Open Economy: Objectives, Characteristics, Pros and Cons

Understanding how an open economy works is important for policymakers, economists, and anyone interested in global trade and finance. Learn about the open economy on this blog.

Due to the consolidation of international trade and globalization, the concept of an open economy has become the basis of the economic model of most countries, representing a significant percentage of GDP. Let us learn more about this concept.

Content

• What Is An Open Economy?
• Objectives of the Open Economy
• Characteristics of the Open Economy
• Advantages and Disadvantages of an Open Economy
• Examples of an Open Economy

Must Read –What is Finance?

What is an Open Economy?

An open economy is an economic model proposed by Erich Schneider in 1995. It engages in international trade and has a relatively free flow of services and goods between countries. In such an economy, changes in foreign exchange rates, trade policies, and international capital flow influence a country’s economic activities.

Consequently, consumers have the opportunity to receive exactly the services and goods that they dreamed of. At the same time, the entire society of a certain nationality is included in the international division of labor.

Explore Online Finance Courses

Objectives

• Reduce the risk of economic instability. 
• Reduce unemployment.
• Increase production efficiency.
• Increase the efficiency of the distribution of goods to reach the greatest number of people possible.
• Increase the efficiency of the allocation of resources so that a greater number of public and private companies participate in the country’s economy.

Characteristics

With an open economy, world capital is distributed and the exchange of knowledge, technology and qualified personnel. This benefits society, as well as the state as a whole.

It has the following characteristics:

• The specialization of the economy focuses on both external and internal markets.
• There is a price comparison of domestic and foreign goods, ultimately reducing consumer costs.
• It classifies consumption into private consumption (families), public consumption (government) and foreign consumption (exports).
• Part of the operations of national business entities is export-oriented.
• When organizing the production and development of technologies, foreign trends are considered.
• International treaties and obligations take precedence.
• It has foreign relations and also capital formation.
• It has five sectors: companies, families, government, capital, and abroad.

Advantages of an Open Economy

The macroeconomics of an open economy is extremely beneficial, considering the benefits associated with its implementation. For a country that decides to use this economic model, the main advantages are:

• A greater quantity of goods and services for consumers and an increase in competitiveness and, therefore, pressure to offer consumers the best quality.
• Job creation by foreign industries.
• Increases investment opportunities, economic growth and economic development.
• Participation of national production in the world economy and greater exploitation of the potential and export to the world
• Consumers also have more choices between products.
• You have a better chance of adapting to changes in the world economy.
• It contributes to faster and more dynamic global growth.
• It encourages research, development and innovation.
• There is a wide variety of products since the commercial base is so large that there is always a less expensive and more efficient alternative.
• It gives a country a say in international trade, decisions and relations.
• Increase in the social welfare of the inhabitants.

Disadvantages

Despite the obvious advantages, an open economy also has certain disadvantages:

• It is susceptible to global risks such as a slowdown.
• A country with a completely open economy risks becoming too dependent on imports.
• Domestic producers can suffer in an open economy because they cannot compete at low international prices. As a result, governments can use trade controls such as tariffs, subsidies, and quotas to help domestic companies.
• Any change in these determining factors may result in a large-scale international movement of funds.
• A country may be forced to adopt certain production technologies that prevent it from making the most of its factor endowments.
• Alternatively, you may be forced to limit your exports. Such a situation may be imposed on a country with limited bargaining power or experiencing balance of payments difficulties.

Examples

Most countries today have an open economy. Their goods and services can be traded across borders, and most industries tend to be privately owned.

Imports and exports represent a large part of GDP. As a result, the citizens of the countries have access to a wide range of products from national and international brands.

Among the countries with great economic openness consolidating their open economy are Singapore, Ireland, Switzerland, Taiwan, Luxembourg, Hong Kong, Djibouti and Malta.

Conclusion

An open economy has its advantages and disadvantages. On the one hand, the citizens of these countries have more opportunities to choose goods and services and invest their savings abroad. On the other hand, the interdependence of open economies and, consequently, a high probability of additional risks.

Top Trending Finance Articles:

Financial Analyst Interview Questions | Accounting Interview Questions | IFRS Certification | CPA Exams | What is Inflation | What is NFT | Common Finance Terms | 50-30-20 Budget Rule | Concept of Compounding | Credit Cards Rewards System | Smart Budgeting Approaches