Chapter 06

Macroeconomic Context of

Business: International

EconomyBy Omesh Perera

International trade

Benefits

Allows specialisation

Limited by:

Factor immobility

Transport costs

Market size

Govt. policies

Economies of scale

Enhance competition

Lower prices and greater amount of choices available for the consumer.

Protectionism

Protectionism is policies taken by a govt. to restrict the flow

of imports into the domestic economy.

Tariffs

Quotas (eg: VERA)

Hidden restrictions

Special testing regulations and certifications

Complicated forms

Public procurement

Subsidies

Arguments For: Arguments against:

To protect employment To help infant industries To protect declining industries

to buy time for structural

management. To prevent unfair competition

(eg: counterfeit products,

dumping) To protect the balance of

payments To raise revenue (eg: taxation) To maintain security (eg:

defence equipment)

Inefficiency is encouraged Resources are misallocated The cost of living is raised Retaliation may occur

Trade agreements

In many parts of the world, govt.s have created trade agreements and common markets to encourage free

trade.

The World Trade Organisation (WTO) is opposed to these trading blocs and customs unions because even though

they encourage trading between members theres high restrictions to trading with non-members.

Bi-Lateral and Multi-lateral agreements

Agreements between 2+ countries to eliminate

any trade barriers on trading most (all in some

cases) goods & services between them.

Free trade areas

If the members of a multi-lateral free trade agreement

are all in the same geographical area then it is

sometimes referred to as a free trade area.

Customs union

A customs union is a free trade area with a common external

tariff. The purpose of moving from a FTA to a customs union is to

eliminate trade diversions present in a FTA.

Single markets (economic

communities)

A single market is a customs union with common policies

on product regulation and freedom of movement of all

the four factors of production. This creates a more level playing field for producers in different countries.

Economic Union

An economic & monetary union is a single market with a

common currency. (eg: Eurozone)

Effects of regional trade blocs

Encourage trade creation by harmonizing economic policies and standards within member countries and

reducing prices as trade restrictions are removed.

Common external tariffs can encourage a regional fortress mentality which leads to conflicts between

different regional trade blocs. (eg: NAFTA vs EU)

Lead to trade diversion as members buy within the trading bloc when cheaper sources are available

outside.

Can lead to development of protectionism worldwide.

Balance of payments

This is an account showing the financial transactions of one

nation with the rest of the world over a period of time. Each

transaction has a debit/credit entry and overall system

should balance.

Current account

Capital account

Financial account

Exporting goods will create a debit in financial and credit in

the current account.

The current accountVisible trade

trade in goods.

Exports are credits and imports are debits.

The difference between totals is the balance of trade.

Invisible trade

Includes trade in services, investment income and transfers of money between individuals and national bodies.

Income earned from sale of domestic services abroad is invisible export whereas expenses on foreign services is an invisible import.

The invisible account can be considered in 3 sectors:

Interest, profits and dividends (IPD)

Services

Transfers

Capital and financial accounts

These accounts record capital and financial movements by firms, individuals and govt. (external assets and

liabilities).

It also includes a balancing item:

Positive unrecorded net exports

Negative unrecorded net imports

These figures arise due to errors and omissions which occur in

collection of such a vast no. of international transactions.

$$

Can be considered as a net inwards investment

Benefits the BoP in the short run because less official financing is needed

Injects cash to the circular flow

Stimulates domestic economic activity via employment and ancillary production

However in the long run itll be detrimental as the profits are remitted abroad.

Net outward investment

Benefit BoP in the long run as it generates invisible income for the current account.

It may harm the domestic economy as there is a leakage from the circular flow.

$$

Equilibrium and Disequilibrium

The balance of payments accounts always balance for technical reasons

Current account + Capital Account + Financial Account + Balancing items = 0

Persistent imbalances in certain sections indicate fundamental disequilibrium.

Persistent deficits USA, UK, Spain

Persistent surplus China, Japan, Germany

Such disequilibria will force govt.s to undertake policy action to create/restore equilibrium.

This temporary expediency may have damaging consequences for the economy therefore interfering with policies designed to achieve other

economic objectives.

Causes

Import penetration

Can arise from imports occupying a larger share of static markets or from imports maintaining their shares of

expanding markets

Has increased due to:

Growth in consumer spending

Imports are more competitive than domestic substitutes in terms of price and non-price factors such as design, quality, reliability etc.

Domestic currencies are over-valued

Foreign currencies are under-valued

Export performance

Willingness and ability of domestic producers to supply abroad.

Price competitiveness of exports

Firms in some countries tend to have excess capacity which can be quickly utilised to raise output for domestic

consumption when incomes rise.

Policies

1) Do nothing

As a floating exchange rate is claimed to lead to automatic

correction of a BoP disequilibrium.

LKR

2) Deliberate depreciation of the

exchange rate

The objective behind this is to induce expenditure-switching by consumers.

Imports become expensive therefore the consumers switch to consuming local substitutes.

Cheaper exports cause foreign consumers to purchase more of it

Achieved through a dirty floating exchange rate system where the central bank intervenes to change the direction of the value of the countrys currency.

Doesnt benefit BoP immediately as:

Initial worsening of the current account due to fixed volumes and prices adjusting automatically.

Following a depreciation exporters maintain their foreign exchange prices as it raises short-run profits.

3) Deflation

An effective but undesirable policy which aims expenditure-reduction by consumers.

Achieved through tight fiscal or restrictive policies which curb home demand.

BoP is improved as demand for imports is weakened and domestic suppliers might switch to export markets to utilise capacity.

Can weaken trade union power through fear of unemployment.

Retrain on production costs help reduce inflation

However this policy will constrain economic growth and also reduce demand eventually leading to unemployment.

Often used in conjunction with devaluation.

4) Import controls

Effect of causing expenditure-switching via Quotas, Tariffs etc.

The advantages gained are mostly temporary as the basic weakness of price uncompetitiveness has not been

changed.

5) Supply side policies.

Policies which attempt to improve the efficiency of the supply base of the economy.

Globalisation

The economic and social process whereby local markets and cultures are increasingly dominated by

global markets and cultures.

Greater integration is present:

Erosion of trade barriers

Homogenising of tastes across geographies

Firms selling the same product in every world market rather than tailoring to local preferences

Greater harmonisation of laws

Dilution of traditional cultures.

Factors driving globalisation

Improved communication due to the increased use of the internet and related technology

Political re-alignments leading to reduction in trade barriers (eg: collapse of USSR, China joining WTO)

Growth of global industries and firms

Cost differentials

Trade liberalisation - WTO constantly working towards removal of trade barriers

Liberalisation of international capital markets

Impact of globalisation

Industrial relocation

Emergence of growth markets

Access to markets and enhanced competition

Cross national business alliances and mergers

Widening economic divisions between countries

General Agreements of Tariffs and Trade

(GATT) and the World trade Organisation

(WTO) GATT came into play when international trade started recovering after WW2,

around 1948. The negotiations emphasised on removal of trade barriers and

regular trade patterns.

As these negotiations became more complex as time passed around 1995 the Geneva based WTO replaced GATT.

Roles of WTO:

Ensure compliance of member countries with previous GATT agreements.

Negotiate future trade liberalisation agreements

Resolve trading disputes between nations

WTO has the power to police and enforce trade agreements

Is opposed to development of trading blocs

The European Union (EU)

Originated from the Treaty of Rome (1957)

Aims:

Elimination of customs duties and quotas on imports & exports between member states

Establishment of a common customs tariff and commercial policy towards non-members.

Abolition of obstacles to the free movement of factors of production between members.

Establishment of common policies on transport and agriculture.

Prohibition of business practices that restrict competition

Association of overseas countries in order to increase trade and development

The group of eight (G8)

Consists of Canada, France, Germany, Italy, Japan, Russia, UK and the USA

Together represents 65% of the world economy

Agenda of G8 meetings is usually about controversial global issues (eg: global warming, poverty etc.)

Consistently dealt with

Macroeconomic management

International trade

Energy issues and climate change

Development issues and relationships with developing countries

Issues of international concern such as terrorism and organised crime.

Doesnt have any formal resources or powers in comparison to the likes of WTO but provides a forum for powerful nations to discuss international issues.

Provide the international community with direction by setting priorities and guidance to established international organisations.