How Does The Global Economy Work? –Everything You Need To Know

The global economy is a complex system of economic activities between countries of the world, whereby the countries involved pursue certain economic interests. While both major and minor players exist in the global economy, the economic policies of one player tend to affect (some) other players either positively or negatively. It is to this end that we may describe the global economy as a system comprising the world’s interdependent economies.

For a better understanding of the global economy, we may have to define some of the concepts that characterize the nature or workings of the global economy. These concepts include globalization, global investment, international finance, and international trade.

Globalization is a very essential concept in the evolution of the global economy. While some experts might argue that globalization is the process that birthed the global economy, others believe that globalization is responsible for the advancement of the global economy into an integrated network of economies enjoying free flow of capital, trade, labor and information.

While it is believed to have been influenced by globalization, international trade is an activity which entails exchange of commodities –goods and services –between multiple countries.

As part of the activities that characterize the global economy, global investment involves taking investment efforts beyond national boundaries. This, in other words, means establishing and running investments in different foreign territories.

International finance is partly similar in meaning to international trade. The only difference is that while goods/services are dealt with in international trade, money acts as the major item of concern in international finance. This is why international finance covers monetary issues –monetary policies, currency exchange rates, etc. –taking place between countries.

Understanding how the Global Economy Works

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The best way to understand how the global economy works is to view it as a marketplace where “transaction” strongly binds “seller” and “buyer”. In this context, “seller” and “buyer” are the economies that make up the global economy while “transaction” may refer to international trade or any other economic concept that binds countries.

In economics, international trade is a common concept which refers to the exchange of goods and services between two or more countries. It is through this concept that countries of the world sustain the global economy. In simple terms, the workings of the global economy heavily depend on the transactions between economies –including large and small economies.

Broadly, the continuance of the global economy is strongly influenced by the fact that many countries agree to trade with each other in a bid to achieve certain economic goals. Although some countries have strict policies against importation and exportation, it remains a fact that most, if not all countries, engage in international trade by exporting goods/services to other countries or importing from other countries. This is where economists discuss the concept of “comparative advantage”.

An economy is believed as having a comparative advantage in a situation where it can incur lower costs –compared to what other economies will incur –in the production of a particular commodity. The fundamental implication is that countries of the world should produce (and probably export) the commodities over which they have a comparative advantage, but where they don’t have a comparative advantage, they should endeavor to import. While this probably explains why countries continually trade with each other, the transactions in international trade are simply the lubricants oiling the wheels of the global economy.

Analyzing the Impact of the Global Economy

In analyzing the impact of the global economy, it is essential to pay attention to how larger economies influence smaller –or seemingly “less important” –economies. We’ll better understand the global economy by analyzing how major economic decisions of one country affect the economy of another country.

Due to the interrelationship between countries (the interrelationship which often manifests as international trade), major economic decisions, such as imposition of trade quotas and high trade tariffs, by one major country often affects the economies of (minor) countries that substantially export commodities to that major country. While the high trade tariffs may be strategically intended to discourage importation into the major country, imposing trade quotas would be a move by the major country to limit the number of commodities that can be imported from the minor countries.

Stringent import restrictions by the major country would likely have a negative effect on the minor countries by drastically reducing their export earnings.

An illustration of the impact of the global economy can be specifically drawn from the predicted impact of Brexit on the economies of other European countries. While Brexit refers to UK’s exit from the European Union (EU), it was widely argued that the exit might drastically reduce the GDP of the EU, thereby having a negative impact on the economies of other EU member states.

The interrelationship between economies of the world –to form the global economy –is so impactful that the major economic decisions of any large economy (such as US, UK, China, etc.) may affect other economies. Why this is so is that the concept of international trade permits two or more countries to exchange goods and services with each other, and when there is an international trade barrier such as the imposition of import restrictions by a major country, there’s bound to be an (unfavorable) impact on other countries.

The recent failure of Russia to supply gas to Europe is another good angle from which we may describe the impact of the global economy. Russia is one of the powerful economies of the world. As one of the world’s largest producers and exporters of crude oil, Russia definitely has an impact on what happens in the globe especially with respect to energy supplies.

For a long time, Germany and several other European countries have been heavily dependent on Russia for gas. In June 2022, Russia significantly reduced the volume of gas supplies to Europe, and in the month (July) that followed, it shut down the pipeline supplying gas to Europe for several days. While Russia quoted the need for maintenance as the reason for the 10-day shutdown of the pipeline, it is quite unfortunate that –at the time of writing this post –Russia has fully shut down its Nord Stream 1 pipeline, thereby stopping all Europe-bound gas supplies.

The impact of the pipeline shutdown has been badly felt across Europe. According to reports, households in the affected European countries –inclusive of Germany –are now dealing with sky-high gas prices. According to an expert verdict, the shutdown could badly affect European economies to the extent of causing recession.

Management of the Global Economy

Large financial institutions play an important role in the management of the global economy. By deep analysis, these institutions are in fact the major drivers (i.e. financiers) of the global economy.

If we however analyze it superficially, we might mistake governments of the world’s biggest economies as the actual drivers of the global economy. By virtue of their political powers, governments (esp. those of the world’s biggest economies) have a major influence over what happens in the global economy. But for the fact that these governments depend on large financial institutions and corporations for funding, we can safely argue that the world’s biggest corporations and financial institutions are the major drivers of the global economy.

These powerhouses –big corporations and financial institutions –largely influence governments’ decisions and policies. In some cases, they exercise (partial) control over certain public assets and government businesses. In the United States, for instance, banks partake in the control of oil distribution, power production and certain other government businesses.

In What Ways Is the Global Economy Beneficial?

The global economy benefits countries of the world –inclusive of large and small economies –in various ways. First of all, the global economy paves the way for the concept of free trade which implies barrier-free transactions (involving exchange of goods/services) between countries. This concept of free trade, by extension, encourages countries to voluminously produce the commodities over which they enjoy a comparative advantage, with the ultimate aim of exporting the commodities.

Moreover, the global economy encourages movement of labor between countries, and the underlying benefit of such movement is that unemployed individuals can leave their country for countries with lots of employment opportunities.

Free trade, movement of labor, etc., are concepts that bring about favorable outcomes. Since the global economy gives room for cooperation between different countries of the world, there’s bound to be business partnership between the countries. Particularly, the developing nations of the world benefit from such as they tend to attract investments from the large corporations in developed nations.

Largely, the global economy has stimulated some big corporations in the US, UK and China to establish branches across different developing nations in Africa and other continents.


FAQs

What Is Meant by “Global Economy”?

The global economy is a complex system of economic activities among countries of the world, whereby the countries involved pursue certain economic interests. For the sake of simplicity, we can describe the global economy as a system comprising the world’s interdependent economies.

Is “Globalization” the Same as “Global Economy”?

No! Although a relationship exists between them, “globalization” and “global economy” are markedly different concepts. While some experts might argue that globalization is the process that birthed the global economy, others believe that globalization is responsible for the advancement of the global economy into an integrated network of economies enjoying free flow of capital, trade, labor and information.

What Is an Economy?

The term “economy” has been defined under various circumstances and differing contexts. In the context of economics, an economy may be defined as a system of components –precisely economic activities –which influence how a group, society, etc. allocates its resources.


Conclusion

The global economy appears as a complex system, but we can simply view it as a transactional system in which countries (trade partners) of the world pursue economic interests.

Our discourse in this post must have armed you with essential knowledge about the nature and structure of the global economy. While this post has especially analyzed the impact of the global economy and discussed the forces managing the global economy, we believe our discourse has also furnished you with additional knowledge of the subject matter.

References:

https://www.edology.com/blog/accounting-finance/how-does-global-economy-work/

https://corporatefinanceinstitute.com/resources/knowledge/economics/comparative-advantage/

https://www.bbc.com/news/world-europe-60131520.amp

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