Economics of inequality and poverty Paper 2

IBDP Economics  SL – Macroeconomics – Economics of inequality and poverty -Paper 2  Exam Style Practice Questions

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Trade strategies in the Philippines

  1. For more than 20 years the Philippines has been limiting the volume of rice it imports. However, the agreement with the World Trade Organization (WTO) that permitted these restrictions expired in 2017. In early 2019, the government replaced the quantity restrictions with tariff protection. A 35% tariff on imported rice from the Association of Southeast Asian Nations (ASEAN)* was imposed to protect the domestic rice industry in the Philippines. Following the replacement of the quota with a tariff, rice prices are expected to fall significantly. However, urban households want the president to allow rice to be imported without any tariffs to reduce food bills even further.
  2. The poorest quintile of households in the Philippines consumes nearly twice as much ordinary rice and 20 times more National Food Authority (NFA) rice compared to the richest quintile. Rising food prices are pushing up inflation as a result of increasing salaries in urban areas. The daily minimum wage in Manila, the Philippine capital, will increase by 4.9 %, the highest hike in six years, to the equivalent of US$10.11. Farming and fishing provide the livelihoods for around one-third of the labour force in the Philippines. Land reform programmes are slowly being implemented to change the current situation of unfair ownership of land and resources by a few individuals. However, uncertainty continues to discourage investment in adequate irrigation systems in the countryside. As an agricultural country, irrigation in the Philippines is very important. Improvements in the quality of infrastructure services will help cut the cost of doing business, attract more investment, and enhance productivity around the country. Food manufacturing, including food and beverage processing, remains the most dominant primary industry in the Philippines. This has become a focus in the hope of increasing farm incomes, because this part of the economy is currently dominated by big international companies. Major exports of processed fruits and nuts include mangos, pineapples, bananas and peanuts.
  3. The Philippine Export Development Plan (PEDP) 2018–2022 calls for boosting the export of services, increasing export competitiveness, and exploring new markets. Efforts have already been made to harmonize the country’s standards, testing, certification and quality accreditation of products to improve trade and comply with standards in the European Union. The PEDP aims to increase the volume and value of exports by encouraging investment in production processes and supply chains. Another strategy to achieve the plan’s objective is to exploit existing and new opportunities from trade agreements.
  4. The Philippines lacks the infrastructure needed to attract export-oriented manufacturing. To support the PEDP, the government needs to increase its spending on new airports, roads and bridges. These public works are critical to boosting the incomes of people in poorer areas by connecting them better to Manila. To allow for this extra spending, a series of tax reforms was started: the income tax for the highest income earners has been raised from 30 % to 35 %, and indirect taxes have been increased.

Question

Using a Lorenz curve diagram, explain the possible impact on the distribution of income in the Philippines when “the income tax for the highest income earners has been raised from 30 % to 35 %” (paragraph [4]).

▶️Answer/Explanation

A Lorenz curve diagram with 2 curves showing a shift closer to the line of perfect income equality AND an explanation that an increase of the tax rate in the highest income tax bracket makes it more progressive/reduces the disposable income of highest income earners/shifts the curve closer to the diagonal, thereby achieving greater income equality/resulting in greater equity in the distribution of income (decreasing inequality).

Angola’s economic reforms

  1. Following an oil price crash in 2014, Angola has endured a recession, a dramatic rise in inflation and empty supermarket shelves caused by severe shortages of foreign currency. Angola is highly dependent on export revenues from oil production, a major source of United States dollars. The foreign currency is needed to import manufactured goods because the country’s manufacturing sector is small.
  2. To respond to these challenges, the president of Angola has presented a plan with desperately needed reforms to promote economic development. The plan proposes tax incentives to attract foreign investment and privatization of the telecommunication and railway sectors. It also aims to expand infrastructure projects with private sector involvement. In addition, reforms are recommended to make the banking sector stronger. This is important if the government wants to reduce the borrowing costs experienced by Angolan businesses.
  3. The recent 20 % devaluation of the kwanza (Angola’s currency) is another sign that the government is serious about making Angola attractive to foreign direct investment (FDI). Angola has a fixed exchange rate. As the kwanza has been overvalued, this has caused a reduction in foreign currency reserves.
  4. Angola’s future economic growth is likely to be low. The business environment for firms remains difficult. High borrowing costs, corruption and poor infrastructure remain challenges. The government has failed to exploit Angola’s vast agricultural potential. The country depends heavily on oil revenues, which are falling.
  5. Living conditions for households are also poor as inflation is expected to remain above 25 %. Approximately 40 % of Angolans live in absolute poverty and unemployment is high, especially in rural areas. Aware of the urgent need to reduce regional inequality, the government has announced plans to encourage investment in rural areas. However, there are also proposals to reduce public debt by removing some subsidies on food and by introducing ad valorem taxes.
  6. Although Angola’s economic growth has been slow, it remains the third-largest economy in sub-Saharan Africa and the government is the second-largest public spender in the region.

Question

Using a Lorenz curve diagram, explain the likely impact on income distribution of “plans to encourage investment in rural areas”  (paragraph [5]).

▶️Answer/Explanation

A Lorenz curve diagram showing the curve moving closer to the line of perfect equality AND an explanation that plans to encourage investment in rural areas will reduce the gap with urban areas (or will raise wages/employment) making the income distribution more equal as shown by the inward movement of the Lorenz curve (or a reduction in the area below the line of perfect equality).

Infrastructure projects in Tanzania

  1. In 2018, Tanzania’s gross domestic product (GDP) grew by 7 %. But the trade balance deteriorated, with exports declining and imports increasing. Moreover, limits on government current expenditure and lower levels of inward foreign direct investment (FDI) suggest that GDP growth will weaken to 5 % in 2019. Inflation will stay low through 2019, due to lower prices for food and raw materials.
  2. The government has promised reforms to improve the business environment and fiscal management. However, the budget deficit is forecast to increase from 2.3 % of GDP to 4 % of GDP by 2020.
  3. Government investment in large-scale projects, such as the construction of railway lines, dams for electricity generation, bridges, roads and airports, could lead to annual economic growth of 10 %. These projects, however, are financed mainly by loans from commercial banks with a short repayment period and high interest rates. Therefore, the national debt and the cost of debt servicing are increasing. The national debt has risen from US$22 billion in 2015 to US$28.6 billion in 2019.
  4. The Minister for Finance and Planning is optimistic that the debt is sustainable. “The debt assessment shows we can continue to borrow locally and abroad to finance development activities and pay off matured loans using our internal and external revenue,” he said. According to the central bank, the transport and telecommunication sectors received a greater share of the funding, accounting for 26.8 % of the debt, followed by social welfare, education, energy and mining.
  5. All the large infrastructure projects use some materials imported from abroad, such as steel. Therefore, the current account deficit will widen further due to increased imports of resources necessary for production. The government’s ability to use its expenditure to stimulate domestic production will be reduced, because funds are being sent overseas to external lenders and construction firms.
  6. Tanzania is undergoing a structural change with a higher proportion of the labour force working in the manufacturing and service sectors, while agriculture is employing fewer workers. Despite a reduction in the poverty rate, the absolute number of poor people is still high due to population growth. According to a World Bank report, almost half the population lives on less than US$1.90 per person per day. It concludes that the poor have benefited relatively less from recent economic growth, resulting in an increase in income inequality from 2015 to 2019.
  7. Further investments in human capital, targeted towards the poor, are needed to increase access to higher-skilled jobs. However, government efforts to expand public services, including education, health, and sanitation and clean water facilities, have been undermined by their declining quality as the population rises faster than the supply of the services. Therefore, the levels of education and basic services remain low, particularly for the poorest and those living in rural areas.

Question

Define the term human capital indicated in bold in the text (paragraph [7]).

▶️Answer/Explanation

The idea that is labour/ workers and any of two of the following:

  • skills
  • abilities
  • knowledge/qualifications
  • level of health (that make a labour force productive)

Infrastructure projects in Tanzania

  1. In 2018, Tanzania’s gross domestic product (GDP) grew by 7 %. But the trade balance deteriorated, with exports declining and imports increasing. Moreover, limits on government current expenditure and lower levels of inward foreign direct investment (FDI) suggest that GDP growth will weaken to 5 % in 2019. Inflation will stay low through 2019, due to lower prices for food and raw materials.
  2. The government has promised reforms to improve the business environment and fiscal management. However, the budget deficit is forecast to increase from 2.3 % of GDP to 4 % of GDP by 2020.
  3. Government investment in large-scale projects, such as the construction of railway lines, dams for electricity generation, bridges, roads and airports, could lead to annual economic growth of 10 %. These projects, however, are financed mainly by loans from commercial banks with a short repayment period and high interest rates. Therefore, the national debt and the cost of debt servicing are increasing. The national debt has risen from US$22 billion in 2015 to US$28.6 billion in 2019.
  4. The Minister for Finance and Planning is optimistic that the debt is sustainable. “The debt assessment shows we can continue to borrow locally and abroad to finance development activities and pay off matured loans using our internal and external revenue,” he said. According to the central bank, the transport and telecommunication sectors received a greater share of the funding, accounting for 26.8 % of the debt, followed by social welfare, education, energy and mining.
  5. All the large infrastructure projects use some materials imported from abroad, such as steel. Therefore, the current account deficit will widen further due to increased imports of resources necessary for production. The government’s ability to use its expenditure to stimulate domestic production will be reduced, because funds are being sent overseas to external lenders and construction firms.
  6. Tanzania is undergoing a structural change with a higher proportion of the labour force working in the manufacturing and service sectors, while agriculture is employing fewer workers. Despite a reduction in the poverty rate, the absolute number of poor people is still high due to population growth. According to a World Bank report, almost half the population lives on less than US$1.90 per person per day. It concludes that the poor have benefited relatively less from recent economic growth, resulting in an increase in income inequality from 2015 to 2019.
  7. Further investments in human capital, targeted towards the poor, are needed to increase access to higher-skilled jobs. However, government efforts to expand public services, including education, health, and sanitation and clean water facilities, have been undermined by their declining quality as the population rises faster than the supply of the services. Therefore, the levels of education and basic services remain low, particularly for the poorest and those living in rural areas.

Question

Using a Lorenz curve diagram, explain what is meant by an “increase in income inequality from 2015 to 2019” (paragraph [6]).

▶️Answer/Explanation

For drawing a correctly labelled Lorenz curve diagram, with the 2019 curve further from the diagonal line than the 2015 curve AND for an explanation that an increase in income inequality means (that the area between the curve and the diagonal line has increased, which shows) that the lower income people are getting a lower share of the total income (or that the higher income people are getting a higher share of the total income).

Text A — Bangladesh: the economic role of women

  1. Bangladesh is a densely populated country in Asia. Its currency is the Bangladeshi taka (BDT). The annual rate of growth of gross domestic product (GDP) has steadily increased from 5.6
     

    % in 2010 to 8.1

     

    % in 2019. Absolute poverty has declined, but inequality has risen, partly due to higher unemployment rates for women than men. Moreover, the labour force participation rate for women is much lower than the rate for men. Over 80

     

    % of the women’s jobs are in the informal economy, and these jobs are low paid and insecure. Women need regular paid work, which not only raises household income but also improves economic well-being in terms of education and health.

  2. The structure of the economy is changing. The growth of cities is due to the expansion of the manufacturing sector, which now contributes a larger share to GDP than the agricultural sector. These changes have increased the number of women in the labour force. In particular, the growth of the ready-made garments (RMG) industry (mass-produced clothing) has given women the opportunity to move into formal employment. The RMG industry provides jobs for almost 4 million low-skilled and semi-skilled workers, accounting for over 40
     

    % of total manufacturing employment. The majority of these jobs are being filled by women, with the result that the gap between the wages of men and women is gradually being reduced.

  3. There are concerns about working and safety conditions in the RMG factories. After an accident in a factory in 2013, reforms are being implemented, partly in response to criticisms from overseas retailers and consumers who purchase the garments. The minimum wage has been increased, inspections are carried out, and there are fewer small, unsafe factories.
  4. While working conditions are improving, such reforms raise the costs of manufacturing garments. Furthermore, the international garment market is becoming more competitive, putting pressure on Bangladeshi factories to reduce costs.
  5. The overseas demand for Bangladeshi garments had been rising strongly until 2019. However, demand has recently fallen, reducing firms’ revenue. The reduction in revenue and the need to lower costs have forced certain firms to reduce the size of their labour force by dismissing some of their female workers.
  6. The number of ethically and environmentally concerned consumers is increasing globally. Rather than trying to lower costs, firms can be more successful if they produce “green ready-made garments” by implementing sustainable practices. About 100 garment factories in Bangladesh have already been certified as producers that meet specified environmental standards. In addition, global retailers and fashion brands are supporting recycling initiatives through the Circular Fashion Partnership.


Text B — Trade prospects for exports of ready-made garments (RMG)

  1. Exports of RMG account for over 84
     

    % of Bangladesh’s total exports. At present, Bangladesh is the world’s second largest garment exporter after China. Bangladeshi exports could further increase as Chinese garments become more expensive due to rising wages in China.

  2. Bangladesh is designated as an Economically Least Developed Country (ELDC) and is therefore able to sell goods in Europe and China without any quotas or tariffs being imposed. However, Bangladesh will graduate from ELDC status by 2026 and will then no longer be eligible for preferential trade agreements. Moreover, the USA, which is the largest export market for Bangladeshi garments, has applied a 15
     

    % tariff on imports from Bangladesh since 2013, citing concerns about working conditions in factories.


Text C — Role of foreign direct investment in the RMG sector

  1. Vietnam and Myanmar have significantly increased their garment exports to China due to foreign direct investment (FDI) from China. Chinese investors have set up factories that import raw materials from China and re-export the finished goods back to China.
  2. Consequently, to compete successfully in the huge Chinese market, Bangladesh needs to attract more FDI from China. Bangladesh is developing the required infrastructure, such as transport links. It is also necessary to diversify into expensive high-end fashion, market more aggressively, and use branding strategies.
  3. The funds from additional FDI would be helpful, because the relative contribution of Official Development Assistance (ODA) to Bangladesh’s budget is declining. Furthermore, the foreign exchange obtained from foreign investors assists in financing the current account deficit.

Question

Using a Lorenz curve diagram, explain what happened to the distribution of income in Bangladesh between 2010 and 2019 (Table 2).

▶️Answer/Explanation

For a correct Lorenz curve diagram with appropriate labelling, with 2 curves showing a shift away from the line of
(perfect/absolute) equality AND an explanation that an increase in the Gini coefficient implies that the distribution of income has become more unequal.

Chinese investment helps Peru to develop

  1. Over the past decade, Peru has been one of South America’s fastest-growing economies, with an average economic growth rate of 5.9 % and low average annual inflation of 2.9 %. This has been mostly due to a favourable external environment, sensible macroeconomic policies and reforms of environmental regulations designed to increase investment in Peru’s profitable mining sector. However, the deregulation in the mining sector has been opposed by environmental groups and trade unions, fearing increased pollution and poorer working conditions.
  2. Strong growth in employment and income has dramatically reduced poverty rates. Absolute poverty fell from 27.6 % in 2005 to 9 % in 2015.
  3. Gross domestic product (GDP) growth continued to accelerate in 2016, very much helped by higher mining export output as several new large mining projects entered into production and reached full capacity. Peru mines and exports many commodities, including copper, gold, lead, zinc, tin, iron ore, silver, and oil and petroleum products.
  4. China is Peru’s main trading partner, taking 22.1 % of Peru’s exports and supplying 22.7 % of their imports in 2016. Chinese companies are also significant suppliers of foreign direct investment (FDI) to Peru, recently investing over US$2 billion to purchase a hydroelectric power plant. The second main trading partner is the United States (US), taking 15.2 % of Peru’s exports and supplying 20.7 % of their imports in 2016.
  5. Peru’s current account deficit declined significantly from 4.9 % to 2.8 % of GDP in 2016, owing to increasing export growth and lower imports. Peru’s government continues to support a free trade policy; since 2006, Peru has signed trade deals with 17 different countries including the US, Canada, China and Japan. In addition, a trade deal has also been signed with the European Union.
  6. Real GDP growth is expected to slow slightly in 2017 due to an anticipated lower growth rate in the mining sector and weak private investment. To support the economy as mining production slows, the government is expected to increase public investment in 2017.
  7. Growth projections may not be achieved if any, or a combination, of the following occur: external shocks in commodities prices, a further deceleration of China’s economic growth, unpredictability in world capital markets and the threat of tight monetary policy in the US. Raising economic growth requires structural and fiscal reforms to improve productivity, reduce the size of the informal sector and improve the efficiency of public services.

Question

Define the term absolute poverty indicated in bold in the text (paragraph [2]).

▶️Answer/Explanation

An explanation that it is when people live below a certain level of income that is necessary to meet basic needs.

Question

Using information from Table 2, sketch the change in Uruguay’s Lorenz curve from 2010 to 2015.

▶️Answer/Explanation

Question

Define the term relative poverty indicated in bold in the text (Text D, paragraph 4).

▶️Answer/Explanation

An understanding that it is an income too low to maintain a typical (socially acceptable) standard of living within a country
OR
an understanding that it is an income below a specified level (poverty line), which is a certain percentage of the median (or average) income within a country.

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