Virgin calls foul

Virgin have lost the franchise to run the 'West Coast Mainline', there is a map on the article if you are not sure what this is, but it is basically London to Glasgow, via Birmingham.

This is one of the really important rail routes in the UK (London - Edinburgh and London - South Wales being the others).

When rail was privatised the network was split up into franchises (most of the others being smaller and messier geographically) and whoever wanted the lowest subsidy, or would pay the most was allowed to run them.

The whole process was a mess. Too many franchises, franchise periods that were too short to allow investment or too long to promote competition. There were frequent changes and government interference. Nobody came out of the process with any credit.

Now there are medium term franchises (around 13 years) and the 'bid process' is well established. The aim is to maximise revenue to the government and provide better rail services while ensuring investment. The aims are not necessarily complimentary!

The latest route to be competed for is the West Coast Mainline, which the Virgin Group has run since it was first privatised. They have invested in new trains and improved service frequency and quality. They have also received quite staggering favouritism from government (see Private Eye ad infinitum).

But Virgin lost the franchise to First Group, already a major rail operator. Virgin offered less money and less comprehensive service improvements and after 18 months of the process their bid was judged inferior.

Virgin feel hard done by and are using their considerable PR clout to call foul and demand intervention by MP's. It's very sad and I think really embarrassing.

They have, however, one valid point. The way franchises are awarded may not work.

The theory of franchising is this:
1. Competition promotes efficiency.
2. Efficient allocation of resources is better for consumers - lower prices, and society - more efficient use of scarce resources.
3. Rail is a natural monopoly and so it is inefficient to have multiple train providers on single routes.
4. Therefore competition should be provided in the process of bidding to run the routes. Regulation and regular 're-franchising' will keep franchise holders honest and prevent monopoly profits.
5. The government can make money selling the franchises!

But the process can go wrong when a bidder for a franchise offers too much. If they make losses and walk away this can cause massive disruption and reduce investment in the network. And it has happened before. National Express offered too much for the East Coast mainline and had to be replaced at great cost. In another industry Harlech Television paid too much for the ITV franchise for 'Wales and the West' and went bankrupt.

I hope Virgin is wrong. They have been given preferential treatment throughout their time as a rail operator and this just stinks of sour grapes. However the issues are real and not just for Transport Economics.

The BBC covers the story here

What has this got to do with the price of fish?

The report linked below states that the UK cannot supply enough fish from its own waters to meet demand. It uses the idea of a day in the year when we have eaten our years supply of fish - in 2012 that is August 21st.

Of course it does not work like that, each day Britain consumes, on average, about one third more fish than we catch.

The situation is complicated by quotas, which are aimed at preserving fish stocks.

Read the article and consider:

1. What should happen to the price of fish in the UK as a result of this 'excess demand'

2. Is it bad to import fish?

3. What happened to the fish? Britain used to be able to catch more than enough from her own waters.

BBC article is here

Pigou claims another victory over Keynes

The path taken by unemployment over the period of the recession is very odd. During recessions unemployment should go up as real output falls. In line with this employment should fall.

Well that has not happened for a lot of this recession and explanations of why that is the case are far from complete.

The article below, by Stephanie Flanders of the BBC, looks at some of the issues. It could be because so many of the new jobs, over half a million more than two years ago, are part time. It might be because those who have chosen self-employment over unemployment are actually 'self-unemployed' having no significant work to do.

Two explanations Flanders does not mention are:
1. The effect of mobile European workers - if they go home when there are no jobs this stops unemployment rising as each job is lost. This only explains the low rise in total unemployment.

2. Real wage rates have fallen, allowing firms to employ more people.

The second explanation is simply markets working as they should in a microeconomic sense. When there is a surplus of a product then price falls. This encourages higher demand, but lower supply and the market clears.

Pigou and other leading economists explained that this is what would happen at the start of the Great Depression and that this would lead to unemployment falling and output recovering. Of course the 1930 recession continued into the Great Depression and Keynes explained this by saying wages were 'sticky downwards' and the market adjustment didn't happen.

The supply-side reforms to the labour market and the draconian approach to public sector pay since 2009 have allowed real wages to drift down. Firms can now afford to take on workers with lower productivity and so employment could rise with a lower rise in real GDP associated with it.

There are multiple factors at play here, but I'd like to think that Pigou got this one right.

Stephanie Flanders article is here

Lessons in supply and demand

Corn prices are forecast to rise sharply due to a poor US harvest.

The main one is that there has been a drought in the US, causing corn production to be loweer than last year (indeed the lowest for decades).

Falling production means the supply curve of wheat moves to the left compared to last year and the result is a higher price. This is made worse by two other factors:

1. World population growth means there is rising demand for food. The demand for all food products is growing, shifting the demand curve to the right and so putting upward pressure on prices.

2. The US insists that 40% of US corn is used to make ethanol for car fuel. This restricts the amount of corn available for food.

For now we will leave aside the fact that using corn to make ethanol is exceptionally inefficient and is done for political not environmental reasons.

Grecians will have no problem drawing the diagrams for this, but Deps can use it as a good exercise in understanding market prices.

The BBC covers the story here

Unemployment and poor mental health

One of the stated costs of unemployment is that the unemployed become depressed and suffer more physical illness.

The cause of the physical illness is usually put down to poorer diet and also stress. Of course worrying about the future in a recession is easily understood.

There is evidence that the UK is taking more anti-depressants. The article below makes a real meal of it but it is clear that this provides casual empirical evidence to support this particular cost of unemployment.

The BBC article is here

Bank's latest attempt to get lending going

Today the Bank of England started providing cheap loans to banks. This is effectively the same tactic as increasing the money supply, but deals with a problem in the system.

With Quantitative Easing the money supply rises and, in theory, asset prices rise and market interest rates fall. This should lead to more investment and so rising AD and output.

But the problem QE encountered was that banks were reluctant to lend the extra money that would make this process work. This was known before the process began, but it was hoped enough money would get through to make a difference.

Banks are, quite rightly, concerned with building up their balance sheets so that a future financial crisis will not lead to their collapse. As the Euro crisis and double dip recession show there are more than a few reasons to be cautious. So this scheme encourages banks to lend.

The scheme overcomes the QE weakness by lending to banks at very low interest rates on the, fairly weak, condition that their lending will be monitored. The implied threat is that if banks don't up lending to households and firms then the loans will be withdrawn.

The signs are that market rates for borrowers have fallen already and so that is the first objective achieved. Next will be getting firms and households to actually borrow. So far firms have claimed they can't get funds, but we will now see if they are really confident enough to borrow.

The BBC covers the story here

Oh dear, oh dear, oh dear

A government statement here

Britain reported a third quarter of falling economic growth on Wednesday. This is exceptionally disappointing news and leads to a situation where action to at least make people feel better seems inevitable.

The raw figures were that GDP fell by 0.7%. There are factors to be taken into account that mean the fall is as not as bad as it seems, but once they are accounted for GDP would still have fallen. This 'second recession' means that the UK is far from a recovery that will provide the income and jobs people need.

It is an odd type of recession however. It's a recession that is creating jobs, 180,000 in the last three months. That is not typical, recessions should see fewer jobs.

So what is the cause of the problem?

* The main problem is the world economic situation. Markets are weak and so sales are down. The continuing Euro saga means that confidence is low in financial markets and with the overhang from the 2007/8 global financial crisis banks are not lending.

* The EU is the UK's largest export market and recession there means that they are buying less from us. This shows how interdependent economies are.

* Consumer confidence is very low which means consumers are saving (about 8% of income at present, up from 1 to 2% during the period before 2008).

* The governments of the world are very concerned about the level of debt they hold and are making efforts to reduce it. This means higher taxation and lower government spending (and jobs) and so in the short term this helps to contract the economy.

Some people argue for greater government short-term stimulus to rectify the current problems. This would mean stopping the deficit reduction program (or at least delaying it). It also means government investment in infrastructure and probably tax cuts.

Most people completely overestimate the ability of governments to influence economic activity. Governments are actually pretty powerless even when they act together, but when they are seen to be acting this often raises consumer and business confidence. That seems to be the key now, not actually what is done, but being seen doing more.

Of course the weakness of the financial system will remain and it is, frankly, a house of cards which could collapse at any moment. But for once the illusion of Keynesian style stimulus packages might actually be what we need and its about time these cheap conjuring tricks were given top billing.

The BBC have the figures 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

Helping ease the credit channel

The government is to help ease the tight credit situation by providing 'soft loans' to banks so they can in turn lend to businesses and households. The Independent described it as a 'panic measure' but that seems more than harsh.

The measure is presented as a precaution against a second 'credit crunch' which might follow a partial collapse of the Euro area. This is too simple because one of the major issues preventing recovery is that when firms or households approach banks for loans they are turned down. Although the banks deny it, they are very cautious and this caution is stopping growth.

So banks will be able to borrow around £5 bn a month which they can then pass on in loans to firms and households. The risk to the bank is reduced as the cost of these funds is lower than the market rate and as the funds can only be used for relending they make nothing if they don't use the funds.

The result should be a rise in bank lending, followed by higher Consumption and Investment and so an increase in AD.

Ed Balls says it won't work. Odd as his entire economic plan relies on exactly the same principle. He also says that the previous policy has failed and this acknowledges that. Well that may well be true, QE and low interest rates have not persuaded banks to lend and the recovery has stalled, this can only help. The sensible question (something Balls can rarely ask) is will it be enough?

The Independent covers the story here

Understand the Greek crisis?

It's ok, nobody really understands the Greek crisis, and few have a  clear idea of what will happen next.

The Guardian have done a handy interactive flow chart where you can explore the possibilities.

The Guardian flow chart is here