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Chapter 23 – Why do countries trade
What are gains from international trade
International trade: exchange of goods/services between countries. Gains include:
- Lower prices: buying goods/services at much lower prices and purchasing less
expensive raw materials. Prices may be lower in other countries because of their
access to resources, quality of labour, capital and technology
- Greater choice: Variety of products are available from a variety of countries
- Differences in resources: because some countries do not have access to many
resources they need to trade their goods to gain foreign currency to then buy the
products they need
o E.g., Singapore has to import everything, but in turn exports manufactures
goods/services
- Economies of scale: larger markets allow for larger production, specialization,
division of labour, gaining experience and expertise – generates efficiency and
competitiveness
- Increased competition: leads to greater efficiency and less expensive goods – quality
and variety of available goods increases
- Efficient allocation of resources: countries produce goods that they are best at
producing and do this at the lowest cost, thus being efficient – all the world’s
resources are thus being efficiently used
- Source of foreign exchange: trade enables other countries to receive foreign
currencies that they could then use to purchase goods from other countries
o Helpful for developing countries which have inconvertible currencies
Comparative advantage theory (HL)
Absolute advantage (HL)
- When a country can produce a good using fewer resources than another country output will be maximized when countries specialize – both will gain
- Reciprocal absolute advantage: occurs when each country has an absolute production
of one product
Comparative advantage (HL)
- When a country can produce a good at a lower opportunity cost than another country
– giving up fewer resources to produce the good
-
France should specialize in wine because it gives up less kilos of cheese,
and Poland should specialize in cheese because it gives up 1/3 liter of
wine
- Comparative advantage for the more efficient producer – when distance
between possibilities is the greatest (a), for the less efficient – when
distance is least (b)
How is comparative advantage used to illustrate gains from specialization and trade (HL)
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If there is a specialization a country can keep the good that it has not
exported and can import the good it is not good at producing – gain both
at lower costs – and vice versa
- Countries are able to consumer at a point beyond their PPCs – amount
of gain depends on exchange rates
Does the theory of comparative advantage always work (HL)
- Only works when there are different opportunity costs – if they are the
same there are no gains to be made from trade
What gives a country a comparative advantage (HL)
- Based on abundance of certain factors – land
agriculture, unskilled
labour production of manufactured goods, educated labour
financial services, beaches tourism – price of factor is lower than the
price of other factors – making opportunity cost pf things using that
factor be lower than in other countries
Limitations of comparative advantage (HL)
- Assumption of perfect knowledge of where the least expensive goods
may be purchased
- Assumption that there are no transport costs – those costs may erode the comparative
advantage and eliminate its competitiveness
- Normally assumes that there are two economies producing two goods – this however
can be overcome with technology and simulations – comparative advantage may be
found in multiple countries
- Assumption that costs do not change – economies of scale, however, do exist – costs
fall
- Non-identical goods – consumer durables – are harder to compare and see if a country
has a comparative advantage or not
o E.g., Japan’s Toshiba television vs Phillips television
- Factors of production do not necessarily remain in the country that has the advantage
– capital may be moved to developing countries instead
- Free trade might not necessarily be present – government trade barriers may be placed
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Chapter 24 – Free trade and protectionism
What is free trade
- Takes place between countries with no barriers – goods/services are moved freely
Arguments in favour of protectionism
- Protecting domestic employment: small domestic industries will not be able to
compete against foreign industries and thus structural unemployment could occur
o Weak argument because protection might just prolong the fall of industry
rather than help it
- Protecting economy from low-cost labour: workers in developing workers might be
losing their jobs against workers with lower wages in emerging countries
o Comparative advantage concept however is lost – domestic consumers pay
more than if they would import – the government should apply policies to help
its laborers instead of applying barriers
- Protecting an infant industry: small industries do not have economies of scale and
need time for it to develop
o In developed countries however many new industries already start efficiently
and already gain economies of scale – only developing countries can use small
industries as a reason
E.g., Saudi Arabian petrochemical production – have being working
with Chevron, BP – became the largest in the world
- Avoid risks of over-specialization: when a country focuses on exporting one-two
(primary) products then any sudden changes in demand/supply can be harmful to the
economy
o E.g., Rubber production in Malaysia – harmed by synthetic rubber, coffee in
Ethiopia – harmed by overproduction of coffee worldwide
- Strategic reasons: protecting industries that may be needed in an emergency – steel,
power
o Even if war occurs and countries need those resources it is likely they will still
have access to them – this argument is just an excuse
- Prevent dumping: selling large quantities of a product at lower price than its
production price – this harms producers in developing countries – anti-dumping
measures are then imposed
o Hard to prove if dumping has occurred + subsidies may also count as dumping
because they don’t reflect real costs = these would be solved through talking
rather than barriers
E.g., China blames EU, USA for dumping rubber, USA blames China
for dumping aluminum sheets
- Protect product standards: imposing safety, health, environmental standards on
imports – approved by WTO if there is scientific evidence
o Some claims may not be backed up by strong evidence; the cost in meeting
standards might be hard for those in developing countries = documentation
costs, approvals, creation = STDF is made to help those
US and EU hormone treated beef quotas of 20000/year (2009) that
increased to 45000/year (2012) and was banned previously in 1980
- Raise government revenue: developing countries put tariffs to get revenue
o Means to raise revenue – burden falls onto the domestic consumers
E.g., Lesotho % of governmental revenue from tariffs – 41.4% (2017),
Senegal – 11.2% (2017)
- Correct balance of payments deficit: put tariffs to reduce import expenditure
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o Works in the short-run and the issue is not fixed + other countries may also
impose similar measures
Arguments against trade protection
- Raised prices to consumers and producers of imports
- Less choice for consumers
- Reduced competition, firms become inefficient, innovation is reduced, export
competitiveness may be reduced
- Comparative advantage is distorted – inefficient use of resources; specialization is
reduced
- Trade war
- Economic growth may be hindered (see previous reasons)
Main types of protectionism
Tariffs
- Tax charged on import goods – supply shift upward by amount of
tax (World Supply curve)
o When supply is shifted domestic producers receive more
revenue – from g to g+a+b+c+h and foreign producers
receive less, from h+i+j+k to i+j and government receives
d+e
o Dead-weight loss – loss of consumer surplus at point f
o Dead-weight loss – loss of producer surplus at h+c – inefficiency of the firms
against the export producers – more resources are used than necessary
- Importers pay higher prices – it would thus increase costs of production, forcing
consumers to pay more, and thus reducing international competitiveness
o E.g., Car production
- Can be used as an anti-dumping measure
International trade subsidies
- Subsidy to domestic producers to make them competitive – S shifts to the right
o Producers produce at point Q3, revenue increases from a
to a+b+e+f+g, Exporters Q3Q2 revenue falls from b+c+d
to c+d, government pays at points e+f+g
o Dead-weight lost at points b+g – inefficient production
and allocation of resources – other producers would
produce at point b
o No consumer loss however in long-term they might have
to pay higher taxes to fund those subsidies
Quotas
- Physical limit on number/value of imported goods
o A quota is imposed on Q1Q3 point – therefore all imports at points Q3Q2 are
not allowed to be imported
o As price at point Q3 is higher at Pquota domestic producers begin increasing
production shifting it – demand falls to point Q4
o Domestic producers’ revenue = from a to a+c+d+f+i+j
o Foreign producers’ revenue = from b+c+d+e to b+g+h
o Dead weight loss – consumer surplus loss at k
o Dead weight loss – domestic producers produce at c+d+j – inefficient
allocation of resources
Administrative barriers
- Red tape: administrative process for imported goods – ports that are hard to reach,
lengthy paperwork, legal work = slows down imports
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Health, safety, environmental standards: restrictions on types of goods or on their
methods of production
- Embargoes: ban of imports – type of political punishment – normally sanctions are
put instead – one/few products that are limited to be exported/imported
o E.g., US embargoed Cuba, Crimea, Syria, Iran, North Korea
Nationalistic campaigns
- Marketing campaigns to encourage people to buy domestic products – moral suasion
– government links consumption of imports to creation of unemployment
HL – see page 376 for practice questions
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Chapter 25 – Economic integration
Economic integration
- Process where countries coordinate and link their economic policies – more
integration = less trade barriers
- Bilateral trade agreement: between 2 countries to reduce/remove tariffs/quotas
- Multilateral trade agreement: between multiple countries to reduce/remove
tariffs/quotas
Trading blocs and degrees of economic integration
- Trading bloc: Group of countries that joined in agreement to increase trade or gain
economic benefits = process is known as economic integration
- Stages of economic integration include:
1. Preferential trading areas: bloc that gives access to certain products from certain
countries = tariffs are reduced
o E.g., EU + African, Caribbean, Pacific Group of states – enables supply of raw
materials and special funds to achieve price stability
o Reciprocal trade agreement – duty-free access to goods and services to one
another – some ACP countries may choose not to open up to EU
2. Free-trade areas: countries trade in a free market but may trade however they like
with other countries
o E.g., North American FTA (1994) – USA, Canada, Mexico = tariff-free
region, where Canada exports 70% of its goods to USA, and Mexico’s share
of US imports grew from 7% to 13.5%
Other FTA’s include European FTA, South Asia FTA
3. Customs union: free-trade between countries and those countries adopt common
external barriers against any country that attempts to imports into the customs union
o E.g., EU, Switzerland-Liechtenstein, East African Community, Mercosur
(South America)
4. Common markets: customs union with common policies on product regulation and
free-movement
o E.g., EU, CARICOM – Barbados, Belize, Jamaica, Suriname
5. Economic and monetary union: common market, currency and central bank
o E.g., Eurozone that use Euro at their currency – Austria, Belgium, Latvia,
Malta…
Advantages and disadvantages of membership of a monetary union (HL)
- Advantages include:
o Exchange-rate fluctuation disappear – increases cross-border investment and
trade
o Large currency zone makes currency more stable against speculation
o Business confidence is improved – less ricks in trading – leads to growth
o Transaction costs are eliminated – no charges for changing currencies
o Price differences are more obvious – leads to them being equalized across
borders
- Disadvantages include:
o Monetary policy cannot be used by individual countries experiencing inflation
– other policies and measures need to be implemented
o Fiscal integration – common treasury, harmonized tax rates, common budget –
are needed to make the union stable
o Individual countries cannot alter their exchange rates to affect international
competitiveness of their exports or cost of imports
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o Costs to convert currencies – printing, taking out, converting databases and
software, rewriting lists and invoice system , re=pricing goods/services
- All depends on the situation: if there are large fluctuations of exchange rates –
common currency will be beneficial – if minimal fluctuation with high business
confidence, then common currency is not needed
6. Complete economic integration: individual countries have no control of economic
policy, full monetary union and harmonization of fiscal policy
o E.g., Eurozone is moving to become one
Advantages of membership of a trading bloc
All depends on the degree of integration!
- Advantages include:
o Greater market size gives potential to increase scale of production and gain
economies of scale – some will not be able to compete
o Greater efficiency, choice and low prices for consumers = result of increased
competition
o Attraction of investment to a larger market
o Free movement of labour = greater employment opportunities
o Greater political stability and cooperation
o Trade negotiations may be easier
o Customs union may create trade creation – entry of a
country into the union leads to the production of a
good/service from high-cost producer to low-cost
producer – has to be a two-way process (HL)
When a more efficient producer joins the union the
tariffs on it are relaxed and they are able to regain
world efficiency and consumer surplus
Disadvantages of membership of a trading bloc
- Disadvantages include:
o Trading blocs might enact discriminatory policies against non-members –
some international trade rules might be undermined and liberalized trade
might not be achieved
o Governments might lose their sovereignty – product regulation, trade
decisions, movement of goods, management of exchange and interest rates
o Customs unions may create trade diversion – entry of a country into the
union leads to production of good/service from low-cost producer to high-cost
producer (HL)
If UK imports from Thailand and then joins a customs union then the
tariff put on Thailand by EU shifts the supply upwards – inefficient
production from EU and UK create welfare loss and consumer loss
World Trade Organization (WTO)
- International organization that sets the rules for global trading and resolves disputed
between its member countries (1995-present) = 164 members
- Average world tariffs have decline from 40% to 4$ with WTO and GATT help
Aims of WTO
- Aims include:
o Non-discrimination: no discrimination between own and foreign countries and
trading partners
o More open trade: lowering trade barriers thorough negotiation increases trade
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o Predictability and transparency: all stakeholders should be confident that
barriers will not be raised – having confidence to invest, create jobs, choices
and lower prices
o Encouraging fair competition: discouraging unfair practices – dumping, export
subsidies
o More beneficial for developing countries: extra time to adjust to WTO
provisions, flexibility and special privileges
o Protection of the environment: allow for legislation to protect environment,
public, animal and plant health – must be applied equally to all firms and laws
must not be protectionist measures
- Functions of WTO;
o Forum for trade negotiations
o Administer WTO trade agreements
o Handle trade disputes
o Monitor national trade policies
o Provide technical assistance and training for developing countries on trade
o Cooperate with other international organizations
Trade negotiations have rounds – Doha round – covers different tariffs areas
- E.g., 2006 Doha round have been suspended because of inability to reach a
conclusion – EU, USA – reduce subsidies and developed countries should lower
barriers to large developing countries = did not work
Factors that limit WTO effectiveness
- Factors include:
o Unequal bargaining power of member countries: large economies have too
much power in WTO – views of developing countries may be unheard/ignored
o Unfair trade rules for developing countries: many countries grew by using
tariff protection, which developing countries cannot do because of WTO rules
– infant industries are not protected, diversification does not occur
o Number of trade deals negotiated outside WTO: USA and EU, Transatlantic
Trade and Investment Partnership – exclude other countries and diminish
WTO importance
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Chapter 26 – Exchange rates
Exchange rate
- Value of currency in terms of another currency – currencies are exchanged on foreign
exchange market
Exchange rate system
- Exchange-rate regime: how a country manages its exchange rates
Fixed exchange rate system
- Value of a currency is fixed/pegged to the value of another currency, average value of
a selection of currency or to the value of a commodity (gold)
- Changes, because the value of the other currency changes as well
- If the value of currency is raised – revaluation, if value is lowered
– devaluation
- Government intervenes to maintain the exchange rate – supply shifts
when there is a lot of the currency on the exchange market (buying
imports), the government will buy up the excess supply of its own
currency with reserves to shift the demand curve – done in order for
exchange rate not to fall and vice versa – if more demanded the
government sells
- A government can also make it illegal to trade currency at other rates – hard to
enforce – only when you have a monopoly
o Black markets may emerge with different rates
E.g., China in 1990 kept yuan pegged to the US$
Floating exchange rate system
- Value of a currency is allowed to be determined by the demand and supply for/of the
currency on foreign exchange currency – no government intervention
- If the value of currency rises – it appreciates and if it falls – it depreciates
- Appreciation of a currency means that its purchasing power has risen and you are able
to buy more goods with it and vice versa
How to calculate changes in exchange rates and price of a good in different currencies
1. If US$1 = €0.8 what is €1 in US$
a. To solve this you divide 1/0.8 = 1.25 US$
2. Cost of a good selling for US$75 in euros
a. 0.8*75 = €60
3. If exchange rate changes to US$1 = €0.9 what happens to euro price of US dress that
was exported at a cost of US$150
a. Calculate the price pre change and post-change – price in euros will increase
What causes a change in the value of a country’s currency in terms of another currency
- Taking EU/US market; People in EU buy US dollars in order to:
o Buy US export of goods/service and to travel in America
o Invest in US firms
o Save money in US banks
o Speculate the US dollar
- Demand for the US dollar will rise if:
o Increase in demand for US goods/services
Lower inflation rate – less expensive
Increase in EU incomes, which increases demand
Change in tase in favour of US products
o US investment prospects improve
Strong economic growth
New business policies
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o US interest rates increase – attractive to save
o EU speculators will buy US dollars if they think its value
will rise in the future, thus being able to sell more in the
future to make a gain
- Supply of the US dollars depends on if Americans wish to:
o Buy EU exports of goods/service and to travel in Europe
o Invest in EU firms
o Save money in EU banks
o Speculate the euro
- Supply will rise if:
o Increase in demand for EU goods/services
Lower inflation rate – less expensive
Increase in US incomes, which increases demand
Change in tase in favour of EU products
o EU investment prospects improve
o EU interest rates increase – attractive to save
o US speculators will buy euros if they think dollar value will fall
in the future, thus being able to buy more in the future to make
a gain
Managed exchange rate system
- No rate is fully free floating – changes always happen and instability causes
uncertainties – governments have to intervene
- Managed rate: exchange rate regime where the currency is allowed to float with some
element of government intervention
- Central bank sets upper/lower exchange rate value (not public) and the currency floats
normally until it moves out of the band – then intervention occurs
Possible advantages/disadvantages of high and low exchange rates
Possible advantages of high exchange rate
- Downward pressure on inflation: high exchange rate means that imports prices are
low, which will reduce costs of production and lead to lower prices – also makes
firms competitive
- More imports: each unit of currency can buy more foreign currencies and thus
goods/services
- High value forces domestic producers to improve efficiency: forced to lower costs
and become efficient to maintain competitiveness – might result in lay-off of workers
Disadvantages of a high exchange rate
- Damage to export industries: export industries might find it hard to sell their goods
abroad because of high prices – may lead to unemployment
- Damage to domestic industries: imports are inexpensive and it creates a competition
domestically – fall in demand for goods/service – leads to unemployment
Advantages of low exchange rate
- Greater employment in export industries: exports are inexpensive and are competitive
= more employment
- Greater employment in domestic industries: imports are expensive – domestic
goods/service are demanded = more employment
Disadvantages of low exchange rate
- Inflation: low value of currencies makes imports expensive, raw materials costs rise
and high prices are set
Main points
- Trade-off between high/low exchange rates and employment/unemployment
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Government intervention in foreign exchange market
- Governments wish to intervene in order to:
o Lower exchange rate to increase employment
o Raise exchange rate to fight inflation
o Maintain a fixed exchange rate
o Avoid large fluctuations in floating exchange rate
o Achieve exchange stability to improve business confidence
o Improve current account deficit – where spending on imports is greater than
revenue from exports
- There are two methods to manipulate the exchange rate:
1. Use foreign currencies reserve to buy/sell foreign currencies:
a. Use foreign currency to buy own currency – increases demand for national
currencies and exchange rate increases
b. Use own currency to buy foreign currency to increase supply of foreign
currency and lower exchange rate
2. Changing interest rates:
a. Increase interest rates to increase exchange rate – investors are interested
in buying country’s currency
b. Lower interest rates to lower exchange rates – investors invest abroad
exchanging own currency to foreign
Advantages/disadvantages of fixed/floating exchange rates (HL)
Advantages of a fixed exchange rate
- Reduces uncertainty – businesses can plan ahead
- Inflation might have a harmful effect therefore government has to install sensible
government policies
- Should reduce speculation – not always the case
Disadvantages of a fixed exchange rate
- To change the exchange rates interest rates may be manipulated thus having
deflationary/inflationary effect in the economy – employment/unemployment
- Government needs to always have foreign reserves to defend its currency by
buying/selling foreign ones
- Finding the exact rate is difficult – e.g., too high for exports
- Low level might cause international disagreement – makes country’s exports more
competitive
Advantages of a floating exchange rate
- Interest rates can be employed to manage inflation
- Should be able to adjust itself to keep current account balanced
- Not necessary to keep high levels of reserves of foreign currency
Disadvantages of a floating exchange rate
- Create uncertainty – difficult to predict costs and revenues – reduce levels of
investment – difficult to assess level of return and risk
- Do not self-adjust because of government intervention, world events, speculation
- High inflation makes imports less expensive however as exchange rates fall in value
imports become expensive, making raw materials and components more expensive,
thus fueling the overall inflation rate
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Chapter 27 – Balance of payments
Balance of payments account
- Record of value of all transaction between residents of one country and residents of
all other countries over a given period of time – usually one year
- Money that enters the country – credit item, has a positive value
- Money leaving the country – debit item, has a negative value
Elements of current account
- Measure of flow of fund from trade in goods/services + income flows. Is divided into
four parts:
1. Balance of trade in goods:
a. Revenue received from exports of goods – expenditure on imports of
goods over time (tangible goods)
b. When export revenue > import expenditure then there is a surplus on balance
of trade, when opposite – there is a deficit on balance of trade
2. Balance of trade in services:
a. Revenue received from exports of services – expenditure on imports of
services over time
3. Income:
a. Net investment income – net monetary movement of profit, interest and
dividends moving into and out of country over a period of time
b. Profits coming in, investment in foreign countries, dividends – positive, profits
sent out, payments of interest, paid dividends – negative
4. Current transfers:
a. Measure of net transfers of money – payments between countries when no
goods/services are exchanged
i. Include: aid, grants, remittances, private gifts
- Current account balance = Balance of trade in goods + balance of trade in services +
Net income flows + Net transfers
Elements of capital account
- Small part of balance of payments and has two components
1. Capital transfers:
a. Measure of net monetary movements gained/lost through transfers of goods
and financial assets by migrants entering/leaving, debt forgiveness, transfers
of fixed assets sales, gift taxes, death duties and inheritance taxes
2. Transactions in non-produced, non-financial assets:
a. Net international sales and purchases of non-produced assets (land, natural
resources rights) and intangible assets (patents, copyrights, brand names,
franchises)
Elements of financial account
- Measures net change in foreign ownership of domestical financial assets – if foreign
of domestic increasers quicker than domestic of foreign – there is more money
coming in than out – there is a surplus.
- Financial account has three components:
1. Direct investment:
a. Measure of purchase of long-term assets – purchaser aims to gain a lasting
interest in a company/economy – investment does not have to be paid back
i. E.g., property, business, stocks purchases
b. Is expected to have positive returns in the future by making profits or
increasing in value – no guarantee that it will provide a positive return
c. This comes in a form of FDI – investment of 10% is needed to count as FDI
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2. Portfolio investment:
a. Measure of stock/bond purchases, treasury bills buying/selling + savings
account
b. Investor is putting money expecting that interest will be paid on investment
and money will be repaid
3. Reserve assets:
a. Reserves of gold/foreign currencies – movements in and out of financial
account ensure that balance of payments balance to zero
b. If there is a surplus – reserve increases, deficit – decreases
c. Net changes in official reserve account that balances the accounts
Does balance of payments balance
- Too many transactions are taking place to be sure – net errors and
omissions/statistical discrepancy is used in order to balance the accounts
Relationship between current account and exchange rate (HL)
- Deficit in current account results in downward pressure on exchange rate – fixed
exchange system – too high of a value has been set
o The government could increase capital and financial account or use reserve
assets however these could run out and the rate would have to be devalued
o If there is a surplus – the rate is too low and will result in revaluation of the
currency
- Floating exchange rate system – deficit implies that there is an excess supply of
currency – demand for exports fell/demand for imports increased = exchange rate
falls, improving country’s competitiveness
o If there is a surplus – the rate will rise – decreasing competitiveness of
exports and lowering price of imports
Consequences of current account imbalances (HL)
Consequences of a current account deficit (HL)
1. To increase capital account the country may use its reserves – written as a positive
entry in a capital account; HOWEVER, in long-term those reserves could run out
2. FDI can be financing the deficit, it is also believed that too much ownership of
domestic assets can be a threat to economic sovereignty; MOREOVER, if there is a
drop in confidence then FDI could be pulled out and the currency value will fall
3. The deficit could be financed by high levels of lending – high interest rates have to be
paid which drains the economy and creates a further level of debt
4. High levels of debt leads to lower credit ranking, which creates uncertainty to invest
and makes it harder to borrow because of the risk to invest
a. E.g., UK credit ranking was downgraded from AA1 to AA2 in 2017 following
Brexit decision
5. Central bank might lower interest rates to lower exchange rates; however, this creates
an inflationary pressure in the economy
6. AD shifts to the left = reduced economic growth and causes unemployment
Consequences of current account surpluses (HL)
A country can have structural and cyclical (short-term) factors for having an account surplus.
- Structural factors include:
o Long-run competitive advantage in certain goods production – low prices and
high export demands
E.g., South Korea and electronics
o High savings ratio in households which makes imports and overall
consumption levels lower
E.g., Germany has an 11% savings ratio from disposable income
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o Increase in prices of main exports – oil – leading to higher revenues when
demand is inelastic
o Increases in productivity and R&D
E.g., Singapore
- Cyclical factors include:
o Depreciating of a country’s currency – increase competitiveness
o Increase in foreign demand for country’s exports – electronics
o Improvements in global economy – increased demand for country’s exports
o Increase in net income flows and transfers – increases in profits from
remittances
- Consequences of a current account surplus include:
1. The country can have a capital account deficit – building up reserve or purchasing
assets
a. Countries transfer reserves to Sovereign Wealth Funds – manage national
savings
i. E.g., China has 1,554.8 US$ billion assets in savings, Singapore – 556
US$ billion (2018)
2. Shift of AD to the right – increase in output, exports, employment + inflation
3. Long-term – appreciating of the currency would lead to imports being cheaper and
exports expensive – creates unemployment and threatens competitiveness
4. Persistent surplus may lead to savings instead of investment – purchasing assets
abroad rather than domestically
5. Other countries will be experiencing deficits and will increase protectionism against
the surplus country to protect their economies
How big is a big current account deficit/surplus (HL)
- To understand the magnititude the surplus/deficit is compared against the country’s
GDP
o E.g., Germany c.a. surplus US$287 bil. – 7.8% of its GDP (2017), USA c.a.
deficit US$488.5 bil. – 2.4% of its GDP
How does a government correct a persistent current account deficit (HL)
- The government will try to make its producers more competitive and prevent a large
gap in the deficit and will use supply-side policies or the ones below, when the gap is
too large
Expenditure-switching policies (HL)
- Policies that attempt to switch expenditure of domestic consumers away from imports
towards domestically produced goods/services
- Examples include:
o Policies to depreciate/devalue the value of currency: exports become less
expensive, imports expensive – depending on responsiveness export revenue
should increase
o Protectionist measures: putting tariffs or quotas to restrict imports of products
into the economy
- Not a long-run solution because it is against WTO and might encourage producers to
be inefficient
Expenditure-reducing policies (HL)
- Policies that attempt to reduce overall expenditure shifting AD to the left – all
expenditure falls, including imports
- This might lead to fall in employment and economic growth as well as the deficit
- Examples include:
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o Deflationary fiscal policies: increasing taxes/reducing government expenditure
– these are unpopular
o Deflationary monetary polices: increasing interest rates/reducing money
supply – would increase investment into the economy but this will increase
loan and credit payments = limits growth and domestic investment
- To avoid having these costs governments try to promote exports
Marshall-Lerner condition (HL)
- Whether a fall in currency leads to increase in export revenues depends on its
elasticity of demand, similarly for imports decrease in expenditure depends on price
elasticity of demand
- M-L condition tells us if a fall in exchange rate will reduce a current account deficit:
o E.g., if both are inelastic that expenditure increases and revenues decrease,
making the current account deficit worse
- It should be noted that over time elasticity increases and in the long-run countries
could meet the Marshall-Lerner condition
J-Curve (HL)
- In the short-run the current account deficit gets worse before it gets better – J-curve
effect
- As the rate is devalued/depreciated the price will fall
but because communication is not perfect other
countries need time to realise that prices have fallen +
those who have contracts cannot change suppliers
quickly
- PED is inelastic in short run for both imports and
exports = increasing current account deficit
- In the long run PED increases, making exports and
imports PED satisfy the M-L condition, improving the
current account balance
Tip: See page 421 for balance of payments practice questions
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Chapter 28 – Economic and sustainable development
Economic development
- Economic development is a multidimensional complex concept, and for it to occur
growth must be include and benefit all people in the economy without any costs to
future generations (sustainability)
- Economic development – improvement in living standards/economic wellbeing over
time
- It is about reducing poverty, increasing freedom, provision of education, health care,
law, order, guarantee of civil liberties and opportunities for civic participation
Does economic growth lead to economic development
Sources of economic growth
1. Natural factors: increases in quantity/quality of factors of production leads to
economic growth
o E.g., Singapore – increasing land area from 581.5km2 (1965) to 721.5km2
now; but improving quality is better than quantity!
2. Human capital factors: increasing quantity by encouraging population
growth/increasing immigration levels – more emphasis on quality
o Improving health care, education, training, provision of water, sanitation –
improves health and thus quality of human capital
3. Physical capital and technological factors: improving quantity/quality of physical
capital – factories, shops, vehicles – quantity affected by investments and savings and
quality – education, R&D, access to technology
o Two concepts include:
Capital widening: extra capital used with an increased amount of
labour – ratio of capital per worker does not change – production rises
but productivity does not
Capital deepening: increase in amount of capital for each worker –
improvements in technology – improvements in productivity and
increase in total production
4. Institutional factors: adequate banking, structured legal system, infrastructure,
education, stability
- Overall: growth raises people out of poverty, increases income and tax revenues and
this allows for investment in development = not necessarily always leading to
development and not always sustainable development
Sustainable development
- Sustainable development: development that meets the needs of the present without
compromising the ability of future generations to meet their own needs
- Uneconomic growth: occurs when increases in production come at an expense in
resources and well-being that is worth more than the items made
o This includes negative externalities of production, misallocation of resources,
vast consumption of various resources
- Effects on humans are experienced by those in developing countries and these effects
include:
o Limited access to water
o Spread of tropical diseases
o Increase in droughts and flooding
o Production of food in tropics will suffer
o Rising sea leaves affect the low-lying islands
Sustainable development goals
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Created in 2012 to set goals that meet urgent challenges that the worlds faces –
extension of MDGs (Millennium Development Goals) and are helping to shift the
world onto a sustainable path
Relationship between sustainability and poverty (HL)
- Poor rely on environment for food, fuel, sanitation – creates more environmental
problems – deforestation and the need of wood by poor results in poverty traps
- Poor don’t own land, don’t have sufficient agricultural knowledge and productivity =
pushes them into a deeper poverty cycle and threatens sustainability of land as a
source
- Poor are more affected by floods and catastrophes, while being the least likely
contributors to it – developing countries cannot afford climate crisis aversion
Do developing countries have common characteristics
- Common characteristics include:
1. Low standards of living due to low incomes, inequality, poor health and poor
education: low standards of loving are experienced by majority because of the
factors above
2. Low levels of productivity: low education standards and health as well as
access to technology and physical capital investments results in lower amount of
output per person
3. High rates of population growth and dependency burdens: crude birth rates
that are double the ones in developed countries (annual number of births/1000)
World average – 18.2 but some countries have over 40
E.g., Niger 44.2 in 201; Spain 9.2
• High crude rates mean that there are a lot of young people that have
to support more children than there is workforce in developed
countries
• Child dependency ratio: nonproductive as a percentage of those in the
working force:
-
•
Old age dependency ratio:
E.g., Australia – 3rd HDI rank, 29% child-dependency,
24% old age dependency; Congo – 176th HDI, 91%
child dependency and 6% old age dependency (2017)
• Highlights the fact that those in developing countries have a lower life
expectancy, whereas developed try to increase retirement age to reduce
the ratio
4. High and rising level of unemployment/underemployment: 10-20% of
unemployment and more
E,g, Bangladesh 136th HDI 4.4% unemployment, South
Africa 113th HDI, 27.5% unemployment
• It is expected that those with low unemployment rates have more than
50% in reality because of those what gave up searching,
underemployed and those who are unofficially employed
5. Substantial dependence on agricultural goods and primary product exports:
many focus on exports of only one/two product for exports
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E,g., Benin – 84% primary com., 16% manufactures;
Angola – 98% primary com., 2% manufactures (oil
main export); Bangladesh – 4% primary, 96%
manufactures; Maldives – 30% merch, 70% services
• Commodities prices tend to change rapidly and although they
increased again in 2018 (108.1 non-oil) countries that are dependent on
those commodities cannot plan effectively for the future
6. Prevalence of imperfect markets and limited information: many have adopted a
market-approach however developing countries have imperfect markets that
disable them to work efficiently
• Many lack a banking, legal infrastructure and information systems
7. Dominance, dependence, vulnerability in international relations: developed
countries dominate over developing countries and many developing countries
are dependent on them for resources, thus have no control in the international
market
How much diversity is there among developing countries
- There are diversities between them which include:
1. Different resource endowments: developing countries may have a lot of physical
resources – Angola – oil, diamonds, Chad – oil but may lack in human capital – used
in Bangladesh – lack of resources does not mean that a country cannot be successful –
Singapore, Japan
2. Different historical backgrounds: many have been colonized however the affect
depends on time and whether it was given independence or had to be fought for.
There are always going to be differences in historical factors between countries
o E.g., positive outcome – Singapore, Hong Kong; negative outcome – Vietnam,
Angola
3. Different geographic and demographic factors: many countries are large many have a
large population – it all differs and affects the overall production
o E.g., large: China, Brazil; small: Nauru, Jamaica; populations large: China
(1.4 billion), India (1.3 billion); populations small: Fiji, Guyana < one mil.
4. Differences in ethnic and religious breakdown: high levels of ethnic and religious
diversity increases chances of political unrest and conflicts
o E.g., Rwanda, Sri Lanka, Myanmar
5. Different structures of industry: not all have primary production exports – some have
service exports, others have factories
6. Differences in per capita income levels: not all developing countries have low GDP
per capita – all differ between one another
o E.g., Mauritius – 65th HDI – US$20,189 GDP/capita; Ethiopia – 179th HDI –
US$1,719 GDP/capita (2017)
7. Differences in political structure: democracies, monarchies, military rule, single-party
states, theocracies, transitional systems – when there are many changes it is hard to
find solutions to developmental problems
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Chapter 29 – Measuring economic progress
Single indicator: measures to assess development
1. GDP + GNI per capita
- GDP – total economic activity + foreign companies within the country
- GNI – total income + your own companies outside of the country
o Developing countries with large FDI – high GDP – include profits
o Example: Vietnam GDP 2017 = 2,342.2 GNI – 2,160 (per capita) –
movement of earnings abroad
Worker remittances: money sent home by workers abroad
- Example: Tonga – 34.24% of GDP are remittance inflows
2. GNI per capita at PPP and GNI per capita
- Good don’t cost the same amount in different countries – purchasing power of a
person’s income will be different in different countries
- Example: India GNI per capita 1,790$ - you can buy more with that there than in
Vienna
- PPP – equating purchasing power of currencies in different countries
o Compares prices of identical goods and services in different countries
- Example: Big Mac index = Switzerland – 6.76, Ukraine – 1.64
- GNI per capita is lower than GNI at PPP
Health Measures
1. Life expectancy at birth
- Average #years person is expected to live from the time they are born
- Used in HDI
- Factors that can lead to high numbers:
o Good level of health care and services
o Good water supplies and sanitation
o Education
o Food
o Diets
o Low levels of poverty
o Lack of conflict
2. Infant mortality rate:
- Number of deaths under the age of one/per 1k births
- Affected by
o Level of health care
o Clean water
o Food
o Level of poverty
Education measures
1. Expected years of schooling
2. Mean years of schooling
- Includes University – mean average of schooling by people who are 25 and older
Single indicators
1. Economic/social inequality
- Income and wealth distribution
- Pay inequality
- Asset ownership
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- Access to credit
2. Energy
- Inability to maintain the home at an adequate temperature/provide energy services
to ensure decent living conditions
- Access to electricity
- Impact of energy bills on household
- Maintain home at an adequate temperature
3. Environment
- Air pollution
- Climate change
- Biodiversity
- Waste
- Ocean temperatures
- Gas emissions
Overall: are too specific to highlight progress, therefore are most likely used in a composite
indicator
Composite indicator: Combine number of single indicators with weighting
HDI
-
-
Long and healthy life
o Life expectancy at birth
o Education by mean years of schooling
o Standard of living (ability to meet basic needs)
Measured by
o GNI per capita at PPP
Value between 0 and 1 (1 being high level of development)
HDI = success in translating the benefits of national income into economic
development
Example: South Africa – 90th GNI per capita, 113th for HDI
HDI = assess development of the country, not economic growth
More effective than GDP
Average = masks inequalities = rural and urban areas, men and women, ethnic
groups
Gender Inequality Index (GII)
- Reproductive health – maternity mortality ratio and adolescent birth rates
- Empowerment – proportion of parliament seats taken by females, females and
males’ proportion with secondary education
- Economic status – labour market participation rate of female and male populations
of 15+
- Goal: expose differences in distribution between women and men = human
development costs of gender inequality
- The higher the GII, the more inequality
- Example: Yemen – 178 HDI, 0.83 GII, Switzerland 2 HDI, 0.039 GII
Inequality adjusted Human Development Index (IHDI)
- HDI factors are adjusted downwards by its inequality level
- If equality – HDI=IHDI
- Difference – loss to human development owing to inequality
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Example: Iceland HDI – 6th, IHDI – 1st, Hong Kong – 7th HDI, 21st IHDI – more
problems in inequality
Happy Planet Index (HPI)
Measures sustainable well being, how well countries are achieving ling and happy lives
(check Chapter 13)
- Example: 1st Country – Costa Rica 44.6 (2016)
Multidimensional Poverty Index (MPI)
Deprivations experiences by the poor in a country (See chapter 22)
- 3 key Areas:
o Health
Nutrition
Child mortality
o Education
Years of schooling
School attendance
o Standard of living
Cooking fuel
Electricity
Housing
Assets
Sanitation
Drinking water
The Inclusive Development Index (IDI)
- Assessment of countries economic performance on 11 dimensions of economic
progress
o Growth and development
o Inclusion
o Intergenerational equity and sustainability
- Separates into advanced and emerging economies for comparison
- Example: Norway is 1st ranked and it top 20% for 8/12 elements – bottom 20%
for wealth Gini coefficient, Lithuania first in emerging 5/12
- Allows to see specific weak areas that need focus
Summary
- GNI is not a good indicator of living standards - says nothing about whether
people in a country have a good quality of life
- GPI (Genuine Progress Indicator) – measures country’s growth, adds a measure of
non-monetary benefits
- Includes
o Environmental costs - water and noise pollution, loss of farmland
o Social costs – family breakdown, crime
o Commuting costs
o Costs of automobile accidents
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Economic barriers - Chapter 30
Economic barriers to development:
- Lack of access to infrastructure – transport, utilities, companies, communication - can
help with economic development as people would be able to work, exchange goods,
etc…
- Lack of new technology – better technology can reduce labor costs, however still
provide jobs
Lack of education hinders economic progress:
- If there is education more people will be able to go to work
- Women education will allow for a stable birth rate as well as increase in labor
- Improves levels of health, as more people will become aware of various diseases
Lack of health care access hinders economic progress:
- Affects HDI
- High GDP on healthcare = longer life expectancy
- Training nurses and doctors
- Provision of health care facilities
- Improved access to water and sanitation all in developing countries
Primary sector goods hinder progress:
- Commodity prices rising – increase economic growth – revenues are used to finance
education, health and infrastructure
- If prices fall – current account deficit increase – hard to finance expenditure, countries
are limited to just those products and cannot grow or participate in international trade
– are vulnerable and uncertain
- Example: Hawaii and tourism – if there is a pandemic tourism decreases and no
money is spent
- Commodities: inelastic – drastic changes in prices – difficult to plan for investments
- Example: Nigeria: 68.53% - petroleum oil exports
Lack of international trade – hinder economic progress:
- Protectionist policies prevent developing countries from earning foreign exchange
- Countries that can subsidize their products lower international prices which harms
developing countries that produce the same products
- Developing countries can be limited because of location, insufficient infrastructure,
non-convertible currency – this decreases FDI
Informal economy:
- Not taxed and not administered by the government
- Example: 85.8% employment is informal in Africa
- Education – increases, informality – decreases
- Rural are more likely to be in such sector, agriculture being the largest
- Black markets
- Workers: lack of social protection, rights at work, decent working conditions
- Business: low level of productivity, low investment into the business
Capital flight: movement of money out of the country, due to political and economic
instabilities
- Risks in holding domestic assets – hyperinflation, government compulsory purchase
of assets, devaluation of the currency, security of banking
- Restricts growth – capital could have been used in the country, depreciates currency –
increased demand for foreign
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Indebtedness:
- Countries borrow debt and then repay interest on a loan (debt servicing) – when
paying for it the funds leave the country – funds that could have been spent on growth
- Loans are at market interest rates and are in hard currencies – harder for developing
countries to borrow and repay
- Third World Debt Crisis – prices of commodities fell – cannot repay
- Example: Increase in debt repayment by 60% between 2014 and 2017
- Fall in commodity prices – fall in exchange rates – increases size of debt repayments
– most debts are settled in US dollars
- Example: Angola – 55.4% government debt as a proportion of revenue
Geographical factors:
- Landlocked: pay more and wait more for imports to be delivered, transport costs,
bribery, border delays
- Climates and diseases: tropical countries – slow development – agriculture and health
issues – lower production rates
- Due to soil formation and erosion low productivity – poor nutrition and poor health
- Diseases that are hard to control – malaria
Political and social barriers:
Institutional framework:
Legal system and property rights
o Own assets
o Use assets
o Benefit from assets
o Sell assets
o Exclude others taking over our assets
- If a person is not guaranteed those then there is no incentive to invest,
reducing growth
- Dead capital – cant be bought, sold or valued – people cannot profit from it –
traps people in developing countries in poverty
Ineffective taxation
- Means to finance development – developing countries have 3 problems:
o Inefficient, corrupt administration – 3% taxed
o Tax revenues low – low corporate activity, high incentives to attract
FDI
o Export, import, excise duties – need for foreign trade
o = evasion of taxes
- Large informal markets – lower tax revenues – cant promote growth
Banking system
- Financial institutions are essential – dual financial markets – small and are
dominated by foreign commercial banks
- Unofficial markets – illegal, lend money at high interest rates to those who are
desperate
- Saving – needed for investment – cannot save in developing countries –
nowhere safe weak and untrustworthy – assets are bought at high prices
- Saving – development – health and shelter – impossible to gain access to
traditional banking – unemployed, lack savings, difficult to start business
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Gender inequality
= economic development if women are empowered
- Well-being of family, children health = more educated about health and
hygiene
- Education of children
- = Quality of workforce improves
- Women earn more money
- Lower birth rates = better use of contraception
Good governance:
- Eight elements
o Participatory
o Equitable
o Accountable
o Transparent
o Responsive
o Consensus oriented
o Effective and efficient
o Lawful
Corruption – exploitation of power for personal gain
Include: bribery, extortion, fraud, patronage, peddling and nepotism
Occurs where there are:
- Large amount on investment projects
- Accounting problems
- Officials are not well paid
- Elections not controlled
- Legal structure is weak
- No freedom of speech
o Electoral corruption – people’s needs are not met
o Effectiveness of the legal system – not met because people can buy
their way out
o Market failure – highest bidder > efficient producer
o Cost of business are increased
o Reduced trust in an economy – low FDI
o Contracts not being honored – low FDI
o Blind eye to regulations
o Capital flight
o Corruption = barrier for women to gain access to their rights
o Example: Transparency International: Somalia 10/100 corruptness
scale – low economically developed country – Denmark – 88/100
Political instability
When there is stability:
- FDI attracted - economic growth + access to aid – development
- Good government planning – long term
- Citizens have an input into the running of the country = higher living
standards
When there is instability:
- No FDI
- High levels of poverty
- Low standards of living
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Example: Somalia, wars – 1955-1972, 1983-2005, 2013 – unrest with 50k
deaths
Unequal political power and status
- When most of the income is in the hands of a smaller percentage of the
population, unfair policies are installed – not develop the country, but are
about their own interests
- Low income people – less involved in political process – lack background,
education – the voice of low income is not represented
Poverty trap
Low economic growth – low income – low saving – low investment = econ. Growth
Low level of education and health rate – low level of human capital – low productivity – low
income = Development
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Strategies to promote economic growth and development
Goal: growth will only lead to development if the benefits of the growth are shared equitably
- Priority to achieve inclusive growth and pro-poor strategies – confront problem of
poverty
Trade strategies: Government intervention – AD affected
1. Import substitution (import substitution industrialization)
o Developing countries should produce goods domestically rather than
importing
o This results in domestic industry growth, as will economy
o Industries will be competitive on world markets and gain economies of scale
o Opposite of export led growth
- Conditions:
o Policy to organize selection of goods to be produced domestically –
historically: labor intensive, low skill manufactures goods – clothing or shoes
o Subsidies for domestic industries
o Protectionist system – tariff barriers – keep out foreign imports
- Advantages of ISI:
o Protects jobs in domestic market – foreign firms are prevented from
competing, domestic dominate
o Protects local culture and social habits – isolating foreign influence
o Economy is protected from the power and bad influence of MNCs
- Disadvantages of ISI:
o Job protection in the short run, long run – economic growth may be low and
that will lead to lack of job creation
o No benefits of comparative advantage and specialization, results in an
inefficient product production instead of import of efficient foreign producers
o Inefficiency in domestic industries – competition not there – discouragement
of R&D
o High rate of inflation – domestic AS constraints
o Other countries will be forced to take protectionist measures
Example: ISI is adopted in Latin America: Argentina, Brazil, Mexico, Chile, Uruguay, as
well as inward oriented strategies adoption in India, Nigeria, Kenya – failed in 1980s and
abandoned. ISI – not a chosen option for economic growth
2. Export promotion (export-led growth)
o Increase in international trade – growth is achieved based by concentrating on
increasing exports and export revenue – leading factor in AD
o ↑ exports, ↑ GDP, ↑ incomes and growth in domestic and exporting markets
o Focus on production of products in which it has a comparative advantage of
production
o Managing exchange rates – keeping the rate low against other currencies –
making exports more attractive
-
Policies to adopt for export-led growth:
o Liberalized trade: open domestic markets to foreign competition – access to
foreign markets
o Liberalized capital flows: ↓ restriction on FDI
o Floating exchange rate
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o Investment in infrastructure – enable trade
o Deregulation and minimal government intervention
Note: countries do not necessarily need to adopt all of them
-
-
Developing countries export primary products or manufactured products – differences
in the export of both:
o Primary products – to gain export revenue – however the prices of primary
products have been downward for years
Happens due to increased supply and insignificant increase in demand
for commodities
Protectionism and the previous point mean that export-led growth
based on primary products is unlikely to be achieved
o Focus of export growth ↑ of manufacturing exports
Asian tigers – Japan, South Korea, Hong Kong, Singapore, Taiwan –
export products in which they have a comparative advantage, due to
low-cost labour
These have also changed production methods as a result – from labor
intensive production with low skill levels, to sophisticated products,
using intensive production methods and high skilled workers =
achieved by improvements in education
Problems:
o Success of Asian tigers and China - ↑ protectionism in developed countries
against manufactured products from developing countries
Trade unions and workers argued that they could not compete against
imports, and lobbied governments to put tariffs and quotas on low
priced goods
Price ↑, because of tariffs; tariff escalation – reduces the ability of
developing countries to export processed goods and products – forces
to export primary products and low skilled goods instead
o Assumptions of necessary conditions: role of state in successful export led
growth is vital – minimal gov. intervention is not the way
Asian tigers – government provided infrastructure, subsidies credit
terms, promotion of savings, improvement in technology, as well as
policies to protect domestic industries – infant industry protection
o Export growth by attracting MNCs may result in MNCs becoming too
powerful within the country
o Free market export growth may ↑ inequality, economic growth without
economic development
3. Economic integration
o Access schemes and regional free trade agreements – offer opportunities to
achieve economic growth and development
o Opportunities and challenges depend on extend of integration – whether it is
preferential access for particular goods, free trade area, customs union or
common market
- Advantages:
o Larger export markets = economies of scale
o Encouragement of diversification, reduce dependence on a range of
commodities
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o Encouragement of regional cooperation in infrastructure – transport and
telecommunications
o Landlocked – vital links to ports and other networks in neighboring countries
o Further stimulus for inward FDI – foreign companies benefit from large
market size
o Free movement of labour – opportunities to work in other member countries +
worker remittances
o Free movement of capital = opportunities to invest in other member countries
o Greater political stability and cooperation – high levels of investment
o Efficiency – domestic producers compete with lower procures imports
o Countries may ↑ bargaining power in multilateral trade negotiations
o Consumers – access to less expensive good and services – may be limited if
trade diversion takes place – new common external tariff makes some
imported products more expensive (HL)
o Trade creation – benefits producers who import inputs without tariffs (HL)
Disadvantages:
o WTO might be undermined – allows member countries to look inward
o Trade = more complicated with agreements with other trading blocs
o Unemployment ↑, less efficient companies (with high labour cost) cannot
compete with lower priced economies from other member countries
o Trade diversion (HL) - trade is diverted from a more efficient exporter
towards a less efficient one by the formation of a free trade agreement or a
customs union. Total cost of good becomes cheaper when trading within the
agreement because of the low tariff.
Diversification:
o Countries face problems in exporting only one or possibly two commodities
o Many are using export diversification to gain economic growth – to move
from production and exports of manufactured and semi manufactured products
– hope to protect themselves from changes in primary product prices –
stabilize, ↑ export revenue and to stabilize or ↑ employment
o There will be an ↑ use of technology and an ↑ demand for highly skilled
workers
- Barriers:
o Practice of tariff escalation – rate of import tariffs on good rises the more the
goods are processed
Importing country protects its industries = puts lower tariffs on imports
of raw materials and high tariffs on processed and finished products
Little incentive for developing countries to diversify from producing
raw materials to processing them – high prices will make processed
good uncompetitive
o Need for highly qualified workforce – produce sophisticated products
Developing countries: low educational standards, difficult to fund
education
Country = poverty trap
Low education -> production of low profit commodities and
components -> low incomes for governments and individuals –
explains the low ability to fund education
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Market based supply side policies: Affects AS
1. Trade Liberalization:
o Removal of trade barriers – tariffs, quotas, export subsidies, admin.
Legislation
o ↑ World trade – developing countries produce comparative advantage products
However:
o Many lack infrastructure and institutions
o Protectionist policies in developed countries block developing countries from
exporting higher value manufactures goods
o Subsidies in developed countries damage producers in developing countries –
ability to compete
Need for:
o Cooperation through aid-for-trade strategies
2. Privatization:
o Sale of public government owned firms to private sector - will be more
efficient, thus ↑ output of economy
o Will only be successful if:
Carefully designed
Creation of infrastructure
Assessment of poverty
= Challenging in developing countries
o Nationalized firms produce goods that are affordable for everyone – if
privatized then some may not be produced as they are not profitable – become
unaffordable
o Example: water and sanitation may be privatized as it will receive support
from international agencies. If left to market forces – no competition and
regulation = unaffordable prices. Government needs to enforce regulations to
ensure that privatization is “fair”
3. Deregulation:
o Reduction in regulation in businesses (working hours, holidays, etc.) = helps ↑
AS = economic growth
o Reducing difficulty of creating a business = ↑ investment
o Ease of doing business index = how simple to make a business – gap between
economy performance and measure of best practice
Example: New Zealand: 1st rank, 86.6, Somalia 190th – 20.0
Drawbacks:
o If deregulation of labour laws damages their safety and rights – economic
growth is not inclusive
o Debt driven growth, opposed to industrial development and infrastructural
change = growth at cost of development
o Relaxing environmental laws = sustainable development costs
Foreign direct investment:
-
Long term investment by MNEs or MNCs – either new plants or expansions OR
merge with existing firms
MNCs are attracted because:
o Rich in natural resources – MNCs with knowledge and expertise can use that
Example: South Africa, Nigeria
o Huge growing markets = large number of customers -> ↑Incomes and demand
= MNCs wanting to satisfy the demand
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-
-
-
o Low costs of labour are low in developing countries – low costs, low prices,
more profit
o Less severe regulations – easier to set up and reduce cost of production + tax
concessions = policies to attract FDI
Leads to reducing corporate tax rates
Advantages:
o FDI helps fill savings gap that may lead to economic growth
o MNCs provide employment, education and training = improves skill and work
force
o MNCs – allows for R&D, tech and marketing expertise = enhance
industrialization
o ↑ employment and earnings = multiplier effect
o Tax revenues from MNCs can be used to invest in infrastructure, education
o MNCs buying companies = increases AD (injection)
o MNCs may improve infrastructure of economy or help the government
o MNCs = more choice and low prices + essential goods provisions
o Lib. Trade + MNCs = efficient allocation of resources
o Example: China attracted FDI since 1978 = exports are produced by foreign
firms, which allowed for growth and success. China now has FDI abroad for
natural resources
Disadvantages:
o MNCs may bring their own teams and hire low skilled workers = no education
provided
o MNCs have too much power = subsidies and tax advantages + internationally
have an influence on policy decisions
o Transfer pricing: goods are sold from one division to the next in a different
country = countries lose on tax revenue. This is normally regulated to
minimize however hard to monitor
o MNCs set up where pollution laws are weak = reduce private costs and create
external costs
The same is done with low wages
o MNCs use the country for resources and they leave
o MNCs use capital intensive production instead of labour intensive, which is
available in developing countries
o MNCs buy firms and pay in shares which might not be used in the economy
o MNCs’ profits are sent back to the country of origin
Extent to which FDI is helpful depends on type of investment of the host country to
regulate the behaviour of the MNCs and use benefits of that investment to achieve
development objectives
OECD Guidelines for MNEs – code of responsible business, agencies – National
Contact Point serve as a mediator. These guidelines include:
o Contribute to econ, environ. Social progress to achieve sustainable
development
o Respect human rights
o Encourage local capacity building
o Encourage human capital formation = employment and training
o Fill finance and operations information
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Firms are worried about possible allegations – child labour, exploitation of workers =
difficult to conceal information, therefore promote CSR through reports to encourage
development
Example: OBOR (one belt one road) – Chinese plan of investment - 78 different
countries – big infrastructure projects = new markets, better connection and transport
= market leader
Social enterprise
-
Organizations that have specifical objectives – for profit or NPOs = aim for creation
of social wealth + env. Responsible operation ``
Goal: Overcome an issue = poverty, education, health care = financial figures must be
capable to provide a long-term existence
o S.E.s are gender sensitive and env. Conscious
o Example: Sunny Money – solar powered products to rural communities in
Africa = are sold at low prices, done through agents, which creates
employment in areas where are sold
o Believe that through creation of a market the needs of customers are made =
charities ruin the market – how will you earn money if someone if giving it
out for free
Institutional change: How to promote favorable instit. changes
1. Improved access to banking system
- Problem of not being able to save, which limits the ability to buy and sell and
to gain credit. Can be improved through:
o Microfinance – small loans to poor (micro-credit)
Enable startups – kiosks, repairs
Allows for income and wealth
Given to women:
• Pay back probability is high
• Care for children
o Mobile phone banking – ability to earn money through texts and withdrawals
Vodafone presence in Africa – Kenya and Tanzania – over 33 mil.
Users
Pakistan, Norwegian – Telenor – 40 million subscribers
Tanzania – sends money to women for bus fare in the hospitals
2. Increasing women’s empowerment
- Women gain power and control over their lives - getting access to education and care
will benefit society and reduces gender discrimination.
o Strategy should include:
o ↑ Support for education of females
o ↑ Access to healthcare
o Save environment in home
o Women own property and assets
o ↑ female involvement in decision making
3. Reducing corruption
- Corruption destroys trust in government and limits the ability to grow
- = low tax revenues, avoid taxes (those with minimum corruption receive more GDP)
- Reduce corruption:
o Invest in high levels of transparency and independent external scrutiny
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Example: Program to monitor physical and financial progress of
investment projects
o Reform institutions
Example: Reforms to tax administration = easy to pay
o Civil service
Example: Merit-based hiring and pay reduce opportunities for
corruption – ethical behavior promotion
o Keeping up with challenges as tech and opportunities for wrongdoing evolve
Example: Focus on revenue administration and management of
natural resource – Chile – electronic procurement systems to promote
transparency
o Cooperation to fight corruption
Cooperate to prevent spread of corruption and laundering
- Reduce problems of gender and corruption:
o Collect, analyse, disseminate gender desegregated data
Example: Access to information to implement policies to integrate
gender into anti-corruption
o Recognize and address specific gendered forms of corruption
Example: sextortion and other abusive behavior should be in the
judicial systems and have necessary tools to address the cases
o Inclusion of women in anti-corruption decision making
Example: Fair access to political rights, formulation, implementation
of policies
o Empowerment
Example: Ensure women know their rights through campaigns –
makes them not be targets for corruption
o Gender sensitive reporting mechanisms
Example: Save, accountable, accessible mechanisms to report
corruption = gender and culture inclusion
4. Promoting secure property rights and land tenure rights
- Problem of not owning assets which becomes dead capital and traps people in poverty
- Have the land and can use for agriculture but cannot legally use it - if people were
provided with title for land – 9.3$ trillion would be acquired and poverty reduced
- 7 key reasons why it’s important for econ. Growth:
o Secure land rights are important for agriculture
Invest in land and borrow money for improvements
o Urban development
Affordable and livable urban areas through urban planning
o Property rights protect environment
Incentive to look after land
o Privat sector development and job creation
Land is collateral to companies to help finance operations
o Women empowerment
Women lose it because of male guardian rule = legal reforms necessary
o Help secure indigenous people’s rights
Their land is not legally recognized – if they are – can be used for
resources sustainably
o Keeping peace
Due to wars many lose land and are displaced
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Interventionist strategies
- Ensure that economic growth is inclusive – ensure that the assets of poor people are
improved. They should be aimed at:
o Sectors where poor work
o Where poor live
o Factors of production which poor possess
o Products which poor consume
Fiscal policies
- Using money from taxes for transfer payments, where developing countries do not
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have enough revenue to invest
Challenges and strategies:
o Large informal sector = strat. To mobilize informal workers into formal sector
o Reliance on indirect (regressive) taxes, as they are easy to set, but low revenue
= imposing higher taxes on demerit goods
o Loops in taxes – higher don’t pay = improve the structure to make sure that
there are no loops
o High tax rates on high levels of income – incentive to evade = lower rates
o Avoiding taxes because of: corruption and lack of trust, lack of transparency,
weak sense of national identity = reduce corruption, access to budgets
(accountability), public awareness campaigns – role of taxes, discussions
about taxes
Transfer payments
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Hard for government to invest and spend money on transfer payments due to low
revenue
Conditional cash transfer (CCT) – transfer payments for low-income people with
behavioral conditions (e.g., school attendance) = CCTs provide income and can
alleviate poverty and improve quality of human capital
CCTs provide more access to education, however only adds onto the received income
and provides compensation
Role of minimum wages
- Problem when minimum wages do not provide a living wage (to meet needs) =
overall have a moderate impact but are not a major tool to combat poverty
o Using minimum wages as a tool for poverty would not work in informal
sectors, where no legal protection and minimum wages are received
o Formal sector: companies can evade paying full amount of minimum wages
and escape punishment = action to empower workers, campaigns, labour
inspections
o Minimum wages may cause lay off of workers which will increase poverty (if
low-income family) and may cause those workers to work in informal sector
o Example: Sustainable Development Goal 8 – growth of enterprises and labour
rights protection
Provision of merit goods
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Provision of merit goods is beneficial but hard for developing countries / has potential
to increase human capital and ensure that people have access to resources
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Economic development: investment into infrastructure and services
Increasing supply of merit goods – through direct and foreign investment,
microfinance, foreign aid, social enterprise
Foreign aid
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Any assistance to a country that would not have been provided by market forces.
Reasons include:
o Help natural disaster or war survivors
o Help achieve economic development
o Fill savings gap
o Improve quality of human resources
o Strengthen institutions
o Improve technology
o Fund development projects
o Increase capacity to benefit from international trade opportunities (Aid for
trade)
o Help meet SDG
Humanitarian aid
- Given to save lives and alleviate suffering in response to emergencies or human made
crises or medical crisis
- Short term but can be prolonged if the situation is not under control
Development aid
- Given by governments, multilateral organizations and NGOs to alleviate poverty and
promote economic, social, environmental, political development in other countries
- Long term assistance in response to systematic problems
Official development assistance
- ODA – government aid targeting economic development and welfare of developing
countries
- Given by a government through aid agencies or multilateral international institutions
– Example: UN, World Bank, IMF
- Aid given directly = bilateral aid, Aid through agencies – multilateral aid
- SDG 17 – partnership for the goals – developed countries need to assist other
countries – 0.7% of GNI spent on the goal (requirement)
- ODA = to be eligible = must be provided by official agencies and must be
concessional = grant or soft loan, must promote economic development and welfare
as main objective
o Soft loan – interest-free or below market interest rate and is repaid over long
period than commercial loans
- Military aid is not included as it aims to strengthen security, military interests
o Example: UK – Lebanese Armed Forces – non-ODA; Austria – Transitional
Crime Units in 5 West African countries – eligible as it helps domestic
institutions in a way that benefits the population
o Example: Syria top 1 recipient of ODA = 10,361 million, USA top 1st donor –
30,006 million (2017)
Concerns about aid
- Concerns about nature uses and disbursement of aid:
o If the government does not use the welfare for the majority, then the aid
received goes to a particular sector of the economy that does not need support
o Aid given for political and economic reasons rather than in need – poor
receive less, middle income – more
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o Given based on political views of the government – if that changes aid will
change too
o Tied aid (form of bilateral aid) – given for development project where the
recipient must buy goods from the donor country
Minimizes trade between developing countries
Money is lost
Questions motivation = tied aid is subsidy for domestic industries
Example: Tied aid has fallen, UK made it illegal in 2002
o Long term provision of food may affect domestic producers, due to low prices
o Dependence on aid can limit economic development and incentive to develop
– damaging if donors send less aid
o Focus on modern sector may create a gap in incomes and standards between
that and agriculture
o Aid given when policies are adopted = liberalization, deregulation and
privatization – more interest to developed and MNCs rather than developing
o Aid needs to be repaid which can lead to debt
What are NGOs
- Role to promote economic development, humanitarian ideals and sustainable
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development
Operate independently without government influence (may receive funding)
Provide emergency relief, or long-term development assistance
Example: Amnesty International, Oxfam, Cafod, Greenpeace
Two activities: plan and implement projects in developing countries and carry out
advocacy activities to influence policies – can do one or both
Results in pressure on government and influence on consumer buying trends that
contribute to better working conditions and sustainable development
Work directly with the poor and have a better understanding than the donors – work
on enhancing human capital – literacy programmes, education, etc...
Focus on women
NGOs = raise awareness and implement programmes, must demonstrate good
governance, accountability and transparency. Concerns of their work include:
o Heavy reliance on funding which can limit their functions – private
individuals, government, charities
Example: US 2018 ban preventing education about abortions which
led to many illegal abortions and deaths in developing countries
o Many NGOs operating in an area creates incoordination – using workers in
one area limits their use in another and can limit local projects completion
o Political and religious bias that can spread to communities
o Unaccountable and are not selected by people they are representing
o Spend more money on advertisement and promotion rather than allocation to
projects
Multilateral assistance – provided by
The World Bank (post WWII)
- Made up of International Bank for Reconstruction and Development and International
Development Agency
- Provides financial and technical assistance to end poverty and promote shared
prosperity in a sustainable way
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IBRD: originally lent money to re-build war-torn countries, now: loans to worthy
developing countries
- Funds generated by World Bank bonds issue and repaid by member states and
borrowing country government – offer at lower rates than other sources
- IDA (1960) – provides grants and zero to low interest loans to poorest countries for
economic growth, reduction of inequalities and improvement of living conditions
- WB: provided loans for infrastructure, now: small project that target poorest
- Example: 27 development topics: forests, health, trade, nutrition
International Money Fund (1944)
- Organization of 189 countries to foster global monetary cooperation, secure financial
stability, facilitate international trade, promote high employment and sustainable
economic growth and reduce poverty
- Stability of international monetary system: exchange rates and payments,
responsibilities being:
o Promotion international monetary cooperation
o Expansion and balanced growth of international trade
o Promotion of exchange stability
o Help in establishment of a multilateral system of payments
o Resources available to members experiencing balance of payments issues
- 3 Practices: surveillance, financial assistance, capacity development
o Surveillance: analysis of member countries and performance and then
discussion of policies to achieve stable exchange rates and growth – reports
published for transparency
o Capacity development: training and tech assistance – free of charge – fiscal
monetary policies, exchange rates, banking
o Financial assistance: loans when countries cannot finance balance of
payments – quotas that each country deposits to IMF – IMF gives out loans
only if polices are implemented
- IMF provides lending and debt relief and assists those battling natural and health
disasters
o Example: Liberia, Guinea, Sierra Leone – Ebola afflicted – $100 million
assistance
- Both are essential for support and assistances well as achievement of SDGs; however,
problems include:
o Both established in US, have been accused of free market and business
friendly promotions that help developed countries and high income in
developing
o President chooses the head of WB – policies that are in interest to US may be
implemented
o IMF’s conditions on loans – reducing fiscal deficits and encouraging
economic growth – Structural Adjustment Policies – free market school of
thought and included:
Trade liberalization
Encouragement of primary commodities
Devaluing currency
Liberalization of capital flows
FDI encouragement
Privatization of nationalized industries
Elimination of subsidies and price controls
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Measures to reduce government spending, as well as in education and
health
o With that, countries could repay loans but would damage the poor and fail to
economically develop – reducing poverty has then changed IMF’s SAP
approach
Debt relief and its importance
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o Debt relief frees resources for social spending: allows for aid flows that
would help address the development needs of low-income countries and help
sustain debt maintenance – additional money needs to be spent on programs to
benefit poor
o Boosting social spending: before being able to account for highly indebted
countries, countries would spend more on debt than on health and education –
with debt relief that has changed (5x the amount of debt-service payment)
o Reducing debt service: Debt service paid declined 1.5% of GDP (2001-2015)
o Improving debt management: Debt relief helped bring the debt indicator
below HIPS (high indebted poor countries) however they remain vulnerable to
export shocks and other examples – need to pursue cautious borrowing
policies and strengthen debt management
Indebtedness is rising: 126 countries spend more than 10% on interest (highest since
2005 poor countries debt cancelation)
Need to account for ways in which private lenders provide loans
Government Intervention vs Market-oriented Approaches
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2 main categories: help achieve economic growth and development, however growth
can come at the cost of development and sustainability
For any country, more policies should be adopted when approaching an economic
issue to achieve inclusive, sustainable, economic development
You’re done with the syllabus!!! Good luck with all the content and
revising for your exams! :D