Practise analysing actual and potential growth through AD, LRAS and productivity data, then assess output gaps and the benefits and costs of rising real GDP.
In 2021 the value of foreign direct investment (FDI) to Singapore was $176 bn. In 2022 this value of FDI increased to $ 195 bn.
Which one of the following is the most likely impact of an increase in investment in an economy?
An increase in the rate of economic growth
An increase in the rate of unemployment
A decrease in the rate of employment
A decrease in aggregate demand
Study Figures 1 and 2 and Extracts A and B before answering Question 12.
Sources for use with Section C
The Romanian economy
Figure 1 Year-on-year real GDP growth by quarter, 2016-2017
Figure 2 The rate of inflation, as measured by the consumer price index, 2016-2017
Extract A Romania's economic growth
For many years Romania had been viewed as a poor country by European standards, experiencing low wages and a slow rate of economic growth. However, since 2015, Romania's rate of economic growth outperformed other European countries. This growth was stimulated by a number of factors including the Government's expansionary fiscal policy, increased household consumption and high levels of investment in new technology for manufacturing industries.
In 2015 the Government cut VAT from 24% to 20%. It planned to double the minimum wage over a four-year period. It also increased the salaries of public sector employees. However, wage levels are still low compared to other European countries leading to high levels of migration out of the country. This resulted in labour shortages as businesses found it hard to fill vacancies. The unemployment rate fell to 4.6% in 2017.
Romania has one of the fastest broadband internet speeds in the world, behind Singapore, Hong Kong, South Korea and Iceland. It also has a very well-educated workforce, with excellent language, maths and science skills. The technology sector is expanding fast in the country, and many large foreign firms such as Siemens and Ford have set up factories in Bucharest, the Romanian capital. This has increased production in the country and generated strong growth in exports.
Extract B Inflationary pressures
As disposable incomes have risen, consumption has also increased significantly reaching a ten-year peak in 2017. The rate of inflation has risen throughout 2017. This was partly caused by a 3.8% increase in food prices and by a 4.1% price increase in non-food products.
The central bank responded to this inflationary pressure by increasing its base interest rate for the first time in 10 years from 1.75% to 2%. Mugur Isarescu, the Governor of the central bank, suggested that the Romanian Government's fiscal policies are to blame for the higher rate of inflation. The fiscal deficit rose to 3% of GDP in 2016. The Government defended its position, believing that reductions in tax rates and increased government spending on infrastructure will lead to long-term economic growth.
With reference to the information provided, examine the likely impact of increased investment on Romania's economy. [8 marks]
Sources for use with Section C
The UK economy
Figure 1 Index of productivity for selected countries (2010=100), 2010 to 2020
Figure 2 UK net migration, 2010 to 2019
Extract A Low productivity
In 2021 the UK Government argued that the disruption in UK supply chains was mainly as a result of low wages, inadequate skills, and low productivity. The Government stated that reductions in welfare benefits and in the number of low-skilled immigrants were needed to increase the country’s productivity. 5 The UK Government suggested that a decrease in low-skilled immigration would force businesses to invest in training and in capital equipment. The goal of successive UK Governments has been to increase the UK’s productivity to improve living standards. However, between 1997 and 2008, the average annual productivity growth was only 1.9%. Between 2009 and 2019 it fell to 0.7%. 10 By 2021 productivity was nearly 20% below the level it would have reached if it had continued at 1.9%. Some economists believe that high rates of net migration were not the only reason for the UK’s poor productivity performance. They suggested that three other factors were also significant: 15; the 2008 global financial crisis; the UK’s decision to leave the European Union; the 2020–2022 global health crisis. These factors made many UK businesses particularly cautious about investing in innovation and research and development. 20 In 2021 UK employers reported they were facing significant wage increases, especially in jobs where severe shortages exist. There was a concern that these wage increases would harm the UK economy unless there was a growth in productivity. However, some economists argue that rising wages could incentivise businesses to invest in labour-saving machinery and staff training. 25 The shock of the global health crisis may provide a much-needed boost to UK productivity for reasons not associated with labour shortages. Many businesses have an opportunity to innovate and improve their operations before restarting again. The UK Government intends to solve the country’s low productivity by increasing investment in skills and in infrastructure. It is essential that it works in partnership with 30 businesses to achieve an increase in productivity and in the rate of economic growth.
With reference to Figure 1, explain the term 'productivity'.
Sources for use with Section C.
East African economies
Countries include Burundi, Comoros, Djibouti, Eritrea, Ethiopia, Kenya, Rwanda, Seychelles, Somalia, South Sudan, Tanzania and Uganda.
Figure 1 Annual real GDP growth, 2014–2018
Figure 2 Current account on the balance of payments as a percentage of GDP, 2016–2018
Extract A Rapid growth in East Africa
East Africa was the fastest growing region of Africa in 2018. Increasing commodity prices helped the agricultural and mining sectors contribute most to this growth. Higher foreign direct investment (FDI) in the region also contributed to economic growth. Growth in FDI in 2018 was 67% in Uganda, 27% in Kenya and 18% in Tanzania. Governments in East Africa have been investing in infrastructure, such as roads, seaports and airports.
As a result of rapid economic growth, the rate of inflation increased to 13.1% in 2016 and 14.4% in 2017. Appropriate monetary policy in the region helped the rate of inflation to fall to 8.9% in 2019.
Despite rapid economic growth rates, unemployment remains high. Many consumers struggle to meet their basic needs. The governments of the region have been advised to focus on interventionist supply-side policies. These should include continued investment in infrastructure, improving the health and skills of the labour force and increasing the supply of housing.
Extract B East African infrastructure investment needed
East African economies have under-invested in infrastructure. The roads in East Africa are in a poor condition. The combination of low speeds and long distances causes high transport costs. Rail transport is poor, which means most goods have to be transported on a congested road system. Funds from China are being used to build two rail routes in the region.
Inadequate energy supply is the biggest infrastructure problem. East Africa has the lowest energy generating capacity per capita on the continent. Poor energy supply causes blackouts. However, the region has the potential to develop hydro, wind and fossil fuel resources that could increase energy supply.
The region has the smallest proportion of its population with telephone lines and access to mobile phone networks in Africa. However, recently there has been a high level of investment in telecommunications infrastructure. This will result in significant improvements in communications.
With reference to Figure 1 and Extract A, examine two likely impacts of the annual GDP growth rates on the people living in East African countries.
From 2004 to 2018 the Ethiopian economy grew at an average rate of over 10% per year. Over this period there has been significant deforestation in the country. Forests have been cleared to make space for farming and the wood has been used for fuel and construction.
Evaluate whether the costs of economic growth outweigh the benefits.
The table shows the annual percentage change in the real GDP of Canada between 2017 and 2019. The long-term trend rate of economic growth for the economy is estimated to be 2.7%.
Which one of the following can be deduced from the table?
The positive output gap increased between 2017 and 2018
There was a negative output gap in 2018 and 2019
There was a positive output gap in 2018 and 2019
The negative output gap decreased between 2018 and 2019
In Q1 2019 Brazil's output gap was estimated to be equal to -5.6% of GDP.
Explain one likely impact of a negative output gap on Brazil's economy.
Using the IMF chart, explain one reason why measuring an economy’s output gap is difficult.