Theme 4: A global perspective Flashcards
What is globalisation (4.1) (3)
-Globalisation is an increase in worldwide economic interdependence
-Globalisation is a variety of ways in which countries are becoming more and more closely integrated, in an economic, cultural and political sense
-Although the pace of globalisation has risen rapidly over the past 50 years, it is not a recent phenomenom, dating back to colonialism
What characterises globalisation (4.1) (5)
-Increase in trade as a % of world GDP
-More movement of money and people between countries
-Increased international specialisation
-Growing importance of TNC’s
-More FDI
What are some factors contributing to globalisation (4.1) (6,1)
-Huge real fall in transport costs makes it cheaper to import/export
-A decline in communication costs with the internet
-A lowering of trade boundaries, due to the World Trade Organisation
-The collapse of communism and opening up of China to trade
-TNC’s taking advantage of lower costs and boundaries
-Growth in the number/size of trading blocs/regional agreements
-Lowering of trade boundaries most significant, since they allow 4,5,6 to occur, and make 1,2 easier
What are the impacts of globalisation on countries/governments (4.1) (5,3)
-Free trade enables comparative advantages to prosper
-Countries specialising leads to higher world output, incomes, living standards
-2008 financial crisis led to deglobalisation, as countries enacted protectionism to protect their domestic economies
-Globalisation leads to higher inequality in developed countries, low wage jobs outsourced to developing countries
-Migration into developed countries pulls down the wage rate, further increasing income inequality
-Globalisation leads to higher exports, leading to economic growth
-Higher growth leads to higher incomes, leading to higher consumption, government revenue etc
-However, TNC’s might shift their earnings to other countries (transfer pricing)
What are the impacts of globalisation on producers, consumers, workers and the environment (1,1,3,2)
-Producers have lower costs of production due to offshoring and economies of scale
-Consumers have higher choice and lower prices, increasing consumer surplus
-Globalisation in developed countries drives down the wages of the unskilled
-Developing countries’ less demanding health and safety laws/regulations lead to lower costs of production
-The exploitation of workers in developing countries by TNC’s, but they get higher paying jobs
-Specialisation will lead to the over abstraction of specific resources
-External costs such as pollution (increased transport) lead to global warming, and its impacts
What are the pros & cons of globalisation (4.1) (5,5)
+Gains through free trade through comparative advantages
+Increased competition leads to increased efficiency, quality and lower prices
+Increased FDI and access to global capital markets will increase investment
+Increased output leads to increased incomes, increased employment leads to lower poverty
+Increased pace of technological diffusion
-Transmission of shocks (crashes, recessions)
-Increased inequality between countries and workers’ wages
-External costs of production and trade
-Unemployment, as jobs are outsourced
-Migration will lead to decreased populations in poorer countries, as there is a brain drain
How can we use graphs to model international trade (4.1) (2)
(Assuming the world price is fully elastic)
-If the UK’s equilibrium is below world price, the difference between QS at world price and QD at world price will be exported
-If the UK’s equilibrium is above world price, the difference between QD at world price and QS at world price will be imported
What are absolute and comparative advantages (4.1) (3)
-An absolute advantage is when a country can produce more of a good/service than another country
-A comparative advantage is when a country can produce a good/service at a lower opportunity cost than another country
-The law of comparative advantages states that even if a country has absolute advantages in the production of all goods/services, it can still benefit through specialisation and trade in the products in which it has a comparative advantage
What is a numerical example of the theory of comparative advantage (4.1) (4)
-Country A can produce 20,000 mangos and 10,000 TV’s, Country B can produce 8,000 mangos and 8,000 TV’s
-Country A has an opportunity cost of 0.5 TV’s when producing mangos, and an OC of 2 when producing TV’s, and Country B has an OC of 1 either way
-If the countries specialise in their respective comparative advantages, Country A produces 30,000 mangos and 5,000 TV’s, and Country B produces 16,000 TV’s
-Through trade, Country A now has 21,000 mangos (>20,000), 11,000 TV’s (>10,000), and Country B has 9,000 mangos (>8,000) and 10,000 TV’s (>8,000)
How can you illustrate comparative advantages using PPF’s (4.1) (2)
-The country with the steeper gradient should specialise in the good on the y axis
-The country with the less steep gradient should specialise in the good on the x axis
What assumptions are made in the theory of comparative advantage, and what is wrong with these assumptions (4.1) (5,3)
It is assumed there are:
-Perfect mobility of resources between different countries
-Perfect knowledge
-Constant costs, no EOS
-No trade boundaries
-No transport costs
However, there are:
-Not constant costs, as specialisation over time leads to lower costs and economies of scale
-Transport costs, as trading across the world requires people to be paid to move the goods
-Trade barriers, as trade barriers such as tariffs distort comparative advantages
What are the pros & cons of specialisation and trade (4.1) (5,5)
+Specialisation and free trade based on comparative advantages leads to efficient resource allocation
+Higher world output and living standards
+Lower price/Higher choice for consumers
+Higher incentives for firms to become more efficient
+More markets for firms, leading to growth and EOS
-Specialisation forces countries to be reliant on one another
-Law of comparative advantage based on unrealistic assumptions
-Risk of dependence on imports
-What you specialise could be uncompetitive in the future
-Negative externalities
How have patterns of trade changed from 1995-2013 (4.1) (4)
-The US’ share has fallen from 12.5% to 8%
-The EU’s share has fallen from 44% to 37%
-Chinas share has risen from 4% to 18%
-East Asia and China’s share has risen from 20% to 34%
(Everything in terms of regional share in global manufacturing exports from 1995-2013)
What are some reasons for the changing patterns in trade (4.1) (2,3,2,2)
-Comparative advantages changing over time
-Deindustrialisation within the UK leads to a less competitive UK manufacturing sector, and boosts other competitors, such as China
-Growth of emerging economies, such as China
-China/other emerging economies take up more of a countries exports/imports than previously
-International trade is more important for developing countries (developing countries = 20% of output, USA = 8% of output)
-Growth in the number/size of regional trade agreements
-Increases trade between member countries (EU, BRICS)
-Changes in relative exchange rates
-China manipulates its currency to increase trade (weakens it to boost export competitiveness)
What are some factors influencing a countries terms of trade (4.1) (5)
-Relative inflation: higher UK inflation = higher export prices = higher TOT
-Raw material prices: higher raw material prices = higher import prices = lower TOT
-Relative exchange rates: higher exchange rate = higher export prices, lower import prices = higher TOT
-Tariffs: higher tariffs = higher import prices = lower TOT
-Productivity: higher productivity = lower export prices = lower TOT
What are terms of trade, and the impact of changes in a countries terms of trade (4.1) (2,2,3,1)
-Terms of trade are the rate at which exports exchange for imports
-ToT = (indexed export prices / indexed import prices) x 100 (The ratio of export prices to import prices)
-An improvement (ToT>100) means more imports can be purchased for X amount of exports
-A worsening (ToT<100) means less imports can be purchased for X amount of exports
A higher ToT=
-More imports per exports = higher living standards
-Higher export prices = decreased export competitiveness = worsening current account/output
-Decreased imported inflation or higher domestic inflation
-The “resource curse” = resource rich developing countries exchange rates are high, due to high demand for their resources, so the ToT rise, leading to higher export prices and a worser current account
How do tariffs work (4.1) (1,4)
-Tariff is a tax imposed on imports, intending to make foreign goods more expensive, and thus less price competitive, than domestic goods
-Before the tariff, domestic supply was at S1, demand at D1, and D1-S1 was imported (Pw<Pe, comparative advantages abroad)
-After the tariff( price rises from Pw to Pw+t, leading to demand falling from D1 -> D2, supply rising from S1->S2, and imports fall from (D1-S1) to (D2-S2)
-The positive impacts of the tariff are the increased producer surplus (left of S curve from Pw -> Pw+t), and the tariff revenue ((D2-S2)x(Pw+t - Pw))
-The negative impacts of the tariff are the lost consumer surplus (left of D curve from Pw -> Pw+t) and the deadweight loss (areas of lost consumer surplus which aren’t gained through tariff revenue and producer surplus), the resource cost to society as a result of domestic suppliers producing more expensively
How may tariffs be evaluated (4.1) (8)
-How large is the tariff
-In some trading blocs, tariffs are common, not unilateral
-How much of a comparative advantage does the world have (how much greater is Pw than Pe)
-Inelastic curves = lower impact on imports, increased government revenue, decreased DWL
-The greater the increase in the import price = lower the real living standards
-Tit for tat responses
-Many exports require imported raw materials
-How does the government use the tariff revenue
How do quotas work (4.1) (2,3)
-A quota is a limit on the volume of imports allowed into a country per year
-Intention is to restrict the flow of imports without directly changing price (indirectly, via constraining supply)
-Before the quota, domestic supply was at S1, domestic demand was at D1, world price was at Pw (Pw<Pe), and (D1-S1) was imported
-The quota led to Domestic supply shifting outwards, leading to price increasing from Pw to Pw+q, reducing demand, increasing supply, and thus reducing imports
-The impacts are an increased domestic producer surplus (area left of Sdom), increased foreign producer surplus (D1-S1 x Pw+q - Pw), deadweight loss of the triangle gaps between S1 and S2 and D1 and D2, with the whole lot being lost consumer surplus
How to evaluate quotas (4.1) (6)
-A more inelastic supply and demand leads to a higher price rise, thus causing greater producer surplus and DWL
-Are the quotas common or unilateral
-Depends on the size of the quota
-How much of a comparative advantage does the world have
-Higher import prices lead to lower real living standards
-Tit for tat responses
What are export subsidies (4.1) (4)
-Export subsidies are a grant of money given by the government, to an industry, in order to lower prices and increase output for exports
-The intention is to make domestic goods cheaper in foreign markets, hence more price competitive (Pw<Pq)
-After the subsidy, the domestic S curve shifts vertically downwards by the subsidy
-Domestic supply increases from S1 to S2, squeezing imports from D1-S1 to D1-S2
What are non-tariff barriers (4.1) (3)
-Usually, these are rules and regulations that control the standard of products to be sold in a country
-These include technical or health and safety standards
-These are often a grey area, either being entirely sensible and applying equally to domestic and foreign firms, or a disguised restriction on international trade
What is the impact on an economy of a rise in protectionism (4.1) (6)
-Lower output and living standards, since protectionism distorts comparative advantage, so production will occur at higher opportunity cost, reducing output
-Rise in price, due to the protectionist measures, will lead to a fall in consumer surplus, rise in producer surplus and DWL
-Tariffs will raise the prices of imported goods bought by producers, increasing their costs of production and creating cost push inflation
-Rise in import price causes import substitution, shifting AD to the right and causing unemployment to fall
-Tariffs cause less imports, and thus an improvement in the balance of payments
-Tariffs being indirect taxes makes them regressive, leading to increased income inequality
How can you evaluate the impacts on an economy of protectionism (4.1) (6)
-Lower output: How far reaching are the measures, are they to one/two industries or an entire countries output
-Higher price impacts: Depends on PED, PES and size of tariff
-Inflation: Depends what imported goods are subject to tariffs, are they materials or finished goods
-Lower unemployment: Depends on the elasticity of the AS curve, and existing unemployment
-Greater balance of payments: If other countries impose retalitory measures, this may cause lower exports, offsetting the impacts of lower imports
-Greater inequality: Can be mitigated if the government redistributes its tariff revenues to poorer households
What are some justifications of protectionism (4.1) (5)
-Infant industies: Tariff protection is required until the domestic industry learns the ropes, and grows large enough to become internationally competitive
-Job protection: Any rise in imports and fall in domestic production will result in less domestic demand for labour
-Prevent dumping: Tariffs levied on imports to offset international subsidies, which aim to drive competitors out via predatory pricing
-Strategic industry: Governments may not want to be dependant on foreign suppliers for vital goods, such as food and defence
-Geriatric industry: Protecting old industries on the verge of bankruptcy (similar to infant)
How can you evaluate the protectionist justifications (4.1) (2,2,1,1,1)
Infant industry
-Firms may grow accustom to the protectionist measuresd, thus insulating them
-May be better to boost their productivity, through supply side policies
Job protection
-Jobs saved at the expense of consumers, who lose welfare, spend less and reduce AD
-Countries retaliating may offset the jobs saved
Prevent dumping
-Is the dumping due to government subsidies, distorting comparative advantages, or simply foreign firms’ clear surpluses
Strategic industry
-Each country considers different industries to be ‘strategic’
Geriatric industry
-Same as infant industries
What are some examples of protectionism (4.1) (3,3,4)
-The EU had banned US beef imports on health and safety reasons, due to the hormones used
-However. there was no scientific basis found for these claims, and US beef was found safe for consumption
-In 1997, the WTO ruled against the EU, viewing their non-tariff barriers as disguised protectionism
-The US claimed airbus recieved $40billion in subsidies since 1967, the EU claiming Boeing claimed $18billion in subsidies since 1992
-This dispute broke out since Airbus caught up with Boeing and both geared up for their supersized jet release
-The WTO ruled Boeing recieved $5.3billion in unfair aid, and Airbus had recieved illegal aid
-In 2002, Bush imposed 30% tariffs on imported steel
-The idea was to rebuild the US industry and make it more competitive with imports
-Under WTO rules, the EU were planning $2.2 billion worth of extra tariff duties
-However, the US tariffs were dropped in 2003, partially to avoid a trade war a year before the US 2004 elections
What is the WTO, its main roles and principles (4.1) ((1),(2,2)(2,2,2))
-The World trade organisation is an international organisation dedicated to encourage global trade
Roles:
-They negotiate trade agreements (law making)
-The WTO aims to remove trade barriers through agreements, to promote free trade and comparative advantages
-They have a role in dispute settlement (law enforcement)
-They resolve trade disputes and enforce trade agreements
Principles:
-Non-discrimination
-Tariff reductions must apply to all, as imports must be treated as domestic goods
-Reciprocity
-If one country offers tariff reductions, the other should follow suit
-Safety values
-Protectionism is allowed when justified (offset illegal subsidies or to protect infant industries)
What are WTO enforcement mechanisms, and problems with these (4.1) ((2,2),3)
Mechanisms
-Retaliation: when a country hit with illegal protectionism is allowed to impose its own measures, to an equivalent value, against the offender
-This will threaten exports in the offender, pressuring them to drop protectionism
-Cross-retaliation: where a small country, hit by illegal protectionism by a large country, is allowed to suspend its obligations under more than one of its WTO agreements
-This will inflict economic damage on the larger country, despite their advantage
Problems
-Fighting protectionism with more protectionism
-May spark a trade war, a vicious cycle of tariffs and retaliation
-Comparative advantage is no longer the basis for trade, leading to inefficient resource allocations, and a fall in total world output/living standards
What are some case studies of WTO actions (4.1) (3,2,1,1)
-Airbus is a european airline company which recieves significant subsidies
-In 2019, the US announced that it had recieved WTO permission to take retalitory measures (tariffs) against EU airlines, wisky, wine and cheese
-However, the EU also has a case against Boeing regarding US tax concessions
-In 2013, Japan asked the WTO to investigate the South Korean ban on fish caught in the waters around the Fukushima nuclear plant
-In 1018, the WTO ruled the ban was unfair as fish hadn’t been affected by the nuclear waste, however in 2019 many of the key points were overturned
-In 2014, the US and Indonesia sorted out their clove cigarrete dispute outside of the WTO (the US had banned flavoured cigarretes, including clove ones made in indonesia), with the USA removing the ban and indonesia removing its complaint
-The 1947 General Agreement on Tariffs and Trade prevented any further tariffs on goods being placed
What are the different types of trading bloc (4.1) (2,2,2,2)
Free trade Area
-The removal of tariffs and quotas between member states, but members are allowed to retain their commercial policy towards non-members
-ASEAN, NAFTA (now USMCA)
Customs Union
-Removal of tariffs and quotas between member states, and members agree to a common external tariff on non-members
-EU, MERCOSUR (south american)
Commons Market
-Customs union but with the free flow of factors of production (labour)
-The EU became a single european market in 1993
Monetary Union
-Customs union with a common currency
-Eurozone area of EU
What are the effects of a trading bloc (4.1) (2,2,2,)
-Trade creation: Where the dismantling of trade barriers causes a country to switch from purchasing goods from a high cost producer (domestic) to a low cost producer in the bloc, likely to have a comparative advantage
-Trade diversion: Where the common external tariff causes a country to shift from a low-cost producer outside the bloc to a higher cost producer in the bloc
Firms:
-Higher economies of scale, as firms have access to larger markets, and lower costs through imports
-For example, the EU has 450 million people, and a total GDP of $17 trillion
Consumers:
-Increased choice from greater markets
-Greater competition = higher quality, lower price
How can trade creation be illustrated (4.1) (3d)
-price/world supply falls from p+t to P
-Qs falls from Qs to QS1, QD rises from Qd to Qd1, imports rise from QD-QS to QD1-QS1
-There is loss of consumer surplus from the area left of the supply curve, loss of tariff revenue from the rectangle between old price Q and D and new price, the whole area is increased consumer surplus with the remaining triangles being net welfare gain
How can trade diversion be illustrated (4.1) (3d + 2)
-price/world supply has fallen from S+T to SEU
-Qs falls from Qs to QS1, QD rises from Qd to Qd1, imports rise from QD-QS to QD1-QS1
-There is loss of consumer surplus from the area left of the supply curve, loss of tariff revenue from the rectangle between old price Q and D and the price without surplus, the whole area is increased consumer surplus with the remaining triangles being net welfare gain
-There is a net gain from trade diversion if +welfare > -TR (typically large distance from S+T to SEU, and smaller fromS)
-There is a net loss from trade diverion if +welfare < -TR (typically smalldistance from S+T to SEU, and larger fromS)
What are the pros and cons of regional trade agreements (4.1) (2,3,1)
+Trade creation: members can specialise in line with comparative advantages
+Increased FDI: TNC’s will invest within the bloc to avoid trade barriers
-Trade diversion: shifting from a low cost producer to a high one inside the bloc will distort comparative advantages
-Distorting comparative advantages: Unitary protectionist measures on others distorts CA’s, and creates loer growth
-Loss of an independent monetary policy (if in a monetary union)
-The WTO will allow trading blocs to form if trade creation > trade diversion, if there is net trade creation
Why can there be conflicts between the WTO and trading blocs (4.1) (2,4)
-Trading blocs are often highly protectionist to countries outside their bloc, hence distorting comparative advantage
-For example, the WTO ruled against the EU banning US beef in 1997, the EU justifying this as the hormones put in the cows
Trading blocs are highly protectionist outside their bloc to:
-Promote regional security and resolve political concerns
-To promote economic and technical cooperation among developing countries
-To promote south-to-south trade (Africa, Asia, Latin America)
-This is highly relevant in light of the Doha round, WTO trade negotiations started in 2001, which failed in 2008 as the EU and US refused to reduce agricultural subsidies
What is the EU’s economic and monetary union (4.1) (1,3,3)
-The aim of the Economic and Monetary Union is to remove the final barrier to free trade, the existance of multiple currencies, transaction costs and exchange rates
-In 1997, the Euro was introduced in electronic form in 11 countries
-In 2002, the Euro was introduced in physical form
-330 million EU citizens now use the EU, as do many neighbouring countries
-The Eurozone has a single monetary policy, set by the European Central Bank with an inflation target of 2%
-Fiscal policy stays in the hands of individual member states, but they must follow the rules of the Stability and Growth pact (Budget deficit < 3% of GDP, National debt < 60%)
-However, several countries have broken the SGP targets without consequences, and thus in 2005 the enforcement procedures have been reduced to ‘deficit reduction targets’
What is Optimal currency area theory (4.1) (1,(2,2,2),1)
-Mundell’s OCA theory lists 3 characteristics needed for a successful single currency
Wage flexibility:
-A sudden recession in a country will need wages to fall to reduce firms’ costs of production, to help the country recover without interest rates
-In europe we have great wage rigidity, with strong unions, unlike in the US
Labour mobility:
-Unemployed workers should easily migrate from recession hit areas to growth hotspots, to ensure the supply of labour = demand
-Strong cultural/language barriers in Europe limit the flexibility
Fiscal transfer system:
-Individual states should allow a federal authority to tax all member states and redistribute incomes from the hotter area to colder ones
-This allows the US’ federal bank to focus interest rates on booms, with fiscal transfers helping the poor
-If a region in a currency union is hit with a shock, then the three above factors need to adjust
What are the pros and cons of the single european currency (4.1) (3,4)
+Elimination of transaction costs (However, this only accounts for a small amount of GDP)
+Reduced exchange rate uncertainty, encouraging exports and reducing uncertainty in how much money firms recieve when a payment is done (However, uncertainty still exists outside the EU)
+Price transparency makes it easier to see price differences (However, price differences persist as factors of production differ)
-Rounding up inflation to maximise profit (However, consumers will learn eventually)
-Menu costs (However, a minimal one time cost)
-Loss of sovereignty of a single interest rate to benefit a country, not a union
-Loss of sovereignty through the SGP pact (However, been broken and changed)F
What is the balance of payments, and components of the balance of payments (4.1) (1,3)
-The balance of payments is the record of transfers between one country and the rest of the world
-The current account primarily records the trade in goods, trade in services, investment income (dividends, interest, profit) and current transfers (aid, remitances)
-The capital account primarily records international flows of capital, such movements in assets associated with migration, inter-country loans or government investment overseas
-The financial account primarily records net foreign direct investment, as well as portfolio investments, whether long run (government owned bonds, gold) or short run (speculative hot money)
What are the consequences of investment flows between countries on the financial account (4.1) (1,2,2)
-The impact of investment flows between countries depend on the type of investment flows, and whether it is in the short run or long run
-FDI is classed as long term direct capital flow, and involves the enhancement of a countries capital stock
-Even though profits will return to another country, the increased output will create economic growth and employment, boosting the UK’s productive potential
-Portfolio capital flows make it easier for individuals to purchase overseas shares, or UK firms to access global financial markets
-However, a large number of Portfolio capital flows are short term speculative hot money flows, destabilising the international monetary system
What are the causes of a deficit on the current account (4.1) (4)
The UK’s current account deficit could be caused by:
-High economic growth/foreign recessions will increase the value of imports, and reduce the value of exports
-Weak UK price/product competitiveness will reduce the value of exports
-A strong exchange rate will lead to cheaper imports and more expensive exports
-Weak productivity will demand imports to close the gap between domestic production and domestic consumption
What are the impacts of a current account deficit (4.1) (3,2)
-Higher unemployment, if the deficit is caused by a loss of UK export competitiveness
-Cost push inflation, due to higher priced imported raw materials
-Sterling depreciation leads to more imported inflation (However, makes exports more competitive, reducing the deficit)
+UK consumers experience a high standard of living
+If the deficit is being used to sustain growth (imported raw materials), the growth to repay the debt may grow faster than the debt
How can we evaluate the significance of a current account deficit (4.1) (2,2,2)
Size of the deficit-
-Small deficit are unavoidable, given the complexities of international trade
-Large deficits (% of GDP) indicates an economic fundamental weakness, low domestic productivity or overreliance on imports
Duration of deficit-
-If the deficit is short, there is relatively little concern
-A persistant deficit creates a financial issue for the government, leading to corrective measures, which create other macroeconomic problems
Cause of deficit-
-Strong growth = high imports = relatively little concern
-If its caused by a lack of competitiveness, poor productivity, high inflation, then its an issue
What is the significance of global imbalances (4.1) (3,4,4)
Global imbalances may lead to-
-Protectionism by those in deficit
-Reliance on export-led growth by those in surplus
-Investmet into other nations, leading to inflationary pressures
-However, there are mechanisms to reduce global imbalabces
-WTO has rules in place to stop protectionism
-Trade imbalances are often offset by other elements of the BOP
-Currency depreciation = higher export competitiveness (However, hot money isn’t equal to trade, and is 90%)
When countries take corrective action, significance depends on-
-Who?
-What corrective measure (appreciation = greater exports for others)
-How widescale (whole economy or struggling industry)
-What is the reason (fundamental weakness, protectionist retaliation)
How might demand management help reduce a current account deficit (4.1) (3,2)
-This is an expenditure-reducing policy, especially when the deficit is cyclical and due to high spending
-AD will be lowered with contractionary fiscal/monetary policy, reducing domestic spending and hence lower imports
-Lower AD also leads to a lower price level, boosting export price competitiveness
However-
-Significant tradeoffs of lower economic growth and living standards exist
-This can be highly effective, as the UK has a high income elasticity for imports (1.6-2)
What are the types of current account deficit (4.1) (3,1,3)
Exceptional:
-Due to one-off incidents
-Current oil position, due to Russia Ukraine
-Not that major and unpreventable
Cyclical:
-Due to temporary boom in UK (higher imports) or temporary recession abroad (lower exports)
Structural:
-Due to underlying problem in the UK economy, which causes a persistant and substantial deficit
-Requires a persistant capital/financial account surplus
-Can lead to government intervention
How may supply-side policies help reduce a current account deficit (4.1) (3,2)
-Improves the quality of UK goods and services and increases productive capacity
-Involves boosting flexibility/quality in product and labour markets
-Import substitution (higher exports, lower imports) occurs, due to higher price competitiveness, higher non-price competitiveness and a higher productive capacity
However:
-Very long time lags
-The future government may not share same view/commmitment (HS2 vs China + 17yr 3 gorges dam)
How might exchange rate adjustment reduce the current account deficit (4.1) (5,2)
-This is an expenditure-switching policy
-Devaluing/depreciating the exchange rate will occur
-Cheaper exports = higher price competitiveness = more exports
-Dearer imports = less competitive = lower imports
-Illustrated with Sof£ shifting outwards
However:
-Can have policy conflicts (lower AD, higher imported inflation)
-Not very viable in the UK, with a floating ER system and an independent central bank
What are exchange rates, the effect of ER on international trade, and the main reason for trading currencies (4.1) (2,3)
-Exchange rates are the price of one currency in terms of another
-Strong Pound Imports Cheaper Exports Dearer
There are three main reasons for trading currencies:
-International trade in goods and services
-Long term capital movements (FDI) = inward and outward flows of direct investment
-Short term capital markets = speculating ‘hot money’, in search of increased interest rates now or increased future exchange rates, 90% of all Fx transactions
What are some exchange rate indicators (4.1) (3)
-Nominal exchange rate = the value of one currency in terms of another
-Real exchange rate = the value of one currency in terms of another, adjusted for inflation
-Trade weighted indexes = measures the value of sterling against a basket of currencies, each one weighted to reflect its relevant importance for the UK’s trade
($=70%, YEN = 30%, 10% X 0.7 = 7%, 20% X 0.3 = 6%, weighted fall = 13%)
What are the different movements in the value of a currency (4.1) (4,1)
-Revaluation = occurs under a fixed rate system when a government decides to officialy adjust the value of its currency upwards
-Devaluation = occurs under a fixed rate system when a government decides to officialy adjust the value of its currency downwards
-Appreciation = occurs under a floating rate system, when the value of a currency is adjusted upwards due to demand and supply
-Depreciation= occurs under a floating rate system, when the value of a currency is adjusted downwards due to demand and supply
What is the floating exchange rate system, and its self correcting mechanism (4.1) (2,3,2)
-A floating exchange rate system is when equilibrium ER is determined solely by the interaction of the supply and demand for pounds in the FX markets
-No central bank/government intervention, simply appreciations and depreciations
-In theory, a floating exchange rate system should fix a balance of payments disequilibrium
-Countries with constant deficits will sell more currency to buy imports, increasing the supply of £
-This increase in Sof£ will depreciate the ER, making exports more competitive
-However, speculative hot money flows account for 90% of all FX transactions
-A countries ER may still rise despite a chronic CA deficit if speculators increase demand for the pound (higher IR or confidence)
What causes shifts in the supply/demand of the pound (4.1) (4,4)
Supply of £ will shift right if:
-British residents demand more foreign goods/services/assets
-UK interest rates fall relative to overseas
-There is negative speculation over the UK
-There is an outflow of investment by British firms for investment overseas
Demand for £ will shift right if:
-Foreign residents demand more British goods/services/assets
-UK interest rates rise relative to overseas
-There is positive speculation over the UK
-There is an inflow of FDI into the UK by foreign firms
How can you illustrate appreciations/depreciations (4.1) (2,2)
x axis = quantity, y axis = $/£, curves = £
An appreciation will be illustrated with:
-An outwards shift of demand
-An inwards shift of supply
A depreciation will be illustrated with:
-An inwards shift of demand
-An outwards shift of supply
What were some causes of the post-2008 sterling collapse (4.1) (1,(1,3,3))
-The UK’s sterling trade weighted index peaked at 105 in 2007, but dropped to as low as 76 in 2009
Causes:
-Growing current account deficit since 2007
-Global fears that the UK was more prone to the effects of a recession
-The UK economy’s reliance on financial services
-The high indebtedness of UK households (2007 = 187% for UK, 102% for Germany)
-Sharp fall in UK interest rates from 5.75% in 2007 to 0.5% in 2009
-This was also paired with significant quantitative easing
-However, similar measures were implemented abroad
What are factors influencing the exchange rate of a country’s currency (4.1) (6)
-Higher relative inflation = lower ER
-Higher relative interest rates = higher ER
-Improved economic performance = higher ER
-Persistent current account deficit = lower ER
-Positive speculation = higher ER
-Higher political stability = higher ER
What is a fixed exchange rate system (4.1) (1+2d)
-A fixed exchange rate is where a country sets the value of its currency to another, and the central bank maintains this pegged value by exchanging foreign reserves
-A revaluation will be caused by demanding more of foreign currency
-A devaluation will be caused by increasing the supply of domestic currency
What is a managed exchange rate (4.1) (5)
-Instead of targeting a specific rate, a managed exchange rate targets a specific range
-Some governments favour a managed exchange rate, a managed float, aiming to gain from both floating and fixed systems
-If this is done to gain an advantage on trading partners, it is known as a dirty float
-The central bank will set upper/lower limits, and will only intervene in the case of these limits being breached
-Many government’s do this in order to increase export competitiveness, or to reduce imported inflation
What is competitive devaluation and its consequences (4.1) (2,4)
-Competitive devaluation is sometimes referred to as currency wars, when one currency devaluing its exchange rates lead to other countries following suit
-This is all done in an attempt to boost export price competitiveness
-Imports become more expensive, leading to cost push inflation for those who rely on imported factors of production
-Increased export price competitiveness leads to demand pull inflation
-The impact of ER changes on the current account depend on the Marshall-Lerner condition, that the anticipated effects will only occur if the sum of the elasticities of imports and exports are greater than one
-The MLC condition can be illustrated on the J-Curve
What are the pros and cons of floating exchange rates (4.1) (4,4)
+Automatic adjustment of BOP, as currencies in deficit will have weaker currencies, allowing for an improvement in the current account (however, hot money)
+Low requirement for the government to store foreign reserves
+Freedom to pursue other macroeconomic objectives
+Flexibility, as the government isn’t tied to maintaining a specific ER
-Uncertainty on the exact price of a currency
-Speculation by inverstors, with no limits on prices
-Inflation due to higher raw material prices
-Investment may be discouraged, partiuclarly from abroad
What are the pros and cons of fixed exchange rates (4.1) (4,4)
+Reduces uncertainty, as agents know how much a currency is worth
+Economic growth, as certainty leads to higher FDI
+Low inflation, is the exchange rare is set high
+Requires sound financial management and a long term view
-Maintenance, it is expensive in holding foreign currency reserves
-Speculation, as investors can still guess when governments intervene
-No automatic adjustment of balance of payments
-Conflict with other objectoves, interest rate manipulation affects AD and PL
What is the J-Curve (4.1) (d+2)
-The J curve is a J shaped curve where the lower bit is in deficit and the higher bit is in surplus, the downwards sloping = MLC not met and upwards sloping = MLC met
-The J-Curve effect is when a currency depreciation in the short run results ina violation of the M-L condition, things being rectified in the end
-There is also a reverse J-Curve effect for appreciations
What are the effects of exchange rate changes on the current account (4.1) (3,3)
-A fall in the value of the £ makes export prices fall, and import prices rise, thus leading to an improvement in the current account
-In the long run, the marshall-lerner condition must hold for the above
-The M-L condition is that the PED for exports + PED for imports > 1, that the demand responsiveness of exports and imports to a change in price caused by ER must be elastic
-Violations of the M-L condition may occur if inelastic export and import demand responses to a depreciation leading to a reduced current account (lower Px > Higher Qx)
-This could be due to people being locked into trade contracts in the short run, quantities remaining fixed
-It takes time for consumers to respond to exchange rate changes, meaning import/export quantities don’t immediately fall
What is the impact of exchange rate changes on macroeconomic objectives + FDI (4.1) (2,2,2)
-A depreciation leads to a higher value of net exports, leading to higher AD, RO and lower unemployment
-However, an increase in imported FOP prices lead to lower SRAS = lower RO
-Higher (X-M) = Higher AD = Demand pull inflation
-Imported inflation may also occur, particularly if the country is reliant on imported raw materials, causing cost-push inflation
-Depreciation = more £ can be bought with $ = higher FDI
-However, if the depreciation is indicative in poor performance/confidence, FDI flows may not rise
What are some factors strengthening the pound (4.1) (3,2,3)
-Independent MPC in 1997 means interest rate policy is based solely of economic need
-Boosted confidence on fixed interest rate bonds (less inflation), leading to higher D for £
-However, US, Japan and Eurozone also have independent monetary policies
-Between 1995 and 2008, UK IR were consistently higher than abroad, leading to higher hot money flows
-However, IR fell to 0.5% in 2008 and 0.1% in 2020 due to crashes
-UK economic growth from mid 90s-2007 = 2.7% pa, higher than the US’ 2%
-This increased demand for assets and speculative hot money flows
-However, since 2008, the UK has grown less (16.7%) then the US (25.6%)
What is the impact on the UK economy of an appreciation of sterling (4.1) (2,2,2,2,2)
-Fall in international competitiveness, as exports are dearer
-However, UK R&D helps increase quality/non-price competitiveness
-Increase of the balance of payments deficit, due to cheaper imports and dearer exports
-However, temporary decrease due to reverse J-Curve
-Reduced inflation (lower AD and lower imported costs of production)
-However, the UK services sector is less raw material dependant
-Higher unemployment, as demand falls in the economy
-However, depends on the elasticity of the AS curve
-Lower economic growth due to lower (X-M) and lower AD
-However, cheaper COP’s can lead to higher SRAS
What is international competitiveness, and how can it be measured (4.1) (1,1,3)
-International competitiveness represents a countries ability to sell goods/services in domestic and international markets, at a price/quality competitive in those markets
-International competitiveness can be measured through rice or non price (quality, design, availability) factors
Measures include:
-Relative unit labour costs are total wages divided by real output, the cost of employing workers for each unit of a good produced
-Relative export prices is the price of UK exports in comparison to other country’s exports, affected by factors as labour productivity
-Other factors include infastructure, health, education
What are some factors influencing international competitveness (4.1) (2,2,2,2,2)
Relative exchange rates:
-Higher exchange rates = higher export price = lower IC
-From 1996-2006, £1 = $2, 2023 £1 = $1.27
Relative wage costs:
-Higher relative wage costs = higher COP’s = higher export price = lower IC
-Many UK firms (Dyson) offshore manufacturing to countries such as China, with cheaper (£2.76) minimum wages
Relative productivity:
-Higher relative productivity = lower COP’s = lower export price = higher IC
-The UK is around 20-30% less productive than the USA and france
Non-wage costs:
-Red tape, bureaucracy, health and safety all increase costs of production, increasing export prices and reducing IC
-The UK has over 10,000 pages of business tax legislation, some of the most in the world
Non price factors:
-Higher quality, innovation, branding all increase IC
-Particularly important for the UK’s high value financial services
How can we evaluate factors influencing international competitiveness (4.1) (1,2,2,2,2)
ER:
-Higher ER = Lower imported COP’s = lower export price = higher IC
Wage costs:
-More of a problem for price inelastic goods
-For price inelastic services, educated and experienced labour > cheap labour
Productivity:
-The UK is currently working to solve its productivity puzzle
-Increasing the school leaving age, increasing uni participation, putting more emphasis on school exams
Non wage costs:
-Significant problem for the UK
-The current government is under pressure to reduce business regulation
Non price factors:
-You still need to find a balance between price and non-price competitiveness
-Uk G/S heavily depend on quality>price
What policies can the UK use to raise international competitiveness (4.1) (1,2,2,2,2,1)
Capital deepening (F):
-More capital per worker = higher labour productivity
Relocating production (F):
-Fall in wage/non wage costs, whilst product is still produced in the UK
-Recent falls in communication costs = Indian call centres for UK services
Move upmarket (F):
-By investing into R&D, firms will boost quality and innovation
-VW turned Skoda into a high quality car, boosting non-price competitiveness
Privatise inefficient state industried (G):
-Director’s profit motives incentivises innovation and cutting costs, opening up market discipline
-BT in 1984, railways in 1994
-Invest in education/training (G):
-Boost labour productivity, lower unit labour costs and increase IC
-The UK is currently 20% less productive than the US
-Lower tax and benefits (G):
-Increases opportunity cost of not working = higher supply of labour = lower wage rate = higher price competitivness
How can we evaluate policies used to raise international competitiveness (4.1) (6)
-Capital deepening: requires large investment = higher costs in the short run which small firms can’t afford
-Relocating production: UK firms incur around £13.5k in redundancy pay, and there could be a loss of quality due to language/culture barriers (natwest brought call centres back to UK)
-Move upmarket: Not guaranteed to succeed, as consumers need to rid the negative image
-Privatisation: Most public sector firms already sold off in the 1980s, and the only remaining (NHS, education) better without a cost-cutting motive
-Education: Time lags of 10-20 years, whereas productivity is a now problem needing short term solutions
-Lower tax/benefits: Achieves IC at the expense of a more unequal distribution of incomes
What are the pros/cons of being internationally competitive (4.1) (4,3)
+Current account surplus
+Export led economic growth
+Lower unemployment
+Higher confidence = higher FDI
-Other countries may employ protectionism
-Higher ER make it hard to maintain IC (however, hot money)
-Reliance on international trade
What is absolute and relative poverty (4.2) (2,4,2)
-Absolute poverty is when peoples incomes fall below the minimum level to meet basic needs
-World bank’s 2015 poverty line = $1.90 a day
-Relative poverty is when peoples incomes are below a certain income % in a country (hard to sustain good life)
-The EU’s ‘at risk measure’ = <60% of median income
-Relative poverty arises from inequality
-However, relative poverty is subjective, subject to change, and incomparable
-All countries will have some relative poverty, but some will have no absolute poverty
-There can be a rise in relative poverty and fall in absolute at the same time, as growth drags the median up
What are some causes of changes in absolute and relative poverty (4.2) (4,6)
Absolute:
-Increase in aid = decrease in AP
-Increase in debt relief = decrease in AP
-Increase in fair-trade schemes = decrease in AP
-Increase in microfinance schemes (trust based loan) = decrease in AP
Relative:
-Increased employment opportunities = decreased RP
-Increased education/training = decreased RP
-Increased wages and NMW = decreased RP
-Increased social benefits = decreased RP
-Increased ownership of assets = decreased RP
-Increased economic growth = increased RP if driven by rich, but can fund ways to decrease RP
How can we use the Lorenz curve and Gini coefficient to measure income inequality (4.2) (d,2,2)
-The Lorenz curve has the cumulative % of population on the x axis, cumulative % of income on the y axis, a 45 degree line and convex upwards curve from bottom left to top right, A = area between line and curve, B = area between curve and x axis
-45 degree line represents perfect equality
-Lorenz curve represents unequal distribution of income
-Gini coefficient is A/A+B, 0 = absolute equality and 1 = absolute inequality
-GC shows the ratio of areas between the 45 degree line and LC
What are some causes of income and wealth inequality (4.2) (5,3)
Income:
-Increased wages = decreased II
-Decreased unemployment = decreased II
-Increased social welfare = decreased II
-Increased education/training = decreased II
-Increased progressive tax = decreased II
Wealth:
-Increased inheritance tax = decreased WI
-Increased pensions = decreased WI
-Increased ownership of assets = decreased WI
What is the impact of development/capitalism on inequality (4.2) (d,3,3)
-x axis = degree of development, y axis = gini index, reversed U shaped curve (Kuznets curve)
-At low levels of development, most work on land and are poor, so there is little inequality
-In the ‘take-off’ phase, some gain significantly to others, so income inequality rises
-At high levels of development, incomes can be redistributed through tax and benefits, leading to reduced income inequality
-Inequality in free markets are inevitable, as different people have different skill and as such get different rewards
-Private ownership of assets leads to inequality in asset ownership, further creating income inequality
-However, inequality can be necessary to provide incentives to take risks
What are the different types of taxes (4.2) (3,2)
-Progressive taxes are when the proportion of income paid in tax rises as incomes rise
-Proportional taxes are when the proportion of income paid in tax stays the same as incomes rise
-Regressive taxes are when the proportion of income paid in tax falls as incomes rise
-Direct taxes are levied on wealth/income, progressive and can’t be passed on
-Indirect taxes are levied on expenditure, regressive and can be passed on
How can macroeconomic policy be used to reduce poverty/inequality (4.2) (4)
-Government might provide education as a means of reducing poverty
-Tax system may be made more progressive and benefits may be increased (higher tax free allowances, higher income tax rates and lower start tax rates)
-Universal basic income is a guaranteed wage for every individual
-Negative income tax is when the government pays those below a certain threshold, to raise them to a guaranteed floor
How can we evaluate macroeconomic policy’s use in reducing poverty/inequality (4.2) (8)
-Inheritance tax is difficult to enforce, avoidable by careful tax planning
-Raising income taxes could reduce incentives
-Supply side policies have time lags
-Benefits can reduces incentives to work
-Benefits are expensive
-UBI+tax simply increases bureaucracy
-Ubi vs NIT = endowment effect, we value things we currently have > same thing if we don’t own
-Give and take vs neither
What is the difference between growth and development (4.3) (1,2,1)
-Economic growth is an increase in real GDP/the productive capacity of an economy over time
-Economic development is the increase in the welfare and living standards of a population over time
-Broad themes involve higher living standards, improved availability of necessities, expansion of education/healthcare, improved resource allocation
-Economic development is very difficult to achieve without growth, but growth may not necessarily lead to development
What are other measures of development (4.3) (3,3,3,2)
-The inequality adjusted HDI is the HDI but measuring the inequalities in the 3 measures
-This will be equal to the HDI with no inequality, and the difference represents the loss in development due to inequality
-IHDI is broader than the HDI, but still doesn’t account for other measures
-The multi-dimensional poverty index identifies deprivations across HDI dimensions
-This shows the % of people who are suffering deprivations, and the intensity of this
-This is useful for policymakers, as it can be deconstructed by age, race, but needs a lot of data
-Proportion of male population engaged in agriculture
-Agriculture has a low marginal product of labour, reducing economic growth
-Developed world = 2%, developing (asia+africa) = 66%
-Mobile phones per thousand show development potential (communication+trading)
-Phones can overcome infrastructural problems (don’t need constant electricity)
What is the HDI, and pros/cons of using the HDI (4.3) (4,2,3)
The Human Development Index has 3 equal weights:
-Health (life expectancy at birth)
-Education (Mean years in education for a 25yr old and expected education years for a pre school child)
-Income (Real GNI per head at PPP’s)
-Countries are ranked in an index from 0-1, where the higher number represents the higher development level
+Combines growth with other quality of life indicators
+Relatively easy to calculate, governments collect necessary statistics anyway
-Doesn’t account for inequality, deprivation, poverty
-Health/education don’t account for quality
-Other factors omitted, environmental or corruption
What are the impacts of primary product dependency on growth/development + evaluation (4.3) (1,5,4)
-Primary product dependency is when countries rely on hard and soft commodities
-PPD = large price fluctuations, as low PED (necessity) + PES (time lags) =large price changes to S/D
-Price fluctuations make it difficult to plan investment
-Price fluctuations lead to fluctuations in producers incomes and foreign exchange earnings
-Dutch disease: higher demand for primary products = higher ER = lower competitiveness of other sectors (hurt non-oil nigerian sectors)
-Prebisch-Singer hypothesis is terms of trade for PPD’s fall, as there is a higher income elasticity of demand for manufactured goods then primary goods
However:
-Some countries have developed using primary products (saudi oil)
-Developing countries may have comparative advantages in primary products
-Some primary products have a high YED (Diamonds)
-Can’t generalise for all (Chile copper exports fell 50% in 2008 vs Bolivia having 1/2 of the worlds lithium, used for electric car batterys)
What is commodity market volatility (4.3) (4)
-Demand for commodity’s is inelastic, since the commodities are essentials, as well as factors of production for other inelastic goods
-Supply for commodities is inelastic due to long growing/extraction times
-This means shifts in D/S cause significant changes in price, causing fluctuations in producer incomes
-Commodity price rises lead to overinvestment, causing long-term risk when the price eventually falls
How do the savings gap/foreign exchange gap limit growth/development (4.3) ((4,2),4)
-A savings gap is the difference between actual savings and savings required to achieve higher growth
-The Harrod Domar model is cyclical: low GDP per capita = low savings = low investment = capital shortage = low GDP per capita
-Many developing countries have a low GDP per capita, and thus have insufficient funds to finance investment essential to achieving growth/development
-Africa has a 17% savings rate, vs 31% middle income country average
However:
-The savings gap focuses on physical capital rather than human capital
-Savings gap can be filled by other means (aid, debt cancellation)
-A foreign exchange gap is when developing countries have a shortage of foreign currency
-This is due to servicing debt (interest), or dependence on oil/imported FOP’s
-This limits development, as countries would have insufficient currency to buy capital goods
-It is important to have a supply of stable currency, especially if domestic currency is weakening
What is debt/capital flight, and how do they impact growth/development (4.3) (4,4)
-Debt is caused by countries stuggling with debt servicing (interest), meaning less government spending or higher tax occurs, limiting growth/development
-This is a problem as higher oil prices + higher debt service payments reduce countries’ ability to import FOP’s
-The depreciation of developing countries’ currency’s makes debt a larger issue
-However, the ability of a country to service its debt>the size of its debt (debt service payments as a % of GDP as a measure) (Nigeria’s debt is 52% of its GDP)
-Capital flight is when individuals and countries place cash deposits or buy shares/assets in foreign banks
-This is done due to low confidence in the country’s stability, to repatriate profits and to hide money from authorities
-From 2001-2010, developing countries lost $5.9 trillion to illicit capital flows
-Capital flight leads to lower growth, a higher savings/fx gap, and lower tax revenues
How does population growth/access to credit/infrastructure limit growth/development (4.3) (3,2,4)
-Higher population growth means much higher development is required to improve standards of living by a lesser amount
-Higher birth rates will increase the strain on the economy, but with no immediate rise to the working age population
-Africa’s population is estimated to double by 2050, complicating efforts to reduce poverty
-Entrepreneurs need access to banking/credit in order to expand businesses and grow
-One possible solution could be microfinance
-Infrastructure is the range of structures needed for an economy to run smoothly
-Poor infrastructure can deter foreign/domestic investment
-Indian 2012 powercuts damaged their tourism industry
-However, TNC’s may invest in infrastructure in resource rich developing countries to facilitate growth
How do human issues/absence of property rights limit growth/development (4.3) (5,4)
-Lower education = lower productivity = lower growth
-Lower education deters FDI, as TNC’s would have to spend on investment
-Ethiopia struggles with 49% illiteracy rates
-Lower health of a population means adults have to give up work
-Higher strain on healthcare reduces government spending on investment
-Property rights are when individuals can own/decide what happens to certain resources
-Lack of rights mean individuals/firms can’t use the law to protect their assets
-Lower rights = lower investment, as firms are unwilling to build factories
-The removal of property rights in Zimbabwe led to economic collapse
How do non-economic factors limit growth/development (4.3) (5)
-Corruption leads to the diversion of resources to the governing elite, as well as an inefficient allocation of resources
-Poor governance is when government policies cause a countries resources to be allocated efficiently
-Civil wars cause death and destruction of property
-Geographical factors, such as Niger being landlocked and limited in their trade
-All of these factors deter foreign investment, further reducing growth/development
What are strategies to influence growth/development (4.3) (6,6,6)
Market based:
-Trade liberalisation
-Promotion of FDI
-Removing government subsidies
-Floating exchange rates
-Microfinance schemes
-Privatisation
Interventionist:
-Development of human capital
-Protectionism
-Managed exchange rates
-Infastructure development
-Promotion of joint ventures
-Buffer stock schemes
Other:
-Industrialisation
-Development of tourism
-Development of primary industries
-Fair trade schemes
-Aid
-Debt relief
How can trade liberalisation/floating exchange rates help promote growth/development (4.3) ((1,3,2,2)2)
Trade liberalisation involves lowering protectionism (reversal of tariff diagram)
-Trade liberalisation leads to higher choice, higher quality, higher consumer surplus
-Trade liberalisation leads to higher diversification and economies of scale for firms
-Trade liberalisation leads to higher competition, and higher comparative advantage for countries
-However, may negatively affect environment/some industries
-Will hurt infant industries in emerging economies, meaning they stick to worse agriculture
-OECD estimates 10-20% increase in long run exports for G20 economies
-0.9% - 3.9% in jobs for high skilled workers, >8% in wages
-Floating exchange rates mean the government can focus on G&D rather than Gold/Fx reserves
-However, currency volatility can cause large changes in macroeconomic variables
How does the removal of government subsidies/promotion of FDI promote growth/development (4.3) (4,4)
-Subsidies can be an effective way of minimising poverty, placed on essential items
-However, they represent an opportunity cost through large government spending
-Instead of benefitting all, direct payments to poor people could be better
-Subsidies can also lead to dependency and inefficiency
-FDI is investment by one private sector company in one country to another private sector company in another
-FDI leads to higher employment, an injection into the circular flow of income, and a higher productive capacity
-Governments can promote FDI through lower corporation tax, lower trade barriers, tax incentives and liberalised laws (lower minimum wage)
-However, FDI can lead to the repatriation of profits, exploitation, of workers/environment and countries may lose sovereignty
How will privatisation/microfinance schemes promote growth/development (4.3) (3,(3,3))
-Privatisation is the sale of publicly owned assets to the private sector through issuing shares
-Privatisation can lead to higher efficiency (incentives), improves government finances
-BT’s privatisation in 1984 = higher efficiency, higher choice, higher quality and innovation
-Microfinance is a means of providing extremely poor families with small loan to help them grow their tiny businesses
-Microfinance is mostly given to small rural farmers, small urban vendors,, 97% women
-Interest repayment is needed, but focused on groups, who can’t afford proper loans
-However, concerns over repayment, collection methods, questionable accounting
-Overemphasis on microfinance may lead to a reduction of other assistance
-In South Africa, very little is spent on investment, simply increasing consumption
How is the development of human capital, protectionism and managed exchange rates methods to promote growth/development (2,3,4)
-Education and training investment improves human capital, productivity, encourages FDI and growth
-E&T spending also allows countries to develop from the primary sector to a manufacturing one
-Protectionism aims to construct a path towards diversification and industrialisation
-This promotes import substitution and allows domestic markets to achieve EOS’
-However, the distortion of comparative advantages will lead to inefficiency
-The country could fix a currency against a number of different exchange rates
-High ER’s for essentials, low ER’s for others to reduces imports
-Alternatively, a country could reduce volatility by managing a single exchange rate
-However, this may not work in practice, and will require a lot of micromanagement
How can infrastructure development, the promotion of joint ventures and buffer stock schemes help promote growth/development (4.3) (2,2,4+d)
-Infrasture development has positive social benefits, and is vital for an economy, whilst rarely private sector provided
-However, infrasture development is expensive, and may be corrupt/poorly built
-Firms in different countries may enter joint ventures to combine strengths and maximise CA’s
-This will help reduce exploitation from FDI and to keep same profits in the country
-Buffer stock schemes help reduce price fluctuations
-If price is too low, stock is removed to increase price, if price is too high then buffer stock is released to market to decreased price
-However, costs of storage, cooperation and right floor/ceiling is needed
-In 2017, Ghana introduced a cocoa BSS
-Demand curve, perfectly inelastic supply curve, ceiling and floor price and if price is over/under area over/under is stored/released
How can industrialisation/fair trade schemes help promote growth/development (4.3) ((1,2,2)(1,2,2))
Industrialisation:
-The lewis model assumes development requires a move from agriculture to industrialisation
-This assumption is due to the surplus of labour in agriculture, so the marginal product of labour and opportunity cost of moving to industry is 0
-Therefore, industrialisation can lead to higher growth, higher FDI and even higher future productivity and growth
-However, growth/FDI may be invested in capital or not locally, not necessarily local labour
-Growth and development also isn’t linear (India went straight from agriculture to services, due to comparative advantages)
Fair trade:
-A fair trade scheme is when producers are payed above the market price, in return for reinvestment in development
+Extra money can be given to workers, improve the quality of products or be spent on development programmes
+Producers recieve a higher, guaranteed price w/o the risk of price fluctuations
-However, there will be the distortion of market signals and little incentive to increase quality with guaranteed higher prices
-Only 10% of premium coffee prices goes to producers, most going to the supermarkets
How can the development of tourism/primary industries help influence growth/development (4.3) ((2,3)(3,1))
Tourism:
+Tourism is income elastic, and a valuable source of foreign currency
+Tourism attracts investment, creates jobs and thus creates growth and multiplier effects
-Income elastic goods are bad in times of recession, and are demand dependant
-Employment may be seasonal, and may only be low skilled/paid if TNC’s import high skilled managers
-External costs of prioritising tourists to environment/locals
Primary industry:
-If a country has a CA in a primary industry, it helps to allocate resources there
-Higher CA’s = higher growth = higher tax = higher education spending = higher CA’s in better products
-Some primary products (Bolivian Lithium) may have a high YED, and will benefit from worldwide growth
-However, Primary Product dependency will lead to price fluctuations, natural disasters and low YED’s
How can aid influence growth/development (4.3) (2,3,3)
-Aid is the voluntary transfer of resources from one country to another or below interest loans
-The 4 types of aid are tied aid (with conditions attached), bilateral aid (direct from one to another), multilateral aid (countries give money to agency) and concessional loans (lower/no interest rates)
+Funds infrastructure/investment, overcoming the savings gap and leading to growth
+Might contribute to more trade/globalisation
+Improves human capital and reduces absolute poverty and world inequality
-Countries can become reliant on aid, not pursuing their own macroeconomic projects
-Aid can be diverted to the military or lost via corruption
-Opportunity cost of interest repayments or economic imperialism (China’s power in african airports)
How can debt cancellation be used to influence growth/development (4.3) (3,3,4)
-Debt servicing can be a problem as it can limit resources for health/education spending
-Many developing countries have high debts to the IMF, governments, world bank
-World Bank’s Heavily Indebted Poor Countries Initiative aims to provide debt relief
+Allows low income countries to finance investment on capital goods, reducing the savings gap
+Developing countries have more foreign currency to import capital/consumer goods
+May help to conserve the environment (debt for nature swaps)
-Without conditions attached, governments may not pursue sound macroeconomic policy
-Aid is a lot quicker then debt cancellation programmes
-Corruption and who recieves the benefits
-May be less effective then removing protectionism in developed countries
What are the role of international institutions in influencing growth/development (4.3) (3,3,3)
-The World Bank aims to bring long term development and a reduction in poverty
-They provide finance, policy advice, and strengthen private sectors in developing countries
-The World Bank has funded 12,000 development projects since 1947
-The International Monetary Fund provides loans to help countries pay debts/have foreign currencies
-The IMF insist in countries making macroeconomic reform to solve the problems (lower imports, higher exports, lower government spending)
-The reforms, although they seem punishing, should help the country develop in the long run
-Non-Government Organisations are independently run non-profit organisations
-NGO’s can provide project work to countries (oxfam) or lobby governments
-However, NGO’s can’t solve the problems, as they need governments
What are financial markets + the type of financial markets (4.4) (1,5)
-Financial markets are where buyers and sellers can buy and trade a range of services and assets that are monetary in nature
Types:
-Money market: market for short term loan finance (<12 months) for businesses
-Capital market: long term finance (shares and bonds), a share being ownership in a company, and governments selling bonds with a rate of interest
-Foreign exchange markets: where one currency is traded for another
-Commodity markets: investors trade primary products (wheat, gold oil)
-Insurance markets
What are types of financial institutions (4.4) (5)
-Retail banks: provide services to households (direct debits, savings account, loans, mortgages)
-Commercial banks: provide services to businesses
-Investment banks: trade in a range of financial markets (stocks, commodities, foreign currency) and to provide advice to firms on raising finance/mergers
-Insurance companies: insure against a range of risks
-Central banks: run monetary policy, issue government debt
What is the role of financial markets (4.4) (5)
-To facilitate saving: provide facilities for firms/individuals to save, done through range of assets, such as storing money or holding stocks/shares
-To lend to businesses/individuals: without credit, individuals/firms may have cash flow problems, so lending allowed for C & I to occur, boosting AD
-To facilitate exchange of goods/services: this role happens through the creation of a payment system, where central banks print money, institutions process cheques, companies offer credit card services banks buy/sell foreign currency, all to allow buyers/sellers to interact and transfer funds
-To provide forward markets in currencies/commodities: Forward markets are where firms are able to buy/sell in the future at a set price
-To provide equity markets: allowing people to buy/sell stocks, allowing firms to raise funds for capital and allowing investors to gain parts of a company/its dividends
How is asymmetric information/externalities market failure in the financial sector (4.4) ((1,3)(1,3))
Asymmetric information:
-Asymmetric information exists in any transaction where one party has less knowledge than the other
Examples include:
-A lender doesn’t know how likely a borrower is to repay their loan
-Insurance companies being unaware of risks with each individual driver
-Institutions being unaware of the true level of risk with CDO’s (caused the 2008 financial crisis)
Externalities:
-Negative externalities exist when a market transaction has a negative consequence for the 3rd party
-In the 2008 crisis, bankers risky behaviour didn’t fully take into account the potential external costs
-The macroeconomic costs of 2008 include falling GDP, rising unemployment, falling incomes across the world economy, cost to taxpayers of bank bailouts
-The microeconomic costs of 2008 include bankruptcies for businesses if a banks customers lose their deposits
How are moral hazards, speculation and market rigging market failures in financial markets (4.4) (2,2,2)
Moral hazards:
-Moral hazards are when individuals/organisations take more risks then they should
-In the 2008 financial crisis, institutions may take excessive risk if they know the central bank won’t allow them to fail, due to the impact it’d have on the economy
Speculation:
-Speculation leads to market bubbles, where the price of an asset rises massively then falls
-Financial markets lent too much in mortgages, creating a housing bubble which burst, leading to lower AD, wealth effects and banks losing money
Market rigging:
-Market rigging is when a group of individuals/institutions collude to fix prices or exchange information that will lead to gains for themselves at the expense of others
-Insider trading is when individuals buy shares according to future knowledge they don’t have
What are the key functions of central banks (4.4) (3,4)
-Implementing monetary policy: the MPC sets interest rates and controls the supply of money through quantitative easing
-Governments banker: lends to government, holds governments bank account, collects/makes government payments, manages public dent, holds government debt, gold and foreign currency reserves
-Banks banker: central bank is the lender of last resort, providing loans to prevent collapse and ensuring financial stability
-Regulation: protect consumers, prevent risky actions and systemic risk (whole system collapsing)
-They ban market rigging, prevent the sale of unsuitable products, set maximum IR to prevent consumer exploitation. they force future banks to hold a % of liquid assets (liquidity ratios)
-Financial policy committee conduct macro prudential regulation (risk to whole UK financial system)
-Prudential regulation authority conduct micro prudential regulation (focus on solvency (firms’ ability to meet their debt))
What are different types of public expenditure + objectives (4.5) (1,3,5)
-Public expenditure involves spending by the central government and local authorities on running government agencies, and providing public services
-Current expenditure is day to day spending on goods/services
-Capital expenditure is expenditure on long-term projects
-Transfer payments are payments to individuals with no production in return
Objectives include:
-Public goods/goods with external benefit
-Health and education
-Defence
-Income redistribution
-Managing external costs
What are reasons for the changing size/composition of public expenditure (4.5) (6)
-Higher GDP = much higher health and education spending, as they’re demand elastic
-A larger/older population puts increased pressure on health and social services
-Political priorities, as developed countries focus on health/education, and developing focus on infrastructure
-Redistribution of income requires more transfer payments, something refuced by post 2008 austerity leading to less means tested benefits (circumstance dependent)
-More discretionary fiscal policy = more public expenditure, as it’s become increasingly popular to manage the economy
-Higher debt interest (2008 expansionaru fiscal policy = borrowing) has risen public sector net debt
What are the impacts of a rise in public expenditure as a proportion of GDP (4.5) (1,1,1,3,3,3,3)
-Higher spending = higher AD = higher multiplier = higher growth
-Higher spending on health, education, infrastructure = higher productivity = higher LRAS
-Higher spending = higher living standards (However, public services or defence?)
-Higher spending = resource crowding out (higher G = insufficient FOP’s for private sector C&I)
-Higher spending = resource crowding out (Higher government borrowing = higher demand for money = higher IR = lower private sector C&I)
-Higher spending = higher tax = less choice for consumers in spending decisions
-Higher spending = less resource allocation by the free market
-Higher spending = higher benefits = higher equality
-Higher spending = higher education/health spending = higher equality
-Generally speaking, growth is higher in countries where G<35% of AD
-Although, Scandinavian countries have high tax, G and standards of living
What are the economic effects of changes in direct tax rates (4.5) (2, d+2, 1,2,1,1)
-Lower basic tax = higher incentives for unemployed to work
-Higher tax rates = lower incentives to work more, and accept promotions
-Tax revenues may fall when tax rate rises
-Higher tax rate = higher tax avoidance, tax evasion, tax exiles
-The laffer curve is a upside down U with Tax revenue on the y axis and tax rate on the x
-Higher progressive tax = fairer income distribution
-Higher tax = lower disposable income = lower C = Lower AD
-Higher tax = lower LRAS, due to disincentive effects
-Higher tax = lower disposable income = lower imports = higher (X-M)
-Higher corporation/individual tax = lower FDI
What are the economic effects of a change in indirect tax rates (4.5) (7)
-Higher indirect tax may incentivise to work harder to maintain current standard of living, less obvious than direct tax = lower disincentives
-Indirect taxes are regressive, leading to a worser income distribution
-Higher indirect tax = higher tax revenues, as long as PED is inelastic, and there is no black market
-Higher Indirect tax = higher costs of production = lower SRAS = inflation
-Higher indirect tax = lower SRAS = lower output
-Higher tariffs = higher (X-M)
-Indirect tax may deter FDI due to higher prices, but depends on whether the products are sold in foreign or domestic markets
What are types of fiscal policy + evaluation (4.5) (3,6)
Types:
-Fiscal policy is the manipulation of government spending and tax to affect the economy
-Automatic stabilisers are forms of G&T which change automatically with the state of the economy, reducing fluctuations in the business cycle
-Discretionary fiscal policy is deliberately changing G&T (financial crisis = implemented fiscal stimulus)
Evaluation:
-Effective if the multiplier is high
-Difficult to determine effect due to problems in approximating multiplier value
-If income tax is cut, people might save or import
-Can have immediate effects and significant time lags
-Disincentive effects (higher tax = lower workforce)
-Depends on the level of spare capacity/elasticity of AS
What are the significance of deficits/debts, and policies to reduce debts (4.5) ((1,4)(3,2)
Significance:
+Higher productive potential, if higher government spending on infrastructure and capital
-Opportunity cost of debt servicing for future generations
-Resource and financial crowding out
-Governments may be forced to increase tax, deterring foreign and domestic investment
-Danger of inflation
Policies:
-Government could increase tax or reduce spending
-But, lower AD leads to lower output, employment, and the higher benefits and lower taxes
-Also increases inequality whilst reducing work incentives
-Higher spending to facilitate even higher growth, which then could be used to pay off debt
-Hwever this is very risky and can lead to rises in debt in the short run
What are some examples of external shocks (4.6) (6)
-Sudden increase in oil prices
-Financial crisis with repercussions for global banking system
-Severe natural disasters
-Wars
-Cyber attacks
-Global/regional pandemics
What were the policy responses to the 2008 financial crisis (4.6) (3,4,3)
USA:
-Tax cuts and increases in public expenditure amounted to $700 billion
-Interest rates cut from 5.25% in 2007 to 0% in 2008
-$2.1 trillion worth of quantitative easing implemented
UK:
-Expansionary fiscal policy included £3 billion in investment, buying shares in banks, lowering VAT to 15%
-Interest rates cut from 5.75% to 0.5%
-£435 billion worth of quantitative easing implemented
-Budget deficit increased from 2.3% of GDP in 2008-08 to 11.3% in 2008-09
However:
-From 2010, the UK adopted austerity measures
-Avoiding extreme measures meant more serious recessions
-Some argue QE’s main impact was to increase asset prices
What were the policy responses to the COVID-19 pandemic (4.6) (3,2,1)
UK:
-Extra £300 billion of QE implemented, bringing the total to £745 billion
-Bank of England cut interest rates to 0.1%
-£280 billion worth of measures in 2020 to protect jobs and stimulate the economy
US:
-In March 2020, the US launched a $700 billion QE programme and cut interest rates to 0-0.25%
-From March-May, $2 trillion worth of measures annoucned, to stimulate the economy
-The US’ response > the UK’s, one reason why the US recovered quicker than the UK
What are the problems with transfer pricing, and methods to control TNC’s (4.6) (2,3,3)
-TNC’s subsidiary companies adopt pricing policies for transactions aimed at minimising tax liability
-They ensure most profit is made in countries with low corporation tax
However:
-it is difficult to regulate transfer pricing without global agreements
-Many TNC’s are footloose, and move easily between countries
-Governments may have difficulty/reluctance to control TNC’s due to the impacts of their FDI
Methods:
-Make TNC’s use local factors of production
-Set up joint ventures with technology transfers to domestic firms
-Global company exports a certain amount of its output
What are the problems facing policymakers when applying policies (4.6) (3)
-Inaccurate info: information regarding GDP, BoP, retail sails is notoriously inaccurate and subject to subsequent revisisons
-Risks/Uncertainties: risks about QE and its true impact (little impact, inflation or stimulus)
-Inability: impossible to predict external shocks and thus to formulate appropriate policy responses in advance
