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Examine the reasons and consequences/economic effects of a substantial rise in
fiscal deficits in many countries since 2008
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This has led to rising unemployment which has meant a fall in income tax
and VAT receipts
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Therefore in
order to stimulate growth to reduce income inequality the government needs to
inject money into the economy
...

Discretionary fiscal policies have been taken up by governments to help the
economy out the recession
...
The
government also has to pay a higher risk premium on countries’ debt, this means that
the debt interest which has been accumulated will be substantially bigger for the
government to pay back
...

Moreover, the government had to increase their expenditure on public services due
to the increasing size and age of the population
...
This government spending to improve the
quality and quantity of public servicesincreases aggregate demand and creates
employment opportunities for workers
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If the government spending is financed by
borrowing then it will lead to an upward pressure on interest rates which will reduce
private sector investment
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However the extent of the consequences depend on the magnitude of the rise in the
fiscal deficit
...
Moreover, there are some countries who already had fiscal deficits
before the financial crisis
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The falling profits and lower
revenue from this corporation tax along with business failure increased pressure on
the government to spend more
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This will cause a reduction in the quality and quantity of public
services and public sector jobs will be lost
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There will also be a negative multiplier effect as
these individuals who loose their jobs are likely to spend less, resulting in a fall in
firms’ profits and in turn even more unemployment, falling incomes and standards of
living
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If the government were to cut benefits this would increase inequality
...
This would be damaging as it results in a fall in the UKs international
competitiveness and productivity, causing unit labour costs to rise and quality to fall
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The inward shift of
the LRAS curve causes both cost-push inflation and a further reduction in economic
growth
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However increasing the level of direct taxes to reduce the fiscal deficit would lead to
a disincentive to work amongst the rich as they will be less willing to work overtime
and more inclined to reduce working hours and people on benefits would not find an
incentive to work
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(DIAGRAM)
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Therefore tax revenue will falll in the long run
causing a larger fiscal deficit
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An increase in the level of corporation tax would mean that there would be less
inward domestic investment and FDI this would act as a constraint on economic
growth in these countries as it reduces AD
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Some positive effects of reducing public expenditure could be that they reduce the
chances of government failure as there would be a more efficient allocation of
resources
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More importantly it
would reduce the danger of crowding out which restricts private sector investment as
the government would not need to finance its spending through borrowing
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If it is relatively small then the countries will be easily able to
finance this deficit and therefore the size of the deficit would not matter
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Consumption accounts for 65% of ADso therefore

thiswill have a large effect on the economy as it will also cause a negative multiplier
effect
...
Therefore cutting public
expenditure would have far less harmful effects than raising taxes to reduce the fiscal
deficit
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This could be in the form of reducing tariffs, quotas
and subsidies
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It would
also lead to increased trade between countries thereby creating more output and
choice of goods at a lower price due to higher competition between firms
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Communication costs between countries have
fallen due to the introduction of the internet and e-commerce
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There will be increased consumer and producer
knowledge over the quality, price and availability of goods and services across
countries eg
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Firms have gone from brick to click reducing average costs of
production and enabling the firms to benefit from economies of scale
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More reasons are the collapse of communism and the opening up of China
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Communist countries used to only trade with eachother
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Another reason for an increase in globalisation is because of the emergence of
transnational companies (TNCs)
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TNCs outsource to reduce costs of production and offshore to provide a larger
market to sell into, this has led to rapid globalisation in recent years
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However globalisation is not a very recent phenomenon it has been on going for a
very long time and the recent opening up of China is probably the most significant
factor why globalisation has increased at a rapid rate in recent years
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The global integration and interdependence of the world economies can also lead to
deglobalisation whereby the countries start to impose protectionist policies to
protect their domestic industries and if one economy collapses they all are affected
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Furthermore LEDCs are not yet developed
enough to compete in the world market
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They can also exploit labour
and resources: forcing down wages and environmental standards, which would
reduce the standard of living in the domestic country
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The growth of TNCs is as much a
by-product of globalisation as it is a cause of globalisation
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Examine the costs and benefits (consequences) of globalisation? (30)

The law of comparative advantage states that a country should specialise in the
production of a good or service which it has a lower opportunity cost compared to
another trading country
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It will
enable these countries to achieve high economic growth and lead to higher demand
for foreign goods
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There will be more
choice and variety of goods which are higher quality
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Consumers will also benefit from technologically
advanced goods due to free movement of technology and lower unemployment due
to free movement of labour
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This would enable them to achieve high economies of scale and therefore
higher revenues and profits
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The government will benefit from higher tax revenues from TNCs which would be
spent on areas such as improving infrastructure, human capital and public services
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Globalisation has led to increased inequality as its widened the gap between the rich
and the poor over the last 25 years
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Workers in the manufacturing sector will be earning a higher
wage than workers in the agricultural sector
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In the UK the manufacturing sector took a very significant hit
with the emergence of China
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External costs also result from globalisation
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This has led to unsustainable development and can adversely
impact the future generations
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TNCs have
been able to use their power in reducing wages of domestic workers, which has led
to falling standards of living and increase world inequality
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In Bangladesh, 600 people died due to lack of red
tape measures
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TNCs might also engage in tax avoidance policies which
could reduce government tax revenue so they will have less money to spend in other
areas and not helping the fiscal deficit
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Therefore
globalisation can be a bad phenomenon
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They can be in the form of
quotas, tariffs, subsidies, administrative regulations and currency manipulation
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By
protecting infant industries, this allows them to grow due to lack of competition from
imported goods and services so they can compete in the future
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Geriatric
industries need time to restructure and rationalise so that they can get competitive
again
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As a result of less competition, domestic demand and
production would rise therefore increasing the level of real output, exports,
employment and profits
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As a result, incomes of workers
would rise which would improve standards of living
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Protectionist policies can help reduce the fiscal deficit as tax revenue increases
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Another reason for use of protectionist policies is to prevent dumping
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This is a form of predatory pricing and is illegal under WTO rules
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For example China sold solar panels lower than the cost of production in
the USA therefore the USA placed a tariff on Chinese imports
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Moreover exports would fall significantly due to less
domestic production and hence reducing long term economic growth
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Meanwhile protectionist policies often lead to trade wars as the
country that has been affected by the policy will retaliate eg
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Protectionist policies distort comparative advantage
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Protectionist policies can create a dependency culture whereby producers
become inefficient because they know they are protected by the trade barriers
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UK demand is relatively inelastic so the protectionist policies have little effect on
imports
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Therefore
protectionist policies could also lead to a fall in international competitiveness and
employment in the long run
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Trading blocs are groups of countries that promote and manage trade amongst
member nations and place barriers on other non-member countries in the form of
free trade areas, common markets, monetary unions and customs unions
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Member countries will experience increased trade activities with each other as they
have removed trade barriers between each other, thereby increasing GDP and output
through specialisation
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Moreover, there will be a fall in global inflation rates because of increased
competition due to greater choice and variety of goods available
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This will improve the current account balance of payments which will
increase FDI further fuelling global economic growth
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This will lead to a fall in
unemployment and consequently would help reduce inequality
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This will also
help producers in these countries achieve economies of scale
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This is when member
countries buy goods and services from inefficient countries within the bloc rather
than efficient countries outside the bloc as it is costly
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Therefore trade diversion will lead to an
inefficient allocation of resources eg
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However, it depends on the number and the size of the trading blocs and the extent
of protectionist policies undertaken by these countries
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In the case of the EU the size is increasing- Romania, Bulgaria and Croatia
have recently joined and Bosnia and Albania are joining in 2015
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However in reality transport costs could be so high that they could offset the benefits
gained from comparative advantage eg
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It is also assumed that it is just two
countries trading two goods but this is not the case, so it is harder to apply
comparative advantage
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In the long run the WTO would intervene and reduce the trade barriers implemented
by the trading blocs which could reduce trade diversion and help promote
globalisation
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Although disagreements occur between trading blocs and the WTO, the WTO finds it
easier to negotiate agreements with a trading bloc than lots of individual countries
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This could lead to increased inequality between
member and non-member countries
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Therefore joining the Eurozone
would result in loss of sovereignty for individual countries within the bloc
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Examine why trading blocs act as a constraint to economic growth and
development
One of the main reasons trading blocs act as a constraint on growth is because of
limited access to markets
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There is also an issue of tariffs and
subsidies being imposed by trading blocs on developing countries which distorts
comparative advantage due to lack of specialization
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This would lead to many producers going out of the
market
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The EU is exploiting raw materials from Africa
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Members of trading blocs can also be involved in dumping of surplus goods which
would lower the world price of these products on which developing countries are
dependant
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However, there are some trading blocs which include developed and developing
countries eg the EU consists of developed countries such as the UK, France, Germany
but also consists of developing countries such as Hungry, Poland, Romania, Bulgaria
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Regional trading blocs also allow developing countries to take advantage of free
movement of labour, reducing occupational immobility of labour, and capital which
will help them achieve technical economies of scale and increase their market size,
which contributes to economic growth and development
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The lowered trade barriers between members of the trading bloc
will enable developing countries to trade more freely and help them achieve growth
and development
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Firms no longer need to worry about fluctuations in the exchange rate because their
main trading partners have the same currency
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60% of the UK’s trade is with the EU
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Because of the easier
trading conditions, there is more scope to tap into economies of scale
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Competition within the Eurozone increases which leads to lower
inflation and price discrimination as consumers have more choice
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However the current account represents only a small proportion (4%) of the UK’s GDP
and price differences still exist between members of the Eurozone
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In order for a country to join the EMU, there are certain economic criteria that it
needs to fulfil eg
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This will encourage countries to persue sensible
macroeconomic policies
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Germany and France have spent billions bailing out countries such as Greece and
Portugal
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The European Central Bank (ECB) has to set an interest rate that is
applicable for all member states (‘one size fits all’)
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Greece was going through a
severe recession and therefore needed a low interest rate in order to generate
growth
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Also, the
UK has approximately 70% homeowners where as Germany only has 30%
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Moreover, the ECB’s inflation target is to keep inflation below 2% which is less
flexible and more deflationary than the UK’s target of 2%+-1%
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Countries can no longer appreciate and depreciate
their currency to meet its macroeconomic objectives
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However, since its main trading partners also have the
Euro they cannot do this
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As such, the UK
was able to increase exports and reduce imports improving its international
competitiveness, current account and GDP
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Countries such as Greece
experienced difficulties due to irresponsible fiscal policies that resulted in
unmanageable debt levels
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Also, there have been recent moves to create a fiscal union to try and
ensure that member states adopt sensible fiscal policies
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These could reduce the rate of
economic growth which could increase unemployment
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Although there are benefits to joining the EMU, these are outweighed
by the costs, particularly the loss of monetary independence
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(20)

International competitiveness (IC) is the ability to compete and sell goods and
services in domestic and international markets at a price and quality that is attractive
in those markets
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This meant
that imports became cheaper for UK consumers and exports became more expensive
for foreign consumers therefore international competitiveness worsened
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Another reason for a fall in UK competitiveness was due to high inflation relative to
other countries
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High
inflation can also lead to a wage price spiral which would increase the cost of
production for firms due to rising wage costs
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Furthermore, the UK has high non-wage costs
relative to other developing countries in the form of pensions, NI contributions,
health and safety and environmental regulations
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The UK has low relative productivity as compared to other countries eg
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This is due to the fall in the standards of education and training relative to other
countries, this reduces the quality of products and increases relative unit labour costs
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UK competiveness has also been decreasing due to a decline in non-price factors
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Moreover, the UK has a low level of customer
service which has made it less attractive for exporting goods in foreign markets
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Competitiveness may not fall if exporters cut profit margins by charging a
lower price for their goods so exports become more competitive and domestic
consumption will rise
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Moreover, the existence of the MPC means that inflation in the UK has been relatively
stable and low for the past decade
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Whenever inflation is outside of this range, the governor of the Bank of England must
write an open letter to the chancellor to explain why this is the case
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At the moment the most significant factor in the UK is the falling productivity as it
increases costs, and the firms will be producing less so this could lead to inflationary
pressures in the economy
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There are several ways in which businesses can improve competitiveness
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This would enable them to improve
productivity with better technology and reduce costs
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Better customer service
would also help businesses improve their competitiveness in international markets
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They can use labour market policies to increase productivity of labour
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They could also increase spending on education and
training which would increase skills and therefore increase productivity and reduce
unit labour costs
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They
can privatise public firms which will increase allocative and productive efficiency and
reduce X inefficiency amongst firms by giving them a profit incentive
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They could also deregulate the goods market so that there is a bigger variety
and choice of goods which would reduce prices and therefore make goods more
internationally competitive
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Given that the UK has a high marginal propensity to
import, this will cause a decline in imports
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This
causes inflation to fall, and thus the UK would become more prices competitive
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This is where the government reduces spending and/ or increases
taxation
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The government could also depreciate its currency in relation to other currencies
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This weaker
currency would mean that the country’s exports are cheaper abroad and imports are
more expensive so the current account will improve
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This would increase international competitiveness as it would raise the
real output and standard of living of the country, thereby enabling the government
to reduce the current account deficit
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This states that the sum of the
PEDs of imports and exports must be greater than 1 (elastic)
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In the short run, given that firms are tied into contracts, the Marshall Lerner
condition wouldn’t be satisfied resulting in deterioration in the current

account
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The effectiveness of Monetary policy depends on the elasticity of the elasticity of the
LRAS when the AD curve initially intersects it
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Moreover, a decrease in government spending may have
damaging long-term consequences on the UKs competitiveness
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It may also cause an inward shift in the LRAS which
causes cost push inflation making the UK both less price and quality competitive
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Education and training for example will take a long time
until it will benefit the economy
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Firms face high sunk costs of buying specialist capital equipment and investing in
research and development and innovation programmes and there is no guarantee of
success
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New capital equipment might not improve productivity as it
depends on the quality and ability of workers operate it efficiently; they may need to
be retrained
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It also depends on the relative importance of labour costs as a proportion of the total
cost of production
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However wage and non-wage costs are
frequently higher in developed countries than developing countries which usually
reduces their international competitiveness
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This restricts growth as an unstable

commodity therefore there are major price fluctuations so planning production,
investment and employment is uncertain
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Most importantly the Prebisch-Singer hypothesis restricts growth
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This is because the income elasticity of demand for
manufactured goods is greater than that of primary product, especially food
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Therefore, a country that relies on
the export of commodities will see a decline in their terms of trade
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The savings gap can be
represented by the Harod-Domar Model which shows that low GDP per capital, leads
to low savings, which leads to low investment and therefore there is less
accumulation for capital which is a key determinant of growth
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This is when
underdeveloped countries have insufficient levels of foreign reserves because most of
their earnings are spent towards servicing debt and the high cost of importing
manufactured goods
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There are population issues as the population of these countries are growing at a
faster rate than the growth in GDP
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This would increase the dependency ratio in
these countries
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This reduces their productivity and therefore hinders competitiveness and
economic growth and development of countries such as Cambodia
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In recent
years the prices of commodities and especially food have been increasing which
improves terms of trade
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As the world becomes more globalized this represents an opportunity for these
underdeveloped countries to expand their tourist sector, this can help to fill the
foreign exchange gap as tourists will change their international currency to the
domestic currency
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The foreign exchange gap can also be eliminated through debt
cancellation
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However, due to corruption, the aid doesn’t always get to
its main recipients
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This would mean that there would be more output produced which would
contribute effectively to economic growth
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The
European Common Agricultural Policy (CAP) seeks to protect European farmers at the
expense of farmers in underdeveloped countries
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Evaluate strategies used to promote growth and development
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Aid is a voluntary transfer of resources from one country

to another
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Therefore it will help reduce absolute
poverty, world inequality, the foreign exchange gap and the savings gap
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Another strategy to promote growth and development is industrialization
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Therefore the marginal productivity of an additional unit of labour will be zero or
close to zero
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By doing this LEDC is likely to attract
FDI from TNCs as has been the case in countries such as China
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FDI acts as an injection into the circular flow of income
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Also, the government will receive more tax revenue, which
can be spent on improving the infrastructure and on areas such as healthcare and
education
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Tourism is income
elastic and is a valuable source of foreign reserves
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Also, a strong tourist industry is likely to attract MNCs particularly hotel
chains
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In
addition to this FDI acts as an injection into the circular flow of income and so there
will be a positive multiplier effect
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Furthermore, the
government will now receive more tax revenue, both direct and indirect taxation that
it can spend on achieving economic growth and developing the economy
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This is where a country reduced or removes barriers to trade and
becomes more immersed in the global economy
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Also, by becoming more globalized, these countries will have
more access to the latest technology, ideas and are likely to attract FDI
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This
will help to reduce inequality, fill the savings gap and reduce absolute poverty
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Although controversial, it is perhaps better to provide these loans to medium income
individuals who have small to medium sized businesses
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Given this, it will not achieve long-term
sustainable economic growth, as the money is unlikely to be invested
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The problem with the Lewis model is that it assumes that there is surplus labour in
the agricultural sector
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This would limit
growth and development in these countries
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It also leads to external costs such
as pollution, congestion and seasonal unemployment as jobs are created for only
certain times in the year
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Also, the jobs created may only be seasonal
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Given that
tourism is income elastic, in times of recession, there will be a more than
proportionate decrease in demand for tourism, as such a country that is over reliant
on tourism will be very negatively effected by an economic downturn
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For example, the 2004 Tsunami in the Indian Ocean had a
devastating effect on the number of tourists for the following
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Aid and debt cancellation could lead to a dependency culture making countries
inefficient
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Resources are not always diverted to the main recipients due to corruption
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This states that in many developing countries, firms and industries would not have
developed to a point where they could compete against big multinational
corporations
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By
protecting these industries, it will give them time to grow and tap into their
economies of scale so that they can compete with the MNCs in the long run
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This is a form of predatory pricing and is illegal
under WTO rules
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Protectionist policies protect domestic
employment, which is one of the macro- economic objectives for any government
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To conclude there are several strategies that can be implemented to promote growth
and development of countries
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Examine the causes of income and wealth inequality in the UK or a country of
your choice
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When individuals are highly educated and
trained it improves their efficiency, skills and therefore productivity
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ONS figures show those who go into higher education earn on
average £12,000 more than non-graduates
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A lower progressive tax rate and low unemployment benefits
would create a higher incentive to work amongst low income households but it
would increase the level of income inequality
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Varying pension rights is also a major cause of in inequality of income and wealth
within the UK
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They may end up relying on the state
pension alone, which can push them towards absolute poverty in old age
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Those with higher savings, properties, bonds and shares are likely to be in a
better financial position than those without assets
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The high income households
would be able to pass on their assets to the future generations in the form of
inheritance and therefore creating income inequality in the long run
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However education and training would only lead to differences in income inequality if
there is a substantial difference in the uptake of different degree courses
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There are certain degree courses which do not have enough employment
opportunities available for graduates as compared to those who are non-graduates
and in jobs
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However, inequality in developing countries such as Brazil is more extreme
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Weak laws enforcing property rights mean it is difficult
to demonstrate ownership of land – no assets, low income
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Public sector pensions have been reduced to
improve the governments fiscal position following recession of 2008/9
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Evaluate the policies used to reduce income and wealth inequality in the UK or
any country of your choice
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When individuals are highly educated and trained it improves their
efficiency, skills and therefore productivity
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UK ONS figures
show those who go into higher education earn on average £12,000 more than nongraduates
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This
will increase their standard of living and give an incentive to save which could lead to
long run reduction in wealth inequality
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Another measure the UK government can pursue is increasing the level of
progressive taxation and reduce the level of regressive taxation
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Moreover, the UK
government could reduce regressive taxes in the form of VAT as the low income
households spend a greater proportion of their income on goods and services
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However, education and training schemes take a very long time to filter into the
economy and become effective
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Moreover,
education and training programmes are already quite extensive in the UK and
therefore the effects of further improvement might be insignificant
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Therefore government tax revenue falls at a
high marginal tax rate
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Increasing the level of tax also reduces the
level of disposable income which reduces consumption and in turn AD, lowering long
run economic growth
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Increasing the level of unemployment benefits would create a disincentive to work
among low income households and those unemployed
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Although the UK government has increased NMW, it
would lead to unemployment
...




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