Chapter 2: Global Economy

Module 2

Global Economy

Introduction
The global economy is the world economy or the worldwide economy. It is all the
economies of the world which we consider together as one economic system. Put
simply; it is one giant entity. It is also the system of trade and industry across the world
that has emerged due to globalization. In other words, the way in which countries’
economies have been developing to operate collectively as one system.

Learning Outcomes
After successful completion of this module, you should be able to:

 Define economic globalization

 Identify the actors that facilitate economic globalization
 Define the modern world system
 Articulate a stance on global economic integration

Course Materials:

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A. Economic Globalization
Economic globalization refers to the increasing interdependence of world
economies as a result of the growing scale of cross-border trade of commodities
and services, flow of international capital and wide and rapid spread of
technologies. It reflects the continuing expansion and mutual integration of
market frontiers, and is an irreversible trend for the economic development in
the whole world at the turn of the millennium. The rapid growing significance of
information in all types of productive activities and marketization are the two
major driving forces for economic globalization. In other words, the fast
globalization of the world’s economies in recent years is largely based on the
rapid development of science and technologies, has resulted from the
environment in which market economic system has been fast spreading
throughout the world, and has developed on the basis of increasing cross-border
division of labor that has been penetrating down to the level of production chains
within enterprises of different countries.

The advancement of science and technologies has greatly reduced the cost of
transportation and communication, making economic globalization possible.
Today’s ocean shipping cost is only a half of that in the year 1930, the current
airfreight 1/6, and telecommunication cost 1%. The price level of computers in
1990 was only about 1/125 of that in 1960, and this price level in 1998 reduced
again by about 80%. This kind of ‘time and space compression effect’ of
technological advancement greatly reduced the cost of international trade and
investment, thus making it possible to organize and coordinate global production.
For example, Ford’s Lyman car is designed in Germany, its gearing system
produced in Korea, pump in USA, and engine in Australia. It is exactly the
technological advancement that has made this type of global production possible.
Moreover the development of the networking-based economy has given birth to
a large group of shadow enterprises, making the concept of national boundaries
and distance for certain economic activities meaningless. If technological

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advancement and IT development were assumed as the technological driving

force for economic globalization, then the market-oriented reform carried out
throughout the world should be regarded as the institutional driving force for this
trend. Under the framework of GATT and WTO, many countries have gradually
cut down their tariff and non-tariff barriers, more and more countries open up
their current accounts and capital accounts. All of these have greatly stimulated
the development of trade and investment. Moreover the transition of the former
centralized planned economies to market economies has made it truly possible to
for the world’s economies to integrate into a whole.

Multinational corporations (MNCs) have become the main carriers of economic

globalization. They are globally organizing production and allocating resources
according to the principle of profit maximization. And their global expansions are
reshaping macroeconomic mechanisms of the operation of the world economies.
In 1996, there were altogether only more than 44,000 MNCs in the whole world,
which had 280,000 overseas subsidiaries and branch offices. In 1997, the volume
of the trade of only the top 100 MNCs already came up to 1/3 of the world’s total
and that between their parent companies and their subsidiaries took up another
1/3. In the US$ 3,000 billion balance of foreign direct investment at the end of
1996, MNCs owned over 80%. Furthermore, about 70% of international
technological transfers were conducted among MNCs. This type of cross-border
economic activities within same enterprises has posed a challenge for the
traditional international trade and investment theories. Globalization of the
financial sector has become the most rapidly developing and most influential
aspect of economic globalization. International finance came into being to serve
the needs of international trade and investment activities. However, along with
the development of economic globalization, it has become more and more
independent. Compared with commodity and labor markets, the financial market
is the only one that has realized globalization in the true sense of ‘globalization’.
Since 1970’s, cross-border flow of capital has been rapidly expanding. In 1980,

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the total volume of cross-border transactions of stocks and bonds of major

developed countries was still less than 10% of their GDP. However, this figure
had far surpassed 100% in 1995. The value of the average daily transactions of
foreign exchanges has grown from US$ 200 billion in the middle of 1980’s to the
present US$ 1,200 billion, which is 85% of the foreign exchange reserves of all
the countries in the world and 70 times as large as the value of the daily export
of commodities and services. The process of economy globalization is also the
process of global industrial restructuring and readjustment.

With the development of science and technology and increase of income level,
industrial structures of all the countries have been also undergoing readjustment
and upgrading. In recent years, developed countries in the west are gradually
entering the era of knowledge economy and have started to shift to developing
countries many labor-intensive industries of weak international competitiveness.
This process of cross-country shift is pushing forward an in-depth development
of economic globalization. On the other hand, there has existed a surplus of
productivity since the end of the cold war. Due to this fact, economic
globalization has intensified the competition at the international market among
enterprises from different countries. In order to raise their positions and improve
their competitiveness at the international market, both domestic enterprises and
those from other countries have been resorting to mergers and acquisitions one
after another, which has resulted in tides of industrial restructuring. Take a few
cases just as a demonstration: the most recent acquisition of Mannesmann by
Vodaphone, acquisition of MCI by British Telecom, acquisition of 信孚 by
Deutsche Bank, and the amalgamation of Citibank with Travelers and that of
Daimler-benz. All of these restructuring activities will exert far-reaching influence
on the world’s industrial competition pattern. Developed countries have been
playing a dominant role in the process of economic globalization. In 1996, the
total volume of exports of developed countries was US$ 4,057 billion, accounting
for 81.7% of the world’s total value of international trade. In 1995, the foreign

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direct investment by 10 major developed countries including the G7, Switzerland,

Sweden and the Netherlands took up 85.1% of the total value of foreign direct
investment in the whole world. The dominant role of developed countries in the
process of economic globalization is also reflected in the fact that it is they that
determine the rules for international economic exchanges. Although current rules
of game for international economic activities have the good aspect of being in
keeping with socialized mass production, they are generally laid down under the
dominance of developed countries. International economic and financial
organizations are under the control of the United States and other western
countries. They have been using these advantages to promote and dominate the
development of globalization. At the same time, they are the largest beneficiaries
of economic globalization.

In November of last year, China and the United States reached an agreement on
the China’s accession to WTO. With this, China made a decisive step forward on
its way to becoming a member country of WTO. The signing of this agreement
shows the determination of the Chinese government to firmly speed up the
reform of its economic system and further integrate itself into the process of
economic globalization. It is a win-win agreement. On one hand, the United
States can increase its exports of goods and services to China, thus creating
more employment opportunities. While on the other hand, China can boost its
economic growth by increasing its share of the US market. In addition, more
advanced technologies, management experience and capital can be introduced
from developed countries. And the pressure international competition will
become a driving force for the reform and opening toward the outside world.
This in turn will promote the competitiveness of china’s enterprises.

B. Drivers of Economic Globalization

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Economic globalization stands for the economic interconnectedness of countries

with the global economy as a whole. This interdependence relates both to the
exchange of factors of production (labor, capital, technologies, know-how) and
the exchange of products (material goods and services, finished and unfinished
products, consumer and capital goods). In my opinion, there are three main
drivers for economic globalization and its different characteristics such as trade
(see figure 1), international capital markets, currency markets, migration and
more:
1. Demography: The size of the population of a country is important for
factor endowment differences between countries. If a certain economy
has a large number of workers but only a small stock of physical capital,
the country is labor-abundant and capital-poor. Such a country has an
international competitive advantage in manufacturing labor-intensive
products. Concerning international division of labor, it will specialize on
the production and export of labor-intensive products.
2. Technology: Due to technical progress, costs of transportation and of
communication decreased strongly during the last decades. Without
these reductions of costs, phenomena such as outsourcing, long-distance
trade and global value chains would not be possible.
3. Political decisions: Economic processes are not operating in a political or
institutional vacuum. Reducing or even eliminating barriers to trade in
goods, services, labor and capital are political decisions. At the end of the
day, whether economically motivated cross-border activities do actually
take place or not depends on the policy frameworks in place. It is this
framework which decides whether cross-border activities are facilitated,
made more difficult or even completely forbidden

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Political decisions and the extent of globalization

The extent of globalization is shaped by political decisions which promote or
impede economic cross-border interconnections. Just a few examples for the role
of political decisions are the following:

 The decision of a country to reduce import tariffs is essential for the size
and structure of international trade in goods and services. Lower barriers in
trade increase the incentive to trade with other countries. This decisions is
in the hand of the national government respectively parliament. In case of
the European Union, these national competences are transferred to the EU.
Additional trade policy instruments are bilateral or regional free trade
agreements which are used in order to reduce or even eliminate tariff and
non-tariff barriers to trade. The conclusion or non-completion of such an
agreement is a political decision, too.
 The same applies to the decision to reduce capital controls which are used
by national governments in order to regulate in inflow and outflow of
capital. Closely linked to capital controls is the topic of foreign exchange
controls respectively the design of foreign exchange markets (fixed versus
flexible exchange rates).
 Finally, immigration regulations of individual countries are an important
limitation of international migrations flows. Hence the removal of these

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restriction, for example within the fundamental freedoms of the European

internal market, is supposed to increase cross-border migration between
EU-countries.

Political decisions and the results of globalization

In addition to the shaping of globalization, political decisions are decisive factors
for the way society deals with the results of globalization, especially how society
wants to correct the market results produced by globalization.

In advanced economies such as the U.S, Germany, France or the United

Kingdom, international trade with low-wage countries has negative effects for
workers, especially for low-skilled workers. These consequences can be softened
by public intervention (see figure 2). For example, if society does not feel
comfortable with the distribution of market income due to globalization, taxation
and transfer payments can be used in order to achieve a socially desirable
distribution of net income. Other institutions which can adjust market outcomes
according to preferences of society are the education system, labor market policy
tools, all areas of the social security system etc.

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Therefore, political decisions and institutions decide whether those persons, who
suffer from the market processes in a globalized world, are finally the losers of
globalization or not. In case of a strong welfare state (extensive redistribution
policy, high level of protection against dismissal and more), economic and social
policies could compensate the income losses of those persons who lost their job
due to international competition. In that case, looking at the disposable income
(= market income minus taxes minus social security contribution plus social
transfers), these persons might not be classified as ‘losers of globalization’
anymore.
C. Global Economic Integration
Economic integration is an arrangement among nations that typically includes the
reduction or elimination of trade barriers and the coordination of monetary and
fiscal policies. Economic integration aims to reduce costs for both consumers and
producers and to increase trade between the countries involved in the
agreement.

Economic integration is sometimes referred to as regional integration as it often

occurs among neighboring nations.
When regional economies agree on integration, trade barriers fall and economic
and political coordination increases.

Specialists in this area define seven stages of economic integration: a

preferential trading area, a free trade area, a customs union, a common market,
an economic union, an economic and monetary union, and complete economic
integration. The final stage represents a total harmonization of fiscal policy and a
complete monetary union.

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Advantages of Economic Integration

The advantages of economic integration fall into three categories: trade benefits,
employment, and political cooperation.

More specifically, economic integration typically leads to a reduction in the cost

of trade, improved availability of goods and services and a wider selection of
them, and gains in efficiency that lead to greater purchasing power.
Employment opportunities tend to improve because trade liberalization leads to
market expansion, technology sharing, and cross-border investment.

Political cooperation among countries also can improve because of stronger

economic ties, which provide an incentive to resolve conflicts peacefully and lead
to greater stability.

The Costs of Economic Integration

Despite the benefits, economic integration has costs. These fall into two
categories:
Diversion of trade. That is, trade can be diverted from nonmembers to members,
even if it is economically detrimental for the member state.
Erosion of national sovereignty. Members of economic unions typically are
required to adhere to rules on trade, monetary policy, and fiscal policies
established by an unelected external policymaking body.
Because economists and policymakers believe economic integration leads to
significant benefits, many institutions attempt to measure the degree of
economic integration across countries and regions. The methodology for
measuring economic integration typically involves multiple economic indicators
including trade in goods and services, cross-border capital flows, labor migration,
and others. Assessing economic integration also includes measures of

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institutional conformity, such as membership in trade unions and the strength of

institutions that protect consumer and investor rights.

Assignment:

 What is your opinion regarding this topic: “That global free trade has done more
harm than good.” Justify your answer.

Assessment Task

 What are the three main drivers for economic globalization?

 What do you think are the advantages of economic globalization?

Electronic Resources
https://www.un.org/en/development/desa/policy/cdp/cdp_background_papers/bp2000_1.pdf

https://www.igi-global.com/dictionary/economic-globalization/61002

https://ged-project.de/globalization/what-are-the-drivers-behind-economic-globalization/

https://www.investopedia.com/terms/e/economic-
integration.asp#:~:text=Economic%20integration%20is%20an%20arrangement,of%20monetary%20and
%20fiscal%20policies.

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