ZCMG6231:

Economic Policy and

Development – Part 1
ASSOC. PROF. DR. MOHD AZLAN SHAH ZAIDI (azlan@ukm.edu.my)

CENTER FOR SUSTAINABLE AND INCLUSIVE DEVELOPMENT STUDIES,

FACULTY OF ECONOMICS AND MANAGEMENT,
UNIVERSITI KEBANGSAAN MALAYSIA

&

MALAYSIAN INCLUSIVE DEVELOPMENT AND ADVANCEMENT INSTITUTE

UNIVERSITI KEBANGSAAN MALAYSIA
Economic Policy
• Economic policy refers to the strategies, decisions and actions that governments, central
banks, and other relevant authorities take to influence the overall performance and behavior
of an economy.
• These policies are designed to achieve specific economic goals,
– stable economic growth,
https://www.imf.org/external/datamapper/NGDP_RPCH@WEO/OEMDC/ADVEC/WEOWORLD/MYS/IDN

– low inflation,
– low unemployment rate,
– a balanced external trade position.
Economic Policy
• Three primary types of economic policy:
– Monetary Policy:
• This involves the management of a country's money supply and interest rates by the central bank. The primary
goal of monetary policy is to control inflation and stabilize the economy.
• Central banks use tools like open market operations, discount rates, and reserve requirements to influence the
amount of money circulating in the economy and thereby impact borrowing, spending, and investment
GDP
AE = C + I + G + X – M
Y = AE
Y=C+I+G+X–M
 Monetary Policy
I = I0 - I1r
GDP = Y
C AE = C + I + G + X – M
r MS Y = AE Trade/Exchange rate Policy
Y=C+I+G+X–M X
M

r0 C = a + b(Y - T)
I = I0 - I1r
MD = f(Y,r) G= G0
X = X0 Fiscal Policy
M G
M = m0 + m1(Y) T
- Open market operation
- selling or buying government T = G ➔ balanced Budget
securities %Y = (Yt – Yt-1) * 100
T > G ➔ surplus Budget
- Discount rate Yt-1 T < G ➔ deficit Budget
- Reserve requirement
- Interest rate (policy rate)
Economic Policy
• Three primary types of economic policy:
– Fiscal Policy:
• Fiscal policy involves decisions related to government spending and taxation.
• Governments use fiscal policy to influence the level of aggregate demand in the economy.
• For example, during an economic downturn, a government might increase public spending or decrease taxes
to stimulate economic activity. In times of high inflation, it may implement contractionary fiscal policies, such as
reducing government spending or raising taxes.
Economic Policy
• Three primary types of economic policy:
– Trade and Industrial Policy:
• These policies focus on promoting specific industries, encouraging exports, and managing imports.
• They can include measures such as tariffs, subsidies, trade agreements, and regulations that affect domestic
and international trade.
• Industrial policies may aim to foster certain sectors, enhance competitiveness, and promote technological
innovation.
Economic Policy
• Economic policies are formulated based on economic theories and empirical evidence, and they
are often shaped by political and social considerations.
• The effectiveness of economic policies can vary depending on the specific context, timing, and
the degree of implementation.
• Furthermore, economic policies are interconnected, meaning that changes in one policy area can
have ripple effects throughout the economy.
• Economic policy is a dynamic field that responds to changing economic conditions, global trends,
and societal needs.
• It plays a crucial role in shaping the overall economic environment of a country and influencing its
growth, stability, and distribution of wealth.
Economic Development
• Economic development refers to the process by which a country or region improves its
overall economic well-being and quality of life for its citizens. It involves sustained, long-term
efforts to promote economic growth, reduce poverty, and enhance various social and
economic indicators.
• Economic development is a multifaceted concept that encompasses not only increases in
income and wealth but also improvements in education, healthcare, infrastructure,
governance, and overall living standards.
• Key aspects of economic development include:
– Economic Growth:
• Economic development often begins with achieving consistent and sustainable economic growth. This involves
increasing the production of goods and services over time, as measured by indicators such as Gross Domestic
Product (GDP) and Gross National Income (GNI).
Economic Development
• Key aspects of economic development include:
– Poverty Reduction:
• A central goal of economic development is to reduce poverty levels and improve the standard of living for all
citizens. This can be achieved through policies and programs that promote equitable income distribution,
access to basic services, and social safety nets.
– Human Development:
• Economic development emphasizes the well-being of individuals and communities. It involves investing in
human capital, including education, healthcare, and skills development, to enhance people's capabilities and
enable them to participate fully in economic and social activities.
– Infrastructure and Industrialization:
• Building and upgrading infrastructure, such as transportation, energy, and communication systems, is critical
for economic development. Industrialization and diversification of the economy can lead to increased
productivity and job creation.
Economic Development
• Key aspects of economic development include:
– Governance and Institutions:
• Effective governance, rule of law, and transparent institutions are essential for sustainable economic
development. Sound governance practices promote investment, protect property rights, and create an
environment conducive to economic activities.
– Trade and Global Integration:
• Participating in international trade and global markets can enhance economic development by providing
access to new markets, technologies, and resources. Trade policies that balance domestic needs with
international opportunities are important.
– Environmental Sustainability:
• Sustainable economic development takes into account environmental concerns and seeks to balance
economic growth with environmental conservation and responsible resource management.
Economic Development
• Key aspects of economic development include:
– Innovation and Technology:
• Embracing technological advancements and fostering innovation can drive economic development by
increasing productivity, creating new industries, and improving overall efficiency.
– Inclusive Development:
• Economic development aims to benefit all segments of society, particularly marginalized and vulnerable
populations. Inclusive policies and targeted interventions are crucial to ensure that the benefits of
development are equitably distributed.

• Economic development is a complex and dynamic process that requires coordinated efforts
from governments, the private sector, civil society, and international organizations.
• It takes into account social, cultural, and political factors while working towards the
improvement of economic conditions and overall quality of life for people.
Monetary Policy
▪ The evolution of CB monetary-targeting to inflation-targeting.

▪ The modern 𝑀𝑃 framework & modelling how 𝑖 is set.

▪ Use of Quantitative Easing post-crisis and its possible dangers.

▪ How conventional 𝑀𝑃 failed in stabilizing financial cycles.

Monetary aggregate
M1
M2
M3

Monetary targeting
Inflation targeting
Exchange rate targeting
Monetary Policy
▪ Quantity Theory of Money (QTM):

𝑷𝒚 = 𝑴𝑽 (1);

𝑀: money supply, 𝑉: velocity of circulation of money, 𝑃: price level, 𝑦: output.

Δ𝑃 Δ𝑦 Δ𝑀 Δ𝑉
▪ Log-differentiating (1), we get + = + .
𝑃 𝑦 𝑀 𝑉

Δ𝑃 Δ𝑀 Δ𝑀
▪ Assuming Δ 𝑦 = 0 and a constant 𝑉, = → π=
𝑃 𝑀 𝑀

▪ From QTM: Money Supply (𝑀) is a nominal anchor for the economy: growth of 𝑀 fixes the growth of
prices (inflation).

▪ Wages and prices assumed to be perfectly flexible, so economy is always at 𝑀𝑅𝐸 (𝑦 = 𝑦𝑒 ).

Monetary Policy
▪ Using 𝑀–targeting to control π requires the CB being able to control a monetary aggregate
reliably related to inflation.

▪ Goodhart’s Law: When the CB chooses a monetary aggregate as a target, the financial system
responds by switching to a close substitute outside the target and hence undermines it.

→ Shifts in money demand alter the relationship between money supply and inflation → ∴ Monetary
targeting cannot control 𝐴𝐷 predictably.

▪Failure in 𝑀–targeting: Thatcher experiment in disinflation → using M0 to target M3, but

relationship broke down → M0 growth above target, yet disinflation (↓π, ↑ 𝑈) higher than
intended.

▪𝑀–targeting to anchor π was flawed → Now, the modern monetary framework uses π𝑇 to
anchor π, and uses 𝑟 to achieve 𝑦 − 𝑦𝑒 .
Monetary Policy
Adoption of Inflation Targeting: Lower and more stable inflation
Monetary Policy
Modern 𝑴𝑷 framework:

▪ Active rule-based 𝑀𝑃: best-response 𝑟 to achieve π𝑇 :

▪ CB min loss, 𝐿 = (𝑦𝑡 − 𝑦𝑒 )2 + 𝛽(𝜋𝑡 − π𝑇 ) 2 s.t. 𝑃𝐶, π1 = π0 + α(𝑦1 − 𝑦𝑒 ), which yields the 𝑀𝑅 :
𝑦1 − 𝑦𝑒 = −αβ(π1 − π𝑇 ).

▪ CB preferences (reflected by 𝛽) and responsiveness of π to 𝑦 (ie. α) affect the chosen

adjustment path (𝑀𝑅) after a shock.

▪(Fig 13.2 a., next slide) β > 1 → Higher importance on π being away from π𝑇 than 𝑦 being
away from 𝑦𝑒 → Larger output (and hence π) reduction when there is a π shock → Flatter 𝑀𝑅.

▪(Fig 13.2 b., next slide) α ↑ (steeper 𝑃𝐶 ) → π more responsive to 𝑦 → able to cut π by more
for a given cut in 𝑦 → Flatter 𝑀𝑅.
Monetary Policy
▪ 𝜷 and/ or 𝜶 higher → 𝑴𝑹 is flatter.
Monetary Policy
▪ 𝜷 and/ or 𝜶 higher → 𝑴𝑹 is flatter.
Monetary Policy
▪ Sacrifice ratio: The % rise in 𝑈 for a 1% fall in π (cost of disinflation).

▪ Disinflation strategies: (i) ‘Cold turkey’: achieve faster fall in π but with sharper rise in 𝑈; (ii)
‘Gradualism’: 𝑈 rises less, but disinflation process is longer.

▪ Taylor rule (1993): Rule which well described the Fed’s historical int. rate behaviour.
𝑇𝑅: 𝑟0 − 𝑟𝑆 = 0.5 π0 − π𝑇 + 0.5 𝑦0 − 𝑦𝑒 .

1
▪ Best response 𝑇𝑅 in our 3–eqn model: 𝑟0 − 𝑟𝑆 = 1 (π0 − π𝑇 ),
𝒂(α+ )
αβ

Derivation: Substitut𝑃𝐶: π1 = π0 + α 𝑦1 − 𝑦𝑒 into the 𝑀𝑅: 𝑦1 − 𝑦𝑒 = −αβ(π1 − π𝑇 ), yielding

1
π0 − π𝑇 = −(α + αβ) 𝑦1 − 𝑦𝑒 . Then subst. for 𝑦1 − 𝑦𝑒 from the 𝐼𝑆: 𝑦1 − 𝑦𝑒 = −𝒂 𝑟0 − 𝑟𝑆 .

e π1 of the
Monetary Policy
▪ Optimal 𝑇𝑅 is 𝑟0 − 𝑟𝑆 = 0.5 π0 − π𝑇 iff. 𝑎 = 𝛼 = 𝛽 = 1.

▪ E.g. if inflation is 1% above target, the CB needs to raise nominal int. rate (𝑖) by 1+0.5% so
that 𝑟 = 𝑖 −π can be raised by 0.5%.

▪ Taylor principle: The need to raise 𝑖 sufficiently to push up 𝑟, so that the CB’s int. rate
response is actually stabilizing.

1
▪ Optimal CB response is given by 𝑟0 − 𝑟𝑆 = 1 π0 − π𝑇 , thus:
𝒂 𝛼+αβ

(i) ↑ β → High π aversion → respond to shock with larger rise in 𝑟.

(ii) ↑ α → 𝑃𝐶 steeper & 𝑀𝑅 smaller → smaller 𝑟 response to shock.

(iii) ↑ 𝑎 → 𝐼𝑆 flatter (high 𝑟–sensitivity of 𝐴𝐷) → smaller 𝑟 response needed.

 Monetary Policy
Adjustment to an Inflation shock and the Impulse responses:
3-equation model

𝐼𝑆: 𝑦1 − 𝑦𝑒 = −𝒂 𝑟0 − 𝑟𝑆 .

𝑃𝐶: π1 = π0 + α 𝑦1 − 𝑦𝑒

𝑀𝑅: 𝑦1 − 𝑦𝑒 = −αβ(π1 − π𝑇 )
Output gap inflation gap

π = 𝑃𝑡 − 𝑃𝑡 − 1 ∗ 100
Pt-1
π π

PC PC

𝑢𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒 𝑦
 𝑟

𝑟1

3-equation model 𝑟s Inflation shock

• π > πT
𝐼𝑆: 𝑦1 − 𝑦𝑒 = −𝒂 𝑟0 − 𝑟𝑆 . • CB forecasts new PC that
goes thru π0 and ye
IS • CB  r
𝑃𝐶: π1 = π0 + α 𝑦1 − 𝑦𝑒
• π  (π0 to π1)
𝑦 • 𝑦  (𝑦e to 𝑦0)
𝑀𝑅: 𝑦1 − 𝑦𝑒 = −αβ(π1 − π𝑇 ) π PC’
PC” • CB  r
PC • 𝑦  (𝑦0 to 𝑦e)
π0

π1
π𝑇

MR
𝑦0 𝑦𝑒 𝑦
Monetary Policy
Quick Summary: How does a CB respond to an inflation shock in our
3-equation model?
Monetary Policy
Monetary Policy in selected ASEAN countries
• Malaysia: Malaysia has traditionally employed a flexible exchange rate regime and a interest rate targeting
framework. The central bank, Bank Negara Malaysia, aims to manage money supply and interest rates to
achieve its monetary policy goals, which include price stability and sustainable economic growth.

• Indonesia: Bank Indonesia, the central bank of Indonesia, has adopted an inflation targeting framework. The
primary goal of monetary policy is to maintain price stability and keep inflation within a target range. The
exchange rate is also considered, but it is not the primary target of monetary policy.

• Singapore: The Monetary Authority of Singapore (MAS) manages its monetary policy through the exchange
rate-centered approach. Instead of targeting interest rates or money supply, Singapore uses the exchange
rate as the main policy tool to ensure price stability and support economic growth.
Monetary Policy in selected ASEAN countries
• Thailand: The Bank of Thailand has employed a combination of inflation targeting and exchange rate
management. While inflation targeting is a key objective, the central bank also monitors and manages the
exchange rate to ensure export competitiveness and price stability.

• Brunei: Brunei uses a currency board arrangement, where the Brunei dollar is pegged to the Singapore dollar
at a fixed exchange rate. As a result, Brunei's monetary policy is closely aligned with that of Singapore.

• Philippines: The Bangko Sentral ng Pilipinas (BSP) uses an inflation targeting framework as the cornerstone of
its monetary policy. The primary goal is to maintain price stability while also considering growth and financial
stability.

• Vietnam: The State Bank of Vietnam (SBV) has shifted its monetary policy framework over the years. While the
focus has been on controlling inflation, the SBV also considers exchange rate management and credit growth
to support economic stability and development.
Fiscal Policy
▪ The role of 𝐹𝑃 in stabilization: discretionary 𝐹𝑃 , the fiscal multiplier and automatic
stabilizers.

▪ The debt dynamics model and its applications.

Fiscal Policy
▪ Discretionary 𝐹𝑃 : Key stabilization tool, if 𝑀𝑃 is constrained by ZLB (Zero lower bound)

▪ 𝐹𝑃 Automatic stabilizer: 𝐴𝐷 shock insulation to a certain extent.

▪ 𝐹𝑃 affects the public debt → ∴ ∃ downsides to discretionary 𝐹𝑃.

Scope of 𝐹𝑃 :
▪ Income redistribution: using taxes & transfer systems.

▪ Resource allocation: E.g. subsidies/ taxes to particular industries (tobacco industry etc.)

▪ Provision of public goods: Non-excludable and non-rivalrous goods which are not provided
by the market.
Fiscal Policy
Discretionary 𝐹𝑃 for stabilization:
▪ Effectiveness depends on (1) initial state of economy, (2) model used, (3) timescale – short
or medium run.

▪ ‘The Multiplier’ of 𝐹𝑃 differs depending on the timescale.

▪ Short-run (Keynesian) multiplier: how output changes when 𝐺 changes, holding all else
constant.
Δ𝑦
1
Δ𝑦 = Δ 𝐺 = 𝒌 Δ 𝐺, 𝒌 is the multiplier.
1−𝑐1 (1−𝑡)

▪ But general equilibrium effect of 𝐺 depends on the model (e.g. response of 𝑀𝑃) and the
initial conditions of the economy.
GDP = Y GDP = Y
AE = C + I + G + X – M
AE = C + I + G + X – M Y = AE
Y = AE Y = a + b(Y - T) + I0 - I1r + G0 + X0 – m0 - m1Y
Y=C+I+G+X–M Y = a + bY - bT + I0 - I1r + G0 + X0 – m0 - m1Y
Y – bY +mY = a - bT + I0 - I1r + G0 + X0 – m0
Y(1-b+m) = a - bT + I0 - I1r + G0 + X0 – m0
C = a + b(Y - T) Y= 1 (a - bT + I0 - I1r + G0 + X0 – m0)
I = I0 - I1r (1-b+m)
G= G0 Y = 1 Y = -b
X = X0 G (1-b+m) T (1-b+m)
M = m0 + m1(Y) Y = 1 Y = 1
X (1-b+m) I0 (1-b+m)
Y = -1
%Y = (Yt – Yt-1) * 100 m0 (1-b+m)
Yt-1
b = marginal propensity to consume = 0.8
m = marginal propensity to import = 0.1
0 < b <1
Y = 1 = 1 = 3.33G = 3.33 (100b)
(1- 0.8+0.1) 0.3
Fiscal Policy
Debt Dynamics Equation

▪ Gov’t budget identity: 𝐺𝑡 + 𝑖𝑡 𝐵𝑡−1 ≡ 𝑇𝑡 + Δ𝐵𝑡 + Δ𝑀𝑡 (in nominal terms).

▪ We want to derive the debt dynamics equation, which shows how the debt-to-GDP ratio evolves over time:
𝜟𝒃 = 𝒅 + 𝒓 − 𝜸𝒚 𝒃. Derivations below:

1. Abstracting from monetary financing (CB independent), 𝐺 + 𝑖𝐵−1 = 𝑇 + Δ𝐵.

2. Rearranging this, *Δ𝐵 = 𝐺 − 𝑇 + 𝑖𝐵−1 * → Change in debt ≡ budget deficit.

𝐵−1 𝑏𝑢𝑑𝑔𝑒𝑡 𝑑𝑒𝑓𝑖𝑐𝑖𝑡 Δ𝐵 𝐺−𝑇 𝑖𝐵−1

3. Define the debt ratio ≡ 𝑏 ≡ & =" ≡∗ + ∗ ≡ 𝑑 + 𝑖𝑏“ [𝟏];
𝑃𝑦 𝐺𝐷𝑃 𝑃𝑦 𝑃𝑦 𝑃𝑦

𝑑 is the primary deficit/ GDP ratio.

4. Definition: 𝐵 ≡ 𝑏𝑃𝑦 → Totally differentiating this, Δ𝐵 ≈ 𝑃𝑦Δ𝑏 + 𝑏𝑦Δ𝑃 + 𝑏𝑃Δ𝑦.

Δ𝐵 𝑏Δ𝑃𝑦 𝑏Δ𝑦𝑃 Δ𝑏𝑃𝑦 Δ𝑦

5. Dividing this by 𝑃𝑦, = + + = 𝑏π + 𝑏𝛾𝑦 + Δ𝑏 [2]; 𝛾𝑦 =
𝑃𝑦 𝑃𝑦 𝑃𝑦 𝑃𝑦 𝑦

6. Substituting RHS of [𝟏] into LHS of [2] and rearranging, Δ𝑏 = 𝑑 + 𝑖 − π − 𝛾𝑦 𝑏

7. Finally, applying the Fisher equation (𝑟 = 𝑖 − π) → "𝜟𝒃 = 𝒅 + 𝒓 − 𝜸𝒚 𝒃"

𝐺=𝑇 𝐺 + 𝑖𝐵−1 = 𝑇 + Δ𝐵
𝐵−1
𝑏≡ = debt to GDP ratio
𝑃𝑦 𝜟𝒃 = 𝒅 + 𝒓 − 𝜸𝒚 𝒃 ⇒ 𝒅𝒆𝒃𝒕 𝒅𝒚𝒏𝒂𝒎𝒊𝒄 𝒆𝒒𝒖𝒂𝒕𝒊𝒐𝒏
𝐺−𝑇
𝑑 = 𝑃𝑦 = primary deficit

𝒓 = interest rate
𝜸𝒚 = economic growth rate

y 𝜟𝒃
y = a + b𝑥 𝜟𝒃 = 𝒅 + 𝒓 − 𝜸𝒚 𝒃

b = ΔY/ ΔX 𝒓 − 𝜸𝒚 = ΔΔb/ Δb

a 𝒅

y = a - b𝑥

x 𝒃
Fiscal Policy
▪ 𝜟𝒃 = 𝒅 + 𝒓 − 𝜸𝒚 𝒃 : 2 cases → (i) 𝒓 > 𝜸𝒚 and (ii) 𝒓 < 𝜸𝒚 .
▪ Case 1: 𝒓 > 𝜸𝒚 (real int. rate above growth rate)
Fiscal Policy
▪ Case 1 (𝑟 > 𝛾𝑦 ): Upward-sloping phase line → Debt to GDP ratio (𝑏) is rising unless there is a primary
budget surplus (𝑑 < 0).

▪ Intuition: 𝑟 > 𝛾𝑦 → int. payments rising faster than GDP → Debt burden ↑; Need primary surplus for
Δ𝑏 = 0.

▪ Fig 14.3 a.: Primary deficit → Econ. moves N. East along line → 𝑏 ↑ with each period of a deficit.

▪ Fig 14.3 b.: Primary surplus

• If at ‘A’ → Surplus large enough to offset 𝑟 > 𝛾𝑦 → 𝑏 ↓ each period (Moves S.West).

• At ‘B’ → Effect of 𝑟 > 𝛾𝑦 exactly offset by primary surplus → 𝛥𝑏 = 0 (But unstable point → a slight deviation triggers
an ever-rising/ falling 𝑏).

• At ‘C’ → Ever-increasing debt ratio (𝑏).

▪ Note: an appropriate primary surplus can hold 𝑏 constant but cannot mitigate the underlying debt
dynamics (determined by 𝑟 and 𝛾𝑦 ).
Fiscal Policy
▪ Case 2: 𝒓 < 𝜸𝒚 (real int. rate below growth rate)
Fiscal Policy
▪ Case 2 (𝑟 < 𝛾𝑦 ): Growth of econ. sufficient to reduce impact of int. payments on the debt burden → ∴
Some primary deficit is consistent with Δ𝑏 = 0.

▪ Fig 14.4 a.: At ‘C’, debt ratio is rising (Economy moves S.East) → when ‘B’ is reached, 𝛥𝑏 = 0 (Stable
point → Econ. moves back to ‘B’ after any deviation)

▪ Fig 14.4 b.: Primary surplus, gov’t will end up with negative public debt (𝑏 < 0, Gov’t is a net holder of
private sector financial assets).

Comparing Stable & Unstable Equilibria – points ‘B’ in Fig 14.3 b. and 14.4 a.

▪ Fig 14.3 b.: 𝑟 > 𝛾𝑦 → when there is a small increase in 𝑏, the interest burden of debt reinforces the
increase in 𝑏. (unstable equilibrium)

▪ Fig 14.4 a.: 𝑟 > 𝛾𝑦 → the increase in 𝑏 is dampened because 𝑦 grows faster. (stable equilibrium)
Fiscal Policy
Scenario analysis – Fig. 14.5 a. (below):

▪ Initially at ‘A’, primary deficit (𝑑 > 0) and 𝑟 < 𝛾𝑦 .

▪ But shock to 𝑟 and/or 𝛾𝑦 → now, 𝑟 > 𝛾𝑦 → New upward-sloping phase line →

▪ Economy jumps to ‘B’ → 𝑏 rises without limit unless 𝑟, 𝛾𝑦 or 𝑑 changes.

Fiscal Policy
Fig 14.5 b. (below): 𝐹𝑃 shifts.

Same as before, but as soon as 𝑟 < 𝛾𝑦 occurs, gov't tightens 𝑭𝑷 (↑ 𝑇 and/ or ↓ 𝐺) → If tightening is
instantaneous, econ. moves from ‘A’ to ‘C’ and 𝒃 will be constant (but unstable).
Fiscal Policy
Fig 14.5 b. (below): 𝐹𝑃 shifts.

Same as before, but as soon as 𝑟 < 𝛾𝑦 occurs, gov't tightens 𝑭𝑷 (↑ 𝑇 and/ or ↓ 𝐺) → If tightening is
instantaneous, econ. moves from ‘A’ to ‘C’ and 𝒃 will be constant (but unstable).
Trade and Industrial Policy
• Trade policy refers to the set of measures and regulations that a government enacts to manage its
international trade relationships.
• The primary goal of trade policy is to promote the growth of a country's economy by facilitating
the exchange of goods and services with other nations.
• Trade policies can take various forms, including tariffs (taxes on imports), quotas (limits on the
quantity of imports), subsidies (financial support for domestic industries), and trade agreements
(bilateral or multilateral agreements that govern trade rules and practices).
• Key objectives of trade policy include:
– Promoting Export Growth: Governments often design policies to support domestic industries that are
competitive in global markets. This can involve providing incentives, subsidies, or assistance to exporters.
– Import Restrictions: Trade policies can aim to protect domestic industries from foreign competition by
imposing tariffs, quotas, or other barriers on imported goods.
Trade and Industrial Policy
• Key objectives of trade policy include:
– Balancing Trade: Governments may seek to manage trade imbalances by promoting exports and
reducing imports, aiming to achieve a favorable balance of trade.
– Attracting Foreign Investment: Trade policies can be designed to attract foreign direct investment
(FDI) by creating a favorable investment climate and offering incentives to foreign investors.
– Enhancing Trade Relationships: Trade agreements and diplomatic efforts can help establish favorable
trade relationships with other countries, opening up new markets and opportunities.
Trade and Industrial Policy
• Industrial Policy: Industrial policy involves government intervention in the economy to promote
the growth and development of specific industries or sectors.
• It encompasses a range of policies aimed at fostering industrialization, technological
advancement, and economic diversification.
• Industrial policies can include financial incentives, infrastructure development, research and
development support, and regulatory reforms.
• Key objectives of industrial policy include:
– Economic Diversification: Governments often use industrial policies to reduce reliance on a narrow range
of industries and promote the growth of new and diverse sectors.
– Technological Innovation: Industrial policies can support research and development efforts, innovation,
and the adoption of new technologies to enhance industrial competitiveness.
Trade and Industrial Policy
• Key objectives of industrial policy include:
– Job Creation: By nurturing specific industries, governments aim to create employment opportunities
and stimulate economic growth.
– Addressing Market Failures: Industrial policies can correct market failures, such as inadequate
investment in certain sectors due to externalities or lack of information.
– Infrastructural Development: Governments may invest in infrastructure, such as transportation and
utilities, to support the growth of industries.