Question

SECTION B – CASE STUDY

Read the scenario below and answer the questions that follow:

South Africa has a negative trade balance with the East (Asia). The value of imports from the East is more than the value of the goods that South Africa exports to Asia. This means that the trade balance or terms of trade is not in favour of South Africa. This is not a uniquely South African phenomenon. Part of the reason for the trade war between the United States and China is due to the fact that terms of trade tend to be skewed in favour of China.

Source: Examiner

4BQuestion 1

1.1 Use an appropriate diagram to illustrate and explain the effect of the scenario above on the foreign exchange market. (8)

1.2 Discuss the three (3) policy options available to South Africa to mitigate against the outcome in 1.1. (6)

1.3 Briefly discuss the effect of the trade wars between China and the United States on the South African current account. (6)

Answer 1

(1.1)

(1.2) Three policies option are :

1. Cut government spending

The government can cut its public spending to reduce its fiscal deficit depending on the type of government spending you cut. If you cut pension spending (e.g. make people work longer), then there may be an actual increase in productive capacity. If you cut public sector investment, it will have a bigger adverse effect on aggregate demand and the supply side of the economy. Therefore, the temptation is for the government to cut benefits and pensions as this can reduce spending with less impact on economic growth – but it will be at the cost of increased inequality in society.

2. Tax increases

Higher taxes increase revenue and help to reduce the budget deficit. Like spending cuts, they could cause lower spending and lead to a fall in economic growth. Again it depends on the timing of tax increases. In a recession, tax increases could cause a significant drop in spending. During high growth, tax increases won’t harm spending as much. It also depends on the type of tax you increase.

3. Economic growth

One of the best ways to reduce the budget deficit as a % of GDP is to promote economic growth. If the economy grows, then the government will increase tax revenue, without raising taxes. With economic growth, people pay more VAT, companies pay more corporation tax (tax on profits), and workers pay more income tax. High economic growth, is the least painful way to reduce the budget deficit because you don’t need to raise tax rates or cut spending. However, many countries with fiscal deficit crisis are often stuck in recession.

(1.3)

Because both China and the US are such big global markets, a trade war between the two is impacting global trade in general but has a harrowing effect on emerging markets such as South Africa. Around 10% of South Africa’s total exports are destined for China. “This is sure to hit the Chinese economy hard which could put South Africa’s trade with China in jeopardy. Slower trade growth, protectionism and technology pose challenges to export led growth strategy. With South Africa being a very small open economy, economic events across the world will adversely affect South Africa," says Ian Matthews, head of business development at Bravura.

The balance of trade is an indicator of the difference in value between a country’s imports and exports and dictates SA’s current account, which is indicative of the country’s trade with the rest of the world. Analysts had expected the trade account to show a small surplus. The unexpected deficit shows that South Africa has been hit by waning demand from its main trading partners as well as a deterioration in the terms of trade.

The trade war between the USA and China affects US and Chinese firms alike, and these factors will affect both the demand of products as well as the production/supply thereof. While the full impact of Trump’s trade war has not yet been seen, US trade policies will have a series of far-reaching effects that are likely to be felt around the globe. Trade wars don’t produce winners. Everyone loses.