  Chapter 

1.1 Introduction

Economic globalisation process = The increased interdependence of national economies and the trend towards greater integration of goods, labour and capital markets.

The economic globalisation process influences managerial decisions and market organisation.

International economics analyses the interactions in the global economic environment, meaning it analyses the managerial decisions taken of the basis of a cost-benefit analysis in the global economic environment.

This book is all about the global economy; what is it, how big is it, how functions it and how do participants interact are central questions. This first chapter gives some basic background information about the global economy. It forms the basis for the rest of the chapters.

1.2 The universe and population - history

Refer to Figure 1.1 on page 5 in the book. It shows the history of our planet. Mankind appeared on our planet 1.8 million years ago, taking the Homo Erectus who invented tools as a starting point.

Population size

All estimates made of the global population prior to 200 Before Christ (BC) are based on archaeological and anthropological evidence. From the nomadic time (before 8000 BC) we know that people lived from gathering berries and that it took five square kilometres to feed a human being. According to data sources in Kremer, there were around 125.000 people 1 million years ago. The next 700.000 years the population grew to 1 million and reached about 170 million in the year zero. In Figure 1.2 on page 6, the developments of world population over the last 2500 years are shown. All stagnations in growth can be explained historically by wars and other phenomena. Table 1.1 shows population and population density for 20 big countries.

Population projections

Refer to Table 1.2 on page 8 in the book. About 60% of the world total population lives in Asia (as of measures in 2010). It is expected that this share falls to 55% in 2050. The African population is expected to increase most dramatically (from 1.02 billion to 2.19 billion) and the European population is expected to decline from 738 to 719 million. This can be explained by the higher African total fertility rate (average number of children per woman); Europe has a rate of 1.59 and Africa of 4.37. As a result of better health care systems and availability of food and safe water supplies, life expectancy at birth I higher in developed countries than in developing countries (78 years versus 67 years in 2010). Life expectancy is particularly low in Africa (57.4 years), partly due to the HIV/AIDS epidemic. In the 35 most highly affected countries of Africa, life expectancy at birth would be 6.5 years less than it would have been in the absence of AIDS.

Population ageing will be the major demographic trend for the next fifty years. The rise in life expectancy at birth and the decline in fertility rates will lead to rapid increases in the share of older people. The median age is used as an indicator. The median splits a population in two equal halves. Whereas half of the world population was younger than 29.2 and a half was older than 29.2 in 2010, the median is expected to be 38.5 in 2050.

Population and business

Firms study demographic trends very closely, as they have to adapt their products and services to those trends. They also want to know what impact trends have on their core activities and strategies. A few examples;

  • Many automobile firms started production and assembly plants in China since 2000, due to the rapidly growing Chinese population and thus market

  • Investment firms are increasing the share of investments in firm activities that will benefit from the ageing process (health care, travel, etc.)

Business and population

Businesses are also important drives of much that happens at the population level. Policy makers thus take account of business developments and try to influence them so that the whole population takes advantage of them. A few examples;

  • Businesses are the key drivers of employment and growth, particularly in capitalist societies

  • The pharmaceutical industry is the key producer of new medicine

1.3 GNP and GDP- income levels

The total value of goods and services produced in a certain time period is the best indicator of economic power. You should estimate this total value and compare results across nations, taking three steps;

  • A well-functioning statistics office must gather information about goods and services produced

  • What should be compared? Gross domestic product GDP or gross national product GNP?

  • How to compare the outcome?

Point 2- GDP or GNP?

Gross domestic product (GDP) = The market value of the goods and services produced by labour and property located in a country.

Gross national product (GNP) = The market value of the goods and services produced by labour and property of residents of a country.

Example; A Mexican worker is providing labour services in the USA > These services are American GDP and Mexican GNP. Note that the GNP GDP difference does not only hold for labour services, but also for other factors of production.

GDP + Net receipts of factor income = GNP

For big countries the difference between GDP and GNP is ignorable. For small countries it can be very high. Throughout the book, GDP is used.

Point 3- How to compare?

When GDP level in each country is converted to the same international standard currency (USDollar mostly) on the basis of the average exchange rate in the period of observation, you can see in Table 1.3 on page 12 in the book that the US has the world’s largest economy. However, a ranking based on values measured in current USDollar is deceptive, because it overestimates production in high-income countries relative to low-income countries. For this, we have to distinguish between tradable and non-tradable goods.

Tradable goods = Can be transported or provided in another country, perhaps at some cost. Providers of tradable goods compete with one another, implying that prices can be compared effectively.

Non-tradable goods = Have to be provided locally and do not compete with international providers (housing services, getting a haircut, going to the cinema).

Getting a haircut in the USA may cost you Dollar15 and only Dollar1.50 in Tanzania, making the value of production in a high-income country relative to a low-income country being overestimated by a factor of 10.

To solve this problem, the UN International Comparison Project collects data on the prices of goods and services for all countries in the worlds and calculates PPP exchange rates. See Table 1.3.

Income per capita

Income per capita = Gives an idea of the well-being for the average person in a country, but gives no information about income distribution within that country. Table 1.3 on page 12 also lists per capita incomes.

Income and business

Managers of large firms do concern the income level in a country, as they want to know how large the demand will be for a certain product in a certain region. So not only population size and density are important, but also GDP per capita. Take people’s first needs like food and drinks. In India GDP per capita may be low, but food and drinks will be bought. As soon as GDP per capita starts growing, total spending on food and drinks will rise quite gradually and more money is left for luxurious items. This is crucial information for firms.

Business and income

Business developments are a key determinant of a country’s GDP. Profitable businesses create jobs and profitable businesses pay well, the other way around for loss making businesses. In an international context, the locations of multinationals influence cross-country distributions of income and hence of GDP per capita.

1.4 The global economy- Some general information

There is no one standard answer to the question: “What is globalisation?”. Globalisation means different things to different people. Take farm leaders, trade unionists and human rights activists as an example ; they all see different pros and cons for globalisation.

Based on this argumentation, there are five key issues to be considered:

  • Cultural globalisation > Which is about the debate whether there is one big global culture or a set of universal cultural variables, and the degree to which these universal cultural variables displace embedded national cultures and traditions.

An example that illustrates this debate: there are people afraid of ‘McDonaldisation’ (hige multinationals are the carriers of culture globalisation) and there are people seeing enough room for local traditions.

  • Economic globalisation > Which is about the decline of national markets and the rise of global markets. Drivers for economic globalisation are fundamental changes in technology which permit more efficient ways of internationally organizing production processes.

  • Geographical globalisation > Which is about the result of ‘joint time and space’ due to reduced travel times and the rapid (electronic) exchange of information. Some neo-liberals named this development the ‘end of geography’ in which location no longer matters.

  • Institutional globalisation > Which is about the spread of universal institutional regulations across the world, triggered by US President Reagan’s and UK Prime Minister Thatcher’s ‘revolution’ of neo-liberalism. These neo-liberal policies are represented by institutions such as the IMF (International Monetary Fund), the WB (World Bank) and the WTO (World Trade Organisation). These universal institutional regulations are not only on macro-economic level, but also on the micro-economic level: multinationals adopt similar policies under the pressure of competition and regulation.

  • Political globalisation > Which is about the relationship between the power of the market (multinational corporations) versus the nation-state, which continuously has to make changes and updates in reaction to economic and political forces. Popular anti-globalists stress that large multinationals become more and more powerful, out-powering the majority of nation-states. In contradiction, others point out that real evidence for these fears is lacking, as the state has to provide security, a legal system, education and infrastructure, which are all of vital importance for economic activity and growth.

Keynes once said that the master economist should “examine the present in light of the past, for the purpose of the future”, by which the common opinion about economic globalisation was that it was a totally new phenomenon with overwhelming power. Later research, however, showed that it is historically seen not a new phenomenon at all.

1.5 Globalisation and welfare

Before explaining the topic of this section, let’s first take a look at logarithmic graphs:

Note: This explanation of logarithmic graphs is based on Figure 1.7 in the book

A logarithmic scale is a scale that divides the vertical axis in steps of ten-fold increases: 1-10-100-1000-10000.

  • The important advantage of a logarithmic graph is that it can simultaneously show the developments in the level of a variable and its growth rate, where the slope (rise/run) of the line reflects the variable’s growth rate. In Figure 1.7, Variable A grows constantly by 14,7% per year. Variable B has no constant growth rate (-5% for the first 30 years and then 8%). C, finally, does not grow at all: 0%, so a straight line.

  • The important disadvantage of logarithmic graphs is that they can be misleading concerning the difference in levels for variables at the same point in time and for the same variable at different points in time. Let’s illustrate this;

In 1950, the difference between variables A and B is about twice that between the variables B and C, because the vertical difference is twice as large. However, this is a logarithmic graph, so these differences are multiplicative: the level of variable C is 100 times higher than the level of A

In 2000, if the variables all measure something positive, variable A obviously has fared better than variables B and C. But how much better? This is hard to tell from the figure

Now, back to the theory: globalisation and welfare.

To describe the evolution of income over time, researcher Angus Maddison uses so-called ‘1990 international dollars’. Maddison collects data for virtually all countries in the world . The development of the world per capita income is illustrated in Figure 1.6, using a logarithmic scale. The logarithmic scale shows the level of income and the growth rate of the income. As you can see in the figure ; world income per capita only started to increase from the year 1000-1800 approximately. Since 1800, per capita world income rose more than eleven-fold in a period of 188 years. Maddison made a note: not only per capita incomes are a measure of welfare, life expectation also is.

Leading and Lagging nations in terms of relative GDP/capita index

The calculations of the deviation index of GDP per capita can be split in above the world average and below the world average. The calculations over 2000 years are available for 28 individual countries and 6 country groups, together covering the global economy. See Figure 1.8 + description: at the beginning of our calendar (year 0): the leading country was Italy, where many other countries were laggards. Later on, the Netherlands, the USA, Switzerland, Australia and the UK became leaders, where Africa, China, India and Iraq became laggards.

1.6 Globalisation’s manifestation on international trade and business

The most significant manifestation of the idea of a global economy is the rise in international trade and capital flows. Capital flows are not a completely new phenomenon, in the ancient cultures of Egypt and Greece for example such flows have always been central in economic interactions. According to Maddison, capital flows have been the most important for the economic rise of Western Europe the past millennium (Recap: Figure 1.8)

Historical overview of the developments in the world economy

Venice: key figure in the economic rise of Western Europe (1000-1500):

  • Based on improved techniques of shipbuilding and navigation (the compass), Venice opened up trade routes within Europe, the Mediterranean and to China via the caravan routes, bringing in products and new technology (relevant for that time)

  • By establishing a system of public finance, Venice became the lead economy of the period

Portugal: more ambitious interactions between Europe and the rest of the world (second half of the 15th century)

  • By opening up trade and settlement in the Atlantic islands

  • By developing trade routes around Africa, to China, Japan and India

  • Portugal’s geographic location enabled its fishermen to gather knowledge of Atlantic winds, weather and tides

  • Portugal soon became the dominant player in the intercontinental trade due to the gained knowledge, maritime experience and the inventions Venice already did (improved techniques of shipbuilding and navigation)

The Netherlands: most dynamic economy (1400-mid 17th century)

  • By creating large canal networks

  • By developing shipping, shipbuilding and commercial services > Figure 1.9 shows how the carrying capacity of Dutch merchant shipping was about the same as the combined fleets of Britain, France and Germany.

  • By providing property rights, education and religious tolerance

  • Only 40% of the labour force in agriculture > a financial and entrepreneurial elite from Flanders and Brabant emigrated to Holland on a large scale > Holland became the centre for banking, finance and international commerce

Britain: leading economy (18th century)

  • By improving its financial, banking, fiscal and agricultural institutions along the lines pioneered by the Dutch

  • By accelerating technical progress and investing in physical capital, education and skills

  • By reformations in commercial trade policies: reducing protective duties on agricultural imports and eventually removing all trade and tariff restrictions

Europe (18th century-current) > Figure 1.10:

  • Massive outflow of capital for overseas investment (end 19th – beginning 20th centuries)

  • Collapse of trade, capital and migration flows and slow economic growth due to the two world wars and the Great Depression (mid-20th century)

  • The world economy starts growing again, and becomes more closely connected than ever before (end 20th century)

International trade and MNEs

After the before provided historical overview of the world economy, it is clear that there are two waves of globalisation: the end of the 19th century until the beginning of the 20th century and after the Second World War.

Globalisation is not only due to macro-economic forces, but also to effects of micro-level enterprises.

1.7 The global economy- a detailed analysis

Economic globalisation = ‘The increased interdependence of national economies and the trend towards greater integration of flows of goods, labour and capital markets’.

Only focusing on the volume of these flows gives a biased view of the degree of globalisation. Two examples to illustrate this: the price wedge and fragmentation.

The price wedge

Basic economic picture: a downward-sloping demand curve (people buy less if a product becomes more expensive) and an upward-sloping supply curve (firms produce more if the price rises). Take Figure 1.11, international trade flows can also be depicted in this most basic framework, with two twists:

  • Home’s demand curve for imports is the home’s demand for the good not provided by the home’s domestic suppliers. Similarly, this applies for the Foreign’s export supply curve

There may be a number of reasons for a deviation between Home’s and Foreign’s price > The price wedge = for example, because foreign firms have to overcome certain transport costs, tariffs, trade impediments, cultural differences, et cetera.

Point A: price wedge = paH – paF > 0, resulting in volume qa. From point A, rises in international trade flows can occur for two basic reasons:

  • A shift to the right in either demand or supply at a constant price wedge will result in increasing trade flows. In Figure , demand shifts to the right > international economy moves to point B, trade flows move from qa to qb (constant price wedge: paH – paF = pbH – pbF). Generally: increased globalisation if the rise in trade flows is larger than the rise in production

  • Price wedge diminishes, resulting from for example lower tariffs or lower transportation costs. If the price wedge completely disappears, the international economy would move to point C

The price wedge in history

Trade

According to O’Rourke and Williamson, early growth of international trade was of the first kind: a shift to the right in either demand or supply, as the importing countries themselves could not produce the goods then exported (spices, coffee, tea and sugar). Usually, these were expensive luxury items and their buyers could afford to pay the price wedge.

The two waves of globalisation (Figure 1.10) explain the second kind of growth in international trade: decreasing transport costs, technology improvements, falling trade restrictions, international cooperation, the removal of trade restrictions and improved communication possibilities all led to a decreasing price wedge.

Capital

The development of the price wedge in between the two waves of globalisation (decrease in the first wave, increase during the World Wars and a decrease in the second wave) is also visible on the capital market. As you compare Figure 1.10 with Figure 1.13, there are two waves of globalisation in the capital market as well.

Migration

Generally, real wage differences between countries explain the direction of migration flows to a very large extent.

Fragmentation

Fragmentation = Technological and communication advances have enabled many production processes to be subdivided into various phases which are physically separable > Figure 1.15. The fragmentation process is facilitated by service links such as transportation, telecommunications, insurance, quality control and management control. Fragmentation helps to clarify why some phases of the production will be internally organised and why some phases will be outsourced.

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