International Trade and Economy - Essay Example

International Economics: UK as case study Contents ……………………………………………………………………………3 Introduction………………………………………………………………………….4 International Trade and economy………………………………………………….4 Absolute and Comparative advantages……………………………………………….5 Ricardo’s theory and Economic growth……………………………………………….6 UK economy…………………………………………………………………………..7 Impact of International trade………………………………………………………..8 UK’s international trade ……………………………………………………………10 Impact of global recession on UK economy………………………………………..12 Future Prospects of UK Economy…………………………………………………..13 Conclusion…………………………………………………………………………….14 Abstract In the era of globalization, international trade is becoming an essential contributor to the national economy of all trading nations. In the last 50 years there has been a growing economic interdependence between all nations. For any trading nation, absolute and comparative advantages play an important role in shaping the import and export curves. While absolute advantage gives a nation an almost monopoly power over certain goods and services, comparative advantage ensures quality goods readily affordable at low price. According to Ricardo, economic growth of a country can be measured by its output change which is influenced by volume of inputs, capital and technological progress. UK economy has experienced greater growth in the current century as compared to the last few decades of the twentieth century. However, the international trade scenario of UK does not seem promising with a consistent trade deficit although there has been growth in both export and import values. This is because the real value of imports remains far below than the real value of exports. The growth of service exports in developing countries has also affected UK economy as the nation has lost market for service exports in those countries especially China. Introduction In the backdrop of globalization no country can survive within the boundary of economics at national level. A country’s economy including industry, service sectors, employment and standard of living is dependant on the association with its trading partners. This association is established with import and export of goods, services, labour, technologies and investments. It is not possible to create national economic policies without considering their effect on the economies of other countries. With a number of factors like the formation of the European Union in the 1950s, the growth of multinational companies in the 1960s, the growing market strength of the oil producing countries, and introduction of euro in the beginning of twenty first century have all paved the way for interdependence of countries worldwide and evolution of a global economy (Carbaugh, 2010, p.1). In the world of business in the current century, business is the key factor in the relationships between different countries. Today any business enterprise even the small and emerging ones consider every nook of the world as market for its products and services, and no business confines its activities within the national boundaries. In many companies, the annual sales level exceeds the gross national product (GNP) of some countries; these companies consider every corner of the world as a viable source of raw materials, can procure labour from any place and can capture the global market (Ajami, et al, 2006, p.4). This paper will highlight the economic features of UK, the development of the UK economy in last five years, the trade partners and export import items, the impact of the recent financial crisis and future scenario. International Trade and economy Globalization has made nations economically dependant on each other but does not necessarily make the nations more similar as international business is a complex phenomenon. International business means transfer of business activities and resources to other countries (Shenkar & Yadong, 2008, p.16). Since 1950s, international economics has reflected the economics associations with different countries especially among the developed nations (Gowland, 2010, p.2). International economics has the same mode of analysis like any other branch of economics, because the objectives and activities of international trade are no different from domestic trades. In international trade exchange rate of foreign currencies affect the price of the goods (Krugman & Obstfeld, 2008, p.3). Absolute and Comparative advantages: Apparently one can argue that non participation in international trade has one advantage; a country would be forced to manufacture everything it requires thus increasing job opportunities, and the entire circle of inputs and outputs would remain within the country. But, in reality no country is self sufficient as not every single product and service can be available in a country for various reasons like labour inefficiency, adverse climatic conditions and cost factor. The fact is that every nation is good at manufacturing some things, like a country may have adept bookkeepers while the same country may not have efficient car mechanics. In such case, it will be profitable for the country to exchange its bookkeeping services for car parts imported from another country. Thus a country has absolute advantage when it can produce products at lower price than its trading partners, or it is the only country to produce a specific product (Gitman & Mc Daniel, 2008, pp.72-73). For profitable trading relations with other countries it is not sufficient that a country enjoys only absolute advantage. It should also have comparative advantage which means a country should focus on manufacturing goods that have low production cost and relatively easy production process and should trade those products for goods that have low production cost in another country. This will ensure quality goods readily affordable at low price (Maneschi, 1998, p.2). It is the responsibility of government to build policies to encourage exports and hinder imports. A nation will gain from international trade only when exports exceed imports as this will ensure inflow of foreign exchange (Salvatore, 1998, p.4). Ricardo’s theory and Economic growth Ricardo’s theory in this respect states that there are several general factors that determine loss or gain in international trade, and a country having cost advantage over countries is not the only factor. Instead, the two nations who are trade partners can benefit “provided only that their relative costs, that is, the ratios of their real costs in terms of labour inputs, are different for two or more commodities.” (Eicher, et al, 2009, p.16) Ricardo has given an example of two countries England and Portugal who trade wine and cloth with each other. According to Table 1, Portugal has comparative advantage in wine and England in cloth, which means cloth is cheaper in England and wine is cheaper in Portugal. Table 1: Comparative advantage Days of labour required to produce Portugal England Wine (1 barrel) 3 2 Cloth (1 bolt) 10 4 (Source: Eicher, et al, 2009, p.16) The law of comparative advantage shows that countries can be in a win-win situation in international trade because, if one country spends major time and labour to produce goods with comparative advantage, then it will be at the expense of time and labour needed for production of other goods (Conway, 2009). Ricardo’s theory measures economic progress based on output change of a country. It determines economic growth according to the volume of inputs like labour, capital, natural resources, and technological advances needed to produce outputs. It states that output increases when there is increase in labour or technological development (Meir, 2009, p.237). UK economy British economy witnessed an unprecedented growth in the national economy in the twentieth century. In the 1950s and 1960s the growth has been greater than in any other decades, while in the beginning of 1970s the growth had decelerated. In the years between the world wars, UK had the best growth rates compared to the two previous centuries. However, the two world wars caused a havoc on UK economy with an all round disruption. The economic recovery in the following years had been slow and incomplete. The three decades following 1914, UK and also global economic front faced a major crisis period and economic development was slow. Although the growth rate of UK economy has improved by great measures in the current century, other nations like France, Germany and Sweden’s economic growth rates have overtaken UK (Lee, 1986, p.145). Like a number of other developed nations, UK, the seventh largest world economy has services as the biggest sector which contributes 75 percent of total GDP. Services like Distribution, Transport, Hotels and Restaurants comprise 18 percent of GDP, Government and Health and Education comprise 20 percent, Professional and Support contribute 11 percent, Financial and Insurance as well as Real Estate contributes 9 percent each. However UK is still one of the prominent manufacturers and their output comprise 10 percent of the total domestic economy’s production (United Kingdom GDP Growth Rate, 2012). Construction finds a 7 percent of the GDP. The following chart shows the trend of GDP over the 5 years period (2007-2011). (The World Bank, 2012) Impact of International trade International trade plays a major role in all modern economies. The UK economy is no exception. UK imports and exports a wide variety of goods (Bamford & Grant, 2000, p.46). In the year 2010, UK ranked 7th as importer and 11th as exporter in the world. In this year UK had a massive trade deficit which was second only to US. The total value of imports in 2010 was US$546.5 billion and total value of exports was a mere US$405.6 billion. UK government has been taking necessary steps to reduce the deficit, but in 2011 the deficit value increased to £4 billion per month. The major reasons for the huge deficit are considered to be high inflation rate and budget deficit. The principle commodities that were exported in 2010 were manufactured goods, fuels, chemicals, food, beverages and tobacco. The principle commodities that were imported in 2010 were manufactured goods, machinery, fuels and foodstuffs (UK export, import and trade, 2010). Table 1 shows export values of all commodities in the period 2009/10. Table 1: Import values of UK in 2009/10 ($ bn) (Source: UK export, import and trade, 2010) UK is a net importer in terms of goods, services and transfers. The export situation worsened between 2009-2010 following the financial crisis period. The following chart shows the current account balance trend over 2007-2011: (The World Bank, 2012) International trade can have various effects on UK economy. Firms can produce goods that have comparative advantage while will lead to lower price for the consumers. There can be shift in sectors. For instance, UK no longer has comparative advantage in manufacturing industries due to low labour costs in developing countries. Although this can create unemployment, that can be remedied by emphasizing more on other sectors like financial and insurance services. Domestic firms can face competition in the global market which will reduce costs. Globalization can also facilitate migration that will solve the problem of job vacancies in UK, although it will create burden for housing and public services. UK being a major player in international trade can get more affected by recession in other regions, for instance, recession in EU can have negative impact on UK economy as EU is a major export destination of UK (Effects of Globalization for the UK economy, 2013). UK has long benefited from international trade and investments due to its efficient legal system regarding contracts and property rights. Several reforms have been undertaken that include controlling the increasing rate of government spending, and reducing corporate taxes that will continue till 2014 (United Kingdom, 2012, p.449). UK’s international trade The total value of imports and exports of goods and services in UK was US$ 1,256 billion in 2009; this valuation comprised 4.3% of the global trade. UK faced a financial crisis during the period 1998-2008 as export value remained less than import value. During this period export value increased by 99.8% and import value increased by 111.5%. Since UK has an important influence on global trade, this financial crisis resulted in trade depression all over the world. Also, in this period global trade increased at a greater rate than UK international trade which means there was a drop in UK’s share of global trade. During this decade, UK’s export of goods increased by 72% but it has lost market share in developing countries as there has been increase of export of goods in the developing countries especially China. Between 1998 and 2008, UK was the second largest service exporter whose valuation during this period was US$ 288 billion (UK trade performance over the past years, 2011, pp.3-12). Table 2 and Table 3 show top import partners of UK in 2011 and top export destinations in 2011 respectively. Table 2: UK’s top import partners of 2011 (£m) Rank Country Volume % change over 2010 1 Germany 41,107 8.7 2 United States 25,076 -2 3 China 24,828 7.1 4 Netherlands 23,019 7.6 5 Norway 20,014 30.3 6 France 19,138 5.5 7 Belgium 15,729 11.9 8 Italy 11,629 -0.8 9 Irish Republic 10,436 0.1 10 Spain 9,094 8.9 Table 3: UK’s top export destinations of 2011 (£m) Rank Country Volume % change over 2010 1 United States 31,712 2.7 2 Germany 27,539 17.2 3 France 18,905 14.3 4 Netherlands 18,823 9.5 5 Irish Republic 14,063 5.7 6 Belgium 12,949 19.5 7 Italy 8,287 15.2 8 Spain 7,946 -1.5 9 China 7,055 20.8 10 Sweden 5,103 13.3 (Source: Sedghi, 2012) The following chart shows the export position of the country over 2007-2011: (The World Bank, 2012) Impact of global recession on UK economy The global recession that has set in four years back has “sparked the greatest financial crisis and economic downturn since the Great Depression.” (Gokay, 2012) It began with the property market of UK when non performing loans of banks increased with the increasing number of defaulters and high interest rates (1. The financial crisis of 2007/2008 and its impact on the UK and other economies, n.d.). None of the economic contradictions have yet been resolved. The global scenario is that there is imbalance in international trade and the economic crisis seems quite foreboding. To save the banks and financial institutions from sinking hundreds and billions of dollars have been provided. UK and the entire Western world are suffering from unemployment and bankruptcies with no relief in sight in the near future. UK government has provided more than 375 billion pounds to the banking sector through various unique measures; this has caused severe public deficit as most of the fund has not returned to the real economy (Gokay, 2012). Effect of global recession on UK economy has been prominent in 2012. In the fourth quarter of 2012, UK economy weakened as exports declined. There was also a depression in company investments because of a negative economic attitude. GDP started falling from September 2012 and decline rate has been 0.3 percent (Buckle, 2013). However faith in the UK economy has improved from 2010 onwards as reflected in the trend of FDI (given below): (The World Bank, 2012) Some signs of recovery has been seen in th UK economy. The ratio of non performing loans to total loans increased from 1.6 in 2008 (from 0.9 in 2007) to 3.5 in 2009. It was brought little in control when the increase was less in 2010 (4.5) (The World Bank, 2012). Future prospects of UK economy The near future of the UK economy seems bright in the business sector. This is because there seems to be an improvement in the debt crisis situation in the Euro region. The foreboding that surrounded UK economy in the past few years that the nation’s economy would fall back into recession seems to have reduced. There seems to be optimism in the manufacturing sector too with the growing prospect of increasing exports as there is a possibility of rising demand in the overseas market. There is likeliness that UK economy will be witnessing a growth in 2013 although there has been a recent decline in the service industry. Although the general confidence is back the uncertainty regarding economy and finance is still on the minds of UK population. The need is to focus more on technology sectors. This may not solve the unemployment issue, but can ensure growth of international competition. Conclusion Nations have become increasingly economically interdependent. For industrial nations, international trade contributes greatly to the national output. This linkage between international trade and economy is hugely beneficial for trading nations as they are able to consume goods and services at lower prices. However, economic interdependence has uneven effects on different nations and also in different sectors of same nation. The ongoing global economic crisis has hit hard on nations all over the world and UK is not an exception. Although UK economy is slowly beginning to show prospects of growth compared to the depressing outlook that has existed in the past few years, the future still looks bleak. The need is to focus more on increasing imports and depending less on borrowing and imports. References 1. 1. The financial crisis of 2007/2008 and its impact on the UK and other economies, University of Liverpool, retrieved on March 9, 2013 from: http://www.learnhigher.ac.uk/resources/files/business%20comm%20awareness/The%20Financial%20Crisis%20and%20its%20Impact%20on%20the%20UK%20and%20other%20Economies.pdf 2. Ajami, R.A. et al. (2006) International Businees: Theory and Practice, M.E. Sharpe 3. Bamford, C.G. & S. Grant (2000) The UK Economy in a Global Context, Heinemann Education 4. 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