KEYNES ECONOMICS NEWSLETTER Â
Edition 2
TABLE OF CONTENTS
03 Strung Up its own Niche 06 Economics trip to Washington 08 Taking the bend out of the Phillips Curve 11 Should the UK stop calculating RPI?
Editors note:
Rihana Al Nabhani, Yash Bhansali and Aryan Oberoi
Thank you, again, for another amazing half term and brilliant beginning to the new one! Honestly, the society seems to be growing, not only in numbers but in quality too. We have simply been astonished by the diversity and complexity of both the articles in this edition of the newsletter and all the presentations. We had our youngest ever speaker give a talk on the dollar as the reserve currency – blowing away the sixth formers and teachers. We would like to take this opportunity to encourage all members and aspiring economists to use DKS as a chance to enrich their knowledge and we are always on the look out for new speakers – so do come and find us if you would like to lead a session. When it comes to the newsletter, we are looking to include book reviews and even increase the number of articles included so please do use this opportunity. Once again thank you for your continuous effort and support.
Strung Up in its own Niche Ed Joshua Mindanao It was not too long ago that the concept of the guitar hero dominated teenage minds in suburban homes across America. Yet, over the summer, an article by the Washington Post foretold of the electric guitar’s slow death, from the cultural perspective of a lack of guitar heroes to idolise. The rising popularity of disco in the 70s and EDM in the new millennium led to the days of the electric guitar being seen to be numbered. With current guitar manufacturers feeling the pinch of changing consumer preferences for music, is the death of the electric guitar finally in sight? Electric guitars have historically held the status of being luxury goods with average prices of standard catalogue entries playing from the $1,600 to the $3,000 range (in today’s prices) since their entry into the market in 1949, en masse . Though, the introduction of “entry-level” offerings by some manufacturers to extend their products to average households has kept them afloat for most of the years building up to the 2000s, such a strategy does not seem to hold up in today’s market. Guitar manufacturing giant, Gibson (full name Gibson Brands, Inc.), is a clear victim of this change in consumer preferences. Despite having a lower cost subsidiary manufacturing out of China under its licensure since 2002, Gibson’s performance within the last 4 years does not hold much hope for its dominance as a household name in the near future. A decline in profitability has the company, with an outstanding total debt of $520 million with regards to all its brands under its ownership.
This has forced a contraction in its productive capacity in its guitar branch in selling off its Memphis plant in search of a much smaller production facility.
But surely, a company with the second largest hand in the electric guitar market must have some, if not significant, control over its operations with regards to responding to changes in the market? Not really! Guitarists are some of the most irrational consumers on the planet as we know it. Quick to respond to sharp drops in the price of newer guitars they would normally keep their distance from due to the majority preference for older releases that may be relatively cheaper bought second-hand. The irrationality arises from the violation of the transitivity axiom in behavioral economics wherein consumers that prefer X (cheaper vintage guitars) over Y (brand new reissues of vintage guitars), Y over Z (brand new releases), and therefore prefer X over Z. Furthermore, the given kinked demand curve that electric guitar manufacturers face from an oligopolistic industry, lends itself to firms’ reluctance in lowering prices to get their products moving through the market. Simply said, most guitar players won’t buy a Gibson made in 2017 because they prefer a Gibson made before 2013, yet they would buy the former if at a price Gibson would be unwilling to sell at else they’d make losses. If you haven’t caught on yet, investment into research and development to “improve the quality” of their existing product line won’t necessarily help to boost demand for Gibson’s guitars. Guitarists do prefer older gear. Where do they find it? Well, most recently at Reverb.com. The online marketplace has experienced a three-year sales growth of 12,327.2% since its inception in 2013, making it one of America’s fastest growing private companies. Online services such as Reverb’s allows old stock of electric guitars, highly sought after more than brand new ones, only serve to keep a even more solid grip on consumers dissatisfied with Gibson’s already unfavourable responses to an age old preference: doing what they do best with truly classic guitars. Guitarists do prefer older gear. Where do they find it? Well, most recently at Reverb.com. The online marketplace has experienced a threeyear sales growth of 12,327.2% since its inception in 2013, making it one of America’s fastest growing private companies. Online services such as Reverb’s allows old stock Guitarists do prefer older gear. Where do they find it?
Well, most recently at Reverb.com. The online marketplace has experienced a three-year sales growth of 12,327.2% since its inception in 2013, making it one of America’s fastest growing private companies. Online services such as Reverb’s allows old stock of electric guitars, highly sought after more than brand new ones, only serve to keep a even more solid grip on consumers dissatisfied with Gibson’s already unfavourable responses to an age old preference: doing what they do best with truly classic guitars. Perhaps other companies have better luck? The current leading manufacturer of electric guitars, Fender Musical Corporation, was forced to abandon an IPO in 2012. Despite a positive outlook from its board, having cut down on its debt sufficiently to climb to a B1 credit rating, according to Moody’s, from B2, there is much ground for, not just Fender, the industry as a whole to make up.
All hope is not lost for the electric guitar though. Both Fender and Gibson are owners of a long list of subsidiaries involved in the production of other musically related products. Electric guitars may be what they are known for, but not necessarily their main source of income. Some of Gibson’s subsidiaries include Baldwin Pianos and DJ equipment brand Stanton. Thus, despite the decline in profitability of “new and improved” electric guitars in a guitar heroeless age, all may not be lost for electric guitars themselves. The production of such significant culturally iconic goods may be kept alive with their crosssubsidisation of gains in other divisions given the timelessness of piano in music in general and the current popularity of DJ produced music. Moreover, acoustic guitar sales have not suffered as badly, and are usually seen as gateways to electric guitars. Are electric guitars really on their way out? It’s hard to say for sure. Even if their profitability is on the decline for manufacturers, it does not necessarily mean they would stop their production. If things take a turn for the worse, an administrative period to rebrand their focus in the market is highly unlikely as it would mean giving up the heritage that got them to where they stand today. Perhaps they’re as irrational as their consumers in serving a niche market. Whatever it may be, the continued survival of electric guitar manufacturing in the face of rising popularity of electric-guitarless music just goes to show, “You can’t stop rock and roll.”
Economics Trip to Washington Pritvik Sinhadc On Friday, February 9, 2017, post-midnight hours, 17 supercharged students, including myself, from Dubai College, took off to Washington DC under the mentorship of two members of DC staff, Mr Ben Christopher and Ms Emma Caunt.
The 13-hour-flight did not diffuse our excitement of landing on Trumpland, and for the next seven days, the group took in everything the nation’s elite capital had to offer: From a monumental tour of the Einstein Memorial, Korean War and Vietnam Veterans Memorials, to Lincoln Memorial, Martin Luther King Jr. Memorial, etc, Mount Vernon, Capitol building, World Bank, Holocaust Museum, several Smithsonian museums like the National Museum of Natural History and the National Air and Space Museum, to the National Archives, Arlington Cemetery, Pentagon, including the National 9/11 Pentagon Memorial, and of course the zenith of power, the White House, the trip was nothing short of an ecstatic marathon adventure! A visit to Georgetown University was worth it as we met our very own DC alumnus Alesha Gulamhusein, who enlightened us on her campus experience. And if these were not enough, we even managed to watch NBA (basketball) and NHL (ice hockey) matches!
While the think tanks were some of the most fascinating points of the tour, the talks on how companies are run today by expert financial advisors gave us a glimpse of the economics of corporate world. This experience was enriched when we visited the World Bank and witnessed its incredible range and influence on various nations -- from Africa to Asia, and every developing country in between. We also dropped in to ACET, World Bank’s partner. However, given my passions in astrophysics and palaeontology, the trips to the National Air and Space Museum and the Smithsonian National Museum of Natural History were my main highlights. At the Air and Space Museum, we witnessed the development of flight, from the 1903 Wright Flyer (world’s first plane) to NASA’s rocket ships, and explored hundreds of the world’s most significant objects in aviation and space history. We also enjoyed a breathtaking show at the Albert Einstein Planetarium.
Celebrating the natural world, the National Museum of Natural History helped us delve into the fascinating story of our planet, from its fiery beginnings through billions of years of transformation and exploring life on Earth. We saw several exhibits, from the history and cultures of Africa, our earliest mammalian ancestor, the primate diversity, ancient Egypt and of course ancient life forms, including the ever popular dinosaurs of America. We also viewed life in the deepest parts of the ocean and saw the intricate process from which fossils are put on display. Overall, the trip was fabulous and I look forward to attending it once again next year!
TAKING THE BEND OUT OF THE PHILLIPS CURVE Yash Bhansali The Phillips curve marks the inverse relationship between Unemployment and Inflation, whereby the closer the economy is to full employment the higher the rate of inflation. The reason for this seems quite logical and, in the past, data has corroborated the chain or reasoning. The basic notion is that as unemployment falls and more people find themselves in a job, the supply of available labour decreases, and at the same time since demand for labour is high workers have more choices of where to work. As a result, employees are likely to take benefit of this and demand higher wages from employers which pushes the equilibrium wage rate in the market up. Since wages are a cost to any firm, in order to maintain their bottom line these firms are forced to engage in cost plus profit pricing whereby they increase the retail price of their good or service to maintain their profit margin.
However,
of recent it seems that some thing has gone
WRONG
with the Phillips curve, in post 2008 most developed economies such as the UK have both low unemployment and also low inflation. For example, unemployment in the UK is down to 4.3% and inflation is within its target range at 2.7%. It seems that for the first time, low unemployment has not been inflationary as it was expected to be, and this has caused a lot of economist to scratch their heads and wonder about this unusual event. To most it seems counterintuitive that such a situation should arise and it seems to contradict the basic laws of supply and demand that govern most economic thought‌ however as you take a closer look, it becomes easier to identify the probable causes for the flattening of the Phillips curve. The fact that high employment has not contributed to high inflation is primarily attributed to the fact that in recent years, a rise in employment has not actually increased the average wage rate. In fact in most developed economies such as the UK or Germany, wage growth has been stagnant for the past many years, and as such even though there is high demand for labour,and even though labour is in relatively short supply, wages have not increase.
The reasons for this are threefold: Firstly, the weakening of trade unions around the world but especially in places like the UK where Secondary Picketing and Closed shop actions were made unlawful in the 1990’s. the fact that unions have lost much of their negotiation power along with that the fact that fewer workers now subscribe to these unions, means that it has become tougher for them to bargain for higher wages. It appears as though there is less pressure on employers to increase wages as the threat of union strikes have diluted over the years. The second reason for low wages, is the apprehension of workers in developed nation of their jobs being lost to globalisation. All over the world there is raging propaganda surrounding globalisation, and there is significant attention to the movement of the production process of many MNC goods to developing nations such as China or India where labour (which is in abundant supply) is far cheaper and thus more competitive. As a result, factory workers etc in developed nations are fearful to ask for pay rises as there is always the risk that if production costs in the UK become too high, firms may just move production overseas creating unemployment back home. As a result, those working in the secondary industry in developed nations are willing to work for peanuts , because they are fearful that the alternative is being replaced by cheaper Chinese labour and having no income at all.
The final reason
...
for the breakdown of the Phillips curve is the substitutability of capital with labour. Having just come out of the 3rd and now having embarked on the 4th industrial revolution, the rate of technological development is greater than ever before. As a result, we are constantly developing technology that can outperform humans at more tasks by displaying a higher level of efficiency and by mitigating any human error whatsoever. Such technology is especially hurting jobs in the secondary sector such as production and manufacturing. This has increased the downwards pressure that employers can put on wages, because they now have the option of replacing labour, which demands higher wages, takes days off, requires insurance contributions, and poses the risk of strikes etc, with AI that can perform the task at an equally or perhaps more efficient level, and does not require any additional fringe benefits or contribution. As such the dependency of employers of human capital has significantly reduced and this too has allowed wages to remain in check. Overall, it has become clear that in today’s rapidly developing and interdependent world, the average worker has lost the negotiation power they once had and have become more and more vulnerable to an everchanging landscape that puts them at risk of unemployment and prevents their wages from growing.
It seems that more than the relationship between unemployment and inflation, it is the relationship between employer and employee that risks being strained. PS: Be sure to check out The Argumentative Economist for more interesting reads
Should the UK stop calculating RPI? Aryan Oberoi RPI, the UK’s most disliked index has been ridiculed and pushed aside over recent months in the news and media as many global financial and economic heads call for its retirement. The UK officially outcast the index With Mark Carney himself, the Bank of England (BoE) governor, stating the metric simply “has no merit” many would say the ill-fated index’s time has come and its time to bid RPI farwell. But with £400bn index-linked government bond market’s investors minting money off of the RPI’s downfalls,
is there enough backing for opposition to drop the RPI? RPI had long been the UK’s primary calculation of inflation until the 2012 where the ONS (Office of National Statistics) officially dropped RPI as an inflationary measure prefering the widely used Consumer Price Index. The RPI has lost its status as a trusted inflation measure since 2012 when the Office for National Statistics found that an obscure change in the way it collected the price of clothing exaggerated the difference between it and other measures of inflation which show prices rising at a slower pace. The main argument was that the RPI was seriously flawed in calculation. This is based on the Carli Index developed by an Italian economist in 1764 and is the arithmetic mean of the price relative between a period t and a base period. This index has a historical and proven tendency to overstate inflation even when there is no increase in price over successive quarters. Thus, the RPI tends to provide a higher value for the inflation rate which the UK government would prefer to avoid as this would negatively impact other import measures such as Real GDP, economic growth, FDI etc. (Fig.1) Furthermore, the ONS introduced a new measure of inflation CPIH which includes the same basket of goods as the CPI with the additional costs of maintenance of housing – essentially an updated version of the RPI.
Based on these facts it seems the world has moved on from RPI, however the opposite has happened. Financial heads seem obsessed with removing the statistic from existence all together calling for the ONS to stop calculating it at all. This seems like a fair argument considering the evidence presented. However, the ÂŁ400bn index linked government bond market would argue otherwise. Even though the RPI is no longer an official statistic, it is still required to be calculated by law and determines the prices in the index-linked bond market. As global inflation fears rise due to the unconventional monetary policy steps taken over the last decade, bond yields are rising and the Vix gauge of volatility is high. As investors rush to buy inflation protection, opposition from the government to RPI should increase as the BoE has to pay out substantially more interest on the bonds. However at the same time, investors in the inflation protection bond market will argue the change as they would see their current yields fall.
The UK is the only “rich� country still using calculating a measure of inflation based on the Carli Index. If completely scrapping the RPI is not an option due to the index linked market, then changing the calculation may be. At the end of the day, RPI is a flawed metric and there is no arguing that. Especially with competition such as the CPIH, it seems unlikely that FIs will ever return to the RPI. If the bond market is the only blockade stopping a change in the law and removing RPI from long-term contracts, a switch should happen. Of course there would be a big correction in the market however in the long run, the benefits of using a more modern, widely used and accurate measure of inflation far outweigh a temporary drop in bond yields as the market adjusts.