Equilibrium Lite

EQUILIBRIUM LITE IN THIS ISSUE UK AND GLOBAL NEWS UPDATES HOW DO HUMANS REALLY RESPOND TO INCENTIVES? THE IMPACT OF COVID-19 ON INEQUALITY ARE WE SACRIFICING A GREEN RECOVERY FOR A FASTER ONE? WHAT DOES BREXIT MEAN FOR TRADE? AN ECONOMIC POLICY RETHINK OCTOBER 2020 ISSUE 1

UK NEWS UPDATE JAY BATAVIA The UK economy may have grown by as much as 17% in the three months leading up to the end of September, according to the economic forecasting group, The Item Club, at Ernst and Young (one of the largest accounting and professional services network firms in the world), but slower growth is expected to follow. Consumer spending bounced back strongly in the summer as lockdown restrictions were lifted, whilst activity in the housing sector has also intensified, in part thanks to the stamp duty graceperiod (when the tax paid for when purchasing a property was reduced by the government). However, the end of the government furlough scheme, under which workers had part of their salary paid by the government, will mean greater unemployment and sluggish growth. Moreover, recent forecasts indicate that, even if further virus outbreaks are contained and major restrictions on economic activity are avoided, consumers and businesses will remain cautious in their behaviour (meaning they will be less willing to spend money or invest) for an extended period, further hindering the country’s economic growth.

The Bank of England (BofE) has moved a step closer to implementing negative interest rates, after writing to banks and asking them how ready they are for this groundbreaking decision. The BofE cut interest rates to 0.1% at the start of the pandemic and has been looking into the possibility of following the example of other central banks, such as the European Central Bank, which have deployed negative interest rates for some time now. Previously, policymakers have been cautious about pushing interest rates below zero, due to concerns that doing so would harm high-street banks’ profitability and lead to a back-lash from savers. Banks make profits by charging a higher interest rate to borrowers than they do to savers; traditionally, it was thought that negative rates would lead to a narrowing of this ‘spread’.

A post-lockdown boom in Britain’s housing market pushed a gauge of house prices to an 18-year high last month, but the outlook is rapidly darkening ahead of an expected rise in unemployment (currently 4.5% as of the 13th October). The Royal Institution for Chartered Surveyors (RICS) said its house price index unexpectedly rose to +61 in August, the highest reading since June 2002. This upsurge in activity in the housing market was spurred by a release of pent-up demand following the lockdown, people seeking bigger homes, and a temporary cut to the stamp duty. Though, 700,000 people have lost their jobs since the beginning of the pandemic, and once the government furlough scheme draws to a close at the end of October, demand and eagerness to buy will plummet, potentially leading to a slow-down unlike ever before.

GLOBAL NEWS UPDATE JAY BATAVIA An additional 150 million people could be placed into a state of extreme poverty by the end of next year, as conflict, climate change and the COVID-19 pandemic have conjoined to end two decades of progress in raising the living standards of those on the lowest incomes. Extreme poverty can be understood as a condition characterised by a severe lack of basic human needs, including access to food, safe drinking water, shelter, education and sanitation facilities. According to the World Bank, the proportion of the world’s population living on less than $1.90 per day was expected to rise from 9.1% to 9.4% during 2020. In the absence of the coronavirus outbreak, it is estimated the poverty rate would have fallen below 8% during 2020. Eradicating poverty by 2030 has been established by the UN as one of their sustainable development goals; however, the World Bank has commented that this is now impossible without there being rapid and momentous action. In ten years, 7% of the entire world population could still be living on less than $1.90 per day.

The Nobel Prize for Economics was awarded in early October to two American game theory specialists. Paul Milgrom and Robert Wilson won the award for 'the designs of mathematical models that endorse ‘improvements to auction theory and inventions of new auction formats’. Auction theory is a branch of game theory that was developed in the late 1970s, after a group of researchers set about constructing mathematical models that proposed incentives and information into the auction bidding process, maintaining a fair market and preventing collusion among bidders. The theory developed by Milgrom and Wilson has helped design new formats now used to sell diverse products such as fishing quotas, airport landing slots and electricity allowances.

China’s economy is currently experiencing its fastest growth this year, as Chinese firms seize market share from rivals that have struggled during the pandemic. Since February, China has kept cases to a minimum, allowing domestic firms to take advantage whilst global competitors grappled with reduced manufacturing capacity. Chinese factory activity has grown, with exports from the second-largest economy in the world rising by 9.9% in September compared to this time last year. Moreover, China's imports grew at their fastest pace this year, by 13.2% after a fall of 2.1% in August, and thrashing expectations of a mere 0.3% rise. This strong trade performance suggests the country and its economy are set to make a substantial recovery over the coming months.

HOW DO HUMANS REALLY RESPOND TO INCENTIVES? NATASHA PITTAL AND MAYA TRICOTT Did you know that every decision you make is encouraged by incentives around you?

Everything you do has an incentive behind it. An incentive is anything that motivates a person to do something, however you may not have realised that sometimes incentives put into place in society do the opposite to what we may first think.

In ‘The Armchair Economist’ by Steven E Landsburg, the author uses the example of seatbelts to illustrate the human response to additional safety. Seat belts were first introduced to decrease the number of car accidents. However, when you give people that extra level of safety by being attached to their car seat, they consequently feel less at risk. Therefore, they are more inclined to drive recklessly and speed. Eventually this will increase the amount of car accidents yet decrease the amount of injuries per accident due to the use of seat belts. Overall, the number of deaths in car accidents remains approximately equal. This proves how people respond in ways the average person may not predict due to their human nature; they respond to incentives.

Incentives are a part of behavioural economics; a side of economics that studies the affect of psychological and emotional factors on our decision-making, on an everyday basis.

Many economic theories are based on rational decision-making. However, economists argue many people don’t make rational decisions, making the effect of incentives unpredictable. In this case we would assume the use of seatbelts would improve road safety, but irrational behaviour in society (such as reckless driving) makes this incentive very inconsistent.

Humans are constantly behaving irrationally in life, making it hard to predict someone’s behaviour. Peoples’ expectations and emotions can cloud their judgment which influences people’s perception and behaviour.

Therefore, although we use economic theories based on rational behaviour, the way people spend, save and use their money is not something we can ever truly forecast as everyone is different. We recommend reading ‘The Armchair Economist’ and ‘Predictably Irrational’ for a better insight into incentives and irrational behaviour in economics.

THE IMPACT OF COVID-19 ON INEQUALITY SEAN MORAN In the aftermath of the 2008 financial crisis in the UK, there had been little wage growth, leading to almost no reductions in income inequality and perhaps even a worsening of income distributions, as high-earning individuals’ incomes increased over this period.

Austerity policies by the government over the past 10 years have also impacted inequality. Many low-income individuals have had less spending power and lower incomes as a result of receiving fewer welfare benefits and because government spending on healthcare and education is being spread even thinner, exacerbating the impacts of the pandemic on inequality.

Most people in the bottom 10% of the income distribution work in sectors that were forced to shut down (e.g. hospitality), with over 80% of these being unable to work from home, meaning they may have been furloughed or made redundant over this period.

This would have increased income inequality as they would have received only 80% (or potentially even less than 80%) of their typical income, while others would have earned their full amounts.

The shutdown of schools throughout the pandemic has also caused educational inequality to increase in some areas. It is more likely that children from better-off families attending independent schools had a more active engagement with their teachers during lessons compared to state-school pupils studying at home.

However, this pandemic has also created opportunities, as an increase in working from home would be more helpful for more certain individuals, such as stay-at-home parents, as they would still be able to work while providing some form of childcare for example, and the increased time fathers were spending with children during the pandemic may help to accelerate changes in gender norms, reducing gender inequality. There may also be changes in attitudes towards the welfare system and the importance of key workers to society. It would be most beneficial in the long-run if the government tried to limit the severity of career disruptions or restrict the widening of inequalities in healthcare or education, created by the COVID-19 pandemic.

ARE WE SACRIFICING A GREEN RECOVERY FOR A FASTER ONE? EMMA CHOPPING AND TEMI ELESIN Climate change is an ongoing struggle, but the pandemic has caused a shift in government priorities. Towards the beginning of lockdown, with cars coming off roads, airports being deserted and factory workers staying at home, a 17% drop in global carbon emissions was witnessed, the lowest recorded level since 2006. Whilst the environment may have been repairing, the economy shrank by 20.4% in the second quarter of 2020: the UK’s first recession (two consecutive quarters of economic decline) since 2009. With bailing out the economy in mind, investing in a green recovery has not been the priority. In developing countries and petrostates (countries which have an economy heavily dependant on fuel), the domestic price of energy is often kept artificially low, potentially creating an opportunity to reform policies and let the markets determine prices.

However, with demand for oil already having dropped by more than a fifth, it’s unlikely they will do so. Niklas Höhne of the NewClimate Institute has said “Unfortunately, what we’re seeing more of is governments using the pandemic recovery to roll back climate legislation and bail out the fossil fuel industry.” Moreover, with the US pulling out of the Paris agreement on November 4th, it’s easy to be pessimistic about the future of the environment. Nevertheless, many countries have announced plans on how they will invest in a green recovery, though the UK’s proposed £3bn seems meagre compared to Germany’s £36bn. Many governments are unable to spend as much money on tackling global warming this year as they originally had planned. Huge plans such as democratic presidential candidate Joe Biden’s proposed $2tn investment in decarbonising the American economy have been announced with more to come, and whilst the pandemic has been a setback, there is still potential for a green recovery.

WHAT DOES BREXIT MEAN FOR TRADE? AALIYAH PATEL AND ZOE ST JOHN The EU is a group of 27 countries in Europe, tied by an economic and political alliance.

The union has helped foster long periods of economic prosperity, but as with any association, cooperation means weathering downturns together. For example, many argue that the European Central Bank failed to respond effectively in the 2008 global financial crisis, which caused the recession to be much more severe than was needed; this is an example of a reason that triggered the Brexit vote.

After Brexit, the UK will be free to seek trade deals with nations such as China and the US. The EU's trade surplus means, after Brexit, the EU will lose a major partner, heavily reducing exports. The UK is continuing to use the EU’s Common External Tariff until 31st December 2020, when it will be replaced by the UK Global Tariff. Some argue a freetrading Britain would no longer be held back by protectionist EU members, and it will free Britain from the ‘shackles’ of EU control. Britain has already signed its first major trade deal in September – and it means 99% of UK exports to Japan will be free of tariffs.

Although some argue that leaving the EU may allow Britain to make their own trade agreements, it is more convincing to argue that leaving the EU will seriously damage the UK’s trade and economy. With limited free trade agreements to rely on, GDP would most likely fall, decreasing the standard of living. Post-Brexit Britain will have to begin negotiations as an independent nation. This could lead to countries exploiting the UK by introducing higher taxes on British trade products, and arranging trade agreements is expected to be time consuming for the UK.

Despite the fact that Britain might benefit from exiting the EU, as they can make independent trade agreements with nations such as China or India, overall, Brexit will affect trade in the UK and EU, as both parties provided the other with a significant amount of resources.

AN ECONOMIC POLICY RETHINK MRS G LYONS The COVID-19 pandemic has led to a scramble to implement policies that six months ago would have been unimaginable. A weighty shift is taking place in economic policy, unseen since the Keynesian era made way for Friedman’s monetarism in the 1970s. The huge scale of government borrowing around the world has created some concerns. The IMF predicts that rich countries will fund $4.2 trillion in spending and tax cuts, with their main objective being to keep demand buoyant (and therefore jobs) throughout the pandemic.

But how is it being funded? The Bank of England (BofE), the UK’s central bank, became the first in the world to adopt direct monetary financing to fund government spending (‘printing money.’) This move demonstrates once and for all that the government need not depend on borrowing from private markets to finance spending. The idea of turning the government’s spending on to full blast alongside the BofE's financing has been called “modern monetary theory”. This unconventional approach allows countries that can print their own currency, such as America and Britain, to ignore conventional debt-to-GDP ratios.

The Fisher Equation suggests a rise in money supply, all else being equal, will lead to a rise in inflation. Inflation above 2% can cause problems for an economy; however, current experience is seeing huge increases in the money supply with the absence of upward pressure on prices (inflation). This raises the idea that there is no need to slow the growth of central banks' balance sheets, or indeed to raise interest rates from their zero lower bound to fight inflation, as it is not yet appearing.

Low inflation is the fundamental reason not to worry about the enormous increases in government spending / national debt. The question is will the UK government be able to spend their way out of the economic crisis brought about by COVID-19? Is this the age of free money?

EDITING AND DESIGN TEAM: ALY SHAMSI JAY BATAVIA ANJALI PATEL KARISHMA KARA STAFF SUPPORT TEAM: MRS G LYONS MS M SOROHAN

If you would like to write an article for Equilibrium Lite or want to find out more about the newsletter, please contact: ecosoc@habsboys.org.uk OCTOBER 2020 ISSUE 1