The Growth of Trade and Foreign Direct Investment in a Post World War II Economy - Term Paper Example

Global Economy The purpose of this paper is to discuss the growth of trade and foreign direct investment (FDI) in a post World War II economy. The paper will look at this trend across the global environment and highlight the factors contributing to the development of the post World War II economy. The paper first gives some motivations for international trade and foreign direct investment (FDI) from the perspective of both nations and private organizations. Next this paper will describe the global economy towards the end of World War II, and the institutions that came about shortly thereafter such as the Euro Zone, the North American Free Trade Agreement and the implementation of the Bretton Woods Agreement. The paper will then explain the emergence of postwar economies in Europe and North America. Building on this point, this paper will track the progress of these economies as they moved into the new millennium. The paper will explain the steps that have helped make FDI and growth in trade easier, for many nations. Many elements of FDI work with each other so it is difficult to tell which element has had the most impact. Before an analysis of what factors have led to the growth of FDI and international trade, one must understand why so many nations depend on trade in general. According to the Encyclopedia Britannica (2010), countries engage in international trade for many reasons. A country that is resource-deficient would engage in trade in order to obtain goods or services for its citizens. According to the concept of specialization, a nation may excel at producing some sort of good (typically land-, labor- or capital-based). According to Rutgers (2010), there are three reasons for FDI. The first are marketing factors, which include easy access to a large market, market growth, following customers, following competitors, potential for establishing a good market base, and the ability to maintain closer ties to customers. Second, there are cost advantages: being closer to a supply, lower labor costs, better access to capital, lower transaction costs, and an excellent distribution infrastructure. Last, when there is a good investment climate, there is often as a stable political climate, favorable tax policy, an excellent foreign exchange rate, and low trade barriers. According to Dunning (in Twomey, 2000) the motivations for FDI fall under the OLI model. Ownership advantages include trademarks and potential returns to scale. Dunning postulated that there must be some locational advantages insofar as a firm would commit to FDI if investment in a country brought access to raw materials, skilled labor, or tax incentives. Finally, an internationalization advantage would be conducive to special arrangements such as joint ventures. In order to evaluate the growth in FDI and International trade since World War II one should provide a point of reference. Immediately after the Second World War one cold recognize a global economy which had been strongly shaped by the political infrastructure that had existed during the war effort. Goebbels’ Sportpalast speech (1943) had advocated for moving all available resources entirely to the war effort. This made FDI impossible and all trade was to be directed towards the war effort. This is a similar to what could be found in Japan. The United States devoted much of its production efforts to the war, but according to Haggart (2001) it maintained international trade with Canada. After the end of the war the economies of Japan, Germany, and Western Europe were in a horrible economic situation. Spain was still recovering from its civil war which had ended in 1939, England was recovering from the blitzkrieg and other countries were recovering from their occupation. It was during 1948 that the United States enacted the Marshall Plan. This four-year program, provided $13 billion in technical and direct aid to European countries which had joined the Organisation for European Economic Co-Operation (later OECD) (Milward, 1984). As argued by Van der Wee (1984) the focus was not only on reconstruction but on the modernization of financial and industrial institutions and the facilitation of intra-European trade. The direct result of this program was the expansion of the OECD and the Economic Cooperation Administration (ECA) both of which encouraged free trade. It was in the best interest of the United States to have an economically strong Europe as a market for its exports. It is the case that many of the reqirements of the Marshall Plan depended on the Bretton Woods conference (1944). This agreement among 44 Allied countries provided for a stable means of international trade. According to Hudson (2003), the purpose of the system was to avoid currency devaluations being made independently to increase the competitiveness of a country’s exports. Much of the world’s gold reserves were being held in the United States. Rather than a gold standard, the Bretton Woods system would peg most currencies to the United States dollar, which could in theory be converted into gold. This system fell out of favor as growing trade deficits depreciated the value of the artificially high American dollar but whilst the Bretton Woods system was in place, countries had a more stable basis of trade. Ultimately, the Bretton Woods system made the currencies of these nations easily convertible for the purpose of international trade. The Bretton Woods II system of letting currencies float against other currencies closely matches that of the original Bretton Woods agreement. Chakravarty (2008) argued that the emerging economies of Brazil, Russia, India and China would artificially peg their currency to major currencies such as the Euro or the American dollar, in an effort to improve exports and to develop large foreign exchange reserves. The effect of the Bretton Woods system on international trade and FDI is open to question. According to Terborgh (2003), the first two decades after the introduction of the Bretton Woods System saw merchandise exports from non-communist countries grow by over 290%, a pace that remarkably far exceeded world output. The next major consideration are the numerous free trade agreements. The first major trade agreement was the 1947 General Agreement on Trade and Tariffs (GATT) in which twenty three nations signed an agreement on tradable items. Terborgh (2003) claimed that most export duties between the United States and developed nations were reduced by more than 50%. The two largest institutions of the post war era that strongly affected FDI and trade would be the European Union and the North American Free Trade Agreement (NAFTA). While the European Union had many political origins, its effect on the economies of its member states has been profound. According to Paul et al. (2007) the European Union formed when the treaty of Maastricht came into force in 1993 with the original six founding states Belgium, France, West Germany, Italy, Luxembourg, and the Netherlands and expanded to include Austria, Sweden and Finland in 1995). While the reduction of trade barriers was significant within the European Union, the introduction of the Euro was also important for improving trade and FDI. While the currency brings a level of monetary stability to Euro zone member states as there is no risk of currency fluctuations and it has facilitated trade among member nations by reducing transaction costs. Furthermore, the Euro has helped increase FDI by eliminating translation risk from foreign projects. If a German company built a facility in Italy and the lira were to depreciate against the mark, the German company would immediately see a book value depreciation of its property; this could shake the confidence in the German firm. With the reduction of transaction costs, the simple cost of exchanging currencies disappears, making businesses purchase goods and invest in projects. The other added benefit is that the value of goods is immediately visible within the European Economic Community, insofar as it is easy to identify and rectify price differences. For example if a car were to be for sale in the Netherlands for 10,000euros and 9,000euros in Belgium Dutch would naturally purchase cars in Belgium. However when countries operate with different currencies these price differences are more difficult to notice by normal people and organizations may remain less competitive. Lastly, Bells (2010) argued that the European Union allows for a unified front among member states and against anti-competitive behavior such as anti-dumping laws. Bells (2010) added that the EU was able to arbitrate a trade war against Chinese commodities and improve opportunities for new ventures for EU prodcers. What effect has the European Union and monetary union had on the economies of EU member countries? According to McGowan (2007) it is difficult to determine what effect the Euro alone has had; most estimates claim that the direct effect has been an 11% increase in the amount of trade among member states from 1994 to 2004. McGowan (2007) postulated that EU member states traded slightly less than they did prior to the implementation of the EU with non- EU member states. This increase in trade has also translated into increased FDI within the European Union. According to the European Union Foreign Direct Investment Yearbook (2007) the FDI inward flows have consistently increased between 1997 and 2007 and brought a 9% growth in 1995. European Union FDI inward flows increased by a staggering 77%. There has been surprising growth in European trade and FDI as a result of the European Union and monetary union. What effect has NAFTA had on the North American market? While NAFTA has not been as all-inclusive as the European Union, there has been a significant growth in economic activity. The goal of NAFTA was the elimination of tariffs between Mexico and the U.S. The question that arises is what effect has these provisions had on trade and FDI. According to Green (2005) more than $633 billion was traded between the United States and its NAFTA partners, representing a 12.6% increase over 2004. As of 2004 the total value of U.S. trade with its NAFTA partners was up 36.1% from 2001. Green (2005) estimates an 80.5% growth from 1994 when NAFTA took effect. Cuevas et al. (2005) stated that Mexico recognized inflows that were 60% higher than what they would have been without the agreement. It is therefore possible to conclude that NAFTA has profoundly affected FDI and trade. In conclusion, a number of factors have contributed to the growth of FDI and trade. Many of these factors work in conjunction with each other. The Bretton Woods system, the Marshall Plan, the economic integration of Europe and NAFTA have all had a profound effect on FDI and trade between nations. However, only time will tell what direction the economies of developed and emerging economies will take. References Bells, L. (2010). 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