International Economic Integration

International economic integration

● The global economy

● Gross World Product
● Globalisation
○ Trade in goods and services
○ Financial flows
○ Investment and Transnational Corporations
○ Technology, transport and communications
○ International division of labour and migration
● The international and regional business cycles

Past HSC Questions

Past HSC Answers

Key Points

● Countries are classified into being either advanced/developed or developing/emerging

economies.
● Major emerging economies include the BRIC nations- Brazil, Russia, India and China
● The size of the global economy is measured by through the aggregate of every
nation’s gross domestic products (GDP’s) at purchasing power parities (PPP). This is
referred to as Gross World Product.
o Developed nations contribute 50% of GWP
● Globalisation refers to the increasing level of economic integration between
countries, leading to the emergence of a global marketplace or a single world market.
● The forces driving globalisation include:
o Global webs of production and distribution centres across the world.
o Improved levels of technology, communications, transport and information
technology reducing transport, communication and transaction costs
o The liberalisation of global trade and financial flows by the signing of free
trade agreements
● Foreign Direct Investment (FDI) occurs where a company establishes or buy a
controlling interest in a foreign subsidiary. This differs from Foreign Portfolio
Investment where securities are acquired not for the purpose of gaining a controlling
interest in a company.
● The International Business Cycle refers changes in world output or GDP over time.
● An effect of globalisation is the spread of financial contagion across the world such as
that was seen during the Global Financial Crisis.
The Global Economy
● The global economy consists of all the countries in the world that produce goods and
services and contribute to Gross World Product (GWP).
● These countries engage in trade in goods and services and foreign direct investment
and foreign portfolio investment.
● Over time the barriers between these nations have become smaller and this has led to
greater international economic integration
● Economic Integration refers to the liberalisation of trade between two or more
countries or many countries within a region.
● This liberalisation may lead to the formation of a free trade area, customs union,
common market or a monetary union. Examples of these include NAFTA, APEC and
the EU.
● Greater integration has been accompanied by an increasing proportion of trade carried
out by transnational corporations (TNCs).
● Table 1.1 outlines the main forms of economic integration.

The Global Economy

● The International Monetary Fund (IMF) publishes the World Economic Outlook and
classifies countries into the following two categories:
o The advanced economies (39 countries) are characterised by high levels of
economic development, with average per capita incomes of over US$40000
per annum. These are market based economies with free enterprise economic
systems with limited government intervention. Examples include the UK,
USA, Japan, Germany, France, Australia and New Zealand.
o Emerging and developing economies (154 countries) include nations such as
India, China, Nigeria, Brazil and former Communist countries. These nations
are in the process of raising their rates of economic development, but have
lower per capita incomes and living standards than advanced economies.
Emerging economies as they are sustaining rapid growth and development.
● The 39 advanced economies dominate world GDP and trade, accounting for 41.3% of
world GDP and 63.6% of world exports of goods and services despite only
representing 14,4% of world population.
● There are three sub groups in the 35 advanced economies:
o The major advanced economies are the seven largest in terms of GDP and
include the US, Japan, Germany, the UK, France, Italy and Canada. They are
referred to as the G7 (Group of Seven). They account for 30.6% of GDP and
33.8% of world exports in 2017, yet represented only 10.3% of world
population.
o The Euro Area consists of the 19 countries in Economic and Monetary Union
(EMU) which accounts for 11.6% of world GDP and 26.3% of world exports
in 2017. The Euro Area countries accounted for only 4.8% of world
population in 2012.
o The 16 other advanced economies include Australia, the Czech Republic,
Denmark, Iceland, Israel, New Zealand, Norway, San Marino, Sweden,
Switzerland and the newly industrialised Asian economies (NIEs) of South
Korea, Taiwan, Hong Kong and Singapore. They accounted for 6.5% of
world output, 17.3% of world exports and 2.3% of world population in 2017.
● The major emerging economies include
o The BRIC nations of Brazil, Russia, India and China which have sustained
high rates of economic growth and development. The BRIC nations account
for 31.4% of World GDP in 2017.
o Other emerging economies include oil exporting nations in the Middle East
including Saudi Arabia, Kuwait and the UAE.
● Developing nations include many parts of Africa, Asia and Latin America.
● Table 1.3 below shows the shares of emerging and developing economies shares of
world GDP, Exports and Population
 Gross World Product

● The size of the global economy is measured by the International Monetary Fund
(IMF) through the compilation of data for every nation’s gross domestic products
(GDP’s) at purchasing power parities (PPP).
● This calculated by the Gross World Product (GWP) which is the total market value
of all goods and services produced by all countries over a period of time (usually a
year), adjusted for variations in prices and the exchange rate.
● Gross World Product for 2019 was $141,860 in US dollars.
● Figure 1.1 below shows that developed nations (35 nations) and emerging/developing
nations (154 nations) contribute ~58.7% each of GWP. This means that a small
number of advanced economies dominate the global production of goods and services
compared to the emerging and developing economies.
● However there has been high growth in national GDPs of developing and emerging
economies especially of the BRIC nations (Brazil, Russia, India and China).
● This phenomenon is referred to as convergence theory- those countries with less
development will experience higher growth until they reach a state where their level
of development is higher and their growth will slow. This is supported by Figure 1.3
below which shows the growth of emerging and developing nations (top line), the
world (middle line) and advanced economies (bottom line).

● The divergence in the growth between developed and developing & emerging
economies is illustrated in Table 1.4 below. Note the difference in growth between
Emerging Economies like India and China and developed nations like the USA, Japan
and Euro Nations.

Globalisation and Economic Integration

● Globalisation refers to the increasing level of economic integration between countries,

leading to the emergence of a global marketplace or a single world market.
● Economic Integration occurs where trade barriers (like tariffs, subsidies and quotas)
are reduced or removed between countries to facilitate the growth in free international
trade and flows of investment. This can occur through
o The signing of free trade agreements
o The standardisation of products
o Greater use of technology including E-Commerce.
● The forces driving globalisation include:
o Global webs of production and distribution centres across the world.
o Improved levels of technology, communications, transport and information
technology reducing transport, communication and transaction costs
o The liberalisation of global trade by the signing of free trade agreements
● There are a number of characteristics that are evidence of the process of globalisation:
o The integration of world financial systems as a result of deregulation of
financial systems which leads to increased capital flows across borders
through portfolio and foreign direct investment
o Major companies conducting trade across borders. This has meant TNC’s
establishing bases overseas to find competitive advantage.
o The ICT revolution has led to new products, services and employment in
businesses servicing the global market through the internet and E-Commerce
o The global marketplace includes the Asia-Pacific region, North America and
Europe as major regions of global economic activity.
o There has been a growth in the demand for elaborately transformed
manufactured goods, technology and specialised services.
o There has been a growth in Foreign Direct Investment (FDI) as many
companies have sought to gain cheaper access to inputs like labour.
● Globalisation has generally been supported by governments through policies but the
following has cautioned against increasing globalisation:
o the spread of financial contagion during the GFC and the more recent crises
o the widening gap between emerging/developing nations and advanced
economies.

World Trade, Financial Flows and Foreign Investment

● Globalisation has led to higher growth in world output and world trade
● This trend was halted as a result of the GFC (2008-09).
● This is evident in figure 1.4 with global output contracting by -0.1% because of
recessions in most advanced economies.
● Figure 1.5 below shows the change in the shares of world exports of goods between
2010 and 2017. East Asia and the Pacific increased its share the most from 31.2% to
33.8% whilst the high income countries share remained relatively stable

● World exports of services have grown as incomes have increased, greater demand for
specialised services (like accounting and law) and improved communication
technology has occurred.
● The main categories of services include:
o Transport Services
o Travel
o Insurance and Financial Services
o Computer, ICT and Commercial Services
● There has also been a significant growth in the volume of services exported by
developing and emerging economies as a result of outsourcing.
Globalisation and Financial Flows
● Up until 2008 there had been an increase in global capital outflows as shown in figure
1.5 below.
● The GFC lead to significant falls in international financial flows due to lenders being
risk averse, the higher cost of credit and volatility of assets and exchange rates.
● The most significant trend from 2008 to 2011 was the decline in debt securities as
many companies sought to reduce their debt levels.
● Another feature was the rise in bonds issuing by governments to fund fiscal stimulus
packages.

The World Foreign Exchange Market

● The daily turnover in global foreign exchange declined from US$5357bn in 2013to
US$5067bn in 2016 reflecting the growth in world trade and investment due to the
deregulation and integration of financial markets.
● The main types of foreign exchange transactions are:
o Spot Transactions- where the delivery of foreign exchange occurs within two
days)
o Forward Transactions- where delivery of foreign exchange occurs in greater
than two days)
o Swaps- where foreign exchange is swapped at a predetermined date and
swapped back at another date.
● The main groups involved in foreign exchange transactions include dealers (including
investment banks), financial institutions (including superannuation funds) and non-
financial institutions (e.g governments, transnational corporations)
● Table 1.9 shows the major currencies traded on global foreign exchange markets in
2016 with the US Dollar followed by the Euro and Japanese Yen as the most traded
foreign currency.
● Table 1.9 also shows the countries with the most foreign exchange turnover with the
UK followed by the USA and Japan as the countries that traded the most foreign
currency
 Globalisation and Foreign Investment

● Foreign Direct Investment (FDI) occurs where a company establishes or buy a

controlling interest in a foreign subsidiary.
● Total FDI in 2016 was valued at US$2448814m nearly seven times the level in 1995.
However there was a significant drop in FDI post GFC.
● Foreign Portfolio Investment occurs where securities are acquired not for the
purpose of gaining a controlling interest in a company.
● This has undergone a significant increase also with portfolio investment of US$715
869m in 2007 six times the level of 1995.
● The growth in FDI and Portfolio Investment was mainly due to the easing of controls
over foreign ownership and foreign exchange, greater access to technology linking
world share markets

Multinational Corporations and Foreign Investment

● Multinational Corporations (also referred to as Transnational Corporations (TNC’s))

are enterprises that manage production or deliver services in more than one country.
● They are responsible for the majority of foreign direct investment since they set up
subsidiaries in other nations to gain access to global markets
● Many TNC’s have offices, branches or manufacturing plants in different countries
(host countries) from where their main headquarters are located (parent country).
● Often these TNC’s have significant political influence through their control of
resources, production, employment and sales activities. They also play a major role in
global trade and investment.
● Often staff from the parent country will be employed in the host country to manage
the subsidiary. These staff are referred to as Parent Country Nationals.
● Some staff may come from neither the parent or host country. These people are
referred to as third country nationals.
● Table 1.12 lists the topic ten countries with fortune 500 companies

● Foreign Direct Investment by TNC’s involves the acquisition of 10% or more of the
voting power or shareholdings of an enterprise in another economy.
● In competing for FDI many governments offer incentives to TNC’s such as tax
allowance, government assistance, access to infrastructure and less stringent labour
and environmental regulation.
● However critics argue the TNC’s lead to the exploitation of labour, the environment
and tax regulations. They also lead to an outflow of income from funds from the host
country to the parent country.
● On the other hand TNC bring the benefits of greater technology, export &
employment opportunities and additional tax revenue for governments

Global Production Webs

● One of the key features of globalisation is the emergence of production networks

established by TNC’s. There is where raw materials, processing, manufacturing and
assembly takes place in different countries controlled by the TNC.
● This has been driven by the minimisation of costs as companies seek nations with
low labour costs and favourable government policies.
● Developments in technology, transport and communications have enabled TNC’s to
operate these production webs

Technology, Transport, Communications and Labour

Technology

● A major change in the global economy and globalisation is the information

technology (IT) revolution. There has been greater spread of digital technologies and
development of internet.
● This has led to improvements in productivity of labour and capital and reduced the
cost of conducting international business.
● Technological development has also lead growth in the demand for technology such
as computers, smart phones, iPads and tablets.
● E-Commerce is one major means by which business sell the products to the market.
Businesses can access and use information through the Internet more quickly and
efficiently to expand their operations, reduce costs and increase sales. The advantages
of engaging in E-Commerce include
o The ordering of new stock is instantaneous allowing firms to respond to
changes in demand quicker
o Firms can use information technology to manage their stock better
o Time savings through the internet has meant less labour is required in
marketing and operations
● The success of e-commerce has is in a large part due to the uptake of fast internet
connections through cable modems and other high speed technology
● The growth in internet users is illustrated in figure 1.9 below

● The rate at which technology changes are taken up by an economy is referred to

technology diffusion.
Transport
● Transport Infrastructure includes roads, railways, ports, waterways and airports. They
are vital for the operation of domestic economies and the global economy with the
movement of raw materials, intermediate goods, finished goods and labour.
● There has been significant improvement in transport with the development of new
aircraft (such as the Airbus A380), the development of automated stevedoring
machinery and improvements in roads and highways.

Communications

● In the last decade new technology and privatisation of telecommunications companies

(such as Telstra) have led to the growth of communications in many countries.
● This has led to the rapid rise in mobile phones and expansion in access to the internet
and ICT technologies.
● Access to mobile phone technology has grown dramatically over the last 15 years. In
2002 the number of mobile phones overtook the number of fixed line mobile phones.
● In 2008 there were an estimated 4 billion mobile phones globally.

The International Division of Labour and Migration

● The division of labour refers to the specialisation of people according to labour tasks
in production.
● The operation of TNC’s have a significant impact on the international division of
labour through establishing subsidiaries overseas to offshore labour to reduce costs.
This has caused job displacement and unemployment in some advanced economies.
● Parent Country Nationals may relocate overseas to manage production in overseas
subsidiaries of TNC’s.
● As such a global market for labour has emerged and the increased mobility of workers
has led them to work in foreign nations for higher pay.
● The following are examples of the international division of labour
o The establishment of manufacturing plants by TNC’s in China and other
newly industrialised economies to utilise the supply of cheap unskilled labour.
o The outsourcing of a number of services to India, the Philippines, Singapore
and Malaysia
● There has been a movement of high skilled labour across the world. For example the
movement of doctors across the world due to the high demand for skilled labour.
● Unskilled labour has also migrated across the world with unskilled workers from
countries like the Philippines, Romania, Mexico, Poland and Ecuador seeking work in
other nations. Figure 1.10 shows the rate of emigration from these countries.

● The International Labour Organisation (ILO) in a publication called Workers without

Borders discussed a number of problems with the migration of people for work. These
include
 o Workers from Developing nations were often exploited because they are not
protected by minimum standards for wages and working conditions
o There is an emerging black market of workers being smuggled into advanced
economies to work in prostitution or other criminal activities
o There is a growing need for advanced economies to increase their labour
supply because of the ageing of the population. As such this has led to the use
of illegal migrant labour and an increase in the cost of authorities enforcing
visas and border protection.
o There is a flow of illegal refugees from emerging and developing nations into
developed nation into the European Union and North America seeking
employment opportunities and higher living standards. This has increased
unemployment and raised the cost of enforcing border protection.
● There has also been a brain drain of high skilled labour leaving advanced and
emerging economies to work in other advanced economies. This has reduced the
supply of high skilled workers in many nations causing governments to create
incentives for these people to stay such as lower tax rates.

International and Regional Business Cycles

● The International Business Cycle refers changes in world output or GDP over time.
● Figure 1.12 below shows changes in world output between 1985 and 2012 with
forecasts between 2013 and 2015.
● The general trend is for output to rise over time due to greater and more efficient
technology and improvements in knowledge.
● More specific trends in world output are:
o An average growth of 3.9% between 1997 and 2008.
o Between 2004 and 2008 the global resource boom led to growth of nearly 5%.
With BRIC nations (Brazil, Russia, India and China) growing 7.5% annually.
o The GFC in 2008-2009 led to a fall in output and trade with growth
contracting by -0.5%
o There was a recovery in 2010 with world output rising by 5.2%
o This slowed to 4% in 2011 and 3.2% in 2012 due to the European Sovereign
debt crisis and the Fiscal Cliff in the US.
o There was a forecast growth of 3.3% in 2013 and 4% in 2014.
● Increases in world output lead to boom periods in the international business cycle.
This occurred during the global resource boom.
● Decreases in world output lead to recessions in the international business cycle. This
occurred during the GFC.
● Since economies are increasingly integrated through globalisation changes on the
international business cycle will have impacts of domestic business cycle
● Likewise due to the size of the US economy changes in the US domestic business
cycle will impact on the international business cycle.
● The four major phases of the international business cycle are:
 o The Upswing which is characterised by an upturn in demand and a fall in
stock. This occurred between 2003 and 2005 as the global resources boom
lead to world growth of 4.5% which was above trend.
o The Peak which is characterised by supply constraints, increasing inflation
and growth is no longer sustainable. This occurred in 2007 with growth
peaking at 5.2%.
o The Downswing which is characterised by falling demand and rising
unemployment as economic growth slows. This occurred in 2008 – 2009 with
the GFC and between 2011 and 2012 with the European Sovereign Debt
Crisis.
o The trough is where the fall in demand and output reach the minimum point
where unemployment is at the highest point. This occurred in 2009 during the
GFC before recovery in 2010.

The Impact of Changes in the International Business Cycle

● Changes in the international business cycle have different impacts on economies

depending on their level of internationalisation.
● The main transmission mechanisms for changes in the international business cycle on
domestic economies are:
o An increase in world spending, output and growth will lead to an increase in
the demand for a country’s exports. Likewise a decrease in world spending,
output and growth will lead to a decrease in demand for exports.
o If world growth exceeds domestic growth, the demand for exports should
grow faster than the demand for imports leading to a decline in the current
account deficit (CAD). Vice versa due if domestic growth exceeds world
growth.
 o A period of high growth will lead to an increase in the price of raw materials
(like Coal) as such this will lead to an appreciation (increase) in the value of
the exchange rate for countries that export those raw materials.
o An increase in foreign investor confidence will lead to an inflow of investment
into a country leading to an increase in domestic growth by providing funds to
invest in new factories and other capital goods.

External Shocks Transmitted to Domestic Economies

● Two types of external shocks can be transmitted to domestic economies:

o Real Shocks refer to shocks to variables such as world output, prices and
technology.
▪ Examples of negative real shocks were the oil crises in 1973 and 1979
which raised the price of oil, increasing inflation and slowing
economic growth. This was an example of stagflation with high
inflation and unemployment but slow economic growth
▪ An example of a positive real shock was the resource boom between
2004 and 2007 where demand for resources lifted economic growth
and stimulated investment spending,
o Financial Shocks refer to shocks to financial variables such as share prices,
interest rates or inflation rates
▪ An example of a negative financial shock was the Global Financial
Crisis (GFC) which lowered consumer confidence and lower share
prices as aggregate demand and profits fell.

Regional Business Cycle

● Regional Business cycles refer to changes in output, trade and financial flows in
particular geographic regions where economies are integrated.
● Examples of regions integrated include:
o The European Union which has 28 countries, 19 of which use the Euro
o North America including the USA, Canada and Mexico who are all members
of the North American Free Trade Agreement (NAFTA)
o The Asian and South East Asian Nations (ASEAN) group of nations linked
through the ASEAN organisation.

Case Study of the Global Financial Crisis 2007-2009

● In July and August 2007 international financial markets experienced extreme

volatility because of the collapse of the sub-prime mortgage market in the US.
o Sub-prime mortgages are home loans by financial institutions to individuals
with poor credit ratings.
● Bankruptcies rose in 2006 and 2007 reflecting the decline in credit worthiness of
borrowers and low borrowing standards.
● The immediate effects of this collapse were transmitted to international financial
markets where asset prices for shares, bonds and other securities fell and interest rates
increased to reflect the increased risk to borrowing.
● The US Federal Reserve Bank injected money into these markets to restore
confidence and prevent this financial shock from impacting economic growth,
spending and unemployment.
● Sentiment in global financial markets deteriorated in 2008 as banks withdrew funding
to investors with high debt, which forced the sale of assets.
● The US government implemented an $US146bn stimulus package to support
household spending and investment and cut interest rates to 2%.
● The crisis worsened in September 2008 with the collapse of Lehman Brothers bank
and the bail out of two banks Freddie Mac & Fannie Mae and the American Insurance
Group (AIG).
● As a result of this instability GDP growth in the US dropped to 1.1% because of weak
spending, investment and rising unemployment especially in the financial services
sector (e.g. accounting and finance).
● This credit crisis was transmitted to other countries because of their linkages to the
US financial markets and Export markets.
● By the December quarter in 2008 the GFC had led to an unprecedented global
contraction in global GDP of -6.25%. This was the result of lower consumer
confidence, output and employment.
● This meant coordinated policy responses from G20 governments through:
o Extending guarantees for bank deposits and funding banks to prevent them for
being insolvent.
o Central Banks (like the RBA) cut interest rates to encourage spending and
increase aggregate demand.
o Governments across the world implemented stimulus packages to boost
growth and support employment.
o At the G20 summit in April 2009 committed to policies to address the issue of
‘toxic debt’ and restore financial stability including a $1.1 trillion in funding
for international financial institutions like the IMF.