Economics Model Essay 9

This question will be discussed in the eighth week of term 3 (JC2) in economics tuition.

Discuss whether globalisation would benefit firms and households. [25]

Answer

Introduction

Globalisation refers to the increased integration of economies through an increase in flows of goods and services, capital and labour across international borders. The effects of globalisation on firms and households can be discussed in terms of the effects on the profits of firms, the incomes of households and the prices of goods and services.

Increase in Profits: Revenues

Globalisation may increase the profits of firms through increasing their revenues. The production of low value-added goods such as disk drives requires low-skilled labour. Due to their larger amounts of low-skilled labour, less developed economies (LDEs) such as China have a comparative advantage over developed economies (DEs) such as the United States in producing low value-added goods. Therefore, through the increase in international trade, globalisation will lead to an increase in the demand for low value-added goods produced in LDEs. When this happens, the revenues of firms that produce low value-added goods will increase which will lead to a rise in their profits. For example, many firms which produce televisions in China such as Sony Corporation have experienced an increase in their revenues. Similarly, the production of high value-added goods such as pharmaceuticals requires high-skilled labour. Due to their larger amounts of high-skilled labour, DEs have a comparative advantage over LDEs in producing high value-added goods. Therefore, through the increase in international trade, globalisation will lead to an increase in the demand for high value-added goods produced in DEs. When this happens, the revenues of firms that produce high value-added goods will increase which will lead to a rise in their profits. For example, many firms which produce pharmaceuticals in Singapore such as GlaxoSmithKline have experienced an increase in their revenues. Globalisation will lead to a flow of foreign direct investments from DEs to LDEs due to the lower costs of production in LDEs. Globalisation will also lead to a flow of foreign direct investments from LDEs to DEs. When LDEs grow due to globalisation, some firms will become larger. When this happens, some of them will expand overseas to DEs due to several reasons such as the high availability of high-skilled labour which is essential for moving up the value-added chain. For example, Singapore has attracted thousands of Chinese firms to invest in the economy partly due to its high availability of high-skilled labour. When multinational corporations (MNCs) invest in an economy, they may outsource certain functions and activities to domestic firms for several reasons such as reducing costs, increasing flexibility and focusing on core competences. If this happens, domestic firms which play a supporting role to these MNCs will experience an increase in demand and hence revenue resulting in a rise in their profits.

In the above diagram, a rise in the marginal revenue (MR) from MR0 to MR1 and the average revenue (AR) from AR0 to AR1 lead to a rise in the profit from area A to area B.

Increase in Profits: Costs

Globalisation may increase the profits of firms through decreasing their costs. Firms in LDEs import better production technologies from DEs. When this happens, their labour productivities will increase which will lead to a fall in their costs of production resulting in a rise in their profits. For example, firms in China import many advanced production technologies from the United States. Firms in DEs import cheaper intermediate goods from LDEs. When this happens, their costs of production will fall which will lead to a rise in their profits. For example, firms in Singapore import many cheaper intermediate goods from China. Firms in DEs will also experience a fall in their costs of production and hence a rise in their profits due to an inflow of cheaper labour from LDEs, both high-skilled and low-skilled, as wages in DEs are higher than those in LDEs. For example, Singapore attracts many cheaper workers from China to work in the economy. When firms in DEs and LDEs increase production due to the increase in demand, they may increase their scales of production. When this happens, they may reap more economies of scale. A fall in their costs of production will lead to a rise in their profits.

In the above diagram, a fall in the marginal cost (MC) from MC0 to MC1 and the average cost (AC) from AC0 to AC1 lead to a rise in the profit from area A to area B.

Increase in Incomes

Globalisation may increase the incomes of households. When firms that produce high value-added goods and low value-added in DEs and LDEs respectively increase production due to the increase in demand, they will employ more factor inputs from households and hence will pay them more factor income. Therefore, households in DEs and LDEs will experience an increase in income. When MNCs invest in an economy, the demand for factor inputs will rise which will lead to an increase in the incomes of households in DEs and LDEs.

Decrease in the Prices of Goods and Services

Globalisation may decrease the prices of goods and services purchased by households. When firms in DEs and LDEs experience a fall in their costs of production, they may pass on some of it to households as lower prices. Globalisation will expose firms in DEs and LDEs to greater competition which will induce them to lower prices in order to increase competitiveness by increasing labour productivity and decreasing productive inefficiency to lower the cost of production. Therefore, households in DEs and LDEs may experience a fall in prices of goods and services.

Other Benefits to Households

Apart from an increase in income and a fall in the prices of goods and services, globalisation may also benefit households in other ways. Through the increase in imports, globalisation will increase the quantity and the variety of goods and services available to households for consumption in DEs and LDEs. Furthermore, as globalisation will expose firms in DEs and LDEs to greater competition, it will induce them to increase the quality and the variety of their goods and services in order to increase competitiveness. An increase in the quantity, the quality and the variety of goods and services available to households for consumption will increase their material standards of living.

Although some firms and households may benefit from globalisation, some firms and households may not.

Decrease in Profits: Revenues

Globalisation may decrease the profits of firms through decreasing their revenues. Firms that produce the same goods as the MNCs from DEs in LDEs will experience a decrease in demand or be driven out of the market and hence will lose some or all of their revenues resulting in a loss in some or all of their profits. This is because MNCs from DEs are large firms and hence they reap more economies of scale than the smaller domestic firms in LDEs. Globalisation will lead to a decrease in the demand for high value-added goods produced in LDEs as they have a comparative disadvantage over DEs in producing the goods. When this happens, the revenues of firms that produce high value-added goods in LDEs will decrease which will lead to a fall in their profits. Similarly, globalisation will lead to a decrease in the demand for low value-added goods produced in DEs as they have a comparative disadvantage over LDEs in producing the goods. When this happens, the revenues of firms that produce low value-added goods in DEs will decrease which will lead to a fall in their profits. For example, many firms which produced hard disks in Singapore such as Seagate experienced a decrease in their revenues forcing them to relocate their manufacturing plants to China where the cost of production is lower.

Decrease in Profits: Costs

Globalisation may decrease the profits of firms through increasing their costs. Globalisation will lead to a flow of labour from LDEs to DEs, both high-skilled and low-skilled, as wages in DEs are higher than those in LDEs. Therefore, the supply of labour in LDEs will fall which will lead to a rise in the wages. For example, apart from the increase in the demand for labour in China, the decrease in the supply due to the outflow has also led to the rapid rise in wages. When this happens, firms in LDEs will experience a rise in their costs of production which will lead to a fall in their profits. When the world economy grows due to globalisation, the demand for resources such as oil will increase which will lead to a rise in the prices. When this happens, the costs of production in DEs and LDEs will rise which will lead to a decrease in the profits of firms.

Decrease in Incomes

Globalisation may decrease the incomes of households. As low value-added industries in DEs decline due to globalisation, some low-skilled households who are employed in the declining industries will lose their jobs and hence their incomes. Furthermore, as they may not have the skills to move to the expanding high value-added industries, they may be unemployed for a long period of time and this is commonly known as structural unemployment.

Increase in the Prices of Goods and Services

Globalisation may increase the prices of goods and services purchased by households. When the world economy grows due to globalisation, the demand for goods and services will increase which will lead to a rise in the prices. When this happens, the prices of goods and services purchased by households in DEs and LDEs will rise.

Other Costs to Households

Apart from a decrease in income and a rise in the prices of goods and services, globalisation may also hurt households in other ways. Although some low-skilled households who are employed in the low value-added industries in DEs will be able keep their jobs, their wages are likely to remain stagnant or rise less rapidly than the wages of high-skilled households who are employed in the high value-added industries. If this happens, although low-skilled households may be better off in absolute terms, the wider income gap will make them worse off in relative terms which will lead to a fall in their non-material standards of living. For example, income inequity in Singapore has worsened largely due to globalisation. Households in LDEs may be subject to labour exploitation by the MNCs due to the lax labour law. They may be required to work long hours at low wages and this may lead to mental stress resulting in depression and even suicide. For example, the low pay and the long working hours at Foxconn Technology Group in China led a spate of worker suicides in 2010. Households in LDEs may be subject to environmental pollution caused by the MNCs due to the low environmental standards. Furthermore, governments in LDEs may be reluctant to increase environmental standards for fear of discouraging foreign direct investments. As MNCs are footloose, they may pull their operations out of the economy if market conditions elsewhere become more favourable in the future. For example, many foreign firms such as Hitachi, Sanyo and Seagate have relocated their manufacturing plants in Singapore to China where the cost of production is lower. If this happens, households may suffer massive job losses.

Evaluation

In the final analysis, the benefits of globalisation on firms and households are likely to outweigh the costs. Globalisation has lifted hundreds of millions of households in LDEs out of poverty over the last few decades. For example, since China opened up to the world economy in 1978, over 500 million people have been lifted out of poverty. Indeed, China now has the second highest number of millionaires in the world, behind the United States. The purchasing power of households in DEs has also increased substantially. For example, the gross domestic product of Germany has been rising which can largely be attributed to globalisation. Apart from households, firms in both DEs and LDEs have also benefited substantially from globalisation. For example, although the profits of some firms have fallen due to reasons such as sectoral decline, the profits of most firms have been rising which can be largely attributed to globalisation. Nevertheless, globalisation has made some firms and households worse off and governments should take measures to help them. For example, governments of LDEs can provide short-term protection to firms that produce high value-added goods in infant industries to allow them to grow and develop a comparative advantage which will enable them to compete with their mature foreign competitors in DEs. Governments of DEs can implement an education and training funding scheme to increase the skills of low skilled workers to increase their income earning power. An example is the Workfare Training Support (WTS) Scheme in Singapore which provides course fee subsidy to older low-wage workers.

The question will be discussed in economics tuition by the Principal Economics Tutor in greater detail.

Author’s comments

Students simply need to explain the effects of globalisation on firms in terms of their profits and the effects on households in terms of their incomes and the prices of goods and services.

As the question is not asking about the effects of globalisation on the economy, students should not discuss the effects on the four key economic indicators which include the balance of payments, national income, unemployment and inflation.

Students should distinguish between firms and households in developed economies and those in developing economies as they will benefit and suffer from globalisation in different ways.

Students should understand that as a small economy, Singapore has benefited more from globalisation than many other economies.

Click to Read Next Model Essay

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Economics tutors and teachers who wish to use the materials for teaching may submit a request to Economics Cafe.

 

economics tuition, back to homepage

Economics Tuition Singapore @ Economics Cafe
Principal Economics Tutor: Mr. Edmund Quek