NON-UK economies

Question 1

Background and history of the EU

Answer 1

• Predecessor of the Eu was the European Community (EEC) created by the treaty of rome in 1957, Economic indpendance would create political stability.
• France, germany, Italy, Belgium, Netherlands and Luxembrouge were founding members.

1. Euro
2. Single market, freedom of movement (work, retire, study), goods (removal of trade protection).

Question 2

FTAs

Answer 2

Free Trade Areas are groups of countries that agree to elimate trade barriers between themselves over time.
Each member has the right to pursue differential trade policy externally.

NAFTA and ASEAN

This is the first stage of economic contribution that the EU represents

Question 3

Rules of Origin of FTAs

Answer 3

Products may be imported into a country with the lowest traiffs and then sold in another country which has higher tariffs, in practise this is avoidance by ‘rules of origin’ and called tariff subversion.

Goods traded within the FTA must demonstrate the economic nationality of the product so that either preferntial free trade rule are applied.

Question 4

Customs Union

Answer 4

EU customs union was established in 1968, currently all EU countries must be part of EU customs union, Turkey has a CU arrangement with the EU that covers certain industrial and agricultural goods but isnt part of the EU.

• No customs duties imposed between member countries, FREE TRADE.
• Common external tariffs imposed on goods external to the CU.
• European commission negotiates on behalf of EUCU members in international trade deals and at the WTO.
• Sharing of tariff revenue, 80% of revenue goes to the EU central budget.

Question 5

Advantages of a customs union membership

Answer 5

1. Internal free trade
2. Bargaining Power and Cost Efficiency
3. Eliminates need for Rules of Origin
4. Tarriff revenue shared
5. Protection from trade deflection

Question 6

Advantages of a customs union membership - Internal free trade

Answer 6

Countries can operate beyond their PPF, meaning potential output is increased. Potentially consumers have greater choice and lower prices.

Question 7

Advantages of a customs union membership - Bargaining Power and Cost Efficiency

Answer 7

EU has 500 million people and a shared economy rivalling the US. Therefore each individual country has greater bargaining power in trade deals with third countries.

Trade bureauracy is reduced in cost savings, EU can recruit the best negotiators.

Question 8

Advantages of a customs union membership - Rules of origin

Answer 8

As external tariffs are comon among CU members, no need for rules of origin.

Question 9

Disadvantages of Customs Union Membership

Answer 9

1. Lack of sovreignity in negotiating trade deals
2. Lack of autonomy in implementing protecionist measures
3. Complications for current and departing members when a country leaves.

Question 10

Disadvantages of Customs Union Membership - lack of sovreignty in negotiating trade deals

Answer 10

Less control/voice in deciding trade deals, forced to have free trade with other member countries.

EXAMPLE - One country may have CA in a particular good, however this might be very sensitive sector for another member (infant industry) for exampling agriculture and fishing.

However there may be benefits of co-ordinated policy for common resources/public goods as these areas where the utility is maximised by co-ordinating, otherwise fishing resources would be exhausted.

Question 11

Disadvantages of Customs Union Membership - Lack of autonomy in implementing protecionist measures

Answer 11

Sectors without CA or infant industry /strategic sectors

Question 11

Disadvantages of Customs Union Membership - Complications for current and departing members when a country leaves the CU.

Answer 11

Complications occur when the departing member has shared border with the CU. In the UK case, NI has shared border with Ireland, this means that there are either border in Ireland or between UK and NI.

Question 12

Trade Diversion

Answer 12

This occurs when joining a CU results in an increase in imports from a higher-cost CU partner, replacing imports from the lowest cost third-country.

EXAMPLE - Country joining EU may stop importing sugar beet from low cost African country and now import from a CU partner, which is high costs producer.

Question 13

Trade Creation

Answer 13

Occurs when the removal of trade barriers between CU members result in greater trade based on comparative advantage, high cost domestic output is replaced by lower cost foreign output.

Question 14

Trade Creation v Trade Diversion

Answer 14

Whether a CU increases allocative efficiency depends on whether trade creation > trade diversion, this can be modelled using a tariff diagram.

The relative effect of diverson/creation depends on which country is lowest cost and level of tariffs pre and post-CU. However the scenario illustrated is quite common as the EU has high tariffs on agricultural goods which non-eu countries tend to have comparative advantage in.

Question 15

CASE STUDY TURKEY

Answer 15

Downsides of joining for Turkey
1. No say over tariffs with extenral countries
2. US FTA is that the US can export tariff free to rukery but turkey still has tariffs imposed on its exports.

For turkey although the negatives can be outwieghed by the benefits of free trade.

SO WHY is turkey not a EU member?
Reluctance of the EU to grant free movement of the large turkish poppualtion.

Question 16

The EU single market

Answer 16

This was created in 1993 and it represents one more step towards economic intergration, above the customs union. The EUCU implies free trade in goods and a common external policy.

4 fundemental freedoms
1. Movement of labour
2. Goods (customs union already permits this)
3. Capital (money)
4. Services

The Single Market requires even greater policy co-ordination among its members than a CU and a subsequent loss of autonomy for individual states.

WHY? So that for example, UK worker in Spain enjoys benefit of same legislation as a Spanish worker. EU has also added its own legislation which supersedes national legislation.

Question 17

Free movement of people in a single market

Answer 17

Among the many rights enjoyed by individuals in the EU is the ability to live and work in another EU member state.

1. Employment access and clear working conditions on pay, dismissal and health and safety.
2. Access to social and tax advantages
3. Access to training, housing, education and apprenticeships.
4. Membership of trade unions
5. Assistance from employment offices.

Question 18

Advatnages of the free movement of people

Answer 18

1. Safety values
2. Positive economic effects
3. Lower economic burden

Question 19

Advatnages of the free movement of people - Positive economic effects

Answer 19

A8 have positive ratio of revenue/expenditure of 1.4, versus 0.9 for native brits. Meaning that the A8 workers make net positive fiscal contribution. The A8 workers were younger more educated, with higher LF participation rate, higher employment rate, potential output was raised.

Question 20

Advatnages of the free movement of people - Lower economic burden

Answer 20

A8 members up to 60% less likely to recieve benefits or tax credits.

Question 21

Disadvantages of the free movement of labour

Answer 21

1. Social dumping
2. Competition for low skilled jobs

Question 22

Disadvantages of the free movement of labour - Competition for low skilled jobs

Answer 22

A8 workers disproportionatlly focussed in low skilled jobs (70% in these occupations vs 24% of native UK citizens), creates competition and results in wage supression for low-skilled workers.

EVAL, however post-Brexit labour shortages demonstrates the net economic benefits of migration

Question 23

Disadvantages of the free movement of labour - Social Dumping

Answer 23

Undercutting national employment or social rules or legislation. Example being Eastern Europe workers being used in France/Germany and being posted as ‘temporary workers’ and thereby subverting industry level wage agreements.

Richer EU countries have costs and benefits. Benefits for producer who have access to simply of low wage workers and benefit from social dumping. However, local workers in richer Eu countries may suffer from wage competition.

Question 24

Eurozone

Answer 24

• The Euro area is a monetary union of 19 members states of the EU that have all adopted the euro as their primary currency.
• Further step of economic intergration.
• Common monetary policy.
• Coordination of fiscal policy
• Common currency

Question 25

Covergence criteria

Answer 25

In order to join the Euro, countries must meet the following…

1. Low and stable inflation
2. Small government budget deficits relative to GDP (not more than 3%)
3. Low government dept-to-GDP ratio (not more than 60%)
4. Exchange rate stability (fixing their exchange rate under the ERM) Pegged rate with respect to the euro.
5. Low long term interest rates.

Question 26

What is the purpose of the convergence criteria

Answer 26

• Ensure more MACRO stability
• Members can adopt similiar policy response to economic shocks, this is important because they no longer control their own monetary policy.

EXAMPLE - Covid pandemic hit, government spending rise, dept to GDP increase.
If an economy already had a high dept to Gdp, outside of its single currency, its XR would depreciate(investors pull funds out and FA account moves into deficit). BUT in a single currency this adjustment mechanism is not available, therefore large imbalances can occur putting pressure on the currency

Question 27

Benefits of Euro membership - Transaction costs

Answer 27

With a single currency, there will be no longer a cost involved in changing currencies; this will benefit tourists and firms who trade within the Euro area. It has been estimated that this benefit will be equal to 1% of GDP so will be quite significant.

There are reduced transaction costs when being a member of the euro, increased trade and higher growth

Question 28

Benefits of Euro membership - Lower Uncertainty

Answer 28

Lower XR risk, results in greater trade

Question 29

Benefits of Euro membership - Price transparency and increased competition

Answer 29

• Ease of price comparison, raising price competition.
• Since firms operate in a more competitive market, they become more efficient and there is
  a better allocation of resources. There could be the long run benefits of dynamic efficiency
  too, although these benefits are not always spread evenly across each member.

Question 30

Costs of EURO membership - Lack of monetary policy sovreignty

Answer 30

Monetary policy is a key policy tool for controlling inflation and adjusting economic growth. Similar to pegged exchange rate countries, in the absence of this tool country must rely on other levers, such as fiscal policy and structural reforms (with long time lags). Fiscal policy would need to ‘overshoot’ (aka over compensate)

Question 31

Costs of EURO membership - Lack of Exchange rate flexibility as a means of economic adjustment

Answer 31

Scenario 1: Relative inflation rate rises domestically vs. overseas. How would XR typically adjust (outside of currency union)?
Demand for domestic exports would fall, XR would depreciate, price competitiveness of exports would be restored. In Euro currency does not adjust and therefore there is an even larger fall in demand for exports. THE XR PROVIDES A MEANS OF RESTORING COMPETIITIVNESS OF EXPORTS, THIS IS LOST IN A SINGLE CURRENCY

Scenario 2: Germany has a highly competitive export sector and has a large CA surplus against Greece. How would XR typically adjust (outside of currency union)?

Free float – German deutschmark would appreciate relative to Greek Drachma.

Single currency – Without the XR adjustment, the CA imbalance persists. This allowed Greece to overconsume for a long period of time. This raised Greek national dept and stored up problems with exploded in 2007/8.

Question 32

Costs of covergence

Answer 32

Convergence criteria is unrealistic and restrictive. There have been periods when all EU countries broke these criteria. Following Greek crisis, in 2011, EU introduced 6-pack measures.

Greater monitoring of national budgets by EU (EC can comment on budgets)

Question 33

OCA

Answer 33

Optimum Currency Area

An OCA is a geographical area in which it would maximise efficiency fot there to be a single currency.
Economists such as Mundell (1961) have sought to analyse the conditions which must be fulfilled for a successful currency union or OCA.

Question 34

OCA

Answer 34

Optimum Currency Area

An OCA is a geographical area in which it would maximise efficiency fot there to be a single currency.
Economists such as Mundell (1961) have sought to analyse the conditions which must be fulfilled for a successful currency union or OCA.

Question 35

Advantages of a currency union - trade deflection protection

Answer 35

• When goods enter a free trade via the lowest tariff entry point.
• Common external made policy protects agains this.

Question 36

Factors that make a currency union successful

Answer 36

1. Capital/Labour mobility
2. Fiscal risk-sharing/co-ordination
3. Business cycle synchronisation

Question 37

Factors that make a currency union successful - Capital and labour mobility

Answer 37

If domestic and foreign start off with equal output per capita and unemployment levels, an asymetirc shock results in higher unemployment in domestic, no impact on foreign.
Expansionary policy outside a currency union could boost output and unemplpoyment. However this is not possible in a OCA. So Labour mobility would result in migration from foreign to domestic.

EVAL Language, cultural barriers as well as barriers to free market services.

Question 38

Factors that make a currency union successful - Fiscal risk-sharing/co-ordination

Answer 38

This includes policies such as structural funding to less developed regions, one step further would be fiscal risk-sharing (where members havinh shared fiscal responsibility either through control over each others spending or in a extreme case providing bailouts).

Will wealthier countries with a current account surplus accept this idea?

Question 39

Factors that make a currency union successful - Business cycle synchronisation

Answer 39

• If business cycles are in sync than monetarry policy will be approproate for all (it will be counter-cyclical). All countries can pull in the same direction, loose monetary policy when growth is weak.

Question 40

Greek Sovreign Debt Crisis Causes DOMESTIC

Answer 40

1. Large budget deficits and rising dept to GDP ration from the 1980s onwards, from the 1990s onwards, and persistant current account deficit (consuming more than they can produce)
2. Under reporting of fiscal deficit by the greek government, so as to not break convergence criteria, Greek budget deficit by 2009 was between -6% and -8% GDP, later revised forecast upwards to 16%.
3. Tax evasion - greek shadow economy/black marget as % of GDP in 2017 at 22%.

Question 41

EXTERNAL causes of the Greek sovreign dept crisis

Answer 41

1. Eurozone membership
2. Financial crisis

Question 42

EXTERNAL causes of the Greek sovreign dept crisis - Eurozone membership

Answer 42

• Reduces the borrowing costs for the greek government, this is because there was this perception of lower credit risk on joining the Euro, this was because the euro seemed to privde economic stability and implicit support from stronger fiscally prudent countries, this allowed Greece to continue running a budget deficit and in fact increasing this.
• Trade costs decline and Greece, which has historically current account deficit, sees widening deficit, this is exacerbated by rising labour costs, greek labour costs rose by 50% 2000-2010.

Question 43

EXTERNAL causes of the Greek sovreign dept crisis - Financial crisis

Answer 43

Budget and CA deficits worsen and become critically large, CA deficit means you spend more than you produce, FA experienced large and rapid outflows, rising labour costs.

Question 44

Possible solutions to the debt crisis

Answer 44

1. Economic growth via expansioanry monetary policy, not available in the currency union, partiuclary in the Euro due to germanys historical fears of hyperinflation.
2. Massive currency devaluation, increases export competitiveness, helps with the solvency crisis of the greek govt. because higher inflation would make it easier to repay.
3. Supply side reforms, measures in which raise productivity (reducing labour costs, privatisation, deregulation and lower barriers to entry. But these are long run reforms with high time lags and the burden will fall on the works.
4. Budget cuts, places a drag on growth.

Question 45

Possible Solutions to Greeks dept ciris in a CURRENCY UNION

Answer 45

• Adopting the OCA principle of fiscal risk-sharing, mutualisation of dept to all EU countries, although northern states such as netherlands and germany were strongly opposed and dont want to provide bailouts to southern europe.

Question 46

How did the response from the Eu/Euro members and international bodies exacerbate the greek dilema?

Answer 46

Greece pushed into contradictory fiscal policy conditionally for any financial support, support was dependant on greece implementing large cuts and supply side reforms.

No risk sharing will mean loss of investor confidence and raise govt dept yields and worsen the dept crisis.

This combination of negative growth and rising dept servicing costs risk a debt spiral and ultimatelt default.

Question 47

German response to the Greek crisis

Answer 47

1. No bailout, Germany as the most powerful economy in the Eurozone is the critical voice in all areas of policy making, the german policymakers orginal position would there would be no bailout.
2. Moral Hazard, Germnay was fiscally prudent and rejected any prospect of bailing out ‘profligate’ southern european economies like Greece, which had indulged in large current and budget account deficits for decades.
3. Promotion of austerity, Germany advocated that Greece and other crisis-affected economies embark on deep fiscal and private sector austerity.

Question 48

Euro response to Greece BAD

Answer 48

This, too, is false. True, the loans supplied by the eurozone and the International Monetary Fund amount to the huge sum of €226.7bn (about 125 per cent of GDP), which is roughly two-thirds of total public debt of 175 per cent of GDP. But this went overwhelmingly not to benefiting Greeks but to avoiding the writedown of bad loans to the Greek government and Greek banks. Just 11 per cent of the loans directly financed government activities. Another 16 per cent went on interest payments. The rest went on capital operations of various kinds: the money came in and then flowed out again. A more honest policy would have been to bail lenders out directly. But this would have been too embarrassing.

Question 49

EU enlargement

Answer 49

The expansion of the EU to embrace more countries has been perhaps the most important development in Europe in recent years, for example in 2004 9 nations joined the EU and in 1973 Denmark, Uk and ireland joined.

Question 50

How does EU enlargement affect existing countries - Export potential

Answer 50

• There are trade creation effects from increasing the size of a customs union, Britain can now source some of her imports of goods and services more cheaply leading to a imrpovement in their terms of trade, further resources can be diverted to the UKs comparative advantage.

Question 51

How does EU enlargement affect existing countries - Economies of scale

Answer 51

As the size of the european market increases the accession countries become richer creating new demand for goods and servcies, the value of the british exports to poland has more than doubled since their accession to the EU in 2004.

Question 52

How does EU enlargement affect existing countries - Foreign inevsement and Income and profits

Answer 52

Foreign invesment by british firms into europes newest states will provide a flow of interest profits and dividens thereby boosting out GNP and supporting the current account of the balancee of payment, FDI will also help to speed up the economic transformation of europes new countries.

Question 53

How does EU enlargement affect existing countries - A more diverse labour market

Answer 53

There are now greater opportunities for British businesses to import lower-cost skilled labour in areas where there are labour shortages.
Inward migration into the UK helped to offset some of the longer-term effects of ageing populations and the slow growth of the population of working age. It kept wage inflation and consumer price inflation lower than would otherwise be the case and may have contributed to a higher level of potential national income.

Question 54

Risks of EU enlargement for existing countries

Answer 54

• Extra budgetary costs for financing EU programs, most of the new member states have relatively low GDP and the EU has raised the size of their spending on cohesion funds much of which has been targeted at poorer regions.
• Social and economic pressures from inward labour migration.
• A shift of foreign direct investment and jobs to eastern europe, party driven by tax competition and lower unit labour costs.