UK Economy in a Global Context

8/6/2019 UK Economy in a Global Context

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Economics Online 2011

Globalisat ionFDI

Liberal isat ion

Protect ionism

Integrat io

n WTO

Competi t iveness

alance ofpayments

xchangerates

Inflat ion

Unemployment

i sca lpolicy

onetarypolicy

upply sidepolicy

The UK Economy in a globalThe UK Economy in a globalcontextcontext

evelopmentindicators

evelopmenttheories

evelopmentstrategies

overty andinequali ty

ons tra in ts todevelopment

olicy object ives andpolicies

lobalshocks


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GlobalisationGlobalisation


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Globalisation is the integration of markets in theworld economy. Markets where globalisation isparticularly common include:

1. Financial markets, including capital, moneyand insurance markets.

2. Commodity markets, such as markets for oiland coffee.

3. Product markets, such as markets for motorvehicles and consumer electronics.


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Factors leading to globalisation1. Developments in transport and communications for

example, the internet has enabled fast and 24/7global communication.

2. Common technology - global firms use common ITsystems helping to integrate their global operations.

3. Capital mobility - when capital can move freely fromcountry to country, it is easier for firms to locateand invest abroad, and repatriate profits.

4. Free and open trade the relative success of the World Trade Organisation (WTO), and the collapse of communism.

Over the last 30 years, trade openness, which isdefined as the ratio of exports and imports tonational income, has risen from 25% to around40% for industrialised economies, and from 15%to 60% for emerging economies. (Source: The Bank of En land 2006


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The benefitsbenefits of globalisation for firms1. Access to larger markets so that firms can benefit

from increased demand, and economies of scale.2. Worldwide access to the cheapest sources of raw

materials, which make firms more costcompetitive.

3. Increased profit for shareholders of MNCs.4. Avoidance of regulation by locating production in

countries with softer regulatory regimes, such asthose in some developing economies .


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Benefits to countriescountries:1. If trade is free, then countries can benefit from the

application of the principle of comparativeadvantage.

2. New trade can be created, a process called tradecreation.

3. Benefits of inward investment to recipient countries,such as sharing knowledge between firms indifferent countries.

4. The macro-economic benefits of increasedinvestment.

5. Job creation in the more competitive countries.


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The costs The costs of globalisationof globalisation

1. The over-standardisation of products through globalbranding, such as Microsofts Windows, leadingto a lack of product diversity.

2. Diseconomies of scale for large firms, such asdifficulties co-ordinating the activities of firmsthat operate in many countries.

3. Increased power and influence MNCs - MNCs canmove their investments between territories -MNCs can be local monopsonies of labour, andpush wages lower than the free marketequilibrium.

4. Loss of jobs in domestic markets because of increased, and in some cases unfair free trade.5. Loss of jobs caused through structural

unemployment, causing a widening gap betweenrich and poor within a particular country.

6.


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The The costscosts of globalisationof globalisation

6. Increased risks associated with interdependence of economies:a. Because countries are increasingly dependent on

each other, a negative shock in one countrycan quickly spread to other countries e.g. therecent credit crunch.

b. Over-specialisation - countries can become over-reliant on producing a limited range of goodsfor the global market. Many LDCs suffer byover-specialising in a limited range of products,such as agriculture and tourism.

8. Possible increased inequality as richer nationsbenefit relative to poorer nations, as suggestedin the Kuznets Curve.

9. Increased trade associated with globalisation hasincreased pollution and helped contribute to CO 2 emissions and global warming. It has alsoaccelerated the depletion of non-renewableenergy resources, such as oil.


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Inequality and developmentInequality and development

The KuznetsKuznets curvecurve Globalisation

may widenthe gapbetweenrich andpoorcountries.

The greatestinequalitycan be

observedascountries'take-off' intheirdevelopment, leadingtoconsiderabl

Kuznets KuznetsC urveC urve

In eq u a lity in cre ases in th e ea rly sta g es o fde velopm en t

D eve lop m en t

I n e q u a

l i t

y


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Foreign directForeign directinvestment (FDI)investment (FDI)


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Foreign direct investment Foreign direct investment (FDI)(FDI)

FDI is the flow of real capital between countries, andis undertaken by private sector firms and bygovernments.

A large proportion of FDI is associated with cross-border mergers between private firms.

The benefitsbenefits to firms of investing abroad1. Reduction in transport costs - locating within a

foreign market reduces transport costs to thatmarket, especially for bulk increasing products.

2. Access to the countrys markets.3. Access to cheap labour and to skilled labour.4. Access to local knowledge and expertise.5. Exploitation of economies of scope, especially

managerial economies, where fixed management

costs can be spread between territories.6. Avoidance of barriers to trade, such as tariffs and


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InvestmentInvestment incomeincome

7. Increased investment income - outward investmentcan lead to increased overseas investmentincome for a country, such as:

1. Profits from overseas subsidiaries.2. Dividends from owning shares in overseas firms.

3. Interest payments from lending abroad. FDI in the balance of payments accounts

The initial outflow is a debit on the capitalaccount, and the investment income is enteredas a credit on the current account.

6.


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Inward investmentInward investment

Countries receiving inward investment gainthrough:

1. An increase in GDP, initially through the FDI itself,followed by a positive multiplier effect on thereceiving economy.

2. The creation of jobs.3. An increase in productive capacity this can be

illustrated by a shift to the right in the AggregateSupply (AS) or the Production Possibility Frontier(PPF).

4. Producers have access to the latest technology fromabroad.

5. Less need to import because goods are produced inthe domestic economy.

6. The positive effect on the countrys capital account.FDI represents an inflow, or credit, on the capitalaccount.


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Who invests?Who invests?

The USA, Franceand the UK are thethree mostimportantinternational

investors, andrecipients of investment.


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Share of EU inward investmentShare of EU inward investment

EU inwardinvestment

The UK receives22% of allinwardinvestmentinto the EU(2003).

There are over18,000differentinvestorsinto the UK,with 1.8mpeople aredirectlysu orted

Source HSBC, 2005


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Why is FDI volatile?Why is FDI volatile?

FDI is highly volatile - possible causes are:1. Fluctuations in exchange rates.2. Fluctuations in interest rates and other monetary

policy.3. Changes in the trade cycle growth in an economy

may encourage FDI, but recession will deter it.4. Expectations about the future.5. Changes in business regulation tighter or looser.6. Changes in the level of business taxes.

7. Relative wage rates and changes in the minimumwage.8. Inducements and incentives by host countries.9. Changes of government and political stability.


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Trade liberalisationTrade liberalisationand protectionand protection


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Liberalisation and protectionismLiberalisation and protectionism

Two opposing forces have shaped the changingpattern of world trade over the last 200 years.

1. Trade liberalisation - this is the process of makingtrade free of barriers such as tariffs and quotas.

2. Protectionism - protectionism is the process of

erecting barriers to trade. Protectionism may be on the increase as a resultof the global economic crisis and recession.


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Specialisation is the basis of free trade1. Countries trade because they do not have all the

goods, services and resources they need, and buyimports.

2. To pay for these imports countries must export

goods, services and resources that other countriesneed.3. Countries can become increasingly specialist in

producing particular goods, services andresources, and this makes them more efficientover time.

4. Efficiency reduces costs and gives the country a costadvantage, which makes it more competitive.


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Comparative advantage

It can be argued that world output will increase whenthe principle of comparative advantage is appliedby countries to determine what goods and servicesthey should specialise in producing.

Comparative advantage is a term associated with

19th Century English economist David Ricardo. Ricardo argued that countries should specialise inproducing goods for which they have acomparative advantage.

Absolute advantage means being more productive

and competitive than another country comparative advantage concerns how much betteris one country than another.


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Vans

Cars


UsingUsing PPFsPPFs to show advantageto show advantage

Productionpossibilityfrontiers canbe used toillustrate costadvantage.

Country Bs PPF isfurtheroutward andindicates it hasan absoluteadvantage inboth goods.

But it has acomparativeadvantage incars because it

can producetwice as many,

0

Count r yB

C

o u n t r y A

Twice asproductive

%Only 50 moreproductive

bsoluteadvantage

omparativeadvantage


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Opportunity cost ratios

We saw earlier that the gradient of a PPF reflects theopportunity cost of increasing production of onegood in relation to another - the lost output of X asa result of increasing output of Y.

If two countries PPFs, in terms of two goods, have

different gradients then they must have differentopportunity costs. Only when the gradients are different will one

country have a comparative advantage, and onlythen will trade be beneficial.


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The benefits and costs of free trade

The benefits1. Applying the principle of comparative advantage

means producing in higher volumes for the exportmarket as well as the domestic market, whichleads to the benefit of economies of scale.

2. Increased competition and lower world prices.3. Welfare gains (including increased consumer

surplus).4. Trade creation.5. The breakdown of domestic monopolies.

6. Increased quality of goods and services.7. More employment as (efficient) domestic firms can

sell to the global market and jobs are created.8.


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The costs1. Over-specialisation - workers risk losing their jobs

when world demand changes (structuralunemployment).

2. Exhaustion of non-renewables.3. Industries can be destroyed, including:

1. Infant industries2. Declining industries3. Inefficient industries

4. Strategic industries8. Welfare loss associated with loss of trade for

domestic producers (loss of producer surplus).


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Motives for protectionMotives for protection

Why engage in protection? Despite the arguments in favour of free trade

protectionism is still widely practiced. The mainarguments for protection are:

1. To protect sunrise industries - also known as infantindustries, such as those involving newtechnologies.

2. To protect sunset industries - also known asdeclining industries, such as steel production.

3. To protect strategic industries - such as energy,water, steel, and armaments.

4. To protect a resource which is non-renewable, as inthe case of oil.

5. To deter unfair competition such as to protectfrom dumping at prices below cost.

6. To save jobs.


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Methods of protectionMethods of protection

There are two types of protection:1. Tariffs - tariffs are taxes, or duties, on importedgoods designed to raise the price to the level of,or above the existing domestic price.

2. Non-tariff barriers which include all other barriers,

such as:a. Quotas- which are physical limits on the volumeof imports.

b. Public procurement policies where nationalgovernments favour local firms, such as wherea countrys police or ambulance service

purchase only locally produced vehicles.c. General subsidies to domestic firms, which can be

used to help reduce price and deter imports -this financial support can also be in the form of an export subsidy, making it easier for firms toexport.

d. Health and safety such as banning imports of


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Price

Quantity


Domest c

supplyImports

QuotasQuotas

A quota is aphysicallimit onimports.

The no-trade

price andquantity areP and Q.

The free tradeprice andquantity areP1 and Q1.

A quota of Q2 -Q limitsimports andallowsdomesticfirms to

Domesticsupply

DomesticDemand

Q

P

Q1

P1

0

Worldsupply

Q2

QUOTA

Domestic+supply

quota

PqDome

t icsupp

ly

Q4

QUOTAomesti supply

, The effect of the quota is to shift the domestic supply curve to the right byquota


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Tariffs Tariffs

Tariffs are taxes on imported products, usually in anad valorem form. They are also called customsduties.

The impactimpact of tariffs1. Domestic consumers face higher prices and lower

consumer surplus.2. Domestic producers receive higher prices and

higher producer surplus but there is likely tobe an overall net welfare loss, which can be seenlater.

3. There is a distortion of the principle of comparativeadvantage.

4. There is the likelihood of retaliation from exportingcountries, which could trigger a costly trade war.

5. However, in the short run tariffs may protect jobs,infant and declining industries, and strategic


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Price

Quantity


The Tariff diagram The Tariff diagram

Without trade,domestic priceand quantityare P and Q.

If an economy

opens up toworld supply,price falls to P1,Q increases to

Q2 - domesticproducers

share falls toQ1!

The imposition of atariff causesprice to rise,imports to fall,domestic

roducers

DomesticSupply

DomesticDemand

Q

P

World Supply

Q1

P1

Q2

ConsumerSurplus

ProducerSurplus

+ World Supply TariffP2

Q3Q40

TariffRevenue

ImportsDomesticsupply Domesticsupply

X Y

-more than producer surplus increases even adding in tariff revenue there is still a ne.Y


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Costs and benefits of trading blocsCosts and benefits of trading blocs

The main benefitsbenefits for members of blocs:1. Members can specialise, knowing that they have

free access to others members markets. Thismeans there is a more complete application of the principle of comparative advantage.

2. Easier access to each others markets means thattrade between members is likely to increase -trade creation.

3. Producers can benefit from the application of scaleeconomies, which will lead to lower costs and

lower prices for consumers.4. Jobs may be created in member economies.5. Protection from countries outside the bloc6. Firms inside the bloc can be protected from cheaper

imports from outside.7.


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Price

Quantity


Trade creation Trade creation

With a tariff,domesticprice andquantity areP1 and Q1 .

Domestic marketshare is 0 Q4, andimports areQ4 Q1 .

If an economy joins a

customsunion it musteliminatetariffs. This

increasesimports, from

DomesticSupply

DomesticDemand

Q

P

World Supply

Q3

P2

Q2

+ World SupplyTariff1

Q1Q40

Importsomesticsupply omest ic

supply

X Y World Supply


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EconomicEconomicintegrationintegration


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Stages in economic integrationStages in economic integration

Pre fe ren tia l trade area( )PTA

M e m b e rs e lim in a te ta riffs o n some goods Free trade area( )FTA

Members eliminate tariffs on al l goods ustoms Union( )U

Members eliminate tariffs on l l goods and ,ervices and have a ommon extemembers

onetary( )nion MU

Members share a ,i ng le c urr en cy ,central bank and have a commopolicy

ull economicintegration

A ommon market , a ,in gl e cu rre nc y ,central bank and common monepolicies

I n t

e g r a t i o

n

I n t

e g r a t i o

n ommon market

single

market

Members eliminate tariffs on ,l l resources allowing ree movement of labour and cpolicies


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Regional trading blocs (RTBs)Regional trading blocs (RTBs)

A trading bloc is a group of countries that protectthemselves from imports from non-members.

There are several types:1. Preferential Trade Area (PTA)

Members eliminated tariffs on some goods

2. Free Trade Areas (FTAs) Members eliminated tariffs on all goods But they do not have a common external tariff

against non-members Example - North Atlantic Free Trade Area (NAFTA)

(USA, Canada and Mexico)


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Regional trading blocs (RTBs)Regional trading blocs (RTBs)

3. Customs Unions These also aim to reduce or eliminate tariffs

between members But they do have a common external tariff - a

common external tariff means that membersmust set the same level of tariff against a non-member

5. Common Market ,M em b e rs e lim in a te ta riffs o n a ll re so u rce s

,a llow in g free m o ve m e n t o f lab o u r an d cap ita l-a n d com m on m icro e con om ic p o licie s

6.


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The European Union (EU) The European Union (EU)

The EU - originally calledCommon Market wasformed in 1957,following the Treaty of Rome.

The EU has evolved throughstages of integration. The aim was to create one

market for all products,capital and labour, byeliminating trade

barriers. By 2007, following

continuous enlargementthe EU had 27 members.

Austria Germany Norway

Belgium Greece Poland

Bulgaria Ireland Portugal

Cyprus Italy Romania

CzechRepublic

Latvia Spain

Denmark Lithuania Slovenia

Estonia Luxembourg Slovakia

Finland Malta SwedenFrance Netherlands UK


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The Common Agricultural Policy (CAP) The Common Agricultural Policy (CAP)

The EU protects its farmers and growers through itsCommon Agricultural Policy (CAP). Through the CAP European farmers received annual

subsidies of around 43 billion (2010). The evolution of CAP

CAP was created to ensure continuous food suppliesfor Europe, and to provide a fair income forEuropean farmers.

Price support schemes, such as guaranteed prices,were first introduced in 1962.

By the mid 1980s, over-production created massivesurpluses and this led to major reforms, includingthe use of set-aside programmes.

By the early 1990s there was a movement awayfrom guaranteed prices towards direct subsidiesto farmers, irrespective of the output theyproduced.


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The Common Agricultural Policy (CAP) The Common Agricultural Policy (CAP)

The Fischler Reforms , of 2003, continued theprocess of decoupling subsidies and farm output,and introduced a green element to CAP, forcingfarmers to meet environmental and animalwelfare standards.

Single Farm Payments (SFP) were introduced in2005, and set-aside programmes were abolishedin 2009.

The UK receives a controversial rebate againstpayments into the EU to compensate for that factthat it receives relatively little income from CAPin comparison with France and Spain.


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European monetary union and the singleEuropean monetary union and the singlecurrencycurrency

The main features of Monetary Union include:1. A single currency, the Euro - introduced in 2000,

with national currencies scrapped in 2002.2. An independent central bank, the

European Central Bank (ECB) - responsible formonetary stability in the Euro Area (Euro-16).

3. The co-ordination of macro-economic policies - theaim of policymakers is to converge the Euroeconomies.

5. The Stability Pact - all members agree to keep theirbudget deficits under control. Under the rulesdeficits must be no more than 3% of GDP. Thisrule was designed to limit the use of fiscal policywhich might de-stabilise the economy andweaken the Euro.

6. A single interest rate - the ECB sets interest rates

for the whole Euro area no country has theabilit to alter its own interest rate.

ECOA11
http://www.ecb.europa.eu./ecb/educational/html/index.en.htmlhttp://www.ecb.europa.eu./ecb/educational/html/index.en.html


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The case against the Euro The case against the Euro

1. Loss of economic sovereignty The Bank of England will not be free to stabilise

the UK economy by using interest rates theyare under the control of the ECB.

2. Convergence problems

The UK will find it hard to converge with Europe,because of the uniqueness of the UK housingmarket, and because of the closeness of the UK trade cycle to the USA, rather than the EU.

3. Only one interest rate Having only one interest rate is not sensible when

dealing with a diverse range of economies andeconomic circumstances.


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The case against the Euro The case against the Euro

4. Asymmetric shocks These are external shocks that have an unequal

impact on an economy. The following areexamples of recent asymmetric shocks:

1. September 11th did not affect all Euroarea countries evenly.

2. The collapse of the Argentinean peso inthe late 1990s mainly affected Spain.

3. The handover of Hong Kong to China ledmany to leave and relocate to the UK,rather than other European countries.

4. The recent financial crisis affected someeconomies more than others (especiallythose with large financial servicesectors).

In this type of circumstance it is argued that oneinterest rate (or common macro-economicpolicy) will not be appropriate.


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Tests for membership Tests for membership

Under the previous Labour government, fiveconditions were laid down for membership of theEuro area:

1. Economic convergence - the trade cycles of the UK and Euro area should be in alignment.

2. Flexibility- joining should not harm the flexibleproduct and labour markets of the UK incomparison with the EU.

3. Investment - joining should not discourage domesticinvestment and FDI.

4. Financial services the City should not suffer.5. Growth and jobs - membership should be good for

growth and job creation.


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The World TradeThe World Trade

OrganisationOrganisation(WTO)(WTO)


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The World Trade Organisation (WTO) The World Trade Organisation (WTO)

The WTO was formed in 1995, and has itsheadquarters in Geneva. It replaced the GeneralAgreement on Tariffs and Trade (GATT) whichwas formed in 1947. By 2008 there were 153member countries.

The purpose of the WTO is to:1. To promote free and fair trade throughmultilateral talks and negotiations

2. To arbitrate between countries who are in dispute


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The World Trade Organisation (WTO) The World Trade Organisation (WTO)

Evaluation Since its formation there have been over 60

separate agreements between members. Tradeliberalisation clearly brings many economic andpolitical benefits, but many claim that the WTO:

1. Has failed to tackle ethical issues, such as the useof child labour and poor working conditions indeveloping economies.

2. Has failed to tackle environmental issues, such asthe depletion of global fish stocks.

3. Takes too long to arbitrate and settle disputes.4. Favours the powerful developed nations over

weaker developing ones.5. Has failed to promote multi-lateralism.


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The Doha Round The Doha Round

The Doha Round of trade talks began in 2001, withmajor summit meetings in Mexico (2003), HongKong (2005) and Geneva (2004, 2006, and 2008)

The Doha round of talks was also called thedevelopment round reflecting its emphasis ontrying to promote free trade for the benefit of developing nations.

The Cancun talks focussed on:1. Reducing agricultural subsidies and industrial

tariffs imposed by developed nations whichlimit the market access of developing nations.

2. Harmonising competition rules within differentcountries.

3. Help to poor countries. The talks collapsed because:

The US and EUs failed to agree reductions inagricultural support and because somedeveloping countries did not want to agree newinvestment rules which make it easier for


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The Doha Round The Doha Round

Since the collapse - the USA and EU have returnedto bilateral agreements with favoured nations,rather than multilateral WTO agreements. Thishighlights a fundamental weakness of the WTO- the failure to promote multilateralism.

The failure of the Doha round means that richcountries protect themselves from goodsproduced by the poor by 2005, averageagricultural tariffs imposed by the USA and EUwere 60%, against average industrial tariffs of only 5% (Source: WTO, 2005 )

See Video
http://www.wto.org/library/flashvideo/video_e.htm?id=65&display=shorthttp://www.wto.org/library/flashvideo/video_e.htm?id=65&display=short


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UK UK competitivenesscompetitiveness


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UK competitivenessUK competitiveness

What is competitiveness? Competitiveness means the ability of a country to

compete effectively in global markets.Competitiveness is closely related toproductivity.

Measuring competitiveness Competitiveness can be measured in a number of ways, including:

1. Relative export prices - relative export prices areone countrys export prices in relation to othercountries, expressed as an index.

2. Labour productivity - labour productivity for acountry is usually expressed as GDP per worker,or it can also be measured in terms of GDP perhour of employment.

3. Unit labour costs - unit labour costs are the cost of

labour per unit of output.4.


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The World Economic Forum Competitiveness Index The World Economic Forum lists the following

indicators of competitiveness:1. Effective institutions - which create an economic

environment in which businesses can develop,

and consumers have confidence. These shouldbe sound, honest and fair.2. Effective infrastructure which provides effective

transport and energy supplies.3. A sound macro-economic environment, including

sound public finances, and low and stableinflation.

4. A healthy and educated labour force, with anemphasis on higher education, and thecontinuous upgrading of skills.


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5. Efficient goods markets, with high levels of competition, and low levels of regulation.6. Efficient labour markets, which are flexible, and

provide effective incentives to work and effort.7. An effective financial market, which provides a

flow of capital to business, effectively managesfinancial risk, and is trustworthy andtransparent.

8. The readiness of firms to adopt new technology.9. The size of global markets enables firms that are

willing to trade to gain from economies of scale.

10. Business sophistication, which relates to the levelof business networks, supporting industries,and advanced business processes.

11. Continuous innovation, which counteractsdiminishing returns to existing technology.


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UK export competitivenessUK export competitiveness

Export price competitiveness this refers to howwell a countrys exports compare in terms of price. This is affected by a number of factors,including:

Relative UK inflation - even small annualdifferences can build-up over time and becomesignificant.

The relative real exchange rate (RER) which isthe nominal exchange rate deflated by anindex of prices. For example, if the SterlingIndex appreciated by 7% and UK prices rose by

2%, the RER is 107/102 x 100 = 105, i.e. thereal value of Sterling rose by 5%. Labour costs per unit - including wage and non-

wage costs.

E i


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Labour productivityLabour productivity

There are twocommonlyused indices of productivity:

1. GDP perworker.

2. GDP perhourworked.

The UK performsrelativelypoorly againstits majorcompetitors.

The main causesof the UKs

poor

E iE i


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The productivity gap The productivity gap

Which ever measure of productivity is used it isclear that the UK lags behind most of its majorcompetitors.

The difference between the productivity of countrieslike the USA, Japan and Germany and the UK, is

called the productivity gap. In most other areas of economic performance theUK out-performs Germany and Japan, but not inthe case of productivity.

One clear problem for the UK is the level of

educational achievement. According to the Officefor National Statistics (ONS) an estimated 4.5 mpeople have no qualifications.

E iEconomi


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Factors causing the productivity gapFactors causing the productivity gap

The productivity gap According to research by the Economic and Social

Research Council (ESRC, 2004) the UKsproductivity gap is caused by:

1. The level of capital investment The level of investment per head in the UK is

lower than in other advanced economies. A shortage of skilled labour means that machinery

is less effectively used. Relatively low wagesmeans less incentive for UK firms to substitutecapital for labour.

3. Information technology The ESRC found that the use of IT in Europe lags

behind that in the USA because of lower levelsof competition, higher levels of regulation andless desire to change management practices to

incorporate more IT.

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Factors affecting UK productivityFactors affecting UK productivity

3. Innovation and technology transfertechnology transfer The lack of competition in Europe may help

explain the lower levels of R&D as comparedwith the USA.

5. Skills and human capital development

The ESRC found that that a relative lack of skills inthe UK is a primary cause of the UKsproductivity gap. This appears especiallyproblematic in terms of management skills. It isargued that the best graduates go into finance,accounting and consultancy rather than intomanagement.

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Flexible labour marketsFlexible labour markets

The share of totalUK employmentcomposed of part-time workis high.

This may act as adisincentive toinvest inlabour, and notallocatesufficientresources totraining anddevelopment.

However, labour

market

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Investment per headInvestment per head

Investment perhead in the UK is relativelylow.

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UKs manufacturing investmentUKs manufacturing investment

Many economists attribute the poor level of UK investment in manufacturing over the last 20years to:

1. A relatively low savings ratio - high consumer debtlevels, which reduce aggregate savings levels.

2. Relatively high interest rates - according to the

MEC diagram, demand for investment contractswhen rates are high because of the higheropportunity cost of investing. Typically UK ratesare higher than those of the USA, Japan and theEU area.

3. More attractive investment alternatives, including:

Foreign investment Shares Property The service sector


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Policies to improve competitivenessPolicies to improve competitiveness

OLICIES TO IMPROVECOMPETITIVENESS

mproveproductivity

mproveinfrastructure

mprove education andskills

tabilise the macro economy

Integrated transport . .links e g Cross

rail Subsidies to public

transport Reduce congestion

Public investment in newtechnology

Tax incentives for firms to

invest Improve education

and skills Promote flexible

labour markets Measures to improve

competition

Incentives to learn Subsidise university

education Subside infant

. .education e g Sure Start Individual learning

accounts Government schemes

. .e g Learn Directwebsite

Keep UK close to its trend rate of

( . %)growth 2 5 : by

Monetary policy Fiscal policy: To

Reduce inflation Stabilise the

exchange rate


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Policies to help improve competitivenessPolicies to help improve competitiveness

2. Improving competition in product markets, by Deregulation - but some regulation is needed toprotect consumers and workers from unfairpractices.

Privatisation - but there are few industries left inthe UK to privatise.

Reducing monopoly power - but it can be arguedthat monopoly power helps generate dynamicefficiency.

Bringing down barriers to entry - but this is verydifficult as some barriers are natural ones,

such as economies of scale.

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3. Improving the level of investment in the UK, by arange of measures including: Investment grants Investment subsidies Encouraging new product development - these

measures may be helpful, with no majorconflicts associated with them, though, asalways, spending by government has to befunded.

Keeping interest rates as low as possible - but thedanger with this is that low interest rates could

trigger an increase in household spending (C)causing demand pull inflation. Reducing the interest rate elasticity of investment

- so it is easier to raise interest rates withoutnegatively affecting investment, for example,by investment grants and tax relief on

investment.

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4. Creating a stable macro-economic environment,including: Keeping inflation under control, through a mixture

of monetary and fiscal measures. However,higher interest rates deter investment, andcould harm competitiveness in the long run.

Keeping sterling stable.

Conclusion Perhaps the best way to improve UK

competitiveness is through a mixture of policiesdesigned to help improve labour productivity,product market competitiveness and long terminvestment all of which will improve both priceand non-price competitiveness.

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Exchange ratesExchange rates

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The importance of exchange rates The importance of exchange rates

Exchange rates are important for a tradingeconomy:1. They represent a cost to firms when they have to

pay commission on changing s for othercurrencies.

2.

They create a risk to those firms that hold assets incurrencies other than s.3. They affect the price of exports, which form a

significant part of aggregate demand (AD), andthe price of imports, hence they affect thebalance of payments.

4. The Monetary Policy Committee (MPC) of the Bankof England may take the exchange rate intoaccount when setting short term interest rates.Changes in the exchange rate have anothertransmission route into the economy, via theireffect on interest rates.

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Measuring exchange ratesMeasuring exchange rates

Exchange rates can be measured in two ways:1. A bi-lateral rate which is the rate of exchange of

one currency for another, such as 1 exchangingfor $1.75.

2. A multi-lateral rate which is the value of acurrency against more than one currency. Multi-lateral rates indicate the average value of acurrency. This is achieved by using an indexwhich reflects changes in one currency against abasket of other currencies.

Sterlings average is measured by the SterlingTrade Weighted Index.

This tracks changes over time, starting with abase year index of 100.

The index is weighted to reflect the relativeimportance of different countries in terms of UK trade.

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Exchange rate regimesExchange rate regimes

An exchange rate regime is a system fordetermining exchange rates for specificcountries, for a region, or for the globaleconomy. Throughout history, three basicregimes have existed:

1. Floating - where currencies are allowed to movefreely up and down according to changes indemand and supply.

2. Fixed - where currencies are tied to a preciousmetal such as gold, or being anchored to anothercurrency, like the US Dollar.

3. Managed - where a currency partly floats and ispartly fixed, such as happened between 1990and 1992, when Sterling was managed in theExchange Rate Mechanism (ERM) of theEuropean Monetary System.


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ChangesChanges in exchange ratesin exchange rates

In a floatingregimeexchangerates reflectdemand and

supply. Theprice of onecurrency isexpressed interms of another

currency. For example, anincrease inexportswould shiftthe demandcurve forsterling to

Q

= $

D (derived)from exports

Q

S (derived)from imports

= .1 $1 50

= .1 $1 60

The equilibrium exchange rate exists at the rate where demand aequate

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Exchange rates andExchange rates and interest ratesinterest rates

Changes ininterest ratesaffect acountryscurrency.

Higher interestrates lead to anincrease indemand forfinancial assets,and an increase

in the demandfor a currency. Lower interest

rates reducespeculativedemand forassets and

Q

= $

(D derived from

)exports

Q

(S derived)from imports

1

Q1

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Fixed exchange ratesFixed exchange rates

The IMF system In 1944, at Bretton Woods, New Hampshire (USA),

the International Monetary Fund (IMF) wasformed and a system of fixed rates introduced.

The IMF was one of three pillars to support the

development of post-war economies the othertwo being The General Agreement on Tariffs and Trade, later to become the World TradeOrganisation, and the World Bank.

The system involved:

1. The US Dollar (US$) as the anchor for the systemwith the US$ given a specific value in terms of gold

2. Other currencies were given a value in terms of the$, such as 1 = $2.40c

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Fixed exchange ratesFixed exchange rates

But the system collapsedcollapsed in 1971 because of:1. The build up of US debts abroad, mainly to fund the

war in Vietnam2. Inflation in the USA3. Growing doubts about the stability of the $4. Speculative activity against the $ - speculators

frantically sold $ until US President, RichardNixon, took the US out of the system

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Managed regimesManaged regimes

Managedregimescombinemarketforces andinterventionto achieve adesiredrate, such asthe EuropeanExchangeRateMechanism(ERM), whichoperatedfrom 1979 to1999.

Currencies weremanaged to

Time

+ . *%2 25

- . *%2 25

nge rate rose too high interest rates would have to fall to create an outflow of hot mon

If the exchange rate fell too much interest rates would have to rise o

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Evaluation of regimesEvaluation of regimes

Benefits of floating exchange rates1. Flexibility and automatic adjustment.

Under a floating regime deficits and surpluses willlead to adjustments in the exchange rate, whichalter relative import and export prices in thefuture. So, imports and exports can readjust tomove the balance of payments back towards adesirable equilibrium.

Exogenous shocks can occur from time to time floating exchange rates can help thereadjustment process.

2. Freedom Policymakers are free to devalue or revalue to

achieve specific objectives, such as stimulating jobs and growth - by devaluation to stimulateexports - and reducing inflationary pressure - byrevaluation to reduce import prices.

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Evaluation of regimesEvaluation of regimes

Benefits of fixed exchange rates1. Stability for firms

Exporting firms prices are more stable, as areimporting firms costs. This is the main reasonthe Chinese Yuan was fixed against the USDollar for nearly 20 years.

2. Predictability and confidence Firms can plan ahead hence they are likely to

invest more. Confidence is a necessary conditionfor investment.

3. Discipline Policy makers cannot devalue the currency in an

attempt to hide inflation or a balance of payments deficit - remember, keeping acurrency low would reduce export prices abroadand nullify any domestic inflation as well asproviding a boost to exports. Policy makerscannot revalue to keep a currency artificially

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Recent UK Exchange ratesRecent UK Exchange rates Sterling fell during

2005, but rosebetween 2006and 2007.However, withthe onset of theglobalrecessionsterling fellback reflectingthe UKsexposure to therecession.

Between 2005 and2010 sterlinglost 20% of itsvalue.

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Indicators of Indicators of

developmentdevelopment

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Development and growth

Growth and development Economic growth refers, narrowly, to increases in

economic welfare, whereas economic developmentrefers, more widely, to economic, political and socialprogress.

Economic growth is an important and necessary condition

for development, but it is not a sufficient condition.Growth alone cannot guarantee development.Freedom and development

According to the influential development economist,Amartya Sen, development is about creating freedomfor people, and about removing obstacles to greaterfreedom.

Obstacles to freedom, and hence to development, includepoverty, lack of economic opportunities, corruption,poor governance, lack of education and lack of health.



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Indicators of development

The Human Development Index (HDI) The HDI was introduced in 1990 to provide an accepted

way of measuring economic development. The HDI has two main features:

1. A scale from 0 (no development) to 1 (completedevelopment).

2. An index, which is based on three criteria:1. Longevity - measured by life expectancy at birth2. Knowledge - measured by adult literacy and number of

years in school3. Standard of living - measured by real GDP per head at

Purchasing Power Parity

What the figures mean1. An index of 0 0.49 means low development - for

example, Nigeria was 0.42 in 2010.2. An index of 0.5 0.69 means medium development for

example, Indonesia was 0.6.3. An index of 0.7 to 0.79 means high development for

example, Romania was 0.76.



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HDI for selectedcountries:

Veryhigh

High

Medium

Low



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Life expectancy

A variety of factors maycontribute todifferences in lifeexpectancy, including:

The stability of food supplies

War and naturaldisasters

The incidence of disease

According to the WorldBank:

Over the past 30years, lifeexpectancy indevelopingcountries as awhole increasedby 10 years

however the


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Literacy

Adult literacy rates Adult literacy can be broadly defined as the percentage of

those aged 15 and above who are able to read and writea short, simple, statement on their everyday life.

More extensive definitions of literacy includes those basedon the International Adult Literacy Survey.

This survey tests ability to understand printed text, tointerpret documents and perform basic arithmetic.


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GDP per capita

GDP per capita GDP per capita is the commonest indicator of material

standards of living, and hence is included in the index of development.

Evaluation of GDP measures: GDP statistics are widely used for comparing economic

performance of developing countries, but they can becriticised because:1. Average GDP per head may increase, but the distribution

of income may get wider. Mean averages can bemisleading, and median figures may be more useful.

2. Citizens may work longer hours - in which case some of the growth may occur because of increased work ratherthan through greater productivity.

3. Citizens may do more unpaid work in one country - but thisis not likely to be recorded.

4. Prices of similar products may be different - figures mustbe adjusted to take into account different purchasingpower of the local currency. The process of undertakingthis conversion is called adjusting to create Purchasing


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5. Negative externalities may be greater in one country -countries with higher GDP may have the higher levels of pollution.

6. Non-marketable transactions public and merit goods arenot generally bought and sold in markets, so the valueof these to a national economy tend to beunderestimated.

7. The size of the hidden economies can vary - using crudeGDP statistics for diverse countries could be misleading.8. Conversion to a common currency - converting GDP figures

to a common currency may give misleading figures.Exchange rates for closed economies may be under orover valued.


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Measure of economic welfare (MEW)

Nordhaus and Tobin In 1972, Yale economists William Nordhaus and James

Tobin introduced their Measure of Economic Welfare (MEW)* as an alternative to crude GDP.

MEW adjusts national income to include the value of leisure time and the amount of unpaid work in an

economy. It also includes the value of the environment damagecaused by industrial production and consumption, whichreduces the welfare value of GDP.

*Nordhaus, WD and Tobin, J (1972) Is GrowthObsolete? Economic Growth, National Bureau

of Economic Research, no 96, New York. The Index of Sustainable Economic Welfare

The Index of Sustainable Economic Welfare (ISEW),develops MEW by adjusting GDP further by taking intoaccount a wider range of harmful effects of economicgrowth, and by excluding the value of publicexpenditure on defence.


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Purchasing power parity

Purchasing power parity (PPP) The alternative to using market exchange rates is to use

purchasing power parities (PPPs). The purchasing power of a currency refers to the quantity

of the currency needed to purchase a given unit of agood, or common basket of goods and services.

Purchasing power is determined by the relative cost of living and inflation rates. Purchasing power parity means equalising the purchasing

power of two currencies by taking into account thesecost of living and inflation differences.

The Big Mac Index This index, devised by The Economist magazine, calculates

how many units of a local currency are needed topurchase a Big Mac. Exchange rates can then beadjusted according to how much local currency isrequired.


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Growth anddevelopment

theories


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Linear stage theoryRostows linear stage theory

One of the first growth theories was that proposed byAmerican economic historian W. Rostow in the early1960s.

Rostowargued that economies must go through a numberof developmental stages. He argued that these stagesfollowed a logical sequence:

Rostows stages are:

raditionalsociety

Dominated by agriculture and barterexchange

-re take off Increased savingsratio

ake off Positive growthrate

r ive tomaturity

Ongoing movement towardsdevelopment

assconsumption

Citizens enjoy high and rising consumption per.head


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The Harrod-Domar growth model

The Harrod-Domar Model The importance of savings is central to the work of Harrod

and Domar. According to this theory there are two determinants of the

rate of growth:1. The capital-output ratio - which shows how much new

capital (e.g. 10) is needed to create a given amount of new national output (e.g. 2).3. The savings ratio - which shows how much is saved (e.g.

10) from a given amount of national income (e.g.100)

The model indicates how these two ratios affect the rate of growth

1. The higher the savings ratio, the higher the rate of growth2. The higher the capital-output ratio, the higher the rate of

growth Economies must save and invest a certain proportion of

their income to grow at a certain rate failure to

develop is caused by the failure to save, and


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In the Lewis model the line of argument runs:1. Agriculture generally under-employs labour2. The marginal productivity of labour is virtually zero3. So transferring workers out of agriculture does not

reduce productivity4. Labour is now free to work in the more productive

urban industrial sector5. Industrialisation is now possible6. Profits are recycled into more and more

industrialisation7. Capital accumulation is now possible

8. Once this occurs development sustains itself


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Evaluation of the Lewis model

Limited benefits of industrialisation Despite the logic of the Lewis approach the benefits of

industrialisation may be limited because:1. Profits may leak out of the economy and find its way to

developed economies - capital flight.2. Capital accumulation may reduce the need for labour in

the urban industrial sector.3. The model assumes competitive product and labour

markets, which may not fully exist.4. Urbanisation creates urban squalor with unemployment

replacing underemployment.5. Only a small elite may benefit from industrialisation.


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Industry

Clark-Fishers structural change model As early as 1935 Allan Fisher had noted that economic

progress led to the emergence of a large service sector. The Clark-Fisher hypothesis states that development willeventually lead to the majority of the labour forceworking in the service sector.

This is because high income elasticity of demand forservices as income rise demand for services increasesand more employment and national output areallocated to service production.

Lower productivity in the service sector (with less abilityto apply new technology), so prices of services riserelative to primary and secondary goods. This means anincreasing share of national consumption is allocated tothe service sector.

A g ricu ltu re In d u stryAgricultur

eIndustr

y

Labour

IndustryAgriculture Services

Labour


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Dependency theory

Dependency theory became popular in the 1960s as aresponse to research by Raul Prebisch.

Prebisch found that increases in the wealth of the richernations appeared to be at the expense of the poorerones.

What did dependency theory advocate? Dependency theory advocated an inward looking approach

to development and an increased role for the state interms of:

Imposing barriers to trade Making inward investment difficult Promoting nationalisation of industries


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Dependency theory

Why did it lose favour? Although still a popular theory in history, dependency

theory has disappeared from the mainstream of economic theory in recent years.

This is largely as a result of the emergence Far Easterneconomies, especially India.

The inefficiencies of state involvement in the economy,and the growth of corruption, have been dramaticallyexposed in countries that have followed this view of development, most notably a number of Africaneconomies, including Zimbabwe.


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Neo-classical theory

Three different Neo-classical approaches to developmenthave emerged:

1. The free market approach - markets alone are sufficient togenerate maximum welfare.

2. The public choice approach - an extreme Neo-classicalmodel which stresses that all government is bad and

leads to corruption and the gradual confiscation of private property.3. The market friendly approach - while markets work, they

sometimes fail to emerge, and government has a role tocompensate for three main market failures; missingmarkets, imperfect knowledge and externalities.

Neo-classical economists believe that, to develop, countriesmust:

1. Liberate markets2. Encourage entrepreneurship (risk taking)3. Privatise state owned industries

4. Reform labour markets (such as reducing the powers of


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Liberalisation There is a broad consensus between Neo-classical

economists that free trade can help stimulate growthand development by:

1. Encouraging FDI.2. Encouraging the application of economies of scale.

3. Increasing competition and breaking down domesticmonopolies.

4. Creating a low inflation, stable, macro-economicenvironment.

5.


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New growth theory

New growth theory A central proposition of New Growth theory is that, unlike

land and capital, knowledge is not subject to diminishingreturns.

The importance of knowledge The development of knowledge is seen as a key driver of

economic development. The implication is that, in order to develop, economies

should move away from an exclusive reliance onphysical resources to expanding their knowledge base,and support the institutions that help develop and shareknowledge.

Government should invest in knowledge and humancapital, and the development of education and skills.

It should also support private sector research anddevelopment and encourage FDI, which will bring newknowledge with it.

1.


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Income and wealth

Introduction One clear feature of less developed countries is the

impoverishment of a large proportion of theirinhabitants, caused by a lack of income, either throughunemployment, under-employment, or low wageemployment.

Types of income The types of income that can be earned are:1. Earned income, from selling labour in the labour market,

including: Wages, which is the largest source of income Salaries and commission, which represents a very small

fraction of income, in comparison with more developedeconomies

2. Unearned income, such as Rents from land ownership and interest from lending

money (i.e. credit)

Common types of wealth in developing economies


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Measuring inequality

Measuring inequality Inequality can be quantified by looking at the distribution

of income or wealth.1. The distribution of wealth is likely to be much greater than

income because wealth is built up over many decades,and for some families, over centuries.

2. The distribution of income is relatively easier to measure -valuing wealth is difficult because much wealth ishidden from view and wealth changes its value overtime.

The Gini co-efficient and index The Gini co-efficient or index is a mathematical devise to

compare income distributions over time and betweeneconomies.

The co-efficient is calculated by comparing the area underthe Lorenz curve and the area from the 45 0 line to theright hand and bottom axis. The co-efficient ranges from0 to 1 - the closer to one, the greater the inequality.


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C i g countr ies


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C o m p a r i n g countr ies

Comparing countries The further the

Lorenz Curvefrom the 45degree line, theless equal

(wider) thedistribution of income.

100

90

80

70

60

50

40

30

20

10

Cumulative Cumulative(%)Income (%)Income

(%)Cumulative Population (%)Cumulative Population

L i n e

o fp e r f

e c t l

y

e q u a

ld i s t

r i b u t

i o n

L o r e

n zC u r v

ef o r

C o u n

t r y

X

10 20 40 60 80 100

% of Pop % of Y in Country X

% of Y in Country Y

20 2 1

40 10 5

60 25 15

80 45 30

100 100 100

L o r e

n zC u r v

ef o r

C o u n t r

yY

( - )the Lorenz curve and Gini co efficient can be used to assess the effectiveness of polici.income


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Poverty

What is poverty?1. Absolute poverty The simplest definition of being poor is being unable

to subsist, and being deprived of basic humanneeds, such as food, drink, shelter and clothing. Acommon monetary measure is ..receiving less than$2 a day.

It is also possible to establish an international povertyline, at, say $700 per person per year, and thencompare countries by estimating the purchasingpower equivalent of that sum in terms of thecountries own currency.

2. Relative poverty It can be argued that poverty is best understood in a

relative way what is poor in New York is not thesame as what is poor in Calcutta.

Most relative definitions suggest that poverty is theinability to reach a minimum accepted standard of living in a particular society.

Definitions of relative poverty vary considerably, but


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Estimated absolute poverty

Absolute poverty, by region Taking the

internationalpoverty line, as aregion, Asia has thehighest populationliving in poverty.

However, as a regionof the world, Sub-Saharan Africa hasthe highest level of poverty as aproportion of totalpopulation, at over60%.

The second poorestregion is LatinAmerica, with 35%

of its population

%23

%25

%62

%28

%35

Source United Nations

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The KuznetsKuznets curvecurve Economic

development maywiden thegapbetweenrich andpoorcountries.

The greatestinequalitycan beobservedascountries'take-off'in theirdevelopment,

Kuznets KuznetsCurveCurve

Inequality increases in the early stages ofdevelopment

Development

I n e q u a

l i t

y


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Constraints to

development


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Im b a la n ce s


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Constraints todevelopment

In e ffic ie n ci

e s

P o p u la tio n

a ck o fca p ita l

C o rru p tio niss in gm a rk e ts

E n v iro n m e ta l

d e p re cia tion

r a d eb a rrie rs

a ck o fe d u c a tio n


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Inefficiencies

A significant limit to economic growth anddevelopment is inefficiency in the use of scarceresources:

1. Productive inefficiency (not producing at lowestpossible average cost.)

This may be because of the failure to applytechnology to production, or because of theinability to achieve economies of scale. Openingup the economy to free trade may help reducethis type of inefficiency.

2. Allocative inefficiency when competition isrestricted, or when production is in the hands of the state, prices might not reflect the marginalcost of production.

3. X Inefficiency also arises from an absence of competition and is associated with inefficientmanagement.


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Imbalances

Not all sectors of an economy are capable of growth.

For some countries, too many scarce resources maybe allocated to sectors with little growth potential.

This is especially the case when countriesspecialise in agriculture and primary commodities.

In these sectors there is little opportunity foreconomic growth because the impact of real andhuman capital development is small, and marginalfactor productivity is very low.

Most development theorists argue for a drive foragricultural efficiency to allow resources to moveto high productivity uses.


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Aging population An aging population is also a potential constraint on

growth, as more workers leave the labour market,tax rates rise, and government spending onhealthcare increases. Resulting public debt maylimit the possibility of fiscal expansion during arecession.


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Lack of financial capital

Many developing economies do not have sufficientfinancial capital to engage in public or privateinvestment because:

1. Growth is insufficient to allow savings to accumulate.2. High interest rates needed to encourage more

saving will deter investment.3. Public debts may be too large.4. Private investment may be crowded out by public

sector borrowing.5. An absence of credit markets in many developing

economies, which discourages both lenders andborrowers.


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Missing markets


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Missing markets

Credit markets Missing markets usually arise because of information

failure. Lenders in credit markets may be unawareof the full creditworthiness of borrowers. Thispushes up interest rates for all borrowers.

Low risk individuals are deterred from borrowing, andcredit markets in developing economies may becompletely missing.

Microfinance is increasingly used to reduce thisproblem in developing economies.

Insurance markets Similarly, insurance markets may be under-

developed, with few insurers wishing to acceptbad risks. Insurance premiums are driven up, andgood entrepreneurs may not be prepared to takesuch uninsured risks.

The result new businesses fail to develop.


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Lack of education

Human capital development requires investment ineducation. Education is a merit good, and as suchthe long term benefit to the individual, and tosociety, is under-perceived.

For many in developing economies, the return onhuman capital development is uncertain in

comparison with the return on immediateemployment on the land so there is little incentiveto become educated.


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Over exploitation of environmental capital

The long term negative effect of the excessive use of resources may be less clear than the short termbenefit.

This means that there is a tendency for countries notto conserve resources. But this can have anadverse effect on growth rates in the future ..


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Development

strategies


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Low elasticity


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y

Low income elasticity of basic commodities As world incomes rise proportionately less income

is allocated to primary products, with low incomeelasticity, and more is allocated to manufacturesand services.

Low price elasticity of basic commodities

Many commodities tend to be price inelastic, suchas foods, beverages and basic clothing, andprices have tended to fall in the long run inrelation to manufactures.

This means that commodity exporting countrieshave tended to suffer, and as export prices fall

relative to import prices of manufactures, theterms of trade of many developing economies fall This means they have to export increasingly more

commodities to pay for the same volume of imported manufactures, including both consumerand capital goods.


OnlineOnlineFalling terms of trade - The Prebisch-Singer h th i


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hypothesis A countrys terms of trade indicate how high a

countrys export prices are in relation to theirimport prices, and is expressed as:

The Prebisch-Singer hypothesis states that:

Over time the terms of trade for commodities andprimary products deteriorates relative tomanufactured goods. This implies it iseconomically unsound to rely on agriculture to

secure growth and development. This means that, just to keep up with developedeconomies, and maintain the existingdevelopment gap, countries relying on producingand exporting primary products, whose terms of trade decline, must continually increase output.

Index of export prices Index of import prices

X 100


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Incomes havefallen because,in the long termthe supply of food hasincreasedbecause:

The greateruse of newtechnology andbetteryields.

Newentrantsintomarkets(likeVietnaminto the

coffee

QQ

PricePrice

D

PP

QQ

S

P1P1

Q1Q100

AA

BB

Revenue

Revenue


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The cobwebdiagram bestexplains thetendency forpriceinstability.

Initially, we canassume a

stableequilibriumprice.

Followed by anegativesupply shock(e.g. badweather).

Price is nowdriven up toP1.

Next year,planned

Q

Price

D

P

Q

S

P1

Q10

S1 S2

Q2

P2

S3

Q3

Long Run Supply


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Development of agriculture Most development theories conclude that

improvements in agriculture are crucial todevelopment prospects.

Agriculture can be developed by a range of policies,including:

1. Extending property rights to workers.2. Land reform and improvement programmes.3. Applying technology to food production.4. Preserving environmental capital.

5. Joining trading blocs.


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Many development theorists, including the Fisher,

Clark and Lewis, highlight the significance of increasing factor productivity throughindustrialisation.

The Lewis model, also known as the two sectormodel, and the surplus labour model, focused onthe need for countries to transform theirstructures, away from traditional agriculturaleconomic activity, with low productivity of labourtowards industrial activity, with high productivityof labour.

1. A g ricu ltu re

In d u stry

Agriculture

Industry

Labour


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Inward looking policies


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An inward looking strategy dominated thinking in thepost-war period this approach can be describedas interventionist, centralist and protectionist, andguided policy making in many African and LatinAmerican countries.

The general economic strategy was import

substitution. The industries targeted were thosewhich provided the largest quantity of imports. Inward looking strategies also involved heavy

subsidies to domestic producers as well as limitingthe activities of MNCs.


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h e b e n e fits f inward looking policies


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Inward looking policies generated some clear shortterm benefits including:

1. Protecting infant industries.2. Protecting declining industries.3. Generating employment.4. Increasing incomes.5. Preserving traditional ways of life.


OnlineOnlineOutward looking policies embracingglobalisation


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globalisation A number of important global events have forced

countries to become more outward looking,including:1. The realisation that decades of using an inward

looking strategy had not resulted in growth ratesnecessary to close the development gap betweencountries.

2. With the collapse of communism the opportunityarose for many countries to introduce moreoutward looking policies.

3. The benefits of globalisation cannot be exploitedwith an inward looking approach.

Outward looking policies typically include:1. Trade liberalisation and market reforms.2. Membership of the WTO.3. Encouraging FDI.4. Encouraging inflows of human capital.


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The benefits of outward looking policies


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1. Welfare gains from tariff removal.

2. Trade creation as a result of free trade.3. The greater spreading of risks.4. Greater positive feedback effects from growth.5. Greater competition and increased efficiency of

domestic firms.6. More able to cope with globalisation and external

shocks.


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The promotion of tourism


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Many countries have promoted tourism as a meansof achieving development.

The benefits of promoting tourism include:1. A strong multiplier effect following the injection of

FDI which accompanies the development of acountry as a tourist destination. (Hotels,infrastructure). This can be significant due to thehigh marginal propensity to consume (mpc) indeveloping economies.

2. Job creation through the initial development phase,and following the ongoing development of tourism.

3. The creation of a more balanced and diversifiedeconomy, with a developing service sector oftenseen as a key indicator of economic progress.

4. Positive externalities as a result of the developmentof infrastructure.


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The problems of relying on tourism include:1. Tourist revenue may go to firms in the country from

which the tourists come (travel agents and touroperators).

2. Development of a parallel hidden economy, withtransactions unrecorded and tax revenue lost.

3. Negative externalities, such as: Overcrowding Loss of areas of natural beauty Historic and special sites may be over-exploited by

tourism

Too much pressure on the local infrastructure4. Diversion of resources from necessary industries,

such as from food production.5. Tourist revenue may be unreliable.


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Financing

development


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Official Development Aid (ODA)


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ODA comes in two basic types:1. Long term aid to relieve poverty2. Short term humanitarian aid for relief following

disasters The UK allocated around 0.5% (7.3bn) of its GDP to

development assistance, but has agreed toimplement the UN Millennium aid goal of 0.7% of GDP by 2015.

By 2009 total ODA had reached $120b, equivalent to0.33% of global GNP. (Source: UN, 2009).

The UN has estimated that and extra $150b needs tobe spent to meet the Millennium DevelopmentGoals agreed in 2000.


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Official Development Aid (ODA)


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The USA is the

UK Economy in a Global Context

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