Balancing Trade-Offs: Comparing Closed and Open Economies for Global Expansion
What on Earth is This? A shuttered economy—this daunting terrain where no trades occur with foreign nations. Its growth is nourished solely by household spending, business investments, and government expenditure.
You'll be hard-pressed to stumble upon a country that adheres to this economic isolationism. Not even North Korea, despite its formidable efforts, manages to completely disconnect from the global market.
Shuttered vs. Open Economy
A shuttered economy signifies a country with almost no interaction with the external sector, devoid of any exports or imports, or international financial transactions.
An open economy, in contrast, boasts a fully operational external sector, engaging freely in international trade, allowing the import and export of goods and services. Interaction with other nations includes the exchange of production factors (capital and labor), technology, and intellectual properties.
This interaction sparks the development of a foreign exchange market, facilitating transactions between nations. Currency exchanges, for example, help fund imported products, while domestic currency conversions can be completed when we have foreign currency to spare.
Open economies offer multiple advantages. Consumers gain access to a rich tapestry of foreign goods and services unavailable in the domestic market. Producers benefit from an expanded array of raw materials and capital goods. Investors diversify their investments and enjoy global opportunities. And let's not forget those gunning for better career prospects abroad.
However, this openness also comes with drawbacks. Exchange rate risks arise, making domestic economies vulnerable to the volatile whims of international finance. International capital flows may introduce instability, potentially destabilizing the domestic economy. Economic shocks in one country can swiftly spread to others, as we witnessed during the 2008-2009 global economic crisis in the United States.
To rein in these threats, governments implement various protective policies. They seek to shield the domestic economy from unfavorable conditions by imposing import tariffs, quotas, and non-tariff barriers on foreign goods. They opt for exchange rate controls and capital controls to manage excess capital inflows, preventing harmful inflation and economic instability.
As globalization progressed, such protective policies have diminished in popularity. Modern trends favor increased openness. Production, trade, capital flows, and labor have become more intertwined among countries, marked by:
- Heightened participation of developing countries in world markets
- The march towards free trade zones
- Economic integration under a single currency, like the eurozone
- Lower transportation costs between countries
- Rapid technological advancements that span the globe
- The growing role of transnational and multinational corporations in the global production chain
Curious about countries that embrace shuttered economies? Here's a hint—even one as mysterious as North Korea still maintains some contact with the global market, albeit minimal.
Some countries, however, choose to limit their transactions with the external sector. They control the flow of goods, services, and capital while shutting out foreign investment in certain industries, like oil-producing countries that ban foreign oil companies from operating within their borders.
Can a shuttered economy bloom? Theoretically, yes, but it would grow at a fraction of the speed of an open economy. Instead, such an economy relies heavily on household consumption, business investments, and government spending, using only domestically-sourced production inputs and relying exclusively on national savings for investment capital.
Embracing a shuttered economy is a difficult path to tread in today's world. With few countries possessing the raw materials for self-sufficient production, many are forced to acquire essential resources from abroad. Take crude oil, for instance—more than just an energy input, it's also used to produce everyday items like fertilizers and plastics. And, unless you're lucky enough to live in an oil-rich nation, your access to these essential resources is highly compromised by shuttered economy policies.
The growth of a shuttered economy is comparable to a shrub forcing its roots to take hold in an arid wasteland. It may struggle to cultivate goods and services, limiting the range and quality available to consumers.
Contemporary economic theory largely disapproves of shuttered economies. International trade is seen as the gateway to a prosperous economy, with exports driving economic growth. As exports increase, domestic production flourishes, creating more jobs and generating income.
To accrue benefits from international trade, countries should focus on producing goods and services where they possess a comparative advantage—allocating labor and resources to those areas with the lowest costs. For goods beyond their comparative advantage, they can import them from abroad—usually at a lower cost.
In a shuttered economy, the external sector remains non-operational, limited by a lack of exports, imports, or international financial transactions, contrasting sharply with the dynamic environment of an open economy with multiple global interactions.
Given the interconnectedness of modern economies, maintaining a shuttered economy is challenging, especially for countries lacking self-sufficient production capabilities like essential resources such as crude oil.
