UNDERSTANDING

GOBAL ECONOMICS

Jerome Nugent-Smith
MBA. B.Comm. Dip. Ed.

1
Published by: Montreux Management Pty Ltd
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1st Edition Published 2007.

© Copyright 2007 Jerome Nugent-Smith. All Rights Reserved.

Licensed to Montreux Management Pty Ltd

All rights reserved. No part of this publication may

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The exception is the person/entity that purchases this

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2
 ABOUT THE AUTHOR

Jerome Nugent-Smith is the international bestselling

author of fiction and non-fiction novels including
autobiographies A Baby, Maybe and
Australian Country Life. He lives
in Australia.

His latest work, THE SCHOOL, is a ripping yarn.

Readers will laugh until they drop from sheer pleasure.

Visit Jerome Nugent-Smith website at

rippingstories

3
By the same Author
The Clan Campbell Burma Saga so far consists of:
1894-1897: Shan
1886-1894: River of Lost Footsteps
1878-1886: Bo-gyi

Other Novels on Burma

1995-1997: The Burma Conspiracy

Other Fiction
The School

Autobiography
Australian Country Life
A Baby, Maybe (Co-Authored with his wife, Carmel)

Academic Economics eTextbooks & eSupport Materials

Economics Practice Exam Questions & Example Answers, Exam Skills &
Techniques,
Economics Definitions
H.L. & S.L. Economics From An International Perspective
S.L. Economics From An International Perspective
Year 10 & 11 Economics From An International Perspective
Economics Data Response Practice Exam Questions & Example Answers
Economics Data Response Software Programme

Economics eBook
Understanding Global Economics

Academic Marketing eTextbook

Commonsense Marketing

Other eBooks
Australian Buyer’s Used Car Super-Saver Handbook-New Edition
U.K. Buyer’s Used Car Super-Saver Handbook-New Edition
U.S.A. Buyer’s Used Car Super-Saver Handbook-New Edition

To download Free eBooks visit: www.lazeaway.org/

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Let it rip…
1st Edition ebooks EXCLUSIVE & DIRECT FROM THE AUTHOR (S). All
ebooks are only available on and through the official website.

Join the ripping stories exclusive online ebook club.

Come on the journey of your life, in your imagination to far away exotic places, with
a helping hand from our ebooks.

Spoil yourself, a member of your family or a special friend.

Examples of available ebooks.

THE SCHOOL
By Jerome Nugent-Smith

The School is an intriguing politically incorrect satire on life within and beyond
The Schools’ classrooms and grounds.
Australian Country Life is an autobiography about living and communing with
Australia’s native animals. Author: Jerome Nugent-Smith.

Shan is Jerome Nugent-Smith’s third thrilling adventure novel in the Clan Campbell
dynasty series.

River of Lost Footsteps is Jerome Nugent-Smith’s second novel in the Clan Campbell
dynasty series, set in Burmah between 1886 and 1894.

Bo-gyi is Jerome Nugent-Smith’s first thrilling adventure in the Clan Campbell

dynasty series.

The Burma Conspiracy by Jerome Nugent-Smith.

Set in Burma between 1995 and 1997, The Burma Conspiracy is a political thriller.

A Baby, Maybe
Authors: Carmel & Jerome Nugent-Smith

A Baby, Maybe is an autobiographical story of a couple for whom In Vitro

fertilization (IVF) is their last chance.

5
 DEDICATION

To my wife, Carmel.

6
Everything that happens in the world has an economic impact.
It will affect you either directly or indirectly.

7
 CONTENTS PAGE

Introduction 10

The Author 11

SECTION 1: INTRODUCTION TO ECONOMICS 12

SECTION 2: MICROECONOMICS

2.1 SECTIONS

2.1.1 Markets 19
2.1.2 Elasticity of Demand and Supply 32
2.1.3 Theory of the Firm: Costs 51
2.1.4 Theory of the Firm: Five Market Structures Examined 66
2.1.5 Theory of the Firm: Concepts of Efficiency 89
2.1.6 Market Failure 92

SECTION 3: MACROECONOMICS

3A: INTRODUCTION TO MACROECONOMICS 102

3B: SUMMARY OF INTER-RELATIONSHIP BETWEEN THE FIVE

MACROECONOMIC POLICY OBJECTIVES 103

3B.1 SECTIONS
3B.1.1 MACROECONOMIC OBJECTIVE OF ECONOMIC GROWTH
3B.1.2 MACROECONOMIC OBJECTIVE OF ECONOMIC DEVELOPMENT
3B.1.3 MACROECONOMIC OBJECTIVE OF FULL EMPLOYMENT
3B.1.4 MACROECONOMIC OBJECTIVE OF PRICE STABILITY
3B.1.5 MACROECONOMIC OBJECTIVE OF EXTERNAL EQUILIBRIUM

3C: MACROECONOMICS: MAJOR CHAPTERS

3C.1 SECTIONS

3C.1.1 Five Major Macroeconomic Policy Objectives 139

3C.1.2 Measuring National Income and Economic Growth 140
3C.1.3 Introduction to Economic Development 147
3C.1.4 Macroeconomic Models 154
3C.1.5 Demand-side and Supply-side Policies 160
3C.1.6 Unemployment 172
3C.1.7 Inflation 181
3C.1.8 Trade-off between Inflation/Unemployment 191
3C.1.9 Distribution of Income 207

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SECTION 4: INTERNATIONAL ECONOMICS

4.1 SECTIONS

4.1.1 Major Reasons for Trade 212

4.1.2 Major Types of Protectionism 219
4.1.3 Free Trade and Protectionism 225
4.1.4 Economic Integration/Trade Agreements 229
4.1.5 World Trade Organization 232
4.1.6 Balance of Payments 233
4.1.7 Exchange Rates 235
4.1.8 Balance of Payments Problems 245
4.1.9 Terms of Trade 251

SECTION 5: DEVELOPMENT ECONOMICS

5.1 SECTIONS

5.1.1 Introduction to Economic Development 253

5.1.2 Sources of Economic Growth and Economic Development 260
5.1.3 Measuring Economic Development Through Development Indicators 265
5.1.4 Growth and Development Strategies 269
5.1.5 Major Barriers To Economic Growth and Economic Development 288
5.1.6 Evaluation of Economic Growth and Development Strategies 294

SECTION 6: APPENDICES

6.1 OTHER ECONOMICS RESOURCES 298

6.2 500+ ECONOMIC DEFINITIONS & EXPLANATIONS 300
6.3 ALTERNATIVES TO THE MARKET SYSTEM 332
6.4 ZIMBABWE: A SPECIAL ECONOMIC ‘BASKET CASE’ 338
6.5 SECTION 4: INTERNATIONAL ECONOMICS 395

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INTRODUCTION

‘Understanding Global Economics’ has been written to provide a basis for

understanding what happens in the real world and its impact.

As a social science, economics is a dynamic subject.

While many of the theories and principles have remained constant for a long time, the
world in which they apply has not. The world is constantly changing: testing-and
often discarding-old theories, bringing forth new ones.

One reason is that human wants change and people’s behaviour is often unpredictable.
Consider the goods, services and lifestyle of both your parents and grandparents with
that of yours today.

Another reason relates to the relative scarcity of resources. Not so long ago, water was
abundant and often available free. Today, water is a precious, scarce resource and
users pay dearly for it.

The third reason: with the information and technology revolutions from the 1980s
onwards, the world has become global necessitating great change in people’s thinking
and behaviour.

Studying economics provides an insight into these global phenomena and develops
valuable key analytical, interpretative and evaluative skills.

Readers will come away from ‘Understanding Global Economics’ with the realization
that everything that happens in the world has an economic impact and will affect them
either directly or indirectly.

10
THE AUTHOR

Jerome Nugent-Smith holds a Master of Business Administration from the University

of Southern California, USA, and a Bachelor of Commerce Degree and Diploma of
Education from the University of Melbourne, Australia.

As a teacher in Australia, Switzerland, and Togo in West Africa, Jerome has taught IB
H.L. and S.L. Economics and Pre-IB Economics.

With many years prior business experience, as well as part-time lecturing and tutoring
economics at an Australian university, he brought a fresh approach by bringing the
real world into the classroom.

The real world involved living in Hong Kong, USA, Burma, Switzerland, Togo and
Australia; conducting business throughout Asia, the Pacific, USA and Europe; ten
years serving the community in various Government appointments as Chairman and
Deputy Chairman, including Honorary Consul General of the Philippines for Victoria,
Australia.

Business experience covered a range of industries in multinational, publicly listed and

private companies.

He is the author of 18 published books and numerous articles.

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SECTION 1: INTRODUCTION TO ECONOMICS

Economics is a social science. It is about the relative scarcity of resources versus

unlimited changing human wants.

Economics is a social science

A social science is the scientific study of human behaviour. Other examples of social
sciences are psychology, politics and sociology.

It is different from a physical science, which involves the study of the physical world.
Examples of physical sciences are chemistry and physics.

The Scientific Method

Both physical and social sciences follow a scientific method of study. The method
involves forming a hypothesis, or idea, which can then be tested. In the physical
sciences, the hypothesis can be tested repeatedly in a laboratory until it is proved or
disproved. It uses empirical data; that is, factual information.

A hypothesis in a social science can be tested through using methods such as a survey
or through observation. For example, if the idea to be tested is ‘the favourite drink of
students in this class is Coke’, I can test this by asking the students. However, the
result will not be as exact as a result in a physical test because it involves humans
whose behaviour is not always easy to measure. For example, they may not tell the
truth and their answers may change from day to day.

Social sciences often use models help them study complex ideas in economics. A
model is a simplification of reality. It often means that parts of the problem being
studied are kept the same (held constant) while one part is changed. This would show
that the result would be due solely to the part that was changed. Parts that change are
called variables, holding other things constant is called ‘ceteris paribus’.

Normative and Positive Statements

One of the basic tasks of all scientists is to separate facts from opinions (or value
judgments).

Positive statements are statements of fact; they can be proved to be correct or

incorrect by looking at the facts. They can be tested empirically.

Statistics are available to help prove facts in Economics. For example, the inflation
rate in a country. This data is available to provide past facts and some information
about the future; for example, when the next set of inflation statistics will be
available.

Normative statements are statements of opinion or value judgments. They

cannot be tested empirically.

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For example the statement, ‘unemployment is a worse problem than inflation’ is both
a matter of opinion and involves a value judgment. A person’s opinion cannot be
proved to be right or wrong. The economist traditionally does not make value
judgments while analysing problems.

The Economic Problem

• The economic problem is one of relative scarcity.

• It is the relative scarcity of resources used to produce goods and services in

relation to the wants of society for the goods and services.

• Resources are limited; that is, they will eventually run out.

• Human wants are unlimited, or infinite. This is because consumers will always
have new wants and wants which reoccur (e.g. the need for food).

• Scarcity means that there is not enough of something. Economic goods are scarce
goods.

• The opposite of scarcity is abundance. The air that surrounds us is an abundant

good. You can have as much of it as you want. Free goods are abundant goods.
Free goods become economic goods if they are scarce; air is an economic good to
an underwater diver.

• Many abundant goods have now become scarce, and so are of interest to
economists; e.g. water, traffic-free city centres, and tropical forests.

Productive Resources or Factors of Production

The scarce resources referred to above are called the factors of production.

There are 4 factors of production:

1. Land is all natural resources used in production e.g. land used to produce
wheat or build a factory; the sea when it is used for fishing; and, minerals like
gold and silver.

2. Capital is man-made goods used in production e.g. machine, trucks,

computers, office blocks, and telephones.

3. Labour is all human effort, both physical and mental, used in production. The
workers are paid a wage or a salary for contributing this factor to production

4. Enterprise is a human factor and is the activity that organises the other factors
of production. Entrepreneurship is the risk taking involved in organising
production and the entrepreneurs receive profit (or loss) for their efforts.
Sometimes this factor is combined with labour e.g. a small farmer.

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Three Questions arise because of the Economic Problem

1. What to produce? – There are not enough resources to produce all the goods
and services wanted so a decision must be made to produce some and not
others.

2. How to produce? – Refers to the method of production. Should mainly

capital or mainly labour be used? (i.e. capital intensive or labour intensive
production); should electricity be produced using mainly gas, oil or solar?

3. For Whom? Who should receive the goods and services produced? This is a
problem of distribution of economic goods. Should the goods and services go
to those who can afford to pay? Should resources be taken from the rich and
given to the poor?

Links: The Economic Problem, Opportunity Cost and Economic Systems

Because there is scarcity of productive resources 3 major questions arise. What to

produce? How to produce? And For Whom to produce?

• Because the society doesn’t have enough resources to produce all the goods and
services wanted it must choose between alternatives, these alternatives are called
production possibilities. When a choice is made then other production
possibilities can’t be produced, this is a cost to the consumer.

• The best alternative forgone-or second best alternative- is the opportunity cost of
production. This is one of the most important concepts in economics.

• Each society must find a way to resolve the three questions that arise because of
scarcity; that is, they must choose an economic system to answer these questions.

Economic Systems and Resource Allocation

Economic systems are classified according to their method of resource allocation or

according to ownership of resources.

The way in which a society organizes itself to decide What, How and For Whom to
produce is known as an economic system.

Three fundamental methods of resource allocation go to make up an economic

system:

• A traditional system.
• A market system.
• A planning system.

14
Traditional systems use methods that have been used for generations to decide on the
allocation of resources. They use traditional crops, traditional seeds, traditional
techniques and traditional division of labour.

Market system depends on the market mechanism of supply and demand to allocate
resources.

Planning system is to use planning by a central body (e.g. a government) to decide on

the allocation of resources.

An economy that allowed resource allocation to be decided by market forces only

would be called a ‘laissez faire’ economy.

An economy that relied solely on planning would be called a ‘centrally planned

economy’ or a ‘command economy’.

In most modern economies there is a mixture of market system and planning system
in resource allocation.

Economic systems and ownership of resources

Private ownership means individuals or groups of individuals (e.g. companies) can

own resources. Private ownership is a feature of most market economies.

Social ownership means ownership by the state, communes, cooperatives etc.

This is a common feature of centrally planned economies.

Microeconomics and Macroeconomics

It is important to understand the difference between Microeconomics and

Macroeconomics.

Microeconomics is the study of a section or part of an economy.

Macroeconomics is the study of the whole economy. This textbook and support
material concentrates on macroeconomics.

Links: Opportunity Cost and the Production Possibilities Model

Each economy has a limited amount to resources so it must make choices amongst the
alternative goods and services that it can produce with these resources. This means
there will be an opportunity cost.

Economists use a Production Possibilities Curve (PPC) model, also called a

Production Possibilities Frontier (PPF).

In this model, three assumptions are made: that the economy can…

• Only produce two goods-bread and submarines.

• Resources are held constant.
• Technology is held constant.

Note: later we will change the above three assumptions as they are unrealistic.

15
If the economy was to use all its resources to produce bread, it would at A; a large
amount of bread but no submarines at all. See Figure 1.1.

If it used all its resources to produce submarines, it would produce at B; a large

amount of submarines but no bread at all.

It could use all its resources produce a variety of combinations of bread and
submarines at C, D, E and all other points on the PPC.

Figure 1.1: Production Possibility Model

Bread A
C G = Outside PPF

Production Possibility Frontier (PPF)/

F Production Possibility Curve
Within PPF
E

B
0 Submarines

If you want more bread then submarines have to be sacrificed, e.g. a move from point
B to E to D and so on. Thus, there is an opportunity cost to having more bread,
which is the production of submarines foregone. Moreover, any other move along the
PPC would involve changing the combination of bread and submarines.

Point F is a possible combination of bread and submarines but the economy is not
using all its resources. There are unemployed resources. At Point F, the economy is
operating within its PPC. It can produce more bread and submarines by moving to
point D at no opportunity cost.

PPF and Economic Growth

Economic Growth is an increase in Real Gross Domestic Product (GDP) per

Capita. It is an increase in the total output of goods and services, minus depreciation,
discounted by inflation over a period divided by the total population.

Real GDP Per Capita = Nominal GDP minus Inflation

Total Population

Nominal GDP is the output of final goods and services valued at current prices.

16
Real GDP is the nominal value of output of final goods and services discounted by
the increase in the price level as measured by the inflation rate.

Inflation is a sustained increase in the general price level. Measured by the

Consumer/Retail Price Index.

It is impossible to reach the point G with the fixed resources. However, if an economy
can increase its resources or increase the productivity of these resources (e.g.
through better education or technology) it could shift its PPC outwards. See Figure
1.2 below. This model illustrates economic growth.

An increase economic growth is one of the five key macroeconomic objectives.

Figure 1.2: Production Possibility Model: Economic Growth

Bread

A Economic Growth

PPF2
F
PPF1

B
0 Submarines

PPF and Economic Development

Economic Development is achieved when a country has an increase in Real GDP per
Capita plus an improvement in the standard of living (SOL) of its citizens.

An improvement in SOL includes:

• Better education-primary, secondary and tertiary. Greater access for females. An

increase in the level of literacy.

• An improvement in the necessities of life-food, housing, clothing, education,

health, basic services and so on.

• Improved health care-an increase in doctors, hospitals and dentists. The reduction
and/or removal of life-threatening diseases such as AIDS.

• Improvements in infrastructure-such as roads, airports, communications- that are

more accessible to the majority of citizens.

Statistics for the above are known as Development Indicators. These include
measures such as literacy, malnutrition and the poverty level that indicate a country’s
level of economic development.

17
In Figure 1.3 luxury goods and services is shown on the vertical axis and necessities
on the horizontal axis. PPF1 shows the existing situation before an increase in
economic development.

Figure 1.3: Production Possibility Model: Economic Development

Luxury
Goods
And
Services

PPF2

PPF1

0 Necessities

Economic development as described above is now shown in the PPF model as an

outward shift in the PPF Curve from PPF1 to PPF 2. That is, society is now producing
more of both necessities and luxury goods and services but relatively more
necessities.

Economic Growth with and without Economic Development

A country can achieve economic growth on its own.

A country can achieve economic growth with economic development.

A country can achieve economic growth without economic development.

Sustainable Development

Sustainable development refers to one generation leaving enough of its factors of

production for future generations.

Over-fishing, deforestation, land degradation and air pollution are all examples of
problems associated with a decline in world sustainable development. They are of
major concern to Economists because these problems arise from the achievement of
greater economic growth, but are real threats to sustainable development.

18
SECTION 2: MICROECONOMICS

2.1 SECTIONS

2.1.1 Markets

A Market is a meeting of buyers and sellers for the purposes of exchange.

Alternative Market Structures & Price Signals

Economists classify markets by their competitive structure. The degree of competition

depends upon the number of buyers and sellers, the type of product, the barriers to
entry into the industry and the degree to which free market forces of demand and
supply determine price.

Five major Models will be examined later in depth: perfect competition, monopolistic
competition, oligopoly, monopsony and monopoly.

Degree of Competition
High Low

Perfect Monopolistic Oligopoly Duopoly Monopsony Monopoly

Competition Competition

The degree to which free market forces of demand and supply determine price is a
very important consideration.

Influence on Price
Low High

Perfect Monopolistic Oligopoly Duopoly Monopsony Monopoly

Competition Competition

Demand and Supply

Demand is the amount consumers are willing to buy at each price.

Supply is the amount producers are willing to provide at each price in a time period.

Demand

The demand function is the relationship between Price (P) and Quantity Demanded
(Qd).

Qd of good X is a function of the price of good X. i.e. Qdx = f Px.

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Normal and Inferior Goods

Economists classify goods as Normal Goods or Inferior Goods. The relationship

between Income (Y) and Demand (D) is expressed as follows:

Normal Goods Y↑→ D↑ where Y = Income

Y↓→ D↓ where D = Demand

Inferior Goods Y↑→ D↓

Y↓→ D↑

For example, in some Asian countries chicken can be an inferior good. As incomes
rise many people choose to eat meat instead of chicken. That is, as incomes increase
the demand for chicken falls.

Most goods are considered to be Normal Goods.

A change in Price and Quantity Demanded

Demand Schedule is a table showing the relationship between price and quantity
demanded.

Demand Curve is a curve showing the relationship between P and Qd. It is

downward sloping to the right. See Figure 2.1.1 (a).

Figure 2.1.1(a): Demand Curve

Price

0 Quantity

The Law of Demand states that as price increases, the quantity demanded would
decrease: as price decreases, the quantity demanded will increase.

Law of Demand - P↑→Qd↓ where P = Price

P↓→Qd↑ where Qd = Quantity demanded

This is called an inverse or negative relationship.

20
This relationship only applies if all other variables (things which can change) are held
constant: that is, they do not change. This is called ceteris paribus.

A change in quantity demanded due to a change in Price is shown as a movement

along the demand curve

P↑→Qd↓. This causes a movement to the left along the demand curve. It is called a
contraction in quantity demanded.

P↓→Qd↑. This causes a movement along the demand curve to the right. It is called an
expansion in quantity demanded.

Eight Major Determinants of Demand

A change in Demand is caused by a change in one of the Conditions of Demand.

These are sometimes called ‘Factors affecting Demand’ or ‘Determinants of Demand’

1. Price: As we have seen, Qd is a function of Price. Qd is also a function of…

2. A change in Household Income(Y)

If Y↑→ D↑ or if Y↓→D↓

3. A change in tastes or fashion.

If cassette tapes become unfashionable due to the popularity of CDs and DVDs, then
Demand for cassette tapes will fall.

4. A Change in the Price of Substitute or Complementary goods/services.

A complementary good/service is good or service that goes together with another

good or service. For example, cars and petrol.

If Pcars ↓→ Qd of cars ↑→ Dpetrol ↑

A substitute good/service is one that can be used to replace another good or service
e.g. Coke and Pepsi.

If Pcoke↑→ Qd of coke ↓→ Dpepsi ↑

5. A change in Population

Changes in population will increase/decrease the demand for all goods/services.

6 .A change in Income Distribution

If there is an increase/decrease in the share of income going to lower income earners

there will be an increase/decrease in Demand for basic goods and services, like food
and basic medical services.

21
7 .Advertising

A successful advertising campaign for a good/service would lead to an increase in

Demand for that good/service.

8. A change in the Age Structure of the Population

If the proportion of older people in the population increase, it could lead to an

increase in Demand for walking sticks or for retirement villages.

Demand is a function (f) of all these factors.

Therefore, the quantity demanded (Qd) is fp, Ps, Pc, Y, taste, population, advertising
etc

A change in one of the determinants of Demand, other than Price, will cause a
shift in the Demand Curve (DC). See Figure 2.1.1 (b)

For example, if Y↑→ D ↑, and the D.C. will shift to the right. (From D1 to D2)
if Y↓→ D ↓, and the D.C. will shift to the left. (From D1 to D3)

Figure 2.1.1 (b): Shift in Demand Curve

Price

D2

D1
D3

0 Quantity

22
Two reasons why the Demand Curve slopes down to the right.

Substitution effect: If the price of a good/service increases consumers will switch

and purchase a substitute goods/services. That is, P↑→ Qd↓; this would be shown as
a downward sloping Demand Curve.

Income effect: If the price of a good/service increases consumers will be only able to
buy a smaller amount with the money income they have. They may choose to
purchase a little less of all goods/services they normally buy rather than reduce
significantly the amount they purchase of the good/service whose price has risen.

The effect is that their ‘purchasing power’, or real income, is reduced. They will
purchase less of the good/service whose price has risen.

Exceptions to the Law of Demand

There are three possible exceptions to the Law of Demand.

1. Giffen Goods

Named after an Economist.

Giffen goods refer to goods where the income effect of a price change of inferior
goods is greater than the substitution effect. Many economists dispute this claim.

• The income effect is bigger than the substitution effect.

• A Giffen Good is an inferior good and forms a large part of a person’s total
expenditure.

• For example, in the case of Ireland and potatoes in the time of a disastrous famine
in the 19th Century, it was observed that as potatoes became scarce their price rose
so people would look for substitute food. The dominant effect was as their real
incomes fell people started to buy more potatoes (an inferior good) because the
potatoes formed a large part of their diet. People bought more potatoes-and very
little of anything else- even as their price rose. Y↓→ D↑. This can also be
expressed as P↑→ Qd↑.

2. Veblen Goods

Named after an Economist.

Veblen goods are goods that are have snob value and are bought to display wealth.
Their demand curve slopes upwards from left to right, as the higher the price the
greater the quantity demanded.

• This refers to goods that have ‘snob’ value.

• As their prices go up some people have a greater desire to own them because
fewer people can afford them (e.g. Rolex watch; diamonds etc). P↑→Qd↑

23
In both (Giffen & Veblen) of the above cases the Demand Curve would slope upward
to the right. See Figure 2.1.1(c).

Figure 2.1.1 (c): Upward Sloping Demand Curve

Price

0 Quantity

Note how this differs from a Demand Curve for a Normal Good.

3. The Role of People’s Expectations

The role of people’s expectations is a third possible reason why P and Qd may be
positively related.

If people expect the price of a good/service to increase, they may bring forward their
purchases. Alternatively, if people expect the price to decrease, they may postpone
their purchase. P↑→ Qd↑ or P↓→ Qd↓.

SUPPLY

Supply is the amount producers are willing to provide at each price in a time period.

Law of Supply expresses the positive relationship between price and quantity
supplied.

- if P↑→ Qs↑ where Qs = Quantity supplied

- if P↓→ Qs↓

The relationship is a direct or positive relationship. See Figure 2.1.1(d)

24
 Figure 2.1.1(d): Supply Curve

Price
S

0 Quantity

The Law of Supply states that as price increases, the quantity supplied would
increase; as price decreases, the quantity supplied will decrease.

A change quantity supplied due to a change in Price is a movement along the

Supply Curve.

- if P↑→ Qs↑, this is shown as a movement to the right along the Supply Curve.

- if P↓→ Qs↓, this is shown as a movement to the left along the Supply Curve.

A Shift of the Supply Curve will occur if a variable (one of the Determinants of
Supply) changes. (Note: a change in Price will cause a Movement along SC).

Six Major Determinants of Supply

1. Price As we have seen, Qs is a function of Price. Qs is also a function of…

2 . A Change in the Price of a Substitute Producer Good

Substitute producer goods are alternative goods that the producer might supply. For
example, if the price of cheese rises → farmer will supply more cheese → farmer will
supply less milk.

3. A Change in Factors of Production

For example, if the price of oil increases, fewer plastic chairs will be produced at each
price.
Costs↑→ S↓ or costs↓→ S↑

25
4. Government Action

If an indirect tax (e.g. GST) is applied to capital goods→ sellers’ costs↑→

production of the good at each price will fall.

If the government provides subsidies to producers, these reduce producers’ costs so

they will be willing to supply more at each price.

5. Improvements in Technology (T)

Improvements in technology → productivity↑→ costs↓→ producers will be willing to

supply more at each price.

6. Weather (W)

Good weather can mean more agricultural production. Bad weather can mean less
production e.g. flood or droughts.

Supply is a function (f) of all these factors.

Supply function – QSx = fPx; Ps; Pf; G; technology; weather etc.

A change in one of the determinants of Supply, other than Price, will cause a shift in
the Supply Curve (SC). See Figure 2.1.1 (e)

For example, if W↑→ S ↑, and the S.C. will shift to the right. (From S1 to S2)
if W↓→ S ↓, and the S.C. will shift to the left. (From S1 to S3)

Figure 2.1.1 (e): Shift in Supply Curve

S3
Price
S1

S2

0 Quantity

26
Interaction of Supply and Demand & Market Equilibrium

Market Mechanism is the interaction of supply demand. It leads to the setting of an

equilibrium price and quantity and to the allocation of scarce resources.

Market equilibrium occurs where the DC and SC intersect. This determines price. See
Figure 2.1.1 (f). Price of P1; Quantity of 0Q1.

Figure 2.1.1 (f): Market Equilibrium

Price
S1

P1

D1

0 Q1 Quantity

If there is a surplus or a shortage, a situation of disequilibrium, the market will move

back toward equilibrium.

e.g. P↑→ surplus→P↓→ equilibrium

P↓→ shortage→P↑→ equilibrium

The market will tend back to equilibrium except if there are institutional forces
preventing this from happening. These institutional forces include:
- Government.
- Big business.
- Trade Unions

All three exercise some Monopoly power. Consequently, they have an undue
influence on the free market determination of Price and, therefore, on the allocation of
scarce resources in society.

Price Controls

Price controls are prices imposed upon a market so that the control price prevails
more than the market price or equilibrium price. Three examples.

27
1. Maximum (Ceiling) Prices are set below the equilibrium market price.

Why does this occur? Their purpose is to assist the consumers, especially the poorer
consumer, by making prices cheaper.

Before the introduction of a maximum or ceiling price, the quantity was 0Q1 and
price, P1. The market cleared. See Figure 2.1.1 (g).

Figure 2.1.1 (g): Maximum (Ceiling) Price

Price
S1

P1

P2 Maximum Price
D1

0 Q2 Q1 Q3 Quantity

Shortage/excess demand

A maximum (ceiling) price is imposed.

The price at P2 is lower than the price set by market forces (P1). There is a shortage;
Qd = 0Q3 is more than Qs = 0Q2. D >S.

The government will need to find another way of allocating resources. These include:

1. Rationing the product. The government can choose a formal way of dividing
the scarce good. For example, it could give ration cards to people specifying
exactly how much each person or family is to receive- e.g. wartime; former
USSR.

2. Subsidising the product. The government could give money to producers to

encourage them to produce more. This will shift the SC to the right thereby
reducing the excess demand, but it means taxpayers are paying for the extra
goods for consumers- e.g. agricultural products: USA/EU/Japan.

3. Queuing (forming lines). Consumers can either physically wait in line, or put
their name on a list that is administered by a government body. This was a
frequent experience for consumers in former communist countries.

28
Effect of Ceiling Price/Excess Demand can lead to:

A parallel market (black market)

• Exists in parallel to the normal market for goods and services. It is often illegal,
and the black market sells the goods and services that are scarce- e.g. Myanmar
(Burma).

• May emerge because some consumers are willing to pay more than the maximum
price to get scarce goods.

Foreign exchange price manipulation

Poor countries often set the value of their currency at a low level to encourage exports
and reduce imports. Others countries, set an artificially high exchange rate.

Other examples of Price Controls are tickets for popular sporting events, pop concerts
etc.

2. Minimum (floor) Prices are the lowest prices the government allows
goods/services to be sold.

Their purpose is to assist producers, for without the subsidies they may not be able to
stay in business- e.g. Australian Wool in 1980s/1990s.

Before the introduction of a minimum or floor price, the quantity was 0Q1 and price,
P1. The market cleared. See Figure 2.1.1 (h).

Figure 2.1.1 (h): Minimum (floor) Price

Price
S1
P2 Minimum price

P1

D1

0 Q2 Q1 Q3 Quantity

Surplus/excess supply

A minimum (floor) price is imposed, P2.

29
The price at P2 is higher than the price set by market forces (P1). There is a surplus;
Qs = 0Q3 is more than Qd = 0Q2. S > D, known as a surplus or glut.

Mainly occurs in Agriculture.

A price support system is required to reduce the glut. Schemes the government may
use include:

1. Set-Aside: farmers are paid not to produce. This is a cost to tax payers.

2. Buffer stock: An agency is given funds to buy and stockpile the surplus and to
release it on to the market when there is a shortage- e.g. Australian wool.

However, usually the result is a surplus and this involves costs.

Under a ‘buffer stock’, there are the costs of storage and management of the stock.

Any surplus could be sold at cheap rates to poor countries, but this would have a bad
effect on the farmers in those countries because it could lower the domestic market
price.

3. Tree-Pull: Refers to Government paying primary producers to cut/eliminate

production by pulling-out trees- e.g. peaches, apricots, vines etc. Common in
Australia.

3. A Minimum Price for Labour (Wages)

Governments may pass legislation that requires minimum wages to be paid.

The purpose is to protect the lower skilled worker, to ensure that they receive a wage
that enables them to obtain the basic requirements for living or to ensure they have a
standard of living nearer to the average for the country.

The setting of a minimum wage will occur only if the equilibrium wage is too low.
Therefore, the minimum wage must be above the equilibrium wage. See Figure
2.1.1(i).

Before the introduction of a minimum wage, the equilibrium wage = We at

employment level = 0Q1.

30
 Figure 2.1.1 (i): Minimum (floor) Wage

Price
S1
Wmin Minimum Wage

We

D1

0 Q2 Q1 Q3 Employment

A minimum (floor) wage is imposed, Wmin.

The minimum wage at Wmin is higher than the price set by market forces (We).
Demand for labour = 0Q2; supply of labour = 0Q3. The higher wage will create a
surplus of labour, Q2-Q3.

A result of the above is that unemployment may increase.

However, the above situation/model is static and is not necessarily representative of

what happens in the real world. For example, the minimum wage will increase
consumption, investment, total output and employment. As a result, aggregate
demand and aggregate supply will increase affecting all five macroeconomic
objectives. See later Sections.

31
2.1.2 Elasticity of Demand and Supply

Elasticity is the responsiveness of one variable (e.g. Qd) to a change in another

variable (e.g. Price).

Major types of elasticity:

• Price Elasticity of Demand (PED)

• Price Elasticity of Supply (PES)
• Income Elasticity of Demand (YED)
• Cross Elasticity of Demand.

Price Elasticity of Demand (PED)

Price Elasticity of Demand is the responsiveness Demand (Qd) to a change in price

(P).

Key Formula: (one to remember)

PED = %ΔQd − = − and + = −

%ΔP + −

Example: if the price of tea rises form 50c to 60c and the Qd falls from 100 cups to 90
cups, using the key formula PED = –10 = - 0.5
+20
Features:
1. There are no units (e.g. kgs), a number only e.g. 2.
2. Elasticity is always a decimal figure e.g. 2.1.
3. PED is always negative e.g. –2.1.

Note: sometimes the sign is omitted.

Alternative formula:

ΔQd x P
Qd ΔP

Additional Formulae for the Measurement of Elasticity

ΔQd × P is not considered accurate enough by some economists.

Qd ΔP

It is considered better to average the range of P and Q

i.e. (P1 → P2) and (Q1 → Q2)

= P1 + P2 and Q1 + Q2
2 2

∴ Formula = ΔQd × P1 + P2
Qd1 + Qd2 2
2 ΔP

32
Now let’s use the tea example and see how the three different ways of calculating
PED work and what are the different PED:

1) Key Formula

PED = −10 = − 0.5

+20

2) Alternative Formula

PED = − 10 × 60 = − 0.66
90 +10

3) Averaging Formula

PED = −10 × 55 = − 0.58

95 +10

The average method is more accurate using the Averaging Formula. The bigger the
change in price the bigger the difference in the answers.

Note: Students need only remember and use the Key formula. They should be aware
of the limitations of earlier formulae and the existence of more accurate methods.

Price Elasticity of Demand (PED) and Points on a Demand Curve

PED is different at every point on a straight line Demand Curve. See Figure 2.1.2 (a).

Figure 2.1.2 (a): Price Elasticity of Demand

Price

PED = - 0.66
0.60 B C PED = - 0.58
0.50 A PED = - 0.5

D
Quantity
0 90 100

33
Price Elasticity of Demand (PED)

PED >1 = elastic – goods/services which are price elastic in demand e.g. movie
tickets or vacations.

PED = 1 unit elastic

PED < 1 = inelastic – goods/services which are price inelastic in demand e.g.
cigarettes and alcohol.

Slope and elasticity should not be confused. Often a steep curve is inelastic and a
flat curve is elastic. However, any curve can be made to have a steep slope or a flat
slope merely by altering the scale of the axis. Figure 2.1.2 (b & c).

Figure 2.1.2 (b) Figure 2.1.2 (c)

Price 8 Price 8

6 6

4 4

2 2 D
D
0 10 20 30 40 Q 0 2 4 6 8 10 12 14 Q

Note: Be careful. Watch the scale of both axes. If you want to compare the PED of
two or more products, draw the demand curves on same axis/graph.

When comparing the price elasticity of two or more products, graph them on the same
graph. Figure 2.1.2 (d).

Figure 2.1.2 (d)

Price

D2

D1

0 Quantity

From above, we can say that D1 is less elastic than D2.

PED can be different at every point on a DC.

34
The PED and the slope of the DC are not the same. There are however three
exceptions to this.

• There are three diagrams where the slope of the DC has the same elasticity at any
point.
• And where the elasticity can be known just by looking at the diagram.

These are where the DC’s are: vertical, horizontal, or the slope of a rectangular
hyperbole. See Figure 2.1.2 (e, f, g).

Figure 2.1.2 (e) Figure 2.1.2 (f) Figure 2.1.2 (g)

Price PED=0 Price Price

P1 PED= α

PED =1
Q Quantity Quantity Quantity

• The vertical DC has a PED of zero (0), the DC is perfectly inelastic. This means
the same quantity will be bought at any price.

• The horizontal DC, which has a PED of infinity, the DC is infinitely elastic. At
price P1 an infinite amount will be demanded. At any other price nothing will
be bought.

• The slope of a rectangular hyperbole, has a PED = 1. A percentage change in P

will lead to an exact same percentage change in Qd.

Most goods and services do not have these extremes of elasticity but are either
relatively elastic or relatively inelastic.

Price Elasticity and Total Revenue (TR)

Total Revenue = Price x Quantity. TR = P x Q.

As the price of a good/service changes up or down, how TR will change depends on

the PED of the good/service.

Price Increase Price Decrease

Elastic good %ΔQd↓ > %Δ P↑ %ΔQd↑ > %ΔP↓
(PED > 1) TR↓ TR↑
Unit Elastic good %ΔQd↓ = %ΔP↑ %ΔQd↑ = %ΔP↓
PED = 1 TR is constant TR is constant
Inelastic good %ΔQd↓ < %ΔP↑ %ΔQd↑ < %ΔP↓
PED < 1 TR↑ TR↓

35
Elastic Demand

Figure 2.1.2 (h): Elastic Demand

Price
TR = 10

4 TR = 10
B
2 TR = 20
A C D

0 5 15 Quantity

1. If P rises, then Q falls proportionately more; therefore TR falls. Rectangle B is

gained; rectangle C is lost. TR = 20
2. If P falls; then Q rises proportionately more; therefore TR rises. Rectangle B is
lost; rectangle C is gained. TR = 30

Examples of goods/services with Elastic Demand

1. Goods/services having close substitutes which buyers find acceptable- e.g.

butter/margarine.
2. Goods/services that are durable- e.g. TV’s; cars; furniture.
3. Goods/services that take-up a higher proportion of Yd- e.g. luxuries, holidays.

Inelastic Demand

Figure 2.1.2 (i): Inelastic Demand

Price
4 TR = 30
B TR = 30
2 TR = 10
A C
D
0 15 20 Quantity

1. If P rises, then Q falls proportionately less; therefore TR rises. Rectangle B is

gained, rectangle C is lost. TR = 60
2. If P falls, then Q rises proportionately less, therefore TR falls. Rectangle B is
lost, rectangle C is gained. TR = 40

36
Examples of goods/services with Inelastic Demand

1. Habit forming goods-e.g. drugs, cigarettes.

2. Goods/services that are considered necessary-e.g bread, potatoes, rice,
electricity, cooking oil.
3. Products that are used in conjunction with other, more expensive goods.
Complimentary goods/service- e.g. petrol/car, spare parts for vehicles, driving
licenses, motor vehicle registration, car insurance.
4. Goods/services that make-up a relatively small part of Y-.e.g. matches,
ballpoint pens.
5. Agricultural goods, exports of LDCs. Most important.

Unit Elastic Demand

Figure 2.1.2 (j): Unit Elastic Demand

Price

TR = 10
5

B
2 TR = 10
C
0 Quantity
2 5

1. If price rises, Q falls proportionately; TR remains constant. Rectangle B is

equal in area to rectangle C. TR = 10
2. If price falls, Q rises proportionately; TR remains constant. Rectangle B is equal
in area to rectangle C. TR = 10

Summary of PED

1. One or more of these factors determines PED.

2. PED for a good/service will be affected by an individual’s economic situation.
3. Producer’s are/should be very interested in PED. Influences their TR & profit.
4. Government’s are/should be very interested in PED. Affects their TR from
taxation on goods/services- e.g. Cigarettes, alcohol etc.

Income Elasticity of Demand (YED)

Income (Y) is a major determinant of Demand.

Normal good: If Y↑→ D↑ or if Y↓→ D↓

Inferior good: If Y↑→ D↓ or if Y↓→ D↑

37
Income Elasticity of Demand (YED) is the responsiveness of Demand (Qd) to a
change in Income (Y).

Qdx = f Px; Ps, Pc, Y, Taste, population, etc. Now we examine Income (Y).

The Formulae are:

Key Formula: (one to remember)

YED = % ΔQd
% ΔY

Alternative Formula:

YED = ΔQ x Y1
Q1 ΔY

If goods/services have an income elasticity of one they are known as unit elastic.

If goods/services have income elasticity greater than one they are income elastic.
Refer earlier examples.

If goods/services have income elasticity less than one they are income inelastic.
Refer earlier examples.

Example: Average Y increases from $100/wk to $120/wk that leads to an increase in

demand for restaurant meals by 30%. Calculate the YED.

YED = % ΔQd = + 30 = +1.5

% ΔY + 20

The sign of elasticity can be positive or negative and the sign is very significant.

1. Normal goods have positive elasticity i.e. If Y↑D↑ YED = + = +

+
or If Y↓D↓ YED = − = +
−
2. Inferior Goods have negative elasticity i.e. If Y↑D↓ YED = + = −
−
If Y↓D↑ YED = − = −
+

Cross Price Elasticity of Demand

Cross price elasticity of demand is a measure of the responsiveness of one good’s

quantity demanded to changes in a related good’s price.

Related goods are complementary and substitute goods.

Cross PED x,y, = Percentage change in quantity demanded of good x

Percentage change in price of good y

38
Key Formula:

Cross PED x,y = % ΔQdx

% ΔPy

Alternative Formula:

ΔQ x P1y
Q1x ΔPy

Cross PED and Complementary Goods

Complementary goods/services are those that go with one another- e.g. bread/butter,
cars/petrol, and socks/shoes.

If two goods are complements of each other then an increase in price of one will lead
to a fall in the quantity demanded of the other and vice versa.

The Cross PED will be negative:

Cross PED x,y = %ΔQdx = − or + = −

%ΔPy + −

Goods with negative cross price elasticity are complementary goods.

Cross PED and Substitute Goods

Substitute goods/services are those which perform the same function/purpose as

another- e.g. butter/margarine, synthetic fibres/wool, different brands of petrol,
Coca-Cola/Pepsi.

Substitute goods have positive cross price elasticity.

If the price of a good increases then the quantity demanded of the substitute good rises
and vice versa.

Cross PED x,y = %ΔQd = + = + or - =+

%ΔPy + -

Example: There is an increase in the price of beef from $4/kg to $5/kg that results in
the Qd for lamb increasing from 500/kg to 700kg. Calculate the Cross PED.

Cross PED x,y = %ΔQd = +40 = +1. 6

%ΔPy +25

39
Six Major Determinants of Elasticity of Demand

1. The number of close substitutes

If the price of a product changes and there are many close substitutes it is very
easy for consumers to switch to, or away form, the product.

The broader a product is defined the fewer the substitutes there will be.
e.g. footwear → inelastic.
Black Reebok trainers → elastic.

2. Passage of Time

When PED is measured, the degree of elasticity will depend upon the time
changing and recording of new quantity figures.

The longer the period of time the more elastic the demand (because people
have more time to change their minds)- e.g. if the price of train fares increases,
initially likely to have a small decrease in demand, then greater as people
adjust and find alternatives forms of transport.

3. Addiction

Goods which people are addicted to are very price inelastic-e.g. cigarettes.
Drug addicts will keep buying their drugs no matter how high the price rises.

4. Proportion of income spent on the good/service

Small proportion of income – very price inelastic- e.g perishable foods.

Large proportion of income – price elastic-e.g durable items, TV’s etc.

5. Branding and Advertising

Producers try to reduce the number and closeness of substitutes through brands
and advertising. This can reduce the elasticity of demand. Some people have
strong ‘brand loyalty’.

40
 6. Luxuries and Necessities

Luxuries – price elastic. People are likely to buy a lot less of these as their
price rises- e.g. gold jewellery.

Necessities - price inelastic. People are likely to keep buying these even
though the price keeps rising- e.g. rice.

Elasticity of Supply (PES)

Price Elasticity of Supply is the measure of responsiveness of the quantity supplied

(Qs) to a change in price (P).

Key Formula:

PES = %ΔQsx

%ΔPx

Alternative Formula

PES = ΔQsx Χ P1
Q1x ΔPx

Use 1st Formula as Key.

Qs changes positively with a change in price.

Px↑→ Qsx↑ or if Px↓→ Qsx↓

PES = + = or − = +
+ −

Note: the sign for PES is always positive.

The slope of the SC is not the same as elasticity (as with DC and elasticity).

PES is different at every point on the SC (as with PED and the DC).

41
There are three exceptions:

1. Perfectly Inelastic Supply Curve

Figure 2.1.2 (k): Perfectly Inelastic Supply Curve

The SC is vertical, PES = 0

Price S PES = 0 PESx = %ΔQsx = 0

%ΔPx ΔP

=0

0 Quantity

The same quantity is supplied whatever the price.

2. Perfectly Elastic Supply Curve

The SC is horizontal, PES = α

An infinite quantity will be supplied at one price, nothing is supplied at any other
price.

Figure 2.1.2 (l): Perfectly Elastic Supply Curve

Price

S PES = α

0 Quantity

PESx = %Δ Qsx = α
%Δ Px ΔP

= α

42
3. Unitary Elasticity of Supply

Figure 2.1.2 (m). The PES = 1

Note. Any straight line passing through the origin has a PES of 1.

Figure 2.1.2 (m): Unitary Elastic Supply Curve

Price
PES = 1
PES = 1

PES = 1

Quantity
0

The percentage change on each axis will always be proportional.

e.g. if %ΔQs = 10% so PES = 1

%ΔP 10%

Three Major Determinants of Elasticity of Supply

1. The closeness of producer substitutes

If a producer can produce several products, the quantity supplied of any one
product will be quite elastic- e.g. dairy farmer can produce milk, cream,
butter, and cheese. Even if the price of cheese rises a little and the price of
other products remains the same, a lot more cheese will be produced and lot
less of the other products.

If a producer can only produce one product then the quantity supplied will be
inelastic. That is,

- if P↑→ Qs↑ proportionately less than the rise in price.

- if P↓→ Qs↓ proportionately less than the fall in price.

43
 2. The passage of time

When a price change occurs, the price elasticity will be greater the longer the
time that elapses between the price change and the change in quantity
supplied.

- Short time → inelastic supply.

- Long time → elastic supply.

The reason being is that in the short run people will find it difficult to find an
alternative good/service; much easier to do so in the long term.
See Figure 2.1.2 (n)

Figure 2.1.2 (n): Price Elasticity of Supply and Time

Price
S momentary
S short run
S long run

S very long run

0 Quantity

3. Unused capacity and costs of inputs

If an industry is operating at full capacity → inelastic supply (in the short run).

As well, the costs of inputs will rise. This will also deter producers from
increasing production.

If there is unused capacity (e.g. unemployed labour or machines) then supply can
easily be increased without higher costs.

Elasticity and Business Decisions

Knowledge of elasticity (e.g. PED, YED, Cross PED and PES) is important to
businesses. Some examples, and reasons why, follow.

PED – the effect of a change in price on TR depends on its elasticity- e.g. P↑→ if
PED is elastic → TR↓

YED – business needs to know if a good is a normal good or an inferior good.

If Y↑→ D↑ for a normal good but if Y↑→ D↓for an inferior good.

As well the YED indicates by how much quantity demanded will change (the
responsiveness of Qd) when price changes.

44
Businesses will wish to invest in the production of goods whose Demand increases
proportionately faster than Income rises i.e. income elastic goods/services e.g.
recreation.

If YED is very elastic sales will change significantly as economic activity rises or
falls.

If YED is inelastic sales will be more stable, less affected by changes in economic
activity.

Cross PED

Business needs also to be aware of changes in prices of substitute and complementary

goods/services- e.g. if the price of English Channel tunnel tickets rise the sales of
channel ferry tickets (a substitute service) will rise. The amount of the change will
depend on the Cross PED.

Sales of a good will also be affected if the price of a complementary good changes-
e.g. computers and software. If there is a large fall in the price of computers it is likely
people will buy more software. The amount of the change will depend on the Cross
PED.

PES

The supply of agricultural goods is highly inelastic. The ‘supply tap’ cannot be simply
turned off and on like a machine in a factory. If a farmer is harvesting one crop a year,
and if the rains do not come or a frost occurs, then QS will be affected.

This is important in the study of LDCs.

On the other hand, within certain constraints the PED for manufactured good is
elastic.

INCIDENCE OF INDIRECT TAXES AND SUBSIDIES

The concept of elasticity is important in determining who pays (consumer and/or

producer and what %) when the government imposes an indirect tax on a
good/service; and who benefits (consumer and/or producer and what %) when a
good/service is subsidised.

Imposition of an indirect tax or and subsidies affect three areas

Incidence of tax - who pays the indirect tax, the buyer or the seller or both.
Revenue - how much tax revenue a government will raise
or how much a subsidy will cost the government.
Resource allocation - to what extent the behaviour of buyers are affected by a tax or
a subsidy.

45
Types of Taxes

Direct tax is a tax upon income. Income includes wages, rent, interest and profits.

Indirect tax is a tax on goods or services. It is taken indirectly from income when
spending occurs.

Types of Indirect Taxes

A specific or flat rate tax is when a specific amount is imposed upon a good/service-
e.g. $1 per litre of whisky.

A percentage or ad valorem tax is when the tax is a percentage of the selling price-
e.g. a sales tax of 10% of the selling price of the good/service.

Effect of imposing a flat rate tax

The tax is collected by the seller for the government. However, not all the amount of
the tax will necessarily be passed on to the consumer.

The supply curve for the good or service will shift upwards by the amount of the tax.

However, because the demand curve is not vertical but sloping, then the price rises by
less than by the full amount of the tax. See Figure 2.1.2 (o).

Figure 2.1.2 (o): Flat Tax Rate

Price S2 – after tax

c S1 before tax

P after tax Vertical distance

P before tax is the amount of the tax

0 Q2 Q1 Quantity

Effect on:

1. Incidence – payment of the tax is shared between buyers and sellers. The price rise
is not the same as the tax, which means the full amount of the tax is not paid by
the consumer, therefore some must be paid by the producer. The only situation
where the consumer pays the full amount is when there is perfectly inelastic
demand.

2. Government revenue – the government will receive the full amount of the tax. The
government’s revenue is equal to the amount of the tax multiplied by the quantity
sold.

3. Resource allocation – there are fewer resources allocated to the production of this
good. The quantity demanded and the quantity supplied of the good will both have
fallen (0Q1 to 0Q2). There may be a loss of satisfaction to both consumers and

46
 producers. The government may wish to reduce the demand for harmful goods
(e.g. cigarettes) by imposing an indirect tax.

Taxation and Elasticity

The PED and PES are what determines the

1. The incidence of the tax.
2. The revenue a government receives from a particular tax.
3. The effect upon resource allocation.

Example # 1: PED = 0 Perfect Inelastic Demand & PED = α Perfectly Elastic

Demand

This is shown in Figures 2.1.2 (p) and (q).

Figure 2.1.2 (p) PED = 0

Price D

S after tax
P2 b
S before tax

P1 a

0 Q1 & Q2 Quantity

47
1. Incidence:
Figure 2.1.2 (p): 100% on consumer.
Figure 2.1.2 (q): 100% on producer.

2. Government Revenue:
Figure 2.1.2 (p): area P1abP2; there has been no fall in quantity bought.
Figure 2.1.2 (q) area tabP1,2 is small; there has been large fall in quantity sold.

3. Resource Allocation:
Figure 2.1.2 (p): unaffected. Same quantity bought and produced.
Figure 2.1.2 (q): significantly affected. Major decline in production, from 0Q1
to 0Q2.

Example # 1: PES = 0 Perfect Inelastic Supply & PES = α Perfectly Elastic Supply

This is shown in Figures 2.1.2 (r) and (s).

Figure 2.1.2 (r) PES = 0

Price S=0

P1,2 b

t a D

0 Q1 & Q2 Quantity

Figure 2.1.2 (s) PES =α

Price

P2 b S after tax

P1 a S before tax
D

0 Q2 Q1 Quantity

1. Incidence:
Figure 2.1.2 (r): 100% on producer.
Figure 2.1.2 (s): 100% on consumer.

48
2. Government Revenue:
Figure 2.1.2 (r): area tabp1 is relatively large; there is no fall in quantity.
Figure 2.1.2 (s) area p1abp2 is relatively small.

3. Resource Allocation:
Figure 2.1.2 (r): no change. Quantity sold remains the same.
Figure 2.1.2 (s): this is likely to change considerably.

Ad Valorem or Percentage Taxes

A percentage or Ad Valorem tax is when the tax is a percentage of the selling price-
e.g. a sales tax of 10% of the selling price of the good/service.

• This is when a tax is applied as a percentage, the supply schedule and curve will
move up proportionately at each price.
• Means the amount of tax paid will be higher at higher prices.
• The supply curve will move away from the original supply curve as the quantity
supplied increases. See Figure 2.1.2 (t).

Figure 2.1.2 (t): Ad Valorem Taxes

Price S after tax

S before tax

P2

P1

D
0 Q2 Q1 Quantity

Subsidies on Goods and Services

Subsidies are money paid to producers by the government.

• Whether producers share the subsidy with consumers will depend on PED and
PES Curves.
• Subsidies have the opposite effect to a tax.
• A subsidy shifts the supply curve down by the amount of the subsidy. See Figure
2.1.2 (u).

49
 Figure 2.1.2 (u): Subsidies

Price S1 before subsidy

S2 after subsidy

amount of subsidy = vertical distance

P1
P2

0 Q1 Q2 Quantity

Effects

1. Given the PED and PES Curves drawn above, the subsidy will be shared between
the producer and the consumer. The full amount of the subsidy is a vertical
distance between the two supply curves. This is more than the fall in price.

2. It costs the government the amount of the subsidy multiplied by the quantity
produced.

3. Resource allocation has changed; an extra amount is consumed and produced

(0Q1 to 0Q2).

Summary:

Three issues emerge when an indirect tax is imposed:

1. Incidence of the tax – who pay the tax, producers or consumers.

2. Government expenditure – what is the total revenue to the government.
3. Resource allocation – how is consumption and production of the good/service
affected.

Three issues emerge when a subsidy is given:

1. Incidence of the subsidy – who benefits from the subsidy, producers or consumers.
2. Government expenditure – what is the total cost to the government.
3. Resource allocation – how is consumption and production of the good/service
affected.

50
2.1.3 Theory of the Firm: Costs

A firm may consist of one, several or very many factories, shop or offices.

An industry consists of all the companies that produce a particular product- e.g.
Toyota is part of the motor industry; Microsoft is part of the IT industry.

Motivation

Profit is the major motivation of privately owned firms. But it is not the only one: for
some firms, market share or total sales revenue is set as the key objective.

Profit = Total Revenue minus Total Cost. Profit = TR – TC.

Total Revenue is the total income of the firm. It is price of goods/services sold
multiplied by the quantity sold. TR = P x Q.

Total Cost is obtained by adding together all the firms’ costs.

Production Function

A Production Function expresses production as a function of the inputs required to

make it. e.g. 200 tonnes of output = 200 units of land + 500 units of capital + 50 units
of labour.

Land

Labour Production Process

Production Process Output = f of
Capital Inputs

Enterprise

Short and Long Run Costs

The Short Run is defined as the time period where at least one factor of production
is fixed. For example, a factory may increase its raw materials and the number of its
workers but not its floor space/factory size.

The Long Run is defined as that time period when all inputs can be changed. There
are no fixed factors.

51
Short Run Output – The Law of Diminishing Returns or the Law of Variable
Proportions

A firm in the short run has at least one fixed factor and one variable factor.

If a firm wishes to increase output each unit of the variable factor has less and less of
the fixed factor to work with; that is, the proportion of the inputs will change,
(e.g.1 worker and 100 hectares of land (1:100); 2 and 100ha.(1:50); 3 and
100ha.(1:33).)

Concept of Marginal = last or extra unit.

The concept of ‘Marginal’ examines the change in output with each extra unit of the
variable factor; that is, marginal output at first increases, peaks, and then decreases.
This is called diminishing returns.

The Law of Diminishing Returns states “if some inputs are increased while at least
one is fixed, the extra output produced by the extra unit of input may at first increase
but it will reach a point where it will diminish. This is known as the point of
diminishing returns”. Also known as the Law of Variable Proportions.

This law expresses the physical relationship between Input and Output.

David Ricardo, Economist, wrote about the increase in population and fixed supply of
the most important factor of production-land-in post-industrial revolution in England.

Land (hectares)- Labour- Production - Marginal Product

fixed factor variable factor tonnes
100 0 0 -
100 1 10 10
100 2 25 15
100 3 45 20
100 4 65 20
100 5 75 10
100 6 70 -5
100 7 60 -10

In the Table above, there are increasing returns to scale when the second and third
units of labour are added. There are constant returns when the fourth unit of labour is
added (MP remained at 20) and when the fifth unit was added there is decreasing
returns- this is the point of diminishing returns.

In the SR if output increases, the proportion of factors will change; that is, the
proportion of fixed factor to variable factor, in the production process. (100 to1; 50 to
1; etc…).

Law of Variable Proportions states that when some factors are changed and one or
more remains fixed, the output of the firm changes in a strictly predictable pattern.
The proportion of the inputs (fixed to variable) changes which is the reason it is called
the law of variable proportions.

52
Long Run Costs

• Inputs like land and labour are a cost to a producer.

• Variable inputs lead to variable costs, e.g. labour and wages.
• Fixed inputs lead to fixed costs, e.g. land and rent.

In the long run, all costs are variable. When inputs are increased in the L.R., output
may:

Rise more than proportionately. There are increasing returns to scale because
economies of scale may occur. In the above Table 1/10; 2/25 or 0.1 to 0.08. The
advantages of the increased size of production may lead in a drop in the average cost
per unit. The firms’ costs will rise less quickly than output.

Rise proportionately. That is, there are constant returns to scale, average costs will
remain the same.

Rise less than proportionately. That is, decreasing returns to scale, or diseconomies of
scale, may occur.

Returns to Scale = increases in output that result from increasing all input by the same
%.

This is shown in Figure 2.1.3(a).

Figure 2.1.3 (a): Returns to Scale

Long run AC Long Run Costs

Long run average costs

Increasing Constant returns Decreasing

returns to scale to scale returns to scale

Output

Economies of Diseconomies of
scale scale

• At any point in time, the firm is in a S.R. situation.

• The LR consists of all the SR periods as the firm expands.
• The LRAC curve is the track of all the SRAC curves as the firm expands.

See Figure 2.1.3 (b).

53
 Figure 2.1.3 (b): SRAC & LRAC

SRAC
and
LRAC
SRAC1
SRAC2
SRAC10

SRAC6 SRAC7

0 Output

• The average costs of the firm when it is smallest is shown as SRAC1.

• As the firm expands, its average costs fall, until they are at their lowest, at the
bottom of the SRAC curve. The costs begin to rise because of diminishing returns.

• The firm would then change its fixed factor so it could increase production; that
is, it would expand its scale of production.

• It will now have moved to another SR situation, SRAC2, and because economies
of scale are gained when it increases its size, average costs have fallen.

• Economies of scale are gained with each new SRAC curve up SRAC6, then there
are constant returns to scale with SRAC7 after which diseconomies of scale occur.

• The LRAC curve is drawn by joining the SRAC curves.

The Law of Diminishing Returns and Average and Marginal Output

Quantity of the Total Output: Average Output Marginal

variable factor (Tonnes of maize (Tonnes per year) Output
(Number of per year) = Total Output (Tonnes per
workers) No. of workers year)
0 0 - -
1 1 1 1
2 5 2.5 4
3 12 4 7
4 18 4.5 6
5 20 4 2
6 21 3.5 1
7 21 3 0
8 20 2.5 -1

Marginal Output = difference in total output between 2 periods.

• The above figures in the Table show the input and output figures for a
hypothetical maize farm.

54
• A situation like this is common in poorer nations; namely, a situation of fixed,
small, plots of land and rapid population growth, with more and more people
trying to make a living from small farms.

• The addition of each of the first three workers results in output rising by
increasing amounts. On Figure 2.1.3 (c), the curve gets steeper with each
additional worker.

• The fourth worker further increases output but by less than the third worker,
diminishing returns have set in. On Figure 2.1.3 (c), the curve now gets flatter.

• The addition of the eighth worker actually lowers output. On Figure 2.1.3 (c),
total output actually declines.

Figure 2.1.3 (c): Law of Diminishing Returns: Maize Farm

Total
Output
of
Maize
Total Output

0 No of workers

• Diminishing returns to a variable factor can also be shown by looking at

what happens to average output and marginal output.

• Average output is the average amount produced by the variable factor –

average per worker.

• It is calculated: Total Output = average output per worker

Number of workers

See Figure 2.1.3 (d).

55
 Figure 2.1.3 (d): Average Output & Marginal Output

AO
and
MO

4.5

AO

0 4 MO Variable factor

• In the above Figure, it can be seen that average output at first increases as
there are increasing returns to labour, but after 4.5 tonnes per year, the
average falls.

• This point with average output at 4.5 tonnes and 4 workers is the point of
average diminishing returns.

• Marginal output peaks between 2 and 3 workers. This is the point of

diminishing marginal returns.

• It is marginal output which determines the average, thus when MO is

rising it is ‘pulling up’ the average.

• If MO is higher than the average even though it is falling, it ‘pulls up’ the
average, up to the fourth worker in the example.

• When MO is less than the AO, it ‘pulls down’ the average.

• When the MO equals the AO the average will not change. This is the point
at the top of the AO curve where the output is neither falling nor rising,
and where it is cut by the MO curve.

The law of diminishing returns is very important in determining the costs of the
firm in the SR.

Long Run Output – Returns to Scale

• In the long run, all factors of production can change.

56
 • Thus, it is possible for a firm to change all of its inputs proportionately;
there are no fixed factors to cause diminishing returns.

• The firm can change its scale of production; that is, it can make the firm
bigger or smaller in proportion.

Below are the three possible outcomes when inputs are increased. The changes are
due
to the scale of the firm changing, it is called returns to scale. See Table below.

Inputs Outputs Returns to scale

Increase Increases more than proportionately Increasing
Increase Increases proportionately Constant
Increase Increases less than proportionately Decreasing

Five Sources of Increasing Returns to Scale

1. Technical Economies

Some factors of production can’t be divided up (e.g. capital goods like

computers, machinery, office buildings), so to make full use of them a large
output is required. A small firm may use a computer a few hours per week so
there is a relatively high input for a relatively small output whereas a larger
firm may use it more fully and so the output to input ratio increases
significantly.

2. Managerial Economies

A smaller company will need its staff to perform a number of roles, some of
which they are not trained to perform and which they may not perform well.
A large company can employ specialist staff and so gain greater output from
those skilled staff.

3. Marketing Economies

The cost of marketing a product, per unit, becomes cheaper the more units of
the product that are sold. Examples: packaging, advertising and sales costs.

57
 4. Financial Economies

Large firms are considered by financial institutions to be more financially

secure, and so can borrow funds at lower interest rates.

5. Purchasing Economies

Bigger firms can buy inputs cheaper which reduce their average costs.

On the other hand, decreasing returns to scale may occur due to the increased
difficulties of managing very large companies. Example: Government departments.

Short Run Costs

The short run means there are a fixed factor and variable factors, so there are fixed
costs and variable costs.

Fixed and Variable Costs

Total cost = Fixed Cost + Variable Cost. TC = FC + VC

Fixed costs do not change with output, e.g. rent on a factory. They are also called
Indirect Costs or Overheads. Same $’s regardless of volume produced.

Figure 2.1.3 (e): Fixed Costs

Fixed Costs

FC

0 Output

Variable Costs are costs incurred that are directly related to output. They are also
called Direct Costs. Variable costs rise as output rises. Examples: labour, electricity,
gas and oil.

Its curved shape is because of the law of diminishing returns. See Figure 2.1.3 (f)

Some of a firm’s bills may have a fixed and a variable cost part-e.g. electricity.

When production = 0; variable costs = 0.

58
 Figure 2.1.3 (f): Variable Costs

Variable
Costs
VC

0 Output

The total cost curve is the sum of the Fixed cost and Variable cost curves.
TC = FC + VC. See Figure 2.1.3 (g).

Figure 2.1.3 (g): Total Costs

Total Costs TC = FC=VC

FC

0 Output

Average Costs and Marginal Costs

AFC = FC AVC = VC ATC = TC

Output Output Output

ATC = AFC + AVC

Marginal cost is the cost of producing the ‘last’, or marginal, unit. It can be measured
as the total cost of a unit minus the total cost of n – 1 units.

59
MC = TCn - TC n – 1

The concept of ‘marginal’ is very important in economics.

Average fixed costs (AFC) is shown in Figure 2.1.3 (h).

Figure 2.1.3 (h): AFC Curve

Average
Fixed
Cost

AFC

0 Output

Features of the AFC Cost Curve

• AFC is initially high because the whole of the fixed costs are being averaged over
a small number of units.

• AFC falls sharply as they are spread over more and more units.

As we shall see in later Sections, the concept of AFC is an important

argument/advantage for increased world trade.

60
Average Variable Cost curves and Marginal Cost curves

The relationship is shown in Figures 2.1.3 (i) and (j).

Figure 2.1.3 (i): MC and AC

AVC/MC

MC AVC

0 Output
Figure 2.1.3 (j): MO and AO

AO/MO

AO
MO

0 Units of the Variable factor

• The AVC curve is ‘U’-shaped because variable costs first fall and then rise
because of the ‘law of diminishing returns’, as shown on the MO and AO curves.

Understanding how this works is most critical to understanding SR costs as a

whole.

• The MO and AO curves change as increasing amounts of a variable are added to

a fixed factor, MO first increases and then decreases.

• Consequently, AO increases and then falls.

• Variable costs increase regularly as more variable factors are employed (e.g.
more workers means more wages).

• However, output does not rise regularly, because of the law of diminishing
returns.

• MO at first increases: output increases more than proportionately compared to the

increased cost (variable cost). Thus, the MC of producing the first units of output
declines.

61
• This will continue as long as MO is increasing right up to the point where MO
peaks, as firms begin to experience diminishing marginal returns.

• As MO declines, so the MC of producing extra units of output will increase.

Note: MO determines the MC, which in turn determines the AC of the firm.

• If MC< AC they will be lowering the firm’s AC.

• If MC>AC then AC will rise.

• If MC=AC then AC will be constant, that is at the bottom of the AC curve, where
AC are neither rising nor falling.

Note: the AC curve mirrors the behaviour of the AO curve.

If the addition of variable factors causes AO to rise then AC must be falling.

If the addition of variable factors causes AO to fall then AC must be rising.

Average Total Cost

ATC = AFC + AVC

See Figure 2.1.3 (k)

Figure 2.1.3 (k) ATC

AFC, AVC,
MC, ATC
MC AFC

ATC
AVC

AFC
0 Output

The ATC is the result of adding AVC to the AFC curve. Therefore, the vertical
difference between the AVC curve and the ATC curve at any output is AFC.

• As AFC is large at low output and becomes smaller and smaller with increased
output the ‘gap’ between the ATC and AVC curve also gets smaller.

• The shape of the AFC and AVC curves determines the shape of the ATC curve.

• Both AFC and AVC fall over the initial output, so ATC also falls.

• AVC will reach a turning point, however, as diminishing returns become

effective.

62
• AFC continue to fall, this makes the ATC curve less steep than the AVC curve,
and they converge as AFC continues to decline.

• However, the ATC curve is also markedly ‘U’ shaped; as more output is
produced, its costs are increasingly dominated by expanding AVC, whilst AFC
become less significant.

• As the firm expands, its fixed costs do not change, so its entire MC is due to
increased VC.

• Therefore, the MC curve is most important in shaping the firm’s ATC.

• If MC< AC producing more will lower the firm’s AC.

• If MC> AC producing more will raise the firm’s AC.

If MC = AC and AC are neither rising nor falling, the MC must cut the ATC curve at
its lowest point at the bottom of the ‘U’.

Revenue

Total revenue is equal to price times quantity. TR = P x Q

The area under the Demand Curve can represent total Revenue.
See Figure 2.1.3 (l).

Figure 2.1.3 (l): Total Revenue

Price

P1

0 Q1 Output

This can also be shown as follows. Figure 2.1.3 (m).

63
 Figure 2.1.3 (l):Total Revenue

Total TR
Revenue

Occurs when a firm sells

output at a constant price

0 Output

If the firm sells its output at a constant price, TR will appear as a straight line through
the origin. As the price of the firm is assumed constant, the TR curve is a straight line.
The TR of the firm rises steadily with the quantity sold.

Profit

Accounting Profit is total revenue minus total costs. AP = TR – TC.

• Accounting costs are costs that have a money value like raw materials, rent,
wages etc.

• Economic Profit and Economic Costs have a different meaning.

• Economic costs include any further opportunity cost to the firm in addition to the
accounting costs.

• The opportunity cost of capital is the missed opportunity to use that capital in
another firm or even to gain interest from the money by leaving it in the bank.

• The opportunity cost is money value of the capital, which is the total rate of
interest that money could earn in another firm with the same degree of risk.

• This cost is known in economics as ‘normal profit’; this is the amount of profit
that must be earned by a firm to cover its opportunity cost.

• It is the amount of profit needed to just keep the firm in the industry. Any extra
profits are known as ‘supernormal profit’.

64
Profit Maximizing Equilibrium

The major motivation of firms is to maximize profits. However, it is not the only one.

It will maximize profits where the positive difference total cost and total revenue is
the biggest-.i.e. at point Qe on Figure 2.1.3 (n).

Figure 2.1.3 (n): Profit Maximization

TC
TR &TC
TR

Losses

Profit

0 Qe Output

A second way to consider profit maximization is to look at MR and MC.

The firm should add additional units of output when the MR is greater than MC; the
firm will gain profit from each of these additional units.

It should keep adding extra units of production until MR=MC. This is the profit
maximizing point. See Figure 2.1.3 (o).

MC will rise as the firm expands until an additional unit will be reached where
MC>MR; any additional unit will reduce total profit, so the firm should not add this
extra unit of output.

Figure 2.1.3 (o): MR & MC

MR/MC
MC

Profit maximization = MR=MC

P MR

0 Output

expand output (MR>MC) contract output (MC>MR)

MR = MC (equilibrium)

65
2.1.4 Theory of the Firm: Five Market Structures Examined

Market Power

Market power is the amount of power an individual firm has to influence the price or
supply of a product.

• The amount of this power depends upon the degree of competition.

• The degree of competition is the major characteristic of each ‘market structure’.
• The market structures include monopolistic competition through oligopoly to
monopoly. Note: there are many market structures; not just five we will examine
closely.

5 Different Types of Market Structures Examined

Overview:

Market Structure

Type PC MC Oligopoly Monopsony Monopoly

Degree of Competition: High Low

Degree of Price Control: Low High

1. Perfect Competition (PC)

Assumptions of the Perfect Competition Model

Perfect competition will exist if the firm has no control over the price of the product.

Several conditions/assumptions must exist before a firm ends up as a price-taker.

1. Many small buyers.

2. Many small sellers.
3. The products are identical i.e. homogeneous.
4. There are no barriers to entry into the industry.
5. There is perfect knowledge. Firms and buyers are informed about the product
prices of each firm in the industry.

Because of the above:

* Firms have no control over price. They are price takers.

* As a result, they face a perfectly elastic demand curve. This means they can sell as
much as they want at one price, but nothing at any other price.

Figure 2.1.4 (a) shows the Demand and Supply curves for the market. Both curves
are ‘normal’ sloping.

66
 Figure 2.1.4 (a): PC: The Market

Price
S

P1

0 Q1 Quantity

The Demand curve for each Firm, however, is different because of the features of a
PC market described. See Figure 2.1.4 (b).

Figure 2.1.4 (b): PC: The Firm

Price

P1 D, AR, MR

0 Output

For each Firm, P = D = AR = MR.

Output and Profits: PC Structure

TR = P x Q

AR = TR = P x Q = P
Q Q

MR = AR = P

Short Term Equilibrium

In the short run, a firm can earn Supernormal Profit. It will produce where MR = MC,
where profit is maximized. See Figure 2.1.4 (c) and Figure 2.1.4 (d).

67
Figure 2.1.4 (c): Short Run Equilibrium

Price

MC

ATC

P D, AR, MR

0 q Output

The firm will produce 0q1 units of output. This is where MR = MC.

Figure 2.1.4 (d): Short Run Profit Maximization

Price

MC

ATC

P a D, AR, MR
c b

0 q Output

• Total Revenue = Paq0

• Total Cost = cbq0
• Profit = TR – TC = pabc = supernormal profit.
• This situation can exist only in the short term.

Moving to Long Run Equilibrium

If a firm is earning supernormal profits, new firms will move into the industry. They
have perfect knowledge. They know the firm is making supernormal profits.

There are low barriers to entry. New firms can easily enter the industry.

As a result, market supply will increase and the S.C. will move to the right.

68
The market price will fall because there is a new equilibrium.

This will be the new price for the firm, a ‘price taker’, and a new demand curve and
its output will decrease.

The firms’ costs are its economic cost, which includes ‘normal profit’.

The increases in Market Supply will continue and the price will fall. This will become
the firm’s price and DC, until the firm is earning only ‘normal profit’.

This is where P = MC = ATC, which is at the lowest point of the ATC curve. The
firm is now is L.R. equilibrium. This is point ‘b’ on Figure 2.1.4 (d) above because
DC has eventually moved to this position.

Firm Making Short Term Losses

Figure 2.1.4 (e): Short Run Profit Maximization

Price

MC ATC

AVC
c b
P a D, AR, MR
d e

0 q Output

• Total Revenue = Paq0

• Total Cost = cbq0
• Profit = TR – TC = cbaP = loss.
• This situation can exist in the short term because the firm is covering some fixed
costs.

• The firm is making a loss – pabc, BUT if it closes down the firm will still have to
pay all of the fixed cost – debc.

• If it continues to operate it will be able to pay all of its variable cost – 0qed and
some of its fixed cost – deap with its revenue – Oqap.

• The firm makes a smaller loss if it stays open. This is true of any price that
covers part of the fixed cost and all of the variable cost.

• At prices between the AVC and the ATC curves the firm will continue to produce
but only in the SR.

69
When will the firm close down?

The firm’s shut-down point = MR = MC = AVC. See Figure 2.1.4 (f).

Figure 2.1.4 (f): Firm’s Shut-down Point

Price

MC ATC

AVC

P D, AR, MR

0 q Output

Firm’s Supply Curve

The firm will continue to produce at any price where its MC curve is above the
AVC curve - this is therefore its Supply Curve. See Figure 2.1.4 (g).

Figure 2.1.4 (g): Firm’s Supply Curve

Price

MC >AVC = Supply Curve

AVC

0 Output

70
Concept of Optimal Allocation of Resources

This section is very important.

The material has been included under the Perfect Competition Market Structure
because a pure market system is likely to be both technically efficient and allocatively
efficient.

Resources = land, labour, capital & enterprise (here, normal profit).

Technical Efficiency occurs when output is produced with the minimum amount of
resources. No wastage of scarce resources.

This will happen in a Perfectly Competitive (P.C.) market because firms must
continuously seek to lower costs because there is so much competition.

Allocative Efficiency occurs where suppliers are producing the optimal mix of
goods/services desired by consumers.

• This will occur as a result of the operation of the market mechanism (D & S).

• The market mechanism operates best in a P.C. market structure where it will
produce an equilibrium price and an optimal allocation of resources. That is, an
allocation of resources used to produce the combination of goods/services most
wanted by consumers.

• This occurs because there is ‘consumer sovereignty’; producers produce the

goods/services that consumers indicate they want, as shown by their buying
preferences (their Demand).

Consumer Sovereignty is where the consumer, by his or her choice expressed through
demand, decides what is produced and what price is paid for the goods/services.
Therefore, they determine the allocation of resources in an economy.

Exist under Perfect Competition where P = MC.

Importance of the relationship between Price and Marginal Cost.

P = value put on one good/service compared to other good/service.

MC = cost to society of the resources used.

If P > MC it shows consumers value the product more than it costs.

If P < MC it shows that society is using more resources in producing a good/service

than its value to consumers.

P = MC the optimal allocation of resources will occur. This is key.

71
Thus, if P>MC (as normally exists with all other major market structures) then, by
definition, there is non-optimal allocation of resources. Understanding this is
crucial.

Note: above does not take into account externalities, which are not taken account of by
any market system.

72
2. Monopolistic Competition

Features:
1. Large number of small producers.

2. As a result, they are price takers.

3. Low barriers to entry and exit. Because they are small-scale operators, they
have small capital costs to consider in entering or leaving the industry. As a
result, any high profits exist only in the short term because they attract new
entrants to the industry, which leads to lower prices and profits.

4. Similar products. There are only small differences in the product of different
firms (or perceived differences) and it provides an opportunity for firms to
compete with other firms in the industry.

5. Firms will compete by trying to convince consumers that their product has
important differences from other firms’ products; this is called product
differentiation. Each firm may produce many very similar products with
different ‘brand names’. They will often use advertising to market these
brands strongly hoping to achieve brand loyalty.

This is called non-price competition.

Firms in this market structure face downward sloping highly elastic demand curves.
As in the case of a monopoly, the MR curve is below the DC. See Figure 2.1.4 (h)

Examples are retailing, restaurants, hairdressers, motels etc.

Figure 2.1.4 (h): Monopolistic Competition

Price

MR

0 Output

73
Supernormal Profits

Figure 2.1.4 (i): Monopolistic Competition: Supernormal Profits

Price

MC
p a
ATC

c b D

0 q MR Output

Firm will maximize profit where MR = MC. Produce quantity 0q, at Price, p.

TR = P x Q = 0qap
TC = Cost x Q = 0qbc
Profit = TR – TR = pabc = a supernormal profit.

Normal Profits

New firms will enter and firms will produce where they are only earning ‘normal’
profit.

That is, where the D.C. is tangential to the ATC curve (at point ‘a’) and TR = TC

Figure 2.1.4 (j): Monopolistic Competition: ‘Normal’ Profits

Price

MC
p a
ATC

0 q MR Output

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The firm will still produce where MR = MC. Quantity = 0q and price = p.

However, P = ATC and TR = TC so the firm is only making normal profits.

Points to note about monopolistic competition

Production will occur where:

- Price is greater than in the P.C. market.
- Quantity is less than in the P.C. market.
- Price is greater than M.C.

Because producers face a very elastic D.C., their control over price is not high.

Therefore, their degree of difference to a situation of optimal allocation is small.

That is, they are close to optimal allocation of resources (or inefficiency is small).

Price Discrimination

Price discrimination occurs where a product that costs the same is sold at different
prices to different customers- e.g. airline tickets to students are cheaper than to normal
passengers.

Or a product with different costs is sold at the same price to different customers e.g.
postal customers, e.g. postal charges in Australia, a letter can be sent anywhere for the
same cost whether 50 kms or 5,000 kms.

Price differentiation is where different prices are charge because of different costs of
production e.g. a cup of coffee in a ‘five star’ hotel and in McDonalds.

Reasons for Price Discrimination

Price discrimination occurs because different people are willing to pay different
prices for a product. This is shown as a downward sloping D.C.

Figure 2.1.4 (k) shows the single profit maximizing price of a product. Note:

• The portion of the D.C. above ‘x’ represents all consumers who are willing to pay
more for the product than the price ‘P’.
• The difference between what they are willing to pay and the price they have to pay
is called ‘consumer surplus’(the area ‘Pxa’); this occurs when the consumer feels
he has ‘got a bargain’.
• The firm can increase its profit if it can get some of this consumer surplus.

75
 Figure 2.1.4 (k): Single Price Monopolist

Price a
Consumer surplus
MC

P x

MR

0 q Output

Necessary Conditions for Price Discrimination

1. The supplier must have some monopoly power i.e. be a ‘price-maker’.

This can occur in all markets except a P.C. market.

The more the monopoly power the easier it is to price discriminate, e.g. much
discrimination occurs in the national monopolies that supply gas, electricity etc. in
various countries.

2. There must be groups of different buyers with different PED for the product

There must be different customers willing to pay different prices for a product
e.g. men and women for haircuts. For haircuts, the PED for men is less than the PED
for women.

3. Groups can be identified and separated

Price discrimination cannot work if one group can buy and resell to another.

This usually applies to a service- e.g. bus fares when an I.D can be demanded-
so that students cannot buy their discount tickets and sell it to other users.

Time can also be used to discriminate- e.g. ‘off peak’ charges on airlines.

An example of a situation where a firm with some control over price identifies two
groups with different D.C.’s is the airline industry. The firm has a way of identifying
the various consumer groups and preventing re-sale of tickets.

See Figure 2.1.4 (l) & (m). Two groups of consumers are identified, each with a
different DCs, D1 and D2.

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 Figure 2.1.4 (l): Price Discriminating Monopolist

Price

P1

MC
D1

0 Q1 MR1 Output

Figure 2.1.4 (m): Price Discriminating Monopolist

Price

P2

MC
D2

0 Q2 MR2 Output

Note:
• MC is the same.
• One has a steeper D.C.(lower PED) and thus a steeper MR curve, i.e. D1 and
MR1.
• The profit maximizing firm will produce where MC = MR in each market. This
gives a higher price in the first case (Figure 2.1.4 (l), thereby obtaining some part
of its consumer surplus.

By separating consumers into two groups, and selling at MR=MC in each market, the
firm can sell at a higher price to group 1, and take away some of their consumer
surplus for itself. (Marginal Cost has been assumed constant for simplification.)

77
The more market separation the p` discriminating supplier can achieve, the more
income it can earn. Profit would rise as long as costs remained the same.

Pure price discrimination would exist if the firm could charge every single consumer a
different price, but administering many prices would be costly.

Total Revenue and Price Discrimination

The greater the degree a firm can identify and engage in market segmentation, the
greater the possibility of price discrimination.

With this comes greater total revenue. Profits will rise so long as costs remain
unchanged.

78
3. Oligopoly

The market structure, Oligopoly, is common in the real world.

Features:

1. A small number of large firms

2. High barriers to entry – e.g. high ‘start up’ costs of machinery as in the car industry.

3. Similar products so the firms compete by branding and advertising their products
and stressing product differentiation rather than price.

4. The firms see themselves as rivals, and consider the actions of other firms when
making their own decisions. This is called interdependent behaviour. If one firm
makes a small change to price or output, other firms are likely to follow e.g. Toyota
puts airbags in their small cars, Ford and General Motors soon do the same.

5. There is relatively little price competition. If there is a price war, it is fierce, with a
lot of cost cutting. This can have very severe effects on their profitability. As a result,
prices are very stable and there is very intensive, non-price competition.

Examples include the automotive, airline, digital camera, and banking and cardboard
box industries in many countries.

Two main types of Oligopoly

1. Collusive Oligopoly

The most common is a cartel.

A cartel occurs when firms make agreements on price, advertising and market share
to reduce uncertainty and make larger profits.

Cartels behave much the same and have features to a monopoly. See section on
monopoly.

The best example is OPEC.

2. Non-collusive Oligopoly

As the name suggests, this type of oligopoly occurs in the absence of a formal
agreement by members of the industry.

Price stability is still a major feature.

Kinked Demand Curve for Oligopoly

The oligopoly faces the two possible D.C.’s; that is, DC1 and DC2. See Figure 2.1.4
(n).

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 Figure 2.1.4 (n): Oligopoly: Kinked Demand Curve

Price
D1
MR1 relatively elastic demand

MC1
P x = kink-where firm usually produces

MC2

relatively inelastic demand

D2

0 q MR2 Output

Explanation

• If a firm wished to raise price, it is likely that the other firms would not raise
their prices. The firm would lose many customers, even for a small rise in price.
That is, it would face a very elastic D.C. (D1).

• If a firm wanted to lower its prices, it is likely that the other firms would lower
price also. They could not afford to let the firm gain more ‘market share’. It is
possible that at a lower price they would all sell a little more. That means the D.C.
is relatively inelastic.(D2).

• As a result, firms are likely to keep to the same price. There will be a lot of non-
price competition.

Note:

1. The MR curve for D1 stops immediately below point ‘x’.

2. The MR curve for D2 begins directly below point ‘x’.

3. The ‘kink’, or break in the D.C., causes a ‘gap’ to exist between the MR curves.

4. The profit maximising quantity is 0q, where MC1 = MR1 and MC1 = MR2. Any
MC curve between MC1 and MC2 will be at the same price and output.

4. Monopoly

Features:

1. One large seller or a group of companies acting together (a cartel).

2. High barriers to entry that prevent other entrants entering the market.

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 3. The monopoly has some market power.

4. It is the situation where the firm can charge higher prices and produce lower
output than when there is competition. It is therefore less efficient.

5. The producer power is maximised; it is the situation where there is greatest

producer sovereignty.

6. However, they don’t have total market power; they cannot set whatever price
and output they like. This is because they control supply but not demand. For
example, if they reduce output and price rises, consumers may buy less and so the
firm’s total revenue would fall, a situation they would not want.

Monopolies may have positive economic benefits; namely,

• Economies of scale may be gained, meaning larger output and cheaper prices.

• Research and development is more likely to be undertaken because of their

financial resources. This may mean more new products will be produced than in a
more competitive situation.

Profit Maximization in a Monopoly

A Monopoly is an industry with only one seller or a cartel.

Under a Monopoly, the firm is the monopoly. Therefore, the demand curve for the firm
and industry are the same-downward sloping.

If the monopolist wants to sell more goods/services, they must reduce their price.

A Monopolist does not control Demand.

A Monopolist controls Supply. They can change price by altering supply. Therefore,
they are a price-maker.

The Demand Curve facing a Monopoly

The Market Demand Curve and the Firm’s Demand Curve are the same for a
Monopoly.
It is a downward sloping D.C. Therefore a monopoly must accept a lower price to sell
more. See Figure 2.1.4 (o).

That is, it can reduce price by increasing the quantity it is willing to supply so Price
falls.

Therefore a Monopoly can affect price by changing supply; therefore, it is a price

maker.

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Monopoly Price and Marginal Revenue

In a P.C. market a firm’s P = MR (always).

In a Monopoly, a firm must accept a lower price in order to sell more, therefore its
MR < P. See Figure 2.1.4 (o).

Figure 2.1.4 (o): Monopoly: Demand Curve & MR Curve

Price

MR

0 Output

Profit Maximization

The monopolist will produce 0Q1, where MC = MR. Output = 0Q1. Price = P. It is a
profit maximiser like all firms.

Figure 2.1.4 (p) illustrates this point.

Figure 2.1.4 (p): Monopoly: Profit Maximization

Price

MC
P

0 Q1 MR Output

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Monopoly and Supernormal Profits

Figure 2.1.4 (q): Monopoly: Supernormal Profits

Price

MC
p a
ATC

c b

0 q MR Output

TR = P x Q = 0qap
TC = Cost x Q = 0qbc
Profit = TR – TC = pabc = a supernormal profit.

• It is likely that monopoly will earn a supernormal profit-ATC Curve < D/AR
Curve.
• It can maintain supernormal profit because there are high barriers to entry so new
firms cannot easily enter the industry causing an increase in supply and a fall in
price.
• It will produce the quantity where MR = MC. It can sell this quantity at the price
consumers are willing to pay (as shown by the Demand Curve).

Monopoly and “Normal” Profit

Figure 2.1.4 (r): Monopoly: ‘Normal’ Profits

Price

MC
p a
ATC

0 q MR Output

83
The Monopolist will still produce where MR = MC. Quantity = 0q and price = p.

However, P = ATC and TR = TC so the monopolist is only making normal profits.

Where a monopolist would not produce

It does not need to operate at the profit maximizing position (i.e. MC = MR).

It may choose to earn less than maximum profits if:

- It feared that the barriers to entry were too low to keep out other firms.
- It fears that its high profits may attract public criticism and unwanted attention
from the government.

A firm may be a monopoly in the domestic market, but face a great deal of
competition in the international market.

See Figure 2.1.4 (s).

Figure 2.1.4 (s): Monopoly: Where it would not produce

Price

MC

ATC

0 MR Output

The Monopolist will not produce where TC > TR.

Theory of Contestable Markets

In recent years, this theory has gained much support with Economists.

The Theory of Contestable Markets argues that it is the threat of competition,

rather than actual competition, that determines a firm’s price and output.

For example, a monopolist would alter their price if faced by a threat of another firm
entering the industry and taking over its market. Examples abound in the real world,
including the airline industry.

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An example of a contestable monopoly is shown in Figure 2.1.4 (t).

A single monopolist will maximize profits at Q1, with price of P1. Supernormal profit
= P1abc. If the monopolist sees a treat of competition, they would lower prices to P2
= AC2, and increase output to Q2.

Under these circumstances, another firm will only enter the market if it believes it can
take over the whole market. It will not be able to do this if the single monopolist
keeps lowering prices and increasing output. If this happens, the single monopolist
will not make supernormal profits.

Thus, the single monopolist behaves very competitively, benefiting consumers

through lower prices.

Figure 2.1.4 (t): Contestable Monopoly

Price

P1 a

AC1= c b

P2=AC2 d LRAC

D = AR

0 Q1 Q2 Output

Exist costs, or the costs of leaving an industry, are crucial in determining the degree of
contestability. If they are low, a firm maybe more willing to enter the market. If they
are high, a possible new entrant is unlikely to enter the contestable market.

5. Monopsony

Monopsony is a market structure in which there is one buyer, or just a few large
buyers.

The economic power of big business may distort the efficient operation of the market
system, this is a major form of ‘market failure’ and it may lead to government
intervention.

Examples: supermarket chains in Australia/overseas (few very large buyers).

85
Competition versus Monopoly

There are two extreme market structures, perfect competition and pure monopoly. In
the real world, however, this distinction is often blurred.

We will now examine two variations, with emphasis on economies of scale.

1. Perfect Competition versus Monopoly when no economies of scale exist

If we assume there is a P.C. industry with many small firms.

If a buyer buys all of the small firms and makes the industry a monopoly but keeps
many small plants (e.g. factories) then it will be still producing on a small scale in
many plants. It will not gain economies of scale. See Figure 11.1.4 (u).

Figure 2.1.4 (u): Multi-Plant Monopolist

Price

S =MC
Pm

Ppc

D
MR

0 Qm Qpc Output

The monopolist makes decisions at the industry level and not at the individual plant
level. The price in the P.C. market is the market equilibrium Ppc. The monopoly
firm would produce where it can make maximum profit, the quantity where MC =
MR. The price it will receive for this profit maximising quantity is determined by the
D.C., that is price Pm.

The monopoly would produce at a higher price – Pm > Ppc.

• And produce a smaller amount - 0Qm< 0Qpc.
• And resource allocation in a monopoly is not optimal - P> MC.

2. Competition versus Monopoly when economies of scale are gained

Achieving economies of scale is a powerful reason for growth of the firm.

86
If there are many small firms they are likely to produce only small quantities so at a
high level of AC/MC e.g. SRAC1 and MC1. See Figure 2.1.4 (v).

However, if one firm grows large and becomes a monopoly and rationalise production
it will be able to take advantage of economies of scale. It will then be able to produce
at a lower level of AC/MC e.g. SRAC2/MC2

Figure 2.1.4 (v): Economies of Scale

Average
and
Marginal
Costs
SRAS1

SRAS2
MC1
LRAC
MC2

0 Output

The advantages of achieving economies of scale are highlighted in Figure 2.1.4 (w).

Figure 2.1.4 (w): Monopoly versus perfect Competition

Price
MC1 = Spc

Ppc MC2 =S monopoly

Pm

D
MR

0 Qpc Qm Output

If the monopoly can gain economies of scale then it is possible it will produce at a
lower price than in a PC market (Pm is less than Ppc) and the quantity would be
greater (0Qm is more than 0Qpc). This is because the MC has shifted to the right

87
(MC1 to MC2) and costs are now much lower because of the economies of scale that a
monopoly firm operating a large-scale plant can gain.

However, the monopoly will not have achieved optimal allocation of resources because
Price is greater than MC. That is, the consumer values the product (P) more than it
costs to produce (MC).

Reason for Divergence of D Curve and MR Curve:

(a) At low Output, MR Curve will be “closer” to D Curve because monopolist firm
only has to lower Price by a small amount for extra-or marginal-units.

(b) At High Output, there will be greater divergence of D and MR Curves because to
achieve higher volume/output, monopolist firm can afford to lower marginal price
because of greater economies of scale.

88
2.1.5 Theory of the Firm: Concepts of Efficiency

The concept of Optimal Allocation of resources has already been covered.

Efficiency is concerned with how well the market allocates resources. In particular,
how well scarce resources are allowed to solve the What, How and For Whom
questions.

Productive (Technical) Efficiency occurs when a firm is producing goods/services

with the minimum amount of inputs.

• This will mean it will be producing for the minimum cost.

• The incentive for firms to achieve technical efficiency is profit; firms will gain
more profits by reducing costs to a minimum.
• Productive/Technical efficiency must be present for economic efficiency to occur.
• It occurs within firms.

Economic Efficiency occurs when society is producing the goods/services most

valued by society.
• As a result, it is impossible to move resources to make people better off without
making others worse off. This is known as the Pareto Effect, after the Economist.
• It is prices and the price system, which signal the value that people put on
different goods and services.
• It occurs outside firms.

Degree of Competition and Efficiency

• A market in Perfect Competition in the long run will result in economic efficiency
because P=MC. See exceptions below.

• In a Monopoly and Imperfect Competition P>MC. If more resources were

allocated to such industries price would fall and marginal costs would rise; the
allocation of resources in society would become more economically efficient.

Usually in a PC market all resources would be allocated at optimal efficiency where

P=MC. There are two exceptions:

1. Economies of Scale – if these are present society benefits because of increased

output and lower prices. These often come with a monopoly. Unlikely to achieve
economies of scale under P.C.

2. Externalities – the market fails if there are externalities; that is, private cost or
benefit differs from social cost or benefit. In a PC market, based on freely
operating market forces, there will be social benefits that need to be considered
and social costs will occur.

Use and Limitations of Government Policy to Control Monopoly

The assumption here is that a monopoly is bad for society. This is not always the case.

89
Seven examples of the use of government policies are considered under this
assumption.

1. Taxation

Profit taxes can be imposed on monopolists to remove supernormal profits that may
not be ‘accepted’ by consumers. This will not lessen the problem of misallocation of
resources.

2. Subsidies

Subsidies can improve efficiency by bringing MC closer to Price.

So MC curve shifts to the right, consequently ↓P and ↑Q. See Figure 2.1.5 (a).

Price/cost MC Figure 2.1.5 (a)

P1 MC with subsidy
P2

0 Q1 Q2 MR Output

A private monopolist will produce at P1Q1. A subsidy can shift the MC curve to the
right to give an optimal solution of P2Q2. A profit tax on the supernormal profit could
be used to pay for the subsidy.

Production without Subsidy = 0Q1.

Production with Subsidy = 0Q2. Have increase in Q, Q1-Q2, reduction in P, P1 to P2.

3. Nationalising the industry

Nationalising industries means the government taking control of the industry. There is
no need for profit, and so for P=MR the price and output can be set closer to MC.
However, nationalisation can lead to inefficiency.

4. Price Controls

The government can limit profits and impose price controls on monopolies through a
body, such as an ‘industry watchdog’. A maximum price can be set at the level of
economic efficiency. For example, at the price P in Figure 2.1.5 (b) where MC cuts
the DC, not the MR Curve as with a monopoly.

90
 Figure 2.1.5 (b):Price Controls on a Monopoly

Price/Cost MC

0 Q Output

5. Monopoly Break-Up

A monopoly can be broken up into smaller, competing, firms, if it can be cost-

efficient at a smaller size. This would be suitable for multi-plant monopoly or a cartel
agreement, not for a national monopoly.

6. Reduction of Entry Barriers

The government can lessen the entry barriers stopping other firms from entering the
industry allowing market forces to break up the monopoly. Removal of trade
restrictions to allow foreign competition will weaken a domestic monopoly.

Example: Australia: Removal of Agricultural Boards throughout the 1990s.

7. Changing Demand and Technology.

Market forces may lead naturally to the break up of a monopoly as smaller firms, for
example, “catch-up” on the technology of the monopoly.

Note:
1. In Australia: Anti-Monopoly Government Bodies: Restrictive Trade Practices
Act, Competition and Prices Control Tribunal, and the ACCC.
2. In USA: Anti-Monopoly: Sherman Act, Other Anti-Trust Legislation.

91
2.1.6 Market Failure

Market Failure is the situation where the markets do not work at all, or do not work
well.

Examples of Market Failure

1. Externalities

This is the first type of Market Failure.

• Externalities are benefits/costs external to the Private Market forces of Demand

and Supply.

• A market represents the private forces of supply and demand; that is, consumers
demand products to maximise their own utility and producers supply them to
maximise their own profit.

• However, many market activities affect other people – both positively and
negatively. These are called positive and negative externalities.

See Figure 2.1.6 (a).

Figure 2.1.6 (a). Positive Externality

Positive Externality
Price D S private

Ps
Pp
D private & social

S D private
0 qp qs Quantity

• If we add the social benefits to the private benefits we could get a new demand
curve (Dprivate + social) that shows the private and social benefits.

• Society would be willing to bear the higher price, Ps, in order to get the extra
benefit, but the market reflects private benefits only.

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Possible Responses to the Existence of Externalities

a) Provision of Public Goods

The bases for distinguishing between public and private goods are:

Rivalry
• a good is rivalrous if the use of it by one person prevents the use of
it by another person. e.g. personal computers, pens.
• a good is non-rivalrous if the use of it by one person does not diminish its use by
others. e.g. radio, TV.

Excludability
• People who cannot pay for a good or service are excluded from its use. e.g. Pay
TV.

• If people who don’t pay cannot be excluded from using the good and it is difficult
to find a way to make them pay for the good. e.g. lighthouses, defence, street
lighting.

Private Goods are both excludable and rivalrous.

• As private goods are excludable the purchaser enjoys the benefits and the non-
purchaser does not.

• The benefits are wholly or largely internal with relatively few positive
externalities.

Public Goods are both non-rivalrous and non-exclusive. Goods/services valued by

society.

• It is difficult to exclude from using the goods or service (e.g. light from
lighthouse) people who won’t pay (the ‘free-rider’ problem).

• Those who would be willing to pay would be paying for the free-riders and so
would refuse to pay.

• So there would be market failure, that is, the market would not supply the g/s.

Solution: The government can provide them directly and pay for them through
taxation. That is, it can intervene in the market and modify the allocation of resources.

b) The Provision of Merit Goods

A merit good is a private good that has positive externalities-social benefits enjoyed
by others. They have good effects on society.

A market will only provide the optimum amount required for private purposes but
under-provide the social optimum. e.g. condoms to prevent the spread of Aids;
pharmaceuticals to prevent Aids.

The government could intervene and attempt to increase the resource allocation
toward the socially optimal quantity.

93
It could:
i) Sponsor an advertising campaign to promote the use of the good. See Figure 2.1.6
(b).

Figure 2.1.6 (b): Advertising to Increase Demand

External Benefit
Price D S private

Ps
Pp
D private & social

S D private
0 qp qs Quantity

ii) Provide the good free- e.g. primary school education. See Figure 2.1.6 (c).

Figure 2.1.6 (c): Supply of good free

Price D S private

Pp

P3
S D private
0 qp q3 q2 Quantity

0q2 would be quantity supplied if totally free. Or, if Government charged P3, then
QS = 0q3.

iii) Provide the good free but ration its use or at below market price to prevent
waste or to reduce costs- e.g. dental care, health care, goods/services to pensioners.
See Figure 2.1.6 (d).

Figure 2.1.6 (d): Rationing

Price D S private

Pp

P3 D private
S
0 qp q3 Quantity

If the Government rationed good/service at below the market price, P3, then Qd =
0q3.

iv) Pay a Producer Subsidy. This Shifts the SC to the right. See Figure 2.1.6 (e).

94
 Figure 2.1.6 (e): Subsidy

Price S private

S with a subsidy
Pp

P2 D private

0 qp q2 Quantity

This lowers the price to P2 and increases QS/Qd to 0q2.

Negative Externalities

Negative externalities are costs not paid for by the producer but borne by the society
as a whole.

These are common in society.

These are external costs, or costs external, to the economic decision of the market
place.

Negative externalities are ignored by the market place. There is, therefore, ‘market
failure’.

Examples: pollution –air, noise, rivers-; global warming; corrosion of public

buildings; death & injury to people in workplace and on roads.

Therefore, must add the Social Costs. This results in the Supply Curve shifting to the
left. See Figure 2.1.6 (f).

Figure 2.1.6 (f): Negative Externality

S private & social

D
S private

Ps Negative externality

Pp

0 qs qp
Quantity

95
Restriction of Demerit Goods

Demerit goods are private goods that have negative externalities. They have a bad
effect on society. Use affects other people negatively.

• They are goods that are rivalrous and exclusive, so the market will provide them.

• However, they have net social costs that are borne by other people.

• The market price does not reflect these additional costs.

• If the market reflected these additional costs a lower quantity of resources would
be allocated to them than in a pure market.

Examples: alcohol, cigarettes, cars with pollution/traffic congestion, guns, narcotic

drugs, burning of forests.

The government could intervene to try to ensure that fewer resources were allocated
to the production of these goods.

It could:
i) Run a negative advertising campaign.

Figure 2.1.6 (g): Negative Advertising Campaign

S private & social

Price D private
S private

Ps externality

Pp

D2
0 q2 qp
Quantity

Socially optimal quantity = 0q2. The Government’s negative advertising campaign

shifts DC to the left to D2.

Examples: anti-drinking, anti-drug, anti-smoking campaigns.

96
ii) Tax the product.

Figure 2.1.6 (h): Taxing the Product

S private & social

Price D private
S private

Ps a) amount of externality
b)amount of tax
Pp

0 q2 qp
Quantity

Government shifts the SC to the left by imposing a tax. Qd now = 0q2.

Examples: Government tax on alcohol & cigarettes.

iii) Prohibit the good.

Figure 2.1.6 (i): Prohibition

Price D private
S private

Pp

0 qp
Quantity

Government uses legislation to prohibit the good/service to achieve its desired

outcome. Effectiveness depends on a) success of the law and/or b) black market
operations. Aim would be to reduce Qd from 0qp to zero.

Examples: Law prohibiting certain drugs, guns. Australia.

c) Environmental degradation.

Pollution is a major form of environmental degradation.

The costs imposed by the pollutant are not borne by the polluter, who might be a
producer or a consumer. It is a major negative externality in today’s world.

Pollution is one of the world’s major problems. Causes: burning fossil fuels, CFC’s,
automobiles, and animals (dung from cows). It is a major cause of global warming.

97
Four major reasons why it is difficult to reduce pollution

1. The costs are external

The costs of pollution are not paid for by the agents causing it so there is no economic
incentive in the market system to cause them to stop.

2. Distributional problem

The people who are benefiting from the activities that are causing the pollution are
imposing some of the costs on others.

So the pollution needs to be reduced but, as well, those who suffer from its impact
need to be compensated.

3. Placing a value upon the external cost

For example, how to value the negative impact of noise on those who live near a
freeway, the loss of a rainforest or an endangered and beautiful animal?

We also need to be able to make a comparison between the benefits and costs of
market activities. For example, the benefits and costs of a freeway in terms of savings
in time, fuel used, and accidents against the extra noise and damage to the
environment.

4. Valuing the impacts that will be felt in the future.

Some present environmental problems may be having little impact now, but may
impose severe costs on future generations. It is difficult to convince the present
generation to accept the cost of reducing environmental damage when they will not
see the benefit. For example, reducing the CFC chemicals that cause holes in the
ozone layer.

Methods of Control

1. Modify the market by taxing the activity that causes the negative externality.
2. Extending property rights to internalise the externality.
3. Legislation- i.e. the law.

These methods are expanded below.

1. Taxing the Externality

A tax is imposed on the activity to equate with the value of the externality. The
Marginal Social Cost (MSC) is above the Marginal Private Cost (MPC); the
difference is the value of the externality. MSC = MPC + the externality. It is the true
opportunity cost of the activity. See Figure 2.1.6 (j).

98
 Figure 2.1.6 (j): Taxing the Externality

S private & social

Price D private
S private

Ps a) amount of externality
b)amount of tax
Pp

0 q2 qp
Quantity

In the above graph the private resource allocation decision leads to the price Pp and
the quantity 0qp - there is too much of this product.

Solution: The government should now impose a tax on this product to shift the supply
curve to the left by exactly the amount of the externality. Including the externality
gives a socially optimal resource allocation of Ps and 0q2 where the benefits of the
demand are equated with the true cost of the activity.

The external costs of motoring could be tackled in this way e.g. road pricing in city
centres as is done in Singapore and the U.K. or the tax on leaded petrol to encourage
people to switch to unleaded petrol in many countries.

2. Extending Property Rights (internalise the externality)

Consumers and companies already have to meet the costs and damage to other
peoples’ properties. However, polluters can avoid paying for the damage they cause.

Polluters can be made to pay for the damage they cause using the same methods as
they have to pay for property damage. The polluting activity will no longer be free.
Polluters will “think twice”. This is called internalising the externality.

People can be given the right to enjoy clean beaches, smoke-free work places, or dirt
and noise free residential areas.

This is more difficult when the property is “internationally used and abused” e.g. who
is to grant property rights over the ozone layer or the oceans?

Another solution is to issue Tradeable Permits.

3. Legislation

Laws can be passed to tackle market failure, especially pollution. For example,
emission limits on cars or chimneys.

99
However, it takes little account of balancing benefits with costs. If the legislation is
too tough the benefits of the polluting activity (i.e. the company’s production) will be
curtailed too much. If the legislation is too slack there is little incentive for polluters
to cut back to the point of social equilibrium.

2. Inequality of Income and Wealth

This is the second type of Market Failure.

Major problem for LDCs

Income is the flow of economic payments in the form of wages, rent, interest and
profit over a period of time.

Wealth is the stock of economic goods and services measured at one particular point
of time.

Problem: the distribution of income and wealth amongst people is not necessarily the
“best” if left to the market alone. Some people may have access to a great amount of
income and wealth while others may be very poor.

Many people in a society may wish to live in a society where the distribution of
income and wealth is fairly equal. The market fails to achieve this.

Solution: People would expect their government to do something to reduce this

inequality of income and wealth.

They can use a progressive tax system: a direct tax, where the rate of tax increases as
peoples’ incomes increase.

Note: as distinct from Proportional-the average tax rate is constant-or Regressive-the

average tax rate falls as Y increases.

This will reduce the inequality of after-tax income.

The tax revenue can then be used to pay transfer payments (negative direct taxes) to
those whose incomes might be considered inadequate. It can also be used to pay for
free or low cost merit goods that benefit those on lower incomes e.g. low cost health
care, education and housing.

100
3. Abuse of Monopoly Power

This is the third type of Market Failure.

Covered more fully earlier in this Section.

Problem: In a market system producers (e.g. large businesses) and owners of factors
of production (e.g. large trade unions) strive to increase their market power; that is,
their ability to raise profits by reducing output and raising prices. Prices that are
higher and greater output that would occur in a non-monopoly market structure.

This is called monopoly power. Partial monopoly power is far more common than
full monopoly power.

When monopoly power exists in the economy, resource allocation is not at its most
efficient.

Solution: governments can pass anti-trust, or anti-monopoly laws, and restrictive

practices in the courts to reduce the concentration of power in such markets.

Courts work to curtail the existence of monopoly power where these practices work
against the interest of the public.

Governments can provide financial and other incentives to encourage new entrants
into the industry. For example, tax concessions and reduction in forms of protection
barriers.

They can introduce financial and other disincentives against the existing firm thereby
encouraging new entrants into the industry. For example, tax penalties and reductions
in subsidies.

101
SECTION 3: MACROECONOMICS

3A: INTRODUCTION TO MACROECONOMICS

3A.1 SECTIONS

Distinction between Macroeconomics and Microeconomics

Microeconomics is concerned with a section, or part, of the economy e.g. the study of
a particular market structures, the behaviour of households or of businesses.

Macroeconomics means the whole economy is studied e.g. the output of all
industries, the total unemployment in the country, the economic growth and
development of the nation, price stability, and external equilibrium.

5 Major Macroeconomic Policy Objectives: Definitions

There are five major macroeconomic objectives.

1. Economic growth is an increase in Real GDP per capita.

2. Economic development includes economic growth plus an improvement in

the standard of living.

3. Full employment exists when the labour market clears allowing for structural,
seasonal and frictional unemployment. These three types of Equilibrium
Unemployment are also known as the natural rate of unemployment.

4. Price stability is a situation in which the average level of prices is moving

within an acceptable band, known as creeping inflation, usually defined as
between 2% to 3% p.a.

5. External equilibrium is concerned with the Balance of Payments (BOP) on

Current Account of a country. That is, whether it is in balance, surplus or
deficit. It is a reflection of the external health of an economy.

All of the above are closely inter-related. This is the key.

Students should understand how a change in one policy objective would affect all
other macroeconomic objectives. This will be covered throughout the following
sections.

102
3B: SUMMARY OF INTER-RELATIONSHIP BETWEEN THE FIVE
MACROECONOMIC POLICY OBJECTIVES

3B.1 SECTIONS

The purpose of this section is…

(a) To provide students with an overview of each of the five macroeconomic policy
objectives.

(b) To explain and show how a change in one policy objective will affect all other
macroeconomic objectives.

…in order that when they come to study each objective in greater depth they will do
so knowing the importance of the inter-relationship between each macroeconomic
objective.

(a) Overview of the Five Macroeconomic Policy Objectives.

3B.1.1 MACROECONOMIC OBJECTIVE OF ECONOMIC GROWTH

Economic Growth is an increase in Real Gross Domestic Product (GDP) per

Capita. It is an increase in the total output of goods and services, minus depreciation,
discounted by inflation over a period divided by the total population.

Real GDP Per Capita = Nominal GDP minus Inflation

Total Population

Nominal GDP is the output of final goods and services valued at current prices.

Real GDP is the nominal value of output of final goods and services discounted by
the increase in the price level as measured by the inflation rate.

Inflation is a sustained increase in the general price level. Measured by the

Consumer/Retail Price Index.

Real GDP and GDP Per Capita

As GDP may also increase due to price inflation, the money or nominal GDP figure is
adjusted to arrive at Real GDP.

Year 1 GDP Year 2 GDP

$100m $110m

= $10m x 100 = 10% Inc.

$100m 1

If inflation was at 5.5% during this year then 55% of the increased GDP is due to
price increases. So only 4.5% or 45% is due to real growth (10% - 5.5% = 4.5%).

If the population is growing at 2% then the increase in real output per head/capita is:
4.5% - 2% = 2.5%.

103
Economic Growth is the increase in Real GDP per capita, over a certain period,
usually one year.

Note. If GDP figure given does not state whether it is nominal or Real GDP, then
assume and state in your answer that you assume that it is a nominal figure.

The Significance of the % Growth Rate

• If GDP increases by 1% per year it will double in 72 years, 2% in 36 years and so

on. See Table 3B.1 below. Learn.

Table 3B.1: Growth Rates and Doubling Time

Growth Rate-% Doubling Time-years

1 72
2 36
3 24
4 18
5 14.4
10 7.2
etc etc

• The two parts of GDP per head, namely GDP and population, are of major
importance.

• More growth enables higher levels of production and consumption.

• If there are more good and services it is possible to reduce poverty by improving
nutrition, health care or literacy and so economic development has occurred as
well as economic growth.

Production Possibility Model: Economic Growth

If an economy can increase its resources or increase the productivity of these

resources (e.g. through better education or technology) it could shift its PPC outwards.
See Figure 3B.1.1 (a) below. This model illustrates economic growth.

An increase economic growth is one of the five key macroeconomic objectives.

104
Figure 3B.1.1 (a): Production Possibility Model: Economic Growth

Bread

A Economic Growth

PPF2
F
PPF1

B
0 Submarines

The PPF has shifted to the right, from PPF1 to PPF2, indicating an increase in
economic growth.

Introduction to Macroeconomic Models

A model is a simplification of reality.

In Economics models are used to help in the understanding of complex economic

issues. In this section we study the Aggregate Demand/Aggregate Supply Model
(AD/AS model).

This is part of macroeconomics, a study of the whole economy. Microeconomics is

the study of parts of an economy; e.g. demand for a good by a household.

Aggregate Demand (AD) is the sum total of all final goods and services purchased
in the economy.

The formula for AD is: AD = C + I + G + X-M

Aggregate Demand is related to the price level. A rise in the price level usually
results in a fall in AD. A fall in the price level usually results in an increase in AD.

It is shown on an AD curve that slopes down from left to right.

The price level is an average of all prices, measured by an index of prices.

105
Derivation of the AD Curve

Aggregate Demand is the total planned spending by all sectors for all final goods and
services in the market. This figure is known as National Income. It can be measured in
3 separate ways: National Income (NI), National Output (NO) and National
Expenditure (NE).

For the model, we use NE. We measure the sum of planned expenditure of all sectors
in the economy; that is Aggregate Demand (AD).

The formula is: AD = C + I + G + X-M, where:

AD = Aggregate Demand
C = Consumption Expenditure
I = Investment Expenditure
G = Government Expenditure
X = Exports.
M = Imports.

As we are relating the Total Output of goods and services to changes in the price level
we must use the Real National Income or the Real GDP figure. That is, nominal
GNI/GDP has been deflated by the inflation rate.

The AD Curve slopes downwards to the right. See Figure 3B.1.1 (b)

Figure 3B.1.1 (b): Aggregate Demand Curve

Price
Level

AD

0 Real GDP

Note:
1. A change in the price level results in a movement along the AD Curve.
2. Factors causing a shift in the AD Curve will be examined later.

106
Derivation of the Aggregate Supply Curve

• Aggregate Supply is the total value of all the goods and services that firms plan
to produce.

• Short Run is the period when prices of goods and services rise but factor prices
do not change. Factor prices include the prices of labour (wages) and capital
(interest).

• Long Run is the period when factor prices rise to adjust to price changes in goods
and services.

• AD and AS are equal in all markets in the L.R., including labour demand and
supply.

• There is Full Employment (FE) in the L.R. in the labour market when there is
L.R. equilibrium. It is not zero percentage Unemployment (U.E.) The U.E. that
still exists is ‘the natural rate of unemployment’.

Short-Run Aggregate Supply (SRAS)

The SRAS Curve in the intermediate range is shown in Figure 3B.1.1 (c).

Figure 3B.1.1 (c): SRAS Curve Intermediate Range

Price
Level SRAS

0 Real GDP

Long Run Aggregate Supply (LRAS)

Long Run Aggregate Supply (LRAS) is the relationship between real output and the
price level at full employment. Full Employment (FE) includes ‘the natural rate of
unemployment’.

Figure 3B.1.1 (d) shows the levels of production where firms would normally operate
in the long run, which is the intersection of the SRAS and the LRAS Curves.

107
 Figure 3B.1.1 (d) Long Run Aggregate Supply Curve

Price LRAS
Level
Full Employment / Natural Rate of
Unemployment
SRAS

Unemployment Full Employment

Range Range

0 Real GDP

• LRAS Curve is vertical, at the full employment level of production. Because

factor prices rise for the reasons outlined above, there is no incentive to produce
more because profits will be consumed by the higher costs. In the Short Run factor
costs did not rise so profits generated by price rises were not used up by rising
costs.

• If output increased above the full employment level, decreasing ‘the natural rate of
unemployment’, the shortage of labour forces wages up so that they rise faster
than price rises, profits will fall, firms will cut production and their number of
workers and so unemployment will fall back to the natural rate.

6 Main Factors That Cause a Shift in Aggregate Demand

There are six main factors that cause a shift in the AD Curve. These are:

1. Fiscal policy
2. Monetary Policy
3. Foreign Incomes
4. Currency Exchange Rates
5. Expectations
6. External Shocks

The above factors are examined in a later section.

A shift in the AD Curve is shown in Figure 3B.1.1 (e).

108
 Figure 3B.1.1 (e): Shift in The Aggregate Demand Curve

Price
Level

AD1

AD0
AD 2
0 Real GDP

A shift in the AD Curve to the right, from AD0 to AD1, shows an increase in Real
GDP.

A shift in the AD Curve to the left, from AD0 to AD2, shows a decrease in Real
GDP.

7 Main Factors That Cause a Shift in Aggregate Supply

Factors that cause a shift in AS Curve include:

1. A change in the quantity and quality of capital investment.

2. A change in the quantity and quality of labour.
3. Supply side polices of government.
4. Government legislation.
5. Weather.
6. Currency Exchange Rates
7. Supply-side shocks

Note: New Model: factor prices can/do change in the short run.

All of the above affect both LRAS and SRAS.

Changes in factor prices and the weather affect SRAS only.

For example, if factor prices increase then at each price level firms will supply less;
the SRAS will shift to the left. Refer to Figure 3B.1.1 (f).

109
 Figure 3B.1.1 (f): Shift in Short Run Aggregate Supply

Price LRAS
Level
SRAS2

SRAS1

0 Real GDP

This shift of the SRAS curve is different from the movement along the SRAS curve.
A movement occurs when there is a change in the price level.

The LRAS is not affected. In the long run, all prices change proportionately so a
change in the price of final goods is matched by proportional changes in factor prices.
So there is no incentive to change the firm’s output. There would be no increase in
profit if output were increased.

However, as we shall see later on, a change in certain factors will cause an
increase/decrease in total output and cause a shift in the LRAS curve.

Macroeconomic Equilibrium

Macroeconomic equilibrium occurs where the quantity of Real GDP demanded and
supplied meet. It is where AD = SRAS.

Now we bring SRAS and AD together.

Macroeconomic equilibrium occurs where SRAS = AD. Refer to Figure 3B.1.1 (g).

110
 Figure 3B.1.1 (g): Macroeconomic Equilibrium

Price
Level
SRAS

P1 Macroeconomic
Equilibrium

AD

0 Q1 Real GDP

Macroeconomic equilibrium is where SRAS = AD. The price level is P1, and Real
GDP is 0Q1.

Note: as we shall see in the next section, this may or may not coincide with the full
employment level of output as shown by the LRAS Curve.

Macroeconomic Equilibrium and Full Employment

The economy is at full employment when it on the LRAS Curve.

Note: The definition of full employment includes ‘the natural rate of unemployment’.

Macroeconomic equilibrium where AD = SRAS may be equal to, less than, or greater
than, full employment (on the LRAS Curve) Real GDP.

In the ‘perfect/ideal world’, governments and economists strive to achieve a

macroeconomic situation where SRAS =AD =LRAS.

Note: It is important to continually ask yourself three questions:

(a) Where is the economy operating now?

(b) Ideally, where do you want the economy to operate?

(c) What policy areas can be used to achieve (b), where SRAS =AD =LRAS?

THREE TYPES OF MACROECONOMIC EQUILIBRIUM

a) Full Employment Equilibrium: Refer to Figure 3B.1.1 (h).

111
 Figure 3B.1.1 (h) Full Employment Equilibrium

Price LRAS
Level
Full Employment / Natural Rate of
SRAS Unemployment

P1 Macroeconomic
Equilibrium
AD
Unemployment Above Full Employment
Range Range

0 QE Real GDP

The ‘perfect economy’! Where SRAS = AD = LRAS. Real GDP = 0QE,

Price level = P1.

The economy is operating at full capacity, full employment exists, and Real GDP is
maximized.

b) Unemployment Equilibrium: Refer to Figure 3B.1.1 (i).

The economies of the majority of countries are operating in this range. Where
macroeconomic equilibrium (SRAS = AD) is less than full employment equilibrium
(on LRAS Curve).

Figure 3B.1.1 (i) Unemployment Equilibrium

Price LRAS
Level SRAS
Full Employment / Natural Rate of
Unemployment
P1 Macroeconomic
Equilibrium
Recessionary gap

Unemployment Above AD
Full Employment
Range Range
0 Q1 QE Real GDP

Actual Real GDP =0Q1.

Potential Real GDP = 0QE.

In this situation, the actual level of Real GDP, 0Q1, is less than the level of potential
Real GDP, 0QE, at price level P1.

112
Thus, the economy is operating in the unemployment zone. Less than full
employment is achieved. A recessionary gap exists.

As a result, we can see that the following macroeconomic objectives are not being
achieved:

(a) Economic Growth.

(b) Economic Development.
(c) Full employment.

Without additional information it is difficult to comment on whether the other two

macroeconomic objectives-price stability and external equilibrium-are being
achieved.

With regard to external equilibrium, we can say that the Balance of Payments on
Current Account could be improved because the economy is operating below its
potential. That is because actual Real GDP is less than potential Real GDP.

This is less than an ideal/satisfactory situation and of concern to economists, and the
government and Central Bank.

c) Above Full Employment Equilibrium: Refer to Figure 3B.1.1 (j).

Occasionally economies will operate in this zone. They are ‘over-heated’.

Figure 3B.1.1 (j) Above Employment Equilibrium

Price LRAS
Level
Inflationary Full Employment / Natural Rate of
gap SRAS Unemployment
P1
Macroeconomic
Equilibrium
AD
Unemployment Above Full Employment
Range Range

0 QE Q3 Real GDP

In this situation, the actual level of Real GDP, 0Q3, is greater than the level of
potential Real GDP, 0QE, at price level P1.

Thus, the economy is operating in the above full employment zone. An inflationary
gap exists. This cannot exist in the long run.

113
As a result, we can see that the following macroeconomic objectives are being
achieved:

(a) Economic Growth.

(b) Economic Development. This depends on whether resources from (a) are
directed in this area.
(c) Full employment.

Because an inflationary gap exists, we can say that the macroeconomic objective of
price stability is not being achieved.

Without additional information it is difficult to comment on whether the other

macroeconomic objective of external equilibrium is being achieved.

With regard to external equilibrium, we can say that the Balance of Payments on
Current Account is likely to worsen due to domestic inflationary pressures. Domestic
goods and services will now be less competitively internationally. As a result, X’s are
likely to decline and M’s (which will become relatively cheaper) are likely to
increase.

This is less than an ideal/satisfactory situation and of concern to economists, and the
government and Central Bank.

SUMMARY SO FAR

From the above, we can see why it is important to continually ask yourself three
questions:

(a) Where is the economy operating now?

By examining a few key relevant statistics on the economy-in particular, the rate
of unemployment-you can quickly determine where the economy is operating.

Which of diagrams (h), (i) or (j) above is relevant? This is your starting point.

(b) Ideally, where do you want the economy to operate?

Having determined the answer to (a) above, you can then easily identify where
you want the economy to be/end up in an ideal world. This is diagram showing
Full Employment Equilibrium (h). Now you have your second diagram.

(c) What policy areas can be used to achieve (b), where SRAS =AD =LRAS?

Now you are in a position to present, analyse and evaluate various policy areas
that can be utilized to shift one or both of the SRAS and AD Curves.

These policy areas are in covered later Sections.

More detailed coverage of the relevant economic theories, their application, analysis
and interpretation is provided in later Sections of the book.

114
3B.1.2 MACROECONOMIC OBJECTIVE OF ECONOMIC DEVELOPMENT

Economic Development occurs when a country has an increase in Real GDP per
Capita plus an improvement in the standard of living (SOL) of its citizens. It is one of
the five macroeconomic objectives.

An improvement in SOL includes:

• Better education-primary, secondary and tertiary. Greater access for females. An

increase in the level of literacy.

• An improvement in the necessities of life-food, housing, clothing, education,

health, basic services and so on.

• Improved health care-an increase in doctors, hospitals and dentists. The reduction
and/or removal of life-threatening diseases such as AIDS.

• Improvements in infrastructure-such as roads, airports, communications- that are

more accessible to the majority of citizens.

Statistics for the above are known as Development Indicators. These include
measures such as literacy, malnutrition and the poverty level that indicate a country’s
level of economic development.

PPF and Economic Development

In Figure 3B.1.2 (a) luxury goods and services is shown on the vertical axis and
necessities on the horizontal axis.

PPF1 shows the existing situation before an increase in economic development.

Figure 3B.1.2 (a): Production Possibility Model: Economic Development

Luxury
Goods
And
Services

PPF2

PPF1

0 Necessities

Economic development as described above is now shown in the PPF model as an

outward shift in the PPF Curve from PPF1 to PPF 2. That is, society is now producing
more of both necessities and luxury goods and services but relatively more
necessities.

115
Economic Growth with and without Economic Development

A country can achieve economic growth on its own.

A country can achieve economic growth with economic development.

A country can achieve economic growth without economic development.

116
3B.1.3 MACROECONOMIC OBJECTIVE OF FULL EMPLOYMENT

Full Employment exists when the labour market clears allowing for frictional,
structural, and seasonal unemployment. Also known as the natural rate of
unemployment. It is one of the five major macroeconomic objectives.

Unemployment: Introductory Notes

1. Achieving Full Employment or the Natural Rate of Unemployment in the

Long Run is a Macroeconomic objective. One of 5 macroeconomic objectives.

2. Having a high level of Unemployment, therefore, is not good-economically,

socially or politically for an economy.

3. The rate of unemployment is considered one of the most important measures

of how healthy an economy is.

4. This chapter examines various issues associated with unemployment.

Definition of Unemployment Rate

A country’s unemployment rate is defined as the number of unemployed expressed

as a percentage of the labour force.

Formula is:

No of Unemployed x 100 = Unemployment Rate

Labour force 1

It is the number of adult workers who are seeking jobs.

As a guide, an ‘acceptable’ unemployment rate = 4% to 5%.

Overview of the Two Major Types of Unemployment

1. Equilibrium Unemployment 2. Disequilibrium Unemployment

3 Causes 2 Causes

- Frictional Unemployment - Real-Wage or Classical Unemployment

- Structural Unemployment - Demand-Deficient or Cyclical Unemployment
- Seasonal Unemployment

Now let us examine each of the above Types and the relevant Causes in turn.

117
Two Major Types of Unemployment

1. Equilibrium Unemployment or Natural Unemployment

Some natural unemployment will always exist in an economy. The natural rate of
unemployment includes three causes: frictional unemployment, structural
unemployment and seasonal unemployment.

We will cover these three causes of unemployment shortly. They are all included in
the economist’s definition of Equilibrium Unemployment, also referred to as the
Natural Rate of Unemployment. The reason for this is that for an economy to operate
efficiently and effectively, a natural rate of unemployment is considered healthy.

Graphically, this unemployment state is shown in Figure 3B.1.3 (a). The average real
wage rate is graphed on the vertical axis; the number of workers, on the horizontal
axis.

Now we plot the Aggregate Demand for Labour (ADL): this slopes downwards
because at higher wages rates firms will demand/use less labour.

The Aggregate Supply of Labour (ASL): this slopes upwards because at higher wages
rates more labour will supply/offer their services.

Figure 3B.1.3 (a): Equilibrium Unemployment

or Natural Unemployment

Average
Real ASL Total Labour Force
Wage
Rate

A B
We
ADL

0 QE Q1 Number of Workers

The above figure shows the total demand and supply of labour, and equilibrium
occurs where ASL = ADL at a real wage of We.

The Total Labour Force line represents the total labour force. This includes the three
causes of Equilibrium Unemployment: frictional, seasonal and structural, also known
as the Natural Rate of Unemployment.

At equilibrium point A, there is, consequently, natural unemployment of AB.

118
Types of Equilibrium Unemployment by Cause:

1. Frictional (Search) Unemployment.

People entering, or re-entering, the labour force and other people switching
jobs.

2. Structural Unemployment:

Unemployment resulting from fundamental changes in the structure of the

economy-e.g. may be due to technological changes. Occupational and
geographic immobility make it worse.

3. Seasonal Unemployment:

Some occupations are weather dependent-e.g. agricultural industries

Measure to deal with Equilibrium Unemployment

1. Frictional Unemployment:

Improve the flow of information between employers and job seekers. Reduce
unemployment benefits.

2. Structural Unemployment:

Market orientated approach. Encourage workers to leave the depressed region, help
retrain workers and perhaps decrease benefits to encourage mobility (move workers to
the work).

Interventionist approach. Government develops direct action to bring jobs to the

region through tax concessions, grants and retraining schemes (work to the workers).

3. Seasonal Unemployment:

Similar to 2 above.

2. Disequilibrium Unemployment

Occurs when the labour market is not in equilibrium due to classical (or real wage)
unemployment and demand-deficient or cyclical unemployment.

There are 2 causes of disequilibrium unemployment:

2.1 Real-Wage or Classical Unemployment

2.2 Demand-Deficient or Cyclical Unemployment:

119
Types of Disequilibrium Unemployment by Cause:

2.1 Real-Wage or Classical Unemployment

Graphically, this unemployment state is shown in Figure 3B.1.3 (b).

The average real wage rate is graphed on the vertical axis; the number of workers, on
the horizontal axis.

Now we plot the Aggregate Demand for Labour (ADL) and the Aggregate Supply of
Labour (ASL).

Figure 3B.1.3 (b): Real-Wage or Classical Unemployment

Average
Real ASL
Wage
Rate
W1 Above Equilibrium Wage Rate

Equilibrium Wage Rate

We
ADL

0 Q2 QE Q1 Number of Workers

The above figure shows the total demand and supply of labour, and equilibrium
occurs where ASL = ADL at the Average Real Wage Rate, We, and Number of
Workers, 0QE.

Then, due to the action of the Unions and/or government minimum wages legislation,
an Above Equilibrium Wage Rate of W1 is established.

In the above figure, the Average Real Wage, W1, is above the equilibrium level. ADL
falls to OQ2. ASL increases to OQ1.

Q2-Q1 is the level of Disequilibrium Unemployment. This is in addition to

Equilibrium Unemployment/the Natural Rate of Unemployment.

2.2. Demand-Deficient or Cyclical Unemployment:

A feature of every economy is that they go through business cycles: fluctuations of

vicissitudes in economic activity. Hence the word ‘Cyclical’ in the definition.

This type of disequilibrium employment is mainly due to a fall in Aggregate Demand

(AD), resulting in a fall in the demand for labour.

120
Note that it is the decline in AD that results in a fall in the demand for labour. As we
have seen earlier, AD = C + I + G + X - M.

So if any one of the components of AD declines (C, I, G, X) or M increases, then first

there will be a decline in AD followed by a resultant increase in demand-deficient
unemployment.

A second causal factor is that as labour markets do not work smoothly, labour resists
the wage cuts and consequently demand-deficient unemployment occurs.

Diagrammatically, it is important to examine the above problem from two

perspectives: first, the decrease in AD; second, the resultant decrease in ADL.

Decrease in Aggregate Demand

The Price Level is shown on the vertical axis, Real GDP on the horizontal axis. The
SRAS and the AD1 curves are plotted on the diagram.

Before the decrease in AD, macroeconomic equilibrium was where the SRAS and
AD1 curves intersect. The Price Level is P1: Real GDP equals 0QE. See Figure
3B.1.3 (c).

Figure 3B.1.3 (c): Decrease in Aggregate Demand

Price Level SRAS

P1

P2

AD1
AD2

0 Q1 QE Real GDP

Because of a decrease in AD, the AD curve shifts to the left from AD1 to AD2.

Macroeconomic equilibrium now = SRAS =AD2. The Price Level has declined from
P1 to P2. Real GDP has declined from 0QE to 0Q1.

The decline in Real GDP will result in an increase in unemployment because total
output has declined and, consequently, firms do not need as many workers.

Note:
1. The decline in the Price Level has reduced inflationary pressures. This is good for
the macroeconomic objective of Price Stability. The decrease in inflation means that

121
the price of the country’s Exports decline. This will assist Exports and, in turn, be
good for the macroeconomic objective of External Equilibrium.

2. However, the decline in Real GDP is bad for the macroeconomic objectives of
Economic Growth, Economic Development and Full Employment.

3. The macroeconomic objective of External Equilibrium may be negatively affected

based on the decline in AD generated within the economy. This will be offset by Point
1.
Decrease in Aggregate Demand For Labour (ADL)

The decline in AD will lead to a decline in the ADL.

Prior to the decrease in AD, the labour market was in equilibrium where
ADL1 = ASL at Average Real Wage Rate, We. See Figure 3B.1.3 (d).

Figure 3B.1.3 (d): Decrease in Aggregate Demand for Labour

Average
Real ASL
Wage
Rate

Equilibrium Wage Rate

We
W1 ADL1

ADL2

0 Q1 QE Number of Workers

In above figure, the fall in AD results in the demand for labour falling. There is a shift
to the left in the ADL curve from ADL1 to ADL2. Real wages do not fall from WE to
W1 quickly enough, hence disequilibrium unemployment Q1-QE results.

Measures to deal with Disequilibrium Unemployment

Classical Unemployment

Given that the source of the problem is market restrictions, then the solution lies in
removing them.

Through legislation, remove all the restrictions and make the market work. For
example, reduce the minimum wage level. And/or, reduce the power of Unions.

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Other solutions lie in removing or reducing the payment of social security benefits to
encourage people to work at the ‘acceptable’ wage level. This would lower the
opportunity cost of not working.

Demand-Deficient Unemployment

As we know that Disequilibrium Unemployment exists, then we also know that

macroeconomic equilibrium, where AD = SRAS, must be to the left of Full
Employment Equilibrium (LRAS).

Figure 3B.1.3 (e) shows this existing situation. Actual Real GDP = 0Q1. Potential
Real GDP is less, at 0QE. Unemployment and a recessionary gap exist.

Figure 3B.1.3 (e): Economy With Disequilibrium Unemployment

LRAS Full Employment Equilibrium

Price
Level
SRAS1

P1 Macroeconomic equilibrium

Recessionary Gap

Under F.E. AD1

0 Q1 QE Real GDP

In an ideal world, the objective is to achieve SRAS =AD =LRAS.

The Government can use Fiscal and/or Monetary Policies to increase Aggregate
Demand (AD), thus increasing demand for jobs.

Remember AD = C + I + G + X – M.

Fiscal Policy refers to the government’s policy on taxation (direct and indirect),
government expenditure and transfer payments and their affect on aggregate demand
and aggregate supply.

The government uses fiscal polices to increase some/all of the components of AD:

Increase in C: reduction in personal, indirect and company taxes.

Increase in I: reduction in company taxes, indirect and personal taxes.

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Increase in G: increase in government spending.

Increase in X: provision of tax and other financial incentives to exporters.

Reduction in M: imposition of penalties on importers through forms of protectionism.

Such measure will stimulate C, I, G and X, and provide disincentives to M.

Combined, all other factors held constant, AD should increase.

Monetary Policy refers to changes in the money supply and interest rates to affect
aggregate demand and aggregate supply. In most countries, these policy decisions are
made by the Central Bank.

In some countries, such as China, Myanmar and North Korea, these policy decisions
are made by the government; consequently, governments control monetary policy and
fiscal policy, which is not at good situation.

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3B.1.4 MACROECONOMIC OBJECTIVE OF PRICE STABILITY

Macroeconomic Objective of Price Stability

Price Stability is one the five key macroeconomic objectives. It is used as an

indicator of the economic health of an economy. Price stability impacts on the other
four macroeconomic objectives.

The level of the Inflation rate in a country is used as the measurement of price
stability.

Introductory Notes

1. Achieving Price Stability is a Macroeconomic objective. One of 5

macroeconomic objectives.

2. Having a high level of Inflation, therefore, is not good-economically, socially

or politically-for an economy.

3. The rate of Inflation is considered one of the most important measures of

how healthy an economy is.

4. This chapter examines various issues associated with Price Stability.

Definition of Inflation and Price Stability

Inflation is a sustained increase in the general price level. A once only rise in prices
is not regarded as inflation.

Price Stability is when the changes in the average price level are small and don’t
have adverse effects on the economy. As we shall see later, the acceptable level of
inflation rate is referred to as creeping inflation.

Levels of Inflation

For ease of understanding, we will categorize the rate of inflation into three broad
areas:

Creeping Inflation Inflation Hyperinflation

Up to 2%-3% increase p.a. 4%+ to 15% 15%+ to 1,000%+

Acceptable Not acceptable at Definitely not acceptable

Higher end

Economists consider a certain level of inflation as necessary and good for an

economy. This rate of inflation is defined as Creeping Inflation.

Creeping Inflation means a low rate of inflation; say 2% to 3%-e.g. Australia 2002-
2005, Switzerland in 2004 and 2005.

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All other levels of inflation are not good for an economy, especially
Hyperinflation.

Hyperinflation means a very high rate of inflation-e.g. Brazil in 1993 = 1,200%.

Two Major Causes of Inflation

Price Stability exists when there is neither inflation nor deflation, when AD and
SRAS are in equilibrium.

There are two major causes of inflation:

1. Demand-Pull Inflation: Caused by a persistent shift in AD to the right.

2. Cost-Push Inflation: Caused by a persistent shift in SRAS to the left.

Demand-Pull Inflation:

This is caused by persistent shifts of the AD curve to the right.

Figure 3B.1.4 (a) shows a SRAS and AD model. The Price Level is on the vertical
axis; Real GDP is on the horizontal axis.

Figure 3B.1.4 (a) Demand-Pull Inflation

Price
Level SRAS

P2
P1

AD2
AD1
0 Q1 Q2 Real GDP

The AD Curve shifts to the right, from AD1 to AD2. As a result, Real GDP increases
from 0Q1 to 0Q2. The Price Level increases from P1 to P2.

Note:

1. The increase in the Price Level, caused by demand-pull inflation, is inflationary.

Thus, the macroeconomic objective of Price Stability is affected.

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2. The increase in Real GDP results in an increase in Economic Growth. This increase
in growth can fund an improvement in Economic Development. The increase in Real
GDP results in a decrease in unemployment. Three of the five macroeconomic
objectives are improved.

3. Demand-Pull Inflation will negatively affect the macroeconomic objective of

External Equilibrium. An increase in domestic prices will mean that export prices will
increase and exports will be less competitive internationally. In addition, as import
prices become relatively cheaper, imports increase.

There must be a sustained increase in AD for inflation to continue.

Two major Causes of Demand-Pull Inflation

What causes the increase in AD? Answer:

(a) An increase in one or more of the components of AD e.g. C, I, G, X-M

(b) An increase in the money supply. Economists who believe this are
called monetarists. (Note: not all economists believe this theory).

Measures To Deal with Demand-Pull Inflation

The solutions lie in understanding the causes and taking appropriate steps to rectify
them.

Solutions to Cause # 1: Change in the Components of AD

AD = C + I + G + X – M

Therefore, changes in Fiscal Policies and Monetary Policies are required.

Using Fiscal Policy for example, the Government could:

Decrease C: increase personal and indirect taxes, company taxes.

Decrease I: increase company taxes and reduce government incentives.

Decrease G: reduce government spending.

Decease X: reduce export incentives.

Increase M: provide incentives to importers; reduce levels of protection.

Solutions to Cause # 2: reduce the money supply

Using Monetary Policy for example, the Central Bank could decrease the money
supply. This would raise interest rates and impose higher costs on all sectors of the
economy.

The components of AD- C, I, G, X – M would all be affected.

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Cost-Push Inflation

Cost-Push Inflation is caused by a persistent shift in the SRAS Curve to the left,
resulting from increases in the firms’ costs.

What caused an increase in the firms’ costs? Answer: one or a combination of the
following factors.

(a) Wage-push inflation. Higher demand for, and payment of, wages. This
could result from Labour Union demands.

(b) Profit-push inflation. A firm using its monopoly power to increase

prices and profits independently of consumer demand.

(c) Import-price-push inflation. Where the price of imports increase

independently of aggregate demand. For example, the 2005 major
increase in oil prices.

(d) Tax-push inflation. Where taxes are raised causing an increase in

prices of goods and services.

(e) Reduction of finite natural resources. Examples include over-fishing,

deforestation, and the depletion of oil and minerals.

Figure 3B.1.4 (b) shows a SRAS and AD model. The Price Level is on the vertical
axis; Real GDP is on the horizontal axis.

There must be a sustained increase in the firms’ costs for inflation to continue. As a
result, total output falls.

Figure 3B.1.4 (b) Cost-Push Inflation

Price
Level SRAS2

SRAS1

P2

P1

AD1

0 Q2 Q1 Real GDP

The SRAS Curve shifts to the left, from SRAS1 to SRAS2. As a result, Real GDP
decreases from 0Q1 to 0Q2. The Price Level increases from P1 to P2.

128
Note:

1. The increase in the Price Level, caused by cost-push inflation, is inflationary. Thus,
the macroeconomic objective of Price Stability is affected.

2. The decrease in Real GDP results in a decrease in Economic Growth. This decrease
in growth will negatively affect Economic Development. The decrease in Real GDP
results in an increase in unemployment. All of these three of the five macroeconomic
objectives are negatively affected.

3. Cost-Push Inflation will also negatively affect the macroeconomic objective of

External Equilibrium. An increase in domestic prices will mean that export prices will
increase and exports will be less competitive internationally. In addition, as import
prices become relatively cheaper, imports increase.

4. All five macroeconomic objectives are negatively affected by Cost-Push

Inflation.

There is a very important distinction between the effect of Cost-Push Inflation and
Demand-Pull Inflation: the former results in a decrease in Real GDP.

There must be a sustained increase in the SRAS for inflation to continue.

Measures To Deal With Cost-Push Inflation

The solutions lie in understanding the causes and taking appropriate steps to rectify
them. The Government should implement supply-side policies to reduce costs.
Examples follow.

Wage-push inflation. Example is legislation to reduce the power of the Unions.

Profit-push inflation. Anti-monopoly legislation to break-up monopolies.

Import-price-push inflation. Measures to discourage imports.

Tax-push inflation. Reduce company taxes and other business tax costs.

Reduction in finite natural resources. Encourage sustainable development.

Interaction of Demand-Pull & Cost-Push Inflation

It is important to note that both types of inflation may occur at the same time.

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3B.1.5 MACROECONOMIC OBJECTIVE OF EXTERNAL EQUILIBRIUM

Balance of Payments

External Equilibrium is concerned with the balance of payments on current account

of a country. That is, whether it is in balance, surplus or deficit. It is one of the five
major macroeconomic objectives.

The attainment of balance over a period of time is an indication that a country can pay
its way in the world. Persistent BOP on current account deficits-a major problem for
many LDCs-obviously indicates that a country is living beyond its means.

The Balance of Payments (BOP) is a record of the financial transactions of a nation

with all other nations.

The items of receipt and expenditure in the BOP is divided into two main sections:

1. The Current Account.

2. The Capital Account.

1. The Current Account is divided into:

a) Merchandise Trade or Visible/Tangible Items: export and import of

goods; e.g. coal, cars, machinery, computers, agricultural goods etc.

b) Trade in Services or Invisible/Intangible Items: export and import

of services; e.g. education, tourism, films, transport, shipping,
insurance, other services etc.

c) Investment Income Flows: e.g. profits, interest, dividends etc. Both

coming in and going out.

d) Government Grants: Both outflow and inflow. e.g. foreign aid.

e) Private Transfers: e.g. wages and pensions sent home or received

from abroad.

2. The Capital Account is divided into:

a) Capital Inflows and Outflows: both short (e.g. bonds and bank
deposits) and long term (purchase/sale of assets such as companies,
farms etc).

b) Increase or Decrease in Foreign Exchange Reserves.

c) Increase or Decrease in Foreign Aid Assets.

Any Capital Account surplus has to balance the Current Account deficit. The demand
for every dollar has to be matched by an equal supply.

Net Balance of Payment = Current Account balance + Capital Account balance = 0.

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The Current Account generally reflects the economic health of country in the short
term. That is, shows whether a country is paying its way.

Having continual Current Account deficits in the long term is cause for concern.

However, this may not be so in the short term if the country was importing productive
assets (machinery, technology etc) that will, in turn, lead to an increase in exports in
the longer term.

Another example is spending overseas on education. Creates an Outflow in the short

term; leads to increase in GDP in longer term. Examples of countries that are
investing in Human Capital include China and India.

Exchange Rates

An Exchange Rate is the rate at which one currency trades for another on the foreign
exchange markets (FOREX).

An exchange rate is a Price. Students should “treat/view” the currency like any other
goods or service.

Determination of Exchange Rates

In a Floating Exchange System (that is, the rate is allowed to float freely up or down),
the rate of exchange (price) is set solely through the interaction of demand and supply.

Some countries have a Fixed Exchange Rate with certain currencies. Either the
Central Bank or the Government determines the price at which the exchange rate is
fixed. Examples include China: the Yuan rate is currently fixed at US$1.00 to Yuan
8.11, and Saudi Arabia, where the Real rate is currently fixed at US$1.00 to Real 3.75.

Note: Unless otherwise stated in this text, we will assume that the currency is
Floating.

Factors affecting the Demand for the Currency

The following major factors will affect the Demand for the currency.

1. Export of goods/services.
2. Income credits.
3. Capital inflow.

Factors affecting the Supply of the Currency

The following major factors will affect the Supply of the currency.

1. Imports of goods/services.
2. Income debits.
3. Capital Outflow.

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Demand and Supply of a Currency

If Demand (D) > Supply (S), the value of currency ( the price of the currency) will
rise (Appreciation).

If Supply (S) > Demand (D), the value of currency (the price of currency) will fall
(Depreciation).

Although temporary disequilibrium occurs, as with other markets, the normal market
position is equilibrium. That is D = S.

Because of the Laws of Demand and Supply, the Demand Curve for a Currency will
slope downwards and the Supply Curve will slope upwards as shown in Figure
3B.1.5 (a).

In practice, the process of reaching equilibrium on the FOREX is extremely rapid.

Today, it is done electronically, 24 hours a day, 7 days a week, somewhere in the
world.

Figure 3B.1.5 (a) shows the Demand and Supply of a currency. The price of the
currency is shown on the vertical axis; the quantity of the currency on the horizontal
axis.

Figure 3B.1.5 (a): Demand and Supply of a Currency

Price S
of
Currency

P1

0 QE Quantity of Currency

Market equilibrium is where demand and supply curves intersect. Price = P1.
Quantity = 0QE. The market clears.

Key Terms

Unless a government intervenes or a fixed exchange rate exists, the changing forces of
demand and supply will cause the exchange rate to change.

Depreciation is a fall in the price of a currency against other currency/currencies.

Results from a Shift in the Demand and/or Supply Curve.

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Devaluation is depreciation under a regime of fixed exchange rates. Results from
Government action.

Appreciation is a rise in the price of a currency against other currency/currencies.

Results from as Shift in the Demand and/or Supply Curve.

Revaluation is an appreciation under a regime of fixed exchange rates. Results from

Government action.

Note:
1. Depreciation and Appreciation relate to a Floating Exchange rate.

2. Devaluation and Revaluation relate to a Fixed Exchange rate and result from
Government action.

Major Factors Causing the Demand and Supply of a Currency to Appreciate or

Depreciate

1. A Change in Incomes: Examples:

a) Imports (M) are a function of Income (Y). If Domestic National

Income increases it leads to increased demand for Imports. Supply of
currency increases leading to a depreciation of currency.

b) If foreign incomes rise, demand for Exports (X) will increase. The
demand for its currency will increase leading to an appreciation of its
currency.

2. A Change in Relative Prices: Inflation in a country will affect the exchange

rate.

a) As domestic prices of goods/services increases, M become relatively

cheaper and X become relatively dearer. The supply of the currency
will rise and the demand for it will fall. Both will put downward
pressure on the exchange rate i.e. depreciate.

b) As domestic prices of goods/services decreases, M become relatively

dearer and X become relatively cheaper. The demand for the currency
will rise and the supply of it will fall. Both will put upward pressure on
the exchange rate i.e. appreciate.

3. A Change in Relative Investment Prospects.

a) If overseas investors raise their expectations of a higher return on their

capital in a country, then demand for the currency will increase to
enable them to invest. Appreciation.

b) If overseas investors lower their expectations of a lower return on their

capital in a country, then demand for the currency will decrease.
Depreciation.

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 4. A Change in Relative Interest Rates.

a) High interest rates in USA, say relative to Australia, will result in

investors wanting to invest in the USA rather than in Australia.
Increased demand for US dollars. Appreciation of US$.

b) However, in order for a) to happen, the supply of A$ will have to

increase. Depreciation of A$.

c) Speculative activity = approx. 80% of all daily currency transactions.

It is the trading changes that determine long-term exchange rates.

5. Use of Foreign Reserves.

a) Sometimes Governments intervene, using gold and foreign currency

reserves, to create greater stability of their currency.

b) In a floating system, this known as a “dirty float”.

Note: A change in Exchange Rates affects a country’s Terms of Trade (see later
Section). Terms of Trade is the ratio of Average Export Prices to Average Import
Prices. Expressed as an Index. If X prices increase relative to M prices = improvement
in Terms of Trade. And vice-versa.

Shifts in Demand and Supply Curves

The above factors will cause the Demand and Supply Curves to shift.

Example # 1: Increase in Demand for Currency

Prior to the increase in demand, market equilibrium is where demand and supply
curves intersect. Price = P1. Quantity = 0QE. The market clears.

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Figure 3B.1.5 (b) shows what happens when the demand for a currency increases.

Figure 3B.1.5 (b): Increase in Demand for Currency

Price S
of
Currency
P2

P1
D2

D1

0 QE Q1 Quantity of Currency

The increase in demand results in a shift in the demand curve to the right, from D1 to
D2.

The quantity of the currency increases from 0QE to 0Q1. The price of the currency
increases from P1 to P2. Appreciation. The market clears at the new price, P2.

Example # 2: Decrease in Demand for Currency

Prior to the increase in demand, market equilibrium is where demand and supply
curves intersect. Price = P1. Quantity = 0QE. The market clears.

Figure 3B.1.5 (c) shows what happens when the demand for a currency decreases.

Figure 3B.1.5 (c): Decrease in Demand for Currency

Price S
of
Currency
P1

P2
D1

D2

0 Q1 QE Quantity of Currency

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The decrease in demand results in a shift in the demand curve to the left, from D1 to
D2. The quantity of the currency decreases from 0QE to 0Q1. The price of the
currency decreases from P1 to P2. Depreciation. The market clears at the new price,
P2.

Example # 3: Increase in Supply of a Currency

Prior to the increase in demand, market equilibrium is where demand and supply
curves intersect. Price = P1. Quantity = 0QE. The market clears.

Figure 3B.1.5 (d) shows what happens when the supply of a currency increases.

Figure 3B.1.5 (d): Increase in the Supply of a Currency

Price S1
of
Currency
S2

P1

P2

0 QE Q1 Quantity of Currency

The increase in supply results in a shift in the supply curve to the right, from S1 to
S2.

The quantity of the currency increases from 0QE to 0Q1. The price of the currency
decreases from P1 to P2. Depreciation. The market clears at the new price, P2.

Example # 4: Decrease in Supply of a Currency

Prior to the decrease in supply, market equilibrium is where demand and supply
curves intersect. Price = P1. Quantity = 0QE. The market clears.

136
Figure 3B.1.5 (e) shows what happens when the supply of a currency decreases.

Figure 3B.1.5 (e): Decrease in the Supply of a Currency

Price S2
of
Currency
S1

P2

P1

0 Q1 QE Quantity of Currency

The decrease in supply results in a shift in the supply curve to the left, from S1 to S2.

The quantity of the currency decreases from 0QE to 0Q1. The price of the currency
increases from P1 to P2. Appreciation. The market clears at the new price, P2.

Note: Market forces are affecting both the demand and supply at the same time.
Consequently, both curves will shift.

Affects of change in Value of Currency on Balance of Payments

Any change in the value of the currency will impact on the Balance of Payments
(BOP).

Remember that the BOP figure is expressed in a monetary unit. This is arrived at by
Quantity (Q) x Price (P).

Price is influenced by the exchange rate. Any change in the exchange rate will affect
the value shown in the BOP figure.

Depreciation of Currency

Depreciation in the value of the currency will lower the price of exports of the
country. Exports will become more competitive internationally and should increase.

Depreciation in the value of the currency will raise the price of imports of the
country. Imports will become dearer and should decrease.

137
The combined effect is an improvement in the Merchandise Trade Account, Balance
of Trade and in the BOP on Current Account.

Appreciation of Currency

Appreciation in the value of the currency will raise the price of exports of the
country. Exports will become less competitive internationally and should decrease.

Appreciation in the value of the currency will lower the price of imports of the
country. Imports will become cheaper and should increase.

The combined effect is deterioration in the Merchandise Trade Account, Balance of

Trade and in the BOP on Current Account.

(b) Inter-relationship between the Five Macroeconomic Objectives

Understanding the inter-relationship between the five macroeconomic objectives

highlighted throughout this Section is very important.

In summary, any change in one area will influence the other objectives.

A practical help hint, and shortcut, to understanding the inter-relationship is to

examine the following key statistics of a country:

1. Economic Growth: Real GDP per Capita.

2. Economic Development: Real GDP per Capita plus key development

indicators such as absolute poverty level, illiteracy, malnutrition and life
expectancy.

3. Price Stability: The inflation rate.

4. Full Employment: The unemployment rate.

5. External Equilibrium: The Balance of Payments on Current Account and level

of foreign debt.

The above key statistics are the ‘signposts’.

For example, a very high inflation rate (if primarily caused by Cost-Push Inflation) is
often associated with high unemployment and BOP current account problems. If this
is the case, then there will be problems with all 5 macroeconomic objectives: price
stability, full employment, economic growth, economic development and external
equilibrium.

As a useful guide, study a country’s inflation rate and unemployment rates first. Then,
examine other key economic statistics.

138
3C: MACROECONOMICS: MAJOR CHAPTERS

3C.1 SECTIONS

3C.1.1 Five Major Macroeconomic Policy Objectives

Distinction between Macroeconomics and Microeconomics

Microeconomics is concerned with a section, or part, of the economy e.g. the study of
a particular market structures, the behaviour of households or of businesses.

Macroeconomics means the whole economy is studied e.g. the output of all
industries, the total unemployment in the country, the economic growth of the nation
and so on.

5 Major Macroeconomic Policy Objectives

There are five major macroeconomic policy objectives.

1. Economic growth is an increase in Real GDP per capita.

2. Economic development includes economic growth plus an improvement in the

standard of living.

3. Full employment exists when the labour market clears allowing for structural,
seasonal and frictional unemployment. Also know as the natural rate of
unemployment.

4. Price stability is a situation in which the average level of prices is moving

within an acceptable band, usually defined as between 2% to 3% p.a.

5. External equilibrium is concerned with the Balance of Payments on Current

Account of a country. That is, whether it is in balance, surplus or deficit. It is a
reflection of the external health of an economy.

All of the above are closely interrelated. This is the key. Students should understand
how a change in one policy objective would affect all other macroeconomic
objectives.

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3C.1.2 Measuring National Income and Economic Growth

Given that Economic Growth is a major macroeconomic policy objective, the

question arises: how is economic growth measured/calculated?

In most secondary school courses/exams on economics, students are not required or

expected to know the details of how the figures are compiled. However, a general
understanding is important and helpful. This is what follows.

Measuring National Income

National Income is the accepted measurement.

National Income (N.I.) is the sum total of all final goods and services of a country
produced in a year and measured in money terms.

Note the word ‘final’ in the above definition. This means that intermediate goods and
services are excluded. For example, there are thousands of components in a car: these
are not measured twice, only once at the final stage of the completed car.

Also note the words ‘money terms’ in the above definition. This means that the figure
is a Nominal figure. The figure had not been discounted by the inflation rate to arrive
at a Real figure.

The Circular Flow of Income

A “flow” is a measure over a period of time e.g. over a year. National Income is a
“flow’.

A “stock” is a measure at a point in time e.g. the number of students in the class at
this moment.

Wealth is a stock concept, it is the sum total of all things of an economic value at a
point in time.

The wealth of a family might consist of a house, a car etc. The money value of these
added together is family wealth at a particular time e.g. 30th June 2005.

The family income is derived from adding together the flow of income from wages,
rent, interest and profit over a period of time e.g. one year.

There is a connection between the two – people with high incomes often use their
incomes to gather wealth. People can hold their wealth in forms that give income e.g.
shares that give dividends, property for rent income.

A family is a microeconomic unit; these concepts also apply for a macroeconomic

unit, like a country. A country that creates high national income can invest part of it in
wealth creation, like factories, roads etc. This wealth can then help create higher
future incomes.

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National Income – can be shown in a “circular flow of income diagram”. It is a model
of the macro economy. To begin with, we take a simple model, and assume that there
is only two sectors only – households and firms.

Households own and provide the factors of production. Firms provide the goods and
services.

Figure 3C.1.2 (a) Two Sectors: Circular Flow of Income

Factors of Households
Production:
Land
Labour Goods and Services
Capital Firms
Enterprise

Households provide the factors of production. Firms produce the goods and services.

Each of the above resources has a flow and counter-flow. This is shown in Figure
3C.1.2 (b).

Figure 3C.1.2 (b) Two Sectors: Circular Flow of Income:

Households

$ $
Factor Factors Goods and Consumer
Payments: of Services Expenditure
Wages Production
Rent
Interest
Profit
Firms

The above diagram shows the payments for goods and services running from
households as Consumer Expenditure. It also shows payments to the factors of
production as wages, rent, interest and profit running from firms to households.

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Injections and Leakages

Some income earned is not used to buy goods and service from domestic firms; it is
saved, taken as tax by the government, or to buy overseas goods and services known
as imports. See Figure 3C.1.2 (c).

Figure 3C.1.2 (c) Injections and Leakages

Leakages = Savings (S)

Taxes (T)
Imports (M)
Households

Income Consumption
(Y) Expenditure (C)

Firms

Injections = Investment ( I )
Government
Spending (G)
Exports (X)

While households receive Income (Y) from firms, they do not spend it all on
domestically produced goods and services. There are leakages in the form of Savings
(S), Taxes (T) and Imports (M).

Firms receive part of Consumption Expenditure (C) of households. They also receive
other spending flows. These spending flows are known as injections and include
Investment (I), Government Spending (G) and Exports (X).

Major Concepts in National Income Accounting

Now let us move on and expand the model.

National Income, National Expenditure, National Output.

Governments use three ways to measure the money value of all final goods and
services produced in a nation in one year.

These three measures are:

National Output is the money value of all final goods and services produced in a
nation in one year. It is final goods and services, so it does not include intermediate
goods (e.g. steel used in a car).

National Expenditure is the spending on national output.

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National Income is all factor payments (wages, rent, interest, profit) earned from the
factors of production used in producing National Output.

Therefore, National Income = National Output = National Expenditure

These three must be equal by economic definition. There are adjustments to make
sure they are equal.

National Income also has a generic meaning: it is an overall term for the three
measures.

Some Distinctions in National Income Accounting

Gross National Income (GNI) is the value of all output.

Net National Income is the value of all output less depreciation. Depreciation is the
wearing out of capital goods (e.g. machines, buildings).

Gross Domestic Income (GDI) is the sum of the value of all economic activity
within a country. It includes output and incomes generated by foreigners operating in
a country.

Gross National Income (GNI) is the sum of all the value of all economic activity
within a country less output and incomes generated by foreign firms operating in the
country plus Income earned overseas. (i.e.‘net property income to abroad’).

National Income at Factor Cost and National Income at Market Prices

National Income (NI) at market value is the value of final goods and services
(National Output) expressed in money terms.

National Income at factor cost is equal to National Output, minus indirect taxes plus
subsidies.

Nominal National Income and Real National Income

Nominal National Income is national income at current prices.

Real National Income is N.I. for the current year adjusted to take account of
inflation. Also called N.I. at ‘constant prices’.

This enables us to measure the value of output compared to previous year. To see
whether the increase is due to increases in prices or increases in production. The
latter-an increase in production- is the important measure.

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Calculation of National Income

As stated earlier, there are three basis measures. These are:

1. Gross Domestic Product (GDP) by the Expenditure Method

GDP at market prices = C + I + G + X–M, where…

• Consumption Expenditure (C) is spending by individuals and households on

durable goods (those that last more than one year), non-durable goods (e.g. food)
and services.

• Government Expenditure (G) is spending by all levels of government.

• Investments Expenditure (I) includes spending by firms on capital goods plus

changes in stock (inventories) and work in progress (uncompleted goods).

• Exports minus Imports (X-M) include the exports of a country minus its imports.

The formula GDP = C + I + G + X–M can also be expressed as…

AD = C + I + G + X–M, where AD = Aggregate Demand.

Aggregate Demand is the relationship between the aggregate quantities of goods and
services demanded-or Real GDP- and the price level– the GDP Deflator-holding
everything else constant. AD = C + I + G + X-M.

2. GDP by the Income Method

Factors of Production Income

Labour Wages
Land Rent
Capital Interest
Entrepreneurship Profit

Income for self-employment can include both wages and profits.

Stock appreciation is the increase in the price of stock. This is deducted.

3. GDP by the Output Method

The value of output from each industry is added. Final output only, not intermediate
goods and services, to avoid double counting.

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Summary of Methods 1-3:

GDP by all three methods equals the same figure. It must by definition. Any
adjustments are called “statistical error”.

Calculating Real GDP from Nominal GDP

The nominal GDP is reduced by the amount of the price increase-that is, inflation.
The nominal figure has to be deflated by the price increase; the price increase over
“x” years is know as a deflator.

i.e. Nominal GDP x 100_______ = Real GDP

1 100 + % price increase

Measuring Economic Growth

These are:

Real GDP per Capita

and/or,

Real GNI per Capita

The two summary statistics are inter-changeable.

For our purposes the following definition is used.

Economic Growth is an increase in a country’s Real GDP per capita. It is one of the
five major macroeconomic objectives.

As you will see from the Class Exercises and Assignments, economists use two
summary statistics as a measure of economic growth.

Consideration of Uses and Limitations of National Income Accounts

Uses of N.I. Accounts:

1. Forecasting changes in the economy. The forecasts are often used

in planning.

2. Testing hypothesis – N.I. provides data that can be used to test

hypotheses.

3. Comparison of economic performance over time and between

countries.

4. To make judgements about economic welfare. Often increases in

NI means there will be improved standard of living. (S.O.L.)

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Problems with N.I. Figures

1. GDP per head and SOL

(a) It is not a complete measure of SOL. Other measures are needed to get a good
indication of SOL e.g. education levels achieved, number of doctors per
person etc.

(b) Distribution of income is not reflected in the GDP per head. It is an average
figure and there may be a very unequal distribution of income in a country.
For example, the USA has the highest per capita income in the world but in
some groups there is a great deal of relative poverty.

2. GDP figures do not take into account productive activity that is not paid for
(marketed) e.g. persons doing house duties. Nor does it count the ‘underground
economy’ or black market economy.

3. The composition of output is not revealed – a country may produce a lot of

military goods as part of its GDP and few consumer goods. As well, there may be
very few capital goods; this would mean there would be less production in the
future.

4. The quality of goods is not measured. Improvements in goods produced have been
significant.

In spite of the weaknesses mentioned above, Real GDP per capita is still the best
single indicator of SOL.

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3C.1.3 Introduction to Economic Development

Distinction Between Economic Growth and Economic Development

Economic Growth is an increase in Real GDP per Capita. This is an increase in a

country’s total output (production) over time per head of population.

Economic Development includes an increase in Economic Growth plus tangible and

intangible improvements in the standard of living (S.O.L.).

Economic growth is important for economic development. If there is an increase in

national output the S.O.L. is usually better and poverty is reduced. But this not always
the case.

‘Trickle-Down’ Effect

Less Developed Countries (LDCs) often pursue economic growth vigorously

believing there will be a ‘trickle-down effect’. That increased creation of wealth
amongst a few would lead to benefits over time for all. This is not necessarily true.

Use of Production Possibility Model

Economic Growth is an increase in Real GDP per Capita.

A Production Possibility Model is a useful tool in understanding this. See Figure

3C.1.3 (a).

In this simplified model of reality, three assumptions are made: that the economy
can…

• Only produce two types of goods-manufactured goods and agricultural goods.

• Resources are held constant.
• Technology is held constant.

Note: later we will change the above three assumptions as they are unrealistic.

Figure 3C.1.3. (a): Production Possibility Model: Actual Growth

Manufactured
Goods B
C F

D
A

0 Agricultural Goods

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B to E is attainable and efficient.

A move from D to C involves an opportunity cost in agricultural goods.

F is unattainable; the country cannot produce this combination of goods, given

assumptions.

A move from A to C would increase output. This is described as an increase in

actual output.

Now we modify the model to examine an increase in potential economic growth. See
Figure 3C.1.3. (b).

Figure 3C.1.3 (b): Production Possibility Model: Potential Growth

Manufactured
Goods

PPF1 PPF2

0 Agricultural Goods

When whole PPF shifts to the right, from PPF1 to PPF2, this is an increase in
potential output.

This could be achieved if more resources or better technology were available.

Whereas, a move from A to C in the previous diagram would increase actual output.

In this section we are studying how to increase potential output.

An Increase in Real GDP and GDP Per Capita

As GDP may also increase due to price inflation, the money GDP figure is adjusted to
arrive at Real GDP.
Year 1 GDP Year 2 GDP
$100m $110m = $10m x 100 = 10% inc.
$100m 1

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If inflation was at 5.5% during this year then 55% of the increased GDP is due to
price increases. So only 4.5%, or 45%, is due to real growth (10% - 5.5% = 4.5%).

If the population is growing at 2% then the increase in real output per head is:
4.5% - 2% = 2.5%.

Economic Growth is the increase in Real GDP per capita, over a certain period,
usually one year.

Note. If GDP figure given does not state whether it is nominal or Real GDP, then
assume and state in your answer that you assume that it is a nominal figure.

The Significance of the Growth Rate

• If GDP increases by 1% per year it will double in 72 years, 2% in 36 years and so

on.

• The two parts of GDP per head, namely GDP and population, are of major
importance.

• More growth enables higher levels of production and consumption.

• If there are more good and services it is possible to reduce poverty by improving
nutrition, health care or literacy and so development has occurred as well as
growth.

Economic Growth with and without Economic Development

Now we will bring the above information together to examine economic growth with
and without economic development.

Figure 3C.1.3 (c) shows economic growth with economic development. Growth has
gone toward producing goods and services used by the poor like food, basic clothing,
education etc.

PPF1 shows the existing situation where the economy is producing a combination of
luxury goods and services plus necessities.

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 Figure 3C.1.3 (c): Production Possibility Model:
Economic Growth with Economic Development

Luxury
Goods
And
Services

PPF1 PPF2

0 Necessities

A shift in the PPF, from PPF 1 to PPF2, demonstrates economic growth as potential
output has increased. But, more importantly, the economy has increased its output of
necessities at a greater rate than luxury goods and services that is an achievement of
an increase in economic development.

Figure 3C.1.3 (d) shows economic growth without economic development. The
benefits have all gone to the rich; an unequal distribution of income exists and then
the production mix will reflect their demand for luxury goods.

Figure 3C.1.3 (d): Production Possibility Model:

Economic Growth without Major Economic Development

Luxury
Goods
And
Services

PPF1 PPF2

0 Necessities

PPF1 shows the existing situation where the economy is producing a combination of
luxury goods and services plus necessities.

A shift in the PPF, from PPF 1 to PPF2, demonstrates economic growth as potential
output has increased. But the economy has increased its output of luxury goods and

150
services at a greater rate than necessities. This demonstrates an achievement of an
increase in economic growth without a major increase in economic development.

Economic Development

• Development involves value (normative) judgments being made. For example, a

city airport is of benefit to travellers but a source of noise pollution to its
neighbours.

• However, there is agreement amongst economists about what to include in a

measure of development. These include sufficient food, adequate shelter, and
health care, employment, low infant mortality, freedom from aggression and fear,
self-respect and dignity.

• The growth of income forms an important part of any study of development.

• Development is a broad multi-dimensional concept, which includes economic

growth- defined as Real GDP per capita- plus other economic measures to
improve one S.O.L. This is key.

• It is possible to have economic growth without development. For example,

economic growth might benefit a small rich sector of society.

• The increased prosperity of the country is expected to ‘trickle down’ from the rich
to the poor, raising the overall standard of living. Often, it does not.

• So many poor countries concentrated their efforts on a few criteria only, like
investment and GDP.

• However, this focus usually hasn’t improved the lot of the poor; their poverty
hasn’t decreased and the gap between the rich and the poor hasn’t decreased.

• One definition of development is ‘the reduction and elimination of poverty,

inequality and unemployment within a growing economy’. There also are other
definitions of economic development.

Characteristics of Economic Growth

Variations in Long Run Growth Rates

Differences in growth rates do not necessarily mean that one nations growth is greater
than other nations. There are two considerations that must be kept in mind.

(i) It is statistically easier to achieve a high rate of growth in a poor economy than
a rich one. This is because the base dollar figure is small. A small percentage
increase in the huge GDP of the USA, for example, represents a large increase
in production whereas a large percentage increase in the GDP of a tiny Pacific
Island nation does not.

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(ii) Increases in economic growth need to be weighed against population
increases. Many poor countries have fast rates of population growth so their
GDP per head may be less than if they had rates of population growth like
developed countries.

Warning: The message above is clear: be careful when interpreting figures/data.

Changes Generally Associated with Economic Growth

Changes in Economic Structure

There is a clear relationship between the level of a country’s income and the structure
of its production. Poor countries tend to have a high proportion of production in the
primary sector. Income rises as it moves to the secondary and tertiary sectors.

Features of the primary sector:

* Low productivity. High percentages of the populations of LDCs live and work in the
rural sector. Subsistence agriculture is a feature of many LDCs.

* Primary products also form the basis of the majority of exports from LDCs.

* The percentage of primary goods of world exports is falling.

* For output to grow there must be an increase in the quantity and/or quality or
resources used in production. For example, the development of Human Capital.

* There must also be appropriate attitudes of the people in a country. Often this
requires changes in peoples’ customs and social behaviour before an economic change
can take place.

Characteristics of the Growth Process in the already Developed Countries

Professor Simon Kuznets identified the following characteristics that require

examination:

• GDP growth.
• GDP per capita growth.
• Population growth.
• Productivity growth.
• Structural transformation.
• International trade.
• Social and ideological change.

152
Since the industrial revolution:

* Huge gains in output have been based on increases in productivity, based on

improved technology and better human skills-development of Human Capital.

* There have been structural changes from primary to tertiary production.

* International trade has grown remarkably.

* There have been dramatic changes in beliefs, ideologies and institutions. Traditional
beliefs have been replaced by scientific. Most important, if an economy is to achieve
economic development. Critical area.

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3C.1.4 Macroeconomic Models

A model is a simplification of reality.

In Economics models are used to help in the understanding of complex economic

issues. In this section we study the Aggregate Demand/Aggregate Supply Model
(AD/AS model).

This is part of macroeconomics, a study of the whole economy. Microeconomics is

the study of parts of an economy; e.g. demand for a good by a household.

Aggregate Demand (AD) is the sum total of all final goods and services purchased
in the economy.

The formula for AD is: AD = C + I + G + X-M

Aggregate Demand is related to the price level. A rise in the price level usually
results in a fall in AD. A fall in the price level usually results in an increase in AD.

It is shown on an AD curve that slopes down from left to right.

The price level is an average of all prices, measured by an index of prices.

Derivation of the AD Curve

Aggregate Demand is the total planned spending by all sectors for all final goods and
services in the market. This figure is known as National Income. It can be measured in
3 separate ways: National Income (NI), National Output (NO) and National
Expenditure (NE).

For the model, we use NE. We measure the sum of planned expenditure of all sectors
in the economy; that is Aggregate Demand (AD).

The formula is: AD = C + I + G + X-M, where:

AD = Aggregate Demand
C = Consumption Expenditure
I = Investment Expenditure
G = Government Expenditure
X = Exports.
M = Imports.

As we are relating the Total Output of goods and services to changes in the price level
we must use the Real National Income or the Real GDP figure. That is, nominal
GNI/GDP has been deflated by the inflation rate.

154
The AD Curve slopes downwards to the right. See Figure 3C.1.4. (a)

Figure 3C.1.4 (a): Aggregate Demand Curve

Price
Level

AD

0 Real GDP

Note:
1. A change in the price level results in a movement along the AD Curve.
2. Factors causing a shift in the AD Curve will be examined later.

Two Major Reasons Why the AD Curve Slopes Down to the Right:

1. Income Effect: If the price level increases it will lead to a decline in Real Income.
Therefore, AD decrease. As a result, people may need to save more or borrow more.

Note: The price level and AD are inversely related.

2. Substitution Effect: An increase in the Price level will result in consumers

purchase cheaper substitutes. If all the prices in the domestic economy rise, that is the
general price level rises, consumers may purchase from abroad resulting in an
increase M’s.

Three reasons why substitution effect operates:

(a) Net Export Effect

If domestic prices are rising relative to other countries-as measured by the rate of
inflation- then other countries will find an alternative country to buy goods and
services from. An increase in domestic prices will be reflected in an increase in
export prices. All other factors held constant, this means exports from the
country where inflation is increasing at a faster rate that it trading
competitors will fall.

At the same time, imports become relatively cheaper. All other factors held
constant, domestic consumers would buy cheaper foreign substitute goods and
services instead of domestic goods and services. As a result, imports will
increase.

X’s and M’s are two key components of AD.

155
 The net effect is summarized as follows:

General Price Level↑→X↓ and M↑→∴AD↓

(b) The Real Balance Effect

When prices rise, real bank balances fall. To maintain the real value of these bank
balances, consumers will increase their savings. In addition, their spending on
goods and services will be reduced.

For example, if Stephen saves $20,000 for 5 years in order to buy a Ferrari but
finds that the price has risen from $100,000 to $120,000 he must save $20,000
more and so spends less.

This would be true for all consumers if the general price level has risen so AD
will fall as prices rise.

This is summarized as:

General Price level↑→Value of bank balances↓→savings↑→spending↓→AD↓.

(c)The Interest Rate Effect

The majority of consumers borrow money: from the banks, via credit card
purchases, through finance companies. If prices rise, and if consumers wish to
maintain their levels of spending, they have to borrow more. This will lead to
increased competition for the funds the banks have to lend. This, in turn, will lead
to an increase in interest rates.

For firms, they too borrow money to finance their business. The interest paid is a
cost of doing business. If interest rates rise, business costs increase and profits will
decrease. As a result, the level of investment undertaken by firms will decrease.

If interest rates rise, firms and consumers will borrow less and spend less, so AD
will fall.

This is summarized as:

General price level↑→to maintain their spending level consumers borrow more
→ rate of interest↑ I↓ and C↓ AD↓

Derivation of the Aggregate Supply Curve

• Aggregate Supply is the total value of all the goods and services that firms plan
to produce.

• Short Run is the period when prices of goods and services rise but factor prices
do not change. Factor prices include the prices of labour (wages) and capital
(interest).

156
 • Long Run is the period when factor prices rise to adjust to price changes in goods
and services.

• AD and AS are equal in all markets in the L.R., including labour demand and
supply.

• There is Full Employment (FE) in the L.R. in the labour market when there is
L.R. equilibrium. It is not zero percentage Unemployment (U.E.) The U.E. that
still exists is ‘the natural rate of unemployment’.

• First, we will examine the Short Run Aggregate Supply (SRAS).

Short-Run Aggregate Supply (SRAS)

SRAS is the relationship between Aggregate Supply (AS) of final goods and services
and the price level, holding all else constant. In this Model, the important assumption
is that factor prices remain constant. See Figure 3C.1.4 (b).

Figure 3C.1.4 (b): Short-Run Aggregate Supply Curve

Price
Level SRAS

Depression Intermediate Physical

Range Range Limit

0 Real GDP

Refer to the above diagram:

Depression Range: The firm will be willing to produce increasing amounts at the
same price. Why? Because factor prices do not increase. For example, there is
unemployment and workers will not demand higher wages, so the firm’s costs will not
increase in this range.

Intermediate Range: It is the normal range in which the economy would operate.
Firms can charge higher prices for their goods and services, without an increase in
factor prices. Their profits would increase, so they produce more goods and services.

Physical limit: there are no more resources available so firms are unable to produce
beyond this amount no matter how much the price level increases. All the resources
are employed. The SRAS Curve is perfectly inelastic.

157
The SRAS Curve in the intermediate range is shown in Figure 3C.1.4 (c).

Figure 3C.1.4 (c): SRAS Curve Intermediate Range

Price
Level SRAS

0 Real GDP

Two reasons why SRAS Curve is upward sloping:

(a) The law of diminishing returns.

(b) The existence of resource, or supply side, bottlenecks. That is, as the economy
moves closer to full employment some of the factors of production are in short
supply – e.g. certain skilled labour.

Long Run Aggregate Supply (LRAS)

Long Run Aggregate Supply (LRAS) is the relationship between real output and the
price level at full employment. Full Employment (FE) includes ‘the natural rate of
unemployment’.

Figure 3C.1.4 (d) shows the levels of production where firms would normally
operate, which is the intersection of the SRAS and the LRAS Curves.

Figure 3C.1.4 (d) Long Run Aggregate Supply Curve

Price LRAS
Level
Full Employment / Natural Rate of
Unemployment
SRAS

Unemployment Full Employment

Range Range

0 Real GDP

158
• LRAS Curve is vertical, at the full employment level of production. Because
factor prices rise for the reasons outlined above, there is no incentive to produce
more because profits will be consumed by the higher costs. In the Short Run factor
costs did not rise so profits generated by price rises were not used up by rising
costs.

• If output increased above the full employment level, decreasing ‘the natural rate of
unemployment’, the shortage of labour forces wages up so that they rise faster
than price rises, profits will fall, firms will cut production and their number of
workers and so unemployment will fall back to the natural rate.

6 Main Factors That Cause a Shift in Aggregate Demand

There are six main factors that cause a shift in the AD Curve. These are:

1. Fiscal policy
2. Monetary Policy
3. Foreign Incomes
4. Currency Exchange Rates
5. Expectations
6. External Shocks

The above factors are examined in the next part of this Section.

A shift in the AD Curve is shown in Figure 3C.1.4 (e).

Figure 3C.1.4 (e): Shift in The Aggregate Demand Curve

Price
Level

AD1

AD0
AD 2
0 Real GDP

A shift in the AD Curve to the right, from AD0 to AD1, shows an increase in Real
GDP.

A shift in the AD Curve to the left, from AD0 to AD2, shows a decrease in Real
GDP.

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3C.1.5 Demand-side and Supply-side Policies

Now let us examine the six factors that cause a shift in the AD Curve.

1. Fiscal Policy (FP)

Fiscal Policy refers to the government’s policy on taxation (T) (direct and indirect),
government expenditure (G) and transfer payments (G) and their affect on aggregate
demand and aggregate supply.

Fiscal Policy involves the government budget. All governments prepare and publish
an annual budget. This lists major items of revenue and expenditure and sets out
government policy in each of these key areas.

Government policy can be used to change AD through changing items in its Budget
like tax (T), government spending (G) and transfer payments (G).

Changes in Fiscal Policy can increase AD and/or decrease AD.

Examples of an increase in AD, where

Yd = disposable income

→ = leads to/results in

↑ = increases

↓ = decreases

If the government reduced income tax → personal income tax↓→Yd↑→C↑→AD↑

If the government increased transfer payments→ G→Yd↑→C↑→AD↑

If the government reduced company tax → company profits↑→ I↑→ AD↑

If the government spends more money on infrastructure like roads or hospitals or on

wages for public servants→ G↑→AD↑

Note: Government fiscal policy can also be used to reduce AD.

2. Monetary Policy (MP)

Monetary Policy (MP) involves changes in the rate of interest rates (i/r) and
money supply (MS). MP in most countries is determined by the Central Bank. It is,
therefore, independent of Fiscal Policy.

160
However, in some countries- such as China, North Korea and Myanmar- MP is
controlled by the Government. This means that the government controls both MP and
FP. This can cause economic problems.

For example if i/r ↓→ the cost of borrowing is cheaper for both households and
firms→ C↑ & I↑→AD↑

Or if MS↑→C↑→AD↑ or

→i/r↓→C↑ & I↑→AD↑

3 Foreign Income Changes

If incomes in other countries, (particularly the country’s major trading

partners)↑→X↑→AD↑

If domestic incomes↑→M↑→AD↓

4. Currency Exchange Rates:

Exchange rate is the price of a currency expressed against another, or group of

currencies, on the foreign exchange market.

Depreciation of currency is the reduction in the value of a domestic currency against

foreign currencies under a regime of floating exchange rates.

Appreciation of currency is an increase in the value of a domestic currency in terms

of other currencies. Occurs as a result of market forces.

If the value of the currency ↓→ the price of exports↓→X↑→AD↑ and

→ the price of imports↑→M↓→AD↑

If the value of the currency↑ → the price of exports↑→X↓→AD↓ and

→ the price of imports↓→M↑→AD↓

5. Expectations

If consumers expect prices to rise, an increase in inflation, they may buy now.
Therefore, → C↑→AD↑

Or if firms are optimistic about future sales it is likely that they will buy more capital
goods →I↑→AD↑

If consumers expect their incomes to rise → C↑→AD↑

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6. External Shocks

If AD increases suddenly, and then falls back again to its original level, is known as
external shock or demand-side shock.

Example: the Earthquake/Tsunami in December 2004.

Note: Can also have External Supply-Side shocks (as above).

7 Main Factors That Cause A Shift In Aggregate Supply

Factors that cause a shift in AS Curve include:

1. A change in the quantity and quality of capital investment.

2. A change in the quantity and quality of labour.
3. Supply side polices of government.
4. Government legislation.
5. Weather.
6. Currency Exchange Rates
7. Supply-side shocks

Note: New Model: factor prices can/do change in the short run.

All of the above affect both LRAS and SRAS.

Changes in factor prices and the weather affect SRAS only.

For example, if factor prices increase then at each price level firms will supply less;
the SRAS will shift to the left. Refer to Figure 3C.1.5 (a).

Figure 3C.1.5 (a): Shift in Short Run Aggregate Supply

Price LRAS
Level
SRAS2

SRAS1

0 Real GDP

This shift of the SRAS curve is different from the movement along the SRAS curve.
A movement occurs when there is a change in the price level.

162
The LRAS is not affected. In the long run, all prices change proportionately so a
change in the price of final goods is matched by proportional changes in factor prices.
So there is no incentive to change the firm’s output. There would be no increase in
profit if output were increased. However, a change in the factors below will cause an
increase/decrease in output.

Factors that affect both LRAS and SRAS (and cause the LRAS/SRAS Curves to
shift)

Other than changes in factor prices and the weather, supply-side changes will shift
both the SRAS and LRAS Curves. Refer to Figure 3C.1.5 (b).

Figure 3C.1.5 (b): Shift in SRAS & LRAS

Price LRAS1 LRAS2

Level

SRAS1 SRAS2

Increase
in AS

0 Q1 Q2 Real GDP

Now let us examine each of the seven factors.

1. Quantity and Quality of Capital Investment

An increase in the amount of capital investment (e.g. more computers or machinery)

will increase the productivity of workers and consequently lead to an increase in
production. Known as Capital Widening.

Productivity is the output per unit of input.

An improvement in the quality of capital (improved technology) also leads to

increased supply. Known as Capital Deepening.

2. Quantity and Quality of Labour

Human Capital is the investment that takes place in the factor of production-labour-
aimed to increase productivity, well-being and job satisfaction. Occurs through the
investment in education and training of people.

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A larger number of workers (labour force) will lead to increased output. For example,
an increase in the labour force will occur if there is increased migration or increased
participation of women in the workforce.

Better training and education will result in a better quality workforce. This, in turn,
will lead to increased productivity and production.

The development of Human Capital is one of the most important factors for a
country to increase is Aggregate Supply.

3. Supply-Side Policies

Supply-side policies and deliberate government action to increase AS. Government

action to increase the quantity and quality of the labour force e.g. more Government
spending on education and training.

4. Changes in Legislation

Changes in laws can affect AS; e.g., changes in the school leaving age can affect the
size of the labour force.

5. Changes in Weather

Production and output of some sectors of the economy are weather-dependent. As a

result, SRAS will be affected.

For example, weather can affect the level of agricultural production. A drought or a
flood can reduce the amount produced in a particular year. However, these are only
temporary changes and shift only SRAS.

Note: Current theory argues that the LRAS curve remains unaffected. Economic
reality suggests otherwise; that is, the LRAS curve shifts.

6. Currency Exchange Rates

AS will be affected by changes in the exchange rates.

If the value of the currency ↓→ the price of exports↓→X↑→AS↑ and

→ the price of imports↑→M↓→AS↑

If the value of the currency↑ → the price of exports↑→X↓→AS↓ and

→ the price of imports↓→M↑→AS↓

7. Supply-Side Shocks

These can be the same as demand-side external shocks, except they affect AS.

For example, international political, social or natural events can affect the output of
firms and governments thus affecting AS. Examples include 9/11, a tsunami, war and
an earthquake. All can cause major disruptions to AS.

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Macroeconomic Equilibrium

Now we bring SRAS and AD together.

Macroeconomic equilibrium occurs where SRAS = AD. Refer to Figure 3C.1.5 (c).

Figure 3C.1.5 (c): Macroeconomic Equilibrium

Price
Level
SRAS

P1 Macroeconomic
Equilibrium

AD

0 Q1 Real GDP

Macroeconomic equilibrium is where SRAS = AD. The price level is P1, and Real
GDP is 0Q1.

Note: as we shall see in the next section, this may or may not coincide with the full
employment level of output as shown by the LRAS Curve.

Macroeconomic Equilibrium and Full Employment

The economy is at full employment when it on the LRAS Curve.

Note: The definition of full employment includes ‘the natural rate of unemployment’.

Macroeconomic equilibrium where AD = SRAS may be equal to, less than, or greater
than, full employment (on the LRAS Curve) Real GDP.

In the ‘perfect/ideal world’, governments and economists strive to achieve a

macroeconomic situation where SRAS =AD =LRAS.

Note: It is important to continually ask yourself three questions:

(d) Where is the economy operating now?

(e) Ideally, where do you want the economy to operate?

(f) What policy areas can be used to achieve (b), where SRAS =AD =LRAS?

165
THREE TYPES OF MACROECONOMIC EQUILIBRIUM

a) Full Employment Equilibrium: Refer to Figure 3C.1.5(d).

Figure 3C.1.5 (d) Full Employment Equilibrium

Price LRAS
Level
Full Employment / Natural Rate of
SRAS Unemployment

P1 Macroeconomic
Equilibrium
AD
Unemployment Above Full Employment
Range Range

0 QE Real GDP

The ‘perfect economy’! Where SRAS = AD = LRAS. Real GDP = 0QE,

Price level = P1.

The economy is operating at full capacity, full employment exists, and Real GDP is
maximized.

b) Unemployment Equilibrium: Refer to Figure 3C.1.5 (e).

The economies of the majority of countries are operating in this range. Where
macroeconomic equilibrium (SRAS = AD) is less than full employment equilibrium
(on LRAS Curve).

Figure 3C.1.5 (e) Unemployment Equilibrium

Price LRAS
Level SRAS
Full Employment / Natural Rate of
Unemployment
P1 Macroeconomic
Equilibrium
Recessionary gap

Unemployment Above AD
Full Employment
Range Range
0 Q1 QE Real GDP

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Actual Real GDP =0Q1.

Potential Real GDP = 0QE.

In this situation, the actual level of Real GDP, 0Q1, is less than the level of potential
Real GDP, 0QE, at price level P1.

Thus, the economy is operating in the unemployment zone. Less than full
employment is achieved. A recessionary gap exists.

As a result, we can see that the following macroeconomic objectives are not being
achieved:

* Economic Growth.
* Economic Development.
* Full employment.

Without additional information it is difficult to comment on whether the other two

macroeconomic objectives-price stability and external equilibrium-are being
achieved.

With regard to external equilibrium, we can say that the Balance of Payments on
Current Account could be improved because the economy is operating below its
potential. That is because actual Real GDP is less than potential Real GDP.

This is less than an ideal/satisfactory situation and of concern to economists, and the
government and Central Bank.

c) Above Full Employment Equilibrium: Refer to Figure 3C.1.5 (f).

Occasionally economies will operate in this zone. They are ‘over-heated’.

Figure 3C.1.5 (f) Above Employment Equilibrium

Price LRAS
Level
Inflationary Full Employment / Natural Rate of
gap SRAS Unemployment
P1
Macroeconomic
Equilibrium
AD
Unemployment Above Full Employment
Range Range

0 QE Q3 Real GDP

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In this situation, the actual level of Real GDP, 0Q3, is greater than the level of
potential Real GDP, 0QE, at price level P1.

Thus, the economy is operating in the above full employment zone. An inflationary
gap exists. This cannot exist in the long run.

As a result, we can see that the following macroeconomic objectives are being
achieved:

* Economic Growth.
* Economic Development. This depends on whether resources from (a) are
directed in this area.
* Full employment.

Because an inflationary gap exists, we can say that the macroeconomic objective of
price stability is not being achieved.

Without additional information it is difficult to comment on whether the other

macroeconomic objective of external equilibrium is being achieved.

With regard to external equilibrium, we can say that the Balance of Payments on
Current Account is likely to worsen due to domestic inflationary pressures. Domestic
goods and services will now be less competitively internationally. As a result, X’s are
likely to decline and M’s (which will become relatively cheaper) are likely to
increase.

This is less than an ideal/satisfactory situation and of concern to economists, and the
government and Central Bank.

SUMMARY SO FAR

From the above, we can see why it is important to continually ask yourself three
questions:

Where is the economy operating now?

By examining a few key relevant statistics on the economy-in particular, the rate
of unemployment-you can quickly determine where the economy is operating.

Which of diagrams above-(d), (e), (f)- is relevant? This is your starting point.

Ideally, where do you want the economy to operate?

Having determined the answer to (a) above, you can then easily identify where
you want the economy to be/end up in an ideal world. This is diagram showing
Full Employment Equilibrium (d). Now you have your second diagram.

What policy areas can be used to achieve (b), where SRAS =AD =LRAS?

Now you are in a position to present, analyse and evaluate various policy areas
that can be utilized to shift one or both of the SRAS and AD Curves.

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 These policy areas have already been briefly covered in this chapter. Review earlier
sections/material.

Six main factors that cause a shift in the AD Curve. These are:

1. Fiscal policy
2. Monetary Policy
3. Foreign Incomes
4. Currency Exchange Rates
5. Expectations
6. External Shocks

Seven main factors cause a shift in the AS Curve. These are:

1. A change in the quantity and quality of capital investment

2. A change in the quantity and quality of labour
3. Supply side polices of government
4. Government legislation
5. Weather
6. Currency Exchange Rates
7. Supply-Side Shocks

More detailed coverage of the relevant economic theories, their application, analysis
and interpretation is provided in later Sections of the book.

Overview of the Keynesian Expenditure Multiplier

These notes have been written to provide students with a basic understanding of this
economic theory/concept.

One of the great insights of the Keynesian macroeconomic model was that an increase
or decrease in AD would cause an even greater change in national income-Real GDP.
This in known as the Multiplier Effect.

k = multiplier

Real GDP changes by the amount of the initial autonomous expenditure change, plus
a further amount of expenditure that is income-dependent.

The autonomous expenditure change = ΔC + ΔI + ΔG + ΔX-ΔM.

A change in any of above components will lead to a further amount of expenditure

that is income-dependent. That is, it will have a multiplier effect.

In most MDCs, the most important component of AD is C. As an example, we will

consider this.

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With a change in Disposable Income (ΔYd), people have 2 choices: they can either
save (MPS), or spend their extra money on consumption (MPC). MPS is a leakage.

With the extra money spent on Consumption, they have 2 choices: they can either
spend their extra Yd on domestic goods/services, or on Imports (M). Spending on
imports is a leakage. Therefore,

MPC = MPC domestic + MPCm

…where:

MPC = Marginal Propensity to Consume = ΔC/ΔY

MPC domestic = Marginal Propensity to Consume domestic goods/services

= ΔC domestic/ΔY

MPCm = Marginal Propensity to Consume Imports (M) = ΔCm/ΔY

Formula: Multiplier = 1
1- MPC domestic

Examples:

Assume MPC domestic = 0.8, then k = 5

Assume MPC domestic = 0.2, then k =1.22

Conclusion: The higher the value of MPC domestic, the greater the increase in
Real GDP.

Note that the multiplier can also work in reverse. That is, if there is a decline
MPC domestic then there will be a greater decrease in national income.

It is also important to note that any change in the components of AD will lead to a
multiplier effect.

The Multiplier-Accelerator Model

This model focuses on how changes in income can cause accelerated changes in
investment spending (I).

All firms extrapolate their sales to determine investment decisions. That is, to decide
their level of spending on capital goods. If projected sales are increasing, then an
accelerated rate of investment is required to meet future demand.

Note that the accelerator will not work when there is unemployment because demand
can be met with existing capital investment.

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Fiscal Policies and the Multiplier

Given that the autonomous expenditure change = ΔC + ΔI + ΔG + ΔX-ΔM, a change

in any of above components will lead to a further amount of expenditure that is
income-dependent. That is, it will have a multiplier effect.

Fiscal Policies can, therefore, influence the multiplier. For example, if the economy is
in a recession, the Government can introduce fiscal policies to increase C, G, I and X-
M. The Government can reduce taxation, increase transfer payment, provide tax
concessions for exporters and impose sanctions on imports.

In times when the economy is ‘over-heated’, the Government can reverse the above
policies to reduce the components of AD.

Note that for some countries, such as LDCs, exports is the key component. This is
also true for countries such as Taiwan, Singapore and Hong Kong. In these cases,
fiscal policies would target exports.

Does Crowding-Out Occur?

At low levels of Real GDP, Keynesian policy requires the Government to increase
spending in order to increase AD and create jobs.

The question arises as to whether this spending creates additional demand, or replaces
private sector demand (the latter know as crowding-out).

Full crowding-out would occur if the increase in G replaces an equivalent amount of

private investment.

If the unemployment rate is above the natural rate of unemployment, (i.e. Real GDP is
less than potential GDP), idle labour resources can be employed, full crowding-out
will not occur. It will also not occur if the increase in G is on capital goods that were
as productive as the private investment that is displaces.

Crowding-out can occur, however, if the economy is at or near full employment if the
Government increase spending on goods/services by borrowing (running a budget
deficit).

A budget deficit will increase demand for loanable funds that will increase interest
rates that will reduce demand for private investment. Increased Government
borrowing displaces private sector borrowing and crowds-out productive investment.

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3C.1.6 Unemployment

Full Employment exists when the labour market clears allowing for frictional,
structural, and seasonal unemployment. Also known as the Natural Rate of
Unemployment. It is one of the five major macroeconomic objectives.

Unemployment: Introductory Notes

1. Achieving Full Employment or the Natural Rate of Unemployment in the

Long Run is a Macroeconomic objective. One of 5 macroeconomic objectives.

2. Having a high level of Unemployment, therefore, is not good-economically,

socially or politically for an economy.

3. The rate of unemployment is considered one of the most important measures

of how healthy an economy is.

4. This chapter examines various issues associated with unemployment.

Definition of Unemployment Rate

A country’s unemployment rate is the number of unemployed expressed as a

percentage of the labour force.

Formula is:

No of Unemployed x 100 = Unemployment Rate

Labour force 1

It is the number of adult workers who are seeking jobs.

As a guide, an ‘acceptable’ unemployment rate = 4% to 5%.

Problems of Measuring Unemployment

1. Unemployment is a ‘stock” concept- i.e. it is measured at a point in time.

2. Different measures are used in different countries.

3. Only those people that are registered (i.e. for social security payments) as
unemployed are included. Often people who may not qualify for benefits,
including school-leavers and part-time workers, are excluded from the
calculation.

4. People who are underemployed-i.e. a person who accepts a part-time job

because that is all that is available, but who wants to work full time, are
excluded.

5. People who are in the disguised unemployment category-i.e. people who are
working full-time but in fact contributing very little (e.g. workers at State
Owned Enterprises in China)- are excluded.

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 6. A national figure disguises many irregularities in the distribution of
unemployment such as geographical, gender, racial, education and age factors.

Cost of Unemployment and a Benefit

Costs:

* Individuals and Governments lose Income.

* Loss of self-esteem, ill health, family breakdowns etc.

* Decrease in living standards.

* Loss of Aggregate Demand.

* Economy operating within its PPF.

Benefit:

For an economy to operate efficiently and effectively, a natural rate of

unemployment is healthy.

Overview of the Two Major Types of Unemployment

1. Equilibrium Unemployment 2. Disequilibrium Unemployment

3 Causes 2 Causes

- Frictional Unemployment - Real-Wage or Classical Unemployment

- Structural Unemployment - Demand-Deficient or Cyclical Unemployment
- Seasonal Unemployment

Now let us examine each of the above Types and the relevant Causes in turn.

Two Major Types of Unemployment

1. Equilibrium Unemployment or Natural Unemployment

Some natural unemployment will always exist in an economy. The natural rate of
unemployment includes three causes: frictional unemployment, structural
unemployment and seasonal unemployment.

We will cover these three causes of unemployment shortly. They are all included in
the economist’s definition of Equilibrium Unemployment, also referred to as the
Natural Rate of Unemployment. The reason for this is that for an economy to operate
efficiently and effectively, a natural rate of unemployment is considered healthy.

Graphically, this unemployment state is shown in Figure 3C.1.6 (a).

173
The average real wage rate is graphed on the vertical axis; the number of workers, on
the horizontal axis.

Now we plot the Aggregate Demand for Labour (ADL): this slopes downwards
because at higher wages rates firms will demand/use less labour.

The Aggregate Supply of Labour (ASL): this slopes upwards because at higher wages
rates more labour will supply/offer their services.

Figure 3C.1.6 (a): Equilibrium Unemployment

or Natural Unemployment

Average
Real ASL Total Labour Force
Wage
Rate

A B
We
ADL

0 QE Q1 Number of Workers

The above figure shows the total demand and supply of labour, and equilibrium
occurs where ASL = ADL at a real wage of We.

The Total Labour Force line represents the total labour force. This includes the three
causes of Equilibrium Unemployment: frictional, seasonal and structural, also known
as the Natural Rate of Unemployment.

At equilibrium point A, there is, consequently, natural unemployment of AB.

Types of Equilibrium Unemployment by Cause:

1. Frictional (Search) Unemployment.

People entering, or re-entering, the labour force and other people switching
jobs.

2. Structural Unemployment:

Unemployment resulting from fundamental changes in the structure of the

economy-e.g. maybe due to technological changes. Occupational and
geographic immobility make it worse.

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 3. Seasonal Unemployment:

Some occupations are weather dependent-e.g agricultural industries

Measure to deal with Equilibrium Unemployment

1. Frictional Unemployment:

Improve the flow of information between employers and job seekers. Reduce
unemployment benefits.

2. Structural Unemployment:

Market orientated approach. Encourage workers to leave the depressed region, help
retrain workers and perhaps decrease benefits to encourage mobility (move workers to
the work).

Interventionist approach. Government develops direct action to bring jobs to the

region through tax concessions, grants and retraining schemes (work to the workers).

3. Seasonal Unemployment:

Similar to 2 above.

2. Disequilibrium Unemployment

Occurs when the labour market is not in equilibrium due to classical (or real wage)
unemployment and demand-deficient or cyclical unemployment.

There are 2 causes of disequilibrium unemployment:

2.1 Real-Wage or Classical Unemployment

2.2 Demand-Deficient or Cyclical Unemployment:

Types of Disequilibrium Unemployment by Cause:

2.1 Real-Wage or Classical Unemployment

Graphically, this unemployment state is shown in Figure 3C.1.6 (b).

The average real wage rate is graphed on the vertical axis; the number of workers, on
the horizontal axis.

Now we plot the Aggregate Demand for Labour (ADL) and the Aggregate Supply of
Labour (ASL).

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 Figure 3C.1.6 (b): Real-Wage or Classical Unemployment

Average
Real ASL
Wage
Rate
W1 Above Equilibrium Wage Rate

Equilibrium Wage Rate

We
ADL

0 Q2 QE Q1 Number of Workers

The above figure shows the total demand and supply of labour, and equilibrium
occurs where ASL = ADL at the Average Real Wage Rate, We, and Number of
Workers, 0QE.

Then, due to the action of the Unions and/or government minimum wages legislation,
an Above Equilibrium Wage Rate of W1 is established.

In the above figure, the Average Real Wage, W1, is above the equilibrium level. ADL
falls to OQ2. ASL increases to OQ1.

Q2-Q1 is the level of Disequilibrium Unemployment. This is in addition to

Equilibrium Unemployment/the Natural Rate of Unemployment.

2.2. Demand-Deficient or Cyclical Unemployment:

A feature of every economy is that they go through business cycles: fluctuations of

vicissitudes in economic activity. Hence the word ‘Cyclical’ in the definition.

This type of disequilibrium employment is mainly due to a fall in Aggregate Demand

(AD), resulting in a fall in the demand for labour.

Note that it is the decline in AD that results in a fall in the demand for labour. As we
have seen earlier, AD = C + I + G + X - M.

So if any one of the components of AD declines (C, I, G, X) or M increases, then first

there will be a decline in AD followed by a resultant increase in demand-deficient
unemployment.

A second causal factor is that as labour markets do not work smoothly, labour resists
the wage cuts and consequently demand-deficient unemployment occurs.

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Diagrammatically, it is important to examine the above problem from two
perspectives: first, the decrease in AD; second, the resultant decrease in ADL.

Decrease in Aggregate Demand

The Price Level is shown on the vertical axis, Real GDP on the horizontal axis. The
SRAS and the AD1 curves are plotted on the diagram.

Before the decrease in AD, macroeconomic equilibrium is where SRAS and AD1
curves intersect. The Price Level is P1: Real GDP equals 0QE. See Figure 3C.1.6 (c).

Figure 3C.1.6 (c): Decrease in Aggregate Demand

Price Level SRAS

P1

P2

AD1
AD 2

0 Q1 QE Real GDP

Because of a decrease in AD, the AD curve shifts to the left from AD1 to AD2.

Macroeconomic equilibrium now = SRAS =AD2. The Price Level has declined from
P1 to P2. Real GDP has declined from 0QE to 0Q1.

The decline in Real GDP will result in an increase in unemployment because total
output has declined and, consequently, firms do not need as many workers.

Note:
1. The decline in the Price Level has reduced inflationary pressures. This is good for
the macroeconomic objective of Price Stability. The decrease in inflation means that
the price of the country’s Exports decline. This will assist Exports and, in turn, be
good for the macroeconomic objective of External Equilibrium.

2. However, the decline in Real GDP is bad for the macroeconomic objectives of
Economic Growth, Economic Development and Full Employment.

3. The macroeconomic objective of External Equilibrium may be negatively affected

based on the decline in AD generated within the economy. This will be offset by
Point 1.

177
Decrease in Aggregate Demand For Labour (ADL)

The decline in AD will lead to a decline in the ADL.

Prior to the decrease in AD, the labour market was in equilibrium where
ADL1 = ASL at Average Real Wage Rate, We. See Figure 3C.1.6 (d).

Figure 3C.1.6 (d): Decrease in Aggregate Demand for Labour

Average
Real ASL
Wage
Rate

Equilibrium Wage Rate

We
W1 ADL1

ADL2

0 Q1 QE Number of Workers

In above figure, the fall in AD results in the demand for labour falling. There is a shift
to the left in the ADL curve from ADL1 to ADL2. Real wages do not fall from WE to
W1 quickly enough, hence disequilibrium unemployment Q1-QE results.

Measures to deal with Disequilibrium Unemployment

Classical Unemployment

Given that the source of the problem is market restrictions, then the solution lies in
removing them.

Through legislation, remove all the restrictions and make the market work. For
example, reduce the minimum wage level. And/or, reduce the power of Unions.

Other solutions lie in removing or reducing the payment of social security benefits to
encourage people to work at the ‘acceptable’ wage level. This would lower the
opportunity cost of not working.

Demand-Deficient Unemployment

As we know that Disequilibrium Unemployment exists, then we also know that

macroeconomic equilibrium, where AD = SRAS, must be to the left of Full
Employment Equilibrium (LRAS).

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Figure 3C.1.6 (e) shows this existing situation. Actual Real GDP = 0Q1. Potential
Real GDP is less, at 0QE. Unemployment and a recessionary gap exist.

Figure 3C.1.6 (e): Economy With Disequilibrium Unemployment

LRAS Full Employment Equilibrium

Price
Level
SRAS1

P1 Macroeconomic equilibrium

Recessionary Gap

Under F.E. AD1

0 Q1 QE Real GDP

In an ideal world, the objective is to achieve SRAS =AD =LRAS.

The Government can use Fiscal and/or Monetary Policies to increase Aggregate
Demand (AD), thus increasing demand for jobs.

Remember AD = C + I + G + X – M.

Fiscal Policy refers to the government’s policy on taxation (direct and indirect),
government expenditure and transfer payments and their affect on aggregate demand
and aggregate supply.

The government uses fiscal polices to increase some/all of the components of AD:

Increase in C: reduction in personal, indirect and company taxes.

Increase in I: reduction in company taxes, indirect and personal taxes.

Increase in G: increase in government spending.

Increase in X: provision of tax and other financial incentives to exporters.

Reduction in M: imposition of penalties on importers through forms of protectionism.

Such measure will stimulate C, I, G and X, and provide disincentives to M.

Combined, all other factors held constant, AD should increase.

179
Monetary Policy refers to changes in the money supply and interest rates to affect
aggregate demand and aggregate supply. In most countries, these policy decisions are
made by the Central Bank.

In some countries-such as China, Myanmar and North Korea- monetary policy

decisions are made by the government. Consequently, the government controls both
monetary and fiscal policies. Economists do not see this as a good situation.

Acceptable level of Unemployment

There is no precise or agreed definition as to the acceptable level of unemployment.

As a guideline, 4% to 5% unemployment is acceptable. Consequently, a level above

this presents problems for the government.

In an earlier Class Assignment, we noted there are many countries where major
unemployment problems exist.

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3C.1.7 Inflation

Macroeconomic Objective of Price Stability

Price Stability is one the five key macroeconomic objectives. It is used as an

indicator of the economic health of an economy. Price stability impacts on the other
four macroeconomic objectives.

The level of the Inflation rate in a country is used as the measurement of price
stability.

Introductory Notes

1. Achieving Price Stability is a Macroeconomic objective. One of 5

macroeconomic objectives.

2. Having a high level of Inflation, therefore, is not good-economically, socially

or politically-for an economy.

3. The rate of Inflation is considered one of the most important measures of

how healthy an economy is.

4. This chapter examines various issues associated with Price Stability.

Definition of Inflation and Price Stability

Inflation is a sustained increase in the general price level. A once only rise in prices is
not regarded as inflation.

Price Stability is when the changes in the average price level are small and don’t
have adverse effects on the economy. As we shall see later, the acceptable level of
inflation rate is referred to as creeping inflation.

Measuring Inflation

It is useful to have a general understanding of how inflation is measured.

The most common measure of inflation is the ‘inflation rate’.

Formula: Inflation rate: currents year’s prices – last year’s prices x 100
last year’s prices 1

Example: Year Price Level

2004 130
2005 135

Inflation rate is: 135 -130 x 100 = 5 x 100 = 3.8%

130 1 130 1

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Constructing a price index

Key terms:

Price index: is a measure of the average level of prices in one period as a percentage
of their level in an earlier period (e.g. the previous year).

Price level: is the average level of prices as measured by a price index.

Regimen/Basket of goods: a sample of goods or services used in calculation of the

price index.

Base year: the year chosen as the first year of measurement. It is given the value 100.

Weighting: a value given to a good/service to indicate its importance in a regimen as

indicated by expenditure on the item compared to other good/service.

Steps:

A regimen is chosen. This can be done by a survey of households. In Australia there

are 30,000 items in the sample and a new sample is worked out every ten years.

Prices are gathered for all the items. In Australia the prices are obtained from a survey
carried out every three months.

For each good and service an index is calculated as follows:

• 2004 price of rice is $10 per kilo; in 2005 it is $11.

• 2004 price of beer is $20 per box of ten and in 2005 it is $24.
• 2004 is chosen as the base year so its price index = 100.
• For 2005 the price index is calculated as follows:

Price year 2 x 100 Beer index = 24 x 100 = 120

Price year 1 1 20 1
Rice index = 11 x 100 = 110
10 1

Average price index = 120 + 110 = 115

2

This is an increase on the base year of 15 or 15%.

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 However, this does not give an idea of the importance to society of each good;
weighting each item does this.

Product Index Weight Weighted Price Index

(Index X weight)
Beer 120 0.2 24
Rice 110 0.8 88
112

Rice is much more important to consumers than beer; this is shown by how much
they spend on it. If consumers spend 0.2 of their income on beer and 0.8 on rice
this becomes their weighting.

The weighted price index shows an increase of 12%, not the 15% shown before
weighting.

Problems of Measurement

1. Arrival and disappearance of goods

As time passes the regimen may not accurately represent the spending patterns
it was supposed to represent (e.g. of households). For example, in Australia
the survey is done every ten years. In that time some goods may become
common items (e.g.DVDs) and some may no longer be purchased (black and
white TVs).

2. Quality of goods

To compare the price of a good in two time periods its quality would need to
be constant. The quality of goods in the regimen may change significantly
over time or there may be additions, e.g. air bags in cars. The price increase
may reflect these changes rather than just general increases in the price level.

3. Choice of Weight

The expenditure pattern that determines the weights used in the price index is
an average for the economy as a whole. It may not represent the pattern of
certain group’s e.g. old-age pensioners or teenagers and so may be of little use
in determining price changes of goods and services used by those groups.

Expenditure patterns change over time, and so the weights based upon them
will not remain accurate.

183
Levels of Inflation

For ease of understanding, we will categorize the rate of inflation into three broad
areas:
Creeping Inflation Inflation Hyperinflation

Up to 2%-3% increase p.a. 4%+ to 15% 15%+ to 1,000%+

Acceptable Not acceptable at Definitely not acceptable

Higher end

Economists consider a certain level of inflation as necessary and good for an

economy. This rate of inflation is Creeping Inflation.

Creeping Inflation means a low rate of inflation; say 2% to 3%-e.g. Australia

2002-2005, Switzerland in 2004 and 2005.

All other levels of inflation are not good for an economy, especially
Hyperinflation.

Hyperinflation means a very high rate of inflation-e.g. Brazil in 1993 = 1,200%.

Four Costs of Inflation

1. Redistribution Costs

If prices all changed at the same rate it would not affect resource allocation.
Prices move to show the change in scarcity of one good compared to others
(relative scarcities). However when there is inflation, prices of some goods
and services change more easily than others.

If prices move erratically this distorts the price system. Wrong signals are
sent to markets, and resources no longer move according to relative values
and scarcities.

Three examples:

(i) Fixed Income Earners suffer a loss of real incomes. Their money
incomes will buy less at the end of a period of inflation than at the
beginning.

(ii) Borrowers will gain at the expense of lenders. If a person borrows

$1,000 at 5% interest p.a. and repays it 12 months later and
inflation has risen by 10%, he/she gains. Often interest rates are not
set high enough to cover the real income loss due to inflation.

(iii) Export prices will change relative to import prices. If domestic

inflation rates rise more than prices in competing producer
countries, overseas buyers may buy from an alternative country.

184
 Exports will decline. As well, domestic consumers may buy more
from overseas. Imports will increase.

The redistribution of resources in each of these cases is arbitrary.

That is, it does not follow the normal laws of economics.

2. Uncertainty

Inflation makes it difficult for firms to predict their revenues and costs, so
businesses may not wish to invest.

3. Resource cost

Extra resources will be needed to deal with the changes caused by inflation
e.g. extra labour will be needed to simply keep changing prices.

4. Savings lose value

Money kept in the bank will buy less and less as time passes. It will become
more difficult to save money to buy large expensive items.

Anticipated and Unanticipated Inflation

If inflation is correctly anticipated then many of its worst effects can be eased. For
example, wages can be raised so real incomes do not fall.

Unanticipated inflation causes serious problems because its effects haven’t been
prepared for.

Two Major Causes of Inflation

Price Stability exists when there is neither inflation nor deflation, when AD and
SRAS are in equilibrium.

There are two major causes of inflation:

1. Demand-Pull Inflation: Caused by a persistent shift in AD to the right.

2. Cost-Push Inflation: Caused by a persistent shift in SRAS to the left.

We will now examine each in turn.

Demand-Pull Inflation:

This is caused by persistent shifts of the AD curve to the right.

Figure 3C.1.7 (a) shows a SRAS and AD model. The Price Level is on the vertical
axis; Real GDP is on the horizontal axis.

185
 Figure 3C.1.7 (a) Demand-Pull Inflation

Price
Level SRAS

P2
P1

AD2
AD1
0 Q1 Q2 Real GDP

The AD Curve shifts to the right, from AD1 to AD2. As a result, Real GDP increases
from 0Q1 to 0Q2. The Price Level increases from P1 to P2.

Note:

1. The increase in the Price Level, caused by demand-pull inflation, is inflationary.

Thus, the macroeconomic objective of Price Stability is affected.

2. The increase in Real GDP results in an increase in Economic Growth. This increase
in growth can fund an improvement in Economic Development. The increase in Real
GDP results in a decrease in unemployment. Three of the five macroeconomic
objectives are improved.

3. Demand-Pull Inflation will negatively affect the macroeconomic objective of

External Equilibrium. An increase in domestic prices will mean that export prices will
increase and exports will be less competitive internationally. And as import prices
become relatively cheaper, imports increase.

There must be a sustained increase in AD for inflation to continue.

Two major Causes of Demand-Pull Inflation

What causes the increase in AD? Answer:

a. An increase in one or more of the components of AD e.g. C, I, G, X-M

b. An increase in the money supply. Economists who believe this are

monetarists. (Note: not all economists believe this theory).

186
 One version of the monetarist’s theory is related to the Quantity Theory
of Money that claims in the long run an increase in the quantity of money
causes an equal percentage increase in the price level.

The theory is based on the Velocity of Circulation (V): is the average

number of times a unit of money is used annually to buy goods and
services.

Equation: V = PY where…
M

V = velocity of circulation.
P = price level.
Y = Real GDP.
M = quantity of money.

The equation of exchange states that MV = PY.

The consensus view is that in the long-run increases in the money supply
does cause inflation. In the short run, economists are divided as to whether
it does or not cause inflation.

Measures To Deal with Demand-Pull Inflation

The solutions lie in understanding the causes and taking appropriate steps to rectify
them.

Solutions to Cause # 1: Change in the Components of AD

AD = C + I + G + X – M

Therefore, changes in Fiscal Policies and Monetary Policies are required.

Using Fiscal Policy for example, the Government could:

Decrease C: increase personal and indirect taxes, company taxes.

Decrease I: increase company taxes and reduce government incentives.

Decrease G: reduced government spending.

Decease X: reduce export incentives.

Increase M: provide incentives to importers; reduce levels of protection.

Solutions to Cause # 2: reduce the money supply

Using Monetary Policy for example, the Central Bank could decrease the money
supply. This would raise interest rates and impose higher costs on all sectors of the
economy.

The components of AD- C, I, G, X – M would all be affected.

187
Cost-Push Inflation

Cost-Push Inflation is caused by a persistent shift in the SRAS Curve to the left,
resulting from increases in the firms’ costs.

What caused an increase in the firms’ costs? Answer: one or a combination of the
following factors.

Wage-push inflation. Higher demand for, and payment of, wages. This could result
from Labour Union demands.

Profit-push inflation. A firm using its monopoly power to increase prices and profits
independently of consumer demand.

Import-price-push inflation. Where the price of imports increase independently of

aggregate demand. For example, the 2005 major increase in oil prices.

Tax-push inflation. Where taxes are raised causing an increase in prices of goods and
services.

Reduction of finite natural resources. Examples include over-fishing, deforestation,

and the depletion of oil and minerals.

Figure 3C.1.7 (b) shows a SRAS and AD model. The Price Level is on the vertical
axis; Real GDP is on the horizontal axis.

There must be a sustained increase in the firms’ costs for inflation to continue. As a
result, total output falls.

Figure 3C.1.7 (b) Cost-Push Inflation

Price
Level SRAS2

SRAS1

P2

P1

AD1

0 Q2 Q1 Real GDP

The SRAS Curve shifts to the left, from SRAS1 to SRAS2. As a result, Real GDP
decreases from 0Q1 to 0Q2. The Price Level increases from P1 to P2.

188
Note:

1. The increase in the Price Level, caused by cost-push inflation, is inflationary. Thus,
the macroeconomic objective of Price Stability is affected.

2. The decrease in Real GDP results in a decrease in Economic Growth. This decrease
in growth will negatively affect Economic Development. The decrease in Real GDP
results in an increase in unemployment. All of these three of the five macroeconomic
objectives are negatively affected.

3. Cost-Push Inflation will also negatively affect the macroeconomic objective of

External Equilibrium. An increase in domestic prices will mean that export prices will
increase and exports will be less competitive internationally. And as import prices
become relatively cheaper, imports increase.

4. All five macroeconomic objectives are negatively affected by Cost-Push

Inflation.

There is a very important distinction between the effects of Cost-Push Inflation and
demand-Pull Inflation: the former results in a decrease in Real GDP.

There must be a sustained increase in the SRAS for inflation to continue.

Measures To Deal With Cost-Push Inflation

The solutions lie in understanding the causes and taking appropriate steps to rectify
them. The Government should implement supply-side policies to reduce costs.
Examples follow.

Wage-push inflation. Example is legislation to reduce the power of the Unions.

Profit-push inflation. Anti-monopoly legislation to break-up monopolies.

Import-price-push inflation. Measures to discourage imports.

Tax-push inflation. Reduce company taxes and other business tax costs.

Reduction in finite natural resources. Encourage sustainable development.

Interaction of Demand-Pull & Cost-Push Inflation

It is important to note that both types of inflation may occur at the same time.

189
Deflation

Deflation is the sustained fall in the general price level. This occurred in Japan in the
1990’s to 2002.

It is the opposite of inflation.

We have seen that inflation is not good for an economy. Neither is deflation.

Price Stability exists when there is neither inflation nor deflation, when AD and
SRAS are in equilibrium. Creeping inflation of between 2% to 3% occurs.

Major Problems with Deflation

1. Incentive to producers is reduced. If the price of goods and services firms produce
and sell continually falls, then this will negatively impact on their profits.

2. Declining profits will result in less Investment by firms.

3. With less profits there is less desire to innovate and increase sales.

4. Spending on research and development is likely to decline in periods of deflation.

5. Assets, like property and shares, lose value. This can become a serious problem if
the owners have borrowed to buy the assets and can’t repay their loans due to less
demand resulting from declining asset values.

6. Banks are less willing to lend in periods of deflation and so the whole economy is
affected.

190
3C.1.8 Trade-off between Price Stability and Full Employment

Price Stability and Full Employment are two of the five key macroeconomic
objectives. The Government placing a priority on one objective will affect the
achievement of the other objective.

This chapter examines both these objectives in more detail.

Models are used to explain the relationship between the Price Level and Real GDP.
The Price Level reflects Inflation; changes in Real GDP impact on the level of
employment.

A Shift in the AD Curve

We will examine two models where the AD Curve shifts: first, a persistent shift in the
AD Curve to the right: second, a persistent shift in the AD Curve to the left.

Figure 3C.1.8 (a) shows a persistent increase in AD leads to Inflation and increasing
Real GDP, and indirectly a decrease in unemployment.

Figure 3C.1.8 (a) Increase in Aggregate Demand

Price
Level SRAS

P2
P1

AD2
AD1
0 Q1 Q2 Real GDP

The AD Curve shifts to the right, from AD1 to AD2. The Price Level increases from
P1 to P2, causing inflation. Real GDP increases from 0Q1 to 0Q2, leading to a
reduction in unemployment.

191
Figure 3C.1.8 (b) shows a persistent fall in AD leads to deflation and falling Real
GDP, and indirectly an increase in unemployment.

Figure 3C.1.8 (b) Decrease in Aggregate Demand

Price
Level SRAS

P2
P1

AD1
AD2
0 Q2 Q1 Real GDP

The AD Curve shifts to the left, from AD1 to AD2. The Price Level decreases from
P1 to P2, causing deflation. Real GDP decreases from 0Q1 to 0Q2, leading to an
increase in unemployment.

In both Figures, where AD shifts:

1. The Price Level and Real GDP are positively correlated; they move in the same
direction.

2. The Unemployment Level and Real GDP are negatively correlated. That is, as
Real GDP increases, unemployment decreases; as Real GDP decreases,
unemployment increases.

3. Thus, Price Level increases and unemployment are therefore inversely related.

That is, as Price levels increases, unemployment decreases; as Price Levels decreases,
unemployment increases.

A Shift in the SRAS Curve

Now let us examine what happens when there is a persistent shift in the SRAS Curve.

Figure 3C.1.8 (c) shows a persistent fall in SRAS leads to inflation and falling Real
GDP, and indirectly an increase in unemployment.

192
 Figure 3C.1.8 (c) Decrease in SRAS

Price
Level SRAS2

SRAS1

P2

P1

AD

0 Q2 Q1 Real GDP

The SRAS Curve shifts to the left, from SRAS1 to SRAS2. As a result, Real GDP
decreases from 0Q1 to 0Q2. The Price Level increases from P1 to P2.

Figure 3C.1.8 (d) shows a persistent increase in SRAS leads to deflation and rising
Real GDP, and indirectly falling unemployment.

Figure 3C.1.8 (d) Increase in SRAS

Price
Level SRAS1

SRAS2

P1

P2

AD

0 Q1 Q2 Real GDP

The SRAS Curve shifts to the right, from SRAS1 to SRAS2. As a result, Real GDP
increases from 0Q1 to 0Q2. The Price Level decreases from P1 to P2.

193
In both Figures, where SRAS shifts:

1. The Price Level and Real GDP are negatively correlated; they move in the
opposite direction.

2. The Unemployment Level and Real GDP are negatively correlated. That is, as
Real GDP increases, unemployment decreases; as Real GDP decreases,
unemployment increases.

Impact of Shifts in AD or SRAS on Macroeconomic Objectives

As can be seen from the above models, persistent shifts in the AD or SRAS will have
different impacts on the five macroeconomic objectives.

This is important for Governments and Central Banks in deciding the appropriate mix
of policies to implement to bring about the desired macroeconomic outcomes.

The macroeconomic mix of policies include:

* Fiscal policies
* Monetary policies
* Supply-Side policies
* Foreign Exchange policy

Economist’s Different Points of View

John Maynard Keynes: An Overview

The British Economist, John Maynard Keynes, argued that Governments needed to
manipulate AD.

This could be done through Fiscal Policy- i.e. through Government Spending
(G) and/or Net Transfer Payments (G) and/or Taxation (T).

Or through the Central Bank’s use of Monetary Policy using interest rates and/or the
money supply.

In this way, they could achieve a politically acceptable rate of unemployment and
inflation based on the inverse relationship between inflation and unemployment.

Figure 3C.1.8 (e) shows the relationship between the SRAS Curve and AD Curves as
Keynes saw it. The Price Level is on the vertical axis; Real GDP on the horizontal
axis.

This figure shows the demand deficiency as Keynes saw it. Remember that Keynes
was writing his theories based in major part upon his observations and experiences of
the 1929 to 1933 Great Depression.

194
 Figure 3C.1.8 (e): Keynesian Short Run SRAS and AD

SRAS
Price Physical
Level Limit of
Production

AD3
AD1 AD2

0 Real GDP

In the original Keynesian model, the SRAS Curve was assumed to be ‘L’ shaped, so
that AD could increase to the physical limit of production before prices rose.

When Real GDP is low, as in the first section of the SRAS Curve, the SRAS Curve is
perfectly horizontal. If AD shifts to the left over this range, output falls and
unemployment rises. As the SRAS Curve is flat, prices are stable.

The Government can increase AD, from AD 1 to AD2, to increase output and reduce
unemployment without raising the price level.

Later modifications to SRAS Curve produced the upward sloping middle section
where unemployment and rising prices were found together. This is closer to reality.

Keynesian theory and policy prescription held up until the late 1960s. One
explanation for the change in thinking can be found in a shift in the SRAS Curve to
the left.

Milton Friedman: Monetarist Macroeconomic Policy

US Economist, Milton Friedman, in the 1970s argued that economies are better off
without Government interference. Also, that inflation is directly the result of
government expansion of the money supply. He argued that government should only
expand the money supply neutrally in line with increases in economic activity.

Note: Friedman views/theories were the opposite to those of Keynes.

In the oil crisis of the early 1970s, inflation and unemployment rose together causing
stagflation (increase in inflation and unemployment). The SRAS Curve shifted to the
left, wages rose to keep up with increased prices and governments expanded AD
(shifted AD Curve to the right) to reduce unemployment. A wage-price spiral
followed and inflation increased sharply.

195
Supply-Side Macroeconomic Policy

Since the 1970s, industrial countries have primarily concentrated on shifting the
SRAS Curve to the right. See Figure 3C.1.8 (d). Objective has been to increase Real
GDP, lower the Price Level and reduce unemployment. Known as Supply-Side
Macroeconomic Policy.

Supply-Side Policies refer to government policies designed to increase output. Shift

both the SRAS and LRAS Curves to the right.

Examples include the following policies:

* Reductions in company tax to encourage risk-taking and investment.

* Action to increase the quantity of labour.

* Incentives to improve the quality of labour/development of Human Capital.

* Measures to increase the quantity and quality of capital.

* Reducing personal income taxes. This raises the opportunity cost of not working.

* Reducing unemployment benefits. This encourages people to find jobs.

Which Problem should be treated as a Priority?

Of the two priorities, price stability and full employment, which of these should be
treated as the priority?

No single/simple answer.

Monetarists argue that that strict control of the money supply is the government’s
central role in order to give price stability. The Government should not attempt to
increase AD to reduce unemployment.

Keynesians argue that below full employment, AD should be increased and that
Government intervention is necessary through Fiscal and Monetary Policy.

Answer lies in the shape of the SRAS Curve. The moderate consensus view is that
the economy normally functions in the middle section as shown in Figure 3C.1.8 (e).
In the long run, the economy would be on the vertical LRAS Curve.

Summary: in the end, the priority between unemployment and inflation will be
influenced by the political persuasion of the government.

Government or by Market-Led Strategies?

With regard to inflation and unemployment, should the Government interfere in the
market? Or allow and encourage market-led strategies to operate?

196
With regard to Unemployment, it is a controversial area.

If the market works effectively for example when there is demand-deficient

unemployment and wages adjust downwards, then answer is leave it to market forces.
If wages are “sticky” downwards, then answer is that government intervention is
called for. For example, there is a need to change minimum wages and/or reduce the
power of the unions.

With regard to Inflation, both Monetarists and Keynesians agree that Government
intervention is necessary. However, they disagree on the strategy.

Monetarists claim that expanding the money supply causes inflation. Therefore,
Government’s role is to expand the money supply neutrally to match the growth in
real output. Result: inflation will be controlled.

Keynesians argue that demand-pull or cost-push inflation can occur independently

and they advocate direct government action to curb excess demand (through
Fiscal/Monetary Policy) and cost-push inflation to be tackled by a prices and incomes
policy. They regard the change in money supply as being the result of inflation, not
the cause.

Use of Monetary and Fiscal Policy to Influence SRAS, LRAS and AD

Before examining the policy options, it is first necessary to ask: where is the economy
operating now? Identify where macroeconomic equilibrium is in relation to LRAS. Is
macroeconomic equilibrium on the LRAS Curve? Is it to the left? Is it to the right?

Monetary Policy

Monetary Policy involves…

(a) Changing the Money Supply
(b) Changing the Interest Rate

…to affect macroeconomic policy.

In most countries, this is executed by the Central Bank. Note: in most countries, like
Australia, U.K. and the USA the Central Bank is independent of the government; in
other countries, like China, the Central Bank is under the control of the government.
This is very important distinction.

Example # 1: Monetary Policy to Decrease AD

Figure 3C.1.8 (f) shows the situation where the Central Bank wishes to decrease AD
because macroeconomic equilibrium is to the right of the LRAS Curve. The economy
is operating in the Above Full Employment zone. The economy is over-heated.

SRAS1 = AD1 at Price Level P1. Real GDP is 0Q1.

197
 Figure 3C.1.8 (f): Excessive Aggregate Demand

LRAS
Price Full Employment Equilibrium
Level
SRAS1

P1 Macroeconomic
Equilibrium
AD1

0 QE Q1 Real GDP

This situation cannot persist in the long run. The economy is ‘too hot’. Above full
employment, and inflationary pressures, exist. AD needs to decrease.

To decrease AD, the Central Bank will reduce the money supply. This will increase
interest rates resulting in increased costs to consumers and firms.

Figure 3C.1.8 (g) shows the use of monetary policy, through decreasing money
supply.

Figure 3C.1.8 (g): Decease in Money Supply

Interest MS2 MS1

Rate

R2

R1

0 Q2 Q1 Quantity of Money

The Central Bank reduces money supply, resulting in a shift in the money supply
curve from MS1 to MS2. Interest rates rise from R1 to R2.

As a result, borrowing costs to consumers and firms increase. This leads to a decrease
in the components C and I of AD.

Now let us examine the impact of the above on Figure 3C.1.8 (f).

198
A new diagram, Figure 3C.1.8 (h) below reflects the impact of the decrease in money
supply on the C component of AD.

Figure 3C.1.8 (h): Monetary Policy to Reduce Excessive AD

LRAS
Price Full Employment Equilibrium
Level
SRAS1

P1 New Macroeconomic
Equilibrium
P2 AD1

AD2

0 QE Q1 Real GDP

The AD Curve shifts to the left, from AD1 to AD2. The Price Level decreases from
P1 to P2. Real GDP decreases from 0Q1 to 0QE.

Result: macroeconomic equilibrium and full employment equilibrium are in balance.

Example # 2: Monetary Policy to Increase AD

Figure 3C.1.8 (i) shows the situation where the Central Bank wishes to increase AD
because macroeconomic equilibrium is to the left of the LRAS Curve. The economy
is operating in the Below Full Employment zone.

SRAS1 = AD1 at Price Level P1. Real GDP is 0Q1.

Figure 3C.1.8 (i): Inadequate Aggregate Demand

LRAS
Price Full Employment Equilibrium
Level SRAS1

P1 Macroeconomic
Equilibrium

AD1

0 Q1 QE Real GDP

199
This situation is unsatisfactory because actual Real GDP, 0Q1, is less than potential
Real GDP, 0QE. Unemployment exists. AD needs to increase.

To increase AD, the Central Bank will increase the money supply. This will decrease
interest rates.

Figure 3C.1.8 (j) shows the use of monetary policy, through increasing money
supply.

Figure 3C.1.8 (j): Increase in Money Supply

Interest MS1 MS2

Rate

R1

R2

0 Q1 Q2 Quantity of Money

The Central Bank increases money supply, resulting in a shift in the money supply
curve from MS1 to MS2. Interest rates fall from R1 to R2.

As a result, borrowing costs to consumers decrease. This leads to an increase in the

component C of AD.

Now let us examine the impact of the above on Figure 3C.1.8 (i).

A new diagram, Figure 3C.1.8 (k) below reflects the impact of the increase in money
supply on AD.

200
 Figure 8.1.2 (k): Increase in Aggregate Demand

LRAS
Price Full Employment Equilibrium
Level SRAS1
P2 New Macroeconomic
Equilibrium
P1
AD2

AD1

0 Q1 QE Real GDP

The AD Curve shifts to the right, from AD1 to AD2. The Price Level increases from
P1 to P2. Real GDP increases from 0Q1 to 0QE. The increase in Real GDP will
reduce unemployment.

Example # 3: Monetary Policy to Increase SRAS

Figure 3C.1.8 (l) shows the situation where the Central Bank wishes to increase
SRAS because macroeconomic equilibrium is to the left of the LRAS Curve. The
economy is operating in the Below Full Employment zone.

SRAS1 = AD1 at Price Level P1. Real GDP is 0Q1.

Figure 3C.1.8 (l): Inadequate SRAS

LRAS
Price Full Employment Equilibrium
Level SRAS1

P1 Macroeconomic
Equilibrium

AD1

0 Q1 QE Real GDP

201
This situation is unsatisfactory because actual Real GDP, 0Q1, is less than potential
Real GDP, 0QE. Unemployment exists. SRAS needs to increase.

To increase SRAS, the Central Bank will increase the money supply. This will
decrease interest rates.

Figure 3C.1.8 (m) shows the use of monetary policy, through increasing money
supply.

Figure 3C.1.8 (m): Increase in Money Supply

Interest MS1 MS2

Rate

R1

R2

0 Q1 Q2 Quantity of Money

The Central Bank increases money supply, resulting in a shift in the money supply
curve from MS1 to MS2. Interest rates fall from R1 to R2.

As a result, borrowing costs to firms decrease. Firms will undertake more investment.
This leads to an increase in SRAS.

Now let us examine the impact of the above on Figure 3C.1.8 (l).

A new diagram, Figure 3C.1.8 (n) below reflects the impact of the increase in money
supply on SRAS.

Figure 3C.1.8 (n): Increase in SRAS

LRAS
Price Full Employment Equilibrium
Level SRAS1

SRAS2
P1
New Macroeconomic
P2 Equilibrium

AD1

0 Q1 QE Real GDP

202
The SRAS Curve shifts to the right, from SRAS1 to SRAS2. The Price Level
decreases from P1 to P2. Real GDP increases from 0Q1 to 0QE. The increase in Real
GDP will reduce unemployment.

The level of Inflation is reduced.

Note: Policies may be implemented to change both AD and SRAS at the same time.

Fiscal Policy

Fiscal policy refers to the government’s policy on taxation (direct and indirect),
government expenditure and transfer payments and their affect on aggregate demand
and aggregate supply.

Like changes to monetary policy, any changes in fiscal policies will affect both AD
and SRAS.

Fiscal Policy acts directly on spending by all sectors of the economy.

Changes to Fiscal Policy on AD

AD = C + I + G + X – M

Government Fiscal Policy has a considerable influence over C, I, G and X-M.

A reduction in indirect and/or personal taxes leads to increase in C and AD. An

increase will have the opposite effects.

A reduction in indirect (e.g. payroll tax) and/or company taxes leads to reduction in
costs/increase in profits which leads to increase in I which results in an increase in
employment/reduction in unemployment leads to increase in C and AD. An increase
will have the opposite effects.

An increase in G (either through increase directly in G and/or through increase in Net

Transfer Payments) leads to an increase in employment that results in an increase in
Yd and increase in C and AD. An increase in Net Transfer Payments will directly lead
to an increase in C and AD. A decrease will have the opposite effects.

A reduction in T, as described above and its effects, could make locally produced
goods and services more competitive which will lead to an increase in X’s and AD. A
decrease will have the opposite effects. It may also make M’s dearer leading to a
decrease in spending on M’s leading to a switch in spending to locally made goods
and services which will increase C and AD. A decrease will have the opposite effects.

Note: For easy of understanding, the above comments are ‘simplistic’. In reality, any
change in one component of AD will impact on many of the other components thus
having a multiplier effect (+/-) on AD.

The various diagrams in this chapter demonstrate the impact of these effects.

203
The Phillips Curve

The Short Run Phillips Curve (SRPC):

A study by New Zealand Economist, A W Phillips, confirmed a strong inverse

relationship between inflation and unemployment i.e. high wage inflation was
associated with low unemployment; low wage inflation was associated with high
unemployment. See Figure 3C.1.8 (o).

This show the relationship between inflation and unemployment when:

a) The expected rate of inflation is constant; and,
b) The natural rate of unemployment is constant.

Note: as we have seen in earlier chapters, both a) & b) are largely irrelevant in today’s
world.

Figure 3C.1.8 (o): Short Run Phillips Curve

Inflation Rate
%

0 Unemployment Rate-%

Phillips showed that:

• Reducing unemployment below a certain level would cause increasing

inflation-i.e. moving from c to a to b.

• Reducing inflation below a certain level would cause increasing

unemployment-.i.e. moving from b to a to c.

Given his theory, there is a trade-off between inflation and unemployment, two of the
key macroeconomic objectives.

204
The Long Run Phillips Curve (LRPC)

‘Time’ and ‘expectations’ are now introduced into the model.

The original Phillips Curve = the Short Run Phillips Curve.

The inflation rate depends partly on people’s expectations of the inflation rate.
Businesses set prices and workers negotiate wage rates according to anticipated
inflation.

Anticipated Inflation

If people correctly anticipate inflation, then expected inflation will equal actual
inflation at the natural rate of unemployment.

The natural rate of unemployment = full employment.

Unanticipated Inflation

This could occur as cost-push inflation and the SRAS Curve shifts to the left and the
AD Curve does not increase as much as expected- the SRAS and AD Curves
intersect to the left of the LRAS Curve.

Unemployment is higher than the natural rate, and actual Real GDP is less than
potential Real GDP.

The Long Run Phillips Curve (LRPC)

This shows the inflation/unemployment relationship when the actual rate of inflation
is equal to the expected rate of inflation.

The LRPC is vertical at the natural rate of unemployment; there can be any rate of
inflation at the natural rate of unemployment. See Figure 3C.1.8 (p).

Figure 3C.1.8 (p): Long Run Phillips Curve

Inflation Rate
%
LRPC1
Decrease in expected inflation
shifts the SRPC downward

A
SRPC1

SRPC2

0 Unemployment Rate-%

205
However, the natural rate of unemployment will change if any of the components
change:
a) Frictional unemployment.
b) Structural unemployment.
c) Seasonal unemployment.

If a) to c) changes from 2% to 4% for example, then LRPC shifts to the right. See
Figure 3C.1.8 (q).

Figure 3C.1.8 (q): Increase in natural unemployment

Inflation Rate
%
LRPC1 LRPC2

Increase in natural unemployment

rate shifts LRPC and SRPC rightwards

A B
SRPC2
SRPC1

0 Unemployment Rate-%

At each point on the LRPC where the expected and actual rate of inflation are equal
there is a SRPC.

The Phillips Curve Applied To Recent Experience

Since the late 1960s, industrial countries have experienced periods of high
unemployment and high inflation known as stagflation.

The SRPC (original) has not been a suitable model due to the importance of expected
inflation and a higher rate of natural unemployment. The SRPC has shifted to the
right.

206
3C:1.9 Distribution of Income

The issue of distribution of income raises the question of poverty. It is important to

understand the following distinction.

Relative poverty exists when the people do not enjoy the same…
• Standard of living or quality of life as the rest of the people in the country.
• However, these people may be considered to be poor in comparison with the rest
of the people in the country, but may be regarded as economically well off
compared with people in other countries.

Absolute poverty exists if people cannot acquire the…

• Basic needs in order to survive.
• This happens when people do not have basic food, shelter and clothing.
• People are considered to be living below the breadline.

Should Taxes be used for Redistribution or are the Incentive Effects of Lower
Taxation more important?

Supply-side economics, introduced by President Reagan of USA and Prime Minister

Thatcher of UK, advocates cutting direct taxes to increase the incentive to work and
invest. Also, monies from high rate of taxation can be utilized to redistribute income
from the wealthy to the less wealthy in society.

Government’s use…
a) Income taxes.
b) Transfer payments.
c) Goods & services in kind

… to relieve poverty and redistribute income.

Types of Taxation

Taxes can be categorized into two broad groups. Within each group, Government’s
can use several types. Examples follow.

Direct Taxes Indirect Taxes

-Progressive -GST
-Proportional -Payroll
-Regressive -Land

Direct taxes are taxes imposed directly on income.

Indirect taxes are taxes imposed on other economic activities.

Major types of Direct Taxes are:

a) Progressive- the marginal tax rate increases as Y increases.
b) Proportional-a tax at a constant rate of Y.
c) Regressive-a tax that is at a reducing marginal rate as income increases.

207
Most Governments use progressive direct income tax systems-e.g. Australia, USA,
UK. Hong Kong and Singapore are examples of b).

Government’s can redistribute income within society by altering the type of direct
income tax and/or the average and marginal rates of taxation.

Examples:
1. By changing from a progressive to proportional/regressive tax system.
2. If a progressive tax system exists, by lowering the average and/or marginal
rate of tax or changing the Income Tax Thresholds to benefit low-income
groups.

Transfer Payments

Transfer payments refer to payments made by the government to redistribute

income.

Examples include pensions, travel and health concessions for the elderly, the
provision of government low cost housing, and child and family benefits.

They are common in MDCs, but not in LDCs.

Goods and Services in kind

Government’s can also provide a range of goods and services in kind to low-income
or disadvantages groups to redistribute income.

Examples include rebates on travel and heath.

These are very rare in LDCs.

Trade-off between equity and efficiency

However, in the above situations/examples, there is a trade-off between equity and

efficiency.

Income redistribution causes inefficiency by:

a) Providing a disincentive for higher income earners to work.
b) Due to the costs of administering the schemes.
c) Reducing the opportunity cost of leisure causing a substitution out of work
into leisure, known as the “dead-weight” loss effect.

The concept of “fairness’ is subjective. In the 1980s, many industrialized countries

followed the USA and UK and shifted to efficiency rather than equity.

The Laffer Curve

The Laffer Curve is named after Professor Laffer, an economic advisor to US

President Ronald Reagan.

208
Laffer advocated cutting direct taxes, as he believed that such measures would
increase both total output and the total amount of taxes.

Lower taxes provide workers with more incentive to work and increase productivity.
They also stimulate investment.

See Figure 3C.1.9 (a).

Figure 3C.1.9 (a): The Laffer Curve

Tax
Revenue Rmax

0 t1 Average Tax Rate-%

At a tax rate of zero, no tax is collected. As tax rates rise above zero, more tax
revenue is collected. And so on, until t1 = Rmax. After this, the tax revenue will
continue to fall, reaching zero at 100% tax rate.

Professor Laffer’s idea reinforced government’s fiscal policies to cut taxes as an

important part of supply-side measures to stimulate both short run and long run
aggregate supply.

Many Western Governments have adopted this concept, including the USA, UK and
Australia.

Note: The above is a Model. The curve may not be symmetrical; it may peak at 50%
or some other %. It is the economic concept that is important to know.

The Lorenz Curve

Lorenz curve measures income inequality within the population.

On the vertical axis is the cumulative percentage of national income received. On the
horizontal axis is plotted the number of income recipients as a cumulative percentage.

See Figure 3C.1.9 (b). Remember it is a Model and, like all models, it is a
representation of reality.

209
 Figure 3C.1.9(b): Lorenz Curve

100

% of
Income
Line of
Equality

Lorenz Curve

0 100
% Income Recipients

At any point on the ‘Line of Equality’, the % of Income Recipients = % of Income

received. For example, 20% of Income Recipients = 20% of Income received. And so
on. Both sets of figures will always be equal.

The Lorenz curve shows a different situation. A smaller % of Income goes to a

larger% of recipients. For example, 10% of Income = 30% of Income Recipients.

Gini Coefficient

The Gini coefficient converts the Lorenz curve to a single statistic.

Is a simple way of showing inequality by converting the Lorenz curve into a single
statistic.

In Figure 3C.1.9 (c), the Gini coefficient = Area A

Total area BCD

Figure 3C.1.9 (c): Lorenz Curve

100 C

% of
Income
Line of
Equality

A Lorenz Curve

B D
0 100
% Income Recipients

210
Kuznets Ratio

Income Distribution Ratios

The % of income earned by the bottom 40% (two quintiles) are added together and
expressed as a ratio of income earned by the top 20%.

Most important.

Calculation: Bottom 40% of Household Income expressed as a Ratio

Top 20% of Household Income

This ratio is known as the Kuznets Ratio.

The greater the difference between the two numbers, the greater the degree of
inequality/poverty.

Section 5 further examines the issue of distribution of income.

211
SECTION 4: INTERNATIONAL ECONOMICS

4.1 SECTIONS

4.1.1 Major Reasons for Trade

Trade has the ability to raise the standard of living; that is, improve a country’s
economic development and make those who trade better off.

However, although consumers are the beneficiaries from free trade through increased
choice and reduced prices, some domestic producers can be disadvantaged through
loss of income through reduced prices and increased competition.

1. The Theory of Comparative Advantage

As countries are endowed with different economic resources (Factors of Production),

countries should specialize in those goods/services in which they have a Comparative
Advantage.

This is because the country can then consume beyond its Production Possibility
Frontier and achieve Economic Growth. This is the most important reason and is the
key to this section on trade. With economic growth can come Economic
Development.

Absolute Advantage occurs when one country can produce a good/service using less
resources-factors of production- than another country.

Examples: Australia: beef, gold, beach holidays etc; Japan: cameras, computers;
China: textiles, toys; Taiwan: computer chips; Indonesia, coffee.

Comparative Advantage exists over another country in the production of a

good/service if it can produce at a lower opportunity cost (the cost of any activity
measured in terms of the best alternative which is forgone) than the other country.

Note: this is different to Absolute Advantage.

World output increases as countries specialize in the goods/services they do best and
exchange them for goods/services other countries do best.

Comparative Advantage As An Explanation Of Trading Patterns

A country will be better off by specializing and trading than being self-sufficient.

A country’s comparative advantage will depend upon its resource endowment. All
countries are likely to have factors of production that are relatively abundant and
others that are relatively scarce.

For example:
Land: abundant: -e.g. Australia, USA, Canada, Brazil.
Labour: abundant: -e.g. China, India, Philippines.
Capital: abundant: -e.g. USA, Japan, Germany, Taiwan, Singapore, Switzerland.

212
Some countries are suited to labour-intensive industries; others are more suited to
capital-intensive industries.

The effect of trade between countries is to equalize factor prices; e.g. the demand for
labour in Taiwan will lead to increased wages. Conversely, wages will fall in those
industries as demand for labour intensive goods transfers from domestic to imported
goods. The returns on land and labour will tend to equalize with trade.

Limits to Specialization

In practice countries do not specialize totally, because…

1. Opportunity Cost is not constant in the real world.

2. The Production Possibility Frontier is not a straight line, but a curve convex to
the origin.

3. Transport costs are ignored in the model.

4. Mobility (or lack thereof) of the factors of production.

5. Dangers of being over-specialized.

6. The existence of unemployment is relevant, particularly in LDCs.

PPF Diagram

In earlier chapters we used the PPF Model to explain economic growth.

Figure 4.1.1 (a) revisits the PPF Model.

Prior to economic growth, the country was operating on PPF1.

Figure 4.1.1 (a): Production Possibility Model: Economic Growth

Bread

A Economic Growth

PPF2
F
PPF1

B
0 Submarines

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Economic growth has been achieved through greater trade. As a result, the PPF
expands, from PPF1 to PPF2.

2. Greater Economies of Scale

The theory of long run costs shows that firms frequently gain economies of scale as
they grow and the average cost of production falls as production increases. Trade
allows business to sell in much larger markets than just selling in the domestic market.

Figure 4.1.1 (b) shows the relationship between a firm’s total output and their long
run average costs (LRAC) of production.

Figure 4.1.1 (b): Achieving Economies of Scale

Long Run
Average
Costs

LRAC

0 Output

As firms increase their total output their long run average costs decline. With lower
average costs of production, firms are better able to compete in world markets.
Exports increase, improving the BOP on current account.

3. Increased International Competition

International trade may well increase efficiency in industries which would otherwise
enjoy a domestic monopoly and/or reduced competition, leading to a very competitive
market with lower prices and higher output.

For example, domestic monopolies or oligopolies will face increased international

competition in their domestic market. To now compete, these firms will have to
improve their operational efficiencies, lower prices, improve quality and so on.

Domestic consumers will benefit through increased competition and lower prices.

214
4. The Spread of Modern Technology

Best practice in production techniques spreads rapidly with international trade.

China is a very good example. Since opening its doors to major trade in the 1980s,
many MNCs have established manufacturing operations in China. These companies
have brought, and introduced into China, new modern technology and manufacturing
best practices.

5. Lower Domestic Prices/Importing Deflation

Generally with expanding world trade comes lower domestic prices because of
increased competition. This is a major benefit to consumers. It is also a benefit to
domestic producers that use imports as major inputs in their production.

From a macroeconomic view, cheaper imports can result in countries ‘importing

deflation’ with resultant flow-on benefits to the whole economy. Lower inflation leads
to cheaper goods/services, higher consumption, increased investment, increased
exports, and increased AD and SRAS.

In the past decade, many Western countries-USA, Australia, EU members, Canada-

have received the major benefits above as a result of increased trading with countries
such as China and India. For example, in the USA the world’ largest department
store, Wal-Mart, imports US$ billions of goods from China at very low prices. These
goods are bought by a significant percentage of Americans. A visit to any Wal-Mart
store will bear this out.

However, lower domestic prices do not always follow from increased world trade.
They can, in fact, result in higher domestic prices. For example, many LDCs suffer in
their ability to export their primary products to MDCs because of MDCs agricultural
protection policies- e.g. countries: USA, Japan, South Korea and EU.

Consequently, consumers in the USA, EU, South Korea and Japan are worse off.
They pay higher prices for goods that are protected. Domestic producers that could
use cheaper imports from LDCs as inputs are also worse off.

From a macroeconomic view, this lack of cheaper imports can result in higher
domestic inflation in countries with resultant flow-on benefits to the whole economy.
Higher inflation leads to dearer goods/services, lower consumption, decreased
investment, decreased exports, and decreased AD and most likely decreased SRAS.

6. Technology Deflation

Technology deflation is a sustained decrease in the price of goods and services that
result from improvements and application of technology. Examples include digital
cameras and DVDs.

Expanding world trade has resulted in technology deflation in many countries.

Other reasons for trade include: political, military, cultural and social gains; greater
variety and choice of goods and services.

215
The Theory of Comparative Advantage in more detail

Absolute Advantage occurs when one country can produce a good/service using less
resources-factors of production- than another country…e.g. Australia: beef, gold,
beach holidays etc; Japan: cameras, computers; China: textiles, toys; Taiwan:
computer chips; Indonesia, coffee.

Comparative Advantage exists over another country in the production of a

good/service if it can produce at a lower opportunity cost ( the cost of any activity
measured in terms of the best alternative which is forgone) than the other country.
(Note: this is different to Absolute Advantage).

World output increases as countries specialize in the goods/services they do best and
exchange them for things other countries do best.

The Rate at which they exchange is knows as The Terms of Trade.

The Theory of Comparative Advantage: PPF/PPC

Figure 4.1.1 (c) shows the PPF/PPC for two countries.

Figure 4.1.1 (c): PPF/PPC for two countries

Production of Food (’000units)

10
Country A Country B

PPF/PPC

4 PPF/PFC

0 0
5 4
Production of machines (’000 units) Production of machines (’000 units)

Note: The PPF/PPC is also the Consumption Possibility Frontier (CPF) when
countries do not trade.
Table 4.1.1

Country Prod. Food Prod. Machines O.C. of Food O.C. Machines

A 10 5 0.5 2

B 4 4 1 1

O.C.= Opportunity Cost

216
Q: What is the Opportunity Cost to these countries?

Both country A & B produce the same goods.

Country B has an Absolute Advantage in both goods.

Answer: shown in Table 4.1.1

.
Country A: Because the Opportunity Cost of Food is lower, this country’s
comparative advantage lies in Food.

Country B: Because the Opportunity Cost of Machines is lower in country B

compared to country A, then this country’s comparative advantage lies in Machines.
Q: Given the Comparative Advantage and Opportunity Cost for both countries, what
good should each produce?

Answer: Country A should produce Food; Country B, Machines.

Both countries should specialize in their comparative advantage and Trade. Total
world output will increase. See Table 4.1.1 (b) & 4.1.1 (c).

Table 4.1.1 (b) Before Specialization: Assume each country is self-sufficient by

devoting half its resources to each product. Following would result.

Country Prod. Food Prod. Machines

A 5,000 2,500

B 2,000 2,000

World 7,000 4,500

Table 4.1.1 (c) After Specialization: Assume each country specializes according to
its comparative advantage. Assumes that country A moves 80% of its resources into
food/20% into machines; country B totally specializes with 100% resources into
machines. Following would result.

Country Prod. Food Prod. Machines

A 8,000 1,000

B - 4,000

World 8,000 5,000

The two countries can now trade. Country A will export food and import machines.
Country B will export machines and import food. The Rate of Exchange = Terms of
Trade.

217
Terms of Trade is usually expressed as an Index.

Terms of Trade: Export Price Index x 100

Import Price Index 1

Note:

1. The assumptions in Table 4.1.1 (c) gives rise to new Opportunity Cost Ratios.
2. The PPF/PPC shifts to the right for both countries.
3. With 2, new CPF’s are created for both countries.

218
4.1.2 Major Types of Protectionism

Protectionism is the act of imposing trade barriers to protect the income of domestic
producers.

It is the result of Government action. Protectionism distorts the market allocation of

scares resources in an economy; therefore, the economy does not achieve economic
efficiency. Domestic consumers are worse off.

Key issues:
1. Who benefits? How/Why?
2. Who is disadvantaged? How/Why?
3. Need to separate “what nations say they do” from “what they actually do”.

Free Trade

Free trade is the movement of goods and services without protectionist barriers.

The objective is for world free trade to expand. We will briefly examine this situation.
Figure 4.1.2 (a) illustrate Free Trade.

Figure 4.1.2 (a): Free Trade

Price

S1

P1

P2 S2 = Free trade

0 Q1 QE Q2 Quantity

Prior to Free Trade: D = S equilibrium = 0QE, Price of P1.

After Free Trade:

Supply Curve: becomes horizontal at S2
Price: this is lowered from P1 to P2
Domestic Supply: 0Q1
Imports: Q1 to Q2
Winners: domestic consumers because price is lower at P2; foreign producers.
Losers: domestic producers because they sell less and the price is lower.

219
Major Types of Protectionism

1. Embargo

An Embargo is a total ban on trade.

An embargo can be imposed:

(a) From outside the country. Likely for political or military reason. e.g.
U.N. embargo on sale of arms to South Africa during Apartheid era.
Most effective where the country cannot produce the goods and
services, or at very great cost.

(b) By a domestic government. e.g. drugs, guns, endangered species of

animals.

Figure 4.1.2 (b) illustrate an embargo.

Figure 4.1.2 (b): An Embargo

Price

P1

0 QE Quantity

Domestic Supply: 100%. Domestic industry flourishes.

Imports: nil
Examples: see above.

2. Tariffs

A Tariff is a tax on imports. It raises the price of domestic goods and services. Two
types:
(a) Specific Tariff: a specific amount per unit; e.g. $1 per litre/kg.

(b) Ad Valorem: amount of tax depends on the value of good/service; e.g. 10%
of Selling Price.

A Tariff raises the Supply Curve vertically by the amount of the tariff, exactly as an
indirect tax does.

220
Figure 4.1.2 (c) illustrate the effect of the imposition of a tariff.

Figure 4.1.2 (c): Imposition of a Tariff

Price

S1

P1
P3 S3 = With Tariff
P2 S2 = Free trade

0 Q1 Qt QE Q2 Quantity

Supply Curve: increases by the amount of the tariff, from S2 to S3

Price: this is increased from P2 to P3
Domestic Supply: increases from 0Q1 to 0Qt
Imports: Qt to Q2
Winners: domestic producers because price is higher at P3 and they sell more
Losers: domestic consumers because the cheaper quantity of imports is less and they
have to pay the higher domestic price

3. Quotas

A Quota is a physical limit imposed on the amount of goods and services imported.

Figure 4.1.2 (d): Imposition of a Quota

Price D1
S1
S3

D New equilibrium post-quota

P3
P2 S2 = with Free trade

0 Q1 Q2 Q3 Quantity

Imports
Domestic Domestic
Production production
before Quota post-Quota

Total Domestic
Supply

221
Supply Curve: at Q2, increases from S2 to S3
Price: this is increased from P2 to P3
Domestic Supply: 0Q1 plus Q2-Q3
Imports: Qt to Q2
Winners: domestic producers because price is higher at P3
Losers: domestic consumers because the cheaper quantity of imports is less and they
have to pay the higher domestic price

Results in reduced the consumption of the good or service compared to Free Trade.

4. Subsidies

A Subsidy is an amount paid of money by the Government to domestic producers.

Subsidies can:

(a) Be applied to domestic goods and services to lower domestic prices to

make them more competitive with imports.

(b) Be placed upon exports. This lowers their price below their true
production cost. Make them cheaper compared with their overseas
competitors.

Major Effects:

(a) Distorts the market.

(b) Results in artificial pricing mechanism.
(c) Allocation of resources is non-optimal.
(d) Protects inefficient domestic producers.
(e) Disadvantages efficient foreign producers.
(f) Distorts BOP on Current Account, Balance of Trade, and Terms of Trade.

Dumping: selling goods and services below the cost of production. Regarded as unfair
by WTO.

Figure 4.1.2 (e): Domestic Subsidy

Price D Shift in S.C. by amount of subsidy

S1

S subsidy

P1 S

0 Q1 Q2 Quantity

Imports

222
A subsidy shifts the supply curve down by the amount of the subsidy, from S1 to
S subsidy.

Domestic supply = 0Q1

Imports = Q1 to Q2
Winners: domestic producers
Losers: domestic consumers because they pay higher prices and their taxes subsidises
domestic producers; foreign exporters because their lose export sales/income.

Examples: USA: steel; agricultural products

EU: steel; agricultural products
Japan: agricultural products

5. Voluntary Export Restraints (VER)

The World Trade Organization (WTO) forbids countries to apply tariffs and quotas in
all but a few explicit circumstances, like dumping. Countries try to get around the
rules by inventing new restrictions.

An example is VER. A VER is where an exporting country agrees to a voluntary

quota of exports into a second country.

Example: Japan “agreed” to such restrictions on automobiles, steel and computer

chips requested by the USA and Europe.

The economic effect is just like that of an imposed quota. See Figure 4.1.2 (d).

Consumers end up paying more for less.

6. Exchange Controls

Exchange controls are a form of protection.

An exchange control exists where the Government of a country limits the amount of
foreign currency available to importers, or to citizens wishing to travel abroad, or to
companies wishing to invest abroad.

Examples: South Africa, Myanmar (Burma), and Zimbabwe.

7. Import Licensing

This is a form of rationing.

A license, or permission to import, has to be obtained from the Government. The

Government limits the amount of foreign currency available to importers.

Examples: Indonesia, Myanmar (Burma).

223
8. Administrative Barriers

Administrative barriers can be set up which make it expensive for importers to

compete. Often “hidden” costs.

Examples: establishing stringent (tough) safety, health and/or legal requirements for a
goods/services to be imported.

Example: Japan (in the cases of Rice, Beef) has often been accused of this. Why? To
protect local Japanese farmers who are politically very powerful.

Effects: domestic consumers often pay higher prices. Exporters may be prevented
from supplying goods as importers find it difficult to compete.

9. Health and Safety Standards

Some countries, such as Japan and Australia, imposed stringent health and safety
standards.

Common examples can be found in primary products-e.g. fruit and vegetables, rice
and meat products.

Their trading partners see these standards as a form of protectionism.

10. Environmental Standards

Environmental issues are of great concern to many countries. Governments are

worried about the economic, social, health and political effects of pollution and
environmental degradation.

These concerns may lead to the imposition of environmental standards on imports of

certain items. Again, if this happens it is a form of protectionism.

This issue is discussed in greater depth in Section 5.

224
4.1.3 Free Trade and Protectionism

Arguments Against Protection or For Free Trade

Chapter 4.1.1 examined the powerful arguments for Free Trade.

The most powerful argument against protection is the loss of comparative

advantage.

The effects of a loss of comparative advantage are:

1. Price of goods/services to consumers will be higher.

2. As a result of 1, consumer’s Yd (disposable income) will buy less.

3. Non-traded goods/services that use imported goods and services as inputs will
be more expensive.

4. Governments will protect the wrong (i.e. inefficient) industries.

5. There will be both “down stream” and “up stream” effects on goods/services
of 1-4. Example: say a LDC (Less Developed Country) offered infant industry
protection to its agricultural machinery industry. “Up stream”, the farmers as
users of tractors, are denied cheaper/superior imported tractors leading to
higher farm costs. “Down stream”, the agricultural produce will be more
expensive to local consumers and also less competitive as export to foreign
markets.

Arguments For Protectionism

1. The Assumption of Comparative Advantage is Unrealistic. Why?

The model assumes that opportunity cost is static. It is not. It is dynamic.

LDCs would be locked-in to low skilled, labour intensive methods of
production. Some countries- Japan, Taiwan, Singapore, Hong Kong, and
China-have/are continually changing their comparative advantage.

The model does not allow for uncertainty and risk. Concentration on a few
primary commodities subjects LDCs to considerable risk. Why? Because:
- synthetic substitutes replace primary goods.
-MDCs protect their primary industries against cheap M’s.

In the model prices reflect opportunity cost. However, it is only under

conditions of Perfect Competition that relative prices reflect opportunity costs.
Governments distort prices; for example through subsidies and taxes.

The model does not take into consideration who gains from trade. As the
majority of world trade is by MDCs, and MNCs, it is they who gain the most
from trade, not the LDCs.

225
 The model assumes full employment (and, therefore, countries are
producing on their PPF ). Not true. LDCs experience high levels of
unemployment and under-employment (China).

The model does not allow for economies of scale. LDCs may enjoy lower
opportunity costs in the future through economies of scale.

2. Infant Industry Argument

New industries in LDCs cannot compete with major MNCs of MDCs. They need
to be protected until they can benefit from economies of scale and become more
internationally competitive.

Figure 4.1.3 (a): Achieving Economies of Scale

Long Run
Average
Costs

LRAC

0 Output

As firms increase their total output their long run average costs decline. With
lower average costs of production, firms are better able to compete in world
markets. Exports increase, improving the BOP on current account.

3. Protecting Employment Argument

Protection to declining industries reduces structural unemployment. The social

and economic cost to workers may justify protection.

4. Loss of Government Revenue Argument

With trade comes increasing competition. Domestic industries may suffer a

decline in production resulting in higher unemployment. The net effect may be a
loss of government taxation revenues.

5. Strategic Arguments

Government’s in LDCs may wish to develop certain industries for strategic or

national security reasons.

For example, companies manufacturing defence equipment.

226
 Other examples include food production in order to attain self-sufficiency, the iron
and steel industries in order to produce strategic goods.

6. Balance of Payments Disequilibrium Argument

Protection may be used to overcome a deficit in BOP on current account.

Reduction of M’s helps reduce BOP on current account deficit.

7. Anti-Dumping Argument

Anti-dumping cases are continually before the WTO.

Even though it is against WTO rules, dumping occurs. That is, goods and services
are sold (exported) below their true cost of production.

Key effects of dumping in the country in which they occur are:

* Loss of sales and profits for domestic firms. Some may go out of business.
* Increased domestic unemployment.
* Reduced AD.
* Worsening BOP on current account.
* Less taxation revenues for government.
* Less government revenues to fund economic development programmes.

Arguments against Protectionism

In addition to those arguments already advanced, there are other arguments. For
example:

1. Inefficiency in the Allocation of Scarce Resources

Protectionism can lead to monopoly power in the market. Firms earn supernormal
profits.

As P>MC, economic efficiency is not achieved. There is non-optimal allocation of

scarce resources. Consumers/society are worse off.

2. Costs of long-run Protectionism

Reliance on protectionism in the long run can result in the following costs being
incurred:

* The costs of imports are more expensive. Domestic industries that import goods-
either in finished form or as inputs in their manufacturing process-pass these costs on
to other manufacturers and to consumers.

* Given the above, the cost of higher domestic goods/services will be passed on to
consumers.

227
3. Increased Prices to Consumers

Consumers are generally worse off under protectionism.

They face:
* Higher domestic prices.
* Reduced choice of goods/services.
* Often lower quality of goods/services.
* Lower standard of living.

4. Cost Effect of Protected Imports on Export Competitiveness

Refer to Point 2 above. In this situation, with higher costs firms that enter the
international market will find they are often non-competitive in terms of price.
Possible flow-on effects include:

* Reduced exports.
* Negative effects on the BOP current account.
* Worsening terms of trade.
* Negative effect on merchandise trade account.

Further flow-on effects from the above include:

* Reduction in AD.
* Reduced economic growth.
* Increased unemployment.
* Lower taxation revenues.
* Lower economic development.

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4.1.4 Economic Integration/Trade Agreements

General

GATT: General Agreement on Trade and Tariffs. Formed 1947.

WTO: World Trade Organization. Formerly GATT.

Globalisation is a process of breaking down barriers between countries resulting in

greater integration and interdependence. Since the 1980s, largely brought about
through massive technological changes in communications and information.

Globalised economy is the movement, through globalisation, to a borderless world

economy.

Two Major Types of Trade Agreements

There are two major types of trade Agreements:

1. Multilateral Trade Agreements.

The most important is under the auspices of the WTO.

New members can gain large tariff reductions immediately by joining the WTO due to
the “Most Favoured Nation” clause: ‘the most preferential tariff offered by any
member can be claimed by every other member’.

Since 1947, there have been 9 trading rounds. The objective is to reduce tariffs and
other forms of protectionism to enable an expansion of world trade. Major problems
exist in getting agreement in agriculture.

China joined the WTO in late 2001.

The latest is the Doha Round. It is still continuing.

The Doha Round (2001 to current)

Multilateral trade negotiations under the DOHA ROUND got underway in 2001 at
the WTO, currently with 148 member countries, in Geneva, Switzerland. The latest
negotiations were conducted at Cancun, Mexico, in 2003.

Major objective of the WTO is to further reduce tariffs, particularly in agriculture.

However, it has proved very difficult to get member countries to agree.

So far, the Doha Round has been a failure-primarily because of the reluctance of
several MDCs, most noticeably the USA, EU, Japan and South Korea, to make major
concessions to reforms to reduce protectionism in agriculture.

As a result, many countries have decided to primarily pursue and enter into Bilateral
FTAs. Countries have also sought to join the major Trading Blocs as a means of
expanding trade.

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Economic Integration

Economic integration occurs when groups of countries form limited free trade areas
by integrating economically. These are known as trading blocs.

There are three major types of trading blocs:

1. Free Trade Areas: goods and services move freely between these countries.
Most important that goods/services do not enter with the lowest tariffs then
move freely to the member countries with higher trade barriers. Each country
maintains its sovereignty.

2. Customs Union: unification of customs and trade policies.

3. Common Market: goods and services, as well as factors of production, move

freely among members. e.g. EU

Examples of major trading blocs include APEC; ASEAN; EU; MERCOSUR;

NAFTA.

Also, new Trading Blocs are being proposed all the time. Example include ASEAN
Plus 3 (China, Japan & South Korea); expansion of EU.

A major effect of the development of above trading blocs is that the world is forming
into major trading areas, almost to the exclusion of the poor LDCs. In other words,
LDCs are being ‘squeezed out’ from participating in the benefits of the growth in
world trade.

2. Bilateral Free Trade Agreements

Bilateral free trade agreement refers to a free trade agreement between two
countries.

In recent years these have become more common, partly due to the breakdown of the
Doha Round.

Examples include: USA-Australia Free trade Agreement signed in 2005; Australia-

Thailand FTA; Australia-Singapore FTA; Australia-New Zealand FTA.

Other examples abound. Students should obtain examples of FTAs for their country of
interest.

A major effect of the development of above is that the world is forming into major
trading areas, almost to the exclusion of the poor LDCs. In other words, LDCs are
being ‘squeezed out’ from participating in the benefits of the growth in world trade.
Why? Mainly because LDCs do not have the economic and political ‘muscle’ in the
world trade arena.

230
Trade Creation and Trade Diversion

Important to make distinction between:

1. Trade creation

Trade creation causes total economic welfare to increase as a result of the new trade
grouping.

Example: prior to joining new trade grouping if a country was protecting an

inefficient industry, then consumers would have been paying more for goods/services.
After joining, consumers have lower costs of good/services that leads to lower prices
and increase in quantity consumed.

2. Trade Diversion

This occurs when a country was already benefiting from low cost goods/services on
the world market before entering the trade grouping.

Example: UK was buying agricultural products cheaper from USA, Australia,

Argentina and N.Z. prior to joining EU in 1971. Once it joined EU, with higher
tariffs, U.K. consumers ended up paying more.

Because of this, results in trade diversion. Trade was diverted from low cost to high
cost producers.

231
4.1.5 World Trade Organization

GATT: General Agreement on Trade and Tariffs. Formed 1947.

WTO: World Trade Organization. Formerly GATT.

Refer to material covered in Chapter 4.1.4 and in Section 5.

This Chapter examines the aims and success and failure of the WTO in more detail.

Aims

WTO aims/objectives can be summarised as follows:

1. To promote an expansion of world trade through Multilateral Free Trade

Agreements under the auspices of the WTO.
2. To reduce trade restrictions.
3. To reduce agricultural protectionism, particularly tariffs and subsidies.
4. To promote trade in services.
5. To strengthen intellectual property rules.
6. To curtail dumping.

Successes and Failures

Successes

These include:

1. Increasing membership. Member countries account for over 90% of world

trade.

2. In real money terms, the value of world trade has increased 15-fold in the past
45 years.

3. Major reduction in tariff levels from 40% in 1947 to 5%.

4. Major reduction in non-tariff barriers.

Failures

These include:

1. The Doha Round has been unsuccessful in reducing agricultural protectionism.

Particularly in reducing tariffs and subsidies imposed by MDCs. As a result,
most LDCs are still disadvantaged.

2. The growth in world trade has been dominated by MDCs, accounting for 68%
to 70%. LDCs have gained in dollar terms, but not in percentage terms.

3. Dumping still common.

232
4.1.6 Balance of Payments

External Equilibrium is concerned with the balance of payments on current account

of a country. That is, whether it is in balance, surplus or deficit. It is one of the five
major macroeconomic objectives.

The attainment of balance over a period of time is an indication that a country can pay
its way in the world. Persistent BOP on current account deficits-a major problem for
many LDCs-obviously indicates that a country is living beyond its means.

The Balance of Payments (BOP) is a record of the financial transactions of a nation

with all other nations.

The items of receipt and expenditure in the BOP is divided into two main sections:

* The Current Account.

* The capital Account.

The Current Account is divided into:

Merchandise Trade or Visible/Tangible Items: export and import of goods; e.g.

coal, cars, machinery, computers, agricultural goods etc.

Trade in Services or Invisible/Intangible Items: export and import of services; e.g.

education, tourism, films, transport, shipping, insurance, other services etc.

Investment Income Flows: e.g. profits, interest, dividends etc. Both coming in and
going out.

Government Grants: Both outflow and inflow. e.g. foreign aid.

Private Transfers: e.g. wages and pensions sent home or received from abroad.

The Capital Account is divided into:

Capital Inflows and Outflows: both short (e.g. bonds and bank deposits) and long
term (purchase/sale of assets such as companies, farms etc).

Increase or Decrease in Foreign Exchange Reserves.

Increase or Decrease in Foreign Aid Assets.

Any Capital Account surplus has to balance the Current Account deficit. The demand
for every dollar has to be matched by an equal supply.

Net Balance of Payment = Current Account balance + Capital Account balance = 0.

The Current Account generally reflects the economic health of country in the short
term. That is, shows whether a country is paying its way.

233
Having continual Current Account deficits in the long term is cause for concern.

However, this may not be so in the short term if the country was importing productive
assets (machinery, technology etc) that will, in turn, lead to an increase in exports in
the longer term.

Another example is spending overseas on education. Creates an Outflow in the short

term; leads to increase in GDP in longer term. Examples of countries that are
investing in Human Capital include China and India.

Table 4.1.6 shows the BOP figures for ‘Country x’ as an example.

Table 4.1.6: BOP of ‘Country x’

Amount US $ Billions

Inflows Outflows
1. Merchandise Exports-$600 2. Merchandise Imports-$800

Merchandise Trade Balance -$200

3. Service Exports-$300 4. Service Imports-$200

5. Income US Inv’ts-$200 6. Income Outflow US Inv’ts-$100
7. Gov’t Grants Received- 7. Net US Gov’t Grants-$50
8. Private Transfers & Pensions- 8. Net Private Transfers/ Pensions-$50

Current Account Balance (Items 1-8) -$100

9. US Capital Inflow-$150 10. US Capital Outflow-$115

11. Increase in US Official Reserves-$25
12. Increase in foreign aid assets in US-$50

Capital Account Balance (Items 9-12) +$110

13. Statistical discrepancy 13. Statistical discrepancy-$10

Net Balance (Items 1-13) $0

234
4.1.7 Exchange Rates

An Exchange Rate is the rate at which one currency trades for another on the foreign
exchange markets (FOREX).

An exchange rate is a Price. Students should “treat/view” the currency like any other
goods or service.

Determination of Exchange Rates

In a Floating Exchange System (that is, the rate is allowed to float freely up or down),
the rate of exchange (price) is set solely through the interaction of demand and supply.

Some countries have a Fixed Exchange Rate with certain currencies. Either the
Central Bank or the Government determines the price at which the exchange rate is
fixed. Examples include China: the Yuan rate is currently fixed at US$1.00 to Yuan
8.11; Saudi Arabia, where the Real rate is currently fixed at US$1.00 to Real 3.75.

Note: Unless otherwise stated in this text, we will assume that the currency is
Floating.

Factors affecting the Demand for the Currency

The following major factors will affect the Demand for the currency.

1. Export of goods/services.
2. Income credits.
3. Capital inflow.

Factors affecting the Supply of the Currency

The following major factors will affect the Supply of the currency.

1. Imports of goods/services.
2. Income debits.
3. Capital Outflow.

Demand and Supply of a Currency

If Demand (D) > Supply (S), the value of currency ( the price of the currency) will
rise (Appreciation).

If Supply (S) > Demand (D), the value of currency (the price of currency) will fall
(Depreciation).

Although temporary disequilibrium occurs, as with other markets, the normal market
position is equilibrium. That is D = S.

Because of the Laws of Demand and Supply, the Demand Curve for a Currency will
slope downwards and the Supply Curve will slope upwards as shown in Figure 4.1.7
(a).

235
In practice, the process of reaching equilibrium on the FOREX is extremely rapid.
Today, it is done electronically, 24 hours a day, 7 days a week, somewhere in the
world.

Figure 4.1.7 (a) shows the Demand and Supply of a currency. The price of the
currency is shown on the vertical axis; the quantity of the currency on the horizontal
axis.

Figure 4.1.7 (a): Demand and Supply of a Currency

Price S
of
Currency

P1

0 QE Quantity of Currency

Market equilibrium is where demand and supply curves intersect. Price = P1.
Quantity = 0QE. The market clears.

Key Terms

Unless a government intervenes or a fixed exchange rate exists, the changing forces of
demand and supply will cause the exchange rate to change.

Depreciation is a fall in the price of a currency against other currency/currencies.

Results from a Shift in the Demand and/or Supply Curve.

Devaluation is depreciation under a regime of fixed exchange rates. Results from

Government action.

Appreciation is a rise in the price of a currency against other currency/currencies.

Results from as Shift in the Demand and/or Supply Curve.

Revaluation is an appreciation under a regime of fixed exchange rates. Results from

Government action.

Note:
1. Depreciation and Appreciation relate to a Floating Exchange rate.

2. Devaluation and Revaluation relate to a Fixed Exchange rate and result from
Government action.

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Major Factors Causing the Demand and Supply of a Currency to Appreciate or
Depreciate

1. A Change in Incomes: Examples:

a. Imports (M) are a function of Income (Y). If Domestic National

Income increases it leads to increased demand for Imports. Supply of
currency increases leading to a depreciation of currency.

b. If foreign incomes rise, demand for Exports (X) will increase. The
demand for its currency will increase leading to an appreciation of its
currency.

2. A Change in Relative Prices: Inflation in a country will affect the exchange

rate.

a. As domestic prices of goods/services increases, M become relatively

cheaper and X become relatively dearer. The supply of the currency
will rise and the demand for it will fall. Both will put downward
pressure on the exchange rate i.e. depreciation.

b. As domestic prices of goods/services decreases, M become relatively

dearer and X become relatively cheaper. The demand for the currency
will rise and the supply of it will fall. Both will put upward pressure on
the exchange rate i.e. appreciation.

3. A Change in Relative Investment Prospects.

a. If overseas investors raise their expectations of a higher return on their

capital in a country, then demand for the currency will increase to
enable them to invest. Appreciation.

b. If overseas investors lower their expectations of a lower return on their

capital in a country, then demand for the currency will decrease.
Depreciation.

4. A Change in Relative Interest Rates.

a. High interest rates in USA, say relative to Australia, will result in

investors wanting to invest in the USA rather than in Australia.
Increased demand for US dollars. Appreciation of US$.

b. However, in order for a) to happen, the supply of A$ will have to

increase. Depreciation of A$.

c. Speculative activity = approx. 80% of all daily currency transactions.

It is the trading changes that determine long-term exchange rates.

237
 5. Use of Foreign Reserves.

a. Sometimes Governments intervene, using gold and foreign currency

reserves, to create greater stability of their currency.

b. In a floating system, this known as a “dirty float”.

Note: A change in Exchange Rates affects a country’s Terms of Trade (see later
Chapter) Terms of Trade is the ratio of Average Export Prices to Average Import
Prices. Expressed as an Index. If X prices increase relative to M prices = improvement
in Terms of Trade. And vice-versa.

Shifts in Demand and Supply Curves

The above factors will cause the Demand and Supply Curves to shift.

Example # 1: Increase in Demand for Currency

Prior to the increase in demand, market equilibrium is where demand and supply
curves intersect. Price = P1. Quantity = 0QE. The market clears.

Figure 4.1.7 (b) shows what happens when the demand for a currency increases.

Figure 4.1.7 (b): Increase in Demand for Currency

Price S
of
Currency
P2

P1
D2

D1

0 QE Q1 Quantity of Currency

The increase in demand results in a shift in the demand curve to the right, from D1 to
D2.

The quantity of the currency increases from 0QE to 0Q1. The price of the currency
increases from P1 to P2. The market clears at the new price, P2.

Example # 2: Decrease in Demand for Currency

Prior to the increase in demand, market equilibrium is where demand and supply
curves intersect. Price = P1. Quantity = 0QE. The market clears.

238
Figure 4.1.7 (c) shows what happens when the demand for a currency decreases.

Figure 4.1.7 (c): Decrease in Demand for Currency

Price S
of
Currency
P1

P2
D1

D2

0 Q1 QE Quantity of Currency

The decrease in demand results in a shift in the demand curve to the left, from D1 to
D2. The quantity of the currency decreases from 0QE to 0Q1. The price of the
currency decreases from P1 to P2. The market clears at the new price, P2.

Example # 3: Increase in Supply of a Currency

Prior to the increase in demand, market equilibrium is where demand and supply
curves intersect. Price = P1. Quantity = 0QE. The market clears.

Figure 4.1.7 (d) shows what happens when the supply of a currency increases.

Figure 4.1.7 (d): Increase in the Supply of a Currency

Price S1
of
Currency
S2

P1

P2

0 QE Q1 Quantity of Currency

The increase in supply results in a shift in the supply curve to the right, from S1 to
S2.

239
The quantity of the currency increases from 0QE to 0Q1. The price of the currency
decreases from P1 to P2. The market clears at the new price, P2.

Example # 4: Decrease in Supply of a Currency

Prior to the decrease in supply, market equilibrium is where demand and supply
curves intersect. Price = P1. Quantity = 0QE. The market clears.

Figure 4.1.7 (e) shows what happens when the supply of a currency decreases.

Figure 4.1.7 (e): Decrease in the Supply of a Currency

Price S2
of
Currency
S1

P2

P1

0 Q1 QE Quantity of Currency

The decrease in supply results in a shift in the supply curve to the left, from S1 to S2.

The quantity of the currency decreases from 0QE to 0Q1. The price of the currency
increases from P1 to P2. The market clears at the new price, P2.

Note: Market forces are affecting both the demand and supply at the same time.
Consequently, both curves will shift.

Affects of change in Value of Currency on Balance of Payments

Any change in the value of the currency will impact on the Balance of Payments
(BOP).

Remember that the BOP figure is expressed in a monetary unit. This is arrived at by
Quantity (Q) x Price (P).

Price is influenced by the exchange rate. Any change in the exchange rate will affect
the value shown in the BOP figure.

240
Depreciation of Currency

Depreciation in the value of the currency will lower the price of exports of the
country. Exports will become more competitive internationally and should increase.

Depreciation in the value of the currency will raise the price of imports of the
country. Imports will become dearer and should decrease.

The combined effect is an improvement in the Merchandise Trade Account, Balance

of Trade and in the BOP on Current Account.

Appreciation of Currency

Appreciation in the value of the currency will raise the price of exports of the
country. Exports will become less competitive internationally and should decrease.

Appreciation in the value of the currency will lower the price of imports of the
country. Imports will become cheaper and should increase.

The combined effect is deterioration in the Merchandise Trade Account, Balance of

Trade and in the BOP on Current Account.

241
Fixed Exchange Rates: Advantages

1. Increased Certainty: businesses do not like uncertainty because it makes it

difficult to plan and budget. Exchange rates are beyond their control.

2. Possible Increased Trade: there is no evidence that this happens. Not a strong
argument.

3. Eliminates Currency Speculation: very important. Therefore, no

destabilization of currency.

4. Promotes Government Discipline: by definition the Government cannot

influence the exchange rate to influence macroeconomic policy. Therefore, the
Government needs disciplined economic policies.

5. Eliminates influence on Domestic Inflation: eliminates the effect of an

appreciation of currency that leads to an increase in M prices that leads to
increased inflation.

Fixed Exchange Rates: Disadvantages

1. Central Bank must keep large stocks of Gold & Foreign Reserves to intervene
in the FOREX and support the currency.

2. Domestic policy is dictated by the world economy: domestic inflation is

dictated by world inflation rates that cannot be neutralized by domestic
monetary policy. Major macroeconomic disadvantage.

3. No automatic adjustment: means that there is a real danger of large changes in

exchange rate-e.g. Argentina 2002; various countries in 1987 Asian Currency
crisis; in 1970s due to massive increase in price of crude oil.

Examples of Fixed Exchange Rate:

1. Saudi Arabia Real to US$ = Real 3.75: US$1.00
2. China Yuan to US$ = Yuan 8.30: US$1.00 (pre-mid July 2005).
3. Argentina Peso to US$= Peso 1: US$1 (to late 2001).
4. Myanmar Kyat to US$.

Note: In July 2005, the Chinese Government-through the Bank of China-announced a

2.1% revaluation of the Yuan to the US$. It is now Yuan 8.11: US$1.00. In addition,
the Yuan is now pegged to a basket of currencies.

Floating Exchange Rates: Advantages

1. There is Auto-Correction: BOP is self-correcting. Therefore, no need for

Government intervention.

2. No reserves/liquidity shortage: argument is that there is no Central Bank

intervention. (theory; not true in reality).

242
 3. Freedom to make domestic policy: because the Government is not locked into
unacceptable high world interest rate policy, the Government can set its own
monetary policy to suit macroeconomic objectives (i.e. unemployment and
inflation levels). The exchange rate will then adjust the BOP. Major
macroeconomic advantage.

4. Smooth exchange rate changes: major changes are avoided-e.g. Argentina in

2002.

5. Reduced speculation: because the rate can move freely, and in decimal points,
according to demand and supply. See counter-argument below.

Floating Exchange Rates: Disadvantages

1. Increased uncertainty: a floating rate adds to uncertainty.

2. Increased speculation: exchange rate traders are motivated by profit. They can
influence the value of a currency, particularly smaller countries-e.g. Malaysia,
Thailand, Indonesia etc in mid-1987 onwards. This became known as the
Asian Currency Crisis.

3. Promotes lack of Government discipline. Because they know that the

exchange rate will adjust inflation differentials, Governments can pursue
inflationary policies.

Single Currency/Monetary Integration

The Euro is the most widely used single currency resulting from monetary integration
within the EU.

Most members of the EU use the Euro as their currency. There are exceptions, the
major one being the U.K., that still uses its own currency, the Pound Sterling.

Advantages

Major advantages include:

1. Lower transaction costs for businesses, consumers and governments.

2. Benefits of economies of scale in terms of printing and stamping costs of the

currency.

3. The argument that a single currency eliminates exchange rate uncertainty is

often advanced. This argument is flawed because control passed from EU
Member Central Banks to the European Central Bank (ECB).

243
Disadvantages

Major disadvantages include:

1. No control over the exchange rate as a macroeconomic policy instrument. The

European Central Bank (ECB) controls the Euro exchange rate.

2. Because of 1, the government/Central Bank of EU Members cannot use the

exchange rate to influence External Equilibrium (BOP).

3. As a result, adjustments to External Equilibrium (BOP) cannot be made to

influence a country’s Internal Equilibrium (Budget).

4. The effects of the above flow through to all five macroeconomic objectives.

5. There are major structural differences between Members; each country is at a

different stage in their economic growth and development, and in their
business cycle. A single currency does not take this into major consideration.

Purchasing Power Parity-Theory of Exchange Rates

Purchasing Power Parity (PPP) exists when a given amount of currency will buy
exactly the same bundle of goods, in each of two countries, at the current exchange
rate.

The PPP theory holds that movements in exchange rates will offset movements in
relative inflation rates. It argues that the exchange rates will rise/fall in line with
inflation. Why? The difference in inflation rates will affect the balance of trade that
will, in turn, result in a change in the demand for or supply of a currency that will lead
to an appreciation or depreciation of the currency.

Examples:

1. An increase in inflation leads to an increase in the cost of local goods/services that

will lead to an increase in M’s and thus an increase in supply of money. This will lead
to a fall in the price of the currency. Depreciation.

2. A decrease in inflation leads to a decrease in the price of local goods/services that

will lead to an increase in X’s and thus an increase in the demand for money. This
will lead to an increase in the price of the currency. Appreciation.

244
4.1.8 Balance of Payments Problems

This chapter provides an overview of the links between the external balance and the
internal balance of the macro-economy.

That is, the effect of imbalances in the Balance of Payments (BOP) on the other four
macroeconomic objectives: economic growth, economic development, full
employment and price stability (Inflation).

Changes in Exchange Rate

In Chapter 4.1.7 we covered the major changes that determine the value of the
exchange rate. We also noted how these changes affect the BOP.

Changes in the External Balance, Aggregate Demand and the Domestic

Macro-economy

There is a strong relationship between External Balance (X-M) and Internal Balance
(Budget surplus or deficit). That is, between the BOP and AD = (C + I + G + X – M).

A change in the external balance (X – M) will affect the domestic economy. It acts
through the multiplier (+ or -) to raise or lower National Income.

This is summarised as follows:

If X↑ → AD↑
If X↓ → AD↓

If M↑→ AD↓
If M↓ →AD↑

If (X – M)↑ then AD (National Income) will increase and consequently may reduce
unemployment or add to inflation (if the economy is near to full employment levels of
production).

If (X-M)↓→ then AD (National Income) will fall and this may lead to an increase in
unemployment or a fall in inflation.

Affect on Five Macroeconomic Objectives

A change in the External balance will have an impact on all other macroeconomic
objectives.

Example # 1: Deterioration in BOP Current Account

As discussed above, a deterioration in BOP Current Account will reduce AD. As a

result:

245
 (a) Economic Growth will decline.

(b) Economic Development will be less because the necessary funds from
economic growth are not available.

(c) Because Real GDP has declined, the Full Employment objective cannot
be achieved.

(d) Inflationary pressures will abate, thus the objective of price stability is
more likely.

(e) The objective of External Equilibrium is less likely.

Example # 2: Improvement in BOP Current Account

As discussed above, an improvement in BOP Current Account will increase AD. As

a result:
(a) Economic Growth occurs.

(b) Economic Development will be more likely because the necessary funds
from economic growth are available.

(c) Because Real GDP has increased, the Full Employment objective is more
likely to be achieved.

(d) Inflationary pressures will increase, thus the objective of price stability is
less likely.

(e) The objective of External Equilibrium is more likely.

Countries Resorting to Protectionism

A major benefit of a floating X rate system is that imbalances in the BOP will
automatically correct themselves.

For example, if there is an increase in the BOP current account deficit the value of the
currency will decrease. The price of exports will decline and the price of imports will
increase. Export volumes will increase; import volumes will decrease. The combined
effects will be a reduction in the BOP current account deficit.

This is summarized as follows:

If there is a CAD ↑ → value of the currency↓ → price of X↓ price of M↑→ X↑M↓

→ CAD↓

However, if a country has a managed exchange rate system then the Government will
have to adopt other measures to reduce a growing current account deficit. For
example, it may impose import controls but this is increasingly difficult under World
Trade Organization (WTO) Rules and any country that imposes import controls may
face retaliatory action from the countries that are affected.

246
Exchange Rate Movements

Most countries have a Managed Exchange Rate. Most common type is called an
Adjustable Peg.

The Government sets an acceptable “band”, with a ceiling (top of band) and floor
(bottom of band) rate, and allows the rate to fluctuate within the band.

The Central Bank regulates the exchange rate. It intervenes by buying/selling

currency to keep the rate within the band. Thus, the exchange rate is managed.

There are ways, for example, to prevent an Exchange rate falling excessively

1. Impose import restrictions. This against WTO and the country could suffer
from trading retaliation.

2. Deflate the domestic economy. The Government could use monetary/fiscal

policies to deflate or contract the economy. Demand for imports would fall
leading to a reduction in the supply of the currency resulting in a shift in SC to
the left.

Note: if above does not work, then it will be necessary to re-set the Peg; either,

1. Upwards: known as a revaluation of the currency.

2. Downwards: known as a devaluation of the currency.

Dirty Float

A Dirty Float is where there is interference to “smooth” out changes in the floating
exchange rate. It is part of a managed float of the exchange rate.

A Dirty Float affects an orderly adjustment, by the Central Bank buying/selling

currency using foreign exchange reserves.

Most countries operate this managed system.

Long Term Methods of Adjusting the Exchange Rate under a Managed System

1. Expenditure Switching is persuading people to switch expenditure between

foreign and domestic goods and services by changing their relative prices.
This can be achieved by:

a) Encouraging expenditure switching by using one or more forms of

protection. Imposing tariffs or subsidizing X’s is a way of improving
the Current Account result and manipulating the value of the currency.
Less likely because of WTO rules, but still goes on.

247
 b) Encouraging expenditure switching via changing the exchange rate. A
currency can be depreciated to help improve the Current Account
deficit. A depreciation of the exchange rate make X’s cheaper/M’s
dearer, which leads to an increase in volume of X’s/decrease in the
volume of M’s which leads to a reduction in the Current Account
deficit.

2. Expenditure Changing is changing the total amount spent on M’s by altering

income.

The government can do this through deflationary/contractionary policies.

These policies aim to reduce National Income/AD. In turn, this will lead to a
reduction of M’s, less supply of the currency to the FOREX markets, and the
value of the currency will rise.

These policies will affect the internal economy; unemployment will rise/fall
and inflation will fall/rise. How? Examples follow.

An increase in the price of the currency will lead to an increase in X prices, a

reduction in X volume. Domestic production will decrease leading to an
increase in unemployment.

On the M side, an increase in the price of the currency will lead to a decrease
in M prices. This will follow through to lower domestic inflation. This will
make domestic production cheaper which will lead to an increase in
X’s/reduction in M’s. Unemployment will fall. Current Account deficit will
improve.

Deflation is likely to affect interest rates and thus the Capital Account. For
example, if restrictive monetary policies reduce income and M’s, the
corresponding rise in interest rates will attract inflows on the Capital Account.

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Marshall-Lerner Condition

Marshall-Lerner condition states that if the PEDx + PEDm > 1, then a depreciation
of the exchange rate will improve the balance of payments. If the PEDx + PEDm = 1,
then the BOP will remain unchanged. If the PEDx + PEDm < 1, then a depreciation
will worsen the BOP.

Up to now we have not considered the impact of price elasticity on X’s and M’s, and,
therefore, its affect on BOP.

Students should review Ch 2.1.2 before proceeding.

Need to consider the value change-i.e. P x Q.

Need to consider PED for X’s and PED for M’s.

PED for Exports: Depreciation of Exchange Rate

Qd X’s > 1 = PED X’s price elastic = depreciation will lead to improvement in BOP.

Qd X’s = 1 = PED X’s unitary = no change in BOP.

Qd X’s < 1 = PED X’s price inelastic = depreciation will lead to deterioration in BOP.

PED for Imports: Depreciation of Exchange Rate

Qd M’s > 1 = PED M’s price elastic = depreciation will lead to improvement in BOP.

Qd M’s = 1 = PED M’s unitary = no change in BOP.

Qd M’s < 1 = PED M’s price inelastic = depreciation will lead to deterioration in
BOP.

A change in exchange rates affects both X’s and M’s at same time.

It is possible to calculate the combined effects of a depreciation on X’s and M’s

jointly.

PEDx + PEDm > 1 BOP will improve.

PEDx + PEDm = 1 BOP will not change.

PEDx + PEDm < 1 BOP will deteriorate.

Above is known as the Marshall-Lerner condition.

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For a country with BOP Deficit: depreciation of currency will be more effective the
higher the combined elasticity’s of X’s and M’s.

For countries with PEDx + PEDm < 1 BOP will deteriorate. Therefore, depreciation
will not work. Appreciation is better solution.

The J-Curve Effect

J-Curve effect refers to the way and the time frame in which the trade balance may
initially worsen before it improves, after a devaluation/depreciation of the exchange
rate.

When a devaluation/depreciation of a currency occurs the BOP is likely to worsen

before it improves. This is the J-Curve Effect.

Reason: it takes time before the adjustments take effect. Why? Time is an important
determinant of elasticity.

In the short term, % change in M’s < % change in X’s because:

a) It takes time for domestic producers/consumers to switch to local

products. That is, away from dearer M’s to cheaper domestic
goods/services.

b) It takes time for overseas producers/consumers to switch away from

dearer domestic goods/services to cheaper M’s (X’s of country which
has devalued).

In the short term, the J-Curve Effect over-rides the Marshall-Lerner Condition. See
Figure 4.1.8 (a).

Figure 4.1.8 (a): The J-Curve Effect

X-M

Surplus

Deficit

t1 Time

The figure above shows that BOP first worsens, and then recovers, due to the J-Curve
effect.

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4.1.9 Terms of Trade

The international Terms of Trade is the rate at which exports will trade for imports.

Measurement of Terms of Trade

The Terms of Trade reflects the Prices of goods and services. The terms of trade
expresses a price relationship.

Three Indices are used:

1. Index of Export (X) prices.
2. Index of Import (M) prices.
3. Terms of Trade Index.

Terms of Trade = Index of X Prices 100

--------------------- X -----
Index of M Prices 1

= Expressed as an Index. Base year = 100.

Therefore,

a) If the % Increase in X Prices > % Increase in M Prices = improvement

in the terms of trade.

b) If the % Increase in X Prices < % increase in M Prices = terms of

trade worsens.

This is only measuring changes in Prices.

Above does not tell us what happens to BOP figure. BOP Value = P x Q.

Changes in a country’s Terms of Trade will also affect a country’s internal economy.
For example, an increase in X prices will increase X income which will increase AD
and economic growth.

Causes of Changes in the Terms of Trade

1. Short Run: day-by-day changes in a floating exchange rate will affect both X
and M prices. Capital movements dominate this change.

2. Long Run: the movement in domestic prices determines the trend of exchange
rates. The domestic inflation rate and productivity determine domestic prices.
The relative inflation rates of trading countries are important.

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Volatility of the Terms of Trade For LDCs

Most LDCs are heavily dependent on a few primary products for X’s.

Major factors that determine LDCs Terms of Trade include:

1. Their Primary products tend to be PED inelastic.

2. Their Primary products tend to be PES inelastic.

3. Their Primary products tend to be YED inelastic.

4. Their M’s tend to be PED elastic.

5. They are subjected to major supply-side external shocks.

6. Most LDCs are heavily reliant on oil M’s. In recent years, particularly 2004-
2005, the price of crude oil has skyrocketed.

In summary, LDCs “cop it” from all sides. Their major exports are primary products;
major imports are oil and capital items.

Another major consideration is that LDCs have not been the major beneficiaries, in
terms of increased % share, of expanding world trade. This has gone to MDCs.

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SECTION 5: DEVELOPMENT ECONOMICS

5.1 SECTIONS

5.1.1 Introduction to Economic Development

This material has already been covered in Chapter 3C.1.3.

Before studying new concepts under Development Economics, students will find a
review of this material beneficial.

Distinction Between Economic Growth and Economic Development

Economic Growth is an increase in Real GDP per Capita. This is an increase in a

country’s total output (production) over time per head of population.

Economic Development includes an increase in Economic Growth plus tangible and

intangible improvements in the standard of living (S.O.L.).

Economic growth is important for economic development. If there is an increase in

national output the S.O.L. is usually better and poverty is reduced. This not always the
case.

‘Trickle-Down’ Effect

Less Developed Countries (LDCs) often pursue economic growth vigorously

believing there will be a ‘trickle-down effect’. That increased creation of wealth
amongst a few would lead to benefits over time for all. This is not necessarily true.

Use of Production Possibility Model

Economic Growth is an increase in Real GDP per Capita.

A Production Possibility Model is a useful tool in understanding this. See Figure

5.1.1 (a).

In this simplified model of reality, three assumptions are made: that the economy
can…

• Only produce two types of goods-manufactured goods and agricultural goods.

• Resources are held constant.
• Technology is held constant.

Note: later we will change the above three assumptions as they are unrealistic.

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Figure 5.1.1 (a): Production Possibility Model: Actual Growth

Manufactured
Goods B
C F

D
A

0 Agricultural Goods

B to E is attainable and efficient.

A move from D to C involves an opportunity cost in agricultural goods.

F is unattainable; the country cannot produce this combination of goods, given

assumptions.

A move from A to C would increase output. This is described as an increase in

actual output.

Now we modify the model to examine an increase in potential economic growth. See
Figure 5.1.1 (b).

Figure 5.1.1 (b): Production Possibility Model: Potential Growth

Manufactured
Goods

PPF1 PPF2

0 Agricultural Goods

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When whole PPF shifts to the right, from PPF1 to PPF2, this is an increase in
potential output.

This could be achieved if more resources or better technology were available.

Whereas, a move from A to C in the previous diagram would increase actual output.

In this section we are studying how to increase potential output.

An Increase in Real GDP and GDP Per Capita

As GDP may also increase due to price inflation, the money GDP figure is adjusted to
arrive at Real GDP.

Year 1 GDP Year 2 GDP

$100m $110m = $110m x 100 = 10% inc.
$100m 1

If inflation was at 5.5% during this year then 55% of the increased GDP is due to
price increases. So only 4.5%, or 45%, is due to real growth (10% - 5.5% = 4.5%).

If the population is growing at 2% then the increase in output per head is:
4.5% - 2% = 2.5%.

Economic Growth is the increase in Real GDP per capita, over a certain period,
usually one year.

Note. If GDP figure given does not state whether it is nominal or Real GDP, then
assume and state in your answer that you assume that it is a nominal figure.

The Significance of the Growth Rate

• If GDP increases by 1% per year it will double in 72 years, 2% in 36 years and so

on.

• The two parts of GDP per head, namely GDP and population, are of major
importance.

• More growth enables higher levels of production and consumption.

• If there are more good and services it is possible to reduce poverty by improving
nutrition, health care or literacy and so development has occurred as well as
growth.

Economic Growth with and Without Economic Development

Now we will bring the above information together to examine economic growth with
and without economic development.

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Figure 5.1.1 (c) shows economic growth with economic development. Growth has
gone toward producing goods and services used by the poor like food, basic clothing,
education etc.

PPF1 shows the existing situation where the economy is producing a combination of
luxury goods and services plus necessities.

Figure 5.1.1 (c): Production Possibility Model:

Economic Growth with Economic Development

Luxury
Goods
And
Services

PPF1 PPF2

0 Necessities

A shift in the PPF, from PPF 1 to PPF2, demonstrates economic growth as potential
output has increased. But, more importantly, the economy has increased its output of
necessities at a greater rate than luxury goods and services that is an achievement of
an increase in economic development.

Figure 5.1.1 (d) shows economic growth without economic development. The
benefits have all gone to the rich; an unequal distribution of income exists and then
the production mix will reflect their demand for luxury goods.

Figure 5.1.1 (d): Production Possibility Model:

Economic Growth without Major Economic Development

Luxury
Goods
And
Services

PPF1 PPF2

0 Necessities

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PPF1 shows the existing situation where the economy is producing a combination of
luxury goods and services plus necessities.

A shift in the PPF, from PPF 1 to PPF2, demonstrates economic growth as potential
output has increased. But the economy has increased its output of luxury goods and
services at a greater rate than necessities. This demonstrates an achievement of an
increase in economic growth without a major increase in economic development.

Economic Development

• Development involves value (normative) judgments being made. For example, a

city airport is of benefit to travellers but a source of noise pollution to its
neighbours.

• However, there is agreement amongst economists about what to include in a

measure of development, these include sufficient food, adequate shelter, and
health care, employment, low infant mortality, freedom from aggression and fear,
self respect and dignity.

• The growth of income forms an important part of any study of development.

• Development is a broad multi-dimensional concept, which includes economic

growth- defined as Real GDP per capita- plus other economic measures to
improve one S.O.L. This is key.

• It is possible to have economic growth without development. For example,

economic growth might benefit a small rich sector of society.

• The increased prosperity of the country is expected to ‘trickle down’ from the rich
to the poor, raising the overall standard of living. Often, this does not happen.

• So many poor countries concentrated their efforts on a few criteria only like
investment and GDP.

• However this focus usually hasn’t improved the lot of the poor; their poverty
hasn’t decreased and the gap between the rich and the poor hasn’t decreased.

• One definition of development is ‘the reduction and elimination of poverty,

inequality and unemployment within a growing economy’. There also are other
definitions of economic development.

Characteristics of Economic Growth

Variations in Long Run Growth Rates

Differences in growth rates do not necessarily mean that one nations growth is greater
than other nations. There are two considerations that must be kept in mind.

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(i) It is statistically easier to achieve a high rate of growth in a poor economy than a
rich one. This is because the base dollar figure is small. A small percentage increase
in the huge GDP of the USA, for example, represents a large increase in production
whereas a large percentage increase in the GDP of a tiny Pacific Island nation does
not.

(ii) Increases in economic growth need to be weighed against population increases.

Many poor countries have fast rates of population growth so their GDP per head may
be less than if they had rates of growth like developed countries.

Warning: The message above is clear: be careful when interpreting figures/data.

Changes Generally Associated with Economic Growth

Changes in Economic Structure

There is a clear relationship between the level of a country’s income and the structure
of its production. Poor countries tend to have a high proportion of production in the
primary sector. Income rises as it moves to the secondary and tertiary sectors.

Features of the primary sector:

* Low productivity. High percentages of the populations of LDCs live and work in the
rural sector. Subsistence agriculture is a feature of many LDCs.

* Primary products also form the basis of the majority of exports from LDCs.

* The percentage of primary goods in world exports is falling.

* For output to grow there must be an increase in the quantity and/or quality or
resources used in production. For example, the development of Human Capital.

* There must also be appropriate attitudes of the people in a country. Often this
requires changes in peoples’ customs and social behaviour before an economic change
can be take place.

Characteristics of the Growth Process in the already Developed Countries

Professor Simon Kuznets identified the following characteristics that require

examination:

• GDP growth.
• GDP per capita growth.
• Population growth.
• Productivity growth.
• Structural transformation.
• International trade.
• Social and ideological change.

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Since the industrial revolution:

* Huge gains in output have been based on increases in productivity, based on

improved technology and better human skills-development of Human Capital.

* There have been structural changes from primary to tertiary production.

* International trade has grown remarkably.

* There have been dramatic changes in beliefs, ideologies and institutions. Traditional
beliefs have been replaced by scientific. Most important, if an economy is to achieve
economic development. Critical area.

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5.1.2 Sources of Economic Growth and Economic Development

For National Output to grow-.i.e. an increase in Real GDP per Capita-, either the
quantity of inputs/factors of production must increase and/or the quality of those
inputs/factors of production must improve.

Quantity of Inputs – The Factors of Production

1. Land/Natural Resources

Land includes all natural resources.

Increases in farmland could increase output. However, most suitable land is occupied
and increases in population mean that there are diminishing returns from this land.

Discoveries of minerals can boost the wealth of an LDC.

Some nations with few natural resources have achieved economic growth through the
use of their human resources.

2. Labour

An increase in population can increase the labour force and economic growth.

A larger population can also mean a larger market for producers.

However, generally larger populations just mean more mouths to feed and lower Real
GDP per head.

Note: What is most important is an increase in the Quality of Human Capital.

3. Capital

Increases in the stock of direct productive capital (e.g. machinery, factories) is an

important key to economic growth. This is known as Capital Widening.

Appropriate infrastructure in supporting capital that is indirectly productive is also

essential.

Some forms of capital add more to productivity e.g. factories rather than dwellings.

Problems LDC’s have in trying to increase Capital.

1.Savings are needed before there is investment. Savings means less consumption,
which can mean hardship for the already poor.

2. Appropriate mix of technology/labour. Most capital is designed to be labour saving.

It is economically efficient to use more labour in an LDC. Capital-intensive
development may displace workers, so unemployment will rise.

Financial rewards often go to foreigners/multinational corporations (MNCs).

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Quality of Inputs

1. Quality of Land

Agricultural land is generally fixed in supply so, usually, increases in labour to land
leads to smaller incremental outputs of food. This is law of ‘diminishing returns’.

So productivity increases (an increase in output per unit of input) are the key to
development e.g. irrigation, drainage, pest control etc. are important. Also, new high
yielding varieties of grain (the ‘Green Revolution’) are important. They shift the PPF
to the right.

Agricultural Output increases over the last 30 years have been slow, especially
compared to manufacturing. Major reasons:

(a) ‘Law of Diminishing Returns’ – fixed supply of land and an increasing labour
force.
(b) Severe droughts and famines.
(c) Large increases in the price of fertilizers – especially with rises in the price of oil.
(d) Continuing production crises in Africa.

Often all of the above are the result of neglect of the agricultural sector due to
emphasis on efforts to promote development in the manufacturing sector.

Often there are major industrial sectors and a primitive agricultural sector: ‘dual
economies’.

Nature of Farming in Third World Countries

Farming in developed countries is scientific, efficient and highly productive involving

only a few farmers supporting large populations.

Farming in LDCs is a basic struggle to survive. Peasants are faced with very high risk,
not risks of profit and loss, but of life and death. Risk avoidance is central to the way
of life in LDCs.

Farms are small, traditional and productivity is low. However population growth is
high as death rates fall.

2. Quality of Labour – Human Resources/Human Capital

Note: This is the key to economic growth of LDCs.

Education and Training:

Most LDC’s have made an enormous effort to provide universal primary schooling
for children. But they are still way behind Most Developed Countries (MDCs) in
terms of secondary and tertiary education; also, in the provision of education in all
areas for females.

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Increased use of capital and technology means a country must have workers trained in
the skills to use them. Both the required funding and application present problems for
LDCs.

Spending on education requires giving up spending on other things such as

infrastructure projects. Most importantly, first their needs to be savings before
investment can occur. And the problem is that the level of savings if often inadequate.

However, spending on education is another form of investment: human investment or

human capital.

Social and Cultural

There are social and cultural factors that are resistant to change, and to those practices
which are believed to assist change including modern methods and scientific progress.

A key area is the attitude to women. In some countries, women are treated as second-
class citizens. Educational opportunities at all levels are often not the same for girls
and they are for boys. This needs to change.

Entrepreneurship

Entrepreneurial skill is important in generating output and growth.

There is a great deal of small scale entrepreneurial skill involved in small scale
enterprises common in LDCs. Assistance to these increases growth and provides
labour and income to the poorer segments of society.

3. Quality of Capital – Technological Progress

New capital often includes technological change and is a very important factor in
creating economic growth. However, technological innovations in LDCs need to take
into account their large labour force.

It is important that both capital deepening and capital widening occurs.

Capital Deepening is an increase in the quality of capital. It is the new ideas and
inventions that find their way into the productive process via capital goods.

Capital Widening is an increase in the quantity of capital.

Institutional Factors

Saving and Investment

Before investment can place, savings must first occur.

Low incomes are common in LDCs. Poor people will spend the majority of their
income on consumption. As a result, the level of savings is very low.

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Low-income earners in LDCs have a very high marginal propensity to consume
domestic (MPCdomestic) and, therefore, a very low marginal propensity to save
(MPS).

This situation presents a major development problem for LDCs. How do they fund
necessary economic development? Can they source the funds internally? Or is it
necessary to find external sources of funding and at what financial cost?

One solution is that the government can tax high-income earners-through progressive
taxation- as a way of generating government revenue and undertaking necessary
investment. While theoretically desirable, often this presents a major political
problem.

Note: This is not necessarily true today in all LDCs.

Role of Financial Institutions

The formal financial sector caters for medium and large companies.

There is little banking on behalf of the vast majority of small farmers and traders in
LDCs. They are likely to borrow from family, moneylenders and loan sharks, and
may have to pay extremely high rates of interest.

Development banks have been set up to aid longer-term investment projects that aid
growth and development. They use foreign funds as well as large aid agencies. But
they do not cater for the poor either.

The lack of funding institutions and mechanisms to assist the small traders and
farmers in LDCs presents one of the major obstacles to economic growth and
development in these countries.

In some LDCs, informal arrangements and credit associations have grown up to cater
to small traders and farmers. People may group together to borrow a large sum and
then divide up the repayments.

The Grameen Rural Bank in Bangladesh is one of the best examples of providing a
solution to this problem via the establishment of Micro-Lending facilities to the rural
and small business sectors.

Role of Health Care

The level of health of a population has a major impact on the development of Human
capital.

Improved health care results in greater productivity, less expenditure on health

services, and an improvement in the standard of living.

An examination of Development Indicators for LDCs reveals that most LDC countries
face major health care issues. High prevalence of AIDS, malnutrition and poor access
to clean water are examples.

263
Infrastructure

Roads, railways, air services, telephone, internet and so on are all part of a country’s
infrastructure. The better the infrastructure, the greater the opportunity for increased
economic growth and development.

An examination of Development Indicators for LDCs reveals that most LDC countries
face major infrastructure problems. Poor road and rail transport, for example, prevents
goods reaching domestic and international markets.

Political Stability

Lack of political stability in many LDCs results in reduced foreign investment and
foreign aid, increases the possibility of corruption, and causes the diversion of scarce
resources away from where they can contribute to economic growth and development.

Political instability is usually associated with a major proportion of GDP being spent
on military items. This causes increasing BOP deficits and external debts, and an
increasing proportion of exports to pay for imports.

Tourists stop coming to the countries cutting off important export earnings.

In short, ‘everything and everybody’ stays away.

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5.1.3 Measuring Economic Development Through Development Indicators

Economic Development occurs in a country when there is an increase in Real GDP

per capita plus an improvement in the standard of living. It is one of the five major
macroeconomic objectives.

Economic Development is hard to define so ‘Indicators’ of development are used

instead.

The best way to way to learn and understand the Indicators is by undertaking
Class Exercises and Assignments.

1. Real GDP per Capita or Real GNI per Capita

Real GDP per Capita = Real GDP

Total Population

Real GNI per Capita = Real GNI

Total Population

These are the most commonly used ‘summary index’ of economic development.
Following we will use Real GDP per Capita.

There seems to be a correlation between Real GDP per Capita and measures of the
Standard of Living (SOL) of a country. For example, there is a positive relationship
between an increase in Real GDP per Capita and an improvement in Life Expectancy,
Infant Mortality and Adult Illiteracy.

On the other hand there are exceptions: some countries have low incomes and high
life expectancy; some poor countries may have relatively high living standards by
distributing their income fairly evenly.

Limitations of Using Real GDP per Capita

Following are some of the limitations in simply using Real GDP per Capita as a
measurement.

Non-Market Output

Only ‘marketed’ output is recorded in GDP figures, it does not include unrecorded
work like housework, ‘rent’ of an owner-occupied house.

In countries where there are a large proportion of women doing house duties then the
GDP will be lower than comparable countries where a lot of women work.

Many LDCs have large subsistence sectors where families consume a large section of
their own production. This is not recognized in GDP figures.

Another factor is the importance of the parallel or black market economy.

265
Military Spending and Investment

More spending on military goods reduces the spending on consumption and so

reduces the SOL. May make figure less than a country with a similar Real GDP per
Capita.

Pollution and Irreplaceable Extraction

This lowers the quality of life, yet production that causes pollution is included in GDP
in total (e.g. new tollway with its noise pollution) and production to help deal with
pollution is also included (e.g. double glazing to reduce noise). Loss of non-renewable
resources is not taken into account. Nor is increased leisure taken into account in the
figures.

Distribution of Income

Two countries with similar Real GDP per head may have widely different
distributions of income and levels of poverty. So pursuing GDP growth may not
reduce poverty.

Exchange Rates

To compare Real GDP per Capita between countries, the local currency is converted
to $US but speculative flows may affect the value of a currency or it may be a
managed or fixed currency.

2. Birth Rates, Population Growth and Structure

Birth Rates

Birth rates of LDCs are much higher than MDCs. Death rates in LDCs have been
significantly reduced so the natural increase in population is faster in LDCs. The
population of LDCs is much younger, so future population is expected to grow more
quickly.

Population Growth Rates

Populations in LDCs are growing more quickly than in MDCs. Increases in

population provide labour as well as mouths to feed, but generally rapid population
growth is considered to increase poverty.

Poverty causes population growth, so reducing poverty must precede population

reduction.

3. Life Expectancy and Health

While it is difficult to measure the state of health of the population some indicators
may be used to measure the health of individuals:

(a) Infant mortality rate. The number of children who are reaching their first birthday.

266
(b) Life expectancy. Average age to which people are expected to live.

(c) Calories per day. Food intake that provides the energy required to sustain life.
Calories per day in LDCs will be lower than MDCs.

(d) Protein per day. Provides the energy required to avoid malnutrition. In LDCs, the
lack of high protein leads to death from malnutrition.

(e) Number of doctors per 100,000 people. LDCs have fewer doctors, therefore risk
of disease and death is greater.

(f) Number of hospital beds per 100,000 people. Fewer hospitals give rise to greater
health risk and death.

(g) Adult literacy rate. Literacy is a development issue. Attempts have been made to
improve the adult literacy rates of LDCs with very little success.

4. Energy Consumption

Energy consumption increases when there is a shift in production from primary to

secondary production. Energy consumption increases as the countries become more
developed.

5. Rural-Urban Migration and Unemployment

(a) Rural-Urban migration. People migrate from rural areas to cities. Low
productivity and lack of modernization motivates people to move from rural areas
to the cities. The ‘bright city lights’ and the hope for better jobs and financial
security influence rural people.

(b) Unemployment. Unemployment is high in LDCs. As more people flood into the
cities, unemployment rises in these urban areas as well. Keynesian demand
economics does not work in LDCs. In order to improve the economies in LDCs,
Supply-Side factors need to be considered.

6. Poverty and the Distribution of Income

Poverty

Relative poverty exists when people do not enjoy the same standard of living or
quality of life as the rest of the people in the country.

However, while these people may be considered to be poor in comparison with the
rest of the people in the country, they may be regarded as economically well off
compared with people in other countries.

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Absolute poverty exists if people cannot acquire the basic needs in order to survive.
This happens when people do not have items such as the basic food, shelter and
clothing.

Such people are considered to be living below the Poverty Line. The UN defines this
as a person living on less than US$1/day.

The two definitions above are most important distinctions.

Income Distribution Ratios:

The % of income earned by the bottom 40% (two quintiles) are added together and
expressed as a ratio of income earned by the top 20%.

Calculation: Bottom 40% of Household Income expressed as a Ratio

Top 20% of Household Income

The greater the difference between the two numbers, the greater the degree of
inequality/poverty.

7. Composite Indicators

In order to arrive at a measure to overcome the problems associated with GDP,

composite indicators are used.

An example of a composite indicator is the Human Development Index (HDI).

The HDI includes life expectancy, literacy and purchasing power into a single
measure to rank countries by the quality of life their citizens enjoy, rather than the
amount of GDP their economies produce.

Another example is the Human Suffering Index (HSI).

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5.1.4 Growth and Economic Development Strategies

Note: There are more than 12 major growth and development strategies. This
Chapter presents a summary of the key strategies.

Growth and Development Strategy # 1: LDC Debt Forgiveness

LDCs are wallowing in a mountain of foreign debt.

The first priority, highlighted yet again by the public announcements relating to the
G8 Summit in Gleneagles, Scotland, in July 2005, is for all the poor countries to
receive debt forgiveness. Not just the 18 countries at the top of the political agenda.
Countries like Malawi, plus the other countries, need to be included in the debt relief
package.

Membership of the G8, consisting of some of the most powerful and richest countries,
includes the USA, Russia, Germany, UK, France, Japan, Italy and Canada.
Interestingly, it does not include China

Without debt forgiveness, LDCs have little prospect of disengaging themselves from
the never-ending debt trap and poverty cycle.

Urgent remedial action is required by the international lenders-The World Bank, the
IMF, international banks and other financial institutions-some of which are controlled
by the voting rights of the G8 members.

But this is only part of the solution and package.

G8 Members rightly argue that debt forgiveness must go hand-in-hand with key
reforms in LDCs, including the elimination of political corruption and the
introduction of democracy.

LDCs argue that the MDCs must combine debt forgiveness with increased foreign aid
and the rich nations reaching agreement on cutting subsidies and other forms of
protectionism that depress farm imports of farm products from poor nations.

Debt forgiveness must also be combined with greater access for LDCs goods and
services to MDC markets through reduced protectionism by MDCs; and, a
restructuring of Aid packages and reformulation of Aid strategies to make current and
future Aid in the form of Grants. These areas are now examined.

Growth and Development Strategy # 2: Greater Access To World Trade For

LDCs

Greater access to MDC markets is one the major economic and political problems
facing LDCs.

Before examining this issue, let us take an overview of world trading patterns.

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World Trading Patterns

• From 1964 to 2000 world trade expanded rapidly. This was of benefit to LDCs,
but, in relative terms, has since stagnated due to:

(a) Periods of global recession.

(b) Continued and increased protectionism of MDCs; in particular, the

USA, EU and Japan.

(c) An increase in the absolute level, and % of GDP, of third world debt
by LDCs.

• World trade is dominated by developed countries, which account for

approximately 68% to 70%. Only about 28% to 30% of world exports are from
LDC countries or from the former socialist countries.

• World trade is dominated by Multinational Corporations (MNCs). And ever-

increasingly so through the rapid process of globalisation. Many of these
corporations record worldwide sales in excess of the GDP of most middle and
low-income countries.

• Amongst the LDCs, there have been significant differences. Former LDCs, some
now Newly Industrialised Countries (NICs) and others now major oil-exporting
countries, have experienced times of fast growth. However, The proportion of
trade going to the remaining LDCs has fallen significantly.

Trade problems for LDCs are both long term and short term.

Long Term Trade Problems for LDCs:

The long-term trend in international trade away from poor countries is because they
mainly export primary products and import manufactures and services.

This trade structure leads to three major problems:

1. Slow growth of exports is due to:

* Low-income inelasticity of demand for primary products. YED < 1. From any
increase in income in developed countries, only a small portion is spent on increased
imports of primary products and their consumption.

* Low price elasticity of demand for primary products which exist because each
country which purchases raw materials can choose from the many nations wanting to
sell close substitutes. For example, tea and coffee are produced in many LDCs.
PED < 1.

* Major Imports by LDCs from MDCs consist of oil, capital and manufactured goods
and services. The purchase of these items is generally not price sensitive.

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* Agricultural protection. In developed countries farmers have a high level of
protection for their production.

* Synthetic substitutes for many raw materials have reduced the markets for primary
products e.g. acrylic for cotton or wool, plastic for wood.

* Miniaturization. Many products have because smaller (e.g. because of microchips)

and so use less raw materials.

As a partial solution to overcoming the above problems, there have been many
attempts at maintaining prices by establishing International Commodity Agreements
or forming Cartels. A successful example includes OPEC.

2. Fast growth of imports is due to:

* High-income elasticity of demand for imported manufactures and services. As

incomes grow in LDCs amongst the wealthier part of the population, they want to buy
more sophisticated goods from the developed world-e.g computer hardware/software,
mobile phones.

* Low price elasticity of demand for imported manufactures and services. There are
few domestic substitutes for sophisticated imported technology so they tend to be
price inelastic. Even if their prices rise they are still imported.

3. Worsening terms of trade

The terms of trade is the ratio of the index of export prices to the index import prices
expressed as an index.

Terms of Trade Index Formula = Index of Export Prices x 100

Index of Import Prices 1

Note: There are three Indices:

* Export Price Index.

* Import Price Index.
* Terms of Trade Index.

The base year for each Index is always 100.

For the reasons outlined in the previous sections, the terms of trade for LDCs against
MDCs has declined since the 1980s.

That is for LDCs, the price of exports from LDCs (mainly primary products),
compared to the price of imports from MDCs (oil, capital and manufactured goods,
services) has declined considerably since the 1980s. These relative prices, as
measured by the Terms of Trade Index, are just as important as the volume of exports
bought and sold.

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Short term trade problems of LDCs

Commodity price fluctuations.

The prices of primary products tend to fluctuate considerably in the short term.

The reasons for this are: the price elasticity of demand and supply, and shift in
demand and supply. Demand for primary products tend to be price inelastic.

There is short-term inelasticity of supply because of the nature of farming and mining.
As a result, if there is a shift in supply or demand the effect on price is dramatic.

Supply shifts in agriculture, ‘supply-side shocks’, are common due to unusual changes
in weather patterns resulting in droughts, floods and frosts.

With minerals, the shifts are more likely to be on the demand side. Many minerals are
used extensively in making capital equipment. Demand for capital goods varies
significantly due to trade cycle and accelerator effects.

Part Solution: International Commodity Agreements

International Commodity Agreements are schemes to raise or stabilize prices.

Schemes to raise prices include forming a producer’s cartel and issuing production
quotas to members. An example is OPEC.

Schemes to stabilize prices include operating buffer stocks through buying and selling
to reduce price movements.

In some case, like OPEC, the solution has worked. Member countries have become
economically powerful, and many have achieved developed country status.

For the existing LDCs, however, these countries continue to remain undeveloped.
They have little or no economic or political muscle in the international trading arena,
a situation dominated by MDCs and, within them, MNCs.

Other solutions, therefore, need to be developed and implemented.

Major Problem: Increasing Protectionism by MDCs

Protectionism is the restriction of international free trade by governments. Measures

include quotas, tariffs, embargoes and import duties.

For example, EU farmers receive a subsidy of US$2/day per cow. This is twice the
UN definition of US$1/day/person for someone living below the poverty line.

MDCs protectionism of their markets, through a series of measures, results in a breach

of one of the fundamentals principles of economics: namely, economic efficiency.

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Economic efficiency occurs when society is producing the goods and services most
valued by society. Occurs outside firms, where demand and supply of goods and
services is determined by market forces to establish price.

The worst MDC offenders are the USA, EU members and Japan.

All these countries have well-established forms of protectionism, they have been in
operation for decades, and the level of protectionism is increasing.

Within this web, agricultural protectionism most affects LDCs because, as we have
seen, the majority of their exports consist of primary products. And the latest Round
of World Trade Organization (WTO) negotiations, The Doha Round, have failed to
resolve these issues. This is despite years of meetings and negotiations.

This topic is on the G8 agenda at the Gleneagles meeting in July 2005.

Talkfest follows talkfest, to little satisfaction of the LDCs. Why? Primarily because it
is not in the political interest of the MDCs to resolve the matter. The political muscle
of farmers-including the major corporations running farming operations in some
countries-sways political opinion and sound economic judgement in these countries.

So what can the LDCs do? In reality, very little apart from continuing to push reduced
protectionism on the world political agenda.

Growth and Development Strategy # 3: Restructing Foreign Aid and

Reformulation of Foreign Aid Policies

When considering this topic students should think about the following key issues:

(a) Who gains the most through Foreign Aid? The Donor? The Recipient
country? How? Why?
(b) What are the motives of the donor country? What do they gain? How?
Why do they really give aid?
(c) What is the % of Aid which is (i) cash, (ii) goods & services?
(d) What is the % of Aid that is (i) tied; (ii) untied?
(e) What is the % of Aid that is in the form of Grants?
Overview

• Most LDCs have a deficit on their BOP on current account, which therefore
requires a surplus on the capital account to finance it. The latter creates debt.

• Sources of incoming funds into the capital account include private investment
from MNCs and foreign Aid.

• Foreign Aid is either transferred by public bodies, Official Development

Assistance (ODA), officially, or unofficially.

• ODA can be divided into 2 major types:

1. Bilateral Aid. Provided by individual governments.

2. Multilateral aid – Provided by multilateral agencies- e.g. The

World Bank, Regional Development Banks and the UN agencies.

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• Unofficial aid is given by non-government organizations (NGOs) e.g. Red Cross.

The Amount of Aid

• The amount, in absolute $’s, of ODA has increased significantly since 1960.

• However, ODA as a percentage of the developed countries GDP has sharply

declined, from 0.51% in 1960 to 0.33% in 1991. Declined even further since 1991.

• The two major reports since WW2, the Pearson Report and the Brandt Report,
have both recommended a target of 0.7 of GDP to be given as ODA; very few
countries meet, let alone exceed, this target.

• Among OECD members, the USA is the largest donor in absolute $’s but it is near
the bottom when their ODA is calculated as a percentage of GDP.

• Substantial Aid is given by multilateral development banks, UN agencies and

NGOs.

Direction of Aid

• A large amount of Aid has been based upon the military and political interests of
the donor and has gone to relatively well-off LDCs, rather than to relieve poverty
in the poorest countries.

• US Aid from the 1940’s to the 1960’s was mainly directed at containing
communism. Soviet aid was politically motivated in support of communism.
French and British Aid goes disproportionately to their former colonies.

• In the 1990’s a large amount of Aid was diverted to former communist countries
at the expense of previous recipients in the poorest countries.

• Multilateral agencies generally give more weight to development criteria.

• The World Bank and the IMF are very influential in influencing domestic policies
of the recipients by imposing strict conditions to Aid. Recipient countries often
resent this, seeing it as interference in their domestic affairs. Example: Indonesia
in 1990s; this caused much resentment by the government.

• NGOs are very strong in the field of Aid, dealing directly with poor people.

• NGOs also have major educational and publicity functions, keeping development
issues in the minds of people in MDCs and lobbying governments.

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The Argument for Aid

Reason for Aid

1. Aid can be used fill the resources ‘gap’. Foreign Aid is a source of foreign
exchange that can be used to import capital goods (closing the capital gap), which can
be then be combined with the abundant labour and natural resources to increase
economic growth.

2. Technical assistance helps to fill a personnel gap and ensures a good use of Aid
funds. Technical assistance is subsidizing the transfer of people with particular skills.

Arguments against Aid

1.Economic motivations for giving Aid sometimes fill the needs of the donor country.

For example, the purchases of goods needed in development projects must be from
the donor country. This creates income and jobs in the donor country and therefore
wins votes for politicians. It might be possible to purchase these goods more cheaply
elsewhere.

2 .Aid maintains income inequalities in the LDCs

The emphasis on large projects and capital goods helps the rich and the city dwellers
in the LDCs. It does little to help relieve poverty that is rural and labour based.

Modern labour saving technology may create more unemployment.

3. Aid can postpone necessary reforms

Food Aid can lower local food prices. Local farmers therefore cannot afford to
introduce better farming techniques. It can displace local savings, local trade and local
capital formation.

4. Aid has helped keep repressive regimes in power

Foreign Aid can come in the form of military Aid-missiles, tanks, other weapons,
personnel training and infrastructure support. Often this goes to governments of
disrepute, but who are strategically and politically important to the donor country.

5. Most Aid is Tied, not in the form of Grants

This is crucial. Tied Aid results in most of the problems outlined above.

Grants, as discussed earlier, are of major benefit to LDCs.

6. Aid is a poor substitute for free trade.

This is the key.

Free trade is the movement of goods and services without protectionist barriers.

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Free trade and reduced protectionism are inextricably linked. The former objective
can only be achieved with the abolition of the latter roadblock.

Free trade would mean LDCs would have access to the markets of developed
countries. This would increase their ability to generate their own incomes and reduce
the need for Aid.

Increased Protectionism-particularly by the USA, EU and Japan; and, especially

agricultural protectionism that reduces necessary exports of LDCs- leads to a
worsening of LDCs BOP on Current Account and increases their debt through capital
inflow on their BOP on Capital Account.

Growth and Development Strategy # 4: The Role of International and Domestic

Financial Institutions

Main International Financial Institutions are the IMF and The World Bank

Note: when considering this section, students should be mindful of:

1. Who controls the IMF and The World Bank?

2. Which countries have the majority influence on where IMF & The World
Bank funds go?

3. Which countries benefit the most from the direction of IMF and The World
Bank funds?

The answers lie in who controls the Voting Rights of both organizations? Voting
rights are determined according to the economic size and contributions of member
countries. In simple terms, this means the MDCs have control, and within their ranks
the USA exerts the most control.

Next question: US Government policy is substantially influenced by MNCs due to (a)

their economic power; and, (b) their political influence.

Above is the key.

The IMF was established to manage a system of exchange rates and to hold currency
reserves to aid countries with temporary BOP problems. The managed exchange rate
system operated form 1946 to 1971.

The IBRD, now known as The World Bank, was set up after WW2 to provide the
loans for reconstructing war torn Europe and Japan. It has involved development
funding ever since.

The International Monetary Fund (IMF)

Historical development of the role of the IMF:

• World oil price rises of the 1970s led to a dramatic increase in international
indebtedness, BOP deficits, inflation and government debt in LDCs.

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• Private commercial credit to LDCs dried up.

• The IMF helped restructure the LDCs debt and put together a finance package to
allow their economies to continue to function.

• The package involved the cooperation of the IMF, the LDC government and
private foreign commercial banks.

• The IMF would offer some credit but on strict conditions, known as a ‘policy of
conditionality’. Example: Indonesia in 1990s.

• IMF conditions have reduced the welfare of the poor in these countries and led to
a great deal of criticism from Aid agencies and from the poor within the country.

The World Bank

• Its role is to promote economic growth by obtaining funds from wealthy countries
for investment in LDCs.

• It has lent the money with technical advice and stringent conditions.

• Initially much of the lending was for infrastructure like roads, bridges etc. but this
has not been successful because of the supply-side constraints.

• In the 1960’s and 1970’s lending was mainly for individual productive projects. A
success story was India’s Green Revolution that turned India from an importer to
an exporter of food.

• The International Finance Corporation was established to undertake more

commercial loans. This support to private business has aided economic growth
and complements the broader work of The World Bank although it is not strictly
part of the bank.

• The emphasis has been on economic growth not on development.

• A separate agency has been set up to lend to the very poorest countries, the
International Development Agency (IDA).

• Countries qualify for credit on concession terms, that is, with an Aid element.
That is, the loans are interest free and they have a much longer pay back period.

• The World Bank has other, broader functions. It sponsors research, provides
statistics information, education services, information, and technical support to
back up its lending.

• There has been a great deal of criticism of IMF and The World Bank, especially
since they became involved in structural adjustment programs.

• The policies are seen as anti-development by many other agencies e.g. UNICEF,
because they have led to increased poverty, higher infant mortality rates and a
decline in economic development.

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Private Sector Banks

Private sector banks in LDCs cater for the modern and foreign trade sectors. The
majority of the population that are poor cannot get access to funding.

So, small traders often borrow from the moneylenders who often charge very high
rates of interest. Not a viable solution.

One of the success stories here has been the Grameen Bank in Bangladesh. Through
Micro-Lending, it lends small amounts of money to poor rural traders and farmers. It
has an excellent record of repayment. The problem is that the volume of money
available is small compared to the market need.

Another example is the Australian-founded organization, Opportunity International. It

is operating along similar lines to the Grameen Bank.

In summary, too little funding is made available by too few organizations to make a
significant dent in the worldwide level of poverty. But it is an important step in the
right direction.

Growth and Development Strategy # 5: Managing Foreign Investment And

MNCs

Multinational companies (MNCs), or Transnational companies (TNCs), are

firms that own productions units in more than one country.

Many are enormous in size and control more economic resources than the GDP of
many countries.

American owned MNCs account for about half the foreign investment total.

Most of the foreign investment is between the rich MDCs. That which does filter
down mainly finds it way to Middle Developing Countries.

There is division about the desirability of MNCs investment in LDCs. The division of
opinion is around the ‘growth’ versus ‘development’ debate.

MNCs and Economic Growth

Reasons why MNCs assist Economic Growth

• The injection of direct foreign investment increases the national income of the
receiving country. GDP, investment, saving and manufacturing all grow.

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• MNCs investment can close supply ‘gaps’, in savings, foreign exchange, taxes,
technology and human skills. Increases capital inflow on BOP on Capital
Account.

• Their activities generate jobs, saving, tax revenue and exports. Multiplier effect.

Argument Against MNCs and Economic Growth

• MNCs are monopolistic or oligopolistic and so may not be efficient. Note: (i) if
P>MC, therefore not optimal allocation of resources; (ii) MNCs achieve
supernormal profits.

• Transfer pricing – that is the setting of internal prices within branches of an

MNC such that when components are shipped between branches so that the total
tax bill is minimized and less taxation revenue is collected by LDCs. Most
important.

• Competing LDC governments may offer tax concessions, subsidies and other
forms of protectionism that reduces the benefit of the investment. These benefits
to MNCs are ultimately paid for by the taxpayers of LDCs.

MNCs and Economic Development

It is possible that MNCs are good for Economic Growth but not good for Economic
Development for the following reasons:

1) Widens the inequality between rich and poor by developing a modern high wage
sector.

2) Results in market inappropriate, sophisticated products for elite groups, using the
advertising techniques of oligopoly to create a desire for these products.

3) Widens the rural-urban divide by locating businesses in the cities and as a

consequence encourages further rural-urban migration.

4) Uses capital-intensive modern technology that is inappropriate for labour

abundant countries, and does little for jobs and incomes of the poor majority.

5) Can use their immense size and consequent power to influence governments into
anti-development activities. MNCs gain subsidies & tax concessions.

6) MNCs may make it difficult for local enterprises to develop.

Impact of Globalisation

Globalisation is a process of breaking down barriers between countries resulting in

greater integration and interdependence. Since the 1980s, largely brought about
through massive technological changes in communications and information.

Globalised Economy is the movement, through globalisation, to a borderless world

economy.

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The process of globalisation and to a globalised economy is increasing at fast pace.
No country is immune to the process. Certainly not the LDCs.

Through their dominance of world trade and economic might, MNCs are the driving
force in this process.

The key issue, therefore, is how should/can LDCs participate and manage this process
to achieve an increase in economic development?

Growth and Development Strategy # 6: Export Promotion versus Import

Substitution

Also known as: Open, Outward-Oriented versus Closed, Inward-Oriented approach.

Introduction

• This area is concerned with government policy toward trade and exchange rates.

• The main debate is between ‘export promotion’ free traders and ‘import
substitution’ protectionists.

• LDCs want to produce more manufactures rather than depend on the primary
products.

• However, BOP problems prevent LDCs buying all the imported manufactures
they need to industrialize.

Governments must therefore choose between trade policies which:

1) Encourage export to pay for the needed imports; and/or

2) Discourage imports, whilst developing substitute domestic products.

In practice, governments operate a mixture of free trade and protectionist polices.

Export-Promotion (E-P) Policies

• E-P policies encourage free trade in goods and the free movement of capital and
labour.

• MNCs are encouraged, together with their technology and products, usually
manufactures.

• Key reasons for E-P are the increased output and growth arising from trade (i.e.
comparative advantage), economies of scale, increased competition and modern
technology.

• Those who argue for E-P reject protection policies because of the higher prices
and lower output that comes with protection.

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• E-P countries have been very successful in recent decades (e.g. South Korea,
Hong Kong, Singapore and Taiwan). Many economists say this is proof of the
success of E-P policies.

• A problem with E-P has been the protectionism of MDCs, which has limited the
access to their markets of goods in which LDCs have a comparative advantage,
especially textiles and footwear. As we have seen, this is a major problem.

• Free access of manufactured goods to MDCs, like textiles and footwear, threaten
the jobs of lower paid workers in MDCs and so governments in MDCs are
reluctant to reduce protection. Major problem.

• On the other hand, rising incomes in NICs have created new markets through
intra-trade. For example, within S.E. Asian countries and Latin American
Countries. Trading Blocs such as ASEAN and MERCOSUR have benefited
member LDCs.

Import Substitution (I-S) Policies

These policies encourage self-reliance in the production of manufactures.

Features of I-S policies:

• Tariff barriers are used against imports to protect the home markets/producers.

• Factor movements of capital and labour are also restricted.

• MNCs access is also limited.

Arguments for I-S

1) Free trade creates unemployment.

2) There is danger in over-specialization; nations need to maintain a variety of

industries.

3) MNCs might introduce expensive, labour saving technology that is inappropriate

for LDCs.

4) ‘Infant-industry’ argument. That is, LDCs need protection so that new industries
can develop without competition from MDCs and MNCs. Protection can be
reduced as they grow, become low-cost producers, and can compete
internationally. They may eventually become export industries.

5) The Balance of Trade improves with the restriction of imports.

Stages in implementing I-S policies:

• First, LDCs protect final stage assembly industries and consumer goods.

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• Later it proceeds to building components and more sophisticated manufactures.
Through this process, domestic firms can gain economies of scale in their
production leading to internationally competitive exports. See Figure 5.1.4 (a).

Figure 5.1.4 (a): Infant Industries Achieving Economies of Scale

Long Run
Average
Costs

LRAC

0 Output

The above figure shows the relationship between a firm’s total output and their long
run average costs (LRAC) of production.

As firms increase their total output their long run average costs decline. With lower
average costs of production, firms are better able to compete in world markets.
Exports increase, improving the LDCs BOP on current account.

Key Reasons why I-S has not been successful

1) Infant industries in LDCs do not develop and become more internationally

competitive. They remain high cost and inefficient.

2) Higher cost of protected domestic goods raise costs of inputs for other local
industries that may use protected industry products e.g. tractors from protected
industries may be more costly than imported tractors; this raises costs of
production for domestic farmers.

3) The poor may gain little. Major benefits may go to wealthy local manufacturers,
and to foreign firms located inside the tariff walls.

4) Exchange rates are held artificially high to encourage the use of imported capital
and imported goods. This makes agriculture exports more expensive which may
limit the incomes of poor farmers in LDCs.

Summary

A key issue in the above arguments is: if LDCs are successful in developing local
industries will they find open export markets for their products?

Central to this issue of LDC success, as we have seen, is the levels and forms of
protectionism of MDCs. And this presents a major problem for LDCs.

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Growth and Development Strategy # 7: Structural Transformation or Dual
Sector Model

This model is based on transforming a poor largely rural subsistence economy to a

modern industrial economy by labour transfer from the large rural sector to the small
urban sector.

This model is also known as the Lewis Dual Sector Model.

The rural sector has surplus labour and, consequently, zero marginal output. Law of
Diminishing Returns applies.

What has happened in China since the economic reforms of Deng Xioaping from the
early 1908s onwards is a very good example. Today, Rural-Urban migration is
occurring at an ever increasing pace causing major economic, social and political
problems for the Chinese government. Despite this, major economic progress has
been made in China.

But for the majority of LDCs today, structural transformation still has a long way to
go.

Some weaknesses of this model for today’s LDCs:

1. Assumes continuing investment (I) in cities to create jobs.

2. In practice, new technology is mainly labour saving.

3. Assumes large capitalists reinvest their profits at home, rather than keeping
them or investing abroad.

4. It is a model of economic growth, not necessarily of economic development.

Growth and Development Strategy # 8: Harrod-Domar Growth Model

Harrod-Domar growth model refers to a model of growth, which

focuses on the constraint in growth caused by shortage of capital in LDCs.

For growth to occur, first there must be investment.

Before Investment can take place, Savings must occur.

Therefore, the higher the level of savings the higher the level of economic growth.

And for economic development to occur, first there must be economic growth.

Examples of the importance of this model include Singapore, Hong Kong, Taiwan,
South Korea and Japan since the end of WW2.

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The level of savings in most LDCs, and the MPS, is very low. MPCdomestic is very
high, in many LDCs 0.9 to 1.0.

Again, when examining Development Indicators you will see this borne out in the
figures.

Growth and Development Strategy # 9: Population Policy

Introduction

Most LDCs have promoted Capital Investment as a way of achieving economic

growth.

Some LDCs have favoured human investment in education and health care, an
investment in Human Capital. Examples: China and India. This is key.

Population policy and agricultural policy are two investment programmes that have
been very successful in reducing poverty.

Population and Investment

There is a need to:

(i) Curtail population growth to reduce poverty; and,
(ii) Implement other policies to increase economic growth.

Causes of population growth in LDCs

* High birth rates – a larger proportion of girls marry in LDCs than in MDCs and they
marry at a younger age. Therefore, a greater proportion of women have children and
they have more years in which to have children.

* Falling death rates, due to better health care and nutrition.

* Increases in life expectancy, the main reason being the fall in infant mortality rates.

Birth Rates and the National Income per capita

High birth rates are usually associated with low income per head. This does not mean
that high birth rates cause low incomes. However, population growth has been linked
to living standards, for example, by Thomas Malthus (in 1798).

A Micro Approach – Family Size as an Economic Decision

A micro approach to population growth focuses on why poor people have many
children.

The reasons for the first two or three children are primarily due to cultural and
psychological factors.

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Additional children are desired because they ensure a certain number will survive
(especially males), the costs and benefits of those children, and the level of family
income.

Economic benefits of children:

• Labour on the farm.
• Security in old age.

Economic costs of having children:

• The direct costs of feeding, clothing and education.
• The opportunity cost of the mother’s time in rearing children.

According to standard theory of consumer demand, increasing the ‘price’ or cost of

children should reduce the demand for children. How? This could be the result of a
combination of policies:

• An increase in direct costs such as charging school fees for the third and
subsequent children.
• Raising the opportunity cost of having children, primarily by providing more
education for girls and more jobs for women.
• Reducing the benefit of children by raising the legal age of work.
• Reducing the benefit of children by setting up pension and sickness schemes to
reduce the need for family support in old age.

Experience from countries employing these policies show they are effective:

• Higher female employment and higher school attendance for both males and
females tend to be associated with lower fertility.
• There is a strong relationship between the decline in child mortality and the
decline in fertility. Thus improved health care and nutrition increase the chances
of children surviving and reduce the need for future births.
• Higher incomes seem to encourage a few ‘high quality’ children rather than many
‘low quality’ children.
• Where the majority of the population, and especially the very poor, share in the
benefits of development there will be the greatest effect in lowering the fertility
rate.

Population Policy Measures

1) Development leads to lower fertility for example by eliminating absolute poverty;

reducing income inequality; expanding education and jobs etc.

2) Direct family planning policies like persuasion through education and advertising;
family planning programs to provide health and contraceptive advice; and offering
economic incentives for restricting family size.

3) Developed countries reducing their resource use and making more available to
LDCs.

4) More assistance from MDCs to LDCs to help them develop; for example, more
direct financial aid, lower tariff barriers.

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Growth and Development Strategy # 10: Agricultural Policies

Note: the most important agricultural policies are those that achieve:

* Greater access for LDCs to MDCs markets; and,

* Reduced agricultural protectionism by MDCs; and,
* Closing of the gap between what MDCs want-i.e. Free trade-and what MDCs do-
i.e. increased agricultural protectionism.

Refer WTO Doha Round of negotiations, specifically, in terms of agricultural

negotiations. Bottom line: MDCs-such as USA, EU and Japan- say they want free
trade but in fact have progressively increased agricultural protectionism.

Above is key.

Features of Agricultural Sector in LDCs and Their Importance to Reform Policies

1. Agriculture is a way of life not just a business. Therefore policies to reform and
modernise must consider the effect on the rural way of life.

2. Policies should not just widen the gap between wealthy landowners and poor
farmers. It is richer farmers who can afford to take the risk of new methods. These
new methods may increase their wealth and widen the gap between rich and poor.

Reasons why subsistence farmers are unwilling to change

1. Cost – switching to cash crops involves spending on fertilizers, marketing etc.

2. Risk - a poor harvest results not only in financial loss but loss of their livelihood.
The poor therefore continue with well-tried, low risk, traditional methods even
though these result in low output.

3. Rented land – farmers are reluctant to improve land that is rented.

1. Policies to assist farmers to make gradual changes are needed.

Mixed Farming is an alternative to a complete change from subsistence agriculture to

cash crops.

Aims:

* To have a surplus to sell which could be used either to raise the consumption levels
and living standards of the family OR to allow investment in the farm.

* To diversify and so reduce the risk of failure of a single crop and the subsequent
loss of livelihood.

286
In order to implement a change to mixed farming the farmers would need certain
parallel changes such as access to credit, fertilizers, water, crop information and
marketing facilities. A successful agricultural reform policy would need to include
these if it is help the poorest farmers.

2.Land Reform to increase the ownership of land by poor farmers is considered

essential.

Farmers who own their land are more likely to try to improve their farms.

The rich own most land in LDC. Examples: Philippines, Zimbabwe (pre-2000).

3. Development in rural areas needs to be seen as a whole

Many of the problems are inter-related and need to be tackled at the same time. A
package of policies is needed to all the problems of rural poverty like health, nutrition,
housing etc.

287
5.1.5 Major Barriers To Economic Growth and Economic Development

Overview

Growth models in the past suggested only that if savings, investment, and GDP
increased then economic growth and development would follow. However, this did
not occur in many LDCs.

There were other barriers to growth and development. These are discussed below.

Institutional Barriers

1. Attitudes and Institutional Resistance to Change

• Changes in an economy and in political structures will cause tensions and can lead
to political instability.

• Between WW2 and 1989 there were 127armed conflicts around the world, nearly
all in LDCs. In the 2000s, most armed conflicts are in LDCs.

• Most LDCs only gained independence since WW2 and have had little time to
develop a national identity allied with popular development policies.

• In contrast, MDCs were nation states well before industrialisation. They had time
to develop a broad consensus of attitude towards ‘modernisation’.

• The material and cultural values underlying economic growth is largely alien to
many contemporary LDCs.

• A rich elite control power and hold back changes in many LDCs.

• Technological transfer is controlled by huge MNCs that are first world owned.

• International trade and international finance are both dominated by developed

countries.

• Many believe international economic relations maintain the power of the

industrialised countries e.g. through organizations such as The World Bank, IMF
and GATT. This “International Economic Order’ is seen as a constraint on growth
by the poor LDCs and there are demands by some LDCs for a New International
Order.

2. Differences Between the Present Day LDCs and the MDCs in their Pre-
Industrialization Period.

Physical Differences

• Many LDCs have few natural resources; the exception is Middle Eastern countries
that have oil. Some MDCs had abundant natural resources on which to base their
industrialization.

• In Africa, those countries with resources need MNCs to extract them.

288
• LDCs tend to be in tropical areas and so their soil is often poor compared to the
soil in more temperate climates.

Population Differences

• Populations in many LDCs are larger than pre-industrialised MDCs.

• Population growth in LDCs is much faster than ever it was in MDCs.

• Large population movements are a problem for LDCs, including many refugees
and war victims.

• Expanding populations in older MDCs in Europe could migrate to the ‘New’

World countries (USA, Australia, Canada etc.). This relieved excessive
population pressures in those countries. In today’s world, this is not an option for
LDCs.

Economic Differences

Features of Pre-Industrial MDC’s compared with current LDCs:

* Income per head higher.

* Populations better educated and more skilled.

* They enjoyed free trade and free capital movements.

* Surplus labour could migrate.

Current LDCs face the following situations:

* Terms of trade have moved steadily against current LDCs so it takes more exports
to purchase the same quantity of imports.

* LDCs rarely develop new and improved products because the rich countries
dominate science and technology. In addition, synthetic products from MDCs are
replacing many of LDCs primary products.

* Where LDCs have a distinct comparative in secondary production, developed

countries have frequently resorted to protectionism against them.

Technological Differences

• Developed countries were scientifically and technologically ahead of the world

when they developed.

• Most R & D is concentrated in MDCs so it is usually being done to suit their

needs.

• New technology is capital intensive, whereas a method of production that use

capital sparingly and labour intensively is needed in LDCs.

289
• MDC products are sophisticated: simple designs would be more suited to the
needs of LDCs.

International Financial Barriers

The extremely high level of International Indebtedness of LDCs is the key

problem.

Need to consider (i) amount of loans, (ii) nature of debt.

In summary,

• The problem of indebtedness became unmanageable after the oil crisis of the
1970’s when oil prices rose 400%.

• Prior to this the BOP current account deficits of LDCs could be covered by capital
inflow.

• Between 1975 and 1979 LDC debt doubled.

• The nature of the loans changed from being on concessional terms (‘soft loans’)
from governments and international institutions to loans from commercial banks
at market interest rates (‘hard loans’).

• After the second ‘oil shock’ of 1979 the crisis deepened considerably.

• In 2005, LDCs are going through another oil price shock.

• The import bills of LDCs grew dramatically and the recession in the MDCs led to
a fall in their exports.

• MDCs used high interest rate policies to reduce inflation.

• The rise in interest rates meant higher interest repayments on LDCs debt and so
debt servicing problems for the LDCs.

• ‘Capital flight’- the transfer on money by the elite in LDCs to safe havens in
MDCs- occurred from LDCs where the money was reinvested overseas where
there were higher returns and lower risk. Example: Indonesia in 1990s.
Resulted in major problems for the economy/country.

• LDCs were unable to service debts from export earnings and were forced to
reschedule them: short-term alleviation to a long-term problem.

• In the longer term, LDCs have had to make major structural reforms, often guided
by the IMF that has imposed unworkable policies in the domestic economy. For
example, the privatisation of public assets such as water, electricity and food
distribution. What’s happened in Malawi is a good example.

290
IMF-Stabilization Policies

These policies include:

• Market-oriented supply-side measures aimed at increasing output and investment,

including foreign investment.

• Trading measures including devaluing the official exchange rate to encourage

exports and discourage imports.

• Deflation-a sustained reduction in prices- of the economy through tight Monetary

Policy and Fiscal Policy aimed at reducing government deficits, inflation and
interest rates.

These deflationary policies have been politically very unpopular.

Non-Convertible Currencies

• Many LDCs use fixed exchange rates rather than floating exchange rates. That is,
the currencies are not freely convertible through the market forces of demand and
supply. Example is the Myanmar Kyat.

• These ‘Official Exchange Rates’ are usually set above the market rate. That is,
they are overvalued. Examples: Myanmar Kyat; Argentina’s Peso pre-2002. An
example set below is the Chinese Yuan. Note: in China’s case, the argument is
that the Yuan has been set below the market rate.

• The majority of the fixed currencies are fixed in terms of U.S. dollars. Exporters
have to sell U.S. dollars at the ‘official rate’. They therefore receive less local
currency for their dollars than the true market value. This is, in fact, a tax on
exporters.

• Most LDC exporters are primary producers so they are the ones who are
penalized.

• On the other hand, by making their foreign currency cheap, imports enjoy a
subsidy.

Over-Valued Non-Convertible Currency

Figure 5.1.5 (a) shows a supply and demand diagram for foreign currency, imposing
a high fixed price.

On the diagram, the price of the currency is plotted on the vertical axis and the
quantity of currency is on the horizontal axis. Demand is shown as the D Curve,
supply by the S Curve.

291
 Figure 5.1.5 (a): Over-Valued Non-Convertible Currency

Price
of
Currency S

P1 Official Exchange Rate

P2 Market Exchange Rate

0 Q1 QE Quantity of Currency

The market exchange rate, P2, is below the official rate, P1. The currency is
over-valued. As a result, demand for the currency at 0Q1 is less than what is would be
at the market rate, 0QE.

Under-Valued Non-Convertible Currency

Figure 5.1.5 (b) shows a supply and demand diagram for foreign currency, imposing
a low fixed price.

Figure 5.1.5 (b): Under-Valued Non-Convertible Currency

Price
of
Currency S
P1 Market Exchange Rate

P2 Official Exchange Rate

Shortage
D

0 Q1 Q2 Quantity of Currency

The market exchange rate, P1, is above the official rate, P2. The currency is
under-valued. As a result, there is a shortage of the currency, 0Q1 to 0Q2.

292
An alternative is to use ‘Exchange Controls”; that is, quotas or licenses to ration the
scarce foreign exchange. However this may lead to corruption, evasion and black
markets in foreign currency.

The solution is to devalue the currency or to set it free to float.

Other Factors

There are other factors that present barriers to economic development.

Unequal Distribution of Income

The problems associated with unequal distribution of income have been covered in
earlier chapters.

Formal and Informal Markets

• In most LDCs two distinct economies exist, called ‘dual economies’.

• The formal modern economy is centred in the central business district with its
modern office blocks and is like modern capitalist economies anywhere.

• In the slums there are intensive small-scale economic activities. This informal
economy is economically very efficient.

Lack of Infrastructure

• Infrastructure is the public facilities needed before productive industry can

operate. It includes roads, rail, gas, electricity, telephones etc.

• They are usually all found in urban areas and are a major reason why business
locates there.

• This is one reason why rural-urban migration takes place. But this migration has
overburdened the infrastructure in LDCs.

• The real shortage of infrastructure is found in the rural areas and much investment
in infrastructure facilities is needed to slow the rural-urban migration.

Open Unemployment, Underemployment and Disguised Unemployment.

• Open unemployment is commonly 10%-20% of the workforce in LDCs.

• However, there are many people who working but are producing very little; this is
called ‘disguised unemployment’. For example, more and more family member
working on a family plot of farmland the extra marginal product of each extra
member is practically zero.

• Underemployment also commonly exists; that is, people have jobs for only a few
hours per week or a few days a month when they would prefer to work longer.

• Adding the three types of unemployment mentioned above, the unemployment

problem in LDCs is massive; far greater than in a MDC.

293
5.1.6 Evaluation of Economic Growth and Development Strategies

This is a very important chapter.

New concepts are introduced. Their impact and consequences for LDCs are
discussed. As well, key strategies examined in earlier Chapters are evaluated.

1. Environmental Degradation

Environmental degradation is deterioration in the environment, through, for

example, pollution and deforestation. Major problem largely ignored by many world
leaders.

• As more LDC countries grow and develop more and more damage to the
environment occurs.

• Soil erosion occurs as people move to marginal land on hills and clear it for
farming; forest cover is lost by cutting wood for fuel; desertification is a growing
problem because of the overgrazing of animals; over fishing of seas, lakes and
rivers is a growing problem.

• The serious international environmental consequence of depleting the ozone layer

and environment through pollution is primarily the creation and responsibility of
the industrialised nations. Approximately, 80% of all fuel is burnt by 20% of the
richest people.

• LDCs will aggravate these problems as they develop; in particular China, the
fastest growing major economy in the world.

• These forms of environmental degradation are examples of market failure. They

are negative externalities, where the costs are not borne by the offenders but by
society as a whole. This represents an extra tax on everyone. This issue is
particularly important for LDCs where the extra costs to society are the result of
economic activities of MNCs.

Key questions that LDCs need to address are:

1. Should they blindly follow MDCs growth path that has heavily relied upon high
polluting technology and massive environmental degradation?

2. Should they “leap-frog” old technology?

3. Can they afford to do 2?

4. What is sacrificed to achieve 2? That is, will less be spent on hospitals, heath
care, education and infrastructure.

294
2. Income Distribution

• Economic development includes improvements being broadly distributed through

the population. In other words, that income becomes relatively evenly distributed.

• However, many economists believe that the pursuit of growth has to be given
priority over development; that development will follow growth. In terms of
economic theory this is a sound argument. But ask the starving poor living on less
than US$1/day for their response to economic rationalism and they will give a
very different answer.

• LDCs are therefore likely to argue for the very latest technology to achieve
economic growth. This has to be paid for. And for most LDCs, this means
incurring increasing external debt and suffering the economic consequences that
follow.

• LDCs would also argue that investment, which first requires saving, is more likely
to follow from an unequal income distribution: high-income earners will generate
the necessary savings. Poor people have a very high marginal propensity to
consume, while rich people have a high propensity to save.

There is evidence that this strategy works. For example, what has happened in
China and India since the 1980s. However, many of the very poor smaller African
countries do not have the required people/financial base for this to occur. For
example, Niger and Malawi.

3. Sustainable Development

Sustainable development refers to the use of the factors of production by the current
generation that results in the resources being available for future generations.

• Most pollution is caused by the high output of industrialized countries.

• LDCs urgently need to raise their standard of living. However, if they industrialise
with the same or similar polluting technologies used by MDCs there will almost
certainly be further serious deterioration in the world environment.

• More environmentally friendly technologies are needed. Yet they involve costs
that LDCs can ill-afford.

• In the case of pollution, for example, there is a physical limit to the amount of
pollution that can be absorbed.

• There is no doubt that there is an urgent need for sustainable development. By the
MDCs and LDCs. The key questions are: at what economic cost? what is the
political cost? who will pay, the polluters or society?

295
World Solutions

To a major extent, all three negative consequences of economic growth require a

global solution. Not just by a select group of nations.

Key Forums in which these issues are debated include:

* The United Nations

* The World Bank

* IMF

* G8

* Paris Club

The Kyoto Protocol

The concept of sustainable development dates back a long way but it was at the UN
Conference on Human Environment (Stockholm, 1972) that the international
community met for the first time to consider global environment and development
needs.

The 20th anniversary of Stockholm took place in 1992 in Rio de Janeiro. The UN
Conference on Environment and Development, the "Earth Summit", agreed
on Agenda 21 and the Rio Declaration.

The Summit brought environment and development issues firmly into the public
arena. Along with the Rio Declaration and Agenda 21 it led to agreement on two
legally binding conventions: Biological Diversity and the Framework Convention on
Climate Change (FCCC).

The Kyoto Protocol is a document signed by about 180 countries at Kyoto, Japan, in
December 1997.

The protocol commits 38 industrialised countries to cut their emissions of greenhouse

gases from 2008 to 2012 to levels that are 5.2 per cent below 1990 levels.

This issue was debated at the G8 meeting in Gleneagles, Scotland, in July 2005.

Significantly, the USA is still not a signatory.

4. Aid and Trade

Foreign aid can fill the resource gap in the short term. BOP current account deficits
can be financed by capital inflows. This is important if the aid is in the form of
grants.

But only a very small percentage of foreign aid is provided as grants. The majority is
tied aid.

296
Regardless of the above, free and fair trade is critical to the economic growth and
development of LDCs. This is not happening, given higher levels of protectionism by
the USA, EU and Japan.

As we have seen in earlier Chapters, LDCs want free and fair trade combined with
debt forgiveness and the majority of Aid in the form of Grants. In short, LDCs want a
package deal. To-date this has not happened, despite continual talkfests by the major
MDCs.

5. Commodity Agreements

Apart from OPEC, commodity agreements have not been long-standing or successful
as a means of increased economic growth and development.

One key reason is the purchasing power and financial and economic muscle of
companies in MDCs, the major markets for LDC products.

6. Role of International Financial Institutions

The World Bank, IMF and private sector banks have all played an important role in
providing investment funds in LDCs.

But in recent years, loans from the all institutions have become ‘hard loans’ with
higher interest rates and shorter repayment periods as well as with more stringent
conditions. The IMF, for example, placed onerous political and economic conditions
on Indonesia in the 1990s.

7. Microlending

Earlier Chapters highlighted the limited success of microlending in countries like

Bangladesh and India. But the quantum of loans and percentage of market covered is
miniscule compared to the market need.

But it is an important first step.

297
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SECTION 6: APPENDICES

APPENDIX 6.2: 500+ ECONOMIC DEFINITIONS & EXPLANATIONS

A
ABOVE FULL EMPLOYMENT EQUILIBRIUM exists when macroeconomic
equilibrium occurs at a level of Real GDP above long-run aggregate supply (LRAS).

ABSOLUTE ADVANTAGE exists when one country can produce a good or service
with less resources or factors of production compared to another country.

ABSOLUTE POVERTY exists when only the minimum level of basic needs- such
as food, shelter and clothing-can be met.

ABUNDANCE occurs when a person can obtain as much of something as they want.
It is the opposite of scarcity.

ACCELERATOR refers to a larger percentage change in investment as a result of a

percentage change in demand.

ACCOUNTING PROFIT is the difference between total revenues and total explicit
costs.

AD VALOREM TAX is an indirect tax on a good or service imposed by a

government whose amount of tax depends on the value of the item or service.

AGGREGATE DEMAND is the relationship between the aggregate quantity of

goods and services demanded-or Real GDP- and the price level– the GDP deflator-
holding everything else constant. AD =C+I+G+X-M.

AGGREGATE DEMAND SHOCK is any shock, such as 9/11 or a war, which

causes the aggregate demand curve to shift to the left or right.

AGGREGATE SUPPLY CURVE is the relationship between planned rates of total

production for the whole economy and the price level.

AGGREGATE SUPPLY is the sum total of planned production for the whole
economy.

AGGREGATE SUPPLY SHOCK is any shock, such as 9/11 or a dramatic change

in the weather, which causes the aggregate supply curve to shift to the left or right.

AGRICULTURAL PROTECTIONISM is the restriction of agricultural

international trade by governments. A of major concern to LDCs. It is a major reason
for the failure of the WTO Doha Round of negotiations.

AID is money and/or goods and services provided to a country. It can be tied-that is,
certain conditions are imposed by the donor-or untied. It can come from private
investment and or Overseas Development Assistance.

300
 ALLOCATIVE EFFICIENCY occurs when no resources are wasted; when no one
can be made better off without making someone else worse off.

ANTICIPATED INFLATION is an inflation rate that has been correctly forecast.

ANTI-DUMPING measures are imposed by governments against exports of goods

and services, which are sold into their country below the cost of production.

APPRECIATION is an increase in the value of a domestic currency in terms of other

currencies. Occurs as a result of market forces.

ASEAN refers to the free trade area of The Association of South East Asian Nations.

ASEAN PLUS 3 refers to ASEAN plus the possible inclusion of China, Japan and
South Korea.

ASSET is anything of value that is owned; such as a house, shares and furniture.

AUTOMATIC STABLIZER is a mechanism that decreases the size of fluctuations

in aggregate expenditure.

AUTONOMOUS CONSUMPTION is that part of consumption which is

independent of the level of disposable income.

AVERAGE ANNUAL GROWTH IN GDP refers to the average percentage growth

in GDP over a period of time.

AVERAGE ANNUAL GROWTH IN GDP PER CAPITA refers to the average

percentage growth in GDP per capita over a period of time.

AVERAGE ANNUAL POPULATION GROWTH refers to the average percentage

growth in population over a period of time.

AVERAGE FIXED COSTS (AFC) are total fixed costs divided by the number of
units produced.

AVERAGE PROPENSITY TO CONSUME (APC) is consumption divided by

disposable income at any given level of income. It is the proportion of total disposable
income that is consumed.

AVERAGE PROPENSITY TO SAVE (APS) is savings divided by disposable

income at any given level of income. It is the proportion of total disposable income
that is saved.

AVERAGE TAX RATE is the total direct tax payment divided by total income. Or
the proportion of total income paid in direct tax.

AVERAGE TOTAL COSTS (ATC) are total costs divided by the number of units
produced.

AVERAGE VARIABLE COSTS (AVC) are total variable costs divided by the
number of units produced.

301
B
BALANCE OF PAYMENTS is an account of a country’s transactions with the rest
of the world.

BALANCE OF TRADE is the difference between the value of visible exports and
the value of visible imports.

BALANCE OF TRADE DEFICIT refers to a situation where a country’s visible

imports exceed its visible exports.

BALANCE OF TRADE SURPLUS refers to a situation where a country’s visible

exports exceed its visible imports.

BILATERIAL FREE TRADE AGREEMENT refers to a free trade agreement

between two countries.

BRAND NAME is a name given by an organization to a product or service with the

aim to distinguish from other goods and services on the market, thereby enhancing its
value and resulting in consumer loyalty.

BALANCING ITEM refers to the estimated net value of omissions from all other
items recorded in the balance of payments accounts.

BANKRUPTCY is a situation where an entity is unable to pay its debts.

BARRIERS TO ENTRY refers to obstacles placed to make it difficult for firms to

enter an industry and provide competition to existing suppliers of a good or service. A
form of protectionism; often imposed by governments to protect their domestic
industries.

BARTER is a system of exchange where goods and services are exchanged without
the use of money. Still used by some countries, such as Myanmar.

BASE YEAR is the year selected as the point of reference for comparison.

BIRTH RATE is the number of births per 1,000 people in the population per year.

BLACK MARKET ECONOMY refers to the unofficial economic activity in an

economy. It cannot be precisely measured because the value of the activities is not
officially recorded in a country’s accounts.

BUDGET is the annual statement of accounts of a government for a forthcoming

period, usually the next twelve months. The surplus or deficit reflects the internal
health of a country or state.

BUDGET SURPLUS occurs where the government’s income exceeds its

expenditure.

BUDGET DEFICIT occurs where the government’s income is less than its
expenditure. Persistent deficits reflect poor management of a country’s internal
accounts/affairs.

302
BUFFER STOCK SCHEME refers to attempts, by producers and/or governments,
to smooth out fluctuations in prices in goods and hence producer incomes.

BUSINESS CYCLE refers to the fluctuations in economic activity over a period of

time. Usually measured by Real GDP and other macroeconomic variables.

CAPITAL is one of the four factors of production. It refers to man-made items. For
example, machines, robots, factories.

CAPITAL CONSUMPTION refers to the reduction in the value of capital goods

over a one-year period due to obsolescence and physical wear and tear.

CAPITAL COSTS are the cost incurred in providing capital goods.

CAPITAL DEEPENING refers to improvements in the quality of capital. Examples

include new ideas and inventions that find their way into the productive process via
new, or improvements to existing, capital goods.

CAPITAL FLIGHT is the movement of domestic financial capital across

international boundaries. It usually is a result of domestic problems-such as a war or
insurgency- and results in problems of capital deepening, particularly for LDCs
leading to increased international debt.

CAPITAL GOODS consist of one of the four factors of production produced by

people. For example, machines, robots, factories.

CAPITAL INVESTMENT is the investment in capital or capital goods.

CAPITAL MOVEMENTS is the flow of funds across international boundaries for

investment in capital goods and/or in response to, or anticipation of, obtaining a
higher interest rate.

CAPITAL WIDENING refers to an increase in the quantity of capital.

CAPITALISM refers to an economic system in which the productive resources are

owned by individuals/corporations.

CARTEL exists when a group of producers enter into a collusive agreement to limit
output and control supply in order to raise prices and profits. Results in increased
producer sovereignty. OPEC is a good example.

CENTRAL BANK refers to the official institution in a country, which controls the
money supply, and also sets interest rates. It controls monetary policy. In the majority
of countries, it operates independently of the government.

CERITUS PARIBUS is the assumption that all other variables are kept constant,
except those variables under study.

303
CHILD MALNUTRITION refers to situations where a child does not have
sufficient sustenance for a healthy life.

CLASSICAL UNEMPLOYMENT is caused when labour unions or minimum

legislation hold the real wage above the equilibrium level, not allowing the market to
clear. It is one of the two types of disequilibrium unemployment.

COLLUSION is a situation where a group of individuals or firms join together, either

officially or usually unofficially, to exercise greater producer sovereignty.

COLLUSIVE OLIGOPOLY refers to the price setting by oligopolies to prevent a

price war from occurring.

COMMAND ECONOMY is the economic system in which the government controls

all or the majority of the factors of production, makes decisions about the allocation of
scarce resources and the distribution of income.

COMMODITY AGREEMENTS are arrangements between producers to control

supply onto the market, aimed at stabilising and/or raising commodity prices. They
create a buffer stock.

COMPARATIVE ADVANTAGE exists where a country can produce a good or

service at a lower opportunity cost compared with another country.

COMPETITION is rivalry among buyers and sellers of the inputs and outputs of the
factors of production.

COMPLEMENTARY GOOD OR SERVICE exists when the change in price of

one good or service causes an opposite shift in the demand for another good or
service.

CONCENTRATION RATIO refers to the percentage of all sales contributed by a

small number of the largest firms in an industry.

CONSTANT PRICES is the currency expressed in terms of real purchasing power,

using a base year as a comparison.

CONSTANT RETURNS TO SCALE exists when the percentage change in a firm’s

output equals the percentage change in its inputs.

CONSUMER EXPENDITURE is expenditure on durable and non-durable goods

and services by consumers.

CONSUMER GOODS refer to durable and non-durable goods and services.

CONSUMER PRICE INDEX is an index of the average household’s purchase of

goods and services most commonly used in western countries to measure inflation.

CONSUMER SOVEREIGNTY exist where consumers, by their spending,

ultimately determines which goods and services will be produced in an economy.

CONSUMER SURPLUS is the difference between the amount a consumer is willing

to pay for a commodity and the amount that is actually paid.

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CONSUMPTION is the process of using up goods and services.

CONSUMPTION FUNCTION expresses the relationship between the amount

consumed and disposable income.

CONSUMPTION GOODS are goods bought by households to use up.

CONTESTABLE MARKETS refers to markets where entry and exit is free, thereby
allowing greater competition in an industry.

COST-BENEFIT ANALYSIS refers to the process of putting a monetary value on

the total costs and total benefits of an economic activity, and then weighing them up
to make a decision. A major problem in economics is “how do you place a monetary
value on the social or external costs and benefits of an economic activity?”

COST-PUSH INFLATION refers to the sustained increase in the general price level
resulting from increased cost in the inputs of the factors of production.

COUNTER-CYCLICAL POLICY is the use of expansionary and contractionary

monetary and fiscal policies to offset wide fluctuations in economic activity.

COUNTER-PRODUCTIVE ECONOMIC ADVICE refers to advice, or terms,

imposed on a country by an international financial institution that the government of
the country believes is not in the country best economic interest. Often used in
relation to IMF loans granted to LDCs.

CREEPING INFLATION refers to a sustained low rate of increase in the general

price level. Considered not only acceptable but also good for an economy.

CROSS-PRICE ELASTICITY OF DEMAND is a measure of the responsiveness in

quantity demanded of one good/service to the change in price of a related good/
service.

CROWDING IN refers to the likelihood of an expansionary fiscal policy will result

in an increase in investment.

CROWDING OUT refers to the likelihood of an increase in a government’s

expenditure on goods and services will result in an increase in interest rates, thereby
crowding out private investment because firm’s borrowing costs are higher.

CRUDE BIRTH RATE is the number of births per year per 1,000 population.

CRUDE DEATH RATE is the number of deaths per year per 1,000 population.

CURRENCY TRADER is a person or organization which deals/trades in one or

more currencies. They are engaged in speculative foreign exchange transactions,
which account for the majority of all currency dealings.

CURRENT ACCOUNT is that part of the balance of payments which records the
transactions of goods/visible items and services/invisible items. Used as a measure to
determine how healthy a country’s external account is.

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CURRENT ACCOUNT BALANCE refers to whether the current account is in
surplus or deficit.

CURRENT ACCOUNT BALANCE TO GDP (%) expresses the relationship in

percentage terms between the current account balance and GDP. It is a measure of
both the importance and health of a country’s external account.

CURRENT ACCOUNT DEFICIT exists where imports of goods and services

exceed their exports. Persistent deficits are a major problem for a country-particularly
LDCs- because they indicate that the country is living beyond its means. To overcome
this, a country has to increase its borrowings on its BOP capital account.

CURRENT ACCOUNT SURPLUS exists where exports of goods and services

exceed their imports. Indicates a healthy external account, and a healthy economy.

CUSTOMS UNION is a unification of two or more countries of their customs and

trade policies.

CYCLICAL UNEPLOYMENT is unemployment resulting from a downturn in the

business cycle resulting in a recession. Occurs when total demand is insufficient to
create full employment.

D
DEATH-RATE is the number of deaths per 1,000 population.

DEBT-SERVICING refers to the ability of an organization and/or country to meet

interest and principal payments on its debts/borrowings as and when they fall due.
Often represents a major external account problem for LDCs.

DECREASING RETURN TO SCALE occurs when an increase in a firms’ inputs

results in a less than proportional increase in its output.

DEFAULT ON LOANS exists when an organization or country fails to repay its

borrowings on the due date.

DEFICIT SPENDING exists when a government’s spending exceeds its tax

revenues.

DEFLATE refers to government action to reduce aggregate demand through fiscal

and/or monetary measures.

DEFLATION is a sustained decrease in the general price level. Often accompanied

by a fall in total output and an increase in unemployment.

DEMAND is the relationship between the quantity demanded of a good or service

and its price.

DEMAND-DEFICIENT (CYCLICAL) UNEMPLOYMENT occurs as a result of a

fall in aggregate demand for goods and services. This leads to a decline in the demand
for labour. It is one of the two types of disequilibrium unemployment.

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DEMAND CURVE shows the relationship between the quantity of a good or service
and its price, holding all else constant. Shown on a graph/diagram.

DEMAND SCHEDULE lists the quantities of a good or service and its price, holding
all else constant.

DEMAND-PULL INFLATION is a sustained increase in the general price level

resulting from an increase in aggregate demand.

DEMERIT GOOD is a good or service that is socially undesirable. It is the opposite

of a merit good.

DEPENDENCY RATIO is the percentage of the population under aged 15 years and
65 plus years. Refers to the fact that these people generally do not pay tax and are
dependent upon the economic activity of others.

DEPRECIATION OF CAPITAL is the reduction in the value of capital goods over

a year due to obsolescence and wear and tear.

DEPRECIATION OF CURENCY is the reduction in the value of a domestic

currency against foreign currencies under a regime of floating exchange rates.

DERVIVED DEMAND is when the demand for the final product produced results in
an increase in the demand for inputs of the factors of production.

DEVALUATION is a fall in the value of a currency operating under a fixed

exchange rate system. Results from government action.

DEVALUE is to lower the value of a currency operating under a fixed exchange rate
system. Results from government action.

DEVELOPMENT is a process that improves the lives, or standard of living, of all

people in a country. Includes both tangible and intangible factors.

DEVELOPMENT INDICATORS are measures-such as literacy, malnutrition and

the poverty level- that indicate a country’s level of economic development.

DIMISHING OR MARGINAL RETURNS occurs at the point when continual

increases in a variable factor of production applied to a fixed factor of production
results in a less than proportional increase in output.

DIRECT TAX is a tax imposed by governments directly on an individual or

organization. Most commonly applied on personal income and company profits.

DIRTY OR MANAGED FLOAT exists when a government intervenes in the

managed float of its currency. It creates an artificial value or price of the currency,
and is unsustainable in the long term.

DISECONOMIES OF SCALE exists when an increases in output leads to increases

in long-run average costs.

DISGUISED UNEMPLOYMENT exists in the workplace where labour produces

very little output, their marginal product is very low and inefficiency is high. In short,

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too many workers are employed for a given task. Examples exist in many of China’s
State Owned Enterprises.

DISTRIBUTION OF INCOME refers to the way in which income is distributed

among the population.

DIVISION OF LABOUR is the segregation of the factor of production-labour-into

different tasks. Occurs in most organizations.

DOHA ROUND OF TRADE NEGOTIATIONS refers to the current WTO round

of negotiations of members aimed at reductions in trade restrictions. It began in 2001
and was due to be completed in 2004, but has been extended.

DOMINANT PRICE LEADER refers to the market leader in an industry that is

usually the first to change prices.

DOUBLE COUNTING exists when expenditure is counted on both intermediate and

final goods and services. It is avoided in the preparation of national accounts.

DUAL ECONOMY is the existence of two distinct types of economies, operating

side-by-side.

DUMPING is when the price of a country’s exports is below the true costs of
production.

DUOPOLY is a market structure where there are only two sellers in a market and
interdependence plays a major role in price determination.

DURABLE CONSUMER GOODS are goods used by consumers that have a life
span of more than one year.

DUTIES are a form of protectionism. They are levies imposed by governments on

imports. Result in increased consumer prices and less competition in the marketplace.

E
ECONOMIC DEVELOPMENT occurs in a country when there is an increase in
Real GDP per capita plus an improvement in the standard of living. It is one of the
five major macroeconomic objectives.

ECONOMIC EFFICIENCY occurs when society is producing the goods and

services most valued by society. Occurs outside firms, where demand and supply of
goods and services is determined by market forces to establish price.

ECONOMIC GOOD is any good or service that is scarce.

ECONOMIC GROWTH is an increase in a country’s Real GDP per capita. It is one

of the five major macroeconomic objectives.

ECONOMIC PROBLEM is one of relative scarcity of resources relative to

unlimited human wants.

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ECONOMIC PROFIT is the extra profit a firm earns over the combination of
accounting profit and normal profit. Also referred to a supernormal profit.

ECONOMIC REFORMS refers to changes-usually resulting in improvements- to a

country’s economic systems.

ECONOMIC STRUCTURE refers to the classification of a country’s output

produced by sectors of the economy-usually, primary, secondary and tertiary sectors.

ECONOMIC SYSTEM refers to the system that guides the use of resources to
satisfy human wants.

ECONOMIC THEORY is a principle or rule that allows us to understand and

predict economic choices.

ECONOMICS is the study of how people/societies use their scarce resources to

satisfy unlimited wants.

ECONOMIES OF SCALE occurs when increasing the scale of production leads to a

lower cost per unit of output.

EFFICIENCY is concerned with how well scarce resources are allocated to solve the
three problems of what to produce, how to produce, and for whom production should
take place.

ELASTICITY is a measure of the responsiveness of one variable to the change in

another variable.

EMBARGO is a total ban on trade. It is one of the forms of protectionism. It may be

imposed by a domestic government or from outside the country. An example of the
former is an embargo on drugs.

EMPLOYMENT refers to the paid utilisation of the factor of production-labour.

EMU refers to the European Monetary Union, a group of countries that use the single
currency-the Euro.

ENERGY CONSUMPTION PER CAPITA is the amount of energy consumed

divided by the total population.

ENTERPRISE is a key factor of production and is the reward derived from

combining the other three factors-land, labour and capital-to produce goods and
services.

ENVIRONMENTAL DEGRADATION is a deterioration in the environment

through, for example, pollution and deforestation. Major problem largely ignored by
many world leaders.

EQUATION OF EXCHANGE is expressed as formula M x V = P X Q.

EQUILIBRIUM is a situation where demand equals supply at a given price and the
market clears.

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EU refers to the European Union, a group of countries that have formed a trading
bloc.

EURO is the official currency of the majority-but not all-of members of the EU.

EUROCURRENCY is the official currency of the majority-but not all-of members of

the EU.

EUROPEAN MONETARY SYSTEM (EMS) refers to the agreement whereby EU

members promoted exchange rate stability within the EU before the introduction of
the Euro.

EXCHANGE is the act of trading goods and services between countries for their
mutual economic benefit.

EXCHANGE RATE is the price of a currency expressed against another, or group pf

currencies, on the foreign exchange market.

EXCHANGE RATE THEORY refers to the economic theory of managing an

exchange rate.

EXPANDING DOWNSTREAM refers to a situation where a company expands its

operations away from the market towards the original source of raw materials.

EXPENDITURE-REDUCING POLICIES are contractionary macroeconomic

policies designed to reduce incomes and thus expenditure.

EXPENDITURE-SWITCHING POLICIES are policies which a designed to reduce

spending on imports and lead to an increase in spending on domestically produced
goods and services and exports.

EXPORTS are goods and services sold by one country to another.

EXPORTS AS A % OF GDP expresses the relationship, in percentage terms,

between exports and GDP.

EXTERNAL BALANCE refers to a country’s balance of payments on current

account. That is, whether it is in surplus or deficit. Related to the key macroeconomic
objective of external equilibrium.

EXTERNAL DEBT is the amount of money owed by a country to the rest of the
world.

EXTERNAL EQUILIBRIUM is concerned with the balance of payments on current

account of a country. That is, whether it is in balance, surplus or deficit. It is one of
the five major macroeconomic objectives. The attainment of balance over a period of
time is an indication that a country can pay its way in the world. Persistent deficits-a
major problem for many LDCs-obviously indicates that a country is living beyond its
means.

EXTERNAL SHOCK relates to an unexpected shift in aggregate demand and/or

aggregate supply.

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EXTERNALITY is an effect of production or consumption that is not taken into
account by producers or consumers that affects the utility or costs of other producers
or consumers.

F
FACTORS OF PRODUCTION refers to the scarce resources-land, labour, capital
and enterprise-used to produce economic goods and services.

FARM SUBSIDIES are payments by governments to agricultural producers. These

subsidies by the USA, EU and Japan are a major reason for the failure of the Doha
Round of Free Trade negotiations.

FEMALE ILLITERACY is the percentage of females in a population who cannot

read and write.

FERTILITY RATE is the average number of children born to each female in a

country.

FINANCIAL MARKETS are markets which savings pass through to firms and
governments for investment purposes.

FIRM is an organization that utilises the factors of production to produce and sell
goods and services.

FISCAL DEFICIT AS A % OF GDP expresses the relationship in percentage terms

between the budget deficit and GDP. It is an indicator of the internal health of an
economy-the higher the %, the “sicker” the economy.

FISCAL DEFICIT exists where government expenditure exceeds its tax revenues.

FISCAL POLICY refers to the government’s policy on taxation (direct and indirect),
government expenditure and transfer payments and their affect on aggregate demand
and aggregate supply.

FISCAL SURPLUS exists where government tax revenues exceed its expenditure.

FIXED COSTS (FC) refer to those costs that do not vary with output in the short
run. In the long run, all costs are variable.

FIXED EXCHANGE RATE exists where the price of one currency against another
is fixed on the foreign exchange market. Currently, this is the situation with the
Chinese Yuan to the US$.

FIXED INVESTMENT refers to purchases of capital goods.

FLOATING EXCHANGE RATE is one where the price of one currency against
another is determined by market forces on the foreign exchange market.

FLOOR PRICE, or minimum price, is a price imposed above the market equilibrium
price. It is designed to assist producers.

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FOREIGN AID refers to assistance to a country from private sources or public
bodies from outside a country. For LDCs, it is a major source of financing BOP
current account deficits.

FOREIGN DIRECT INVESTMENT (FDI) refers to the investment by overseas

firms in another country. Majority is undertaken by MNCs.

FOREIGN EXCHANGE MARKET refers to the institutions through which

currencies are traded on the open market.

FREE ENTERPRISE is the system that allows individuals and firms to obtain scarce
resources, organise them, and sell goods and services without major government
interference.

FREE GOOD is any good or service that is abundant.

FREE RIDER is someone that consumes a good or service without paying for it.

FREE TRADE is the movement of goods and services without protectionist barriers.

FREE TRADE AGREEMENT is an agreement that allows the movement of goods

and services without protectionist barriers between two or more countries.

FREE TRADE AREA refers to a group of countries (two or more) that engage in the
movement of goods and services without protectionist barriers.

FREELY FLOATING EXCHANGE RATE is one where the price of one currency
against another is determined by market forces on the foreign exchange market.

FRICTIONAL UNEMPLOYMENT refers to unemployment caused by new

entrants into the market, technological change and geographic movement of workers.

FULL EMPLOYMENT exists when the labour market clears allowing for structural,
seasonal and frictional unemployment. Also known as the natural rate of
unemployment. It is one of the five major macroeconomic objectives.

G
GDP IMPLICIT PRICE DEFLATOR is an index that measures the changes in
prices of all goods and services produced by an economy.

GDP PER CAPITA is the gross domestic product divided by the total population.

GIFFEN GOODS refers to goods where the income effect of a price change of
inferior goods is greater than the substitution effect. Many economists dispute this
claim.

GINI COEFFICIENT is a way of showing income inequality by converting the

Lorenz curve into a single statistic.

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GLOBALISATION is a process of breaking down barriers between countries
resulting in greater integration and interdependence. Since the 1980s, largely brought
about through massive technological changes in communications and information.

GLOBALISED ECONOMY is the movement, through globalisation, to a borderless

world economy.

GLUT is an excess of supply of a good or service over demand at the equilibrium

price.

GNI is the sum of all the incomes within a country allowing for net property income
from abroad.

GNI PER CAPITA is gross national income divided by the total population.

GROSS DOMESTIC PRODUCT (GDP) is the value of a country’s total output of

goods and services before depreciation.

GROSS NATIONAL SAVINGS AS A % OF GDP expresses the relationship in

percentage terms between gross national savings and GDP. For investment to occur,
savings must first take place. Therefore, the higher the % of gross national savings to
GDP the greater will be future total output.

GROWTH IN INVESTMENT refers to the increase-usually expressed in percentage

terms-in investment that is a precursor to increased total output and employment.

GROWTH IN OUTPUT refers to the increase-usually expressed in percentage

terms-in the value of a country’s total output in goods and services.

H
HARD LOAN is a loan with commercial rates of interest and terms of repayment.

HARROD-DOMAR GROWTH MODEL refers to a model of growth, which

focuses on the constraint in growth caused by shortage of capital in LDCs.

HIDDEN UNEMPLOYMENT exists in a firm where too many people are employed
resulting in many employees producing very little. Inefficiency is high. Also known
as disguised unemployment.

HUMAN CAPITAL is the investment that takes place in the factor of production-
labour- aimed to increase productivity, well-being and job satisfaction. Occurs
through the investment in education and training of people.

HUMAN DEVELOPMENT INDEX measures the average achievement of a country

in three dimensions of human development-life expectancy at birth, adult literacy rate,
and purchasing power through GDP per capita (PPP US$).

HUMAN SUFFERING INDEX is an index of ten indicators of human well-being.

Used to rank countries and make comparisons.

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HYPER-INFLATION is an excessive sustained increase in the general price level.
Very damaging to an economy as it results, for example, in domestic goods and
services being non-competitive in international markets.

I
ILLITERACY is the percentage of the population who cannot read and write.

IMPERFECT COMPETITION refers to the many market structures that fall

between the two extremes of perfect competition and pure monopoly.

IMPORT SUBSTITUTION is increasing domestic production of goods and services

to replace imports. Process adopted by many LDCs in an attempt to industrialise.

IMPORTS are the purchase of goods and services from another country.

INCOME ELASTICITY OF DEMAND is the responsiveness of the quantity

demanded of a good or service to a change in income. Important tool used by
businesses and governments in their decision making process.

INCOME INEQUALITIES refers to the gap in incomes between high, middle and
low income-earners. Statistics indicate that the gap is widening, rather than
narrowing, in most countries.

INCREASING RETURNS TO SCALE occurs when output increases more than

proportionally to the increase in inputs.

INDIRECT TAX is a tax imposed by government directly on spending. Examples

include: GST, payroll tax, sales tax, land tax, stamp duty paid on the purchase of a
property.

INFANT INDUSTRY ARGUMENT refers to the argument for governments to

protect newly established industries from foreign competition, to enable them to grow
domestically and internationally.

INFANT MORTALITY RATE is the number of live-born infants who die before
one year old per 1,000 of the population.

INFERIOR GOOD is a good for which consumption falls as income rises.

INFLATION is a sustained increase in the general price level. Measured by the

Consumer/Retail Price Index.

INTEREST is the cost of borrowing money or return received for money lent. Also,
the return paid to the owners of capital.

INTEREST RATE is the price paid or received for borrowing or lending money.

INTEREST RATE DIFFERENTIAL refers to the difference in Central Bank

interest rates between countries.

INTERNAL BALANCE refers to the state of the government’s fiscal budget.

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INTERNATIONAL INDEBTEDNESS is the amount of borrowings a country has
obtained from overseas. Major problem for LDCs.

INTERNATIONAL MONETARY FUND (IMF) is now primarily involved in

arranging credit and providing mainly macroeconomic advice to LDCs. Often accused
by LDCs as being interfering in their internal affairs as credit provided often comes
with stringent conditions which have political and social consequences for borrowing
governments.

INVESTMENT is expenditure on investment in goods and services or capital

creation.

INVESTMENT LOANS refer to World Bank loans that are long term, 5 to 10 years,
and are used to finance specific projects involving goods, services and works in poor
countries.

INVISIBLE BALANCE refers to the balance of all items on the balance of payments
of current account, except for the exports and imports of goods.

J
J-CURVE EFFECT refers to the way and the time frame in which the trade balance
may initially worsen before it improves, after a devaluation/depreciation of the
exchange rate.

K
KEYNESIAN THEORY advocates government intervention due to the inherently
unstable nature of the economy. Favours fiscal policy measures rather than monetary
policy measures to correct macroeconomic problems in the economy.

KINKED DEMAND CURVE is a pricing model in an oligopolistic market structure.

Rivals follows one firm’s decision to decrease their price, but not to increase their
price, of a good or service.

KUZNETS RATIOS refers to the percentage of income earned by the bottom 40%
expressed as a ratio of income earned by the top 20%.

L
LABOUR is one of the four factors of production. Refers to human resources
involved in productive contributions to the economy.

LABOUR FORCE is the number of people who have jobs plus those who are
unemployed.

LABOUR PRODUCTIVITY is the output per unit of labour input.

LAFFER CURVE refers to a graphical representation of the relationship between tax

rates and total revenues raised by taxation.

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LAISSEZ-FAIRE is a viewpoint that advocates non-government intervention in an
economy.

LAND is one of the four factors of production. Refers to all natural resources.

LAW OF DIMISHING OR MARGINAL RETURNS advocates that, at some

point, continual increases in a variable factor of production applied to a fixed factor of
production will result in a less than proportional increase in output.

LESS DEVELOPED COUNTRY refers to countries with a low standard of living,

such that many people do not have the basic necessities of life such as adequate food,
water, clothing, heath and education.

LIFE EXPECTANCY is the average number of years a person is expected to live. It

is one indicator of the level of economic development of a country.

LIVING BELOW THE POVERTY LINE refers to the percentage of the population
living on less than US$1 per day. This is the World Bank definition. It is one indicator
of the level of economic development of a country.

LONG RUN is the time period when all factors of production are variable.

LONG-RUN AGGREGATE SUPPLY is the relationship between Real GDP and

the Price Level at full employment. Unemployment is at its natural rate.

LONG-RUN AVERAGE COST CURVE represents the cheapest way to produce

goods and services. It is derived by joining the minimum point of the various SRAS
curves.

LONG-RUN PHILLIPS CURVE shows the relationship between inflation and

unemployment when the actual rate of inflation equals the expected rate of inflation.

LONG-RUN SUPPLY CURVE describes the response of the quantity supplied to a

change in price after all technology adjustments have been made.

LORENZ CURVE measures income inequality within the population.

LOW-INCOME HOUSEHOLDS refers to households where the basic necessities

of life cannot be met. Covers approximately 3 billion of the world’s population.

MACROECONOMIC EQUILIBRIUM occurs where the quantity of Real GDP

demanded and supplied meet. It is where AD = SRAS.

MACROECONOMIC OBJECTIVES refers to the five key macroeconomic issues

that are of concern to governments: economic growth, economic development, full
employment, price stability, and external equilibrium.

MACROECONOMICS is the study of the whole economy.

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MALE ILLITERACY refers to the number or percentage of males who cannot read
or write.

MANAGED EXCHANGE RATES is a system of exchange rates where

governments intervene to influence the price of their currency.

MARGINAL COST (MC) is the change in total cost for the last unit increase in the
variable input.

MARGINAL COST PRICING is a system of pricing in which the price charged is

equal to the opportunity cost to society of producing one more unit of good or service.

MARGINAL PRIVATE COST (MPC) is the marginal cost directly incurred by

producers.

MARGINAL PROPENSITY TO CONSUME (MPC) is the ratio of the change in

consumption to the change in disposable income.

MARGINAL PROPENSITY TO CONSUME DOMESTIC (MPCd) is the

proportion of an increase in disposable income that is spent on domestic goods and
services.

MARGINAL PROPENSITY TO IMPORT (MPM) is the proportion of an increase

in disposable income that is spent on imports.

MARGINAL PROPENSITY TO SAVE (MPS) is the ratio of the change in savings

to the change in disposable income.

MARGINAL REVENUE (MR) is the change in total revenue resulting from selling
one more unit.

MARGINAL SOCIAL BENEFIT is the total value of the benefit from one
additional unit of consumption. It includes benefits to the buyer plus any indirect
benefits to society.

MARGINAL SOCIAL COST is the total cost of producing one additional unit of
output. This includes costs borne by the producer plus any indirect costs borne by
society.

MARGINAL TAX RATE is applied to the last tax bracket of taxable income. It is
the percentage of extra income that must be paid in taxes.

MARKET ECONOMIC SYSTEM refers to a system where individuals, rather than

governments, own the factors of production and decide what, how and when to
produce.

MARKET ECONOMY refers to an economy where individuals, rather than

governments, own the factors of production and decide what, how and when to
produce.

MARKET EQUILIBRIUM PRICE is the clearing price where the demand curve
and supply curve intersect.

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MARKET EXCHANGE RATE refers to the price of a currency determined by the
market forces of demand and supply of a currency.

MARKET FAILURE occurs where markets do not work at all or do not work well.

MARKET POWER refers to a market structure where a high degree of producer

sovereignty exists.

MARKET SHARE is the percentage of the total market or market segment captured
by a producer.

MARKET STRUCTURE is primarily classified by the degree of competition that

exists in the market. Structures range from perfect competition through to monopoly.

MARSHALL-LERNER CONDITION states that if the PEDx + PEDm > 1, then a

depreciation of the exchange rate will improve the balance of payments. If the PEDx
+ PEDm = 1, then the BOP will remain unchanged. If the PEDx + PEDm <1, then a
depreciation will worsen the BOP.

MAXIMUM OR CEILING PRICE is a price imposed below the market

equilibrium price. It is designed to help consumers by making the price cheaper.

MERCHANDISE EXPORTS are the visible goods one country sells to another.

MERCOSUR refers to a free trade area formed by major South American countries,
such as Brazil and Argentina.

MERGER is the joining of two entities.

MERIT GOOD is a good that is socially desirable. It has positive externalities and
will often be underprovided in a free market.

MICRO-LENDING refers to the lending of very small amount of money to private

small businesses. It is has the potential to be an important source of funding in LDCs.

MICROCREDIT refers to the provision of a credit facility or lending of very small

amount of money to private small businesses. It has the potential to be an important
source of funding in LDCs.

MICROECONOMICS is the study of the behaviour of households and firms and

how the prices of goods and services are determined.

MIDDLE-INCOME DEVELOPING COUNTRIES have a higher standard of

living compared with low-income countries, but still there are many people who still
cannot meet their basic needs.

MINIMUM BASIC LIVING STANDARD refers to being able to satisfy the basic
necessities of life, such a food, clothing, water, shelter, education and health care.

MINIMUM OR FLOOR PRICE is a price imposed above the market equilibrium

price. It is designed to assist producers.

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MINIMUM WAGE LAW is a regulation that makes it illegal to hire labour below a
specified wage.

MIXED ECONOMY refers to an economic system in which the economic decisions

regarding the allocation of scarce resources is partly determined by the private sector
and partly by the government.

MODELS OR THEORIES are simplified representations of the real world.

MONETARIST is an economist who assigns a high degree of importance to

variations in the money supply as the main determinant of aggregate demand.

MONETARY POLICY refers to changes in the money supply and interest rates to
affect aggregate demand and aggregate supply. In most countries, these policy
decisions are made by the Central Bank. In some countries, such as China, Myanmar
and North Korea these policy decisions are made by the government; consequently,
monetary policy and fiscal policy are controlled by governments-not at good situation.

MONETARY UNION refers to the replacement of the currencies of the majority

members of the EU with a single currency, the Euro.

MONEY is a medium of exchange.

MONOPOLIST is a single supplier that supplies the whole industry.

MONOPOLISTIC COMPETITION is a type of market structure in which a large

number of firms compete with similar items.

MONOPOLY is a type of market structure where there is a single supplier that

supplies the whole industry.

MONOPOLY POWER exists where producer sovereignty is maximized.

MONOPSONY is a market structure where there is a single buyer or small group of

buyers of a good or service. Such an entity exerts very significant market power.

MOST DEVELOPED COUNTRY (MDC) refers to a country where its people have
the basic necessities of life, plus the majority of people have money for luxuries. A
country that has a high level of economic development- Real GDP per capital plus a
high standard of living.

MULTILATERAL FREE TRADE AGREEMENT is a free trade agreement

entered into by three or more countries.

MULTINATIONAL COMPANIES/CORPORATIONS (MNC) refers to

companies that have production units in more than one foreign country.

MULTIPLIER is the change in equilibrium Real GDP divided by the change in

autonomous expenditure, which causes Real GDP to change.

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N
NAFTA refers to North American Free Trade Agreement. Member countries include
the USA, Canada and Mexico.

NATIONAL DEBT is the central government debt.

NATIONAL INCOME is the final value of the goods and services available to a
country during a year.

NATIONALISATION is the government act of placing a privately owned company

under public ownership.

NATURAL MONOPOLY occurs when a monopoly can supply the entire market at
a lower price than two or more smaller firms.

NATURAL RATE OF UNEMPLOYMENT is the unemployment rate when the

economy is at full employment and the labour market clears. It includes any frictional,
seasonal and structural unemployment.

NATURAL RESOURCES refer to the factors of production that are not man-made.

NEGATIVE EXTERNALITY is a market activity that negatively affects other

people. It is a form of market failure.

NEGATIVE TAX is effectively a subsidy paid by the government.

NET IMPORTER OF FOREIGN DIRECT INVESTMENT refers to a country

that imports more investment than it exports.

NET INVESTMENT is the net additions to the capital stock-gross investment minus
depreciation.

NET NATIONAL PRODUCT (NNP) is GDP minus depreciation.

NEWLY INDUSTRIALISED COUNTRIES (NICS) refers to a small group of

countries with advanced industrial, financial and services sectors in their economy.
Examples include: Hong Kong, Singapore, South Korea, Greece and Mexico.

NOMINAL GDP is the output of final goods and services valued at current prices.

NOMINAL INTEREST RATE is the price or borrowing or lending money at

current prices.

NOMINAL VALUES refer to the value of variables expressed in current prices.

NON-GOVERNMENT ORGANISATIONS (NGO) refers to organizations that are

not government bodies. They are involved in unofficial aid programmes in LDCs-e.g.
the Red Cross and Oxfam.

NON-PRICE COMPETITION generally refers to the branding and advertising of

products/services to increase sales, market share and profits by firms, without having
to engage in price competition.

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NON-RENEWABLE NATURAL RESOURCES refers to natural resources that can
only be used once.

NORMAL GOOD is a good or services for which demand increases when income
increases.

NORMAL PROFIT refers to the opportunity cost of capital.

NORMATIVE STATEMENT is an expression of opinion that cannot be verified by

observation or statistical fact.

O
OECD is the Organization for Economic Co-operation and Development.

OFFICIAL DEVELOPMENT ASSISTANCE (ODA) is aid transferred by public

bodies. Divided into bilateral aid and multilateral aid.

OFFICIAL RESERVES refers to governments’ holdings, in the vaults of their

Central Bank, of gold, securities and foreign currencies.

OLIGOPOLY is a type of market structure in which a small number of producers

compete with each other.

OPEC is the Organization of Petroleum Exporting Countries. It is a oil cartel. Sets

production quotas.

OPEN ECONOMY is an economy that has economic links with other economies.

OPPORTUNITY COST is the cost of any economic activity measured in terms of

the best alternative that is foregone. When the best alternative is chosen from a range
of alternatives, the second best choice is the opportunity cost. It is one of the most
important economic principles.

OUTSOURCING refers to the transfer of the manufacturing of a good or performing

of a service from within the firm to outside the firm. For example, many IT services
are being transferred from firms in Western countries to India, because of India’s
comparative advantage and it can perform these functions at a substantially lower
cost.

OVER-CONSUMPTION exists where consumption of a good or service exceeds its

available long-term supply. Clean water, a very scarce resource in the 21st Century,
used for drinking, cooking and sanitation is a good example in LDCs.

OVER-VALUED CURRENCY refers to any currency whose price is set by a

government above the free market equilibrium rate. The Myanmar Kyat is a good
example. The Argentina Peso until its devaluation in January 2002 is another
example.

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P

PARADOX OF THRIFT refers to an increased desire to save-an increase in MPS-

that leads to a reduction in the equilibrium level of saving.

PEGGED CURRENCY exists where the price of one currency is fixed to another.

PERFECT COMPETITION is a market structure in which the decisions of buyers

and sellers have no effect on the market price. It is a structure where consumer
sovereignty is maximised.

PERFECTLY ELASTIC DEMAND is demand with an elasticity of infinity.

PERFECTLY ELASTIC SUPPLY is supply with an elasticity of infinity.

PERFECTLY INELASTIC DEMAND is demand with an elasticity of zero.

PERFECTLY INELASTIC SUPPLY is supply with an elasticity of zero.

PERSISTENT BOP CURRENT ACCOUNT DEFICITS refers to a country that

has sustained deficits on its current account. It is indicative of poor financial health of
its external account, and failure to achieve one of the five key macroeconomic
objectives. Has an impact on the other four macroeconomic objectives.

PHILLIPS CURVE shows the trade-off between unemployment and inflation.

POPULATION DOUBLING TIME is the number of years it will take for a

population to double, assuming a constant rate of increase.

POPULATION GROWTH RATE is the percentage increase in population in a

year.

POPULATION--RATE OF NATURAL INCREASE is the birth rate minus the

death rate expressed as a percentage, ignoring net migration.

POSITIVE EXTERNALITIES refer to activities external to the market that affect

other people in a positive way.

POSITIVE STATEMENT is an expression that can be verified by observation

and/or fact.

POVERTY refers to those members of society who cannot enjoy the basic necessities
of life. There are two types of poverty: absolute and relative.

PRESENT VALUE OF DEBT/EXPORTS expresses the ratio of the present value

of a country’s debt to its exports. As exports are the means without borrowing to
repay external debt, this ratio indicates a country’s ability to meet its external debt
commitments.

PRICE CEILING is a price imposed below the market equilibrium price.

PRICE CONTROL refers to a government regulation of free market prices.

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PRICE DIFFERENTIATION is a situation in which price differences for similar
products reflect only the marginal cost in providing those goods and services to
different groups of buyers.

PRICE DISCRIMINATION is the practice of charging a higher price to some

customers and not others for an identical good or service when there is no difference
in cost.

PRICE ELASTICITY OF DEMAND (PED) is the responsiveness of quantity

demanded of a good or service to a change in its price.

PRICE ELASTICITY OF SUPPLY (PES) is the responsiveness of quantity

supplied of a good or service to a change in its price.

PRICE FIXING occurs when individuals or firms collude to set the price of a good
or service above the market price. It is illegal in most countries.

PRICE INDEX is a measure of the level of prices in one period expressed as a

percentage of their level in another period.

PRICE LEVEL is the average level of prices as measured by a price index.

PRICE STABILITY is one the five key macroeconomic objectives. It is used as an

indicator of the economic health of an economy. Price stability impacts on the other
four macroeconomic objectives.

PRICE TAKER is a firm that cannot influence the price of its output. Exists for
firms, for example, that operate in a perfectly competitive market structure.

PRICES AND INCOME POLICY is government policies that restrict the increase
of prices and incomes in order to achieve price stability.

PRIMARY HEALTH CARE refers to the provision of health services based upon
preventing, rather than curing, diseases. For example, providing clean water and
immunization.

PRIMARY PRODUCTION is that sector of the economy engaged in producing

goods that can be found in, or depend upon, nature.

PRIMARY SCHOOL ENROLEMENT RATE is the percentage of children of

primary school age that attend primary school.

PRIVATE DEBT refers to the external debt of a country provided by private

sources/firms.

PRIVATE GOOD is a good or service consumed by only one person.

PRIVATE INVESTMENT is investment by firms/individuals.

PRIVATIZATION is the process of selling a public corporation to private

shareholders.

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PRODUCER SURPLUS is the difference between a producer’s total revenue and the
opportunity cost of production.

PRODUCT DIFFERENTIATION refers to real and/or perceived slight differences

in a good or service.

PRODUCTION involves the conversion of natural, human and capital resources into
goods and services.

PRODUCTION FUNCTION shows the relationship between how output varies

when the employment of inputs changes.

PRODUCTION POSSIBILITY CURVE (PPC) refers to the boundary between

attainable and unattainable levels of production.

PRODUCTION POSSIBILITY FRONTIER (PPF) refers to the boundary between

attainable and unattainable levels of production.

PRODUCTION QUOTAS are restrictions on the amount of production. A topical

example is the OPEC production quotas.

PRODUCTIVE EFFICIENCY occurs within a firm. It exists when they are

producing output with the minimum amount of inputs. The incentive for a firm to
achieve this is the profit motive. Also known as technical efficiency.

PRODUCTIVTY is the increase in output per unit of input.

PROGRESSIVE INCOME TAX is where the marginal rate of tax applied is greater
than the average tax rate as incomes increase.

PROPORTIONAL INCOME TAX is where the average and marginal tax rates are
the same, regardless of income levels.

PROTECTIONISM is the restriction of international free trade by governments.

Measures include quotas, tariffs, embargoes and import duties.

PROTECTIONIST BARRIERS refers to the government establishing any form of

restriction on the free trade of goods and services. They can include measure such as
tariffs through to administrative and health constraints.

PUBLIC GOOD is a good or service that is non-excludable and non-rivalrous.

PURCHASING POWER PARITY (PPP) exists where money has equal value
across countries.

QUANTITY DEMANDED is the amount of a good or service that consumers plan

to buy at each price in a given period of time.

QUANTITY OF LABOUR DEMANDED is the number of labour hours hired by all

firms in an economy.

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QUANTITY OF LABOUR SUPPLIED is the number of hours of labour services
that households supply to firms.

QUANTITY SUPPLIED is the amount of a good or service that producers plan to

sell at each price in a given period of time.

QUANTITY THEORY OF MONEY states that an increase in the quantity of

money will lead to an equal percentage increase in the price level.

QUOTAS are restrictions on the quantity of a good or service that a firm is permitted
to sell or that a country is permitted to import.

R
REAL EXCHANGE RATE refers to the price of a currency against another after
discounting for inflation.

REAL GDP is the nominal value of output of final goods and services discounted by
the increase in the price level.

REAL INCOME is nominal income discounted by the increase in the price level
(inflation).

REAL INTEREST RATE is nominal interest rate discounted by the increase in the
price level (inflation).

RECESSION is a decline in Real GDP in two or more successive quarters.

REFLATION refers to the use of tax cuts, increased government expenditure and
easier monetary policy to increase aggregate demand, aggregate supply and
employment.

REGIONAL TRADING BLOC refers to regionally-based economies forming a free

trade area. For example, ASEAN and NAFTA.

REGRESSIVE INCOME TAX is where the marginal rate of tax is lower than the
average tax rate as income increases.

RELATIVE POVERTY exists where a proportion of the population in a country

cannot enjoy the standard of living normal to their society. This type of poverty will
always exist where there is any substantial degree of income and asset inequality
within a given society.

RELATIVE SCARCITY refers to a situation where there is not enough of one

scarce resource compared to another. For example, Singapore has a relative scarcity
of land compared to capital.

RESOURCE ALLOCATION is the assignment of scarce resources to specific uses.

That is, deciding the questions of what will be produced, how and when?

RESOURCES are the factors of production.

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RETAIL PRICE INDEX measures the average level of the prices of a basket of
goods and services consumed by the typical household.

RETURNS TO SCALE refers to increases in output that result from increasing all
inputs by the same percentage.

REVALUATION is government action to increase the price of its currency relative

to other currencies.

RURAL-URBAN MIGRATION refers to the movement of labour from the

countryside to the cities. The best example today exists in China where tens of
millions per year are migrating each year; and will continue to do so for the
foreseeable future.

S
SAVINGS is disposable income minus consumption. S = Yd – C.

SAVINGS FUNCTION is the relationship between savings and disposable income.

SCARCE RESOURCE is not enough of a factor of production.

SCARCITY exist when human wants exceed the amount that available resources can
produce.

SEASONAL UNEMPLOYMENT refers to unemployment caused by seasonality in

demand or supply of a good or service.

SECONDARY SCHOOL ENROLEMENT RATE is the percentage of secondary

school age children that are enrolled at school.

SELF-SUFFICIENCY exists where each individual consumes only what they

produce.

SERVICES refer to purchases that do not have physical characteristics-e.g. teaching,

shipping and financial advice.

SHORTAGE is an excess of demand over supply of a good or service at the

equilibrium price.

SHORT RUN is the period of time in which at least one factor of production is fixed.

SHORT TERM DEBT is borrowings that must be paid back within one to three
years.

SHORT-RUN AGGREGATE SUPPLY is the relationship between Real GDP and

the price level, holding everything else constant.

SHORT-RUN AGGREAGTE SUPPLY CURVE is a curve showing the

relationship between Real GDP and the price level, holding everything else constant.

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SHORT-RUN PHILLIPS CURVE shows the relationship between unemployment
and inflation, holding the expected rate of inflation and the natural rate of
unemployment constant.

SHUTDOWN POINT is where the firm is just covering its total variable costs.

SOCIAL COSTS refers to those costs of a good or service that are not borne by the
producer but by society as a whole. They include the cost of negative externalities.

SOCIAL COST-BENEFIT ANALYSIS attempts to identity and quantify in

monetary terms the social costs and benefits of an economic activity. Examples
include the effects from pollution and environmental degradation.

SOFT LOAN is a loan on more favourable terms compared with market terms.

SPECIFIC TAX is a tax set at a fixed amount per unit on a good or service.

STAGFLATION refers to the combination of very high rates of inflation and very
high rates of unemployment.

STANDARD OF LIVING covers range of tangible and intangible goods, services

and benefits that people enjoy in a society. Items include health care, education, free
speech, employment, and freedom from oppression.

STRUCTURAL ADJUSTMENT LOANS refers to loans made the World Bank that
are short term, 1 to 3 years, and help finance institutional reform in poor countries.

STRUCTURAL UNEMPLOYMENT refers to the type of unemployment that

results from a fundamental change in the structure of the economy.

SUBSIDY is a government payment to producers of a good or service.

SUBSISTENCE AGRICULTURE is the production of farm output mainly for own

consumption.

SUBSISTENCE FARMING is the production of farm output mainly for one’s own
consumption.

SUBSITUTION EFFECT is the tendency of people to substitute away from more

expensive commodities to cheaper commodities.

SUBSTANTIAL DEBT WRITE-OFF refers to a situation where a lender forgives a

borrower a major part of the borrower’s debt.

SUBSTITUTES are goods or services that may be used in place of another.

SUPERNORMAL PROFIT refers to the extra profit over normal profit. If the AC
curve is below the AR (demand)curve then a firm can earn supernormal profit.

SUPPLY is the relationship between the quantity supplied and its price.

SUPPLY CURVE is graph or diagram showing the relationship between the quantity
supplied and the price of a good or service, holding everything else constant.

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SUPPLY SCHEDULE is a list of quantity supplied at different prices, holding
everything constant.

SUPPLY-SIDE POLICIES refer to government policies designed to increase output.

Examples include tax reductions and concessions.

SUSBSISTENCE FARMERS refers to farmers that produce just enough for their
own consumption. They are common in most LDCs.

SUSTAINABLE DEVELOPMENT refers to the use of the factors of production by

the current generation that result in the resources being available for future
generations.

T
TARIFFS are taxes imposed by the government of an importing country. They are a
major form of protectionism, particularly of agricultural protectionism by the USA,
EU and Japan against agricultural imports from LDCs.

TAX INCIDENCE refers to the distribution of the tax burden among various groups
in society.

TAX RATE is the percentage rate of tax levied on a particular activity.

TECHNOLOGICAL UNEMPLOYMENT is unemployment caused by

technological changes in an economy that leads to a reduction in the demand for
labour.

TECHNICAL EFFICIENCY occurs within a firm. It exists when they are

producing output with the minimum amount of inputs. The incentive for a firm to
achieve this is the profit motive. Also known as productive efficiency.

TECHNOLOGY refers to the method of converting resources into goods and

services.

TECHNOLOGY DEFLATION is a sustained decrease in the price of goods and

services that result from improvements and application of technology.

TERMS OF TRADE is the rate at which exports will trade for imports. It expresses a
price relationship and measured through the Terms of Trade Index.

TERMS OF TRADE INDEX is the ratio of export prices to import prices expressed
as an index.

THEORY OF DEMAND states that the quantity demanded and price are inversely
related, other things being equal.

THIRD WORLD DEBT is the total external deficits of LDCs.

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TOKEN INTEREST RATE refers to a very low price of borrowing money or paid
on money lent. Exists under conditions of deflation. For example, in Japan in the early
years of 2000.

TOTAL COST (TC) is the sum of the costs of all the inputs used in production.
TC = TFC + TVC.

TOTAL DEBT SERVICE AS A % OF EXPORTS expresses the relationship, in

percentage terms, between a country’s total interest payments on external borrowings
and the value of their exports. The higher the figure, the less export income a country
has to fund future economic growth and development.

TOTAL DEBT SERVICE AS A % OF GDP expresses the relationship, in

percentage terms, between a country’s total interest payments on external borrowings
and the value of their GDP. The higher the figure, the less export income a country
has to fund future economic growth and development.

TOTAL FIXED COST (TFC) is the cost of all the fixed inputs.

TOTAL REVENUE (TR) is the price of goods or services multiplier by quantity

sold. TR = P X Q.

TOTAL VARIABLE COST (TVC) is the cost of all variable inputs.

TRADEABLE PERMITS refers to an international scheme that allows “pollution

permits” to be bought and sold between countries. The scheme is designed to control
worldwide pollution and its effects on the environment.

TRADE CYCLE refers to is the long term fluctuation of national income.

TRADE LIBERALIZATION is the freeing-up of trade by a country and between

countries. It is a major objective of the current WTO Doha Trade negotiations.

TRADE UNION is an organization formed to represent the interest of the factor of

production, labour.

TRADING BLOC is a group of countries that have joined together to benefit from
free trade and economic integration.

TRANSFER PAYMENTS refer to payments made by the government to redistribute

income. Examples include pensions, travel and health concessions for the elderly, the
provision of government low cost housing, and child and family benefits. They are
common in MDCs, but not in LDCs.

TRANSFER PRICING is the process, undertaken by MNCs, of minimizing their tax

bills by setting their internal prices so that the highest value added work appear to be
done in the countries with the lowest tax rates. Transfer pricing problems present a
loss of tax revenue for governments. Can be major problem for a country, particularly
LDCs.

TRANSNATIONAL CORPORATIONS (TNCS) are companies that have

production units in one or more foreign countries.

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U
UNANTICIPATED INFLATION is inflation that it not expected or planned for.

UNDEREMPLOYMENT refers to situations where a person desires to work more

hours than is currently available to them.

UNDER-VALUED CURRENCY refers to the price of a currency that is below is the

free market rate. Currently, this is a criticism by the USA, Japan and other countries
levelled against the Chinese Yuan.

UNEMPLOYMENT EQUILIBRIUM exists where macroeconomic equilibrium at

Real GDP is below long run aggregate supply.

UNEMPLOYMENT is the number of adult workers who are not employed but are
seeking jobs. The figure includes frictional, seasonal and structural unemployment.

UNEMPLOYMENT RATE is the number of unemployed expressed as a percentage

of the total labour force. The figure includes frictional, seasonal and structural
unemployment.

UNIT ELASTIC DEMAND is an elasticity of demand of 1. The quantity demanded

and price change in equal proportions.

UNPRODUCTIVE FARMLAND refers to agricultural land that cannot be used or

provide adequate food, whether used to grow crops or graze animals.

URBAN POPULATION is the percentage of the total population living in towns or

cities.

V
VALUE ADDED is the value of a firm’s output minus the value of inputs brought in
from other firms.

VARIABLE COST (VC) is a cost that varies with the output level.

VARIABLE INPUTS are inputs whose quantity can be varied in the short run.

VEBLEN GOODS are goods that are have snob value and are bought to display
wealth. Their demand curve slopes upwards from left to right, as the higher the price
the greater the quantity demanded.

VELOCITY OF CIRCULATION refers to the average number of time a unit of

money is used annually to buy the goods and services that make up GDP.

VIRTUAL MONOPOLY refers to a firm that has monopoly power because of its
dominance of an industry, but it is not the only supplier of a good or service.

VISIBLE BALANCE is the difference between the value of exports and imports of
goods.

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VISIBLE TRADE is the value of exports and imports of goods.

VOLUNTARY EXPORT RESTRAINT (VER) is a self-imposed restriction by an

exporting country on the volume of its exports.

WANTS refer to the unlimited desires of people for a good or service.

WEALTH is the total assets of an individual, firm or government minus its total
liabilities.

WORLD BANK is an international financial institution owned by its members

responsible for providing technical assistance and funding to poor countries.

WORLD TRADE ORGANISATION (WTO) is an international agreement of

member nations committed in principle to free multinational trade through the
reduction of trade barriers. In reality, as the Doha Round demonstrates, this key
principle does not always work in practice to the detriment of LDCs.

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SECTION 6: APENDICES

Appendix 6.3: Alternatives to the Market System

Centrally Planned Economic Systems (CPES)

Planning is a setting of future goals and a method of achieving these objectives.

Central bodies, such as governments, can make plans for economies about the way in
resources will be allocated.

Totally CPES are largely history. This form of economic system was mainly used in
the former USSR, the former communist countries of Central Europe and many
countries in Africa/Central and South America.

Until the 1980s, China was a Centrally Planned Economic (CPE). Today, however,
while central planning still operates the country has combined this with a free market
economy.

Examples still relevant today include North Korea, Myanmar and a few countries in
Africa, Central and South America.

Students are recommended to view the TV Series “Commanding Heights-The Battle

For The World Economy” and read the book of the same title to gain greater insight
into what has happened to CPES in the 20th century.

The Nature of Central Planning

• Mixed economies use a combination of markets and planning to allocate

resources. Merit goods, like health care and education, may well be better planned
rather than left to the market and planning may be used in cases of market failure,
e.g. to provide resources for defence forces.

• Centrally Planned Economies (CPE) are Governments that rely on planning to

allocate resources because they believe that markets fail to allocate resources
efficiently or fairly e.g. Cuba or North Korea. These are communist countries

• They also favour social ownership of resources.

• CPE appoint planners to allocate resources and they limit the free operation of
market forces. Prices are set to regulate demand and to match the planned
supply.

• Companies are usually owned and managed centrally by the state, with managers
required to work to the plan.

• Development plans have the overall aim of increasing economic growth and the
standard of living. They include economic plans that set targets for the amount of
production to be reached in a particular time period e.g. one year. Many African
countries tried planning when they achieved independence after WW2. They had a
need to transform the structure of their economies as well as to use their scarce
resources efficiently.

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Types of Planning

1. Public sector plans are use in economies that are primarily market economies
to ensure resources are allocated to public goods like defence, and merit
goods like health.

2. Indicative planning refers to plans that indicate where the government thinks
the economy should be headed.

3. Central Economic Planning refers to economies where most resources are

allocated on the basis of plans set by a central body.

Reasons for using planning in LDCs

1. Market Failure is a major argument for using Planning in LDCs. The markets are
not very well established which leads to incorrect price signals, the signals needed to
achieve market efficient resource allocation.

2. The existence of Externalities. Planning can adjust economic decisions to take

account of externalities such as relieving poverty and the production of necessities.

Stages of Planning

The development plan comprises three stages:

1. Aggregate growth models

Aggregate growth models focus upon major variables e.g. increasing national savings,
income, investment and foreign exchange.

2. Input-output or inter-industry planning

If the aggregate plan is to increase the standard of living through increasing Real
GDP, then each industry needs to plan to increase its inputs to achieve the target for
the increased Real GDP.

One firm’s input becomes the other firms’ output and therefore the problem becomes
more complex.

3. Project appraisal

Project appraisal is the micro-economic method used to evaluate individual

investment projects.

Social cost-benefit analysis is used to measure the costs and benefits in order to
evaluate whether an investment decision should be undertaken or not.

For example, a private investor will use the market rate of wages to decide on the
wage cost as the cost of factor input of labour. A planner would reflect on the total
opportunity cost to society; in a labour abundant LDC a lower wage is likely to be

333
offered and more people employed so that there is an external gain to society by the
reduction of unemployment and poverty.

Key Features of a CPE that lead to Economic Problems

1. Planning

• A central planning agency makes production plans for the economy.

• Each industry is set production targets that it must achieve. Planners allocate
resources on the basis of these production targets.

2. Allocation of Resources

• Planning works better in a simple economy.

• As an economy develops it gets more complex and planning gets more difficult
and more errors occur. The resources are often used wastefully, for example
labour.

• In a market economy, prices (wages) are used to allocate resources.

• In CPES full employment and job security are promised but as a result there is less
motivation to work hard.

• Non-material incentives (e.g. worker of the month) work as well as some

material incentives (e.g. improved housing) to encourage plan fulfilment.

• In summary, the following major problems occur:

a) Prices are set too low-.e.g. Food, housing. They do not reflect D & S.
b) Costs of factors of production are set too low-.e.g. Wages, raw materials.
c) End supply prices are usually too low.

All of the above do not reflect D & S resulting in poor allocation of resources.

3. Equality of Income Distribution

• Another aim of CPE. Partly achieved by full employment and job security.

• As well, low prices were set on basic commodities (e.g. food and housing).

• One consequence of the low prices was high demand (as the law of demand
suggests).

• The planners’ targets limited supply.

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4. Shortages of Goods & Services

• Occur because maximum prices are set (e.g.on food).

• As a result of the severe shortages of basic commodities queues (long lines of

people waiting to obtain items) occurred, as well as parallel markets (black
markets) and the need for rationing. Sometimes planners’ errors led to an excess
supply of unwanted goods, so there was unsold stock in the shops.

5. Producer Sovereignty

• Producer sovereignty exists rather than the consumer sovereignty.

• Producer sovereignty means the planner decides what to produce and the
consumer could only buy from amongst those things the planner decided to
produce.

6. Full Employment and the absence of inflation

• Were normal in CPES.

• However, there was a great deal of hidden or disguised UE. People were
producing goods planners decided they should produce and without any regard to
what was demanded by consumers. Many people produced very little and had very
little motivation to work hard.

• Inflation was non-existent because planners set and maintained all prices,
including wages. Shortages resulted and in a market economy would have led to
higher prices but resulted in suppressed inflation in a CPES.

7. Isolation from World Markets

• CPES industrial firms did not import or export goods because the planners did not
permit it. Or, imports were kept at a low level.

• Domestic prices bore no relation to external prices.

• The currency had no market-based value because it was not bought or sold on the
foreign exchange markets (FOREX markets). That is, countries had non-
convertible currencies.

• Any trade that did occur was amongst CPES. It was based on barter, which is
time-consuming, inefficient and cumbersome.

• The huge benefits of trade were not available to CPES.

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Problems of Transition from a CPE to a Market Economy

1. Prices

Planned prices were kept low to achieve social goals. When prices were freed they
initially rose dramatically causing hyperinflation-e.g. USSR, Afghanistan.

However, as market forces began to work supply increased and, in some countries,
inflation stabilised.

To become a market economy the market mechanism must be allowed to operate

freely. That is, the interaction of D & S, setting prices and subsequently allocating
resources.

2. Money Supply

A rapid rise in money supply in led to hyperinflation -e.g. USSR, Afghanistan.

Prices rose, the money supply rose, which led to further price rises (inflation), but
real prices were not rising so producers did not have an incentive to increase supply.

3. Currency Reform

Exchange rates were too high and had to be devalued when CPE changed to market
economies. A devaluation of the currency made imports more expensive, leading to
further inflation (import-cost inflation).

4. Privatisation

Land and industries have to be transferred from social to private ownership. Private
ownership means there will be an incentive for the owners to develop the assets and to
produce more. This required major changes in the Law.

5. Private profit

This had to be introduced as a motivation. Had to change economic culture.

In some of the longer established Socialist economies (e.g. in the former USSR) there
was virtually no memory of a market system so re-establishing the idea of private
profit and private ownership has been difficult.

Legal and judicial infrastructure has to be put in place to support the ownership of
private property and market transactions. It is difficult to establish a system where
experience of the market system doesn’t exist. To some Economists these are the
major transitional problems; that is, the rule of law regarding the private
ownership of economic resources.

336
6. Benefits of the old system disappeared in the transition to a market system so
there was a great deal of resistance to the changes. These benefits included:

Equitable distribution of income, because:

1. Income came from labour rather than property.
2. Merit goods were well provided.

Job Security. Now it has weakened.

Low prices because of subsidies. Now they have disappeared.

Low Inflation. Now very high.

High real Value of Pensions. Now their real value had fallen dramatically.

337
APPENDIX 6.4: ZIMBABWE: A SPECIAL ECONOMIC ‘BASKET CASE’

HYPERINFLATION:

July 2007: officially, at 4,500%. Private Economists predict that true rate is closer to
20,000%.

Immediate Future: One Economist has predicted 1,500,000%.

Medium to Long Term: economically, the situation is unsustainable.

PRICE CONTROLS:

Recently, a Cabinet-level taskforce on price controls ordered factories and sellers to

cut the prices of basic goods and services by as much as 50%─to levels that existed
about a week ago.

Shopkeepers throughout the country ignored the decree.

CURRENCY CRISIS:

Hyperinflation is so steep that Zimbabwe’s currency, the dollar, is almost worthless.

On the black market it is trading at Z$130,000 to US$1:00, after collapsing earlier to

Z$ 400,000 to US$1:00.

A key reason for the drop was because Zimbabwe’s Central Bank flooded the market
with newly printed Zimbabwe Dollars as it sought to buy much needed foreign
currency to meet external debt interest and principal repayments. More later.

Where it will end up is anybody’s guess; but all agree it’s still heading ‘South’.

NEW TAKEOVER LEGISLATION:

July 2007: The Government under Mugabe has put forward Legislation that would
require publicly traded companies to cede controlling interests to ‘indigenous’
citizens, raising the possibility of a sizeable redistribution of the country’s remaining
wealth.

Controlling interest = 51%.

The Zimbabweans who will purportedly benefit are those who were ‘disadvantaged
by unfair discrimination on the grounds of his or her race’ before April 1980. The
nation won independence from white rule at that time.

The Government calls it a plan for black empowerment; white critics label it a bid by
President Robert Mugabe to shore-up crumbling political support.

Given that Mugabe controls Parliament, the Legislation is almost certain to pass.

338
The Legislation would establish a government fund to help ordinary citizens buy
stock in public companies, and would allow the government to reject any corporate
mergers, acquisitions, investments and other transactions in which so-called
indigenous Zimbabweans do not hold a 51% stake.

Conveniently ignored is where will the government funds come from, given that all
sources of International funding has dried up, and how will the borrowings be repaid.

One solution, already in practice, is for the Central Bank to simply print more money;
an ideal way to solve rampant hyperinflation!

BILATERAL FTAs-THE MUGABE WAY:

What’s Generally Known

Zimbabwe currently has five (5) preferential bilateral trade agreements under which
exporters can benefit. However, this does not mean that every good and service move
freely between Zimbabwe and the countries. The tariff is only lifted for certain goods
and services but not others. This is discussed below:

• Zimbabwe and Botswana

• Zimbabwe - Malawi: Implemented in 1995, this is a reciprocal trade
agreement, with 25 percent domestic value added requirements. Arrangements
are characterized Zimbabwe and Namibia
• Zimbabwe and Namibia
• Zimbabwe and South Africa
• Zimbabwe and Mozambique

Zimbabwe - Botswana: Ratified in 1988, reciprocal duty free trade on all products
grown, wholly produced, or manufactured wholly or partly from imported inputs
subject to a 25 percent local content requirements.

Zimbabwe - Namibia: A reciprocal agreement in effect since 1992, subject to rules of

origin which require at least 25 percent local content for manufactured goods and that
Zimbabwe and Namibia should, as exporters, be the last place of substantial
manufacturing. Other eligible products include mineral and vegetable products, live
animals and their products.

Zimbabwe - South Africa: A duty free regime or preferential tariff quota applies to
items including dairy products, potatoes, birds, eggs. Specified types of woven fabric,
for example cotton is subject to concessional tariff rates when they meet the specified
levels of Zimbabwean content: 75 percent in most cases. Most recent version of the
agreement was signed in August 1996 at which time the tariffs and quotas on textile
imports into South Africa were lowered.

Zimbabwe - Mozambique: Signed in January 2004, this agreement becomes

operational on March 1 2005. Its objective is to eliminate tariff and non-tariff barriers
and also to cooperate in customs and trade promotion. The agreement provides for
duty free trade between the two members with the rules of origin specifying a 25
percent domestic value added. Excluded from the arrangement are refined and

339
unrefined sugar, Coca-Cola/Schweppes soft drinks, firearms, ammunition and
explosives, motor vehicles and cigarettes.

All these Agreements have the same purpose and offer the same benefits under the
same qualifying criteria. They aim to encourage and stimulate trade between
Zimbabwe and the cooperating partner through the elimination of tariffs and other
non-tariff barriers to trade. The agreement allows the Zimbabwean buyer/importer to
purchase goods from the signatory country without paying import duty ( or paying a
small agreed duty rate) as long as the goods in question qualify under the terms of the
agreement and are registered as such with the relevant authorities. (ZIMRA)

What’s Generally Not Known

In the first half of 2007, Zimbabwe and Namibia held further talks on expanding their
Bilateral FTA. Economically, and on the surface, one could argue that the expansion
of Free Trade between the two countries would result in increased economic growth
and economic development. In short, the citizens of both countries would be better
off.

Not necessarily so, given that the Zimbabwe Delegation were suggesting that Namibia
follow down President Mugabe’s economic road. Specifically, it was reported that
Zimbabwe were proposing that Namibia adopt Zimbabwe’s ‘give all’ to the Blacks,
take away everything from the Whites policies.

Since Mugabe came to power and started implementing his agenda of handing
everything over to the Blacks, Zimbabwe has become the economic laughing stock
of the world.

What was even more strange─ if such is possible─ is that Namibia appeared to fall
into the Zimbabwe economic ‘death trap.’ Perhaps it is not strange, given that many
African leaders court Mugabe while the rest remain focussed on their internal political
agenda.

Such an approach to Bilateral FTAs is inviting disaster─ economic, social,

educational and, ultimately, political.

In all of this, the people who suffer the most are those President Mugabe suggest
benefit the most.

340
KEY STATISTICS:

Zimbabwe Data Profile

Click on the indicator to view a
2000 2005 2006
definition
People
Population, total 12.6 million 13.0 million ..
Population growth (annual %) 1.0 0.6 ..
Poverty headcount ratio at national poverty
.. .. ..
line (% of population)
Life expectancy at birth, total (years) 39.8 37.3 ..
Fertility rate, total (births per woman) 3.8 3.3 ..
Mortality rate, infant (per 1,000 live births) 73.0 81.0 ..
Mortality rate, under-5 (per 1,000) 117.0 132.0 ..
Births attended by skilled health staff (% of
.. .. ..
total)
Malnutrition prevalence, weight for age (%
.. .. ..
of children under 5)
Immunization, measles (% of children ages
70.0 85.0 ..
12-23 months)
Prevalence of HIV, total (% of population
.. 20.1 ..
ages 15-49)
Primary completion rate, total (% of
.. .. ..
relevant age group)
School enrolment, primary (% gross) 98.1 .. ..
School enrolment, secondary (% gross) 42.3 .. ..
School enrolment, tertiary (% gross) 3.6 .. ..
Ratio of girls to boys in primary and
93.6 .. ..
secondary education (%)
Literacy rate, adult total (% of people ages
.. .. ..
15 and above)
Environment
390.8 390.8
Surface area (sq. km) ..
thousand thousand
191.1 175.4
Forest area (sq. km) ..
thousand thousand
Agricultural land (% of land area) 53.1 .. ..
CO2 emissions (metric tons per capita) 1.2 .. ..
Improved water source (% of population
.. .. ..
with access)
Improved sanitation facilities, urban (% of
.. .. ..
urban population with access)
Energy use (kg of oil equivalent per capita) 795.7 .. ..
Energy imports, net (% of energy use) 14.0 .. ..
Electric power consumption (kWh per
847.0 .. ..
capita)

341
Economy
GNI, Atlas method (current US$) 5.7 billion 4.5 billion ..
GNI per capita, Atlas method (current US$) 460.0 350.0 ..
GDP (current US$) 7.4 billion 3.4 billion ..
GDP growth (annual %) -7.9 -6.5 ..
Inflation, GDP deflator (annual %) 56.2 237.7 ..
Agriculture, value added (% of GDP) 18.5 18.1 ..
Industry, value added (% of GDP) 25.0 22.6 ..
Services, etc., value added (% of GDP) 56.5 59.3 ..
Exports of goods and services (% of GDP) 35.9 42.8 ..
Imports of goods and services (% of GDP) 36.2 52.9 ..
Gross capital formation (% of GDP) 13.6 13.9 ..
Revenue, excluding grants (% of GDP) .. .. ..
Cash surplus/deficit (% of GDP) .. .. ..
States and markets
Time required to start a business (days) .. 96.0 96.0
Market capitalization of listed companies
32.9 71.2 ..
(% of GDP)
Military expenditure (% of GDP) 4.7 .. ..
Fixed line and mobile phone subscribers
41.0 78.9 ..
(per 1,000 people)
Internet users (per 1,000 people) 4.0 76.9 ..
Roads, paved (% of total roads) .. .. ..
High-technology exports (% of
1.7 .. ..
manufactured exports)
Global links
Merchandise trade (% of GDP) 51.2 123.1 ..
Net barter terms of trade (2000 = 100) 100.0 .. ..
Foreign direct investment, net inflows 102.8
23.2 million ..
(BoP, current US$) million
Long-term debt (DOD, current US$) 3.0 billion 3.3 billion ..
Present value of debt (% of GNI) .. 85.4 ..
Total debt service (% of exports of goods,
.. .. ..
services and income)
Official development assistance and official 175.8 367.7
..
aid (current US$) million million
Workers' remittances and compensation of
.. .. ..
employees, received (US$)
Source: World Development Indicators database, April 2007

FURTHER INFORMATION:
Refer to other Case Study material in this eTextbook.

Further information can be sourced from the CIA World Factbook, Bloomberg, South
African newspapers, and other websites.

342
Select a Country or Location

Introduction
Geography
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Click to enlarge Government
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Home Reference Maps Appendixes Print-Friendly Page
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This page was last updated on 19 June, 2007

343
 Legend: Definition Field Listing Rank Order
Introduction Zimbabwe Top of Page

Background:
The UK annexed Southern Rhodesia from the [British] South Africa Company in
1923. A 1961 constitution was formulated that favored whites in power. In 1965
the government unilaterally declared its independence, but the UK did not
recognize the act and demanded more complete voting rights for the black
African majority in the country (then called Rhodesia). UN sanctions and a
guerrilla uprising finally led to free elections in 1979 and independence (as
Zimbabwe) in 1980. Robert MUGABE, the nation's first prime minister, has been
the country's only ruler (as president since 1987) and has dominated the country's
political system since independence. His chaotic land redistribution campaign,
which began in 2000, caused an exodus of white farmers, crippled the economy,
and ushered in widespread shortages of basic commodities. Ignoring
international condemnation, MUGABE rigged the 2002 presidential election to
ensure his reelection. Opposition and labor strikes in 2003 were unsuccessful in
pressuring MUGABE to retire early; security forces continued their brutal
repression of regime opponents. The ruling ZANU-PF party used fraud and
intimidation to win a two-thirds majority in the March 2005 parliamentary
election, allowing it to amend the constitution at will and recreate the Senate,
which had been abolished in the late 1980s. In April 2005, Harare embarked on
Operation Restore Order, ostensibly an urban rationalization program, which
resulted in the destruction of the homes or businesses of 700,000 mostly poor
supporters of the opposition, according to UN estimates. ZANU-PF announced in
December 2006 that they would seek to extend MUGABE's term in office until
2010 when presidential and parliamentary elections would be "harmonized."
Geography Zimbabwe Top of Page

Location:
Southern Africa, between South Africa and Zambia
Geographic
coordinates: 20 00 S, 30 00 E

Map references:
Africa
Area:
total: 390,580 sq km
land: 386,670 sq km
water: 3,910 sq km
Area -
comparative: slightly larger than Montana

Land boundaries:
total: 3,066 km
border countries: Botswana 813 km, Mozambique 1,231 km, South Africa 225
km, Zambia 797 km
Coastline:
0 km (landlocked)
Maritime claims:
none (landlocked)

344
 Climate:
tropical; moderated by altitude; rainy season (November to March)
Terrain:
mostly high plateau with higher central plateau (high veld); mountains in east
Elevation
extremes: lowest point: junction of the Runde and Save rivers 162 m
highest point: Inyangani 2,592 m
Natural resources:
coal, chromium ore, asbestos, gold, nickel, copper, iron ore, vanadium, lithium,
tin, platinum group metals
Land use:
arable land: 8.24%
permanent crops: 0.33%
other: 91.43% (2005)
Irrigated land:
1,740 sq km (2003)
Natural hazards:
recurring droughts; floods and severe storms are rare
Environment -
current issues: deforestation; soil erosion; land degradation; air and water pollution; the black
rhinoceros herd - once the largest concentration of the species in the world - has
been significantly reduced by poaching; poor mining practices have led to toxic
waste and heavy metal pollution
Environment -
international party to: Biodiversity, Climate Change, Desertification, Endangered Species,
agreements: Law of the Sea, Ozone Layer Protection
signed, but not ratified: none of the selected agreements
Geography - note:
landlocked; the Zambezi forms a natural riverine boundary with Zambia; in full
flood (February-April) the massive Victoria Falls on the river forms the world's
largest curtain of falling water
People Zimbabwe Top of Page

Population:
12,311,143
note: estimates for this country explicitly take into account the effects of excess
mortality due to AIDS; this can result in lower life expectancy, higher infant
mortality and death rates, lower population and growth rates, and changes in the
distribution of population by age and sex than would otherwise be expected (July
2007 est.)
Age structure:
0-14 years: 37.2% (male 2,308,731/female 2,266,027)
15-64 years: 59.3% (male 3,663,108/female 3,641,519)
65 years and over: 3.5% (male 198,867/female 232,891) (2007 est.)
Median age:
total: 20.1 years
male: 19.9 years
female: 20.2 years (2007 est.)

345
Population growth
rate: 0.595% (2007 est.)

Birth rate:
27.72 births/1,000 population (2007 est.)
Death rate:
21.76 deaths/1,000 population (2007 est.)
Net migration rate:
0 migrant(s)/1,000 population
note: there is an increasing flow of Zimbabweans into South Africa and
Botswana in search of better economic opportunities (2007 est.)
Sex ratio:
at birth: 1.03 male(s)/female
under 15 years: 1.019 male(s)/female
15-64 years: 1.006 male(s)/female
65 years and over: 0.854 male(s)/female
total population: 1.005 male(s)/female (2007 est.)
Infant mortality
rate: total: 51.12 deaths/1,000 live births
male: 53.87 deaths/1,000 live births
female: 48.29 deaths/1,000 live births (2007 est.)
Life expectancy at
birth: total population: 39.5 years
male: 40.62 years
female: 38.35 years (2007 est.)
Total fertility rate:
3.08 children born/woman (2007 est.)
HIV/AIDS - adult
prevalence rate: 24.6% (2001 est.)

HIV/AIDS - people
living with 1.8 million (2001 est.)
HIV/AIDS:
HIV/AIDS - deaths:
170,000 (2003 est.)
Major infectious
diseases: degree of risk: high
food or waterborne diseases: bacterial diarrhea, hepatitis A, and typhoid
vectorborne disease: malaria
water contact disease: schistosomiasis (2007)
Nationality:
noun: Zimbabwean(s)
adjective: Zimbabwean
Ethnic groups:
African 98% (Shona 82%, Ndebele 14%, other 2%), mixed and Asian 1%, white
less than 1%
Religions:
syncretic (part Christian, part indigenous beliefs) 50%, Christian 25%,
indigenous beliefs 24%, Muslim and other 1%

346
 Languages:
English (official), Shona, Sindebele (the language of the Ndebele, sometimes
called Ndebele), numerous but minor tribal dialects
Literacy:
definition: age 15 and over can read and write English
total population: 90.7%
male: 94.2%
female: 87.2% (2003 est.)
Government Zimbabwe Top of Page

Country name:
conventional long form: Republic of Zimbabwe
conventional short form: Zimbabwe
former: Southern Rhodesia, Rhodesia
Government type:
parliamentary democracy
Capital:
name: Harare
geographic coordinates: 17 50 S, 31 03 E
time difference: UTC+2 (7 hours ahead of Washington, DC during Standard
Time)
Administrative
divisions: 8 provinces and 2 cities* with provincial status; Bulawayo*, Harare*,
Manicaland, Mashonaland Central, Mashonaland East, Mashonaland West,
Masvingo, Matabeleland North, Matabeleland South, Midlands
Independence:
18 April 1980 (from UK)
National holiday:
Independence Day, 18 April (1980)
Constitution:
21 December 1979
Legal system:
mixture of Roman-Dutch and English common law
Suffrage:
18 years of age; universal
Executive branch:
chief of state: Executive President Robert Gabriel MUGABE (since 31
December 1987); Vice President Joseph MSIKA (since December 1999) and
Vice President Joyce MUJURU (since 6 December 2004); note - the president is
both the chief of state and head of government
head of government: Executive President Robert Gabriel MUGABE (since 31
December 1987); Vice President Joseph MSIKA (since December 1999) and
Vice President Joyce MUJURU (since 6 December 2004)
cabinet: Cabinet appointed by the president; responsible to the House of
Assembly
elections: presidential candidates nominated with a nomination paper signed by
at least 10 registered voters (at least one from each province) and elected by
popular vote for a six-year term (no term limits); election last held 9-11 March

347
 2002 (next to be held in March 2008); co-vice presidents appointed by the
president
election results: Robert Gabriel MUGABE reelected president; percent of vote -
Robert Gabriel MUGABE 56.2%, Morgan TSVANGIRAI 41.9%
Legislative branch:
bicameral Parliament consists of a Senate (66 seats - 50 elected by popular vote
for a five-year term, 6 nominated by the president, 10 nominated by the Council
of Chiefs) and a House of Assembly (150 seats - 120 elected by popular vote for
five-year terms, 12 nominated by the president, 10 occupied by traditional chiefs
chosen by their peers, and 8 occupied by provincial governors appointed by the
president)
elections: Senate last held 26 November 2005 (next to be held in 2010; House of
Assembly last held 31 March 2005 (next to be held in 2010)
election results: Senate - percent of vote by party - ZANU-PF 73.7%, MDC
20.3%, other 4.4%, independents 1.6%; seats by party - ZANU-PF 43, MDC 7;
House of Assembly - percent of vote by party - ZANU-PF 59.6%, MDC 39.5%,
other 0.9%; seats by party - ZANU-PF 78, MDC 41, independents 1
Judicial branch:
Supreme Court; High Court
Political parties
and leaders: African National Party or ANP; Movement for Democratic Change or MDC
[Morgan TSVANGIRAI, anti-Senate faction; Arthur MUTAMBARA, pro-
Senate faction]; Peace Action is Freedom for All or PAFA; United Parties [Abel
MUZOREWA]; United People's Party [Daniel SHUMBA]; Zimbabwe African
National Union-Ndonga or ZANU-Ndonga [Wilson KUMBULA]; Zimbabwe
African National Union-Patriotic Front or ZANU-PF [Robert Gabriel
MUGABE]; Zimbabwe African Peoples Union or ZAPU [Agrippa MADLELA];
Zimbabwe Youth in Alliance or ZIYA
Political pressure
groups and Crisis in Zimbabwe Coalition [Arnold TSUNGA]; National Constitutional
leaders: Assembly or NCA [Lovemore MADHUKU]; Zimbabwe Congress of Trade
Unions or ZCTU [Wellington CHIBEBE]
International
organization ACP, AfDB, AU, COMESA, FAO, G-15, G-77, IAEA, IBRD, ICAO, ICCt
participation: (signatory), ICRM, IDA, IFAD, IFC, IFRCS, ILO, IMF, IMO, Interpol, IOC,
IOM, IPU, ISO, ITU, ITUC, MIGA, NAM, OPCW, PCA, SADC, UN,
UNCTAD, UNESCO, UNIDO, UNMIS, UNWTO, UPU, WCL, WCO, WFTU,
WHO, WIPO, WMO, WTO
Diplomatic
representation in chief of mission: Ambassador Dr. Machivenyika T. MAPURANGA
the US: chancery: 1608 New Hampshire Avenue NW, Washington, DC 20009
telephone: [1] (202) 332-7100
FAX: [1] (202) 483-9326
Diplomatic
representation chief of mission: Ambassador Christopher W. DELL
from the US: embassy: 172 Herbert Chitepo Avenue, Harare
mailing address: P. O. Box 3340, Harare
telephone: [263] (4) 250-593 and 250-594
FAX: [263] (4) 796-488

348
 Flag description:
seven equal horizontal bands of green, yellow, red, black, red, yellow, and green
with a white isosceles triangle edged in black with its base on the hoist side; a
yellow Zimbabwe bird representing the long history of the country is
superimposed on a red five-pointed star in the center of the triangle, which
symbolizes peace; green symbolizes agriculture, yellow - mineral wealth, red -
blood shed to achieve independence, and black stands for the native people
Economy Zimbabwe Top of Page

Economy -
overview: The government of Zimbabwe faces a wide variety of difficult economic
problems as it struggles with an unsustainable fiscal deficit, an overvalued
exchange rate, soaring inflation, and bare shelves. Its 1998-2002 involvement in
the war in the Democratic Republic of the Congo drained hundreds of millions of
dollars from the economy. The government's land reform program, characterized
by chaos and violence, has badly damaged the commercial farming sector, the
traditional source of exports and foreign exchange and the provider of 400,000
jobs, turning Zimbabwe into a net importer of food products. Badly needed
support from the IMF has been suspended because of the government's arrears on
past loans, which it began repaying in 2005. The official annual inflation rate
rose from 32% in 1998, to 133% in 2004, 585% in 2005, and approached 1000%
in 2006, although private sector estimates put the figure much higher.
Meanwhile, the official exchange rate fell from approximately 1 (revalued)
Zimbabwean dollar per US dollar in 2003 to 160 per US dollar in 2006.
GDP (purchasing
power parity): $25.36 billion (2006 est.)

GDP (official
exchange rate): $3.146 billion (2006 est.)

GDP - real growth

rate: -4.4% (2006 est.)

GDP - per capita

(PPP): $2,100 (2006 est.)

GDP - composition
by sector: agriculture: 17.7%
industry: 22.9%
services: 59.4% (2006 est.)
Labor force:
3.958 million (2006 est.)
Labor force - by
occupation: agriculture: 66%
industry: 10%
services: 24% (1996)
Unemployment
rate: 80% (2005 est.)

Population below
poverty line: 80% (2004 est.)

Household income
or consumption by lowest 10%: 2%
percentage share:

349
 highest 10%: 40.4% (1995)
Distribution of
family income - 56.8 (2003)
Gini index:
Inflation rate
(consumer prices): 976.4% official data; private sector estimates are much higher (2006 est.)

Investment (gross
fixed): 16.1% of GDP (2006 est.)

Budget:
revenues: $1.411 billion
expenditures: $1.924 billion; including capital expenditures of $NA (2006 est.)
Public debt:
108.4% of GDP (2006 est.)
Agriculture -
products: corn, cotton, tobacco, wheat, coffee, sugarcane, peanuts; sheep, goats, pigs

Industries:
mining (coal, gold, platinum, copper, nickel, tin, clay, numerous metallic and
nonmetallic ores), steel; wood products, cement, chemicals, fertilizer, clothing
and footwear, foodstuffs, beverages
Industrial
production growth -1.8% (2006 est.)
rate:
Electricity -
production: 9.412 billion kWh (2004)

Electricity -
consumption: 11 billion kWh (2004)

Electricity -
exports: 0 kWh (2004)

Electricity -
imports: 2.25 billion kWh (2004)

Oil - production:
0 bbl/day (2004 est.)
Oil - consumption:
22,500 bbl/day (2004 est.)
Oil - exports:
0 bbl/day (2004 est.)
Oil - imports:
23,000 bbl/day (2004 est.)
Natural gas -
production: 0 cu m (2004 est.)

Natural gas -
consumption: 0 cu m (2004 est.)

Current account
balance: -$264.6 million (2006 est.)

Exports:

350
 $1.766 billion f.o.b. (2006 est.)
Exports -
commodities: cotton, tobacco, gold, ferroalloys, textiles/clothing

Exports - partners:
South Africa 26.9%, China 7.9%, Japan 6.7%, Zambia 5.5%, Netherlands 5.4%,
US 4.9%, Italy 4.5%, Germany 4.4% (2005)
Imports:
$2.055 billion f.o.b. (2006 est.)
Imports -
commodities: machinery and transport equipment, other manufactures, chemicals, fuels

Imports - partners:
South Africa 52.5%, China 5.7%, Botswana 4.1% (2005)
Reserves of
foreign exchange $140 million (2006 est.)
and gold:
Debt - external:
$5.26 billion (2006 est.)
Economic aid -
recipient: $178 million; note - the EU and the US provide food aid on humanitarian
grounds (2000 est.)
Currency (code):
Zimbabwean dollar (ZWD)
Exchange rates:
Zimbabwean dollars per US dollar - 162.07 (2006), 77.965 (2005), 5.729 (2004),
0.824 (2003), 0.055 (2002)
note: these are official exchange rates; non-official rates vary significantly
Fiscal year:
calendar year
Communications Zimbabwe Top of Page

Telephones - main
lines in use: 328,000 (2005)

Telephones -
mobile cellular: 699,000 (2005)

Telephone system:
general assessment: system was once one of the best in Africa, but now suffers
from poor maintenance; more than 100,000 outstanding requests for connection
despite an equally large number of installed but unused main lines
domestic: consists of microwave radio relay links, open-wire lines,
radiotelephone communication stations, fixed wireless local loop installations,
and a substantial mobile cellular network; Internet connection is available in
Harare and planned for all major towns and for some of the smaller ones
international: country code - 263; satellite earth stations - 2 Intelsat; 2
international digital gateway exchanges (in Harare and Gweru)
Radio broadcast
stations: AM 7, FM 20 (plus 17 repeater stations), shortwave 1 (1998)

351
 Television
broadcast stations: 16 (1997)

Internet country
code: .zw

Internet hosts:
7,954 (2006)
Internet users:
1 million (2005)
Transportation Zimbabwe Top of Page

Airports:
403 (2006)
Airports - with
paved runways: total: 17
over 3,047 m: 3
2,438 to 3,047 m: 2
1,524 to 2,437 m: 4
914 to 1,523 m: 8 (2006)
Airports - with
unpaved runways: total: 386
1,524 to 2,437 m: 5
914 to 1,523 m: 187
under 914 m: 194 (2006)
Pipelines:
refined products 261 km (2006)
Railways:
total: 3,077 km
narrow gauge: 3,077 km 1.067-m gauge (313 km electrified) (2005)
Roadways:
total: 97,440 km
paved: 18,514 km
unpaved: 78,926 km (2002)
Waterways:
on Lake Kariba (2005)
Ports and
terminals: Binga, Kariba

Military Zimbabwe Top of Page

Military branches:
Zimbabwe Defense Forces (ZDF): Zimbabwe National Army, Air Force of
Zimbabwe (AFZ), Zimbabwe Republic Police (2005)
Military service age
and obligation: 18 years of age (est.) (2004)

Manpower
available for males age 18-49: 2,778,404
military service: females age 18-49: 2,681,531 (2005 est.)

352
 Manpower fit for
military service: males age 18-49: 1,304,424
females age 18-49: 1,115,096 (2005 est.)
Military
expenditures - 3.8% (2006)
percent of GDP:
Transnational Top of Page
Zimbabwe
Issues
Disputes -
international: Botswana built electric fences and South Africa has placed military along the
border to stem the flow of thousands of Zimbabweans fleeing to find work and
escape political persecution; Namibia has supported, and in 2004 Zimbabwe
dropped objections to, plans between Botswana and Zambia to build a bridge
over the Zambezi River, thereby de facto recognizing a short, but not clearly
delimited, Botswana-Zambia boundary in the river
Refugees and
internally refugees (country of origin): 6,536 (Democratic Republic of Congo)
displaced persons: IDPs: 569,685 (MUGABE-led political violence, human rights violations, land
reform, and economic collapse) (2006)
Trafficking in
persons: current situation: Zimbabwe is a source, transit, and destination country for
women and children trafficked for forced labor and sexual exploitation; children
may be trafficked internally for forced agricultural labor, domestic servitude, and
sexual exploitation; women and girls are lured out of the country to South Africa,
China, Egypt, and Zambia with false job or scholarship promises that result in
domestic servitude or commercial sexual exploitation; there are reports of South
African employers demanding sex from undocumented Zimbabwean workers
under threat of deportation; women and children from Malawi, Zambia, and the
Democratic Republic of the Congo transit Zimbabwe en route to South Africa;
small numbers of South African girls are trafficked to Zimbabwe for domestic
labor
tier rating: Tier 3 - Zimbabwe does not fully comply with the minimum
standards for the elimination of trafficking and is not making significant efforts
to do so
Illicit drugs:
transit point for cannabis and South Asian heroin, mandrax, and
methamphetamines en route to South Africa

This page was last updated on 19 June, 2007

353
 History Country Brief last updated April 2006

Zimbabwe became independent in April 1980 when the Lancaster House agreements
with Britain brought to an end fifteen years of unilaterally declared independence by
the former white-minority Government of Rhodesia and the armed conflict that it
engendered. The Zimbabwe African National Union-Patriotic Front (ZANU-PF), led
by Robert Mugabe, has been in power since 1980.

Independent Zimbabwe inherited an economy that was more industrialized than most
in Africa, with a diversified productive base, well-developed infrastructure, and a
relatively sophisticated financial sector.

Most of the productive land used to be owned by the white minority on large scale
commercial farms, while the majority of the population lived on less productive
agricultural land. The government has been implementing a land reform program
since 1999/2000.

Zimbabwe embarked on a substantial economic reform process in 1991, which was

not successfully carried through. Since the late 1990s it has been grappling with the
resolution of fiscal problems; the inequities in land distribution, poverty, and
unemployment problems; population pressures; and unfavourable rainfall patterns. It
also faces a growing HIV/AIDS epidemic, partly due to increasing poverty levels and
reduced access to basic social services. Economic deterioration has further been
exacerbated by the uncertainties surrounding the land reform program and,
consequently, decreased agricultural production and tourism revenues.

Economy

Zimbabwe’s economy relies heavily on agricultural crops, such as tobacco, cotton,

and sugarcane, and on related manufacturing industries, such as textiles and sugar
production. Mining, primarily gold, is also a major activity.

Zimbabwe’s economy has continued to deteriorate since 1997. Expansionary

macroeconomic policies, a breakdown in law and order, and the virtual collapse of the
agricultural sector as a result of the fast-track land reforms have reduced the potential
for growth. Real GDP declined by 6.5 percent in 2005, which was the 7th
consecutive year of negative GDP growth since 1997. Over the period 1997-05, GDP
declined by more than 30 percent.

The fiscal deficit for 2005 is estimated at 3 percent of GDP. However, this figure
excludes quasi-fiscal activities of the Reserve Bank of Zimbabwe (RBZ), primarily to
support loss-making parastatal firms through sales of foreign exchange, fuel and
electricity at subsidized rates. According to the recent analysis by the IMF, the
combined government and RBZ fiscal deficit in 2005 was close to 60 percent of GDP.
The composition of public expenditure remains highly distorted, with the wage bill
absorbing more than a third of total expenditure and fewer resources available for
poverty-reducing activities.

354
The massive combined fiscal deficit led to sharp growth of money supply, fuelling
inflation. While year-on-year inflation declined from its peak of 623 percent in
January 2004 to 124 percent in March 2005, it picked up sharply in mid-2005.
According to the latest statistics, year-on-year inflation reached 914 percent in March
2006. The IMF warns that inflation could exceed 1,000 percent by the end of the year
in the absence of a comprehensive and immediate policy package.

Two major changes in the exchange rate regime were introduced in 2005. First, an
inter-bank market for foreign exchange was established in late October 2005. Upon
receipt of proceeds, exporters were required to surrender 30 percent to the RBZ at the
official exchange rate (Z$26,000 per US dollar), and retain 70 percent for own use or
for sale in the inter-bank market in line with the stipulated holding period (45 days).
Despite initially disappointing start of inter-bank trading, with very few transactions
and little rate movement, since mid-November, the volume of transactions have
increased, and the Zimbabwe dollar has depreciated by more than 60 percent against
the US dollar in the inter-bank market. This has allowed the parallel market premium
to narrow.

In light of the rapid depreciation of the Zimbabwean dollar, the RBZ on January 24,
2006 introduced a partial control on daily exchange rate fluctuations, allowing the
inter-bank market exchange rate to fluctuate only within the bands (zero to +/-2
percent on the mid rate ) based on the actual volumes traded in the market. Since the
introduction of the new system, the inter-bank market exchange rate has remained
unchanged at Z$99,201.58 per dollar. While this has stabilized the exchange rate
volatilities, the introduction of a partial control on the inter-bank market has
contributed to the widening of the parallel market premium. Immediately after the
statement, the Zimbabwean dollar in the parallel market fell sharply by more than 40
percent within a matter of a week, to over Z$150,000 per US dollar at end-January.
As of April 2006, the Zimbabwean dollar is being traded at Z$22,500 per US dollar
on the parallel exchange rate market.

Politics
Zimbabwe is a multiparty republic with an executive president and a parliament
consisting of 150 members. Ten members are chosen by traditional chiefs, twenty
are appointed by the president, and the rest are elected. The Zimbabwe African
National Union-Patriotic Front (ZANU-PF) won the latest parliamentary elections in
2000, and Mugabe was re-elected president in 2002. The next presidential elections
are scheduled for 2008. President Mugabe has stated that he intends to stay in office
until his presidential term ends in 2008.

The March 31, 2005 parliamentary elections took place peacefully. Out of 120 elected
MP positions 78 were won by ZANU-PF, 41 by MDC, and 1 by an independent
candidate. The additional 20 MPs appointed by the President and 10 elected by the
traditional chiefs, who mostly support the Government, give ZANU-PF a comfortable
two/thirds majority in the 150 seat parliament. President Mugabe and the ZANU-PF
party used their two thirds majority in the Parliament won during the last election, to
push through important constitutional amendments on land, denying landowners the
right of legal appeal against land expropriation, and creation of the Senate.

The Senate elections, held on November 26, 2005, have resulted in a sweeping victory
of the ZANU-PF party, and the opposition MDC in a total disarray, despite a very low
voter turnout of less than 20 percent. Of the 50 electable seats, MDC only contested

355
25 seats. The MDC candidates who contested did so in defiance of the directive to
stay away from the elections, issued by Mr. Morgan Tsvangairai, the leader of the
MDC. Recently infighting in the MDC has intensified ahead of parallel congresses
set for the next month, with the two factions led by Tsvangirai and Sibanda,
respectively, claiming the presidency of the MDC.

Development Picture / Donor Coordination

A large number of donors have scaled down or suspended their operations in

Zimbabwe. The IMF Board suspended Zimbabwe’s voting rights on June 6, 2003
because of Zimbabwe’s lack of cooperation in policy implementation and payments.
Other donors and agencies have limited their activities to social concerns, including
HIV/AIDS, social protection, and human rights. Increased donor support is contingent
on progress in orderly land reform and macroeconomic stabilization, in particular the
clearance of arrears.

Zimbabwe announced its withdrawal from the Commonwealth following its barring
from the December 2003 meeting.

World Bank Role

Zimbabwe’s arrears to the Bank are estimated at about US$409 million as of April 5,
2006. The arrears to the Fund stood at US$119 million at end-February 2006 and to
the AFDB were estimated at US$300 million at end-January 2006. The Bank’s role in
Zimbabwe is thus now limited to technical assistance and analytical work focusing on
macroeconomic policy, food security issues, social sector expenditures, social service
delivery mechanisms, and HIV/AIDS. An interim strategy for Zimbabwe has been
finalized in August 2005. The Interim Strategy covers a twelve-month period and was
designed in close consultation with a core group of donors and the Zimbabwean
government. The activities within the twelve month strategy period close important
analytical gaps in the areas of poverty and safety nets, social service delivery, and
agriculture and infrastructure sectors. A resumption of disbursements is contingent on
clearance of arrears.

On September 7, 2005, Zimbabwe paid US$4.5 million to the Bank. The Bank Board
endorsed a one-year Interim Strategy for Zimbabwe (ISN) on March 17, 2005. Trust
fund proposals are under implementation for poverty analysis and social sector
delivery within the ISN framework and the Government has recently signed off the
HIV/AIDS study. In November 2005 two Bank missions visited Harare to conduct
analytical work on infrastructure and the civil service wage bill. Another mission
visited Harare in January 2006 to initiate social service delivery analyses. The
Government continues to express keen interests in the Bank’s further assistance in
civil service reform.

The World Bank has helped to fight poverty and improve living standards for the
people of Zimbabwe. As of April 2006, the Bank had approved 19 IBRD loans
and 14 IDA credits for a total of approximately US$1.55 billion.

The lending program in Zimbabwe is inactive due to arrears. The Bank’s role here is
now limited to technical assistance and analytical work focusing on macroeconomic
policy, food security issues, social sector expenditures, social service delivery
mechanisms and HIV/AIDS. For more information on how the World Bank has
supported Zimbabwe, refer to All Projects.

356
 World Economic Forum on Africa Concludes in Cape Town

June 20, 2007––Cape Town, South Africa played host to the 17th annual World
Economic Forum on Africa last week with the focus on building capacity for success.

This year’s conference theme, “Raising the Bar,” underscored the objective of the
meeting––to tackle issues such as investment, infrastructure, energy, governance,
skills development, malaria and other health issues, urbanization, and climate change.

The conference provided an excellent networking opportunity, as it brought together

diverse players from the continent as well as other countries––800 participants from
42 countries in all. The convention centre buzzed with activity as delegates rushed to
their panel discussions or media conferences, pausing for informal hallway
discussions. Others held bilateral meetings on the sidelines, while enterprising
journalists used the opportunity to conduct interviews and grab quick quotes and
sound bites for their reports.

Representatives and experts from

governments, business, international
Senegalese President Wade, right, with organizations and civil society focused
on leveraging Africa’s increasingly
South African businessman Tokyo strategic role in the global arena. Many
Sexwale, left (moderator in middle) used the forum to commend the
continent’s economic growth—while
noting challenges that remain.

Africa as an Investment Destination

Among those participating in the event was World Bank Vice President for the
African region Obiageli Ezekwesili. She stressed “the time for declarations is over,
Africa wants action.” Ezekwesili participated in panel discussions, including the
opening plenary where she joined South African President Thabo Mbeki, Senegalese
President Abdoulaye Wade, South African businessman Tokyo Sexwale, and Cynthia
Carroll, the CEO of the Anglo American Corporation.

Ezekwesili noted that Africa is a more attractive investment destination, as

governments pursue economic and political reforms that are boosting their
economies. “Africa is beginning to do certain things right. The kind of sustained
growth we’re seeing, where at least 36 percent of the population on the continent is
living in economies that are growing around 5 percent, is an indication that the right
policy choices are growing.”

Ezekwesili noted it is more important than ever for the world to support Africa. “It is
critical to support countries to make the right decisions and ensure they have the
institutions and technical capacity to sustain growth. There are still huge areas that
need reform.”

357
 African Competitiveness Report
Launched
South African President Thabo Mbeki,
A highlight of the conference was the
launch of the African Competitiveness right, with forum founder Klaus
Report 2007, the first report on the region’s Schwab at the opening plenary
business environment to leverage
knowledge and expertise within the World Economic Forum, the World Bank, and the
African Development Bank.

The report concludes that African businesses can become far more competitive, but
that African governments and their international partners will need to improve access
to finance, rebuild infrastructure and strengthen institutions. World Bank Chief
Economist for Africa John Page noted, “Africa can compete, but that competitiveness
is not uniform.”

The report also points to the growing number of success stories. It analyses steps
countries can take to improve aspects of their business environment, and highlights
themes that will boost the prosperity of nations. It offers detailed assessments of the
drivers of productivity and employment growth, including the rankings of 29 African
countries in the Global Competitiveness Index.

The report looks at the competitiveness and

Africa Vice President Obiageli
Ezekwesili, right, and forum
participant Sean Cleary discuss
growth
investment climate in Africa’s four largest
economies (South Africa, Algeria, Nigeria and
Egypt), and the effect of gender disparities on
employment and competitiveness. It also
identifies the role of new technologies in
fostering a more dynamic business
environment.

IFC Package for Mobile Networks

The IFC announced its own deal during the conference—a $320 million package to
five subsidiaries of Celtel International, to help expand and upgrade its fast growing
mobile networks in the Democratic Republic of Congo, Madagascar, Malawi, Sierra
Leone, and Uganda.

The investment will result in better-quality mobile access in countries with extremely
limited telephone services, creating new opportunities for businesses and consumers.
The financing transaction, for the first time, takes the IFC’s annual investments in
Africa over the $1 billion mark.

Vision for the Future

Klaus Schwab, Founder and Executive Chairman of the World Economic Forum
noted: "The world needs Africa as much as Africa needs the world." He particularly
underscored the importance of partnerships to address global issues affecting
the continent, and emphasized the role of the forum to help cement these
partnerships.

358
Both Mbeki and Wade noted African countries should
concentrate on building the capacity necessary to help their
economies sustain the strong growth many of them have Plenary networking
achieved in recent years. "Sustainable development
requires human resources necessary to move a country forward," Wade said. He
noted his country is a success story, partly because the government has allocated 40
percent of its budget to education and launched numerous infrastructure projects.

Mbeki noted that everything Africa does must be linked to building the necessary
capacity to take the continent away from poverty. “The future must be of a more
prosperous and developed continent, one catching up with the rest of the world,” he
said. All agreed that solutions need to be home-grown, and cannot be imposed from
outside.

For more on the World Economic Forum on Africa.

For more on the competitiveness report.

Data and Statistics

The World Bank gathers and shares development data to improve understanding of
the challenges facing each country. The following resources cover a range of social
and economic measures of poverty and development.

Zimbabwe: Quick Facts

For a complete list of indicators refer to the Zimbabwe Country Data Profile. Refer
to the Africa Quick Query to customize and manage Time-series data on a wide
range of topics.

Yr 2005
Population, total (millions) 13.0
Population growth (annual %) 0.6
Surface area (sq. km) (thousands) 390.8
Life expectancy at birth, total (years) 37.3
Mortality rate, infant (per 1,000 live births) 81.0
GNI (current US$) (billions) 3.2
GNI per capita, Atlas method (current US$) 350.0
Prevalence of HIV, total (% of population ages 15-49)20.1
Source: World Development Indicators

359
Summary: Zimbabwe has currently the highest rate of inflation in the world (an
annual rate of 1,730 percent in February, 2007). The high rates of inflation have
contributed to the contraction of the economy, which has declined by about 30 percent
since 1999. This paper examines the stabilization experience of countries that
experienced similar rates of inflation (above 1,000 percent) during 1980-2005 and
draws lessons for Zimbabwe. First, with appropriate stabilization policies, the fall in
inflation can be very rapid and output normally recovers within the first year or two of
stabilization. Second, while reforms need to be comprehensive, a strong upfront fiscal
consolidation, including elimination of quasi-fiscal activities, is a critical element of a
successful stabilization program. Third, although stabilization itself can be done
without significant external financing in the first year, most countries benefited from
external policy advice and technical support, including from the IMF, during
stabilization and from an increase in financial assistance in subsequent years.

IMF Executive Board Considers Zimbabwe's Arrears to the Fund

Press Release No. 07/30
February 23, 2007
The Executive Board of the International Monetary Fund (IMF) met today to
consider issues related to Zimbabwe's outstanding arrears to the Poverty Reduction
and Growth Facility-Exogenous Shocks Facility (PRGF-ESF) Trust.1 The Board also
considered the sanctions, including the suspension of voting and related rights, that
had been imposed on Zimbabwe with respect to its arrears to the IMF's General
Resources Account (GRA),2 which were settled in full in February 2006 (see Press
Releases No. 06/33 and No. 06/45).

With regard to Zimbabwe's outstanding arrears to the PRGF-ESF Trust, the Board
expressed deep concern over the deteriorating economic and social conditions and
regretted that the authorities have not undertaken the policies recommended by the
IMF. The Board also noted that Zimbabwe's payments towards settlement of its
PRGF-ESF arrears have been minimal and that its arrears to the Trust have further
increased. The Board urged the authorities to decisively address the ongoing
economic crisis by immediately implementing a comprehensive stabilization package
comprising several mutually reinforcing actions centred on fiscal tightening
(including transferring the quasi-fiscal activities carried out by the Reserve Bank of
Zimbabwe to the budget) and price and exchange regime liberalization. The Board
also called for fundamental structural reforms, including public enterprise and civil
service reforms, strengthened property rights and improvements in governance.
In light of Zimbabwe's deteriorating policy performance and payments to the IMF,
the Board kept in place the decisions previously taken to address Zimbabwe's arrears

360
to the PRGF-ESF Trust—the declaration of non-cooperation, the suspension of
technical assistance, and the removal of Zimbabwe from the list of PRGF-ESF-
eligible countries. The Board urged Zimbabwe to resolve its remaining arrears to the
PRGF-ESF Trust promptly, and agreed that it will again consider Zimbabwe's arrears
to the Trust in six months.

Zimbabwe has been in continuous arrears to the IMF since February 2001 and is the
only case of protracted arrears to the PRGF-ESF Trust, which currently amount to
SDR 86 million (about US$129 million).
With respect to the suspension of Zimbabwe's voting and related rights, the Board
made no decision and agreed to return to the issue at a later date.

1
http://www.imf.org/external/np/exr/facts/prgf.htm
2
http://www.imf.org/external/pubs/ft/pam/pam45/pdf/PAM45.pdf

361
Statement by IMF Staff at the Conclusion of the 2006 Article IV Consultation
Discussions in Zimbabwe
Press Release No. 06/282
December 18, 2006
An International Monetary Fund (IMF) staff mission that recently visited Harare
issued the following statement today:

"A staff mission from the International Monetary Fund (IMF) visited Zimbabwe
during December 4-16, 2006 to conduct the Article IV Consultation discussions. We
would like to thank Zimbabwe's economic team led by Minister of Finance, Herbert
Murerwa, Minister of Economic Development, Rugare Gumbo, and Reserve Bank of
Zimbabwe (RBZ) Governor, Gideon Gono, as well as private sector participants and
members of the civil society for useful discussions and for facilitating our work.

"The discussions focused on the economic situation and policies to stabilize the
economy and achieve sustained growth and low inflation, which would lay the
foundation for improving the living standards of all Zimbabweans. The mission noted
the deteriorating economic conditions since its last visit in January/February this
year. Inflation has accelerated while shortages of food, fuel, basic consumer goods,
and essential agricultural inputs remain acute. Progress on structural reforms has been
limited and uncertainty over property rights continues to depress investor confidence.
Although recent data on social indicators are not available, high inflation and falling
output are likely to have polarized incomes and increased poverty.

"As emphasized in previous rounds of discussions last year and January/February this
year1, Zimbabwe's economic crisis calls for the urgent implementation of a
comprehensive policy package comprising several mutually reinforcing actions.
Without a fundamental change in policies, prospects are for a continued deterioration
in the economic situation.

"A crucial element of this package will be strong fiscal adjustment. The inclusion in
the 2007 budget of substantial quasi-fiscal activity reported by the RBZ, such as the
provision of subsidized foreign exchange to the public sector and price supports to
commodity exporters, marks a positive step towards increasing transparency. Going
forward, the key will be first to ensure that sharp cuts are made in real terms in fiscal
spending, including quasi-fiscal activity previously undertaken by the RBZ. This will
mean that the government should aim to stay within the current 2007 budget
envelope. Second, fiscal expenditure needs to be prioritized, in particular to ensure
adequate food imports, an urgent improvement in health infrastructure, and well-
targeted social safety nets to protect the poor and address the needs of those affected
by HIV/AIDS and "Operation Murambatsvina".

"Strong fiscal adjustment will need to be supported by complementary policies, in

particular: (i) unifying all official exchange rates and moving the unified rate towards
market-determined levels; (ii) removing restrictions on current account payments and
transfers; (iii) liberalizing price controls and imposing hard budget constraints on
public enterprises, whose losses have been largely responsible for quasi-fiscal
activities; and (iv) establishing a strong monetary anchor, with the RBZ focusing on
its core function of ensuring overall price stability.

362
"Achieving sustained economic growth and low inflation will require comprehensive
structural reforms and a strengthening of governance over the medium term. Such
reforms include public enterprise and civil service reform; tax and expenditure
management reform; agriculture sector reforms; and the strengthening of private
property rights.

"Finally, we encourage the authorities to improve relations with the international

community in order to support the government's reform policies and facilitate
progress towards the Millennium Development Goals. We hope the authorities will
work more closely with the IMF to design and implement a policy package that
would help achieve macroeconomic stability and growth and improve the welfare of
the Zimbabwean people.

"The 2006 Article IV discussions with Zimbabwe are expected to be concluded by

the IMF's Executive Board by March 2007."

1
A further elaboration of the Fund's policy advice and the Executive Board's views
can be found on the IMF website, Zimbabwe's country page

363
 Zimbabwe bans bulk buying as shops run empty
Thu Jul 5, 2007 4:48AM EDT

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Power. Price. Service. No Compromises.

By MacDonald Dzirutwe

HARARE, July 5 (Reuters) - Zimbabwe authorities ordered businesses on Thursday

to stop selling basic goods in bulk to avert shortages after an official price freeze
triggered a frenzied buying spree that has emptied most shop shelves.

President Robert Mugabe's government last week ordered businesses to roll back
prices to June 18 levels after wild increases of up to 300 percent within a week
following the plunge of the local currency on a thriving black market.

Spiralling prices have pushed inflation above 4,500 percent, the highest in the world,
underscoring an eight-year economic recession that has ravaged urban workers the
most and sparked foreign currency, fuel and food shortages.

"Wholesalers and retailers should desist from allowing bulk buying of basic
commodities," Obert Mpofu, the Minister of Industry and International Trade, told the
official Herald newspaper on Thursday.

Mugabe denies charges he has presided over the country's worst economic crisis since
independence from Britain in 1980 and instead says the West has sabotaged the
economy to punish him for seizing white-owned commercial farms for blacks.

Over the past week shoppers have been buying sugar, cooking oil, flour, salt and
maize-meal in bulk, leaving shelves empty while manufacturers have stopped
producing. They say the price freeze is not viable given the price of other goods and
raw materials continue to skyrocket.

Police had to be called in at a supermarket in central Harare early on Thursday to

control a huge crowd that had jammed the shop after word quickly got round that
sugar was available.

"We heard there is sugar here that is why there is all this commotion," Rosemary
Marawa said as she tussled in a long queue which also included uniformed police and
soldiers.

Some people have formed teams to trawl shops in the capital and buy whatever basic
goods they can in bulk.

364
Mugabe has accused businesses of being drafted in a conspiracy by his Western foes
to topple him from power by increasing prices without justification. He warned his
government could seize and nationalise the companies.

More than 200 business people -- including a ruling party senator -- have been
arrested for defying the price freeze, which economic analysts say will only entrench
the black market.

Police also said they had unearthed huge quantities of sugar, soap and cooking oil --
all in short supply -- at a site in Harare and suspect the goods were being hoarded to
create artificial shortages in the market.

"The public is urged not to be involved in panic buying of commodities whose prices
have been reduced as sustainable continuous supplies will be provided," Information
Minister Sikhanyiso Ndlovu told the Herald.

365
The ZIMBABWE Situation
extensive and up-to-date website containing news, views and links related to
ZIMBABWE - a country in crisis
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order to see the index of articles on this webpage

• The virtues of isolationism

• Zimbabwe bans bulk buying as shops run empty
• SA insists on Mugabe invitation
• Govt concerned about Zimbabwe's economic crisis
• Implats concerned about power supply in Zimbabwe
• Social distinctions fade in the face of survival
• Mugabe's policies anger top cronies
• Zimbabwe-SA protection deal stalls
• Government blamed for increasing prison deaths
• Zim journalist rots in Botswana prison
• What Zimbabweans think of Pius Ncube
• Archbishop Williams blames Kunonga for blocking food aid
• Mbeki to dump Zimbabweans
• Cricket - KPMG to investigate Zimbabwe's finances

The virtues of isolationism

Jul 5th 2007

From The Economist print edition

Robert Mugabe should be a pariah, not a regular feature on the summit

circuit

AFP
ANOTHER week, another stark contrast in how to deal with Zimbabwe's
president, Robert Mugabe. In a blistering attack on Mr Mugabe's rule, the
Roman Catholic Archbishop of Bulawayo, Pius Ncube, said that the state of
the country was now so bad that foreign governments (particularly Britain's)
should intervene to "remove" Mr Mugabe from power. Meanwhile, at an African
Union summit in Ghana, Mr Mugabe was, as usual, feted by his fellow African
leaders, where he pronounced on the virtues of pan-African unity.

Not only that, but the African Union is also insisting on Mr Mugabe's
presence at a summit with the European Union to be held in Portugal in
December. The Portuguese, who took over the rotating European Union
presidency on July 1st, are making better links with Africa a priority of
their six-month presidency. They say they would prefer not to have Mr Mugabe
(who is already subject to an EU travel ban) at the summit, but that it
would be worse to lose the summit altogether.

It is shameful that African leaders continue not only to shield but also
positively to promote Mr Mugabe in this way. Apart from anything else, it
makes a mockery of the noble talk of human rights and good government the
African Union spouted when it relaunched itself five years ago. Instead, the

366
African Union is coming increasingly to resemble its discredited and
unlamented predecessor, the Organisation of African Unity, a
mutual-protection club for dodgy presidents. The continent's leaders should
by now be confident enough to see Mr Mugabe's harping on about African
solidarity against imperialism for the self-serving smokescreen it is.

Every week brings grimmer news about the impoverishment and degradation of
what used to be one of Africa's most prosperous countries. Zimbabwe's
official inflation rate has now passed 3,700%; unofficially it is a good
deal higher than that. The government's only response has been to try to
impose a price freeze by force, arresting 194 people in the process. Shops
have shut down and factories have stopped production because they could only
carry on at a loss.

Mr Ncube's courageous outburst reflects the huge frustration that is

building up inside Zimbabwe as the country falls into ruin. He also has a
special animus against the president. Apart from witnessing the worst of Mr
Mugabe's regime over the full 27 years of its existence, Mr Ncube was a
priest in Matabeleland when Mr Mugabe first turned on those he saw as
potential opponents there and massacred some 20,000 people, most of whom
were entirely innocent civilians.

For that reason, Mr Ncube's appeal to the West to remove Mr Mugabe should be
taken as a cry of pain, not a reason for the West to invade. Mr Ncube
stressed that any intervention should be non-violent. And he knows that the
threat of Western interference, particularly by Britain, the former colonial
power, is one of the few ways in which Mr Mugabe can still drum up domestic
support. So although the West is preparing to put Zimbabwe back on its feet
once Mr Mugabe is gone, it is only the Africans, and particularly the
southern Africans, who can apply the strong pressure needed to get rid of
him quickly.

Say no to the African Union's blackmail

Yet the Portuguese do now have a way to give the African Union a much-needed
jolt. They should refuse to let Mr Mugabe come to Lisbon. That will force
Africa's leaders to reconsider their priorities. If that stops the summit
from taking place, so be it: a firm stand would send a powerful message of
solidarity to all those in Zimbabwe who long to be rescued from their
plight. Welcoming their tormentor to Lisbon for the sake of a jamboree would
be a corresponding disgrace.

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Zimbabwe bans bulk buying as shops run empty

Reuters

Thu Jul 5, 2007 4:48AM EDT

By MacDonald Dzirutwe

HARARE, July 5 (Reuters) - Zimbabwe authorities ordered businesses on

Thursday to stop selling basic goods in bulk to avert shortages after an

367
official price freeze triggered a frenzied buying spree that has emptied
most shop shelves.

President Robert Mugabe's government last week ordered businesses to roll

back prices to June 18 levels after wild increases of up to 300 percent
within a week following the plunge of the local currency on a thriving black
market.

Spiralling prices have pushed inflation above 4,500 percent, the highest in
the world, underscoring an eight-year economic recession that has ravaged
urban workers the most and sparked foreign currency, fuel and food
shortages.

"Wholesalers and retailers should desist from allowing bulk buying of basic
commodities," Obert Mpofu, the Minister of Industry and International Trade,
told the official Herald newspaper on Thursday.

Mugabe denies charges he has presided over the country's worst economic
crisis since independence from Britain in 1980 and instead says the West has
sabotaged the economy to punish him for seizing white-owned commercial farms
for blacks.

Over the past week shoppers have been buying sugar, cooking oil, flour, salt
and maize-meal in bulk, leaving shelves empty while manufacturers have
stopped producing. They say the price freeze is not viable given the price
of other goods and raw materials continue to skyrocket.

Police had to be called in at a supermarket in central Harare early on

Thursday to control a huge crowd that had jammed the shop after word quickly
got round that sugar was available.

"We heard there is sugar here that is why there is all this commotion,"
Rosemary Marawa said as she tussled in a long queue which also included
uniformed police and soldiers.

Some people have formed teams to trawl shops in the capital and buy whatever
basic goods they can in bulk.

Mugabe has accused businesses of being drafted in a conspiracy by his

Western foes to topple him from power by increasing prices without
justification. He warned his government could seize and nationalise the
companies.

More than 200 business people -- including a ruling party senator -- have
been arrested for defying the price freeze, which economic analysts say will
only entrench the black market.

Police also said they had unearthed huge quantities of sugar, soap and
cooking oil -- all in short supply -- at a site in Harare and suspect the
goods were being hoarded to create artificial shortages in the market.

"The public is urged not to be involved in panic buying of commodities whose

368
prices have been reduced as sustainable continuous supplies will be
provided," Information Minister Sikhanyiso Ndlovu told the Herald.

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SA insists on Mugabe invitation

Mail and Guardian

Paul Simao | Pretoria, South Africa
05 July 2007 02:22

South Africa and other African nations will insist that

Zimbabwean President Robert Mugabe be allowed to attend a long-delayed
summit between the European Union (EU) and Africa later this year, the
government said on Thursday.

Mugabe and more than 100 other Zimbabwean officials are banned
from travelling to EU nations under sanctions imposed in 2002, a restriction
that threatens to derail an EU-Africa summit scheduled for December in
Portugal.

The African Union has said its 53 members should decide who to
send to the meeting.

"I think Africa will not move on its position of what

constitutes the African delegation," South African Deputy Foreign Minister
Aziz Pahad said at a news briefing in the capital Pretoria.

"Today, it is Zimbabwe [under pressure], tomorrow it could be

us."

Pahad said he was encouraged by comments from senior Portuguese

officials, including its foreign affairs minister, suggesting the political
crisis in Zimbabwe and Mugabe's presence should not block a summit.

Portugal holds the rotating six-month EU presidency, giving it

additional sway over how to approach the problem of Mugabe's invitation. The
Portuguese term will expire in early 2008.

Widely accused of abusing human rights, suppressing political

opposition and driving Zimbabwe's economy into the ground, Mugabe became
persona non grata in much of Europe in 2002 after winning an election
described as rigged by international observers.

South African President Thabo Mbeki is brokering talks between

Mugabe's government and representatives of Zimbabwe's main opposition
Movement for Democratic Change under a mandate granted to him earlier this
year by the Southern African Development Community (SADC).

Pahad said he believed Mbeki had briefed other SADC nations on

the talks, but gave no further details.

The issue of the 83-year-old Zimbabwean leader, who has vowed to

369
run for another term as president next year, is the main reason the EU and
Africa have not held a summit since their first effort in Cairo seven years
ago.

Britain, which ruled Zimbabwe under its former name Rhodesia

until independence in 1980, is believed to be among the EU members most
opposed to inviting Mugabe to Portugal. Under EU rules, any member can veto
the invitation.

The summit would likely focus on areas requiring closer

cooperation between Europe and Africa, notably trade, migration and the
establishment of an energy partnership.

Spain, Italy and other southern European nations are struggling

to cope with illegal immigration from Africa.

Consumer shortages
Meanwhile, in Zimbabwe, the most basic goods are disappearing
from shop shelves.

Long queues of shoppers now form early in the morning at many

Harare supermarkets and shops, hoping to grab essentials such as sugar and
oil amid a price crisis that has sharpened already desperate consumer
shortages.

Zimbabwe's latest shopping nightmare comes after the government

last week ordered a 50% cut in prices to fight galloping inflation, a move
critics say is bound to worsen the country's economic problems.

On Wednesday, Zimbabwe state media reported manufacturers, state

firms and some retailers had agreed to cut prices in compliance with the
government order, but privately many grumble the drive is unsustainable.

The official move to exert price controls came after a wild week
that saw the price of many basic goods jump by more than 300%. - Reuters

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Govt concerned about Zimbabwe's economic crisis

SABC

July 05, 2007, 17:45

Aziz Pahad, the deputy minister of foreign Affairs, says for South Africa
the solution to Zimbabwe's political, economic and social issues has become
fundamental. He expressed government's concern on the effect of Zimbabwe's
economy on South Africa.

Briefing the media in Pretoria, Pahad referred to Zimbabwe's inflation rate

of around 5 000%. He says about three million Zimbabweans are estimated to
be in South Africa. Pahad says there is no way they can prevent the flow of
Zimbabweans into South Africa and this is why the government is concerned
about the neighbouring state's situation.

370
Meanwhile, the important Africa-European Union summit, already held up for
seven years, is still in the balance because of the EU travel ban on Robert
Mugabe, the Zimbabwean president. However, Pahad welcomed indications from
the current EU president and host of the summit, Portugal, that Mugabe might
be welcome after all.

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Implats concerned about power supply in Zimbabwe

Reuters

Thu 5 Jul 2007, 9:30 GMT

By Eric Onstad

JOHANNESBURG, July 5 (Reuters) - The world's second biggest platinum

producer Implats <IMPJ.J> said on Thursday it was working on ensuring a
steady power supply for its mines in Zimbabwe, hit by a severe economic
crisis and hyper-inflation.

Chief Executive David Brown told Reuters so far there had been only minor
problems with electricity in Zimbabwe, the company's major future growth
area.

He said in an interview the company has been lucky to operate successfully

in Zimbabwe over the past six years despite economic crisis, but it was now
concerned about power supplies.

"Certainly the issues that are starting to come through are the consistency
of electricity supply, which obviously is quite crucial for our business,"
he said.

When asked if there had been outages, he replied: "There's been some minor
stuff, but certainly not on a major scale... electricity supply is probably
one of the risk factors of doing business there at this particular point of
time."

The company was working on making sure power supplies did not have a major
impact on its business there, he added.

"There are a number of solutions that are being worked on, and certainly we
are communicating with the various parastatals to make sure we solve the
issues," he said, declining to give details.

Implats has a majority stake in Zimplats Holdings Ltd <ZIM.AX>, which it

hopes will boost annual output to 1 million ounces of platinum per year in
the long term from 90,000 ounces currently.

The firm also has joint venture along with Aquarius Platinum Ltd
<AQPJ.J><AQP.L> in Zimbabwe's Mimosa mine.

371
WELL PLACED FOR NEW LAW

Brown said Implats was well placed for planned legislation to require
companies to sell 51 percent stakes to local Zimbabwean investors.

The firm agreed a deal last year to get credits towards the 51 percent
requirement by giving up some unused mining claims in Zimbabwe, which has
the second richest resources of platinum after South Africa, the world's
biggest producer of the metal.

The Zimbabwe government also agreed to give credits for building roads and
other infrastructure towards the local ownership rules.

"I think the value of those credits probably needs to be finalised, but
certainly the principle is established and is accepted," Brown said.

The credits, however, would not meet the full 51 percent requirement and
Impala Platinum Holdings Ltd plans to sell a stake to local investors, he
added.

"Between the 51 percent and these other items, there would have to be a gap,
and that gap would have to be filled. We have always been comfortable with
the fact that there should be some indigenisation."

Brown said he was unable to comment on comments by President Robert Mugabe,

who threatened last month to seize foreign companies, including mines, he
accused of economic sabotage as part of a campaign to oust his government.

"I don't know the context in which statements like that were made, so it is
very difficult to comment on how those statements might have an impact on
us. It’s not particularly clear at all."

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Social distinctions fade in the face of survival

United Nations Office for the Coordination of Humanitarian Affairs -

Integrated Regional Information Networks (IRIN)

Date: 05 Jul 2007

HARARE, 5 July 2007 (IRIN) - A senior Zimbabwean police official has

employed five young men to sell foreign currency on the streets of the
capital, Harare, but while the police play cat and mouse with the illegal
dealers, his "employees" conduct their business undisturbed because they
cannot be arrested.

"We sell the foreign currency openly because we are untouchable. Some
constables arrested me at one time, even though I had informed them that I
was working for their boss. They have been transferred from Harare and after
that no-one dares touch us," said one of the dealers, who identified himself
as Peter.

372
He claimed that a number of police officers were selling foreign currency
and using their positions to ensure that their agents were protected from
arrest.

Besides dealing in foreign currency on the parallel market, the police

official also has other "employees" who vend vegetables or cigarettes, and
cell phones confiscated from unauthorised vendors.

As Zimbabwe's economy plumbs new depths, some police officials have joined
the ranks of company executives who have resorted to moonlighting as
dealers, running intricate networks in the informal market to supplement
their income.

A police spokesman, Assistant Commissioner Wayne Bvudzijena, told IRIN, "It

is illegal to sell foreign currency in the streets, be it policemen or
ordinary Zimbabweans, and they will be arrested."

Something extra

Every Friday, Stanley Cele, 48, the managing director of a vehicle spare
parts company in Harare, takes bags of assorted essentials - ranging from
imported cooking oil, laundry soap, detergents and even sweets - to sell at
his workplace.

He enlists the help of some of his colleagues to encourage others to buy the
goods; those who purchase items have their names written down and are given
the option of paying at the end of the month when they receive their
salaries.

There is a large sign that prohibits hawking on the firm's premises. "I am
aware that there are people out there who scoff at me, saying that as a
managing director I am not supposed to be seen hawking; they say it reduces
my esteem as the head of the company but I don't care, I have to survive,"
Cele told IRIN.

The stranglehold of Zimbabwe's seven-year economic recession, characterised

by runaway inflation - currently at around 4,000 percent - acute shortages
of essential commodities, power and foreign currency, has left 80 percent of
the population living below the poverty datum line.

Many company executives are augmenting their incomes in ways that would be
unacceptable in a normal economy. "As a manager, before the economic
meltdown I used to be fussy when junior employees brought their items,
mostly buns for breakfast, to sell on the company premises. Of course, I
have now swallowed my pride," Cele said.

Cross-border traders

His wife quit her job as a nurse at the beginning of the year to start
cross-border trading, bringing into the country the items that Cele sells to
other staff and the employees of neighbouring companies.

She has joined the thousands of others who go mainly to neighbouring South

373
Africa and Botswana to buy goods for resale in Zimbabwe, a business that is
proving to be the mainstay of many families.

Most basic commodities are not readily available on Zimbabwean shop shelves
but can easily be found on the streets. By bringing the goods to the people
at work instead of selling them on the streets, Cele ensures quick sales.

He said his company, which used to have branches nationwide, has hit a low
ebb because they were finding it difficult to source foreign currency -
scarce in banks but available on the parallel market at exorbitant rates -
to import the spare parts that were the company's core business.

"We are performing well below capacity and salaries have been stagnant for a
long time, and if things continue like this we might be forced to close
down," said Cele, whose take-home pay is a paltry Z$10 million (about US$77
at the parallel market rate of Z$130,000 to US$1).

Crossing the line

He has to keep up appearances, going out for lunch with other executives and
wearing expensive clothes, but this cannot be sustained on his meagre
salary.

Cele admitted that he sometimes used unorthodox methods to force his

employees to buy his goods.

With poor monthly incomes, most of them were reluctant to buy too many items
in case they were left with no money, but Cele, particularly near the end of
the month, held general meetings with them and brought out his goods after
addressing them. "I know they are forced to buy because they want to curry
favour with me and believe that that is the best way of keeping their jobs."

However, other employees have also started hawking, plunging the company
into chaos and virtually turning the premises into a marketplace; even the
security guard in the firm's reception area has set up a stall outside the
gate, selling cigarettes, sweets and bananas.

"Almost everyone is doing it because that is the only way to earn a

semblance of a living, but we are careful not to bring in goods that the
boss is selling because that would mean we are directly competing with him,
and that could easily cost our jobs," Absalom Mutsvangwa, the guard, told
IRIN.

"Second hand clothes, sugar, vegetables and slaughtered chickens are among
the most popular commodities on sale, and employees are now spending most of
their time doing that instead of their duties. Workers from the surrounding
factories inundate the firm, especially during lunchtime," he said.

Innocent Makwiramiti, an economist and past chief executive officer of the

Zimbabwe National Chamber of Commerce, said it was not surprising that
company executives were resorting to other means to augment their salaries,
because industry was performing poorly.

374
"Most executives are no longer held in high regard by their juniors because
of the coping tactics they have been forced to adopt by the current economic
crisis. That has created another problem, in that where a company head is
not respected, performance at the workplace suffers and returns diminish,"
Makwiramiti told IRIN.

The Confederation of Zimbabwe Industries recently indicated that industry

was performing at a third of its pre-2000 capacity, while analysts say the
economy has shrunk to its pre-1965 level.

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Mugabe's policies anger top cronies

Zimbabwejournalists.com
5th Jul 2007 17:02 GMT
by a Correspondent

HARARE - President Robert Mugabe has come under strong condemnation from
colleagues within the top echelons of Zanu PF for ordering the current
massive price cuts that have seen shop shelves going empty after shoppers
emptied them in a buying frenzy.

Sources within the party told zimbabwejournalists.com that top Zanu PF

officials who have their hands right in the national pie and are the major
culprits benefiting from the country's economic collapse, are angry with
Mugabe for cutting their huge profits through the price cuts.

The Zimbabwean government recently ordered that prices be cut by 50 percent

on basic commodities, a move which has angered those in the business
community and the Zanu PF gurus who were making a killing out of the
ordinary person's misery.

High emotions among top party elites have also come to light following the
arrest of a senator who had defied the government order to cut prices.

Most leading Zanu PF politicians have businesses in food outlets and some
have invested in hotel chains, restaurants and confectioneries.

Mugabe himself is alleged to be a leading investor in Bakers Inn, a backing

confectionery in Zimbabwe but we have not been able to confirm this.

Some of those affected by the price cuts include the Zvobgo family and
retired army general Solomon Mujuru who is the husband too the vice
president, Joice Mujuru. Ignatius Chombo, Leo Mugabe, Oppah Muchinguri, are
some of the affected.

The move to cut prices by 50 percent has led to consumers buying goods in
bulk which has left some supermarkets running dry.

"I know once all this is over, there will be no sugar, cooking oil and soap
in the shops. I have no option but to stock up. I might even resell some if
I get some extra stuff, it's a matter of survival," one consumer said,

375
referring to the ongoing crackdown.

Recently the state media reported that some firms were raising prices as a
way of frustrating the Mugabe regime.

"There are some private companies which are raising prices as part of a plot
to oust President Mugabe, who has been pilloried in the West for his
controversial policies," said a senior Zanu PF official.

Mugabe critics have however claimed that it is desperate move by the ageing
dictator in making sure he buys votes well in time as 2008 polls will more
likely have intense monitoring.

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Zimbabwe-SA protection deal stalls

Business Report
July 5, 2007
By Donwald Pressly

Cape Town - There had been little progress in protecting South African
businesses that might face nationalisation in Zimbabwe, trade and industry
minister Mandisi Mpahlwa acknowledged yesterday.

Talks on an investment promotion and protection agreement began many years

ago. But when Business Report asked Mpahlwa what progress was being made in
protecting business from South Africa and the rest of southern Africa, he
replied: "We have not come round to signing that agreement."

He noted that he had written to then Zimbabwe finance minister Herbert

Murerwa two years ago, telling him how important it was for South Africa to
have this agreement in place.

"We had bilateral meetings between ourselves and the government of

Zimbabwe which threw up technical issues." Then there had been a change of
the Zimbabwean finance minister - Samuel Mumbengegwi replaced Murerwa in
February - "which cost us the momentum".

More than two years ago Mpahlwa said a provisional date had been set to sign
the deal. South Africa had maintained for three years before then that the
only hold-up with signing had been the inability to find a mutually suitable
date with Zimbabwe.

The original draft agreement dealt with promotion and reciprocal protection
of investment between the two countries. It would protect the land rights of
South African farmers who own land in Zimbabwe.

Meanwhile, Mpahlwa acknowledged that his department had been slow to arrange
a benchmarked and developmental pricing system for telecoms to help attract
business process outsourcing companies.

"This is something we identified quite early on. The costs of telecoms is

376
crucial if we are to succeed in attracting investments into the area," said
the minister.

"Unfortunately, we haven't concluded our work," he said, but added that

research by various ministries, including the communications department, was
"quite advanced". He acknowledged that there was a limited "window of
opportunity" to attract the outsourcing market.

Mpahlwa could not give a date when the lottery, suspended in March, would
resume. "We are processing the responses from the National Lotteries Board."

Asked if higher interest and inflation rates would necessitate any

adjustments in scenarios for the accelerated and shared growth initiative,
he said: "We haven't found reason to review any of the projections." Growth
was "deep rooted" because it was not only fuelled by the commodity boom and
global demand. "It is fuelled by a rising level of investment."

Implats moved in without waiting for government action

Johannesburg - Impala Platinum (Implats) yesterday shrugged off trade and

industry minister Mandisi Mpahlwa's admission that the bilateral investment
agreement between South Africa and Zimbabwe was still in limbo.

Eighteen months ago the company was waiting anxiously for the agreement to
be finalised, as it considered expansion in the Zimbabwean context of
runaway inflation and a capricious government. In March 2006 it gave up
waiting and took its chance without government support.

Bob Gilmour, the company's spokesperson, said the mooted pact had been up in
the air for a while and Implats was expanding and operating platinum mines
in Zimbabwe without it. In May 2006 Implats swapped some mineral rights in
Zimbabwe for empowerment credits that allowed it to precede with the
expansion of its Zimbabwe operations. - Justin Brown

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Government blamed for increasing prison deaths

Zimbabwejournalists.com
5th Jul 2007 16:53 GMT
by Trust Matsilele

HARARE - THE Zimbabwe government has come under strong criticism for the
increasing number of deaths in state prisons. The number is pegged close to
eight thousand, according to a human rights defender.

"About 7 800 prisoners have died in country prisons since January this year
and the number is likely to triple by the year end," said Tapera Kapuyi.

"Some reports allege that the deaths are a result of poor sanitation and
living conditions as prisoners are being underfed whilst being overworked."

"Sometimes prisoners go for two days without a descent meal and this is

377
quite embarrassing since the country's constitution upholds human dignity
regardless of a crime they might have committed," continued Kapuya.

A close relative to the late William Nhara, a former principal director in

the government, said that his brother had died after being denied medication
for two consecutive months.

Gilbert Moyo, who was imprisoned for three years for allegedly being
involved in the killing of Cain Nkala, said the issue of deaths was not a
surprise as tens of prison inmates die on daily basis.

"In November 2001 whilst I was in prison about 19 people died on a single
day and reports said they had gone for days without food whilst being
subjected to torture," said Moyo, now exiled in South Africa.

A senior official with the Prison Fellowship of Zimbabwe, speaking on

condition that he would not be named, said that on several occasions they
had urged the Zimbabwean government to revise conditions in which prisoners
were living.

"We have tried to urge the government to revise its treatment on prisoners
since 2004 but there has been no change. We urge all civil societies
advocating for human rights to also participate in shaming evils perpetrated
by the government," he added.

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Zim journalist rots in Botswana prison

Zimbabwejournalists.com
5th Jul 2007 16:47 GMT
By Trust Matsilele

FRANCISTOWN - A former Zimpapers journalist, David Mpofu, has been detained

for five years at Jerald Estate Prison, 20 km outside Francistown, following
the rejection of his asylum application by the Botswana government in 2002.

Mpofu who worked for the government-controlled daily paper, The Herald
before he became an editor of the now defunct Plumtree Post, is refusing to
be returned to Zimbabwe as he fears that his life would be in danger
following alleged death threats from Zimbabwe security agents.

According to his relative, James Mushandu who escaped from the same prison
last March, Mpofu had opted to stay in detention for such a long period
despite poor living conditions as he fears that he might get killed.

"When I was arrested and sent to Jerald Estate Prison in 2004, I met David
there and he told me he has been there since 2002 the time his asylum
application failed and he says he can not go back to Zimbabwe as he fears to
be killed," said Mushandu.

Mashandu said Mpofu's health had been greatly compromised because of harsh
prison conditions.

378
Botswana is known for its inhuman treatment of illegal immigrants and in the
past some illegal immigrants were reported to have been forced to
masturbate by state security officials.

According to Mashandu, Mpofu left Zimbabwe in 2002 after allegedly exposing

some vote rigging in the Plumtree Post.

After publishing the story he received numerous death threats from state
security agents and Zanu PF supporters, forcing him flee to Botswana and
seek political refugee, which he was denied.

Zimbabwe is one of the leading countries whose journalists have fled the
country due to political instability and most being victims of former
Minister of Information and Publicity, Jonathan Moyo's draconian media laws,
especially the Access to Information and Protection of Privacy Act (AIPPA)
and Public Order Security Act (POSA).

Mashandu said the prison, which also houses common criminals, is known for
gruesome activities being perpetrated by prison officials on inmates.

"Shaban Ramadan from Burundi was shot dead by one of prison officials as he
tried to escape from Jerald Estate Prison since he wanted to go and try
to apply for political asylum elsewhere," said Mashandu.

Zimbabwe currently tops the list of countries that have forced the largest
number of journalists into exile.

More than 48 Zimbabwean journalists had escaped persecution by the

government between July 2001 and this month.

This accounts for about 20 percent of the total global number of scribes
forced to flee their countries in the past six years with Botswana becoming
one of the countries with a bigger population of Zimbabweans
who have fled persecution and economic meltdown caused by President Robert
Mugabe's failed policies.

In this country there is voluntary repatriation if one's

asylum applications fails but if one opts to stay in the country he or she
is send to Jerald estate prison for detention until they feel safe to go
back to their own home country.

Efforts to get a comment from Botswana officials were unsuccessful as the

officials refused to answer questions from this reporter.

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What Zimbabweans think of Pius Ncube

New Zimbabwe
--------------------------------------------------------------------------------
ARCHBISHOP Pius Ncube of the Roman Catholic Church's Bulawayo diocese has
said he supports a military invasion of Zimbabwe to "put down" President

379
Robert Mugabe by former military ruler, Britain. Here are some of your
e-mails in response:

--------------------------------------------------------------------------------
Last updated: 07/06/2007 01:10:14
Editor - Every time one is exposed to news from home the situation seems to
be getting more desperate. My initial response has always been that divine
intervention was inevitable.
It has not happened everywhere but where and when it finally comes, it
leaves a very lasting and very welcome change to the defenceless and
voiceless majority. In the basket case of Zimbabwe this intervention is long
overdue. We can not by any shred of the imagination expect that to come from
President Thabo Mbeki's initiative because that is a dead end. The more Zim
burns, the more prosperous our Southern members become thanks to all the
illegal and legal professionals and labourers now resident in that country.

Zimbabweans are hardworking and obedient workers. Who would not want to have
them? And all those investors with an eye for the immense market in Southern
Africa where would they rather be? Mbeki may be anything but a fool. He
knows what is good for his people and Robert Mugabe knows that too. He also
knows that he has no oil so Bush won't be in too much of a hurry to pay
state house a visit. And besides he is also aware that Bush has his hands
full, so his life at the helm of Zimbabwe's destruction is relatively safe.

I know where the Archbishop is coming from. He is far from losing his
marbles unless of course if you are a beneficiary of the status quo. What
the poor man of God is saying is that which ever way you look at it,
bloodshed is inevitable and sacrifices have to be made, are being made and
will continue to be made by Zimbabweans and with a lot of help from very
powerful friends.

Is he still a man of God you may ask? Your guess is as good as mine but
hands up all those that still do stuff they used to five years ago, haven't
been involved in some sinister manoeuvres here and there so as to make ends
meet in the difficult times that we live in? Yeah just as I thought, this
Government has changed our lives for ever and mostly for the worst. Breaking
up families, homes and marriages! We are now scattered all over the globe
missing home like crazy but knowing that we can't go back. I don't have the
energy or space to go into the reasons why, but may God make the Archbishop
have a very long life and as for Bob, well, we need him to account for the
atrocities.
Sam Mapulango

Editor - That is highly irrational thinking. His ideas are archaic. Is he

not seeing what is happening in Iraq? How did the dual occupation of that
country help the people other than bloodbath? What a poor archbishop!!
Pasi Neupenzi
UZ

Editor - Quite simply the man is an embarrassment. Is this best we expect

from our clergy?
S. Mutsatsa

380
Editor - I think it's high time this man just quit the pulpit and got
full-time into politics. There's nothing holy from his little mouth. He's no
longer just a Mugabe critic. Recolonisation is never an option. In a way,
he's admitting that Mugabe can't b defeated, and that's bull***. To hell
with him!
Nashie
South Africa

Editor - Mugabe should go!

Edmore Mupisaunga

Editor - Yes Mugabe has his sins as red as blood, god will judge him for
that but here on earth and in Zimbabwe we will not allow Britain again to
invade us, they have done it before which is the cause of all this that we
are in today. Do not be desperate archbishop Ncube, our god is a god of
justice blessed are those who wait on him.
Virimai Chipere
Lyo
France

Editor - If you have 12 relatives and friends dying due to mismanagement of

the country, why not support an invasion that saves 12 lives for eternity?
There are so many silent voices ready to join the invasion as soon as they
hear the sound of the gun.
WaMutema
J. Matongo

Editor - I respect the Archbishop's bravery in speaking against the

injustice and suffering of the people of Zimbabwe. However, calling for
military invasion from the super powers especially at this time when there
is a mess in Iraq and Afghanistan demeans the mental status of the
Archbishop.

His utterances can only be forgiven in the context of a desperate situation

we are in but an invasion is not an option. He should not take advantage of
Zimbabwe's situation to express his ignorance. It is the likes of him that
strengthens the fallacy of Zanu PF that they are the right custodians of our
country and only they can defend it.
Zimbabweans, let's move away from raising high anyone who opposes Mugabe but
only those whose contributions are constructive and can help in attaining
our second independence (so to speak) much quicker. Sudan and Palestine also
comes to mind. People need not to suffer more!!!
Nixon Mandigo

Editor - The Bishop has lost it. As much as we would like change in Zim, the
issue does not merit a British mandate for a lasting solution because this
is generally resented by a majority of people I've met. Any interference in
Zim should only be instigated and carried out by the UN or under the
auspices of the UN. Any direct involvement by the Brits would certainly
smack of Recolonisation!

Therefore, from that stand point, I don't sanction the Bishops views, no,
not at all!!

381
Goneshell Masendeke

Editor - This Ncube Bishop is very stupid. He should be reminded that

Zimbabwe is not easy to invade, without the people going underground to
start guerrilla warfare. You can't take Zimbabwe again. Kutora munda iye
munhu atombo taster kuti mari iri muvhu? Kunofiwa! Mugabe should be handled
with care, otherwise a lot of people, including your relatives will die. He
is not foolish and the British aren't either.

They know the repercussions of that before they act. In fact they don't
think by heart like Ncube but by brains. Ndariite chikuruku chekunyepera
maBritish richi
puwa mapounds rakanyarara. Makes me feel sorry on how dip sometimes colonial
minds can be damaged. Born in colonial Rhodesia, still hallucinating to
return! Hototi mavende.
Moses Chirwa

Editor - Ncube has a point but the language he uses weakens the point. We
are all in agreement (except for a small minority) that Mugabe has done more
harm than good to a lovely country and he does not have enough time left for
him to make any significant change to a battered economy.

Therefore he should leave politics and the leadership of the country to

those who can make an impact for the benefit of the country economically. If
the truth was to be said Mr Mugabe has outlived his usefulness and is now
more of a liability to the country and surely we are better off without him.

Having said that, I do not agree with Ncube when he advocates for external
force to remove Mugabe. Mr Mugabe must use the few remaining senses and quit
politics quietly. We can not afford to shed blood over an 83 year old
individual. Zimbabwe is a several trillions bigger than him.
Ndlovu, V

Editor - The Archbishop should learn to keep quiet and stop acting as the
official spokesperson of the Zimbabwean masses. His rants do a great
disservice to those fighting for political change and by making such
irresponsible statements he plays into the hands of Zanu PF who have always
claimed that the opposition is a product of Britain. The western media are
giving him too much space to express these misplaced comments and it clearly
exposes their agenda.
Jameel Asani

Editor - I agree things are bad at home but want I don't understand is one
man saying or selling the country because he wants to rule. Who gave him the
mandate to represent us? Zimbabweans, who said he is a good leader! I think
this Priest has lost his mind or has been given too much sugar or tea.

From his statements he is a worse dictator to Mugabe because at least we put

Mugabe into power which he is now clinging onto whilst the Priest wants to
be given the crown through blood shed or the barrel of the gun. Clearly this
man has his own agenda and not the people of Zimbabwe at heart.

I basically think he should bear in mind that Zimbabweans are too educated

382
to fight for an individual. Maybe he should go buy beer for the unemployed
but this only works whilst they are still drunk because when they sober up
they will realise how stupid he is. Change can only come from within Zanu PF
and only if and only if we stop making noise and let the man retire. People
benefiting are making noise encouraging him to stay on.

If a builder is completing a building and has built rubbish, let him finish
and you thank him and as soon as he leaves get a new one to start afresh. If
you confront him, he will destroy the house and start afresh so as to get
his credit at your expense.

Who would smile when told that if you relinquish power your effort is going
to come to nothing after 44 years?
Kusemamuriwo Deigratia

Editor - Firstly l would like to thank you for bringing this informative
paper to people of Zimbabwe and the world. Keep up the good work. Only a
person who has lost his orientation will not agree with the Archbishop. I
know for a fact that some people in Mugabe's Zanu PF party also need him to
bid the people of Zimbabwe a farewell.

In fact we need more people of Ncube's ideology. Mugabe has overstayed and
any mechanism to remove him from power will not only be welcomed by the
people of Zimbabwe but the rest of the world.

Mugabe must go the Saddam route, Snr Kabila, Charles Taylor, or the Mobutu
way. We are in Diaspora because of this man and are experiencing xenophobia
at its height. l appeal to western powers to unseat this man with violent
possible means. He (Mugabe) does not have dignity and he and his top members
must die like dogs. By now every one knows the extent of damage the man and
his cronies have done to the nation.

This weekend l was in Zimbabwe. My cousin, a Maths teacher who graduated in

Cuba a decade ago showed me his payslip. His salary converts to 80 rands a
month. This is not even a house maid's daily salary. In short I would like
to say that Zanu PF's madness must come to an end. I support the Archbishop
that a military intervention is the only solution for the people of
Zimbabwe. If there were contributions towards this, l will also be at
liberty to donate a great potion of my salary for this move. Mugabe must go
and it's not very far before we cross Messina border post to celebrate.
Duduza Nkala

Editor - In my considered opinion, Ncube's comments are absolutely correct

because he is talking about the real history of events as they happen on a
day to day basis. And everyone who lives in Zimbabwe is aware of the
situation which is now unbearable.

Anyone challenging Ncube's assertions is crazy. President Matibili Mugabe's

allegations that western countries are behind the collapse of the country's
economy are pure fiction because there is no "prima facie" evidence to that
effect.

Ncube should not be blamed because he is clearly speaking of the right

383
information from the horse's mouth. I strongly support him intoto!
Dr L M SIBANDA, UK.
SENIOR POLITICAL ACTIVIST AND DEMAGOGUE

Editor - To be honest, I love debates, but what's there to debate here, why
should anybody take this senile man seriously???

Babethi Lishonile
kanti lifihlwe ngamafu
Bayeeeethe!!

Dalaza kaNdlovu
UK

Editor - Pius Ncube is just a modern day Judas Iscariot of our time. I am
happy he knows the people of Zimbabwe are not ready to follow his stupid
ideas. I will not attend the Roman Catholic Church from now onwards. If such
a diabolic person is an archbishop then they worship Satan.
P Togarepi

Editor - I wish to respond to Archbishop Pius Ncube assertion that stronger

nations ought to invade Zimbabwe in order to curb President Mugabe's
excesses. While I agree with Archbishop Pius Ncube that political change
must occur prior to the normalisation and betterment of the current
Zimbabwean situation, it is on the modus operandi that I differ.

Zimbabweans ought to take their destiny into their hands in order to shape
and build a better future for posterity. An invasion will play into Mugabe's
game plan. Having ruined the one-time jewel of Africa and reduced it to a
beggar's bowl, it would make him appear an innocent victim of Western
machinations should the powerful nations invade Zimbabwe.

What Zimbabweans need to do, is to unite and chart a way forward on how they
can remove this tyrant, against all odds. The 2008 harmonised election could
be one such occasion. If people go out and vote in their thousands in the
next year's polls, no amount of rigging and intimidation would avert their
voice. Voter apathy is one big challenge that Zimbabweans must overcome if
meaningful change is to happen.

I rest my case,
Plato
Zimbabwe

Editor - This mad bishop is satanic, he must go die and leave our beloved
land instead of calling for invasion. He is shameless.
Tinashe Makumbe

Editor - Well, who will be shocked by Pius's utterances that he is prepared

to face the "blazing guns"? This is the problem facing Zimbabwe today, that
publicity centres on useless people who in anyway do not resemble the true
thinking of the majority of Zimbabwe.

Journalism also played a role in the present Zimbabwe quagmire.

384
Why would these journalists keep on interviewing a person like Ncube who at
one time contradicted himself by saying "people should pray for Mugabe to
die"? In as much as we want outspoken people in Zimbabwe's situation, we
condemn the demonstration of shallow reasoning capacity by our clergyman
Pius.
Oliver Mtyambizi
Tehran
Iran

Editor - He is doing exactly what the Bible says, that is defending the
righteous from the evil. If the Bible says otherwise to the servants of God
then I will certainly choose not to believe in it. He has sacrificed his
whole for the liberation for all Zimbabweans. He is a true hero. I am not
sure God will allow the good Bishop to watch his flock maimed and murdered
knowing well the cause and not be able to at least voice disapproval. He
obviously does not come from the school of thought that equates Mugabe with
Jesus.
Sagwete Chad

Editor - People are getting carried away by this thing called sovereignty of
nations, if nations start to act against citizens then those nations must be
reshaped by all means necessary. As Pius has suggested I agree with him
fully. Didn't the liberation movements such as ZAPU, ZANU, and ANC etc seek
foreign assistance?

Did they not source scary weapons from white "master" regimes to fight
against the colonialists? What has changed today? Is it because Mugabe is
pitch black? Would Africans prefer to die of squalor rather than enlisting
the help of former "masters"?

To me it is an absurd proposition based on ego and devoid of principles.

Principles see no colour. Britain, America, China, South Africa etc must
"invade" Zimbabwe and put Mugabe down as the God's man has proclaimed.
Thusi Woyane

Editor - Ncube is okay about bringing this killer man down. But what we need
to be careful about is the involvement of the imperialist nations like
Britain and USA. Otherwise we need to bring down the devil and remain with
Zimbabweans in control.

Remember the massacre of Ndebeles during Gukurahundi and you will understand
Pius Ncube better. After all Ncube has all along been counselling and taking
care of victims of Mugabe's torturing madness and he's thus more aware than
some who criticise him from the comfort of the Diaspora.

Ingqwele, Durban Ncube

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385
Archbishop Williams blames Kunonga for blocking food aid

By Lance Guma
05 July 2007

The Archbishop of Canterbury, Rowan Williams blames Harare's Anglican Bishop

Nolbert Kunonga for blocking church attempts to provide food aid. Williams
is reported to have made the remarks at a meeting held at the Royal
Institute for International Affairs in London a month ago. There had been
suggestions the church use its resources to help feed starving Zimbabweans
but Kunonga is alleged to have said, 'No'. Under the scheme truckloads of
food were to be sent across the Beitbridge border from South Africa to feed
vulnerable groups in Matabeleland.

Archbishop Williams says he asked Kunonga 5 weeks before the London meeting
to, not only rediscover his soul in relation to the Mugabe government, 'but
whether he would contemplate an arrangement which we would willingly broker
with the World Food Programme administered through the Anglican church in
Zimbabwe. The answer was 'No!' The archbishop narrated how 4 years ago he
held discussions with South Africa's Archbishop Njongonkulu Ndungane of Cape
Town to map out a way of helping people in Zimbabwe.

Last year Williams held similar talks with Bishop Kunonga but the response
was also negative. He said the message he got was that any intervention
would be viewed as help coming from the British government and not the
church. Pedzisai Ruhanya a Programmes Manager with the Crisis in Zimbabwe
Coalition said the argument did not make sense as the British government was
already heavily involved in sponsoring humanitarian projects in the country.
He accused government of trying to control food aid and use this to buy
votes ahead of elections.

SW Radio Africa Zimbabwe news

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Mbeki to dump Zimbabweans

The Zimbabwean
05-07-07
Plans are underway for mass deportations for
Zimbabweans if the Robert Mugabe regime fail to bow
down to pressure to constitutional amendments and
transitional government mediation initiated by South
Africa President Thabo Mbeki.

The deportations are to start in January to concede

with Zimbabwe election in 2008.Southern Africa leaders
view the talks as the last effort to solve the
Zimbabwe conflict and are washing their hands if the
mediation fails.

386
The Zimbabwean has it on good authority that Botswana
is going to follow suit-deporting Zimbabweans.
"Zimbabweans should brace themselves for mass
deportations which is going to sweep across the two
countries. The countries are fade up with Mugabe and
exiles inactive to force or vote Mugabe out," said the
intelligence officer from National Intelligence Agency
who is privy to the plan.

The deportations code named 'Mugabe take your people'

will mean hundred of thousands of Zimbabweans will be
deported even with proper documents. Pretoria have
been frustrated by Mugabe hardness and playing games
while he has destroyed the economy of the country
forcing millions to flee the country.

Mugabe has made it clear his unwillingness to

negotiate with Movement for Democratic Change. "The
deportations will cause confusion in the Zimbabwean
side. At least hundred coaches will leave for Zimbabwe
every day and twenty thousands will be deported in a
week's time," said a South African intelligent agent.

Mugabe will be caught unaware as 'his people' will be

making unwelcome back to roots to vote in en-masse.

The South African government is also irked that some

Zimbabwean exiles are now behaving like Mugabe
supporters who are benefiting from the regime.

Many Zimbabweans in exiles are working against the

democratic forces while members of Central
Intelligence Organisations who are harassing the
activists have infiltrated many civic society
organizations.

"The people who are coming from Zimbabwe are acting as

Mugabe people and they are trying to prop up Mugabe
regime. People will be deported to go and vote in
their country whether with proper documents," added
the agent.

The South African intelligence has been making a long

surveillance on the character of Zimbabweans in South
Africa. They have noticed that the behaviour and
actions of Zimbabwe are the same as Robert Mugabe
supporters.

"We don't know whether we are dealing with Mugabe

supporters or victims of economic turmoil," said the
agent.

387
Click here or ALT-T to return to TOP
Cricket - KPMG to investigate Zimbabwe's finances

Cricinfo staff
July 4, 2007

KPMG in South Africa have been appointed to carry out the forensic audit of
Zimbabwe Cricket which the ICC insisted on at its annual conference in
London last month. They will be assisted by the KPMG office in Harare.

The ICC studied the findings of a forensic audit undertaken by the Harare
firm of Ruzengwe and Partners and a number of areas of concern arose.

In a leaked document co-written by Malcolm Speed, a number of items were

flagged and he noted that "the auditors and ICC have been misled about these
transactions".

The report concluded: "It is clear that the accounts of ZC have been
deliberately falsified to mask various illegal transactions from the
auditors and the government of Zimbabwe. The accounts were incorrect and at
no stage did ZC draw the attention of the users of these accounts to the
unusual transactions. It may not be possible to rely on the authenticity of
its balance sheet."

However, at the meeting Peter Chingoka, the Zimbabwe Cricket chairman, put
up a robust defence which persuaded the ICC to ask an international firm of
high repute to carry out a second audit. They are due to report back when
the ICC next meets in Dubai in October.

KPMG were appointed by FIFA, football's world governing body, in 2003 to

investigate allegations of financial mismanagement against the Zimbabwe FA.

Even though Speed wrote that the ZC accounts had been "deliberately
falsified" it emerged that the ICC will, nevertheless, pay over millions of
dollars because, it claimed, it had no power to withhold the money.

Many stakeholders inside Zimbabwe who have been ostracised by the

Chingoka-led board have made serious allegations of financial mismanagement
against the executive.

Back to the Top

Back to Index

388
Last Updated: Thursday, 21 June 2007, 14:52 GMT 15:52 UK
E-mail this to a friend Printable version
Country profile: Zimbabwe
The fortunes of Zimbabwe have for
more than two decades been tied to
President Robert Mugabe, the pro-
independence campaigner who
wrested control from a small white
community and became the
country's first black leader.

Now, he presides over a

nationwhose economy is in
tatters, where poverty and unemployment are endemic and
political strife and repression commonplace.

OVERVIEW

OVERVIEW | FACTS | LEADERS | MEDIA

Zimbabwe is home to the Victoria Falls, one of the natural

wonders of the world, the stone enclosures of Great Zimbabwe -
remnants of a past empire - and to herds of elephant and other
game roaming vast stretches of wilderness.

For years it was a major AT-A-GLANCE

tobacco producer and a
potential bread basket for
surrounding countries.

But the forced seizure of

almost all white-owned
commercial farms, with the
stated aim of benefiting
landless black Zimbabweans, Politics: President Robert
led to sharp falls in productionMugabe, in office since 1980,
and precipitated the collapse ofhas been accused of resorting
the agriculture-based economy. to heavy-handed methods to
The country has endured remain in power
rampant inflation and critical Economy: Economy in crisis,
food and fuel shortages. with rampant inflation, "de-
industrialisation" and shortages
Many Zimbabweans survive on of food and fuel. Agricultural
grain handouts. Others have production is shrinking
voted with their feet; hundreds International: Faces
of thousands of Zimbabweans, increasing international
including much-needed isolation over human rights
professionals, have emigrated. abuses and restrictions on
freedom
Aid agencies and critics partly
blame food shortages on the Timeline

389
land reform programme. The government blames a long-running
drought, and Mr Mugabe has accused Britain and its allies of
sabotaging the economy in revenge for the redistribution
programme.

The government's urban slum demolition drive in 2005 drew

more international condemnation. The president said it was an
effort to boost law and order and development; critics accused
him of destroying slums housing opposition supporters.

Either way, the razing of "illegal structures" left some 700,000

people without jobs or homes, according to UN estimates.

The former Rhodesia has a history of conflict, with white

settlers dispossessing the resident population, guerrilla armies
forcing the white government to submit to elections, and the
post-independence leadership committing atrocities in southern
areas where it lacked the support of the Matabele people.

Zimbabwe has had a rocky relationship with the Commonwealth

- it was suspended after President Mugabe's controversial re-
election in 2002 and later announced that it was pulling out for
good.

FACTS

OVERVIEW | FACTS | LEADERS | MEDIA

• Full name: Republic of Zimbabwe

• Population: 12.9 million (UN, 2005)
• Capital: Harare
• Area: 390,759 sq km (150,873 sq miles)
• Major language: English (official), Shona, Sindebele
• Major religions: Christianity, indigenous beliefs
• Life expectancy: 37 years (men), 37 years (women)
(UN)
• Monetary unit: 1 Zimbabwe dollar = 100 cents
• Main exports: Tobacco, cotton, agricultural products,
gold, minerals
• GNI per capita: US $340 (World Bank, 2006)
• Internet domain: .zw
• International dialling code: +263

LEADERS

OVERVIEW | FACTS | LEADERS | MEDIA

President: Robert Mugabe

390
Robert Mugabe played a key role in ending white rule in
Rhodesia and he and his Zanu-PF party have dominated
Zimbabwe's politics since independence in 1980.

The main challenge to the

octogenarian leader's authority
has come from the opposition
Movement for Democratic
Change (MDC). The MDC says
its members have been killed,
tortured and harassed by Zanu-
PF supporters. The president
has accused the party of being a President Mugabe has defended the seizures of
white-owned farms
tool of Western powers.

Mr Mugabe was declared the winner of the 2002 presidential

elections, considered seriously flawed by the opposition and
foreign observers. He received a boost in 2005 when Zanu-PF
won more than two-thirds of the votes in parliamentary
elections, said by the MDC to be fraudulent.

The size of the win enabled the president to change the

constitution, paving the way for the creation of an upper house
of parliament, the Senate.

Ideologically, Mr Mugabe belongs to the African liberationist

tradition of the 1960s - strong and ruthless leadership, anti-
Western, suspicious of capitalism and deeply intolerant of
dissent and opposition.

His economic policies are widely seen as being geared to short-

term political expediency and the maintenance of power for
himself. Mr Mugabe has defended his land reform programme,
saying the issue is the "core social question of our time".

Foreign minister: Simbarashe Mumbengegwi

Finance minister: Samuel Mumbengegwi
MEDIA

OVERVIEW | FACTS | LEADERS | MEDIA

All broadcasters transmitting from Zimbabwean soil, as well as

the main newspapers, are state-run and toe the government line.

391
The press is dominated by two
pro-government dailies, the
Harare-based Herald and the
Bulawayo-based Chronicle,
both tightly controlled by the
Information Ministry.

Private publications, which are

relatively vigorous in their Newspapers operate under restrictive media laws
criticism of the government, have come under severe pressure.
A leading private daily, the Daily News, was banned after a
legal battle.

The remaining independent press is largely confined to two

weeklies, the Standard and the Zimbabwe Independent. Another
weekly, The Zimbabwean, is produced in London and
distributed in Zimbabwe as an international publication.

Because of rampant inflation, cover prices have spiralled and are

beyond the reach of many Zimbabweans. Publishers have been
hit by escalating printing and newsprint costs.

Draconian laws

A range of draconian laws and institutions, along with prison

sentences for "publishing false news", are used to clamp down
on critical comment. Journalists who fail to register with a
government body risk imprisonment.

State-run Zimbabwe Broadcasting Corporation (ZBC) operates

the country's only TV and radio stations. ZBC formerly had two
TV channels; its second network was leased to private station
Joy TV which closed in 2002. Some of its programmes were
said to have ruffled government feathers.

Radio is the main source of Surveillance, threats,

information for many
Zimbabweans. Although there
are no private stations, the
country is targeted by overseas-
based operations.
imprisonment, censorship,
blackmail, abuse of power
and denial of justice are all
brought to bear to keep firm
control over the news

The Voice of the People, set up Reporters Without Borders,

by former ZBC staff with 2007
funding from the Soros Foundation and a Dutch organisation,
operates using a leased shortwave transmitter in Madagascar.

Another station, the UK-based SW Radio Africa, aims to give

listeners in Zimbabwe "unbiased information".

From the US, the government-funded Voice of America (VOA)

operates Studio 7, a twice-daily service for listeners in
Zimbabwe which aims to be a source of "objective and balanced

392
news".

Radio broadcasts by foreign stations deemed hostile to the

government have been jammed.

The press

The Herald - government-owned daily

The Chronicle - Bulawayo-based, government-owned daily
The Financial Gazette - private, business weekly
The Standard - private, weekly
Zimbabwe Independent - private weekly
The Daily Mirror - ceased publication in March 2007

Television

Zimbabwe Broadcasting Corporation (ZBC) - state-run,

operates ZTV1

Radio

Zimbabwe Broadcasting Corporation (ZBC) - state-run,

operates National FM, Power FM, Radio Zimbabwe and S-FM
SW Radio Africa - studio in London, broadcasts via
mediumwave (AM) transmitter based outside Zimbabwe
Voice of the People - studio in Harare, broadcasts to
Zimbabwe from hired shortwave transmitter on Madagascar
Studio 7 - based in Washington DC, operated by VOA

News agency/internet

New Ziana - state-run

ZimOnline - private, South Africa-based
Zimdaily.com - private, UK-based
The Zimbabwe Times - private, US-based

393
APPENDIX 6.5: INTERNATIONAL ECONOMICS

WTO, TRADING BLOCS, MULTILATERAL TRADE, BILATERAL FTAs,

FREE TRADE AGREEMENTS (FTAs)

394
SECTION 4: INTERNATIONAL ECONOMICS

PROJECT ON WTO, TRADING BLOCS, BILATERAL FTAs, FREE TRADE

AGREEMENTS.

(INFORMATION AVAILABLE/CURRENT AS OF AUGUST 2007)

Contents
WTO: SUMMARY

WTO: THE DOHA DEVELOPMENT ROUND-SUMMARY

NAFTA

EU

ASEAN

MERCOSUR

APEC

BILATERAL FTAs-SUMMARY # 1

BILATERAL FTAs-SUMMARY # 2

FREE TRADE AGREEMENTS

STATISTICAL TABLES FOR ABOVE

World Trade Organization‐Summary

WTO is an organization for liberalizing trade. It’s a forum for governments to

negotiate trade agreements. It’s a place for them to settle trade disputes. It operates a
system of trade rules.

The WTO is a place where member governments go, to try to sort out the trade
problems they face with each other. The first step is to talk. The WTO was born out of
negotiations, and everything the WTO does is the result of negotiations. The bulk of
the WTO's current work comes from the 1986-94 negotiations called the Uruguay
Round and earlier negotiations under the General Agreement on Tariffs and Trade
(GATT). The WTO is currently the host to new negotiations, under the “Doha
Development Agenda” launched in 2001.

Where countries have faced trade barriers and wanted them lowered, the negotiations
have helped to liberalize trade. But the WTO is not just about liberalizing trade, and in
some circumstances its rules support maintaining trade barriers — for example to
protect consumers or prevent the spread of disease.

The WTO began life on 1 January 1995, but its trading system is half a century older.
Since 1948, the General Agreement on Tariffs and Trade (GATT) had provided the
rules for the system.

The last and largest GATT round, was the Uruguay Round which lasted from 1986 to
1994 and led to the WTO’s creation. Whereas GATT had mainly dealt with trade in
goods, the WTO and its agreements now cover trade in services, and in traded
inventions, creations and designs (intellectual property).

The WTO Committee on Trade and Development has a wide-ranging mandate.

Among the broad areas of topics it has tackled as priorities are: how provisions
favoring developing countries are being implemented, guidelines for technical
cooperation, increased participation of developing countries in the trading system, and
the position of least-developed countries.

Member-countries also have to inform the WTO about special programmers involving
trade concessions for products from developing countries, and about regional
arrangements among developing countries. The Trade and Development Committee
handle notifications of:

Generalized System of Preferences programmers (in which developed countries

lower their trade barriers preferentially for products from developing countries)

preferential arrangements among developing countries such as MERCOSUR (the

Southern Common Market in Latin America), the Common Market for Eastern and
Southern Africa (COMESA), and the ASEAN Free Trade Area (AFTA)

The importance countries attach to the process is reflected in the seniority of the
Trade Policy Review Body — it is the WTO General Council in another guise.
The objectives are:

To increase the transparency and understanding of countries’ trade policies and

practices, through regular monitoring

To improve the quality of public and intergovernmental debate on the issues

To enable a multilateral assessment of the effects of policies on the world trading

system.

The reviews focus on members’ own trade policies and practices. But they also take
into account the countries’ wider economic and developmental needs, their policies
and objectives, and the external economic environment that they face. These “peer
reviews” by other WTO members encourage governments to follow more closely the
WTO rules and disciplines and to fulfill their commitments. In practice the reviews
have two broad results: they enable outsiders to understand a country’s policies and
circumstances, and they provide feedback to the reviewed country on its performance
in the system.

Over a period of time, all WTO members are to come under scrutiny. The frequency
of the reviews depends on the country’s size:

The four biggest traders — the European Union, the United States, Japan and
Canada (the “Quad”) — are examined approximately once every two years.

The next 16 countries (in terms of their share of world trade) are reviewed every
four years.

The remaining countries are reviewed every six years, with the possibility of a
longer interim period for the least-developed countries.

For each review, two documents are prepared: a policy statement by the government
under review, and a detailed report written independently by the WTO Secretariat.
These two reports, together with the proceedings of the Trade Policy Review Body’s
meetings are published shortly afterwards.

The trading system should be

Without discrimination — a country should not discriminate between its trading
partners (giving them equally “most-favored-nation” or MFN status); and it should
not discriminate between its own and foreign products, services or nationals (giving
them “national treatment”);

Freer — barriers coming down through negotiation;

Predictable — foreign companies, investors and governments should be confident

that trade barriers (including tariffs and non-tariff barriers) should not be raised
arbitrarily; tariff rates and market-opening commitments are “bound” in the WTO;

More competitive — discouraging “unfair” practices such as export subsidies and

dumping products at below cost to gain market share;
 More beneficial for less developed countries — giving they more time to adjust,
greater flexibility, and special privileges.

The ten benefits

1. The system helps promote peace

Peace is partly an outcome of two of the most fundamental principles of the trading
system: helping trade to flow smoothly and providing countries with a constructive
and fair outlet for dealing with disputes over trade issues. The short-sighted
protectionist view is that defending particular sectors against imports is beneficial.
But that view ignores how other countries are going to respond. The longer term
reality is that one protectionist step by one country can easily lead to retaliation from
other countries, a loss of confidence in freer trade, and a slide into serious economic
trouble for all — including the sectors that were originally protected. Everyone loses.

2. Disputes are handled constructively

Around 300 disputes have been brought to the WTO since it was set up in 1995.
Without a means of tackling these constructively and harmoniously, some could have
led to more serious political conflict. The fact that the disputes are based on WTO
agreements means that there is a clear basis for judging who is right or wrong. Once
the judgment has been made, the agreements provide the focus for any further actions
that need to be taken.

3. Rules make life easier for all

The principle of non-discrimination built into the WTO agreements avoids that
complexity. The fact that there is a single set of rules applying to all members greatly
simplifies the entire trade regime.

And these agreed rules give governments a clearer view of which trade policies are
acceptable

4. Freer trade cuts the costs of living

Protectionism is expensive: it raises prices. The WTO’s global system lowers trade
barriers through negotiation and applies the principle of non-discrimination. The
result is reduced costs of production (because imports used in production are cheaper)
and reduced prices of finished goods and services, and ultimately a lower cost of
living.
5. It provides more choice of products and qualities

This expands the range of final products and services that are made by domestic
producers, and it increases the range of technologies they can use. When mobile
telephone equipment became available, services sprang up even in the countries that
did not make the equipment, for example.

Sometimes, the success of an imported product or service on the domestic market can
also encourage new local producers to compete, increasing the choice of brands
available to consumers as well as increasing the range of goods and services produced
locally.

6. Trade raises incomes

In Europe, the EU Commission calculates that over 1989–93 EU incomes increased

by 1.1–1.5% more than they would have done without the Single Market.

So trade clearly boosts incomes.

7. Trade stimulates economic growth

This is a difficult subject to tackle in simple terms. There is strong evidence that trade
boosts economic growth, and that economic growth means more jobs. It is also true
that some jobs are lost even when trade is expanding. But a reliable analysis of this
poses at least two problems.

First, there are other factors at play. For example, technological advance has also had
a strong impact on employment and productivity, benefiting some jobs, hurting
others.

Second, while trade clearly boosts national income (and prosperity), this is not always
translated into new employment for workers who lost their jobs as a result of
competition from imports.

8. The basic principles make life more efficient

Trade allows a division of labor between countries. It allows resources to be used

more appropriately and effectively for production. But the WTO’s trading system
offers more than that. It helps to increase efficiency and to cut costs even more
because of important principles enshrined in the system.
9. Governments are shielded from lobbying

One of the lessons of the protectionism that dominated the early decades of the 20th
Century was the damage that can be caused if narrow sectoral interests gain an
unbalanced share of political influence. The result was increasingly restrictive policy
which turned into a trade war that no one won and everyone lost.

10. The system encourages good government

The rules include commitments not to backslide into unwise policies. Protectionism in
general is unwise because of the damage it causes domestically and internationally, as
we have already seen.

Particular types of trade barriers cause additional damage because they provide
opportunities for corruption and other forms of bad government.
WTO: The Doha Development Round-Summary

Introduction:

The Doha Development Round of World Trade Organization negotiations aims to

lower trade barriers around the world, permitting free trade between countries of
varying prosperity.

The Doha round, also known as the Doha Development Agenda (DDA) of WTO
negotiations began in November 2001. This round was to have begun at the WTO
Ministerial Conference of 1999 in Seattle. All countries were committed to
negotiations opening agricultural and manufacturing markets, as well as services
negotiations and expanded intellectual property regulation.

Aims and Objectives:

• To bring down tariff barriers, especially on products that matter to developing

countries, for example, agriculture, intensive manufacturing, and textile.
• To consider additional measures to improve market access for the exports.
• To establish a fair and market-oriented trading system through a programme of
fundamental reform.
• To combat global terrorism by promoting economic opportunity in the third
world through trade breaks.

Countries Where Talks Held:

Cancun, Geneva, Paris and Hong Kong

Key Statistics
There is an average of a 12% cut across the board for agricultural products, which is
having a devastating effect on developing countries, especially on Africa, which relies
heavily on agriculture.

Cancún-2003
The 2003 Cancún talks — intended to forge concrete agreement on the Doha Round
objectives — collapsed after four days during which the members could not agree on
farm subsidies and access to markets. Negotiations focused upon four key areas:
agriculture, industrial goods, trade in services, and updated customs codes. The
collapse seemed like a victory for the developing countries. But unlike Seattle, which
prevented the commencement of the second round of negotiations, Cancun resulted in
continued negotiating.
Geneva-2004
The August 2004 Geneva talks achieved a framework agreement on opening global
trade. The U.S., EU, Japan and Brazil agreed to end export subsidies, reduce
agricultural subsidies and lower tariff barriers. Developing nations agreed to reduce
tariffs on manufactured goods, but gain the right to specially protect key industries.
The agreement also provides for simplified customs, and stricter rules for rural
development aid.

Paris-2005
Paris talks were hanging over a few issues: France protested moves to cut subsidies to
farmers, while the U.S., Australia, the EU, Brazil and India failed to agree on issues
relating to chicken, beef and rice. Most of the sticking points were small technical
issues, making trade negotiators fear that agreement on large politically risky issues
will be substantially harder.

Hong Kong-2005
The Sixth WTO Ministerial Conference took place in Hong Kong, December 13 to
18, 2005. The final declaration from the talks, which resolved several issues that have
stood in the way of a global trade agreement, also requires industrialized countries to
open their markets to goods from the world's poorest nations, a goal of the United
Nations for many years.

Geneva-2006
The July 2006 talks in Geneva failed to reach an agreement about reducing farming
subsidies and lowering import taxes, and continuation of the negotiations will take
months to resume. A successful outcome of the Doha round has become increasingly
unlikely, because the broad trade authority granted under the Trade Act of 2002 to
U.S. president George W. Bush expires in 2007. Any trade pact will then have to be
approved by the U.S. Congress with the possibility of amendments, which creates an
additional burden on the U.S. negotiators and decreases the willingness of other
countries to participate.

Key Issues:
The key players in the negotiations, known as the G6, are Brazil and India
(representing the G20 group), the EU, the US, Australia (representing the Cairns
group of agricultural exporters) and Japan (representing the G10 group of net
agricultural importers). The major sticking points in their discussions are:

Agricultural market access: The US currently has much lower agricultural tariffs than
the EU or advanced developing economies. It therefore wanted a 90% reduction of
highest farm tariffs and an average tariff cut of 66% for developed countries. While
the EU agreed to raise its initial offer (of a 39% average tariff cut) to close to the G20
proposal of 54%, this was deemed insufficient by the US. The US also accused the
EU of using sensitive products to counterbalance the level of new market access it
was offering, because the EU wished to maintain higher protection levels for 8% of its
farm products. The EU insists that it is already very open to agricultural exports from
the developing world, providing tariff and quota free access to the 50 LDCs through
its Everything But Arms system and absorbing more farm goods from LDCs than the
rest of the developed world combined.

Agricultural subsidies: Although agriculture makes up only 8% of world trade, it

represents the main income source for about 2.5 billion people, mainly in developing
countries. However, farmers from poor countries are unable to compete with vastly
subsidised exports from the EU, US and Japan. The EU agreed to slash its overall
trade-distorting subsidies (OTDS) by 75%, as the G20 group of developing countries
were requesting. This would have seen EU OTDS levels reduced from €58.1 billion in
actual spending in 2004 to a future cap of around €28 billion. The US proposal to
reduce its OTDS by 53% would have cut its WTO-permitted spending limit from
$48.2 billion to roughly $22.7 billion, but the EU and G20 complained that this could
actually lead to an increase in US farm subsidies as the latter actually only paid out
$19.7 billion in such payments in 2005. They demanded minimum cuts of 60% and
75% respectively, but the US refused to give in.

Anti-dumping: The United States will be under serious pressure at Doha to revise its
rules on "dumping" - which allows the US government to put up tariff barriers
unilaterally if it believes that another country is selling its goods at below the price of
production.
Many countries, including Japan, Brazil and the EU, believe that the US has long been
abusing this loophole to protect its domestic industries, especially steel, from foreign
competition.
But any attempt to change US domestic laws on dumping will face opposition from
trade unionists and politicians, and accusations that the World Trade Organization has
impinged on US sovereignty.
If the US agrees to put anti-dumping on the table at Doha, it will be a significant
concession that would show how keen it is to reach an overall agreement.

Major Successes:

Doha round has already led to access to cheaper antiretroviral drugs; a deadline for
the end of the worst of the European Union's agricultural subsidies; a U.S.
commitment to end cotton-export subsidies; and almost unfettered access for the
poorest of poor countries exporting into the markets of developed countries. None of
these gains have been sufficiently quick or total, but they are a start

Major Failures:

• The alleged link between global poverty and global terrorism, for example, has
never withstood serious scrutiny.
• Trade initiatives around the world generally should be focusing not on third
world development at all, but on the biggest threat facing the world trading
system and the global economy underpinning it: the enormous and
unprecedented imbalances in worldwide trade and related investment
flows. At the heart of these imbalances lies America’s current account deficit,
which at $792 billion in 2005 not only comprised an alarming 6.36 percent of
the U.S. economy, but also nearly two-thirds of the world’s total current
account deficits last year.
TRADING BLOC: NORTH AMERICAN FREE TRADE
ASSOCIATION (NAFTA)-Summary

Overview of NAFTA
In January 1994, Canada, the United States, Canada and Mexico launched the North
American Free Trade Agreement (NAFTA) and formed the world's largest free trade
area. The Agreement has brought economic growth and rising standards of living for
people in all three countries. In addition, NAFTA has established a strong foundation
for future growth and has set a valuable example of the benefits of trade liberalization.

NAFTA: A Foundation for Canada’s Future Prosperity

The North American Free Trade Agreement (NAFTA) has generated economic
growth and rising standards of living for the people of all three member countries
since 1994. By strengthening the rules and procedures governing trade and investment
throughout the continent, NAFTA has proved to be a solid foundation for building
Canada’s future prosperity.

Canada's merchandise trade with its NAFTA partners has increased 122% since 1993,
reaching $598.7 billion in 2005. Canadian merchandise exports to the United States
grew at a compounded annual rate of 6.0% between 1994 and 2005. With regard to
Mexico, bilateral trade in 2005 reached $18 billion, a 296% increase from pre-
NAFTA levels (1993). Our NAFTA partners account for 84.7% of Canada's total
merchandise exports.

Trade in services has also increased under NAFTA. Canada's trade in services with
the United States and Mexico grew at an average annual compounded rate of 5.4% to
reach $82.7 billion in 2004, up from $46.4 billion in 1994. Our trade in services with
the United States reached $81.2 billion in 2005, up from $42.3 billion in 1993. Two-
way trade in services between Canada and Mexico has grown at an annual
compounded rate of 9.0%, to reach over $1.6 billion in 2004. Approximately 57% of
Canada's services exports go to our NAFTA partners.

NAFTA has also had a positive impact on investment. Since 1994, the annual stock of
foreign direct investment in Canada has averaged $279.1 billion. In 2005, total FDI in
Canada reached $415.6 billion, of which more than 64% came from our NAFTA
partners. FDI in Canada from the United States increased to $266.5 billion in 2005.
Canadian direct investment in its NAFTA partners also grew, reaching $213.7 billion
in the United States and $3.14 billion in Mexico.

In turn, the enhanced economic activity and production in the region have contributed
to the creation of more and better paying jobs for Canadians. Close to 3.1 million net
new jobs have been created in Canada since 1994, representing an increase of 126.6%
over pre-NAFTA employment levels.

For Canadians, it is important that trade and investment liberalization proceed hand in
hand with efforts to protect the environment and improve working conditions. Under
NAFTA, our three countries have been able to introduce the successful approach of
parallel environmental and labour cooperation agreements.

The economic collaboration promoted by NAFTA has spurred better environmental

performance across the region. Through the North American Agreement on
Environmental Cooperation, the three partners agreed to promote the effective
enforcement of environmental laws. Through the North American Agreement on
Labour Cooperation, the three partners agreed to work together to protect, enhance
and enforce basic workers’ rights.

Canada and its NAFTA partners will continue to work together to reduce the costs of
trading within the region and to improve the competitiveness of North America.
Trading Bloc: European Union: Summary
The EU is supranational and intergovernmental union of twenty-seven states and a

political body

Commencement

It was established in 1992 by the Treaty on European Union (The Maastricht Treaty),
and is the de facto successor to the six-member European Economic Community
founded in 1957. Since then new accessions have raised its number of member states,
and competences have expanded. The EU is the current stage of a continuing open-
ended process of European integration.

Key Objectives

1. To help consolidate the peace process and foster inter-Entity co-operation.

2. To help ethnic reconciliation and the return of refugees and displaced persons to

their homes of origin.

3. To establish functioning institutions and a viable democracy based on the rule of

law and respect for human rights.

4. To lay the foundations for sustainable economic development and growth.

5. To bring Bosnia and Herzegovina closer to EU standards and principles.

Key Statistics:

The EU had a surplus in trade in goods of more than 90 billion Euro with the USA in
2006.

Taking goods and services together, the EU and the USA account for the largest
bilateral trade relationship in the world. The significant amount of bilateral trade and
investment illustrates a high degree of interdependence of the two economies.

Germany and the United Kingdom largest EU trade partners of the USA.

Unusual Features:

This is the only union that is applies to an entire continent and excludes all other

countries. This has benefited the less developed countries in Europe, Ireland for

example.
Major Successes:

For instance, UK firms currently spend about £1.5 billion a year buying and selling
foreign currencies to do business in the EU.
With the EMU this is eliminated, so increasing profitability of EU firms.

Many firms become wary when investing in other countries because of the uncertainty
caused by the fluctuating currencies in the EU. Investment would rise in the EMU
area as the currency is universal within the area; therefore the anxiety that was
previously apparent is there no more.

If we look out in the world today we can see strong currencies such as the Japanese
Yen and The American $. America and Japan both have strong economies and have
millions of inhabitants. A newly found monetary union and a new currency in Europe
could be a rival to the "BIG TWO".

There is also a political agenda to European bank (the European System of Central
Banks -ESCB), the complete removal of national control over monetary policy and
the partial removal of control over fiscal policy. Individual nation states will lose
sovereignty (i.e. the ability to control their own affairs). It will be a considerable step
down the road towards political union.

Risk of inflation reduced.

Major Failures:

Some economists argue that the trade and cost advantages of EMU have been grossly
over estimated. There is little to be gained from moving from the present system
which has some stability built into it, to the rigidities which EMU would bring.
Members:

Year History of European Union membership Total

1957 Belgium Italy 6

France Luxembourg
West Germany Netherlands

1973 Denmark United Kingdom 9

Republic of Ireland

1981 Greece 10

1986 Portugal Spain 12

1995 Austria Sweden 15

Finland

2004 Cyprus Lithuania 25

Czech Republic Malta
Estonia Poland
Hungary Slovakia
Latvia Slovenia

2007 Bulgaria Romania 27

Monetary Policy:

The only countries in the European Union that still have control over their monetary
policies are Poland and the UK as they did not adopt the Euro.
TRADING BLOC: Association of Southeast Asian Nations (ASEAN)-
Summary

ASEAN was preceded by an organization called the Association of Southeast Asia

(ASA), an alliance consisting of the Philippines, Malaysia and Thailand that was
formed in 1961.

The Association of South East Asian Nations (ASEAN) encompasses 10 South East
Asian countries. Its key position in the Asia-Pacific region, its dedication to peace and
stability in the region and its important economic weight has made ASEAN an
essential partner for the European Union in Asia. ASEAN was established on August
8, 1967 in Bangkok, Thailand with the signature of the Bangkok declaration by the
five original member nations (Indonesia, Malaysia, Philippines, Singapore, and
Thailand). In 1984, Brunei Darussalam was admitted as the sixth member. In 1995,
Vietnam also joined ASEAN. Lao People's Democratic Republic and
Burma/Myanmar became members in 1997. Cambodia joined in 1999. The Member
countries that make up ASEAN have a combined GDP of 656 billion € (2002), but
there are large economic disparities between the ASEAN members. With a population
of some 503 million people, they make up one of the largest regional markets in the
world. Its aims include the acceleration of economic growth, social progress, cultural
development among its members, and the promotion of regional peace. In 2005, the
bloc had a combined GDP of about USD$ 8884 billion-2.755 trillion growing at an
average of around 4 per cent per annum.

A significant development for ASEAN took place at the Bali Summit of October
2003: the ASEAN leaders projected the creation of an ASEAN Economic, Security
and a Socio-cultural community. The EU greatly supports this development,
considering it’s first hand experience of the benefits of closer regional integration.
The EU is a longstanding dialogue Partner of ASEAN. Co-operation between the EU
and ASEAN is based on a Co-operation Agreement (1980) between the EC and
member countries of ASEAN: Brunei, Indonesia, Malaysia, Philippines, Singapore,
Thailand and Vietnam. Protocols for the accession of Laos and Cambodia to the
Agreement were signed in July 2000 but the EU has indicated that it cannot agree to
negotiate an extension of this agreement to Burma/Myanmar as long as the situation
as regards democracy and human rights in that country does not improve significantly.
Burma/Myanmar, therefore cannot participate in EC-ASEAN co-operation actions. In
September 2001, the European Commission’s presented its Communication "Europe
and Asia: A Strategic Framework for Enhanced Partnerships", which identified
ASEAN as a key economic and political partner of the EC and emphasised its
importance as a locomotive for overall relations between Europe and Asia. The
Commission Communication ‘A New Partnership with South East Asia’, presented in
July 2003, reaffirms the importance of the EC-ASEAN partnership.

In 2006, ASEAN was given observer at the United Nation General Assembly. As a
response, the organization awarded the status of dialogue partner to the United
Nation. The ASEAN Free Trade Area (AFTA) is an agreement by the member nations
of ASEAN concerning local manufacturing in all ASEAN countries. The AFTA
agreement was signed on January 28, 1992 in Singapore. When the AFTA agreement
was originally signed, ASEAN had six members, namely, Brunei, Indonesia,
Malaysia, the Philippines, Singapore and Thailand. Vietnam joined in 1995, Laos and
Myanmar in 1997, and Cambodia in 199. The latecomers have not fully met the
AFTA’s as they were required to sign the agreement upon entry into ASEAN, and
were given longer time frames in which to meet the AFTA’s tariff reduction
obligations. Western countries have criticized ASEAN for being too soft in its
approach to promoting human rights and democracy in the junta –led Myanmar. This
has caused concern as the European Union, a potential trade partener, has refused to
conduct free trade negotiations at a regional level for these political reasons.
International observers view it as talk shop which implies that the organization is big
on words but small on action. During the 12th ASEAN summit in Cebu, several
militant groups staged anti-globalization and anti –Arroyo rallies. According to the
militants, the agenda of economic integration would negatively affect industries in the
Philippines and would cause thousands of Filipinos to lose their jobs. They also
viewed the organizations as imperialistic that threaten the country’s sovereignty. A
human rights lawyer from New Zealand was also present to the protest about the
human rights situation in the region in general.

In conclusion, ASEAN has become one of the key driving forces in the Asian
economy. Global companies are looking to ASEAN in many cases to engage with
China, India and Indonesia. It present a new enabling environment for international
alliances and business partnering, allowing even the risk averse investors to
increasingly share in the opportunities and rewards presented by a diverse and in some
cases a risky choice.
Trading Bloc: Mercosur-Summary
Commencement

On March 26th, 1991 Argentina, Brazil, Uruguay and Paraguay signed the Treaty of
Asunción, establishing "Mercosur” that took effect on December 31, 1994.

The purpose of the agreement was to set up a common market and eliminate trade
barriers among the signatory parties. The Mercosur trade bloc's purpose, as stated in
the 1991 Treaty of Asunción, is to allow for free trade between member states, with
the ultimate goal of full South American economic integration.

Members and Statistics

Mercosur's full members include Argentina, Brazil, Paraguay, Uruguay, and

Venezuela. Brazil is the region's largest economy with a GDP of nearly $800 billion.
The population of Mercosur countries totals more than 250 million people and
members have a collective output of $1.1 trillion, accounting for over 75 percent of
South America's GDP (PDF). Mercosur’s associate members include Chile, Bolivia,
Colombia, Ecuador, and Peru each of which do not enjoy full voting rights or
complete access to markets of Mercosur's full members. Of these countries, Bolivia is
being considered for full membership within the next six months.

Key Objectives

Mercosur primary interest has been eliminating obstacles to internal trade, like high
tariffs, income inequalities, or conflicting technical requirements for bringing
products to market.

Key Issues

Mercosur has been attempting to create a trade agreement with the European Union
“since its creation,” says Wheeler, of the Council on Hemispheric Affairs.

The deal appears to have stagnated, however. The problem is that with “so much
internal division and internal disputes, [Mercosur] has lost some of its credibility
abroad,” says Wheeler.

Despite Mercosur's prominence and potential as an economic entity, some speculate

that its agenda is becoming increasingly politicized, especially since the incorporation
of Venezuela as a full member in 2006.There are exemptions being placed for Bolivia
to join the trade union. This however would anger already disenchanted Uruguay and
Paraguay, Mercosur's smallest full members, who have not been allowed similar
exemptions. “Can Mercosur keep a straight face in exceptions to the common external
tariff, but say it's not OK for Uruguay and Paraguay to negotiate a bilateral free trade
agreement with the United States, since that would undermine the common tariff?,”
asks Agustin Cornejo of the Institute for International Economics in the Wall Street
Journal. Uruguay, also angry over an ongoing dispute with Argentina over a paper
pulp mill on their shared border, has gone so far as to sign a Trade and Investment
Framework Agreement (TIFA) with the United States. CAN and Mercosur leaders
have discussed the possibility of allying to form a South American Community of
Nations, modeled on the European Union, but those talks have not progressed quickly.

Unusual Features

Because Mercosur's charter does not allow its member nations to have FTAs with
non-member nations, Mercosur members are not permitted to join the Andean
Community of Nations (CAN), a smaller trade bloc which includes Bolivia,
Colombia, Ecuador, and Peru. When Venezuela joined Mercosur, it was required to
resign from CAN, as Bolivia will have to do if it is admitted this year.

Major Successes and Failures

Mercosur played a key role in the failure of the FTAA (Free Trade Agreement of the
Americas). Mercosur has been attempting to create a trade agreement with the
European Union “since its creation,” says Wheeler, of the Council on Hemispheric
Affairs. The deal appears to have stagnated, however. The problem is that with “so
much internal division and internal disputes, Mercosur has lost some of its credibility
abroad,” says Wheeler.
APEC
APEC's 21 Member Economies
Australia; Brunei Darussalam; Canada; Chile; People's Republic of China; Hong
Kong, China; Indonesia; Japan; Republic of Korea; Malaysia; Mexico; New Zealand;
Papua New Guinea; Peru; The Republic of the Philippines; The Russian Federation;
Singapore; Chinese Taipei; Thailand; United States of America; Viet Nam.

About APEC
APEC is the premier forum for facilitating economic growth, cooperation, trade and
investment in the Asia-Pacific region.

APEC is the only inter governmental grouping in the world operating on the basis of
non-binding commitments, open dialogue and equal respect for the views of all
participants. Unlike the WTO or other multilateral trade bodies, APEC has no treaty
obligations required of its participants. Decisions made within APEC are reached by
consensus and commitments are undertaken on a voluntary basis.

APEC has 21 Member Economies which account for more than a third of the world's
population (2.6 billion people), over 50% of world GDP (US$ 19, 254 billion) and in
excess of 41% of world trade. APEC also proudly represents the most economically
dynamic region in the world having generated nearly 70% of global economic growth
in its first 10 years.

Purpose and Goals

APEC was established in 1989 to further enhance economic growth and prosperity for
the region and to strengthen the Asia-Pacific community.

Since its inception, APEC has worked to reduce tariffs and other trade barriers across
the Asia-Pacific region and to create efficient domestic economies and dramatically
increasing exports. Key to achieving APEC's vision are what are referred to as the
'Bogor Goals' of free and open trade and investment in the Asia-Pacific by 2010 for
industrialised economies and 2020 for developing economies. These goals were
adopted by Leaders at their 1994 meeting in Bogor, Indonesia.

Free and open trade and investment helps economies to grow, creates jobs and
provides greater opportunities for international trade and investment. In contrast,
protectionism keeps prices high and fosters inefficiencies in certain industries. Free
and open trade helps to lower the costs of production and thus reduces the prices of
goods and services - a direct benefit to all.

APEC also works to create an environment for the safe and efficient movement of
goods, services and people across borders in the region through policy alignment and
economic and technical cooperation.
Economic Growth
Since its inception in 1989, the APEC region has consistently been the most
economically dynamic part of the world. In its first decade, APEC Member
Economies generated nearly 70 percent of global economic growth and the APEC
region consistently outperformed the rest of the world, even during the Asian financial
crisis.

APEC Member Economies work together to sustain this economic growth through a
commitment to open trade, investment and economic reform. By progressively
reducing tariffs and other barriers to trade, APEC Member Economies have become
more efficient and exports have expanded dramatically.

Benefits to the People in the APEC Region

Consumers in Asia-Pacific have both directly and indirectly benefited from the
collective and individual actions of APEC Member Economies. Some direct benefits
include increased job opportunities, more training programmes, stronger social safety
nets and poverty alleviation. More broadly however, APEC Member Economies on
average enjoy lower cost of living because reduced trade barriers and a more
economically competitive region lowers prices for goods and services that everyone
needs on a daily basis, from food to clothes to mobile phones.
Key Economic Indicators

Table 1: Real GDP Growth in APEC Member Economies, 2000 - 2005

(Annual Percent Change)

2000 2001 2002 2003 2004 2005

Australia 3.3 2.2 4.1 3.1 3.5 2.5
Brunei Darussalam 2.9 2.7 3.9 2.9 0.5 0.4
Canada 5.2 1.8 2.9 1.8 3.3 2.9
Chile 4.5 3.4 2.2 3.9 6.2 6.3
China 8.4 8.3 9.1 10.0 10.1 10.2
Hong Kong, China 10.0 0.6 1.8 3.2 8.6 7.3
Indonesia 5.4 3.6 4.5 4.8 5.1 5.6
Japan 2.9 0.4 0.1 1.8 2.3 2.6
Korea 8.5 3.8 7.0 3.1 4.7 4.0
Malaysia 8.9 0.3 4.4 5.5 7.2 5.2
Mexico 6.6 0.0 0.8 1.4 4.2 3.0
New Zealand 3.4 3.0 4.8 3.4 4.4 2.3
Papua New Guinea -2.5 -0.1 -0.2 2.0 2.9 3.1
Peru 3.0 0.2 5.2 3.9 5.2 6.4
Philippines 6.0 1.8 4.4 4.9 6.2 5.0
Russia 10.0 5.1 4.7 7.3 7.2 6.4
Singapore 10.0 -2.3 4.0 2.9 8.7 6.4
Chinese Taipei 5.8 -2.2 4.2 3.4 6.1 4.1
Thailand 4.8 2.2 5.3 7.0 6.2 4.5
United States 3.7 0.8 1.6 2.5 3.9 3.2
Vietnam 6.8 6.9 7.1 7.3 7.8 8.4

Note:

• Local currency based.

• Source: IMF, World Economic Outlook, September 2006.
 Table 2: Inflation in APEC Member Economies, 2000 - 2005
(Annual Percent Change)

2000 2001 2002 2003 2004 2005

Australia 4.5 4.4 3.0 2.8 2.3 2.7
Brunei Darussalam 1.2 0.6 -2.3 0.3 0.9 1.1
Canada 2.7 2.5 2.3 2.7 1.8 2.2
Chile 3.8 3.6 2.5 2.8 1.1 3.1
China 0.4 0.7 -0.8 1.2 3.9 1.8
Hong Kong, China -3.7 -1.6 -3.0 -2.6 -0.4 0.9
Indonesia 3.8 11.5 11.8 6.8 6.1 10.5
Japan -0.4 -0.8 -0.9 -0.3 0.0 -0.6
Korea 2.3 4.1 2.7 3.6 3.6 2.7
Malaysia 1.6 1.4 1.8 1.1 1.4 3.0
Mexico 9.5 6.4 5.0 4.5 4.7 4.0
New Zealand 2.6 2.6 2.7 1.8 2.3 3.0
Papua New Guinea 15.6 9.3 11.8 14.7 2.1 1.7
Peru 3.8 2.0 0.2 2.3 3.7 1.6
Philippines 4.0 6.8 2.9 3.5 6.0 7.6
Russia 20.8 21.5 15.8 13.7 10.9 12.6
Singapore 1.3 1.0 -0.4 0.5 1.7 0.5
Chinese Taipei 1.3 0.0 -0.2 -0.3 1.6 2.3
Thailand 1.6 1.7 0.6 1.8 2.8 4.5
United States 3.4 2.8 1.6 2.3 2.7 3.4
Vietnam -1.6 -0.4 4.0 3.2 7.7 8.2

Note:

• Consumer price index based.

Source: IMF, World Economic Outlook, September 2006.
 Table 3: Government Balance in APEC Member Economies, 2000 - 2005 (Percent of
GDP)

2000 2001 2002 2003 2004 2005

Australia 1.4 0.1 0.3 1.1 1.7 2.3
Brunei Darussalam - - - - - -
Canada 2.9 0.7 -0.1 0.0 0.7 1.7
Chile - - - - - -
China - - - - - -
Hong Kong, China -0.6 -4.9 -4.8 -3.3 -0.3 1.0
Indonesia - - - - - -
Japan -7.7 -6.4 -8.2 -8.1 -6.3 -5.6
Korea 1.1 0.6 2.3 2.7 2.3 2.1
Malaysia - - - - - -
Mexico - - - - - -
New Zealand 1.2 1.6 1.7 3.4 4.6 4.8
Papua New Guinea - - - - - -
Peru - - - - - -
Philippines - - - - - -
Russia - - - - - -
Singapore 7.9 4.8 4.0 5.7 6.0 6.0
Chinese Taipei -4.5 -6.4 -4.3 -2.8 -2.9 -2.4
Thailand - - - - - -
United States 1.6 -0.4 -3.8 -4.8 -4.6 -3.7
Vietnam - - - - - -

Notes:

• Government balance is revenue minus expenditure plus balance of state-owned

enterprises, excluding privatization receipts.
• '-' Not available.
• Source: IMF, World Economic Outlook, September 2006.
Table 4: Current Account Balance in APEC Member Economies, 2000 - 2005 (Percent of
GDP)

2000 2001 2002 2003 2004 2005

Australia -3.9 -2.1 -3.9 -5.6 -6.3 -6.0
Brunei Darussalam 48.6 47.6 39.4 46.2 44.9 53.3
Canada 2.7 2.3 1.7 1.2 2.1 2.3
Chile -1.2 -1.6 -0.9 -1.3 1.7 0.6
China 1.7 1.3 2.4 2.8 3.6 7.2
Hong Kong, China 4.1 5.9 7.6 10.4 9.5 11.4
Indonesia 4.8 4.3 4.0 3.5 0.6 0.3
Japan 2.6 2.1 2.9 3.2 3.8 3.6
Korea 2.4 1.7 1.0 2.0 4.1 2.1
Malaysia 9.4 8.3 8.4 12.7 12.6 15.2
Mexico -3.2 -2.8 -2.1 -1.4 -1.0 -0.6
New Zealand -5.2 -2.8 -4.1 -4.3 -6.7 -8.9
Papua New Guinea 8.5 6.5 -1.0 4.4 2.1 3.3
Peru -2.8 -2.1 -1.9 -1.5 0.0 1.3
Philippines -2.9 -2.5 -0.5 0.4 1.9 2.4
Russia 18.0 11.1 8.4 8.2 9.9 10.9
Singapore 11.6 13.8 13.4 24.1 24.5 28.5
Chinese Taipei 2.8 6.3 8.7 9.8 5.7 4.7
Thailand 7.6 5.4 5.5 5.6 4.2 -2.1
United States -4.2 -3.8 -4.5 -4.8 -5.7 -6.4
Vietnam 2.3 1.6 -1.9 -4.8 -3.1 0.1

Source: IMF, World Economic Outlook, September 2006.

Table 5: Short-Term Interest Rates in APEC Member Economies, 2000 - 2005 (Percent
per Annum)

2000 2001 2002 2003 2004 2005

Australia 5.90 5.06 4.55 4.81 5.25 5.46
Brunei Darussalam 5.50 5.50 5.50 5.50 5.50 5.50
Canada 5.52 4.11 2.45 2.93 2.25 2.66
Chile 10.09 6.81 4.08 2.72 1.88 3.48
China 3.24 3.24 2.70 2.70 3.33 3.33
Hong Kong, China 7.13 2.69 1.50 0.07 0.13 4.25
Indonesia 10.32 15.03 13.54 7.76 5.38 6.78
Japan 0.11 0.06 0.01 0.00 0.00 0.00
Korea 5.16 4.69 4.21 4.00 3.65 3.33
Malaysia 2.66 2.79 2.73 2.74 2.70 2.72
Mexico 16.96 12.89 8.17 6.83 7.15 9.59
New Zealand 6.12 5.76 5.40 5.33 5.77 6.76
Papua New Guinea 9.54 11.05 9.11 13.58 7.79 4.36
Peru 14.00 5.00 4.50 3.25 3.75 4.00
Philippines 10.84 9.75 7.15 6.97 7.05 7.31
Russia 7.14 10.10 8.19 3.77 3.33 2.68
Singapore 2.57 1.99 0.96 0.74 1.04 2.28
Chinese Taipei 4.63 2.13 1.63 1.38 1.75 2.25
Thailand 1.95 2.00 1.76 1.31 1.23 2.62
United States 5.84 3.45 1.61 1.01 1.38 3.17
Vietnam 5.42 5.49 5.92 5.83 - 6.13

Notes:

• Money market rates unless otherwise noted.

• Brunei Darussalam: Lending rate.
• China: Bank rate.
• Peru and Chinese Taipei: Discount rate (end of period).
• US and Vietnam: Treasury bill rate.
• '-' Not available.
• Sources: IMF, International Financial Statistics, 2006.
• Data for Chinese Taipei are provided by Council for Economic Planning and
Development, Chinese Taipei.
 Table 6: Nominal Exchange Rate in APEC Member Economies, 2000 - 2005 (National
Currency per USD)

2000 2001 2002 2003 2004 2005

Australia 1.72 1.93 1.84 1.53 1.36 1.31
Brunei Darussalam 1.72 1.79 1.79 1.74 1.69 1.66
Canada 1.49 1.55 1.57 1.40 1.30 1.21
Chile 539.59 634.94 688.94 691.43 609.37 560.09
China 8.28 8.28 8.28 8.28 8.28 8.19
Hong Kong, China 7.79 7.80 7.80 7.79 7.79 7.78
Indonesia 8,421.8 10,260.9 9,311.2 8,577.1 8,938.9 9,704.7
Japan 107.77 121.53 125.39 115.93 108.19 110.22
Korea 1,131.0 1,291.0 1,251.1 1,191.6 1,145.3 1,024.1
Malaysia 3.80 3.80 3.80 3.80 3.80 3.79
Mexico 9.46 9.34 9.66 10.79 11.29 10.90
New Zealand 2.19 2.38 2.15 1.72 1.51 1.42
Papua New Guinea 2.76 3.37 3.89 3.55 3.22 3.10
Peru 3.49 3.51 3.52 3.48 3.41 3.30
Philippines 44.19 50.99 51.60 54.20 56.04 55.09
Russia 28.13 29.17 31.35 30.69 28.81 28.28
Singapore 1.72 1.79 1.79 1.74 1.69 1.66
Chinese Taipei 31.23 33.80 34.58 34.42 33.42 32.17
Thailand 40.11 44.43 42.96 41.48 40.22 40.22
Vietnam 14,167.7 14,725.2 15,279.5 15,509.6 - 15,858.9

Notes:

• '-' Not available.

• Sources: IMF, International Financial Statistics, 2006.
• Data for Chinese Taipei are provided by Council for Economic Planning and
Development, Chinese Taipei.

This section contains individual economy reports from each of APEC's 21

Member Economies, providing a valuable snapshot of the economic health
and performance of APEC's economies. The reports are extracted from the
2005 APEC Economic Outlook and 2006 APEC Economic Policy Report
publication for easy reference.

For each economy, information is provided on -

• Gross Domestic Product

• Inflation
• Employment
• Current Account
• Exchange Rate
• Fiscal Policy
• Long Term Fiscal Strategies
• Monetary Policy
• Medium-Term Outlook
• Overall Economic Performance
Simply use the list below to access economy information for each APEC
Member Economy.

Australia

Brunei Darussalam

Canada

Chile

China

Hong Kong, China

Indonesia

Japan

Korea

Malaysia

Mexico

New Zealand

Papua New Guinea

Peru

Philippines

Russia

Singapore

Chinese Taipei

Thailand

United States

Viet Nam
BILATERAL FREE TRADE AGREEMENTS-Summary # 1
Bilateral Free Trade Agreements refers to a Free Trade Agreement (FTA) between
two countries.

EXAMPLES: MEMBERS/COUNTRIES INVOLVED.

• The US has bilateral agreements with the following countries and blocs:
o Australia/U.S.-Australia Free Trade Agreement (signed and ratified
2004; implemented 2005)
o Bahrain/US-Bahrain Free Trade Agreement (signed 2004; ratified
2005; implemented 2006)
o Chile/US-Chile Free Trade Agreement (signed and ratified 2003;
implemented 2004)
• Japan has bilateral agreements with the following countries and blocs:
o Chile
o Malaysia
o Mexico
• Mexico has bilateral agreements with the following countries and blocs:
o Bolivia
o Brazil
o Chile
• Costa Rica has bilateral agreements with the following countries and blocs
o Canada
o Chile
o El Salvador
• Singapore has bilateral agreements with the following countries and blocs:
o Australia
o Chile
o India
• Turkey has bilateral agreements with the following countries and blocs:
o Bosnia and Herzegovina
o Croatia
o Egypt
• The EU has bilateral agreements with the following countries and blocs:
o Algeria European Union Association Agreement
o Chile
o Croatia Stabilisation and Association Agreement
o Egypt European Union Association Agreement
KEY OBJECTIVES

REASONS WHY COUNTRIES GET INVOLVED IN BILATERAL FREE

TRADE AGREEMENTS.
* Disillusionment with work with the multilateral for a (e.g. in the areas of IP,
standards, TBT)
* Unsatisfactory result through multilateral cooperation
* Bigger market to attract FDI
*Optimization of resources
*Stronger voice

BENEFITS OF BILATERAL AGREEMENTS

*Geographical proximity (same culture/language); less cost of negotiations.
*Lesser member countries, easier to negotiate.
*More practical and realistic targets.
*Allow developing countries and LDC’s (especially non-WTO members) opportunity
to start liberalizing e.g. Vietnam and Cambodia. Preparation to compete Globally.
*Possible to achieve regional cooperation in other areas beyond trade.

DISADVANTAGE’S OF BILATERAL AGREEMENTS

*Preferential
*Trade Diversion
*Some too ambitious targets, difficult to implement
*Trade diversion instead of trade creation (protectionist)
*Wastage of resources (dumping and overlapping)

TRADE DIVERSION Versus TRADE CREATION

Economic theory suggests that bilateral agreements like the FTA will lead to trade
creation between the parties directly involved, but will also cause trade diversion from
third countries, offsetting any benefits. Bilateral agreements may also undermine
multilateral agreements such as those associated with the World Trade Organization.
EXAMPLE OF A BILATERAL FREE TRADE AGREEMENT
The Australia-United States Free Trade Agreement (FTA) is a preferential trade agreement between
Australia and the United States of America modeled on the North America Free Trade
Agreement (NAFTA). The FTA was signed on May 18, 2004, ratified by the U.S. House of
Representatives on July 14, 2004.

National Treatment and Market Access for Goods

The agriculture section of the agreement outlines the system for eliminating most
tariffs for agriculture products being traded between the two countries. It also agrees
to eliminate export subsidies when the good in question is being exported to one of
the two party countries.

Rules of Origin
The rules of origin section outlines the rules for determining the origin of the goods
being traded in order to establish elegibility and also the method to determine the
value of the goods traded.

Customs Administration
Sanitary and Phytosanitary Measures Technical Barriers to Trade
Safeguards
Cross-border Trade in Services
Investment
Telecommunications Financial Services
Government Procurement Electronic Commerce
Intellectual Property Rights

Australian attitudes to the FTA-support

Economic benefits :- The government relied on estimates of the economic benefits of

the FTA computed by the Centre for International Economics, a consultancy group.

Dynamism and economic integration :-The leading group supporting the FTA was
called Austa. Austa's arguments focused on the dynamic benefits of integration with
the US economy.

Australian Attitudes to the FTA - opposition

Criticisms of the FTA appeared from a number of sources and on a number of
grounds:

Intellectual property :- The provisions of the FTA required Australia to offer

stronger protection to American intellectual property.
Manufacturing and Agricultural Sector
Australia as a whole is heavily reliant on primary industry and the main benefits of a
FTA between the two countries were seen to be increased access to the large, but
heavily subsidized and protected, American market by Australian producers.

Outcomes
In the year following the agreement, Australian exports to the U.S. declined, while
U.S. exports to Australia increased. This followed the International Monetary Fund's
prediction that the Australia-United States FTA would shrink the Australian economy
marginally because of the loss of trade with other countries. The IMF estimated
$US5.25 billion of extra U.S. imports entering into Australia per year under the FTA,
but only $US2.97 billion of extra Australian exports to the U.S. per year.[9] However,
it remains unclear whether or not Australia's worsening trade deficit with the United
States can be solely attributed to the FTA. It may have been a lagged effect of an
appreciation of the Australian dollar against the US dollar between 2000 and 2003.
The FTA improved the overall U.S. trade deficit situation with Australia creating a
trade surplus with Australia which rose 31.7% in the first quarter of 2005, compared
to the same timeframe in 2004. U.S. exports to Australia increased 11.7% in the first
quarter of 2005 to nearly $3.7 billion for the quarter. Agriculture exports to Australia
were up 20%.
BILATERAL FREE TRADE AGREEMENTS-Summary # 2

REASONS WHY COUNTRIES GET INVOLVED IN BILATERAL FREE

TRADE AGREEMENTS

*Disillusionment with work with the multilateral fora (e.g in the areas of IP,
standards, TBT)
*Unsatisfactory result through multilateral cooperation
*Bigger market to attract FDI
*Optimization of resources
*Stronger voice

BENEFITS OF BILATERAL AGREEMENTS

*Geographical proximity (same culture/language); less cost of negotiations.

*Lesser member countries, easier to negotiate.
*More practical and realistic targets.
*Allow developing countries and LDC’s(especially non-WTO members) opportunity
to start liberalizing e.eg Vietnam and Cambodia. Preparation to compete Globally.
*Possible to achieve regional cooperation in other areas beyond trade.

DISADVANTAGE’S OF BILATERAL AGREEMENTS

*Preferential
*Trade Diversion
*Some too ambitious targets, difficult to implement
*Trade diversion instead of trade creation (protectionist)
*Wastage of resources (dumping and overlapping)

List of agreements between two States, two Blocs or a Bloc and a State

• The US has bilateral agreements with the following countries and blocs:
o Australia/U.S.-Australia Free Trade Agreement (signed and ratified
2004; implemented 2005)
o Bahrain/US-Bahrain Free Trade Agreement (signed 2004; ratified
2005; implemented 2006)
o Chile/US-Chile Free Trade Agreement (signed and ratified 2003;
implemented 2004)
 o Israel/US-Israel Free Trade Agreement (signed, ratified and
implemented 1985. The Palestinian Authority is also participating.)
o Jordan/US-Jordan Free Trade Agreement (signed 2000, ratified and
implemented 2001)
o South Korea/U.S.-Korea Free Trade Agreement (Agreement reached
on 2 April 2007, the parties must still finalize the text and ratify the
Agreement)
o Morocco/US-Morocco Free Trade Agreement (signed and ratified
2004, implemented 2006)
o Oman/US-Oman Free Trade Agreement (signed and ratified 2006)
o Singapore/US-Singapore Free Trade Agreement (signed and ratified
2003, implemented 2004)
• Japan has bilateral agreements with the following countries and blocs:
o Chile
o Malaysia
o Mexico
o Philippines
o Thailand (Agreement signed, the parties must still ratify the
Agreement)
o Singapore
• Mexico has bilateral agreements with the following countries and blocs:
o Bolivia
o Brazil
o Chile
o Colombia
o Costa Rica
o El Salvador
o Guatemala
o Honduras
o Israel
o Nicaragua
o Panama
o Uruguay
o Venezuela
o Mercosur
o the EU
o the EFTA
• Costa Rica has bilateral agreements with the following countries and blocs
o Canada
o Chile
o El Salvador
o Dominican Republic
o Guatemala
o Honduras
o Caribbean Community (CARICOM)
o Nicaragua
o Panama
• Chile has bilateral agreements with the following countries and blocs:[1]
o Canada (came into force on July 5, 1997)
o Central America: Costa Rica (February 14, 2002) and El Salvador
(June 3, 2002)
o South Korea (April 1, 2004)
o European Free Trade Association (December 1, 2004)
 o People's Republic of China (October 1, 2006)
o Panama (unratified; signed on June 27, 2006)
o Peru (unratified; signed on August 22, 2006)
o Colombia (unratified; signed on November 27, 2006)
• Singapore has bilateral agreements with the following countries and blocs:
o Australia
o Chile
o India
o Jordan
o New Zealand (separate from the Trans-Pacific Strategic Economic
Partnership (see above) and is still in force)
o Panama
o South Korea
o the EFTA
• Panama has bilateral agreements with the following countries and blocs:
o El Salvador
o Guatemala
o Honduras
o Nicaragua
o Costa Rica
o Republic of China (Taiwan)
• Dominican Republic has bilateral agreements with the following countries
and blocs:
o El Salvador
o Guatemala
o Honduras
o Nicaragua
o Costa Rica
• Turkey has bilateral agreements with the following countries and blocs:
o Bosnia and Herzegovina
o Croatia
o Egypt
o Israel
o Morocco
o Macedonia
o Palestinian Authority
o Tunisia
o The European Free Trade Association
• Israel has bilateral agreements with the following countries and blocs:
o Bulgaria
o Romania
o Canada
o The European Free Trade Association
o The EU
• The People's Republic of China has bilateral agreements with the following
countries and blocs:
o Pakistan
o Chile
o Jordan
o Thailand
o ASEAN (currently the Early Harvest Program is in operation, but a full
FTA is not expected until 2010 [2])
o Hong Kong as a CEPA (Closer Economic Partnership Arrangement)
 o Macau as a CEPA
• The Republic of China (Taiwan) has bilateral agreements with the following
countries and blocs:
o El Salvador
o Guatemala
o Honduras
o Nicaragua
o Panama
• Jordan has bilateral agreements with the following countries and blocs:
o Algeria
o Libya
o Syria
o Kuwait
o Bahrain
o Peru
o The European Free Trade Association
o The European Union
• Georgia has bilateral agreements with the following countries and blocs:
o Armenia
o Azerbaijan
o Kazakhstan (Entry into force: 16 July 1999)
o Russian Federation (Entry into force: 10 May 1994)
o Turkmenistan (Entry into force: 1 January 2000)
o Ukraine
• Faroe Islands has bilateral agreements with the following countries and blocs:
o Switzerland
o Norway
o Iceland (the Hoyvík Agreement)
o The European Union
• Canada - Costa Rica
• Australia - New Zealand (under the CER)
• South Korea has bilateral agreements with the following countries and blocs:
o Chile
o Singapore
o EFTA
o US
• The EU has bilateral agreements with the following countries and blocs:
o Algeria European Union Association Agreement
o Chile
o Croatia Stabilisation and Association Agreement
o Egypt European Union Association Agreement
o Macedonia Stabilisation and Association Agreement
o Morocco European Union Association Agreement
o Palestinian Authority European Union Association Agreement
o South Africa
o Switzerland
o Tunisia European Union Association Agreement
The Australia-United States Free Trade Agreement (FTA) is a preferential trade
agreement between Australia and the United States of America modelled on the North
America Free Trade Agreement (NAFTA). The FTA was signed on May 18, 2004,
ratified by the U.S. House of Representatives on July 14, 2004 by a vote of 270-156
and by the U.S. Senate on July 15, 2004 by a vote of 80-16. [1] President George W.
Bush signed the United States-Australia Free Trade Agreement Implementation Act
into law on August 3, 2004. [2] The FTA came into force on January 1, 2005.

Provisions of the FTA

The text of the Free Trade Agreement is divided into twenty-three sections, listed and
summarized as follows:

Establishment of the Free Trade Area and Definitions

This chapter lays the framework for the FTA. It states that the provisions are
consistent with the relevant sections of the General Agreement on Tariffs and Trade
(GATT) 1994 and the General Agreement on Trade in Services (GATS). Both GATT
and GATS are documents created by World Trade Organization (WTO) agreements
and they lay the boundaries for subsequent bilateral agreements such as the Australia-
U.S. FTA.

National Treatment and Market Access for Goods

Chapter three of the FTA lays out conditions for what types of goods are subject to
non-discriminatory treatment. Certain types of goods are fully applicable to the
agreement immediately and some are phased in over a period of years or temporarily
applicable.
The chapter also reminds the two countries that they must abide by the WTO rules
applying what is called national treatment. National treatment means that each
country will provide the same treatment to imported goods from the other country as
if they were domestically produced goods.
Finally, the chapter established a Committee on Trade in Goods with the purpose of
providing arbitration for each country to "raise issues of concern in relation to tariffs,
non-tariff measures, rules of origin and customs administration."

Agriculture
The agriculture section of the agreement outlines the system for eliminating most
tariffs for agriculture products being traded between the two countries. It also agrees
to eliminate export subsidies when the good in question is being exported to one of
the two party countries.
Special tariff rate quotas are part of the agreement. These quotas allow Australian
producers to export increasing amounts of these products free of duty to the United
States during the tariff elimination period. The following agricultural products are
designated:

• Beef
• Dairy
• Tobacco
• Cotton
• Peanuts
• Avocadoes

The quota systems vary for the different products and are outlined, in detail, in this
section.
The section also sets up a Committee on Agriculture with the purpose of providing
"a formal opportunity for Australia and the United States to discuss a wide range of
agricultural issues relevant to the Agreement, including trade promotion activities;
barriers to trade; and consultation on the range of export competition issues."
Finally, the two countries have committed to working with the WTO on a multilateral
scale to eliminate export subsidies to other WTO member countries.

Textiles and Apparel

Chapter four deals with the trade of texiles and apparel between the two party
countries. The bulk of this section outlines the rules of origin provisions with regard
to textile goods and safeguarding the domestic markets of the two countries. The
agreement provides a mechanism to institute emergency action should the sudden
increase in imports due to the reduction of tariffs lead to detrimental effects on the
domestic industry of the importing country.
In addition, this section details the cooperation of Customs authorities for ensuring
that the rules of the agreement are carried out and outlines possible actions which can
be taken if the exporting country appears to be acting in bad faith.
Rules of Origin
The rules of origin section outlines the rules for determining the origin of the goods
being traded in order to establish elegibility and also the method to determine the
value of the goods traded.
For the purposes of the FTA, this section defines an originating good as those that:

• are wholly obtained or produced entirely in the country, such as

minerals extracted there, vegetable goods harvested there, and live
animals born and raised there;
• are produced in the country wholly from originating materials; or
• are produced in the country partly from non-originating materials.

The section also outlines supporting documentation and verifications that the goods
being traded are, indeed, originating in the exporting country, as defined by the
agreement. The responsibility for verification of the applicable conditions is given to
the importer. Denial of preferential treatment and penalties may apply if proper
verification is not provided by the importer upon request made by the importing
country.

Customs Administration
This section outlines the requirements of the customs authorities to:

1. promptly publish law, regulations, guidelines and administrative

rulings,
2. administer customs laws in a uniform, impartial and reasonable
manner,
3. provide advance rulings on tariff classifications and rules of origin
within a given period of time,
4. provide some sort of administrative body to review customs
determinations,
5. cooperate with each other on all reasonable matters, especially those
involving suspicion of illegal activity,
6. protect the confidentiality of information provided in cooperation with
other customs authorities,
7. impose their respective penalties for violations of customs laws and
regulations,
8. promptly release goods consistent with ensuring compliance with
customs laws,
9. apply risk management systems to concentrate on high-risk areas and
facilitate low-risk areas, and,
10. maintain expedited procedures with respect to express shipments.

Sanitary and Phytosanitary Measures

In conjunction with the existing WTO Sanitary and Phytosanitary (SPS) Agreement,
this section sets up two committees to ensure that the SPS agreement provisions are
followed.
 • Committee on Sanitary and Phytosanitary Matters- provided with a
mandate for "increasing the mutual understanding of the SPS measures
and regulatory processes of each Party as well as continuing the
cooperative efforts of the Parties internationally."
• Standing Working Group on Animal and Plant Health- to help with
the resolution of specific animal and plant health matters with the goal
of resolving the problems with the least adverse effect on trade as
possible.

Technical Barriers to Trade

This section acknowledges the rights and obligations or Australia and the United
States to each other with respect to combating barriers to trade. These rights and
obligations were laid out by the WTO Agreement on Technical Barriers to Trade,
which deals with standards, regulations, and conformity assessments, among other
things.
Most of the section is language from both countries agreeing to share information on
several levels of government regulation. They agree to attempt to accept each others
regulations and publish such rules and regulations in a timely manner in order to
ensure transparency.

Safeguards
The goal of the safeguards section of the agreement is to lay out an agreed upon
structure to guard against severe adverse effects to each countries domestic industries
during the transition period after lifting tariffs. The countries also agree to consider
the exclusion from the application of global WTO safeguards imports from the other
country where those imports are not a substantial cause of the injury to the domestic
industry.

Cross-border Trade in Services

This effect of the FTA gives clear meaning to the phrase cross-border trade in
services and provides suppliers with an open environment in which to conduct their
business. It requires that each country give the other's service suppliers national
treatment or most-favored-nation treatment and prohibits many restrictions to market
access and transfers.

Investment
The investment chapter of the FTA provides clear definitions as to what investments
are covered and gives cross-border investors assurances in order to make it as safe as
if they were investing in their own country. Among other things, the section prohibits
each country from imposing or enforcing any of the following requirements in
relation to an investment in its territory:

• to export a given level or percentage of goods or services;

• to achieve a given level or percentage of domestic content;
• to purchase, use, or accord a preference to goods produced in its
territory, or to purchase goods from persons in its territory;
• to relate in any way the volume or value of imports to the volume or
value of exports or to the amount of foreign exchange inflows
associated with an investment;
• to restrict sales of goods or services in its territory that an investment
produces or supplies by relating such sales in any way to the volume or
value of its exports or foreign exchange earnings;
• to transfer a particular technology, a production process, or other
proprietary knowledge to a person in its territory; or
• to supply exclusively from its territory the goods that an investment
produces or the services it supplies to a specific regional market or to
the world market.

Telecommunications
This section details agreed upon terms by both countries to assure fair trade between
the telecommunications industries in each country. The rules specifically exclude
measures relating to broadcast or cable distribution of radio or television
programming.
Among other provisions, the agreement lays out rules for settling disputes among the
members of the telecommunications industries in one country with the members in the
other. It entitles enterprises to:

• seek timely review by a regulator or court to resolve disputes;

• seek review of disputes regarding appropriate terms, conditions, and
rates for interconnection; and
• to obtain judicial review of a determination by a regulatory body.

Financial Services
This effect is concerned with ensuring a non-discriminatory environment with regard
to financial services. The section defines financial services as "all insurance and
insurance-related services, and all banking and other financial services, as well as
services incidental or auxiliary to a service of a financial nature."

The section further lays out the scope of its application as it applies to measures by
either country that affect:

• financial institutions located in the territory of that country that are

controlled by persons of the other country;
 • investors of the other country who have invested in financial
institutions located in that country;
• the investments of investors of the other country in financial
institutions located in that country; and
• cross-border trade in financial services by service suppliers of the other
country.

Competition-related Matters

The parties agreed to minimize obstacles to the operation of each others' competition
and consumer protection policies. Australia agreed that its governments at all levels
would not provide any competitive advantage to any government businesses simply
because they are government-owned. This provision is consistent with existing
provisions of Australia's National Competition Policy

Government Procurement
Subject to some exceptions, and the non-participation of some US states, the
agreement required, in government and government agency procurement, that each
party should accord to the other treatment no less favourable than the most favourable
treatment accorded to domestic goods, services and suppliers.

Electronic Commerce
The parties agreed to co-operate on mechanisms to facilitate electronic commerce, not
to impose customs duties on digital products and for each to apply non-discriminatory
treatment to the digital products of the other.

Intellectual Property Rights

Australia agreed to extend its copyright expiration period from 50 to 70 years after the
author’s death where copyright is calculated on the basis of the life of a natural
person, and 70 years after the first performance or publication in other cases.

The agreement expands the rights of patent holders.

The agreement requires legal enforcement of digital rights management systems,

however an Australian legislative committee has issued a report stating that this
portion of the treaty has a "significant flaw". The report goes on to term it a
"lamentable and inexcusable flaw", an "egregious flaw", and even a "flaw that verges
on absurdity". The committee expressed the strong view that the Government must
find a solution to the flaw before implementing this portion of the treaty.

US Attitudes to the FTA

After the FTA was signed, there were initially concerns that the American
agricultural sector would lobby against the agreement, due to a fear that it could
interfere with the government's farm subsidies program. However, the agreement,
with time limits on importation of Australian agricultural products such as beef and
sugar cane managed to allay the concerns of the American agricultural market (while
greatly frustrating many Australian producers).
A coalition of trade unions and other groups did speak out against the agreement on
the basis that it would cause similar problems to those experienced by NAFTA.
More substantial lobbying was undertaken by American Pharmaceutical companies,
who were concerned about the Australian Pharmaceutical Benefits Scheme. See
below.
American manufacturing lobbies strongly supported the FTA.
On the 15th July American time, both houses of the United States Congress gave
strong support to the FTA. The agreement was also supported by Democratic Party
Presidential Nominee John Kerry.
Additionally, labor groups expressed concern regarding the agreement. In a report to
the USTR office, the Labor Advisory Committee (LAC) recommended that Congress
reject the US-Australia FTA because they believed the agreement failed to meet
congressional negotiating objectives.

Australian attitudes to the FTA-support

The agreement became a major political issue leading up to the 2004 Elections. After
a protracted period of negotiation under Howard government Trade Minister Mark
Vaile, the agreement was strongly supported by the Howard government as an
enormous potential gain to the Australian economy and as essential to the
continuation of the U.S.-Australia alliance.

Economic benefits
The government relied on estimates of the economic benefits of the FTA computed by
the Centre for International Economics, a consultancy group.
Dynamism and economic integration
The leading group supporting the FTA was called Austa. Austa's arguments focused
on the dynamic benefits of integration with the US economy.

Australian Attitudes to the FTA - opposition

Criticisms of the FTA appeared from a number of sources and on a number of
grounds:

Trade Diversion
Economic theory suggests that bilateral agreements like the FTA will lead to trade
creation between the parties directly involved, but will also cause trade diversion from
third countries, offsetting any benefits. Bilateral agreements may also undermine
multilateral agreements such as those associated with the World Trade Organization.
Partly as a result of these factors, the estimates of benefits produced by the CIE and
relied on by the government were disputed by most economists who made
submissions to the Senate Committees inquiring into the topic, some of whom
concluded that the agreement would reduce Australia's economic welfare.
Intellectual property
The provisions of the FTA required Australia to offer stronger protection to American
intellectual property. In particular, the minimum term of copyright was extended to 70
years after the author's death. Most economists and others interested in intellectual
property issues regarded this as undesirable. A number of prominent American
economists took the same view in the case of Eldred v. Ashcroft.
Other key changes included:

• special copyright term extension for photographs

• broader definition of technological protection measures, narrow exceptions,
and review process
• protection of temporary copies
• stronger protection of electronic rights management information
• protection of pay television broadcasts
• safe harbour provisions for Internet Service Providers
• protection of performers' economic and moral rights in respect of sound
recordings
• broader civil and criminal offences

For a discussion of the copyright changes, see Rimmer, M. "Robbery Under Arms:
Copyright Law and the Australia-United States Free Trade Agreement”
Local Content Provisions
Many in the Australian film and television community expressed concern over the
affect of the agreement on government regulations enforcing a mandatory minimum
of locally-produced content on television. Due to the fact that high-quality American
content can be purchased by networks more cheaply than it could be produced in
Australia, fears were raised that the agreement would see an even larger portion of
Australian media content being composed of American imports. A number of
prominent artists as well as the Media, Entertainment and Arts Alliance argued for
rejection of the FTA on the grounds that it would erode Australian culture.

Manufacturing and Agricultural Sector

Australia as a whole is heavily reliant on primary industry and the main benefits of a
FTA between the two countries were seen to be increased access to the large, but
heavily subsidized and protected, American market by Australian producers. In
particular, the rural and regional-based National Party lobbied hard to have the
agreement extend to the export of sugar. The eventual provisions of the agreement did
not go as far as had been hoped, and as a result, some lobbyists for the sugar industry,
notably independent senator Bob Katter, urged rejection of the FTA. However, many,
such as Premier of Queensland Peter Beattie, still felt that the agreement was a net
gain for Australian agriculture and supported ratification on that basis.
The Australian manufacturing sector was another problematic area. Australian labour,
wage and environmental protection standards are significantly higher than those of
America. The Australian Manufacturing Workers Union ran a high-profile campaign
against the FTA on the basis that it would lead to manufacturing jobs being
outsourced overseas.

Pharmaceutical Benefits Scheme

The Pharmaceutical Benefits Scheme (PBS) is a central component of the Australian
healthcare system. The scheme provides reimbursement to community pharmacy for
the costs of dispensing prescription medicines prescribed in accordance with the PBS
Schedule, a comprehensive but closed formulary. Drugs are added to the formulary on
the basis of an assessment of comparative effectiveness and cost effectiveness
compared to the therapy most likely to be replaced in practice. The result is that where
there is no evidence of incremental benefit, a drug may not be listed at a higher price
than the comparator with the result that for many (but by no means all) drugs the
prices for subsidy purposes are a great deal cheaper than in many other major markets.
While the scheme is very effective at keeping many drug prices low, pharmaceutical
corporations in both the US and Australia are wary of the operation of the scheme,
since they argue that higher drug prices are necessary to fund the costs of research and
development. The American pharmaceutical companies claim that in enjoying low-
cost medicines, Australians are essentially "freeriding" on the costs of research
performed in the US.
While companies have in particular criticized the process by which drugs are listed on
the PBS, claiming that it lacks transparency, public health advocates have claimed
that calls for transparency are merely an effort by drug companies to gain greater
control over the process of listing. To a large degree the existing limitations on the
transparency of the process are those that have been imposed by the industry itself.
Disquiet about the Pharmaceutical Benefits Scheme led to speculation that the
American side would lobby heavily for its abrogation as an integral component of a
free trade agreement. The Government has been criticized, particularly by the
Australian Democrats and Greens parties, for not doing enough to safeguard the
operations of the Pharmaceutical Benefits Scheme, which the Government has
strenuously denied.

Ratification of the FTA

The Australian Government did not hold a majority in the Senate, and thus required
the support of the opposition Labor party, the Greens, Democrats, or independent
senators in order to secure ratification. The Government put heavy pressure on Labor
Party leader Mark Latham to secure his party's support of the agreement, knowing that
Latham, as well as many members of his party, viewed the FTA as beneficial. The
issue had divided the party, with some members, particularly of the Left faction,
arguing that Labor should reject the agreement.
Latham responded unexpectedly by making Labor's support of the FTA conditional
on the addition of an amendment in enabling that would allegedly safeguard the PBS
[8]. This effectively turned the tables on Howard: if the Government refused the
amendment as unnecessary, it opened itself to claims it was not safeguarding
Australian interests; if it supported the amendment, it then tacitly admitted that the
original terms of the agreement were inadequate. The bill was eventually passed with
both amendments.
Latham's amendment proposals were supported by the Australian Medical
Association but dismissed as ineffective by the Greens and Democrats, who still
argued for rejection of the agreement.
In January 2006, it was reported that the government was considering repealing the
amendments, as a result of pressure from the US pharmaceutical industry.

Outcomes
In the year following the agreement, Australian exports to the U.S. declined, while
U.S. exports to Australia increased. This followed the International Monetary Fund's
prediction that the Australia-United States FTA would shrink the Australian economy
marginally because of the loss of trade with other countries. The IMF estimated
$US5.25 billion of extra U.S. imports entering into Australia per year under the FTA,
but only $US2.97 billion of extra Australian exports to the U.S. per year.[9] However,
it remains unclear whether or not Australia's worsening trade deficit with the United
States can be solely attributed to the FTA. It may have been a lagged effect of an
appreciation of the Australian dollar against the US dollar between 2000 and 2003.
The FTA improved the overall U.S. trade deficit situation with Australia creating a
trade surplus with Australia which rose 31.7% in the first quarter of 2005, compared
to the same timeframe in 2004. U.S. exports to Australia increased 11.7% in the first
quarter of 2005 to nearly $3.7 billion for the quarter. Agriculture exports to Australia
were up 20%.

The United States-Jordan Free Trade Agreement

The Jordan Free Trade Agreement (FTA) was signed on October 24, 2000. It was
America's third free trade agreement, and the first ever with an Arab state. The Jordan
FTA achieves significant and extensive liberalization across a wide spectrum of trade
issues. It will eliminate all tariff and non-tariff barriers to bilateral trade in virtually
all industrial goods and agricultural products within ten years.

Canada-Chile Free Trade Agreement

The Government of Canada and the Government of the Republic of Chile (Chile),
resolved to:
* Strengthen the special bonds of friendship and cooperation among their nations;
* Contribute to the harmonious development and expansion of world and regional
trade and provide a catalyst to broader international cooperation;
* Create an expanded and secure market for the goods and services produced in their
territories;
* Reduce distortions to trade;
* Establish clear and mutually advantageous rules governing their trade;
* Ensure a predictable commercial framework for business planning and investment;
* Build on their respective rights and obligations under the Marrakesh Agreement
Establishing the World Trade Organization and other multilateral and bilateral
instruments of cooperation;
* Enhance the competitiveness of their firms in global markets;
* Create new employment opportunities and improve working conditions and living
standards in their respective territories;
* Undertake each of the preceding in a manner consistent with environmental
protection and conservation;
* Preserve their flexibility to safeguard the public welfare;
* Promote sustainable development;
* Strengthen the development and enforcement of environmental laws and
regulations;
* Promote, enhance and enforce basic workers' rights;
* Facilitate the accession of Chile to the North American Free Trade Agreement; and
* Contribute to hemispheric integration.
Free Trade Agreements

Get rid of obstacles—like tariffs on imports and

exports—and you get more movement of products
across borders. More movement of products means
more production. More production requires more
means of production. More means of production calls
for more investment.

That’s the gospel Asean has adopted, and the Asean

Free Trade Agreement, or AFTA, is fast becoming a Agence France-Presse
reality. If you believe the pure-markets theory,
Thirteen-year-old Bui Xuan Manh walks back home from
everyone—all the residents of all the member nations rice field with his family buffalo on Wednesday, Oct 9 in a
of Asean and the rest of the world besides—stands to village west of Hanoi. Animals still play an important role
in farming in the countrysides of Southeast Asia due to
benefit.
their low cost when compared to machines.

“Trade is good. Period,” one Western diplomat in Phnom Penh said. “It just takes
time. They can survive, they can do well, they can compete. It’s all part of the
process—you don’t just start to produce computer chips.”

Over time, the diplomat maintained, Asean countries will rise to the challenges of the
increased competition brought on by freer trade—and prosper as a result. “The US
went through this at the turn of the century. Japan went through it after World War II.
It can be done.”

But with the US’ powerhouse economy continuing to struggle and Japan entering its
second decade of recession, is “it” a good thing?

Long Road to Freedom

Asean’s first six members signed the Asean Free Trade Agreement in 1992 and began
implementing it in 1993. It provided for the gradual reduction of tariffs over 15 years.
The aim was for all trade between the “Asean 6” countries to face tariffs of no more
than 5 percent by 2007.

With the Asian financial crisis of 1997 and 1998, Asean members decided free trade
was more urgent than ever. The so-called Common Effective Preferential Tariff
schedule was shortened by five years, putting the target at Jan 1, 2003.

At this point, more than 96 percent of trade between Asean’s original six members is
subject to tariffs of zero percent to 5 percent. The newer members of Asean have their
own 10 year schedules: Vietnam is to reach the target by 2006, Laos and Burma by
2008 and Cambodia by 2010.

In five more years, the target drops to zero. By 2008, trade in goods between the
Asean 6 will be tariff-free; by 2015, all intra-Asean trade will be tariff-free.
Flexibility is built into the agreement so countries can apply the provisions more
gradually to industries they feel they have to protect. For example, Cambodia hopes to
use such exemptions to keep its agriculture protected by higher tariffs until 2017.

Following the Leader

When AFTA was signed in 1992, regional free trade agreements were all the rage—
Canada and the US came together in 1989, extending the privilege to Mexico with the
formation of the North American Free Trade Agreement in 1994. Meanwhile, the
European Community agreed to form a common market in 1992.

Reducing tariffs within a single region gives the countries in that region an advantage
in that market that countries outside the region usually don’t have. In that sense, free
trade agreements, or FTAs, are a protectionist measure, which has caused some
laissez-faire enthusiasts to decry their popularity.

“A proliferation of small FTAs with little movement towards consolidation would

result in an enormously fragmented and complicated trading system,” Claude
Barfield, a resident scholar at the American Enterprise Institute, wrote in the Far
Eastern Economic Review in July. Such agreements threaten the global multilateral
trading system, exemplified by the World Trade
Organization, he warned.

Philip Levy, an expert on regional trade agreements at Yale University in the US,
points out that FTAs are an obstacle to the natural efficiency of free markets. “The
main potential downside to a regional trade agreement is the possibility that it will
induce people to buy more expensive regional goods [that face no tariffs] rather than
the cheapest goods available worldwide,” Levy wrote in an e-mail.

That is, if consumers in Mexico can buy a US-made car without paying tariffs, they
are more likely to buy it than to buy a European-made car of comparable or better
quality—decreasing economic efficiency, but boosting regional industries.

The same applies to a Thai-made car, or a Singaporean-made audio system. The

Asean countries feared seeing their shares of the US and European markets reduced.
AFTA, then, would do the same thing for the then-six Asean countries: Give them
markets and investment opportunities at home instead of abroad.

However, observers note, AFTA is both a hedge against globalization—promoting

regional interests over external ones—and a step toward it. AFTA’s guidelines and
requirements are consistent with WTO requirements.

So regional integration hopes to allow Asean countries eventually to integrate into the
global economy as a single bloc.
Bring Us Your Factories
AFTA’s main objective is to encourage domestic and foreign investment, partly by
spurring intra-regional trade—for example, foreign companies that started factories in
the Philippines would be able to sell the goods made there to five other countries for
no extra charge.

But the EC and Nafta included large consumer markets. Asean’s countries have
always specialized in production, relying on the prosperous nations of the West and
Japan to consume most of what they make.

That hasn’t changed much. Exports from one Asean country to another accounted for
only 17.8 percent of total Asean exports in 1980, 18.5 percent in 1990 and 23.2
percent in 2000 (counting only the original Asean 6).

Growing percentages, it’s true, but not skyrocketing ones, even as trade barriers began
to be dismantled during the 1990s. And many doubt that the percentages will climb
much higher, even without tariffs. An average of 30 percent of intra-Asean trade is
intra-company trade—between various divisions, subsidiaries and contractors of a
single company, points out Francis Perez, regional trade policy adviser for the UK-
based advocacy group Oxfam GB.

“This reflects a derived demand for finished products from developed countries, in
this case the US,” Perez wrote in an e-mail from Bangkok. “Considering the
continuous decline of the US market, this characteristic of intra-regional trade has to
change if it is to become sustainable.”

AFTA is also supposed to boost foreign investment by attracting investors’ attention

to a single, unified region. In a way, the Asean countries do have a common interest in
attracting foreign investment. By marketing the whole bloc to the rest of the world as
an attractive investment destination, they have more collective strength than any one
of the mostly small countries that make up Asean.

“As an integrated Southeast Asia with many strengths and abundant resources, we can
compete with China, Latin America and Eastern Europe for our fair share of foreign
direct investment,” Singaporean Minister for Trade and Industry George Yeo said at a
January seminar on AFTA in Jakarta.

But given the similar industries the Asean countries have developed—despite their
diverse resources—in practice, every investment that lands in Indonesia is one that
doesn’t land in the Philippines. “East Asian countries have always been competing
against each other,” Perez said.

“The history of dependence of these countries on a singular developed country market

(either US, Japan or EU) has not helped efforts toward real integration among East
Asian countries,” he noted.
Yale’s Levy agrees. “The principal difficulty for intra-Asian liberalization is that
Asian countries often produce similar types of products and therefore the benefits of
trading amongst them are quite small relative to those from trading with the rest of the
world.”

This might be different, Perez says, if Asean countries could band together for their
common interests and show a united front to the rest of the world. “One immediate
indicator of real economic integration...would be for instance the ability of Asean to
negotiate as an economic bloc in multilateral negotiations such as in the WTO—in the
interest of local [regional] capital, labor and agriculture—similar to the EU or North
America.”

Protecting the Home Front

There’s evidence that the Asean countries are often competitors more than partners in
the snags AFTA has encountered as it tries to reduce tariffs within the Asean 6.
Malaysia, for example, has persisted in protecting its auto industry, winning
extensions on its tariffs of up to 300 percent on imported cars. Malaysia and Thailand
are locked in heated competition to be Asean’s main hub for car and auto-parts
manufacturing.

Malaysia’s car tariffs make foreign automakers gnash their teeth as they block access
to a potentially huge market. But the government is hesitant to stop protecting its
Protons, whose lack of competitiveness is clearly evidenced by their absence from
foreign streets.

Malaysia is not the only one—Thailand has been accused of protecting its glass
industry, and the Philippines has continued to shelter its cement producers. Several
countries are defending weak agricultural sectors as well.

These problems won’t last, Asean Secretary-General Rodolfo Severino said at the
January AFTA seminar. Acknowledging that certain sectors were continuing to lag
behind the tariff reduction schedule, he said, “These shortcomings have to do with
small parts of the total trade in Asean, and they are temporary.

“Tariffs on sensitive agricultural products will still fall to zero to 5 percent. Tariffs on
automobiles will drop to zero percent to 5 percent for all Asean members, although a
little later than originally scheduled.... In any case, no free trade area can be free of the
need for flexibility in dealing with difficult and sensitive sectors.”

Critics counter that such exceptions aren’t “flexibility”—they’re weaknesses. AFTA

can’t achieve its goals, they say, unless Asean is willing to get tough. Liberalization is
often painful in the short term, but if you don’t swallow the bitter pill, you’ll never get
cured.
Uniting the Two Aseans
The vision of a Southeast Asia bustling with frictionless trade is, so far, only a vision.
The most glaring difference between reality and this ideal is the vast “development
gap” between the Asean 6 and the four newer members—Burma, Cambodia, Laos and
Vietnam.

“Asean integration into an economic bloc is still a long way to go,” Perez said. “If
current trends of liberalization continue, only [the US, Canada, the EU countries and
Japan], and perhaps China, will continue to benefit.”

Asean is not pretending that economically integrating the region will happen by itself.
In 1999, the Initiative for Asean Integration was created, producing a six-year plan
targeted at the new members. This focuses on four areas: Infrastructure, human
resources development, information and communications technology and regional
economic integration.

To Oxfam America’s Femy Pinto, East Asia regional program officer, the initiative
relies on unquestioned assumptions, such as the idea that privatization can reduce
poverty. The initiative promotes privatizing services such as education, health care,
electricity and water. These measures will put vital services in the hands of for-profit
corporations—and out of governments’ control—thus hurting the poor, she said.

“[The initiative] is being billed as a way to bridge or narrow the development gap
between these countries, but it doesn’t actually address that. These projects say they
aim at supporting and assisting poor countries, but they don’t meet what we feel are
good poverty reduction measures,” said Pinto, who attended a Jakarta workshop on
the integration initiative in August.

Much of the integration talk revolves around building up infrastructure, especially

transportation links. But this will only facilitate the flow of trade, not create
opportunities for production, Pinto said.

“For example, the East-West corridor road will link Thailand and Vietnam, and
Cambodia and Laos will be in the middle,” she said. Trucks laden with Thai and
Vietnamese goods will lumber through Cambodia and Laos, polluting the air and
straining public-works budgets—but otherwise bypassing the poor neighbors.

Freeing Trade and the Poor

Oxfam and other critics argue that the assumptions of classical economics—the view
that trade liberalization is in itself a good thing—need to be questioned. When poor
countries open up their economies, they can be used for their cheap, unskilled labor
and natural resources, without ever developing industries of their own.
“The assumption is that getting rid of barriers to trade will benefit all countries,” Pinto
said. “If you really want to bridge the development gap you need to increase
protections for developing countries and lower the barriers for more developed
countries.”

A Cambodian Ministry of Commerce official said keeping import tariffs high would
only encourage smuggling—already a major challenge to Cambodian industries such
as steel and gasoline—and coddle industries so that they never become competitive.

Currently, Cambodia, like Asean’s other poor members, is predominantly a rural,

agricultural, subsistence economy—around 80 percent of Cambodians are rural
farmers. They use centuries-old methods of small-scale farming without the benefit of
modern agricultural tools.

In addition, Cambodia lacks processing facilities, so products such as rice and palm
oil have to be exported, processed, and re-imported—depriving Cambodia of the vital
ability to add value to its products.

Cambodia will use AFTA’s flexibility provisions to extend protections to these

industries as long as possible—until 2017—so they can develop and become
competitive, the commerce ministry official said.

“We don’t put that kind of product on the immediate schedule. Because of the war,
our agricultural products are not able to compete with [goods from] Vietnam and
Thailand,” the official said. “This will give industries and farmers time to strengthen
their competitiveness.”

In the end, the official said, the poor can’t help but benefit from increased trade.
“Trade makes the economy grow, so there are more jobs for people. That means more
income, and that helps poverty. It’s a chain reaction.”
Yale’s Levy argues that when governments orchestrate sectoral growth—through
measures such as tariffs—they shut themselves off from the creativity of the free
market. Competition, he said, is what produces adjustment—not protection.

“Trade liberalization is not premature for the Southeast Asian economies,” he said.
“In fact, liberalization at an early stage can be helpful since the exposure to world
prices can direct investment to its best use.

“The difficulty with temporary protection is that it tends to be very difficult to

remove. Governments around the world have also done very poorly at predicting
which sectors will eventually take off,” Levy said. “Those East Asian countries that
grew so rapidly—Korea, Singapore, Taiwan and Hong Kong—subjected their
products to the test of competitiveness on world markets. In my opinion, this was a
very important element of their success.”
But Oxfam’s Pinto insists that this type of rhetoric focuses only on economic
growth—not on helping the poor.
Economic growth, she says, tends to favor only a select few, while the poverty-
stricken masses get poorer and poorer at the expense of the rich.
“It’s no longer the time when you could easily separate discussions of trade and
poverty reduction,” Pinto said. “The foundation of that thinking should be
challenged.”

Plunging Forward
From internal competition to dependence on external markets to its yawning
development gap, Asean faces a number of hurdles as it attempts to integrate into a
single bloc of thriving, mutual, tariff-free trade. When and if that goal is achieved, a
bigger one looms: Extending AFTA’s provisions to China to create the world’s largest
free-trade area, starting 10 years from now.

Over those 10 years, the argument goes, Asean as a bloc will become more
competitive—as a market and an investment destination—with booming, fast-growing
China. But even with its shared market of more than 500 million, Asean can’t
compare to China—which has a population of 1.6 billion, a vast supply of extremely
cheap labor, and, since last year, membership in the WTO.
Eventually, then, Asean will be positioned to ride China’s coattails to economic
success. “China has more competitive labor costs, but Singapore has technology, and
so does Malaysia,” Cambodian economist Sok Hach said. “And even though China is
very big, it has deficits of agricultural products. If there is free trade, Asean can find a
niche. Maybe not now, but in 10 years, why not?”

Further into the future, Japan and South Korea want an overarching East Asian Free
Trade Area, and everybody—including Cambodia—is clamoring for entry to the
WTO. The wheels of global trade liberalization keep on turning, and only time will
tell whether they carry the world’s economies forward—or squash the world’s poor
underneath.
Bilateral Trade Agreements

Bilateral free trade agreements: An outline of elements, nature and

development implications

In recent years, there has been a growing tendency for many developing countries,
both individually and in groups, to enter into free trade agreements (FTAs) with
developed countries. Experience has shown that such bilateral agreements are not
necessarily the best option for developing countries as under these agreements,
developed countries are better placed to wrest concessions which developing
countries would not make in multilateral trade forums such as the WTO. In warning
of the serious development policy implications of such FTAs, there is need for a
proper policy framework and a proper assessment of costs and benefits before
embarking on such enterprises.

Many developing countries have signed or are negotiating free trade agreements
FTAs) with developed countries or other developing countries (see box next page).
It is generally recognized, however, that bilateral FTAs, especially between a
developing and a developed country, are not the best option and that multilateral
negotiations and agreements are preferable. The reasons for this include:

1. Bilateral agreements usually lead to 'trade diversion', in that the partners divert
away products that may be more cheaply priced in favor of products from the FTA
partner, even if they are not cheaply priced, thus resulting in inefficiency.

2. In an FTA between a developed country and a developing country or countries, the

latter are usually in a weaker bargaining position due to the lack of capacity of their
economies, their weaker political situation, and their weaker negotiating resources.

3. In the World Trade Organization (WTO), the forum in which multilateral trade
negotiations are held, the principles of special and differential treatment, and less than
full reciprocity, are recognized. Thus, developing countries are better able to
negotiate on the basis of non-reciprocity and for non-reciprocal outcomes, in which
they are not obliged to open up their markets (or undertake other obligations) to the
same degree as developed countries. However, these 'development principles' are
usually absent in FTAs, or are only reflected in longer implementation periods for the
developing country. The FTAs are basically on the basis of reciprocity. This 'equal
treatment' of parties that are unequal in capacity is likely to result in unequal
outcomes.

4. The FTAs contain many items that are not the subject of rules in the WTO. Many
North-South FTAs include rules on investment, government procurement and
competition law, which have so far been rejected by developing countries as subjects
for WTO negotiations or rules. Developing countries have also been opposed to
making labor standards and environment standards subjects of discussion in the WTO.
All these topics, however, are now entering 'by the side-door' through the FTAs, even
though the same reasons for developing countries to reject rules on these issues should
apply in FTAs as they do in the WTO.
5. Even where issues are already the subject of rules in the WTO (e.g. intellectual
property and services), there were many 'flexibilities' and options open to developing
countries in interpreting and in implementing obligations in these areas. However,
there are attempts by developed countries to remove these flexibilities for developing
countries in the FTAs. If these attempts succeed, the 'policy space' for developing
countries to pursue development and socio-economic goals would be significantly
reduced.

6. The proliferation of so many agreements also puts pressure on personnel and

financial resources in developing countries and requires a lot of technical expertise
which may be not adequately available, given the large number of agreements and the
limited resources.

As a result of the inefficiency of Bilateral Trade between developed and developing

countries, some developing countries form a bilateral trade agreement amongst
themselves. Example is Zimbabwe which signed a bilateral trade agreement with
some neighboring countries.

These agreements are based on assumptions that free trade and the removal of
regulations on investment will lead to economic growth, reduction of poverty,
increased living standards and employment opportunities.

Zimbabwe currently has five (5) preferential bilateral trade agreements under which
exporters can benefit. However, this does not mean that every good and service move
freely between Zimbabwe and the countries. The tariff is only lifted for certain goods
and services but not others. This is discussed below:

• Zimbabwe and Botswana

• Zimbabwe - Malawi: Implemented in 1995, this is a reciprocal trade
agreement, with 25 percent domestic value added requirements. Arrangements
are characterized Zimbabwe and Namibia
• Zimbabwe and Namibia
• Zimbabwe and South Africa
• Zimbabwe and Mozambique

Zimbabwe - Botswana: Ratified in 1988, reciprocal duty free trade on all products
grown, wholly produced, or manufactured wholly or partly from imported inputs
subject to a 25 percent local content requirements.

Zimbabwe - Namibia: A reciprocal agreement in effect since 1992, subject to rules of

origin which require at least 25 percent local content for manufactured goods and that
Zimbabwe and Namibia should, as exporters, be the last place of substantial
manufacturing. Other eligible products include mineral and vegetable products, live
animals and their products.

Zimbabwe - South Africa: A duty free regime or preferential tariff quota applies to
items including dairy products, potatoes, birds, eggs. Specified types of woven fabric,
for example cotton is subject to concessional tariff rates when they meet the specified
levels of Zimbabwean content: 75 percent in most cases. Most recent version of the
agreement was signed in August 1996 at which time the tariffs and quotas on textile
imports into South Africa were lowered.
Zimbabwe - Mozambique: Signed in January 2004, this agreement becomes
operational on March 1 2005. Its objective is to eliminate tariff and non-tariff barriers
and also to cooperate in customs and trade promotion. The agreement provides for
duty free trade between the two members with the rules of origin specifying a 25
percent domestic value added. Excluded from the arrangement are refined and
unrefined sugar, Coca-Cola/Schweppes soft drinks, firearms, ammunition and
explosives, motor vehicles and cigarettes.

All these Agreements have the same purpose and offer the same benefits under the
same qualifying criteria. They aim to encourage and stimulate trade between
Zimbabwe and the cooperating partner through the elimination of tariffs and other
non-tariff barriers to trade. The agreement allows the Zimbabwean buyer/importer to
purchase goods from the signatory country without paying import duty ( or paying a
small agreed duty rate) as long as the goods in question qualify under the terms of the
agreement and are registered as such with the relevant authorities. (ZIMRA)

Reasons why Countries get involved in Bilateral Free Trade

Agreements.

Unsatisfactory result through multilateral agreements.

Bigger market to attract Foreign Direct Investment (FDI). Money invested
directly from one country to another.
Stronger voice.
Optimization of resources.

Benefits of Bilateral Trade Agreement.

Geographical Proximity (same culture, language, etc.
Lesser member countries, easier to negotiate.
More practical and realistic targets.
Allows LDCs especially non-WTO members opportunity to start liberalizing
Possible to achieve regional cooperation in others areas beyond trade.

Disadvantages of Bilateral Agreements.

Preferential
Trade Diversion
Some too ambitious targets, difficult to implement
Trade diversion instead of trade creation
Wastage of resources (dumping and overlapping)
TRADE CREATION Versus TRADE DIVERSION

Strong emphasis was placed in this approach on the distinction between trade creation
and trade diversion. Trade creation refers to a situation in which the production of
particular goods in country A, which does not have a comparative advantage in that
area, is replaced by the purchase of cheaper goods from country B which does. Trade
diversion, on the other hand, takes place if country A turns from lower cost suppliers
in country C to what are in reality higher cost suppliers in country B, now enjoying an
`artificial' advantage because of a preferential tariff arrangement. Under the trade
integration paradigm, economic integration was held to be economically desirable in
cases where the trade creation effects were greater than trade diversion. In the
literature, this was seen as most likely to occur in situations where:

Trade among co-operating partners was either currently or potentially a large

proportion of their total trade.

Where there was a high level of complementarities in productive structures: A

produced what B needed and vice versa.
STATISTICAL TABLES FOR ABOVE
 NAFTA
Population 433.1 (1000 inhabitants)
Area 21 726 (1000qkm)
Gross domestic product 2005 11 562 Bn euros Exports-to-GDP ratio: 10.0 % in 2005
GDP per capita 2004 24 892 Euros
(IMF, World Economic Outlook) 2002 2003 2004 2005
Real GDP (% growth) 1.6 2.5 4.1 3.4

Current account balance (% of GDP) -4.0 -4.1 -4.9 -5.5

NAFTA MERCHANDISE TRADE WITH THE WORLD EU25 MERCHANDISE TRADE WITH NAFTA
(Bn euros) Imports Exports Balance (Bn euros) Imports Exports Balance

2 000.0 1 755.2 1 807.0

350.0
1 521.5 291.7
1 264.2 282.5
1 500.0 1 155.9 300.0 262.3
1 009.4 228.7
1 000.0 250.0
179.7 189.1
200.0
500.0
150.0
102.7
82.6
100.0
53.8
-500.0
50.0
-491.0 -512.2
-1 000.0 -651.1
2001 2003 2005 2001 2003 2005
Source: IMF (Direction of Trade Statistics) * excl intra EU Trade Source: Eurostat, statistical regime 4

% OF THE WORLD * 2001 2003 2005 % OF EU TOTAL 2001 2003 2005

Imports 30.45 36.55 32.54 Imports 23.26 19.11 16.10
Exports 23.57 26.18 22.26 Exports 31.65 29.86 27.49
EU25 MERCHANDISE TRADE WITH NAFTA BY PRODUCT (2005)
(Mio Euros) Imports Exports Balance
80 000 71 599
70 000
56 371 54 646 54 399
60 000
50 000
40 000 32 952
28 379 26 267
30 000 21 447
14 492 17 641 15 228
20 000 11 324
9 225 5 267 6 318 5 477
10 000 1 444 4 033

Agricultural products Energy Machinery Transport equipment Chemicals Textiles and clothing

Source: Eurostat, statistical regime 4

EU25 TRADE IN SERVICES WITH NAFTA

(Bn Euros) Imports Exports Balance
123.1
116.3 112.8
108.0

8.4 10.3

2003 2004
Source: Eurostat (excluding government services)

EU25 FOREIGN DIRECT INVESTMENT WITH NAFTA

(Bn Euros) Inflows Outflows Balance Inward Stocks

61.4 (Bn Euros) Outward Stocks

60.0 55.0
870.8 865.0
845.0 841.5 849.4
20.0
10.7 7.9

736.6
-5.0
-12.1

-50.7
2002 2003 2004 2002 2003 2004e

Source: Eurostat 2004, estimated FDI stock = stock 2003 + flows 2004
Canada, Mexico, USA.
DG TRADE

15 September 2006
 NAFTA 15-sept-06
EU BILATERAL TRADE AND TRADE WITH THE WORLD DG TRADE

(EU: 25 members, recalculated series since 2001)

Canada, Mexico, USA, Venezuela.

TOTAL MERCHANDISE TRADE, 2001-2005

1. Evolution of the EU's Trade Balance with Nafta
2. Evolution of the NAFTA's Trade Balance

GEOGRAPHIC BREAKDOWN OF TRADE, 2005

3. EU Trade with Main Partners
4. NAFTA's Trade Balance with Main Partners

SECTORAL BREAKDOWN OF TRADE

Sitc Rev3, Sections and Product Grouping

5. European Union, Trade with the World and Nafta, by Sitc Section
6. European Union Imports, by Product Grouping
7. European Union Exports, by Product Grouping
8. Rank of NAFTA in European Union Trade

Harmonized System, Sections

9. EU Trade with the World and EU Trade with Nafta (2005)
 EVOLUTION OF THE EU'S TRADE BALANCE WITH NAFTA
(Mio euro)

European Union, Trade with the World European Union, Trade with ... Nafta
Share of Share of
Yearly % Yearly % Imports + Yearly % Yearly % Imports +
Year Imports Exports Balance Year Imports total EU Exports total EU Balance
change change Exports change change Exports
imports exports
2001 983 443 892 720 -90 723 1 876 164 2001 228 727 23.26 282 508 31.65 53 781 511 234
2002 941 885 -4.2 900 424 0.9 -41 462 1 842 309 2002 205 032 -10.4 21.77 285 149 0.9 31.67 80 116 490 181
2003 940 347 -0.2 878 483 -2.4 -61 864 1 818 830 2003 179 733 -12.3 19.11 262 316 -8.0 29.86 82 584 442 049
2004 1 031 999 9.7 964 652 9.8 -67 347 1 996 652 2004 181 491 1.0 17.59 271 335 3.4 28.13 89 844 452 827
2005 1 176 055 14.0 1 061 836 10.1 -114 219 2 237 891 2005 189 219 4.3 16.09 292 100 7.7 27.51 102 880 481 319

3m 2005 262 361 234 231 -28 130 496 593 3m 2005 43 593 16.62 65 369 27.91 21 776 108 962
3m 2006 328 931 25.4 274 381 17.1 -54 550 603 313 3m 2006* 51 090 17.2 15.53 76 911 17.7 28.03 25 822 128 001
Average Average
annual 4.6 4.4 4.5 annual -4.6 0.8 -1.5
growth growth

European Union, Trade with the World European Union, Trade with ... Nafta
1 400 000 350 000

1 200 000
300 000

1 000 000
250 000

800 000

200 000
600 000

150 000
400 000

100 000
200 000

50 000

-200 000

2001 2002 2003 2004 2005 2001 2002 2003 2004 2005

Imports Exports Balance Imports Exports Balance

World excluding Intra-EU trade and European Union: 25 members.

NAFTA: Canada, Mexico, USA, Venezuela.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

1
15-sept-06
 EVOLUTION OF THE NAFTA'S TRADE BALANCE
(Mio euro)

NAFTA,Trade with the World NAFTA, Trade with the European Union
EU Share EU Share
Yearly % Yearly % Imports + Yearly % Yearly % Imports +
Year Imports Exports Balance Year Imports of total Exports of total Balance
change change Exports change change Exports
imports exports
2001 1 755 231 1 264 228 -491 004 3 019 459 2001 310 563 17.69 200 249 15.84 -110 314 510 812
2002 1 688 222 -3.8 1 149 944 -9.0 -538 278 2 838 166 2002 300 817 -3.1 17.82 172 285 -14.0 14.98 -128 532 473 102
2003 1 521 516 -9.9 1 009 366 -12.2 -512 150 2 530 882 2003 274 552 -8.7 18.04 153 299 -11.0 15.19 -121 253 427 850
2004 1 609 815 5.8 1 043 043 3.3 -566 772 2 652 858 2004 279 943 2.0 17.39 156 805 2.3 15.03 -123 138 436 748
2005 1 807 024 12.3 1 155 933 10.8 -651 092 2 962 957 2005 307 100 9.7 16.99 173 451 10.6 15.01 -133 649 480 552

3m 2005 392 882 256 718 -136 165 649 600 3m 2005 67 947 17.29 40 054 15.60 -27 893 108 001
3m 2006 489 488 24.6 325 687 26.9 -163 801 815 175 3m 2006 81 337 19.7 16.62 48 694 21.6 14.95 -32 643 130 031
Average Average
annual 0.7 -2.2 -0.5 annual -0.3 -3.5 -1.5
growth growth

NAFTA,Trade with the World NAFTA, Trade with the European Union
2 000 000 350 000

300 000

1 500 000
250 000

200 000
1 000 000
150 000

100 000
500 000
50 000

-50 000

-500 000 -100 000

-150 000

-1 000 000
-200 000
2001 2002 2003 2004 2005 2001 2002 2003 2004 2005

Imports Exports Balance Imports Exports Balance

European Union: 25 members.

NAFTA: Canada, Mexico, USA, Venezuela.

Source: IMF (Dots) 2 DG TRADE

15-sept-06
 EU TRADE WITH MAIN PARTNERS

(2005)

The major imports partners The major export partners The major trade partners

Partners Mio euro % Partners Mio euro % Partners Mio euro %

World 1 176 055 100.0 World 1 061 836 100.0 World 2 237 891 100.0

1 USA 163 057 13.9 1 USA 251 657 23.7 1 USA 414 714 18.5
2 China 158 098 13.4 2 Switzerland 81 980 7.7 2 China 209 894 9.4
3 Russia 106 766 9.1 3 Russia 56 445 5.3 3 Russia 163 211 7.3
4 Japan 73 243 6.2 4 China 51 796 4.9 4 Switzerland 148 334 6.6
5 Norway 67 474 5.7 5 Japan 43 663 4.1 5 Japan 116 906 5.2
6 Switzerland 66 354 5.6 6 Turkey 41 849 3.9 6 Norway 101 261 4.5
7 Turkey 33 492 2.8 7 Norway 33 787 3.2 7 Turkey 75 341 3.4
8 Korea 33 326 2.8 8 United Arab Emir. 25 288 2.4 8 Korea 53 456 2.4
9 Taiwan 23 835 2.0 9 Canada 23 681 2.2 9 Canada 40 855 1.8
10 Brazil 23 300 2.0 10 Romania 21 825 2.1 10 India 40 021 1.8
11 Saudi Arabia 22 092 1.9 11 India 21 110 2.0 11 Brazil 39 287 1.8
12 Algeria 20 735 1.8 12 Australia 20 710 2.0 12 Saudi Arabia 37 535 1.7
13 Libya 19 473 1.7 13 Hong Kong 20 434 1.9 13 Romania 37 130 1.7
14 India 18 911 1.6 14 Korea 20 130 1.9 14 Taiwan 36 653 1.6
15 Singapore 18 219 1.5 15 South Africa 18 077 1.7 15 Singapore 35 447 1.6
16 Canada 17 174 1.5 16 Singapore 17 227 1.6 16 United Arab Emir. 35 087 1.6
17 South Africa 16 731 1.4 17 Mexico 16 762 1.6 17 South Africa 34 808 1.6
18 Malaysia 15 905 1.4 18 Brazil 15 987 1.5 18 Algeria 31 150 1.4
19 Romania 15 305 1.3 19 Saudi Arabia 15 443 1.5 19 Hong Kong 31 109 1.4
20 WA_AO 13 761 1.2 20 WA_AO 13 484 1.3 20 Australia 30 182 1.3

NAFTA 189 219 16.1 NAFTA 292 100 27.5 NAFTA 481 319 21.5

EU Imports from … EU Exports to … Imports + Exports

Partner regions Mio euro % Partner regions Mio euro % Partner regions Mio euro %

World 1 176 055 100.0 World 1 061 836 100.0 World 2 237 891 100.0

NAFTA 189 219 16.1 NAFTA 292 100 27.5 NAFTA 481 319 21.5
Latin America 64 201 5.5 Latin America 54 557 5.1 Latin America 118 758 5.3
EU Candidates 58 061 4.9 EU Candidates 81 216 7.6 EU Candidates 139 277 6.2
EFTA 136 648 11.6 EFTA 119 333 11.2 EFTA 255 981 11.4
Medit.Countries* 54 679 4.6 Medit.Countries* 59 822 5.6 Medit.Countries* 114 502 5.1
ASEAN 70 809 6.0 ASEAN 44 966 4.2 ASEAN 115 775 5.2

NAFTA: Canada, Mexico, USA.

Latin America: 20 countries.
EU Candidates: Bulgaria, Croatie, Romania, Turkey
EFTA: Iceland, Norway, Switzerland.
Mediterranean countries *excluding Turkey : Algeria, Cisjordanie Gaza , Egypt, Israel, Jordan, Lebanon, Morocco, Syria, Tunisia.
ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

World excluding Intra-EU trade and European Union: 25 members.

NAFTA: Canada, Mexico, USA, Venezuela.

Source: EUROSTAT (Comext, Statistical regime 4) 3 DG TRADE

15-sept-06
 NAFTA'S TRADE BALANCE WITH MAIN PARTNERS

(2005)

The major import partners The major export partners The major trade partners

Partners Mio euro % Partners Mio euro % Partners Mio euro %

World 1 807 024 100.0 World 1 155 933 100.0 World 2 962 957 100.0

1 EU 307 100 17.0 1 USA 369 227 31.9 1 USA 632 232 21.3
2 USA 263 005 14.6 2 Canada 179 570 15.5 2 EU 480 552 16.2
3 Canada 237 078 13.1 3 EU 173 451 15.0 3 Canada 416 648 14.1
4 China 235 311 13.0 4 Mexico 98 691 8.5 4 China 275 221 9.3
5 Mexico 149 237 8.3 5 Japan 52 448 4.5 5 Mexico 247 928 8.4
6 Japan 130 690 7.2 6 China 39 910 3.5 6 Japan 183 138 6.2
7 Korea 43 851 2.4 7 Korea 24 418 2.1 7 Korea 68 269 2.3
8 Malaysia 33 186 1.8 8 Singapore 17 343 1.5 8 Malaysia 41 909 1.4
9 Venezuela 30 794 1.7 9 Australia 14 264 1.2 9 Brazil 41 606 1.4
10 Brazil 27 763 1.5 10 Hong Kong 14 219 1.2 10 Venezuela 37 612 1.3
11 Saudi Arabia 24 844 1.4 11 Brazil 13 843 1.2 11 Singapore 31 280 1.1
12 Nigeria 20 320 1.1 12 Switzerland 9 368 0.8 12 Saudi Arabia 30 648 1.0
13 Thailand 18 638 1.0 13 Malaysia 8 723 0.8 13 India 25 676 0.9
14 India 18 157 1.0 14 Israel 8 144 0.7 14 Thailand 24 914 0.8
15 Israel 14 688 0.8 15 India 7 519 0.7 15 Hong Kong 23 145 0.8
16 Russia 14 437 0.8 16 Caribbean 7 357 0.6 16 Israel 22 833 0.8
17 Singapore 13 937 0.8 17 United Arab Emir. 7 196 0.6 17 Switzerland 22 446 0.8
18 Switzerland 13 078 0.7 18 Venezuela 6 818 0.6 18 Australia 22 266 0.8
19 Caribbean 12 021 0.7 19 Thailand 6 276 0.5 19 Nigeria 21 706 0.7
20 Algeria 11 812 0.7 20 Philippines 5 806 0.5 20 Caribbean 19 378 0.7

Imports from … Exports to … Imports + Exports

Partner regions Mio euro % Partner regions Mio euro % Partner regions Mio euro %

World 1 807 024 100.0 World 1 155 933 100.0 World 2 962 957 100.0

NAFTA 649 321 35.9 NAFTA 647 488 56.0 NAFTA 1 296 809 43.8
Latin America 260 689 14.4 Latin America 158 323 13.7 Latin America 419 012 14.1
EU Candidates 7 164 0.4 EU Candidates 4 821 0.4 EU Candidates 11 985 0.4
EFTA 23 350 1.3 EFTA 11 877 1.0 EFTA 35 227 1.2
* * *
Medit.Countries 30 685 1.7 Medit.Countries 14 019 1.2 Medit.Countries 44 705 1.5
ASEAN 93 981 5.2 ASEAN 42 292 3.7 ASEAN 136 273 4.6

NAFTA: Canada, Mexico, USA.

Latin America: 20 countries.
EU Candidates: Bulgaria, Croatie, Romania, Turkey
EFTA: Iceland, Norway, Switzerland.
Mediterranean countries *excluding Turkey : Algeria, Cisjordanie Gaza , Egypt, Israel, Jordan, Lebanon, Morocco, Syria, Tunisia.
ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

European Union: 25 members.

NAFTA: Canada, Mexico, USA, Venezuela.

Source: IMF (Dots) 4 DG TRADE

15-sept-06
 EUROPEAN UNION, TRADE WITH THE WORLD AND NAFTA, BY SITC SECTION
(2005)

European Union, Imports from the World European Union, Imports from … Nafta
Share of
Products (Sitc Sections) Products (Sitc Sections)
Mio euro % Mio euro % total EU
by order of importance by order of importance imports

TOTAL 1 176 055 100.0 TOTAL 189 219 100.0 16.1

Machinery and transport equipment 375 952 32.0 Machinery and transport equipment 84 798 44.8 22.6
Mineral fuels, lubricants and rel. Materials 249 695 21.2 Chemicals and related prod., n.e.s. 32 981 17.4 35.1
Miscell. manuf. Articles 166 967 14.2 Miscell. manuf. Articles 25 450 13.5 15.2
Manuf goods classif. chiefly by material 116 362 9.9 Manuf goods classif. chiefly by material 12 239 6.5 10.5
Chemicals and related prod., n.e.s. 93 872 8.0 Crude materials inedible, except fuels 8 993 4.8 19.6
Food and live animals 54 653 4.6 Commodit. and transactions n.e.c. 8 850 4.7 34.4
Crude materials inedible, except fuels 45 851 3.9 Mineral fuels, lubricants and rel. Materials 6 327 3.3 2.5
Commodit. and transactions n.e.c. 25 720 2.2 Food and live animals 5 298 2.8 9.7
Beverages and tobacco 4 778 0.4 Beverages and tobacco 1 246 0.7 26.1
Animal and vegetable oils, fats and waxes 4 093 0.3 Animal and vegetable oils, fats and waxes 111 0.1 2.7

European Union, Exports to the World European Union, Exports to ... Nafta
Share of
Products (Sitc Sections) Products (Sitc Sections)
Mio euro % Mio euro % total EU
by order of importance by order of importance exports

TOTAL 1 061 836 100.0 TOTAL 292 100 100.0 27.5

Machinery and transport equipment 478 928 45.1 Machinery and transport equipment 126 369 43.3 26.4
Chemicals and related prod., n.e.s. 163 339 15.4 Chemicals and related prod., n.e.s. 54 454 18.6 33.3
Manuf goods classif. chiefly by material 133 539 12.6 Miscell. manuf. Articles 34 429 11.8 28.8
Miscell. manuf. Articles 119 503 11.3 Manuf goods classif. chiefly by material 29 224 10.0 21.9
Mineral fuels, lubricants and rel. Materials 38 847 3.7 Mineral fuels, lubricants and rel. Materials 17 855 6.1 46.0
Food and live animals 35 126 3.3 Beverages and tobacco 7 148 2.4 44.4
Commodit. and transactions n.e.c. 28 663 2.7 Commodit. and transactions n.e.c. 5 030 1.7 17.5
Crude materials inedible, except fuels 19 440 1.8 Food and live animals 4 949 1.7 14.1
Beverages and tobacco 16 111 1.5 Crude materials inedible, except fuels 2 935 1.0 15.1
Animal and vegetable oils, fats and waxes 2 420 0.2 Animal and vegetable oils, fats and waxes 798 0.3 33.0
World excluding Intra-EU trade and European Union: 25 members.

NAFTA: Canada, Mexico, USA, Venezuela.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

15-sept-06
5
 EUROPEAN UNION IMPORTS, BY PRODUCT GROUPING
(Mio euro)
European Union, Imports from the World European Union, Imports from ... Nafta
Share of
SITC Rev.3 SITC Rev.3
2001 % 2003 % 2005 % 2001 % 2003 % 2005 % total EU
Product Groups Product Groups
imports

TOTAL 983 443 100.0 940 347 100.0 1 176 055 100.0 TOTAL 228 727 100.0 179 733 100.0 189 219 100.0 16.09
Primary Products 284 210 28.9 274 641 29.2 383 646 32.6 Primary Products 26 762 11.7 20 930 11.6 24 290 12.8 6.33
of which: of which:
Agricultural prod. 81 060 8.2 78 499 8.3 80 932 6.9 Agricultural prod. 12 250 5.4 10 339 5.8 9 239 4.9 11.42
Energy 155 904 15.9 155 826 16.6 249 695 21.2 Energy 4 382 1.9 3 199 1.8 6 327 3.3 2.53
Manuf. Products 667 914 67.9 634 832 67.5 728 577 62.0 Manuf. Products 195 955 85.7 154 548 86.0 153 153 80.9 21.02
of which: of which:
Machinery 262 923 26.7 233 724 24.9 277 426 23.6 Machinery 84 897 37.1 57 155 31.8 56 424 29.8 20.34
Transport equipm 89 425 9.1 92 898 9.9 98 526 8.4 Transport equipm 37 115 16.2 33 254 18.5 28 374 15.0 28.80
of which: of which:
Automotive prod. 34 734 3.5 38 579 4.1 44 010 3.7 Automotive prod. 8 332 3.6 8 259 4.6 7 391 3.9 16.79
Chemicals 76 880 7.8 80 360 8.5 93 872 8.0 Chemicals 30 835 13.5 30 790 17.1 32 981 17.4 35.13
Textiles and cloth. 67 220 6.8 66 680 7.1 70 415 6.0 Textiles and cloth. 2 281 1.0 1 555 0.9 1 445 0.8 2.05

Structure of Imports (%)

from the World from ... Nafta

30.0 40.0
25.0 35.0
30.0
20.0
25.0
15.0 20.0
10.0 15.0
10.0
5.0
5.0

2001 2003 2005 2001 2003 2005

Agricultural prod. Energy Machinery Agricultural prod. Energy Machinery

Transport equipm Automotive prod. Chemicals Transport equipm Automotive prod. Chemicals
Textiles and cloth. Textiles and cloth.

World excluding Intra-EU trade and European Union: 25 members.

NAFTA: Canada, Mexico, USA, Venezuela.

Source : EUROSTAT (Comext, Statistical regime 4) DG TRADE

Agricultural prod.: food&live animals incl.fish, beverages&tobacco, hides, skins&furskins, raw, oil seeds&oleaginous fruits, natural rubber..., cork&wood, silk, cotton, jute&other textile bast fibres..., veget.textile fibres (other than 15-sept-06
cotton)..., wool, crude animal&vegetable materials, oil, fat Energy: mineral fuels etc Manuf.products: chemicals,
6 basic manuf.excl.non-ferrous met, machines, transport equip, misc.manuf.
 EUROPEAN UNION EXPORTS, BY PRODUCT GROUPING
(Mio euro)
European Union, Exports to the World European Union, Exports to ... Nafta
Share of
SITC Rev.3 SITC Rev.3
2001 % 2003 % 2005 % 2001 % 2003 % 2005 % total EU
Product Groups Product Groups
exports

TOTAL 892 720 100.0 878 483 100.0 1 061 836 100.0 TOTAL 282 508 100.0 262 316 100.0 292 100 100.0 27.51
Primary Products 99 252 11.1 98 404 11.2 125 129 11.8 Primary Products 28 100 9.9 28 038 10.7 37 559 12.9 30.02
of which: of which:
Agricultural prod. 58 969 6.6 58 331 6.6 61 819 5.8 Agricultural prod. 13 311 4.7 13 946 5.3 14 490 5.0 23.44
Energy 22 351 2.5 22 856 2.6 38 847 3.7 Energy 10 010 3.5 10 632 4.1 17 855 6.1 45.96
Manuf. Products 775 305 86.8 760 712 86.6 882 125 83.1 Manuf. Products 249 171 88.2 229 118 87.3 240 604 82.4 27.28
of which: of which:
Machinery 268 866 30.1 248 408 28.3 308 796 29.1 Machinery 78 789 27.9 63 762 24.3 71 646 24.5 23.20
Transport equipm 145 563 16.3 146 766 16.7 167 386 15.8 Transport equipm 60 002 21.2 55 108 21.0 54 643 18.7 32.64
of which: of which:
Automotive prod. 83 954 9.4 93 941 10.7 107 822 10.2 Automotive prod. 34 934 12.4 39 392 15.0 41 053 14.1 38.07
Chemicals 131 133 14.7 142 377 16.2 163 339 15.4 Chemicals 44 940 15.9 52 507 20.0 54 454 18.6 33.34
Textiles and cloth. 35 923 4.0 33 882 3.9 33 003 3.1 Textiles and cloth. 7 147 2.5 5 938 2.3 5 480 1.9 16.61

Structure of Exports (%)

to the World to ... NAFTA

35.0 30.0
30.0 25.0
25.0
20.0
20.0
15.0
15.0
10.0
10.0
5.0 5.0

2001 2003 2005 2001 2003 2005

Agricultural prod. Energy Machinery Agricultural prod. Energy Machinery

Transport equipm Automotive prod. Chemicals Transport equipm Automotive prod. Chemicals
Textiles and cloth. Textiles and cloth.

World excluding Intra-EU trade and European Union: 25 members.

NAFTA: Canada, Mexico, USA, Venezuela.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

Agricultural prod.: food&live animals incl.fish, beverages&tobacco, hides, skins&furskins, raw, oil seeds&oleaginous fruits, natural rubber..., cork&wood, silk, cotton, jute&other textile bast fibres..., veget.textile fibres (other than 15-sept-06
cotton)..., wool, crude animal&vegetable materials, oil, fat Energy: mineral fuels etc Manuf.products: chemicals,
7 basic manuf.excl.non-ferrous met, machines, transport equip, misc.manuf.
 RANK OF NAFTA IN EUROPEAN UNION TRADE

(2005)

European Union, Imports from ... Nafta European Union, Exports to ... Nafta
Share of Share of
SITC Rev.3 SITC Rev.3
Product Groups
Mio euro total EU %
Product Groups
Mio euro total EU % Balance
imports exports

TOTAL 189 219 16.09 100.0 TOTAL 292 100 27.51 100.0 102 880

Agricultural products 9 239 11.42 4.9 Agricultural products 14 490 23.44 5.0 5 252
Energy 6 327 2.53 3.3 Energy 17 855 45.96 6.1 11 528
Non-agricultural raw materials 2 794 2.19 1.5 Non-agricultural raw materials 521 49.47 0.2 -2 273
Office/telecom. Equipment 22 206 13.84 11.7 Office/telecom. Equipment 15 973 16.80 5.5 -6 233
Power/non-electrical mach. 26 921 37.21 14.2 Power/non-electrical mach. 43 706 26.65 15.0 16 784
Transport equipment 28 374 28.80 15.0 Transport equipment 54 643 32.64 18.7 26 269
Chemicals 32 981 35.13 17.4 Chemicals 54 454 33.34 18.6 21 474
Textiles and clothing 1 445 2.05 0.8 Textiles and clothing 5 480 16.61 1.9 4 035
Iron and steel 1 035 6.68 0.5 Iron and steel 4 914 23.23 1.7 3 879
Share by products in EU 25 Total Trade excluding Intra-EU trade.

EU Trade with ... Nafta

Agricultural Non-agricultural Office/telecom. Power/non- Transport Textiles and
products Energy raw materials Equipment electrical mach. equipment Chemicals clothing Iron and steel
60 000 54 643 54 454

50 000
43 706

40 000
32 981
26 921 28 374
30 000 26 269
22 206 21 474
17 855 16 784
20 000 14 490 15 973
11 528
9 239
10 000 5 252 6 327 5 480 4 035 4 914 3 879
2 794 1 445 1 035
521
0
-2 273
-10 000 -6 233

Imports Exports Balance

NAFTA: Canada, Mexico, USA, Venezuela.

Source: EUROSTAT (Comext, Statistical regime 4) 8 DG TRADE

Agricultural prod.: food&live animals incl.fish, beverages&tobacco, hides, skins&furskins, raw, oil seeds&oleaginous fruits, natural rubber..., cork&wood, silk, cotton, jute&other textile bast fibres..., veget.textile fibres (other than 15-sept-06
cotton)..., wool, crude animal&vegetable materials, oil, fat Energy: mineral fuels etc Manuf.products: chemicals, basic manuf.excl.non-ferrous met, machines, transport equip, misc.manuf.
 EU TRADE WITH THE WORLD AND EU TRADE WITH NAFTA (2005)
(Ranking by Trade Flows in 2005)

EU Imports from … EU Exports to … EU Balance with …

Harmonized Nafta Harmonized Nafta Harmonized

System System System
World Share of World Share of World Nafta
Mio euro % total EU Mio euro % total EU
Sections: Sections: Sections:
imports exports

TOTAL 1 176 055 189 219 100.0 16.09 TOTAL 1 061 836 292 100 100.0 27.51 TOTAL -114 219 102 880

TDC XVI 286 987 57 743 30.5 20.12 TDC XVI 324 117 74 171 25.4 22.88 TDC VI 60 413 21 841
TDC XVII 95 253 31 980 16.9 33.57 TDC XVII 161 947 53 069 18.2 32.77 TDC XVII 66 694 21 089
TDC VI 86 790 30 596 16.2 35.25 TDC VI 147 203 52 438 18.0 35.62 TDC XVI 37 130 16 428
TDC XVIII 45 014 18 370 9.7 40.81 TDC XVIII 51 712 19 386 6.6 37.49 TDC V -242 486 9 279
TDC V 285 197 9 107 4.8 3.19 TDC V 42 712 18 386 6.3 43.05 TDC XV 2 109 9 080
TDC XV 68 868 6 538 3.5 9.49 TDC XV 70 977 15 618 5.3 22.00 TDC IV 7 857 7 143
TDC VII 29 488 6 133 3.2 20.80 TDC IV 33 623 9 991 3.4 29.71 TDC XI -36 741 4 262
TDC X 13 670 4 820 2.5 35.26 TDC VII 41 346 7 462 2.6 18.05 TDC XIII 7 008 3 240
TDC II 27 449 4 181 2.2 15.23 TDC XI 36 315 5 775 2.0 15.90 TDC XX -11 095 2 651
TDC XIV 29 696 3 644 1.9 12.27 TDC XIV 28 397 5 303 1.8 18.68 TDC XIV -1 300 1 659
TDC IV 25 766 2 848 1.5 11.05 TDC XX 18 219 4 522 1.5 24.82 TDC XII -8 085 1 512
TDC XXI 3 119 2 103 1.1 67.44 TDC XIII 15 228 4 497 1.5 29.53 TDC VII 11 858 1 329
TDC XX 29 314 1 871 1.0 6.38 TDC X 24 110 4 296 1.5 17.82 TDC VIII -1 178 1 116
TDC XI 73 056 1 513 0.8 2.07 TDC XXI 4 279 2 734 0.9 63.90 TDC XVIII 6 698 1 016
TDC IX 11 619 1 340 0.7 11.53 TDC IX 8 387 2 233 0.8 26.63 TDC IX -3 233 893
TDC I 17 041 1 294 0.7 7.59 TDC XII 5 824 1 629 0.6 27.97 TDC III -1 432 693
TDC XIII 8 220 1 257 0.7 15.29 TDC II 10 472 1 584 0.5 15.12 TDC XXI 1 160 631
TDC VIII 10 007 412 0.2 4.12 TDC VIII 8 829 1 527 0.5 17.30 TDC XIX 999 251
TDC XIX 705 302 0.2 42.82 TDC I 12 370 1 450 0.5 11.72 TDC I -4 671 156
TDC XII 13 910 116 0.1 0.84 TDC III 2 492 803 0.3 32.24 TDC X 10 440 -524
TDC III 3 924 110 0.1 2.81 TDC XIX 1 704 552 0.2 32.42 TDC II -16 976 -2 597

Labels of TDC sections: TDC XI Ch.50-63 Textiles and textile articles

TDC I Ch.01-05 Live animals; animal products TDC XII Ch. 64-67 Footwear, headgear, umbrellas, sun umbrellas, walking-sticks
TDC II Ch.06-14 Vegetable products TDC XIII Ch.68-70 Articles of stone, plaster, cement, asbestos, mica or similar
TDC III Ch.15 Animal or vegetable fats and oils and their cleavage products TDC XIV Ch.71 Natural or cultured pearls, precious or semi-precious stones…
TDC IV Ch.16-24 Prepared foodstuffs; beverages, spirits and vinegar; tobacco ... TDC XV Ch.72-83 Base metals and articles of base metal
TDC V Ch.25-27 Mineral Products TDC XVI Ch.84-85 Machinery and mechanical appliances; electrical equipment; parts
TDC VI Ch.28-38 Products of the chemical or allied industries TDC XVII Ch.86-89 Vehicles, aircraft, vessels and associated transport equipment
TDC VII Ch.39-40 Plastics and articles thereoof animal gut (other than silkworm gut) TDC XVIII Ch.90-92 Optical, photo, cinema, measuring, checking, precision instrum…
TDC VIII Ch.41-43 Raw hides and skins, leathematerials; basketware and wickerwork TDC XIX Ch. 93 Arms and ammunition; parts and accessories thereof
TDC IX Ch.44-46 Wood and articles of wood; wood charcoal; cork and articles of TDC XX Ch.94-96 Miscellaneous manufactured articles
TDC X Ch.47-49 Pulp of wood or of other fibrous cellulosic material; paper or paperboard TDC XXI Ch.97 Works of art, collectors’ pieces and antiques excl.chapter 99 other products
World excluding Intra-EU trade and European Union: 25 members.

NAFTA: Canada, Mexico, USA, Venezuela.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

9
15-sept-06
DONNEES GRAPHIQUES SUR LES SERVICES
Graph non affiché pour ces régions:
#REF! 235926 World
USA 214728 EFTA
Switzerland 77635 NAFTA
Japan 29080 APEC
Other A. ASEM
 EC REGIONAL TRADE AGREEMENTS
Updated on 04/12/2006

Tables I and II list all preferential trade agreements that the EC has notified under either Article XXIV of the GATT or Article V of the GATS
and where the GATT/WTO notification has not been overtaken by later notifications of successor agreements.
Table III lists similar agreements that are in force, but have not been notified.
Table IV lists preferential trade agreements for which the EC has requested a waiver from WTO MFN obligations.

I. Agreements notified under GATT Article XXIV (Free Trade Areas and Customs Unions covering Trade in Goods)

Date of
Date of
Nature of Entry Status of GATT/WTO
Partners OJ Reference Notification to Comments
Agreement into examination
GATT/WTO
Force

European Community

EC Member States Treaty of Rome 01.01.58 24.04.57 Examination concluded

(EC12) in 1957. Subsequent
accessions of
Denmark/Ireland/UK,
Greece and Portugal/
Spain were also all
notified and examined.
EC - Accession of C/241, 29.08.94 01.01.95 19.01.95 Consultations on draft
Austria, Finland report
and Sweden
(EC15)
EC – Accession of L/236, 23.09.03 01.05.04 26.04.04 Under factual
Cyprus, Czech examination
Republic, Estonia, (Pending satisfactory
Hungary, Latvia, resolution of a couple of
Lithuania, Malta, outstanding issues.)
Poland, Slovakia,
Slovenia (EC25)
 Date of
Date of
Nature of Entry Status of GATT/WTO
Partners OJ Reference Notification to Comments
Agreement into examination
GATT/WTO
Force

Customs Union

Andorra Exchange of L/374, 31.12.90 01.07.91 25.02.98 Factual examination Customs union for
Letters concluded industrial products only

Turkey Decision 1/95 of L/35, 13.,2.96 31.12.95 22.12.95 Factual examination Final phase of customs
the EC-Turkey concluded union
Association (industrial products only)
Council

Free Trade Agreements

(a) Europe

Bulgaria Europe L/358, 31.12.94 31.12.93 23.12.94 Factual examination Provisions first applied
Agreement concluded under Interim Agreement

Romania Europe L/357, 31.12.94 01.05.93 23.12.94 Factual examination Provisions first applied
Agreement concluded under Interim Agreement

Denmark (Faroe Free Trade L/53, 22.2.97 01.01.97 19.02.97 Factual examination Replaces earlier (1991)
Islands) Agreement concluded trade agreement
Switzerland Free Trade L/300, 31.12.72 01.01.73 27.10.72 Working Party report FTA also covered
Agreement adopted 19.10.73 Liechtenstein, which now
participates in EEA
Former Yugoslav Stabilisation and L/084, 20.03.04 23.10.01 Factual examination Provisions first applied
Republic of Association L/085, 23.03.04 01.05.04 (notification of concluded under Interim Agreement.
Macedonia Agreements C/213e, 31.07.01 the Interim
Agreement on
Trade and Trade-
related Matters)
Croatia Stabilisation and L/26, 25.01.05 Factual examination Provisions first applied
Association 01.02.05 20.12.02 concluded under Interim Agreement.
Agreements (notification of
the Interim
Agreement on
Trade and Trade-
related Matters)

(b) Mediterranean

Algeria Association Factual examination not Euro-Mediterranean

Agreement L/265, 10.10.05 01.09.05 24.07.06 started Agreement replaces co-
operation agreement
(L/263, 27.09.78) notified
to GATT on 28.07.76
(report adopted 11.11.77)
Egypt Association L/345, 31.12.03 01.6.04 04.10.04 Factual examination not Euro-Mediterranean
Agreement started Agreement; replaces co-
operation agreement
(L/266, 27.09.78) notified
to GATT on 15.07.77
(report adopted 17.05.78)
Israel Association L/147, 21.06.00 01.06.00 20.09.00 Factual examination Euro-Mediterranean
Agreement concluded Agreement; trade
provisions initially
applied under Interim
(1995) Agreement
Jordan Association L/129, 15.05.02 01.05.02 20.12.02 Factual examination Euro-Mediterranean
Agreement concluded Agreement, signed on
24.11.97
Lebanon Interim L/262, 30.09.02 01.03.03 04.06.03 Under factual Euro-Mediterranean
Agreement examination Agreement signed on
17.06.02; replaces
cooperation agreement
(L/267, 27.09.78) notified
to GATT on 15.07.77
(report adopted 17.05.78)
Morocco Association L/70, 18.03.00 01.03.00 13.10.00 Factual examination Euro-Mediterranean
Agreement concluded Agreement

Palestinian Association L/187, 16.07.97 01.07.97 30.06.97 Factual examination not Interim Euro-
Authority Agreement started Mediterranean
Agreement
Syria Co-operation L/269, 27.09.78 01.07.77 15.07.77 Working Party report Euro-Mediterranean
Agreement adopted 17.05.78 Agreement signed in
October 2004. It has not
entered into force yet.
Tunisia Association L/97, 30.03.98 01.03.98 23.03.99 Factual examination Euro-Mediterranean
Agreement concluded Agreement
 (c) Others

Certain Overseas Association 1.1.071 14.12.70 Working Party Association of the

Countries and Agreement reported adopted Overseas Countries and
Territories 09.11.71 Territories, as foreseen
(OCT/PTOM II) under Part Four of the
Treaty of Rome
Chile Association L/352, 30.12.02 01.02.03 03.02.04 Factual examination Association Agreement
Agreement, and L/38, 10.02.05 concluded signed in November
Additional 2002.
Protocol
Mexico Economic L/276, 28.10.00 01.07.00 25.07.00 Factual examination EC-Mexico free trade
Partnership, L/157, 30.06.00 concluded area in March 2000, in
Political L/245, 30.09.00 the context of global
Coordination and L/293, 16.09.04 agreement signed in
Cooperation December 1997.
Agreement Decisions 2/2000 &
3/2004 of the EC-Mexico
Joint Council
South Africa Trade, L/311, 04.12.99 01.01.00 02.11.00 Factual examination not Under an Exchange of
Development and started Letters, the provisions
Co-operation establishing an FTA in
Agreement Goods are applied
provisionally from
01.01.00 pending entry
into force of the full
agreement.
II. Agreements notified under GATS Article V (Regional Economic Integration Agreements covering Trade in Services)

Date of
Date of
Nature of Entry Status of WTO
Partners OJ Reference Notification to Comments
Agreement into Examination
WTO
Force

European Community

EC Member Treaty of Rome - 01.01.58 10.11.95 Factual examination

States (EC 12) concluded

EC 15 C/241, 29.08.94 01.01.95 19.01.95 Consultation on draft

Enlargement report

EC 25 L/236, 23.09.03 01.05.04 26.04.04 Factual examination not

Enlargement started
 Europe

Iceland, European L/1, 03.01.94 01.01.94 10.10.96 Factual examination EEA replaces previous
Liechtenstein, Economic Area concluded FTA agreements with
Norway these countries (L/300-
301, 31.12.72 and L/171,
27.06.73) which were
notified to GATT on
27.10.72, 24.11.72 and
13.07.73. (reports
adopted on 19.10.73 and
28.03.74

Bulgaria Europe L/358, 31.12.94 01.02.95 25.04.97 Factual examination

Agreement concluded

Romania Europe L/357, 31.12.94 01.02.95 09.10.96 Factual examination Europe Agreement
Agreement concluded
 Others

Chile Association L/352, 30.12.02 01.03.05 28.10.05 Factual examination not

Agreement L/38, 10.02.05 started
Mexico Economic L/276, 28.10.00 01.10.00 21.06.02 Under factual examination Decision 4/2004 of
Partnership, L/192, 22.07.05 EC-Mexico Joint
Political Council, in context
Coordination of EC-Mexico
and Economic
Cooperation Partnership, Political
Agreement Coordination and
Cooperation
Agreement signed
8.12.1997
III. Agreements not notified to the WTO (Trade in Goods)

Nature of OJ Date of Date of Entry

Partners Comments
Agreement Reference Signature into Force

San Marino Customs Union L/359, 27.11.92 01.12.92 Interim agreement, pending entry into force of
09.12.92 Customs Union also signed on 16.12.91. MFN
exemption for customs regime with Italy
recognised by the GATT Havana Conference

IV. Agreements for which the EC has received a waiver in WTO

Date of
Date of
Nature of Entry
Partners OJ Reference Waiver WTO status Comments
Agreement into
request
Force
ACP countries Partnership L/317, 15.12.00 01.03.00 29.02.00 Waiver granted on Successor to Lomé Convention.
(77) Agreement 14.11.01 (WTO Trade provisions, providing for non-
(Cotonou document reciprocal preferential access to the EC
Agreement) WT/MIN(01)/15) market, carried over from Lomé and applied
since 01.03.00. Negotiations to establish
Economic Partnership Agreements (EPAs)
began in September 2002 to establish FTAs
in the sense of GATT Article XXIV.
 LDCS

Area 21,163 (1000qkm)

Gross domestic product 2005 231 Bn euros Exports-to-GDP ratio: 24.5 % in 2005

(IMF, World Economic Outlook) 2002 2003 2004 2005

Real GDP (% growth) 7.1 7.1 6.8

Current account balance (% of GDP) -4.3 -4.4 -3.1 -3.1

LDCS MERCHANDISE TRADE WITH THE WORLD EU25 MERCHANDISE TRADE WITH LDCS
(Bn euros) Imports Exports Balance (Bn euros) Imports Exports Balance

80.0 70.1 18.0 16.2

70.0 14.5 15.0
52.3 56.7 16.0 13.3 13.2 13.0
60.0 50.3 14.0
50.0 37.9 36.3 12.0
40.0 10.0
30.0 8.0
20.0 6.0
10.0 4.0
2.0
-10.0
-20.0 -12.4 -2.0
-16.0 -13.4 -0.2
-30.0 -4.0 -1.3 -1.2
2001 2003 2005 2001 2003 2005
Source: IMF (Direction of Trade Statistics) * excl intra EU Trade Source: Eurostat, statistical regime 4

% OF THE WORLD * 2001 2003 2005 % OF EU TOTAL 2001 2003 2005

Imports 0.87 1.26 1.26 Imports 1.48 1.41 1.38
Exports 0.71 0.94 1.09 Exports 1.49 1.48 1.41
EU25 MERCHANDISE TRADE WITH LDCS BY PRODUCT (2005)
(Mio Euros) Imports Exports Balance
6,000 4,664
4,505 4,395
5,000 3,912
4,000 2,809
3,000 2,219 2,251
1,261 1,714 1,508
2,000 870 991
1,000 110 206 276

-1,000
-2,000 -590
-3,000
-4,000 -3,042
-5,000
-4,389
Agricultural products Energy Machinery Transport equipment Chemicals Textiles and clothing

Source: Eurostat, statistical regime 4

Afghanistan, Angola, Bangladesh, Benin, Bhutan, Burkina Faso, Burundi, Cambodia, Cape Verde, Central Africa, Chad, Comoros, Congo (Dem Rep), Djibouti, Equatorial
DG TRADE
Guinea, Eritrea, Ethiopia, Gambia, Guinea, Guinea-Bissau, Haiti, Kiribati, Lao Dem Rep, Lesotho, Liberia, Madagascar, Malawi, Maldives, Mali, Mauritania, Mozambique,
Myanmar, Nepal, Niger, Rwanda, Samoa, Sao Tome Principe, Senegal, Sierra Leone, Solomon Islands, Somalia, Sudan, Tanzania, Togo, Tuvalu, Uganda, Vanuatu, Yemen,
15 September 2006
Zambia.
 ASEAN
Population 544.4 (1000 inhabitants)
Area 4 480 (1000qkm)
Gross domestic product 2005 693 Bn euros Exports-to-GDP ratio: 75.0 % in 2005
GDP per capita 2004 1 171 Euros
(IMF, World Economic Outlook) 2002 2003 2004 2005
Real GDP (% growth) 4.8 5.2 5.5 5.9

Current account balance (% of GDP) 6.4 7.6 7.0 6.7

ASEAN MERCHANDISE TRADE WITH THE WORLD EU25 MERCHANDISE TRADE WITH ASEAN
(Bn euros) Imports Exports Balance (Bn euros) Imports Exports Balance

600.0
519.3 80.0 70.8 65.8 70.7
500.0 449.2 60.0
412.8 400.8 43.8 45.0
39.2
400.0 358.2 333.7 40.0

300.0 20.0

200.0

54.6 67.1 70.2

100.0 -20.0

-40.0 -26.9 -26.5 -25.8

2001 2003 2005 2001 2003 2005
Source: IMF (Direction of Trade Statistics) * excl intra EU Trade Source: Eurostat, statistical regime 4

% OF THE WORLD * 2001 2003 2005 % OF EU TOTAL 2001 2003 2005

Imports 6.21 8.02 8.09 Imports 7.20 6.99 6.02
Exports 7.69 10.40 10.00 Exports 4.91 4.47 4.24
EU25 MERCHANDISE TRADE WITH ASEAN BY PRODUCT (2005)
(Mio Euros) Imports Exports Balance
35 000 31 497
30 000
25 000 19 960
20 000
15 000
7 523 6 450 6 241 5 210
10 000
3 126 4 727
5 000
2 193 1 492 618 1 600 624

-5 000 -874 -208

-10 000 -5 330 -4 586
-15 000 -11 537
Agricultural products Energy Machinery Transport equipment Chemicals Textiles and clothing

Source: Eurostat, statistical regime 4

EU25 TRADE IN SERVICES WITH ASEAN ASEAN SHARE OF EU25 TRADE IN SERVICES
(Bn Euros) Imports Exports Balance 4.3%
14.3 Imports+Exports
12.1 12.1 12.2
2004
43.7% 34.8% ASEAN
USA
2.1 Switzerland
0.1
Japan
2003 2004 Other
4.7% 12.6%
Source: Eurostat (excluding government services)

EU25 FOREIGN DIRECT INVESTMENT WITH ASEAN

(Bn Euros) Inflows Outflows Balance Inward Stocks
(Bn Euros) Outward Stocks
7.6
76.1
71.6
61.4
4.9 4.6 4.6
4.3
3.3
2.7
1.9 17.6 17.7 20.3

0.3

2002 2003 2004 2002 2003 2004e

Source: Eurostat 2004, estimated FDI stock = stock 2003 + flows 2004
Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.
DG TRADE

15 September 2006
 ASEAN 15-sept-06
EU BILATERAL TRADE AND TRADE WITH THE WORLD DG TRADE

(EU: 25 members, recalculated series since 2001)

Brunei, Cambodia, Indonesia, Laos, Malaysia,

Myanmar, Philippines, Singapore, Thailand,
Vietnam.

TOTAL MERCHANDISE TRADE, 2001-2005

1. Evolution of the EU's Trade Balance with Asean
2. Evolution of the ASEAN's Trade Balance

GEOGRAPHIC BREAKDOWN OF TRADE, 2005

3. EU Trade with Main Partners
4. ASEAN's Trade Balance with Main Partners

SECTORAL BREAKDOWN OF TRADE

Sitc Rev3, Sections and Product Grouping

5. European Union, Trade with the World and Asean, by Sitc Sectio
6. European Union Imports, by Product Grouping
7. European Union Exports, by Product Grouping
8. Rank of ASEAN in European Union Trade

Harmonized System, Sections

9. EU Trade with the World and EU Trade with Asean (2005)
 EVOLUTION OF THE EU'S TRADE BALANCE WITH ASEAN
(Mio euro)

European Union, Trade with the World European Union, Trade with ... Asean
Share of Share of
Yearly % Yearly % Imports + Yearly % Yearly % Imports +
Year Imports Exports Balance Year Imports total EU Exports total EU Balance
change change Exports change change Exports
imports exports
2001 983 443 892 720 -90 723 1 876 164 2001 70 791 7.20 43 842 4.91 -26 949 114 633
2002 941 885 -4.2 900 424 0.9 -41 462 1 842 309 2002 67 731 -4.3 7.19 40 513 -7.6 4.50 -27 218 108 244
2003 940 347 -0.2 878 483 -2.4 -61 864 1 818 830 2003 65 770 -2.9 6.99 39 247 -3.1 4.47 -26 523 105 017
2004 1 031 999 9.7 964 652 9.8 -67 347 1 996 652 2004 69 084 5.0 6.69 42 880 9.3 4.45 -26 204 111 964
2005 1 176 055 14.0 1 061 836 10.1 -114 219 2 237 891 2005 70 809 2.5 6.02 44 966 4.9 4.23 -25 842 115 775

3m 2005 262 361 234 231 -28 130 496 593 3m 2005 16 201 6.18 9 994 4.27 -6 207 26 195
3m 2006 328 931 25.4 274 381 17.1 -54 550 603 313 3m 2006* 19 660 21.4 5.98 11 493 15.0 4.19 -8 167 31 153
Average Average
annual 4.6 4.4 4.5 annual 0.0 0.6 0.2
growth growth

European Union, Trade with the World European Union, Trade with ... Asean
1 400 000 80 000

1 200 000
60 000

1 000 000

40 000
800 000

600 000 20 000

400 000

200 000

-20 000

-200 000 -40 000

2001 2002 2003 2004 2005 2001 2002 2003 2004 2005

Imports Exports Balance Imports Exports Balance

World excluding Intra-EU trade and European Union: 25 members.

ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

1
15-sept-06
 EVOLUTION OF THE ASEAN'S TRADE BALANCE
(Mio euro)

ASEAN,Trade with the World ASEAN, Trade with the European Union
EU Share EU Share
Yearly % Yearly % Imports + Yearly % Yearly % Imports +
Year Imports Exports Balance Year Imports of total Exports of total Balance
change change Exports change change Exports
imports exports
2001 358 152 412 753 54 601 770 905 2001 45 575 12.73 65 469 15.86 19 894 111 044
2002 355 069 -0.9 409 756 -0.7 54 687 764 825 2002 42 305 -7.2 11.91 61 320 -6.3 14.97 19 015 103 625
2003 333 715 -6.0 400 831 -2.2 67 116 734 546 2003 39 054 -7.7 11.70 57 496 -6.2 14.34 18 442 96 550
2004 382 487 14.6 440 557 9.9 58 070 823 044 2004 45 545 16.6 11.91 63 921 11.2 14.51 18 376 109 466
2005 449 152 17.4 519 332 17.9 70 180 968 484 2005 47 526 4.3 10.58 69 478 8.7 13.38 21 952 117 004

3m 2005 97 838 112 379 14 541 210 217 3m 2005 10 148 10.37 15 819 14.08 5 671 25 966
3m 2006 127 064 29.9 148 097 31.8 21 033 275 161 3m 2006 13 096 29.1 10.31 20 045 26.7 13.53 6 949 33 140
Average Average
annual 5.8 5.9 5.9 annual 1.1 1.5 1.3
growth growth

ASEAN,Trade with the World ASEAN, Trade with the European Union
600 000 80 000

70 000
500 000

60 000

400 000
50 000

300 000 40 000

30 000
200 000

20 000

100 000
10 000

2001 2002 2003 2004 2005 2001 2002 2003 2004 2005

Imports Exports Balance Imports Exports Balance

European Union: 25 members.

ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

Source: IMF (Dots) 2 DG TRADE

15-sept-06
 EU TRADE WITH MAIN PARTNERS

(2005)

The major imports partners The major export partners The major trade partners

Partners Mio euro % Partners Mio euro % Partners Mio euro %

World 1 176 055 100.0 World 1 061 836 100.0 World 2 237 891 100.0

1 USA 163 057 13.9 1 USA 251 657 23.7 1 USA 414 714 18.5
2 China 158 098 13.4 2 Switzerland 81 980 7.7 2 China 209 894 9.4
3 Russia 106 766 9.1 3 Russia 56 445 5.3 3 Russia 163 211 7.3
4 Japan 73 243 6.2 4 China 51 796 4.9 4 Switzerland 148 334 6.6
5 Norway 67 474 5.7 5 Japan 43 663 4.1 5 Japan 116 906 5.2
6 Switzerland 66 354 5.6 6 Turkey 41 849 3.9 6 Norway 101 261 4.5
7 Turkey 33 492 2.8 7 Norway 33 787 3.2 7 Turkey 75 341 3.4
8 Korea 33 326 2.8 8 United Arab Emir. 25 288 2.4 8 Korea 53 456 2.4
9 Taiwan 23 835 2.0 9 Canada 23 681 2.2 9 Canada 40 855 1.8
10 Brazil 23 300 2.0 10 Romania 21 825 2.1 10 India 40 021 1.8
11 Saudi Arabia 22 092 1.9 11 India 21 110 2.0 11 Brazil 39 287 1.8
12 Algeria 20 735 1.8 12 Australia 20 710 2.0 12 Saudi Arabia 37 535 1.7
13 Libya 19 473 1.7 13 Hong Kong 20 434 1.9 13 Romania 37 130 1.7
14 India 18 911 1.6 14 Korea 20 130 1.9 14 Taiwan 36 653 1.6
15 Singapore 18 219 1.5 15 South Africa 18 077 1.7 15 Singapore 35 447 1.6
16 Canada 17 174 1.5 16 Singapore 17 227 1.6 16 United Arab Emir. 35 087 1.6
17 South Africa 16 731 1.4 17 Mexico 16 762 1.6 17 South Africa 34 808 1.6
18 Malaysia 15 905 1.4 18 Brazil 15 987 1.5 18 Algeria 31 150 1.4
19 Romania 15 305 1.3 19 Saudi Arabia 15 443 1.5 19 Hong Kong 31 109 1.4
20 WA_AO 13 761 1.2 20 WA_AO 13 484 1.3 20 Australia 30 182 1.3

ASEAN 70 809 6.0 ASEAN 44 966 4.2 ASEAN 115 775 5.2

EU Imports from … EU Exports to … Imports + Exports

Partner regions Mio euro % Partner regions Mio euro % Partner regions Mio euro %

World 1 176 055 100.0 World 1 061 836 100.0 World 2 237 891 100.0

NAFTA 189 219 16.1 NAFTA 292 100 27.5 NAFTA 481 319 21.5
Latin America 64 201 5.5 Latin America 54 557 5.1 Latin America 118 758 5.3
EU Candidates 58 061 4.9 EU Candidates 81 216 7.6 EU Candidates 139 277 6.2
EFTA 136 648 11.6 EFTA 119 333 11.2 EFTA 255 981 11.4
Medit.Countries* 54 679 4.6 Medit.Countries* 59 822 5.6 Medit.Countries* 114 502 5.1
ASEAN 70 809 6.0 ASEAN 44 966 4.2 ASEAN 115 775 5.2

NAFTA: Canada, Mexico, USA.

Latin America: 20 countries.
EU Candidates: Bulgaria, Croatie, Romania, Turkey
EFTA: Iceland, Norway, Switzerland.
Mediterranean countries *excluding Turkey : Algeria, Cisjordanie Gaza , Egypt, Israel, Jordan, Lebanon, Morocco, Syria, Tunisia.
ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

World excluding Intra-EU trade and European Union: 25 members.

ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

Source: EUROSTAT (Comext, Statistical regime 4) 3 DG TRADE

15-sept-06
 ASEAN'S TRADE BALANCE WITH MAIN PARTNERS

(2005)

The major import partners The major export partners The major trade partners

Partners Mio euro % Partners Mio euro % Partners Mio euro %

World 449 152 100.0 World 519 332 100.0 World 968 484 100.0

1 Japan 63 023 14.0 1 USA 78 367 15.1 1 USA 125 062 12.9
2 China 48 030 10.7 2 EU 69 478 13.4 2 Japan 121 395 12.5
3 EU 47 526 10.6 3 Japan 58 372 11.2 3 EU 117 004 12.1
4 Singapore 46 773 10.4 4 China 48 773 9.4 4 China 96 803 10.0
5 USA 46 694 10.4 5 Singapore 35 968 6.9 5 Singapore 82 741 8.5
6 Malaysia 33 305 7.4 6 Malaysia 34 331 6.6 6 Malaysia 67 636 7.0
7 Korea 21 534 4.8 7 Hong Kong 32 181 6.2 7 Korea 42 145 4.4
8 Thailand 18 672 4.2 8 Indonesia 24 123 4.6 8 Hong Kong 42 040 4.3
9 Saudi Arabia 15 525 3.5 9 Korea 20 611 4.0 9 Indonesia 39 621 4.1
10 Indonesia 15 498 3.5 10 Thailand 18 516 3.6 10 Thailand 37 188 3.8
11 Hong Kong 9 859 2.2 11 Australia 17 742 3.4 11 Australia 27 402 2.8
12 Australia 9 659 2.2 12 India 11 497 2.2 12 India 18 729 1.9
13 Philippines 7 976 1.8 13 Philippines 8 023 1.5 13 Saudi Arabia 17 647 1.8
14 United Arab Emir. 7 646 1.7 14 Vietnam 7 390 1.4 14 Philippines 15 999 1.7
15 India 7 232 1.6 15 United Arab Emir. 6 430 1.2 15 United Arab Emir. 14 076 1.5
16 Kuwait 4 576 1.0 16 Canada 3 999 0.8 16 Vietnam 11 234 1.2
17 Switzerland 3 913 0.9 17 Pakistan 2 208 0.4 17 Canada 6 272 0.6
18 Vietnam 3 844 0.9 18 New Zealand 2 162 0.4 18 Switzerland 5 370 0.6
19 Russia 3 042 0.7 19 Saudi Arabia 2 122 0.4 19 Kuwait 4 987 0.5
20 Qatar 2 847 0.6 20 Mexico 2 082 0.4 20 Russia 4 463 0.5

Imports from … Exports to … Imports + Exports

Partner regions Mio euro % Partner regions Mio euro % Partner regions Mio euro %

World 449 152 100.0 World 519 332 100.0 World 968 484 100.0

NAFTA 49 677 11.1 NAFTA 84 449 16.3 NAFTA 134 126 13.8
Latin America 5 967 1.3 Latin America 7 511 1.4 Latin America 13 479 1.4
EU Candidates 597 0.1 EU Candidates 1 939 0.4 EU Candidates 2 535 0.3
EFTA 4 445 1.0 EFTA 1 948 0.4 EFTA 6 393 0.7
* * *
Medit.Countries 2 033 0.5 Medit.Countries 3 296 0.6 Medit.Countries 5 329 0.6
ASEAN 129 365 28.8 ASEAN 132 280 25.5 ASEAN 261 645 27.0

NAFTA: Canada, Mexico, USA.

Latin America: 20 countries.
EU Candidates: Bulgaria, Croatie, Romania, Turkey
EFTA: Iceland, Norway, Switzerland.
Mediterranean countries *excluding Turkey : Algeria, Cisjordanie Gaza , Egypt, Israel, Jordan, Lebanon, Morocco, Syria, Tunisia.
ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

European Union: 25 members.

ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

Source: IMF (Dots) 4 DG TRADE

15-sept-06
 EUROPEAN UNION, TRADE WITH THE WORLD AND ASEAN, BY SITC SECTION
(2005)

European Union, Imports from the World European Union, Imports from … Asean
Share of
Products (Sitc Sections) Products (Sitc Sections)
Mio euro % Mio euro % total EU
by order of importance by order of importance imports

TOTAL 1 176 055 100.0 TOTAL 70 809 100.0 6.0

Machinery and transport equipment 375 952 32.0 Machinery and transport equipment 34 653 48.9 9.2
Mineral fuels, lubricants and rel. Materials 249 695 21.2 Miscell. manuf. Articles 13 834 19.5 8.3
Miscell. manuf. Articles 166 967 14.2 Chemicals and related prod., n.e.s. 6 450 9.1 6.9
Manuf goods classif. chiefly by material 116 362 9.9 Manuf goods classif. chiefly by material 4 215 6.0 3.6
Chemicals and related prod., n.e.s. 93 872 8.0 Food and live animals 3 598 5.1 6.6
Food and live animals 54 653 4.6 Crude materials inedible, except fuels 2 831 4.0 6.2
Crude materials inedible, except fuels 45 851 3.9 Animal and vegetable oils, fats and waxes 1 966 2.8 48.0
Commodit. and transactions n.e.c. 25 720 2.2 Mineral fuels, lubricants and rel. Materials 1 492 2.1 0.6
Beverages and tobacco 4 778 0.4 Commodit. and transactions n.e.c. 309 0.4 1.2
Animal and vegetable oils, fats and waxes 4 093 0.3 Beverages and tobacco 139 0.2 2.9

European Union, Exports to the World European Union, Exports to ... Asean
Share of
Products (Sitc Sections) Products (Sitc Sections)
Mio euro % Mio euro % total EU
by order of importance by order of importance exports

TOTAL 1 061 836 100.0 TOTAL 44 966 100.0 4.2

Machinery and transport equipment 478 928 45.1 Machinery and transport equipment 24 728 55.0 5.2
Chemicals and related prod., n.e.s. 163 339 15.4 Chemicals and related prod., n.e.s. 6 248 13.9 3.8
Manuf goods classif. chiefly by material 133 539 12.6 Manuf goods classif. chiefly by material 4 667 10.4 3.5
Miscell. manuf. Articles 119 503 11.3 Miscell. manuf. Articles 3 508 7.8 2.9
Mineral fuels, lubricants and rel. Materials 38 847 3.7 Food and live animals 1 371 3.0 3.9
Food and live animals 35 126 3.3 Commodit. and transactions n.e.c. 1 038 2.3 3.6
Commodit. and transactions n.e.c. 28 663 2.7 Crude materials inedible, except fuels 702 1.6 3.6
Crude materials inedible, except fuels 19 440 1.8 Beverages and tobacco 649 1.4 4.0
Beverages and tobacco 16 111 1.5 Mineral fuels, lubricants and rel. Materials 618 1.4 1.6
Animal and vegetable oils, fats and waxes 2 420 0.2 Animal and vegetable oils, fats and waxes 46 0.1 1.9
World excluding Intra-EU trade and European Union: 25 members.

ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

15-sept-06
5
 EUROPEAN UNION IMPORTS, BY PRODUCT GROUPING
(Mio euro)
European Union, Imports from the World European Union, Imports from ... Asean
Share of
SITC Rev.3 SITC Rev.3
2001 % 2003 % 2005 % 2001 % 2003 % 2005 % total EU
Product Groups Product Groups
imports

TOTAL 983 443 100.0 940 347 100.0 1 176 055 100.0 TOTAL 70 791 100.0 65 770 100.0 70 809 100.0 6.02
Primary Products 284 210 28.9 274 641 29.2 383 646 32.6 Primary Products 8 610 12.2 8 869 13.5 10 332 14.6 2.69
of which: of which:
Agricultural prod. 81 060 8.2 78 499 8.3 80 932 6.9 Agricultural prod. 6 705 9.5 6 973 10.6 7 535 10.6 9.31
Energy 155 904 15.9 155 826 16.6 249 695 21.2 Energy 542 0.8 813 1.2 1 492 2.1 0.60
Manuf. Products 667 914 67.9 634 832 67.5 728 577 62.0 Manuf. Products 57 023 80.6 56 246 85.5 58 844 83.1 8.08
of which: of which:
Machinery 262 923 26.7 233 724 24.9 277 426 23.6 Machinery 32 115 45.4 31 186 47.4 31 526 44.5 11.36
Transport equipm 89 425 9.1 92 898 9.9 98 526 8.4 Transport equipm 2 066 2.9 2 864 4.4 3 127 4.4 3.17
of which: of which:
Automotive prod. 34 734 3.5 38 579 4.1 44 010 3.7 Automotive prod. 1 284 1.8 1 057 1.6 1 173 1.7 2.67
Chemicals 76 880 7.8 80 360 8.5 93 872 8.0 Chemicals 2 840 4.0 4 313 6.6 6 450 9.1 6.87
Textiles and cloth. 67 220 6.8 66 680 7.1 70 415 6.0 Textiles and cloth. 6 952 9.8 5 717 8.7 5 213 7.4 7.40

Structure of Imports (%)

from the World from ... Asean

30.0 50.0
25.0
40.0
20.0
30.0
15.0
20.0
10.0

5.0 10.0

2001 2003 2005 2001 2003 2005

Agricultural prod. Energy Machinery Agricultural prod. Energy Machinery

Transport equipm Automotive prod. Chemicals Transport equipm Automotive prod. Chemicals
Textiles and cloth. Textiles and cloth.

World excluding Intra-EU trade and European Union: 25 members.

ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

Source : EUROSTAT (Comext, Statistical regime 4) DG TRADE

Agricultural prod.: food&live animals incl.fish, beverages&tobacco, hides, skins&furskins, raw, oil seeds&oleaginous fruits, natural rubber..., cork&wood, silk, cotton, jute&other textile bast fibres..., veget.textile fibres (other than 15-sept-06
cotton)..., wool, crude animal&vegetable materials, oil, fat Energy: mineral fuels etc Manuf.products: chemicals,
6 basic manuf.excl.non-ferrous met, machines, transport equip, misc.manuf.
 EUROPEAN UNION EXPORTS, BY PRODUCT GROUPING
(Mio euro)
European Union, Exports to the World European Union, Exports to ... Asean
Share of
SITC Rev.3 SITC Rev.3
2001 % 2003 % 2005 % 2001 % 2003 % 2005 % total EU
Product Groups Product Groups
exports

TOTAL 892 720 100.0 878 483 100.0 1 061 836 100.0 TOTAL 43 842 100.0 39 247 100.0 44 966 100.0 4.23
Primary Products 99 252 11.1 98 404 11.2 125 129 11.8 Primary Products 3 240 7.4 3 029 7.7 3 850 8.6 3.08
of which: of which:
Agricultural prod. 58 969 6.6 58 331 6.6 61 819 5.8 Agricultural prod. 2 162 4.9 1 895 4.8 2 195 4.9 3.55
Energy 22 351 2.5 22 856 2.6 38 847 3.7 Energy 270 0.6 218 0.6 618 1.4 1.59
Manuf. Products 775 305 86.8 760 712 86.6 882 125 83.1 Manuf. Products 39 005 89.0 34 901 88.9 38 687 86.0 4.39
of which: of which:
Machinery 268 866 30.1 248 408 28.3 308 796 29.1 Machinery 22 596 51.5 18 189 46.3 19 962 44.4 6.46
Transport equipm 145 563 16.3 146 766 16.7 167 386 15.8 Transport equipm 3 409 7.8 3 902 9.9 4 729 10.5 2.82
of which: of which:
Automotive prod. 83 954 9.4 93 941 10.7 107 822 10.2 Automotive prod. 1 796 4.1 1 532 3.9 1 596 3.5 1.48
Chemicals 131 133 14.7 142 377 16.2 163 339 15.4 Chemicals 5 122 11.7 5 410 13.8 6 248 13.9 3.83
Textiles and cloth. 35 923 4.0 33 882 3.9 33 003 3.1 Textiles and cloth. 738 1.7 670 1.7 624 1.4 1.89

Structure of Exports (%)

to the World to ... ASEAN

35.0 60.0
30.0 50.0
25.0
40.0
20.0
30.0
15.0
20.0
10.0
5.0 10.0

2001 2003 2005 2001 2003 2005

Agricultural prod. Energy Machinery Agricultural prod. Energy Machinery

Transport equipm Automotive prod. Chemicals Transport equipm Automotive prod. Chemicals
Textiles and cloth. Textiles and cloth.

World excluding Intra-EU trade and European Union: 25 members.

ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

Agricultural prod.: food&live animals incl.fish, beverages&tobacco, hides, skins&furskins, raw, oil seeds&oleaginous fruits, natural rubber..., cork&wood, silk, cotton, jute&other textile bast fibres..., veget.textile fibres (other than 15-sept-06
cotton)..., wool, crude animal&vegetable materials, oil, fat Energy: mineral fuels etc Manuf.products: chemicals,
7 basic manuf.excl.non-ferrous met, machines, transport equip, misc.manuf.
 RANK OF ASEAN IN EUROPEAN UNION TRADE

(2005)

European Union, Imports from ... Asean European Union, Exports to ... Asean
Share of Share of
SITC Rev.3 SITC Rev.3
Product Groups
Mio euro total EU %
Product Groups
Mio euro total EU % Balance
imports exports

TOTAL 70 809 6.02 100.0 TOTAL 44 966 4.23 100.0 -25 842

Agricultural products 7 535 9.31 10.6 Agricultural products 2 195 3.55 4.9 -5 340
Energy 1 492 0.60 2.1 Energy 618 1.59 1.4 -874
Non-agricultural raw materials 205 0.32 0.3 Non-agricultural raw materials 366 1.72 0.8 161
Office/telecom. Equipment 26 412 16.47 37.3 Office/telecom. Equipment 9 815 10.32 21.8 -16 598
Power/non-electrical mach. 2 453 3.39 3.5 Power/non-electrical mach. 7 702 4.70 17.1 5 249
Transport equipment 3 127 3.17 4.4 Transport equipment 4 729 2.82 10.5 1 602
Chemicals 6 450 6.87 9.1 Chemicals 6 248 3.83 13.9 -202
Textiles and clothing 5 213 7.40 7.4 Textiles and clothing 624 1.89 1.4 -4 589
Iron and steel 151 0.97 0.2 Iron and steel 1 137 5.38 2.5 987
Share by products in EU 25 Total Trade excluding Intra-EU trade.

EU Trade with ... Asean

Agricultural Non-agricultural Office/telecom. Power/non- Transport Textiles and
products Energy raw materials Equipment electrical mach. equipment Chemicals clothing Iron and steel
30 000 26 412
25 000

20 000

15 000
9 815
10 000 7 535 7 702 6 450 6 248
5 249 4 729 5 213
5 000 2 195 2 453 3 127
1 492 618 366 1 602 624 1 137 987
205 161 151
0
-874 -202
-5 000
-5 340 -4 589
-10 000

-15 000

-20 000 -16 598

Imports Exports Balance

ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

Source: EUROSTAT (Comext, Statistical regime 4) 8 DG TRADE

Agricultural prod.: food&live animals incl.fish, beverages&tobacco, hides, skins&furskins, raw, oil seeds&oleaginous fruits, natural rubber..., cork&wood, silk, cotton, jute&other textile bast fibres..., veget.textile fibres (other than 15-sept-06
cotton)..., wool, crude animal&vegetable materials, oil, fat Energy: mineral fuels etc Manuf.products: chemicals, basic manuf.excl.non-ferrous met, machines, transport equip, misc.manuf.
 EU TRADE WITH THE WORLD AND EU TRADE WITH ASEAN (2005)
(Ranking by Trade Flows in 2005)

EU Imports from … EU Exports to … EU Balance with …

Harmonized Asean Harmonized Asean Harmonized

System System System
World Share of World Share of World Asean
Mio euro % total EU Mio euro % total EU
Sections: Sections: Sections:
imports exports

TOTAL 1 176 055 70 809 100.0 6.02 TOTAL 1 061 836 44 966 100.0 4.23 TOTAL -114 219 -25 842

TDC XVI 286 987 32 468 45.9 11.31 TDC XVI 324 117 20 637 45.9 6.37 TDC XVII 66 694 2 180
TDC VI 86 790 6 491 9.2 7.48 TDC VI 147 203 5 381 12.0 3.66 TDC XV 2 109 1 742
TDC XI 73 056 4 924 7.0 6.74 TDC XVII 161 947 4 474 9.9 2.76 TDC X 10 440 556
TDC VII 29 488 3 348 4.7 11.36 TDC XV 70 977 2 956 6.6 4.16 TDC XVIII 6 698 302
TDC XII 13 910 3 028 4.3 21.77 TDC XVIII 51 712 2 204 4.9 4.26 TDC XIX 999 240
TDC XX 29 314 2 664 3.8 9.09 TDC VII 41 346 1 616 3.6 3.91 TDC XXI 1 160 6
TDC XVII 95 253 2 293 3.2 2.41 TDC IV 33 623 1 406 3.1 4.18 TDC VIII -1 178 -87
TDC V 285 197 2 230 3.1 0.78 TDC X 24 110 1 132 2.5 4.70 TDC XIII 7 008 -98
TDC IV 25 766 1 955 2.8 7.59 TDC V 42 712 725 1.6 1.70 TDC I -4 671 -320
TDC XVIII 45 014 1 902 2.7 4.22 TDC XIV 28 397 697 1.6 2.46 TDC XIV -1 300 -495
TDC III 3 924 1 840 2.6 46.89 TDC XI 36 315 690 1.5 1.90 TDC IV 7 857 -549
TDC IX 11 619 1 497 2.1 12.88 TDC I 12 370 527 1.2 4.26 TDC II -16 976 -978
TDC XV 68 868 1 213 1.7 1.76 TDC XX 18 219 409 0.9 2.24 TDC VI 60 413 -1 110
TDC II 27 449 1 203 1.7 4.38 TDC XIII 15 228 404 0.9 2.65 TDC IX -3 233 -1 380
TDC XIV 29 696 1 193 1.7 4.02 TDC VIII 8 829 320 0.7 3.63 TDC V -242 486 -1 505
TDC I 17 041 847 1.2 4.97 TDC XIX 1 704 246 0.5 14.43 TDC VII 11 858 -1 732
TDC X 13 670 577 0.8 4.22 TDC II 10 472 225 0.5 2.15 TDC III -1 432 -1 798
TDC XIII 8 220 502 0.7 6.11 TDC IX 8 387 117 0.3 1.40 TDC XX -11 095 -2 255
TDC VIII 10 007 407 0.6 4.07 TDC XII 5 824 51 0.1 0.88 TDC XII -8 085 -2 977
TDC XXI 3 119 20 0.0 0.64 TDC III 2 492 42 0.1 1.70 TDC XI -36 741 -4 234
TDC XIX 705 6 0.0 0.87 TDC XXI 4 279 26 0.1 0.60 TDC XVI 37 130 -11 831

Labels of TDC sections: TDC XI Ch.50-63 Textiles and textile articles

TDC I Ch.01-05 Live animals; animal products TDC XII Ch. 64-67 Footwear, headgear, umbrellas, sun umbrellas, walking-sticks
TDC II Ch.06-14 Vegetable products TDC XIII Ch.68-70 Articles of stone, plaster, cement, asbestos, mica or similar
TDC III Ch.15 Animal or vegetable fats and oils and their cleavage products TDC XIV Ch.71 Natural or cultured pearls, precious or semi-precious stones…
TDC IV Ch.16-24 Prepared foodstuffs; beverages, spirits and vinegar; tobacco ... TDC XV Ch.72-83 Base metals and articles of base metal
TDC V Ch.25-27 Mineral Products TDC XVI Ch.84-85 Machinery and mechanical appliances; electrical equipment; parts
TDC VI Ch.28-38 Products of the chemical or allied industries TDC XVII Ch.86-89 Vehicles, aircraft, vessels and associated transport equipment
TDC VII Ch.39-40 Plastics and articles thereoof animal gut (other than silkworm gut) TDC XVIII Ch.90-92 Optical, photo, cinema, measuring, checking, precision instrum…
TDC VIII Ch.41-43 Raw hides and skins, leathematerials; basketware and wickerwork TDC XIX Ch. 93 Arms and ammunition; parts and accessories thereof
TDC IX Ch.44-46 Wood and articles of wood; wood charcoal; cork and articles of TDC XX Ch.94-96 Miscellaneous manufactured articles
TDC X Ch.47-49 Pulp of wood or of other fibrous cellulosic material; paper or paperboard TDC XXI Ch.97 Works of art, collectors’ pieces and antiques excl.chapter 99 other products
World excluding Intra-EU trade and European Union: 25 members.

ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

9
15-sept-06
DONNEES GRAPHIQUES SUR LES SERVICES
2004 Graph non affiché pour ces régions:
#REF! 26421 World
USA 214728 EFTA
Switzerland 77635 NAFTA
Japan 29080 APEC
Other A. ASEM
 MERCOSUR
Population 226.1 (1000 inhabitants)
Area 11 863 (1000qkm)
Gross domestic product 2005 802 Bn euros Exports-to-GDP ratio: 23.0 % in 2005
GDP per capita 2004 2 759 Euros
(IMF, World Economic Outlook) 2002 2003 2004 2005
Real GDP (% growth) -0.4 2.9 5.0 3.4

Current account balance (% of GDP) 0.3 1.9 1.9 1.7

MERCOSUR MERCHANDISE TRADE WITH THE WORLD EU25 MERCHANDISE TRADE WITH MERCOSUR
(Bn euros) Imports Exports Balance (Bn euros) Imports Exports Balance

200.0 184.5 35.0 30.5

180.0 30.0 25.8 24.6 26.0
160.0 25.0 20.6
128.6
140.0 118.0 117.6 115.0 20.0 15.6
120.0 15.0
100.0 10.0
71.8 69.4
80.0 5.0
60.0 45.8
40.0 -5.0
10.6 -1.1
20.0 -10.0
-15.0 -10.4 -9.8
2001 2003 2005 2001 2003 2005
Source: IMF (Direction of Trade Statistics) * excl intra EU Trade Source: Eurostat, statistical regime 4

% OF THE WORLD * 2001 2003 2005 % OF EU TOTAL 2001 2003 2005

Imports 2.05 1.72 2.07 Imports 2.62 2.76 2.59
Exports 2.40 3.05 3.55 Exports 2.76 1.77 1.94
EU25 MERCHANDISE TRADE WITH MERCOSUR BY PRODUCT (2005)
(Mio Euros) Imports Exports Balance
20 000
14 574
15 000
10 000 6 763 5 159 3 890 4 256 3 066
5 000 618 753 1 604 2 163 1 728 1 190
299 210 233 23

-5 000 -454
-10 000
-15 000
-13 956
-20 000

Agricultural products Energy Machinery Transport equipment Chemicals Textiles and clothing

Source: Eurostat, statistical regime 4

EU25 TRADE IN SERVICES WITH MERCOSUR MERCOSUR SHARE OF EU25 TRADE IN SERVICES
(Bn Euros) Imports Exports Balance 1.6%
4.7 4.7
5.2 Imports+Exports
4.5
2004
34.8%
Mercosur
46.4%
USA
0.5
Switzerland
-0.2 Japan
2003 2004 12.6% Other
4.7%
Source: Eurostat (excluding government services)

EU25 FOREIGN DIRECT INVESTMENT WITH MERCOSUR

(Bn Euros) Inflows Outflows Balance Inward Stocks
3.2 (Bn Euros) Outward Stocks
2.4 72.8 74.0
68.6
1.2 1.2
0.8
0.2

-0.4
4.8 8.0
3.2
-2.3 -2.0

2002 2003 2004 2002 2003 2004e

Source: Eurostat 2004, estimated FDI stock = stock 2003 + flows 2004
Argentine, Brazil, Paraguay, Uruguay, Venezuela
DG TRADE

15 September 2006
 MERCOSUR 15-sept-06
EU BILATERAL TRADE AND TRADE WITH THE WORLD DG TRADE

(EU: 25 members, recalculated series since 2001)

Argentine, Brazil, Paraguay, Uruguay.

TOTAL MERCHANDISE TRADE, 2001-2005

1. Evolution of the EU's Trade Balance with Mercosur
2. Evolution of the Mercosur's Trade Balance

GEOGRAPHIC BREAKDOWN OF TRADE, 2005

3. EU Trade with Main Partners
4. Mercosur's Trade Balance with Main Partners

SECTORAL BREAKDOWN OF TRADE

Sitc Rev3, Sections and Product Grouping

5. European Union, Trade with the World and Mercosur, by Sitc Sec
6. European Union Imports, by Product Grouping
7. European Union Exports, by Product Grouping
8. Rank of Mercosur in European Union Trade

Harmonized System, Sections

9. EU Trade with the World and EU Trade with Mercosur (2005)
 EVOLUTION OF THE EU'S TRADE BALANCE WITH MERCOSUR
(Mio euro)

European Union, Trade with the World European Union, Trade with ... Mercosur
Share of Share of
Yearly % Yearly % Imports + Yearly % Yearly % Imports +
Year Imports Exports Balance Year Imports total EU Exports total EU Balance
change change Exports change change Exports
imports exports
2001 983 443 892 720 -90 723 1 876 164 2001 25 772 2.62 24 628 2.76 -1 144 50 400
2002 941 885 -4.2 900 424 0.9 -41 462 1 842 309 2002 25 172 -2.3 2.67 18 529 -24.8 2.06 -6 643 43 701
2003 940 347 -0.2 878 483 -2.4 -61 864 1 818 830 2003 25 992 3.3 2.76 15 585 -15.9 1.77 -10 407 41 577
2004 1 031 999 9.7 964 652 9.8 -67 347 1 996 652 2004 28 361 9.1 2.75 18 367 17.9 1.90 -9 993 46 728
2005 1 176 055 14.0 1 061 836 10.1 -114 219 2 237 891 2005 30 541 7.7 2.60 20 652 12.4 1.94 -9 888 51 193

3m 2005 262 361 234 231 -28 130 496 593 3m 2005 6 490 2.47 4 532 1.93 -1 958 11 022
3m 2006 328 931 25.4 274 381 17.1 -54 550 603 313 3m 2006* 8 058 24.2 2.45 5 453 20.3 1.99 -2 605 13 511
Average Average
annual 4.6 4.4 4.5 annual 4.3 -4.3 0.4
growth growth

European Union, Trade with the World European Union, Trade with ... Mercosur
1 400 000 35 000

1 200 000 30 000

25 000
1 000 000
20 000
800 000
15 000

600 000 10 000

400 000 5 000

200 000
-5 000

-10 000

-200 000 -15 000

2001 2002 2003 2004 2005 2001 2002 2003 2004 2005

Imports Exports Balance Imports Exports Balance

World excluding Intra-EU trade and European Union: 25 members.

Mercosur: Argentine, Brazil, Paraguay, Uruguay.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

1
15-sept-06
 EVOLUTION OF THE MERCOSUR'S TRADE BALANCE
(Mio euro)

Mercosur,Trade with the World Mercosur, Trade with the European Union
EU Share EU Share
Yearly % Yearly % Imports + Yearly % Yearly % Imports +
Year Imports Exports Balance Year Imports of total Exports of total Balance
change change Exports change change Exports
imports exports
2001 117 956 128 593 10 638 246 549 2001 27 769 23.54 22 637 17.60 -5 132 50 407
2002 82 215 -30.3 121 887 -5.2 39 672 204 102 2002 20 382 -26.6 24.79 22 558 -0.4 18.51 2 176 42 939
2003 71 772 -12.7 117 584 -3.5 45 811 189 356 2003 16 663 -18.2 23.22 23 416 3.8 19.91 6 753 40 079
2004 91 982 28.2 147 469 25.4 55 488 239 451 2004 20 117 20.7 21.87 26 410 12.8 17.91 6 293 46 527
2005 115 018 25.0 184 455 25.1 69 437 299 473 2005 25 370 26.1 22.06 32 636 23.6 17.69 7 266 58 006

3m 2005 23 539 36 816 13 277 60 355 3m 2005 5 566 23.65 6 820 18.52 1 254 12 386
3m 2006 31 500 33.8 48 182 30.9 16 682 79 682 3m 2006 6 748 21.2 21.42 8 651 26.8 17.96 1 903 15 400
Average Average
annual -0.6 9.4 5.0 annual -2.2 9.6 3.6
growth growth

Mercosur,Trade with the World Mercosur, Trade with the European Union
200 000 35 000

180 000 30 000

160 000
25 000

140 000
20 000
120 000
15 000
100 000

10 000
80 000

5 000
60 000

40 000

20 000 -5 000

-10 000
2001 2002 2003 2004 2005 2001 2002 2003 2004 2005

Imports Exports Balance Imports Exports Balance

European Union: 25 members.

Mercosur: Argentine, Brazil, Paraguay, Uruguay.

Source: IMF (Dots) 2 DG TRADE

15-sept-06
 EU TRADE WITH MAIN PARTNERS

(2005)

The major imports partners The major export partners The major trade partners

Partners Mio euro % Partners Mio euro % Partners Mio euro %

World 1 176 055 100.0 World 1 061 836 100.0 World 2 237 891 100.0

1 USA 163 057 13.9 1 USA 251 657 23.7 1 USA 414 714 18.5
2 China 158 098 13.4 2 Switzerland 81 980 7.7 2 China 209 894 9.4
3 Russia 106 766 9.1 3 Russia 56 445 5.3 3 Russia 163 211 7.3
4 Japan 73 243 6.2 4 China 51 796 4.9 4 Switzerland 148 334 6.6
5 Norway 67 474 5.7 5 Japan 43 663 4.1 5 Japan 116 906 5.2
6 Switzerland 66 354 5.6 6 Turkey 41 849 3.9 6 Norway 101 261 4.5
7 Turkey 33 492 2.8 7 Norway 33 787 3.2 7 Turkey 75 341 3.4
8 Korea 33 326 2.8 8 United Arab Emir. 25 288 2.4 8 Korea 53 456 2.4
9 Taiwan 23 835 2.0 9 Canada 23 681 2.2 9 Canada 40 855 1.8
10 Brazil 23 300 2.0 10 Romania 21 825 2.1 10 India 40 021 1.8
11 Saudi Arabia 22 092 1.9 11 India 21 110 2.0 11 Brazil 39 287 1.8
12 Algeria 20 735 1.8 12 Australia 20 710 2.0 12 Saudi Arabia 37 535 1.7
13 Libya 19 473 1.7 13 Hong Kong 20 434 1.9 13 Romania 37 130 1.7
14 India 18 911 1.6 14 Korea 20 130 1.9 14 Taiwan 36 653 1.6
15 Singapore 18 219 1.5 15 South Africa 18 077 1.7 15 Singapore 35 447 1.6
16 Canada 17 174 1.5 16 Singapore 17 227 1.6 16 United Arab Emir. 35 087 1.6
17 South Africa 16 731 1.4 17 Mexico 16 762 1.6 17 South Africa 34 808 1.6
18 Malaysia 15 905 1.4 18 Brazil 15 987 1.5 18 Algeria 31 150 1.4
19 Romania 15 305 1.3 19 Saudi Arabia 15 443 1.5 19 Hong Kong 31 109 1.4
20 WA_AO 13 761 1.2 20 WA_AO 13 484 1.3 20 Australia 30 182 1.3

Mercosur 30 541 2.6 Mercosur 20 652 1.9 Mercosur 51 193 2.3

EU Imports from … EU Exports to … Imports + Exports

Partner regions Mio euro % Partner regions Mio euro % Partner regions Mio euro %

World 1 176 055 100.0 World 1 061 836 100.0 World 2 237 891 100.0

NAFTA 189 219 16.1 NAFTA 292 100 27.5 NAFTA 481 319 21.5
Latin America 64 201 5.5 Latin America 54 557 5.1 Latin America 118 758 5.3
EU Candidates 58 061 4.9 EU Candidates 81 216 7.6 EU Candidates 139 277 6.2
EFTA 136 648 11.6 EFTA 119 333 11.2 EFTA 255 981 11.4
Medit.Countries* 54 679 4.6 Medit.Countries* 59 822 5.6 Medit.Countries* 114 502 5.1
ASEAN 70 809 6.0 ASEAN 44 966 4.2 ASEAN 115 775 5.2

NAFTA: Canada, Mexico, USA.

Latin America: 20 countries.
EU Candidates: Bulgaria, Croatie, Romania, Turkey
EFTA: Iceland, Norway, Switzerland.
Mediterranean countries *excluding Turkey : Algeria, Cisjordanie Gaza , Egypt, Israel, Jordan, Lebanon, Morocco, Syria, Tunisia.
ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

World excluding Intra-EU trade and European Union: 25 members.

Mercosur: Argentine, Brazil, Paraguay, Uruguay.

Source: EUROSTAT (Comext, Statistical regime 4) 3 DG TRADE

15-sept-06
 MERCOSUR'S TRADE BALANCE WITH MAIN PARTNERS

(2005)

The major import partners The major export partners The major trade partners

Partners Mio euro % Partners Mio euro % Partners Mio euro %

World 115 018 100.0 World 184 455 100.0 World 299 473 100.0

1 EU 25 370 22.1 1 USA 49 176 26.7 1 USA 73 392 24.5

2 USA 24 216 21.1 2 EU 32 636 17.7 2 EU 58 006 19.4
3 Brazil 10 670 9.3 3 China 11 040 6.0 3 China 17 703 5.9
4 Argentina 7 398 6.4 4 Argentina 7 059 3.8 4 Brazil 16 751 5.6
5 China 6 663 5.8 5 Chile 6 444 3.5 5 Argentina 14 456 4.8
6 Nigeria 4 303 3.7 6 Brazil 6 081 3.3 6 Chile 8 925 3.0
7 Japan 3 605 3.1 7 Caribbean 5 800 3.1 7 Mexico 8 451 2.8
8 Mexico 2 678 2.3 8 Mexico 5 773 3.1 8 Japan 7 355 2.5
9 Korea 2 496 2.2 9 Japan 3 750 2.0 9 Caribbean 6 072 2.0
10 Chile 2 481 2.2 10 Canada 3 693 2.0 10 Canada 4 947 1.7
11 Algeria 2 327 2.0 11 Colombia 2 319 1.3 11 Nigeria 4 932 1.6
12 Colombia 2 323 2.0 12 Russia 2 293 1.2 12 Korea 4 772 1.6
13 Saudi Arabia 1 492 1.3 13 Korea 2 276 1.2 13 Colombia 4 642 1.6
14 Hong Kong 1 340 1.2 14 Venezuela 2 119 1.1 14 Russia 3 030 1.0
15 Canada 1 255 1.1 15 Peru 1 744 0.9 15 Algeria 2 994 1.0
16 Switzerland 1 252 1.1 16 Uruguay 1 734 0.9 16 Uruguay 2 627 0.9
17 Paraguay 910 0.8 17 South Africa 1 469 0.8 17 Saudi Arabia 2 505 0.8
18 Uruguay 893 0.8 18 Paraguay 1 383 0.7 18 Peru 2 460 0.8
19 Bolivia 878 0.8 19 Ecuador 1 259 0.7 19 Venezuela 2 380 0.8
20 Singapore 848 0.7 20 Iran 1 242 0.7 20 Paraguay 2 293 0.8

Imports from … Exports to … Imports + Exports

Partner regions Mio euro % Partner regions Mio euro % Partner regions Mio euro %

World 115 018 100.0 World 184 455 100.0 World 299 473 100.0

NAFTA 28 148 24.5 NAFTA 58 642 31.8 NAFTA 86 790 29.0

Latin America 30 498 26.5 Latin America 39 464 21.4 Latin America 69 962 23.4
EU Candidates 273 0.2 EU Candidates 1 355 0.7 EU Candidates 1 628 0.5
EFTA 1 719 1.5 EFTA 836 0.5 EFTA 2 554 0.9
* * *
Medit.Countries 3 317 2.9 Medit.Countries 3 855 2.1 Medit.Countries 7 171 2.4
ASEAN 2 833 2.5 ASEAN 3 639 2.0 ASEAN 6 472 2.2

NAFTA: Canada, Mexico, USA.

Latin America: 20 countries.
EU Candidates: Bulgaria, Croatie, Romania, Turkey
EFTA: Iceland, Norway, Switzerland.
Mediterranean countries *excluding Turkey : Algeria, Cisjordanie Gaza , Egypt, Israel, Jordan, Lebanon, Morocco, Syria, Tunisia.
ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

European Union: 25 members.

Mercosur: Argentine, Brazil, Paraguay, Uruguay.

Source: IMF (Dots) 4 DG TRADE

15-sept-06
 EUROPEAN UNION, TRADE WITH THE WORLD AND MERCOSUR, BY SITC SECTION
(2005)

European Union, Imports from the World European Union, Imports from … Mercosur
Share of
Products (Sitc Sections) Products (Sitc Sections)
Mio euro % Mio euro % total EU
by order of importance by order of importance imports

TOTAL 1 176 055 100.0 TOTAL 30 541 100.0 2.6

Machinery and transport equipment 375 952 32.0 Food and live animals 10 271 33.6 18.8
Mineral fuels, lubricants and rel. Materials 249 695 21.2 Crude materials inedible, except fuels 7 807 25.6 17.0
Miscell. manuf. Articles 166 967 14.2 Machinery and transport equipment 3 768 12.3 1.0
Manuf goods classif. chiefly by material 116 362 9.9 Manuf goods classif. chiefly by material 3 309 10.8 2.8
Chemicals and related prod., n.e.s. 93 872 8.0 Chemicals and related prod., n.e.s. 1 190 3.9 1.3
Food and live animals 54 653 4.6 Miscell. manuf. Articles 1 105 3.6 0.7
Crude materials inedible, except fuels 45 851 3.9 Mineral fuels, lubricants and rel. Materials 753 2.5 0.3
Commodit. and transactions n.e.c. 25 720 2.2 Beverages and tobacco 528 1.7 11.1
Beverages and tobacco 4 778 0.4 Animal and vegetable oils, fats and waxes 474 1.6 11.6
Animal and vegetable oils, fats and waxes 4 093 0.3 Commodit. and transactions n.e.c. 263 0.9 1.0

European Union, Exports to the World European Union, Exports to ... Mercosur
Share of
Products (Sitc Sections) Products (Sitc Sections)
Mio euro % Mio euro % total EU
by order of importance by order of importance exports

TOTAL 1 061 836 100.0 TOTAL 20 652 100.0 1.9

Machinery and transport equipment 478 928 45.1 Machinery and transport equipment 10 701 51.8 2.2
Chemicals and related prod., n.e.s. 163 339 15.4 Chemicals and related prod., n.e.s. 4 263 20.6 2.6
Manuf goods classif. chiefly by material 133 539 12.6 Manuf goods classif. chiefly by material 2 146 10.4 1.6
Miscell. manuf. Articles 119 503 11.3 Miscell. manuf. Articles 1 402 6.8 1.2
Mineral fuels, lubricants and rel. Materials 38 847 3.7 Commodit. and transactions n.e.c. 334 1.6 1.2
Food and live animals 35 126 3.3 Mineral fuels, lubricants and rel. Materials 299 1.4 0.8
Commodit. and transactions n.e.c. 28 663 2.7 Food and live animals 267 1.3 0.8
Crude materials inedible, except fuels 19 440 1.8 Crude materials inedible, except fuels 219 1.1 1.1
Beverages and tobacco 16 111 1.5 Beverages and tobacco 183 0.9 1.1
Animal and vegetable oils, fats and waxes 2 420 0.2 Animal and vegetable oils, fats and waxes 86 0.4 3.6
World excluding Intra-EU trade and European Union: 25 members.

Mercosur: Argentine, Brazil, Paraguay, Uruguay.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

15-sept-06
5
 EUROPEAN UNION IMPORTS, BY PRODUCT GROUPING
(Mio euro)
European Union, Imports from the World European Union, Imports from ... Mercosur
Share of
SITC Rev.3 SITC Rev.3
2001 % 2003 % 2005 % 2001 % 2003 % 2005 % total EU
Product Groups Product Groups
imports

TOTAL 983 443 100.0 940 347 100.0 1 176 055 100.0 TOTAL 25 772 100.0 25 992 100.0 30 541 100.0 2.60
Primary Products 284 210 28.9 274 641 29.2 383 646 32.6 Primary Products 17 768 68.9 18 261 70.3 20 402 66.8 5.32
of which: of which:
Agricultural prod. 81 060 8.2 78 499 8.3 80 932 6.9 Agricultural prod. 13 902 53.9 14 152 54.4 14 645 48.0 18.10
Energy 155 904 15.9 155 826 16.6 249 695 21.2 Energy 280 1.1 598 2.3 753 2.5 0.30
Manuf. Products 667 914 67.9 634 832 67.5 728 577 62.0 Manuf. Products 7 770 30.1 7 352 28.3 8 804 28.8 1.21
of which: of which:
Machinery 262 923 26.7 233 724 24.9 277 426 23.6 Machinery 1 081 4.2 1 065 4.1 1 604 5.3 0.58
Transport equipm 89 425 9.1 92 898 9.9 98 526 8.4 Transport equipm 2 360 9.2 1 495 5.8 2 164 7.1 2.20
of which: of which:
Automotive prod. 34 734 3.5 38 579 4.1 44 010 3.7 Automotive prod. 742 2.9 718 2.8 1 277 4.2 2.90
Chemicals 76 880 7.8 80 360 8.5 93 872 8.0 Chemicals 883 3.4 1 013 3.9 1 190 3.9 1.27
Textiles and cloth. 67 220 6.8 66 680 7.1 70 415 6.0 Textiles and cloth. 207 0.8 237 0.9 210 0.7 0.30

Structure of Imports (%)

from the World from ... Mercosur

30.0 60.0
25.0 50.0
20.0 40.0
15.0 30.0
10.0 20.0
5.0 10.0

2001 2003 2005 2001 2003 2005

Agricultural prod. Energy Machinery Agricultural prod. Energy Machinery

Transport equipm Automotive prod. Chemicals Transport equipm Automotive prod. Chemicals
Textiles and cloth. Textiles and cloth.

World excluding Intra-EU trade and European Union: 25 members.

Mercosur: Argentine, Brazil, Paraguay, Uruguay.

Source : EUROSTAT (Comext, Statistical regime 4) DG TRADE

Agricultural prod.: food&live animals incl.fish, beverages&tobacco, hides, skins&furskins, raw, oil seeds&oleaginous fruits, natural rubber..., cork&wood, silk, cotton, jute&other textile bast fibres..., veget.textile fibres (other than 15-sept-06
cotton)..., wool, crude animal&vegetable materials, oil, fat Energy: mineral fuels etc Manuf.products: chemicals,
6 basic manuf.excl.non-ferrous met, machines, transport equip, misc.manuf.
 EUROPEAN UNION EXPORTS, BY PRODUCT GROUPING
(Mio euro)
European Union, Exports to the World European Union, Exports to ... Mercosur
Share of
SITC Rev.3 SITC Rev.3
2001 % 2003 % 2005 % 2001 % 2003 % 2005 % total EU
Product Groups Product Groups
exports

TOTAL 892 720 100.0 878 483 100.0 1 061 836 100.0 TOTAL 24 628 100.0 15 585 100.0 20 652 100.0 1.94
Primary Products 99 252 11.1 98 404 11.2 125 129 11.8 Primary Products 1 508 6.1 1 112 7.1 1 364 6.6 1.09
of which: of which:
Agricultural prod. 58 969 6.6 58 331 6.6 61 819 5.8 Agricultural prod. 851 3.5 618 4.0 617 3.0 1.00
Energy 22 351 2.5 22 856 2.6 38 847 3.7 Energy 181 0.7 160 1.0 299 1.4 0.77
Manuf. Products 775 305 86.8 760 712 86.6 882 125 83.1 Manuf. Products 22 315 90.6 13 859 88.9 18 202 88.1 2.06
of which: of which:
Machinery 268 866 30.1 248 408 28.3 308 796 29.1 Machinery 8 383 34.0 4 556 29.2 6 764 32.8 2.19
Transport equipm 145 563 16.3 146 766 16.7 167 386 15.8 Transport equipm 4 991 20.3 2 881 18.5 3 904 18.9 2.33
of which: of which:
Automotive prod. 83 954 9.4 93 941 10.7 107 822 10.2 Automotive prod. 2 903 11.8 1 909 12.2 2 567 12.4 2.38
Chemicals 131 133 14.7 142 377 16.2 163 339 15.4 Chemicals 4 496 18.3 3 678 23.6 4 263 20.6 2.61
Textiles and cloth. 35 923 4.0 33 882 3.9 33 003 3.1 Textiles and cloth. 356 1.4 189 1.2 233 1.1 0.71

Structure of Exports (%)

to the World to ... Mercosur

35.0 35.0
30.0 30.0
25.0 25.0
20.0 20.0
15.0 15.0
10.0 10.0
5.0 5.0

2001 2003 2005 2001 2003 2005

Agricultural prod. Energy Machinery Agricultural prod. Energy Machinery

Transport equipm Automotive prod. Chemicals Transport equipm Automotive prod. Chemicals
Textiles and cloth. Textiles and cloth.

World excluding Intra-EU trade and European Union: 25 members.

Mercosur: Argentine, Brazil, Paraguay, Uruguay.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

Agricultural prod.: food&live animals incl.fish, beverages&tobacco, hides, skins&furskins, raw, oil seeds&oleaginous fruits, natural rubber..., cork&wood, silk, cotton, jute&other textile bast fibres..., veget.textile fibres (other than 15-sept-06
cotton)..., wool, crude animal&vegetable materials, oil, fat Energy: mineral fuels etc Manuf.products: chemicals,
7 basic manuf.excl.non-ferrous met, machines, transport equip, misc.manuf.
 RANK OF MERCOSUR IN EUROPEAN UNION TRADE

(2005)

European Union, Imports from ... Mercosur European Union, Exports to ... Mercosur
Share of Share of
SITC Rev.3 SITC Rev.3
Product Groups
Mio euro total EU %
Product Groups
Mio euro total EU % Balance
imports exports

TOTAL 30 541 2.60 100.0 TOTAL 20 652 1.94 100.0 -9 888

Agricultural products 14 645 18.10 48.0 Agricultural products 617 1.00 3.0 -14 028
Energy 753 0.30 2.5 Energy 299 0.77 1.4 -454
Non-agricultural raw materials 1 118 0.36 3.7 Non-agricultural raw materials 77 0.76 0.4 -1 041
Office/telecom. Equipment 365 0.23 1.2 Office/telecom. Equipment 1 268 1.33 6.1 903
Power/non-electrical mach. 1 007 1.39 3.3 Power/non-electrical mach. 4 474 2.73 21.7 3 467
Transport equipment 2 164 2.20 7.1 Transport equipment 3 904 2.33 18.9 1 740
Chemicals 1 190 1.27 3.9 Chemicals 4 263 2.61 20.6 3 073
Textiles and clothing 210 0.30 0.7 Textiles and clothing 233 0.71 1.1 23
Iron and steel 901 5.82 2.9 Iron and steel 396 1.87 1.9 -504
Share by products in EU 25 Total Trade excluding Intra-EU trade.

EU Trade with ... Mercosur

Agricultural Non-agricultural Office/telecom. Power/non- Transport Textiles and
products Energy raw materials Equipment electrical mach. equipment Chemicals clothing Iron and steel
20 000
14 645
15 000

10 000
4 474 3 467 3 904 4 263
5 000 2 164 3 073
753 1 118 1 268 903 1 007 1 740 1 190 901
617 299 77 365 210 233 23 396
0
-454 -1 041 -504
-5 000

-10 000

-15 000
-14 028
-20 000

Imports Exports Balance

Mercosur: Argentine, Brazil, Paraguay, Uruguay.

Source: EUROSTAT (Comext, Statistical regime 4) 8 DG TRADE

Agricultural prod.: food&live animals incl.fish, beverages&tobacco, hides, skins&furskins, raw, oil seeds&oleaginous fruits, natural rubber..., cork&wood, silk, cotton, jute&other textile bast fibres..., veget.textile fibres (other than 15-sept-06
cotton)..., wool, crude animal&vegetable materials, oil, fat Energy: mineral fuels etc Manuf.products: chemicals, basic manuf.excl.non-ferrous met, machines, transport equip, misc.manuf.
 EU TRADE WITH THE WORLD AND EU TRADE WITH MERCOSUR (2005)
(Ranking by Trade Flows in 2005)

EU Imports from … EU Exports to … EU Balance with …

Harmonized Mercosur Harmonized Mercosur Harmonized

System System System
World Share of World Share of World Mercosur
Mio euro % total EU Mio euro % total EU
Sections: Sections: Sections:
imports exports

TOTAL 1 176 055 30 541 100.0 2.60 TOTAL 1 061 836 20 652 100.0 1.94 TOTAL -114 219 -9 888

TDC IV 25 766 6 323 20.7 24.54 TDC XVI 324 117 7 476 36.2 2.31 TDC XVI 37 130 5 116
TDC II 27 449 5 113 16.7 18.63 TDC VI 147 203 3 789 18.3 2.57 TDC VI 60 413 2 809
TDC V 285 197 3 968 13.0 1.39 TDC XVII 161 947 3 297 16.0 2.04 TDC XVII 66 694 1 725
TDC I 17 041 2 472 8.1 14.51 TDC XV 70 977 1 305 6.3 1.84 TDC XVIII 6 698 787
TDC XVI 286 987 2 360 7.7 0.82 TDC VII 41 346 1 124 5.4 2.72 TDC VII 11 858 661
TDC XV 68 868 2 114 6.9 3.07 TDC XVIII 51 712 910 4.4 1.76 TDC XIV -1 300 37
TDC XVII 95 253 1 572 5.1 1.65 TDC X 24 110 461 2.2 1.91 TDC XIII 7 008 26
TDC X 13 670 1 337 4.4 9.78 TDC V 42 712 349 1.7 0.82 TDC XIX 999 2
TDC IX 11 619 990 3.2 8.52 TDC IV 33 623 315 1.5 0.94 TDC XXI 1 160 -33
TDC VI 86 790 980 3.2 1.13 TDC XI 36 315 263 1.3 0.72 TDC XI -36 741 -117
TDC VIII 10 007 569 1.9 5.68 TDC XIII 15 228 233 1.1 1.53 TDC XX -11 095 -235
TDC VII 29 488 464 1.5 1.57 TDC II 10 472 154 0.7 1.47 TDC III -1 432 -366
TDC III 3 924 462 1.5 11.77 TDC XX 18 219 135 0.7 0.74 TDC XII -8 085 -368
TDC XII 13 910 380 1.2 2.73 TDC XIV 28 397 129 0.6 0.45 TDC VIII -1 178 -518
TDC XI 73 056 380 1.2 0.52 TDC III 2 492 96 0.5 3.87 TDC XV 2 109 -809
TDC XX 29 314 370 1.2 1.26 TDC I 12 370 72 0.3 0.58 TDC X 10 440 -876
TDC XIII 8 220 208 0.7 2.53 TDC VIII 8 829 51 0.2 0.58 TDC IX -3 233 -940
TDC XVIII 45 014 123 0.4 0.27 TDC IX 8 387 50 0.2 0.60 TDC I -4 671 -2 400
TDC XIV 29 696 92 0.3 0.31 TDC XII 5 824 12 0.1 0.21 TDC V -242 486 -3 619
TDC XXI 3 119 44 0.1 1.40 TDC XXI 4 279 10 0.1 0.24 TDC II -16 976 -4 959
TDC XIX 705 6 0.0 0.79 TDC XIX 1 704 8 0.0 0.45 TDC IV 7 857 -6 008

Labels of TDC sections: TDC XI Ch.50-63 Textiles and textile articles

TDC I Ch.01-05 Live animals; animal products TDC XII Ch. 64-67 Footwear, headgear, umbrellas, sun umbrellas, walking-sticks
TDC II Ch.06-14 Vegetable products TDC XIII Ch.68-70 Articles of stone, plaster, cement, asbestos, mica or similar
TDC III Ch.15 Animal or vegetable fats and oils and their cleavage products TDC XIV Ch.71 Natural or cultured pearls, precious or semi-precious stones…
TDC IV Ch.16-24 Prepared foodstuffs; beverages, spirits and vinegar; tobacco ... TDC XV Ch.72-83 Base metals and articles of base metal
TDC V Ch.25-27 Mineral Products TDC XVI Ch.84-85 Machinery and mechanical appliances; electrical equipment; parts
TDC VI Ch.28-38 Products of the chemical or allied industries TDC XVII Ch.86-89 Vehicles, aircraft, vessels and associated transport equipment
TDC VII Ch.39-40 Plastics and articles thereoof animal gut (other than silkworm gut) TDC XVIII Ch.90-92 Optical, photo, cinema, measuring, checking, precision instrum…
TDC VIII Ch.41-43 Raw hides and skins, leathematerials; basketware and wickerwork TDC XIX Ch. 93 Arms and ammunition; parts and accessories thereof
TDC IX Ch.44-46 Wood and articles of wood; wood charcoal; cork and articles of TDC XX Ch.94-96 Miscellaneous manufactured articles
TDC X Ch.47-49 Pulp of wood or of other fibrous cellulosic material; paper or paperboard TDC XXI Ch.97 Works of art, collectors’ pieces and antiques excl.chapter 99 other products
World excluding Intra-EU trade and European Union: 25 members.

Mercosur: Argentine, Brazil, Paraguay, Uruguay.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

9
15-sept-06
DONNEES GRAPHIQUES SUR LES SERVICES
2004 Graph non affiché pour ces régions:
#REF! 9957 World
USA 214728 EFTA
Switzerland 77635 NAFTA
Japan 29080 APEC
Other A. ASEM
 MEETING OF APEC MINISTERS RESPONSIBLE FOR TRADE
Cairns, Australia
5-6 July, 2007

We, APEC Ministers Responsible for Trade (MRT), met on 5-6 July in Cairns,
Australia under the chairmanship of the Hon Warren Truss MP, Minister for Trade of
the Commonwealth of Australia.

We welcomed the participation in the meeting of the APEC Business Advisory

Council (ABAC), the Pacific Economic Cooperation Council, the Association of
South-East Asian Nations, the Pacific Islands Forum and the APEC Secretariat.

Promoting dynamism in the Asia-Pacific Region

The Asia-Pacific region remains one of the fastest growing and dynamic regions in the
world, but a number of challenges lie ahead of us. Greater economic integration,
demographic and technological changes, social and environmental issues, including
climate change, are impacting on the region’s economic landscape. These challenges
require collective solutions for the benefit of all our people. APEC is already making
an important contribution but needs to remain attuned to further opportunities to
promote sustainable growth, improve living standards and reduce poverty.

Continuing support for the multilateral trading system

We reaffirmed the importance of supporting an open, rules-based, multilateral trading

system under the World Trade Organization (WTO) for global economic growth and
development. We noted the urgency of advancing the DDA negotiations and issued a
separate Statement on the DDA.

We also welcomed the continued work to achieve progress of the Russian Federation
in the WTO accession negotiations and underlined the importance of efforts to
expedite conclusion of these negotiations.

Creating an enabling environment for economic growth through trade and

investment liberalisation and facilitation

- Regional Economic Integration

We had a broad-ranging and constructive discussion about ways and means to

promote regional economic integration. We discussed various ways to achieve free
trade in the region, including the possibility of developing a Free Trade Area of the
Asia-Pacific (FTAAP) as a long term prospect. In this regard, we reaffirmed our
commitment to the Bogor Goals. We agreed that the time is right to further examine
the prospect for an FTAAP, including its implications. We agreed that scope exists for
more intensive activity across APEC’s agenda in support of regional economic
integration. We provided guidance to officials to finalise the draft report for
September’s APEC Ministers Meeting (AMM) recommending a range of practical
measures to further promote economic integration in the region, building on APEC’s
current work program.

- Regional Trade Agreements/Free Trade Agreements (RTAs/FTA)s

High-quality and comprehensive RTAs/FTAs can advance economic openness in the

region and strengthen regional economic integration. They can also serve as building
blocks for the further development of the multilateral trading system, and they can
bring the realisation of the Bogor Goals nearer.

We took note of the concerns of the business community over possible complexities
caused by the spread of RTAs/FTAs and the possibility of trade diversion. To this end
we have instructed officials to examine, in close cooperation with the business sector,
the scope for a rationalisation of preferential rules of origin and other relevant
provisions of such agreements and to report to us when next we meet. The model
measures for RTA/FTA chapters are a pioneering contribution by APEC to promote
greater consistency and coherence among the RTAs/FTAs within the region. They are
also an effective capacity-building mechanism. Ministers reaffirmed that the model
measures would serve as a reference for APEC member economies to help them
achieve comprehensive and high-quality free-trade agreements and reiterated the non-
binding and voluntary nature of the model measures. We noted the progress in
developing model measures for additional RTA/FTA chapters and have instructed our
officials to accelerate efforts to complete model measures for at least three additional
chapters in time for the APEC Ministerial Meeting in September.

- Trade Facilitation

We endorsed APEC’s second Trade Facilitation Action Plan (TFAP II) which sets out
a framework and timetable for achieving the goal of another 5 per cent reduction in
trade transaction costs by 2010. APEC’s current trade facilitation work on customs
procedures, standards and conformance, e-commerce and mobility of business people
is already providing substantial benefits. We welcomed the greater focus in TFAP II
on collective actions, the role of capacity building and its linkage with APEC’s wider
business facilitation agenda. This reinforces the important role trade facilitation
measures and APEC’s behind-the-border reform agenda have to play in facilitating
economic growth as recognised in APEC’s Busan Business Agenda.

We acknowledged the call by business that Key Performance Indicators (KPIs) be

developed to measure TFAP II progress. We have instructed officials to develop
appropriate KPIs when implementing TFAP II collective actions and measures.

We welcomed the study commissioned for APEC from the World Bank on
“Transparency and Trade Facilitation in the Asia-Pacific: Estimating the gains from
reform”, which indicates that the collective trade performance of APEC economies

2
would be boosted by USD$148 billion from greater trade policy predictability and
simplification. We instructed officials to consider how the findings of the study can be
used in APEC’s trade facilitation and transparency work.

We welcomed agreement to launch a Data Privacy Pathfinder at the Sydney AMM

and the expansion of the APEC Business Travel Card (ABTC) scheme to more
economies by creating a transitional membership category.

- Intellectual Property Rights and the Digital Economy

We affirmed that APEC should remain at the forefront of strengthening protection and
enforcement of IPR in the region, underscoring that trade in counterfeit and pirated
goods continues to stifle investment, innovation and economic development. We also
acknowledged the importance of a comprehensive and balanced intellectual property
system, as well as an environment that encourages creation and innovation and
provides the tools for the successful management and exploitation of intellectual
property rights.

We encouraged economies to contribute to the Best Practices Paper on Innovative

Techniques for IPR Border Enforcement and undertake greater information exchange
among IPR authorities and enforcement authorities. We acknowledged and
encouraged the continuing implementation of the APEC Anti-Counterfeiting and
Piracy Initiative, including through implementation of the five existing IPR
Guidelines. We endorsed the IPR Guidelines on Capacity Building and welcomed the
continued work on the Education and Awareness Project and seminars and workshops
on IPR. We encouraged work to develop the APEC Cooperation Initiative on Patent
Acquisition Procedures.

We welcomed APEC’s on-going work on trade and the digital economy and
encouraged economies to further intensify their efforts on bridging the digital divide.
We welcomed the announcement by Malaysia to join the Pathfinder on Technology
Choice Principles and encouraged other members to join. We also encouraged
officials to explore further steps to address concerns that some technologically
advanced versions of products covered by the Information Technology Agreement
may be in danger of no longer receiving duty-free treatment.

- Investment

We stressed the importance of further investment liberalization and facilitation in

meeting our development and infrastructure needs and agreed that reducing behind-
the-border barriers to investment was necessary to help achieve this. We welcomed
the analytical work undertaken in APEC and the policy dialogue conducted in
collaboration with ABAC to identify those behind-the-border barriers in the APEC
region that have the greatest impact on deterring investment. We will provide greater
coherence to APEC’s investment work by exploring a possible Investment Facilitation
Action Plan. This would bring together public-private sector dialogue, policy

3
recommendations and identify capacity building needs in improving the investment
climate.

We called for additional work, including capacity building, to promote better

understanding of the elements of a sound investment policy regime.
- Transparency and Anti-Corruption

We reiterated our stand in fighting corruption and welcomed the report on APEC
economies’ progress in implementing the APEC Transparency Standards. We pledged
to close those remaining gaps in implementation, including through targeted capacity
building activities and other initiatives where appropriate.

We reiterated the high priority we attach to fighting corruption, which poses a

significant threat to economic growth by undermining the rule of law, distorting
markets and deterring investment. We endorsed a model Code of Conduct for
Business, a model Code of Conduct Principles for Public Officials and the
complementary Anti-Corruption Principles for the Private and Public Sectors. This
work gives practical impetus to APEC’s commitment to combat corruption and the
commitment expressed by our Leaders towards a cleaner and more honest and
transparent community in the Asia-Pacific region.

- Individual Action Plans (IAPs)

We noted the commencement of the current cycle of IAP Peer Reviews of Individual
Action Plans and in particular those concluded involving Australia; China; Hong
Kong, China; Japan; Korea; New Zealand; and Chinese Taipei. The new improved
IAP peer review process, which includes consideration of members' broader trade
policies, is proving to be an effective way for economies to learn from the experiences
of one another and monitor progress toward the Bogor Goals.

- Improving the Business Environment and Structural Reform

We re-emphasised the importance of structural reform for the full realisation of the
benefits of trade and investment liberalisation. We welcomed the Economic
Committee’s new policy focus to reflect this and its on-going work to progress the
Leaders’ Agenda to Implement Structural Reform (LAISR) towards 2010. This
includes measures to improve market efficiency in areas such as regulation,
competition policies, transparency and corporate and public sector governance with
benefits to trade, investment and economic growth. We welcomed APEC’s important
role in support of reform efforts through information sharing and targeted research and
analysis, including identifying better practice approaches. We have called for officials
to explore ways to accelerate the work being conducted under the Private Sector
Development Agenda to promote better regulatory and business practices by using the
World Bank’s Ease of Doing Business indicators as a guide to best practice.

4
In order to support APEC’s work on trade, investment and structural reform, we
welcomed a proposal to establish a Policy Support Unit attached to the APEC
Secretariat to provide analytical capacity and policy support for APEC’s trade and
economic agenda.

Securing trade and people movement to ensure continued prosperity in the region

We discussed the importance of developing coherent regional policy responses to the

major human security challenges facing APEC members, including cross-border
issues such as terrorism, pandemic diseases, natural disasters and energy security and
the importance of this to sustaining growth and prosperity in the region. We welcomed
the findings of the 5th APEC Secure Trade in the APEC Region Conference, in
particular its call for greater public-private partnerships in secure trade to mitigate
risks, while containing costs. We look forward to APEC further developing its close
engagement with the private sector in secure trade and building on our cooperation in
transport security, customs procedures, border controls, food defence, terrorist
financing and other areas. We encouraged officials to explore the scope for improving
the interoperability of supply chain security measures.

We noted that energy security and sustainable development are of vital interest to
APEC and that climate change and clean development will be a key focus for APEC
Leaders in 2007. We recognised the need to take strong and early action to address
the challenge of climate change taking into account the need to balance environmental
concerns and economic growth. We represent a unique mix of energy exporting and
importing economies and our common energy interests are heightened by our growing
regional economic integration. As Ministers Responsible for Trade, we have a
particular interest in promoting well-functioning energy markets that are characterised
by free and open trade, secure and transparent frameworks for investment, market-
based price signals, market transparency, good governance and effective competition.
Such frameworks are important in encouraging greater energy efficiency and the
adoption of new, lower-emission and more energy efficient technologies. We urged
APEC economies to continue their work on environmental goods and services and
explore ways to reduce trade barriers in this area. We also urged further work on
remanufactured products in APEC. We welcomed the proposal by APEC Energy
Ministers for an APEC Energy Investment and Trade Study and Roundtable to take
forward these objectives.

5
Ensuring APEC is responsive to the changing needs of the Asia-Pacific community

We discussed the need for APEC to become more efficient and results-oriented and to
maintain cooperative links with key stakeholders in order to remain responsive to the
changing economic landscape.

We encouraged continuing efforts to strengthen and professionalise APEC’s

institutional base. We noted work by officials to develop a package of reform
measures which will further strengthen APEC’s operational capability. We urged
them to complete this work in time to make recommendations to the AMM in
September.

We noted the on-going and constructive dialogue between APEC and ABAC and
other forums, which informs APEC’s work to promote and enhance economic
prosperity in the Asia-Pacific region. We welcomed the closer engagement between
ABAC and Ministers and officials this year to progress work across the APEC agenda
including on support for the Doha negotiations, trade facilitation and regional
economic integration.

We welcomed ABAC’s Letter to Ministers Responsible for Trade, which identifies

some of the key business challenges which need to be addressed and agreed to take
account of these in our future work. We also commended public-private cooperation
in the industry dialogues, and in this regard, welcomed work on expediting customs
for low-risk shippers, expressed concern over the negative impact of the European
Commission’s chemicals legislation on the chemical sector, and called for a study on
the benefits of investment in health innovations.

We endorsed the SOM Chair’s Report on APEC’s 2007 work program.

6
Apec@glance06.fmx 1/15/07 3:14 AM Page 7
C M Y CM MY CY CMY K

APEC
at a Glance

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Apec@glance06.fmx 1/15/07 3:14 AM Page 8
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The Asia-Pacific Economic Cooperation (APEC)
What is forum was established in 1989 to capitalize
Asia-Pacific on the growing interdependence of Asia-
Economic Pacific economies. By facilitating economic
Cooperation? growth, intensifying economic and technical
cooperation and enhancing a sense of
community, APEC aims to create greater
prosperity for the people of the region.
APEC is a unique forum, operating on the
basis of open dialogue and respect for the
views of all participants. There are no binding
commitments; compliance is achieved through
discussion and mutual support in the form
of economic and technical cooperation. In
APEC, all economies have an equal say and
decision-making is reached by consensus.
Since its inception, APEC has grown to
become one of the world's most important
Building a Prosperous Asia-Pacific through Free and
Open Trade and Investment
Which
Economies 1989 1991 1993
are Members
of APEC?
Composite
Y CM MY CY CMY K
regional groupings. Its 21 member economies
are home to more than 2.6 billion people
and represent approximately 56% of world
GDP and 49% of world trade.*(Source: The World
Bank and The APEC Region Trade and Investment 2006)
APEC is the most economically dynamic region
in the world. Building on the five-year target
set in Shanghai in 2001 to reduce trade
transaction costs by 5%, APEC member
economies have targeted a further 5%
reduction by 2010.
The forum constantly adapts itself to enable
members to discuss important new economic
challenges. These include facilitating electronic
commerce, addressing the digital divide,
countering terrorism and introducing
measures to safeguard against infectious
diseases.
1994 1998
Apec@glance06.fmx 1/15/07 3:14 AM Page 1
C M Y CM
In 1989, the founding members of APEC
What are developed three objectives –
APEC’s Goals? • To develop and strengthen the multilateral
trading system;
• To increase the interdependence and
prosperity of member economies; and
• To promote sustainable economic growth.
APEC’s vision was further defined in 1994,
when APEC Leaders committed to the ‘Bogor
Goals’ of free and open trade in the region.
Recognizing the differing levels of
development among member economies, the
Leaders set two broad timetables. The goal
Connecting People and Economies through Trade,
Investment and Technology
APEC operates as a cooperative, multilateral
How does economic and trade forum. Member
economies take individual and collective
APEC actions to open their markets and promote
Operate? economic growth. These actions are discussed
at a series of meetings of Senior Officials,
Ministers and finally, by the Leaders of APEC’s
21 member economies.
APEC policy direction is provided by the
21 APEC Economic Leaders. Strategic
recommendations, provided by APEC
Ministers and the APEC Business Advisory
Council, are considered by APEC Economic
Leaders as part of this process.
Leaders’ Meeting
How is APEC
Structured? APEC Business Ministerial
Advisory Council Meeting
Senior Officials
Meeting (SOM)
Committee on Budget &
Trade & Investment Management
(CTI) Committee (BMC)
Policy Level
Working Level
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MY CY CMY K
of free and open trade will be achieved by
industrialized economies no later than 2010,
and by developing economies no later than
2020. It is a voluntary commitment, based
on good faith and a pledge of best endeavor.
APEC also works to create an environment
for the secure and efficient movement of
goods, services and people across borders in
the region through policy alignment and
economic and technical cooperation. This
cooperation also helps to ensure that the
people of the APEC region have access to
training and technology to take advantage
of more open trade and investment.
APEC's working level activities and projects
are guided by APEC Senior Officials and
undertaken by four core committees:
• Committee on Trade and Investment
• Senior Officials' Meeting - Steering
Committee on Economic and Technical
Cooperation
• Economic Committee
• Budget and Management Committee
Sub-Committees, Experts' Groups, Working
Groups and Task Forces carry out the activities
led by these four core committees.
Sectoral
Ministerial Meetings
APEC
Secretariat
SOM Steering
Economic Committee on
Committee (EC) ECOTECH (SCE)
SOM Special Working Groups (WG)
Task Groups
Apec@glance06.fmx 1/15/07 3:14 AM Page 2
C M Y CM MY CY CMY K

APEC's activities are focused in three key Enhancing Economic

What is areas: and Social Prosperity
APEC's Scope • Trade and Investment Liberalisation
of Work? • Business Facilitation
• Economic and Technical Cooperation

The outcomes of these three areas enable

APEC member economies to strengthen their
economies by sharing ideas and promoting
cooperation within the region to achieve
efficiencies and growth.

Trade and Investment

Liberalisation

Trade and Investment Liberalisation focuses information and communications technology

on opening markets and reducing, and
eventually eliminating, tariff and non-tariff
barriers to trade and investment. Liberalisation
measures have lead to sizeable reductions
in tariffs. APEC member economies
average tariffs have declined significantly,
from 16.6% in 1988 to 6.4% in 2004.
All of the developed economies of APEC
but one, now have average tariffs of less
than 5%.
Business Facilitation
Business facilitation focuses on reducing
business transaction costs, with APEC aiming
to reduce transaction costs by 5% by 2006
(based on 2001 figures). Business facilitation
also focuses on improving access to trade
information, maximising the benefits of
and aligning policy and business strategies
to facilitate growth. Essentially, business
facilitation helps importers and exporters in
the Asia Pacific to conduct business more
efficiently. Costs of production are reduced,
leading to increased trade, cheaper goods
and services and more employment
opportunities.
Economic and Technical
Cooperation (ECOTECH)
Economic and Technical Cooperation
(ECOTECH) comprises training and other
cooperative activities to build capacities at
the institutional and individual levels in
member economies to enable all to take
advantage of global trade and the new
economy.

Economic Challenges

Over the last few years new threats to the economic well-being of the region have emerged.
The commercial impact of the terrorist attacks on member economies, the epidemics of avian
influenza and SARS and the devastating tsunamis and hurricanes, reinforces the nexus of trade
and human security. APEC is meeting these challenges through cooperative activities aimed
at ensuring trade and economic development continues, while safeguarding the people and
economies of the region.

Other new challenges facing APEC include ensuring that sub-regional trade agreements (regional
trade agreements (RTAs) and free trade agreements (FTAs) contribute to global free trade.
APEC recently agreed to model measures for RTAs and FTAs, which help ensure that agreements
are comprehensive, consistent with WTO requirements and genuinely pave the way for the
realization of the Bogor Goals. APEC has also embarked on a substantive exercise of reform
to the forum to ensure it continues to meet the needs of its members.

Strengthening Security against the Terrorist Threat

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Apec@glance06.fmx 1/15/07 3:14 AM Page 3
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In order to meet APEC's Bogor Goals for free
How does and open trade and investment in Asia-Pacific,
APEC Put Into APEC member economies follow the strategic
Action its roadmap agreed by APEC Economic Leaders
in Osaka, Japan. This roadmap is known as
Goals and
the Osaka Action Agenda.
Vision?
Osaka Action Agenda
The Osaka Action Agenda provides a
framework for meeting the Bogor Goals
through trade and investment liberalisation,
business facilitation and sectoral activities,
underpinned by policy dialogues and
economic and technical cooperation. As part
of this framework, General Principles have
been defined for APEC Member Economies
as they proceed through the APEC
liberalisation and facilitation process.
The following General Principles are provided
in the Osaka Action Agenda and are applied
to the entire APEC liberalisation and
facilitation process -
• Comprehensiveness - addressing all
impediments to achieving the long-term
goal of free and open trade.
• WTO-consistency - measures undertaken
in the context of the APEC Action Agenda
are consistent with the principles of the
World Trade Organization (WTO).
• Comparability - APEC member economies
endeavor to have comparable trade and
investment liberalization and facilitation,
taking into account the general levels
achieved by each APEC economy.
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Y CM MY CY CMY K
• Non-discrimination - reductions in barriers
to trade achieved through APEC are
available to all APEC member economies
and non-APEC economies.
• Transparency - the laws, regulations and
administrative procedures in all APEC
member economies which affect the flow
of goods, services and capital among APEC
member economies are transparent.
• Standstill - APEC member economies do
not take measures which have the effect
of increasing levels of protection.
• Simultaneous start, continuous process
and differentiated timetables - APEC
member economies began simultaneously
the process of liberalization, facilitation
and cooperation and continuously
contribute to the long-term goal of free
and open trade and investment.
• Flexibility - APEC member economies deal
with the liberalization and facilitation
process in a flexible manner, taking into
account differing levels of economic
development.
• Cooperation - Economic and technical
cooperation contributing to liberalization
and facilitation is actively pursued.
Implementing Reforms
to Reduce Impediments
to Trade
Apec@glance06.fmx 1/15/07 3:14 AM Page 4
Individual Action Plans
APEC member economies report progress
toward achieving the free and open trade
and investment goals through Individual and
Collective Action Plans, submitted to APEC
on a regular basis. Individual Action Plans
(IAPs) contain a chapter for each specified
policy area and report the steps that each
member is taking to fulfill the objectives set
out in the Osaka Action Agenda for each
action area.
Reporting is based on the following
issue areas:
• Tariffs
• Non-tariff measures
• Services
• Investment
• Standards and Conformance
• Customs Procedures
• Intellectual Property
• Competition Policy
• Government Procurement
• Deregulation/Regulatory Review
• WTO Obligations (including Rules of Origin)
• Dispute Mediation
• Mobility of Business People
• Information Gathering and Analysis
• Strengthening Economic Legal
Infrastructure
Sharing Knowledge and Skills to Promote Growth in the Asia-Pacific Region
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C M Y CM MY CY CMY K
Over the past few years additional areas have Facilitating Trade
been included in the IAP reporting process through
including the APEC Food System, Transparency Simplifying and
and Regional Trade Agreements/Free Trade Developing
Agreements (RTAs/FTAs). Common
Approaches
Collective Action Plans
Collective Action Plans (CAPs) detail the joint
actions of all APEC member economies in
the same issue areas outlined in the Osaka
Action Agenda. CAPs are the compass by
which APEC charts its course towards the
ultimate objective of free trade and
investment.
Capacity Building
Aimed at enhancing economic growth and
prosperity for the region, projects are a vital
part of the APEC process. APEC projects build
capacity in key priority areas identified by
Leaders' call for action. Targeting specific
policy areas, projects cover a wide range of
activities, such as seminars, publications and
research, and focus on trade and investment
liberalization and economic and technical
cooperation. Projects typically focus on
building human capacity, strengthening
economic infrastructure and ensuring security
for the region.
Apec@glance06.fmx 1/15/07 3:14 AM Page 5
C M Y CM MY CY CMY K

Members continue to work together to sustain • APEC implements technical assistance

How does economic growth through a commitment to projects which develop skills and
APEC free and open trade, investment liberalization strengthen economic infrastructure.

Benefit the and facilitation, and economic reform. Being • 17 member economies participate in the
APEC Business Travel Card allowing bona
Economies of more responsive to the needs of business in
fide frequent business travelers fast-track
the region, members have progressively
the Region? reduced tariffs and other barriers to trade
entry and exit through special APEC lanes
at major airports in the region.
making the flow of business easier and less
• APEC works to harmonize, standardize,
costly. Actions taken have resulted in the
Promoting the Safe and simplify customs procedures.
development of more efficient economies
and Efficient and have seen exports expand dramatically. • APEC works to align standards regimes
Movement of with international norms to reduce barriers
to trade, facilitate innovation and new
Goods, Services Highlights -
technologies, and offer consumers better
and People through • Political leaders, ministers, government prices and greater choice.
the Asia-Pacific administrators business people come
(Source: Open Economies Delivering to People, 2005)
Region together regularly for active information
exchange and dialogue that help promote
cooperation and policy development.

The people of the Asia-Pacific benefit from
How do the the collective and individual actions of APEC
People of the member economies in a number of ways.
Asia-Pacific Direct benefits include increased job
Benefit from opportunities and training programs, stronger
social safety nets and poverty reduction. More
APEC's Work? broadly, APEC member economies, on
• Unemployment in the APEC region is well
below the world average, with an average
rate of 4.3%compared to 6.2% for the
world in 2003
• Measures of health and sanitation have
improved, infant mortality has fallen
considerably and life expectancy has risen.

average, enjoy a lower cost of living because • Nearly all APEC economies are achieving
close to 100% primary completion rates
reduced trade barriers and a more
for both males and females, generating
economically competitive region helps to
higher literacy rates amongst both adults
lower prices for goods and services that and the young.
everyone needs on a daily basis, from food
• APEC economies have improved their
to clothes to mobile phones.
governance, particularly in the areas of
r e g u l a t o r y q u a l i t y, g o v e r n a n c e
Highlights - effectiveness, accountability and political
stability, and are ahead of the rest of the
• Making travel safer, facilitating faster
world in this area.
processing of legitimate travelers while
reducing opportunities for unauthorized (Source: Open Economies Delivering to People, 2005)
and improperly documented persons to
cross borders.
• The APEC region is meeting the Millennium
Development Goals by reducing the
proportion of its population living on less
than US$1 a day by approximately 60%
since 1990.

Improving the Business Environment by

Removing Barriers between Economies

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APEC recognizes that strong and vibrant
Other than economies are not built by governments
Government alone, but by partnerships between
Officials, government and its key stakeholders including
Which Other the business sector, industry, academia, policy
Groups and research institutions, and interest groups
within the community. APEC actively involves
Participate in
these key stakeholders in the work of the
the APEC forum.
Process?
Business
At the highest level, APEC Economic Leaders
communicate through annual meetings with
the APEC Business Advisory Council (ABAC),
which comprises high-level business people
from all 21 APEC member economies.
At the working level, representatives from
the private sector are invited to join many
APEC working groups and expert groups.
This process provides an important
opportunity for industry to provide direct
input into APEC's ongoing work.
Academic and Research Institutions
Through the APEC Study Centres (ASC)
Consortium, APEC Member Economies
If you are interested in participating in the
How do I Get APEC process you can apply to attend or be
Involved invited to APEC meetings or seminars. Contact
with APEC? the APEC Secretariat or visit the website for
further information.
How Can I Keep up to date with the latest APEC news
Keep Up-to- by regularly accessing the APEC website at
date with www.apec.org. The APEC Secretariat also
APEC produces a free APEC E-Newsletter. It provides
information on selected key outcomes of the
Progress?
For general information about APEC, please contact -
Contact Us
APEC Secretariat
35 Heng Mui Keng Terrace,
Singapore 119616
Telephone Number: (65) 6775 6012
Facsimile Number: (65) 6775 6013
Website: www.apec.org
Copyright © 2007 APEC Secretariat APEC#206-SE-05.4
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Y CM MY CY CMY K
engage academic and research institutions
in the APEC process. The ASC facilitates
cultural and intellectual exchanges in the
Asia-Pacific region and undertakes advanced,
collaborative interdisciplinary and policy-
relevant research from an independent and
long-term perspective.
There are ASCs in 19 APEC Member
Economies, comprising universities, research
centres and centres of academic excellence.
Academics and research institutions also
participate in the working level of APEC
through meetings, seminars and other
activities.
APEC Observers
APEC has three Official Observers: the
Association of Southeast Asian Nations
Secretariat, the Pacific Economic Cooperation
Council and the Pacific Islands Forum
Secretariat. These observers participate in
APEC meetings and have full access to
documents and information related to
these meetings. The observer groups
provide partnership, expertise and insight
that assist APEC to attain its goals and
implement its initiatives.
Views can also be expressed about APEC's
work to your economy's APEC office. Enquiries
can be directed to contacts in APEC Member
Economies. A complete list of these contacts
is available through the APEC Secretariat.
APEC process, new publications,
upcoming meetings and more. Simply fill
out your details on the APEC website and
the latest edition of the APEC E-Newsletter
will be emailed to you.
General Inquiries: info@apec.org
Media Inquiries: media@apec.org
Publications Inquiries: jt@apec.org
ISSN1793-2440
 APEC
Population 2.6 Mio inhabitants
Area 62 695 (1000qkm)
Gross domestic product 2005 19 917 Bn euros Exports-to-GDP ratio: 17.6 % in 2005
GDP per capita 2004 7 127 Euros
(IMF, World Economic Outlook) 2002 2003 2004 2005
Real GDP (% growth) 4.4 4.2 4.8 5.0

Current account balance (% of GDP) -1.3 -1.2 -1.3 -1.3

APEC MERCHANDISE TRADE WITH THE WORLD EU25 MERCHANDISE TRADE WITH APEC
(Bn euros) Imports Exports Balance (Bn euros) Imports Exports Balance
3 788.2
4 000.0 3 499.8 800.0
3 243.8 687.3
3 500.0 2 961.7 3 014.1 700.0 603.3 566.9 570.4
2 752.9 600.0 507.3
3 000.0 490.3
2 500.0 500.0
2 000.0 400.0
300.0
1 500.0
200.0
1 000.0
100.0
500.0
-100.0
-500.0 -200.0 -96.0 -76.6 -116.9
-282.1 -261.2 -288.4
2001 2003 2005 2001 2003 2005
Source: IMF (Direction of Trade Statistics) * excl intra EU Trade Source: Eurostat, statistical regime 4

% OF THE WORLD * 2001 2003 2005 % OF EU TOTAL 2001 2003 2005

Imports 56.28 72.41 68.23 Imports 61.35 60.28 58.51
Exports 55.21 71.40 67.39 Exports 56.83 55.81 53.76
EU25 MERCHANDISE TRADE WITH APEC BY PRODUCT (2005)
(Mio Euros) Imports Exports Balance
250 000
230 640

200 000 169 917

150 000
80 398 90 383 95 497
100 000 67 747 56 779
28 945 32 144 38 718 31 697
50 000 18 880 22 636 13 891
3 198

-50 000 -17 806

-100 000 -61 518 -60 723

Agricultural products Energy Machinery Transport equipment Chemicals Textiles and clothing

Source: Eurostat, statistical regime 4

Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore,
DG TRADE
Thailand, USA, Vietnam.

15 September 2006
 APEC 15-sept-06
EU BILATERAL TRADE AND TRADE WITH THE WORLD DG TRADE

(EU: 25 members, recalculated series since 2001)

Australia, Brunei, Canada, Chile, China, Hong

Kong, Indonesia, Japan, Korea, Malaysia, Mexico,
New Zealand, Papua New Guinea, Peru,
Philippines, Russia, Singapore, Thailand, USA,
Vietnam.

TOTAL MERCHANDISE TRADE, 2001-2005

1. Evolution of the EU's Trade Balance with Apec
2. Evolution of the APEC's Trade Balance

GEOGRAPHIC BREAKDOWN OF TRADE, 2005

3. EU Trade with Main Partners
4. APEC's Trade Balance with Main Partners

SECTORAL BREAKDOWN OF TRADE

Sitc Rev3, Sections and Product Grouping

5. European Union, Trade with the World and Apec, by Sitc Section
6. European Union Imports, by Product Grouping
7. European Union Exports, by Product Grouping
8. Rank of APEC in European Union Trade

Harmonized System, Sections

9. EU Trade with the World and EU Trade with Apec (2005)
 EVOLUTION OF THE EU'S TRADE BALANCE WITH APEC
(Mio euro)

European Union, Trade with the World European Union, Trade with ... Apec
Share of Share of
Yearly % Yearly % Imports + Yearly % Yearly % Imports +
Year Imports Exports Balance Year Imports total EU Exports total EU Balance
change change Exports change change Exports
imports exports
2001 983 443 892 720 -90 723 1 876 164 2001 603 319 61.35 507 303 56.83 -96 016 1 110 622
2002 941 885 -4.2 900 424 0.9 -41 462 1 842 309 2002 573 573 -4.9 60.90 511 149 0.8 56.77 -62 424 1 084 723
2003 940 347 -0.2 878 483 -2.4 -61 864 1 818 830 2003 566 876 -1.2 60.28 490 274 -4.1 55.81 -76 601 1 057 150
2004 1 031 999 9.7 964 652 9.8 -67 347 1 996 652 2004 617 046 8.9 59.79 528 167 7.7 54.75 -88 879 1 145 213
2005 1 176 055 14.0 1 061 836 10.1 -114 219 2 237 891 2005 687 977 11.5 58.50 570 902 8.1 53.77 -117 075 1 258 880

3m 2005 262 361 234 231 -28 130 496 593 3m 2005 154 341 58.83 126 774 54.12 -27 567 281 115
3m 2006 328 931 25.4 274 381 17.1 -54 550 603 313 3m 2006* 192 548 24.8 58.54 149 505 17.9 54.49 -43 042 342 053
Average Average
annual 4.6 4.4 4.5 annual 3.3 3.0 3.2
growth growth

European Union, Trade with the World European Union, Trade with ... Apec
1 400 000 800 000

1 200 000 700 000

600 000
1 000 000
500 000
800 000
400 000

600 000 300 000

400 000 200 000

100 000
200 000

-100 000

-200 000 -200 000

2001 2002 2003 2004 2005 2001 2002 2003 2004 2005

Imports Exports Balance Imports Exports Balance

World excluding Intra-EU trade and European Union: 25 members.

APEC: Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore, Thailand, USA, Vietnam.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

1
15-sept-06
 EVOLUTION OF THE APEC'S TRADE BALANCE
(Mio euro)

APEC,Trade with the World APEC, Trade with the European Union
EU Share EU Share
Yearly % Yearly % Imports + Yearly % Yearly % Imports +
Year Imports Exports Balance Year Imports of total Exports of total Balance
change change Exports change change Exports
imports exports
2001 3 243 841 2 961 707 -282 134 6 205 549 2001 529 914 16.34 513 700 17.34 -16 213 1 043 614
2002 3 182 089 -1.9 2 900 217 -2.1 -281 872 6 082 305 2002 518 928 -2.1 16.31 483 011 -6.0 16.65 -35 916 1 001 939
2003 3 014 096 -5.3 2 752 924 -5.1 -261 172 5 767 019 2003 490 779 -5.4 16.28 473 836 -1.9 17.21 -16 943 964 615
2004 3 308 001 9.8 3 020 144 9.7 -287 857 6 328 145 2004 522 705 6.5 15.80 527 397 11.3 17.46 4 692 1 050 102
2005 3 788 190 14.5 3 499 817 15.9 -288 373 7 288 007 2005 568 952 8.8 15.02 625 987 18.7 17.89 57 035 1 194 939

3m 2005 810 980 746 029 -64 952 1 557 009 3m 2005 124 334 15.33 136 639 18.32 12 305 260 974
3m 2006 1 038 635 28.1 958 901 28.5 -79 735 1 997 536 3m 2006 157 334 26.5 15.15 172 765 26.4 18.02 15 431 330 099
Average Average
annual 4.0 4.3 4.1 annual 1.8 5.1 3.4
growth growth

APEC,Trade with the World APEC, Trade with the European Union
4 000 000 700 000

3 500 000 600 000

3 000 000
500 000

2 500 000
400 000
2 000 000

300 000
1 500 000

200 000
1 000 000

500 000 100 000

-500 000
-100 000
2001 2002 2003 2004 2005 2001 2002 2003 2004 2005

Imports Exports Balance Imports Exports Balance

European Union: 25 members.

APEC: Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore, Thailand, USA, Vietnam.

Source: IMF (Dots) 2 DG TRADE

15-sept-06
 EU TRADE WITH MAIN PARTNERS

(2005)

The major imports partners The major export partners The major trade partners

Partners Mio euro % Partners Mio euro % Partners Mio euro %

World 1 176 055 100.0 World 1 061 836 100.0 World 2 237 891 100.0

1 USA 163 057 13.9 1 USA 251 657 23.7 1 USA 414 714 18.5
2 China 158 098 13.4 2 Switzerland 81 980 7.7 2 China 209 894 9.4
3 Russia 106 766 9.1 3 Russia 56 445 5.3 3 Russia 163 211 7.3
4 Japan 73 243 6.2 4 China 51 796 4.9 4 Switzerland 148 334 6.6
5 Norway 67 474 5.7 5 Japan 43 663 4.1 5 Japan 116 906 5.2
6 Switzerland 66 354 5.6 6 Turkey 41 849 3.9 6 Norway 101 261 4.5
7 Turkey 33 492 2.8 7 Norway 33 787 3.2 7 Turkey 75 341 3.4
8 Korea 33 326 2.8 8 United Arab Emir. 25 288 2.4 8 Korea 53 456 2.4
9 Taiwan 23 835 2.0 9 Canada 23 681 2.2 9 Canada 40 855 1.8
10 Brazil 23 300 2.0 10 Romania 21 825 2.1 10 India 40 021 1.8
11 Saudi Arabia 22 092 1.9 11 India 21 110 2.0 11 Brazil 39 287 1.8
12 Algeria 20 735 1.8 12 Australia 20 710 2.0 12 Saudi Arabia 37 535 1.7
13 Libya 19 473 1.7 13 Hong Kong 20 434 1.9 13 Romania 37 130 1.7
14 India 18 911 1.6 14 Korea 20 130 1.9 14 Taiwan 36 653 1.6
15 Singapore 18 219 1.5 15 South Africa 18 077 1.7 15 Singapore 35 447 1.6
16 Canada 17 174 1.5 16 Singapore 17 227 1.6 16 United Arab Emir. 35 087 1.6
17 South Africa 16 731 1.4 17 Mexico 16 762 1.6 17 South Africa 34 808 1.6
18 Malaysia 15 905 1.4 18 Brazil 15 987 1.5 18 Algeria 31 150 1.4
19 Romania 15 305 1.3 19 Saudi Arabia 15 443 1.5 19 Hong Kong 31 109 1.4
20 WA_AO 13 761 1.2 20 WA_AO 13 484 1.3 20 Australia 30 182 1.3

APEC 687 977 58.5 APEC 570 902 53.8 APEC 1 258 880 56.3

EU Imports from … EU Exports to … Imports + Exports

Partner regions Mio euro % Partner regions Mio euro % Partner regions Mio euro %

World 1 176 055 100.0 World 1 061 836 100.0 World 2 237 891 100.0

NAFTA 189 219 16.1 NAFTA 292 100 27.5 NAFTA 481 319 21.5
Latin America 64 201 5.5 Latin America 54 557 5.1 Latin America 118 758 5.3
EU Candidates 58 061 4.9 EU Candidates 81 216 7.6 EU Candidates 139 277 6.2
EFTA 136 648 11.6 EFTA 119 333 11.2 EFTA 255 981 11.4
Medit.Countries* 54 679 4.6 Medit.Countries* 59 822 5.6 Medit.Countries* 114 502 5.1
ASEAN 70 809 6.0 ASEAN 44 966 4.2 ASEAN 115 775 5.2

NAFTA: Canada, Mexico, USA.

Latin America: 20 countries.
EU Candidates: Bulgaria, Croatie, Romania, Turkey
EFTA: Iceland, Norway, Switzerland.
Mediterranean countries *excluding Turkey : Algeria, Cisjordanie Gaza , Egypt, Israel, Jordan, Lebanon, Morocco, Syria, Tunisia.
ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

World excluding Intra-EU trade and European Union: 25 members.

APEC: Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore,
Thailand, USA, Vietnam.

Source: EUROSTAT (Comext, Statistical regime 4) 3 DG TRADE

15-sept-06
 APEC'S TRADE BALANCE WITH MAIN PARTNERS

(2005)

The major import partners The major export partners The major trade partners

Partners Mio euro % Partners Mio euro % Partners Mio euro %

World 3 788 190 100.0 World 3 499 817 100.0 World 7 288 007 100.0

1 EU 568 952 15.0 1 USA 781 932 22.3 1 USA 1 247 176 17.1
2 China 533 507 14.1 2 EU 625 987 17.9 2 EU 1 194 939 16.4
3 USA 465 244 12.3 3 China 333 672 9.5 3 China 867 180 11.9
4 Japan 359 458 9.5 4 Japan 236 280 6.8 4 Japan 595 738 8.2
5 Canada 258 053 6.8 5 Canada 208 824 6.0 5 Canada 466 877 6.4
6 Korea 166 123 4.4 6 Hong Kong 189 864 5.4 6 Korea 293 025 4.0
7 Mexico 156 007 4.1 7 Korea 126 902 3.6 7 Mexico 273 190 3.7
8 Malaysia 110 409 2.9 8 Mexico 117 182 3.3 8 Hong Kong 222 601 3.1
9 Singapore 104 510 2.8 9 Singapore 95 339 2.7 9 Singapore 199 848 2.7
10 Saudi Arabia 87 601 2.3 10 Malaysia 69 320 2.0 10 Malaysia 179 729 2.5
11 Thailand 70 902 1.9 11 Australia 61 466 1.8 11 Australia 128 309 1.8
12 Australia 66 844 1.8 12 Thailand 56 054 1.6 12 Thailand 126 955 1.7
13 Indonesia 61 562 1.6 13 Indonesia 49 139 1.4 13 Indonesia 110 701 1.5
14 Brazil 50 739 1.3 14 India 41 366 1.2 14 Saudi Arabia 105 380 1.4
15 India 42 888 1.1 15 Philippines 30 609 0.9 15 India 84 254 1.2
16 United Arab Emir. 40 505 1.1 16 United Arab Emir. 29 728 0.8 16 Brazil 77 923 1.1
17 Philippines 39 522 1.0 17 Brazil 27 184 0.8 17 United Arab Emir. 70 232 1.0
18 Russia 38 862 1.0 18 Switzerland 24 996 0.7 18 Philippines 70 131 1.0
19 Venezuela 32 921 0.9 19 Russia 23 130 0.7 19 Russia 61 992 0.9
20 Hong Kong 32 738 0.9 20 Turkey 22 520 0.6 20 Switzerland 55 102 0.8

Imports from … Exports to … Imports + Exports

Partner regions Mio euro % Partner regions Mio euro % Partner regions Mio euro %

World 3 788 190 100.0 World 3 499 817 100.0 World 7 288 007 100.0

NAFTA 879 305 23.2 NAFTA 1 107 938 31.7 NAFTA 1 987 243 27.3
Latin America 324 770 8.6 Latin America 225 978 6.5 Latin America 550 748 7.6
EU Candidates 11 626 0.3 EU Candidates 31 561 0.9 EU Candidates 43 187 0.6
EFTA 44 317 1.2 EFTA 31 284 0.9 EFTA 75 601 1.0
* * *
Medit.Countries 38 907 1.0 Medit.Countries 35 432 1.0 Medit.Countries 74 339 1.0
ASEAN 415 250 11.0 ASEAN 327 649 9.4 ASEAN 742 899 10.2

NAFTA: Canada, Mexico, USA.

Latin America: 20 countries.
EU Candidates: Bulgaria, Croatie, Romania, Turkey
EFTA: Iceland, Norway, Switzerland.
Mediterranean countries *excluding Turkey : Algeria, Cisjordanie Gaza , Egypt, Israel, Jordan, Lebanon, Morocco, Syria, Tunisia.
ASEAN: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam.

European Union: 25 members.

APEC: Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore,
Thailand, USA, Vietnam.

Source: IMF (Dots) 4 DG TRADE

15-sept-06
 EUROPEAN UNION, TRADE WITH THE WORLD AND APEC, BY SITC SECTION
(2005)

European Union, Imports from the World European Union, Imports from … Apec
Share of
Products (Sitc Sections) Products (Sitc Sections)
Mio euro % Mio euro % total EU
by order of importance by order of importance imports

TOTAL 1 176 055 100.0 TOTAL 687 977 100.0 58.5

Machinery and transport equipment 375 952 32.0 Machinery and transport equipment 298 741 43.4 79.5
Mineral fuels, lubricants and rel. Materials 249 695 21.2 Miscell. manuf. Articles 109 544 15.9 65.6
Miscell. manuf. Articles 166 967 14.2 Mineral fuels, lubricants and rel. Materials 80 416 11.7 32.2
Manuf goods classif. chiefly by material 116 362 9.9 Manuf goods classif. chiefly by material 59 035 8.6 50.7
Chemicals and related prod., n.e.s. 93 872 8.0 Chemicals and related prod., n.e.s. 56 818 8.3 60.5
Food and live animals 54 653 4.6 Crude materials inedible, except fuels 23 696 3.4 51.7
Crude materials inedible, except fuels 45 851 3.9 Food and live animals 15 877 2.3 29.1
Commodit. and transactions n.e.c. 25 720 2.2 Commodit. and transactions n.e.c. 13 406 1.9 52.1
Beverages and tobacco 4 778 0.4 Animal and vegetable oils, fats and waxes 2 455 0.4 60.0
Animal and vegetable oils, fats and waxes 4 093 0.3 Beverages and tobacco 2 347 0.3 49.1

European Union, Exports to the World European Union, Exports to ... Apec
Share of
Products (Sitc Sections) Products (Sitc Sections)
Mio euro % Mio euro % total EU
by order of importance by order of importance exports

TOTAL 1 061 836 100.0 TOTAL 570 902 100.0 53.8

Machinery and transport equipment 478 928 45.1 Machinery and transport equipment 261 477 45.8 54.6
Chemicals and related prod., n.e.s. 163 339 15.4 Chemicals and related prod., n.e.s. 95 616 16.7 58.5
Manuf goods classif. chiefly by material 133 539 12.6 Miscell. manuf. Articles 68 500 12.0 57.3
Miscell. manuf. Articles 119 503 11.3 Manuf goods classif. chiefly by material 60 312 10.6 45.2
Mineral fuels, lubricants and rel. Materials 38 847 3.7 Mineral fuels, lubricants and rel. Materials 19 095 3.3 49.2
Food and live animals 35 126 3.3 Food and live animals 15 165 2.7 43.2
Commodit. and transactions n.e.c. 28 663 2.7 Beverages and tobacco 10 991 1.9 68.2
Crude materials inedible, except fuels 19 440 1.8 Crude materials inedible, except fuels 10 491 1.8 54.0
Beverages and tobacco 16 111 1.5 Commodit. and transactions n.e.c. 9 176 1.6 32.0
Animal and vegetable oils, fats and waxes 2 420 0.2 Animal and vegetable oils, fats and waxes 1 473 0.3 60.9
World excluding Intra-EU trade and European Union: 25 members.

APEC: Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore, Thailand, USA, Vietnam.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

15-sept-06
5
 EUROPEAN UNION IMPORTS, BY PRODUCT GROUPING
(Mio euro)
European Union, Imports from the World European Union, Imports from ... Apec
Share of
SITC Rev.3 SITC Rev.3
2001 % 2003 % 2005 % 2001 % 2003 % 2005 % total EU
Product Groups Product Groups
imports

TOTAL 983 443 100.0 940 347 100.0 1 176 055 100.0 TOTAL 603 319 100.0 566 876 100.0 687 977 100.0 58.50
Primary Products 284 210 28.9 274 641 29.2 383 646 32.6 Primary Products 101 202 16.8 97 644 17.2 137 626 20.0 35.87
of which: of which:
Agricultural prod. 81 060 8.2 78 499 8.3 80 932 6.9 Agricultural prod. 31 616 5.2 29 083 5.1 28 980 4.2 35.81
Energy 155 904 15.9 155 826 16.6 249 695 21.2 Energy 44 506 7.4 47 706 8.4 80 416 11.7 32.21
Manuf. Products 667 914 67.9 634 832 67.5 728 577 62.0 Manuf. Products 477 040 79.1 448 117 79.1 511 303 74.3 70.18
of which: of which:
Machinery 262 923 26.7 233 724 24.9 277 426 23.6 Machinery 221 488 36.7 198 880 35.1 230 812 33.5 83.20
Transport equipm 89 425 9.1 92 898 9.9 98 526 8.4 Transport equipm 68 107 11.3 70 166 12.4 67 929 9.9 68.95
of which: of which:
Automotive prod. 34 734 3.5 38 579 4.1 44 010 3.7 Automotive prod. 28 584 4.7 30 822 5.4 32 382 4.7 73.58
Chemicals 76 880 7.8 80 360 8.5 93 872 8.0 Chemicals 47 623 7.9 49 444 8.7 56 818 8.3 60.53
Textiles and cloth. 67 220 6.8 66 680 7.1 70 415 6.0 Textiles and cloth. 27 474 4.6 26 360 4.6 31 739 4.6 45.07

Structure of Imports (%)

from the World from ... Apec

30.0 40.0
25.0 35.0
30.0
20.0
25.0
15.0 20.0
10.0 15.0
10.0
5.0
5.0

2001 2003 2005 2001 2003 2005

Agricultural prod. Energy Machinery Agricultural prod. Energy Machinery

Transport equipm Automotive prod. Chemicals Transport equipm Automotive prod. Chemicals
Textiles and cloth. Textiles and cloth.

World excluding Intra-EU trade and European Union: 25 members.

APEC: Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore, Thailand, USA, Vietnam.

Source : EUROSTAT (Comext, Statistical regime 4) DG TRADE

Agricultural prod.: food&live animals incl.fish, beverages&tobacco, hides, skins&furskins, raw, oil seeds&oleaginous fruits, natural rubber..., cork&wood, silk, cotton, jute&other textile bast fibres..., veget.textile fibres (other than 15-sept-06
cotton)..., wool, crude animal&vegetable materials, oil, fat Energy: mineral fuels etc Manuf.products: chemicals,
6 basic manuf.excl.non-ferrous met, machines, transport equip, misc.manuf.
 EUROPEAN UNION EXPORTS, BY PRODUCT GROUPING
(Mio euro)
European Union, Exports to the World European Union, Exports to ... Apec
Share of
SITC Rev.3 SITC Rev.3
2001 % 2003 % 2005 % 2001 % 2003 % 2005 % total EU
Product Groups Product Groups
exports

TOTAL 892 720 100.0 878 483 100.0 1 061 836 100.0 TOTAL 507 303 100.0 490 274 100.0 570 902 100.0 53.77
Primary Products 99 252 11.1 98 404 11.2 125 129 11.8 Primary Products 50 265 9.9 49 905 10.2 64 596 11.3 51.62
of which: of which:
Agricultural prod. 58 969 6.6 58 331 6.6 61 819 5.8 Agricultural prod. 29 948 5.9 29 620 6.0 32 140 5.6 51.99
Energy 22 351 2.5 22 856 2.6 38 847 3.7 Energy 10 714 2.1 11 425 2.3 19 095 3.3 49.15
Manuf. Products 775 305 86.8 760 712 86.6 882 125 83.1 Manuf. Products 444 772 87.7 428 797 87.5 478 525 83.8 54.25
of which: of which:
Machinery 268 866 30.1 248 408 28.3 308 796 29.1 Machinery 162 861 32.1 144 505 29.5 169 989 29.8 55.05
Transport equipm 145 563 16.3 146 766 16.7 167 386 15.8 Transport equipm 86 730 17.1 85 520 17.4 90 388 15.8 54.00
of which: of which:
Automotive prod. 83 954 9.4 93 941 10.7 107 822 10.2 Automotive prod. 52 507 10.4 59 804 12.2 62 202 10.9 57.69
Chemicals 131 133 14.7 142 377 16.2 163 339 15.4 Chemicals 76 339 15.0 85 554 17.5 95 616 16.7 58.54
Textiles and cloth. 35 923 4.0 33 882 3.9 33 003 3.1 Textiles and cloth. 15 622 3.1 13 906 2.8 13 900 2.4 42.12

Structure of Exports (%)

to the World to ... APEC

35.0 35.0
30.0 30.0
25.0 25.0
20.0 20.0
15.0 15.0
10.0 10.0
5.0 5.0

2001 2003 2005 2001 2003 2005

Agricultural prod. Energy Machinery Agricultural prod. Energy Machinery

Transport equipm Automotive prod. Chemicals Transport equipm Automotive prod. Chemicals
Textiles and cloth. Textiles and cloth.

World excluding Intra-EU trade and European Union: 25 members.

APEC: Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore, Thailand, USA, Vietnam.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

Agricultural prod.: food&live animals incl.fish, beverages&tobacco, hides, skins&furskins, raw, oil seeds&oleaginous fruits, natural rubber..., cork&wood, silk, cotton, jute&other textile bast fibres..., veget.textile fibres (other than 15-sept-06
cotton)..., wool, crude animal&vegetable materials, oil, fat Energy: mineral fuels etc Manuf.products: chemicals,
7 basic manuf.excl.non-ferrous met, machines, transport equip, misc.manuf.
 RANK OF APEC IN EUROPEAN UNION TRADE

(2005)

European Union, Imports from ... Apec European Union, Exports to ... Apec
Share of Share of
SITC Rev.3 SITC Rev.3
Product Groups
Mio euro total EU %
Product Groups
Mio euro total EU % Balance
imports exports

TOTAL 687 977 58.50 100.0 TOTAL 570 902 53.77 100.0 -117 075

Agricultural products 28 980 35.81 4.2 Agricultural products 32 140 51.99 5.6 3 160
Energy 80 416 32.21 11.7 Energy 19 095 49.15 3.3 -61 321
Non-agricultural raw materials 4 417 33.34 0.6 Non-agricultural raw materials 2 254 52.74 0.4 -2 163
Office/telecom. Equipment 144 193 89.89 21.0 Office/telecom. Equipment 48 410 50.91 8.5 -95 783
Power/non-electrical mach. 53 342 73.72 7.8 Power/non-electrical mach. 93 794 57.18 16.4 40 452
Transport equipment 67 929 68.95 9.9 Transport equipment 90 388 54.00 15.8 22 459
Chemicals 56 818 60.53 8.3 Chemicals 95 616 58.54 16.7 38 797
Textiles and clothing 31 739 45.07 4.6 Textiles and clothing 13 900 42.12 2.4 -17 839
Iron and steel 6 358 41.08 0.9 Iron and steel 10 222 48.33 1.8 3 863
Share by products in EU 25 Total Trade excluding Intra-EU trade.

EU Trade with ... Apec

Agricultural Non-agricultural Office/telecom. Power/non- Transport Textiles and
products Energy raw materials Equipment electrical mach. equipment Chemicals clothing Iron and steel
200 000

144 193
150 000

93 794 90 388 95 616

100 000 80 416
67 929
48 410 53 342 56 818
40 452 38 797
50 000 28 980 32 140 22 459
31 739
19 095 13 900
3 160 4 417 2 254 6 358 10 222 3 863
0
-2 163
-17 839
-50 000
-61 321
-100 000
-95 783
-150 000

Imports Exports Balance

APEC: Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore, Thailand, USA, Vietnam.

Source: EUROSTAT (Comext, Statistical regime 4) 8 DG TRADE

Agricultural prod.: food&live animals incl.fish, beverages&tobacco, hides, skins&furskins, raw, oil seeds&oleaginous fruits, natural rubber..., cork&wood, silk, cotton, jute&other textile bast fibres..., veget.textile fibres (other than 15-sept-06
cotton)..., wool, crude animal&vegetable materials, oil, fat Energy: mineral fuels etc Manuf.products: chemicals, basic manuf.excl.non-ferrous met, machines, transport equip, misc.manuf.
 EU TRADE WITH THE WORLD AND EU TRADE WITH APEC (2005)
(Ranking by Trade Flows in 2005)

EU Imports from … EU Exports to … EU Balance with …

Harmonized Apec Harmonized Apec Harmonized

System System System
World Share of World Share of World Apec
Mio euro % total EU Mio euro % total EU
Sections: Sections: Sections:
imports exports

TOTAL 1 176 055 687 977 100.0 58.50 TOTAL 1 061 836 570 902 100.0 53.77 TOTAL -114 219 -117 075

TDC XVI 286 987 237 320 34.5 82.69 TDC XVI 324 117 176 928 31.0 54.59 TDC VI 60 413 34 261
TDC V 285 197 93 024 13.5 32.62 TDC VI 147 203 87 788 15.4 59.64 TDC XVII 66 694 20 723
TDC XVII 95 253 66 515 9.7 69.83 TDC XVII 161 947 87 237 15.3 53.87 TDC IV 7 857 10 478
TDC VI 86 790 53 527 7.8 61.67 TDC XVIII 51 712 35 983 6.3 69.58 TDC X 10 440 2 989
TDC XV 68 868 35 907 5.2 52.14 TDC XV 70 977 33 832 5.9 47.67 TDC XIII 7 008 2 654
TDC XVIII 45 014 34 864 5.1 77.45 TDC V 42 712 20 410 3.6 47.78 TDC XVIII 6 698 1 119
TDC XI 73 056 31 720 4.6 43.42 TDC VII 41 346 19 031 3.3 46.03 TDC XXI 1 160 890
TDC XX 29 314 23 973 3.5 81.78 TDC IV 33 623 18 369 3.2 54.63 TDC XIX 999 547
TDC VII 29 488 19 447 2.8 65.95 TDC XI 36 315 14 761 2.6 40.65 TDC I -4 671 270
TDC XIV 29 696 11 196 1.6 37.70 TDC X 24 110 11 266 2.0 46.73 TDC VIII -1 178 -266
TDC XII 13 910 9 547 1.4 68.64 TDC XIV 28 397 10 209 1.8 35.95 TDC VII 11 858 -416
TDC II 27 449 8 585 1.2 31.28 TDC XX 18 219 8 816 1.5 48.39 TDC III -1 432 -922
TDC X 13 670 8 277 1.2 60.55 TDC XIII 15 228 8 044 1.4 52.82 TDC XIV -1 300 -987
TDC IV 25 766 7 891 1.1 30.63 TDC I 12 370 6 241 1.1 50.45 TDC XV 2 109 -2 074
TDC IX 11 619 6 613 1.0 56.91 TDC VIII 8 829 5 963 1.0 67.55 TDC IX -3 233 -2 353
TDC VIII 10 007 6 229 0.9 62.25 TDC IX 8 387 4 260 0.7 50.80 TDC II -16 976 -4 601
TDC I 17 041 5 971 0.9 35.04 TDC II 10 472 3 984 0.7 38.04 TDC XII -8 085 -6 525
TDC XIII 8 220 5 390 0.8 65.57 TDC XXI 4 279 3 195 0.6 74.67 TDC XX -11 095 -15 157
TDC III 3 924 2 329 0.3 59.35 TDC XII 5 824 3 022 0.5 51.89 TDC XI -36 741 -16 960
TDC XXI 3 119 2 305 0.3 73.90 TDC III 2 492 1 406 0.2 56.43 TDC XVI 37 130 -60 393
TDC XIX 705 364 0.1 51.65 TDC XIX 1 704 911 0.2 53.45 TDC V -242 486 -72 614

Labels of TDC sections: TDC XI Ch.50-63 Textiles and textile articles

TDC I Ch.01-05 Live animals; animal products TDC XII Ch. 64-67 Footwear, headgear, umbrellas, sun umbrellas, walking-sticks
TDC II Ch.06-14 Vegetable products TDC XIII Ch.68-70 Articles of stone, plaster, cement, asbestos, mica or similar
TDC III Ch.15 Animal or vegetable fats and oils and their cleavage products TDC XIV Ch.71 Natural or cultured pearls, precious or semi-precious stones…
TDC IV Ch.16-24 Prepared foodstuffs; beverages, spirits and vinegar; tobacco ... TDC XV Ch.72-83 Base metals and articles of base metal
TDC V Ch.25-27 Mineral Products TDC XVI Ch.84-85 Machinery and mechanical appliances; electrical equipment; parts
TDC VI Ch.28-38 Products of the chemical or allied industries TDC XVII Ch.86-89 Vehicles, aircraft, vessels and associated transport equipment
TDC VII Ch.39-40 Plastics and articles thereoof animal gut (other than silkworm gut) TDC XVIII Ch.90-92 Optical, photo, cinema, measuring, checking, precision instrum…
TDC VIII Ch.41-43 Raw hides and skins, leathematerials; basketware and wickerwork TDC XIX Ch. 93 Arms and ammunition; parts and accessories thereof
TDC IX Ch.44-46 Wood and articles of wood; wood charcoal; cork and articles of TDC XX Ch.94-96 Miscellaneous manufactured articles
TDC X Ch.47-49 Pulp of wood or of other fibrous cellulosic material; paper or paperboard TDC XXI Ch.97 Works of art, collectors’ pieces and antiques excl.chapter 99 other products
World excluding Intra-EU trade and European Union: 25 members.

APEC: Australia, Brunei, Canada, Chile, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru, Philippines, Russia, Singapore, Thailand, USA, Vietnam.

Source: EUROSTAT (Comext, Statistical regime 4) DG TRADE

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