(2013) A Level H2 Econs Essay Q4 Suggested Answer by Mr Eugene Toh (A Level Economics Tutor)
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4. Governments have aims in relation to unemployment, economic growth and the balance of payments.
(a) Explain the consequences of failing to achieve these aims. [10]
Introduction
Governments typically aim to achieve
A low rate of unemployment (typically 2-3% for small economies, 4-5% for larger economies)
Sustained, sustainable & inclusive economic growth
Favourable balance of payments
Consequences of failing to achieve low unemployment
Inefficient allocation of scarce labour resources
When an economy is not operating at full employment level, it is not making use of its scarce labour resources to produce the maximum output it can possibly be producing
Illustration on PPC curve, situation of unemployment can be shown by a point within the PPC curve as opposed to a point on the PPC curve (if there was full employment instead)
High fiscal costs associated with unemployment (worsens budget balance)
Many governments pay some sort of benefits to unemployed workers e.g. unemployment benefit. Thus in periods of high unemployment, a larger fiscal cost is incurred as the government will have to pay out more unemployment benefits
Workers who are unemployed do not pay personal income taxes and also contribute less to value-added taxes. As a result, less tax revenues are contributed when there is higher unemployment, resulting in a larger fiscal cost
Consequences of failing to achieve sustained economic growth
Loss in competitiveness in relation to failure to achieve sustained growth
Failing to achieve sustained economic growth can result in a stagnation of incomes for both individuals and the government (tax revenues collected also stagnates)
This can result in the economy losing competitiveness as individuals may move outwards to other economies with better income prospects
The government may also not have available spare funding to finance improvements in infrastructure
An example would be Japan in the last 2 decades where economic growth was stagnant
Note: In the 9757 curriculum - you can also discuss sustainable & inclusive economic growth
Consequences of failing to achieve a favourable balance of payments
Depreciation of the currency
If the balance of payments is in a persistent deficit as opposed to a favourable surplus balance, outflows of payments > inflows of receipts
There is likely an increase in supply of domestic currency (to pay for imports / outflows) and/or decrease in demand for domestic currency (by foreigners for exports receipts)
This can result in a depreciation of the currency → affects import prices → making imports more expensive for locals
Depletion of foreign exchange reserves
A persistent balance of payment deficits can cause depletion of foreign exchange reserves
This can make conducting exchange rate policy more difficult as it requires a healthy foreign exchange reserves (to buy back domestic currency)
(b) Discuss whether failure to achieve these macroeconomic aims is more likely to be caused by domestic or international factors. [15]
When domestic factors are likely to result in failure to achieve these macroeconomic aims
High labour costs
A country with high labour costs compared to other countries producing similar goods can over time, experience a fall in export competitiveness and a loss in comparative advantage
This can result in a fall in (X-M) → worsening current account → worsening balance of payments and also a fall in AD → fall in real NY (lower economic growth) and firms hire less factor inputs such as labour → causing increase in unemployment
Singapore experienced this in the 1990s and early 2000s as higher labour costs compared to countries like China made it no longer viable to produce goods such as hard disk drives and manufacturers moved out to lower labour cost countries
Timeliness and competency of government policies
Incompetent governments coupled with political instability may result in government policies being poorly co-ordinated, implemented & lacking in timeliness
Governments may implement incorrect measures to address macroeconomic issues e.g. imposing price controls to address food shortages, ironically causing more firms to shutdown, resulting in prices going higher - exports of such goods fall, higher unemployment as workers get laid off
When international factors are likely to result in failure to achieve these macroeconomic aims
A global recession
A global recession such as that of the 2008 Global Financial Crisis or the ongoing COVID-19 pandemic may result in fall in incomes of trading partners which result in a fall in demand for a country’s exports
This can result in a fall in (X-M) → worsening current account → worsening balance of payments and also a fall in AD → fall in real NY (lower economic growth) and firms hire less factor inputs such as labour → causing increase in unemployment
Whether failure is more likely to be caused by domestic or international factors
Dependence on trade vs size of domestic markets
A country like Singapore with large exposure to trade (trade taking up >300% of GDP) may find that international factors will likely see failure in achieving these objectives to be caused by such international factors.
Countries like China have both a large exposure to trade (it is the largest exporter in the world) and also a large domestic market of 1.4 billion population - and thus both domestic & international factors can equally cause failure in the ability to achieve these macroeconomic aims
Whether failure is more likely to be caused by domestic or international factors depend on the individual circumstances of individual countries but in today’s globalised world, both domestic and international factors are likely to be important factors that could contribute to failure in achieving these macroeconomic aims.
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