International economic issues (A Level)

11.1 Policies to correct disequilibrium in the balance of payments

The balance of payments

The balance of payments has the current account, capital account (capital transfers) and financial account (foreign direct investment, portfolio investment, loans, reserves). By definition, the balance of payments balances (the current account deficit is financed by a financial account surplus or a fall in reserves).

Causes of disequilibrium

Current account deficit: high AD (imports), low competitiveness, strong currency, low productivity, recession abroad, structural weaknesses. Surplus: export strength, weak currency, low consumption.

Policies

Persistent deficits may be sustainable if financed by FDI and the country is growing; persistent surpluses affect others (global imbalances).

11.2 Exchange rates

Determination

In a floating system, the exchange rate is set by the demand and supply of the currency. Factors affecting it: relative interest rates (hot money), relative inflation (purchasing power parity), current account, speculation, investment flows, government intervention and confidence.

Fixed systems use reserves and interest rates to maintain the rate; devaluation and revaluation are deliberate changes. Currency union (a common currency) removes exchange-rate risk but removes independent monetary policy.

Effects of exchange rate changes

Exchange rate changes affect competitiveness, inflation, growth, employment, terms of trade, foreign debt and tourism. Real exchange rate adjusts for inflation differences.

Nominal exchange rates are the actual market rates; real exchange rates adjust for inflation differences, showing true competitiveness. A country whose inflation is higher than its partners' can see its real rate rise even if the nominal rate is unchanged, harming exports. The effect on the external economy: by Marshall–Lerner a depreciation improves the current account when PED(exports) + PED(imports) > 1, and by the J-curve the balance worsens first (prices change before quantities adjust) then improves.

11.3 Economic development

Economic development is an improvement in people's standard of living and wellbeing, broader than growth (it includes health, education, poverty reduction, freedoms).

Measuring development

Limitations: averages hide inequality, informal activity, environment and freedom.

Factors influencing growth and development

Physical capital, human capital, technology, institutions and governance, natural resources, trade and openness, savings, political stability, geography and conflict. Barriers: poverty traps, low savings, debt, corruption, poor infrastructure, disease, dependence on primary products, population pressures.

Strategies for development

Primary product dependence: volatile prices, low income elasticity of demand for primary goods, declining terms of trade (the Prebisch–Singer hypothesis).

Monetary indicators: real GDP per head (and GNI per head), compared using purchasing power parity (PPP) to adjust for different price levels. Issues in comparing: informal and subsistence output, exchange-rate distortions, inequality hidden by averages, quality and pollution. Non-monetary indicators: life expectancy, literacy, infant mortality, school enrolment, access to clean water, and composite measures such as the Human Development Index. The Kuznets curve suggests that inequality first rises then falls as an economy develops (an inverted U), because early growth benefits those in the new sectors, and later gains spread through education and redistribution. Growth rates and living standards differ widely between countries, so comparisons use growth rates, PPP and non-monetary data together.

11.4 Characteristics of countries at different levels of development

Emerging economies (for example China, India) have rapid growth, industrialisation and urbanisation but inequality and environmental pressure. Demographic transition: birth and death rates fall as countries develop.

Population: the birth rate and death rate (per 1,000 people), infant mortality and migration determine growth and structure; falls in birth rate with development lead to an ageing population and a higher dependency ratio. Optimum population is the size that gives the highest output per head; below it there is under-population, above it over-population (diminishing returns). Income distribution: the Gini coefficient (0 to 1) and the Lorenz curve show inequality; Lorenz curve analysis compares how far a curve bows from the line of equality. Economic structure: developing countries have most employment in the primary sector, middle-income countries in the secondary, and developed economies in the tertiary sector.

11.5 Relationship between countries at different levels of development

Trade and the terms of trade

Developing countries often export primary goods whose prices are volatile and whose terms of trade may decline. Trade barriers in rich countries (agricultural subsidies, tariffs) may limit exports. Fair trade and trade agreements try to help.

Aid, debt and investment

• Aid: bilateral (country to country) or multilateral (through institutions like the World Bank, IMF); grants or loans; can fund infrastructure and health, but may be tied to purchases, create dependency or be lost to corruption.
• Debt: high debt servicing diverts funds; debt relief and restructuring are used.
• Foreign direct investment (FDI) by multinational companies: capital, technology, jobs, exports; but profit outflows, tax avoidance, environmental and labour concerns, dependency.
• Remittances from workers abroad support incomes.

Institutions

The IMF (stability and loans), the World Bank (development finance) and the WTO (trade rules) shape the international economy; conditions attached to loans (structural adjustment) can be controversial.

International aid takes the forms of grants, concessional (cheap) loans, technical assistance, emergency (humanitarian) aid and food aid. Reasons for giving aid: poverty relief and humanitarian need, political influence, trade interests and global stability. Multinational companies (MNCs) are firms that operate in more than one country; their activities include production, sales, R&D and investment across borders; consequences: jobs, technology transfer, exports and tax revenue, but also profit repatriation, tax avoidance, pressure on local firms and environmental and labour concerns. Foreign direct investment (FDI) is investment by a firm in physical assets abroad (factories, shops), with consequences of capital, technology and jobs but dependence and profit outflows.

External debt arises from borrowing abroad to fund deficits, investment or consumption; causes include persistent current account deficits, falling commodity prices, high interest rates and corruption; consequences: debt servicing takes up export earnings and government spending, currency weakness and loss of investor confidence, sometimes leading to debt relief or austerity. The IMF promotes monetary and exchange rate stability, lends to countries with balance of payments problems (with conditions) and gives policy advice.

11.6 Globalisation

Globalisation is the increasing integration of economies through trade, capital flows, migration and technology.

Causes: technology (communications, transport), trade liberalisation, growth of multinationals, capital market freedom, falling costs.

Multinational companies shift production for low costs, spread technology, but wield market power and may harm host economies.

Impact on different countries: newly industrialised economies gain through exports and FDI; some poor countries are marginalised; developed economies see deindustrialisation.

Trading blocs differ in depth: a free trade area removes tariffs between members, each keeping its own external tariffs; a customs union adds a common external tariff; a monetary union adds a common currency; full economic union adds common economic policies. Trade creation is where trade shifts from a high-cost domestic producer to a lower-cost partner (a gain); trade diversion is where trade shifts from a lower-cost non-member to a higher-cost member because of the tariff (a loss). A bloc is beneficial overall if trade creation exceeds trade diversion.