Edexcel IAL Economics: Global macro policies, TNC control and policy problems (YEC11)

This guide teaches statement 4 (a to e) of 4.3.5, The role of the state in the macroeconomy, in the Pearson Edexcel International Advanced Subsidiary/Advanced Level Economics specification (Issue 2, June 2018). The specification labels Unit 4, Developments in the global economy, as an IAL compulsory unit. Units 1 and 2 make up International AS (IAS); Units 3 and 4 carry the extra International A2 (IA2) content. The specification also says Unit 4 questions may draw on content from Units 1, 2 and 3. All countries, firms and figures below are invented and illustrative.

Related pages: revision notes, practice questions, the course hub, the printable checklist and the free 10-minute diagnostics. For the Unit 2 background see fiscal and monetary policy, supply-side policies, the multiplier and globalisation. Public expenditure, taxation, deficits and debt (statements 1 to 3) are taught elsewhere.

What you must be able to do

Ref	Outcome
4.3.5 (4a)	Explain how fiscal, monetary, exchange-rate and supply-side policies and direct controls are used to cut deficits and debts, control inflation, respond to external shocks and reduce poverty and inequality
4.3.5 (4b)	Explain the demand-side policies used after the 2008 global financial crisis
4.3.5 (4c)	Explain measures to reduce TNC tax avoidance, regulate transfer pricing and judge the limits to control
4.3.5 (4d)	Assess policy impacts on local, national and global economies
4.3.5 (4e)	Explain inaccurate information, risks and uncertainties, and uncontrollable external shocks

1. Policy tools and four objectives (4a)

The five tools are: fiscal (government spending and taxes), monetary (interest rates, money supply, central bank asset purchases), exchange-rate (managing the currency’s value), supply-side (raising productive capacity) and direct controls (rules such as price caps, import quotas or capital controls). A useful grid is tool by objective.

Objective	Main tools	Typical chain of reasoning
Cut deficit and debt	Fiscal (lower spending, higher tax), supply-side	Less spending lowers AD, but supply-side growth lifts tax revenue over time
Control inflation	Monetary, exchange-rate, fiscal	Higher rates cut borrowing, AD falls; a stronger currency lowers import prices
Respond to shocks	All, plus direct controls	Match the tool to whether the shock hits AD or costs
Cut poverty and inequality	Progressive tax, transfers, education, minimum wage	Redistribution now versus higher productivity later

Other pairings: supply-side measures (training, infrastructure, competition policy) cut costs and lift growth, which eases inflation and raises revenue; direct controls such as price caps or wage restraint can hold inflation down but distort markets; lower interest rates cut debt-servicing costs but may weaken the currency; capital controls can limit sudden outflows after a shock.

Worked example 1: cutting a deficit (Country A, illustrative). GDP is 800 billion currency units (cu) and the fiscal deficit is 48 billion cu, so deficit/GDP = 48/800 = 6.0%. The government cuts spending by 20 billion cu. The multiplier is 1.5 and revenue is 30% of any change in GDP.

• GDP falls by 20 x 1.5 = 30 billion cu, to 770 billion cu.
• Tax revenue falls by 0.30 x 30 = 9 billion cu.
• Net saving = 20 - 9 = 11 billion cu, so the deficit is 37 billion cu.
• Deficit/GDP = 37/770 = 4.8%.

The cut of 20 billion cu “saved” only 11 billion cu. If the multiplier were 2.5, GDP falls by 50 billion cu, revenue by 15 billion cu, the deficit is 43 billion cu and the ratio is 43/750 = 5.7%. Evaluation: the same cut helps much less in a recession, when the multiplier is high, so the timing matters.

Worked example 2: controlling inflation with the exchange rate (Country B). The currency appreciates from 0.50 to 0.55 units of foreign currency per unit of home currency, a 10% appreciation. An imported good costs 22 foreign units.

• Home price before = 22/0.50 = 44. After = 22/0.55 = 40.
• Change = (40 - 44)/44 = -9.1%.
• Imports are 25% of the consumer price basket, so full pass-through lowers the price level by 0.25 x 9.1 = 2.3%. With 60% pass-through the effect is 1.4%.

Evaluation: a strong currency lowers inflation but cuts export competitiveness, and exporters may lose jobs. Monetary policy works through spending and works with time lags, so the size and timing of the effect are uncertain.

Worked example 3: an external shock (Country C). GDP is 500 billion cu and energy imports are 30 billion cu (6% of GDP). The world energy price rises 40% and volumes stay the same in the short run.

• New bill = 30 x 1.4 = 42 billion cu, an extra 12 billion cu, or 2.4% of GDP.
• Terms of trade index = (index of export prices divided by index of import prices) x 100. If exports are 104 and imports 130, the index is 104/130 x 100 = 80.0, a fall of 20% from a base of 100.

Policy dilemma: the shock raises costs (SRAS shifts left), so output falls and prices rise together. Stimulating AD cuts unemployment but adds inflation. Tightening does the opposite. Supply-side measures (energy efficiency) and direct controls (price caps on fuel) are slower or distort markets.

Worked example 4: poverty and inequality (Country D). Tax is 0% on the first 10,000 cu, 20% from 10,000 to 60,000 and 40% above 60,000.

• Household L earns 12,000: tax = 0.20 x 2,000 = 400, net 11,600.
• Household H earns 120,000: tax = 0.20 x 50,000 + 0.40 x 60,000 = 10,000 + 24,000 = 34,000, net 86,000.
• Pre-tax ratio = 120,000/12,000 = 10.0. After tax = 86,000/11,600 = 7.4. If L also gets a transfer of 3,000, net = 14,600 and the ratio is 5.9.

Evaluation: very high marginal rates may weaken incentives to work (see the Laffer curve in the taxation unit). Education and training reduce poverty more durably but take years. A minimum wage is a direct control that may raise incomes for those in work but may cost jobs if set too high.

2. Demand-side policy after the 2008 crisis (4b)

The 2008 global financial crisis began in the banking sector. Banks cut lending, confidence fell, and investment and consumption dropped in many economies. Governments and central banks used demand-side policies:

• Monetary: policy interest rates were cut sharply, to very low levels, and many central banks used quantitative easing (QE), creating money to buy government bonds to lower long-term yields and raise lending.
• Fiscal: governments rescued banks, cut some taxes and raised spending. Automatic stabilisers also raised deficits as revenue fell and benefits rose.

Worked example 5 (Country E, illustrative). Real GDP is 900 billion cu. The marginal propensities to save, tax and import are 0.10, 0.20 and 0.10, so the marginal propensity to withdraw is 0.40 and the multiplier is 1/0.40 = 2.5. Investment falls by 24 billion cu.

• Fall in GDP = 24 x 2.5 = 60 billion cu, to 840 billion cu, or 60/900 = 6.7%.
• A spending rise of 16 billion cu adds 16 x 2.5 = 40 billion cu, so GDP is 880 billion cu: a gap of 20 billion cu remains.
• A further 20/2.5 = 8 billion cu of spending would close it.

Evaluation: low interest rates may not revive lending when banks and firms want to repair balance sheets and expect weak demand. Stimulus raised debt, and several governments later tightened policy. QE can raise asset prices, which benefits wealthy asset holders (an inequality effect). Spending leaks abroad when the import propensity is high.

3. Controlling TNCs (4c)

Transnational corporations (TNCs) operate in several countries. Tax avoidance is legal minimisation of tax; evasion is illegal. Transfer pricing is the price charged between parts of the same firm. If it differs from the market price, profit is moved to a low-tax country.

Worked example 6 (Firm X, illustrative). A subsidiary in Country H (corporate tax 30%) makes 100,000 units at a cost of 50 each. It sells them to a subsidiary in Country L (tax 10%), which sells them to customers at 100.

Transfer price	Profit in H	Tax in H	Profit in L	Tax in L	Total tax
80 (market)	3.0m	0.90m	2.0m	0.20m	1.10m
55	0.5m	0.15m	4.5m	0.45m	0.60m

Group profit is 5.0m either way. The lower transfer price saves the group 0.50m of tax and costs Country H 0.75m of revenue, while Country L gains 0.25m.

Measures: the arm’s length principle (intra-firm prices must match those between unrelated firms), documentation requirements, country-by-country reporting of profits and tax paid, anti-avoidance rules, closing loopholes such as interest deductions, and international agreements on minimum effective tax rates.

Limits to control:

• TNCs can threaten to move FDI elsewhere, so governments compete with low rates (tax competition).
• Tax authorities lack information about private intra-firm prices, and low-income countries often have few experts.
• Rules differ by country, and one country alone cannot change a firm’s global tax bill.
• Strict rules may deter FDI, jobs and technology transfer.

4. Impact on local, national and global economies (4d)

Assess each policy at three scales. A rise in interest rates in Country G cuts national AD and inflation. Locally, a town whose main employer sells big-ticket goods bought on credit may lose jobs, while savers elsewhere gain. Globally, a higher rate can attract capital, appreciate the currency and reduce demand for partners’ exports, while a large economy’s stimulus raises imports and helps exporting countries. TNC tax rules shift revenue between countries: curbing avoidance raises revenue at home but may reduce FDI in the host region.

5. Problems facing policymakers (4e)

• Inaccurate information: data are estimated and revised. If potential output is mis-measured, the output gap is wrong.
• Risks and uncertainties: the multiplier, pass-through and confidence effects are unknown, and policies have time lags.
• Inability to control external shocks: policymakers cannot set world prices, foreign demand or other countries’ policies.

Worked example 7 (Country F). Actual GDP is 960 billion cu. Officials estimate potential at 1,000, a gap of -4.0%, and, with a multiplier of 2.5, choose spending of 40/2.5 = 16 billion cu. Revised data show potential was 970, so the true gap is 10 billion cu (-1.0%). The stimulus adds 40 billion cu, overshooting by 30 billion cu (3.1% of potential), so inflationary pressure builds.

Common errors

• Writing “cut spending” without the multiplier effect on revenue.
• Treating transfer pricing as illegal evasion; the problem is often legal avoidance.
• Describing the 2008 response without linking each tool to a weakness or side effect.
• Giving one-sided answers; a policy can work nationally and harm locally.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2, June 2018, first assessment June 2020, Pearson Education Limited: Unit 4, 4.3.5 statement 4 (a to e).