The Global Economy

what is sustainable development

development that allows the present generation to meet its needs without compromising the ability of future generations to meet their own needs

UN Sustainable Development Goals

1. End poverty in all its forms everywhere

2. End hunger, achieve food security, and improved nutrition and promote sustainable agriculture

3. Ensure healthy lives and promote well-being for all at all ages

4. Ensure inclusive and equitable quality education and promote lifelong learning opportunities for all

5. Achieve gender equality and empower all women and girls

6. Ensure availability and sustainable management of water and sanitation for all

7. Ensure access to affordable, reliable, sustainable, and modern energy for all

8. Promote sustained, inclusive, and sustainable economic growth, full and productive employment, and decent work for all

9. Build resilient infrastructure, promote inclusive and sustainable industrialisation and foster innovation

10. Reduce inequality within and among countries

11. Make cities and human settlements inclusive, safe, resilient, and sustainable

12. Ensure sustainable consumption and production patterns

13. Take urgent action to combat climate change and its impacts

14. Conserve and sustainably use the oceans, seas, and marine resources for sustainable development

15. Protect, restore, and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification, and halt and reverse land degradation and halt biodiversity loss

16. Promote peaceful and inclusive societies for sustainable development, provide access to justice for all and build effective, accountable, and inclusive institutions at all levels

17. Strengthen the means of implementation and revitalise the global partnership for sustainable development

poverty and sustainability

• Poverty is the inability to satisfy minimum consumption needs

• This results in pollution of poverty, which is environmental pollution caused by poor people for survival needs

  • Mainly due to over-reliance on natural resources by the poor for survival, who deplete natural resources without replenishment due to lack of income

• The rapid depletion of common pool resources threaten sustainability

Measuring economic development

Single Indicators

• GDP/GNI per capita at PPP

• Health and education indicators

• Economic and social inequality indicators

• Energy indicators

• Environmental indicators

Composite indicators

• Human Development Index

• Gender Inequality Index

• Inequality adjusted Human Development Index

• Happy Planet Index

Components of human development index

• GNI per capita (PPP rates) - decent standard of living

• Life expectancy at birth - long and healthy life

• Expected years of schooling and mean years of schooling - knowledge

strengths and limitations of single indicators of measuring economic development

• Strengths

  • Generally less complex than composite variables - more straightforward to calculate

  • More widely available, which facilitates comparison

• Limitations

  • Insufficient if used individually

  • Difficult to assess overall effect on economic development if information is inconsistent

what is economic development

Economic development refers to sustained improvements in overall living standards/economic well-being,

which in turn implies higher per capita income, reduced poverty, lower inequality in income and wealth, better accessibility and quality of education and health services, etc.

PPC to show relationship between economic growth and development

Diagram must include a merit good, e.g. healthcare, with industrial or luxury (non-merit) goods

• By labelling the relevant points (ref. points B and C), you can show how economic growth does or does not lead to the increased production of merit goods, which will aid in economic development

• Similarly, you can show economic development without economic growth, by showing a shift along the PPC to favour the increased production of merit goods

draw and explain diagram of poverty cycle

• This results in the perpetuation of poverty across generations, where individuals are unable to break out on their own

  • e.g. children in poverty cannot afford to go to school

  • e.g. inability to afford healthcare/food → malnourished and physically disadvantaged children

  • e.g. large families, where children are a source of income

  • any of these examples penalise the children for life, resulting in a demographic trap

• To break out of the poverty cycle, external help (usually governmental) is needed

  • to provide human capital (health and education services, nutrition)

  • to provide physical capital (sanitation, water supplies, roads, power supplies, etc.)

  • increase participation in private sector activities through access to credit

• If the entire nation is trapped in poverty, external help is needed.

economic barriers to development

• Rising economic inequality

• Lack of access to infrastructure

  • due to problems of:

    • financing (e.g. insufficient revenue)

    • inadequate maintenance and poor quality

    • limited access by the poor (due to lack of revenue, which limits the quantity of infrastructure)

    • misallocation of resources (e.g. due to corruption → infrastructure is inappropriate given the needs of the population)

    • neglect of the environment

• Limited access to appropriate technology

  • appropriate → technology that is well-suited to particular economic, geographical, ecological, and climate conditions

    • e.g. labour intensive technologies (use more labour in relation to capital) is more suited for developing countries as it increases local employment → increase in income → poverty alleviation + saves scarce foreign exchange, as compared to capital intensive technologies (use more capital in relation to labour), which displaces workers → increased unemployment → reduced incomes → increased poverty + requires highly skilled labour (which may not exist locally) and foreign exchange for imports

    • e.g. usage of ploughs (labour intensive technology) is more appropriate for developing countries as compared to heavy agricultural machinery (capital intensive technology), such as tractors

  • improves the quality of physical capital (infrastructure)

• Low levels of human capital

  • Lack of access to healthcare and education

• Geography (e.g. landlocked countries)

• Dependence on primary products

  • Volatile prices of primary products (as PED and PES are both usually <1) → unstable income → inability to plan for future spending, especially spending on human capital, which inherently has longer timelines

  • Overspecialisation of the economy on that one primary product increases the risk

• Lack of access to international markets

  • difficulties encountered by developing countries in their exports to developed countries

  • e.g. tariff barriers, administrative barriers (e.g. technical regulations, testing, and certification), agricultural subsidies by rich countries (e.g. EU’s Common Agricultural Policy)

• Informal economy

  • Tax revenue from these workers is less stable

  • As these industries are not regulated, the government is unable to ensure the basic welfare of these workers

• Indebtedness → lower economic growth

  • Debt servicing costs → government has fewer resources for social services, infrastructure, etc.

  • Poor credit ratings → harder to borrow

  • To reduce debt, taxes may increase, govt. spending may decrease (contractionary f.p.)

  • Lower private investment due to uncertainty

  • Possibility of a debt trap → the government keeps borrowing more to pay back old debts

• Tropical climates and endemic diseases

  • Some preventable diseases are made more serious due to climate conditions

  • Heat and humidity affect productivity

  • Soil quality and its impacts on human and animal health

• Capital flight

  • Money does not return to the home country, resulting in a loss of financial capital that could have been invested domestically

  • Could result in the depreciation of the currency, increasing foreign debt and potentially causing financial crises

political and social barriers to development

• Weak institutional framework

  • Legal framework and access to justice, or lack thereof

    • affects tax collection and property rights

    • This affects the functioning of the economy

• Ineffective taxation structures

  • Developing country tax systems typically are:

    • highly dependent on indirect taxation, e.g. VAT or tariffs (easier to collect)

    • inefficient and highly bureaucratic

    • weak, with significant corruption

    • minimizing of tax burden on the wealthy due to their influence on the government

  • This results in:

    • Low levels of revenue (corruption, inefficiencies, tax exemptions on wealthy, etc.)

    • Inequities in tax systems (regressive)

    • Negative impacts on resource allocation (increased barriers to entry for new firms that lack connections with the government, or favouring of political allies)

• Banking system

  • Banks provide:

    • incentive to save

    • credit to open/run businesses or make investments in physical/human capital

      • important to low income earners, who are least able to save and therefore need to borrow to invest in physical/human capital

  • However, banking systems in developing countries are underdeveloped, and overseas branches of large multinational banks are more interested in loaning to large domestic firms/multinational corporations

    • small scale producers and consumers who need small loans and lack the collateral to secure their loans cannot get credit, and are forced to rely on illegal sources of credit

• Property rights and land rights

  • can be used as collateral, which improves access to credit

• Gender inequality

• Corruption/lack of good governance

  • governance - process which state and nonstate actors interact to design and implement policies within a set of formal and informal rules that shape and are shaped by power

  • corruption → abuse of public office for private gains → makes economic activity more expensive, leads to low per capita income and low investment

  • Bribes in place of tax evasion

  • Misallocation of resources

  • Damages trust of state, encourages contempt for rule of law

• Unequal political power and statuses

  • e.g. caste system in India, apartheid in South Africa

• Political instability

  • Political stability is positively correlated to economic growth and development

    • continuity facilitates the implementation of effective policies

    • encourages investment

    • prevents outflows of financial capital due to uncertainty

    • prevents hunger and famine

name strategies to promote economic development

dont explain

international trade strategies

• import substitution

• export promotion

diversification

social enterprise

market-based strategies

• deregulation

• privatisation

interventionist policies

• redistribution policies

• provision of merit goods

Foreign direct investment

Multinational corporations

Foreign aid

• humanitarian aid

• development aid

Multilateral Development Assistance

• World Bank, IMF

Institutional change

• microfinance

Women’s empowerment

Reducing corruption

Property and land rights

what is import substitution

• A growth and trade strategy where a country begins to manufacture simple consumer goods for the domestic market to promote its domestic industry (e.g. shoes, textiles)

• Depends on protective measures such as tariffs or quotas to limit the entry of imports that compete with domestic producers

  • theoretical justification - infant industry argument

advantages and consequences of import substitution

• Advantages of import substitution

  • assuming that imports fall and exports remain the same, the increase in net exports (due to a reduction in imports) will:

    • drive economic growth and development

    • promote employment in domestic industries

    • reduce the trade deficit as net exports increases

  • however, this assumes ceteris paribus

• Consequences of import substitution policies:

  • high levels of protection of domestic firms, inefficiency, resource misallocation → high prices for consumer goods

  • overvalued exchange rates to reduce price of imports and increase price of exports (allow firms to import more cheaply)

    • cheap capital imports → capital intensive production methods (inappropriate technology for labour-abundant and capital-scarce developing countries) → unemployment, growth of informal economy

    • Made exports more expensive → worsen poverty

  • encouragement of capital-intensive production methods → negative impacts on employment and income distribution, as these methods result in income being distributed amongst a small group of landowners, with significant unemployment for the rest of the population

  • too much government intervention → inefficiencies, resource misallocation

    • most import substitution policies rely on industrial policies with protective trade barriers, overvalued exchange rates, subsidised credit, etc.

  • deterioration in the balance of payments

  • retaliation from trade partners

  • limited possibilities for growth over the long term (domestic producers continue to produce for the domestic market even though they are inefficient, and may be complacent in reducing costs as they know the government will protect them)

what is export promotion

• a country attempts to achieve economic growth by expanding exports

  • adopted by China, Indonesia, Japan, Singapore, South Korea

• similar to import substitution, this also requires extensive government intervention, including:

  • financial assistance to targeted key industries

  • strong government intervention (subsidised credit and large public investments in key areas)

  • requirements on MNCs

    • maximise benefits of FDI, such as the promotion of r&d, transfer of desired and targeted technologies to the domestic economy, training of domestic workers, and use of local inputs where possible

  • undervaluing currencies (! opposite of import substitution) to encourage exports while making imports more expensive

  • economic integration → trade liberalisation, e.g. through bilateral FTAs

strengths and disadvantages of export promotion

• increased net exports → economic growth and development

• investments in human capital → greater levels of education and economic development

• investments in physical capital → aid in breaking the poverty cycle

• diversify goods produced in the economy

  • export promotion can gradually change the promoted industries to suit the skill and technological levels of the population

• reap economies of scale from domestic firms expanding into foreign markets

  • encourages them to become more efficient by competing in foreign markets

• Disadvantages of export promotion

  • exporting countries may become overly dependent on exports → if major trading partners have a recession, the fall in exports → fall in AD → they also get a recession

  • issues in the maintenance of low wages to keep labour costs low and exports competitive

  • strong exports over a long period of time lead to trade surpluses with trading partners which can lead to trade protection by trading partners who feel threatened

is export promotion better than import substitution

• expansion into foreign markets → benefits of economies of scale

• emphasis on diversification

  • major investments in human capital and appropriate technologies under export substitution facilitate the diversification of the economy from simple, labour intensive goods to more advanced goods based on increasing skill and technology levels

• increased employment → use of labour intensive tech rather than capital intensive tech to start developing the economy

• no balance of payments issues due to increase in exports and export earnings

what is diversification

Diversification involves a reallocation of resources into new activities that broaden the range of goods or services produced (usually with the intent that production is diversified into higher value-added products, like manufacturing or services)

strengths and limitations of diversification

• Strengths

  • exports can increase over time, especially into higher value-added markets that can experience a sustained increase in global demand

  • Reduced vulnerability to short-term price volatility.

  • Diversification also incentivizes greater investment into physical and human capital in new industries, which helps with economic growth and development.

• Limitations

  • In the short term, developing countries would likely lack the technology or the resources (be it in terms of skills or infrastructure needed) to diversify their exports and compete in foreign markets.

  • Trade barriers can make it more difficult for developing countries to break into new export markets.

  • Diversification may result in lower efficiency as countries are not as specialised in their comparative advantage.

what is social enterprise

Social enterprises are a type of commercial organisation that aims to achieve particular social goals to improve people’s well-being and promote social change. May be either for-profit or non-profit organisations.

*even if the social enterprise is for profit, the primary goal is still to achieve their social goals. it just means that they try to be commercially viable, and the profits made are put back into the enterprise rather than received as profit income by the owners

e.g. microfinance (Gramean Bank)

strengths and limitations of social enterprise

• Strengths

  • does not take up government budget to achieve social goals (applies to for profit social enterprises)

  • can operate in a wide variety of areas across various social goals (e.g. education, health, social care, clean technology, etc.)

• Limitations

  • more limited financial resources → hard to scale up business to reap economies of scale

  • hard to raise funds from investors due to lack of profit

  • harder to compete on cost due to their social missions → tend to be small → makes their impact more limited and localised

examples of market based strategies

strengths and limitations of market based strategies

Trade liberalisation

• Removal of tariffs and other trade barriers

• Strengths

  • greater exports → economic growth → economic development

  • increased competition, productivity, efficiency

  • countries in trading blocs get more FDI as they can be bases in which to expand and export into other countries they are in a trading bloc with

• Limitations:

  • Domestic industries may not be able to compete with foreign imports and close down → job losses

  • greater income inequality → certain export industries benefit while other domestic industries that cannot compete with imports lose out

  • Only beneficial if trading partners also remove their trade barriers (e.g. NAFTA, where US subsidies on corn remained, flooding the Mexican market)

Deregulation

• market-based supply side policies for labour, removing barriers to enter product markets

• Strengths

  • It can limit the inefficiencies created by excessive government control and regulations.

    • This can reduce cost of production for firms, especially if it comes to deregulating the labour market (reducing minimum wages or making it easier to hire and fire workers) or reducing the cost of compliance to rules and regulations.

    • Firms become more competitive as a result and increase in efficiency.

• Limitations

  • However, limitations are that there might be greater harmful activities taken by businesses, such as exploitation of workers, corporate abuse, damage to environment or other illegal activities that might be hard to detect with reduced regulations.

  • This can be a particularly big problem for ELDCs where the political institutions and rule of law are weaker, and further deregulation will make it even harder for the government to protect economic wellbeing of citizens.

Privatisation

• privatising state enterprises, e.g. transport

• Strengths

  • Increased efficiency, competition, and productivity as firms have a profit motive to reduce costs

  • Generates revenue for the government from the sale of the company

• Limitations

  • Companies may raise prices due to profit motive → harms consumers

  • If privatised companies have a monopoly/large market power, could be detrimental to consumers due to lack of competition

examples of interventionist policies

factors affecting interventionist policies

• Interventionist policies that results in inclusive economic actual growth with reduction in income inequality can be achieved through

  • redistribution policies

  • the provision of merit goods (enables economic long-term growth)

Redistribution policies

• Effective at achieving economic development in both material and non-material aspects

• Includes transfer payments, minimum wages

• Transfer payments and minimum wages allows broad-based spending (↑C) across the economy as low-income households experienced higher income

  • ↑ C → ↑ AD → ↑ actual growth

  • Assuming ↑ actual growth > ↑ population growth → ↑ real GDP per capita → ↑ material welfare

• Redistribution policies → reduction of income inequality → ↑ non-material welfare

  • ↑ equity (fairness) as more can afford basic necessities such as healthcare, education & better accommodation → ↑ non-material welfare

  • Transfer payments or cash transfers have emerged as effective policy tools to fight poverty, reduced child labor, ↑ schooling and improved childhood nutrition → ↑ non-material welfare

Factors affecting the effectiveness of redistribution policies

• Ineffective taxation system → low budget to spend on redistribution policies limiting economic development

• Risk of over-reliant & misuse of transfer payments limiting economic development

• Minimum wage unemployment → ↓non-material welfare & material welfare → adversely affecting economic development

Provision of merit goods

• Merit goods (e.g. healthcare, education, infrastructure) to be subsidized or directly provided by the governments, making them broadly available across the economy

• Education programmes → increase in labour productivity → more, better & higher paid employment opportunities

• Better health → more active & productive participation in the community → greater health improves education, greater education improves health

• Vital drivers of growth (↑material welfare) and development (↑ both material & non-material welfare)

• Infrastructure includes schools, health-care centres, energy, transport, telecommunications, better sanitation and clean water supplies.

  • Will result in an increase in human capital, which will increase the income earning capacity of the poor leading to higher incomes, growth and development.

  • Increases productivity and lowers the costs of production.

Factors affecting the effectiveness of infrastructure, healthcare, and education programmes

• Lack of financial resources

• Poor governance and prevalent corruption

define FDI

When a firm establishes a productive facility in a foreign country or acquires controlling interest (at least 10% of the ordinary shares) in an existing foreign firm

characteristics of developing countries that attract FDI

• Sound macroeconomic, political stability & security

• Well-defined & enforced property laws

• Low cost factor input

• Well-educated, but at the same time low-cost labour force

• Weak regulatory systems (such as labour safety & environmental standards)

• Govt concessions to MNCs such as favourable tax rules & ease of profit repatriation (ie. transfer of profits back to the MNC’s home country

• Proximity to a major & growing market areas with high & or growing levels of income

• Membership in wider free trade areas or trading blocs; avoidance of tariffs

• Natural resources including climate

• Cultural similarities

• Infrastructure

effectiveness and limitations of FDI

Effectiveness of FDI in achieving economic development

Non-material welfare

• Increased employment opportunities

• Training of the local workforce, leading to improved human capital

• Transfer of organizational and managerial know-how and new production technologies

• Providing a source of foreign exchange

Both material and non-material welfare

• Higher tax revenues that can be used to fund spending in other areas

• Helps to fill saving and investment gap

Limitations of FDI

• Lack of training if the local workforce is employed only in low skill positions

• Capital-intensive technology that does not create employment

• Tax contribution that is not significant

• Forced relaxation of labour and environmental protection laws

• Repatriation of profit

• Environmental damage

Define foreign aid

Foreign aid refers to the transfer of funds, goods and services, grants or loans from EMDCs to ELDCs on a non-commercial basis to promote an improvement in economic, social or political conditions, usually on concessionary terms.

what must transfers be to be considered foreign aid

• concessional - the transfers involve more favourable conditions than could be achieved in the market. e.g. loans would have lower interest rates and longer repayment periods

• non-commercial - must not involve buying or selling or other activities concerned with making a profit

types of foreign aid

• Humanitarian aid

  • usually temporary assistance meant to alleviate poverty and other forms of suffering caused by a humanitarian crisis due to conflicts or natural disasters

• Development aid

  • Development aid is long-term in nature, focused on the economic development of the recipient country.

  • May be official or unofficial (NGOs).

  • May be bilateral (between two countries) or multilateral (eg: World Bank, International Monetary Fund, Asian Development Bank, Asian Infrastructure Investment Bank).

    • In multilateral aid, donor countries donate to the organisation, which then donates to the recipient country

Sources of foreign aid

• Official Development Assistance (ODA)

  • Comes from government funds

  • Consists of bilateral aid (most important way), multilateral aid, and through non-governmental organisations (ODA → NGO → ELDC)

• Non-governmental organisations

  • Independent of the government, non-profit driven

  • Promotes economic development, humanitarian ideals, sustainable development by publishing studies, forming pressure groups, and providing aid

  • Usually only gives grants, unlike ODA which has grants and loans

advantages and limitations of official development assistance

advantages

• Helps countries whose governments have insufficient funds to break out of the poverty cycle

• Makes resources available for investments in health, education, infrastructure

• Focus on disadvantaged groups helps to improve their relative income positions and improve income distribution

• Increased investment, increased consumption → AD increases → actual economic growth

• Enables ELDCs to achieve the UN SDGs

• Prevents countries from falling into the debt trap by reducing their debt burden and releasing resources that can be used for poverty reduction and economic growth and development

limitations

• Tied aid

  • donors make recipients spend all/a portion of borrowed funds to buy g&s from them

  • recipients cannot seek lower price alternatives and are forced to buy from the donor country → higher import costs

  • Having to buy specific g&s → inappropriate capital intensive technologies

  • Beneficiaries are usually large firms whose g&s the recipient countries are forced to buy

• Conditional aid

  • Donors do not pay sufficient attention to the preferences of the government or the population groups the project is intended to benefit

  • Policy prescriptions may not fit with the government’s development strategy and priorities, weakening the recipient government’s authority and accountability to its citizens

• Volatility and unpredictability of aid

  • Flow of aid funds is volatile due to changing volumes of aid in donor budgets and changing donor priorities

  • Makes implementation of policies dependent on aid funds difficult as governments cannot be sure if and when such funds will be available to undertake necessary investments and activities

• Uncoordinated donors

  • Uncoordinated bilateral/multilateral donors results in numerous inefficiencies in use of aid resources

    • e.g. overlapping and duplication of some projects, inconsistencies with other projects, and an overall lack of coherence

• Aid becomes a substitute for domestic resources

  • Governments overly depend on aid and make insufficient efforts to increase domestic revenues

• Corruption

advantages and limitations of NGOs

Advantages of NGOs

• Anti-poverty orientation

• Close cooperation with project beneficiaries

• Expertise and advice

• Innovative solutions

• Trust

Limitations of NGOs

• Size and impact

• Level of independence

• Competition for talent with ELDCs

• Challenge to state authority

what is multilateral development assistance

• Involves lending to developing countries on non concessional terms

  • rates of interest and repayment periods dependent on the market

  • e.g. World Bank, International Monetary Fund

what is the washington consensus

• A set of 10 economic policy prescriptions considered to constitute the ‘standard’ reform package promoted for countries in crisis by institutions like the IMF and World Bank

  • Fiscal discipline

  • Tax reform (lower marginal rates, broadened tax base)

  • Interest rate liberalisation

  • A competitive exchange rate

  • Trade liberalisation

  • Liberalisation of inflows of FDI

  • Privatisation

  • Deregulation (both entry and exit barriers)

  • Secure property rights

criticism of world bank and IMF

• Voting power is dominated by richer nations

• Excessive interference in countries’ domestic affairs

• Conditional lending - restricts economic activity

• Damaging effects on ELDCs

  • Conditions often lack attention on poverty alleviation and overly focus on market-based ss policies

  • Conditions also often create recessions in the recipient countries

  • Historical trends show that IMF recipients suffer increasing poverty and low/negative rates of growth and are stuck in their BOP difficulties and external debt problems

what is microfinance

controversy

Microfinance

• Refers to credit in small amounts to people who normally do not have access to credit

• Delivered through microfinance institutions which include a wide variety of organisations, such as credit unions, NGOs, etc.

Controversies of microfinance

• Microfinance may become a substitute for urgently needed government anti-poverty policies, e.g. affordable education, sanitation, clean water, etc.

• Contributes to the growth of the informal economy → workers have no protection and exploitative conditions often prevail

• Poor and highly unskilled people may be harmed, as they lack the skills for micro-enterprise → microfinance may be a burden with payments on loans that cannot produce income

• Interest rates are too high as the costs of providing many small loans are higher than providing a few large loans

evaluate benefits of reducing corruption

• Increased tax revenue (less loss to corruption)

• More actual spending by the government

• More redistribution of wealth to lower income groups

• Lower costs of doing business (less bribes needed)

• Incentives for FDI

importance of property and land rights

• Important pillar for agriculture

• Essential for urban development

• Helps protect the environment

• Crucial for private sector development

• Important for empowering women

• Vital for keeping peace

strengths and limitations of govt intervention versus market based approaches to achieving economic growth and economic development

Market oriented strategies

Need for good supporting institutions such as:

• legal system

• banking sector

Strengths

• More efficient allocation of resources

  • Max free operation of demand & supply

  • Automatic clearance of markets → max society’s welfare

  • Reduce inefficiency

• Econ Growth

  • Increases incentive to work and invest

  • Attracts FDI into the country

  • SR: Actual econ growth & lower UnN+

  • LR: Potential growth

• Competition among firms

  • More innovation

  • More competitive exports

  • Greater growth

• Reduce Budget deficits

  • Less govt spending needed due to investment from private firms

  • Free floating exchange system

    • trade deficit = automatically eliminated through market forces of DD & SS of currency.

    • allows a country to implement dd-side policies to tackle internal problems like high inflation and unemployment w/o worrying about trade deficits

Weaknesses

• Market failure

  • Externalities

  • Missing market (public goods)

  • Market power

  • Asymmetric info

• Income inequality & Dual Economy

  • Income distribution depends on skills, assets and opportunity => income disparity

  • Trade liberalization => Closure of domestic firms

  • Dual economy

    • Rural VS Urban

    • Urban: formal VS informal

    • Informal sector: displaced workers have to engage in informal sector in order to survive

    • increases the divide between rich & poor

• Growth of monopolies & oligopolies

  • high prices for essential goods & services

Interventionist strategies

Strengths

• Provision of infrastructure/merit goods

  • Infrastructure - large scale, provided by government, needed for economic activity

  • A school is not infrastructure as it is too small scale. Transport networks and ports can be considered infrastructure.

• Invest in human capital

• Stabilize the economy

  • increase growth, lower inflation etc + good institutional environment

• Provision of social safety

• Redistribution of income

  • e.g. transfer payments, price and income policies such as the imposition of minimum wage (removal of minimum wage is labour market reforms)

Weaknesses

• Inefficiencies due to absence of profit motive/protectionism/price floors

• Poor planning due to imperfect info and time lags

• Corruption

• Large public debts

should a government pursue market oriented, interventionist, or both?

• Depends on the

  • stage of economic development

  • type-[ of economy

  • government budget

  • development of existing institutions and rule of law

• For lower levels of economic development, interventionist is better

• Government should gradually withdraw with increasing development

• At higher levels of econ development, there should be more market-based ss policies

what is free trade

Free trade refers to international trade that takes place without any trade barriers

benefits of free trade

To consumers

• Increased specialisation of scarce resources → increased output and consumption

• Increase in competition (due to international competition) → increase in efficiency → lower prices → lower cost of living

• Increase in choices of goods and services

To producers

• Benefits of internal and external economies of scale

  • due to larger international market

• Access to much needed capital goods and raw materials

• Enables spread of technology and innovation to improve productivity and profitability

For economic growth

• Vent for surplus (dumping basically)

• Engine of growth

  • export revenues, advancement of technology, spurring competition

• Structural change allowing diversification from manufacturing to services industry

  • facilitates economic growth and possible economic development

draw world market, market of exporting country, market of importing country

what is protectionism

Protectionism is the partial or complete protection of domestic industries from foreign competition within domestic markets.

define tariffs

Tariffs are taxes levied on products when they cross national boundaries. Taxes can be applied either to imports or exports.

types of tariffs

purpose of tariffs

Types of tariffs

• Specific tariffs

  • Expressed in terms of a fixed amount of money per physical unit of the imported product ($ a ton, 10 cents per litre).

  • It is independent of the initial price

• Ad valorem tariffs

  • Expressed as a percentage of the value of the commodity e.g. 35% of the value of the product

Purpose of tariffs

• Raise revenue

  • Important source of revenue in ELDCs

• Protectionism purpose

  • Dumping

These 2 aims are conflicting since a tariff will not yield much revenue is it is effective in reducing imports

draw and explain tariff diagram

Before tariffs:

• consumer surplus: PfXZ

• domestic output: 0A

• domestic revenue: 0PfA

• domestic output: 0B

• domestic producer surplus: the small triangle below segment PfA

• imports: AD

• foreign producer revenue: APfD

After tariffs

• consumer surplus: PtXY (lost area 1+2+ 3+4)

• domestic revenue: 0PtB

• domestic producer surplus: add area (1)

• government revenue: area (3)

• imports: BC

• foreign producer revenue: BPfC

• Welfare loss: areas 2+4

  • Welfare loss comes from increased reliance on less efficient domestic producers as well as loss of consumer surplus from making consumers pay more for the same good

Beneficiaries of tariffs

• Domestic producers

• Workers in protected industries

• Government (tariff revenue)

Losers from tariffs

• Domestic consumers

• Foreign firms

• Increased inefficiency of production

• Misallocation of resources

define import quotas

Import quotas are legal limits on the amount of a good that may be imported (import quotas) during a given period of time.

why may import quotas be preferred over tariffs?

• Import quotas do not create any revenue for the government and less likely to attract retaliation from other countries

• Thus, the effect is only protectionist (there are no conflicting aims)

draw and explain import quota diagram

Before import quota

• Price before import quota = P1

• Qty demanded = Q4

• Qty supplied by domestic producers = Q1

• Qty imported = Q1Q4

After import quota

• Quota - Q2Q3

  • if the government approves Q2Q3 of imports into the country, this shifts the supply curve from S1 to S2

• Price after quota = P2

• Qty demanded = Q3

• Qty supplied by domestic producers = Q2

• Qty imported = Q2Q3 (quota amount)

• Quota revenue: Area C

  • Imports are sold at a higher price than the world price

  • Why C? it is because the distance between the two parallel supply curves is the same as the qty of the quota.

  • Quota revenue is earned by foreign producers and counts as welfare loss for the home country

• Welfare loss for the domestic country: Areas B+C+D

Beneficiaries of import quotas

• Domestic producers

• Workers in protected industries

• Exporting firms (in rare cases)

Losers of import quotas

• Domestic consumers

  • increased price

  • worsens income inequality

• Increased inefficiency of production

• Global misallocation of resources

• Foreign producers affected by quota

  • in most cases, the limit on supply by the quota outweighs the increase in revenue from each unit of good, resulting in a net loss

define production subsidies

A production subsidy is a grant provided by the government to firms aiming at lowering production costs for domestic firms competing against foreign imports

Production subsidies aim to enable less efficient domestic producers to be more competitive against more efficient foreign producers

draw and explain production subsidy diagram

• Consumer surplus is not affected since both price paid and quantity bought by consumers have not changed

  • initially, domestic producers produce Q1, quantity demanded is Q2, excess demand of Q2-Q1 is satisfied by imports

  • the subsidy shifts the supply curve, but the good continues to be sold at Pw, though the price received by producers is now Pw+s

  • Since consumers still consume Q2 of goods at price Pw, consumer surplus remains unchanged

• Producer surplus increases by area A due to the higher price they receive (subsidy money) and the larger quantity they sell

• Government spends area A and B to provide the subsidy

• Welfare loss is area B

Beneficiaries of production subsidies

• Domestic firms

• Workers in domestic industries

Losers from production subsidies

• Government budget

• Taxpayers

• Inefficiency in domestic production

• Exporting countries competing with the domestic country

• Misallocation of resources globally

define export subsidies

Export subsidies involves payments by the government per unit of the subsidised good that is exported

draw and explain export subsidy diagram

Before export subsidy

• Before opening up to trade, the world price Pw is higher that domestic price, given by intersection between Dd and Sd

  • thus the country becomes an exporter if it trades

• When trading, at the world price Pw,

  • the domestic quantity demanded is Q1

  • the domestic quantity supplied is Q2

  • the exports is given by Q1Q2

After export subsidy

• The supply shifts down by the amount of subsidy per unit to Ss

• Producers increase the quantity they supply to Q4 (intersection between Ss and Pw)

• This results in a new higher domestic price, Pw+s, which is determined by drawing a vertical line up from the intersection of Ss and Pw to the line Sd (basically the world price plus the subsidy per unit)

  • Unlike production subsidies, the price paid by domestic consumers increase, instead of remaining unchanged at Pw

  • This is because the export subsidy reduces the qty of goods available in the domestic market from Q1 to Q3 → increase in price

  • Cus basically the foreigners are also paying Pw+s, but the government pays s for them so it remains at Pw

• Domestic consumers decrease the quantity demanded to Q3 (intersection between Dd and Pw+s)

• Exports is quantity Q3Q4

• The price paid by foreigners remains at Pw

• Loss in consumer surplus of areas a+b due to higher price paid and lower qty bought

• Increase in producer surplus of areas a+b+c due to higher price and larger qty

• Government loses areas b+c+d which is what they pay for the subsidy (subsidy per unit x quantity of exports)

• Welfare loss = (a+b+c)-(a+b)-(b+c+d)=-(b+d)

  • welfare loss is areas b and d

welfare loss from export subsidies are always greater than those of production subsidies, as export subsidies make both the government and consumers worse off

what are administrative barriers

Administrative barriers are trade barriers in the form of regulations that aim to limit imports into a country. These barriers may take the form of product safety standards, sanitary standards or pollution standards but may also include more stringent than necessary application of customs procedures.

arguments for protectionism

To develop infant industries

- Industries in their infancy are too small to have gained economies of scale

- Without protection, these infant industries will not survive competition from abroad

- Protection will increase their competitiveness

- E.g. Airbus’ early subsidies that allowed it to develop to compete with Boeing

Issues

- Complacency

- Once given, hard to remove

- Failure to identify the right industries to protect

National security

- Protect industries essential to national defence

- So that the country can produce them itself and does not need to depend on imports that may be controlled by unfriendly nations

- E.g. steel and weapons production

Health, safety and environmental reasons

- Governments are justifiably concerned of imported goods that may fall short of health/safety/environmental standards

- Lower income countries accused of polluting/destroying the environment due to their environmental activities

- Trade protectionism could help tackle the problem of over production

To retaliate against ‘dumping’ and other anti-competitive actions

- Prevents domestic producers from being wiped out by ‘unfair foreign competition’, which can take the form of:

- production/export subsidies to artificially achieve lower CoPs

- administrative barriers

- undervalued currencies → makes exports more competitive

- violation of intellectual property

- Issues

- hard to prove that prices are artificially lowered

- excuse to protect inefficient industries

- causes a permanent reduction of trade and welfare

Correcting a balance of payments deficit

- deficit means that there is a net outflow of money from a country

- Decreased imports would affect the exports of the affected countries → retaliation

- Issues

- does not solve underlying long term problems

- e.g. poor quality of products or lack of comparative advantage

- retaliation

- Self defeating → fall in output and income of trading partners → fall in their demand for exports from home country → fall in output and income of home country

To protect employment during recession

- Limits imports to stimulate domestic production and generate employment

- Issues:

- does not solve underlying cause of a lack of competitive advantage

- Hard to remove

- Self defeating → fall in output and income of trading partners → fall in their demand for exports from home country → fall in output and income of home country

Source of government revenue

- Important source of revenue for govts in ELDCs

- poorer countries use tariffs because they rely more on goods, while richer countries rely more on services

- additionally, due to the greater prevalence of tax evasion in ELDCs, tariffs are a better source of revenue than taxes

- Tariffs are easier to collect compared to income taxes

- Issues:

- May impeded the transition towards other sources of tax

- Tariffs applied to imported goods are regressive in nature

Enable and industry to decline gradually

- Provides time for labour to be retrained and rechanneled to other growing industries

- Helps to reduce the incidence of structural unemployment

- Issue

- may instead unnecessarily slowdown the process, depriving other industries of resources

To achieve political objectives

- e.g. sanctions on russia or syria

arguments against trade protection

• Allocative inefficiency and welfare losses

• Danger of retaliation

• Higher costs of production and reduced effciency

• Higher prices and loss of consumer surplus

• Impact on export competitiveness

• Domestic firms have less incentives to be efficient

• Trade protection may have negative effects on real GDP

  • protected goods may be used as inputs in the production of other goods

  • protection using means like tariffs would increase the COP for these goods → SRAS shift left

types of economic integration

Trading Blocs

• Preferential trade agreements

• Free trade area

  • a group of countries that have abolished all tariff barriers among themselves but maintain their individual tariffs against the outside world

• Customs unions

  • common external tariff that applies to the imports by any member country from the outside world

• Common markets

  • Allows for the free movement of products like the free trade area and customs union

  • Also allows for the free movement of labour and capital, common taxes, and common trade laws

• Monetary union

  • Requires a common market

  • Adoption of a common currency, central bank, and monetary policy

Advantages of trading blocs

• Trade creation

• expansion into larger markets

• Lower prices and increased choices for consumers

• Increased competition and efficiency

• Increased FDI

• Benefits from movement of labour and mobility of entrepreneurship (common market)

• increased bargaining power as a bloc

disadvantages of trading blocs

• Trade diversion

• Challenges the multilateral trading agreements pursued in the WTO

• Unequal distribution of gains and losses

• Economic integration and loss of sovereignty

what do exchange rates show

• The price of a currency in terms of another currency

• Measures the external value of a currency

• May be quoted either:

  • in the amt of foreign currency needed to buy a unit or domestic currency

  • or the amt of domestic currency needed to buy a unit or foreign currency

Why is the DD for currency downward sloping and the SS upward sloping?

• As the currency appreciates, exports and assets denominated in that currency becomes dearer → less demand for the currency

• As the currency appreciates, foreign goods become cheaper

  • consumers will sell off the currency to buy foreign currencies to pay for more imports and invest overseas

causes of shifts in demand and supply of a currency

• Changes in long term capital movements (foreign direct investment)

  • more long term profit opportunities in the country and expected long term appreciation of its currency → inflow of long term capital and increase in demand for its currency

• Changes in relative growth rates

  • increase in domestic income due to economic growth → higher demand for imports → increased supply of home currency

  • increase in foreign income → higher export demand → increased demand for home currency

• Changes in taste for exports and imports

  • Change in favour of exports → increased demand for currency

  • Change in favour of imports → increased supply for currency

• Changes in interest rates

  • increase in interest rates attracts short term capital inflows and increases demand for its currency

  • decrease in interest rates attracts short term capital outflows and increases supply of the currency

• Expectations of future exchange rates

  • If speculators expect a currency to appreciate, they will buy more of the currency, causing it to actually appreciate

• Change in relative prices (domestic vs foreign inflation)

  • higher rate of domestic inflation → exports are more expensive, imports are cheaper

  • leads to a depreciation of the currency

Note: Although the central banks of countries with free floating currencies do actually intervene when necessary, such passages will not appear in paper 2.

what is a free float exchange rate

• Exchange rate is determined by market demand and supply of a currency

  • Demand for a currency is affected by exports and capital flow into the country

    • Increase in exports increases demand for the domestic currency → more USD is needed to pay for these goods

    • Capital flow into the country (both short and long term) increases demand for the currency

  • Supply for a currency is affected by imports and capital outflow from the country

    • Imports cause an increase in supply of the domestic currency

    • Capital outflow from the country increases supply of the currency

• Rise in exchange rate → appreciation

• Decrease in exchange rate → depreciation

foreign exchange market scenarios (change in USD)

• investors from us invests in indonesian stock market

• french importers buy machinery from US

• us residents come to singapore for holidays (from US perspective, it is an import since the income is accruing to the trading partner)

• european companies seek to increase investments in US

1. increase in supply of usd, depreciation of usd

2. demand of usd increases, appreciation of usd

3. increase in supply of usd, depreciation of usd

4. increase in demand of usd, depreciation of usd

what is a managed float

• Managed by demand and supply, but the central bank intervenes to prevent excessive fluctuations

• Allows central bank to eliminate wild fluctuations and speculations under a free float yet not need to defend a fixed exchange rate

• e.g. Singapore

what is fixed exchange rates

• Maintained at a fixed rate and not permitted to change freely

• e.g. hong kong

what happens when market rate above the fixed exchange rate

Market rate above the fixed exchange rate

this increases their reserve of foreign currencies

to maintain the fixed rate, the central bank has to sell HK$ and buy foreign currencies to prevent the HK$ from rising in value

alternatively, they can also lower interest rates to help increase the supply of HK$ in the market or revalue the currency

what happens when market rate is below fixed exchange rate

to maintain the fixed rate, the central bank has to buy HK$ and sell foreign currencies

this results in a decrease in the central bank’s reserves of foreign currencies

they can also raise interest rates to increase demand for HK$

Additionally, they can:

• borrow from abroad

• use protectionism to limit imports

• contractionary dd-side policies to lower national incomes and in turn imports

• devalue the currency

what is devaluation

• central bank devalues the currency

  • fixed exchange rate is lowered

• does not require the central bank to increase the demand for the currency in the foreign exchange market

what is revaluation

does not require the central bank to increase supply in the foreign exchange market

fixed exchange rate is raised

what is balance of payments

Balance of payments refers to the monetary value of all economic transactions that have taken place over a period of time, usually one year, between a country and the rest of the world.

only external transactions are recorded - i.e. the total payments made by the country to other countries and its receipts from them.

what are credit and debit items

Credit item

• An international transaction that leads to an inflow of money from abroad

• e.g. exports → foreigners have to convert their currencies to the domestic currency to pay domestic exporters, resulting in an inflow

Debit item

• An international transaction that leads to an outflow of money overseas

• e.g. imports

what are the components of BOP

• Current account → exports/imports of g&s

  • Covers all earnings and expenditures of a country arising from the current purchases and sales of goods and services during a year

  • This includes

    • visible trade - exports/imports of physical goods

    • invisible trade - exports/imports of services, income, current transfers (transactions where goods/services/financial items are transferred without something of economic value being received in return, which is basically unilateral transfers)

  • The current account balance is therefore calculated by the sum of the balance of trade in goods and the invisible balance, which is simply the value of visible/invisible exports - value of visible/invisible imports

• Capital account → capital transfers

  • Capital transfers - transfer of ownership of assets without a specific exchange of goods or services

    • Debt forgiveness

    • Investment grants (gifts by other governments for financing physical capital)

  • Transactions in non-produced, non-financial assets

    • e.g. international sales and purchases of rights to natural resources (fishery, minerals, air space)

• Financial account

  • Direct investment

    • all long term inflows minus outflows of physical capital undertaken by MNCs

  • Portfolio investment

    • All inflows minus outflows of investments in stocks, bonds and other financial instruments

  • Reserve assets

    • All foreign currency reserves held by the central bank

    • A positive value for reserve assets means that there is an inflow of domestic currency, and an outflow of foreign currency

    • Reserve assets must be denominated in domestic currency!

what should the BOP be equal to

The sum of the current account, capital account, financial account, and the errors and omissions should be zero (0)

how to determine BOP deficit or surplus

To determine if the BOP has a deficit or surplus, simply exclude the use of reserve assets from the calculation.

BOP deficit

• A balance of payment deficit means that there is a deficit in the combined current, capital and financial accounts (plus errors and omissions), excluding use of the reserve assets (buying and selling of currencies).

• This means that the export revenue is less than the import expenditure

  • Overall, this leads to a supply of the domestic currency, causing the domestic currency to depreciate

BOP surplus

• A balance of payment surplus means that there is a surplus in the combined current, capital and financial accounts (plus errors and omissions), excluding use of the reserve assets (buying and selling of currencies).

• This means that the export revenue is more than the import expenditure

  • This leads to a rise in demand of the domestic currency, causing the domestic currency to appreciate

how to show trade surpluses on a PPC

how to show trade deficit on PPC

why are surpluses considered waste in current account balance

Trade surplus

point within a PPC

The economy is consuming less than it is producing

Trade deficit

point outside of PPC, since you are consuming more than you are producing

current account balance → any surplus is considered a waste cause its for the future, not for the current