BUSINESS ECONOMICS: THE UK ECONOMY
- Introduction3
- Reasons for Economic Downturn in 2008/094
a). Financial Crisis4
b). Business Cycle4
c). Government Policy before Crisis5
- Analysis of the Effects of the Downturn6
a). Microeconomic Effects6
1). Effects of Households6
2). Effects on Businesses6
b). Macroeconomic Effects7
1). Effect on Unemployment7
2). Effect on GDP and Inflation7
3). Effect on Share Prices and Company Profits8
- Government Policies Aimed at Recovery8
a). Fiscal Policy8
b). Monetary Policy9
c). Austerity9
- Actions/Steps Taken by the Government9
- Expectations of the Government Actions10
- Conclusion11
- References12
- Introduction
The United Kingdom is made up of England, Ireland, Wales and Scotland. The Economy is one of the largest in Europe and the world in terms of GDP and Purchasing Power Parity (PPP). By 2010, The Economy was the 8th largest exporter and 6th largest importer of the world’s products in Europe (Phillips, 2013, P.45). Just like any other economy, the three dominant sector industries dominate it; Manufacture, Service and Agriculture, however most f the country’s income comes from the service industry. 78% of its GDP come from the service industry; the financial service industry to be precise.
In the past few years, the UK economy has not been performing very well. Since 2012, the country has been experiencing some recessionary features which had immense effects on its performance. There was a decrease in both aggregate demand and supply. This was followed by a decreased GDP and inflation was on the rise. The first quarter of 2013, the economy narrowly escaped a triple dip recession when its service sector improved by an impressive 0.3%. A triple dip recession is a third recession for any economy to fall into within a period of less than five years (Phillips, 2013). It is characterized by an increase in unemployment and investment also decreases. The following is a graphical illustration of the recessionary period that has been experienced by the economy since 2008. Courtesy of www.money.cnn.com/2013/04/25/news/economy/uk
UK
2013, UK in Recession
Recovery in 1st Quarter
-5 2008 UK in Recession
- Reasons for Economic Downturn in 2008/09
There are several reasons as to why the economy of UK was flourishing and then started experiencing repeated recessions followed by drastic decline in its performance both domestically and internationally.
a). Financial Crisis
As earlier stated, 78% of the economy’s GDP comes from the financial service sector. The manufacturing sector of the economy was greatly neglected; this led to a decline in its performance. During the double dip recession experienced the manufacturing sector declined by 12% and was expected to decline to a further 15% had the economy was to fall into the triple dip recession earlier on this year (Phillips, 2013, P67).
The financial crisis started when the country net export decrease, this led to a trade deficit. The currency then depreciated and inflation was on the rise. This is a problem that can easily be fixed in any economy, but it was hard because the financial service sector made up more than three quarters of the economy and GDP (Marvin, 2009, p.76). Contractionary monetary policy were applied, however as clearly stated by Keynes in his theory of money supply, monetary policies are only effective in the short run. In the long run, the economy was still on shaky grounds (Review of Keynesian Economics, January, 2013, p14).
b). Business Cycle
The business cycle also had immense contribution to the recessionary setbacks in the economy. This is evident from the fact that;
- Poor management- poor management of resources, led to a decline in the resource faster than innovation, invention and improvement in technology (Higgs, 2008). A decline in the resources led to an employment of most of the factors of production during the first phase of the recession in an effort to be cost effective.
- Trade union structure and labour relations- most of the qualified labour chose to work outside the country due to a comparative analysis of the labour relations of the neighbouring countries (Marvin, 2009, p.88). Loss in labour led to less production and the country started depending on imports which affected the balance of payment.
- Foreign policy relation- the UK was dependent on the commonwealth countries always purchasing their products regardless of the price level; however most of the commonwealth countries choose not to purchase the products from the country (Yates, 2002, p.54). Decrease in the influence in the international market led to a decline in exports. This led to unemployment in the UK.
c). Government Policy before Crisis
The government has policies that when put in place can easily be able to control the commercial activities in the country. The following are some of the government policies that were in place before the crisis;
- Tax- personal income tax rate was high than the Value Added Tax and the corporate tax charged. This meant that the people will have less disposable income available to be spent.
- Fiscal policy- a big portion of the government spending was directed towards the improvement of the health and pension schemes. These are meant to improve the living standards of the people. The government on a yearly basis, has an average budget of £400billion, more than a third of this is used in the mentioned activities (Higgs, 2008, p.90).
- Analysis of the Effects of the Downturn
The economic downturn definitely had some effects on the country. The effects can be divided into two macroeconomic effects on the households and individual businesses and macroeconomic effects on the aggregate factors of the country.
a). Microeconomic Effects
They are as follows;
1). Effects of Households
Decrease in the unemployment level, created structural and frictional unemployment that led to a decrease in the income of a household (Marvin, 2009, p.111). Decrease in income decreased the amount of goods and services the families can afford. Consumption of luxuries and comfort was minimized.
Increase in the inflation rate led to an increase in the consumer price index, CPI, reducing the consumer purchasing power (Geroski, 1997, p.107). This meant that most households could not afford the previous life they had and there was decrease in the rate of college attending students as it become impossible for the households to send all children to college.
2). Effects on Businesses
The businesses experienced decrease in investment due to increased interest rates that are usually a sign of recession. The businesses could no longer expand and had to decrease their labour force. This led to a decrease in supply of goods and services to the market, decrease in revenue earned and consequently the profit margin also decreased as well.
This made most of the businesses to operate at the shutdown point where the marginal revenue curve and the average variable cost curve are at per. This decreases the opportunities that the businesses can exploit.
b). Macroeconomic Effects
They are as follows;
1). Effect on Unemployment
An increase in unemployment means a decrease in the national income and national savings. An economy with low savings has low investment and low financial performance as well. Increase in unemployment means two things; there is decrease in resource and potential exploitation and there is a decline in aggregate demand for goods and services.
Decrease in resource exploitation allows for the available resources to be completely worn out and become scarce, while decrease in aggregate demand always leads to decrease in aggregate supply. GDP is heavily dependent on the consumption level and when the latter decreases the former follows suite (Yates, 2002, p.33).
2). Effect on GDP and Inflation
In a well operating economy, the Philip’s curve is used to demonstrate the situation on the ground. The situation is simple, an increase in the level of employment by a certain percent leads to an increase in the level of inflation, however for the situation in the UK was a reverse. The economy experienced an increase in inflation and a decrease in the level of unemployment. Currently the inflation rate is still a double digit and hardly goes below 10% (Giudice, 2012, p.31).
Inflation has the following effect; it makes the currency to depreciate. Exports become cheap and imports expensive. The economy experiences a trade deficit, which the same as a negative net export. This decreases the GDP from what it was initially meant to be. Currently GDP is 2.5% below the level it was before the economic crisis started (Giudice, 2012, p.44).
3). Effect on Share Prices and Company Profits
Decrease in the investment rates led to decrease in the revenue made by companies and the profit margin reduced substantially. For fear that their investment may shrink and not become viable; most of the business men decided to sell their shares back to the government or to foreign investment at very low prices (Harris, 2005, p.90). This increased the level of unemployment and domestic investments made.
- Government Policies Aimed at Recovery
The UK economy had been one of the most influential and well performing in Europe. Different leadership skills and global occurrences have taken a toile on it; however the government is willing to return it to its former glory using the following policies;
a). Fiscal Policy
Fiscal policy includes the government purchases, investment and use tax in improving the country. The economy previously was in the private sector, but due to the recession, most of the investors sold their shares to the government. This has made the economy to go back to the hands of the government where consumer welfare will be properly catered for.
Government had been very much involved in making investments in the health and pension sectors; however this had led to other sectors that are profitable to be neglected. For instance, investments in human infrastructure like education; that increase the efficiency of labour. The government now invests in more profitable endeavours that will have good plough backs that can increase government revenue and improve the economy.
Reduction in corporate tax charged, this is meant to attract more domestic and foreign investment in the future. Currently tax is based on the final product produced, for instance there is an increase in tax charged for beer and other alcoholic beverages, cigarettes and junk food. This is because it was noted that the products have an almost perfectly inelastic demand that is not responsive to changes in the price level.
b). Monetary Policy
Monetary policy is meant to control the quantity of money that is in circulation in an economy. The most prominent one is the use of the interest rates. Currently the interest rate in UK is very low as it is meant to encourage the investors to borrow more money to invest. However, just as Keynes argued in his theory, monetary policies should be employed only in the short run. This is because if the interest rates will be kept low for a long period of time they will discourages savings and reduce the lending power of the commercial banks as they will have less money in their reserve (Review of Keynesian Economics, January, 2013, p23).
c). Austerity
Currently the UK economy has a budget deficit of £116.5billion in revenue and $10billion in foreign economic aid as of March, 2013 .. This is because the economy has been used to working under a surplus budget that a deficit budget will only increase its international debt to GDP ratio. In order to achieve this, there have been serious cuts in government spending leaving only the basic needs. This reduces the budget and ensures that the budget deficit is decreased.
Austerity is done to reduce international debt and make the country to more lucrative for international investments.
- Actions/Steps Taken by the Government
The UK economy was based on laissez-faire approach, whereby the market forces were believed to bring the market back to equilibrium and optimum point with time. But this is not the case because the government has had to interfere in order to prevent the economy from falling into a triple dip recession within a period of less than five years.
The government has been working in conjunction with the Bank of England, which is considered as the central bank for UK, in controlling the inflation rate, the interest rate, the level of inflation and its effect on unemployment which is expected to decrease as the economy recovers.
- Expectations of the Government Actions
The following are some of the expectations of the government before the next election for the economy. Political pressure has a lot of effect on the performance of an economy and this means that the economy should be strong and ready to cushion any form of negative results.
- Decrease in unemployment levels- currently, UK has the lowest labour productivity in all the countries in central and west Europe (Giudice, 2012, p.99). Labour productivity and employment go hand in hand; they can be increased by encouraging investment in manufacture and agriculture industries. This will diversify the source of national income because currently it is centred on the service industry.
- Decrease in inflation level- currently UK has a high inflation rate that is above 10%, the government seeks to decrease the inflation rate to a level below 10% (Harris, 2005, p.29).
- Increase in the GDP- GDP can only be improved if the net export is kept positive and the country has trade surplus instead of deficit. Increase in exports and decrease in imports will be the main focus when the industries are more diversified. Increase in aggregate demand and supply will increase investment and domestic consumption of goods and services.
- Decrease in deficit budget- the government should decrease on spending in non profitable sectors and focus on spending in sectors that are profitable. This will increase the amount of revenue available to the government. It will also decrease international aid and reduce the debt to GDP ratio to a favourable value.
- Conclusion
UK has one of the most well developed economies; the only problem is the policies embraced by the governments lead the economy to stagnation in comparison to neighbouring countries like Germany and France. The implementation of the policies by the government has allowed for the economy to experience a 0.3% increase in the service sector and a 0.8% increase in the GDP. This gives hope for the economy as it is expected to improve with time (Phillips, 2013, p60).
References
Geroski, P. A, Greg, P, 1997, Coping With Recession: UK Company Performance in Adversity, Psychology Press Print
Giudice, G, Kuenzel, R, Springbett, T, 2012, UK Economy: The Crisis in Perspective, Psychology Print
Graphical Illustration of the Recessionary Period That Has Been Experienced By The Economy Since 2008. Retrieved from www.money.cnn.com/2013/04/25/news/economy/uk
Higgs, P, L, Cunningham, S, D, Bakhshi, H. 2008, Beyond the creative industries: Mapping the creative economy in the United Kingdom, Harvard University Press
Harris, R, Siegel, D. S. Wright, M. 2005, Review of Economics and Statistics, MIT Press, London
Marvin, P Jacob, M, C, Chase, M, Jacob, J, R. 2009. Western Civilization: Ideas, Politics, and Society (9th edition.). Boston: Houghton Mifflin Harcourt. p. 503.ISBN 0-547-14701-5.
Phillips, M, Yanofsky, D, 14 May 2013, Brits are now poorer than the French, Swiss, Belgians, Swedes, Austrians, Aussies and Canadians Quartz. Retrieved 15 May 2013.
Yates, I, 2002, Assessing the Impact of Management Buyouts on Economic Efficiency: Plant-Level Evidence from the United Kingdom, Cambridge University Press, London
Review of Keynesian Economics, January, 2013, Aggregate Demand, Instability and Growth"
