Tuesday, June 24, 2008

World Bank Article - Globalization and International Trade

A must read for key issues within the topic of Globalisation and International Trade.

(Click to download pdf file)


'Globalization” refers to the growing interdependence of countries resulting from the increasing integration of trade, finance, people, and ideas in one global marketplace. International trade and cross-border investment flows are the main elements of this integration.

Globalization started after World War II but has accelerated considerably since the mid-1980s, driven by two main factors. One involves technological advances that have lowered the costs of transportation, communication, and computation to the extent that it is often economically feasible for a firm to locate different phases of production in different countries. The other factor has to do with the increasing liberalization of trade and capital markets: more and more governments are refusing to protect their economies from foreign competition or influence through import tariffs and nontariff barriers such as import quotas, export restraints, and legal prohibitions.


Geography and Composition of Global Trade (IMPT!!)

Over the past 10 years patterns of international trade have been changing in favor of trade between developed and developing countries. Developed countries still trade mostly among themselves, but the share of their exports going to developing countries grew from 20 percent in 1985 to 22 percent in 1995. At the same time, developing countries have increased trade among themselves. Still, developed countries remain their main trading partners, the best markets for their exports, and the main source of their imports.

Most developing countries’ terms of trade deteriorated in the 1980s and 1990s because prices of primary goods—which used to make up the largest share of developing country exports—have fallen relative to prices of manufactured goods. For example, between 1980 and 1995 real prices of oil dropped almost fourfold, prices of cocoa almost threefold, and prices of coffee about twofold. There is still debate about whether this relative decline in commodity prices is permanent or transitory, but developing countries that depend on these exports have already suffered heavy economic losses that have slowed their economic growth and development.

In response to these changes in their terms of trade, many developing countries are increasing the share of manufactured goods in their exports, including exports to developed countries (Figure 12.2). The most dynamic categories of their manufactured exports are labor-intensive, low-knowledge products (clothes, carpets, some manually assembled products) that allow these countries to create more jobs and make better use of their abundant labor resources.

By contrast, developing countries’ imports from developed countries are mostly capital- and knowledge-intensive manufactured goods—primarily machinery and transport equipment—in which developed countries retain their comparative advantage.

Monday, June 23, 2008

Comparative Advantage & Its Sources

A country has a comparative advantage in producing a good if the opportunity cost of producing the good is lower for that country than for other countries.

There are 3 main sources of comparative advantage:

(a) Differences in climate
(b) Differences in factor endowment (factors of production such as land, labour and capital are of different levels of abundance in different countries)
(c) Differences in technology

The causes of differences in technology are somewhat mysterious. Sometimes they seem to be based on knowledge accumulated through experience. Sometimes, they are a result of set of innovations that for some reason occur in one country but not in others.

Note: Technological advancement is also often transitory. For example, Europe's aircraft industry has closed the gap with that of the US. China's level of technology is also advancing rapidly as a result of technological transfer from the large volume of foreign direct investments into the country, as well as huge funding for R&D from the government as well as private enterprise. At any given point in time, differences in technology are a major source of comparative advantage for any country.

Differences in factor endowment (through differences in the distribution of resources, both quantity and quality) will also affect the cost of production, hence accounting for the differences in opportunity costs. For example, China's abundance of labour, both skilled and unskilled, have allowed her to produce at lower opportunity costs due to the cheap labour, hence giving China a comparative advantage in the labour-intensive industries.

Lastly, climatic differences between countries can play a major role in determining the costs at which different countries produce a good, specifically agricultural produce. For example, certain regions of France have climatic conditions that are highly favourable to the growing of grapes for producing champagne, giving these regions a comparative advantage in production of champagne. On the other hand, the arid climate in many parts of the Australian continent does not favour the growing of agricultural goods such as rice, which requires a lot of water for the paddy fields. In order to supply sufficient water to these crops, complex irrigation networks have been set up and maintained at high cost, which reflects that Australia clearly does not have a comparative advantage in the production of rice.

(Link: Ricegrowers' Association of Australia - Australia's rice is more highly priced; NY Times Article: A Drought in Australia, a Global Shortage of Rice & Article: The Australian Rice Industry and Water)