The international economic system has undergone a deep structural transformation over recent decades, with globalization allowing for a greater exchange of products, services, people and technology. Globalization has been credited with enhancing prosperity and quality of life all over the world thanks to the liberalization of trade, production, and investment. Globalization has also allowed for more foreign direct investment (FDI), which has led to increased availability of services in developing regions. It has boosted domestic production, innovation, and productivity as local markets seek to adapt to the inflow of goods and services.
There are those who have argued that organizations and governments have yet to fully adapt to globalization and the volatility it entails. Many governments and industries have felt the strain of competition, leading to increased protectionist policies and, more recently, the rise of populist political groups seeking to channel the frustration of people excluded from globalization. To better understand this argument, it is crucial to examine the international economic system and its main components to see how globalization impacts and affects them.
Microeconomics vs. Macroeconomics
The field of economics is divided into two main branches. Macroeconomics deals with the overall functioning and activity of the economy and involves the study of aggregate indicators, such as gross domestic product (GDP) and policies surrounding government spending and borrowing, exchange rates, productivity, inflation, and interest rates. Microeconomics looks at specific markets and concepts, such as market equilibrium, perfect competition, and elasticity, and also studies how individuals and firms make decisions to allocate resources.
Microeconomics and macroeconomics constitute the very basis of economic practice, and understanding them can help make sense of how the modern international economic system works and how globalization can have an impact on various economic actors and systems. Depending on the degree of openness of an economy, macroeconomic indicators, such as GDP, can be significantly influenced by changes in global markets. This was demonstrated during the 2008 financial crisis, which impacted a large number of governments and their financial health, directly affecting their growth.
When responding to changes in the global market, countries’ macroeconomic policies often have a corresponding microeconomic impact, affecting individual consumers and small firms who then vary their consumption and investment decisions accordingly. Conversely, the economic performances of certain countries can strongly affect global markets. We can see how significant political, economic and social events in certain nations can create major upheavals in international trade and finance practices, such as the Asian financial crisis in 1997.
International trade is the economic exchange of goods and services between countries and is governed by the law of comparative advantage, which states that some markets hold specific advantages that allow them to generate products and services at a lower opportunity cost than others.
In recent decades, innovations in transportation, technology, and communications have allowed for expanded trade at lower costs and faster speeds. Worldwide, the preponderance of trade has grown, as measured by the percentage of international trade that makes up GDP—from 20 percent in 1995 to 30 percent in 2014. Depending on the country, foreign exports can have an important impact on the business cycle by increasing employment and aggregate demand. Some countries benefit tremendously from trade as an important part of their GDP. For example, Singapore is considered one of the world’s most open economies and has the highest trade-to-GDP ratio in the world at 400 percent.
International trade and globalization have varying effects on other economic indicators. When a national economy is strong, industries and businesses feel confident in expanding and spending, which directly impacts the average citizen. However, because local demographics can affect microeconomic indicators, a local economy can still succeed even while national and international economies are facing difficulty.
When and if countries feel as though they are not benefiting from international trade, they can seek to restrict it in order to boost local domestic production. To do so, these nations can impose either tariffs or nontariff barriers—such as quotas—to limit the number of imports entering the country. A complex regulatory environment can make it costlier for products and services to enter a market.
While international trade has been criticized for not providing uniform benefits to all countries, experts agree that it has brought overall net gains to most countries and regions and contributed to global prosperity. Countries heavily involved in the production of goods and services thrive because their GDP is positively impacted by trade, while more consumption-oriented countries benefit from the lower costs that come with a comparative advantage.
International finance focuses on how macroeconomic indicators, such as GDP and inflation, affect the international economy and global exchange rates. It studies various components of finance, such as a balance of payments (all financial and trade transactions between a nation’s residents and the rest of the world), the foreign exchange market, financial markets, and international monetary policy.
The wholesale foreign exchange market studies how central banks, major corporations, and investment firms exchange currency, while the retail market studies how individuals worldwide engage in the buying and selling of currency. Countries can adopt a fixed exchange currency system in which governments intervene to peg their exchange rates; a floating currency system in which demand and supply and the free market determine the exchange rates; or a managed float system in which governments allow their currencies to float and only intervene when and if they need to stabilize the currency. International monetary policy is affected by different actors, such as governments, international organizations such as the World Bank, and businesses that are involved in the exchange of financial assets.
Understanding elements of international finance can help explain how state and non-state economic actors influence international markets, as well as other nations and their policymaking. Depending on how open a country is to global capital flow, globalization can affect all elements of international finance. In an attempt to influence its economy, a country can increase or decrease interest rates to affect the value and demand for its currency and attract investment. Speculation on whether a country will raise its interest rates, for example, can directly affect the demand for its currency and can influence the stability of international financial markets. A global market’s performance can affect countries’ monetary and fiscal policies, which can, in turn, affect other countries and markets.
Multinational corporations (MNCs) can be defined as businesses with investments and operations in nations other than their countries of origin. Many view MNCs as synonymous with globalization and MNCs play a key role in the free movement of capital, labor, goods, and services across borders. Major MNCs hold significant influence over policymaking, and can even boast revenues larger than the GDPs of some countries. Multinational corporations usually expand to locations where the business climate is friendliest and the potential for returns is highest—typically, in countries with low taxes. According to the Government Accountability Institute, two-thirds of U.S. corporations did not pay U.S. taxes between 1998 and 2005; however, many declare their costs in the United States and therefore receive tax benefits. While there are many who passionately criticize the business models and practices of MNCs, these corporations can contribute to economic growth and innovation by employing significant portions of the population.
Increasing Globalization of Currency and Economic Systems
Before the Bretton Woods negotiations of 1944, many countries were still operating under the gold standard, in which countries agreed to peg and freely convert their currencies to the price of gold. After the agreements, the U.S. dollar became the dominant world currency, and dozens of countries agreed to fix their exchange rates to it, while the dollar itself was pegged to gold; the United States also happened to hold half of the world’s gold reserves at the time. This system worked until the 1960s when European economies began to recover. Countries started leaving the Bretton Woods system and asking the United States to exchange their dollars for gold. Fearing depletion of the country’s gold reserves, the United States unilaterally dissolved the system, de-pegging the dollar from gold and allowing the operation of a floating exchange rate. The dollar remains the dominant world currency today, with 64 percent of the world’s foreign exchange currency reserves in U.S. dollars.
The U.S. dollar is the closest thing there is to a global currency, prompting countries such as China and Russia to call for a legitimately universal currency. Many countries, firms, and individuals seek alternatives to the dollar that could better withstand shock and changes in the international economic system. The world’s currencies and economic systems have become increasingly globalized and integrated, with major world currencies such as the U.S. dollar having an impact across industries and borders. Therefore, it is important to learn how this can influence economic actors and their behaviors.
Globalization has profoundly impacted the world economy. While some governments and nations may feel the strain from increased global competition, others have benefited from globalization, receiving an overall increased return on trade and production efforts. Many components of the international economic system—such as international trade, international finance, and multinational corporations—continue to expand thanks to globalization, but they are also facing volatility and change. An advanced degree, such as the Master of Arts in Diplomacy degree offered by Norwich University, can help individuals develop an understanding of both globalization and current international economic trends, interpret ongoing trends in global economics, and extrapolate said data in order to help project potential outcomes.
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Globalization and Macroeconomics, The National Bureau of Economic Research
Monetary Policy: Stabilizing Prices and Output, International Monetary Fund
Micro and Macro: The Economic Divide, International Monetary Fund
Exchange Rates, International Trade and Trade Policies, Science Direct
Global Economic Prospects: The Turning of the Tide?, The World Bank Group