Econ

• Role of financial markets:

  • Financial markets are where buyers and sellers can buy and trade a range of services or assets that are fundamentally monetary in nature
  • Exist for two main reasons: to meet the demand for services such as saving and borrowing, and to allow speculation and financial gains
  • Facilitate savings, lending to businesses and individuals, exchange of goods and services, provide forward markets, and market for equities
• • Examples include the cost of bailing out banks after the 2007-8 financial crisis and long-term costs to the economy
  • Moral hazard:
  • Individuals make decisions in their own best interests knowing there are potential risks
  • Can lead to adverse risk-taking by employees and excessive risk-taking by financial institutions
  • Speculation and market bubbles:
  • Trading in financial markets is speculative and can lead to market bubbles
  • Market bubbles occur when the price of an asset rises massively and then falls, causing panic selling
  • Market rigging:
• Market failure in the financial sector:

  • Financial markets are prone to crises due to a combination of speculation and provision of genuine services
  • Asymmetric information:
  • Financial institutions often have more knowledge compared to customers, leading to selling products with hidden risks
  • Asymmetric information between financial institutions and regulators can lead to harmful activities
  • Externalities:
  • Costs placed on firms, individuals, and the government that the financial market does not pay
• • Group of individuals or institutions collude to fix prices or exchange information for personal gains
• Role of central banks:

  • Control monetary policy through interest rates and money supply to keep inflation low and stable
  • Act as a banker to the government and other banks
  • Regulate the financial system to prevent harmful activities and systemic risks
  • Financial regulation includes banning market rigging, preventing sale of unsuitable products, setting maximum interest rates, deposit insurance, and liquidity ratios
• Measures of development:

  • Economic growth is measured by real GDP and the productive potential of the country
  • Economic development is about improvements in living standards
  • Human Development Index (HDI) is a composite index based on health, education, and income
  • HDI factors:
  • Health: life expectancy at birth
  • Education: mean years of schooling of adults aged 25+ and expected years of schooling of a current 5-year-old
  • Income: real GNI per capita at purchasing power parity
  • Advantages of HDI:
  • Takes into account three key factors important for development
• • Relatively easy to calculate
  • Disadvantages of HDI:
  • Health doesn't consider quality of life
  • Education doesn't consider quality and success of education
  • No consideration for income equality
  • Doesn't account for other factors like freedom from corruption or environment
  • Other indicators:
  • Inequality-adjusted Human Development Index (IHDI)
  • Multidimensional Poverty Index (MPI)
  • Genuine Progress Indicator
• • High population growth in developing countries
  • Strains on education system and youth unemployment
  • Debt issues in developing countries
  • Access to credit and banking limitations
  • Infrastructure challenges and impact on businesses
  • Education and skills as a factor in productivity
  • Absence of property rights and its impact on investment
  • Non-economic factors:
  • Corruption and its negative impact on development
  • Diseases like HIV/AIDS and malaria affecting economic growth
  • Natural disasters due to poor climates and geographical terrain
  • Civil wars in some countries
• Factors influencing growth and development:

  • Primary product dependency:
  • Issues with primary products like agriculture and mining
  • Natural disasters can wipe out production
  • Low-income elasticity of demand for primary products
  • Prebisch Singer Hypothesis on declining prices of primary goods
  • Dutch disease and its effects on competitiveness
  • Volatility of commodity prices
  • Savings gap and its impact on borrowing and investment
  • Foreign currency gap and its consequences
  • Capital flight and its effects on credit and investment
  • Demographic factors:
• Market-orientated strategies:
• Trade liberalisation:

  • Countries can aim for export led-growth
  • Removing trade barriers will mean that domestic industries either close or are forced to become as efficient as other world producers
  • Resources will be allocated to their best use where the country has a comparative advantage
  • Countries like Singapore and South Korea and regions like Hong Kong have benefitted from this method
• Promotion of FDI:

  • FDI is investment by one private sector company in one country into another private sector company in another
  • Firms tend to undertake FDI because production costs are lower in developing countries and because it enables them access to a new market
  • It involves the transfer of knowledge from one country to another, with the company bringing production and management techniques and training for staff which will benefit the country as a whole
  • It will create jobs and leads to the effect of the multiplier
• • However, there is usually a repatriation of profits and developing countries may find the company exploits them
  • India has benefited greatly from FDI
  • Samsung’s investment in Vietnam has been crucial
• Removal of government subsidies:

  • Subsidies are placed on essential items within a country, such as food or fuel, or target agriculture and industry in an attempt to increase output and investment
  • They represent a large amount of government spending, incurring an opportunity cost and often leading to high levels of debt
  • Removing a subsidy can be very politically unpopular
  • Venezuela has placed subsides on almost all goods due to high inflation and low wages
• Interventionist strategies:
• Development of human capital:

  • This would provide workers with skills and training and thus help them to be more efficient and improve productivity
  • Human capital could be developed through schools or vocational training
  • Better education also improves quality of life
• Protectionism:

  • Protectionism allows domestic industries to grow by keeping foreign goods out and protects them from strong competition
  • Managed exchange rates:
  • Infrastructure development is essential for development
• Promoting joint ventures with global companies:

  • One way to reduce the exploitation of countries as a result of FDI would be to set up a joint venture
  • Tata Starbucks Pvt.Ltd is a joint venture company with Starbucks in India
• Buffer stock schemes:

  • This is where the government imposes both a maximum and minimum price for goods
  • It is used on commodities, where the prices are volatile
  • The Ivory Coast and Ghana implemented a buffer stock scheme for cocoa in 2017 due to low prices
• Industrialisation:

  • Lewis model assumed developing countries had dual economies with a traditional agricultural sector and a modern industrial sector
  • Modern industrial sector attracts workers from rural areas with higher wages
  • Labour productivity in agricultural areas is low, leading to surplus food when people move to urban areas
  • Savings and investment are key to growth
  • Rural-to-urban migration can lead to growth
  • Migration can lead to urban poverty replacing rural poverty
  • Technology improvements can reduce demand for labour
• • Government can build factories to encourage industrialisation
  • India transitioned from agriculture to services based on comparative advantage
• Development of tourism:

  • Some countries build tourism industry to improve economy and living standards
  • Tourism industry is income elastic
  • Tourism provides foreign currency to fund imports
  • Investment from transnational hotel companies can fund infrastructure improvements
  • Tourism industry creates local jobs
  • Higher tax revenues from tourism can fund diversification
  • Seasonal industry with low skilled, low paid jobs
  • Tourism destinations can go in and out of fashion
  • TNCs repatriating profits can cause capital flight
• • Tourism industry can lead to externalities like pollution and environmental damage
• Development of primary industries:

  • Some countries develop based on abundance of natural resources
  • Primary industry development provides funds for diversification, infrastructure development, and better education
  • Primary products are volatile and suffer from corruption
  • Dutch Disease can be addressed by investing oil revenues overseas
• Fairtrade schemes:

  • Fairtrade is based on dialogue, transparency, and respect in international trade
  • Fair price agreements provide stability and raise producers' income
  • Child labour is not used in Fairtrade
  • Fairtrade producers have higher income and satisfaction
  • Fairtrade may not have a significant impact on the developing world
  • Higher incomes from Fairtrade may reduce incentive to diversify
• Aid:

  • Different types of aid include tied aid, bilateral aid, multilateral aid, and concessional loans
  • Aid can reduce absolute poverty and fill savings gap for investment
  • Aid can contribute to increased globalisation and trade
  • Aid may create a dependency culture and be affected by corruption
  • Debt relief can ease government finances and aid development
• International institutions and NGOs:

  World Bank:

  • Aims to bring about long-term development and reduce poverty
  • Made up of IBRD, IDA, IFC, MIGA, and ICSID
  • Provides financing, policy advice, and technical assistance
  • Has funded over 12,000 development projects since 1947
• IMF:

  • Provides loans to help countries in exchange rate crises or debt repayment issues
  • Requires macroeconomic reforms when providing loans
  • Provides advice for economic stability and raising living standards
  • Criticised for causing problems for countries
• NGOs:

  • Non-profit organisations independent from the government
  • Provide direct assistance to countries and act as pressure groups
  • NGOs alone may not solve problems, government intervention is necessary
  • Some see NGOs as having an anti-capitalist agenda
• Absolute poverty:

  • People are unable to afford sufficient necessities to maintain life
  • UN defines it as severe deprivation of basic human needs
  • World Bank defines it as living on less than US$1.90 a day
  • Economic development tends to be correlated with absolute poverty
• Relative poverty:

  • Bigger issue in the UK
  • People's income compared to others in their area
  • In the UK, income below 60% of median household income is considered relative poverty
  • 1 in 5 people in the UK live below the official poverty line
  • Defined as those who cannot afford goods needed to not be considered poor according to social norms
• Causes of changes in poverty:

  • Unemployment, lack of skills, health problems, and income dependency
  • Absolute poverty tends to fall as GDP increases
  • Growth of relative poverty due to higher income growth for higher salaries, changes in government spending and taxation
• Inequality:

  • Distinction between wealth and income inequality
  • Income is a flow of earnings, wealth is a stock of assets
  • Wealth likely more unequally distributed than income
  • Measurements of income inequality: Lorenz curve and Gini coefficient
• Causes of wealth and income inequality:

  • Wages, wealth levels, chance, age
  • Between countries: wars, droughts, famines, earthquakes
  • Impact of economic change and development: Kuznets hypothesis and Piketty's theory
  • Significance of capitalism: leads to income inequality due to wage differentials, ownership of resources, and incentive for hard work
• Public expenditure:

  • Government spends money for macroeconomic management to control AD and achieve objectives like economic growth, low inflation, balanced current account, and low unemployment
  • Aims for equity and equality by providing services to individuals or groups who would not receive them otherwise
  • Corrects market failure by providing public goods and fixing externalities
  • Types of expenditure:
  • Capital government expenditure: spending on investment goods like new roads, schools, and hospitals consumed over a year
• • General government final consumption: spending on goods and services consumed within the next year, like public-sector salaries
  • Transfer payments: government payments without corresponding output, e.g., benefits and pensions
  • Interest payments for national debt
  • Major areas of expenditure: defense (6%), protection (4%), education (12%), pensions (20%), welfare (15%), transport (2%), and health care (18%)
• Composition and size of public expenditure:

  • Lower average income countries spend a lower percentage of GDP due to lower tax revenue and demand for more services in higher income countries
  • Significant differences in government spending among developed countries
  • Global Financial Crisis led to increased government spending and bailouts using taxpayer money
  • UK government followed austerity policy since 2010 to reduce debt
  • Pressure on government spending in Europe and Japan due to aging populations
• • Debate on government efficiency and disincentive impact on workers affecting output and living standards
  • Government faces principal-agent problem but society decides government spending priorities
• Impacts of government spending:

  • Productivity and growth:
  • Government spending can be wasteful but provides economies of scale and necessary infrastructure
  • Education creates human capital for growth, healthcare reduces worker illness days, and research and development give businesses a competitive edge
  • Government spending creates a multiplier effect focused on areas with high unemployment
  • Living standards:
  • Government spending improves living standards by correcting market failure, providing public goods, and reducing absolute poverty
• Crowding out:

  • Government borrowing competes with private sector for finance, causing higher interest rates and discouraging investment
  • Limited resources mean government spending reduces resources available for private sector
  • Investment may be more efficient if done by private sector
  • Crowding out felt most at full employment, transfer payments do not cause crowding out