China, India and G7 Inequality — Macro Hybrid DRQ

Case

Extract 6: China’s achievement and challenges

In the past four decades, the Chinese economy has been transformed from a predominantly agricultural one to an industrial powerhouse and is now increasingly service oriented. With China’s tremendous economic development, average incomes grew nine-fold since 1990, and some 800 million people were lifted out of poverty. This was associated with an increase in labour productivity, which led to higher wages, saving, investment and capital stock growth. However, population ageing, productivity slowdown, rising inequality and environmental degradation are constraining China’s economic growth potential. As China approaches the technological frontier, productivity growth is slowing, and so has the growth of the Chinese economy in recent years.

Source: Adapted from UN ESCAP Policy Brief, 27 March 2019

Figure 2: Real GDP growth rates of five largest world economies, 2016–2019 — GDP growth rates of four of the five largest economies have been slowing; three of the five fell from 2018 to 2019, and the UK and Japan grew only slightly and remained below 2%.

Extract 6 (cont.): The crisis that shattered India’s economic dreams

India’s slumping consumption is so severe that it’s denting global growth. From 8% growth three years ago, the economy is set to expand just 5% in the fiscal year through March 2020, the weakest performance since 2009. At the heart of the economy’s problems is a lingering credit slowdown. As lenders choked off credit, domestic spending took a knock — and with consumption making up almost two-thirds of India’s GDP, it wasn’t long before growth numbers were hit. The government is now confronted with rising unemployment as layoffs spread across industries; the jobless rate climbed from a four-decade high of 6.1% in June 2018 to 7.85% in the final quarter of 2019.

Source: Adapted from Bloomberg, 30 January

Extract 7: Rising inequality in the G7 countries

G7 countries have been facing a prolonged period of low growth and persistent slower income growth of the poorest. The poorest 20% of the G7 population receives, on average, only 5% of all income earned from work, while the richest 20% receives about 45%. Multidimensional inequalities tend to accumulate and self-perpetuate from one generation to the next. A wide range of factors like skill-biased technological change, economic globalisation and structural changes in the labour market have contributed to rising and/or persistently high inequalities. In addition, the tax and benefit systems became less redistributive between the mid-1990s and mid-2000s.

Source: Adapted from OECD.org, 2017

Questions

(a)(i) Define the Production Possibility Curve. [2]

(a)(ii) With the aid of a production possibility curve diagram, explain why economic growth would slow as an economy approaches its technological frontier as described in Extract 6. [3]

(b) With reference to Figure 2, explain any evidence that suggests that a global recession is imminent. [2]

(c) Using the circular flow of income, explain how the ‘credit slowdown’ can worsen two aspects of the economic crisis in India. [5]

(d) Explain how “skill-biased technological change” leads to wage differential as referred to in Extract 7. [4]

Answers

(a)(i) Define — [2]

The Production Possibility Curve (PPC) shows the maximum combinations of two goods which the economy can produce when a given quantity and quality of resources are used fully and efficiently at a given state of technology.

(a)(ii) Explain, with a PPC diagram — [3]

As an economy approaches its technological frontier, its output moves closer to the production possibility frontier — the movement from point A toward point B. Once near the frontier, further growth requires increasing the quantity or quality of resources or improving technology; absent that, output is capped by the PPF and actual growth slows, since real output cannot exceed the frontier. [2m explanation/description]

[1m accurate diagram.]

(b) Explain — [2]

The GDP growth rates of four of the five largest economies have been slowing from 2016 to 2019 (and three of five fell from 2018 to 2019, with the UK and Japan below 2%). [1m accurate trend] Slower growth worsens consumer and investor confidence, lowering consumption and investment; if the trend continues, growth rates could turn negative, producing a global recession. [1m explanation]

(c) Explain, using the circular flow of income — [5]

The circular flow of income traces money and real flows between households, firms, banks, government and the foreign sector.

A “credit slowdown” implies a fall in both household consumption expenditure and investment expenditure — an autonomous fall in injections and in aggregate demand. [1m how injections fall] As C and I fall, India’s national income falls by a multiple of the initial fall through the reverse multiplier effect, reducing actual growth and worsening “the weakest performance since 2009”. [1m reverse multiplier + 1m link to growth]

Facing lower demand, firms suffer an unplanned rise in inventories, cut production and hire fewer factors of production, generating demand-deficient unemployment — worsening India’s “rising unemployment”. [1m link to unemployment]

[1m accurate diagram.]

(d) Explain — [4]

“Skill-biased technological change” shifts firms’ demand within the labour market, a non-price determinant of labour demand. [1m non-price demand factor]

Demand for high-skilled workers rises, so their equilibrium wage rises. [1m] At the same time, as technology substitutes for routine tasks, demand for low-skilled workers falls, so their wage falls. [1m] The widening gap between high- and low-skilled wages is the “wage differential”, a driver of the income inequity Extract 7 describes. [1m]