4.5 Role of the State in the Macroeconomy Flashcards
What are the main types of expenditure
- Capital Expenditure
- Current Expenditure
- Transfer Payments
What is capital expenditure
This is government spending that increases the capital stock of the economy (Increasing LRAS)
What is current expenditure
This is government spending on items that are recurring and only lasts a limited time e.g. spending on public sector wages
What are transfer payments
payments from the government to individuals, represents a redistribution of income in society
e.g. pensions, welfare payments
What are the 2 key measures of government spending
- Real government spending – Spending levels adjusted for inflation.
-
Government spending as a % of GDP – Government spending, as a
share of national income.
How has UK public spending as a % of GDP changed over time
Government spending as a % of GDP rose sharply from 2000 to 2022, with a
peak in 2020/21 due to the Covid Pandemic.
How has UK public sector reciepts changed as % of GDP
government spending also correlates to UK public sector receipts (mostly tax revenue). There was a prolonged fall in tax revenues as a % of GDP from 1981 to 1993, which has since been reversed.
What is the impact of higher government spending
- More investment in education and infastructure
- Redistribution
- Fiscal Policy - in rrecession can be effective to stimulate economy
- Crowding in
Evaluate the effects of higher government spending
- Higher taxes create disincentives for work/investment
- Public Sector lacks efficiency from no profit motive
- Crowding out resources from the private sector
- Vested interests push governments to inefficiency e.g. lobbying
- Kind of Spending- welfare payments may be detrimental to efficiency
- Spending doesn’t have to be inefficient if it utilises the private sector
What is UK government spending in 2023 by size
- Healthcare (20%)
- Pensions (17%)
- Welfare (13%)
- Education (10%)
- Interest (8%)
- Defence (6%)
- Transport (4%)
What influences the size and composition of public spending
- Incomes
- Demographics
- Expectations - esp in democracy
- Business Cycle
- Interest on debt
- Inflation- raise MNW, UE Benefits, Pensions
- Political Priorities -political churn, election
- State of Global Economy
How does the stage of development influence public expenditure
- Developing: low tax revenue due to avoidance, inefficiency and little wealth to tax–> Can’t provide much through spending
- Developed: demand more services frrom governments ( income elastic )
How did the 2008 Global Financial Crisis influence public expenditure
- Huge increases for welfare payments + Bailouts
- but induced 2010 austerity to rweduce debt
How will ageing populations affect public expenditure
Europe and Japan will see pressure on government spending due to aging populations meaning larger pension bills and higher levels of care
needed.
What is the effect of public expenditure on productivity and growth
- infrastructure reduces costs for businesses
- Education increases human capital –> increased productivity
- Healthcare reduces the number of days sick
- Crowding in on frontier
- Free Market argues gov. spending is wasteful
What is the government multiplier of spending according to the OECDs
Gov. fiscal multiplier of 1.5-8 according to IMF
What is the effect of government spending on living standards
- Improve social welfare (correcting mkt failure + providing public goods)
- Reduce absolute poverty through benefits + Healthcare
but needs funding by higher tax - debt so crowding out
Evaluate the effect of government spending on living standards
government will be inefficient at providing goods and services and will have a negative disincentive impact on workers, meaning that output overall is reduced and so living standards fall.
government principal agent problem since they make decisions on behalf of the people who may have spent that money differently. As a result, there is a loss in welfare and so a fall in living standards.
What is crowding out
a process where an increase in government spending
leads to a fall in private sector spending.
What is financial crowding out
If the government increases it’s spending – say through selling bonds – The demand for money will increase, which, ceteris paribus, raises interest rates.
At higher interest rates, both consumer spending and investment spending are likely to fall.
The aggregate effect on the economy is that financial resources are diverted from private firms to be used by the public sector.
How does financial crowding out lead to a fall in GDP
Initially, via a multiplier effect, national income increases, but as a result of the government selling securities in the financial markets, the demand for scarce loanable funds increases.
This drives up interest rates, which causes a contraction in the demand by the
private sector for investment goods (capital) as well as reducing the demand for
consumer goods. This, in turn, leads to a fall in GDP.
What is crowding out in relation to the labour market
a relative increase in the public sector may push up wages in order to attract workers from the private sector.
The increased demand for labour reduces unemployment and ‘tightens’ the labour market, leading to possible shortages of labour available for the private sector use as well causing upward pressure on wage levels across the economy.
What fundamental financial fact drives crowding out
that financial and real resources are ultimately scarce, and if one sector of the economy increases its use of these resources, fewer are available for use in other sectors.
What is the Ricardian Equivalence
This means that attempts to stimulate an economy by increasing debt-financed government spending will not be effective because investors and consumers understand that the debt will eventually have to be paid for in the form of future taxes.
The theory argues that people will save based on their expectation of
increased future taxes to be levied in order to pay off the debt, and that this will offset the increase in aggregate demand from the increased government spending.
What did Barro say to support the Ricardian Equivalence
an increase in government spending will lead individuals and organisations to expect interest rates to rise in the future, they will save more in order to pay higher interest rates.
What is the evaluation of crowding out
it may be a weak effect, this depends on the various elasticities that exist in the relevant markets.
if the supply of loanable funds is elastic and the demand for capital is inelastic, the impact of higher interest will be relatively small.
What evidence did Enrice Moretti from MIT find about federal spending to oppose the ‘crowding out’ theory
Government spending leads to an increase in private spending; a ‘crowding in’ effect
What are 3 reasons for the crowding in effect
- Frontier technology projects have extremely high fixed costs so by letting the public
sector fund the research, it allows the private sector to realise higher
profits. -
“Spillover effects”, where new technologies find different applications
in the private sector. GPS, for instance, was first developed to help
missiles find their targets -
Credit constraints on the private sector, where a project is difficult to
fund without government support due to, say, an economic downturn.
Why does frontier/speculative funding have a crowding in effect
the potential outcomes from speculative research and development are inherently unknowable, which makes a new project impossible to justify commercially.
What is crowding out
a process where an increase in government spending
leads to a fall in private sector spending.
What is financial crowding out
If the government increases it’s spending – say through selling bonds – The demand for money will increase, which, ceteris paribus, raises interest rates.
At higher interest rates, both consumer spending and investment spending are likely to fall.
The aggregate effect on the economy is that financial resources are diverted from private firms to be used by the public sector.
How does financial crowding out lead to a fall in GDP
Initially, via a multiplier effect, national income increases, but as a result of the government selling securities in the financial markets, the demand for scarce loanable funds increases.
This drives up interest rates, which causes a contraction in the demand by the
private sector for investment goods (capital) as well as reducing the demand for
consumer goods. This, in turn, leads to a fall in GDP.
What is crowding out in relation to the labour market
a relative increase in the public sector may push up wages in order to attract workers from the private sector.
The increased demand for labour reduces unemployment and ‘tightens’ the labour market, leading to possible shortages of labour available for the private sector use as well causing upward pressure on wage levels across the economy.
What fundamental financial fact drives crowding out
that financial and real resources are ultimately scarce, and if one sector of the economy increases its use of these resources, fewer are available for use in other sectors.
What is the Ricardian Equivalence
This means that attempts to stimulate an economy by increasing debt-financed government spending will not be effective because investors and consumers understand that the debt will eventually have to be paid for in the form of future taxes.
The theory argues that people will save based on their expectation of
increased future taxes to be levied in order to pay off the debt, and that this will offset the increase in aggregate demand from the increased government spending.
What did Barro say to support the Ricardian Equivalence
an increase in government spending will lead individuals and organisations to expect interest rates to rise in the future, they will save more in order to pay higher interest rates.
What is the evaluation of crowding out
it may be a weak effect, this depends on the various elasticities that exist in the relevant markets.
if the supply of loanable funds is elastic and the demand for capital is inelastic, the impact of higher interest will be relatively small.
What evidence did Enrice Moretti from MIT find about federal spending to oppose the ‘crowding out’ theory
Government spending leads to an increase in private spending; a ‘crowding in’ effect
Why does frontier/speculative funding have a crowding in effect
the potential outcomes from speculative research and development are inherently unknowable, which makes a new project impossible to justify commercially.
How does government spending affect the level of taxation
● In most cases, where government spending is high, levels of tax must be high –> disincentive effect on work + investment
but.
● Oil-rich countries tend to be an exception, where revenue from oil can pay for most
of government spending.
What is the effect of government spending on equality
● Spending should increase equality as it leads to redistribution and helps to provide
a minimum standard of living for the poorest in society.
e.g. Northern Powerhouse, A Levels free after 18, pupil premium scheme
- But can help the rich disproportionately e.g. QE which can also harm poorest through higher asset prices
What arre the 2 main reasons for public expenditure
- Correct market failure (public goods, externalities, info failure)
- Prove more equity
What is the main justification for the government being as small as possible
Inefficiency of government (gov. failure)> market failure
Do tax and benefits always have disincentive effects?
No, depends on magnitude and context
e.g. Nordic Countries have high taxes + generous welfare benefits, activity rates are also very high while Nordic countries have similar rates of economic growth as the USA or the UK
What is a budget deficit
where the level of gov spending > tax revenue
What type of budget deficit is seen as undesireable
- Budget deficits to fund specifically current expenditure is seen as undesireable as future generations are paying for current spending
- However borrowing for ccapital expenditure or transfer payments (benefitting people directly today) is seen as fair because futurre generations will benefit from this investment - inter-generational equity
What is the Gordon Brown’s Golden Rule of borrowing and spending
Borrowing should only be used to finance expenditure on infrastructure which will benefit the UK in the longer term, and is not to be used to finance current spending/debt, as taxes should cover current spending.
What are the implications of Gordon Brrown’s golden rule of borrowing and spending
· The government needs to gain better control of the budgets.
· In the longer term, the increase in economic activity gained by the infrastructure investment should pay off the extra borrowing.
· The chancellor Gordon Brown also has a sustainable investment rule. This states national debt should always be less than 40% of GDP.
What are the causes of a budget deficit
- Recession –> rising UE
- Decrease in consumer spending
- Increase in **inactivity **
- Use of **expansionary fiscal policy **
- Increase in interest rates
- Ageing population
What are the economic justificatiions of a budget deficit
- To increase AD when economy operating below PPF
- Automatic stabilisers cushion fall in AD
- Fiscal stimulus will improve budget deficit in LR from higher growth and higher tax revenue
What are the arguments in favour of Austerity
- Reducing debt –> helps to keep UK taxes lower + reducing opp. cost
- Shrinking state encourages private sector growth
- ** increases investor confidence** in stability – attracts FDI into the UK
What are arguments against Austerity
- Austerity is self-defeating –> lower tax revenue
- Infrastructure investment will increase AD and LRAS
- Wrong to cut spending when economy is in liquidity trap
e.g. UK and USA response to GFC
Draw a diagram for crowding out
Increased government borrowing may lead to higher demand for loanable funds and a rise in market interest rates e.g. on bonds. This might increase borrowing costs for private sector businesses.
What is fiscal multiplier
fiscal multiplier measures the effect of a £1 change in spending or a £1 change in tax revenue on the level of GDP
What did the IMF find about fiscal multipliers compared to revenue multiplier
IMF research report published in 2014, “the literature finds that (government) spending multipliers tend to be larger than revenue multipliers.”
- This would be supported by Keynesian theory, which argues that tax cuts are less effective than spending increases in stimulating the economy
- The IMF also found that fiscal multipliers are generally larger in downturns than in expansions – this supports the Keynesian view of using fiscal stimulus when conventional monetary policy is found to be ineffective
When is there a low and high fiscal multiplier
What is progressive tax
This occurs when **those on higher income levels pay a
higher % of their income in tax **
e.g. the UK has a top rate of 45% on
marginal income over £150,000.
What is a regressive tax
This occurs when an increase in income leads to a smaller % of their income going on the tax
e.g. excise duties and VAT take a bigger % of low income earners.
What is proportional taxation
takes same % of income, whatever income band.
What is direct taxation
taken from people’s earnings directly e.g. income tax
and NI.
What is indirect taxation
Paid by firms selling goods
e.g. VAT is included in final price consumers pay.
What is the impact of increasing rate of income tax
- Higher revenues - but laffer curve
- Tax Evasion - might go work in another country
- Work Incentives- may reduce incentive to work or income effect means want to work more
- Redistribution
- Lower AD - cetirus paribus
- Improve X-M- lower spending on imports
- FDI - ‘race to the bottom’ e.g. Apple Ireland 0.005%
Evaluate the impacts of higher income taxes
- Disincentives? economists suggest evidence is mixed.
o income effect encourages them to work more - depends how tax revenue is used. If income tax revenue is invested in
improved infrastructure it can the benefit long run productive capacity.
If income tax revenue is needed for welfare payments, there will be no
increase in productive capacity.
What is the impact of increasing indirect tax
-
Cost-push inflation
However, this price rise will be a one-off increase and, after 12
months, the price rise will no longer count toward inflation. - Fall in Output - depends on other factors affecting AD and AS, unlikely to cause a fall in GDP on its own
- Social Efficiency
- Changed easily and less likely to distort work incentives
What is tax competition
- Countries may seek to encourage foreign direct investment (FDI) through
offering lower tax rates.
e.g. Ireland 12.5% has attracted many big multinationals to invest, through
low tax rates.
- The problem with tax competition is that it can encourage countries to
keep trying to offer lower tax rates to attract big companies. This leads to
countries having to increase tax on consumers and workers.
which taxes affect AS and which affect AD
Direct Taxes affect AD directly due to lower consumption
Indirect taxes affect SRAS
What is VAT standard rate and the discounted rates
- The standard rate of VAT has been 20% since 2011
Reduced rate of 5% is applied to these items
○ Domestic fuel and power, women’s sanitary products, children’s car seats, contraceptives, certain residential conversions and renovations
Zero-rated VAT on these items:
○ Food, Construction of new dwellings, Domestic passenger transport, Books, newspapers and magazines, Children’s clothing, Water and sewerage services, Drugs and supplies on prescription, Supplies to charities, Cycle helmets
How could tax cuts stimulate economic recovery
-
Consumer spending
Cuts in VAT or income tax to boost demand for goods and services -
Business investment
Lower corporation tax to increase investment and tax incentives for R&D -
Lower employment taxes
Reduced national insurance so that businesses create more jobs -
Lower fuel / carbon taxes
Lower costs for businesses, less inflation and higher profits
Evaluate the view that tax cuts will stimulate economic recovery
- Low confidence – tax cuts likely to be saved rather than spent
- Businesses might choose to invest overseas instead
- Skills shortages might limit new job creation
- Possible conflicts with environmental policies e.g. 91p on pound for investment in oil extraction
- Lower Revenue multiplier
What is the Laffer Curve
tax rate cut could lead to an increase in tax revenue, or a decrease in tax revenue, depending whether you have already passed the ‘optimal tax rate’ (whatever % that may be)
Evaluate the Laffer Curve
- Many people are on fixed hours / zero hours contracts – so tax rates have little bearing on work incentives
- Tax rates not the only factor affecting work incentives – we must also consider the impact of the benefits system
- Where is the optimal point? Could work in either way
What is the case for windfall taxation on Energy Companies
- Levy estimated to raise £8 Billion to provide funding for the Energy Price Guarantee and Energy Bill Support Scheme
- BP earned record £7.1 billion in just 3 months during summer last year
- Shell CEO said that they are not planning to stop any future projects
What are the possible uses of the £8 billion revenues
£700 million investment in Sizewell C alone will be enough electricity to power 6 million houses for over 50 years
e.g. budget invested £20 billion in carbon capture
What ability do firms have for investing in oil and gas extraction
firms have the ability to claim a 91p tax saving for every pound invested in oil and dgas extraction that make expansion revenue neutral
* Shell went public to say it did not pay any windfall tax in 2022, partly because its North Sea investments can be set against profit
What did Total Energies do in response to the near 70% tax
- TotalEnergies announced that is it cutting planned investments in the North Sea by a quarter is a more explicit response
What is Public Sector Net Borrowing (PSNB)
This is the annual difference between net spending and net taxation. It is the amount the government needs to borrow in a particular year. It is referred to as the budget deficit.
What is Public Sector Net Debt (PSNB)
This is the total (cumulative) amount of debt that the government owes the private sector; this is approximately £1,487.7 billion (80.4% of GDP) as at April 2015.
What is a cyclical deficit
During a recession, it is likely we will see a rise in government borrowing, due to cyclical factors.
- With lower growth, tax revenues will be lower.
-
Government spending will increase. In a recession, the government will need
to spend more on unemployment benefits and income support benefits.
What is a structural deficit
If the government has a budget deficit, when the economy is growing at
its long run trend rate, this shows the underlying, structural deficit
What are automatic stabilisers
An automatic way to blunt off the worst extremes in the economic cycles and buy time for discretionary government policy
What are 2 examples of automatic stabilisers
- Welfare Benefits
In Recession Government spending automatically increases through transfer payments, this increases AD
- Progressive Income Tax
in a Boom, Higher incomes makes workers be pushed into another tax band so tax regulates AD
What is discretionary fiscal policy
- This is a deliberate effort by the government to influence aggregate
demand and the rate of economic growth.
What are factors influencing the size of fiscal deficits
1.State of economy .
2. Government spending decision/Fiscal Policy - if government wants to spend without increasing taxes
3. Political Priorities
4. Efficiency of tax collection
3. Demographics an ageing population needs higher spending
4. Rules on borrowing levels e.g. Eurozone obliged to keep structural borrowing less than 3% of GDP.
5. Interest Rates –> higher increase debt
What are factors influencing the size of national debt
1) Large budget deficits over 3% in previous years will increase national debt as a proportion of GDP
2) If the economy has a high growth rate, this will tend to reduce national debt as a % of GDP
3) Willingness to invest. A government may decide to borrow, to fund
investment decisions.
4) Unexpected events
5) Willingness of private sector to buy government debt. e.g. Japan debt over 255% of gdp
What are the economic effects of higher government borrowing
- Higher debt interest payments
- Increased AD
- In future may have to do austerity to fix debt
- May have to increase interest rate to attract investors to bonds
- Financial Crowding Out
- Loss of confidence –> struggle to attract borrowers
- Inflation e.g. Hermany in 1923
- Loss of intergenerational equity
- Reduced Credit RRating e.g. Greece drop to CCC
- May lead to foreign currency crisis e.g. Sri Lanka
Evaluate Government borrowing
- Recession; by borrowing, the government is compensating for the rapid rise in private sector saving. The government is helping make use of
unemployed resources. - Investment. If the government borrows to increase spending on infrastructure spending, such as better roads, this can increase productivity and enable a higher rate of economic growth and more tax revenues in the future.
-
Bailout key industries prevent them going bankrupt and
causing a possible loss of confidence in the banking system
What is the Public Sector Net Cash Requirement
Total amount of money that the government needs to borrow in order to fufill its spending plans, the difference between spending and revenue
Whatt is a structural surplus
A structural surplus occurs when at the peak of the boom, there is an actual fiscal
surplus whilst a structural balance occurs when at the peak of the boom, the actual
fiscal balance is 0.
Whatt is a structural surplus
A structural surplus occurs when at the peak of the boom, there is an actual fiscal
surplus whilst a structural balance occurs when at the peak of the boom, the actual
fiscal balance is 0.
What is the effect of a structural deficit on national debt
If the government has a structural deficit, it is likely that national debt will grow over
time as the government has to consistently borrow money to finance spending.
For this reason, it is argued that structural deficits need to be eliminated but this is
difficult since it is impossible to know what part of the deficit is structural and
what part of it is cyclical , just as it is impossible to know the size of the output gap.
How did the credit rating downgrade in 2013 affect the UK
But in 2013 UK had their credit rating downgraded as agencies were concerned about the impact of sluggish economic growth on the public finances, yet bond yields remained at record lows for a number of years
Concerns about unjustified debt during Truss caused what
e.g. yield on 10 year UK government bonds surged from over 3% to over 4% in a matter of days
What was the Lawson Boom Demand-Pull Inflation
Lawson Boom: Gov tax cuts in 1987 led to house prices rising by 25% per year in 1988-89 and a marginal propensity to consumer greater than 1
How is the UK experiencing a tight labour market
vacancies are greater than those unemployed
How is the Swiss Franc an example of hot money flows
In 2011, the Swiss Franc experienced a rapid rise as investors sought to buy Swiss Francs. Interest rates in Switzerland were not particularly high, but investors saw Switzerland as a safe haven from the Eurozone difficulties. Therefore, these hot money flows went from the Eurozone to Switzerland.
How have strikes been made less deadly + popular
- Decline in TU membership
- Legilsation
How has a decline in TU membership 1995-2019
25% from 1995-2019
What strike legilsation has been introduced since 1995
secret ballots, result must include all eligible employees, notice period needed, outlawing of compulsory membership, right for employees to sue
e.g. Stealth ban on ambualnce strikes by requiring higher minimum level of service
How has real earnings changed for public sectors workers changed since 2009
- Real Earnings for public sector workers has fallen since 2009 becaause of apy freezes continuously
How has real earnings changed for public sectors workers changed since 2009
- Real Earnings for public sector workers has fallen since 2009 becaause of apy freezes continuously
What is national debt
unpaid fiscal deficits i.e. accumulation of fiscal defeicits yet to be repaid
What are the effects of persistent structural deficits
- Loss of credit rating
- Crowding out
- Inflation (net injection into the economy)
- Lower confidence in the economy –> reduce FDI
- Needd for fiscal austerity
What are the reasons for low inflation until 2021
- Low worldwide inflationary expectations
- Improved tech reducing cost of manufactured goods
- Weak Commodity Price Growth
What were the reasons for surge in inflation during 2022
- Rising oil and gas prices
- Ukraine war disrupting gas/energy and food supplies.
* Lingering supply side issues from Covid lockdowns and impact on the
price of shipping. - Strong demand in US, with economy close to overheating.
- Central Banks leaving interest rates at a low level.
Why did lower interest rates may not boost growth in 2008
- Banks didn’t have money to lend.
- Confidence was very low, due to the banking crisis
- Time lags. Cutting interest rates can** take up to 18 months to have an
effect** e.g. people on fixed rate mortgages don’t notice straightaway. - Fiscal policy was tight, with governments pursuing austerity measures to
reduce budget deficits. - Cost push inflation from the 2008 oil price rise made some Central Banks
concerned about inflationary pressures.
What areas of regulation would governments like to regulate in TNCS
- Environmental laws. regulate the amount of CO2 produced by firms.
- Monopoly power prevent the abuse of monopoly power and promote competition.
-
Treatment of workers / monopsony power
transnational companies move labour intensive industries to countries
with the lowest wages and lowest degree of labour protection (“sweat
shop syndrome”). - Transfer pricing to avoid paying tax or to reduce competitiveness in certain industries e.g. selling petrol at high prices to discourage competition in petrol retail.
What are the difficulties in regulating TNCS
- Global Co-operation- difficult to get countries to agree on legilslation; differing carbon markets
- Different Standards- hard to implement universal standards of working practices
- Poor Information- difficult for governments to know how much regulation is needed or hot to regulate
- Individual Governments - small countrries may earn less than TNC’s e.g. Mozambique
- Intense Lobbying
What are common difficulties in macro-economic policy making
- Inabillity to control external shocks
- Unexpected events
- Inaccurate information/forecasting
- Risks and uncertainities
- Uncertainty how people will respond
How did fiscal deficit as a % of GDP compare in the UK and US in 2015
By 2015, the fiscal deficit as a percentage of GDP was
similar in the US and UK.
While US used expansiony fiscal policy + automatic stabilised
The UK used austerity
How can governments reduce poverty and inequality
- Progressive Tax + Inheritance Tax (reduce wealth)
but laffer curve/disincentives
2.Benefits and Transfer e.g. Social Security + NI make up 30% of UK G - Provide access to ensure equal opportunities; healthcare, education, pupil premium
- Attempt to reduce wage differential; NMW, TU
How does the concept of diminishing marginal utility link with redistribution
The law of diminishing marginal utility suggests that redistribution increases
total utility and therefore is a better allocation of resources
e.g. The high growth rates of Nordic countries, like Denmark, where
redistribution is high suggests that it is not negative for economic growth
Is there a simple relationship between supply of money and inflation
There is no simple relationship between the supply of money and inflation and it
can be argued that central banks don’t have complete control over the money supply
because they cannot control the ability of the financial system to create credit.
Why does increasing the money supply not always cause inflation
- The growth of real output is the same as the growth of the money supply
- Increase in bank reserve ratios (banks didnt want to lend)
- Hard to Measure Money Supply
- Changes in velocity of Circulation
- Liquidity Trap
How can the government increase international competitiveness
- Supply Side measures to improve productivity + flexiblity of labour
- Tight fiscal policy –> low inflation
- Encourage competition to force firms to be efficient
- Education to enhance human capital
- Deregulation e.g. UK ‘Red Tape Challenge’ to simplify regulation
- Devaluation
- Sign FTA
How could a government respond to a commodity price shock
- The government could use expansionary policy to reduce the impact of a fall in GDP or they could use deflationary policy to reduce the impact on inflation
- Invest in long term to reduce vulnerabaility
- Appreciate exchange rate
How could a governnment respond to a financial crisis
- Expansionay fiscal policy, crowd in banks
- Bailouts to restore confidence
- Resolution and protecting deposits
What are some examples of regulation to TNCs
- Illegal for TNCs to use bribery or corrupt practices anywhere in the world
- TNCs have to set up with a joint company + local partner
- Governments use import contracts with TNCs
How are TNC’s regulated for transfer pricing
● In the UK, companies which don’t allocate sufficient profits here are challenged by HMRC and this has led to billions of pounds earnt in taxes .
● The Transfer Pricing Guidelines were introduced by the OECD in 1995 , providing guidelines on cross-border services, intangibles, cost contribution arrangements and advance pricing guidelines; these were modified in 2010.
* They aim for the price to be the same as if the two parties were independent of each other; the ‘arm’s length’
principle .
What legal tax avoidance schemes does the EU suffer from
the ‘Dutch sandwich’ and the ‘double Irish’ , where costs, revenues and profits are routed through Ireland, the Netherlands or Luxemburg and then sent to a tax haven like the Bahamas or the Cayman Islands.
It is suggested that for every £1 gained in extra taxes by Luxemburg, other countries are collectively losing possibly £1000 in tax revenues.
What are external economic shocks
- World demand shocks. These are associated with a rise or a decline in spending and confidence abroad.
- World supply/price shocks. These affect the global supply and prices of goods and services.
- World financial shocks. These occur in the global financial system, such as increased stress in the international banking system or financial markets
Not all shocks are necessarily negative- can be positive ones
What are key external influences on the UK Economy
- Global commodity prices
- Inflation rates in trading partners
- Economic cycles of trading partners
- Impact of changes in international interest rates
- Fluctuations in global equity and bond markets
- Longer term shifts in competitiveness
What are examples of external shock
- Global Financial Crisis (GFC)
- Volatile Commodity Prices
- Currency volatility and policy changes e.g. devaluation
- Extreme weather events
Geo-political uncertainty & terrorism
What are shock absorbers of external shocks
*Floating exchange rates (scope for a depreciation)
* Freedom to set / adjust monetary policy when conditions change
* Geographically and occupationally mobile / flexible labour force
* Strong non price competitiveness of domestic businesses
* A diversified economy (not over reliant on a few sectors)
* Strong fiscal position (stabilisation funds)
What are the types of external shocks
- Supply Shocks
- Demand Cost
- Financial Shocks - credit to fund normal operations
- Policy Shocks
- Technology Shocks; affect productivity
How is Coca Cola guilty of transfer pricing
When a company is developing IP or creating IP over time—such as marketing—it needs to keep careful track of its transfer pricing, she said.
The IRS’s $3.4 billion victory against Coca-Cola Co. signals that the battle with multinationals over how to account for profits from intangible property, like brand trademarks, isn’t going away.
How is Apple ‘racing to the bottom’
Apple; few hundred people in Ireland were a real source of it’s profits and it deal with **Irelands govt leading it to pay a tax amounting to 0.005% of its profit **
How are countries responding to TNC’s race to the bottom
Global minimum tax rate of 15% signed by over 136 countries
What is the money illusion
the increase in GDP from printing money is a money illusion. – True you have more money, but if everything is more expensive, you are not any better off
How does printing money contribute to national debt
- Inflation would reduce the value of bonds
- People will no longer hold bonds and sell them –> lower price –> greater yields so more debt for gov.
- If government print too much money, investors will not trust the government and it will be hard for the government to borrow anything at all
e.g. Zimbabwe 98% daily inflation
What is a liquidity trap characterised by
1) Very low interest rates
2) Low inflation
3) Slow/**negative economic growth **
4) Preference for saving rather than spending and investment
5) Monetary policy becomes ineffective in boosting demand
What happened in liquidity trap of 2009-15
there was a large increase of 7% in M0 but it could not stop the decline in M4
e.g. at start of the credit crunch, there waas a sharp rise in the UK saving ratio from 4.2% in 2008 q1 to 2010 q2
Inelastic demand for investment (MEC) so firms are not tempted by lower interest rates
What are policies to fix the liquidity trap
- Quantitive Easing - policy to create money and reduce yields on bonds
- Helicopter money - giving money directly to the people
Expansionary Fiscal Policy
What are the top 5 causes of the Great Depression
- Stock Market of 1929- loss of 40 billion in 2 months
- Bank Failures- 3,700 collapsed in 1930
- Reduction in Purchasing Across the Board - UE rose above 25%
- American Protectionism - Smoot-Hawley Tariff; world trade fell by 2/3
- Drought Conditions - the Dust Bowl drought
What was the cost of the major cum-ex tax evasion scheme
Major tax evasion scheme of cum-ex trades costed governments over over 150 billion euros from 2000-2020
What were HSBC and Santander charged for money laundering
- HSBC hit with £64 million fine for serious weaknesses in ant-money laundering control
- Santander fined 107.8m million over serious and persistent gaps in it’s anti money laundering control that opened the door to financial crime
WHat did Black Thursday, Monday anad Thursday cause
caused fall of Boden-Kredit Anstalt; Austria’s most important bank
How did the FED mismanage the Great Depression
- Thus the FED instigated the rapid expansion
- When the bubble burst the FED cut money supply by a third causing severe liquidity problem
How did Hoover keep prices high
- Thus Hoover resorted to the Smoot-Hawley Tariff Act 1930 that imposed huge duties on 880 foreign products causing international trade to decline by 66% by 1934
How did WW2 help take the US out of the Depression
- Opened up trade routes and reversed price/wage controls
- In first 12 months after private investment rose from 10.6 billion to $30.6 billion
What caused the Great Recession of 2008-13
- Housing Bubble; prices faster than inflation and incomes; countries like Ireland and Spain experienced booms
- Also a rise in oil prices that caused cost-push inflation, made Central Bank reluctant to cut interest rates
- Fall in housing price may many cut back on spending as they couldn’t rely on mortgaging to gain equity withdrawal
- Euro Crisis 2010-12 a rise in bonds yield partly due to recession let to a period of austerity
What was the Great Recession of 2008-13
- 2007/8 credit crunch –> negative growth and fiscal severity creating a double dip recession in EU
- UK did not catch up to lost output; 2012 real GDP lower than 2008
Why did the UK have the slowest recovery on record
- Balance Sheet recession: the UK saving rate rose from 0-7% as banks focused on paying back debt
- Shortage of Credit: Banks were short of cash so didn’t lend
- Eurozone Crisis + Austerity
- Productivity Crisis
What is the Eurozone Crisis
· Ireland, Portugal, Italy had overspent and required bailouts to prevent default
· Spain was impacted by its banks being overexposed to the real estate bubble; spain bailed them out but had to ask the EU for help
· Germany wanted to enforce austeirty but this made it harder to pay the debt
What is internal devaluation
Countries in the south ran uncompetitive large current account deficits had to restore this with internal devaluation as they had no central bank to avoid any liquidity shortages.
Internal devaluation involved lower wages, increased competitiveness and supply side reforms
Causing unemployment in Spain, Greece and Portugal above 20%
What is a Sovreign Debt Crisis
· When a country isnt able to pay its bills
· when country cannot get a low IR from lenders, lenders require higher and higher yields
· This causes rollover risk as costs get higher to refinance
* Investors’ fears become a self-fulfilling prophecy
What was the Greece Sovreign Debt Crisis
- Greece 12.7% GDP more than quadruple than 3%
- Greece had to accept loans from the EU with austerity
- Caused Greece to default and IMF demanded a bigger austerity creating a downward spiral
What was Greece’s situation by 2013
- GDP ratio was 160% by 2012 and bondholders accepted 25 cents on dollars
- UE rose to 27.9% in 2013
What was the US Debt Ceiling Crisis
· Dollar position and Central bank make it unlikely to default
* Political positions force potential defaults as parties can refuse to raise the debt ceiling
e.g. 2013 Republicans demanded Obamacare to be defunded to raise the debt ceiling, leading to US national debt:GDP going over more than 100%
What was the Iceland Debt Crisis
· Iceland took on $62 billion of bank debt when it nationalised the 3 largest banks despite them growing to 10x GDP
· Its currency plummeted by 50% the next week and inflation to soar
What is a Currency Crisis
- Countries runs out of a foreign currency to pay debt
- Asian Financial Crisis of 1997 where economic reliant on FDI struggled to meet debt repayments when they lacked it
What are the solutions to a Currency Crisis
- Floating Exchange Rates; avoid currency crisis by ensuring that the market is always setting the price as opposed to fixed exchange rates
- Avoid monetary policy that fights the market, accept inevitability of currency outflows and use investment policy to attract FDI
What is a Balance of Payments Crisis
· Unsustainable bop position means countries have a large difficult in borrowing to make up the difference
· Causes a a fall in FX reserves as the country can no longer attract sufficient capital flows to finance the deficit
· Can** devalue currency or slow down** imports through a recession
e.g. Sri Lanka
What is the effect of the Russia Ukraine war on bakeries in the Nigerian Capital of Abuja
At least 40% of bakeries in the Nigerian capital of Abuja shut down after the price of flour jumped about 200%.
What has been the effect of Russia-Ukraine war and Covid on China
Goldman Sachs predicts 2% it’s an anemic figure for China, down from a jaw-dropping 8.1 percent last year
What is the impact of the supply-side shocks on the global economy
World growth to slow to 2.2% in 2023
What is the impact of the supply-side shocks on the global economy
World growth to slow to 2.2% in 2023
What would UK wages be more if we had stayed on pre-productivity growth
6,300
What would UK wages be more if we had stayed on pre-productivity growth
6,300
How is short-terminism affecting UK productivity
- The UK companies are relatively quick to become public limited companies (PLC), where anonymous shareholders often put pressue on managers to deliver quick returns in the forms of dividends
- In Germany while there are plenty of PLCs, there are far more medium to small sized family run Companies known as Mittelstand
- German state has actively supported the Mittelstand through promoting sources of finance, KfW Development Bank; the organisation has now loaned more than £1.3 trillion to various buisnesses
How is Government Industrial Strategy
- State Aid is less than 0.5% of GDP + to encourage companies to ‘stand on their own feed’
- State aid and spending in France is double what it is in the UK on a per capita basis and 3 times greater in Germany
- ‘Full Expensing’ + ‘Super Deduction’
How is shortcomings in management affecting UK productivity
- UK companies invest less time in training up their middle-managers, leading to the ‘accidental manager’ phenomenon, and do not employ as many specialist managers to oversee specific areas of the business
- Family owned and run businesses are not exposed to significant international competition so are poorly productivity and is called the ‘long tail’ of business with low productivity and mediocre managers
- Management alone accounts for a quarter of the difference between the UK’s productivity and that of her competitors
- Access to cheap finance has kept many of these unproductive ‘zombie companies’ afloat
How are shorfalls in skills affecting UK productivity
- Not as nearly as much vocational training
- UK spends less on worker training than many other adcanced economies
e.g. Capital Spending is estiamted to make up productivity gap with Germany
How do regional disparities affect the UK economy
London is 34% higher than the UK average whilst Northern Ireland is around 17% lower
What was the Aftermath of the Great Depression
- Most dynamic sectors have seen the biggest fall in productivity performance
- 4 dynamic sectors: manufacturing, finance + banking, ICT and professional services
- ‘Labour Hoarding’ to protect highly skilled nature of jobs
How does productivity differ with sector
Across sector productivity differs with sector; UK best at finance and utilities/extraction/info + comms - UK higher productivity even more than Germany
How has the public sector decreased productivity
Public sector accounts 44% of GDP and employs around a quarter of the workforce but productivity dropped by 1.3% and output per worker is now lower than its pre-pandemic level
How low is Capital Investment now compared to
6.2% lower than before the EU referendum
Lowest in G7 and 3rd lowest in OECD
Brexit Investment is 11% lower than it might have been and productivity is 4% lower than it should have been
Why has capital investment fallen so much
- Economic Shocks + Uncertainty - Imperial say GFC damage to FS and Insurance caused 1/3 of productivity drop
- Flexible Labour Market- UK has the 4th most flexible labour market but encourages capital shallowing
- Access to Finance
- Coporation Tax e.g. Aztra Zenecachose to locate their new site Dublin where coporatiion tax is 12.5%
How has a lack of investment in human capital suffered productivity
- Nearly 12 million people lack digital skills to cope with everday life, 30% of the workforce may have to change occupation
- UK PISA score lower in reading and maths than most countries with higher productivity
- Little opportunity for life-long learning - real spending on education same as early 2000s
How does political and economic climates
- Economic problems need long term solutions while political cycles are relatively short
- Political decisions in the long term are influenced by concerns over government borrowing and keeping the tax burden low
Policy Churn - constant changes in economic policy - have made it difficult to implement the structural changes needed to drive productivity in the long term
How has the Supplier Credit Financing Facility led to export-led growth
Rautomead used our Supplier Credit Financing Facility, which allows UK companies to get paid on dispatch for their exports whilst letting buyers benefit from deferred payment terms.
£1 million worth of financing for Dundee-based firm to supply machinery to specialist Chinese metals manufacturing company in Xian
Why has the UK inactivity rate not decreased back to pre-pandemic levels
- OBR says long term sickness; fall in health spending as % of GDP frrom 2010-20
Sickness benefits mean you have to requalify if you leave workforce again (disincentive to join workforce) - Institute for Fiscal Studies, used time series data and they found that retirement was the main reason
Why has the UK inactivity rate not decreased back to pre-pandemic levels
- OBR says long term sickness; fall in health spending as % of GDP frrom 2010-20
Sickness benefits mean you have to requalify if you leave workforce again (disincentive to join workforce) - Institute for Fiscal Studies, used time series data and they found that retirement was the main reason
What is the impact of economic inactivity
- Reduces long term GDP growth
- Inactivity –> loss of self esteem + skill
- Makes labour supply for skilled jobs more inelastic as a higher wage requirement
- Firms are reluctant to give these which creates higher vacancies
- Worsens government finances (G-T)
What policies can reduce economic inactivity
- Older workers face discrimination when applying to jobs; employers are less likely to take them on and retrain them
- Occupation health services provide services that focus on the health of staff in the workplace
- Boosting access to this may help tackle the problem
- Fix the sick payments scheme
- More generous immigration policy to fill in skills gap
What is the repalcement ratio in the UK
0.22
when >1 it creates an UE trap
How signifiicant is the Gig economy to the UK economy
- Contributing to record low UE figures
- 4.4% of the population has worked in the gig economy, dwaring industries like finance or the nHS
**Gig economy worth over £25 billion **
Relation with Gig Economy and workers rights
Workers’ rights are often lacking as they are classified as self-employed so no access to pensions, minimum wages, holidays, sick pays, statutory pay, NI contribution
2018 Uber lost case and had to classify as worker
How has the enforcement of workers rights been weakened
- HMRC has suffered budget cuts and tax collection is less effective
Employment tribunals to enforce employment rights has been restricted since 2013 to be replaced with charged for claimants
How accurate is economic forecasting
OBR made 5 sets of predictions for government borrowing, inflation and GDP growth in 2021-22, each a revision of another
In January 2023, the OBR downgraded growth prospects while the Bank of England upgraded their outlook
David MIles: ‘should be satnav’
How essential are OBR forecasts to the confidence of the market in the UK’s public finances
Truss failed to pass plans to OBR and this made markets uncertain (3–>4% yield)
Hunt made many references, over 52 in his autumn statement
How has Youngstown a victim of deindustrilisation
· Youngstown used to be a hub of American manufacturing with steel mills and General Motors employing over 13,000
· With each passing year, its population shrinks
· About 38% of the population lives below the poverty line, ; making it the second poorest city in America
The crime rate is double the national average
How has isolationist policies helped revive the city
· In 2019 GM teamed up with LG to create Ultium Cells, an electric battery manufacture, employiong over a 1000
* Foxconn has agreed to buy the original GM plant and reconfigure it as a production facility for electric vehicles
Training is being undertaken by Youngstown State University who made a test to identify who could operate its sophisticated machinery
What are 3 reasons for the crowding in effect
- Frontier technology projects have extremely high fixed costs so by letting the public
sector fund the research, it allows the private sector to realise higher
profits. -
“Spillover effects”, where new technologies find different applications
in the private sector. GPS, for instance, was first developed to help
missiles find their targets -
Credit constraints on the private sector, where a project is difficult to
fund without government support due to, say, an economic downturn.
