Discuss with relevant examples the best way to sustaining long run economic growth for a small country, such as Singapore, with an aging population. [25]

Economic growth is defined as an increase in the real output of an economy over a period of time. Positive growth means that real output has increased while negative growth means that real output has fallen. Sustaining economic growth means long-run growth, defined as the rate of growth in real output of a country over a extended period of time. For long-run growth to occur, productive growth capacity needs to rise which means that there should be potential growth. Therefore, a sustaining economic growth needs not only actual growth but also potential growth. This essay attempts to explain the impacts on the economic growth due to small country with aging population, various methods to counter these problems and discuss about the best method to achieve a sustaining economic growth.

An aging population in a small country results in two major problems: shrinking labour force and decreasing national income. When there is a shrinking labour force, the burden on the productive workforce in supporting non-productive residents would rise. This means the number of new entrants into the workforce is smaller than the number of people retiring from it. Shrinking size of the workforce results decrease in labour supply. As a factor production, shrinking labour force leads to AS curve to shift left. Therefore, the potential growth slows down. Meanwhile, more retirees have lower income than the time when they work. They feel poorer to consume. Hence, consumption decreases. Shrinking workforce means that firms have more difficulty finding workers, so they might downsize, close down or relocate. They will not want to invest anymore. A decrease in consumption and investment results a decrease in AD as AD = C + I + G + (X – M). Hence, actual growth is reduced. Both AD and AS are likely to decrease due to an aging population; the economy would contract and economic growth would be negative. Hence, there is a need to raise AD and AS. 

[Insert diagram on increase in AD and AS]

From the diagram above, when the AS curve shifts to the right, at full employment level, an increase in AD will not cause demand-pull inflation, hence, a sustaining economic growth is achieved. 

To increase AD, there are several methods, namely, expansionary fiscal policy, expansionary monetary policy and exchange rate policy. 

Expansionary fiscal policy involves raising government spending on infrastructure like transportation, public utilities and telecommunication and on merit goods like education and healthcare. Cutting direct taxes can also have beneficial effects on long run growth. Cutting personal income taxes raises the monetary returns to work thereby increasing the incentive to work harder. Furthermore, more disposable income generates greater savings thereby increasing the funds available for investment. Lastly, cutting corporate taxes raises firm’s post tax profitability and hence their incentive to invest. As AD = C + I + G + (X – M), a increase in C and I and G will then raise AD.

The first limitation of expansionary fiscal policy is that it results in government debt as the government has to borrow to finance its budget to finance a budget deficit. Hence, future welfare is actually being sacrificed for the sake of raising current welfare. Secondly, in a small country with small multiplier (k), expansionary fiscal policy is very costly and not very effective. For instance, Singapore has a high MPS as we have compulsory savings like CPF and also a high MPM due to our dependence on imports. Since k = 1/(MPW) and MPW = MPS + MPT + MPM, Singapore has a high withdrawal and therefore a small multiplier. Thirdly, there is crowding out effect. Expansionary fiscal policy involves running a higher budget deficit that is probably financed from increasing borrowing. The demand for loanable funds rises and hence raising interest rates. This deters consumption (C) and investments (I) and also causes the currency to appreciate, thereby curbing net exports (X – M). As AD = C + I + G + (X – M), AD decreases due to decrease in C, I and (X – M). The expansionary effects of the budget deficits are therefore negated by a reduction in consumption, investments and net exports. Fiscal policy also has limitations like time lags and tax insensitivity. 

Expansionary monetary policy refers to increase money supply by Loanable Funds Theory, hence boost borrowing for consumption and investment. Lowering interest rates also causes hot money outflow, which causes the currency to depreciate because the demand for currency decreases hence boosting net exports. As AD = C + I + G + (X – M), AD is increased due to increase in C and I or (X – M). 

One of the limitations of expansionary monetary policy is the liquidity trap which refers to the situation where interest rates are already so low such that the further cuts in interest rates are unlikely to have any impact in stimulating borrowing. At the extreme, when interest rates hit zero, this means that there is no more room for further interest rates cuts and expansionary monetary policy stops being a viable policy tool. Meanwhile, small country such as Singapore is usually trade dependent. With free capital mobility, and fixed or managed exchange rate, small countries find it hard to implement monetary policy because of the economic trilemma. 

Exchange rate policy can be used to increase AD by depreciation of the currency. When the exchange rate is lowered, consumers find imports more expensive compared with domestic products, hence consume fewer imports. With lower exchange rate, country’s exports are more competitive and the quantity demanded for its exports increases. Hence an increase in net exports results in an increasing AD as AD = C + I + G + (X – M).

However, depreciation of currency will cause imported inflation which is very harmful to import-dependent small countries. These small countries prefer to have fixed or managed exchange rate, hence exchange rate policy may not be used. 

Governments can also use supply-side policies to ensure long-run economic growth. To counter the decreasing AS due to shrinking workforce, governments can choose to increase the quantity of labour or improve the quality of labour. 

The first option is to increase the size of the population with higher birth rates. i.e. pro-natal policies. Tax rebates and subsidies can be given to encourage more births. The labour market can also be regulated to allow for more flexible work arrangements so that parents can better balance work and family commitments. The size of the working population (labour force) can be increased by raising labour force participation. This can be done with policies to encourage non-working women and retirees to re-join the labour force. One way to do so is to increase the retirement age. Policies should also create more flexible and less intensive work arrangements which make jobs less demanding for older workers, hence encouraging them to remain in or to re-join the workforce. 

Besides trying to raise birth rates, a faster and easier way of increasing the size of the labour force is to allow more inflow of foreign labour. i.e. increase immigration. Allowing more inflow of higher skilled foreign labour like doctors, managers and engineers usually does not face that much social and political resistance. Being more educated and generally small in numbers, it is arguably easier for such foreigners to integrate into the local society. To improve the quality of labour force, governments have to increase labour productivity and occupational mobility. This involves two main elements. i.e. education and training. 

However, these supply-side policies have limitations as well. It is very hard to increase birth rate due to the fact that the opportunity cost of having children in terms of the sacrifice in consumption, leisure and career advancement is often too high. Re-joining the workforce is not easy as this cannot prevent people from getting old and retiring early. Immigration creates social tensions and depresses the wages of domestic low skilled labour, thus worsens the country’s income distribution. Education programs typically take many years to implement and their effects are felt only much later. Most of the labours and companies are reluctant to take and set up workshops for training. 

In conclusion, to achieve sustaining economic growth in a small country with aging population, the best way is to use supply-side policies to increase AS which is the root cause of slowing economic growth. Expansionary fiscal policy can be considered as one of the better choices if the small country has a relatively large multiplier hence it will not be so costly to use fiscal policy. Monetary policy is usually not a good choice due to the fact that small country is usually trade dependent and is limited by the economic trilemma. Small country which is usually import dependent will not choose to depreciate its currency. Therefore, supply-side policy is considered as the best way to sustaining economic growth for a small country with an aging population. 

JC Economics Essays - H2 'A' Level standard essay on the Singapore macroeconomy: Economics Tutor's comments. Macroeconomics essays covering the various macroeconomic aims and goals of governments, as well as the demand management policies and supply side policies are important. Often, macroeconomics essay topics will focus on either the goals as a standalone topic, or in conjunction with economic policies. Economics policies often come accompanied with some economics issues or economics news in a preamble, but economic policies can be assessed also on their own theoretical merits. (In a way, that's the beauty of macroeconomics - it can be quite theoretical and while often macro is in the news, and often catches attention with the headlines, in economics examinations macroeconomic policies can be considered theoretically too. The thrill of theory is often too beautiful for economists to ignore.) In any case, the usual economics tutor's questions apply: what are the strengths and what are the weaknesses of this economics paper? Does the student develop her arguments cogently, clearly, and build on theory and real world economic examples? Think about how you could help this student write an even better essay, or how you could help the student to get the highest marks possible. Having said that, this economics essay is very well written for a variety of reasons. The materials presented are wide ranging and very well applied to Singapore's context. There is a lot of economic theory, but also examples as well. The conclusion is nuanced, evaluative, and generally very well written. Note: this essay was written under examination and timed conditions by an actual A level student in a class Economics H2 test (not an economics assignment). Special thanks for AG, SS, and other students for their kind feedback and invaluable contributions and suggestions. 

Discuss monetary policy and fiscal policy’s importance for the USA, in the light of stagflation.

Introduction to Monetary and Fiscal Policy, and Stagflation

Monetary policy means to control the money supply and interest rates to affect aggregate demand (AD) in an economy, according to what is known as demand-management. Fiscal policy is another demand-management policy that deals with manipulating government spending and direct taxes so as to affect AD. Stagflation is defined as a situation of low economic growth with high inflation - both stagnation and inflation. Inflation is defined as a persistent and sustained increase in the general price level (GPL), that poses a problem to society because this increase in GPL is sustained and inordinate. 

This Economics paper discusses the strengths and limitations of monetary and fiscal policy, each in turn, in relation to stagflation in the USA. This paper concludes that both policies are equally important for the US, but they should be used in conjunction with supply side policy. 

Monetary Policy

Monetary policy works, in theory, by two ways. First, according to the classical direct transmissions mechanism, increases in money supply help consumers spend more and firms invest more directly because they have more money and they feel richer. Second, according to the indirect transmissions mechanism, increases in the money supply lower the interest rate, which lowers the cost of borrowing. Since it is cheaper for households to borrow money to consume, and cheaper for firms to borrow money to invest, C and I both increase, and since AD = C + I + G + (X-M), then AD increases, which helps to solve unemployment and which also causes actual economic growth. 

Unemployment is defined simply as the situation where people who are able and willing to work cannot find jobs, or they are unwilling to take up the jobs at the wage rate given to them. Actual economic growth merely refers to increases in real output at the macroeconomic level caused by increases in AD. Hence, it would seem that prima facie, monetary policy can help solve unemployment and lack of growth in the USA, and hence fight stagflation by countering the “stagnation” part.  

Limitations of Monetary Policy

However, monetary policy might suffer from the liquidity trap, which means that beyond a certain point interest rates cannot be lowered further, thus hampering the workings of monetary policy. If interest rates cannot be lowered, the costs of borrowing cannot be reduced. This can be seen in an analysis of the liquidity preference theory put forth by Keynes. 

Fiscal Policy

On the other hand, Keynesian fiscal policy works when governments spend more, for instance on national defence and education, or when they tax less, through lowering income and corporate taxes. Increasing G raises AD directly given that G is one of the components of AD. Lowering direct taxes cause C and I both to increase, and since AD = C + I + G + (X-M), then AD also increases, which helps to solve unemployment and which also causes actual economic growth. Because of the multiplier effect, where the multiplier means that national income increases by a factor more than the initial increase in the injections into the economy, the USA’s AD will increase, promoting and boosting growth. 

In the USA, both C and I are large components of the AD. It can also be argued that G is also a big component given that the USA has a large military. Hence, it would seem that prima facie, fiscal policy can also help solve unemployment and lack of growth in the USA, and thus fight stagflation by countering the “stagnation” part.  

Limitations of Fiscal Policy

However, there are also limitations to fiscal policy, one of which is the famous “crowding out effect”. If governments run a budget deficit, and the USA is arguably famous for running both a budget as well as a trade deficit for many years, then they will have to borrow money. According to the loanable funds theory, this increase in demand for funds by governments will crowd out private consumption and investment, and hence C and I will fall despite G increasing, thus negating the effects of fiscal policy. The US government would be “crowding out” private consumption and investment. 

Supply Side Policies?

Hence, supply side policies that target the aggregate supply (AS) curve, which is affected by the factors of production which are land, labour, capital, and enterprise, could be better for the USA in handling stagflation. Subsidies for energy and other natural resources, increases in the US labour force in both numbers and quality, for instance by increasing American high school education and human capital, and increases in both the quantity and quality of American capital, plus encouraging immigration especially of entrepreneurial foreigners, would help massively. 

These methods and means would shift the AS curve both down and to the right and help solve cost push inflation in the USA. These would be better because they would solve both the “lack of growth” and “high inflation” aspects. 

Conclusion

In conclusion, perhaps both demand side and supply side policies should be used hand in hand, and together they can help solve stagflation because they encourage both potential and actual growth, which is great for the American economy. 

JC Economics Essays: Tutor's Comments - This Macroeconomics essay on monetary policy and fiscal policy, set in the context of the USA, is interesting and provides a suitable level of analysis. There are consistent references to the USA as well as relevant macroeconomic policies, and the underlying economic reasoning behind those policies. There are also well-defined terms that are explained clearly. Note: this particular Economics essay on the USA is related to the earlier Economics question on stagflation: Explain possible causes of stagflation in the USA. However, my usual question applies here: if you were the Economics tutor grading this Economics paper, what areas of improvement would you suggest? Let's look, for example, at the conclusion. While this essay's conclusion makes a good argument and tries to justify the argument made, there is a lack of detailed evaluation which could possibly make it an even better essay. What other areas of improvement for this Economics essay do you observe or notice? Thanks for reading and cheers!

What can a government do to increase economic growth? Discuss. [25] (Second Version, Revised)

What can a government do to increase economic growth? Discuss. [25]

Note: This essay has appeared before on my site; this is a second version.

What can a government do to increase economic growth? There are many policies a government can utilise to achieve this macroeconomic objective. Economic growth can be measured by percentage increases in real Gross Domestic Product (GDP), and there are two main aspects – actual and potential growth. Actual growth measures the actual rate of change in the volume of output produced within a given country, within a year. Potential growth is the percentage annual increase in the economy’s potential capacity to produce output. Economic growth can be increased via increasing aggregate demand (AD) and increasing aggregate supply (AS), which target actual growth and potential growth respectively.

Thus, this paper suggests that a government may introduce demand-management policies, such as monetary and fiscal policy, which target actual growth, as well as supply-side policies, which target potential growth, in order to increase economic growth.

Demand-Management Policies

First, a government can use expansionary demand-management policies. Monetary policy is the manipulation of monetary variables such as money supply, interest rates, and even the exchange rate (for example in Singapore’s case) to achieve macroeconomic policy objectives such as steady, sustained economic growth, low and stable inflation, a healthy Balance of Payments (BOP) and full employment. Expansionary monetary policy may be employed to promote economic growth. It involves reducing interest rates, where the reduction of interest rates leads to an increase in consumption spending (C) or firms’ investments (I), thus raising AD, or reducing the external value of the currency which makes a country’s exports look relatively cheaper, thus boosting export sales. A reduction in interest rates will increase consumer spending on consumer durables and may encourage spending at the expense of savings. A lowered interest rate will also encourage investment. As AD is made up of C + I + G + (X-M), (G means government spending and (X-M) means net exports), hence, when both C and I increase, AD shifts to the right. A lower cost of borrowing will increase the incentive for investment as now the returns would be greater. The increase in both consumption expenditure (C) and investment expenditure (I) will cause AD to rise and thus, promote actual growth.

In terms of exchange rate policy, devaluation or depreciation in the exchange rate is often used by governments of open economies that operate a fixed exchange rate system or a managed float system. By devaluing their domestic currency, a country would be more export competitive as their exports will appear to be cheaper relative to other countries. Assuming the Marshall-Lerner condition is satisfied, net exports as well as AD will rise. This, in turn, will cause output and employment to increase.

Fiscal policy refers to the use of government spending and taxation to achieve macroeconomic objectives. To promote economic growth, to boost output and to increase employment, a government can also employ an expansionary fiscal policy. The government can increase government expenditure (G) or reduce taxes (t). An increase in G will cause an increase in aggregate demand directly since AD = C + I + G + (X-M). A reduction in personal income tax would raise consumption as it would further increase the disposable income of households and thus their ability to spend. Moreover, a decrease in corporate tax will increase profits and hence raise the level of investment in the economy. An expansionary fiscal policy thus raises AD, and hence output and employment, and thus promotes actual growth.

Supply-Side Policies

Secondly, and on the other hand, to promote potential growth, the government may adopt supply-side policies. Supply-side policies are designed to shift the AS curve to the right by increasing the quantity and quality of resources via improving the efficiency in product and labour markets, and also by improving the level of technology.

A reduction in labour market rigidities can be carried out via provision of education and training, reduction in direct taxes, cut in unemployment benefits, reforming trade unions, and wages and prices policies. Education and training can raise labour productivity and mobility and thus increase productive potential of the country. Labour productivity or the efficiency of labour is measured by output per hour worked. Reducing personal income tax and corporate tax rates can raise the productive capacity of a country by increasing the quantity and quality of labour and capital available to a country. A lower income tax rate would create incentive for work as now there is as expansion in the amount of disposable income. A lower corporate tax rate would also increase investment as businessmen would be able to keep a larger share of profits. The cut in unemployment benefits will also increase the incentive to work as the unemployed would be disadvantaged if they are not engaged in productive labour. The power of trade unions can also be reduced by the government as this would result in a reduction of wages of labour. This, in turn, will increase employment, labour markets flexibility and efficiency. Thus, if labour costs to employers are reduced, their profits will probably rise. This would encourage and enable more investment and economic growth.

Pro-business policies are designed to promote greater private investments in the country. These include building world-class infrastructure, investing in R&D and tax reforms to ensure greater compatibility with international trends in taxes. The government can also increase AS via the adoption of more pro-competitive policies such as the passing of anti-monopoly laws, removal of barriers to entry to certain regulated industries, eliminating tariffs as well as other restrictions on imports.

Limitations of Policies

However, both aggregate demand and supply side policies have their share of limitations. Reducing interest rates may cause the country’s currency to depreciate as it encourages hot money outflows. A lower exchange rate will make the exports of a country more competitive whereas imports will be dearer. Moreover, if the consumer and business outlook is gloomy, a fall in interest rates may not encourage firms and households to increase borrowing because firms’ profits are falling and consumers may be expecting lower wages and lower year-end bonuses. When the exchange rate is reduced, if the economy is operating near or at full employment, inflation will result. If the demand for exports and imports is price inelastic, net exports and AD will fall. This, in turn, will cause output and employment to fall. Hence, inflation can cancel out the price advantages resulting from a reduction in the external value of the currency.

Fiscal policy may conflict with other macroeconomic goals because if AD increases by too much, economic growth will be achieved at the cost of demand-pull inflation. Also, if the government has to borrow in order to increase spending, it may result in a BOP deficit. The decrease in tax rates may not bring about the desired increase in consumption and investment if households and businesses are pessimistic about future prospects. Moreover, a cut in personal income tax may induce an increase in the amount that they save rather than spend. The full effects of an expansionary fiscal policy may only be felt after a considerable time period. Thus, its effectiveness may not be realised in the short term.

Supply-side policies such as education and training take time to have an effect and are also very costly. Reducing taxes may encourage some people to work fewer hours so that they can enjoy more leisure. Reducing corporate taxes may result in firms paying higher dividends rather than undertaking more investment. Cutting unemployment benefits would also not guarantee that it would reduce unemployment as jobs are not created and neither are their skills upgraded. It increases the urgency of finding a job. However, it does not increase their capability of getting a job.

Conclusions

Thus, economic growth can be achieved via fiscal policy, monetary policy, supply-side policies as well as by pro-business policies. However, it may be achieved at the expense of the limitations discussed and thus, a combination of policies could result in better economic growth rather than the policies being utilised as standalone measures to improve the economy.

JC Economics Essays – Tutor’s Commentary: This Economics essay on economic growth has appeared before on my site; this is a second version (amended, revised, changed version). One major problem with this Economics essay is that the conclusion is still not evaluative enough. Economics tutors usually lament that their students cannot write excellent evaluations after writing many excellent paragraphs before that. How do you write an evaluative paragraph? One tip that many Economics tutors give is that students should be sure to signpost their essays with phrases such as: “to a large extent, in my opinion, it is likely that, one can argue that”, and so on. Now put yourself back into the shoes of your own Economics lecturer in school, here once again. How would a good Economics tutor make this conclusion here better? Also, which diagrams do you need here, and why? A good Economics tutor would point out that AD/AS would be really useful here: my advice for this piece of work would be – always include a relevant Economics diagram and also write an evaluative conclusion to get the highest, best grades. 

"Singapore is among economies worldwide that have the most to gain from globalisation." Discuss. [25]

"Singapore is among economies worldwide that have the most to gain from globalisation." Discuss. [25]

Economics Tutor's Note: This Economics A level examination question has been modified; it was attempted in 2009 by one of my MJC students. 

Globalisation refers to the rising volume of economic activities taking place across countries worldwide, which includes the exchange of goods and services through trade, capital through capital flows, labour as well as technology. These impacts are most often than not far reaching which means that the spatial extent to which these exchange occur is fairly wide and dense. This paper discusses whether Singapore is among the countries worldwide that have the most to gain from globalisation. 

Looking at Singapore’s economy, its nature is small and open – Singapore’s resources are scarce, therefore she depends heavily upon the trade of goods and services, and the international flow of labour and capital. Since the 1980s, Singapore has been faced with strong economic growth, low unemployment with some structural unemployment and generally low inflation rates accompanied by a healthy balance of payment surpluses. Such attributes allow Singapore to gain from globalization.

Firstly, Singapore gains from globalization due to its increase in the market reach as market size increases. With an increase in market size, exports will also increase as more goods are traded to more countries, leading to an increase in the net exports. Using the AD-AS analysis, with an increase in the net exports, the AD will increase because AD = C + I + G + (X-M). This will lead to actual growth, as AD shifts to the right.

Insert the AD-AS diagram. Think: how would it look like, and what lines, labels, and other details would you need to draw this? 

Therefore, as such, the increase in the AD from AD1 to AD2 results in economic growth through actual growth and also resulting in a decrease in unemployment rates. In addition, balance of payments improves, assuming that the Marshall-Lerner condition holds. However, due to Singapore’s small multiplier, because of her high savings rate due to the compulsory savings scheme leading to a high MPS (Central Provident Fund) and because of her lack of natural resources resulting in a high MPM, the increase in economic growth or national income may not be that significant and thus its gains are arguably small.

Via globalization, Singapore also gains as firms here can now find cheaper factors of production overseas, for example, China is set upon as a good premise for investments as it has comparative advantage in land, which is abundant and labour, which are cheap. This will therefore reduce the cost of production resulting in the savings achieved by the producers to pass on the savings to the consumers. In addition, firms can also import cheap foreign labour as well as import foreign machinery to boost the levels of factors of production in Singapore. The improvement in the quality and the quantity of factors of production allow the inflation to be kept at a low level as cost push inflation is prevented.

Cheaper production costs which results in cheaper domestic products improves Singapore’s export competitiveness and therefore encourages economic growth. Also the balance of payment position may also improve from globalization due to increased investments, which would likely boost the capital account. With foreign investment overseas, this could improve Singapore's current account. Furthermore, with globalization, investment levels in export-oriented industries could increase, attributed to an increase in the inflow of foreign direct investment. As such, both the quality and quantity of exports is affected. Quality is improved due to more advanced technology, which increases the quality of capital together with more capable human resources which improves the quality of labour. This will increase Singapore's long run productive capacity, resulting in possible potential growth. This is especially important seeing that FDI has been the main engine of long run potential economic growth in Singapore.

However, while Singapore gains from globalization, it also experience some losses or costs. Firstly, Singapore can potentially face demand-pull inflation because of an increase in export numbers, heavily accentuated with over increase in investment and consumption levels. This leads to an increase in the levels of aggregate demand and demand pull inflation could occur shortly after. This will lead to detrimental effects in Singapore, for example, the housing prices could soar. With increases in capital inflows, there could be possible asset bubbles from loose monetary policies in other countries. Hence, inflation could be a possible issue. 

Besides demand pull inflation, Singapore might experience a loss in comparative advantage. Comparative advantage is when a country produces and trades a good which it produces at a lower opportunity cost than another country. This might be seen in the sunset industries where there is low value added-ness, and low skilled and low waged jobs. The closing down of these industries, together with labour immobility, causes structural unemployment, leading to income inequity.

Lastly, Singapore may also face volatile external shocks. If our main trading partners experiences recession, Singapore’s macroeconomic goals may be affected, particularly economic growth, employment and balance of payment as trade may decrease and result in decreased exports. Also, the imposing of protectionism and establishment of barriers of trade due to political turmoil may also result in the aforementioned effects. Hence, it can be seen that Singapore may be made more vulnerable to external events.  

Therefore, while Singapore gains from international trade and global factor mobility in the long run, there may be limitations. This highlights the need for policies to be established, such as Singapore's focus on the managed exchange rate and supply side policies in general, to come up with strategies so that Singapore can gain most from globalization while reducing losses. Singapore's use of exchange-rate focused monetary policy ameliorates inflation because of its gradual appreciation, whilst Singapore's supply side policies effectively address retraining and skills-upgrading to target structural unemployment and maintaining flexibility in the face of a volatile external environment. 

JC ECONOMICS ESSAYS - Economics Tutor's Comments: There are many aspects of this economics essay that can be improved on, but overall this is a very well written economics paper, interesting and well-thought out; overall, this is a really good effort in Economics! NOTE: This economics question is an amended version of the H2 A level Economics paper. This economics response written by my student was recently edited for flow and made more relevant to the 2014, 2015 context, as it was written in 2009. Grammatical and spelling errors were also changed, from the original submission. Most importantly, the initial original conclusion has been made and modified into the evaluative conclusion required for the highest evaluation grade in the current 2014 economics A level essay paper section. Thanks for reading and cheers. 

(b) What can the government do to increase Economic Growth? [15]

(b) What can the government do to increase Economic Growth? [15]

There are many policies a government could undertake to increase economic growth. Economic growth is measured by percentage increase in real Gross Domestic Product (GDP). There are two main aspects to economic growth. Actual and potential growth. Actual growth (AG) measures the rate of change in the volume of output produced within the country in a year. Potential growth (PG) is the percentage annual increase in the economy’s capacity to produce. Economic growth can be increased via increasing aggregate demand and increasing aggregate supply. Thus, the government may introduce demand management policies, such as monetary and fiscal policy as well as supply-side policies in order to aid economic growth.

Monetary policy is the manipulation of monetary variables such as money supply, interest rate and the exchange rate to achieve macroeconomic policy objectives such as steady and sustained economic growth, low and stable inflation, a healthy Balance of Payment (BOP) and full employment. Expansionary Monetary Policy may be employed to promote economic growth. It involves, raising monetary supply, reducing interest rates (as seen from Figure 1 - think of WHAT diagram and HOW to draw the diagram) where the reduction of interest rates leads to an increased supply of goods or reducing the external value of the currency. A reduction in interest rates will increase consumer spending on consumer durables. It may also encourage spending at the expense of saving. It also increases the amount available to spend after people have paid less for loans with low interest rates. A lowered interest rate will also encourage investment. This is shown in Figure 2 as AD0 increases to AD1 as AD is made up of C + I + G + (X-M). Hence, when C and I increase, AD shifts to the right. A lower cost of borrowing will increase the incentive for investment as now the returns would be greater. The increase in both consumption expenditure (C) and investment expenditure (I) will cause the AD to rise and thus, promote actual growth. A reduction in exchange rate is often used by governments of open economies that operate a fixed exchange rate system. By depreciating their domestic currency, a country would be more export competitive as their exports to other countries will be cheaper. Assuming the Marshall-Lerner condition is satisfied, net exports as well as AD will rise. This, in turn, will cause output and employment to increase.

Fiscal policy refers to the use of government spending and taxation to achieve the macroeconomic objectives. To promote economic growth, boost output and employment, a government can also employ an expansionary fiscal policy. With reference to Figure 3, the economy initially operates at A which is below the full employment level Yf. The government could adopt an expansionary fiscal policy. The government can increase government expenditure (G) or reduce taxes. An increase in G will cause an increase in aggregate demand directly since AD = C + I + G + (X-M). A reduction in personal income tax would raise consumption as it would further increase the disposable income of households and thus their ability to spend. Moreover, a decrease in corporate tax will increase profits and hence raise the level of investment in the economy. An expansionary fiscal policy thus raises AD and hence, output, employment and thus promotes actual growth.

To promote potential growth, the government may adopt supply-side policies. Supply-side policies are designed to shift the AS curve to the right by increasing the quantity and quality of resources via improving the efficiency in product and labour markets, and also by improving the level of technology. A reduction in labour market rigidities can be carried out via provision of education and training, reduction in direct taxes, cut in unemployment benefits, reforming trade unions and wage and price policies. Education and training can raise labour productivity and mobility and thus increase productive potential of the country. Labour productivity or the efficiency of labour is measured by output per hour worked. Reducing personal income tax and corporate tax rates can raise the productive capacity of a country by increasing the quantity and quality of labour and capital available to a country. A lower income tax rate would create incentive for work as now there is as expansion in the amount of disposable income. A lower corporate tax rate would also increase investment as the businessmen would be able to keep a larger share of profits. The cut in unemployment benefits will also increase the incentive to work as the unemployed would be disadvantaged if they are not engaged in productive labour. The power of trade unions can also be reduced by the government as this would result in a reduction of wages of labour. This, in turn, will increase employment, labour markets flexibility and efficiency. Thus, if labour costs to employers are reduced, their profits will probably rise. This would encourage and enable more investment and economic growth.

Pro-business policies are designed to promote greater private investments in the country. These include building world-class infrastructure, investing in R&D and tax reforms to ensure greater compatibility with international trends in taxes. The government can also increase Aggregate Supply via the adoption of more pro-competitive policies such as the passing of anti-monopoly laws, removal of barriers to entry to certain regulated industries, eliminating tariffs as well as other restrictions on imports.

However, both demand and supply side policies have their share of limitations. Reducing interest rates may cause the country’s currency to depreciate as it encourages hot money outflows. A lower exchange rate will make the exports of a country more competitive whereas imports will be dearer. Moreover, if consumer and business outlook is gloomy, a fall in interest rate may not encourage firms and households to increase borrowing because firms’ profits are falling and consumers may be expecting lower wages and lower year-end bonuses. When exchange rate is reduced, if the economy is operating near or at full employment, inflation will result. If the demand for exports and imports is price inelastic, net exports and AD will fall. This, in turn, will cause output and employment to fall. Hence, inflation can annul the price advantage resulting from a reduction in the external value of the currency. Fiscal policy may conflict with other macroeconomic goals as if AD increases by too much; economic growth will be achieved at the cost of inflation. Also, if the government has to borrow in order to increase spending, it may result in a BOP deficit. The decrease in tax rates may not bring about the desired increase in consumption and investment if households and businesses are pessimistic about future prospects. Moreover, a cut in personal income tax may induce an increase in the amount that they save rather than spend. The full effects of an expansionary fiscal policy may only be felt after a considerable time period. Thus, its effectiveness may not be realised in the short term. Supply-side policies such as education and training take time to have an effect and are also very costly. Reducing taxes may encourage some people to work fewer hours so that they can enjoy more leisure. Reducing corporate taxes may result in firms paying higher dividends rather than undertaking more investment. Cutting unemployment benefits would also not guarantee that it would reduce unemployment as jobs are not created and neither are their skills upgraded. It increases the urgency of finding a job. However, it does not increase their capability of getting a job.

Thus, economic growth ca be achieved via Fiscal Policy, Monetary Policy, Supply-side policies as well as by pro-business policies. However, it may be achieved at the expense of the limitations named above and thus, a combination of the policies could result in better economic growth rather than them being utilised as a stand alone measures to improve the economy.

JC Economics Essays: Tutor's Comments: A very well written essay, which was composed under examination conditions. Total Marks: 20.5/25. 

Further Economics tutor's comments: think of how you could work on this Economics paper to make it better, tighter, clearer, or worth more marks. Also, think of how the conclusion could be made more evaluative, interesting, and readable. Do think of how to draw the relevant and proper Economics diagrams for this essay as well. Thanks for reading and cheers!