Pearson Edexcel IAL Economics: Causes and effects of globalisation (YEC11)

This guide follows the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11) specification, Issue 2, June 2018. It covers section 4.3.1, Causes and effects of globalisation, items 1 to 3. The specification calls Units 1 and 2 the International AS (IAS) units and Units 3 and 4 the additional International A2 (IA2) content. Unit 4, Developments in the global economy, is an International Advanced Level compulsory unit, so this material is for the full qualification and not for IAS alone. Every figure below is invented for illustration.

Related pages: revision notes, practice questions, exam preparation, the course hub, the checklist and the free diagnostics.

What this guide covers

Spec point	You must be able to
1a to 1c	Describe globalisation through trade as a share of GDP, TNCs and FDI, and migration
2a	Explain trade liberalisation, trading blocs, political change, lower transport and communications costs, and TNCs as causes
2b	Explain the reasons for FDI and its impact on recipient countries
3a	Analyse growth, tax revenue, economies of scale, lower prices and consumer surplus, choice and living standards
3b	Analyse displaced workers, exploitation, environmental impact, transfer pricing, inequality and TNC influence on policy

The unit description asks for application, analysis and evaluation, so each section ends with the chain of reasoning and the judgement points.

1. Characteristics of globalisation

Globalisation is the growing integration of national economies through flows of goods, services, capital, labour and ideas. The specification lists three signs.

1a. Trade as a share of GDP. A common measure is the openness ratio: (exports + imports) / GDP x 100.

Worked example. Country A (illustrative):

	GDP	Exports	Imports	Trade	Openness
Year 1	400	60	70	130	32.5%
Year 2	600	114	126	240	40.0%

Trade rose by 84.6% while GDP rose by 50%. Trade grew faster than output, so the ratio rose. That is the pattern the specification describes.

1b. TNCs and FDI. A transnational company (TNC) operates production in more than one country. Foreign direct investment (FDI) occurs when a firm puts money into a factory, subsidiary or other productive base in another country. Country B receives an FDI inflow of 12 on a GDP of 300, which is 4.0% of GDP. Rising FDI relative to GDP, and rising TNC sales and employment, show growing importance.

1c. Migration. More people move across borders for work, study or safety. The net migration rate is (immigrants - emigrants) / population x 1,000. Country D has a population of 20 million, 150,000 arrivals and 70,000 departures: net migration is 80,000, or 4.0 per 1,000. Migrants may also send remittances. If Country E receives 6 on a GDP of 120, remittances equal 5.0% of GDP.

2. Causes of globalisation (last 50 years)

Trade liberalisation. Governments cut tariffs and quotas, often through multilateral agreements. Lower trade barriers cut the price of imports, widen markets for exporters and make it profitable to locate production wherever costs are lowest.

Worked example. A good has an ex-factory price of 50 and freight of 10. A 20% tariff applies to the price plus freight.

• Before: (50 + 10) x 1.20 = 72.
• After a tariff cut to 5% and a freight fall to 6: (50 + 6) x 1.05 = 58.80.
• The landed price falls by 13.20, or 18.3%.

This also shows the next cause.

Reduced transport and communications costs. Containerisation, bigger ships, cheaper air freight and the internet lower the cost of moving goods, data and management instructions. Firms can split production into stages in different countries and coordinate them. Services can also be traded across borders.

Increased number and size of trading blocs. A bloc removes or reduces tariffs between members. Chain of reasoning: lower internal barriers, so intra-bloc trade rises; larger bloc market, so firms gain scale; investors outside the bloc may build inside it to avoid the common external barriers. A bloc can divert trade from cheaper outside producers, so the net effect on globalisation depends on whether creation outweighs diversion.

Political change. The specification names the breakdown of the Soviet system and the opening up of China. Economies that had been largely closed or centrally planned began to trade, accept investment and use market prices. This added large labour forces, new consumers and new sources of resources to the world economy.

Increased significance of TNCs. TNCs drive trade within their own networks, move capital and technology across borders, and lobby for open markets. Causes and consequences reinforce each other: more openness attracts TNCs, and TNCs push for further openness.

Reasons for FDI (2b)

A TNC chooses FDI over exporting when the gains from producing abroad exceed the extra costs of managing it.

Worked example. A firm makes 5 million units. Home unit cost is labour 9 + materials 6 + other 5 = 20. In Country F, labour is 4, materials 6, other 5 and transport and import costs 3, a total of 18. Saving per unit is 2, so 10 million in total, before set-up costs. FDI is worthwhile if the present value of such savings exceeds the set-up cost.

Other motives: access to a large or growing market; avoiding tariffs by producing inside the barrier; securing raw materials; skilled labour or local knowledge; investment incentives and low taxes; lower exchange-rate risk by producing and selling in the same currency; and gaining scale across a larger market.

Impact of FDI on recipient countries (2b)

Possible benefits	Possible costs
Capital inflow lifts investment and AD, then LRAS	Profits repatriated, so GNI rises by less than GDP
Jobs, and skills through training	Jobs may be low paid or replace local firms
Technology and management transfer	Little spill-over if the TNC runs an enclave
Tax revenue and export earnings	Transfer pricing and tax incentives cut revenue
More competition lowers prices	Local firms may be crowded out

Evaluation: the net effect depends on how much the TNC sources locally, how long it stays, whether the host retains tax revenue, and the host’s ability to absorb technology. TNCs may be footloose and move on if costs change.

3. Effects of globalisation

3a. Possible benefits

• Economic growth. Trade, FDI and specialisation raise exports (a component of AD) and productivity (AS). Technology transfer shifts LRAS right.

• Tax revenue. Higher output, profits and employment raise corporation, income and expenditure tax receipts. Country G’s output rises 4.5% and its population 1.5%. Output per head rises by (1.045 / 1.015 - 1) x 100 = 2.96%, so the tax base per person is larger.

• Economies of scale. Serving a larger market lets firms spread fixed costs. A TNC raises output from 100,000 to 400,000 units while total cost rises from 1.0 million to 2.2 million. Average cost falls from 10 to 5.5, a 45% fall. If competition passes this on, prices fall.

• Lower prices and higher consumer surplus. Suppose domestic demand is P = 100 - 2Q and imports allow the price to fall from 60 to 40. Quantity rises from 20 to 30. Consumer surplus = half x quantity x (100 - price). Before: 0.5 x 20 x 40 = 400. After: 0.5 x 30 x 60 = 900. Gain: 500.

  	Price	Quantity	Consumer surplus
  Before	60	20	400
  After	40	30	900

  Domestic producers lose part of their surplus, so the net gain is smaller than 500 for the economy.

• More choice. Consumers can buy varieties not made at home, and producers can buy better inputs.

• Higher living standards. Real incomes rise through lower prices, more jobs and growth. Look at real GDP per head, not only the total.

3b. Possible costs

• Displaced workers. Industries that cannot compete shrink. Suppose 12,000 manufacturing jobs are lost and 9,000 new export jobs are created: net -3,000. The new jobs may be in other regions or need other skills, so structural unemployment can persist unless retraining works.
• Exploitation of workers. Where laws are weak, TNCs or their suppliers may pay very low wages, demand long hours or ignore safety. Competition for investment can weaken labour standards.
• Environmental impact. More trade means more transport emissions and more resource use. If an external cost of 4 per unit is not in the price and 50,000 units are traded, 200,000 of cost falls on third parties. Producers may also move to countries with weak rules.
• Loss of tax revenue from transfer pricing. Transfer pricing means setting the internal price between a TNC’s own subsidiaries. A TNC pays tax at 30% in Country H and 10% in Country L. Its H subsidiary buys 100,000 components from its L affiliate at 30 instead of an arm’s-length price of 20. Profit shifted = 10 x 100,000 = 1,000,000. H loses 300,000 of tax and L gains 100,000, so the group saves 200,000.
• Increased income inequality within countries. Skilled workers and owners of capital may gain more than unskilled workers. In Country C the top 20% share rises from 42% to 48% while the bottom 20% share falls from 6% to 5%. The ratio of the two shares rises from 7.0 to 9.6.
• TNC influence on domestic policy. Large TNCs can threaten to leave, so governments may cut taxes, relax rules or offer subsidies. That can erode revenue and standards, a “race to the bottom”. Evaluation: governments can respond through international tax rules and local content requirements.

Evaluating globalisation

Strong answers weigh gains against costs and then judge. Useful questions:

1. Who gains and who loses, and can winners compensate losers?
2. Is the effect short run or long run? Job losses come first, gains take time.
3. How strong are institutions, such as tax rules and labour law?
4. Is the country a large or small economy, rich or poor, diversified or dependent on one export?

Common errors

• Confusing FDI with a TNC’s trade. FDI is investment in productive assets abroad.
• Using exports alone for trade as a share of GDP. Add imports.
• Listing a benefit with no mechanism, such as writing “growth” without saying how.
• Treating profit repatriation as a loss to GDP. It reduces income received by residents, not output.
• Giving only one side. The specification lists both benefits and costs.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2, June 2018, first assessment June 2020, published by Pearson Education Limited: section 4.3.1, Causes and effects of globalisation (Unit 4, Developments in the global economy).