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Introduction to World Economy

An economy is the ways in which people use their environment to meet their material
needs. It is the realized economic system of a country or other area. It includes the
production, exchange, distribution and consumption of goods and services in that area.

Economy come from the Greek words Oïkos (house) and Nomos (rules) and hence
practically means house management.

• Primary sector → extraction of raw materials (corn, coal, wood, iron) 1% (GER)
• Secondary sector → transformation of raw materials to goods (textiles into clothing)
29% (GER)
• Tertiary sector → provision of services to consumers and businesses (cinema,
banking) 70% (GER)
• Quaternary sector → research and development needed to produce products from
natural resources (education in some cases included)

Trade:
Best example to demonstrate why people trade is Sweden. They got fish and they got
forests, but hardly anything else. Therefore they have to trade to satisfy their needs and
wants.

The Babylonians (Iraq) created many tools to facilitate trading. For instance writing was
invented as records of trading had to be hold. Likewise money was created, first
commodity value (gold, silver, copper) was used, where nominal and real value was equal,
than money as we know it today, where the value written on it is much higher then the
material value. (This just because we trust in it, having that value)

Trading was facilitated trough both, alliances and wars. The Greeks established
commercial routes along with alliances. The Romans fought wars to force and to secure
trade routes.

Throughout the Dark Ages (5th - 15th century) there was hardly any trade (except the Silk
road: a network for trade of high profitable products from Asia to southern Europe)
because of general impoverishment, insecure trading routes and because of different
currencies and different measurement systems. Out of this situation Mercantilism
established.

Mercantilism:
Mercantilism is on of the first economic theories in Europe (1500-1750). It states that the
wealth of a state is entirely dependent of the capital it holds (gold or silver
predominantly). It implies that states control very tightly the economy (planing,
production) by closing it and building up industries trough tariffs. Wars were extremely
expensive, wherefore the economies had to be strengthened. Spain, France, Britain and
Holland were very good in this at that time (state monopoly – centrally planned economy)
Trade was limited on exports to obtain more gold.
According to the Navigation Acts (starting in 1650) the colonies were limited to trade just
with GB and only on their or British ships and gave GB the control over the products
(redistribution, selling → taxes).
Mercantilism was main source of animosity and struggles in that time.

9 Rules of mercantilism (von Hornick):


• every inch of a country's soil be utilized for agriculture, mining or manufacturing.
• all raw materials found in a country be used in domestic manufacture, since finished
goods have a higher value than raw materials.

• a large, working population be encouraged.

• all export of gold and silver be prohibited and all domestic money be kept in
circulation.

• all imports of foreign goods be discouraged as much as possible.

• where certain imports are indispensable they be obtained at first hand, in exchange
for other domestic goods instead of gold and silver.

• as much as possible, imports be confined to raw materials that can be finished [in
the home country].

• opportunities be constantly sought for selling a country's surplus manufactures to


foreigners, so far as necessary, for gold and silver.

• no importation be allowed if such goods are sufficiently and suitably supplied at


home

This policy implies that mercantile countries must have in all circumstances a positive
trade balance (exports must be higher than imports) Note: This still today is an
advantage!

Colbertism: a French example


Colbert was finance minister from 1665 to 1683. He encouraged the country to produce
by their self and imposed strong taxation on imported goods or banned them. Reduced
taxes within the economy and build roads and canals.

The idea of Colbert was to increase productivity and protectionism to strengthen the
economy and become self sufficient (Autarky = not dependent in times of war).
A perpetual (continuous) growth was needed to steadily increase the economy (exports,
furthering of raw materials). European markets were closed, therefore European powers
had to find ne markets and started the colonisation of the Americas. Europeans had
exclusive trade rights and used military power to maintain these rights.

Triangular trade was the basis of worldwide


growth and of the economic industrial
revolution. (key: cotton for textile)

Weapons, alcohol, tools for African slaves.

Slaves for tobacco, cotton, sugar, gold.

Raw materials are transformed and sold on


the market.

Triangular trading went from the early 14th


century to the mid 18th century. It reached its peak in the mid 18th century. An estimated
11 million Africans were deported and founded the basis for the growth of the world
economy and the basis of what will later become the US economy.
Ad- and disadvantages:
There have been problems with mercantilism. Because of the blockage of imports (to stop
gold and silver leaving the country) many countries had to suffer famines ad many
industries were dislocated (weakened) because the price of raw materials increased. The
control over all colonies turned out to be impossible and the preservation cost a lot of
money on military spending. (e.g. USA)
Furthermore there was a general impoverishment of the population as the government
was keen on keeping the wealth together.
For mercantile governments trading was a zero sum game (just one winner, i.e wealth
from exports) this actually is not true.

However strong development of national industries, the consolidation of nation-states as


we know them today and the modernization of these states (construction of roads and
canals and the creation of a bureaucracy) are positive aspects of the economic model of
that time.

Mercantilism today is represented by the four Asian dragons Singapore (3rd biggest
refiner), Hong Kong (financial metropole), Taiwan and South Korea (information
technology). In our economy we can call it a form of mercantilism when a government
gives projects to domestic companies.

With the start of the Enlightenment (focus on reason and individuality) in the beginnings
of the 18th century and under the influence of Hume, Locke, Smith and Ricardo
mercantilism started to vanish and to be replaced by liberalism and free trade.

Keywords:
empire-building, economic philosophy, state control over human behavior, acquisition of
colonies, satisfy needs of mother country, accumulation of wealth at colonies' expense,
colonies for trade without competition, regulatory policies, manufacturing prohibitions for
colonies (wool or iron industry), reliable market for colonies

Liberal theory:
With the Age of the Enlightenment (1700-1800) intellectuals started to criticize the
absolute power of the monarchies.
The Enlightenment allowed for the creation of a public sphere, reason was held for
supreme and therefore everything was open to criticism. The population became critical
and was opposed to secrecy and in favour of tolerance and what we now know as to be
modern politics and democracy.

Adam Smith (1723-1790):


Adam Smith is considered to be one of the protagonists of the Age of the Enlightenment
and of liberalism. He was professor of moral philosophy at the University of Glasgow and
stated that “men are selfish and seek only self gain” but that the nations wealth is the
wealth of all. During his travels form 1764 to 1766 he met the Physiocrats, and learned
especially from Quesnay. He then expressed his theory in An Inquiry into the Nature and
Causes of the Wealth of Nations (1766) which is a reflection on economics at the
beginning of the Industrial Revolution and which argues that free market economies are
more productive and beneficial to their societies.

Physiocrats:
Physiocracy (from the Greek for "Government of Nature") is an economic theory
developed by the Physiocrats, a group of doctors and economists who believed that the
wealth of nations was derived solely from the value of land agriculture or land
development, as it is the only factor which really produces something, all other sectors
are sterile. For them goods are like blood, they need to circulate.
Their theories originated in France and were most popular during the second half of the
18th century.
Their main leader is Quesnay, French physician and economist, who wrote the first essay
on economics: Le Tableau économique (1758). It was the first economic circular model
based on three classes, farmers and miners, merchants and workman and aristocrats and
landlords with the assumptions of free trade, price market, goods and money exchange
between classes and capitalism.

The Physocrats are strongly opposed to mercantilism as for them the wealth of a country
is the sum of all the individual wealth and they favour trade were the “natural price” is
settled by international competition. A natural price is beneficial for the farme who gets a
good wage, the landlord who gets a good rent, the state who gets taxes and the customer
who gets an optimal price.

In this terms the Physocrats distinguish between three types of economic players:

• The peasant who work the land and create wealth


• The tradesmen and industrialists who transform or sell something (therefore
being sterile)
• The landowner who provide the land and collect rents (also sterile)

They think that all people are free to work and exchange, have the right of private
property, that the state should not intervene but just protect the natural right (human
rights) “Laissez faire et laissez passer“ and that the state should favour free enterprise.

Division of labour in this context was very important as it increased productivity. Less
skilled personnel was needed as the operations were easy and few so that workers were
than enabled to specialise on one kind of operation. Which resulted in benefits like in the
matter of free trade. The division of labour needed a high initial investment for new
machinery and the work became very monotone.

According to Smith labour is the main factor of production, but there are also:

Two types of capital:

• fixed: physical assets used for the production of goods (factory, machines)
• circulating: short-lived items used for the production of goods (resources, R&D)

Resulting from the production process there are three forms of revenue (wealth):

• Wages for workers: compensation for work, at least the subsistence wage, which is the
amount that is enough to make the worker survive during the winter, when prices are
generally high. The rest of the year the subsistence wage enables the worker to better
his situation. When the economy grows, the wages increase. Higher wages for some
industrialists mean higher productivity.

• Profits for industrialists: revenue of sold goods and services – the production cost
(machines → fixed capital and rent, raw materials, wages → circulating capital). Profits
are not guaranteed, they are just hoped for. They are the result of an investment and
a risk.
• Rents for landlords: compensation for rented land/buildings

All have the same interest: grow their revenues


According to Smith the wealth of a nation is either:
• The gross wealth: all which is produced within the country
• The net revenue: the gross wealth minus everything you had to spend in order to
produce goods (circulating capital)

The formation of price:


The law of the natural price states that the price has to be high enough to pay
wages, profit and rent. Another factor deciding over the price is competition.
In a situation of monopoly, industrialists sell their
products at a high price, which they can dictate.
Competition forces them to lower their prices as more and
more companies produce and try to maximise their profits
by reduction of cost and market-share gaining. Therefore a
market price, depending on offer and demand can be
established.

A market economy is according to Smith the best way


to establish prices and guarantee economic growth. He therefore
opposes state intervention. The sum of all individuals interests leads to the general well
being (natural order of things). The state hence should protect not disturb.
Adam Smith claimed there is an “invisible hand” which pushed the individual interest to
chase the collective good. This “invisible hand” is composed of the self-interest,
competition and supply and demand and refers again to the self-regulating nature of the
market. This process is also an effective form of democracy as the people are promoting
their own interest in view of the common wealth and not the interest they think are the
best (politicians).

Smith's criticism of mercantilism:


For Smith gold is equal to every other product. The accumulation of gold is sleeping
capital and hence not helping to increase wealth. Wealth is what you produce and what
you can get from that production (consumption – gold can't be consumed).
Furthermore trade is the possibility to exchange something you have too much for
something you are lacking. This made Smith expose his theory of the absolute advantage
which states the ability of a country to produce more of a good or service than
competitors, using the same amount of resources. Trade is therefore beneficiary.

Example:
GB can produce 100m of cloth in an hour and 90L of wine in an hour.
Portugal can produce 90m of cloth in an hour and 100L of wine in an hour.

GB has an absolute advantage in producing cloth and Portugal in producing wine.


Therefore GB should specialize in the production of cloth and Portugal in the production
of wine.
After the specialisation GB would produce 200m of cloth and Portugal would produce 200L
of wine (in an hour)
After trading GB would have 100m of cloth and 100L of wine, Portugal would have 100m
of cloth and 100L of wine and both are better off.
By specialising in the product where the countries have an absolute advantage they can
profit from it and trading. But what if a country has no absolute advantage, how can it
benefit then from trade?

David Ricardo's comparative advantage:


David Ricardo (1772-1823) was a member of the liberal school and strongly influenced by
Smith. He was economist and PM, a strong opponent to protectionism and favoured free
trade. For him trade is always better than autarky.
If a country does not have a comparative advantage it should concentrate on the
production of what it is most competitive.

Example (with 3 factors of production):


Portugal produces 12L of wine (2 factors) and 5m of cloth (1).
GB produces 4L of wine (2) and 4m of cloth (1).

Opportunity cost for wine: Opportunity cost for cloth:


Portugal: 5/12 = 0.42 Portugal: 12/5 = 2.4
GB: 4/4 = 1 GB: 4/4 = 1

Since the opportunity cost of wine is lower for Portugal than for GB, one can say that
Portugal has a comparative advantage in producing wine, so it should produce wine to
maximize the output.
Likewise the opportunity cost of cloth is lower for GB than for Portugal, which means that
GB should concentrate on the production of cloth to maximise output.
If the countries would do so then following would result:

Portugal would produce 18L of wine (3) and GB 12m of cloth (3). If these would be shared
in the same ratio per trade Portugal would have 13.5L and GB 4.5L of wine. Additionally
Portugal would have 6.6m and GB 5.4m of cloth. Both would gain respectively to the
starting quantities.

Liberals and protectionism:


The Liberals are strongly opposed to protectionism, as countries can simultaneously gain
wealth through trade.
Smith however justifies three situations in which protectionism is useful: defence and
protection of civilians (police and justice), retaliation for countries who impose
protectionism and to protect young industries which would disappear and destroy many
jobs/wealth. (And to maintain infrastructures and institutions)

The Liberals and taxation:


Liberals of course also believed taxes were needed. For them a progressive taxation rate
and high taxation on inheritance was just, as they believed every individual should have
the same opportunities in life. However they favoured low taxes on direct investment and
imports.

Today Liberalism has a different definition if Europe (no state intervention) than it has in
America (state intervention). The model is predominant throughout the world.

This economic model was contested by Marx and the 1929 crisis.

The Industrial Revolution (1750-1900):


The Industrial Revolution was a period of strong economic growth first in Great Britain
than in Europe, North America and eventually the whole world. It marked a brutal change
in society as almost every aspect of life was influenced in one way or another.
It was a turning point in recent human history after with wealth and development set in
the Western World and was the major cause for international economic affairs.

Causes:
• the accumulation of capital (period of low
taxation, high productivity → investment)
• through protestant growth capitalism was
possible as these could be rich other than
Catholics (Max Weber, The Protestant Ethic
and the Spirit of Capitalism)
• new technologies and innovations especially in
textiles (spinning mule), steam power (machines), chemicals and iron making.
• mechanization and standardization
• agricultural revolution (freeing workers form land trough machines (plough))
• demographic transition (more manpower for factories)
• patents and protectionism
• international organizations in charge of protecting patents
• strong nation states protecting industries

Effects:
• high increase in population
• strong economic development (factories opening all over the country)
• Cities and urban areas like London or the conglomeration of Manchester-Liverpool
were created (urbanisation)
• increase of wages as demand for labour increases
• creation of a strong middle class (which will take the place of the aristocracy)
• peasants became less (mechanisation of agriculture)
• strong increase of general wealth

The industrial revolution shaped the world we live in today. It created the modern
economies and lead to Taylorism (division of labour and wage system based on
performance) and Fordism (massproduction through assembly lines). The industrial
revolution provided economic, social and political progress. It created a new division of
the population, based on capital.

Capitalism

Karl Marx (1818-1883):


Marx was a German philosopher and political economist whose ideas played a significant
role in the development of modern communism and socialism.He refused the economic
model of Liberalism and presented hits own.

Marx argued that the capitalistic society was divided into social classes, mainly two:

• proletariat – does not own and just works


• capitalists – divided into:
• bourgeoisie – owns capital and hires people
• small bourgeoisie – hires people and works
• landlords – own land

and

• lumpenproletariat – people without work and baggers


• peasantry and farmers

Ideas and criticism: “Do you own capital or do you not?”, “Minority exploits majority”,
“History is a big struggle between social classes”

For Marx this situation, where the capitalists take away the created wealth from workers,
was not correct. To stop this extortion (räuberische Erpressung) the proletariat had to
takeover the means of production. This leads to a Dictatorship of proletariat: workers gain
class consciousness, and via proletarian revolution depose the capitalists to assume
control of a socialist state.
Gradually workers should then organize themselves. They should put all the means of
production together, hence bringing on communism, a stateless and classless society
Communism is only possible once the economy is fully capitalist and industrialized
(because once a communist system is established).
This ideology will have a certain amount of success throughout the XXth century in the
Russian and the Chinese revolution and is respected in the strong presence of communist
parties in many countries.

Note:
Although Karl Marx joined the Communist Party his ideas (Marxism) were not
predominantly communist but were meant to be an analysis and a critique of capitalism.
The Communist Party however liked his ideas which clearly were more social and adopted
them. Therefore we have to distinguish between a marxian, who is someone who agrees
with Marxist analysis and critique of the capitalist society, and a marxist, who agrees with
the proletariat dictatorship (communism).

The 1929 crash:


The Great Crash was the most devastating stock market crash in the history of the United
States of America. The crash began a 12-year economic slump that affected all the
Western industrialized countries and that did not end in the United States until the onset
of American mobilization for World War II at the end of 1941.

It was the worst depression in history for the US and Europe shaking the foundations
of Western capitalism. At the depth of it, in 1933, one in four American workers were
out of a job and every fifth NY school child was malnourished and under weight.

The New Deal (1933-1939):


To get the economy back to work US president Roosevelt introduced the New Deal, a plan
to relief, recover and reform. It was a Keynesian approach which foresaw governmental
action with the scope to stimulate industrial recovery, assist victims of the Depression,
guarantee minimum living standards and prevent future economic crises.
In the first two years the New Deal was concerned mainly with relief, setting up shelters
and soup kitchens to feed millions of unemployed. However time moving on the focus
shifted to recovery wherefore several agencies were created.
The National Recovery Administration (NRA) was their keystone. It permitted businesses
to draft “codes of fair competition” with presidential approval, that regulated prices,
wages, working conditions and credit terms, those who complied with the code were freed
from antitrust laws. Workers were given the right to organize unions and bargain
(negotiate) collectively.
The Public Work Administration (PWA) was designed to stimulate US industrial recovery by
pumping federal funds into large-scale construction projects. The PWA build schools,
libraries, hospitals, rail roads, highways and military armament for $6 billion employing
650 000 workers.
The most important agency however was founded at the end of the New Deal era in 1939.
The Works Projects Administration developed relief programmes to preserve peoples skills
an self-respect by providing useful work for 8 million people during a period of massive
unemployment, at the cost of more than $11 billion. It also founded the construction of
thousands of public buildings and facilities as well as The Federal Theater, Art and Writters'
Project. At the end of the New Deal policy The Social Security Act created a system of
pensions and unemployment insurance, which are still around today.
The Fair Labour Standards Act in 1938 finally established a federal minimum wage and
maximum-hours policy to prevent competitive wage cutting by employers.
In the late 1930 the World War II erupted causing an enormous growth in the economy as
war goods were once again in great demand.

Causes:
• strong economic growth in the US
• new technologies, new industries (General Electronics)
• establishment of a consumer society
• “cheap” money
• deregulation (less state intervention)
• creation of a speculative bubble

Effects:
• a depression that lasted over a decade
• demand for manufactured goods and services decreased sharply
• overproduction and the implosion of the speculative bubble → loss of value
• factories closed
• unemployment rose
• companies went bankrupt, leading to even more unemployment and a vicious cicle

John Maynard Keynes (1883-1946):


Keynes was a British economist whose ideas have profoundly affected the theory and
practice of modern macroeconomics, as well as the economic policies of governments
(father of welfare state 0 redistribution). He greatly refined earlier work on the causes of
business cycles, and advocated the use of fiscal and monetary measures to moderate the
adverse effects of economic recessions and depressions. His ideas are the basis for the
school of thought known as Keynesian economics.

The basis of his theory is the criticism of market economy and the invisible hand.

• the market if left alone is imperfect (monopolies would form)


• profit is not enough to guarantee economic growth (the money also has to be
reinvested and used)
• unemployment exists (therefore welfare)
• capitalists can't have a perfect knowledge of the market

Demand is the centrepoint of Keynesian economics. If demand is low, the production will
be low, unemployment will go up and the general wealth will go down. The solution to
have economic growth therefore is a state sponsored support of demand. This was
explained by the following.

Marginal propensity to consume (MPC):

Keynes supports redistribution of wealth, as poorer people are more likely to spend extra
earnings than wealthier people. The lower the wage the higher the MPC will be.

For example, suppose you receive a bonus with your paycheck, and it's $500 on top of
your normal annual earnings. You suddenly have $500 more in income than you did
before. If you decide to spend $400 of this marginal increase in income on a new business
suit, your marginal propensity to consume will be 0.8 ($400 / $500).
Keynesian policies today:

Welfare state:
• redistribution of wealth (social welfare)
• progressive taxing
• “tobin tax” (financial transaction tax)
• healthcare
• market monitoring agencies

An example for this would be Obama's stimulus plan which provided the US economy with
787 billion dollars, divided as follows:

• 288bn in tax cuts (95% benefited)


• 224bn in extended unemployment benefits
• 275bn for job creation (maintaining infrastructure)

The purpose of the stimulus plan is to support demand and domestic consumption and to
maintain employment. However a lot of money went to trade partners and many people
saved because of the fear of further depressions.

Inflation:
Inflation is a rise in the general level of prices of goods and services in an economy over a
period of time. Consequently the value of a money diminishes.

5 types of inflation:
• Inflation due to demand (increase in offer)
• Monetary inflation (increase of the mass of money superior to the increase of the
real economy)
• Imported inflation (due to the imports of products which prices have increased)
• Inflation due to costs (production is more expensive)
• Budget inflation (financing public debt by the emission of money)

Inflation levels:
• 0-2% - normal inflation
• 2-10% open inflation
• 10-20% high inflation
• 20-...% hyperinflation

Deflation: general price level decrease in an economy over a period of time


Disinflation: a decrease in the rate of inflation

Hyperinflation:
• out of control inflation, occurs in extreme situations (1923 Germany)
• causes a strong economic downfall
• the only way to stop it is the creation of a new finance system (Dollarization)

Hyperinflation: a Zimbabwean example

See article

Stagflation:
• occurred during the 1970's in Europe/USA
• situation of high inflation
• situation of low growth
Traditionally inflation was accepted as producing wealth. The stagflation however was the
chance for a new economic school to impose itself replacing the thoughts of Keynes.

Neoliberalism:
Neoliberalism stresses the efficiency of private enterprise, liberalized trade and relatively
open markets, and therefore seeks to maximize the role of the corporate sector in
determining the political and economic priorities of the state.

Milton Friedman (1912-2006):


Friedman considered high inflation as a major problem. He argues that the Keynesian
model has reached its limits. Stagflation is the result of strong unions (maximising wages)
and high state intervention (lower taxes for growth, esp. supply). To control inflation the
amount of money in circulation has to decrease through higher interest rates and lower
state deficits.

Aspects of neoliberal policies:

• Monetarism: economic policy which emphasizes on the necessity to control the


state budget and fight inflation. The underlying philosophy is to reduce the size of
the state. This translates with:
• fiscal discipline - the state should not spend more than what it earns (3%)
• fight inflation
• redirection of public spending - the state should only finance the domains in
which it has the rights (security, justice, control of the monetary system,
foreign affairs)
• tax reform - reform the tax system in a way which favours investment (end
progressive taxation – rich people know how to invest)
• competitive exchange rates - controlling the currency in order to favour
international trade
• trade liberalization - put an end to tariffs and trade barriers
• liberalization of inward foreign direct investment - dismantle any barrier
which limits the inflow of foreign direct investment
• privatization of state enterprises that are not the role of the state (DB, Post)
• deregulation - limit state intervention in the conduct of everyday business life
to achieve a purely free market
• legal security for property rights - offer better guarantees for the protection
of copyrights
• make entrepreneurship easier.

Different than Keynes neoliberals thought supply should be supported. As increasing offer,
increases competition which has a decreasing effect on prices and a increasing effect on
sales and production, hence jobs.
This idea was justified by the assumption that the individuals inside a market know better
than the state. The state intervention just disturbs the natural course of the market and
therefore is responsible for crises.

The establishment of Neoliberalism: a British example


In the late 1970’s Britain was going through a violent economic crisis: the GDP growth
had stalled and the inflation was over 20%. Strikes and violent demonstrations took place
in order to demand increases in wages. The state was unable to respond positively: this
episode is known as the winter of discontent.
It is in this context that Margaret Thatcher arrived in power and implemented
neoliberal/monetarist policies. Thatcher slashed state spending during the decade she was
in power, reducing defence (-3%), transport (-6%), trade and industry (subsidies) (-38%)
and housing (-70%). At the same time GDP grew by 23%.
She went on privatising companies such as BP, British Airways, Jaguar... The direct effect
of these privatisations was to lower the spending and therefore the debt of the state:
most of the companies were loosing money and the state was doing nothing more than
subsidising, at great expense, jobs.
At consequence the inflation rate fall to a 5% rate by the mid eighties and the state had a
balanced budget. However millions ended up unemployed (3 million more than during the
Great Depression) and entire regions were dislocated from the industry.

However Thatcherism inspired reaganomics (economists that follow the hard-line policy of
US president Reagan) and soon conquered the world.
After the fall of the Soviet Union the system was imposed on Russia in a process referred
to as the “liberal big bang”.

Neoliberalism: a Russian example


After the end of the Soviet Union in 1991 the IMF and the US government wanted to
promote market economy and democracy in Russia and the other countries by imposing
as a condition for aid the shock therapy. This required sharp increases in price (except for
rents, medicines, baby food and utilities) as the country had to move from a distorted to a
market price system. Next to this they had to favour entrepreneurship, new companies
who would takeover the allocation of resources of production in a more efficient way,
therefore the state had to privatize its economy. There was the fear that this could happen
to slow or to fast. In the end it was to fast.
There had been just a slow growth in income however prices increased, as they were set
free in 1992, resulting in high inflation. This problem then was tried to counteract by
increasing interest rates.
As however the prices for natural resources were kept low, this was an open invitation for
capitalist, who bought oil and resold it in the Western making fortunes. (Chodorkowski)
This meant that no new wealth was made but the mistakes of government policies were
exploited.
The privatization of the economy however was hindered by the high inflation which had
wiped out all the savings so that there were to few people in the country who could buy
them. And even if they could, then the high interest rates and the lack of financial
institutions would not permit it to revitalize them.
Structural Adjustment Programs are the major objective of the IMF. However the strains
on the economy to restructure it had also social and political consequences.
The given aid was mainly to westernise the country. Debt rescheduling favoured foreign
creditors and bilateral aid mainly helped Western exporters and not the domestic
economy, who instead would have needed to increase domestic output and supplies to the
consumers through technical assistance and equipment.
The US government and the IMF were urged to reconsider their style of approach and
their criteria for giving aid as the harsh strategy they adopt was as such liberal but not
appropriate. Like the World Bank had do they should also consider a gradual transition to
democracy with different way of approach which would be “development with a human
face”.
In reality however the GDP fall year after year and the bottom was never in sight.
Oligarchs were favoured and once stripped the wealth from the country they moved their
money to more stable and profitable markets. Leaving Russia poor and not able to build
up a stable and secure country.

Neoliberalism today:
Today Neoliberalism is a very important economic theory as the vast majority of
governments are neoliberal. On European basis this can be seen by the Maastrich
criterions which states that a states deficit cannot exceed 3% of budgetary deficit and
60% of national debt. On a worldwide basis it can be seen by the free trade agreements
(WTO), on the ongoing privatisations of companies and the main ideology of the World
Bank and the IMF.
Free Trade vs Protectionism:
International trade is the exchange of capital, goods, and services across international
borders. Not only because of its strong growth since the 1950's it is the best way to gain
wealth for liberals.

Protectionism:
F. List (1789-1846) said that
protectionism is essential for the
development of a country. (“educative
protectionism”)
Good example for this is the
Singapore cigarettes industry. The
government imposed tariffs of up to
400% for foreign cigarettes to make
sure that the own companies could
first settle before opening the market.

Steps of economic integration:


• Preferential trading areas: is a
trading bloc which gives preferential access to certain products from the
participating countries by reducing tariffs. (India - Afghanistan)
• Free trade areas:is a trading bloc which has decided to eliminate tariffs, quotas and
preferences on most, if not all, goods and services traded between them.
(NAFTA/SAFTA)
• Custom union: is a trading bloc composed of a free trade area with a common
external tariff system. (Zollverein in Germany 1833)
• Common market: There is the establishment of common policies, freedom of
movement of people and capital. (The European Economic Area)
• Economic and Monetary Union: A customs union with a common market and a
single currency. The participant countries have common policies on product
regulation, freedom of movement of goods, services and the factors of production
(capital and labour) and a common external trade policy. It is the final step before
total integration of countries.

NAFTA (North American Free Trade Agreement) was established in 1994. The purpose was
to eliminate all tariffs, ensure mobility of labour and set up a dispute mechanism.

After World War II there was the necessity for new world organizations:

• Bretton Woods Agreement – stabilizing international economies so that history wont


repeat itself.
• Creation of the IMF and establishment of a new monetary system
• Creation of the UN - international forum where states can talk
• Attempt to establish an international trade organization: GATT

GATT:
The General Agreement on Tariffs and Trade was signed in 1947 by 23 countries. After
WWII there was a need to create more dialogue between nations and favour strong
cooperation between nations. GATT isn’t a direct consequence of the Bretton Woods
System but was created in the same dynamic.
In 1947 the Havana Charta was signed in order to create the international trade
organization (ITO). However the US did not ratify the Charta therefore the states created
the GATT which was a more informal organization (with the US).
Their purpose was to create a liberal and multilateral code of conduct wherefore it
organized rounds of negotiation to reach agreements in order to lift or lower tariffs on
goods. The purpose of these actions is to lower prices for consumers, increase
employment and productivity and favour employment in the sectors where countries have
a comparative advantage.
To secure fairness the GATT established the principle of the most favoured nation (MFN).
In international economic relations and international politics, most favoured nation (MFN)
is a status or treatment given by one state to another in international trade.
Hence if a country grants another one a special favour (such as a lower tariff for one of
their products) it has to do the same for all other WTO members.
However there are some strictly applicable restrictions so that countries can set up
individual trade agreements, give developing countries special access to their markets or
raise barriers for products considered to be traded unfairly.
WTO members treat each other as MFN.

The rounds of negotiation:


From 1947 to 1962 there have been five rounds of negotiation with the purpose of
lowering trade tariffs. After this there has been the Kennedy Round (1964-1967), the
Tokyo Round (1973-1979) and the Uruguay Round (1986-1994) which led to an increase
of the number of the member countries and a widening to new subjects. The Uruguay
Round was long and disputed. However it lead to a series of progress, most notably for
the liberalization of the agricultural sector, services and the creation of international rules
concerning copyright.
Many countries joined the GATT at that period. In 1994 a 123 countries were members.
The Uruguay Round then lead to the need of the creation of the World Trade Organization
(WTO), mainly because the GATT system was inefficiently working in a Barter-way.

WTO:
The WTO came to existence on the 1st of January 1995 under the Marrakesh Agreement.
At its creation, a 123 states were members. Today the organization counts a 153
members representing 95% of international trade. The headquarters are in Geneva and
the actual president of the WTO is the french socialist Pascal Lamy.
The WTO has the same mission as the GATT, however it has a wider field of action and
takes care of all the aspects of international trade (not only goods). The Organization’s
role is to act as an institutionalized forum where countries can reach agreements in order
to liberalize trade. Although there is a voting system, where every member has one voice,
votes are never taken, as decisions are taken by consensus.
On a generally biyearly period, a conference is organized where the leaders of all member
states get together in order to negotiate and reach agreements on new sectors of the
economy to liberalize. In Geneva in 1998 liberalization of electronic trade is discussed.
In Hong Kong in 2005 it was agreed to ban subsidies to export agricultural goods. The
WTO also still uses negotiation Rounds. The Doha Round for example tried to liberalize the
agricultural sector, unfortunately it was a failure. The negotiation rounds go on till a
decision is made.

The WTO also supported the signature and adoption of a series of agreements:
• GATT 1994 (goods)
• GATS (General Agreement on Trade in Services
• TRIPS (Agreement on Trade Related Aspects of Intellectual Property Rights)

Disputes:
The main role of the WTO is to act as a referee in cases of disputes between member
states. To do so inside the WTO there is the Dispute Settlement Understanding (DSU),
which creates the Dispute Settlement Body (DSB).
The DSB is composed of all the ambassadors of the member states. If a country thinks
another country is violating Trade Rules, it has the possibility of formulating a complaint at
the DSU. Multilateral approaches, and not unilateral actions, are favoured to settle Trade
disputes.
Direct contact between countries → creation of a mediation panel which gives report to
member states and to the DSB → DSB decides → country can appeal → Appellate Body
sets final decision

Sanctions:
The DSB and the Appellate Body don’t impose financial sanction. However the losing state
has to change its legislation in order to comply with WTO Agreements. If a country refuses
or takes too much time, the DSB can give the possibility to the complainant country to
take retaliatory measures (Gegenmaßnahmen).

Free trade: a bananian example:


In 1994 the EU established common rules concerning the imports of bananas.
The rules were supposed to grant free access to bananas from countries having signed the
Lome agreement in1975 (referred to as the ACP (African, Caribbean, Pacific) countries).
Those countries could also benefit from guarantees on prices for quotas of bananas. This
wasn’t the case for most of the bananas from the dollar zone. The MFN principle did not
apply.
This situation led four Latin American countries (Ecuador, Mexico, Honduras and
Guatemala) with the support of the US to complain to the DSB. The EU was twice
“sanctioned” by the BSD in September 1997 and in April 1999 (Appellate Board)
The four countries were given the right to impose trade barriers which would result in a
loss equivalent to the loss their banana companies sustained (close to 200 million dollars)
In 2001 an agreement is reached between the US and the EU. The EU announces it will
stop giving all those benefits to bananas coming from the Lome agreement countries.
In 2006 the dispute starts again when the EU announces new taxation on none ACP
bananas (230 euros a tone). A new complaint is made and the EU loses again in 2008,
however again having implemented favoured conditions on Lome bananas for years.

Another dispute was the on on hormone beef from the US which Europe refused.

Benefits of WTO:
• pacification of trading relations through an internationally recognized organ
• absolute and comparative advantages for all
• according to neoliberals an increase in trade results in an increase in wealth for
everyone.
• wealthy countries benefit from trade
• developing countries have access to new markets

Critics of WTO:
The most outspoken and visible opponents to the WTO are alter-globalization groups
which have accused the WTO of promoting the interest of wealthier countries:

• They are the ones with the more powerful corporations who can engage lobbyists.
• The wealthier countries have the means to address all the issues put forward by the
WTO
• These groups (but not exclusively) criticize the little interest the WTO displays for
social and ethic dimensions. However there is a International Labour Organization
(ILO) which focuses on labour conditions.
• Economists have also criticized the WTO for only tackling the problem of trade
protectionism, as the WTO does not attack such issues as monetary protectionism
(trafficking the value of a currency has direct consequences on trade).
• The WTO is also criticized on a “philosophical” level, for elevating trade and wealth
as supreme values.
• More generally it is criticized for promoting neoliberalism (deregulation) as the only
way for economic development.
Bretton Woods Agreement:
In 1944 World War II was still in action when delegates of the Allied Nations met to sign
the Bretton Woods Agreement and decide on its system.
The Bretton Woods system established the rules for financial and economic relations
among the world's major industrial states in the mid 20th century. In first place it had the
purpose of rebuilding after WWII through currency stabilization programs (only in 1959 all
European currencies became convertible) and infrastructure loans. By 1946 the system
was in full operation through the newly established International Bank for Reconstruction
and Development (IBRD, part of the World Bank) and the International Monetary Fund
(IMF).
The chief features of the Bretton Woods system were an obligation for each country to
adopt a monetary policy that maintained the exchange rate of its currency within a fixed
value (plus or minus one percent). The currency had to be backed by gold reserves. This
became known as the Gold Standard (every unit of currency had to be backed by a unit of
gold).

"The nations should consult and agree on international monetary changes which affect
each other. They should outlaw practices which are agreed to be harmful to world
prosperity, and they should assist each other to overcome short-term exchange
difficulties."

IMF:
• Membership: 187 countries
• Headquarters: Washington, DC
• Executive Board: 24 Directors representing countries or groups of countries
• Total quotas: $325 billion (as of 3/31/09)
• Additional pledged or committed resources: $500 billion
• Loans committed (as of 9/1/09): $175.5 billion, of which $124.5 billion have
not been used yet
• Biggest borrowers: Hungary, Mexico, Ukraine

The goal of the IMF is to foster global monetary cooperation, secure financial stability,
facilitate international trade, promote high employment and sustainable economic growth,
and reduce poverty around the world. They do so by providing policy advice and financing
to members in economic difficulties.
The IMF was important when it was first created because it helped the world stabilize the
financial system. Every state had to define the value of its currency with the US$. Every
currency should have a fixed value with the US$ which should not fluctuate more than 1%
on the Foreign exchange market.

The mission of the IMF is to help states reach that goal, with the use of the IMF pool.
At first member countries financed a pool. Their part in the pool (quota) is proportionate
to their GDP. From 1944 to 1971 the purpose of the IMF was to help countries stabilize
their currencies (within a 1% fluctuation). At that time a country could withdraw 25% of
its quota to secure its balance of payment without asking the IMF.
Then the country could borrow up to 125% of the value of its quota but with conditions.
These loans are supposed to help the central banks support the currencies of their
countries and keep them stable. So for the IMF worked as the central bank of central
banks.
By borrowing money, countries with a deficit in their balance of payment could stabilize
their currencies and their economy. They would later be in a position to reimburse their
loan. The purpose of having such an international system is to prevent countries from
brutally changing the value of their currencies and take unilateral decisions, therefore
protecting from another war.
That system came to an end with the end of the gold standard in1971 when president
Nixon suspended the convertibility of dollars in gold because of the high expensed in the
Vietnam War. Therefore in 1973 the IMF adopted a floating rate for currencies which was
made official in 1976 with the Jamaica agreement. This marked the end of the Bretton
Woods system and made it necessary for the IMF to redefine its purposes.

The purpose of the IMF today:

• Surveillance of economies:
• To maintain stability and prevent crises in the international monetary
system, the IMF reviews national, regional, and global economic and
financial developments through a formal system known as surveillance
• The IMF then provides advice, encouraging its member countries to
adopt policies that foster economic stability, reduce their vulnerability
to economic and financial crises, and raise living standards
• It provides regular outlooks of global economic aspects in various
publications

• Financial assistance:
• IMF financing is available so that member countries can correct their
balance of payments problems.
• A policy program supported by IMF financing is designed by the
national authorities in close cooperation with the IMF
• Continued financial support is conditional on effective implementation
of this program
• The IMF has doubled loan access limits and is boosting its lending to
the world’s poorer countries, with interest rates set at zero until 2011
• The IMF is the last organization countries turn to when they have
problems reimbursing their debts
• The financial assistance offered by the IMF is conditioned to the
implementation of a series of political and economical reform (fiscal
conservatism and privatisations)
• The assistance is never handed out in one payment: it is done
progressively

• Technical assistance:
• The IMF offers assistance and training to help member countries
strengthen their capacity to design and implement effective policies
• Technical assistance is offered in several areas, including:
• tax policy and administration expenditure
• management
• monetary and exchange rate policies
• banking and financial system supervision
• regulation, legislative frameworks, and statistics

Special Drawing Rights:


The IMF issues an international reserve asset (currency) known as Special Drawing Rights
(SDR) which value is defined by a basket of monetary values. The SDR were created in
1970 at a time when gold was the reference. The world economy grew steadily which
wasn’t the case for the gold stock. It was therefore important to create a new standard to
which currencies could be settled against which grew proportionally to the world economy
In 1971 the convertibility of gold was stopped but SDR were still useful.
Today they are still used as a way of payment between states (credits and debt) and as
international monetary reference for international organizations.

Decision taking:
The Executive Board is responsible for conducting the day-to-day business of the IMF. It is
composed of 24 Directors, who are appointed or elected by member countries or by
groups of countries. For a decision to be taken, it must get 85% of the vote. The
importance of the vote (number of votes) of the country is dependent on the size of its
quota. The US represent 16% of the fund and therefore gets 371 743 votes
Germany represents 5,88% of the fund and gets 130 332 votes (Palau, 0,1%, 281 votes)
The board decides on the countries to help and negotiates the terms of the loan:
How much? How long? What conditions? And so the role of the Board is central in the
functioning of the IMF.
The Board of Governors, which has higher powers, takes little decisions. It consists of one
governor and one alternate governor for each member country. The governor is appointed
by the member country and is usually the minister of finance or the head of the central
bank.
The managing director of the IMF is Strauss-Kahn.

The IMF is clearly a neoliberal institution. It focuses on deregulation and low state
intervention. (stability?)

Examples: Big bang in Russia, Argentina crisis (had to sell all national industries and cut
public jobs.

The World Bank:


The World Bank, one of the two Bretton Woods institutions, was created in1945. The
original purpose of the World Bank was to assist Europe and Japan in their reconstruction
efforts in the aftermath of WWII by offering loans. However with the Marshall Plan, the
economic boom in Europe and the decolonization process, the World Bank started to shift
its attention to developing countries in the 1950’s.

The World Bank comprises two organizations:


• The International Bank for Reconstruction and Development (IBRD) (1945)
• International Development Association (IDA) (1960)

The World Bank is different from the World Bank Group which comprises the:
• The two World Bank Organizations
• The International Finance Corporation (IFC) (1956)
• The Multilateral Investment Guarantee Agency (MIGA) (1988)
• The International Centre for Settlement of Investment Disputes (ICSID) (1966)

The Head of the World Bank Group (and the World Bank) is Robert Zoellick

Like the IMF, the World Bank has its headquarters in Washington, DC and a membership
of 187 countries.
The original role of the World Bank was to lend to countries so they could build
infrastructures which would help the economic development. (power plants, roads, canals,
dams). The purpose was to help countries devastated by the war to rebuild their
infrastructures. The burrowing states were supposed to reimburse their loans.
The role of the World Bank today is helping
developing countries.
The main task of the organization is to
fight poverty and to improve living
conditions for the less fortunate. The World
Bank wants to bring up the Human
Development Index (HDI) in developing
countries. The HDI is a composite statistic
used to rank countries by level of "human
development" and separate developed
(high development), developing (middle development), and underdeveloped (low
development) countries. The statistic is composed from data on life expectancy, education
and per-capita GNI (as an indicator of standard of living). (GNI = GDP + NET PAYMENTS)
It offers loans or aid to developing countries to help them promote education, healthcare,
agriculture and industry. However like for the IMF, the loans are conditioned.

The World Bank works on a triennial cycle. During the last triennial cycle (2005-2008)
$12,2 billion were distributed to developing countries. 20% as donations and 80% as
loans with no interest rate (just 0,75% commission). The main borrowers were India,
Pakistan, Vietnam, Ethiopia and Nigeria. The goal for the next triennial cycle is to
distribute $41 billion. More and more in microcredits.
This modern concept was developed by Muhammad Yunus and his Grameen Bank (Nobel
peace prize 2006). The concept was lending money to poor people who can’t borrow from
a regular bank with the purpose of supporting local development. (98% of the given loans
were paid back). Criticized were the high interest rates and the though rules and
obligations prescribed to borrowers.

The funding of the World Bank:


The World Bank disposes of a pool of funds which is provided by the member states who
act like shareholders and by donating countries which are 45.
The main contributors are:
• The US (13,8%)
• The UK (13,2%)
• Japan (12,2%)
• Germany (8%)
• France (7,1%)

• South Africa and China are also contributors

The World Bank has also the possibility of borrowing money from financial markets in the
same way states do.
Not everybody gets money from the World Bank. The beneficiaries of loans or donations
are countries with a GDP per inhabitant inferior to $1085. The number of beneficiary
countries is around 80 and are mainly concentrated in the southern hemisphere. However
numerous post soviet countries benefited from World Bank loans.

Decision taking:
The highest authority at the World Bank is the Board of Governors which meets once a
year. The Board of Directors takes care of day to day affairs. They are 24 (5 for the main
contributors, 19 for the rest) who meet twice a week to vote on the projects which should
be funded. The voting power depends on the amount of shares a state has in the pool plus
the 250 basic votes.
As it is the case for the IMF, countries applying for loans at the World Bank must respect a
certain number of conditions:
• Good governance
• Fight corruption
• Promote democracy and state of law
• Engagement in structural adjustments

Structural adjustment programs (SAP):


Structural adjustments are the policy changes implemented by the International Monetary
Fund (IMF) and the World Bank in developing countries. These policy changes are
conditions for getting new loans from the IMF or World Bank, or for obtaining lower
interest rates on existing loans. Conditions are implemented to ensure that the money
lent will be spent in accordance with the overall goals of the loan.
Conditions:
• Cutting expenditures, also known as Austerity.
• Focusing on exports
• Devaluation of currencies
• Trade liberalization, or lifting import and export restrictions
• Increasing the stability of investment (by supplementing foreign direct
investment with the opening of domestic stock markets)
• Balancing budgets and not overspending
• Removing price controls and state subsidies
• Privatization, or divestiture of all or part of state-owned enterprises
• Improving governance and fighting corruption.

These conditions have also been sometimes labelled as the Washington Consensus.

Criticism:
There are multiple criticisms that focus on different elements of SAPs.

National sovereignty:
Critics claim that SAPs threaten the sovereignty of national economies because an outside
organization is dictating a nation's economic policy. Critics argue that the creation of good
policy is in a sovereign nation's own best interest. Thus, SAPs are unnecessary given the
state is acting in its best interest. However, it is important to consider that in many
developing countries the government will favour political gain over national economic
interests. In many sub-Saharan countries the political power has steadily increased with
economic downturn. Many of these poorest countries in the world however already have
tremendous debt.
It is however criticised that these western regulations undermine the countries own path
to development and democracy. As for example, the opening of countries to outside
investment allows U.S. corporations to build factories in impoverished areas. The
corporations are able to exploit the surplus of cheap labour, and usual lack of
environmental regulations to create goods at a lower price. As a result, corporate profits
rise and trade flows increase for that particular country. While this increases the GDP the
majority of the profit actually benefits the corporation and the country in which the
corporation is based. On the other side, many argue that the people employed by the
corporations are desperately in need of any work at all. It is argued that the alternative
forms of employment or life styles available to them are much worse.

Privatisation:
A common policy required in structural adjustment is the privatization of state-owned
industries and resources. Supposedly, this policy aims to increase efficiency and
investment, and decrease state spending. State-owned resources are to be sold whether
they generate a fiscal profit or not.
Critics, however, have condemned privatization requirements. When resources are
transferred to foreign corporations and/or national elites, the goal of public prosperity is
replaced with the goal of private accumulation. Furthermore, state-owned firms may show
fiscal losses because they fulfil a wider social role, such as providing low-cost utilities and
jobs. Many scholars have argued that SAPs and neoliberal policies have negatively
affected many developing countries. The privatization of water in Bolivia and the
privatization of the health system in Sub-Saharan Africa are few examples of such
negative implications. Privatization makes essential needs such as water and health care a
commodity, and those who are poor are unable to access such basic necessities because
they are unable to pay for these commodities.
Therefore, the privatization of a previously social service such as health care is actually
counter-productive to the purpose of structural adjustment programs.

Agriculture.
The agricultural, anti-land reform and food trade policies associated with SAPs have been
pointed to as a major engine in the urbanization of the global South, the ballooning of
megacities, worldwide migration towards the global North, and the growth in urban
poverty and slums.
They are also a source of contention for environmental activists. A large portion of SAPs
policy on agriculture focuses on the increased use of fertilizers and pesticides which harm
the health of local bodies of water and therefore fish populations. The runoff caused by
the overuse of fertilizers increases the amount of algae in local water bodies, causing
different scales of dead zones
Furthermore due to the conditions of SAPs, one of which is to devalue a nation’s currency,
a developing nation’s agricultural exports become more competitive because of their
devalued currency, which means a country is able to export more goods. However, the
nation also loses purchasing power which may not be able to be compensated by the
increase in demand for its export goods. Ultimately, the agricultural sector of a developing
nation will suffer and decline.

Environment:
Local environments can easily become casualties of pro-trade policies. Pro-trade policy
promotes an increase of industry adapted to Western needs. As a result of the new policy,
local industries begin to focus on producing cheap goods to sell on the international
market. The focus on creating the least expensive product often leads to environmentally
exploitative industry. As these new industries are often unregulated there are no laws
prohibiting this exploitation.
For example, emissions from factories are much less regulated in developing nations. As a
result, the environmental cost of producing a product like steel in China is much greater,
than it would be in the U.S. Another example would be the run off of chemicals or
pharmaceuticals into local rivers. In developing nations the pollution of rivers has become
a cause for international intervention.
There are just few regulatory clauses in SAPs, as the majority of the policy creators view
these regulations as a hindrance to trade and therefore to economic development. And it
would be unfair to forbid it to them after we have harmed the environment in our
development process.
The objectives of SAPs may be to reform the economical structure of impoverished or
developing nations. However, their lack of consideration for their influences on the
household level can foster the global issue of environmental degradation as farmers have
to undertake unsustainable measures. Potential deforestation and desertification are only
a few of the negative results of extensive cultivation.

Austerity:
Critics hold SAPs responsible for much of the economic stagnation that has occurred in
borrowing countries. SAPs emphasize maintaining a balanced budget which forces
austerity programs. The casualties of balancing a budget are often social programs.
The programs most often cut are education, public health, and other social safety nets.
Commonly, these are programs that are already underfunded and desperately need
monetary investment for improvement.
For example, if a government cuts education funding long term economic growth is at
risk. Similarly, cuts to health programs have allowed diseases such as AIDS to devastate
some areas' economies by destroying the workforce.

IMF and World Bank in comparison:


The IMF and the World Bank were both created with the Bretton Woods Agreement to
achieve peace through economic stability.
Their roles differ as the IMF is in charge of consolidating the general financial health of
states, whereas the World Bank finances projects with the aim of fighting poverty.
The two organizations are complementary and are not in competition.
Globalization:
Globalization is the name given to the process of increasing the connectivity and
interdependence of the world’s markets, businesses and societies. It is not only an
economical phenomenon: there is also a cultural, political, sociological and geographical
globalization

Economic globalization:
Economic globalization refers to increasing economic interdependence of national
economies across the world through a rapid increase in cross-border movement of goods,
service, technology and capital.
Economic globalization includes the globalization of production, markets, competition,
technology, and corporations and industries. Whilst economic globalization has been
occurring for the last several hundred years (since the emergence of triangular trade), it
has begun to occur at an increased rate over the last 20–30 years. This recent boom has
been largely accounted by developed economies integrating with less developed
economies, by means of foreign direct investment, the reduction of trade barriers and the
modernization of these developing cultures.
The two main factors in this globalization process are the internationalization of financial
and commercial connections and the internationalization of companies.

Internationalization of financial and commercial connections :


• expansion of commercial routes, with the development of modern means of
transport (supertankers, air freight, rail roads…)
• implementation of financial and monetary tools which facilitate trade
• diversification of products and services due to innovation
• improvement of the living conditions of certain populations which created new
needs
• development of means of communication and transport which lead to the
consumption of foreign products
• International agreements promoting free trade
• development of specialization of countries: corporate outsourcing becomes more
important
• liberalization of finance has also increased the possibilities to invest money and to
borrow in order to finance projects throughout the world
• internationalization of companies:

• Distribution of products across the world


• Producing goods in the most productive countries
• Going to countries which has natural wealth

When does the process of globalization begin?


The starting point of globalization is very disputed, as some historians claim it started in
the Ancient Times, with the Hellenistic and Roman empires, some, like Fernand Braudel,
claim it started with the discovery of the America’s and the development of the Triangular
Trade and others affirm it started with the creation of the Bretton Woods system.
Therefore there is no general understanding on the beginning of globalization. However it
is most generally accepted as being a process which took a lot of importance during the
second half of the 20th Century when the amount of international trade has been
multiplied by a 100 since. Foreign direct investment has gone up from a few 100 billions in
1950’s, to 1600 billion dollars in 1990 and to 6600 billion in 2000.

Multinational Corporations (MNC):


One of the main consequences of globalization is the development of Multinational
Corporations. A MNC is a company which produces goods and/or delivers services in more
than one country and has a certain size. They have mainly developed during the 1970's.
In 1980 there were close to 7000 MNC. In 2002 the number rose to 64000. MNC hire 54
million people worldwide and represent close to 70% of all trade.

Biggest MNC's in 2010:


• 1 Wal-Mart Stores (USA) Retail
• 2 Royal Dutch Shell (Netherlands) Petroleum
• 3 Exxon Mobil (USA) Petroleum
• 4 BP (UK) Petroleum
• 5 Toyota Motor (Japan) Automobiles
• 6 Japan Post Holdings (Japan) Diversified
• 7 Sinopec (China) Petroleum
• 8 State Grid (China) Power
• 9 AXA (France) Insurance
• 10 China National Petroleum (China) Petroleum

Three approaches for a MNC coming to exist:

• Outsourcing production:
• The multinational corporation has its executive headquarters in one nation,
while production facilities are located in one or more other countries.
• This model often allows the company to take advantage of benefits of
incorporating in a given locality, while also being able to produce goods and
services in areas where the cost of production is lower

• Operating subsidiary companies:


• A MNC can base the parent company in one nation and operate subsidiaries
in other countries around the world
• A subsidiary is: “A company for which a majority of the voting stock is owned
by a holding company.”
• With this model, just about all the functions of the parent are based in the
country of origin
• The subsidiaries more or less function independently in the country where
they are settled

• Diversification:
• A third approach to the set up of a MNC involves the establishment of a
headquarters in one country that oversees a diverse conglomeration that
stretches to many different countries and industries.
• With this model, the MNC includes affiliates (a company related but not
controlled by the MNC), subsidiaries and possibly even some facilities that
report directly to the headquarters
• Contract manufacturing is also a key element (Nike's t-shirts)

Concentration:
This is process by which MNCs “unite” through different actions called takeovers:
• friendly (making an offer the other board of directors will accept)
• hostile (buying up shares till having a majority)
• Mergers (combination of two companies like ARCELOR-Mittal (steel)

In a merger R&D is much cheaper and you have the benefits of economy of scale. There
are to forms of concentrations. The vertical and the horizontal. The horizontal is the
acquisition of many companies of the same kind, while the vertical one forsees the
acquisition of companies that complement each other. (KFC owns everything from the
farm to the outlets)

The other forms of globalization:


Cultural:
Increasing interconnections and growing influences of cultures. Societies are influenced by
other societies and wish to adopt their norms and values. A good example would be the
“American way of life” which imposed itself in the decades following the second world war.
Cultural globalization is considered a threat to cultural diversity.

Cultural globalization: A Nigerian example


In 2009 a Nigerian Manchester United fan drove a minibus into a crowd celebrating
Barcelona's victory of the Champions League killing four people.
Both teams have a large fan base across the African continent.

Cultural globalization: A Chinese example


China is super-sizing its children as fast as its economy, prompting fears of an American-
style obesity crisis here. New figures have shown that urban Chinese boys are higher and
heavier than 30 years ago. Trough the economic expansion living standards have risen
and allowed families to adopt a new diet.
But the globalization has not just changed diets but also the physical activity. Nowadays
Chinese use more internet and cars than one decade ago. Only 45 years ago China was
still in the grip of a massive famine, today this problem does not persist in Cities any
more, however rural areas still suffer under malnutrition.
Biggest contributor to this are MNCs like KFC, McDonald's and Burger King, which have
hundreds of outlets in China. Which makes the government counteract by building more
an d more playgrounds to enhance children's physical activity.

Political:
Political globalisation refers to the increasing number and power of human associations
which influence or govern the world as a whole. It is also of significance that a series of
key inter-governmental organizations (IGOs) established in the post-war period have
become increasingly influential over the affairs of individual nations and the world. Prime
amongst these bodies are the United Nations (UN), the World Bank, the International
Monetary Fund (IMF), the World Trade Organisation (WTO), the Organisation for Economic
Co-operation and Development and the Group of Eight (G8).
However there are also non-governmental organizations (NGOs) like Amnesty
international which has a vast impact on politics. 2.2 million members in 50 countries help
political controversial issues to be discussed and eventually solved. Political globalization
hence leads to the general acceptance of certain values.

Sociological:
What happens in one country can have effects in very distant countries. When taking a
decision, leaders have to take in account the reactions of other countries. The process of
globalization is irreversible according to many sociologists, the interconnections being so
strong.

Geographical:
Globalization has an effect on geography: it creates “strongholds” which are regional
blocks which eventually will unite. This is most visible through the process of regional
integration like happened with the creation of the EU, the NAFTA and the Mercosur (south
America)

Positive effects:

Globalization accelerates the development of Third World countries:


Although there are obvious problems with to rapid development, globalization is a very
positive force that lifts countries out of poverty, as it causes a virtuous economic cycle
associated with faster economic growth.
Globalization of communications:
Especially the internet has a democratizing effect, as the exchange of important
information via the internet is much faster and broader.

Globalization brings about the equalization of income distribution


The globalization of the workforce has the potential to equalize income distribution. In the
past, workers in industrialized countries occupied a privileged position. With the advent of
the global job market, this is no longer the case. (see income increase in China)
Production workers in industrial countries are loosing ground, as jobs and income are
being transferred to production workers in developing countries.

Globalization brings about increased opportunity in the Third World:


Workers in developing countries now have more occupational choices then ever before.
Educated workers in developing countries are able to compete on the global job market
for high paying jobs, thus urging people to educate themselves. This translates into
increased opportunity. Workers have the choice of emigrating and taking jobs in industrial
countries or staying at home to work in outsourced industries.

Negative effects:
Globalization has generated significant international opposition over concerns that it has
increased inequality and environmental degradation. Many jobs in the western world have
been replaced by workers from developing countries, especially in agriculture.
Some also criticise the effect of globalization on culture. Along with globalization of
economies and trade, culture is being imported and exported as well. The concern is that
the stronger, bigger countries such as the United States, may overrun the other, smaller
countries' cultures, leading to those customs and values fading away. This process is also
sometimes referred to as Americanization or McDonaldization.

Sweatshops:
In many poorer nations, globalization is the result of foreign businesses utilizing workers
in a country to take advantage of the lower wage rates.
One example used by anti-globalization protesters is the use of sweatshops by
manufacturers. According to Global Exchange these "Sweat Shops" are widely used by
sports shoe manufacturers, in particular by Nike. There are factories set up in the poor
countries where employees agree to work for low wages. Then if labour laws alter in those
countries and stricter rules govern the manufacturing process the factories are closed
down and relocated to other nations with more business favourable policies, such as
Cambodia or Bangladesh. There are several agencies that have been set up worldwide
specifically designed to focus on anti-sweatshop campaigns and education of such.
Also electronic sweatshops have become a problem. These are call centres, often to be
found in India, where the employees have to face long work hours and an intense work
pace which results in health problems and alienation (Distanzierung) from family and
friends.

Negative effects of economic liberalization:


The world today is so interconnected that the collapse of the sub-prime mortgage market
in the U.S. has led to a global financial crisis and recession on a scale not seen since the
Great Depression. Government deregulation and failed regulation of Wall Street's
investment banks were important contributors to the sub-prime mortgage crisis.
The economic activities by now are so interconnected that anything affects everything.
Chinese market expansion costs jobs to the rest of the world, companies lose market
share to low-cost products or even disappear. Deregulation and the opening of markets
has not just positive effects but many negative, especially as the world is not on the same
standards.
Brain drain:
Opportunities in rich countries drives talent away from poor countries, leading to brain
drains and for example the African continent to employ 150,000 expatriate professionals
annually. Indian students going abroad for their higher studies has a high social cost to
the country.

Income inequality:
The globalization of the job market has had negative consequences in developed
countries. High skilled workers like engineers, attorneys, scientists, professors,
executives, journalists, consultants are still able to compete successfully in the world
market and command high wages. Production workers and service workers in
industrialized nations though are unable to compete with workers in developing countries
and either lose their jobs through outsourcing or are forced to accept wage cuts.
This has resulted in a growing gap between the incomes of the rich and poor in developed
countries and is at its greatest in the United States.

Environmental degradation:
The removal of forest to make way for livestock was the leading cause of deforestation in
the Brazilian Amazon from the mid 1960s. Recently, soya has become one of the most
important contributors to deforestation in the Brazilian Amazon leading to great CO2
problems. In 2007, China overtook the United States as the world's biggest producer of
CO2. Only 1 percent of the country’s 560 million city inhabitants breathe air deemed
(erachtet) safe by the European Union.
At present rates, tropical rainforests in Indonesia would be logged out in 10 years, Papua
New Guinea in 13 to 16 years. But not just forests are running out, also a huge number of
different metals and other raw materials could cease to exist.
The world's ecological capacity is simply insufficient to satisfy the ambitions of China,
India, Japan, Europe and the United States as well as the aspirations of the rest of the
world in a sustainable way.

Food security:
The gradual change in diet among newly prosperous populations is the most important
factor underpinning (untermauernd) the rise in global food prices. From 1950 to 1984, as
the Green Revolution transformed agriculture around the world, grain production
increased by over 250%. The world population has grown by about 4 billion since the
beginning of the Green Revolution and most believe that, without the Revolution, there
would be greater famine and malnutrition than the UN presently documents
(approximately 850 million people suffering from chronic malnutrition in 2005).
It is becoming increasingly difficult to maintain food security in the developing world.

Remember:
− “The wealth of nations” by Adam Smith
− monopsony: a market with only one buyer but many producers
− “The Protestant Ethic and the Spirit of Capitalism” by Max Weber
− insider trading is the trading of a corporation's stock or other securities by
individuals with potential access to non-public information about the company
− ad-hoc means in this moment or from situation to situation (fallweise)
− the head of the ECB is Trichet
− “Brave new world” by Aldous Huxley
− Paul Krugman – New York Times
− the head of the European Council is Van Rompuy
− the head of the European Commission is Barroso
− the head of the UN is Ki-moon