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Governments, businesses, and individuals around the world are waking up to the realisation that everything around them is interconnected. This interconnectedness is not just within their national borders, but with the governments, businesses, and individuals of other countries, directly or indirectly. This global interconnectedness has some advantages and disadvantages. Let’s learn about the international economy and how it connects us all.
The international economy refers to economic activity around the world.
Figure 1. The international economy, Alanna Odagbu. Made with icons from Flaticon - StudySmarter Originals
When economists study the international economy as a whole, they look for patterns in any transactions between individuals, firms, and governments in different countries.
Most economics studies will look at countries' trades, investments, and any other financial or political transactions. But why do countries engage in trade with other countries? And what is the importance of international trade?
Every country has different endowments that their land naturally has.
The resource endowments of a country consist of its natural resources, its workflows (the workers’ skills and abilities), and its capital stock that is made up of machinery, infrastructure, etc.
The Democratic Republic of Congo (DRC) is abundant in natural wealth like diamonds, gold, copper, coffee, and oil.
Because of the difference in resource endowments, countries engage in advantageous trade to benefit from each other's resource endowments and add to their economic activity.
Unlike the DRC, the United Kingdom (UK) is not abundant in natural resources. Therefore, the UK would initiate a trade deal with the DRC so it can have gold and add it to its economic activity.
Countries also differ from each other in terms of technology.
Technology turns input (resources) into output (goods and services).
Technology can help countries produce goods and services at a cheaper cost or make higher quality products that they can trade with.
Demand is different in each country. This could be due to many reasons. One of the main reasons is the difference in consumers’ preferences and tastes.
Consumers in China may demand more rice than consumers in Canada. Consumers in Canada might eat more bread than consumers in Germany, who prefer and demand more beer than consumers in France.
These demands and preferences can’t be fulfilled often by domestic resources. Hence the need to engage in international trade.
Some firms in certain countries can produce a particular good or service at lower costs than others. Using economies of scale, countries, where the production costs are lower, would trade with countries where the domestic production of those goods or services would be more expensive.
Don’t worry if you are unsure of what economies of scale are. Our Economies of Scale explanation will help you.
Certain government policies like subsidies, tariffs, and quotas help firms achieve lower production costs. That way they can engage in the trade and exchange of those goods and/or services.
International economic relations play a huge part in the international economy. These interactions include trade in goods, services, assets, and ideas. These, in turn, lead to the development of new rules, regulations, and policies like tariffs, trade quotas, controls on the international flow of capital and the exchange rate regime.
Having strong international economic relations is important and beneficial. It is important because it helps economists understand the workings and transitions of past societies. Additionally, as the world becomes more interconnected, having good relations with every nation is important to maintain peace and cooperative relations.
Global issues highlight another importance of international economic relations. There are many issues, like climate change, pandemics, etc. that are faced everywhere around the world. Having strong and stable relations between countries will allow them to take on these global concerns. This allows nations to share relevant information and their pool of resources quickly.
As we looked at earlier, countries trade for many different reasons. Having good economic relations allows for effective trade policies. These policies benefit national businesses, allowing domestic firms to have good business international relations with other international firms. They will be able to trade their goods and services perhaps more freely, and this helps the businesses grow.
An example of this is the travel and tourism industry.
Tourism contributed 10.4% to the global economy in 2018.1 There are millions of jobs in the tourism industry and many more millions are being created. Having strong economic relations benefits many firms in the industry.
Tourists have a high marginal propensity to consume, so having a lot of tourists means an increase in consumption in a country’s economy. The tourists’ spending increases aggregate demand (AD) and thus a country’s GDP.
Job creation is the key benefit that highlights the importance of travel and tourism to the international economy. It creates jobs in a country which boost their economy, as well as the global economy.
Croatia is a good example of how travel and tourism can impact an economy. In 2019, the country generated $13 billion from tourism alone. With a population of 4 million, 25% of the population work in the travel and tourism industry.
Often, economics and politics go hand in hand, so it's no surprise that the political economy also has an impact on national economies. The behaviour of governments and the central authorities’ decisions on economic issues all over the world are bound to structure the world's economy.
We can explain this with an example:
Country A and Country B have been trading partners for centuries. Country A is now facing social and political unrest. The government in Country B doesn't agree with how the situation is being handled in Country A, so they decide to cut their trade agreements and impose sanctions on Country A.
In the example above, we can see how the political economy can impact the international economy. It was beneficial to both countries to trade with each other. Politics has influenced Country A to condone the actions of Country B, which leaves both countries in a worse off position.
We have considered some reasons why a country might engage in trading their goods and services. But some reasons and motivations for trade will differ between developing, emerging, and developed economies.
Let's take a look at some reasons each type of economy might have.
International trade can really benefit developing countries' economies. Some benefits are:
International trade can benefit emerging countries' economies too. Some benefits are:
Even though developed countries experience sustainable economic growth and development, they can still benefit from international trade. Some benefits are:
Besides the conventional international trade and the tourism industry, another emerging trend in the international economy is that of the 'digital trade' enabled by the Fourth Industrial Revolution, technological change, and digitalisation. But, what is digital trade?
Digital trade is digitally enabled or digitally ordered cross-border transactions in goods and services which can be digitally or physically delivered.
Digital trade is enabled due to the decreasing costs of sharing information, which results in more international trade, more transactions, or order processing across borders, a rise in trade of services that can be digitally delivered, and consequently increased data flows across borders.
The reason why digital trade could be the future of the international economy is that thanks to it countries can sell more products and reach more markets.
Previously, digitalisation was only being promoted for sectors such as textiles, manufacturing, agriculture, and healthcare, but its importance for exports and digital deliverable services is increasingly prominent.
But digital trade is no different from other conventional trade for the risks it faces with trade barriers. These could look like barriers that can affect communications infrastructure or measures that can negatively impact e-payments. These barriers could limit a firm's ability to offer digital services that can compete against other firms in the international market.
Let's take a look at some of the articles StudySmarter has on the international economy.
As we mentioned previously, the world is more connected than ever before. This increasing interconnectedness is known as globalisation.
In our explanation of Globalisation, you will understand the characteristics of globalisation, its benefits and drawbacks, and the impacts of globalisation on both developing and developed countries.
With the topic of globalisation come three more interesting topics:
Free trade is all about international trade without restrictions. Free trade makes the world more connected as there are no barriers to international trade.
In our explanation about Free Trade, you will learn about the benefits and costs to free trade and the UK's pattern of trade.
Protectionism is the complete opposite to free trade. It is trade with government-specific restrictions. Its main aim is to benefit domestic firms in an economy.
Our Protectionism explanation will consider the different types of protectionist policies a government can implement. It will also explore real-life examples of these policies, and the benefits and costs of protectionism.
We have looked at some reasons why a country might engage in trading with other countries. But how does each country know who to trade with and what to trade for?
Our Trading Blocs explanation will help you answer those questions. You will understand the different types of trading blocs that exist and study real-life examples. You will also learn about two other important concepts in the international economy: trade diversion and trade creation.
When countries engage in international trade, they must bear in mind that every country has different currencies.
Our Exchange Rate explanation will help you understand the different types of exchange rate systems that exist and how you can calculate a foreign exchange rate.
As mentioned previously, there are different types of exchange rates. Our Floating Exchange Rate explanation will discuss this type of exchange rate system in more detail. You will understand how it differs from the other exchange rates and how it is determined.
Our Fixed Exchange Rate explanation will discuss this type of exchange rate system in more detail. You will understand how it differs from the other exchange rates and its costs and benefits.
Specialisation focuses on international trade in detail. It considers what countries should produce, what goods and services, and why.
In the Specialisation article, you will understand trade from a more mathematical point of view.
Sources
1. James Reily, 'How important is international tourism to the global economy?', Schrodes 2020.
In the year 1929, Wall Street crashed and caused the Great Depression. This triggered a collapse of the international economy. It was further made worse by the policy decisions of the government of the United States. Tariffs, as well as speculation, are considered to be the causes that led to it.
International trade is the biggest factor that drives the international economy. It forms the basis of patterns of trade between countries. Each country makes decisions for its allocation of resources in the domestic economy based on specialisation and the comparative advantage it has over other countries and their trading partners.
The international economy consists of international trade, international investments, and international finance.
International markets, the competitive behaviour of firms, and the role and relationship of the governments with all of these actors form a major part of the international economy.
Some examples of international economics are international trade, comparative advantage and opportunity costs, competition, specialisation, international finance, international relations, and the global financial system.
International economics is the study of the economic activity between different countries in the international market.
The interaction of countries over trade, finances, investments, aid, technological assistance, etc. results in many challenges and problems, and the field of international economics aims to study these areas to solve the issues and avert international crises.
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