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Flashcards in Theme 4 Deck (58):

Trade liberalisation vs. protectionism

Protectionism => import substitution - as there is a reduced ability for consumers to import foreign goods, they must substitute these for now cheaper domestic goods
Trade liberalisation => economic theory suggests that in the long run, output and growth of output will be lower than it would otherwise have been as the country cannot benefit from specialisation & protectionism leads to dynamic inefficiency because there is no incentive to reduce costs or improve products as the there is a lack of foreign competition - opposite for liberalised trade


Problems with subsidies

- poorly targeted if everyone in the population can buy the good (both rich and poor benefit) as it widens the income gap
- economic theory would suggest that welfare would probably be higher if poor households were given cash payments rather than subsidies, since this would allow them, as rational consumers, to make the spending decision in their own best interest
- large opportunity cost may develop
- can become a major source of corruption internationally, involving smuggling due to different costs e.g. fuel from Venezuela
- the eventual removal of subsidies can be problematic => can be alright if removal is during fall in market price for instance


+/- of floating ER system

+ no intervention required & no worries about gold and foreign currency reserves
- volatile currency -> may deter investors who prefer stability & can lead to large swings in macroeconomic variables like X and M which may damage a country's economy, especially if it is reliant on exports for instance


What is a tiered ER system and why does it not work in reality

It looks to fix a number of different ERs, for instance different ones for M and X.
Generally does not work because of: black markets, imperfect information, corruption


+/- of developing a financial sector

Consumers/firms/government must be able to save and borrow money to increase its spending power, as well as enabling the transferring of assets and liabilities from now into the future and having insurance - saving facilitates borrowing.
HOWEVER: unlikely to be successful with very low-income households - solution might be microfinance & mobile phone banking services


+/- of FDI and joint ventures

+ inflows of FDI add to the resources which can be given over to investment, helping to close an savings gap* or foreign currency gap* and associated transfers of knowledge to add to human and physical capital
- can be associated with exploitation of smaller firms


+/- of privatisation

+ market forces result in firms cutting their average coasts to a minimum leading to productive efficiency
- privatised monopolies face no competitive pressure & there may be corruption in the process of privatisation


+/- of buffer stock schemes

+ encourages firms to invest by stabilising (commodity) prices & prevents sharp falls in prices, that may send the poorest farmers into absolute poverty through net falls in income & consumers will also benefit from less price volatility
- hight capital, administrative and transport cost & those funding the stock must feel there are sufficient gains for themselves as there may be positive externalities towards third parties & minimum prices tend to be set too high, which is unsustainable in the long term & may be issues with deterioration of food stocks for instance


Explain the Lewis Model

The industrialisation of the economy can be seen as an objective of development. Assuming that marginal workers in rural areas add nothing to the output of the rural economy, the workers could gradually be transferred into the urban higher productivity sector - the rate of transfer dependent on the rate of capital accumulation in the modern sector of the economy


Issues with the Lewis Model

Causality - government built infrastructure ( => forced industrialisation) will not necessarily spark economic growth. It has tended to lead to a waste of scarce resources as these industries have failed.
Marginal workers cities often have as low incomes and be as underemployed as marginal workers in the countryside
=> encouraging rural depopulation will simply lead to urban poverty, not increased affluence.


+/- of primary industry development

+ can be advantageous as it leads to rapid economic growth with lots of exports and the exploitation of comparative advantage, particularly if this is followed by sufficient diversification of the economy
- is very risky due to the potential collapse of prices
- can lead to appreciation of the currency, which may price out domestic industries/consumers dependent on imports. Therefore, Norway has a sovereign wealth fund for instance <==== (preventing 'Dutch Disease')


+/- of tourism

+ tourism (high YED) is an export, resulting in a net inflow of money into a country. *tourism was the first/second most important source of X earnings in 20 out of the world's 48 least developed countries
+ uses natural/existing assets
+ labour intensive, creating lots of employment which does not necessarily require much training
+ can create a significant multiplier effect
- local inhabitants feel more economically inferior
- can degrade local culture and environment
- too much focus can lead to a lack of diversification in the economy


+/- of fair trade

+ producers receive a fair + certain price -> community may be aided also in the process
+ communities do benefit according to studies
+ it is growing rapidly *2013, over 1.5 million farmers and workers were in fair trade certified producer organisations = a fraction of the total
- retailers simply want to appear ethical, whilst there is a limited real impact
- those not part of the schemes worse off
- raising the price of fair trade commodities may encourage producers to grow more, leading to falls in the price of non-fair trade products


Reasons for foreign aid

> because citizens of developing countries have a very high MPC and a very low MPS, savings are below the level of investment needed to generate high economic growth, with high capital inflows helping to fill this savings gap
> FOREX may be very scarce, therefore insufficient to cover imports of machinery etc., meaning that the foreign aid can be used to cover the trade gap
> can be used for countries that find it difficult to attract private capital funding


4 forms of aid

1) Grants - sum of money for a development project for instance
2) Loans - can be at either commercial rates of interest or a soft loan
3) Tied aid - only available if the recipient country is prepared to purchase goods and services from the donor country (now illegal)
4) Bilateral and multilater aid


Criticisms of aid

>< benefits from aid are often spread unequally
>< aid agencies often lack sufficient knowledge to identify areas most in need of aid
>< results in over dependence
>< tied foreign aid is likely to give the recipient countries bad deals
>< loan repayment issues usually arise


What happens with debt relief

Forces countries to adopt fiscal austerity policies and could not borrow much more because they were already so indebted and had to export more than they import in order to earn the foreign currency to make repayments on debt


What happens with debt relief

Forces countries to adopt fiscal austerity policies in return for total or partial clearing of debt


+/- of debt relief

+ works if debts were relatively small
+ debt may be limiting growth
+ in the case of world debt crises, IR payments had already exceeded the value of original debt
+ people were paying for past mistakes
- moral hazard
- debt relief eased pressure on weak governments to adopt more stern policies
- cost of tied economic reform is huge


Impact of globalisation on consumers

Increased choice
Prices have increased in some areas, with increased demand due to higher incomes putting upwards pressure on prices
Incomes have generally increased due to greater productivity although some areas have lost out due to outsourcing


Reasons for international trade

1. Differences in factor endowments: e.g. Saudi oil
2. Price + comp. advantage: some countries can produce goods at a lower price/with a lower opportunity cost
3. Product differentiation: preference similarity theory, demanding a wide range of goods
4. Political reasons


Reasons for changes in the pattern of international trade

1. Impact of emerging economies: will increase both inflow and outflow of trade from that country
2. Growth of trading blocs and bilateral trading agreements: trade creation and trade diversion
3. Changes in relative ERs *(chain of reasoning): will affect relative prices of goods between countries


Eval of comparative advantage

1. It assumes no transport costs, which, although becoming more accurate with improved communications, is still not a realistic image of global trade
2. Assumes that traded goods are homogeneous - only the case for commodities perhaps, very few other goods
3. Assumes no tariffs or trade barriers - only the case in very well integrated economic areas e.g. monetary union


Index of terms of trade

((index of export prices)/(index of import prices)) x 100


What is it called when the value of terms of trade increases/decreases

T of T said to improve when its value increases i.e. when export prices rise relative to import prices and deteriorate vice versa.


SR factors influencing the terms of trade

1. Changes in the ER -> rise in the ER will lead to fall in the price of imports, therefore improvement in the T of T
2. Rise in inflation relative to trading partners is likely to improve the terms of trade => everything becomes more expensive domestically, increasing the costs of exports for people abroad and reducing relative costs of imports.
3. Changes in demand for X and M


LR factors influencing the terms of trade

1. Rise in relative productivity is likely to lower export prices due to resultant lower costs of production = deterioration
2. Changes in global incomes - higher global income (or just in trading partners) will increase demand for exports, leading to an improvement in the T of T.


Effects of changes in the terms of trade on the current account on the balance of payments

1. Exports are price elastic: rise in export prices with price elastic demand for exports will lead to a fall in the value of exports => deterioration in the T of T but a worsening of the current account
2. Exports are price inelastic: rise in export prices will lead to an improvement in T to T and an improvement in the current account
3. Imports are price elastic: increase in import prices will lead to a deterioration in the T of T and an improvement in the CA position
4. Imports are price inelastic: rise in import prices will lead to a deterioration in the T of T and in the current account position


Preferential trade agreement

Tariff and other trade barriers are reduced on some but not all goods traded between member countries


Free trade areas

All tariffs and quotas are removed on trade in goods between member countries, with each member still able to impose its own tariffs and quotas on external imports


Customs union

Free trade (all F of P) inside + market seepage is prevented through a common external tariff + common regulatory framework over trade and standards of goods and services and capital


Monetary union

Share a currency, share a central bank, no autonomy over fiscal policy


WTO rules



Full economic integration

Operating like different regions in the same country


Static benefits

from the gains through specialisiation


Dynamic benefits

from increased competition and the transfer of resources


Advantages of monetary union for eurozone countries

+ fixed prices -> eliminates potential risk in trade as result of fluctuating relative prices.
+ reduced ER costs -> associated costs in currency exchange are cut
+ greater price transparency -> perfect information to a larger extent
+ greater ability to access the larger common market
+ inward investment -> investment into one of the countries of the EMU is an attractive prospect because it means that one can in turn freely invest into the other countries
+ longer term agenda -> the fact that there are several nations involved means that the ECB is able to discern short term from long term needs, thereby pursuing more longer term policy


Disadvantages of monetary union for eurozone countries

- transition costs -> costs of changing currencies for instance
- loss of policy independence -> no common policy which suits all countries
- inability to change value of currency -> different countries may be suited to different ER values.
- structural problems -> the fact that certain countries are better than others can lead to problems (however, different regions in the same country have different levels of prosperity as well)
- huge risk if the monetary union were to fall apart, collateral damage


Two functions of the World Trade Organisation

1. Increase levels of trade liberalisation
2. Enforcing the trade agreements that countries have signed


Criticisms of the WTO

>< allows rich countries to exploit developing countries' workers
>< allows the unsustainable exploitation of resources in poorer countries
>< forces countries to adopt free trade policies
>< gives ownership of world trading system to a few large countries and important TNCs.


Reasons for restrictions on trade

1) Infant industry argument - small firms need to be protected initially from larger foreign firms benefitting from E of S (however; governments often fail to pick winners, protected industries lack competitive pressure, more specific and targeted spending methods tend to be more effective)
2) Job protection (consumers lost out on price and range of choices - preference similarity theory)
3) Dumping - prevent foreign firms/countries from undercutting domestic businesses through anti-competitive practices
4) Cheap labour - countries with high labour coasts will find it difficult to compete with countries that have chapter labour
5) *Terms of trade - the imposition of a tariff will reduce demand for imported goods and this in turn will lead to a fall in the price of imported goods, improving the terms of trade. Also, one can view there to be a negative externality in the purchasing of imports to society
=> optimal tariff argument


What are the most important components of the balance of payments

Current, financial and capital account:
1. Net trade in goods and services & investment incomes & net transfers
2. Part of FDI flows, portfolio investment, other investment
N.B. balancing item


+/- of international capital flows

+ facilitates growth in world trade
+ provides capital for firms that would otherwise not be able to secure finance within their own countries
+ allows transfers of tech and info
- world economy more susceptible to economic shocks due to increased interdependence
- excessive FDI can make MNCs too powerful
- availability of international credit encourages governments/firms/individuals to borrow


Causes of surpluses and deficits on the current account

Natural resources, underlying international competitiveness, exchange rates, inflation, investment and long-term economic growth, spending by consumers and government


Measures to reduce imbalances on the current account

Exchange rate changes => devaluation can lead to additional imported cost push inflation
Deflationary policies => more effective if they can marginal propensity to import is high
Supply side policies
Protectionism - consumer switching policy
Currency controls => black markets develop in reality


Causes of changes in demand for a currency

Change in exports, change in exports, change in ER, in/outflow of investment funds, confidence


What is the idea behind the purchasing power parity theory of exchange rates

Nominal ERs reflect speculative activity as well, whereas purchasing power parity theory of ER states that ERs in the long term change in line with inflation rates between economies


Marshall-Lerner condition

A fall in the value of the pound will result in an improvement on the current account if the combined elasticities of demand for exports and imports are greater than one


Problems with devaluation

J curve, cost-push inflation, risk of competitive devaluation


Why do financial markets exist

1. Provide services demanded by households, firms and government i.e. borrowing and lending on credit
2. Allow participants to speculate and realise financial gains


Three types of bank

Retail - borrowing and saving for consumers mainly
Commercial - borrow from business and allow them to save
Investment - trade financial instrument and consultancy


Market failure with financial institutions

1. Asymmetric information: Payment Protection Insurance (PPI) - UK banks in the 1990s and 2000s sold tens of millions of insurance contracts to customers - failed to find out whether insurance was appropriate
2. Moral hazard e.g. RBS bailed out
3. Speculation and market bubbles


Market failure with financial institutions

1. Asymmetric information: Payment Protection Insurance (PPI) - UK banks in the 1990s and 2000s sold tens of millions of insurance contracts to customers - failed to find out whether insurance was appropriate
2. Moral hazard e.g. RBS bailed out
3. Speculation and market bubbles; by lending too much into the property market, excess demand for houses is created -> unsustainable increases in the house prices -> bubble bursts due to large increase in IR for instance -> more difficult for those with existing mortgages to make repayments and increases the number of households that are forced to default on debts etc.
4. Market rigging
5. Externalities; cost to the UK taxpayer of supporting UK financial institutions during the 2007-08 financial crisis was £1.162 trillion at its peak & nationalisation of banks cost £2,000 per person


Chain of reasoning as to why increase AD will simply lead to increased inflation according to classical economics

Increased demand for labour will mean the rate of unemployment goes below the natural rate of unemployment. Consequently, as there is a smaller available supply of labour, workers in general have relatively larger bargaining power in terms of demanding higher wages. Consequently, following rises in wages, employees will have to sack some workers, reducing output and thus AD, bringing it back to the level of natural unemployment


Why may banks have liquidity crises

A bank at the end of a day's trading can run out of liquid assets to pay money it owes.
The bank may have fundamental problems because its assets have fallen in value for example


Reasons for public expenditure

1. Efficiency and market failure - public goods, natural monopolies, subsidies
2. Equity and equality
3. Macroeconomic management - intervention in the case where externalities exist


Reasons for changing size and composition of public expenditure

> the lower the average income, the lower is likely to be the percentage of GDP spent by the government
=) USA - 38%, Finland - 58% of GDP
> ageing populations - more spending on the elderly, less spending elsewhere
> type of fiscal policy


Factors that play a role in the potential size of the state

Efficiency, disincentive effects (high income tax), utility (loss of welfare in government vs consumer spending), taxation, crowding out, transfer payments (no output), unemployment (extra G can lead to crowding in*), economic growth