Economic development and globalisation

1 Economic development

Start with a distinction the two words in this chapter’s title depend on.

Development is what the lead outcome is about, and growth is only one of its ingredients.

1.1 Developed, developing and emerging economies

Countries are conventionally grouped into three, though the boundaries are matters of judgement rather than definition:

The middle column is the one that matters most commercially, and §3.2 returns to it: an emerging economy is where a business meets both a new low-cost production location and a new set of customers, often within the same decade.

1.2 Measuring development

The obvious measure is GDP per head — national income divided by population, which chapter 1 gives you the tools to compute and to deflate. It is the right starting point, and it is not sufficient. Four things it does not capture:

• Distribution. An average says nothing about how the income is shared. Two countries with the same GDP per head can have very different numbers of people in poverty.

• Non-market activity. Subsistence agriculture, unpaid care and the informal economy are real output and are largely uncounted — which understates poorer economies systematically.

• What the output is. Spending on cleaning up pollution, on prisons and on repairing damage all adds to GDP without adding to anybody’s wellbeing.

• Everything that is not income. Life expectancy, literacy, infant mortality, personal security and the quality of the environment are the substance of development and do not appear in the figure at all.

Because of the last of these, development is usually measured on more than income. The best known composite measure is the Human Development Index (HDI), published annually by the United Nations Development Programme, which combines three dimensions into a single index between 0 and 1:

HDI is not a better number than GDP per head; it is a wider one. A country can rank far higher on income than on HDI, which is the diagnosis that matters: it is growing and not developing.

1.3 Barriers to economic development

The influences on development are most easily learned as the obstacles, because each obstacle names its own remedy:

1.4 What raises development

Read the table upwards and the influences are the mirror image: domestic saving and inward investment; infrastructure; education and health spending; the rule of law and the control of corruption; diversification out of primary products; debt relief; and access to other countries’ markets. Two of them come from outside the country, and both belong to the rest of this chapter — foreign direct investment, which is one of the things globalisation moves (§3), and the development institutions (§4.3), which exist to supply capital and expertise that a poor country cannot raise for itself.

2 Globalisation

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As explained in the previous chapter, there are powerful arguments for the advantages of international trade, though there are potential political problems. Over the last few decades the progress of globalisation has been fast, and many products are now produced internationally by large multi-national companies. Examples include Apple, Unilever, Toyota and Nike.

Globalisation can be defined as:

“The process by which the countries and businesses throughout the world are becoming increasingly interconnected because of increased trade. Globalisation has increased the production of goods and services. The biggest companies are multi-national companies with subsidiaries in many countries throughout world.”

Globalisation has been caused by:

• Improved communication (both physical and the transfer of information, for example, over the Internet).
  

• Political alliances (such as the European Union).
  

• The growth of global industries. Some of this is driven to achieve economies of scale and to allow increasingly complex products to be developed and sold economically.
  

• Cost differentials. For example, making use of low labour costs in some countries.
  

• Trade and political agreements allowing freer movement of goods, money and people.

3 The effects of globalisation

3.1 Patterns of production

Production and sales occur internationally. There are various patterns:

• Sometimes companies make in only one location and export production. For example, Boeing assembles aircraft only in the USA.

• Sometimes companies manufacture almost all their products abroad and the product is then sent throughout the world – including back to the home country. For example, the majority of Apple iPhones are assembled by Foxconn in China. Most Nike trainers are made in Indonesia, China and Vietnam. The process of sending manufacturing abroad is known as off-shoring.

• Alternatively, they can set up many manufacturing operations near their markets, and this can reduce transport costs and improve the speed of delivery. There is little point in a company like Coca Cola having all its production in the USA and spending a fortune moving its product, which by weight is mainly flavoured, carbonated water, across the globe. Local production makes much more sense. Even if not all of a product is made abroad, components might be, with only assembly done locally. This siting of production close to the market is industrial relocation.

• Manufacturing by sub-contracting or licensing. Setting up a factory abroad can be risky, because local laws and customs might be misunderstood. An easier way is to sub-contract production to a firm in the country where the products will be sold. Often the manufacturer is also given marketing rights and a royalty is paid to the company owning the brand or the process. Franchising is another form of international expansion, but is rather more hands-on than a simple royalty agreement. For example, many McDonalds branches are franchises, where a local business is given the right to set up as a McDonalds outlet. They have to comply closely with McDonalds’ ways of doing business.

3.2 The emergence of growth markets

Globalisation is usually taught from the production side — where things are made, and how cheaply. The syllabus also names the other side of it, and it is the side a management accountant is more likely to be asked about: globalisation creates new customers, not only new factories.

As an economy develops, a large part of its population crosses the threshold at which people stop spending everything on necessities and begin buying discretionary goods and services — packaged food, branded clothing, consumer electronics, motor vehicles, financial services, travel. For a business in a developed economy, whose home market is large, saturated and slow-growing, that is where the growth is:

• Volume growth of a kind no longer available at home, because the market is being created rather than fought over.

• A different product specification. Growth markets are usually price-sensitive, so entering them often means a simplified, lower-priced version of the product rather than the domestic one — which changes the cost structure and the margin, and is a costing question as much as a marketing one.

• Different distribution. Small independent retailers, cash payment and weak logistics change the working-capital profile of a sale.

• A currency exposure on the revenue as well as on the cost (chapter 2 §6), and a political and legal risk to appraise (§5).

The same shift creates a second effect that businesses systematically underestimate: as an emerging economy’s incomes rise, its labour ceases to be cheap. A country that was attractive as a production location becomes attractive as a market instead, and the low-cost production moves on somewhere else.

3.3 Enhanced competition

Globalisation increases the number of competitors a business faces, and it does so in both directions:

• More competitors at home. A domestic producer that once competed with a handful of domestic rivals now competes with every producer in the world that can reach its market, including producers with lower labour costs or larger scale.

• More competitors abroad. The same is true of every market it exports to.

• Competition on more than price. Wider choice raises customers’ expectations of quality, delivery and service, so the whole standard rises.

• A shorter life for any advantage. Products, processes and business models are copied and shipped quickly, so a cost or design advantage is held for less time than it once was.

The consequences are the ones chapter 2 §4 lists as advantages of trade — lower prices, more innovation, better use of resources — seen from the point of view of the firm that has to survive them. Chapter 2 also names the loser’s version: a domestic industry that cannot match world costs contracts, and the resulting unemployment is the structural kind of chapter 1 §8.4, which a demand stimulus will not cure.

3.4 The criticisms of globalisation

On the downside, many people are increasingly sceptical about the benefits of globalisation, as it can be seen as:

• The export of jobs.

• Crushing of local industries by powerful multi-nationals, and a loss of variety as the same products and specifications displace local ones.

• Undermining democracy, as large multi-national companies are larger, richer and therefore more powerful than many national economies.

• Environmental cost: the transport of goods over long distances consumes fuel and produces emissions that local production would not, and production may be sited where environmental regulation is weakest.

4 Trade agreements, trading blocs and institutions

4.1 Trade agreements and trading blocs

Trade agreements are treaties between countries on their reciprocal tariffs, quotas etc. The purpose of the agreements is to reduce the barriers to trade. For example, two countries could agree to import/export cars from one another without tariffs, or with the same tariffs, so that there is a level playing field. These arrangements should simplify international trade, improve economic efficiency and provide consumers with more choice. They reduce protectionism.

Trading blocs differ in how far they go, and the syllabus expects you to be able to tell them apart. They form a ladder, each step including the one below it:

Examples of trade agreements include:

• The European Union (EU) – a customs union and a single market, with a single currency, the euro, used by most but not all of its member states. The United Kingdom left the EU on 31 January 2020, and the transition period ended on 31 December 2020; trade between the UK and the EU is now governed by a separate trade and cooperation agreement.

• The European Free Trade Association (EFTA) – a smaller free trade area whose members trade with the EU under separate arrangements.

• The United States–Mexico–Canada Agreement (USMCA) – between the USA, Mexico and Canada, in force since 1 July 2020. It replaced the North American Free Trade Agreement (NAFTA), which had run since 1994; you will still see NAFTA referred to in older material.

4.2 The World Trade Organisation

The World Trade Organisation (WTO) is the global international organisation dealing with the rules of trade between nations. The objectives of the World Trade Organisation are to:

• Reduce the barriers to international trade
  

• Promote free and fair trade through multilateral talks and negotiations
  

• Arbitrate between countries that are in dispute. 
  

The WTO’s rules are the default: a specific trade agreement between two countries can go further than them, but the rules apply where no such agreement exists, and they are what a country falls back on if an agreement lapses.

4.3 Institutions promoting development

The lead outcome for this chapter is about institutions promoting global trade and development, and the WTO is only the trade half. Three kinds of body address the barriers in §1.3 directly:

Two other flows do the same work without an institution behind them. Foreign direct investment — a multi-national building or buying productive capacity in a country — brings capital, technology, management skills and access to export markets in one package, which is why developing economies compete for it. And official development assistance (aid) supplies capital where no commercial return is available at all. Both are among the influences on development the lead outcome asks about, and both are consequences of globalisation.

5 PESTEL

PESTEL is a way of appraising the macro-environment of countries. This is important when decisions are being made about whether to invest in a country or to export to it.

PESTEL stands for:

• Political
  

• Economic
  

• Social
  

• Technological
  

• Ecological
  

• Legal.
  

Examples of PESTEL factors, all of which will affect how attractive it is to trade with a country or to set up a manufacturing company there:

• Political: elections and changes of government, war, the expansion or contraction of trading blocs, and realignments such as the UK’s departure from the EU — a completed change whose trading consequences a business exporting to either side still has to appraise. If a country is ruled by a dictator, property rights are likely to be weak and corruption likely to be high.

• Economic: interest rates, tax rates, exchange rates, economic boom or recession. Countries often go through different parts of the trade cycle at different times. If a country seems to be coming out of recession and heading towards a period of growth, then that might be a good time to start exporting to it. Similarly, companies can withdraw from countries which are heading for an economic trough. The level of development itself belongs here too (§1): a market’s size depends on income per head, not only on population.

• Social: nowadays the main social trend arises from changes in populations. In most western countries the birth rate has fallen and there is an increasing proportion of elderly people. This can affect recruitment, and it can also affect the economics of companies that have to support a larger number of retirees. It can of course affect the marketing of products: products suited to older people may become more popular while those suited to younger people become less so. However, taste and culture are also important influences — there is little point in trying to export pork products to Muslim countries.

• Technological: technological changes often come out of the blue, but once they are invented there is really no turning back. Think how the internet has profoundly affected the fortunes of organisations like travel agents. Think how banks have responded by closing branches and encouraging their clients to do more and more banking online. Some products require a certain level of technical sophistication in user countries, and companies such as Amazon have made great use of the internet to expand internationally.

• Ecological: carbon emission restrictions and taxes, more stringent laws governing air and water pollution, and concern about the effects of global warming. Some companies are suspected of locating their manufacturing facilities in countries which have less stringent ecological rules. Energy is a genuine location factor in its own right: the large data centres that technology companies operate are routinely sited in cold northern countries — Meta’s Lulea site in northern Sweden, opened in 2013, is the standard example — because the naturally cold air removes most of the cooling cost.

• Legal: health and safety legislation, equality legislation, regulation of industries, quotas, tariffs, bureaucracy, and the enforceability of contracts and property rights (§1.3).

6 Tests

The four tests below are the chapter’s own. Work each one before you open its answer.

7 Test your knowledge

Two quick checks before you move on: work through the flashcards to fix this chapter’s key terms and definitions, then sit the objective questions for exam-style practice. Both mark themselves and explain the answers as you go.