Meddling in markets

For some reason governments can't help interfering in agricultural markets. And most of the time they make things worse, an example of government failure.

Thailand are the latest government to distort a food market. They are offering a premium of about 50% to rice farmers to buy up rice in unlimited amounts. The claimed motive for this policy is to raise the income of farmers who are amongst the lowest paid in the country.

But such policies, however well intentioned, distort the market. This effectively raises the price in the local market, (see the diagram above) but will inevitably lead a situation of excess supply in Thailand and a distortion of the international market.

As a major rice exporter changes to the local market will inevitably lead to changes in the international price. Why would a Thai farmer sell on the open market when the government will pay more? So the supply of Thai rice to the international market will fall, forcing up the world price and causing problems for the poor of other nations.

There is also the question of what to do with the rice the government buys. Some schemes stockpile food in years of surplus to release in lean years. Doing so helps moderate price fluctuations and smooth out farm incomes. However the Thai floods mean production is actually down this year so its not the time to start buying up stocks.

The EU pursued a disastrous agricultural policy from the 1950's to the mid 2000's where they paid farmers far to high a price for food. This caused an inefficient over production in Europe and reduced the incomes of farmers in LDC's where the market would produce the food most cheaply and efficiently. The solution for the EU was to move to direct income payments, simply giving money to the farmers and so avoiding the incentive to them to produce ever more unwanted food.

Businessweek report the Thai policy here

Costs and benefits of a Heathrow-Gatwick rail link

There is a proposal to link Heathrow and Gatwick airports by a high-speed rail link. This suggestion will require a thorough cost-benefit analysis (CBA).

The idea is to help improve airport capacity and avoid building new runways or new airports to achieve that. While I am not really clear how much capacity it could add the costs and benefits are worth investigating.

A CBA identifies all the costs and benefits of a project, both private and external, gives them a monetary value and then decides if the investment is worth the cost. Perhaps the strongest advantage of CBA is that it allows comparison of projects. So in this case the Heathrow-Gatwick rail link can be compared to expanding Gatwick, or Heathrow or building a new airport somewhere.

For those doing transport economics this year it represents an excellent opportunity to apply CBA. Also it is not too late for this to be included in the June Transport paper, and is a certainty for 2013 otherwise.

The Telegraph reports the scheme here

Petrol consumption falls 15%

The AA has reported that petroll consumption was 15% lower in the period January to June this year. The AA say this is due to rising fuel prices.

AA President Edmund King said: "There is no downplaying the impact of record fuel prices on family's and other people's lives. A 1.7bn litre drop in petrol sales says just one thing - too many car owners cannot afford these record prices."

On an annual basis prices have risen about 20% for the period in question. So does this mean that the rise in price by 20% has led to a 15% fall in quantity? That would imply a price elasticity of demand (PED) of -1.3.

In this case simple PED cannot be applied. While quantity demanded has fallen 15% this is not just due to the rising fuel prices. Ceteris paribus does not apply because at least two vital factors have also changed:

1. Real  disposable income has fallen in the period due to high inflation, rising taxes and falling actual incomes due to higher unemployment.

2. Consumer confidence has fallen leading to a change in tastes and preferences.

Both of these changes mean the demand curve for fuel has shifted to the left meaning that less is demanded at all prices.

So the change in the amount of fuel consumed is a good example of how in the real world more than one factor can change at once. However we can understand the change as a combination of a move 'up' the demand curve as price rises and a movement of the demand curve to the left as some conditions of demand change.

The BBC report the AA findings here

Monetary boost to avoid inflation being too low

The Bank of England Monetary Policy Committee kept interest rates on hold today. No surprise there, nor in the announcement that that there would be more quantitative easing (QE).

The aim of the MPC is to keep inflation at 2% on the CPI measure. But they can't work in the short term, inflation is a complicated process and monetary policy takes up to two years to take effect, so the MPC must aim to keep inflation on target in two years time.

At the moment inflation is well above target and will go up rather than down in the next few months. So why not try to contain inflation? Well the horse is several fields away on that one and so the MPC look past he current inflation figures as they cannot affect them. They see the VAT rise dropping out of the index in January, weak economic growth around the world reducing export growth and domestic inflationary pressures being contained. They believe that without action inflation will drop below 2% in the final quarter of 2013.

So the MPC will boost the liquidity of the financial sector by pumping £75bn of new money into the economy. This will stimulate lending and demand and hopefully assist growth in aggregate demand.

The BBC have helpfully restored their Q&A on Quantitative Easing, explaining how it works, why it is used and why its not going to cause runaway inflation such as the German and Zimbabwe hyper-inflations. The BBC Q&A will answer the questions of Deps on what this measure means, but everyone should read the reports of this move carefully.

The BBC Q&A on QE is here

UK economic growth cut to 0.1% for April to June

These figures released yesterday have led to the usual argument over potential policies. These are the usual demand management options. The calls are coming for the government to increase spending and for the Bank of England to adopt QE. It is important to remember the source for the financial downturn which is greatly influenced by the poor economic performance in Europe.

Guardian Article Here

Is 15p enough (a tough balancing act)?

The National Minimum Wage (NMW) has risen by 15 pence per hour to give a pay rise for Britain's lowest paid workers.

With RPI inflation running at 5.2 per cent (CPI at 4.5%) the real income of these workers will fall. Inflation is high due to this year's VAT increase, increasing fuel prices and any number of other significant price pressures.  This years increase in the NMW won't allow Britain's lowest paid workers to maintain their standard of living.

However, before rushing to any judgement on this apparently about the small increase, consider that the Low Pay Commission (LPC) (which oversees increases in the minimum wage) had a truly tricky job on its hands. Given the poor GDP growth forecasts and rising unemployment, they couldn't risk making a tough labour market worse.

Therefore the key conflicting issues the LPC need to consider are:
What increase do we require to maintain the lowest income earners' standard of living?
and
What level would an increase in pay cost jobs in this economic climate?

Retailers take the view the NMW will cost jobs here

When is a single market not a single market?

Barriers to entry in a market allow firms some monopoly power and that gives them the chance to raise prices. produce at lower quality and earn excess profits. This is not good for the consumer and most countries attempt to prevent it through Competition Law. As the European Union is a 'single market' that means Competition Law is a European and not a national matter unless a firm operates only in one country.

The '1993' rules of the EU make it clear there can be no barriers to firms, workers or capital between member nations. All firms are free to operate in any other member state and all citizens of the EU can work where they like within the EU.

To illustrate this before 1993 a computer manufacturer had to produce 11 different models of the same computer to meet local regulations and a British lawyer could not appear in a court in Germany or Italy. The 1993 regulations said that such barriers were illegal.

However in many countries not all of these regulations were adopted. The Spanish banks continue to charge non-Spanish customers a higher interest rate, insurance companies are denied access to the Irish market and domestic broadcasters deny the right of foreign broadcasters to sell their services in the UK.

Yesterday the European Court ruled that the Premier League had no right to deny broadcasters other than Sky and ESPN to sell access to their broadcasts of football matches. To do so breached the 1993 EU regulations and EU competition law.

This is an example of the law removing a barrier to entry in the market. The result will be that more firms will enter the British market, competition will increase and everyone will have cheaper access to broadcasts. (Although the ruling is complicated and will take some time to work through.)

The actual case involves showing Premier League football in a Portsmouth pub. Of course Sky and the Premier League will protest, it will affect their profits, but the winner is the consumer. Just 38 years after Britain joined the European Union it is about to get one of the benefits it was promised!

 The BBC covers the story here

Dealing with a different sort of recession

Political debate usually generates more heat than light. That is one of the basic rules of life and the political debate over policy to deal with the recession illustrates this well. So we have to try and look through the politics of the latest announcement.

The last recession was caused by a collapse in financial markets which, by various means, led to a collapse in Aggregate Demand. A prudent response by most governments was to pursue an expansionary fiscal and monetary policy. This was to deal with the immediate effects of the crisis.

The debate now rages on how to continue to cope with the crisis, especially now that a 'double-dip' recession seems a possibility. Sadly at least one group in this debate have missed the point.

The Keynesians have, as usual, crawled out from under their stones and claimed they have the answer. 'Boost Aggregate Demand by the government spending more money', which they borrow. But Keynes was talking about a recession caused by a failure in the goods market in the General Theory, not one caused in the financial markets. (Read the General Theory if you like, it's pretty obvious. There is a copy at the back of Mr Lewis's room and online).

The time for old fashioned demand management has passed. It is necessary to deal with the financial market problems, such as the European Debt Crisis and Bank re-capitalisation. But this has led to a drying up of funds available for lending to businesses and this is preventing a timely recovery in the private sector.

Despite encouragement banks find they cannot both re-capitalise their balance sheets (so they can survive a second GFC or major default by Euro area countries) and lend to small and medium size businesses. This prevents those businesses expanding and reducing the unemployment problem.

Small and medium size businesses basically have two sources of capital, loans and retained profit. Unlike in the USA (where such bonds are a major source of funding) they cannot easily issue 'corporate bonds' as there is no established market for them.

So now the Chancellor is proposing to help develop this additional source of funding by offering to buy bonds issued by smaller firms. It is an unusual, and potentially far sighted, move to help recovery. It is, however, fraught with difficulties.

As the market for small firm bonds is currently tiny it is likely the costs of operating in this market will be high. It will also take time to establish and the firms that can benefit will find it is some time before they are ready to issue bonds. However they now have a guaranteed buyer in the government and so they can raise money with certainty and, presumably, at a lower cost than any alternative. The government hopes it will allow the development of a small/medium firm bond market that will persist in the future.

The measure is being called a credit easing plan. It directly addresses an issue caused by a financial market induced recession and so should be applauded. I would call it a 'supply side' measure as it is trying to help a market work, is specifically targeted at an issue, will allow the expansion of productive capacity and will take a long time to work.

Time will tell how effective it is.

The Guardian reports the measure here

Fat tax for Denmark - where next?

Denmark has just introduced a 'Fat Tax'. The aim is to raise the price of foods with a high saturated fat content.

The problem for markets is that they don't work properly when one side of the market does not have, or ignores, full information. A classic case is tobacco. Despite the known dangers of smoking people continue to smoke, imposing costs on themselves and others (negative externalities).

As with somoking a high fat diet imposes long term health problems on those who eat the food and costs on the rest of society as the cost of treating those health problems falls on the rest of the population through the NHS.

Traditional policies to tackle these 'lack of information' or 'demerit goods' include education, labeling of the products and, usually, tax. By raising the price of tobacco fewer people buy it. That's the law of demand. (Education and labeling shift the demand curve to the left, so the policies are complementary.)

Denmark has now taken the first step in introducing a tax on high fat goods. Any product with more than 2.5% saturated fat attracts the tax. How effective it will be remains to be seen. When tobacco was taxed at first demand was very inelastic (did not respond to the change in price very much) as people were addicted to smoking. Maybe there are more substitutes for high fat foods than there are to tobacco and so this will see a bigger response?

The Guardian reports the Danish tax here

Retirement age abolished

Supply side policies are far more important than managing aggregate demand when it comes to sustaining economic growth and achieving long term prosperity. Hence the focus of policy in the early 1980's (under the benign leadership of the Blessed Margaret) moved to improve the capacity of the UK economy. Despite the recent emphasis on maintaining aggregate demand that is just a short-term 'make-do and mend'.

The aging population means that there are two pressing factors to be dealt with. One is to ensure that the workforce is big enough to support a growing dependent (old) population. The second is how to pay the benefits and pensions the old will require without running an ever larger budget deficit.

One solution is to let everyone work longer. They get benefits later and pay more tax while they continue to work. The effect is that the Aggregate Supply curve (technically the Long-run AS curve) shifts to the right. It has positive effects on growth, employment and inflation.

The BBC explains that some firms may offer 'golden goodbyes' to get rid of staff they can't make retire. Personally I am open to offers now.

You may not have noticed but the National Minimum Wage also rose today. This is also a supply side policy, although unusually one that restricts markets rather than freeing them up. The NMW rose to £6.08 an hour for those over 21, that's 15p an hour more than before. For 16 and 17 year olds the rate is now £3.68 an hour.

The effect of a minimum wage depends on if the market would have set a lower or higher wage than the government minimum.  It can reduce employment if set too high, but can reduce poverty when firms would have set a lower wage, but can afford a higher one.

The BBC cover the retirement age abolition here