Saturday, May 30, 2009

Why Oil Prices Climb Steadily Though We Are Still In Recession?

At the moment of writing, oil prices have hit seven-months high thus breaking the barrier of $66 dollar per barrel. At one look, it seems to be very contradictive with the conventional economic wisdom. We often hear or read that during the period of global recession, people will become thrifty. They will cut their spending in almost everything. Firms in response, slash their production and rationalise the number of workers. The breakdown in entire economic activities should in theory hamper the demand for oil

But think again. Sometimes economic theories such as simple demand and supply may not be sufficient to explain such sort of phenomenon. It goes beyond the ordinary functioning of the market such as psychology factor


(1) Quantitative easing. In layman term it means easing the economy with quantity of money. The financial market in US is currently crippled with major financial institutions reporting historical loss. Common names like Bank of America, AIG, Citigroup, Wells Fargo and Goldman Sachs are popular headlines in recent times. In short, the whole financial system suffers from liquidity problem. Banks find it increasingly difficult to raise additional financing from money market since interbank lending rate increase. That left them with one most viable option that is attracting deposits. However, there is pressure from Fed to lower down the interest rates, which may shoo away savers

Therefore, Fed announced an alternative plan and that is pumping extra cash into the system by buying $300 billion worth of long term Treasury bonds and about $700 billion of mortgage backed securities from those troubled financial institutions. So investors and some countries are speculating that the end of dollar is near. They are afraid that US will inflate their way out of recession, thus imperilling the value of dollar. Another way to see this is increase in the quantity of dollar circulating around, so the greenback will fall in its value. Although this is yet to happen or will not happen actually, but unfortunately people “want” to believe that it will eventually come true. So this “self-fulfilling prophecy” could have gradually worked itself out. More people are dumping the dollar, causing it to really depreciate in value against other currencies. However, not to forget that black gold is quoted in dollar. So now it seems that buying oil is artificially cheap, pushing the demand upward

(2) OPEC’s optimism. Again this is another type of “self-fulfilling prophecy”. The OPEC members could have digested the report released in the recent saying that US economy will most likely recover by the end of 2009. Also it will be the catalyst in reviving global recession. In what capacity can an organisation or policymakers foresee a future? Is number crunching alone enough? I’m pretty doubtful of this

However, due to the “believe” that the OECD economies have seen the worst, OPEC is likely to stop increasing supply in order to help the gas-guzzling Western economies. They will want to hoard more oil inventories. Besides why increase the supply when these can be kept and sold at higher price in the future? Why make less when you can actually make more? In a nutshell, they wanted to “believe” that major economies will recover and thereby fuelling the demand once more. This is another point that explains the recent oil rally

(3) Investors’ sentiment. They too “feel” that the US economy will recover by the end of this year. As such by that time, revival of economic activities will once again fuel the demand for oil. In such anticipation, they immediately flock into oil futures betting that oil price will increase in near future. So the mentality of why-not-invest-now prevails and when oil price possibly hit beyond $70 dollar per barrel, they claim that their prophecy is truthful when they are the one who actually engineered it

Tuesday, May 26, 2009

Forecast Essay, GCE Edexcel Unit 2: Examine The Merits Of Fiscal & Monetary Policy To Revive UK Economy (30m)

Both fiscal & monetary policy are demand management tools. They are meant to influence the movement of aggregate demand (AD). To revive the present economy from recession, the UK government will have to increase public spending & slash taxes. Meanwhile Monetary Policy Committee (MPC) will resort to cutting interest rates

Source: economicshelp

With lower interest rates, private consumption is set to increase. There are two reasons. First, fall in the costs of borrowing is likely to induce entrance into the property market since financing mortgage becomes much affordable. Also, low interest rates discourage the savings habit. Sterling is expected to weaken since many rich individuals & pension funds withdraw their money from UK & park elsewhere, say European banks. This is a good news for beleaguered manufacturers as their products gain some competitiveness. Exports will rise. Increase in both private consumption & exports will shift AD rightward, thus expanding the real economy

Rise in public spending say building of schools, hospitals, repairing roads & bridges will directly lead to an increase in AD since government expenditure is one of its component. Through the multiplier effect, an initial increase in injection will lead to a larger secondary increase in AD. For instance, just consider the impact of the construction of Heathrow Terminal 5. Thousands of jobs have been created & related industries such as producer of cement, steel, construction equipments benefited too. Real GDP will expand thus pulling UK out of deep recession

Lastly, with lower income tax working people will have greater amount of disposable income. They will therefore increase their spending into the economy. As for firms, lower corporation tax will increase post-tax profits. This will increase the incentive of firms to invest in new capital equipments & other forms of research. These two also have supply side effects. People will be more motivated to work with larger take-home pay & firms may make discovery on more cost-efficient techniques

However, the nature of the recession is very different this time. It is due to shortage of liquidity in the financial market. UK banks have made large losses in 2008 & therefore they are very reluctant to lend. While lower rates have created some interest to borrow, banks put condition such as requiring high deposit of 25% of value of property. As such house prices & confidence remain low. UK economy is expected to contract further

Large scale government spending may create crowding out effect. When government increase borrowing by issuing bonds, usually it is those private sectors which take up these paper assets. As a result, they have lesser money to invest. Having said so, one could argue that crowding out may not happen since government is just making good use of idle financial resources. Otherwise firms may not even bother to invest in such period

Third, while it is true that government usually slash direct taxes, at the same time they might impose other form of taxes like sin taxes. Alcoholic drinks & cigarettes are the common target. This has regressive effect especially onto the lower income people. This is because the spending onto these items as a percentage of their income will increase

Forecast Essay, GCE Edexcel Unit 2: Assess The Effectiveness Of Supply Side Policies To Increase Employment In UK Economy (30m)

Supply side policies seek to influence the movement of AS by increasing the productive capacity of the economy. There are two thrusts & one of them is supply side measures for labour market

Source: economicshelp

First, the Labour government should continuously improve the British education system & set up more training centers. Courses taught in universities must be reviewed all time to ensure that it is relevant to industrial need. Also new courses that teach modern skills must be introduced. By doing so, UK will have a more productive workforce that are able to apply their knowledge into working life, understand complex instructions & take up more challenging jobs that require mental skills. The government can also consider increasing the existing number of training centers to help those people who lost their job in old industry. These should be able to reduce the damage done by structural unemployment & increase mobility. These two lead to rightward shift of AS

Next is labour union reform. UK government has actually removed some legal protections once enjoyed by unions such as restrictive close shop agreements, putting constrain to their ability to take industrial action and others. The result has been an increase in the flexibility of the labour market & firms are more willing to hire given that there is less pressure on wages increase

Lastly, continuous improvement must be made to the benefit system. For instance, government can consider reducing the amount of jobseekers allowance compared to average wages of people in work. By doing so, the opportunity cost of staying idle will increase & these people especially those frictionally unemployed will have more incentive to look for jobs. Others like Working Tax Credit (WTC), a payment to people on work but with low income should also increase participation rate

Improvement on education system is however more suitable as a long term goal. This is because one has to go through years of education before ending up in job market. Even then, they may need another several years of on-the-job experience before their productivity really pick up. More training centers could a better solution to reduce unemployment in short run

Although reform to trade union is an effective policy, it is somehow less relevant these days given that the unions had been crippled during the era of Conservatives. Furthermore UK has moved from traditional manufacturing sector into more modern sector like services & quaternary, resulting in lower concentration of workers in one area. Therefore it is even much more difficult to organise a strike

Cut in unemployment benefits is actually meant to ‘punish’ those people who refuse to look for jobs. However, it could be seriously unfair to those who have tried their best to look for jobs but fail to secure one. It will just worsen the condition of relative poverty. Meanwhile, WTC has been subject to much criticism surrounding its implementation. Also its computer system often have problem leading to delays in many receiving payments

Forecast Essay, GCE Edexcel Unit 2: Assess The Effectiveness Of Monetary Policy To Combat Deflation (30m)

Monetary policy is the manipulation of interest rates to influence the movement of aggregate demand (AD) & thus overall level of economic activities. Deflation means falling price level & normally happens in period of fast contracting economy. Hence in this case, the Bank should consider cutting interest rates

With lower interest rates, more people will be induced to spend since cost of borrowing has fallen. More will take up loans to buy property, cars, LCD TV & others. With rise in demand say, for property, house prices will increase & this have positive wealth effect which will further trigger spending. Also lower interest rates discourage saving. These will lead to rightward movement of AD. Real economy will expand & price level will also increase, hopefully to the targeted level of CPI 2% +/- 1%

In period of low interest rates, firms are also encouraged to spend of capital equipments & expansion of businesses. This is because cost of financing them has fallen. It also indicates that rate of return on capital has increased. This will shift AD rightward, leading to an expansion of real GDP & rise in price level. Targeted inflation rate may be met

Lastly, lower interest rates will cause wealthy foreigners, pension funds & other wealth management companies to withdraw their money from UK. They will seek for other countries that give better yield such as European banks. In order to do so, they will need to exchange pound for other currency as in this case euro. Therefore pound will depreciate against euro. This is a good news for UK manufacturers. Demand for exports will rise & possibly resulting in increase in net exports. Again, AD shifts rightward

Having said so, consumer confidence plays a major role. In the period of pessimism, probably fall in interest rates will not be enough to prevent deflation. For instance, the Federal Reserve have reduced interest rates to between 0-0.25% & the Bank of England 0.5%, yet it fail to kickstart the economy

It is also worth to take note that monetary policy could be a blunt tool. In the period of high inflation, it can be increased indefinitely. However in period of deep recession which is often followed by deflation, interest rates cannot be cut below 0%. In the current crisis, both the monetary authority in UK & US have to abandon interest rate policy & adopt non-traditional method such as quantitative easing

Lastly, it could have severe effect lags. It is said that any interest rate cut will not produce visible results, not until at least after 18 months. This means that recent interest rate cut in UK may not produce the result until the mid of June 2010. This is likely true given that increasing number of UK people have switched to fixed rate mortgages due to fast rising interest rates prior to subprime crisis
Note: I met the Edexcel Chief Examiner for Economics, Mr. Brian Ellis last year in a conference held in Kuala Lumpur, Malaysia. According to him, although the extracts are taken from previous years article, students can apply his knowledge of current issue into the writing. Furthermore the purpose of the exam is to test students application skill

Thursday, May 21, 2009

Evaluation On Obama's Fuel Efficiency Plan

Recently, President Obama has announced an ambitious first ever national standard for fuel efficiency & carbon emission target, something he called as ‘historic’. According to the underlying plan, US carmakers are expected to increase fuel efficiency by 5% annually from 2012 to 2016, emission reductions will be 34% by 2016 and consumption of oil will fall by 1.8 billion barrels throughout the life time of the cars sold in next 5 years

I have to agree with Mr. President, car manufacturers, consumers & environmentalists due to the following:

(1) Costs of driving go down. While it is true that Americans will have to pay a higher price for new cars by an approximate of $1300, somehow it will be offset by lower fuel cost. The payback period is around three years. With better mileage, one can reach a destination by paying less for fuel

(2) Less outflow of money. With more fuel efficient cars on the road, petrol consumption & demand will fall. US will need to import lesser oil from Saudi Arabia, Venezuela, Libya & Nigeria. There will be lesser outflow of money. US’ deficit in net oil trade as a percentage of GDP will get better. Current account deficit may also improve. The extra money that goes to pocket can be spent locally, thus boosting US economy. Also Americans can reconsider to kick start savings habit

(3) Cleaner environment. US is the biggest car market in the world. It has about 250 million cars & light lorries on the road. Hence, if the targeted reduction of 34% in carbon emission materialise, the impact onto slowing down the process of global warming is highly significant. It may also bear positive externalities onto other countries climate although the magnitude is questionable

(4) Provide competition to foreign carmakers. In terms of fuel efficiency, US automakers got to learn a lot from its European counterparts as well Asian manufacturers. The Big 3 have focused too much on safety features of the cars they make, hence all cars designed are big & bulky like the SUV. Japanese carmakers especially, have noticed long ago that Americans actually desire much fuel economy car in those days where pump prices are rising steeply. So they created models like Toyota Prius & hybrid versions of popular Honda models. Now, with new ruling hopefully Ford & GM will push themselves to be more competitive

(5) Encourage innovation. The targeted 5% annual fuel efficiency improvement will ensure US carmakers to continuously invest onto R&D. In the future, it is hoped that they can come out with much better green technology, innovative ways to cut production costs & be more efficient in other ways. This may also turn their fortune around & allow them to once again chunk in supernormal profits

(6) Single national standards. Operating with single standard nationwide is much better than two, shall California’s standard come into full force. Also, the costs of operating the two will be high with no additional benefits to environment, cause confusion & prevent time wastage in court battles

Despite all the applaud, I have more critics:

(1) Less effective. This fuel efficiency plan is considered less effective than gas taxes in reducing petrol consumption. This is because, the latter affect types of cars bought & choices of driving. In short, a big SUV is expected to very fuel consuming. But if combined with distance of travelling, motorists are expected to be ‘punished twice’. Therefore, under gas taxes people have the incentive to plan their journey. However with the new plan, demand for petrol is likely to increase since cost of travelling indirectly has fallen. At the end of the day, fuel emissions will not be reduced

(2) Hidden costs. This leads us to second argument. When one travels more often, there are other non-petrol costs to be considered such as costs of maintaining the car. Cars that travel intensively will definitely be sent in to workshop more often, changing of tires etc. So the claim of cost saving throughout the lifetime of the vehicle is highly questionable

(3) Counter productive. Since the standards raise the price of new cars, it may create unintentional effect of keeping older, dirtier & less fuel efficient cars on the road longer. What about companies? Keeping old light lorries is counter supply side measure in a way that there will be lower level of investment into the economy. It may break down more often thus disrupting the timely delivery of goods

(4) Affecting other economies. US is the largest consumer of oil. As said earlier, if the plan materialise, demand for fuel will fall & this may send crude oil prices down, thus reducing the profitability of oil exporting nations. This could be very detrimental to some like Iran & Nigeria since their economies are not well diversified. Furthermore, within the short run of 7 years, it is quite difficult for them to discover an area where they may comparative advantage & start to build strength on it. Having said so, some may also argue that they could cut oil supply to maintain oil at high price

(5) Falling contestability. In the next few years, the US auto industry will becoming increasingly uncontestable. In other word, the barriers of entry & exit will be very high. Theoretically, new comers will have to invest heavily on green technology & yet there is no guarantee that they will be successful in getting a foothold in US auto market. In this case, we may refer to Chinese carmaker, Chery which yet to have reputation in this area

(6) No match to foreign cars. US automakers are still at infancy stage if to compare with firms like Honda & Toyota which have long established themselves as more fuel-economy carmakers. By the time US reach 39 miles per gallon in 2016, probably the Japanese car firms would be laughing with their models that travel at 50 miles per gallon. So, how to compete?

(7) Inferior quality. One of the features that will definitely reduce amount of petrol consumption in new cars would be to produce underpowered, smaller cars & probably with lesser steel content so that it can become lighter. If this is the case, then better mileage is achieved at the expense of safety of the motorists. Also smaller trucks can be highly inefficient since it will not be able to transport much weight of goods. So it will end up with more trucks carrying similar quantity of goods

9 Reasons For Protectionism

As a matter of fact, no countries in the world that truly practise free trade although the arguments put up are very persuasive. All governments to some extent do restrict the movement of goods & services in & out of borders

What are some of the reasons given for trade restrictions?

(1) Protecting the infant industry.
This is the most traditional excuse & is often used by developing countries. They claim that they have many sunrise industries with great potential to be transformed into international business. However, at the meantime they yet to realise the cost advantages from economies of scale. They need time to enlarge their market share, trained their labours & learn to produce via the most cost-efficient method. As such they need ‘temporary’ protection from low-cost foreign producers until they are able to compete on equal footing. So tariffs are put up, making the once-cheap foreign goods to be artificially expensive. Local producers can now raise the price of their goods & thus enable them to enjoy some profits

Evaluation: However, there problems appear to be bigger than the solution. Firstly, once protectionist measures are erected it is so politically unpopular to remove it. People with special interests will always convince policymakers that further protection is justified. Secondly, it is very difficult for a government to decide which industries that really have the potential comparative advantage & therefore merit protection. If the industry turns out to be not having a good chance, then this is an enormous waste of financial resources. Lastly, this argument is not that relevant to developed nations like US, Germany & Japan where most of its industries have reached maturity stage.

(2) Protecting jobs. At any given time in an economy, there will also be some industries which are declining (sunset industries). Normally firms in this industry have reached maturity stage but yet inefficient. Let’s consider US. In 2002, President Bush imposed the controversial 8-30% steel tariffs after mounting pressure from industry leaders & increasing number of steel mills that went under administration. If there was no further action taken, probably structural unemployment would have increased even more. Let’s not forget that there are many industries that are steel related. So bankruptcy of mills have negative spill over onto others

Evaluation: However, we can also argue that jobs protection in steel mills is at the expense of other businesses. First, think of the US producers of cars, bikes & other goods which are forced to use more expensive US steel. They’ll see an increase in the production costs which will force them to raise prices, thus losing customers. This will cause reduction of jobs in those industries. Or, to mitigate sudden increase in costs firms often resort to downsize its workforce. So whose job is more important, the steelworker’s or auto producer’s?

(3) Revenue. In many developing countries, it is quite difficult to earn sufficient revenue from income tax & corporation tax. This is because, the level of unemployment is usually high & there are very few large firms around. Therefore the governments impose tariffs onto foreign goods in order to raise the desired revenue. From the diagram below, revenue from tariff is given by the area of KLMN

Evaluation: However it is worth to take that not all developing nations have the freedom to impose tariffs. Consider those Sub Saharan African economies. Many of them have considerable comparative advantage in agriculture sector & production of minerals like diamonds, gold, copper etc. Their economic & political will are somehow tied due to the high level of debts to IMF. They are forced to undergo strict Structural Adjustment Policies (SAP) which among require them to liberalise their economy

(4) National security. Some governments admit that although they may not have comparative advantage in the production of a good, protectionist measures must be maintained to ensure their survival. Agriculture & steel industries can become strategically important especially in time of crisis or war where they are easily cut off. In Japan, very high restrictive quotas & tariffs are placed on rice. The farmers need to be protected so that they can grow enough food to feed the Japanese in crisis. The same reason for US which wants protection for its steel industry so that they can produce sufficient tanks & munitions during an international conflict

Evaluation: However, this argument is often overstated. In many cases, it is unlikely that a country which goes on war or in crisis be cut off from all supplies. It is merely an excuse to erect protectionism

(5) Protect consumers from unsafe products. Very often consumers are unaware of the quality & safety of the products they consume. Therefore we have the government stepping in to act as an agent guaranteeing consumers product safety. Cars must pass safety inspection, rules are made regarding types of chemicals that can be used onto food etc. Having said so, different countries have different standards that might not conform to other beliefs about product safety. For instance, the famous EU ban on US beef & dairy products claiming that the cattle have been injected with hormones to increase its size & milk production. The US government defends itself by saying that this does not pose a risk to consumers & EU medical authorities have no hard evidence for this

Evaluation: However, it is believed that there is no safety issues involved here. What EU did was actually to protect its inefficient beef & dairy producers like France & Spain. Also this form of ‘obvious’ protectionist measure often invite retaliation. This was the case as later in 1999, US retaliated by imposing trade sanctions against dairy goods from EU worth more than $117 million. In return, it harmed those EU farmers as much as it hurt those in US

(6) Discourage unethical practices. Sometimes a country might wish to impose trade restrictions to force a change in other countries. For instance, tariffs are placed onto shoes & textile from East Asia to exhibit dissatisfaction & a form of ‘boycott’ against the working practices there. In China employees have to endure long working hours & yet ill-paid. Also in many instances, these employers fail to comply with compulsory health & safety legislations thus giving them artificial cost competitiveness. Also trade restrictions are a method to show dissatisfactions with some like African nations as the money is used to finance civil war & terrorism within Africa

(7) Protection from dumping. Dumping is an act of selling large quantities of a good in another country at price below its production costs. For example, EU has large surpluses of butter & milk. Therefore it decided to sell these at a very low price in another developing economy. If that particular country does not have any form of protection onto its local dairy industry, very soon all those dairy farmers will be driven out of job

Evaluation: However, it is very difficult to distinguish whether the case of dumping is purely done with intention to drive out local industries or the exporting countries really enjoy significant EOS

(8) Narrowing BOP deficit
. One of the arguments for protectionist measures is also to fix the deficit in balance of payments particularly current account. It is hoped that with more expensive foreign goods, its demand will fall in relation to exports. As such over the time current account deficit will be narrowed. The IMF actually allows member countries to impose temporary trade restrictions to get their BOP fixed

Evaluation: However, this is more like a short run solution. To seek for long run remedy, it is best if the particular country identifies the root cause for deficit. Is it due to lack of commitment onto education & healthcare sector? Could it be accrued to low level of investment onto capital equipments? Chances to narrow the deficit will increase if solutions to boost exports & cut imports are both taken simultaneously. Also a government will have to be careful not to impose excessive import tariffs onto intermediate goods. Or else, production costs will increase & exports fall at a faster rate than imports. BOP deficit worsens

(9) Cultural preservation. This is a non-economic reason. In some countries like Canada, various forms of restrictions such as 80% tax are put onto US sales of publications, magazines & textbooks. In 1990s this cultural protectionism was expanding to kill off US ‘intruders’. Critics argued that without media protection, US magazines like Time & Business Week could soon deprive Canadians of the ability to read about themselves. In short, to filter the cultural imperialism

Saturday, May 16, 2009

Why Tariffs More Preferable Than Quota?

Both tariffs & import quota are protectionist tools that attempt to limit the number of foreign goods from flooding the domestic market. They are also similar in many ways such as safeguarding locals from job losses, local consumers ending up paying higher price, loss of consumer surplus & increase in producer surplus

However, tariffs may be a better option than import quotas


(1) Revenue for government. After the imposition of tariffs, quantity of goods imported will shrink & become Q’sQ’d. The value of tariff is (P* - Pw) per unit of good. Therefore the tariffs revenue for the government would be (Q’sQ’d) x (P* - Pw) & is given by area D. There is another way of looking at this. Suppose UK government puts a 20% tariff on imported textile from China & they will therefore collect £20 millions if £100 millions worth of textile are imported in a year. Although this figure could be insignificant for a government, bear in mind that there are hundreds if not thousands of goods that are subjected to tariffs. However, under import quota the area D will be lost as it turns into profits of foreign producers

(2) Corruption. Assume that currently there is no restriction on imported steels into US & therefore 45 million tonnes are brought in every year. Now, since US is in recession, say President Obama ruled that foreign steels must be limited to give local steel mills some breathing space & as such only 20 millions tonnes can be brought in the following year. This import quota now raises an issue. Which 20 million gets in & which 25 million don’t? Of course some importers will be told that their steels will be let into US while some others will not be. This gives custom officials the opportunity to abuse their power. They permit access but only to those corporations that bribe them the most.

With tariffs, the same objective may be achieved without corruption. This is because the tariff is set at a level which causes the price of steel to increase just enough so that the demand for steels fall to only 20 million a year. Although it controls the price of steels, indirectly it is also able to control the quantity of goods due to the interaction of demand & supply

(3) Encourage smuggling. If quota is set at an unreasonable level, it may lead to smuggling activities. For instance, restricting the import of a particular good to only 10, 000 units while the demand is 50, 000. With such great shortage, smuggling will be very profitable. On the other hand, tariff does not limit the amount of goods that can enter into a country, but rather discouraging it. So, if the demand for a good is so great, firms can just place higher order & bring more in. Government’s revenue will also increase in such a way

Friday, May 15, 2009

Gordon Brown's 5 Economic Tests

The five economic tests were designed by Chancellor Gordon Brown together with his assistant, Ed Balls back in 1997. The purpose is to assess whether UK is ready to join the Economic & Monetary Union (EMU) or not, therefore ditching the pound & adopt euro as its official currency

The UK Treasury is responsible for assessing the tests. It first did in October 1997. That time it was concluded that UK was neither sufficiently converged with the rest of EU nor sufficiently flexible to join as euro member. It is said that the first two tests are the most important which will eventually affect the outcome of the third & fifth test. The government then published the revised assessment in June 2003. The outcomes were broadly similar in many ways

What are those 5 economic tests?

(1) Convergence. To what extent UK’s business cycle have converged with those in EU? Is UK able to live comfortably with the euro interest rates on a permanent basis? What about inflation rate, unemployment or level of government’s debt? As a matter of fact, there are many incompatibilities
Source: tutor2u
Unemployment rate in UK is persistently lower than those in France, Germany & Spain due to the success of labour market reform embarked by Conservatives in the past. Before the crisis, UK economic growth was much higher than its major euro rivals. In terms of interest rates, if UK would have joined earlier, it would have to be adjusted downward accordingly to the single ECB interest rates. With already a rapid growth, lower interest rates will send UK economy to another boom & bust. Housing market is another major stumbling block. Most people in UK that time chose variable rate mortgages. With lower base rates, Britons will unnecessarily experience higher level of personal debts given the appetite for property market. The only minor convergence would be the inflation rate between euro & UK. This is because both adopted the targeted inflation rate of 2%, except that UK allows it to be within +/- 1%

(2) Flexibility. If problems emerge, is there sufficient flexibility to deal with them? This is another major hindrance of adopting the euro. First of all, UK will totally lose its control over monetary policy. It can no longer set interest rate that is in favour of its own economic fundamentals. It will have to bow to the interest rates set by ECB which is more often suitable for some, but not for many. This means fiscal policy is the most important tool now. However, according to the Growth & Stability Pact, a country should not incur budget deficit of more than 3% of its GDP. In a recession, blindly adhering to this will prove to be more curse than cure. We often heard countries that spend themselves out, not tighten their way out. Lastly, labour market will be less flexible. Firms will find it difficult to hire & fire given that traditionally euro countries give more power to labour unions than companies

(3) Investment. Would joining EMU create a better condition for firms making long-term decisions to invest in UK? The Treasury believes that a successful single currency market will turn UK into an attractive area with low inflation & therefore stability for firms to invest. Also investment could be boosted with reduction in transaction costs & elimination of exchange rate uncertainty. Being a single market will have greater elements of competitions due to transparent pricing & provide new opportunities for companies. However, this will only materialise if the convergence & flexibility criteria are met. Therefore, it fails the third assessment. Interestingly, UK has been very successful in attracting FDI & yet the largest even it stays out of euro

(4) Financial services. What impact would entry into EMU have on UK's financial services industry, particularly the London’s wholesale market? It is said that by joining euro, London’s position as the world largest financial centre will not be affected, given that it is already established as the world’s largest financial centre. It houses London Stock Exchange, London Metal exchange, Lloyds of London, Bank of England & many other prominent banks

(5) Growth & jobs. In summary, will joining EMU promote long lasting economic growth, stability & low unemployment? There is no clear evidence to this. However, we know that in order for these to be met, again the first two conditions will be the prime determinant. Critics argue that UK’s economic performance was much more impressive even it decided to stay out of euro

Brain Drain In UK

This round of recession is expected to slam British economy with another shock & that is worse exodus of its own national. Over the past few years, on average more than 200, 000 British citizens or one in every three minutes had chose to leave UK. Majority of emigrants chose to settle in English speaking nations like US, Canada, Australia, New Zealand & tourist attraction like France & Spain

UK’s exodus is far higher than any of the OECD’s other 29 members


(1) High house prices. UK property prices are traditionally known to be overvalued. During the era of cheap borrowing, banks & building societies have been very keen in lending money even to high risk borrowers. This is because they thought that the property prices will bubble ‘forever’ & as such these people will have no problem in repaying it in future. However, years later prices of residential property would have been too high for many first-time buyers. Also, supply of housing is very inelastic. There is acute shortage of land due to Green Belt policy, difficulty to get planning permit etc. These two factors combined, provide sufficient reason why UK is increasingly unaffordable

Despite some may argue that house prices had fallen recently from its peak in August 2007 by 22.5%, still I would say it is unaffordable within this period. The house price to average earnings ratio is currently standing at 4.26 (April 2009) compared to its peak 5.84 (July 2007), above long term trend of 4.0. Let’s not forget that banks these days are more stringent in lending, for instance requiring borrowers to place 25% deposits of value of property. We know that British society has very low marginal propensity to save
(2) High level of income tax. In the recent budget, Labour revealed that income tax onto those earning more than £150, 000 will increase from 45% to 50%. It will come into effect by next year’s April onward. This may herald a 1970s style of brain drain. The emigration of those British entrepreneurs to tax haven countries could have a more damaging effect onto economy than ordinary Britons.
Tax haven countries
These are some comments from the richest 1% of Britons:

Hugh Osmond (pub to insurance entrepreneur)
“It’s highly unlikely that I will continue to have the UK as my country of residence. It’s just as easy to work from any close location – Switzerland or wherever.”

Peter Hargreaves (co-founder of Hargreaves Lansdown, financial adviser)
“I won’t pay, I’ll leave.”

Stanley Fink (the former chief executive of the Man Group hedge fund)
“There will be some successful entrepreneurs who decide to move to Switzerland or Ireland. I’m aware of one or two people who made active plans to decamp when Labour announced 45 per cent and will put those plans in motion.”

Philip Lambert (Chief executive of Lambert Energy)
“We are seriously considering” relocating abroad since the state has total hostility or apathy towards entrepreneurs”.

(3) Higher salaries abroad. Of more than 3 million British-born people living abroad, approximately one-third of them are highly skilled university graduates. They are largely made up of teachers, doctors, engineers & scientists. This is certainly bad for UK which is in dire shortage of manpower in these areas. Unfortunate for UK, foreign governments such as US is very willing to pay high salary to retain the brightest of hopes. They have various staff-retaining programs. Other than US, many countries are willing to do the same & let’s not forget that cost of living abroad is more affordable compared to UK

(4) Other reasons cited. Some move out to enjoy their retirement day while some take advantage of the historical strength of sterling against many other major currencies. Some move to France as they claim that the working hours are shorter, labours are favoured than firms & less working pressure. Last but not least, some cited that UK is too congested & they are looking to stay in a ‘cleaner’ environment

I will write about implications of massive brain drain in next few postings

Thursday, May 7, 2009

Effective Revision Techniques For Unit 6: UK In The Global Economy

Sorry for the slow posting. My timetable is extremely packed with appointments & I was away for training these past few days. The training was about psychology of students & how to help teenagers to learn better. It’s hilarious & I will share some with readers now as well as in the next two postings. At the moment, I would like to outline some effective learning techniques for the most difficult topic in GCE Edexcel Economics, the Unit 6

To be honest, it’s no big secret. Just some simple learning methodologies that are effective & yet often overlooked by many

(1) Right atmosphere. Organise a small group of friends, probably not more than five of you. Please ensure that the friends you chose are seriously committed to learning. Avoid friends that are chatter-bugs that will divert you or those extreme gamers. Also avoid studying in open space. I noticed that some of my students love to spend their time studying in Starbucks which I doubt they will benefit anything out of it. Just too much of distraction. Why not choose one of your friends’ place? From the training today, I was told that students learn much better with their peers than their teachers as there is a natural ‘barrier’. Hence students are less expressive which distort the learning process

(2) Reading materials. NEVER rely on one reading material. Well, that doesn’t mean that I’m asking you to bomb your brain with several books. What I meant was, by relying on several references, you can compare the quality of information. I found that certain books have more superior explanations than the others. Also by you can ‘plug’ the hole. What is lack in one set of notes can be supported by the others. One book you MUST have now is the Student Unit Guide for Unit 6 (refer above)

Also, I strongly do not recommend students to read The Economist. Speaking from students’ point of view, the contents are seriously hard to digest

(3) Internet. Learning is not complete without internet. To me it is a complement. I get more information there than the book. Students normally underestimate the power of internet when it comes to learning. They hardly use it to search useful information, except downloading games, videos & songs. Websites that I again strongly recommend for revision are:

tutor2u is rich with online notes that you can’t get anywhere. If you are looking for specific issues like UK economy, enlargement of EU, productivity in depth, monopsony power of labour union etc, they are all there. Also there are daily posting on its economics blog

economicshelp is the brainchild of Tevgan Pettinger, an Economics teacher. He too organise his work in topics. What I seriously like about his postings is his creativity of issues & his evaluations to most topics are out-of-box. I can bet till my last dollar that some of his most ‘explosive’ evaluations are not in typical textbook

newsbbc to me is a perfect substitute to The Economist. Click on business/ economy on the left hand bar. The articles are so readers-friendly, that even fishermen or mechanics can understand economics, provided they can at least read

Also there are techniques to search for information. If you’re reading about national debt, go to Google & type something like ‘national debt economicshelp’ then click on search. You’ll be surprised by the precision of the information. Or if you want to know about Working Time Directive, then type ‘Working Time Directive bbc’ & search. See the results for yourself

(4) Analyse past years. Before you really embark on past year questions, run through all set of papers you have. If not, please make sure you get them from your lecturers. Analyse the popularity of questions. I’m not afraid to tell you that in Unit 6, issues that are often tested in Part A are like role of WTO, protectionism, UK’s balance of payment & competitiveness & macroeconomic policies to achieve certain goals

As for data response question in Part B, popular topics are on fiscal deficit & national debt, comparison between UK & eurozone in terms of inflation & unemployment, why UK refuse to join euro, implications of BOP deficit, implications of protectionism etc. I hope this helps !!
(5) Brainstorm. Another important key skills. For instance on the topic of Balance of Payments (BOP), ask yourself:

Why UK’s BOP is almost permanently in deficit?
Is trade deficit bad & surplus necessarily good?
Why some countries like China can run surplus?
Implications of deficit on UK economy?

(6) Attempt. Always attempt on Part B before Part A (essay). This is because students need to build up their writing skills like ability to be expressive & argue before they can write something long & challenging. Also take note that some issues that are not tested in Part B can appear in Part A. For instance, one of the questions I recall in Part B was ‘examine the implications of fall in interest rate’. It has appeared in both parts

(7) Timing. The paper as a whole is 1 hour 45 minutes. But I strongly recommend practice on Part B first. In short, specialise in an area. Do approximately 6 questions. Same questions can be attempted twice maybe in future. Even as a teacher I did more than 5 times. I discovered that every different attempt my evaluation ability on some issues grow sharper. For beginning, maybe time yourself around 1hour 15 minutes on Part B. As you go along, reduce the duration by 5 minutes in each successive attempt.

As for Part A, although the recommended time is 45 minutes for two essays, I would suggest an hour for yourself. Again as you go along, reduce 5 minutes in each successive trial. Perhaps you should go read up some relevant reading materials on the internet before start writing. This will give a boost to your confidence in essay

(8) Appointment with your teachers. Your teacher is probably very busy now with tonnes of appointments. Nevertheless, seek more of his wisdom. Learn to correct your mistakes. By no mean, perfecting your practice will make you perfect ! Think about that

Tuesday, May 5, 2009

Why Eurozone Will Be The Last To Exit Recession?

While US economy is still plagued by recession, there are tentative signs that situation begins to stabilise. In other word, the States economy will nosedive but at slower rate. The data released in past few weeks showed some stabilisation in house & commodity prices. Even the stock market is not that badly hit by the swine flu. On the other hand, firms ran down their inventories suggesting that consumers have begin to spend

Back in Asia, large economies like India & China are expected to experience a slowdown, not a contraction in 2009. With such a stronghold, other emerging economies within the region are expected to benefit from the multiplier effect of these two. Interestingly, PwC even predicted that in 2014, more than half of world’s GDP could s be accounted for by these high growth nations. Just imagine, how a recession like this can change the fortune of advanced economy

Conservative estimates showed that Russia could grow by 3.1% & Brasil 2.7%. In Mid East, growth of about 3% is expected ( for the year

Another area infest by worst-than-expected recession is EU. In fact there is large number of reasons that put EU economies especially euro in a great disposition. From economics point of view both theory & practice, ‘dead-lock’ recession in EU will be much longer than expected by many



(1) Unemployment is higher than elsewhere. Jobless rate in the 27-nation EU is expected to hit 10.9% in 2010. Interestingly, if we only look at the unemployment rate in eurozone, it is estimated that the figure could be as high as 11.5%. Why such a trend? This is because unemployment is extremely high in places like Spain 17.4%, Ireland 11% & Germany 8.6%. These figures raised the average. It is not difficult to understand why.

Firstly, unemployment benefits are traditionally high which increase frictional unemployment. Secondly, labour market rigidities. Issues like difficulty to hire & fire workers, 48 hours maximum working week, excessive power given to trade unions & sticky wages all tend to raise production costs for firms. It retard job creation& is worsen in period of recession. Taking into account hystereseis & negative multiplier effect onto whole euro, the picture just looks glimmer for EU economy

(2) Conservative ECB. In UK, the targeted inflation rate is CPI 2% +/- 1%. This means UK places equal importance to growth & inflation. However ECB is said to strictly adhere to the 2% targeted rate which shows that it has high anti-inflationary bias at the expense of higher unemployment & slower growth. That explains why they are pretty hesitant to cut interest rates when major central banks around the world take such stance

Another relevant argument is all countries that adopt euro have lost their authority in setting interest rates. Leading economists felt that the current 1% interest rate is still high for some economies like Germany, France, Italy & Ireland. In short, all euro members can no longer manipulate the interest rate to give their economy a boost. A decision made by ECB may therefore be favourable to some but bad for many

(3) Strong euro. The third reason is related to second. In the absence of flexibility in labour market, the only way to cut costs & boost competitiveness is devaluation of pound. However, the Economic & Monetary Union removed the possibility of exchange rate adjustments to give euro products an artificial advantage. To make things worse, euro remains stubbornly high in recent months thus creating more problems to export-drive economy like Germany

(4) Fiscal constraint. Commitment to the Growth & Stability Pact is fatal in current period. According to the agreement, countries budget deficit must not exceed 3% of GDP in any fiscal year. Although some countries like Portugal, Belgium, France & Italy are well known for side-stepping it, nevertheless they are still tied to the commitment of bringing their national debt down in immediate future. Therefore, any signs of green shoots recovery are likely to be muted by the rise in tax

Ireland had announced in its emergency budget in April that Irish government will raise taxes & slash public spending. With such measure, personally I feel that the contraction will be larger than estimated 8% this year. That’s why we have heard of large scale stimulus by US, China & Japan but not Euro. Other problems are like issue of ageing population in Italy which will further place a constraint in its public finances. Tax revenues will shrink & government’s obligation on pension increase

(5) Overdependency on one sector. Euro economies are not well diversified. For instance, Germany places too much of importance onto its export sector. With the pace of fall in trade among EU members & dyeing appetite among American consumers, its manufacturing sector will be restless with rising jobless toll. Others like Spain & Ireland economy focused too much on construction sector. With falling mortgage approval & rising unemployment, prices of house is set to fall much deeper, triggering negative wealth effect

(6) Tentative sign of protectionism. With such depth of recession, some countries may desperately withdraw their operations from other member countries back to home. The aim is to create local employment. Nevertheless, this move is looked as form of protectionism which will just infuriate host countries. For instance, recently France was accused of shifting some of the Renault car production back to France suburbs from Slovenia. However European Commission will look into this to ensure that France comply with competition rules

(7) Weaker allies. Eastern European economies have borrowed more than $1.7 trillion abroad & to make things worse most of the obligations are short-term in nature. It must repay or roll over by $400 billion this year, equivalent to one-third of the region’s GDP. Most of it is owed to Greek, Belgian, Italy, Swedish & Austrian banks. Unfortunately, credit window has been shut. Western European economies are cutting aid onto these poorer EU states given their own financial problem. If these Eastern blocs were to collapse, it will trigger a devastating impact of several times the East Asian financial crisis in 1997/98.