Many developing countries are facing a renewed debt crisis. This is directly related to Covid-19, which is now sweeping across many poor countries in a new wave.
Between 2016 and 2020, debt service as a percentage of GDP rose from an average of 7.1% to 27.1% for South Asian countries, from 8.1% to 14.1% for Sub-Saharan African countries, from 13.1% to 42.3% for North African and Middle Eastern countries, and from 5.6% to 14.7% for East Asian and Pacific countries. These percentages are expected to climb again in 2021 by around 10% of GDP.
Incomes have fallen in developing countries with illness, lockdowns and business failures. This has been compounded by a fall in their exports as the world economy has contracted and by a 19% fall in aid in 2020. The fall in incomes has led to a decline in tax revenues and demands for increased government expenditure on healthcare and social support. Public-sector deficits have thus risen steeply.
And the problem is likely to get worse before it gets better. Vaccination roll-outs in most developing countries are slow, with only a tiny fraction of the population having received just one jab. With the economic damage already caused, growth is likely to be subdued for some time.
This has put developing countries in a ‘trilemma’, as the IMF calls it. Governments must balance the objectives of:
- meeting increased spending needs from the emergency and its aftermath;
- limiting the substantial increase in public debt;
- trying to contain rises in taxes.
Developing countries are faced with a difficult trade-off between these objectives, as addressing one objective is likely to come at the expense of the other two. For example, higher spending would require higher deficits and debt or higher taxes.
The poorest countries have little scope for increased domestic borrowing and have been forced to borrow on international markets. But such debt is costly. Although international interest rates are generally low, many developing countries have had to take on increasing levels of borrowing from private lenders at much higher rates of interest, substantially adding to the servicing costs of their debt.
Debt relief
International agencies and groups, such as the IMF, the World Bank, the United Nations and the G20, have all advocated increased help to tackle this debt crisis. The IMF has allocated $100bn in lending through the Rapid Financing Instrument (RFI) and the Rapid Credit Facility (RCF) and nearly $500m in debt service relief grants through the Catastrophe Containment and Relief Trust (CCRT). The World Bank is increasing operations to $160bn.
The IMF is also considering an increase in special drawing rights (SDRs) from the current level of 204.2bn ($293.3bn) to 452.6bn ($650bn) – a rise of 121.6%. This would be the first such expansion since 2009. It has received the support of both the G7 and the G20. SDRs are reserves created by the IMF whose value is a weighted average of five currencies – the US dollar (41.73%), the euro (30.93%), the Chinese yuan (10.92%), the Japanese yen (8.33%) and the pound sterling (8.09%).
Normally an increase in SDRs would be allocated to countries according their IMF quotas, which largely depend on the size of their GDP and their openness. Any new allocation under this formula would therefore go mainly to developed countries, with developing economies getting only around $60bn of the extra $357bn. It has thus been proposed that developed countries give much of their allocation to developing countries. These could then be used to cancel debts. This proposal has been backed by Janet Yellen, the US Secretary of the Treasury, who said she would “strongly encourage G20 members to channel excess SDRs in support of recovery efforts in low-income countries, alongside continued bilateral financing”.
The G20 countries, with the support of the IMF and World Bank, have committed to suspend debt service payments by eligible countries which request to participate in its Debt Service Suspension Initiative (DSSI). There are 73 eligible countries. The scheme, now extended to 31 December 2021, provides a suspension of debt-service payments owed to official bilateral creditors. In return, borrowers commit to use freed-up resources to increase social, health or economic spending in response to the crisis. As of April 2021, 45 countries had requested to participate, with savings totalling more than $10bn. The G20 has also called on private creditors to join the DSSI, but so far without success.
Despite these initiatives, the scale of debt relief (as opposed to extra or deferred lending) remains small in comparison to earlier initiatives. Under the Heavily Indebted Poor Countries initiative (HIPC, launched 1996) and the Multilateral Debt Relief Initiative (MDRI, launched 2005) more than $100bn of debt was cancelled.
Since the start of the pandemic, major developed countries have spent between $10 000 and $20 000 per head in stimulus and social support programmes. Sub-Saharan African countries on average are seeking only $365 per head in support.
Articles and blogs
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Questions
- Imagine you are an economic advisor to a developing country attempting to rebuild the economy after the coronavirus pandemic. How would you advise it to proceed, given the ‘trilemma’ described above?
- How does the News24 article define ‘smart debt relief’. Do you agree with the definition and the means of achieving smart debt relief?
- To what extent is it in the interests of the developed world to provide additional debt relief to poor countries whose economies have been badly affected by the coronavirus pandemic?
- Research ‘debt-for-nature swaps’. To what extent can debt relief for countries affected by the coronavirus pandemic be linked to tackling climate change?
With the coronavirus pandemic having reached almost every country in the world, the impact on the global economy has been catastrophic. Governments have struggled balancing the spread of the virus and keeping the economy afloat. This has left businesses counting the costs of various control measures and numerous lockdowns. The crisis has particularly affected small and medium-sized enterprises (SMEs), causing massive job losses and longer-term economic scars. Among these is an increase in the market power held by dominant firms as they emerge even stronger while smaller rivals fall away.
It is feared that with the full effects of the pandemic not yet realised, there may well be a wave of bankruptcies that will hit SMEs harder than larger firms, particularly in the most affected industries. Larger firms are most likely to be more profitable in general and more likely to have access to finance. Firm-level analysis using Orbis data, which includes listed and private firms, suggests that the pandemic-driven wave of bankruptcies will lead to increases in industry concentration and market power.
What is market power?
A firm holds a dominant position if its power enables it to operate within the market without taking account of the reaction of its competitors or of intermediate or final consumers. The key role of competition authorities around the world is to protect the public interest, particularly against firms abusing their dominant positions.
The UK’s competition authority, the Competition and Markets Authority (CMA) states:
Market power arises where an undertaking does not face effective competitive pressure. …Market power is not absolute but is a matter of degree; the degree of power will depend on the circumstances of each case. Market power can be thought of as the ability profitably to sustain prices above competitive levels or restrict output or quality below competitive levels. An undertaking with market power might also have the ability and incentive to harm the process of competition in other ways; for example, by weakening existing competition, raising entry barriers, or slowing innovation.
It can be hard to distinguish between a rapidly growing business and growing concentration of market power. In a pandemic, these distinctions can become even more difficult to discern, since there really is a deep need for a rapid deployment of capital, often in distressed situations. It is also not always evident whether the attempt to grow is driven by the need for more productive capacity, or by the desire to engage in financial engineering or to acquire market power.
It may be the case that, as consumers, we simply have no choice but to depend on various monopolies in a crisis, hoping that they operate in the public interest or that the competition authorities will ensure that they do so. With Covid-19 for example, economies will have entered the pandemic with their existing institutions, and therefore the only way to operate may be through channels controlled by concentrated power. Market dominance can occur for what seem to be good, or least necessary, reasons.
Why is market power a problem?
Why is it necessarily a problem if a successful company grows bigger than its competitors through hard work, smart strategies, and better technology adoption? It is important to recognise that increases in market power do not always mean an abuse of that market power. Just because a company may dominate the market, it does not mean there is a guaranteed negative impact on the consumer or industry. There are many advantages to a monopoly firm and, therefore, it can be argued that the existence of a market monopoly in itself should not be a cause of concern for the regulator. Unless there is evidence of past misconduct of dominance, which is abusive for the market and its stakeholders, some would argue that there is no justification for any involvement by regulators at all.
However, research by the International Monetary Fund concluded that excessive market power in the hands of a few firms can be a drag on medium-term growth, stifling innovation and holding back investment. Given the severity of the economic impact of the pandemic, such an outcome could undermine the recovery efforts by governments. It could also prevent new and emerging firms entering the market at a time when dynamism is desperately needed.
The ONS defines business dynamism as follows:
Business dynamism relates to measures of birth, growth and decline of businesses and its impact on employment. A steady rate of business creation and closure is necessary for an economy to grow in the long-run because it allows new ideas to flourish.
A lack of business dynamism could lead to a stagnation in productivity and wage growth. It also affects employment through changes in job creation and destruction. In this context, the UK’s most recent unemployment rate was 5%. This is the highest figure for five years and is predicted to rise to 6.5% by the end of 2021. Across multiple industries, there is now a trend of falling business dynamism with small businesses failing to break out of their local markets and start-up companies whose prices are undercut by a big rival. This creates missed opportunities in terms of growth, job creation, and rising incomes.
There has been a rise in mergers and acquisitions, especially amongst dominant firms, which is contributing to these trends. Again, it is important to recognise that mergers and acquisitions are not in themselves a problem; they can yield cost savings and produce better products. However, they can also weaken incentives for innovation and strengthen a firm’s ability to charge higher prices. Analysis shows that mergers and acquisitions by dominant firms contribute to an industry-wide decline in business dynamism.
Changes in market power due to the pandemic
The IMF identifies key indicators for market power, such as the percentage mark-up of prices over marginal cost, and the concentration of revenues among the four biggest players in a sector. New research shows that these key indicators of market power are on the rise. It is estimated that due to the pandemic, this increase in market dominance could now increase in advanced economies by at least as much as it did in the fifteen years to the end of 2015.
Global price mark-ups have risen by more than 30%, on average, across listed firms in advanced economies since 1980. And in the past 20 years, mark-up increases in the digital sector have been twice as steep as economy-wide increases. Increases in market power across multiple industries caused by the pandemic would exacerbate a trend that goes back over four decades.
It could be argued that firms enjoying this increase in market share and strong profits is just the reward for their growth. Such success if often a result of innovation, efficiency, and improved services. However, there are growing signs in many industries that market power is becoming entrenched amid an absence of strong competitors for dominant firms. It is estimated that companies with the highest mark-ups in a given year, have an almost 85 percent chance of remaining a high mark-up firm the following year. According to experts, some of these businesses have created entry barriers – regulatory or technology driven – which are incredibly high.
Professor Jayant R. Varma, a member of the MPC of the Reserve Bank of India (RBI), observed that in several sectors characterised by an oligopolistic core and a competitive periphery, the oligopolistic core has weathered the pandemic and it is the competitive periphery that has been debilitated. Rising profits and profit margins, improving capacity utilisation and lack of new capacity additions create ripe conditions for the oligopolistic core to start exercising pricing power.
The drivers and macroeconomic implications of such rises in market power are likely to differ across economies and individual industries. Even in those industries that benefited from the crisis, such as the digital sector, dominant players are among the biggest winners. The technology industry has been under the microscope in recent years, and increasingly the big tech firms are under scrutiny from regulators around the world. The market disruptors that displaced incumbents two decades ago have become increasingly dominant players that do not face the same competitive pressures from today’s would-be disruptors. The pandemic is adding to powerful underlying forces such as network effects and economies of scale and scope.
A new regulator that aims to curb this increasing dominance of the tech giants has been established in the UK. The Digital Markets Unit (DMU) will be based inside the Competition and Markets Authority. The DMU will first look to create new codes of conduct for companies such as Facebook and Google and their relationship with content providers and advertisers. Business Secretary Kwasi Kwarteng said the regime will be ‘unashamedly pro-competition’.
Policy Responses
The additions in regulation in the UK fall in line with the guidance from the IMF. It recommends that adjustments to competition-policy frameworks need to be made in order to minimise the adverse effects of market dominance. Such adjustments must, however, be tailored to national circumstances, both in general and to address the specific challenges raised by the surge of the digital economy.
It recommends the following five actions:
- Competition authorities should be increasingly vigilant when enforcing merger control. The criteria for competition authorities to review a deal should cover all relevant cases – including acquisitions of small players that may grow to compete with dominant firms.
- Second, competition authorities should more actively enforce prohibitions on the abuse of dominant positions and make greater use of market investigations to uncover harmful behaviour without any reported breach of the law.
- Greater efforts are needed to ensure competition in input markets, including labour markets.
- Competition authorities should be empowered to keep pace with the digital economy, where the rise of big data and artificial intelligence is multiplying incumbent firms’ advantage. Facilitating data portability and interoperability of systems can make it easier for new firms to compete with established players.
- Investments may be needed to further boost sector-specific expertise amid rapid technological change.
Conclusion
The crisis has had a significant impact on all businesses, with many shutting their doors for good. However, there has been a greater negative impact on SMEs. Even in industries that have flourished from the pandemic, it is the dominant firms that have emerged the biggest winners. There is concern that the increasing market power will remain embedded in many economies, stifling future competition and economic growth. While the negative effects of increased market power have been moderate so far, the findings suggest that competition authorities should be increasingly vigilant to ensure that these effects do not become more harmful in the future.
Reviews of competition policy frameworks have already begun in some major economies. Young, high-growth firms that innovate and create high-quality jobs deserve a level playing field and a fair chance to succeed. Support directed to SMEs is important, as many small firms have been unable to benefit from government programmes designed to help firms access financing during the pandemic. Policymakers should act now to prevent a further, sharp rise in market power that could hold back the post-pandemic recovery.
Articles
Podcast
Official documents
Questions
- What are the arguments for and against the assistance of a monopoly?
- What barriers to entry may exist that prevent small firms from entering an industry?
- What policies can be implemented to limit market power?
- Define and explain market dynamism.
Throughout the pandemic, the fight against COVID-19 has often been framed in terms of striking a balance between the health of the public and the health of the economy. This leads to the assumption that a trade-off must exist between these two objectives. Countries, therefore, have to decide between lives and livelihoods. However, one year on since lockdowns swept the globe the evidence suggests that the trade-off between sacrificing lives and sacrificing the economy is not necessarily clear cut.
Controlling the virus
Restrictions such as social distancing and lockdowns were introduced in order to minimise the spread of the virus, prevent hospitals from being overwhelmed, and ultimately save lives. However, as these measures are put in place, schools were closed, businesses and factories stopped operating, and economic activity shrank. This would suggest therefore, that society inevitably faces a trade-off between lost lives versus lost livelihoods.
It could be argued, therefore, that in the short run these interventions create a ‘health–wealth trade-off’. The lockdown restrictions save lives by preventing transmission, but they came at the cost of lost output, income and therefore GDP. This would also imply that the trade-off works in reverse when the lockdown restrictions are eased. As measures are relaxed, the economy can begin to recover but at the cost of an increased threat of the virus spreading again.
What are the costs?
In order to work out if a trade-off exists and what costs are involved, there must be a monetary value placed on human life. While this may seem unethical, governments, civil courts, regulatory bodies and companies do it all the time. The very existence of the life insurance industry is testament to the fact that human lives can be measured in monetary terms. One approach to measuring valuing life, commonly used by economists who conduct cost-benefit analyses, is the ‘value of statistical life’. It measures the loss or gain that arises from changes in the incidence of death, by eliciting people’s willingness to pay for small reductions in the probability of death, or their willingness to accept compensation in exchange for tolerating a small increase in the chance of death. (see the blog Lockdown – again. Is it worth it?)
Take the example of a complete lockdown. The potential number of lives saved can be estimated based on infection and fatality rates estimated from epidemiological models. This can then be multiplied by value of statistical life to compute the monetary value of saved lives. If this number exceeds the economic costs of a complete lockdown, then we know that it is desirable.
The trade-off between lost lives versus the economy is often erroneously viewed as an all-or-nothing choice between complete lockdown versus zero restrictions. However, in reality, there is a continuum in stringency of restrictions and it is not an all-or-nothing comparison.
Death rates vs downturns
In order to explore the existence of this trade-off, we can compare the health and economic impacts of the pandemic in different countries. If such a trade-off exists, then countries with lower death rates should have experienced larger economic downturns. However, when comparing the COVID-19 death rates with GDP data, the result is the opposite: countries that have managed to protect their population’s health in the pandemic have generally also protected their economy too. This suggests that there was never a simple binary trade-off between the two factors. Those countries that experienced the biggest first wave of excess deaths, also had the biggest hits to the economy.
The UK was the hardest hit of similar countries on both measures within the G7 group of industrialised countries. The shape of the recession in the UK from the pandemic and lockdowns was extraordinary and historic. However, it was also unique as there was a very sharp fall followed by a rapid rebound. Over 2020, GDP saw the largest hit in three centuries; larger than any single year of the Great Wars or the 1920s Depression.
Studies of the declines in GDP contradict the idea of a trade-off, showing that countries that suffered the most severe economic downturns, such as Peru, Spain and the UK, were generally among the countries with the highest COVID-19 death rates. There are countries that have experienced the reverse too; Taiwan, South Korea, and Lithuania all experienced modest declines in economic output but have also managed to keep the death rate low.
It should also be noted that some countries that had similar falls in GDP experienced very different death rates from each other. When comparing the USA and Sweden with Denmark and Poland, they all saw similar declines in the economy with contractions of around 8–9%. However, the USA and Sweden recorded 5–10 times more deaths per million. This therefore suggests that there is no clear trade-off between the health of the population and the health of the economy.
There will be many different factors that impact on the death rate for each individual country and by how much the economy has been affected. Such factors will even go beyond the policy decisions that have been made throughout the pandemic about how best to suppress the transmission of the virus. However, from the data available, there is no clear evidence to suggest that a trade-off between the health and the economy exists. If anything, it suggests that the relationship works in the opposite direction.
Save the economy by saving lives
Given the arguments against the existence of the trade-off, it could be argued that in order to limit the economic damage caused by the pandemic, the focus needs to start and end with controlling the spread of the virus. Experiments that have been conducted across the world definitively show that no country can prevent the economic damage without first addressing the pandemic that causes it. Those countries that acted swiftly in implementing harsh measures to control the virus, are now reopening in stages and their economies are growing. Countries such as China, Australia, New Zealand, Iceland, and Singapore, which all invested primarily in swift coronavirus suppression, have effectively eliminated the virus and are seeing their economies begin to grow again.
China, in particular, stands out amongst this group of countries. The Chinese authorities acted very quickly, and firmly, but also the levels of compliance of the population have been very high. However, it could be argued that few countries possess the infrastructure that exists in China to facilitate such high compliance. The fact that the lockdown in China was so effective reduced both losses to the economy and the need for stimulus measures. China is also one of the few countries that have achieved a “V-shaped” recovery. Countries such as Korea, Norway and Finland also appear to have responded relatively well.
Most of the countries that prioritised supporting their economies and resisted, limited, or prematurely curtailed interventions to control the pandemic faced runaway rates of infection and further national lockdowns. The examples of the UK, the USA and Brazil are often quoted, with many arguing that these countries responded too late and too haphazardly. Both have experienced high numbers of deaths.
Conclusion
Discussions around the responses to the pandemic and what appropriate action should be taken have predominately been about how countries can strike the balance between protecting people’s health and protecting the economy. However, from observing the GDP data available there is no clear evidence of a definitive trade-off; rather the relationship between the health and economic impacts of the pandemic goes in the opposite direction. As well as saving lives, countries controlling the outbreak effectively may have adopted the best economic strategy too. It is important to recognise that many factors have affected the death rate and the impact on the economy, and the full impacts of the pandemic are yet to be seen. However, it is by no means clear that the trade-off between greater emphasis on sacrificing lives or sacrificing the economy is as real as has been suggested. If such a trade-off does exist, it is, at best, a weak one.
Articles
- In a pandemic it isn’t a case of health v wealth
BBC News, Faisal Islam (17/3/21)
- To Save the Economy, Save People First
Institute for New Economics Thinking, Phillip Alvelda, Thomas Ferguson, and John C. Mallery (18/11/20)
- Covid-19: Is there a trade-off between economic damage and loss of life?
LSE Blogs, Bernard H Casey (18/12/20)
- The COVID-19 dilemma: Public health versus the economy
Asian Development Bank Blogs, Euston Quah, Eik Leong Swee and Donghyun Park (24/11/20)
- Valuating health vs wealth: The effect of information and how this matters for COVID-19 policymaking
VOXEU, Shaun P. Hargreaves Heap, Christel Koop, Konstantinos Matakos, Asli Unan, Nina Weber (6/6/20)
- Which countries have protected both health and the economy in the pandemic?
Our World in Data, Joe Hasell (1/9/20)
Questions
- Define and explain the difference between a substitute and complementary good.
- Using your answer to question 1, describe the existence of a trade-off.
- Discuss the reasons why the trade-off between health and the economy would work in the opposite direction.
On 10 March, the House of Representatives gave final approval to President Biden’s $1.9tr fiscal stimulus plan (the American Rescue Plan). Worth over 9% of GDP, this represents the third stage of an unparalleled boost to the US economy. In March 2020, President Trump secured congressional agreement for a $2.2tr package (the CARES Act). Then in December 2020, a bipartisan COVID relief bill, worth $902bn, was passed by Congress.
By comparison, the Obama package in 2009 in response to the impending recession following the financial crisis was $831bn (5.7% of GDP).
The American Rescue Plan
The Biden stimulus programme consists of a range of measures, the majority of which provide monetary support to individuals. These include a payment of $1400 per person for single people earning less than $75 000 and couples less than $150 000. These come on top of payments of $1200 in March 2020 and $600 in late December. In addition, the top-up to unemployment benefits of $300 per week agreed in December will now continue until September. Also, annual child tax credit will rise from $2000 annually to as much as $3600 and this benefit will be available in advance.
Other measures include $350bn in grants for local governments depending on their levels of unemployment and other needs; $50bn to improve COVID testing centres and $20bn to develop a national vaccination campaign; $170bn to schools and universities to help them reopen after lockdown; and grants to small businesses and specific grants to hard-hit sectors, such as hospitality, airlines, airports and rail companies.
Despite supporting the two earlier packages, no Republican representative or senator backed this latest package, arguing that it was not sufficiently focused. As a result, reaction to the package has been very much along partisan lines. Nevertheless, it is supported by some 90% of Democrat voters and 50% of Republican voters.
Is the stimulus the right amount?
Although the latest package is worth $1.9tr, aggregate demand will not expand by this amount, which will limit the size of the multiplier effect. The reason is that the benefits multiplier is less than the government expenditure multiplier as some of the extra money people receive will be saved or used to reduce debts.
With $3tr representing some 9% of GDP, this should easily fill the estimated negative output gap of between 2% and 3%, especially when multiplier effects are included. Also, with savings having increased during the recession to put them some 7% above normal, the additional amount saved may be quite small, and wealthier Americans may begin to reduce their savings and spend a larger proportion of their income.
So the problem might be one of excessive stimulus, which in normal times could result in crowding out by driving up interest rates and dampening investment. However, the Fed is still engaged in a programme of quantitative easing. Between mid-March 2020 and the end of March 2021, the Fed’s portfolio of securities held outright grew from $3.9tr to $7.2tr. What is more, many economists predict that inflation is unlikely to rise other than very slightly. If this is so, it should allow the package to be financed easily. Debt should not rise to unsustainable levels.
Other economists argue, however, that inflationary expectations are rising, reflected in bond yields, and this could drive actual inflation and force the Fed into the awkward dilemma of either raising interest rates, which could have a significant dampening effect, or further increasing money supply, potentially leading to greater inflationary problems in the future.
A lot will depend what happens to potential GDP. Will it rise over the medium term so that additional spending can be accommodated? If the rise in spending encourages an increase in investment, this should increase potential GDP. This will depend on business confidence, which may be boosted by the package or may be dampened by worries about inflation.
Additional packages to come
Potential GDP should also be boosted by two further packages that Biden plans to put to Congress.
The first is a $2.2tr infrastructure investment plan, known as the American Jobs Plan. This is a 10-year plan to invest public money in transport infrastructure (such as rebuilding 20 000 miles of road and repairing bridges), public transport, electric vehicles, green housing, schools, water supply, green power generation, modernising the power grid, broadband, R&D in fields such as AI, social care, job training and manufacturing. This will be largely funded through tax increases, such as gradually raising corporation tax from 21% to 28% (it had been cut from 35% to 21% by President Trump) and taxing global profits of US multinationals. However, the spending will generally precede the increased revenues and thus will raise aggregate demand in the initial years. Only after 15 years are revenues expected to exceed costs.
The second is a yet-to-be announced plan to increase spending on childcare, healthcare and education. This should be worth at least $1tr. This will probably be funded by tax increases on income, capital gains and property, aimed largely at wealthy individuals. Again, it is hoped that this will boost potential GDP, in this case by increasing labour productivity.
With earlier packages, the total increase in public spending will be over $8tr. This is discretionary fiscal policy writ large.
Articles
- Biden’s $1.9 trillion COVID-19 bill wins final approval in House
Reuters, Susan Cornwell and Makini Brice (10/3/21)
- Biden’s Covid stimulus plan: It costs $1.9tn but what’s in it?
BBC News, Natalie Sherman (6/3/21)
- Biden’s $1.9 Trillion Challenge: End the Coronavirus Crisis Faster
New York Times, Jim Tankersley and Sheryl Gay Stolberg (22/3/21)
- Joe Biden writes a cheque for America – and the rest of the world
The Observer, Phillip Inman (13/3/21)
- Spend or save: Will Biden’s stimulus cheques boost the economy?
Aljazeera, Cinnamon Janzer (9/3/21)
- After Biden stimulus, US economic growth could rival China’s for the first time in decades
CNN, Matt Egan (12/3/21)
- Larry Summers, who called out inflation fears with Biden’s $1.9 trillion COVID-19 relief package, says the US is seeing ‘least responsible’ macroeconomic policy in 40 years
Business Insider, John L. Dorman (21/3/21)
- With $1.9 Trillion in New Spending, America Is Headed for Financial Fragility
Barron’s, Leslie Lipschitz and Josh Felman (30/3/21)
- Biden unveils ‘once-in-a generation’ $2tn infrastructure investment plan
The Guardian, Lauren Gambino (31/3/21)
- Biden unveils $2tn infrastructure plan and big corporate tax rise
Financial Times, James Politi (31/3/21)
- The Observer view on Joe Biden’s audacious spending plans
The Observer, editorial (11/4/21)
Videos
Questions
- Draw a Keynesian cross diagram to show the effect of an increase in benefits when the economy is operating below potential GDP.
- What determines the size of the benefits multiplier?
- Explain what is meant by the output gap. How might the pandemic and accompanying emergency health measures have affected the size of the output gap?
- How are expectations relevant to the effectiveness of the stimulus measures?
- What is likely to determine the proportion of the $1400 stimulus cheques that people spend?
- Distinguish between resource crowding out and financial crowding out. Is the fiscal stimulus package likely to result in either form of crowding out and, if so, what will determine by how much?
- What is the current monetary policy of the Fed? How is it likely to impact on the effectiveness of the fiscal stimulus?
In his March 2021 Budget, Rishi Sunak announced the setting up of eight freeports in England. These will be East Midlands Airport, Felixstowe & Harwich, Humber, Liverpool City Region, Plymouth and South Devon, Solent, Teesside and Thames. The locations were chosen after a bidding process. Some 30 areas applied and they were judged on various criteria, including economic benefits to poorer regions. Other freeports are due to be announced in Scotland, Wales and Northern Ireland. The Scottish government is stressing their contribution to the green agenda and will call them ‘green ports’.
Unlike many countries, the UK in recent years chose not to have freeports. There are currently around 3500 freeports worldwide, There are around 80 in the EU, including the whole or part of Barcelona, Port of Bordeaux, Bremerhaven, Cadiz, Copenhagen, Gdansk, Luxembourg, Madeira, Malta, Plovdiv, Piraeus, Riga, Split, Trieste, Venice and Zagreb. The UK had freeports at Liverpool, Southampton, the Port of Tilbury, the Port of Sheerness and Prestwick Airport from 1984, but the government allowed their status to lapse in 2012.
Freeports are treated as ‘offshore’ areas, with goods being allowed into the areas tariff free. This enables raw materials and parts to be imported and made into finished or semi-finished products within the freeport area. At that stage they can either be imported to the rest of the country, at which point tariffs are applied, or they can be exported with no tariff being applied by the exporting country, only the receiving country as appropriate. This benefits companies within the freeport area as it simplifies the tariff system.
The new English freeports will provide additional benefits to companies, including reduced employers’ national insurance payments, reduced property taxes for newly acquired and existing land and buildings, 100% capital allowances whereby the full cost of investment in plant and machinery can be offset against taxable profits, and full business-rates relief for five years (see paragraph 2.115 in Budget 2021).
Benefits and costs
Freeport status will benefit the chosen areas, as it is likely to attract inward investment and provide employment. Many areas were thus keen to bid for freeport status. To the extent that there is a net increase in investment for the country, this will contribute to GDP growth.
But there is the question of how much net additional investment there will be. Critics argue that freeports can divert investment from areas without such status. Also, to the extent that investment is diverted rather than being new investment, this will reduce tax revenue to the government.
Then there is the question of whether such areas are in breach of international agreements. WTO rules forbid countries from directly subsidising exports. And the Brexit trade deal requires subsidies to be justified for reasons other than giving a trade advantage. If the UK failed to do so, the EU could impose tariffs on such goods to prevent unfair competition.
Also, there is the danger of tax evasion, money laundering and corruption encouraged by an absence of regulations and checks. Tight controls and thorough auditing by the government and local authorities will be necessary to counter this and prevent criminal activity and profits going abroad. Worried about these downsides of freeports, in January 2020 the EU tightened regulations governing freeports and took extra measures to clamp down on the growing level of corruption, tax evasion and criminal activity.
Articles
Averting a COVID-19 Debt Trap