© 2011 Economics Cafe All rights reserved.

Written by: Edmund Quek

Discuss whether developing economies will benefit more from globalisation than

developed economies.

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Globalisation refers to the increase in flows of goods, services, investments and

labour across international borders. The question on whether developing economies will

benefit more from globalisation than developed economies can be discussed in terms of

the effects on the balance of payments, national income, unemployment, the general price

level and income equity.

Globalisation may lead to an improvement in the balance of payments of

developing economies. The balance of payments is a record of all the transactions

between the residents of the economy and the rest of the world over a period of time and

is made up of the current account and the capital and financial account. Due to their

larger pool of low-skilled labour, developing economies have a comparative advantage

over developed economies in producing low value-added goods, which include consumer,

capital and intermediate goods. Therefore, globalisation will lead to a rise in the exports

of low value-added goods of developing economies. Other things being equal, their

current account and hence their balance of payments will improve. Further, globalisation

will lead to a flow of foreign direct investments from developed economies to developing

economies due to the lower labour cost in developing economies. Other things being

equal, the capital and financial account of developing economies will improve.

The aggregate demand and hence the national income of developing

economies may rise due to globalisation. Aggregate demand is the total demand for the

goods and services produced in the economy over a period of time and is comprised of

consumption expenditure, investment expenditure, government expenditure on goods and

services and net exports. Due to the increase in the investment expenditure and exports of

developing economies, the aggregate demand and hence the national income will rise,

other things being equal.

© 2011 Economics Cafe All rights reserved.

Written by: Edmund Quek

In the above diagram, an increase in aggregate demand (AD) from AD0 to AD1 leads to

an increase in national income (Y) from Y0 to Y1. When aggregate demand rises, firms

will employ more factor inputs to produce more output and hence pay more factor

income to households. Household income and hence consumption expenditure will

increase. Due to the increase in consumption expenditure, firms will employ even more

factor inputs to produce even more output and hence pay even more factor income to

households. Household income and hence consumption expenditure will increase further.

Therefore, the increase in the aggregate demand in developing economies will lead to a

larger increase in the national income and this is commonly known as the multiplier

effect.

Since national income is equal to national output, the increase in the national

income of developing economies due to the increase in the aggregate demand will

lead to a rise in the demand for labour resulting in a fall in unemployment,

assuming the size of the labour force remains the same.

Globalisation may lead to a more rapid increase in the aggregate supply in

developing economies in the long run. Aggregate supply is the total supply of goods

and services in the economy over a period of time. The increase in the investment

expenditure in developing economies will lead to a more rapid increase in the production

capacity in the long run, assuming the net investment is initially positive. Therefore, the

aggregate supply in developing economies will rise more rapidly in the long run. When

this happens, assuming the aggregate demand in developing economies is rising, the

national income will rise more rapidly, unemployment will be lower and the general price

level will rise less rapidly.

Due to the same reasons that may lead to an improvement in the balance of

payments of developing economies, an increase in the aggregate demand and a more

rapid increase in the aggregate supply in the long run, the balance of payments of

© 2011 Economics Cafe All rights reserved.

Written by: Edmund Quek

developed economies may worsen, the aggregate demand may fall and the aggregate

supply may rise less rapidly in the long run.

Due to developing economies’ comparative advantage over developed

economies in producing low value-added goods, globalisation will cause the labour-

intensive industries in developed economies to decline more rapidly which will lead

to a rise in structural unemployment.

The more rapid decline in the labour-intensive industries in developed

economies will depress the demand for low-skilled labour and hence the wages

which will cause income inequity to worsen.

Globalisation may lead to an improvement in the balance of payments of

developed economies. When developing economies grow, the people will become more

affluent and hence their demand for high value-added consumer goods will rise. Further,

to feed its economic growth, developing economies will need more high-value-added

capital and intermediate goods. Due to their larger pool of high-skilled labour, developed

economies have a comparative advantage over developing economies in producing high

value-added goods, which include consumer, capital and intermediate goods. Therefore,

the growth of developing economies will lead to a rise in developed economies’ exports

of high value-added goods. The increase in outward foreign direct investments from

developed economies to developing economies will also lead to an increase in inward

income remittances in developed economies. Other things being equal, the current

account and hence the balance of payments of developed economies will improve. When

developing economies grow, some of the firms which will become larger will expand to

other economies including developed economies. Other things being equal, the capital

and financial account and hence the balance of payments of developed economies will

improve.

The increase in the investment expenditure and exports of developed

economies will lead to an increase in the aggregate demand and hence the national

income resulting in a fall in unemployment, other things being equal.

The aggregate supply in developed economies may rise due to globalisation. When developing economies grow, they will produce more of the intermediate goods that

developed economies need. Therefore, developed economies’ imports of intermediate

goods from developing economies will rise. Due to the lower prices, the cost of

production in developed economies will fall which will lead to an increase in the

aggregate supply. The cost of production in developed economies will also fall due to an

increase in inflow of cheaper labour from developing economies, both high-skilled and

low-skilled.

Globalisation may lead to a more rapid increase in the aggregate supply in

developed economies in the long run. The increase in the investment expenditure in

developed economies will lead to a more rapid increase in the production capacity in the

© 2011 Economics Cafe All rights reserved.

Written by: Edmund Quek

long run, assuming the net investment is initially positive. Therefore, the aggregate

supply in developed economies will rise more rapidly in the long run.

Due to the same reasons that may lead to an improvement in the balance of

payments of developed economies, the balance of payments of developing economies

may worsen.

The problem of brain drain in developing economies may make it difficult

for them to move up the value-added chain which may lead to lower economic

growth in the long run.

If the entry of multinational corporations in developing economies leads to

widespread closure of small firms, over-dependence on these footloose corporations

may occur which may result in massive unemployment if they pull their operations

out of the economies in the future due to more favourable market conditions in

other economies.

Due to the lax labour law and low environmental standards in developing

economies, the entry of multinational corporations may lead to labour exploitation

and environmental degradation which may lower the standard of living.

In the final analysis, developing economies are likely to benefit more from

globalisation than developed economies due to several reasons. Households in

developing economies are poorer and hence have less purchasing power than households

in developed economies. Therefore, developing economies are more export-driven than

developed economies and hence an increase in exports due to globalisation is more

beneficial to developing economies than to developed economies. Further, firms in

developing economies are smaller and hence have less funds for investments than firms

in developed economies. This problem in developing economies is exacerbated by the

high interest rates due to the low supply of loanable funds. Therefore, an increase in

inward foreign direct investments due to globalisation is more beneficial to developing

economies than to developed economies.