Theme 4: A global perspective Flashcards
What are the characteristics of globalisation
- Growth in free trade + movement of labour and capital across national borders.
- Increased importance of global financial systems.
- Growth in trading blocs (groups of countries, like EU).
- Growth of TNC’s
What are the factors contributing to globalisation
- Growth of free trade; made countries more closely integrated.
- Multinational companies.
- Technology: internet has improved communications
- Transport: containerisation + shipping
-
WTO: helped reduce barriers to trade and
provide a forum for discussing global issues. - Trading blocs.
-
Opening up of China and Eastern Block.
e.g. China investment in Africa to benefit from raw materials.
What is the impact of globalisation on the government
- Global trade cycles: dependence on others
- International co-operation.
-
Interdependence.
China has become reliant on Africa for raw materials. Africa is reliant on China for inward investment. -
Higher taxes but TNC’s lobby and ‘race to the bottom’
apple 0.005%
What is the impact of globalisation on workers
-
New opportunities
e.g. finding new opportunities to work abroad, like workers from Eastern Europe coming to work in Western Europe –> but problems of housing shortages -
Wages helped equalise wages across the world.
For example, self-employed computer programmers in India can work for US firms through the internet. - FDI has created manufacturing jobs in developing countries e.g. clothing retailers setting up in Asia.
–> but sweatshops; 36 hr shifts Indonesia - Encourage Skilled labour.
What is the impact of globalisation on firms
- Domestic firms uncompetitive. Some local firms may be pushed out
-
Lower costs for multinationals. outsourcing labour.
but costs to outsourcing (e.g. bad potential
publicity from ‘sweat shop’ factories) and possibly harder to
maintain quality of production. -
Economies of scale. significant for industries with
high fixed costs, like cars and aeroplanes; mainly benefits TNC - Impact on firms in developing world; reliance on primary prod.
o But new opportunities to firms in developing countries, e.g. computer software firms in India - Cheaper imports + lower risk from dependency on one country
What is the impact of globalisation on the enviroment
- Environmental costs. goods are increasingly imported from; higher carbon foorprint
- firms switch production to countries with weaker environmental legislation.
- But greater cooperation
What is the impact of globalisation on economic growth
- Investment by TNC, increase in LRAS
- TNC’s bring human capital through knowledge
- Increased trade
- Compartivie adv. change over time
What are the limitations of MNE’s for economic development
Footloose-MNE’s can and will relocate for more favourable tax and or cheap labour
e.g. Rust Belt (700,000 jobs lost) in USA
Repatriated profit
How does globalisation affect cultural identity
- Cultural globalisation is a key part of globalisation
- Communication and media transmits cultural ideas and has a large effect
- Communication technology allows acculturation through the internet
How did Covid ‘kill’ globalisation
- Clothing sales fell by 73.56% and bangladhes lost out on 2.6 billion dollars, millions of low income workers were laid off
- 2008 caused slowbilisation, opposition to the system grew in response to the movement of labour to China
- Desire to bring back maufacturing brought Populist leaders to ban immigrants ‘the future does not belong to Patriots, it belongs to Globalists’
According to the Economist how much has containerisation impacted bilateral trade over 20 years
over 790%
How much of the world’s outsouring businesss does India control
controls 44 percent of world outsourcing business
How much of the world’s wealtth does the top 1% of income earners control
43% of the world’s wealth
What is slowbalisation
The stagnation of the rate of globalisation after 2008
- Cost of moving goods hasn’t fallen
- the average tariff rate on all American imports will rise to 3.4%, its highest for 40 years
- Asian firms made more foreign sales within Asia than in America in 2017
How can it be argued that globalisation isn’t dying but changing
Figures in physical goods doesn’t take into explosion of digital economy
Cross border data flows have increased from 1 terabit per second in 2005 to 1,400 in 2017
What did Hal Varian say if trade flows recorded the true value of US-made operating systems installed on smartphones assembled in Asia
It would reduce the U.S.’s $500 billion trade deficit with the world by more than $120 billion in one fell swoop.
What is absolute advantage
This occurs when one country can produce a good with fewer resources than another.
What is comparative advantage
A country has a comparative advantage if it can produce a good at a lower opportunity cost i.e. it has to forego less of other goods in order to produce it.
What is the law of comparative advantage
This states that trade can benefit all countries, if they specialise in the goods in which they have a comparative advantage.
According to the law of comparative advanatage, what should happen in this scenario
Clothes:
For the UK to produce 1 unit of clothes, it has an opportunity cost of 4
computers.
* For India to produce 1 unit of clothes, it has an opportunity cost of 1.5
computers.
* Therefore, India has a comparative advantage in producing clothes
because it has a lower opportunity cost.
Computers
* If the UK produces a computer, the opportunity cost is 1/4 (0.25).
* If India produces a computer, the opportunity cost is 2/3 (0.66).
* Therefore, the UK has a comparative advantage in producing computers.
After Specialisation, total output increases by 2
What are the limitations of the theory of comparative advantage
- Increased specialisation –> diseconomies of scale
- Trade may be restricted through tariffs.
- Comparative advantage measures static advantage but not any dynamic
advantage. - Assumes constant cost, homogenous goods, perfect knowledge, no transport costs, constant return to scale
- Ignores exchange rate
Portray absolute advantage diagramatically
in the context of the PPF. Country 1 has an absolute advantage in both as they can produce more of both. However, trade is not worthwhile because they have the same opportunity cost since the gradients of the lines are the same.
Portray comparaitive advantage diagramatically
Country 1 has an absolute advantage in producing good B and country 2 has absolute advantage in good A. Specialisation is worthwhile since the opportunity cost is different.
This creates the new green PPF, since they maximum they can produce is 200 and 1600. If they produce at a rate of 1:1, they produce on the line but they can produce anywhere in the area between all three lines, A.
Both countries are able to produce beyond their PFF, which shows both have benefitted from specialisation.
Why do manufactured goods tend to be non-homogenous and what does Preference Similarity Theory suggest
Preferance similarity theory suggests that some goods are imported simply because consumers want choice.
What is the Hecksher Olin principle
Countries export what they can most easily and abundantly produce
What is the pattern of trade
The pattern of trade refers to how a country trades with other countries and in which direction.
Trade flows refer to where the countries exports and imports go
What are the factors influencing the pattern of trade
-
Comparative Advantage
e.g. deindustrilisation in UK led to moving to other places such as Poland -
Emerging Economies
As countries grow, likely to need more imports such as China
International trade contributes 20% of LIC’s economies compared to 8% of US - Trading blocs and bilateral trading agreements Leaving EU meant that the UK had a 14% fall in trade w them
-
Relative exchange rate
UK’s trade deficit with Europe is due to the strength of the pound.
China have kept their currency weak in order to increase their trade surplus by making exports more competitive.
What is the pattern of trade between the UK/USA + China/Germany
- UK/USA run a persistent current account deficit
- China and Germany run a consistent surpluss
What is the reason for the nature of the pattern of trade between the UK/USA + China/Germany
China lower labour costs –> gives a omparative advantage in manufactured goods.
* Chinese currency relatively undervalued. China has often sought to
maintain an undervalued currency to make exports cheaper.
* In the Euro, German exports become relatively cheaper because in the
Euro, there is no appreciation within the Eurozone
* It also reflects a higher marginal propensity to consume in the UK and the
US. This means more willing to spend income.
What is the terms of trade
dividing the price of the exports by the price of the import
an improvement if buy more imports with the same level of exports.
Detoriation if converse
What are the factors influencing the terms of trade
-
Exchange rate. depreciation cause a deterioration in the
terms of trade. - Commodity prices. If a country produces mainly primary products, then falling commodity prices worsens their terms of trade.
-
Higher inflation. A relatively higher inflation rate will increase the price
of exports relative to imports and improve the terms of trade- but depreciation on FX -
Demand for products. rising export demand will push
up export prices, causing an improvement in the terms of trade.
Long-run:
* Improvement in productivity will decrease terms of trade
* changing incomes - Prebish Singer Hypothesis –> primary goods decline in price propotionately so those dependent on them will see fall in terms of trade
What is the effect of a detoriation in the terms of trade
countries will need to export more goods to finance the
same quantity of imports.
* A deterioration in the terms of trade could mean higher import prices and
cost-push inflation.
* A long-term decline in the terms of trade can lead to lower living
standards, because the country can afford relatively fewer imports
- Beneficial if caused by depreciation; if demand elastic then increase in exports
How does elasticity affect the terms of trade and the current account
If PED of exports and imports is inelastic, a favourable movement in terms of trade would improve the current account on the balance of payments
if it is elastic, a favourable movement would worsen the current account
Why is an improvement in the terms of trade likely to lead to a fall in GDP and a rise in unemployment
, since if it is caused by a rise in export prices, exports will fall and if it is caused by a fall in import prices, imports will rise. Both of these causes a reduction in production within the country and so a fall in jobs and output
What is the issue with a long-term decline in the terms of trade
suggests a long term decline in living standards as less imports can be bought.
What are the stages of economic integration between countries
- Free Trade Area
- Customs Union
- Single/Common Market
- Economic Union
- Monetary Union
- Fiscal Union
What is a PTA and FTA
● Preferential trading areas (PTA): These are where tariff and other trade barriers are reduced on some but not all goods traded between member countries.
● Free trade areas (FTA): These occur when two or more countries in a region agree to reduce or eliminate trade barriers on all goods coming from other members. Each member is** able to impose its own tariffs and quotas on goods it imports from outside the trading bloc. **
What is a customs union
A customs union involves the removal of tariff barriers between members and the acceptance of a common external tariff against non-members.
members may negotiate as a single bloc with third parties such as other trading blocs or countries.
(FTA + Common External Tariff)
What is a single/common market
hen members trade freely in all economic resources so barriers to trade in goods, services, capital and labour are removed.
They impose a common external tariff on imported goods from outside the market
significant level of harmonisation of micro-economic policies
‘aim to create a single market’
What is an economic union
A common market as well as a common external tariff but free to pursue independent macro economic policy
What is a Monetary Union
– Economic Union plus common currency and common
monetary policy. (e.g. Eurozone).
What is a fiscal union
A fiscal union is an agreement to harmonise tax rates, to establish common levels of public sector spending and borrowing, and jointly agree national budget deficits or surpluses.
The majority of EU states agreed a fiscal compact in early 2012, which is a less binding version of a full fiscal union.
What are the conditions necessary for the success of a monetary union
- there should be free movement of labour, capital mobility and wage and price flexibility, fiscal transfers from one country to another when a country is performing poorly, and countries should share the same
The main problem for the EU is the lack of automatic fiscal transfers, for example these would have helped Greece, Spain and Portugal following the financial crisis of 2007-08.
What are the costs and benefits of a monetary union
- prices are fixed as all currencies are the same and there are reduced exchange rate costs.
- It becomes easier for prices to be compared across the union and so MNCs are less able to price discriminate.
- There are financial costs in starting a new currency and with one breaking them
- Loss of policy independence can be bad for countries e.g. black wednesday, greece
What are the advantages of a customs union
Without a unified external tariff, trade flows would become distorted
A common external tariff effectively removes the possibility of arbitrage
What are the disadvantages of a customs union
Union members must negotiate collectively with non-members or organisations like the WTO as a single group of countries. While this is essential to maintain the customs union, it means that members are not free to negotiate individual trade deals.
Also, it makes little sense for a particular member to impose a tariff on the import of a good that is not produced at all within a that country.
e.g. banana tariff 10.9%
Members that trade relatively more with countries outside the union, such as the UK, may not get their ‘fair share’ of tariff revenue.
What are regional trade agreements
- These are agreements between neighbouring countries e.g. South-East
Asia, Latin America, Africa and the EU. - The WTO often calls these regional trade agreements preferential trade
agreements, because they are exclusive to a certain number of countries.
What are the advantages of regional trade agreements
- Most trade is with neighbours so large effect
- enable more free trade –> trade –> increase economic growth
- They are a potential stepping stone to more inclusive trade agreements.
What are the costs of regional trade agreements
- WTO argues they should be preferable since FTA should involve all countries
- PTA can conflict with WTO global trade treaties
- Leads to conflict between other trading blocs
- Increasesd complexity –> NTB
What are the benefits of general economic integration
- Greater trade and gains from comparative adv. –> EoS
- Greater competition –> encourage efficiency
- Increased FDI e.g. Poland
- Clout for international negotiations
- More flexible labour markets
What are the potential costs of economic integration
- Regional inequality due to geographical immobilities e.g. difficult to move from Spain to Germany to get a job.
- Increased specialisation –> structural unemployment
- The UK experienced trade diversion when joining the EU, because
agricultural tariffs to Commonwealth countries increased. - Free movement of labour may cause friction over housing and
overpopulation.
What is trade diversion
when tariff agreements cause imports to shift from low-cost countries to higher-cost countries; concentrates production in countries with a higher opportunity cost and lower comparative advantage.
typically occurs w a common external tariff
Draw the trade diversion diagram
- decline in consumer surplus
- DWL
- Loss of EU efficiency in net loss area
- also net loss to society
What is trade creation
increase in economic welfare from joining a free trade area, such as a customs union due to a reduction in tariffs allowing for lower prices
- increase in consumer surplus, equal to area 1+2+3+4
- Domestic producers will sell less as consumers buy cheaper imports (decline in producer surplus is shown by area 1)
- Government lose tax revenue (from import tariffs) (shown by area 3)
How can the impact of trade creation and trade diversion be lessened
If demand and supply are inelastic, the effect will be much lower.
How does trade creation benefit exports
If you cut import tariffs, other countries are likely to reciprocate and reduce tariffs on your exports. Therefore, there will also be an extra benefit from increased exports.
What are the potential issues with trade creation
Often domestic job losses are more visible, than the gains from cheaper prices.
e.g. nafta caused rust belt 700k america and 2 million agricultural mexico
What is the WTO
- responsible for trying to promote and regulate free trade and trade agreements between countries.
- Forum for agreeing and resolving conflict
- Help trade flow except when conflicts with other objectives
How has world exports as a % of GDP changed from 1970
World Bank stats show how world exports as a % of GDP have increased from 13% in 1970 to 30% just before the financial crisis of 2008.
In the past decade, world exports as a share of GDP have flatlined, with no rise since the peak of 2008.
What are the benefits of free + international trade
- Use of abdundant resources - e.g. oil in UAE
- Comparative Advantage
- Greater Choice for Consumers - Preference Similarity Theory e.g. Primark and Gucci
- Economies of Scale - Apple designs their computers in the US but contract the production Asian factories
- Global economic development - reduction in absolute poverty (90 million raised from poverty in India)
- Encourage FDI - Poland
- Increased competition to increase efficiency + stop domestic monopoly
- Engine of Growth - World Trade has increased by avg. of 7% since 1945
9.
What are the costs of free + international trade
- Infant industry argument - free trade leads to primary sector dependence/dumping so need to diversify
- Cultural homogenisation - local brands have a cultural niche and expertise
- Displacement effects - cause uncompetitive domestic industries to close down –> structural UE
eval: creative destruction + new jobs in diff. industry to supplement TNC
- Enviromental Costs
What are the principles of the WTO
- Promote free trade through gradual reduction of tariffs
- Provide** legal framework for negotiation of trade disputes**. This aims to provide greater stability and predictability in trade.
- Trade without discrimination - avoiding preferential trade agreements.
- WTO is not a completely free trade body. It allows tariffs and trade restrictions under certain conditions, e.g. protection against ‘dumping’ of cheap surplus goods.
- WTO is committed to protecting fair competition. There are rules on subsidies, dumping
- WTO is committed to economic development. For example, recent rounds have put pressure on developed countries to accelerate restrictions on imports from the least-developing countries.
What are the successes of the WTO
The WTO has over 160 members representing 98 per cent of world trade. Over 20 countries are seeking to join the WTO.
- Prevent trade war, according to (Bagwell and Staiger 2002) the average tariff in 1930s was 50%. In 2000s, average tariff is 9%
the value of WTO in preventing trade wars could be estimated at up to $340 billion per year according to Ralph Ossa
the value of WTO in preventing trade wars could be estimated at up to $340 billion per year
What are the disadvantages of the WTO
- Free Trade policies unfavourable to developing countries, Ha Joon chang argues it is ‘ pulling away the ladder they used themselves to climb up
- Preventing development of infant industries
- WTO still have lots of protectionism in areas such as agriculture that favour developed countries
- ‘Most favoured nation’ principle - mean developing countires cannot give preference to local contractors over footloose TNCs (favour developed)
- Damage to enviroment, cultural diversity
- WTO structure is undemocratic +enbales rich countries to win what they desire
Evaluate the WTO
- free trade has been an important engine of growth for developing countries in Asia. Although there may be some short term pain, it is worth it in the long run.
- Also the WTO has sought to give exemptions for developing countries; enabling in principle the idea developing countries should be allowed to limit imports more than developed countries.
- Growth of world trade has reduced absolute poverty - 90 million India
What can protectionism involve
- **Higher tariffs **(type of tax on imports).
- Non-tariff barriers e.g. diff uk + eu regulation
- Voluntary export restraint is effectively a type of quota where voluntary limits are placed on imports of goods.
- Embargo .
- Government subsidy e.g. Chaebols
- Distorted exchange rate e.g. international yuan
- Weakest environmental law. A way to attract certain types of business.
- Administrative barriers
What are reasons for protectionism
- Infant Industry
- Job Protection
- Protection from dumping/unfair competition
- Improve the terms of trade
- Prevent over-dependence
- Stop dangerous goods
- Protecting senile industries
- Reducing a deficit
What is economic dumping
· Monopoly from another country sells a good/service at or below costs temporarily, to increase market share and force out domestic firms to form a monopoly in a foreign market.
· They will then increase price and exploit consumers as those firms gain a monopoly foothold.
or
Selling excess stock at a price that injures domestic comp e.g. chinese steel 9-14% tariff
What is the infant industry argument
- Prevent economic dumping
- Need to diversify from a reliance on primary products:
1) Low YED in LR
2) Price Volatility
What are the criticism of the infant industry argument
- May encourage firms to be inefficient –> X-inefficiency
- Retaliation
- Political pressure group, may become politically difficult to remove because of vested interests.
- Which industries to choose?
- **Welfare loss **of tariff protection
- May be a stronger case for subsidies
How does protectionism decrease a current account deficit
· By protecting against imports and promoting exports the value of M should fall and X should rise current account deficit, ceteris paribus
· Makes it easier to finance an equilibrium
A large C/account deficit will also likely mean that domestic multipliers are weaker, and growth can be restricted.
How does protectionism protect domestic employment
· As M decreases and X increases and as labour is a derived demand, protectionism would help to control cyclical unemployment and in the long run prevent structural unemployment.
- The US uses steel tariffs as a method to protect domestic jobs in steel.
What are strategic reasons for protectionism
· Domestic control over key strategic industries is seen as favourable, for example nuclear power, and armaments.
· Protects against importation of demerit goods, e.g. through embargo/law.
Helps prevent over specialisation
e.g. Banning Huawei
How does protectionism help senile industries
· Industries which may have had national significance – Jingoistic
Culture/heritage E.g. Sunset industries in decline due to foreign comp/changing demand then there may be an argument to slow that decline, protect employment etc. This tends to be a weaker argument.
Draw the effect of a tariff
S world shifts up
tariff of size (Pw + t – Pw) is introduced. That raises the price of chicken wings in the UK to Pw + t. Quantity supplied by domestic producers increases Q1 -> Q2 (extension of S domestic).
· Quantity demanded contracts Q4 -> Q3.
· Hence, imports shrink to (Q3 – Q2).
What is the effect of tariffs on: consumers, government, domestic producers, foreign producers, DWL
· Consumers: consumer surplus lost by area (Area 1 + Area 2 + Area 3 + Area 4) lost.
· Government: gain in revenue of Area 3
· Domestic producers: domestic producers gain surplus Area 1.
· Foreign producers: they lose revenue as tariff decreases the quantity of chicken wings imported.
Deadweight welfare loss: due to tariff there is social surplus lost to nobody which is the DWL: Area 2 + Area 4.
Draw the effect of subsidy on trade
the domestic supply curve shifts downwards by the size of the subsidy per unit: (Pw + subsidy – Pw).
Domestic production increases Q1 → Q2 and the quantity imported shrinks to Q4-Q2
What is the effect of a subsidy on governments, consumers, domestic producers, foreign producers, DWL
· Government: paying the subsidy of the green-marked area.
· Consumers: loss of the consumer surplus does not occur, as the price of the rice does not change.
· Domestic Producers: the price that they receive increases to Pw+subsidy. Their revenue increase from (Area 1 + Area 2) to (Area 1 + Area 2 + green-marked area).
· Foreign Producers: their revenue decreases from (Area 2 + Area 3 + Area 4) to (Area 3 + Area 4) as rice imports shrank.
Deadweight welfare loss: due to increased production by the inefficient domestic producers (over allocation of resources to those producers), Deadweight Welfare Loss (DWL) marked triangle Area 5 emerges.
The green area is the size of the subsidy, everything in the green area apart from Area 5 goes to producers to increase their revenue. Hence, what is left in the green are goes to no one – that is why Area 5 is said to be a DWL
What are the advantages for using a subsidy for protectionism
· Helps achieve government objective.
· Can reduce imports and boost X
· Tends to be more well tolerated than a tax on M from foreign countries (less likely to cause retaliation)
More effective if PED’s are elastic
What are the disasdvantages of the effect of a subsidy on protectionism
· Welfare loss
· Helps to create inefficiency amongst domestic producers
· PED may be inelastic of M therefore policy does not achieve objectives just harms domestic consumers.
· Can lead to retaliation
e.g. UK is a member of the WTO committed to free trade. There may also be sanctions for protectionism.
What is the evaluation of use of a subsidy for protectionism
· This trade protection could be said to be more favourable than tariff as it does not lead to possible loss of living standards.
but tariffs better for demerit goods
However, consumers are affected by the government subsidising producers rather than funding more socially desirable projects.
Also, to fund the subsidy, the government might have to increase taxes.
What are the 2 diagrams for quotas
Same as tariff and just shifting
or
This leads to a fall in imports to just Q3-Q2
Domestic suppliers gain more revenue. The price rises to P quota and domestic suppliers, supply more Q1 to Q2. It can create domestic jobs.
What is the welfare loss of quotas
Consumers pay a higher price and also total quantity falls from Q4 to Q3.
Governments are not affected directly, as there is no income.
There is a net welfare loss to society because the increase in producer surplus is outweighed by the decline in consumer surplus.
World exporters will make less revenue – unless demand is very inelastic, meaning increase in price is greater than fall in quantity.
Quotas or Tariffs
- Quotas cause a bigger fall in economic welfare because the government don’t gain any tax revenue
- Quotas may be harder to enforce if it is difficult to count the amount of the good coming into the country.
- Quotas could be more unfair; distribution political
Quota better:
* Quotas allow the country to be certain on the number of imports coming in, while tariffs depend on elasticity
What is a non-tariff barrier
a way to restrict trade using trade barriers in a form other than a tariff such as licenses or administrative barriers
What is a VER - Voluntary Export Restraint
A voluntary export restraint (VER) is a trade restriction on the quantity of a good that an exporting country is allowed to export to another country. This limit is self-imposed by the exporting country.
Exporting countries often wish to impose their own restrictions than risk sustaining worse terms from tariffs or quotas
How do you avoid a VER
the exporting country’s company can always build a manufacturing plant in the country to which exports would be directed.
By doing so, the company will no longer need to export goods, and should not be bound by the country’s VER.
What is VIE - Voluntary Import Expansion
a change in a country’s economic and trade policy to allow for more imports, by lowering tariffs or dropping quotas. Often VIEs are part of trade agreements with another country or the result of international pressure.
What are the advantages and disadvantages of VER
ADV:
Producers in the importing country experience an increase in well-being, though, as there is decreased competition, increased price, profits, and employment
Disadv:
VERs reduce national welfare, by creating negative trade effects, negative consumption distortions, and negative production distortions.
What is a good example of a VER
Japan imposed a VER on its auto exports into the U.S. as a result of American pressure in the 1980s.
The VER subsequently gave the U.S. auto industry some protection against a flood of foreign competition.
This relief was short-lived though, as it ultimately resulted in a rise in exports of higher-priced Japanese vehicles and a proliferation of Japanese assembly plants in North America.
What has been the effect of structural adjustment policies on Latin America compared to protectionism
During Protectionism per capita income in Latin America grew at an impressive 3.1 per cent per year.
Since structural adjustment, it has been growing at a paltry 0.5 per cent
What are the reasons for a current account deficit
- Overvalued exchange rate; worsens X-M
- Declining competitiveness,
- Fast economic growth; higher income means greater income consumption
-
Low savings ratio. Lower savings tends to cause higher consumer
spending on imports. -
Capital inflows. Large inflows of foreign capital enable the country to
afford more imports and run a current account deficit.
Capital inflows also
increase the value of the exchange rate making exports less competitive
How is a current account deficit financed
- Attracting FDI and hot money flows
What are potential problems of a current account deficit
- Potentially unsustainable. borrowing can be unsustainable in the long term and countries will be burdened with high interest payments.
- Foreign claim on UK assets. foreigners will have an increasing claim on UK assets, which they could require return of at any time.
- Depreciation likely to cause depreciation in the exchange rate, leading to higher import prices and lower living standards.
- Reflection of economic weakness.:
Declining competitiveness, due to higher labour costs or declining
productivity.
* Lack of productive capacity/ infrastructure in the UK.
* Declining comparative advantage in many manufactured goods.
Why is a current account deficit not necessarily harmful
- Used to finance investment
-
Inward investment can be beneficial for the economy. If a current
account deficit is financed by long-term capital flows, it can create jobs
and more output -
Floating exchange rate will restore balance. With a floating exchange
rate, a large current account deficit should be reduced over time by a depreciation to restore competitiveness. - Size of deficit. .
What are measure to reduce a current account deficit
-
Devaluation / depreciation
lead to an improvement in net exports (X-M) and therefore
improve the current account on the balance of payments. -
Reduce consumer spending. Higher taxes and/or higher interest rates will
reduce disposable income and cause lower spending on imports. This will
improve the current account deficit. - Supply Side Policies:
○ Policies to raise labour productivity
○ Investment in human capital to boost productive capacity and competitiveness
What is the Marshall Lerner Condition
- If (PED x + PED m > 1), then a devaluation will improve the current
account while an appreciation will worsen it
Essentially, if demand for exports and imports is elastic, then a depreciation will
improve the current account.
What is the J Curve Effect
In the** short term**, demand for imports and exports tends to be inelastic
Therefore, after a devaluation, the current account can get worse before it gets
better. However, over time, demand becomes more price elastic and the current
account improves.
Evaluate devaluation leading to inflation
- can lead to imported inflation, because imports will be more expensive and
we will get higher AD. Relatively higher inflation can reduce the country’s
competitiveness. - Therefore, if we do get inflation, the improvement in the current account
might only be temporary.
What are potential problems of a large current account surplus
- It represents an unbalanced economy – dominated by exports and
showing less consumer spending. - it means other countries will have a similar deficit.
- In the Eurozone, current account imbalances are more of a problem
because countries can’t rely on a depreciation to solve the imbalance
How could a government reduce a current account surplus
- Allowing the exchange rate to appreciate, reducing competitiveness.
- Encouraging consumer spending (e.g. lower income tax), leading to higher
import spending.
What is the export multiplier effect
Many industries rely heavily on key export industries remaining competitive – these include:
* Transportation / freight / logistics businesses
* Trade finance businesses e.g. Insurance and trade credit
* Service businesses that operate in ports and airports
Exports particularly important for regional economic performance
What is a sovereign wealth fund
state-owned investment fund that is used to benefit the country’s economy and citizens
The money typically comes from a nation’s budgetary surplus to funnel it into investments rather than simply keeping it in the central bank or channeling it back into the economy.
to stabilize the country’s economy through diversification and to generate wealth for future generations.
Can be funded through commodities or non-commodities, financed by fx reserves
What is the international debate about sovereign wealth funds
Following the mortgage crisis of 2006-2008, sovereign wealth funds helped rescue struggling Western banks CitiGroup, Merrill Lynch, UBS, and Morgan Stanley.
This led critics to worry that foreign nations were gaining too much control over domestic financial institutions and that these nations could use that control for political reasons.
projects that if sovereign wealth funds continue to grow at their current pace, they will exceed the annual economic output of the U.S. by 2015 and that of the European Union by 2016.
What is a floating exchange rate
When the value of the currency is determined by market forces i.e. the supply and demand for currency
What is a fixed exchange rate
Where the value of a currency is set at a certain peg, compared to other countries
What is a managed exchange rate
‘Semi fixed exchange rate’. This is a situation where there is no set exchange rate level but the Central Bank (or government) intervene, to try and influence the exchange rate.
For example, if the value of the currency is falling, the Central Bank may use foreign exchange reserves to buy currency
What is an exchange rate index
This gives a measure of a currency against a tradeweighted basket of currencies. It is expressed as an index, where the value of the index will be 100 in the base year.
weight given to each currency depends upon the proportion of
transactions done with the country
What is the real exchange rate
This is the exchange rate after being adjusted for the effects of inflation, which more accurately reflects purchasing power.
What is a devaluation
This occurs when the government reduces the set level of the currency in a fixed exchange rate.
What is a depreciation
This occurs when the value of an exchange rate in a floating exchange falls.
Caused by an increase in supply or fall in demand for the pound on the forex.
What is revaluation
When the government increases the set level of the currency in a fixed exchange rate.
What is an appreciation
When the value of the currency in a floating exchange rate
rises.
Caused by an increase in supply or fall in demand for the pound on the forex.
Evaluate the J Curve
· The current account will **depend on consumer spending **and the rate of economic growth.
· It also depends on consumer spending in foreign countries (hence demand for exports)
· It depends on Inflation (e.g. depreciation can cause imported inflation which reduces the competitiveness of exports)
Firms may engage in insurance policies to hedge against exchange rate movements.
What is the **inverse J curve effect **
When an appreciation of the exchange rate initially causes the current account or trade balance to improve.
What are factors influencing the exchange rate
- Interest rates will attract hot money
- **Inflation. ** affects competitiveness
- Speculation. If speculators believe the value of sterling will rise in the future, they will demand more, causing an appreciation.
- Economic growth interest rates are likely to rise, to keep inflation low. This will encourage investors to buy Pounds, in anticipation of better returns.
-
Current account. A large deficit on the current account is likely to cause a
depreciation in the value of the exchange rate. - Open Market Operations - Central Bank uses FX reserves to buy domestic currency on the forex
How can governments intervene in the currency markets
- Use foreign currency reserves
2.** Change interest rates** -
Change money supply. If a country wanted to depreciate its currency, it
could print more money -
Fiscal / monetary policy. If the government used tight fiscal policy
(higher taxes), it could reduce inflation
Evaluate the effectiveness of government intervention in currency markets
- A government has only limited foreign exchange reserves
e.g. In 1992, the UK government failed to protect the value of the Pound, because foreign currency markets had more buying power than the government.
- The Central Bank could use interest rates to protect the currency but it would be at the cost of lower growth and higher unemployment.
- To manage the exchange rate in the long-term requires efforts to tackle
long-term competitiveness.
Evaluate the effectiveness of government intervention in currency markets
- A government has only limited foreign exchange reserves
e.g. In 1992, the UK government failed to protect the value of the Pound, because foreign currency markets had more buying power than the government.
- The Central Bank could use interest rates to protect the currency but it would be at the cost of lower growth and higher unemployment.
- To manage the exchange rate in the long-term requires efforts to tackle
long-term competitiveness.
What are the effects of an appreciation in the exchange rate
- Export quantity falls, Import quantity increases
- Lower AD –> cyclical UE esp in manufacturing and higher NRU if appreciation is sustaianed
- Lower inflation, from cheaper imports and lower AD
- Worsening of current account i.e. bigger deficit, because of decline in
exports and rise in quantity of imports. - Foreign direct investment may fall. A rise in the exchange rate may
discourage FDI (foreign direct investment), because it is now more
expensive for foreign firms to invest.
Evaluate the effects of an appreciation
- Marshall Lerner condition states an appreciation will only worsen current
account, if PEDX + PEDM >1. - It depends on other components of AD, consumer bigger impact
- Inverse J Curve
- It depends on productivity growth. If the exchange rate appreciates
because firms are becoming more productive, then they will remain
competitive. - Capital Equipment + tech becomes cheaper –> inc productivity and LRAS
- It depends on the state of the economy. If the economy is growing
strongly and is near full capacity, a rise in the exchange rate could help
reduce inflationary pressure and keep growth sustainable.
What is a competitive devaluation
This is a situation where a government actively tries to reduce the value of its
currency, to gain a competitive advantage by:
- Selling its own foreign currency and buying foreign assets
e.g. China has bought US$3.12 trillion to keep the Chinese currency undervalued
against the dollar.
- Pursue loose monetary policy e.g. low interest rates and quantitative
easing (increasing money supply).
What is the impact of competitive devaluation
- increase exports, create employment and reduce its current account deficit, but may be at the expense of other countries
- It may cause inflation: a rise in import prices + require printing money,
which also causes inflation. - It doesn’t deal with the fundamental economic issues. A depreciation
gives a ‘relatively easy’ improvement in competiveness but this may
prove short-lived.
It can avoid firms dealing with the long-term issues of
productivity and competitiveness.
What does joining the Euro involve
- Replacing domestic currency with Euros.
- No possibility of fluctuating exchange rates within the Euro area.
- A common monetary policy. Interest rates are set by the ECB for the
whole Eurozone area. -
Rules about size of budget deficits (3% of GDP). Fiscal stability pact
though, in practice, this is often broken.
What are the advantages of joining the Euro
-
Lower transaction costs; Lower costs have been estimated to be worth 1% of
GDP. - Eliminate exchange rate fluctuations more confidence about future export prices.
- Increased inward investment.
-
Greater price transparency/comparibility. should hopefully lead to
greater price competition and easier for firms to identify the cheapest suppliers. -
Lower Inflation. The ECB has a strong tradition of keeping inflation low.
Joining the Euro will help reduce inflation expectations. - Incentive for greater competitiveness as can’t rely on devaluation
What are the problems of the Euro
- Countries will lose the ability to set interest rates.
-
Lack of exchange rate flexibility.
e.g. detoriation in competitiveness 2000-07 in EU countries - Low inflation may conflict with other objectives.
-
Loss of independence over fiscal policy.
e.g. growth and stability pact limits government borrowing to no more than 3% of GDP. - Bond Yields in the Eurozone, there is no Central Bank willing to print money and act as lender of last resort
Evaluate what is needed for a succesful monetary union
1.Convergence of economic cycle, to deal with common interest rate and
monetary policy.
2. Similar inflation rates. If inflation is much higher, a country will become
uncompetitive
3. Mobility of labour and capital
e.g. will unemployed workers find it easy to move to other areas in the monetary union?
4. Fiscal union. Similar levels of budget deficits and fiscal union to be able to
offer help to depressed economies.
What is a reserve currency
anchor currency, a currency that national governments and other instuitons are happy to hold as a key part of their foreign exchange reserves
reserve currency of choice has been the US dollar
What is an adjustable and crawling peg system
- An adjustable peg system is where currencies are fixed against another but
the level at which they are fixed can be changed.
o Crawling peg systems are a form of this but have a mechanism which allows
the value to change.
What are the arguments for a floating exchange rate
- Central bank doesn’t need to maintain a particular rate ot use reserves
- Interest rates are reserved for domestic monetary policy
- Partly able to auto-correct a trade deficit
- Reduced risk of cuurrency speculation
What are the arguments for and against a fixed exchange rate
For:
* Avoids currency fluctuations –> encourage trade + investment
* Reduces costs of currency hedging
* Gives incentive to keep inflaiton low + helps if fixed to strong currency
Against:
* Govt has to intervene by rasising IR which has negative effects
* Information failure; easy to set the wrong exchange rate, if too high wiill make goods uncompetitive + if too low it could cause inflation from high imports
* Less flexibility to respond to temporary shocks
* Cause current account imbalance
* Dificult to keep at correct level; target of speculators
How much did Soros make and Treasury spend on Black Wednesday
Soros made a £1 billion profit from Black Wednesday.
The UK Treasury spent £27bn in buying sterling on the foreign exchange markets.
What did the 18% fall in value of the Sterling Black Friday cause for UK exports from 1992-7
Uk exports to increase in value by 53% from 92-97
After 2008, the sterling depreciated but what happened to the trade balance
trade balance did not recover
Why did the trade balance not recover after the 20% depreciation in the sterling in 2008
Sheffield Political Economy research suggested that it was due to ‘deep-rooted economic imbalances’ and needs a rebalance towards maanufacturing and diversification of the export base
1) Much greater reliance on global supply chains so **higher import costs can offset impact **
2) Impact of protectionism e.g. US tarifs of 11.2 billion on EU imports such as Land Rover
3) Demand for imports are price inelastic while exports more price elastic;UK is a net importer of Oil e.g. 2008 in dollar terms the oil price increased by 14% but in Sterling terms it rose by 42%
4) Depressed economic growth in EU
What is a foreign currency gap
when currency outflows persistently exceed currency inflows
Normally needs capital flight too and a fall in the value of inflows
What is import cover
the number of months of imports the currency could finance
What does a foreign currency crisis imply for imports
a nation does not have enough currency to pay for essential imports like medicine, foodstuffs, raw materials and replacement components for machinery; hamper sr economic growth
e.g. Sri Lanka in 2020 ran out of fx reserves
How do you measure international competitiveness
-
Relative export prices. The relative cost of UK exports to other
countries. -
Relative unit labour costs. Unit labour costs are the cost of employing
workers to produce one unit labour costs.
what factors influence international competitiveness
- Labour productivity – (output per worker)
- Relative inflation rates- experincing lower inflation means lower costs and prices
- Levels of infastructure- if a country experiences transport bottlenecks, it will lead to higher costs and higher export prices
e.g. Malwai/Zimbabwe through a single railway to Mozambique
- Cost of business- levels of regulation and taxes reduce competition
- Exchange Rate - undervalued exchange rate will make exports more competitive
What are measures to increase international competitiveness
- Education and training - increase labour productivity
- Investment in Infastructure- but susceptible to time lag +govt. failure
- Privatisation and Deregulation - aim to increase efficiency
- Devaluation in Exchange - but doesn’t deal with issues of competitiveness
- Limiting Wage Growth - reduces growth of unit labour costs
- Flexible Labour Markets - help reduce labour costs
What are the benefits of international competitiveness
-
Rising Exports - lead to job creation + economic growth
e.g. China rapid growth - Improved CA
- Low inflation- competiitive exports lead to appreciation which helps with inflation
- Higher living standards - with low import prices and higher export revenues
- Lower unemployment
What are the problems of international competitiveness
- ** Appreciation in exchange rate could damage growth** and make
exports less competitive - Economy may become too reliant on exports. and it will be more vulnerable to a downturn in the global economy.
What are factors that make a place a competitive location for FDI
- Variations in coporation tax rates
- Low RULC
- Non-wage costs such as regulation
- Quality of infastructure
- Avaliability of skilled labour
- Ease of doing business
- Macroecnomic stability
What is the UK competitiveness ranking sin 2022
What are supply side poliicies to increase investment in Britain
- Super-deduction tax relief (130%) for encouraging small business investment
- Creation of Free Ports
- New UK Infastructure Bank- Bank of British Businesss
- Capital Financing 100% of capital at point of purchase
What are some current examples of UK infastructure projects
- HS2
- Thames Tideway Tunnel
- Hinkley + Sizewell Point C
- 400 million investment in Scottish Rail
What are UK pro-competitiveness policies Post-Brexit
- Points-Based immigration system; allow a more competitive labour market for highly inelastic skilled labour markets
- 5 billion Levelling Up Fund
- Agreed trade deals with 70 countries plus the EU trade and cooperation agreement
What has the effect of Brexit been on competitiveness
- Big rise in NTBs which add costs
- Employees struggling to hire workers, vacancies>UE. Uk migration has reached new levels
- High budget deficit, rising tax burden
- Loss of talent + R+D funding such as Erasmus funding
- Real investment has stalled since referendum
What is absolute poverty
This measures the number of people living below $2.15, which is necessary to be able to afford basic goods and services.
What is relative poverty
when the income of a household is low compared to others
e.g. when a person has income below 60 of the median household income (
What is the Lorenz Curve
Agraph that measures the degree of income inequality. The further the Lorenz curve is from the 45 degree line of perfect equality, the more inequality there is in society.
What is the Gini Coefficient
This is a measure of inequality based on the Lorenz
curve:
- The Gini coefficient is area a / a+b.
- The bigger area a is, the more inequality exists.
- A Gini coefficient of 0 = perfect equality.
- A Gini coefficient of 1.00 = perfect inequality.
How does inequality in the UK changed since the 80s
- UK had fallen through the post-war period of 1945-80 but reversed in the 80s
By 1994 the top 1% of household’s share of total income is 8%
How can absolute poverty be reduced
- Absolute poverty can be reduced by economic growth, which benefits the
poorest in society. - Absolute poverty could also be solved by greater redistribution of income
in society, to provide minimal housing / food & water for the poorest. - Developed countries have very minimal levels of absolute poverty, due to the welfare state
What causes relative poverty/inequality in the UK
- Inequality in wages and earnings growth- UK deindustrilisation + globalisation
- SU Unemployment - have to rely on dole
- Falling relative value of state benefits
- Regressive Taxes -set to hit 30 year high
- Decline in TU membership - fallen to 22%
- growth in underemployment, zero-hour contracts,
part-time jobs and temporary jobs, all of which mean lower wages for
workers. - Discrimination - ‘Muslim Penalty’
- Single Income Family- 50% of live births to single mothers
- Poverty Cycle passes onto next generation
What is the poverty trap
when the tax and benefits system creates a disincentive to look for work or work for longer hours. By working longer hours, individuals may find they lose income due to income tax and national insurance contributions as well as losing some income-related state benefits.
but UK replacement rate is 0.22
How many times bigger are the wages of the riches compared to the average workers, and how has this statistic changed
The wages of the richest are now
170 times the average worker, compared to 60 times before.
What are the consequences of high relative poverty for growth
1) Causes a self-perpetuating poverty cycle
* Limited access to health care and education
* Volatile incones, high debts + low savings
2) Misallocation of scarce resources * Capital investment in society is skewed towards the preferences of the rich * Low collateral - limits growth of entrepreneurship
How can government spending reduce poverty
1) Welfare State/Transfer Payments:
* Universal Child Benefits
* Public Pensions
* Conditional + means tested welfare transfers e.g. Job Centre
2) State Provided Services:
* Education; social mobility
* Healthcare
* Social Housing provided by LA
* Training e.g. free A Levels for over 21
What is the difference between wealth and income
- Wealth is a stock concept; it is the value of assets, such as savings,
housing, and shares. - Income is the amount of money a person receives per time period e.g.
salary
Why is wealth inequality usually greater than income inequality
- Those with low income do not have any disposable income to save to
increase wealth. - Those who are wealthy (e.g. own a house) can gain rentable income,
which they can use to invest in the accumulation of more assets. - Wealth can be inherited, income cannot.
Is inequality necessary?
- Gives incentives to take risks and put the effort into setting up a business. Without the prospect of higher income, enterprise would be limited.
- Policies to reduce inequality may create disincentives to work e.g. higher
income tax may discourage working overtime.
Benefits to the unemployed / low paid can discourage taking work (unemployment trap / poverty trap).
Is inequality necessary?
- Gives incentives to take risks and put the effort into setting up a business. Without the prospect of higher income, enterprise would be limited.
- Policies to reduce inequality may create disincentives to work e.g. higher
income tax may discourage working overtime.
Benefits to the unemployed / low paid can discourage taking work (unemployment trap / poverty trap).
What are the issues associated with inequality
- Exploitation. e.g. landlords monopoly power in setting rents, especially in places like London.
-
Social friction. High levels of inequality can cause social friction and
resentment in society- Gini above 0.4 -
Diminishing marginal utility of money- more tax from highincome
earners has little impact on living standards. Taking tax from low
earners has a greater impact, because they have to cut back on essentials.
4.Difference between equality of opportunity and equality of outcome-
How can economic growth + development exacerbate inequality
-
Skilled labour. Growth could lead to increased demand for skilled labour
and a fall in demand for unskilled labour - Regional inequality - prosperous regions sucking in labour
-
Monopsony power of larger firms
* Living costs. Economic development can lead to increased costs of living
(transport / housing), which negates any rise in real wages.
How can economic growth + development reduce inequality
- Bigger Welfare State and opportunity to pursue policy - tax revenues rise and it can be used to fund a welfare state
-
Real wages. Economic growth tends to put upward pressure on real
wages, as firms compete to get workers, leading to a ‘trickle down effect’. -
More opportunities - diversification away from
producing primary products. - Organised Labour - growth of trade unions to enable rising real wages
What are causes of absolute poverty
· Drug/alcohol addiction
· Mental illness
· Homelessness/no fixed address
To Claim benefits –> you need a bank account –> you need an address. Therefore those in homelessness are de facto in absolute poverty
Living in a third world country/a country without established the benefit/welfare system.
What are Policies to tackle poverty
- Free Market Approach
- Training and Education
- Increase in Benefits
- Increase in Progressive Tax
What are the advantages of the free market approach to tackle poverty
- Trickle Down. The spending and investment of the rich trickles down to the low income earners, reducing relative poverty.
- Greater** incentive to achieve more in school**+ more tax revenue which can be spent on policies to reduce inequality such as training and education
- No UE trap
- The money spent on schemes such as transfer payments could be better spent on training and education which arguably tackle the root cause of poverty
What are the disadvantages of the free market approach to ackling poverty
- Does** little to resolve absolute poverty** as people who don’t have the skills to get a job will still not be able to find employment
- Doesn’t protect those in poverty so there’s no guarantee there will be any redistribution
- With less government intervention, there will be more discrimination
- Relative poverty may increase in a more free market approach
IMF - ‘rising income share of the top 20% results in lower growth’
LSE - ‘tax cuts for the risk have only increase inequality, with no gains’
What are the advantages of training and education in tackling poverty
· helps tackle root cause
* the qualifications gained from T+E helps increase employability + prevent structural Un
* More education –> higher bargaining power and earning
* Break out of poverty cycle
What are the disadvantages of training and education in tackling poverty
· time lag - doesn’t help those currently in poverty
* Even with a high level of T+E you can face discriminaiton
* Standards of T+E rely on local schools which are typically better in high-Y areas
e.g. Schools in the most affluent areas are more than twice as likely to be rated ‘outstanding’ by Ofsted
- Depends on success of the actual training e.g. 42% dropout rate for apprenticeships
What are the advantages of increasing benefits to those on low income to tackle poverty
● Directly targets those in poverty
* benefits eradicate absolute poverty + can reduce relative poverty
* lower Y have higher MPC so transfer benefits cause increased AD
* Increase opportunities for children –> increased LRAS LR
What are the disadvantages of increasing benefits to tackle poverty
● Raising benefits may reduce the incentive to find employment–> strengthens the unemployment trap and the cycle of poverty
* doesn’t tackle the root cause of why individuals or families are in poverty.
* Opportunity cost of transfer payments
What are the advantages of increasing progressive taxation to tackle poverty
- Increasing top band tax + personal allowance
- allows for lower income earners to keep a greater proportion of their income, + taxes higher income earners to a greater extent so relative poverty decreases.
- Redistribution leads to greater AD and thus more tax revenue
- Opp. cost of not working increases as PA increased
What are the limitations of increasing progressive taxation to tackle poverty
- Increasing top band tax + personal allowance
- Raising PA only affects those in work; doesn’t address absolute poverty
- Decreases trickle down effects incentives to invest decrease
- Doesn’t tackle root cause
- Laffer curve
What are the causes of wealth + income inequality
- Simply higher wages which also allows to build up more wealth
- High wealth levels allow a high level of income
- Chance; buying asset at right time or lucky to inherit wealth
- Age: older earns higher income and more assets
- Country: developed country places you alr in top 5%
What did Kuznets and Picketty say about the impact of economic growth on inequality
Kuznets hypothesis says that as society develops and moves from agriculture to industry, inequality increases as the wages of industrial workers rises faster than farmers
Piketty discredited this theory by arguing that inequality rises as the
country develops as the rate of return on capital grows, so the rich get richer an inequality increases.
What is the significance of capitalism for inequality
● A capitalist economy leads to income inequality because of wage differentials and
wages vary as they are based on demand and supply
● Individuals also own resources and thus wealth differs based on the assets they
own
* inequality is essential for capitalis incentives to work
* but excessive inequality causes problems with efficiency and social justice.
What is horizontal and vertical equity
· Horizontal equity is the equal treatment of equals
Vertical equity is the unequal treatment of unequal’s
What is the relevance of housing to inequality
- House price inflation + income stagnation = serious intergenerational inequalities
- House price inflation has outstriped average earning with the ratio increasin from 6 to 9 and 7 to 13 in London
- One of the main stores of household wealth
- While renting improves the posiiton of landlorders and are not subject to the wealth tax
- 43% of renters in relative poverty while only 12% of homeowners are
How much of the world’s carbon emissions do the world’s top 10% cause
richest 10 percent accounted for over half (52 percent) of the emissions added to the atmosphere between 1990 and 2015
What is the Quintile Ratio
ratio of the average income of the richest 20% of the population to the average income of the poorest 20% of the population
An alternative measure is the average income of the richest 10% of the population to the average income of the poorest 10% of the population
What is the Palma Ratio
This is the ratio of the richest 10% of the population’s share of gross national income divided by the poorest 40%’s share
What is the Human Development Index
composite economic development index from 0-1 based on three factors:
1. Health: life expectancy at birth
2. Education: expected years of schooling of a current 5-year old over their lives
3. Income: real GNI per capita at PPP
What are the advantages of using the Human Development Index
● It takes into account three key factors which are important for the development of a country.
● It is relatively easy to calculate because governments tend to collect the statistics
used in the data.
What are the disadvantages of using the Human Development Index
● However, there are some issues with the figures : health takes no notice of the
quality of life that people enjoy and education doesn’t take into account the quality
and success of education.
● There is no consideration for the equality of income - average loss in the HDI due to inequality is about 23%
● Also, there are other factors which affect development, for example freedom from corruption or the environment.
* Within countries there are regional differencestherefore one overall HDI figure can be misleading
What is the Inequality adjusted Human Development Index (IHDI)
adjustment of HDI which includes a fourth indicator of development:
inequality.
The Atkinson Index adjusts measures for education, health and income
according to the level of inequality. It is broader than HDI but can still be criticised
for not taking into account more measures and quality.
What is the Multidimensional Poverty Index (MPI)
- measures the percentage of the population that is multidimensional poor
- uses 10 indicators
- doesn’t take into account the environment.
What is the Genuine Progress Indicator
calculated from 26 different indicators grouped into three main categories:
economic, environmental and social .
It aims to look at economic sustainability ,
to ensure development does not limit the amount produced and consumed in the
future.
tend to show developed countries experiencing negative growth over time, due
to their impact on the environment. Some argue this proves that development is
unsustainable whilst others argue the index is biased and is constructed to prove
the anti-growth case .
What is the difference between economic growth and economic development
What are limitations to economic growth and development
- Poor Infastructure
- Human capital inadequacy –> low level of education and training
- Primary Product Dependency –> low income elasticity
- Savings Gap –> limits investment
- Foreign Exchange Gap
- Capital/Human flight
- Corruption –> reduces tax revenue
- Debt –> High debt interest payments limit investment
- Absence of property rights –> limits investment
- Political Uncertainty –> limits investment
- Volatility of Commodity Prices
- Access to Credit + Banking
What are the advantages of primary product dependency
- Comparitive adv. w/o they would be worse off
- Large + elastic supply of labour willing and able to work
- Doesn’t require costly investment; can be managed by local workers
- Important source of export rev. + foreign currency
- Attract FDI - China has been investing in central Africa to improve access to raw material which has ivolved building roads and railways to have wider benefits to the economy
- Stepping stone in economic development
What are the disadvantaages of primary product dependency
- Volatile Prices
- Finite Supply
- Low YED
- Lack of investment in other sectors
- Dutch Disease + Resource Curse
- Prebish-Singer Hypothesis
What is Dutch Disease
term that refers to the negative consequences arising from large increases in the value of a country’s currency causing:
- A decrease in the price competitiveness for exports of the affected country’s manufactured goods.
- An increase in the quantity of imports.
In the long run this contributes to higher unemployment as manufacturing jobs are moved to lower-cost industriies
What is the example from which Dutch Disease was coined
e.g. newfound wealth and massive exports of oil caused the Dutch guilder to rise sharply, making exports of all nonoil products less competitive on the world market. Unemployment rose from 1.1% to 5.1%, and capital investment in the country dropped.
What is the Prebish-Singer Hypothesis
Prebish-Singer Hypothesis suggests that countries who concentrate on primary products are vulnerable to a declining terms of trade
What is the evidence of the Prebish-Singer Hypothesis in primary product exporting Countries in Africa ffrfom 1970-97
‘World Bank estimates suggest that 1970-97 declining terms of trade cost non-oil-exporting countries in Africa the equivalent of 119% of their combined annual GDP in lost revenue’
What is the modern reality of the Prebish Singer Hypothesis
Since 1960 theer has been a significant improvement in the terms of trade for Resource Rich countries from around 0.35 to 1.12
What is the natural resource curse
1) Expensive resources create tensions such as corruption + war - Angola Jose dos Santos sent 500 million to London Account
2) Monopoly power: resources are often owned by a small section of society and there is a poor distribution
3) ‘Easy wealth’ from resources discourages economic development in other areas
How does the volatiliity of commodity prices affect growth and development
● These large changes in price mean that producers’ income and the country’s
earnings are also rapidly fluctuating, making it difficult to planand carry out long term investment as well as meaning that producers can see their income fall very rapidly, causing poverty.
e.g. collapse of oil prices in 2015 saw recession in Angola
What did volatility of commodity prices in 2014 lead Ghana to do in 2014
Ghana . Gold, cocoa and oil account for 75% of their total exports and they had to ask the IMF for a loan in 2014 due to their unsustainable balance of payments deficit
How does the savings gap affect economic growth and development
● Developing countries have lower incomes and thus they save less. This means there is less money for banks to lend, reducing borrowing and thus **reducing
investment/consumption. **
A savings gap is the difference between actual savings and the level of savings needed to achieve a higher growth rate, so countries often rely on debt/external fiinance
The savings rate in **Africa is around 17% of GDP compared to 31% on average for middle income countries **
What is the Harrod-Domar Growth Model
- Rate of economic growth depends on:
○ Level of national saving (S) - The productivity of capital investment (capital-output ratio)
What are examples of the Harrod-Domar relationship between savings and investment in Kenya and Bangladesh
- Kenya + Rwanada savings is only 11% of GDP and thus gross capital investment as a % of GDP is only 18%
- On the other Hand Bangladesh has a 32% savings of GDP and 31% of GDP is capital investment
How can the savings gap be overcome
- Attract FDI
- External finacing: aid, remittances, debt
- Nudges to rsavings. Smart opt-in pensions
- Growth of E-Finance; Kenya 2013 63% bank penetration now at 98.3% 2023
- Universal Basic Income (UBI) - Alaska
How does a foreign currency gap impact economic growth and development
● This is when exports are too low compared to finance the import of capital required for faster economic growth.
e.g. Sri Lanka in 2020 ran out of fx reserves so couldn’t import basic food and medicines
How does capital flight impact economic growth and development
● Large amounts of money are taken out of the country , rather than being left there for people to borrow and invest.
● This can occur because of lack of confidence in the country’s stability, to hide it from government authorities or simply for profit repatriation.
* During periods of macroeconomic change investors will likely ‘rotate’ or flight to quality from riskier assets to more secure ones ‘emerging –> blue chip’
What was the effect of capital flight in the 1997 Asian Financial Crisis
The Asian Crisis triggered capital flight leading **international stocks to fall as much as 60% **until the IMF intervened and provided bridge loans
How do Governments deal with capital flight
- Governments institute capital controls restricting flow of the currency outside the country; eval, greater panic + bitcoin can avoid it
- Tax treaties with other jurisdictions to make it expensive to flee
- Gov can raise IR to increase currency valuation
What is an example of illegal Capital Flight
India’s capital flight amounted to billions of dollars in the 70’s and 80s due to stringent currency controls. The country liberalisation of the economy in the 1990s, reversing this capital flight as foreign capital flooded into the resurgent economy
What are the effects of demographics on economic growth and development
● Developing countries tend to have higher population growth , which limits
development. If population grows by 5%, the economy needs to grow by 5% to even maintain living standards.
high birth rates increases the number of dependents within a country but does not immediately increase those of working age. It places strains on the education system and leads to youth unemployment
Population decline in developed countries means a greater strain on those employed for more tax revenue
What are the effects of debt on economic growth and development
● high levels of interest repayment ; for every dollar of aid given from rich to poor, developed countries get 7-10 dollars back
* less money to spend on services for their population and they may need to raise taxes , which limits growth and development
e.g. Sri Lanka’s growing debt contributed to a default in 2022
How does access to credit and banking impact economic growth and development
- those in developing countries cannot access funds for investment and they struggle to save for the future to make basic investments
- families may use loan sharks , who give high interest rates and leave
individuals permanently in debt.
In developing countries what percentage of adults have access to a bank account
· In developing countries nearly half of adults do not have access to an account at a bank
How were deferred wage payments used to overcome barriers to saving in Malawi
The workers who participated in the scheme increased their net savings by 23% through the program
spent their lump sum mostly on durable goods like home improvements; the amount of their durable assets increased by 10%
How does infastructure impact economic growth and development
● Low levels of infrastructure make it hard for businesses to trade and set up within
the country
● However, the development of infrastructure can be expensive and tends to conflict
with environmental goals.
e.g. In India abouthalf their roads are not paved
What is the impact of education + training on economic growth and development
● Poor education within these countries means that workers are low skilled, sometimes unable to read and write, so have low levels of productivity .
e.g. Ethiopia suffers from high illiteracy rates at around only 49%. (Unesco)
- Debate over type of education needed and over-education; graduates arre unable to find graduate level jobs
What is the impact of an absence of property rights on economic growth and development
Property rights are where individuals are allowed to own and decide what happens to
certain resources. A lack of rights mean that individuals and businesses cannot use
the law to protect their assets, leading to reduced investment
e.g. Loss of property rights in Zimbabwe led to economic collapse as FDI fell to 0 by 2001
What did Research by Simon Johnson say about the importance of property rights to development
well defined property rights are most important in shaping long-run economic growth and prosperity
e.g. the difference in institutions set up in the colonisations of north and south america led to rapidly different economic development
What are some non-economic factors that impact economic development and growth
- Corruption- individuals make decisions to axmisise bribes rather than development; Jose dos Santos Angola $500 million
- Diseases- effects of COVID-19 on Sri Lanka
- Poor Climates + Geographical Terrain - Malawi has to export goods through a one way 800km train to Nacala, Mozambique
- Civil Wars- During Saddam FDI in Iraq was near 0
How does India show that growth doesn’t result in the same rate of development
- India has overtaken the UK making it the 5th largest economy in the world; by 2027 it is expected to become the largest economy in the world
- But India ranks only 132 out of 191 in terms of HDI - same par with Tuvalu and Micronesia
- India is one of the most unequal; top 10% hold 77% of total national wealth
Between 2011-15 how many people in India were lifted out of extreme poverty by economic growth
Between 2011-15 more than 90 million people we lifted out of extreme poverty
How does the development of India and China portray the higher productivity rates of manufacturing compared to the service sector
- Compared to China, GDP per capita is very similar at the start of the period but by the end there is a five-fold difference
- Another difference in China scores much better on infrastructure and productivity growth
- Urbanisation took fast placer with a greater focus on manufacturing compared with the less productive service sector in India
Define FDI
investment from a party in one country into a business or corporation in another country with the intention of establishing a lasting interest. Or when an individual/business owns at least 10% of a foreign company
e.g. Amazon opening new headquarters in Vancouver, Canada
What are the benefits of FDI for business
- Diversification
- Lower labour costs
- Potentially: lower tariffs, taxes and subsidies
- Transfer of knowledge and human capital
What are the beneftis of FDI for the home country
- Economic stimulation
- Development of human capital
- Increase in employment + PPF
- Access to management expertise, skills and technology
- Improved Captal Flow to Finance Account - easier to finance deficit
- Creation of a competitive market; breaking domestic monopolies
What are the main disadvantages of FDI
- Displacement of local businesses
e.g. entry of large firms like Walmart which is criticised for driving out local businesses that cannot compete with its lower prices
- Profit Repatriation e.g. large capital outflows from the host country
- Political + enviromental + cultural impact e.g. Open-Door Policy
- Inequality worsens e.g. Russia 1995
- Creating local monopolies –> higher inflation e.g. OPEC
- TRIPS/TRIMS mean countries have to produce certain products at a higher price through FDI
- Footloose e.g. shoe making Brazil –> China 2/3 share
What is horizontal FDI
Horizontal: same activities but in a foreign country e.g. McDonalds
What is vertical FDI
Vertical: different part of the supply chain abroad e.g. Primark Manufacturing in Bangladesh
What is Conglomerate FDI
Conglomerate: unrelated business in a foreign country
What is Platform FDI
- Platform: Business expands into a foreign country but the output from the foreign operatios is exported to a 3rd country; often happens in low-cost locations inside free-trade areas
e.g. UK manufactures moving to Poland/Ireland to export to the EU
What is Quality FDI characterised by
→ Contribution to valued job creation
→ Enhancing skill base (human capital)
→ Facilitating transfer of technology and knowledge
→Boosting competitivness of domestic firms + enabling their access to markets
* Operating in a socially and environmentally responsible manner
What are tailored policies to enable Quality FDI
1) Open Markets to allow for FDI inflow; providing open, transparent conditions . Improving ease of business, flexible labour markets and protection of property + intellectual
2) Investment Promotion Agency (IPA): targets suitable foreign investors, prompt domestic host to provide top notch infrastructure and ready access to skilled workers
3)Put up infrastructure required for a quality investor: such as transport, energy, education
4) Strengthen backward linkages + spillovers from FDI into the indigenous economy: Competitive pressure of foreign entrants + forms of direct assistance from foreign to domestic firms in the form of training (setting up production lines, management coaching)
7) Provide access to credit by reforming domestic financial markets
8) Set up a vendor development programme to support the match making process between foreign customer and local supplier - offering financing opportunities to indigenous suppliers for required investment on the basis of purchase contracts from foreign buyers
e.g. Local Industry Upgrading Programme (LIUP) of Singapore
Set up a secondary industrial zone for local suppliers next to the EPZ
Why is Poland the largest recipient of FDI inflows in Central Europe
- Strategic position
- large population with cheap skilled labour
- EU membership , economic stability
- a fiscal system attractive to business with a number of Special Economic Zones and a Polish Investment and Trade Agency (PAIZ) to improve conditions for FDI
What are Polish Policies to motivate FDI
- Regional aid is most used for companies carrying out intial or new investment progests; can be tax exemption, grants or loans
- It is only granted for investments related to: diversification of the output of an establishment into products not previously produced, setting up a new establishment, extension of the capacity of an existing establishment
- Maximum level of aiid depends on size and where the project is located
What are Polish Policies to incentivise aid in priority sectors
- Government Grant MASP (Multi-Annaul Support Programme - MASP) dedicated to supporting large investments in ‘priority sectors’ such as automotive, electronics, aviation, biotech, modern centres and R+D
What are Joint Ventures
When 2 Companies work together
- Useful + necessary way to enter markets
- Could be w/o equity in a strategic allliance
What are the advantages of a Joint Venture
- Share technology (increasing know;edge transfer) and complementary IP - intellectural property
- For smaller organisation it allows them to enter a new market
- Provide specialist knowledge of local markets
- Helps to undertake frontier research that is considered too large for an individual company
What are examples of successful Joint Ventures
1) 2008 NBC Universal Television Group (Comcast) and Walt Disney Company created HULU; product became a billion dollar success
2) Kellogg International entered to Chinese market with Wilmar to access its extensive supply chain network
What is the Capital-Output Ratio and how does it relate to the rate of growth of GDP
○ For example, if £100 worth of capital equipment produces each £10 of annual output, a capital-output ratio of 10 to 1 exists.
When the quality of capital resources is high and when an economy can better harness capital e.g. by using more advanced ideas, then the capital output ratio will be lower
Rate of growth of GDP = Savings ratio / capital output ratio
What are the contraints to the Harrod-Domar Growth Model
- Persistent savings gap in some countries e.g. Thailand still experienced growth
- Ignores other factors; labour productivity, tech innovations, levels of corrupption
- Small scale financial institutions
- Deep weaknesses in human capital
- Risks from unbalanced growth (C v I)
- Foreign flows can vary and their effectiveness
- Risks of borrowing to fund savings gap
How important are remittances to economic development
- Make up the largest source of external finance and 95% of remittances are sent to MIC
What are the advantages of remittances for families in LDC’s
- Additional disposable income helps to fund education & health care+save for investment
- Lower risk of extreme poverty
- Can be used as collateral for loans including micro-finance debt
Less malnutrition which can impair brain development
Whare are the macroeconomic advantages of remittances for LDC’s
- Lower Gini coefficient if they flow to poorest rural areas
- Higher productivity from better nutrition and health care
- Help absorb the impact of external economic shocks
- A key source of foreign exchange, they help to overcome a domestic savings gap
- Inflow on current account of balance of payments
- Politiical stability
What is the negative impact of remittances
- Firsly needs migrational ‘brain drain’ of workers
- Appreciation of domestic currency
- Increase non-labour income -> incentivisation to nor work as much
- LR takes families away from productive activities as money is used for C rather than I
What did the research of Rodriguez and Tiongson on remittances show for its effect of labour supply
Research of Rodriguez and Tiongson: remittances reduce the labour supply of receiving households in the Phillipines, especially female members
How much of wheat, maize and rice does China hoard since it started in 2017
China held 69% of the world’s maize reserves, 60% of rice and 51% of wheat
What has caused recent Food Commodity Inflation
- Drought in Brazil, USA + horn of africa worst drought in 40 years
- Floods in China; world’s largest wheat producer
- High temp in India; world’s 2nd largest producer of wheat
- Food Hoarding: since 2017 China has been stockpiling food
- War: Russia Ukraine produce 28% of world wheat and 75% of the sunflower oil; Ukraine’s food exports provide calories to feed 400 million people
- Disruption to feriliser: prices tripled between 2021-2 as Russia, Ukraine produce 40% of worlds potash.
What has been the impact of food inflation on the poorest
95 million additional people could be living in extreme poverty; goal of bringing global poverty rate to less than 3% by 2030 was now beyond reach
Number of severely food insecure people has doubled in 2 years from 135 million pre-pandemic to 276 million today
How does inflation affect the poorest the most
· Lowest income households spend up to 50% of their income on food
· Contrasts with high income households for which the proportion is around 20% on average
1) High-income households can change their expenditure from high quality to low quality
2) They can also buy in bulk e.g. Costco wholesale 20% cheaper on average
How has a rise in food inflation detoriated the Balalnce of Trade of emerging countries
- Increased expenditure on imports can lead to Sir Lanka type scenario where can’t afford basic foods such as rice sugar lentils and milk powder that tripled in price from January to April 2022
What has the effect of rapid IR rises been on emerging countries
- Developed countries increased IR rapidly
- Hot money flows mean developing countries depreciate which means commodities cost even more
What is the middle income trap
countries find it difficult to make the climb from being a middle-income country to achieve high-income fully-developed status.
World Bank finds that only 13 of the 101 countries deemed to be middle-income countries in 1960 had achieved high-income levels
What are possible causes of the middle-income trap
- Rising Wages/Unit Labour Costs - Lewis Turning Point, erosion of comparitive adv.
- Possible failure to invest in human capital
- Institutional Failures - doesn’t support a creative economy
- Social Capital - may not support sustained growth
- Inability to maintain macro-economic stability- fast growing causes inflation
What is a Lewis Turning Point
A Lewis Turning Point occurs when a country’s surplus labour evaporates, pushing up wages, consumption and inflation rates.
Within a country the supply of migrants from the countryside might dry up causing urban wages to surge.
What are strategies to help avoid the Middle Income Trap
- Sufficiently large middle class/rising incomes
- Improving working condiitons/ welfare safety net
- FDI to higher value industry + R/D
- Investment in human capital –> increase productivity e.g. Korea one of highest PISA
- Open up economy to international comp. e.g. India
- Responsible Macro Policy e.g. independent Central Bank
- Regional Trading Blocs e.g. ASEAN
- Tackle income and wealth inequalities
How has debt grew in emerging markets
Government debt as a share of GDP in emerging economies has risen from 27% in 2008 to 55% in 2019, especially in external debt
What are the benefits of a debt-led growth model
· needed to overcome the savings gap
· cover the cost of mega-infrastructure projects - pay itself off in the future
· Borrowing to invest will do the same
* Capital market discipline can sometimes lead to governmens following better macroeconomic policies and introducing economic reforms; help with MI TRAP
How is Mexico in the Middle Income Trap
- Growth of 2.5% over past decade not fast enough (Malaysia 6%)
- Lowest Tax Level of OECD (13%) –> social welfare spending 7% of GDP
- Under-developed financial economy (cash ermaind dominant) –> 1/3 of Adult Mexican have a bank account
- 138th/180 on Corruption
- Crime also major barrier
What was the Third World Debt Crisis
massive recessions meant developing countries couldn’t pay higher rates and money was demanded back.
Commodity prices fell so little revenue to pay back debt in ‘hard’ currencies
Export revenue fell more and more so they couldn’t even pay interest rates leading to places such as Mozambique declaring bankruptcy
How did the IMF respond to the Third World Debt Crisis
- bailouts were provided by the IMF such as the Carribean Countries;forced ‘structural adjustment’ policies to reablance economy
- Some economist arguments these led to ‘de-development’
- Strict fiscal policy, austerity, free market policies, reducing protectionist measures, removing intervention in currency markets
- Intervention cut in areas like education, healthcare, protectionism
What are some solutions to indebtedness of emerging markets
- Debt Relief - HIPC
- Reschedule debt - allow it to be paid over a longer time period
- Debt Swaps - UNICEF Debt for Child Relief
- Cancel the Debts - many countries already serviced through interest
What is the HIPC - Heavily Indebted Poor Countries
developed countries agree that debt doesn’t have to be paid back immediately as long as money is spent on development outcomes
Lots of debt relief took place in the Caribbean leading ot greater healthcare, education, tech advancement
What are Debt Swaps
Transfer debt to NGO’s who can redistribute this money, instead of paying money to Western bank in hard currencies, it is paid to NGOs in soft currencies while western banks are given a tax break.
e.g. UNICEF Debt for Child Relief
What is Rostow model of development
- 5 main stages
Agriculture–>pre-conditions–> Industrilisation –> Drive to maturity with diversification –> high mass consumption
oversimplified, simply shows western stages which may not be the same
What were the 2015 Sustainable Development Goals to be achieved by 2030
What are market orientated strategies to enable growth and development
- Free Trade- exploiting comparitive adv. to increase efficiency
- Promotion of FDI
- Removal of government subsidies - subsidies encourage inefficiency
- Microfinance - helps gain access to credit + invest
- Floating Exchange Rate - increases competitiveness
- Privatisation/ Deregulation
- Fiscal Discipline
- Tax Reform
How does trade liberalisation enable growth and development
● Countries can aim for export led-growth.
● Competitive Presssures create efficiency –> Resources will be allocated to
their best use where the country has a comparative advantage.
* Comparative Advantage
* Attractive to FDI
e.g. Countries like Singapore and South Korea and regions like Hong Kong have
benefitted from this method.
Evaluate the effects of trade liberalisation in enabling growth and development
- However, free trade may mean developing economies focus only on
primary products; this may limit development in the long term. - To develop new industry, they may need tariff protection, at least in the short
term. - Encourage Dumping
- Footloose + Enviromental impacts
- Structural UE
How does the Promotion of FDI enable growth and development
- FDI involves transfer of knowledge from one country to another bringing specialist management and traning techniques
- Creates jobs and leads to effects of multipliers –> higher labour productivity
- Helps fill savings gap
- Creation of competitive monoply
- Increasing employments
- MNE’s will invest in infrastructure, allowing reliable finance and transport systems to exist, making banking more accessible for economic agents.
Evaluate the effects of promotion of FDI to enable growth and development
● repatriation of profits and developing countries may find the company exploits them, by offering lower wages and poorer conditions than they would in a developed country.
● The country will also lose some sovereignty and become dependent on another
firm.
* Local competition may find it hard to set up and compete and the best jobs often
go to imported labour, leaving only low skilled jobs for locals.
● Environmental damage and exploitation of natural resources and tend to
become problems.
e.g. India benefitted greatly from FDI ‘Make In India’ liberalised FDI policy and lead to a 48% increase in FDI
Samsung’s investment in Vietnam has been crucial; local firms are now part of their supply chain
How does the removal of government subsidies enable growth and development
- government subsidies to support ailing firms encourages inefficiency.
- government can use money for more productive uses.
- cause problems in terms of corruption and criminality
e.g. Venezuela subsidised fuel is smuggled across its borders and sold in neighbouring countries for profit
Venezuela has subsidies on almost everything yet demand is still higher than supply
Evaluate the effects of removing government subsidies to enable growth and development
● Subsidies are placed on essential items within a country, effective way of minimising absolute poverty and ensuring a minimum standard of living
* Beneficial in helping infant industry grow
* Removing it is politicall unpopular –> bread riots, India farmers
*
What are the effects of floating exchange rates on enabling growth and development
● The country does not have to worry about their gold and foreign currency reserves and the government does not intervene.
* Acts as an auto-corrector to economic shocks
* Fixed exchange rates can damage competitiveness
* Government MP can focus on other policy rather than maintaining fixed FX rate
Evaluate the effects of floating exchange rates on enabling growth and development
- It means that the currency can be volatile which makes it difficult for exporters/importers to make decisions about the future
- Floating can cause large changes in macroeconomic variables, including economic
growth. - If fixed to low-inflation economy; help keep costs and prices under control
- Reduced costs of currency hedging
How can microfinance schemes enable growth and development
- Helping people on very low incomes gain access to credit t start small-scale projects and avoid excessive interest rates of moneylenders
- Take little or no collateral
- Enable saving + investment
Evaluate the effects of microfinance on enabling growth and development
- DFIF review ‘no clear evidence of positive impacts’
- Most loans are for consumption; SA consumption accounts for 49% of microfinance use
- If used for business than it encounters a lack of demand
- Interest rates can reach 200% per annum such as Banco Comparatamos
What is the effect of privatisation and deregulation on enabling growth and development
● Privatisation can end the corruption within a firm who is owned by the state .
● Selling off a firm, particularly if it is loss making, will improve government finances
and reduce levels of debt.
* Profit Motive creates efficiency + competition
* Deregulation reduces red tape
Evaluate the effects of privatisation on enabling growth and development
- deregulation may increase inequality and cause environmental problems.
- Privatisation may lead to thecreation of private monopolies and inequality (Russia 1995), which charge higher prices for consumers.
- Corruption in selling the industry
e.g. Water Privatisation UK 18.7 billion profit, 18.1 dividends. Bills increased by 40%. Net Debt increased by 55 billion
What are some interventionist strategies on enabling growth and development
- Development of Human Capital
- Protectionism
- Managed Exchange Rate
- Infastructure Development
- Promoting Joint Ventures with global companies
- Buffer Stock Schemes
How does the development of Human capital enable growth and development
● skilled workers more productive so allow diversification
* Increase in MRP, increase in wages
* Increased tax revenue
* Helps attract FDI
e.g. Both China and South Korea have some of the highest PISA scores
Evaluate the effects of the development of Human Capital enable growth and development
· Money could be spent elsewhere e.g healthcare that can increase HDI
· There is a time lag on the results of training and education.
· Increased labour supply = more pressure on wage rate
* Could lead to increased brain drain.
* Overeducation
How does protectionism enable growth and development
● Protectionism allows domestic industries to grow by keeping foreign goods out and protects them from strong competition.
* Infant Industry Argument
* Protection of domestic employment
- Both lead to greater employment, tax revenue and consumption
Evaluate the effects of protectionism on enabling growth and development
● However, it means countries lose out from the benefits of specialisation and comparative advantage
X-inefficiency , since domestic producers suffer from a lack of competition.
* Other countries are likely to retaliate.
e.g. Several Asian countries used a degree of tariff protection, when they were developing.
How do managed exchange rates enable growth and development
● The currency could be fixed against a number of different exchange rates . They can introduce high exchange rates for the import of essential products and lower exchange rates for others
* Helps reduce poverty and encourages investment if they are capital goods
* Lower FX rate for impports encourages import substitution
* Confidence and planning ahead
Evaluate the effects of managed exchange rates in enabling growth and development
- fail to work in practice ; black markets in foreign exchange develop which can destabilise the system
-
corruption becomes an issue, when government officials buy currency at ne exchange rate and sell it for profit at another.
● Alternatively, governments can manage a single exchange rate which will reduce
volatility , but speculation may mean that countries find it difficult to maintain an
exchange rate over a number of years.
How does investment in infastructure enable growth and development
● Infrastructure is essential for development ; a country needs roads, airports, schools, hospitals, railways etc.
- Infrastructure tends to suffer from the free rider problem and has very high capital costs , making it unlikely the private sector will develop it. Moreover, it has many positive social benefits which suggests the government should provide it.
Evaluate the effects of investment in infastructure enable growth and development
● government may not have the funds to provide the infrastructure and it is argued that they may be inefficient.
* Infrastructure projects are often associated with bribery and corruption , cause environmental damage and may be poorly built and maintained.
● Some argue that intermediate technology , which uses local materials and can be
fixed locally, is better than large scale infrastructure.
What are the effects of promoting joint ventures with global companies on enabling economic growth and development
● reduces the exploitation of FDI –> keep some of the profits generated within the country
e.g. Tata Starbucks Pvt.Ltd is a joint venture company with Starbucks in India
Kellogs Wilmer Collab in China
What are the effects of buffer stock schemes on enabling economic growth and development
- it should be self-financing : money is raised when selling the products, which allows the government to buy the next lot of stock
- Reduces volatility of commodity prices –> encourages investment
- Prevents sharp falls so reduces absolute poverty
Evaluate the effects of Buffer Stock schemes on enabling economic growth and development
- Requires volatility; if just goes up it will run out of stock
- Huge opp. cost: start-up costs, administration costs and problems of storage
e.g. 66% of EU Budget, butter mountains - Other countries may benefit; free riders
- Minimum Prices set too high and encourage inefficiency
e.g. causes dumping elsewhere, East Africa milk powder - Can cause retalitation
- Harms the enviroment
- Not overcome poverty, fund primarily goes to large farmers
What are other strategies to enable economic growth and development
- Industrilisation
- Development of Tourism
- Developmet of Primary Industry
- Fairtrade Schemes
- Aid
- Debt Relief
What is the impact of industrilisation on ecnomic growth and development
Countries who rely on primary products face volatile income and limited prospects for growth.
The Lewis model suggests that industrialisation and diversification of the economy enables more rapid economic development and higher growth in the future.
Evaluate the impacts of industrilisation on economic growth and development
- However, although labour productivity is low for some parts of the year, during
planting and harvesting vast amounts of labour is needed - migration has led to urban poverty replacing rural poverty as the industrial sector is unable to provide jobs for all those who have move
- Industrilisation is a result of development, rather than a cause
- India went from agriculture to services
- Governments choose wrong time + place
What is the effect of development of tourism on economic growth and development
- Tourism is a way to make use of natural resources.
- Tourism creates employment and inflows of foreign capital.
- Income elastic so will grow with economic growth
- Encourages FDI + improvements in infastructure
- Creation of Jobs with low skilled workers
- Higher tax revenues
Evaluate the effects of the development of tourism on economic growth and development
- Industry is seasonaland involves low skilled jobs so limited multiplier
- Destinations can go out of fashion
- TNC’s repatriate profits
- Large number of externalities
In Morocco how is tourism being developed
In Morocco, 7 eco-resorts are being built on the north coast where unemployment is
40%. (The Economist)
How is the development of primary industries enabling economic growth and development
- Comparitive adv. w/o they would be worse off
- Large + elastic supply of labour willing and able to work
- Doesn’t require costly investment; can be managed by local workers
- Important source of export rev. + foreign currency
- Attract FDI - China has been investing in central Africa to improve access to raw material which has ivolved building roads and railways to have wider benefits to the economy
- Stepping stone in economic development
e.g. Norway Sovreign Wealth Fund $250,000 per citizen
Evaluate the effects of the development of primary industries on enabling economic growth and development
- Volatile Prices
- Finite Supply
- Low YED
- Lack of investment in other sectors
- Dutch Disease + Resource Curse
- Prebish-Singer Hypothesis
- Corruption
How do Fairtrade schemes enable economic growth and development
- give farmers a bigger share of the final market price.
- A guaranteed price above the market price when the agreement was made.
- This gives producers stability and raises their income
- Sustainable production without child labour
What did a study in Sri Lanka state about Fairtrade
- those under fair trade had higher income and satisfaction, a greater understanding of the market and a more optimistic view of the future than those not under fair trade.
- They were able to save for the future and invest or provide financial support for their children.
- However, they still did not feel their income was sufficient.
Evaluate the effect of fairtrade schemes on economic growth and development
- system has an insignificant impact on the developing world.
- It benefits the Fairtrade producers but can leave others worse off since non-Fairtrade producers see a fall in demand.
- In the long term, the higher price for Fairtrade goods will increase supply and thus this could bring price back down (but low PES)
- Higher income reduces the incentive to diversify or move to urban
What is the effect of aid on economic growth and development
- used to finance investment in infrastructure and human capital.
- This can increase capital stock / aggregate supply and can enable higher growth rates.
- able to reduce absolute poverty, particularly emergency relief provided after disasters such as the Haiti earthquake (2010)
- Long term aid builds human capital
Evaluate the effects of aid on economic growth and development
- results in a dependency culture where countries are unconcerned by their finances
- Corruption means impact of aid is limited
- Politically motivated: Israel and Egypt
- May distort market forces
- Magnitude; other parts of external finance are more important
- Principle Agent Problem- failure of Millenium Villages
- Helps donor; get 7-10 dollars back through interest and tied aid
What was the failure of the Millenium Villages
Jeffrey Sachs’ aid project that ended up costing $12,00 to lift out of poverty, 34x average income
What is bi/multi-lateral aid
- Bi-lateral aid: aid from one country to another
Multi-lateral aid: channeled through international bodies
What is project aid
Project Aid: direct financing of projects
improves human capital
What is technical aid
funding of expertise
What is humanitarian aid
emergency disaster relief, food aid,refugee relief
What is a soft/concessionary loan
Soft loan: a loan made to country on concessionary basis
What is tied aid
projects tied to suppliers in donor country
How did Public health aid help treat the parasitic Guinea Worm in Sub-Saharan Africa
1986 3.5 million cases of Guinea Worm reported –> 2015, 126 cases reported
How many times bigger is remittances than aid
2014: 534 billion remitances flow - 3X size of ODA
What is the Lewis Model
- Two sector model/surplus labour model
1) Economy starts with 2 sectors: agriculture + urban sectors
2) Labour is released for work in the **more productive, urban sectors **
3) Industrialisaiton is possible, they make profits which can be reinvested and capital starts to accumulate
4) As more capital accumulates, further economic development can sustain itself
e.g. Chinese Urban Incomes 3.5x Rural
Evaluate the Lewis Model
- Profits may leak out; capital flight
- Capital accumulation –> may reduce need for labour
- Model asssumes competitive labour + Product markets
- Urbanisation may create problems and trickle down may not happen e.g. Cape Town 1 billion slums
According to Clark-Fischer why does the tertiary sector come from
-
High Income Elasticity of Demand- High YED for services, esp leisure tourism and financials services. As incomes rise and demand even more, more resources are allocated to service production e.g. 72% of UK is employed in the service sector
Low Productivity of Labour - Productivity in the service sector is lower because it is harder to apply new tech to services so prices rise relative to primary and secondary goods.
What did Victor Fuchs say that the tertiary sector would cause
Fuchs argued that the service sector contributed to the slow-down in economic growth rates in more developed economies as productivity growth in the service sector would tend to be much slower than for the manufacturing sector
What is balanced growth
: all sectors to support each other, interconnectedness implies growth across economy needed, clear role for gov. in supporting those tha don’t ‘naturally’ grow as much
Govt. should do a Big Push to support industries that aren’t growing
What is unbalanced growth
- Unbalanced growth: overall growth is faster, resource prices pick up where growth is unabalances and this will signal investors to allocate funds to open these bottlenecks, grater investment + growth due to efficient allocation of resources
- Government should support industries with strong linkages to the growth industries
e.g. grants, incentives
What is the warranted growth rate
- Growth Rate at which all saving is absorbed into investment
for example, people save 10 percent of their income, and the economy’s ratio of capital to output is four, the economy’s warranted growth rate is 2.5 percent (ten divided by four)
What is natural growth rate
- Growth rate required to maintian full employment
If the labor force grows at 2 percent per year, then to maintain full employment, the economy’s annual growth rate must be 2 percent
What is the Paradox of Thrift
If everyone saves at once, it can cause a drop in AD and a recession
What is the Paradox of Savings
People save more when they think it’s a bad time to save and save less when it’s a good time
Did Asian economies grow completely from market forces?
- Japanese government cultivated steel, aluminium, car and shipbuilding industry after WW2 and then targed semi conductors and electronics through window guidance
- Malaysia has protected its infant car building industries through credit from the government and high tariff on imported cars
- Japan and South korea emphasised on large domestic conglomerates like Hitachi and Samsung
How much did Latin America grow when it adopted ISI
averaged 6% in the 1970s
Evaluate government intervention in economic growth and development
- More govt intervention –> leads to overstuffing (underemployment), bureaucracy (red-tape) and inefficiency
- Political instability and a lack of transparency can also contribute to corruption
- Borrowing to cover this create unsustainable debt that are not used on infrastructure
- In total this can lead to capital flight e.g. India
e.g. Zimbabwe, a redistribution of land, lead to the collapse of its agriculture industries
What were the results of basic income grants conducted in Nambia, Mexico, South Africa and Indoneisa
- smooth out consumption deficits
- improve health indicators
- allow people to start small businesses that are successful because they can take advantage of increased local demand
What are Special Economic Zones
- Area in a country that is subject to different economic regulations than other regions within the same country
- SEZ economic regulations tend to be conducive to and attract FDI such as tax incentives or lower tariffs
What are the potential disadavntages of SEZ’s
- SEZ increase export levels but countries may abuse it to retain protectionist barriers
SEZ may **create a level of bureaucracy with possibility of corruption + regulatory capture **
What are SEZ in China and what do they have the power to do
- 4 SEZ in SE coastal region; Shenzen, Zhuhai and Shantou in Guandong province and Xiamen in Fujian Porvince
- Enjoy benefits of power to approve investment projects, offer incentives to foreign investors, import equipment and technology tax free
How has the Shenzen SEZ benefitted
- Shenzhen is a world leader in shipping and supply chain and has the world’s 4th busiest contianter port as of 2019
- Shenzhen’s fast economic growth is characterised by shipping logistics, high technology and financial services
- Has Huawei Tech City wehre R+D has created a global innovation sector and one of the leading financial sector
How much did Shenzhen’s GDP per Capita grow from 1979-2019
By over 30,000%
What are the primary aims of the IMF
- Primary aim is to stabilise exchange rate and provide loans to countries in need
functions
1) International monetary cooperation
2) Promote exchange rate stability
3) To help deal with BOP adjustment
4) Help deal with economic crisis
What does the IMF do in practice
1)Economic surveillance and monitoring; produces reports on member countries economies to suggest weaknesses
2) Loans to countries with a financial crisis: IMF has a $300 billion of loanable funds e.g. Greek $110 billion bailouts
3) Conditional loans/structural adjustment: when giving loans, the IMF usually insists on certain criteria being met
4. Technical assistance and economic training
Financed by member contributions from 183 members
What is structural adjustment in maco and micro policies
Combination of free market policies like privatisation, fiscal austerity, free trade and deregulation
Macro:
* Policies to tackle inflation or budget deficit (tightening monetary/fiscal policy)
* Removal of tariff barriers
* Abandoning fixed exchange rates
Micro:
- Privatisation to improve efficiency
- Ending food subsidies
- Reducing red tape (deregulation)
What are the problems of Structural Adjustment
- spending cuts on important welfare services like education are bad in long run
- Privatisation can benefit a small rich elite (Russia 1995 or Egypt’s Open Door Policy) and worsen inequality
- Privatisation of key utilities like water can lead to higher prices for a key commodity
- Unemployment
- Social development ignored
- Free trade hampers diversification; focus on comparitive advantage and raw materials
How did Privatisation affect water prices in Bolivia
Bolivia where the IMF forced privatisation to water as a key part leading to mass protests against the raised price.
It is argued that the privatization process did little to address water access and that the increase in water prices following such measures was met by an approximate 2% increase in levels of poverty
What was the role of the IMF in the 1997 Asian Crisis
Asian crisis of 1997 Indonesia, Malaysai and Thailand were required by IMF to pursue tight monetary policy but this caused a serious recession
What was the Goldberg Scandal
IMF intervention in Kenya in the 1990s made the central bank remove outflow of capital control that made it easier for corrupt politicians to transfer money out of the country
Evaluate the IMF structural adjustment policies and actions
- Dependent on implementation
- Structural adjustment can still provide political will to take necessary and difficulty step for long term growth and stability
- Places too much emphasis on macroeconomic objectives
- Crisis will always have difficulty and the IMF is an easy target
- Provides a confidence boost
- IMF has some successes such as Mexico in 1982, Greece and Cyprus
What is the role of the World Bank
Aid long term economic development and reduce poverty by making technical and financial support available
- lends to MIC and Creditworthy LIC
- offers interest free loans and grants to the world’s poorest countries
- finances investment, capital, mobilisation and gives advisory services to businesses and governments in economically developing nations
- promotes FDI in economically developing countries
What is the critcism of the World Bank
- Smoke screen to use conditional loans in exchange for countries to establish neoliberal economic policy that ultimately benefit western companies and financial insitutions
- Ha Joon-Chang argues that the real point of the World Bank is to create poliicy friendly to TNCs, deterotiating social development
- John Pilger argues that the World Bank is the agent of the richest countries in the world that offer loans only if they privatise and give access to raw materials
What was housing like in Finalndd during the early 1990s
- Early 1990s there was limited supply of rental properties (the number of rental properties fell by 11% between 1975 and 1985 ) in a highly regulated market.
- Rising costs and unable to raise prices due to rent control caused exodus of landlords from market
- Caused black market to emerge, avoiding rent control and tax, and caused tenants to pay significantly more than market value for their properties’ rent
What was the effect abolishing rent control in 1995 in Finland
- Rent control was abolished in 1995 causing rental supply to increase 45% in 1990-2000
- This caused black market to fall apart and prices to fall
How did Botswana esacpe the natural resource curse
- Use resources creatively; 50/50 ownership, trade deal with European Economic Committee, loan from IMF
- Upheld civil liberties and freedom of law; lowest for corruption + instability
- Diversify and improve human capital; 90% of citizens have ana education and 65% employed in service sector
How much did the welath of a citizen in Botswana increase by in just 13 years
12,000%
However, it places high on inequality due to diamond sector being biggest growth and exporter
How has the EU countered Chinese aid in Africa
150 billion of the Global Gateway funding will go to Africa
How has China used aid for influence in Africa
- Involved in estimated 35 countries, ports, power plants, railways
e.g. China has estiimated to invested more than $340 billion in Africa
e.g. important infastructure such as the Railyway line from mombasa to Nairobi or the Addis Abbada - Djibouti Railway
How much of Bangladesh’s exports are from the Garment Inudstry
2018: 83.49% as it has the 2nd lowest pay for production i n the world
What are the challenges facing Bangaldesh’s continued 7% growth
- Severe infastructure gap - only 20% of Dhaka has a sewage system
- Low complexity of imports - limited linkages to rest of economy
- Climte Change - threatens to get rid of 30% of food production by 2050
How is Rwanda utilising microfinance
initiated the Business Development Fund (BDF) which is providing guarantees and grants to accompany the ongoing financial inclusion initiatives with a deliberate effort targeting marginalised women and young girls
What are Rwanda’s financial policies
- Government- supported LTSS Long term saving scheme for basic pension benefits for half population
- Supporting Ease of Business
- Authorities prmoting a cashless economy; high mobile penetration, value of e-money has increased from0 in 2011 to 34% of GDP in 2018
What are Rwanda’s Supply-Side Policies
- Constructing 3 international airports; encourage trade + overcome landlockedness
- Carnegia Mellon Uniiversity Africa established in 2011 to produce creative and technically capable engineers - located in Kigali Innovation City
- Kigali Special Economic Zone to encourage manufacturing
What has been the effect of Rwanada’s strong instiutions, deregulation, property rights been on it’s ease of doing business
- Only Low Incoome Country in the top 100
- 29th easiest place to do business in the world
What has been the effect of the Kigali Special Economic Zone
- Creation of first phones made in Rwanda: Mara Phones in Partnership with Google
- Deal with Chinese firm Pink Mango to set up garment factory –> providing 7500 jobs and 20 million dollars in 5 years
How has Morocco diversified its export base away from farm exports to drive growth
Vehicles is now the biggest single export sector
Morocco overtook South Africa as Africa’s largest car maker with 400,000 cars in 2018
How has Morocco utilised its natural comparative advantage of benefits from 3,000 hours of sunshine per year
- The Noor Plant in Morocco is the world’s biggest concentrated solar power farm. It is the size of 3500 soccer fields and powers more than 1 million households.
How is Mexico in the Middle Income Trap
- Growth of 2.5% over past decade not fast enough (Malaysia 6%)
- Lowest Tax Level of OECD (13%) –> social welfare spending 7% of GDP
- Under-developed financial economy (cash ermaind dominant) –> 1/3 of Adult Mexican have a bank account
- 138th/180 on Corruption
- Crime also major barrier
How reliant is Mexico on the US
Gravity Theory suggest exports should be 1/3 from Mexico to USA while the acttual figure is 72%
94% of FDI flows come from the US
- Vulnerable to Protectionism of ‘the Wall’ and new Nafta
What ddo results from PISA 2015 show for Mexico’s progress
Only half of 15-yearr olds obtain the necessary skills to participate effectivvely and productively in society and in the labour market - World Bank
How reliant is Angola on oil
95% of exports
* Oil booms cause wide swings in economic growth e.g. 2015 oil slump caused recession –> causing Angola’s external debt to treble to over 60 percent of GDP
How has corruption impacted Angola `
Jose dos Santos took over 500 million in government funds
165/181
How has the natural resource curse impacted development in Angola
Angola had 1 physician per 10,000 people
Gini Coefficient of over 0.6
149th HDI ranking
How open is Cambodia to Trade
Trade as a share of GDP is 125%
membership of ASEAN
FDI 11% of GDP
How has Cambodia utilised growth for development
2017 Cambodia has the 8th fastest rate of HDI growth
1. reduction in poverty (47.8% in 2007 to 13.5% in 2014)
2. a fall in measured inequality (Gini from 40 in 1997 to 28 in 2012)
How is the garment industry both beneficial and restrictive to Cambodia
Beneficial:
- 75% of Annual Exports and main driver of growth to ASEAN market of 750 million
Restrictive:
- Parts of Garments are foreign so restricts multiplier
- Infastructure not built around it -106th on infastructure
- Too narrow Export base
How has Mozambique benefitted from discoveries of natural gas
- Increasing FDI: now 18% of GDP
e.g. Anadarko investment of $22 billion; double the size of its GDP
but has borrowed heavily with external debt reaching 100% of GDP
What is the stock market
Enabling the buying and selling of shares on listed stock
markets. Firms can use stock markets to issue more shares and raise
finance.
What is the bond market
This involves buying and selling government bonds, to
fund public sector borrowing. As well as government bonds, there are
also private sector bond markets for firms.
What is commercial banking
Offering firms the chance to save and borrow for
investment.
What is a personal bank
Offering individuals the opportunity to save and
borrow
What are money markets
means for lenders and borrowers to meet their short term financial needs.
· Assets bought and sold usually have a maximum maturity of a year (24 hours-365 days) and are easily convertible into cash.
What are the main roles of financial markets
- Saving - gain interest through bonds/bank to transfer spending power to future
- Lending –> fund investment
- Facilitate the Exchange of Goods - creation of a payments system
-
Reducing Risk –> enables companies to hedge (swaps, forwards, options)
e.g. Forward Market in Commodities -
Shares –> raising finance for investment
e.g. Eurotunnel financed by selling shares to investors
What is the money supply
money supply measures the total amount of money in the economy at a particular time. It includes actual notes and coins and also any deposits which can be quickly converted into cash.
What is M0 to M4
M0 = This is the level of notes and coins in circulation + banks operational balances at the Bank of England. (This is the most liquid form of money)
· M4 = This is notes and coins in circulation plus private sector deposits in banks and building societies.
How do you increase the money supply
· Print more money
· Quantitative easing – electronic creation of money by Central Banks
· Increased bank lending – banks lending higher % of their deposits
* Central Bank purchasing bonds from private individuals which can be spent.
What are financial markets
where financial assets (eg loans) or securities (stocks/bonds/treasury bills) are traded.
What are capital markets
Shares and bonds are issued to raise medium and long term financing for both firms and government
divided into the primary market, newly issued, and the secondary market, second-hand securities
What is the foreign exchange market
market in which different currencies are bought and sold.
traded on either the spot market (immediate exchange) or the forward market.
What is the relationship between the price of a bond and the yield
there is an inverse relationship between the price of the bond and the interest, it is the coupon that remains fixed.
What are the main functions of Commercial Banks (High Street Banks)
· Accepting deposits
· Lending to economic agents
Providing efficient means of payment (bills etc)
Provide foreign currency
Offer other functions-give advice, insurance etc.
Banking is private, what does this imply
· Need to be profitable to provide a return for shareholders
· There needs to be certain level of liquidity to meet the needs of depositors
· There is a balance that needs to be found between liquidity and profitability
What is the balance sheet of a Commercial Bank
Assets - cash, balances at the BofE, Loans (advances), securities (e.g. bonds), fixed assets
Liabilities - customer deposits, money owed to bond holders, money owed to other banks
How do banks create credit
When a bank makes a loan, for example to someone taking out a mortgage to buy a house, or a business taking out a loan to finance their expansion it credits their bank account with a bank deposit of the size of the loan/mortgage.
At that moment, new money is created.
’ Bank making loans and consumers repaying them are the most significant ways in which bank desposits are created and destroyed in the modern ecnonomy’
What are the benefits of a bank attracting fresh deposits
- By attracting new deposits, the bank can increase its lending without running down its reserves.
- Longer-term savings deposits therefore typically offer a higher rate of interest for savers, a reward for the inconvenience of sacrificing some of their liquidity
What are the limits to money creation by commercial banks
- Market forces – the scale of profitable lending opportunities
- Regulatory policies e.g. capital reserve requirements
- Behaviour of consumers and businesses e.g. decisions about how much debt to repay
- Monetary policy - level of policy interest rates influences the aggregate demand for loans
Evaluate the role of banks
- Banks are not the only source of finance, may turn to private investors, stock market, government grants or personal savings
- In times of recession, banks may not be willing to lend e.g. 2008
- Poorest consumers often do not have access to bank account
What are Bank Stress Tests
- Put in after 2008, test the liqudity and capital of a bank in simulations of an ecnomic crisis
Banks that fail stress test mistake steps to rebuild capital reserves
EU stress tests cover 70% of banking institutions,US Banks with over 50 billion pounds or more in assets are required to undergo
What are the criticisms of Bank Stress Tests
- Stress tests are over-demanding, and require too much capital
- Thus there is an under provision of credit to the private sector; which many argue led to the relatively slow pace of economic recovery after 2008
- Timing is hard to know making banks overly cautious during normal fluctuations
What is a Hedge Fund and it’s goal
- Pool contributed to by a limited number of partners and operated by a professional managers
- Only open to qualified investors ( over a million net wealth or annual income over 200,000)
- Common goal is market direction neutrality; make money despite market fluctuations
What is the structure of a hedgefund and what is the issue with this structure
- 2 and 20 fee structure: gives the hedge fund manager 2% of the assets and an incentive fee of 20% of the profits each year
- But even if the hedge fund loses money, the manager get sa good amount ( moral hazard )
What are the type of Hedgefunds
1) Macro hedge funds try to maximise on changes in macroeconomic variables; biggest busts and highly leveraged
2) Equity hedge funds is maintying ‘long’ positios in stocks you own and ‘short’ positions in stocks you don’t tha you believe will decrease
3) Relative value arbitrage hedge fund buy securities that are expected to appreciate while simultaneously shorting a similar security that is expected to depreciate in value
4) Distressed hedge fund help companies turn themselves around by buying some of the securities in hopes they will appreciate
What is a building society
a mutual organisation; all elligible customers are known as members
· They have rights to vote and speak at meetings
· Each member always has one vote and there is a board of directors
· Societies have no shareholders requiring dividens; allowing lower costs, cheaper mortgages, better interest rates
· Building societies have a limit on what proportion of their funds that building societies can raises from the wholesale money markets ( can only raise 30%)
What makes the longer length of a bond give it a higher yield
Longer length of the bond makes it more risky as there can be more factors ( raising IR value, default)
e.g. SVB collapse from purchasing longer length bonds for a higher yield
What is a bond default
- Occurs when an issuer fails to make an interest payment or pincipal payment
- usually a last resort and is often solved by restructuring
- In case of coporate bands the bondowner usually recieves a compensation, in a high yield market the avergae recovery rate from 19577-2011 was 42%
How do distressed debt investors utilise defaulted bonds
- When bonds default they continue to trade as sharply reduced prices, attracting distressed debt investors who believe they will be able to recover more than the disperal of the company’s assets than the price of the bond reflects
In the 42 year period till 2011 how many AAA rated municipal and coporate bonds paid out interest and principal
- In the 42 year period through 2011, 100% of AAA rated municipal bonds paid alll of the epexcted interest and principal payments
From 1920-2009, only 0.9% of AAA rated coporate bonds default
What are derivatives
Financial securities with a value that is reliant upon an underlying assert or a group of assets
- Derivatives can be used to hedge, speculate or give leverage
What is the difference between over the counter (OTC) derivatives and exchange based
- Over the counter derivatives have counterparty risks - the danger that one of the parties involved in the transaction might default; this is private and unregulated
Exchange based derivatives are standardised and heavily regulated
What are futures
- Agreement between 2 parties for the purchase and delivery of an asset at an agreed upon price at a future date; obliged to fufill
- Can undwide (sell) before expiration
- Requires Margin Payments
- Market has high liquidity; exchange based
What are forwards
- Only over the counter; greatter counterparty risk but customised
- Parties in a forward contract can offset their position with counterparties
- To reverse you have to go to same counterparty who has monopoly over you
- No margin required
What are swaps
- Used to exchange one kind of cash flow with another e.g. interest rate swap to switch from variable to fixed
- Swaps can also be used to exchange currency exchange rate risk or the risk of default on a loan
- swaps on the cash flow and the potential defaults of mortgage bonds led to the counterparty risk that caused the credit crisis of 2008
What are options
- Similar to futures to but buyer has no obligation to exercise the agreement
- Options are used to hedge or speculate on future prices
- Investors buy a put ( sell ) or call (buy) option at a strike price to buy at a date in the future - the expiration date
Options have time decay; value of assets decline over time and severely reduce profitability
What are the advantages of derivatives
- Mitigate risk
- Lock prices
- Hedge
- Can be purchased on margin to make less expensive
What are the disadvantages of derivatives
Buffet describes them as ‘financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal’
- Difficult to value because based on prices of another asset
- Counterparty risks that are difficult to value
- Sensitive to changes in amount of time to expiration, cost of holding asset and interest rates; hard to value
- Leverage can have externalities e.g. 2008
- difficult for regulators to maintain oversight to the market since they are so hard to value
What 2 sections is the financial market split into
- Money Markets - assets w a maturity of less than a year
e.g. Bonds, Interbank Lending
Capital Markets - assets w a maturity of more than a year
What is the quantity theory of money
- Theory that links growth in money supply, to growth in inflation
- Embarced by Monetarists; it is the reason for inflation
1) M (money supply)
2) V (velocity of circulation; no. of transactions given an amount of money)
3) P (Avg. Price Level - Inflation )
4) Q (Quantity of Goods/services sold) i.e. real gdp
Fischer Equation:
MV (what is bought ) = PQ ( what is sold )
P = MV / Q
But V and Q are fixed in the long run or their changes are negligible
Therefore only M can influence price
Evaluate the Quantity Theory of Money
- Assumptions of V and Q same
- Recession
- Doesn’t hold
- Big increases in money supply doesn’t translate due to liquidity traps
What do investment banks do
- Proprietary Trading - taking any excess capital and investing it to get a better rate of return
- Market Making - a place where markets can be made; where you can buy shares + bonds but also issue bonds and shares
Advisory Roles:
* Mergers and Acquisitions: Companies might go through an investment bank for advice: when? Structure? Due diligence? Paperwork? Media? Regulation?
* New Issues and IPO’s
Underwriting IPO’s: buying all the shares up and then charging a higher price to sell to the market
What is systemic risk
most banks like hsbc and barclays are nor pure commercial or investment. Thus it makes them vulnerable to black-swan events to bring down the entire financial system
What is capital on the banks balance sheet
Shareholder’s Funds + Retained Profit (reserves)
- since you need to pay them back to the shareholder
What is SONIA (Sterling Overnight Index Average)
reflects the average of the interest rates that banks pay to borrow sterling overnight from other financial instiutions
How is insolvency caused on the balance sheet
- If any loans go bad, capital - specifically retained profit - will take the hit
- Thus banks need enough capital to offset bad loans
If there isnt enough capital, there will be an unsustainable position on the balance sheet where the bank owes more than they own which is bank failure/insolvency
What is a liquidity crisis and how is it shown on the balance sheet
There may also be a position where the bank can’t meet short-term borrowing with short term assets ( Cash, reserves at BoE, Money at Short Notice (Near Money), Short term investments) therefore they are in a liquidity crisis and there will be a run on the bank; another form of bank failure
What is a liquidity crisis and how is it shown on the balance sheet
There may also be a position where the bank can’t meet short-term borrowing with short term assets ( Cash, reserves at BoE, Money at Short Notice (Near Money), Short term investments) therefore they are in a liquidity crisis and there will be a run on the bank; another form of bank failure
What are the 2 types of bank failure
Insolvency - unsustainable position on the balance sheet
Illiquidity- unable to meet short term borrowing with short term assets
What is the Money Multiplier
- Through frational reserve banking, new money is created by loans which comes back into the bank as the form of a deposit
Money Multiplier equation comes from 1/reserve ratio
What are the types of market failure in the financial sector
- Assymetric Information - struggle to know how reliable the loan is
- Moral Hazard - bank bailouts £45.8 billion for RBS
- Speculation and Market Bubbles
- Market Rigging - Libor
- Externalities - opp. cost of bailouts
How is assymetric information in Financial Markets a market failure
- financial institutions often have more knowledge so they can sell them products that they do not need
e.g. PPI costed over £53 billion
FInancial Crisis sub-prime mortgages
How are externalities a market failure in the financial sector
- Bailouts are a burden on the tax payer
e.g. 2008 total bailout cost of £700 Billion - Profit maximisation can be contrary to social objectives
e.g. Madoff fraud estimated around £65 billion
How is Moral Hazard a market failure of the financial sector
- individual workers take adverse risk in order to increase their salary
e.g. Mortgage brokers gained from increased risk as the burden was shifted to investors - Central Bank is lender of last resort, some banks such as Credit Suisse are categorised as of structural damage to the economy
How is speculation and market bubbles a market failure in the financial sector
all trading in financial markets is speculative and this leads to the creation of market bubbles due to herd behaviour
e.g. 2008, Dot.Com Bubble, Wall Street Cash 1929
How is market rigging a market failure in the financial market
- Group or individual collude to fix prices - insider trading
e.g. Libor Scadal of 2008
How much did Citibank make from a 1% fall in the LIBOR rate
$1,935 million if they were to fall by 1 percentage point instantaneously
How did the Housing bubble affect the Irish House prices
Irish house prices rose 30% in just two years, but fell 35% when the housing bubble ended.
100% mortgages were common
What was the Big Bang and it’s consequences
The reform program focused on the elimination of the city’s major problems: overregulation and the widespread practice of old-boy networks.
the concentration of power was focused on the big companies that took over long-standing firms
Now, companies that are “too big to fail” dominate financial cities. This characteristic has turned financial centers fragile, as seen in 2008,
What are the types of market bubbles
- Market Bubble - When a particular market sees a rapid increase in price
- Commodity bubble e.g. price of gold, e.g. in the 1970s and 1980.
- Credit bubbles- a rapid growth in consumer and business credit to finance higher consumer spending
-
Economic boom/bubble- AD grows faster than LRAS
*
What are some examples of market bubbles
- Tulip mania of the 1630s. When the price of tulips rose to over 500 times their previous price before collapsing when buyers stopped entering the market.
- Dot Com Bubble
- House Price Bubbble- Between 2000 and 2006, house prices rose 80% and house price to earning ratios rose above long-term averages. This was partly fuelled by a growth in mortgage lending to subprime customers
What are the main causes of market bubbles
- Irrational exuberance investor buy assets because of strong psychological pressures which encourage them to ignore the fundamental value of the asset
- Herding behaviour.
- Short-termism
- Cognitive dissonance – filtering out of the bad news and looking for views which reinforce their beliefs.
- Financial instability hypothesis. The theory that periods of economic prosperity cause investors to be increasingly reckless leading to financial instability.
- Monetary policy. Excess liquidity can more easily lead to bubbles because people need somewhere to put their money.
e.g. Low IR 2000 –> fuelled 80% rise in house prices 2000-6
What are the varying effects of market bubbles
- stock market crashes don’t always cause a recession.
e.g. 1987, the stock market crash didn’t cause any slow down in economic growth
- But 1929 one was a major factor to the Great Depression
- Bubble in housing market is most damaging since it affects consumers
e.g. housing crash of 1991 contributed to UK recession. The house price bubbles and bust were a strong factor behind recessions in Ireland and Spain.
- Breaking bubbles in oil and commodities can help net importers
What is financial instability Hypothesis by the economist Hyman Minsky
financial crisis are endemic in capitalism because periods of economic prosperity encouraged borrowers and lender to be progressively reckless
Success breeds excess which leads to crisis
Or
Economic stability itself breads instability.
How do economies go from stability to instability
- Higher asset prices –> increrase confidence –> irrational exuberance –> speculatie lending –> Ponzi Borrowing to keep asset prices rising
- Regulaters + Credit rating agencies get caught in irrational exuberance
- Unsustainable and cannot be maintained, until stop rising and realisation that there isnt enough credit to meet repayments
What is the Minsky Moment
point where the financial system moves from stability to instability. It is that point where over-indebted borrowers start to sell off their assets to meet other repayment demands.
Can lead to a balance sheet recession
What is a balance sheet recession
occurs when the private sector is focused on paying down debt and unwilling to borrow and spend, despite 0 IR
In a balance sheet recession the banking sector is unwilling to lend because it needs to improve its balance sheet and increase bank reserves.
Features
- Liquidity Trap
- Falling Asset Prices
- Deflationary Pressure; falling asset prices and stagnant economy
- Higher saving rates
- low bond yields
What is irrational Exuberance
Irrational exuberance refers to a situation where economic agents develop overconfidence in the economy and financial markets that is misplaced
- Rapid asset price inflation
- Increased risk willingnesss
- Tendency to ignore potential for asset to fall
- Growth in Speculative or Ponzi Lending
What are the main roles of the Central Bank
- Monetary policy - IR, QE, OMO, Currency
- Banker to the Government
-
Lender of Last Resort - providing liquidity to government + financial system
e.g. Liquidity Assurance Scheme, BOfE buying government bonds after Truss disaster - Printing Money
- Regulation of Financial System - maintaing reserve ratios + preventing Rigging
What are open market operations
When the Federal Reserve buys or sells securities from its member banks, it’s engaging in what’s known as Open Market Operations.
When the Fed wants interest rates to rise, it sells securities to banks. This is known as contractionary monetary policy –> reduces bank credit –> higher interbank rate
What will the Bank do when OMO’s are not enough
- In extreme scenarios OMOs may not be enough, the CB can create more money by extraordinary market operations in which it buys riskier longer govt securities or assets known as QE
What are the effects of negative interest rates
Negative interest rates are designed to:
* Get banks lending – they will pay the central bank interest for holding money on deposit with them
* Bring about a reduction in real interest rates – which might in turn stimulate increased business investment
* Negative rates are partly designed to cause an outflow of hot money thereby depreciating the exchange rate
* * Main aim of negative rates is to lower the risks to output, profits, employment & wages from deflation
What are the Risks from negative interest rates
- lower bank profitability by narrowing the interest-rate margins between savings and loans rates – threat to their long run stability
- Pension and insurance companies may struggle to meet their long term liabilities if long term interest rates (yields) are close to zero or below
- May become dependent on ultra-low IR and cheap money
Why are there doubts about the effectiveness of QE
doubts about the effectiveness of quantitative easing – bank lending has struggled to recover since the end of the last recession. In the summer of 2015, QE in the UK totalled £375bn
Evaluate the Lender of Last Resort Funtion
- Liquidity from the central bank isn’t without conditions or interest. More emergency the liquidity is the more stringent these conditions and interest
BUT
1) Promotion of moral hazard
2) Banks are incentivised to take more risky deals and not hold sufficient liquidity
3) Regulatory Capture
4) Why should banks have this luxury and not other firms?
e.g. 85,000 of individual savings back by Gov.
What is the countercyclical capital buffer (CCyB)
The FPC sets the level of the UK CCyB rate. If the Committee thinks risks are growing, it sets a higher UK CCyB rate. This means that banks are required to have an additional cushion of capital to absorb potential losses
e.g. Current Rate is 1%, upcoming rate from 5th July 2023 will be 2%
How does the FPC (Financial POlicy Committee) utilise its reccomendation power to stop risky mortgages growing
The FPC uses it recommendation power to restrict the proportion of risky mortgages banks take on. This helps us to reduce the risks to the financial system from high levels of household debt, particularly if the economy suffers a downturn.
For example, we have put a limit on the amount of new mortgages that lenders can approve that are 4.5 times or more the size of a borrower’s income.
What does resolution involve
- Doesn’t require agreement of management/shareholders/creditors or recourse to taxpayers money
- Ensure customers have access to services they require
- Costs of failures fall on the shareholders + creditors of failed bank not taxpayers
- Senior Executives take blame and are replaced
- Transfer most important partss of bank to another bank
- If no purchaser then can be transferred to bridge bank
- Insure consumer deposits returned through the Compensation Scheme or transfered to another firm
Whats a bail in
- repairing balance sheet using the firms own resources e.g. losses of failing firm is absorbed by the shareholders
- Creditors converted to shareholders; debt for equity swap
How did the BOfE deal with the fallout of SVB bank in the UK
- Got HSBC to buy SVB’s UK unit in a rescue deal
- Avoids taxpayer being needed to protect deposits of over 10 billion
How did the FED deal with the fallout of SVB
- Insured all consumer deposits
- Took it over and utilised firm’s assets to repay depositors; investors will not be made whole
*
How is the FED trying to prevent contagion from the fall of SVB
The Federal Reserve also announced a new lending facility that other banks can draw on to help them meet demands from depositors.
Fed’s lending reduces the risk that banks’ paper losses, estimated to be above $600bn at the end of 2022, will crystallise into actual losses.
How is the failure of SVB partly down to poor regulatory oversight from the Central Bank
- US dual banking system meant things were lost in co-ordination
- 96% of SVB deposits were not covered by the FDIC insurance
- SVB was reliant on the Federal Home Loan Bank of San Francisco
- Financial policies had begun to pile up from long-term fixed bond rates
How is the failure of SVB partly down to poor regulatory oversight from the Central Bank
- US dual banking system meant things were lost in co-ordination
- 96% of SVB deposits were not covered by the FDIC insurance
- SVB was reliant on the Federal Home Loan Bank of San Francisco
- Financial policies had begun to pile up from long-term fixed bond rates
To what extent was the failure of SVB down to a loosening of regulatory policies by the government
- 2018 rollback of the Dodd-Frank act, the biggest deregulatory effort since the 2007-08 financial crisis, exempted some banks with assets of up to $250bn from the Fed’s toughest supervisory measures, including stress tests as well as capital and liquidity requirements.
- decision was predicated on the view that large regional banks were not “systemic” and “don’t need close regulatory and supervisory scrutiny”.
What can the lender of last resort role be divided into
· the routine provision of liquidity
· the emergency provision of liquidity to a bank that has cash flow problems or there is a systemic issue
How does the BOfE prevent abuse of the liquidity assurance schemes
- Requires high quality collateral
- Premium over Bank Rate to access emergency funds with stringent conditions
How does the BOfE change the supply of money
1) Reserve Requirements
2) Discount Rate - rate at which commercial banks borrow from the central bank to meet their liquidity needs in the short-run
3) Open-Market Operations - buying and selling of gov bonds
What is the impact of increasing the money supply on interest rates
Usually, an increase in the money supply will lead to a fall in interest rates.
However, in a liquidity trap, an increase in the money supply may have no effect on reducing interest rates.
What are the main 3 regulators of the financial system
- Tripartite regulation; 3 major organisations
2 work for BoE and one with the treasury
BOfE
Financial Policy Committee (Macro-Prudential Regulation)
Prudential Regulation Authority (Micro-Prudential Regulation Authority)
Treasury:
Financial Conduct Authority (also micro-prudential authority)
What is macro-prudential regulation
This identifies, monitors and acts to remove risks that affect the **stability of the financial system as a whole.
**
The FPC is primarily responsible for macroprudential regulation.
What is micro-prudential regulation
· Focuses on ensuring the stability of individual banks and other financial institutions.
It involves identifying, monitoring and managing risks that relate to individual firms.
PRA and FCA are mainly responsible for microprudential regulation.
What is the Financial Policy Committee (FPC): macro-prudential
primary objective is to mitigate/remove systemic risk, secondary objective is to support the economic policy of the government.
· The FPC has two main powers: it can issue mandatory directions to the PRA and the FCA, and it can make recommendations to anyone, including the government
It has the power to make comply-or-explain recommendations to the PRA and FCA
e.g. 2 annual stress tests from 2017. Liquidiity Assurance Scheme
What is the Prudential Regulation Authority (PRA): mirco-prudential
· It sets standards and supervises financial institutions at the level of the individual firm to enhance stability
* The PRA may require individual institutions to maintain specified capital and liquidity ratios.
* However, the PRA does not seek to operate a ‘zero-failure’ regime. Instead, the PRA tries to ensure that if a financial firm fails it does so in a way that avoids significant disruption to essential financial services.
What is the Financial Conduct Authority (FCA): micro-prudential
- Protect consumers + increase confidence in financial institutions/products by:
1) Supervising conduct of firms being legal ( no market rigging )
2) Promote competition so consumers get better deals - deregulate to reduce red tape
3) Banning financial products against interest of consumers - stopping PPI scandal and getting over 50 million paid back
4) Banning or changing mis-leading adverts for financial products - loan sharks e.g.
mandatory APR and terms and conditions
What did the CMA say abut challenges to the clearing bank
The Competition and Markets Authority report on UK banking in August 2016 said that “the older and larger banks, which still account for the large majority of the retail banking market, do not have to work hard enough to win and retain customers and it is difficult for new and smaller providers to attract customers.”
What are SIFI financial instiutions
The Financial Stability Board, an international body that monitors and makes recommendations about the global financial system, every year since 2011, identified a list of G-SIBs. Any financial institution that is a SIFI is considered “too big to fail” and according to regulators poses a serious risk to the economy if it were to collapse
“Both Credit Suisse and Deutsche Bank are designated as systemically important financial institutions (SIFI): i.e. they are ‘too big to fail.’”
What is the effect of financial instability on the broader economy
Instability and confidence
* Negative impact on business investment and paradox of thrift
* High levels of debt and falling asset prices hit consumer wealth
Instability and loss of trust
* Higher interest rates on loans to businesses
Instability and inequality
* Evidence that poorer communities and families are more vulnerable during periods of financial stress/recession
* Policy response of ultra-low interest rates hits real incomes of savers
What are the Basel Reccomendations
a framework of agreements to prevent something like the GFC ever happening again. Only recommendations so no power but every developed nation adopted them apart from US which has a strong community banking lobby
What are ratios and requirement to increase liquidity
- Cash Ratio
- Liquidity Ratio
- Reserve Requirements
What is a Cash Ratio
cash assets/current liabilities
What are Liquidity Ratios
= short term current assets/ short term current liabilities
Basel Reccomendation –> 1 Jan 2015 60% and a 10% increase each year until 2019 to reach LCR
What is LCR - Liquidity Coverage Ratio
100% liquidity cover to liabilities owed in 30 days or less
How can reserve requirements be used to increase liquidity
- Fraction of deposit that must be held at the BOE
- Prevent liquidity crisis
FED puts 10% reserve requirement
What are ratios to reduce and insolvency risk (and de facto illiquidity)
- Capital Ratios
- Leverage Ratio
What are Capital Ratios
= Capital / Loans (can be specified)
- Intention is to prevent insolvency + thus bank failure/systemic risk
- Basel Reccomendation is 8%
- However its possible to specify which loans are included e.g. GFC used capital ratio that didn’t include ‘safe’ loans including mortgages
Unfavoured
What are Leverage Ratios
= Capital/ Loans + Long Term Investment
**Includes all loans **
- Intention is gains to prevent insolvency and thus …
Basel Recommendation of 3% minimum
What are some types and effects of financial market regulation
1)** Ban Market Rigging with strong enforcement**
Less market rigging/collusion which harms consumers, businesses and other financial institutions
2) Prevent sale of unsuitable products to consumers e.g. PPI
Protect consumers from products with excessive risk, charges + limited benefits
** 3) Maximum Interest Rates**
Prevent consumer exploitation whilst preventing excessively risky lending
4) Deregulation
More competition –> lower IR on borrowing and a higher IR on savings
5) Deposit insurance - up to £85,000
Protect consumer deposits in case of Bank Run –> Increases trust
6) Ring fence commercial banking away from investment banking
Lowers systemic risk e.g. Barclays split into commercial and investment
7) Set Limits on Bank Lending
8) Liquidity Assurance with conditions and punishments
What are the problems with financial market regulation
1) Moral Hazard - liquidity assurance creates bad incentives
2) Regulatory Capture - regulation is weakened by those who see through the industry’s eyes rather than the govt.
3) Assymetric Information - regulator always one step behind in product development - time lag
5) Unintended Consequences - deregulation of some can be dangerous for competition and systemic risk.
Maximum interest rates; excess demand in the market, encouraging bad borrowers and discouraging lending to reduce investment
6) Administration + Enforcement costs - PRA budget of over 600 million
What is an example of regulatory capture in financial
When Timothy Geithner was FED president became unusually close with the scions of Wall Street banks.
Geithner engineered the New York Fed’s purchase of $30 billion of credit default swaps from American International Group (AIG), which it had sold to Goldman Sachs, Merrill Lynch, Deutsche Bank and Société Générale.
By purchasing these contracts, the banks received a “back-door bailout” of 100 cents on the dollar for the contracts. Had the New York Fed allowed AIG to fail, the contracts would have been worth much less, resulting in much lower costs for any taxpayer-funded bailout.
Evaluate the problems with Financial market regulation
i) Balance needed to protect against systemic risk but to maintain bank profitability
ii) Regulation should promote equity without damaging efficiency
iii) Costs vs Benefits; are the costs of regulation greater than the benefits?
What are the clearing banks and how much of the market do they contain
Clearing Banks - Llyods, RBS, HSBC, Barclays and Santander
FCA reported that 77% of PCA market, 85% of business current account and 90% of business loans
What are examples of UK Government and Regulatory Intervention
- Current Account Switching Service - launched in Sept 2013 to ease barriers
- Authorisation Procedures for new banks, New Bank Start-Up Unit
- Sterling Monetary Framework for all banks in 2013- provide stability and liquidity assurance
- British Business Bank- nov 2014 for finance for SME lending
How has challenger metro bank grown to how many assetts
Metro Banks now has assets of over 20 billion
What are the main types of expenditure
- Capital Expenditure
- Current Expenditure
- Transfer Payments
What is capital expenditure
This is government spending that increases the capital stock of the economy (Increasing LRAS)
What is current expenditure
This is government spending on items that are recurring and only lasts a limited time e.g. spending on public sector wages
What are transfer payments
payments from the government to individuals, represents a redistribution of income in society
e.g. pensions, welfare payments
What are the 2 key measures of government spending
- Real government spending – Spending levels adjusted for inflation.
-
Government spending as a % of GDP – Government spending, as a
share of national income.
How has UK public spending as a % of GDP changed over time
Government spending as a % of GDP rose sharply from 2000 to 2022, with a
peak in 2020/21 due to the Covid Pandemic.
How has UK public sector reciepts changed as % of GDP
government spending also correlates to UK public sector receipts (mostly tax revenue). There was a prolonged fall in tax revenues as a % of GDP from 1981 to 1993, which has since been reversed.
What is the impact of higher government spending
- More investment in education and infastructure
- Redistribution
- Fiscal Policy - in rrecession can be effective to stimulate economy
- Crowding in
Evaluate the effects of higher government spending
- Higher taxes create disincentives for work/investment
- Public Sector lacks efficiency from no profit motive
- Crowding out resources from the private sector
- Vested interests push governments to inefficiency e.g. lobbying
- Kind of Spending- welfare payments may be detrimental to efficiency
- Spending doesn’t have to be inefficient if it utilises the private sector
What is UK government spending in 2023 by size
- Healthcare (20%)
- Pensions (17%)
- Welfare (13%)
- Education (10%)
- Interest (8%)
- Defence (6%)
- Transport (4%)
How does the stage of development influence public expenditure
- Developing: low tax revenue due to avoidance, inefficiency and little wealth to tax–> Can’t provide much through spending
- Developed: demand more services frrom governments ( income elastic )
How did the 2008 Global Financial Crisis influence public expenditure
- Huge increases for welfare payments + Bailouts
- but induced 2010 austerity to rweduce debt
How will ageing populations affect public expenditure
Europe and Japan will see pressure on government spending due to aging populations meaning larger pension bills and higher levels of care
needed.
What is the effect of public expenditure on productivity and growth
- infrastructure reduces costs for businesses
- Education increases human capital –> increased productivity
- Healthcare reduces the number of days sick
- Crowding in on frontier
- Free Market argues gov. spending is wasteful
What is the government multiplier of spending according to the OECDs
Gov. fiscal multiplier of 1.5-8 according to IMF
What is the effect of government spending on living standards
- Improve social welfare (correcting mkt failure + providing public goods)
- Reduce absolute poverty through benefits + Healthcare
but needs funding by higher tax - debt so crowding out
Evaluate the effect of government spending on living standards
government will be inefficient at providing goods and services and will have a negative disincentive impact on workers, meaning that output overall is reduced and so living standards fall.
government principal agent problem since they make decisions on behalf of the people who may have spent that money differently. As a result, there is a loss in welfare and so a fall in living standards.
What is crowding out
a process where an increase in government spending
leads to a fall in private sector spending.
What is financial crowding out
If the government increases it’s spending – say through selling bonds – The demand for money will increase, which, ceteris paribus, raises interest rates.
At higher interest rates, both consumer spending and investment spending are likely to fall.
The aggregate effect on the economy is that financial resources are diverted from private firms to be used by the public sector.
How does financial crowding out lead to a fall in GDP
Initially, via a multiplier effect, national income increases, but as a result of the government selling securities in the financial markets, the demand for scarce loanable funds increases.
This drives up interest rates, which causes a contraction in the demand by the
private sector for investment goods (capital) as well as reducing the demand for
consumer goods. This, in turn, leads to a fall in GDP.
What is crowding out in relation to the labour market
a relative increase in the public sector may push up wages in order to attract workers from the private sector.
The increased demand for labour reduces unemployment and ‘tightens’ the labour market, leading to possible shortages of labour available for the private sector use as well causing upward pressure on wage levels across the economy.
What fundamental financial fact drives crowding out
that financial and real resources are ultimately scarce, and if one sector of the economy increases its use of these resources, fewer are available for use in other sectors.
What is the Ricardian Equivalence
This means that attempts to stimulate an economy by increasing debt-financed government spending will not be effective because investors and consumers understand that the debt will eventually have to be paid for in the form of future taxes.
The theory argues that people will save based on their expectation of
increased future taxes to be levied in order to pay off the debt, and that this will offset the increase in aggregate demand from the increased government spending.
What did Barro say to support the Ricardian Equivalence
an increase in government spending will lead individuals and organisations to expect interest rates to rise in the future, they will save more in order to pay higher interest rates.
What is the evaluation of crowding out
it may be a weak effect, this depends on the various elasticities that exist in the relevant markets.
if the supply of loanable funds is elastic and the demand for capital is inelastic, the impact of higher interest will be relatively small.
What evidence did Enrice Moretti from MIT find about federal spending to oppose the ‘crowding out’ theory
Government spending leads to an increase in private spending; a ‘crowding in’ effect
What are 3 reasons for the crowding in effect
- Frontier technology projects have extremely high fixed costs so by letting the public
sector fund the research, it allows the private sector to realise higher
profits. -
“Spillover effects”, where new technologies find different applications
in the private sector. GPS, for instance, was first developed to help
missiles find their targets -
Credit constraints on the private sector, where a project is difficult to
fund without government support due to, say, an economic downturn.
Why does frontier/speculative funding have a crowding in effect
the potential outcomes from speculative research and development are inherently unknowable, which makes a new project impossible to justify commercially.
What is crowding out
a process where an increase in government spending
leads to a fall in private sector spending.
What is financial crowding out
If the government increases it’s spending – say through selling bonds – The demand for money will increase, which, ceteris paribus, raises interest rates.
At higher interest rates, both consumer spending and investment spending are likely to fall.
The aggregate effect on the economy is that financial resources are diverted from private firms to be used by the public sector.
How does financial crowding out lead to a fall in GDP
Initially, via a multiplier effect, national income increases, but as a result of the government selling securities in the financial markets, the demand for scarce loanable funds increases.
This drives up interest rates, which causes a contraction in the demand by the
private sector for investment goods (capital) as well as reducing the demand for
consumer goods. This, in turn, leads to a fall in GDP.
What is crowding out in relation to the labour market
a relative increase in the public sector may push up wages in order to attract workers from the private sector.
The increased demand for labour reduces unemployment and ‘tightens’ the labour market, leading to possible shortages of labour available for the private sector use as well causing upward pressure on wage levels across the economy.
What fundamental financial fact drives crowding out
that financial and real resources are ultimately scarce, and if one sector of the economy increases its use of these resources, fewer are available for use in other sectors.
What is the Ricardian Equivalence
This means that attempts to stimulate an economy by increasing debt-financed government spending will not be effective because investors and consumers understand that the debt will eventually have to be paid for in the form of future taxes.
The theory argues that people will save based on their expectation of
increased future taxes to be levied in order to pay off the debt, and that this will offset the increase in aggregate demand from the increased government spending.
What did Barro say to support the Ricardian Equivalence
an increase in government spending will lead individuals and organisations to expect interest rates to rise in the future, they will save more in order to pay higher interest rates.
What is the evaluation of crowding out
it may be a weak effect, this depends on the various elasticities that exist in the relevant markets.
if the supply of loanable funds is elastic and the demand for capital is inelastic, the impact of higher interest will be relatively small.
What evidence did Enrice Moretti from MIT find about federal spending to oppose the ‘crowding out’ theory
Government spending leads to an increase in private spending; a ‘crowding in’ effect
What are 3 reasons for the crowding in effect
- Frontier technology projects have extremely high fixed costs so by letting the public
sector fund the research, it allows the private sector to realise higher
profits. -
“Spillover effects”, where new technologies find different applications
in the private sector. GPS, for instance, was first developed to help
missiles find their targets -
Credit constraints on the private sector, where a project is difficult to
fund without government support due to, say, an economic downturn.
Why does frontier/speculative funding have a crowding in effect
the potential outcomes from speculative research and development are inherently unknowable, which makes a new project impossible to justify commercially.
How does government spending affect the level of taxation
● In most cases, where government spending is high, levels of tax must be high –> disincentive effect on work + investment
but.
● Oil-rich countries tend to be an exception, where revenue from oil can pay for most
of government spending.
What is the effect of government spending on equality
● Spending should increase equality as it leads to redistribution and helps to provide
a minimum standard of living for the poorest in society.
e.g. Northern Powerhouse, A Levels free after 18, pupil premium scheme
- But can help the rich disproportionately e.g. QE which can also harm poorest through higher asset prices
What arre the 2 main reasons for public expenditure
- Correct market failure (public goods, externalities, info failure)
- Prove more equity
What is the main justification for the government being as small as possible
Inefficiency of government (gov. failure)> market failure
Do tax and benefits always have disincentive effects?
No, depends on magnitude and context
e.g. Nordic Countries have high taxes + generous welfare benefits, activity rates are also very high while Nordic countries have similar rates of economic growth as the USA or the UK
What is a budget deficit
where the level of gov spending > tax revenue
What type of budget deficit is seen as undesireable
- Budget deficits to fund specifically current expenditure is seen as undesireable as future generations are paying for current spending
- However borrowing for ccapital expenditure or transfer payments (benefitting people directly today) is seen as fair because futurre generations will benefit from this investment - inter-generational equity
What influences the size and composition of public spending
- Incomes
- Demographics
- Expectations - esp in democracy
- Business Cycle
- Interest on debt
- Inflation- raise MNW, UE Benefits, Pensions
- Political Priorities -political churn, election
- State of Global Economy
What is the Gordon Brown’s Golden Rule of borrowing and spending
Borrowing should only be used to finance expenditure on infrastructure which will benefit the UK in the longer term, and is not to be used to finance current spending/debt, as taxes should cover current spending.
What are the implications of Gordon Brrown’s golden rule of borrowing and spending
· The government needs to gain better control of the budgets.
· In the longer term, the increase in economic activity gained by the infrastructure investment should pay off the extra borrowing.
· The chancellor Gordon Brown also has a sustainable investment rule. This states national debt should always be less than 40% of GDP.
What are the causes of a budget deficit
- Recession –> rising UE
- Decrease in consumer spending
- Increase in **inactivity **
- Use of **expansionary fiscal policy **
- Increase in interest rates
- Ageing population
What are the economic justificatiions of a budget deficit
- To increase AD when economy operating below PPF
- Automatic stabilisers cushion fall in AD
- Fiscal stimulus will improve budget deficit in LR from higher growth and higher tax revenue
What are the arguments in favour of Austerity
- Reducing debt –> helps to keep UK taxes lower + reducing opp. cost
- Shrinking state encourages private sector growth
- ** increases investor confidence** in stability – attracts FDI into the UK
What are arguments against Austerity
- Austerity is self-defeating –> lower tax revenue
- Infrastructure investment will increase AD and LRAS
- Wrong to cut spending when economy is in liquidity trap
e.g. UK and USA response to GFC
Draw a diagram for crowding out
Increased government borrowing may lead to higher demand for loanable funds and a rise in market interest rates e.g. on bonds. This might increase borrowing costs for private sector businesses.
What is fiscal multiplier
fiscal multiplier measures the effect of a £1 change in spending or a £1 change in tax revenue on the level of GDP
What did the IMF find about fiscal multipliers compared to revenue multiplier
IMF research report published in 2014, “the literature finds that (government) spending multipliers tend to be larger than revenue multipliers.”
- This would be supported by Keynesian theory, which argues that tax cuts are less effective than spending increases in stimulating the economy
- The IMF also found that fiscal multipliers are generally larger in downturns than in expansions – this supports the Keynesian view of using fiscal stimulus when conventional monetary policy is found to be ineffective
When is there a low and high fiscal multiplier
What is progressive tax
This occurs when **those on higher income levels pay a
higher % of their income in tax **
e.g. the UK has a top rate of 45% on
marginal income over £150,000.
What is a regressive tax
This occurs when an increase in income leads to a smaller % of their income going on the tax
e.g. excise duties and VAT take a bigger % of low income earners.
What is proportional taxation
takes same % of income, whatever income band.
What is direct taxation
taken from people’s earnings directly e.g. income tax
and NI.
What is indirect taxation
Paid by firms selling goods
e.g. VAT is included in final price consumers pay.
What is the impact of increasing rate of income tax
- Higher revenues - but laffer curve
- Tax Evasion - might go work in another country
- Work Incentives- may reduce incentive to work or income effect means want to work more
- Redistribution
- Lower AD - cetirus paribus
- Improve X-M- lower spending on imports
- FDI - ‘race to the bottom’ e.g. Apple Ireland 0.005%
Evaluate the impacts of higher income taxes
- Disincentives? economists suggest evidence is mixed.
o income effect encourages them to work more - depends how tax revenue is used. If income tax revenue is invested in
improved infrastructure it can the benefit long run productive capacity.
If income tax revenue is needed for welfare payments, there will be no
increase in productive capacity.
What is the impact of increasing indirect tax
-
Cost-push inflation
However, this price rise will be a one-off increase and, after 12
months, the price rise will no longer count toward inflation. - Fall in Output - depends on other factors affecting AD and AS, unlikely to cause a fall in GDP on its own
- Social Efficiency
- Changed easily and less likely to distort work incentives
What is tax competition
- Countries may seek to encourage foreign direct investment (FDI) through
offering lower tax rates.
e.g. Ireland 12.5% has attracted many big multinationals to invest, through
low tax rates.
- The problem with tax competition is that it can encourage countries to
keep trying to offer lower tax rates to attract big companies. This leads to
countries having to increase tax on consumers and workers.
which taxes affect AS and which affect AD
Direct Taxes affect AD directly due to lower consumption
Indirect taxes affect SRAS
What is VAT standard rate and the discounted rates
- The standard rate of VAT has been 20% since 2011
Reduced rate of 5% is applied to these items
○ Domestic fuel and power, women’s sanitary products, children’s car seats, contraceptives, certain residential conversions and renovations
Zero-rated VAT on these items:
○ Food, Construction of new dwellings, Domestic passenger transport, Books, newspapers and magazines, Children’s clothing, Water and sewerage services, Drugs and supplies on prescription, Supplies to charities, Cycle helmets
How could tax cuts stimulate economic recovery
-
Consumer spending
Cuts in VAT or income tax to boost demand for goods and services -
Business investment
Lower corporation tax to increase investment and tax incentives for R&D -
Lower employment taxes
Reduced national insurance so that businesses create more jobs -
Lower fuel / carbon taxes
Lower costs for businesses, less inflation and higher profits
Evaluate the view that tax cuts will stimulate economic recovery
- Low confidence – tax cuts likely to be saved rather than spent
- Businesses might choose to invest overseas instead
- Skills shortages might limit new job creation
- Possible conflicts with environmental policies e.g. 91p on pound for investment in oil extraction
- Lower Revenue multiplier
What is the Laffer Curve
tax rate cut could lead to an increase in tax revenue, or a decrease in tax revenue, depending whether you have already passed the ‘optimal tax rate’ (whatever % that may be)
Evaluate the Laffer Curve
- Many people are on fixed hours / zero hours contracts – so tax rates have little bearing on work incentives
- Tax rates not the only factor affecting work incentives – we must also consider the impact of the benefits system
- Where is the optimal point? Could work in either way
What is the case for windfall taxation on Energy Companies
- Levy estimated to raise £8 Billion to provide funding for the Energy Price Guarantee and Energy Bill Support Scheme
- BP earned record £7.1 billion in just 3 months during summer last year
- Shell CEO said that they are not planning to stop any future projects
What are the possible uses of the £8 billion revenues
£700 million investment in Sizewell C alone will be enough electricity to power 6 million houses for over 50 years
e.g. budget invested £20 billion in carbon capture
What ability do firms have for investing in oil and gas extraction
firms have the ability to claim a 91p tax saving for every pound invested in oil and dgas extraction that make expansion revenue neutral
* Shell went public to say it did not pay any windfall tax in 2022, partly because its North Sea investments can be set against profit
What did Total Energies do in response to the near 70% tax
- TotalEnergies announced that is it cutting planned investments in the North Sea by a quarter is a more explicit response
What is Public Sector Net Borrowing (PSNB)
This is the annual difference between net spending and net taxation. It is the amount the government needs to borrow in a particular year. It is referred to as the budget deficit.
What is Public Sector Net Debt (PSNB)
This is the total (cumulative) amount of debt that the government owes the private sector; this is approximately £1,487.7 billion (80.4% of GDP) as at April 2015.
What is a cyclical deficit
During a recession, it is likely we will see a rise in government borrowing, due to cyclical factors.
- With lower growth, tax revenues will be lower.
-
Government spending will increase. In a recession, the government will need
to spend more on unemployment benefits and income support benefits.
What is a structural deficit
If the government has a budget deficit, when the economy is growing at
its long run trend rate, this shows the underlying, structural deficit
What are automatic stabilisers
An automatic way to blunt off the worst extremes in the economic cycles and buy time for discretionary government policy
What are 2 examples of automatic stabilisers
- Welfare Benefits
In Recession Government spending automatically increases through transfer payments, this increases AD
- Progressive Income Tax
in a Boom, Higher incomes makes workers be pushed into another tax band so tax regulates AD
What is discretionary fiscal policy
- This is a deliberate effort by the government to influence aggregate
demand and the rate of economic growth.
What are factors influencing the size of fiscal deficits
1.State of economy .
2. Government spending decision/Fiscal Policy - if government wants to spend without increasing taxes
3. Political Priorities
4. Efficiency of tax collection
3. Demographics an ageing population needs higher spending
4. Rules on borrowing levels e.g. Eurozone obliged to keep structural borrowing less than 3% of GDP.
5. Interest Rates –> higher increase debt
What are factors influencing the size of national debt
1) Large budget deficits over 3% in previous years will increase national debt as a proportion of GDP
2) If the economy has a high growth rate, this will tend to reduce national debt as a % of GDP
3) Willingness to invest. A government may decide to borrow, to fund
investment decisions.
4) Unexpected events
5) Willingness of private sector to buy government debt. e.g. Japan debt over 255% of gdp
What are the economic effects of higher government borrowing
- Higher debt interest payments
- Increased AD
- In future may have to do austerity to fix debt
- May have to increase interest rate to attract investors to bonds
- Financial Crowding Out
- Loss of confidence –> struggle to attract borrowers
- Inflation e.g. Hermany in 1923
- Loss of intergenerational equity
- Reduced Credit RRating e.g. Greece drop to CCC
- May lead to foreign currency crisis e.g. Sri Lanka
Evaluate Government borrowing
- Recession; by borrowing, the government is compensating for the rapid rise in private sector saving. The government is helping make use of
unemployed resources. - Investment. If the government borrows to increase spending on infrastructure spending, such as better roads, this can increase productivity and enable a higher rate of economic growth and more tax revenues in the future.
-
Bailout key industries prevent them going bankrupt and
causing a possible loss of confidence in the banking system
What is the Public Sector Net Cash Requirement
Total amount of money that the government needs to borrow in order to fufill its spending plans, the difference between spending and revenue
Whatt is a structural surplus
A structural surplus occurs when at the peak of the boom, there is an actual fiscal
surplus whilst a structural balance occurs when at the peak of the boom, the actual
fiscal balance is 0.
Whatt is a structural surplus
A structural surplus occurs when at the peak of the boom, there is an actual fiscal
surplus whilst a structural balance occurs when at the peak of the boom, the actual
fiscal balance is 0.
What is the effect of a structural deficit on national debt
If the government has a structural deficit, it is likely that national debt will grow over
time as the government has to consistently borrow money to finance spending.
For this reason, it is argued that structural deficits need to be eliminated but this is
difficult since it is impossible to know what part of the deficit is structural and
what part of it is cyclical , just as it is impossible to know the size of the output gap.
How did the credit rating downgrade in 2013 affect the UK
But in 2013 UK had their credit rating downgraded as agencies were concerned about the impact of sluggish economic growth on the public finances, yet bond yields remained at record lows for a number of years
Concerns about unjustified debt during Truss caused what
e.g. yield on 10 year UK government bonds surged from over 3% to over 4% in a matter of days
What was the Lawson Boom Demand-Pull Inflation
Lawson Boom: Gov tax cuts in 1987 led to house prices rising by 25% per year in 1988-89 and a marginal propensity to consumer greater than 1
How is the UK experiencing a tight labour market
vacancies are greater than those unemployed
How is the Swiss Franc an example of hot money flows
In 2011, the Swiss Franc experienced a rapid rise as investors sought to buy Swiss Francs. Interest rates in Switzerland were not particularly high, but investors saw Switzerland as a safe haven from the Eurozone difficulties. Therefore, these hot money flows went from the Eurozone to Switzerland.
How have strikes been made less deadly + popular
- Decline in TU membership
- Legilsation
How has a decline in TU membership 1995-2019
25% from 1995-2019
What strike legilsation has been introduced since 1995
secret ballots, result must include all eligible employees, notice period needed, outlawing of compulsory membership, right for employees to sue
e.g. Stealth ban on ambualnce strikes by requiring higher minimum level of service
How has real earnings changed for public sectors workers changed since 2009
- Real Earnings for public sector workers has fallen since 2009 becaause of apy freezes continuously
How has real earnings changed for public sectors workers changed since 2009
- Real Earnings for public sector workers has fallen since 2009 becaause of apy freezes continuously
What is national debt
unpaid fiscal deficits i.e. accumulation of fiscal defeicits yet to be repaid
What are the effects of persistent structural deficits
- Loss of credit rating
- Crowding out
- Inflation (net injection into the economy)
- Lower confidence in the economy –> reduce FDI
- Needd for fiscal austerity
What are the reasons for low inflation until 2021
- Low worldwide inflationary expectations
- Improved tech reducing cost of manufactured goods
- Weak Commodity Price Growth
What were the reasons for surge in inflation during 2022
- Rising oil and gas prices
- Ukraine war disrupting gas/energy and food supplies.
* Lingering supply side issues from Covid lockdowns and impact on the
price of shipping. - Strong demand in US, with economy close to overheating.
- Central Banks leaving interest rates at a low level.
Why did lower interest rates may not boost growth in 2008
- Banks didn’t have money to lend.
- Confidence was very low, due to the banking crisis
- Time lags. Cutting interest rates can** take up to 18 months to have an
effect** e.g. people on fixed rate mortgages don’t notice straightaway. - Fiscal policy was tight, with governments pursuing austerity measures to
reduce budget deficits. - Cost push inflation from the 2008 oil price rise made some Central Banks
concerned about inflationary pressures.
What areas of regulation would governments like to regulate in TNCS
- Environmental laws. regulate the amount of CO2 produced by firms.
- Monopoly power prevent the abuse of monopoly power and promote competition.
-
Treatment of workers / monopsony power
transnational companies move labour intensive industries to countries
with the lowest wages and lowest degree of labour protection (“sweat
shop syndrome”). - Transfer pricing to avoid paying tax or to reduce competitiveness in certain industries e.g. selling petrol at high prices to discourage competition in petrol retail.
What are the difficulties in regulating TNCS
- Global Co-operation- difficult to get countries to agree on legilslation; differing carbon markets
- Different Standards- hard to implement universal standards of working practices
- Poor Information- difficult for governments to know how much regulation is needed or hot to regulate
- Individual Governments - small countrries may earn less than TNC’s e.g. Mozambique
- Intense Lobbying
What are common difficulties in macro-economic policy making
- Inabillity to control external shocks
- Unexpected events
- Inaccurate information/forecasting
- Risks and uncertainities
- Uncertainty how people will respond
How did fiscal deficit as a % of GDP compare in the UK and US in 2015
By 2015, the fiscal deficit as a percentage of GDP was
similar in the US and UK.
While US used expansiony fiscal policy + automatic stabilised
The UK used austerity
How can governments reduce poverty and inequality
- Progressive Tax + Inheritance Tax (reduce wealth)
but laffer curve/disincentives
2.Benefits and Transfer e.g. Social Security + NI make up 30% of UK G - Provide access to ensure equal opportunities; healthcare, education, pupil premium
- Attempt to reduce wage differential; NMW, TU
How does the concept of diminishing marginal utility link with redistribution
The law of diminishing marginal utility suggests that redistribution increases
total utility and therefore is a better allocation of resources
e.g. The high growth rates of Nordic countries, like Denmark, where
redistribution is high suggests that it is not negative for economic growth
Is there a simple relationship between supply of money and inflation
There is no simple relationship between the supply of money and inflation and it
can be argued that central banks don’t have complete control over the money supply
because they cannot control the ability of the financial system to create credit.
Why does increasing the money supply not always cause inflation
- The growth of real output is the same as the growth of the money supply
- Increase in bank reserve ratios (banks didnt want to lend)
- Hard to Measure Money Supply
- Changes in velocity of Circulation
- Liquidity Trap
How can the government increase international competitiveness
- Supply Side measures to improve productivity + flexiblity of labour
- Tight fiscal policy –> low inflation
- Encourage competition to force firms to be efficient
- Education to enhance human capital
- Deregulation e.g. UK ‘Red Tape Challenge’ to simplify regulation
- Devaluation
- Sign FTA
How could a government respond to a commodity price shock
- The government could use expansionary policy to reduce the impact of a fall in GDP or they could use deflationary policy to reduce the impact on inflation
- Invest in long term to reduce vulnerabaility
- Appreciate exchange rate
How could a governnment respond to a financial crisis
- Expansionay fiscal policy, crowd in banks
- Bailouts to restore confidence
- Resolution and protecting deposits
What are some examples of regulation to TNCs
- Illegal for TNCs to use bribery or corrupt practices anywhere in the world
- TNCs have to set up with a joint company + local partner
- Governments use import contracts with TNCs
How are TNC’s regulated for transfer pricing
● In the UK, companies which don’t allocate sufficient profits here are challenged by HMRC and this has led to billions of pounds earnt in taxes .
● The Transfer Pricing Guidelines were introduced by the OECD in 1995 , providing guidelines on cross-border services, intangibles, cost contribution arrangements and advance pricing guidelines; these were modified in 2010.
* They aim for the price to be the same as if the two parties were independent of each other; the ‘arm’s length’
principle .
What legal tax avoidance schemes does the EU suffer from
the ‘Dutch sandwich’ and the ‘double Irish’ , where costs, revenues and profits are routed through Ireland, the Netherlands or Luxemburg and then sent to a tax haven like the Bahamas or the Cayman Islands.
It is suggested that for every £1 gained in extra taxes by Luxemburg, other countries are collectively losing possibly £1000 in tax revenues.
What are external economic shocks
- World demand shocks. These are associated with a rise or a decline in spending and confidence abroad.
- World supply/price shocks. These affect the global supply and prices of goods and services.
- World financial shocks. These occur in the global financial system, such as increased stress in the international banking system or financial markets
Not all shocks are necessarily negative- can be positive ones
What are key external influences on the UK Economy
- Global commodity prices
- Inflation rates in trading partners
- Economic cycles of trading partners
- Impact of changes in international interest rates
- Fluctuations in global equity and bond markets
- Longer term shifts in competitiveness
What are examples of external shock
- Global Financial Crisis (GFC)
- Volatile Commodity Prices
- Currency volatility and policy changes e.g. devaluation
- Extreme weather events
Geo-political uncertainty & terrorism
What are shock absorbers of external shocks
*Floating exchange rates (scope for a depreciation)
* Freedom to set / adjust monetary policy when conditions change
* Geographically and occupationally mobile / flexible labour force
* Strong non price competitiveness of domestic businesses
* A diversified economy (not over reliant on a few sectors)
* Strong fiscal position (stabilisation funds)
What are the types of external shocks
- Supply Shocks
- Demand Cost
- Financial Shocks - credit to fund normal operations
- Policy Shocks
- Technology Shocks; affect productivity
How is Coca Cola guilty of transfer pricing
When a company is developing IP or creating IP over time—such as marketing—it needs to keep careful track of its transfer pricing, she said.
The IRS’s $3.4 billion victory against Coca-Cola Co. signals that the battle with multinationals over how to account for profits from intangible property, like brand trademarks, isn’t going away.
How is Apple ‘racing to the bottom’
Apple; few hundred people in Ireland were a real source of it’s profits and it deal with **Irelands govt leading it to pay a tax amounting to 0.005% of its profit **
How are countries responding to TNC’s race to the bottom
Global minimum tax rate of 15% signed by over 136 countries
What is the money illusion
the increase in GDP from printing money is a money illusion. – True you have more money, but if everything is more expensive, you are not any better off
How does printing money contribute to national debt
- Inflation would reduce the value of bonds
- People will no longer hold bonds and sell them –> lower price –> greater yields so more debt for gov.
- If government print too much money, investors will not trust the government and it will be hard for the government to borrow anything at all
e.g. Zimbabwe 98% daily inflation
What is a liquidity trap characterised by
1) Very low interest rates
2) Low inflation
3) Slow/**negative economic growth **
4) Preference for saving rather than spending and investment
5) Monetary policy becomes ineffective in boosting demand
What happened in liquidity trap of 2009-15
there was a large increase of 7% in M0 but it could not stop the decline in M4
e.g. at start of the credit crunch, there waas a sharp rise in the UK saving ratio from 4.2% in 2008 q1 to 7.4% 2010 q2
Inelastic demand for investment (MEC) so firms are not tempted by lower interest rates
What are policies to fix the liquidity trap
- Quantitive Easing - policy to create money and reduce yields on bonds
- Helicopter money - giving money directly to the people
Expansionary Fiscal Policy
What are the top 5 causes of the Great Depression
- Stock Market of 1929- loss of 40 billion in 2 months
- Bank Failures- 3,700 collapsed in 1930
- Reduction in Purchasing Across the Board - UE rose above 25%
- American Protectionism - Smoot-Hawley Tariff; world trade fell by 2/3
- Drought Conditions - the Dust Bowl drought
What was the cost of the major cum-ex tax evasion scheme
Major tax evasion scheme of cum-ex trades costed governments over over 150 billion euros from 2000-2020
What were HSBC and Santander charged for money laundering
- HSBC hit with £64 million fine for serious weaknesses in ant-money laundering control
- Santander fined 107.8m million over serious and persistent gaps in it’s anti money laundering control that opened the door to financial crime
WHat did Black Thursday, Monday anad Thursday cause
caused fall of Boden-Kredit Anstalt; Austria’s most important bank
How did the FED mismanage the Great Depression
- Thus the FED instigated the rapid expansion
- When the bubble burst the FED cut money supply by a third causing severe liquidity problem
How did Hoover keep prices high
- Thus Hoover resorted to the Smoot-Hawley Tariff Act 1930 that imposed huge duties on 880 foreign products causing international trade to decline by 66% by 1934
How did WW2 help take the US out of the Depression
- Opened up trade routes and reversed price/wage controls
- In first 12 months after private investment rose from 10.6 billion to $30.6 billion
What caused the Great Recession of 2008-13
- Housing Bubble; prices faster than inflation and incomes; countries like Ireland and Spain experienced booms
- Also a rise in oil prices that caused cost-push inflation, made Central Bank reluctant to cut interest rates
- Fall in housing price may many cut back on spending as they couldn’t rely on mortgaging to gain equity withdrawal
- Euro Crisis 2010-12 a rise in bonds yield partly due to recession let to a period of austerity
What was the Great Recession of 2008-13
- 2007/8 credit crunch –> negative growth and fiscal severity creating a double dip recession in EU
- UK did not catch up to lost output; 2012 real GDP lower than 2008
Why did the UK have the slowest recovery on record
- Balance Sheet recession: the UK saving rate rose from 0-7% as banks focused on paying back debt
- Shortage of Credit: Banks were short of cash so didn’t lend
- Eurozone Crisis + Austerity
- Productivity Crisis
What is the Eurozone Crisis
· Ireland, Portugal, Italy had overspent and required bailouts to prevent default
· Spain was impacted by its banks being overexposed to the real estate bubble; spain bailed them out but had to ask the EU for help
· Germany wanted to enforce austeirty but this made it harder to pay the debt
What is internal devaluation
Countries in the south ran uncompetitive large current account deficits had to restore this with internal devaluation as they had no central bank to avoid any liquidity shortages.
Internal devaluation involved lower wages, increased competitiveness and supply side reforms
Causing unemployment in Spain, Greece and Portugal above 20%
What is a Sovreign Debt Crisis
· When a country isnt able to pay its bills
· when country cannot get a low IR from lenders, lenders require higher and higher yields
· This causes rollover risk as costs get higher to refinance
* Investors’ fears become a self-fulfilling prophecy
What was the Greece Sovreign Debt Crisis
- Greece 12.7% GDP more than quadruple than 3%
- Greece had to accept loans from the EU with austerity
- Caused Greece to default and IMF demanded a bigger austerity creating a downward spiral
What was Greece’s situation by 2013
- GDP ratio was 160% by 2012 and bondholders accepted 25 cents on dollars
- UE rose to 27.9% in 2013
What was the US Debt Ceiling Crisis
· Dollar position and Central bank make it unlikely to default
* Political positions force potential defaults as parties can refuse to raise the debt ceiling
e.g. 2013 Republicans demanded Obamacare to be defunded to raise the debt ceiling, leading to US national debt:GDP going over more than 100%
What was the Iceland Debt Crisis
· Iceland took on $62 billion of bank debt when it nationalised the 3 largest banks despite them growing to 10x GDP
· Its currency plummeted by 50% the next week and inflation to soar
What is a Currency Crisis
- Countries runs out of a foreign currency to pay debt
- Asian Financial Crisis of 1997 where economic reliant on FDI struggled to meet debt repayments when they lacked it
What are the solutions to a Currency Crisis
- Floating Exchange Rates; avoid currency crisis by ensuring that the market is always setting the price as opposed to fixed exchange rates
- Avoid monetary policy that fights the market, accept inevitability of currency outflows and use investment policy to attract FDI
What is a Balance of Payments Crisis
· Unsustainable bop position means countries have a large difficult in borrowing to make up the difference
· Causes a a fall in FX reserves as the country can no longer attract sufficient capital flows to finance the deficit
· Can** devalue currency or slow down** imports through a recession
e.g. Sri Lanka
What is the effect of the Russia Ukraine war on bakeries in the Nigerian Capital of Abuja
At least 40% of bakeries in the Nigerian capital of Abuja shut down after the price of flour jumped about 200%.
What has been the effect of Russia-Ukraine war and Covid on China
Goldman Sachs predicts 2% it’s an anemic figure for China, down from a jaw-dropping 8.1 percent last year
What is the impact of the supply-side shocks on the global economy
World growth to slow to 2.2% in 2023
What is the impact of the supply-side shocks on the global economy
World growth to slow to 2.2% in 2023
What would UK wages be more if we had stayed on pre-productivity growth
6,300
What would UK wages be more if we had stayed on pre-productivity growth
6,300
How is short-terminism affecting UK productivity
- The UK companies are relatively quick to become public limited companies (PLC), where anonymous shareholders often put pressue on managers to deliver quick returns in the forms of dividends
- In Germany while there are plenty of PLCs, there are far more medium to small sized family run Companies known as Mittelstand
- German state has actively supported the Mittelstand through promoting sources of finance, KfW Development Bank; the organisation has now loaned more than £1.3 trillion to various buisnesses
How is Government Industrial Strategy
- State Aid is less than 0.5% of GDP + to encourage companies to ‘stand on their own feed’
- State aid and spending in France is double what it is in the UK on a per capita basis and 3 times greater in Germany
- ‘Full Expensing’ + ‘Super Deduction’
How is shortcomings in management affecting UK productivity
- UK companies invest less time in training up their middle-managers, leading to the ‘accidental manager’ phenomenon, and do not employ as many specialist managers to oversee specific areas of the business
- Family owned and run businesses are not exposed to significant international competition so are poorly productivity and is called the ‘long tail’ of business with low productivity and mediocre managers
- Management alone accounts for a quarter of the difference between the UK’s productivity and that of her competitors
- Access to cheap finance has kept many of these unproductive ‘zombie companies’ afloat
How are shorfalls in skills affecting UK productivity
- Not as nearly as much vocational training
- UK spends less on worker training than many other adcanced economies
e.g. Capital Spending is estiamted to make up productivity gap with Germany
How do regional disparities affect the UK economy
London is 34% higher than the UK average whilst Northern Ireland is around 17% lower
What was the Aftermath of 2008 for uk productivity
- Most dynamic sectors have seen the biggest fall in productivity performance
- 4 dynamic sectors: manufacturing, finance + banking, ICT and professional services
- ‘Labour Hoarding’ to protect highly skilled nature of jobs
How does productivity differ with sector
Across sector productivity differs with sector; UK best at finance and utilities/extraction/info + comms - UK higher productivity even more than Germany
How has the public sector decreased productivity
Public sector accounts 44% of GDP and employs around a quarter of the workforce but productivity dropped by 1.3% and output per worker is now lower than its pre-pandemic level
How low is Capital Investment now compared to
6.2% lower than before the EU referendum
Lowest in G7 and 3rd lowest in OECD
Brexit Investment is 11% lower than it might have been and productivity is 4% lower than it should have been
Why has capital investment fallen so much
- Economic Shocks + Uncertainty - Imperial say GFC damage to FS and Insurance caused 1/3 of productivity drop
- Flexible Labour Market- UK has the 4th most flexible labour market but encourages capital shallowing
- Access to Finance
- Coporation Tax e.g. Aztra Zenecachose to locate their new site Dublin where coporatiion tax is 12.5%
How has a lack of investment in human capital suffered productivity
- Nearly 12 million people lack digital skills to cope with everday life, 30% of the workforce may have to change occupation
- UK PISA score lower in reading and maths than most countries with higher productivity
- Little opportunity for life-long learning - real spending on education same as early 2000s
How does political and economic climates
- Economic problems need long term solutions while political cycles are relatively short
- Political decisions in the long term are influenced by concerns over government borrowing and keeping the tax burden low
Policy Churn - constant changes in economic policy - have made it difficult to implement the structural changes needed to drive productivity in the long term
How has the Supplier Credit Financing Facility led to export-led growth
Rautomead used our Supplier Credit Financing Facility, which allows UK companies to get paid on dispatch for their exports whilst letting buyers benefit from deferred payment terms.
£1 million worth of financing for Dundee-based firm to supply machinery to specialist Chinese metals manufacturing company in Xian
Why has the UK inactivity rate not decreased back to pre-pandemic levels
- OBR says long term sickness; fall in health spending as % of GDP frrom 2010-20
Sickness benefits mean you have to requalify if you leave workforce again (disincentive to join workforce) - Institute for Fiscal Studies, used time series data and they found that retirement was the main reason
Why has the UK inactivity rate not decreased back to pre-pandemic levels
- OBR says long term sickness; fall in health spending as % of GDP frrom 2010-20
Sickness benefits mean you have to requalify if you leave workforce again (disincentive to join workforce) - Institute for Fiscal Studies, used time series data and they found that retirement was the main reason
What is the impact of economic inactivity
- Reduces long term GDP growth
- Inactivity –> loss of self esteem + skill
- Makes labour supply for skilled jobs more inelastic as a higher wage requirement
- Firms are reluctant to give these which creates higher vacancies
- Worsens government finances (G-T)
What policies can reduce economic inactivity
- Older workers face discrimination when applying to jobs; employers are less likely to take them on and retrain them
- Occupation health services provide services that focus on the health of staff in the workplace
- Boosting access to this may help tackle the problem
- Fix the sick payments scheme
- More generous immigration policy to fill in skills gap
What is the repalcement ratio in the UK
0.22
when >1 it creates an UE trap
How signifiicant is the Gig economy to the UK economy
- Contributing to record low UE figures
- 4.4% of the population has worked in the gig economy, dwaring industries like finance or the nHS
**Gig economy worth over £25 billion **
Relation with Gig Economy and workers rights
Workers’ rights are often lacking as they are classified as self-employed so no access to pensions, minimum wages, holidays, sick pays, statutory pay, NI contribution
2018 Uber lost case and had to classify as worker
How has the enforcement of workers rights been weakened
- HMRC has suffered budget cuts and tax collection is less effective
Employment tribunals to enforce employment rights has been restricted since 2013 to be replaced with charged for claimants
How accurate is economic forecasting
OBR made 5 sets of predictions for government borrowing, inflation and GDP growth in 2021-22, each a revision of another
In January 2023, the OBR downgraded growth prospects while the Bank of England upgraded their outlook
David MIles: ‘should be satnav’
How essential are OBR forecasts to the confidence of the market in the UK’s public finances
Truss failed to pass plans to OBR and this made markets uncertain (3–>4% yield)
Hunt made many references, over 52 in his autumn statement
How has Youngstown a victim of deindustrilisation
· Youngstown used to be a hub of American manufacturing with steel mills and General Motors employing over 13,000
· With each passing year, its population shrinks
· About 38% of the population lives below the poverty line, ; making it the second poorest city in America
The crime rate is double the national average
How has isolationist policies helped revive the city
· In 2019 GM teamed up with LG to create Ultium Cells, an electric battery manufacture, employiong over a 1000
* Foxconn has agreed to buy the original GM plant and reconfigure it as a production facility for electric vehicles
Training is being undertaken by Youngstown State University who made a test to identify who could operate its sophisticated machinery
