The Tutor2u Covid-19 presentations had a very good circular flow diagram by Richard Baldwin from VoxEU.org. I have used it in my teaching this week – great for NCEA Level 2 Growth standard and A2 Unit 4.
Below is a link to a very good interview with Corin Dann and Don Brash this morning on National Radio’s ‘Morning Report’. Former Reserve Bank Governor Don Brash says that the major Central Banks need to act together and reduce interest rates to offset the impact of Covid-19. The Central Banks he refers to are: US Fed, Bank of England, Bank of Japan and the European Central Bank. Good discussion of the impact of the NZ dollar on trade and the fact that just the past month in New Zealand, the virus may have cost as much as $300 million in lost exports to China. Worth a listen
Below is a graph from the FT site that shows growth rates in leading developing countries and it makes a good comparison with the Eurozone and the World. Some emerging economies have, nevertheless, achieved high economic growth rates in recent years. China has witnessed particularly rapid economic growth and has become the second largest economy in the world behind the US. China’s increase in output has been driven by increases in investment and exports. This has been helped by a fall in the renminbi which makes Chinese exports cheaper. India’s growth rates has also been significant because of an increase in the labour force and advances in IT. Remember that ‘economic development’ is the process of improving people’s economic well-being and quality of life whilst economic growth is an increase in an economy’s output and the economic growth rate is the annual percentage change in output.
Economists use the term Japanification as shorthand for the situation where economic growth remains stagnant even with significant monetary easing – lower interest rates and increased government spending. With interest rates already at record low levels it seems that a lot of economies are going the same way as Japan. However as discussed in the video below from the FT, Japan is a nice place to live and has a very high life expectancy. The concern for central banks is what other policy instruments do they have after really low interest rates – they are running out of ammunition. To boost growth in the USA is a lot different than in Japan according to Ben Friedman. He states that Japan does not have the problems of widening inequality and the stagnation of the middle income groups.
The question is why Japanese society seems to cope with an economy that doesn’t respond to very low interest rates and increase government spending? The FT look to Robert Pringle’s book ‘The Power of Money’ and suggest three reasons:
- Long established business – 5500-odd companies that are 200+ years old, more than 3,000 are Japanese. They are much more resilient to change and have less of a focus on short-term profits but too service, patience and a disdain for pecuniary motives.
- Immaterialism – unlike a lot of western countries (US in particular) money in Japan is less significant in showing success. Therefore there is less social conflict.
- Japanese version of capitalism – US = individualism and democracy. Japan = individual is part of a group and discourage competition = a stable society.
HT to former colleague Kanchan Bandyopadhyay for this piece on the Genuine Progress Indicator. Most economics courses will include the topic of limitations of Gross Domestic Product as an indicator of standard of living. US senator Robert F Kennedy pointed out 50 years ago that GDP traditionally measures everything except those things that make life worthwhile.
Genuine Progress Indicator (GPI) is designed to include the well-being of a nation and it incorporates environmental and social factors which are not included in GDP. The GPI indicator takes everything the GDP uses into account, but adds other figures that represent the cost of the negative effects related to economic activity (such as the cost of crime, cost of ozone depletion and cost of resource depletion, among others). The GPI nets the positive and negative results of economic growth to examine whether or not it has benefited people overall. The figure below shows the aspects of Social, Economic and Environmental variables.
US senator Robert F Kennedy pointed out 50 years ago that GDP traditionally measures everything except those things that make life worthwhile.
The introduction of the living standards framework in New Zealand takes into account environmental resources, individual and community assets, ‘social capital’ – which includes cultural norms and how people interact – and human capital, such as people’s health, and their skills and qualifications.
By living standards, the NZ Treasury means more than income; it’s people having greater opportunities, capabilities and incentives to live a life that they value, and that they face fewer obstacles to achieving their goals.
Limitations of GDP as a measure of standard of living – see list below.
- Regional Variations in income and spending
- Inequalities of income and wealth
- Leisure and working hours
- The balance between consumption and investment
- The shadow economy and non-monetised sectors
- Changes in life expectancy
- Innovation and the development of new products
- Defensive expenditures
Below is CNBC video which looks at what capitalism is and the history behind it. It began in the 17th century in Europe and has spread to most parts of the world. Critics of the present form of capitalism argue that it harms the environment, increases inequality and slows economic growth. The video has some good data on inequality and discusses the fact that shareholder value is no longer the main priority of some firms.
Statistics New Zealand produced a great interactive graphic showing which industries have contributed to New Zealand’s GDP. It takes the top 10 industries that contributed most to the production measure of gross domestic product (GDP) in a given year. Industries are coloured based on four broad industry groups:
- Goods-producing industries: manufacturing; electricity, gas, water, and waste services; and construction industries.
- Primary industries: agriculture, forestry, fishing, and mining industries.
- Service industries: wholesale trade; accommodation and food services; retail trade; transport, postal, and warehousing; information, media, and telecommunications; finance and insurance services; rental, hiring, and real estate services; professional, scientific, technical, and admin support services; government administration; health; education; and other service industries.
- Taxes on production: includes GST, import duties, and stamp duties.
Below the doughnuts show the changes from 1973 to 2018.
Things to note:
- The contribution from the goods sector has fallen from 33% to 19%
- The service sector has increased from 51% to 65% over the period
- The primary sector has halved over the period from 14% to 7% – agriculture was the biggest industry in 1972 at 11.2 but by 2018 this figure was 4.3% and the industry was relegated to10th in 2018
Click here to go the interactive – well worth a look and great for Macro at NCEA Level 2 and 3.
This part of the syllabus will come up either as a multiple-choice question or part of an essay. The accelerator theory states that investment is determined by the RATE AT WHICH INCOME, AND HENCE OUTPUT, CHANGES OVER TIME. The principle states simply that unless the rate of increase in consumption is maintained, the previous level of investment will not be maintained.
This theory assumes that firms try to maintain some constant relationship between the level of output and the stock of capital required to produce that output. In other words, we assume a constant capital-output ratio which can be expressed in either physical terms or money terms. The accelerator helps us to understand how small changes in demand in one sector can be magnified and spread throughout the economy. The example below assumes that the firm starts with 8 machines each year and 1 machine wears out each year and that each machine can produce 100 units of output per year. In the second year, demand rises for capital goods rises by 200% (from 1 to 3). When the rate of growth of demand for consumer goods slows in year 4, demand for capital goods falls. In year 6 demand drops and they is no requirement for any investment.
Limitations of Accelerator:
* Firms can meet output with stocks – may not need investment
* Changes in technology may mean firms don’t need to invest in as much capital as before
* Firms need to be convinced that demand is long-term to warrant investment
* Limited supply of technology available
In explaining the differences between internal and external balances I came across an old textbook that I used at University – Economics by David Begg. It was described as ‘The Student’s Bible” by BBC Radio 4 and I certainly do refer back to it quite regularly. Part 4 on macroeconomics has an informative diagram that shows the impact of booms and recessions on the internal and external balances.
Internal Balance – when Aggregate Demand equals Aggregate Supply (potential output). And there is full employment in the labour market. With sluggish wage and price adjustment, lower AD causes a recession. Only when AD returns to potential output is internal balance restored.
External Balance – this refers to the Current Account balance. The country is neither underspending nor overspending its foreign income. For a floating exchange rate, the total balance of payments is always zero. Since the balance of payments is the sum of the current, capital, and financial accounts, saying the current account is in balance then also implies that the sum of the capital and financial accounts are in balance.
In the diagram right the point of internal and external balance is the intersection of the two axes, with neither boom nor slump, and with neither a current account surplus nor a deficit.
The top left-hand quadrant shows a combination of a domestic slump and a current account surplus. This can be caused by a rise in desired savings or by an adoption of a tight fiscal policy and monetary policy. These reduce AD which cause both a domestic slump and a reduction in imports.
The bottom left-hand corner shows a higher real exchange rate, which makes exports less competitive, reduces export demand and raises import demand. The fall in net exports induces both a current account deficit and lower AD, leading to a domestic slump.
In a downturn a more expansionary fiscal and monetary policy can hasten the return to full employment eg. Quantitative easing, tax cuts, lower interest rates. However one could say that today it doesn’t seem to be that effective.
GROSS DOMESTIC PRODUCT (GDP) – Under new definitions introduced in the late 1990s, Gross Domestic Product is also known as Gross Value Added. It is defined as the value of output produced within the domestic boundaries of the NZ economy over a given period of time, usually a year. It includes the output of foreign owned firms that are located in NZ, such as the majority of Trading Banks in the market – ASB, Westpac, ANZ, BNZ etc. It does not include output of NZ firms that are located abroad. There are three ways of calculating the value of GDP all of which should sum to the same amount since by identity:
NATIONAL OUTPUT = NATIONAL INCOME = NATIONAL EXPENDITURE
1. THE EXPENDITURE METHOD – This is the sum of the final expenditure on NZ produced goods and services measured at current market prices (not adjusted for inflation). The full equation for calculating GDP using this approach is: GDP = Consumer expenditure (C) + Investment (I) + Government expenditure (G) + (Exports (X) – Imports (M))
GDP = C + I + G + (X-M)
2. THE INCOME METHOD – This is the sum of total incomes earned from the production of goods and services. By adding together the rewards to the factors of production (land, labour, capital and enterprise), we can see how the flow of income in the economy is distributed. The rewards to the factors of production can be loosely summarised by the following:
Land – Rent. Labour – Wages and Salaries. Capital – Interest. Enterprise– Profit.
Only those incomes generated through the production of a marketed output are included in the calculation of GDP by the income approach. Therefore we exclude from the accounts items such as transfer payments (e.g. government benefits for jobseekers allowance and pensions where no output is produced) and private transfers of money.The income method tends to underestimate the true value of output in the economy, as incomes earned through the black economy are not recorded.
3. THE OUTPUT MEASURE OF GDP – This measures the value of output produced by each of the productive sectors in the economy (primary, secondary and tertiary) using the concept of value added. Value added is the increase in the value of a product at each successive stage of the production process. For example, if the raw materials and components used to make a car cost $16,000 and the final selling price of the car is $20,000, then the value added from the production process is $4,000. We use this approach to avoid the problems of double-counting the value of intermediate inputs. GDP will, therefore, be equal to the sum of each individual producer’s value added.
Below is a useful mindmap using OminGraffle software (Apple). It is adapted from CIE A Level Economics Revision Guide by Susan Grant