Globalization and welfare

GLOBALIZATION AND WELFARE: A GENERAL

Abstract

Globalization describes an ongoing process by which regional economies, societies and cultures have become integrated through globe-spanning network of exchange. The term is sometimes used to refer specifically to economic globalization: the integration of national economies into the international economy through trade, foreign direct investment, capital flows, migration, and the spread of technology. Globalization has become a contentious issue with the advent of international organizations like International Monetary Fund and World Trade Organization.

In this paper, we attempt to build up a 3 x 4 general equilibrium model following the Jones type of framework with labour market segmentation. The paper examines the implications of globalization on developing countries with special focus on welfare. The economy consists of three sectors: an export oriented industrial sector, an import oriented industrial sector and an export oriented agricultural sector. Skilled labour is specific to export oriented industrial sector and land is specific to the agricultural sector. However, unskilled labour is mobile between the three sectors. The different comparative static exercises inter alia are increase in world demand for skill intensive and agricultural products and reduction in tariffs. The paper shows that in presence of perfect capital mobility, an increase in world demand for agricultural and industrial goods would lead to an increase in overall welfare. However, the effect of reduction in tariffs on overall welfare is ambiguous.

1. INTRODUCTION

Globalization is the closer integration of the countries and the people of the world which has been brought about by the enormous reduction of costs of transportation and communication, and the breaking down of artificial barriers to the flow of goods, services, capital, knowledge and (to a lesser extent) people across the border Globalization has emerged as one of the key areas of the international trade regime. The economic environment is changing in a remarkable way due to changes in the domestic policies and international trade agreements. Open economy issues have attracted a fair amount of attention in recent times, thanks to the policy debates pertaining to trade liberalization and WTO provisions.

This paper analyses the implications of globalization on the welfare of developing countries. The paper is organized as follows. In section 2, we give a brief overview of the process of globalization. In section 3 we construct a 3x4 general equilibrium model small open economy to explore the impact of globalization on developing countries with special emphasis on welfare. Section 4 concludes the paper.

2. GLOBALIZATION: A BRIEF OVERVIEW

The International Monetary Fund defines globalization as the growing economic interdependence of countries worldwide through increasing volume and variety of cross-border transactions in goods and services, free international capital flows, and more rapid and widespread diffusion of technology.

Globalization, since World War II, is largely the result of planning by politicians to break down borders hampering trade to increase prosperity and interdependence thereby decreasing the chance of future war. Their work led to the Bretton Woods conference, an agreement by the world's leading politicians to lay down the framework for international commerce and finance, and the founding of several international institutions intended to oversee the processes of globalization. These institutions include the International Bank for Reconstruction and Development (the World Bank), and the International Monetary Fund. Globalization has been facilitated by advances in technology which have reduced the costs of trade, and trade negotiation rounds, originally under the auspices of the General Agreement on Tariffs and Trade (GATT), which led to a series of agreements to remove restrictions on free trade.

Supporters of free trade claim that globalization increases economic prosperity as well as opportunity, especially among developing nations, enhances civil liberties and leads to a more efficient allocation of resources. The theoretical basis was David Ricardo's work on Comparative advantage and Say's Law of General equilibrium Economic theories of comparative advantage suggest that free trade leads to a more efficient allocation of resources, with all countries involved in the trade benefiting. In general, this leads to lower prices, more employment, higher output and a higher standard of living for those in developing countries.

Proponents of laissez-faire capitalism say higher degrees of political and economic freedom in the form of democracy and capitalism in the developed world are both ends in themselves and also produce higher levels of material wealth. The globalization of economy has benefitted countries that took advantage of it by seeking new markets for their exports and by welcoming foreign investments. Advances in medicine, improved public health policies, and greater food supplies have lowered infant mortality and lengthened life expectancy. Life expectancy has increased in the developing world since World War II and is starting to close the gap to the developed world where the improvement has been smaller. Life expectancy increased from 44 years in 1960 to 59 years in 1999. Child mortality has also decreased in every developing region of the world .In developing countries in the 1950s, 178 children per every 1000 live births died before reaching their first birthday. By the late 1990s, the infant mortality rate in these countries had declined to 64 per 1000. Between 1950 and 1999, global literacy increased from 52% to 81% of the world. Women made up much of the gap: Female literacy as a percentage of male literacy has increased from 59% in 1970 to 80% in 2000. Due to globalization the entire world has become a global village and human beings have greater access to an array of goods and services never seen before in human history. From German cars, to Colombian coffee, from Chinese clothing, to Egyptian cotton, from American music to Indian software, human beings may be able to purchase a wide range of goods and services.

The benefits of globalization have been less than its advocates claim; the price paid has been higher, as the environment has been destroyed, as political processes have been corrupted, and as the rapid pace of change has not allowed countries time to cultural adaption. The crisis that have brought in there wake massive unemployment, have been in-turn followed by long term problem of social dissolution- from urban violence in Latin America to ethnic conflicts in other parts of the world, such as Indonesia. Unrestricted free trade benefits those with more financial leverage (i.e. the rich) at the expense of the poor. Global inequality was estimated at around 65 Gini points, whereas the new numbers indicate global inequality to be at 70 on the Gini scale. Many "anti-globalization" activists see globalization as the promotion of a corporatist agenda, which is intent on constricting the freedoms of individuals in the name of profit. Some "anti-globalization" groups argue that globalization is necessarily imperialistic, is one of the driving reasons behind the Iraq war and is forcing savings to flow into the United States rather than developing nations. Critics of free trade also contend that it may lead to the destruction of a country's native industry and a country may lose its economic sovereignty and may be forced to set policies that are contrary to its citizen's interests or desires. Moreover, multinational companies that invest in a country may also acquire too much political and economic power in relation to its citizens.

The western countries have pushed poor countries to eliminate the trade barriers, but kept up their own barriers; preventing developing countries from exporting their agricultural products and so depriving them of desperately needed export income. The deterioration of protections for weaker nations by stronger industrialized powers has resulted in the exploitation of the people in those nations to become cheap labor. Due to the lack of protections, companies from powerful industrialized nations are able to offer workers enough salary to entice them to endure extremely long hours and unsafe working conditions.

Anti globalization activists argue that the benefits of globalization are less than what is advocated by the capitalists and usually the benefits are tilted in favour of the developed countries rather than the poor, less developed countries. Prof. Joseph Stiglitz talks about globalization with a human face. According to him the pace of globalization matters: a more gradual process means that traditional institutions and norms, rather than being overwhelmed, can adapt and respond to new challenges. What are needed are policies for sustainable, equitable, and democratic growth. This is the reason for development. Development is about transforming societies, improving the lives of the poor, enabling everyone to have a chance for success and access to health care and education.

Some argue that globalization imposes credit-based economics, resulting in unsustainable growth of debt and debt crises. The financial crises in Southeast Asia, that began in the relatively small, debt-ridden economy of Thailand but quickly spread to Malaysia, Indonesia, South Korea and eventually was felt all around the world, demonstrated the new risks and volatility in rapidly changing globalized markets. The IMF's subsequent 'bailout' money came with conditions of political change (i.e. government spending limits) attached and came to be viewed by critics as undermining national sovereignty in neo-colonialist fashion. Anti-Globalization activists pointed to the meltdowns as proof of the high human cost of the indiscriminate global economy.

3. OPEN ECONOMY GENERAL EQUILIBRIUM MODEL: A WELFARE PERSPECTIVE

3.1. Introduction:

The model used in this paper belongs to Jones type of general equilibrium framework. The paper explores the implications of reform of globalization and agricultural policies with special focus on welfare.

The economic cost of globalization is measured in terms of contraction of the traditional import competing sector. The main features of the model can be summarized as follows. The model distinguishes three sectors, .Sector is an export oriented IT sector, which uses skilled labour, unskilled labour and capital. Supply of skilled labour depends on its wage. Sector is an import competing sector and we assume that there is an ad-valorem tariff on imports. This sector uses unskilled labour and capital. Sector is the agricultural sector, which uses unskilled labour and land.

We note that skilled labour is specific to sector and land is specific to the agricultural sector. Here unskilled labour is mobile between all three sectors and there is no unemployment of skilled and unskilled labour. Return on capital is internationally determined and is thereby a parameter.

3.2.1. Notations:

: Wage of skilled labour

: Wage of unskilled labour

: Rate of return on capital

: The co efficient of skilled labour for sector i.e. skilled labour/unit of.

: The co efficient of capital in sector i.e. capital/unit of.

: The co efficient of unskilled labour in sector i.e. unskilled labour/unit of.

: The co efficient of unskilled labour in sector i.e. unskilled labour/unit of.

: The co efficient of capital in sector i.e. capital/unit of.

: The co efficient of unskilled labour in sector i.e. unskilled labour/unit of.

: The co efficient of land in sector i.e. land/unit of.

: Employment of unskilled labour.

: Employment of skilled labour.

: Composite factor of production (land, technology, etc.)

: Rate of return on land.

: Cost share of skilled labour in sector.

: Cost share of unskilled labour in sector.

: Cost share of unskilled labour in sector.

: Cost share of unskilled labour in sector.

: Cost share of land in sector.

: Proportion of skilled labour in sector.

: Proportion of unskilled labour in sector.

: Proportion of unskilled labour in sector.

: Proportion of unskilled labour in sector.

: Proportion of land in sector.

: Elasticity of supply of skilled labour with respect to the wage of skilled labour

: Elasticity of supply of land with respect to its rate of return.

3.2.2. Equation Structure:

We assume that markets are competitive and price charged for the product equals average cost of production. For the sake of simplicity, we assume that the factor co efficients are fixed. The model is represented by the following equations:

Price system

(1)

(2)

(3)

The price system of our model follows from our characterization of producers as profit maximizers operating under perfectly competitive conditions. On these assumptions, output prices will equal the average costs of production and therefore will depend upon the prices of inputs into production.

Quantity system

(4)

(5)

(6) [ ]

Equation (1),(2) and (3) represents the zero profit conditions for sector respectively. This follows from the assumption of competitive markets. Equation (4) simply represents the equality between the demand for skilled labour and its supply. Now the supply of skilled labour depends upon the wage it gets. There is a positive relationship between the supply of skilled labour and wage. Equation (5) represents the full employment of unskilled labour. It follows from flexible wage of unskilled labour. Equation (6) represents the equality between demand and supply of land. The endowment of land depends on the rate of return on land.

Welfare Equation

Welfare is the value of production evaluated at international prices relative of return on foreign capital which is repatriated.

3.2.3. Working of the Model:

Since prices are given, for a small open economy equations (1),(2) and (3) determine the factor prices. More specifically, wage of unskilled labour is determined by equation (2) and that of skilled labour by equation (1). Return on land is obtained from equation (3).Thus, factor prices are determined independent of factor endowments. Once is determined, we get the supply of skilled labour and hence from equation (4) we can determine the production of. Similarly, with the determination of, production of is obtained from (6). Production of can be determined from equation (5).

3.3. Comparative Statics:

This section examines the results of demand increase, in the export oriented sector agricultural sector; furthermore, focusing especially upon welfare related variables.

3.3.1. Increase in world demand for skill intensive products

The impact of an exogenous general increase in demand for skill intensive products can be modeled in terms of a parametric increase in the world price of. Given the values of return on capital, the price of the importables and the price of the agricultural goods, wage of unskilled labour and return on �T� remains unchanged. Therefore, given �R�, �T� remains unchanged, implying thereby that output of sector neither expands nor contracts. From equation (1), rises in response to an increase in. Consequently there will be an increase in the supply of skilled labour which induces an expansion of the export oriented IT sector. This amounts to inferring that sector will contract as a part of the unskilled labour employed in sector will now move to sector.

Another result of this study that is worth noticing is the rise in the overall welfare of the economy. This discussion leads to proposition 1.

Proposition 1: For a given increase in demand for skill intensive products, there is an increase in the output of the export oriented industrial sector and contraction of the import competing industrial sector. The agricultural sector neither expands nor contracts. Overall well being of the economy is enhanced.

3.3.2. Increase in world demand for agricultural goods

The gains to developing countries could be greatly enhanced by a more comprehensive liberalization. If developing countries reduced all agricultural distortions, including agricultural taxation, their total gains would increase.

Productivity gains stimulated rising world demand for agricultural commodities which in turn alters the commodity price. From equations (1) and (2), it follows that wages of the skilled and unskilled labourers remain unchanged, given the internationally determined prices of and and return on capital. Given, skilled labour is likely to be in fixed supply, which in turn implies that sector neither expands nor contracts. Rise in must allow �� to rise, causing an expansion of the agricultural sector. Thus the system responds to an increase in aggregate demand by shifting resources from import competing sector, i.e. sector to meet increased demand for this sectors� output.

This provides useful insight into the effects of liberalization on the prices and acts as a guide to the welfare implications of liberalization in context of continuing distortions in agriculture. We can reckon that the economy on the whole would benefit from the liberalization of their own policies, which directly affect both their exports and their imports. This leads us to the following proposition:

Proposition 2: Agricultural trade liberalization leads to an increase in exports of agricultural products from less developed countries. Therefore, the agricultural sector expands and the import competing industrial sector contracts. However, the export oriented industrial sector neither expands nor contracts. Overall welfare of the economy increases.

3.2.3. Tariff Liberalization

This section quantifies the economic effects of tariff reduction (i.e. we consider the effects of a fall in ��). Equation (1) portrays that the skilled laborers does not suffer from the depressant effect on their wages as does the low skilled laborers in the import competing sector, so that �� will rise from equation (3).As indicated by the rise in , both the export dependant sectors, agricultural sector as well as the IT sector widens. It is seen that with the unskilled labour in fixed supply and fully employed, an expansion of sectorsand requires the import competing sector to contract. Resources released from contraction in this sector are redeployed elsewhere to allow the export oriented sectors to expand.

The issue of welfare, however, cannot be addressed with certainty as the trade liberalization policy might be welfare enhancing or welfare reducing. The major findings of this section are summarized as follows:

Proposition 3: Reduction in tariffs leads to an expansion of export oriented industrial sector and agricultural sector. However, the import competing industrial sector contracts. The effect of tariff liberalization on overall welfare is ambiguous.

4. CONCLUSION

People search for conclusions but when we talk about a complicated reform process no facile conclusion can be warranted. The model shows that globalization in presence of perfectly integrated capital market is beneficial in case of a structured economy like ours in case of increase in world demand for skill intensive and agricultural products of the less developed countries. However, tariff liberalization may decrease the overall welfare of the economy. There is a vast literature on food security being affected by agricultural trade liberalization. However, the present paper does not offer an explanation for food security, which provides a scope for future research.

MATHEMATICAL APPENDIX

(1)

Differentiating we get,

(7)

(2)

Differentiating we get,

(8)

(3)

Differentiating we get,

(9)

(4)

Differentiating we get,

[

(10) [

(5)

Differentiating we get,

(11) [=1]

(6)

Differentiating we get,

[

(12)

COMPARATIVE STATICS:

Increase in world demand for skill intensive products

We have,

From (2)

From (3)

From (6)

From (1)

From (4)

From (5)

Increase in world demand for agricultural goods

We have,

From (2)

From (1)

From (4)

From (3)

From (6)

From (5)

Tariff Liberalization

We have,

From (2)

From (3)

From (6)

From (1)

From (4)

From (5)

Welfare Implications

We define welfare as:

(i)

1. Increase in world demand for skill intensive products

Differentiating (i) we get,

We have,

Therefore, we get

2. Increase in world demand for agricultural goods

Differentiating (i) we get,

We have,

Therefore, we get

3. Tariff Liberalization

Differentiating (i) we get,

We have,

REFERENCES

* Jones R.(1965): The Structure of Simple General Equilibrium Models�, Journal of Political Economy, 73,557-72

* Marjit S. � International Trade and Economic Development: Essays in Theory and Policy� (2008, Oxford University Press)

* Ray Debraj � Multilateral Approaches to Trade Policy�, Development Economics, (Oxford University Press)

* Caves Frankel Jones. �World Trade and Payments� (Ninth Edition)

* Indain Agriculture in the Changing Environment. Edited by: Raj Kapila and Uma Kapila.volume 1: Changing Contours of Indian Agriculture by V.S.Vyas

Please be aware that the free essay that you were just reading was not written by us. This essay, and all of the others available to view on the website, were provided to us by students in exchange for services that we offer. This relationship helps our students to get an even better deal while also contributing to the biggest free essay resource in the UK!