Conflicts between objectives

In this post a limited range of conflicts have been chosen, although for each objective there are issues with every other objective. Some objectives, such as growth and employment, have ore in common than others, such as growth and the environment. THe degree to which there is conflict is a useful way to approach your evaluation.

Inflation and unemployment
Consider this scenario. You are running a restaurant and the head chef is asking you for a wage increase. He may be good at his job, but you are not keen to pay more for the same service because it will eat into profits. What do you do? If there were a selection of unemployed chefs eager and willing to take up the post, you would probably look to employ a replacement, at the same or possibly a lower rate than your current chef. If, however, chefs are in short supply, and the success of your restaurant relies on having a good head chef that you can rely on, you would be more likely to enter into dialogue with him to keep him onboard.

In other words, a shortage of labour in a specific field can cause wage pressures to build up. The net effect in the wider economy is that, as wages go up, people start spending more, the costs of production increase as labour is a major production cost, and inflation begins to rise. In other words, low unemployment or reduced spare capacity leads to higher inflation.

The basic analysis is the rationale for the Phillips curve, which was an observation of an apparent trade-off between unemployment and inflation in the UK between 1861 and 1913.

[phillips curve on page 45]

In practice, if a government tries to exploit this trade-off it is unlikely to have the desired result. For example, because of the transparency of a governments actions, if it tries to spend its way into reducing unemployment the most likely effect will be an increase in wages to absorb the government’s extra spending; that is, inflation. As inflation goes up, newly employed workers will soon realise their wages are being eroded by inflation and firms will realise they are not getting as much profit out of their workers because of inflation therefore any increase in employment is likely to not last in the long term. For these reasons, while the Phillips curve is an observable phenomenon, it is not necessarily a viable tool for a government.

Economic growth and the balance of payments on the current account
As an economy grows and incomes rise, consumers are likely to demand more imports and firm’s incentives to export will diminish, as it is easier to find eager customers in the domestic market. Therefore, economic growth is likely to worsen the current account. The main exception to this is export-led growth, where the driver of growth is an increase in the net export component of the balance of payments. Export led growth means that the balance of payments will improve as more goods and services are sold abroad.

A second reason why growth might not necessarily worsen the balance of payments is if the growth is caused by an increase in aggregate supply. For example, owing to decreases in costs or increases in investment, an economy will become more internationally competitive, meaning the economy can export more an import less while growing.

Increased employment and sustainable environment
If more workers are being employed, there is likely to be more congestion on the roads an more carbon use because of more factories, more manufacture and greater energy usage. In addition, as people’s incomes increase, workers are more likely to go abroad for their holidays, and most foreign travel will involve increased carbon emissions.

On the other hand, higher employment can mean that the government has more scope for taxation, and one spin off might be the opportunity to use green taxes, where taxation is specifically designed to reduce carbon use. For example, in the March 2008 budget the first year of road tax was introduced for new ‘gas-guzzling’ vehicles. The effect of higher employment also depends on wether the increase is in the manufacturing or services sector. As more people can work remotely in the service sector, it may be that an increase in employment has a minimal effect on the environment.

Economic growth and income redistribution
When an economy grows, incomes are most likely to rise at the top end of the income spectrum: for example, in the form of bonuses for sales executives. The effect is a widening of income equality. However, over time, people a the high-income end of the scale might employ people from lower income groups, such as domestic staff. Increased demand for low-skilled labour should eventually lead to increased wages. This is called the ‘trickle-down’ effect.

Nevertheless, many economists argue that, while there may be some transferred benefits of growth, there is a two-track labour market and those with low skills rarely benefit because, as skill shortages develop, immigration fills the gaps and the wages of low-skilled workers dont rise. Another counter argument is that, even if wage rise by a constant percentage for everyone, income inequality will still increase in absolute terms.

Inflation and equilibrium on the balance of payments
Low inflation should help to improve a balance of payments deficit on current account. Low prices relative to other countries will mean that exports become more attractive on world markets and imports are less attractive. However, if the balance of payments tends to be in surplus, control of inflation will not restore equilibrium in the sense of removing a surplus.

Furthermore, when one of the main objectives of macroeconomic policy is to control inflation, interest rates might be tighter than they would otherwise be. High interest rates often mean that the exchange rate rises: ‘hot money’ flows in, as funds move between international capital markets seeking the best interest and exchange rates. A strong currency makes a country’s exports less competitive and its imports relatively cheap, worsening its trade position.

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