Chapter 1: Introduction to the Global Economy
Today we live in a global economy where the economies of individual countries are
linked to each other and changes can have ripple effects on others. The linkages
between economies are stronger and more far-reaching than ever before with few
aspects of life that have not been affected by the waves of global influences,
especially being the case in a small economy such as Australia, which has embraced
the global economy and pursued integration.
From an economic point of view, the major indicators of integration between
economies include:
 International trade in goods and services
 International financial flows
 International investment flows and transnational corporations
 Technology, transport and communication
 The movement of workers between countries
Measuring the Size of Global Economy
Gross World Product – refers to the total level of economic activity worldwide, as
measured by the summation of total output of goods and services by all economies
in the world over s period of time, and then converted to a common unit of
measurement, e.g. USD.
It is based on the relative purchasing power parity (PPP), meaning the total market
value of all goods and services produced is adjusted for national variances in prices
and different exchange rates.
Since calculations of GWP began, the advanced economies made up the majority of
GWP until recently, in 2013 where 15% of the world’s population hold 50% of the
GWP, where as the other 85% hold the other 50% in the developing economies.
Measuring Economic Progress
Economic Growth – refers to increases in real output that is measured by changes in
real GDP over time, referring to the total value of goods and services produced in an
economy over a period of time adjusted for the rate of inflation.
Economic Development – a broad measure of welfare in a nation that includes
indicators of health, education and environmental quality as well as material living
standards. A measure of economic development is the Human Development Index
devised by the United Nations Development Program to measure the level of
economic development in countries, taking into account:
 Life expectancy at birth
 Levels of educational attainment
 GNI per capita
Drivers of Globalisation
 Technological advancements – led to improvements in transport and
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communications technologies facilitating…
The growth of TNCs – led to increase in global FDI flows, and sharing of
information between nations.
The De-regulation of the Financial System – has facilitated globalisation
process through domestic banking sectors, enabling freer flow of money
Trade liberalization – policies by nations removing the protectionist barriers
e.g. tariffs, increasing trade within the global economy.
The global consumer – demand for G + S has increased interactions between
nations, moving towards a global market place.
Indicators of Globalisation
1. Trade in goods and services – international trade in goods and services are
an important indicator of globalisation because it measures how goods and
services product in an economy are consumed in other economies around
the world. Trade in G+S has increased rapid in recent decades from almost
$US 9 trillion in 1990 to $US53 trillion in 2012. The size of the gross world
product is now over ten times it’s level in 1950 and the volume of world
trade has grown to almost 50 times its 1950 level.
Annual growth in value of trade has consistently been around twice the level
of world economic growth, but during downturns however the growth of
global trade has contracted faster than world economic output, highlighting
the greater volatility of trade compared with gross world product.
2. Financial Flows – international finance now plays a leading role in the global
economy because it’s crucial to many aspects of how modern economies
work. Finance is the most globalised feature of the world economy because
money moves between countries more quickly than goods and services or
people.
International financial flows have expanded substantially following financial
deregulation around the world, which in most countries occurred in 1970s
and 1980s. Controls on foreign currency markets, flows of foreign capital,
banking interest rates and overseas investments in share markets were lifted
with new technologies linking the markets of the world. Global finance flows
grow roughly ten times the rate of Gross World Product.
The major benefit of greater global financial flows is that it enables countries
to obtain funds that are used to finance their domestic investment, allowing
them to increase economic growth, than they would have been otherwise.
However, changes could also have significant negative economic impacts
with speculation causing volatility in foreign exchange markets and domestic
financial markets. It has been blamed for large currency falls and financial
crises in East Asia in 1997.
3. Investment and Transnational Corporations:
One measure of the globalisation of investment is the expansion of foreign
direct investment (FDI), involving the movement of funds that are directly
invested in economic activity or in purchase of companies. FDI flows have
traditionally favored developed nations, but in recent decades this is now
changing to developing nations from holding a quarter of the global total FDI
to over half in recent years. For the first time in 2012, developing countries
received more FDI flows than developed countries. FDI grows at
approximately 3 times the rate of the GWP.
Transnational corporations (TNCs) play a vital role in global investment
flows, bringing foreign investment, new technologies and knowledge to the
countries that they expand to. They will have production facilities, sourcing
inputs, manufacturing, packaging and marketing done in their comparatively
advantageous countries. They often bring foreign investment, new
technologies, skills and knowledge and job opportunities to countries and
often governments encourage TNCs to set up in their country through
supportive policies like subsidies or tax concessions. Since the early 1990s,
the number of TNCs has increased from 37 000 to 104 000.
4. Technology, transport and communication – technology plays a central role
in globalisation, in part because technological developments facilitate the
integration of economies:
a. Developments in freight technology facilitate greater trade in goods
b. Cheaper and more reliable international communications allow
provision of commercial services to customers around the world.
c. In finance and investment, technology plays key role in facilitating
globalisation through computer and communication networks that
allow money to move around the world in a fraction of second.
d. Modern TNCs could not function without the communications
technology of telecommunication and internet.
e. Advances in transport such as aircraft and high-speed rail allow
greater labour mobility and increased accessibility to the world.
Technology is an ultimate driver of globalisation because it acts as a tool,
which facilitates integration.
5. International division of labour and migration – refers to the specialization
of labour, focusing on the individual parts or operations of the production
process in order to increase economic efficiency and increase the level of
output. Globalisation has led to the international division of labour where
now the spatial distribution of production processes are past national
boundaries, leading to a large migration of workers between countries in
search of jobs. If the market for a specialist type of labour in one country
does not respond to higher incomes paid overseas, a ‘brain drain’ may occur,
which is the movement of professionals to overseas job markets, creating a
shortage for this type of skilled labour.
The World Bank estimates that there are almost 200 million people (3% of
world population) who have migrated to work in different countries in the
world. The movement of labour between economies appears to be
concentrated at the top and bottom ends of the labour markets. At the top,
highly skilled workers are attracted towards the richest economies such as
the US because of better pay opportunities available there and at the
bottom, low skilled labour is also in demand in advanced economies where it
may be difficult to attract sufficient people born locally to do certain types of
work e.g. require basic skills and not much language skills.
These trends in migration reflect an international division of labour where
people move to jobs where their skills are needed.
The international and regional business cycles
The international business cycle refers to fluctuations in the level of economic
activity in the global economy over time. The strength of the international business
cycle depends on the extent at which economies experience similar conditions, i.e.
the more countries experience similar conditions, the stronger the international
business cycle.
Factors that strengthen the international business cycle include increased trade and
financial flows, an increased role for international organizations, the growth of TNCs
and the spread of technology. Factors that weaken the international business cycle
are domestic government policies, exchange rates and structural factors within
domestic economies.
The more a country is integrated into the global economy, the increased likelihood
that they will be affected by changes in the international business cycle and for most
countries, domestic growth is stronger when the rest of the world is growing
strongly and weaker when the rest of the world is in recession.
The long run trend of the international business cycle is for there to be an increase in
global growth, however, the short run international business cycle fluctuates both
above and below this long run growth trend. These fluctuations can be categorized
into either upswings or downswings:
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Upswing (expansion) – occurs when there is an increase in global demand
and is characterized as a situation in which growth is above the long run
trend.
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Downswing (contraction) – occurs when there is a decrease in global
demand and is characterized as a situation which growth is below the long
run trend.
The extent of global economic synchronization has increased and a strong
relationship between the economic growth performances of the world’s major
economies is now evident. The US, Euro economies, Japan and Australia all
experienced a long period of moderate growth during the 2000s, followed by a sharp
collapse when the GFC hit in late 2008.
As a small open economy, the Australian economy is particularly affected by
economic growth rates overseas. The RBA has found 63% of changes in the level of
output in Australia can be explained by the changes in interest rates, growth levels
and inflation rates in the Group of Seven (G7) largest industrialized countries. Thus,
for Australia, international factors have more influence than domestic factors on
economic growth in any given year.
Regional Business Cycles – refer to the changes in economic activity in particular
geographic regions where economies are highly integrated, usually through a form
of economic integration. Regional business cycles strengthen the international
business cycle, with growth patterns in major regions having significant impacts on
global growth.
Factors Affecting the Transmission of Economic Conditions (Not in
Syllabus)
Trade Flows – if there is a boom or recession in one country, this will affect its
demand for goods and services from other nations. The level of growth in an
economy will have flow on effects on the economic activity of its trading partners.
Investment flows – stronger economic conditions in one country will make it more
likely that businesses in that country will invest in new operations in other nations,
increasing the flow of investment.
Transnational corporations – TNCs are increasingly powerful in influencing global
upturns and downturns in the global economy.
Financial Market and Confidence – consumer confidence and spirits of investors are
constantly influence by conditions in other countries shown by strong correlation
between movements in share prices of the world’s major stock exchanges.
Global Interest Rate Levels – monetary policy conditions in individual economies are
increasingly influenced by interest rate change in other countries.
Commodity Prices – global prices of key commodities such as energy, minerals and
agricultural products play a critical role in the general level of inflation in the world
economy, therefore having an effect on investment, employment, growth and other
features of the international business cycle.
International Organizations: International forums such as the Group of Twenty
(G20) can play an important role in influencing global economic activity. Discussions
can act as the unofficial forum coordinating global macroeconomic policy.
Economic Growth Differences Between Countries (Not in Syllabus)
Interest Rates – have a significant impact on level of economic activity and interest
rates differ between countries.
Government Fiscal Polices also have significant effect upon the level of economic
growth in the short to medium term and this differs between countries.
Exchange Rates – differ between countries and impact on the level of trade
competitiveness and confidence within economies.
Structural Factors - differ between economies and countries have different levels of
resilience in their financial systems, attitudes towards consumption and saving,
population growth and age distribution.
Regional Factors – some economies are closely integrated with their neighbors and
influenced by the economic performance of their major trading partners, while
others may be less.