THEME 4 Flashcards
Globalisation
The growing interdependency and integration of countries both economically and socially
Impacts of globalisation on consumers
More choice/quality of goods/services
Cheaper goods/services
More job opportunities
Enrichment
BUT
Exploitation of labour
Western job losses
Impacts of globalisation on producers
Producers in saturated markets can expand to untapped markets
Cheaper labour/other factors of production (offshoring)
Better labour
BUT
Small, local firms get outcompeted
Difficult to control/diseconomies of scale
Impacts of globalisation on the government
PUTS PACOS
Less poverty in the world
Less unemployment
More tax revenue
More social cohesion between countries
BUT
Pollution
Tax avoidance by MNCs
Culture loss
Overdependence on exports/imports
Spread of economic shocks e.g. 2008
Factors contributing to globalisation
Improvements in Transportation (cheaper to move abroad –> global/domestic markets closer in price)
Improvements in Tech/Communications (e-commerce; cheaper international calls)
Reduction of Trade Barriers; Trading Blocs (less protectionism; EU/NAFTA/APEC etc. –> economies of scale…)
Deregulation of markets and increased capital mobility
Increased significance of MNCs
Phillips Curve
A curve that shows the short-run trade-off between inflation and unemployment
Low U –> shortage of labour –> higher wage demands –> higher wage inflation
Draw diagram
Stagflation
Inflation accompanied by stagnation in the rate of growth of output and an increase in unemployment in the economy; simultaneous increases in the inflation rate and the unemployment rate.
Conflicts between objectives
BoP/Growth (Growth –> more consumption –> more imports [esp. if high mpm])
Inflation/Growth (Growth –> more spending/AD –> demand-pull inflation)
Distribution of Income/Growth (Growth –> assets more valuable –> rich gain more than poor)
Employment/Inflation (Phillips curve)
Environment/Growth (Growth –> more production –> more emissions)
Absolute advantage
the ability to produce more of a given product using a given amount of resources
Comparative advantage
The ability to produce a good at a lower opportunity cost
Advantages of specialisation and trade
Lower price
More choice
Larger markets/EoS
Higher economic growth and living standards
Disadvantages of specialisation and trade
STUDM
Poss trade deficit if domestic G&S are uncompetitive
Higher unemployment
Unbalanced development
Global monopolies get larger
Spread of economic shocks
Arguments for international trade
Increased access of producers to larger markets
International division of labour
Domestic producers more efficient due to foreign competition
More goods at lower prices
Technology spillover - developing countries can catch up
Arguments against international trade
Can’t rely on foreign countries where national security is concerned e.g. food
Some industries forced out of business
Economies hurt by sudden changes in global demand
Protectionism
The reduction of imports by a government through the imposition of high tariffs or quotas
Reasons for protectionism
Raise tax revenue
Protect infant industries
Protect geriatric industries
Protect employment
Retaliation
Protect strategic industries
Correct BoP disequilibrium
Protect the environment
Prevent dumping
Costs of protectionism
Higher prices/less choice for consumers
Inefficient resource allocation (distorts comparative advantage)
Regressive effect on distribution of income (tariffs fall on food, clothes etc., which low income households spend a lot on)
Production inefficiencies due to less competition
Trade wars
Difficulty of removing barriers
Methods of trade barriers + effects
Tariffs (deadweight loss)
Quotas (prices rise; imports fall; domestic output rises; NO tax revenue; loss of business to some importers; revenue to remaining importers up)
Embargoes (domestic output up; prices rise)
Rules/Regulations (increased costs for importers)
Domestic subsidies (reduces costs for domestic producers)
Preferential procurement policies (eliminates competition)
Evaluation of protectionist methods
DREAD
DREAD
Deadweight welfare loss/producer & consumer surplus
Potential retaliation, regressive effects, inefficiencies etc.
Elasticity of D&S
Amount of the tariff
Ability of domestic firms to increase output
Case against import controls
‘Second best’ way of controlling trade
Welfare loss for consumers
Higher costs too for importers of components/technology
World multiplier effects from reduction in trade
Threat of retaliation
Import controls cushions X-inefficiency - act as a barrier to entry
Bureaucratic cost of administering and enforcing import controls
International competitiveness
The ability to sell quality goods and services at competitive prices in foreign countries
Main measures of international competitiveness
Unit labour costs (ULC) - improves when wage costs fall, worker skills/education improves, workers become more productive
Global Competitiveness Index (GCI) from WEF
Real exchange rate
Terms of trade
Factors determining international competitiveness
FIR SUITS
FIR SUITS
Labour flexibility
Innovation
Regulation
Labour skills
ULCs
Infrastructure
Tax regimes
Economic stability
Benefits of international competitiveness
Households: employment; wage growth; higher purchasing power
Firms: more FDI; higher demand; higher profit
Government: current account surplus; employment; fiscal improvement
Economic effects of a fall in competitiveness
Unemployment - fall in exports (depends on new export markets being found; elasticity of goods)
Deterioration of BoP (but ER will adjust; does it really matter?)
Fall in actual economic growth (depends on other AD components)
Price levels fall
Impact on investment
Balance of payments
Record of all UK financial transactions between the UK and other countries over a year
Current account; capital account; financial account
Current Account
Trade in goods
Trade in services
Investment income
Transfers
Capital account
Government investment grants; purchase and sale of patents; trade marks and land for foreign embassies; debt forgiveness; currency trading
Financial account
Portfolio investment (buying bonds and shares) and direct investment (buying land and factories)
Reasons for a BoP deficit
High value of sterling
Cheap imports - changing comparative advantage
Recession in EU/Rest of World
Increased UK income - economic growth
Poor quality/design/reliability/availability of UK goods - R&D gap
Insufficient productive capacity from UK suppliers
Reasons for a BoP surplus
A world boom causing an increase in demand for UK exports
A recession in the domestic economy causing a lower demand for imports
Improved quality, design, reliability and availability of UK goods
Weak pound making UK goods internationally competitive
2015 election - policies regarding international competitiveness
Need access to finance - hard for small/medium sized firm post-2008
Need access to expertise - R&D; Labour ideas implemented by the coalition - catapult centres which bring firms together to progress in the industry and target technological research
All parties had similar innovation policies
Differences: Labour wanted to increase corp tax; Tories wanted to keep it the same
Too much emphasis on debt: interest payments cause profits to fall, making corp tax fall
Crowdfunding, shares, venture capital etc. would be better for innovation
Labour proposed a small business administration like in the USA
Curcial for long-term prosperity (more investment, infrastructure, education)
Supply side policies to boost international competitiveness
Tax incentives for firms to increase R&D expenditure (May not invest though)
Education & training (better skills/occupational mobility) (Time lag)
Privatisation (may be inefficient; not much left to privatise)
Public spending on infrastructure (opportunity cost; time lag; can they afford it?)
Deregulation; lower corp tax (Unintended consequences)
Lower benefits/income tax (hurts the poor)
Demand side policies to boost international competitiveness
Exchange rate policies (not a free economy)
Control inflation; macroeconomic stability –> encourage investment; keep prices low (difficult)
Impacts of a Current Account deficit
Higher standard of living
Better quality goods
BUT
Negative impact on AD and a fall in growth - long term if supply-side causes? (only if deficit is big; could be consequence of strong growth, so good)
Impacts of a Current Account surplus
Increase in international competitiveness
Greater confidence in the UK economy
Greater FDI
Exporting producers benefit –> employment
BUT
Inflationary pressure because injections are high relative to leakages
Increase in the value of the pound –> fall in international competitiveness
Living standards may fall
Economic policies to reduce a trade gap
Cyclical element of the deficit tends to be self-correcting
Lower ER improves the trade balance after a time lag, but this depends on the PED/PES for UK output
Marshall-Lerner condition
WIDEC only applies if PEDx + PEDm > 1
Causes of a Current Account deficit
Demand-side: Strong domestic growth, overseas recession, strong pound
Supply-side: low productivity, low investment, high relative inflation, high labour costs, poor quality products
Policies to reduce a Current Account deficit
Expenditure-reduction and expenditure-switching
Caused by high demand for imports: tighten fiscal and monetary policy BUT may conflict with other objectives e.g. growth; depends on multiplier and confidence
Caused by price: protectionism BUT retaliation; WTO conflicts; imported inflation; X-inefficiency
Caused by strong pound: depreciation BUT Marshall-Lerner; J curve; imported inflation; floating rate; retaliation
Can use supply-side policies BUT time lag; no guarantee of success; expensive
J-curve
PED for imports/exports inelastic in the short run, so a depreciation leads to a worsening deficit until contracts expire etc.
Exchange rate
The rate at which one currency is converted into another
Factors determining the exchange rate
GESTIC FRIG
Growth relative to other countries
Exports of goods/services (X up –> D£ up –> ER up)
Speculation or special factors such as political events
Trade performance with other countries
IR differentials (hot money flows)
Central bank official buying and selling
FDI inflows and outflows
Relative inflation (low inflation implies stability)
Imports of goods/services (M down –> D£ up –> ER up)
Government finances (confidence)
Free floating exchange rate
Value determined purely by supply and demand
Trade flows and capital flows affect the ER
No target for ER and no central bank intervention
Sterling floated since UK suspended ERM membership in 1992
Bank of England not intervened to influence ER since independence in 1997
Managed floating exchange rate
Value determined by market supply and demand
Some market intervention
Governments normally engage in managed floating if not part of a fixed ER system (pursued in the UK from 1973-1990)
Fully-fixed exchange rate
Pegged
Countries can improve competitiveness by cutting costs below other countries, knowing ER will be stable
Need large currency reserves to make this work
Benefits of a floating currency
Low need for foreign currency reserves
Freedom to set policy IR to meet domestic objectives
May help prevent imported inflation
Insulates an economy after an external shock, especially if export-dependent
Partial automatic correction for a current account deficit
Less risk of speculative attack
Benefits of a fixed currency
Certainty –> confidence for inward investment
Low costs of currency hedging for businesses
Stability helps control inflation
Can lead to lower borrowing costs (lower yields on bonds)
Imposes responsibility on government policies
Less speculation if the fixed ER is credible
Benefits of a strong currency
Lower import prices - higher living standards
Higher real purchasing power overseas
Cheaper raw materials –> SRAS up
Helps control inflation (tough competition for domestic producers; fall in imported input costs)
Costs of a strong currency
Cheaper imports leads to rising import penetration and larger trade deficit
UK exporters lose price competitiveness and global market share - difficult to recover
Damages profits/employment in sectors such as manufacturing
Negative impact on growth in the medium term
Some regions affected more than others - different export dependency; exposure to import competition
Reasons for public expenditure
Efficiency and market failure: some markets (e.g. public goods) are allocatively inefficient. Others productively inefficient - a monopsony (e.g. NHS) can fix that
Equity and equality: certain goods have unequal burdens e.g. healthcare for elderly; education for poor
Macroeconomic management: Free market doesn’t account for externalities
Reasons for changing size/composition of public expenditure
Income elastic (low income less revenue; high income high demand for more/better services)
Ideology (USA spends 38% GDP; Finland 58%)
Population (ageing e.g. Japan less productive; need more spending)
Economic crises (austerity post-2008)
Current and capital expenditure and transfer payments
Capital expenditure: spending on long-term investment goods (infrastructure)
Current expenditure: government consumption + transfer payments + debt interest
Transfer payments: mainly welfare, not included in GDP because there is no corresponding output
A current expenditure deficit is undesirable because the burden of borrowing will fall on future generations
Can government spending improve living standards and equality?
Government efficiency: with the right controls/incentives, govt can be allocatively, productively and dynamically efficient. However, no profit motive
Disincentive effects: high tax/spend discourages work, so should be small. However, Nordic countries have similar activity rates/growth as UK/USA
Utility: principal-agent problem between politicians and taxpayers. However, this is because taxpayers would not make decisions in their best interests (public goods)
Crowding out
If an economy is operating on its PPF curve, an increase in public spending will crowd out the private sector
Even below full employment, govt borrowing money to spend can lead to financial crowding out - higher D for finance –> higher IR –> less borrowing by firms to invest
May not happen: transfer payments don’t increase output; high U leads to crowding in (multiplier); could lead to growth, shifting PPF outwards, allowing for private sector growth
Free market economics disagree: higher tax is discouraging; low multiplier –> crowding in unlikely; public investment inefficient
Advantages of government borrowing
Spending on public services benefits people. Education is a supply side policy, increasing economic growth
Extra G increases GDP –> more tax revenue
Improvements in living standards
Disadvantages of government borrowing
STOIC
Spending cuts to reduce the deficit
Increase tax to repay the debt - unpopular and reduce consumption
Opportunity cost of higher interest repayments
Danger of inflation
Potential ‘crowding out’ effect
Composition of govt spending
Current spending on goods & services
Capital spending
Transfer spending
Interest on debt repayments
Reasons for government spending
Provision of public and merit goods
Redistribution of income and wealth
Influencing regional resource allocation and industrial efficiency (done via regional policy)
Influencing the level of economic activity
Macro benefits of state spending
AD injection into the circular flow
Boosts AD during slowdown
Regional employment increases due to investment
Improvements in LRAS from better national infrastructure/education/healthcare
Micro benefits of state spending
A PIPE
Wider access to public/merit goods - living standards, econ. welfare up
Improved public service funding
Income inequality down if real value of welfare benefits rises
Relative poverty down if benefits low income families
Externality effects e.g. from better public transport and healthcare
Factors influencing the size and pattern of govt spending
Level of GDP (more revenue; less demand)
Size and age distribution of population (higher pop. –> more pressure on services; ageing pop?)
Political priorities
Redistribution of income
Need for discretionary fiscal policy e.g. post-2008
Debt interest
Hypothecated tax
A tax that is raised for a specific purpose
Pigouvian tax
Tax to correct a negative externality (internalise it)
Stealth tax
A new tax/tax rise introduced in a way that is difficult to notice it
Fiscal drag
When tax allowances do not rise in line with prices and incomes
Effect of an increase in income tax
Fairer income distribution
Lower incentive to work
Less economic activity
More tax revenue (Laffer curve)
Effect of an increase in VAT
Worse income distribution
Greater incentive to work - need to
Tax revenue depends on elasticity
Inflationary wage-price spiral
Leakage –> less economic activity
Absolute poverty
An absence of sufficient income to access basic human needs
Poverty line $1.90 a day (~800mn people)
Objective measure
Same standard across different locations/time periods
However, minimum level of income to meet basic needs varies by time and location
Relative poverty
Lower standard of living than those around you
EU measure: below 60% median income
Allows comparison within a country
However, highly subjective; can change over time; can’t compare between countries; doesn’t take needs into account (pensioners have low income but low needs - mortgage paid off)
Composite measures of poverty
HPI-1 (% not expected to reach 40; % that are illiterate; % of illiterate children; % that don’t have access to safe water and healthcare)
HPI-2 (Probability at birth of not surviving to 60; Adult literacy rate; population in relative poverty; rate of long-term unemployment)
Lorenz curve
Graph showing how much the actual distribution of income differs from an equal distribution
Gini Coefficient
Measure of inequality on a Lorenz curve. Higher = less equal
A/(A+B)
Causes of inequality
AUSPICATE
Access to capital to start businesses
Unemployment
Social benefits
Pay differences
Inheritance
Corruption
Assets
Tax system
Education
Consequences of inequality
SASHI
SASHI
Social consequences e.g. high crime rate
Access to capital - low for poor
Savings low (poor)
High poverty
Imports (rich)
Interventionist policies to reduce inequality
MITSC
MITSC
Minimum wage - MW £7.70; LW £8.21 - boosts work incentives/take-home pay BUT might cost jobs; higher prices
Income tax - 45% might rise to 50% - progressive tax reduces inequality BUT risks brain drain/tax avoidance
Training - apprenticeship levy since 2017 - Helps raise productivity, jobs and real wages BUT time lag; free rider problem (?)
Service provision - NHS, state education - Access to merit goods not based on ability to pay BUT universal access less effective than targeted provision
Child care - £2,000 a year per child - improve incentives for mothers to work BUT quality of child care needs improving
Causes of poverty in the UK
WASSUP P
Wages (low for unskilled/casual work)
Age (elderly have no income; imperfect information –> low pension investment; health)
Sickness & disability (can’t work as much; unemployable)
Social stigma around benefits –> might not claim; paperwork
Unemployment (long term –> unemployable)
Poverty trap (disincentive to look for work; job –> tax)
Parenthood (alone: leave child alone or no income)
Causes of poverty in developing countries
Natural: Floods, famines, volcanoes, earthquakes, tornadoes, drought, inaccessible location, few natural resources etc.
Manmade: GOBEFACEUP - Govt policies; Overpopulation; Barriers to trade; Environmental degradation; Forced migration; Advice from IMF bad; Corruption; Exploitation; Unemployment; Political strife
Consequences of poverty
Physical/mental health issues
Lower life expectancy
Bad education/less likely to stay in education
Causes of change in absolute and relative poverty
GDP rises reduces absolute poverty, but often hurts relative poverty (depends on welfare state etc.)
Relative changes because of market force impacts on wages and wealth; changes in benefits and tax levels
Relationships between causes of poverty
Debt/Unfair trade: unfair trade means LEDCs can never pay their debts off
Debt/War: must borrow to buy weapons
Disease/War: war creates dirty conditions and lack of stability for healthcare, making disease spread
Education/War: schools become dangerous; learning becomes difficult; kids at war
Education/status of women: Women don’t get education, so they can’t contribute to the economy
Economic development
Cannot be defined precisely
Takes into account the quality of growth, not just the quantity (living standards; sustainability; freedom of choices)
Indicators of a developed country
Can satisfy basic human needs
Opportunity to raise standard of living
Freedom to make choices
Growth is sustainable
Indicators of a developing country
Focus on individual survival
Basic human needs barely met
Poor healthcare and sanitation
Low levels of education
Gender inequalities
Poor and unstable governance
Indicators of development
Real GDP
Income equality
HDI (education, life expectancy, income etc.)
Access to clean water, internet; size of tertiary sector
HPI? (life expectancy, wellbeing, ecological footprint)
What is HDI?
UN measure of development that attempts to rank all countries. The goals of development considered are standard of living (GDP per capita); Longevity (life expectancy); knowledge (adult literacy/enrollment in primary, secondary and tertiary education)
Advantages/disadvantages of HDI
Reliable/easy to obtain indicators
Takes income into account, but qualified by cost of living
Figures recorded with consistency
With GDP and HDI, assumptions on healthcare and education can be made
Can judge success of govt policies
BUT
Fails to take into account income equality
Large disparities may exist between regions, genders or ethnicities
Life expectancy doesn’t tell us about quality of life
Knowledge is academic only - practical knowledge?
Omits important factors e.g. democratic freedom, HR abuses
Human capital
The knowledge and skills embodied in individuals that facilitate the creation of personal, social and economic wellbeing
Importance of high quality human capital
AT BAT
Attractive to MNCs because of lower costs in training workers
Training –> greater productivity
Basic needs of the economy met e.g. lorry drivers being able to read
Adaptable economy if flexible
Technological change contributions
Constraints on human capital improvement
Government can’t afford education investment
Families too poor to send children to school
Culture e.g. lack of education for girls
AIDS/HIV (parents leave work, so children leave school; teachers leave work; MNCs pull out due to unprofitability)
Weaknesses of human capital investment
Very expensive
Long run nature of the investment (ILO: hard focus on education would cause “a protracted period, approximately 15 years, of net costs”)
Brain drain
Primary Product Dependency with examples
When a country is dependent on a single finite commodity
Most developing countries concentrate production on the primary sector (SSA: 95% of exports are primary products)
Can be hard commodities (copper, tin, iron ore) or soft (wheat, palm oil, rice, fruit)
2010 % of exports:
Angola: 97% oil
Zambia: 84% copper
Tanzania: 37% gold
Ghana: 39% gold, 26% oil, 17% cocoa
Issues with Primary Product Dependency
P-P-P-P-PEN
Price fluctuations
Price naturally falls (supply naturally increases; demand falls as synthetic materials can be used)
Producer incomes and foreign exchange earnings fluctuate
Planning investment is difficult (uncertainty)
Protectionism can destroy an economy
Elasticity (Income inelastic products - Prebisch Singer)
Natural disasters can cause quick jolts
Evaluation of PPD
Some countries have developed on the basis of their primary products e.g. UAE (when price is high, they can make a lot of money and reinvest it in diversification)
Some countries have natural resources with growing demand e.g. Congolese cobalt used in phones/electric cars
Comparative advantage
Food prices likely to rise because world population is rising, so demand for agricultural products rises, benefiting farmers
Prebisch-Singer Hypothesis
The argument that countries exporting primary commodities will face declining terms of trade in the long run due to primary goods being income inelastic, which will trap them in a low level of development as more and more exports will need to be sold to ‘pay for’ the same volume of imports of secondary sector or capital goods.
Terms of Trade
(Export prices/Import prices)*100
Ratio between the price of goods a country exports compared to those it imports
Countries export certain goods and need those earnings to fund imports
If ToT improves, the country can buy more imports with money from exports, and vice versa
Depends on elasticity (Elastic exports: ToT improves –> XD falls –> revenue falls)
Thomas Malthus
Eighteenth-century English intellectual who warned that population growth threatened future generations because, in his view, population growth would always outstrip increases in agricultural production.
Problems with population growth
GFUCW
GDP per capita falls
Food
Unemployment rises
Crime rates rise
Wages fall
Benefits of population growth
Higher output
Cheap labour attracts FDI
Higher tax revenues
Infrastructure and issues if it’s low quality
Transport - inability to transfer goods reduces trade; may reduce chances of kids getting to school; high supply costs and delays for businesses; reduces mobility of labour
Public utilities - power failures disrupt production; sanitation and clean water vital for good health
Public services - need for effective emergency services and adequate schooling/healthcare
Communications - inability to coordinate economic activity; underdeveloped radio/TV/internet makes communities insular
Impacts of bad infrastructure
Higher supply costs
Delays for businesses
Reduces labour mobility
Need to invest more to deal with climate change (1901-1910 82 natural disasters; 2003-2012 >4,000)
Examples of bad infrastructure
India: Irrigation is bad, making food production hard to sustain, especially when there is little rain e.g. 2012 - farms had to draw more power to pump water, and hydroelectric plants had less supply, leading to a blackout which left >700mn people without power
Brazil: 2011 - only 14% of roads were paved in 2011
SSA: combined power generation capacity of 48 countries is 68GW - about the same as Spain. 47 without South Africa: 28GW - about the same as Argentina. Africa only invests about 4% GDP into infrastructure
Corruption
Dishonest exploitation of power for personal gain
Types of corruption
Embezzlement, bribes, seizure of property, fraud, nepotism, spending on political aims e.g. weapons
Where corruption occurs
Govt not accountable
Large-scale capital investment projects (payoffs unnoticed)
Accounting practices poorly formulated
Officials not well-paid
Elections not well-controlled
Weak legal structure
Lack of freedom of speech
Effects of corruption
CAMEL PITS
Cost of business rises
Allocation of resources unfair
Monetary gains may be moved out the country
Environmental impacts
Legal system ineffective
Public funds wasted
Investment falls due to risk of contracts not being honoured
Trust in the economy falls
Small bribes reduce citizens’ economic wellbeing
Just 5 of top-25 countries in the Corruption Perceptions Index are non-OECD
Poor governance
Government failure - rulers of a country adopt policies that result in the country’s resources being allocated inefficiently, restricting growth
Connection of civil war to PPD
A country at ‘peak danger’, with commodities comprising 32% of GDP, has a 22% risk of falling into civil war in a given 5-year period, which a country with no primary commodity exports has a 1% risk.
It is easy to capture and control the output of a gold mine or oil field compared to a sector of garment manufacturing or hospitality services.
Connection of civil war to human capital
Young males (majority of combatants) are less likely to join a rebellion if they are being educated and/or have a comfortable salary, and can reasonably assume that they will prosper in the future
Effects of political instability/conflict
Uncertainty –> potential economic breakdown
Unlikely to receive FDI, or even aid
Loss of life, damage to infrastructure, displacement of population, loss of investment/aid, impact on education, impact on healthcare etc.
Examples: Sudan, Iraq, Rwanda, Somalia, Turkey…
Causes of debt
Legacy of colonialism (Indonesian independence in 1949 required assuming Dutch debt, much of it from fighting pro-independence rebels; Haiti paid 150mn francs for independence)
Odious debt (civil wars in Guatemala, El Salvador, Colombia; apartheid regime in South Africa; Duvaliers in Haiti) - should be written off?
1973 oil crisis (LEDCs had to borrow, and banks funded by OPEC deposits lent. Much of the borrowing was odious. 1970-92: LEDC debt up 2000%)
War
Decisions to borrow for major investment projects when economy was strong; borrowing money speculating export prices would rise, and being wrong (Zambia); currency depreciation
Ability to finance debt
Japan debt $2.2tn, 42% GDP
Liberia debt $3.2bn (606% GDP)
Problems with debt
SOURCE
Servicing the debt
Opportunity cost
Unsustainable debt (not used to increase export earnings)
Repayment ability
Conditions on borrowing
Expenditure on debt
Debt cancellation
Heavily Indebted Poor Countries Initiative 1996
Debt forgiveness if the country commits to ‘good’ policies for growth e.g. investing in people, free market practices, widening export base
By end of 2009, 35/41 identified countries benefited; $130bn cancelled
JUBILEE DEBT CAMPAIGN
Advantages of debt forgiveness
SPUD FARM
Stability –> more FDI
Poverty alleviated
Unfair odious debt relieved
Development of infrastructure/human capital
Foreign exchange gap shrinks –> more investment
Aid less needed in the future
Rich countries benefit (exports)
Mutual gains e.g. environment better looked after
Disadvantages of debt forgiveness
CAD GUM
Corrupt misuse?
Appropriate? May need conditions e.g. HIPC
Dependency culture
Govt policies needed as well to reduce poverty
Unfair to countries that managed finances well
Moral hazard
Policies to boost development
Inward looking (protectionism; subsidies; restrict MNC activity) e.g. USSR, India (ISI economics pre-1990)
Outward looking (no protectionism; promote MNC activity; permit labour mobility; free trade; deregulation)
Benefits and costs of inward looking policies to boost development
Self-reliance; develop while preserving culture; necessary forerunner to international trade (infant industries); preserve traditional forms of life
BUT
Distorts comparative advantage; Lack of competition; higher prices; consumer surplus falls
Benefits and costs of outward looking policies to boost development
Welfare gains from tariff reduction; competition forces efficiency; benefit from world growth; EoS; qualify for World Bank aid
BUT
Infant industries can’t develop; deregulation –> collusion; brain drain; no gains from MNC profit (repatriated); tax incentives for FDI –> low revenue
Interventionist approaches to development + criticisms
Import substitution; nationalisation; farmers forced to sell to the state at low prices; subsidies; over-valued exchange rates; encourage MNC activity
BUT
Slow growth; no profit motive –> inefficiency; govt failure; corruption?; fiscal deficit; BoP deficit
Free market approaches to development + criticisms
Trade liberalisation; market liberalisation; supply-side policies; SAPs
BUT
Asymmetric information; externalities; absence of property rights (tragedy of the commons); investment decisions
Aid
The voluntary transfer of resources from one country to another, or loans given on concessionary terms
Bilateral, multilateral, NGO, tied aid, emergency aid
Advantages of aid
KID HARM
Kick-start economic development
Inequalities between countries shrink
Develop infrastructure –> investment
Human capital improvement
Absolute poverty reduced
Rebuilding disaster stricken areas
Multiplier effect
Disadvantages of aid
ACID PIC
ACID PIC
Allocative inefficiency (distorts market forces)
Crowding out of domestic investment
Imperialistic uses through conditions
Dependency culture
Postpones economic restructuring
Ineffective due to limited resources
Corruption
Harrod-Domar model
A model of economic growth that emphasises the importance of savings and investment
FDI
The acquisition of non-financial assets of a country by foreign countries
Involves a flow of capital to build a factory, buy a business, or buy land/buildings
Why are firms attracted to LEDCs?
Cheap labour/resources
Low tax
Subsidies
Setting up inside a customs union
Expanding market scope
Weak regulation
Advantages of FDI
HER SPASM
Develops human capital
Provides employment
Government revenues up
Spillover effects e.g. copying tech
Higher labour productivity –> higher wages than from local firms
Access to world class tech and management
Crucial source of investment funds to encourage savings (Harrod-Domar)
Regional multiplier effects
Disadvantages of FDI
Flaws in job creation (not many jobs due to capital tech; expats for managers, leaving only low paying unskilled work for locals)
Outcompetes local companies
Exploits job-hungry workers
Environmental risks taken
Race to the bottom –> low tax revenue
Repatriated profits
Deals with repressive political regimes
Fair trade
Aims to reduce exploitation of producers, by giving them a ‘fair price’ for their product
Workers from co-operatives to get better bargaining power with MNCs
Businesses signing up to the ‘fairtrade’ label must treat workers well, take care of the envt etc. Pay a ‘fair price’ for the goods, plus a ‘premium’ to improve the product or the area e.g. schools
Fairtrade Foundation gives these firms certification to alleviate a consumer’s guilty conscience
Benefits of fair trade
Guarantees the farmer a certain income
Protects farmers from price fluctuations
Money can be spent on improving the product/production methods, increasing competitiveness
Money can be invested into education, health, infrastructure etc.
Farmers not subject to monopsony power from developed countries
Drawbacks of fair trade
Can be ‘middle men’ involved, reducing the benefit
Not all farmers benefit (awareness, membership fees etc.)
Market distortions - low price indicates oversupply
Reduces incentives to improve quality/productivity
Co-operatives discourage private enterprise
Dependency trap
Alternatives to fair trade
Minimum price schemes
Minimum wage
Subsidy
Regulation
Unions
Buffer stock schemes
A situation where a government intervenes to stabilise prices, often in markets for commodities (raw materials) e.g. agriculture, buy setting ceiling and floor prices. They influence these by buying/selling the needed amount to shift prices
Criticisms of buffer stock schemes
Floor price too high –> constant surpluses
Ceiling price too low –> insufficient stocks
Costs of storage
All major producers must cooperate; no cheating
Lewis model
A development approach which encourages the movement of labour from agriculture to industry (Marginal productivity in agriculture near 0 due to excess supply –> OC of moving = 0)
Criticisms of the Lewis model
Industrial profits may not be invested locally, especially if made by TNCs
Reinvestment in capital equipment would hurt
Assumption of surplus labour in agriculture is unfair e.g. favelas in South America
Financial sector
Connects lenders with borrowers through bond/stock markets, or intermediaries (commercial banks, investment banks, hedge funds, mutual funds etc.)
Market failure in the financial sector
When financial markets fail to allocate financial products at the socially optimum level of output. This is a misallocation of resources
Deregulation of financial markets
Lower reserve requirements (abolished in the UK in 1981); allowing commercial and investment banks to be joined, leading to a higher risk of bank failure
Causes of financial market failure
Excessive risk by banks
Collusion to fix loan rates for self interest (LIBOR)
Monopoly pricing
Types of financial market failure
SMEAR
Speculation and market bubbles (Buy low, sell high; wrongly high predictions can create bubbles e.g. housing/bitcoin, which then bursts)
Moral hazard - too big to fail
Negative externalities e.g. cost to taxpayer of bailout (£27bn estimated); loss of savings; lost jobs, income and growth in the economy
Asymmetric information (regulators don’t know what banks are doing)
Market rigging (LIBOR, FOREX)
Role of the central bank
Implement monetary policy
Bank for the government
Bank for commercial banks
Regulate financial industry
