tut 16-18 - case study (pjc

HWA CHONG INSTITUTION Year One H1 & H2 Economics 2013

Tutorials #13-18: Macroeconomics II – Internal Macroeconomic Problems & Policies

TUTORIAL #16-18: MACROECONOMIC POLICIES

SECTION A: Case Study Practice – PJC Prelim 2009

Economic Performances of Germany and France

(a) (i) Describe the trend in the government budget balance as a percentage of GDP in Germany between 2003 and 2007. [2]

Table 3: Germany’s Macroeconomic Indicators

Germany 2003 2004 2005 2006 2007Government Budget (% of GDP) -4 -3.8 -3.3 -1.5 0.1

With reference to Table 3:The government budget balance as a percentage of GDP in Germany has improved [1] from deficit to a surplus [1].

Note: Those candidates who described budget as ‘negative’/’positive’ will not be given credit. Students are expected to present answers in an economic context, not a mathematical one.

(ii) Compare this trend with the change in the France’s government’s budget balance as a percentage of GDP in the same period. [2]


Germany 2003 2004 2005 2006 2007Government Budget (% of GDP) -4 -3.8 -3.3 -1.5 0.1

Table 4: France’s Macroeconomic Indicators

With reference to Tables 3 & 4:BOTH countries’ budget balances have improved over time [1]. HOWEVER, France’s budget balance remains in deficit whilst Germany’s budget balance has improved to a surplus position, at the end of the period [1].

Alternative answers are accepted as refinement for ‘difference’: Germany’s budget improved faster than France’s.

Hwa Chong Institution. All Rights Reserved. Tutors’ Copy1

France 2003 2004 2005 2006 2007Government Budget (% of GDP) -4.1 -3.6 -3 -2.4 -2.7



(b) Extract 4 indicates that wages in Germany are kept low. Explain a possible reason for Germany’s unemployment rates shown in Table 3. [2]

Note: Wage rates and employmentWhile wages are low (Extract 4), the unemployment rates (Table 3) seem fairly high. However, according to market forces (for labour), low wage rate would induce higher qty demanded for workers (by firms), ceteris paribus. Hence the data may not be explained by simple DD/SS theory.

Germany 2003 2004 2005 2006 2007Unemployment rate (%) 9.3 9.8 10.6 9.8 8.4

With reference to Table 3:Germany’s unemployment rate was between 8.4 to 10.6%. The figures seem incompatible with the fact that wage rates were kept low (i.e. real wage unemployment was not an issue).

Suggested answers:

1m – identify a possible reason1m – elaborate the reason using information from the extracts or otherwise.

(1) Technological unemployment:According to the data, the use of capital or capital-intensive method of production results in the low demand for labour (capital as a substitute for labour), thus unemployment will still be high (i.e. as firms prefer to use capital than labour for production) although wage is low. This is a form of “structural” unemployment, i.e. machines displacing workers.

(2) Frictional unemployment due to unemployment benefits/Welfare:If unemployment benefits are high in Germany, this could encourage more to remain unemployed and make claims for unemployment benefits. This is a form of “search” unemployment or frictional unemployment.

Note: The 1st answer can be inferred from Extract 4 but not the 2nd. But the question asks for ‘a possible reason’. So answers need not be found in the data.




(c) With reference to the data, account for the difference in the current account balance between France and Germany. [6]

Note: Refer to Case Study Skills Package. Since the command word is ‘account’, this question is still considered a type of Lower Order Skills Question. But the weighting is high, therefore the answers have to be detailed and yet concise.

General Mark Scheme for 6m LOS Questions:

L3 Elaborate (Extend to include analysis)Analyse – use relevant theory to aid explanationApply – place explanation in context of evidences from the data

5 – 6

L2 Consolidate (Add some details – application)Explain the economic concepts more in depth.Clarify – give examples from data with more elaboration

3 – 4

L1 Knowledge/Recognise (Description)Identify – the key theory without explanation or/and key evidence without explanationOutline: give a list of relevant factors

1 – 2

Tips: Use ‘SEED’StateElaborate with economic analysisExemplify with evidence from Data


Germany 2003 2004 2005 2006 2007Current A/C balance (% of GDP) 2 4.7 5.2 6.1 7.5Current A/C balance (Billion Euro) 47.3 77.9 95.8 116.1 181.9

Table 4: France’s Macroeconomic Indicators

Mark Scheme:

L3 Provides a balance analysis and reaches a reasoned conclusion on the basis of the tables and the extracts.

5 – 6

L2 Uses the tables and extracts to elaborate with economic analysis on the difference in the current A/C balance in Germany and France.

3 – 4

L1 Makes some relevant points without/with little elaboration 1 – 2

Suggested Answers:


France 2003 2004 2005 2006 2007Current A/C balance (% of GDP) 0.8 0.6 -0.6 -0.7 -1.2Current A/C balance (Billion Euro) 10.3 -4.4 -30.9 -32.6 -28.5



State

Identify the difference

With reference to Tables 3 and 4:Germany: current account balance surplus improved over the years. France: current account balance deteriorated from surplus to a deficit

Current A/C balance = net trade in visibles (goods) + net invisibles (services) + net balance on income and transfers

Elaborate with economic analysis

Why Germany BOT improved:

According to Extract 4, Germany’s improving current account surplus may be explained by her export competitiveness (rise in export revenue leads to improvement in current balance). This is achieved by maintaining low wages and hence lowering production costs. Thus Germany’s exports can be priced competitively in the international markets. Assuming demand for exports is price elastic in the overseas market due to availability of other substitutes, export revenue will rise since quantity demanded will increase more than proportionately with lower price.

Moreover, her comparative advantage in producing capital goods (“machine tools” in Extract 4) is helping her to export significantly to developing countries (such as China, India and Russia mentioned in the extract). With growing demand from developing countries and competitively-priced exports, Germany is able to enjoy improving current account surplus.

Why France BOT deteriorated:France is losing her export competitiveness as high wages drives up production cost. With more imports and deteriorating exports (or export competitiveness), France’s current account position worsened, ceteris paribus.

In addition, based on Extract 5, France’s worsening current account could be explained by the robust consumer spending which may encourage consumers to import more.

Conclusion The main reason for the difference in the current account for Germany and France is that the former has improved in terms of its export competitiveness while the latter is still lagging behind.

Missing information:Lastly, the data only suggest trade or visible accounts as possible reasons for the countries’ current account positions. No information about the invisible trade accounts is available to provide more evidence for the current account positions of Germany and France in Tables 3 and 4.

Note: It is not needed to include the missing info in the answers for an ‘account’ question. Nonetheless, it is always good to notice the insufficiency of the data.

Exemplify with evidence from Data

Germany’s and France’s current account position




(d) Discuss whether the data are sufficient to assess changes in the standard of living in these economies over the period. [8]

Note: Refer to Case Study Skills Package This is a typical ‘Higher Order Skills’ question. So it should be written in a form of ‘mini-essay’.

The style and approach would be similar to writing an AWEsome essay using thesis, anti-thesis and synthesis for structure. Nonetheless, it does not mean they are the same.

In terms of emphasis given to synthesis and conclusion, it is less demanding than an essay.

General Mark Scheme for 8m HOS Questions:

L3 Elaborate (Extend to include analysis)Analyse – use relevant theory to aid explanationApply – place explanation in context of evidences from the dataBalanced viewJustified conclusion

7 – 8

L2 Consolidate (Add some details – application)Explain the economic concepts more in depth.Clarify – give examples from data with more elaborationConsider both sides but lopsidedNo justified conclusion.

4 – 6

L1 Knowledge/Recognise (Description)Identify – the key theory without explanation or/and key evidence without explanationOutline: give a list of relevant factorsConsider 1 side – no evidence of discussion.

1 – 3

Tips: Use ‘SE3DS’StateElaborate with economic analysisEvaluateExemplify with evidence from DataStand




TIPS:For such a high weighting discursive question in the case study, the following steps are highly recommended:

1. While planning for the answers, approach it from an essay perspective to form a structure.

SOL over time:Introduction: Define SOL + approachMaterial: Nominal GDP Real GDP Real GDP per capita Composition DistributionNon-material: Suggest other supplementary indicators.

2. Next, based on the case material, select the relevant points and organize the points in order of importance according to the amount of evidence from the data.

3. Throughout the analysis, always remember to ‘insert’ evidence from the case material.

Key words: With reference to/According to (Extract 1, para 2, Table 4, Chart 2..)

1. For this particular question, nominal GDP will not be selected since real GDP is given.2. Real GDP is rising and thus shows an improvement in terms of material well-being. Do the

extracts ‘agree to’ or support that?3. It is obvious that population figures are absent.4. There are some forms of ideas on composition since the extracts mentioned that Germany’s

growth is more export-driven and France has robust consumer spending.5. The case study material also provides ideas on distribution: Germany – those who work in

industries producing machines for exports, France – those who work in the IT and services industry are most likely to fare better. But a better indicator is always the Gini-coefficient.

6. Non-material: Information on longer life expectancy and high expenditure on healthcare is useful. But more info such as stress level, working hours, environment, etc should be provided. Others indicator such as HDI / NEW / PQLI is needed.




Discuss whether the data are sufficient to assess changes in the standard of living in these economies over the period. [8]

1. This question requires the students to assess whether the data is sufficient to reach a conclusion whether SOL in Germany and France has improved.

2. To answer this question, the approach is ‘there is data but there are gaps and more information is needed’.

Suggested Answers

IntroductionStandard of living reflects the material and non-material well-being of the residents in a country. I shall be discussing whether and to what extent information from the data, namely tables 3 & 4 and extracts 4 & 5 are sufficient to assess changes in the standard of living in Germany and France over the period.

BodyMaterial well-being

Germany France

Real GDP According to the Real GDP growth (%) figures from Tables 3 & 4, both Germany and France are enjoying economic growth from 2004 to 2007. This would mean that there are more quantity of goods and services available for consumption. It also means that Germans and French are experiencing higher income and purchasing power which can be used to improve their material well-being. Extract 4 states that real wages did not increase significantly when firms try to stay competitive by keeping wages low. Hence the extent of SOL improvement may be limited. But the high unemployment rates in Tables 3 & 4 may signal structural unemployment. As a result, a significant number of Germans and French may suffer from lower material well-being,

Real GDP per capita

Simply looking at real GDP statistics may end up overstating the improvement in standard of living. One should take population growth into consideration. Thus, a better indicator will be real GDP per capita. This piece of information is absent from the data.

Distribution If a large proportion of the national income is earned by the minority, then we cannot conclude that the average German’s or French’s SOL has improved.The data does suggest that those who work in the export markets benefit more from the growth.

If the bulk of the income is earned by those in the IT and service sectors, then it may not be accurate to conclude that an average resident in France is enjoying higher SOL.

Nonetheless, to have a better picture of income distribution, Gini coefficient should be available.




Composition From Extract 4, it suggests that the economy was doing well due to an improvement in export sector. The increase in goods and services is not for local consumption and thus current standard of living may not have improved.

Extract 5 mentions ‘robust consumer spending’ and that it may suggest better material well-being of the French and thus higher SOL. This is especially so if consumers in France indulge in better-quality imports or enjoys a wider range of consumer goods that enhance their material and non-material well-being.

Non-material Quality of life indicatorsThe significant expenditure on healthcare (more than 10% of GDP) and the longer life expectancy are evidence to support that Germany’s and France’s SOL has improved over the period (2004-2007).

German’s workers may be under more stress out of fear of losing their jobs since ‘managers can threaten to move work to central Europe’ i.e. go offshore and capital seems to be replacing labour (Ext 4).

Extract 5 seems to suggest that with the help of strong unions, French workers may not be subjected to a competitive work environment (e.g. less stressful work or shorter working hours), and their fringe benefits may be secured to improve their quality of life.

Conclusion (evaluative judgment)The data provided is clearly insufficient to assess accurately/conclusively changes in SOL for both countries over the given period of time. This is because the most basic indicator of material well-being which is REAL GDP per capita is not available. Furthermore even if this available there are other issues which must be considered such as whether income disparity has worsened.

Moreover the information provided which pertain to the quality of life is far too inadequate. There are other issues besides health care and life expectancy that impact on quality of life e.g. stress; quality of the environment. At best, the information provided is only indicative of changes in the SOL. Other indicators such as PQLI are needed.

Mark Scheme:

L3 Assesses both sides for both countries and come to a justified conclusion. 7 – 8 L2 Considers both sides/countries and with some form of economic analysis & evidences

from the data.4 – 6

L1 Considers only sufficient or insufficient data without/with little elaboration OR considers only 1 country.

1 – 3




(e) With reference to the data, evaluate the measures that France can adopt to achieve its macroeconomic aims. [10]

Note: This is another typical ‘Higher Order Skills’ question. So it should be written in a form of ‘mini-essay’.

The style and approach would be similar to writing an AWEsome essay using thesis, anti-thesis and synthesis for structure.

General Mark Scheme for 10m HOS Questions:

L3 Elaborate (Extend to include analysis)Analyse – use relevant theory to aid explanationApply – place explanation in context of evidences from the dataBalanced view

7 – 8

L2 Consolidate (Add some details – application)Explain the economic concepts more in depth.Clarify – give examples from data with more elaborationConsider both sides but lopsidedNo justified conclusion.

4 – 6

L1 Knowledge/Recognise (Description)Identify – the key theory without explanation or/and key evidence without explanationOutline: give a list of relevant factorsConsider 1 side – no evidence of discussion.

1 – 3

E2 Judgment based on analysis 2E1 Mainly unexplained judgments 1




TIPS:For such high weighting discursive question in the case study, the following steps are highly recommended:

1. While planning for the answers, approach it from an essay perspective to form a structure.

Measures to achieve macro goals:Introduction: State the goals + approachBody: Measures: Short-run policies and their limitations: Fiscal, monetary, exchange

rate Long-run policies and their limitations: Trade and supply-side

policiesConclusion: Synthesis + Judgment

2. Next, based on the case material, select the relevant points and organize the points in terms of importance according to the amount of evidence in the data.

3. Throughout the analysis, always remember to ‘insert’ evidence from the case material.

Key words: With reference to/According to (Extract 1, para 2, Table 4, Chart 2..)

For this particular question:a. Identify the goals/problems – slow growth rates, high unemployment rates and

current a/c deficitb. Identify the policies to be used:

Table 4 has evidence of expansionary fiscal policy based on budget deficit, Thus for short-run policy, FP will be chosen. Limitations?

Extract 5 mentions ‘low interest rate’, so may consider expansionary monetary policy. Limitations?

Note: The question is ‘measures France can adopt’. So any logical policy can do. In reality cutting i/r cannot be carried out unilaterally or independently by France. This

is because as a member of the Eurozone (i.e. EU countries using a common currency the euro), France is bound by treaty to adopt a common interest rate or monetary policy in order to uphold the value or exchange rate of the euro. If France were to say cut i/r independently of the rest of the Eurozone, then funds will flow out of France, thus de-stabilising the value of the euro.

Similarly, as a member of the Eurozone (i.e. common currency area), France cannot independently devalue the euro to improve its trade deficit. This is the price it has to pay for being a member of the EU.

So if these policies are chosen, it must be brought to the attention of the examiners, it is not done by France unilaterally.

As short-run policies do not solve the root cause of the problem, it is necessary to introduce appropriate long-run policies.




(e) With reference to the data, evaluate the measures that France can adopt to achieve its macroeconomic aims. [10]

IntroductionTo be a successful economy is to achieve the four macroeconomic.goals – one that is characterised by sustained growth, stable price level, full-employment and favourable BOP.

However, with reference to Table 4, it appears that the French economy is facing: Slow Growth rates (1.1-2.2%) and High Unemployment rates (8-9%) Unfavourable or deficit in the current account Note: inflation is least of the concerns here. But the use of expansionary policies, if not

accompanied with SSP, can lead to demand-pull inflation.

This part of the case study shall discuss on the measures that France can adopt to achieve its macroeconomic aims.

Body: Possible policies that can be used to spur economic growth and reduce unemployment and reduce trade deficits (any 3, but should include long-run policies)

(A) Expansionary Fiscal Policy (fiscal stimulus)

Explain how expansionary FP can stimulate AD, hence lead to actual growth and lower cyclical unemployment (refer to notes): In theory through a budget deficit, the government can inject more expenditure into the circular flow to create K effects. Given the relatively low inflation rate (less than 2%), an increase in AD is likely to expand output and hence create more jobs for the economy.

Limitations:According to Extract 5 and Table 4, the French government already has been running persistent deficits between 2003-2007.

This policy might result in the government having to finance its deficit by further borrowing which leads to crowding-out effects. Crowding out effects: Increased government borrowing in the financial markets pushes up interest rates leading to higher cost of borrowing for the private sector. This in turn may discourage private consumption and investment expenditure. In short, private spending is displaced by more G spending and borrowing, resulting in only marginal increase, if any in overall aggregate expenditure for the economy. Hence growth may be limited.

From Ext 5 para 2, budget deficit is also well-above the eurozone average of 1.6% and its accumulated debt levels amounted to 64% of GDP. There is thus little room for more fiscal deficits, as further borrowing may lead to a debt crisis.

Possible demand-pull inflation may ensue, conflict macro goal of price stability. In the worse case scenario, may worsen the export price uncompeitiveness that France is currently facing and worsen the current account deficit.




EXTRAOther possible adverse effects on the economy of mounting public debts: Cut spending or Austerity Measures: Government may adopt austerity or “belt-tightening”

measures such as cutting G spending on welfare benefits; healthcare and education. Such cutbacks on G spending may adversely impact on quality of life and standard of living for the average resident of the country.

Print Money: Government may have to resort to “printing” money i.e. monetizing the debt to finance the deficit. This would lead to hyperinflation if economy is flushed/flooded with excessive liquidity.

Increased T: Raising taxes to finance the deficit. Hefty tax increases may lead to a sapping of productivity due to its disincentive effects on individuals and firms willingness to work, save and invest. This in turn may hinder future growth as productivity and innovation shrinks.

(Bi) Expansionary Monetary Policy

Explain how expansionary MP can stimulate AD, hence lead to actual growth and lower cyclical unemployment (refer to notes): Cut interest rates to stimulate more borrowing to spend on C and I. Could be effective if the demand for loans is interest elastic. That implies borrowers are optimistic and upbeat about the economic outlook. Extract 5: ‘economy propped up by low interest rate and robust consumer spending’ seems to suggest monetary policy is effective in France.

Limitations Since the interest rate is already low, there is thus limited scope for further cut/reductions in

nominal interest rate. In reality cutting i/r cannot be carried out unilaterally or independently by France. This is

because as a member of the Eurozone (i.e. EU countries using a common currency the euro), France is bound by treaty to adopt a common interest rate or monetary policy in order to maintain the value or exchange rate of the euro. If France were to say cut i/r independently of the rest of the Eurozone, then funds will flow out of France, thus de-stabilising the value of the euro.

Possible demand-pull inflation may ensue, conflicting with the macro goal of price stability. In the worse case scenario, may worsen the export price uncompeitiveness that France is currently facing and worsen the current account deficit.

(C) Exchange rate policy (not mentioned in the data)In theory, a country can devalue its currency to improve its BOP. Devaluation lowers the price of exports in terms of foreign currency and raise the price of imports in terms of dmextic currency. According to the Marshall-Lerner Condition, if the sum of the price elasticities of demand for X and M >1, the BOT would improve. Ceteris paribus, BOP would improve. With BOT improving, AD will rise and shift right since (X-M) increases, leading to actual growth.

Limitations However, as a member of the Eurozone (i.e. common currency area), France

cannot independently devalue the euro to improve its trade deficit. This is the price it has to pay for being a member of the EU.

The J-curve effect suggests that BOT may worsen in the short-run Price of imports will be more expensive in terms of domestic currency, so this

will lead to import-price-push inflation. If France’s exports have a high import content, then it will lose its export price compeitiveness and worsen the current account deficit.




(D) Supply-side Policies

The root of the problems may be due to the fact that France has lost its comparative advantage and the skills of the workers are obsolete.

Use SSP To gain export competitiveness to correct for the unfavourable current account position. To upgrade the skills of workers to fit them in the ‘new jobs’

Possible ways to carry out such policy would be to reduce to reduce/cut business costs and/or expand productive capacity

Examples: Government’s investment in infrastructure. Tax incentives: Introduce tax incentives to those firms in the export sector and those which can

develop new comparative advantage through R&D. According to Extract 5, France’s comparative advantages seem to be IT and services and they are attracting substantial investment.

Subsidies: Subsidises education/training e.g. IT industry

Positive spin-offs:With more firms engaging in production, more tax revenue can be collected although with lower corporate tax rate, the tax collected from each firm is lower, the increase no. of firms would compensate for the lower tax rate imposed, to end up with higher tax revenue at the end of the day. This could also help to address the high debt burden and the persistent budget deficit.

Limitations Time-lags – long-gestation period to bear fruit e.g. R&D. Government’s investment in infrastructure may be limited since the budget deficit is a concern at

present (based on Extract 5). Tax and subsidies/benefits to exporters might be construed by trade partners as a form of

protection or unfair competitive advantage given by the government and thus might attract retaliatory measures.

(E) Labour market reforms including wage policy

According to Extract 5, “poor labour market performance” appears to be a major source of France’s poor economic performance in terms of exports and growth. Solution institute reforms in the labour market to make wages and hiring more flexible to changes in economic conditions.

Examples:Ban union militancy (e.g. ban strike; give employers the right to hire/fire) Adopt flex-wage policy ( wages can rise/fall in tandem with economic conditions)Adopt performance-based wage policy ( wage growth is tied to productivity growth)

LimitationsStrong political resistance -The French people are ardent supporters of “socialist” or pro-labour policies. Difficult to break this culture. As mentioned in Extract 5, it may be difficult to garner support to implement wage or labour market reforms to make the labour force more flexible and nimble.




Conclusion (justified judgment)Given the special circumstances, it would appear that the French government has indeed very limited policy options to address the macroeconomic problems on hand i.e. unemployment, slow growth and unfavourable BOP.

As a member of the Eurozone it does not have the option of using monetary policy and exchange rate policy. Its ability to use fiscal stimulus is also curtailed by its mounting public debt. Moreover, its strong unions and socialist culture pose formidable challenges to implementing labour market reforms.

Perhaps, the silver lining seems to come from French comparative advantages in IT and services. Thus effective policies targeted at making the Paris region Europe’s ‘Silicon Valley’ and a service hub may be a promising proposition in dealing with the current economic problems.

Note: Under exam conditions, you need not have all the points. Just ensure there are at least 3 policies with a balance of short and long run measures.

Mark Scheme:

L3 Evaluates the measures with strong reference to the data. 7 – 8 L2 Explains the measures more in depth and with some reference to the data. Limitations

are mentioned.4 – 6

L1 Identifies – the key measures without explanation or/and key evidence without explanationNo mentioning of the limitations of the policies

1 – 3

E2 Judgment based on analysis (justified conclusion) 2E1 Mainly unexplained judgments 1


tut 16-18 - case study (pjc

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