A world of whose making - Economic Interdependence and Political Order - Essay Example

?A world of whose making - Economic Interdependence and Political Order In the recent years, there has been an increasein the number of multinational businesses. Many factors have contributed to this growth, one of which is the increasing realization of businesses that specialization can cause an increase in production efficiency. There are a number of economies all over the world which are showing an advantage in specialized products. U.S. and Japan have gained a technology advantage whereas countries like Jamaica, Mexico and South Korea represent an advantage in terms of lower labor costs. These advantages cannot be transferred from one economy to the other, and therefore countries aim to use the advantages they have for producing goods with relative competence. This provides an insight into the reasons for countries like Japan and U.S. to develop their technology with relative efficiencies. When countries produce a specific good with comparative efficiency, they may not focus on the production of other goods. As a result, they would have to trade their goods with other countries. This is the argument buttressed by the theory of comparative advantage (Madura 2008). The theory provides an insight into the dynamics of the international trade and helps to show how trade provides advantages to the trading parties (D'Anieri 2009). The theory of comparative advantage in economics refers to the concept of production of goods and services at a lesser cost than that produced by another country. The country has a margin of superiority in the goods produced; this pertains to the notion that the opportunity cost of the goods produced by one country is less than that in the other country. David Ricardo was the developer of the basic theory of comparative advantage. He was of the view that absolute advantage is a subset of the more general theory. After Ricardo, a number of theorists furthered and developed the theory of comparative advantage including Heckscher, Ohlin and Samuelson. The theory projected the facts that different countries have varying factor endowments of labor, land and capital input. Countries are going to prefer the production of those products which extensively use the factors of productions with the greatest endowment (Tutor2u 2011). This follows that if the countries gain advantage by specializing in these goods, there will be an increase in the total output and economic welfare. This holds credibility even when one nation may have an absolute advantage over the other country. One of the assumptions which constitute the theory of comparative advantage is that there is perfect occupational mobility of the factors of production. This means that the resources of one industry can be transferred to another without significant loss of efficiency. The theory also assumes that there should be constant returns to scale; a proportionate increase in the inputs leads to an equal increase in the outputs. There are no externalities surfacing from production and consumption. Also transportation costs are not taken into consideration. Increased returns are a product of specialization and the idea was put forward by Paul Romer and Paul Ormerod. If businesses take advantage from increasing returns to scale, the gains from the trade are more. There is no transport costs associated with comparative advantage. Costs do not vary and economies of scale are not present. There are two economies producing and trading homogenous goods. Moreover the trade carried out between the two countries is not impeded by trade barriers. Also the buyers and sellers have perfect knowledge and the buyers are able to trace down the cheapest goods available in the market (AC Mulligan n.d.). Comparative advantage is not a static concept; rather it keeps changing. Businesses may have had comparative advantage in a market in one product for years in a row. However the gains made during this period may suddenly be at stake as new competitors enter the market. The contribution of Ricardo in the basic theory of comparative advantage lies in the fact that he differentiated between absolute and comparative advantage and provided the argument that competitive markets lead to the formation of comparative advantage instead of absolute advantage. Ricardo argued that when the economies are driven by market forces, trade leads to greater prosperity amongst the economies (Southgate, Graham & Tweeten 2007). However the application of the theory to small and vulnerable states has been contentious, as argued by Srinivasan (2009). Srinivasan observes that this is attributable to the fact that the theory has been greatly misunderstood. The argument forms the core of the paper and explores how the theory prevents developing countries from prospering as predicted by the theory. There are a number of factors that affect the costs of production and hence the comparative advantage the country has. One of the factors is the amount and the quality of the factors of production available. For instance, the size and efficiency of the employees directly affect the costs of the production. If the economy can improve the efficiency and subsequently the productivity of the workforce, there are greater chances of gaining comparative advantage. More investment in research and development also impacts the costs of production and particularly shows it influence in economies where patents can produce substantial market advantage for one party. The rates of inflation and their degree of stability are also an important contributing factor to achieving comparative advantage. For a country which has a lesser rate of inflation, but is not consistent, as compared to a country with a higher but more stable rate of inflation, will be likely to see the price of its goods rise over the years. This causes a decrease in the competitiveness of the economy. Import controls like tariff s and quotas are useful in creating an artificial comparative advantage. Non-price competitiveness of producers such as product design, reliability etc can also confer comparative advantage to the economy (tutor2u 2011). Paul Samuelson was of the point of view that comparative advantage is the only thing that is true, yet trivial. The limitation of the theory of comparative advantage is the element of vulnerability. Waltz was also of the view that specialization and trade can cause countries to become dependent on each other for meeting their needs and hence vulnerable (Bromley, Mackintosh, Brown & Wuyts 2004). Countries which rely on foreign countries for their supply of essential resources such as oil and minerals can face grave shortages if some clash occurs between the trading partners or if international prices of the products soar. Countries that specialize in the production of a limited range of products and trade them are vulnerable to disasters if the demand and the prices for the goods decrease (Maier & Nelson 2007). Moreover such trade liberalization also leads to social disruption. When counties become increasingly dependent on imports and have no safety nets such as financial aid to families, national health services etc., then fluctuations in the global market causing unemployment can completely wreck families (Bromley, Mackintosh, Brown & Wuyts 2004). The comparative advantage theory is used by economists for supporting their free trade arguments. The proponents of comparative advantage argue that free trade leads to countries gaining comparative advantage over others. However, there are two sides to a coin and people who are in opposition to the theory of comparative advantage argue that it fails to be legitimate in the modern era. Many economists adhere to the point of view that globalization renders advantages to developed countries only and the poor and developing countries do not gain any advantage from globalization. Two impacts of globalization is the erosion of national boundaries, depriving governments of the individual choice to participate willfully in international trade, and the migration of workers. When analyzing the past few decades, one can appreciate that migration to the US was high before the First World War, fell between the two Wars and then peaked after World War II (Bromley, Mackintosh, Brown & Wuyts 2004). The argument presented in favor of globalization is that developing countries have some areas of production where they have an absolute advantage over other countries in terms of the costs of production. Poor countries are able to gain advantage from specializing in these factors of production. As a result even the poorest of countries are able to acquire comparative advantage over other countries (Slembeck 2005). However a consequence of greater market integration can be that infant exporters are faced with increasingly difficulties to survive in the market. It is seen that globalization leads to lower costs as output increases, particularly in the manufacturing industries characteristic of low income countries. This trend tends to be biased towards the larger firms, making them stronger and causing firms who just got started to go out of business (Bromley, Mackintosh, Brown & Wuyts 2004). It is a contentious subject whether globalization and outward orientation have reduced poverty. It is observed that neither of these measures provides a conclusive trend suggesting whether the countries will progress economically or not. However, according to Pritchett, globalization has caused “divergence, big time”, with the gap between the developed and poor countries widening over the past decades; the countries losing the most are those that liberalized into a poverty trap (Bromley, Mackintosh, Brown & Wuyts 2004). Furthering the notion of free trade, it is argued that developing countries are able to benefit from specialization and trade (Slembeck 2005). The WTO gives its Members the option to call themselves developing, and labels about 30 countries to be least developed and deserving of special treatment. Bromley, Mackintosh, Brown and Wuyts (2004) contend that several of the benefits WTO has promised to these developing countries are not delivered because of the shortcomings of trade negotiations. WTO policies promote free trade, and free trade and comparative advantage give rise to the process of globalization. Globalization is the process whereby there is increased transfer of goods, services, people and capital across the border. Globalization gives rise to an environment in which there is a much greater flow of goods and capital such that market forces come to play a significant role in the lives of the people. Globalization is leading to changes in politics, communications and trends of human migration to name a few aspects. However where several countries all across the world have benefitted from globalization and have seen a rise in their living standards, growth has not been the same for other countries. For countries such as Brazil and Russia as well as Southeastern states, there has been a decrease in economic growth ever since the late 1990s. The capital flows across the borders have been turned around and there has been a sheer decrease in the international currency values. Some theorists are of the point of view that “massive inflows of foreign investment into developing countries cannot be effectively absorbed, especially as regards the protection of the environment and workers' rights since standards and enforcement mechanisms are not as well established in developing countries” (Holzman 2006). There has been a lot of debate about globalization and whether it causes an increase in poverty. Critics have questioned the role of the WTO and the IMF, amongst other aspects and beneficiaries of globalization. The trade regime, developed by the WTO policies, has a great impact on the economy of the developing countries. The trading rules devised by the Organization affect economic growth in the country and also dictate which parties get to extract the most advantages. The WTO, as a mediator and creator of trade rules and negotiations, promotes unequal distribution of power and change how national sovereignty is exercised. The WTO does not force countries to become a Member. It acts as an international forum for countries to come together and negotiate their deals. It may not be actively involved in impeding progress and development in developing countries. It acts to promote greater liberalization of trade and the policies enforced on the developing countries is not by an independent WTO bureaucracy but by the rich, industrialized nations (Bromley, Mackintosh, Brown & Wuyts 2004). Many theorists adhere to the view that trade liberalization does not confer significant benefits to developing countries (Weisbrot & Baker 2011). Developing countries are faced with the choice of disadvantages of not being part of important export markets and the dubious advantages of being a junior Member of the WTO. The propositions argued for international trade which entice developing countries to trade encompass that trade and wealth are coupled to each other. Despite the fact that trading internationally exacerbates poverty in developing countries and that the current trade regime is biased towards the rich, countries are still willing to carry out trade across borders in order to increment their wealth (Bromley, Mackintosh, Brown & Wuyts 2004). An example of how WTO policies lead to a reduction in welfare benefits to developing countries is an analysis of the average tariff rates by region. It can be seen that South Asia has very high tariff rates as compared to industrialized economies. The tariff rates on goods which are relevant to low income exporters are considerably high. Agricultural products constitute the bulk of the peak tariffs over 50%; in certain instances, when the tariff rates on rich countries also climb as agricultural products undergo further refinement and processing, low income countries are divested of any chances to enter manufactured exports (Bromley, Mackintosh, Brown & Wuyts 2004). The doctrine of comparative advantage has caused a global disadvantage to the developing countries. As observed by one theorist, a world where growth and development are not even, unequal free trade develops. A range of arguments are presented that emphasize the notion that comparative advantage does not provide the welfare advantages it promises to developing countries. One of the arguments presented is that comparative advantage is something that is made and is cumulative, rather than natural or being developed spontaneously from historical development procedures, gained skills, cultured industry trends or first mover advantages. This follows that comparative advantage is subject to change by both governments and industry leaders and can also undergo decay if not given due attention. If this is the case, Faundez and Tan (2010) argues that developed countries would either cause the permanent presence of inequalities or would make it difficult and time consuming for the inequalities to fade away. It has been argued by another school of thought that free trade inevitably creates inequalities. The perspective argued is that when the exports of a country have a lower elasticity of demand while there is a high elasticity in demand for imports, then the export prices in comparison to import prices will cause a continuous trade deficit. This trend would dictate the conditions at which some developing countries export their products and import manufactured goods. As a result, if free trade is present, the developing countries will become subject to continuous trade deficit, which impedes them from gaining the benefits that comparative theory promises (Faundez & Tan 2010). Comparative advantage is not the only impediment that they countries face that causes a trade deficit. There are other factors that contribute to the continuing trade deficit. However, the economic situation in which these countries find themselves in is exacerbating as a result of the trade deficit produced by their inability to realize potential gains promised by comparative advantage. In the real world, the developing countries are on the receiving end of the deal that WHO offers and are consequently powerless. The theory of comparative advantage does not grant welfare benefits to the developing countries. Perfect knowledge is not available. Countries do not share goods but are involved in the buying and selling of goods. Also, the prices at which the goods are sold determine the advantages that countries are going to derive from trade. The available benefits received depend on the prices that are charged on the products. If the export prices are less compared to the import prices, the country is defined to have low terms of trade. Therefore extreme specialization and trade are actually having a negative impact on the economy of the country. Although the theory of comparative advantage is considered to be a general theory and is applicable to parties wherever they are, it becomes complicated and controversial when political elements come into play. Waltz theory of anarchy asserts that in a state, there is a hierarchal political authority which has control over other levels of the political system. However no such authority exists between states and hence there is anarchy, representing the absence of a government. When states are in a system of anarchy, they have to take steps to protect themselves, becoming self-help systems in the process. Powerful states are considered a potential threat. This brings into limelight the gains that are provided by international trade. The gains may not be equal and the country that has gained more may see its power waning when evaluated on relative terms. Analyzing the economy within the state, the government can compensate a decrease in the productivity of the workers by taxing the parties that are better off. Between states, there is no such mechanism in operation. As a result, states let go of opportunities that make them absolutely better off, but at the same time are making them worse off in relative terms. This is a political argument that comes into contradiction with the assumptions of the comparative theory. Thus from the above discussion, it can be concluded that the theory of comparative advantage and the policies of the WTO do not grant welfare benefits to the developing countries as promised by the theory. Developing countries are faced with the realities that surface from trading policies (Audet, Safadi & Organisation for Economic Co-operation and Development 2004). WTO by encouraging free trade and the removal of trade barriers becomes counterproductive in the creation of welfare benefits for developing countries. Where WTO may not be an independent sovereign body in itself, it can be argued that the interaction of sovereign states can lead to new patterns of sovereignty, causing power to be transferred to a higher body. This can be a valid possibility of how the WTO can evolve in the future (Bromley, Mackintosh, Brown & Wuyts 2004). References AC Mulligan n.d., David Ricardo and Comparative Advantage, University of Bristol, retrieved from 21 February 2011, Audet, D, Safadi, R & Organisation for Economic Co-operation and Development 2004, A new world map in textiles and clothing: adjusting to change, OECD Publishing. Bromley, S, Mackintosh, M, Brown,W & Wuyts, M 2004, A World Of Whose Making? Pluto Press, Milton Keynes. D'Anieri, P 2009, International Politics: Power and Purpose in Global Affairs, Cengage Learning. Faundez, J & Tan, C (Eds) 2010, International Economic Law, Globalization and Developing Countries, Edward Elgar Publishing, Glasgow. Holzman 2006, Globalization Supporting Comparative Advantage in Economies, echeat, retrieved from 21 February 2011, Madura, J 2008, International Financial Management, Cengage Learning. Maier, MH & Nelson, JA 2007, Introducing economics: a critical guide for teaching, M.E. Sharpe, New York. Slembeck, T 2005, Facts and Fiction about Globalization, Tilman Slembeck, retrieved from 21 February 2011, Southgate, DD, Graham, DH & Tweeten, LG 2007, The world food economy, Wiley-Blackwell, Massachusetts. Srinivasan,TN 2009, Trade, growth and poverty reduction: least-developed countries, landlocked developing countries and small states in the global economic system, Commonwealth Secretariat, London. Tutor2u 2011, Comparative advantage and international trade, tutor2u, retrieved from 21 February 2011, Weisbrot, M & Baker, D 2011, The Relative Impact of Trade Liberalization on Developing Countries, Policy Innovations, retrieved 21 February 2011, Read More