Fighting the fat

Denmark's 'Fat tax' has been repealed but doctors are pushing for a similar tax in the UK backed up with supporting measures.

For doctors in the UK the big problem is fizzy drinks, which are basically water and sugar. They want a tax which will arise prices by 20%.

Of course the PED of these drinks might be quite inelastic, but with so many potential substitutes, from juice to water, we might be pleasantly surprised by the effectiveness of such a tax. (However you can see the dentists getting ready to warn us against the effect of acid in fruit juice.)

The problem of fatty and high calorie foods is that they are 'imperfect information goods' and impose significant costs on the consumer and negative externalities on society who must treat their weight related diseases.

So using a price rise alone isn't enough. It is necessary to improve knowledge and directly intervene, such as banning advertising of unhealthy foods and closing take-aways near schools.

The problem of obesity is the 'new smoking'. The 1970's saw us begin to tackle the evils of smoking, but today the threat to peoples health from eating too much is just as serious.

It will take a broad range of measures to solve this. Some will cause a movement along the demand curve, but most will attempt to move the demand curve to the left.

The BBC report the proposals here

Practicalities defeat 'Fat tax'

Denmark introduced the worlds first 'Fat Tax' just over a year ago. It was covered in this blog and got one of the highest number of hits of any post to date.

Now Denmark is scrapping the tax. They say its because it has cost jobs, caused people to go into Germany to shop and inflated prices.

Well taxes do raise price! That's the point. This is a disappointing move as it represents a victory political expediency over economic policy.

It would be nice to find out how much the tax changed behaviour, especially in areas a long way from the German border.

If there is an important lesson to learn it is that a country acting alone can disadvantage itself. This has often be said of acting on carbon emissions and pollution. If you impose higher costs on domestic firms in a market with few barriers to international movement then the result maybe that firms move. So perhaps the answer is a European Fat Tax; good luck convincing David Cameron on that one.

The Daily Mail report the story here

Missing the point on Carbon Trading

 Reducing the supply of permits will raise the price and maintain the incentive to cut emissions further

Australians have little grasp of the concept or problems of Carbon emissions and the need to correct this market failure. In the EU the need to reduce CO2 emissions is accepted and is being tackled.

The Age, the Australian daily paper, has got hold of the story that the carbon price in the EU emissions trading scheme has fallen and have interpreted this as a sign that the scheme is somehow failing. It represents the deep misunderstanding of how these schemes work which is prevelant in Australia.

The report that prices have fallen while volumes traded are up 26% in 2012 shows the success of the scheme! It means that firms are reducing carbon emissions and therefore can sell their surplus permits. That is a key incentive provided by carbon trading, those who can reduce CO2 emissions are rewarded by the revenue of the permit sales.

What is required is for the EU to now withdraw, or buy up, surplus permits so that the trading price rises again. The ETS market will then provide a further incentive for firms to cut emissions even more. Here the EU is too slow to act, but this is because it tends to work in 'phases'. It would be better if the EU intervened more actively in the market to stabalize the price of permits both to maintain incentives and provide certainty for firms who need to buy or sell them.

The Age report is here

The price is wrong?

The rise in university tuition fees is supposedly to allow the cost of education to be spread more fairly. The fact that someone has a degree means they can earn more. So the government reason that a student should repay part of the cost of the education which allowed them a higher income.

Most feel that the real reason is to reduce public expenditure, although it does provide universities with a higher net income and this allows them to spend more on their students education.

The problem is that the higher fees put people off from applying to university. They don't understand the full benefits higher education will give them and so see the expenditure as greater than the benefit. This occurs because education is an imperfect information good.

Education is also referred to as a merit good. The market will provide education, but less than the socially optimal amount.

The BBC reports the decline in UCAS applications for the second year running. You can search the blog to find earlier posts on this issue.

The BBC article is here

When regulation is necessary

Governments have tried everything to reduce smoking. 

They have used the best method available to such a market failure - tax and forced the price up to many times the actual cost of production. The problem is that this addictive good has very inelastic demand and so the effect on existing smokers is small.

Two primary methods of moving the demand curve to the left have been tried:

Education has failed. Everyone knows that smoking is bad for them, but they have failed to understand the full extent of the damage they do to themselves yet young smokers continue to take up the habit.

Banning advertising has not worked either.

However all these measures have reduced smoking and it is much less of a problem than it was in the 1960's when almost everyone smoked.

So what can governments do when they are faced with the failure of policy to correct this market failure? Unusually the best answer is more regulation. Normally the best solution to market failure is some sort of tradeable permit, then tax, but not with smoking.

The latest attempt is the banning of distinctive packaging. This has been introduced by Australia where all cigarette packets are now olive green with nasty pictures on them. The idea is to deny brand loyalty and make them unattractive.

Of course the tobacco companies claim its not going to work and even claim it is unfair. But these were the same companies who claimed smoking didn't cause cancer when they had evidence that it did, so lets not take too much notice of them.

The Telegraph report the new scheme here

Poor consumption decisions lead to poor health

Today there is news that in the UK deaths from liver disease has risen by 20%. Is this a surprise? Yes, because in the rest of Europe deaths from the same cause have fallen by 20%!

The cause of liver failure is usuall either drinking too much, being overweight or having a poor diet. Of course hepatitis, which is an infection, can also cause liver failure.

From our point of view this is another example of market failure. It is caused by consumers failing to take into account the full information available about the goods they consume.

There are three different failures identified here, but all have a similar cause. Lack of information, or demerit goods, are over-consumed compared to optimal levels.

In the case of alcohol there is already a high tax, but a minimum price per unit of alcohol will soon be considered by the government in an attempt to reduce binge drinking. As for poor diet and over-eating the question about how to tackle this remains unresolved.

What is certain is that more education will help in all three cases and stories like the one in The Guardian below needs to be taken seriously.

The Guardian story is here

Regulating demerit goods

Merit goods are technically 'lack of information goods', where consumers do not have all the information necessary to make a decision on consumption, or ignore information that is relevant.

Demerit goods, such as tobacco, are similarly lack of information goods. Where they are present in the market an inefficient allocation of resources will occur as consumers maximise perceived private benefits weighted against private costs.

They consume to the point where Marginal Private Benefit equals Marginal Private Cost. With demerit goods Marginal Private Cost understates the true costs of consumption and so the market fails.

One way to correct this is through price. A tax will raise private costs and reduce consumption. But what if the harm done by the good is so great that the optimal level of consumption is zero? Then regulation must be used to ban the good or service.

In Australia it has long been recognised that ultraviolet radiation causes skin cancer. It appears that sunbeds cause a much greater amount of harm than natural sunlight, but consumers do not consider the full information on harmful effects and continue to use sunbeds.  Therefore Australian governments are starting the process of banning sunbeds.

As with all policy choices there are costs of acting. There is no guarantee that it will work for a while as second hand sun beds are traded and who knows if there will be a trade in illegal sunbeds from states that do not act? Of course zero may not be the optimal level of consumption of sunbeds, for example some people suffer from a lack of vitamin D and need them to correct this. All regulation is a guess and can be a sledgehammer to crack a walnut.

The Age report on progress in Victoria to ban sunbeds here

The Living Wage

Earlier this week there was a concerted effort to persuade employers to pay the 'Living Wage' as opposed to the legal minimum wage. It had support from both Boris Johnson (Conservative) and Ed Millipead (Labour) showing that this is more than a partisan measure.

In the late 1990's a minimum wage was introduced to protect the lowest paid. It set the floor price in the labour market.

The arguments for the minimum wage was that the relative bargaining power of some workers was too weak to obtain a fair wage. Therefore government would ensure they received one and so reduce in-work poverty.

The argument against the minimum wage was that it would cause wage costs to rise too far and firms would simply reduce employed numbers as workers became too expensive.

In the event there is little (if any) evidence that workers lost their jobs due to the minimum wage. It certainly meant that some workers got pay rises that allowed them a better standard of living.

However the minimum wage was introduced at a much lower level than some wanted. They argued that the minimum wage level set was still too low to allow families a reasonable standard of living. The result was the calculation of a 'Living wage'. This could be defined as:

A living wage is the minimum income necessary for a worker to meet basic needs (for an extended period of time or for a lifetime). These needs include shelter (housing) and other incidentals such as clothing and nutrition.

There are two articles linked below. One is the Daily Mirror's coverage of this weeks story. The other is the Living Wage Foundations explanation of what it means and its advantages.

Of course there is an argument against it. If wage costs rise then workers become more expensive and some may lose their jobs. So higher wages for some are paid for by no wages for others.

The economics of the Living Wage is partly about setting price floors in markets. It is also about what should be done.

The Daily Mirror article is here

The Living Wage Foundation page is here

When adjusting prices does not work

Markets do not always allocate resources efficiently. One such market failure is in the area of demerit goods such as tobacco.

Demerit goods are more accurately described as 'lack of information goods'. Consumers do not fully appreciate the costs and benefits of consumption and so the demand curve for the product is further to the right than it would be to achieve an efficient allocation of resources.

The usual response to this type of market failure is to tax the good. This raises the price and so reduces consumption. However sometimes this does not work to the extent desired. For example with tobacco consumers are addicted and the PED is very inelastic. Educating the population on the dangers is therefore another option and that can include graphic pictures of the harm that tobacco does.

One area of great concern is the diet of the nation. We eat too much overall and or diets include too much fat and salt. This is very concerning because of the health impacts which will shorten life expectancy and impose heavy costs on the NHS.

Taxing fat and salt is difficult, mainly because of the very many products involved. In addition any tax on food would be highly regressive as food takes up a higher proportion of the income of poor households. So far education has not been that effective. Therefore resorting to warning people at the point of sale and trying to get them to more fully consider the information about the product may help.

People know that fat is bad for them in too great a quantity (as are too may calories, salt etc). What they don't know is how much of each is in modern processed food. For some time there has been a call for a uniform method of labelling food to show the content. Each retailer and manufacturer disagreed on the format (some prefer traffic lights others % of daily maximums etc).

Now there is agreement on a uniform system that combines all of the approaches. The move has to be accompanied with education which allows people to understand the dangers of exceeding the recommended daily amounts. But if successful then the demand for high fat and salt goods will shift to the left.

Unfortunately this is only going to be a voluntary scheme so it falls short of 'Regulation'. It is, however, a good example of where adjusting prices is not enough and an example of an alternative policy to reduce market failure. But will it work?

The BBC covers the story here

Nobel prize - solutions to market failure

This year the Nobel Prize in Economics has been awarded to two people who have worked on solutions to allocations of resources when prices don't work.

Market failure is common. Scarce resources are then not allocated efficiently and this reduces overall welfare.

Sometimes prices can be adjusted to compensate, perhaps by taxing or subsidising the good or service. When that can't be done other solutions may not be obvious except for some sort of rationing system.

Lloyd Shapely, a mathematician, helped develop early game theory and also produced a paper on matching demand and supply when there are ethical or legal complications. Alvin Roth developed a method to allocate resources from this work, such as organs for transplant.

These two men are unusual winners of the prize, but perhaps appropriately they are applying economics to the real world and it is helping save lives. Given the bad press Economics got thanks to the banks this is good exposure for the discipline.

The prize in Economics is still worth  $1.2 million, and is shared by the two men. Shapely is 89 and could probably have done with the prize a little earlier!

The Guardian reports the prize here

The effectiveness of taxing externalities

Australia introduced a carbon tax of $23 a tonne on July 1st. The aim was to help Australia reduce carbon emissions and meet its 5% reduction target by 2020 (UK target is 50% by 2020 and  80% by 2050 - just saying).

The point of a tax is to raise the price and reduce consumption. By getting people to change the pattern of their expenditure toward the relatively cheaper, lower carbon, goods and services Australian carbon emissions will fall.

By far the biggest contributor to Australian carbon emissions is electricity generation. Australia uses a lot of very dirty coal (especially in Victoria) which has been likened to environmental terrorism. The first data available shows us that there has been a significant change in the use of electricity.

One reason is that there has been quite a take up in solar showers. This reduces an important fraction of daily electricity use, as long as the weather is reasonable of course. So less electricity needs to be generated.

The other effect in the market is the move away from coal by the generators. This is exactly why the carbon tax was introduced.

The Age gives details of the change in power generation.

Incomplete analysis can lead to errors

In a time when the Department for Transport have admitted their analysis of Rail Franchise bids is flawed we are reminded that a faulty method can lead to poor decisions.

One of the most difficult decisions to be made is what transport infrastructure to invest in. There are very many factors to consider, such as forecasts of future demand and external costs and benefits. All of these are difficult to value.

The solution is a full Cost-Benefit Analysis that considers all the private and external costs and values them properly. Only then can a judgement be made and even so substantial margins of error must be considered.

So should we give much credibility to a study by MIT that a third runway at Heathrow is a bad idea?

The MIT study says that, compared to a new Thames Estuary airport (Boris Island), a third runway at Heathrow would cause more early deaths due to pollution. So that's it then, decision made.

However when questioned the authors admitted they had not included any of the following issues in their study:

* The cost of construction at either site
* The impact on local transport at either site
* The impact of extra road traffic too and from any new airport
* The external costs and benefits of either airport

Of course their defence was that they were only looking at health impacts of the two options and that is actually quite reasonable. It represents a contribution to the full cost-benefit analysis and a valuable one at that.

The Guardian reports the study here

Lack of information goods - Pensions

A market can only work efficiently if both sides of the market (buyers and sellers) have all the information they need. Therefore a common market failure is where one side of the market has insufficient information or places too little value on that information.

Pensions are an excellent example. Many people do not save enough for retirement because they do not fully understand the benefits. This makes them look on pensions as too expensive and they decide not to 'consume' that service.

The problem with pensions is that the benefits are a long way into the future when you are in your 20's. When you realise that you need a pension it is too late to build up one you are satisfied with.

So the solution is to make pensions more attractive. Until now the government has given a tax incentive to those contributing to pension schemes. All contributions are 'tax free' saving 20% of the cost and up to 40% for higher rate tax payers.

Despite this generous incentive the number of people in private pension schemes has dropped below 3 million for the first time. (There are around 5 million in public sector schemes.) With 29 million people in work this means around 21 million workers in the UK have no private pension.

Of course the state will pay everyone an old age pension and there is a state earnings related pension, but this may not be enough to let people live comfortably. If that happens the government will end up paying out more benefits in other forms and with an ageing population they can't afford that.

So a new scheme is being introduced. All employers will have to offer a workplace pension and all workers will have to opt out of their workplace schemes. It is hoped that the effort of having to do so will mean many people will get a private pension by default.

This is an example of regulation and looks like being more successful than the market solution of tax rebates (although that remains too).

The Independent reports the scheme here

Pricing carbon causes a change in behaviour

Australia has ever so reluctantly introduced a carbon tax that will take effect from Sunday. Many there question the need to even take action, while in the EU we have been trying to make a difference since the early 1990's.

It is interesting to see the effect of a 'first move' in a tax regime. Taxes rely on changing prices to affect consumer and firms behaviour. If the price goes up then the nature of demand says that less will be bought.

Therefore the Australian carbon tax charges large firms for the carbon they use (Carbon dioxide emitted really) and they must recover this cost by raising prices.

How much prices go up and how much less of the high carbon goods are consumed is the interesting question. Economists have a way of estimating this, its called 'elasticity of demand' but it is not easy to tell exactly.

The Age reports that many firms have now prepared 'carbon-reduction plans' to avoid the Australian carbon tax. That is exactly the response they wanted - a case where tax avoidence is to be applauded.

The Age reports the story here

Scotland's 50p per unit minimum alcohol price

Alcohol is an imperfect information good. Those who consume it don't take fully into consideration the complete costs of drinking it on themselves, or on others. There are clear negative externalities, such as the cost to the NHS of treating alcohol related disease. Drinkers also overestimate the private benefits to themselves.

Overall then the market consumes more alcohol than is optimal.

Scotland has decided that they will impose a minimum of 50p per unit of alcohol to try to address the problem of people abusing alcohol. This means that a drink that contains two units of alcohol (say a pint of lager) cannot be sold for less than £1. Of course there is no effect if the price is already over a pound.

The effect of this minimum price therefore depends on the current price. Setting a minimum price below the market equilibrium has no effect at all, while setting a price above equilibrium will reduce demand. Of course it can also raise the willingness to supply!

The aim of this policy is to overcome the 'cheap alcohol' available in supermarkets (such as ownbrands) and 'happy hours'. These promote heavier drinking and, as some people know, this is habit forming!

The real question is will it be effective? Alcohol is already heavily taxed, restricted by age limits and only available from licenced premises. There is also a concerted effort to educate people about the true effects of drinking (although this is far less than the effort made on smoking). So far these have failed to eliminate the problem.

The PED of alcohol is likely to be inelastic. Therefore the effect on current drinkers will be small, but maybe it will stop some people from starting to drink. Therefore the pay-off will come in the long-term. What is clear is that dealing with imperfect information goods needs a set of complementary measures which reinforce each other.

The Guardian has details here

Imperfect information - the case of payday lenders

In recent years there has been a boom in the business of lending people small amounts for short periods. These have become known as 'payday lenders'.

They specialise in allowing people to meet their bills between today and the next time they are paid. It seems an easy way to manage personal cash flow. Added to this the small loans are easy to arrange and the borrower can choose the term of the loan.

So what is the problem? Do the borrowers actually fully understand what they are doing? The interest rates are potentially 16,000% (although that is very unusual) and always much higher than borrowing from a bank or even a cash advance on a credit card.

The industry is, according to many, under-regulated. Are people being properly informed about what they are buying? This lack of information market failure can lead to disastrous consequences where consumers make bad choices, in this case buying more services than are optimal. The financial services industry has many other examples of this, such as payment protection insurance and endowment policies.

The attached article makes the concerns of many clear. People may well start taking out loans each month or week out of habit and believe they are managing their finances. In fact they will be compounding mismanagement of their finances and in the end they will reach the limit of their ability to borrow but with higher and more expensive debt.

Another worry is that this is just another example of 'sub-prime lending'. This was the cause of the credit crunch when banks extended mortgages to those who were in weak and unreliable financial circumstances. Maybe the lenders think this is safer, lower amounts and faster repayments so default on the scale of 2007/8 is impossible? But where is the moral justification for this? Lending to people not able to fully understand their product and endorsing behaviour that is unsustainable.

This does need sorting!

The Guardian covers the story here

Carbon emissions and national income

Many variables move with national income (some in the opposite direction of course). One of them is carbon emissions.

During the recession industrial production fell and households took fewer holidays. Carbon emissions fell and our progress towards the carbon reduction targets looked good. Now it appears that the recovery is reversing the trend and carbon emissions are rising.

In a week where 100 idiot Conservative backbenchers called for the cutting of subsidies for renewable energy it is important to remember why these industries need help.

Carbon emissions are a market failure. The market does not price emissions as there is no charge for putting them into the atmosphere and so firms don't consider the cost of those emissions. The result is that more carbon is dumped in the atmosphere than is optimal.

There is a way to stop this. We tax firms on their carbon emissions or issue tradeable permits. This isn't always popular and does not do enough in a highly inelastic market to reduce demand. So directly subsidising renewable energy, which cannot compete on price with coal, oil or gas will allow low carbon energy production.

It is a case of attacking the problem from two directions. Another way, as an article linked to the one below points out, is to insulate homes properly. A staggering 10 million homes have no or inadequate loft insulation and almost as many don't have cavity wall insulation. Subsidising insulation (and it is already) can shift the demand for energy to the left and will help in a third way.

The Guardian article is here

Climate change action needs growth

Climate change is, in my view, a far more important problem than economic recovery. While a second financial crisis might see us moving back to the Stone Age it remains unlikely, but climate change is a certainty and threatens the very survival of the species.

The inaction on climate change globally is therefore quite staggering (although the EU is far ahead of the rest of the world on this). In other countries, such as the US and Australia 'climate change deniers' hold sway and even get some support in the UK as the picture above shows.

In the Guardian Max Boykoff reviews the current situation and explains that before we can get serious and effective action on climate change we need economic growth. The irony of course is that it is economic growth that caused the climate change in the first place. However for politicians to be prepared to commit resources to tackling climate change they need the population to feel well enough off to afford it, otherwise they vote for the guy who promises tax cuts.

Boykoff's article is here

Regulating market failure

Market failure occurs in many ways. One of the less well covered is the 'Tragedy of the commons'.

Nobody used to own the fish in the sea and so fishermen could catch them without paying for them. This led to chronic overfishing and so declining fish stocks. This is really a case of 'lack of information' and failing to take account of externalities. The fishermen maximise profits according to their private costs which do not include any cost of fish themselves.

The way to regulate this is not easy. With the Commons on land the answer was to enclose them and confer property rights on individuals. The farmers then consider the full costs of the land (well nearly, most ignore the effects of intensive farming on the environment) and farm it sensibly.

It was not possible to confer private property rights on the sea, but in the last forty years EU governments have established government control of the sea for 200 nautical miles offshore.

The solution taken by the EU to the problem of fish stocks is quotas. Each fishing boat is allowed to catch so much a year and can only fish for so many days each month. In this way fewer fish are taken and stocks should recover. Of course the fishermen earn less and some leave the industry. Others are compensated by the higher fish price as supply in the markets fall.

So that's easy then! Problem solved?  Except fish stocks have not recovered. Every year they seem to decline, or at least not improve. Every year the fishermen complain they will never survive and need higher quotas (obviously stupid as fish will then run out and they all lose their livelihood). And each year each EU government tries to negotiate their fisherman's quota higher.

Overall this is an example of an attempt to correct market failure that has turned into a classic example of government failure. It does have some sense. Hayek would applaud it for using the rule of law to enforce a solution that attempts to be fair. Others would point out that the lower quotas raise fish prices and so use the market to reallocate resources more fairly.

However the obvious point is that after 40 years of fishing quotas the policy has not worked. This is because the quotas chosen were wrong (due to imperfect information, 'accidental' fishing AND cheating). The other obvious solution is to offer tradeable fishing permits to operators of vessels. Price the fish accordingly and the fishermen won't try to overfish. A tax is another possible solution, but much more expensive to administer (as each catch must be weighted and taxed, permits could apply to boat capacity per day).

The annual quota negotiation has just finished. The BBC cover the story below.

The BBC covers the story here

Discrimination is not always conscious

The difference between the pay and job opportunities for different groups in society is not easy to explain. Despite legislation dating back to 1970 and numerous Act's since men are still payed more than women, whites more than black and those from the middle class get more than those from working class. The difference in unemployment rates are similar.

One way to overcome this is to allow free access to higher education and select those who can access this opportunity on the basis of academic ability and not the ability to pay. Then at least everyone has the chance to present qualifications to potential employers that makes their worth clear, regardless of race, gender or background.

The first indications of university applications this year, with the new higher fees, show a substantial drop. This is probably inevitable (straightforward law of demand), but has wider issues.

The drop in applications from women is roughly double that of men. This may reflect the, very old fashioned view, that education benefits women less than men as women will become 'homemakers' and so it is not worth spending as much on them. While this seems strange to us it was the received view up to the 1960's.

But the damage that will be done to Britain's long term productive capacity and competitive position, by a less well educated workforce, is the most worrying aspect of this data. In a knowledge based economy, as Britain's future economy must be, this move is akin to cutting off an arm in an attempt to lose weight. Effective in reducing short-term expenditure, but plain stupid as a strategy.

The problem of education is that it is an imperfect information good, people don't understand how good education is for them and how much their education benefits society as a whole. Education is a merit good therefore, the market will never provide the socially optimal amount and it needs to be encouraged by the government.

Notice in The Independent report below that overseas applications are up. Britain is a relatively cheap place to study in international terms and this has been enhanced by the fall in the value of the pound over the last two or three years.

The Independent story is here