2. The examination for this unit is based on pre-released material In July 2011 the material concerns the problems of the PIIGS The exam lasts for 2 hours and there are 60 marks available This gives roughly 2 minutes per mark - don’t spend lots of time on low mark questions All questions are compulsory The mark allocation for the individual questions on the paper are as follows 1(a) 4 marks 1(b) 6 marks 1(c) 10 marks 2(a) 4 marks 2(b) 6 marks 2(c) 10 marks 3 20 marks
3. With most exam boards The following are required to achieve a particular grade: Grade A* - 90% = 72 marks Grade A - 80% = 64 marks Grade B - 70% = 56 marks Grade C - 60% = 48 marks Grade D - 50% = 40 marks Grade E - 40% = 32 marks
4. The pre-release material has 4 extracts: Extract 1: Recession in the euro area economies 2008 – 2009 Extract 2: Portugal, Italy, Ireland, Greece and Spain – the PIIGS Extract 3: The future of the Spanish economy Extract 4: International trade, international trade negotiations and developing economies A few general observations to assist examiners around my age Write clearly and use black ink – Economics examiners are elderly and myopic Never attempt to correct a diagram – clearly cross it out and draw it again Draw diagrams neatly and large (you are not paying for the paper) Always use a ruler/your debit card – it gives a better impression to the examiner Questions will be drawn from all areas and you must be prepared using your knowledge gained from the course to answer them
5. With essay type questions there are 5 levels The paper is synoptic: This means that you can be tested on anything you have done in economics Level 4 (a) 16-20 marks – requires excellent analysis, evaluation and includes a final paragraph giving a judgement on the question asked Level 4 (b) 11-15 marks - a balanced discussion of the question but without the level of evaluation & final judgement shown in 4(a) Level 3 5-10 marks – some analysis but is likely to be weak and one sided Level 2 3-4 marks – some application of knowledge and understanding of the question but lacking economic analysis Level 1 1-2 marks - For limited knowledge and understanding
6. The level achieved and the mark obtained within the level is determined by the quality of the answer as judged against 4 criteria Markers are required to identify these criteria as they occur in the response Criteria Knowledge and Understanding (K) – of concepts, appropriate economic terminology, definitions and theories relevant to the Q Application (Ap) –applying the data given in the texts to the economic theories, terminology, concepts relevant to the question Application (Ap) in the essay Qs involves making reference to the experience of the UK, EU or world economies Remember in the global paper you are supposed to have a knowledge of UK economic experience and performance over the past 10 years Analysis (An) – this is where you build up your argument, explaining and developing your theories and arguments and proving a logical chain of reasoning leading to your conclusion Diagrams and any formula constitute analysis
7. Judgement/Evaluation (E) – here, you will look at alternative points of view or consider occasions/circumstances in which there may be different outcomes In your evaluation you should make extensive use of words/phrases such as “as compared to”, “whereas”, “however”, “on the other hand” Make comparisons explicit not implicit – an evaluative statement E.g. “Whilst on the one hand UK membership of the Euro would reduce the risk to UK importers and exporters of exchange rate fluctuations it would mean that the UK would lose the valuable ability to control the domestic economy through adjustments to interest rates”
8. To score a high mark – Levels 4 and Answer the question set, not the question you wish had been set All 4 criteria must be addressed to some extent Good An and E applied to the Q and making use of the data provided is essential & you need to spend most time on questions that reward thi Failure to provide evaluation/judgement will reduce your marks Make extensive use of diagrams throughout – these will score high on An and enable you to present theories clearly and concisely If in doubt of the relevance of a diagram put it in – you will not lose anything Examiners use the phrase “evaluative tone” which applies to the overall presentation of an answer It is better to provide E throughout your response (using the key words and phrases), rather than attempt all your E at the end
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10. How to apply the criteria Assume the following question: The Extract (lines 35-36) argues that 'a more ambitious set of common macro-economic policies would help speed recovery in the Eurozone'. Using the data and your economic knowledge, assess the impact on the UK economy of recovery in the Eurozone as a whole. (25 marks) “ Macro economic policies are designed to...” (explain that they are designed to stabilise and increase GDP in the economy) (K) “ Recovery would mean closing the negative output gap..” (K) “ As Extract A indicates current macro policies have led to slower rates of growth” (Ap) (Analysis could take many forms, e.g)
11. The implications for economic growth The impact on employment/unemployment – possible diagram to cover 1 st two points The consequences for the balance of payments on current account The effects on the £/€ exchange rate The greater likelihood of avoiding a period of deflation The dangers of inflationary pressures building up The further development of the SEM in a period of recovery and increasing prosperity
12. Evaluation could come in the form of: The possible significance of a slow recovery – could mention PIIGS at this stage The possible supply problems if recovery is too rapid Whether the UK can take advantage of EU recovery Whether the advantage lies more with the rest of the EU in terms of exporting to the UK than for the UK exporting to the rest of the EU The significance of EU recovery for the UK relative to recovery taking place elsewhere in the world, i.e. in markets which have significance for the UK Whether or not recovery has implications for the movement of labour in and out of the UK and how this affects the UK labour market Now provide a final conclusion/judgement which could be along the lines of: Whether increased economic activity in the eurozone would or would not have A beneficial or negative effect
14. Recession in the Euro area economies Introduction Key terms: Recession – 2 quarters ( 6 months) of negative growth – a diagram opportunity is presented GDP 0 Time Trend Actual A Z X
15. Convergence in economic cycles The lack of convergence of economic cycles means that countries in the Euro Area were not at the same stages of their business cycle - Boom Slowdown Recession Recovery The problem faced by the European central bank – setting the Rate of interest (ROI) This lack of convergence really gets to the heart of the problem of the PIIGS GDP 0 Time Convergence Spain Germany Needs increasing ROI Needs falling ROI A
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17. Real convergence indicators: Trend growth rate of GDP Labour market - structural unemployment - NAIRU Growth of labour productivity – i.e. output per person employed Trade balances - share of GDP taken up by trade Capital investment as a share of GDP Housing market - rates of home ownership and the size of the rented property sector Cost/price competitiveness - index of relative unit labour costs in manufacturing industry and annual changes in output prices Importance of convergence Necessary to occur if the Eurozone is to be a optimal currency area (OCA) A key point to consider here in any judgement is could the PIIGS have created convergence by following deflationary policies or would it have been politically impossible? A case of government failure?
18. While not specifically mentioned in the specification the theory of an Optimal Currency Area provides and analytical frame work through which to view the PIIGS Remember you will not be penalised by examiners for having extra knowledge and understanding – just a lack of it What is a OCA? The following may help you to grasp the essentials: A geographical region in which it would maximize economic efficiency to have the entire region share a single currency - where the benefits of a single currency outweigh the disadvantages Assume Wales experiences an asymmetric shock (coal mines close down) Causes recession in Welsh economy - ↑ unemployment ↓ inflation As a separate entity Wales would ↓ ROI and depreciate its currency But in reality unemployed Welsh workers can move to Midlands or London
19. UK firms can invest in Wales to take advantage of lower labour costs and surplus labour There are not many geographical barriers to moving between areas within the UK. Now assume asymmetric shock in Greece: More difficult for Greek workers to move to Germany language barriers attachment to native country poor information regarding job availability etc German firms would have much more reluctance to invest in Greece due to language difficulties and poor perception of the Greek work ethic and inappropriate fiscal policies So there may be a difference between the UK and EU as a OCR as indicated below
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21. 2. Openness Capital mobility and price and wage flexibility across the region Market forces automatically distribute money and goods to where they are needed Does not work perfectly as there is no true wage flexibility in the Eurozone 3. Automatic fiscal transfer mechanism To redistribute money to areas/sectors which have been adversely affected Usually takes the form of taxation redistribution Politically difficult to implement - better-off regions rarely give up their revenue easily Current EU arrangements ad-hoc and not built in
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23. The OCR theory prompts the following question How far do you agree with the view that countries that are not economically convergent should not be allowed inside the single currency area? 20 marks Plan an answer A currency union works best with a small cluster of highly integrated and similar countries The reasons for keeping them out The PIIGS have not exercised the same budgetary controls During boom times they have run up huge fiscal deficits This has caused a loss of confidence among investors and speculators in international bond markets PIIGS have seen the interest rates they pay on their loans rise sharply Greece can no loner afford to borrow on the bond markets PIIGS are now forced to borrow form more fiscally prudent states & the IMF Why should they be allowed to join Met initial criteria Not totally their fault – German economy saves rather than spends – limited national trade multiplier effect European Commission should have exercised more oversight Given the right policies convergence could occur
24. Your evaluation could be along the lines of How far the problem caused by the PIIGS is likely to affect support for the Euro Whether exit from the zone would benefit the PIIGS or other members Whether given current conditions there currencies can converge These problems faced by the PIIGS have given rise to the concept of a 2 speed Euro area You need to be conversant with this idea
25. A two speed Euro area - Variation in the average growth rates achieved by countries inside the currency union Some suffering years of slower growth & high unemployment & ↓ living standards PIIGS likely to continue to experience difficulties in ↓ fiscal deficits & ↓ increase in government debt Why is this a problem for monetary union: ↓ standard of living in under-performing Euro Area countries High and rising unemployment Recession = ↓ tax revenues & huge ↑ budget deficits as a share of national income Sovereign debt crisis - emergency bail-outs from IMF & EU members Deflationary conditions attached to the emergency financial support
26. Brings about reductions in living standards for millions of people in these countries ↓ in public support for the Euro - threat to stability of the single currency system No discussion of recession is complete without a consideration of the shape that it may take The most outrageous example was probably given by the cartoonist in the mail who referred to “the dead cat bounce” I shall limit my discussion to the idea of the “double dip” The situation where an economy goes back into recession without achieving trend growth
27. AD ↑ from AD- to AD1 and rises to FE level at AD but falls back to AD1 With the aid of a diagram explain the possible causes of a double dip recession Price level 0 AS FE AD AD1 X AD- Z Real output
28. Possible causes of a double dip: Another external economic shock – collapse in major overseas export markets ↓ consumer confidence – so ↓ consumption – unemployment; ↑ debt; ↓ house prices ↓ business confidence – negative expectations - production cut-backs; ↓ investment ↑ exchange rate - ↓ international competitiveness – ↑ Euro against the US dollar Govt. policy - e.g. tightening of policy too soon - ↑ ROI or ↓ fiscal stimulus - Japan Inability to borrow – pressure from Bond markets forcing expenditure cut
29. At this stage of the proceedings it may be as well to remind ourselves of the stages of integration in an endeavour to decide whether monetary union is a step too far Knowledge of this area should assist with both analysis and evaluation It also contains a number of diagrams that are extremely relevant
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34. Trade Creation ↑ in trade due to ↓/elimination of tariffs and quotas 0 Price W1 Domestic demand Domestic supply W Price + tariff Price minus tariff E B A C Quantity W1 – price before joining – Demand OA supply OB W price after joining – Demand ↑ to OC supply ↓ to OE Trade creation EB + AC Before I go any further make sure you can explain the important areas on the diagram
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36. Trade diversion ↑ in prices as producers in common market less efficient 0 Price Domestic demand Domestic supply E B A C Quantity EU price World price At world price demand OA and supply OB Price ↑ demand ↓ to OC supply ↑ to OE Explanation of the effects will complement the diagram and increase the marks
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38. Transfers of resources: Contributions may be spent on an area that does not directly benefit the contributor e.g. the UK and the common agricultural policy Net transfer of resources = static losses and gains Dynamic economies - attract inflows of capital and labour making them more dynamic Customs unions - not as efficient as world wide free trade Single market - negative impact on some sectors due to ↑ international competition Your job in a question would be to decide whether the benefits outweigh the disadvantages
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40. There are a number of areas that you can analyse and evaluate Free trade area: All members abolish tariffs with other members Trade between the members would flourish – benefits of EOS, MES, specialisation comparative advantage – trade creation diagram could be drawn All members individually free to set external tariff with non-members Countries could impose tariffs against external countries where trade diversion was taking place Possible danger of trade deflection but remedied by rules of origin No loss of monetary control Central bank free to set optimum ROI for the country Enables currency to float in accordance with market forces
41. Monetary union – a single market with a common currency Advantages Price transparency -make price comparison easier may lead to ↓ prices ↑ FDI due to ↑ currency stability & increased potential market size Potentially ↓ ROI, ↓ Govt interference, credible commitment to low inflation But : Loss of an independent monetary policy Inability to choose a different short term inflation/unemployment trade off Inability to react to country specific economic shocks 'Real' misalignment Asymmetric policy sensitivity
42. Evaluation PIIGS could have made it work using appropriate fiscal policies Given that its an un-optimal currency area – can it work? Deficit countries likely to struggle along with grudging help from surplus countries Would an independent monetary policy solve their problems Lets look at the PIIGS problems in more detail
43. The potential costs of a Single currency to the PIIGS Loss of an independent monetary policy Members pass control of monetary policy to the European Central Bank ECB would set ROI for area as whole rather than for any one country within the EMU This has several implications:
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45. Normally increased inflation would lead to a depreciation of the currency But in the Euro Area, a country with a relatively high rate of inflation cannot expect a depreciation of their exchange rate to restore lost competitiveness The PIIGS should have run a deflationary fiscal policy when AD was ↑ too rapidly They will have to achieve this in other ways such as a better supply-side of the economy or lower wages Part of their decline in competitiveness stems from these economies having a ‘fixed’ exchange rate against other members of the euro area. If the PIIGS had their own currency, they could let the value fall to a level that would make the country's tradable goods sectors competitive. Evaluate the view that PIIGS economic performance would improve by a currency devaluation and leaving the Euro Area (20) What issues could be considered and analysed in answer to this question Need to reduce wage costs to compete with Germany Rather than facing trade union anger over continuous wage deflation devaluation might be preferable
46. Price of $’s in Euros D & S of $’s Demand for $ Supply of $’s 1 D1 for $’s S1 of $’s 2 0 Equilibrium where $1 = €1 ↑ price of UK goods ->↓ US demand and ↓ supply of $’s – S-S1 PIIGS import more of the relatively cheaper US goods - demand for $’s ↑ - D-D1 ↓ supply of $’s and ↑ in demand ->↑ in the price of $s The overall effect of these changes is that the dollar has appreciated to $1 = €2. How inflation would depreciate the value of a currency
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48. Fig 12 - The J-Curve Following devaluation the account will get worse before it gets better Takes time for foreign buyers to realise PIIGS goods are cheaper and ↑ expenditure Long term contracts fix prices Short run - volume of exports remain the same and less will be spent on them More will be spent on imports until consumers find substitutes The short run demand for exports and imports will tend to be inelastic 0 BOP + BOP - Time J
49. 2. Other policy options by using supply side measures – outlined later Second part of question – leaving the Euro area Advantages Regain monetary independence Avoid years of grinding wage deflation to reduce unit labour costs Bring wage costs into line with workers productivity But: Euro took years to introduce PIIGS central banks would have to introduce new notes and coin FAST Bank runs as depositors shift money abroad to avoid losses – caps on withdrawal Cut off from foreign credit – banks would be reluctant to lend until currency stable Legal challenges – depositors with large losses might sue as in Argentina Foreign banks and pension funds would suffer effective default
50. Evaluation/judgement Will the depreciation set off inflationary pressures that PIIGS are unable or unwilling to contain or will there be a rising inflationary spiral given the power of trade unions Will the increased inflation wipe out the benefits of the initial depreciation Will the country be likely to increase welfare benefits as imported food prices increase Long run versus short run – how long will it take for the J curve effect to produce a surplus balance Are all the PIIGS able to benefit from increased international trade as opposed to the loss of intra community trade that they will suffer? Would costs of leaving Euro be greater than benefits
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53. ↑ labour costs and output prices are likely to create cost push inflation SRAS shifted left leading to a higher level of prices and a lower level of output Possibly shifting the economy to a negative output gap - ↑unemployment & ↓GDP Cost push inflation Supply side pressure Price level Real output P 0 AD P1 A B SRAS SRAS1
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56. Effect on incentives to actively search for work ↑ voluntary unemployment – make sure you know what this is ↑ frictional unemployment – don’t need to take first job to come along ↑ structural unemployment – no rush to retrain or move to where jobs are Social consequences of ↑ unemployment Estimated 40% of under 25’s 20% of working population ↑ relative poverty if no wage earner ↑ social unrest - loss of social cohesion damaging the fabric of society ↑ in unemployment-related crime ↑ stress related health problems and family breakdown ↑ social costs of rising level of debt – hits poor high rates Failure of labour market = ↑ negative externalities
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58. Large budget deficits incurred by the PIIGS have increased their economic problems Evaluate the view that governments should always balance their budgets Explanation of term budget balance and the stance a government might take: Neutral fiscal stance is where the government runs a balanced budget Expansionary fiscal policy government uses a budget deficit (G>T) to ↑ AD Contractionary/deflationary fiscal policy - budget surplus (G<T) to ↓AD Influencing the level of AD in the economy is referred to as demand management Governments do this to smooth out fluctuations in the economic cycle Automatic stabilisers – the cyclical deficit
59. Auto stabilisers should balance out over the duration of the cycle Spain - large welfare state, big public sector as % total GDP automatic stabilisers have ↓ impact of the recession on her GDP GDP Time Trend Actual Govt,Y from tax increasing Govt. expenditure on benefits falling = Cyclical surplus Govt Y from tax decreasing Govt. expenditure on benefits increasing Cyclical deficit 0
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62. Auto stabilisers take AD- to AD Fiscal stimulus required to get from AD to AD1 If government has a large structural deficit may not be able to afford the stimulus Govts. that ↑ the structural deficit in times of boom are risking problems when the economy contracts Price level Real output AS AD- AD FE AD1 0
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64. Evaluation points: Will a cyclical deficits/surpluses balance over the period of the cycle Risk that governments will ↑ handouts in good times leading to ↑ structural deficits Re- election may be more important than sound economic policy – govt. failure Possible damage to supply side of the economy of increasing benefits Opportunity costs of increasing PSNCR Problems with Bond markets and increasing national debt Will deficit benefit the supply side or just increase AD Short run effects versus long run effects Perhaps a final judgement that the deficit has helped prevent a worse depression but has left PIIGS with huge deficits to manage
65. Spain has had to introduce a period of fiscal austerity to ↓ their budget deficit Retirement age has risen to 67 from 65 ↓ government spending - wage cuts for civil servants and frozen welfare payments make it easier to lay off employees and reduce redundancy packages. Spain urgently needs to increase its LRAS – its trend growth rate This means labour market reforms to improve efficiency of factor markets Product market reforms – where there is a lack of competition & contestability Aims of supply-side policies ↑ supply and efficiency of labour ↑ skills of the labour force – investment in human capital ↑ mobility of labour – geographical & occupational Remove barriers that stop wages reaching equilibrium levels – reduce TU powe Encourage flexible working practices What are the policies 1. Labour market measures: Lower rates of income tax - create incentives to work
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67. ↓ benefit payments to make voluntary unemployment less affordable Welfare benefits can also be made more difficult to claim Tax relief on Y from renting out accommodation - ↑geographical mobility Welfare to work strategy to ↑ levels of employment and participation National Minimum Wage to ↑ incentives to supply labour rather than live off benefits 2. Education and training To increasing the productivity of labour Should ↑ LRAS & ↓. unit labour cost per unit of output ↑ international competitiveness. 3. Trade union reforms TU’s –↑ the wages of their members by restricting the supply of workers ↑ labour costs ↓ efficiency & market flexibility ↓ international competitiveness 4. Reform employment laws ↓ govt. regulation of labour market to lower non-wage costs of employing workers Encourage short term contracts and part time labour Encourage profit related pay Encourage employee share ownership
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69. 6. Measures to encourage entrepreneurship and capital spending: Loan guarantees for new start-ups Reducing rates of corporation tax for small businesses Allowing tax relief on profits used for investment purposes Regional policy assistance in depressed areas 7. Policies to encourage enterprise ↓ taxation & govt. spending ↓ corporation tax to increase investment Incentives to encourage FDI Encouraging business start ups
70. Consequences of policies Boost long term growth ↑ prosperity in long run Helps to achieve all macro-economic objectives simultaneously ↑ employment ↓ cost push inflation by increasing efficiency ↑ international competitiveness We can show the effects of these policies diagrammatically but remember they take time to have an effect
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72. An alternative diagram ↑ AD from AD to AD1 ↑ inflation PL to PL1 A supply side increase allows ↑ real output with lower prices PL- Price level Real output AS FE AD- AD AD1 AS1 PL PL1 PL- Fe1 0
73. In a rapidly-changing world there needs to be a high level of flexibility as patterns of demand change bringing about changes in the pattern of employment Analyse the determinants of a flexible labour market – 6 marks Labour market flexibility ↓ natural rate as labour moves from declining industries to growing industries Labour markets need to - adapt to change, respond to economic signals created by wage differentials Flexible labour market characterised by: Mobility of labour - adaptable, capable of learning new skill Training and retraining opportunities must be available Must be possible for employers to hire people with the skills they need Labour force must have good basic educational foundations Employers must be able to get rid of workers Employment protection laws but make employers less likely to hire in the first place Short term contracts - workers able and willing to adapt to employers requirements.
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76. Extract 4 – Pascal Lamy emphasises the importance of international trade Free Trade and Protection Free trade – absence of protection - based on Comparative Advantage Worlds’ resources used more efficiently when countries specialise in producing those goods and services in which they have a comparative advantage Comparative advantage – opportunity cost of producing the good in one country is less than elsewhere Benefits obtained by importing from countries where the opportunity cost is lower Concentrating on exporting something in which a country has a comparative advantage
77. Worldwide specialisation based on comparative advantage = efficient resource use Competition/economies of scale should lead to dynamic efficiencies Theory states that countries should specialise in the production of those goods where they have the greatest comparative advantage, or least comparative disadvantage Assume 2 areas Europe and Australia, both producing food and clothing. Australia Europe Product units per hour units per hour food 6 2 clothing 3 1.5 Australia produces more of both goods in less time - has an absolute advantage Benefits of Trade Australia Europe Product units per hour units per hour Food 6 3 Clothing 4.5 1.5
78. Case for trade - all countries taken together will gain in terms of increased production, economic efficiency, and welfare No guarantee gains equally distributed some countries may feel that it is their interest to restrict trade Arguments for protection The infant industry argument Cushion home employment Prevent dumping - anti dumping measure may be a technique of protection Improve Balance of payments Protect employment levels Avoid "unfair" competition – NIC’s exploit labour by paying low wages Arguments against protection . Retaliation - reduces world trade to the detriment of all Props up inefficient producers’ - do not face efficient competition Welfare loss to consumers
79. World price before tariff is OP domestic demand OC domestic supply OB Tariff ↑ price increases to P+T domestic demand ↓ to OA domestic output ↑ to OE Imports ↓ from BC to EA Total consumer welfare has fallen by P, P+T,F,G Domestic suppliers gain P,P+T,H,J at the expense of consumers HFKL represents the revenue from the tariff – the amount imported times the price Net loss - triangles JHL and FGK - tariff has reduced welfare as a whole Fig 5 Welfare loss Price Quantity Domestic demand Domestic supply World price 0 P P+T Tariff price C B E A J H L F K G
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82. International Organisations The World Trade Organisation (WTO) WTO - global international organisation dealing with the rules of trade between nations WTO agreements, negotiated and signed by the bulk of the world’s trading nations and ratified in their parliaments Aim is to ↓ tariffs and other types of protection through “rounds” where countries try to agree to reduce tariff levels To help producers of goods/services, exporters/importers conduct their business Multi-lateral agreements using the principle of “most favoured nation status” If a country agrees a tariff reduction with one country it has to accept the reduction with all others This can be contrasted with bi-lateral agreements where the country only agrees trading terms with another country and does not extend it to others
90. The problem of mis-alignment Straight line shows desired economic convergence The trade cycles are shown as horizontally opposed UK in recession while Euroland in boom - different monetary policies are appropriate 0 GDP Euroland UK Time
91. Evaluation/judgement: Costs greater where: there is a lack of economic convergence Countries suffer differently from asymmetric shocks There is a lack of flexibility & mobility in factor markets Concern that the Euro area is not an optimal currency area
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94. 6. Comment on the extent to which a reduction in global trade barriers in manufacturing and agricultural goods can help a developing country (10) Introduction Explanation of global trade barriers Reasons for global barriers Both developed and undeveloped countries use barriers Benefits of free international trade & their limitations Terms of trade Analysis Diagram of tariff barriers Numerical example of benefits of free trade Outline the problems that the country might incur - ↑ unemployment ↑ BoP deficit Evaluation Are advantages > costs May depend on individual circumstances of the country
