Question 23M.2.SL.TZ0.1
| Date | May 2023 | Marks available | [Maximum mark: 40] | Reference code | 23M.2.SL.TZ0.1 |
| Level | SL | Paper | 2 | Time zone | TZ0 |
| Command term | Calculate, Define, Discuss, Explain, Sketch, State | Question number | 1 | Adapted from | N/A |
Text A — Overview of Uruguay
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With a population of only 3.5 million, Uruguay is one of the smallest nations in South America. Its membership of the MERCOSUR common market allows Uruguayan producers tariff-free access to 290 million consumers in Argentina, Brazil and Paraguay.
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Agriculture accounts for 8 % of Uruguay’s gross domestic product (GDP) and 65 % of its export revenue. Exports have increased since the early 2000s, partly due to China’s rising demand for commodities. In particular, Uruguay’s soybean producers benefitted from significantly higher prices during the commodity boom. China is now Uruguay’s most important export destination, with soybeans accounting for over 50 % of its exports to China.
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Uruguay’s real GDP increased by an average of 5.39 % per year from 2005 to 2014. However, the economy slowed considerably when the commodity boom ended in 2015. It slowed further because of decreased regional demand when the largest members of MERCOSUR, Argentina and Brazil, faced a recession in 2017. Uruguay’s real GDP grew on average by 1.04 % per year from 2015 to 2018.
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With the increasing importance of China and the European Union (EU) as export markets, Uruguay has managed to reduce its dependency on MERCOSUR. However, attempts to diversify its exports away from agriculture have not been successful. The end of the commodity boom contributed to a fall in export revenue and the depreciation of the peso (Uruguay’s currency). The currency has lost over 25 % of its value since 2015.
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Inflation stayed at a relatively high rate of 8 % in 2018 due to the weaker currency. The unemployment rate also increased to 7.9 % as a result of the economic slowdown. The higher cost of living and the lower rates of employment could inhibit efforts to reduce inequality and poverty levels.
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Despite rising inflation and unemployment, Uruguay’s minimal corruption, abundant natural resources and access to a large common market continue to attract foreign direct investment (FDI). Investments in the paper and wood industries have made forestry one of the country’s fastest growing industries. Increased FDI inflows have also prevented the peso from depreciating further.
Text B — The EU–MERCOSUR free trade agreement
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The EU and MERCOSUR are finalizing the terms of a free trade agreement, which would enable Uruguay to increase its exports to the 27 EU member states. The EU currently buys 11 % of all Uruguayan exports, mostly animal products, paper, vegetables and wood.
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Once the free trade agreement comes into effect, almost all agricultural and industrial tariffs between the EU and MERCOSUR will be removed. The imports of beef, poultry and sugar will not be included in the list of tariff-free products but will be subject to very large quotas. This will allow increased exports of these products to EU countries.
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The free trade agreement may cause bankruptcies in the manufacturing sector and higher structural unemployment in Uruguay. EU exports to Uruguay largely consist of manufactured goods, such as chemicals, machinery, transport equipment and plastics, which are in high demand despite the current tariffs of up to 35 %.
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One third of FDI into Uruguay comes from the EU. Anticipation of the free trade agreement has led to more EU investments in Uruguay’s forestry sector. Environmental organizations have warned that the free trade agreement could be a threat to sustainability as South American forests are cleared to create land for cattle farming, paper and wood production. The deforestation might also disrupt water sources that supply rural villages, depriving the villagers of clean water.
Text C — Uruguay seeks trade agreements outside MERCOSUR
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Members of MERCOSUR have differing views on trade policies. Brazil, Paraguay and Uruguay believe in trade liberalization and want to increase competition through a reduction of the common external tariff. On the other hand, Argentina wants to maintain the high external tariff to protect industries from cheap imports from China and to avoid prolonging its current recession.
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Uruguay has expressed its desire to seek trade agreements apart from MERCOSUR,
which is prohibited by the common market’s rules. If Uruguay pursues separate bilateral agreements, it is likely to lose its MERCOSUR membership and the benefits of any existing free trade agreement.
Table 1: Current account data for Uruguay (US$ billion)
Table 2: Selected income data for Uruguay
[Source: Text A: The World Bank, 2022. [online] Available at: https://data.worldbank.org/ [Accessed 14 March 2022]
Source adapted.
Text B: European Commission, n.d. [online] Available at: https://ec.europa.eu/trade/policy/countries-and-regions/
countries/uruguay/ [Accessed 14 March 2022] Source adapted.
McGuinness, R., 2019. Macron minister dashes EU hopes as France refuses to ratify EU-Mercosur trade deal
[online] Available at: https://www.express.co.uk/news/world/1157866/france-news-eu-mercosur-trade-deal-emmanuel-macron [Accessed 14 March 2022] Source adapted.
Table 1: The World Bank, 2022. [online] Available at: https://data.worldbank.org/ [Accessed 14 March 2022]
Source adapted.
Table 2: The World Bank, 2022. [online] Available at: https://data.worldbank.org/ [Accessed 14 March 2022]
Source adapted.]
Define the term gross domestic product (GDP) indicated in bold in the text (Text A, paragraph 2).
[2]
Definitions of GDP that were awarded 1 mark often failed to identify the concept of value or simply repeated the formula for GDP using the expenditure method (GDP = C + I + G + (X - M)) without providing a comprehensive definition.
Define the term sustainability indicated in bold in the text (Text B, paragraph 4).
[2]
On the other hand, while almost all students were able to define sustainability by considering either future generations or preserving the environment/resources, incorporating both aspects was required for full marks.
Using information from Table 1, calculate the change in Uruguay’s current account balance between 2018 and 2019.
[2]
Current account in 2019:
(18.52 – 17.88) – 3.05 + 0.19 = -2.22
Any valid working is sufficient for [1] (eg correct calculation of either initial or final current account balance or if the units are missing).
The quantitative questions did not appear to pose significant challenges for candidates. Most students were able to calculate the current account balance, although a few mistakenly added import expenditure instead of subtracting it.
[1]
Surprisingly, several candidates referred to the current account values calculated in (b)(i) rather than Table 1 to answer (b(ii)), resulting in the incorrect identification of a deficit in the balance of trade. It is important to remind students that part (b) questions are purely quantitative, and therefore, the word "surplus" was sufficient to earn the 1 mark available in (b)(ii). It is unnecessary to provide sentences justifying the answer.
Using information from Table 2, sketch the change in Uruguay’s Lorenz curve from 2010 to 2015.
[2]
Candidates who label diagrams incorrectly can be awarded a maximum of [1].
For the vertical axis, the label may be cumulative percentage of income or percentage of income. For the horizontal axis, the label may be cumulative percentage of population/households or percentage of population/households.
The Lorenz curve shift was often correctly illustrated.
Using a demand and supply diagram, explain how China might have contributed to the Uruguayan soybean producers’ higher (total) revenue (Text A, paragraph 2).
[4]
Candidates who label diagrams incorrectly can be awarded a maximum of [3].
The use of P and Q on the axes is sufficient for a demand and supply diagram. A title is not necessary.
Candidates may indicate the increase in (total) revenue with shaded areas or numbers/letters in the diagram (eg a gain of total revenue of P2Q2-P1Q1 on the diagram below).
Responses often included a correctly drawn diagram depicting both price and quantity increasing. However, many candidates did not receive full marks as they didn't identify the precise area(s) for (total) revenue. This could have been accomplished through shading or referencing in the explanation (e.g. stating that P1Q1 and P2Q2 represent the old and new revenue areas). It is worth noting that this question was similar to one presented in the November 2022 paper, where candidates encountered the same challenge identifying revenue areas.
Using an exchange rate diagram, explain how the end of the commodity boom might have contributed to the depreciation of the peso (Text A, paragraph 4).
[4]
Candidates who label diagrams incorrectly can be awarded a maximum of [3].
For an exchange rate diagram, the vertical axis may be exchange rate, price/value of the peso in US$, US$/peso or US$ per peso (another currency or simply ‘another currency’ may be used instead of ‘US$’). The horizontal axis should be quantity, or quantity of peso. A title is not necessary.
Except for occasional mislabelling of the vertical axis and incorrect curve shifts, this question was generally well attempted. Some explanations were incomplete as they merely stated that decreased exports would shift the demand curve to the left without elaborating on the reduced need for foreign consumers to purchase the peso to pay for goods from Uruguay.
Using an appropriate diagram, explain how the MERCOSUR-EU free trade agreement may lead to higher structural unemployment in Uruguay (Text B, paragraph 3).
[4]
Candidates may draw a labour market diagram that assumes the wage rate is fixed (sticky) and state that the difference between the number of workers demanded and supplied illustrates the structurally unemployed. This approach, if properly explained, may be awarded full level 2.
NB Candidates may provide an alternative explanation, which should be fully rewarded. They may draw a supply and demand (or international trade) diagram showing a decrease in the demand (or domestic production) for machinery (or any other good imported from the EU) and state that the decrease in the demand for machinery would lead to a decrease in the workers who are employed in the industry and whose skills may not be transferable to other industries.
Candidates who label diagrams incorrectly can be awarded a maximum of [3].
The vertical axis may be labelled real wage, real wage rate, wage or price of labour and the horizontal axis labelled quantity of labour or number of workers or just labour.
The intention of the question was to assess candidates' ability to illustrate structural unemployment using a diagram "showing a fall in the demand for labour for a particular market or geographical area" (as stated in the subject guide). However, a range of diagrams (labour market, good market, or tariff diagrams) were accepted as long as candidates could explain how participation in the free trade agreement could lead to structural unemployment, with reference to their chosen diagram. The use of an AD/AS diagram was not permitted since it does not cover a specific good/market (and consequently, specific skills), but rather indicates cyclical unemployment. Similarly, to earn full marks in the explanation, it was insufficient to simply state that unemployment might increase. Candidates needed to provide an explanation as to why this unemployment is structural, such as skills becoming irrelevant or geographical immobility.
Using an AD/AS diagram, explain the likely impact of the reduction of the common external tariff on Uruguay’s potential (long-term) output (Text C, paragraph 1).
[4]
Candidates who label diagrams incorrectly can be awarded a maximum of [3].
For AD/AS, the vertical axis may be Average (General) Price Level, or Price Level. The horizontal axis may be real output, real national output, real income, real national income, real GDP or real Y. Any abbreviation of the previous terms is acceptable. Alternatively, a Keynesian AS may be drawn with the vertical portion shifting to the right. A title is not necessary.
It was evident that many students were unaware that a change in potential (long-term) output can only be demonstrated by a shift in LRAS (or rightward shift of the Keynesian AS). Additionally, a significant number of students didn't consider the information provided in Text C, which was crucial for understanding the reasons behind the shift. Trade liberalization is classified in the subject guide as a market-based policy that promotes competition. Regrettably, many students displayed limited familiarity with the effects of such supply-side policies.
Using information from the texts/data and your knowledge of economics, discuss the impact of economic integration on the Uruguayan economy.
[15]
- a definition of economic integration
- a definition of a common market
- a definition of a free-trade agreement
- diagrams (eg AD/AS, tariff, quota).
- The advantages of membership of the MERCOSUR common market and EU - MERCOSUR free trade agreement:
- Greater access to a market of 290 million consumers through the MERCOSUR common market and possibility to access the markets of the 27 members of the EU; offer potential for economies of scale for Uruguayan producers who would otherwise be limited to the small size of the domestic market (Text A, paragraph 1 and Text B, paragraph 1).
- Increase in export revenue has contributed to economic growth and higher real GNI per capita (Text A, paragraphs 2 and 3, Table 2) and poverty reduction (Text A, paragraph 5; Table 2). Although the country benefitted significantly from exports to China, which is not a member of either trade bloc (Text A, paragraph 2).
- Membership to the EU-MERCOSUR free trade agreement may lead to greater exports to the EU (Text B, paragraphs 1 and 2) and may help restore Uruguay’s growth rate (Text A, paragraph 3). This could be contrasted with the negative/low balance of trade (table 1). But quotas, which cause inefficiencies and higher prices, remain for some items (Text B, paragraph 2).
- With freedom of movement of labour within MERCOSUR, there are greater employment opportunities. However, the freedom of movement might have contributed to the unemployment rate (Text A, paragraph 5).
- Uruguay’s tariff-free access to MERCOSUR and the EU makes it an attractive destination for foreign investors (Text A, paragraph 6 and Text B, paragraph 4).
- A high common external tariff protects Uruguayan producers from cheap imports from China (Text C, paragraph 1).
- Membership in a trading bloc may allow for stronger bargaining power in multilateral negotiations such as the EU-MERCOSUR free trade agreement.
- Greater political stability and cooperation.
- The disadvantages of membership of the MERCOSUR common market and free trade agreement:
- Uruguay is susceptible to external shocks (Text A, paragraph 3). As Uruguay is over reliant on trade of primary products and is not diversifying its exports (Text A, paragraph 4), this may explain why the Gini index and real GNI per capita have only narrowly improved since the end of the commodity boom (Table 2).
- Increased production of meat, paper and wood for exports represent a threat to sustainability (Text B, paragraphs 1 and 4).
- Lowered protectionist measures may lead to more structural unemployment (Text B, paragraph 3) once tariffs are removed/reduced as part of the EU- MERCOSUR free trade agreement.
- Uruguay has suffered from a loss of sovereignty, which prevents the country from entering bilateral trade agreement(s) and reducing its tariffs (Text C, paragraphs 1 and 2).
- Challenge to multilateral trading negotiations.
Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.
To address the specific demands of this question, candidates were expected to provide a balanced discussion on both the benefits and drawbacks of economic integration. Responses that focused solely on one aspect of economic integration, particularly participation in the free trade agreement with the EU, only partially addressed the demands of the question (descriptor for the 7-9 markband). High-achieving responses presented a well-rounded perspective, considering both the benefits and drawbacks of membership in the MERCOSUR common market and the impacts of the free trade agreement, with reference to the provided texts and data. Weaker answers tended to summarize the text and disproportionately emphasized the impact of trade with China, which was largely irrelevant as Uruguay is not part of a trading bloc with China. The strongest responses added value to the information from the texts such as explaining how freedom of movement of capital or access to a larger market in a common market can drive an increase in foreign direct investment (FDI). Moreover, these strong answers incorporated trade-related concepts like economies of scale, rather than simply restating statements such as "the MERCOSUR common market allows Uruguayan producers tariff-free access to 290 million consumers".
