Topic 8 - Finance And Inequality Flashcards
(189 cards)
1
Q
How is the poverty line measured ?
A
By the income needed for a basic standard of living
2
Q
What is poverty a measure of ?
A
Poverty is the measure of the number of people who fall below the poverty line (income needed for a basic standard of living)
3
Q
What is relative poverty ?
A
When your income is low compared to the rest of society
4
Q
How is relative poverty measured ?
A
When your income is measured as less than 60% of the median income of a country
5
Q
What is absolute poverty ?
A
When someone can’t afford basic human needs (like food, water and shelter)
6
Q
What are causes of poverty ?
A
Low income
Low wealth
Being unemployed and not having desirable (employable skills)
Wages rising more quickly then those on sate benefits
7
Q
What is the poverty trap ?
A
Happens when there’s no net gain from working
Whatever the poor earn in income they lose in assistance
E.g. they earn £100 so lose £100 from government benefits
No incentive to work as are working to make as much as not
8
Q
What are the benefits of poverty ?
A
Poverty can be good as it encourages (gives an incentive for) people to work so they improve their incomes and escape poverty
This can reduce absolute poverty in the long term.
Higher inequality means those at the top will do better financially (so increase in tax and derived demand for labour)
This will have a trickle down effect through higher levels of employment to the poorest in society. They will be more able to rise out of poverty
- But this may mean relative poverty will increase as the rich are gaining proportionally more then those getting the benefit of the trickle down effect. So relative poverty will rise
9
Q
What are the negatives of poverty ?
A
Poverty will increase the level of crime
Some people have the entrepreneurial talent and drive but lack resources this is a waste as some of this innovation may have benefited society, therefore poverty causes waste in intelligent people
Entrepreneurs and labour are factors of production so economic growth will fall
10
Q
If corporation taxes were lowered for the top 100 companies in the UK, what would we expect to happen to the proportion of the population in relative poverty?
A
Increase in relative poverty
11
Q
Johnny is a low-earning graduate in poverty. He gets promoted, but his student loan increases and he is taxed more. What situation is he in?
A
Poverty trap
12
Q
What is a commonly used threshold for the poverty line in the UK ?
A
60% below median income
13
Q
What is income ?
A
A flow of money, often received monthly or annually
14
Q
What is wealth ?
A
The sum of the value all of assets
Including pensions, money in the bank, financial investments and the value of a home
15
Q
What are the factors that influence the distribution of income/wealth?
A
Taxation policy: regressive policies will tend to increase the income and wealth gap between different groups in a country. Progressive taxation policies will reduce the gap.
The differences in wage between low and high skilled labour.
The level of discrimination against different groups of workers.
Regional differences in earnings.
Unsalaried individuals depending on state benefits.
16
Q
How does wealth inequality work ?
A
The money that a person does not spend is saved and accrues as wealth.
Over time the person on the higher income gains wealth quickly compared to the middle income, with the low-income person acquiring very little wealth at all.
In the UK, wealth is distributed more unequally than income. This is because differences in income can compound over years and over generations if wealth is passed on through families.
17
Q
How does income inequality work ?
A
Incomes are the payments for factors of production. For most people, their wages are their primary incomes.
In a market economy, different people get different wages based on the jobs they have. Each person then spends money on the basic costs of survival (needs, the cost of which are the same for each person) and then spends a proportion of what is left on wants.
18
Q
What’s an example on how wealth inequality can become larger in an economy ?
A
A 0% inheritance tax
19
Q
How do some people avoid inheritance tax ?
A
gifting family members income each year and putting assets in trusts is a way that wealthy families try to avoid inheritance tax.
20
Q
Enrique Iglesias is estimated to have $100M in stocks, bonds, cash and other real estate assets. How are all of these assets best described?
A
As wealth
21
Q
What does equality measure ?
A
Equality measures the difference in income and wealth from the very richest in society to the poorest.
22
Q
What does equity judge ?
A
Equity tries to judge whether the distribution of income and wealth is fair or not.
23
Q
Why is equity hard to quantify?
A
Because equity tries to judge whether the distribution of income and wealth is fair or not, it’s hard to quantify. So a value judgement needs to be made.
Equity can be horizontal or vertical:
Horizontal equity would imply individuals with similar incomes/wealth paid similar amounts of tax.
Vertical equity would imply that individuals with higher incomes/wealth paid more tax.
24
Q
What is likely to reduce the level of inequality of wealth in the UK ?
A
A 100% inheritance tax
25
What are the benefits of unequal income distribution?
Trickle down economics says that the poor may benefit from the success of the rich.
Unequal distributions can motivate some to work hard and can encourage entrepreneurship.
26
What are the negatives of unequal income distribution?
They will increase levels of absolute and relative poverty.
If poverty is high, people may not be able to afford the basic needs, leading to increased levels of crime.
If some people have a very high income, depending on the marginal propensity to import, this could lead to a worsening of the balance of trade. If income rises, people will import more.
27
Why might inequality worsen the balance of trade in a nation?
Wealthy people might have a higher propensity to import
28
What are two ways to analyse inequality between nations ?
inequality in income within a nation
average incomes (GDP per capita)
29
What does capitalism rely on ?
Capitalism relies on firms, individual incentives and the price mechanism to allocate resources.
Although this has led to economic growth, many people believe that government policies to manage inequality between nations and within nations is needed.
The UK allocates 0.7% of Gross National Income towards foreign aid.
30
How much of the UKs gross national income goes towards foreign aid ?
0.7%
31
In 2018 what did Joseph Stiglitz argue about ?
About Job creation or destruction
although many Western jobs were relocated to developing nations, jobs in developing nations were still destroyed faster than they were created.
Although people moved out of farming to work in higher 'value-add' industries like manufacturing, more people lost jobs than gained them.
But the creation of jobs in the poorest developing countries may reduce the amount of people living in absolute poverty.
32
In the late 1900s why did the demand for manual and factory works’ skills fall ?
Globalisation and deindustrialisation
The outsourcing of the manufacturing sector to developing nations created inequality in developed nations as the demand for manual and factory workers' skills fell drastically in the late 1900s.
However, GDP per capita growth in nations like China has benefited hugely from this change.
Although inequality in the USA has risen in recent years, in the last three decades, inequality between nations in the world has fallen.
33
Over the last three decades what happened to inequality between nations ?
Inequality fell
34
What does the Lorenz curve show ?
A Lorenz curve shows the cumulative percentage of total income received by the cumulative share of the population.
(Income quantiles on the x axis) quantiles are just the constant increase of 20%
(Share of income on the y axis)
35
How can you understand the Lorenz curve and use it to find a country with a more unequal distribution of income and a country with a more equal distribution of income ?
“perfect equality” is a 45-degree line (x=y)
In a Lorenz curve diagram, a more unequal distribution of income is represented below the 45-degree line.
A more equal distribution will be closer to the 45-degree line.
36
What is Gini coefficient? (If not understood perfectly look online)
The Gini coefficient is a measure of inequality that can be shown on the Lorenz curve.
This is equal to Area A ÷ (Area A + Area B).
Area A is the area in between the “perfect equality” line and actual equality line
Area B is the area below the actual equality line
A coefficient of 0 represents perfect equality.
A coefficient of 1 represents complete inequality.
The Organisation for Economic Co-operation and Development (OECD) said that the UK had a Gini coefficient of about 0.35 in 2017.
37
What does a Gini coefficient of 0 show?
Perfect equality
38
Why is poverty undesirable for governments ?
as it leads to significantly reduced welfare and also has spillover effects (negative externalities) in terms of crime and health care.
39
What are some government policies to alleviate poverty ?
Benefits
Progressive tax
Minimum wage
State provision
Stimulate the economy
40
How do the government use benefits to alleviate poverty ?
Governments pay benefits to those who are unable to support themselves due to being out of work, suffering from long-term illness or for several other reasons.
Benefits are an example of transfer payments and are funded through taxes.
Benefits are designed to prevent people from living in absolute poverty by meeting the cost of needs. By providing enough to ensure food, shelter and other essentials and for those who are temporarily unemployed it means they are fit enough to return to work.
41
How does the government use progressive taxes to alleviate poverty ?
Progressive taxes are designed so that the higher your income is, the higher the proportion of your income you pay in tax.
So the rich pay proportionately more tax than the poor.
This reduces the inequality in income and wealth.
42
How does the government use minimum wages to alleviate poverty ?
A minimum wage could also be used to try to guarantee that workers receive a fair wage and can afford the basic needs.
A minimum wage can also stop monopoly employers from paying workers too little and putting them in poverty.
Or a benefits system could be used.
43
How does the government use state provision to alleviate poverty ?
State provision means that those goods and services which are deemed essential by the government are available for all regardless of income or wealth.
By providing schooling, children are given a more equal start in life regardless of their family background.
Without adequate schooling, the children themselves are limited in what jobs they can do when they are older which may keep them in poverty. They would also bring fewer skills to the workforce making the country less productive.
44
How do the government stimulate economic growth to alleviate poverty ?
Governments can generate economic growth using expansionary policies. This can be used to try to get people out of poverty.
This should also create jobs.
This should mean workers get higher wages and the government should collect higher tax revenue in return.
But this is difficult and inequality could worsen.
45
What are the negative effects of progressive taxation?
By increasing the tax on higher income brackets, you are discouraging workers from earning more money.
The gain from working might not be as great as the loss of benefits from moving up an income bracket.
So progressive taxation can reinforce the poverty trap
46
What are the negative effects of minimum wage?
In a perfectly competitive labour market, the introduction of a minimum wage can increase the levels of unemployment.
A national minimum wage underestimates the cost of living differentials across a country.
So a national minimum wage could be better for people who live in cheaper areas than for people who live in more affluent areas.
But the presence of a minimum wage could incentivise work
47
What are the negative effects of the benefit system ?
The benefits system can disincentivize work.
This is bad for productivity and the economy.
Benefits that are means tested can also lead to a worsening of the poverty trap.
If people think that their benefits will go down if their income increases, they may intentionally not go up an income bracket.
48
What are the negative effects of economic growth ?
Economic growth is not a simple way to alleviate poverty effectively. It must be carefully managed.
It can also impact the environment by using up scarce resources
49
What are some measure that are factors in economic development?
access to internet coverage, access to clean drinking water, years of schooling
50
What is the human development index ?
Human Development Index (HDI)
The most popular measure is the Human Development Index (HDI)
51
What is HDI a composite of ?
life expectancy, education, and income indicators
52
How do you calculate HDI ?
Life expectancy at birth (health).
Mean years of schooling and expected years of schooling (education).
Gross national income (GNI) per capita (PPP US$) (standard of living).
Each item is equally weighted.
53
What are the limitations of HDI ?
The HDI is not a comprehensive measure of human development.
It just focuses on the basic dimensions of human development, excluding factors such as political freedom.
It does not reflect the input efforts in terms of policies, nor can it measure short-term human development achievements.
HDI is an average measure and so masks inequalities within countries.
But it is important to keep it simple with minimum variables to make sure its acceptable, understandable and predictable.
54
What does the Indian economist Amartya Sen see development as ?
being concerned with improving the freedoms and capabilities of the disadvantaged to enhance the overall quality of life.
While the standard set of freedoms could be around hunger, for example, you can also expand it to increasing political freedom, cultural and social freedom.
For example, if a woman cannot vote or drive a car, her level of economic development is a lot lower than HDI or other measures would imply.
55
What’s the difference between economic growth and economic development ? (Fact)
Economic growth is measured by an increase in real GDP.
While this allows for higher real incomes, which means people can afford a higher standard of living, it is very important for economists to realise that an increase in real GDP does not equate to economic development, although it may contribute.
Supporting research & development is viewed as a huge supporter of economic growth. South Korea has grown rapidly since 1992 and its R&D has been up to 3.5% of GDP.
Where as
The United Nations (UN) defines development as "the expansion of people’s freedom to live long, healthy and creative lives; to advance other goals they have reason to value; and to engage actively in shaping development equitably and sustainably on a shared planet.”
56
What are common characteristics of less developed countries ?
Low investment and savings
Command and corrupt economy
Lack of education
Lack of loans and borrowing
57
Why should investment and saving be important and a goal for less economic developed countries ?
Increasing the quality or quantity of physical capital can increase the productivity of an economy.
A country or business needs to save money to invest the savings in capital. If a country does not save, then investment in physical capital will be lower.
58
Why should a free market economy and less corruption be important and a goal for less economic developed countries ?
Command economies, where the price mechanism (or invisible hand) does not allocate resources.
Corruption and infighting, where resources and investment are not directed to the place where it is intended.
For example, the Democratic Republic of Congo is resource-rich, but politics seems to have slowed economic development.
59
Why should better education be important and a goal for less economic developed countries ?
Education is sometimes called the accumulation of human capital.
High levels of education can make the labour force more productive and increase the output of an economy
60
Why should loaning and borrowing be important and a goal for less economic developed countries ?
If households or businesses cannot borrow money (get access to capital), then they won't be able to invest in houses, capital (like machinery) or inventory. This will harm economic growth and development.
61
What are some barriers to development ?
Geography
Corruption
Conflict
Infrastructure
Foreign exchange gap
Savings gap
Lack of property rights
Inadequate human capital
Lack of healthcare
Primary product dependency
Debt
Human capital flight
62
How is geography a barrier to development ?
Issues such as climate and geographical location can restrict a country's ability to develop through targeting certain industries or impacting their ability to trade.
For example, a landlocked country may find it more difficult to pursue export-led growth.
63
How is corruption a barrier to development ?
High levels of corruption and bureaucratic delays can harm growth by discouraging foreign direct investment (FDI).
Corruption also leads to allocative inefficiency because resources are allocated for personal gain rather than what is good for the economy.
Corruption makes it likely that domestic businesses will invest overseas rather than at home.
Corruption can lead to the government collecting less tax revenue, which has knock on effects for growth and anti-poverty policies
64
How is conflict a barrier to development ?
Physical capital is destroyed by war. This shifts the LRAS in.
Human capital is destroyed or emigrates, shifting the LRAS in.
Resources are diverted from long term capital goods to short term military expenditure, harming the long-term trend rate of economic growth.
Conflict also discourages both domestic investment and foreign direct investment (FDI) because of the huge uncertainty it creates. This reduces aggregate demand (AD) and could also shift the LRAS to the left.
65
How is infrastructure a barrier to development?
Infrastructure includes physical capital, such as critical energy power and water supplies, sanitation, telecommunications and transport networks, schools and hospitals.
Poor energy reliability leads to shortages and blackouts, which deters foreign direct investment (FDI) and investment and reduces efficiency and productivity.
Poor trains and roads reduce the mobility of labour and the ability to get goods to export markets.
66
What is the Harrod-Domar model ?
The Harrod-Domar model stresses the importance of the need for saving and investment to fund economic growth.
The higher the level of saving there is, the more money there is available for firms to borrow for investment.
The model also states that, if the productivity of capital improves, then so will the LRAS and economic growth.
Policies to improve either of the two above would help to improve the financial system to allow for savings to be channelled into funds for investment.
67
How is the foreign exchange gap a barrier to development ?
A lack of foreign currency may prevent businesses from being able to purchase 'big ticket' items, such as capital machinery, especially if the exporting country will not accept the currency being offered.
This makes investment by domestic firms more difficult and can restrict growth.
68
How is the savings gap a barrier to development ?
Savings are needed to provide finance for capital investment.
In many smaller low-income countries, high levels of poverty make it almost impossible to generate sufficient savings to provide the funds needed to fund investment projects.
Low savings rates and poorly developed financial markets make it more expensive for firms in less-developed economies (LDEs) to get funds for investment. Higher borrowing costs deter capital investment.
69
How is lack of property rights a barrier to development ?
Institutional factors include a lack of property rights, a democratic government or an independent legal system.
Property rights are defined as having four main characteristics:
The right to use the good.
The right to earn income from the good.
The right to transfer the good to others.
The right to enforce property rights (rights of ownership).
By lacking them, or not enforcing them, this discourages entrepreneurship or FDI.
70
How is inadequate human capital a barrier to development ?
Poor quality of human capital leads to a lack of productivity and efficiency.
This leads to the cost of production being higher than in other countries and uncompetitive exports.
In 1972, Iraq nationalised the western Iraq National Oil company. It was better to nationalise in 1972 than in 1950 because this gave the Iraqi population 22 years to build up the skills to run oil wells and oil refineries.
71
How is lack of adequate healthcare a barrier to development ?
The lack of adequate healthcare causes people to be ill more often and to have lower life expectancy.
Both of these factors cause workers’ productivity to be lower with more absenteeism (staying off work for no good reason).
Poor healthcare also means people try to have larger families as a way to hedge the risk of some children not surviving. This creates an added burden of high population growth and dependants.
72
How is primary product dependency a barrier to development ?
Primary products are commodities like iron ore, oil or agricultural products like coffee, rice and cocoa beans.
Supply in commodities is inelastic. These crops can take years or even millennia (for things like oil) to develop. When demand changes, prices can change by a large amount.
Income from exports can rise if commodity prices rise and exports can decrease rapidly if commodity prices fall.
This uncertainty may deter investment in that country.
It can also create exchange rate volatility which also discourages investment.
73
How is debt a barrier to development ?
If a developing nation has a lot of debts, it will spend some of its tax revenues on interest payments. Developing nations are usually riskier borrowers than developed nations, so they may pay a higher interest rate too.
Debt can reduce a developing nation's government's spending on infrastructure, education and healthcare.
Some people argue for debt relief for developing nations. This would involve cancelling these nation's debts. However, the money from the debt may be embezzled by corrupt individuals and may generate moral hazard, with nations borrowing with no intention of repaying a debt.
74
How is human capital flight a barrier to entry ?
Poor quality of human capital leads to a lack of productivity and efficiency.
This leads to the cost of production being higher than other countries and uncompetitive exports.
Often, high skilled labour migrates to other nations to earn higher wages. This can leave developing nations with a labour shortage.
75
What is the Prebisch-singer hypothesis (why primary product dependency is not good for longtermgervity ?
The Prebisch-Singer hypothesis claims that, because the demand for primary products doesn't change much with income (they are income inelastic), that rising incomes don't lead to increased demand for primary products, unlike manufacturing and services' products.
Therefore, if incomes rise globally, nations producing primary products won't see much of a change in demand. Nations producing manufacturing goods would because manufactured products are income elastic.
This would suggest that primary products are not a sustainable development strategy for a country.
76
Who wrote the book “the bottom billion” In 2007 and what does it explore ?
Paul Collier. It explores why poverty can persist in some countries over long periods of time.
77
What is the Dutch disease ?
Dutch Disease, sometimes called the 'resources trap', usually affects nations with lots of natural resources. Nations with lots of raw minerals export these to nations all over the world. As a result, their currency appreciates. This makes it relatively cheaper to import goods and services, but makes all of the nation's other industries uncompetitive on price when they try to export. The exchange rate appreciation crowds out all of the nation's other industries
78
What did the Netherlands discover that led its currency to appreciate crowding out other sectors?
North Sea gas
79
What are two instances of the “Dutch disease” ?
The Netherlands (thus the name Dutch Disease) - The Netherlands discovered North Sea gas and the currency appreciated, making other industries less price competitive.
Nigeria - Nigeria is an oil-rich nation. The Nairu has appreciated and this has harmed some of Nigeria's other sectors and industries.
80
What was colliers list of 4 traps that hinder economic growth ?
The Conflict Trap - usually involving civil wars.
The Natural Resource Trap (including Dutch Disease)
The Landlocked Trap
The Bad Governance Trap - having things like corruption & weak institutions (legal, government etc.)
81
What are some market-orientated strategies can be used to promote growth and development in LEDCs ?
Floating exchange rate systems
Microfinance schemes
Privatisation
Export-driven development
Promotion of FDI
Trade liberalisation
Removal of government subsidies
82
What is (the market orientated strategy for LEDCs), floated exchange rate system ?
By using a floating exchange rate, the currency is determined by market forces.
This can help the country's balance of payments come to an equilibrium.
The depreciation of the exchange rate can stimulate export-led growth.
It also allow the government to focus on monetary policy.
83
What is (the market orientated strategy for LEDCs), microfinance schemes?
Microfinance schemes are designed to give financial support to local entrepreneurs.
They can receive: micro-credit, micro-savings, micro-insurance and remittance management.
Microfinance schemes target women in particular (as they are less likely to gain access to mainstream finance).
84
What is (the market orientated strategy for LEDCs), privatisation ?
Privatisation is when the government sells ownership of an enterprise to a private body.
Privatisation typically leads to a business becoming more efficient and competitive.
It also decreases government intervention and increases government revenue.
Privatisation is most effective in producing economic growth and development when it is properly regulated.
85
What is (the market orientated strategy for LEDCs), export driven growth ?
Joe Studwell argues that the Asian nations that tried to build exporting businesses facing domestic competition performed better than protected national champions.
In Korea, the Kia and Hyundai car companies competed against other domestic champions. Loans, credit, and informal government support were given to nations that exported. Korea produced national champions in cars, technology (LG and Samsung).
In Malaysia, there was 1 domestic car company, Proton, that sold mainly in Malaysia. It failed to export and Malaysia failed to develop at the same speed.
86
What is (the market orientated strategy for LEDCs), promotion of FDI ?
Lower taxes, especially lower corporation tax, may encourage FDI to locate in the country, or indeed domestic firms to set up, which can lead to the LRAS shifting out.
FDI often creates positive multiplier effects through employment.
Multinational corporations (MNCs) can simply employ workers without providing any training, meaning that attracting FDI is less useful in the long-term.
87
What is (the market orientated strategy for LEDCs), trade liberalisation?
A special economic zone (SEZ) is an area in which business and trade laws are different from the rest of the country.
SEZs are located within a country's national borders.
Their aims include increased trade, increased investment and, job creation.
To encourage businesses to set up in the zone, financial policies are introduced.
These policies typically regard investing, taxation, customs and labour regulations.
Additionally, companies may be offered tax 'holidays' or breaks.
88
What is (the market orientated strategy for LEDCs), remove government subsidies ?
By removing subsidies, suppliers are forced to cope with international competition.
This market orientated approach means suppliers will either survive or go under.
Removing protectionist policies stops suppliers being dependent and also reduces government expenditure.
89
Why would a country want to grow out of the primary sector ?
Primary industries usually include farming (agriculture) and raw material mining.
The 'value-add' of labour in primary industries is usually low because they are low productivity. The value added by human labour is a lot less than in other sectors.
Many developing nations have rich mineral deposits and can extract these natural endowments of resources. Although the sectors may be a lower value-add, they will still generate employment and a nation may have comparative advantage in primary products.
90
What is the Lewis model ?
Because labour is low productivity in agriculture, the model assumes that there is no opportunity cost from moving that labour into the industrial sector.
This means the industrial sector of a nation can grow without the output in agriculture decreasing.
Because there is an excess supply of labour in agriculture, output in agriculture can stay flat, output in the industrial sector can rise and inflation can stay constant, as the economy grows.
Occupational immobility of labour and the assumption of no opportunity cost are two problems with this model.
91
According to the Lewis model what is the most important factor in development?
According to the Lewis model, industrialisation and growth in the industrial sector are the most important factor in development.
Industrialisation helped Britain and the USA develop in the 18th and 19th century and helped China from 1970
92
Why is development of the tourism industry important for some countries?
Tourism has been notable in the development of many nations like Mauritius and nations in the Carribean.
Exports are goods and services sold primarily outside of the country of production. So tourism is an export.
Increasing exports will increase the X component of GDP.
Hotels and services for tourists are quite labour-intensive (need a lot of labour), so employment should rise.
Hotel chains like the Hilton or Marriott may invest in the countries, increasing their levels of FDI.
However, imports may rise in order to build the airport/hotel infrastructure needed for tourists and tourism is cyclical (because it is income elastic). Cyclical unemployment, although positive is not perfect
93
What are some interventionist strategies to promote growth and development ?
Infrastructure developments
Promoting joint ventures
Managed exchange rates
Protectionism
Development
Buffer stock schemes
Fair trade
Debt relief
94
How does the (interventionist strategy), infrastructure development help an emerging economy's development ?
The government could build better highways, trains, airports and ports.
This will improve productivity because goods and labour can be transported around the country more efficiently.
Infrastructure can help connect rural areas to urban areas and so improve the geographical mobility of labour.
The problem with this and many other policies to promote development is that they are expensive and many less economically developed governments do not have the tax revenue to finance them.
95
How does the (interventionist strategy), joint ventures help an emerging economy's development ?
A joint venture is when two or more companies work together in a project.
A joint venture between a MEDC business and a LEDC business could lead to economic growth and development.
This is because the LEDC can learn from the MEDC and benefit from their skills and resources.
In return, the MEDC company has a foothold in an emerging economy.
It is in the interest of all parties for the LEDC's economy to develop.
96
How does the (interventionist strategy), managed exchange rates help an emerging economy's development ?
Governments have the option of intervening in foreign exchange markets if they wish to alter the value of their currency.
For example, if the government wishes to devalue the currency, exports can become more competitive. This helps improve AD and could lead to export-led economic growth.
97
How does the (interventionist strategy), protectionism help an emerging economy's development ?
The 'infant industry' argument can be used to justify using protectionism in emerging economies.
Protectionist measures, such as tariffs or quotas can protect the developing industries in a country and allow them to get on their feet.
Once the industries are fully-fledged, the protectionist measures can be removed.
This policy is potentially dangerous as the industries can use the protectionist measures as a crutch.
98
How does the (interventionist strategy), development of human capital help an emerging economy's development ?
Policies like improving primary education (both quality and quantity) would allow for higher literacy rates. This would make it more likely that the young generation would go onto higher skilled jobs.
The younger generation is likely to earn higher incomes, which can be channelled into both consumption and savings. These are both determinants of short-run and long-run economic growth.
For developing countries, the focus is more on primary education because many primary students lack basic literacy skills.
99
How does the (interventionist strategy), buffer stock schemes help an emerging economy's development ?
A buffer stock scheme can be used to stabilise the price of primary products.
This is particularly useful for agricultural goods.
By buying up more stocks, the price of goods can be maintained despite the harvests.
This helps LEDCs overcome the issue of volatile primary product prices.
100
How does the (interventionist strategy), fair trade help an emerging economy's development ?
Fairtrade schemes effectively implement a minimum price in the markets where they are operated.
Groups of farmers receive a minimum price that is deemed to be 'fair'. In exchange, the farmers must meet certain standards of health and safety and production.
The farmers receive a higher price but also a certain price, enabling them to plan more effectively for the future. This certainty can encourage investment. Particularly when the prices for primary products can be volatile.
101
How does the (interventionist strategy), debt relief help an emerging economy's development ?
If the markets view the country’s national debt as unsustainable, then demand for government debt will fall. So the cost of borrowing will rise.
High repayments on the national debt (principal and interest) have a significant 'opportunity cost'. This is money which could be spent on health, education, etc.
Instead of spending money on infrastructure and education, more money goes on debt payments.
There is also a question of intergenerational fairness: will future generations have to face increased taxes to pay off the debt being built up now?
Some people question if there is a moral hazard if countries know they are likely to receive debt relief.
102
What is a long-standing debate in economics, regarding the best way for a less-developed economy (LDE) to develop ?
Aid or trade
103
How does trade enable a LDE (less developed economy) to develop ?
Export-led growth and trade with other countries enable an LDE to be self-sufficient and reinvest the proceeds of such an approach.
But many LDEs are restricted by issues such as worsening terms of trade - meaning that their exports are continually falling in value relative to more high-end imports.
A lack of skilled labour and capital may also mean that LDEs don't have the resources to focus on a profitable export industry, making this strategy unrealistic.
104
What are the types of aid ?
Bilateral aid
Multilateral aid
Tied / conditional aid
Charitable aid
Non-financial aid
105
What is bilateral aid ?
aid between one government and another
106
What is multilateral aid ?
aid provided by many governments instead of just one government
107
What is tied / conditional aid ?
when one country donates money or resources to another (bilateral aid) but with conditions attached
108
What is charitable aid ?
funded by donations from the public through organisations such as Water Aid
109
What is non-financial aid ?
donation of items, such as malaria nets.
110
What are the limitations of aid ?
Market distortions - Firms will focus their resources on trying to secure aid, rather than putting their resources to the best use
Corruption - Corruption can restrict aid from getting to where it needs to go
Aid dependency - African economist Dambisa Moyo argues that a dependency culture on aid might be created, where no government has an incentive to improve.
Conflicts of interest - Aid can lead to less-economically developed governments focussing on keeping the donors happy rather than their own citizens
111
What are the benefits of aid ?
Savings gap - Less-developed economies (LDEs) have a savings gap and aid can provide a way of filling that gap.
Benefiting human capital - Aid can improve healthcare outcomes.
Mutual benefit - Donor countries benefit because recipient countries grow and then demand exports from the donor country.
Increasing the LRAS - Project aid can help with building infrastructure to increase the capital stock, especially energy (e.g. electricity generation, to improve efficiency).
112
What are some Intergovernmental organisations (Bretton Woods institutions) ?
Intergovernmental organisations (IGOs):
The World Trade Organisation (WTO)
The International Monetary Fund (IMF)
The World Bank
113
What do Bretton woods institutions do ?
Promote free trade policies to encourage FDI and to accelerate globalisation.
Since World War 2, these organisations have worked together to remove tariffs and quotas on goods that act as barriers to free trade
As more developing and emerging countries join the organisations, their actions to encourage free trade arguably continue to accelerate globalisation. China joined the World Trade Organisation in 2011.
These IGOs are collectively referred to as the ‘Bretton Woods institutions’ after the place in America where they are established
114
Who are the BRIC institutions?
Brazil Russia India China
115
What do the BRIC institutions do ?
New alternatives or rivals to the Bretton Woods institutions are rising as the BRICs gain global influence and set up their own organisations - such as the China Development Bank.
In 2015, the BRIC nations set up the New Development Bank to rival the World Bank.
By 2017, this New Development Bank had given loans of $1.5 billion dollars to member countries. Most of these loans went on developing renewable energy in these countries.
China is particularly influential in Africa, where Chinese money funds lots of infrastructure projects in the likes of Kenya.
116
What is the role of the International Monetary Fund (IMF)?
The IMF was founded in 1944. It aims to help stabilise global currencies and it provides loans to developing countries to reduce poverty.
In return for a loan, a country must enforce a Structural Adjustment Program (SAP).
A SAP ensures that capitalism is promoted within the country and it can require a country to impose cuts to public services and privatise many state industries.
Many countries (particularly those in Africa) can see the IMF as a lender of last resort.
Many people also argue that SAPs and loans from the IMF result in the worsening of poverty for many developing countries as they can then become trapped in a cycle of debt (paying back debt & interest).
Although the IMF is a global IGO, 8 countries control 47% of the total votes between them and these are the global superpowers.
So, through their control of the IMF, the superpowers have significant influence over the global economic system.
Recently, there have been reports of countries being loaned money from China in order to meet the conditions needed for further loans from the IMF.
This is an example of China’s growing influence as a superpower and an alternative to the IMF.
117
What is the role of the world bank ?
The World Bank was founded in 1944.
Similarly to the IMF, the World Bank aims to support capitalism.
It also provides loans to developing countries and provides finance following natural disasters and humanitarian emergencies.
Whilst aiming to reduce poverty, the World Bank also wants to achieve sustainability.
Sustainability is the ability to meet the needs of the current generation without compromising the ability of future generations to meet their own needs.
The World Bank is currently working towards two goals for the world to achieve by 2030:
To end extreme poverty by decreasing the percentage of people living on less than $1.90 a day to no more than 3%.
To promote shared prosperity by ensuring that the income of the bottom 40% in every country increases.
118
The most important 8 nations in the IMF control what percentage of its votes?
47%
119
What is the role of the World Economic Forum?
The WEF is a slightly different IGO as it works with businesses and governments.
It is a Swiss not-for-profit organisation that was founded in 1971. It holds an annual conference in Davos, Switzerland that promotes public-private co-operation.
The WEF is an IGO that wants to bring together businesses and governments and other members of society to ‘improve the world’.
The WEF has a wider remit than the other IGOs as it discusses wider issues like corruption and terrorism.
120
What is the role of the World Trade Organisation (WTO) ?
The WTO focuses on trade and the rules of trade. It wants to ensure that capitalism thrives and so trade is free, allowing the market to act independently of government involvement.
The WTO negotiates free-trade agreements.
In 2016, it had 164 members. Over three-quarters of its members are developing or the least-developed countries.
It is noticeable that North Korea, as a switched-off country is not part of the WTO.
Some people argue that the explosion in global trade since 1950 is a sign of the WTO’s success.
Others argue that this explosion in global trade is the result of globalization, rather than the work of one IGO.
121
What are Heavily Indebted Poor Countries (HIPC) schemes ?
HIPC stands for Heavily Indebted Poor Countries. There are 37 nations in this group, including Ghana, Ethiopia, Afghanistan and Senegal.
HIPC schemes aim to make sure that no country faces an unmanageable debt burden (amount of debt).
Under HIPC schemes, countries must reduce poverty over time and meet other criteria. If they meet all of these criteria, then they may have all their external debt cancelled.
Chad achieved this in 2015.
Some people argue that SAPs and HIPCs mean the sovereignty of these nations is questionable - are they perhaps neo-colonial?
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What are Structural Adjustment Programmes (SAP schemes) ?
SAP stands for Structural Adjustment Programmes. They are usually made up of loans from the IMF and World Bank.
SAPs have made countries that receive lending follow specific routes to development, such as privatisation.
Africa Action, an NGO, is critical of SAPs, claiming that the assumption that the market leads to benefits for the rich and poor is flawed.
Ghana launched its structural adjustment plan in 1983. The IMF and World Bank say it is one of the most successful SAPs in Africa.
123
Which nation does the IMF promote as its most successful SAP in Africa?
Ghana
124
How did China use market-orientated strategies to develop after the 1980s?
How did China use market-orientated strategies to develop after the 1980s?
China, from the 1980s, began pursuing a path of development which was a departure from the communist, command-economy approach it had adopted following the creation of the People's Republic.
China created special economic zones (SEZs) in coastal cities like Shanghai. SEZs have different financial policies, usually, they attract foreign investment by providing tax breaks, subsidy benefits, and other incentives.
China also encouraged multinational corporations to settle. China could offer a low-skilled labour force at an unmatched wage rate which reduced business costs and led to many firms outsourcing their manufacturing to the country.
But, China also used interventionist strategies to carefully manage development and these often conflicted with the free-market approach. The Chinese currency, the Renminbi, for example, is heavily managed by Beijing and there are capital controls.
125
What are the roles of financial markets ?
Facilitate savings - bank accounts
Lens to businesses and individuals - money from bank accounts distributed
Exchange of goods and services - buying and selling of goods/services
Provide forward markets - buying and selling currencies and commodities
Provide a market for equities - buying and selling shares
126
Why do financial markets facilitate saving ?
People can invest their savings and pensions into assets like company shares or government bonds.
This can help people to keep their money safe and to generate a 'return' on their savings.
Savings can also be recycled for investment by businesses and individuals.
127
Why do financial markets lend to businesses and individuals ?
Capital markets can be used by businesses to borrow money or sell equity (shares).
This lending can be used for things like capital investment
128
What are some forward markets that financial markets provide?
currencies and commodities
129
What are the types of financial markets ?
Currency markets
Capital markets
Money markets
130
What is a currency market ?
A market where currencies (foreign exchange) are traded.
Currency markets are generally very volatile, with prices moving every second.
The spot exchange rate is the rate that you can purchase or sell currency right now.
131
What is a capital market ?
Governments and firms use capital markets to borrow and lend long term.
This is usually for longer than 12 months.
Borrowing takes place on the capital markets by issuing bonds and shares.
Bonds (government or corporate) can be issued for as long a duration as people are willing to lend to it.
E.g. Disney and Coca Cola have a 100-year bond issued!
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What is a money market ?
Money markets are used by firms and governments to borrow and lend short term.
Short term is usually up to 12 months.
It is in the money markets that commercial banks may provide short term funds for each other.
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What is moral hazard in financial markets?
Moral hazard happens when people engage in riskier behaviour with insurance than they would without insurance
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What are the causes of morale hazard in the financial sector ?
Imperfect information is the cause of moral hazard.
If insurance companies had perfect information, they could simply add a premium every time a consumer engaged in risky behaviour. Technology is helping to do this in some areas e.g. car telemetry boxes.
But in a world of asymmetric information, this is not possible. So, moral hazard exists.
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How can financial markets reduce morale hazard ?
Moral hazard cannot be removed completely. But its effects can be reduced.
You could require the injured party to pay a share of the costs.
E.g insurance policy deductibles. This is an amount you must pay out of your own pocket before your insurance covers the fee.
You can also focus on the incentives of the providers rather than the consumers.
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What are examples of market failure in the financial sector ?
Externalities of speculation
Market rigging
Morale hazard
Asymmetric information
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How is speculation an example of market failure in the financial sector ?
Speculation can stop markets functioning correctly. In 2008, house prices rose so high that many could not afford to buy any more. However, lots of these purchases were made based on speculation. Speculative asset purchases can have negative externalities.
Hedge fund and asset managers can speculate on stocks, without creating any extra value for the people whose money they trade with. In exchange for speculating, they also take a 1% annual management fee. John Kay's 'Other People's Money' is very critical of this feature of speculation in financial markets.
138
How is market rigging an example of market failure in the financial sector ?
Market rigging is when people in the market artificially fix or control prices.
Investment bankers like Tom Hayes of UBS, rigged the financial market for 'LIBOR'. He was sentenced to 14 years in prison for this offence.
139
How is moral hazard an example of market failure in the financial sector ?
Moral hazard happens when people engage in riskier behaviour with insurance than they would without insurance.
In 2007-08, investment banks and insurance companies like AIG were 'Too big to fail'. If they collapsed, there was a risk that the global economy would also collapse. So governments bailed out these large banks and insurance companies.
Bailing out AIG cost the US government $182bn.
140
How is asymmetric information an example of market failure in the financial sector ?
Lots of bad loans were made to people who couldn't afford to make their mortgage payments.
Banks lent these people the whole cost of the house plus 10% to 'do it up nicely'.
The individuals arguably had better information than the bank that they may not be able to repay these loans.
Insider trading, where people profit from non-public information, can also be individuals benefitting from asymmetric information.
141
How much did bailing out AIG cost the US government?
$182 billion
142
What are the main functions of a central bank ?
Implementation of monetary policy
Act as a banker to the banks - The central bank is the lender of last resort
Act as a banker to the government
Regulation of the banking industry
143
What is the Bank of England ?
The Bank of England (BoE) is the central bank of the UK and was made operationally independent in 1997. This means that it is not directly accountable to the government.
144
What are the Bank of Englands objectives ?
Since becoming independent, inflation (price stability more formally) has been the BoE's target – in 1997 it was set at 2.5%. In 2004, the government changed the Bank’s target to 2%.
The BoE is allowed a range of +/- 1 percentage point in the inflation outcome before it has to write a letter to the Chancellor explaining why inflation is away from target, what is being done about it and when we can expect it to be back on target.
The UK government has not set a target for the exchange rate since 1992.
145
Who are the monetary policy committee (MPC) ?
The MPC is the body within the Bank of England that is in charge of achieving price stability.
It is made up of nine members – the Governor, the three Deputy Governors for Monetary Policy, Financial Stability and Markets and Banking, the Chief Economist and four external members appointed directly by the Chancellor.
They meet once every six weeks to vote on whether there will be a change to monetary levers or not. The vote is determined by a simple majority with every member having an equal vote.
146
What are the factors that effect the MPCs decision on the interest rate and quantitative easing ?
Inflation expectations.
Consumer spending forecasts.
Real GDP growth rate.
Exchange rate.
Trade balance
Consumer and firms’ confidence (animal spirits).
State of labour market, full employment, wage pressures – unemployment and employment trends.
147
What’s a reason the Bank of England was made independent?
The Bank of England was made independent in 1997. Central banks being independent is good because it stops governments using monetary policy for short-term gain. 'Stop-go' economics describes governments in the 1960s cutting interest rates before elections to create a mini-boom
148
What are the main roles of a central bank? (EQ)
Monetary policy
A central bank is in control of the economy's monetary policy. This means that they must set base interest rates and monitor the amount of money supply in circulation. Because of this, a central bank is usually tasked with managing inflation and expectations of future inflation. If the currency does not float as is fixed, the central bank may control the national currency.
Regulation
The central bank has a role in regulation of the banking industry. For example, the UK Bank of England regularly stress tests (FPC) commerical banks to prove that they hold the necessary liquidity (PRA) to deal with exogenous shocks such as sharp falls in housing markets.
Lender of last resort
In times of economic crisis, the central bank must fulfil the role of lender of last resort in order to save the financial markets, and by extension, the wider macroeconomy. This was put to the test in the UK & USA in 2008 when central banks across the world had to lend to financial institutions that had low reserves & a liquidity crisis.
149
What are the types of government/public expenditure ?
Transfer payments
Capital expenditure
Public expenditure
150
What are transfer payments ?
Transfer payments are payments made by the government without receiving a good or service in exchange.
Government transfer payments include the spending on benefits and aid expenditure.
151
What is capital expenditure?
Capital expenditure is the spending on goods which create or help market other goods.
When the governments spend on capital it is usually infrastructure like transport networks which make it easier and cheaper for firms to produce goods and services.
152
What is current expenditure ?
Current expenditure is the spending on consumables and other non-capital goods, services and labour.
Governments’ current expenditure includes payment of public sector workers.
153
What are the correlations between government spending and standard of living ?
Government spending is usually driven by improving the standard of living of an entire country, thus it could be expected that a country with greater government spending is likely to be meeting the basic needs of its population.
However, high levels of government spending could actually indicate that individuals aren’t able to demand much for themselves, indicating a lack of prosperity for individuals.
154
The greater government expenditure is as a proportion of GDP, what can be said about the influence of the allocation of goods and services?
The closer that country is to being a command economy rather than free market.
Public sector expenditure is considered less effective than private sector spending in terms of productivity and growth because the government doesn’t have the same profit motive as a private firm.
However, targeted public spending may raise the level of productivity if it is focused on deficiencies in the free market e.g. education.
155
Why is public sector expenditure is considered less effective than private sector spending in terms of productivity and growth ?
Because the government doesn’t have the same profit motive as a private firm
156
How do high levels of government spending effect welfare and equality ?
High levels of government spending have to be financed somehow or the government risks insolvency. In the short-run this can be covered by borrowing but in the long-run it has to be paid by higher taxes which could have an impact on welfare.
In most countries taxes are taken in greater proportion from the rich than the poor and spent on goods, services and transfer payments which which predominantly benefit the less well off (e.g. free schooling which children from poorer families may not otherwise have got). This leads to an improvement in equality.
157
What is crowding out and how can it occur ?
Crowding out occurs when government spending replaces, rather than adds, to private sector spending and investment.
This can happen either by forcing the price of goods and services up or by physically taking up all the resources, goods or services being produced so they aren’t available for the private sector.
158
What can be used by governments to influence the distribution of aggregate demand ?
Taxation
159
What are direct taxes ?
Direct taxes are taxes on wealth and income (e.g. inheritance tax, income tax, national insurance contributions).
160
What are indirect taxes ?
Indirect taxes are taxes on consumption (e.g. VAT, stamp duty, congestion charge, fuel duty, council tax).
161
What is a proportional tax ?
With a proportional tax, the marginal rate of tax is always the same and so, therefore, is the average rate of tax.
For example, some countries have a single rate of income tax paid by everyone.
This has the advantage of being simple to use but has different distributional effects to a progressive tax.
162
What are progressive taxes ?
Income tax is a form of progressive taxation, meaning that marginal rates increase as an individual's income increases.
E.g. If you earn up to £12,570 in the UK, you pay 0% tax.
For every extra pound (£) you earn, you pay 20p in income tax up to £50,000.
For every £1 you earn between £50,000 and £150,000, you pay 40p in income tax.
For every £1 you earn over £150,000, you pay 45p in income tax.
163
What are regressive taxes ?
With a regressive tax, the average rate of tax paid falls as incomes rise.
For example, the Sugar Tax (a duty on sugary drinks and the like) would cost households on lower incomes more as a % of their income and so could be said to be regressive.
Policymakers may want to consider the distributional effects of taxes they implement.
164
Who put forward four canons (rules) of taxation ?
The famous 18th Century economist Adam Smith
165
What are Adam Smiths 4 cannons of taxation (ways to make a good tax) ?
Canon of equality
Canon of certainty
Canon of convenience
Canon of economy
166
In Adams Smiths 4 cannons of taxation, what is meant by the cannon of equality ?
Taxes should be determined according to the ability to pay
So richer people should pay more
167
In Adams Smiths cannons of taxation, what is meant by the cannon of certainty ?
The timing and amount of tax must be certain to the tax payer so there are no shocks or unexpected tax bills.
168
In Adams Smiths cannons of taxation, what is meant by the cannon of convenience ?
It must be convenient to pay - in terms of how it is paid and when it is paid.
169
In Adams Smiths cannons of taxation, what is meant by the cannon of economy ?
The cost of collecting / enforcing a tax should be low relative to the amount collected.
170
How do indirect and direct taxes affect the incentive to work ?
Reduce the incentive to work.
Both direct and indirect taxes have a substitution effects by which labour views hours worked as decreasingly valuable compared to leisure time as the real disposable income earned will fall.
Direct taxes reduce nominal disposable income and indirect taxes increase prices, reducing real disposable income.
171
What is the income effect from taxes, and what is the Laffer curve ?
By making work less valuable taxes result in workers having to work more in order to afford the same amount of goods and services.
The Laffer curve shows that there is a tax rate between 0-100% which maximises tax revenue, if the tax is too low then little revenue is earned but if the tax is too high the disincentive to work can also reduce tax revenue.
172
How do indirect and direct taxes affect income distribution?
Indirect taxes are usually regressive, this means that real incomes for those on lower incomes are reduced more than those on higher incomes as price changes are a greater proportion of the former’s income. This increases the range of income distribution.
Direct taxes are often more progressive which leads to a decrease in the range of income distribution. More so if the taxes are used to fund transfer payments to those on lower incomes.
173
How do indirect and direct taxes affect real output ?
Real output and employment are, ceteris paribus, both reduced by taxes.
Direct taxes reduce real incomes which leads to a fall in aggregate demand leading to reduced output and increased unemployment.
Indirect taxes reduce (short-run) aggregate supply leading to an increased negative output gap.
The price level changes differently depending on the type of tax.
A direct tax reduces aggregate demand which leads to a fall in the price level and inflationary pressure.
Indirect taxes increase the cost of production, reduces aggregate supply and therefore leads to an increase in the price level and inflationary pressure.
174
How do indirect and direct taxes affect balance or trade ?
Direct taxes reduce disposable income and therefore reduces household’s ability to pay for imports, improving the trade balance.
Indirect taxes make domestic goods more expensive and less competitive leading to a worsening of the trade balance
175
How do indirect and direct taxes affect FDI ?
Both types of taxes have an adverse effect on FDI flows.
Both direct and indirect taxes make domestic trade less profitable (increased costs of production and decreased real incomes). This makes inward FDI less attractive to foreign firms.
176
What are the main categories that make up government spending
national defence
social security
health programs
interest payments
177
What is the difference between national debt and budget deficit ?
The national debt refers to the total amount the government has borrowed over time.
The budget deficit refers to how much has been spent (when spending>tax revenue)in a particular year.
E.g. In 2018, the UK national debt was £1.9 trillion.
The amount being added to the national debt is the budget deficit (of c.£47 billion).
178
What are the problems with national debt ?
If the markets view the country’s national debt as unsustainable, then demand for government debt will fall. So the cost of borrowing will rise.
High repayments on the national debt (principal and interest) have a significant 'opportunity cost'. This is money which could be spent on health, education, etc.
There is also a question of intergenerational fairness: will future generations have to face increased taxes to pay off the debt being built up now?
179
How can you analyse a national debt (what should you consider) ?
The key measure is national debt as a % of GDP, rather than debt as a raw figure. This is over 100% in some countries.
Key factors to consider when considering whether this is a concern or not are:
Has the money borrowed gone to current or capital spending (such as spending on infrastructure)? The latter would contribute more to future economic growth.
What is the rate of interest on the borrowing?
180
What is a budget surplus, deficit and balance budget?
When a government receives more money in taxes than it spends in a year, it runs a surplus.
When the government spends more money that it receives in a year, it runs a deficit.
If government spending and taxes are equal, it runs a balanced budget.
181
What is a cyclical deficit ?
A cyclical budget deficit is the budget deficit that arises because of the stage of the economic cycle an economy is at, rather than underlying problems
182
What is a key cause of a cyclical deficit ?
A key cause is the role of automatic stabilisers:
In a recession, an economy’s budget deficit rises because unemployed people pay less income tax and consume less, reducing indirect taxes such as VAT. They also receive more welfare payments through housing benefit, income support, etc.
So, government spending (G) automatically rises and government revenue through taxes (T) automatically falls.
183
What is a structural deficit ?
A structural budget deficit is defined as the part of the budget deficit that still exists when the economy is growing at the trend rate of economic growth.
184
Why do structural deficits occur ?
This could be because of something structurally wrong with the economy - e.g. tax collection systems could be fundamentally weak, tax evasion and avoidance could be high, or there could be an overly generous welfare system.
So a structural budget deficit would be more of a concern for the government.
185
What is the difference between crowding in and crowding out ?
If the government is spending, is it helping the private sector gain confidence to spend (this is known as crowding in).
If, on the other hand, the higher borrowing the government is having to do is creating competition for loans with the private sector, this could lead to higher interest rates for the private sector too. This may put off certain private sector investment (known as financial crowding out), which would dampen any increase in aggregate demand (AD).
186
What is the role of automatic stabilisers ?
Automatic stabilisers are tax and government spending measures that automatically dampen a boom and increase demand in a recession.
187
What is the main role of automatic stabilisers?
In a recession, more people will become unemployed and corporate profits are likely to fall.
Because of this, a government's income tax and corporation tax receipts will fall.
At the same time, unemployment benefits and welfare payments are likely to increase.
These are automatic stabilisers that increase G (government spending) and decrease T (taxation) in a time of falling demand.
Automatic stabilisers should offset some of the volatility in economic cycles.
In a time of economic growth, more taxes are paid to the government, slowing GDP growth and moderating the economic prosperity.
188
What are discretionary fiscal policies?
Discretionary fiscal policy is tax and government spending programmes that affect AD, but are not automatic stabilisers.
A government may increase the VAT rate on consumption from 10% to 30%, but this is independent of the cycle. In 2009, the Labour government cut VAT to try to stimulate demand.
A decision to increase G (government spending) on the NHS, police force or intelligence services would be examples of discretionary fiscal policy.
HS2, which is expected to be a £56bn project, improves the UK's rail infrastructure. This is an example of a discretionary fiscal policy.
189
Between 2010 - 2017 the Conservative governments made reducing the deficit a central policy. Is deficit reduction important?
Explain deficit reduction
The budget deficit refers to how much money the government has borrowed in a given year to balance expenditure not financed by taxation. The accumulation of this borrowing over time is called the national debt. To reduce a deficit, a government must either lower expenditure or raise revenue and this is called austerity.
Why deficit reduction is important
The Conservatives reduced the deficit from over 100bn to a figure half that size in 7 years. High budget deficits balloon the national debt, repaying debt interest over time has significant opportunity costs. For example, debt interest has more money spent on it in the UK than on defence. A deficit is also important to reduce so that markets do not view the debt levels as unsustainable and thus dry up loans.
Why deficit reduction is not important
The Conservatives were criticised for pursuing austerity too harshly. Many argued that borrowing for capital expenditure, such as new infrastructure projects for northern rail services or airport expansions, would grow the economy in the long-run. The debt-GDP ratio of the UK is a lot smaller than in other countries. Japan's is over 200% and yet they are not focusing on deficit reduction
