Thursday, August 13, 2009

Why France & Germany Out Of Recession But Not UK?

The recent miracle showed by France and Germany’s economic recovery is highly likely to reignite the debate about just how robust and flexible the UK economy has turned out to be. Successive government was once so flamboyant and claimed that UK can perform much better without staying inside the Eurozone. This is because of so called flexibility where UK will not lose the power in controlling in monetary destiny. It can influence the level of interest rate which will successively determine private spending and investment. Also, it can manipulate sterling to change the fate of the beleaguered manufacturing industry

On top of that, the UK government is not constrained by Stability and Growth Pact, which states that in any fiscal year members of Eurozone should not incur a budget deficit of more than 3% and a national debt must not exceed 60%. As such, in theory UK suppose to be the first European nation to escape from recession since their ‘hands and legs are not tied’. However, the current situation is very disturbing. A-Levels Economics and related references probably will have to be rewritten and to some extent with lower tone, instead of bragging how great the flexibility was

Source: BBC

Why France and Germany escape recession before UK?

(1) Reliance on France and Germany. UK used to a consumption driven economy where private spending once stood at about 65%-70% of its GDP. Unfortunately, the present Great Recession has turned the British economy into a pessimism state. Certain sectors of the economy almost come to a standstill after consumption and investment spending have both collapsed. In such case, the health of the economy is then very much reliant on the other two components of AD which are public spending and exports. Bear in mind that about 55% of UK’s trade is with the rest of Europe especially France, German and Ireland. Therefore, it is not difficult to see that economies of France and Germany need to pick up before UK does

(2) Legacy of debts. It is also worthy to note that UK’s growth was paddled by credit boom in earlier years. Since interest rate was quite low and credit easily obtainable, British people had engaged in a form ‘luxury’ spending. The property market was the biggest beneficiary fuelling an increase in personal wealth at that time. The vicious cycle repeated itself through the process called mortgage equity withdrawal (MEW). Now, with the collapse of both economy and housing market many went into bankruptcies and some saddled by burden of debt in the midst of losing their job.

It is said that most of the income now goes to servicing the debts upon the loan they took out earlier. Meanwhile in France and Germany, their economy is not driven by property market and the percentage of house ownership is significantly lower. Therefore debt is ‘trivial’ and with great level of household savings in Germany, the people can spend themselves out of recession

(3) Less exposure to financial crisis. Although Germany and France experienced similar problems in their financial sector, it was not to the similar extent as in UK. The Labour government is reported to have spent nearly £1.5 trillion in bailing out the financial sector, an amount which is significant as a percentage of GDP and much bigger than total spending by the rest of G20 put altogether. Clearly, UK’s financial sector still has a long and winding road ahead. Banks are still relying on state financing and until now very much reluctant to lend as can be seen from the high deposits required for any form of lending. One need to understand that banks are the main facilitator of economic activities, which without will be major impediment on road towards recovery

(4) Stimulus plan for auto industry. The German’s car-scrappage scheme has been accredited for turning around the fortunes of its automotive industry. At €5 billion, it was on an entirely different scale to the UK’s £300 million scheme. This scheme has been so successful that it has been extended until the end of year after attracting 1.2 million applicants. The initiative actually offers buyers new and more fuel-efficient car in return for their nine years old car

In fact purchasers benefited twice. First, falling demand leads to lower car price and with further € 2500 subsidy, car price looks even much cheaper. It has great domino effect. A revival of auto industry will have multiplier effect onto other car related industries. More jobs will be created. As people begin to spend, they will eventually jump start every sector of the economy. It is unlikely that British half-baked policy could produce such desirable result

(5) Growing demand from outside. Unlike UK, Germany’s economy is export-driven. As such, with the collapse of global commerce, its economy sank by as much as 6.7%, a bigger figure if compared to contraction in UK by 4.9% in the first three months of 2009. However the revivals of Chinese economy and reported stabilization in US have both fuelled demand for Germany’s exports particularly high end manufactured goods, thus pulling it out of recession earlier than expected. The latest statistic shown that German exports had grown at their fastest pace for nearly three years at 7%. This has positive spillover effect onto France economy as German is its major trading partner. UK’s fate is somewhat different since it has grown to become a service based economy

(6) Relaxation of fiscal rule. The Growth and Stability Pact is believed to have permitted certain flexibility onto France and Germany, therefore allowing them to spend more than usual. No doubt, both run huge budget deficit and have enormous national debt, but if we were to stringently follow the book, situations could have turned for the worse. Pro-long recession will inevitably lead to higher unemployment, deflation and increasing difficulty to finance debts. Besides, these two are the largest economies in Eurozone. Their survival will lead to the survival of the rests of Europe. The recent reported contraction in Eurozone was 0.1% and this figure would have been much larger if not due to the green shoots recovery of 0.3% in France and Germany

In the next posting, I will discuss the potential downside risks towards recovery

Tuesday, August 11, 2009

Impacts Of Low Oil Price On Oil Exporting Nations

Perhaps the glorious days for Middle East are over-at least for the time being. Once, when oil prices were high, the mighty Saudi Arabia generated a billion dollars a day. Now, it has to contend with earnings around $700 million. That’s a collapse of 30% and considering the state of its economy which is not well-diversified, this is big money. Others like Oman and Bahrain felt the pinch more

We will consider the consequences both micro and macro


(1) Falling revenue. Since oil is a form of necessity with no close substitutes, it has inelastic price elasticity of demand (PED). As such, any fall in market price for oil will brutally hit their total revenue

(2) Lower producer surplus. It’s defined as the difference between the market price and the lower price these oil producers are willing to sell at. Since the market price has deteriorated from its high of $150 last year and now lingering around $70 per barrel, that is an enormous fall in producer surplus. However one could also argue that since the OPEC oil cartel can always cut the oil supply which they recently did, they can always manipulate the level of producer surplus from nose diving

(3) Difficult to increase output. Oil producing nations need to invest heavily on oil exploration, oil production facilities and R&D. Unfortunately, most of the funding is derived from oil revenue. With such a drastic collapse in oil prices, I’m uncertain if this will discourage oil companies from continuing the oil exploration process since the operating costs are very high too. If materialise, it is expected that oil supply in the near future may increase but at slower rate than demand. Given the supply of oil is inelastic, any increase in demand will quickly drive the oil price up and could be hazardous in a fragile economy

(4) Job losses. Governments in the region derive 75% to 95% of their income from oil exports. That shows that their economies are too dependent on oil and very thinly diversified at same time. There is no solid manufacturing or even services sector to back them up. As such, falling oil prices will begin to eat into employment and so oil engineers particularly will be the first to feel it. It has devastating effect considering the negative multiplier effect. In the end, an initial collapse in exports will bring private consumption and investment to its knee. More unemployment will result leading to even greater problems

(5) Shrinking economy. Simple AD-AS analysis. Collapse in oil exports, fall in investment rate and private consumption will mean that AD shifts leftward. As this happens, real GDP will shrink and therefore resulting in recession. Also, recession will usually lead to price deflation, a gruesome enemy. We have seen how the mechanics work on Japanese economy. However, one could also argue that this may not happen especially when the governments’ fiscal stimulus is effective enough to prevent the three components of AD from collapsing too much

(6) Fiscal deficit. Happens when government spending is in excess of what it earns from tax. In the current circumstance, fiscal deficit is almost inevitable since tax revenue from all sources like employment, corporate earnings, stamp duties, oil related etc fall. Simultaneously, the ambitious spending by some like Saudi Arabia and Dubai on construction projects and lucrative development projects aggravates. To balance the book, they definitely prefer oil prices to be higher than the current rate. Saudi Arabia and Kuwait while may face the danger of budget deficit, need not worry since these two have the biggest pile of cash reserves. It is those like Oman and Bahrain with smaller cash reserves and lower oil wealth which may face the spending wrath

Monday, August 10, 2009

High Sugar Price


The price of sugar settled at 22 cents per pound as on Monday, a level which we have not seen since 1981. Again the fundamental cause can be explained via the interaction of demand and supply. As in this case, demand increases as Brazil intensifies its ethanol production which requires sugar

At the same time, supply decreases as one of the world largest producers, India is facing supply disruption due to unfavourable changes in weather. Its had less rain during the monsoon season. Sugar production from India fell 45% on a year-on-year basis from 2008-2009

Tuesday, August 4, 2009

Why Do People Earn Different Amounts?

Until now, there is no single dominant factor that is capable of explaining the gulf in pay that persists between occupations or even within the same occupation itself. Some of the relevant factors are explained in detail as below. In reality, however it is much more complicated as is often the combination of two or more factors


(1) Compensating differential. A popular economic term that relates wage rate to unpleasantness, risk and other undesirable attributes of a job. Technically, it is defined as an additional income that must be offered to motivate one to take up the undesirable job. A construction worker is most likely to receive a much higher pay than, say a cleaner or a clerk for the risk undertaken. They assume risk like falling off from building, industrial accident when dealing with machineries etc. Some IT officers especially system support, may have to work nights or other unsociable hours. As such they receive higher pay to compensate for this

(2) Education and qualification. Level of education should be a good discriminator of pay scale. If an individual who studies for degree receives a pay equivalent to a cashier having O-Level, there will be very few pursuing tertiary study. The logic is, there is an opportunity cost in terms of income lost when one spends more time studying regardless of full time or part time. So now they are compensated for it

Also, depends on number of years one has to spend. The longer it is, the higher the pay (ceteris paribus). For instance a lecturer with PhD earns more than an ordinary teacher. Similarly, a heart specialist earns much more than an ordinary doctor given the length of time adopted for training. The supply of labour from these highly skilled professionals are low and highly inelastic while the demand for their service is great. That accounts for the vast difference in pay

(3) Marginal revenue. Some people are able to command high salary as every economic transaction they involve in yields high marginal revenue. Consider professional footballers like C. Ronaldo and Beckham. They are central in every game. They influence the number of tickets and merchandise related to MUFC sold, fans base and probably to some extent shape the English premier league. Whenever Beckham advertises for Pepsi, directly or indirectly he influences people to drink Pepsi. As such the company generates unimaginable supernormal profit (MC = MR) and wouldn’t mind paying him millions for one advertisement

(4) Protection by trade union. There is empirical evidence that unionized workers receive better pay than those who are not represented. Although the number of trade unions has declined steadily both in UK and US due to the shift from manufacturing sector to services sector, the effect of their presence is much felt. Probably you have heard of United Auto Workers (UAW), United Steel Workers (USW) etc. The chief aim is to gather more voice and to have more negotiation power, namely collective bargaining

There are many ways to push up the salary. First, they try to increase the demand for the goods produced by union workers. For instance, USW once in early 2000s pressurised the Congress under Bush administration to impose tariffs on imported steel hoping that American industries will turn to ‘cheaper’ locally processed steel. Also they could decrease supply of labour to push up wage rate. Craft unions such as bricklayers and electricians have often adopted restrictive membership policies such as high initiation fees, long apprenticeship programs and limitations on union’s membership. Professional associations such as American Bar Association and American Medical Association also adopted similar practice

(5) Fringe and benefits. To some extent, it is true that some jobs may offer lower wages than others because they got more to offer to employees such as annual holiday, company cars, free life insurance, monthly gathering etc. These jobs are thought by some people to give lots of satisfaction and hence may be prepared to undertake without expecting high salary

(6) Immobility. Some people may be offered a hard-to-resist deal, but is in another area which could be far away from current residence. However, at the same time they value family, relatives and friends more than the pay. As such they reject they job. Also some people may want to move to a better-paid job but not able to do so since they cannot afford housing in new area. Consider receiving a pay which is just extra several hundred £ in City. Accommodation would be disastrous. Nevertheless high labour mobility does help to reduce differences in unemployment and wage rates in different parts of a country

(7) Imperfect information. Some people settle down for a lower pay because they do not know about better-paid jobs elsewhere. Meanwhile, people like fresh graduates although may not be able to demand for high wages, sometimes could end up doing a job which its pay is much lower than market as they were ‘misinformed’ that that is the pay they deserve being freshies. These two situations are called imperfect information

Why Supply Is Highly Inelastic In Short Run?

Source: economicshelp

Price elasticity of supply (PES) measures the responsiveness of supply for a good to a change in price. It is given by the formula of:

PES = (% of change in quantity supplied) / (% of change in price)

It is meant to determine whether the supply of a good is sensitive to price changes or not. The sign obtained from the calculation must always be positive due to the natural relationship between the decision to supply and market price. The higher the price the more will be supplied and the lower the price the lesser will be supplied. However, not all the time producers can be very responsive to market price. In this case the PES < 1. The interpretation is, a large change in price leads to a smaller than proportionate change in quantity supplied. In other word, say even with large increase in market price, producers will be unable to supply much

In real world, there are several items that fall into this. For instance supply of new housing, fresh vegetables and commodities (this may be arguable). Consider a property developer. Even if he receives the information that the area will be booming in nearest time, he will not be able to suddenly increase the quantity of houses and shop lots due to constraint in factors of production. He needs more time to hire necessary workers, obtain planning permission to enlarge the housing area, order raw materials and getting the right number of construction machines

In some extreme cases, PES could be 0 (perfectly inelastic). How is that possible? Yes it is, if we are considering a very immediate time period. Last week when I was in a hobby shop, I planned to get an item called Fallen from Transformers: Revenge of the Fallen and at that time I am willing to offer much higher market price due to its rarity. However I was told by the shop owner that next wave of stocks will arrive the following two weeks. This means, no matter what price I offer he will be unable to supply me that item. So his PES at that time was zero

In short, PES is largely concern with time frame under consideration. The shorter the time, the more inelastic is the supply and the longer the time, the more elastic it will be

Casino And Recession

The ‘Great Recession’ had claimed another casualty-MGM Mirage. It’s a powerful group of 20 casinos operating in Nevada, Michigan, Illinois, Mississippi and China. In the recent report, its quarterly profit ending June took a sharp dip with the lost of $216.2 million. This whooping figure is tantamount to a fall of 69%

Based on this statistic, gaming industry may be regarded as a form of luxury goods but an ‘extreme’ one, perhaps surpassing the income elasticity of demand (YED) in sports car industry, designers’ clothes, expensive handbags and shoes, foreign holiday etc. Even between these goods some can be ‘more luxury’ than others. Recall the formula of YED which is given by:

YED = (% of change in quantity demanded) / (% of change in income)

Being a luxury good, YED must be greater than 1. The relationship must be positive. This means, as income falls the quantity demanded for gaming will fall but GREATER THAN PROPORTIONATE. Consider a numerical example of (-28%) / (-10%) = + 2.8 and vice-versa

However, some may argue that a fall of 69% profit may not necessary related to the number of gamers and patrons of its premises. It could be due to other factors yet to be considered such as soaring fuel and food prices which increase its operating costs as well as other cost inefficiencies

Saturday, August 1, 2009

How China Accumulate So Much Of Foreign Reserves?

Before 1980s, the Chinese economy was rather insignificant due to the establishment of herself as a ‘self-centered’ economy. In other word being a centrally planned economy where there was very little trading that took place, very few private enterprise and much of the economic activities were in the hand of the government. China conducted minimal trade with outside world by exporting just enough raw materials and simple manufactured goods to cover payments for the import of strategic minerals and other necessities not available back home

How it accumulate so much of foreign reserves then?

(1) Massive trade. The Chinese economy took a turn when Deng Xiaoping, the leader of the Communist Party of China became a reformer who transformed China towards market economics. It took place somewhere in late 1970s. This means unleashing the economy from the central grip by allowing private firms to grow, promoting international trade and encouraging the flow of foreign capital.

As at 1978, its foreign reserves stood at $1.6 billion. However by 1984 the figure whooped up to $17.4 billion. What an amount during that time and considering the accumulation within just 6 years. However by 1985 and 1986 the foreign reserves shrank to around $12 billion. Nevertheless it was a healthy indicator as China was importing capital goods like machineries to finance and expand its production capacity (outward shifting PPF) to meet the growing demand from outside. China’s major export destinations are like US, Hong Kong, Japan, South Korea and Germany. Since then, China’s accumulation of foreign reserves continues to mountain ‘abnormally’ especially with her accession into WTO (World Trade Organisation) in 2001. Countries like US being the world’s largest consumer, continues to buy from China due to factors like low production cost, improving quality and innovation but mainly due to the undervalued yuan. Amazingly China is set to topple Germany as the world’s largest exporter this year due to tumbling European economy.

(2) Inflow of foreign capital. The liberalisation of Chinese economy is one but out of many other reasons as to how it becomes the centre of attention. Large number, cheap and yet educated workforce is often cited as the top reason why increasing number of transnational firms are relocating or even outsourcing part of their production process in China. Of course there are other reasons too, such as tax-friendly policy, ease of obtaining certain natural resources and modern infrastructure. When foreign firms set up subsidiaries, factories or outlets in China the process is called inward investment. They will more often than not, raise capital from home country and bring it into China, especially new firms

In the recent, its foreign reserves had surpassed $2.13 trillion for the first time. However, it is not due to excess of exports over imports. This is as a result of foreign investors perceiving China as the world’s ‘safest’ haven in uncertainties like now. Its economy is estimated to grow by around 8% in the second quarter, indicating that the stimulus package seems to be working well unlike in other major economies. As foreign investors continue to pour money into Chinese stock market as well as property market. The Shanghai Composite Index surged has jumped over 74% alone in this year. There is also a fear that this will create a bubble in an already heating commercial property market. Much of these however are hot money. It refers to money controlled by investors who actively seek short term but high-yielding investment opportunities

As such it can flow out of the country anytime too. Therefore it could be highly unlikely for China to sustain its position of foreign reserves at such high level for long term