The Development of the International Economy - Literature review Example

? Topic: Lecturer: Presentation Word Count: 1800 Introduction Riley (2006) defines economic growth as “the long-term expansion of productive potential of the economy.” It is characterized by improved standards of living and increased employment opportunities as well as labour productivity. The economic growth of a country is enhanced by improved life expectancy, lower fertility, low inflation, level of education, maintenance of rule of law as well as improvements in the terms of trade (Barro 1998). Trade liberalization and investments as a result of the General Agreement on Tariffs and Trade (GATT) has led to growth of the world economy for the last two decades and the developing countries have not been left behind in exploiting the opportunities for economic growth through trade. According to the World Bank reports, the net capital flows to developing countries have increased tremendously from $ 28 billion in 1970s to $306 Billion 1997 (World Bank 2001: 110). This has led to increased investments and economic growth of those countries. However, the performance of a nation depends on its structural characteristics, resource endowment and policies or the investment climate. Though developing countries account for a third of world trade, most of its trade is to other developing countries and mainly depends on primary commodity exports. Trade liberalization in these countries therefore has not been able to stimulate economic growth and exports (Parikh 2007). For economic growth to be realised, developing countries need to engage in trade of manufactures and services. If developing countries still remain underdeveloped and the gap between developed and developing countries continues to widen, what then is the role of trade liberalization and investment in the economic growth of third world countries? To answer this question, the paper will discuss trade liberalization, investment liberalization, economic growth, and the reasons why there is a wide gap between developed and developing countries. Trade Liberalization There has been a tremendous growth of the world trade for the past 20yrs. The International Monetary Fund (IMF) puts the growth rate at six percent per year (IMF 2001). This has been made possible by various rounds of multilateral trade agreements under GATT which later formed the world Trade Organization (WTO) in 1995. The WTO is entrusted with the role of regulating world trade and settling disputes among trading nations and is guided by several principles. The Most favoured Nation (MFN) and national treatment principles guard against any form of discrimination. The trade is also supposed to freerer by removing trade barriers through rounds of negotiations. The trade is also competitive as unfair practices such as damping of products at cheap prices are not encouraged. The trading partners are guided by the WTO rules hence cannot change trade policies arbitrarily thus the trade is predictable. Another principle of the world trade is that it is to be beneficial to less developed countries. As such, various rounds of negotiations have been going on to decide on how to make trade favourable to developing countries especially by allowing them more time to implement tariff reduction. As a result, most developing countries have opened their economies to trade and are enjoying the benefits. According to Blandford (2007), 2/3 of the current 148 members of WTO are developing countries. Despite opening the economies to trade, most developing countries continue to put restrictions to trade to protect domestic industries. Furthermore, as Parikh (2007) notes, most developed countries continue to put restrictions of access in areas of export interest to developing countries and are also experiencing slow growth hence do not import a lot from those countries. This affects many developing countries that rely on primary commodities for export as their imports outweigh exports resulting in unfavourable terms of trade. Most beneficiaries of trade liberalization are the oil rich countries especially in Asian markets. However, the Doha development round is concerned with the plight of third world countries and is putting much emphasis on agriculture through the Agreement on Agriculture (AoA). The WTO has also enhanced trade in services through the General Agreement in Trade in Services (GATS) and is encouraging developing countries to take advantage of differential treatment to diversify trade in manufactures and services (WTO 2011). This will enable them to realise the benefits of trade liberalization and experience sustainable economic growth. Investment Liberalization Growth in global trade attracts foreign direct investments. Previously, developing countries used to get aid from foreign governments through the Official Development Assistance (ODA). According to DEPweb (2004), by offering aid, the donor countries aimed at expanding their markets. These donations are also tied up with conditionality hence are viewed as undermining the receiving governments. As a result, few countries implemented the conditional reforms of donor countries. Due to trade liberalization, the third world countries now have various options for investment funds; the ODA has declined as it has been replaced with foreign direct investments, portfolio investments and remittances from locals abroad (WTO 2011). Investment liberalization means that countries are able to invest anywhere in the world. Developing countries with favourable investment climate are able to attract foreign investments instead of relying on aid which can lead to trade deficits. There has been growth in transnational corporations which provide employment to the domestic market leading to economic growth. Some investors acquire shares in domestic companies thus providing capital for growth. Moreover, foreign direct investments are a source of advancements in technology, managerial and marketing skills as well as easier access to export markets (DEPweb 2004). Though private capital flows are beneficial to developing and least developed countries, they also come with problems. The foreign investors may not be sensitive to social and economic needs of the developing country thereby produce goods or use processes harmful to the locals, for example by degrading the environment. More so, if the investment climate becomes unfavourable, the foreign investors move out of the country thereby leading to more capital outflows than inflows and this may result in decline in economic growth (World Bank 2001). The governments of these countries therefore have the responsibility of protecting citizens from such eventualities. Economic Growth The growth of the world economy according to the IMF has been enhanced by trade liberalization and investments (IMF 2001). Most of the effects of trade liberalization are felt by developed countries and few developing countries which are rich in oils but economic growth in other developing countries cannot also be overemphasized. Economic growth leads to improved standards of living as well as increased employment opportunities thus poverty alleviation. Trade liberalization allows countries to have increased volume of exports and consequently export earnings. This provides the national income needed to provide essential services and improve living standards of citizens. The income is also used to acquire goods and services which the country cannot be able to produce efficiently at low cost due to reduced tariffs thus offering consumers a variety of choice (Riley 2006). Employees are also able to move to other countries and acquire new skills which they experiment in home country hence innovations and creativity and consequently improved productivity and economic growth. Moreover, these employees abroad send remittances home thereby improving the living standards of citizens. Increased competition in the global market also leads to low prices for goods and services hence consumer can buy same bundle of goods with less proportion of income (World Bank 2001). Foreign direct investments on the other hand, result in increase in employment for third world countries especially for unskilled workers thereby increasing their income and standard of living (IMF 2001). The investors also bring in skills and expertise which is transferred to managers and workforce thereby improving productivity and economic growth of third world countries. Furthermore, these countries are able to get funds for investments without having to borrow from foreign markets thereby reducing debt burden and the conditionalities associated with official development assistance funds. Despite economic growth for third world countries, they remain underdeveloped due to various reasons as outlined by Collier and Dollar (2002). The population growth in these countries is higher than output growth hence no increase in real incomes is observed. The countries also depend on export of agricultural products which are not competitive in the global market thus low export earnings and expensive imports thus trade deficits and balance of payment problems. Moreover, the developed countries demand for agricultural products is low and such sectors are overly protected in these countries hence decline in volume of exports. For economic growth to be realised, countries need to have sound economic policies which developing countries seem to lack. Some countries have geographical disadvantage hence cannot benefit from trade liberalization due to high transport costs. As noted by Collier and Dollar (2002:39), “transport costs are more of a barrier to integration than trade policies of rich countries.” Most of prices in the world market are determined by the developed countries hence the third world countries are dominated by the rich nation’s thereby prohibiting growth. World Bank (2001) argues that third world countries need to have robust financial institutions if economic growth is to be realised. This is to guard them against volatility of capital flows hence avoid serious crisis of capital outflows. Many markets are affected by external economic conditions such as the recent financial crisis and also the Asian financial crisis hence the need to have sound institutions. Furthermore, developing countries are viewed as high risk areas of civil war and easy source of finance for liberals hence not a suitable area for investment. This leads to capital outflows from these countries instead of inflows. According to Barro (1998), due to foreign investors who are not sensitive to societal needs, there is rampant environmental pollution which is detrimental to the health of citizens hence reduced productivity and economic growth. The governments thus put restrictions to protect citizens from effects of pollution. Income inequalities in these countries have also been blamed for non realization of economic growth as it has adverse effects on investments. Conclusion Trade liberalization and investments play a great role in the economic growth of third world countries. This has been made possible by removal of barriers to trade through several rounds of negotiations by the ministerial conference of the WTO. The GATT and GATS act as the guiding rules for trade in goods and services in the world market. Liberalization of trade and investments have enabled developing countries to have improved export earnings, technology advancements, improved technology and increased employment thereby economic growth. As a result, poverty has reduced drastically as living standards are improved. However, most developing countries have not been able to experience real growth due to poor economic policies, population explosion, poor geographical location coupled with reduced growth in developed countries which affects trade and investments in these countries negatively. This situation can be remedied if third world countries engaged in trade in manufactures and services instead of relying on primary commodities only. References Barro, R. 1998. Determinants of Economic Growth: A Cross-Country Empirical Study. MIT Press. Blandford, D. 2007. How to Increase the Benefits of the Doha Development Round for the Least Developed Countries. In: Niek, k., Per, P. (eds). Agricultural Trade Liberalization and the Least Developed Countries. Netherlands: Springer. Collier, P., Dollar, D. 2002. Globalization, Growth, and Poverty: Building an Inclusive World Economy. Washington, DC: The World Bank. DEPweb. 2004. Beyond Economic Growth: An Introduction to Sustainable Development. 2edn. Washington, DC: The World Bank. http://www.worldbank.org/depweb/english/beyond/global/ (Accessed Nov, 22, 2011). International Monetary Fund. 2001. “Global Trade Liberalization and the Developing Countries.” http://www.imf.org/external/np/exr/ib/2001/110801.htm (Accessed Nov, 21, 2011). Parikh, A. 2007. Trade Liberalization: Impact on Growth and Trade in Developing Countries. Singapore: World Scientific Publishing. Riley, G. 2006. “International Economy: Economic Growth.” Tutor2u. http://tutor2u.net/econ/revision-notes/as-macro-economic-growth.htm (Accessed Nov, 22, 2011). World Bank. 2001. The World Bank Research Program 2001: Abstracts of Current Studies. Washington, DC: World Bank. World Trade Organization. 2011. www.wto.org Read More