Writing skills - AS Level Example 1
China’s economic growth has resulted in a significant increase in pollution within the
country. It is believed that recent government legislation to lower pollution will cause
China’s real GDP to increase at a slower rate.
Evaluate the view that conflicts between macroeconomic objectives are inevitable. (Source : Edexcel May 2019)
Possible Guidelines -
To start with let me present my understanding on the issue.
Conflict in macroeconomic objectives could be described as a consequence of a government effort to achieve one of its many objectives leading to unable to achieve the other objective(s).
As we can see from the case study above that China has enjoyed economic growth for a long time, but at the same time they have experienced an increase in pollution across the country. If China tries to control the pollution, then many people such as economists and policy makers believe that their actions will slow down the GDP rate for China. As a result, a clear conflict in objectives is visible.
Before I get into the conflict analysis let me mention those macroeconomic objectives first. Those are as follows; higher economic growth, maintaining lower unemployment, stabilizing the inflation, protecting the environment, balancing the government budget, balancing the balance of payments, higher living standard and reducing the income inequality etc.
Like any other governments, government of China would also expect to achieve all the objectives at the same time, as they are all important to improve the living stand of the people of China. Unfortunately, measures taken to achieve one, may not support in achieving the other objectives at the same time. This means, there is likely to have conflicts between objectives. Let me discuss those conflicts below.
Inflation and living standard – Generally, a government aims to lower the inflation at the same time increase the living standard. Inflation means rise in average price level and the living standard means an increase in quality of life due to higher consumption and greater convenience. If the inflation rate rises beyond the targeted level due to higher aggregate demand, then Government of China may try to bring down the aggregate demand to bring down the inflation rate to their targeted level. To do that government of China may raise the interest rate or tax rate to incentivize higher saving and lower consumption. This will definitely help to achieve the objective of bringing down the inflation rate, but at the cost of higher living standard. This is because, as the interest rate or tax go higher, it becomes either costly to borrow or have less disposable income to fund their consumptions. As a result, this will lead to achieving one objective at the cost of the other.
Inflation and unemployment – Objective of any government would be to stabilize the inflation at the same time lowering the unemployment. If a government tries to achieve the first objective, then they must take measures to bring down the inflation, if in case it is higher than their targeted level. Such measures, could be, using the contractionary or deflationary monetary or fiscal policy. Which means, Government would either increase the interest rates or increase the tax rates. In both cases, aggregate demand led by lower consumption and investment spending, will drop in the economy. As a result, national output would decrease leading to an increase in unemployment in the economy. This is presented through the Phillips curve below, where there is a clear trade-off between unemployment rate and inflation rate.
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| Phillips Curve |
Macroeconomics - AS Conflict in Macroeconomic Objectives
Inflation and current account balance - government of China may have objective to reduce the inflation at the same time reducing the balance of trade deficit or increase the trade surplus in current account balance. If the government of China tries to reduce the inflation by increasing the interest rate then, it may cause appreciation in the currency leading to higher imports and lower exports. This will lead to widening in trade deficit or narrowing trade surplus leading to deteriorating current account balance. Thus, achieving one objective will lead to not achieving the other.
Government budget and economic growth – Generally, Government tries to maintain a balanced budget without intervening into the economy. Balancing the fiscal budget means, any spending in the economy will be in line with similar amount of tax revenues collected by raising the tax. This is good for balancing the fiscal budget but not for promoting the higher economic growth as it causes injection into an economy to be equal with leakages. Which in turn causes multiplier effect to be neutral in broader sense. As a result, the objective of balanced budget comes at the cost of higher economic growth, leaving to have a conflict between both the objectives. On the other hand, if a government wants to promote higher economic growth in the economy then, it has to inject more money into the economy without increasing the leakages. This means, government of China may have to spend more money into the economy compared to the revenue they may collect. As a result, they may have to run a fiscal budget deficit. Thus, we can see there is a conflict between higher economic growth and government budgetary position, as the higher economic growth may come at the cost of balanced budgetary position.
Economic growth and protecting the environment - Government of China may have objective of higher economic growth at the same time an objective to protect the environment. Higher economic growth means producing more output compared to last year, whereas protecting the environment means government efforts to stop the actions of the economic agents who are affecting the environment negatively. To achieve higher economic growth, government of China may encourage firms to produce more output in order to generate more employment and income to improve the living standard among people. Whereas, to protect the environment government of China may have to introduce many legislations to stop the irresponsible actions of the firms that are exploiting the environmental norms. If the earlier objective is prioritized then government may allow firms to produce more output by relaxing the environmental norms. This may cause huge damage to the environment, whereas prioritizing the latter means bringing down the output leading to bringing down the economic growth. Thus, achieving one objective comes at the cost of the other.
Economic growth and income equality - In order to achieve higher economic growth government may encourage large industries and attract higher skills as they are the ultimate driver of economic growth. With their efforts, a government may achieve their objective of higher economic growth but not without the greater advantage of economic growth going to them (the industrialists and highly skilled white collar workers). This is because, they are they people who would mostly own the resources and pursue the higher skills that a large portion of the population may not afford to own or pursue. As a result, income gap among people is likely to increase leading to not being able to achieve the objective of equal income distribution. If a government tries to achieve the objective of equal income distribution then it may take some measures such as minimum wage to bring down the income gap. Such measures will increase the cost among firms leading to less incentive for firms to higher more workers and produce more output. Thus, affecting the economic growth to some degree. As a result, it would be real hard to achieve both the objectives at the same time.
Economic growth and current account balance - in order to achieve higher economic growth government of China may spend more leading to rise in aggregate demand in the economy leading to an increase in production of more output. This will cause government of china to achieve higher economic growth. But we should not forget that the higher economic growth means higher income among people leading to higher confidence among people to fund their consumptions. This may cause importing more goods from overseas. If the imports are higher than the exports then China may experience deficit in balance of trade leading to deteriorating current account balance. Thus, again achieving one objective may lead to sacrificing the other.
Macroeconomics - AS Conflict in Macroeconomic Objectives
However, the conflict between objectives depends on the types of economic growth or sectors specific.
No trade-off between inflation and unemployment - If the growth is long run economic growth then the conflict between objectives would be fewer. As we can see from the graph below (Figure 2), if China’s economic growth is led by the shift in LRAS then, the price level may go down causing inflation to be under control at the same time unemployment will decrease leading to no trade-off between unemployment and inflation.
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| Figure 2 - Supply-side Policies |
Macroeconomics - AS Conflict in Macroeconomic Objectives
Economic growth may lead to almost close to equal distribution of income - Income equality is likely to increase, if the shift in LRAS (Figure 2) was led by increase in productive potential due to higher education and training among people. This will cause the number of skilled workers to increase leading to higher pay and higher income distributed among greater portion of the population. The current example would be the European nations such as Finland, Norway and Denmark where higher literacy rate and skills (due to investment in human capital) among people caused lower income equality in the country. Thus, economic growth can be achieved in line with greater equal distribution of income among people. Same is possible for China.
Power of trade union - There is another possibility that trade union with more power would negotiate with firms time to time to increase the pay scale among workers in response to the higher economic growth. This will help to redistribute the income among people in more equal way than to a situation where trade union has less power.
Minimum wage - As the economic growth increases, government may increase the minimum wage to benefit a larger portion of workers leading to decrease in income inequality in the country. Thus, government of China would be able to enjoy higher economic growth at the same time be able to decrease the income inequality in the country by pushing the minimum wage up to an accepted level. Thus, lesser or no conflicts between the objectives.
Economic growth and investment in cleaner technology - Higher economic growth in China would make firms to have enough profit to fund R&D to develop new environment friendly cleaner technologies that increase productivity among firms at the same time reduces the negative impacts on the environment, which would have not been possible if there was no economic growth. Thus, achieving higher economic growth may lead to protecting the environment better than before leading to have lesser or no conflicts.
Economic growth and current account balance surplus - As we can see from the Figure 2, if the economic growth is achieved by increasing the productive potential, then firms in China are likely to enjoy the price competitiveness in the overseas market. This will lead to higher exports. If the exports value is higher than the imports value, then China is likely to enjoy higher economic growth and greater current account surplus altogether. As a result, fewer or no conflict in achieving both the objectives.
On the other hand, if the economic growth is export-led, means, growth comes from greater amount of exports, then an economy like China would experience higher economic growth and greater current account surplus at the same time. As a result, achieving both the objectives altogether without any conflict.
Economic growth may cause improvement in budget value - Though budget deficit may take place in order to achieve higher economic growth, but once higher economic growth is achieved then, it may cause higher income among people leading to collection of higher direct and indirect tax revenues that could be used to pay back any debt due to running a budget deficit before. It is regardless to say that the overall budget value of the government would be greater than before. As a result, China may experience higher economic growth leading to greater budgetary position.
Macroeconomics - AS Conflict in Macroeconomic Objectives
Deflation and living standard - This is when an economy is going trough chronic recession and the confidence among buyers and sellers are very low leading to less economic activities in the country. As a result, a huge amount of spare capacity will not be utilized and the economy may experience deflation. In this case, government objective would be increase inflation by rising aggregate demand. A rise in aggregate demand may lead to a small rise in price level but huge increase in output (depending on the increase in AD and how far the economy is from the full employment). As, more output produced with small rise in price level, government objective to keep inflation within a range will be achieved at the same time more income among people would be generated. This increase in income led by higher inflation may lead to an increase in living standard compared to before. Thus, objective of keeping inflation within a range and improving the living standard among people would be achieved together.
Economic growth and higher living standard - Economic growth may allow government of China to collect more tax revenues than before. This will allow government of China to provide better public services such as education, healthcare, transportation services and securities. These will help China to improve the living standard of the people further. Thus, economic growth and higher living standard both can be achieved together without any conflicts.
To conclude, I must say that, it is not possible to achieve all the macroeconomic objectives altogether, though use of supply-side policy may help to achieve them with fewer conflicts.
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