Theme 4 - A Global Perspective Flashcards
(174 cards)
1
Q
Globalisation
A
The process of increasing interconnectedness and interdependence between countries through trade, investment, technology, and cultural exchange
2
Q
Factors contributing to globalisation
A
- Improvements in transport infrastructure and operations
- Improvements in IT and communication
- Trade liberalisation
- International financial markets
- Multinational Corporations
3
Q
How improvements in transport infrastructure and operations contribute to globalisation
A
Means there are quick, reliable and cheap methods to allow production to be separated around the world
4
Q
How improvements in IT and communication contribute to globalisation
A
The spread of IT has resulted in it becoming easier and cheaper to
communicate, which has led to the world being more interconnected
5
Q
How trade liberalisation contributes to globalisation
A
The growing strength and influence of organisations such as the World Trade Organisation, which advocates free trade, has contributed to the decline in trade barriers
6
Q
How international financial markets contribute to globalisation
A
Provided the ability to raise money and move money around the world, necessary for international trade
7
Q
How Multinational Corporations contribute to globalisation
A
They have used marketing to become global, and by growing, they have been able to take advantage of economies of scale, such as risk-bearing economies of scale. The spread of technological knowledge and economies of scale has resulted in lower costs of production
8
Q
Positive impacts of globalisation on consumers
A
- Consumers have more choice since there are a wider range of goods available from all around the world
- Can lead to lower prices as firms take advantage of comparative advantage and produce in countries with lower costs, for example low labour costs
9
Q
Negative impacts of globalisation on consumers
A
- Can lead to a rise in prices since incomes are rising and so there
is higher demand for goods and services - Many consumers worry about the loss of culture.
10
Q
Positive impacts of globalisation on workers
A
- TNCs tend to provide training for workers and create new jobs
- Workers can take advantage of job opportunities across the globe, rather than just in their home country
11
Q
Negative impacts of globalisation on workers
A
- Increased migration may affect workers by lowering wages
- The wages for high skilled workers appear to be increasing, since there is more demand for their work, increasing inequality
- Large scale job losses in the western world in manufacturing sectors as these jobs have been transferred to countries such as China and Poland
12
Q
Positive impacts of globalisation on producers
A
- Firms are able to source products from more countries and sell them in more countries. This reduces risk since a collapse of the market in one country will have a smaller impact on the business
- They are able to employ low skilled workers much cheaper in developing countries and can exploit comparative advantage and have larger markets, both of which can increase profits
13
Q
Negative impacts of globalisation on producers
A
- Firms who are unable to compete internationally will lose out
- Increased competition, domestic firms face intense competition from international businesses, which can lead to lower market share and profitability
14
Q
Positive impacts of globalisation on the government
A
- Higher tax revenues, increased international trade and foreign direct investment (FDI) lead to higher corporate and income tax revenues, allowing governments to fund public services
- Access to foreign investment, governments benefit from FDI, which can help develop infrastructure, industries, and public services
15
Q
Negative impacts of globalisation on the government
A
- Economic vulnerability, global financial crises or economic downturns in other countries can negatively impact a nation’s economy, reducing government stability
- Tax avoidance and evasion, large multinational companies can shift profits to low-tax countries, reducing government tax revenues and limiting public spending
16
Q
Absolute advantage
A
When a country, business, or individual can produce a good or service more efficiently (using fewer resources) than another entity
17
Q
Comparative advantage
A
When a country, business, or individual can produce a good or service at a lower opportunity cost than another entity
18
Q
Advantages of specialisation and trade
A
- Increased efficiency and productivity, specialisation allows countries and businesses to focus on producing goods where they have a comparative advantage, leading to more efficient resource use and higher output
- Lower costs and economies of scale, as firms or countries specialise, they can produce larger quantities at lower costs due to economies of scale
- Encourages innovation, exposure to global competition and markets incentivises firms to innovate and improve production methods
19
Q
Disadvantages of specialisation and trade
A
- Overdependence on certain industries, if a country or business relies too heavily on one industry, economic downturns or demand shifts can lead to instability
- Risk of structural unemployment, workers in declining industries may struggle to find new jobs if their skills are not transferable
- Exploitation of workers and resources, some countries may exploit cheap labor or natural resources to remain competitive, leading to poor working conditions and environmental damage
20
Q
Factors influencing the pattern of trade
A
- Comparative advantage
- Emerging economies
- Trading blocs and bilateral trading agreements
- Relative exchange rates
21
Q
Terms of trade
A
Measures the rate of exchange of one product for another when two countries trade. It tells us the quantity of exports that need to be sold in order to purchase a given level of imports
22
Q
Formula for terms of trade
A
(Index of export prices / Index of import prices) * 100
23
Q
Factors influencing a country’s terms of trade
A
- In the short run, exchange rates, inflation and changes in demand/supply of imports or exports affect the terms of trade since these affect the relative prices of imports and exports
- In the long run, an improvement in productivity compared to a country’s main trading partners will decrease the terms of trade since export prices will fall relative to import prices
24
Q
Regional trading bloc
A
A group of countries within a geographical region that protect themselves from imports from non-members. They sign an agreement to reduce or eliminate tariffs, quotas and other protectionist barriers among themselves
25
Free trade areas
When two or more countries in a region agree to reduce or eliminate trade barriers on all goods coming from other members. Each member is able to impose its own tariffs and quotas on goods it imports from outside the trading bloc
26
Customs unions
Involves the removal of tariff barriers between members and the acceptance of a common external tariff against non-members. This means that members may negotiate as a single bloc with third parties such as other trading blocs or countries.
27
Common markets
When members trade freely in all economic resources so barriers to trade in goods, services, capital and labour are removed. They impose a common external tariff on imported goods from outside the markets
28
Monetary unions
Two or more countries with a single currency, with an exchange rate that is monitored and controlled by one central bank or several central banks with closely coordinated monetary policy
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Static benefits
Immediate or short-term advantages that arise from economic activities such as trade, specialisation or market efficiency
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Dynamic benefits
Long-term advantages that arise from economic activities such as trade, investment and innovation, leading to sustained economic growth and development over time
31
Trade creation
When the formation of a trade agreement (e.g., a free trade area or customs union) leads to a shift in production from a high-cost domestic producer to a lower-cost producer within the trade bloc, increasing overall economic efficiency
32
Trade diversion
When a trade agreement causes imports to shift from a more efficient, low-cost producer outside the trade bloc to a higher-cost producer within the bloc due to the imposition of tariffs on non-member countries
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World Trade Organisation
An international body that regulates global trade, ensuring that it runs smoothly, freely and fairly among nations
34
Trade liberalisation
Process of reducing or removing trade barriers, such as tariffs, quotas and import restrictions, to encourage free trade between countries
35
Reasons for restrictions on free trade
1. Infant industry argument
2. Job protection
3. Protection from potential dumping
4. Protection from unfair competition
5. Terms of trade
6. Danger of over specialisation
36
Infant industry argument
An infant industry is one that is just being established within a country. They need to be able to build up a reputation and customer base and will have to cover a lot of sunk costs, meaning their AC will be higher. Therefore, the industry would be unable to compete in the international market and so the government protect them until they are able to compete on an equal level
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Dumping
When a country or company with surplus goods sells these goods off to other areas of the world at very low prices, harming domestic producers in those countries
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Tariff
Tax imposed on imported goods and services, making them more expensive to consumers
39
Quota
Trade restriction that sets a physical limit on the quantity of a specific good that can be imported into a country over a given period
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Subsidies to domestic producers
Financial grant or support provided by the government to domestic producers to lower production costs, making their goods or services more competitive against imports
41
Embargo
Government-imposed ban on trade with a specific country or the restriction of certain goods and services
42
Causes of a current account deficit
1. Appreciation of the currency
2. Economic growth
3. Increase in competitiveness
4. Deindustrialisation
5. Membership of trade union
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Measures to reduce a country’s imbalance on the current account
1. Increase income tax, this will reduce disposable incomes reducing the quantity of imports
2. Reduce government spending, this would reduce aggregate demand leading to less imports
3. Increase spending on education and training, could help increase productivity making the country more internationally competitive causing an increase in exports
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Exchange rate
Price of one currency in terms of another. It determines how much one currency can be exchanged for another in foreign exchange markets
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Types of exchange rate systems
1. Fixed exchange rate system
2. Floating exchange rate system
3. Managed exchange rate system
46
Fixed exchange rate system
When a country's government or central bank pegs its currency to another currency (e.g., the US dollar) or a basket of currencies. The exchange rate remains constant, and the central bank intervenes in the foreign exchange market to maintain the fixed value
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Floating exchange rate system
Where the value of a currency is determined by market force, (supply and demand) in the foreign exchange (forex) market without direct government intervention. The exchange rate fluctuates freely
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Managed exchange rate system
Where a currency's value is primarily determined by market forces (supply and demand) but with occasional government or central bank intervention to reduce excessive fluctuations
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Appreciation
When the value of a currency rises in comparison to another currency in a floating or managed exchange rate system. This means that the currency can buy more of another currency
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Depreciation
When the value of a currency falls in comparison to another currency in a floating or managed exchange rate system. This means the currency can buy less of another currency
51
Revaluation
When a government or central bank deliberately increases the value of its currency in a fixed or managed exchange rate system. This makes the currency stronger compared to other currencies
52
Devaluation
When a government or central bank deliberately decreases the value of its currency in a fixed or managed exchange rate system. This makes the currency weaker compared to other currencies
53
Factors affecting floating exchange rates
1. Inflation
2. Speculation
3. Other currencies
4. Government finances
5. Balance of payments
6. International competitiveness
54
Marshall-Lerner condition
A currency depreciation or devaluation will only lead to an improvement in the current account balance if the sum of the price elasticities of demand for exports and imports is greater than 1 (i.e., PEDx + PEDm > 1)
55
J-curve
Describes how a currency depreciation or devaluation initially worsens a country's current account balance before improving it over time
56
Impact of changes in exchange rates
1. Current account of balance of payments
2. Economic growth and unemployment
3. Rate of inflation
4. Foreign Direct Investment
57
Measures of international competitiveness
1. Relative unit labour costs
2. Relative export prices
58
Factors influencing international competitiveness
1. Exchange rates
2. Productivity
3. Regulation
4. Investment
5. Taxation
6. Inflation
7. Economic stability
8. Flexibility
9. Competition and demand at home
10. Factors of production
11. Openness to trade
59
Benefits of international competitiveness
1. Improvement in trade balance
2. Lower unemployment
3. Attraction of Foreign Direct Investment
60
Problems of international competitiveness
1. Risk of over-reliance on exports
2. Pressure on wages and working conditions
3. Rising income inequality
61
Absolute poverty
When people are unable to afford sufficient necessities to maintain life. The UN defines absolute poverty as ‘a condition characterised by severe deprivation of basic human needs, including food, safe drinking water, sanitation facilities, health, shelter, education and information (less than US$1.90 a day)
62
Relative poverty
When an individual’s income is significantly lower than the average income in their society, making it difficult to maintain an acceptable standard of living. It is measured in comparison to others rather than by an absolute level of income (income of less than 60% of median household income)
63
Poverty trap
When the tax and benefits system creates a disincentive to look for work or work for longer hours. By working longer hours, individuals may find they lose income due to income tax and national insurance contributions as well as losing some income related state benefits
64
Causes of changes in absolute and relative poverty
1. Inequality in wages or unemployment
2. Government policy
3. Disease, malnutrition and other health problems
4. Wars, conflicts and natural disasters
5. Corruption and political oppression
6. Trade unions
7. Economic growth
65
Income
Flow of earnings
66
Wealth
Stock of assets
67
The Lorenz curve
Graphical representation of income or wealth inequality within an economy. It shows the cumulative percentage of income earned by different proportions of the population, helping to illustrate how equally income is distributed
68
The Gini coefficient
Numerical measure of income or wealth inequality within a country. It ranges between 0 and 1 (or 0% to 100%), where 0 (or 0%) represents perfect equality and 1 (or 100%) represents perfect inequality
69
Formula for Gini coefficient
Area A / Area A + Area B
70
Causes of wealth and income inequality within countries
1. Wages
2. Wealth levels
3. Chance
4. Age
71
Kuznets hypothesis
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
72
Capitalism
A society where capital is privately owned and workers are paid wages by private firms. There is minimal government intervention and resources are distributed according to the market
73
Measures of development
1. Human Development Index
2. Inequality-adjusted Human Development Index
3. Multidimensional Poverty Index
4. Genuine Progress Indicator
74
Human Development Index
Measure of economic development calculated by the UN, based on health measured by life expectancy at birth, education measured by mean years of schooling and income measured by by real Gross National Income per capita
75
Advantages of Human Development Index
1. Takes into account three key factors which are important for the development of a country
2. Relatively easy to calculate because governments tend to collect the statistics used in the data
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Disadvantages of Human Development Index
1. Health takes no notice of the quality of life that people enjoy and education doesn’t take into account the quality and success of education
2. No consideration for the equality of income
3. Doesn't include other factors which affect development, for example freedom from corruption or the environment
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Inequality-adjusted Human Development Index
An adjustment of the Human Development Index which includes a fourth indicator of development inequality
78
Multidimensional Poverty Index
Measures the percentage of the population that is multidimensional poor, it uses data for health, education and standard of living but uses a broader range of indicators within these categories
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Genuine Progress Indicator
Calculated from 26 different indicators grouped into three main categories, economic, environmental and social. It aims to look at economic sustainability, to ensure development does not limit the amount produced and consumed in the future
80
Economic factors influencing growth and development
1. Primary product dependency
2. Volatility of commodity prices
3. Savings gap
4. Foreign currency gap
5. Capital flight
6. Demographic factors
7. Debt
8. Access to credit and banking
9. Infrastructure
10. Education/skills
11. Absence of property rights
81
Primary product dependency
When a country relies heavily on the export of raw materials (primary products) such as agriculture, oil, minerals, and other natural resources, rather than manufacturing or services. Many developing countries face this issue, making their economies vulnerable to external factors
82
Prebisch Singer Hypothesis
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
83
Dutch disease
When a country becomes a significant commodity producer in a short amount of time, causing an increase in demand for the currency (to enable people to buy the goods) 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
84
Savings gap
Developing countries have lower incomes and thus they save less. This means there is less money for banks to lend, reducing borrowing and thus reducing investment/consumption. A savings gap is the difference between actual savings and the level of savings needed to achieve a higher growth rate.
85
Harrod-Domar model
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.
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Foreign currency gap
When exports from a developing country are too low compared to imports which are needed to finance the purchase of investment or other goods from overseas, required for faster economic growth
87
Capital flight
When money and assets rapidly leave a country due to economic or political instability, reducing investment and weakening the economy. This can happen through legal means (such as investors moving funds abroad) or illegal means (such as tax evasion or money laundering)
88
Property rights
Where individuals are allowed to own and decide what happens to certain resources. A lack of rights mean that individuals and businesses cannot use the law to protect their assets, leading to reduced investment. They will be unwilling to buy machinery, build factories or establish brands.
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Non-economic factors influencing growth and development
1. Corruption
2. Diseases
3. Poor climates and geographical terrain
4. Civil wars
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Market-orientated strategies influencing growth and development
1. Trade liberalisation
2. Promotion of Foreign Direct Investment
3. Removal of government subsidies
4. Floating exchange rate systems
5. Microfinance schemes
6. Privatisation
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Trade liberalisation
Removal or reduction of trade barriers such as tariffs, quotas, and regulations, allowing for free movement of goods and services between countries. Means that domestic industries either close or are forced to become as efficient as other world producers
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Foreign Direct Investment
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
93
Benefits of Foreign Direct Investment
1. 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
2. Will create jobs and leads to the effect of the multiplier
3. Labour productivity tends to increase and wages are often higher. It is a source of investment and can help to fill the savings gap
94
Drawbacks of Foreign Direct Investment
1. 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
2. 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
3. Environmental damage and exploitation of natural resources
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Microfinance schemes
Schemes aimed to give poor and near-poor households permanent access to a range of financial services , including loans, savings, insurance and fund transfers
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Interventionist strategies influencing growth and development
1. Development of human capital
2. Protectionism
3. Managed exchange rates
4. Infrastructure development
5. Promoting joint ventures with global companies
6. Buffer stock schemes
97
Human capital
The skills, knowledge, experience, and abilities that workers possess, which contribute to their productivity and economic value. It includes both education and training, as well as on-the-job experience
98
Protectionism
Government policies that restrict international trade to protect domestic industries from foreign competition. These policies limit imports through tariffs, quotas, and other trade barriers
99
Impacts of protectionism
1. 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
2. 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
100
Impacts of buffer stock schemes
1. 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
2. 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
101
Other strategies influencing growth and development
1. Industrialisation
2. Development of tourism
3. Development of primary industries
4. Fairtrade schemes
5. Aid
6. Debt relief
7. International Monetary Fund
8. World Bank
9. Non profit organisations (NGOs)
102
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
103
Industrialisation
Process of transforming an economy from primarily agricultural to one based on manufacturing and industry. It involves the growth of factories, mass production, and technological advancements, leading to increased economic output and urbanisation
104
Benefits of development of tourism
1. 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
2. Tourists represent a source of foreign currency, which will fill the currency gap, so countries will be able to fund their imports without negative consequences
3. 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
4. Jobs are created locally since the tourism industry relies on low skilled workers who know the local area, rather than to high skilled workers which may be sourced from abroad
5. Government will see higher tax revenues due to higher income and higher profits. It can provide funds to allow countries to diversify
105
Drawbacks of development of tourism
1. 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
2. A large amount of wealth created will be withdrawn as TNCs repatriate their profits, causing problems involving capital flight
3. Country can suffer from a large number of externalities, including pollution, waste, environmental damage and impact on culture
106
Impacts of development of primary industries
1. Provides funds to allow a country to diversify as well as allowing infrastructure development and better education
2. However, primary products are volatile and primary product dependency causes many issues. Primary industries also suffer from corruption
107
Fairtrade schemes
Initiatives that ensure producers in developing countries receive fair prices and better working conditions for their goods. These schemes aim to promote ethical trade, sustainability, and social development by supporting small-scale farmers and workers
108
Impacts of fairtrade schemes
1. Gives producers stability and raises their income
2. Means that child labour is not used and that production is sustainable and does not take place at the expense of environmental degradation
3. Can leave others worse off since non-Fairtrade producers see a fall in demand. In the long term, the higher price for Fairtrade goods will increase supply and thus this could bring price back down, but this will depend on the price elasticity of supply
4. Higher incomes reduces the incentive to diversify and keeps farmers engaged in low profit activities
109
Tied aid
Aid with conditions attached, such as economic or political reforms or a commitment to buy goods from the donor country
110
Impacts of aid
1. Able to reduce absolute poverty
2. Can fill the savings gap thus provides funds for investment, whether this be in infrastructure or in human capital
3. Can contribute to increased globalisation and trade as well as reducing world inequality
4. 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
111
Debt relief
Partial or total cancellation, restructuring, or rescheduling of a country's external debt to make repayment more manageable. It is often granted to heavily indebted poor countries (HIPCs) that struggle to meet their debt obligations while funding essential public services
112
Moral hazard
When an individual, business or government takes higher risks because they do not bear the full consequences of their actions. This typically happens when they are protected from the negative outcomes, such as through insurance, bailouts, or debt relief
113
Financial markets
Where buyers and sellers can buy and trade a range of services
or assets that are fundamentally monetary in nature
114
Roles of the financial market
1. Facilitate saving
2. Lend to businesses and individuals
3. Facilitate the exchange of goods and services
4. Provide forward markets
5. Provide a market for equities
115
Forward markets
Where firms are able to buy and sell in the future at a set price, for example if a farmer wants to sell the crop they are growing at a guaranteed price in a month’s time. The forward market exists for commodities and in foreign exchange and helps to provide stability
116
Examples of market failure in the financial sector
1. Asymmetric information
2. Externalities
3. Moral hazard
4. Speculation and market bubbles
5. Market rigging
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Speculation
Act of buying or selling assets (such as stocks, bonds, commodities, or currencies) with the hope of making a profit from future price movements. Speculators take on high risks, betting on the direction in which the market will move, rather than holding assets for long-term use or investment
118
Market bubbles
When the price of an asset, such as real estate, stocks, or commodities, rises far beyond its intrinsic value, driven by speculative demand rather than fundamental factors. Eventually, the bubble bursts, and prices rapidly fall back to more realistic levels, often causing significant financial losses for investors
119
Market rigging
Where a group of individuals or institutions collude to fix prices or exchange information that will lead to gains for themselves at the expense of other participants in the market, such as insider trading
120
Roles of the central bank
1. Implement monetary policy
2. Banker to the government
3. Banker to the banks (lender of last resort)
121
Financial regulation
The set of rules, laws, and guidelines established by government authorities or regulatory bodies to oversee and manage financial markets, institutions, and systems. The goal is to ensure the stability, fairness, transparency, and integrity of financial markets, protect consumers and prevent financial crises
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Types of expenditure
1. Capital government expenditure
2. Transfer payments
3. Current government expenditure
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Capital government expenditure
Spending on infrastructure and long-term assets that will be used over many years, such as building new roads and hospitals
124
Transfer payments
Payments made by the government to individuals without any goods or services being received in return, such as unemployment and state pension
125
Current government expenditure
Spending on the day-to-day running of government services, such as public sector wages or interest payments on national debt
126
Composition and size of public of public expenditure
In most mixed and free economies, the lower the average income of the country, the lower is likely to be the percentage of GDP spent by the government. This is because poorer countries tend to have a lower tax revenue, due to avoidance, inefficiency at collecting and a smaller amount of wealth to tax
127
Impacts of composition and size of public of public expenditure on productivity and growth
1. Free market economists argue that government spending is wasteful and causes inefficiency. However, the government is able to enjoy economies of scale when it provides goods, and this improves productivity
2. Education creates the human capital necessary for growth whilst the healthcare system reduces the number of days workers lose from serious illness. Spending on research and development may not be done by the private sector and the government will undertake it to give businesses a long term competitive edge
3. Government can create a multiplier effect and this can be
focused on areas of the country with high unemployment, creating growth
128
Impacts of composition and size of public of public expenditure on living standards
1. Government corrects market failure and provides public goods , which improves social welfare
2. important since they reduce absolute poverty by providing benefits
and basic goods, such as education and healthcare. In developing countries, governments do not have the resources to do this and this leads to malnutrition and poor water
3. Argued that the government will be inefficient at providing goods and services and will have a negative disincentive impact on workers, meaning that output overall is reduced and so living standards fall
4. Argued that the government suffers from the principal agent problem since they make decisions on behalf of the people and individuals may have spent that money differently. As a result, there is a loss in welfare and so a fall in living standards
129
Impacts of composition and size of public of public expenditure on crowding out
1. The limited number of resources in the economy means that for
every resource used in government spending, there are less resources available for the private sector. The result is that government borrowing crowds out private sector borrowing and spending and may lead to no real increase in AD
2. Free market economists argue that investment would be more efficient if done by the private sector and that the government targets investment poorly and is wasteful
3. The crowding out effect is felt most at full employment
4. When levels of unemployment are high then extra government spending could lead to crowding in where it encourages investment through the multiplier
130
Crowding out
In order to spend money above their tax revenues, the government has to borrow from individuals and businesses. However, the amount of money in the economy available to borrow does not increase. The government will therefore be competing with the private sector for finance and will cause higher interest rates. This will discourage firms from investing and individuals from buying on credit
131
Impacts of composition and size of public of public expenditure on the level of taxation
1. In most cases, where government spending is high, levels of tax must be high in order for spending to be sustainable. High levels of tax may have a disincentive effect
2. Oil-rich countries tend to be an exception, where revenue from oil can pay for most of government spending
132
Impacts of composition and size of public of public expenditure on equality
1. Spending should increase equality as it leads to redistribution and helps to provide a minimum standard of living for the poorest in society. It ensures everyone has access to basic goods, such as education and healthcare, which will help to give them a fair start in life
133
Taxation
Tax is used to pay for the number of goods and services that the government provides. On top of this, tax can be used to correct market failure at a microeconomic level and to manage the economy and redistribute income at a macroeconomic one
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Progressive tax
Where those who are on higher incomes pay a higher marginal
rate of tax, they pay a higher percentage of their income on tax. Direct taxes tend to be progressive, for example income tax
135
Regressive tax
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, for example 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
136
Proportional tax
Where the proportion of income paid on tax remains the same
whilst the income of the taxpayer changes e.g. 10% of income is spent on tax, regardless of income. Everyone pays the same percentage of their income on the tax
137
Impacts of tax changes on incentives to work
1. 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
2. High taxes on high income earners could encourage them to move abroad and taxes on the poor may lead to a poverty trap
3. 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
138
Impacts of tax changes on tax revenues
1. 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%
2. 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
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Laffer curve
Theory that shows the relationship between tax rates and tax revenue. It suggests that increasing tax rates beyond a certain point will decrease total tax revenue because it disincentivises work, production, and investment
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Impacts of tax changes on income distribution
1. A progressive tax system will increase the equality of income distribution as more money is proportionally taken from the rich than from the poor
2. 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
3. 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
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Impacts of tax changes on real output and employment
1. 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
2. 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
3. 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
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Impacts of tax changes on price level
1. Taxes can impact LRAS, SRAS and AD. Therefore, these changes will impact price depending on where the economy is producing
2. Indirect taxes, particularly VAT, often cause cost push inflation
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Impacts of tax changes on trade balance
1. 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
2. However, in the long run, lower AD will reduce businesses’ need to invest and this could reduce competitiveness meaning that exports decrease
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Impacts of tax changes on FDI flows
1. 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
2. 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
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Automatic stabilisers
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
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Evaluation of automatic stabilisers
1. Automatic stabilisers cannot prevent fluctuations; they simply reduce the size of these problem and there can be negative aspects to these stabilisers.
2. 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
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Discretionary fiscal policy
The deliberate manipulation of government expenditure and taxes to influence the economy; expansionary and deflationary policies
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National debt
The sum of all government debts built up over many years
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Fiscal deficit
When the government spends more than it receives that year
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Cyclical deficit
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
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Structural deficit
The fiscal deficit which occurs when the cyclical deficit is zero, it is long term and not related to the state of the economy
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Actual deficit
The structural deficit plus the fiscal deficit
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Structural surplus
Occurs when at the peak of the boom, there is an actual fiscal
surplus
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Structural balance
Occurs when at the peak of the boom, the actual fiscal balance is 0
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Relationship between a structural deficit and national debt
If the government has a structural deficit, it is likely that national debt will grow over time as the government has to consistently borrow money to finance spending. For this reason, it is argued that structural deficits need to be eliminated but this is difficult since it is impossible to know what part of the deficit is structural and what part of it is cyclical, just as it is impossible to know the size of the output gap
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Factors influencing the size of fiscal deficits
1. Trade cycle
2. Unforeseen events
3. Interest rates
4. Privatisation
5. Government aims
6. Number of dependents
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How the trade cycle influences the size of fiscal deficits
As explained by the concept of cyclical and structural debts. During a downturn, government tax revenue decreases whilst government spending increases and so the deficit increases
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How unforeseen events influence the size of fiscal deficits
Natural disasters or recessions, lead to huge increases in spending which increase the deficit
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How interest rates influence the size of fiscal deficits
If interest rates on government debt increase, the amount the government pays in interest repayments increases and this is likely to 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 the government
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How privatisation influences the size of fiscal deficits
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
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How government aims influence the size of fiscal deficits
Important in the size of the deficit, as this will influence their
fiscal policy, for example the austerity aim has helped to decrease the size of the deficit but attempting to increase AD would increase spending
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How the number of dependents influences the size of fiscal deficits
Affects both spending and tax revenues so influence the deficit
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Factors influencing the size of national debts
1. If the government is continuously running a deficit, then the national debt will increase overtime. There is a consensus view 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
2. 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 and this leads to a high national debt
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Disadvantages of fiscal deficits and national debts
1. High levels of borrowing may raise interest rates in the economy since an increase in the demand for money will increase the price of money, i.e. interest rates. This could cause crowding out of the economy. However, this may not always be the case as the government may borrow from overseas and during a recession, private sector investment falls which means interest rates may remain unchanged
2. Countries have to spend a large amount of money on servicing their national debt through interest repayments, which has a high opportunity cost
3. High fiscal deficits can cause inflation. If the government increases their spending and there is no similar fall in private sector spending, AD will rise and this can be inflationary
4. High levels of debt tend to result in a reduced credit rating for the government. Lower credit ratings mean that lending to the
government is riskier and so higher interest rates are demanded from lenders
5. If a government has borrowed from abroad, it may have difficulties getting enough foreign currency to make repayments on its debt. This could also cause problems for consumers as if there is not enough foreign currency, they will be unable to import
goods
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Advantages of fiscal deficits and national debts
1. Government borrowing can benefit growth if it used for capital
spending since this will improve the supply side of the economy and thus reduce the deficit in the long term
2. 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
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Use of policies to reduce fiscal deficits and national debts
1. 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
2. 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
3. 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
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Use of policies to reduce poverty and inequality
1. Government can use a progressive tax system which 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
2. Can use government expenditure in the form of benefits and
transfer payments, with Social security and National Insurance benefits now representing 30% of government spending in the UK
3. Government can also 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, for example poor children do not lose out because their parents are unable to afford education. The problem with these is that they also benefit those on higher incomes and incur a high opportunity cost.
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Use of policies for external shocks
1. One example could be a commodity price shock , for example where oil prices greatly increase. The government could use expansionary policy to reduce the impact of a fall in GDP or they could use deflationary policy to reduce the impact on inflation
2. Another example may be a financial crisis, where the government can use expansionary policy to increase AD. It is estimated that shocks in the global economy accounted for about 2/3 of weakness in the UK output after the financial crisis, due to the impact on trade
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Impacts of transnational companies
1. 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
2. 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
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Transfer pricing
One way for firms to engage in tax avoidance. This can occur if a
firm produces a good in one country and then transfers it to another to make it into another good which it then sells. If taxes are higher in the first country than the second country, they can set a low price on the product made in the first country. The overall aim is to increase their profit made in the low tax country and decrease it in the high tax country and so overall reduce their tax bill
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Problems facing policy makers
1. Inaccurate information
2. Risks and uncertainties
3. External shocks
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Innacurrate information as a problem facing policy makers
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. Also, 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
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Risks and uncertainties as a problem facing policy makers
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
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External shocks as a problem facing policy makers
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
