Macroeconomic Policy Conflicts and the Phillips Curve: Question 5

Worked solution

Part (a): Growth and the current account of the balance of payments

As Astara’s economic growth accelerates, households’ and firms’ incomes rise. Part of this extra income is spent on imported goods and services. The size of this effect is captured by the marginal propensity to import. Infrastructure projects and business investment linked to the growth strategy may themselves require importing machinery, materials or specialist expertise that Astara does not produce domestically. If import spending grows faster than export earnings (which are not directly boosted by a domestically-driven growth strategy), the current account balance deteriorates. This illustrates the interrelatedness of macroeconomic objectives: pursuing faster growth can directly conflict with maintaining a sustainable current account.

Part (b): Growth and environmental sustainability

Astara’s growth strategy relies on expanding infrastructure and business investment, which typically involves greater use of energy, raw materials and industrial capacity. As output expands, this tends to be accompanied by more resource extraction, higher energy consumption, and increased emissions, waste and other forms of environmental degradation, unless the additional output is produced using cleaner technologies or renewable resources. Where growth is not “decoupled” from environmental damage in this way, a faster rate of growth directly conflicts with the objective of environmental sustainability, since achieving one (higher output today) can come at the cost of the other (preserving the natural environment and resources for the future).

Part (c): Growth and the distribution of income and wealth

Faster growth does not necessarily benefit everyone in Astara equally. Investment-led growth, in particular, can disproportionately raise the returns earned by the owners of capital (business profits, returns on investment) relative to wage growth for lower-skilled workers, and infrastructure projects may be concentrated in particular regions or sectors, boosting incomes there more than elsewhere. If the additional national income generated by growth accrues mainly to already-wealthier groups, regions or sectors, the gap between rich and poor widens even as the economy as a whole grows, creating a conflict between the objective of raising economic growth and the objective of achieving a more equal distribution of income and wealth.

Final answers

• (a) Higher incomes from growth raise import spending (via the marginal propensity to import), worsening the current account
• (b) Growth from expanding infrastructure/investment raises resource use and emissions, conflicting with environmental sustainability
• (c) The gains from investment-led growth can flow disproportionately to capital owners, higher-skilled workers or certain regions, worsening income/wealth inequality