Readers Question: Discuss the impact of a decrease in government spending? If the UK government cut government spending, it would have a significant impact on both aggregate demand (AD) and the supply side of the economy – depending on which areas of public spending were cut. Firstly, government spending (G) is a component of Aggregate …
Readers Question: To what extent are higher government debt levels a constraint on economic growth? There has been much debate about the extent to which high levels of government debt might slow down rates of economic growth. In particular, a 2010 paper “Growth in a Time of Debt,” by Carmen Reinhart and Kenneth Rogoff seemed to suggest that GDP growth significantly falls once government-debt levels exceed 90% of GDP. This paper was used as a justification for austerity in both the US and EU, but the paper has recently received substantial criticism. Firstly because an excel coding error left out several countries data. Secondly, because it is not clear whether high debt causes low growth or low growth causes higher debt levels.In 2010 two American Economists Carmen Reinhart and Kenneth Rogoff, circulated a paper, this paper suggested that once government debt reached 90% of GDP it led to a sharp drop off in economic growth.It was very influential in 2010 as there was a political interest in reducing debt. However, the paper was later criticised on numerous fronts
They omitted some data
There was an excel coding error
They used questionable statistical analysis.
Later researchers couldn’t replicate their results and only found a very weak link between debt and lower growth rates.Also, they were criticised for their assertion that
“growth drops off sharply when debt exceeds 90 percent of GDP”.
Because even if there is data suggesting a relationship between growth and debt. It remains another question of which factor causes the other factor. It could be that countries with slow growth tend to accumulate debt to GDP (in a recession, you expect debt to GDP to rise. A fairer statement is to say
“countries with debt over 90% of GDP tend to have slower growth than countries with debt below 90% of GDP”
Public debt and Growth OECDThere is a reasonably good summary at the Economist here – relationship between growth and debt. Source: De Long. The relationship between growth and debt amongst G7 in post-war period. However, you have to be careful from reading too much in this. E.g. Japan’s post-war miracle with growth of 10% + is different era to today’s situation. But, it is worth mentioning other papers have given a mixture of results.
A 2010 IMF paper turns up “some evidence” of a 90% threshold.
A 2011 study by the Bank for International Settlements identifies a threshold of 85%.
A 2012 IMF paper found “there is no particular threshold that consistently precedes sub-par growth performance.”
Theory behind Growth and debt link
Let us examine the theory behind the possible link between government debt and economic growth Firstly, how might high government debt levels constrain economic growth? Crowding Out. Higher government debt usually requires the government to borrow from the private sector. Therefore, with higher government debt, there is likely to be a fall in private sector investment as the private sector use funds to buy government bonds. In addition, some economists argue that government spending tends to be more inefficient than the private sector. For example, if the government borrow to finance higher pension commitments, there will be less impetus to boosting economic growth than if the private sector had been free to invest itself.
However, crowding out is only likely to occur if the government borrows when the economy is close to full capacity. If the government borrow when savings are high and the economy is stuck in a recession, then there will not be crowding out, but an actual injection of spending into the economy. The government debt is financing spending which otherwise would not occur. In other words, in a recession, higher debt could cause higher growth rates than countries who try to cut budget deficits. The fact European economies have entered a double-dip recession after pursuing austerity policies, suggests there is empirical support for this.
Readers Question: List and briefly describe the positive and negative attributes of multinational corporations (MNCs). Multinational corporations are large companies with operations in several countries across the world. For example, Apple, Ford, Coca-Cola, Alphabet (Google) and Microsoft. Their size and turnover can be greater than the total GDP of many developing economies. Benefits of Multinational …
Summary: Capitalism is the dominant economic system because the concept of private property and freedom to pursue economic choices are deeply embedded in human nature. Also, alternatives based on co-operation, sharing and state control have many flaws and limitations making capitalism least worst option for many. Definition of capitalism Capitalism is an economic system where …
What policies can a government use to reduce pollution?
Pollution is a negative externality – a cost to society. To reduce pollution, the government can use four main policies – tax to raise the price, subsidise alternatives, regulations to ban certain pollutants and pollution permits.
Government policies to reduce pollution
Tax. e.g. Carbon tax, which makes people pay the social cost of pollution.
Subsidy. e.g. subsidy of alternative energy sources.
Pollution permits, e.g. carbon trading schemes where firms are given the right to pollute a certain amount; these permits can be traded with other firms.
Regulation. Limits on a number of pollutants that can be discarded into the atmosphere.
Changing consumer behaviour – e.g. through advertising, nudges.
1. Tax
The idea of a tax is to make consumers and producers pay the full social cost of producing pollution. For example, petrol tax or a carbon tax.
In this case, the social marginal cost (SMC) of producing the good is greater than the private marginal cost (PMC) The difference is the external cost of the pollution. The tax shifts the supply curve to S2 and therefore, consumers are forced to pay the full social marginal cost. This reduces the quantity consumed to Q2, which is the socially efficient outcome (because the SMC=SMB)
Evaluation
The advantage of this scheme is that the government raises substantial revenue, which could be used to finance other pollution reduction schemes (e.g. subsidising alternatives)
It provides a market incentive for firms to offer more efficient engines, which cause less pollution. Increased petrol tax has created an incentive for firms and consumers to switch to less fuel intensive engines.
One drawback of tax is that demand may be quite inelastic and that an increase in petrol tax may do little to reduce demand and only marginally reduce the amount of pollution. Though in the long term, demand may become more elastic as people switch to other forms of transport over time.
Another potential problem is that it can be difficult to implement green taxes due to administration costs or it is difficult to know how much to tax.
In practical terms (non-economic issue), the difficulty is often political resistance – people never like paying new taxes, even if there is a long-term goal of reducing pollution.
Definition: The Life-cycle hypothesis was developed by Franco Modigliani in 1957. The theory states that individuals seek to smooth consumption over the course of a lifetime – borrowing in times of low-income and saving during periods of high income. The graph shows individuals save from the age of 20 to 65. As a student, it …
“Nothing is so permanent as a temporary government program.” Milton Friedman, “Tyranny of the Status Quo,” (1984) p. 115 Friedman was a free-market economist critical of government intervention. With this quote, he was making the point that government intervention can invariably lead to government failure and inefficient use of resources. One example, Friedman used was …
Definition of the Free Rider Problem This occurs when people can benefit from a good/service without paying anything towards it. It also occurs, if people can get away with making only a token contribution (Something less than their overall benefit) If enough people can enjoy a good without paying for the cost – then there …
