Globalisation: Friend or Foe?

Hello readers, in this post I will be discussing a well known economic phenomenon, namely Globalisation. I will firstly give a brief definition before moving on to looking at the net effect on employment as well as the impact on the UK economy.

Globalisation can be defined as the increasing interconnectedness and interdependence of countries economical, politically and socially, primarily achieved by the reduction in physical barriers (time-space compression) due to the technological revolutions such as containerisation. This has resulted in increased trade, lower production costs, an increase in cultural awareness and greater connectivity amongst nations. That said the financial crisis of 2008/09 stood testimony to the detrimental effect of having such an interconnected world; how a domestic issue in one country can rapidly ripple across the globe and threaten the entire financial system (see my post on causes of the financial crisis for more information on this). Having said that, with President Trump’s move  towards protectionist policies and countries such as the UK looking to move away from the EU some would argue that we are headed towards a new phase of “de-globalisation”.

 

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The net effect of globalisation on employment:

Globalisation may first have an impact on the number of jobs available in the economy. Closing an enterprise in country A to move it to country B may result in job losses in a particular economic activity of country A. It may also result in job gains for country A as a whole because of higher productivity in the remaining enterprises, higher wages, and higher consumption demand. Globalisation may also affect the structure of jobs, i.e. their distribution across economic activities. Jobs linked to certain economic activities may tend to disappear whereas jobs linked to other, maybe new activities, are created due to changing competitive advantages and patterns of specialisation. The composition of jobs, i.e. the mix of skilled and unskilled jobs in the economy, is also likely to be affected by globalisation. So far, in developed countries, low-skilled workers have been most affected by stagnating revenues and / or increasing unemployment due to competition from developing countries’ workers and also as a result of technological progress.

Globalisation and employment are multidimensional and dynamic and are inextricably linked. The impacts are constantly evolving and for that reason there is not enough research to conclude definitely that globalisation is either good or bad overall. Some believe that globalisation since the 1980s has left economies worse off whilst others suggest that arguing against globalization is like arguing against the laws of gravity i.e. it can’t be stopped and eventually if left to market forces alone (invisible hand theory), the distribution of wealth between rich and poor countries will eventually even out. Globalization has impacted nearly every aspect of modern life.

While there are a few drawbacks to globalization, most economists agree that it carries a net benefit to the world economy, by making markets more efficient, increasing competition, limiting military conflicts, and spreading wealth more equally around the world. There have always been periods of protectionism and nationalism in the past, but globalization continues to be the most widely accepted solution to ensuring consistent economic growth around the world. Although in general, members of the public tend to assume that the costs associated with globalization outweigh the benefits, especially in the short-term, particularly in America, which was why Trump’s and his protectionism ideology was popular amongst lower-middle class Americans. Globalization has impacted nearly every aspect of modern life and continues to be a growing force in the global economy. It focuses heavily on trade and a study by the OECD estimated that a 10-percentage point increase in trade openness translates over time into an increase of around 4% in per capita income in the OECD area. It is not completely clear whether more or less jobs have and will be created with globalisation. What is clear though is that globalisation is compatible with high employment rates, provided the right domestic policies are in place. That said the labour market adjustment is not always smooth because many workers displaced from declining sectors are poorly positioned to move into newly created jobs, which may be located in different regions or require different qualifications.

In the future, if the trend of globalisation continues, and with automation and AI on therise we may see a significant decline in low-skill jobs such as cleaners, shopping assistants and bartenders. That being said as we have seen in the past, this new technology could lead to the next macro economic epoch and result in the emergence of jobs, which do not even exit yet, almost like another industrial revolution.

 

 

Effects of globalisation on the UK economy:

The UK has benefitted from a more globalised world ever since first exports and imports. During the industrial revolution, global ties were important for enabling the UK to import raw materials and exports goods. Recent decades are a continuation of this process of globalisation and we often forget the obvious benefits of a greater choice of imports, lower prices and economies of scale in production. Although textile industries, coal manufacturing and industries have closed down (deindustrialisation) in Northern cities, creating mass unemployment in the 1980s, this has led to the emergence of London being a key financial hub. The UK exports its financial products across the globe and this is one of its largest revenue streams. Although this has caused a ‘North/South Divide”, it is suggested that other cities will follow suite particularly when HS2 is completed.

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Economic Boom and Recession Periods in the UK.

Hello readers, welcome back to my blog. This time I thought I would discuss the idea of economic booms and recessions (‘The Economic Cycle’)-an important concept in Economics with a specific focus on the UK economy. My last post was quite topical and relevant to the UK’s current situation. This post will focus more on the UK’s economic history to provide a background understanding as well as discuss the concept of the boom and bust cycle. I will summarise the information across two tables so that it is easier to interpret and process the information as well as make comparisons.

A diagram showing the Economic Cycle within a typical economy and the stages that it oscillates through:

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Boom period in the UK

An economic boom is a period of rapid economic expansion resulting in higher GDP, lower unemployment and rising asset prices. One example of an economic boom period in the UK was the post world war II economic boom which led to the sustained period of economic growth and near full employment until the late 1970s, where it was inevitably followed by a recession (boom and bust cycle). This growth saw rising real incomes, which in turn led to higher tax revenues and falling debt to GDP ratios.

Causes of Boom Effects of Boom
Rapid global economic growth, especially in Western Europe, caused by recovery of Japan and Germany, low global inflation, increased free trade, with reduction of tariff barriers and relative political and economic stability. Also major technological improvements, such as computers, better petrol engines, and containerization. This led to more jobs being created, falling unemployment and higher real wages. There was also a fast growth in consumption helped by rising real incomes, strong confidence and a surge in house prices and share prices. Government tax revenues increased as people earned and spent more and companies made larger profits – this gave the government money to increase spending in areas such as education, the environment, health and transport. Led to overall improved standard of living (SOL) and quality of life (QOL).
Immigration and rebuilding of infrastructure

UK growth was so rapid, it experienced labour shortages. This led to the mass immigration of the 1950s and 60s to help deal with the labour market shortages. This helped increase the working population and increase real GDP. Also damaged infrastructure from the war was rebuilt.

More people working and generating more income in taxes for the government. Business with a greater labour force could expand to meet the rising demand and increase profits. Rebuilding of infrastructure led to increased spending on raw materials. Although the government spent high amounts of money on this, in turn it led to economic growth. Infrastructure projects also created jobs and more opportunities for people of all abilities.
Improved education

In the post-war period there was a growth in university education and secondary education became more comprehensive.

This created new types of jobs in the services sector, which paid more, leading to higher incomes.
Higher levels of confidence and high ‘animal spirits’, between firms and business A pick up in demand for capital goods as businesses invested more in extra capacity to meet strong demand and to make higher profits (accelerator effect)

 

Worsening of balance of paymentsand trade deficits High demand for imports because the country could not supply all of the goods and services that consumers were buying. Caused the economy to run a larger trade deficit. An increase in inflationary pressures if the economy overheats and has a positive output gap. This is the increase in the general price level, and this affected lower income families, as basic items had increased in price.

 

Recession period in the UK

 

A recession is a period of economic decline resulting in lower GDP, higher unemployment and falling asset prices. It is often defined as two consecutive quarters of negative growth.  An example of a period of economic recession in the UK was in 2008-2009, which was known as the Great Recession. According to the UK Office for National Statistics (ONS) the UK entered a recession in Q2 of 2008, and exited it in Q4 of 2009. It was the deepest UK recession since the war and affected many sectors including banks and investment firms, with many well known and established businesses having to close and declare bankruptcy.

 

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Causes of Recession Effects of Recession
The global financial crisis of 2007-2008 and the subprime mortgagecrisis.

Sub-prime mortgages: these are a type of mortgage characterised as being taken on by a borrower with a low credit rating and often secured on a low value property. Lenders will charge higher interest rates than for conventional mortgages as they seek to compensate for carrying higher risk).

 

The immediate trigger of the crisis in the UK was the bursting of the U.S.A. housing bubble, which peaked in 2004.

As banks in the USA began to give out more loans to potential homeowners, housing prices began to rise. However these were sub-prime mortgages and eventually when the bubble burst and houses prices fell, it resulted in homes being worth less than the mortgage loan, leading to lots of negative equity, creating a negative wealth effect and overall ‘low animal spirits’ providing a financial incentive to enter foreclosure. As the US dollar is the global currency for all commodities and as the US economy impacts the rest of the world as a result of, this caused economic turmoil in the UK too.

UK mortgage lenders also gave out subprime mortgages although did not lend so many bad mortgages and it still had more controls in place than the US. Despite this it caused very serious problems for Northern Rock brank. Northern rock had a high % of risky loans, but also had the highest % of loans financed through reselling in the capital markets (long term investments, and bonds). When the sub-prime crisis hit, Northern Rock could no longer raise enough funds and eventually had to make the humiliating step to asking the Bank of England for emergency funds. Money from the taxpayer was also used to fund this. As a result of this the Bank it caused customers to start to worry and they withdraw their savings (even though savings weren’t directly affected).

Credit Crunch Sudden shortage of funds for lending since the markets had dried up resulted in a decline in loans available.
A fall in purchases of components and raw materials As a result of being unable to borrow, overall confidence in manufacturing and within firms was low and there were high levels of uncertainty, leading less confidence and no further investment.

As there was less demand for materials and products, it created lots of unemployment and fewer job vacancies available for people looking for work. By end 2008 the Manufacturing output had declined by 7%.

The unemployment rate rose to 8.3% (2.68m people) in August 2011, the highest level since 1994.

 

A rise in the number of business failures and businesses announcing lower profits and investment

 

As interest rates had been raised (at 5%) it meant that any loans businesses had were likely to have risen. Together with a contraction in sales because of little consumer confidence and spending led to lower profits and many companies being unable to survive. The whole financial crisis also impacted the value of exports and imports of goods and services hence affecting growth

 

Brexit: Deal or no Deal?

Hello readers, welcome back to my blog. Last time you might remember me discussing some of the common misconceptions with privatisation and how sometimes it may be useful for the government to intervene within certain sectors of the economy. However, I pointed out that nationalisation is by no means a universal policy, rather each industry is unique and often governments need to strike a balance between the two extremes in order to reach the most optimal solution for society, as is the case with many economic problems. In this post I will be discussing something more topical. Brexit. Yes we have all heard it in some context a million times, “Brexit means Brexit”, ‘Hard or Soft”, “no deal”. Featuring in almost every newspaper, tv report or public debate about the welfare of the UK, Brexit seems to have become ubiquitous. Some of you may have already stopped reading this post after seeing the title and not being able to read anything further about this, but if you are still here it’s time to get down to business and actually assess some of the possible outcomes for the UK. Although it has caused a huge deal of concern and confusion among the public, politicians, other countries and even the UK prime minister-Theresa May, the deadline for the UK government to strike a deal with the EU is fast approaching and Britain needs to reach some sort of agreement before a “no deal” means “no deal”. Here’s everything you need to know about the current issues, in particular the impacts of a no deal, why it may be the only option and the potential consequences for the UK, in a nutshell. Please feel free to share any of your own ideas below or contact me about the content discussed at rajveersira@gmail.com

Brexit is an issue which is omnipresent; for an event which started over two years ago it is still considered a ‘recent’ news event, as the deadline to reach a deal between the UK and the EU is imminent. Although triggering article 50 is an extremely complex and multifaceted scenario, I am particularly interested in 3 aspects: The impact of a ‘no-deal Brexit’, the dilemma surrounding the Irish boarder and whether Brexit could be reversed.Screen Shot 2017-08-06 at 14.39.37

Firstly, if the UK was unable to come to any deal with the EU, then trading would revert to WTO rules resulting in tariffs on goods moving in and out of the UK. This includes the millions of German cars that people in Britain purchase every year (imports) as well as the financial products that Britain essentially exports, not to mention that there would also be physical disruptions due to increased custom and border checks resulting in production delays, inefficiency and potentially lower profits. It is some-what ironic that the UK population opted to Brexit considering a major source of income for the country is derived from the export of financial services, mainly within London. It has been estimated that without the contribution from London of such products, the UK’s GDP would be the same size as Spain’s.

If however the UK was able to strike a deal in its favour i.e. tariff free trading (access to the single market) yet without free movement of people (control over its borders) then other EU countries may want to do the same i.e. increased sovereignty without any strings attached. Essentially in game theory terms, this is a ‘zero sum game’ whereby one person’s losses are equal to the other person’s gain. This is where we hear the terms ‘hard’ and ‘soft’. The former referring to a clean break between the UK and EU i.e. no free movement of people and the latter allowing free movement to continue as normal. Since one of the underlying root causes of Brexit was the issue of immigration it is unlikely that Britain would want to remain in the single market. Clearly immigration in the UK has a negative connotation and stigma as it supposedly ‘steals jobs’. This is a huge misconception that was wrongly portrayed by the leave campaign who were myopic in their reasoning and did not consider some of the long term net benefits of migration hence why some argue that due to misinformation there should be a second referendum (more on this later). Although I have discussed the benefits of migration in an earlier post, I will reiterate them here. Firstly, with an ageing population, the UK needs to consider alternative avenues to fund pension schemes. One such way is to boost its tax base from immigrants working in both low and high skilled sectors of the economy. Secondly, migrants are often seen to be more hardworking than their British counterparts and as such they have a higher productivity, which can result in greater profits and efficiencies for firms and businesses. Moreover there are a number of acute skill shortages in the UK, particularly within the NHS and thus closing down the border would have major implications for the millions of  British people that rely on free healthcare. Finally, many people often forget that immigrants can create local and regional multiplier effects. The income that they earn may partly be sent back to their home country (remittances) although a large proportion is used to spend on local goods and services which can create different avenues of income for others and potentially result in the construction of new jobs. We should also consider the fact that previous waves of immigration have been a huge success in areas such as Leicester or London where there is a significant cultural diversity and these places are currently thriving. There are a number of other benefits and thus Britain should consider the impact of pulling up the drawbridge and  preventing like-minded, hardworking, individuals from entering the country. There are also implications for EU nationals currently living in the UK. Many lack the full political understanding of the situation and are concerned about their future regardless of what they may be promised by the UK. As such we could start to see skill shortages and lower tax revenues before Brexit has even occurred.

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The biggest impact of a ‘no deal’ is that both parties would face disruption to trade which is costly but also regressive-wealthy individuals can afford to absorb any shocks to consumer prices but poorer households may struggle to cope with increases in essential goods and services. This means that consumer incomes are essentially being ‘wasted’ on a tariff when they could have been spent on another utility enhancing good i.e. there is an opportunity cost. Moreover imposing tariffs may damage result in retaliation and trade wars between countries leading to higher prices and disruption.

Secondly, I am particularly interested in the dilemma posed by the question of the Irish Border. A return to a hard border may reignite the social and political tension of the past but also lead to customs checks causing massive disruption for the people and businesses on both sides of the border. A possible solution proposed by the EU is to allow Northern Ireland to remain in the EU customs union effectively making the Irish Sea the border, leading to the break up in all but name of the United Kingdom; this is something that no UK government can agree to. A technological solution is being suggested but details about this are still vague. A hard border is not wanted by either the UK or the EU but would be inevitable in a ‘no deal’ Brexit scenario. Both sides know this and its implications but seem powerless to prevent it from happening whilst the deadline looms ever closer. Having said that, an article from the Guardian (written today) points out that the EU is willing to extend the transition period after the UK leaves the bloc, but warned Britain must not renege on previous agreements to prevent a hard border between the Irish Republic and Northern Ireland.

Finally many argue that the people should have a chance to vote on the terms of the deal (once they have actually been formalised and confirmed) or even have the opportunity to reject the proposal and remain in the EU. After all there were many inaccuracies and misunderstandings about the referendum which may have skewed the outcome. In particular, the confusion about the impacts of immigration, the complexities in triggering article 50 and of course the potential for violence in Ireland. One should also consider that fact that the formation of the EU has resulted in the longest period of peace since WW2 and perhaps, economic & political arguments aside we should look beyond this and opt for the option that results in stability rather than ‘experimenting’ in ways to increase the UK’s control and sovereignty. In addition the amount of money that has been spent on this issue and the time that has been invested; has diverted the country’s resources away from focussing on other, arguably more important issues. Thus whilst the UK is trying to negotiate its position, other countries may be focussing on innovation and the roll out of AI or upgrading existing social institutions e.g. healthcare.

However this fundamentally comes down to the principles of democracy and the fact that an outcome which may not be desirable for many has been voted for by the majority and thus should be respected regardless. Going back on this would essentially be breaking a code and undermines the true meaning of living in a society whereby democratic decisions are adhered to.

Below is a short animated video to help clarify some of the issues surrounding Brexit and provide some optimism about the issue; how it could be a potential success. Don’t be too persuaded, its a lot more complex than it seems!

 

Privatisation vs. Nationalisation

Hello readers, welcome back to my blog. This time I will be discussing Privatisation vs Nationalisation, in other words the Thatcherite’s vs the Corbynite’s. As with most economics problems, there is never ‘a one one size fits all policy’ and so there is no straight forward answer as to which is better.

I will be analysing this issue through Corbyns view i.e. pro nationalisation-Why privatisation may not work in practice. Although I do not support one or the other myself since it often depends on the industry or service in question, I do think that there are a number of myths about privatisation that need to be debunked.

We often hear a lot about the merits of privatisation such as how increased competition may result in efficiency gains, namely productive and dynamic efficiency; however, often the only way to solve the problems that really matter to people such as the shortage of homes, the awful trains or the unsatisfactory economic situation-is to break with the consensus that Mrs Thatcher established in the 1980s.

  • Firstly the long-term costs of privatising industries such as the coalmines were estimated to be much more than the cost of employing the miners. When Thatcher shut down the mines, it resulted in mass structural unemployment as workers who had spent their lives in mining had developed few transferable skills (occupational immobility of labour). Not only did this mean that the government had to pay unemployment benefits but it also caused hysteresis, which left workers in a difficult position unable to feed families and defaulting on mortgage payments which worsened levels of relative poverty. Moreover it meant that workers had very low MRPs and were unable to demand higher wages or work in service sector jobs. The negative multiplier effect of this long-term structural unemployment is argued to have had much more profound and lasting effects than the costs of actually financing the industry, such as a reduction in AD leading to further unemployment and further costs for the government, which would worsen the budget deficit and burden future generations with high levels of national debt. This may lead to Ricardian Equivalence (consumers are forward looking and will therefore reduce consumption to save for future tax rises).

 

  • Privatisation can also result in the demise of unions who lose their collective bargaining power on benefits, perks, holidays, and wages as firm would look for new ways to reduce costs and maximise profits. Even in the boom years of the mid-1980s, the unemployment rate remained high-levels not seen since the 1930s and in the late 1980s, unemployment was still over 2 million. Since then there has been growth in north-south divide and regional inequality. Admittedly one could argue that de-industrialisation caused by the global shift in manufacturing and the transform to a more service based economy was inevitable as the UK started to loose it comparative advantage to the new and emerging Asian tigers; however, this does not been that nationalisation should just be abandoned as an economic policy

 

  • One of the biggest criticisms of privatisation is the Natural monopoly argument e.g. Network Rail, as such industries are likely to be underinvested if left to the free market. A natural monopoly occurs when there is no scope for having competition amongst several firms. Privatisation of such industries would just create a private monopoly which might seek to set higher prices which exploit consumers. Therefore it is better to have a public monopoly rather than a private monopoly.

 

  • We should also consider the Public interest. There are many industries that perform an important public service, e.g. health care, education and public transport. In these industries, the profit motive shouldn’t be the primary objective of firms and the industry. For example, in the case of health care, it is feared privatising health care would mean a greater priority is given to profit rather than patient care. American health care system or some of their prisons stand testament to the stark inequality that can arise-42% of ill Americans skipped doctor visits/medication in 2011 because of excessive costs. Furthermore, private companies may choose the market, which is most profitable to operate in leaving less wealthy customers without a service. This could lead to equity concerns-would a private NHS provide enough operations for those on low incomes who tend to need such provisions more. Is there a merit good argument for not privatising at all? Krugman in his blog concludes: There are, no examples of successful health care based on the principles of the free market, for one simple reason: in health care, privatisation just doesn’t work. And people who say that the market is the answer are flying in the face of both theory and overwhelming evidence. By analogy, a major reason for providing universal healthcare, as a public service is that decent medical treatment should not be a privilege reserved for the few. Although some public firms have been shown to be inefficient, as we know from the sad experience of Soviet-style central planning, it is by no means a universal principle.

 

  • Furthermore the government loses out on potential dividends, instead going to wealthy shareholders. For example, train companies in the private sector routinely pay more than £200m a year in dividends to their shareholders. In addition state-owned rail industry could borrow more cheaply from the government than it could if it issued new debt to the bond market.

 

  • Fragmentation of industries. In the UK, rail privatisation led to breaking up the rail network into infrastructure and train operating companies. This led to areas where it was unclear who had responsibility. For example, the Hatfield rail crash was blamed on no one taking responsibility for safety. In addition, the increased competition and choice that may arise from privatisation may not actually improve consumer welfare as too much choice could lead to choice overload.

 

  • Although short-term pressures may motivate the government, this is something private firms may do as well. To please shareholders they may seek to increase short-term profits and avoid investing in long-term projects. For example, the UK is suffering from a lack of investment in new energy sources; the privatised companies are trying to make use of existing plants rather than invest in new ones.

 

  • Prices may actually rise after privatisation as the government may have been operating it at a loss to ensure that prices do not become unaffordable for everyday citizens. For example rail fares in the UK after privatisation were allowed to rise above inflation for certain ticket types thus reducing allocative efficiency. This demonstrates that even regulated privatisation is failing to deliver price competition, the primary argument underpinning privatisation.

 

  • Many of the privatized firms were transferred as monopolies into the private sector and this necessitated regulation to avoid market failure and to ensure performance standards were met. This is costly and is susceptible to regulatory capture and thus it makes more sense for the government to manage these industries directly. The recent chaos on Southern Rail underlines how the relentless drive for profits and dividend pay-outs can threaten essential safety, as well as jobs and reliability of service on the railways.

 

  • State-owned companies solely operate in the best interests of the citizens of their state, as ultimately their primary objective is to maximise utility and create a functioning society for all. On the flipside, privately operated firms generally aim to maximise profits at the expense of their customers and exploit market power by raising prices and making huge supernormal profits damaging consumer welfare. Also some institutions are unable to manage their risks properly, thus they get ‘too big to fail’ which leads to an even worse outcome.

 

  • By considering market structures: If the firm is operating in a market close to perfect competition then there may not be an incentive to innovate as there is perfect information and no barriers to entry meaning that cost reducing technology can be copied or employed by other firms and in the long run only normal profits will be made. If the firm is operating in an oligopoly there is a risk of collusion and price fixing, which could reduce consumer surplus. In a monopoly, there may be X inefficiencies as well as allocative inefficiency (price charged above the marginal cost) due to complacency. It is possible that there may be significant price discrimination, which means that peak time commuters for example will be faced with increased fares. This could worsen geographical immobility as workers are less able to travel across the country and could be regressive if such costs make up a large percentage of an individual’s income.

 

  • Problems with private firms also arise from the Divorce of ownership and control and the Principal agent problem: We have heard that privatisation is likely to result in productive efficiency as such firms must answer to shareholders, therefore they may pay increased dividends at the expense of consumers as they opt for a low quality service. We have also heard that the profits made by such firms can be used to invest in R&D to stay ahead of the game and actually improve the industry. However if firms have are concerned with the political stability or long-term future of the economy for example the impact of Brexit, they may delay such projects as there is a risk they may not see a return. Thus we may see a decelerator effect and the so-called ‘creative destruction’ process may not occur as expected. The government however is able to take a more risk seeking approach as it relies on the public purse and such investment decisions are likely to be in line with the country’s political decisions. Moreover private firms may deleverage and pay of debts rather than providing an improved service or reducing costs to the MES level of output.

 

  • Privatisation may also decrease safety standards due to a greater incentive to cut corners, which is of particular concern for industries such as National Air Traffic Services and defense. These are also Public goods and would not be provided at all by the free market due to the free rider problem thus they have to be nationalised without a doubt.

 

  • Privatisation takes time to be successful if it ever does. e.g. opening Royal Mail up to competition didn’t lead to a competitive market overnight-there was customer inertia, brand loyalty, barriers to entry. The process is also costly According to David Hall, an expert in this field at the University of Greenwich, turning the provision of water into private hands costs almost £1bn a year extra. Were it still to be in the public sector, he estimates, that would amount to about 12% off the average household bill.

 

  • Finally public provision can tackle the issues of externalities. For example a private company might want to cut down swathes of forest to grow crops for biofuel, disregarding the long-term environmental impact. Whereas the government will consider the long-tern environmental effect or take into account any other form of market failure.

 

In conclusion, arguments favouring private over public provision typically favour the few at the expense of the many. Moreover there are a number of key issues with privatisation that are often overlooked. Admittedly there are many flaws with public provision and not every industry would be worth taking back into public ownership, instead there should be a balance between the two and it is highly dependent on the type of industry in question.

Stay tuned for my next posts which include: China’s social credit system, AI and recent mergers and acquisitions.

 

 

Everything you need to know about Interest Rates.

Executive summary:

This short article has been written to explain the idea of interest rates in a nutshell as well as clarify many common misinterpretations surrounding the base rate and the primary role of the Bank of England. Questions such as why the central bank use a base rate, how they actual change the rate, what the changes to this rate actually mean and how this can affect mortgage rates will be explored and answered so that next time you see a news headline or billboard discussing interest rates, you can understand it like an ‘undercover economist’. A few comparisons will also be drawn between the U.K. and other leading economies such as the USA, which is currently pursuing contractionary monetary policy by increasing the base rate to curb rising inflation and prevent the economy from ‘overheating’. On the flipside, Japan, which has suffered from persistent deflation over the last 20 years, has been experimenting with negative interest rates to try and ‘kickstart’ the economy and reverse the negative impacts of deflation.

The research referred to in this article is from well-established and trusted sources including the Financial Times, The Bank of England, The Guardian and the BBC. Figures used are up to date at the time of writing (August 2018). If you have any questions about the content discussed in this article please contact me at rajveersira@gmail.com.

 

Interest Rates:

An interest rate refers to the cost of borrowing money from a financial intermediary or the rate of return on savings. It is essentially where those who have extra cash can lend this to others who require this cash now in exchange for a financial reward. Banks facilitate this process, as people with excess cash do not directly lend to others, instead they deposit their money into an account where they receive a financial reward for holding it there. Banks use these deposits as loanable funds and the amount they charge to borrow is more than the amount they pay depositors allowing them to make a profit.

 

The Central Bank and The Government:

A central bank also known as a ‘reserve bank’ or ‘monetary authority’ is a financial institution, which enables a country’s economy to function. In the UK the central bank is the Bank of England (BoE) and in the US it is the Federal Reserve.

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The role of a central bank varies from country to country but in the UK the BoE is responsible for issuing banknotes, keeping an eye on the financial system to prevent systemic risk and most importantly setting interest rates at the right level. They hold other currencies to manipulate rates as well as gold reserves belonging to the UK. During the financial crisis they acted as the ‘lender of last resort’ to bail out banks such as Northern Rock and protect the economy from collapsing. Consequently their role is different to a conventional high street bank that aims to maximise profits.

Although the BoE is wholly owned by the UK government, the two parties are independent from each other. This means that they can maintain monetary and fiscal stability without a political mouthpiece. The current governor of the BoE is Mark Carney who heads up a committee of eight other members.

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Inflation and Interest Rates are inextricably linked:

The primary objective of the BoE is to meet the target of 2% (+/-1%) set by the government-often referred to as target 2.0. A committee known as the Monetary Policy Committee (MPC) meets eight times a year to agree on the rate at which the base rate is set to control inflation and provide stability within the economy. Of course political factors do enter the remit of such decisions, for example interest rates were cut by 0.25% following the 2016 referendum vote to prevent the economy entering a recession. Changes to the base rate filter through the transmission mechanism meaning that their effects can take up to 18-24 months. As a result the MPC tries to forward plan to overcome this; however, in many cases it speculation related.

 

Bank Rate, Base Rate, Mortgage Rate, Savings Rate……….?

Economists often like to use niche jargon to make something, which is actually quite simple, seem more complex. To clarify things, the bank rate is the rate at which the central bank in the country lends money to commercial banks and it is the rate of interest the BoE pays on reserves held by commercial banks at the Bank of England. For this reason, banks normally pass any changes in Bank Rate onto their customers. When the Bank Rate is raised, banks usually increase the interest customers have to pay on borrowing and the interest they earn on savings, and vice versa. Higher interest rates mean people will spend less in order to service their debts and benefit from good savings rates. This puts downward pressure on inflation. When interest rates are lower, the opposite is true. ‘Bank Rate’ is the single most important interest rate in the UK. It is set by the MPC, normally eight times a year and is often called the ‘Bank of England Base Rate’ or even just ‘the interest rate’.

 

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Why are loans not the same as the bank rate?

The number of different interest rates available when you borrow or save can be confusing.

That is because the interest rates that commercial banks set depend on more than just Bank Rate. For loans, these other factors include the risk that the loan will not be paid back. The greater the risk, the higher the rate the bank will charge.

 

What other tools do they have?

 There is no upper limit to the level of Bank Rate, but there is a level below which it cannot be reduced – this is known as the ‘effective lower bound’ or ‘zero lower bound’. The MPC currently judges this bound to be close to, but a little above, zero. This ‘zero-lower bound’ was experienced during the financial crisis whereby reducing interest rates further did not yield an increase in inflationary pressure. To help overcome this, they introduced unconventional monetary policy measures, namely Quantitative Easing (QE) which essentially involves creating money electronically (“Printing Money”), with the intention of stimulating the economy.

 

How do changes in this rate affect the economy and consumers?

The most recent change at the time of writing (Aug 2018) to the base rate is the increase from 0.5% to 0.75% – the second time that the base rate has been raised since the global financial crisis a decade ago. Four key Economic reasons why the MPC unanimously voted to raise the base rate include:

  1. Expectations of a strengthening economy- After the Beast from the East depressed consumer spending in the first part of the year, the Bank of England is now convinced that the British economy is regaining strength.
  2. Solid employment levels – the UK is estimated to be at the natural rate of unemployment of around 4.3% meaning there is a small positive output gap. If slack in the economy is dissipating, inflation may overshoot without a rate rise.
  3. More consumer spending – linked to rising confidence and real wage increases-Inflation 2.4% in June 2018.
  4. Argument that the Bank should raise rates now while the ‘going is good’, to give itself wriggle room when a recession hits in future.

 

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Generally, a rise in the Bank rate is good for the UK’s 45 million savers and bad for borrowers – but the reality is a bit more nuanced. Here are some of the main impacts of the most recent change according to the BBC:

  • Mortgages will become more expensive unless you have a fixed rate agreement. Across the UK, 9.1 million households have a mortgage. Of these, more than 3.5 million are on a standard variable rate or a tracker rate. These are the people who would be most affected, as their monthly payments would increase. The relatively small rise will not be particularly painful for the vast majority of householders, although debt charities say that some squeezed families will find this extra burden a real challenge.
  • The interest rate on fixed rate savings accounts, linked savings accounts, and cash ISAs should increase along with the new base rate – but it isn’t guaranteed, and the rate might not increase by the full 0.25%. (Savings rates didn’t increase by much the last time the base rate increased by 0.25%).
  • The APR on some credit cards is linked to the Bank of England base rate meaning a rise could follow.
  • Most personal loans are on a fixed interest rate, which means they’re unaffected by a base rate increase.
  • Any rate rise might also good for retirees buying an annuity – a financial product that provides an income for life.

 

 Clearly there are winners and losers with this outcome and as is the case in economics, there is no “one size fits all policy”; however, one can agree that this does seem like a logical decision which should help keep the economy on track. That said, with Brexit currently heading toward a ‘no deal’ outcome, the situation might deteriorate resulting in new measures having to be taken by the MPC. Although the UK is at a record low level of unemployment putting upward pressure on the price level, there are a significant proportion of underemployed workers primarily due to the expansion of the ‘Gig Economy’ and prevalence of zero hour contracts. This means that the actual level is masked, perhaps exacerbating the impact of a change to the base level, worsening final outcomes.

 

Further Reading:

If you enjoyed reading this article and are looking to expand your knowledge of economics by reading similar articles, check out: https://rsira-economics.com and make sure to subscribe if you haven’t already, where a wide variety of topical economic issues ranging from Brexit, a world without oil and common economic themes such as the invisible hand to more esoteric concepts such as Akerlof’s lemon theory, are discussed. As a starting point, you may wish to read the post on the causes of the 2007-8 financial crisis and some of the precautions banks are now required to take in light of this. Arguably one of the greatest financial meltdowns in recent times, it took many economists by surprise, yet by understanding what went wrong it can help us to analyse future situations and prevent the same happening again. Alternatively you may wish to read the post on quantitative easing to get a more in depth and technical understanding of how this works.

The Petrol Industry: Past, Present, Future

Background on oil

 Oil prices are volatile primarily due to the fact that they are determined by the market forces of supply and demand. These forces can be influence by a range of factors; for example conflict in Middle Eastern countries could result in political insatiability that may disrupt supply chains. Likewise economic sanctions may be placed on certain countries, which limit supply and put upward pressure on prices. On the flipside, oil prices may fall when governments are pressured to consider ‘cleaner and greener’ options or when new oil wells are discovered. Consequently when we fill up at the pump, the price per litre is rarely exactly the same as it was last time. Companies e.g. petrol station owners and even consumers must factor in this volatility to ensure that profit and utility are maximized.  Despite these short-term challenges, there are greater and perhaps more important issues to consider such as the options left for conventional refueling stations as the market changes to adapt to alternative energy in light of the 2040 UK ban on the combustion engine.

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The Petrol Industry:

The demand for petrol can be considered relatively inelastic in demand since alternative technology e.g. electric cars and the charging infrastructure that this requires is not up to scratch yet and such projects/investments still remain expensive.

Therefore in the short term, petrol stations are somewhat protected by the fact that there are few suitable substitutes. 99% of trucks on the road use diesel engines and there are estimated to be only 200,000 electric cars on the road by the end of this year. However, this does not mean that petrol stations are ‘protected’ or shielded in the long run. In fact in 2040, when the UK introduces a ban on diesel and petrol engines, fuel stations will need to rethink their strategy to prevent becoming obsolete. Many consumers are likely to make the switch to such technology before the due date as the government rolls out tax breaks and offers trade in values in exchange for their combustion engine.  Although this ban does not include hybrid vehicles the demand for conventional fuels will be extremely low and such stations will need to make an investment to cater for the new emerging ‘green’ market.

Moreover many brands e.g. Volvo are looking to move toward hybrid plug in vehicles by 2020 with highly efficient engines meaning fewer fill ups and thus lower revenues.

 

What can petrol stations do?

When even the boss of Shell says his next purchase will be an electric car, one could be forgiven for thinking the game is up for petrol stations.

The main stations in the UK include Shell, BP, and Esso together with supermarket providers and independent stations. In terms of ‘future proofing themselves’ shell seems to be ahead of the game. There are a variety of fronts that they have taken these being: Hydrogen, Electric and convenience services. Below are some examples of the ventures that have been undertaken/planned:

  • Shell is part of a joint venture with Daimler and others to commercialise hydrogen gas for powering hydrogen fuel cell vehicles, which are electric cars that have a range nearer that of conventional cars than battery-powered cars. The Berlin-based joint venture has eight sites and plans to have hydrogen-fuelling pumps at 400 locations across Germany by 2023.
  • There are areas where it’s clear that there is a growing demand for battery electric cars, particularly in California and parts of Holland, so they are working on developing supercharging technology.
  • Shell is running trials in China to generate all the energy needs of a site from solar panel canopies.
  • In today’s digitally connected on-demand economy, retailers must work harder than ever to attract customers. Almost every UK Shell station now has a Costa coffee concession and around 30 have a Waitrose store attached. There is a huge number of people coming to service stations who are not filling up their cars but instead are coming in to buy breakfast, to get a cup of coffee, to get their car washed. Their need for convenience retail is more frequent than their car’s need for fuel.”
  • Shell sold 60m cups of Costa coffee last year. In the UK there are some Shell-branded stations that are already making more money from selling products other than fuel. With that in mind, Shell is experimenting with different ways of luring customers to its stores and encouraging them to spend more time there. The company has two sites in Bangkok that sell only V-Power, Shell’s highest quality fuel, alongside a luxury cafe. Each customer gets two attendants – one to serve them and one to service their car.
  • Increasing the retail offering of service stations will become even more important as cars become more efficient, needing to refuel less frequently. This means that revenues from fuel will be on a downward path until the switch is made or revenues from non-fuel products take over.
  • Shell is preparing to open Britain’s first “no-petrol” service station in the capital next year as part of its drive towards cleaner motoring.
  • Later this year Shell plans to roll out high-speed electric vehicle charge points across a selection of its 400 UK service stations, allowing drivers to charge their electric vehicle batteries by up to 80pc in 30 minutes. The group is about to begin an 18-month pilot scheme to test what the forecourt of the future might look like. Service stations will be presented ambitiously as “retail destinations”, providing good quality food and coffee alongside high-speed Wi-Fi. The trial will also include collection points for online shopping deliveries to improve convenience and perhaps even the addition of a post office or pharmacy to “transform” into a retail hub rather than a traditional fuel station.

 

Potential problems:

  • Tesla, although a niche segment of the market has its own network of superchargers, meaning such customers may be reluctant to use other “inferior” charging stations. That said the network still remains small and these owners will inevitably have to use other stations.
  • Other manufactures may develop their own charging networks e.g. BMW/Audi reducing the need to visit a ‘transformed station’ but instead to use the manufacturer’s network. That said, it is unlikely every manufacturer will build a network, rather they are likely to collaborate to prevent a misallocation of resources and focus and expanding the network as much as possible.
  • Independent stations may struggle to invest and stay ahead of the game especially if they are slowly experiencing a fall in their revenues and cannot afford to make adequate investments.
  • In the short term, the government may look to introduce a more hefty ‘carbon tax’, squeezing consumers further and perhaps forcing them to consider moving towards renewable options. This could drastically reduce profits for petrol stations owners from fuel sales.
  • Apple, the first company to hit $1trn could launch the iCar within the next 5 years. Apple has a trend for disrupting the market e.g. the death of blackberry, and some rumors suggest that this car may be entirely powered by solar power eliminating the need for on route charging stations.

 

Verdict

Overall it is clear that in the short term, conventional petrol stations are not going anywhere soon, in fact there have been a number of setbacks with alternative energy, together with the technical & ethical issues of driverless cars meaning that such a transformation to a new automotive market could take time. However with the 2040 ban in the pipeline, the clock is ticking and as we’ve seen in the past with the revolution of smartphones and social media, once technology takes off, there’s no looking back and only those that have read the market correctly will be left standing. The impact of this is not solely on petrol station owners but on the government.  The Treasury stands to lose up to £20billion of fuel duty and VAT every year if retail sales of petrol and diesel evaporate meaning that it has less to ring-fence and put toward grants to help embrace this change.

Potential questions:

  1. The Government is boosting its push to promote electric and driverless cars with a draft law requiring petrol stations across the country to install more charging points. Have do independent petrol stations plan to insulate themselves from the expected future changes to the market such as the roll out of electric cars following the 2040 ban on conventional combustion engines?
  2. How will they compete with the big players within the industry who have access to large amounts of capital to invest and embrace this new change? (Shell invests £1billion a year on renewable energy)
  3. Supermarkets now dominate the petrol-selling market – Tesco alone sells 15%. They often undercut their rivals on pump prices and sometimes run at a loss with the sole aim of attracting customers to their stores. If customers make a move towards electric vehicles it is likely Tesco and others will make large scale investments to ensure their customer’s can ‘shop and charge’. How will independent stations compete with this competition? Would they consider merging with other services e.g. post office/pharmacies?
  4. Finally, the Number of petrol stations has fallen from 14,000 in 2000 to 8,500 today. If new charging points become ubiquitous e.g. in every office, car park, supermarket, the future for such stations could look even more bleak. What could they do to ensure their profits remain in tact?

 

 

Amazon to patent a wristband which measures productivity.

Hello readers,

Welcome back to my blog,

I recently came across an article in the New York Time about the idea of measuring productivity in the labour market. As this was so relevant to the theory I was learning in class, I thought I would research this further and share with you some of my findings. Before we being it is useful to define what we mean by productivity, in particular labour productivity. This is essentially, output per worker per unit time. In other words how much one worker can produce in a given period of time. This is useful for a firm to understand where they can cut costs or how they can increase revenue or profit depending on their business objectives. We should also note that capital productivity refers to output by capital products such as machinery and thus it is important not to confuse the two or use them interchangeably .

As things currently stand, it is very difficult to measure productivity in the work place. Although with certain blue collar jobs it is easy to count the number of items produced in a given time period by each worker, there is still asymmetric information. This being the lazy worker who can still get away with distractions, taking too long in the bathroom, fidgeting or making basic errors on the job. To counter this amazon has recently been granted a patent for a wristband, similar to a FitBit which measures worker’s productivity more rigorously, assesses how hard they actually work rather than how hard they claim to work and even nudges you when you place an item in the wrong zone.

This means that firms which have a more productive labour force can produce more with the same output, allowing them to reduce X-ineffcieincy (using more resources than necessary for a given level of output) or to offload unproductive/extra workers who are no longer needed, providing trade unions are not able to challenge the monopsony power that employers may have.

Although we have heard a lot about the gender pay gap in recent times, this is another prime example of wage differentials in action within the labour market. According to the marginal revenue product of labour theory (MRPL), an increase in productivity leads to higher pay for those who are more productive and a decrease in pay for those who are less productive. More productive workers can subsequently demand a higher salary as a reward/incentive for producing more and increasing the profits of the company. This idea is similar to how John Lewis issue all their employees shares to incentives them to be more productive and work hard so that the whole company benefits and thus they receive more in shareholder dividends, except amazon’s band is primarily for very low skill, blue collar work.

Although this sounds like a utopian situation for employers and could allow them to maximise supernormal profits in the long run, it comes at the expense of workers’ privacy and there are a number of drawbacks that should be considered as these could potentially offset some of the benefits of this band.

Firstly in the case of Amazon, they already have a reputation for a workplace culture that thrives on hard-hitting management style which pushes workers to meet delivery targets. This has resulted in many workers feeling undervalued or overworked for the amount they are payed and subsequently may cause employment issue down the line if people can find easier jobs in similar companies which have a different ethos.

There is also the issue that technology today is not 100% reliable and things can go wrong in terms of hacking/tampering or with mis-measurements. This extra layer of surveillance would also result in an envision of privacy as well as employees being treated more like robots than human beings which would lead to lower morale, workers feeling less morale, thus worsening productivity and also people leaving their jobs, creating disruptions to delivery and production lines.

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Companies are increasingly introducing artificial intelligence into the workplace to help with productivity, and technology is often used to monitor employee whereabouts. Currently this new band bridges the gap between full scale AI and current workers. In Wisconsin, a technology company called Three Square Market offered employees an opportunity to have microchips implanted under their skin in order to be able to use its services seamlessly. Its only a matter of time before the labour market undergoes a technological epoch resulting in a revolution in the way goods and service are produced. Perhaps the updates version of this news article will consider difference in the productivity of robots or how human capital may soon be redundant. On that note, if you are interested in reading further into the role of automation in the future, I would recommend Susskind’s, ‘The Future of the Professions’, which not only considers who blue collar work is chaining but have professions such as doctors, lawyers, bankers and accountants could be at risk in the near future. He provides a practical and logical scenario using statistical information and ‘big data’ to evaluate the potential effects on society and also raises some key questions about the ethics of using AI.

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Sources Used:

https://www.commondreams.org/news/2018/02/01/latest-dystopian-step-amazon-sparks-worries-patent-worker-tracking-wristband