An open economy is anyone that carries out commercial interactions with the exterior; in other words, they are those that carry out the purchase and sale of goods, services, or financial assets with other economies of the world.
Concepts such as international trade and globalization currently find their greatest expression due to the existence of economies increasingly exposed to imports and exports, which in turn are established as the economic base of most countries in the world. This aspect favours the weight in their respective GDP.
In general, to open their economies, countries sign trade agreements whose objective is to control and regulate the entry and exit of goods and services, which in turn allows the creation of trade routes, which can later be expanded in terms of economic integration.
Just as there are open economies, there are also closed ones. Their main difference is that, as there is an input and output of goods and services, the savings-investment identity is transformed because the economy is not financed. Internal physical capital with the support of savings since this is used to finance capital in other territories. The other aspect that changes is the expenditure-production; since there is an opening to the exterior, it is possible to acquire more financing, which is given through loan mechanisms between countries.
However, the opening of a country’s economy means that a flow of imports and exports throws up new concepts to take into account:
- Exchange rates
- Balance of payments
- Current account balance
This type of economy is measured in terms of net exports, that is, how many monetized goods and services leave the country to be added or entered, to be subtracted.
The main reason for an open economy is that every country is partially self-sustaining; it does not produce or have all the products, services, raw materials, technology, etc., and therefore requires support from another country or region.
This type of economy allows the exchange not only of goods and services but also of technology, capital, and labour force, and among its main features are:
Public Expenditure: It consists of the purchase of goods and contracting services carried out by the States. Generally, this public spending uses products and services from the internal market so that the local economy is favoured.
There may be exceptions where foreign prices are significantly lower, or there is no local production in a foreign economy.
Private consumption is the purchase of goods and services carried out by individuals, families, and private companies.
In an open economy, private and public consumption can be local or foreign products and services.
Domestic investment is using capital (money, foreign currency, gold) to obtain higher income over time.
Domestic investment is that made by individuals, companies, or the State in local companies, which means that the capital remains within the internal economy.
Foreign investment: In an open economy, there is an alternative to domestic investment: sending or receiving capital to or from abroad.
When a company wants to make a foreign investment, it puts long-term capital in a foreign country to create production branches.
This means that the capital leaves the internal market; however, if the company grows, it will obtain more capital that can be returned to the domestic market or increase investments in the foreign market.
Likewise, a local company can seek investment to grow (increase its production, its profits, or the quality of its products).
Exports refer to goods or services produced within a national territory but consumed outside of it.
Local production can have a greater volume of products if they have an international market that offers them export; the greater the volume of production, the greater the profits if that production is consumed in the country in which it is provided.
In the case of service providers, exporting allows them to have a greater number of clients and a greater range of prices since, in other countries, the same service may have a higher cost.
Imports: These are those products that a company buys abroad to be distributed and sold within its country of origin.
The demand for foreign products and services may exist when they are of better quality than the local ones or their price is cheaper.
Another example is when it cannot be manufactured in the country due to a lack of raw materials, heavy industry, or the necessary environmental conditions that do not exist.
Import-Export Agreements: To achieve better conditions or prices, the governments of various countries usually sign agreements that regulate and thus facilitate trade.
Exchange rates: Each country has its currency, making it difficult to buy and sell products and services to other countries.
To solve this, two solutions are proposed:
- Use a third currency, which is a benchmark in both countries.
- Calculate an exchange rate between the two currencies, a proportion of value existing between one and the other.
- Currently, exchange rates are set by central banks internationally.
Advantages
Among the advantages offered by open economies, you can find:
- It supposes the possibility for consumers to choose between a greater variety of goods or services, considering that the offer is expanded by adding nationals and foreigners. Additionally, it allows you to find products at a lower price.
- Increase in the number of investment possibilities, this thanks to a greater opening in the financial field, to which must be added the role played by technology.
- Companies and organizations can develop economic and exploitation activities around the world.
- For producers, it represents an opportunity to offer better products at a lower price so that competitiveness is maintained. Likewise, they can export their products and, in some cases, have foreign capital that makes direct investments.
Disadvantages
- The improvements in competitiveness that international trade brings can be negative for smaller producers.
- The benefit of trade is much greater for the economies that export than for those that import, proportionally speaking.
- Consumption focuses on foreign products, leaving national production aside, which results in losses for the local economy.
- Open economies allow constant growth only when exports exceed imports.
- Small and medium-sized companies, which need more resources to compete at all levels with large companies, could go bankrupt.
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