Economic Dilemmas 2014 Welcome to the third issue of the Harris Academy Economics Society Magazine. There have been some excellent contributions. This time from:
Connie, Courtney, Cody, Amelia, Sana, Shivani, Nadia, Ayo, Maddy, Shivani, Edward, Andrew, Luke, Felix, James, Kayrie, Heen, Igne, Andrew, Chanell, Johnston, Charlie, Harriet, Alex and others. Your work is greatly appreciated and I hope enjoy making contributions. We are looking for editors, at least one from each class, so I hope some of you will come forward. We have really good articles on The Chocolate Market, on Supply-Side economists, Frederick Hayek and Milton Friedman, Corruption and FDI, the Autumn Statement, the Eurozone Crisis, China’s high speed rail ambitions, and more….. Meanwhile in the economics of the real world, you might want to scrutinise UK performance over the next few months, and take a view on Europe, as it stumbles and stalls from one economic problem to another. You should also keep a close eye on Russia. It is currently spending a lot of money on arms, (around 20% more) and yet has a real problem with the massive fall in world oil prices. Inflation is taking root at 10% and interest rates have had to go up to 17%. The rouble has collapsed in value by 50%. Russia could be heading for a whole heap of trouble in 2015 and this could have knock on effects for us…….. On the brighter side, the UK and the USA seem to be among the best performing economies at the moment, so let’s hope that continues strongly into 2015. Have a Very Merry Christmas and Happy New Year!
Costly Chocolate Cuts Celebration Connie, Courtney, Cody, Amelia, Sana, Shivani
Will chocolate become an unaffordable luxury for many? With a soaring demand for chocolate globally and a frighteningly low supply of chocolate, the price is rising at a record rate. Chocolate prices are becoming inflated as demand is growing faster than supply. It is predicted that next Easter chocolate eggs could be smaller and more expensive. On the other hand substitutes such as palm oil, cotton seed oil or cheaper cocoa butter equivalents could be included in order to cut the costs. The International Cocoa Organisation has predicted that there could be a 115,000 tonne deficit of cocoa beans this year. They also warned that global companies could be heading towards the largest production shortage in over 50 years. The decline in production has driven up the price of cocoa beans. For example a tonne of beans has risen from $2680 to $3031. There is a shortage of beans as young farmers in Africa are aiming for higher paid jobs and don’t want to be part of the farming industry. Many chocolate companies are waking up to the situation, and to the fact that ‘Fairtrade’ can be part of a solution, helping to ensure decent incomes for farmers and a long-term supply of quality product to chocolate companies. Fairtrade sales are generating significant amounts of Fairtrade Premium funds for cocoa farmer organisations to invest in their farms, businesses and communities.
Corruption and FDI
Corruption is colour coded in this graph….
The surge in foreign direct investment (FDI) flows during the 1990s has motivated a host of recent studies into their determinants. Recently, the level of corruption in the host country has been introduced as one factor among the determinants of FDI location. From a theoretical viewpoint, corruption is paying bribes to corrupt government bureaucrats to get favour’s such as permits, investment licenses, tax assessments and police protection—is generally viewed as an additional cost of doing business or a tax on profits. As a result, corruption can be expected to decrease the expected profitability of investment projects. Investors will therefore take the level of corruption in a host country into account in making decisions to invest abroad. In a survey of international business managers the costs of investing in a more corrupt host country were shown to be as much as 20% higher than those with less corruption. By this line of reasoning corruption in a host country will increase the costs of foreign investors and will hence discourage FDI. Corruption in the political system is a serious threat to foreign direct investment. Letting people take position of power through bribes rather than ability will produce instability in the political process and will distort the economic and financial environment. This instability can lead to a decrease in the profitability of invested projects. This will tarnish the perception of a country’s stability and the quality of investment potential, and will discourage future potential FDI. However some argue corruption is not too harmful because bribery can speed up the process and help avoid bureaucratic inefficiency.
Masters of Money: Friedrich Hayek Nadia Uddin Hayek was the great free-market thinker who argued with Keynes in the 1930s over government intervention in the economy. In 1920s through the 1930s Hayek’s work was mainly in the Austria theory of business cycles, which describes the phases of growth and decline in an economy; capital theory, which is predicting the progression of capital over time on the basis of mathematical models; and monetary theory, which are a set of ideas about how monetary policy should be conducted within an economy. Hayek noticed a connection among all three of these theories and argued the major problem for any economy is how people’s actions are coordinated. From Adam Smith’s idea of the free market and allocating resources using the price mechanism, he found that this particular method was able to successfully coordinate people’s actions, even though the idea of coordination was not part of anyone’s intentions. Hayek explained that the ‘free market’ was a spontaneous order meaning that the economy is unplanned – the market was not controlled by anyone but evolved slowly as a result of human actions. One issue that arises from this is that at times there are large numbers of people within the labour force whom are unemployed. Hayek believed that increases in the money supply by the central bank, would drive down interest rates, making credit artificially cheap. Firms would then make capital investments that they would not have made had they understood that they were getting a distorted price signal from the credit market. However capital investments are not all the same. Long-term investments are more sensitive to interest rates than short-term ones. He concluded therefore artificially low interest rates not only cause investment to be artificially high, but also cause “malinvestment”— too much investment in long-term projects relative to short-term ones, and the boom turns into a bust. Hayek saw the bust as a healthy and necessary readjustment. He argued the way to avoid the busts is to avoid the booms that cause them. The market economy today is when resources are allocated by the forces of demand and supply through the price mechanism. Decisions of how resources are allocated are dependent on households and firms. Price and the free operation of the price system are central to the way in which resources are allocated. An increase in demand raises price and encourages businesses to bring more resources into the production of that good or service. The amount of products consumed by people depends on their income and income depends on the market value of an individual’s work.
Milton Friedman and other Supply Siders‌.
. Ayo Olukoya Friedman and Hayek subscribed to the free market paradigm. Having witnessed the hyperinflation of Germany in the 1920s, Hayek held the view that markets would have selfcorrected if money supply was not controlled by government. He had much more in common with Adam Smith than with John Maynard Keynes. His ideas could be associated with the monetarist movement, headed by Milton Friedman, who also promoted the virtues of the free market in the 1980s. Hayek was against the growth of the state, and argued that such growth, along with the policies of Keynes, would hold economies back and limit choice. In the 1970s Keynesian demand management was the accepted economic paradigm, but with stagflation, (growing unemployment and growing inflation), monetarism began to increase in popularity and politicians like Margaret Thatcher and Ronald Regan began to embrace supply side economics in the 1980s The economic crash of 2008 was a global, monetary phenomenon. Money markets had been liberalised too much, and so we can argue that Hayek’s market solution does not always work. In fact, the government rescue of the banks and the budget deficits that have followed, supporting demand in the economy, could be described as decidedly Keynesian. It seems that Monetarism and Keynesianism may not be as incompatible as previously thought - both paradigms can have their place in different economic circumstances, just as they sit beside each other in Milton Keynes – a new town named after them.
Summary of 2014 Autumn Statement Chancellor George Osborne has updated MPs about the state of the economy in his last Autumn Statement before the general election.
Current state of the economy
The UK has the fastest growth in the G7, there is a 3.0% growth forecast in 2014 (higher than 2.7% predicted in March). 500 000 new jobs created this year – 85% of them being full time. Unemployment is set to fall to 5.4% in 2015 and inflation is predicted to be 1.5% in 2014, falling to 1.2% in 2015. This year borrowing falls from £97.5bn to £91.3bn and by 2019-20 a surplus.
Stamp Duty (Land Tax) Stamp duty will be cut for 98% of people who pay it - only the highest value residential properties will pay more. Previously residents had to pay stamp duty at a ‘single rate’ on the ‘entire’ property price whereas under the new rules residents pay stamp duty within tax bands over the price of £125 000 and then 2% up to £250 000, 5% up to £950 000, 10% up to £1.5m and 12% above that. Transport Air passenger duty for children (under 12) is to be removed from May 1 and for under 16s the following year. Immediate reduction in oil industry supplementary charge from 32% to 30% and as expected fuel duty is frozen. Savings and pensions Spouses will be able to inherit their partners’ ISAs tax free upon their death. The surviving spouse or civil partner will be allowed to invest as much into their own ISA as their spouse used to have, in addition to their normal annual ISA limit. Personal and business taxation The tax-free personal allowance is being increased by a further £100 rising to £10,600 next April 2015 instead of £10,500 as previously planned. Higher rate income tax threshold to rise to £42 385 next year.
It is unsustainable that some banks will not be making corporation tax payments for another 15 to 20 years. Therefore restrictions are being placed on banks, limiting the amount of
profits that can be offset by losses to 50%, to bring in extra £4bn over five years, increasing their contribution to public finances through their tax payments. Currently some large multinational companies divert profits abroad through complicated business structures in order to avoid paying taxes. The government introduced the ‘diverted profits tax’ applied to a company’s profits that have been diverted from the UK through complex arrangements, and will apply to both UK and foreign multinational companies from April 2015. So if a company conducts a lot of activity in the UK – sales, for example - but can avoid paying corporation tax by moving profits generated in the UK to other countries through the manipulation of the international tax rules (often called transfer pricing), the UK will now be able to tax those profits at a rate of 25%.
Health and education: The government is providing £2 billion of additional funding for frontline NHS services in England in 2015-16. This is part of a multi-year £3.1 billion UK-wide investment in the NHS. GP services are to get £1.2bn in extra funds from bank foreign exchange manipulation fines.
From 2016-17, income-contingent loans will be available for postgraduate taught masters courses in any subject for those under the age of 30. The loans, of up to £10,000, will beat commercial rates.
Science: £5.9 billion sustained investment in science. This will make sure the UK remains the best place in the world for science and research, and includes £95 million to take the lead in the next European mission to Mars.
Scotland, Wales and Northern Ireland Agreement reached on full devolution of business rates to Welsh Government. Corporation tax devolved to Northern Ireland if the Stormont executive can manage the "financial implications". Income tax is to be devolved in full to Scottish Parliament. Housing and infrastructure Long term plans for infrastructure including £15bn for 84 roads projects in England by 2021; £2.3bn for flood defence schemes in England; nearly £6bn for funding towards local road improvements. Tendering for Northern Rail and Trans-Pennine Express franchises will replace pacer carriages with modern trains. A £78m theatre and arts venue is to be built on the former site of Granada's TV studios in Manchester.
Eurozone still in crisis
Maddy Johns
There are feuds over bailout money, there are feuds over the infrastructure investment plan, there are feuds over monetary policy sovereignty. Rebellion is rife in the Eurozone and it only spells trouble……. France’s new economy minister is urging Germany to stop opposing plans to invest the Eurozone bail out funds in the struggling economies. European Commission President Jean Claude Junker has proposed a 3 year infrastructure plan worth 300 billion euros to steer the weakest economies toward prosperity and long term stability. Meanwhile in Italy, a baffling ideological shift towards restructuring the Lira has emerged. Comparable to the rise of UKIP on these shores, a worrying proportion of the population are failing to see past short-term quick fixes for long term gains. Economic uncertainty, transaction costs, a lack of price transparency, exchange rate risk, consumer confusion,,,,, The risk of abandoning the Euro for the nostalgic comfort of the Lira would set back the Italian economy. GDP may be 10% lower than before the recession, but as economic growth in Greece has shown – and listen up, Germany – the Euro can have a bright future for all of those in the Eurozone. There are undoubtedly hard times ahead, but patience will certainly be rewarded in the end – as the pre-recession boom once proved.
Will Interest Rates Rise? Shivani Kumar Interest rates are at a record low of 0.5%, and this has been the case since 2009. Members of the rate-setting committee, the MPC, are in disagreement on whether interest rates should increase or not. MaCaffery and Wedle both want interest rates to increase from 0.5% to O.75%, but other members,, including the bank governor, Mark Carney, do not want interest rates to increase just yet. The target will be to put interest rates a couple of per cent above inflation, which is currently 1.2% Markets are expecting an increase in the New Year. Generally, an increase in interest rates will shift the AD curve to the left, as borrowing will become more expensive for firms and consumers. Also, there is more of an incentive to save. Mark Carney and the other supporters of keeping interest rates as they are are probably thinking that the leftward shift in the AD curve could cause prices to fall further, but more importantly, stall the recovery. This is turning into a real waiting game……
Delaying a rise in interest rates could come at a high price later. Savers looking for higher interest rates are having their patience tested. The official interest rate has remained at the emergency level of 0.5% since 2009 and a rise is unlikely before the next general election. At a recent Inflation Report briefing, Mark Carney said that interest rates will stay low because of uncertainties in the global economy and the Eurozone, spare capacity in the labour market and a subdued outlook for inflation…. Charlie Simmonds Even with the financial crisis largely behind us, wages and living standards are not keeping up with growth. Infrastructure spending like the HS2 project is not necessarily the answer as it will cost £32 billion.
Comments on the Economy Luke Hucker: The UK government is struggling to reduce the deficit any further Geoge Osborne will once again miss his target for the deficit in 2014/15 The size of the deficit has fallen from £157 biliion in 2009/10 to £108 billion in 2013/14 This limits the ability of the government to deliver tax cuts before the election. Although output has recovered quite strongly with growth at 3%, earnings have not kept pace. Felix Ideh The OBS (Office for Budget Responsibility) has assessed that George Osborne will miss his target for 2014/2015. Government borrowing has grown by 10% in the last financial year, affecting both the deficit and the size of the overall debt. Clouds gather as bank announces its latest forecast……. Igne Kisuniate The first interest rate rise is not expected to come until well after the next election. Inflation has not changed drastically – it was 1.8% in May and 1.9% per annum in August Prices are rising much more slowly than had been expected, but joblessness is falling more quickly than expected. Wages have had weak growth, leading to slack in the economy. Even so, Britain will be on course to grow more quickly than any other G7 nation.
Public Sector Pay The deficit is when the government spends more than income through taxation. When added together year on year it becomes the national debt. The chancellor has been predicted to miss the deficit again this time, meaning that once again the UK government is spending more than what they earn from their tax revenue and other sources of income. Due to the decrease in wages, consumers disposable income will be less, meaning consumption will decrease. Consumption is the largest factor of aggregate demand and if this is decreasing then aggregate demand will also decrease. The deficit in 2009/2010 was £137,000,000,000 and now in 2014/2015 it has been reduced to £108,000,000,000, this is valuable to the country as it shows we are making progress and are slowly coming out of the deficit.
Sub Saharan Economics….
Edward Haig One in ten workers in in some sub-Saharan economies have an informal job as they are shunned from the formal sector. A larger informal workforce makes it harder to to reduce poverty. South African firms are reluctant to to hire workers to avaoid beaurocrats and higher taxes. Productivity is also poor and affects competitiveness. A population increase of 250 million, projected for 2010-2050 could also create problems if there is not the economic growth to go with it. Four fiths of revenue comes from commodities, which can lead to fluctuating exchange rates, damage competitiveness and curb growth.
Sorry, No Job Vacancies Kayree Do and Heen Chan Nine out of ten people are employed in the UK, but in sub-Saharan Africa, nine out of ten people are employed in the informal economy. One of the major problems is corruption, making firms wary of growing through normal channels. Estimates are that these impediments to growth are making African workers less productive and in fact more expensive to employ than in China and other emerging economies. Heen “I suggest that to increase productivity in Africa they should adopt better farming techniques and bring unproductive land into use, and produce higher value crops.” James Smith African firms typically employ 24% less than equivalent firms elsewhere. With low productivity and corruption, Africa could become a ‘switched off’ region in terms of globalisation. The dependence on commodities really makes the situation worse as prices fluctuate and steady income flows cannot be assured. If the commodities themselves become exhausted, this will make things even worse – so there needs to be more balance in these economies. Structural reforms are certainly needed to achieve this. Africa is achieving good growth overall but debts are increasing too and the question is whether it is sustainable……
China goes High Speed… China have revealed that they want to sell their high speed trains to California. They are hoping to win a contract to supply 95 trains worth $69 billion for the high speed project. The trains can travel at up to 354 Km per hour. If they win the bid, the trains will be built in California and they will connect Los Angeles and San Francisco. The Sungroup say: “We believe that high speed trains is something we do very well and it is a product we can export across the world.”
Tata Steel threatens 30,000 jobs Andrew and Channel
The Indian based company, Tata Steel has announced plans to sell its Long Product Division in the UK and Europe. 17500 of the 35,000 jobs are in the UK, the decision will create uncertainty for employees. The deal could go ahead with the Klesch group, and there are discussions with trade union representatives – but don’t hold your breath – sales like this often lead to rationalisation and efficiency savings.
Productivity Nightmare for the UK
Within the UK, productivity has fallen. The average output per hour in the UK is 17% behind the G7 average. This fall has been most dramatic in recent times – between 2000 and 2008 Britain had the highest productivity growth in the G7. The 2008 recession had a damaging effect on productivity however, and this will affect growth, particularly wage growth.
Public Spending to fall to 1930s levels. Johnson Public spending is set to fall dramatically according to George Osborne, the Chancellor of the Exchequer. Falling to 35% of GDP in the next Parliament, some fear that “spending will fall to levels not seen since the 1930s@. In the Autumn Statement, George Osborne estimates a further loss of one million jobs in the public sector by 2020. This may in fact be a readjustment that is necessary. Unemployment is falling to levels seen just before the 2008 financial crisis, so we may getting back towards full capacity, and this can mean inflation taking off. By freeing up a million jobs from the public sector, we could end up with the supply curve moving outwards – so long as the loss of public sector jobs is not felt by the wider economy.
Bonds see borrowing build up for sub-Saharan countries Maddy Johns Countries within Africa have seen a growing trend of sovereign-bonds, where government debt is sold in return for a healthy yield. As African debt is growing, so is the reliance on private sources for borrowing – and result is increasing demand for bigger yields. This will happen when the world’s interest rates and investment returns normalise – a likely situation from 2015 onwards. On the whole, Africa’s debt to GDP ratio remains low due to a fast growing GDP, but some countries have seen their debt rocket to 70% of GDP. Growth in African GDP can be largely attributed to high levels of government spending, but this has also seen huge budget deficits in Sub-Saharan countries. This is yet to put off private investors due to low returns currently from western economies, but if the predicted growth of the world economy materialises in 2015, Africa’s creditors may be less forgiving.
Is Globalisation making a comeback? Panashe
The financial crash of 2008 caused huge shifts in economic behaviour, and there was a retreat from globalisation to what might be termed ‘de-globalisation’. Globalisation has four types of crossborder flows, in people, goods and services, capital and information / technology. The fear is that since the crash, trade has been curbed, rather than enhanced, yet the WTO projects that, with its first global pact in 20 years, there could be a $1 trillion boost to the world economy. Projections are that global interdependence will be significantly greater by 2025 on current trends. China looks set to liberalise its financial markets, and along with its status in the world’s global supply chain, this could be highly significant for the global financial system.
Russia still bullies Ukraine
Anisa Connie Russia’s state run energy giant Gazprom is still seeking agreement for upfront payments for gas imports. Ukraine has not been able to convince Russia that it can pay in advance for gas supplies over the coming winter. Ukraine are hoping to resolve the issue with help from the European Union, but Russia seems to be involved in disputes in eastern Ukraine, where there is a large Russian population. Russia increased the price it charged for gas after annexing the Black Sea peninsular of Crimea from Ukraine, in March. On top of this, the fighting has hit coal production in Ukraine and it is also struggling to get supplies from Russia. It could be a long, cold winter for Ukrainians…. Panashe Russia’s economic slowdown has been catastrophic. It is down to lack of economic integration and a failure to make structural reforms which would have helped the economy diversify. Central Asia has grown and diversified, but this has not benefitted Russia in any way. Since Russia annexed Crimea, the European Union and the USA have imposed sanctions on Russia. These have been criticised for not going far enough, but, coupled with the recent fall in the price of oil – Russia’s main export, there are far-reaching problems ahead.
GDP Shock sends Japan stumbling back into recession Liiza Tu
Japan has fallen back into recession an Prime Minster Shinzo Abe will now postpone a planned rise in consumption tax and call a snap general election in an attempt to consolidate support for his ‘Abenomics’ growth strategy. Private consumption, which makes up more than half of the Japanses economy has grown by only 0.4%. Business investment has fallen by 0.2%, and housing investment by 6.7%. The idea of a consumption tax (like our VAT) is highly unpopular in Japan, even though the rate is less than half that of the UK. Professor of economics at Yale University, Kochi Hamada opposes the idea of a consumption tax saying that “A tax rate increase is meaningless if it slows the economy so far that is does not increase tax revenues.” She added that Mr Abe should cut corporation tax instead, thereby stimulating economic activity. Mr Abe has opposition from the powerful Ministry of Finance and the governor of the Bank of Japan Haruhiko Kuroda who agree that any delay in reducing the national debt, which is the highest in the world at more than 240% of GDP, could have severe consequences.
State of the UK….. and some good news at last. Harriet Woznizk and Alex Egbnike
Economic data for the UK is dramatically changing. Since 1950, growth had been around 2.5% but from 1980 to 2007, average growth has been over 3%. In 2014 the UK is expected to outpace the other G7 economies, growing by 3% once more. Why? 1) The Euro Crisis seems to have eased, the relatively high inflation of 2011-2012 has eased, with consumption picking up again and there has been a stimulus from ‘Help to buy’ in the housing market. 2) The UK has also benefitted from the new method of measuring GDP. GDP growth has been 0.5% higher as a result between 2009 and 2012. Growth for 2014 could now reach 3.5% based on this data. It is good that the UK economy is improving as we have seen positive figures this past month on employment and inflation and positive news on economic growth. Wages are finally growing by more than inflation, and with prices falling at the petrol pumps, it could be a merrier Christmas than expected for many. Let’s hope it continues. We are set to lead the G7 in growth this year, but we must remember that interest rates are still very low and the public finances are not improving as quickly as expected.