets for goods and services have converged but wages have shown no tendency
towards convergence
• Nations tend to specialise in the production of the G&S in which they are relatively low-cost producers. This changes
over time due to public policies
• This specialisation allows for mutual gains for the people of trading countries but the distribution may favour those with
superior bargaining power
• Within nations some sectors of the economy, and the owners of some factors of production, benefit while others lose in
short run. In long run, exploiting mutual gains from international specialisation and investment, and distributing fairly
depend on the institutions and policies adopted.
• Transporting costs fell due to revolutions in transport such as Suez Canal, expansion of railway in USA, steam ships.
There was also a revolution in farming technology- in the US new types of wheat, better machinery which made
farming more capital intensive and productive.
• Governments imposed tariffs to protect the incomes of farmers in France and Germany. Other countries like Denmark
encouraged their farmers to product other crops instead.
• Drawing on a tradition of cooperation, farmers responded to the incentives to produce milk, cheese and other
commodities that could not be transported cheaply over long distances. In turn, cheaper grain meant families could
increase spending on these dairy products.
• The world’s grain was now grown in places where it could be produced most efficiently. But tariffs fully prevented this
reallocation of resources. Manufactures welcomed the expansion of trade with the US but farmers of grain did not
• Globalisation is a process by which economies of the world become increasingly integrated by freer flow across
national boundaries of goods, investment, finance and labour (lesser extent). We also apply term to culture and ideas
• Off shoring is an important aspect- can take place within a MNC or with other firms.
• Basic concepts for the global economy: exchange means the possibility of mutual gains but conflict over distribution.
Competition leads to a Nash equilibrium but it may not be Pareto efficient nor fair
• The government may impose tariffs, use immigration policies, use capital controls(limits of transferring fin assets) and
use monetary policy. But it cannot enforce contracts and protect property rights globally
16.1 GLOBALISATION AND DEGLOBALISATION IN THE LONG RUN
• Merchandise trade is the trade in goods that are physically shipped across borders by road, air etc. Services commonly
traded across borders are tourism, financial services and legal advice. Many traded services make merchandise trade
easier or cheaper—shipping services, insurance
• 19th Century, UK became leading provider of these services as it was the most advanced industrial economy and had
a strong navy.
• To measure the extent of globalisation for G&S, we could consider trade volumes i.e. consider share of imports/exports
in GDP so we consider the growth of GDP as well. This gives us an upward tend.
• A second method is to measure the reduction in trade costs. These are transport costs, tariffs or other factors incurred
in trading between markets in two countries that mean that, for affected goods, the Law of one price will not hold
across each market. Trading between markets in two countries is costly. Smaller trade costs mean more globalisation.
• We consider a good made in one country and exported to another. Assume only 2 countries and none of the good is
produced in the consuming country so everything produced is traded. We plot the supply curve for the
producing(exporting) country which is a function of the price in that country. Then plot demand curve in the in the
consuming (importing) country which is a function of the price in that country.
• Let t be the cost of shipping a unit of the good from the exporting to the importing country. It is a measure of the price
gap between the price the good in the exporting country and the price of the good in the importing country.
• If the market is competitive, then the total cost of obtaining a unit of the good in the importing country will be the cost of
buying it in the exporting country, plus the trade cost. Price gaps are entirely due to trade costs. E.g. if the trade cost is
4.5 then Q=4000
• Globalisation benefits exporters and importers by bringing them closer together and increasing trade volumes so more
surplus.
,• Arbitrage explains why the price gap should tend to equal the sum of
all trade costs. If the price gap was higher than the total costs of
trade, traders would buy at a low price in export markets and sell at
a higher price in import markets and make a profit. This lowers the
supply in the export market(price increases) and increases the
supply in the import market(price falls). This continues until the price
gap declines to the trade cost and further arbitrage is no longer
profitable. A low price gap indicates a globalised world where trade
is cheap.
• Globalisation should lead to falling import prices and rising export prices. But if we witness these, it doesn’t mean that
globalisation has occurred. It could be that demand or supply if changing and the price gap remains.
• Some price gaps fell less sharply in late 19th century due to tariffs
• Protectionist policies measures taken by a government to limit trade; in particular to reduce the amount of imports in
the economy. Policies are designed to protect local industries from external competition. E.g. tariff, quota.
• Economists calculate trade costs why looking at a pair of countries e.g. if trade between Germany and France
increased but it did not increase between them and their other trading partners then this suggests declining trade costs
for this pair of countries.
• If we sum total trade costs each year for all major economies, we have an indicator of the process of globalisation
• Two separate periods of increasing global economic integration: Globalisation I extended from before 1870 until the
outbreak of the first world war in 1914 Globalisation II extended from end of second world war into the 21st century
- Post 1945 period was re-globalisation, slow initially and then accelerating after 1990. But, agriculture was protected
- From 1970, re-liberalisation of trade and transport improvements, tariffs were higher in lower income countries
16.2 GLOBALISATION AND INVESTMENT
• International capital markets follow a similar pattern- 19th century globalisation, interwar de-globalisation and late 20th
century re-globalisation.
• A country can spend more than it earns by borrowing from abroad. Similarly a country can decide not to use its savings
to finance domestic investment, and instead lend it abroad and earn a return on these foreign loans. In this case its
savings will exceed domestic investment, or (equivalently) its income will be higher than expenditure.
• We use BOP to track lending and borrowing. Imports represent payments from the domestic economy to the rest of the
world, while exports represent payments from the rest of the world to the domestic economy.
• If the records of transactions were complete, the balance would sum to zero because the source and use of each dollar
crossing an international border could be accounted for.
• E.g. If the home country imports more than it exports, then its residents are making more international payments than
they are receiving. Country has to borrow from another to cover the difference. Conversely if exports exceed imports
then its nationals must be lending to trading partners so they can pay for the exports. These loans are a use of foreign
exchange for the home country, and a source of foreign exchange for its trade partners.Thus a trade deficit will imply
that the country is borrowing, while a trade surplus implies it is lending
• Another reason why people pay someone abroad is the purchasing of assets in another country. This is portfolio
investment. FDI involves ownership/substantial control over assets abroad. Doing this means you earn dividends from
portfolio and profits from FDI which are repatriated to home country and so are a source of foreign exchange.
• Remittances (payments back home by migrants) and aid flows from gov are other international payments.
• The Current account is the sum of all payments made to a country minus all payments made by the country.
- CA= X-M+NINV=exports-imports-net earnings from assets abroad
- CA deficit means the country is borrowing in order to cover the excess payments it is making to the rest of the world
- N.b. we can have a trade deficit (imports exceed exports) but still have a current account surplus.
• Borrowing and lending tracked by the CA are called net capital flows. A country that is borrowing to fund deficit is
receiving a net capital flow i.e. is being lent cash. This increases foreign debt for the country. This is sometimes good
as the country can finance good investments.
• When countries trade more, they tend to borrow and lend more. If we consider the volume of capital flows, we see
during the late 19th century that there were large capital flows from northwest Europe e.g. UK, France and Germany
who had CA surpluses. They lent to countries like the US who invested in railways and exploiting abundant natural
resources During war, capital flows fell due to limits . These controls persisted until the 1970-80s
, • Looking at price gaps, we see the late 19th century saw significant globalisation in capital flows. This is because
previously the speed of information was very slow so traders could not act successfully on a price gap by arbitrage.
Only a large price gap could enable speculation. Telegram solved this.
16.3 GLOBALISATION AND MIGRATION
• Later 19th century- migration to US due to lower transport costs and higher wages. Immigration curbed during the
wars. Labour migration has not improved much. There are now more strict barriers to immigration following WWI.
• Wages have not converged e.g. cultural and language barriers
16.4 COMPARATIVE ADVANTAGE, SPECIALISATION AND THE GAINS FROM TRADE
• Most nations are part of a global economy characterised by specialisation and trade
• trade and specialisation provide the conditions necessary for each other- without specialisation there would be nothing
to trade
• Specialisation occurs when an economy produces a more narrow range of g&s than it consumes, acquiring the g&s
that it does not produce by trade.
• There are 2 influences on specialisation: comparative advantage, Head starts, and economies of scale and external
economies from co-location.
- e.g. Ukraine and Kansas have best climate and soil for grain, Germany has distinctive institutions which ensure
high levels of productivity and has economies of scale in manufacturing. Manufacturing industry is highly
competitive and Germany has a head start
• Economies of agglomeration are an external economy and the cost reductions for the entire industry that occur when
similar firms are located in the same area
• So specialisation results from a combo of history, geography, institutions, population
Comparative advantage
• Greta lives on wheat island and Carlos lives of Apple Island. The islands do not trade. The land on each island can be
used to grow what and apples and the people consume these two goods.
• Wheat Island has better soil for both crops- a year of labour produces more apples and wheat.
• Although Great can produce more of either crop, she can produce much more wheat than Carlos but only a few more
apples. Apple Island is especially poor for producing wheat.
• Greta has an absolute advantage (produce more with same input e.g.labour) in both crops but only has a comparative
advantage in wheat. Carlos is relatively good at producing apples, Greta will buy apples off him.
• Even though Carlos lacks an absolute advantage, he specialises in what he is least bad at and gets the other good he
needs through exchange. Greta specialises in what she is comparatively best at. Both benefit from specialisation and
trade
Diversification in the absence of trade
• We plot the feasible frontier for both- shows all the combinations that can be
produced in a year.
• We assume that FF is straight i.e takes same time to make an apple regardless of
how many apples have already been made. There is constant MP of labour.
• The FF is the same for consumption and production as each person consume their
produce
• This graph shows the outcome without trade- assume preferences are same
(same shape of IC)
Trade and specialisation on Wheat and Apple Islands
• For mutually beneficial trade, the relative prices determines whether there are mutual gains.
• The relative prices depend on the cost of producing which depends on the productivity of worker
• For Carlos to produce one more wheat, he has produce 2.5 fewer apples so the MRT between wheat and apples is 2.5.
• Since it takes the same amount of inputs to produce 1 wheat than 2.5 apples, relative price of wheat to apples is 2.5
• For Carlos, the relative price of apples to wheat is 400/1,000 = 0.4. For Greta, the relative price of wheat is 1.25 and
relative price of apples is 0.8
• Wheat Island has a comparative advantage in producing wheat as it can produce wheat relatively more cheaply than
Apple Island. Greta only has to give up 1.25 apples for 1 extra wheat whereas Carlos must give up 2.5
• Apple Island has a comparative advantage in apples
Gains from trade
• If there is no trade, the economies are closed so the feasible production frontier equals the feasible consumption
frontier. Total production was 8500 what and 8750 apples
• When specialising, Greta produces 10000 wheat and Carlos produces 10000 apples
• through trade, they can consume both goods
