Chapter 24 · Macroeconomics
Globalisation and Trade
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Key Definitions
- Globalisation
- The growing economic interdependence of economies through trade, production and capital flows.
- Comparative advantage
- A country has a comparative advantage in the good it can produce at a lower opportunity cost than its trading partner.
- Dynamic comparative advantage
- The pattern of comparative advantage changes as factor endowments, technology and skills develop over time.
- Terms of trade
- The ratio of the export price index to the import price index, times 100, with a base year set at 100.
Core Concepts
Factors driving globalisation
- Recognition of the benefits of trade.
- Falling transport costs.
- Technological advances: cheaper communication and easier overseas job search.
- Government policies favouring openness, including the WTO.
Benefits of globalisation
- Lower prices and greater consumption.
- Economies of scale.
- Faster growth.
- Higher living standards.
Comparative advantage assumptions
- Free trade between countries.
- Perfectly mobile factors within a country.
Worked example: USA and China
- USA can produce 1000m metres of cloth or 1000 machines.
- China can produce 800m metres of cloth or 200 machines.
- The USA's opportunity cost of one machine is 1m metres of cloth; China's is 4m metres.
- The USA has a comparative advantage in machines and should specialise in them.
- The terms of trade must lie between 1 and 4 metres of cloth per machine for both to gain.
Dynamic comparative advantage
- Develops through factor endowments, remembered as CELL: capital, entrepreneurship, labour, land.
- Follows a ladder from natural to acquired factors.
- Singapore has moved from labour-intensive to capital-intensive specialisation.
Limitations of the theory
- Trade barriers.
- Factor immobility.
- High transport costs.
- Foreign-exchange restrictions.
- Demand factors and non-economic reasons, including security of essential goods and the costs of structural unemployment.
Patterns of trade
- Supply factors.
- Free-trade agreements (FTAs).
- Geographical proximity.
- Demand factors, such as variety, rising incomes and high world demand.
Improvement in the terms of trade
- Higher foreign demand for exports.
- A fall in domestic export supply.
- A fall in demand for imports by a large exporter.
- A rise in the foreign supply of imports.
- Appreciation of the domestic currency.
Real-World Examples
- Singapore's move from labour-intensive to capital-intensive specialisation illustrates a rising ladder of dynamic comparative advantage.
- Singapore's reliance on agreements and openness is captured by the CELL factor-endowment approach.
Essay Outline
- Define comparative advantage and state its assumptions.
- Work the USA-China example to show how opportunity cost drives specialisation and gains.
- Extend to dynamic comparative advantage using CELL and Singapore's experience.
- Evaluate the limits: barriers, immobility, transport, FX and non-economic reasons.
- Conclude on how far the theory explains real-world trade patterns.