The Global Economy

Economic Globalization

- Refers to the increasing interdependence of the world economies and services, flow of
international capital and wide and rapid spread of technologies.
- According to the International Monetary Fund economic globalization is a historical process, the
result of human innovation and technological progress. It refers to the increasing integration of
economies around the world, particularly through the movement of goods, services, and capital
across borders. It also refers to the movement of people (labor) and knowledge (technology)
across international borders.
- In economic terms, globalization is nothing but a process making the world economy an organic
system by extending transnational economic processes and economic relations to more and
more countries and by deepening the economic interdependencies among them.

Two Major Driving Forces for Economic Globalization

1. The rapid growing of information in all types of productive activities.

2. Marketization (A restructuring process that enables state enterprises to operate as market-
oriented firms by changing the legal environment in which they operate and can be achieved
through reduction of state subsidies, organizational restructuring f management such as
corporatization, decentralization, and privatization.

Dimension of Economic Globalization

1. The globalization of trade of goods and services

2. The globalization of financial and capital markets
3. The globalization of technology and communication
4. The globalization of production

Difference between Economic Globalization from Internationalization

 Economic Globalization is a functional between internationally dispersed activities which means

that it is a qualitative transformation rather than a quantitative change while
internationalization is an extension of economic activities between internationally dispersed
activities.
 Economic Globalization produces its own major players in the form of transnational
corporations (TNCs), the main driving forces of economic globalization of the last 100 years of
roughly two-thirds of world export. Transnational corporation otherwise known as multi-
national corporation is a corporation that has a home base, but is registered, operates and has
assets or other facilities in at least one other country at one time.

Origin of Economic Globalization

  In the 16th century world system analysts identify the origin of modernity and globalization
through a long-distance trade in the 16 th century. This best-known example of archaic
globalization is the Silk Road, which stated in western China, reached the boundaries of the
Parthian empire, and continued onwards towards Rome.
 It also connected Asia, Africa, and Europe
 In the 17th and 18th century the global economy exists only in trade and exchange rather than
production as the world export to World GDP did not reached 1 to 2 percent.
 In the 19th century the advent of globalization approaching its modern form is witnessed. A short
period before World War 1 is referred to as golden age of globalization characterized by relative
peace, free trade, financial and economic stability. Growth in international exchange of goods
accelerated int eh second quarter of the 19 th century.
 Global economy in the 19th and 20th centuries grew by an average of nearly 4 percent per
annum, which is roughly twice as high as growth in the national incomes of the developed
economies since the late 19th century.

International Monetary Systems and Gold Standard

 International monetary system (IMS) refers to a system that forms rules and standards for
facilitating international trade among the nations.
 It is the global network of the government and financial institutions that determine the
exchange rate of different currencies for international trade. It is a governing body that sets
rules and regulation by which different nations exchange currencies with each other.
 Gold Standard is a system of backing a country’s currency with its gold reserves. Such currencies
are freely convertible into gold at a fixed price, and the country settles all its international trade
transaction in gold.

International Trade and Trade Policies

 International Trade is the exchange of goods, services and capital across national borders.
 international trade is the exchange of goods or services along international borders. This type of
trade allows for a greater competition and more competitive pricing in the market.
 The two key concepts in the economics of international trade are specialization and comparative
advantage.
 Comparative advantage comes in; so long as the two countries have different relative
efficiencies, the two countries can benefit from trade – the country with absolute advantage will
still benefit by directing its resources to those goods where it is most productive and trading for
the others while..
 Specialization refers to this process; countries as well as individual businesses can maximize all
their welfare by specializing in the production of those goods where they are most efficient and
enjoy the largest advantages over rivals.
  Trade policies on the other hand refer to the regulations and agreement of foreign countries. It
defines standards, goals, rules, and regulations that pertain to trade relation between countries.
Each country has specific policies formulated by its officials.

Focuses of Trade Policy in International Trade

 There are two different types of economies associated with economic globalization, these are
protectionism and trade liberalization.
 Protectionism means “a policy of systematic government intervention in foreign trade with the
objective of encouraging domestic production. This encouragement involves giving preferential
treatment to domestic-to-domestic producers and discrimination against foreign competitors.”
 Trade protectionism usually comes in the form of quota and tariffs.

Tariffs

These are taxes or duties paid for a particular class of imports or exports. Imposing taxes on imported
and exported goods is a right of every country.

Trade barriers

They are state-imposed restrictions on trading a particular product or with a specific nation. It can be
linked to the product, service like technical requirement and it can also be administrative in nature such
as rules and procedures of transactions.

Safety

This ensures that imported products in the country are of high quality.

 Inspection regulation laid down by public officials ensure the safety and quality standards of
imported products.

Types of Trade Policies

 National Trade Policy

o This safeguards the best interest of its trade and citizen
 Bilateral Trade Policy
o Under the trade agreement the national trade policies of both the nations and their
negotiations are considered while bilateral trade policy is being formulated.
 International Trade Policy
o This defines the international trade policy under their charter like the international
economic organizations, such as Organization for Economic Cooperation and
Development (OECD), World Trade Organization (WTO) and International Monetary
Fund (IMF). The best interests of both developed and developing nations are upheld by
the policies.
Evolution of the International Monetary System
In 1870 to 1914, with the help of gold and silver, trade was carried without any
institutional support. Monetary system during that time was decentralized while market
based and money played a minor role in international trade in contrast to gold.
Gold was believed to guarantee a non-inflationary, stable economic environment,
a means for accelerating international trade and the gold standard functioned as a
fixed exchange rate regime, with gold as the only international reserve.

Gold Standard is a system of backing a country’s currency with its gold reserves.
Such currencies are freely convertible into gold at a fixed price, and the country settles
all its international trade transactions in gold.

After World War I, the use of gold declined due to increased expenditure and
inflation which were caused by war. Major economic powers were on gold standards but
could not maintain it and failed because of the Great depression in 1931.

In 1944, 730 representatives of 44 nations met at Bretton Woods, New

Hampshire, United States to create a new international monetary system called as the
Bretton Woods system, the aim of which is to create a stabilized international currency
system and ensure a monetary stability for all the nations.

Since the United States held most of the world’s gold, all the nations would
determine the values of their currencies in terms of dollar. The central banks of nations
were given the task of maintaining fixed exchange rates with respect to dollar for each
currency. The Bretton Woods system ended in 1971 as the trade deficit and growing
inflation undermined the value of dollar in the whole world. In 1973, the floating
exchange rate system, also known as flexible exchange rate system was developed
that was market based.

To assess whether the gold standard was successful, the following roles of a
properly designed IMS must be considered: to lend order and stability to foreign
exchange markets, to encourage the elimination of balance-of-payments problems, and
to provide access to international credits in the event of disruptive shocks. The gold
standard has never worked satisfactorily in controlling inflation or maintaining
equilibrium in international transactions.

European Monetary Integration

European monetary integration refers to a 30-year long process that began at
the end of the 1960s as a form of monetary cooperation intended to reduce the
excessive influence of the US dollar on domestic exchange rates, and led, through
various attempts, to the creation of a Monetary Union and a common currency. This
Union brings many benefits to Member States.
However, over the past decade, the build-up of macroeconomic imbalances, and
the imprudent fiscal policies of some Member States, resulted in the continuing double
crisis in banking and sovereign. As a result of this crisis, many individual Member States
face difficult re-adjustment processes, and Members States collectively must reappraise
the governance architecture of Monetary Union and adopt new mechanisms to detect,
prevent, and correct problematic economic trends.

The European Monetary System (EMS) on the other hand is a 1979

arrangement between several European countries which links their currencies in an
attempt to stabilize the exchange rate. This system was succeeded by the
European Economic and Monetary Union (EMU), an institution of the European
Union (EU), which established a common currency called the euro.
The European Monetary System originated in an attempt to stabilize inflation and
stop large exchange rate fluctuations between European countries. Then, in June 1998,
the European Central Bank was established and, in January 1999, a unified currency,
the euro, was born and came to be used by most EU member countries.

According to the European Commission in 2008, the first ten years of the EMU
were an evident success for participating countries in terms of increased trade and
capital transactions, more integrated economies, restored macroeconomic stability and
the utilization of Euro as the second most widely used reserve currency. But in 2008 to
2009 the European Union (EU) is presented with dramatic challenges brought by global
financial and economic crisis.
The EU in 2010 in response to the crisis enacted the three- pillar financial rescue
program which includes: the European Financial Stability Mechanism, the European
Financial Stability Facility, the financial assistance of International Monetary Fund (IMF).
Since the three -pillar system is temporary EU in 2013 activated its own permanent
European Stability Mechanism. The future of EMU depends on the willingness of
member states to agree on more fundamental changes in the governance of Eurozone.

The European Financial Stability Mechanism (EFSM) is a permanent fund

created by the European Union (EU) to provide emergency assistance to member
states within the Union. It raises money through the financial markets, and is
guaranteed by the European Commission. Fund raised through the markets, use the budget of the 
European Union as collateral. The European Financial Stability Facility
(EFSF) on the other hand, is an organization created by the European Union to provide
assistance to member states with unstable economies. The EFSF is a special purpose
vehicle (SPV) managed by the European Investment Bank, a lending institution. The
fund raises money by issuing debt, and distributes the funds to eurozone countries
whose lending institutions need to be recapitalized who need help managing their
sovereign debt or who need financial stabilization

Trade Policy and International Economy

In most developed countries where open market economy prevails, the
international economic organizations support free trade policies. In the case of
developing nations partially-shielded trade practices are preferred to protect their local
trade industries. The following are dependent on globalization: sound trade policies for
market changes, establishment of free and fair trade practices and expansion of
possibilities for booming international trade.

The World Trade Organization (WTO)

The World Trade Organization (WTO) deals with the global rules of trade
between nations with the main function of ensuring that trade flows smoothly,
predictably and freely. It is the only global international organization dealing with the
rules of trade between nations with WTO agreements, negotiated and signed by the
bulk of the world’s trading nations and ratified in their parliaments at its heart. WTO
is viewed as the means by which industrialized countries can gain access to the
markets of developing countries.

Global Economy Outsourcing

Outsourcing is an activity that requires search for a partner and relation-specific
investments that are governed by incomplete contracts and the extent of international
outsourcing depends on the thickness of the domestic and foreign market for input
suppliers, the relative cost of searching in each market, the relative cost of customizing
inputs and the nature of the contracting environment in each country. Subcontracting
is a central element of the new economy. It is the practice of assigning part of the
obligations and tasks under a contract to another party known as a subcontractor and especially
prevalent in areas where complex projects are the norm like construction and
information technology. 

Outsourcing is a means of finding a partner with which a firm can establish a

bilateral relationship and having the partner undertake relationship-specific investments
so that it becomes able to produce goods and services that fit the firm’s particular needs.

Often, the bilateral relationship is governed by a contract, but even in those cases the
legal document does not ensure that the partners will conduct the promised activities
with the same care that the firm would use itself if it were to perform the tasks.
One of the most rapidly growing components of international trade is the
outsourcing of intermediate goods and business services. There are three essential
features of a modern outsourcing strategy.

1. Firms must search for partners with the expertise that allows them to perform
the particular activities that are required.
2. They must convince the potential suppliers to customize products for their
own specific needs.
3. They must induce the necessary relationship-specific investments in an
environment with incomplete contracting.

Possible Determinants of the Location of Outsourcing

1. Size of the country can affect the “thickness” of its markets.
2. The technology for search affects the cost and likelihood of finding a suitable partner.
3. The technology for specializing components determines the willingness of a partner to undertake the
needed investment in a prototype.
4. The contracting environments can impinge on a firm’s ability to induce a
partner to invest in the relationship.

Trade Liberalization or Free Trade. It is the removal of tariff and reduction of barriers or the free
exchange of goods between nations

Free trade agreements and technological advances in transportation and communication mean goods
and services move around the world more easily than ever.

A free trade agreement is a pact between two or more nations to reduce barriers to imports and
exports among them.