So much for competition

The way markets are structured is critical to delivering an efficient allocation of resources. During the 1980's the movement to increase competition in markets in order to drive prices down and consumer service up was the basis of the privatisation and deregulation programme.

The idea is essentially that monopolies can exploit their customers and the more firms in the market the better it is for keeping costs and prices down.

In some markets economies of scale means you can't efficiently have hundreds of firms. One such market is energy supply, but you could certainly have up to 15 or 20. But when you have oligopoly market structures there is a tendency to collude and so some regulation to ensure fairness and maintain competition is needed.

So the energy market, dominated by six big suppliers, is one that might fall into a situation where they each decide not to compete too hard for business and all keep prices quite high.

Many people have been disappointed by recent high energy prices, some believe that the firms are keeping prices high when they need not. Others think that pricing is unfair with some people getting good deals while others (without Internet or able to pay by direct debit) pay too much.

So the government are introducing a new regime where there will be fewer price plans and customers will have to be put on the lowest available tariff.

This seems to be abandoning the idea of competition as a way of making sure resources are allocated efficiently.

The fear is that this will eliminate competition. The big firms will set similar but higher prices and while some people will be better off the good deals will disappear. The danger is that the government has just done the firms collusion for them and will prevent prices being forced down in the market.

The BBC survey the change here and make some excellent points

Economic nationalism is still there

Virtually any economist will tell you that free trade is the best thing for the welfare of all. Some will tell you that it has to be be free and 'fair' trade.

What is certainly true is that consumers benefit from the lower prices due to competition caused by free trade. European consumers have certainly benefited massively from cheaper goods made in China in recent years.

Of course there are losers as well as winners in this process. Many of those who made goods now supplied by the Chinese have lost their jobs and some firms have closed down. The knowledge that these resources are now released to be used in more profitable areas of the EU economy is of little consolation to the unemployed.

Governments are not good at practising what they preach. While a government claims to support free trade they are nervous about the votes of those adversely affected in the declining industries. They act to protect them and slow the transition, or even stop it.

One way of defying free trade is to claim a competitor is 'dumping' goods on the market. That technically means they are selling the goods at a price below the cost of production. The motives for a country doing this would be to raise domestic employment or to destroy the industry of another country in order to then monopolise that market.

The EU has just announced a tax (called a tariff or duty) on Chinese ceramics. Around half the cups, plates etc sold in the UK are made in China. The duty can be as much as 58.8%!

The EU is allowed to do this as an interim measure while the matter is investigated. The World Trade Organisation (WTO) can intervene but that takes a couple of years. Sadly the EU is quick to suspect dumping, usually due to complaints from EU firms and it is rarely true. The Chinese, in this case, are simply cheaper.

The attached article reveals a surprising number of cases where the EU has acted to restrict trade. In this case there seems to be more opposition that support for the move within the EU itself.

The Yahoo article is here

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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

Unemployment down - at least in some ways

The debate on whether the recovery is going to be sustained will go on for a long time. Yesterday there was some good news on unemployment, although not consistently, and a warning from the Bank of England that the recovery will be slower than they previously expected.

The unemployment figures on the ILO measure fell by 49,000, largely due to a fall in youth unemployment. This really is good news as it means that the jobs market at the bottom end may be recruiting again. If school and university leavers had to endure another year of poor recruitment then then problems of long term, but young unemployed would present a massive policy problem for a decade at least.

Unusually the claimant count measure of unemployment rose. This difference is unusual because it is harder to get Job Seekers Allowance than it is to say you are unemployed according to the ILO definition. However we should wait for more data before reading too much into this.

Meanwhile the Bank of England said that the growth of the economy will be much slower than they thought in their last report, just three months ago. They now think the economy will return to 2008 levels of output in 2015 and not 2013. That is really quite a big difference.

The bank expects recovery to be uneven and does not rule out future declines in output in some quarters. The Euro area recovery is key. If Europe does not recover, and today it was announced that the Euro area slipped back into recession, then Britain will suffer too.

The BBC review the unemployment figures and comment of future prospects here

Inflation makes a surprise upward move

Lots of people are expressing their surprise at the rise in inflation to 2.7% (from 2.2% last month).  I'm not sure we really should be that surprised or that worried.

Inflation is the CONTINUOUS RISE in the general price level, reducing the purchasing power of real incomes. This rise is due to three main factors:

1. A rise in university tuition fees.
2. A rise in food prices due to the poor weather
3. A rise in energy bills

The Bank of England is supposed to keep inflation at 2%, but are allowed a 1% margin before they have to apologise. Should they really be concerned with this rise?

Well 2.2% was a 34 month low for inflation and so things seemed to be coming back under control, so this will be a blow to the men from Threadneedle Street. But the first two factors that caused inflation must be seen as 'one-off' influences. Tuition fees will not rise as much next year (from £3k to £9k this year) and it is unlikely that the awful weather of this year will be repeated next year.

So both the first two influences will drop out of the index next year. As for energy bills this market is known to be volatile and so there is little that can really be read into the price rise in terms of future inflation.

Also inflation is really concerning when it affects everybody. Tuition fees affect only a small proportion of the population, but the current massive rise makes the index jump significantly despite the small weight it is given in the basket.

So the Bank of England will almost certainly carry on looking at underlying inflation when setting interest rates and not the headline figure. Overall demand remains weak and while there are encouraging signs of recovery it is unlikely that interest rates will rise until well into next year even so.

The Daily Telegraph has a good explanation of inflation trends here

Transfer pricing - legal but is it right?

Today a Parliamentary Select Committee questioned senior executives of Amazon.co.uk, Starbucks and Google as to why their companies pay virtually no corporation (profit)tax.

The firms concerned are able to minimise the profit tax they pay by declaring profits in countries with lower tax rates. It works like this:

Suppose Amazon sells a book in the UK for £20. The book cost £10 from the publisher giving a gross profit of £10. Amazon incurs other costs of £5 running their business in the UK meaning they have made £5 net profit.

So Amazon pay corporation tax on £5 profit? Well that could happen but not if they do it like this:

Amazon UK sells a book in the UK for £20. The book cost £15 from Amazon Luxembourg giving a gross profit of £5. Amazon UK incurs other costs of £5 running their business in the UK meaning they have made no net profit.

Amazon Luxembourg bought the book from the publisher and made £5 profit in Luxembourg which has a lower rate of corporation tax.

Amazon do pay tax where they declare the profit. But by selling goods between subsidiaries they can make the profit appear where they want it to; in the countries that tax least.

This is all totally legal. Amazon, Starbucks and Google are multinational companies and are able to do this, but a firm operating only in the UK can't. Some feel that this is unfair as in my example Amazon UK really made the money by its UK operations and they should pay tax on their real profits here.

As the companies made clear to the committee, they do pay tax. Millions of pounds in payroll taxes such as employers National Insurance Contributions, local Business Rates and VAT. However in these days of poor public finances many will have little sympathy with them.

A Guardian article explaining Amazons actual operation here

Who won the banana war?

The EU is well known for its protection of agriculture. Farmers in the EU have benefited from taxes on agricultural imports that have made more efficient farmers from outside the EU uncompetitive within the EU.

So perhaps it is surprising to learn that the EU has also protected farmers in the Caribbean. They did this by putting a tax on bananas grown in countries that were not former colonies of EU countries benefiting mainly former UK and French dependencies in the West Indies.

Other countries, such as Costa Rica and Venezuela complained to the World Trade Organisation that this was unfair. Their plantation grown bananas were, according to them, bigger and better quality than the small Caribbean bananas and were being unfairly disadvantaged in the EU market.

For more than twenty years this dispute raged on and now the EU has agreed to lower the tariffs on bananas. (Details are in the linked Daily Telegraph article.)

So who has 'won'. Well the non-EU colonies have greater access to the EU market, so they have a victory. The other big winner is the EU consumer who will now be able to buy bananas more cheaply as tariffs fall and competition in the market will increase.

However the tariff is not abolished, just reduced. So EU consumers will still be paying more than they could do for  bananas and so there is a continued welfare loss due to the tariff that remains.

The clear losers are Caribbean banana growers. They are high cost, small producers who operate in conditions that produced lower quality and smaller bananas than other countries. They will probably find their incomes will fall. Fortunately sugar cane is the best crop to use for making bio-fuel and the Caribbean is ideally suited to produce that leading to a rapid expansion of that industry.

A victory for partial free trade anyway.

The Daily Telegraph covers the story 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

The EU Budget - should it rise?

The Government suffered a defeat in the House of Commons because some members wished to see a cut in the spending of the EU. 

It would be tempting to say this was because they disagreed with cutting public spending and preferred instead to see higher spending to boost economic activity. Interestingly the Labour Party supported an amendment to cut the EU budget despite opposing cuts at home. The Conservatives who rebelled may have done so to give the UK a stonger bargaining position to oppose the rise in the EU budget.

The European Commission (the group of appointed officials who run the EU) wanted a 6.8% rise in the EU budget and were backed by the EU Parliament. The committee of governments - the EU Council - only agreed a 2.79% rise.

The BBC show how the budget is spent here

There are a number of issues, among them:

The EU spends 32% of its budget supporting farmers. 

The EU spends 36% of its budget supporting poorer areas of the EU

The EU budget has risen every year since 2000 

A few countries are large net contributors to the budget - this includes the UK

All EU countries have had to cut expenditure since the recession to balance budgets

The debate about UK membership of the EU may depend on how fair our contribution to the EU budget is seen to be. Iain Duncan-Smith (Works and Pensions Secretary) said he could see the UK 'thriving' outside of the EU over the weekend - it's not clear if he or Michael Gove had the brain they share at the time. But there is a lot at stake.

A strong EU with a large budget could help to stabilise Europe and provide economic management of the continent. However many oppose this view and prefer nation states to run their own affairs.

Both visions may be unrealistic. No nation can stand alone, but the political integration needed for the EU to be the economic manager of Europe is unacceptable to most at present.

For a view on why the EU budget should be raised read The Guardian article here