Globalisation

1. Why this topic matters

AS Level established why countries trade. This topic asks what happens when trade, capital and production become genuinely global, and who gains.

Globalisation is the increasing integration and interdependence of national economies, through trade in goods and services, movement of capital and labour, and the transfer of technology and ideas.

The examinable difficulty is that globalisation produces winners and losers within every country as well as between countries, so a question asking whether it is beneficial cannot be answered without specifying beneficial for whom. Candidates who reach for a single verdict lose marks; candidates who separate effects by group and by time horizon gain them.

2. Causes of globalisation

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Deal with these as mechanisms rather than as a list.

• Falling transport costs, particularly containerisation, which made shipping manufactured goods across the world cheap enough that production location could be chosen on labour cost rather than proximity to market.
• Falling communication costs, which allow a firm to coordinate design in one country, production in another and customer service in a third. This made services tradable for the first time.
• Trade liberalisation: successive reductions in tariffs and quotas, and the growth of trading blocs covered in 11.2.
• Capital market liberalisation, removing exchange controls so capital can move to wherever returns are highest.
• The growth of multinational corporations, which both respond to and drive the process.
• The entry of large populations into the world trading system, notably China and the former planned economies, roughly doubling the effective global labour supply available to capital.

3. Multinational corporations

3.1 Definition

A multinational corporation (MNC) produces goods or services in more than one country, whether by building facilities or acquiring existing firms.

3.2 Why firms become multinational

• Lower production costs, chiefly labour, but also land, regulation and taxation.
• Access to raw materials, particularly in extractive industries.
• Market access, producing inside a market to avoid tariffs or transport costs, and to be close to customers.
• Economies of scale, spreading fixed costs of research and branding across a larger output.
• Tax minimisation, through transfer pricing and locating profits in low tax jurisdictions.
• Avoiding regulation on environmental or labour standards.

3.3 Transfer pricing

An MNC sets the prices at which its own subsidiaries trade with each other. By charging a high price from a subsidiary in a low tax country to one in a high tax country, it shifts recorded profit to where tax is lowest.

The effect is that the country where the value is genuinely created may collect little tax on it. This is a substantive problem for developing countries with limited administrative capacity to challenge such arrangements, and it connects to the narrow tax base identified in 10.4.

4. Effects on the host country

4.1 Potential benefits

• Investment and capital without incurring debt.
• Employment, and often wages above the local average.
• Technology and management transfer, raising productivity in the wider economy where spillovers occur.
• Training, raising human capital.
• Linkages to domestic suppliers, multiplying the effect.
• Exports and foreign exchange, easing the foreign exchange gap of 10.4.
• Tax revenue, where profits are actually taxed locally.
• Consumer choice and lower prices through competition.

4.2 Potential costs

• Profit repatriation, so GDP rises by more than GNI, which is the diagnostic established in 10.3.
• Transfer pricing, reducing the tax actually collected.
• Enclave development, where the operation has few local linkages and the benefits do not spread.
• Environmental and labour standards lower than the home country would permit.
• Market power, where the MNC dominates a small domestic economy and can crowd out local firms.
• Political influence, where a firm's revenue is large relative to the host government's budget.
• Volatility, since production can be relocated, leaving the host with unemployment and idle infrastructure.
• Resource depletion, particularly in extractive sectors.

4.3 Judgement

The host's gain depends on its bargaining position and institutional capacity: whether it can negotiate local content requirements, tax the profits effectively, enforce environmental standards, and supply enough skilled labour for technology transfer to happen. Where those hold, MNC investment contributes substantially. Where they do not, GDP rises while development changes little.

5. Effects on the home country

Frequently overlooked, and worth marks.

• Losses: employment falls in industries relocating abroad, with concentrated regional effects; and downward pressure on wages for lower skilled workers competing with foreign labour.
• Gains: profits and dividends flow home, raising GNI; consumers gain from cheaper imports; and firms remain competitive against rivals who would otherwise gain the cost advantage.

The distributional point matters. Consumers and shareholders gain, while workers in the affected industries lose. Aggregate income may rise while a substantial group is worse off, which is why globalisation generates political opposition even where it raises measured income.

6. Consequences of globalisation

6.1 Benefits

• Higher world output through specialisation according to comparative advantage.
• Lower prices and wider choice for consumers.
• Economies of scale from serving a global market.
• Faster technology diffusion.
• Poverty reduction where export-led growth has raised employment and incomes, which has been substantial in parts of Asia.
• Competitive pressure raising productivity.

6.2 Costs

• Inequality, both between countries that participate successfully and those that do not, and within countries between those with skills complementary to globalisation and those whose work is substitutable.
• Structural unemployment in declining industries, concentrated regionally.
• Interdependence, so a shock in one economy transmits quickly to others. Financial contagion is the clearest case.
• Environmental costs: transport emissions, and the risk of production migrating to jurisdictions with weaker standards.
• Loss of policy autonomy, where governments compete to attract mobile capital by lowering taxes and regulation, sometimes described as a race to the bottom.
• Cultural homogenisation and the erosion of local production.

6.3 Structuring the evaluation

The reliable approach separates the question three ways:

• Which country? Countries that integrated with existing manufacturing capability and reasonable institutions gained substantially. Those dependent on a single commodity gained far less.
• Which group within the country? Consumers and capital owners generally gain; workers in import-competing industries generally lose.
• What time horizon? Adjustment costs are immediate and concentrated; efficiency gains are gradual and dispersed. This asymmetry explains why opposition is louder than support even where the net effect is positive.

<!-- merged from the former 11.2; syllabus 11.6.2 and 11.6.3 place integration and trade creation/diversion under globalisation -->

7. The stages of integration

Learn these in order, since each includes the features of the one before.

• Free trade area. Members remove tariffs and quotas on trade between themselves, but each keeps its own external tariff against non-members. Because external tariffs differ, goods may enter through the lowest tariff member and be shipped on, so rules of origin are needed to prevent this.
• Customs union. A free trade area plus a common external tariff, so the rules of origin problem disappears. Members must negotiate trade agreements collectively.
• Common market. A customs union plus free movement of the factors of production, labour and capital, between members.
• Economic union. A common market plus harmonisation of economic policies, such as common regulation, and often coordination of fiscal rules.
• Monetary union. An economic union plus a single currency and a single central bank, so members give up independent monetary policy and the exchange rate as an adjustment mechanism.

The distinction between a free trade area and a customs union, and the reason rules of origin exist, is a reliable Paper 3 question.

8. Trade creation and trade diversion

10.1 Trade creation

Trade creation occurs when the formation of a bloc shifts production from a higher cost domestic producer to a lower cost producer within the bloc.

Before the union, a tariff protected the inefficient domestic producer. Removing it exposes them to a more efficient partner. Consumers pay less, resources move to where the country has comparative advantage, and world efficiency rises.

Trade creation raises welfare.

10.2 Trade diversion

Trade diversion occurs when the bloc shifts production from a lower cost non-member to a higher cost member.

Before the union, both faced the same tariff, so the genuinely cheapest supplier won. After the union, the member's goods enter tariff free while the non-member's still pay the tariff. The member may now be cheaper inclusive of the tariff while being more expensive in real resource terms.

Trade diversion lowers world efficiency, because production has moved to a higher cost source.

10.3 Worked example

A country imports a good. Production costs before any tariff:

• Domestic producer: $100
• Partner country (future bloc member): $80
• Non-member country: $70

The country initially applies a 50 per cent tariff to all imports.

Before the union, prices faced by consumers are:

• Domestic: $100
• Partner: $80 plus 50 per cent, which is $120
• Non-member: $70 plus 50 per cent, which is $105

The consumer buys domestic at $100, even though it is the most expensive to produce. The tariff has protected inefficiency.

After forming a customs union with the partner, the partner's goods enter tariff free while the non-member still pays 50 per cent:

• Domestic: $100
• Partner: $80
• Non-member: $105

The consumer now buys from the partner at $80.

Analysis: production has moved from the domestic producer at $100 to the partner at $80, a real resource saving of $20 per unit. This is trade creation, and it raises welfare.

10.4 A second case showing diversion

Now suppose the initial tariff is only 20 per cent.

Before the union:

• Domestic: $100
• Partner: $80 plus 20 per cent, which is $96
• Non-member: $70 plus 20 per cent, which is $84

The consumer buys from the non-member at $84, the genuinely lowest cost producer.

After the union:

• Partner: $80
• Non-member: $84

The consumer switches to the partner at $80.

Analysis: the consumer pays $4 less, but production has moved from a producer costing $70 in real resources to one costing $80. World efficiency has fallen by $10 per unit. The government also loses the tariff revenue it previously collected on the non-member's goods. This is trade diversion.

The contrast between these two cases is the heart of the topic. Note that the same union produces creation or diversion depending on the initial tariff level, which is why the welfare effect cannot be asserted in general.

10.5 The net effect

A customs union raises welfare where trade creation exceeds trade diversion. Creation is more likely where:

• members' economies are competitive rather than complementary before the union, meaning they produce similar goods so there is scope to reallocate to the more efficient producer;
• the initial tariffs between members were high, so removing them has a large effect;
• the common external tariff is low, so little diversion occurs;
• members are geographically close, so transport costs do not offset the gains; and
• the bloc is large, so more of the efficient world producers are inside it.

9. Other effects of integration

10.1 Benefits

• Economies of scale from access to a larger market, lowering long run average costs.
• Increased competition within the bloc, raising efficiency and lowering prices.
• Greater choice for consumers.
• Investment, since firms outside may build inside the bloc to avoid the external tariff, which is tariff jumping FDI.
• Bargaining power in negotiations with other blocs.
• Factor mobility in a common market, allowing labour to move to where it is most productive.

10.2 Costs

• Loss of sovereignty over trade policy, and in a monetary union over monetary policy and the exchange rate.
• Structural adjustment costs, as industries that cannot compete within the bloc contract, with concentrated regional unemployment.
• Regional imbalance, where activity concentrates in already prosperous areas.
• Discrimination against non-members, which harms developing countries outside the bloc.
• Trade diversion, as analysed above.

10.3 Monetary union specifically

Joining a monetary union means giving up two adjustment mechanisms at once: the interest rate and the exchange rate.

• Benefits: elimination of transaction costs and exchange rate uncertainty within the union, price transparency encouraging competition, and possibly lower interest rates for members with previously weak monetary credibility.
• Costs: a single interest rate must suit economies at different points in their cycles, so it will be too tight for some and too loose for others. A member facing an asymmetric shock cannot depreciate, so adjustment must come through wages and unemployment instead, which is slower and more painful given the wage stickiness of 9.3.

This last point is why an optimal currency area is usually said to require high labour mobility, wage flexibility and fiscal transfers between members.

10. Blocs and the multilateral system

Regional blocs sit uneasily with the principle of non-discrimination that underpins the multilateral trading system.

• The optimistic view: blocs are stepping stones, liberalising among a group and building support for wider liberalisation.
• The pessimistic view: blocs are stumbling blocks, entrenching discrimination, diverting negotiating effort from multilateral talks, and disadvantaging the developing countries least able to join one.

Both views are examinable and neither is settled.

11. Integrated analysis and common traps

7.1 A complete chain

An MNC buys a manufacturing firm in a developing country and re-equips it for export production.

Immediate effects: capital enters without debt, employment rises, workers receive training, and exports earn foreign exchange, easing the foreign exchange gap of 10.4. GDP rises.

Over time: profits are repatriated, so GNI rises by less than GDP. If transfer pricing shifts profit abroad, corporate tax receipts rise little. Whether productivity spreads beyond the firm depends on linkages to local suppliers and on whether trained workers move to domestic firms. If the operation is an enclave, the wider economy is largely unchanged.

Judgement: the investment raises output and employment with reasonable confidence, and raises development only under conditions the host government partly controls. The policy conclusion is not to accept or refuse FDI but to negotiate local content, invest in the skills that make spillovers possible, and build the tax capacity to charge for the profits. That returns to the institutional constraint of 10.4.

7.2 Common examination errors

• Treating globalisation as uniformly good or bad rather than separating winners from losers.
• Forgetting profit repatriation and the GDP against GNI gap.
• Omitting effects on the home country entirely.
• Confusing FDI with aid, or with portfolio investment, which is the purchase of financial assets rather than productive capacity.
• Asserting a race to the bottom without acknowledging that many countries have raised standards while integrating.
• Ignoring the time asymmetry between concentrated adjustment costs and dispersed gains.

12. Paper 3 and Paper 4 mastery

Paper 3 tests: the most likely consequence of more MNCs entering an economy, identifying transfer pricing, and distinguishing FDI from other capital flows.

Paper 4 asks whether globalisation or MNC investment benefits developing countries. The strong structure sets out the mechanisms, separates effects by group and horizon, and concludes with the conditions under which the host gains, rather than delivering a verdict on globalisation as a whole.

Use the GDP against GNI comparison whenever MNCs appear. It converts a general discussion into a specific, quantitative point.

13. Final checklist

A fully prepared learner can:

• define globalisation and give at least five causes as mechanisms;
• define an MNC and give at least five reasons firms become multinational;
• explain transfer pricing and why it matters for host country tax revenue;
• list at least six benefits and six costs of MNC activity for the host;
• explain the effects on the home country, including the distributional split;
• explain the GDP against GNI divergence caused by profit repatriation;
• list the benefits and costs of globalisation for the world economy;
• structure an evaluation by country, by group and by time horizon;
• explain why opposition can exceed support even where net income rises; and
• state the host country conditions under which FDI contributes to development.