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explain how the factors of production, such as labour, capital, human capital and technology, lead to economic development and growth
compare and analyse Ireland’s economic development to that of a less-developed nation using the inequality-adjusted human development index
assess and evaluate the effectiveness of a priority area of the
Irish government’s programme on overseas development
5.2 Globalisation: explain the concept of globalisation and discuss the positive and negative implications of globalisation
discuss the reasons for multinational corporations (MNCs) investing in countries outside their home country
investigate data patterns in inflows/outflows of foreign direct investment into Ireland over a period of time and evaluate the effect of multinational corporations/foreign owned industry on Ireland’s economy
5 .3 International trade and competitiveness: investigate and analyse patterns in Irish trade in terms of quantity and types of goods and services over a period of time; assess the benefits and costs of trade on the Irish economy
describe the main components/the basic composition of Ireland’s balance of payments account
discuss the factors that determine a country’s competitiveness
explain the principle of comparative advantage and its role in determining competitiveness
discuss the arguments in favour of international trade, trade protection and the fair trade movement
discuss the determinants of exchange rates; analyse the effects of changes in exchange rates on the Irish economy
examine the role and effectiveness of trade agreements and global institutions in the operation and management of international trade
Strand 5.1: Economic Growth and Development.
Economic Growth refers to increases in the output per worker without changes in the structure of society.
Advantages of Economic Growth:
Unemployment falls/employment grows.
Government revenues increase.
The standard of living improves.
A wider choice of goods and services are provided.
Increase in immigration/Irish emigrants return home.
An improvement in the balance of payments.
Disadvantages of Economic Growth:
Increased pollution.
Increase in property prices.
Rapid growth of urban centres.
Welfare may not improve. Welfare refers to the overall material, moral and psychological well-being of an individual or a group of people.
Benefits of economic growth not evenly distributed.
Characteristics of Least Developed and Developing Countries:
Four imbalances characterise these economies, they are:
Imbalanced economy: The economy is mostly based on agricultural production with little or no manufacturing, construction or services. This results in most “high-end” jobs being exported out of the country.
Imbalanced population structure: High percentage of population below 25 years of age and a very low life expectancy of less than 40 years.
Imbalanced distribution of wealth: In most cases 80% of the wealth is owned by less than 5% of the population.
Imbalanced employment structure: The vast majority work in agriculture.
Four lacks also characterise these economies, they are:
Lack of education: Most people are illiterate and innumerate as these countries cannot afford a national educational system. Output per worker tends to be low which discourages direct foreign investment.
Lack of infrastructure: Roads and telecommunications tend to be poor making it difficult for firms to get their produce to the market.
Lack of capital: As capital formation requires savings, it is unlikely as wages are at subsistence level.
Lack of demand: Low incomes mean low demand which inhibits expansion.
Other characteristics include:
Poverty trap: Subsistence living does not offer the hope of improving one’s lot or that of one’s family, therefore the cycle continues.
Economic dualism: In some less developed countries the lucrative natural resource is to be found in one part of the country only leading to a concentration of resources in that area alone.
Political corruption: A problem in the developed world also.
Political instability: Little or no respect for the rule of law and lip-service democracy both inhibit direct foreign investment.
Poor health facilities: This results in an unhealthy poorly motivated workforce.
No financial services sector: This causes practical problems like payment of creditors and workers.
High National Debt: A high debt/GDP ratio negatively impacts on investor confidence.
Unfavourable terms of trade: Less developed countries tend to export unprocessed crops at low prices and import high-end and expensive goods.
Economic Development refers to increases in output per worker accompanied by changes in the structure of society.
An example of “changes to the structure of society” could be a large decrease in employment in the agricultural society. This can be accompanied by greater development of the manufacturing industry or the increased urbanisation of a country as it develops.
These are some of the features/problems of less developed countries (LDC’s):
Lack of employment
Dependence on an unproductive agricultural sector
Overdependence on one crop, e.g. coffee for which first world countries pay a poor price
Low incomes
Poverty
Poor health and educational services
Poor infrastructure
HIV and AIDS
High rates of crime
Political corruption
High birth rates
Huge foreign debt
Little investment
Political instability.
Note: The advantages/disadvantages of economic development are similar to those of economic growth above.
Promoting Economic Development:
High profile campaigns like Live 8 and the work of Bob Geldof and Mr. Bono have put pressure on G8 leaders to do more to help solve the problems of less developed countries, e.g. ending huge debt repayments.
How can governments of LDCs encourage development?
Attract investment by improving the infrastructure: This would also have the benefit of creating much needed employment for citizens of the country.
Promote political stability and peace: Stable democracies attract investment.
Reduce corruption: Reputations for corruption and bribery make investors nervous.
How can governments of developed countries encourage development?
Increase aid: The Irish government has pledged to donate 0.7% of GNP to LDCs annually. This is officially known as official development assistance (ODA) and is a target which has been set by the UN for all rich nations.
Improve terms of trade: Much of the exports from LDCs are subject to tariffs. Fairer prices could be given for their exports.
Restructure/eliminate huge debts: Many LDCs spend more on repaying debts than they do on health services. If LDCs are ever to develop, these debts need to be reduced or even cancelled.
The Debt Crisis:
The following statistics show to some extent how serious is the debt crisis facing LDCs:
The total external debt of LDCs is $525bn. Africa alone has an external debt of $300bn.
$90m flows from LDCs to rich countries every day in debt repayments.
In 2002, Malawi, where 20% of the population is HIV positive, more is spent on debt servicing than on health provision.
The World Bank, which was established in 1945, aims to fight poverty and improve living standards in developing countries. It provides low interest loans, grants and technical assistance to developing countries in areas such as healthcare, education, agriculture, environmental protection and infrastructural development. It also helps to address the issue of corruption in developing countries.
Rostow’s Stages of Economic Development:
Walt Rostow explained a linear theory of development in The Stages of Economic Growth: A Non-Communist Manifesto. He suggests a common pattern of structural change in less developed economies:
The Traditional Society: Economic activity is at subsistence level only.
The Preconditions for take-off: Producers begin to produce a surplus which they can trade. Savings become possible leading to further investment.
The takeoff: Production increases to the extent that labour can now be employed in the industrial sector.
The drive to maturity: Incomes continue to rise and the economy now diversifies. Technological innovation creates a new range of investment opportunities. International trade increases. Infrastructural improvements take place in communication and transport and the population begins to urbanise.
The age of mass consumption: The services sector becomes increasingly dominant. Population is now predominantly urban.
The post-industrial society: Workers demand a shorter working week and there is a demand for more leisure time.
Criticisms of Rostow’s theory:
It is argued that his theories were devised with Western cultures in mind and that these may not apply to other LDCs.
Some of the stages may be shortened depending on the speed of economic development.
The Human Development Index:
The HDI was created to emphasize that people and their capabilities should be the ultimate criteria for assessing the development of a country, not economic growth alone. The HDI can also be used to question national policy choices, asking how two countries with the same level of GNI per capita can end up with different human development outcomes. These contrasts can stimulate debate about government policy priorities.
The Human Development Index (HDI) is a summary measure of average achievement in key dimensions of human development: a long and healthy life, being knowledgeable and having a decent standard of living. The HDI is the geometric mean of normalized indices for each of the three dimensions. The health dimension is assessed by life expectancy at birth, the education dimension is measured by means of years of schooling for adults aged 25 years and more and expected years of schooling for children of school entering age. The standard of living dimension is measured by gross national income per capita. The HDI uses the logarithm of income, to reflect the diminishing importance of income with increasing GNI. The scores for the three HDI dimension indices are then aggregated into a composite index using geometric mean. The HDI simplifies and captures only part of what human development entails. It does not reflect on inequalities, poverty, human security, empowerment, etc. The HDRO offers the other composite indices as a broader proxy on some of the key issues of human development, inequality, gender disparity and poverty.
Ireland and overseas development:
Ireland’s overseas development programme is designed to contribute towards decreasing global poverty and hunger. The government allocates significant funding towards achieving this aim through Irish aid which is funded by the department of foreign affairs.
Ireland plays its part in addressing global poverty and hunger and helping to build a better future for some of the world's poorest communities through work in the following priority areas:
Ending poverty: Ireland is committed to a world without poverty and hunger.
Hunger: Ireland is playing a leading role in the fight against global hunger.
Gender equality: all of Ireland's work takes account of the needs and experiences of women and girls.
Environment and climate change: Ireland supports poor communities to better cope with the impact of climate change.
Health: Ireland's work is focused on ensuring that poor people especially women and children lead healthier lives.
HIV and AIDS: Irish support programmes have a strong focus on HIV prevention.
Governance and human rights: these are central to Ireland development work.
Education: Ireland works to improve access to and quality of education for all, especially girls.
Trade and economic growth: Ireland supports countries to achieve sustainable and inclusive economic growth.
Strand 5.2: Globalisation.
Globalisation is the word used to describe the growing interdependence of the world’s economies, cultures, and populations, brought about by cross-border trade in goods and services, technology, and flows of investment, people, and information. Countries have built economic partnerships to facilitate these movements over many centuries. But the term gained popularity after the Cold War in the early 1990s, as these cooperative arrangements shaped modern everyday life.
Factors that result in the rise of globalisation:
Containerisation: The costs of ocean shipping have come down, due to containerisation, bulk shipping, and other efficiencies. The lower unit cost of shipping products around the global economy helps to bring prices in the country of manufacture closer to those in export markets, and it makes markets more contestable globally.
Technological change: Rapid and sustained technological change has reduced the cost of transmitting and communicating information – sometimes known as “the death of distance” – a key factor behind trade in knowledge products using web technology.
Economies of scale: Many economists believe that there has been an increase in the minimum efficient scale (MES) associated with some industries. If the MES is rising, a domestic market may be regarded as too small to satisfy the selling needs of these industries. Many emerging countries have their own transnational corporations.
Differences in tax systems: The desire of businesses to benefit from lower unit labour costs and other favourable production factors abroad has encouraged countries to adjust their tax systems to attract foreign direct investment (FDI). Many countries have become engaged in tax competition between each other in a bid to win lucrative foreign investment projects.
Less protectionism: Old forms of non-tariff protection such as import licensing and foreign exchange controls have gradually been dismantled. Borders have opened and average import tariff levels have fallen. That said, it is worth knowing that, in the last few years, there has been a rise in non-tariff barriers such as import quotas as countries have struggled to achieve real economic growth and as a response to persistent trade and current account deficits.
Growth Strategies of Transnational and Multinational Companies: In their pursuit of revenue and profit growth, increasingly global businesses and brands have invested significantly in expanding internationally. This is particularly the case for businesses owning brands that have proved they have the potential to be successful globally, particularly in faster-growing economies fuelled by growing numbers of middle class consumers.
Increased consumer demand: people want more choice than ever, and their improved disposable incomes give them the purchasing power they need to fund that extra choice.
Positive impacts of globalisation:
Employment: MNC’s provide jobs.
Advancements in ICT: Developing countries in particular benefit from technological changes introduced by MNCs.
Economic growth in developing countries: The impact of MNCs on the economies of developing countries can be significant.
Improvements in fair trade: Globalisation has greatly reduced the trade barriers between countries.
Better international relations: It has long been noticed that countries who enjoy good relationships rarely go to war against one another.
Negative impacts of globalisation:
Widens the gap between rich and poor: Globalisation empowers those with specialist skills to charge premium prices for their output. As developed countries have far higher levels of training and education, they have the skills that MNCs require most.
Environmental impact: Soil erosion, deforestation, urban congestion, pollution and carbon emissions are just some of the problems blamed on globalisation.
Outsourcing: Globalisation takes jobs from a cheap-labour economy and finds an even cheaper-labour economy in a constant race to the bottom to cut costs at all costs.
Multinational corporations:
A multinational corporation (MNC) has facilities and other assets in at least one country other than its home country. A multinational company generally has offices and/or factories in different countries and a centralized head office where they coordinate global management. These companies, also known as international, stateless, or transnational corporate organizations tend to have budgets that exceed those of many small countries.
Key features of MNCs:
Huge Assets and Turnover: Because of operations on a global basis, MNCs have huge physical and financial assets. This also results in huge turnover (sales) of MNCs. In fact, in terms of assets and turnover, many MNCs are bigger than national economies of several countries.
International Operations Through a Network of Branches: MNCs have production and marketing operations in several countries; operating through a network of branches, subsidiaries and affiliates in host countries.
Unity of Control: MNCs are characterized by unity of control. MNCs control business activities of their branches in foreign countries through head offices located in the home country. Managements of branches operate within the policy framework of the parent corporation.
Mighty Economic Power: MNCs are powerful economic entities. They keep on adding to their economic power through constant mergers and acquisitions of companies, in host countries.
Advanced and Sophisticated Technology: Generally, a MNC has at its command advanced and sophisticated technology. It employs capital intensive technology in manufacturing and marketing.
Professional Management: A MNC employs professionally trained managers to handle huge funds, advanced technology and international business operations.
Aggressive Advertising and Marketing: MNCs spend huge sums of money on advertising and marketing to secure international business. This is, perhaps, the biggest strategy of success of MNCs. Because of this strategy, they are able to sell whatever products/services they produce/generate.
Better Quality of Products: A MNC has to compete on the world level. It, therefore, has to pay special attention to the quality of its products.
What are the economic reasons for MNCs:
Economies of scale: Fixed costs can be spread over a far greater total output when a firm expands in size.
Market growth: Being a MNC allows a firm to target new markets across the globe.
Product sourcing: Operating as a MNC gives the company more scope in sourcing better and cheaper inputs.
By-passing local laws: A MNC can easily set up a local office so as to avail of nationalistic economic regulations that might not be available to a ‘foreign’ company.
Reduce costs: MNC;s have the ability to locate close to the source of raw materials, or the market and reduce transport costs.
The impact of FDI on the Irish economy:
We may be an island nation on the periphery of Europe, but we are very much at the core when it comes to foreign direct investment (FDI) in Europe. Ireland consistently ranks in the top ten globally for high-value FDI flows. The Global Cities of the Future 2018/2019 report recently ranked Dublin as the number one large city in the world for FDI.
There are many reasons why Ireland has become such a power with respect to FDI in recent years, including:
EU membership provides access to almost 30 other countries;
an open, business-friendly economy, with few restrictions on trade has also been critical;
a young and educated workforce;
a transparent tax regime;
an English-speaking jurisdiction;
a straightforward common-law environment;
Ireland’s National Development Plan
The latter will see capital public investment in Ireland move from €4.8 billion in 2017 to €7.8 billion in 2021 putting it among the highest in the EU.
The impact of FDI can be seen both across Irish society and across the EU. The IDA’s annual report for 2018 shows FDI employment growth stands at 7%, compared to the national average of 3% in other sectors. In 2019, exports from FDI sources experienced annual growth of 10%. The corporation tax paid by IDA client firms make up an estimated two-thirds of Ireland’s total and one-third of the country’s combined income tax, employer PRSI tax and USC.
Strand 5.3: International trade and competitiveness.
Why do countries engage in international trade?
They import because:
• They cannot produce certain goods at home
• Consumers can have a wider choice
• Consumers can avail of lower prices
• Businesses need access to raw materials
They export because:
• Exporting creates employment
• Money is injected into the economy (it is the best way of acquiring foreign reserves)
• Exporting gives Irish firms access to much larger markets, e.g. there are 500m citizens of the EU alone.
• Export-led growth might be the only way to get oneself out of recession.
In addition, international trade benefits a country like Ireland in that it helps with labour shortages.
The Balance of Trade and the Balance of Payments.
Key Terms:
Visible exports: physical goods that leave the country in exchange for money, e.g. Irish beef.
Invisible exports: foreigners buying Irish services, e.g. U2 playing a concert abroad.
Visible imports: physical goods that come into the country in exchange for money, e.g. bananas.
Invisible imports: Irish people use the services provided by foreign-owned firms, e.g. Irish people going abroad on holiday.
The balance of trade: Visible exports minus visible imports.
The balance of invisible trade (invisible balance): Invisible exports minus invisible imports.
The balance of payments on the current account: Visible balance plus Invisible balance or (Visible exports – Visible imports) + (Invisible exports – Invisible imports).
Balance of payments on the capital account: This is a record of our receipts (inflows) and payments (outflows) of capital items.
Balance of payments on the financial account: the financial account deals with foreign financial transactions. These include:
Direct investment: this is net investment in buildings and machinery by foreign companies working in Ireland, e.g. if Google invests in a new plant in Cavan.
Portfolio investment: this refers to the money that foreign companies spend or receive when they buy and sell shares and bonds.
Other investments: this refers to the amounts of money foreign companies save or borrow in/from Irish banks.
Reserve assets: the currency that is primarily used by nations for their foreign reserves.
Net errors and omissions: in some instances figures need to be estimated as no accurate figures are available.
Net transfer payment: This is money sent abroad that is not for a factor of production, i.e. foreign aid.
Net factor income from abroad: this is the difference between money sent abroad from Ireland and that sent back to this country from abroad.
Net transfer payment: money sent abroad that is not for a factor of production, e.g. foreign aid.
The word ‘current’ indicates that the money is flowing into or out of the economy on a continuous basis during the year.
The word ‘capital’ indicates items of a once-off nature.
Examples of receipts include: Foreigners buying Irish property or shares in Irish companies, external government borrowing.
Examples of payments include: Irish people buying property abroad or shares in foreign companies.
Do the balance of payments accounts balance?
In theory it would seem like they should, however, this is almost never the case. The transactions involved are too complex and fluid to allow for pin-point accuracy. This is the principal reason for the ‘net errors and omissions’ entry referred to above.
What impact do MNCs have on the balance of payments on the current account:
If the foreign company brings workers from their country these people might send some portion of their salary back home to their family.
The firms might import raw materials in order to assist in production.
These goods in turn might themselves be exported.
The profits of these companies might be sent out of the country.
What impact do MNC’s have on the balance of payments capital account?
Foreign firms probably bring machinery with them to their Irish installation constituting a capital inflow into the country.
The impact of a current account deficit/surplus on the Irish economy:
Deficit:
Leakage from the circular flow of income: As imports constitute a leakage from the circular flow of income, the multiplier contracts, and national income falls.
Less external reserves: As the government needs to fund the deficit, this may eat into our foreign exchange reserves.
Unemployment: If imports exceed exports, this will have a negative impact on the jobs sustained by domestic firms.
Surplus:
Injection into the circular flow of income: Just as a leakage causes the multiplier to contract, so an injection does the opposite resulting in an increase in national income.
Rise in external reserves: the government can enjoy an increase in our external reserves.
Export-led jobs: More exports will have a positive impact on job creation.
How does specialisation encourage international trade?
Greater efficiency in the allocation of scarce resources: When countries specialise in production they reduce waste.
More interdependence: If countries need to trade to achieve the goods their populations require, they will develop better relations with their trading partners.
Increased wealth and aggregate demand: Specialisation allows countries to sell better quality goods at a higher price which results in greater purchasing power for all concerned.
Lower costs: Specialisation allows countries to source the best and cheapest components needed for prodution.
Economies of scale: Specialisation allows firms access to large international markets that can be exploited in a way a domestic market cannot.
What factors affect the competitiveness of a country involved in international trade?
The rate of inflation: This is crucial to the maintenance of a competitive advantage over other countries. An acceptable level of inflation is between 1 and 2%.
The rate of exchange: A strong currency will result in more expensive exports, but will make imports cheaper.
Transport costs: We are at a disadvantage in Ireland in that we have no direct road links to the E.U. which can have a negative impact on our ability to trade.
Infrastructure costs: The price of property, local property taxes, the level of services, and the availability of broadband are just a few of the issues affecting the cost of doing business in Ireland.
Labour costs: One of the main reasons firms relocate to other countries is to avail of cheap labour. Our minimum wage of Eur10.10 per hour (2020) is in many respects laudable, but it can have an unintended effect on the cost of labour in Ireland.
Government policies: If we have a ‘business-friendly’ party in government this can help businesses to keep costs down, e.g. employers PRSI. However, this is sometimes used as an argument against supporting certain left-wing parties, perhaps unfairly.
Social partnership and national wage agreements: These help to ensure industrial peace and harmony in an economy which is a significant help to business interests.
Reducing/Eliminating a deficit in the Balance of Payments (Current Account):
If a deficit in the balance of payments (current account) is a regular occurrence, more money is leaving the country than coming in on a continuous basis. Consequently, reserves of foreign currency get depleted and eventually the country will run out of money to pay for imports, e.g. Kenya. Therefore, in order to reduce the deficit, the government can:
• Reduce imports: Using methods of trade protection like tariffs and quotas, the government can discourage imports.
• Increase exports: The government could provide assistance and incentives such as subsidies to firms that export.
• Reduce disposable income: The government could raise direct taxes, thereby reducing the spending power of consumers and their ability to buy imports. As usual, there is a negative to this positive in that demand for domestically produced goods is also affected. Such measures as these are known as ‘deflationary measures’.
• Devaluation of the currency: A government or central bank could devalue its currency and thereby make exports cheaper and more attractive abroad. Imports would, by consequence, become more expensive and less attractive to buy. This option is of course not open to the Irish government because of our membership of the EMU.
The Economic Effects of Devaluation:
1. Exports cheaper: a devaluation of the exchange rate will make exports more competitive and appear cheaper to foreigners. This will increase demand for exports
2. Imports more expensive: a devaluation means imports will become more expensive. This will reduce demand for imports.
3. Increased Aggregate Demand: a devaluation could cause higher economic growth. Part of AD is (X-M) therefore higher exports and lower imports should increase AD (assuming demand is relatively elastic). Higher AD is likely to cause higher Real GDP and inflation.
4. Inflation is likely to occur because:
• Imports are more expensive causing cost push inflation.
• Aggregate Demand is increasing causing demand pull inflation
• With exports becoming cheaper manufacturers may have less incentive to cut costs and become more efficient. Therefore over time, costs may increase.
5. Improvement in the current account. With exports more competitive and imports more expensive, we should see higher exports and lower imports, which will reduce the current account deficit.
The Marshall-Lerner condition:
The Marshall-Lerner condition, which states that a currency devaluation will only lead to an improvement in the balance of payments if the sum of demand elasticity for imports and exports is greater than one, is named after English economist Alfred Marshall (1842-1924) and the Romanian born economist Abba Lerner (1905 - 1985).
The Law of Absolute Advantage:
Classical economist David Ricardo developed the Law of Absolute Advantage and the Law of Comparative Advantage to show that countries specialised in producing goods which they can produce efficiently, and engaged in international trade to acquire their other needs, would be better off than countries that tried to be self-sufficient and did not engage in international trade. The Law of Absolute Advantage states that each country should specialise in the production of that good in which it has an absolute advantage, i.e. if it can produce the good more efficiently than other countries.
Country Output per worker per week Output per worker per week
Food Cars
Spain 15 2
Japan 5 3
Total Output: 20 5
Notice that each country is efficient at producing one good. In this initial situation both countries are attempting to be self-sufficient and are not specialising or engaging in international trade.
Spain is three times more efficient than Japan in food production, 15/5
Japan is 1.5 times better than Spain in car production, 3/2
If Spain specialised in food production, and Japan specialised in cars, the following would apply:
Country Output per worker per week Output per worker per week
Food Cars
Spain 30 0
Japan 0 6
Total Output 30 6
After specialisation and trade, total world production has risen by 10 units of food and one car.
The Law of Comparative Advantage:
The law states that a country should specialise in the production of goods at which it is relatively more efficient and should obtain its other requirements through international trade.
Country Output per worker per week Output per worker per week
Machines Cars
Spain 20 5
Japan 40 15
Total Output 60 20
In this example, Japan is better at producing both goods, which is more likely in real world economics. We now establish how much better Japan is in the production of both goods.
Japan is twice as efficient in the production of cars, 40:20; and three times as efficient in the production of cars, 15:5. Therefore, since Japan is relatively more efficient in the production of cars, it should produce them and let Spain produce food. The following table shows the result of that specialisation:
Country Output per worker per week Output per worker per week
Machines Cars
Spain 40 0
Japan 0 30
Total Output: 40 30
Twenty less machines are now produced (33% or 60 down to 40) while 10 more cars (50% or 20 up to 30) are made. As 50% > 33%, both countries are now better off from trading.
Terms of Trade:
• Spain – 1 worker can produce 5 cars or 20 machines, so 1 car is worth 4 machines (20/5). One machine is worth 0.25 of a car (5/20)
• Japan – 1 worker can produce 15 cars or 40 machines, so 1 car is worth 2.67 machines (40/15). One machine is worth 0.375 of a car (15/40)
Given this information the terms of trade are as follows:
• 1 car will cost between 2.67 and 4 machines
• 1 machine will cost between 0.25 and 0.375 cars.
This video will explain how the calculations of Comparative Advantage,
Assumptions of the Law of Comparative Advantage:
• Strategic reasons in favour of self-sufficiency are ignored: No country wishes to be totally dependent on another for its supply of important goods. What if they went to war against each other?
• Transport costs are ignored: The benefits of free trade could easily be outweighed by substantial transport costs.
• The law assumes perfect mobility of the factors of production: In the above example, it is assumed that Spanish and Japanese workers can effortlessly switch from machine to car production with no loss of productivity.
• The Law of Diminishing Returns is ignored: In Spain, one worker produces 20 machines, and two produce 40 thus ignoring the law of diminishing returns.
• Free trade is assumed to exist: Governments often introduce protectionist policies thereby restricting free trade.
What are the sources of Ireland’s comparative advantage?
Climate: Our mild climate is conducive to a wide variety of production.
Educated and skilled workforce: Despite constant criticism from education correspondents in the main-stream media, education standards in this country are good which is why we have a large number of multinational companies working here.
Low personal and corporate taxation: Our corporate tax rate of 12.5% (2020) is relatively low by international standards, and the government keeps telling us that rates of personal tax are low too, although this one is harder to prove.
What is protectionism:
This refers to the efforts by a government to restrict free trade and imports in particular. Why would a government want to reduce imports?
To protect Irish jobs
To protect Irish firms from competition from low-wage economies
Sometimes trade is restricted for political reasons, e.g. South African produce during Apartheid.
To prevent “dumping”.
To reduce a deficit in the balance of payments.
To protect “infant” industries.
For political reasons.
What barriers to trade exist?
Tariffs: a tax on imports.
Quotas: a limit on the amount of goods allowed to enter a country.
Administrative barriers: bureaucracy and ‘red-tape’ intended to slow down the process of importing goods.
Trade embargos: an outright ban on the import of certain goods.
Local laws and customs: the smoking ban in various countries places a barrier in the path of tobacco manufacturers.
Regulatory standards: countries can use higher production standards to block access from countries with lower standards.
Brexit: Economic Implications and Challenges:
Brexit, short for "British Exit," refers to the United Kingdom's decision to leave the European Union (EU). This historic event, fueled by political and economic factors, has significant implications for the UK and the global economy.
Trade Disruption: One of the primary concerns surrounding Brexit is its impact on trade. As a member of the EU, the UK benefited from free trade agreements and access to the single market. With Brexit, trade relationships with EU member states are subject to renegotiation, potentially leading to disruptions in supply chains and increased trade barriers.
Economic Uncertainty: The uncertainty surrounding Brexit has led to volatility in financial markets and decreased investor confidence. Businesses face challenges in planning for the future, with concerns about regulatory changes, tariffs, and labor mobility.
Currency Fluctuations: The decision to leave the EU has also affected the value of the British pound. Since the Brexit referendum in 2016, the pound has experienced fluctuations against major currencies, impacting imports, exports, and purchasing power.
Regulatory Divergence: Brexit has opened the door for the UK to diverge from EU regulations and standards. While this could potentially create opportunities for innovation and trade agreements with other nations, it also raises concerns about regulatory alignment and market access.
Regional Disparities: Brexit has highlighted existing regional disparities within the UK, with regions heavily dependent on EU funding and trade facing particular challenges. Addressing these disparities will be crucial for ensuring inclusive economic growth post-Brexit.
However, despite a lot of fear mongering ahead of the Brexit referendum in 2016, GDP/capita has not dipped and instead has remained broadly in line with other large economies as shown in the graph:
Asia-Pacific Economic Cooperation (APEC): The Asia-Pacific Economic Cooperation (APEC) is an intergovernmental forum for 21 member economies in the Pacific Rim that promotes free trade throughout the Asia-Pacific region. Following the success of ASEAN's series of post-ministerial conferences launched in the mid-1980s, APEC started in 1989, in response to the growing interdependence of Asia-Pacific economies and the advent of regional trade blocs in other parts of the world; it aimed to establish new markets for agricultural products and raw materials beyond Europe. Headquartered in Singapore, APEC is recognized as one of the highest-level multilateral blocs and oldest forums in the Asia-Pacific region, and exerts a significant global influence.
The World Trade Organisation: The WTO was established on January 1st, 1995 and has over 150 members. It is based in Geneva. WTO agreements help establish the rules of trade between nations and its main goal is to help producers of goods and services to export and import their goods with a minimum of fuss. Its functions include:
Providing a forum for trade negotiations
Handling trade disputes
Monitoring the national trade policies of member states
Providing technical assistance and training for developing countries
Co-operating with other international organisations.
The World Trade Organisation permits trade blocs, provided that they result in lower protection against outside countries than existed before the creation of the trade bloc
North American Free Trade Agreement (1994) – USA, Canada and Mexico
Mercosur – Brazil, Argentina, Uruguay, Paraguay and Venezuela
Association of Southeast Asian Nations Free Trade Area
Common Market of Eastern and Southern Africa (COMESA) includes Zambia, Rwanda, Swaziland, Ethiopia and Kenya
Trans-Pacific Partnership – an agreement negotiated between Australia, Brunei, Chile, Canada, Malaysia, Mexico, New Zealand, Peru, Singapore, the United States, and Vietnam. (The USA under Trump has decided to leave TPP)
What is ‘fair trade’?
Fair trade is an arrangement designed to help producers in developing countries achieve sustainable and equitable trade relationships. Members of the fair trade movement add the payment of higher prices to exporters, as well as improved social and environmental standards. The movement focuses in particular on commodities, or products which are typically exported from developing countries to developed countries, but also used in domestic markets (e.g. Brazil, England, and Bangladesh) most notably handicrafts, coffee, cocoa, wine, sugar, fruit, flowers and gold. The movement seeks to promote greater equity in international trading partnerships through dialogue, transparency, and respect. It promotes sustainable development by offering better trading conditions to, and securing the rights of, marginalized producers and workers in developing countries. Fair trade is grounded in three core beliefs; first, producers have the power to express unity with consumers. Secondly, the world trade practices that currently exist promote the unequal distribution of wealth between nations. Lastly, buying products from producers in developing countries at a fair price is a more efficient way of promoting sustainable development than traditional charity and aid. The benefits include:
The Fairtrade Minimum Price which helps farmers become more self-sufficient.
Communities are empowered to organise themselves into cooperatives which helps them better negotiate future trade arrangements.
Better access to agricultural services like organic training.
The Rate of Exchange of a Currency:
The following factors determine the rate of exchange of a currency:
The Purchasing Power Parity Theory: This theory states that in a free market situation, the internal purchasing power of a currency will equal the external pruchasing power.
The Balance of Payments: The demand for a country’s currency is affected by the demand for its’ exports and also, by it’s demand for imports (which can only be bought using the currency of that country).
The Role of Speculators: People who buy and sell currencies on a large scale have a direct influence on the rate of exchange in the same way as demand for any product affects its price.
The Role of Multinational Companies: Companies operating in many different countries can have an effect on the rate of exchange in a similar way to point 2 above.
Intervention by Central Banks: Any country’s Central Bank can use it’s own foreign currency reserves to buy up quantities of its own currency in order to shore up its value. It can also sell its own currency in order to devalue it.
International Agreements: Some countries “tie” the value of their currency to another more stable currency. For example, the Irish ‘punt’ was linked to the British pound between 1921 and 1979 (foundation of the E.M.S.) Argentina used to have their currency linked to the US dollar. In Zimbabwe, the US dollar has replaced the Zimbabwean dollar as legal tender since 2011. Inflation by that point had reached over 11,000,000%.
Purchasing-power parity theory:
A theory which states that the exchange rate between one currency and another is in equilibrium when their domestic purchasing powers at that rate of exchange are equivalent. In short, a bundle of goods should cost the same in Canada and the United States once you take the exchange rate into account. However, the following points must be borne in mind:
Transport costs are ignored.
Many goods are not tradable or transportable, e.g. medical services.
Free trade is not characteristic of all markets.
What are the different types of exchange rates?
Fixed Exchange Rates:
A fixed exchange rate is one where the respective values of currencies are set at an agreed level and cannot deviate from that. Governments must take whatever action is necessary to maintain the rate of exchange.
Advantages:
Elimination of Risk/Uncertainty: Fluctuating exchange rates put pressure on importers especially when they decrease significantly, i.e. imports become much dearer.
Speculation is pointless: There is no point buying a foreign currency expecting to make a profit when the rate of exchange changes if rates are fixed.
Disadvantages:
Pressure on Governments: Maintaining the rate of exchange can put governments under pressure to introduce unpopular austerity measures.
Depletion of Foreign Reserves: Central Banks may be forced to spend large quantities of the foreign reserves shoring up the value of a currency under pressure.
Floating Exchange Rates:
Under this system, currencies find their own values relative to one another through the interaction of supply and demand. Thus, floating exchange rates change freely and are determined by trading in the forex market. This is in contrast to a "fixed exchange rate" regime. In some instances, if a currency value moves in any one direction at a rapid and sustained rate, central banks intervene by buying and selling its own currency reserves (i.e. Federal Reserve in the U.S.) in the foreign-exchange market in order to stabilize the local currency. However, central banks are reluctant to intervene, unless absolutely necessary, in a floating regime.
Advantages:
Currencies will find a level appropriate to the state of their economy: If a currency needs to be weakened in order to make exports more attractive, this can easily be done using the central Bank intervention mentioned above.
Balance of payments equilibrium can be achieved: If a country’s exports are less than its’ imports, the value of its’ currency will go down, thereby making exports cheaper and imports more expensive.
Disadvantages:
Uncertainty: Countries may become less likely to engage in foreign trade if the rate of exchange is very uncertain.
Borrowing would be less likely: Countries again would be less likely to borrow for the same reason.
Speculation is profitable: This has the effect of making it more likely which increases uncertainty in the market.
'Crawling Peg':
A crawling peg is a system of exchange rate adjustments in which a currency with a fixed exchange rate is allowed to fluctuate within a band of rates. The par value of the stated currency and the band of rates may also be adjusted frequently, particularly in times of high volatility in exchange rates. Crawling pegs are often used to control currency moves when there is a threat of devaluation due to factors such as inflation or economic instability with coordinated buying or selling of the currency to allow the par value to remain within its bracketed range.
What is the role of global institutions in the operation and management of international trade?
There are five key global institutions associated with the operation and management of international trade:
The World Trade Organisation (WTO): This organistion oversees the administration of the General Agreement on Tariffs and Trade (GATT) and provides a platform to negotiate agreements to reduce obstacles to international trade and establish a level playing field for all. Furthermore the WTO holds countries accountable and settles disputes that occur between countries.
The World Bank: The World Bank provides long-term capital to boost economic development and provides funds to countries who need them provided they agree to tight monetary policy. It provides low-cost loans and grant aid funding to developing countries for education, health, public administration, infrastructure, financial and private sector development, and environmental and natural resource management projects.
The International Monetary Fund (IMF): The IMF exists to ensure the stability of the international monetary system, i.e. the system of exchange rates and international payments that enable people and governments to transact with each other. In 2012 it’s brief was updated to include all macroeconomic and financial sector issues that influence global stability. The IMF achieves these objectives by monitoring the global economy and the economies of member countries, lending to countries with balance of payments difficulties.
The International Labour Organisation (ILO): The ILO is a specialised agency of the United Nations that brings together governments, employers and workers of 187 member states to establish labour standards. It holds signatories to account and develops policies and devises programs promoting sustainable work for men and women.
The Organisation for Economic Co-operation and Development (OECD): The mission of the OECD is to promote policies that would improve the economic and social well-being of people around the world. The OECD provides a platform for governments to work together to share best practice and 6 solutions to common problems. The OECD works with governments to understand what is driving economic, social and environmental change before generating predictive analytics. It sets international standards on agriculture comer tax, chemical safety and more. So far 36 countries are members of the OECD area.