T4 - Role of the state in the macroeconomy Flashcards

Question

eval points for running a budget/fiscal deficit

Answer 1

State of Government Finances If the government has low existing debt, running a fiscal deficit may be sustainable, as it can borrow at low interest rates. eg UK at 2.4% However, if debt levels are already high, further borrowing may increase default risk, leading to higher borrowing costs. Higher debt servicing costs reduce fiscal flexibility, limiting future spending on essential public services. Countries with strong credit ratings (e.g., developed economies) can sustain deficits longer than economies with weaker financial positions. 2️⃣ Short vs. Long Term In the short run, a fiscal deficit can stimulate growth, reduce unemployment, and prevent economic downturns. However, in the long run, persistent deficits may increase debt burdens, causing higher interest payments and potential austerity measures. If spending is on capital investment (e.g., infrastructure, education, R&D), it can boost productivity and lead to higher future tax revenues, making the deficit more sustainable. If borrowing is used for current spending (e.g., welfare, subsidies), the long-term benefits may be limited, making future repayments more difficult. 3️⃣ Stage of the Economic Cycle During a recession, running a fiscal deficit can be highly beneficial as it boosts aggregate demand (AD) and prevents long-term stagnation. During a boom, a deficit may be inflationary, leading to higher interest rates and overheating. If a deficit is used to finance productive investments, it can smooth economic fluctuations, leading to more stable long-term growth. However, failing to reduce deficits during periods of strong growth may limit the ability to respond effectively to future downturns. 4️⃣ Business and Consumer Confidence If a fiscal deficit is seen as manageable, it can boost business confidence, leading to higher private investment and job creation. However, if investors fear government insolvency, borrowing costs may rise, leading to capital flight and currency depreciation. High confidence levels can result in a multiplier effect, amplifying the benefits of deficit spending. Low confidence levels can result in a paradox of thrift, where consumers and businesses save instead of spend, reducing the effectiveness of the deficit. 5️⃣ Automatic Stabilisers In a downturn, automatic stabilisers (e.g., higher welfare spending, lower tax revenues) naturally increase the fiscal deficit without discretionary policy changes. This helps to soften the impact of recessions, preventing extreme falls in GDP and employment. However, if a country relies too heavily on automatic stabilisers, it may become structurally dependent on deficit spending. In the long run, governments need to ensure that structural deficits (deficits that persist even in periods of growth) do not undermine fiscal sustainability.

Answer 2

tax rev > govt spending in a year

Answer 3

1️⃣ Confidence in Government Finances Running a budget surplus signals strong fiscal discipline, reassuring investors and international markets. This reduces borrowing costs, as the government is seen as less likely to default on its debt. Lower borrowing costs mean that the government can save on interest payments, freeing up resources for future spending or tax cuts. Increased confidence may also encourage foreign direct investment (FDI), boosting long-term economic growth. 2️⃣ Flexibility with Fiscal Policy A surplus provides the government with more options in the future, as it does not have to worry about high debt burdens. In the event of a recession, the government can use expansionary fiscal policy without fear of unsustainable debt accumulation. The ability to lower taxes or increase spending when needed gives policymakers more control over economic cycles. Countries with fiscal surpluses are also more likely to have higher credit ratings, which keeps borrowing costs low when they do need to borrow. 3️⃣ Less Crowding Out When the government runs a deficit, it borrows from the private sector, potentially reducing the availability of funds for private investment. A budget surplus means less government borrowing, allowing private firms easier access to capital at lower interest rates. This can lead to higher private sector investment, which can drive long-term economic growth. Reducing crowding out means that businesses can invest in capital, technology, and innovation, increasing productivity and competitiveness. 4️⃣ Less X-Inefficiency In times of fiscal surplus, the government has less pressure to raise taxes or cut spending inefficiently, reducing distortions in the economy. The private sector is often more efficient than government-run programs, meaning fewer resources are wasted on inefficient public spending. This can increase allocative and productive efficiency, as government resources are only used where they are most needed. Lower government intervention in markets may also encourage competition, reducing monopoly power and driving down prices. 5️⃣ Inflation Unlikely & Current Account Deficit Reduction Running a surplus means the government is withdrawing demand from the economy, reducing inflationary pressures. This keeps prices more stable, benefiting consumers and businesses by ensuring predictable costs. A government surplus often reduces the need for foreign borrowing, improving the trade balance and reducing the current account deficit. With lower inflation and a stronger trade position, the currency may appreciate, making imports cheaper and improving living standards.

Answer 4

1️⃣ Demand-Side Shock (Increased Unemployment, Lower Growth) Running a budget surplus often means higher taxes and/or lower government spending, which reduces aggregate demand (AD). Lower AD leads to lower economic growth, as firms experience weaker consumer demand for goods and services. Firms may respond by cutting production and reducing their workforce, increasing unemployment. If unemployment rises significantly, negative multiplier effects may occur, as unemployed workers spend less, further reducing consumption and investment. 2️⃣ General Macro & Micro Impacts of Increased Taxes Higher taxation reduces household disposable income, lowering consumption (C) in the economy. This reduces firm revenues, which can lead to lower business investment, slowing capital accumulation and innovation. If corporate taxes rise, firms may relocate operations abroad, reducing domestic job opportunities. In microeconomic terms, higher indirect taxes (e.g., VAT) increase costs for businesses, which may lead to higher prices for consumers (cost-push inflation). 3️⃣ Long-Run Returns of Increased Government Spending & Lower Tax Rates Cutting government spending to maintain a budget surplus may reduce investment in key sectors like infrastructure, healthcare, and education. Lower investment in these sectors harms long-run productivity growth, reducing the potential growth rate (LRAS shifts left). Similarly, lower tax rates can stimulate entrepreneurship and private sector investment, driving innovation and efficiency improvements. Therefore, prioritizing a budget surplus over strategic long-term investment may limit a country’s future economic potential. 4️⃣ Incentive Distortion of Increased Taxes If higher taxes are used to generate a budget surplus, this may distort incentives for work and investment. Higher income tax rates may create disincentives for individuals to work longer hours or seek higher-paying jobs, leading to lower productivity. Increased corporate taxes may reduce firms' willingness to invest, limiting capital stock growth and reducing competitiveness in global markets. In extreme cases, high tax burdens may encourage tax avoidance or evasion, reducing government tax revenues in the long run. 5️⃣ Risk of Income Inequality If government spending cuts affect welfare programs, public services, and subsidies, lower-income groups may suffer disproportionately. Reduced government support can worsen absolute poverty and limit social mobility, as low-income households struggle with affordability of education, healthcare, and housing. Austerity measures may increase regional inequalities, as poorer regions rely more on public sector spending for economic support. Rising inequality can lead to weaker social cohesion, lower overall well-being, and greater political instability, affecting long-term economic stability.

Answer 5

📏 1. Depends on Size of the Surplus → Small Surplus → Minimal AD Impact → Growth Maintained A small budget surplus may only slightly reduce government spending → The fall in AD might be minor → Business and consumer confidence may remain strong → Economic growth and development continue with little disruption 🧑‍🔧 2. Depends on State of the Economy → Near Full Capacity → Reduces Overheating → Controls Inflation If the economy is close to full employment → Contractionary policy can ease inflationary pressures → Stabilises the economy without drastically reducing output → Improves long-term economic stability and purchasing power 🇩🇪 3. Depends on Source of the Surplus → Structural Surplus (e.g. Germany) → Confidence Signal → Attracts Investment Surpluses from efficient tax collection and spending restraint (structural) → Show strong government discipline and solvency → May boost investor and credit market confidence → Can crowd in investment and support growth in the long run 🧾 4. Depends on How the Surplus is Used → Used for Debt Repayment → Lower Future Interest Payments → Increases Fiscal Space Surpluses used to pay down national debt → Reduces future debt interest burden → Frees up future government resources for investment or welfare → Improves long-run growth and development prospects 🚨 5. Depends on Confidence Effects → Households/Firms Expect Slowdown → Cut Spending → AD Falls More Than Expected Surplus may be seen as a sign of upcoming austerity or downturn → Consumers and firms may reduce spending pre-emptively → Confidence falls, leading to a larger than intended fall in AD → Can trigger or deepen a recession, worsening unemployment

Answer 6

AA-, UK has never defaulted a loan, and credit ratings are historically biased around £2.8 trillion

Answer 7

Australia with AAA Burkina Faso with CCC

Answer 8

income tax largest proportion of tax revenue: >340 bn - corporation tax : > 58 bn - VAT : > 135bn - business rate tax : > 31bn - capital tax: > 30bn

Answer 9

💼 1. Simpler Tax System → Lower Administrative Costs → Greater Compliance → Efficiency Gains A flat tax applies the same rate to all income levels → Simplifies tax calculations and reduces complexity → Cuts down costs for governments and taxpayers in compliance and enforcement → Improves tax efficiency and may reduce tax evasion 📈 2. Incentivises Work and Investment → Increases Labour Supply and Entrepreneurship → Boosts Output Flat tax means marginal tax rates don’t increase with income → Encourages individuals to work more or invest without fear of higher taxes → Supports greater labour participation and entrepreneurial activity → Can lead to long-term economic growth 💸 3. Attracts Foreign Investment → Competitive Tax Environment → FDI Inflows Increase A flat and predictable tax rate makes a country more attractive to foreign investors → Encourages multinational firms to locate operations there → Leads to job creation and technology transfer → Supports both growth and development in the host country 🏦 4. Reduces Tax Avoidance and Evasion → Higher Effective Revenue → More Fiscal Stability Flat taxes are less distortive and offer fewer loopholes → Reduces incentives for tax planning or shifting income to avoid tax → Increases effective tax collection → Improves government revenue and fiscal stability over time

Answer 10

a single percentage income tax rate applied to all taxpayers regardless of income

Answer 11

🔹 Microeconomic Disadvantages 1️⃣ Regressive Effect – Increased Income Inequality A flat tax applies the same rate to all incomes, meaning low-income earners pay a higher proportion of their disposable income compared to high earners. This reduces their ability to afford essential goods and services, leading to lower living standards for the poorest in society. As income inequality rises, there may be greater social tensions, increasing pressure for welfare spending or tax reforms. 2️⃣ Reduction in Government Revenue for Public Services Progressive tax systems allow governments to collect more revenue from high earners, which helps fund education, healthcare, and welfare programs. A flat tax often reduces total tax revenue, leading to cuts in essential public services that benefit lower-income groups the most. Over time, underfunded infrastructure and public services can reduce overall economic efficiency and productivity. Reduced Incentives for Work Among Low Earners Without lower tax bands or exemptions for low-income workers → Flat tax may reduce post-tax earnings for the poorest → This weakens the incentive to enter or remain in the workforce → May increase dependency on benefits and reduce labour market participation. 🔹 Macroeconomic Disadvantages 5️⃣ Worsened Income Distribution and Lower Social Mobility With wealthier individuals benefiting more from a flat tax system, wealth concentration increases over time. This can lead to reduced opportunities for low-income individuals, as government investment in education and social mobility programs declines. Over time, widening inequality can reduce economic stability and increase demand for redistributive policies. 6️⃣ Potential Budget Deficits or Need for Spending Cuts If the flat tax leads to lower overall government revenue, the government may need to cut spending on public goods or increase borrowing. If spending is cut in areas like education and infrastructure, long-run economic growth may suffer due to lower productivity. If borrowing increases, this may lead to higher debt servicing costs, crowding out other areas of government spending. 7️⃣ Negative Impact on Consumer Spending and Aggregate Demand If a flat tax increases the tax burden on middle- and lower-income households, consumer spending falls, as they have a higher marginal propensity to consume. Lower consumer spending reduces aggregate demand (AD), leading to lower short-run economic growth. If businesses see weaker demand, they may reduce investment, slowing down long-run growth potential. 8️⃣ Risk of Fiscal Instability in Economic Downturns Progressive tax systems act as an automatic stabilizer—when incomes fall, tax payments fall proportionally, softening the impact of recessions. A flat tax reduces this stabilizing effect, making economic downturns more severe as government revenue falls sharply. Without sufficient fiscal flexibility, the government may have to raise taxes or cut spending during a downturn, making the recession even worse. 9️⃣ Less Room for Targeted Fiscal Policy Progressive tax systems allow governments to adjust tax bands and deductions to address specific economic or social issues. A flat tax removes this flexibility, making it harder to implement targeted fiscal policies during economic crises. Governments may have fewer policy tools to respond to macroeconomic shocks, leading to greater instability.

Answer 12

💰 1. Increases Government Revenue → More Public Investment → Boosts Long-Term Growth Higher direct taxes (like income/corporation tax) raise revenue → Government has more funds to invest in healthcare, education, or infrastructure → Improves productivity and human capital in the long run → Supports sustainable economic growth and development 📉 2. Helps Reduce Budget Deficit → Lower Borrowing → Improves Fiscal Stability Increased direct tax receipts reduce reliance on borrowing → Cuts down the budget deficit → Improves government credit rating and reduces debt interest payments → Creates long-term fiscal space for counter-cyclical policy ⚖️ 3. Promotes Income Redistribution → Reduces Inequality → Supports Inclusive Development Progressive direct taxes (e.g. higher income tax on the wealthy) reduce income disparities → Government can redistribute income through welfare schemes or public services → Increases access to opportunities for low-income households → Supports equitable development and reduces social unrest 📊 4. Helps Control Demand-Pull Inflation → Slower Consumption → AD Stabilised Higher direct taxes reduce disposable income → Consumers cut back on spending → This can help reduce excess demand in the economy → Keeps inflation under control and stabilises the macroeconomic environment

Answer 13

🧍‍♂️ 1. Disincentive to Work → Lower Labour Supply → Lower Output → Slower Growth Higher income tax reduces the post-tax reward for working → May discourage individuals from working extra hours or entering the workforce → Labour supply and productivity fall → Reduces potential output and GDP growth 🏢 2. Reduced Investment → Slower Capital Accumulation → Lower Productivity → Weaker Long-Term Growth Higher corporation tax lowers retained profits for firms → Reduces internal funds available for investment in capital and innovation → Slows improvements in productivity → Damages long-term supply-side growth 🌍 3. Capital Flight Risk → Lower Investment → Currency Depreciation → External Instability High direct taxes may encourage wealthy individuals and firms to move capital abroad → Reduces domestic investment and weakens financial markets → Capital outflows can cause currency depreciation → Leads to inflation and macroeconomic instability 📉 4. Reduced Disposable Income → Lower Consumption → Negative Multiplier → Lower Real GDP Households have less income after tax → Consumption, a key component of AD, falls → Triggers a negative multiplier effect → Slows economic growth and worsens living standards 📉 5. Impact on Business Confidence → Delayed Expansion → Slower Job Creation → Development Impact Tax hikes signal a less business-friendly environment → Firms may delay expansion or hiring → Reduces employment opportunities → Slows improvements in living standards and worsens poverty

Answer 14

🔹 Macroeconomic Advantages 6️⃣ Boosting Government Revenue Without Raising Direct Tax Rates Raising indirect taxes provides a way for the government to increase revenue without the need to increase direct taxes like income or corporate taxes, which could negatively impact incentives to work or invest. This additional revenue can be used to fund government programs without worsening the economy's overall tax burden. 7️⃣ Encouraging Domestic Production of Goods Higher taxes on imports (such as import tariffs) make imported goods more expensive, encouraging consumers to purchase domestic goods instead. This can stimulate the domestic economy, promote local production, and reduce reliance on foreign goods, which can help improve the trade balance (reducing the current account deficit). 8️⃣ Addressing Market Failures and Externalities By raising indirect taxes on goods that cause negative externalities, such as pollution or unhealthy food products, governments can use taxes as a tool to internalize the cost of these externalities. This leads to more efficient market outcomes, as the prices of harmful goods reflect the social cost of their consumption, ultimately reducing their negative impact on society. 9️⃣ Demand Management and Economic Stabilization Raising indirect taxes can be used as a tool to manage inflation or reduce excess demand in an overheated economy. By increasing the prices of goods, consumer spending may decrease, leading to lower demand-pull inflation. This can be particularly useful during periods of economic overheating or when an economy is experiencing unsustainable growth.

Answer 15

🧺 1. Regressive Impact → Disproportionately Affects Low-Income Households → Worsens Inequality → Reduces Development Indirect taxes (like VAT) are charged at the same rate regardless of income → Low-income households spend a larger proportion of their income on taxed goods → Increases income inequality and reduces disposable income for the poor → Hinders inclusive development and worsens living standards 📉 2. Reduced Consumer Spending → Lower Aggregate Demand → Slower Economic Growth Higher indirect taxes increase the final price of goods and services → Reduces real purchasing power and consumption, especially for essentials → Falls in consumer demand reduce aggregate demand (AD) → May lead to lower GDP growth, especially in consumer-driven economies 🏭 3. Higher Costs for Firms → Reduced Competitiveness → Fall in Exports/Output Indirect taxes increase the cost of raw materials and intermediate goods → Raises firms' costs, especially in manufacturing and export industries → Reduces international price competitiveness → Can lead to job losses and lower productive capacity 🔁 4. Cost-Push Inflation → Lower Real Incomes → Wage-Price Spiral Risk Tax-induced price increases (e.g., VAT hikes) raise the general price level → Real incomes fall as wages lag behind price rises → May trigger wage demands, increasing costs for businesses again → Leads to persistent inflation and economic instability

Answer 16

an indirect tax which is regressive. is at 20%

Answer 17

19%, lowered from 20% 32% from apr 2025

Answer 18

💷 1. Wage Rates Lower wage rates reduce production costs for labour-intensive firms → Increases profit margins for MNCs in sectors like textiles or manufacturing → Makes host country more attractive for FDI seeking cost-efficiency → Leads to relocation of production from high-wage to low-wage economies 🧠 2. Labour Skills / Human Capital A skilled workforce improves productivity and quality of output → Attracts FDI in high-tech or knowledge-intensive industries (e.g., IT, biotech) → Reduces training costs and risk of operational inefficiency → Encourages long-term investment in human capital-rich economies 🏦 3. Tax Rates Lower corporation tax increases post-tax profitability of investment → Acts as a financial incentive for MNCs to locate in low-tax jurisdictions → Can create tax competition between countries to attract FDI → Too low, however, may raise concerns over sustainability or fairness 🛣️ 4. Transport and Infrastructure Efficient infrastructure (roads, ports, telecoms) reduces logistical delays → Enables smoother supply chains and access to domestic & global markets → Increases investor confidence in operational efficiency → Poor infrastructure can deter FDI due to higher delivery costs and delays 📈 5. Size of Economy / Growth Potential Large or rapidly growing economies offer greater market size → Increases demand for goods/services → higher expected returns on investment → Attracts FDI aiming to access consumer markets (e.g., India, Brazil) → Small or stagnant economies may be overlooked by market-seeking FDI 🗳️ 6. Political Stability / Property Rights Political instability increases risk of expropriation or abrupt policy changes → Undermines investor confidence and deters long-term FDI → Strong legal systems and enforceable property rights build trust → Countries with rule of law attract more consistent and higher-value FDI ⛏️ 7. Availability of Commodities / Natural Resources Resource-rich countries attract FDI in extraction industries (oil, minerals) → Offers secure access to vital inputs for global production → However, may lead to "resource curse" if poorly managed → Strategic resource access can drive vertical integration of MNCs 💱 8. Exchange Rate Stability and Value Stable exchange rates reduce currency risk for foreign investors → Depreciated local currency reduces relative cost of investment → But fear of further depreciation may increase repatriation risk → Volatile or overvalued currencies may deter FDI due to uncertainty 🏭 9. Clustering and Agglomeration Economies FDI is attracted to areas with existing industry clusters (e.g., Silicon Valley) → Benefits from shared suppliers, labour pools, and innovation spillovers → Reduces start-up risks and encourages collaboration → Lack of clusters may increase operational and recruitment difficulties 🌍 10. Access to Free Trade / Trade Agreements Being in a customs union or FTA (e.g., EU, USMCA) gives access to wider markets → Encourages "tariff-jumping" FDI seeking to bypass trade barriers → Facilitates export-oriented investment and supply chain integration → Protectionist regimes may discourage FDI due to restricted market access

Answer 19

refers to the practice of determining the price at which goods or services are bought and sold between related companies, such as subsidiaries of the same multinational corporation operating in different countries

Answer 20

to allocate the profits earned by the multinational corporation among its different subsidiaries, based on the value they contribute to the overall business.

Answer 21

1️⃣ Governments can enforce antitrust laws to prevent monopolies or abusive practices by large global firms → Protects local SMEs from being driven out of the market → Encourages competition, innovation, and efficient resource allocation → Promotes long-term inclusive development and economic diversification 📌 Evaluation: Some MNCs operate in multiple jurisdictions, making enforcement of competition laws difficult without global cooperation. 2️⃣ Tax Regulations & Corporate Taxation → Reduce Profit Shifting → Ensure Fair Tax Contributions → Boost Government Revenue Global companies often shift profits to low-tax countries (e.g., through transfer pricing). Governments implement minimum corporate tax rates (e.g., OECD’s Global Minimum Tax at 15%) to prevent tax avoidance. This increases government revenue, which can be reinvested into public services and infrastructure. Reducing tax avoidance also creates a level playing field between MNCs and domestic businesses. 📌 Evaluation: If tax rates are too high, firms may relocate headquarters to tax-friendly jurisdictions, reducing the effectiveness of such policies. 3️⃣ Environmental & Labour Regulations → Prevent Exploitation → Improve Working & Environmental Standards → Enhance Sustainability Governments impose stricter labour laws to prevent poor working conditions and exploitation in factories. Environmental laws (e.g., carbon taxes, pollution limits) ensure companies reduce negative externalities like emissions. This leads to more ethical and sustainable business practices, benefiting both workers and the environment. Companies that comply with these regulations may benefit from stronger brand reputation and consumer loyalty. 📌 Evaluation: If regulations are too strict, MNCs may offshore production to countries with weaker environmental and labour laws. 4️⃣ Trade Policies & Tariffs → Limit Market Dominance → Protect Domestic Industries → Maintain Economic Sovereignty Governments impose tariffs and quotas to prevent MNCs from undercutting domestic firms through low-cost production. This protects local industries, ensuring job security and economic stability in certain sectors. It prevents over-reliance on global companies, reducing risks associated with foreign control of key industries. Ensuring economic sovereignty allows nations to shape their own industrial policies without excessive foreign influence. 📌 Evaluation: Overprotection can lead to reduced competition, making domestic firms inefficient and less innovative. 5️⃣ International Agreements & Cooperation → Strengthen Global Oversight → Prevent Exploitation → Standardise Regulations Bodies like the United Nations (UN), WTO, and IMF enforce international agreements to regulate MNC behaviour. Agreements on corporate responsibility, climate change, and fair trade prevent companies from exploiting regulatory loopholes. This ensures global fairness, reducing the race to the bottom, where countries compete by lowering standards. Standardised regulations make it harder for MNCs to bypass rules through legal loopholes. 📌 Evaluation: International cooperation can be slow, as different nations have conflicting economic interests.

Answer 22

when aid is given from one government to another government

Answer 23

when aid is diverted through an international organisation eg IMF - theyll then decide who needs aid the most then the aid will be distributed between those who need it the most

Answer 24

💰 1. Raise government revenue Governments impose taxes on goods, income, or profits → This provides the state with essential funding → Revenue is used to finance public goods like healthcare, education, and defence → Improves social welfare and economic stability 🏥📚 🧾 2. Correct market failure (e.g. negative externalities) A tax can be placed on demerit goods like cigarettes or petrol → This internalises the external cost of consumption/production → Leads to higher prices and lower quantity demanded → Helps bring the market closer to the socially optimum level ⚖️ 💸 3. Redistribute income and reduce inequality Progressive taxes take a higher proportion from higher incomes → Allows redistribution through welfare payments and public services → Reduces income and wealth inequality → Promotes social cohesion and inclusive growth 🧍‍♀️🧍‍♂️ 📉 4. Manage demand in the economy (fiscal policy) Higher taxes reduce disposable income → Consumption falls, reducing aggregate demand → Helps control demand-pull inflation during boom periods → Used as a stabilisation tool in macroeconomic management 📊

Answer 25

💼 1. Job creation TNCs set up production plants or offices in host countries → Local workers are employed across various skill levels → Incomes rise, improving living standards → Reduces unemployment and stimulates local economies 💸 2. Increased investment and infrastructure TNCs often invest in roads, energy, and communications to support their operations → Improves national infrastructure for both firms and citizens → Attracts further foreign and domestic investment → Boosts long-term economic growth potential 📈 3. Technology and skill transfer TNCs introduce advanced production techniques and training → Local workers and firms gain knowledge and skills → Increases labour productivity and innovation → Supports the development of human capital in the long run 🌍 4. Improved access to global markets TNCs integrate host countries into global supply chains → Domestic firms can become suppliers or partners → Encourages specialisation and export-led growth → Improves the balance of payments over time

Answer 26

⚖️ 1. Exploitation of labour TNCs may seek to lower costs by paying low wages in poorer countries → Workers may face poor working conditions and limited rights → Increases income inequality and worker dissatisfaction → Limits long-term social and economic development 💰 2. Repatriation of profits Profits made in the host country are often sent back to the TNC’s home country → Reduces the money circulating within the domestic economy → Limits tax revenue and reinvestment in local development → Hinders sustainable economic growth 🏭 3. Environmental degradation TNCs may exploit natural resources with limited regulation → Leads to pollution, deforestation, and habitat destruction → Harms public health and long-term ecological sustainability → Increases the burden on governments to clean up damage 🧠 4. Limited technology diffusion TNCs might use technology without sharing key expertise → Local firms struggle to compete or innovate independently → Host country remains dependent on foreign knowledge → Slows down industrial and technological development

Answer 27

🏛️ 1. Strong welfare state The government provides universal benefits like healthcare, education, and pensions → Improves human capital and reduces inequality → Increases labour productivity and social cohesion → Boosts long-term economic growth and stability 🤝 2. High union density and cooperation Strong trade unions cooperate with employers and government in wage-setting → Leads to wage compression and reduced income inequality → Maintains industrial peace and labour market flexibility → Increases trust and resilience during economic shocks 💼 3. Active labour market policies Government provides retraining, job search support, and unemployment insurance → Reduces structural unemployment and helps workers transition between jobs → Increases workforce adaptability to economic changes → Maintains high employment levels and productivity 💸 4. High taxation to fund public services Progressive taxes on income and consumption fund generous public services → Redistributes income and funds high-quality infrastructure → Encourages social mobility and reduces poverty → Can increase long-run efficiency by correcting market failures

Answer 28

🧑‍⚕️ 1. Welfare Provision Nordic: Universal welfare services like healthcare, education, and childcare → Increases human capital and equality of opportunity → Reduces poverty and improves living standards → Boosts long-run growth through a healthier, educated workforce USA: Targeted welfare and largely private healthcare → Lower public spending but higher inequality → May reduce access to healthcare/education for low-income groups → Could harm long-term productivity and social mobility 💰 2. Taxation Nordic: High progressive taxes on income and consumption → Funds generous welfare programs → Reduces post-tax income inequality → But may disincentivise high earners or FDI if taxes are seen as excessive USA: Lower taxes and more tax competition → Encourages entrepreneurship and higher post-tax income → But limited public funding for social programs → Greater income inequality and underinvestment in public goods 🧑‍🔧 3. Labour Market Structure Nordic: Coordinated wage bargaining and strong unions → Wage compression and low inequality → High trust and fewer strikes → May reduce reward for top talent or innovation USA: Flexible labour markets with weaker unions → Greater wage differentials and “hire and fire” culture → Encourages competition and high rewards → But can increase job insecurity and working poverty 📊 4. Income Inequality & Social Mobility Nordic: Low income inequality and high social mobility → Strong safety nets and access to services → Reduces crime and increases social cohesion USA: High income inequality and lower social mobility → Education and healthcare often depend on income → Can entrench poverty across generations

Answer 29

💸 1. Higher Interest Payments As national debt increases, the government must pay more interest on its debt → These interest payments become a larger portion of government expenditure → Leaving less room for public investment in areas like infrastructure, healthcare, and education → Limiting long-term economic growth and the government’s ability to stimulate the economy. 🏦 2. Crowding Out of Private Investment When the government borrows heavily, it competes with the private sector for loanable funds → This increases interest rates, making borrowing more expensive for businesses → Firms may reduce investment in capital, R&D, or expansion → Slowing down productivity growth and economic development. ⚖️ 3. Reduced Fiscal Flexibility A high national debt limits the government’s ability to respond to future economic crises (e.g. recessions or natural disasters) → With large debt obligations, governments may be forced to implement austerity measures → Cutting essential public services or increasing taxes → Reducing social welfare and potentially causing public unrest. 🏚️ 4. Risk of Sovereign Debt Crisis If national debt becomes unsustainable, investors may lose confidence and demand higher interest rates → This increases the likelihood of a sovereign debt crisis, where the government cannot meet its debt obligations → Leading to defaults or restructuring, damaging the country’s credit rating → Spelling further economic instability, loss of investor confidence, and potential for recession.

Answer 30

STRUCTURAL: 🏭 1. High Government Spending Some governments have a high level of expenditure on welfare, public services, and infrastructure → Structural factors like an aging population can lead to increased spending on pensions and healthcare → This creates a persistent gap between government revenue and expenditure → Leading to a structural budget deficit that doesn’t disappear even during periods of economic growth. 💸 2. Insufficient Tax Revenue If a country’s tax system is inefficient or poorly designed, it may fail to generate sufficient revenue → For example, high levels of tax evasion, low tax rates on capital, or informal economies → This leads to a chronic shortfall in government income → Contributing to a structural deficit as the government continually spends more than it collects. 🏚️ 3. Dependence on Borrowing Some governments rely heavily on borrowing to finance long-term projects or cover gaps in income → This dependence on debt may stem from historical budget deficits or a lack of alternative funding sources → Over time, interest payments on debt can become a significant part of government expenditure → Sustaining a structural deficit as borrowing to finance the deficit becomes a routine method of operation. 🏛️ 4. Economic Structure and Development Model In some economies, there’s a structural reliance on industries or sectors with low profitability or limited tax revenue potential → For instance, reliance on agriculture or basic manufacturing in developing economies may result in lower tax yields → This can perpetuate low revenue generation, contributing to a consistent structural budget deficit → Which is hard to resolve without major structural shifts in the economy. CYCLICAL: 📉 1. Economic Recession During a recession, economic output falls, and unemployment rises → This leads to lower tax revenues as businesses earn less and fewer people are employed → Simultaneously, government spending on welfare, unemployment benefits, and stimulus increases → Creating a cyclical budget deficit that typically improves once the economy recovers. 💼 2. Reduced Consumer and Business Confidence In times of economic uncertainty, both consumers and businesses cut back on spending → This results in lower demand for goods and services, leading to lower tax receipts → At the same time, government spending may rise to stimulate the economy (e.g., stimulus packages, public works) → Causing a temporary cyclical budget deficit until confidence is restored and the economy picks up. 🏚️ 3. Falling Tax Revenue During Economic Downturns Economic downturns result in reduced incomes and corporate profits → This reduces the overall tax base, leading to lower government revenue from income tax, VAT, and corporate tax → In contrast, government spending on social benefits and support programs often rises → Leading to a cyclical deficit that is expected to resolve once economic growth resumes. 🏛️ 4. Increased Government Spending on Stabilization Measures Governments may increase public spending during economic slowdowns to stimulate demand (e.g., through infrastructure projects or social support) → These measures are intended to boost economic activity and reduce unemployment → However, they often lead to higher short-term government expenditure, especially if tax revenue is falling → Resulting in a cyclical budget deficit that is expected to close once the economy recovers.

Answer 31

📊 1. Inaccurate Information Governments base policy decisions on economic data such as GDP, inflation, and unemployment → If data is outdated, misreported, or incomplete, it can lead to poor policy choices → For example, underestimating inflation might result in interest rates being kept too low → This could overstimulate demand and worsen inflation, undermining macroeconomic stability ⚠️ 2. Risks and Uncertainties Economic agents may behave unpredictably in response to policy changes → For instance, consumers might save instead of spending after a tax cut if confidence is low → This uncertainty limits the effectiveness of demand-side policies like fiscal stimulus → It makes it harder for governments to achieve desired outcomes, such as boosting AD or employment 🌍 3. Inability to Control External Shocks Policymakers often can’t prevent global events like oil price spikes, financial crises, or pandemics → Such shocks can cause supply-side inflation or reduce exports and investment flows → For example, an oil price shock may raise production costs and inflation, making monetary policy less effective → This reduces the ability of domestic policies to maintain stable growth, employment, and living standards

Answer 32

💰 Economic Growth Rate → Fiscal Deficit Slower economic growth reduces tax revenues from income, profits, and consumption → Government collects less revenue but may need to spend more on welfare and stimulus → Budget deficit widens as expenditure exceeds revenue → Fiscal deficit size increases 📉 Government Spending Levels → Fiscal Deficit Higher government spending on public services, welfare, or infrastructure → Increases total government expenditure without immediate revenue increase → Budget deficit grows if tax revenue doesn’t rise correspondingly → Larger fiscal deficit results 🔺 Interest Rates on Government Debt → Fiscal Deficit Rising interest rates increase the cost of servicing existing government debt → More government revenue diverted to interest payments rather than public services → Higher expenditure without revenue growth widens budget deficit → Fiscal deficit expands 🔄 Automatic Stabilizers (Unemployment Benefits, Welfare) → Fiscal Deficit In economic downturns, more people claim benefits, increasing government spending automatically → Tax revenues fall due to lower incomes and profits → Automatic stabilizers increase expenditure and reduce revenue simultaneously → Fiscal deficit naturally grows during recessions

Answer 33

💸 Persistent Fiscal Deficits → National Debt If a government runs frequent or large budget deficits → It must borrow to cover the shortfall, usually by issuing government bonds → Each year’s deficit adds to the total stock of debt → Over time, the national debt increases 📈 Interest Rates on Existing Debt → National Debt Rising interest rates increase the cost of servicing existing government debt → Government must borrow more to meet interest payments if revenues don't increase → This adds to the debt stock, especially with compound interest → National debt grows faster 🏥 Aging Population → National Debt Older populations increase pressure on public pensions and healthcare services → Government spending rises without matching tax revenue → Leads to long-term structural deficits and more borrowing → National debt increases steadily over time 🌍 Economic Growth Rate → National Debt (as % of GDP) Slower or negative economic growth reduces tax revenues → Government struggles to reduce deficits or pay off debt → Debt-to-GDP ratio rises even if borrowing stays constant → National debt appears larger relative to economic output 💼 Bailouts, Crises, and Emergency Spending → National Debt Financial crises or wars often require huge, unplanned spending (e.g. COVID-19) → Governments borrow heavily to fund stimulus, healthcare, or bailouts → Short-term spikes in borrowing lead to large increases in national debt → National debt rises sharply in the aftermath of crises

Answer 34

government interventions that directly impact specific goods, services, or Examples of Direct Controls: Price controls: Maximum prices (price ceilings) or minimum prices (price floors) on goods or services. Quotas: Limits on the amount of goods that can be imported or exported. Regulations: Rules and guidelines that govern the production, pricing, and distribution of goods. Minimum wage laws: Setting a minimum wage for labor. Objectives of Direct Controls: Preventing inflation: Direct controls can be used to control prices and prevent excessive price increases. Correcting market failures: Direct controls can be used to address issues like externalities (e.g., pollution) or to ensure a more equitable distribution of resources. Promoting specific industries: Direct controls can be used to encourage investment in particular sectors or to protect domestic industries from foreign competition. Examples of situations where direct controls might be used: Controlling inflation during a crisis: Governments might impose price controls on essential goods to prevent price gouging during a crisis like a natural disaster. Protecting consumers: Minimum wage laws aim to protect low-wage workers by setting a minimum acceptable wage. Addressing environmental concerns: Regulations on pollution emissions can help protect the environment. Potential Drawbacks of Direct Controls: Distortions in the market: Direct controls can create inefficiencies and disincentives for producers and consumers. Black markets: Price ceilings, for example, can lead to the development of black markets if the price is set too low. Bureaucracy: Implementing and enforcing direct controls can be costly and bureaucratic.

Answer 35

Transfer pricing is when TNCs manipulate prices of intra-firm transactions to shift profits to low-tax countries. Governments regulate this using transparency rules and audits.

Answer 36

1️⃣ 📈 Higher Debt Interest Payments → Opportunity Cost Large national debt → government must allocate more revenue to interest payments → UK debt interest hit ~£100bn in 2023 (ONS) → less available for public services (e.g., NHS, education) → Reduced investment in human capital/infrastructure → long-term development hindered → Slower improvements in living standards 2️⃣ 📉 Crowding Out of Private Investment To finance debt, government borrows by selling bonds → increases demand for loanable funds → Raises interest rates in capital markets (especially if demand is inelastic) → Private firms face higher borrowing costs → reduced investment in productive capacity → Long-run growth and job creation fall 3️⃣ 🧾 Pressure to Raise Taxes or Cut Spending Persistent high debt → government may raise taxes or reduce spending to balance budget → Higher taxes reduce disposable income and consumption → AD falls → Cuts to welfare or education worsen inequality and reduce long-term development outcomes 4️⃣ ⚠️ Reduced Fiscal Space During Crises A country with large debt may lack flexibility in emergencies (e.g., pandemics, wars) → Less room to borrow and stimulate economy without risking investor confidence → Slower or weaker crisis response → greater long-term economic and social damage 5️⃣ 🧨 Risk of Sovereign Debt Crisis Very large debt (e.g., >120% of GDP) may raise fears of default → Investors demand higher bond yields or stop lending altogether → Currency falls, capital flight increases, and economy may need bailout (e.g., Greece 2010s) → Severe cuts to spending worsen development 6️⃣ 🇬🇧 Weaker Credit Rating Credit agencies (e.g., Moody’s, S&P) may downgrade government bonds if debt seen as unsustainable → Increases cost of borrowing further due to higher yields demanded → Vicious cycle of rising debt servicing → budget cuts → reduced growth 7️⃣ 🔁 Debt Overhang → Reduced Confidence Large debt creates expectations of future austerity or tax rises → Firms delay investment and households reduce consumption → Slower growth and productivity gains → worsens debt-to-GDP ratio further → Development progress stagnates 8️⃣ 🪙 Potential for Inflation (Especially if Debt Monetised) If central bank is pressured to finance debt (monetary financing or QE used irresponsibly) → Too much money chasing fewer goods → inflation rises → Real incomes fall, especially hurting the poor → worsens inequality and development indicators 9️⃣ 🌍 External Vulnerability in Emerging Markets Developing countries often borrow in foreign currencies → large debt exposes them to FX risk → If local currency depreciates, cost of repayments soars → Can lead to IMF bailouts with strict conditions → cuts in health, education, subsidies → Negative impact on HDI and long-term development

Answer 37

🔗 Chain 1: Higher Borrowing → Higher Interest Payments → Opportunity Cost A large fiscal deficit requires more government borrowing → National debt increases → interest payments rise → Less money available for investment in infrastructure or education → Slower long-run growth and development 🔗 Chain 2: Increased Borrowing → Crowding Out → Lower Private Investment Government sells more bonds to finance deficit → Raises interest rates in financial markets → Private firms find it more expensive to borrow → investment falls → Slower productivity growth and employment creation 🔗 Chain 3: Debt and Deficit → Risk to Investor Confidence → Currency Depreciation Investors worry about fiscal sustainability → May sell off assets → capital flight → Exchange rate falls → imported inflation → Lower real incomes → reduced consumer confidence and development 🔗 Chain 4: Higher Deficit → Pressure to Raise Taxes or Cut Spending Governments may respond to large deficits by raising taxes or cutting welfare → Higher taxes reduce disposable income → AD falls → Cuts to education and health undermine human capital → Negative long-term development impacts 🔗 Chain 5: Debt → Reduced Fiscal Space → Weak Emergency Response If debt is already high, governments have limited capacity to respond to future crises → Delayed stimulus during recessions (e.g., pandemic) → Longer economic downturns, more unemployment and poverty 🔗 Chain 6: Large Deficits → Rating Downgrades → Higher Borrowing Costs Credit rating agencies may downgrade the country’s bonds → Investors demand higher yields to compensate for risk → Further increases debt servicing burden → feedback loop 🔗 Chain 7: Persistent Deficits → Inflation Risk (in some contexts) If government uses central bank financing (QE/printing money), money supply rises → More demand without supply-side increase → demand-pull inflation → Damages real incomes and price stability 🔗 Chain 8: External Debt → Foreign Exchange Pressure in Developing Countries Many EMDEs borrow in USD → if local currency weakens, repayments become costlier → Risk of default or IMF intervention with austerity conditions → Hurts education/health spending → worsens HDI 🔗 Chain 9: Deficits Can Be Positive If Used for Productive Investment (Evaluation chain) If borrowing funds are used for growth-enhancing infrastructure (e.g. HS2, broadband) → Boosts LRAS and productivity → tax revenues rise over time → Debt/GDP falls in the long run → sustainable development

T4 - Role of the state in the macroeconomy Flashcards

(61 cards)