Competition & Monopoly in Markets,IGCSE,GCEO

Introduction

A market structure describes the characteristics of a market which can affect the behaviour of businesses and also affect the welfare of consumers. Some of the main aspects of market structure are listed below:

• The number of firms in the market
• The market share of the largest firms
• The nature of production costs in the short and long run e.g. the ability of businesses to exploiteconomies of scale
• The extent of product differentiation i.e. to what extent do the businesses try to make their products different from those of competing firms?
• The price and cross price elasticity of demand for different products
• The number and the power of buyers of the industry’s main products
• The turnover of customers - this is a measure of the number of consumers who switch suppliers each year and it is affected by the strength of brand loyalty and the effects of marketing. For example, have you changed your bank account or your mobile phone service provider in the last year? What might stop you doing this?

What is a monopoly?

• A pure monopolist in an industry is a single seller. It is rare for a firm to have a pure monopoly – except when the industry is state-owned and has a legally protected monopoly.
• A working monopoly: A working monopoly is any firm with greater than 25% of the industries' total sales. In practice, there are many markets where businesses enjoy some degree of monopoly power even if they do not have a twenty-five per cent market share. 
• An oligopolistic industry is characterised by the existence of a few dominant firms, each has market power and which seeks to protect and improves its position over time.
• In a duopoly, the majority of sales are taken by two dominant firms.

How monopolies can develop

Monopoly power can come from the successful organic (internal) growth of a business or throughmergers and acquisitions (also known as the integration of firms).

Horizontal Integration 

This is where two firms join at the same stage of production in one industry. For example two car manufacturers may decide to merge, or a leading bank successfully takes-over another bank.

Vertical Integration      

This is where a firm integrates with different stages of production e.g. by buying its suppliers or controlling the main retail outlets. A good example is the oil industry where many of the leading companies are explorers, producers and refiners of crude oil and have their own retail networks for the sale of petrol and diesel and other products.

• Forward vertical integration occurs when a business merges with another business further forward in the supply chain
• Backward vertical integration occurs when a firm merges with another business at a previous stage of the supply chain

The Internal Expansion of a Business 

Firms can generate higher sales and increased market share and exploiting possible economies of scale. This is internal rather than external growth and therefore tends to be a slower means of expansion contrasted to mergers and acquisitions.

Barriers to Entry

Barriers to entry are the means by which potential competitors are blocked. Monopolies can then enjoy higher profits in the longer-term. There are several different types of entry barrier – these are summarised below:

• Patents: Patents are legal property rights to prevent the entry of rivals. They are generally valid for 17-20 years and give the owner an exclusive right to prevent others from using patented products, inventions, or processes. Owners can sell licences to other businesses to produce versions of their patented product.

• Advertising and marketing: Developing consumer loyalty by establishing branded products can make successful entry into the market by new firms much more expensive. Advertising can also cause an outward shift of the demand curve and make demand less sensitive to price

• Brand proliferation: In many industries multi-product firms engaging in brand proliferation can give a false appearance of competition. This is common in markets such as detergents, confectionery and household goods – it is non-price competition.

Monopoly, market failure and government intervention

Should the government intervene to break up or control the monopoly power of firms in market?

The main case against a monopoly is that it can earn higher profits at the expense of allocative efficiency. The monopolist will seek to extract a price from consumers that is above the cost of resources used in making the product. And higher prices mean that consumers’ needs and wants are not being satisfied, as the product is being under-consumed. Under conditions of monopoly, consumer sovereignty has been partially replaced by producer sovereignty.

In the two diagrams above we contrast a market where demand is price inelastic (i.e. Ped <1) with one where demand is more sensitive to price changes (i.e. Ped>1). The former is associated with a monopoly where consumers have few close substitutes to choose from. When demand is inelastic, the level ofconsumer surplus is high, raising the possibility that the monopolist can reduce output and raise price above cost thereby operating with a higher profit margin (measured as the difference between price and average cost per unit).

If a monopoly reduces output from the equilibrium at Q1 to Q2 then it can sell this at a price P2. This results in a transfer of consumer surplus into extra producer surplus. But because price is now about the cost of supplying extra units, there is a loss of allocative efficiency. This is shown in the diagram by the shaded area which is not transferred to the producer, merely lost completely because output is lower than it would otherwise be in a competitive market.

Example: UK Cement Monopoly under Scrutiny
The Competition Commission is investigating the market for aggregates, cement and ready-mix concrete. Five businesses account for 90% of the cement market, 75% of aggregates and 68% of ready-mix concrete. There are worries that a lack of competition has raised building costs, meaning the government is paying too much for schools, hospitals and roads.

Source: News reports, Aug 2011

Example: Sky Film Monopoly criticized

Sky's control over pay-TV movie rights in the UK is restricting competition, leading to higher prices and reduced choice, the UK Competition Commission has ruled. The commission may decide to restrict the number of Hollywood studies from which Sky currently has the exclusive rights to be the first to air their new releases. Sky has twice as many pay-TV subscribers as all its rivals combined - a reflection of its market dominance.

Source: News reports, Aug 2011

Higher costs – loss of productive efficiency:

• Another possible cost of monopoly power is that businesses may allow the lack of real competition to cause a rise in costs and a loss of productive efficiency.
• When competition is tough, businesses must keep firm control of their costs because otherwise, they risk losing market share. 
• Some economists go further and say that monopolists may be even less efficient because, if they believe that they have a protected market, they may be less inclined to spend money on research and improved management.
• These inefficiencies can lead to a waste of scarce resources.

Evaluation – Potential Economic Benefits of Monopoly

The possible benefits of monopoly power suggest that the government and the competition authorities should be careful about intervening directly in markets and try to break up a monopoly. Market power can bring advantages both to the firms themselves and also to consumers and these should be included in any evaluation of a particular market or industry.

1. Research and development spending: Huge corporations enjoying big profits are well placed to fund capital investment and research and development projects. The positive spill-over effects of research can be seen in more innovation. This is particularly the case in industries such as telecommunications and pharmaceuticals. This can lead to gains in dynamic efficiency and social benefits.
2. Exploitation of economies of scale: Because monopoly producers often supply on a large scale, they may achieve economies of scale – leading to a fall in average costs.
3. Monopolies and international competitiveness: The British economy needs multinational companies operating on a scale large enough to compete in global markets. A firm may enjoy domestic monopoly power, but still face competition in overseas markets.

SPEW
Here is a good way to remember some of the issues we have covered regarding monopoly, efficiency and economic welfare

Service - does the lack of competition affect the quality of service to consumers?
Prices - how high are prices compared to competitive / contestable market
Efficiency - productive, allocative and dynamic
Welfare - what are the overall welfare outcomes? Is there a net loss of welfare in markets dominated by businesses with monopoly power?
Acknowledged source: Ruth Tarrant

Government Intervention in Markets – an introduction to UK competition policy

Competition policy involves the regulation of markets to protect and improve consumer welfare:

• The Competition Commission – its main concern is to investigate mergers and takeovers to examine if these mergers will have a negative effect on competition. It also engages in in-depth investigations of markets where there are competition worries. A good example was the recent report into the UK supermarket industry.
• The Office of Fair Trading reports on allegations of anti-competitive practices including claims ofcollusive “price-fixing” behaviour.
• The European Competition Authority examines anti-competitive behaviour, mergers and takeovers between European businesses and investigates state aid to struggling businesses to make sure that subsidies do not reduce or distort competition.
• Utility regulators such as OFGEM, OFCOM and OFWAT monitor the industries that were privatised during the 1980s and 1990s. The regulators have used the power to introduce and review price capping and they have also have sought to bring fresh competition into markets. Competition was introduced into the telecommunications in 1984; in Gas from 1996-98 and in Electricity from 1998.

Many markets have firms with monopoly power but they seem to work perfectly well from the point of view of the consumer. Although there is a consensus among many economists that competition is a force for good in the long-run, we should be careful not simply to assume that monopoly power is bad and competition is good. There are persuasive arguments on both sides.

Competition Policy Snapshots
In the Frame
The European Commission has launched two competition inquiries to study whether IBM has abused its dominant position in mainframe computers. The study will examine whether IBM has put obstacles in place that prevent competitors from operating freely. The other inquiry, launched by the Commission itself, will look at IBM’s relations with maintenance suppliers. (August 2010)
Bathroom cartel
Seventeen bathroom equipment makers have been fined a total of 622m Euros by the European Commission for price-fixing. Given the relatively homogenous nature of the products offering in this industry, and the high concentration ratio, it is ripe for collusion and cartel-like behaviour. (June 2010)
Capping mobile charges
The Telecoms regulator OFCOM has ordered UK mobile phone companies to cut the cost of termination charges - levied when people phone different networks from 4.5p to 0.5p by 2015. Mobile termination rates are the wholesale charges that operators make to connect calls to each others’ networks. (April 2010)
Heavy fines for tobacco cartel
The Office of Fair Trading (OFT) has given out the largest ever total fine in a case under the UK Competition Act 1998. A huge fine has been imposed on two tobacco manufacturers and ten retailers engaged in illegal price fixing for tobacco products in the UK. This is a good example of the financial risks that companies face when found guilty of anti-competitive behaviour. The tobacco manufacturers involved are Imperial Tobacco and Gallaher, and the retailers are Asda, The Co-operative Group, First Quench, Morrisons, One Stop Stores (formerly T&S Stores), Safeway, Sainsbury’s, Shell, Somerfield and TM Retail.
Imperial Tobacco was fined £112m and Co-op and Asda were penalized by £14m each (April 2010)

Source: Tutor2u Economics Blog

CONSUMERS SURPLUS,IGCSE,GCEO NOTES

Consumer surplus

When there is a difference between the price that you pay in the market and the value that you place on the product, then the concept of consumer surplus becomes a useful one to look at.

• Consumer surplus is a measure of the welfare that people gain from consuming goods and services
• Consumer surplus is the difference between the total amount that consumers are willing and able to pay for a good or service (indicated by the demand curve) and the total amount that they actually do pay (i.e. the market price).
• Consumer surplus is shown by the area under the demand curve and above the equilibrium price as in the diagram below.

Consumer surplus and price elasticity of demand

1. When the demand for a good or service is perfectly elastic, consumer surplus is zero because the price that people pay matches what they are willing to pay. 

2. In contrast, when demand is perfectly inelastic, consumer surplus is infinite. Demand does not respond to a price change. Whatever the price, the quantity demanded remains the same. Are there any examples of products that have such zero price elasticity of demand?

3. The majority of demand curves are downward sloping. When demand is inelastic, there is a greater potential consumer surplus because there are some buyers willing to pay a high price to continue consuming the product. This is shown in the next diagram.

• When there is a shift in the demand curve leading to a change in the equilibrium market price and quantity, then the level of consumer surplus will change too
• In the left hand diagram, following an increase in demand from D1 to D2, the equilibrium market price rises to from P1 to P2 and the quantity traded expands. There is a higher level of consumer surplus because more is being bought at a higher price than before.
• In the diagram on the right we see the effects of a cost reducing innovation which causes an outward shift of market supply, a lower price and an increase in the quantity traded in the market. As a result, there is an increase in consumer welfare shown by a rise in consumer surplus.

Consumer surplus can be used frequently when analysing the impact of government intervention in any market – for example the effects of indirect taxation on cigarettes consumers or the introducing of road pricing schemes such as the London congestion charge or a rise in air passenger duty.

Profit notes ,IGCSE,GCEO LEVEL

The Nature of Profit

Profit measures the return to risk when committing scarce resources to a market or industry.

Entrepreneurs organise factors of production and take risks for which they require an adequate rate of return. The higher the market risk and the longer they expect to have to wait to earn a positive return, the greater will be the minimum required return that an entrepreneur is likely to demand.

Economists distinguish between different types of profit:

Normal profit - is the minimum level of profit required to keep factors of production in their current use in the long run.

Normal profits reflect the opportunity cost of using funds to finance a business. If you put £200,000 of savings into a new business, those funds could have earned a low-risk rate of return by being saved in a bank account. You might use the rate of interest on that £200,000 as the minimum rate of return that you need to make from your investment

Because we treat normal profit as an opportunity cost of investing financial capital in a business, we include an estimate for normal profit in the average total cost curve, thus, if the firm covers its AC then it is making normal profits.

Sub-normal profit - profit less than normal (P < average cost)

Abnormal profit - is any profit achieved in excess of normal profit - also known as supernormal profit. When firms are making abnormal profits, there is an incentive for other producers to enter a market to try to acquire some of this profit. Abnormal profit persists in the long run in imperfectly competitive markets such as oligopoly and monopoly where firms can successfully block the entry of new firms. We will come to this later when we consider barriers to entry in monopoly.

Calculating economic profit

Consider the following example:The table shows data for an owner-managed firm for a particular year.

• Total revenue £320,000
• Raw material costs £30,000
• Wages and salaries £85,000
• Interest paid on bank loan £30,000
• Salary that the owner could have earned elsewhere £32,000
• Interest forgone on capital invested in the business £20,000

In a simple accounting sense, the business has total revenue of £320,000 and costs of £145,000 giving an accounting profit of £175,000. But profit according to an economist should take into account the opportunity cost of the capital invested and the income that the owner could have earned elsewhere. Taking these two items into account we find that the economic profit is £123,000.

Accounting Profit and Economic Profit

Short Run Profit Maximisation

Profits are maximised when marginal revenue = marginal cost

Price Per Unit (AR) (£)	Demand / Output (units)	Total Revenue (TR) (£)	Marginal Revenue (MR) (£)	Total Cost (TC) (£)	Marginal Cost (MC) (£)	Profit (£)
50	33	1650		2000		-350
48	39	1872	37	2120	20	-248
46	45	2070	33	2222	17	-152
44	51	2244	29	2312	15	-68
42	57	2394	25	2384	12	10
40	63	2520	21	2444	10	76
38	69	2622	17	2480	6	142
36	75	2700	13	2534	9	166
34	81	2754	9	2612	13	142

Consider the example in the table above. As price per unit declines, so demand expands. Total revenue rises but at a decreasing rate as shown by the column showing marginal revenue. Initially the firm is making a loss because total cost exceeds total revenue. The firm moves into profit at an output level of 57 units. Thereafter profit is increasing because the marginal revenue from selling units is greater than the marginal cost of producing them. Consider the rise in output from 69 to 75 units. The MR is £13 per unit, whereas marginal cost is £9 per unit. Profits increase from £142 to £166.

But once marginal cost is greater than marginal revenue, total profits are falling. Indeed the firm makes a loss if it increases output to 93 units.

As long as marginal revenue > marginal cost, total profits will be increasing (or losses decreasing). The profit maximisation output occurs when marginal revenue = marginal cost.
In the next diagram we introduce average revenue and average cost curves into the diagram so that, having found the profit maximising output (where MR=MC), we can then find (i) the profit maximising price (using the demand curve) and then (ii) the cost per unit.

• The difference between price and average cost marks the profit margin per unit of output.
• Total profit is shown by the shaded area and equals the profit margin multiplied by output

The Short Run Supply Decision - The Shut-down Price

A business needs to make at least normal profit in the long run to justify remaining in an industry but in the short run a firm will continue to produce as long as total revenue covers total variable costs orprice per unit > or equal to average variable cost (AR = AVC). This is called the short-run shutdown price.

The reason for this is as follows. A business’s fixed costs must be paid regardless of the level of output. If we make an assumption that these costs cannot be recovered if the firm shuts down then the loss per unit would be greater if the firm were to shut down, provided variable costs are covered.

• Average revenue (AR) and marginal revenue curves (MR) lies below average cost, so whatever output produced, the business faces making a loss
• At P1 and Q1 (where marginal revenue equals marginal cost), the firm would shut down as price is less than AVC. The loss per unit of producing is vertical distance AC. No contribution is made to fixed costs
• If the firm shuts down production the loss per unit will equal the fixed cost per unit AB.
• In the short-run, provided that the price is greater than or equal to P2, the business can justify continuing to produce
• In the long run the shut down point is AVC=AR because all cost are variable

Recession and factory closures

• The concept of the shutdown point has become topical due to the recession and the weak subsequent recovery
• Many businesses have opted to close down loss-making production plants and retailers have announced the closure of retail outlets in a bid to cut their losses.

Some of the plant closures have been temporary, for example some high-profile car manufacturers mothballed their factories and reduced the number of shifts. But for other businesses, the downturn brought about an end to trading. We have seen the demise of a large number of well-known retail businesses.

Deriving the Firm’s Supply Curve in the Short Run

• In the short run, the supply curve for a business operating in a competitive market is the marginal cost curve above average variable cost.
• In the long run, a firm must make a normal profit, so when price = average cost, this is the break-even point. It will therefore shut down at any price below this in the long run. 
• As a result the long run supply curve will be the marginal cost curve above average total cost.

The concept of a ‘supply curve’ is inappropriate when dealing with monopoly because a monopoly is a price-maker, not a “passive” price-taker, and can thus select the price and output combination on the demand curve so as to maximise profits where marginal revenue = marginal cost.

Changes in demand

• A change in demand and/or production costs will lead to a change in the profit maximising price and output.
• In exams you may often be asked to analyse how changes in demand and costs affect the equilibrium output for a business. Make sure that you are confident in drawing these diagrams and you can produce them quickly and accurately under exam conditions.
• In the diagram below we see the effects of an outward shift of demand from AR1 to AR2 short run costs of production remain unchanged). The increase in demand causes a rise in the price from P1 to P2 (consumers are now willing and able to buy more at a given price) and an expansion of supply (the shift in AR and MR is a signal to firms to move along their marginal cost curve and raise output). Total profits have increased.

Functions of Profit in a Market Economy 

Milk farmers could lose thousands of pounds a year after suppliers imposed a huge cut in milk prices. The average cow produces 7,500 liters of milk a year, meaning an annual loss of £45,000 for a typical herd of 120 cows. The number of dairy farmers has halved in the past ten years.
Robert Wiseman Dairies, Arla Foods UK and Dairy Crest – intend to cut the prices paid to farmers for milk. The processors say the move is a result of deterioration in the commodity markets for skimmed milk powder and wholesale cream. Some of the major retailers have corporate responsibility strategies which include terms to protect farmers. Tesco and Sainsbury's pay a price per liter that covers the cost of production, with Sainsbury's paying 30.56p per liter. Waitrose pays a market leading price, aiming to top the prices paid by the other retailers

Profits serve a variety of purposes in a market economy:

1. Finance for investment Retained profits are source of finance for companies undertaking investment. The alternatives such as issuing new shares (equity) or bonds may not be attractive depending on the state of the financial markets especially in the aftermath of the credit crunch.
2. Market entry: Rising profits send signals to other producers within a market. When existing firms are earning supernormal profits, this signals that profitable entry may be possible. In contestable markets, we would see a rise in market supply and lower prices. But in a monopoly, the dominant firm(s) can protect their position through barriers to entry.
3. Demand for factor resources: Scarce factor resources flow where the expected rate of return or profit is highest. In an industry where demand is strong more land, labour and capital are then committed to that sector.
4. Signals about the health of the economy: The profits made by businesses throughout the economy provide important signals about the health of the macro economy. Rising profits might reflect improvements in supply-side performance (e.g. higher productivity or lower costs through innovation). Strong profits are also the result of high levels of demand from domestic and overseas markets. In contrast, a string of profit warnings from businesses could be a lead indicator of a macroeconomic downturn.

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Economic Growth - Constraints

Introduction

Economic growth is not guaranteed and some countries struggle and sustain the minimum growth rate needed to bring down poverty and sustain their chosen development path.

What Factors Can Limit Growth and Development?

In this section we will explore some of the many growth limiters that a country may face

1 / Infrastructure

• Infrastructure includes physical capital such as transport networks, energy, power and water supplies and telecommunications networks.
• Evidence shows that there is a strong positive correlation between a country's economic development and the quality of its road network
• Poor infrastructure hampers growth because it causes higher supply costs and delays for businesses. It reduces the mobility of labour and affects the ability of exporters to get their products to international markets.

Here are three examples of infrastructure deficiencies:

India: India’s irrigation system is deficient and not properly managed and this has made it very difficult to sustain food grain production when rainfall is less than expected – as was the case in 2012. This has led to a surge in food prices which hits the poorest communities hardest. For a few days in the summer of 2012, much of northern India was plunged into darkness for two consecutive days. About 700 million people were left without power, a situation that affected transport, communication, healthcare, industries and farming. India needs an estimated $400bn investment in the power sector if it is to meet its development goals.

Brazil: Host for the 2014 World Cup and the 2016 Olympics. Brazil’s growth is constrained by infrastructure weaknesses: In 2011, only 14% of her roads were paved. The World Economic Forum ranks Brazil’s quality of infrastructure 104th out of 142 countries surveyed, behind China (69th), India (86th) and Russia (100th). 

Sub-Saharan Africa: The combined power generation capacity of the 48 countries of Sub-Saharan Africa is 68 gig watts – no more than Spain’s. Excluding South Africa, this figure falls to 28 GW, equivalent to the capacity of Argentina (except Argentina has a population of 40 million and Africa has 770 million.) A recent report from the Infrastructure Consortium of Africa (ICA), found that poor road, rail and harbour infrastructure adds 30-40% to the costs of goods traded among African countries. This chronic shortage of energy - with firms and people facing acute shortages of power – is a major barrier to growth and development.

One key barrier to infrastructure investment in developing countries is that tax revenues are low or come from a narrow base of businesses. For example, East African Breweries accounts for nearly 10% of the direct and indirect tax revenues going to the Kenyan government.

Many countries will need to increase their spending on infrastructure in the years ahead to adapt to and deal with the consequences of climate change. There has been much interest in recent years concerning the investment in infrastructure that businesses from emerging countries such as Brazil and China are making in the continent of Africa. China’s foreign direct investment in Africa has jumped from under $100 million in 2003 to more than $12 billion in 2011.

2 / Dependence on limited exports

• Many nations still relying on specializing in and exporting low value added primary commodities. The prices of these goods can be volatile on world markets.
• When prices fall, an economy will see a sharp reduction in export incomes, an adverse movement in their terms of trade, risks of a higher trade deficit and a danger that a nation will not be able to finance state-led investment in education, healthcare and core infrastructure.

Exports of least-developed countries by major product, 2010
(Percentage of total exports)
	2005	2010
Others	14.6	19.4
Textiles	1.4	1.3
Other semi-manufactures	3.2	2.3
Raw materials	4.3	3.5
Food	9.2	9.9
Clothing	13.7	11.8
Fuels	53.6	51.7
Source: World Trade Organisation

Here are some examples of export dependence for a selection of countries in Sub-Saharan Africa: The data shows the % of total exports in 2010:

• Angola: 97% oil
• Ghana: 39% gold, 26% oil, 17% cocoa
• Kenya: 19% tea, 12% horticulture
• Nigeria: 90% oil
• Senegal: 11% fish, 11% phosphate
• Tanzania: 37% gold
• Uganda: 18% coffee
• Zambia: 84% copper

Sub-Saharan Africa (SSA) is often cited as a region where primary sector dependence is high. SSA’s share in global manufacturing trade remains extremely low.

3/ Vulnerability to external shocks

Events in one part of the world can quickly affect many other countries. For example, the global financial crisis of 2007-2010 brought about recession in many countries and deep financial distress in many regions. It also led to a fall in foreign direct investment flows into many poorer countries and pressure on governments in rich nations to cut overseas aid budgets.

If a resource rich country exports the resource, then it exposes itself to damaging volatility of its export earnings. In 2010, economists Bruckner and Ciccone found that a 10% fall in income due to falling commodity prices raises the likelihood of civil war in sub-Saharan Africa by around 12%.

4/ Landlocked countries

Land-locked economies face particular challenges to integrate in global trade – without good infrastructure and efficient logistics businesses it can be difficult, costly and slow to get products to the countries of trade partners - but some landlocked countries have been doing well especially when they achieve regional economic integration with other land-locked nations.

5/ Low national savings and low absolute savings

Savings are needed to provide finance for capital investment. In many smaller low-income countries, high levels of poverty make it almost impossible to generate sufficient savings to provide the funds needed to fund investment projects. This increases reliance on overseas borrowing or tied aid.  This problem is known as the savings gap. In Africa for example, savings rates of around 17 percent of GDP compare to 31 percent on average for middle income countries. Low savings rates and poorly developed or malfunctioning financial markets make it more expensive for African public and private sectors to get funds for investment. Higher borrowing costs impede capital investment.

Problems facing The Bottom Billion – Paul Collier’s 4 Development Traps

Professor Paul Collier finds that the living standards of the world's bottom billion have stagnated over the past forty to fifty years.

He identifies four “development traps” - they are conflict, reliance on natural resources, being landlocked with bad neighbours, and bad governance.

6/ Limited financial markets

Many of the least developed countries have limited financial markets such as banking, money and credit systems, insurance markets and stock markets.

Worldwide, approximately 2.5 billion people do not have a formal account at a financial institution. Access to affordable financial services is linked to overcoming poverty, reducing income disparities, and increasing economic growth

These are essential for providing long term capital for the private sector and helping to channel savings and provide funds for investment projects.

Some progress is being made in Sub-Saharan Africa – there are now 19 stock markets in operation – but most of these are very small by international standards.

The Nigerian stock market accounts for only 3% of Brazil’s or India’s stock market capitalization.

6/ Volatile incomes and employment

Income growth so much more volatile in poor countries than in rich ones:

Volatility can be disruptive to economic health. It increases the risks for businesses considering capital investment, it raises the chances of people falling into extreme poverty and it makes a nation’s finances more fragile perhaps lowering the scope for important investment in public goods.

7/ Weaknesses in business management

Few development textbooks give much emphasis to the complex roles for and effects of business management as a constraint on growth and subsequent development. A fundamental cause of poverty is low wages and poverty pay is linked to relatively low productivity (measured in different ways, one of which is the value of output per person employed).

Economists such as Nicholas Bloom from Stanford University have been studying the impact of weak management in some developing countries including India. Bloom has argued for example that “In India are badly managed: equipment is not looked after, materials are wasted, theft is common because inventory is not monitored, defects keep occurring, etc.  In a recent project with the World Bank, we found that giving management advice to Indian factories increased productivity by 20%.”

Weaker management may also help to explain why many poorer countries have not fully and intensively adopted new technologies. Economist Diego Comin finds that extensive adoption of new technologies has accelerated in recent years – witness the rapid expansion of mobile technology in many African countries – but that many of the least developed countries tend to use technologies less intensively - fewer people use less advanced computers less often.

8/ Capital flight

Capital flight is the uncertain and rapid movement of large sums of money out of a country. There could be several reasons - lack of confidence in a country's economy and/or its currency, political turmoil or fears that a government plans to take privately-owned assets under government control

Capital flight can lead to a loss of foreign currency reserves and put downward pressure on an exchange rate – driving the prices of essential imports of goods and services higher.

According to figures from Global Financial Integrity, developing countries lost $5.86 trillion in 2001-2010 to illicit financial flows

9/ Conflict, corruption and poor governance

Governance refers to how a country is run and whether the exercise of authority manages scarce resources well improving economic outcomes and the quality of life for a country’s people. High levels of corruption and bureaucratic delays can harm growth by inhibiting inward investment and making it likely that domestic businesses will invest overseas rather than at home.

Governments need a stable and effective legal framework to collect taxes to pay for public services. In India, there are 15 times more phone subscribers than taxpayers. If a legal system cannot protect private property rights then there will be less research and development & innovation.

Conflicts – there have been an estimated 150 conflicts since 1945 with 28 million deaths (this is twice the toll of WW1). Conflicts have huge collateral damage effects – for example, Angola has lost 80% of its farmland because of landmines. Most conflicts are intra-state i.e. civil war and reconstruction can take decades and many countries remain aid-dependent. About 1.5 billion people live in countries suffering repeated waves of political and criminal violence.

A recent example of the cost of conflict comes from the Ivory Coast. After a disputed presidential election in late 2010 violence erupted and the country descended into a four-month civil war that killed an estimated 3000 and displaced around a million people. The war could only be ended by a French intervention in April 2011. Since then the new government under President Ouattara has struggled to re-establish security but raids against army and policy installations still threaten stability.

Corruption has long been a barrier to sustained growth and development in Africa. Conflict has had terrible consequences; over one third of economies in Africa have suffered some kind of warfare from Rwanda, Sierra Leone, Eritrea, Uganda, and Somalia.

That said encouraging progress has been made in building democratic institutions in many African countries.

Economic growth can collapse and go into reverse when states fail – there are numerous reasons whychronic government failure can hamper growth and development:

• Failures to protect property rights and provide sufficient incentives for new businesses to flourish
• Forced labour, caste labour and other forms of discrimination –  all of which waste scarce human resources not least limiting the roles that women can play in labour markets and – over the long term - holding back innovation and technological progress (two key drivers of growth)
• Power elites controlling an economy - using their power to create monopolies and blocking new technologies
• Stateless areas - large parts of the world are still dominated by stateless societies where the rule of law barely exists
• Public goods - chronic failures to provide basic and effective public services such as education, health and transport. Many of the world’s least developed countries have not built effective tax systems and so their revenue base is inadequate for much needed capital investment and the annual revenues required to provide public health and education programmes
• Conflicts – there have been many conflicts over natural resources e.g. in Sierra Leone

10/ Population decline and / or an ageing population

• In some countries the size of the population is declining as a result of net outward migration
• If a nation loses younger workers, this can have a damaging effect on growth
• The changing age-structure of a population also matters, leading to a fall in the ratio of workers to dependants

Demographic change is important to many of the fast growing countries in Asia.

• Most countries in East Asia are expected to experience a decline the portion of their working age population (15-64 years) to total population from now until 2025
• Seven countries are expected to see declines of 10 percent or more (including China, Japan, Thailand and Vietnam) while three will see declines of over 20 percent (Hong Kong SAR China, Korea and Singapore)
• Countries such as Indonesia, Mongolia, Myanmar and Vietnam are forecast to see a decline in their population size due to a combination of emigration and demographics

Declining populations in Eastern Europe

Many countries in Eastern Europe must face the challenges of continued population decline. Only two out of twelve countries will experience population growth according to recent estimates.

The relationship between demographic trends, per-capita income and economic growth is complex. Lower per-capita income should lead to higher growth, but it also has a negative impact on labour supply. Eastern Europe will have to rely on capital accumulation and productivity growth rather than labour force growth to generate economic growth.

One of the BRIC countries – Russia – is experiencing a sustained decline in their population and their active labour force. High levels of net migration, rising death rates linked to exceptionally high accident rates and the effects of alcohol abuse have all contributed to a fall in population to below 150 million.

Globally the world’s population is ageing. Within next 10 years, there will be 1 billion older people worldwide. By 2050 nearly one in five people in developing countries will be over 60

11/ Rising inflation

Fast growing countries may experience an accelerating rate of inflation which can have damaging economic consequences.

Two effects in particular can hit growth, namely falling real incomes and profits together with higher costs and also reduced competitiveness in international markets.

12/ Persistent trade deficits due to rising imports

Some countries may experience large deficits on the current account of their balance of payments. This means that the value of imported goods and services is greater than the value of exports and net investment incomes leading to an outflow of money from their economy.

High trade deficits might have to be covered by foreign borrowing (increasing external debt) or a reliance on inflows of capital investment from overseas multinationals

Large trade gaps can eventually lead to a currency crisis and possible loss of investor confidence.

13/ Over-extraction of the natural resource base

Natural resources provide an important source of wealth for many lower-income countries and when world prices are high, there is an incentive to increase extraction rates to boost export earnings.

This might lead to an excessive rate of extraction that damages growth potential

Deforestation and rapid extraction of oceanic fish stocks are two good examples of this.

A report from the OECD published in 2012 found that there is a growing need to improve the sustainable use of available land, water, marine ecosystems, fish stocks, forests, and biodiversity. Some 25% of all agricultural land is highly degraded.

Critical water scarcity in agriculture is a fact for many countries

Extreme weather events are becoming more frequent and climatic patterns are changing in many parts of the world. The damaging effects of these extreme climatic events tend to fall most heavily on the poorest and most vulnerable communities in developed and developing countries.

14/ Inadequate investment in human capital

To sustain growth requires improvements in productivity, research & development and innovation. Whilst physical capital such as factories and technology plays a role, so too does the quality of the human input into production.

Economic growth might be limited by skills shortages as businesses seek to expand which forces up average wages and labour costs.

High level skills and qualifications are also needed to help businesses to move up the value chain and supply products that can be sold for higher prices in the world economy.

In many of the least developed countries there are acute shortages of human capital. Although primary enrolment rates have risen, secondary enrolment and teacher quality is poor and the tertiary education sector is tiny and low-quality. Some countries lose some of its limited skilled workforce to other countries. Gender inequality can have a hugely negative effect on human capital development.

15/ High levels of inequality of income and wealth

Although two decades or more of globalisation has strengthened average growth rates in many lower and middle-income countries, it has brought an increase in inequalities of income and wealth.

When the gap between rich and poorer communities gets bigger there are many possible dangers not least the costs of social tension and conflict and increasing spending on insurance, law and order systems and government welfare bills.

Recent theoretical work finds a negative correlation between income inequality and economic growth. One book that supports this view is The Spirit Level (Pickett and Wilkinson) which finds evidence that unequal societies may become less competitive over time.

16/ Gender inequality and discrimination

In many countries women are subject to deep-rooted cultural norms that prevent them playing a full and active role in their economy.

• According to the World Bank, 232 million women live in economies where they can't get a job without their husband's permission
• Less than 10% of credit for small farmers in Africa is directed to women

Some progress is being made, from 2009 through to 2011, 39 developing countries made legal changes towards gender parity – but only 38 out of 141 nations set the same legal rights for men and women in their own labour markets

Economic and social dangers from rising inequality

17/ Malnutrition and limits to growth and development

High rates of malnutrition can severely impair development and bring untold human misery. Poor nutrition can have serious negative effects on development prospects:

• It impairs brain development among the young – nearly one in five children aged under five in the developing world is under-weight
• It is responsible for half of all child deaths – 38% of under-five children in the poorest 20% of families in developing countries are underweight compared to 14% of under-fives in the wealthiest 20%
• It increases the risks of HIV infection and cuts the numbers who survive outbreaks of malaria
• Malnourished children are more likely to drop out of school and suffer reductions in their lifetime incomes
• According to the World Bank, “the effects of this early damage on health, brain development, educability, and productivity caused by malnutrition are largely irreversible.”
• The surge in global food prices has had a terrible effect on the risk of malnutrition in many of the world’s poorest countries. It has certainly led to a sharp rise in premature deaths and severe illnesses linked to poor nutrition in countries such as India.

Here is the 2011 data for the % of people who are undernourished:

• Sub-Saharan Africa: 27% (equivalent to 231 million)
• Southern Asia: 20%
• Developing regions: 15%
• Rural children in developing countries: 32%
• Urban children in developing countries: 17%

There has been progress in reducing malnutrition but high prices for basic foods in recent years have curbed this trend.

Prevalence of undernourishment (% of population)
Country	Data is from 2008
Eritrea	65
Burundi	62
Haiti	57
Zambia	44
North Korea	35
Kenya	33
Low income countries	29
Least developed countries	29
Heavily indebted poor countries (HIPC)	28
Sub-Saharan Africa (all income levels)	22
India	19
Low & middle income countries	14
World	13
Middle income	13
China	10
European Union	5

Policies to reduce malnutrition

• Schemes to promote health and nutrition education plus direct provision of micro-nutrient supplements and fortified foods
• Growth monitoring schemes for the newly born and infants supplemented with vitamin provision from community organisations
• Targeting cultural norms – in some countries, young girls are often allowed to eat only after their brothers
• Cash transfers – i.e. consumer subsidies that can be spent on certain foods
• Government subsidies for grain prices and export bans on domestically produced foods
• Better food prices paid to small-scale farmers
• Opening up retail markets to international supermarkets where food prices might come down through economies of scale and increased competition

Infrastructure spending to improve access to and improved quality of sanitation and clean water supplies

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The Greek Economic Crisis

Case Study: The Greek Economic Crisis – Debt, Default, Deflation and Social Breakdown

Macroeconomic indicators for Greece – negative growth and mass unemployment

1. Greece has been a member of the single European currency since it was launched in 2001
2. 2013 will be the sixth year in succession that Greece has been in recession
3. Cumulatively the economy will have lost more than 20% of national output before a recovery starts
4. Private sector demand has collapsed, there have been deep falls in consumer spending on goods and services and even great reductions in real private sector capital spending
5. Government consumption on state-provided goods and services is now shrinking rapidly too as the fiscal austerity measures take effect.
6. This combination of weak private sector demand and a contracting public sector makes it inevitable that the Greek economy stays in recession
7. Net trade (X-M) is making a small contribution to positive growth and the current account deficit is likely to dip below 5% of GDP for the first time in several years. But this on its own is insufficient to provide Greece with the means to achieve a sustainable recovery
8. Greek national output is vastly below potential – there is a huge margin of spare capacity
9. This is one reason why the Greek economy remain at risk of price deflation – which given the scale of national and private sector debt could be catastrophic. Low positive inflation is good news for Greece if it helps to restore price competitiveness, deflation would be a different story.
10. Unemployment has reached historic highs, more than 25% of the working population is out of work and youth unemployment has soared to nearly 60%
11. Despite austerity measures the fiscal deficit remains high and national debt will move higher – towards 190% of GDP. IMF aims to bring this down to 120% of GDP in 2020 look fanciful.
12. The OECD estimates that the trend rate of growth for Greece is zero or perhaps slightly negative – this is highly unusual and reflects the depth of the economic and fiscal crisis facing the country. The IMF does not see Greece returning to growth until 2015 by which time its economy is forecast to be 25% smaller than at the start of the crisis.

The Greek Debt Crisis

The Greek economy became embroiled in a huge debt crisis in the aftermath of the global financial crisis from 2007 onwards. Having struggled to keep public sector spending under control and tackle widespread tax evasion, it became clear a few years ago that the annual Greek budget deficit was much higher than expected. About €30bn annually of tax revenues go uncollected in Greece.

The tipping point for Greece was the immediate and short-run fall-out from the Global Financial Crisis (GFC). Students ought to be familiar with the background here. The sub-prime mortgage crisis in the United States quickly turned into a major global financial meltdown affecting most countries but especially those with highly leveraged financial systems i.e. banking systems and other lenders that had created too much credit to private sector businesses and individuals.

The Greek economy was hit by a fierce demand-side shock and this was made worse because the economy was already suffering from structural competitiveness problems inside the single currency system.

As a direct consequence of the GFC:

• Most of Greece’s main trading partners went into a deep recession – cutting exports
• There was a 2% fall in world output (unusual) but worse, a 12% fall in global trade

Greece suffered badly because her economy was heavily dependent on tourism and construction, two sectors badly hit by the sharp fall in demand and production.

In 2009 Greek exports collapsed by nearly a fifth (causing a large inward shift of AD) and the Greek fiscal deficit grew from 5% of her national income in 2007 to nearly 14% in 2009. A decade of progress in reducing unemployment was reversed within the space of two harsh years.

The Greek government has run a budget deficit in every year of at least 4% of GDP. Even during the first half of the last decade there was a sizeable deficit although corruption and fraud meant that the official figures hid this. The deficit peaked at over 15% of GDP in 2009 and in 2011 the budget deficit was nearly 10%. Strong growth in Greece helped to keep the government debt to GDP ratio at or around 115% during the years from 2001 to 2008 but a combination of huge annual deficits and six years of recession has brought about a huge rise in the scale of the national debt.

The OECD is forecasting that this will reach 200% of GDP in 2014 despite attempts to cut the deficit. The reason is simple – even though the Greek budget deficit is coming down, their economy is shrinking so the base level of real GDP is falling. In December 2012, the 'troika' of the IMF, the EU and the European Central Bank reached a new funding agreement for which will cut Greece's long term debt burden. And Greece has made some progress in cutting the annual budget deficit. Greece reduced its fiscal deficit before interest payments by 13.4% of GDP between 2009 and 2012.

The European Union, International Monetary Fund and the European Central Bank are the main creditors to the Greek government. They are known as the EU-IMF-ECB troika

Fiscal austerity means contractionary fiscal policy measures in the form of higher taxes and/or cuts in planned government (public) spending. In Greece in 2010, the country was forced to agree a Euro 110bn emergency bailout and introduce an austerity budget. These measures included a VAT rise from 19% to 23%, higher duties on fuel, alcohol and cigarettes, an increase in the retirement age, a public sector pay freeze and a freeze on the size of the basic state pension.

There is a fierce debate in economics about the most effective ways to address the problems caused by high levels of government debt. Many economists including Nobel-winner Joseph Stiglitz argue that contractionary policies make the debt problem worse and that sustained growth is the best pathway out of a debt crisis.

Greece is also seeking to implement structural economic reforms as part of their bail-out package. Structural economic reforms have included:

• Pension reforms including raising the official state retirement age
• Privatisation of state assets both to raise revenue and to increase competition
• Cuts in the national minimum wage
• Measures to reduce entry barriers to certain occupations / professions including transport
• Cutting taxes on employing workers to boost employment
• Making the Greek judicial system more efficient
• Cutting red tape for businesses to promote investment
• Stronger measures to tackle tax evasion by individuals and businesses

The key issue is whether these structural supply-side reforms will be sufficient to improve competitiveness and generate the minimum growth that Greece needs to break out of their debt trap?