Question 1: To what extent is government intervention in the international trade of goods and services between two countries necessary to yield economic welfare? Discuss in the context of any one market with which you are familiar.
Since the turn of the century, the developing countries are struggling hard to establish their foothold in the world. These developing nations were once corridors of trade to the Central Asian Market but now they are being swiped off their feet due to the overwhelming response of the capitalist world. It is becoming hard for them to keep pace with the competition and those countries which are trying, eventually fall back with the worst failures of their times. The leaders of these countries have successfully deciphered that the problem lies within the administrative structure and hence government intervention is imperative to enjoy the benefits which economic progress would yield from international trade (Akrami 2008).
One such example is of Brazil. Brazil is one of the economies in Latin America which is suffering through inequality in the income distribution patterns, low level of employment, heavy dependence on goods as a source of foreign exchange, high levels of poverty, immense differences across the regions, and scarcity in the funds to allocate resources effectively (Bittencourt, 2004). Thus it becomes fundamental for the government to intervene and introduce some instruments that are able to take Brazil from the rudimentary stages to become a more developed nation.
Reforms promoting trade liberalization are an important policy tool that the government can implement to bring about economic progress. The reason being that trade liberalization is exhibited to have positive impact on the employment level and wage rates in a country (Giovannetti, 2006). In Brazilian market, we experience that the labor markets are rigid meaning that they are not capable of adjusting immediately to the changes in the society or the world (Arbache, 2002).Thus with a deteriorating economy, increasing real wages to match the purchasing power would mean a rise in the production costs of the manufacturing firms, and in this scenario they would only be left with the option of laying off workers which point to increased unemployment. All this would come down to the production levels falling and the national output of the country dwindling pushing it further into drudgery. With the coming of a liberalized trade, the economy can escape from this vicious cycle by tapping on many opportunities available. Also decline in input tariffs have proved significant in upgrading the skill levels in Brazil (Giovannetti, 2006). The government of Brazil has taken some initiatives in this matter. According to Oliveira (2009), the government has reduced the tariff rates according to the multilateral commintments made in 1994 Uruguay Round and has also provided with trade subsidies. Many quantitative restrictions and exchange control have largely been eliminated and ordinary custom duties are a means of control for international trade (World Bank)
Foreign Direct Investment is one of the most instrumental tools in bringing about a smooth and swift flow of technology and other imperative resources from the host country to the recipient country. Many economists agree to the fact that foreign direct investment caters to an economic environment that holds many benefits. The first one being that FDI is not only reported to bring an influx of technology but they also bring marketing, managerial and financial skills. Improving the knowhow in these fields and instilling organizational techniques in this otherwise unskilled labor would help them to find the solutions to economic problems more swiftly. Skilled labor of a country trickles down to high output levels, high employment, favorable balance of payment and most of all freedom from the vicious cycle of poverty by tapping onto the economic development (Arbache, 2002). Furthermore, foreign direct investment is not only pursued because of the benefits that it yields but also is deemed significant by many important institutions over which a country may be relying for assistance. According to expert Medeiros, (2012) important organizations have made it a criterion for their seekers to take part n foreign investments as a means of solving their domestic problems. The role of government here is to ensure favorable licensing agreements, trade conditions and educated labor to be able to attract the foreign direct investments amongst a sea of many other competitors.
Finally the most important role of government is to answer the domestic governance issue which includes infrastructure problems as well as terrorism issues. These problems hamper the competitiveness of the local firms and foster an environment that is unwelcoming to foreign direct investments. Inadequate infrastructure includes insufficient electricity; poor transport and port facilities. Terrorism give rise to vandalism, unsafe working conditions for manufacturers particularly when they operate outside city and strikes every alternate day which hampers the smooth production capacity. According to many studies the impact of inadequate infrastructure and terrorism has been increased costs to firms and a backdrop on their supply chains. Hence the government holds the responsibility of providing novel solutions particularly for small to medium enterprises (SMEs) that cannot thrive on their own in such a dire situation (Brazil Infrastructure report, 2013). The government need to answer the problems by promoting flexible regulations, access to capital and sufficient electricity, and a favorable position in the supply chain (Bevins, 2013)
Brazil is losing its advantageous position in the international trade arena due to poor governmental standards. It is also looking forward to hold World Cup 2016 in Rio (Bevins, 2013). Hence, to prevent the media from attaching to Brazil an international image of as a low quality, low value added producer of goods, and an insecure territory, the government needs to intervene with tighter and more favorable policy controls as identified above.
Reference list
Arbache, J. 2002, Unions and the Labor Market in Brazil, Rochester
Bevins, V. 2013, THE WORLD; Problems linger in Brazil; As the country prepares to host the World Cup and Olympics, logistical, infrastructure and security issues threaten its image, Los Angeles, Calif.
Bittencourt, M.V.L. 2004, The impacts of trade liberalization and macroeconomic instability on the Brazilian economy, The Ohio State University.
Brazil Infrastructure Report - Q3 20122012, Business Monitor International, London.
Gevorkyan, A.V. 2009, Innovative fiscal policy and economic development in the transition economies, New School University.
Giovannetti, B. & Menezes-Filho, N. 2006, "Trade Liberalization and the Demand for Skilled Labor in Brazil/Comments", Economia, vol. 7, no. 1, pp. 1-28.
Medeiros, M.d.A. & Froio, L. 2012, "Actors, Interests and Strategies of Brazilian Foreign Policy on Biofuels", Brazilian Political Science Review, vol. 6, no. 1, pp. 37-52,6
Oliveira, G.A.S. 2009, The political economy of Brazilian trade policy: Domestic determinants, world and regional strategies, University of Southern California.
Question2: Many economists are asking for governments to engage in a fiscal and monetary stimulus to bolster economic growth. Critically consider whether this is a desirable or ruinous policy for economic prosperity.
Developing economies which hold 80% of the world’s population but contributes only 20% with respect to the GDP have started gaining significance during the last decade in terms of international trade and financial development (Tantitemit 2008). However inflation in these economies is still rampant which require its monetary authorities to adopt monetary and fiscal policy similar to the one being used in the developed nations.
Fiscal policy is a tool which is used to invigorate a stagnant economy by adjusting the level of taxations and government spending (Tantitemit, 2008). The operations of this are such that for instance an economy is operating in a deteriorating condition when the businesses are slow, there are no investments and the unemployment rate is really high. Then the government can intervene by reducing taxation which would leave the population with more money to spend. The demand for consumer goods would increase which will pump money into the businesses and hence reenergize the cycle of trade. At the same time, the government can increase its spending in public sector projects which will increase employment. What is essential here is to find a balance in implementing this policy because excessive use of it runs the risk of rising inflation. This is indicated by the fact that if there is too much money in the economy, the rise in money supply will push the prices of goods high and so inflation will wanton (Vasishtha, 2006)
Monetary policy is seen as another policy tool utilized by the government to alter the interest rates and hence the money supply. It works through open market operations in which the central bank buys and sells government bonds in the market. When there is an increased demand for money, the central bank goes to the market and buys a financial asset which raises the local bank’s reserves by the amount of money worth that financial asset. If there is excess money in the system which is causing inflation than the central bank will run contractionary measures by selling the government bonds in the market so that the reserves of the local bank are reduced by the amount worth the financial asset.
Iqbal, (2011) has thrown light on the use of monetary and fiscal policy by the American government during the times of recession in 2007-2009. This recession was caused by the housing market boom and the situation was such that inflation was highly on the rise. The Fed reduced the federal funds target rate, the rate at which the banks can borrow from each other and also announced a cut in the taxation rates. Despite of this, 2008 experienced the worst financial meltdown which turned into global financial crises after the fall down of big banks like Lehman brothers and Bear Stearns. Another reason was the oil price shocks. Fed, now more determined to curb the situation, announced a further cut in the interest rates. Bush also signed a fiscal stimulus package (Iqbal 2011). All of this resulted in positive GDP growth rates and helped the economy to recover.
However, monetary and fiscal policy may not have equivalent effects on other economies particularly the developing ones because these policies hold certain limitations. According to Manish (2012) monetary policy can get affected by the expectations of the people. For instance when the central bank increases the short term rates in anticipation of contracting the money supply, expectations of no future inflation may cause the long term rates to fall and hence in the long run the economy may experience stimulation again. Manish, (2012) classifies another limitation to be the liquidity trap. This is a situation when the short term nominal interest rate is zero and any increase in the money supply doesn’t change the output or the price. Finally Manish(2012) states that a lose in confidence because of recent economic crises can prevent the banks from lending their money freely to the borrowers even if the short term interest rates are falling
Similarly, fiscal policy also holds a set of limitations. According to Gevorkyan, (2009) it has more to do with the specific class of people who may really feel its affect. For instance if the government increases its taxation then only the middle class, which is usually the largest segment of population, would feel the difficulty. Similarly if the government increases it’s spending in the public sector projects, only a specific class of population, those who are constructors would experience a rise in employment. The rest will continue suffering
Udah (2009, pp 1-13) has tried to provide an evidence that monetary or fiscal policy may not always bring about the desired results. He states that in Nigeria, a 10% decrease in the money supply led to a reduction in the inflation rate by 2.17% but it also reduced the output and employment level by 0.41 and 0.35 percent respectively. Thus Udah, (2009, pp 1-13) is actually highlighting the notion that a contractionary monetary policy means a tradeoff between the inflation and GDP growth There are many other examples proposed by the economists around the world trying to prove the efficiency of one policy over the other. For example Taylor (2009), Mishkin (2009) and many more believe that monetary policy is useful in bringing about stabilization during the times of recession. They claim that in recession, fiscal policy has the potential to lead to crowding out or inefficient allocation of resources. On the flip side of the coin Krugman,(2008) favors fiscal policy and in doing so highlights the limitations of monetary policy.
In conclusion, I would like t say that many groups support their arguments based on their own set of rationales but what has actually been seen in many examples of recession in countries like US, Japan that the government has made use of both the policies simultaneously i.e. they may opt for a cut in the taxation rate and a rise in the government spending and to counter the effects of increased inflation they may opt for a rise in interest rates.
Reference List
- Gevorkyan, A.V. 2009, Innovative fiscal policy and economic development in the transition economies, New School University.
- Kumar,S . ‘9 Main Limitations of the Monetary Policy adopted by the Reserve Bank of India’ Retrieved from http://www.shareyouressays.com/117042/9-main-limitations-of-the-monetary-policy-adopted-by-the-reserve-bank-of-india
- Manish (2012) ‘Limitations of Monetary Policy’ Retrieved from http://financetrain.com/limitations-of-monetary-policy/
- Silvia, J. & Iqbal, A. 2011, "Monetary Policy, Fiscal Policy, and Confidence", International Journal of Economics and Finance, vol. 3, no. 4, pp. 22-35.
- Spacov, A.D. 2007, Essays on fiscal consolidation and monetary policy, University of California, Berkeley.
- Taborsky, C.J. 2002, Essays on monetary and fiscal policy, University of California, Santa Barbara
- Tantitemit, K. 2008, Essays on examining monetary policy in emerging countries, University of Hawai'i at Manoa.
- Udah, E.B. 2009, "Monetary policy and macroeconomic management: a simulation experiment", Global Journal of Social Sciences, vol. 8, no. 1, pp. 1-13.
- Voyvoda, E. & Erinç Yeldan 2005, "IMF Programmes, Fiscal Policy and Growth: Investigation of Macroeconomic Alternatives in an OLG Model of Growth for Turkey1", Comparative Economic Studies, vol. 47, no. 1, pp. 41-79.
- Vasishtha, G. 2006, Domestic and external debt of emerging markets: Implications for fiscal and monetary policy, University of California, Santa Cruz.
