Issue 17 by Nottingham Economic Review

Issue 17 NOVEMBER 2016

Making the Most of the Refugee Crisis

Inside This Issue

Interviews with Vince Cable, Robert Chote & Michael Jacobs

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Letters

The Nottingham Economic Review

Foreword

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Foreword As I write this foreward, there are many uncertainties in the world around us: the future for Greece under its new government and the impact on the Eurozone; the decline in the price of oil – great for consumers, less so for producers and exporters; the political arguing in the UK around austerity or support for the NHS; the discussions around TTIP (Transatlantic Trade and Investment Partnership) between the EU and US; the apparent inequality in the distribution of wealth both globally and within countries; and as we come out of the warmest year in history, continuing debate over climate change and global warming. The real joy of being an economist is that we can use our analytical eye to explore all these a myriad of other problems that face the global economy now and in the future.

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To that end, students within the School of Economics have always been keen to apply their learning, knowledge and interests to a plethora of fascinating topics and the Nottingham Economic Review continues to be an excellent channel for sharing these thoughts. The quality of the thinking, the writing and indeed the sheer energy in researching these pieces has been a hallmark of the NER since its inception. I am delighted that it continues to offer this opportunity and equally I am very pleased again to offer my support to this latest edition. What I hope is that the readers of the NER will gain insight into areas of topical concern in a written style that is informative and communicates economic analysis in an appealing and intuitive fashion. I hope too that it prompts the reader to think further about these subjects, to find out more through research and indeed most importantly to be inspired to write their own article for the next edition. I sincerely hope this is the case but whatever your motivation for reading, I hope you enjoy it and will come back for more in future editions. Incidentally, those of you who are loyal readers will appreciate that this is possibly the first time in ages I haven’t mentioned my own research interest in food and food prices. For that you may be grateful, but who knows, maybe next time there might just be some food for thought from me! Professor Wyn Morgan Assistant Pro-Vice-Chancellor for Teaching and Learning & Professor of Economics

Dear readers, On behalf of the NER team, it is our pleasure to present the 17th issue of the Nottingham Economic Review. Now in its 9th year, the NER continues to build on the success of previous issues, offering students from Nottingham and other universities around the world a platform to engage with a range of current economic and political themes. This issue includes a selection of external submissions and articles written by our editorial team, as well as a special contribution by Nottingham alumni Philip Watson. Economic analysis of current topics such as the Paris terror attacks, Europe’s ongoing refugee crisis, and what Corbyn means for UK businesses are but a few of the diverse and gripping pieces that make up this edition. Our interview section is definitely not to be missed, featuring dynamic discussions with Sir Vince Cable, former Secretary of State for Business, Innovation and Skills, Michael Jacobs, Senior Advisor on International Climate Change Policy, and Robert Chote, current Chair of the Office of Budget Responsibility. We would like to extend our gratitude to the many people who make the NER possible through their continued support and dedication. The School of Economics, in particular Kevin Lee, Hilary Clayton, Sue Berry, Sue Andrews and Richard Kneller, continue to be of vital support in all aspects of the production of the publication. Without Philip Watson, a University of Nottingham alumni, the NER would not exist in its current form, and we thank him sincerely for the wonderful opportunity he has provided us with. Special mention must be made to our Head of Design Jason Sayer, who has worked particularly hard this year to create our new website, as well as our team of Associate Editors for their contributions. Finally, we thank our readers and everyone who has taken the time to contribute to the NER. Sophy Rolson and Diana Beltekian

Congratulations to our September 2016 Prize Winners Gainsborough Prize Winner: Chris Brownlie, The Economic Consequences of Terrorist Attacks

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The NER Team

The Nottingham Economic Review

Contents

The NER Team About us: The Nottingham Economic Review is a student run bi-annual journal whose purpose is to showcase undergraduate research and promote ongoing advancements in economic thought. Every semester we gather submissions and publish those that we believe contain the most thought provoking, insightful arguments while simultaneously capturing the interest of our readers. We also publish a section dedicated to features and editorials concerning current affairs alongside interviews and Q&A sessions. Co-Editors in Chief Sophy Rolson Diana Beltekian

Special thanks to Phillip Watson Hilary Clayton Sue Berry Sue Andrews Louise Hemming Prof. Richard Kneller

Associate Editors Ashita Gaglani Apoorva Bihani Steven Thavendran Joshua Chan Fausto Gernone Tom Dooner Rushabh Malde Matthew Hills

03 Foreword and Prize Winners 04 The NER Team 05 Contents Features 06 Assessing the consequences and motives behind the French bombings - Thavendran 08

Contact: General: team@neronline.co.uk Advertising: team@neronline.co.uk Submissions: team@neronline.co.uk Website: neronline.co.uk

Magazine Design Jason Sayer

Sponsored by EY

Features 11 Why would a Moroccan man who doesn’t have enough to eat buy a television? - Dooner 13 Wages Around the World - Bihani 15 Why economists are worried about the UK’s current account deficit - Malde 13 Wages Around the World - Bihani 16 About Time: America’s Interest Rate Rise - Beltekian 17 How the Chinese Stock Market has Become the Biggest Casino in the World - Juan Yin 20 Jeremy Corbyn and Business: Friend or Foe? - Thompson

Research 28 FDI, Economic Growth and Emissions in Developing Countries - Tripathi

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[Interview] A Conversation with Michael Jacobs - Rolson & Beltekian

[Gainsborough Winner] The Economic Consequences of Terrorist Attacks & Resulting Policy Implementation - Brownlie

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[Interview] A Conversation with Sir Vince Cable - Malde & Hills

Cover Story 24 Making the Most of the Refugee Crisis: A Guide for Beginners - Gernone

GET INVOLVED!

[Interview] A Conversation with Robert Chote - Olutola

Special 10 The Price of Natural Rubber (NR): What causes the Spikes? - Watson

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36 Understanding Generation Rent - Rolson

THE PREDICTABILITY OF MARKETS: CAN FINANCIAL CRISES BE PREVENTED?

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DOES AN INCREASE IN HEALTHCARE SPENDING NECESSARILY MAKE US BETTER OFF?

Prize Competition Former Alumnus Philip Watson is offering a £100 prize to all our readers who can solve this problem. The semi-mathematical problem requires “De Bono” thinking.

Submit your research and articles to NER £750 Gainsborough Prize for the Best Submission For more info, including our latest issues, visit www.neronline.co.uk or email team@neronline.co.uk

Drilling a cube: A cube of 1 unit side is drilled through from all three sides with a drill size of 1 unit in diameter. What is the volume of one of the eight corner pieces that remain? Clue: Philip at university was considered ‘a square’ and not ‘a mod or rocker’! There is a solution available if required. The prize will be given to the first timed and dated by email that is correct. Please email the answers to team@neronline.co.uk

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Feature

The Nottingham Economic Review

State, anti-ISIS hatred could overshadow the root cause of why Syria has become so defunct. The crimes and problems circulating around President Bashar al-Assad may be forgotten, a point that was keenly stressed by Hollande, a prime advocate of removing the leader.

Assessing the consequences and motives behind the French bombings Steven Thavendran (BSc Economics, ‘17, The University of Nottingham)

The Bataclan in April 2008 (Courtesy Céline via Wikipedia)

ollowing the November 2015 attacks, François Hollande described the bombings as an “act of war,” an act that would later lead to France destroying the Islamic State. The strategically organised attacks resulted in almost 130 people dead with a near equivalent in a critical or wounded condition. What came to the public eye first was the suicide bombing outside the Stade De France, where the tremor and bellow from the bomb was heard during the international friendly that was held in the stadium. However, more horrifically and bloody were the scenes at the Bataclan concert hall, where three gunmen opened fire at a defenceless concert crowd that had just attended to see the American Band, Eagles of Death Metal. The scenes were nothing short of a large scale massacre as 89 people ended up losing their lives as the assailants shot their assault rifles, with many initially assuming the gunfire to be pyromaniacs as part of the show (BBC Europe, 2015). What quickly ensued following the crisis was worldwide political support from high ranking political officials across the globe as well as a strong social media support, all demonstrating unity under the face of adversity. Laird (2015) adds that following the bombings, the CAC 40, the French stock exchange, opened sourly. This is to be expected after an event of that magnitude

occurs on French soils. Reassuringly it returned to a modest level shortly following. However, the effect on the stocks of aviation and cruise line organisations weren’t as lucky, with both suffering a heavier burden as their shares plummeted from ongoing fears of further terrorist attacks. The effect on retail will also become more pronounced in January as retail outlets will have more than likely suffered a fall in sales this Christmas as families faced a sudden increase in their agoraphobia. The full economic effects deriving from the bombings will become more noticeable soon with many hoping the effect to be minimal at best.

Francois Hollande believed France was targeted because it is a “nation of human rights” where everything is “free” As with any terrorist attack the organisation that ‘masterminded’ such a sinister, brutal attack was quick to claim their credit with the IS saying they had planned the attack as a response to the French bombing in Syria. This also became apparent during the tragedy as the aggressors shouted several adages about the Syrian war and their religion (Rachman, 2015).

The Nottingham Economic Review

Whilst the motive seems clear, in contrast, Steafel (2015) claimed that Francois Hollande believed France was targeted because it is a “nation of human rights” where everything is “free.” Ultimately following on from this crisis, questions are being raised about French foreign policy. What can be certain is that the recent calamity has incited the masses to support further intense bombing of Syria, and the eradication of the Islamic State. Worryingly this spark of hatred has spread into the support of The National Front - the EDL’s French equivalent. The party has gained a favourable following in recent years, enough so that Marine Le Pen, the female leader of the party, became third in the 2012 French presidential election. One of the key policies underpinned by Le Pen is the tightening up of borders, a policy that, invoked by the November bombings, has led to E.U. ministers to discussing a similar proposal. Depressingly this has come at a time when immigration into Europe is needed and is occurring with a huge amount of Syrian refugees leaving the war torn country and needing urgent help. Ultimately this will put more pressure on Merkel, as Rachman (2015) mentions, who despite constantly proposing immigration to be more free, may be forced to adopt a different stance due to pressure from within the EU. Amidst the turmoil surrounding the Islamic

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Feature

previous examples, with the Madrid attacks in 2004 following this rationale. Following the Madrid train bombings in 2004, three days before a highly anticipated election, voting for socialist candidate

to suffer through seeing their loved ones in a critical condition. What has always been worrying about the IS is that they act in an irrational manner, one that has nothing significant to lose. As Balthasar Gracian wisely spoke, “never contend with a man who has nothing to lose.”

Questions have been raised asking Of course this is whether there no real option with was method to the general sentiment madness and was being one that wants there any significance to remove the terror in these bombings organisation. The in their much larger Islamic State will plan. Hamid (2015) likely always continue believes that there to be a threat; they is some sort of are, as their maxim structural thinking goes, “remaining and within the largely expanding.” mysterious group. The most important They will always question in all this persist as one cannot was what was ISIS easily, or even at all, aiming to achieve by get rid of an ideology, their brutal showing French police gathering evidence at the Bataclan theatre on 14 November (Courtesy Maya-Anaïs Yataghène via Wikipedia) but the latter can be in one of the ‘more changed through the militarily powerful Western countries?’ Zapatero increased culminating in his current course of action. However, what will victory. What is really important was that also increase through the current course of The general consensus was that the militants one of his key pre-election promises was to action is the number of innocent civilians were expressing revenge and a message to pull Spanish troops out of Iraq – a promise caught up in all the mess. France to remove their presence in Syria. he upheld following his victory. However, their actions have been perfectly irrational simply because the end product has been further bombing in the war torn country. Almost immediately after the attacks further bombings were announced, including the large scale bombing attacks on Raqqa, Syria – rumoured to be the Islamic State bastion (Doherty, 2015). Even with the benefit of hindsight on our side it was clear that such attacks in France would only prompt further military action against the recipient group; after all it’s clearly known that governments ‘do not negotiate with terrorists.’ This is the expected outcome when a small terrorist group damages the national security of a Western superpower. However, there may be a method to the irrationality behind ISIS’s activities as Hamid (2015) suggests. One could assume that their bizarre method of thinking was that a large terrorist attack could lead to reduced active involvement within Syria. This isn’t so farfetched an idea when considering

What has always been worrying about the IS is that they act in an irrational manner, one that has nothing significant to lose Knowing that there is even some rational thinking behind the Islamic State’s terrorist actions would be highly advantageous in pre-empting behaviour. But on occasion, as we all know, there have been times where their instrumental rationality has been questioned. Without even basic understanding and rational actions from ISIS, negotiation is out of the question– a point that has been understood by nearly all of the Western powers for several years.

References

BBC Europe (2015, December 9) http://www.bbc. co.uk/news/world-europe-34818994 Doherty, B. (2015, November 20) http://www. theguardian.com/world/2015/nov/16/francelaunches-massive-airstrike-on-isis-stronghold-insyria-after-paris-attack Hamid, S. (2015, November 23) http://www. theatlantic.com/international/archive/2015/11/ isis-rational-actor-paris-attacks/417312/ Laird, L. (2015, November 16) http://www. forbes.com/sites/laurielaird/2015/11/16/the-parisattacks-and-the-economic-impact-of-terrorism/ Rachman, G. (2015, November 14) The global consequences: http://www.ft.com/cms/ s/2/7b201298-8ab1-11e5-a549-b89a1dfede9b. html#axzz3ut7dltBL Steafel, E. (2015, November 21) http://www. telegraph.co.uk/news/worldnews/europe/ france/11995246/Paris-shooting-What-we-knowso-far.html

The consequences of the French bombings have been dire with over 130 people losing their lives and many more people having

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Interview

The Nottingham Economic Review

A Conversation with Robert Chote

British economist and current chairman of the Office of Budget Responsibility

The Nottingham Economic Review

The government has now got to a situation where it looks like debt as a share of GDP is going to fall this year on the basis of the last published forecast we did, primarily because the government is selling a lot of assets.

Interviewed by Yinka Olutola (BSc Economics, ’17, The University of Nottingham)

.obert Chote, Chair of the Office for .Budget Responsibility, visited the .university in October 2015 to give a public lecture entitled: ‘Reflections on our First Five Years’.

I think one thing to bear in mind is that the outcome – the history you’re trying to explain and the history you use to try to estimate the

look a lot less over optimistic than they did at the time. That’s one reason why I think you have to be pretty wary of these sorts of multiplier estimates because you have to make judgements on these sorts of things.

The OBR was established in 2010 to produce forecasts, judge the government’s performance against its fiscal targets, and assess the long-term sustainability of the public finances. In the case of the UK budget deficit, is austerity doing more harm than good in your opinion? One thing that we’ve concluded is that if we announce tax increases or spending cuts, it’s going to depress activity in the economy in the short term, but there is a huge debate about how much that is the case or not. In the forecasts that we produce, we have to make judgements about the impact that’s going to have, using multipliers as a way of estimating this. This was particularly the case in June 2010 when the coalition government came in and they announced that they wanted to do a bigger fiscal consolidation and they wanted to do it more quickly. We concluded then that the policy decisions that have taken place since 2008 – an initial period of fiscal stimulus followed by a period of contraction – probably ended up depressing activity or real GDP by something over 1%. That’s partly because you have the initial stimulus which has some lingering effects, and then you have the contraction as well, so it’s not a clean estimate of what just the contraction would do. Clearly there’s debate about that. If you look at the work of the IMF, some analysis they produced suggests that the multipliers would be bigger and therefore the impact of that would have been bigger, some would suggest it was smaller, some roughly the same size.

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Robert Chote on BBC Newsnight on July 2015 (Courtesy liarpoliticians via YouTube)

effects fiscal policy has had on the economy in the past – that history is re-written quite a lot.

“Policy decisions that have taken place since 2008... Probably ended up depressing activity or real GDP by something over 1%” So if you look at the way the Office of National Statistics has re-written the history of this economic recovery over the last couple of years, they now suggest that the recession was shallower and the recovery was stronger than you would have thought if you looked at the numbers that were published in 2013. So if one was to ask the question: ‘How much might fiscal policy has explained why you were over optimistic about your growth forecasts in 2010?’ The funny thing is you now look back and our earlier forecasts are more accurate than the ones we produced in 2013 because history is being nudged back up towards what still remain over optimistic forecasts, but they

But when you consider that we’re re-writing the history not just of this recession and recovery but of the 1990s and 1980s, statistical relationships between what fiscal policy has done and how economies behave is constantly evolving and as soon as you think you’ve got the answer it slips out of your fingers.

How concerned should we be that the national debt remains high at over 81% of GDP? Our job is to do a projection of this, not to say what is too high or too low. There’s clearly a lot of literature around, some of which would say there is a particular level of the debt-to-GDP ratio at which you should start to worry. Some people would start to worry at 80% and some would start to worry at other levels. My personal view is that there isn’t some magic number beyond which it’s disaster but if you’re the other side it’s fine – circumstances are going to be different in the wake of each sort of recession or recovery and it’s hard to put a number on it. I personally would be happier with a higher debt ratio that was falling rapidly than a lower debt ratio that was rising rapidly. We had a very high debt ratio coming out of the second world war which then fell consistently over a very long period. I think if you went a few decades after the second world war and had what in today’s terms would look like a very high debt ratio but it was falling sharply, you might be less worried than a situation where it was going up a lot.

In future years the fiscal repair job on its own is probably enough to keep the debt-to-GDP ratio falling. There’s then a debate about how quickly you want it to fall. Some people would argue you should get it down very quickly because there may be another recession around the road that will push it up again. On the other hand, Simon Wren-Lewis at Oxford made the argument quite strongly that once you have an increase in debt you want to reduce it relatively slowly. That’s not a choice for us to make but it’s one that’s a live debate. Certainly in the forecasts we’re producing it does now look like debt is coming down as a share of GDP but still rising in cash terms. Do you think the budget balance will be significantly affected by the EU referendum? I think in the process of coming up to the EU referendum, one issue will be that you’ll have to look out for is whether the referendum and what people think the results will be creates uncertainty which affects the way consumers and businesses behave. That’s something I think we’ll need to keep an eye out for. It may be that we’ll be looking at the behaviour of business investment intention surveys and consumer confidence surveys and some people may say: ‘Well, is this being driven by the referendum?’ I think it would be very hard to prove it one way or the other but it is doubtless something that people will be talking about. In terms of the outcome, a lot then depends on what negotiations are taking place either side of it. Because we are required by parliament only to look at the current policies of the current government, until it becomes the policy of the current government to leave the EU, we are restricted to looking at the world if we stay in. If the referendum were to be a vote in favour of us leaving, at what point that becomes a government policy to leave and we have to start producing forecasts on that basis I’m not sure yet. We’ll have to wait and see how that turns out.

Interview

Can our public finances cope with admitting greater numbers into the country in the wake of the migrant crisis that is currently going on? Generally speaking, we produce long-term projections for the public finances and we produce those projections looking at different sets of population projections produced by the Office of National Statistics.

“Inward migrants are more likely to be of working age than the native population on average. So essentially speaking, somebody else has paid to educate them” One of the variants is more or less inward migration, so we can crunch the numbers on that. Generally speaking the conclusion that we reach is that higher net inward migration is generally positive for the public finances over the 50-year horizon you would be looking at. The simple reason for that is that inward migrants are more likely to be of working age than the native population on average. So essentially speaking, somebody else has paid to educate them. They may leave before they get to the point at which they’re really expensive in terms of pensions, health, and social care.

“If you have net inward migrants coming in and GDP per head were to go up, then you’ve actually got more real spending on schools and hospitals”

clearly there are distributional issues about whether you need a particularly greater amount of public spending in particular areas in response to the patterns of migration that is obviously well out of our remit. But from the perspective of us and from the perspective of most fiscal watchdogs and forecasters, higher net inward migration because of the working age tends to be positive over that sort of horizon. So it’s less a case of can we cope with it and more a case of it would be beneficial. The fiscal impact at a national level is clearly only one of the factors that leads governments to make decisions on migration policy. One area where some people would say, for example if you look at the analysis that we’ve done, ‘Ah, what we don’t take into account is that when you have more migrants coming in is that we need to spend more money on schools and hospitals etc.’ Well actually we do take that into account at a national level because we assume that things like schools and health and defence spending are constant as a share of GDP adjusted slightly for demographics. As a result, if you have net inward migrants coming in and GDP per head were to go up, then you’ve actually got more real spending on schools and hospitals and things as well, so you do take that sort of thing into account. However, I think obviously in public policy terms, if you’re worrying about things like does this place particular pressure on housing demand in a particular area of the country, then that might be an important policy consideration. It wouldn’t necessarily lead you to the conclusion that you have more or less migration – it might lead you to the conclusion that you have a different housing policy. The NER would like to thank Robert Chote for his time and effort in participating in this interview.

Moreover, on the analysis that we’ve produced, the projections on relatively high net inward migration tend to give you lower budget deficits than lower net inward migration. That’s not to say that we are therefore concluding that you should have more net inward migration – governments could take other policy choices that offset those, and

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Special

The Nottingham Economic Review

Feature

The Nottingham Economic Review

The Price of Natural Rubber (NR): What causes the Spikes?*

Why would a Moroccan man who doesn’t have enough to eat buy a television?

Phillip Watson (BA Hons. Economics; Chief Statistician, IRSG 1979-2002)

Tom Dooner (BA Economics and Politics ’17, University of Nottingham) Rubber plantation in Malaysia with the extraction process underway (Courtesy Craig via Wikipedia)

Supply Basics ..he production of NR is obtained by tapping the rubber tree (Hevea Braziliensis). However the tree takes 5–7 years after planting to mature sufficiently to be tapped and its peak production period is from years 10–20 of its life. After this the latex flow declines until around year 25–30 when the tree should be replaced.

Thus, the maximum potential output of NR over the next few years is almost predetermined. This tree originates from the Amazon rain forests and can only be grown in areas of similar conditions, namely high temperature, rainfall and humidity and low altitude, which effectively restricts production to regions 15 degrees latitude north or south of the equator. After the rubber trees have been tapped, the latex, a white milky fluid, is usually coagulated to produce ‘ribbed smoked sheet’ (RSS) or technically specified rubber (TSR). Consequently, the ‘normal’ production of NR is dependant on previous planting and replanting policies (including the use of highyielding clones) with a given age structure and yield potential of the trees, the ‘farm-gate’ price of NR, linked with possible alternative opportunities of other methods of generating income. About 80% of the annual output is derived from small-holdings of less than 2.5 hectares, from which about 6 million small farmers derive their income. Thus, under a ‘normal’ production scenario today’s annual output of NR would be in the order of 10 million tonnes, of which about 1415% would be concentrated latex (about 1.5 million tonnes – dry rubber content [drc]). Demand Fundamentals The main end use of (dry) NR is in the production of tyres. NR is an essential component in the manufacture of heavy vehicle commercial (HCV) truck tyres and light commercial vehicle (LCV) truck tyres, especially those of radial-ply construction. Over the past 30 or so years the

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usage of NR in the manufacture of truck tyres has increased gradually in percentage terms, but significantly in absolute terms. This has been primarily due to the increasing penetration of radial-ply technology for truck tyres and the development of tubeless and low-profile HCV (and LCV) tyres. In radial HCV tyres, which can be retreaded two or three times, the NR content of total elastomers used in them is almost 90%. Consequently the main determinant of the movements in the price of NR is the normally the steady up and down movements in the growth of the world economy, with other influencing factors, such as exchange rates, speculation on the futures markets and prevailing weather conditions, which may occasionally affect the day-to-day price on the markets in the short term. Thus, under ‘normal’ circumstances consumption of NR in the tyre sector accounts for about 70% of dry NR (or 6 million tonnes) in a world total of about 8.5 million tonnes (excluding concentrated latex). Consequently, it can be seen that the world’s tyre industry has a significant influence on the demand for NR. However, far more important is the fact that heavy commercial vehicle (HCV) – or heavy truck – tyres account for about 45% of dry NR consumption (or nearly 4 million tonnes!). The Spikes (dramatic rises and falls in the price of NR)! - The trailer hibernation-cannibalization concept When the world economy enters a severe recession, large fleet operators and hauliers begin to stack their trailers in their compounds, with or without wheels (tyre + rim). This is normally done for purposes of cash-flow and economy, as an economic recession begins to reduce the demand for the movement of goods. Thus fleet operators take the wheels off their trailers and use them as replacements for

those still on the road (cannibalization), or just retire the trailers being used when their tyres are worn out – but they do not buy replacement tyres in the short term. Some of the unused trailers, as tractor units are mutli-functional with regard to towing trailers, are thus able provide a reservoir of partly-worn tyres to be fitted, in due course, to those trailers still being used for moving raw materials, manufactured products and foodstuffs. Although retreaded tyres are often used on trailers, the demand for these will, in some circumstances, be increased as the economic pressure to reduce the purchases of new HCV tyres continues. Consequently during a leadin to a world economic recession the demand for new replacement HCV tyres (as well as those tyres for original equipment-OE) drops dramatically and leads very quickly to a fall in the NR price – see for example the price of SMR20 during the period October 2008 to June 2009. When countries in the world begin to enter the recovery stage of an economic cycle, it becomes necessary for fleet operators to replace the tyres on the hibernating and cannibalized trailers to take advantage of the increased demand for transport of goods and products. This phenomenon rapidly increases the demand for both new replacement (and also for OE tyres) and to some extent retreaded HCV tyres, such that the NR market rises dramatically – see SMR20 price from November 2009 to May 2010. Consequently, as can be seen, the demand for HCV tyres is in fact the major ‘fundamental’ in the demand for dry natural rubber. Any movements in world’s economic cycles downwards or upwards have a dramatic effect on the price of natural rubber causing ‘spikes’!

* This theory of the main cause of price spikes in natural rubber was originally given at the International Rubber Conference in Malaysia in October 1997.

A caravan camels trek across the Sahara Desert in Morocco (Courtesy Pexels)

.o baffling is the discovery that, for many of the world’s poorest, the utility gained from a television eviscerates that of more, better quality food that we must ask ourselves the question why? For many, global poverty simply is an existence, a global, horrifying truth; while our efforts towards its alleviation are forceful, we rarely ask ourselves why the current situation is as dismal as it is. Why, exactly, are the poor so poor and why does it seem that they don’t actually want to escape poverty? This essay answers these questions, and offers a solution to poverty rooted not in the Western world, but in the undernourished countries themselves. It is estimated that around 805 million out of the 7.3 billion people in the world are suffering from chronic undernourishment, with almost all of these undernourished people living in developing countries. With global food production being enough to feed everyone on the planet, the issues concerning world hunger have become even more important. The predominant issue does not lie with how much food the world produces but the availability of the food within these countries. The nutrition based poverty trap has been the forefront of chronic undernourishment causes for many years and, as a result, programmes adopted by governments have aimed to tackle this issue. The nutrition based poverty trap is based on the idea of the capacity curve, whereby the ‘rich get richer’ and the ‘poor get poorer’. The lack of consumption from the poor prevents them attaining the strength needed to work productively and as a result are less employable and unlikely to find work. Thus their income tomorrow is lower than their income today, leaving many of them with insufficient incomes to buy the food necessary. Consequently, many of the poor become structurally unemployed, as they lack sufficient nutrition to work productively making them unable to find gainful employment in manual

jobs in agriculture or construction. Similarly, these people cannot acquire skilled jobs because they lack the skills, and as there are very few jobs available, most do not get the opportunity to specialise and develop vocation specific skills. With long stretches out of work, they can become deskilled further, making them even less desirable as an employee. This skills mismatch is the root cause of the structural unemployment.

The lack of consumption from the poor prevents them attaining the strength needed to work productively and as a result are less employable and unlikely to find work Moreover, the assumption so far is that given the opportunity or the money to consume more, the poor would do so as this would move them out of the poverty trap. The popularly noted solution to undernourishment in these countries would be food subsidisation, which we have seen many governments in developing countries introduce in order to tackle the issue of starvation. In Indonesia for example, the Rakshin Programme entitles the poor to 55 pounds of rice a month at about 4 rupees a pound, which is less than 20% of the market price. Distributing at more affordable prices should encourage the poor to increase their daily intake. Consequently what we should see is an increase in the average calorie consumption of the extremely poor. However, statistics show the reality is that most people who earn less than $0.99 USD a day do not act as if they are starving. Rather, food becomes less of a priority. Research in Udaipur, India found that given the opportunity to increase food consumption by 30% (by cutting out spending on alcohol,

tobacco and festivals), the poor would rather keep their luxuries. Furthermore, with the global market being at its most accessible yet, there may be a possibility for access to luxury goods to be taking priority in poor households over food. A study in India asked two questions to households. 1) Does everyone in the house have two square meals a day?

2) Does everyone in the house eat enough food everyday? The percentage of people who consider themselves as not having enough food to eat has dropped 15 percentage points between 1983 and 2004. One reason for this may be due to the increased consumption options of the poor, given the opportunities of the poor to purchase entertainment at more affordable prices in today’s world. Thus “enough food to eat” all becomes relative to what you prioritise as the most important. This can further be explained by the rational choice theory, whereby people will choose to make logical decisions, which result in highest level of satisfaction or benefit for themselves. As previously explained, long-term consistent consumption of food can be a way in which the poor are able to increase income. However, it is a common occurrence that the poor struggle to find work, leaving many of them structurally unemployed and with a lot of spare time. A study in a rural village in Morocco analysed the consumption choices of agricultural workers who were at best in part time employment. With 265 days a year out of employment, villagers may not deem it necessary to eat as much to sustain their needs, lowering their perceived marginal utility for food. With many villages lacking any sort of entertainment facilities, villagers choose to buy a television over more food as increased consumption does not necessarily secure you a job.

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Many jobs are unavailable due to cuts in labour during times of price volatility or a shortage of jobs in the village. Thus a higher utility is gained from purchasing a TV, which provides entertainment for a third of the year, rather than food, which has the potential to have no impact on the lifestyle of these villagers. We have seen that structural unemployment is an issue of great magnitude in the underdeveloped world as poor infrastructure increases supply costs and incurs travel delays, in some cases disincentivising travel completely, obliterating mobility of labour. The Infrastructure Consortium of Africa reported that poor infrastructure adds 35% onto the costs of goods traded in Africa, making it clear that this is a huge barrier that needs breaking. In order to do so, steps must be taken to improve opportunities for the poor and reduce the instability that poor infrastructure and technology carries with it. Our previous analysis highlights the importance of migration between villages in order to reduce the unemployment rate in rural areas. This will rely on good infrastructure from governments, including roads and transportation, to ensure access is available where needed. By investing into these changes, the priorities of the Moroccan villagers may automatically change as they are faced with the option of more work throughout the year, giving them less time to watch TV. Better transport links also means poorer countries have access to a wider market and trade can occur on a larger scale, enabling investment opportunities and increasing economic growth. In addition, a more prosperous region will increase the incomes of inhabitants, owing to a greater quality of life. This has knock on effects as more money can be spent on educating the younger generations to ensure the escape from poverty. Rationality is also questioned in our analysis on status-driven consumption. Status driven consumption conflates the nutrition-based measure and the income-based measure of

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poverty; while a larger monthly expenditure might appear to show that poverty is alleviating, this extra expenditure may be at the expense of a greater nutritional intake. In two regions of China, Hunan and Gansu, the price of the basic staple of the region (wheat noodles in Gansu and rice in Hunan) was subsidised.

and poor people start to see a lot more security and stability in their lives, allowing them to make better use of their money through educating, providing for others, investing in themselves and local businesses. The idea is that small-scale loans and saving groups will have multiplier effects in the wider community, resulting in economic prosperity. An example of microfinance is chit funds, which is a monthly meeting in which members put in at amount of money to a kitty fund. One member is randomly selected to receive the lot to do with what they please. This happens every month until everyone has had their chance at ‘winning’; in this way, saving is encouraged and, in a way, ensured.

To conclude, it could be said that the poor have A rooftop in Ahmedabad, Gujarat, India (Courtesy Emmanuel DYAN via Wikipedia) skewed preferences, as Normally, when the price of a good goes down, where we would expect them to save, they one would expect the quantity consumed to spend and vice versa. To us - the Western increase, but the opposite occurred - this is an economists – although this difference in example of Giffen good behaviour. Ordinarily, priorities seems irrational, given many poor the staple takes up the majority of the household people’s socioeconomic situations, it actually food spend, but as price is lowered, people are can be justified through rational choice and made to feel comparatively richer. Consumption status-driven analysis. of the staple food may be associated with being poor, therefore people switch to buying more It is important to note that it is not just about expensive meat and shrimp, leading to an behaviour of the poor in order to alter the overall reduction in total calories consumed. choices that are made but also an improvement in the choices that they are presented with, What is visible to us is their focus on shortthrough better policies towards agriculture and term pleasures as opposed to long-term investment into the development of the country. improvement in their quality of life - this is a Additionally an improvement in information phenomenon that has to be corrected if we are provision will allow the poor to make more to eradicate poverty. informed decisions regarding consumption choices. As we have seen from our analysis, the ‘irrational’ saving habits of the poor are a This will require a rapport between the provider key barrier blocking the path to economic and the positions of authority in the village. It development. It is important to introduce will take time to discuss with a village leader measures to change their habits and to the benefits of certain foods and why focusing encourage long-term saving so that the on a long-term nutrition goal is a better choice. absconsion from poverty is easier. Only then can the village leaders get on board with the idea and only then can the village Microfinance is one such measure, first people better assimilate the information and introduced by Muhaamd Yunus who started the consequently use it to bring these long-term Grameen Bank. The idea behind microfinance goals to fruition. is that in providing small scale loans, the irregularity of income flows begin to disappear

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Wages Around the World Apoorva Bihani (BSc Economics ‘16, The University of Nottingham) U.S. twenty Dollar bills (Courtesy Unsplash)

...uch has been spoken about ..wage inequality in the recent past as countries address it as a macroeconomic challenge and industries express concerns over the gender pay gap and high executive pay in particular. High inequality remains a concern for developing countries, such as China and India, where the rich enjoy luxurious lifestyles and economic progress but not many benefits trickle down to the poor. On the other hand, developed countries are concerned with a rising wage gap as the valuation of the highly skilled increases, thereby increasing wages and widening the gap. These concerns, which have risen in the past few years and decades, coincide with the fast growth of globalization. It is then vital to question whether there exists a relationship between escalating inequality and globalization. The dynamics of both developed and developing economies have been affected by the rapid increase in globalization in several ways. World markets now trade more freely, with several countries agreeing to relaxed policies regarding exchange of goods and services, movement of capital and labour and foreign direct investment. Even though the developed world has supported free trade for a long time, most of the developing world only opened its doors to the world market towards the end of the twentieth century. Examples include China, India, Mexico, Vietnam and other South American and African countries. For such low-income countries, high tariffs seemed viable to protect domestic industries. However, most of them had to introduce trade reforms in order to overcome their respective economic crises. Upon liberalization, most developing economies experienced the anticipated benefits of increased growth, lower poverty levels, and higher employment. But one anticipated effect that hasn’t been observed in recently liberalized developing economies is a reduction in wage inequality.

Trade liberalization is expected to benefit developing economies by encouraging enhancement of their competitive advantage. Assuming that low-income countries are abundant in unskilled labour, they are expected to exploit this advantage by exporting production goods. High exports from the secondary sector would imply an increase in demand and wages for unskilled labour, thus reducing the wage gap between the two groups.

One anticipated effect that wasn’t observed in recently liberalized developing economies is reduction in wage inequality As a result, prices of these factors would increase, as returns in the industry are likely to go up due to higher exports. The HeckscherOhlin model furthers this argument through the Stolper-Samuelson theorem: the price of the intensively used resource would increase as exports in the industry increase. Following the theory, a developing country’s wages for unskilled labour should go up post liberalization. This will reduce the skill premia, defined as the wages of skilled labour relative to that of unskilled labour (5).

high-skilled labour, implying that liberalization should benefit its unskilled labour and increase prices, employment and wages in the manufacturing sector of developing countries like Mexico. Researchers, however, have found varied results while studying the consistency between theory and real patterns of skill premia in Mexico. Some argue that the HOS framework proves right for Mexico, while others argue the opposite. Research by Esquivel and Rodrigues-Lopez (2003) finds results consistent with the predictions of the StolperSamuelson theorem. The paper aims to study the impact of technological change along with that of trade liberalization on wage inequality in Mexico’s manufacturing sector. The authors gather annual data on 49 branches of the country’s industrial sector between the years 1988 and 2000, using the National Accounts System. In order to incorporate the total factor productivity improvements in the industry, the authors use the labour productivity information provided by INEGL. Esquivel and Rodrigues-Lopez further divide their analysis into two periods of time, 1988-94 and 19942000, in order to separately test effects of pre and post-NAFTA periods respectively.

Developing countries, however, have demonstrated an opposite effect to what the theory predicts. Even though tariffs were reduced, and wages in labour intensive industries increased, the skill premia seems to have widened. Although tariff reductions have a big impact, other changes induced by globalization, such as technical change, net migration, and offshoring also contribute in explaining why changes in premia differ from those predicted in theory.

Their results find a big drop in the growth rate of the wage ratio before NAFTA and after NAFTA, thereby reflecting consistency with the HOS framework. Furthermore, the statistically significant coefficients of the extrapolated data find trade liberalization to cause a decrease in the wage gap between skilled and unskilled workers during 198894. Thus, results suggest coherence with the Stolper-Samuelson predictions of reduced wage gap in a post-liberalized period.

A noteworthy example of significant distributional changes in skill premia in the post liberalization period is Mexico, which saw two major changes in a short span: GATT (1986) and NAFTA (1994). The majority of Mexico’s trade is with countries abundant in

On the other hand, Raymond Robertson (2000) explores the relationship between trade liberalization and inequality in Mexico but does not find results consistent with the predictions of the HOS framework, rather only with a part of it. Robertson discusses Mexico’s

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trade reforms to study the link between tariff and relative prices and their contribution to the wage inequality pattern. The paper uses several data sources to gather information about the distribution of production and nonproduction workers across industries. Records from the Mexican Monthly Industrial Survey show an increase in the employment of skilled workers between 1987 and 1995. Upon finding results that contradict the theory, the author studies the neoclassical trade theory to identify the weakness in its applicability to Mexico’s experience. Extending the research, Robertson finds that the reduction in tariffs benefited the skill-intensive activities, implying higher average relative wages for skilled workers as well as a higher relative price of skill-intensive goods (4). For advanced economies, their most abundant resource is their pool of highly skilled labour, which is likely to be exploited as trade liberalization grows, adhering to the predictions of the Heckscher-Ohlin model. Thus, increased trade, especially with lowincome countries abundant in unskilled labour, shall increase demand for high skilled labour and raise its price. This translates into a higher wage for high skilled labour in developed countries and an expanded wage gap between the skilled and unskilled. The United States of America remains a prime example, where income inequality had risen by nearly 15% between the years 1980 to 1995. This period also coincides with the period of liberalization of many developed countries with which the US increased trade. The fear of a diminishing middle class also exists as statistics suggest an increase in the income of the uppermost tier and a decline in the incomes of the bottom 90%. Literature supports this prediction of the Heckscher-Ohlin model of globalization aggravating the growing inequality in the United States. A study by John O’Loughlin published in the Urban Affairs Annual Reviews finds that increased imports have reduced demand for unskilled labour in the manufacturing sector. O’Loughlin suggests

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that a great influx of manufactured products from low-skilled countries in Asia and Latin America has lowered the price and thus wages of the unskilled labour in the United States.

The explanation that globalization provides for wage inequality in developing countries remains ambiguous. Results from some researchers conflict with those of others, thereby painting a vague picture of the future trend for wages in countries like Mexico, Vietnam and India. Further research and study of certain observables may bring more clarity, thus providing better grounds for drawing measures to achieve the macroeconomic objective of lowering income inequality. References 1. Amiti, Mary and Cameron, Lisa. (2011). Trade Liberalization and the Wage Skill Premium:

A five Euro note (Courtesy Unsplash)

Immigrants from Asia and Latin America shall put a downward pressure on wages of the low skilled (in the USA) Leamer (1996b) finds a fall of 40% in the wages of unskilled labour in the 1970s, a period when the US’s trade dependence was increasing. O’Loughlin also assesses immigration as a contributor to the income inequality as rising rates of immigrants from Asia and Latin America shall put a downward pressure on wages of the low skilled. The pool of native unskilled workers shall continue to experience an expansion, as the population of unskilled immigrants is likely to increase. (7) Research and evidence seem consistent with the theoretical predictions for developed countries. Countries like United States and United Kingdom, however, explore technological change, immigration and educational attainment as causes of rising inequality between skilled and unskilled workers. Measures to lower this gap are being taken, such as increasing minimum wage or capping executive pay.

Evidence from Indonesia. Journal of International Economics, 277-287. 2. Aldaba, R.M. (2013). Trade Liberalization and Wage Skill Premium in Philippine Manufacturing. Philippine Institute for Development Studies. 3. Esquivel, G. and Rodrıguez-López, J.A. (2003). Technology, trade, and wage inequality in Mexico before and after NAFTA. Journal of Development Economics. 72(2), 543-565. 4. Robertson, Raymond. (2000). Trade liberalisation and wage inequality: lessons from the Mexican experience. The World Economy. 23(6), 827-849. 5. Hornstein, A., Krusell, P. and Violante, G.L. (2005). The effects of technical change on labor market inequalities. Handbook of economic growth. 1, 1275-1370. 6. http://www.pewresearch.org/fact-tank/2013/12/05/ u-s-income-inequality-on-rise-for-decades-is-nowhighest-since-1928/ 7. http://www.colorado.edu/ibs/intdev/johno/papers/ inequality.pdf 8. http://www.epi.org/publication/income-inequalityby-state-1917-to-2012/

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Why economists are worried about the UK’s current account deficit Rushabh Malde (BSc Economics ‘18, The University of Nottingham) A caravan camels trek across the Sahara Desert in Morocco (Courtesy Pexels)

..he UK is experiencing a record deficit on the current account. In 2014, the current account deficit hiked to 5.1 per cent of GDP, the highest record since the end of Second World War, leading many economists to believe that there is an underlying imbalance in the UK economy. Why are economists so worried about the UK’s current account balance, and what is its implication for the overall economic performance of the country? To understand this concept, it may be helpful to start with some simple explanations. The current account is a broad measure of whether the UK is a net borrower or lender from the rest of world. It comprises of net exports, net transfers and net investment income. Economists previously looked at the net exports (exports minus imports) component in terms of visible goods. Helpfully, given Britain’s services prowess, the net exports component now includes trade in services and other invisible goods as well. Historically, the current account deficit was primarily exacerbated by British consumers importing goods from the rest of the world. Since 2012, Britain’s trade balance, in terms of net exports, has remained roughly constant because greater imports have been broadly offset by the growth in exports of British services, such as the soaring service industry based in the City of London. The second element of the current account is net transfers. This is money sent abroad in which none is expected back, such as remittances or international aid payments. So why has Britain’s current account deteriorated so remarkably? The answer lies with the net investment income component. Net investment income includes dividend payments and rents from the assets that British companies and British citizens hold abroad. This has deteriorated from a 3.3 per cent of GDP surplus in 2011, to just a 0.1 per cent surplus in 2014. In pecuniary terms, it has swung from positive to negative since 2011 . UK companies and citizens

have simply not been earning as much income on the assets they hold abroad. There has also been a lamentable decrease in income from the UK’s investments in overseas commodities businesses.

UK companies and citizens have simply not been earning as much income on the assets they hold abroad The balance of payments must, of course, balance. Thus, a deficit on the current account has to be funded by a surplus on the capital account and financial account. Whilst the capital account is traditionally used to balance the deficit on the current account, the capital account and current account together have been in deficit since 1983. We have, therefore, been increasingly reliant on the financial account (direct and portfolio investment) to fund the deficit in the current and capital account. The concern is that such deficits are a signal of an economy that it is becoming increasingly reliant on consumption as opposed to exports. Mark Carney, Governor of the Bank of England, commented in his recent speech that “sustained borrowing from abroad, to consume at home, is hardly a recipe for a balanced and sustainable expansion”. Some of this has been put down to the relatively strong growth of the UK economy and record low unemployment. Ten-year gilts on government debt are only 1.9 per cent. Britain has remained an attractive destination for foreign capital to flow in to. In an increasingly gloomy outlook for the world economy, the UK has continued to remain as a safe haven in which Britain - as Mark Carney noted in his February inflation report - continues to receive “a disproportionate large share of foreign direct investment for countries in the European Union”. This - contrasted with sluggish growth in the Euro area – has meant that foreign investors have

been earning greater dividends on UK assets than British investments in Europe. Indeed, in the November Inflation Report published by the Bank of England, the BoE recognises the “weak investment income from the Euro area” as an important reason for the shrinking net investment income component. Nine per cent of the UK’s foreign assets are in France and 7 per cent are in Holland. This can be contrasted with approximately only 1 per cent in China and a similar percentage in other fast growing and emerging markets. Another worry is that the stock of British assets abroad has been falling as the current account deficit has widened. According to the Bank of England, the UK’s net stock of foreign assets - the difference between what assets British investors own overseas and foreign investors own in the UK - is negative, at approximately 20 per cent of GDP. The UK’s stock of assets has been falling since the Second World War, when the current account had been running into deficit. The concern is that this trend may become persistent, and reduce the potential of a turnaround in net investment income. The deficit is not, however, seen as a concern until investors start to believe it is a concern and reduce investment in the UK. This could lead to depreciation in sterling and rising inflation. Risks from financial shocks or potential withdrawal from the European Union could also potentially reduce foreign flows of capital in the UK (9). Yet Britain’s flexible exchange rate, and a potential depreciation in sterling, would help bolster the trade balance. There is, of course, difficulty in measuring a country’s balance of payments. Oxford Economics have noted, for example, that a British house sold to a foreign buyer isn’t counted as an export in the same way a British Jaguar sold abroad is. Yet, functionally, it is much the same. George Osborne, Chancellor of the Exchequer, proclaimed in his budget and Autumn Statement that Britain “is paying its way in the world”. We most certainly are not.

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About Time: America’s Interest Rate Rise Diana Beltekian (BSc Economics ‘16, The University of Nottingham)

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How the Chinese Stock Market has Become the Biggest Casino in the World

Wall Street in New York City (Courtesy Jason Sayer)

...ith the world economy emerging ..from the shadow of the 2008 financial crisis, the Federal Reserve has, at long last, increased its short-term interest rates by a quarter of a percentage point. This small rise is set to mark only a gradual rise in U.S interest rates as emphasised by the Chair, Janet Yellen. The Federal Reserve predicts interest rates to rise to 1.375% by the end of 2016. Why has the Federal Reserve chosen to increase interest rates now? As the Federal Reserve is tasked with keeping the inflation rate in check, it determined the falling unemployment rate, standing at 5.0% in November 2015, down from the 9.9% in November 2009, had the potential to trigger inflation over the short-term. US inflation currently stands at 0.5% from the 12 months since last November, below target but with the potential to rise, encouraged by rising employment. As a leading economic superpower, and with emerging market debt primarily denominated in US dollars, the increase in short-term interest rates is not good news for emerging markets. Although the quarter of a percentage point rise seems negligible, its continued rise is not. The US’s loose monetary policy has engendered excessive borrowing by countries including Brazil, but most notably China. Tightening monetary policy is likely to exacerbate China’s instability through encouraging capital outflows in search of safer alternatives. Head of emerging market operations, David Lubin at Citi, emphasises the growth in foreign lending in the Chinese market and the costs associated with it will be affected by the incipient rise in US interest rates. The repercussions of reduced capital for the Chinese market may manifest itself in reduced purchases of US treasury bills and liquidation; this is liable to increase interest rates further as the price of government bonds falls. More generally, emerging markets in debt are likely to be affected by the rise in the

Chan Joshua Juan Yin (BSc Economics ‘17, The University of Nottingham)

short-term interest rate. Tightening monetary policy causes investors to flock to the US; the dollar appreciates relative to other currencies. Although traditionally this would signal difficulties in repayment from these countries, optimists references the decline in “original sin” where borrowing in US dollars or foreign currencies in general would expose countries to the risk of domestic currency devaluation and a mounting debt burden.

“Private sector debt (as a percentage of GDP) in emerging markets exceeds economic sector debt in developed countries before the 2008 financial crisis” Although governments have abstained from “original sin”, there has been an upward trend of foreign borrowing by emerging market firms. With a rising private sector debt burden denominated in a steadily appreciating dollar, the decline in original sin will not stave off future difficulties in honouring debt repayments. While accumulating debt from productive investments is not harmful, evidence suggests that debt has risen to excessively high levels; private sector debt (as a percentage of GDP) in emerging markets exceeds economic sector debt in developed countries before the 2008 financial crisis. A recent study by BIS investigated the leverage and profitability of 280 big emerging market corporate bond issuers. It found while they were highly leveraged, profitability was low. In this context, worsening lending conditions, precipitated by rising US interest rates, can push up foreign borrowing costs with capital outflows further weakening the

local currency. The Institute of International Finance announced that the lending conditions in emerging markets, accounting for credit demand and availability, non-performing loans, had significantly worsened. The IIF’s managing director does not share the sentiment that debt denominated in foreign currency no longer poses a danger to emerging markets. Although tightening monetary policy signals some strength returning to the US economy, ending the era of zero rates, this may potentially have a significantly negative effect on emerging economies without proper controls in place. Emerging markets have taken full advantage of low US interest rates since 2006 to accumulate unsustainable levels of debt. As capital inflows strengthen the US dollar, in the search for higher rates, debt-ridden countries will be under greater pressure to manage repayments under deteriorating circumstances. Developing countries with a depreciating local currency must overcome the mounting challenges of debt to avoid a similar emerging market crisis that befell the developed world in 2008. References 1. http://data.bls.gov/timeseries/LNS14000000 (viewed 24/12/2015) 2. http://www.usinflationcalculator.com/inflation/ current-inflation-rates/ (viewed 24/12/2015) 3. http://www.ft.com/cms/s/0/7edb6a0a-524d-11e5b029-b9d50a74fd14.html#axzz3vFw75ecx (viewed 03/01/2015) 4. http://www.ft.com/cms/s/0/7edb6a0a-524d-11e5b029-b9d50a74fd14.html#axzz3vFw75ecx (viewed 03/01/2015) 5. http://www.ft.com/cms/s/0/7edb6a0a-524d-11e5b029-b9d50a74fd14.html#axzz3vFw75ecx (viewed 24/12/2014) 6. http://www.ft.com/cms/s/0/46f42c36-8965-11e590de-f44762bf9896.html#axzz3vFw75ecx (viewed 03/01/2015)

A man has his head in his hands at the Chinese Stock Exchange in Shanghai (Courtesy WikiCommons)

..f you have ever been to a casino, you would probably have had this experience: in the first few bets—before you gain experience in playing that game—you could win without much difficulty. People around (the casino spies) would start cheering for you, associating your winnings with the socalled “new comers’ luck”. This is where the casino starts to rope you in: as you feel more confident about yourself and make a bigger bet, you begin to lose. But the casino spies would keep you in the game. They would teach you a few techniques, which usually worked on a smaller bet, but never worked on a big bet. Overall, you win every small bet but lose in every big bet, so the balance falls below zero. Casino is never a fair game. Indeed, they apply tricks on every single game, together with brilliant manipulative skills on human psychology, to keep players interested and make the casino win as much money as possible. The Chinese stock market is similar: it does not operate on its own. It is only an economic tool manipulated by the Chinese government. Understanding the Nature of the Chinese Stock Market By its appearance, the size of the Chinese stock market is comparable to New York or London. For instance, the Shanghai Stock Exchange (SSE) is the third largest in the world, with a market capitalization of US$ 5.5trillion. The Shenzhen Stock Exchange (SZSE) has a market capitalization of US$ 2.2 trillion. However, the number of listings is only 2500 in total; and most of them are State Owned Enterprises (SOEs); their performances are mostly driven by government policy rather than market forces. Foreign investors cannot

enter the Chinese stock market except through certain institutions. (1) The reason is because the government wants no foreign influences in order to keep its stock market stable. Eighty percent of the investors are individuals, two-thirds of whom do not have a high-school diploma. This, together with the media censorship and China Securities Regulatory Commission (CSRC)’s administrative power, which allows it to suspend any stocks at its own free will, make the stock market an easily manipulable tool in the hands of the government.

The Chinese stock market is fundamentally disconnected from the broader economy Scott Kennedy, director of the China business program at the Center for Strategic and International Studies in the US, comments that the Chinese stock market is fundamentally disconnected from the broader economy. (1) As long as the government policy on SOEs, the media tone and CSRC’s use of administrative power is working towards the stock market boom, stock prices will still rise despite the economic downturn. Save GDP by Stock: Wrong Dose to Patient A common consensus among modern day monetary economists is that monetary policy only works insofar as to adjust output deviation from its trends. On the other hand, the responsibility to increase the output trend (or the GDP growth rate in a long run) resides in the supply side policy. Under the administration of Premier Lee Keqiang, the thinking is the exact opposite: GDP has to be saved by the stock market. The result is catastrophic.

In the second quarter of 2011, GDP growth was recorded to be below 10%, and in the second quarter of 2012, it fell below 8%. (2) There are structural reasons for this economic downturn: first, the high debt ratios of the provincial and regional governments jeopardize the monetary stability. Lee Yukqiang, Professor at Tamkang University, points out that in 2010 the regional governments’ debt was 10,717 billion RMB in total, which was close to 50% of China’s GDP. (3) In 2013, government debt rose by 40% within a year—an indicator that the government had already become addicted to debt. By the end of 2014, government debt had risen to 24,000 billion RMB (3,800 billion USD). (4) A high government debt ratio contributes to high default risk. It also leaves little room for the government’s fiscal policy to manoeuvre in the future. Second, the financial disaster of 2008 made a lot of export industries lose their revenues. One of the ways to mitigate the effect of shrinking exports to an economy is to boost domestic demand. This, however, is very difficult to achieve because most of the Chinese households are struggling to afford their future expenditure on children’s education and the elderly’s medical care, so they will devote a large portion of their income to savings and be reluctant to increase current spending. As exports shrink and domestic demand remains weak, many industries face the problem of overproduction and decreasing revenue. Tackling the structural economic problem in China would require a more long-term, supply-side policy. This way of thinking, however, is abandoned by Lee Keqiang. Instead of finding ways to regulate the regional governments’ debts, Lee tried to boost the

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stock prices, hoping this would lower the loan default risks of State Owned Enterprises or that of the regional governments. Instead of lowering households’ burden on education and medical care or increasing the real wage of workers, Lee is boosting the stock market to create ‘easy money’, hoping the households can afford more consumer goods. This is no different to a doctor giving the wrong dose to his patients.

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listed companies that were based in Zhong Guan Cun, the Chinese Silicon Valley, pledged to comply with government policy to stabilize the stock market. (16) On 9th July 2015, all stockholders who were holding over 5% stocks in their companies were forbidden to

is punishing people for revealing the truth behind all these bubbles. Indeed, blaming people for self-committed fault has always been a practice of the Chinese government. On 3rd July the Monetary Times of China posed a passage titled ‘No Delay in Fighting Against Deliberate Capital Flight’, (22) (23) and the tone of that passage blames Morgan Stanley and various foreign financial institutions for withdrawal of capital from the stock market. (24) The reason for blaming foreigners is simple: it turns the public grievances away from the government towards an outsider.

A Fabricated Rise and a Fabricated Fall The whole story started on 21st April 2015. The day before, A-stock SSE Composite Index had risen to 4000 points—a new record since the previous peak in 2014. The largest ‘A cup of water to rescue a car official newspaper, China Daily, set on fire’ is a Chinese idiom published an article titled ‘4000 to describe the situation in A group of woman at China’s Shanghai SE look concerned at share prices falling (Courtesy WikiCommons) which the measures conducted points is merely the start of a bull market’ (an upward trend). That could do little in overturning a paper even used a cartoon depicting a bull decrease their holdings—and this measure is catastrophe. The CSRC’s measures are also pushing up a giant red arrow that is pointing expected to last for a further six months. (17) following this pattern. As the SSE Composite to the sky. With the Chinese propaganda Index and SZSE Composite Index has a much machine applauding for the rise, the stock stronger effect on the public impression than Tackling the structural market continues to soar. (5) the real performance of the stock market, all the administrative measures conducted by economic problem in This rising trend, however, is unsustainable. the CSRC is only rescuing the stock prices China would require By 22nd April, stocks in Shanghai are trading of the stocks that are in the basket of the at 21.8 P/E ratio. Shenzhen’s start-up board composite indices; those stocks that are not a more long-term, ChiNext is trading at 94 P/E ratio. (6) With in the basket are not taken into account. (25) supply-side policy its market value highly overvalued, one will (26) (27) (28) question how much longer this rising trend Special discretionary measures allowed can be sustained. The tragedy is that, since the composite these big stockholders to increase their indices only include stocks of big listing holdings during the blackout period, although Then comes the inevitable. On the 26th June companies which usually have higher a decrease in holdings was never allowed at 2015, SSE Composite Index fell by 19%, and barriers of entry - while the public or normal any time. (17) On 3rd July 2015, the CSRC SZSE Composite Index fell by 20% compared households would usually engage in stock started a large scale legal prosecution action, to the peak on 12th June. (7) On 4th July, trading of smaller companies that are not in (18) arresting people suspected of being twenty-five mutual funds and twenty-one the basket of composite indices - rescuing involved in shortlisting and false message stockbrokers were forced to pledge the only the composite indices related stocks publication. (19) CSRC to increase their holdings on various is only saving the big institutions, not the stocks. (8) (9) If you think you can evade the households or public. Thus, even though The director board of Hundsun Technology, order, here is the show of force: a total of 210 the stock prices did rebound after the Hithink RoyalFlush Information Network and billion RMB were ordered to be mobilized by administrative measures were conducted, Shanghai MingChuang were arrested, (20) 11:00am sharp. (10) This deadline was less the public is still making a loss overall. because they were accused of engaging in than two hours away from the CSRC meeting off-the-counter placing (securities margin held at 9am in the morning. How ‘brutal’ The More the Government Intervenes, trading that has a lower entry requirement is the CSRC’s policy on fund houses and the More it Destabilizes and therefore allows public household entry) stockbrokers—after all, this is China. On 1st January 2016, the Chinese stock leading to uncontrollable leverages. (21) market introduced a new measure named And more to come! On the same day, all ‘circuit breaker’. That is, when the stock How ironic it is for the government to arrest IPOs (new stock listings) were suspended. prices fall by 5% within a short period of time, people associated with false messaging! (11) (12) (13) (14) This limited the supply trading will be suspended automatically. On At the very beginning, it was the Chinese of stocks. Fifty small and middle listed 7th January, the CSI 300 fell by 5% within 13 propaganda machine creating false illusion companies pledged not to decrease their minutes, triggering the circuit breaker. Then, to fabricate a bull market; now the CSRC holdings. (15) Over two hundred and seventy after 15 minutes of pause, when trading

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resumed, the CSI 300 fell by a further 2%, and with a total fall of 7% it triggered the second circuit breaker. (29) On the surface, having a circuit breaker is effective in stabilizing the stock market in extraordinary circumstances. However, in the case of China in which the stock market is always moving in big swings, those ‘extraordinary circumstances’ have already become ordinary. Circuit breaker is like a stockholding prison or a capital prison for many households, because it locks the capital liquidity of their holdings—and this prison is a legitimate threat because of the frequent use of circuit breaker. (30) If the market is always threatened to close, households or large stockholders do not sit and idly wait for it to happen. Indeed, what they will do is to withdraw their capital as soon as possible, once the threat of market closure is approaching. As Arthur Levitt, the former chairman of America’s Securities and Exchange Commission (SEC), explained: ‘Circuit-breakers were meant, from their inception, to be triggered only in truly extraordinary circumstances… As long as the markets are closed or have the potential to close early, there is uncertainty. Uncertainty for individual investors leads to confusion.’ (32) What the Chinese government does is only creating uncertainty and confusion, instead of having a stabilization effect. Indeed the Chinese government has always been committing interventionist policies that end up destabilizing the stock market. (7) The crash from June to August 2015 is an example of how the media fabricated the rise and fall of the stock prices; the circuit breaker in January 2016 is inducing an even quicker capital flight. If you see the use of colour signal in the Chinese stock market, you would notice the jarring phenomenon: red is used to indicate a rising price; green is used to indicate a falling price. Yet this should not have surprised you, because creating confusion through violating the norm has become customary in Chinese policy. The Chinese stock market, by its fundamental nature, is very much similar to a casino. First, it is can be easily manipulated by government policy. Second, the media would start cheering for you when the stock prices are rising, only to lure you into making a bigger bet before a catastrophic fall hits in.

Perhaps the stock market crash from June to August 2015, and the destabilization effect following the circuit breaker in January 2016, is not the deliberate outcome of Lee Keqiang’s economic policy; after all, economic stability, sustainable growth, non-rising unemployment rate and political stability are all that the premier would wish for.

c67815-26880528.html 6. http://www.reuters.com/article/markets-chinastocks-close-idUSZZN2RFP0020150422 7. http://www.newyorker.com/news/dailycomment/the-real-risk-behind-chinas-stockmarket-drama http://money.163.com 8. /15/0704/19/ATN17SOT00254IU1.html 9. /15/0704/13/ATMDD1FL00254IU1.html

At the very beginning, it was the Chinese propaganda machine creating false illusion to fabricate a bull market; now the CSRC is punishing people for revealing the truth behind all these bubbles. Indeed, blaming people for selfcommitted fault has always been a practice of the Chinese government Nevertheless, to achieve all these outcomes, Lee would need to abandon his old way of policy thinking. As media censorship and intervention has always been a usual practice of government policies, one would not expect the government to relinquish its grip on the media all at once. What Lee could do in a short to medium run is to focus on the structural components of the economy: to regulate the regional governments’ debts or to lower households’ burden on education and medical care, instead of banking on the unsustainable stock market. References

10. /15/0704/17/ATMR17QR00254IU1.html 11. /15/0704/19/ATN1D32G00252G50.html 12. /15/0703/16/ATK5SE6O00254IU1.html 13. /15/0704/22/ATNC6TGA00254TFQ.html 14. /15/0704/04/ATLE231600253B0H.html 15. /15/0704/22/ATNARHIF00254IU1.html 16. /15/0704/16/ATMO56KG00254IU1.html 18. /15/0703/17/ATK91FBV00254TFQ.html 19. /15/0703/16/ATK4SFQ100254IU1.html 21. /15/0615/07/AS4QKSMV00254IU4.html 17.http://hk.apple.nextmedia.com/news/ art/20150709/19213741 20. http://www.aastocks.com/tc/cnhk/commentary/ comment.aspx?id=9773 22. http://stock.sohu.com/20150703/n416102345. shtml 23. http://stock.17ok.com/ news/335/2015/0703/2472013.html 24. http://www.etnet.com.hk/www/tc/news/ categorized_news_detail.php?category=editorchoi ce&newsid=ETN250703776 25. http://news.xinhuanet.com/finance/201507/06/c_127987879.htm 26. http://blog.sina.com.cn/s/blog_ b6fcda620102vkcj.html?tj=fina 27. http://blog.sina.com.cn/s/ blog_97641ce50102voxz.html?tj=fina 28. http://finance.sina.com.cn/stock/ jsy/20150703/090922582196.shtml

1. http://www.npr.org/2015/08/27/435113627/chinas-government-encouraged-ordinary-investors-tomake-risky-margin-bets

29. http://www.bloomberg.com/news/ articles/2016-01-07/china-stock-regulator-said-tocall-unscheduled-meeting-on-market

2. http://www.economist.com/blogs/ freeexchange/2015/07/chinese-economy

30. http://www.economist.com/blogs/ freeexchange/2016/01/chinas-brokenstockmarket?fsrc=scn/fb/te/bl/ed/ chkmarketwithcircuitbreakersmeanttosaveit

3. Lee, Yukqiang (2013). ‘Chinese Regional Debts and Shadow Banking Outlook’ Tamkang University Institutional Repository. Translated by Chan, Joshua Juan Yin (2015). 4. http://www.nanzao.com/tc/ national/14f81314a2e8018/zhong-guo-di-fangzheng-fu-zhai-da-24-wan-yi-18-ge-yue-jinzeng-34-

31. Levitt, Arthur (1998). ‘Concerning Circuit Breakers’, Testimony before the Subcommittee on securities of the Senate Committee on Banking, Housing and Urban Affairs, 29 January 2998.

5. http://finance.people.com.cn/stock/n/2015/0421/

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Jeremy Corbyn and Business: Friend or Foe? George Thompson (BA Economics and Politics ’17, The University of Nottingham)

...he experts deemed the chances of Jeremy Corbyn winning the labour leadership so low that bookies offered 200-1 odds to those punters who believed in the impossible. The experts were proved wrong; they failed to foresee the passion that Corbyn ignited in the labour membership and there may be similar forces that have yet to manifest that could produce a Corbyn government in 2020. This possibility, therefore, is something all should consider and business leaders have been doing just that. Their responses to the prospect of an anti-capitalist prime minister have not been unanimously negative. Statements from the Royal Institution of Chartered Surveyors who see “opportunity in his agenda” sit along side the Institute of Directors’ aversion to higher taxes. This spread of responses demands investigation. What is the likely effect of a Corbyn administration on Great British business? The Bottom Line Corbyn has his sights set on business with an increase in corporation tax, a removal of tax subsidies and a clamp down on tax evasion. In particular, banking would be targeted with a tax that takes a percentage off of every stock market trade and a one off tax on ‘excessive profits’ in 2020. Alone these policies would hit businesses hard. However, Corbyn’s promise of “People’s Quantitative Easing” (PQE) might lessen the blow. This policy mandates the Bank of England (BoE) to ‘‘upgrade our economy,’’ enabling an increase in the money supply to pay for “housing, energy, transport and digital spending”. This money creation would boost growth and productivity, in turn increasing returns for business. This mix of policies begins to explain the varied business response. Just compare the fortunes of different sectors: banking faces a plethora of profit pinching policies whereas the construction industry sees the prospect of building on an unprecedented scale. Or, compare the fortunes of different sized businesses. Those smaller companies, which do not benefit from

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Interview

A Conversation with Sir Vince Cable Former Secretary of State for Business, Innovation and Skills Interviewed by Rushabh Malde (BSc Economics, ‘18) and Matthew Hills (BSc Economics, ‘18)

Jeremy Corbyn at a rally last year (Courtesy ITV)

clever tax lawyers or subsidies, are likely to lose less from the changes. Critics - such as the BBC’s Robert Peston - however, believe that everyone would lose. They focus on PQE, arguing the government would put pressure on the BoE to keep spending, leading to inflation and a loss of independence for the bank.

The NHS, a socialist policy of that post-war government, remains a treasured asset, sustaining the country’s health and providing the foundations upon which business has thrived They foresee a resulting lack of confidence and capital outflows that would negate any benefits the policy may have to offer. Despite support from some economists, notably David Blanchflower, a former BoE monetary policy committee member, the uncertainty surrounding PQE, when compared with the certainty of Corbyn’s tax increases, means that for most risk averse businesses the outlook is bleak. Is there any respite for businesses in Corbyn’s dealings with their high flyers? The Bright Sparks Unlikely. Reinstating a 50p maximum tax level, introducing a wealth tax on the richest 10% and implementing a maximum wage, Corbyn has produced policies that will harm the interests of the top paid. With these employees receiving a lower salary, the incentive to immigrate to countries with lower taxes shall increase. To compensate for employees’ losses, firms would have to increase wages or struggle to win candidates from the globally competitive job market. Businesses would end up out of pocket either through higher wages or less productive workers. The magnitude of these losses depends upon the importance high flyers place on their pay packet. Intuitively we know that money isn’t the only factor that motivates us to work.

Studies provide statistical confirmation of this, such as that by behavioural economist Vernon Smith. Further evidence is found in the tax advantage other countries already have over the UK. Clearly there are other factors keeping top earners in the UK, when countries such as Hong Kong or Singapore already have much lower tax rates (17% and 20% respectively). This suggests that the brain drain arising from a tax rise may be small. However, leaders in the field must look once again to their business to understand the likely effect. The greater the proportion of employees in the higher tax bracket, the more damage. With higher incomes found in London based corporate services, these businesses will be hit hardest. Moreover, the coders and financiers of this industry add proportionally more value to the final service than, say, a construction worker does, who requires significant capital equipment to complete the final product. For these corporates the loss of each employee will result in a greater effect on profits. It appears then that Corbyn’s high-flyer tax changes will challenge businesses’ profits with the service sector being especially affected. Conclusion After all, Corbyn’s anti-capitalist credentials signal troubled times for corporations. Higher taxes, a higher wage bill and problems retaining international high flyers will likely affect most businesses. Some will do better than others, with construction set to outperform corporate services, explaining the differing Corbyn-enthusiasm among lobby groups. Corbyn promises radical change beyond mere economic policies. He envisages a more equal Britain in which the government plays a larger role, reminiscent of the socialist Labour party of the late 1940s. Such aspirations may appear at odds with the needs of business. Yet the NHS, a socialist policy of that post-war government, remains a treasured asset, sustaining the country’s health and providing the foundations upon which business has thrived. The prospect of ‘Corbynomics’ becoming law is unlikely; alone it would cause problems, but it could be a source of opportunity in the bigger picture.

..n May 2015 Sir Vince Cable lost his .Twickenham seat in a 9000 vote swing to the Conservatives: the electorate had clearly rejected his party after their performance in the coalition government. In the limited time Rushan and I had to interview him we wanted to ask about his views on the coalition government and, in particular, the austerity his party agreed to. We also wanted to ask him about his varied past and learn more about his political history along with his time spent working in the turbulent Kenyatta government in Kenya. And finally to ask him, as an Economist, his views on Jeremy Corbyn and ‘People’s Quantitative Easing’ – the current policy of the party he used to be a member of. I would like to start on Economic policy, in 2010 in particular. I think it’s fair to say that austerity has had its fair share of criticism from the Paul Krugmans, the Blanchflowers and the two thirds of macro economists surveyed before the election saying that austerity was bad for the UK Economy. I don’t think it’s a binary issue between austerity and no austerity. I don’t think that’s a very helpful way of putting it. It’s like saying the only choice in a shower is between freezing cold water and scalding water. I’d disagree with anybody who says we’re against austerity – what on earth do they mean? I mean, you can argue that the coalition government was acting prematurely or excessively and you can debate each of those propositions, but the idea that you can be against austerity doesn’t seem to me to be a sensible debating position. Do you feel that the level of cuts was too severe at the time? Well my own internal critique was that I thought it was right to make an initial signal of small cuts to show that the government was serious and aggressive against the structural deficit and also that we had a target to try

and deal with the structural elements of the deficit. My criticism of my own government and this is something I argued about internally was that they cut capital spending and I’ve always believed that public investment should be treated quite differently. Overall, I think it was right to concentrate on what the coalition agreement said that we were trying to reduce the current structural deficit at the time, but that public investment should have been protected because it isn’t part of the structural deficit. Osborne didn’t do this and this was one of my disagreements.

“I’d disagree with anybody who says we’re against austerity – what on earth do they mean?” However, I did have public debates with the so-called Keynsians, with Robert Skidelsky in the New Statesman and I think the Keynsian criticism was often wrong on several grounds: First of all what the Government was doing was trying to sustain demand in other ways by monetary policy through the Bank of England ; the second point was the Government was actually quite flexible in allowing counter cyclical stabilisers to operate in 2011/12 and allowing the whole programme to be phased over a longer period of time (‘moving the goal posts’) which I think was actually the right thing to do. But where the Keynsians or so-called Keynsians ( I like to think of myself as Keynsian) where I think their criticism was misapplied was first of all they underestimated the importance of monetary policy and the flexibility the government showed but the key point was that they took no account of supply constraints and we were in the aftermath

of a banking crisis which severely restricted the supply of credit. The Keynsian model is entirely demand led and took no account of supply and as a result the Keynesian multiplier was much smaller than it was in the General Theory. I think Keynes had a figure of 2 whereas ours was much lower as you simply couldn’t expand supply when you can’t get credit. It’s been a few years since you were chief economist at Shell. How do you think the British Oil Industry will cope with lower oil prices as it looks like they will be for the foreseeable future? The North Sea is highly depleted for a start and its relatively high cost because it’s offshore. Also you have a very strange supply curve with distinct steps. The bottom step is Saudi Arabia where the cost is $5 or $10 and then at the top end you have the Arctic at something like $100 per barrel and the you have the North Sea which is somewhere in between. If oil prices stay at present levels there isn’t a great deal of money to be made by drilling off Shetland in very difficult conditions in deep water. The Government can partly offset that by taxes which is what they’ve done. But if oil prices were to stay at their present level, I would think that there would be a pretty severe contraction in N Sea production over and above the trend decline that is happening anyway because of depletion. However I don’t think that oil prices are fixed in that way forever: we’ve been through a whole series of cycles, as you know there was a price spike in ‘74 another in ’81/82, the last in 2009/10. It only requires Saudi Arabia to change its policy and then you’re back to much higher prices because they’ve asserted their control over production. I think it’s quite likely that prices will go up again in 2 or 3 years providing that demand returns from China and other countries and if Saudi decides that it

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Interview

has achieved what it wanted to by flooding the market then they will tighten up supply and you will get a return back to high price levels and then investment in the North Sea will come back.

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the view that the white farmers had an important role to play as long as they stuck to commercial farming and agreed to land distribution.

worked for John Smith who was the leader for some time as his special advisor. I didn’t feel inclined to leave, but then there was a civil war and you have to take sides and the Gang of Four as they were called, (Roy Jenkins, Shirley Williams, David Owen and Bill Rogers) left and took lots of people with them.

What was it like to work as the Treasury Finance Officer for the Kenyan Government? Oh yes, well that was my first job afCertainly in London where I lived ter I graduated and it was a wonderyou were dealing with completely ful life enhancing experience. I don’t way out loony people. I have to say think I helped Kenya very much as Jeremy Corbyn was one of them toI was learning but it was a fantastic gether with Ken Livingstone. They thing for me – I was a Cambridge were way out on the Marxist , Lengraduate, I’d only done 2 years of inist part of the spectrum. Those of economics and really should have us who were broadly social demodone a Master’s to be properly crats did not feel we should belong Cable in 2014 as Secretary of State for Business, Innovation & Skills (Courtesy Richter Frank-Jurgenmons) to this part and formed the Social qualified, but I was plunged into a job in which certainly after the initial Democrats. stages I got some really quite challenging roles in the government. With hindsight we underestimated the caSo in many ways he was an admirable and pacity of the labour party to regenerate itself visionary figure and he helped to get indeI was broadly responsible for anything to do which Blair and Brown did. They turned it into pendent Kenya off to a very good start. The with the industrial sector: Treasury funding of the kind of party I would have been comfortproblems were when people close to him got industrial estates, new development loans. able with, but they have now gone back to interested in acquiring property and things I was heavily involved talking to foreign intheir old ways, I’m not sure what the historistarted to happen that shouldn’t have been vestors who wanted to set up shop in Kenya. cal verdict will be. happening. It spread through the ministries I was in some ways out of my depth, but I who wanted their cut and then the officials – learnt as I went. You mentioned Corbyn, what would be it was all happening while I was there. your hopes for the Labour Party? I think one of the things I greatly valued was Well, I’m trying at the moment to work with “Where I lived you were that my opposite number in the planning people in Labour who are, quote, ‘sensible’ ministry was a very brilliant and quite famous and I’ve written a series of articles with Chuka dealing with completely Swedish economist called Savosnik who had Umunna who is a perfectly sensible and imway-out loony people. I done lots of pioneering work on trade theory. pressive guy and I’ve been doing joint camHe was a very rigorous economist and he have to say Jeremy Corbyn paigning with Francis O’Grady of the Trade taught me how to deal with issues properly, Union Congress who’s a very good socialist was one of them, together in a moderate, sensible, practical sort of way so I learned a lot and I had a lot of time for the Kenyans that I worked with. so I’m quite happy working with people like with Ken Livingstone. that . I think if Corbyn and his people remain They were way out on the it will kill the Labour Party – the Tories will There were subsequently a lot of them who became corrupted, but at the time they were Marxist , Leninist part of murder them. very straight. I got married in Kenya and the spectrum.” when my wife who was a Kenyan Asian died Do you think he will remain? it was after 30 years of happy marriage. I still Well I don’t know, I’m not in it. Because he The standards of probity declined quite raphave in-laws and friends in Kenya so I’m very has this mandate from his own membership idly and the other problem with Kenyatta was attached to the country. it’s quite difficult to get rid of him. But he’s although he was accommodating to the white been such a disaster that – I suppose the farmers he wasn’t equally accommodating to As you were saying, what was your weakness is that people like Tom Watson the Asian business people who were if anyexperience of working with the Kenyatta and the leader of the Unite Union and other thing more important to the Economy. They government? [Jomo Kenyatta was the power brokers may decide that this is a joke were forced out and this did quite a lot of that’s gone too long and they may organise a President of Kenya at the time] Although damage to the productive sector of the Kenit was in the later years that it came coup. I know that there is a lot of discussion yan economy. going on among the remaining Blairites and under more criticism, what did you think? the Brownites and some of the hard men of Yes, in some ways Kenyatta was almost a Why did you decide to leave the Labour the unions to get rid of Corbyn and replace Mandela figure, because he was imprisoned Party in 1982 and join the SDP? him with someone more electable. I’m not for many years in very bad conditions. He Well, I was quite happy in the Labour Party in close enough to know what’s happening. could have emerged like Mugabe in that the 1970s. I’d been a city councillor and had vengeful sort of way, but he didn’t. He took

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What do you think of People’s Quantitative Easing then? I don’t know what it means in practice and Corbyn isn’t an Economic thinker so I don’t know where this has all come from. In an emergency, of course, since you’ve done monetary economics you know helicopter drops using government deficit financing through the central bank are extreme options you could use. Lord Turner has just published a book describing circumstances in which this can happen and it’s something we discussed in Government. It was certainly an idea which I promoted when we were struggling in 2011, but it’s got to be done on a non-political basis and he sees it essentially as a way of financing vast amounts of government spending which is not the point – the point is to counter a deflationary emergency and it would have to be supervised by the Bank of England and done non-politically. If it were to be done like that then there may well be a place for it. I wanted to ask about the current account deficit. Osborne has been saying Britain’s paying its way in the world. Well I don’t worry about it, it doesn’t provoke the kind of problems which existed when we had a fixed exchange rate, I mean, you don’t have sterling crises anymore. And some people argue that the reason that the current account deficit is so bad is for some slightly odd specific reasons. One is there are some peculiar figures around gold and diamonds and precious metals I’m told. Second is the profit stream from British investments overseas which is significant and if you strip those two factors out it is said that it isn’t quite as bad as it would appear and it doesn’t reflect an enormous disparity between savings and investment. But what does worry me is that I do think the economy is seriously unbalanced which is something we tried to counter in government with the industrial strategy. It tends to mean the economy is more than ever dependent on domestic consumption and on property and all those things that led us into trouble in the first place. What would you say was the biggest failure of the Liberal Democrats during their time in coalition with the Conservative Party?

Interview

Well we failed really to communicate the reason why we were in the coalition in the first place, that it was actually inevitable given the numbers in 2010 and given the economic emergency. We had to do it even though it was pretty unpalatable for some of us. And we never really explained that and the Labour Party was fairly tribal You were in Talks with the Labour Party. Yes I talked to Gordon Brown and he was willing to form a coalition but the other leading labour people weren’t. Balls and the two Millibands were not interested, but in any event he didn’t have the numbers so it was academic. I think the other failure was the failure of leadership to anticipate the Tory assault at the end when they were trying to destroy us. There was no argument that we were facing a tsunami, we could have been given a bit more steer earlier on as to how you deal with this and we weren’t and then a poor election campaign. These were the two biggest problems.

“Housing [is] the biggest disaster at all levels. Its socially divisive, its economically destabilising, it’s distorting bank lending away from productive activities. It’s dreadful and is creating massive gaps between generations” What would you say is the most important way the British Economy should be changed. Property, housing I think that’s the biggest disaster at all levels. Its socially divisive, its economically destabilising, it’s distorting bank lending away from productive activities. It’s dreadful and is creating massive gaps between generations. I think that’s the biggest one. I think the second is the need to think long term, that’s what the industrial strategy was about, trying to think beyond one parliament, getting behind successful technologies and industries and trying to get round the problems of political cycles and dealing with the positive externalities that they generate.

Do you think we should keep the green belts? For housing you mean. I don’t think you should scrap the green belts, they were after all one of the great post-war achievements but I think you can be flexible about it. Quite a lot of the green belt is very poor land and a not very attractive public amenity with little access to it anyway so we should be pragmatic about it. If you go back to 2010 I think your leader Nick Clegg overplayed how big a crisis we had, although it was severe, he made comparisons to Greece which I think were slightly erroneous. Well at the very beginning that was how it was communicated to us by senior officials. I was spoken to by the head of the civil service, the head of the treasury, one removed from the Governor of the Bank of England. There was a Greek crisis going on but obviously as any economist will know if you have a flexible exchange rate you don’t have quite the same problems as Greece. None the less the British deficit and the structural deficit was bigger than anywhere else in the world at the time. And there was a genuine worry that while we were not talking about currency crises Government borrowing would become extremely expensive and if borrowing rates surged as they did in Greece, it would become difficult to manage. That was the argument. Even so was it not really a fair comparison but only scaremongering? Well you asked me the question at the beginning, was the macroeconomic response correct? You see people like Larry Elliot and Danny Blanchflower just did not understand or accept that there were serious supply problems. The best analysis came from people like Meghnad Desai who is way on the left of New Labour, a Marxist actually. He would argue that it wasn’t a Keynesian problem, it was an Austrian problem - it was what happens after a crisis. The NER would like to thank Sir Cable for his time and cooperation.

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Making the Most of the Refugee Crisis: A Guide for Beginners Fausto Gernone (BSc Economics & International Economics, ‘17, The University of Nottingham)

.,ollowing political turmoil, thousands .of Syrian families have found it impossible to conduct normal and safe lives in their home-land and therefore have moved to neighbouring countries such as Turkey, Lebanon and Pakistan. Around 11% of them, however, have made their way across the Mediterranean to the European Union (UNHCR, 2015), which proved unprepared to enforce a coordinated resettlement plan. The responses offered by individual countries are greatly different, ranging from the embarrassing decision by UK to accept 20,000 refugees over five years to the German commitment to welcome about 250 times as much. Whether inflows of refugees have a negative or positive impact on the host economies is not clear. Economists are often reluctant to talk of this issue in terms of gains or losses, afraid of being accused of reducing it to its economic aspects and ignoring its humanitarian, political and cultural components. However, understanding how the “refugee crisis” affects our balance sheet is essential for assessing the adequateness of the current migration policies. On closer inspection it emerges that these refugee inflows could prove beneficial to the European economies. In this article I will put aside the humanitarian and political dimensions in favour of a purely economic focus. I will outline the main benefits and risks and eventually I will draft what policies should be adopted in my opinion to maximise the former and escape the latter. The Good Europe is facing a demographic crisis, particularly strong in countries such as Portugal, Spain and Poland. The overall fertility rate, the average number of children a woman is

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expected to have, is 1.55 (Eurostat, 2013): much lower than 2.1, the rate needed to keep the population constant. The UN predicts that by 2030 the percentage of Germans in the workplace will drop by 7%. When new generations are smaller than the one that came before, the economy suffers. A shrinking labour force struggles to support the economy, pay pensions and meet health care demands. Furthermore, population decline empties out rural areas, since young people are more likely to move to big cities than the elderly. The shortage of young people in the work force, however, can be offset by the current influx of refugees, most of which are under 18 years old (UNHCR, 2015). Even though welcoming refugees would not tackle the systematic causes for low birth rates in Europe, it can mitigate its adverse consequences. In Sweden, which is the second highest European recipient of asylum applications, the ageing population proved the most powerful argument for accepting refugees (The Guardian, 2015). Related – but not equivalent – to the demographic problem, there are labour shortages, especially severe in the sectors of construction, manufacturing and, even more, technology. Labour gaps are most common in Eastern Europe. In Romania, for instance, more than 60% firms struggle to fill their vacancies, and the situation is not much better in Greece, Bulgaria, Hungary, Poland and Germany (ManpowerGroup, 2015). Labour shortages are unlikely to be beneficial for economic development. Jaguar Land Rover is planning to build a factory in Slovakia, its first European plant outside the UK. However, almost 80% of the current Slovak automotive suppliers stated that the lack of skilled labour slows down

their growth (PwC, 2015). It cannot be denied that refugees could fill these gaps. The evidence shows that Syrians, for instance, are on average well educated and could meet the demand for skilled employees. Well-known companies such as Volkswagen are already spying an opportunity in the influx of refugees as a way to fill labour shortages (Bloomberg, 2015). The paradox is that some of the loudest opponents of resettlement plans for refugees are, in fact, those countries who need them most, such as Hungary and Poland. It is also important to mention that migration influxes could boost the local host economy by increasing the demand for goods and services. A World Bank study (2015) focuses on the case of the Lebanon, a major recipient of refugees. Despite the negative effects that the Syrian war has caused in terms of investment and tourism in the neighbouring countries, the Lebanese economy is expected to grow by 2.5%, its highest rate since 2010. The wave of Syrian refugees stimulated output growth by increasing the demand for local services, triggered by their own savings, work salaries, remittances and international humanitarian aid. This phenomenon is not uncommon when a large flow of refugees enters a country: a similar effect occurred in Tanzania with refugees from Burundi and Rwanda (Maystadt and Verwimp, 2014). The Bad However, it would be naive to assume that managing the influx of refugees is an easy task. Among the potential benefits, there are arguably plenty of issues that must be taken in consideration. The most urgent problem is that European countries currently don’t have adequate infrastructure to face a wave of refugees of this magnitude. The number of processing centres for registering the arrivals is not enough and there is a lack of staff. The housing situation is even worse: many cities are using former schools, sports halls and other public buildings to house refugees. Not only is there a shortage of facilities such as beds and showers, but even security is understaffed and fights among refugees are not uncommon. Consequences can be dreadful: last summer in Greece around 2,500 refugees were locked in a stadium for almost 24 hours and some of them had no access to water or shade (The Guardian, 2015). Another major problem are the adjustment costs related to absorbing refugees into the labour market. There is evidence that refugees such as Syrians are relatively well educated and often speak English. However it is unreasonable to assume that one can just stick some thousands of refugees from far away into the host workforce since most of them don’t speak local languages. Hence, language barriers and cultural differences could make them unemployable and susceptible to extremism. Integrating young refugees in the education

system is key for consequently incorporating them in the labour market. In Germany, some schools simply place the refugees, most of whom speak no German, in regular classes. In elementary school this approach may be better than separate “welcome classes” since children pick up languages quickly. In large numbers, however, they could lower the academic level for local students. Older children, by contrast, would face larger difficulties to attend the same class as their native peers. Taking Measures In this context, a tailored plan of action could be effective in amplifying the benefits of the “refugee crisis” and minimising the risks. Such measures would arguably prove complex to put into practice, especially in the current political background. Nonetheless, they could act as a benchmark for policy decisions, and thus defining how an appropriate response should look is still relevant. The first step is to adapt the present elaborate asylum process to the size of the current refugee inflows. The Common European Asylum System was instituted in 1999 when the number of asylum applications was far smaller. Today it is necessary to dramatically cut down waiting times in order to process the current amount of applications with minimised costs. This may require a commission of experts with the task of making bureaucratic procedures faster and smoother. In addition, national security forces should be involved to a greater extent and high-unemployment countries may train and hire new staff to work in the asylum process. An optimistic target would be reaching an average waiting time of a week. Indeed, these measures may imply a big initial investment, but the overall gain from the shorter waiting times might outweigh the cost. Secondly, it is complex but essential to ease the assimilation of refugees into their host societies. Two dimensions of integration must be promoted: on a technical level, in order to enable immigrants to fairly participate in the local economy, and on a cultural level, in order to be accepted and trusted by the host communities. In this respect, partnerships between public, government institutions and the private civil society including NGOs would be beneficial and should be encouraged (UNHCR, 2013). Parts of the host populations are willing to help and this desire should be satisfied for bringing citizens and refugees together. In order to allow young people to engage directly, for instance, local governments could introduce voluntary schemes for helping refugees resettle. Incentives for taking part can be boosted by valuing these volunteering experiences in the selection processes for placements within the public sector.

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Furthermore, it is necessary to plan a homogeneous allocation of the immigrants. Locating them in separated areas would be a mistake since ghettoes create exclusion and diffidence. By contrast, a balanced resettlement plan could facilitate the integration process. In particular, policy-makers could aim at repopulating the rural areas and villages that have been emptied by migration and a shrinking population. In this way, the resettlement plan would turn into a solution for preserving the urban balance. Moreover, in order to grease the access of refugees into the local workforce, red tape must be cut and innovative and faster processes must be found. In the case of high-school and university students, for instance, transitional classes can be introduced for harmonizing language and competence discrepancies. Similar measures could be experimented with in the labour market. Some countries are already making efforts in this respect. Sweden, for example, is looking for creative ways to bring below two years the medical accreditation process which enables Syrian doctors to practice. In the creation of the new bureaucratic framework, however, it is important to take into account the opinions of the refugees themselves, which are in the best position to tell what may be beneficial for their own integration. In addition, technological innovation can be exploited for giving host communities the opportunity and the reason to give their contribution. Apps such as AirBnB have been made available to help immigrants find homeowners with free rooms with financial aid from local governments. In the same way, many any other apps could be developed to help them settle and integrate. Through these platforms, governments can easily track and monitor the flows of refugees and this is surely much better than the existing bureaucratic maze. Another important step is to make clear to citizens that there are social and economic benefits associated with accepting refugees, especially in the light of the shrinking workforce. At the moment this is not understood at all, especially in countries such as Hungary and the UK, and the public is not aware of what welcoming refugees would really imply. Probably media have to be blamed since they failed to provide an unbiased picture of the real situation.

Undoubtedly, hosting and integrating refugees would be costly in the short run. One of the most pessimistic figures came from the Ifo institute, which estimated that in 2015 the government expenditure in Germany will amount to almost €20,000 per refugee. “That figure includes accommodation,

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However, the extra government spending does not disappear, but would act as a fiscal stimulus, boosting internal demand, output growth and employment (European Commission, 2015). In conclusion, the expenditure is unlikely to be a burden for the host governments. If anything, fast and considerable returns could be expected from this initial investment. Another concern is that refugees take jobs from native workers and reduce wages. This is one of the most common wrong beliefs in economics. In the very short term the arrival of refugees increases the number of jobs available for local people, because more workers are needed to meet their demand for food, heating, housing and so forth. In the medium term refugees would increase the low-skilled labour supply because adjustment costs would prevent them from filling high-skill placements. In the absence of deliberate policies, this could lower the wages of the low-skilled labour already in place, but history shows that this effect is extremely small (Ottaviano, 2011). In anything beyond the medium term the effects are positive because the higher population increases the demand for goods and services and because the labour market would specialise, raising productivity. In short, thinking that more people means fewer jobs or lower wages is wrong. Another common argument is that migration negatively affects health care. It is specifically claimed that migrants increase waiting times. Research, however, failed to detect any negative effect on waiting times (LSE, 2015). In the light of the structural problems affecting European Countries today, the “refugee crisis” has the potential to significantly help attenuate or solve them. For this reason, the resistance showed by some countries to host refugees has little justification from an economic point of view. In this regard, third factors such as media or the presence of other refugees (such us Ukrainians in Poland) could play a role. However, employing resources to contrast the flow of refugees may be more costly than channelling it into the host communities. An adequate action plan should aim at encouraging the assimilation of refugees into the native population, also by making use of new technologies and creative solutions. Throughout history movements of people have been shaping each aspect of Europe. Even though the current “refugee crisis” sounds like an unprecedented phenomenon, it is not. In past centuries, the integration of populations created the cultural richness which is much praised by European countries. Migration influxes means new lifeblood and this is exactly what Europe needs today.

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Side Issues Now, I would like to shed light on some other issues commonly mentioned in the debates over refugee influxes but which are often unclear.

food, crèches, schools, German courses, training and administration,” stated Gabriel Felbermayr of the Ifo Institute. Indeed, financing this expenditure would not be painless for the current debt-burdened Europe.

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FDI, Economic Growth and Emissions in Developing Countries Saurabh Tripathi (MSc Economics ‘16, The University of Nottingham)

Steel plant chimneys spout pollution in Kazakhstan (Courtesy LeRoy Woodson)

1. Introduction ..n the past few years, the world has stood witness to an unprecedented scale of debate and discussion about the future of the planet. How producers produce, consumers consume and governments govern, have implications for the short- and long-term quality of the environment around us.

As we have begun to realise this, we have undertaken conscious public discourse to ascertain our impacts on nature, and how these in turn, impact our own safety and immediate future. Is the nature of our economic activities partly responsible for the increasing frequency of environmental disasters? If yes, then can we even scale back these activities given how intricate our global economy is? These questions have prompted economists since the 1990s to test the relationship between the GDP and the environment. The literature on this subject has focussed almost exclusively on developed countries, perhaps due to the lack of funding for environmental research in the development context. This paper certainly addresses that gap, but even then, are all developing economies alike? Over the course of this paper, you will see, that the relationship between nature and the economy is certainly not a ‘one size fits all’. Moreover, since the advent of globalisation, there has been a tremendous surge in capital flowing from developed countries to developing countries (LDCs), and this FDI is said to have promoted economic growth and improved the lives of people at all levels of the income distribution. In the midst of this rapid increase of FDI however, have we ignored its impacts on environmental quality? A significant number of people in LDCs depend on fishing and forestry for their livelihoods. What if the FDI that is thought to improve the

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lives of people, in fact diminishes their source of income by means of its adverse impact on ecosystem services and environmental quality? This paper estimates the magnitude and direction of the relationships between FDI and growth, with environmental quality in a dynamic simultaneous equations framework. These relationships are considered from a broad worldview, and a narrower regional viewpoint, in order to assess the consistency of global findings at the local level. 2. Methodology The basic Cobb-Douglas production function with capital and labour is used to determine the equation for GDP as an endogenous variable. The function is given as:

(1) Y = AKα Lβ GDP is a function of more variables than just capital and labour. Omri (2013) explains that output is determined to a great extent by the energy consumed in production. Due to savings and fiscal constraints, growth in LDCs could be driven by investment from foreign firms (Anwar and Sun, 2011). Adding these two variables to (1), we get:

(2) Y = AKα Lβ Eγ FDIθ eμ where, Y is the dependent variable representing real GDP, A is an exogenous technological change parameter, K is capital formation, L is the labour force, E is the energy consumed in production, FDI is foreign investment inflows and µ is the error term of the equation. The exponents α, β, γ and θ are the elasticities of their respective inputs of production. Pereira and Pereira (2010) note, that at any given point in time, there is often a direct and linear correlation between energy

consumption and CO2 emissions. Therefore, if we assume that:

E = λCO2 Then we can alter (2) to get:

(3) Y = λγ AKα Lβ COγ2 FDIθ eμ As there is heterogeneity in the selection of countries employed in the study, to make the interpretation of the results more robust, it would be preferable to analyse the variables in per capita terms. Dividing each side by L, and assuming constant returns to scale, we get:

(4) Y/L = Aeμλγ (K/L)α (CO2/L)γ (FDI/L)θ The variables also need to be converted to their natural logarithms to make the interpretation of results convenient, as the estimated regression coefficients are seen as elasticities, or semi-elasticities. Following the log transformation, we get:

(5) log(Y/L) = log(Aλγ) + αlog(K/L)

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expect all independent variables to have a positive correlation with GDP per capita. We know that CO2 emissions are a linear transformation of energy consumption, and thus, an increase in the amount of energy consumed should ideally mean an increase in the growth of GDP. Based on (6), I can now formulate the regression equations for FDI and CO2, to complete the set of equations. These will be used to determine the relationship between the variables.

+ β1 log(YL)it + β2 log(CO2/L)it In (7), FDEV stands for the level of financial development of the economy while OPEN is the level of openness of the economy. FDEV is proxied by the amount of domestic credit provided by the financial sector, as a percentage of GDP. OPEN is simply the ratio of the sum of exports and imports to GDP. As these variables are already expressed as a percentage, there is no need for a log transformation. Anwar and Nguyen (2010) explain that the more financially developed and liberalised an economy is, the more likely it is to attract FDI. We should expect to see a positive coefficient for GDP growth, as an increase in the level of economic activity would ideally make foreign investors feel confident about the performance of the economy.

(6) log(Y/L)it = β0+β1 log(K/L)it +

(8) log(CO2/L)it = β0 + β1 log(Y/L)it

Here, i = 1,…, n is the subscript for country and t = 1,…, n denotes the year from the dataset. As the variables on the RHS are in their logarithms, we can interpret them as the growth rates of capital accumulation, CO2 emissions and FDI per capita. We would

+ β2 [log(Y/L)it]2 + β3 log(FDI/L)it

+ β4 log(IND/L)it + β5 log(URB/L)it + β6 OPENit + μ

In (8), IND stands for the value added by industry to the entire economy, and URB stands for urbanisation, which is the growth

The data is sourced from the World Bank’s World Development Indicators. 4. Results This section presents first, the results from the world panel, and then the five regional panels by way of a comparative analysis. The unit of interpretation for the variables will vary between absolute terms, percentage terms and growth rates, because of the need to use the first-difference of non-stationary variables (Granger and Newbold, 1974). The three models in Table 2 (next page) are the three primary regression equations (6)(8) from section 2. Model 1: A 10% increase in emissions reduces GDP growth by nearly 0.5 percentage points. Herein lies a vicious cycle: more activity in the economy results in higher emissions, and that in turn leads to a fall in the rate of growth. Therefore, increasing GDP by advancing polluting industries will not be a source of sustained growth. FDI appears to have no significant impact on growth, which challenges the rationale behind FDI. Perhaps current levels of FDI are just not adequate to make it a primary driver of development in low-income countries.

+ β3 FDEVit + β4 OPENit + μ

Taking the first term on the RHS to be some constant value, we can rewrite (5) in panel data form. The equation (6) below is the primary regression specification for GDP.

β2 log(CO2/L)it + β3 log(FDI/L)it + μ

of the total urban population of a country. A positive coefficient on URB should be expected, as life in an urban environment is more resource intensive than in a rural environment. Depending on which set of research papers from the literature one chooses to side with, FDI can be interpreted to have a positive or a negative coefficient. Growth in developing countries in the 1990s and 2000s was largely attributed to their transition from agricultural to manufacturing

(7) log(FDI/L)it = β0

On CO2 emissions, intuitively, we should expect to see a negative coefficient as foreign firms might see increasing per capita emissions as a sign of production inefficiencies. However, for developing countries, an increase in CO2 emissions could also signal to investors that the scale of industrial activity in the economy is growing.

+ γlog(CO2/L)+θlog(FDI/L)+μ

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economies, and this is why IND has been included in the analysis. OPEN is added here as a control variable. For the estimation of the three simultaneous equations [(6), (7) and (8)] , I make use of Blundell and Bond’s (1998) Generalised Method of Moments (GMM) procedure. 3. Data Description This paper covers a total of 73 countries from five of the world’s most important developing regions: Middle East and North Africa (MENA), South America, South Asia, Southeast Asia and Sub-Saharan Africa (SSA). The time period used is 1990 to 2011.

Model 2: We see that the growth rate has no significant impact on the level of FDI it receives. This is surprising, given that capital often flows towards the fastest growing countries, as that provides investors with some security about the future returns to their investment. A 1% increase in CO2 emissions results in a 0.6% increase in FDI. This could be the result of one of two effects: a) foreign firms view an increase in CO2 per capita as a sign that economic activity is booming, or, b) polluting capital seeks a ‘haven’ that is becoming increasingly polluted, perhaps due to the low stringency of environmental regulation. The latter might be a far-fetched hypothesis, but I cannot test which theory is more plausible as there is little data that breaks down the sources of FDI flowing into developing countries. Model 3: This establishes the presence of an Environmental Kuznets Curve (EKC) in the global panel. 1% growth in GDP initially increases the level of CO2 by 1.6%, and then after a critical point, this effect reverses as emissions fall by 0.12%. This critical point has been measured to be 6.6% growth in GDP. This is, to my knowledge, the first paper

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to comment on the effect of growth rate on emissions, as opposed to the level of GDP. This implies that when countries are growing at a slow pace, they tend to increase emissions, but when they grow at a high enough rate then the replacement of old technology and industrial processes is fast enough to reduce CO2 emissions, despite the increase in economic activity. Furthermore, the results show that a 10% increase in FDI leads to a 1% rise in CO2 emissions, implying that FDI inflows into LDCs have negative consequences for environmental quality.

makers might not see the economic incentive in pursuing stringent environmental regulation either.

South America: There is evidence for unidirectional causality from GDP to FDI, and from GDP to CO2. The former is an expected result, as growth in FDI should depend upon growth of the economy as a whole. The latter is not unexpected either, as more cars on the road and more production in industries would predictably increase emissions. This panel shows support for the EKC hypothesis. One percentage point rise in GDP growth results in an 8 percentage point increase in emissions growth, which is substantial. After a peak of 8.5% growth in GDP, South American countries have a fall in emissions. This is an unrealistic target for countries in this region given that over the past 10 years, the only countries to have gone above 6% annual growth are Argentina (2010: 6.1%), Bolivia (4 times; average: 8%) and Venezuela (2013: 6.8%).

We cannot look at the EKC in isolation and hypothesise a unidirectional relationship when there is overwhelming evidence that the correlation flows both ways. This is a matter of concern even for supporters of a ‘brown-economy’ with no environmental regulation, as emissions seem to turn around and affect growth negatively in the immediate short-run. These results were from a panel of 73 countries that are very different from one another. Do they hold true even after splitting the countries into five regions? Not quite. The most striking point from Tables 3.1 and 3.2 is the disparity between the regional and world panel results. While this might not be surprising, it raises the question of whether the studies that analyse large world panels have any applicability to policy, given that policies tend to be based on regional or national realities. The results vary widely between regions as well, indicative of the subtle differences in investment patterns, economic history and environmental endowments. South Asia: There appears to be absolutely no relationship between foreign investment, growth and emissions. However, there is a positive and significant impact of the change in value added by industry on the growth rate of CO2 emissions. When the YoY change in industry value increases by one percentagepoint, the growth rate of CO2 emissions increases by the same amount. Given that South Asian economies are just getting started with strengthening their manufacturing sectors, this positive relationship will push CO2 emissions upward. Since emissions are not growth retarding in South Asia, policy-

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effect is larger, with a 10 percentage point rise in FDI resulting in a 1.2 percentage point rise in emissions.

Sub-Saharan Africa (SSA): This is the only region that replicates the bidirectional relationship between

Southeast Asia: Here, FDI seems to be positively growth augmenting. The result, while statistically highly significant, is economically negligible with a 10 percentage point increase in FDI growth amounting to only a 0.06 percentage point increase in GDP growth. The reason for this might be the size of the informal sector in the region. In LDCs, a large portion of economic activity is unrecorded and near impossible to accurately account for. Therefore, even if FDI forms a significant percentage of the formal economy, we can hardly extend the argument to claim that foreign investment is thus pivotal to the entire economy. A 10 percentage point increase in the rate of emissions growth results in the growth of GDP falling by 0.16 percentage points in Southeast Asia. This mirrors the finding of the world panel, but the magnitude is reduced to a third. This is the only region to replicate the world panel result of a positive flow of causality from FDI to CO2 emissions. The

CO2 emissions and GDP growth from the world panel. The irony of the relationship is that high growth results in increasing emissions, which in turn are growth retarding. This is not to say however, that high growth rates cannot be sustained due to CO2 emissions, because the magnitudes of the two directions of this relationship are very different. The emissionsaugmenting impact of growth appears to be far larger than the growth-augmenting impact of emissions. There is evidence for a unidirectional relationship from CO2 to FDI: the effect is significant at the 10% level, but shows that when emissions rise by 1%, FDI rises by 0.8%. Middle East & North Africa (MENA): This is the only region that shows presence of a bidirectional relationship between GDP and FDI. This again proves how important it is to study regions in isolation, and go beyond pooled data sets. The coefficient on GDP in model 2 suggests that a one percentage point increase in economic growth results in a 6% increase in foreign investment. This finding is significant at the 1% level, and goes on to show just how big a factor growth is to attract FDI in MENA countries.

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The most interesting result from this panel is the relationship between FDI and CO2. It is the only region where an increase in FDI reduces the growth rate of emissions. This supports the hypothesis that FDI brings along with it, the transfer of clean and efficient technologies that can spill over to domestic firms, ultimately reducing the level of emissions in the country. This is negligible however, as a 10% rise in FDI reduces the growth rate of emissions by 0.07 percentage p o i n t s . Therefore, I do not consider this to be an important result, at least not one that should have much bearing on policy discussions. The relationships between the three main variables with the direction of causation are summarised in table 4. This regional comparative analysis helps us understand better the heterogeneity that exists even between countries that would otherwise be classified under the umbrella of developing countries. 5. Conclusions This paper helped plug a gap in the literature, which was the lack of comparative regional analyses of the aforementioned relationships. There was weak evidence if favour of a Pollution Haven Hypothesis from the world and SSA panels. In testing for the EKC, we found strong evidence in favour of the hypothesis from the South America, SSA and world panels. The peaks of the EKC were measured in terms of GDP growth rates, a possible ‘first’ in the literature. Between the three main variables, some panels showed no relationships; while some showed unidirectional causality and

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others supported bidirectional causality. The research literature on the relationships between FDI, growth and CO2 emissions

is dense. However, most papers have attempted to explain these relationships using static econometric methodologies that do not consider all sides of the proverbial coin. This paper, by making use of a simultaneous

formulated in the region. Moreover, the use of regional panels in a comparative format showed just how much heterogeneity there is between panels. This is a non-trivial aspect of the methodology seeing as it helps us understand where and how regions differ from each other. There are several pointers for future research. Firstly, studies could use a similar system of equations with a different measure of environmental quality to check for consistency of the results found in this paper. Data availability at a global level is challenging, but recreating this model using a different measure at a provincial or national level should be possible. Secondly, to factually validate the presence of a pollution haven hypothesis, papers could consider breaking down the sources and destinations of FDI inflows under a similar econometric framework.

system of equations, tests the presence of causation across the three variables and ascertains the direction of the relationships. In the presence of bidirectional causation, when papers look at just one estimating equation, they presume the possibility of reverse causality to be non-existent. This can bias results and lead us to draw potentially unwarranted conclusions for policy. The estimation results for the Southeast Asian panel are testament to the success of the simultaneous equations system, as they show just how intricate these relationships can be, and therefore by extension, how carefully policy needs to be

Finally, econometricians might find it useful to develop the applicability of the Granger Causality (GC) for panel data further, as that would make causality analyses more robust. There is room for further development in the econometric methods available for the estimation of simultaneous equations. The number of papers analysing the impacts of FDI and growth on emissions are plenty, and that is very encouraging for future researchers as well. The hope is that analyses such as this one, that focus on developing countries, continue to dig deeper into these intricate relationships to uncover robust econometric evidence for policy makers to take cue from.

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A Conversation with Michael Jacobs

Author of: The Green Economy (1991) & The Politics of the Real World (1996) Interviewed by Sophy Rolson and Diana Beltekian (BSc Economics, ’17 & ’16, The University of Nottingham)

..ichael Jacobs, Senior Advisor on ..International Climate Change Policy, visited the University of Nottingham in October to deliver a talk called: ‘Crunch time in Paris: The political economy of a new climate change agreement.’ His hopes of an agreement being made in Paris were realised after two weeks of negotiations at the Climate Change Conference (COP21) in December, where the first ever universal, legally binding global climate deal was made by 195 countries. This agreement will enter into force in 2020 and aims to limit global warming to below 2 degrees. We caught up with Mr Jacobs in October to discuss his views on some issues in environmental economics. In your report on the New Climate Economy you stress that the de-coupling of growth from emissions needs to accelerate if we are to meet the emissions targets. However, Tim Jackson expressed some doubt over this method in a discussion he had on The Economist. Are you optimistic that we can enjoy both economic growth and sustainable living or is a zero growth economy the only answer? Let’s take some time periods. I think over the next twenty years there’s absolutely no question that we can have both economic growth and reduce greenhouse gas emissions, and deal with a number of other environmental problems where there are very clear technological solutions that growth can accommodate. In the field of greenhouse gas emissions we know how to produce energy without carbon dioxide and the cost of that is falling very rapidly. Solar and wind power are now at parity with carbon gas in many parts of the world. I heard recently that the National Grid thinks that solar

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will be at parity with gas in under two years in the UK. So if the cost of not producing emissions is no more than the cost of

Over the longer term, you can only have growth and hold environmental impacts constant if your rate of technological improvement, your rate of reduction of carbon per unit of output, exceeds your rate of output growth. That will become increasingly hard. We will have diminishing marginal returns to all of our technologies and things will become more difficult as we squeeze carbon out – squeezing it more and more will become more difficult.

At that point you will start getting much tighter conflicts between Jacobs speaking to ‘The Carbon Brief’ in 2015 (Courtesy The Carbon Brief via YouTube) growth and emissions reduction, producing emissions, then capitalism will find and I can see a point where it becomes really a way to do that. It is finding a way to do that difficult to do this. Technologically it is not clear and is still generating growth. That’s also true when that will be. Thermodynamically we’ve of other air pollutants in practice which are not got a very, very long way to go and in so far as needed for production and can be eliminated most of our emissions still come from energy technologically. All the evidence suggests that we get growth without carbon at all. Other that process is now occurring, that the carbon environmental problems are more difficult. intensity in the economy is falling quite rapidly, not nearly rapidly enough, but falling rapidly, So I think Tim Jackson is wrong in the short and the technologies look like they’re coming term, but he will be increasingly right over the on stream relatively quickly. medium term. We still have an issue of what we’re measuring – GDP is not a measure of However, let’s now caveat this. There are material or energy flows through the economy; some environmental problems which are it’s a measurement of value, and value can much harder to deal with than growth: habitat be created in all kinds of ways, including loss is much more central to the patterns of lots of dematerialised ways of producing, economic growth that are occurring. This is and of course our economies are gradually largely because of population growth; we are dematerialising. So I think in the long term just taking over more and more of the world’s it will become harder and harder to do this, biomass. I particularly for some environmental factors. t’s difficult to see that halting as long as you have population growth – not primarily economic growth but population growth. Right now there are things like ocean pollution and marine fish stocks which are much more closely tied to economic growth than air pollution or greenhouse gas emissions. So different environmental problems have different characteristics in their relationship to growth.

We can still produce value. Whether we will want to carry on producing value in order to create prosperous societies with high quality of life I think is an important social question. But in the very short term, the world needs growth. It needs growth to get people out of poverty. Moreover, the world will have growth. Getting rid of growth is an incredibly difficult thing to do so I’ve never really understood what it means to aim for a zero growth society. When

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we have zero growth we have recession, we have mass unemployment, and so on and so forth. So I think there’s a huge opportunity to combine these objectives in the short to medium term which is the term we’re acting in now. As you mentioned in the July 2015 New Climate Economy Report, climate smart infrastructure assets pose a long term investment. In which sectors would you expect to see these targeted investments making the greatest difference in fostering development and improving well-being? The big area now is in urban infrastructure. The population is growing rapidly. People are urbanising all over the world. Now about half of the world’s population live in cities; by 2030 it will be about 60% and by 2050 it will be about 70%, and it will be a much larger population. We have a massive challenge as a human community to create cities that are economically viable and are nice to live in. Right now we’re getting the urban development model wholly wrong, in that most people are moving into cities that are becoming bigger and bigger in land area. They are depending on private motorised transport which is creating terrible air pollution problems, and they’re economically dysfunctional. You sit in a traffic jam in Jakarta as I did relatively recently for an hour to go three miles and you can’t breathe the air. It’s completely economically dysfunctional as well as socially disastrous. The big challenge now is how we design cities that are much more compact, which rely on public transport rather than private transport, and which use information technologies much better than they do now as a source of economic growth. That’s a challenge particularly in developing countries where cities are growing, but it’s also a challenge in those parts of the world, not least the US, which have very sprawling urban models. Urban infrastructure, which is roads, transport, water, energy and buildings, is the huge challenge, and it’s the one that is in many ways the most difficult because cities are not planned enough – cities just happen because people move to them and build their own buildings and it’s very difficult to control the infrastructure. So I think that’s where the real challenge is now, but it’s also where a lot of the energy is – people are really thinking about this and city authorities are really trying to think about it. About a year ago, Ban Ki-Moon was

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expressing his frustration at a lack of progress being made on the climate change front. Do you think much progress has been made since then, and what do you think the biggest challenges to progress are that we face today? There are two completely different aspects to progress and I think what Ban Ki-Moon was largely talking about was the pace of negotiations towards an international agreement. The pace of negotiations has been too slow and it’s still a problem, but I think that most observers think that there now will be a new international agreement in Paris in December this year, and that will be a very important signal of commitment by all of the world’s countries to take action on climate change, particularly to reduce emissions. The other form of progress is progress towards actually cutting emissions, which is not exactly the same as the agreement to do so.

Right now we’re getting the urban development model wholly wrong, in that most people are moving into cities that are becoming bigger and bigger in land area. On that, progress is much too slow in the sense that we have to reduce emissions drastically and to do it very quickly. Over the next 15 years we have to make a huge cut – by 2030 we have to get from where we are now, which is about 58 gigatonnes of greenhouse gases, to about 42 or less, and that isn’t happening fast enough. If you look at the projections, including the commitments that countries have made, they’re not going to get anywhere near there – they’re going to get to about 55. That’s much lower than business as usual – business as usual would be up in the mid-60s – so it’s action but it’s not sufficient action to keep the world on a pathway to hold global warming to 2 degrees, which is the international goal. So in that sense the progress is too slow. The problem is that every bit of infrastructure that we put in that is high carbon now locks in emissions over 30 or 40 years, so there’s a huge premium on the decisions that are made now in order to get your emissions down in the future, because if you build a coal-fired power station it will last for 30 years. If you build a city

plan around motorways you will have traffic for 30 years. If you build a bus rapid transit system you will have much lower emissions for 30 years. There’s no question that those decisions are not happening quickly enough. They’re beginning to, they’re quicker than they were, but they’re not happening quickly enough. The hope is that the Paris agreement will get every country committed to cutting their emissions and this will start to change these investment decisions, but it’s the translation from the commitments that countries make in an agreement about what they will be doing in 2025 or 2030 to the decisions they literally make now that is crucial. If countries delay making those decisions then we will fall further behind. We’re already way behind where we need to be, but we will fall further behind. You said you were hoping there would be a legally binding agreement in Paris. Are there ways to enforce the agreement? Well I don’t think enforcement is so important, and it’s not going to happen because countries don’t want to be put under a penal system. We had one under Kyoto where countries would effectively be punished (although there wasn’t much punishment to it) and Canada for example withdrew from the Kyoto protocol before those provisions could be enacted or applied to Canada when it was clear that it wasn’t going to meet its targets. The record on targets is that two countries in the Kyoto protocol, Australia and Canada, completely failed to hit their targets, but Japan and the EU, which had much tighter targets, met theirs – the EU by way over. China, which has had targets for the last 5 years, has met its targets. The US is now on course to meet its targets. So I’m not so worried about countries not meeting their targets. I think it’s very likely that countries will exceed their targets, partly because they will set them in ways that they feel confident of with current technologies, and technology is improving and technology costs are coming down so I think it will be a bit easier. So I think I’m not so worried that we will have a problem of compliance and the problem with a regime with compliance is it encourages countries to be less ambitious so that they always comply, so that’s not the issue for me. The issue is can we drive the technologies and the costs of the technologies faster so that countries in fact exceed their targets. Innovation causes high upfront costs with uncertain returns for companies investing, so how can the international community strike a balance between incentivising private

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investors to commit their resources to low carbon research and development whilst also finding a means of disseminating the information to developing economies who could benefit from that as well? This is now beginning to happen. The R&D space, as it were, is now filling with money for low carbon. You look at a company like Tesla which is a tiny manufacturer of cars, but looks like it is making the big technological advances on storage, and money is piling in to Tesla. Tesla is valued at half that of GM which produced 13.7 million cars last year and Tesla produced 25,000. So the incentives now are very considerable, and you’ve got Google

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piling in to all these technologies. Bill Gates is putting a billion of his own money in to this. So right now the incentives in some areas are very considerable, and that’s because policy is signalling where we’re going. That’s what Paris, in a sense, will do. The issue for developing countries is slightly different. It’s much less than it was. China, for example, doesn’t really have a technology problem. China is now manufacturing its own technologies. Most developing countries are now able to access many of the technologies, but not all of them. Agriculture is much more of an issue, where agricultural technologies are still very patent-heavy and are expensive. One

of the things I hope the Paris agreement will do is to stimulate innovation or R&D agreements and that’s beginning to emerge. I think we’re going to see some more from the US over the next few weeks which will help the transfer of technology. In the end, for developing countries, they need to be developing the technologies themselves – that’s part of growth for them, and it’s also because those technologies will be needed in developing countries. So there’s a shift beginning to occur, I think. The NER would like to thank Robert Chote for his time and effort in participating in this interview.

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The Economic Consequences of Terrorist Attacks & Resulting Policy Implementation Chris Brownlie (BSc Economics ’17, The University of Nottingham)

the attack and the immediate costs of dealing with the threat. The direct costs can include provision of temporary housing for those affected, costs of rebuilding damaged property and costs of extra emergency services. As these are both observable and measurable, there is little of interest that can be said about them. They also tend to be relatively insignificant, for example the OECD estimated that the direct costs of the 9/11 terror attacks to be $27.2 billion, which represented just 0.25% of the U.S’ annual GDP. (5) Indirect costs are where the majority of economic damage will arise and as such, addressing these is where most policies tend to be directed. Many of these policies create unintended costs and these consequences can be considered as seconddegree indirect costs. Indirect costs initially result from confidence being undermined and panic spreading through the economy.

U.K anti-terrorism police in North London, June 2015 (Courtesy Wikipedia)

.n the 13th November 2015, Paris suffered the worst terrorist attack in Europe in a decade. A series of mass shootings, bombings and hostagetaking occurred throughout the French capital and the northern suburb of Saint-Denis, resulting in 130 deaths and over 350 injuries. This abhorrent attack has shocked the world and undermined confidence throughout economies, markets and societies. It is an example of ‘transnational terrorism,’ whereby attackers strike targets across borders. This has become increasingly prevalent in the past few decades as there has been a noticeable change in the motivations and composition of terror groups. Before 1980, terrorist groups were mostly nationalist, separatist, Marxist or nihilist groups which had an aim of taking out very specific targets in order to win public approval. However in the last 35 years these familiar ideological groups have been increasingly replaced by religious fundamentalist groups. Only 2 of the 64 active terrorist groups in the year 1980 were identified to be “modern religious terrorist groups”. This proportion of religious terrorist groups rose to nearly

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half of all active groups in 1995. (1) The consequences of this also include a shift in the method of attacks, away from complex and expensive operations such as assassinations of individuals or hostage taking and towards frequent use of bombs to achieve maximum casualties on a large, innocent group of civilians. This change since 1980 corresponds to the number of people killed by terrorist attacks worldwide which has also been increasing the past couple of decades, as shown in Figure 1 below. When analysing historical terrorist attacks, there are also visible trends that occur in the frequency and timing of events. Trends have been attributed to various factors; one of these explanations is demonstration and copycat effects. In the period following a substantial terror attack, a very sensitive public means a very sensitive media. Therefore any attacks in the following days and weeks are more likely to gain extensive media coverage and this period of time is consequently a more efficient choice of target date. Other explanations include economies of scale when planning attacks and an attackcounterattack cycle between terrorist groups

and governments. Economists have been applying their theory and analysis to terrorist attacks since Landes studied aircraft hijacking in the US. In the last decade, however, the topic has gained significant attention in the field, mostly as a result of the 9/11 attacks in the US. Using an economic approach to examine terrorist attacks can be a controversial process as it involves considering the terrorist as a rational economic agent that responds (to an extent) to ‘incentives’ and the actions of governments. Doing this allows economists to judge the effectiveness of various counter terrorism policies and their respective costs. Throughout this process it is imperative for economists to remain objective and - where possible - use empirical evidence, which is very difficult as governments and terrorist groups for obvious reasons do not share information about their capabilities or procedures. It is widely understood that the economic cost of a substantial terrorist attack on a particular economy can be split into direct and indirect losses. Direct losses include the costs of the physical damage that occurs as a result of

In the days and weeks following a significant attack, consumers cut any spending that isn’t essential and tend to avoid public places. This could be seen after the Paris attacks of November 2015, when two big department stores, Printemps and Galeries Lafayette, reported footfall down by 30-50% in the days following the violence. This is hugely damaging to traders in the areas affected and they often record substantial losses. Another issue for these businesses is when the transport infrastructure of the region is shut down, a common procedure following a terror attack. This lack of transport often leaves employees with no way to get to work, extending the amount of time the businesses have to remain shut. The other major industry that, along with the retail sector, suffers most from a terrorist attack is the financial industry. The shock of the initial attack coupled with the uncertainty of how governments will react to it often results in investors off-loading stocks and this can often snowball into all out panic selling, triggering a drop in asset prices and a flight to quality. There is evidence that the damage to the stock market following a terror attack is limited for countries with a stable banking sector and is becoming less significant

in recent years – although the CAC40 index fell 1.2% following the Paris attacks, this was more or less a continuation of recent trends. A common second-degree indirect cost comes from the extra time spent on security checks and public monitoring following an attack. Some estimates state that the cost of passenger delays due to more thorough airport checks post-9/11 was up to $100 billion. Many problems arise when considering the proper policy response to a terrorist attack.

Paris attacks as panic spread throughout the developed world and many countries around the globe were affected. The interests of a given country are no longer confined within that nation’s borders. If the UK has interests in a foreign country it must rely on that country to protect them. Therefore terrorists who target UK interests abroad may be able to operate under less scrutiny as governments will favour protecting their own interests above those of the UK. This leads to under-deterrence on a global scale. However if damages are limited purely to domestic interests, governments will overdeter.

Over-deterrence can also arise as a result of governments wanting to appease a population which is panicking. In the days following the Paris attacks David Cameron (Courtesy The Economist) announced extra funding for 1900 new security and intelligence staff and doubled One of which stems from the difficulty in aviation security spending for the UK and disentangling emotions and politics from the French Prime Minister Manuel Valls pledged decision making process. The biggest obstacle an extra €425m for security forces. There is that governments have to overcome when it no clear evidence that these policies will be comes to trying to prevent attacks is that the effective in halting terrorist attacks but they increasing transnationality of terrorism means have been widely praised by the public and that a group may strike any place at any time. have reassured many people. This shows that After the IRA tried and failed to assassinate a lack of communication and differing interests Margaret Thatcher in 1984, they released can be severe restrictions to successfully and a statement which read “Today we were efficiently preventing terrorist attacks. unlucky, but remember we only have to be lucky once – you will have to be lucky always.” Attacks like the tragic events of November 13th 2015, whilst obviously having terrible This comment captures the dilemma that social effects, can also have a significant security services face as they must always economic impact. It is very difficult to measure stay one step ahead and although many just how damaging these kinds of attacks terrorist plots are uncovered in time, it is are due to the abstract nature of the costs, inevitable there will be some which are not. In but it is clear that the atmosphere of panic, this drive to constantly be aware of potential apprehension and sadness which follows is not threats, efforts must be made to monitor conducive to economic growth. known terrorists or persons who pose a danger to society. As a result, this can make it extremely difficult for governments to assess the correct course This in turn raises the ethical question of how of action and may lead to decisions being much surveillance is acceptable and this worry made with emotion rather than reason. I of a so-called “big brother state” has been hotly believe it is important for costs and benefits contested in recent times. Another problem of policies to be fully analysed and, more that security forces have to face is the scope of importantly, increasing international copotential targets. As the world becomes ever operation is imperative if events like these are more interconnected, transnational terrorism to stand a better chance of being prevented in can affect a vast array of different countries an increasingly militarised world. from just one attack. This was evident in the

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Foundation suggests that private rents will rise by more than twice as much as incomes by 2040, resulting in a majority of private renters in England living in poverty. For a wealthy, developed country, this is shocking and profoundly disturbing.

Understanding Generation Rent Sophy Rolson (BSc Economics ‘16, The University of Nottingham)

‘To Let’ signs line many streets in London (Courtesy iStock)

..he British dream of becoming a .homeowner is still hugely popular throughout the nation. However, for many that dream may never be realised. With the rise of so-called ‘Generation Rent,’ more and more people under the age of 40 are struggling to make it on to the property ladder, becoming trapped in the private rental market. Since 2001 the percentage of households in the private rented sector has doubled, not due to higher preferences for rented housing, but due to a lack of other affordable options. The adverse effects of this reach far across society and if nothing is done to fix it soon, the UK may find itself with a housing crisis on its hands. Why has this problem arisen? The housing market is riddled with imperfections on both the demand and supply side. For buyers, ability to pay is a major barrier to getting on the property ladder. An increase in house prices in the early 2000s caused the house price to earnings ratio to double, and since the late 1990s the average first time buyer deposit has increased from £10,000 to almost £50,000. In contrast, average earnings have only increased by around 50 percent, making it almost impossible for first time buyers to raise a deposit or secure a mortgage. For those who are able to live with parents while they save, this may not be too difficult. However, once someone starts living in rented housing, on average over half of their earnings will go straight to their landlord in rent payments. In comparison, mortgage repayments are only around 23 percent of earnings after tax, meaning that owning a house could be the much more affordable option if only deposits weren’t so prohibitively high. Another problem buyers face is that they are in direct competition with landlords – and losing. Buy-to-let mortgages have been increasing in popularity over the last couple of decades, and 70 percent of landlords have

been looking to buy homes worth less than £250,000, the same price range as most first time buyers will be looking. Given the choice between a first time buyer and a landlord, banks will choose to lend to landlords because the risks are lower.

Once someone starts living in rented housing, on average over half of their earnings will go straight to their landlord in rent payments The increased demand for housing from landlords pushes up house prices, making it harder for first time buyers to get into the market. They are forced to rent instead, which increases demand and therefore prices for rented housing, and creates even more of an incentive for landlords to buy-to-let. If something isn’t done to break this vicious cycle then before long then the country will be divided into rich property owners and those who are dependent on them. The housing supply is struggling to keep up with this excessive demand. Britain needs to build over 200,000 houses every year, but current figures are lagging behind at only 140,000. As can be seen from the graph below, the UK never used to have difficulty producing over twice this many houses, so why the continuous decline in numbers? One reason commonly cited is a lack of skilled workers in the construction industry. This can be traced back to the financial crisis of 2007, where demand for housing fell substantially and so fewer houses could be sold. Approximately 250,000 people left the construction industry as a result, meaning there are now insufficient workers to meet

current levels of demand. There are others who blame the planning system, claiming that it is too slow, bureaucratic and expensive. Either way, it’s clear that this downward trend in house building is incompatible with the demands of a rising population and needs to be addressed. Why should we care? Some may wonder what the big problem is with rented housing – after all, it gives tenants the flexibility to move at short notice and they don’t have to worry about undertaking any repair work. However, the quality of rented housing tends to be lower than any other form of housing, with over a third of private rented homes failing to meet the Decent Homes Standard set by the government. Some of the problems commonly listed include mould, electrical hazards, animal infestations and gas leaks, and this has unsurprisingly led to health issues for 10 percent of renters. Research has shown that 1 in 33 renters have been evicted or threatened with eviction for complaining about problems in their home, meaning that even though the landlord is usually obligated to fix these issues, the tenants are too frightened to report them in the first place. As long as demand remains inflated, landlords will have no incentive to invest in improving the quality of their properties and those trapped in rented housing will continue to suffer. Further to this, excluding those on lower incomes from the property market causes inequality to escalate. Owning a home is a way for the lower and middle classes to accumulate wealth, but being driven into the rental market redistributes this wealth towards those who need it the least. According to the ONS, the richest 1 percent of the population already has as much wealth as the poorest 57 percent combined, and if rents continue to rise at a faster rate than earnings this gap will only widen. A rather pessimistic piece of research by the Joseph Rowntree

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What can be done about it? The government has introduced many Help to Buy schemes to help first time buyers get on the property ladder. These include the mortgage guarantee scheme, which allows buyers to get a mortgage with only a 5 percent deposit, and the equity loan scheme, in which the government offers loans of up to 20 percent that are feefree for five years. These schemes have been used by almost 120,000 households in just two years, and mortgage lending is now 8.4 percent higher than it would have been if Help to Buy hadn’t been introduced. Clearly it has made home ownership a more affordable option for some. However, these numbers are small in the context of the overall housing market, and the effects have varied across regions, with the largest impact being in areas where house prices are already lowest. In addition, Help to Buy is generating even more demand for housing and fuelling further price rises. Research has shown that the schemes have increased the average cost of a home by 3 percent, therefore potentially pricing even more people out of the market. This policy suffers from the common flaw of treating the symptoms rather than the cause; simply helping more people afford overpriced housing won’t fix the UK’s inflated house prices and the risks associated with it. Only an increase in the housing supply will ease the pressure building in the housing market. The problem of the skills shortage outlined earlier should, in time, be rectified through the market forces of supply and demand. There is some evidence that this is at work already, with pay growth among construction workers rising by almost 5 percent, compared to 3 percent in the services industry.

A fine example has been set by Germany, where leases are typically five years or more in length, rents are tightly controlled, and the property is usually freshly decorated before each new tenant moves in. Given this, it’s no surprise that there is a lower preference for homeownership in Germany than in the UK. Germany’s success on this front seems to stem from the fact that it is one of the most regulated rental markets in the world, but there is much aversion to similar measures being implemented In Balham, South London, the council has banned the display of ‘To Let’ signs (Courtesy iStock) in Britain. construction industry. The government has Both the property industry and the buy-toalso attempted to tackle the supply shortage let lobby believe the government shouldn’t through a series of planning liberalisation interfere in the free market, and many measures, which has led to a record number economists probably agree. On the other of planning permissions being granted in hand, regulation might encourage landlords 2014. to find different financial assets to invest in – ones that don’t have quite so huge an influence over the quality of life of others – and therefore go some way to reducing both housing demand and prices. However, this could be encouraged further by offering retraining programmes to make it easier for labour to move back into the

1 in 33 renters have been evicted or threatened with eviction for complaining about problems in their home On the other hand, while the number of new houses being constructed grew significantly in 2014/15, if the government wants to reach its target of a million new homes by 2020, it needs to greatly step up its efforts. If construction doesn’t pick up soon, the housing shortfall will only become harder to defeat. There is also a third solution, one that won’t do much to solve the problem of Generation Rent but could certainly help mitigate some of its effects. This is to simply make the private rental market a more appealing place to live. If rents weren’t so unreasonably high, the Decent Homes Standard was better enforced, and renters had more security of tenure, then perhaps less people would feel the need to own their own home in the first place.

Conclusion The rise of Generation Rent threatens to radically alter life for many in Britain. If the problem isn’t dealt with effectively, we can certainly expect to see higher rates of poverty and inequality, but in the long-term housing affordability will also affect many other aspects of people’s lives. For example, some may decide to have fewer children, or pursue higher paid careers like banking rather than teaching or nursing. The need to act is urgent, with the problem only growing in scale the longer it is left unchecked. The only way to fix the root of the problem is to drastically increase the housing supply and restore equilibrium in the market. In the meantime, reforms to improve the quality of privately rented housing would be warmly welcomed by renters everywhere, regardless of their preferences towards home ownership. Some efforts are being made, but it may be too little, too late.

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Here’s a London ‘Rent Map’ of the London Underground

Thinking of Renting in London?

Data Sourced from Zoopla. Map courtesy of TfL

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