Globalisation
What you'll learn
- What globalisation means and why it has accelerated.
- How international competitiveness, absolute advantage and comparative advantage help explain trade.
- How to calculate the terms of trade and interpret changes.
- How the Marshall-Lerner condition and J-curve link exchange rates to the current account.
1. What is globalisation?
Globalisation is about economies becoming more connected. Countries do not just trade finished goods; they also share finance, technology, workers, data, brands and production stages.
Globalisation
Globalisation is the increasing integration and interdependence of economies through flows of goods, services, capital, labour, technology and information across borders.
Interdependence means events in one economy affect others. For example, a semiconductor shortage in East Asia can raise car prices in the UK if UK car manufacturers rely on imported chips.
Main causes of globalisation
- Trade liberalisation: governments reduce barriers such as tariffs — taxes on imports — and quotas — legal limits on import quantities.
- Lower transport and communication costs: container shipping, air freight and the internet make it cheaper to coordinate production globally.
- Multinational corporations (MNCs): firms operating in more than one country use foreign direct investment (FDI), which is investment into overseas productive assets or business operations.
- Global value chains: production is split across countries, with each location specialising in a particular stage.
- Financial liberalisation: capital moves more freely between countries, allowing firms and governments to access global finance.
Tracing a global supply-chain shock
- A UK retailer buys products assembled in Vietnam using components from several countries because global value chains allow firms to use low-cost or specialist suppliers.
- If shipping costs rise after a disruption, imported inputs become more expensive, increasing firms’ costs.
- Firms may raise prices, reduce profit margins, or switch suppliers, showing that globalisation can create efficiency but also vulnerability.
Globalisation is not just trade
In essays, treat globalisation as a web of links: trade, investment, migration, technology, finance and supply chains all matter.
2. International competitiveness
International competitiveness
International competitiveness is the ability of a country’s firms to sell goods and services successfully in world markets while supporting rising real incomes over time.
Competitiveness can be price-based or non-price-based.
Price competitiveness
A country is more price competitive if its goods are relatively cheap compared with overseas rivals. This depends on:
- Unit labour costs (ULCs): labour cost per unit of output.
- Productivity: output per worker or per hour.
- The exchange rate: the price of one currency in terms of another.
- Energy, transport and regulatory costs.
An appreciation of the pound means the pound rises in value, making UK exports more expensive for foreign buyers and imports cheaper for UK consumers. A depreciation means the pound falls in value.
Non-price competitiveness
This is about quality, reliability, branding, design, after-sales service and innovation. For example, Germany may export high-value machinery even if it is not the cheapest because buyers value precision and reliability.
Comparing unit labour costs
- A UK firm pays £30 per hour and produces output worth £60 per hour, so ULC=3060=0.50ULC = \frac{30}{60} = 0.50ULC=6030=0.50. Labour costs are 50p per £1 of output.
- A foreign competitor pays £12 per hour but produces output worth £20 per hour, so ULC=1220=0.60ULC = \frac{12}{20} = 0.60ULC=2012=0.60. Labour costs are 60p per £1 of output.
- The UK firm is more price competitive on labour cost despite paying higher wages, because higher productivity more than offsets the wage difference.
Competitiveness shortcut
Do not assume low wages mean high competitiveness. The key comparison is usually wages relative to productivity, plus the exchange rate and product quality.
3. Absolute and comparative advantage
Before you learn the theory, start with opportunity cost: the next best alternative given up when a choice is made.
Absolute and comparative advantage
Absolute advantage means a country can produce more of a good with the same resources, or the same output with fewer resources. Comparative advantage, associated with David Ricardo, means a country can produce a good at a lower opportunity cost than another country.
A production possibility curve (PPC) shows the maximum combinations of two goods an economy can produce when resources are fully and efficiently used. The PPCs below show why comparative advantage can exist even when one country has absolute advantage in both goods.
Finding comparative advantage
- Compare maximum outputs: Country A can produce 10 cars or 20 textiles, while Country B can produce 4 cars or 16 textiles. Country A has absolute advantage in both goods.
- Calculate opportunity cost of cars: in Country A, 1 car costs 2 textiles; in Country B, 1 car costs 4 textiles.
- Country A has comparative advantage in cars because it gives up fewer textiles per car.
- For textiles, Country A gives up 0.5 cars per textile, while Country B gives up 0.25 cars per textile. Country B has comparative advantage in textiles.
- If 1 car trades internationally for 3 textiles, both can gain: Country A receives more than its domestic opportunity cost, while Country B pays less than its domestic opportunity cost.
Absolute is not comparative
A country can have absolute advantage in everything but comparative advantage in only some goods. Trade is driven by relative opportunity costs, not just who is most productive.
4. Terms of trade
Terms of trade
The terms of trade measure the average price of exports relative to the average price of imports, usually using index numbers where the base year equals 100.
If the index rises, the terms of trade improve: a given volume of exports can buy more imports. If it falls, the terms of trade deteriorate.
Calculating the terms of trade
- Suppose the export price index is 112 and the import price index is 105, with base year = 100.
- Substitute into the formula: Terms of trade index=112105×100=106.7\text{Terms of trade index} = \frac{112}{105} \times 100 = 106.7Terms of trade index=105112×100=106.7.
- Interpret the result: the terms of trade have improved by 6.7% compared with the base year, so exports have greater purchasing power over imports.
An improvement is not automatically “good”. If export prices rise because UK goods become less competitive, export volumes may fall. A deterioration is not automatically “bad” if lower export prices help firms gain market share.
Terms of trade is not the trade balance
The terms of trade compare prices of exports and imports. The trade balance compares the value of exports and imports, which depends on both price and quantity.
5. Marshall-Lerner condition and the J-curve
The balance of payments records economic transactions between residents of one country and the rest of the world. The current account includes trade in goods and services, net income and transfers. A current account deficit means payments overseas exceed receipts from overseas on the current account.
Marshall-Lerner condition
The Marshall-Lerner condition states that a depreciation will improve the current account in the long run if the sum of the absolute price elasticities of demand for exports and imports is greater than 1: ∣PEDX∣+∣PEDM∣>1|PED_X| + |PED_M| > 1∣PEDX∣+∣PEDM∣>1.
Price elasticity of demand (PED) measures how responsive quantity demanded is to a change in price. The condition uses absolute values because PED is normally negative.
A depreciation makes exports cheaper to foreign buyers and imports more expensive to domestic consumers. But quantities may not adjust immediately because of contracts, habits, lack of substitutes or essential imports.
J-curve
The J-curve describes how a depreciation may initially worsen the current account before improving it later, as demand for exports and imports becomes more elastic over time.
Applying the Marshall-Lerner condition
- In the short run, suppose export demand elasticity is 0.3 and import demand elasticity is 0.4 in absolute terms. Since 0.3+0.4=0.7<10.3 + 0.4 = 0.7 < 10.3+0.4=0.7<1, depreciation is unlikely to improve the current account immediately.
- Import prices rise in pounds, but import volumes do not fall much, so the import bill may increase.
- In the long run, suppose elasticities rise to 0.8 for exports and 0.6 for imports. Since 0.8+0.6=1.4>10.8 + 0.6 = 1.4 > 10.8+0.6=1.4>1, export volumes rise and import volumes fall enough to improve the current account.
Depreciation is not a guaranteed fix
The Marshall-Lerner condition may fail if firms cannot increase output, imports are essential, foreign demand is weak, or UK goods have poor non-price competitiveness.
6. Evaluating comparative advantage as an explanation of trade
Comparative advantage is powerful because it explains why countries can gain from trade even when one is more efficient in all goods. It supports specialisation, higher world output and mutually beneficial exchange.
However, it is only a simplified model. It assumes resources move easily between industries within a country, factors of production do not move internationally, there are no transport costs or trade barriers, and goods are relatively standardised.
In reality, trade patterns are also shaped by:
- Economies of scale and large firms.
- Product differentiation and branding.
- Government policy, tariffs and subsidies.
- FDI and global value chains.
- Exchange rates and financial flows.
- Political relationships and trade agreements.
A good judgement is that comparative advantage is a strong starting point, especially for trade based on resources or clear cost differences, but it does not fully explain modern trade between similar developed economies. Paul Krugman’s new trade theory helps explain intra-industry trade, where countries import and export similar products, such as cars.
7. Consequences of globalisation for different economies
Developed economies
A developed economy is a high-income economy with advanced infrastructure and diversified industries, such as the UK, Germany or the US.
Globalisation can bring cheaper imports, wider consumer choice, export markets for high-value services, inward investment and lower production costs. For the UK, financial services, higher education and creative industries can benefit from access to global markets.
But there can also be job losses in manufacturing regions, greater income inequality, exposure to global shocks and pressure on tax revenues if MNCs shift profits overseas. Brexit trade frictions and post-pandemic supply-chain disruption show that global links can also create adjustment costs.
Emerging economies
An emerging economy is a rapidly growing middle-income economy becoming more integrated into global markets, such as China, India, Vietnam or Brazil.
Globalisation can support export-led growth, job creation, technology transfer and infrastructure investment. China’s growth after joining the World Trade Organization in 2001 is a major example.
Risks include pollution, poor working conditions, regional inequality, dependence on foreign demand and vulnerability to changes in global interest rates or investor confidence.
Developing economies
A developing economy is typically lower income, with weaker infrastructure and often greater dependence on primary products such as agriculture or minerals.
Globalisation can provide access to export markets, FDI, remittances from migrant workers and cheaper imported technology. But benefits may be limited if countries remain dependent on commodities with volatile prices, lack bargaining power, or cannot move into higher-value production.
Evaluation lens
For globalisation essays, judge outcomes by asking: who gains, who loses, how quickly, and under what conditions? Institutions, education, infrastructure and diversification often decide whether globalisation raises living standards.
8. Impact of emerging economies on other economies
The performance of emerging economies matters because they are large sources of demand, supply, labour, savings and investment.
If emerging economies grow quickly, they can:
- Increase export demand for developed economies, such as German machinery or UK business services.
- Raise commodity prices by increasing demand for oil, copper, lithium and food.
- Reduce global inflation by supplying cheaper manufactured goods.
- Increase competition for firms and workers in developed economies.
- Attract FDI away from some countries but create new investment opportunities for others.
If emerging economies slow down, the effects can reverse. A slowdown in China can reduce demand for Australian iron ore, German cars and luxury goods, while also lowering some global commodity prices. Financial market confidence may fall if investors fear wider contagion.
Overall, the impact depends on trade links, commodity dependence, supply-chain exposure and how easily firms can find alternative markets or suppliers.
In the exam
- Start with precise definitions, then build a chain of analysis: cause → mechanism → effect on trade, growth, inflation, employment or the current account.
- For terms of trade, state the formula, use base year = 100, and interpret whether the index shows an improvement or deterioration.
- Evaluate by comparing short run versus long run, developed versus emerging versus developing economies, and the conditions needed for benefits to appear.
Check yourself
- Why can a country with absolute advantage in both goods still gain from trade?
- If export prices rise faster than import prices, what happens to the terms of trade, and why might the current account not improve?
- Why might a depreciation worsen the current account in the short run but improve it in the long run?
