INTERNATIONAL TRADE FINANCE

PROJECT

A Report on Open Economy and Globalisation

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Table of Contents
EXECUTIVE SUMMARY ............................................................................................................................. 1
ECONOMIC SYSYTEM ................................................................................................................................2
CAPITALISM .............................................................................................................................................2
Merits of Capitalism: ............................................................................................................................. 2
Demerits of Capitalism: ........................................................................................................................ 2
SOCIALIST ECONOMY........................................................................................................................... 3
Merits of Socialist Economy: ............................................................................................................... 3
Demerits of Socialist Economy: .......................................................................................................... 3
COMMUNISM ......................................................................................................................................... 4
Merits of communism: ......................................................................................................................... 4
Demerits of communism: .....................................................................................................................5
MIXED ECONOMY...................................................................................................................................5
Merits of Mixed Economy: ...................................................................................................................5
Demerits of Mixed Economy: ............................................................................................................. 6
GLOBALISATION ....................................................................................................................................... 8
Drivers of Globalisation ....................................................................................................................... 8
a) Integration of economics ................................................................................................................. 8
b) Trade.................................................................................................................................................. 9
c) Corporate Expansion ........................................................................................................................ 9
Main reasons that have caused globalisation: ............................................................................. 10
JOURNEY OF INDIA FROM CLOSED TO OPEN ECONOMY ........................................................... 11
Pre-liberalisation Policies.................................................................................................................... 11
Liberalisation in India ........................................................................................................................... 11
Globalisation and Privatization in India: ......................................................................................... 11
Major steps in becoming open economy: .......................................................................................... 12
(1) New Industrial Policy ................................................................................................................. 12
(2) New Trade Policy ........................................................................................................................ 13
(3) Fiscal Reforms ............................................................................................................................ 14
(4) Monetary Reforms ...................................................................................................................... 14
(5) Capital Market Reforms............................................................................................................. 15
(6) Phasing out Subsidies .............................................................................................................. 16
(7) Dismantling Price Control ........................................................................................................ 16
COMPARATIVE ANALYSIS: ................................................................................................................... 17
India’s Performance as Closed Economy v/s as Open Economy ............................................ 17

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EXECUTIVE SUMMARY

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ECONOMIC SYSYTEM
An economic system is a process that involves the production, distribution and
consumption of goods and services by organizing labor, capital and naturalresources between the
entities in a particular society. It is the method used by society to produce and distribute goods and
services.

In general, there are four major types of economic systems prevailing around the world.

 CAPITALISM
 SOCIALISM
 COMMUNISM
 MIXED ECONOMY

CAPITALISM
Capitalism is an economic system in which each individual in his capacity as a consumer, producer, and
resource owner is engaged in economic activity with a large measure of economic freedom. Individual
economic actions conform to the existing legal and institutional framework of the society which is
governed by the institution of private property, profit motive, freedom of enterprise, and consumers’
sovereignty.

All factors of production are privately owned and managed by individuals. The raw materials, the
machines, the firms, and the factories are owned and managed by individuals who are at liberty to
dispose of them within the prevalent laws of the country. Individuals have the freedom to choose any
occupation, and to buy and sell any number of goods and services.

Merits of Capitalism:

1. Practice of democracy: Capitalism offers opportunity to everyone for making profit.

2. Less government rules: Government tries to stay out of the way of businesses.
3. Scope of innovation: In a market economy, it is easier for someone with initiative and virtue to
create a better life for themselves and their family; economic freedom makes it easier to
transform hard work and perseverance into material wealth.
4. Competitive market: Competition among business provides consumers lower price, better
service and improved products.
5. Competitive prices: In capitalism a unique price is determined by the demand and supply in
absence of any monopolistic influences.

Demerits of Capitalism:

1. Instability: A private market economy may be quite unstable (unemployment, inflation, growth)
2. Discrimination: It does not always provide the basic needs to everyone in the society. The
weak, sick, disabled, and old sometimes have trouble. They often slip into poverty.
3. Production of demerit goods: Because of competition and vision of maximizing profit of
business, some harmful products are produced.

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4. Increase gaps between rich and poor: Rich people control the economy that’s why they
deprive the poor. And thus a gap between poor and rich is increased.
5. Increase of unemployment: Rate of unemployed people increases. Business wants to
maximize profit by minimizing costs. They get minimum number of staffs.

SOCIALIST ECONOMY
In socialist economic system means of production are owned and managed by the State. Ownership
of means of production is not allowed. In socialism economic activities are carried on mainly for social
gains and personal interest is of less significance. In this economic system the anti social activities like
smuggling and hoarding find no place. Economic activities are planned with the motive of social benefit
by a central planning authority.

Merits of Socialist Economy:

1. No Labour Exploitation: There is only one class in a socialistic economy hence there is no
question of exploitation.
2. Proper Utilisation of Resources: Under this economy, all types of natural resources are
utilized in a most organized manner. Its main objective is to exploit these resources for the
welfare of society.
3. No Wasteful Advertisement: The government is virtually the owner of almost every sector.
Hence, all the individual producers are also more according to the plan targets. Therefore, the
competition among the producers is almost nil. Hence, very less money is spent on wasteful
advertisement.
4. Proper Planning: In order to solve various problems, which arise from time to time, there is
proper economic plan in this type of economy. Thus, with the help of economic plans socialist
economy will adopt the balanced development strategy
5. No Cyclical Fluctuations: It means economy faces no boom, depression, unemployment or
over production etc. Economic stability is maintained by the government on the basis of
economic planning.
6. Social Welfare: The aim of socialist economy is to maximize social welfare of the society. It
provides equal opportunities of employment to all individual according to their abilities.

Demerits of Socialist Economy:

1. Loss of Consumer Sovereignty: A consumer has no choice of his own, he acts as a mere
slave under this system. Government produces goods and services keeping in view the needs of
the people.

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2. Less Democratic: Socialist economy is always less democratic as it possesses no element of

freedom. It is also like government dictatorship.
3. No Automatic Functioning: Under this system, no automatic function in system exists at all. It
is the Central Authority, i.e., government that governs the country according to its own interest.
4. Evils of Bureaucracy: In socialist economy, all economic activities are controlled by the
government. Thus, they develop all evils of bureaucracy like favouritism, delay, corruption and
other sue evils,
5. Rigid Economy: Socialist economy is very rigid and not susceptible to change according to
requirements. Hence people work like a machine and never get any incentive to work.
6. Burden on Government: All the economic activities are performed by the Central Authority on
behalf of the government. Hence, it is overburdened with daily activities and, therefore, it gets
very less time to think and plan for the economic prosperity of the economy.
7. Expenditure on Planning: In fact, planning is a long process in a socialist economy. This
expenditure is unnecessarily wasteful and a burden on the national economy.

COMMUNISM
Communism is an economic system where means of production are controlled and managed by a
Central State Authority, and there is also a restriction on the ownership of personal property. In
communism personal belongings, as clothing, watches, and shoes are allowed to be owned by
individuals and the houses are owned by the State.

Communism is the extreme form of Socialism

Merits of communism:
1. Stability: Long-term infrastructure investment can be made without fear.
2. Equality: In this system equality is focused on. The government tries to eliminate
all private property and distribute its good equally. The government will provide equal health
care, education opportunities, and make sure all people are fed.
3. Assurance of the use of resources: A planned economy can maximize the continuous
utilization of all available resources.
4. Efficiency of managing: This system is organized in such a way that helps tosatisfy the
majority of the population.
5. Quick problem solving: It is capable of rapid change for major problems. Thegovernment owns
the companies, so if production needs need to be shiftedinto a different area, the government is
capable of doing it rather quickly.

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6. Reduction of unemployment: This system helps to reduce unemployment. Government

provides services to all.

Demerits of communism:
1. Inefficient resource distribution: Sometimes it cannot detect consumer preferences
accurately.
2. Lack of freedom: People cannot decide about the production of their desired products. They
have less opportunity to decide what they want to do for a career.
3. Lack of incentive for innovation: Planned Economy does not encourage taking innovations.
4. Individual’s initiative goes unrewarded: Hard work is not rewarded here. Everybody is equal
here.
5. Overstaffing problems: Sometimes organizations are filled with over staffs.
6. Waste of resources: Resources owned by the government are sometimes.
7. Production standards problem: The absence of profit motives acts as a deterrent to individual
contribution. For that sometimes products are not maintained standard.
8. Corruption: A planned economy creates social conditions favoring political corruption.

MIXED ECONOMY
Mixed economy is a term used to describe an economic system, where some important production is
undertaken by the state, directly or through its nationalized ndustries, and some is left for private
enterprise. In a mixed type economy, both the private ownership as well as the government takes part in
the process of production, distribution and other types of economic activities. The mixed economy allows
private participation in the field of production in an environment of competition with an objective of
attaining profit. On the contrary following to the socialism features it includes public ownership in
production for maximizing social welfare.

Merits of Mixed Economy:

1. Government support: In mixed economy government has the control of many of the key
aspects of the economy, such as public schools, police department, firedepartment, military,
museums, libraries, and streets, or sewers.
2. Highest possible use of resource: A mixed economy can maximize the continuous utilization
of all available resources.
3. Flexibility: This economic system is more flexible than Planned economy andCapitalism.
4. Freedom of choice: In this type of economic system everybody has the right of enterprise
ownership, work for social welfare, profit earnings, political freedom.
5. Limited rules: The government has limited control, which is good for structure.

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Demerits of Mixed Economy:

1. Corruption: Mixed economic systems incentives corruption and political bureaucracy capitalist
nexus enjoying at the cost of the citizens.
2. Increase of unemployment: Rate of unemployed people increases. Business want to maximize
profit by minimizing costs. They get minimum number of staffs.
3. Waste of resources: Resources owned by the government are sometimes.
4. Lacking of standard: The absence of profit motives acts as a deterrent to individual
contribution. For that sometimes products are not maintained standard.

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Economic System followed by different countries:

China

China once had a socialist, planned economy where the government controlled and owned all the
means and methods of production. It is now near a mixed economy after privatization of most of the
state owned enterprises and opening up to western countries. For example, peasants now have their
own firms; foreign businesses are allowed to set up in China and so on.

U.S.A.

The USA economic system is “mixed capitalism”. It became mixed when government established
operating guideline and laws for business to follow. For example, postal service is a government
business that competes with private business such as Federal Express.

Cuba

Cuba has a dual economy, with two distinct systems operating side by side. The socialist peso economy
applies to most Cubans, providing them with free education, free health care, universal employment,
unemployment compensation, disability and retirement benefits and the basis necessities of life: food,
housing, utilities and some entertainment at very low cost. The market economy operates in the tourist,
international and exports sectors, and substantially sustains the socialist economy.

Bangladesh

Bangladesh economic system is mixed economy. Both private and government is producing and
distributing goods and services. Defense, roads, education, pension and some medical care are under
the authorization of government. Private sectors are also providing goods and services to the people.

Conclusion

Different countries follow different types of economic system. But now a days most of the countries are
adopting mixed economy system. Even capitalist country U.S.A., socialist countries like China, Cuba are
moving their economic system towards mixed economy. Now pure capitalism and socialism are found in
booksonly. Because of flexibility, government support, international business policycountries are being
interested in mixed economy.

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GLOBALISATION
The movement towards the expansion of economic and social ties between countries through the spread
of corporate institutions and the capitalist philosophy that leads to the shrinking of the world in economic
terms.
Globalization is a process of interaction and integration among the people, companies, and
governments of different nations, a process driven by international trade and investment and aided by
information technology.

Globalisation is defined by following terms

Drivers of Globalisation

a) Integration of economics
• The increasing reliance of economies on each other
• The opportunities to be able to buy and sell in any country in the world
• The opportunities for labour and capital to locate anywhere in the world
• The growth of global markets in finance

Made possible by:

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• Technology
• Communication networks
• Internet access
• Growth of economic cooperation – trading blocs (EU, NAFTA, etc.)
• Collapse of ‘communism’
• Movement to free trade

b) Trade
Trade involves the transfer of the ownership of goods or services from one person or entity to
another in exchange for other goods or services or for money. Possible synonyms of "trade"
include "commerce" and "financial transaction".

Benefits of Trade:
• Increased choice
• Greater potential for growth
• Increase international economies of scale
• Greater employment opportunities

Disadvantages of trade:
• Increase in gap between the rich and the poor
• Dominance of global trade by the rich, northern hemisphere countries
• Lack of opportunities for the poor to be able to have access to markets
• Exploitation of workers and growers

c) Corporate Expansion

Multi-national or trans-national corporations (MNCs or TNCs) – businesses with a headquarters

in one country but with business operations in a number of others.

Characteristics:
– Expanding revenue
– Lowering costs
– Sourcing raw materials
– Controlling key supplies
– Control of processing
– Global economies of scale

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Main reasons that have caused globalisation:

1. Improved transport, making global travel easier. For example, there has been a rapid growth in air-
travel, enabling greater movement of people and goods across the globe.

2. From 1970, there was a rapid adoption of the steel transport container. This reduced the costs of
inter-modal transport making trade cheaper and more efficient.

3. Improved technology which makes it easier to communicate and share information around the world.
E.g. internet. For example, to work on improvements on this website, I will go to a global online
community, like elance.com. There people from any country can bid for the right to provide a service. It
means that I can often find people to do a job relatively cheaply because labour costs are relatively lower
in the Indian sub-continent.

4. Growth of multinational companies with a global presence in many different economies.

5. Growth global trading blocks which have reduced national barriers. (e.g. European Union, NAFTA,
ASEAN)

6. Reduced tariff barriers encouraging global trade. Often this has occurred through the support of the
WTO.

7. Firms exploiting gains from economies of scale to gain increased specialisation. This is an important
feature of new trade theory.

8. Growth of global media.

9. Global trade cycle. Economic growth is global in nature. This means countries are increasingly
interconnected. (E.g. recession in one country affects global trade and invariably causes an economic
downturn in major trading partners.)

10. Financial system increasingly global in nature. When US banks suffered losses due to sub-prime
mortgage crisis, it affected all major banks in other countries who had bought financial derivatives from
US banks and mortgage companies.

11. Improved mobility of capital. In past few decades there has been a general reduction in capital
barriers, making it easier for capital to flow between different economies. This has increased the ability
for firms to receive finance. It has also increased the global interconnectedness of global financial
markets.

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JOURNEY OF INDIA FROM CLOSED TO OPEN ECONOMY

The present process of economic reforms was born out of the crisis in the economy, which climaxed in
1991. The crisis compelled the government to adopt a new path-breaking economic policy under which a
series of economic reform measures were initiated with the objective to deal with the crisis and to take
the economy on a high-growth path.

New economic policy was a discovery after 1991 crisis which as three major features are liberlisation,
privatisation and globalisation of the economy (LPG policy).

Pre-liberalisation Policies
Indian economic policy after independence was influenced by the colonial experience (which was seen
by Indian leaders as exploitative in nature) and by those leaders' exposure to Fabian socialism. Policy
tended towards protectionism, with a strong emphasis on import substitution, industrialisation under
state monitoring, state intervention at the micro level in all businesses especially in labour and financial
markets, a large public sector, business regulation, and central planning.

Five-Year Plans of India resembled central planning in the Soviet Union. Steel, mining, machine tools,
water, telecommunications, insurance, and electrical plants, among other industries, were effectively
nationalised in the mid-1950s. Elaborate licences, regulations and the accompanying red tape,
commonly referred to as Licence Raj, were required to set up business in India between 1947 and 1990

Liberalisation in India
The economic liberalisation in India refers to the ongoing economic liberalisation, initiated in 1991, of the
country's economic policies, with the goal of making the economy more market-oriented and expanding
the role of private and foreign investment. Specific changes include a reduction in import tariffs,
deregulation of markets, reduction of taxes, and greater foreign investment.

Liberalisation has been credited by its proponents for the high economic growth recorded by the country
in the 1990s and 2000s. Its opponents have blamed it for increased poverty, inequality and economic
degradation. The overall direction of liberalisation has since remained the same, irrespective of the ruling
party, although no party has yet solved a variety of politically difficult issues, such as liberalising labour
laws and reducing subsidies. There exists a lively debate in India as to what made the economic reforms
sustainable.

Globalisation and Privatization in India:

In the 1990s due to change in world economic order and due to heavy pressures from rich countries like
USA, Japan, European countries dominating the WTO (World Trade Organisation, established in 1995)
and IMF (International Monetary Fund) and World Bank engaged in development financing activities, the
developing and the poor countries all over the world were forced to open their trade and market and
allow foreigners to share their major chunk of a business. Thus, India first started the process of
globalisation and liberalisation in 1991 under the Union Finance Minister, Shri Manmohan Singh.

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The first 5 years in globalisation did not yield appreciable results. The coming of Multinational cold drinks
manufacturers like Coke, Pepsi, and others like Mc. Donald, KFC, Boomer Chewing gums, Uncle Chips,
Cornflakes only dominated the show. Due to further liberalization of trade and the privatization, the late
1990s showed the effect to globalisation by the coming of giant car manufacturers like Daewoo Motors,
Ford, Honda, Hyundai which resulted in availability of varieties of cars and reduction of domestic car
prices.
Electronic giants like IBM and world leaders in the telecommunication sector like Ericsson, Nokia, Aiwa
etc., delivered wide range of quality products at affordable prices and brought a major revolution in
Indian electronic industries. In the power sector Enron, AES-CESCO are dominating the show. The
resultant effects were tremendous boost to industrial sector economy. The price level came down due to
cut throat competition and Indian consumers are so far happy.
Thus, Indian economy had experienced major policy changes in early 1990s. The new economic reform,
popularly known as, Liberalization, Privatization and Globalization (LPG model) aimed at making the
Indian economy as fastest growing economy and globally competitive. The series of reforms undertaken
with respect to industrial sector, trade as well as financial sector aimed at making the economy more
efficient.

Indian economy was in deep crisis in July 1991, when foreign currency reserves had plummeted,
inflation had roared, fiscal deficit was very high and had become unsustainable; foreign investors and
NRIs had lost confidence in Indian economy. So major measures were initiated as a part of the
liberalization and globalization strategy in the early nineties included the following:-

Devaluation
Disinvestment
Dismantling of the Industrial Licensing Regime
Allowing Foreign Direct Investment
Non Resident Indian Scheme Throwing Open Industries Reserved For the Public Sector to
Private Participation.
Abolition of the (MRTP) Act
The removal of quantitative restrictions on imports
The reduction of the peak customs tariff

Major steps in becoming open economy:

(1) New Industrial Policy
Under Industrial Policy, keeping in view the priorities of the country and its economic development, the
roles of the public and private sectors are clearly decided.

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Under the New Industrial Policy, the industries have been freed to a large extent from the licenses and
other controls. In order to encourage modernization, stress has been laid upon the use of latest
technology. A great reduction has been effected in the role of the public sector.

Efforts have been made to encourage foreign investment. Investment decision by companies has been
facilitated by ending restrictions imposed by the MRTP Act. Similarly, Foreign Exchange Regulation Act
(FERA) has been replaced with Foreign Exchange Management Act (FEMA).

Some important points of the New Industrial Policy have been highlighted here:-

(i) Abolition of Licensing

(ii) Freedom to Import Technology
(iii) Contraction of Public Sector:
(iv) Free Entry of Foreign Investment
(a) In 1991, 51% of foreign investment in 34 high priority industries was allowed without
seeking government permission.
(b) Non-Resident Indians (NRIs) were allowed to invest 100% in the export houses,
hospitals, hotels, etc.
(c) Foreign Investment Promotion Board (FIPB) was established with a view to speedily
clear foreign investment proposals.
(d) Restrictions which were previously in operation to regulate dividends repatriation by the
foreign investors have been removed. They can now take dividends to their native countries.
(v) MRTP Restrictions Removed
(vi) FERA Restrictions Removed
(vii) Increase in the Importance of Small Industries:

(2) New Trade Policy

Trade policy means the policy through which the foreign trade is controlled and regulated. As a result of
liberalisation, trade policy has undergone tremendous changes. Especially the foreign trade has been
freed from the unnecessary controls.

The age-old restrictions have been eliminated at one go. Some of the chief characteristics of the New
Trade Policy are as follows:

(i) Reduction in Restrictions of Export-Import

(ii) Reduction in Export-Import Tax
(iii) Easy Procedure of Export-Import
(iv) Establishment of Foreign Capital Market

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(v) Providing Incentive for Export:

(vi) Full Convertibility on Current Account:

In 1994-95, full convertibility became applicable on current account.

Here it is important to clarify the meaning of current account and full convertibility. Therefore, this has
been done as follows:

Current Account: Transactions with the foreign countries are placed in two categories: (i) transaction with
current account, for example, import-export, (ii) Capital account transactions, like investment.

Full Convertibility: In short, full convertibility means unrestricted sale and purchase of foreign exchange
in the foreign exchange market for the purpose of payments and receipts on the items connected with
current account. It means that there is no government restriction on the sale and purchase of foreign
exchange connected with current account.

On the other hand, sale and purchase of foreign exchange connected with capital account can be
carried on under the rates determined by the Reserve Bank of India (RBI),

Many incentives have been allowed to Export- oriented Units (EOU) and Export Processing Zones (EPZ)
for increasing export trade.

(3) Fiscal Reforms

The policy of the government connected with the income and expenditure is called fiscal policy. The
greatest problem confronting the Indian government is excessive fiscal deficit. In 1990-91, the fiscal
deficit was 8% of the GDP. (It is important to understand the meaning of fiscal deficit and GDP.)

(i) Fiscal Deficit: A fiscal deficit means that the country is spending more than its income,

(ii) Gross Domestic Product (GDP):

The GDP is the sum total of the financial value of all the produced goods and services during a year in a
country. Generally, the financial deficit is calculated in the form of GDP’s percentage. Presently, the
government of India is making efforts to take it to 4%.

(4) Monetary Reforms

Monetary policy is a sort of control policy through which the central bank controls the supply of money
with a view to achieving the objectives of the general economic policy. Reforms in this policy are called
monetary reforms. The major points with regard to the monetary reforms are given below

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(i) Statutory Liquidity Ratio (SLR) has been lowered. (A commercial bank has to maintain a definite
percentage of liquid funds in relation to its net demand and time liabilities. This is called SLR. In liquid
funds, cash investment in permitted securities and balance in current account with nationalised banks
are included.)

(ii) The banks have been allowed freedom to decide the rate of interest on the amount deposited.

(iii) New standards have been laid down for the income recognition for the banks. (By recognition of
income, we mean what is to be considered as the income of the bank. For example, should the interest
on the bad debt be considered as the income of the bank directions have been issued in this context.

(iv) Permission to collect money by issuing shares in the capital market has been granted to nationalised
banks.

(v) Permission to open banks in the private sector has also been granted.

(5) Capital Market Reforms

The market in which securities are sold and bought is known as the capital market. The reforms
connected with it are known as capital market reforms. This market is the pivot of the economy of a
country. The government has taken the following steps for the development of this market:

(i) Under the Portfolio Investment Scheme, the limit for investment by the NRIs and foreign companies in
the shares and debentures of the Indian companies has been raised. (Portfolio Investment Scheme
means investing in securities.

(ii) In order to control the capital market, the Securities and Exchange Board of India (SEBI) has been
established.

(iii) The restriction in respect of interest on debentures has been lifted. Now, it is decided on the basis of
demand and supply.

(iv) The office of the Controller of Capital Issue which used to determine the price of shares to be issued
has been dispensed with. Now, the companies are free to determine the price of the shares.

(v) Private sector has been permitted to establish Mutual Fund.

(vi) The registration of the sub broker has been made mandatory.

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(6) Phasing out Subsidies

Cash Compensatory Support (CCS) which was earlier given as export subsidy has been stopped. CCS
can be understood with the help of an example.

If an exporter wants to import some raw material which is available abroad for 100, but the same
material is available in India for 120 and the governments wants the raw material to be purchased by the
exporter from India itself for the protection of indigenous industries, the government is ready to pay the
difference of 20 to the exporter in the form of subsidy.

The payment of 20 will be considered as CCS. In addition to this, the CCS has been reduced in case of
fertilizers and petro products.

(7) Dismantling Price Control

The government has taken steps to remove price control in case of many products. (Price Control
means that the companies will sell goods at the prices determined by the government.) The efforts to
remove price control were mostly in respect of fertilizers, steel and iron and petro products. Restrictions
on the import of these products have also been removed.

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COMPARATIVE ANALYSIS:
India’s Performance as Closed Economy v/s as Open Economy

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