Open economy

An open economy is an economy in which there are economic activities between the domestic community and outside (people, and even businesses, can trade in goods and services with other people and businesses in the international community, and funds can flow as investments across the border). Trade can take the form of managerial exchange, of technology transfers, and of all kinds of goods and services. (However, certain exceptions exist that cannot be exchanged - the railway services of a country, for example, cannot be traded with another country to avail this service, a country has to produce its own.) This contrasts with a closed economy in which international trade and finance cannot take place.

The act of selling goods or services to a foreign country is called exporting. The act of buying goods or services from a foreign country is called importing. Together exporting and importing are collectively called international trade.

There are a number of economic advantages for citizens of a country with an open economy. One primary advantage is that the citizen consumers have a much larger variety of goods and services from which to choose. Additionally, consumers have an opportunity to invest their savings outside of the country.

If a country has an open economy, that country's spending in any given year need not equal its output of goods and services. A country can spend more money than it produces by borrowing from abroad, or it can spend less than it produces and lend the difference to foreigners.[1] As of 2014 no totally closed economy exists.

On the other hand, a managed or closed economy is characterized by protective tariffs, state-run or nationalized industries, extensive government regulations and price controls, and similar policies indicative of a government-controlled economy. In a managed economy the government typically intervenes to influence the production of goods and services. In an open economy, market forces are allowed to determine production levels.

A completely open economy exists only in theory. For example, no country in the world allows unlimited free access to its markets. Most nations have fiscal and monetary policies that attempt to improve their economies. Many economies that are open in some respects may still have government owned, monopolistic industries. A country is considered to have an open economy, however, if its policies allow market forces to determine such matters as production and pricing.

The transition from a managed economy to an open economy can be a difficult one. Following the collapse of the Soviet Union, efforts to establish free trade and an open economy in Russia resulted in widespread hardship among the nation's middle class and a failed bank system. In Southeast Asia a fullscale financial, economic, and social crisis erupted in 1998, revealing how difficult it was to maintain a small open economy in countries such as Thailand, Indonesia, Malaysia, the Philippines, and Singapore. In South Korea, the nation's president asked its citizens to accept widespread unemployment and bankruptcies in order to move the country toward an open economy by selling off government-owned industries. Germany's transition to an open economy resulted in high levels of unemployment throughout the nation.

Social, political, and economic instability can be avoided in countries moving toward open economies, but domestic conditions must be favorable. For example, states with powerful bureaucracies can establish favorable domestic economic conditions if they have the proper ideology, accept diversity, and achieve legitimacy in the eyes of their citizens. For open economies to succeed in small countries that formerly had managed economies, favorable domestic conditions include a working education system, legal system, judicial system, and low inflation. Such conditions provide the stability necessary for an open economy to flourish.

Economists recognize an open economy as being more efficient than a managed economy. In the 18th century, economist Adam Smith (1723 1790) wrote Inquiry into the Nature and Causes of the Wealth of Nations to explain the benefits of an open economy and free trade. He wrote that interventions in international trade, such as tariffs and duties, serve only to reduce the overall wealth of all nations. Similarly, interventions in the domestic economy are also regarded as inefficient. Smith developed the concept of "the invisible hand," which in effect stated that when individual enterprises work to maximize their own profits and well-being, then the economy as a whole also operates more efficiently. He argued that the economy does not require government intervention, because the operations of domestic producers are guided, as if by an invisible hand, to benefit the economy as a whole.

Date: 2015-04-20; view: 1174