MACRO BOP Flashcards
Benefits of trade
• Specialise in key industries
• Lower unit costs-larger production runs (econs of scale)
• Lower prices
• More exports a Lower prices for consumers
a Import of raw materials => more choice for consumers
• More quality products
Costs of trade
• Outsourcing/relocation o Structural unemp n Loss of tax rev
D Brain drain
a Exploitation of smaller, less developed economies
D Low pay a Poor working conditions n Destruction of rural areas /rainforests
• Transfer of
pollution/externalities
o Higher unit costs-diseconomies of scale
a Higher prices for consumers - monopoly (oil)
a Less choice for consumers if mergers make goods identical
Define BOP
A record of financial transactions of UK trade with the rest of the world
What are the main determinants of demand for exports/imports?
- Exchange rates
- Interest rates
- Relative inflation rates
- Real GDP growth abroad
(Standard of living of trading partners) - Productivity levels
Some Reasons for the UK’s Persistent Trade Deficit
High income elasticity of demand (Yed) for importe goods and services - demand for imports grows strongly when consumer spending is rising
Some weaknesses on supply-side of the economy (i.e.
Low research and development spending, low rate of capital investment)
Many UK businesses finding it hard to finance a rise in exports (effects of credit squeeze)
Majority of British exports go to slower-growing countries in Europe e.g. Ireland, Spain and also the USA. Less successful in exporting to emerging nations
Consequences from a current account deficit
•Loss of aggregate demand if there is a trade deficit (M>X) which causes weaker real GDP growth and reduced living standards and rising unemployment
•Big current account deficits will cause the currency to depreciate, leading to higher cost-push inflation and a deterioration in the terms of trade
•Can lead to currency weakness and higher inflation and a country may run short of vital foreign currency reserves
•Trade deficit might be a reflection of lack of competitiveness / supply-side weaknesses in the economy
•Some countries running current account deficits may choose to borrow to achieve a financial account surplus - increases risks
•Unsustainable current account deficits can ultimately lead to a loss of investor consequence, leading to capital flight and a currency / balance of payments crisis
Economic Policies to Reduce a Trade Deficit
• Demand side policies: A tightening of fiscal and/or monetary policy reduces real spending power of consumers and leads to lower spending on imports (fall in M improves trade balance)
• Not long term sustainable as it reduces growth and living standards
• Lower exchange rate reduces the foreign price of exports and makes imports more expensive - causes changes in demand
• Make importing raw materials for production also more expensive
• Effect depends on the elasticities of imports and exports
(Marshall-Lerner condition)
• Supply-side improvements:
• Policies to raise labour productivity, investment in human capital to boost productive capacity and competitiveness in high-value industries such as bio-technology, engineering, medicine, tourism
• Many of these policies are expensive, have a long time-lag, and there is no guarantee of an improvement (people make take these skills and leave)
• Protectionist measures such as import quotas and tariffs (NB:
UK limited by global trade agreements)
• Arguments against protectionism, which include retaliation (trade wars) and shortages of resources and people
Possible Problems from Running Trade Surpluses
If GDP is close to capacity, a rise in the trade surplus might cause demand -pull inflation
• Out of gov’t control
Persistent trade surpluses might lead to threat of protectionism from trade deficit nations
If the surplus is due to high saving / low consumption, living standards might be too low
Surplus might be result of exporting high-priced commodities - prices are volatile/unpredictable
WHY DOES UK HAVE A DEFICIT?
< Strong currency compared to trading partners
• Persistent inflation
a Low PeD for imports (D=inelastic)
• Lower productivity levels-uncompetitive X
• Protectionist policies EU cet
• De-industrialisation - lost manufacturing - high labour costs
• Economic cycles not harmonised
• Surplus in services not enough to cancel out deficit in goods
DOES A BOP DEFICIT REALLY MATTER?
Depends on..
• Size of deficit - huge?/growing = borrowing to finance
• Extent of deficit - consumer v capital goods, goods v services
• Type of deficit -structural/cyclical
• Length of time- persistent/cyclical
• Type of exchange rate system
• Trade imbalances more damaging
• Effect on the other key objectives
• Inflation, employment, growth
Conclusion;
• Short term possibly not
• Long term - suggests an underlying lack of competitiveness - structural - big cause for concern
WHY DOES CHINA HAVE A PERSISTENT SURPLUS
• Self sufficient - low imports a Low PeD for M
• Low inflation levels
• Huge exporter with world boom
• Comparative advantage with low labour costs=comp X prices
• Weaker exchange rates (Yuan is fixed)
• Protectionist policies
J curve effect shows time lag between deprecation and improved trade balance
Add a pic shawty
What is the Marshall Lerner condition
The Marshall-Lerner condition states that the J-curve effect will only take place if the absolute sum of PED for exports and imports > 1
Define exchange rates
• The rate at which one currency exchanges for another
What is a free floating exchange rate
The exchange rate is determined by the forces of demand and supply on the FOREX. There is no govt
Intervention
