6.3 – Business and the International Economy

Globalization

Globalization is a term used to describe the increases in worldwide trade and movement of people and capital between countries. The same goods and services are sold across the globe; workers are finding it easier to find work by going abroad for work; money is sent from and to countries everywhere.
Some reasons how globalization has occurred are:

• Increasing number of free trade agreements– these are agreements between countries that allows them to import and export goods and services with no tariffs or quotas.
• Improved and cheaper transport (water, land, air) and communications (internet) infrastructure
• Developing and emerging countries such as China and India are becoming rapidly industrialized and so can export large volumes of goods and services. This has caused an increase in the output and opportunities in international trade, allowing for globalisation

Advantages of globalisation

• Allows businesses to start selling in new foreign markets, increasing sales and profits
• Can open factories and production units in other countries, possibly at a cheaper rate (cheaper materials and labour can be available in other countries)
• Import products from other countries and sell it to customers in the domestic market- this could be more profitable and producing and selling the good themselves
• Import materials and components for production from foreign countries at a cheaper rate.

Disadvantages of globalisation

• Increasing imports into country from foreign competitors- now that foreign firms can compete in other countries, it puts up much competition for domestic firms. If these domestic firms cannot compete with the foreign goods’ cheap prices and high quality, they may be forced to close down operations.
• Increasing investment by multinationals in home country- this could further add to competition in the domestic market (although small local firms can become suppliers to the large multinational firms)
• Employees may leave domestic firms if they don’t pay as well as the foreign multinationals in the country- businesses will have to increase pay and conditions to recruit and retain employees.

When looking at an economy’s point of view, globalisation brings consumers more choice and lower prices and forces domestic firms to be more efficient (in order to remain competitive). However, competition from foreign producers can force domestic firms to close down and jobs will be lost.

Protectionism

Protectionism refers to when governments protect domestic firms from foreign competition using trade barriers such as tariffs and quotas; i.e. the opposite of free trade.

Import quota is a restriction on the quantity of goods that can be imported into the country.
Tariffs are taxes on imports.

Imposing these two measures will reduce the number of foreign goods in the domestic market and make them expensive to buy, respectively. This will reduce the competitiveness of the foreign goods and make it easy for domestic firms to produce and sell their goods. However, it reduces free trade and globalisation.
Free trade supporters say that it is better to allow consumers to buy imported goods and domestic firms should produce and export goods and services that they have a competitive advantage in. In this way, living standards across the globe will improve.

 

Multinational Companies (MNCs)

Multinational businesses are firms with operations (production/service) in more than one country. Also known as transnational businesses. Examples: Shell, McDonald’s, Nissan etc.

Why do firms become multinationals?

• To produce goods with lower costs– cheaper material and labour may be available in other countries
• To extract raw materials for production, available in a few other countries. For example: crude oil in the Middle East
• To produce goods nearer to the markets to avoid transport costs.
• To avoid trade barriers on imports. If they produce the goods in foreign countries, the firms will not have to pay import tariffs or be faced with a quota restriction
• To expand into different markets and spread their risks
• To remain competitive with rival firms which may also be expanding abroad

Advantages to a country of a multinational setting up in their country:

• More jobs created by multinationals
• Increases GDP of the country
• The technology that the multinational brings in can bring in new ideas and methods into the country
• As more goods are being produced in the country, the imports will be reduced and some output can even be exported
• Multinationals will also pay taxes, thereby increasing the government’s tax revenue
• More product choice for consumers

Disadvantages to a country of a multinational setting up in their country:

• The jobs created are often for unskilled tasks. The more skilled jobs will be done by workers that come from the firm’s home country. The unskilled workers may also be exploited with very low wages and unhygienic working conditions.
• Since multinationals benefit from economies of scale, local firms may be forced out of business, unable to survive the competition
• Multinationals can use up the scarce, non-renewable resources in the country
• Repatriation of profit can occur. The profits earned by the multinational could be sent back to their home country and the government will not be able to levy tax on it.
• As multinationals are large, they can influence the government and economy. They could threaten the government that they will close down and make workers unemployed if they are not given financial grants and so on.

 

Exchange Rates

The exchange rate is the price of one currency in terms of another currency.

For example, €1= $1.2. To buy one euro, you’ll need 1.2 dollars. The demand and supply of the currencies determine their exchange rate. In the above example, if the €’s demand was greater than the $’s, or if the supply of € reduced more than the $, then the €’s price in terms of $ will increase. It could now be €1= $1.5. Each € now buys more $.

A currency appreciates when its value rises. The example above is an appreciation of the Euro. A European exporting firm will find an appreciation disadvantageous as their American consumers will now have to pay more $ to buy a €1 good (exports become expensive). Their competitiveness has reduced. A European importing firm will find an appreciation of benefit. They can buy American products for lesser Euros (imports become cheaper).

A currency depreciates when its value falls. In the example above, the Dollar depreciated. An American exporting firm will find a depreciation advantageous as their European consumers will now have to pay less € to buy a $1 good (exports become cheaper). Their competitiveness has increased. An American importing firm will find a depreciation disadvantageous. They will have to buy European products for more dollars (imports become expensive).

In summary, an appreciations is good for importers, bad for exporters; a depreciation is good for exporters, bad for importers; given that the goods are price elastic (if the price didn’t matter much to consumers, sales and revenue would not be affected by price- so no worries for producers).

Confused? Don’t worry, it is a confusing topic. Check out our more detailed Economics notes on exchange rates.

 

 

Notes submitted by Lintha

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