(a) Explain why the Chinese are 'concerned over the formation of real estate bubbles'. [2]

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1 Case Study Question 2: The Pains and Gains of Economic Restructuring Suggested Answers (a) Explain why the Chinese are 'concerned over the formation of real estate bubbles'. [2] 1. If the real estate bubbles were to burst, prices of housing would fall. 2. Consumers would feel less wealthy OR consumers would have to cut down on expenditure to pay their debts, thus cutting consumption and reducing AD, adversely affecting actual growth/national income. Many students left out wealth effect affecting autonomous C. A handful did not mention the impact on macro aims and digressed to effects on banks. Some failed to understand the meaning of real estate bubbles burst and others spent much on explaining what created the bubbles which is not required in this question. (b) From Extract 6, comment on the likely change in China s multiplier value after restructuring. 2 steps to explain the multiplier value (k) will most likely increase. 1. Explain the initial value to be small. 2. Explain why the value will rise. The multiplier is the number of times national income will change given a change in autonomous expenditure and can be calculated by 1/(1-MPC) or 1/MPW in which MPC which is the marginal propensity to consume and MPW is the marginal propensity to withdraw that includes marginal propensity to save, tax and import (MPS, MPT and MPM). Original average propensity to consume (APC=C/Y) is Using this as a proxy, it is likely that the k value is below 2 initially. (k = 1/(1-0.36) = 1/0.64 = 1.56.) OR MPS which is the the increase in savings that results from one additional dollar of income is likely to be high due to high precautionary savings and thus the k value is likely to be low. Explain that MPS is likely to decrease because improvements in health and pension coverage will reduce the need for high precautionary savings and hence reduce the necessary savings ratio (APS) which can be a proxy to MPS. A fall in MPS which mean a fall in MPW and thus k size will rise. Note: Some credit for relevant evaluative comment (but it is not a requirement) Many students did not show understanding of the difference in C, APC and MPC or S, APS and MPS and thus were not able to use the APC given as a proxy to estimate the initial k and also mixing up APS with MPS. Some did not give the formula of k (or give wrongly) and even when it was given, there were little efforts in understanding the idea of marginal. Quite a number mentioned urbanisation leading to growth of middle income and increases MPC. While we gave some credit during marking, this is not encouraged because usually the lower income household s MPC which is the increase in consumption that results from one additional dollar of income tends to be higher than the rich who do not need to spend much of their additional income since the autonomous consumption will be generally high. The multiplier is the number of times national income will change given a change in autonomous expenditure that includes autonomous C and not just injection of I, G and X or withdrawal of S, T and M. Some students went into speculation of MPM or MPT though not much info is given in the case material. Some students made the conceptual error that unemployment means fall in quantity of labour and hence fall in LRAS [4]

2 (c) Restructuring for higher productivity will be a risky and painful process for companies. (Extract 7) Explain the above statement. Answers should address both risks and pain involved in the process and link to the impact on firms profits. Painful process - Cutting foreign manpower growth and imposing higher levies may increase wages and lead to increase in average variable cost of production. This leads to increased MC and AC, leading to lower profits. [4] Risky - Investment for productivity e.g. using productive capital goods increased fixed cost, i.e. increasing AC. (d) This would pay off if there is improvement in productivity such that MC decreases as much as expected. Show understanding that it may not lead to lower marginal costs in future and hence may not increase profits/ uncertainty on the returns on capital equipment (idea of risk). Note: revenue reasons can also be accepted. Some students failed to realise this is a cost-revenue question and used macro approach. Many did not realise both variable and fixed costs are involved. Some did not link to change in profits explicitly. Many did not elaborate on the risks involved. Compare the trend of unemployment rate and youth unemployment rate in Eurozone from 2011 to Similarity Both unemployment rate and youth unemployment rate generally increase from 2011 to Or Both unemployment rate and youth unemployment rate rose from 2011 to 2013 and fell in 2014 (acceptable for comparison question though for describe qn, overall trend is preferred.) Difference youth unemployment rate is consistently higher than (or approximately twice) that of unemployment rate over the period (this is the preferred answer as it focuses on the severity of the youth unemployment rate). OR Increase in youth unemployment rate is higher than (or more) that of unemployment rate. Note: There is difference in % points by simple subtraction will do. Some state the relationship rather than comparing the similarity. Some did not give the difference. Some went to calculate the rate of change of a rate which is not encouraged as it would lead to answer like unemployment rate rose at a faster rate which is not a meaningful comparison as the stats clearly showed youth employment is more severe than unemployment rate. Some stated youth unemployment rate rose faster than unemployment rate which is mathematically incorrect also. [2]

3 (e) To what extent would youth unemployment in the Eurozone adversely affect its current and future economic growth? Introduction Define youth unemployment as those of legal age but under 25 in the labour force who are willing and able looking for a job but not hired. Define growth as the rate of change in national income. State that Table 4 shows that Eurozone s youth unemployment rate to be around 23% from and could affect both current and future growth adversely. Note: Refrain from giving any judgment of the extent in the introduction. For Economics essays, judgment/evaluation should come after analysis. Body 3 Steps Economic Analysis Evidence Explain Loss in production and Income: launching a how youth Loss of jobs brings about reduction in production and career without a unemploy income. Sscarring effect (where young people job suggests ment in may not have a full time stable job and earn lower that young Eurozone wages and at greater possibility of unemployment) people who may affect low consumer confidence among the youths endure early its actual (expectations) fall in (autonomous) spells of economic growth. consumption fall in AD and a fall in Y leading to a fall in actual growth. Excess labour means the economy is not producing on the boundary of PPC and thus actual growth is affected. The longer youths remain unemployed, the more it will hamper the Eurozone s recovery. Note: A fall in purchasing power reduce ill INDUCED consumption which is multiplier and will not shift AD. unemployment are likely to have lower wages and greater odds of future unemployment than those who don t. [8] Loss of social stability Unemployment appears to be linked to greater incidence of crime and violence as seen in some Southern Eurozone nations where jobless youth lash out violently. This in turn lowers investors confidence in the economy and local firms will cut back on expected rate of returns due to poor business outlook and reduce investment. (evidence: jobless youth lashing out violently) canfurthermore, the high youth unemployment is also an indication that these youths may be structurally unemployment (mismatch of skills and jobs available), FDI may be wary of investing in Eeurozone. Evidence: jobless youth lashing out violently Loss in tax revenue which may affect future government spending: reduction in G in long run. Lack of work income of greater proportion of labour force who are unemployed leads to less tax revenue, compounded over a longer period of working life will lead to less

4 resources for the government to allocate to expenditure. If the government, especially in Eurozone is already running a budget deficit, the loss in tax revenue could possibly lead to a cut in budget spending in other areas which in turn exert a further contractionary effect on the economy s, affecting actual growth. Explain how youth unemploy ment in Eurozone may affect its Potential Economic Growth. Evaluate the extent of adverse effects of youth unemploy ment on Eurozone Loss in human capital With a long productive worklife ahead of him/heryouths, the lack of opportunities when young will hamper future work life and lead to loss of skills and even dropping out of the labour force quality and quantity of labour will be adversely affected thus - lower potential growth Lack of tax revenues can also affect the ability of governments to invest in infrastructure and education + since FDI and domestic investment may decline lower potential growth In general, the fact that youth has longer productive lives ahead of them amplifies the consequences of unemployment, with the impact on potential growth particularly pronounced. The impact on economic growth is also not evenly spread out as it seems that Germany and Austria s youth unemployment rate is significantly lower compared to Eurozone s youth unemployment. The extent of the negative impact also depends on the government policies to help youths to find jobs in the near future. Evidence: Germany and Austria have youth unemployment rates of just 7.6% and 8.2%, respectively. Excess labour means the economy is not producing near PPC and thus actual growth is affected. The longer youth remain unemployed, the more it will hamper the Eurozone s recovery. Mark Scheme L3 (6-8) L2 (4-5) L1 (1-3) Balanced and well developed economic analysis based on the case material and evident evaluation and judgment. Students are expected to include the idea of AD/AS or PPC in their analysis. Answers tend to be lope-sided or insufficient use of economics analysis. Little or no evaluation/judgment. Should students only explain effects of unemployment in general on economic growth or did not consider actual vs potential growth. Weak attempt in answering the question requirement i.e. did not address youth unemployment and its effects on economic growth of Eurozone. Major conceptual errors were evident. Many did not define key concepts like unemployment and growth which are usually essential for good analysis. Confusion over cause and effects many elaborated on youth unemployment means lower purchasing power leading to fall in AD and thus slows down actual growth. Such an answer means students failed to realise the fall in purchasing power is a result of a fall in AD in the first place. They are confused over induced and autonomous consumption.

5 For youth unemployment to lead to slower actual growth, students have to link a fall in autonomous consumption to expectations. Quite a handful of students mentioned the loss in human capital to a fall in PPC and LRAS. Usually for a country s potential output to fall, it has to do with a massive destruction of factors of production due to natural disasters or massive war. A more accurate wat to phrase is a slower or stagnate potential growth. Some gave very descriptive answers by lifting lots of evidence and elaborated with layman terms with no or little reference to AD/AS or PPC framework. Many were not able to evaluate well on the extent and usually digressed to other factors that affect growth. While Germany and Austria have much lower youth unemployment rate than Greece and Spain, at 7.6% and 8.2% which are close to double digit, students should refrain from saying they are low. (f) A Eurozone recession would have a significant contagion impact on other economies. Assess the effectiveness of China's and Singapore s restructuring efforts in mitigating this impact on their economies. Introduction From Table 5, Eurozone is the 2 nd and 3 rd top trading partner to China and Singapore respectively and thus a recession would affect them adversely. As a result, China and Singapore embarked on a restructuring journey to mitigate the contagion impact. Body 1. Briefly explain contagion impact From Table 4, growth rate in Eurozone was either negative or below 1% from Low income + poor consumer confidence fall in DDx from other countries including China and Singapore especially when Eurozone is the top trading partners for both countries. There is also indirect impact on DDx from China and Singapore by other countries as the contagion spreads to other parts of the world. 2. Identify and explain how China and Singapore restructure their economy to mitigate the contagion effect on their economies and discuss the effectiveness of these policies. China Rebalance efforts to boost growth driven by consumption instead of trade less affected by contagion effects of Eurozone recession. Evidence 1 Extract 6, para: Current data of China shows C only takes up about 36-37% of GDP while (X +and I) as % GDP is close to 70%. So there is huge room for China to reposition C as an engine of growth given that it is the most populous country in the world. China is doing this by improving the health and pension coverage and expanding the middle class as mentioned in Extract 6, para 2. China is also restructuring toward a service-based, skills-intensive economy and not just merely focusing on manufacturing to diversify its basket of exports to spread out risks. Note: It is not merely to increase C to offset a fall in X. It is really about aiming to have C as a higher proportion to GDP so as to rely less on X. Effectiveness of restructuring efforts Restructuring efforts are incomplete and still on-going. Despite the measures to improve health and pension coverage, and urbanisation, there are still significant There are many obstacles e.g. finding its graduates suitable jobs.. Exports (as % of GDP) has declined only gradually as seen in Table 2 and consumption (as % of GDP) only increased marginally from 2011 to [10]

6 Since GDP per capita is still rather low at US$6807, and it takes time for measures to encourage longer term unemployed and new graduates takes time, successfulness in reducing dependence on trade and hence mitigate contagion is yet to be seen. Furthermore, only Germany is one of China s top 5 trading export partner (but only at 3% of total exports). The contagion impact may not be significant. Singapore Increase Productivity and to move towards Creative economy, from high skilled to even higher skilled industries. Manpower lean leveraging capital goods for higher productivity and reducing reliance on foreign manpower. Creative economy - the new competitive advantage: carve out new markets and create new markets through the fusion of business, technology and arts. This may lead to new comparative advantage and new sources of export revenue and find new trading partners. Design, which serves to bring about such a fusion has emerged as the key differentiation strategy for businesses. Improvement in productivity will bring about lowering cost of production and thus enable Singapore s exports to be able to price competitively and assuming demand is price elastic, a fall in price will lead to a more than proportionate rise in output and thus revenue. All these will help to mitigate the contagion impact if Eurozone goes into recession. Effectiveness of restructuring efforts Still very reliant on exports (176.5% of GDP in 2014) and a Eurozone recession can have global impact and impact Singapore directly and indirectly. Increased productivity from restructuring efforts can mitigate some of the impact. Movement into the creative economy e.g. servicization of manufacturing, can also help mitigate since most manufacturing is offshored to low cost countries. The ability to design, and thus carve out or create new markets to react to the world economic situation can also help Singapore adapt more adequately. Synthesis (can vary based on student s analysis): Based on the overall direction of the restructuring efforts and nature of each economy,. China will may be better able to weather the storm as they leverage the might of their large national.market should their measures mentioned above shows success overtime. As for Singapore, its survival is always about finding new comparative advantage and constantly improving on the price and non-price competitiveness of its exports and thus will still be able to cushion any negative impact from a Eurozone crisis. Students can also rank whether Sg or China is more effective in mitigating the contagion impact of Eurozone recession Mark Scheme L3 (7-8) L2 (4-6) L1 (1-3) E1 E2 Balanced and well-developed economic analysis on the effectiveness of China s and Singapore s restructuring efforts in mitigating contagion effect on their economies, based on the case material. Lopsided or under-developed analysis with insufficient application of case evidence. Descriptive answer with minimum link to question. Attempts to synthesize or some judgment Provide good synthesis and a reasoned conclusion. Many did not understand what China s restructuring efforts are about and went into fiscal stimulus or simply moving towards service-based economy. The main restructuring effort

7 is really about the rebalance of the weight of C as compared to X & FDI to GDP. Some went into details of increasing the multiplier size. This is probably because of question (b) but failed to realise this will not help to mitigate the negative impact of a Eurozone crisis. Because if there is a fall in X from Eurozone, then Y in China will contract by a bigger multiplier! And it is not only about a rise in C to offset a fall in X but a rebalancing effort to make C as the engine of growth and not X and FDI since external factors are beyond the government s control. Answers were generally descriptive with little efforts to have economics analysis especially for the policies of Singapore. Some thought that our restructuring efforts include offshoring of manufacturing to lowcost economies rather than this is an outcome of losing our CA and thus it is critical for Singapore to move up the supply chain into service and design. A handful of candidates went off-tangent into great details on the effects of wage-push inflation in Singapore because of the tightening of the foreign labour and then into details of generic supply-side policies that are not targeted to address the question. A handful actually said reduction in foreign labour means lesser reliance on Eurozone which is not accepted. Many were unable to use stats to support their evaluation. Some stated that Eurozone is not a top trading partner of Singapore because it only constitutes 9.8% and is lesser than Malaysia and China, is not acceptable. Table 5 is a list of the top 5 trading partners and at almost 10% of the total trade, it is very high!