ACJC Macro Policies Case Study Suggested Answers

Suggested Answers: SECTION B: CASE STUDIES Case Study Question 1: Imbalances in the United Kingdom and China economies Table 2: Government debt (percentage of GDP) Year China UK 2010 33.7 76 2011 33.6 81.6 2012 34.3 85.1 2013 37 86.2 2014 39.9 88.1 2015 42.6 89 Source: IMF Table 3: GDP Composition breakdown by percentage in 2015 China UK Consumption Expenditure 37% 65% Government Expenditure 14% 19% Gross Capital Formation 45% 17% Export Revenue 22% 28% Import Expenditure 18% 29% Source: World Bank Extract 5: Is the game up for China’s much emulated growth model? From the early 1990s, China adopted an export -led strategy that delivered continuously increasing shares of the world market, fed by relatively low wages and very high rates of investment, enabling massive increases in infrastructure. It led to big increases in inequality and even bigger environmental problems, but the strategy seemed to work – until 2008-09, when exports were hit by the global financial crisis. Yet even then, China, India and other large emerging markets continued to grow. The talk at the time was that they were already dissociated from the west. In reality, China (and much of developing Asia) had simply shifted to a different engine of growth without abandoning the focus on exports. The Chinese authorities could have generated more domestic demand by stimulating

consumption through rising wage shares of national income, but this would have threatened their export-driven model. Instead they put their faith in investments to keep growth rates buoyant. So the “recovery package” in China essentially encouraged more investment, which was already nearly half of GDP. Provincial governments and public sector enterprises were encouraged to borrow heavily and invest in infrastructure, construction and more production capacity. To utilise the excess capacity, a real estate and construction boom was instigated, fed by lending from public sector banks. Total debt in China increased fourfold between 2007 and 2014, and the private debt-GDP ratio nearly doubled to over 280%. All this comes in the midst of an overall slowdown in China’s economy. Exports fell by around 8% in 2014. Stimulus measures such as interest rate cuts do not seem to be working. As such, the recent devaluation of the yuan is clearly intended to help revive the economy. However, it will not really help. Demand from the advanced countries – still the driver of Chinese exports and indirectly of exports of other developing countries – will stay sluggish. Meanwhile, China’s slowdown infects other emerging markets across the world as its imports fall even faster than its exports. A weaker yuan is bad news for export -oriented economies like Singapore, Hong Kong, South Korea and Taiwan as their exports will be more expensive to Chinese buyers. Their exports to other countries will also have to compete against Chinese rivals who have the advantage of a weaker currency. This is not the end of the emerging markets, but is – or should be – the end of this growth model. Relying only on exports or debt-driven bubbles to deliver rapid growth cannot work for long. For developing countries to truly “emerge”, a more inclusive strategy is essential. Sources: The Guardian, 23 August 2015 and The Straits Times, 7 January 2016 Extract 6: New economic crash fears as British families run £40 billion deficit. British families are on course to spend £40 billion more than they earn this year, fuelling fears that the country’s economic growth is based on soaring levels of debt and could easily collapse. The forecast by the independent Office for Budget Responsibility (OBR) led to warnings that the UK could be heading towards a credit crunch similar to that of 2008 because of unsustainable levels of borrowing and household spending. Five years ago, UK households were comfortably not in debt, running a surplus of £70 billion as Britons tightened their belts in the wake of the financial crash and put money aside to save. But the new OBR figures show households are now deeply in debt, as growing economic confidence has led to a national spending spree. There is a real risk that millions of families will face serious hardship if interest rates start to rise. A Bank of England study found that the average mortgage debt in Britain rose from £83,000 in 2014 to £85,000 this year. Unsecured debt, which includes credit card charges, personal loans, student loans and utility bills, stands at around £8,000 per household.

Source: The Independent, 21 December 2015 Extract 7: UK trade deficit widens to four-year high. UK’s trade deficit last year was the widest since the alliance of political parties came to power, dealing a blow to the government’s drive to rebalance the economy away from consumer spending. Forecasting the outlook for this year, economists said exports would come under pressure from a stronger pound and a slowdown in important markets, especially the UK’s main trading partner, the Eurozone. The Eurozone remains unlikely to see much of an acceleration in growth in 2015, particularly given the uncertainty being generated by the prospect of a Greek exit from the single currency area. In addition, economic expansion is expected to continue cooling in China over the medium term, weighing down on export prospects there. Chris Leslie, the shadow chancellor, said: “Britain needs a serious strategy to help exporters – this means redoubling efforts to boost productivity, tackling infrastructure obstacles, addressing the skills deficit and ensuring innovators can access the funds they need.” Source: The Guardian, 6 February 2015 Questions (a) Compare the change in government debt levels as a percentage of GDP in China and the UK from 2010 to 2011. [2] (b) With reference to Extract 5, (i) “A weaker yuan is bad news for export-oriented economies like Singapore” Using a supply and demand diagram, explain how the devaluation of the Chinese Yuan may eventually affect the revenue (in SGD) of a Singapore firm that exports to other countries. [4] (ii) Explain the possible reasons why neither a cut in interest rates nor a devaluation of currency seem to work for China. [4] (c) With reference to Extract 6, explain how households’ standard of living in the UK may be affected if UK interest rates were to rise. [2] (d) Assess the effectiveness of the UK government’s proposed strategy to boost exports. [8] (e) Discuss the factors that the UK and China’s governments should consider in their macroeconomic decisions to rebalance their economies to achieve sustained economic growth. [10]

Suggested answers (2017 ACJC H2 Prelims) Question 2: Imbalances in the United Kingdom and China economies (a) Compare the change in government debt levels as a percentage of GDP in China and the UK from 2010 to 2011. [2] • Direction of change: China’s debt levels as a % of GDP decreased while UK’s increased [1] • Magnitude of change: UK’s change is much larger while China’s is an insignificant change. [1] (b) With reference to Extract 5, (i) “A weaker yuan is bad news for export -oriented economies like Singapore.” Using a supply and demand diagram, explain how the devaluation of the Chinese Yuan may eventually affect the revenue (in SGD) of a Singapore firm that exports to other countries. [4] • Singapore goods may be substitute to Chinese goods in other countries [1] • Devaluation causes Chinese goods to be relatively cheaper in other countries’ currency [1] • Leads to a fall in demand for Singapore’s exports. Therefore fall in price, quantity, and total revenue [1] • Diagram showing shift of demand curve to the left → lower equilibrium price and quantity → lower total revenue [1] For students that only focus on exports to China: maximum 2 mar