Fears of growing debt problems in the EU have caused global stock markets to plummet. On 25th May, the FTSE was down by 2.6%, Germany’s Dax index fell by 2.34% and in France the Cac 40 was also down 2.74%. Shares across Asia fell, including those in Australia, Hong Kong, Japan and Thailand. On top of this, there are concerns of rising military tensions between North and South Korea. This has only added to the pessimism of investors.
Then came the rescue of the Spanish bank Cajasur by the Bank of Spain, which did little to restore confidence in the world economy. The Spanish deficit has reached 11% of GDP, which is nearly 4 times higher than eurozone rules allow. Spain is also suffering from unemployment of more than 20%, which has led the IMF to call for massive structural reform in the country. The euro has also weakened, as investors sell the currency, because of growing fears of debt default amongst the eurozone countries.
Amid concerns of possible default by Greece, Spain and other countries, the IMF and the members of the European Union have agreed an emergency package of €750 billion (£650 billion). €250 billion comes from the IMF, with €440 billion available as loan guarantees for struggling nations and €60 billion from emergency European Commission funding. We can only wait to see how effective this rescue package will be in restoring confidence in the Eurozone economies.
Articles
Global stock markets see sharp falls BBC News (25/5/10)
Spain must make wide ranging reforms, weak recovery – IMF Reuters (24/5/10)
FTSE falls another 2.5% after Europe’s debt crisis sparks fears in Asian markets Mail Online (25/5/10)
IMF raises fresh concerns about the Spanish economy BBC News (24/5/10)
IMF Chief Economists – doubts over Greek aid remain Reuters, John Irish (24/5/10)
Markets still tense over eurozone debt Independent, Ian Chu (21/5/10)
FTSE falls below 5,000 due to eurozone crisis Telegraph (21/5/10)
FTSE plunges nearly 3% in opening seconds (including video) Sky News (25/5/10)
The contagion of austerity BBC News blogs: Gavin Hewitt’s Europe (25/5/10)
Europe debt crisis threatens recovery, OECD warns BBC News (26/5/10)
Data
In graphics: Eurozone in crisis BBC News (24/5/10)
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission (especially sections 1, 6, 16 and 18)
Questions
- Using a diagram, illustrate why the euro has weakened.
- Explain why stock markets have fallen across the world.
- What type of reforms are needed in Spain?
- What factors are likely to determine the effectiveness of the IMF emergency package?
- Are the austerity measures in the Spanish economy likely to lead to the similar outcomes that we saw in Greece, such as widespread strikes?
- Discuss the advantages and disadvantages of the rescue package. Does rescue involve a moral hazard?
Labour’s Chancellor, Alistair Darling, delivered his last budget on the 24th March 2010. However, with the new Coalition government planning to make more substantial cuts and with George Osborne and other ministers claiming to find ‘black holes’ in the budgets left by Labour, an emergency budget will take place on the 22nd June 2010. The Coalition government has agreed to make £6 billion of spending cuts in the current year in a bid to reduce the UK’s substantial budget deficit, which stands at nearly 12% of GDP. Vince Cable told the Times:
I fear that a lot of bad news about the public finances has been hidden and stored up for the new government. The skeletons are starting to fall out of the cupboard.
There are plans to reform capital gains tax, possibly increase VAT to 20% and remove tax credits from some middle-income families. In Alistair Darling’s budget, it was middle-income families who were among the ‘losers’, with tax rises of around £19 billion, and it looks as though middle-income families may be hit again. Throughout the election all parties pledged to continue to help the poorest families, but there appears to be a lot of uncertainty ahead for middle-income families. They are likely to face reduced benefits and higher taxes as the Coalition government tackles the £163 billion deficit.
Despite critics of spending cuts arguing that it could cause a double-dip recession, the government is confident that cutting spending now is the right thing to do. As Osborne told GMTV:
I am pretty clear that the advice from the Governor of the Bank of England was that [cutting spending now] was a sensible thing to do, and if there is waste in Government that people at home are paying for with their taxes, let’s start tackling that now.
Chancellor launches audit of government spending Independent, Andrew Woodcock (17/5/10)
Osborne to give details of £6bn spending cuts next week (including video) BBC News (17/5/10)
Savings cuts to ‘hit middle class families’ BBC News (15/5/10)
Osborne to deliver emergency budget on June 22nd Times Online, Susan Thompson (17/5/10)
David Cameron declares war on public sector pay Telegraph, Rosa Prince (16/5/10)
All eyes on the emergency Budget Financial Times, Matthew Vincent (14/5/10)
Tax rises likely under Coaliation government, says Institute of Fiscal Studies Telegraph, Edmund Conway (13/5/10)
Questions
- What will be the likely impact on middle-income families if proposed spending cuts go ahead? How might this affect the recovery?
- What are the arguments for a) cutting spending now and b) cutting spending later?
- In the future, the Coalition government plans to limit bonus payments. How might this policy affect jobs and recruitment?
- What is the likely impact of the future increase in personal tax allowance? Who will it benefit the most?
- How are the proposals for corporation tax and capital gains tax likely to affect the economic recovery?
- Is a rise in VAT a good policy? Who will it affect the most? Will it reduce consumption and hence aggregate demand or is it likely simply to raise tax revenue? (Hint: Think about the type of tax that VAT is.)
Russia is now ranked alongside Zimbabwe on the worldwide corruption index, despite the fact that the Russian authorities have been doing their best to tackle it. The Russian bribery ‘industry’ is worth some $300 billion per year and those who can be bought include several government officials.
The Russian economy is in much need of foreign investment, but the growing world of bribery is deterring international businesses from investing in Russia. Not only will they face the costs of building and running the business, but they are also likely to face substantial costs in trying to get the paperwork through, as IKEA found. Having said that they would never resort to bribery, IKEA had to pay $4 million for investment in local infrastructure and donate a further $1 million for local government projects just to get the 300+ permits they needed to begin construction. This then led to further bribes and a number of lawsuits. For some companies, the delays caused by not paying a bribe may actually cost more than the bribe itself.
The following webcast and articles look at the case of IKEA and the push by foreign businesses to avoid the clutches of Russian bribery.
Webcast
Russian bribes culture hits international business BBC News (14/5/10)
Articles
Foreign firms pledge not to give bribes in Russia BBC News (21/4/10)
IKEA masters rules of Russian business The Moscow Times (14/5/10)
Russians are spending twice as much on bribes Prime Time Russia (13/5/10)
Data Source
Corruption Perceptions Index 2009 Transparency International 2009
Questions
- Why is Russia in need of significant foreign investment? How would it help the economy?
- Can we classify IKEA (or any other company that uses bribery) as a risk-lover? Explain your answer.
- If a foreign firm wants to invest in Russia, which type of expansion do you think would be the easiest and the least open to bribery?
- IKEA began building without the necessary permits, but then ‘the bureaucrats took advantage of the situation’. Was IKEA operating under conditions of risk or uncertainty?
- In the article ‘IKEA masters rules of business’, Lennart Dahlgren said: “If we had waited to receive them all, we would have lost years”. What economic concept is being referred to?
- To what extent is government intervention and international co-operation needed to tackle corruption in Russia?
On April 20 2010, there was an explosion on one of BP’s drilling rigs approximately 50 km offshore and over 1000 metres underwater in the Gulf of Mexico. This has led to more than 5000 barrels of oil leaking into the sea every day. The slick now covers an area the size of Luxembourg. Attempts have, at this time, failed to stop the leaks and the massive sheet of oil is edging closer and closer to the coast.
A giant dome was the original idea to stop the oil leak, however, this proved ineffective, due to a buildup of crystallised gas in the dome. The next step is to shoot debris underwater, including golf balls, tyres and human hair, under intensely high pressure and try to clog the leak. However, every time a new idea to stop the leak is tested, costs for BP mount. Furthermore, every time an idea fails, costs for the environment and the affected industries increase. Costs to BP are currently estimated to be $350 million, but other businesses are also suffering. Oil has now started to appear at costal resorts, yet even before it did, the tourism industry was suffering. Captain Louis Skmetta from Ship Islands Excursions said:
“Yesterday was beautiful. School are letting out, and we were hoping for about 500 passengers yesterday. We had a total of 166. So we are definitely seeing a little bit of an impact”.
Another industry that is concerned about the effects is the restaurant trade, in particular those who specialise in sea-foods. With the oil killing off marine life, prices of seafood for businesses and customers have already begun to rise in New York and London. The impact on this industry cannot be accurately estimated at present, but costs are continuing to rise every day this environmental crisis continues. These price rises are on top of already rising commodity prices: Wholesale food prices rose 7 percent in the 12-month period that ended March 31 2010. There is great uncertainty about the overall economic impact of this crisis, but what is certain is that every day oil continues to leak, costs will continue to rise.
Dome fails to stop Louisiana oil leak Independent (10/5/10)
Aerial view of oil leak in Gulf of Mexico BBC News (9/5/10)
BP plans to use debris to staunch Louisiana oil leak Financial Times (10/5/10)
Cost of oil leak spills into valley Dayton Daily News, Mark Fisher and Steve Bennish (9/5/10)
BP: oil leak will be stopped but can’t say when Associated Press (7/5/10)
BP shares down; Says Deepwater cost $350m so far Wall Street Journal (10/5/10)
BP misses out on FTSE rally as oil spill costs reach $350m so far Guardian, Nick Fletcher (10/5/10)
Conn. restaurants fear spike in costs of crabs, shrimps, oysters following Gulf oil-spill The Middletown Press, Cara Baruzzi (10/5/10)
BP examining oil leak options ABC News (10/5/10)
Oil-soaked crab threatens sea-food prices at top-ranked eateries Bloomberg BusinessWeek (10/5/10)
Tourism operators say oil threat hurting their pocketbooks WLOX, Danielle Thomas (10/5/10)
Coastal businesses feel the pain of Gulf oil leak NPR, Debbie Elliott (7/5/10)
Questions
- Try to carry out a cost-benefit analysis of the two attempts to stop the oil leak.
- Which industries are likely to be affected by the oil rig explosion? Explain your answers.
- Who should have to pay for the clean-up? Could the oil spill be seen as a negative externality?
- Why are restaurants in London seeing rising food prices, when the oil leak is located in the Gulf of Mexico?
- What has happened to BP share prices? How do you think they will change when the oil leak is stopped?
- What will be the impact on BP in the long term? Think about the role of corporate social responsibility.
Greece’s public deficit currently stands at 13.6% and the UK isn’t that far behind. Austerity measures are planned to reduce the Greek deficit to less than 3% of GDP by 2014. This will be achieved through a variety of spending cuts and tax rises. This is the price that Greece will have to pay to receive a £95 billion bailout. Wages are likely to be frozen, cuts will be evident throughout the economy in areas such as education and pensions and the general population may see a tax rise.
In response to these proposals, on which Parliament will vote by the end of the week, the Greek economy has suffered from widespread strikes. Flights were grounded, trains stopped, schools shut, hospitals closed their doors, offices closed for business and those close to retirement are considering resignation before the measures are passed.
As life almost comes to a stop in Greece, could the UK follow suit? It’s no secret that the UK deficit is enormous – £163 billion or about 12% of GDP. Nor is it a secret that spending cuts and tax rises are inevitable. Furthermore, over the past two years, there have been several high profile strikes. (See article The Winter of Discontent: the sequel? and Turbulence in the air). A spokesman from The Public and Commercial Services Union said:
“If the cuts are anything like what is being suggested, industrial action by the unions is not only likely, it’s inevitable”.
The bailout of Greece may avert one Greek tragedy, but another one could be just around the corner and that’s not just for Greece.
Greece brought to half over general strike over cuts BBC News (5/5/10)
Greek strikes test government austerity plans Reuters (4/5/10)
Bank of England Governor: poll winner will be out of power for a generation Independent, Andrew Grice and Colin Brown (30/4/10)
Flights grounded, shops shut in Greek strike Channel 4 News, Kris Jepson (5/5/10)
Greek strikers hit Athens streets over austerity plan BBC News (4/5/10)
Greek strikes test government austerity plans The Economic Times (4/5/10)
Questions
- What is the purpose behind the strikes? How effective are they likely to be?
- What are the costs of strikes to a) consumers b) businesses c) the wider economy?
- Why is collective bargaining more effective than individual bargaining?
- Why could the Greek picture be a possible forecast of the UK economy after the May election?
- Are strikes a price worth paying if the government is to reduce its debt?