H1 Case Study Question 2 Answers

Answer all questions. Question 2 Economic Priorities Extract 5: Financial crisis could turn the tide against unrestricted capital flows The theory says that free capital flows allow savings to be directed – by the invisible hand of the financial markets – to wherever they will be most profitably employed. In this way, savers get a better return on their nest egg, while underdeveloped economies receive the financial leg-up they need. Except that isn't what's been happening: instead, for the past decade and more, savings have been pouring uphill from poor c ountries to rich. Fa r from nurturing development and improving the standard of living of the poore st, these vast flows of money have created a repeated pattern of boom, bust and financial crisis. In recent years, several countries have quietly begun erecting breakwaters against the latest tidal wave of capital, driven by low interest rates in the west. Brazil, Argentina and Costa Rica have used various measures, in cluding taxes on purchases of shares and bonds and insisting that short-term invest ors deposit funds with the central bank for a year, to dampen the stop-go cycle. One unlikely recent champion of the reintro duction of regulations on capital flows is the Bank of England. The shock of being ca ught unawares by the vulnerability of the UK's financial system in 2007 and 2008 c aused soul-searching in Threadneedle Street, and recent papers and speeches have helped build the case for new thinking. Adapted from: The Observer, 8 January 2012 Extract 6: Counter-cyclical policy responses An important lesson from the se verity of the recent world financial crisis is that policy in various areas will have to be more prud ent during upswings and to build in greater safety margins to be able to react to large adverse shocks. For instance, the room for fiscal policy to react to a downturn is c onstrained by budget defic its and debt at the outset. In general, the poorer th e fiscal position the less reactive governments have been and can be in their response to adverse shocks. Adapted from: Organisation for Economic Cooperation and Development (OECD), 2010 Extract 7: IMF cuts UK economic growth forecast for 2011 to 1.75% The International Monetary Fund (IMF) has cu t its 2011 growth forecast for the UK economy to 1.75%, its third downgrade in a y ear. The cut cement s the widely held view that Britain faces a year of lo w growth and rising une mployment with little prospect of a job-creating recovery until later in 2012. The report warns that the downside risks to UK growth have increased as the potential for policy mistakes in the eurozone have risen. The cost of oil and other raw materials, which have jumped 32% over the last year according to the IMF's own index, also pose extra risks. Source: The Guardian, 11 April 2011

9732/01/IJC/Sep 12 2 Extract 8: South Korea economy One of the major threats to the Korean economy is the global economy facing a patchy recovery due to continued stiff hea d winds, such as high-flying commodity prices and currency disputes among advanced economies. Global economies will continue to fall into two distinctive camps dubbed the “two- speed world.” Western economies and Japan will undergo a slow recovery mode, while developing economies, including emer ging market economies, will continue to enjoy robust growth. Under this new trend, the Ko rean economy and companies shou ld shift their focus to emerging economies from developed countries to capitalize on the upcoming change triggered by the outcome of the global financial crisis. “We expect the global recovery to rema in a two-track one, with the emerging economies growing much faster than the developed world economies,” Nomura Securities said in its 2011 outlook repor t. “For the developed economies, the post- crisis world likely means prolonged anemic growth.” Source: The Korea Times, 31 Dec 2010 Table 1: Youth Unemployment Rates, December 2007 to March 2012 (Percentage of total youth labour force (15-24) Country December 2007 March 2012 Greece 21.6 51.2 South Korea 8.7 9.5 UK 13.6 21.9 Source: The Guardian, 16 May 2012 Table 2: Labour Productivity Annual Growth Rate Country 2007 2008 2009 2010 2011 Greece 2.8 -1.5 -0.3 -2.8 -0.9 South Korea 5.5 4.3 1.2 6.5 1.8 UK 2.2 -0.8 -2.3 1.8 1.9 Table 3: Gross Domestic Product Annual Growth Rate Country 2007 2008 2009 2010 2011 Greece 3 -0.2 -3.3 -3.6 -7.2 South Korea 5 2.3 0.3 6.1 3.6 UK 3.4 -1.1 -4.5 2.1 0.7 Source: OECD, 2012

9732/01/IJC/Sep 12 3 Extract 9: Innovation Much of the rise in living standards is due to innovation. Today, innovation performance is a crucial determinant of competitiveness and national progress. Moreover, innovation is import ant to help address global c hallenges, such as climate change and sustainable development. But despite the importance of innovation, many OECD countries face difficulties in strengt hening performance in this area. Indeed, many OECD countries have seen little impr ovement in productivity performance in recent years despite the new opportuni ties offered by globalisation and new technologies, especially the information and communication technologies. Source: OECD, Innovation and Growth Rationale for An Innovation Strategy, 2007 Questions (a) (i) State the economic relationship that exists between labour productivity growth and economic growth in UK and South Korea. [1] (ii) Account for the above economic relationship in South Korea. [2] (b) Explain the case for the use of regulat ions by UK governm ent to manage huge ‘capital floods’. [4] (c) (i) Compare the youth unemployment rates in Greece, South Korea and UK. [2] (ii) Explain the impact in both the shor t run and the long run of the above situation in Greece or UK. [3] (d) Extract 9 suggests that ‘much of the rise in living standards is due to innovation.’ Discuss the validity of this argument. [8] (e) “An important lesson from the severity of the recent worl d financial crisis is that policy in various areas will have to be more prudent during upswings and to build in greater safety margins to be able to react to large adverse shocks.” Assess the extent to which the UK gov ernment’s economic priorities may be adjusted in response to growing youth unemployment? [10] [Total 30 marks] -End of Paper-

9732/01/IJC/Sep 12 4 Suggested Answer: (a) (i) State the economic relationship that exists between labour productivity growth and economic growth in UK and South Korea. [1] Direct relationship (ii) Account for the above economic relationship in South Korea. [2] Students can choose to use PPC model or AD/AS model to explain the direct relationship that exists bet ween labour productivity growth and economic growth in South Korea. Using PPC analysis:  in labour productivity growth rate  Rise in output produced per man hour  Outwards shift of PPC  Higher economic growth achieved by South Korea economy Using AD/AS analysis:  in labour productivity growth rate  More output with the same amount of input   unit labour cost of production  Rightwards shift of AS curve  Higher real national income achieved by South Korea economy (b) Explain the case for the use of regul ations by UK government to manage huge ‘capital floods’.