Session 3 - 2009 Promos Case Study

P-Cube Session 3

Today’s objectives

1. Key points for case study skills

2. Understanding 2009 Promos Case study

3. Sample answers for (d)

Key case study skills

Case material

+Concepts


•Should not just paraphrase the extracts (no

concepts)

• Neither should it be just regurgitation of notes (no

application to context)

•Whenever possible – use numbers

•We will be looking at samples later


•Data handling skills

•Be sensitive eg. change vs absolute figures, real vs nominal, etc…

•Trend


•Time management


•Do refer to case study skills package for more details and tips

Dissecting the question

ai) Using AD/AS analysis, explain how an increase in FDI inflows affect economic growth. [3]

Actual and potential growth


aii) Describe the trend in growth in FDI inflows and growth in real GDP observed in Table 1. [2]


aiii) To what extent is the relationship described in (ai) consistent with the observation made in (aii). [3]

2 sides


b) Discuss whether the data provided is sufficient to suggest an improvement in the living standard of an average Chinese resident from 2000 to 2008. [8]

Across time comparison

Schematic plan (b)

IntroductionBody

Thesis – Data provided shows

improvement in SOL

Real GDP growth is positive

Anti-thesis 1 – Data provided is insufficient1. Not per capita2. Distribution and composition of NI is unknown3. Lack of concrete information on non-material

aspects

Conclusion – Data is insufficient to show improvement in SOL


ci) Describe the trend in the Chinese government budget balance (% of GDP) from 2003 to 2008. [2]

Position of the balance – surplus/deficitDirection of change – increasing/decreasing


cii) With reference to data, predict the change in government budget balance in 2009. [2]

Government revenue – Government expenditure


d) To what extent can the Chinese government’s stimulus plan power her economy to lead the rest of the world to recovery. [10]

1. Stimulus plan to raise China’s growth2. With China’s growth, other countries will recover too

Schematic plan (d)

IntroductionBody

Explain how the Chinese government’s stimulus plan can help China achieve

EG

Explain how China’s growth can help other countries achieve growth as well Limitations of stimulus plan on China’s growth

Synthesis & Conclusion – Whether China’s growth can be propped up by the stimulus plan is unknown. Even if China’s growth does increase she still may not be able to help other countries.

Your feedback/request

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•Hci survey 691 <your feedback/request>

Answer all questions.

Question 1 Extract 1: China’s Rise China's economy during the past 30 years has changed from a centrally planned system that was largely closed to international trade to a more market-oriented economy that has a rapidly growing private sector and is a major player in the global economy. Reforms started in the late 1970s with the phasing out of collectivized agriculture, and expanded to include the gradual liberalization of prices, increased autonomy for state enterprises, the foundation of a diversified banking system, the rapid growth of the non-state sector, and the opening to foreign trade and investment. China has generally implemented reforms in a gradualist fashion. Although it has opened up its economy in recent years, still China has invigorated its support for leading state-owned enterprises in sectors it considers important to "economic security," explicitly looking to foster globally competitive national champions. This is carried out while it still continued its effort to privatize the inefficient state owned industries that falter in the face of growing competition from the multinationals that have moved operations to China to take advantage of its low labour cost and huge domestic market. Today, China is one of the world’s largest recipients of foreign direct investment (FDI) which has not only provided employment opportunities for the locals, but has also become an important source for technology transfers. Measured on a purchasing power parity (PPP) basis that adjusts for price differences, China in 2008 stood as the second-largest economy in the world after the US, although in per capita terms the country is still lower middle-income. The Chinese government faces numerous economic development challenges, including: spending more to strengthen its social safety net, including pension and health system reform, to counteract a low domestic demand; sustaining adequate job growth for rural-urban migrant workers and those laid off from state-owned enterprises; reducing corruption and other economic crimes; and containing environmental damage related to the economy's rapid transformation. Economic development has been more rapid in coastal provinces than in the interior, and approximately 200 million rural laborers and their dependents have relocated to urban areas to find work.

Adapted from Thomson Reuters Jan 2009 and CIA Factbook 2009 Extract 2: Can China save the World? With the U.S., Japan and all of Europe mired in the worst global recession in 30 years, China has shown a restorative strength that six months ago many doubted it had. A devastating slump in exports crippled growth late last year, but on the back of a US$586 billion government stimulus program, China has snapped back. The economy grew 7.9% in the second quarter and will now probably expand 8% or more this year. Factory production has begun to edge up, in part because Chinese consumers continue to spend money at a healthy pace. Auto sales, helped significantly by government subsidies for small-car purchases, hit an all-time record in April. Overall, retail sales in China this year are up 16%. Nations that depend on producing commodities, such as Australia and Brazil, have benefited immensely over the past six months as demand from China has driven up the price of raw materials. Helped by trade with China, Asia's export-driven economies are sputtering back to life. Overall, the International Monetary Fund (IMF) forecasts that in the three years from 2008 to 2010, China will, astonishingly, account for almost three-quarters of the world's economic growth. As Shanghai-based economist Andy Xie puts it, "Everyone wants to know the same thing: Can China save the world?"

©HCI Promotional Exam 2009 9732/01/O/09

2 The speed and relative success so far of China's stimulus stands in stark contrast with that of the U.S. According to a recent study by the World Bank, Beijing's government spending will generate more than 80% of the country's overall economic growth this year. This is partly because China was already in the midst of a nationwide infrastructure program when the recession hit. Emergency spending measures simply added to existing schemes already under way. Still, the best possible answer to the question of whether China can save the world is: Not yet. Plenty of economists doubt that China's economy is as sound as it appears. Even though China’s economy continues to power ahead, it will probably not, on its own, be enough to drag the rest of the world into a recovery. Ultimately, China is not yet the leader of the global economy, although it appears to be getting there. Moreover, economists do not believe that the relatively poor Chinese consumers have the purchasing power to rescue China's economy, let alone the rest of the world. Brisk though auto sales may be, most Chinese still can't afford a Volkswagen, let alone a BMW. Even as China's consumers feel richer, their share of its economy may not change much until Beijing enacts reforms to the rural infrastructure, health-care and social-security systems -- steps that would give people more confidence to spend rather than save.

Some aspects of China's glimmers of economic turnaround do seem as though they might offer hope to the country's trading partners. Take car sales, which rose in March for the third straight month, once again making China the largest market for automobiles in the world, ahead of the U.S. Those statistics, you'd think, would bring good news to the world’s automobile industry; but the recovery may only be temporary.

Without a recovery in China's hugely important export sector, the economy may resume its downward track later in the year. In addition, China still faces a number of internal challenges – a massive shift of population from rural areas to cities, cleaning up decades of environmental degradation, continuing to provide the increase in prosperity that has underpinned political stability. Given their scale, it should surprise nobody that it is still most concerned with saving itself economically — not anyone else.

Adapted from Time, 10 Apr and 10 Aug 2009

Table 1: Selected Key Macroeconomic Indicators for China, 2000-2008

2000 2001 2002 2003 2004 2005 2006 2007 2008 Real GDP (US$ bn) 1457 1578 1722 1894 2085 2303 2570 2904 3165Growth in real GDP (% change) 8.4 8.3 9.1 10.0 10.1 10.4 11.6 13 9FDI Inflows (US$ bn) 193 203 217 228 245 272 293 327 NAGrowth in FDI Inflows (% change) 3.8% 5.2% 6.9% 5.1% 7.5% 11.0% 7.7% 11.6% NABudget balance (% of GDP) -2.5 2.3 2.6 -2.2 -1.3 -1.2 -0.8 0.6 -0.4Consumer prices (% change) 0.3 0.7 -0.8 1.1 3.8 1.8 1.8 4.8 5.9

Adapted from EIU Statistics


3 Table 2: U.S. Economy versus China’s Economy

Macroeconomic Indicator United States China

GDP US$14 trillion US$4.4 trillion

GDP (as % of global GDP) 21% 6.4%

Domestic consumption (as % of GDP) 70% 40%

Annual per capita income US$39,000 US$6,000

Adapted from Time, 10 Apr 2009

Questions (a) (i) Using AD-AS analysis, explain how an increase in FDI inflows could affect

economic growth. [3] (ii) Describe the trend of growth in FDI inflows and growth in real GDP

observed from Table 1. [2] (iii) To what extent is the relationship described in a(i) consistent with the

observation made in a(ii)? [3] (b) Discuss whether the data provided is sufficient to suggest an improvement in the

living standard of an average Chinese resident from 2000 to 2008. [8] (c) (i) Describe the trend in the Chinese government budget balance (% of GDP)

from 2003 to 2008. [2] (ii) With reference to the data, predict the change in the Chinese government

budget balance in 2009. [2]

(d) To what extent can China’s government stimulus plan power her economy to lead

the rest of the world to a recovery? [10]

[Total: 30] Permission to reproduce items where third-party owned material protected by copyright is included has been sought and cleared where possible. Every reasonable effort has been made to the publisher to trace copyright holders, but if any items requiring clearance have unwittingly been included, the publisher will be pleased to make amends at the earliest possible opportunity.


4a) (i) Using AD-AS analysis, explain how an increase in FDI inflows could affect economic growth. [3] Components of Aggregate demand – C, I, G and (X-M). Increase in FDI will increases AD which causes an unplanned decrease in stocks. Firms will increase production to bring the stocks to desired levels. This increase in output level is actual growth. In the long run, increase in FDI causes capital accumulation which raises the productive capacity (Potential growth) this is illustrated by the shifting of AS rightwards. Both increase in AD and AS will bring about increase in national income, hence economic growth. Comments: Weak AD analysis – increase in I will lead to increase in C and hence increase in NY and then AD

(hence making the argument sound like it is going on in circles). Should have looked at the direct impact given I is part of AD. The increase in C is induced consumption.

(ii) Describe the trend of growth in FDI inflows and growth in real GDP observed from Table 1. [2] Growth in real GDP showed rising trend in general from 2000-2008, except for 2000 – 2001 and 2007-2008. Growth in FDI inflows showed increasing trend in general from 2000-2007, except from 2002-2003 and 2005-2006. Comment: Quite a number commented that growth of GDP/FDI increase at increasing rate. This is incorrect.

Table 4 shows growth of GDP/FDI. For growth to increase at increasing rate the percentage change must be increasing and at a larger and larger percentage. It is only true if the comment is GDP/FDI is increasing at increasing rate. However, this does not answer the question as the focus of the question is on ‘growth’. Missed out on exceptions / pointed out the less obvious year (2001) when stating exception for

growth in real GDP. Focused on describing peaks rather than on describing the trend. Many “COMPARE” instead of “DESCRIBE”. This is a very strange phenomenon. When question

asks for compare students tend to just describe and when the question only requires description, students compared. Please read the command word carefully.

(iii) To what extent is the relationship described in a(i) consistent with the observation made in a(ii)? [3] There is a positive relationship between FDI inflows and real GDP, as with the rate of change has broadly suggested. However, differences in the rate of increase in the 2 variables suggest that FDI inflows are not the only factor affecting real GDP growth in China. When the FDI growth slowed down from 2002-03 and 2005-06 while real GDP growth continued on the rise, other factors could be affecting growth in China e.g. consumption (40% of GDP) and exports. Comments: Most candidates only focused on the data skills and did not provide the economic analysis to

explain why the relationship is not consistent throughout the whole period. “To what extent” already hinted the need to look at the other side. However not many of the

students explored the other side.


5 Not acceptable to explain the inconsistency by merely quoting 911 and SARs without links to

how these may affect the other components of AE. b) Discuss whether the data provided is sufficient to suggest an improvement in the living standard of an average Chinese resident from 2000 to 2008. [8] Define SOL – material and non-material aspects Thesis – the data suggest an improvement in living standards Evidence from Table 1 – real GDP growth shown is positive indicating real GDP has increased. GDP measures the market value of all final goods and services newly produced within the geographical boundaries of an economy in a given period of time (usually one year). Real GDP means that the effect of inflation has been removed. Hence with an increase in real GDP, there is an increase in physical quantities of goods and services produced and thus available for consumption, and hence improving SOL. Anti-thesis – shortcomings of the data to indicate improvement in SOL/data shows worsening of living standards However, to have a better gauge of whether there is improvement in living standards of an average Chinese, increase in real GDP figures alone is grossly insufficient. Population tends to grow over time, so one has to consider how the rate of change in population compares with the rate of change in national income. If the population of China has grown faster than the real GDP then what this means is that on the average, less is available for each individual. Hence, by focusing only on real GDP may overstate the actual increase in SOL. Even with growth in real GDP per capita, the growth may benefit certain sectors more than others evidence e,g, those who are employed in the selected state-owned firms and those residing in the coastal provinces. Structural unemployment may be quite high given the displaced rural farmers and those previously hired workers in the state-owned firms which have now been privatized. This is especially so given that an average Chinese is likely still trapped in the lower middle-income group, thus the purchasing power has probably not improved in tandem with the growth in GDP. Hence, income inequality may be widening though GDP is growing and supplementary indicators eg the Gini coefficient is needed to have a better assessment of the improvement in living standards. Although manufacturing is the activity driving economic growth in China, most of the goods produced are exported. Hence, though GDP may be growing, its growth could be attributed more to the growth in exports and FDI, rather than domestic consumption. Non-material well-being may also have been shortchanged given the rising environmental degradation brought about by the growth in the manufacturing activities and rising crime rates that could be attributed partially by the widening rich-poor gap and rising rural-urban unemployment. In addition, Extract 2 also hints at the lack of spending on healthcare which implies the quality of healthcare may be lacking in China. Hence, the information does not clearly point towards an improvement in living standards. Comment: Lack of application to the case. Sounded more like just answering an essay question without

using the evidences from the case. Did not realize the changes in price already accounted for since real GDP is given in Table 1. PPP is useful when comparing SOL over space. This question is for over time.


6 For students who tried to use evidence, some merely lifted from the extracts without much

attempt to explain clearly how they can be applied in the analysis of the answer. c) (i) Describe the trend in the Chinese government budget balance (% of GDP) from 2003 to 2008. [2] The Chinese government budget balance as a percentage of GDP is in a deficit but is getting smaller. Comments: Negative budget balance is not accepted. Some students looked at the wrong years like 2001 to 2008. (ii) With reference to the data, predict the change in the Chinese government budget balance in 2009. [2] Likely to continue to run a budget deficit and the size of the deficit is likely to increase. Comments: Budget Balance (T – G) is NOT the same as government expenditure (G). This misconception is

very clear when students explained that the govt will increase its spending and thus the budget balance will increase.

There is no need to give exact numerical figures for the size of change. There is no need to give ½ page worth of explanation for the prediction. Students did not take into account the economic situation presented in the extracts and simply

looked at the trends in the table while doing the prediction.

d) To what extent can China’s government stimulus plan power her economy to lead the rest of the world to a recovery? [10] The Chinese government’s $586 billion stimulus plan is an expansionary fiscal policy to help China’s economic growth. An expansionary fiscal policy is the use of government spending and taxation to stimulate economic activity and hence economic growth. We will discuss the extent to which the expansionary fiscal policy helps China’s growth and also the rest of the world. Explain how expansionary fiscal policy can bring about economic growth to China through the multiplier effect. Need to give a brief account of the multiplier process. With the expansionary fiscal policy, government expenditure (G) increases hence the aggregate demand (AD) increases as G is a component of AD. With a reduction in income tax, the disposable income increases and consumer expenditure (C) increases, and with a reduction in corporate tax, the after-tax profits of firms increases shifting MEI to the right and level of investment (I) increases. Since C and I are also components of AD, AD increases. With G, C and I increasing, AD shifts from AD0 to AD1. This causes an unplanned decrease in stocks and firms will increase production to bring the stocks levels to desired range. This increase in output will increase the national income. Through the multiplier effect, the higher income induces an increase in aggregate consumption. This leads firms to hire more workers again to meet the rising demand for goods and services and national income rises a second round. This second round increase in national income induces another round of consumption, leading to a third round increase in national income. With each successive round of increase in income, the amount of leakages, in terms of savings, taxes and


7import expenditure, also rises. This process will continue until the total change in leakages is equal to the initial increase in C+I+G, by which time, national income would have increased by a multiple and employment would also have risen significantly. Since 80% of China’s growth is due to G (Extract 2 para 3) signifying that G takes up a significant proportion of AD and the increase in G can help China to achieve growth. Moreover, the problem of time lag seems to be less of an issue in China given that the government has already put in place plans for infrastructure spending. Hence, less time is wasted in getting the stimulus plan into action. Explain how, with China’s growth, it will help other countries’ export sectors and hence growth When China grows, it could bring about positive spillover effects for other countries (as evidenced in para 2 of Extract 2). China will demand for more imports of both raw materials and end-consumer goods which could help boost export growth for these trading partners. Countries that export to China will see an improvement in the net exports and hence their AD and hence economic growth. Explain how the stimulus plan may not help China’s growth significantly Limitations:

- MPC may not be very high given the tendency of the Chinese to save especially if the slow down in the economy sparks fears in losing of jobs especially in the export-oriented sectors (extract 2 para 5 implies people are saving)

- Growth still very dependent on exports (extract 2 para 7) which is very much dependent on the economic performance of its trading partners, of which many are undergoing recession

- Recent spike in consumption may be temporary with use of tools such as subsidies. Moreover, C is only 40% of GDP in China, compared to 70% in US. (Table 2)

Given these limitations, the extent of effectiveness of the fiscal plan in boosting growth in China is questionable. Conclusion: Ultimately, size still matters and China is no where near U.S. in terms of size (as seen in Table 2). Hence, though Chinese consumption seems to be growing but is not sufficient to lift the world’s advanced economies out of recession. (Even with China’s growth, its demand is not as significant as US given the vast difference in the size of the 2 economies.) Comments: Students do not realize that there is two parts in the question China using the fiscal stimulus plan to power her economy China, with the plan, is able to lead the rest of the world to recovery

Quite a handful disregarded the explanation of how the stimulus plan could lead to a multiplied increase in NY, hence helping to power China’s economy. Some answers are very theoretical. The points of discussion lack support from the extracts. For

example, quite a handful mentioned that crowding out effect will be experienced when govt borrows to spend, hence I will decrease. But extract 1 and Table 1 pointed out that FDI has been increasing. Even if domestic investment may be ‘crowded out’ by government spending, overall there could still be increase in I if FDI increase more significantly. Some merely lifted phrases from passage without making the attempt to link to relevant

economics analysis, for e.g. “…consumers lack confidence to spend…”. Students should add on to argue that this could imply that MPS is quite high and this has implications on size of k, hence the multiplier effect. Not much reference to Table 2 to support argument that China may not have the economic clout

to power the rest of the economies in the world. Merely quoted that ‘China is not the leader yet’.

(d) To what extent can China’s government stimulus plan power her economy to lead

the rest of the world to a recovery? [10]

Sample answer 1 China’s government stimulus plan of $586 billion has helped China to grow. In 2008 with the unfolding of the US sub-prime crisis, China was also affected with its growth falling to only 9% from 13% growth the previous year. Hence the Chinese government used the stimulus plan and it helped China to achieve 7.9% growth in the second quarter of 2009 and experts are predicting that growth for China for the year may be more than 8%. Considering that US is still in recession, China’s growth of 8% for 2009 means that the stimulus plan worked. There is also evidence that China is doing well with the stimulus plan. The consumption of cars has increased with small-car purchases hitting an all-time record. Retail sales have also increased by 16%. In addition, compared to US, China’s stimulus plan is more successful as it will generate 80% of the economic growth for China. If China were to continue growing, the other countries like Australia and Brazil will grow too as ‘Nations that depend on producing commodities, such as Australia and Brazil, have benefitted immensely over the past six months as demand from China has driven up the price of raw materials. Helped by trade with China, Asia's export-driven economies are sputtering back to life.’ These are all evidence that China can lead the rest of the world to recovery. However, ‘China will not be able to save the world as “China is not yet the leader of the global economy”. As many Chinese are not consuming enough and are not able to consume Volkswagen and BMW. In addition, China has a lot of other problems to deal with. Thus in conclusion the stimulus plan will not help the rest of the world to recover. Examiner’s Comments: This answer lack economic analysis. Although the student did attempt to address how the stimulus plan can help China to grow and with China’s growth, other countries will benefit, the answer is mainly a rehash of the information in the Extracts. There is no attempt to bring in economic analysis in the discussion. Hence this script was awarded a level 1 mark. Take for example, the most basic analysis which should have been used would be to at least identify the stimulus plan is an expansionary fiscal policy. And from there explain how in theory the expansionary fiscal policy helps an economy to achieve growth.

Sample answer 2 The stimulus plan is an expansionary fiscal policy to help China’s economic growth. An expansionary fiscal policy is the use of government spending and taxation to stimulate economic activity and hence economic growth. With the expansionary fiscal policy, government expenditure (G) increases hence the aggregate demand (AD) increases as G is a component of AD. With a reduction in income tax, the disposable income increases and consumer expenditure (C) increases, and with a reduction in corporate tax, the after-tax profits of firms increases shifting MEI to the right and level of investment (I) increases. Since C and I are also components of AD, AD increases. With G, C and I increasing, AD shifts from AD0 to AD1 illustrated in figure 1. This causes an unplanned decrease in stocks and firms will increase production to bring the stocks levels to desired range. This increase in output will increase the national income. Through the multiplier effect, the higher income induces an increase in aggregate consumption. This leads firms to hire more workers again to meet the rising demand for goods and services and national income rises a second round. This second round increase in national income induces another round of consumption, leading to a third round increase in national income. With each successive round of increase in income, the amount of leakages, in terms of savings, taxes and import expenditure, also rises. This process will continue until the total change in leakages is equal to the initial increase in C+I+G, by which time, national income would have increased by a multiple and employment would also have risen significantly.

However, there are limitations to fiscal policy. Firstly, the size of the multiplier may be small. Given that China is also Asian country, the value of thriftiness is important and hence MPC may be small leading to a small multiplier. With a small multiplier, NI will increase insignificantly and hence the expansionary fiscal policy will not work.

If the relative size of government spending relative to the other components of AD is small, government would have to increase government expenditure more than proportionally to offset the fall in AD. For example, a fall in export revenue of 5% would require an increased government spending by some 100% in Singapore, as export revenue is more than 20 times government spending. This makes fiscal policy a more difficult tool for the Singapore government to stimulate AD compared to other economies with government spending occupying a large proportion in the AD. There may also be crowding out effect if the government chooses to finance their increased expenditures through borrowing from the banking system, there will be an increase in demand for loanable funds and hence an increase in interest rate. As a result, private businesses will cut back on their investments. Therefore the increased government spending will simply be offset by lower private household consumption and lower private sector investment.

GPL

Real national income

AS

AD0

AD1

Y0 Y1

P0

P1 Figure 1

There is often a serious time lag between the identification of the problem to be dealt with and the time when the fiscal measures begin to take effect. This may mean that fiscal policy takes effect at the wrong time. In addition, consumers do not base consumption simply on current income levels but also on future expected income. Thus, tax cuts may not stimulate consumption if consumers view such attempts as only temporary measures. Hence, fiscal policy will only have a weak impact on the economy. Moreover, private investment depends on business confidence and large tax cuts may not bring about huge increase in private investment if businessmen are not optimistic about future prospects. Finally, in times of recession when the government needs to increase spending, problems may arise. Budgets are usually drawn up only once a year and governments are very reluctant to increase government expenditure as parliamentary debates and approval may take months. Hence, expansionary fiscal policy may not be able to help China achieve economic growth. Examiner’s comments: This script on the other hand is purely regurgitation of theory. In terms of theory, this script displays quality. Other than recognizing that the context is China by using the word ‘China’ in the answer, there was no other indication that the student understands the Extracts. In addition, the answer is incomplete in the sense that there is no attempt to discuss if the rest of the world will recover with China’s growth. Hence this student did not understand the full requirement of the question. Hence, this script is a level 1 script as well because of the lack of awareness of the evidence given and failing to grasp the full requirement of the question. An example of how the script demonstrates lack of awareness of the evidence is the explanation of limitation.

1. Relative size of G in AD – the exemplification given was that of Singapore!!! 2. Failing to eliminate relative inflexibility and crowding out effect as limitations –

a. Relative inflexibility - as stated in Extract 2 para 3, Chinese government was already spending on programmes, hence when the slowdown began, it was just adding on to existing schemes.

b. Crowding out effect – table 1 shows positive growth in FDIs.

Session 3 - 2009 Promos Case Study

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Transcript of Session 3 - 2009 Promos Case Study