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Econ 219 – current economic problems

Lecture 1 – 5th Jan – the post 2008 economy

The expansion of markets


Horizontal dimension
 expanding the reach of the market to include new geographic areas which results in
globalisation, this is expansion in the same process
Vertical dimension
 expanding the reach of the market to include new activities, goods, and services which were
not previously produced
 the causes of economic growth has changed through periods of time to new focus of production
o primary sector (farming)
o secondary sector (industry/manufacturing)
o tertiary sector (services and information)
 this movement from traditional economy to an industrial economy to a post industrial society

Factors contributing to the expansion of markets


 technology
 political entities (nation-states)
 ideology (liberalism, neoliberalism)
 cultural (individualism, postmodernism)

Factors which resist expansion of markets


 political entities (certain nation states)
 ideological (traditionalism)
 cultural (collectivism)

Should higher authorities which resist the expansion of markets act to override the preferences of
individuals and organisations
 markets under perfect competition are allowing individuals to pursue their own interests and
satisfy their own preferences given some constraints (such as endowments and skills however
these are objective in their worth)
 although some might argue that that regulations can reach a more superior outcome than that
of a free market, especially to domestic supply

Advantages of globalisation
 globalisation improved standards of living, particularly in developing and emerging countries
leading to an expansion of the global middle class
 globalisation has reduced world inequality such as the Gini co-efficient of the world economy
improved
 economic globalisation leads to higher cultural and political integration
 trade enhances the division of labour as countries specialise, economies of scale and efficiency
 competitive markets reduce monopoly profits and incentivise business to seek cost reducing
innovations on what they sell

Disadvantages of globalisation
 anti-corporation and anti-capitalist, against expansion of markets due to commodification and
consumerism
 anti political integration against global governance perceived as inevitable unaccountable and
undemocratic
 anti-cultural integration
o against cultural imperialism (colonialism, misappropriation, ethnocentrism)
o against corrosive influence of neoliberal individualism
 environmental argument continuous economic growth and market expansion can be a negative
influence on society
 can lead to high inflation due to strong demand for food and energy, acts to influence
macroeconomic stability due to interdependence
 structural unemployment in certain industries due to cheaper labour being provided in other
countries

Standard assumptions of neoclassical economics


 methodological individualism
o instrumental rationality (individuals are rational in their behaviour) this means
autonomously formed individual preferences which are transitive in addition to being
clear and distinct
o self-centred hedonism (pleasure seeking behaviour)
 value neutrality in order to avoid prejudging individual preferences

Methodological individualism
 explains social phenomena through the idea of individual motivations and actions
 weberian sociology (interpretive explanations, theory of ideal-types)
 looks for micro foundations in order to form a basis for ideas
 rational choice theory and game theory identifies the collective action problem

Methodological collectivism
 emphasis on collective agency and on the constraints and regulating human actions
 functionalism are parts of a social system which must have a function/role/purpose
 there is no sense of individual agency

Subjective theories of value


 neoclassical economics, where value is derived from the incremental utility of consuming an
additional unit of a good
 all factors of production earn a return that depends on he value of their marginal product
 general equilibrium model

Objective theories of value


 theory of intrinsic worth (Locke)
 all inputs could be expressed in terms of their labour content
 command vs embodied labour leads to a theory of surplus value and exploitation
 factor prices are underdetermined, relevance of political action

Equilibrium
 in the long run markets reach equilibrium
o Keynesian: free markets are volatile and not always self correcting, movement towards
the equilibrium in the long run takes time and so government intervention may be
appropriate
 free market is naturally prone to periods of recession and depression
o Laissez faire economics says that in the absence of external intervention, markets move
back towards equilibrium and that government often has unintended consequences

State formation theories


 voluntary theories
o Wiffofogel – the need to build large scale irrigation projects
o automatic hypothesis – the development of agriculture automatically leads to the
production of surpluses, division of labour and state formation
o the need to build and maintain trade infrastructure
o social contract theories
 conflict theories
o Engles: the need to protect private property, economic stratification leads to state
formation, whereby the state protects only the interests of the elite
o Oppenheimier: a tribe conquers another tribe and sets up state institutions in order to
govern them and extract a surplus
o Circumscription theory: one needs a geographic barriers to have a state

Market formation theory


 voluntary theories
o liberal theories: willing buyers and willing sellers
o these theories rely on the finding that the advantage of free markets is that, under
certain conditions they lead to pareto optimality (allocative and productive efficiency)
 conflict theories
o theory of primitive accumulation, reference to the transformation of communal land in
privately owned land
o Polanyi: laissez faire was planned, social protection was a spontaneous reaction

The Great Recession


Poor economic performance of world markets starting with 2008, worst global recession since WW2
which started with the US subprime mortgage crisis of 2007-2009
 Process of the recession
1) large amount of homeowners default on their mortgages, and so sub-prime related
losses in the first half of 2007
2) the crisis spreads to other asset classes and to financial institutions
3) In the US and UK a number of smaller financial institutions go bankrupt or get taken
over
4) Lehman Brothers go bankrupt in September 2008
5) Equity markets lose 50% of their pre crisis levels, money markets become illiquid
6) this then becomes an economic downturn leading to high unemployment and GDP
growth rates
7) policy responses
 government bailouts, insurance companies
 Troubled asset program relief was adopted
 expansionary fiscal (government expenditure and tax cuts for AD) and monetary
policy (low interest rates and quantitative easing)
 aftermath
o equity markets bounced back, unemployment rates went down in some countries
o GDP has started to grow, but not back to pre recession level
o monetary policy means that interest rates are not back to pre recession level
o governments have a large budget deficit, but the political consequences aren’t clear

The underlying causes of the great recession


The background
 the internet bubble from the soaring of share prices due to unrealistic expectations of the
potential of the internet
 increased global imbalances or large amounts of deficits in developed economies, and
surpluses in developing countries
 public and private debt in the US from bush era tax cuts, and the war related expenditure help
to increase the underlying stability

Banking sector
 there is a moral hazard where bankers might be willing to take more risks than optimal if
losses are socialised while gains are privatised, meaning that the negative impact wouldn’t be
focused on them
 in response to the internet bubble the FED, adopted a lax monetary policy which ignored
inflated asset markets, which left the economy susceptible to the impact
 global imbalances form excessive private and government consumption, Chinese government
policy, liberalisation of financial markets all resulted in a large unavoidable global impact
 politicians prefer economic growth due to their greater chance of being re elected as a result

Main trends of the post 2008 economy


 low global growth and low inflation rates
 the emergence of the new/digital economy
 concerns about global imbalances and the lack of coordination of policy responses due to the
high interdependence especially in the EU
 rising fiscal deficits and increased difficulty of national governments to protect to protect their
tax base
 rising inequality particularly in the developed world, which came about with the high
unemployment rate

Policy responses: the austerity vs stimulus debate


 austerity – reducing budget deficit and aiming for a balanced budget over the business cycle
o this is a contractionary fiscal policy which results in higher taxes and/or cuts in planned
government spending
o although the Laffer curve illustrates the limitations which can occur with higher taxes
o rising bond yields if investors lose confidence
o state can be argued to do a poor job at stimulating economic activity (impact of
multiplier effect, crowding out)
o high debt to GDP ration may be detrimental to growth (although this is more considered
a long term problem)
 stimulus – raising government expenditures in order to boost aggregate demand
o interest rates are at a historic low
o GPD growth is low and unemployment has been relatively high
o Keynesian economics in the short run government policies should stabilize output and
so government expenditures need to be counter cyclical
o this can be seem to be increasingly effective dependent on the fiscal multiplier which
can depend on numerous different factors

Debates between
 short run vs long run, should economic growth rely on indiviudals and markets or on
governments
 four solutions
o 1) government intervention in the short run, market based economy in the long run
 compatible with both austerity and stimulus depending on how successful the
short run is
 this can be seen to initially boost the economy to get some initial growth which
may have been impossible without some sort of stimulus
o 2) market based economy in short and long run
 this is on the side of austerity due to the lack of government spending
o 3) government intervention in short and long run
 allows for considerable stimulus
 although this can lead to large levels of debt to occur and this in the long run can
hinder growth and future prospects
o 4) market based economy in the short run, government intervention in the long run
(purely theoretical approach)
 this would not be appropriate as this leaves the economy to start it self up then
supports it, this would likely be the wrong way to address the problem

The secular stagnation hypothesis


 despite monetary policy interest rates are low, inflation is low and recovery is lower than
predictions

Causes of these effects


 debt overhanding means that there is weak economic activity resulting in lower disposable
income there is less investment and business in the incumbent nation
 supply side limitations such as reduced technical production and innovation, new technology is
less transformational
o limitation: why is there no inflation as a result
 savings glut – global excess of desired savings over desired investment at normal interest rates
due to wrong policy decisions adopted by certain governments
o limitation: capital exports from emerging markets make it an unlikely cause
 liquidity trap – ineffective monetary policy when economic agents are hoarding cash
o limitation: does not explain persistently weak demand

Secular stagnation hypothesis


 this is the idea that the natural interest rates have lowered considerably reflecting low
aggregate demand and high savings
 contributing factors
o greater inequality
o uncertainty about the future
o accumulation of assets by foreign central banks
o slower growth in labour force and cheaper capital goods

Fiscal vs monetary policy


Monetary policy problems
 monetary policy has diminishing returns and consequences which are excess leverage, risk
taking and asset bubbles
 can cause the liquidity trap where interest rates can’t be lowered but there is no growth
Expansionary fiscal policy benefits
 reduces national savings and increases interest rates
 channels funds toward growth enhancing investments
 cheaper to invest in infrastructure
 acts to stimulate economic growth
Expansionary fiscal policy problems
 can create a large deficit for a government which can take large amounts of time to eradicate
and interest rates can cause this figure to be large leading to austerity within the incumbent
county
 there are time lags associated with fiscal policy and the outcome may be difficult to predict as a
result of the multiplier effect
Lecture 3 – the economics of globalisation
Economic history – important turning points
 Neolithic revolution (pre 10,000 bc) transition from hunting to farming, changes the optimal
skill set
o specialisation and exchange from farming and use of money
 Bronze and iron age (3rd millennium BC)
o smelting and alloying, emergencies of cities and early law
 classical antiquity (1st millennium BC)
o early civilisations and empires, early scientific knowledge, long distance trade
 middle ages (400-1500)
o economic decline and stagnation, society is divided into orders, urban life isn’t
developed
 early modernity (1500-1800)
o age of geographic discovery and new trade routes, mercantilism and absolutism and
triangular trade (slaves -> cash crops -> manufactured goods)
 first industrial revolution (1760-1840)
o political revolution of France and US, technological improvements, steam power, canal,
chemicals
o social changes of factory system, urbanisation, organised labour, ideologies
 second industrial revolution (1870 – 1914)
o technological developments – railway, cars, iron and steel production, mass production,
electricity and telecommunications
o social changes – Fordism, taylorism (improving efficiency), public helf, public opinion,
expansion of the state
 1900-1945
o two major wars, great depression (1929 to late 1930s), welfare systems, technological
developments such as flight, home appliances, reliance on advertising
 post war world
o capitalist-communist divide after 1945, Fordism and Keynesian economics
o during 1970s, high inflation, low per capita GDP growth, slower technological
development – advent of the post-industrial society, political independence
o advance of Japan, Korea, Singapore etc

Economic Growth
 according to neoclassical economists aggregate GDP depends on
o supply side (technology, stock of capital, size of labour force)
o demand side (labour leisure, individual preferences, government)
 growth typically takes place in this way and does not take place in a linear, homogenous and
even way
o improved technology -> increased labour productivity -> more output -> higher wages
o more consumption due to higher wages and so more demand -> more money for R&D
 economic growth is inherently not smooth and prone to fluctuations, It is often uncertain and
that various sectors are important in order to allow growth to happen

Neo-classical growth
 classic economists tend to see the leisure labour choice as a substantial barrier against
economic growth
 neoclassical economists assume preferences to be exogenous and stable, there is also an
underlying assumption that individuals from their preferences autonomously
 Jean Baptiste Say argued that AS creates an equal amount of AD,
 the neoclassical model aims to separate economics from the stances of the 19th century
classical economists and so the development of the general equilibrium model
 although from a normative standpoint the neoclassical economics concludes that the
overriding of individual preferences lowers welfares

20th century growth theories


 capital accumulation from developing countries need more machienes in order to attain higher
per capita GDP levels
 technology – it is technology rather than machines that allows for long run economic growth
 education is a key drive to long run economic growth
 demographic trends

Today’s growth focus’s on


 the importance of institutions and the focus is on social rather than private capital
 individual incentives

Fordism vs the post industrial economic


Fordism (1930-1970)
 extensive regulation
 organisations and institutions more important than markets
 collectivism, mass production and mass production
 national industrial champions
 big capital and big government
o collective bargaining, important role of unions
o mass political parties, the nation state
 the view that the individual is less important than that of society

The post industrial economy (1970-today)


 flexibility and deregulation
 markets more important than hierarchies
o outsourcing, vertical disintegration globalisation
 demise of collectivism and the rise of individualism
 emphasis on choice and difference
 reliant on knowledge/creativity and information