Theme 4 - A Global Perspective Flashcards

Question

What is the impact of protectionist policies for producers?

Answer 1

- Domestic producers tend to benefit from import controls since they have less competition and so can sell more goods at a higher price than otherwise and they will benefit from measures to increase exports. - They may suffer from higher costs if there are controls on the imports they need for production. - Foreign producers will lose out as they are limited in where they can sell their goods. Inefficient domestic producers are kept in production whilst efficient foreign ones lose out.

Answer 2

- Evidence suggests that there is little difference to employment figures. - It can be argued that allowing inefficient firms to close would be better for workers in the long run. The market would reallocate resources and create new jobs, with greater security. - E.g. following the steel tariffs imposed in America in 2018, it is estimated that 16 jobs will be lost elsewhere for every job gained in the steel industry. But, Argentina have been successful at implementing tariffs which protect jobs.

Answer 3

- In the short run, governments benefit from protectionist policies as they can gain tariff revenues and they are politically popular. - It can lead to an inefficient economy which stifles growth.

Answer 4

- The imposition of import controls results in deadweight welfare loss. - It causes trade wars since the introduction of restrictions often leads to retaliation by other countries where each country continues to impose more tariffs on the other's goods. This causes a reduction in trade and a reduction in growth. E.g. the US - China trade war.

Answer 5

- It has a regressive effect on the distribution of income as the rise in price affects the poorer members of society far more than the well off as it is they that can no longer afford the products.

Answer 6

The exchange rate is the purchasing power of a currency in terms of what it can buy of other currencies.

Answer 7

- The spot exchange rate is the actual exchange rate for a currency at current prices, which can change on a minute to minute basis. - Forward exchange rates involve providing a currency at some point in the future for an agreed rate. It is usually used by companies who want to reduce uncertainty and know the actual cost they will pay. - The bilateral exchange rate is simply the value of one currency against another (£1 = $2) - The exchange rate index shows the value of a currency against a basket of currencies weighted against the proportion of trade that that country does with each currency and gives an indication of the overall strength of the currency in the market.

Answer 8

A free floating system Managed floating A fixed system

Answer 9

A free floating system is where the value of the currency is determined purely by market demand and supply of the currency, with no target set by the government and no official intervention in the currency markets. Both trade flows and capital flows affect the exchange rate under a floating system.

Answer 10

- The central bank does not need to try to maintain a particular exchange rate and therefore will not need to use reserves to buy pounds in the market to keep it at the target. - Interest rates are reserved for domestic monetary policy to control inflation rather than maintaining the exchange rate. - A floating exchange rate is able to partly auto-correct a trade deficit as a large trade deficit will cause a fall in the value pound since supply of pounds is high and demand is low. The fall in the pound will make exports cheaper and imports more expensive and so may reduce the trade deficit. - Reduces the risk of currency speculation since speculation is most attractive when the currency is over or undervalued and floating exchange rates reduces this because the price is determined by the market.

Answer 11

Managed floating is where the value of the currency is determined by demand and supply but the central bank will try to prevent large changes in the exchange rate on a day to day basis. This is done by buying and selling currency and by changing interest rates. An adjustable peg system is where currencies are fixed against another but the level at which they are fixed can be changed. A crawling peg system has mechanisms which allows the value to change. Managed float or dirty float is where the government intervenes to improve macroeconomic stability.

Answer 12

A fixed system is when a government sets their currency against another and that exchange rate does not change. The country can decide to devalue its currency overnight to improve international competitiveness of its industry. E.g. the gold standard, where each major trading country made its currency convertible into gold at a fixed rate.

Answer 13

- Good as it avoids currency fluctuations, this encourages trade and investment as firms and individuals know the true costs of the deal. - It reduces the cost associated with trade, as firms have to spend less on currency hedging which is the process of agreeing on forward exchange rates. - A stable exchange rate may reduce inflation as there is not a sudden reduction in the value of the currency leading to a rise in imports and therefore inflation. - It can cause conflict with other objectives - If the currency falls below the government's set level, they have to intervene by raising interest rates to increase the desire to move hot money into the country or buy sterling using gold or foreign currency reserves to increase demand. The rise in interest rates will have a negative effect on other policies. - It is easy to set the exchange rate at the wrong rate, if it is too high, goods become uncompetitive but if its too low, it could cause inflation due to high import prices. - There is less flexibility and so it is difficult to respond to temporary shocks.

Answer 14

An appreciation of the currency is an increase in the value of the currency using floating exchanging rates.

Answer 15

Depreciation is a fall in the value of the currency under floating exchange rates.

Answer 16

A revaluation of the currency is when the currency is increased against the value of another under a fixed system.

Answer 17

A devaluation of the currency is a decrease in the value of one currency against another under a fixed system.

Answer 18

Floating exchange rates are determined by the interaction of demand and supply, and so are affected by changes in demand and supply.

Answer 19

Floating exchange rates are determined by the interaction of demand and supply, and so are affected by changes in demand and supply.

Answer 20

- Changes in demand and supply because exchange rates are determined by the interaction of demand and supply. - The demand for pounds is determined by the amount of British goods that foreigners want to buy, the number that want to invest in the UK, visit the UK or place their money in British banks, and the amount of speculation on the pound. - The supply of pounds is determined by the amount of foreign goods people in the UK want to buy, the number of British firms that want to invest abroad, the amount of British people wanting to go on holiday abroad or place their money in foreign banks, and the amount of speculation on the pound. - Currency is affected by the level of exports and imports, the level of investment, those going on holiday and speculation. - Speculation affects the determinant of the short-term price because if speculators fear a fall in the pound, the pound will fall as they will sell their pounds and buy another currency. - In the long-term, currency is determined by economic fundamentals such as exports, imports and long-term capital flows. - The purchasing power parity theory argues that in the long run, exchange rates will change in line with changes in prices between countries. Inflation makes exports less competitive and imports more competitive, causing a fall in the trade balance and so a fall in the pound.

Answer 21

If they want to increase or decrease demand for their currency, a government can use interest rates. An increase in interest rates will strengthen the pound as people will convert their money to pounds to put them in English banks, so demand for pounds will rise. Falls in interest rates will decrease demand for the pound and so weaken the currency. Governments can use gold and foreign currency reserves to manipulate the value of their currency. If the value of the pound is too high and they want to weaken it, they can increase supply by buying foreign currency or gold with pounds. To strengthen the pound, they can increase demand by selling their foreign currency or gold in exchange for pounds. Central banks have found that this method tends to have little impact on currencies in the long term. They are also able to limit supply of currency by introducing currency controls, and by doing so they can fix the value of the currency.

Answer 22

This is where a country deliberately intervenes in foreign exchange markets to drive down the value of their currency to provide a competitive boost to their exporting industries. A weaker currency will encourage exports and discourage imports and therefore the balance of payments should improve assuming the Marshall-Lerner condition. However, the problem is that this can cause inflation and this may reduce competitiveness, leading to a fall in the balance of payments.

Answer 23

One problem is that other countries may follow and reduce their currency as well, this is unlikely if there is a currency account deficit but if the country who devalues has a surplus, other countries are likely to retaliate.

Answer 24

- The Marshall-Lerner condition states that the sum of the price elasticities of imports and exports must be more than one (elastic) if a currency devaluation is to have a positive impact on the trade balance. - The J-curve (google diagram) shows how the current account will worsen before it improves. People will not immediately recognise that British exports are cheaper and it will take a while to find a source for them, whilst UK consumers will not see that imports are more expensive and may be unable to switch straight away. Demand tends to be inelastic in the short run. Therefore, the amount sold of each will stay the same but the price of exports will fall, so the value will fall, and the price of imports will rise, so the value will rise. However, in the long term, the current account deficit will fall as demand becomes more elastic.

Answer 25

- Economic growth and unemployment, a weaker exchange rate is likely to increase exports, since they become cheaper, and decrease imports so lead to an increase in AD. This will increase employment and economic growth. - Rate of inflation, falls in the exchange rate will increase inflation as imports become more expensive, causing a rise in prices and a fall in SRAS. Also, the net exports section of AD will increase and so inflation will rise further. - FDI, a fall in the currency may increase FDI because it becomes cheaper to invest. However, if the currency is continuing to fall then this is an indication that an economy has serious economic difficulties which will discourage investment.

Answer 26

Income is a flow of earnings, whilst wealth is a stock of asset.

Answer 27

Income inequality refers to the extent to which income is distributed in an uneven manner.

Answer 28

Wealth is likely to be more unequally distributed than income because assets that make up wealth can be accumulated over time. People who are wealthy now can generate an income from those assets and as long as income exceeds expenditure, they are able to build up a stock of assets. This accumulation of wealth can occur over successive generations through inheritance.

Answer 29

The Lorenz curve | The Gini coefficient

Answer 30

This shows the cumulative percentage of the population plotted against the cumulative percentage of income that those people have. A perfectly equal society would have a straight line from corner to corner, the degree of the bend away from that straight line indicates the degree of inequality. Google curve.

Answer 31

Formula = A/(A+B) This is the ratio of the area between the 45-degree line and the Lorenz curve divided by the whole triangle under the 45-degree curve. It is measured between 1 and 0 and the bigger the coefficient, the more unequal the country.

Answer 32

- Wages, some workers earn more than others, maybe due to higher educational achievements, working longer hours or having more skills in demand. Those not in work will have a lower income than others, moreover, the higher the level of income, the more someone can save and thus the more wealth they can build up. Those on high incomes will be able to build up a stock of assets whilst those on lower incomes may have to spend most of their money on everyday items. - Wealth levels, someone who already has a high level of wealth is able to build up larger wealth than those on lower levels of wealth. Those with lower levels of wealth are unable to do so. Inheritance often allows high levels of wealth and high levels of wealth mean people can earn rent and interest on their assets and so increase income. - Chance, those who bough houses in the right area or bought the right assets will see a huge increase in the price of their assets and hence an increase in their wealth. They may have been lucky to inherit wealth and also those who chose the right sort of job will have seen their income rise higher than other areas. - Age, working adults at the peak of their career will earn a higher income than those who have just started. Those who are older will have had a chance to build up more assets, although some of this stock may have been used up to pay for retirement.

Answer 33

Some countries have been held back by wars, droughts, famines and earthquakes. Certain social groups may have been excluded and marginalised. Developed countries tend to favour each other when trading, negotiating, etc, and this helps them to develop more than countries who are not involved in the agreements.

Answer 34

The Kuznets hypothesis says that as society develops and moves from agriculture to industry, inequality increases as the wages of industrial workers rises faster than farmers. Then, wealth is redistributed through taxation and government spending and so inequality falls. However, Piketty discredited this theory by arguing that inequality rises as the country develops as the rate of return on capital grows, so the rich get richer and inequality increases.

Answer 35

- A capitalist economy leads to income inequality because of wage differentials. Wages vary as they are based on demand and supply, and demand and supply vary for different jobs. - Individuals also own resources and thus wealth differs based on the assets they own. Wealth can be passed on or gained through saving of incomes. - It is argued that equality can never be achieved in a capitalist society where the possibility of having more is important to encourage hard work. Without the incentive to gain more, people will not try hard or take risks since they have no reason to and this means the economy won't grow; inequality is essential for capitalism to work. - A degree of inequality is necessary and desirable, but excessive inequality causes problems with efficiency and social justice.

Answer 36

``` Primary product dependency Volatility of commodity prices Savings gap Foreign currency gap Capital flight ```

Answer 37

Primary products include agriculture, mining, etc. A large amount of most developing country's economic activity is based on a primary product (primary products are goods that are available from cultivating raw materials without a manufacturing process). There are issues with this, natural disasters can wipe out production of the primary-product and so means that farmers are left with no income. They are often non-renewable, which means the country will suffer when they run out of the product. Also, they tend to have a low-income elasticity of demand, which means as people get wealthier, they don't continue to increase the amount of primary products they buy where they are likely to increase their demand for manufactured goods. However, not all primary products have a low income elasticity of demand, like diamonds. The Prebisch Singer Hypothesis suggests the long run price of primary goods declines in proportion to manufactured goods, which means those dependent on primary exports will see a fall in their terms of trade. However, in recent years, there has been a rise in the prices of some key commodities, such as food and a fall in prices of some manufactured goods due to the expansion to places like China. Another problem is the Dutch disease, this is when a country becomes a significant commodity producer in a short amount of time, causing an increase in demand for the currency which pushes its value up. This increases export prices and leads to a reduction in competitiveness of the economy, causing a fall in output in other areas. This occurred for the non-oil sectors in Venezuela and Nigeria. Some countries have been able to use primary products to develop (Saudi Arabia and oil), it is suggested that countries should use primary product revenue to invest in manufacturing. A country that has suffered this is Ghana. Gold, cocoa and oil account for 75% of their total exports and they had to ask the IMF for a loan in 2014 due to their unsustainable balance of payments deficit.

Answer 38

Primary products tend to have inelastic demand and supply curves which means relatively small changes in demand or supply leads to huge fluctuations in price. These large changes in price mean the producers' income and the country's earnings are also rapidly fluctuating, making it difficult to plan and carry out long term investment as well as meaning that producers can see their income fall very rapidly, causing poverty. When prices of commodities rise for a number of years, there tends to be over-investment in the production of the commodity causing long term risk when the price eventually falls.

Answer 39

Developing countries have lower incomes and thus they save less. This means there is less money for banks to lend, reducing borrowing and thus reducing investment/ consumption. A savings gap is the difference between actual savings and the level of savings needs to achieve a higher growth rate. The savings rate in Africa is around 17% of GDP compared to 31% on average for middle income countries. India is another country with low savings as a share of GDP. The Harrod-Domar model suggests savings provide the funds which are borrowed for investment purposes and that growth rates depend on the level of saving and the productivity of investment. It concludes that economic growth depends on the amount of labour and capital and that developing countries have a vast labour supply, so their problems are caused by capital. In order to improve capital, investment is necessary and investment requires savings. However, there are problems with this model, economic growth is not the same as economic development. It is difficult for individuals to save when they have little income and borrowing from overseas causes problems with debt. It is possible that investment could be wasted.

Answer 40

This is when exports from a developing country are too low compared to imports to finance the purchase of investment or other goods from overseas required for faster economic growth. One country which suffers from this is Ethiopia, in 2018 public debt was around 60% of GDP, most of it in foreign currency so it is possible that they will not have enough foreign currency to repay their debt. It is thought there are only enough currency reserves to pay for a month of imports.

Answer 41

Large amounts of money are taken out of the country, rather than being left there for people to borrow and invest. If money was placed in banks within the country, then credit could be created by banks for consumers and businesses to spend. This can occur because of lack of confidence in the country's stability, to hide it from government authorities or simply for profit repatriation. This caused the Argentine economic crisis in 2001.

Answer 42

Developing countries tend to have higher population growth, which limits development. If population grows by 5%, the economy needs to grow by 5% to even maintain living standards. This means developing countries need to have higher rates of growth to develop than more developed countries would do. The high population growth is caused by high birth rates, which increases the number of dependents within a country but does not immediately increase those of working age. It places strains on the education system and leads to youth unemployment. The population of Africa is expected to more than double by 2050, complicating efforts to reduce hunger.

Answer 43

During the 70s and 80s, developing countries received vast loans from banks in the developed world. Now, they suffer from high levels of interest repayments, sometimes even higher than the loans and aid they received. This means money is flowing from developing to developed countries. This also means they have less money to spend on services for their population and they may need to raise taxes, which limits growth and development. Borrowing for growth makes sense, but the problem occurs when governments take on too much debt and do not spend it well. Nigeria's debt is 52% of GDP.

Answer 44

Developing countries have limited access to credit and banking compared to developed countries, who have complex systems. This means those in developing countries cannot access funds for investment and they struggle to save for the future. Some use loan sharks who give high interest rates and leave people permanently in debt.

Answer 45

Low levels of infrastructure make it hard for businesses to trade and set up within the country, lack of infrastructure makes services and production less reliable. However, the development of infrastructure can be expensive and tends to conflict with environmental goals. India is a country suffering from poor infrastructure, they saw power blackouts in 2012 and this damages their potential tourism industry, about half their roads are not paved and they need to invest around $400bn in the power sector.

Answer 46

Poor education within these countries means that workers are low skilled, sometimes unable to read and write and so have low levels of productivity. Countries like China and South Korea invested heavily in their human capital when they were developing, and this has benefitted them in the long term. Ethiopia suffers from high illiteracy rates at around only 49%. However, there is a debate about what type of education is needed and problems concerning over-education, e.g. if graduates are unable to find graduate level jobs.

Answer 47

Property rights are where individuals are allowed to own and decide what happens to certain resources. A lack of rights mean that individuals and businesses cannot use the law to protect their assets, leading to reduce investment. They will be unwilling to buy machinery, build factories or establish brands. The loss of property rights in Zimbabwe led to economic collapse.

Answer 48

Many developing countries suffer from corruption (individuals make decisions which maximise the bribes they receive as oppose to those which maximise development and output). Leaders are likely to make decisions which benefit themselves rather than benefitting the economy. High levels of bureaucracy are often linked to corruption and this is costly and time-consuming, deterring new businesses and reducing output of those already established. Ghana's high level of freedom and democracy is one reason why it has been able to develop so quickly. Diseases such as HIV/ AIDS and malaria have a negative impact on economic growth. Countries with poor climates and geographical terrain may suffer from natural disasters and it may be difficult for farmers or to set up businesses. Many countries suffer from civil wars, this causes high levels of poverty and destroys infrastructure, making it very difficult for the country to rebuild even after the war has ended.

Answer 49

Rostow's model of development has five main stages of growth . 1. The country begins as a traditional society based in agriculture and a subsistence economy. 2. They tend to develop into the pre-conditions, with an increase in capital used in agriculture and some mining industries. 3. Next, they take-off with increased industrialisation. 4. They then drive to maturity with diversified industry and higher levels of technology. 5. Eventually, they end up a stage of high mass consumption with a strong service sector and high output levels.

Answer 50

It is often seen as an oversimplified model and necessitates financial infrastructure and investment. It does not show how to encourage development, but simply shows that stages and is based on the Western world so may not apply to current developing countries.

Answer 51

``` Trade liberalisation Promotion of FDI Removal of government subsidies Floating exchange rate systems Microfinance schemes Privatisation ```

Answer 52

With trade liberalisation countries can aim for export led growth, removing trade barriers will mean that domestic industries either close or are forced to become as efficient as other world producers. Resources will be allocated to their best use where the country has a comparative advantage. Countries like Hong Kong, Singapore and South Korea have benefitted from this method.

Answer 53

FDI is investment by one private sector company in one country into another private sector company in another. It includes direct acquisition of a foreign firm, construction of a facility, investment in a joint venture with a local firm or licensing of intellectual property. Firms tend to undertake FDI because production costs are lower in developing countries and because it enable them access to a new market. It is different from a loan because if the investment fails, it is the company who has to deal with it and the country does not owe money to foreigners. FDI also involves the transfer of knowledge from one country to another, with the company bringing production and management techniques and training for staff which will benefit the country as a whole. It will create jobs and leads to the effect of the multiplier. Labour productivity tends to increase and wages are often higher. It is a source of investment and can help to fill the savings gap. However, there is usually a repatriation of profits and developing countries may find the company exploits them, by offering lower wages and poorer conditions than they would in a developed country. The country will also lose some sovereignty and become dependent on another firm. Local competition may find it hard to set up and compete and the best jobs often go to imported labour, leaving only low skilled jobs for locals. Environmental damage and exploitation of natural resources tend to become problems. India has benefited from FDI, the Make In India initiative liberalised FDI policy and led to a 48% increase in FDI in a range of sectors. Samsung's investment in Vietnam has been crucial, many firms are now a part of their supply chain and other businesses have set up around their factories.

Answer 54

Subsidies are placed on essential items within a country, target agriculture or industries as an attempt to increase output and investment. They can be effective at minimising absolute poverty and ensuring a minimum standard of living but they create many problems. They are often poorly targeted since subsidies on basic goods benefit everyone in the country, not just the poor. Economic theory suggests the problem would be better solved by giving poor households cash payments, as this would mean they were targeted at the poor. Subsidies to farmers and producers tend to lead to inefficiency and if they are given a large amount over a long period of time, the subsidy becomes ineffective in increasing development. In other cases, they can be beneficial in allowing an infant industry to grow. They represent a large amount of government spending, incurring an opportunity cost and often leading to high levels of debt. They may also cause corruption and criminality, in Venezuela subsidised fuel is smuggled across its borders and sold in neighbouring countries for profit. This fuel subsidies have also led to high emissions, an unintended consequence. Removing a subsidy can be very politically unpopular and some government have even been thrown out because of attempting to do this. The best time to remove a subsidy is when the free market price is falling, as this means the removal is less noticeable to the people. Venezuela has placed subsidies on almost all goods due to high inflation and low wages, but this is still not enough and demand is still higher than supply.

Answer 55

In these systems, market forces determine the currency. The country does not have to worry about their gold and foreign currency reserves and the government does not intervene. The problem with this however is that the currency can be volatile which makes it difficult for exporters/ importers to make decisions about the future and can cause large changes in macroeconomic variables, including economic growth.

Answer 56

These schemes aim to give poor and near-poor households permanent access to a range of financial services (loans, savings, insurance, fund transfers). It is used to refer to loans from providers known as mircofinance institutions who deliver small loans to unsalaried borrowers, such as opportunity. They take little or no collateral and use group lending, pre-loan saving requirements and an implicit guarantee of access to future loans if present loans are repaid fully and promptly. It allows borrowers to invest in their businesses or start up new ones. South Africa has shown the problems that can occur with this system. It has become a method of financing consumption spending and unemployment means that most people do not have the funds necessary to ensure repayment of their loan, meaning the have to sell off family assets, borrow from friends and family or simply take out new loans to repay old ones. When actually used for investment, it has simply increased the informal economy with very little being spent on sustainable methods of development. Financial resources have been diverted away from more productive and sustainable activities.

Answer 57

Privatisation can end the corruption within a firm who is owned by the state, as well as encouraging them to be more efficient by increasing competition. Selling off a firm, particularly if it is loss making, will improve government finances and reduce levels of debt. However, if the firm is privatised as a monopoly there will be no competition within the market. On top of this, it can be associated with corruption where politicians or officials sell the company at below market price to a friend or family member or receive bribes to accept one company's bid. The water industry in Ghana was privatised in 2006 but when the contract was expired in 2011, the government did not extend it. Water quality improved but reliability did not. There had been increased revenue and efficient and improved customer service.

Answer 58

``` Development of human capital Protectionism Managed exchange rates Infrastructure development Promoting joint ventures with global companies Buffer stock schemes ```

Answer 59

Developing human capital would provide workers with skills and training and thus help them to be more efficient and improve productivity. Businesses struggle to expand where there are skills shortages and it also limits innovation. Human capital could be developed through schools or vocational training, whether this be apprenticeships or simply classes provided for business people. Higher skills would allow the country to develop from the primary sector to a manufacturing sector, overcoming the primary product dependency. Better education also improves quality of life. Both China and South Korea developed their human capital massively in order to develop.

Answer 60

Protectionism allows domestic industries to grow by keeping foreign goods out and protects them from strong competition. They can use a policy of import substitution, where they deliberately attempt to replace imported goods with domestically produced goods by adopting protectionist measures. This will create jobs in the short run and will allow the industry to develop, perhaps to the extent where the barriers can be removed, and the industry can compete globally. However, it means countries lose out from the benefits of specialisation and comparative advantage and could cause inefficiency, since domestic producers suffer from a lack of competition. Other countries are likely to retaliate.

Answer 61

The currency could be fixed against a number of different exchange rates, they can introduce high exchange rates for the import of essential products and lower exchange rates for others. A high exchange rate for essential products will mean that the price within the country is low, which helps to reduce poverty if the goods are consumer goods and encourages investment if they are capital goods. A lower exchange rate for other imports will mean that the price of these goods within the country is higher, discouraging their import and encouraging consumers to buy from domestic producers. The problem with this is that the exchange rates often fail to work in practice, black markets in foreign exchange develop which can destabilise the system and corruption becomes an issue, when government official buy currency at one exchange rate and sell it for profit at another. Alternatively, governments can manage a single exchange rate which will reduce volatility, but speculation may mean that countries find it difficult to maintain an exchange rate over a number of years.

Answer 62

Infrastructure is essential for development; a country needs roads, airports, schools, hospitals, railways... Interventionists believe the government should provide these systems whilst a market-based system would be for the private sector to provide them. Infrastructure tends to suffer from the free rider problem and has vey high capital costs, making it unlikely the private will develop it. Moreover, it has many positive social benefits which suggests the government should provide it. One problem of this is that the government may not have the funds to provide the infrastructure and it is argued that they may be inefficient. Infrastructure projects are often associated with bribery and corruption, cause environmental damage and may be poorly built and maintained. Some argue that intermediate technology, which uses local materials and can be fixed locally, is better than large scale infrastructure.

Answer 63

One way to reduce the exploitation of countries as a result of FDI would be to set up a joint venture. The government may insist that firms setting up production plants in their country find a local partner to create a jointly owned company with. This will help to keep some of the profits generated within the country, which can be used in investment. Tata Starbucks Pvt.Ltd is a joint venture company with Starbucks in India.

Answer 64

Buffer stock schemes are where the government imposes both a maximum and minimum price for goods, buying up stocks when there is excess supply and selling them off when there is excess demand. As a result, it should be self-financing: money is raised when selling the products, which allows the government to buy the next lot of stocks. It is used on commodities, when the prices are volatile, and can either be set up by a group of countries or within a country. When it works effectively, it is beneficial because it stabilises prices and thus encourages investment since producers can plan for the long term. It also prevents sharp falls in prices, meaning that producers are kept from falling into absolute poverty, and prevents sharp rises in prices, meaning that consumers are able to afford the good. It can solve some of the issues relating to primary product dependency. However, it requires stocks to go up and down, if they keep rising, then the scheme will run out of money and if they keep falling, the scheme will run out of stocks. They require huge start-up costs, as well as administration costs and problems of storage. Other countries may benefit from a buffer stock system since it keeps global prices fairly stable when undertaken by a group of countries, and so they can be seen as free riders of the system. This may mean that some countries will not want to introduce the system. The biggest issue is that minimum prices may be set too high, encouraging producers to become inefficient. They will produce as much as they like and know they will be able to sell it anyway, meaning that supply is high and the government has to continually buy up the stocks. If the scheme is operating at a loss. the taxpayer feels the burden and the government finances are worsened. The Ivory Coast and Ghana implemented a buffer stock scheme for cocoa in 2017 due to low prices.

Answer 65

Industrialisation is where an economy is transformed from a primarily agricultural one to one based on the manufacturing of goods. The Lewis model suggested that the modern industrial sector would attract workers from rural areas by offering higher wages. Lewis believed that labour productivity was so low in agricultural areas that people leaving the area would have no impact on output and would in fact mean there was a surplus of food, since the same amount was being shared amongst less people. Those who moved to the urban areas would have higher incomes and thus more savings for investment. He believed savings and investment were the key to growth and thus growth could be achieved though rural-to-urban migration. However, although labour productivity is low for some parts of the year, during planting and harvesting vast amounts of labour is needed. Also, it is not necessarily true that those with higher wages will save and invest their money. Recently, migration has led to urban poverty replacing rural poverty as the industrial sector is unable to provide jobs for all those who have moved. Improvements in technology will lead to a reduced demand for labour. It can be argued that industrialisation is a result of development, rather than a cause. Though it is possible for the government to build factories and plants to encourage the transition to industrialisation. This has been successful in countries such as South Korea, but in many countries the industry fails and so there is just a waste of scarce resources. Instead of industrialising, India went from agriculture to services as this is where they have comparative advantage. This shows that not all countries will develop in the same way.

Answer 66

The Lewis model assumed that developing countries had dual economies with a traditional agricultural sector, which had low wages, low productivity, underemployment and low savings, and a modern industrial sector, with high levels of investment and urbanisation.

Answer 67

Some countries have taken advantage of their climate and geography to build up a tourism industry, such as the Caribbean. This provides them with the funds to develop their economy and improve living standards. The income elastic nature of tourism means that as the global economy grows, demand for the industry will increase even further, allowing the developing country to continue development. However, it also means that they will suffer in times of recession. Tourists represent a source of foreign currency, which will fill the currency gap, this allows countries to fund their imports without negative consequences. However, holidaymaker's demand for products from their home countries mean that the tourism industry is associated with an increase in imports and so may not help the foreign currency gap at all. Countries are likely to attract investment from transnational hotel companies, who will also bring knowledge with them. It can help to fund improvements in infrastructure, as tourism requires reliable electricity, airports and so the government have an incentive to provide them. This will also have a multiplier effect on the economy. Jobs are created locally since the tourism industry relies in low skilled workers who know the local area, and the government will see higher tax revenues due to higher income and higher profits. It can provide funds to allow countries to diversify. However, the industry is seasonal and involves low skilled, low paid jobs which means the effect of the multiplier is limited. Tourism destinations can go in and out of fashion, meaning some areas will see a loss of employment and that investment may only receive a short-term return. A large amount of wealth created will be withdrawn as TNC's repatriate their profits, causing problems involving capital flight. The country may suffer from externalities, including pollution, waste, environmental damage and impact on culture. In Morocco, 7 eco-resorts are being built on the north coast where unemployment is 40%.

Answer 68

``` Some countries (Saudi Arabia, Norway, Australia) were able to develop because of an abundance in natural resources. The development of a primary industry provides funds to allow a country to diversify as well as allowing infrastructure development and better education. However, primary products are volatile and primary product dependency causes many issues, primary industries also suffer from corruption. The government can address the Dutch Disease, for example in Norway the government uses some of its oil revenues to invest overseas and this increases supply of their currency, depreciating it and helping other industries to compete overseas. ```

Answer 69

Fairtrade is defined as being a trading partnership based on dialogue, transparency and respect, which seeks greater equity in international trade. There are a number of organisations which monitor that what is being sold under the Fairtrade label conforms to a number of key principles: a fair price, community development, fair working conditions and protecting the environment. A fair price typically means that agreements are made to buy a guaranteed amount of produce over a period of time at a price which is above the market price when the agreement was made. This gives producers stability and raises their income. The system means that child labour is not used and that production is sustainable and does not take place at the expense of environmental degradation. A study carried out in Sri Lanka showed that those under fair trade had higher income and satisfaction, a greater understanding of the market and a more optimistic view of the future than those not under fair trade. They were able to save for the future and invest or provide financial support for their children. However, they still did not feel their income was sufficient. It is argued that the system has an insignificant impact of the developing world. It benefits producers but can leave others worse off since non-Fairtrade producers see a fall in demand. In the long term, the higher price for fairtrade goods will increase supply and thus bring price back down, but this will depend on the price elasticity of supply, Another issue is that higher incomes reduces the incentive to diversify and keeps farmers engaged in low profit activities. On the other hand, it can be argued that it allows parents to send their children to school (whether because it provides the funds necessary or means children are no longer expected to stay at home to work and land) and this will allow them to gain skills which in the future will allow them to move away from agriculture.

Answer 70

Egypt, Afghanistan and Vietnam are the greatest recipients of aid, whilst the EU and US are the largest donors. Aid is good as it is able to reduce absolute poverty, particularly emergency relief provided after disasters such as the Haiti earthquakes. However, it is unclear whether the money really reduces absolute poverty, as improving infrastructure does little to help those most suffering. It can fill the savings gap, as outlined by Harrod-Domar, and thus provides funds for investment, whether this be infrastructure or in human capital. Both of these often have to be done by the government because they can be seen as public goods and suffer from the free rider problem. It also provides foreign exchange to fill the foreign currency gap. It can contribute to increased globalisation and trade as well as reducing world inequality. However, some argue it results in a dependency culture where countries are unconcerned by their finances as they know they can receive aid from another country. Corruption means that money does not always go to where it is meant to. In the long term, tied aid and concessional loans may mean that the country loses out. Sine concessional loans still have to be repaid, this may limit where the money is spend, countries may only spend money on things they know will see a return in the short term. It is difficult to know the best way to develop a country and therefore it is difficult to know the best place to spend the aid.

Answer 71

Aid is when a country voluntarily transfers resources to another or gives loans on concessionary terms. There are different types of aid: - Tied aid is aid with conditions attached, such as economic or political reforms or a commitment to buy goods from the donor country. - Bilateral aid is directly from one country to another. - Multilateral aid is when countries give aid to an international organisation who distributes it to other countries. - Concessional loans are loans given on lower, or no, interest rates.

Answer 72

Many countries suffer greatly from the high interest repayments to loans they have taken out. It limits the growth of some of the poorest countries, whilst being relatively small for the countries and agencies that are owed the money. Therefore, it seems reasonable for the debt of developing countries to be written off. It will ease government finances and allow more money to be spent on provision of services and infrastructure to aid development. However, it causes moral hazard because it creates a precedent: every poor country may now expect to receive debt relief. It also eases pressure on weak government to adopt reforms and good economic policies.

Answer 73

The world bank was founded at the Bretton Woods Conference after the Second World War. It aims to bring about long-term development and a reduction in poverty. The world bank has funded over 12,000 development projects since 1947 through interest free loans and grants and supports long term human and social development.

Answer 74

The IMF was set up to ensure that exchange rate systems work well. They provide loans to help countries when there are international exchange rate crises or when they cannot afford to pay off their international debt. When providing loans, the IMF insists that countries make macroeconomic reforms to resolve the problems. The IMF has received criticism for this because it causes problems for countries, usually it involves reducing imports and increasing exports which reduce the amount of resources available for domestic consumption. It can also be in the form of lower government spending. The reforms intend to help countries overcome issues and should allow a country to develop in the long term, they are not meant to be a punishment. The IMF also provides advice which aims to bring about economic stability and raise living standards and help countries to develop their economic institutions through training and technical assistance, for example the central bank in Kosovo.

Answer 75

These are non-profit organisations that are run independently from the government. They can provide direct assistance to countries in the form of project work, this can range from education to wells to healthcare and can either be emergency or long term. They can act as pressure groups to lobby governments to adopt more pro-development strategies. A problem of NGOs is that it is believed that they alone can never solve the problem, it is the government who has to fix the issues. On top of this, many see them as having an anti-capitalist agenda which blames problems on the World Bank, the IMF and the WTO. This causes divisions in the development project and is also an issue since past experience suggests global capitalism is the best system for development.

Answer 76

Financial markets are where buyers and sellers can buy and trade a range of services or assets that are fundamentally monetary in nature.

Answer 77

They exist for two main reasons; - To meet the demand for services, such as saving and borrowing, from individuals, businesses and the government. - To allow speculation and financial gains.

Answer 78

One role of the financial market is to facilitate savings, which allows people to transfer their spending power from the present to future. It can be done through a range of assets, such as storing money in savings accounts and holding stocks and shares. They lend to businesses and individuals which allows consumption and investment. They are sometimes referred to as a financial intermediary, the step between taking money from one person to give to another since money from savings is used for investment. They facilitate the exchange of goods and services by creating a payment system. Central banks print money, institutions process cheque transactions, companies offer credit card services and banks buy and sell foreign currencies. They provide forward markets. This is where firms are able to buy and sell in the future at a set price, the forward market exists for commodities and in foreign exchange and helps to provide stability. They provide a market for equities, company shares. Issuing shares is an important way for companies to finance expansion but people would be unlikely to buy shares if they were unable to sell them on in the future. Financial markets provide the ability for shares to be sold on in the future, making the asset more appealing.

Answer 79

``` Asymmetric information Externalities Moral Hazard Speculation and market bubbles Market rigging ```

Answer 80

Financial institutions often have more knowledge compared to their customers, both consumers and other institutions. This means they can sell them products that they don't need, are cheaper elsewhere or are riskier than the buyer realises. The global financial crisis was partially caused by the banks selling packages of prime and subprime mortgages, but advertising them as all prime mortgages. Those buying these packages suffered from asymmetric information and it is unlikely they would have bought them if they knew the risk involved. Additionally, there can be asymmetric information between financial institutions and regulators. The institutions have little incentive to help regulators understand their business and this causes difficulties for the regulators and may allow institutions to undertake harmful activities.

Answer 81

There are a number of costs placed on firms, individuals and the government that the financial market does not pay. One example of this is the cost to the taxpayer of bailing out the banks after the 2007 - 1008 financial crisis. Even higher than this, was the long-term cost to the economy of the crisis due to its effects on demand and growth. Moral hazard also shows some external costs.

Answer 82

This is where individuals make decisions in their own best interests knowing there are potential risks. This can happen in two main ways in the financial markets. Firstly, it will occur where individual workers take adverse risk in order to increase their salary. Any problems they cause will be the problem of the company and not the individual. The global financial crisis was caused by moral hazard, when employees sold mortgages to those who would not be unable to pay them back. By selling more mortgages, they would see higher salaries and bonuses but would not see the negative effects if the loan was not repaid. On top of this, financial institutions may take excessive risk because they know the central bank is the lender of last resort and so will not allow them to fail because of the impact it would have on the economy.

Answer 83

Almost all trading in financial markets is speculative (a person or organisation tries to predict what will happen to the price of an asset and buys / sells accordingly in order to try and make a profit) and this leads to market bubbles, where the price of an asset rises massively and then falls. They tend to occur because investors see the price of an asset rise and so decide to purchase believing the price to continue rising and so make them profit. Prices however become excessively high and investors decide that the price will fall, so they sell their assets and panic sets in, causing mass selling. This is known as herding behaviour. Moreover, the financial market has also caused market bubbles in the housing market by lending too much in mortgages and increasing demand for houses. When this bubble bursts, e.g. due to rising interest rates, there is a fall in demand for houses and a negative wealth effect, reducing AD, and banks are left with loans that will not be repaid in full. Other bubbles included the dot com bubble in the 1990s and the Wall Street Crash in 1929.

Answer 84

This is where individuals collude to fix prices or exchange information that will lead to gains for themselves at the expense of other participants in the market. One example being insider trading, where an individual or institution has knowledge about something that will happen in the future that others do not know and so can buy or sell shares to make a profit. Another example is where individuals affect the price of a commodity, currency or asset to benefit themselves, e.g. large trades in a currency will shift its value and this will make a difference to individuals selling or buying assets with that currency. In the Libor scandal of 2008, financial institutions were accused of fixing the London Interbank Lending Rate, one of the most important rates in the world.

Answer 85

Tax is used to pay for the number of goods and services that the government provides. Tax can be used also to correct market failure at a microeconomic level and to manage the economy and redistribute income at a macroeconomic one.

Answer 86

The government's current aims include keeping the burden of tax low, improving incentives, using equitable taxes, correcting market failure and taxing spending rather than income.

Answer 87

Adam Smith argues there were 4 canons of taxation (characteristics requires of a good tax): - cost of collection should be low - timing of collection and amount to be paid should be clear and certain - means and timing of payment should be convenient to the taxpayer - taxes should be levied according to the ability of the individual taxpayer to pay Recently it has been added that a good tax should lead to the smallest loss of economic efficiency possible or even increase it, it should be compatible with foreign tax systems and adjust to changes in price levels.

Answer 88

Progressive tax is where those who are on higher incomes pay a higher marginal rate of tax, they pay a higher percentage of their income on tax. E.g. direct taxes like income tax

Answer 89

Regressive tax is where the proportion of income paid in tax falls as the income of the taxpayer rises. Those on higher incomes pay a smaller percentage of their income on the tax. Most indirect taxes are regressive, e.g. everyone pays the same rate of VAT and for those on higher wages this represents a small proportion of their earnings compared to those on low wages.

Answer 90

Proportional tax is where the proportion of income paid on tax remains the same whilst the income of the taxpayer changes. Everyone pays the same percentage of their income on the tax.

Answer 91

- Incentives to work - Tax revenues - Income distribution - Real output and employment - Price level - Trade balance - FDI flows

Answer 92

It is argued that high marginal rates of tax will discourage individuals from working. Free market economists argue that the supply of labour is relatively elastic and a reduction in marginal taxes on income will lead to a significant increase in work as individuals work longer hours, accept promotions and more people join the workforce. High taxes on high income earners could encourage them to move abroad and taxes on the poor may lead to a poverty trap. It is income tax which is important: high income tax reduces incentives more than high VAT. Thus, a switch from direct to indirect taxes may increase incentives. However, there is no hard evidence for the link between income tax and incentives. Nordic countries have high taxes and welfare benefits but have similar rates of growth compared to lower tax and government spending countries like US and UK. It can be argued that higher taxes mean people have to work longer hours in order to maintain their income and so even increases the incentive work.

Answer 93

The Laffer curve shows that a rise in the tax rate does not necessarily increase tax revenue. If people were taxed at 100%, they would not do any work and this means that tax revenue is 0 at both 0% and 100%. Tax revenue will initially rise as the tax rate is increased but it will come to a point where revenue is maximised and will then fall. As tax rates rise, motivation and drive will fall so there will be a fall in output and there is an increased incentive to use tax avoidance and tax evasion. Revenue from indirect taxes can be uncertain as they depend on consumer spending patterns.

Answer 94

Google curve. | Describe what it shows and where optimal level of tax is.

Answer 95

A progressive tax system will increase the equality of income distribution as more money is proportionally taken from the rich than from the poor. A regressive one will decrease income equality. Since direct taxes tend to be progressive and indirect taxes regressive, a move from indirect to direct taxes will improve equality. Inheritance taxes are the most progressive form of taxation. High corporation taxes take money from shareholders, who tend to be very well off, and give them to the government to spend on the poor. One problem with using tax to redistribute income is that it does not give the poor anything, so the system needs to be supported with benefits.

Answer 96

Some taxes affect AD whilst others affect AS. A rise in direct taxes will reduce the level of disposable income an individual has, which will cause a fall in their spending and thus a fall in AD. It could also cause a fall in leftover profits for businesses and therefore a fall in investment. The effect this has on output will depend on where the economy is: whether it is at full employment or not. On top of this, higher indirect taxes and NICs increase costs for firms and this will decrease SRAS. This impact will again depend on where the economy is producing. It can be argued that income taxes cause a disincentive to work and therefore reduce LRAS as the most skilled workers go overseas and more people become inactive.

Answer 97

Taxes can impact LRAS, SRAS and AD, therefore these changes will impact price depending on where the economy is producing. Indirect taxes, particularly VAT, often cause cost push inflation.

Answer 98

A rise in taxes will decrease income and therefore decrease consumption, theoretically this will also mean consumers spend less on imports . Imports in the UK have been found to be highly income elastic. As a result, the trade balance will improve in the short run. However, in the long run, lower AD will reduce businesses’ need to invest and this could reduce competitiveness meaning that exports decrease.

Answer 99

Low taxes on profit and investment tend to encourage businesses to invest in a country since it will help them to see a higher level of return. The problem with this is that it can be a ‘race to the bottom’ where countries have to continue to lower their taxes in order to make them the lowest to encourage investment; the eventual result is a fall in revenues for all countries.

Answer 100

Automatic stabilisers are mechanisms which reduce the impact of changes in the economy on national income; government spending and taxation are automatic stabilisers. In a recession, benefits increase as more people are unemployed and so the benefits are a stabiliser as it means that the overall fall in AD is reduced, preventing too much change in the economy. On the other hand, during a boom, tax increases as people have more jobs and higher incomes, and this tax reduces disposable income so decreases consumption and AD, meaning that demand doesn’t grow too high. These automatic stabilisers cannot prevent fluctuations; they simply reduce the size of these problem and there can be negative aspects to these stabilisers. Benefits may act as a disincentive to work and lead to higher unemployment whilst high levels of tax can decrease the incentive to work hard.

Answer 101

Discretionary fiscal policy is the deliberate manipulation of government expenditure and taxes to influence the economy; expansionary and deflationary policies.

Answer 102

The national debt is the sum of all government debts built up over many years whilst a fiscal deficit is when the government spends more than it receives that year. They can either be measured in money terms, for example national debt in 2018 is around £1.8 trn, or as a percentage of GDP, the UK’s national debt is 87.7% of total GDP. The GDP measure is often more useful because it gives an indication of how easy to will be for the government to finance a deficit or repay the national debt. In 2018, the fiscal deficit is £48bn, 2.3% of GDP.

Answer 103

The public-sector net cash requirement is the total amount of money that the government needs to borrow in order to fulfil its spending plans, the difference between spending and revenue.

Answer 104

A cyclical deficit is the part of the deficit that occurs because government spending and tax fluctuates around the trade cycle. When the economy is in recession, tax revenues are low and spending is high creating a larger deficit. At the peak of the boom, there is no cyclical deficit; any deficit at this point is a structural deficit.

Answer 105

The structural deficit is the fiscal deficit which occurs when the cyclical deficit is zero; it is long term and not related to the state of the economy. Governments can have structural deficits, structural surpluses or structural balances. A structural surplus occurs when at the peak of the boom, there is an actual fiscal surplus whilst a structural balance occurs when at the peak of the boom, the actual fiscal balance is 0. If the government has a structural deficit, it is likely that national debt will grow over time as the government has to consistently borrow money to finance spending. For this reason, it is argued that structural deficits need to be eliminated but this is difficult since it is impossible to know what part of the deficit is structural and what part of it is cyclical, just as it is impossible to know the size of the output gap.

Answer 106

The actual deficit is the structural deficit plus the fiscal deficit.

Answer 107

- The trade cycle, during a downturn, government tax revenue decreases whilst government spending increases and so the deficit increases. In the UK, the fiscal deficit peaked in 2010 at 10.1% of GDP. - Unforeseen events, such as natural disasters or recessions, lead to huge increases in spending which increase the deficit. - Interest rates, if interest rates on government debt increase, the amount the government pays in repayments increases and this can increase the deficit. The impact of this will depend on how significant interest repayments are in the size of the deficit. Interest rates depend on market rates and the credit ratings of governments. 7% of all UK government spending is on interest repayments of loans. - Privatisation provide one-off payments to the government which will decrease the deficit in the short-term, it will depend on the value of the company sold. - Government aims will influence their fiscal policy, austerity aims will decrease the size of the deficit but attempting to increase AD will increase spending. The austerity policy managed to reduce the fiscal deficit by 75% since 2010. - Countries with high revenues from oil (the OPEC countries) run a budget surplus and so government revenue is important in the size of the deficit. - Number of dependents in a country affect both spending and tax revenues and so influence the deficit.

Answer 108

- If the government continuously runs a deficit, the national debt will increase overtime. There is consensus that fiscal deficits over 3% will lead to growing national debt as a proportion of GDP. It is only when the government runs a budget surplus that the size of the national debt decreases. - Ageing populations tend to contribute to a high national debt since the government runs a structural deficit in order to fund their pensions and care, this leads to a high national debt.

Answer 109

- High borrowing may raise interest rates in the economy as an increase in demand for money increases the price of money. May not always be case as government may borrow from overseas and during a recession private sector investment falls meaning interest rates may remain unchanged. - National debt costs a lot to service through interest repayments, it has a high opportunity cost. Primary budget deficit is the actual deficit not including interest repayments on national debt. The impact will depend on the level of interest rates and the size of the primary deficit compared to interest repayments. In a liquidity trap (low interest rates), gov can borrow for low rates for long times. - High deficits and debts can benefit citizens not but cause intergeneration inequality for future generations. A current budget deficit is problematic as it means future generations are forced to pay the bill for today's expenditure. If the deficit is due to capital expenditure, future generations benefit from increased spending and so their tax bill is justified. - The value of debt tends to fall overtime due to inflation eroding the real value and GDP grows allowing debt to be paid off easier, this limits the impact on future generations. - High fiscal deficits cause inflation, increased gov spending with no fall in private sector spending will increase AD so thus inflation. If gov can't borrow money, they may print more, this caused hyperinflation in Germany in 1923. This depends on how much is printed and where the economy is producing on the LRAS. - High debt levels reduces the credit rating for the government, this will increase interest rates on loans given. - If borrowing from abroad, gov may not have enough foreign currency to make repayments, this may mean consumers cannot import goods. - Gov borrowing can benefit growth if used for capital spending since this will improve the supply side of the economy and thus reduce the deficit in the long term. The budget deficit can be used as a tool for short term demand management: Keynesians argue a deficit is acceptable to use as a stimulus in demand during recessions.

Answer 110

A current budget deficit is one where government revenues are less than current expenditure; the government has to borrow money simply to finance day to day spending.

Answer 111

To decrease the national debt, the UK government has been using a policy of austerity since 2010, where they attempt to decrease spending. It would also be possible to increase taxes. Both of these are unpopular, could limit growth, and reduce living standards and income equality. Free market economists say that spending can be reduced by cutting out waste, but it is highly unlikely that these efficiency savings will make a significant difference. Sweden used spending cuts and tax increases to balance their budget in the 1990s. On the other hand, opposition parties offer an alternative in the form of demand stimulus by high spending , which will cause economic growth and therefore bring about higher tax revenues. This will allow for budget surpluses and eventually a reduction of national debt. Another approach is to simply rely on automatic stabilisers to allow the economy to grow so national debt/fiscal deficit will reduce as a percentage of GDP. This is mainly the approach that the US took after the Global Financial Crisis and their economy recovered fairly quickly. By 2015, the fiscal deficit as a percentage of GDP was similar in the US and UK. One way to reduce national debt would be for the government to default on their loans but the economic cost of this is so large that governments only default if it is the only option. Russia and Argentina have defaulted on their debts in the past.

Answer 112

- Free market forces are unlikely to create an equal society, leading to absolute or relative poverty and inequality. Most agree that some redistribution from rich to poor is necessary , but the degree to which it is done is contentious. Those on the right argue that high incomes and profits are essential to provide an incentive, whilst those on the left argue that those on low incomes need to be supported. - Progressive tax systems will produce a more equal distribution of income after tax. Inheritance taxes mean that wealth inequality will be reduced as less money can be passed on to the next generation. However, this tax is difficult to enforce as they are avoidable by careful tax planning. The USA has a progressive tax system but the welfare system is not effective at redistributing income . In countries such as Finland and Scandinavia, the tax system is less progressive but the government collects a lot of tax revenue which they are effective at redistributing. - Government expenditure in the form of benefits and transfer payments, social security and National Insurance benefits now represent 30% of government spending in the UK. Universal benefits are available to everyone who meet certain criteria, respective of personal income. Means tested benefits are only available to people who have sufficiently low levels of income/wealth. They are targeted at people who need the most help and provide a safety net/minimum standard of living and are better at improving inequality since they directly affect the poor. Some argue that benefits reduce people’s incentive to work, especially if they can earn a similar amount on benefits to what they could in work. The extent to which governments should use spending to redistribute income is highly controversial, particularly with high levels of national debt and austerity as seen in the UK. - provide goods and services which give citizens equal opportunities and access to services they may not otherwise be able to afford, such as healthcare, education and housing. This helps to ensure that everyone is given an equal start in life

Answer 113

- Free market forces are unlikely to create an equal society, leading to absolute or relative poverty and inequality. Most agree that some redistribution from rich to poor is necessary , but the degree to which it is done is contentious. Those on the right argue that high incomes and profits are essential to provide an incentive, whilst those on the left argue that those on low incomes need to be supported. - Progressive tax systems will produce a more equal distribution of income after tax. Inheritance taxes mean that wealth inequality will be reduced as less money can be passed on to the next generation. However, this tax is difficult to enforce as they are avoidable by careful tax planning. The USA has a progressive tax system but the welfare system is not effective at redistributing income . In countries such as Finland and Scandinavia, the tax system is less progressive but the government collects a lot of tax revenue which they are effective at redistributing. - Government expenditure in the form of benefits and transfer payments, social security and National Insurance benefits now represent 30% of government spending in the UK. Universal benefits are available to everyone who meet certain criteria, respective of personal income. Means tested benefits are only available to people who have sufficiently low levels of income/wealth. They are targeted at people who need the most help and provide a safety net/minimum standard of living and are better at improving inequality since they directly affect the poor. Some argue that benefits reduce people’s incentive to work, especially if they can earn a similar amount on benefits to what they could in work. The extent to which governments should use spending to redistribute income is highly controversial, particularly with high levels of national debt and austerity as seen in the UK. - Provide goods and services which give citizens equal opportunities and access to services they may not otherwise be able to afford, such as healthcare, education and housing. This helps to ensure that everyone is given an equal start in life. The problem with these is that they also benefit those on higher incomes and incur a high opportunity cost. In the UK, the government provides free healthcare, but this is not the case in many countries. - Reduce wage differentials, a national minimum wage will improve the incomes of the poor whilst maximum wages or pay ratios will reduce the incomes of the rich and could even mean companies increase the pay of their lowest income workers. However, minimum wages may cause unemployment and maximum wages may lead to a loss of the most skilled workers. Equal pay legislation will prevent inequality between men and women or between different ethnic groups. Trade union friendly legislation will allow the wages of their workers to rise, and those in unions are more likely to be the low paid so this will positively affect equality. Employers could be forced to provide benefits to their workers, such as sickness benefits, pensions and medical care, which will effectively increase wages. - Improvements in access to education and training opportunities will prevent children from poorer backgrounds achieving less than others, which would reduce their earning potential. The government has attempted to address this by offering additional funding through the pupil premium scheme and easier access to universities, for example lower grades for those in certain areas. - Price controls on essential goods, such as housing, bus fares, bread, electricity etc. This will increase the spending power of the poor. However, this could cause excess supply and may lead to the development of black markets. - Free market economists use the concept of trickle down, arguing that increasing the incomes of the rich will lead to an increase in the income of the poor. The rich create jobs by spending their money and employing others and reducing their income would reduce employment and lead to lower living standards. They also believe inequality is necessary to encourage people to work hard and therefore increase their income. - The law of diminishing marginal utility suggests that redistribution increases total utility and therefore is a better allocation of resources. The higher the spending of an individual, the less satisfaction they gained from spending an extra pound. £10 a week given to a poor family increases satisfaction more than £10 given to a rich family would. The high growth rates of Nordic countries, like Denmark, where redistribution is high suggests that it is not negative for economic growth.

Answer 114

The central bank has the ability to change interest rates and monetary supply. They may do this for domestic reasons, such as to control inflation, or due to global issues such as a low exchange rate or a change in world commodity prices. A fall in the bank rate is likely to increase the supply of money because it will mean there is more demand for loans. There is no simple relationship between the supply of money and inflation and it can be argued that central banks don’t have complete control over the money supply because they cannot control the ability of the financial system to create credit. The globalisation of the financial market has also made it increasingly harder to control domestic money supply. The consensus is that central banks should allow inflation caused by supply side shocks but manage demand side inflation. Following the financial crisis of 2007-08, some central banks were concerned with deflation rather than inflation and this led to the policy of quantitative easing. For example, the Bank of England and the European Central Bank used this policy. This is because interest rates were so low they could not be reduced much further.

Answer 115

The government can improve competitiveness by taking action to increase any of the factors which affect competitiveness. Supply side measures will improve productivity and flexibility and can involve taxes and deregulation. They can encourage competition, forcing firms to be efficient and thus competitive within the global market. They can place an emphasis on quality of products and use tax incentives to encourage incentives. Education will improve the skills of the workforce and help improve flexibility. The UK government has established the ‘Red Tape Challenge’, which aims to simplify regulation for businesses. Exchange rate policies may be used, and they may control inflation and macroeconomic stability. For example, China devalues their currency in order to reduce export prices. They can join the WTO or sign trade agreements.

Answer 116

TNCS can bring huge gains to an economy through their creation of jobs, the tax revenue they raise, the knowledge they bring and the investment they undertake. However, they can have a negative economic and social impact by destroying local culture, affecting the environment and withdrawing more in profits than they inject through investment. They also have a history of influencing politicians to take decisions that will favour their interests and are involved in tax avoidance. In the EU and the USA, it is illegal for TNCs operating in their country to use bribery or corrupt practices anywhere in the world and they can be fined for doing so. Some developing countries don’t allow TNCs to set up in their country without first setting up a joint company with a local partner, meaning that some profits are retained within the country and knowledge/technology is transferred. Many governments use import contracts with TNCs, meaning that at least some part of the value of the order must be manufactured in the country.

Answer 117

Inaccurate information Risks and uncertainties External shocks

Answer 118

Short term information, such as GDP figures for the previous month, are often inaccurate and so may mean that the government is unable to see if there are problems within the economy. Trying to cut down on tax evasion and avoidance is difficult as the government does not have the full picture on the level of avoidance, who it is that is avoiding the tax and the best way to reduce it. The Bank of England makes its decisions based on past data but it is possible trends in the economy may be changing so past data gives an inaccurate picture of where the economy is currently heading. With interest rates so low for such a long period, past data is unlikely to give an accurate representation of the current economic climate which makes it difficult for the Bank to know which action to take. Full cost-benefit analyses can be time consuming and costly and it is impractical for the government to gain every single bit of information they need.

Answer 119

The government cannot accurately predict the future and so it is difficult for them to know whether extra spending is necessary etc. They can’t know the full impact of their decisions as consumers often react unexpectedly and this could undermine government policy. Managing risk is an essential part of good decision making.

Answer 120

The government is unable to control and prepare for these external shocks; the best they can hope to do is lessen their impact. Since every situation is different, it may be difficult to know the best method to solve the problem. Policies employed by policy makers may not have their intended impacts and it may undermine current policies in place, for example Brexit has delayed government plans to balance the budget.

Theme 4 - A Global Perspective Flashcards

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