Causes and Effects of Globalisation
Causes and Effects of Globalisation
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Globalisation guide: causes, effects and how to evaluate them
Countries now depend on each other more: a decision in one can change prices and jobs in another.
Think about a phone sold in Norla, a small country that buys and sells a great deal abroad. Its screen may be made in one country and its chips in another. If the chip factory abroad closes, phones in Norla may cost more.
The producers, consumers, governments and entrepreneurs (people who start businesses) who make economic decisions, such as closing a factory or buying a phone, are called economic agents. When agents in each of two countries are affected by the choices of agents in the other, those countries are called interdependent.
Globalisation: the increasing international interdependence of economic agents (producers, consumers, governments, entrepreneurs).
Put simply, more of what happens to you depends on choices made in other countries, such as a factory abroad that you will never see.
Interdependence is the key word. Two countries can trade a little and hardly affect each other. They are interdependent when prices and jobs in each country depend on decisions made in the other.
You can see this interdependence growing in three ways, called the characteristics of globalisation:
Countries have traded for a long time, but many of these links have grown a great deal in the last fifty years.
To see whether a country trades more of what it produces, compare its trade with its output.
When a country produces more, it usually buys and sells more abroad too. So the total value of its trade can rise even when its links with other countries have not grown. To see the links, compare trade with output: divide one by the other to get a ratio. A country's output is measured by its gross domestic product (GDP): the value of all the goods and services it produces in a year.
Trade has two flows: exports, sold to other countries, and imports, bought from them. Both are counted, because each one is a link to another economy. Exports depend on foreign buyers, and imports depend on foreign producers.
Trade as a proportion of GDP: the value of a country's exports plus imports, expressed as a percentage of its GDP.
Put simply, it tells you how many dollars of trade there are for every $100 the country produces. The higher it is, the more the country depends on trade with others. A country that trades a large share of its output is called an open economy.
The ratio rose because trade grew faster than output. If trade had grown 7.5 times, the same as output, the ratio would still be 30%, and Norla would depend on other countries no more than it did fifty years ago. If trade had grown more slowly than output, the ratio would have fallen below 30%. The rise means Norla now depends more on other countries. A larger share of what it produces is sold abroad, so more of its jobs rely on foreign buyers, and more of what it uses is made abroad.
Exam Matters: In a Calculate question, show both steps: add exports and imports, then divide by GDP and multiply by 100. Give the answer as a percentage.
A firm that owns production in several countries is different from one that only sells abroad.
Picture two shoe firms. The first makes all its shoes in one factory at home and sells them in forty countries. The second has factories in three countries, and each factory sells mainly to buyers nearby. Both reach foreign buyers, but only the second produces abroad.
Transnational company (TNC): a company that owns or controls production or service facilities in more than one country.
Put simply, a TNC has its own factories, shops or offices in more than one country, so it is a producer abroad and not only a seller there. The second firm is a TNC. A firm like the first, which makes everything at home and sells abroad, is called an exporter, however many countries it sells to.
Why does the test look at where a firm owns production, and not at where it sells? An exporter can stop selling to a country, and it leaves nothing behind there. A TNC has plants (factories), offices and workers in each country, so its decisions change jobs and output in all of them.
Today TNCs play a large part in the world economy. A TNC often moves parts from one of its plants to another in a different country. Each time the parts cross a border, they are recorded as trade, even though no customer has bought anything yet.
Real Example: UNCTAD, the United Nations body for trade and development, estimated in 2013 that about 80% of world trade, measured for around 2010, was linked to the production networks of TNCs: the plants and suppliers (the firms that sell them parts and materials) that each TNC uses to make its products. So TNCs matter for world trade, not only for production in the countries where they own plants.
A firm that builds or buys a factory abroad, and runs it, ties two economies together for years.
Ravelo, a transnational electronics company based in another country, builds a $120m plant in Norla to make device components. The plant, its machines and its land are called productive assets: things a firm uses to produce. Ravelo owns the whole plant, so it has a controlling interest, which means enough ownership to decide what the plant does.
Foreign direct investment (FDI): investment by a firm in productive assets in another country, such as a factory, in which it has a controlling interest.
Put simply, FDI is a firm putting money into production abroad and running it. It is one way a firm becomes a TNC.
Control is the test. A saver in Norla (a person who puts money aside) who buys a few shares in a foreign firm, small parts of its ownership, sends money abroad, but gains no say in what the firm does. This is called portfolio investment: buying a small share with no control. It is not FDI.
FDI takes two forms. A firm can build a new plant, as Ravelo did, or buy enough of an existing firm abroad to control it. Both are FDI, because in both the investor ends up running productive assets in another country.
FDI is also hard to undo. The investor's money is now in a plant, and a plant is hard to sell. A saver can usually sell shares within days, but a plant cannot be sold quickly, and moving its production to another country is slow and costly. So FDI ties two economies together for years: jobs in Norla depend on Ravelo's decisions, and Ravelo's profit depends on how well its plant in Norla does.
Real Example: UNCTAD, the United Nations body for trade and development, put the world's stock of FDI (all the FDI that firms hold abroad) at $7.1 trillion in 2002. Its estimate for 2024 was about $51 trillion, about seven times as much, valued at each year's prices. Part of the rise is therefore higher prices, so this is a rise in value, not a count of plants. Even so, the value of what firms hold abroad is far higher than in 2002.
People move to another country to work when the higher pay there is worth more than the cost of moving.
Picture a nurse who is offered three times her wage to work in another country. Moving has costs: the journey, a visa (permission to enter the country), weeks without pay and living apart from her family. She moves only if the higher pay is worth more to her than these costs.
Migration: the movement of people from one country to another to live and work.
Put simply, migration is workers crossing borders, just as goods and money do, so it is the third way economies are linked, after trade and investment.
The difference between the wage for the same work at home and abroad is called the wage gap. When the wage gap, added up over the years a worker expects to stay abroad, is larger than the cost of moving, some people move. A wider gap or a lower cost of moving makes more people move. A narrower gap or a higher cost of moving makes fewer people move.
Cheaper flights and cheaper calls home have lowered the cost of moving. So more people now gain from moving, even where the wage gap has not changed. For some workers, the wage gap over their years abroad used to be smaller than the cost of moving. Now that moving costs less, that same gap is larger than the cost.
Migration also links to the other signs of globalisation. Ravelo, the transnational electronics company with a plant in Norla, can fill skilled jobs with engineers from abroad when Norla has too few. A rise in migration is a sign that economies are more interdependent, because employers in one country then depend on workers from another, and those workers depend on pay from employers abroad. A rising ratio of trade to GDP is a sign of the same kind.
Real Example: The International Organization for Migration reports about 281 million international migrants (people living outside the country where they were born) in 2020, more than three times as many as in 1970. But they were still only about 3.6% of the world's population. So migration has risen a great deal, but most people still live in the country where they were born.
When a country removes a tax on imports, cheaper foreign goods come in, so the price falls and more is bought.
Think about devices in Norla, a small country. Galmo, Norla's own device maker, sells each one for $120. Zenko, a large maker in another country, sells the same kind of device for $60.
But Norla charges a tax of $70 on each imported device, so a Zenko device costs buyers in Norla $130. That is more than Galmo's $120, so none are imported. A tax like this is a trade barrier: anything a government uses to make imports more expensive or harder to bring in.
Tariff: a tax on imported goods.
Put simply, a tariff makes a foreign good more expensive in the shops, so home producers can charge more and still sell.
Quota: a limit on the quantity of a good that may be imported.
Put simply, a quota limits the quantity, not the price: once the limit is reached, no more can come in.
Trade liberalisation: the reduction and/or removal of trade barriers such as tariffs and quotas.
Put simply, foreign goods then compete on their own price. Countries often agree to it together, each lowering its barriers in return.
Now Norla removes its $70 tariff, and a Zenko device costs $60 in Norla. Why exactly $60? Buyers can now buy Zenko's device at $60, so no seller can charge more and still sell: Galmo's buyers would switch to Zenko. The price does not fall to $50, which is Galmo's $120 less the $70 tariff. The tariff was never part of Galmo's price: it was added only to imports. Without it, a Zenko device costs $60.
At $120, buyers in Norla bought 100,000 devices a year. At $60, the quantity bought rises to 200,000 devices a year. The quantity demanded is the quantity buyers are willing and able to buy at a given price, and the demand curve shows it at every price. Here only the price has changed, so this is a movement along the demand curve, not a shift of it. The quantity demanded extends, because more buyers are willing to pay $60 than $120. Norla now imports devices it did not import before, so its trade grows.
When a group of countries agree to remove the barriers between them, trade between them grows.
Suppose Norla and three neighbouring countries agree to remove the tariffs and quotas on goods they sell to each other. Each country keeps its own barriers on goods from everywhere else.
Trading bloc: a group of countries who agree to reduce trade barriers between the participating nations.
Put simply, members trade with each other on easier terms than with outsiders, so a good made inside the group can become cheaper than one from outside it.
A bloc works like trade liberalisation, but many countries lower their barriers at once, by agreement. When Norla removes its tariff on a neighbour's goods, they become cheaper in Norla, the quantity demanded extends, and Norla imports more of them. The same happens in every member.
Each member's barriers with the rest of the world stay the same. So why does trade grow? Because goods that cross between members are now cheaper, so more of them are bought. Trade with outsiders faces no higher barrier than before. Some members may now buy less from outsiders, because their partners' goods have become cheaper. But if the new trade between members is larger than that fall, total trade rises.
This is why the number of blocs and the size of each one both matter. Each new bloc lowers barriers on the trade between its members. A bloc of three small countries covers a little trade, because small economies buy and sell little. A bloc of many countries, or of large ones, covers far more trade than that.
Real Example: Trading under the African Continental Free Trade Area began on 1 January 2021. By 5 December 2020, 54 of the 55 member countries of the African Union, the body that brings together Africa's countries, had signed the agreement. It shows how a single agreement can reach the trade of many countries at once.
When a country that traded very little opens to trade and foreign investment, its producers and consumers join the world market.
Picture an economy where the state decides what is produced, and very little is traded with other countries. This is a closed economy: its factories serve only home buyers, and foreign firms cannot build plants there.
Two political changes opened very large economies like this. The first was the breakdown of the Soviet system, the planned economies (where the state plans what is produced) of the Soviet Union and its allies: the Soviet Union broke up in December 1991 into 15 countries. The second was the opening up of China, which began in 1978. In 2001 China joined the World Trade Organization, the body that sets rules for trade between its members.
When a closed economy opens up, allowing trade and foreign investment, three things happen:
Why did this raise world trade, not only these countries' trade? Because of their size. Very large numbers of workers and consumers joined the world market. Their producers' exports and their consumers' imports were new trade for everyone else.
When moving goods gets cheaper, goods that were not worth shipping become worth trading.
Think of a cheap, bulky good (one that is large for its value): a plastic chair that leaves the factory at a price of $8. This is its factory price: its price before any freight is added. Freight, the cost of moving goods to the buyer, was $12 a chair. Then it fell to $3.
At $20, buyers abroad paid 2.5 times the factory price, so most of them bought chairs made in their own country instead, and few chairs were shipped. At $11, a shipped chair can compete with the chairs made there. So cheaper freight changes which goods are traded, not only how much.
Freight fell by $9, from $12 to $3. Why does the same $9 fall matter less for a device with a factory price of $60? There it is only 15% of the factory price, so the price on arrival changes by a small share, and the device was already worth shipping. For the $8 chair, $9 is more than its whole factory price. So cheaper freight brings low-value, bulky goods into trade.
Much of this came from containerisation: packing goods in standard steel boxes that move from ship to truck without being unpacked. With the internet, communications became cheaper too, so a firm can manage a plant its managers rarely visit. Unlike trade liberalisation, trading blocs and political change, this cause came mainly from technology, not from a government decision.
Real Example: In 1956, loading loose cargo onto a medium-sized ship cost about $5.83 a ton. Loading the Ideal-X, an early container ship, cost about 16 cents a ton. This shows how containers cut the cost of loading goods, one of the costs of moving them.
Exam Matters: In a Calculate question on freight, divide the freight by the factory price and multiply by 100. Check whether the question wants the freight before or after the change.
When a TNC makes the parts of a product in one country and finishes it in another, one product crosses borders more than once.
Ravelo, a transnational electronics company, makes $20 of components (the parts that go into a device) for each device at its plant in Norla. It ships them to its assembly plant (where the parts are put together) in another country, where they become a finished device worth $60. Ravelo splits the work this way because a TNC can put each stage in the country where that stage costs least. The device is then shipped back to Norla and sold there.
The stages a product passes through, from its parts to its buyer, are called its supply chain. Ravelo's supply chain crosses a border twice.
Why does trade rise by $80 when nobody owns more devices? Trade counts every crossing of a border, not every product bought. The $20 of components is counted once when it leaves Norla. It is counted again when it comes back, because the $60 device has the components inside it. The amount produced and bought is the same as if one plant had made the whole device.
So splitting production is one reason why trade can grow faster than output. Lower barriers, blocs and open economies raise trade by moving more of what is bought across borders, and they can also raise what is produced. Splitting production adds something different: the same output is counted as trade more than once, so trade rises with no rise in output. That raises trade as a proportion of GDP, the ratio that rose in Norla from 30% to 70%.
The causes also reinforce each other. Splitting production pays only when moving components is cheap, so cheaper freight and communications made it worthwhile. In Ravelo's case, the components cross one border and the finished device crosses another. A tariff can be charged at each crossing, so lower barriers matter twice.
A TNC invests abroad when owning production in a country does better than exporting to it.
Before it built its plant in Norla, Ravelo wanted to sell components to device makers there. It could make them at home and export them, or it could build a plant in Norla. Building the plant was foreign direct investment (FDI). A firm chooses it only when owning production abroad earns it more profit than exporting. These are the main reasons it can:
Ravelo's reasons are lower wage costs and Norla's membership of a trading bloc. From Norla, its plant can serve Norla and its neighbours without paying their tariffs.
A foreign plant brings jobs, wages, orders and tax to the country that receives it.
Ravelo has built its $120m components plant in Norla. Norla is the recipient country: the country that receives the investment. What does Norla gain from the plant?
Why does Norla's GDP rise by more than the $9m of wages and $18m of orders? Because the money is spent again. Workers spend their wages in Norla's shops, and suppliers pay their own workers, who spend in turn. This is called the multiplier effect. New spending that enters an economy, such as investment, is called an injection, and a rise in an injection raises GDP by more than the rise itself. The more of the money is spent on goods and services made in Norla, the larger the rise in GDP.
The plant also adds to Norla's public finances (the government's tax revenue and spending), because the plant and its workers pay tax. The plant makes $30m of profit a year. Norla taxes profit at 25% and wages at 10%.
The government can spend the $8.4m on schools and roads, or borrow less. These are Norla's gains. The net effect also depends on what leaves Norla, such as the profit the plant sends to its owners.
Part of what a foreign plant earns leaves the country, so the gain is smaller than the plant's size suggests.
Ravelo's Norla plant makes $30m of profit a year, and that profit belongs to Ravelo's owners abroad. Norla's government keeps the $7.5m of tax on it. Ravelo can send the rest home: $30m − $7.5m = $22.5m a year. Profit sent home to owners in another country is called repatriated profit.
Repatriated profit is an outflow (money leaving the country) on Norla's current account, the part of the balance of payments that records trade and income flows. But the $120m came in on the financial account. Why does the profit go out on a different account? The $120m bought the plant, so it was investment. The profit is income earned on that investment, and income is recorded on the current account.
Other gains can also be smaller than they look:
So the impact of FDI on Norla is what stays in the country, set against what leaves.
A foreign plant is worth having only if it adds more than the best other use of the same land and workers.
Before Ravelo built its plant, Norla's government had to decide whether to offer it a tax concession: a tax cut offered to attract the firm. To judge the project, it can ask three questions.
Why is the gain not the whole $9m of wages and the $7.5m of profit tax? Because many of the workers would have earned wages elsewhere without Ravelo, and the land would have produced something too. The plant adds only the difference between what it brings and what the same workers and land would have produced without it. What a country gains after subtracting what it gives up is the net benefit.
A concession reduces the gain in the same way, because Norla gives up tax that the plant would otherwise pay. If Norla let Ravelo pay no profit tax at all, it would give up the $7.5m a year of profit tax and keep only the $0.9m a year of tax on wages.
Opening to the world can raise what a country produces, and more production gives its government more to tax.
Fifty years ago, Norla, a small country, traded less than it does today and made most of what it used. Today it trades far more, and its output (the goods and services it produces) is 7.5 times as large. Globalisation may explain part of that rise in output, which is economic growth. Growth then brings a second benefit: more tax revenue.
Economic growth is a rise in a country's output over time. Globalisation can add to it in two ways.
Why does growth raise tax revenue even at the same tax rates? A tax rate is the share of an income that goes in tax, such as 25% of a firm's profit or 10% of a worker's wage. When output grows, there are more profits and wages to take that share from. Ravelo's plant and its workers together pay Norla $8.4m a year in tax.
The government can spend this revenue on schools and roads, which can raise output again in later years.
Neither benefit is certain to arrive. Growth may stay in one region. And revenue arrives only if the new activity is taxed: a government that gives a foreign firm ten years without profit tax collects far less.
A firm that sells to the whole world can spread the cost of its plant over far more units, so each unit costs less.
Galmo, Norla's own device maker, and Zenko, a large device maker in another country, both pay $40 a device for materials and labour. Yet Zenko sells a device for $60, while Galmo needs $120.
A fixed cost does not change with output: Galmo's plant costs $8m a year, whether it makes one device or 100,000. A variable cost, such as the $40 of materials and labour in each device, is paid again on every unit made. So the total variable cost rises as output rises, but the variable cost per device stays $40, however many devices a firm makes. Average cost is the fixed cost per unit plus the variable cost per unit.
Why does a larger output lower the fixed cost per device? Zenko's plant costs five times as much as Galmo's, but it makes twenty times as many devices. So each Zenko device carries $20 of plant cost, a quarter of the $80 that each Galmo device carries. A firm can change the size of its plant only in the long run, which is the time it needs to build a bigger or smaller plant. The size of a firm's plant and its output is called its scale of production.
Economies of scale: the falls in long-run average cost that a firm gains as it increases its scale of production.
Put simply, growing bigger lowers the cost of each unit, because the cost of the plant is shared by more units.
Why does globalisation bring economies of scale? A firm that sells only at home can grow only as large as its home market: Galmo sold about 100,000 devices a year in Norla. Zenko sells in many countries, so it can sell 2 million devices and build a plant large enough to make them all.
Exam Matters: In a Calculate question on average cost, show both steps: divide the fixed cost by the output, then add the variable cost per unit.
When a price falls, buyers gain in two ways: those already buying pay less, and new buyers now find it worth buying.
Before Norla removed its tariff (a tax on imports), a device cost $120 there. Then Zenko's devices could compete, and its economies of scale let it sell at $60. The price fell to $60, and the quantity bought rose from 100,000 to 200,000 devices a year.
A buyer's willingness to pay is the highest price they would pay for a good. Many would pay more than the price charged, and the difference is their gain.
Consumer surplus: the difference between the price consumers are willing to pay for a good and the price they actually pay, summed over all units bought.
Put simply, it is the value buyers get beyond what they pay, added up over every unit bought. If you would pay $140 for a device that costs $120, you gain $20.
The demand curve shows buyers' willingness to pay. The price line, a flat line at the price, shows what they pay. So consumer surplus is the area under the demand curve and above the price line. In Norla, no buyer would pay more than $180, and the demand curve is a straight line, so this area is a triangle. Its height is $180 minus the price, and its base is the quantity bought, so its area is ½ × base × height.
The $9m has two parts, one for each group of buyers:
Why do new buyers gain less each? Each is willing to pay between $60 and $120. The new buyer who values the device most would pay almost $120, so they gain almost $60. The one who values it least would pay only just $60, so they gain almost nothing. On average a new buyer gains $30, half an existing buyer's $60.
A world market makes it worth producing more versions of a good, so buyers can choose one that suits them.
Before Norla opened to trade, its shops sold two models of device, both made by Galmo. Today they sell a dozen, most of them imported. Each model is called a variety: a version of a good with its own design.
Trade gives Norla's buyers access to goods made abroad. It also makes it easier to cover the cost of offering a variety. Each variety has its own fixed cost, such as the cost of its design. This cost is the same whether the firm sells 1,000 units or 100,000.
So a world market makes it worth producing varieties that suit small groups of buyers.
Why is more choice a gain? Each buyer can buy the variety that suits them best, not the nearest one on sale. A student who needs a long battery life gets one, instead of paying for a camera they will not use.
When a country's output grows faster than its population, the average person has more goods and services.
Fifty years ago, Norla produced $40bn of goods and services a year for 8 million people. Today it produces $300bn for 20 million people. Are its people better off?
A country's living standards are how well its people live: the goods and services they can buy and the quality of their lives. A common measure is GDP per head: the country's GDP (its output in a year) divided by its population. This gives the average output for each person.
Globalisation may have helped to raise Norla's GDP per head through the growth it brings, though other causes may have played a part. It can also add to living standards in two further ways. Lower prices let the same income buy more. More choice lets people buy the varieties that suit them.
But GDP per head is an average. It can rise while some households are worse off. Why? Suppose the incomes of half the households rise by a lot and the other half fall a little. The average rises, yet half the households have less. So a higher GDP per head tells you that output per person rose. It does not tell you who received the extra output. To show that most households gained, you need evidence that reaches most of them, such as a lower price for a good nearly everyone buys, or a survey of households' own incomes. A total, an average or one group's income cannot show it.
When a firm closes or moves abroad, its workers lose their jobs, and many cannot easily move into new ones.
Once Norla removed its tariff, a device sold for $60. Galmo, Norla's own device maker, had an average cost of $120, so it lost money on every device. It moved its assembly (putting the devices together) to Menda, a country where wages are lower. A firm moving its production to another country like this is called relocation. Galmo's 500 workers in Norla lost jobs that paid $4,000 a year.
Displaced workers: workers who lose their jobs when the industry or firm they work in shrinks, closes or moves elsewhere.
Put simply, they lose their jobs because of a change they did not cause, such as cheaper imports or a plant moving abroad.
Norla may still gain jobs overall: Ravelo, a transnational electronics company, has opened a plant there with 1,500 jobs. So why is displacement still a cost?
Why can't a Galmo machine operator simply take a Ravelo job? The new jobs may be in a city far from Galmo's town, and they need workers trained to make components. The operator would have to move home and retrain (learn new skills), and some cannot. Unemployment caused by a mismatch between workers' skills or location and the jobs on offer is called structural unemployment.
So the cost lasts. Two years later, 200 workers still have no job, and the 300 who work again each earn $1,000 a year less than before.
Exam Matters: In an Examine question, end with a judgement: say what the size and length of the cost depend on in the case, such as other employers nearby or the workers' skills.
A firm that can choose between countries has more power than a worker who has few employers to choose from.
Ravelo, a transnational electronics company, wants to build a new plant. Several countries want the jobs and tax it would bring, so they compete for it.
One way to compete is to ask less of the firm. A country may have weak employment legislation (laws on pay, hours and safety), or not make firms obey it, so the firm spends less to meet it. A government that insists on strict rules may lose the plant to a country with weaker rules.
So the firm's ability to move weakens the government's position. The government cannot raise its standards without risking the plant, because the firm has other places to go.
Now think about a worker near the plant, who is in the opposite position. Bargaining power is the ability to get better terms: better pay and conditions. It comes from having an alternative. If the plant is the only employer within reach, a worker who refuses its terms has no job. So the worker may accept low pay, long hours or unsafe conditions. Exploitation of workers means paying workers little and giving them poor conditions because they have no alternative.
But the plant's jobs often pay more than people's previous work, such as farm work, which is why they take them. So exploitation is possible, not certain: it depends on how strong employment legislation is and how many employers compete for workers.
More trade means more goods carried around the world, and the harm from that transport is not paid by the buyer or seller.
A container ship carries Zenko's devices from its plant to Norla. It burns fuel all the way and releases emissions (gases and smoke from burning fuel, such as carbon dioxide). The emissions harm people's health and add to climate change, the warming of the world's climate.
Globalisation means far more of these journeys. Norla's trade is 17.5 times what it was fifty years ago. Its output is only 7.5 times what it was. So the value of its trade for each dollar of output is more than twice what it was.
Who pays for the harm? Zenko pays the shipping firm for fuel and crew, and a Norla buyer pays $60 for the device. Neither price includes the harm the emissions do. That harm falls on third parties: people who are not part of the deal. A cost that falls on third parties, and is not paid by the buyer or the seller, is called a negative externality.
Because nobody in the deal pays it, the harm does not raise the price of traded goods. If the price did include the harm, it would be higher, and buyers would buy fewer goods. So more goods are shipped than if the harm were counted.
Two other channels add to the damage. Production can move to countries where environmental laws are weaker, so the same output causes more pollution (harmful waste in the air, water or land). And growth means more output in many countries, which uses more energy and resources.
Real Example: The International Maritime Organization, the United Nations body for shipping, estimated that shipping produced 2.89% of the world's greenhouse gas emissions (the gases that trap heat and warm the planet) from human activity in 2018, up from 2.76% in 2012. Its study linked the rise mainly to growing sea trade. This shows that moving traded goods is a measurable source of emissions.
A firm with parts in several countries sets the prices those parts charge each other, and so can choose where its profit is taxed.
Ravelo, a transnational electronics company, runs a plant in Norla that makes $30m of profit a year. Norla taxes profit at 25%, so the plant would pay $7.5m of profit tax.
Ravelo has parts in several countries, and they trade with each other. One part may sell components, designs or services to another. The price one part of a firm charges another part is called a transfer price.
Transfer pricing: the prices one part of a transnational company charges another part of the same company for goods and services traded between them.
Put simply, the firm is on both sides of the sale, so it can choose the price, and with it the country where its profit appears.
Another part of Ravelo is in Talu, a country that taxes profit at 5%. It charges the Norla plant $20m a year to use Ravelo's designs. For the plant, this $20m is a cost, so its profit in Norla falls. For the part of Ravelo in Talu, the $20m is income. Assume it has no costs to set against it, so all of it counts as profit there, and Talu taxes it at 5%. So most of the plant's $30m of profit is now taxed in Talu.
Why does the same plant now pay less tax in Norla? It makes the same devices with the same workers. Only the price of the designs changed, and Ravelo set that price itself. Between two separate firms, the buyer would refuse to pay more than the designs are worth to it. Inside one firm, both sides belong to Ravelo, so nobody refuses a high price.
Real Example: In October 2021, 136 countries agreed through the OECD, an organisation that helps governments agree economic rules, that large transnational companies should pay a tax rate of at least 15% on their profits.
Globalisation can raise some incomes in a country much faster than others, so the gap between them widens.
Compare two groups of Norla workers today. The 1,500 workers at Ravelo's plant, a transnational electronics company, earn $6,000 a year. Galmo, Norla's own device maker, moved its assembly to Menda, and those of its former workers who found new jobs earn $3,000. At Galmo they had earned $4,000.
Income inequality means how unequally income is shared among a country's people. Today a Ravelo worker earns twice as much as a re-employed Galmo worker. If Galmo's workers had kept their $4,000, a Ravelo worker would earn only one and a half times as much. So the move of Galmo's assembly to Menda made the gap between these two groups wider than it would have been.
Why can globalisation widen the gap inside a country? Workers whose skills the world market wants gain, because firms selling abroad need them. Workers whose firms compete with imports can lose, because buyers switch to the cheaper imports and their firm sells less.
Owners of resources (the people who own capital and land, such as factories and farmland) can gain most. Their capital can move to a country where it earns more profit, but most workers cannot move with it. So owners can choose where to invest, while most workers must accept the pay available where they live. When owners of resources benefit more than workers, the gap between them grows.
Inequality can rise even if nobody's income falls. If one worker's pay rises by $2,000 and another's by $200, both are better off, but the gap between them is wider.
This cost is about the gap inside one country. Whether the gap between rich and poor countries grows is a different question.
A large transnational company can change what a government decides, because the government fears losing what the company brings.
Norla's government is thinking about raising its tax on profit from 25% to 30%. It compares two outcomes for Ravelo, the transnational electronics company with a plant there. If Ravelo stays, it pays tax on its $30m of profit at 30% instead of 25%: an extra 5% of $30m, which is $1.5m more tax a year. If it leaves, Norla loses the $8.4m a year that the plant and its workers pay in tax on profit and wages, and 1,500 jobs.
The rules a government sets for its own economy, such as tax rates and minimum wages, are called its domestic economic policy. A TNC can influence it in two ways:
Why does the firm not need to threaten anything? The government can see the two figures for itself. Losing $8.4m a year would cost far more than the $1.5m the rise would gain. So even a small chance that Ravelo leaves may be enough for the government to keep the tax at 25%, without Ravelo asking.
This influence is stronger when one firm is large compared with the economy: a country with fifty large plants can afford to lose one, but a country with one cannot. The reverse also holds: a firm whose business is tied to this country, because what it needs is found only there, has less influence, since the government knows it will stay. The result can be policies that favour large companies, such as lower profit taxes.
Countries now depend on each other more: a decision in one can change prices and jobs in another.
To see whether a country trades more of what it produces, compare its trade with its output.