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

What causes the erosion of Sovereignty and Territorial Integrity?

Hello readers, welcome back.

In my last post I looked at one of the most heated conflicts the world has seen between two nations over territory, namely the region of Jammu and Kashmir. I hope that you found this interesting and a change from hearing about Brexit or Trump in the media or my usual posts about topical economics news stories. In this post I will also be looking at something more abstract, and will be exploring the factors that lead to the erosion of sovereignty and territorial integrity. Such factors are extremely relevant in the current economic climate and in fact they go as far as explaining some of the reasons why Britain voted to leave the EU-“To get our country back” and restore sovereignty or what it would mean if Scotland were to become an independent state. I would be interested to hear any thoughts you may have on this subject, so please leave your comments below.

Sovereignty refers to the absolute authority which independent states exercise in the government of the land and people in their territories. In other words, it refers to the power or independent control that states have. Territorial integrity is the principle that a state’s borders are sacrosanct; the idea that states should not attempt to promote secessionist movements or to promote border changes in other states. The two are interrelated as states exercise their sovereignty within a specific territory; the boundaries of which have been established by international law. Thus the preservation of territorial integrity and sovereignty is important in achieving and maintaining international security and stability in the world. Although it may appear at the outset that political factors/geopolitics such as the transnational movement of terrorist and extremist activity across the Turkey-Syria border or contested maritime boundaries such as in Atlantic Waters off Ivory Coast and Ghana are responsible for the erosion of sovereignty and loss of territorial integrity, they can be influenced by a number of economic, social and even environmental factors.

Let us first consider the political factors, which are often said to play the greatest role in eroding territorial integrity and sovereignty. Firstly, the current system of nation states is based on the Westphalian model and these principals of sovereignty and territorial integrity are reinforced in the UN charter today. The system has been challenged by many current threats and in the last two decades, both within and between sovereign states we have witnessed contested territory-the most obvious example being Russia’s annexation of Crimea and support for separatists in Ukraine. This conflict has led to the deaths of 7000 people, including 298 people shot down in a civilian aircraft. Although sanctions/embargos were imposed by the EU and USA on Russia, these caused impacts for other countries e.g. Germany’s oil supply and often had regressive effects, whereby the poorest and most vulnerable in society were most affected. Other examples include contested islands in South & East China seas, as well as the U.K. and Argentinian claims over the Falklands. In the Middle East/North Africa, factional or sectarian tensions have led to political and ethnic conflicts, which has reduced sovereignty. Furthermore, transnational movement of terrorist/extremist activity such as across the Turkey-Syria border, where smuggling of foreign fighters, oil and weapons, has threatened territorial integrity and sovereignty of the two countries. In addition, the legacy of colonialism such as the ‘Scramble for Africa’ has lead to ethnic partitioning which has promoted nationalist groups that weaken the states power.

As well as the role of individual governments, supranational institutions such as the EU, UN, and NATO are made up of member states that retain their sovereignty; however, they are bound to the requirements of this body, including any treaties they sign. For this reason they are sometime said to “surrender” sovereignty, as they must comply with these. The EU, made up of 28 sovereign member states, was first established as a trading bloc with a common tariff/access to the European single market, but is now an economic and political union with its own parliament. On one hand, the benefits of this integration protect states interest, for example, transnational issues such as air/water pollution and international crime. On the other, some states are required to implement EU laws and decisions even if they did not vote for them and 19 members of the Eurozone have financial restrictions preventing them from setting interest rates and forcing them to accept harsh austerity measures e.g. Greece. This was one of the driving forces behind Brexit-“To get our country back” and regain sovereignty. Similarly one of the policies of the UN is that the international community will intervene in a state without its consent when that state is allowing violation of human rights to occur. Although this may be deemed the right thing to do, there is still a loss of sovereignty to such countries and there is the argument that why should Western countries be enforcing their ideology on the rest of the world.

Although such factors are central, it may be argued that the role and influence of economic factors in disputes are just as important. For example TNC’s who exploit ‘soft power’, bi-lateral trade agreements or even currency strength can all come into play. A good example is Scotland who over the past few years has been seen to be ‘vacillating’ between remaining within the UK and becoming a separate state. If they were to leave, this is likely to cause economic complications and ultimately a loss of sovereignty for Westminster. The most notable of all being the loss of oil, tourism, fishing stocks/controls and even the trident nuclear programme. Furthermore, there is likely to be a loss in territorial integrity as a large piece of land is at stake here. In terms of currency, with the UK’s vote to leave the EU, the pound took a major hit and since then imports have become more expensive. This has already led to issues over trade agreements with EU countries.

TNC’s such as Nike who has 692 factories in 42 countries and employs over a million people, have become a driving force of global economic integration and some LIDC’s such as Kenya or Nigeria are reliant on TNC’s to integrate their economy into the global market and promote development or create multiplier effects, thus lifting the population above the poverty level. However, such corporations present major challenges to government control and state sovereignty. Firstly in the last two decades, TNC’s have expanded operations regardless of state boundaries-some states have lost control of territory, work force, environment and even political decision making. Moreover TNC’s have been criticised for pursuing their own profit-making interest at a cost to countries in which they have invested. Business decisions to invest which affect many local people are made outside the host country, which has little involvement, and often there is disrespect for human rights by some TNC’s such as exploitation, low wages, poor conditions and child labour in pursuit for higher profits. That being said, companies such as Nike now aim to shed this reputation with other TNC’s such as Nestlé, Toyota, and Shell following suite, implementing policies to achieve corporate social responsibility and conform to the UN Global Compact.

Social or cultural factors in disputes, which include the challenges by strong nations/people such as the Kurds, the Basques or more topically the Catalonians, are causing a loss to sovereignty and territorial integrity and are often significant as they interlink or affect economic and political factors. Ethnic groups with strong identities often demand full independence to create a new state e.g. Tuareg in Mali or ISIS in Iraq and Syria. Internal conflict between ethnic groups results in governments unable to protect all its citizens often leading to civil wars. We should also note that the geographical distribution of ethnic groups does not always coincide with current political borders. Sovereign states may include more than one ethnic group within its territory such as South Sudan (60 ethnic groups/indigenous tribes) or a single ethnic group may be partitioned by modern state borders e.g. Kurdistan extends across 5 states.

The Basque nation is a prime example of how cultural factors were responsible for the loss of sovereignty and how nationalism (people with a shared identity) can exist without a formal state. It spans across 7 provinces and has a population around 3.1 million. They have a distinct culture, language and a strong tradition of independence/political autonomy with their own Basque parliament. In the past the separatist movement-ETA has carried out violent acts, responsible for over 800 deaths and the French and Spanish governments have always seen them as a threat to sovereign power and territorial integrity. It is often referred to as the IRA of France/Spain. With unique sports (pelota), set traditions such as the Pamplona bull running, and their own food, language, and culture which dates back to the late 1800s which saw rapid industrialisation in Bilbao, the people of Basque have been struggling for either further political autonomy or, chiefly, full independence for years. Despite the violence and turbulence within the political sphere, the key leader of this ‘terrorist’/’ ‘freedom fighters’ group was arrested and this marked the end of the armed activity with a formal ceasefire in 2011. However challenges to sovereignty will exist so long as there are active members of ETA not just in the Basque land but dispersed across the world.

Arguably less important, we should also consider some of the environmental factors that may affect sovereignty. Firstly, TNC’s exploit natural resources; particularly in LIDC’s who are desperate for foreign investment and allow oil rigs/mines to be constructed in exchange for new roads/infrastructure. Secondly, fishing quotas in the Common Fisheries Policy & the Countryside Stewardship under Common Agricultural Policy under EU law has also been criticised for causing environmental degradation/wasting resources.

Overall it is clear that although political factors are important, the issues of sovereignty and territorial integrity are also influenced by a combination of economic e.g. TNC’s, environmental e.g. EU agricultural policy, and social factors e.g. Basque people. Moreover, the issue is actually more complex than this and we should consider the fact that every dispute is unique, meaning some factors will be more dominant than others; it all depends on the situation and each one evolves over time. However we can conclude that stating just political factors in most cases would only examine a part of the issue, in reality a combination of factors work together and there is no “one size fits all” explanation.

 

 

The ongoing dispute between Jammu and Kashmir.

Hello readers,

Welcome back to my blog. You may have seen that in this week’s economist, the main story was on “The war the world ignores”-Yemen. Having read this article, I thought I would base this week’s post on the issue of conflict and explore some of the other wars that are not widely understood or discussed especially in the media today. Currently the news seems to be flooded with stories about Trump or his North Korean counterpart or the issues with the Brexit bill and the negotiations. Although we have seen the ‘ethnic cleansing’ of the Rohingya muslims in Burma in the media recently, we seem to have stopped following one of the biggest, oldest and on going territorial disputes the world has ever seen-Jammu and Kashmir between India and Pakistan. This post will give an overview of the history between the two countries, and consider some of the possible solutions. You might be wondering how at the outset this relates to economics. The answer is that this is directly related to economics. For example such conflicts determine trade, migration, confidence in the economy, sovereignty, foreign investment and social welfare. Furthermore, funding such conflicts has an opportunity cost involved; that is, the money spent on financing this cannot be spent in areas such as education or health which are under severe pressure especialy by India’s 1.3 bn plus population. It is important to remember that Economics does not just look at topical issues in the news or outline how the economy is performing by using mathematical models. Instead the subject is all encompassing and for that reason many economists have different views about its definition. The most interesting definition that I have come across about economics is that “economics is what economists do”-Jacob Viner.  It is not possible to give any fixed definition about this social science and even if it is defined, it is only temporary.

Area of dispute:

  • Some of the biggest geopolitical events in the world are centred on disputed territories-land whose sovereignty is claimed by more than one nation. The list of territorial disputes is long and ever changing/dynamic. There are now more than 150 disputes under way that involve territory, mostly in Africa, Asia, and the Pacific region, but also in Europe and the Americas. Some disputes are on the distant horizon (Antarctica) some are long simmering (Jammu and Kashmir), and others like Syria are at their boiling point.
  • Kashmir, officially referred to as Jammu and Kashmir, is an 86,000-square-mile region (about the size of Idaho) in Northwest India and Northeast Pakistan. The region has been violently disputed by India and Pakistan since their 1947 partition, which created Pakistan as the Muslim counterpart to Hindu-majority India.

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Reasons for the dispute to the territorial integrity:

  • When India and Pakistan became separate and independent nations in August of 1947, theoretically they were divided along religious lines. In the Partition of India, Hindus were supposed to live in India, while Muslims lived in Pakistan. However, the horrific ethnic cleansing that followed proved that it was impossible to simply draw a line on the map between followers of the two faiths – they had been living in mixed communities for centuries.

 

  • For the past 60 years, this mountainous region, often described as a legacy of British colonialism has provided the stage for some extremely tense moments between India and Pakistan, with some claiming that it’s “one of the most dangerous and prolonged disputes in the world, which in the worst-case scenario could trigger a nuclear conflict.” Currently Kashmir is administered by India and claimed by Pakistan and a heavily militarized, 450-mile-long Line of Control has long turned Indian and Pakistani forces against each other in this contested Himalayan region.

 

  • After the partition of India in 1947, because of its location and under the partition plan provided by the Indian Independence Act, Kashmir was free to accede to India or Pakistan. Maharaja Hari Singh, the ruler of Kashmir at the time, was Hindu while most of his subjects were Muslim, thus he was unable to decide which nation Kashmir should join. In the end he chose to remain neutral and declared Jammu and Kashmir’s independence as a separate nation in 1947; however, Pakistan immediately launched a guerrilla war to free the majority-Muslim region from Hindu rule. The Maharaja then appealed to India for aid, signing an agreement to accede to India in October of 1947, and Indian troops cleared the Pakistani guerrillas from much of the area. The newly formed United Nations intervened in the conflict in 1948, organizing a cease-fire and calling for a referendum of Kashmir’s people in order to determine whether the majority wished to join with Pakistan or India. Although, that vote to date has never actually been taken and the Kashmir dispute still remains on the United Nations Security Council’s agenda.

 

  • Since 1948, Pakistan and India have fought two additional wars over Jammu and Kashmir, in 1965 and in 1999. The region remains divided and claimed by both nations; Pakistan controls the northern and western one-third of the territory, while India has control of the southern area.

 

  • Islamabad (capital of Pakistan) has always maintained that majority-Muslim Kashmir should have been a part of Pakistan. India claims that Pakistan lends support to separatist groups fighting against government control and argues that a 1972 agreement, signed after the Bangladesh war, mandates a resolution to the Kashmir dispute through bilateral talks.

 

  • India and Pakistan did indeed agree a ceasefire in 2003 after years of bloodshed along the existing border (formally known as the Line of Control). Pakistan later promised to stop funding insurgents in the territory while India offered them an amnesty if they renounced militancy. Then, in 2014, a new Indian government came to power promising a tougher line on Pakistan.

 

  • Many people in the territory do not want it to be governed by India, preferring instead either independence or union with Pakistan. The population of the Indian-administered state of Jammu and Kashmir is more than 60% Muslim, making it the only state within India where Muslims are in the majority. High unemployment and complaints of heavy-handed tactics by security forces battling street protesters and fighting insurgents have aggravated the problem.

Possible Solutions:

  • Relocation and support for the poorest and most vulnerable from both sides. In November, 2016 – Raja Farooq Haider, the prime minister of Azad Jammu and Kashmir, the Pakistani-controlled part of the disputed region, said the government has so far moved 8,000 people to “safer places” in the wake of on-going “Indian shelling,” and plans are being made to move even more people.In October 2016 India relocated more than 10,000 people from around the disputed border area of Kashmir as tensions continued to escalate with Pakistan.

 

  • China and India both also claim a Tibetan enclave in the east of Jammu and Kashmir called Aksai Chin; they fought a war in 1962 over the area, but have since signed agreements to enforce the current “Line of Actual Control.”

 

  • Further ceasefires/treaties. However the UN has already tried this and has been unsuccessful.

 

  • Carry out the referendum that was suggested by the UN to see what the people want. Although India is reluctant to do this.

 

  • Make a formal boundary-the half that is already occupied by India could be assigned to them and the rest of the area could go to Pakistan. However this is unlikely to hold and each country will almost inevitably encroach further. It is also easier said than done and may even lead to further ethic tensions and just like the partition in 1947-similar consequences may arise e.g. difficult to draw a boundary between villages/towns.

 

  • Others suggest that there is no viable solution and that this battle based purely on religious differences. It is clear that neither country wants Kashmir to become an independent nation, and the future of this long-disputed region is still blurred. Since India, Pakistan, and China all possess nuclear weapons; any hot war over Jammu and Kashmir could have devastating results.

 

Fiscal Facts & Fables

Hello readers,

Welcome back to my blog. I recently discussed monetary policy and the role of interest rates in the economy. In this post I thought I would do some research into fiscal policy and assess some of the different proposals that have been introduced over the years by Osborn and Hammond. For those of you who don’t know, fiscal policy refers to government spending and taxation and such changes are announced in the annual budget. In the 2017 budget which took place last month the main policy we saw being implemented by the chancellor was abolishing stamp duty for first time buyers purchasing homes under £300,000. Although the aim of this was to enable such buyers to gain a foothold in the property market, it is likely that house prices may just increase by the amount that is being saved or by more as a larger number of people will be able to afford a house which they were previously unable to afford, thus increasing demand and pushing up prices. Furthermore, most homes in London are well above this price and there will be no impact to these buyers. Aside from that there were few major changes other than the usual increase to alcohol duties and the implementation of a tax on new diesel cars. More money was inevitably promised to fund the NHS and Hammond has announced that he will be increasing the budget for teaching mathematics across the country as this is vital for long term productivity gains. If you have any questions about the budget or after reading this post, please comment below.

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  1. Phillip Hammond’s Current Fiscal Objectives:

Taxation

  • Chancellor says that £140bn has been raised since 2010 by tackling tax avoidance evasion.
  • Top 1% now pay 29% of all income tax.
  • People’s choices for employment should not be driven by tax implications.
  • Sugar tax set at 18p and 24p.
  • Corporation tax set to fall to 17% by 2020.

Infrastructure

  • £300m of previously announced fund to support “brightest and best research talent”; £200m for local projects to leverage private sector investment in fibre broadband networks; £16m for a 5G hub; £270m for robots.
  • £90m for the north and £23m for the Midlands for “pinchpoints” on the national road network.

Education and skills

  • “While investing in education and skills helps to tackle our productivity gap… it does something else as well: it delivers greater fairness,” Mr Hammond says.
  • Funding for a further 110 new free schools on top of the existing 500, including new specialist maths schools.
  • £216m more investment in the schools estate over the next three years, taking total investment in schools of over £10bn in this Parliament.
  • Loans for part-time undergraduates and doctoral students.
  • Increase by more than 50pc the number of hours of training for technical students aged 16-19 so when they qualify they will be “genuinely work ready”.

Healthcare

  • £2bn of additional grant funding for social care over the next three years, with £1bn available in 2017-18, allowing local authorities to “act now” to commission care packages.
  • £425 million more for NHS development and A&E departments.

2. Current Level of National Debt:

The UK national debt is the total amount of money the British government owes to the private sector and other purchasers of UK gilts. According to the ONS General government gross debt was £1,731.4 billion at the end of December 2016, equivalent to 89.3% of gross domestic product (GDP); an increase of £65.4 billion on December 2015. The UK national debt grows at a rate of £5,170 per second. The truth however is much worse, factoring in all liabilities including state and public sector pensions, the real national debt is closer to £4.8 trillion, some £78,000 for every person in the UK. Although 89% of GDP is high by recent UK standards, it is worth bearing in mind that other countries have a much bigger problem. Japan, for example, has a National debt of 225%, Italy is over 120%. Also, the UK has had much higher national debt in the past, e.g. in the late 1940s, UK debt was over 200% of GDP. Prior to the crash the debt to GDP in 2007 in the UK was 42% and after the recession in 2010 it was 76% of GDP.

3. Current budget deficit (annual borrowing):

The budget deficit is the annual amount the government has to borrow to meet the shortfall between current receipts (tax) and government spending. Net borrowing for the UK 2016/17 is £45bn or 2.3% of GDP. The forecast for 2017-18 is net borrowing of £58bn or 2.9% of GDP.

In 2009/10 at the height of the great recession net borrowing was £152bn or 10% of GDP. This was due to:

  • The financial crisis which led to falling tax revenues, e.g. lower incomes led to less income tax revenue; fewer house sales-led to lower stamp duty.
  • Expansionary fiscal policy including ‘VAT holiday’.
  • Higher spending on unemployment benefits during the recession.
  • Long term spending commitments, e.g. government spending increases in the early 2000s.

4. Role of the OBR:

The Office for Budget Responsibility was created in 2010 to provide independent and authoritative analysis of the UK’s public finances. It is one of a growing number of official independent fiscal watchdogs around the world. They have 5 main roles: Economic and Fiscal forecasting, evaluating performance, sustainability and balance sheet analysis, evaluation of fiscal risks, and scrutinising tax and welfare policy costing.

5. The last time the UK government ran a budget surplus:

In 2000/01, the UK ran a budget surplus of £17bn or 1.7% of GDP.

6. Osborn’s budget in “normal times”:

  • “With our national debt unsustainably high, and with the uncertainty about what the world economy will throw at us in the coming years, we must now fix the roof while the sun is shining,”
  • He was in favour of enforcing austerity in order to ‘balance the books’ and run a budget surplus in “normal times”.
  • However the target was criticised and referred to as ambitious. The savings were to come from a £12bn cut to the welfare bill mainly from cuts to tax credits, housing benefits and a lower welfare cap.
  • The BBC was required to make cuts to its own budget as well as take on the annual £650m bill for providing the over 75s with free TV licenses.
  • He said that this is “A Budget that sets out a plan for Britain for the next five years to keep moving us from a low-wage, high-tax, high-welfare economy; to the higher wage, lower tax, lower welfare country we intend to create”.
  • He pledged to make Britain the richest economy in the world by the 2030s under his plans, suggesting that he would bring in his budget surplus rule once he is nearly finished with his cuts.
  • His idea was: in the good times we stay in surplus – raising more money than we spend and using that to pay down our debts,” Osborne said. “And when the bad times come, the Government will have to set out a clear plan to get back to health.”

7. Taxes in the UK:

According to the Institute for Fiscal Studies (IFS), the proportion of national income that is taxes in the UK is approximately 33% and the total tax receipts in 2017–18 are forecast to be £690 billion. By 2019–20, tax receipts are forecast to be at their highest share of national income (34.4%) since 1981–82. Total government receipts, which include interest, dividends and gross operating surplus, are forecast in 2019–20 to be at their highest level (37.2%). A study by the think-tank the Centre for Cities found that London generated almost as much tax as the next 37 largest cities combined and increased its share of “economy taxes” underpinning the Treasury’s finances to 30%.

In Scandinavian countries Finland, Norway of the Netherlands, taxation make up a larger proportion of national income and these societies are often referred to as being more ‘equal. On the flipside countries such as the UAE or Saudi Arabia who are oil rich, depend less on tax income with many people exempt from paying any income tax at all, as majority of their national income is from oil.

8. Proportion of national income that is government spending:

Government spending as a proportion of national income in the UK is at a similar level to that in Germany but is considerably higher than in Switzerland, Australia and Ireland. Government spending is also somewhat higher in the UK than in Canada, the US and New Zealand. Before the First World War, government spending was about 10 per cent of national income. By 1920, the figure was 20 per cent; and by 1937, it was 30 per cent. Now it is around 46% of national income.

9. Tax system in the UK:

The UK has a progressive tax system. This means that the rate of tax increases as income increases. The US also has a progressive tax system and essentially it reduces the burden on people who can least afford to pay them. These systems leave more money in the pockets of low-wage earners, who are likely to spend all of their money and stimulate the economy. Progressive tax systems also have the ability to collect more taxes than flat taxes or regressive taxes, as tax rates are indexed to increase as income climbs. Progressive taxes allow the people with the greatest amount of resources to fund a greater portion of the services all people and businesses rely on, such as roads, first responders etc. Critics of progressive taxes consider them to be discriminatory against wealthy people or high-income earners.

10. Examples of countries with a proportional or flat rate tax system:

Romania-16%    Russia-13%     Hungary-15      Jamaica-25%

11. Government’s objectives for direct taxation (income) and indirect taxation (VAT):

  • Finance government expenditure & infrastructure
  • Prevent Concentration Of Wealth In A Few Hands- Progressive systems-prevents wealth being concentrated in a few hands of the rich i.e. narrowing the gap between rich and poor.
  • Redistribute Wealth For Common Good- the wealth of the rich is redistributed to the whole community.
  • Promoting economic growth, stability and efficiency-The government controls or expands the economic activities of the country by providing various concessions, rebates and other facilities. The effective tax system can boost the economy. Similarly, taxes can correct for externalities and other forms of market failure (such as monopoly). Import taxes may control imports and therefore help the country’s international balance of payments and protect industries from overseas competition.
  • Reduce Structural Unemployment-The government can reduce the unemployment problem in the country by promoting various employment generating activities. Industries established in remote parts or industries providing more employment are given more facilities.
  • Remove Regional Disparities-Regional disparity has been a chronic problem to the developing countries. Tax is one of the ways through which regional disparities can be minimized. The government provides tax exemptions or concessions for industries established or activities carried out in backward areas. This will help increase economic activities in those areas and ultimately regional disparity reduces to minimum.

12. Reasons for public expenditure:

  • Improve Public Services-Higher government spending can lead to improved public services like health, education and transport. These are important for increasing the quality of life and economic well being.
  • Increase Productive Capacity of Economy-Some types of government spending, can help to overcome market failure. For example, education can help increase labour productivity and reduce structural unemployment; if the education spending is well targeted it can help to increase the long run trend rate of growth. However, not all government spending is guaranteed to actually increase government spending, it may be subject to government failure and inefficiency.
  • Expansionary Fiscal Policy-Increased government Spending without higher taxes is likely to increase AD. It will cause a budget deficit, however, the increased government spending is an injection of spending to the economy and could help to increase the rate of economic growth. Some monetarists argue increased government spending will just cause crowding out, and therefore it will not increase AD.
  • Reduce Inequality-A significant % of government spending is spent on social security. This includes benefits, such as; unemployment benefit, income support, child benefit and housing benefit. The majority of these benefits are means tested; this means they are targeted to those on low incomes. The aim is to reduce relative poverty and inequality.

13. Key Principals of Taxation:

Adam Smith developed his four famous ‘canons’ of taxation:

  • Equity: The amount payable by taxpayers should be equal, by which he meant proportional to income.
  • Ability: The taxpayer should know for certain how much he will have to pay.
  • Convenience: There should be convenience of payment.
  • Economy: Taxes should not be imposed if their cost of collection is excessive.

Other principals include:

  • Adequacy: taxes should be just enough to generate revenue required for provision of essential public services.
  • Broad Basing: taxes should be spread over as wide as possible section of the population, or sectors of economy, to minimize the individual tax burden.

14. UK Current level of:

  • Corporation Tax- 19%
  • VAT- 20%
  • Top Rate of Income Tax- 45% (over £150,000)
  • Tax Free Allowances- up to £11,850 (increase from £11,500-announced in this year’s budget-in line with inflation).

15. Examples of goods exempt from VAT:

Charity shops – selling donated goods, lottery ticket sales, education, water supplied to households, children’s clothes and books.

16. Difference between a cyclical and structural deficit:

Cyclical budget deficit-A cyclical budget deficit takes into account fluctuations in tax revenue and spending due to the economic cycle. For example, in a recession, tax revenues fall and spending on unemployment benefits increases.

Structural deficit-This the level of the deficit even when the economy is at full employment.

17. Examples of how government spending and taxation can influence the pattern of economic activity:

  • In a recession e.g. the 2008/09 crash, consumers may reduce spending leading to an increase in private sector saving. If government spending is increased it may create a multiplier effect e.g. the unemployed gain jobs, they will have more income to spend leading to a further increase in aggregate demand. (e.g. construction workers employed by government increase spending in pubs and transport, causing other sectors of the economy to benefit from the government spending). Some economists would argue increasing government spending through higher taxes would lead to a more inefficient allocation of resources, as governments tend to be less effective in spending money.
  • Increasing taxation perhaps to finance the growing budget deficit would leave consumers with less disposable income and is likely to reduce AD.

18. Factors which could put pressure on public finances over the next 10 years:

  • Healthcare-NHS
  • State Pensions (growing and ageing population)
  • Immigration-increased demand for education, welfare benefits, housing etc. However a ‘Hard Brexit’ i.e. with no free movement of people and a move to a ‘points based system’ may offset this.

Sources Used:

https://www.economicshelp.org/blog/2731/economics/impact-of-increasing-government-spending/

https://www.ifs.org.uk/publications/9178

http://uk.businessinsider.com/budget-2017-live-chancellor-philip-hammond-brexit-tax-borrowing-schools-tech-2017-3

https://www.gov.uk/guidance/rates-of-vat-on-different-goods-and-services

https://www.britannica.com/topic/taxation/Principles-of-taxation

http://www.economicsdiscussion.net/india/public-expenditure/public-expenditure-causes-principles-and-importance/17462

http://www.investopedia.com/terms/p/progressivetax.asp

http://www.telegraph.co.uk/finance/budget/11726259/Budget-2015-George-Osbornes-speech-in-full.html