Globalisation

Economics A2 · International economic issues. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

Globalisation is the growing integration of national economies through freer movement of goods, services, capital, labour and ideas. It has been driven by lower transport and communication costs, the removal of trade barriers and capital controls, and the growth of multinational companies. It brings lower prices, wider choice and faster growth, but also structural unemployment in some industries and the quick spread of shocks between countries.

Countries also integrate in regional blocs, in stages from a free trade area to a full economic union.

Joining a bloc changes where goods are bought. Trade creation replaces high-cost home output with cheaper imports from a member. Trade diversion replaces imports from a low-cost non-member with dearer ones from a member.

Rules to remember

Free trade area: no trade barriers between members; each member keeps its own barriers against non-members.
Customs union: a free trade area plus a common external tariff on imports from non-members.
Monetary union: members share a single currency, a single central bank and one interest rate.
Full economic union: a single market and currency with common fiscal and other economic policies set centrally.
A free trade area needs rules of origin, to stop imports entering through the member with the lowest tariff.
Trade creation moves production to a lower-cost source and raises efficiency; trade diversion moves it to a higher-cost source and lowers efficiency.
To compare sources, use price including tariff = cost × (1 + tariff rate); members pay no tariff.

Common mistake

Students think trade diversion must be good because consumers pay less. The price falls only because the tariff is removed; the goods now come from a producer with higher real costs and the government loses tariff revenue.

Worked example

Country A has a 40% tariff on all imports of a good. The good costs $20 to make in A, $16 in Country B and $13 in Country C. A then forms a customs union with B and keeps the 40% tariff on C. What is the result?

Before: C costs 13 × 1.4 = $18.20 and B costs 16 × 1.4 = $22.40, against $20 at home, so A imports from C.
After: B costs $16 with no tariff and C still costs $18.20, so A now imports from B.
Supply has moved from the lowest-cost producer (C, $13) to a higher-cost member (B, $16).

Answer: Trade diversion: imports switch from C to B, and each unit now uses $3 more of real resources.

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