Module 17: Gov't policy

Question 1

Aims of economic strategy (which are stated in the annual budget)

Answer 1

Common aims:

• economic growth
• price stability
• reducing unemployment
• improving productivity
• protecting the environment

Question 2

Scottish gov’t

Answer 2

role in economic strategy as it controls how it spends its allocated funding (education, housing, health)

SG can also vary the income tax rate

SG still currently controlled by the UK Gov’t

Question 3

The importance of price stability

Answer 3

• measured using the CPI
• annual % change in CPI used as a measure of price instability or inflation (target inflation = 2%)
• price instability - arises when demand > supply.
  Production increases to meet demands but so does costs (overtime, extra material, extra workers) which is passed down to consumer through increased prices
• if prices = stable => VFM is being maintained
• If VFM is falling => interferes with market economy (price changes are harder to interpret)
• price changes act to equalise supply and demand

Question 4

Economic problems created by price instability

Answer 4

1. hard for new suppliers to know whether price increases are due to lack of supply or inflation
2. INDUSTRIAL RELATIONS CONFLICT
   - different expectations over inflation levels increase conflict between employers and employees during wage negotiations => strikes more likely
3. REDISTRIBUTION OF INCOME AND WEALTH
   - inflation causes those living off their savings or benefits to experience loss of purchasing power
   - those who borrowed money may gain as the real value of their repayments fall
4. INTERNATIONAL COMPETITIVENESS
   - if country has higher rate of inflation than its major trading partners => exports will become more expensive and imports relatively cheap => balance of trade may worsen (export rev less than cost of imports)

Question 5

Types of economic policy: two main types

Answer 5

Monetary policy

Fiscal policy

Question 6

What is monetary policy concerned with?

Answer 6

• supply of money
• terms and availability of credit
• broad aim = achieve price stability

Question 7

The role of monetary policy

Answer 7

• sets out to influence level of demand so it will grow in line with the economy’s ability to produce goods
• to slow down demand - interest rates will be increased
• to stimulate demand - increase rates will be decreased

Question 8

The effects of of increasing and decreasing interest rates: increasing interest rates

Answer 8

• COST of existing floating rates loans will be HIGHER
• interest rate return earned on deposits is higher => expected return on potential investment projects will rise => investment will fall
• if business sells goods that usually require financing, this will be more expensive for the consumer => DEMAND for bus goods may FALL

Used to slow down the demand for goods and services, and control inflation

Question 9

The effects of of increasing and decreasing interest rates: DECREASING interest rates

Answer 9

• cost of borrowing reduces => loans and credit cards = less expensive => may encourage individuals and bus to purchase more
• magnification effect as asset prices (shares and property) rise => greater feeling of wealth and ability to spend

Used to stimulate the demand for goods and services

Question 10

The bank of England and monetary policy

Answer 10

Bank of England has the power to change the interest rate through BANK RATE (rate at which the Bank of England lends to other banks)

• changes in the Bank Rate affect the rate of interest charged to borrowing customers
• Bank Rate not directly controlled by the UK Gov’t
• controlled INDEPENDENTLY by Monetary Policy Committee (MPC)

Question 11

Monetary Policy Committee (MPC)

Answer 11

Made up of 9 members

• Governor
• three Deputy Governors
• Chief Economist of BoE
• Four experts appointed by the Chancellor

Minutes of the MPC’s meetings are publicised and closely analysed for indications of possible interest rate changes

Question 12

Bank of England: other functions

Answer 12

• BoE is the GOVT’s banker
  It arranges borrowing and repayment of gov’t debt

Other functions consist of:

1. Maintaining financial stability
   - ‘lender of last resort’ when banking system is short of money
   - ‘quantitative easing’ = injecting liquidity by buying assets from commercial banks with intention of that bank using this cash surplus to lend out and stimulate the economy
2. Maintain foreign currency reserves
   - foreign currency reserves may be used to trade on the foreign exchange markets to stabilise the exchange rate
3. International regulation of the banking sector
   - Basel III Agreement tightened a number of regulations including the minimum capital requirements for commercial banks

Question 13

Fiscal policy

Answer 13

Gov’ts policy on SPENDING AND TAXATION

Tax revenue generated from income taxes, NI, VAT, corp tax, excise duties, council tax

Gov’t spending incurred through social security, education, law, health, defence, housing

Question 14

Impact of changes in gov’t spending

Answer 14

If spending > tax revenues = budget (fiscal) deficit
Creates economic instability
Running deficit for number of years leads to HIGH NATIONAL DEBT
The higher the debt, the higher the risk associated with gov’t bonds
The higher the risk, the higher the interest rates

Question 15

Government spending on specific areas and its taxation decisions have a major impact on businesses: For example

Answer 15

1. TRANSPORT
   - the decisions made on transport spending (new roads, buildings capacity of rail network) affect transport costs
2. HEALTH
   - well funded health service helps minimise time off work
   - pharmaceutical and medical supplies industries are affected directly by gov’t decisions on spending (NHS is main customer in UK)
3. SOCIAL SECURITY
   includes state pensions, disability allowance, unemployment benefits.
   - rise in spending on social security can have a knock-on impact for business costs via wages and availability of labour

Question 16

Measures to support the most recent economic strategies:

Answer 16

1. Employment issues
   - 2019: 1.29m people unemployed, unemployment rate of 3.8%
   - National living wage introduced as minimum wage for workers aged 25 and over
   - failure to pay the appropriate wage rates results in fines being levied
2. Improving productivity
   - creating world class digital infrastructure
   (Committed to completing the rolling out 4G and superfast broadband by 2020, making wifi free on trains and public places)

• improving digital skills
  providing free digital skills training to adults and coding in curriculum at school
• encouraging enterprise and innovation
  create 3m new apprenticeships to encourage economic growth
• creating the right conditions for investment
  steadily reducing corp tax rate
• reducing administration and compliance costs
  reducing compliance costs in regard to tax and audit for small-med firms
  ‘one in, three out policy’ = for every £1 cost introduced by legislation, £3 of savings will be introduced

- promoting competition
Competition Act (1998)

3. protecting the environment
   - Costs associated to economic decisions on environment not always considered in investment appraisal
   Kyoto Protocol on fighting climate change became legally binding and parties are committed to reducing emissions by at least 18% from their 1990s level
   UK Gov’t adopted the measures in an attempt to meet the Kyoto traget:
4. CLIMATE CHANGE LEVY
   - tax on energy use by business (discount given for businesses who sign energy efficiency agreements which meet the gov’ts criteria)
5. LANDFILL TAX
   - tax on disposal of waste
   - serious impact on the waste removal business - aims to encourage waste producers to produce less waste, recover value from waste (recycle) and use more friendly methods of waste disposal
6. EMISSIONS TRADING
   - lets businesses buy and sell greenhouse gas emission allowance to reduce their organisation’s environmental impact

Question 17

Importance of the exchange rate

Answer 17

Foreign trade is extremely significant for the UK economy

The STRONGER pound:

• makes exports more expensive
• makes imports cheaper

The WEAKER pound:

• makes exports cheaper
• makes imports more expensive

Question 18

Volatility of the exchange rate

Answer 18

UK Gov’t has allowed the exchange rate to be determined mainly by market forces => value of the pound has been volatile

Question 19

Influence on the exchange rate

Answer 19

Exchange rate = price (or value) of a pound
Determined by forces of demand and supply (demand and supply of pounds on the global currency markets in this instance)

The exchange rate is linked to inflation and monetary policy => balancing act due to interaction between public spending, interest rates and exchange rates

Question 20

The exchange rate will rise if demand for the pound rises. Could be due to a range of factors:

Answer 20

• higher interest rates - attracting foreign investors
• higher economic growth - attracting foreign investors
• expectations of an increase in the value of the pound
• Lower inflation - increasing the competitiveness of UK exports

Question 21

Regulation -

Answer 21

gov’t seeks to control business activities when it deems this to be in the public interest

Question 22

Competition and Markets Authority (CMA)

Answer 22

CMA’s mission is to make markets work well for consumers

Markets work well when businesses are open, ethical, vigorously compete with each other for consumer’s business
It pursues its mission by:
- the enforcement of competition law
- the enforcement of consumer protection legislation

Question 23

CMA: Enforcement of competition law

Answer 23

The Competition Act 1998 prohibits abuse by one or more parties of a dominant position in the market which may affect UK trade.
Specific examples of prohibited anti-competitive agreements:
- PRICE FIXING - fixing buy or sell prices or other trading conditions
- PRODUCTION LIMITS - controlling production, markets, technical development, investment
- MARKET/SUPPLY SHARING - sharing markets or supply sources
- IRREGULAR CONTRACTING - making contracts subject to unrelated conditions
- IRREGULAR TRADING - applying different trading conditions to equivalent transaction thereby placing some parties at a competitive disadvantage

Agreements do not have to be formal to be prohibited. Where parties do not have >25% market share combined, there will be no appreciable effect on competition

If an undertaking is found to have breached a prohibition, the CMA can order an agreement to be terminated or can impose a financial penalty

Question 24

CMA: Abuse of dominant position

Answer 24

dominant business able to behave independently of competitive pressures

Conduct considered an abuse by a business in dominant position includes:

• charging excessively high prices
• limiting prod’n
• refusing to supply an existing long-standing customer without good reason

General rule - >40% market share => dominant
Undertaking with a lower market share can be considered dominant depending on its structure within the market

Question 25

CMA: enforce consumer protection legislation

Answer 25

CMA monitors markets for goods to identify potential problem traders
Problem trader = neglected responsibilities under civil and criminal law at the detriment of consumers
CMA will prioritise its investigations based on a range of factors:
- impact on customers
- strategic significance
- risk
- resources

Problem traders can be asked for written assurances of future behaviour - can be taken to court if those assurances are broken

CMA can propose changes in law to the Gov’t

Question 26

Regulators of privatised industries

Answer 26

Govt recognised the need to regulate the newly created private monopolies in industries such as rail, water, energy and telephone => created a regulatory body for each of these industry sectors

Role of the regulator = ensure there is on abuse of the monopoly and to encourage efficient services to the consumer through introducing

• competition
• price caps (max selling price)

Question 27

Impact of EU membership: Competition

Answer 27

EU role to regulate competition

Treaty of Rome prohibits all agreements and concerted practices which may affect trade between member states and which are designed to restrict or distort competition within the common market

Businesses prohibited form abusing a dominant position within a market

EU exercises control of mergers where size if significant enough to distort competition

Question 28

Impact of EU membership: Labour rights

Answer 28

Working Time Regulation

• workers cannot be compelled to work more than an average of a 48 hour week
• workers may opt out of the agreement with their employers

Question 29

Impact of EU membership: Taxation

Answer 29

Single Market allows goods to be freely traded within the EU without imposition of custom duties

To facilitate free trade, minimum tax rates are in place for VAT

Question 30

Impact of EU membership: Grants

Answer 30

Through fiscal contributions from member gov’t, EU provides funding for infrastructure projects in areas of economic hardship
Provides grants where job creation is an objective

CAP (Common Agriculture Policy) - set up to ensure efficient farmers throughout EU received incomes comparable to workers in other sectors, while making sure that there were sufficient supplies of food at reasonable prices

Question 31

ECB’s objective (European central bank)

Answer 31

Number of countries have adopted the euro as a common currency

• maintain price stability and to conduct a single monetary policy across the euro area
• in other words, interest rates are set by the ECB rather than within individual countries

Question 32

Brexit

Answer 32

June 2016 - referendum held on whether UK should remain in or leave the EU
51.9% voted in favour of leaving
Terms of withdrawal not yet been established
No member state has ever left the EU
Leaving requires Article 50 of the Lisbon Treaty to be invoked
UK Article 50 invoked 29 March 2017 => UK has two years to negotiate terms of exit with the EU (extension was granted to 31 Jan 2020)

Problems of retaining access to the Single Market (so UK trade does not suffer) whilst restricting the movement of people (one of the most supported arguments for Brexit was to limit immigration)

EU-originated rules will be still apply until UK formally leave the EU