Case Study: UK Economy
1.0 Introduction
The economic growth of a country is impacted by diverse macroeconomic factors. The macroeconomic factors are not limited to a particular country but emanate from the global economy as a result of the high rate of globalization (Rusinova 2010). The 2007/2008 global economic recession is one of the notable global economic events that underline the interconnected nature of the global economy (Sepp & Frear2011). The recession had adverse economic effects on different economies amongst them the UK. According to Verma (2013), economic recession leads to a decline in the level of investment, an increase in the rate of unemployment, a decline in a country’s growth rate, a collapse in the value of assets, a decline in the rate of consumption, and decline in income levels. The overall effect is that a country's Gross Domestic Product (GDP) declines (Mankiw 2009).
In spite of the occurrence of economic recession, it is possible for a country to recover from the adverse effects of economic recession by implementing expansionary or contractionary fiscal and monetary policies depending on the economic issue that the country intends to resolve. The fiscal policies may relate to changes in the level of government spending and adjustments in the rate of taxation. On the other hand, monetary policies may relate to regulation in the value of the currency and the amount of money supply.
1.1 Aim
The aim of this report is to evaluate a number of economic issues in relation to the impact of economic recession on the UK economy.
2.0 Analysis
2.1 Recovery
Recovery entails one of the phases of business cycles arising from the economic recession when a country begins to experience a steady expansion. The recovery period mainly occurs during the early phase of economic expansion after the recession (Kaplana 2009). The recovery period is characterized by low interest rates, and a steady increase in the rate of employment and demand, which stimulates economic recovery.
2.2 Impact of depreciation in the British pound on the value of imports into the UK
Imports constitute one of the key components of a country’s Gross Domestic Product (GDP) (Sepp & Frear 2011). After the end of the 2007/2008 economic recovery, the UK experienced a significant increase in the volume of imports in different economic sectors especially within the manufacturing and construction sectors. Firms in this sector increased their volume of imports in the quest to stimulate their performance. According to Kaplan (2009), a change in the size of imports impacts a country’s net exports and hence the size of a country’s GDP. One of the factors that might contribute to change in the size of imports relates to fluctuations in the value of a country’s currency. The decline in the value of a country’s currency makes imports expensive (D’Souza 2008). This arises from the fact that the price of imports increases while the price of exports falls. Colander and Gamber (2006) assert that ‘the value of a country’s imports and exports is determined by both price and quantity’ (p. 279). Thus, importers spend a substantial amount of money on importing goods due to the loss of value of domestic currency against the foreign currency.
2.3 Impact of reduction in the UK labor productivity on the value of imports
According to Barro (2007), labour productivity is one of the critical macroeconomic variables that is used in determining the volume of output per employee within a given period of time. Barro (2007) asserts that labour productivity is a critical component in determining a country’s productive potential. Thus, labor productivity is a real ratio of a country’s Gross Domestic Product to labor input. Barro (2007) accentuates that ‘under the equilibrium business-cycle model, this concept of labour productivity tends to be pro-cyclical, high in booms and low in recessions’ (p. 198). A country’s labour productivity is positively correlated to its volume of imports. Subsequently, an increase in a country’s labour productivity translates into an increase in the value of imports. Similarly, a decline in a country’s labour productivity translates into a subsequent decline in the value of imports. Therefore, if the UK experiences a decline in labor productivity, the value of its imports will decline significantly. For example, the decline in labour productivity especially in the import-intensive economic sectors such as the food and clothing sectors will lead to a decline in the value of imports of the requisite raw materials (PricewaterhouseCoopers 2017).
2.4 Possible benefits to the UK economy of a weak British pound
The performance of a country’s currency is a critical determinant of a country’s economic performance.
2.4.1 Increase in the country’s GDP
The decline in the value of the British pound may have a positive impact on the UK economy. This arises from the fact that a decline in the value of the pound will make UK exports cheap. Thus, the UK will experience an increase in the volume of exports. Conversely, the volume of imports into the UK will decrease. This arises from the fact that imports into the UK will be relatively expensive. The ultimate effect is that the UK will experience an increase in the volume the size of net exports, which entails the difference between a country’s exports (X) and imports (I), viz., [X-I]. An increase in the size of the country’s net imports will translate into an increase in the UK’s Gross Domestic Product as illustrated by the formula below; Y= C+I+G+(X-I), where, Y= GDP, C=consumption, G=Government spending, and X-I = net exports. This arises from the fact that the country will experience an increase in the country’s aggregate demand.
2.4.2 Expensive imports
As a result of the decline in the value of the country’s currency and the subsequent increase in the price of imports, UK citizens will be forced to purchase products produced by domestic manufacturers. Therefore, the UK will experience an increase in demand for domestic products hence stimulating the country’s economic growth further.
2.4.3 Cheap exports
In addition to the above impacts, a decline in the value of the British pound will make UK exports cheap to foreigners and hence attractive. This will further lead to an increase in the volume of UK exports hence further contributing to improvement in the country’s net exports. The graph below illustrates the relationship between the impact of a decline in the value of the British pound on the level of output and price level.
