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

Can Migration and Piracy be effectively managed?

Hello Readers,

Welcome back to my blog. As our world becomes ‘smaller’ and more interconnected there is significant overlap between human geography and economics. This issue is brought home with the very topical issue of the flow of migrants through the mediterranean to Europe, as well as the emergence of piracy off the horn of Africa. I recently studied the issues of piracy and migration in geography and found that there were a number of significant links to economics such as Tragedy of the Commons, disruption to trade in particular around chokepoints, economic growth, rising debt levels, increased burden of governments and many more. It is quite a lengthy piece of research but is certainly worth a read if you are interested in these issues which have global ramifications.

The oceans have arguably been the biggest victims of humanity’s hubris. In today’s world they are characterised by a number of hazardous obstacles including treacherous journeys taken by migrants in an attempt to flee persecution and economic hardship leading to a mass influx of refugees, particularly in Mediterranean countries such as Italy and Greece; as well as piracy by ‘ex-fishermen’ caused by the crippling poverty occurring in war torn, failed states such as Somalia. Interpretations of these two ‘obstacles’ can vary, thus for the purposes of this essay, piracy will be defined as ‘an act of robbery or criminal violence by ship or boat-bourn attackers upon another ship or coastal area, with the aim of stealing cargo and other valuable items or capturing innocent members of the crew/civilians in exchange for a ransom’. Migration on the other hand will be defined as ‘the flow of people and ethnic groups (diasporas) from their home country to another country usually to seek refuge and apply for asylum status or for socio-economic reasons. In both cases, the problems are ubiquitous and the impacts are wide-ranging thus intervention is not a straightforward process. Furthermore, we should also consider what we mean by ‘management’. If we are referring to implementing policies, which restrict flows of people to dampen the socio-economic factors on host countries, or polices that primarily focus on stopping piracy through armed vessels and military action to reduce the economic toll of disruption to shipping then this only scratches the surface of the issue. The grass roots of the issues lie much deeper than this. Many people often oversee the fact that migration and piracy are the product of poor governance, instability, corruption, persecution, injustice and a lack of human rights, as they tend to look out for their own self-interests. Therefore even though we have seen a decrease in piracy along coastlines previously at risk or around chokepoints across the globe and more control/support for the migrants crossing the oceans in recent years, this does not necessarily imply effective management, and is quite myopic. Consequently, this essay will explore some of these policies but will more importantly focus on management strategies such as those being adopted by the European Commission and the United Nations (UN) to promote ‘voluntary solidarity’ which tackles the underlying root causes. That said, even though the latter policies are more desirable and could be termed as promoting ‘effective management’, in reality, they are much harder to achieve as they often require unanimous global cooperation which is difficult when there are so many different players, laws, governments, ideas and cultures; partly the reason why short term strategies have dominated-to bridge the gap until a long term solution, if any, can be found. We should also address long-term policies suggested by supranational institutional bodies with a degree of caution, as the world we live in is so dynamic and many targets/future goals could be termed over ambitious and nothing more than a utopian pipeline dream.

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To understand the success of these management strategies, let us first consider the nature of the problem; assess some of the driving forces that underpin piracy and migration and recognize why we need to control them in the first place. With regards to piracy, poverty, dysfunctional governments, links to crime networks and loss of traditional fishing (Tragedy of the Commons) are the main reasons why young, economically active men tend to enter the piracy business. Overfishing is perhaps the most significant factor, caused by a lack of property rights and laws over international waters as it has enabled large scale fishing trawlers to scour the ocean beds leaving declining fish populations for the people living in coastal towns. One point to note here is that although large fishing organisations may benefit from this, we should consider “at whose expense?” and the damage that they are creating not just for people but for the environment. It is ironic in the sense that they have created the problem and are now having to invest in strategies to control the problem. Furthermore, maritime piracy costs shipping companies in the Indian and Pacific Oceans, some $13–$15 billion annually in losses. Premiums for a single transit through the Gulf of Aden, for example, have risen from $500 to as much as $20,000. If strict fishing laws were in place, piracy would be less of a problem, thus allowing firms to invest their money in innovation or wildlife conservation instead. Beyond the immediate threat to crews, property, and ships, maritime piracy endangers sea lines of communication, interferes with freedom of navigation and the free flow of commerce, and undermines regional stability. Piracy also is corrosive to political and social development in Africa, interrupting capital formation and economic development, abetting corruption, and empowering private armies. Left unchecked, the cumulative effect of piracy eventually can lead to the decline of vibrant commercial centres. In terms of migration, it is often a result of push factors such as violation of rights and deception by illegal smugglers who present the image of prosperity, education and safety in exchange for a payment around (US$750-3500). However the boats supplied are substandard, with over 400 people on one, intended for a crew of around 50. Pull factors include, successful migrants encouraging their families to move; however, this exacerbates the issue and since life vests are not issued and most people do not know how to swim it means the death toll is extremely high and the short term aid currently provided is vital to survival. If people are lucky enough to stay on board they are likely to get trampled, dehydrated, cuts from nails/wood on the vessel or physically abused by other desperate migrants. They are also misinformed and don’t understand that they will not immediately be accepted/given education. Moreover, like with piracy the effects are damaging particularly on women and children who are at risk of exploitation or death. One shall never forget the picture of the three-year-old Syrian boy, Alan Kurdi, whose body was washed ashore on a Turkish beach.

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By considering short-term management for migration first, NGO’s such as Medecins Sans Frontieres and SOS Mediterranee have arguably been the most important as they have played an active, pivotal role on the front lines. Missions ensure that vulnerable individuals who are desperate for a better life are not left to drown, thus directly preventing loss of life. Although this makes the crossing safer for migrants and ensures a reduction in death tolls, the scale of the problem is enormous and often rescuers have to make decisions on whom to save first as there are simply not enough resources. It also creates the issue of a ‘moral hazard’ as if people know they will be rescued when things get rough, they may be more inclined to take the risk, thus the ‘obstacle’ will continue. That said, NGO’s are working in countries such as Syria, Libya and countries in central and east Africa including Somalia, Eritrea, Burkina Faso and Mali to help alleviate famine and disease, although this too is short term and is expensive to sustain. What’s more is that with such management strategies, there is still a risk of migrants being attacked by pirates or being arrested by Libyan authorities. Migrants can also drift for days facing temperatures upwards of 32 degrees, with little water before help can arrive.

Another management strategy in the medium term that could be implemented is to address the issue of the traffickers. Traffickers provide the ‘oxygen of hope’ and say it “will be like a dream, almost as easy as flying”. Traffickers promise a way out when in reality they know that the boats will not survive in the open water of the Mediterranean. They are largely corrupt; involve violence, threats, and abuse and demand payments depending on where you come from. These militia groups could be termed the driving force behind the movement across the oceans as they facilitate the transfer. However, stemming this is controversial as you are then denying people any way of escaping their countries where atrocities are rife, arguably preventing people’s right to move. Also if international organisations were to impose minimum standards on vessels used this would be controversial, as you would be supporting a form of ‘human trafficking’ and could start political wars with local governments who do not want their citizens to leave and do not like the idea of foreign intervention in their domestic practices. Also laws/policies are rarely enforced in such countries and due to the crippling poverty, individuals have little regard for helping others or making the society safer and fairer for everyone but instead looking out for their own self interests, and above all trying to survive each day.

Nearly two-thirds of all international migrants live in Europe (76 million). Consequently, the role of the European Commission has been important, particularly influencing the long-term management of the crisis. Despite the fact that certain countries such as Greece, Italy and Turkey are most affected, its agenda on migration sets out a collaborative response to take the burden of particular countries. Within this they focus on: Reducing incentives for irregular migration by disrupting smuggler networks; saving lives and securing external borders by ensuring strong shared management of the external borders through full operationalization of the European border and Coast Guard; a strong common asylum policy to ensure a fully efficient, fair and human policy with a common and harmonised set of rules, including a more sustainable system for allocating asylum applications among member states; and a new policy on legal migration, which keeps Europe an attractive destination for migrants in a time of demographic decline via actions such as renewing the Blue Card scheme or by easing remittances. They also have four priority actions: operational measures which has seen presence at sea triple and management support teams becoming operational in Italy and Greece; budgetary support-total funding to address the refugee crisis in 2015 and 2016 was €9.2bn; and implementation of EU law, which has resulted in 40 new infringement decisions against 19 member states. Another aspect is the external dimension and this has focused on tackling the root cause of refugees via diplomatic offensive and an EU Action Plan against migrant smuggling is being implemented. Currently the EU is the world’s leading donor of aid. It has saved over 400,000 lives since 2015 and is working to change migration from a challenge to an opportunity by promoting the idea of ‘voluntary solidarity’. As outlined above, the work of the EU considers a range of time scales and puts together a cohesive and comprehensive plan to manage the problem. However, this is by no means a “one size fits all” strategy. The nature of migration is so complex such that it is difficult to address all flow and movements of people. Furthermore, budgets are still restricted and there are not unlimited amounts of supplies/asylum applications. Many refugees face years of uncertainty while their asylum is processed. As long as the inequalities persist and as long as the North-South and South-South cooperation do not improve, our societies will, unfortunately, continue to face more extraordinary challenges, thus putting in doubt the immense achievements of our civilization. Islamic State in Iraq and the Levant (ISIL/Da’esh) will continue to thrive unless the deep political roots of the Syrian conflict are resolved through a credible and comprehensive political process.

The management of migration also varies across the world and there are a number of contrasts within the EU between the 28 nations e.g. Italy & Greece vs. Sweden & Finland, where the former have been less receptive and welcoming whereas the latter view the influx of refugees as a boost to their economy. This contrasting opinion has led to such countries offering different levels of support-Italy’s sluggish legal system drags out the time spent in limbo. Australia deals with the influx of migrants from the South China Sea in a very different way that Europe accommodates them. In Australia, around 25,000 asylum seekers have arrived in by boat over the last 18 months. The country is represented by one political body and is seen as having a hard immigration policy, by forcing refugees to stay on Islands off the coast of Australia, which it has sovereignty over until their applications are processed. Conditions/provision of basic needs have been reported to be substandard. This is ironic considering Australia’s foundations were built upon immigrants/diverse origins and ethnic groups. What’s more is that today it is relatively under populated and could benefit from an influx of migrants. Australia’s more hard-line approach to immigration is spreading across to European countries such as Austria, France and perhaps even the UK, thus the ship to prosperity may already be headed in the wrong direction. Germany however, has set the bar high although this has created some political tension within the country with far right groups. The migration & “human rights at sea” debate is rather recent idea and countries accept varying degrees of responsibility due to differences in cultures, ideas and policies/levels of enforcement.

Another equally important hazardous obstacle in our oceans is piracy. For many poor people, the pay-offs from illicit activities are so high, and the licit alternatives so unrewarding, that interdiction and prison will not deter them from trying their luck again. The success of the Somali counter-piracy strategy has driven significant security sector reform throughout the Horn of Africa that has enabled over 1000 pirates to be prosecuted. Determining which state should prosecute pirates seized at sea is still particularly vexing. It is important that the use of force is appropriately used and naval forces should try to plan operations accurately in advance, to minimize loss of life.

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The modus operandi of pirates changes in the course of the years as they passed from hijacking of ships and armed robbery to kidnapping, a lucrative activity as they receive ransoms before releasing their hostages. What is clear though is that they are nothing more than fishermen with basic skills, using lightweight skiffs to carry out their attacks, as exemplified via the movie “Captain Phillips”. Hence, stopping acts of piracy in recent times has been successful by implementing private sector defence methods such as laser devices, water cannons, electric fences, stun grenades, nets, compressed air guns and foul smelling liquid. As hijacks for ransom were a big problem for shipping companies such as Maersk as well as insurance companies, in particular of the coast of East Africa around Somali waters, ships were permitted to carry armed guards (largely ex-marines). Although in most of the world’s seas this is illegal, the threat was great enough to warrant such an exception. The private maritime security industry has been a victim of its own success. Anti-piracy measures have been so effective that smaller security firms are going out of business.

In terms of public sector methods, the EU, US and British navy have been successful in reducing piracy. The UK is supporting counter piracy missions-NATO’s Operation Ocean Shield & the EU’s NAVFOR Operation Atlanta in the Horn of Africa, providing Humanitarian and development assistance to Somalia to counteract the root causes of piracy as well as supporting the recognition of Somalia’s Exclusive Economic Zone, which will help protect its natural resources up to 200 nautical miles from, is coastal baselines. Another long-term solution is the role of the UNDP Somalia-aimed at working to improve the livelihoods of various stakeholders in fisheries sector in Puntland. This will result in improved regulation and development through public-private partnerships with the aim to create 20,000 long-term jobs. The US has also undertaken many naval operations to counter piracy and armed robbery off the coast of Somalia, primarily to protect vital trade routes and ensure supply chains are uninterrupted. Like with migration, piracy is widespread, particularly in South East Asia where “organised crime” as opposed to opportunists offload diesel fuel, disguised as regular vessels. It is more difficult to intercept such types of piracy but as controls become stricter and checks become more stringent the level of piracy across the world is falling. Cross-border cooperation, information sharing and joint manoeuvres create trust between countries and new protocols are making it harder for criminals to seek shelter in a neighbouring jurisdiction, making interdiction hugely more effective.

In conclusion, both challenges are severe and present major issues for governments, economies and people living in ‘host’ countries and above all those having to migrate or engage in piracy. Whilst we may frown upon migrants “taking our jobs” or pirates hijacking multi million dollar cargo ships, we must remember that in most if not all cases, the individuals have no choice. Whilst recent global governance and intervention by a number of players primarily the UN Security Council and the US and UK navy has reduced piracy and stemmed flows of migration this does not solve the problem. Instead more complex and expensive strategies are needed to tackle the root of the issue. There is however light at the end of the tunnel if all countries ‘pull their own weight’. If Saudi Arabia and the Gulf States who have taken meagre numbers of migrants can shed their status of being rich, xenophobic and hiding behind barriers then perhaps the next generation will see fewer conflicts and an effective management strategies that promotes a utilitarian approach. Moreover, migrants could massively contribute to the tax base of host countries, helping to cover welfare costs in particular pensions for ageing populations. In terms of the ‘ex fishermen’, if property laws are established and economic zones implemented, it could allow them to go back to fishing, reducing the incentive to disrupt trade and promoting ‘bottom up’ development which is vital in the long run. The oceans could retain their historic significance as a meeting place of nations, trading freely and cross‑fertilizing cultures, or it could descend to a place where insecurity overshadows all such activity.

The Term Funding Scheme

Hello readers,

On reading the Economist this week, I came across the concept of the Term funding Scheme.[1] Although I have looked into monetary policy and quantitative easing in some depth, this is a concept that I was relatively unfamiliar with so I have done some research on it and have summarised my findings below.

The term funding scheme was introduced by the Bank of England in August 2016 following the results of the Brexit referendum. Under the scheme the Bank of England planned to lend £100 billion to banks at a generous rate close to the lower bank rate for four years.[2]After the referendum the the Bank of Endland cut the base rate from 0.5% to 0.25%. At such low base rates banks would struggle to offer savers an adequate interest rate and may even have to offer negative interest rates which would lead to customers understandably withdrawing their funds. Cutting the base rate to 0.25% squeezed the margins between what banks paid savers and what they charged borrowers This is also know as the net interest margin ( the gap between the rate at which banks borrow and lend).

The aim of the Term Funding Scheme was to accelerate the speed at which borrowing costs find their way through to the real economy. Mark Carney stated that following the interest rate cut and the term funding scheme that UK banks have “no excuse” to stop lending[3]. After a slow start, with only one bank drawing funding in the third quarter of 2016, the Scheme has seen banks and building societies draw a total of almost £80billion towards the end of 2017. In total 26 building societies registered for the Scheme, of which eleven have so far utilised the facility by the end of 2017. This includes eight of the ten largest societies. Building societies using the Term Funding Scheme have all increased net lending over the period.[4] Due to the success of the scheme, Mark Carney wrote to the Chancellor in August 2017 requesting a £15 billion increase in the scheme [5]. In November 2017 the Bank of England came to an agreement with the treasurery to increase the scheme by a further £25 billion bring the total value of ‘cheap credit ‘avaialbe to the banks to £140 billion.[6]

The Scheme is due to end in February 2018. Banks are less in need of help than they were in mid 2016 and there is overall lower usage of the scheme, and following the increase rate rise in November 2017 to 2018 there is less of a squeeze on banks’ margins.[7] The ability of banks to borrow at a low repayment rate meant banks didn’t need to rely on retail deposits (savers) for funding; hence reducing the need for banks to compete for savers’ cash, putting downward pressure on interest rates for savers. When the scheme closes, banks will need to offer more competitive rates for savers. The longer term impact will be even more significant. Banks have four years to repay money to the scheme, and will increasingly need to rely on savers during this time. As inflation currently is still above the bank of England’s 2% rise further rate rises are likely to follow soon, but as explained above ultimately the end of the term funding scheme may be more important than any future rate rise for savers.

In essense the TFS – or the Term Funding Scheme – was the big policy innovation announced by Mark Carney, governor of the Bank of England today, as part of a three-pronged monetary stimulus launched in the wake of the UK’s Brexit vote. While this is subtly different to the quantitative easing scheme in some senses (under QE the Bank printed money to buy assets; in the TFS it prints money to lend to banks temporarily, taking collateral in exchange), in other senses it is similar.

Sources:

[1] https://www.economist.com/news/britain/21736521-opening-act-year-tighter-monetary-policy-bank-england-holds-fire-interest

[2] https://www.ft.com/content/7cc617e4-5aec-11e6-9f70-badea1b336d4

[3] https://www.ft.com/topics/organisations/Bank_of_England?desktop=true&ft_site=falcon&format=&page=2

[4] https://www.bsa.org.uk/media-centre/bsa-blog/august-2017/term-funding-scheme-to-close

[5] https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/635439/bank_of_england_governor_letter_August_2017.pdf

[6] https://www.insider.co.uk/news/bank-england-increases-term-funding-11556298

[7] https://www.economist.com/news/britain/21736521-opening-act-year-tighter-monetary-policy-bank-england-holds-fire-interest

[8] https://www.finance-monthly.com/2018/01/end-of-term-funding-scheme-more-important-to-savers-than-any-boe-rate-rise/

The Economics behind driverless cars

Hello readers, welcome back to my blog.

This week I will be looking at a topical yet controversial issue: driverless cars and their impact on the economy. With self driving cars becoming more and more of a reality, most notably Tesla’s model S and X and more recently the model 3, which all feature autopilot technology, it’s only a matter of time before other manufacturers can utilise this and develop more advanced technology. The problem however, is not with the manufacturers producing the technology but instead with the laws that need to be established and the economic implications associated with a driverless economy.

In this post I will explore some of the economics behind driverless cars as well as look at the issues/laws that could prevent this market taking off. I will also consider the idea of rational decision making by machines vs. the moral conscious of a human being. Rational decision making in economics for those who don’t know is an economic principle that states that individuals always make prudent and logical decisions. These decisions provide people with the greatest benefit or satisfaction given the choices available and are also in their highest self-interest. I will also briefly touch upon the reduction of carbon emissions and how the negative externality issue could be reduced (for more information on this topic see the Carbon Taxes and Negative Externalities post). It is estimated that by 2030 the majority of cars on the road will be electric and the combustion engine will have had its time. Many of these are likely to incorporate autopilot/self driving capabilities. Although Tesla currently seems to dominate the market, many conventional German car brands such as Audi, Mercedes and VW are in the development stages of building their cars and it is thought that we may see some new players enter the market such as Google, Apple and even Dyson.

When people mention driverless cars it often conjures two images: The first being the idealistic image of a world in which cars move around by themselves, allowing commuters to maximise their time travelling be it to check their emails or have a power nap whilst they travel to work. The dystopian view holds that these vehicles will put 5 million lorry drivers and cab drivers out of work. The outcome of this scenario most probably lies somewhere between the two extremes, although whatever the outcome research is showing that the global economy will see a big boost. Those at Intel and the research company Strategy Analytics suggest a $7 trillion boost.

Although carmakers like to talk about autonomous vehicles (AVs) as if they will be in showrooms in three or four years’ time, the reality is that they are unlikely to do so anytime soon. Despite their lightning reactions, tireless attention to traffic, better all-round vision and respect for the law, and the fact that they won’t get tired, drunk, have fits of road rage, or become distracted by texting, chatting, eating or fiddling with the entertainment system; too many obstacles lie ahead that are not amenable to brute-force engineering. It could be a decade or two before autonomous vehicles can transport people anywhere, at any time, in any conditions, and do so more reliably and safely than human drivers.

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What are the potential benefits to the economy?

  1. One of the biggest benefits of an economy with no drivers is parking. Driverless cars will drop passengers off at their destination and go find parking elsewhere (or remain on the road if they are part of a ride-sharing program e.g. Uber). The U.S. has about 144 billion square feet of total parking, which represents up to one-third of the total real estate in some large cities. A reduction in the demand for parking can result in reclaiming this valuable real estate for more beneficial social and economic purposes potentially increasing the supply of housing and dampen sky high prices in cities.
  2. Reduction in traffic accidents. In the US, traffic accidents cost $900 billion annually. In addition, we can also expect to see less traffic violations, which may lead to a decrease in the size of police forces or shift people and resources to more important areas of serving and protecting the public.
  3. Insurance: About 90 percent of car accidents are caused by human error. In the world of autonomous vehicles, we can expect to see a major reduction in the number of accidents, which will significantly change the insurance revenue model. As the risk of accidents drops, demand for insurance will be virtually non existant. In anticipation of this shift, some insurers are rolling out usage-based insurance policies, which charge consumers based on how many miles they drive and the safety of their driving habits.
  4. The need for lodging will drop as people sleep in their cars during overnight road trips. Utilizing cars as a moving hotel is much more cost-efficient and convenient than purchasing a hotel room. Audi’s vice president of brand strategy and digital business, Sven Schuwirth, has predicted that car interiors will “eventually be able to morph between driving mode and sleeping mode”, presenting a major obstacle for the hotel industry.
  5. More media consumption as autonomous cars transform into rolling living rooms. A report by McKinsey and Company finds each additional minute occupants spend on the Internet could generate $5.6 billion annually, totaling $140 billion if, for example, half of the time of a 44-minute average round-trip commute is spent online.
  6. For delivery services, there will be enormous economic gains: McKinsey estimates between $100 to $500 billion per year by 2025 from driverless vehicles in the U.S. trucking industry. (The bulk of this windfall will come from the elimination of truck drivers and their wages).
  7. With multiple sensors, no distractions and no drunk driving, self-driving cars will largely eliminate car crashes so collision repair shops will lose a huge portion of their business. Indirectly, the decreased demand for new auto parts will hurt steel producers and part manufacturers.
  8. Price of goods are likely to fall and become more stable. This is because transport costs will drastically fall due to less dependence on oil which is extremely volatile.
  9. Fewer people will buy cars. Instead, they’ll rely on on-demand taxi services to ferry them about, which explains why the number of miles people and things travel in vehicles is expected to rise in the autonomous future. The more cars move around, the faster they’ll wear out. Those that aren’t replaced will be repaired, which means lots of jobs for mechanics and others who keep cars motoring along.
  10. House price fall not only from increased space in urban areas allowing for developers to rapidly construct new developments but because people could travel overnight to work and sleep-(this idea was explored in The Economist a few weeks ago). Furthermore, we may see a reduction in rural-urban migration in particular in LIDC’s providing the price of this technology falls, putting downwards pressure on the population of major cities.
  11. The rise of the automobile helped people rethink how to use space and created new forms of employment, like pizza delivery drivers. The self-driving automobile could do much of the same. No one has officially yet predicated how many jobs the autonomous future will create, and that’s partly because this issue is all-econompassing.
  12. Uber will have a fleet of autonomous vehicles ready by 2030. A Columbia University study suggests that Uber would need just 9000 autonomous cars to completely replace all taxis in New York City, with consumers only having to wait 36 seconds, on average, for a ride. Cars are currently seen as status symbols, giving their owners freedom and a sense of familiarity and luxury that ridesharing cars do not. However, as ridesharing services become safer and cheaper, and wait times continue to fall, the end of car ownership is a real possibility, leaving consumers with much more disposable income, automatically boosting the economy in other sectors.
  13. Self-driving cars will significantly improve the life of disabled individuals, increasing their personal sense of freedom and their employment prospects due to increased mobility. It is estimated that British individuals with limited mobility could see their earnings increase by £8,500 annually, on average and there would also be a reduction in welfare benefits, improving government finances.
  14. Many of these cars will be electric in order to reduce carbon emission which will help tackle the negative externality issue associated with burning fossil fuels. This would not only keep the environmentalists happy but would have huge economic benefits as the “dead weight social loss” would essentially be eliminated, in other words things like respiratory issues associated with pollution or the blackening of buildings in major cities would be reduced.

Sound to good to be true? Some of these benefits may be a little farfetched but are still a possibility perhaps not in the next 10 years but at least by the turn of the century. Lets take a look at some of the drawbacks mentioned at the start and explore the economic consequences that driverless cars may have on the economy.

What are the potential set backs?

  1. Significantly less money for cities through parking tickets. In 2012 alone, Washington, D.C. collected $92.6 million in parking ticket revenues. Whilst this may be a boon for consumers, it may have an adverse effect on government revenue. Morgan Stanley believes US governments could lose US$1.3 billion from revenue sources such as parking fees. This forecasted revenue loss also takes into account fewer registration fees, as American households are expected to reduce their car ownership from 2.1 non-automated vehicles to 1.2 driverless cars, on average.
  2. Insurers and injury lawyers will see their revenues fall.
  3. Major effect on the travel industry. Sven Schuwirth, vice president of brand strategy and digital business at Audi, proclaimed “In the future you will not need a business hotel or a domestic flight. After all, why fork out the money for a flight, and go through the hassle of seat selection, check-in, customs, boarding, disembarking and luggage collection, when your car can take you from Melbourne to Sydney overnight?”
  4. There will be plenty of safety concerns, and it’s unlikely that individuals will be comfortable sitting in the back seat of a self-driving car, let alone sleeping in one.
  5. In the accident that killed a Tesla driver in Florida last year, the driver either failed to respond in time to avert disaster, or mistakenly assumed that Autopilot meant more (as its name implied) than mere driver-assistance. Tesla continues to include the Autopilot sensors and software in its cars, but has deactivated the system while further testing is undertaken. The company plans to re-activate it in 2019.
  6. Lack of trust. Would you travel in a driverless cars which had to cross narrow bridges or drive through windy roads with cliffs on either side and is based on maths, risks and probability with some clever engineering? What about those moments when your laptop has a little blip or crashes when it boots up? Surely this technology will have similar issues. How would it cope with dirt tracks off the map, in blizzards, thunderstorms or pitch darkness, with animals bursting out of bushes, children chasing runaway balls and people doing irrational things?
  7. The recent Uber law case stands testament to the fact that even ‘small issues’ in the grand scheme of things to do with employment etc. are preventing this industry and making this idealistic image we have more of a pipeline dream.
  8. According to statistics from America’s Bureau of Transportation, there were about 35,000 fatalities and over 2.4m injuries on American roads in 2015. That may sound a lot but, given that Americans drive three trillion miles a year, accident rates are remarkably low: 1.12 deaths and 76 injuries per 100m miles. Since accidents are so rare (compared with miles travelled), autonomous vehicles “would have to driven hundreds of millions of miles, and sometimes hundreds of billions of miles, to demonstrate their reliability in terms of fatalities and injuries.
  9. “Safer than human drivers” ought to be a minimum requirement. Some would go further and require them to present no threat whatsoever to human life. That would imply it is acceptable for humans to make mistakes, but not for machines to do so. Such safety issues will have to be resolved before any regulatory framework for autonomous vehicles can be put in place.
  10. Carmakers could find themselves selling fewer vehicles to individuals, and more to operators of driverless fleets, who will run them 24 hours a day, seven days a week, and scrap them after a year or two. This may lead to more wasted resources as companies scrap old technology to upgrade fleets.
  11. Power-stations may not have the capacity to meet the demand to produce enough electricity. Also if energy is not being generated via green and sustainable ways e.g. solar panels, it defeats the purpose of having electric cars. Furthermore this change so far only applies to the automotive industry and not to planes/ships which due to globalisation play a big role in trade.

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What is the moral issue?

In economics, we often refer to the idea of rationality and assume in mathematical models homoeconomicus ( the concept portraying humans as consistently rational and narrowly self-interested agents who usually pursue their subjectively-defined ends optimally). For more information on this concept and its applications see my previous post titled “Key Economics Concepts”.

The issue with driverless cars is that they will be programmed to make rational decisions such as killing an old person who is sick and only has days to live rather than killing a child. Now although this may seem logically the right thing to do; it presents a serious ethical issue, why should a machine “play at God” and choose who lives and dies. “We think of humans as moral decision-makers. Can artificial intelligence actually replace our capacities as moral agents?”. That question leads to the “trolley problem,” a popular thought experiment ethicists have mulled over for about 50 years, which can be applied to driverless cars and morality: In the experiment, one imagines a runaway trolley speeding down a track which has five people tied to it. You can pull a lever to switch the trolley to another track, which has only one person tied to it. Would you sacrifice the one person to save the other five, or would you do nothing and let the trolley kill the five people? In the same way, will these cars optimize for overall human welfare, or will the algorithms prioritize passenger safety or those on the road?

Researchers at the Massachusetts Institute of Technology are asking people worldwide how they think a robot car should handle such life-or-death decisions. Their goal is not just for better algorithms, but to understand what it will take for society to accept the vehicles and use them. Their findings present a dilemma for car makers and governments eager to introduce self-driving vehicles. “People prefer a self-driving car to act in the greater good, sacrificing its passenger if it can save a crowd of pedestrians. They just don’t want to get into that car.”

What do I think will happen?

Overall it is clear that we are definitely going to see a change in the automotive industry. On one side we could see an economy whereby no one owns cars and instead driverless, electric vehicles are summoned like an Uber. On the flipside we may see a shift to electric cars however the driverless capability may not be rolled out for many years maybe even decades, as firstly many people would have a serious trust issue with such technology especially when we all know of times when technology can just fail on us at the most important times and secondly because of the moral “trolley problem” that occurs. I believe that the latter option will dominate but as this topic is so dynamic anything is a possibility. There are clearly economic consequences on both sides for using such cars most notably the number of job losses; however, as mentioned above these will more than likely be replaced by new jobs that we do not even know exist yet. This is an old problem that has happened throughout history and we have seen how it plays out. Admittedly we cant guarantee that history will repeat itself but it does seem likely that new technology is likely to create demand for workers. There will of course have to be major retraining and reshaping of the economy; although any major change in the economy is bound to have some disruption associated with it.

The disruption has begun though and whether we like it or not, there’s not much we can do about it to stop this revolution.  Although I have looked at a number of benefits and complications there are many others points that I have not even touched upon. This just highlights the complexity of the issue; changing the way the whole economy functions and operates every day was never going to be an easy task and it certainly won’t just happen overnight. Also, even though I have discussed more positives than negatives of the autonomous car industry, that’s not to say that driverless cars are overall better; the moral issue is a major problem and could hold back laws from being proposed. The future is unclear but for now car manufacturers will continue to develop and work on this technology. The battle we may win, is reducing carbon emissions by promoting electric cars through EV grants and subsidies, although Donald Trump’s ‘anti climate change’ mentality could act as a major obstacle.

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Sources used and quoted:

http://economicstudents.com/2017/07/economics-self-driving-cars/

https://www.wired.com/2017/06/impact-of-autonomous-vehicles/

https://www.cnbc.com/2017/05/03/self-driving-cars-will-disrupt-10-industries-commentary.html

https://www.economist.com/news/science-and-technology/21722628-forget-hype-about-autonomous-vehicles-being-around-cornerreal-driverless-cars-will

https://news.stanford.edu/2017/05/22/stanford-scholars-researchers-discuss-key-ethical-questions-self-driving-cars-present/

https://www.nbcnews.com/tech/innovation/driverless-cars-moral-dilemma-who-lives-who-dies-n708276

 

Thanks for reading, if you have any thoughts of your own you would like to share or have any questions that you would like answering please comment below.

Bitcoin-What’s the hype all about?

Hello readers, welcome back to my blog.

In this post I thought I would explore the idea of Cryptocurrencies, in particular Bitcoin. With its market price soaring past £10,000, something that many people did not even think would happen, it has certainly got everyone talking about it and wondering whether to invest in it. I’m not just talking about the economists who analyse and process the data from six computer screens whilst monitoring other currencies/commodities but everyday people who are looking to make a quick and effortless profit from their smartphones in the comfort of their own home or office. Its volatile nature however is what makes this quite a risky investment. That said you can yield some big profits if you buy at the right time and are not too risk seeking or risk averse. Although it is actually relatively straightforward to purchase Bitcoin via your smartphone using a coin wallet such as Coinbase, the mechanism behind it is actually rather complex and there is a lot of technical jargon that comes with it from ‘miners’ to ‘blockchain’ to ‘hash rate’.

In this post I will firstly outline what Bitcoin is, briefly summarise how it works, explain how it is different to conventional currencies and explain why it is suddenly growing in popularity. I hope this post clarifies some of the questions you may have about Bitcoin and if you have any further questions, please post them in the comments below. It is an interesting and topical issue which has the potential to replace traditional currencies  (aka Fiat currencies) whereby the central banks control the money supply. Already certain business are starting to accept payments in bitcoin and it was recently reported that people in central London have sold houses in the currency, therefore there is clearly potential. Others however argue its just a ‘craze’ or hype and that people will not be as confident in it due to the growing uncertainty about cybersecurity. Its recent crash last week proved that at some stage the bubble would start to bust, although could it rise again, and more importantly how high will it go this time round.

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Bitcoin was invented by Satoshi Nakamoto (the unknown inventor/ inventors of Bitcoin), who wanted to invent a peer to peer electronic cash system, in essence a decentralised cash system. Previous attempts at this had failed in the past until the invention of Bitcoin. It was created in 2009 and is now classified as a ‘cryptocurrency’. Numerous other cryptocurrencies such as Litecoin and Ethereum have been introduced although Bitcoin is by far the most successful one. [1]

A currency needs a payment network (accounts, balances and a record of transactions) as well as a central server or authority that verifies this network. In conventional currencies ( Fiat Currencies), this role is provided by the central banks such as the Bank of England. The challenge in a decentralised system is that every single transaction needs to be verified as if there are any discrepancies the whole systems will collapse. The game changing innovative feature of Bitcoin was that Satoshi Nakamoto  invented a system that could verify every single transaction in a decentralised system.

A brief summary of this is as follows:

  1. Cryptocurrencies are entries in a database that cannot be changed without fulfilling specific conditions.
  2. Bitcoin transactions are sent from and to electronic bitcoin wallets, and are digitally signed for security. Everyone on the network knows about a transaction, and the history of a transaction can be traced back to the point where the bitcoins were produced.
  3. The transaction is known almost immediately by the whole network. But a specific transaction gets confirmed after a certain amount of time. Confirmation is a critical concept in cryptocurrencies.  An unconfirmed transaction is pending and can be forged. Confirmation usually only takes a few minutes. Once a transaction is confirmed, it cannot ever be reversed, it is part of the so-called blockchain (database).
  4. Only miners can confirm transactions. This is essentially their job in a cryptocurrency-network. After a transaction is confirmed by a miner, it is added to the database and It has become part of the blockchain. For this job, the miners get rewarded with a token of the cryptocurrency.
  5. Anyone can be a miner, a decentralized network has no authority to delegate this task. Satoshi set the rule that the miners need to invest some work of their computers to qualify for this task.[3]

Bitcoin mining is legal and is accomplished by running complex computer programmes in order to validate Bitcoin transactions and provide the requisite security for the public ledger of the Bitcoin network.[4]

The Bitcoin network compensates Bitcoin miners for their effort by releasing bitcoin to those who contribute the needed computational power. The more computing power you contributed then the greater your share of the reward. In the initial stages of Bitcoin mining could be done on a personal computer. Today that’s no longer possible. Specialised computer hardware is now needed for Bitcoin mining. Mining with anything less will consume more in electricity than you are likely to earn.

Like traditional currencies, such as Sterling, Bitcoin has value relative to other currencies and physical goods. Whole Bitcoin units can be subdivided into decimals representing smaller units of value.The smallest Bitcoin unit is the Satoshi, or 0.00000001 Bitcoin. Bitcoin can be used to purchase goods from an increasing number of companies that accept Bitcoin payments. It can be exchanged with other private users for services performed or to settle debts. It can be swapped for other currencies, both traditional and virtual, on electronic exchanges similar to Forex exchanges. And, as it is untraceable, it can be used in illicit activity, such as the purchase of illegal drugs on the “dark web”.[5]

Recently there has been a surge in the value of Bitcoin the current valuation on the day of writing this is 1 Bitcoin is worth £10314.49. though there have been several large fluctuations in the price.[6]

Bitcoin was initially thought off as a niche product but the rest of the financial world is starting to take notice. A blog by Nieplet in the LSE Business Review [7], succinctly summarises the potential effect of Bticoin on Central Banks, he writes

‘Crypto currencies offer limited benefits for users who do not have overwhelming privacy needs. Their usefulness as money suffers from limited liquidity, which creates exchange rate volatility. As long as the number of people using crypto currencies is small, the incentive for others to adopt them too remains limited. But strong network effects may quickly disrupt the payments system once a critical mass of users coordinate on, and adopt a specific crypto currency.’ Central banks increasingly are under pressure to keep ‘their’ currencies attractive. They should let the general public access electronic central bank money, not just financial institutions (Niepelt 2015). To do this, they should embrace the blockchain.’

Why the sudden hype?

The latest spike was driven by the news that the Chicago Mercantile Exchange will trade futures in Bitcoin; a derivatives contract based on a notional currency. If more people trade in Bitcoin  that means more demand, and thus the price should go up. But what is the appeal of Bitcoin? There are three main reasons: the limited nature of supply (new coins can only be created through complex calculations, and the total is limited to 21m); fears about the long-term value of fiat currencies in an era of quantitative easing; and the appeal of anonymity. Perhaps is is time to reassess our relationship with money. Crypto currencies and Bitcoin may be the start of this revolution, if its volatility can somehow be ironed out. However, currencies need to have a steady price if they are to be a medium of exchange. Buyers do not want to exchange a token that might jump sharply in price the next day; sellers do not want to receive a token that might plunge in price. People are buying Bitcoin because they expect other people to buy it from them at a higher price; the definition of the “greater fool theory“. [8]

If you’re reading this from an investors point of view, my advice would be to play it safe and invest only what you can afford to loose. Although it has the potential to make you a millionaire overnight, it is extremely volatile and a crash like the one we recently saw is always a possibility if not a certainty. Its just a question of time.

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References:

[1] https://www.chapman.edu/research/institutes-and-centers/economic-science-institute/_files/ifree-papers-and-photos/koeppel-april2017.pdf

[2] https://blockgeeks.com/guides/what-is-cryptocurrency/

[3] https://www.coindesk.com/information/how-do-bitcoin-transactions-work/

[4] https://www.bitcoinmining.com/getting-started/

[5] https://www.moneycrashers.com/bitcoin-history-how-it-works-pros-cons/

[6] http://www.xe.com/currencycharts/?from=XBT&to=GBP&view=1Y

[7] http://blogs.lse.ac.uk/businessreview/2016/10/21/bitcoin-may-have-implications-for-monetary-policy/

[8] https://www.economist.com/blogs/buttonwood/2017/11/greater-fool-theory-0

IPO’s, PLC’s, LTD’s

Hello readers, welcome back.

In this short post I will outline and explain some of the differences between IPO’s, PLC’s and LTD’s. These terms often used in economics and it is important to distinguish between them.

What is an Initial Public Offering (IPO)?

  • An initial public offering, or IPO, is the very first sale of stock issued by a company to the public and is the process where a privately held company becomes a publicly traded company. Prior to an IPO the company is considered private, with a relatively small number of shareholders made up primarily of early investors (such as the founders, their families and friends) and professional investors such as venture capitalists. Until a company’s stock is offered for sale to the public, the public is unable to invest in it. You can potentially approach the owners of a private company about investing, but they’re not obligated to sell you anything. Public companies, on the other hand, have sold at least a portion of their shares to the public to which are traded on a stock exchange. This is why an IPO is also referred to as “going public.”
  • Even after an IPO, publicly traded companies can revert back to being private entities if they so choose.
  • Companies use this tool to secure capital through investments that are used to expand or improve the business, purchase assets, or provide a dividend to investors.

 

What is the difference between a Public Limited Company (PLC) and a Private Limited Company (LTD)?

  • Both PLC’s and LTD’s have ownerships that are divided up into shares, which are owned by shareholders. However, shares of LTD’s are privately owned and are not traded on the stock exchange i.e. they cannot be offered to the general public. This is different to PLC’s whereby shares in a public company can be freely sold and traded to the general public and their shares can be listed on a stock exchange, meaning that anyone is able to become a shareholder. Public Companies can therefore raise money via IPO’s. Both PLC’s and LTD’s have limited liability. This means that the business has it’s own identity and owners are not personally reliable for any debts that the firm may have.
  • A PLC is usually a large, well-known business. This could be a manufacturer or a chain of retailers with branches in many city centres. An LTD is often a small business such as an independent retailer in a market town. Most companies in the UK are LTDs.
  • A private company must have a minimum of two shareholders and a maximum of 50. On the other hand there must be a minimum of 50 shareholders in a PLC.
  • PLCs must also be incorporated with Companies House and form a constitution. Additionally, they must have a minimum authorized share capital of £50,000.

 

Sources Used:

https://www.investopedia.com/university/ipo/ipo.asp

http://www.bbc.co.uk/schools/gcsebitesize/business/aims/limitedcompaniesrev3.shtml

How does Fiscal Policy influence economic activity?

Hello readers, welcome back to my blog.

You may remember me discussing in one of my posts a few weeks ago, a number of fiscal facts as well as analysing a few of the policies introduced in the recent budget. In today’s post, I thought I would take fiscal policy further and explore how it actually influences economic activity. This post will be quite technical in terms of the economics jargon used; however, it should still be interesting and especially relevant if you are studying A-level Economics.

Fiscal policy is one of the instruments that governments have as part of their economic toolbox to ‘fix’ or manipulate the economy and create the optimal conditions that allow the ultimate macroeconomic objective of improved economic welfare to be achieved. It involves the use of government spending and tax policies (direct or indirect) to influence the level of economic activity. It is often described as being ‘all encompassing’ in the sense that it targets a number of different avenues of the economy; from boosting aggregate demand and economic growth, altering employment and inflation to redistributing income or providing merit goods, which otherwise if left to free market forces alone, would be consumed below the social optimum, thus having negative spillover effects. How such policies are used and implemented is completely dependent on the state of the economy and the objectives that the government is prioritizing. In times of a recession when consumer confidence, consumption, animal spirits and net investment are low then an expansionary policy may be used to stimulate aggregate demand which will result in an increase in GDP in the short run. If governments are looking for non-inflationary or even dis-inflationary growth then they may implement long run supply side fiscal policies, which increase the productive potential of the economy, resulting in an outward shift of the PPF curve or the LRAS curve, thus targeting the supply side of the economy as opposed to the demand side. On the flipside, contractionary fiscal policy may be employed when the economy is ‘overheating’ and needs to be ‘reigned in’. This would involve raising taxation such as income tax and/or reducing government spending perhaps by employing an austerity package.

Fiscal policy is the sister strategy to monetary policy through which a central bank alters a nation’s money supply with the primary aim of promoting price stability. Although there is no ‘one size fits all policy’ in economics the type of policy implemented often depends on the current state of the economic climate and it is vital that governments ensure that the two work in line with each other as this could prevent them meeting their objectives, or worse, lead to government failure. For example, in 2010 the coalition government enforced austerity at a time when expansionary monetary policy was being pursued, thus contradicting the efforts and aims of monetary policy. Perhaps Keynes’ idea that ‘governments should spend their way out of a recession’, would have been a better approach. Furthermore, fiscal policy may be useful when central banks ‘run out of road’; in other words when interest rates are at the ‘zero lower bound’ and no longer work to influence the economy in terms of aggregate demand. Moreover, due to the dynamic and volatile nature of the economy and external influences/shocks such as Brexit and the financial crash of 2008/09, the effectiveness of fiscal policy in altering the level of economic activity in the UK may be reduced. It is also important for governments not to be myopic, in the sense that they should strike a balance between the amount they borrow and the level of debt they are creating for future generations. This is because financing the national debt carries an opportunity cost; of around £50bn (larger than the UK’s defense budget) meaning that other areas of the economy such as the NHS or education budgets are likely to suffer. It also means that at some point in the future, tax rates will have to increase to repay the debt. On the contrary they should consider the long-term prosperity that can arise from investing in a healthcare system for all as well as education free at the point of consumption, allowing the poorest to benefit most from such policies and ultimately increasing economic growth. Since debt is measured against the size of the economy, if economic growth were to substantially increase, the size of the debt would essentially be ‘eroded’ as it is expressed as ratio of debt to GDP.

Over the past decade in the UK, there have been different approaches, largely determined by the political power in party. Although these have been carried out with varying degrees of success, it is clear that governments should set realistic dates for when the budget deficit, currently around £48bn (2.5% of GDP) will be “balanced” and national debt which stands at £1.9 trillion (86% of GDP) can start to be repaid. From Osborne who said we would be running a surplus by the end of 2015 to Mrs May who is to committed to wipe out the UK deficit by the middle of the next decade, supposedly allowing for greater borrowing levels to support the economy in the run-up to Brexit; it is hard to see how the economy will pan out, especially if the UK’s borrowing is predicted to spike over the next two years as the UK attempts to exist the EU. It is also faced with a hefty exit bill and concerns of whether Mrs May will stay in power for much longer are dampening confidence within the UK economy in terms of the already low exchange rate against major currencies.

It is hard to disagree with the fact that the great recession offset and disturbed the economy so violently, that it has led to a rapid rise in levels of government borrowing to finance the deficit which hit £160bn at its peak. The effect of the recession is therefore still felt today indirectly; nevertheless the recession cannot be reversed and governments must look to use fiscal policy effectively in current times.

Let us first analyse the taxation aspect of fiscal policy in altering economic activity in the UK. The primary objective of taxation is to collect revenue to and redistribute income from richer members in society to more vulnerable individuals as well as to provide public goods and other infrastructure. In terms of direct taxes, we could look at the Laffer curve argument, which states that a fall in the higher rate of tax may actually increase tax revenue by increasing work incentives and reducing the black economy. Tax avoidance is a topical issue with the recent exposure of the paradise papers, but has been an underlying problem for years with Apple’s ‘Sweetheart deal’ to companies such as Vodafone, Google and Amazon battling various disputes. Despite the fact that it is legal, it is frowned upon by many people and presents more of a moral issue rather than an economic one.

Different approaches to direct taxes have been tried for example Osborne reduced the higher rate of tax from 50% to 45% with the aim of giving people more disposable income. Corporation tax is also a direct tax and works in a similar way. Hammond recently announced that corporation tax in the UK is set to fall to 17% by the turn of the decade, with the aim of firms using the saving in tax to finance investment projects, which should help to boost the UK’s ‘sluggish’ productivity. Cuts may also be made on the other end of the spectrum to aid poorer households who generally have a higher marginal propensity to consumer meaning any extra income will be spent on consumption. In the recent budget it was announced that the tax-free allowance which primarily benefits low-income earner, will be increased from £11,500-£11,850 although this is only just in line with inflation.

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The diagram shows that the optimal tax rate is at T*, whereby tax revenues are at their greatest. That said, it is difficult to know exactly where this point may be and in reality governments will not know if they are below or above their optimal rate.

As well as altering the economy as a whole, fiscal policy can also influence people’s behaviors i.e. though indirect taxes/Pigouvian taxes. Although a microeconomics issue, this can have ramifications for the economy as a whole. For example ‘sin taxes’ on sugar, alcohol and cigarettes can deter people from using such goods, whilst raising revenue, which can be ring-fenced to spend on the issues, created by such activities. That said, the demand for such goods is inelastic and thus it may not lead to a socially optimal solution. VAT is another indirect tax that can be manipulated. One example was the VAT holiday implemented after the great recession. The intention was to restore consumer confidence and bring about stronger growth by altering the consumption part of AD (around 65% of AD). It was the first cut in VAT for 34 years; however, it was ‘slow to get going’. It was not until it was announced that the change would be reversed did consumers start to purchase big-ticket items and white goods. Furthermore such VAT changes may not have been passed onto consumers and it largely depends on the Price Elasticity of Demand. Such a change is likely to be a part of a number of expansionary policies deigned to kickstart the economy and would not work in isolation. It is important to consider that ‘Freemarketeers’ would not support such changes and they would argue that the allowing markets to operate freely with limited government intervention would enable the price mechanism to allocate scarce resources amongst competing users.

Changing taxation also has an asymmetric effect; that is, firms/consumers will experience different impacts. It also depends on the type of tax being changed and the behaviour of firms. Reducing corporation tax may just lead to increased profits for companies and no change in the level of their investment. Alternatively in Ireland (a “tax haven”) it may lead to the influx of FDI from companies such as Apple and the creation of ‘Enterprise Zones’, which may boost employment as firms look to expand and produce higher levels of output, thus enhancing growth leading to regional multiplier and accelerator effects.

We must also assess some of the issues with taxation. Firstly as stated in Adam Smith’s canon’s of taxation if taxes are complicated it can increase administrative costs thus impinging on the revenue earned by the tax itself. Secondly ‘too high’ levels of tax could lead to a ‘brain drain’ whereby professionals e.g. doctors move to other countries such as Australia or Canada where tax rates at the upper end are lower. Thirdly, asymmetric information may lead to the government forecasting wrong, and ultimately implementing the wrong policy. In addition, certain taxes e.g. ‘sin taxes’ may be termed regressive, whereby poorer households are hardest hit. Fiscal drag may also occur whereby during times of inflation, when wages are increasing, the income tax allowances may not increase in line with the growth in average earnings. As a result people are ‘dragged’ into a higher tax bracket and the government receives more revenue-thus a boon for the government but a negative impact for consumers. Furthermore the tax system used, can play a role in determining the pattern of economic activity. Currently the UK has a progressive tax system; although, others argue a flat rate tax employed in countries such as Romania or Jamaica are more ‘equitable’ and less money would be ‘wasted’ on clamping down on tax avoidance.

Government spending is the other main branch of fiscal policy and involves boosting the ‘G’ part of AD: C+I+G+(X-M). The theory suggests here, that an increase in spending e.g. on social protection or subsidies helps stimulate consumption, and is an injection into the circular flow of income thus benefiting the economy in the short run. Although fiscal policy is often thought of as being largely a demand management tool whereby it affects aggregate demand, it can also be used to alter the supply side of the economy via schemes such as the new ‘National Productivity Investment Fund’ and increasing school’s budgets for Maths and Science etc. Moreover, tax cuts may boost labour supply thus expanding the economy in the long run.

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Both diagrams show how the long run capacity of the economy increase from Y-Y1 putting downward pressure on the general price level.

Despite this, it is important to consider and disaggregate where this money is being spent and which sectors of the economy will receive the money or if it will it make a productive difference. Government spending can be categorized as ‘current’-consumption related, which is unproductive; or ‘productive’, where it is used for investment and boosts the long run trend rate of growth. Gordon Brown’s Golden Rule was to ‘Only borrow to invest’. Further, fiscal policy may be used alongside supply side polices rather than as an alternative. This may ensure fiscal polices can react to economic shocks. We should also consider the role of Automatic fiscal stabilisers – If the economy is growing, people will automatically pay more taxes (VAT and Income tax) and the Government will spend less on unemployment benefits. The increased T and lower G will act as a check on AD. Conversely, in a recession, the opposite will occur with tax revenue falling but increased government spending on benefits-this will help increase AD.

Another point about spending that we should factor in is the government may have poor information about the state of the economy and struggle to understand the best what the economy needs. There may also be time lags-it could take several months for a government decision to filter through into the economy and actually affect AD and by then it may be too late. Another argument is crowding out. Some economists argue that expansionary fiscal policy will not increase AD because the higher government spending will crowd out the private sector. This is because the government will borrow from the private sector who will then have lower funds for private investment. Free market economists would also argue that Government spending is inefficient and that higher government spending will tend to be wasted on inefficient spending projects. It can then be difficult to reduce spending in the future because interest groups put political pressure on maintaining stimulus spending as permanent. There may even be higher borrowing costs-under certain conditions; expansionary fiscal policy can lead to higher bond yields, increasing the cost of debt repayments. Finally, the real business cycle argues that macroeconomic fluctuations are due to changes in technological progress and supply-side shocks. Therefore, using demand-side policy to influence economic growth fails to address the issue and just makes the situation worse.

Other peripheral points around this issue are: Reduced government spending (G) to decrease inflationary pressure could adversely affect public services such as public transport and education causing market failure and social inefficiency. If the government uses fiscal policy, its effectiveness will also depend upon the other components of AD, for example, if consumer confidence is very low, reducing taxes may not lead to an increase in consumer spending. It can depend on the Multiplier effect as any change in injections may be increased by the multiplier effect. Also, fiscal policy is most effective in a deep recession where there is a liquidity trap as higher government spending will not cause crowding out because the private sector saving has increased substantially.

The diagram below shows the effect of expansionary fiscal policy and contractionary fiscal policy on AD in theoretical terms i.e. without the exceptions discussed above. Although the economic theory often deviates from reality, it is important to use it as a base line to compare what would happen to the economy ‘ceteris paribus’. The Monetarist argument is that the LRAS is inelastic therefore an increase in AD will only cause inflation to increase and thus they are generally skeptical of fiscal policy as a tool to boost economic growth.

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In conclusion, a rise in government expenditure, or a fall in taxation, in theory should increase aggregate demand and boost employment, likewise contractionary polices should do the opposite However, the size of the resulting final change in equilibrium national income is determined by the multiplier effect as well as confidence and the current state of the economy. Fiscal policy can be used to influence the level and pattern of economic activity in many ways. Firstly through an increase in government spending on services such as the NHS will create more jobs and thus increase consumption as consumers now have more disposable income. A change in direct taxation such as a change in level of corporate tax on firms may cause firms to increase investment spending due to spare money that hasn’t been removed by the burden of tax. That said, large budget deficits do require financing and in the long run, this requires a higher burden of taxation meaning it is important for governments to strike a balance. When the government sells debt to fund a tax cut or an increase in expenditure then a rational individual will realise that at some future date he will face higher tax liabilities to pay for the interest repayments. Thus, he should increase his savings, as there has been no increase in his permanent income. This gives rise to the Keynesian idea of the Paradox of thrift, whereby increased savings lead to a reduction in aggregate demand and lead to individual being worse off. Overall we have to consider both long run and short run effects of fiscal policy. The effect that fiscal policy has in the long run on the supply side of the economy is particularly important and over time we have seen a switch away from the use of fiscal policy as government tool for demand management and a turn towards its use as a supply side incentive. We also have to consider the drawbacks of fiscal policy such as time lags. Fiscal policy may cause an increase in AD but it takes time to recognise that AD is growing either too quickly or too slowly. It then takes time to implement an appropriate policy and then for the policy to work, as the multiplier process is not instantaneous. Although fiscal policy has been relatively successful in the UK it will be interesting to see how factors such as a growing and ageing population will change things as the pressure increases on the NHS and state pensions.

 

Sources used:

https://www.economicshelp.org/macroeconomics/fiscal-policy/fiscal_policy/

http://www.imf.org/external/pubs/ft/fandd/basics/fiscpol.htm

https://www.investopedia.com/terms/f/fiscalpolicy.asp

https://www.tutor2u.net/business/reference/fiscal-policy-explained

AQA Economics A-Level Textbook 2, Powell and Powell