6.2 – Globalisation, Free Trade and Protection

Globalisation is a process of interaction and integration among the people, companies, and governments of different nations, a process driven by international trade and investment and aided by information technology [definition by: www.globalization101.org)

Multinational Corporations (MNCs)

Businesses which have their operations, factories and assembly plants in more than one country are known as multinational businesses. Examples include Starbucks, IKEA, Toyota, Adidas etc. The country they are based in is called the home country, and the countries they operate in are called host countries.

Advantages to home country:

• MNCs create opportunities for marketing the products produced in the home country throughout the world.
• They create employment opportunities to the people of home country, both at home and abroad.
• It aids and encourages the economic growth and development of the home country.
• MNCs help to maintain favourable balance of payments of the home country in the long run as they export their products abroad.

Advantages to host country:

• Provides significant employment and training to the labour force in the host country.
• Transfers of skills and expertise, helping to develop the quality of the host labour force.
• MNCs add to the host country’s GDP through their spending, for example with local suppliers and through capital investment.
• Competition from MNCs acts as an incentive for domestic firms in the host country to improve their competitiveness and efficiency.
• MNCs extend consumer and business choice in the host country.
• MNCs bring with them efficient business practices, technologies and standards from across the world, which can influence the industries in the home country.
• Profitable MNCs are a source of significant tax revenues for the host economy (for example on profits earned as well as payroll and sales-related taxes).

Disadvantages to home country:

• MNCs transfer capital from the home country to various host countries causing unfavourable balance of payments.
• MNCs may not create employment opportunities to the people of home country if it employs labour from other countries, perhaps due to lower costs or better skills.
• As investments in foreign countries is more profitable, MNCs may neglect the home country’s industrial and economic development.

Disadvantages to host country

• Domestic businesses may not be able to compete with MNC’s efficiency, low costs, low prices and brand image, and may be forced to close shop.
• MNCs may not act ethically or in a socially responsible way, especially by taking advantage of weak countries who gain a lot from the MNCs presence in their country. For example, exploiting workers with low wages and poor working conditions in a country where labour laws are weak.
• MNCs may be accused of imposing their culture on the host country, perhaps at the expense of the richness of local culture.
• Profits earned by MNCs may be remitted back to the MNC’s home country rather than being reinvested in the host economy.
• MNCs may make use of transfer pricing and other tax avoidance measures to reduce the profits on which they pay tax to the government in the host country.

Free Trade and Protection

Free trade is when there are no restrictions for trade between economies.

The advantages of free trade:

• Allows countries to benefit from specialisation: if there was no international trade, then countries wouldn’t be able to specialise – that is, they would have to become self-sufficient by producing all the goods and services they require themselves. Total output would lower and costs would rise. With specialization and free trade, output, incomes and living standards will improve.
• Increases consumer choice: consumers can now enjoy a variety of products from around the globe.
• Increases competition and efficiency: international trade means that there will be more competition among firms in different countries. This would help increase efficiency.
• Creates new business opportunities: free trade will allow businesses to produce and sell goods for overseas consumers and expand and grow their operations by doing so. Profits and revenue would rise.
• Enables firms and economies to benefit from the best workforces, resources and technologies from around the world.
• Increases economic inter-dependency and thus fosters cooperation and reduces potential for international conflicts.

The disadvantages of free trade:

• Free trade may reduce opportunities for growth in less-developed economies and threaten jobs in developed economies. Small businesses in developing countries may not be able to compete with larger foreign firms. Established businesses in developed countries may lose market share as new firms keep entering the market. The US has seen considerable unemployment in manufacturing sectors since China joined the WTO and flooded international markets with their cheap products.
• Causes rapid resource depletion and climate change as more resources are used up by firms.
• Exploitation of workers and the environment: free trade has allowed firms to relocate to countries with lower costs (usually lower wages), where workers and the environment can be exploited (as health, safety and environmental laws in such countries are likely to be relaxed).
• Income inequality worsens: multinational firms and consumers have dominated the international supply and demand. This means that the rich keep getting richer (by buying and selling more products) while the poor lose out on products and resources.

Protection involves the use of trade barriers by governments to restrict international market access and competition. Trade barriers include:

• Tariffs: these are indirect taxes on imported (or exported) goods that make them more expensive, imposed in order to discourage domestic consumers from buying them.
• Subsidies: government allows subsidies to domestic producers so that they can increase their output and reduce costs and in turn reduce prices, in the hope that consumers will be encouraged to buy inexpensive domestic goods rather than imports.
• Quotas: this is a limit on the number of imports allowed into a country in a given period. Restricting supply will push up their market prices and discourage consumption of those imports.
• Embargo: this is a complete ban on imports of a good to a country.
• Excessive quality standards: imports may only enter a country after extensive quality checks which will be costly and so foreign producers will be discouraged to sell their products in the country, reducing imports.

Reasons for protection:

• To protect infant industries: trade barriers will help protect infant/sunrise industries (industries that are new and are hoping to grow). Lesser competition from foreign firms will increase their chances of survival and growth.
• To protect sunset industries: sunset industries are those that are on their declining stage. They would still employ many people and closure of firms in that industry will result in high unemployment. Lesser competition from foreign firms will decrease their rate of decline.
• To protect strategic industries: strategic industries will include transport, energy, defence etc. and governments will want to protect these so they are not dependent on supplies from overseas. If foreign firms supplied these, they would restrict output and raise prices.
• To limit over-specialization: if a country specializes in the production of a narrow range of products and there is a global fall in demand for one of them, then the economy is at risk. Protectionism will ensure diversification into producing more products and reduce this risk.
• To protect domestic firms from dumping: dumping is a kind of predatory pricing, that occurs when imports are sold at a price either below the price charged in the home market or below its cost of production. As a result, domestic firms will be unable to compete and be forced to go out of business. Once this happens, the foreign firms will raise their prices and enjoy monopolistic power. Trade barriers will eliminate the risk of dumping.
• To correct a trade imbalance: protectionism can reduce the imports coming into a country and thus reduce expenditure on imports by domestic consumers. If a country is experiencing a deficit (imports exceeding exports), then protectionism will correct this imbalance.
• Because other countries use trade barriers.

Consequences of protection:

• They restrict consumer choice.
• They restrict new revenue and employment opportunities.
• High levels of import tariffs and quotas will increase the costs of production at home and drive up prices, causing cost-push inflation.
• They protect inefficient domestic firms: when trade barriers are used to protect domestic industries, it might include inefficient industries. Protectionism means that even very inefficient industries are protected (when they are better off being exposed to foreign competition and being forced to become more efficient).
• Other countries may retaliate: if a country introduces trade barriers to restrict imports from other countries, the countries that are affected by this will also impose similar trade barriers. A trade war may develop. Relations between countries will worsen.
• In today’s globalised society, being heavily protected and not engaging in free trade will result in the country being out of pace with the rest of the world. They will be unable to grow and develop, and will lose out on the benefits of free trade.

Tip: If you have trouble remembering all the pros and cons listed above, just remember this: basically, the advantages of free trade are the disadvantages of protectionism and the disadvantages of free trade are the advantages of protectionism.

Notes submitted by Lintha

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