The Balance of Payments and Exchange Rates; Global Economy

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The Balance of Payments and Exchange Rates
Global Economy
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Learning outcomes

• By studying this section students will be able
  to
• understand the arguments for free trade, the role
  of the WTO and GATS
• understand the balance of payments accounts
• understand the significance of exchange rates to
  recreation, leisure and tourism organizations
• distinguish between spot and forward rates of
  exchange

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Leisure and Trade

• Tourists arriving at Koh Phi Phi, Thailand
  bringing foreign currency to spend
• Changi Airport Singapore. Foreign currency
  earnings from transit tourists

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Free trade

• Ricardo argued that specialisation and trade
  would lead to an increase in total output
  compared to a position of no specialisation and
  trade, based upon greater efficiency of
  production.
• it will benefit countries to specialise in
  producing those goods and services which it is
  the very best at producing (where it has a
  comparative advantage over other countries)
• specialisation also leads to economies of scale
  and acquired expertise

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WTO and GATS

• The WTO (World Trade Organisation) is the
  international agency that promotes free trade and
  its GATS (General Agreement on Trade in Services)
  is the treaty that seeks to operationalise this
  aim.

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WTO and GATS

• Free trade liberalisation under GATS is based on
  three specific pillars
• 1. Market access Foreign owned companies have
  free access to domestic markets
• 2. Most Favoured Nation Status Concessions
  granted to any one country must also be made
  available on a non-discriminatory basis to all
  other signatories of the agreement.
• 3. National treatment Foreign investors must be
  treated on an equal basis with domestic
  investors, domestic investors must not receive
  any favourable treatment that could be conceived
  as protectionist.

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Limits to trade benefits

• extra costs involved in currency conversion and
  risk.
• transport costs can add to production costs.
• many countries seek to protect their home markets
  by protectionist policies.
• most countries wish to maintain some balance of
  production in key strategic goods and services so
  as not to expose themselves to over-dependence on
  foreign countries.

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Trading blocs

• The European Union (EU)
• North American Free Trade Agreement (NAFTA)
• The Asia-Pacific Economic Cooperation forum
  (APEC)
• ASEAN Free Trade Agreement (AFTA)

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The terms of trade

• measures the relative prices of what a country
  exports in relation to the prices of its imports.
  
• A persistent argument put forward by developing
  countries is that they face unfavourable terms of
  trade in comparison with developed countries.

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The balance of payments

• The balance of payments is an account which shows
  a countrys financial transactions with the rest
  of the world.
• It records inflows and outflows of currency.
• the balance of payments has three main components
• a current
• a capital
• and a financial account.

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The current account

• The current account records payments for trade in
  goods and services and is thus divided into two
  parts visible and invisible trade.
• Visibles exports and imports in goods
• Invisibles the trade in services or intangibles

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Leisure Balance of Payments

• Tourism is an important foreign currency earner
  for many countries

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Tourism vs other exports Australia
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The capital and financial account

• Investment
• Direct investment is the direct purchase of firms
  or land or buildings abroad. Portfolio investment
  is the purchase of securities or shares abroad.
  Such activity leads to an outflow of funds, but a
  potential future inflow of profits or dividends
  under invisibles in the current account.
• Lending and borrowing
• This records international loans.
• Official reserves activity
• Government use of official reserves of foreign
  currencies is recorded here.

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Government policy

• An acute long-term current account deficit will
  require government intervention. This may take
  the form of
• devaluation or currency depreciation
• protectionism

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Exchange rates

• Significance of exchange rates
• How does a rise in a countrys exchange rate
  affect leisure and tourism?
• Makes imports cheaper (e.g. clothes, equipment)
• Makes exports dearer (e.g. discourages inbound
  tourists)

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Determination of floating exchange rates

• A floating exchange rate is one which is
  determined in the market without government
  intervention.
• Here the exchange rate is determined, like most
  prices, by the forces of demand and supply.
• Using the Australian to stand for all foreign
  currencies, we can identify the main determinants
  of the demand for and supply of sterling as
  follows

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Exchange Rates

• A fixed exchange rate system is where the price
  of one currency is fixed in terms of another
  currency.
• Spot and Forward Markets
• The spot market is the immediate market in
  foreign currency and represents the current
  market rate. Payment is made today and the
  transaction takes place today at todays rate.
• The forward market exists to satisfy demand for a
  guaranteed future exchange rate. Payment is made
  today but the transaction is made in the future
  (e.g. 3 months) at a rate agreed today.

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Exchange rate and government policy

• Governments may attempt to influence the exchange
  rate.
• Policy instruments to affect the exchange rate
  consist of
• interest rates and
• direct buying and selling of currency by the
  Central Bank.
• Raising interest rates will generally increase
  the demand for a currency as savings are moved
  from overseas banks to domestic banks to benefit
  from higher interest rates.

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• Globalization

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Learning outcomes

• By studying this section students will be able
  to
• explain the meaning of globalization
• explain the meaning of an MNE
• understand the motives for extending operations
  overseas

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Globalization

• Robertson (1992 8) describes globalization as
• the compression of the world and the
  intensification of consciousness of the world as
  a whole . . . . concrete global interdependence
  and consciousness of the global whole in the
  twentieth century"

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Economic Globalization

• Friedman (1999 7-8) offers the following
  definition
• "The inexorable integration of markets,
  nation-states, and technologies to a degree never
  witnessed before-in a way that is enabling
  individuals, corporations and nation-states to
  reach around the world farther, faster, deeper
  and cheaper than ever before . . . . the spread
  of free-market capitalism to virtually every
  country in the world

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Economic Globalization

• Refers to the increasing integration of economies
  around the world.
• This integration is evident mainly through
• trade and financial flows but it also includes
• the movement of people (labour) and
• knowledge (technology)
• across international borders

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Benefits of Globalization

• improved communications
• a more open world
• the advent of new, better and cheaper products
• the reduction in barriers to trade
• its contribution to faster economic growth.

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Benefits of Globalization

• Advocates of globalization see the major problem
  that it is not progressing evenly.
• They note that some countries have been
  integrated into the global economy more quickly
  than others and that these are seeing faster
  growth and reduced poverty.
• For example free trade policies have brought
  dynamism and greater prosperity to much of East
  Asia, transforming it from one of the poorest
  areas of the world 40 years ago.

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Problems of Globalization

• Here concerns are expressed about
• the deterioration in the well-being of particular
  groups
• (these range from whole countries, to workers in
  developed countries who have seen their jobs
  exported, to workers in developing countries who
  work under conditions of exploitation),
• the sovereignty and identity of countries,
• the disparities of wealth and opportunities among
  countries and people
• the health of the environment
• the greater exposure it brings countries to
  sudden and profound economic shocks.

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Meaning and extent of multinational enterprise

• An MNE is one which has production or service
  capacity located in more than one country. The
  MNE has a headquarters in a parent country and
  extends its operations into one or more host
  countries.
• The main ways in which multinational operations
  are extended are by
• investment in new or greenfield capacity
• by taking an equity stake in a foreign company
  (i.e. buying up shares)
• or by operating a franchise or alliance with a
  foreign company.

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• The End