How the UAE Government Promote Economic Growth - Example

Running header: Economics Student’s name: Instructor’s name: Subject code: Date of submission: Introduction Governments world wide use various fiscal policy tools in different economic times so as to obtain desired effects on the economy. The fiscal measures may be expansionary or contractionary. Each of the fiscal measures produces different economic results and may be used interchangeably at different times depending on how the economy is performing. This paper examines how the UAE government can apply the tools in its fiscal consolidation to promote economic growth while achieving the desired fiscal consolidation effects. Summary Due to the fiscal consolidation measures being undertaken by the United Arab Emirates government, the country’s economic growth is expected to slow from 4.9% in 2011 to 2.3% in 2012. The IMF expects UAE’s economic growth to moderate at 2.3% given the limited likelihood for further expansion in oil production in the short term. This forecast by IMF is stronger than the one by other analysts polled by Reuters while UAE’s Statistics Bureau has not yet released its estimates. UAE’s economy has been able to recover from the recent Dubai debt crisis owing to good oil prices and strong Asian trade flows. However, the IMF fears that uncertainty in global economic and financial environment could be dangerous to UAE’s outlook and if the global situation worsens, it would be difficult for some government companies to repay some of their debts. Although there have been efforts at restructuring state linked entities debts, they are still faced with high refinancing needs as well as reliance on foreign funding. However, the plans for fiscal consolidation by UAE government after heavy spending during the debt crisis are appropriate according to IMF. Explanation After the debt crisis, the UAE government found it necessary to institute fiscal consolidation strategies. These strategies are aimed at minimizing deficits and curtailing accumulation of more debts. These efforts could either be expansionary or contractionary. It should however be noted that fiscal consolidation measures will affect a country’s GDP and hence growth either positively or negatively depending on the strategy that the government undertakes. It has been established that where interest rates and exchange rates are held constant, fiscal consolidation will have double effect on the GDP. For instance, after tow years, fiscal consolidation of 1% GDP will reduce GDP by about 1% while raising unemployment by 0.6 %. The reduction in GDP may result from reduced government spending which could imply less demand for goods and services since when government spends money; it is released in to the economy thus boosting demand. When there is reduced demand, the supply is affected in a similar manner which leads to an overall slowing GDP growth in the short run. This could hence explain the reduction in UAE’s economic growth from 4.9% in 2011 to the estimated 2.3% as a result of fiscal consolidation. However, the reduced growth is not expected to be permanent and the economy will recover and even perform better in the long run. It should be noted that with the debt restructuring efforts by the UAE government for its state owned companies including the $25 billion debt restructuring of Dubai world coupled with favorable oil prices and strong trade flows within the UAE economy and hence GDP is expected to improve further in future. It should however be noted that the fiscal consolidation efforts can only be expected to result in future growth in GDP if only the global economy remains healthy , the trade between the Asian countries remain strong while the oil prices remain robust. Otherwise, there might be further decline in economic growth and hence decline in GDP. This explains why UAE should avoid overreliance on oil but should diversify its economy to other sectors such as tourism. The UAE market economic situation According to the article, the UAE economy expanded by 4.9% in 2011 while the IMF estimated that its real GDP would grow by 2.3% in 2012. This will be supported by continually robust oil prices, increases in oil production and the kind of fiscal policy that the government adopts. This is in addition to the fact that trade between UAE and her Asian counterparts has also remained strong. With the oil sector accounting for the greatest percentage of UAE’s GDP, the county’s economic future looks bright if the oil production and prices remain high and the government’s fiscal consolidation measures bear fruits though the world economic climate remains largely uncertain. Although the economic growth is expected to slow in 2012, it might perform even better in 2013 and beyond. This is especially if the government seriously considers diversification from an oil economy to tourism and other sectors as is the case in Dubai. As such, despite the economic slow down, the UAE market remains promising and will even perform better in future depending on the fiscal policies the government adopts as well as the global market situation. The right fiscal policy for UAE As observed in the article, the UAE economic growth is expected to slow down in 2012 as the government gradually undertakes fiscal consolidation. However, the country’s economic performance in future will largely be determined by the nature of fiscal policy measures undertaken by the government. There are two types of fiscal policy measures that UAE government could undertake in its fiscal consolidation efforts with each having different results and effects on the country’s GDP. These include; a) Expansionary Fiscal measures This is a fiscal policy which seeks the expansion of monetary supply with the aim of encouraging economic growth while combating inflation. This can be in form of tax cuts as well as increased government spending. The central banks of a country also play a vital role in increasing monetary supply in the economy. Expansionary fiscal policy could also include lowering lending rates thus lowering the cost of capital. Governments adopt expansionary measures during periods of slowed economic growth such as the one described in the article. However, the government must be careful in its implementation to avoid high rates of inflation. This implies that the government must also be prudent in knowing when to halt the expansionary measures or even switch to contractionary measures to avoid undesired effects on the economy. b) Contractionary fiscal measures As the name suggests, a contractionary fiscal policy is used by governments to slow down the economy or reduce the money supply in the economy and hence spending in a bid to close an inflationary gap, decrease inflationary rates and restrain the economy. This is done through increased rates of interest hence making capital acquisition expensive and hence unattractive thereby reducing spending. The government also increases the cash reserves required for commercial banks thus reducing the amount of money available for them to lend. In addition, the government through the central bank can borrow from individuals and institutions through high rate bonds thereby effectively taking money in circulation. However, the government in pursing such a fiscal policy must be careful not to reduce economic growth to a level that increases unemployment to very high rates. Given the slowing economic growth of UAE explained in the article, the UAE government should adopt the expansionary fiscal policy described above due to the need to increase economic growth while still reducing budgetary deficits and debts. Why expansionary fiscal policy? As observed in the article, UAE’s economic growth is expected to slow down to 2.3 % in 2012 compared to 4.9% in 2011. This is a significant decline and should never be allowed to continue. This is because it is likely to lead to undesirable effects such as rise in unemployment rates. As such, any fiscal consolidation efforts adopted in future should lead to increased economic growth besides ensuring reduction of deficits. As such, I am of the opinion that the government should adopt an expansionary fiscal policy due to the following reasons; a) Multiplier effect An expansionary fiscal policy would entail increased government spending among other strategies. When the government spends some money, a person or organisation will receive it. He/she will spend part of it and save the rest depending on what his disposable income is. This will create an economic multiplier effect since another person will also receive the part spent and spend it and so on. In the same way, reduction in taxes will increase people’s disposable income leading to additional spending and hence economic growth. With economic growth, there will be economic surplus that will be used to offset the deficits while restructuring government debts. b) Investments Expansionary fiscal policies entail increased government spending end hence investments. The spending may be stimulus spending or other forms of spending. With slowed economic growth as expected in 2012, expansionary fiscal measures will enable the UAE government fill the investment void left by the cash constrained businesses during the slowed economic period. The government purchases are likely to drive up demand for labor and raw materials which will enable private investments to also pick up. This will lead to increased economic growth in future with surpluses being used to offset deficits. c) employment Increased private and public spending will lead to increased employment. For instance, government spending in construction of a road would lead to increased for labor and raw materials which would not only provide direct employment but also provide employment indirectly by employing suppliers and their staffs. d) Consumption As observed above, expansionary spending measures lead to increase in disposable income. As such, households will spend more on food and other household items. This in turn will lead in increased consumption as factories buy more raw materials to produce goods o cater for excess demand. This will; create a vicious cycle hence generating more consumption, investment and employment in the UAE economy. How the expansionary fiscal policy would impact the economy As explained above, expansionary fiscal policy measures to be undertaken b y the UAE government should aim at increasing aggregate demand through increased govern men t spending and/or tax cuts thus stimulating the slowing economic growth. The increased government spending will increase demand through increased production. The increased demand will lead to increased employment. This is because producers will respond to demand by government by increasing production that will call for more labor. This will lead to a multiplier effect since as the producers hire more workers, the new workers will spend more than they were spending when unemployed. This implies that producers will still have to respond to this increasing demand through provision of more goods and services. This means that the expansionary fiscal policy to be adopted will lead to increased economic growth in the short run The fiscal policy tools to be used by the UAE government There are two fiscal policy tools at the UAE government’s disposal with which to affect t its expansionary fiscal policy and hence enhance economic growth. They include taxes which are also referred to as revenue tools as well as government spending also known as spending tools. a) Revenue tools Revenue tools refer to the taxes that government c collects in various forms whether direst taxes or indirect taxes. Direct taxes are the taxes levied by the government on a person’s or organization’s income or wealth. Examples include income tax, estate tax, wealth tax, capital gains tax, corporate tax and social security tax. On the other hand, indirect taxes are the taxes levied on goods and services that one buys. They include sales tax excise duty and value added tax. By using this as an expansionary fiscal policy tool, the UAE government would have to lower the taxes that both the households and firms are required to pay. Reduction of taxes would increase one’s disposable income thus stimulating demand for goods and services. The increased demand would force producers to produce more and hence require more labor. This implies increased employment which would create a multiplier effect and hence an increase in economic growth in the short run. Spending tools/ Government spending Government spending can either be capital spending or current spending. Current spending is the expenditure on essential goods and services including health and education. Capital spending on the other hand is public investment by government on infrastructure including schools, roads and railway lines. Public spending also entails government subsidies on merit goods and public goods. In this case, an expansionary fiscal policy would involve increased public spending by government. This would stimulate demand by government causing producers to respond to the increased demand through increased production. The increased production would call for increased labor thus increasing employment. The newly employed will increase their spending relative to when they were unemployed thus creating a cyclic multiplier effect that results in increased economic growth in the short run. Government spending is an especially important fiscal policy tool since it leads to enjoyment of services such as defense by everyone while enabling the country to build infrastructure to propel economic growth. How the fiscal tools impact the economy The above fiscal policy tools are expected to have the same effect on the economy. In this case, the UAE government is to use an expansionary fiscal policy to boost economic growth. This means reduction of taxes and increase in government spending. Reduction in taxes will increase one’s disposable income and hence increase demand for household goods and services. Producers will respond to increased demand through increased production and hence will require increased labor. The increased labor implies an increase in disposable incomes of those employed which will again increase their demand. This cyclic effect eventually leads to increase in aggregate demand and hence economic growth. On the other hand, increased government spending leads to similar economic effects. When the government spends some money, a person or organisation will receive it. He/she will spend part of it and save the rest depending on what his disposable income is. This will create an economic multiplier effect since another person will also receive the part spent and spend it and so on. It should however be noted that uncontrolled expansionary fiscal policy would eventually lead to increased inflation which would then force the government to adopt contractionary fiscal measures in order to tame the inflation. How the information provided will impact the macroeconomic indicators Output The article states that a decline in economic growth is expected in 2012 where growth will hit 2.3% while that of 2011 was 4.9%. This implies a decrease in aggregate demand which is significant. This also implies a decrease in aggregate output in response to the decreased demand hence the overall reduced economic growth. However, it is expected that the fiscal consolidation efforts by government which will be expansionary in nature coupled with the relatively robust oil prices, debt restructuring as well as the strong trade in Asia will boost economic growth and hence output. Employment The expected decline in economic growth in 2012 implies a decline in aggregate demand and hence a decline in the level of employment as producers will not find it necessary to employ owing to the reduced demand. However, the expansionary fiscal policy as well as the robust oil prices and strong trade between UAE and Asian countries are expected to stimulate demand. The increase in demand is expected to result in increased employment as production levels increase. Conclusion As has been observed, the UAE government should adopt expansionary fiscal measures. The expansionary fiscal measures will lead to increased demand thus leading to increased employment and hence increased economic growth. The fiscal tools to be used should include taxes as well as reduction in government spending. The government however should ensure that any fiscal measures undertaken do not lead to too much increase in inflation and hence undesired effects. References Janet, B(2011). Principles of economics. London: Rutledge, Read More