China - Case Study I

Key Questions:

·         Is growth increasing incomes on the average Chinese?

·         Is growth lifting people out of poverty?

·         Is minimum wage industrialisation the best way to achieve growth?

QUALITY of growth matters

·         Average income for a Chinese worker is (USD)$8000

·         By 2020, it is estimated that average Chinese wages would have risen to (US) $14,000. This level is considered to be the upper income level that moved countries such as Singapore, South Korea, Greece and Portugal, to ‘rich’ country stats - the level that moved these countries past the boundary

Five year plan

·         China’s growth has been, on average, 9.6% over the past 30 years

·         The five year plan is the government’s 12th five-year plan used to set the future growth agenda for China

·         Renewed in 2011, the priorities for this plan are sustainable growth, industrial upgrading and the promotion of domestic consumption

·         Criticism: there is no implementation plan

See kpmg report:

·         Half of china’s growth comes from adding capital. Bear in mind that growth quality is now becoming the most important thing to think about rather than growth quantity

Total Factor Productivity (TFP) is measured by innovation, allocative efficiency (re-allocation of factors, e.g. rural to urban, state owned to private) and human capital. TFP is the contribution of all factors of production to growth. When TFP increases, the growth rate increases. This means that one or more of the factors of production has been changed.

Innovation - micro level data shows that ⅔ technology comes from imitation, most developing countries imitate first to gain enough wealth to then invest it into R&D for new product development. Imitation leads to innovation - creating an increase in growth.

Human capital - China’s investment in human capital is geographical unevenly distributed. Rural parts of China are under-invested in. If China invests in human capital all round, it has a better chance competing with other economies. Human capital is beneficial because:

·         Skill levels increase. E.g. they will be more qualified to perform tasks and will do so quicker

·         Creates a flexible economy - workers have a greater capacity to adapt to changes in the economy, i.e. seize new opportunities for wealth creation

·         Increases occupational mobility of labour and geographical mobility of labour as because of the previous point

·         High levels of education can increase a worker’s ability to use foreign technology, their ability to absorb new information and acquire technical skills

Middle Income Trap

China needs to avoid the middle income trap. The middle income trap is the trap that developing countries fall into when trying to make their transition from a developing country to a developed country. They are not low income by definition, i.e. they experience high growth rates and make money, but they are not high income countries because they do not have technological advantages. China’s wages are starting to increase, as shown here, demonstrating that what was once the most popular destination for cheap manufacturing, is now losing to countries such as Bangladesh and Singapore.

Key points:

·         Wages are increasing

·         Poverty is slowing decreasing

·         Innovation is creeping up

·         Chinese firms are expanding globally

·         Without the prospect for cheap labour, firms will be deterred from investing in China

·         Only urban members of the workforce are educated, also potentially deterring firms

·         The Chinese economy is still imitating

These points suggest that China is heading for the middle income trap, a limbo between the rich and poor, unable to progress. There are criticisms of the middle income trap, read the Economist article here to gain other perspectives, which will help you build your argument in your exam. Remember that providing alternative views are brownie points. Read the sources at the bottom as well.

The Future

·         Focus on overcoming the middle income trap

·         Increase own market reliance, e.g. US consumers are increasingly buying domestically produced goods

·         Increase domestic demand by lowering exports. E.g. exports are only a fraction in the US - China needs to get to that

·         Privatise. State owned companies are not as productive. They distort the allocation of lending and bank credit. State owned enterprises account for 30% industrial output and ¼ of urban jobs

·         Increase innovation

·         Increase opening - more Chinese firms should go global.

o        We have seen Chinese investment in African natural resources, which is a start. They are building infrastructure in poor African countries and providing jobs (however a negative is that they are competing with local firms and undercutting them, making it difficult for locals to make a living)

o        China should focus on moving up the value chain by producing things that is most competitive

o        The government should push to create Chinese multinationals

o        At the moment, Europe in particular can benefit from the additional investment that Chinese firms can offer

·         Services are important - increase job creation, create a high skilled labour force and help China rebalance

·         Raise consumption as a share of GDP, not rising it in absolute terms

·         Restructure the economy: more services, quality of growth needs to increase

·         Productivity and innovation: compete to produce the best products in the world. Join the ranks of rich countries, e.g. Samsung (South Korea) competing with Apple (US)

·         Political reforms are required to sustain a prosperous middle class

Trade Unions

A collective association of workers whose aim is to improve the pay and conditions of member workers.

Aim to:

·     Improve real incomes

·     Working conditions

·     Pensions

·     Security

·     Unfair dismissal

·     Counter monopsony power

·     Protect against discrimination

Trade union membership has declined to less than 30% of all those employed in the UK (2007). Reasons for this include:

·     Membership is considered to be a waste since the economy was in a boom creating less of a need to bargain for higher wages

·     Tougher employment laws

·     Little evidence for significant mark-ups in wage levels bought about by trade unions

·     You become less employable if you belong to a trade union

·     Changes to the labour market: decline in jobs in heavy industry to more service sector based, shifts towards shorter employment contracts and more people working part-time/flexible hours

·     Some employers restricted trade unions in their work place

Unions influence pay by:

Ø     Collective bargaining

o      negotiate pay levels above the current levels that exist. This is only effective if the union has control over the total labour supply available in the industry.

Ø     Closed shop agreement – employer and union agree that all workers be part of the union

o      Pre-entry: workers must join the union before starting employment

o      Post-entry: non trade union members get the job but have to join to keep the job. This prevents free-riders benefiting from the mark up bought by the union on wages

o      This was considered to be a labour restrictive practice and is now illegal in the UK

Pre-entry closed shop

The diagram below briefly displays a pre-entry closed shop agreement made by unions.

S1 shows the supply for labour in the market before the closed shop agreement. Supply shifts to the left and becomes more inelastic because the increase in wages has minimal effect on employment if the workers have already been employed by the firm. Employment still, however, falls from L1 to L2 when wages rise from W1 to W2.

Perfectly competitive market

To refresh your memory of the PC market, click on the revision notes of the PC market in the short run and long run.

This diagram shows the effects of a trade union in a perfectly competitive market. The equilibrium wage rate is W1 where the number of workers employed is L1. The effect of the trade union is that wages are pushed up to W2 à the acceptable wage rate for union members. The supply curve becomes W2XS. From W2X, the supply curve is perfectly elastic. Along XS, the curve is upwards sloping because more workers are attracted to higher wage rates. The employer wishes to hire L3 workers but the number of workers willing to work at the wage rate of W2 is L2. Thus there is excess supply of labour, causing classical unemployment between L2- L3. 

This diagram argues that the trade union causes unemployment, however one can counter-argue, as in the Keynesian view. It is unrealistic to assume that demand conditions remain unchanged because higher wages would normally increase demand for output, thus increasing output and increasing demand for workers to produce more output.

This diagram can also be used to explain the effect of the National Minimum Wage, as well as trade union mark-ups.

Look out for more on the effects of trade unions in a monopsonistic market soon! (To prepare yourself, you could read Word of the Day)

Oligopoly Case Study

News of tough economic times ahead could be one of the driving forces behind a possible price war between Asda, Tesco and Sainsbury's, among others. The supermarket market is prone to have price wars frequently, particularly ahead of seasonal periods. This article here, explains the strategies used by Asda, Tesco and Sainsbury's, yet competition is getting stronger with European supermarkets Aldi and Lidl increasing their market share (measured by the concentration ratio). Apparently there is no price war going on, yet if consumer prices get lower and lower in the coming weeks, we may have to reconsider what really is happening.

This is a good case study to use and gives you an idea about oligopolistic markets at work.

Supply Side Economics

Supply side economic policy is a set of government initiatives that aim to improve the economic performance of markets and industries. Policies tend to be more microeconomic because they focus of individual economic agents. Policies aim to:

· Increase competition within markets

· Increase efficiency within markets

· Increase the economy’s potential production – PPF/LRAS (see here for more)

Supply side fiscal policy

· Creating personal incentives to improve economic performance of the supply-side of the economy

· Since 1979, supply-side fiscal policy had been used by Labour and Conservative governments

· Supply-side economists believe that high levels of government spending, taxation and borrowing lead to crowding out (see below) of the public sector.

The intended effects of supply-side policies are shown below:

It is the free market view that supply-side policies should be used to increase efficiency and competition within markets.

Crowding out

Resource crowding out

Assuming there is no spare capacity in the economy and full employment of all resources, resource crowding out is when employing more labour and capital in the public sector sacrifices the use of the same resources by the private sector. Resource crowding out does not happen when there is spare capacity in the economy because government spending can be seen as ‘picking up the slack’ of the private sector. The private sector can be stimulated and crowding in can occur.

Financial crowding out

Increasing taxes to facilitate for high levels of government expenditure reduces the spending power of private sector firms.