General Awareness

April 04, 2017 @ 01:15 PM

Concepts of Open economy & closed economy

MBA Aspirants are expected to know in regard to Indian Economy.  Today, you will read on Concepts of Open economy & closed economy
 
Concept of economics is older than the origin of the subject. As soon as the concept of society took birth, economics also took birth. In ancient times, every society exchange goods with other societies, thus even the most conservative societies in the world are open societies engaged trade with the rest of the world. Even the 5000 years old Harappan civilization was an open economy and was engaged in trade with the contemporary Mesopotamia civilization.
 
Today almost every country is engaged in trade as no country produces every commodity enough to satisfy the want of its citizens. For instance, India had to import petroleum products while gulf countries import food grains. In modern world, closed economy is considered as one which does not have any sort of economic relation with rest of the world but is confined to itself only.
 
A closed economy does not enter into any one of the following activities -   
 
(i) It neither exports goods and services to the foreign countries nor imports goods and services from the foreign countries.
 
(ii) It neither buys shares, debentures, bonds etc. from foreign countries nor sells shares, debentures, bonds etc. to foreign countries, thus it is financially also as closed economy.
 
(iii) It neither borrows from the foreign countries nor lends to the foreign countries.
 
(iv) It neither receives gifts from foreigners nor sends gifts to foreigners.
 
(v) Normal residents of a closed economy cannot go to other countries to work in their domestic territory. No foreigner is allowed to work in the domestic territory of a closed economy.
 
Situation where no external trade occurs is also called autarky. Due to above mentioned reasons; Gross Domestic Product and Gross National Product are the same in a closed economy. However, in strict sense, absolutely closed economies are non-existent today as every country trades with the rest of the world. 
 
However a closed economy term is used for the economies with high tariff walls, having relatively low level of foreign trade. India before globalization was considered as a closed economy because it was very apprehensive towards foreign trade and protected its domestic boundaries through high tariff walls. Foreign investment was also not promoted due to the bitter experience of East India Company of England.  
 
On the other hand, an open economy is one, which is not only involved in the process of production within its domestic territory but also can participate in production anywhere in the rest of the world. 
 
An open economy involves itself in the following activities. 
 
(i) It buys shares, debentures, bonds etc. from foreign countries and sells shares, debentures, bonds etc. to foreign countries.
 
(ii) It borrows from foreign countries and lends to foreign countries.
 
(iii) It can send gifts and remittances to foreigners and can receive the same from them.
 
(iv) Normal residents of an open economy can move or be employed and are allowed to work in the domestic territory of other economies.
 
(v) Due to these reasons, Gross Domestic Product and Gross National Product are not same in an open economy. It is to be noted that at present all economies of the world are open economies.
 
Most economies in their initial stages of development follow relatively closed economy policy as their fear that the competition from MNCs may crush their nascent domestic industries. Such policies were followed by India, USA etc in their initials stages of development. Thus the self reliance was a major objective behind the closed economic policies. 
 
Once their domestic industries developed to take the might of MNCs, they adopted the open economic policies. Many economists held that domestic industries must be protected in the initial stages of development but once the domestic industries gathered strength, country must adopt the open economic policy. 
 
According to them nurse the baby, rear the child and free the adult i.e. with the gradual development, industries must be freed to take on the world competition. In case of agriculture, India still follows the closed economy policy as Indian farmers are still vulnerable to the highly subsidized agri-products of developed world. 
 
Another argument which favors the closed economy is the insulation of domestic economy from the cyclical upswings of the world economy. More a country attached to the foreign trade and investment, more it is vulnerable to the global slowdown. If India didn’t have foreign trade and investment with USA, it would not have been impacted by the financial crisis of 2008-09. In 1930s, due to the relative insulation of Russian economy from the other capitalists’ economies of the world, it wasn’t impacted by the Great Depression of 1930s. In this manner autarky also provides a shield from the global upheavals However, the benefits of open economy quite outnumber the advantages of closed economy. 
 
An open economy widens the market of a country to such an extent which a closed economy can never realize. If Indian and Japanese, both are a trillion dollar market, by entering into a free trade pact, both countries widened their market to the tune of 2 trillion dollar, thus bringing upon the huge prospects for their companies in an enlarged market. 
 
Benefits of an open economy can be surmised by comparing India’s economic performance in the pre and post globalization years. In the pre globalization era, the globalization years, GDP growth rate of India was sarcastically called as Hindu Growth rate while in the post globalization years, Indian economy has emerged as one of the fastest growing economy of the world.  
 
Moreover, in an open economy, prices are also found to be low and the qualities of products are better due to increased competition. Consumers also have more choices for consumption. When India was a closed economy, if you have to buy a car, there were only three choices, Maruti, Fiat and Ambassador, while now; there is a vast array of companies. Another benefit of an open economy is that it is more flexible. An open economy has a greater chance of adjusting itself with the changes taking place in world economy.
 
Though it is true that an open economy is vulnerable to the global risks like slowdown but it is true that open economy is also a partner in the faster, vibrant global growth. Despite of inherent risks with the open economy, it is worth to be followed because of the immense direct and indirect benefits associated with it.
 
  
 
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