European Deflation

Latest inflation figures in the UK indicate that deflation could be a major worry in the UK. Inflation in the UK fell to 0.5% which is a worry because if inflation becomes negative, falling prices can lead to a deflationary spiral. Consumers will put off purchasing goods because they know that prices will continue to fall, hence they will be able to save more money by waiting. Furthermore, in the Eurozone, there is deflation of 0.2%. This is one reason why deflation is such as hot topic among economists and businesses (for example, type 'deflation' into Google then click on the 'news' tab to see what comes up).

But I just came across a video on the FT where Sarah Gordon, the business editor, discusses how deflation may not actually be that bad, in the Eurozone. This perspective can also be relevant for the UK. The video explains deflation well and is worth listening to. One of her key arguments is that while inflation remains negative, the CPI is actually positive (0.8%), only being bought down by falling fuel and energy prices. This means that its important to consider what measure of deflation is being used in any figures given. Also, falling fuel prices means that consumers are actually benefiting because living costs have fallen. This might actually increase consumer spending rather than retard it. 

She also mentions that businesses are not worried about deflation because if the European Central Bank embark on a quantitative easing programme, they will buy sovereign and corporate bonds which will reduce interest rates. This is actually good for businesses because it reduces companies' debts.

This video can be accessed here.

Savings or Consumption?

I came across this great video about savings and consumption today. This video highlights the importance of savings in the economy, despite the common conception that consumption may be a more important component of the economy. I was told in school that consumption was roughly 70% of the economy. Indeed, in Keynes' view, increasing consumption will increase growth via higher spending. Remember that AD = C + I + G + (X-I), where AD = aggregate demand, C = consumption, I = investment, G = government spending, X = exports, I = imports. If consumption increases, the left hand side of the equation, AD, increases. An increase in AD will increase economic growth, so the argument goes. 

But this 3 minute video actually argues the opposite. Savings are more important for the economy because it allows investment to grow and this helps increase production. In exams, the examiners are looking for a balanced argument. These alternative views are perfect to help you gain extra marks. 

You want to read this if you're considering studying Economics at university!

So I came across this interesting article recently reporting how a new economics curriculum will be taught at universities in London, Paris, New York, Boston, Budapest, Sydney and Bangalore. Apparently its a 'dismal science' that leaves students feeling 'disenchanted'. I hope you don't feel like that reading my blog! 

This article by the FT outlines how economic events have changed economics curricula over the years, from neoclassical to Keynesian to new Keynesian. Of course curricula must keep changing to adapt to events that make models obsolete, but a message to take away from this is that students are spending years learning models that are continuously changing, which makes it less enjoyable to study at degree level. Perhaps changing from abstract, mundane, incomprehensible maths will indeed make economics more accessible for young people. That's actually the whole reason why I started this blog! 

I'll end this post with the ending sentence of the article to provide my readers with some food for thought: 'The new thought is a return to the past: less maths and more history of economic thought might make for more enthusiastic and useful graduates.'

UPDATE: The state of the European economy

Recently, Europe’s economy has avoided appearing on many of our news screens what with other international affairs such as Russia/ Ukraine, Syria and Iraq in the headlines for probably my entire summer holidays. But that doesn't mean that the European economy is all hunky-dory and the recession is a thing of the past.

This post is an update of what is actually going on in Europe right now, giving you three key case studies: Italy, France and Germany.

Italy

·      Triple dip recession – GDP fell by 0.2% in the second quarter of 2014

·      12.6% unemployment rate

·      43% youth unemployment

·      Little political will to do anything about it

France

·      Rising budget deficit

·      Last quarter’s GDP growth: 0%!

·      Chance of going back into recession, was also 0% in the quarter before last

Germany

·      GDP fell 0.2% in the last quarter, the first GDP contraction this year

·      Manufacturing sector slow down

·      Geopolitics is affecting growth: Russia’s embargo on European food imports is apparently affecting 9.5m European farmers, and is affecting Germany’s trade

Key points to note about Europe right now:

·      Low inflation.

Average Euro Area: 0.4%

Deflation in 8 Eurozone countries including the PIGS (Portugal, Italy, Greece and Spain)

Country in Eurozone	Inflation rate
France	0.4%
Italy	-0.1%
Germany	0.8%
Spain	-0.5%
Greece	-0.3%
Portugal	0.4%

Why is this a problem?

·           Increases the real value of debt which means that government debt increases making it harder to pay off and increasing the likelihood of needing another bail out

·           Taxes will have to rise eventually to fund the increased debt accumulation which means businesses will have a higher tax burden à leaving some Eurozone countries

·           There is danger of falling into a deflation trap where prices just keep falling. This is called a deflation spiral.

·      High unemployment

·      High government debt

·      Political upheaval

·      Geopolitics with Russia

·      Lack of political union

Different countries in the Eurozone want different things and have different views with how situations should be handled, e.g. with Russia, which makes it hard to manage economic policy and introduce austerity measures where needed.

What can be done?

·           Keep interest rates low – increasing interest rates will just decrease inflation more

·           “Quantitative Easing lite”: the European Central bank buys assets to stimulate the economy and help inflation rise

Anything else?

·           Role of competition in markets:

o   There was a period of very low inflation during the late 19^th century in Germany and the UK

o   Analysis shows there was competition in markets and businesses operated in a competitive environment

o   Competition restricts wage growth because there are many companies in the same industry offering the same job and the same wage. This is happening now!!!

o   A competitive market means that firms are unwilling to increase the price of goods and services – preventing inflation from rising. This is happening now!!!

o   It is therefore hard to increase inflation. This is happening now!!!

UK and Foreign Capital

Last week it was reported that 53.2% of shares of UK-listed companies are foreign owned. This post sees globalisation rearing its head again, discussing further impacts of globalisation on the UK economy.

More than half of all shares in UK-listed companies are owned by foreigners which shows the UK’s greater integration with the global economy. One reason for this is that people in emerging economies such as China and India are investing more abroad as they become wealthier. Another reason for this is that foreigners tend to look for investment opportunities in other countries, particularly rich countries, as a safe place to put their money, thus their attraction to the UK.

An increase in foreign capital coming to the UK can help us reduce our current account deficit. Investment is a component of aggregate demand, and so increasing investment can increase demand and help reduce the effects of the financial crisis.

(Evaluation point: it could, however, be showing that many UK-listed companies are foreign and conduct little business in the UK)

One negative consequence of foreigners owning shares in UK companies is that board level decisions are more difficult to make because directors are scattered all around the world. This point is key as it links micro with macro, something examiners relish to find in top exam answers.

China - Case Study II

China's E-Commerce Market

Following on from the Chinese Case Study I post, these notes explain how China is moving in a positive direction to achieve three of its future growth targets (increase innovation, increase the global presence of Chinese companies and increase growth coming from domestic consumption).

By 2020 China’s e-commerce market is forecast to be bigger than the existing markets in America, Britain, Japan, Germany and France combined (from The Economist)

Alibaba

Innovation:

• Alibaba is a business to business e-commerce company that sells Chinese goods to overseas suppliers.
• The company understands the spending habits of Chinese consumers
• Alifinance is microlender to small firms (planning on expanding to normal customers too)
• Insurance

Increase the global presence of Chinese companies: Alibaba is looking to become public (i.e. be listed on a stock exchange), and looking to expand to other emerging economies.

Domestic consumption: ‘Bamboo Capitalism’ is the term used to describe the efficiency of private firms opposed to Chinese state-owned enterprises. Growth in private sector firms drives domestic consumption.

Bottom line: E-commerce is driving future growth in China.

Challenges

• China’s companies are viewed with suspicion abroad
• Chinese firms are accused of supporting human rights abuses for access to resources (read this Economist article about China in Africa) 

China - Case Study I

Key Questions:

·         Is growth increasing incomes on the average Chinese?

·         Is growth lifting people out of poverty?

·         Is minimum wage industrialisation the best way to achieve growth?

QUALITY of growth matters

·         Average income for a Chinese worker is (USD)$8000

·         By 2020, it is estimated that average Chinese wages would have risen to (US) $14,000. This level is considered to be the upper income level that moved countries such as Singapore, South Korea, Greece and Portugal, to ‘rich’ country stats - the level that moved these countries past the boundary

Five year plan

·         China’s growth has been, on average, 9.6% over the past 30 years

·         The five year plan is the government’s 12th five-year plan used to set the future growth agenda for China

·         Renewed in 2011, the priorities for this plan are sustainable growth, industrial upgrading and the promotion of domestic consumption

·         Criticism: there is no implementation plan

See kpmg report:

·         Half of china’s growth comes from adding capital. Bear in mind that growth quality is now becoming the most important thing to think about rather than growth quantity

Total Factor Productivity (TFP) is measured by innovation, allocative efficiency (re-allocation of factors, e.g. rural to urban, state owned to private) and human capital. TFP is the contribution of all factors of production to growth. When TFP increases, the growth rate increases. This means that one or more of the factors of production has been changed.

Innovation - micro level data shows that ⅔ technology comes from imitation, most developing countries imitate first to gain enough wealth to then invest it into R&D for new product development. Imitation leads to innovation - creating an increase in growth.

Human capital - China’s investment in human capital is geographical unevenly distributed. Rural parts of China are under-invested in. If China invests in human capital all round, it has a better chance competing with other economies. Human capital is beneficial because:

·         Skill levels increase. E.g. they will be more qualified to perform tasks and will do so quicker

·         Creates a flexible economy - workers have a greater capacity to adapt to changes in the economy, i.e. seize new opportunities for wealth creation

·         Increases occupational mobility of labour and geographical mobility of labour as because of the previous point

·         High levels of education can increase a worker’s ability to use foreign technology, their ability to absorb new information and acquire technical skills

Middle Income Trap

China needs to avoid the middle income trap. The middle income trap is the trap that developing countries fall into when trying to make their transition from a developing country to a developed country. They are not low income by definition, i.e. they experience high growth rates and make money, but they are not high income countries because they do not have technological advantages. China’s wages are starting to increase, as shown here, demonstrating that what was once the most popular destination for cheap manufacturing, is now losing to countries such as Bangladesh and Singapore.

Key points:

·         Wages are increasing

·         Poverty is slowing decreasing

·         Innovation is creeping up

·         Chinese firms are expanding globally

·         Without the prospect for cheap labour, firms will be deterred from investing in China

·         Only urban members of the workforce are educated, also potentially deterring firms

·         The Chinese economy is still imitating

These points suggest that China is heading for the middle income trap, a limbo between the rich and poor, unable to progress. There are criticisms of the middle income trap, read the Economist article here to gain other perspectives, which will help you build your argument in your exam. Remember that providing alternative views are brownie points. Read the sources at the bottom as well.

The Future

·         Focus on overcoming the middle income trap

·         Increase own market reliance, e.g. US consumers are increasingly buying domestically produced goods

·         Increase domestic demand by lowering exports. E.g. exports are only a fraction in the US - China needs to get to that

·         Privatise. State owned companies are not as productive. They distort the allocation of lending and bank credit. State owned enterprises account for 30% industrial output and ¼ of urban jobs

·         Increase innovation

·         Increase opening - more Chinese firms should go global.

o        We have seen Chinese investment in African natural resources, which is a start. They are building infrastructure in poor African countries and providing jobs (however a negative is that they are competing with local firms and undercutting them, making it difficult for locals to make a living)

o        China should focus on moving up the value chain by producing things that is most competitive

o        The government should push to create Chinese multinationals

o        At the moment, Europe in particular can benefit from the additional investment that Chinese firms can offer

·         Services are important - increase job creation, create a high skilled labour force and help China rebalance

·         Raise consumption as a share of GDP, not rising it in absolute terms

·         Restructure the economy: more services, quality of growth needs to increase

·         Productivity and innovation: compete to produce the best products in the world. Join the ranks of rich countries, e.g. Samsung (South Korea) competing with Apple (US)

·         Political reforms are required to sustain a prosperous middle class

The Economics of Valentine's Day

Happy Valentine's Day everyone!

Have you ever wondered about the economics of Valentine's Day? What does it mean?

This video (strangely) puts into context for us:

http://www.learnliberty.org/videos/economics-valentines-day

It explains three economic principles associated with Valentine's Day:
1. Free markets
2. Signalling
3. The seen and unseen

This video puts these key principles into context for us, hopefully you will understand them clearer after watching it.

Case Study/ Example of Public Sector and Private Sector Cooperation

The UK Driving Standards Agency recently set out plans to run driving tests from Halfords branches around the UK. 15 Halfords branches are set to become test centres to improve accessibility to those who do not live close to a test centre. The driving tests will still be conducted by DSA examiners, so Halfords is simply playing host.

This provides a good example of private firms contributing to social welfare in a positive way, and has been the first for a long time (e.g. remember G4S?). Both examples can be used to describe the benefits and costs of PPPs or private sector involvement with government.

Top Posts of 2012

Happy new years everyone! Like last year when I posted the top 10 posts of 2011, its time to reveal the most viewed posts of 2012.

10. Once again its Trade Unions, posted on 16 November 2011

9. Word of the Day: Economic Growth posted on 3 August 2011

8. New entry Production Possibility Frontier and Long Run Aggregate Supply posted on 5 August 2011

7. Oligopoly, up from last year posted on 21 April 2012

6. Negative Externalities posted on 16 September 2011

5. Monopoly posted on 23 August 2011

4. Another new entry! Unemployment notes posted on 22 January 2012

3. Non mover Word of the Day: Elasticity posted on 13 August 2011

2. Another non mover Perfect Competition Long Run Equilibrium posted on 11 August 2011

1. A further non mover! The most viewed entry in 2012 was Perfect Competition Short Run Equilibrium posted on 10 August 2011

Seems market structures are popular topics that a lot of you are struggling with, but I'm glad that my posts are being viewed to help you out.

Subscribe and recommend to friends!

A Video on The Minimum Wage

Building up a strong argument is essential for getting good grades. When evaluating the minimum wage, its not good enough just to write that it creates unemployment. What are the other effects?

Here is a video describing the effects of a minimum wage. Sure it is slightly biased (free marketeers), but that's why their argument against it is really good.

Notes on the labour market, trade unions and the minimum wage can be found here!

Deck the Halls with Macro Follies

Here's something to get you all into the Christmas spirit, economics style!

This is a video summing up the different economic schools of thought from Keynes, Malthus (less relevant), J. B Say (from Say's Law) and Hayek in playful song.

Its surprisingly enjoyable to listen to and is also a nice quick and dirty memory refresher for the key economics viewpoints. Here you go:

http://www.youtube.com/watch?v=7uKnd6IEiO0

About a year ago I posted up other playful videos from Econstories on Boom and Bust and Fight of the Century.

Very useful website (part from this one obviously!)

Hi everyone, I came across this brilliant website for economics explanations, recent news analysis..etc. They have recommendations for textbooks, tailored exam board guidance, lots and lots of notes and graphs! Read it!

http://economicsonline.co.uk/

Enjoy!

Michael Portillo's 'Great Euro Crisis'

On BBC2 on Wednesday night was a very information documentary about the Eurozone crisis, in particular Greece. You can watch it here on BBC iplayer. Remember it won't be there forever, do take time to watch it.


Summary:

• One quarter shops have closed since the crisis began in 2008
• Social costs: Graffiti everywhere, dereliction
• Michael Portillo's view is that Greece's joining the euro created the crisis
• Introduction of the Euro: purpose - to help the poorer European countries catch up to their richer counterparts
• The Euro has made Greece uncompetitive, considering the Drachma was weak and this helped fuel demand for their exports
• The Euro also increased the amount of exports entering the country, particularly cars (what made it easier was the wide availability of credit for Greeks to finance the purchase of these cars)
• In 6 years, Greece's deficit from Germany went up from under €3bn to over €8bn
• Another contribution to the debt: transport advancements (equipment could not be manufactured in Greece, so had to be imported by German companies) were paid for with debt, and tax evasion
• Devaluing the currency (going back to the Drachma) can help improve their competitiveness
• Government put national assets (e.g. the airport) among other austerity measures, to try to save the country

Case Study: Separation of Ownership and Control

Sometimes it is difficult to understand how some economics concepts can be used in the real world (although with economics, it should be easier to relate that other subjects..) so here is a perfect example of the principal/agent problem.

There seems to be a conflict between what shareholders want and what managers (executives) want at Barclays. At Barclays, £730m was paid out to shareholders last year in contrast to £2.15bn that was paid in bonuses.

Read more here:  http://www.thisismoney.co.uk/money/news/article-2132282/Barclays-boss-Bob-Diamond-lose-1-3m-bonuses-bank-attempts-douse-shareholder-rebellion-pay.html 

Read notes on the Principal Agent Problem here.

Oligopoly

·       A type of market structure where there are a small number of firms dominating the market, all selling similar goods

·       What’s your definition of ‘dominating’ the market? How do economists go about determining whether a market is dominated by a few firms or not? They measure the concentration ratio – the market share of the biggest firms in the market. For example, a four firm concentration ratio shows the percentage of output produced in the market by the four largest firms. Statistically, this method is okay to use, but at A-level (and GCSE), it is better that you know that the essence of understanding the oligopoly market is that firms in the market make decisions on price and output based on the decisions of rival firms. They attempt to predict what the other firms are doing, to compile their own strategy.

·       An example of an oligopoly market is supermarkets

·       Can compete on price (resulting in a price war, see here and here) or not, instead competing on other bases such as:

o   Loyalty schemes (Tesco Clubcard, Sainsbury’s Nectar points)

o   Advertising and marketing

o   Home delivery options (e.g. Asda and Tesco)

o   Discounted petrol  (e.g. Asda, Morrisons)

o   Extension of opening hours (e.g. Metro Bank open on Sundays)

o   Lateral growth in other industries (Asda opticians, Tesco banking and insurance)

·       There are barriers to entry in the market

Kinked Demand Curve Theory

The theory explains how a competitive oligopolist may be affected by rivals’ reactions to its price and output decisions.

 Look at the AR curve for now. The AR curve is relatively elastic from P* to P₁ and relatively inelastic P₁ onwards.

The oligopolist sets price to P₁ initially. When the curve is relatively elastic, if a firm in the market increases the price, other firms will not follow because the resulting fall in demand is greater than the proportionate change in price. The firm loses too much demand to attract other firms to follow.

When the curve is relatively inelastic, if a firm lowers the price, other firms will follow because they benefit from the resulting increase in demand. Even though the resulting increase in demand is lower than the fall in price, firms benefit because consumers ‘shop around’ for lower prices; if Tesco are selling a notebook for £1 and Asda are selling a notebook for 80p, provided that Asda is just as accessible as Tesco, the consumer may decide to shop at Asda instead. This is under the assumption that the oligopoly market compete on price. If this happens, a price war may result.

Now consider the MR and MC curves. The oligopolist sets price and output level to P₁ and Q₁. The profit maximising level of output is Q₁. The initial MC curve is MC₂, but if the MC curve was to shift to above MC₁ or below MC₃, the oligopolist would have to charge a different price to ensure profit maximisation (assuming AR = selling price). Price stability is achieved because the MC curve can be anywhere between MC₁ and MC₃.

Furthermore contributing to price stability, the oligopolist may decide to leave price and output at point X because of the uncertainty from rivals’ price and output decisions.

The Kinked Demand Curve is only a theory and an estimate of how demand changes when the oligopolist changes price because there is not perfect information in the market for olipogolists to know the exact position and shapes of their demand and revenue curves. The theory is useful because it illustrates how firms are interdependent on rivals, and affected by uncertainty.

Government Policies to Reduce Market Failure

If you've watched the news recently, you guys should know that the government are considering changing the packaging on cigarettes to discourage new smokers. Use this as a case study in your exam to demonstrate government policy to reduce market failure caused by demerit goods (See notes on Negative Externality and Market Failure. These notes specifically apply to negative externalities, but it is relevant because the consumption of demerit goods causes negative externalities, e.g. second hand smoke).

The new plain branding is being considered to deter youths from starting to smoke, but critics say that the branding will make no difference to those who are already in the habit of smoking. What is your view? Good idea? Tell the examiner!

Another Contribution to the Business Cycle

Read an interesting article on the BBC about the cost of bank holidays, according to research from The Centre for Economics and Business Research (CEBR).

Each bank holiday costs the economy £2.3m and that means the economy could gain an extra £19bn if bank holidays were scrapped. This can be a contribution to the business cycle (see here) because bank holidays reduce GDP. If the economy was suffering a downturn, the loss of GDP can cause the economy to worsen from a downturn to a recession. For the UK, especially at a time where we are not experiencing strong growth, forecasters are predicting the worst from the working days that are lost.

15% of the economy, which includes pubs, clubs, restaurants, cafes and visitor attractions, do well on bank holidays and 45% of the economy suffers, which includes offices, factories and building sites, where people do not go to work on the bank holiday. The areas that benefit do not balance out the loss of productivity from the services sector of the economy.

Do read the full article for more information.

Principal-Agent Problem

The divorce/separation of ownership and control helps explain the principal/agent problem.

Among large firms, the managers and the owners of the company tend to be separate. One who has the financial capacity to invest into a company (in extreme cases this can be through inheritance, lottery..) can do so without running it. This is the separation of ownership and control.

Because the owners are different to those who run the company (the managers), they may have different objectives. Managers want to benefit from perks (e.g. company car contribution, pension contribution, discounted gym membership) and bonuses. Owners want to maximise shareholder value. They also want to satisfice: achieve minimum targets that are acceptable and satisfactory to all member groups of the coalition that make up the firm. Satisficing helps resolve the conflict bought by the separation of ownership and control because in order to achieve ‘minimum’ targets, both parties must compromise. For more on satisficing, click here.

The principal-agent problem is the conflicting objectives of the owners and the shareholders of the company.

How does the principal-agent problem affect a firm?

The owner can never be sure that the employed managers are aiming to maximise profits or succumb to the temptation of maximising their own benefits, possibly leading to decreased profitability.

Quantitative Easing (QE)

QE causes a change in the money supply. Steps:

1. The Bank of England (BoE) purchases assets such as government bonds and corporate bonds
2. Pays for these assets by creating money electronically and crediting the accounts of the companies that it bought assets from
3. These accounts are called reserves. All banks hold reserves at the BoE and the essence of QE is that it builds up these reserves
4. QE is likely to lead to inflation because banks lend more and increases the money supply (see Quantity Theory of Money). Another reason for inflation is, holding everything else equal (ceteris paribus), more people have more money that they supposedly use for consumption, creating demand pull inflation

Explained by Stephanie Flanders

http://www.bbc.co.uk/news/business-16973560

Stephanie Flanders in the BBC’s economics editor, the link above provides a short video RSAnimate of QE. A summary of the video is as follows:

·         The Bank of England creates money and spends it so that there is “extra cash” flowing into the economy. They spend it by buying government bonds or IOU’s (formal definition: documentation confirming that the debt is owed) from financial institutions such as pension funds or insurance companies.

·         This puts more money into the economy (higher money supply) because these financial institutions that sold these bonds have more money to spend on new businesses or on housing for example.

·         Because of this, it is cheaper for the government to borrow as the BoE pushes up demand for the Treasury’s IOUs and supply of bonds has been reduced. Long term interest rates are lower than they should be making it cheaper for everyone else to borrow as well, because higher demand means more spending and this leads to faster growth.

The last point explains the theory WHY the government uses QE even with the risk of inflation, particularly during recessions. If demand rises, consumption may increase and the economy begins to recover.