Click here to access an excellent piece from the National, on etisalat and du, our favourite two network providers here in Dubai. You all know that we pay a high price for not a very good service. This is a clear example of how high entry barriers cause market failure and the exploitation of the consumer.
We do have our very own government watchdog here in UAE, the Telecommunications Regulatory Authority (TRA).
Questions to consider:
What is the market structure of the UAE netwrok providers?
How will the fixed line sharing initiative help consumers?
Will it, in your opinion, help the producers (as the article suggests)? If so, how?
Does the delay of the agreement suggest 'Regulatory Capture'? (What is this?)
When the agreement to share lines is eventually complete, how will the producers now compete, discuss one price and one non price strategy!
I would like to see some comments to the above questions before the end of the holidays!
Supply shortages in key growing regions have caused the price of peanuts to surge to record highs. Peanut prices in Europe are 60% higher than a year ago and the cost of peanuts in the USA has more than doubled in the last twelve months. The price spike is the result of lower production from India, Argentina and the United States.
In 2010, American farmers harvested 2.1 million tons of peanuts. This dropped to 1.8 million tons in 2011, a 15 percent drop that caused prices to more than double to about $1,000 a ton
With raw peanut prices jumping sharply higher consumers have found that staple products such as peanut butter, peanut oil, peanut flour and nut-enhanced cereals have become more expensive in some case by more than 30%.
Peanut production in the United States has been hit by drought conditions in states such as Georgia and Texas. And some farmers have switched production away from nuts towards cotton and corn because higher world prices have offered better expected profits. However if peanut prices stay high well into 2012, there are hopes that growers may start planting in states such as Arkansas and Mississippi where there is current ample water to achieve good harvests.
Questions for discussion:
How will peanut-loving consumers react to these higher prices?
What does the data suggest about the elasticity of supply for peanuts?
Will the elasticity of demand for all peanut products be the same?
How might this effect the producers of products that require peanuts as a raw material?
At this time of year many of the major news organizations put together collections of some of the most vivid images of the year - here is a personal collection of their output - great for discussion and for you guys, a reminder to keep up with current affairs.
British Petroleum has decided to exit the solar energy energy industry claiming that the business has become unprofitable because of excess supply and falling prices. In 2011 a number of solar firms have gone out of business including California’s Solyndra and Germany’s Solon. BP will focus instead on investing in other renewable energy sectors including wind power and biofuels.
Whilst the decision by BP to exit the industry appears significant, infact total global investment in solar power continues to rise. MidAmerican Energy Holdings owned by Warren Buffett have agreed to purchase a $2 billion solar project under development in California and a 49 percent stake in a $1.8 billion plant in Arizona.
Google Inc. and KKR & Co have announced a joint venture to pump money in four California solar power plants with total capacity of 88 megawatts. The powerful search engine business uses a huge anount of energy every year and has committed itself to large scale investment in renewable energy supplies to help power their server farms
Questions for discussion:
Is this a contestable market?
Who are the consumers? (Governments or individuals)
The UK Competition Commission has published an important report into the market structure of local and regional bus services in the UK, twenty five years after the industry was deregulated and largely privatised.
Largely as a result of a long-term process of consolidation through merger and acquisition, the UK bus industry is found to be highly concentrated with five businesses dominating the sector even though more than 1,200 businesses provides services.
The five largest operators (Arriva, FirstGroup, Go-Ahead, National Express and Stagecoach) carry 70 per cent of those passengers. The CC also found that head-to-head competition between operators is un-common and that-on average-the largest operator in an urban area runs 69 per cent of local bus services - effectively a monopoly position.
Because of the absence of genuine in competition in many towns and cities, the Competition Commission argued that market power had lead to passengers facing less frequent services and, in some cases, higher fares than where there is some form of rivalry.
The Commission wants to increase the contestability of the market and proposes better ticketing, better customer information, fair access for all operators to bus stations and closer scrutiny of future bus company mergers.
Bus Industry Background
* Passenger volumes: In 2010/11, 2.9 billion passenger journeys were made on local bus services
* Long run decline: The volume of passengers has stabilised after several decades of steep decline
* Concessionary fares: 36 per cent of passenger journeys in 2010/11 were made by concessionary passengers. This is a key feature of the UK bus market. Concessionary passengers do not pay any fares (after 9.30am in England and at all times in Scotland and Wales
* Main operators: The five largest operators are Arriva, FirstGroup, Go-Ahead, National Express and Stagecoach
* Local monopoly/duopoly: Most areas are served by just one or two operators with a significant share of supply
* Low price elastcity of demand - the report found that changes in the fare or service on existing services offered by local bus operators had little effect on passengers’ overall use of the bus. It found that the price elasticity of bus demand, from all individuals in the sample, with respect to bus fares is –0.36 (i.e. inelastic). No significant differences were found for the time of day suggesting little actual difference in Ped between peak and off-peak times
* Business stealing effects: The Commission finds this is a key feature of the market, Most customers board the first bus heading towards their destination rather than compare prices between rival operators. ‘Business-stealing’ effects in local bus services occur relation to frequency. If an operator increases its frequency, the increase in demand for its services will largely be as a result of customers switching from other operators, rather than as a result of an increase in the total market demand for bus services.
* Multi-modal competition: The CC report finds that price elasticity of demand for bus service is always low and nearly always less than -0.5 which provides an opportunity for operators to increase fares and raise profit margins. But the bus operators claim that multi-modal competition provides a constraint on their pricing power even when they have a local monopoly. Higher fares might prompt people to use a car or take local rail and tram services if they are available. Fare rises might also be limited by the risk of creating adverse publicity in local areas
* Rates of return (profit): Bus operators with substantial market power have earned profits that were persistently above the cost of capital on a national basis suggesting some supernormal profits for these busiensses. The overall average rate of return on capital employed (ROCE) for the five-year period investigated was 13.5%
* Profitability at the end of the 5 year investigation period were higher than at the start
* Barriers to entry: Sunk costs of bringing a route to profitability can be substantial as are the risks from an intensity of post-entry competition as incumbent operators react and respond to new bus operators
This excellent news piece from Ben Cohen at Channel 4 looks at the increasingly aggressive patent war being fought by the manufacturers of the world’s leading mobile phone and tablet devices - the most profitable products in the digital economy. “Where once the giants (Google and Apple) competed on features, they now compete on patents.”
The news feature looks in particular at the intellectual property surrounding the slide-screen technology used by millions to unlock a device. Apple claims the IP to this but a video tracked back to twenty years ago suggests that developers were already thinking of something remarkably similar long before the iPhone came into existence. Can the makers of Android defend legal claims from Apple that their IP has been infringed? And who will end up paying for the enormous legal fees and possible extra licencing costs?
Who gains and who loses out from persistent and pervasive price targeting by businesses? To what extent does price discrimination help to achieve an efficient allocation of resources? There are many arguments on both sides of the coin – indeed the impact of price discrimination on welfare seems bound to be ambiguous.
Impact on consumer welfare
Consumer surplus is reduced in most cases - representing a loss of welfare. For the majority of buyers, the price charged is well above the marginal cost of supply.
However some consumers who can now buy the product at a lower price may benefit. Lower-income consumers may be “priced into the market” if the supplier is willing and able to charge them less. Good examples might include legal and medical services where charges are dependent on income levels.
Greater access to these services may yield external benefits (positive externalities) that then affect social welfare and equity. Drugs companies might justify selling their products at inflated prices in countries where incomes are higher because they can then sell the same drugs to patients in poorer countries.
Producer surplus and the use of profit
Price discrimination benefits businesses through higher profits. A discriminating monopoly is extracting consumer surplus and turning it into supernormal profit. Price discrimination also might be used as a predatory pricing tactic to harm competition at the supplier’s level and increase a firm’s market power.
A counter argument to this is that price discrimination might be a way of making a market more contestable. For example, the low cost airlines have been hugely successful by using price discrimination to fill their planes.
Profits made in one market may allow firms to cross-subsidise loss-making activities/services that have important social benefits. For example money made on commuter rail or bus services may allow transport companies to support loss-making rural or night-time services. Without the ability to price discriminate, these services may have to be withdrawn and jobs might suffer.
In many cases, aggressive price discrimination is a means of business survival during a recession. An increase in total output resulting from selling extra units at a lower price might help a monopoly to exploit economies of scale thereby reducing long run average costs.
Price discrimination occurs when a business charges a different price to different groups of consumers for the same good or service, for reasons not associated with costs.
Examples of price discrimination
Perfect Price Discrimination – or charging whatever the market will bear
Sometimes known as optimal pricing, with perfect price discrimination, the firm separates the market into each individual consumer and charges them the price they are willing and able to pay. If successful, the firm can extract the entire consumer surplus that lies underneath the demand curve and turn it into extra revenue or producer surplus. This is hard to achieve unless a business has full information on every consumer’s individual preferences and willingness to pay. The transactions costs involved in finding out through market research what each buyer is prepared to pay is the main barrier to a businesses engaging in this form of price discrimination.
If the monopolist can perfectly segment the market, then the average revenue curve becomes the marginal revenue curve for the firm. The monopolist will continue to sell extra units as long as the extra revenue exceeds the marginal cost of production.
In reality, most suppliers and consumers prefer to work with price lists and menus from which trade can take place rather than having to negotiate a price for each unit bought and sold.
Second Degree Price Discrimination
This involves businesses selling off packages or blocks of a product deemed to be surplus capacity at lower prices than the previously published or advertised price. Price tends to fall as the quantity bought increases.
Examples of this can be found in the hotel industry where spare rooms are sold on a last minute standby basis. In these types of industry, the fixed costs of production are high. At the same time the marginal or variable costs are small and predictable. If there are unsold rooms, it is often in the hotel’s best interest to offload any spare capacity at a discount prices, providing that the cheaper price that adds to revenue at least covers the marginal cost of each unit.
There is nearly always some supplementary profit to be made from this strategy. Firms may be quite happy to accept a smaller profit margin if it means that they manage to steal an advantage on their rival firms.
Early-bird discounts – extra cash flow
Customers booking early with carriers such as EasyJet or RyanAir will normally find lower prices if they are prepared to book early. This gives the airline the advantage of knowing how full their flights are likely to be and is a source of cash flow prior to the flight taking off. Closer to the time of the scheduled service the price rises, on the justification that consumer’s demand for a flight becomes inelastic. People who book late often regard travel to their intended destination as a necessity and they are likely to be willing and able to pay a much higher price.
Peak and Off-Peak Pricing
Peak and off-peak pricing and is common in the telecommunications industry, leisure retailing and in the travel sector. For example, telephone and electricity companies separate markets by time: There are three rates for telephone calls: a daytime peak rate, and an off peak evening rate and a cheaper weekend rate. Electricity suppliers also offer cheaper off-peak electricity during the night.
At off-peak times, there is plenty of spare capacity and marginal costs of production are low (the supply curve is elastic) whereas at peak times when demand is high, short run supply becomes relatively inelastic as the supplier reaches capacity constraints. A combination of higher demand and rising costs forces up the profit maximising price.
The internet and price discrimination
The rapid expansion of e-commerce using the internet is giving manufacturers unprecedented opportunities to experiment with different forms of price discrimination. Consumers on the net often provide suppliers with a huge amount of information about themselves and their buying habits that then give sellers scope for discriminatory pricing. For example Dell Computer charges different prices for the same computer on its web pages, depending on whether the buyer is a state or local government, or a small business.
Two Part Pricing Tariffs
Another pricing policy is to set a two-part tariff for consumers. A fixed fee is charged and then a supplementary “variable” charge based on the number of units consumed. There are plenty of examples of this including taxi fares, amusement park entrance charges and the fixed charges set by the utilities (gas, water and electricity). Price discrimination can come from varying the fixed charge to different segments of the market and in varying the charges on marginal units consumed (e.g. discrimination by time).
Product-line pricing
Product line pricing occurs when there are many closely connected complementary products that consumers may be enticed to buy. It is frequently observed that a producer may manufacture many related products. They may choose to charge one low price for the core product (accepting a lower mark-up or profit on cost) as a means of attracting customers to the components / accessories that have a much higher mark-up or profit margin.
Good examples include manufacturers of cars, cameras, razors and games consoles. Indeed discriminatory pricing techniques may take the form of offering the core product as a “loss-leader” (i.e. priced below average cost) to induce consumers to then buy the complementary products once they have been “captured”. Consider the cost of computer games consoles or Mach3 Razors contrasted with the prices of the games software and the replacement blades!
The owners of a private sector company normally elect a board of directors to control the business’s resources for them. However, when the owner of a company sells shares, or takes out a loan or bond to raise finance, they may sacrifice some of their control. Other shareholders can exercise their voting rights, and providers of loans often have some control (security) over the assets of the business. This may lead to conflict between them as these different stakeholders may have different objectives. The flow chart below attempts to show the possible divorce between ownership and control.
The Principal Agent Problem
How do the owners of a large business know that the managers they have employed and who are making the key day-to-day decisions operate with the aim of maximising shareholder value in both the short term and the long run?
This lack of information is known as the principal-agent problem. In other words, one person, the principal, employs an agent (e.g. a sales or finance manager) to perform tasks on his behalf but he or she cannot ensure that the agent always performs them in precisely the way the principal would like. The decisions and the performance of the agent are both impossible and expensive to monitor and the incentives of the agent may differ from those of the principal. The principal agent problem is illustrated in the flow chart above.
Examples of the principal-agent problem that have hit the headlines recently in the UK include the mis-management of financial assets on behalf of investors (e.g. the case surrounding Equitable Life) and the management of companies on behalf of shareholders (e.g. during the turbulent years experienced by Marks and Spencer and Shell). The classic case in the United States is of course the Enron fraud and debacle. Follow this BBC news link for more background on the Enron case.
There are various strategies available for coping with the principle- agent problem. One is the rapid expansion of employee share-ownership schemes and share-options programmes. The government has encouraged the wider use of share-ownership schemes through a series of tax incentives. But the use and occasional misuse of share options schemes has been controversial for several years. A recent example involved the US computer giant Apple.
The growth of "shareholder activism"
Many commentators are now questioning the assumption that shareholders play little direct role in influencing corporate strategy in modern corporations. There are plenty of examples in recent times when both institutional and individual shareholders have exercised their voting rights to express views on the direction that a company is taking or its performance. Typically they are critical of a perceived failure of a business to maximise shareholder value measured in terms of share price, the flow of dividend incomes etc.
An activist shareholder uses an equity stake in a business to put public pressure on its management. The rapid expansion of hedge funds who take equity stakes in many businesses has cemented the idea of shareholder activism. Many hedge funds take minority equity stakes and then try to get the existing management to divest poorly performing or unprofitable parts of a business and focus instead on core activities.
That said it remains the case that the general pattern of ownership and control within British industry is relatively dispersed. Typically the largest shareholder in any large business listed on the stock market is likely to own a voting minority of the shares. Majority ownership by a single shareholder is unusual. The usual presumption from this is that only the very largest shareholders have any incentive to participate in corporate decision making and few shareholders have any real voting power.
Examples of recent shareholder activism
Sainsbury's: In 2004, a third of J Sainsbury's shareholders voted against the supermarket's pay policy, objecting to its decision to give a £2.3m bonus to ousted chairman Sir Peter Davis. Sainsbury's subsequently decided to cancel the controversial pay award. Sir Peter Davis quit Sainsbury's after a group of major institutional shareholders demanded management changes. He was replaced by Justin King.
Disney: In 2004, Michael Eisner, the chairman and chief executive of Disney, resigned after 43% of Disney shareholders voted against his re-election.
Euro Tunnel: In 2004, the management board of EuroTunnel was ousted at the company's AGM. Private French shareholders were encouraged to protest by share tipster Nicolas Miguet and French campaign group, ADACTE because of the huge loss of share value and the assertion that the company could be turned around by a new board. EuroTunnel has continued to experience heavy losses and in July 2006 it filed for bankruptcy protection.
Vodafone: In May of 2006, Vodafone announced the biggest loss in British corporate history (£14.9 billion). Vodafone reported one-off costs of £23.5 billion due to the revaluation of their Mannesmann subsidiary. In July 2006, the CEO of Vodafone Arun Sarin came under huge pressure from a group of shareholders unhappy about the performance of the struggling telecoms company.
Corporate Social Responsibility and Business Ethics
Business ethics is concerned with the social responsibility of management towards the firm’s major stakeholders, the environment and society in general. There is a growing belief that ethical and ‘green’ business are linked to improved business performance over time because of increased public concern for human rights and the world environment. Many businesses are now trumpeting their progress in making their activities carbon neutral for example by offsetting the impact of their production activities on their environment through offset activities. Businesses such as Carbon Clear provide a means by which organisations can find ways to offset their carbon emissions.
Business ethics extends to treating all stakeholders ‘fairly’; hence the growing emphasis on health and safety issues, good working practices and the like in business decision-making.
For more reading on this try this link to the Institute for Business Ethics. The Times 100 Case Studies includes one on Cadbury’s and corporate social responsibility. Click here for BBC news articles on carbon neutrality.
The European Union has decided to deepen its ties to hopefully sort out the mess that is the Eurozone. This clip and article help explain the fiscal issues that the EU faces. This could be a typical question in any unit 4 exam (and a Unit 4 Politics question, but that's for another day). (See points for discussion below)
Questions for discussion:
How will a common fiscal policy help the European Union?
What are the consequences of a toughter fiscal stance in the EU? (Think short term / long term)
What does the New York Times mean by a 'Two Speed Europe'?
European leaders say 26 out of 27 EU member states have backed a tax and budget pact to tackle the eurozone debt crisis.
Only the UK has said it will not join. Prime Minister David Cameron said he had to protect key British interests, including its financial markets.
The 17 countries that use the euro have all agreed to the deal.
Nine other countries have said they will sign up, some pending consultations with their parliaments.
Hungary originally said it would also remain outside the deal but has now changed its stance.
'Stable euro'
The UK effectively used its veto to block an attempt, led by the French and Germans, to get all 27 EU states to support changes to the union's treaties.
This was a night of political drama, and the long-term implications of what happened will be debated for months to come.
But there is a more immediate issue, which will be of primary interest to the financial markets. Will the European Central Bank (ECB) judge that enough has been agreed in Brussels to allow the ECB to do any more to help protect countries which are struggling to pay their debts?
That will not mean becoming a lender of last resort - a commitment to the unlimited buying of bonds. But the ECB could still do more, if it chose, to help bring down the cost of borrowing for countries like Italy and Spain.
Sovereign debt woes in several member states are still at the heart of this crisis, and if further action is not taken to resolve them, there may not be much of a eurozone left to haggle over.
Euro deal means less sovereignty
Instead, eurozone members and others will adopt an accord with penalties for breaking deficit rules. It will be backed by a treaty between governments, not an EU treaty.
"In fact, 26 leaders are in favour of joining this effort. They recognise the euro is a common good," said European Council President Herman Van Rompuy.
Mr Cameron said he had done "the right thing" by not signing up to the deal, as it was not in Britain's interests.
"We were offered a treaty that didn't have proper safeguards for Britain, and I decided it was not right to sign that treaty," he told the BBC.
"We're still in the single market. That is the best safeguard of keeping markets open," he said.
German Chancellor Angela Merkel said the UK was the only country to have expressed reservations, but that Mr Cameron had recognised that a stable euro was in Britain's interest.
Of the nine other EU countries outside the euro, Hungary, the Czech Republic and Sweden have said they must consult their parliaments. Six others - including Denmark, Poland and Latvia - have agreed to join the new deal.
However, some countries - such as the Republic of Ireland, which is in the eurozone - have a constitutional requirement to hold a referendum on any major transfer of powers to the EU.
The Irish Minister for European Affairs, Lucinda Creighton, told the Reuters news agency the probability of a referendum was "50-50 and we will be looking at the detail over the next couple of weeks".
EU leaders aim to have the pact - known as a "fiscal compact" - ready to take effect by March.
Its main provisions include:
a cap of 0.5% of GDP on countries' annual structural deficits
"automatic consequences" for countries whose public deficit exceeds 3% of GDP
the tighter rules to be enshrined in countries' constitutions
the EU's permanent bailout facility, the European Stability Mechanism (ESM), to be accelerated and brought into force in July 2012
the adequacy of 500bn-euro (£427bn; $666bn) limit for the ESM to be reassessed
eurozone and other EU countries to provide up to 200bn euros to the International Monetary Fund (IMF) to help debt-stricken eurozone members
Continue reading the main story Euro agreement - from the papersThe Guardian says Britain is "facing isolation in Europe" after David Cameron vetoed a revision of the Lisbon treaty.
In the Economist, the Charlemagne's notebook blog describes the agreement - and Britain's non-participation - as Europe's "great divorce".
The Financial Times says EU leaders are "struggling to cope" with what it describes as "a profound split".
The New York Times describes the agreement as "not a perfect solution," because it could be seen as institutionalizing a two-speed Europe - but it says the pact could be ratified much more quickly than a full treaty amendment.
The government of the Maldives has temporarily banned the depositing of rubbish from its hotels onto an island used almost entirely as a garbage dump.
Thilafushi, an artificial island 7km (four miles) from the capital, is nicknamed Rubbish Island.
The accumulation of garbage there has become so acute that it has begun spilling into its lagoon.
An emergency clearing operation has begun to remove "hills of rubbish" mostly collected from luxury hotels.
Rubbish Island is a far cry from the Maldives' famous turquoise waters and white sands.
Those who have been there describe vast piles of rubbish and perpetual smog and smoke.
The routine is for mainly Bangladeshi workers to sift through the trash to look for materials their employers can sell.
Waste from the whole country is taken there to the island be buried, burnt or - for some plastic and metal - recycled.
Much of the rubbish comes from the luxury resorts which, reportedly, do not follow the rules on crushing their waste.
The boats that bring rubbish to Thilafushi have recently started dumping it into the lagoon, many boatmen impatient at having to wait up to seven hours to unload it.
The head of the Maldives' Environment Protection Agency, Ibrahim Naeem, says that delays in dealing with rubbish are caused by technical problems with the unloading of trucks.
He stressed that Thilafushi was not full up and that work was under way to improve waste disposal and ban open incineration.
Mr Naeem said the jetty for rubbish from outlying islands will be closed until the lagoon is cleaned up - although a separate quay for the capital, Male, remains open.
Criticising the waste management on Thilafushi, local environmental campaigner Ahmed Ikram said that years of promises to create a biofuel facility on the island to generate more power had come to nothing.
Mr Ikram's Bluepeace organisation has highlighted the problem of toxins from poisonous waste seeping into the sea.
Thilafushi was reclaimed from a coral reef 20 years ago. There are other industries there, including boat repairers.
Questions for discussion:
How could the Maldives government reduce this clear example of market failure?
Several countries have recently implemented 'austerity packages' - attempts to reduce government spending and increase taxes, in an effort to reduce their budget deficit. It was hoped, these austerity packages would 'restore confidence', improve countries fiscal position and enable long-term recovery.
Austerity in the 1930s
Main Impact of Austerity
Lower Demand.
A cut in government spending and higher taxes will lead to lower aggregate demand and lower economic growth. If there is a fall in output, firms will employ less workers leading to higher unemployment. Also, government spending cuts may involve making public sector workers redundant. In addition, media coverage of 'austerity measures' tend to reduce consumer and business confidence. Fears over job losses and expectations of lower growth will encourage consumers to save rather than spend . This will be a further drag on consumer spending and economic growth (paradox of thrift). As a result of austerity measures in 2011, the OECD now forecast negative growth of -0.8% for the Eurozone in 2012.
Lower inflation.
Spending cuts will tend to lead to lower inflation. Firstly, the fall in aggregate demand (AD) will lead to lower inflationary pressures in the economy. Also, if the government limits public sector wages, this will put downward pressure on wages. Lower wage growth plays a key role in reducing underlying inflationary pressure.
Competitiveness.
It is hoped that austerity measures will help create greater pressure to reduce costs. These lower costs can help improve competitiveness. This is important for countries in the Euro, such as Ireland, Greece and Spain. In the boom years, they became uncompetitive leading to lower export demand and a current account deficit. Measures to deflate the economy should make exports more competitive. Ireland has been relatively successful in improving competitiveness, this is reflected in their move from a trade deficit to trade surplus in recent months. However, this attempt to improve competitiveness through lower inflation may take several years, and involve a high cost of lower growth and unemployment.
Irish GNP
Ireland has been one of more 'successful' countries which has embarked on austerity, but this shows GNP is still significantly below pre-crisis levels (when real GNP was growing at an average rate of close to 5% a year)
Budget Deficit.
Higher taxes and lower spending will lead to an improvement in the government's budget deficit. This will help improve public finances in the long term.
However, if austerity measures cause lower economic growth, the government will also see a fall in cyclical tax revenues. e.g. increasing tax rates, should increase revenue. But, if higher taxes cause a recession, there will be less people working and so income tax revenue may actually fall. Also, if austerity measures cause unemployment, it will require higher government spending on benefits.
For example, the UK's budget deficit fell slower than expected. This was partly because growth forecasts proved overly-optimistic. The austerity measures led to a slowdown in growth.
What Determines the Impact of Austerity?
Labour market flexibility.
If labour markets are flexible, it may be easier to cut wages, and labour costs. This may make it easier to restore competitiveness and restore economic growth. However, if there is great resistance to lower labour costs, it will be much harder to restore competitiveness.
What Spending is Cut?
If a government cuts spending by raising the retirement age to 70, then this will not lead to lower growth. In fact it could help increase labour supply and increase productivity. However, if the government cut spending on current infrastructure investment, this will have a much greater impact on reducing domestic demand and lead to lower economic growth.
Monetary policy.
Austerity involves lower domestic demand. However, if monetary policy can be loosened (e.g. lower interest rates or increased money supply) then the deflationary effects of spending cuts can be offset. For example, in the Euro, countries like Greece have fiscal austerity, but there is no corresponding loosening of monetary policy (e.g. the ECB increased interest rates in early 2011 and didn't pursue any quantitative easing). By contrast, the UK has more flexibility because the Bank of England pursued quantitative easing.
Exchange Rate.
Austerity is not as damaging if a country can devalue the exchange rate. This devaluation helps to restore competitiveness much quicker than relying on internal devaluation. The depreciation helps boost export demand. Countries in the Euro, can't devalue and so have to rely solely on internal devaluation to restore competitiveness.
Global Growth.
Austerity is not as damaging if the rest of the world economy is doing well. If global growth is strong, export demand will be strong. However, if all countries are experiencing a recession, then deflationary fiscal policy will have a greater impact in reducing domestic demand.
Central Bank Intervention.
Countries in the Euro, without a lender of last resort, are having to cut spending much quicker than countries outside the Euro. This is because bond yields on Euro debt has risen very quickly because markets fear liquidity shortages.
One of the most prominent economists of the 20th century was the late Milton Friedman, an ardent free market supporter who remained skeptical of government’s ability to correct market failures through interventionist policies.
I found the talk below interesting. Friedman offers several examples of market failures that have been pointed to as a justification for government intervention, and argues that in fact, government often does not truly know what the right outcome is in most cases. He believes that government failure should be just as much a concern as market failure; and that therefore societal welfare would be best met by finding market-based solutions to the misallocation of resources that sometimes arises under conditions in which externalities exist.
As you watch the video, consider Friedman’s claims regarding the role of government, then post your response to one of the discussion questions below.
Discussion Questions:
1.Is government better able to know the “optimal” quantity of output of different goods and services than private individuals are?
2.Under what conditions would the free market be best able to achieve solutions to market failures such as those described by Friedman?
3.What do you think should be of greater to concern to society, market failure or government failure?
Type your yearly income (in US$) into the calculator below and click here to see where you fit in as far as percentile of income relative to everyone else. So, for example if you earn the equivalent of $30,000 (a little under £20,000) you are in the 37th percentile or in other words, 63% of other income earners are paid more than you!
“An annual salary above $506,000 puts you in the top 1%, while you need to make less than $2,500 a year to be in the bottom 1%. Where do you stand?”
This is a real eye opener re income distribution in the US. Unfortunately, (or fortunately depending on your point of view) this widening of the income distribution spread is common place in the developed world.
Are you into your cycling? The huge expansion of interest in cycling in the UK from road racing through to BMX and mountain-biking has gone hand in hand with the fantastic success of British cyclists on the international stage. 2012 promises to be another strong year for the industry despite difficult economic conditions.
Check out this brief documentary on Hope Bikes - a British brand that has a remarkable commitment to design excellence, constant innovation, trial and error, and precision engineering.
Watching this ten minute video is a compelling and beautiful study in the concept of value added and the potential of small businesses to develop durable and successful brands despite competition from huge multi national companies.
