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4 A global perspective
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1 The meaning of globalisation
→ Globalisation is used to refer to a variety of ways in which countries are becoming increasingly
closely integrated – not just economically, but also politically and culturally
→ Peter Jay, BBC Economics Correspondent, defined globalisation as the following:
“The ability to produce any good or service anywhere in the world, using raw materials,
components, capital and technology from anywhere, sell the resulting output anywhere
and place the profits anywhere
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2 Characteristics of globalisation
→ Globalisation, in the economic sense, is characterised by the following:
▪ An increase in trade as a proportion of world GDP
▪ Increased movements of financial capital and human capital (workers) between countries
▪ Increased international specialisation and division of labour; it is increasingly common for
parts and components of products to be made in different countries and for assembly to
occur in another country
▪ The growing importance of global or transnational companies (TNCs)
▪ An increase in foreign direct investment (FDI)
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4 Impacts of globalisation
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1 On countries
→ Free trade enables the law of comparative advantage to come into effect, which suggests that when
countries specialise in the goods in which they have a comparative advantage (a lower opportunity
cost) then world output and living standards will increase
→ There is a correlation between a growth in world trade and an improvement in world GDP
→ However, the global financial crisis in 2008 led to a period of deglobalisation, where countries adopt
protectionist policies in an attempt to protect domestic employment – this has been exacerbated by
Brexit and the Trump administration
→ This led to a decline in specialisation and trade – more recently, however, trade has recovered
→ Globalisation has been associated with increased inequality within developed countries – as
manufacturing has transferred to the developing world, the demand for unskilled labour in
developed countries has declined, leading to an increased wage gap between skilled and unskilled
labour
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2 On governments
→ If globalisation leads to an increase in economic growth (as the theory of comparative advantage
suggests it should) then profits and incomes should increase, meaning governments should gain
extra tax revenues
→ However, transfer pricing by global companies may result in lower tax revenue from corporation tax
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3 On producers and consumers
→ For producers, there are likely to be benefits in terms of lower production costs as a result of
offshoring and also economies of scale
→ For consumers, globalisation may mean a wider choice of goods; prices may also be lower, leading to
an increase in consumer surplus
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4 On workers
→ Globalisation has been criticised on the grounds that it promotes exploitation of workers, including
the use of child labour
→ It is argued that globalisation has driven down wages (especially those of unskilled labourers) as a
share of GDP
→ Further, health and safety law and regulations are usually less demanding in developing countries,
which might have detrimental effects on the workforce
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5 On the environment
→ The external costs associated with increasing globalisation and becoming more apparent, especially
regarding increased trade, air travel and environmental degradation
→ Global warming associated with various forms of pollution arising from increased trade is one
example of external costs arising from increased globalisation

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2 Specialisation and trade
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Advantages and disadvantages of specialisation

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1 Advantages
→ Efficient resource allocation: specialisation and free trade based on comparative advantage results in
an efficient allocation of resources
→ Higher world output and, therefore, higher living standards
→ Lower prices and more choice for consumers
→ Incentive for domestic producers to become more efficient
→ Larger markets for firms, enabling them to benefit from economies of scale
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2 Disadvantages
→ The law of comparative advantage is based on unrealistic assumption
→ For developing economies, specialisation in the production of primary products might prevent
diversification into more productive manufacturing industries
→ There is a danger of overdependence on imports, especially those of strategic importance
→ A country’s goods and services may be uncompetitive, resulting in a persistent trade deficit

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3 Patterns of trade
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Calculation of the terms of trade
𝑖𝑛𝑑𝑒𝑥 𝑜𝑓 𝑒𝑥𝑝𝑜𝑟𝑡 𝑝𝑟𝑖𝑐𝑒𝑠

→ The terms of trade are found with the following formula: 𝑇/𝑇 = 𝑖𝑛𝑑𝑒𝑥 𝑜𝑓 𝑖𝑚𝑝𝑜𝑟𝑡 𝑝𝑟𝑖𝑐𝑒𝑠 × 100
→ Therefore, the terms of trade is the relationship between the price of exports and the price of
imports or the rate at which exports exchange for imports
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3 Impact of changes in a country’s terms of trade
→ There are a number of impacts of changes to a country’s terms of trade:
▪ On living standards – an upward movement in the terms of trade is usually referred to as an
‘improvement’ since it implies that the country has to export less in order to buy a given
quantity of imports, implying a higher standard of living
▪ On the balance of payments on current account – an upward movement in a country’s terms
of trade would decrease the competitiveness of its goods and services because its export
prices would be rising relative to its import prices – the balance of payments is likely to
deteriorate (causing a depreciation of the currency, making goods more internationally
competitive, returning the balance of payments to its previous position)
▪ On the rate of inflation – a fall in a country’s terms of trade may be associated with a higher
rate of inflation if the fall was caused by an increase in the price of imported raw materials
▪ On developing countries – resource-rich developing countries sometimes suffer from what is
called the ‘resource curse’; ownership of raw materials causes an appreciation in currency,
and in turn an increase in the terms of trade – this leads to a loss of competitiveness of
goods and services, and slower economic growth than might otherwise have been the case

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5 Trading blocs and the World Trade Organisation (WTO)
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Free trade areas – trade barriers are removed between member countries, but individual
members can still impose tariffs and quotes on countries outside the FTA, e
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the North
Atlantic Free Trade Area (NAFTA)
Customs union – the characteristics of customs unions include free trade between member
states and a common external tariff on goods imported from outside the bloc, e
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the
European Union (EU) and the Eurasian Customs Union (EACU) of Russia, Belarus and
Kazakhstan, formed in 2010
Common market – these are customs union but with the added dimension that factors of
production, not just goods and services, can be moved freely within member states, e
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Mercosur in South America and the East African Community (EAC)
Monetary unions – these are customs unions that adopt a common currency, e
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the
Eurozone area of the EU
Economic union – these are monetary unions where economic policy is decided and
determined centrally and collectively

Costs and benefits of regional trade agreements

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1 Costs
→ Trade diversion – trade may be diverted away from low-cost producers outside the bloc to high-cost
producers within the bloc because of the existence of tariffs on goods from outside the bloc
→ Distortion of comparative advantage – the existence of trade restrictions on goods from countries
outside the agreement will distort comparative advantage and lead to a less efficient allocation of
resources, lowering global economic growth
→ Loss of independent monetary policy – this would be relevant to countries in monetary unions which
would be unable to control their own interest rates, money supply and exchange rates
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2 Benefits
→ There are a number of general benefits:
▪ Trade creation – the removal of trade barriers between member countries of the bloc will
result in increased specialisation and trade between them
▪ Increase in FDI – global companies may wish to invest inside a trading bloc to avoid trade
restrictions
→ There are also a number of benefits specifically available to monetary unions:
▪ Elimination of transactions costs – in other words, there would be no costs involved in
changing currencies when goods are imported or exported
▪ Price transparency – a single currency means that consumers have the ability to compare
prices more easily across national borders
▪ Elimination of currency fluctuations across member countries – this eliminates uncertainty
and might help to attract FDI
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4 Possible conflicts between regional trade agreements and the WTO
→ The existence of trading blocs has two significant consequences, as described above:
▪ Trade creation
▪ Trade diversion

→ While trade creation is a goal of the WTO, the trade diversion that results from regional trade
agreements clearly is not
→ Nevertheless, it may be argued that the growth both in the number and size of regional trade
agreements has contributed to the WTO goal of promoting free trade

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6 Restrictions on free trade
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2 Types of restrictions on trade
→ There are numerous ways in which free trade can be prevented
→ The most common of these are the following:
▪ Tariffs
▪ Quotas
▪ Subsidies to domestic producers
▪ Non-tariff barriers
→ In countries where the exchange rate is not freely floating (fixed or managed) then the authorities
might also hold down the value of the currency artificially to give their goods a competitive
advantage

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1 Tariffs
→ These are sometimes referred to as customs duties; they are simply taxes on imported goods
→ Before the tariff is imposed:
▪ The price paid by consumers is P1
▪ Domestic output is at Q1
▪ Imports are at distance Q4-Q1
→ Once the tariff is imposed:
▪ The price paid by consumers rises to P2, reducing consumer surplus by area P1P2BG
▪ Domestic output rises to Q2, increasing producer surplus by P1P2AC
▪ Imports fall to distance Q3-Q2
▪ Tax revenue to the government is ABEF
▪ Net welfare loss areas are ACE and BFG
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2 Quotas
→ Import quotas place a physical restriction on the amount of goods that can be imported
→ They have similar effects to those of tariffs, in that the price of imported goods will rise and
domestic producers should
more business
→ However, unlike tariffs, the
government does not
receive any revenue
Subsidies to domestic
producers
→ Grants given to domestic
producers by the
government artificially
their production costs, so
enabling their goods to be
competitive
→ Subsidies therefore act as a
barrier to trade

gain

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lower
more

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4 Non-tariff barriers
→ These take a variety of forms:
▪ Labelling
▪ Health and safety regulations
▪ Environmental standards
▪ Documentation in country of origin
→ In effect, such regulations increase the costs of foreign producers and therefore act as a barrier to
trade in the same manner as a tariff
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1 The components of the balance of payments
→ The balance of payments is a record of all financial transactions between one country and the rest of
the world
→ When there is an inflow of foreign currency into the UK, this is reported as a positive item, or a
credit, on the British balance of payments
→ When there is an outflow, it is recorded as a negative item, or a debit
→ The main components of the balance of payments are the following:
▪ The current account
▪ The capital and financial account
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1 The current account
→ This is composed of the following:
▪ The trade balance – this is the value of goods and services exported minus the value of
goods and services imported; the trade balance may be separated into the trade in goods
balance and the trade in services balance
▪ The income balance (now renamed primary income) – this is income flows into the country
from non-residents minus incomes flows out of the country from residents to non-residents;
income refers to compensation for work
▪ Current transfers (now renamed secondary income) – this relates to items such as food aid
and the UK’s contribution to the EU’s Common Agricultural Policy (CAP), for which nothing is
expected in return
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2 The capital and financial account
→ This comprises transactions associated with changes of ownership of the UK’s foreign financial assets
and liabilities
→ A key factor influencing the financial account is foreign direct investment (FDI)
→ Also included are portfolio investment in shares and bonds, changes in foreign exchange reserves
and the short-term capital flows referred to as ‘hot money flows’
→ The balance on this account should exactly offset the current account balance (although in reality
this does not always occur, due to errors and omissions)
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3 The UK’s current account
→ For many years, the UK current account has been in deficit, caused particularly by a deterioration of
the trade in goods balance
→ The main reasons for the UK’s current account deficit include:
▪ The high-value of sterling 1996-2008
▪ Continuous economic growth 1992-2008 – the UK has a high marginal propensity to import
and so rising real incomes have led to a significant increase in imports
▪ Relatively low productivity of the UK’s workers, resulting in higher average costs
▪ The relocation of manufacturing to countries with lower labour costs, e
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China and eastern
European countries
▪ The Eurozone crisis since 2009, which has meant slow growth and weak demand for the UK’s
exports
▪ The deterioration in ‘net income balance’, i
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net income from interest, profits and
dividends
▪ The ‘Chindia effect’ – the industrialisation of China and India has led to a flood of cheap
imports into the UK
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5 Significance of global trade imbalances
→ Like the UK, the USA has experienced large current account deficits, while in contrast China has
experienced huge current account surpluses
→ Whether such global imbalances can be sustained in the long-term is a major question
→ On the one hand, if the deficits are easily financed by inflows on the financial account, there may be
no cause for concern
→ Further, under a system of floating exchange rates there should be a degree of automatic
adjustment
→ On the other hand, continuous deficits by the USA have, in effect, been financed by the Chinese
through loans, which may not be sustainable in the long-run

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8 Exchange rates
→ The nominal exchange rate is the number of units of the domestic currency that can purchase a unit
of a given foreign currency
→ The real exchange rate is calculated to measure the movements of the competitiveness of a
country’s currency vis-à-vis another country’s currency on the basis of the inflation differential
between the two countries
→ In other words, the real exchange rate is the nominal exchange rate adjusted to reflect the different
inflation rates in the countries of the two currencies concerned
→ Effective exchange rates are estimated to measure the movements of a country’s currency value or
average exchange rate in a basket of currencies of trading partner countries
→ A country’s trade-weighted exchange rate is a common form of the effective exchange rate; it is the
average exchange rate of a basket of currencies, weighted by the amount of trade with each country
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→ There are three main exchange rate systems: floating, fixed and managed
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1 Floating exchange rates
→ Under a system of floating exchange rates, market forces (supply of, and demand for, the currency in
the foreign exchange market) determine the value at which one currency exchanges for another
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2 Fixed exchange rates
→ Under a system of fixed exchange rates, the value at which one currency exchanges for another is
fixed by the central bank or the government against another currency or a basket of currencies or
gold
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3 Managed exchange rates
→ Under a system of managed exchange rates, market forces determine the value at which one
currency exchanges for another but intervention by the central bank influences the exchange rate of
the currency
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3 Distinction between devaluation and depreciation
→ A devaluation of a currency only occurs in a system with a fixed exchange rate, or where a
government using a managed exchange rate intervene to keep the price of the currency low
→ A depreciation of a currency occurs when market forces affect a floating exchange rate, causing the
price of a currency to fall
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5 Government intervention in currency markets
→ There are two main ways by which the exchange rate of a currency against other currencies may be
influenced:
▪ Foreign currency transactions
▪ Interest rates
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1 Foreign currency transactions
→ The central bank can intervene in the foreign exchange market in attempts to influence the
exchange rate of its currency against other currencies
→ To bring about a revaluation in the exchange rate of the currency, the central bank would buy its
currency on the foreign exchange market; this increase in demand for the domestic currency would
cause an increase in its exchange rate
→ To engineer a devaluation, the central bank would sell its own currency and buy foreign currency,
causing an increase in supply of domestic currency, and so the price of domestic currency would fall

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2 Use of interest rates
→ To bring about an appreciation of the currency against other currencies, the central bank would raise
interest rates, attracting hot money flows, boosting demand and causing the price of the currency to
increase
→ For example, in December 2014, the Central Bank of Russia raised interest rates to 17% to make it
more attractive for foreign citizens to place their money in the country
→ A reduction in the interest rate would have the opposite effect, causing the exchange rate to
depreciate
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Effects of a change in the exchange rate of a currency

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1 On the current account of the balance of payments
→ A depreciation/devaluation makes a country’s goods and services more competitive and so should
lead to an improvement in its current account:
→ Suppose that the value of the pound against the dollar falls, from £1 = $2 to £1 = $1
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1 The Marshall-Lerner condition
→ For there to be an improvement in the current account, the Marshall-Lerner condition must be filled
→ The Marshall-Lerner condition is that the sum of the price elasticities of demand for imports and
exports must be greater than 1

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1 Measures of international competitiveness
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1 Relative unit labour costs
→ This refers to the measurement of labour costs in one country relative to those in another country
→ To make international comparisons, the figures are converted into a single currency and are
expressed as an index number
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2 Relative export prices
→ These might be affected by factors such as productivity (relative to other countries)
→ This may be measured in terms of labour productivity, which is output per worker per hours worked
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3 The global competitiveness index
→ This is a composite measure devised by the World Economic Forum and is based on factors such as
infrastructure, macroeconomic stability, health and education, degree of efficiency in the labour and
goods market, technological readiness and innovation
→ The top 10 rankings for 2017-18 were:
▪ 1) Switzerland
▪ 2) USA
▪ 3) Singapore
▪ 4) Netherlands
▪ 5) Germany
▪ 6) Hong Kong
▪ 7) Sweden
▪ 8) UK
▪ 9) Japan
▪ 10) Finland
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3 The significance of international competitiveness
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1 Benefits of being international competitive
→ A country can enjoy several benefits from being internationally competitive:
▪ A surplus on its current account of the balance of payments
▪ Export-led growth
▪ Low levels of unemployment
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2 Problems of being internationally uncompetitive
→ A fall in international competitiveness is likely to be reflected by a deterioration in the trade in goods
balance of the balance of payments
→ This in turn could result in an increase in unemployment, especially in industries in which exports are
significant
→ A fall in exports has a negative multiplier effect on GDP, causing a reduction in economic growth

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1 Absolute poverty
→ According to the World Bank, people are considered to be living in absolute poverty if their incomes
fall below the minimum level to meet basic needs such as food, shelter, clothing, access to clean
water, sanitation facilities, education and information
→ This minimum level is referred to as the poverty line
→ One of the key Millennium Development Goals was to halve the number of people living in absolute
poverty by 2015
→ This target of reducing extreme poverty rates by half was met in 2010, when 700 million people
fewer people than in 1990 were living in conditions of extreme poverty
→ However, in 2017, there were still around 765 million people living in poverty worldwide
→ In 2015, the Millennium Development Goals were replaced by the Sustainable Development Goals,
the first of which was to ‘End poverty in all its forms everywhere’
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3 Measures of absolute and relative poverty
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1 Measure of absolute poverty
→ Absolute poverty is based on a set standard that is consistent over time and between countries,
referring to the ability of individuals or groups to meet their basic needs
→ In 2015, the World Bank set the international absolute poverty line at $1
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4 Causes of changes in absolute and relative poverty
→ Changes in any of the following factors may result in changes in absolute and relative poverty:
▪ Aid
▪ Debt relief
▪ Fair-trade schemes
▪ Microfinance schemes
▪ Employment opportunities
▪ Education and training

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▪
▪
▪

Wage rates and national minimum wages
Property rights
Ownership of assets and their prices, e
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houses and shares
Social benefits (transfer payments)

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2 Inequality
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2 Measurements of income inequality: the Lorenz curve and the Gini coefficient
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1 The Lorenz curve
→ The degree of inequality can be measured using a Lorenz curve, which plots the cumulative
percentage of the population against the cumulative percentage of total income
→ The 45° line represents perfect equality such that the poorest 10% of the population would receive
10% of the income, the poorest 20% would receive 20% of the income, and so on
→ The curved line represents an unequal distribution of income
→ The areas 𝐴 and 𝐵 are used in the calculation of the Gini coefficient
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2 The Gini coefficient
→ This is a measure of the degree of inequality in a country
𝐴

→ It is calculated as follows: 𝐺 = 𝐴+𝐵

→ Where 𝐴 represents the area between the diagonal line and the Lorenz curve and where 𝐵
represents the area under the Lorenz curve
→ The Gini coefficient will have a value of between 0 and 1, with 0 representing absolute equality and
1 is absolute inequality
→ The Gini coefficient may also be
expressed as a percentage
→ The formula for this is as follows: 𝐺 =
𝐴
𝐴+𝐵

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4 Impact of economic change and development on inequality
→ Inequality is often regarded as an inevitable cost associated with economic growth, because owners
of resources and the means of production will become wealthier relative to workers
→ However, it may be argued that inequality itself is a constraint on economic change and
development for the following reasons:
▪ The very poor will have no collateral and so will be unable to start their own businesses
▪ Absolute poverty could remain high in countries where inequality is high
▪ Those on low income will have a low marginal propensity to save, so limiting funds available
for investment, while those on high incomes may spend a large amount of their incomes on
imported goods or may transfer their incomes to other countries, known as capital flight
→ There may be socially undesirable consequences of inequality, such as an increase in crime rate,
which might have an adverse effect on growth and development
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3 EMERGING AND DEVELOPING ECONOMICS
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1 Measures of development
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2 The inequality-adjusted HDI (IHDI)
→ The IHDI is published alongside HDI and takes into account how human development is distributed
→ Countries which are very unequal see their human development scores fall more than those that are
less unequal
→ Therefore, the difference between IHDI and HDI represents the ‘loss’ in potential human
development due to inequality
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4 Other indicators
→ These includes:
▪ The proportion of the male population engaged in agriculture
▪ Energy consumption per person
▪ The proportion of the population with access to clean water
▪ Mobile phones per thousand of population
▪ The proportion of the population with internet access

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2 Factors influencing growth and development
→ All countries face constraints on growth and development, but the nature of these constraints vary
greatly between the developed and developing world
→ The developing world faces a number of constraints:
▪ Primary product dependency
▪ Volatility in commodity markets
▪ Level of savings and investment
▪ Foreign exchange gap
▪ Capital flight
▪ Demographic factors
▪ Access to banking and credit
▪ Infrastructure
▪ Education and skills
▪ Absence of property rights
▪ Non-economic factors
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▪ Difficulty of planning investment and output – the price fluctuations cause uncertainty,
which is a deterrent to investment
▪ Natural disasters – extreme weather such as hurricanes, tornadoes, droughts and tsunamis
can cause severe disruption to the production of primary products, especially agricultural
products
▪ Protectionism by developed countries – for example, the huge subsidies given to US cotton
farmers have created great difficulties for Indian cotton farmers, who are unable to
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the EU’s CAP means that there is no free access to European markets for food
from developing countries
▪ Low income elasticity of demand for primary products – the Prebisch-Singer hypothesis
states that the terms of trade between primary products and manufactured goods tend to
deteriorate over time

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1 The Prebisch-Singer hypothesis
→ This theory suggests that countries that export commodities would face a steadily worsening terms
of trade over time
→ Prebisch and singer examined data and found that the terms of trade for primary product exporters
did have a tendency to decline
→ A common explanation for this is as follows:
▪ The income elasticity of demand for manufactured goods is greater than that for primary
products
▪ Where global GDP rises, and incomes therefore rise, the demand for manufactured goods
will rise faster than the demand for primary products
▪ Therefore, the price of manufactured goods will increase at a greater rate than that of
commodities, and primary product exporters will therefore face a worsening terms of trade
→ The theory may be criticised on the following grounds:
▪ Some countries have developed on the basis of their primary products, e
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Botswana and
diamonds
▪ If a developing country has a comparative advantage in a primary product, then its resources
will be used more efficiently by specialising in the production of that product
▪ Primary product prices rose sharply until the middle of 2008 while the prices of many
manufactured goods were falling
→ Some economists argue that, in the special case of food, prices are likely to rise, improving the index
of export prices for food-producing countries
→ In contrast, countries producing and exporting copper, such as Chile, were faced by a 50% fall in
price between 2008 and 2009
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3 Level of savings and investment
→ Many developing countries have a low GDP per capita, and so they hold inadequate savings to
finance the investment necessary to achieve economic growth and development
→ The Harrod-Domar model illustrates this problem
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5 Capital flight
→ This occurs when individuals or companies decide to place cash deposits in foreign banks or buy
shares or other assets in foreign countries
→ This has serious implications:
▪ It contributes to the savings gap and foreign currency gap
▪ It restricts economic growth
▪ It reduces the tax base because the country loses any tax payable on those assets

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7 Access to credit and banking
→ Inability to borrow money is important for entrepreneurs who wish to start up firms, as well as
existing firms who need credit to purchase capital and raw materials
→ In some developing countries, banking services are poor or almost non-efficient
→ However, microfinance schemes have helped to provide extremely poor families with small loans
(microcredit) to help them engage in productive activities or grow their businesses
→ They can help the poor to increase income, build businesses and reduce vulnerability to external
shocks
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9 Education and skills
→ A country whose education standards are poor and where there is a low school enrolment ratio is
likely to experience a slow rate of economic growth
→ This is because the productivity of the workforce will be low
→ It will also act as a deterrent to global companies investing in the country because of the costs
involved in bring in workers for overseas or training and educating domestic workers
→ A particular problem for some countries is the prevalence of HIV/AIDS; when an adult develops AIDS,
they may be forced to give up work, meaning that their children’s school fees can no longer be paid
→ There is a further problem if it is the teachers who contract AIDS, forcing them to give up work, and
AIDS can disrupt the training of workers
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11 Non-economic factors
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1 Corruption
→ Corruption is usually defined as the use of power for personal gain, it may take a variety of forms,
including bribery, extortion and diversion of resources to the governing elite
→ Corruption acts as a constraint on development when it causes an inefficient allocation of resources
4
...
2
...
2 Poor governance
→ Poor governance implies that the rulers of a country have adopted policies that result in the
country’s resources being allocated inefficiently
→ Government failure might also be evident as part of poor governance
4
...
2
...
3 Civil wars
→ Civil wars, such as those that have occurred in Sudan and the Democratic Republic of the Congo,
disrupt growth and development
→ In so far as they actually cause destruction of infrastructure and the death of many people, they
might negate any progress made in previous years
4
...
2
...
4 Political instability
→ This is likely to affect investment into the country, since it results in a considerable degree of
uncertainty, which does not provide a sound basis upon which firms can operate
4
...
2
...
5 Geography
→ Economic development is limited in a land-locked country such as Niger, because geographic
isolation from world markets arises from high transportation costs

4
...
3 Strategies influencing growth and development
→ A range of strategies may be used to promote growth and development but there is no one correct
universal prescription
→ In practice, a combination of strategies are likely to be pursued, but they can be grouped into three
broad categories:
▪ Market-orientated strategies
▪ Interventionist strategies
▪ Other strategies
4
...
3
...
3
...
1
...
3-3
...
93
...
8-8% for lower-skilled workers and
0
...
1% for higher-skilled workers, depending on the country
▪ Increased exports, as all G20 countries would see a boost in exports; in the long-run, many
G20 countries could see their exports rise by 20% and those in the Eurozone by more than
10%
→ On the other hand, trade liberalisation may have drawbacks:
▪ It may negatively affect some industries or some jobs
▪ It has adverse effects on the environment (external costs associated with trade)
▪ It may negatively affect infant industries in developing and emerging economies
4
...
3
...
2 Promotion of FDI
→ Foreign direct investment (FDI) is viewed as being desirable because it acts as an injection in the
circular flow, provides employment opportunities and increases the productive capacity of the
economy
→ Therefore, governments may try to promote FDI in a variety of ways:
▪ Reduction in corporation tax
▪ Tax incentives and grants
▪ Reduction in bureaucracy, e
...
easing of planning regulations
▪ Liberalisation of labour wars, e
...
ease of hiring and firing workers; zero hours contracts
▪ Reducing trade barriers so that it is easier to import components and to export finished
goods
4
...
3
...
3 Removal of government subsidies
→ Subsidies distort the operation of market forces and are likely to result in a misallocation of
resources
→ Governments in India, Egypt and Indonesia have been trying to cut food and energy subsidies
because of their cost and the distorting effects they have on their economies
4
...
3
...
4 Floating exchange rates
→ Allowing the exchange rate of a currency to float might result in a depreciation against other
countries, making the country’s goods and services more internationally competitive
→ This might encourage global companies to invest in that country since the currency is no longer
overvalued

4
...
3
...
5 Microfinance schemes
→ Microfinance is a means of providing extremely poor families with small loans (microcredit) to help
them engage in productive activities or grow their small businesses
→ It can help the poor to increase income, build businesses and reduce vulnerability to external shocks
→ The pioneer of microfinance was Muhammad Yunnus, who established the Grameen Bank in
Bangladesh
→ The key features of microfinance are the following:
▪ Microcredit insists on repayment (in contrast to development aid)
▪ Interest is charged to cover the costs involved
▪ The focus is on groups whose alternative sources of finance are limited to the informal
sector, where the interest charged would be high
→ The main clients of microfinance are:
▪ Women (who form more than 97% of the clients)
▪ The self-employed, often household-based entrepreneurs
▪ Small farmers in rural areas
▪ Small shopkeepers, street vendors and service providers in urban areas
→ Despite some obvious successes, microfinance has been criticised on several grounds:
▪ Concerns have been raised about the repayment rate, collection methods and questionable
accounting practices
▪ On a larger scale, some argue that an overemphasis on microfinance to combat poverty will
lead to a reduction of other assistance to the poor, such as official development assistance
or aid from non-governmental organisations (NGOs)
4
...
3
...
6 Privatisation
→ The sale of publicly owned assets to the private sector through the issue of shares has been a
popular policy in developed economies for many years and has also been adopted in some
developing countries
→ Privatisation is seen as a way of increasing efficiency and productivity as a result of competition and
the profit motive, which are characteristics of the private sector
4
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3
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3
...
2
...
3
...
2
...
g
...
3
...
2
...
3
...
2
...
3
...
2
...
3
...
2
...
3
...
2
...
1 Critique of buffer stock schemes
→ In practice, many problems are associated with these schemes:
▪ If the floor price is set too high, then there will be surpluses every year
▪ Equally, if the ceiling price is set too low, then there may be insufficient stocks available in
years of shortage
▪ The schemes involve considerable costs of storage
▪ Success depends on ensuring that all the major producers agree to be part of the scheme
and that none of them cheats, e
...
by selling to a major consumer at a reduced price
4
...
3
...
3
...
3
...
e
...
3
...
3
...
1 Key features of the Lewis model
→ This model describes the transfer of surplus labour from a low productivity (subsistence) agricultural
sector to a high productivity industrial sector
→ Lewis thought that, because of the excess supply of workers, the marginal productivity (𝑀𝑃) of
agricultural workers might be zero or close to zero – this is based on the law of diminishing returns
→ With 𝑀𝑃 at zero, then the opportunity cost of transferring workers from the agricultural sector to
the industrial sector would be zero
→ Industrialisation will be associated with investment (possibly from global companies), which will
increase productivity and profitability; if profits are reinvested then further growth will occur

→ The share of profits as a percentage of GDP will increase, as will the savings ratio, providing more
funds for investment and continue economic growth
4
...
3
...
1
...
g
...
3
...
3
...
3
...
3
...
1 Advantages associated with the development of tourism
→ It is a valuable source of foreign currency as tourists spend money on goods and services provided
within the local economy
→ Tourism is likely to attract investment by transnational hotel chains
→ In turn, this will increase GDP via the multiplier
→ Jobs will be created, both as a direct result of the investment in the tourist and leisure industries and
also as a result of the multiplier effects within the economy
→ All of the above will help to increase tax revenues for the government, which may be used to
improve public services
→ It can help to preserve the national heritage of the country
→ Improvements in infrastructure may be made (e
...
a transnational company provides new roads as
part of its contract to build hotels)
4
...
3
...
2
...
g
...
g
...
3
...
3
...
e
...
g
...
3
...
3
...
3
...
3
...
1 Advantages of fair trade schemes
→ Producers receive a higher price
→ Extra money is available to spend on education, health, infrastructure, clean water supplies,
conversion to organic farming and other development programmes in the producers’ countries
→ There are smaller price fluctuations, allowing producers to be shielded from market forces
→ The extra money can also be used to improve the quality of products
→ Producers are enabled to diversify into other products
4
...
3
...
4
...
g
...
3
...
4 Aid
→ The term ‘aid’ is used to describe the voluntary transfer of resources from one country to another or
loans given on concessionary terms, i
...
at less than the market rate of interest
→ Official development assistance refers specifically to aid provided by governments and it excludes
aid given by voluntary agencies

→ Aid may also be given for emergency relief, e
...
in response to natural disasters or to support
refugees fleeing a civil war
→ This kind of aid is not usually contentious and so the focus here is on aid given for more general,
development-focused purposes
→ The UN goal for the amount of aid offered by developed countries (agreed in 1970) in 0
...
g
...
g
...
e
...
g
...
g
...
3
...
5 Debt relief
→ The burden of debt bears heavily on some countries, e
...
the Gambia, Mali, Nicaragua, Bolivia and
Malawi
→ The debt is often owed to a combination of the IMF, the World Bank, governments and banks in
developed countries
→ The problem is that servicing the debt may account for a disproportionate amount of public
expenditure, to the extent where resources available for health and education are severely limited –
as a result, there is pressure to cancel the debts of the poorest countries

→ The World Bank provides debt relief through the Heavily Indebted Poor Countries (HIPC) initiative
and the Multilateral Debt Relief Initiative (MDRI)
→ The HIPC initiative was started in 1996 by the IMF and World Bank with the aim of reducing the
external debts of the poorest and most heavily indebted countries of the world to sustainable levels
→ Changes were made in 1999 to make the process quicker and strengthen the links between debt
relief poverty reduction and social policies
→ In 2005, the HIPC initiative was enhanced by the MDRI in order to speed up progress towards the
Millenium Development Goals (MDGs)
→ 41 countries were identified as being eligible for HIPC initiative assistance and by the end of 2015, 36
countries had benefited from such relief
4
...
3
...
1 Arguments for debt relief
→ Developing countries would have more foreign currency with which to buy imported capital and
consumer goods from developed countries, closing the foreign exchange gap
→ To the extent that the money released from debt cancellation is used for the purchase of capital
goods, there is the potential for improved productive capacity in future
→ In turn, this means that developing countries would be able to buy more goods from richer countries
in future, improving export-led growth in the developed world
→ It would help to reduce absolute poverty
→ It would help to reduce both the savings gap and the foreign exchange gap
→ It might help to conserve the environment, e
...
‘debt for nature swaps’
4
...
3
...
2 Arguments against the cancellation of debt
→ In comparison with aid, it is likely to take much longer to agree a debt cancellation programme
→ Unless conditions are attached to debt cancellation, there is no guarantee that the governments of
these countries will pursue sound macroeconomic policies, i
...
there is a moral hazard problem
→ Corruption might mean that the benefits of debt cancellation are channelled to government officials
rather than to the poor
→ Shareholders of banks in the developed world may bear some of the burden of debt cancellation
→ It may be much less effective than the introduction of policies to reduce protectionism in developed
countries
4
...
3
...
3
...
6
...
g
...
3
...
6
...
3
...
6
...
1 The future of the World Bank and the IMF
→ The roles of the IMF and the World Bank are currently blurred: both have a role in the developing
world and in poverty reduction
→ It is suggested that both the IMF and the World Bank should be reformed to reflect the changing
needs of the global economy
→ Critics of the institutions as they currently operate suggest the following:
▪ The IMF should be slimmed down and should undertake short-term lending to crisis-hit
countries
▪ The World Bank should act as a development agency and undertake a detailed appraisal of
the creditworthiness of recipient countries
4
...
3
...
3 NGOs
→ The work of non-governmental organisations (NGOs) has brought community-based development to
the forefront of strategies to promote growth and development
→ The focus has moved away from centralised state-managed schemes

→ They key characteristics of these community-based schemes are:
▪ Local control of small-scale projects
▪ Self-reliance
▪ Emphasis on using the skills available
▪ Environmental sustainability

4
...
4
...
4
...
1 To facilitate saving
→ A traditional role of banks and other financial institutions, e
...
insurance companies and pension
funds, is to provide facilities for individuals and firms to save
→ This therefore enables them to spend at a later date
4
...
1
...
4
...
3 To facilitate exchange
→ Transfers of money can be arranged easily when there is a fully developed banking and financial
sector
→ With the growth of online banking and smart debit cards, most such transfers now occur
electronically
4
...
1
...
4
...
5 To provide a market for equities
→ Stock exchanges enable stocks and shares to be traded
→ This enables companies to raise money and provides an opportunity for investors to purchase shares

4
...
2 Market failure in the financial sector
4
...
2
...
4
...
2 Externalities
→ Failures of financial institutions have undesirable spillover effects (external costs) on third parties
who are not directly involved in the financial sector
→ For example, the failure of a bank might result in bankruptcies for other businesses if the bank
customers lose their deposits and can no longer pay bills to other businesses, or if the bank failure
results in a fall in sales of other businesses
4
...
2
...
4
...
4 Speculation and market bubbles
→ Between 2000 and 2007, UK banks created £1 billion, doubling the amount of money and debt in the
economy, but only 8% of this went to businesses
→ Over half went to residential and commercial property and 32% went to the financial sector
→ This extra money in the economy helped to feed bubbles in the property market and eventually
debts related to these bubbles became unpayable
4
...
2
...
5 billion for rigging Libor
and was ordered to sack seven employees
→ Also, Barclays was fined £1
...
4
...
4
...
1 Implementation of monetary policy
→ Central banks are usually responsible for controlling the cost and supply of money
→ In this role they set interest rates, and are responsible for asset purchases (quantitative easing) and
sales
→ Many central banks are now interdependent of their government but may be required to make such
decisions in relation to an inflation target
4
...
3
...
4
...
3 Banker to the banks
→ Central banks provide banking facilities to the high street banks
→ In the UK, all banks must keep an account with the Bank of England
4
...
3
...
5 THE ROLE OF THE STATE IN THE MACROECONOMY
4
...
1 Public finance
→ Public finance is composed of three wings: public expenditure, taxation and public sector borrowing

→ Public expenditure is composed of the following:
▪ Current expenditure
▪ Capital expenditure
▪ Transfer payments
→ Taxation is composed of the following:
▪ Direct taxation
▪ Indirect taxation
→ Public sector borrowing is composed of the following:
▪ Fiscal (budget) deficit
▪ National debt

4
...
2 Public expenditure
→ Expenditure by central and local government can be categorised into three distinct categories:
▪ Capital expenditure
▪ Current expenditure
▪ Transfer payments
4
...
2
...
5
...
1
...
g
...
5
...
1
...
g
...
5
...
1
...
5
...
2 Reasons for the changing size and composition of public expenditure
→ Factors influencing the size and pattern of public expenditure include the following:
▪ The level of GDP
▪ The size and age distribution of the population
▪ Political priorities
▪ Redistribution of income
▪ Discretionary fiscal policy
▪ Debt interest
4
...
2
...
1 The level of GDP
→ As incomes increase, so do expectations, and the demand for many government provided services
such as health and education rises more than proportionately
→ Demand for public services is therefore income elastic

4
...
2
...
2 The size and age distribution of the population
→ An increase in the size of the population (e
...
through immigration) is likely to place extra pressure
on public services
→ An ageing population will increase demand for medical services and social services for the elderly
4
...
2
...
3 Political priorities
→ A government in a developed country might place particularly emphasis on improving the quality of
health and education services
→ The priority of a government in a developing country might be to improve infrastructure
4
...
2
...
4 Redistribution of income
→ Expenditure on those in relative poverty and on those with disabilities increased significantly in many
countries before the 2008 financial crisis
→ However, subsequent austerity measures aimed at reducing deficits have ed to cuts in means-tested
benefits such as tax credits and housing benefits, resulting in an increase in relative poverty
4
...
2
...
5 Discretionary fiscal policy
→ The 2008 financial crisis led to the resurrection of fiscal policy as a means of macroeconomic
management in many countries, although often temporarily
4
...
2
...
6 Debt interest
→ The massive increase in fiscal deficits from 2008 is leading to sharp rises in national debts in many
countries
→ For example, Greece’s national debt as a proportion of GDP increased from 125% in 2009 to 180% in
2015
→ In turn, this results in higher interest payments so that less money is available for public services
once the debt has been serviced
4
...
2
...
5
...
3
...
5
...
3
...
5
...
3
...
5
...
3
...
5
...
3
...
5
...
5
...
1 Distinction between progressive, proportional and regressive taxes
→ There are three broad categories of tax:
▪ Progressive tax
▪ Regressive tax
▪ Proportional tax
4
...
3
...
1 Progressive tax
→ This is a tax in which the proportion of income paid in tax rises as income increases
→ Therefore, there are likely to be several tax bands, e
...
10%, 20% and 45%, so that as incomes
increases beyond a certain limit, any further income is taxed at a higher rate
4
...
3
...
2 Proportional tax
→ This is a tax in which the proportion of income paid in tax remains constant as income increases
→ For example, some countries, e
...
Latvia, Estonia and Hong Kong, have a flat rate of income tax
4
...
3
...
3 Regressive tax
→ This is a tax in which the proportion of income paid in tax falls as income increases
→ Although governments do not deliberately set regressive taxes, some taxes have a regressive effect,
most typically those on expenditure
4
...
3
...
e
...
5
...
3

legally imposed, therefore the
burden of the tax cannot be
shifted to any other person or
corporation

Income tax, capital gains tax,
corporation tax
The economic effects of changes in direct tax rates

part from the person on whom
it is imposed to a third party,
e
...
a business may be legally
responsible for paying VAT but
part or all of the burden may
be passed on to consumers, as
discussed in Theme 1
Value added tax (VAT), excise
duties, tariffs

4
...
3
...
1 Incentives to work
→ An increase in tax rates might have significant disincentive effects
→ For example, if the basic rate of income tax were raised, there would be less incentive for the
unemployed or those not currently participating in the workforce to accept jobs
→ Similarly, if the higher rate of tax were increased, then people might be less willing to do overtime
and more inclined to reduce their working hours, retire early or not seek promotion
4
...
3
...
2 Tax revenues
→ Some economists consider that if tax rates are increased too much, tax revenues may actually fall
because the disincentives to work are so great
→ If the higher rate if income tax is increased then there is also likely to be an increase in legal tax
avoidance and illegal tax evasion, and a rise in the number of tax exiles
→ The Laffer curve shows that if the tax rate is increased sufficiently far, then tax revenues will reach a
maximum point and will from there begin to decline
4
...
3
...
3 Income distribution
→ Most countries have a progressive income tax system so that the proportion of income paid in tax
increases as income increases
→ Consequently, income tax makes income distribution more equitable
4
...
3
...
4 Real output and employment
→ An increase in income tax rates would cause a fall in disposable income, which would cause a
reduction in consumption and therefore aggregate demand
→ It may also be argued that the disincentive effects of higher income tax would cause a leftward shift
in the aggregate supply curve
→ Both of these would, therefore, cause a fall in real output and an increase in unemployment
4
...
3
...
5 The price level
→ The fall in aggregate demand would tend to depress the price level, although this may be offset
slightly by a leftward shift in the aggregate supply curve
4
...
3
...
6 The trade balance
→ An increase in income tax rates would cause a fall in disposable income
→ In turn, this would cause a reduction in consumption and therefore a fall in imports
→ This would result in an improvement in the trade balance
4
...
3
...
7 FDI flows
→ Higher income tax rates might act as a deterrent to FDI because entrepreneurs and senior managers
from the global company would face a decrease in their disposable incomes, assuming they would
be based in the country for which the FDI was destined

4
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3
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5
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4
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5
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4
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5
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4
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e
...
5
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4
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5
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4
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5
...
4
...
5
...
4
...
5
...
4
...
5
...
5 Public sector finances
4
...
3
...
1 Distinction between automatic stabilisers and discretionary fiscal policy
→ Fiscal policy refers to the use of government expenditure and taxation in order to influence the level
of economic activity in a country

→ From the 1980s until 2008, its primary role was to ensure stable public finances
→ However, since 2008 it has once again assumed a role in macroeconomic management not only in
the UK but also in China, the USA and a variety of other countries
→ Key features of fiscal policy include the following:
▪ Automatic stabilisers – some forms of government expenditure and taxation change
automatically in line with GDP and the state of the economy
▪ Discretionary fiscal policy – deliberate changes in taxes and public expenditure designed to
achieve the government’s macroeconomic objectives
4
...
3
...
2 Distinction between a fiscal deficit and a national debt
→ A fiscal (budget) deficit occurs when public expenditure (both current and capital) is greater than tax
revenues
→ Public sector net borrowing is the official term used to describe a fiscal deficit
→ The national debt or public sector net debt is the cumulative total of past government borrowing
4
...
3
...
3 Distinction between structural and cyclical deficits
→ The ‘structural’ fiscal deficit is an estimate of how large the deficit would be if the economy were
operating at a normal sustainable level of employment and activity
→ However, it is difficult to estimate exactly what this ‘normal’ level would be
→ The ‘cyclical’ fiscal deficit is that part of the fiscal deficit associated with recession
4
...
3
...
4 Factors influencing the size of fiscal deficits
→ Factors influencing the size of fiscal deficits include the following:
▪ GDP – during a recession, real GDP will be falling, and in turn public expenditure on
automatic stabilisers will be rising while tax revenues will be falling, leading to an increasing
fiscal deficit
▪ The size and age distribution of the population – an increase in the size of the population is
likely to mean an increase in public expenditure on health, education and infrastructure
▪ Discretionary fiscal policy – the 2008 financial crisis led to the resurrection of fiscal policy as
a means of managing the economy in several countries; in July 2015, South Korea pumped
$10 billion into its economy to offset falling exports and an outbreak of Middle East
respiratory syndrome (MERS)
▪ Debt interest – the massive increase in fiscal deficits from 2008 in the UK and many
developed economies led to sharp rises in these countries’ national debts, resulting in higher
interest payments on the national debt
4
...
3
...
5 Factors influencing the size of national debts
→ The national debt of an economy would be affected by the following:
▪ Fiscal deficits or fiscal surpluses – if a country had persistent fiscal deficits then the national
debt would be increasing, whereas if there were persistent surpluses then the size of its
national debt is likely to fall
▪ Fiscal deficits might be caused by recessions – this could result in automatic stabilisers, i
...

government expenditure on means-tested benefits would increase, whereas tax receipts
would fall; further, fiscal deficits might arise because of aging populations, which result in
increased expenditure on state pensions, healthcare and social care

4
...
3
...
6 The significance of the size of fiscal deficits and national debts
→ Some argue that, if the money is being used to finance improvements in infrastructure and other
capital projects, then a large national debt might be justified because it would increasing a country’s
future productive capacity, making it easier to repay in the future
→ However, certain problems may arise:
▪ There is an opportunity cost for future generations, since servicing the national debt means
that less money will be available for public services
▪ Crowding out, especially financial crowding out
▪ Danger of inflation – if the rising national debt has been caused by successive fiscal deficits
then there is a danger that inflationary pressures will develop, since injections will be rising
relative to leakages
→ In the long-run, future governments might be forced to raise taxes and/or cut public spending in
order to service the national debt

4
...
4 Macroeconomic policies in a global context
4
...
4
...
5
...
1
...
5
...
1
...
g
...
g
...
5
...
1
...
5
...
1
...
g
...
5
...
2

Use and impact of macroeconomic policies to respond to external shocks to the global economy

4
...
4
...
1 Characteristics of external shocks
→ External shocks to the global economy may take a variety of forms:
▪ A sudden increase in oil prices
▪ A severe weather event such as a tsunami which has implications for the global economy or
a long-lasting drought affecting crops across the world
▪ A major financial crisis which has repercussions for the global banking system
▪ Wars and civil unrest which disrupt transport links
▪ Cyber-attacks which have implications for communications globally
4
...
4
...
2 Policy responses
→ The policy response will vary according to the situation and the priorities of policy-makers
→ In the 2008 financial crisis, there was a coordinated monetary policy response, which meant that
many central banks slashed their base rate of interest
→ In the UK, the base rate was cut to 0
...
25% in August 2016
→ In addition, many governments adopted a fiscal stimulus involving cuts in taxes and increases in
public expenditure – these measures aimed to prevent a 1930s-style depression
4
...
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5
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3
...
5
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3
...
e
...
g
...
5
...
4 Problems facing policymakers when applying policies
4
...
4
...
1 Inaccurate information
→ Information regarding GDP, the balance of payments on current account and retail sales in
notoriously inaccurate and subject to subsequent revisions
→ This can make it very difficult for policymakers to provide appropriate policies, since they may be
working with faulty data
4
...
4
...
2 Risks and uncertainties
→ Some commentators consider that the financial crisis has had long-term repercussions for savings
and investment – such uncertainties make it more difficult for policymakers to formulate policy
→ There is considerable uncertainty about the possible long-run impact of QE in the Eurozone; some
monetarist economists argue that it could risk unleashing a massive bout of inflation, while others
claim that previous experience in other countries suggests that it will have little effect on the
economy
4
...
4
...
3 Inability to control external shocks
→ Policymakers are usually unable to predict external shocks or their potential consequences
→ As a result, it may be difficult for them to formulate appropriate policy responses
→ Such external shocks could include a sudden and dramatic increase in oil and commodity prices, the
exist of a country from the Eurozone, or political conflict



---