Systemic Transformation, Trade and Economic Growth - Assignment Example

Essay of economic issues Table of Contents Question 5 Introduction 5 Discussion 5 Conclusion 7 Question 2 8 Introduction 8 Discussion 8 Conclusion 9 Question 3 10 Introduction 10 Discussion 10 Conclusion 11 Question 4 12 Introduction 12 Discussion 12 Conclusion 13 Question 5 13 Introduction 13 Discussion 13 Conclusion 14 Question 6 15 Introduction 15 Discussion 15 Conclusion 16 Question 7 16 Introduction 16 Discussion 16 Conclusion 18 Question 8 18 Introduction 18 Discussion 18 Host country 18 Home country 19 Conclusion 20 Question 9 20 Introduction 20 Discussion 21 Conclusion 22 Question 10 22 Introduction 22 Discussion 22 Conclusion 23 References 24 Question 1 Introduction East Asian economies share of world GDP have increased over the years since 1950. This was witnessed mainly because of the increased trade between the Asian economies. The gravity model explains the reasons contributing to such increased level of trade between them. Moreover the shift of trade patterns has led to the increased level of trade between the Asian economies. Discussion The rise in the level of trade between the Asian economies was predominantly not because of size and distance between the countries. Geography, culture and borders have been the critical influencing factor. Favourable legal and political system, resource availability and cheap skilled labour have supplemented the share of East Asian economies in the world GDP. Globalization has completely changed the pattern of trade. Manufacturing products have taken up the major share in world trade with the Asian economies contributing more towards such trade shift. Figure 1: Shifting trade pattern The above figure represents the shifting trade pattern of global trade which has shifted from agriculture to manufacturing. The changing trade composition was mainly witnessed in developing economies i.e. East Asian economies. China is the largest developing economy in the world where 90% of its export trade comprises manufactured goods. The gravity model aims to find the value of trade between economies which is influenced by the size and distance between the economies engaged in trade. Both the factors have favoured trade for Asian economies. The model also tries to find the anomalies that inhibit trade. Asian economies have witnessed low degree of trade barriers like geography, culture, political and legal that has favoured the growth of trade intra Asian economies. The gravity model considers the size and distance to be the important factors that determine the value of trade (Westernhagen, 2002). Where, Tij is the total trade value of country i and j A is a invariable term Yi and Yj are the respective Gross domestic products of countries i and j. Dij is the space connecting the countries i and j. The gravity model estimates that an increase of 1% between the countries will lead to decreased trade volume by 0.7% - 1%. Conclusion East Asian countries have witnessed major change in trade pattern owing to favourable factors as explained under the gravity model. Owing to size and distance, the Asian economies have contributed more towards the world GDP. Question 2 Introduction Leontief paradox challenges the proposition of H.O. model of international trade. The latter’s theory challenges the former’s through empirical evidences. It proposes that the country with high capital labour ratio will export low capital labour ratio goods and import high capital labour ratio goods. Discussion The HO model of international trade assumes that countries engaged in international trade have identical level of technology and taste. It states that countries will produce those goods which require intensive factors of production and such factors are abundant in that country. Trade and income distribution is affected when such trade pattern is followed. Leontief challenged the proposition of the HO model of trade by using statistical evidences which show that countries which are abundant in a particular factor of production imports the good which uses such factor of production and exports goods that is finite and less intensive in production. Both under HO model and Leontief paradox capital (K) and labour (L) are the two factors of production that are used in production of goods. Leontief paradox was primarily tested on US data considering the two factors of production i.e. capital and labour. Figure 2: Export and input of factor inputs of US in 1962 The above figure shows the import and export of capital and labour of US economy in 1962. Leontief paradox was based on the above data. It was found that US being a capital intensive country imported more of it than labour in which it is scarce. This challenges the HO model, under which US should have imported more labour than capital. The data above shows that capital imports are more than labour imports and capital exports were less compared to labour exports for US in the year 1962. US witnessed a high capital-labour ratio for its imports and low capital-labour ratio for its exports. Capital –labour ratio for imports stood at $17,916, whereas capital-labour ratio for exports stood at $14,321. The Leontief paradox holds true in the case of US exports and imports from the given data. Thus, this shows that countries in the real world do not export the goods as stated in the HO model of trade (Dwivedi, 2002). Conclusion The HO theory of trade only considered the comparative advantage of producing goods which uses either capital or labour. US has more skilled labour than capital, this fact itself challenges the proposition of Leontief paradox. Either of theories failed to consider other factors of production like technology that influence international trade and ignored other factors like industry size, demand for goods, etc. Question 3 Introduction Under the proposition of HO model and Stolpher Samuelson theorem, international trade leads to the equalization of prices of factors of production. Both the theories assume that the countries engaged in trade have the same production technology and markets are perfectly competitive. Under competitive market prices of goods equal the prices of input factors i.e. capital and labour. Discussion Prices of factors of production influence the price of final goods under the perfectly competitive markets. The mix of factors of production and the prices directly influence the output price of goods. The return of factor inputs is dependent on the marginal productivity of factor inputs. In other words how much does one additional unit of labour capital will produce? The marginal productivity varies with the varying proportion of the factor inputs. The HO model of trade considers free trade practice between countries. Trade influences the demand of final goods, which in turn increases the prices and also the prices of the abundant factor inputs which are used in producing it. Free trade under the HO model leads to equalization of prices of goods. As discussed above output prices are linked to factor prices, which results in equalization of the factor prices as well. Under free trade practice countries will use the same capital labour ratio in producing a unit of output. They will use the same rental rate and wage rate. The unit factor prices of producing a unit of output will be same, but the quantity produced will vary from country to country owing to factor abundance or factor endowment. The HO model of factor price equalization contradicts the Ricardian model of trade which assumes different production technologies. Under Ricardian theory when countries move to free trade, wage rates would vary depending upon the level of productivity. Countries with higher output will have higher wage rate. Figure 3: International wage rates In the real world, it is not possible to have same factor prices owing to the presence of various trade barriers. Different countries produce different goods and it is always not possible for trading countries to produce identical goods (Bernard, 2002). Conclusion The model ignores various factors that like trade barriers, transportation cost, rate of growth, etc which influences the output price and thus prevents factor prices from equalizing. The workforce characteristic is another important factor that will lead to unequal factor prices. Workforce characteristics include educational level, habits, motivations, etc. Question 4 Introduction Within the annals of Economics industrial district is referred to as a term that is used to denote the way in which in particular industrial area there is clustering of similar industries which results in economic specialization. The present essay tries to define the term and the advantage for an industry to locate in such a district. Discussion Industrial district as referred to in the annals of economics as a particular industrial area in which there is clustering of several industries of similar types. For example Silicon Valley in America is famous for clustering of electronic industries. Similarly Bangalore in India is famous for clustering of software industries. By clustering at one place the industries are able to gain the advantage of economies of scale. Clustering of industries of a particular type in an area results in that fact that the output increases as well as efficiency there by reducing the cost per output and prices per output. This is because as the industries start producing more the supply curve starts sloping forward and intersects the demand curve at a lower point there by reducing the price. It is found that if a firm is located in an area where there is large no. of small firms of a particular industry then the firms can take the benefit of external economies of scale and reduce the cost of production. This is due to: Specialized service or equipment that is required by the firms in the industry is readily available. In case of a concentrated industry other firms in the industry supply the specialized equipment or service that is required. Example may be Silicon Valley in America. Pooling of labour there by reducing the cost of hiring as a concentrated industry may attract a large of workers and so the companies do not have to spend time in searching for employees. Spill over of knowledge in which workers who belong to different firms can easily share their knowledge and ideas which results in the benefit of each firm in the industry. Conclusion It is found through the essay that in an industrial district large no. of firms clusters at a place in order to achieve economy of scale. The clustering of large no. of industries at a place results in the fact that the output efficiency increases and the cost decreases which is in turn caused by several factors like availability of products, cheap labour and spilling of knowledge. Question 5 Introduction In case of constant return to scale; if input increases at a certain rate, then output increases at the same rate. If in any case the inputs are doubled the output will also be doubled. However there may be increasing return to scale or economies of scale. Economy of scale may be either internal or external and may cause output increases at a faster rate, for certain increase in input (Carbaugh, 2008). Discussion In increasing returns to scale or economies of scale, output increases at a faster rate with the corresponding increase in input. Economies of scale are beneficial for the firm as with an increase in the returns to scale the cost per unit of output falls. There are two types of economies of scale. One is external economy of scale that occurs due to the fact that concentration of large no. of similar companies in a particular industry decreases the cost of output per unit. On the other hand, internal economies of scale results in the fact that with increase in the size of the firm the cost per unit of output decreases. Both these factors are important determinants of international trade due to the fact that a country could take the advantage of the economy of scale in order to produce the goods more efficiently than to produce the every goods by it. If in an industry economy of scale is purely external then it will result in the fact that there will be many small firms in the industry and it will be an example of perfect competition. On the other hand when one of the firms achieves internal economy of scale or there is cost advantage of large firms over small firms then there is imperfect competition. With the concentration of firms of a particular industry in an area economy of scale comes in and the firms tend to produce more. As the firms produce more their cost per unit of production falls and the output prices also fall. This is due to forward falling supply curve which causes that with increase in the output of the industry the prices at which the firms are willing to sell falls. Conclusion It is found that external economies of scale are achieved through the location of several firms of a particular industry in a certain location. This in turn helps to achieve efficiency in production bringing down the cost per output and bringing down the price charged due to forward falling supply curve. Question 6 Introduction Internal scale of economies is firm specific unlike external economies which is industry specific. The cost per unit under internal economies of scale is dependent on the size of the firm and not on the industry size. Under external economies the low cost advantage is enjoyed by all the firms in the industry. Discussion Internal scale of economies is enjoyed by some large firms in an industry that have relative advantage over other players in the industry. Both internal and external economies witness a fall in the marginal cost of production. The benefit of lower cost is enjoyed by all the firms in the industry under external economies. Internal economies are achieved by firms which have large resources like capital, technology, manpower, etc. It offers greater competitive advantage as it leads to imperfect competition. Firms which have technical economies i.e. better and efficient equipments will have lower cost per unit of production compared to other small firms. Internal economies of scale are not consistent with pure competition model. Under perfect competition it is not possible for firms to enjoy cost advantage over other firms. It is characterised by many buyers and sellers who sell homogeneous products at identical prices. There is less competition in the industry as all of the sellers sell identical products. On the contrary if in an industry a firm enjoys internal economies it will lead to cost advantage of that firm and will push many small firms out of the industry. It creates high entry barriers owing to high establishment and technical costs. This creates a monopoly market which does not meet the pure competition model. Internal economies is characterised by imperfect market where firms with large resources grow in size compared to other firms in the industry. The industry size increases owing to the increase in the size of few large firms. Under pure competition model all firms are equally benefited from the growth in industry. For example the invention of internet helped many firms in different industry to reduce its operational cost (Sivagnanam, 2010). Conclusion Internal scale of economies leads to imperfect markets that pushes small producers out of business and creates high barriers that restrict the entry of new firms. It creates monopoly, monopolistic, oligopoly, etc which is not consistent with the pure competition model. Internal economies are firm specific and are dependent on the size of the firm and not the industry like in external economies. Question 7 Introduction Proximity concentration trade off influences firms decision regarding foreign direct investment. It is the trade off between exporting a particular commodity and investing in such commodities abroad. Moreover the trade off arises because of the costs associated with the two approaches that affect the value of such transactions. Discussion Different market structures influence the decisions of firms. A monopolist firm will find it easier to export than to invest in foreign country. The demand will be highly in elastic, thus it gives the firm equal opportunity to either consider FDI or exports. Under competitive market and where the market has high demand and price elasticity, it is favourable for foreign investments. The proximity concentration trade off not only compares the costs of exports but also of licensing rights. Exporting refers to producing goods locally and selling it in the foreign country. Exports are subject to high trade barriers and transportation costs. Trade barriers like foreign country’s tariffs and quota restrictions, level of subsidy, trade policies, etc influence a firm’s decision on making foreign investments. High transportation costs will drive the final price of the output that might affect the demand of such goods. If the foreign country has high price elasticity then a slight increase in the price of exported goods will result in reduced demand. Licensing on the other hand refers to the transfer of right that is given to a foreign firm that produces and sells the domestic firms’ product in exchange of a fee i.e. royalty fee. Licensing rights given to foreign entities can drive away the technological knowhow and might result in lack of control over business operations in the foreign market. FDI on the contrary help firms to retain control of their business operation, technical knowhow, business strategies, etc in the foreign market. Thus, it is seen how FDI proves beneficial compared to other strategies like exporting and licensing. FDI also has some inhibitions that create the proximity concentration trade off. Though the benefits of FDI outweigh the negatives, there still exists a cost. FDI requires high investment which takes place through greenfield or brownfield investments. Such investments can be made by large firms. The small and other medium firms consider the other strategies like exporting and licensing to be favourable (Helpman, 2011). Conclusion Firms’ decision is influenced by the trade off between exports or FDI. Either of them has certain costs associated with it and the choice of strategy is incumbent on the trade policies and level of government intervention in the domestic and foreign country. Question 8 Introduction FDI has a list of benefits and costs to the host country and the home country. It helps to expand the business operations of firms as well as increase its market competitiveness. It also affects the domestic or the host country’s sentiment and might lead to negative consequences that question the long term sustainability of firms. Discussion Host country Costs FDI negatively impacts the host country by pushing the small producers out of business. Global firms have large resource base that is detrimental to the producer sentiment in the host country. It affect the balance of payment account when the foreign subsidiary repatriates earnings to its parent company and when it imports certain value added items from other subsidiaries or the parent company. The host country loses economic independence owing to the decisions made by such large foreign companies that have no commitment to the prosperity of the host country. Benefits The host country benefits from FDI by resource mobilization. It is benefited from increased flow of capital, better technology and superior management practices. It generates employment in the host country either directly or indirectly. Directly jobs are created when the foreign subsidiary employs host country’s citizens and indirectly it generates employment through additional investments in host firms. The host country is benefited from increased growth. The foreign subsidiaries make the local market competitive and contribute to the value of goods and services produced in the host country. Home country Costs FDI negatively affects the home country in number of ways. It negatively impacts the balance of payment. FDI requires large capital outflows to setup subsidiaries in foreign countries or in case of brownfield investments. Though it receives substantial inflows through repatriation from its subsidiaries, the high outflow offsets such earnings. Jobs move out of the home country to the host country. This would aggravate the labour market if the unemployment rate in the home country is already high. Benefits It receives cash inflows from its foreign subsidiaries that add to the capital account of the home country. It positively impacts the BOP account when the host country subsidiary creates demand that results in home country’s exports. New skills and operational strategies are adopted that leads to economic prosperity of the home country (OECD, 2002). Conclusion Firms making foreign investment should carefully consider the trade off i.e. the costs and benefits associated with such investments. FDI affects the host and the home country in numerous ways. Firms should also consider the implications of its investment on the host country’s sentiment i.e. economic and social. Question 9 Introduction It is often argued in economics that when the government do not distort the market by way of intervention in order to regulate the prices the producers and the consumers allocate resources most effectively. However with government intervention production surplus results which causes deadweight loss. This is further explained in the following essay. Discussion Figure 4: Deadweight triangle The term dead weight loss in economics refers to the fact that there is a loss of economic efficiency which occurs when it is not possible to achieve equilibrium of goods and service (Dwivedi, 2010). Deadweight loss can caused either by monopoly which causes consumer surplus or by subsidy which causes producer surplus. For examples if the price of a nail in a perfect competition market is 10 cent, the producers have to charge a price that is 10 cent and the consumer will purchase the product only if the marginal benefit from the purchase of nail exceeds the cost. However if the market is a monopoly then the producer will charge a price that gives them maximum benefit. This will result in the fact that some of the consumer to be not willing to purchase the nail as the marginal benefit increases the cost. This is consumer dead weight. On the other hand if the government gives subsidy to the producers in order to produce goods then the producers will produce more goods and the prices will come down leading to consumers buying the good even if the marginal benefit from the purchase is less. This in turn represents an in efficient utilization of resources as the same resources were previously being used to produce certain other goods. The other goods which could be produced could then be exported in order to earn real income for the country. Thus the production dead weight triangle represents an inefficient utilization of the resources in order to produce a good that cannot be sold profitably and causes a loss of real income for the country. Conclusion It is found through the course of the essay that both producers and consumers deadweight result from market inefficiencies and both represents a loss to the society. Thus both forms of dead weights should be avoided. Question 10 Introduction WTO is the world body formed after the General Agreement on Trade and Tariff. It states that the trade barriers between the countries should be removed and the countries should be allowing free trade. In the following essay the gain that an industrial country could have by joining the world trade organization is analyzed. Discussion It is often argued in economics that producers and consumers are able to allocate resources more efficiently if there is no intervention in the market by the governments. In fact failure of the market to achieve uniformity of goods and services results in loss known as dead weight loss. The national welfare of the society is highest when there is free trade. When the trade is restricted then it results in the fact that the consumers are made to pay high prices and consume very little. On the other hand this means that the firms produce too much and the resources of the society are not being used uniformly in order to generate real income for the society. Free trade is beneficial as because it lets the country to use the external economies of scale to their benefits. In markets that are protected the countries gain limited gains as because they inhibit the concentration of the industries at a place. When industries are not allowed to concentrate at a place then the cost of output per unit does not decrease and the price per unit also does not fall. In fact the production is not efficient. It is also estimated that the gains from the free trade will be somewhat smaller for the advanced economies and somewhat large for the developing economies. Whereas the benefits from the move to worldwide free trade will be 0.57% of GDP for US, it will be around 1.4% of GDP for the developing countries (Cline, 2004). Another benefit for free trade is that it allows for competition and provides opportunity for innovation. The free trade provides the entrepreneurs an ideal platform so that they can seek new ways to export or to compete with the imports. Conclusion There are several benefits that the countries can hope to achieve by entering into a regime of free trade that is facilitated by WTO. The benefits range from efficiencies of market, economies of scale, to opportunities for learning and innovation to name a few. References Bernard, B.A., 2002. Factor price equalization in the uk? UK: Centre for Economic Policy Research. Carbaugh, R., 2008. International economics. London: Cengage Learning Cline, W. R., 2004. Trade policy and global poverty. Washington DC: Institute for International Economics. Dwivedi, D. N., 2010. Macroeconomics. New Delhi: Tata Mc Graw Hill. Dwivedi, N.D., 2002. Microeconomics: theory and applications. New Delhi: Pearson Education India. Helpman, E., 2011. Understanding global trade. USA: Harvard University Press. OECD, 2002. Foreign direct investment for development maximising benefits, minimising costs: maximising benefits, minimising costs. France: OECD Publishing. Sivagnanam, 2010. Business economics. New Delhi: Tata McGraw-Hill Education. Westernhagen, V.N., 2002. Systemic transformation, trade and economic growth: developments, theoretical analysis and empirical results. Germany: Springer Science & Business Media. Read More