Globalization. Sherif Khalifa. Sherif Khalifa () Globalization 1 / 46

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1 Sherif Khalifa Sherif Khalifa () Globalization 1 / 46

2 Globalization is a process by which the economies of the world become increasingly integrated and interdependent through expanded international trade, foreign portfolio investment and foreign direct investment. Globalization refers to the increased openness of economies to international trade and financial flows. Globalization refers to the increasing integration of national economies into expanding international markets. Sherif Khalifa () Globalization 2 / 46

3 Globalization is a process by which the economies of the world become more integrated, leading to a global economy and global economic policymaking. For some, globalization suggests exciting business opportunities, rapid growth of knowledge and innovation or a prospect of a world too interdependent to engage in war. For others, globalization increases concerns that inequalities may be accentuated, that environmental degradation may be accelerated, and that the international dominance of the wealthiest may be expanded while other are left behind. Sherif Khalifa () Globalization 3 / 46

4 Primary products are products derived from all extractive occupations such as farming, lubmering, fishing, minimg, and quarrying, foodstuffs, and raw materials. Current account is the portion of a country sbbalance of payments that reflects the market value of the country s exports and imports. Capital account is the portion of a ocuntry s balance of payments taht shows the volume of private foreign investment and public grants and loans that flow into and out of the country. Sherif Khalifa () Globalization 4 / 46

5 In some of the smaller countries, most of the monetary income is derived from the overseas sale of agricultural and primary products. Because markets and prices for these exports are often unstable, primary product export dependence carries with it a degree of risk and uncertainty. Developing countries rely on the importation of raw materials, capital goods, intermediate goods and consumer goods. Import demands exceeded their capacity to generate suffi cient revenues from the sale of exports, which led to chronic deficits on their balance of payment. The deficit in the current account was offset by a surplus in the capital account. They lately suffered severe deficits in capital account due to debt burden of repaying former international loans and investments. This led to a rapid depletion of international monetary reserves and a slow down in economic growth. Sherif Khalifa () Globalization 5 / 46

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12 Commodity terms of trade is the ratio between the price of a typical unit of exports P x and the price of a typical unit of imports P m. It is the ratio of a country s average export price to its average import price. Terms of Trade = P x P m Free trade is the importation and exportation of goods without any barriers in the form of tariffs, quotas, or other restrictions. Sherif Khalifa () Globalization 12 / 46

13 Comparative Advantage Comparative advantage is the production of a commodity at a lower opportunity cost than any of the alternative commodities that could be produced. Specialization is the concentration of resources in the production of relatively few commodities. The principle of comparative advantage asserts that a country should specialize in the exports of the products that it can produce at the lowest relative cost. Sherif Khalifa () Globalization 13 / 46

14 Comparative Advantage It is impossible for individuals to provide themselves with all the consumption requirements. They engage in the activities for which they have a comparative advantage in terms of their natural abilities or endowments. They can then exchange any surplus of these products for products that others may be relatively suited to produce. The principle of comparative advantage asserts that a country should specialize in the export of the products that it can produce at the lowest relative cost. Sherif Khalifa () Globalization 14 / 46

15 Comparative Advantage Country 1 Meat 1 Potato Potatoeville 60 labor 15 labor Beefyland 20 labor 10 labor Autarky is a closed economy that attempts to be completely self reliant. Sherif Khalifa () Globalization 15 / 46

16 Comparative Advantage Country 1 Meat 1 Potato 1 Potatoeville 4 potatoes 4 meat 1 Beefyland 2 potatoes 2 meat Sherif Khalifa () Globalization 16 / 46

17 Comparative Advantage Assume every country has 480 workers. Country Meat Potato Potatoeville 8 32 Beefyland Sherif Khalifa () Globalization 17 / 46

18 Comparative Advantage Meat Potatoes Sherif Khalifa () Globalization 18 / 46

19 Comparative Advantage Meat Potatoes Sherif Khalifa () Globalization 19 / 46

20 Comparative Advantage 3P 1M 1M 4P 1M 2P Potatoeville Beefyland Sherif Khalifa () Globalization 20 / 46

21 Comparative Advantage Potatoeville Beefyland Meat Potatoes Meat Potatoes Without Trade Production & Consumption With Trade Production Trade Consumption Gains from Trade Sherif Khalifa () Globalization 21 / 46

22 Comparative Advantage Potatoeville Beefyland Meat Potatoes Meat Potatoes Without Trade Production & Consumption With Trade Production Trade Consumption Gains from Trade Sherif Khalifa () Globalization 22 / 46

23 Neoclassical Model The Neoclassical model posits that the basis for trade arises because countries are endowed with different factor supplies. Given relative factor endowments, relative factor prices will differ, and so will domestic commodity price ratios and factor combinations. Labor abundant countries should specialize in the production of labor intensive products and export the surplus in return for imports of capital intensive products. Capital abundant countries should specialize in the production of capital intensive products, and export the surplus in return for imports of labor intensive products. Sherif Khalifa () Globalization 23 / 46

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26 Manufacturing M=5A 5M=1A 20M=10A 2M=1A 5 10 Agriculture Sherif Khalifa () Globalization 26 / 46

27 Manufacturing Agriculture Developed Sherif Khalifa () Globalization 27 / 46

28 Manufacturing M=10A 2M=1A 10M=20A 1M=2A Agriculture Sherif Khalifa () Globalization 28 / 46

29 Manufacturing Agriculture Developing Sherif Khalifa () Globalization 29 / 46

30 Outward looking development policies encourage not only free trade but also the free movement of capital, labor, enterprises, and an open system of communications. These policies encourage exports, often through the free movement of capital, workers, enterprises, and students. Inward looking development policies stress the need for LDCs to evolve their own styles of development and to encourage indigenous learning by doing in the development of technologies appropriate to a country s resource endowments. These policies stress economic self reliance on the part of Developing countries, including domestic development of technology, the imposition of barriers to imports, and the discouragement of private foreign investment. Sherif Khalifa () Globalization 30 / 46

31 Import substitution believe that LDCs should initially substitute domestic production of previously imported simple consumer goods and then substitute through domestic production for a wider range of more sophisticated manufactured items. It is a deliberate effort to replace consumer imports by promoting the emergence and expansion of dmoestic industries. Export promotion cite the effi ciency and growth benefits of free trade and competition, the importance of substituting large world markets for narrow domestic markets, and the distorting price and cost effects of protection. These are governmental efforts to expand the volume of a country s exports through increasing export incentives, decreasing disincentives, and other means in order to generate more foreign exchange and improve the current account of its balance of payments or achieve other objectives. Sherif Khalifa () Globalization 31 / 46

32 Income elasticity of demand is the responsiveness of the quantity of a commodity demanded to changes in the consumer s incomes, expressed as the proportionate change in quantity divided by the proportionate change in income. Price elasticity of demand is the responsiveness of the quantity of a commodity demanded to a change in its price, expressed as the proportionate change in quantity divided by the proportionate change in price. Sherif Khalifa () Globalization 32 / 46

33 Low income elasticities of demand, so only a high rate of income growth in developed countries can lead to export expansion of these commodities. Developed country population growth is at or near the replacement level, so no increase in demand from these economies. The price elasticity of demand for most primary commodity is relatively low, causing low revenue for exporting nations with falling prices. The growth of agricultural protection in developed countries also work against the long run expansion of primary product export earnings. The development of synthetic substitutes for commodities, which act as a source of competition. Structural rigidities especially the antiquated institutional and social structures in many rural agrarian systems in developing countries. Sherif Khalifa () Globalization 33 / 46

34 Import substitution entails an attempt to replace commodities that are being imported with domestic sources of production and supply. The strategy is to erect tariff barriers or quotas on imported commodities, and then trying to set up a local industry to produce these goods. The rationale is a hope that the infant industry will grow up and be able to compete in world markets, and then be able to generate net foreign exchange earnings. Tariff protection against imports is needed in order to allow the higher priced domestic producers enough time to learn the business and to achieve economies of scale to lower unit costs and prices. With enough time and protection, the infant will eventually grow up and become competitive with developed country producers. Sherif Khalifa () Globalization 34 / 46 Globalization Infant industry is a newly established industry, usually protected by a tariff barrier as part of a policy of import substitution.

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36 Price S Tariff Price No Tariff Price D Quantity Sherif Khalifa () Globalization 36 / 46

37 The nominal rate of protection shows the extent, in percentages, to which the domestic price of imported goods exceeds what their price would be in the absence of protection. It is an ad valorem percentage tariff levied on imports. t = p p p Sherif Khalifa () Globalization 37 / 46

38 Effective rate of protection shows the percentage by which the value added at a particular stage of processing in a domestic industry can exceed what it would be without protection. It shows by what percentage the sum of wages, interest, profits and depreciation allowances payable by local firms can, as a result of protection, exceed what this sum would be if these same firm had to face unrestricted competition from foreign producers. It is the degree of protection on value added as opposed to the final price of an imported product. ERP = v v v Value added is the amount of a product s final value that is added at each stage of production. Sherif Khalifa () Globalization 38 / 46

39 P car = 10, 000 P steel = 8, 000 v = 10, 000 8, 000 = 2, 000 Sherif Khalifa () Globalization 39 / 46

40 t car = 0.1 P car = 10, 000 ( ) = 11, 000 v = 11, 000 8, 000 = 3, 000 ERP = v v v = = 0.5 Sherif Khalifa () Globalization 40 / 46

41 t steel = 0.1 P steel = 8, 000 ( ) = 8, 800 v = 10, 000 8, 800 = 1, 200 ERP = v v v = = 0.4 Sherif Khalifa () Globalization 41 / 46

42 t steel = 0.1, t car = 0.1 P car = 10, 000 ( ) = 11, 000 P steel = 8, 000 ( ) = 8, 800 v = 11, 000 8, 800 = 2, 200 ERP = v v v = = 0.1 Sherif Khalifa () Globalization 42 / 46

43 South-South Trade There are relative comparative advantage changes to South-South as opposed to North-South trade. Developing countries should orient more of their trade toward one another. Export instability resulting form fluctuations in developed country economic activity can be reduced. Greater collective self reliance will be fostered. Sherif Khalifa () Globalization 43 / 46

44 South-South Trade Economic integration is the merging to various degrees of the economies and economic policies of two or more countries in a region. Economic union is the full integration of two or more economies into a single economic entity. Regional trading bloc is an economic coalition among countries within a geographic region, usually charcterized by liberalized internal trade and uniform restrictions on external trade, designed to promote economic integration. Sherif Khalifa () Globalization 44 / 46

45 South-South Trade Customs union is a form of economic integration in which two or more nations agree to free all internal trade while levying a common external tariff on all nonmember countries. Free trade area is a fomr of economic integration in which free trade exists among member countries, but members are free to levy tariffs on non member countries. A common market is a fomr of economic integration in which there is free internal trade, a common tariff, and the free movement of labor and capital among partner states. Sherif Khalifa () Globalization 45 / 46

46 South-South Trade Sherif Khalifa () Globalization 46 / 46