ECO 404 GDB 11 June 2012 Solution / Idea

The Case:

Before the formulation of World Trade Organization (WTO), there were a lot of barriers in international trade throughout the world. However these barriers seem to be abolished to some extent as member countries of the WTO exceed the figure of 150. All the member countries including Pakistan have agreed and accepted the agreement and principles of WTO like Non-Discrimination, Reciprocity, Binding and Enforceable Commitments and Transparency. According to the World Bank, a lot of fruits have been achieved through this globalization like poverty and income disparity reduction. While considering the case of Pakistan, it seems that Pakistan has not achieved much from the globalization. The poverty condition has been worsening as 65 percent of the people are living below the one dollar poverty line.

Requirements:

Being an economist, analyze the factors which are causing economic slowdown rather than a boost in result of globalization.

Solution:

    Possible Causes for Economic Slow-down and Recession

        Recessions are often caused by a lack in effective demand since people try to accumulate money (new savings are then possibly higher than investments).

        When people perceive that money is becoming scarce or may become scarce in the future, they will reduce spending and increase savings, lowering demand.

        When inflation in a country is higher than in other countries, the currency becomes more expensive, exports become more expensive and exports will decline or grow slower, lowering the economic growth.

        When financial bubbles burst and asset prices decline, investment and consumption decline and thus overall demand declines.

        In case enterprises or consumers first need to reduce a debt burden that has become too high relative to their assets holdings due to fallen asset prices, demand will be pressed down till the debt-asset ratio is back on an acceptable level.

        An external factor as aging demographics may cause a higher savings and lower investment environment.

        External shocks to the economy that increase prices considerably (like increase in oil prices) could lower the demand and put in the economy in recession.

        A growth recession happens when the capacity in the economy expands faster than that demand and the economy grow, resulting in over-capacity and possibly deflation.

        When an economy is facing a period with lesser (growth in) demand due to demographics, nervousness about the future or lack of attractive innovation, and demand cannot be stimulated with lower interest rates, the economy is in a ‘liquidity trap”.

    Economic Growth

        Emerging economies that start to export more manufactured goods and services create higher paying jobs; reduce the pressure on land, increase rural wages, lower unemployment, increase wages further and thus increasing their overall prosperity.

        Increasing foreign investment in a country increases the demand for that currency and increases the value of that currency.

        Increasing demand increases import.

        An overheating economy with fast increasing investments, money supply and credits can lead to higher wages and costs, more expensive exports, lower exports, higher imports, and higher currency (trade) deficits.

        Technological development and innovation increase productivity. This drives investment and increases profits, pushing growth, but also limiting inflation.

        An external impulse like increasing exports could get a country out of a slump.