Thursday, April 30, 2009

Is UK Overly Optimistic About Economic Recovery?

Not long after delivering Budget 2009 speech, the Chancellor was mocked by many as ‘Alistair in Wonderland’ when he quoted that British economy will be back on track end of this year. The Labour projected growth of 1.25% next year & 3.2% in 2011, something deemed as overly-optimistic

Perhaps he shouldn’t even have brought up this retarded statistics in the first place, instead comparing the extent of recession UK is experiencing now with other major European economies. For instance, Germany the largest European economy is expected to contract 5.4% this year, Ireland a drop of 9%, Latvia will shrink by 13.1% etc. That will at least ‘distract’ the Conservative & public away from government weaknesses in running the state. Having said so, these figures indicate that British economy is the star-performer, but only among a bunch of sour grapes

Nevertheless, his pure intention was well understood. First, he is trying to preserve the consumer confidence which seems to have made a comeback in March. Secondly, to gather public support given that there will be election next year

Why the growth figure is not-achievable?

(1) ‘Policy-proof’ recession. UK is said to have entered into a period of unprecedented economic downfall. Many leading economists regard this as probably the worst ever recession haunting the British economy after the post-war era. Given the nature of huge & fast contraction, it gained the name of ‘Great Recession’. In the recent Budget 2009, Chancellor Alistair Darling revealed that the government have to downgrade the forecast growth from -1% to -3.5%, also the biggest downgrade ever. All these prove that the recession is so deep that any ‘ordinary’ policy may not work

For instance, Bank of England had cut interest rate for six consecutive times since October last year. Since then, the interest rate is maintained at 0.5% (from April onward), the lowest ever in 315 years since the Bank was founded. Even at such low level, there is no pick-up in economic activities. People are increasingly cautious in their spending. Even with quantitative easing, house prices still fall by 0.4% in April. Fiscal stance is rather blunt as increase in government spending last year does not put a brake to the current recession

(2) Consensus. The National Institute of Economic & Social Research (NIESR), a leading economic think-tank said that British economy could contract by 4.3% this year. If this materialise, that means government’s statistic although have been downgraded a lot from the pre-budget, still proven to be overly-optimistic. Even the IMF boss dismissed Alistair’s claim saying that the figure was brought up with certain intention. In short, the whole world thinks that UK has not seen the worst & there is still space for further contraction. Therefore the forecasted growth will not be met

(3) Limit in future spending. The UK’s national debt as a percentage of GDP had increased dramatically from 2002 to 2007. This was despite the period of long economic expansion. The Labour government is very ambitious in their spending onto healthcare & education to increase productive capacity of British economy. However, it seems to be the gravest fault they have ever committed. They contradicted the common practice of slashing public spending & rise in tax rate in period of boom. Now it’s rather difficult to make a u-turn

David Cameron slammed the Labour administration by using an interesting quote of ‘not fixing the room when the sun was shining’. Nonetheless, national debt have increased at an exponential rate due to reasons like shrinking tax receipts, financial bailout of Northern Rock & RBS, nationalisation of Bradford & Bingley, purchase of shares in HBOS, pension obligations etc. Given such huge current fiscal deficit the future administration will have no alternative but to slash public spending, a painful but necessary decision. As such, the first sign of recovery in near future may be muted due to this

(4) Future tax rise. As expected, there will be several tax rises. The Chancellor tore up the New Labour election pledge by unveiling a new 50% tax rate onto those earning more than £150, 000 from April 2010 onwards. Also he added 2p on fuel, 1p on a pint of beer & 7p on cigarettes which have regressive effect since lower income people spend larger proportion of their income onto these. It will kick in as early as in September this year. Therefore, most average Britons will have lesser income to spend elsewhere like on leisure, food & clothing

(5) House prices. Despite various measures to ease tension in financial system, clearly there is no quick return to easy lending. Banks are still traumatised by the subprime crisis & as such increasingly cautious in approving mortgages. In fact to some extent, they are ‘discouraging’ borrowing activities. Two-thirds of the mortgage deals are only available to those who can put down a deposit worth at least 25% of the property’s value

With such condition, house prices will continue to fall & the negative wealth effect will spread wider into the economy. Base on past trends, house prices could fall for 4 years

(6) Escalating unemployment. Unemployment figure makes the biggest jump in nearly two decades to reach at 6.7%. The jobless total at the day of Budget was 2.1 million, the highest since Labour came to power in 1997. Rising number of jobless people could have a rippling effect onto whole economic system. It feeds through the negative multiplier effect. When the unemployed spend lesser, other businesses around will either make lesser profits, losses or worst went under administration. More unemployment will result. Leading economists claim that the rippling effect is just half way & as such it will break through the psychological barrier of 3 million by the end of this year

(7) Return of deflation. Deflation is defined as a period of falling price level. Arguably it presents more problems itself than inflation. When prices are falling, people will defer their spending say, on property & other consumer goods in expectation that future prices will be lower. So, aggregate demand (AD) will fall. As such in the following months, prices will be lower as predicted & there is a tendency to again adopt wait-and-see attitude. The cycle repeats itself. It is more like a self-fulfilling prophecy. Although rationally people want to make best decisions for themselves, but they didn’t realise that postponing spending will be ultimately disastrous since contraction in real GDP will lead to higher unemployment

The Japanese economy had tasted this under the so called long lost decade. A great recession, when prolonged turned itself into Great Depression. There might be a chance for the British economy to slip into that although the possibility is remote

Macroeconomic Effects Of Swine Flu Onto Global Economy

The swine flu pandemic could have unleashed itself at the time when it is mostly unwelcome. With no tentative & convincing evidence that the global economy will rebound in nearest time, the fear spread by swine flu is expected to put statistical data to a grimmer look
Mexico is the epicentre of the outbreak. However scores of confirmed cases have been reported in US & as such it has become the largest single country outside Mexico to suffer from the pandemic

Public in Mexico wearing preventive-mask to avoid infection

What’s the macroeconomic effects towards global economy?

(1) Fall in private spending. Take Mexico for instance. The government has announced a temporary curfew. Schools will be closed until May 6th & many other businesses shut down too as a precautionary measure. Within this period economic activities will slow down markedly. People choose to stay at home to avoid being infected. The impact onto Mexican GDP for the second quarter of 2009 will be detrimental. As many as one-fourth of Mexican resides in metro area

Consumers from US, Israel, New Zealand & many other large European economies will probably give the same reaction since there are suspected or confirmed cases there. The combo effect of global recession & swine flu will further reduce consumers’ optimism. Private spending will further decline & it may offset all efforts undertaken previously

(2) Falling share prices. Major stock markets around the world suffered from the beatings with Dow Jones Industrial leading the pack. From economics points of view, this represents negative wealth effect which could change consumption pattern. Stocks that overreact are mostly travel-related. For instance British Airways share prices fell 8%, Air France 7%, Cathay Pacific 8%, Continental Airlines 16% etc. Meanwhile others like Interncontinental hotel down 4.2% & cruise firm like Carnival lost 6.8%.

(3) Falling income for hog farmers. The nearest future is unpredictable for these poor farmers. Demand for sausage, beacon, pork chop & all other pork related meal dwindle in these few days, pushing its price lower. Some major hog farming industries in Kansas, Texas, California & Mexico will be severely affected as China, South Korea & Russia have placed an embargo towards the import of pork from these areas

(4) Drop in exports. Fall in demand for pork from major export destinations mentioned above will not bode well for the already-ailing Mexican & American economy. Fall in real GDP for 2nd quarter of the year due to derailing consumption will be magnified by the fall in exports. Through the negative multiplier effect, an initial fall in these two will lead to a larger secondary fall in aggregate demand (AD). Although export of hogs may not be significant as a percentage of GDP, still it will bring about measurable effect onto local economy

(5) Derailing price of grain futures. Investors are anxious about the rampant outbreaks of the fatal virus which would reduce pork demand, which means decrease in grain consumption. As such soybean, grain & corn futures for July delivery fell

(6) Waste of scarce financial resources. President Obama already asked the Congress for $1.5 billion to fight against the disease. Such huge amount of money perhaps could be better of spent onto helping homeowners to cope with mortgage repayments or spent onto other public services like schools & hospitals construction

(7) Currency sell off. Mexican peso was under some mild selling pressure over the past few days. This is because investors are fearful that the government might not be able to cope with the outbreak since WHO officials declared that they may need to raise the pandemic alert to Level 5 (now possibly 6). Also they could have predicted that recession in Mexico would last longer than thought.

(8) Affect American businesses. Some Mexican-based firms are important in US supply chain. If Mexican government mandated a closure onto the operations of these factories & workers confined, probably lots of businesses in US will be forced to a halt too. This is a good example for negative effect of globalisation


(1) Not all share prices fall. While it is true that many people suffer from negative wealth effect, there are quite a number of people who gain out of it. For instance, share price of Swiss firm Roche the manufacturer of anti-flu drug, Tamiflu rose 3.5% while GlaxoSmithKline which manufactures Relenza gained 5.7%

(2) Name of pandemic changed. The current swine flu virus name has been changed to H1N1 to avoid further damage to the pork industry in North America. Also it is to convey the message to countries that banned the import of pork that this is not a food-borne disease. Nevertheless, I’m doubtful that this will work. The swine-flu stigma is too thick in their head, that consumers almost immediately refer it to pigs

(3) May not be detrimental to global economy. In the worsening of times, people already began to change their lifestyle. Increasing number of people have cut their spending as can be seen from falling retail sales. Also more choose to eat at home. As such, the swine-flu pandemic may not spread the so called fear among global consumers. In other word, whether there is swine flu or not, people already choose to remain at home. Therefore there could be no severe fall in spending as exaggerated by many

Wednesday, April 29, 2009

Where's The Direction For The Price Of Pork?

It is rather unfortunate for the global economy having need to tolerate another economic nuisance when we already have a big one. The swine flu pandemic is set to be the gravity towards any effort to jumpstart the economy. While it hits the global economy hard, it hits hog farmers even harder

Over the past few days, demand for pork plunged critically as consumers are shying away from all pork related meal, from pork chop to sausage to beacon. The fall in consumption happens both inside & outside America. Countries like China, South Korea & Russia have banned the imports of North American pork. This sent the price towards a downward rally

While some may argue that hog farmers can always attempt to stabilise the price by cutting the supply of hogs to market, it is rather futile in this case. Fall in demand is likely to outweigh the fall in supply. So price will fall anyway. Secondly, pork is not a necessity like oil. Unlike oil, pork has many substitutes like chicken, fish, mutton & beef

Any attempt to revive the price upward, will cause consumers to further substitute towards other form of meat

Video Lesson by Richard Pettinger: UK's National Debt

Saturday, April 25, 2009

Why Malaysia Remains An Attractive Destination For Foreign Investors?

Malaysia’s success in attracting inward investment is not something unusual, but a record surge in the midst of global economy slowdown is phenomenon. Throughout 2008, we recorded an increase of 38% of FDI. This shows that in the event of rainy days, our economy is perceived as one of the ‘safest haven’ in the world

However, this figure is likely to decline this year given the worse than expected global recession. Nevertheless, I’m still optimistic that Malaysia will remain an attractive destination due to its underlying fundamental, both in medium & long term


(1) Vast natural resources. Malaysia is blessed with reserves of tin, bauxite, iron ore, copper, uranium, timber, oil & natural gas. Besides, it also has comparative advantage in rubber & palm oil plantation due to the suitability of its soil & weather. As such, it is said that Malaysia should specialise in these areas given that it can produce at a lower opportunity cost than any other nation & then trade. That also explains why we are one of the biggest rubber & palm oil producers for the world market. Multinationals are considering this as an added advantage when deciding where to be based. Raw materials to facilitate production are easily accessible & at reasonable price. It will help them to lower down their average costs (AC)

(2) Income tax lowered. Effective from this year, the maximum individual income tax rate was lowered from 28% to 27%. It has both demand & supply side effects onto those high flying earners like foreign corporate figures or foreign professionals. By having greater disposable income, they are able to increase their private consumption. Also, it can increase their incentive to work harder since they get to keep a greater percentage of their income

Comparison of corporate tax rate
(3) Lower corporation tax. Corporation tax was brought down to 25% in 2009. Now, with higher post-tax profits foreign firms will have greater incentive to invest in capital goods & engage in R&D activities. It may lead to new production techniques or technology that will assist them to further cut costs in times of turbulence

(4) Infrastructure. Malaysian government is committed in its infrastructure spending, although subject to some implementation lags. The Peninsular Malaysia’s highway network is one of the most efficient in Asia, providing the link to seaports & airports. This was complemented by the establishment of ARX (Asean Rail Express) which helps to transport containers to designated destination. It will soon be expanded to Singapore, Laos & Vietnam before ending up in Kunming, China. Multinationals will be able to cut transportation cost significantly

Also we have several airports, with the biggest one KLIA (Kuala Lumpur International Airport) has the capacity of handling up to 8 million tonnes of air cargo a year

Inflation rate in Asia, as in 2007
Inflation rate in Asia, as June 2008
(5) Low inflation. Inflation rate in Malaysia has been quite low for years. Although there was a noticeable increase last year due to surge in food & petrol prices, nevertheless it was within the manageable range. Low inflation translates to low production costs. Goods manufactured in Malaysia will be competitive

(6) Increasing income per capita. Rising income is central in developing economies like ours as it is a sign of the emergence of middle class income earners. These people have high marginal propensity to consume (mpc). It means, with every increase in RM 1 of disposable income a large proportion of it will be spent. The trend is healthy as it indicates the potential market for foreign firms to tap. Although we are growing rapidly in this sense, we are still behind China & India. Therefore, this just remain as a minor attraction for foreign firms

(7) High productivity. Malaysian workforce is one of the most productive in Asian region. Literacy rates are high as on average school leavers will have nothing less than 11 years of basic education. Increasing number of polytechnics & vocational institutions will help to cater for the industrial need. Also, Malaysian government is committed to increase spending onto education & healthcare sector under every of its five-year development plans. This will stretch the productive capacity of the local economy. Workers are able to operate complex machineries, understand complicated instructions & take lesser days off as sick leave

(8) Weak labour union. Our labour union is very weak unlike those in euro zone. Therefore, industrial disputes hardly surfaced. There will be no wage pressure for firms & this will keep production costs low. Also Malaysians are hardworking people. In reality, the people here especially in corporate sectors will work for about 9 to 10 hours a day (start work at 9am) & some even work on weekends. From economics point of view, more works could have been done & these help to minimise production costs. Workforce in an organisation can be rationalised

The World's PPF Shifting Inward Due To Recession

Production possibility frontier (PPF) is curve that (typically) shows the combination of two goods that can be produced within an economy if all resources such as land, labour & capital are fully & efficiently utilised. Based on this definition, therefore PPF is also the aggregate supply (AS) curve

In the period of recession like now, many factors of production remain unutilized

Consider the followings:

(1) Land. Multinationals have decided to hold back the expansion of businesses or the building of new factories. Lands which were acquired earlier will be left idle, so long as the direction of the economy remains bleak. Other sectors like mining of steel, copper, coal & other metals will slow markedly in response to weakening industrialisation

(2) Labour. Many workers from the financial lines such as commercial & investment banking were laid-off as many of these banks went under administration while some undergone consolidations. Real estate agents are not spared either due to the bust in housing market. People are not willing to take huge financial commitment like buying house in times of turbulence. Workers in manufacturing sector are badly hit too due to the weakening of global demand

The latest casualty will be the future of workers in tourism-related industry like hotel & airlines. While it is understood that the current unemployment is cyclical in nature, but it could easily turn into structural & long term in nature, as recession prolongs. Very often people take very long time to be reemployed. This is associated with hysteresis-where workers lose their skills, confidence & de-motivated which make it hard for them to land on future job

(3) Capital. Fall in factory orders will mean more capital equipments are not being used to optimal level. Spare capacity in the economy is said to have increased. This may raise the production costs of firms thus further reducing its profitability

Therefore, the output gap for most nations will widen as in the diagram below. It is defined as difference between actual & potential GDP (near or on PPF), quoted as a percentage of potential GDP
Source: wikimedia

Many countries have therefore witnessed an inward shift of their PPF, one close to the frontier of PPF to a new point inside the curve

Friday, April 24, 2009

Budget 2009: Implications Of Tax Rise

Earlier this week, both Chancellor Alistair Darling & Gordon Brown faced one of the biggest mocks from David Cameron. Being accused by Conservatives for driving unemployment into the highest level & pushing UK into deeper recession wasn’t something unusual. Nonetheless, bringing out the issue of never-ending-borrowing & bulging deficit is almost certainly good enough to put the Labour to an end in the coming election. As evidence, David Cameron has stretched his poll lead over the Labour by 18% following the Budget

One of the hottest talk about is the higher than expected income tax rate on those earning beyond £150, 000. We will also see an increase in tax on tobacco & alcohol

Implications of higher tax in coming years:


(1) A promise meant to be broken. In 2005, the Labour in its manifesto had pledged not to further raise income tax onto high earners. However, they first broke it last year when they announced that they new rate of income tax for the very rich Britons will be 45%. Again, they tore up a key New Labour election pledge by unveiling a new 50% income tax for the top 1% earners in UK in recent budget. These give the public an impression that the government is not trustworthy, especially among the rich. It’s also an effective weapon for Conservatives to attack the government

(2) Lower than expected tax revenue. Probably the current 40% is the optimal tax rate to maximise Treasury revenues from income tax on the rich, since it had stayed at that level for some time. Any attempt to go beyond that will cost Treasury revenue. The analysis can be understood using the Laffer curve analysis as below. This is because the rich will either fled UK or use accounting rules to avoid paying so much. Also, when the rich spend lesser in UK, it will hit other areas such as VAT receipts

(3) Regressive effect. Higher tax such as 2p per liter of petrol, 7p on cigarettes & 1p on a pint of beer will certainly hit those low-middle income people as their total expenditure as a percentage of total income onto these items will increase. Look at it mathematically. Expenditure increases since these essential items are made less affordable & recession is followed by falling income. It may worsen income distribution

(4) Adverse supply side effects. Higher income tax reduces the incentive to work among the rich. It is meaningless to work harder, ending up with higher income & fall into higher tax bracket. It is a counter supply side measure

(5) Putting all families to poverty. The present & future government will have to incur several years of fiscal deficit amounting up to £530 billion (£175b this year, £140b, £118b, £97b in coming years). Government spending onto public services will have to be cut & it will hit those lower income people whether directly or indirectly. Also, not to forget that present borrowing will have to be financed by higher taxes in the future. Conservative estimates show that every UK family will have to fork an additional £2840 every year on income tax by 2017. Standard of living will definitely fall


(1) Balancing the budget. Despite painful, it is necessary to bring UK back into fiscal surplus, something that we can only dream off in near future. Even David Cameron mentioned that they will have to stick to 45% tax rate onto the rich if they come into power. Probably the biggest mistake of Labour is not bringing the deficit back to balance while UK enjoyed a period of high growth these years

(2) Source of revenue. The most traditional argument of all. Rise in taxes is necessary to enable government to carry out its duty to serve the public, paying out wages for workers in public sector, development projects & to avoid heavy borrowing somewhere in future

(3) Demerit goods argument. More expensive cigarettes & alcoholic drink is good to deter first timers from picking up these ‘unhealthy’ habits. The money spent onto these could be better spent elsewhere or save. However, some may argue that those who have picked up the habit will not change their consumption pattern since these goods are addictive

Sunday, April 19, 2009

Possible Reasons Bank Of England Put Interest Rates On Hold

The recent move by Bank of England to keep interest rate on hold on 0.5% was widely expected. Rates remain at all time low after 7 consecutive cuts since August last year

Source: BBC
There are several reasons for this:

(1) Realising that interest rate cut is not effective. Probably BOE took a lesson from Federal Reserve. Not even a 0% interest rates can reverse the contraction of economy. The nature of recession in this round is very much different than the previous. It is due to the fact that banks are trying to revitalise their balance sheet & also at the same time there is shortage of credit in the financial market. In short, banks are very much less willing to lend. Therefore, even though cost of borrowing is at attractive level much of the loan application would have to be turned down. Furthermore, there are lag effects & probably the impact won’t be felt, not until at next year

(2) Better alternative tool. It is called quantitative easing. This is a non-traditional monetary tool. It means easing the economy by increasing the quantity of money. How? By buying assets such as corporate & government bonds so that the bank will be flushed with liquidity & therefore can resume lending to companies & individuals as usual. Bank of England grew fond of this measure recently. It is optimistic that this will have an immediate impact. It has announced the creation money to buy £75 billion worth of bonds & will be done in 3 stages

(3) Protect savers. Keen savers have witnessed the return from their savings diminish sharply in recent months. Although the current level of interest rates is very low, some argued that it’s better than nothing. Also any further cut in interest rates will cause failure in attracting deposits. Commercial banks may still be haunted by liquidity problems & the central bank will have to print more money

(4) Wait & see. It could be very difficult to assess the impact onto wider economy if interest rates are continuously slashed. Also the Bank may need to investigate what is the optimal level of interest rate cut before economic activities begin to pick up? Is it 0.5%, 2.0%, 2.5% or 3.0%? Furthermore, by holding the rates on hold enable economists & policymakers to segregate the effect of these two measures

Saturday, April 11, 2009

Consequences Of Ageing Population In Developing Countries

If there were to be another bigger problem for the global economy in the near future, it will not be another episode of global recession but rather the issue of ageing population. Recession is just a ‘sweetener’ to the crisis of ageing people within an economy. Furthermore, the problem seems to be ideally ‘permanent’ as improvement in economic performance is always followed by falling mortality rate & birth rate

The proportion of people aged between 60 years & above in the world will double between 2000 & 2050, an up from 10% to 21%. As a matter of fact, populations are ageing even faster in developing world as fertility rates have declined more rapidly in recent years than developed world.

Asia, Latin America & Caribbean are the world’s fastest ageing regions. Even Sub-Saharan African with lowest number of elderly people than any region (due to low life expectancy), is projected to see its older population grew 2.3 between 2000 & 2030 (refer diagram below)

Proportion of elderly populations around the world in 2000

Proportion of elderly populations around the world in 2050


(1) Increase in dependency ratio. It is given by the formula of:

[ (number of children 0-15) + (number of pensioners, >65 years) ] / (number of working population, 15-65)

It is worth to take note that falling birth rates (lesser newborns) & falling mortality rates (people live longer) will inflate the numerator figure. Due to falling newborns, the number of people falling into the working age group will decline over time, putting a downward pressure onto the denominator. As such (bigger number) / (smaller number) will therefore increase dependency ratio. If the ratio is 1.2, it means for every 10 working individuals, there will be 12 dependents

Younger generations will be under immense pressure to provide sufficient financial support to the dependents, especially their parents. They are equally divided between working longer hours outside to earn more income & spending more time with the old ones at home. The financial commitment is potentially large since elderly people have poorer health & yet the cost of medication in developing countries is ballooning over the years. This problem will be more significant upon married people as there are other commitments too e.g. spouse, mortgages, cars, children’s education etc

(2) Non-productive labour force. Productivity is defined as output per worker. While it is true that retirement age can be extended, some quarters argued that elderly workforce will pose more problems. They are often forgetful, slow work pace, took many sick days leave & less motivated than young ones. AS curve will shift leftward. There will be lesser work done, thus lesser output within an economy

Evaluation: This is often not true. The argument above is more suitable to cater for manual skills like working on construction site & farm, which requires physical ability. With the emergence of services sector in developing countries such as healthcare & education line, elderly workforce is highly respected for their experience. Many of them are retained due to difficulty to find replacement of such ‘gold standard’ in human capital. Experienced senior surgeons can train more young doctors while experienced lecturers & professors are needed to conduct research & passing on their knowledge to younger generations. Therefore in these areas their productivity is very high

(3) Higher level of pension provision. This is never an issue as long as each successive generation is of approximately the same size (working age vs. retirees). A large group of pensioners with a smaller group of workers however means that sums do not add up. The only way to sustain the growing number of elderly people is to continuously revise tax levels upward, which is often very politically unpopular. The other way would be to reduce pensions. However, many feel that this would deprive pensioners of payments that they have committed for during their working lives & are entitled to

Domestics savings around the world

Evaluations. However, not all governments from developing world face immense pressure in pension provision. Consider East Asia with countries like China, Hong Kong, South Korea, Singapore, Indonesia, Philippine & Malaysia which have among the highest domestic savings rate in the world. It is also an indicator that elderly people in these areas can be self sufficient in their older days, reducing their dependency on government & their kins

(4) Greater demand for healthcare. Elderly people generally frequent hospitals more than the young ones due to deteriorating health. With a ballooning number of ageing populations in near future, governments will be under great financial constraint to build more hospitals, train more doctors & nurses, paying more wages, import more medicines & specialised surgery equipments which easily costs billions. Increase per capita health expenditure onto elderly adults is afraid to create opportunity costs to other sectors like education & infrastructures

Evaluation. Providing state-of-art healthcare centres are utmost important to ensure that ageing people can still contribute actively to the economy, thus maintaining the level of growth. Furthermore, it is an issue of universal basic rights. Besides, governments can collaborate with private sectors especially insurance firms to educate younger generation regarding the importance of owning a personal insurance & medical card. Doing so, will reduce its financial commitments of providing ‘subsidise’ medical treatments to the citizens

Thursday, April 9, 2009

To What Extent Increase In Population Promotes Economic Development?

As the 21st century sets in, the world population was estimated to be at around 6.1 billion people. Projections by UN (United Nations) revealed that this figure will easily surpass 9.2 billion by 2050 & most of them will come from developing countries. The issue of ballooning population is not a new debate. It receives mixed blessings

Some countries like China used to encourage people to have lots of children in order to boost the country’s workforce. But in 1970s, it came to realise that the population growth rate would soon become unsustainable. Therefore, the one-child policy was implemented in 1979. On the other extreme, countries like Russia, US, UK & Japan would like to take immediate remedial steps to change its current demographic structure. Birth rates have fallen drastically. This too, will pave way to some other unimaginable problems

Population growth rate by region
So, increase in population promotes development?

(1) Greater output. Increase in population will ensure a steady supply of workforce within a country. With rising number of people who fall into the working age category, there will be more goods & services produced. Higher economic growth can be achieved. As a matter of fact, East Asia’s economic miracle coincides with its population boom. It accounts for more than one-third of its growth

(2) Attract FDI. Multinational firms especially from the West are largely attracted to developing countries. There are just too many reasons, but all lead to one-lower production costs. Large number of population will almost ensure downward pressure on wages. Cost saving is magnified when we take into account than many of them are educated & they are willing to endure long working hours. Inflow of foreign investment will boost country’s economic growth

(3) Greater savings. Due to the first two factors discussed above, levels of savings within an economy will increase in line with rising number of workforce. Pools of funds in financial institution are important as a source of financing for both domestic & foreign firms. In some very populous countries like China, firms have reaped the benefits from high savings ratio. Raising capital domestically is never an issue

(4) Higher tax revenue.
Larger number of workforce will provide government with more income tax revenue. In fact for most governments, this is the largest source of revenue. Secondly, rising population positively correlates with number of firms established. Firms are set up to tap into the broadening market for their products. This means more corporation tax revenue for government. Lastly, VAT (Value Added Tax) from goods also contributes to the tax base. All these are important to ensure sufficient funding for development projects like building of schools, modern healthcare facilities, improve road conditions from rural to urban etc.

Perhaps not:

(1) Malthus prophecy. Malthus presented his theory of population in 1798. According to him, population will increase geometrically while food expands arithmetically. If nothing is done to slow down the population growth, the nature would apply its own crude method to reduce population from its higher level. This is known as ‘positive checks’ by him which includes natural disaster, epidemics, earthquakes, drought, flood & natural calamities. Well, I feel that he has his point. Volcanic eruptions & Tsunami in Indonesia had taken many tolls. Epidemics like AIDS & drought in Africa have contributed to millions of death every year

(2) No development. If population growth outweighs economic growth, there will be no development. National income will be shared among more people. Income per capita will decrease, thus deteriorating the standard of living

(3) Unemployment. In many developing countries, it is common to witness people migrating from rural area to the urban. Despite providing large job opportunities, the modern secondary & tertiary sectors are unable to absorb all these migrants. Hence it is said that rural unemployment is replaced by urban unemployment. Having no money to return home, many will be stranded up in shanty towns in the midst of city. Sau Paulo, in Brasil & Bombay in India are well known for this

(4) Famine. Although Western economists condemned Malthus theory of food production, to me his argument makes complete sense. Consider LDCs (Less Developed Countries) with high population growth rate like SSA (Sub Saharan African) countries. Famine is no new issue for places like Zambia, Uganda & Zimbabwe. Despite having comparative advantage in farming with large number of workforce & lands, food production is never enough

(5) Constraints onto scarce resource. Rising population is a sign of more desires to be fulfilled. There will be greater demand for oil to fuel economic activity, demand for steels creeping up in manufacturing & construction industry etc. It’s just a matter of time before these natural resources deplete. In the recent years, prices of commodities went up due to the strong demand from both China & India, two of the most populous countries in the world.

(6) Deforestation. It was estimated that 8 million hectares of forests are lost each year. More trees & animals will have to be victimised in order to pave way to rising population. These include the building of residential houses, offices, infrastructures etc. This has disturbed the atmospheric composition & worsening the event of global warming

(7) Civil unrest. There will be more conflict between states & areas due to the problem of overcrowding & fight for natural resources. People will also struggle to ensure their survival by fighting for the source of fresh water

Wednesday, April 8, 2009

How Crowding Out Takes Place?

Crowding out effect is a situation where increase in government spending to stimulate the economy which is in recession will eventually lead to a fall in both private consumption & investment. In other word, the initial increase in AD may be offset by the fall in the latter two

This is closely related to budget deficit where total government spending exceeds total tax revenue. In a period of economy slowdown or recession, public spending like construction of schools, hospitals, repairing roads & bridges etc will definitely increase. So a government will need more financial resources to accommodate this. Unfortunately, tax receipts will fall as many people will be laid off & firms incur losses. In a nutshell, budget deficit will widen in this period

In UK, the deficit is already standing at £8.99 billion as of February 2009 & this was 8 times the figure seen a year earlier. It is in conjunction with the fell in tax revenue by 10%. Total government debt is equivalent to 49% of GDP. However the worst is far from over as they yet to include the potential £1 trillion to £1.5 trillion debts from Royal Bank of Scotland & Lloyds Banking Group which they have to include, since they have taken stakes in these 2

How increase in government borrowing can crowd out both private spending & investment?

(1) Increase in tax. Ballooning deficit will have to be balanced in the future. This means as economy embarks on recovery path, government will have to reduce its spending & increase income tax, corporation tax & VAT. Public & firms expecting that future tax rate will be high are discouraged from spending as they know that they are worse off anyway. Increase in savings may offset the initial increase in AD (aggregate demand)

(2) Increase in interest rates. When a government borrows in large scale, they have to increase interest rates to attract people to hold bonds. However, increase in bond yields will be followed by increase in interest rates offered by commercial banks. This is because they have to compete with government to attract funds. The costs of paying higher rates to depositors will be passed on to people who hold mortgages & businesses that take financing. As such, consumers & firms will be discouraged from spending

(3) Lesser money to spend. As people buy bonds, it is said that they will have lesser money to spend. Also when firms buy government bonds, they have lesser funds to invest

Arguments on why crowding out is unlikely:

(1) High marginal propensity to consume. It depends on whom the tax is targeted at & which sector of the economy receives more funding. Generally, people with lower income have very high tendency to spend when there is an increase in their disposable income. Also if government increases public spending onto areas where salaries are relatively low, it will positively boost consumption

(2) Interest rates may not increase. In the period of recession, generally stock market is not performing. Demand for shares will fall, sending its price much lower. People are more attracted to bonds as long term investment which is also safer. The chance of government defaulting is very low. When demand for bonds increase, its price will escalate. Given that, bond yields & bond price are inversely related, interest rates will be kept low

Saturday, April 4, 2009

Top 6 Reasons Why Dollar May Collapse

At the point of writing, the direction of dollar against euro & sterling is just too inconclusive. There were several ups & downs. However, in the long run there are some evidence that the dollar rally may not last long


(1) Large current account deficit. This has been an ongoing problem with US economy & it becomes worse in recent years. The trade deficit is caused by growing appetite among Americans to consume imported goods. Imports grow relatively at a faster rate than exports. Also it was exacerbated during the era of Greenspan where interest rates were so low, which then leads to housing market boom that raise the economic growth. Such huge trade deficit means outflow of money is greater than inflow, thus creating downward pressure on dollar. People are selling dollars to get hold of Chinese goods

(2) Falling demand for US securities. All these while, US is able to sustain its current account deficit & prevent its currency from falling with the help of capital inflow. China is undoubtedly its biggest & most reliable lender thus far. The Chinese is very willing to help US partly due to the strong trade interrelationship. Letting Americans drown will not do any good to China, which rely on US as its largest export destination. However there is growing evidence that China & some other major economies like Japan are slowly substituting dollar to embrace euro. Since inception in 1999, world euro reserves have been growing at the expense of dollar

(3) Foreign central banks unwinding dollar assets. In the event of global recession, US economy is perceived as the safest haven. Therefore selloff hit many countries around the world, especially emerging economies. The reversal of capital flow has caused some currencies like rupee to depreciate. As such India’s Central Bank is forced to use its dollar reserves to buy home currency. Increase in its demand will raise the value

Another possible reason large budget deficit in oil gulf nations. Oil producing nations like Saudi Arabia has engaged in lavish spending these few years due to their ballooning dollar reserves. Most of it comes from the period where oil price was skyrocketing. Now it runs into budget deficit. One of the ways they are going to finance it, is by selling dollar assets. Again increase in supply will weaken the dollar

Countries like Russia, Saudi Arabia, India & Japan have around $2 trillion dollar holdings. It is expected that if situation worsens, these countries will likely ‘dump’ dollar. Interestingly, who will probably buy all these assets? (Probably …….you know the answer)

(4) US can’t raise interest rates now. It will be ridiculous if one suggests that US should raise interest rates now to attract inflow of foreign money. With such record low interest rates 0-0.25%, average Americans are still frugal & cautious in their spending. Any upward movement of rates will instantly kill the economy. Price deflation is the last thing we would like to see

(5) Quantitative easing. It was introduced as the traditional monetary tool has failed to revive the economy. Basically, it is somewhat like the modern day of printing money to buy US government bonds. Somehow, there is fear that US government could be too immature with this unconventional tool. The effect of quantitative easing could be stronger than predicted. If it were to happen, large increase in supply of dollar will erode its value

(6) Large budget deficit. Basically, when a government runs a budget deficit it means for a particular year, its total expenditure exceeds its total tax revenue. Due to this, it has to borrow by issuing Treasury bills & long term government bonds. The situation is very chronic for US. It has to fund the on going wars in Iraq & Afghanistan, increase the size of bailout for banks & auto companies & bigger stimulus package from time to time. Also it is worth to remember that they have the biggest commitment of all, which are social security & Medicare for the baby boomers. I’m very unsure to what extent they can borrow & to what extent foreign countries are very willing to lend

It has many repercussions. Even US’ closest trade partner began to doubt its ability in repaying all these debts. Recently, Chinese officials have suggested that yuan should be considered as an alternative to dollar. But what ever it is, if other countries began to sell dollar assets or demand for bonds fall, dollar may be slammed to its knee

Improving Your Evaluation Skills

Good one from Geoff Riley. Crucial for GCE candidates sitting for Economics exam in June 2009

As for me, I always recommend my students to ‘CONTRADICT’ what they have written initially. The previous statement could be a theoretical view that is sometimes right, BUT not all the time

Some random examples:

(1) Ideally, the recent cut in interest rates to 0.5% by Bank of England should be able to revive economic activities. However, there is an outweighing factor & that is lack of consumer confidence. This explains why spending & investment activities fail to pick up

(2) Cut in tax rate should be able to increase household spending. But given the current economic turmoil, the extra disposable income is likely to be saved for rainy days or use to pay off their mortgage debts. Therefore we may not witness a significant increase in consumption

(3) Privatisation as one of the supply side policies may no longer relevant in UK context. This is because many firms have undergone privatisation during the era of Mrs. Thatcher & was continued by her successor, John Major. Furthermore some economists argued regarding the wisdom of this policy since some firms were renationalise such as Railtrack in 2001

(4) Increase in tariffs may not necessarily cause the imported goods to be expensive if the firm is willing to absorb part or the whole tariffs. In this case, firms are still able to sell at their old price thus causing harm to domestic companies

It could also be some sort of ‘SUGGESTIONS’ or the issue of ‘SHORT RUN vs. LONG RUN’

(1) GM should not pass on the increase in the price of raw materials like rubber & steel to end consumers given that the car industry in US is so competitive. Any attempt to do so may worsen the situation as American consumers will substitute away to the more fuel-efficient Japanese cars

(2) In the short-run, increase in crude oil prices will cause companies to pass on the increase in production costs to end consumers. Somehow in the long run, these firms will likely attempt to mitigate the impact via an increase in investment onto capital goods. This will counter the backward shifts of AS

Why Price Of Tea Has Gone Up Recently?

Source: BBC (prices of tea have soared)
Refer to this link:
The reported increase in the price of tea can be explained using a simple & yet powerful demand-supply diagram


Evidence from text indicating fall in supply:

(1) Tea producers have probably cut production in 2008 given that there was surplus in 2007. In agriculture, farmers often make future decision based on the past. In this case, they expect 2008 to be in surplus too, which may lead to fall in price

(2) Kenya, India & Sri Lanka as the 3 largest tea producers in the world were hit by drought last year. As such supply of tea leaves fall


Evidence citing an increase in demand:

(1) Tea consumption reached 3.85 million tonnes last year, an increase of 4.8% from 2007 & global demand for tea consumption is expected to soar

Why British consumers may need to pay more?

(1) Any increase in crude oil prices which lead to an increase in transportation costs, will have to be passed on by teamakers

(2) Pound is weakening against dollar recently. As such, consumers in UK will have to pay even much more on top of the already-expensive price

As a matter of fact, fall in supply & increase in demand curve can be put together under one same diagram. (I couldn't find a diagram that shows fall in supply & an increase in demand, so I conduct separate analysis)