Introduction To Economics

Ismail SerageldinOctober 2008

Basic Concepts

Barter Exchange

A B

g + s

g + s

Exchange with Promise to Pay

g + s

Pa

A B Time 1

g + s

Pa

A B Time 2

Exchange with third party promise to pay

g + s

Pa

A B Time 1

g + s

Pa

B C Time 2

g + s

Pa

A C Time 3

Exchange with promise of a Central Bank

g + s g + s

g + s g + s

A Central Bank

E

B D

C

Pa Pa

Pa Pa

Pa Pa

Pb Pd

Cashless System with Central Clearinghouse

B

E

A

C

D

g + s g + s

g + s g + s g + s

g + s

Clearinghouse

Public Goods

• Public goods must not be forgotten

• Public goods research must be funded

• Knowledge transfer is a quintessential public good

Public Goods

• Non-excludable

• Non-Rival

• Recognized by Adam Smith in The Wealth Of Nations in 1775.

Clean Air Is A Public Good

Clean Water Is NOT A Public Good

R&D expenditures as percent of GDP

Source: Ernst & Young, Beyond Borders, Global Biotechnology Report 2006

The Private Sector Is Extremely Important

• 68% of all funding in the US – up from 32% in 1960

• 75% of actual R&D in the US is executed by Private sector

• 63% of Global funding

Source: S&E Indicators 2002

US R&D Funding, by Source

Economics

Adam Smith and his “Wealth of Nations” 1776

Adam Smith and “the Invisible Hand”

“As every individual, therefore, endeavours as much as he can … to employ his capital …He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. … he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention”.

Adam Smith in the Wealth of Nations

“…[the state is responsible] for erecting and maintaining those public institutions and those public works, which though they may be in the highest degree advantageous to a great society, are, however, of such a nature, that the profit could never repay the expense to any individual or small number of individuals, and which it, therefore, cannot be expected that any individual or small number of individuals should erect or maintain.”

Supply and Demand

Supply and Demand

Shifts to new Equilibrium Points

Shifts

Macro and Micro

Understanding GDP

Gross Business SavingGross Business Saving

Net TaxesNet

Taxes

Disposable Personal Income

Disposable Personal Income

Poverty Observed: US and Selected European Countries, 1991

0 5 10 15 20 25 30

Belgium

Canada

Denmark

France

Ireland

Italy

Netherlands

Sweden

UK

USA

% POORSource: Robert Solow, “Welfare: The Cheapest Country”’in NYRB, 23 March 2000, p. 20-23

Poverty before Government policy effects

US and Selected European Countries, 1991

0 5 10 15 20 25 30

Belgium

Canada

Denmark

France

Ireland

Italy

Netherlands

Sweden

UK

USA

% POORSource: Robert Solow, “Welfare: The Cheapest Country”’in NYRB, 23 March 2000, p. 20-23

Policy Effects on Poverty:Pre and Post tax and transfers, 1991

0 5 10 15 20 25 30

Belgium

Canada

Denmark

France

Ireland

Italy

Netherlands

Sweden

UK

USA

% POORSource: Robert Solow, “Welfare: The Cheapest Country”’in NYRB, 23 March 2000, p. 20-23

Policy Effects on Poverty:Pre and Post tax and transfers, 1991

0 5 10 15 20 25 30

Belgium

Canada

Denmark

France

Ireland

Italy

Netherlands

Sweden

UK

USA

% POORSource: Robert Solow, “Welfare: The Cheapest Country”’in NYRB, 23 March 2000, p. 20-23

Policy Effects on Poverty:Pre and Post tax and transfers, 1991

0 5 10 15 20 25 30

Belgium

Canada

Denmark

France

Ireland

Italy

Netherlands

Sweden

UK

USA

% POORSource: Robert Solow, “Welfare: The Cheapest Country”’in NYRB, 23 March 2000, p. 20-23

Policy Effects on Poverty:Pre and Post tax and transfers, 1991

0 5 10 15 20 25 30

Belgium

Canada

Denmark

France

Ireland

Italy

Netherlands

Sweden

UK

USA

% POORSource: Robert Solow, “Welfare: The Cheapest Country”’in NYRB, 23 March 2000, p. 20-23

Gross Business SavingGross Business Saving

Net TaxesNet

Taxes

Disposable Personal Income

Disposable Personal Income

Finance And The Real Economy

Production, Employment

Real World Production

Real World Consumption

Money!

Money and Banking

• Money supply

• Credit

• Banking services (mobilize savings, advance credit)

Like Blood

Circulation or

Respiration are to the

Human Body

Without it you go back to the barter economy

Capital markets

• Securities (equities)

• Bonds

• Credit (loans)

Monetary Policy

• Credit

• Interest rate

• Money supply

• Exchange rate

• FOREX

• Banking system: RRR, capitalization, oversight

The Central Bank

• Responsible to maintain the stability of the national currency and money supply

• Controlling subsidized-loan interest rates

• Lender of last resort to the banking sector during times of financial crisis (private banks being integral to the national financial system).

Central Banks Supervisory Powers

• To ensure that banks and other financial institutions do not behave recklessly or fraudulently.

• Instruments:– RRR– Open market operations– Basic interest rate

Financial regulations • All forms of regulation or supervision,

which subject financial institutions to certain requirements, restrictions and guidelines, aiming to maintain the integrity of the financial system.

• This may be handled by either a government or non-government organization.

Other Supervisory Bodies

• Securities and Exchange Commission (SEC)

• Rating agencies

• Audit regulations

Economic Policies

Objectives of Economic Policy

• Growth

• Price stability

• Employment

• Exchange rate

• Income distribution

• Reserves

Objectives of Economic Policy

• Growth

• Price stability

• Employment

• Exchange rate

• Income distribution

• Reserves

Objectives of Economic Policy

• Growth

• Price stability

• Employment

• Exchange rate

• Income distribution

• Reserves

Objectives of Economic Policy

• Growth

• Price stability

• Employment

• Exchange rate

• Income distribution

• Reserves

Objectives of Economic Policy

• Growth

• Price stability

• Employment

• Exchange rate

• Income distribution

• Reserves

Objectives of Economic Policy

• Growth

• Price stability

• Employment

• Exchange rate

• Income distribution

• Reserves

Objectives of Economic Policy

• Growth

• Price stability

• Employment

• Exchange rate

• Income distribution

• Reserves

0.0

2.0

4.0

6.0

8.0

10.0

10.08.06.04.02.00.0 12.0

% annual growth in GDP/person

% annual decline in poverty(Headcount

index)

Growth and Poverty Reduction

0.0

2.0

4.0

6.0

8.0

10.0

10.08.06.04.02.00.0 12.0

% annual growth in GDP/person

% annual decline in poverty(Headcount

index)

Growth and Poverty Reduction

0.0

2.0

4.0

6.0

8.0

10.0

10.08.06.04.02.00.0 12.0

% annual growth in GDP/person

% annual decline in poverty(Headcount

index)

Jamaica

Costa Rica

India

MalaysiaIndonesia

SingaporeThailand

Taiwan

Sri LankaMexico

Brazil

Bangladesh

Pakistan

Growth and Poverty Reduction

0.0

2.0

4.0

6.0

8.0

10.0

10.08.06.04.02.00.0 12.0

% annual growth in GDP/person

% annual decline in poverty(Headcount

index)

Jamaica

Costa Rica

India

MalaysiaIndonesia

SingaporeThailand

Taiwan

Sri LankaMexico

Brazil

Bangladesh

Pakistan

Growth and Poverty Reduction

0.0

2.0

4.0

6.0

8.0

10.0

10.08.06.04.02.00.0 12.0

% annual growth in GDP/person

% annual decline in poverty(Headcount

index)

Jamaica

Costa Rica

India

MalaysiaIndonesia

SingaporeThailand

Taiwan

Sri LankaMexico

Brazil

Bangladesh

Pakistan

Growth and Poverty Reduction

0.0

2.0

4.0

6.0

8.0

10.0

10.08.06.04.02.00.0 12.0

% annual growth in GDP/person

% annual decline in poverty(Headcount

index)

Jamaica

Costa Rica

India

MalaysiaIndonesia

SingaporeThailand

Taiwan

Sri LankaMexico

Brazil

Bangladesh

Pakistan

Growth and Poverty Reduction

Macro-policy

• Necessary but not sufficient

• Sectoral policies and the development of projects at the grass roots level.

• Money and credit

• The importance of the real economy

• Tradeables and non tradeables

• Public goods and private goods

Macro-policy

• Necessary but not sufficient

• Sectoral policies and the development of projects at the grass roots level.

• Money and credit

• The importance of the real economy

• Tradeables and non tradeables

• Public goods and private goods

Macro-policy

• Necessary but not sufficient

• Sectoral policies and the development of projects at the grass roots level.

• Money and credit

• The importance of the real economy

• Tradeables and non tradeables

• Public goods and private goods

Macro-policy

• Necessary but not sufficient

• Sectoral policies and the development of projects at the grass roots level.

• Money and credit

• The importance of the real economy

• Tradeables and non tradeables

• Public goods and private goods

Macro-policy

• Necessary but not sufficient

• Sectoral policies and the development of projects at the grass roots level.

• Money and credit

• The importance of the real economy

• Tradeables and non tradeables

• Public goods and private goods

Macro-policy

• Necessary but not sufficient

• Sectoral policies and the development of projects at the grass roots level.

• Money and credit

• The importance of the real economy

• Tradeables and non tradeables

• Public goods and private goods

Social Policy

• Not the same as The social impacts of economic policies

• Sound Social policies will have beneficial economic impacts

Social Policy

• Maintain social cohesion

• Promote social mobility

• Reduce income inequality

• Promote gender equality

• Address the ultra-poor

• Cultural identity

• Etc.

Employment• Mobility, both geographic and

occupational• Regulations:

– Labor laws, – credit, – legalization, – Registration of startups– Incubators– venture capital etc.

• Fiscal and other incentives (e.g. military service, training tied to jobs, etc.)

Critical Transitions

Education For Learning & Life

Entering The Labor Force

Choosing Healthy Lifestyles

Forming Families

## 81

Becoming Effective Citizens

Must Ensure Youth Employment

How Much Wasted Talent?

How many youthful dreams will remain unrealized?

Youth Employment Policies

• The opportunities available to youth not only to acquire human capital but also to deploy it in promising jobs

• The capabilities that youth have to choose between the available opportunities, and support them to make the most constructive choices.

• Include second chances.

Youth Employment Policies

• The opportunities available to youth not only to acquire human capital but also to deploy it in promising jobs

• The capabilities that youth have to choose between the available opportunities, and support them to make the most constructive choices.

• Include second chances.

Youth Employment Policies

• The opportunities available to youth not only to acquire human capital but also to deploy it in promising jobs

• The capabilities that youth have to choose between the available opportunities, and support them to make the most constructive choices.

• Include second chances.

Youth Employment Policies

• The opportunities available to youth not only to acquire human capital but also to deploy it in promising jobs

• The capabilities that youth have to choose between the available opportunities, and support them to make the most constructive choices.

• Include second chances.

Empowerment

• Empowerment of youth (and other groups):– Increase assets– Increase returns held by youth (usually

labor and education)

The Instruments/Levers Of Economic Policy

Fiscal Policies

• Pattern of public spending (G)

• Investment and consumption (I+C)

• Subsidies

• Taxes

• Public deficits and surpluses

Taxes

• Income

• Tariffs

• Property

• Transaction (sales or VAT)

• Capital Gains

Borrowing

• Domestic and foreign

• Crowding out the private sector

• The structure of debt

• Preferred creditors

Other Obligations

• Social Security

• Insurance

• Pension Funds

Trade

• Comparative Advantage

• Fair Trade

Monetary Policy

• Credit

• Interest rate

• Money supply

• Exchange rate

• FOREX

• Banking system: RRR, capitalization, oversight

Money and Banking

• Money supply

• Credit

• Banking services (mobilize savings, advance credit)

A wise balance between regulation and encouraging

private initiative

Concern with Busioness cycles

Counter-cyclical Policies

• Anti-recession:– Easy money and credit– Tax cuts– Increased government spending

• Anti-inflation:– Tight money– Higher taxes– Budget surplus

Money, Banking And Finance

Money and Banking

• Money supply

• Credit

• Banking services (mobilize savings, advance credit)

The Lessons Of the Past:Do Not Just Print Money!

Hyperinflation!

• By the end of 1923 the German currency was of no value at all. The quarterly rate of inflation stood at 52,000%, which is the equivalent to an annual rate of 7,000,000,000,000%.

• In 1924 the currency was replaced with a new currency

1Mark

1921- 1923

50Mark

1921- 1923

10,000Mark

1921- 1923

100,000Mark

1921- 1923

1,000,000Mark

1921- 1923

5,000,000Mark

1921- 1923

50,000,000Mark

1921- 1923

500,000,000Mark

1921- 1923

1,000,000,000Mark

1921- 1923

10,000,000,000Mark

1921- 1923

From 1 Mark to 10,000,000,000

Mark

1921- 1923

Worthless Money

• Using paper money as wallpaper or as fuel

Monetary Policy

• Credit

• Interest rate

• Money supply

• Exchange rate

• FOREX

• Banking system: RRR, capitalization, oversight

Recapitulation

Monetary Policy

• Credit

• Interest rate

• Money supply

• Exchange rate

• FOREX

• Banking system: RRR, capitalization, oversight

Fiscal Policies

• Pattern of public spending (G)

• Investment and consumption (I+C)

• Subsidies

• Taxes

• Public deficits and surpluses

Borrowing

• Domestic and foreign

• Crowding out the private sector

• The structure of debt

• Preferred creditors

Taxes

Taxes

• Income

• Tariffs

• Property

• Transaction (sales or VAT)

• Capital Gains

Other Obligations

• Social Security

• Insurance

• Pension Funds

Money and Banking

• Money supply

• Credit

• Banking services (mobilize savings, advance credit)

Counter-cyclical Policies

• Anti-recession:– Easy money and credit– Tax cuts– Increased government spending

• Anti-inflation:– Tight money– Higher taxes– Budget surplus

Excessively Reductionist?

Vehement Reactions

• Dehumanizing the humanities

• Denies individualism

• Treats people like products or machines

• Economics is not the whole story

• Etc. etc.

Serageldin on Reductionist Views

• Three buckets of water and a handful of minerals held together by chemical reactions…

• A society is more than the sum of its economic and financial transactions…

Serageldin on Reductionist Views

• Three buckets of water and a handful of minerals held together by chemical reactions…

• A society is more than the sum of its economic and financial transactions…

Now, let us turn to the global crisis