Government and the Economy, the Global Economy (ch. 33-36)

Aggregate supply is the total amount of goods and services produced in a country at a given price level in a given time period. Supply-side policies are government measures designed to increase aggregate supply in the economy. Here are the reasons for supply-side policies:

  • improve flexibility in labour markets by removing restrictions
  • restore the incentive to work by lowering taxes on work and enterprise
  • promote competition through privatisation, deregulation and helping small firms
  • increase investment by improving the flow of capital in capital markets

Impacts of supply-side policies:

  • productivity increases
    • improved flexibility
    • training and education
    • improves the quality of the workforce
  • total output increases
    • productive potential moves outwards
    • PPC shifts rightwards
    • unemployment decreases
    • when the government increases supply, there is less of a chance of demand-pull inflation, thus increasing jobs

Supply-side policies:

  • privatisation - the breaking up of state monopolies by selling state firms and assets
    • positives:
    • competitive pressure improves quality and reduces prices
    • if the business doesn’t go well, then the government does not make a loss
    • contracting out
    • negatives:
    • private monopolies can form, which could exploit consumers
    • if the firm fails, then it is at a loss
  • deregulation - removal or relaxing of regulations such as:
    • excessive paperwork
    • obtaining unnecessary licenses
    • having lots of people or committees having to approve decisions
    • various rules that slow down business development
  • education and training
    • if quality of human capital improves, workers are more productive
    • slow and expensive
  • policies to boost regions with high unemployment
    • policies can be targeted or used selectively
    • such as building specialist technology parks to boost employment in areas
  • infrastructure spending
    • the productive potential of the economy increases if the quality of infrastructure improves
    • such as:
    • super-fast broadband networks
    • transport systems construction
  • lower business taxes to stimulate investment
    • economic growth increases when businesses invest more
    • maintaining a stable economy and increasing the flow of investment funds can help investment increase in the private sector
    • this can be done by:
    • fewer taxes on profits
    • offsetting (if something, such as a sum of money, offsets another cost it has the effect of reducing or balancing it so that the situation remains the same) costs of investment against tax
    • tax incentives (such as tax relief)
  • lower income taxes to encourage working
    • high taxes reduce the incentive to work
    • high taxes discourage people from setting up and developing businesses

As well as fiscal, monetary and supply-side policies, governments can pass legislation to protect the environment, impose fines on firms that exploit consumers and introduce controls to maintain standards.

Austerity is official action taken by a government in order to reduce the amount of money that it spends or the amount that people spend.

Impact of high interest rates on inflation:

  • discourage consumers and firms from borrowing, fall in consumption, investment, aggregate demand and economic growth, unemployment rises
  • higher mortgage payments, reducing spending power and aggregate demand, firms reduce capacity and lay off staff, unemployment rises
  • firms raise costs, reduce profits, invest less, reducing aggregate demand
  • discourages firms from borrowing to invest in technology and expansion, reducing development and competitive edge
  • higher exchange rates, fewer exports, staff laid off, unemployment rises
  • consumption falls, demand falls, production falls, firms lay off workers
  • government spending reduces, services cut, civil servants laid off

Impact of policies on economic growth and inflation:

  • expansionary fiscal policy
    • lowering taxes, increasing government expenditure
    • lower taxes, more disposable income, aggregate demand rises, more output, economy grows
    • government spends more, more civil servants hired, more demand, output and economic growth
  • expansionary monetary policy
    • lower interest rates
    • people borrow more, spend more, aggregate demand rises, more output and economic growth
    • firms borrow more, invest more, new products developed, driving economic growth
  • quantitate easing
    • increases money supply, aggregate demand, output and economic growth
  • all three of these policies may result in an overheated economy
    • firms cannot meet rising demand, prices rise, demand-pull inflation
  • inflation
    • limited capacity in the economy or immobile FoP
    • supply-side policies can reduce this

Impact of policies on economic growth and environmental protection:

  • economic growth results in environmental damage
    • more output, more emissions, more vehicles, more congestion, pollution etc
    • more land usage, less available for wildlife
  • some believe that this is ok since economic growth results in less poverty, longer life expectancy, lower infant mortality and improved living standards

Impact of policies on the current account, BoP and inflation:

  • high and persistent inflation
    • prices rise, export prices rise, reduces demand for exports, pressuring current account, imports rise
    • monetary policy can make this worse
    • high interest rates, demand for domestic currency rises, exchange rate increases, exports become more expensive, and imports become cheaper, pressuring the current balance
  • fiscal policy can reduce inflation
    • cutting spending raising taxes, demand falls, no effect on the exchange rate, exports and imports become stable, current account unaffected
  • supply-side policies reduce inflation
    • do not change the exchange rate
    • produce more output at lower prices
    • boosts exports
    • benefits current account

Globalisation is the growing interconnection of the world’s economies. Interdependence is where the actions of one country or large firm will have a direct effect on others. Here are the key features of globalisation:

  • goods and services traded freely across international borders
  • people are free to live and work anywhere
  • high interdependence
  • capital flows between countries
  • free exchange of technology and intellectual property across borders

Reasons for globalisation:

  • fewer tariffs and quotas
  • reduced cost of transport
  • reduced cost of communication
  • increased significance of multinational corporations (MNCs) - firms operating in many different countries (because domestic markets are saturated - market in which there is more of a product for sale than people want to buy)

Impact of globalisation on individual countries:

  • countries where multinationals are based benefit from increased wealth
  • countries where multinationals are set up in will benefit from higher GDP, extra output and employment (resulting in economic growth), raised living standards, higher exports, higher current account balance, higher training and technical assistance

Impacts of globalisation on governments:

  • increased tax, more government spending, more businesses
  • governments must do these things for successful globalisation:
    • countries can’t trade if borders are closed
    • trade limited with protectionism
    • people cannot work overseas unless borders are open
    • firms cannot develop if planning permission is denied
    • firms cannot develop if there are laws and regulations to prevent restrict or complicate trade and business

Impacts of globalisation on producers:

  • access to huge markets
  • lower costs
  • increased access to labour
  • reduced taxation

Impacts of globalisation on consumers:

  • lower prices
  • more choice
  • more transport and communications
  • more tourism

Impact of globalisation on workers:

  • new jobs in developing countries
  • local supplies can benefit from contracts from new business ventures
  • more freedom of movement
  • offshoring increases - practice of getting work done in another country in order to save money

Impact of globalisation on the environment:

  • global economic growth means environmental damage
  • more cars purchased, more flights taken, non-renewable resources used up

Features of MNCs:

  • huge assets and revenue
  • highly qualified and experienced CEOs and managers
  • powerful advertising and marketing capabilities
  • highly advanced and up-to-date technology
  • highly influential economically and politically
  • efficient as they can exploit huge economies of scale

FDI stands for foreign direct investment. It happens when a company makes an investment in a foreign country. Here are the reasons for MNCs and FDI:

  • economies of scale
  • access to natural resources and cheap materials
    • reserves (amount of something valuable, such as oil, gas or metal ore) are common in developing countries
  • lower transport and communication costs
  • access to customers in different regions

How do governments attract FDI:

  • offering tax breaks, subsidies, grants and low interest rates
  • lifting restrictions and relaxing regulations
  • investing in infrastructure
  • investing in education

Advantages of MNCs and FDI:

  • job creation
  • investment in infrastructure
  • developing skills
  • developing capital
  • contributing to taxes

Disadvantages of MNCs and FDI:

  • tax avoidance - practice of trying to pay less tax in legal ways
  • environmental damage
  • moving profits abroad
    • repatriation - where a multinational returns the profits from an overseas venture to the counter where it is based, typically from a developing country to a developed country