A suggested answer to an EdExcel June 2013 macro data response question

1. A2
Macro
Data
Response
on
Brazilian
Economy
(June
2013)

2.
a) With
reference
to
Figures
1
and
2,
what
might
be
inferred
about
the
change
in
Brazil’s
GDP
between
2002
and
2011?
(5
marks)
• Define:
GDP
is
the
monetary
value
of
the
output
of
goods
and
services
• Application
• Figure
1
shows
a
rise
in
GDP
per
capita
from
$7,800
in
2002
to
$11,700
in
2011
• Figure
2
shows
the
Brazilian
population
growing
from
176m
in
2002
to
203m
in
2011
• GDP
=
GDP
per
capita
x
population
• Therefore,
GDP
has
risen
from
approx.
$1.78
trillion
in
2002
to
approx.
$2.73
trillion
in
2011
–
calculate
a
percentage
change
=
53%

4. b) With
reference
to
Extract
1,
analyse
two
reasons
why
the
value
of
the
Real,
Brazil’s
currency,
has
appreciated.
(8
marks)
Define
appreciation
–
a
rise
in
the
external
value
of
a
currency
within
a
floating
exchange
rate
system.
In
a
managed
floating
system
the
value
of
a
currency
is
mainly
determined
by
market
forces.
Two
key
causes
of
a
40%
appreciation
in
the
Brazilian
Real
might
be:
i) Brazil
has
relatively
high
interest
rates.
This
leads
to
a
strong
net
inflow
of
hot
money
into
the
Brazilian
banking
system,
leading
to
an
outward
shift
of
currency
demand
for
the
real,
thereby
causing
an
appreciation.
The
effect
could
be
amplified
by
strong
speculative
demand
for
the
Real
if
market
speculators
expect
the
Real
to
continue
appreciating
in
value.
ii) Extract
1
mentions
a
significant
increase
in
the
value
of
Brazilian
exports
of
soft
commodities
such
as
soya
beans,
beef
and
sugar
cane.
This
increase
in
exports
has
contributed
towards
an
increased
current
account
surplus
for
Brazil
which
is
a
net
injection
of
currency
into
their
economy,
ceteris
paribus,
leading
to
an
increase
in
the
external
value
of
the
Real
of
nearly
40%
since
2008.
My
analysis
diagram
shows
the
impact
of
an
increase
in
currency
demand
on
the
Brazilian
real
Only
two
points
needed
for
analysis
–
but
could
also
talk
about
the
effects
of
quantitative
easing
QE)
in
the
USA
which
can
caused
outflow
of
US
$s
and
an
inflow
into
higher-­‐yielding
countries
including
Brazil.

5. c) Examine
the
likely
effects
of
the
appreciation
of
the
real,
Brazil’s
currency,
on
its
Balance
of
Payments
accounts.
(10
marks)
• Define
appreciation:
Rise
in
external
value
of
the
currency,
Extract
1
suggests
a
significant
appreciation
of
nearly
40%
since
2008.
• Define
balance
of
payments:
A
record
of
all
international
financial
transactions,
comprising
current
and
capital
account
and
financing
account.
Then
analyse
the
possible
impact
on
the
Brazilian
current
account:
Imports
Appreciation
causes
lower
import
prices
for
Brazil
–
people
give
up
less
Real
for
every
$1.
Cheaper
imports
will
help
lower
inflation
and
also
reduce
the
cost
of
importing
technologies
and
components
used
in
Brazilian
manufacturing.
This
should
lead
to
an
outward
shift
of
short
run
aggregate
supply
and
perhaps
an
improvement
in
the
current
account
depending
on
the
price
elasticity
of
demand
for
imports.
Exports
Appreciation
will
also
lead
to
a
rise
in
the
foreign
price
of
Brazilian
exports
including
soya
beans,
iron
ore
and
cars
assembled
in
Brazil.
This
might
lead
to
a
contraction
in
export
demand
and
a
worsening
of
the
Brazilian
current
account.
However,
this
depends
on
the
price
elasticity
of
demand
for
Brazilian
products;
for
example,
essential
products
such
as
iron
ore
might
have
a
low
PED
(limiting
the
effect)
whereas
global
demand
for
cars
has
a
higher
PED
for
example
intensive
competition
with
Mexico
could
hurt
Brazilian
car
exporters.
Current
account
In
the
short
run,
the
Brazilian
current
account
may
actually
improve
if
the
currency
appreciates
–
this
would
be
an
example
of
a
reverse
J
curve
effect
until
the
Marshall
Lerner
effect
takes
hold.
(Could
use
an
analysis
diagram
at
this
point).
Don’t
forget
the
capital
account!
An
appreciation
can
also
affect
capital
flows.
For
example,
high
interest
rates
and
expectations
of
a
further
appreciation
of
the
Real
might
lead
to
substantial
inflows
of
short
term
banking
flows.
On
the
other
hand,
a
strong
Real
might
dissuade
some
FDI
into
Brazil
perhaps
due
to
the
higher
cost
of
purchasing
land.
Some
FDI
in
manufacturing
might
shift
from
Brazil
to
Mexico
or
other
lower
labour
cost
countries
resulting
in
less
capital
inflows.
Extra:
Scale
length
of
currency
appreciation;
e.g.
time
at
which
Real
is
over-­‐valued
on
a
PPP
basis
e.g.
using
the
Big
Mac
Index
–
will
the
Real
fall
eventually?
E.g.
as
US
QE
unwinds.

6. d) Assess
the
potential
problems
associated
with
primary
product
dependency
for
a
country
such
as
Brazil.
(12
marks)
PPD
defined
Heavy
dependence
in
terms
of
output,
employment,
exports,
tax
revenues
from
the
primary
sector
which
includes
commercial
agriculture
and
extractive
industries
generally
including
oil
and
gas.
Identify
some
problems
–
analyse
them
i) Risk
of
corruption
associated
with
extractive
industries
–
having
a
negative
effect
on
development
–
resource
rents
not
flowing
to
poorest
communities,
lack
of
inclusive
development
for
the
bottom
40%
/
rising
relative
poverty
in
Brazil
despite
a
fall
in
absolute
poverty
ii) Macroeconomic
volatility
–
big
swings
in
real
GDP,
capital
investment,
real
wages
associated
with
changes
in
world
commodity
prices.
Developing
countries
are
more
exposed
to
external
shocks
e.g.
following
the
global
financial
crisis
in
2008
and
big
falls
in
primary
commodity
prices.
Volatile
terms
of
trade
and
volatile
current
account
iii) Longer-­‐term
view
–
Prebisch
Singer
Hypothesis
–
fall
in
real
price
of
many
primary
commodities
due
to
low
income
elasticity
of
demand.
Need
for
Brazil
to
industrialize
towards
higher
value-­‐added
products.
iv) Risk
of
Dutch
Disease
–
rising
exports
of
primary
products
can
cause
a
currency
appreciation,
making
emerging
manufacturing
industries
less
competitive
and
perhaps
causing
premature
de-­‐industrialisation.
(Refer
here
to
the
extract)
Evaluation:
i) Policies
to
avoid
PPD
include:
Sovereign
wealth
funds
/
stabilisation
funds
-­‐
build
up
a
fund
to
promote
investment
in
other
industries
e.g.
for
Brazil
investment
in
renewable
energy
/
a
more
diversified
industrial
base
/
growth
of
tourism
perhaps
built
around
the
2014
World
Cup
and
the
2016
Rio
Olympics.
ii) With
a
floating
exchange
rate,
we
would
expect
the
real
to
depreciate
if
primary
commodity
prices
fall.
Floating
currencies
more
appropriate
for
developing
countries?
Floating
rates
provide
a
degree
of
automatic
stabilisation
for
an
economy
iii) To
address
corruption
–
political
reforms
needed
–
extract
1
discusses
this!
(2013!)
I.e.
more
transparency
in
how
resource
rents
are
used.
Transparency
International.

7.
e) Evaluate
the
benefits
of
inward
foreign
direct
investment
for
a
country
such
as
Brazil.
(15
marks)
You
can
talk
about
other
countries
but
probably
best
to
focus
your
answer
on
Brazil
• Define
inward
investment
e.g.
inward
FDI
into
farming,
manufacturing,
services
• Some
of
FDI
is
physical
capacity
(i.e.
building
factories)
some
might
be
mergers
and
takeovers
/
commercial
joint
ventures,
land
purchases
• Must
reference
Figure
3:
Trend
rise
in
FDI,
peaking
at
$50.5
bn
in
2011,
GDP
was
$2.37
trillion,
therefore
inward
FDI
was
2.1%
of
Brazilian
GDP
–
is
this
a
high
or
low
figure?
Key
benefits
• Infrastructure
accelerator
effects
–
a
rise
in
investment/GDP
ratio
–
use
the
Solow
diagram!
Higher
capital
intensity
/
capital
deepening
i.e.
more
capital
per
worker
• Better
training
for
local
workers
from
TNCs
–
improved
human
capital
-­‐
Lift
in
the
level
of
labour
productivity
which
increases
GNI
per
capita
• Grows
a
country’s
export
capacity
(e.g.
special
economic
zones)
+
Technology
&
know-­‐how
transfer
/
diversification
of
the
Brazilian
economy
• More
competition
/
contestability
in
domestic
markets
which
then
reduces
consumer
prices
–
important
for
lower
income
Brazilian
households
• Creates
new
jobs
–
higher
incomes
and
household
savings
(refer
to
Harrod
Domar
model)
–
FDI
helps
to
overcome
the
savings
gap,
makes
Brazil
less
dependent
on
aid
…
in
fact
Brazil
is
now
an
aid
donor
–
have
offered
conditional
debt
relief
to
African
countries
• Inward
FDI
is
a
capital
inflow
which
is
a
help
if
the
Brazilian
current
account
of
BoP
worsens
Must
use
an
analysis
diagram
Critically
evaluate:
Reference
figure
3
to
show
the
volatility
of
FDI
i) Inequality
–
profits
from
FDI
are
flow
disproportionately
to
powerful
elites
ii) Land
grabs
/
extractive
FDI
which
generates
little
extra
tax
revenues
iii) Ethical
standards
from
TNCs
may
be
poor
–
especially
in
mining,
farming
and
textiles
iv) Volatile
/
footloose
FDI
flows
–
e.g.
FDI
is
more
volatile
than
remittance
flows
v) Limited
job
creation
effects
/
small
spill-­‐over
for
local
content
suppliers
vi) Monopsony
power
of
TNCs
who
are
able
to
negotiate
favourable
prices