Throughout 2009/10, a new millionaire was created in Brazil every 10 minutes – not bad for a developing country! Despite the global recession, Brazil has managed growth of almost 5% and is set to overtake both the UK and France to become the world’s 5th largest economy. Brazil will hold the next World Cup and the Olympic games after London, bringing it further recognition as a global power. It has the third largest aircraft manufacturing industry in the world and is even doing its bit to tackle climate change, with 50% of its cars running on bio-fuels. It exports more meat than any other country and is looking to become an energy power. With falling unemployment, a buoyant economy, growing confidence, fantastic beaches and 6 millionaires created every hour, Brazil looks like the perfect place to live.
However, that is just one side of the story. Brazil is still a country with deep poverty – approximately 60 million people. The slums, or favelas, are home to 1 million people in Rio alone, where unemployment is high and drug wars common. There has been a concerted effort to reduce the drug trafficking business, but this has only created more unemployment. There is little sanitation, poor electricity and minimal chance of escape. Neighbourhoods need rebuilding, and despite high growth and arguably the most popular president in the world (Lula da Silva), there are calls for political, social, taxation and labour market reforms. This cycle of poverty and the equality gap needs addressing before the Brazilian economy can really be considered a global power.
Webcasts and podcasts
Will Brazil’s economy keep growing? BBC News, Matt Frei (27/5/10)
Brazil’s bid to be ‘world’s breadbasket’ BBC World News America, Paulo Cabral (26/5/10)
Tackling Brazil’s poverty BBC World News America, Gary Duffy (28/5/10)
Brazil’s development spurs economic quality hopes BBC World News America, Matt Frei (27/5/10)
Brazil’s air industry takes off BBC World News America, Paolo Cabral (24/5/10)
‘Our growth quality is better than China’ BBC World News America, Marcelo Neri (25/5/10)
Brazilian economy poised to overtake UK’s BBC News Today, Matt Frei (27/5/10)
Data
Economic data Banco Central do Brasil
Brazil Economy EconomyWatch
Brazil CIA World Factbook
Brazil Geognos
Brazil data World Bank
Questions
- What are the main causes of (a) inequality and (b) poverty in an economy? What is the difference between these concepts?
- How does the government subsidised housing programme aim to help low income households. Use a diagram to illustrate the effect.
- What policies can be used to reduce the equality gap?
- Are those living in the favelas in absolute poverty? How do we distinguish between absolute and relative poverty? Is it the same across the world?
- What are the adverse effects of fast growth in Brazil?
Fears of growing debt problems in the EU have caused global stock markets to plummet. On 25th May, the FTSE was down by 2.6%, Germany’s Dax index fell by 2.34% and in France the Cac 40 was also down 2.74%. Shares across Asia fell, including those in Australia, Hong Kong, Japan and Thailand. On top of this, there are concerns of rising military tensions between North and South Korea. This has only added to the pessimism of investors.
Then came the rescue of the Spanish bank Cajasur by the Bank of Spain, which did little to restore confidence in the world economy. The Spanish deficit has reached 11% of GDP, which is nearly 4 times higher than eurozone rules allow. Spain is also suffering from unemployment of more than 20%, which has led the IMF to call for massive structural reform in the country. The euro has also weakened, as investors sell the currency, because of growing fears of debt default amongst the eurozone countries.
Amid concerns of possible default by Greece, Spain and other countries, the IMF and the members of the European Union have agreed an emergency package of €750 billion (£650 billion). €250 billion comes from the IMF, with €440 billion available as loan guarantees for struggling nations and €60 billion from emergency European Commission funding. We can only wait to see how effective this rescue package will be in restoring confidence in the Eurozone economies.
Articles
Global stock markets see sharp falls BBC News (25/5/10)
Spain must make wide ranging reforms, weak recovery – IMF Reuters (24/5/10)
FTSE falls another 2.5% after Europe’s debt crisis sparks fears in Asian markets Mail Online (25/5/10)
IMF raises fresh concerns about the Spanish economy BBC News (24/5/10)
IMF Chief Economists – doubts over Greek aid remain Reuters, John Irish (24/5/10)
Markets still tense over eurozone debt Independent, Ian Chu (21/5/10)
FTSE falls below 5,000 due to eurozone crisis Telegraph (21/5/10)
FTSE plunges nearly 3% in opening seconds (including video) Sky News (25/5/10)
The contagion of austerity BBC News blogs: Gavin Hewitt’s Europe (25/5/10)
Europe debt crisis threatens recovery, OECD warns BBC News (26/5/10)
Data
In graphics: Eurozone in crisis BBC News (24/5/10)
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission (especially sections 1, 6, 16 and 18)
Questions
- Using a diagram, illustrate why the euro has weakened.
- Explain why stock markets have fallen across the world.
- What type of reforms are needed in Spain?
- What factors are likely to determine the effectiveness of the IMF emergency package?
- Are the austerity measures in the Spanish economy likely to lead to the similar outcomes that we saw in Greece, such as widespread strikes?
- Discuss the advantages and disadvantages of the rescue package. Does rescue involve a moral hazard?
The International Monetary Fund published a report on banking, ahead of the G20 meeting of ministers on 23 April. The IMF states that banks should now pay for the bailout they received from governments during the credit crunch of 2008/9. As the first Guardian article states:
It is payback time for the banks. Widely blamed for causing the worst recession in the global economy since the 1930s, castigated for using taxpayer bailouts to fund big bonuses, and accused of starving businesses and households of credit, the message from the International Monetary Fund is clear: the day of reckoning is at hand.
The Washington-based fund puts the direct cost of saving the banking sector from collapse at a staggering $862bn (£559bn) – a bill that has put the public finances of many of the world’s biggest economies, including Britain and the United States, in a parlous state. Charged with coming up with a way of ensuring taxpayers will not have to dig deep a second time, the top economists at the IMF have drawn up an even more draconian blueprint than the banks had been expecting.
The IMF proposes two new taxes. The first had been expected. This would be a levy on banks’ liabilities and would provide a fund that governments could use to finance any future bailouts. It would be worth around $1500bn: some 2.5% of world GDP, and a higher percentage than that for countries, such as the UK, with a large banking sector.
The second was more surprising to commentators. This would be a financial activities tax (FAT). This would essentially be a tax on the value added by banks, and hence would be a way of taxing profits and pay. Currently, for technical reasons, many of banks’ activities are exempt from VAT (or the equivalent tax in countries outside the EU). The IMF thus regards them as under-taxed relative to other sectors. If such a tax were levied at a rate of 17.5% (the current rate of VAT in the UK), this could raise over 1% of GDP. In the UK this could be as much as £20bn – which would make a substantial contribution to reducing the government’s structural deficit of around £100bn
Meanwhile, in the USA, President Obama has been seeking to push legislation through Congress that would tighten up the regulation of banks. On 20 May, the Senate passed the bill, which now has to be merged with a version in the House of Representatives to become law. A key part of the measures involve splitting off the trading activities of banks in derivatives and other instruments from banks’ regular retail lending and deposit-taking activities with the public and firms. At the same time, there would be much closer regulation of the derivatives market. These complex financial instruments, whose value is ‘derived’ from the value of other assets, would have to be traded in an open market, not in private deals. A new financial regulatory agency will be created with the Federal Reserve having regulatory oversight of the whole of the financial markets
The measures would also give the government the power to break up financial institutions that were failing and rescue solvent parts without having to resort to a full-scale bailout. There is also a proposal to set up a nine-member Council of Regulators to keep a close watch on banking activities and to identify excessive risks. Banks would also be more closely supervised.
So is this payback time for banks? Or will higher taxes simply be passed on to customers, with pay and bonuses remaining at staggering levels? And will tougher regulation simply see ingenious methods being invented of getting round the regulation? Will the measures reduce moral hazard, or is the genie out of the bottle, with banks knowing that they will always be seen as too important to fail?
IMF Webcast
Press Briefing by IMF Managing Director Dominique Strauss-Kahn IMF Webcasts (22/4/10)
Transcript of the above Press Briefing
Articles
The IMF tax proposals
IMF proposes two taxes for world’s banks Guardian, Jill Treanor and Larry Elliott (21/4/10)
IMF gets tough on banks with ‘FAT’ levy Guardian, Linda Yueh (21/4/10)
Q&A: IMF proposals to shape G20 thinking Financial Times, Brooke Masters (21/4/10)
The challenge of halting the financial doomsday machine Financial Times, Martin Wolf (20/4/10)
IMF’s ‘punishment tax’ draws fire from banking industry Financial Times, Sharlene Goff, Brooke Masters and Scheherazade Daneshkhu (21/4/10)
Squeezing the piggy-banks Economist (21/4/10)
IMF, part two Economist, ‘Buttonwood’ (21/4/10)
IMF proposes tax on financial industry as economic safeguard Washington Post, Howard Schneider (20/4/10)
IMF wants two big new taxes on banks BBC News blogs, Peston’s Picks, Robert Peston (20/4/10)
Obama’s proposals
Obama pleas for Wall Street support on reforms Channel 4 News, Job Rabkin (22/4/10)
Q&A: Obama’s bank regulation aims BBC News (22/4/10)
US banks may not bend to Barack Obama’s demands Guardian, Nils Pratley (22/4/10)
President Obama attacks critics of bank reform bill BBC News (23/4/10)
US Senate passes biggest overhaul of big banks since Depression Telegraph (21/5/10)
Finance-Overhaul Bill Would Reshape Wall Street, Washington Bloomberg Businessweek (21/5/10)
US Senate approves sweeping reforms of Wall Street (including video) BBC News (21/5/10)
Obama gets his big bank reforms BBC News blogs: Pestons’s Picks, Robert Peston (21/5/10)
Questions
- What would be the incentive effects on bank behaviour of the two taxes proposed by the IMF?
- What is meant by ‘moral hazard’ in the context of bank bailouts? Would (a) the IMF proposals and (b) President Obama’s proposals increase or decrease moral hazard?
- Why may the proposed FAT tax simply generate revenue rather than deter excessive risk-taking behaviour?
- What market conditions (a) encourage and (b) discourage large pay and bonuses of bankers? Will any of the proposals change these market conditions?
- What do you understand by the meaning of ‘excess profits’ in the context of the banks and what are the sources of such excess profits?
- Criticise the proposed IMF and US measures from the perspective of the banks.
In our blog article IMF warns of the long-term need for fiscal consolidation we highlighted the concerns that the IMF had about the size of public debt-to-GDP ratios in those countries with weak fiscal credibility. Since 1997 the UK has undertaken a series of measures designed to enhance the credibility of fiscal policy and, in particular, to dispel the notion that fiscal policy is unduly sensitive to political needs. Firstly, we have seen the introduction of a Code for Fiscal Stability which outlines a series of principles which should underpin fiscal policy measures. Secondly, in response to the worsening state of the public finances, we have seen the introduction of a Fiscal Responsibility Act which requires governments to outline plans for delivering sound public finances and places a duty on them to deliver them.
The new UK coalition government is now introducing a new independent Office for Budget Responsibility (OBR) which will have responsibility for assessing the public finances and the economy, including the generation of forecasts, and for assessing the public-sector balance sheets (i.e. the sector’s assets and liabilities). The OBR will begin its work immediately in readiness for an ‘emergency Budget’ on the 22nd June. According to the HM Treasury press release on 17 May the OBR will be headed by Sir Alan Budd, an economist who was a founder member of the Monetary Policy Committee (MPC) of the Bank of England. Sir Alan will head a 3-member Budget Responsibility Committee (BRC) which will be supported by economists and public finance experts currently working in HM Treasury, but who in the longer-term will redeployed from the Treasury. Legislation will be drawn up in order to establish the OBR on a permanent statutory basis.
In arguing the case for the OBR, the government points out that all Budget forecasts since 2000 of public borrowing for more than ‘1 year ahead’ have underestimated borrowing. For instance, the average error for ‘2 year ahead’ forecasts since 2000 is £29.5 billion, i.e. borrowing for the financial year after next has, on average, turned out to be £29.5 billion higher than predicted. Of course, we would expect shorter-term forecasts to be more accurate. The evidence presented shows the average error for ‘1 year ahead’ forecasts since 2000 to be £6 billion, i.e. actual borrowing in the following financial year has, on average, been £6 billion higher than forecast. But, more than this, since 2000 four Budgets – those in 2000, 2006, 2007 and 2009 – have produced ‘1 year ahead’ forecasts that over-predicted levels of borrowing.
While it will certainly be fascinating in the years ahead to assess the accuracy of the OBR’s own crystal ball in forecasting, the creation of the OBR is undoubtedly an interesting development in the way in which fiscal policy is both designed and implemented in the UK.
HM Treasury Press Notice
Chancellor announces policies to enhance fiscal credibility HM Treasury (17/5/10)
Articles
Osborne braced for cuts Financial Times, Lionel Barber, George Parker and Chris Giles (17/5/10)
Chancellor launches audit of government spending Independent, Andrew Woodcock (17/5/10)
Osborne gives up power to forecast Financial Times, Chris Giles (17/5/10)
Why the Office for Budget Responsibility Matters BBC News blogs: Stephanomics, Stephanie Flanders (17/5/10)
Osborne confirms new U.K. budget watch dog MarketWatch, William L Watts (17/5/10)
Osborne warns of ‘disastrous consequences’ for economy BBC News, Ben Wright (17/5/10)
Chancellor announces new fiscal watchdog BBC News (17/5/10)
Robert Chote on new OBR BBC Daily Politics, Robert Chote (17/5/10)
George Osborne discovers the joys of kitchen-sinking Telegraph, Tracey Corrigan (17/5/10)
George Osborne tackles Labour’s toxic handover Guardian,
Larry Elliott (17/5/10)
Mixed reaction to Office for Budget Responsibility Public Finance, Jaimie Kaffash (17/5/10)
Questions
- What do you understand by the concept of fiscal credibility?
- How important do you think the new OBR will be in enhancing the UK’s fiscal credibility?
- In what other ways have UK governments attempted to enhance the UK’s fiscal credibility in recent years?
- What do you see as the potential economic benefits of enhancing fiscal credibility?
- One of the first things that the incoming Labour Chancellor, Gordon Brown, did in 1997 was to make the Bank of England independent and create a Monetary Policy Committee (MPC) to set interest rates. What parallels do you see between the MPC and the newly created Budget Responsibility Committee (BRC)?
On the 14th May the IMF published its latest Fiscal Monitor. The key message coming out of this was the need for countries to reduce their public debt ratios, i.e. public debt relative to GDP. Specifically, the IMF is arguing that public debt ratios should be reduced to their ‘post-crisis levels’. In effect, this means countries need to undertake fiscal consolidation. The IMF recognises that the pace of fiscal consolidation should reflect underlying fiscal and macroeconomic conditions, but warns of the dangers of not doing so especially in those countries where the credibility of the current and medium-term fiscal position is weakest.
Underpinning the IMF’s argument for fiscal consolidation is their concern that higher public debt ratios necessitate higher interest rates in order to entice investors to purchase government debt. In those countries with weak fiscal credibility, a sizeable interest rate premium may be needed to entice investors to hold government debt over other types of investments. For instance, we have seen how the markets reacted to the perceived lack of fiscal credibility in Greece and how a series of measures, as discussed in Fixing the Euro: a long term solution or mere sticking plaster were needed to both restore normality to debt markets and to prevent contagion in markets for other country’s public debt.
The IMF argues that the impact of higher interest rates from high public debt-to-GDP ratios would be to reduce an economy’s potential growth. The mechanism by which this would happen would primarily be a reduction of labour productivity growth resulting from lower levels of investment and, hence, from slower growth in the country’s capital stock.
In short, the IMF is arguing that without credible fiscal consolidation plans, countries – particularly advanced economies – run a real risk of restricting their rate of economic growth over the longer-term. Of course, the challenge is to implement fiscal consolidation plans that protect short-term growth by cementing the current economic recovery but do not hinder longer-term growth. Now that is a real challenge!
Report
Fiscal Monitor, May 14 2010 IMF
Articles
IMF Says Rising Public Debt Risk ‘Cannot Be Ignored’ Bloomberg Businessweek, Sandrine Rastello (14/5/10)
US faces one of the biggest crunches in the world – IMF Telegraph, Edmund Conway (14/5/10)
IMF says that developed countries must curb their deficits BBC News (14/5/10)
Outlook for rich economies worsening – IMF Eurasia Review (14/5/10)
Britain’s public debt falls under IMF focus Financial Times, Alan Beattie (15/5/10)
Advanced Economies Face Tougher, Not Impossible, Fiscal Adjustment MarketNews.com, Heather Scott (14/5/10)
A good squeeze The Economist (31/3/10)
Data
IMF Data and Statistic Portal IMF
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission
Questions
- Evaluate the argument put forward by the IMF that fiscal consolidation is necessary to prevent harming long-term economic growth.
- What are the economic dangers of consolidating a country’s fiscal position too quickly?
- What do you understand by short-run and long-term economic growth?
- What do you understand by potential growth?
- What could a government do to increase the perceived credibility of its fiscal position?