Income and wealth are increasingly in the hands of the top 1%. How have we arrived at this stage of global inequality and what does the future have in store?
The recent Amazonian fires here in Brazil and their potential impact on global warming got me thinking about the role of economics, and how economic theories and models may be complicit in the process of environmental destruction and global warming. Do our models factor in the environmental impacts of economic activity, or do they ignore them?
Many analysts think that they ignore them and that new ways of thinking about the role of the economy and it’s connection to the environment are needed. One of these analysts is John Fullerton, an ex-Wall Street banker who has founded the Capital Institute, a non-profit organisation whose aim is to completely rethink our economic and financial models with a view to making them much more responsive and attuned to how they impact our environment.
“ This search first opened my eyes to the profound, interlocking crises we are now facing – ecological, economic, and social – including the shocking prospect that we are destroying the planet’s ability to support life as we know it. My most startling discovery, however, was that the modern scheme of economics and finance – what Wall Street “geniuses” (like me) practiced so well-formed the root cause of these systemic crises”
John Fullerton, Ex-Wall Street Banker
A major criticism of traditional economics is an obsession with economic growth. Maximizing economic growth is an important macroeconomic policy objective for most governments, but this usually has considerable negative environmental impacts.
Amazonian Production Possibility Frontier – The Trade-Off Between Economic Growth and Nature.
Jair Bolsonaro, the controversial new Brazilian President, wants to ‘develop’ the Amazon by encouraging more production of meat, soya and timber. In other words, using the PPF diagram above, he wants the Brazilian economy to move from point e to point f on the above PPF. The opportunity cost of these policies, however, will be less rainforest as shown by the movement from A to X on the horizontal axis.
Brazil is in the process of recovering from one of its worst-ever recessions and Bolsonaro sees Amazonian ‘development’ an opportunity to dig the economy out of the recession. The Amazonian region is also one of the poorest in Brazil and any development of the region could pull many of its inhabitants out of poverty.
However, the Amazon rainforest plays a crucial role in regulating the world’s environment; it contains twenty per cent of the world’s animal and plant species, its plants hold ten years worth of carbon emissions, and it helps regulate the precipitation cycle of the whole of South America. Extensive deforestation of the Amazon would have incalculable impacts on South America’s ecosystem and would sharply accelerate global warming.
IB Business & IB Economics.
For the first time since 1945, as from today, November the 11th, 2017, new labour laws come into force in Brazil. The new laws have been welcomed by the business community, who feel that the laws bring Brazil’s labour market into the 21st century, but many, including the Trade Unions and the poor, have protested against the changes.
In economic language these types of changes are often referred to as ‘ making the labour market more flexible’. In economics it is an example of a ‘ market based supply side policy’ the aim of which is to increase economic growth and shift the long run aggregate supply curve of the economy to the right (see below).
The laws make it easier for companies to hire and fire workers, allow companies to use their workforce in more flexible ways, which will cut the cost of labour for many businesses. However, they are controversial and some feel that Brazil’s poor will be worst hit by the changes.
It is difficult to summarize all the changes to the law in such a short blog, but here are some of the highlights:-
- It will be easier and less expensive to hire and fire workers.
- Meal vouchers, medical insurance, bonuses and travelling expenses will no longer be classified as ‘ employee remuneration’ as they are now.
- Compulsory union contributions have been abolished. They will be voluntary from now on.
- Allowing companies to split their employee’s vacation time into three separate periods. Previously holidays had to be taken over one period of 30 days per year.
- From now on employers will not pay their workers overtime if they stay on at their work premises because of poor weather or unsafe conditions.
- Time spent travelling to work is no longer considered as ‘ working hours’. In the past it was.
- Employers can now bargain directly with their workers to set pay and conditions, rather than with a Trade Union.
- It will be easier to hire workers on different types of contracts – part-time , remote workers (working from home) and intermittent workers.
- Companies with 200 or more employees will have to set up a Worker Representation Committee.
- Outsourcing will now be allowed , even for ‘core business’ functions. Previously it was only allowed for peripheral business functions like catering and security.
- ‘ Equal pay for equal work’ rules will be more flexible. Previously workers working on different business sites, or even in the same city, could claim equal pay for equal work. Now it will be restricted to workers only working on the same site.
Labor Newsletter: Mayer/Brown/Tauil/Chequer. Labor Law (“Labor Reform”) – Federal Law No. 13.467/2017, July 20th, 2017.
If the price of a product falls, by how much will demand increase ? By a small amount or a large amount ?
This question is a very important question in economics. The magnitude by which demand (or supply) changes when price changes is very significant. If you were a business executive, for example, you would want to have an idea of how much demand for your product will increase by, if you decided to lower it’s price. Alternatively, if you were a government official and you wanted to place a tax on cigarettes, you would want to know how much tax revenue you would earn by doing this. Understanding elasticity of demand of the product would give you an idea.
The elasticity of demand measures the amount by which demand changes when the price of a product changes (the ‘sensitivity’ of demand). If the change in price was very small, but the change in quantity demanded was large, then we say that the demand for the product is very elastic (very sensitive). If the opposite were true (the change in price was very large but the change in quantity demanded was small) then we say the demand is inelastic (insensitive).
Elasticity of demand is measured using the following formula:-
If the answer to the above equation was <1 then demand is said to be inelastic.
If the answer exactly equaled 1, then elasticity of demand is said to be unitary.
If the answer were >1, then elasticity of demand is elastic.
For example, if in the above equation the change in quantity demanded was 20%, and the change in price was 10%, then demand would be elastic. (20% divided by 10% equals 2, which is greater than one ).
Working out the ‘percentage change’ in something can sometimes be difficult. Another way of formulating the above equation is to break it down even more. To work out the percentage change in a variable you use the following formula:-
Change in variable/original value of variable × 100
Substituting this into the above equation, you get:-
Another way of formulating the above equation is to write it like this:-
Use what ever method of calculating elasticity of demand you feel most comfortable with. As long as you use the formulas correctly, you will always come up with the correct answer !
Technically, all formulas for calculating elasticity of demand should have a minus sign in their answer. This is because changes in demand and changes in price always move in opposite directions. If the price of a product falls, then quantity demanded increases (change in price is negative, change in quantity demanded is positive). In practice, economists usually don’t bother to put in the minus sign.
Do these exercises to practice the PED calculation. Work out the elasticity of demand for the following examples:-
1) The price of apples rises from $4 to $5. Quantity demanded falls from 340 kg per week to 300.
2) The price of cinema tickets rises from $11 per seat to $14. Demand falls from 2000 seats to 1800 per week.
3) The price of copper rises from $3400 per tonne to $4800. Demand falls from 800 tonnes per week to 200 tonnes.
4) Demand has risen from 33,500 units to 45,000 units because prices fell from $3.2 to $1.6.
5) The price of fuel fell from $ 6 to $4 per litre. Demand rose from 12,000 litres to 16,000 litres.
6) What do you think determines the elasticity of demand of a product ? Why are some products more elastic than others ?
Click here to see the answers.
IB BUSINESS & MANAGEMENT AND IB ECONOMICS.
From ‘Brexit’, to the election of Donald Trump as US president, a number of recent world events have surprised and shocked many people.
Can we link anything on the IB Economics and IB Business & Management syllabuses to these profound changes in politics, society and economics? Can business and economics explain anything about these happenings?
Of course it can!
Let’s look first at executive pay (Section 2.4 of the Business syllabus, salaries and remuneration) . As Ha-Joon Chang points out in his masterly book “23 Things They Don’t Tell You About Capitalism“, the salaries (or more accurately the compensation packages) of senior US company executives has increased dramatically over the past few decades. In Chapter 14 of his book, “US Managers Are Overpriced”, Chang produces some astonishing statistics to back up his claim in the title of the chapter. He says that in the 1960’s the ratio of CEO compensation to average worker compensation used to be in the region of 30-40 to 1; in the 1990’s this ratio rose to about 100 to 1, and in the 2000’s to an astonishing 300-400 to 1 (P150).
How do economists explain such a huge rise in executive pay in US corporations? Demand and supply of course! (Section 1 of the syllabus, Microeconomics) The reason why executive salaries have risen so high, they say, is that the demand for such skilled and able managers far exceeds their supply. Companies have to pay these managers such high salaries because, if they don’t, they would be poached by their competitors. Moreover, these high salaries just reflect the ‘ contribution’ (read productivity) that these executives give to the companies that employ them.
Chang comprehensively debunks this argument. He points out that it is mainly neo-classical, or free-market economists (Section 2 of the syllabus, Macroeconomics), who believe this. US Executives would have to be ten times more productive than equivalent personnel just a generation ago and this is extremely unlikely (P151).
Moreover, why have average US worker wages remained stagnant? Is this because their productivity has remained unchanged over the past two or three decades? Again highly unlikely, says Chang (P152).
The diagram above shows how the average hourly wage growth of the richest people in the US population has increased dramatically since the beginning of the century, whilst the wages of lower income groups, the 20th and median percentiles, have fallen.
Chang also points out that US executives, in comparison to their foreign counterparts, are excessively paid. In 2005, Swiss and German CEO’s were paid 64 and 55 percent of their US counterparts’ salaries; Swedish and Dutch CEO’s were paid 44 and 40 percent respectively, and the Japanese a measly 25 percent (P152).
So what has all this got to do with the election of Donald Trump? A lot. Trump ran on a ticket saying that he was going protect the American middle classes and the jobs of working class Americans. He fed off the justifiable anger that many middle class and poor Americans feel about the stagnation of their wages and the consequent fall in their living standards. He used the language of ‘them and us’ – it is us against the ‘global elite’.
Who is this ‘ global elite’? According to Chang, it is composed of super-wealthy business executives, who for years have paid themselves bigger and bigger salaries and better and better compensation packages at the expense of their own employees (and indeed of their own citizens and own societies).
“ The power of this managerial class has been most vividly demonstrated by the aftermath of the 2008 financial crisis. When the American and the British governments injected astronomical sums of taxpayers’ money into troubled financial institutions in the autumn of 2008, few of the managers responsible for their institution’s failure were punished. Yes, a small number of CEO’s have lost their jobs, but few of those that have remained in their jobs have taken a serious pay cut…” (P155).
The second educational podcast in a series of three that looks at the Section 4 topic of Development, in particular at the question of ‘the balance between markets and government intervention’ (Section 4.8).
Click here to see the first in the series.
Should governments intervene a lot in markets and in that way boost or accelerate development? Or is it better for them to leave markets alone and take a ‘stand off approach’?
What happens if, as is often argued, market failure in poor countries is much greater than in rich countries? Should governments intervene more because of this?
This podcast explores the issues of why market failure is higher, and whether or not the government should therefore intervene in markets because of this.
An educational podcast that looks at the Section 4 topic of Development, in particular at the question of ‘the balance between markets and government intervention’ (Section 4.8).
Should governments intervene a lot in markets and in that way boost or accelerate development? Or is it better for them to leave markets alone and take a ‘stand off approach’?
What happens if the government in question is corrupt? Does a corrupt government, when it intervenes in markets, hinder, or help the situation?
The following video discusses corruption, its causes, its effects, possible solutions to the problem, and the government’s role in the development process.
Anyone studying economics, no matter how briefly, will soon come across the phrase, the ‘ free market’. We also talk about ‘ free marketeers’, who are economists who believe that the less the government ‘ interferes’ in markets the better. They tend to argue that when the government steps into markets and introduces, for example, a minimum wage or a price ceiling, then this results in a restriction on the ‘freedom of choice’ of the players in the market, and also causes a loss of efficiency in the market. One of the main themes of the IB Economics course is the debate about the extent to which governments should intervene in markets and should attempt to control them, and the extent to which should they should leave them alone and let them just get on to ‘do their job’.
For Ha-Joon Chang in his excellent book ‘ 23 Things They Don’t Tell You About Capitalism’ the argument put forward by the free marketeers is superfluous. Governments and politicians have always interfered in markets and have always attempted to control them. In his Chapter entitled ” There Is No Such Thing as A Free Market”, he says that markets have always been subject to rules, regulations and laws, some of which are ‘explicit’ but many others are ‘implicit’ and are not therefore obvious to us. For this reason, there is no such thing as a ‘free’ market.
Chang points out that in 1819 when in Britain Parliament introduced laws to protect children from being exploited in coal mines, the ‘ free marketeers’ of the day protested that this was an unwarranted interference in the market for labour (P2). Now we take it for granted that children should not be forced to work in coal mines. Similar protests occurred in the 1960’s and 70’s when legislation was enacted to stop factories from polluting the environment, or from producing products that damaged the environment. Again, the free marketeers of the era protested, saying that the legislation restricted the free choice of the economic agents involved in those industries. Now we take it for granted that firms should not pollute the environment or produce environmentally unfriendly products (P3).
Chang also points out how there are many rules and regulations emanating from governments determining what can or cannot be sold. For example, in most countries it is illegal to sell votes, university places and government jobs (P4).
How else do governments ‘ control’ or ‘interfere in’ free markets?
One role of government in an economy is to create and enforce laws and two areas of law which are vital for the efficient functioning of free markets are laws of contract and laws about property rights. Take laws of contract. Whenever an economic transaction takes place a ‘contract’ is entered into. A buyer of a house, for example, signs a contract with the seller, usually a physical document, which specifies things like the agreed price that will be paid, how the payments will take place and who the true owner of the property is. If the buyer finds out at a later date that the seller was not the true owner of the property, then that contract becomes null and void, and the buyer can sue the owner for breach of contract.
What a lot of people don’t realize is that even when buying cheaper, more mundane things, like food in a restaurant, or a cup of coffee in a cafe, you are still entering into a contract with the seller. However, the contract is implicit in the transaction, and is something that most people just take for granted. Take buying a coffee in a cafe. When you buy it you are assuming that it is in fact coffee and not another type of product, and you are making the assumption that it is safe to drink. If you bought something that made you violently ill, and turned out not in fact to be coffee, you could sue the sellers of the coffee for breach of contract. Unlike the example above of buying a high value item like a house, you did not sign a contract with the coffee vendors ( i.e. a physical piece of paper), but you did enter into an implicit contract with the seller when you paid for the product. And if this contract is broken then you have the right to redress in the eyes of the law.
So, is there such a thing as a completely ‘free’ market in the sense of being free from government intervention or government interference? No. Laws and regulations govern how efficiently a market operates, and laws and regulations are created by, and enforced by, the state. These laws and regulations can be explicit, but some are implicit and are just taken for granted. To quote Chang:-
” How free a market is cannot be objectively defined. It is a political definition. The usual claim by free market economists that they are trying to defend the market from politically motivated interference by the government is false. Government is always involved, and those free marketeers are as politically motivated as anyone” (P1).
IB Economics & IB Business.
On Thursday June 23rd the British people voted in a referendum to leave the European Union ( EU). The value of the Pound promptly dropped 10% and stock markets around the word fell. As a British citizen myself who is on holiday in the UK, I thought that it would be apposite to make Brexit the topic of my next blog post. Brexit is short for a ‘ British exit’ of the EU.
So what has Brexit got to do with the IB Economics and IB Business courses? A lot. The topics of ‘ globalization’, ‘ trading blocs’ and ‘ common markets’ appears in the IB Economics syllabus ( Section 4, International Economics) and ‘globalization’ is one of the key concepts that runs throughout the IB Business course. The impact on a UK business of Brexit would also come under ‘the external environment’ in the IB Business course ( Section 1, Businesses and their External Environment).
Why did Brexit caused such a shock in markets around the world and how can we link it to the courses that we study?
Up until last Thursday the orthodox economic, business and political view was that globalization ‘is a good thing’. Globalization means the ” increasing inter-connectedness of the world, in all areas – economic, political, technological, social and cultural”. ( See blog post entitled ‘The Course Key Concepts‘ for some definitions of globalization). For businesses globalization opens up both opportunities and challenges. Opportunities include the ability to expand market share by selling in markets abroad, the ability to take advantage of economies of scale, the ability to cut costs by buying cheaper raw materials and by hiring cheaper foreign workers. There are potential challenges for businesses too – more competition from foreign competitors, the lowering of prices in markets and consequently lower profit margins, increasing threats to patents and copyright etc.
The EU, a trading bloc, is also an example globalization. In fact, it could be argued that it is an example of an attempt to accelerate the globalization process between and within a group of countries. The EU is a particular type of trading bloc, where not only goods and services are traded freely, but also the factors of production such as ‘labour ‘ and ‘capital’. Certain countries in the EU also share a single currency, the Euro, a situation known as ‘ economic and monetary union’. Those countries that belong to the Euro are highly integrated, both economically and politically. In order for countries to have the same currency, for example, they necessarily need to have the same monetary policies.
Britain never adopted the single currency, but it did adopt all the other obligations associated with being a member of the EU. So why did British voters vote for a Brexit?
Thousands of words can be written answering this question, but I will attempt to briefly outline what I think are the main reasons:-
1) One of the main obligations of being a member of the EU is adhering to the ‘free movement’ of labour rule. This means that anyone in any EU country has the right to find work in any other member country. One result for the UK of this has been a big increase in immigration from other EU member countries. For example, net EU migration into the UK in 2015 reached an all time high of 183,000, 53,000 higher than the previous year. This huge increase in the number of foreigners living in the UK has exacerbated social tensions, which, unfortunately, some right-wing and racist groups have actively attempted to exacerbate.
2) Disaffection with the current political system and current political elites, especially since the 2008 economic crisis. Many people in the UK were badly affected by the 2008 economic crisis and have suffered due to the policies the government has pursued since. Unemployment rose, people lost their properties because they were unable to pay off mortgages and others have seen the value of their properties fall. Moreover, due to ‘austerity’ measures taken by the government since, they have less access to high quality public services such as healthcare, housing and education. ( Austerity measures occur when governments reduce public spending to correct a budget deficit). In short, living standards have fallen for quite a lot of people in the UK.
3) An inability to see what the benefits of being part of the EU are. Membership of the EU benefits some people in the UK, but not all. Farmers, for example, receive a lot of subsidy money from the EU and have benefitted a lot, as have certain deprived inner-city areas, but many groups in society have not benefitted. Furthermore, any form of financial aid from Brussels is also accompanied by time consuming rules, regulations and bureaucracy, which seem to negate any benefits associated with it’s receipt.
4) Disillusion and dissatisfaction with globalization itself. Increasing competition from Chinese, Indian and US companies in the UK over the last few decades has resulted in the closure of many domestic companies. Workers have lost their jobs due to outsourcing. Those lucky enough to find another job are often forced to accept part-time contracts, or very short term contracts, with lower wages and worse terms and conditions. In short, their lives have become more precarious and unstable.
The vote by the UK to leave the EU was certainly a surprise, a surprise to the financial markets, to the established political elites in both the UK and in Europe, and to the writer of this blog. It was also a ‘ thumbs down’ to globalization by UK citizens, a phenomenon whose benefits have passed many by.
For more information on Brexit, listen to this excellent podcast on the subject by the USA’s National Public Radio.
The Similarities and Differences Between South Africa and Brazil.
(Syllabus Section 4.1 – Similarities and Differences Between Developing Countries).
I am spending the holiday in South Africa at the moment so thought that I would do a post on South Africa and Brazil.
When I started studying economics all those years ago we used the terms ‘ the First World’, the ‘ Second World’ and the ‘ Third World’ – meaning the rich countries, the Soviet Bloc countries and the poor countries of the world. However, the phrase ‘ Third World’ implies that all the poor countries are lumped into one block and are the same. Not true.
One of the most difficult things about development economics ( and for the politicians and government bureaucrats that try and ‘manage’ the development of a country) is that every county is different – they have different histories, different resource endowments, different cultures, different political systems, different climates, different languages and different social institutions.
Each country therefore faces it’s own unique problems that require their own unique solutions.
Here are the similarities between Brazil and South Africa ( SA) :-
- Both are middle income countries – $ 6617 GDP per capita for SA in 2013, and $ 11208 for Brazil.
- They are regarded as the industrial power hubs of their two continents
- Both have been classified as BRICS
- Both rely on the extraction and export of raw materials
- Both have been suffering from falling economic growth recently because of the slowdown in the growth of China and the fall in raw material prices
- Both countries currencies have depreciated a lot recently
- Colonization – Brazil by the Portuguese, South Africa by the Dutch and the British, are common to both countries.
- Both are located in the Southern Hemisphere
- Both countries became truly democratic relatively recently ( see below)
- A strong African culture exists in both countries – in the case of Brazil due to slavery
- Extreme inequality of income and wealth, as shown by the shanty towns of SA and the favela’s of Brazil, are features of both countries.
- Both suffer from very high crime rates
- Both suffer from corruption
Here are some of the differences:-
- South Africa’s experience of colonialism was longer and much more traumatic for the country, due to the racist system of ‘ Apartheid ‘ – the forcible separation of races and cultures in the country. Apartheid only ended in 1994.
- South Africa’s peoples and cultures are more diverse than Brazil’s – SA has eleven official languages!
- Brazil’s population is much bigger than SA’s – 250 million verses 53 million
- Brazil is a much bigger country than SA
- SA, arguably, has a better infrastructure than Brazil.
This thirteen minute video is about the life of Nelson Mandela, one of the greatest leaders of the 20th Century, and the man largely responsible for ending Apartheid in South Africa.