Role Of The State In The Macroeconomy Flashcards
Capital Government Expenditure
Spending on investment goods like new roads/education/hospitals
Transfer payments
Payments with no corresponding output, from one group to another I.e pensions/benefits
Current government expenditure
General government final consumption + transfer payments + interest payments
Uk government main areas of spending
Education (12%), defence (6%), pensions (20%), defence (6%)
What is the size of government expenditure usually relative to?
Average income of the country - lower income means lower tax revenues for the government, and HICs demand more services from the government
Impact of the 2008 financial crisis on government spending
Huge increases in government spending as welfare payments increased and money was needed to bail out banks (I.e Lloyds)
What has been the UK government’s policy since 2010?
Reducing their debt
Why will Europe/Japan suffer from increased government spending in the future?
Ageing population
Positive impacts of increased government spending on productivity and growth
Improves infrastructure, economies of scale so improved productivity, education creates human capital for growth and healthcare creates an active workforce, can target areas with high unemployment to create a multiplier effect
Positive impacts of increased government spending on living standards
Corrects market failure + provides public goods, reduces absolute poverty through benefits
Negative impacts of increased government spending on productivity and growth
Free market economists argue spending is wasteful as government lack knowledge + efficiency is lower as less expertise
Negative impacts of increased government spending on living standards
Government inefficiency may disincentivise workers which reduces output, principal agent problem- government spending taxpayers money, doesn’t benefit them
Why may the principal agent problem not be as much of an issue for the UK government?
Democratic political system, people choose government
Crowding out effect
Government must borrow money to increase spending, so increased demand for loans raises the interest rates which crowds out private sector investment as it becomes more risky
Other examples of government crowding out private sector
Government use resources which then can’t be used by the private sector
When is crowding out effect worst?
High employment as may cause people to lose jobs - if there is high unemployment it may lead to crowding in
Crowding in explained
Increased in government spending leads to an increase in growth, which boosts private sector investment as greater confidence
What are the issues with high government spending regarding taxation?
Tax levels must be high to sustain spending, which disincentivises the rich but improves equality
Impacts of government spending on equality
More spending increases equality, reduces poverty
Progressive tax definition
Those on higher incomes pay a higher proportion of the tax (I.e income tax)
Regressive tax definition
When income increases the proportion of tax paid becomes smaller, usually when tax is the same for everyone (I.e VAT)
Which regressive taxes have the worst effect on lower incomes?
Alcohol duties and cigarette taxes - causes issues as addictive, leads to high proportion of income being spent on these goods
Proportional tax
When proportion of income spent on tax remains the same whilst income changes (I.e tax is 10% of income’
Negative impacts of tax changes on incentives to work
Higher taxes discourage work, those on higher income may move abroad which creates brain drain, those on lower income may be stuck in the poverty trap
Which tax most affects people’s incentive to work?
Income tax - a switch to indirect taxes may increase incentives to work
Indirect tax
A tax levied on goods or services rather than an individual of company (I.e VAT)
Direct tax
A tax that a person or business pays directly to who imposed the tax (usually the government)
Argument that higher taxes increases incentive to work
Means people work longer to maintain income so incentive to work increases
Example of a country with high tax and high growth
Sweden
What does the Laffer Curve show?
A rise in tax doesn’t always increases tax revenue as may encourage avoidance/evasion
Why is revenue from indirect taxes not always dependent on tax levels?
Dependent on consumer spending, lower taxes may increase revenue as more consumption due to lower prices
Impacts of tax increases on income distribution
Progressive taxes increase equality, regressive taxes worsens equality - switch to direct taxes to improve equality
Which tax has the greatest impact on improving income distribution if increased?
Inheritance tax -most progressive tax form
Why does redistributing tax to improve equality not necessarily help the poor?
Benefits are also needed as the poor don’t get the money directly, government could spend it on other goods like defence
Impact of a rise in direct taxes on output and employment
Rise in direct taxes decreases AD as people have less disposable income
Impact of a rise in indirect taxes on output and employment
Rise in indirect taxes decreases AS as hurts firms more
How can income taxes affect LRAS?
High income tax may decrease LRAS as less incentive to work
Impact of taxes on price levels
Rise in indirect taxes causes cost-push inflation , rise in income taxes reduces AD so prices lower
Impact of change in tax levels on trade balance in the short-run
Rise in taxes reduces AD, which benefits the BoP in the short-run as demand for imports decreases
Impact of changes in tax levels on trade balance in the long run
Reduced invesment due to lower availability of credit may hurt export competitiveness, worsening the trade balance
Impact of tax changes on FDI flows
Low taxes encourages investment x issue is countries compete to lower taxes to attract FDI which worsens debt
Automatic stabilisers definition
Mechanism which reduces economic changes on income - recession (benefits increase), boom (taxes increase) - controls AD
What is an issue with automatic stabilisers?
They are unable to prevent economic changes, just reduce the size of the impact
National debt definition
Sum of all the fiscal deficits built up over time
Fiscal deficit definition
The difference between government spending and government revenue over a year
UK debt levels in 2024
101.3% of GDP
Uk deficit levels in Q4 of 2023
6% of GDP (£40 billion)
Cyclical deficit
When a deficit occurs due to the state of the economy - recession likely to have a larger deficit
Structural deficit
Long-term deficit that isn’t related to the economy
Actual deficit
Structural + Cyclical deficit
Issues measuring deficit levels
Difficulty knowing what is structural and cyclical deficit
Factors influencing the size of fiscal deficits?
Trade cycle, natural disasters, interest rates, privatisation, government aims, number of dependants
How does the trade cycle influence the size of the deficit?
During a recession deficit worsened ( 2010 deficit reached 10.1% of GDP)
How do interest rates influence the size of the deficit?
If interest rates on government repayments increase then the real size of the deficit increases ( 7% of UK government spending is in interest repayments on loans)
How does privatisation influence the size of the deficit?
The one-off payment to the government improves the deficit in the short-term
What is the UK government aims influencing the size of the deficit?
UK austerity policy since 2010, fiscal deficit reduced by 75% since 2010
Factors influencing the size of national debt
Consistent fiscal deficit grows national debt, ageing population worsens debt as more spent on pensions/healthcare
Significance of deficit/debt on interest rates
High levels of spending may raise interest rates as there is an increase for demand of money - not always the case as the government may borrow overseas
Significance of deficit/debt on future generations
Interest repayments means future generations pay for todays spendings - argument is fair if spending is in capital like infrastructure
Significance of deficit/debt on inflation
If government increase spending and private sector spending doesn’t fall, AD may rise too much causing severe inflation
How does the deficit/debt cause hyperinflation
If the government can’t borrow money they may print money, which if not controlled causes increase in supply,t and fall in value of currency (Zimbabwe 2008)
Significance of deficit/debt on investment to government
Likely to reduce as is more risky as if debt rises, government may default on payments
How can government borrowing improve growth?
If is used for capital spending will boost supply side
How can the government use loose fiscal policy to reduce deficit/debt?
Increasing spending will cause a demand stimulus which benefits debt in the long run as increases tax revenue
How can the government use tight fiscal policy to reduce debt/deficit?
Decreasing spending reduces import demand and raising taxes increases tax revenue
Negative drawbacks of tight fiscal policy
Worsens equality, living standards and growth
How can the government reduce poverty/inequality?
Use a progressive tax system, use benefits/transfer payments, provide public goods, reduce wage differentials, improve access to education/training, use price controls
How may a progressive tax system worsen poverty/inequality?
Laffer curve - may encourage avoidance ( example USA)
What % of government spending is in transfer payments?
30%
How can the government reduce wage differentials?
Implement a minimum/maximum wage, trade union legislation, employers provide pensions
Issues with the use of a minimum wage?
Increases unemployment
Issues with the use of a maximum wage?
Brain drain
Example of the Uk government improving access to education?
Pupil premium scheme
Trickle down argument
Increasing income of the rich may increase income of the poor as the rich invest money increasing employment
Use of price controls to reduce poverty/inequality
Price controls on essential goods like electricity- but may create black market
Domestic reason for changing interest rates
Control inflation
Global reason for changing interest rates
Lower the exchange rate
Issues due to Globalisation of the financial market
Difficulties managing domestic money supply
When can quantities easing be used?
When the country is suffering from the liquidity trap?
Supply side measures to boost international competitiveness?
Improved productivity - increased competition lowers export prices
How can the government boost international competitiveness?
Decrease taxes on export industries to reduce prices
Exchange rate policies to boost international competitiveness?
Control inflation (used in China)
How else can a country improve international competitiveness?
Join WTO/sign trade agreements
Issues with increasing interdependency of countries in the UK?
Rise in prices in other countries (I.e oil) effects UK GDP - shocks in global economy accounts for 2/3 of weakness in UK output
Issues with Brexit regarding UK economy
Inflation rose due to falling value of the pound as demand for imports fell (£35 billion spent to leave EU)
Positives of TNCs
Can bring huge gains to the economy - jobs, knowledge and investment
Isssues with TNCs
Can corrupt government, damage culture, capital flight
How can capital flight be reduced?
Making TNCs set up a joint company with a local partner meaning some profits are retained in the country
How do firms avoid tax?
Use of transfer/shadow pricing
What regulation is done to prevent transfer/shadow pricing?
Transfer Pricing Guidelines 1995 - however issue as not regulated well
Dutch sandwich meaning
Costs/revenue/profits are sent from an Eu country (I,e Britain) through the Netherlands or Luxembourg then sent to a tax haven like Barbados
Impact of Dutch sandwich on countries tax revenue ?
For every £1 Luxembourg gain, other countries lose £1000 of tax revenue
Difficulties with stopping transfer pricing/dutch sandwich tax avoidance
Solutions require a worldwide agreement - a solution that would benefit the Uk would hurt Luxembourg and Bahamas
Problems facing policy makers in the UK
Inaccurate information, uncertainty of how consumers will react, external shocks
What is another name for interventionist strategies?
Inward-looking
What is another name for market-based strategies?
Outward-looking strategies
If the question states for ‘other’ strategies to promote development, what should you use?
Lewis Model/Develop Tourism
