Open economy is an economy where a country has no restriction in conducting its economic activities with other countries. The country allows free flow of exports and imports in and out of its boundaries. These economic activities may be implemented by individuals or government with other individuals or government from another economy. This makes the economy a free market where there is free movement of goods and services that are tangible and non-tangible to the rest of the world.
Closed economy is where there is no economic relation with other economies. The government of a certain country may decide not to engage in business affairs with other countries by putting restrictions on the way it is conducting its economic activities. Thus, there is an exchange of economic activities only within that country. Since the world is becoming one global village due to globalization and other reasons, all countries in the world have adopted open economic systems in order to meet their internal and external needs.(Suri, n.d.)
The Differences between Open and Closed Economies
In an open economy, export and import take place without restrictions. Excessive goods and services that are produced may be sold to those countries that do not produce them. In a place where a country does not produce such goods or services or produce them expensively, they can easily be received by importing. Therefore, production in an open economy is for international trade, while in a closed economy, it is for domestic consumption. Only those goods that are produced in that country are available on the market.
In an open economy, individuals and the government may invest in foreign capital assets such as shares and bonds. They can sell their domestic shares and securities to foreign investors and buy foreign capital assets to earn an interest rate. In a closed economy, individuals and government invest in their own capital assets and they are not able to invest in foreign countries. (“Open-Economy Macroeconomics: Basic Concepts”, n.d.)
In an open economy, a country can borrow money from another country to fund its projects or pay debts. It can also lend other economies that, in turn, earn income. These processes are facilitated by the presence of global financial market such as World Bank and International Monetary Fund. In a closed economy, there is no such a notion like borrowing or lending due to the controls or barriers that imposed by the government, thus, the country depends on its own resources.
In an open economy, the gifts and remittances to and from other economies are accepted by individuals and government. In a closed economy, the gifts and remittances are not encouraged simply because there is no relation with other economies. Citizens from a closed economy may not be employed in foreign countries, whereas those from an open economy will easily find an employment everywhere in open economies.
The Advantages of Open Economy
An output that is produced is marketed globally, since there is minimal or no barriers of trade such as tariffs and quotas. Such state of affairs gives consumers a wide range of products to choose. Since consumers have different tastes and preferences, they have a wide range of choice of goods and services that will suit their income and tastes. Producers can also brand their goods and in such a way attract customers. For example, many people have vehicles that were manufactured in Japan or America. Another example is different beverages like cocoa, coffee, and tea. Such variety of goods on offer enables consumers to choose.
Modern global economy has enabled producers to expand their market from national to international one. This increases the number of customers who may sell directly to consumers or re-pack and brand to increase the value of that product.
Many producers enter the market because there is an increased global demand. This leads to the competition where each producer strives to produce good quality that can find a market, and this lowers the price of the product, making it affordable to many consumers. This also improves the services that are provided to the customers. An example is airline services where the local and international companies like Fly Emirates are present. These benefits consumers, investors, and even the nation, which receives it in the form of charged tax.
International trade helps in increasing specialization by making producers concentrate on ways of improving their production to increase quality. For example, Japan specializes on vehicle production. Open economy also encourages innovation and invention. For example, many things that are regarded as useless in one economy can be regarded useful in another economy. For example, second-hand clothes are regarded useless in developed countries but useful in underdeveloped countries.
When one economy is saturated with the same category of investment, open economy may enable the investor to look for investment opportunities in other economies globally, for example, financial provision. In many cases, business deals with risk taking; thus, the investor may invest in other economies to increase their returns. Capital and financial markets have attracted many foreign and domestic investors (Hall, n.d.).
Open economy has helped trading partners to have a good relation among themselves. This has brought peace and mutual understanding with these economies. For example, Asian countries established an interrelation with African countries, which can be proved by Chinese building Africa roads. There is no war between countries that have their residents in other related economy. Due to the easy movement within those economies, cultural interaction like international marriage is possible.
Open economy has enabled the economies that do not produce certain goods and services to have an access to them. For example, a country that does not produce oil, can access it through importing from oil producing and exporting countries. This makes economy work with efficiency.
Some economies may have natural resources but lack the technology or funds to produce certain goods. Open economies makes this possible by importing technology or encouraging foreign investors. If the expected return from producing those commodities is high, they may choose financial borrowing. For example, East Africa countries like Kenya and Uganda had to hire foreign countries to discover oil in these countries, which would not be possible, if it was in a closed economy.
The Disadvantages of Open Economy
Competition makes producers strive for improving their products so as to make more customers on the market to buy their products. Moreover, they are forced to lower prices to make their products affordable. Those who are unable to survive the competition are forced to liquidate their enterprise, which leads to the loss of jobs or low wages. It also leads to the loss of income of producers and government in terms of taxes. Due to the fact that there is minimal or no imposed tariffs or quotas, imports may be cheaper than locally produced goods, which, thereby, forces the local firms to be closed due to high operating costs.
Open economy enables the movement of capital resources to where they can be invested with high returns. Investors and professionals move from economies where there are high operating costs to the lower ones, which results in “brain drain”. Experts move to the areas where they can maximise their expertise with high returns. For example, they move from developed countries like Japan to developing countries like Africa. This makes developing countries be over depended.
Specialization makes country rely on what they can produce cheaply and in excess for export. Due to the excessive production, there is a constraint on the resource, which may lead to depletion, if they are non-renewable, e.g. oil, coal, and minerals. Overdependence on one sector may have adverse effects on the economy in the long run. For instance, a country relying on agriculture for its income may be affected when a change of climatic conditions like severe drought or floods is observed. This may lower the quantity of production, thereby, lowering the export and creating deficit and problems of balance of payment.
In an open economy, there are many concerns about employment of its residents. Cheaper import than export may lead to the closure of firms, which will affect its workers, and lower employment opportunities within that country. Lack of these jobs brings idleness, increase of crimes, drug abuse, and overreliance on those working, which all leads to poverty.
Dependence on imports may lead to exposure to political, economic, social, and cultural risks. Import of crude weapons and nuclear may lead to war in those economies that have an access to weapons. For example, weapons from Iraq brought terrorism in America and such situation affects security and defence of the economy. Other imports that may expose a country to risks include food, medicine, and energy among others.
Open economies are exposed to the global market fluctuations of prices and value of the currency that is used. Value of imports and exports depends on the international market price. If the value of a country’s imports exceeds those of its exports, the country experiences a deficit, which leads to indebtedness. Large capital flows affect the country’s economy, because it lowers its income, thus, making difficult funding their projects and financing their loans. The currency that is used in the global market, such as dollar and pound, affects one’s economy especially when its currency depreciates, which leads to the problems on foreign exchange and balance of payment. (“Open and Closed Economies”, 2010)
Open economies have an evident superiority to the closed economies. In order for the countries to develop, they need to trade with other economies, cement their relationship, which will increase employment opportunities, increase the income, receive the goods and services that they cannot produce, and also work with efficiency due to specialisation