Q63. What is globalisation?

Globalisation is, mostly, a buzzword. The general idea is that the whole world is being opened up to world capitalism. For economists, globalisation can be defined as the increased interconnection of factor markets (markets for the factors of production).

Today, goods and services are assembled across many countries, with common technologies, common communications, and globalised capital markets. In the case of trade, this has led to global merchandise exports amounting to over 20% of world gross national product in 2007 compared with 8% in 1913 at the end of the last era of globalisation (from 1870 to the start of the First World War).

Various studies suggest that recent globalisation has increased living standards worldwide, but not for everybody: there have been winners and losers from globalisation. All agree that, with reduced transport costs, tariffs and quotas, and the creation of true multinational businesses capable of exploiting changes in demand across the globe, globalisation has changed the international economy in waves that have lasted for centuries. The current wave of globalisation is only the latest in a long series of historical episodes.

Q64. Does free trade work?

Yes, if the theory of absolute advantage is right.

In the theory of international trade, absolute advantage is a situation where, when two or more countries trade two or more goods, one of the countries is better at producing both goods. In other words, given two countries, say Australia and Brazil, which can produce two goods, wood and steel, Australia outperforms Brazil in both markets, as shown in the table below.

Example of absolute advantage.

Example of absolute advantage.

Australia is absolutely more efficient than Brazil in producing both goods. The principle of absolute advantage appears to rule out attempts to make Brazil better off through trade, but the principle of comparative advantage, which superseded absolute advantage, showed it is not the absolute difference between each country's costs of production of wood and steel that mattered, but their relative opportunity costs in production, which allows Australia and Brazil to specialise in production of either wood or steel.

Thus, although Australia is better at producing both wool and steel, from an opportunity cost point-of-view, it still makes sense for it to trade with Brazil in both commodities.

Therefore there is a role for free trade in helping to increase economic growth internationally.

Q65. Why does comparative advantage mean that free trade is almost always better than restricted trade?

Comparative advantage is the principle that, through trade in goods, a country can produce a product at a lower cost than another country, still buy from abroad the goods it does not produce at home, and be better off.

Imagine two countries, A and B. They use the same resources to produce two goods, X and Y, in quantities described in the table below. Country B is more efficient at producing both X and Y than country A (an absolute advantage), but still can gain by trade, because it is able to produce X at a lower cost than country A, and let country A produce more Y. Country A has a lower opportunity cost of producing Y, so it should trade X for Y with country B. Both countries benefit.

An illustration of comparative advantage: why trade can make different countries better off.

An illustration of comparative advantage: why trade can make different countries better off.

Q66. Why do import / export tariffs matter for free trade?

An import tariff is a tax or duty levied on a product when it is imported into a country. Tariffs can be ad valorem, specific or compound.

An ad valorem tariff adds a percentage increase to the price of the imported product. For example, a 10% tariff on a bicycle worth €100 increases the price of the bicycle in the importing country to €110. Ad valorem tariffs are the type most frequently used by the European Union.

A specific tariff is a fixed lump sum levied on an import. For instance, a specific tariff of €5 increases the price of the bicycle to €105. The USA uses both ad valorem and specific tariffs.

A compound tariff combines an ad valorem and a specific tariff. With a 10% ad valorem tariff, and a specific tariff of €5, the price of the imported bicycle rises to €115.

Tariffs matter because they discourage trade, harm the consumer who has to pay higher prices for the goods and services, and give the home-produced good a competitive advantage. There are economic arguments for supporting tariffs - nurturing infant industries, which would collapse under international competition, for example - but the evidence we have shows, on balance, that tariff reductions increase trade, promote competition, increase employment, increase economic growth, and develop living standards.

 
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