The Irish Government’s policy response to the COVID-19 pandemic has been a mixture of demand-side (Keynesian) and supply-side measures: Business Economics Assignment, NUI, Ireland

Section A: Topical Issue                         

Question 1: 

This question is COMPULSORY

The Irish Government’s policy response to the COVID-19 pandemic has been a mixture of demand-side (Keynesian) and supply-side measures.  This approach has supported many businesses which might otherwise have struggled to survive.

In the words of the Irish Fiscal Advisory Council

“The Government has been able to support the economy unlike in the past: boosting spending and other supports during the downturn. 

This approach may have halved the contraction in real Gross National Income in 2020. The Council assesses that the Government’s response in 2020 was prudent and necessary.”

Source: Fiscal Assessment Report, Irish Fiscal Advisory Council, May 2021. and in the words of Ireland’s Department of Finance

In common with elsewhere, the Corona Virus pandemic has inflicted a seismic shock on the Irish economy and, even when it has passed, will likely cast a shadow on economic developments for some time to come.

 The Government has responded forcefully to limit viral transmission while, at the same time, stepping in to provide households and firms with a bridge through the pandemic; the scale of government intervention in the labour and capital markets would have been unthinkable even a year ago. These interventions prevented an even larger decline in activity, even higher rates of unemployment and even more rapid rate of firm-exit.

In doing so, Government has laid the foundations for a swifter recovery once effective treatments – including possible vaccination – are in place.

 While fiscal policy has been centre-stage, monetary policy has played an important enabling role, by lowering borrowing costs and ensuring favourable financing conditions.

 This comprehensive, and aggressive, fiscal policy response has prevented an even larger economic contraction, albeit at considerable cost. When the virus is effectively brought under control, there will be a need to pivot away from the blunt instruments towards more targeted intervention and, simultaneously, to put the debt-income ratio on a downward trajectory.

 Source:  Taking Stock: The Fiscal Response to Covid-19, Ireland’s Department of Finance, November 2020

Drawing on the two references quoted above, discuss the importance of this twin-track approach by Government in supporting the business sector through the period of the pandemic.

Section B: Microeconomics

Please answer either question 2 or question 3

Question 2:  

Metrics on competitiveness outputs indicate the effectiveness of a country’s economic system to transform natural endowments (through competitiveness inputs) into competitive positions. The key set of competitiveness output indicators that the National Competitiveness Council (NCC) tracks relate to four areas: business performance; costs; productivity; and, employment.

Prior to COVID-19 and the Government’s response, it was clear that Ireland was an extremely open international economy. The data continue to show that Ireland had a strong export performance, though this positive business performance is qualified by the concentration of output, with a small number of firms accounting for a large share of Irish exports. This strong business performance is supported by Ireland’s high levels of productivity (though the globalisation activities of multinational firms continue to make it difficult to accurately assess Irish productivity). Ireland’s productivity advantage is partially offset by its relatively higher average cost base, and it is positive that the data suggest that average costs are increasing relatively slowly in Ireland. However, average costs can obscure cost issues for enterprises at a sectoral and regional level (e.g. commercial property and labour costs)..

Employment, the final aspect of the competitiveness outputs that the NCC tracks, is also the indicator that will be most impacted by COVID-19. At the start of the year, prior to COVID-19, unemployment was at the lowest rate since the Global Finance Crisis. However, this situation has been dramatically reversed, with the most recent data indicating a COVID-19 adjusted unemployment rate of 28.2% in April 2020, Ireland’s highest rate of unemployment since records began. Ultimately, prior to COVID-19, the data suggested that Ireland was a very competitive economy, a view that is qualified by concerns regarding some aspects of concentration and potential cost disadvantages relative to key competitor jurisdictions. It remains to be seen whether Ireland’s current competitiveness stance will continue to hold once the COVID-19 crisis passes.

Business Performance:

As a small open economy, Ireland is very exposed to global economic conditions, leaving the economy particularly exposed to the COVID-19 related disruptions worldwide. Ireland’s large trade-to-GDP ratio (232%) is significantly higher than the EU average of 82% demonstrating our open nature. Ireland’s exports are concentrated in specific products, primarily medical and pharma exports.  Exports primarily go to the EU and to the US, with more than 78% of all goods exports destined for these two important markets. A similar pattern exists for Ireland’s services exports, with 56% of all service exports destined for the EU and the US. The pace and timing of the recovery in the EU and US economies will be crucial to how, and when, Ireland will emerge from the COVID-19 induced recession.

Costs:

Given the differing economic endowments and institutional structures underpinning EU economies, it is natural that there will be price divergences in certain areas (e.g. different taxation policies and social security programmes have consequential impacts on labour costs). However, the NCC believes that large cost differences between similar jurisdictions can signal to Irish policymakers that there are issues in the underlying markets (i.e. the competitiveness inputs). Evidence strongly suggests that Ireland remains a high cost economy relative to the rest of the EU with estimates suggesting that Irish prices are approximately 13% higher than the EU average but that inflation has been rising more slowly than elsewhere in more recent times (in 2019 running at 0.9% compared to the EU average of 1.5%).

However, this general picture has the potential to mask cost concerns in specific sectors or regions.  Labour costs may present an issue for certain businesses but not others, depending on corresponding labour costs in countries where their competition is based. So, while Irish labour costs are only 4% higher than the euro area, they are 16% higher than in the UK, making it challenging for those competing in the UK market or competing with UK exporters in other markets (including Ireland). The NCC also looks at important consumer costs like the price of residential property and childcare, which the data shows continue to be an issue, as high prices in these areas can erode real wages.

Finally, it is likely that cost pressures are building in areas where there is a lack of comparable data such as, cost of insurance and legal services.

Productivity:

Ultimately, productivity is the primary driver of an economy’s competitiveness over time, and data based on GDP indicate that Ireland has high productivity rates. However, measured productivity in Ireland is complicated because of the scale of high value-added activities of FDI companies located here. This is reflected in the sectoral breakdown that shows strong productivity growth in the ICT and manufacturing sectors, while productivity stagnates or declines in other sectors. The CSO data show a clear divergence between the productivity growth of sectors dominated by multinationals, where productivity growth of 6.1% was recorded in 2017, compared to just 0.6% in the rest of the economy. There is less clarity about the productivity performance of the increasingly diverse domestic economy, where both high and low performing SMEs seem to co-exist.

Source: Ireland’s Competitiveness Scorecard 2020, National Competitiveness Council, May 2020

Given that Irish firms may be price-takers in international markets, discuss the importance to business of keeping cost under control.  In answering the question, you should draw on the above extract and your knowledge of cost theory,   In particular, you should explain what is meant by and discuss the importance of deriving, where possible, economies of scale.  

Question 3: 

The application of Game Theory to Economics has given us an important mechanism to analyse the behaviour of companies in markets characterised by an Oligopoly structure.

• Drawing on any real world business sector, which is structured as an oligopoly, discuss the use of Game Theory to help explain company behaviour. (15 marks)
• Explain the concept of the ‘Kinked Demand’ curve (shown below) which may be observed in Oligopoly markets. (15 marks)

Section C:  Macroeconomics

Please answer either question 4 or question 5

Question 4: 

Drawing on the report extract shown in Question 2 above, particularly paragraphs 2 and 4, discuss the impact of global linkages on the performance of a small economy such as Ireland.

Question 5: 

The fiscal discipline imposed on the Irish Government by virtue of its membership of Economic and Monetary Union (EMU) and its adherence to the terms of the Stability and Growth Pact (SGP) create a more stable operating environment for the business sector.

(a) Set out the broad approach implemented by the EU to ensure that member countries observe prudent economic and fiscal governance.  (Note: There is no requirement to set out the detail of the EU economic/fiscal governance structure).

(b) Drawing on your understanding of the theory behind fiscal policy, discuss the above statement focusing on issues such:

• The crowding-out effect;
• Potential inflationary impact of a budget deficit;
• Possible disincentive effects of taxation;
• Possible deflationary impact of budget surplus; and
• Any other issues that you consider relevant.