Relationship between countries at different levels of development

Welcome to the World of International Economics!

In this chapter, we are going to explore how countries—whether they are rich, industrialised nations or developing ones—interact with each other. Why do they trade? Why are some countries "better" at producing certain things? And how do they keep track of all the money moving across borders?

Understanding this is vital because we live in a globalised world. The phone in your pocket might have been designed in one country, with parts made in three others, and assembled in another! Don't worry if this seems like a lot at first; we will break it down piece by piece.

1. Why Countries Trade: Absolute vs. Comparative Advantage

The foundation of the relationship between countries is trade. Even if a country is really good at making everything, it still benefits from trading with others. To understand why, we look at two key concepts.

Absolute Advantage

A country has an absolute advantage when it can produce a product using fewer resources (or more efficiently) than another country.
Example: If Brazil can produce 100 tons of coffee with 10 workers, and the UK can only produce 10 tons of coffee with 10 workers, Brazil has the absolute advantage in coffee.

Comparative Advantage

This is the "magic" of economics. A country has a comparative advantage if it can produce a good at a lower opportunity cost than another country. This means they give up less of "Product B" to make "Product A."

The Golden Rule: Countries should specialise in what they have a comparative advantage in and then trade. This allows both countries to consume more than they could on their own!

A Simple Analogy:
Imagine a world-class Surgeon who is also the fastest typist in the world. Even though the surgeon has an absolute advantage in typing, they should still hire a secretary. Why? Because the opportunity cost of the surgeon typing is very high—every hour spent typing is an hour NOT spent performing life-saving surgery. The secretary has a comparative advantage in typing because their opportunity cost is much lower.

Quick Review Box:
• Absolute Advantage: Who is better/faster at making it?
• Comparative Advantage: Who gives up the least to make it?
• Common Mistake: Thinking a country with no absolute advantage cannot trade. Fact: Every country has a comparative advantage in something!

2. The Terms of Trade (ToT)

If countries are going to trade, they need to agree on a "price." The Terms of Trade measures the ratio of export prices to import prices.

The Formula

We calculate the Terms of Trade index using this formula:
\( \text{Terms of Trade} = \frac{\text{Index of average export prices}}{\text{Index of average import prices}} \times 100 \)

What do the numbers mean?

• Improvement in ToT: If the index rises, it means export prices have risen relative to import prices. The country can now buy more imports for the same amount of exports. (Think of it like getting a pay rise!)
• Deterioration in ToT: If the index falls, the country must export more just to buy the same amount of imports.

Did you know? Many developing countries struggle because they export "primary products" (like sugar or copper) whose prices stay low, while they import "manufactured goods" (like cars or machinery) whose prices tend to rise. This causes a long-term deterioration in their Terms of Trade.

Key Takeaway: The Terms of Trade isn't about how much you sell; it’s about the purchasing power of the money you earn from exports.

3. Protectionism: Putting Up Barriers

Sometimes, countries (especially developing ones) feel that "Free Trade" isn't fair or is hurting their local businesses. They use protectionism to restrict imports.

Methods of Protection:

1. Tariffs: A tax on imported goods. This makes foreign products more expensive, so locals buy "home-grown" products instead.
2. Quotas: A physical limit on the quantity of a good that can be imported.
3. Export Subsidies: The government gives money to local firms to help them sell their goods cheaper abroad.
4. Embargoes: A total ban on trading with a specific country.

Why protect? (Arguments for Protectionism)

• Infant Industry Argument: New industries in developing countries are like "babies"—they need protection until they are strong enough to compete with big global companies.
• Preventing "Dumping": This is when a foreign country sells goods at a price below the cost of production to destroy local competition.
• Protecting Jobs: Keeping foreign goods out can save local factory jobs in the short run.

Memory Aid: Use the acronym T.Q.S. to remember the tools: Tariffs, Quotas, Subsidies.

4. The Balance of Payments: The Global Scorecard

The Balance of Payments (BoP) is a record of all economic transactions between one country and the rest of the world. At AS Level, we focus mainly on the Current Account.

Components of the Current Account:

1. Trade in Goods: Visible items like cars, oil, and food (exports minus imports).
2. Trade in Services: Invisible items like tourism, banking, and insurance.
3. Primary Income: Profit, interest, and dividends coming into or leaving the country.
4. Secondary Income: Transfers of money where nothing is given in return (e.g., foreign aid or money sent home by workers abroad).

Deficits and Surpluses

• Current Account Deficit: When the total value of imports and outflows is greater than exports and inflows. (The country is spending more than it is earning).
• Current Account Surplus: When exports and inflows are greater than imports. (The country is earning more than it is spending).

Is a deficit always bad? Not necessarily! If a developing country has a deficit because it is importing machinery to build factories, it might lead to more growth in the future. However, if they are just borrowing money to buy luxury consumer goods, it can lead to a debt crisis.

Quick Review Box:
• Current Account = Trade in Goods + Services + Primary Income + Secondary Income.
• Exports are a "Credit" (+) because money flows IN.
• Imports are a "Debit" (-) because money flows OUT.

5. Exchange Rates

To trade, countries must swap currencies. Most countries in the AS syllabus use a Floating Exchange Rate, where the value of the currency is decided by Demand and Supply.

What makes a currency value change?

• Appreciation: When the value of a currency increases. (e.g., $1 used to buy £0.80, now it buys £0.90).
• Depreciation: When the value of a currency decreases.

Step-by-Step: The effect of a Depreciation
1. The currency becomes "cheaper" for foreigners.
2. Therefore, Exports become cheaper and more attractive.
3. At the same time, Imports become more expensive for locals.
4. This usually helps improve a Current Account deficit because the country sells more and buys less from abroad.

Mnemonic for Depreciation:
W.P.I.D.E.C.
Weak Pounds Imports Dearer, Exports Cheaper!

Final Encouragement:
You've just covered the core pillars of international relationships in Economics! Remember, it's all about how money and goods move between borders. If you can master Comparative Advantage and the Current Account, you are well on your way to success in your 9708 exams!