# Inequality after tax and transfer payments

The Economist had a very informative graphic which looked at the change in the Gini coefficient after taxes and transfers. The Gini Coefficient is derived from the same information used to create a Lorenz Curve. The co-efficient indicates the gap between two percentages: the percentage of population, and the percentage of income received by each percentage of the population. In order to calculate this you divide the area between the Lorenz Curve and the 45° line by the total area below the 45° line eg.

Area between the Lorenz Curve and the 45° line
Total area below the 45° line

The resulting number ranges between:
0 = perfect equality where say, 1% of the population = 1% of income, and
1 = maximum inequality where all the income of the economy is acquired by a single recipient.

* The straight line (45° line) shows absolute equality of income. That is, 10% of the households earn 10% of income, 50% of households earn 50% of income.

The comparison before and after taxes and transfer gives an indication of how they benefit the levels of inequality in an economy.

America’s tax system is progressive and as the its pre-tax Gini coefficient is high the government has to spend more on transfer payments to reduce inequality. In contrast, countries with low pre-tax inequality, such as South Korea, manage to achieve low post-tax inequality without doing much by way of redistribution. Note that the graph from The Economist is on a scale of 0 – 100. 100 being maximum inequality.

The significance of government spending has a big impact on a country’s Gini coefficient. The Economist note that both France and the US have similar levels of inequality before tax but after taxes France reduces inequality from 45 to 28 whilst the US reduces it from 47 to 38 approximately. In France government spending accounts for 57% of GDP. America’s federal, state and local authorities spend just 35%.

New Zealand has a Gini coefficient of 42 whilst after taxes and transfers goes down to 34.

Ireland does most to slash inequality. After taxes and transfers, Ireland’s income distribution goes from 50 to 30 – the higher income groups pay more in tax than in most other countries, while low-earning households receive generous tax credits and transfer payments. Part of the reason Ireland is able to do so much redistribution is that it relies more than most on taxes paid by multinational companies. Foreign-owned firms accounted for 80% of corporate tax in 2017. Cross-country data suggest that if America wanted to bring its level of inequality down to the OECD average, it would have to boost government spending to 50% of GDP.

Source: The Economist – April 13th 2019.

# A2 Revision – Costs and Benefits of Growth – Mindmap

With the June exams approaching I thought it appropriate to share some mindmaps. Below shows the definition, policies, costs and benefits of Economic Growth. The costs and benefits of Economic Growth is a common essay question at A2 Level.

A country’s gross domestic product (GDP) is a measure of economic activity during a set period of time, normally reported on a quarterly and an annual basis. It is the sum of money values of all final goods and services produced in an economy over a set period. The primary indicator used for tracking economic performance over time is known as real gross domestic product, or real GDP. Real GDP is gross domestic product adjusted for changes in prices.

# Using playing cards for economics discussions

No doubt you’ve had plenty of discussions with your classes on economic issues. One of the challenges is to keep students on task and try and get contributions from all students. In order to overcome these issues I have developed a set of playing cards with certain statements on each. Students receive 8 playing cards with different assessment objectives/ skills/ elements of written work in economics – see photo below.

An exam essay question is given to students and then they debate the questions amongst themselves. However students can only speak when they play a card and they must follow what the card says – e.g. Argument, Building on someone’s point etc. This limits each student’s number of responses and makes sure the discussion helps students practice for an assessment, according to the assessment objectives. It also allows for greater contributions from other members of the class. It generally works well although at times you may have to play one of your own cards to keep students on task. I have attached a link to a document with all the statements – below. All you have to do is buy some packs of playing cards and use wide sellotape to attach statements to the cards. Be interested to know how others get on.

CARDS

# 100k Challenge on a Concept2 indoor rower

Although not technically Economics you could say it does relate to Behavioural Economics and Happiness – the utility of completing a 100k row after 3 months and over 800k’s of training. The marginal utility of the last 5k’s was very high

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Starting at 5.30am on Friday 10th May, myself and Jim Potts (Director of Sport at King’s College) rowed 100km each on a Concept2 rower – Jim 8 hours 10 minutes, myself 8 hours 15 minutes. The idea behind the challenge was to raise awareness for youth mental health issues and to raise much needed funds for the Key To Life Charitable Trust.

Assisting us in achieving 100km, we managed to persuade a crew of 15 other staff members and parents who sat along side us and row 100 minutes each in relay. Many thanks to:

Kris Brewin, Ged Leicester, Udi and Marcel Delport, Onasai Auvaa, Daryl Williams, Daniel Mitchell, John Payne, Matt Cowie, Yvette and Richard Hall, Jonathan Ogg, Matt Tooman, Brendan Boreham and Sarah Couillault. Thanks also to all the students and teachers who dropped by during the day – it definitely helped us through.

Below is a photo from the day – Jim is on the extreme left and I am on the lighter coloured Concept2 rowing machine.

You can still donate – see link below:

https://givealittle.co.nz/fundraiser/the-100-challenge

# The Economics of Uber

Another video from Paul Solman of PBS in his series ‘Making Sense’. With Uber’s initial public offering expected to be one of the largest ever he  visited their headquarters to better understand what happens when a San Francisco company puts economists in the driver’s seat. Useful for those looking at majoring in Economics.

HT – Sex, Drugs and Economics

# UK Economy – Goldilocks and the output gap

Chris Giles of The FT wrote a very good article explaining the output gap using Goldilocks and the three bears. As you may know in the story Goldilocks found the first bowl of porridge too hot, the second bowl too cold but the third bowl just right. We can use this analogy with regard to the economy:

• running too hot – a positive output gap – the economy is overheating and higher interest rates and less government spending is needed to slow the economy down.
• running too cold – a negative output gap – the economy has a lot of spare capacity and needs to be stimulated by dropping interest rates and increasing government spending.
• running just right – no gap – there is neither a requirement for an expansionary monetary and fiscal policy nor a contractionary monetary and fiscal policy.

Just as Messrs Friedman and Phelps had predicted, the level of inflation associated with a given level of unemployment rose through the 1970s, and policymakers had to abandon the Phillips curve. Today there is a broad consensus that monetary policy should focus on holding down inflation. But this does not mean, as is often claimed, that central banks are “inflation nutters”, cruelly indifferent towards unemployment.

If there is no long-term trade-off, low inflation does not permanently choke growth. Moreover, by keeping inflation low and stable, a central bank, in effect, stabilises output and jobs. In the graph below the straight line represents the growth in output that the economy can sustain over the long run; the wavy line represents actual output. When the economy is producing below potential (ie, unemployment is above the NAIRU), at point A, inflation will fall until the “output gap” is eliminated. When output is above potential, at point B, inflation will rise for as long as demand is above capacity. If inflation is falling (point A), then a central bank will cut interest rates, helping to boost growth in output and jobs; when inflation is rising (point B), it will raise interest rates, dampening down growth. Thus if monetary policy focuses on keeping inflation low and stable, it will automatically help to stabilise employment and growth.

However policymakers rely on estimates of the output gap – which compares actual GDP with a country’s full capacity when all resources are fully employed. The concern that the Bank of England have is that official data shows that the UK economy is showing sluggish growth rates with a tight labour market.

Almost all employment indicators suggest the economy close to overheating – recruitment difficulties and industry facing capacity constraints. This is in contrast to economic growth which suggest that there is room for expansion. Add to this the uncertainty about Brexit, the reliability of the output gap even more dubious. Current techniques might correctly measure the output gap but what about the contribution of potential capital projects which are underway?

Some economists have suggested that output gaps are inherently political and chosen to rationalise existing policies, rather than to set the correct prescriptions. However for economists is there an alternative to taking the temperature of an economy.

# NZ Government Spending by Political Parties

The GDP of a country is made up of four things: C+I+G+(X-M).

C = Private Consumption
G = Government Demand
(X-M) = Net Exports

With government spending being very liberal and effective in creating growth there is a need for the other components of GDP to do their part – Private Consumption, Business Investment and Net Exports.

It is interesting to look at government spending as a % of GDP in New Zealand over the last 30 years. It follows a familiar pattern that relates to the Government of the day. As with most economies a government that is more left wing tends to spend more and a government that is right wing tends to spend less. However the graph can be a bit misleading as although spending went down under a National Government as a percentage of GDP, it could mean that spending could have been increasing but overall GDP going up at a much higher rate.

Source: Westpac

A major factor that will support GDP growth over the coming years is the large increase in fiscal spending including:

• Approx \$1.5bn of spending per annum on transfers to low and middle-income households as part of the Families Package.
• Approx \$8.5bn of spending over the coming four years in areas like health, education and infrastructure.

These increases in fiscal expenditure will see Government consumption spending growing by around 4% per annum through 2019 and the early 2020s. That’s roughly double the pace seen over the previous decade, and will see the Government’s share of economic activity rising from around 18% at present to over 20% in the early 2020s. The impact of this spending will be seen across the economy and will help to support employment growth.

Source: Westpac Overview February 2019

# China and the Easterlin Paradox

I have blogged before on the Easterlin Paradox and was interested to read about the relationship between economic growth and happiness. In the mid 1970s Richard Easterlin drew attention to studies that showed that, although successive generations are usually more affluent that their parents or grandparents, people seemed to be no happier with their lives. It is an interesting paradox to study when you are writing about measuring economic welfare and the standard of living.

1. Within a society, rich people tend to be much happier than poor people.
2. But, rich societies tend not to be happier than poor societies (or not by much).
3. As countries get richer, they do not get happier. Easterlin argued that life satisfaction does rise with average incomes but only up to a point. One of Easterlin’s conclusions was that relative income can weigh heavily on people’s minds.

GDP growth is generally held as the most reliable predictor of a country’s level of happiness but in China GDP has increased 5 fold over the last 20 years but the level of well-being is less that in 1990. The levels of well-being bottomed out in the period of 2000-2005 and although have recovered they are not a level to that of 1990 – levels of happiness were high for then a poor country. This was similar to Russia before its transition where high levels of subjective well-being were reported.

Growth not a reliable indicator of happiness in China

Chinese level of happiness was highest in the 1990’s In the days of the “iron rice bowl system” – Chinese term used to refer to an occupation with guaranteed job security, as well as steady income and benefits. So it transpires that GDP growth in China was highest when happiness levels were falling. In fact, none of the six predictors used in the World Happiness Reports prove to be reliable predictors in China as there was little or no correlation between happiness and the six predictors- see below:

1. GDP per capita,
2. healthy years of life expectancy,
3. social support (defined as having somebody to rely on in times of trouble),
4. trust (defined as perceived absence of corruption in government and business),
5. perceived freedom to make life deci-sions,
6. generosity (defined as giving to charity)

The two main factors explaining China’s trajectory in happiness levels are unemployment and the social safety net. Unemployment rose sharply after 1990, reaching its peak in 2000–2005—the trough of China’s happiness—and has since declined moderately, as happiness levels have risen moderately. The level of unemployment is mirrored by the relative coverage of the social safety net over the same time period.

It seems that the restructuring of state-owned enterprises (SOE) has had the most profound effect on the happiness of Chinese people. This mirrors developments in Eastern European countries. In addition to unemployment rates and the social safety net, education and age are also important factors in determining Chinese people’s happiness over the period. Levels of education and of happiness are indeed linked; not only does a college education provide access to better job opportunities, but it also makes one more adaptable to changing circumstances.

Source:
Chinese Discourses on Happiness (2018) Edited by Gerda Wielander and Derek Hird

# Economics website for IGCSE AS A2 and IB courses

Want to learn or need assistance with Economics? Are you studying or teaching A Level Economics, Advanced Placement, or International Baccalaureate (IB)?

Help is at hand, elearnEconomics assists individuals studying Economics. This site covers a wide range of courses and individuals have the ability to customise their course or do extension work. It’s simple, easy to use and very cost effective.

eLearnEconomics is a comprehensive online economics learning resource. It is for both students AND teachers. Students study the concepts of each topic with the key notes, then review those concepts with the audio/video and flash card sections and finally test themselves in the written answer and multi-choice sections. The multi-choice section records student scores enabling them to track their progress and build their confidence leading into exams.

Teachers have the ability to monitor students progess within the teachers’ administration section. Students can be arranged into class groups and full reports generated to quickly identify problem areas. These high quality PDF reports can also be presented at parent/teacher evenings. Click the link below to access the site.

elearneconomics

# Modern Monetary Theory vs Mainstream Monetary Theory

Although not in the A2 syllabus we have had some great discussions in my A2 class on Modern Monetary Theory – MMT. It has its roots in the theory of John Maynard Keynes who during the Great Depression created the field of macroeconomics. He stated that the fact that income must always move to the level where the flows of saving and investment are equal leads to one of the most important paradoxes in economics – the paradox of thrift. Keynes explains how, under certain circumstances, an attempt to increase savings may lead to a fall in total savings. Any attempt to save more which is not matched by an equal willingness to invest more will create a deficiency in demand – leakages (savings) will exceed injections (investment) and income will fall to a new equilibrium. When you get this situation it is the government that can get the economy moving again by putting money in people’s pockets.

MMT states that a government that can create its own money therefore:

1. Cannot default on debt denominated in its own currency;
2. Can pay for goods, services, and financial assets without a need to collect money in the form of taxes or debt issuance in advance of such purchases;
3. Is limited in its money creation and purchases by inflation, which accelerates once the economic resources (i.e., labor and capital) of the economy are utilised at full employment;
4. Can control inflation by taxation and bond issuance, which remove excess money from circulation, although the political will to do so may not always exist;
5. Does not need to compete with the private sector for scarce savings by issuing bonds.

Within this model the only constraint on spending is inflation, which can break out if the public and private sectors spend too much at the same time. As long as there are enough workers and equipment to meet growing demand without igniting inflation, the government can spend what it needs to maintain employment and achieve goals such as halting climate change.

How does it differ from more mainstream monetary policy – see table below.

Those against MMT are dubious of the idea that the treasury and central bank should work together and also concerned about the jobs guarantee. They argue that if the government’s wage for guaranteed jobs is too low it won’t do much to help unemployed workers or the economy, while if it’s too high it will undermine private employment. They also say that trying to use fiscal policy to steer the economy is a proven failure because politicians rarely act quickly enough to respond to a downturn. They can’t be relied upon to impose pain on the public through higher taxes or lower spending to quell rising inflation.

Below is a video from Stephanie Kelton, an MMTer who was the economic adviser on Vermont Independent Senator Bernie Sanders’s presidential campaign in 2016.

Sources:

The Economist – Free Exchange – March 16th 2019

Wikipedia – Modern Monetary Theory