In: Economics
Using the circular flow of income model, supported by a diagram, show the effect on an economy such as the UK, of a fall in investment by British firms and a reluctance by Chinese companies to buy goods from the UK.
Word Limit: 200 words
CASE STUDY BELOW
Growth and Climate Change
Even before the Coronavirus pandemic that swept across the world in
2020 the Organisation for Economic Cooperation and Development
(OECD) was already warning of a slowdown in global economic
activity.
In a report published in November 2019 it argued that it was a lack
of direction on global climate policy that was reducing business
investment. Although it did not go as far as to predict a
recession, it was pessimistic about the future for continued
growth.
There are calls for action from governments to address challenges,
some of which have both long term and more immediate
consequences.
In relation to climate change, the OECD argued that extreme weather
events such as heat waves, drought and storms could lead to
disruption of economic activity and could inflict long lasting
damage on people, capital and land. Economists are well aware of
the negative externalities caused by economic growth and many
economists have long argued that climate change presents the
biggest environmental threat to economic well -being and standards
of living in the future. The British economist, Nicholas Stern,
referred to global climate change as the greatest ever example of
market failure and that insufficient policy action could increase
the costs of climate change.
Stern argued that while climate change presents a long-term
challenge for governments in addressing these issues, there is no
alternative but for immediate action to be taken to try and reduce
these costs. Governments were unwilling to allocate resources in
the short term to deal with long term problems but this was not a
sensible strategy. For Stern, in order to maintain real increases
in economic prosperity in the future, there is a relatively small
cost that needs to be allocated to tackling the problems of climate
change in the short run. The OECD report argues that there is
indeed already an impact on business investment of uncertainty over
climate change policy and that this is at the centre of slowing
growth. For the OECD as for Stern, governments must act
quickly.
"Without a clear sense of direction on carbon prices, standards and
regulation, and without the necessary public investment, businesses
will put off investment decisions, with dire consequences for
growth and employment," the OECD said.
Among the other challenges to short term global growth that the
OECD mentioned was the change in the Chinese economy. As incomes
grow on average in China, it is becoming a more services-oriented
economy which means the country's demand for imported goods for its
industries to process, was unlikely to grow as strongly in the
future. As well as this, after thirty years of rapid economic
growth in China, the Chinese government was trying to manage its
growth so as to prevent overheating in the economy.
If investments by British firm falls then, firms pay a lower tax as their profits are low. This leads to less revenue collection by the government and less income transfers to help the poor. Less disposable income in the hands of the households, wherein instead of spending, they save more and consume less number of imported products.
Additionally as Chinese companies are reluctant to buy goods from UK, exports of these firms reduce and ability of the firm to earn from these exports.
As firms are not able to employ more number of people, households have lower private savings in financial institutions, these financial institutions lend less to the firms thus total production in the economy declines.
Thus as per the circular flow model, the domestic GDP falls as all parameters start to decline and the government has to borrow more from Financial Institutions and indirectly these financial institutions borrow more from other countries.