Michael Huntley
Econ Commentary 2 – Macro
Esteemed British news source Daily Mirror reflected on the state of Sri Lanka’s economy in an October 29 article entitled “IPS releases annual”. The article shows that presently, Sri Lanka is attempting to recover from post-conflict conditions using investment-fueled growth policies, particularly in rebuilding infrastructure destroyed during conflict. Poverty has occurred in Sri Lanka as a result of this destroyed infrastructure, as no resources can be distributed to facilitate economic interaction. This action is a measure of Fiscal Policy, or changes in government spending or taxation levels by a government. In this case, the government of Sri Lanka is attempting to increase Aggregate Demand, which is the total demand for goods and services in an economy, in an effort to increase growth (see figure 1 (AD/AS MODEL)). Aggregate Demand consists of four components: consumption, investment, government spending, and net exports. In rebuilding infrastructure, the government of Sri Lanka will increase government spending in the short-run, ultimately increasing aggregate demand. However, this improvement of infrastructure will result in a medium-run or long-run increase in investment, as businesses will be able to operate more effectively, which will produce a higher net aggregate demand.
However, the article also indicates that “Sri Lanka’s expansionary fiscal policy stance in the midst of shrinking aggregate demand in the economy now needs to be reversed to permit fiscal consolidation” (Daily Mirror 1). This suggests that despite a desired increase in aggregate demand, consumption must remain low, which contradicts conventional thinking. However, this can be achieved by use of a consumption tax. A consumption tax will reduce consumption, and as such consumers will be more prone to saving. An increase in savings will result in an increased level of investment, as seen in the Loanable Funds Market (see figure 2(LOANABLE FUNDS)). This is also easily illustrated using a Production Possibilities Frontier. A consumer tax may shift out the PPF, resulting in a disproportionately small increase in number of consumer goods purchased to a relatively large increase in capital goods purchased, which implies an increase in investment (see figure 5(PPF)). Furthermore, a consumption tax will reduce dependence upon foreign capital. This is beneficial, as “an infrastructure-led investment drive that relies heavily on foreign borrowing can run up against problems… [such as] issues of external debt sustainability in the medium term” (Daily Mirror 1). Intuitively, a government needs tax revenue to service debt. Accordingly, an alternative solution presents itself as viable in the long-run: an increase in education. The article suggests “education sector reforms to enhance the skills set of the workforce in line with market needs” (Daily Mirror 1). Ideally, this will increase employment in the long run, which will lead to more taxes being paid and a more serviceable debt. Furthermore, higher employment leads to higher consumption, as expressed in the Circular Flow Model (see figure 3(CIRCULAR FLOW)). Returning to the earlier proposition, a consumption tax will cut down this increased consumption while maintaining the increased number of tax payers. In the long term, however, Sri Lanka must be aware of several potential issues. Of the greatest concern is the potential for interest rates to rise excessively as a result of an increased aggregate demand. However, this is misleading in a sense, as this is a self-correcting mechanism for inflation. As interest rates rise, savings will decrease and quantity invested will decrease, resulting in a net decrease in aggregate demand and a return to equilibrium levels (see figure 4(BUSINESS CYCLE)). This follows the typical trend of the business cycle, which suggests that an economy goes through stages of growth until it reaches a boom, then recession until it reaches a trough, and repeats. Furthermore, Sri Lanka must be careful to note what it is exactly that motivates investment, as the plan to renew infrastructure is designed to prompt increased investment. Certainly, interest rates are of note; high interest rates will lead to low investment, so Sri Lanka must do what it can to keep interest rates low beyond the typical measures of the business cycle. Expectations are also relevant; if a firm believes future sales will be high, it is more likely to invest. Amount of capital available is related to investment, but this will likely increase as infrastructure is improved. Increased technology is also often correlated to increased investment. Accordingly, once infrastructure has been healthily restored, it may be prudent for the Sri Lankan government to consider delegating resources towards R&D sectors in an effort to maintain high investment. (749)
Econ Commentary 2 – Macro
Esteemed British news source Daily Mirror reflected on the state of Sri Lanka’s economy in an October 29 article entitled “IPS releases annual”. The article shows that presently, Sri Lanka is attempting to recover from post-conflict conditions using investment-fueled growth policies, particularly in rebuilding infrastructure destroyed during conflict. Poverty has occurred in Sri Lanka as a result of this destroyed infrastructure, as no resources can be distributed to facilitate economic interaction. This action is a measure of Fiscal Policy, or changes in government spending or taxation levels by a government. In this case, the government of Sri Lanka is attempting to increase Aggregate Demand, which is the total demand for goods and services in an economy, in an effort to increase growth (see figure 1 (AD/AS MODEL)). Aggregate Demand consists of four components: consumption, investment, government spending, and net exports. In rebuilding infrastructure, the government of Sri Lanka will increase government spending in the short-run, ultimately increasing aggregate demand. However, this improvement of infrastructure will result in a medium-run or long-run increase in investment, as businesses will be able to operate more effectively, which will produce a higher net aggregate demand.
However, the article also indicates that “Sri Lanka’s expansionary fiscal policy stance in the midst of shrinking aggregate demand in the economy now needs to be reversed to permit fiscal consolidation” (Daily Mirror 1). This suggests that despite a desired increase in aggregate demand, consumption must remain low, which contradicts conventional thinking. However, this can be achieved by use of a consumption tax. A consumption tax will reduce consumption, and as such consumers will be more prone to saving. An increase in savings will result in an increased level of investment, as seen in the Loanable Funds Market (see figure 2(LOANABLE FUNDS)). This is also easily illustrated using a Production Possibilities Frontier. A consumer tax may shift out the PPF, resulting in a disproportionately small increase in number of consumer goods purchased to a relatively large increase in capital goods purchased, which implies an increase in investment (see figure 5(PPF)). Furthermore, a consumption tax will reduce dependence upon foreign capital. This is beneficial, as “an infrastructure-led investment drive that relies heavily on foreign borrowing can run up against problems… [such as] issues of external debt sustainability in the medium term” (Daily Mirror 1).
Intuitively, a government needs tax revenue to service debt. Accordingly, an alternative solution presents itself as viable in the long-run: an increase in education. The article suggests “education sector reforms to enhance the skills set of the workforce in line with market needs” (Daily Mirror 1). Ideally, this will increase employment in the long run, which will lead to more taxes being paid and a more serviceable debt. Furthermore, higher employment leads to higher consumption, as expressed in the Circular Flow Model (see figure 3(CIRCULAR FLOW)). Returning to the earlier proposition, a consumption tax will cut down this increased consumption while maintaining the increased number of tax payers.
In the long term, however, Sri Lanka must be aware of several potential issues. Of the greatest concern is the potential for interest rates to rise excessively as a result of an increased aggregate demand. However, this is misleading in a sense, as this is a self-correcting mechanism for inflation. As interest rates rise, savings will decrease and quantity invested will decrease, resulting in a net decrease in aggregate demand and a return to equilibrium levels (see figure 4(BUSINESS CYCLE)). This follows the typical trend of the business cycle, which suggests that an economy goes through stages of growth until it reaches a boom, then recession until it reaches a trough, and repeats. Furthermore, Sri Lanka must be careful to note what it is exactly that motivates investment, as the plan to renew infrastructure is designed to prompt increased investment. Certainly, interest rates are of note; high interest rates will lead to low investment, so Sri Lanka must do what it can to keep interest rates low beyond the typical measures of the business cycle. Expectations are also relevant; if a firm believes future sales will be high, it is more likely to invest. Amount of capital available is related to investment, but this will likely increase as infrastructure is improved. Increased technology is also often correlated to increased investment. Accordingly, once infrastructure has been healthily restored, it may be prudent for the Sri Lankan government to consider delegating resources towards R&D sectors in an effort to maintain high investment.
(749)
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