Category Archives: Externalities

Weaning countries off coal won’t be easy.

Coal UsageGermany, the greenest of green countries, and probably the world’s most enthusiastic investor in renewable energy, is finding it very hard to breakaway from coal fired plants. The German government were all set to impose a levy on the coal industry but instead gave a subsidy of 1.6 billion euros to mothball eight coal-fired plants and shut them down permanently by 2023. The main cause of this change of policy was that there was significant pressure from labour unions and local governments in the coal industry. The resistance in the greenest of green countries is indicative of workers and retirees, local economies and communities still depend on coal.

So from Germany to India, strategies to increase the share of renewable energy in the power mix have relied on a coal base. Although governments worldwide are focused on cleaning up energy sources that cause significant emissions, there needs to be some regard for displaced workers from traditional energy sources like the coal industry. Coal miners skills will hardly be transferable to other occupations – structural unemployment.

Nevertheless, coal remains one of the easiest and cheapest form of energy and this is very apparent in India where usage is about 62% of energy needs. India is the second largest consumer after China and ahead of the USA. Also coal consumption is growing about 7 percent a year to power the country’s economic catch-up. As China is going through a growth period similar to Europe many years earlier, their argument will be that European countries polluted the environment by a similar amount

Climate change activists have highlighted concerns of rising temperatures by 2100, however  are rising temperatures as significant when you consider the long-term implications of much higher unemployment?

Source: New York Times – 30th August 2016

Three Gorges Dam – Positive and Negative Externalities

Below is a very good documentary on the construction of the largest dam in the world – the Three Gorges Dam in China. However in its construction there are both costs and benefits including private and external. This is a topic in Unit 3 of the CIE A2 Economics syllabus and is found under – Externalities. Remember that we have both positive and negative externalities of production and consumption.

THE DIFFERENCE BETWEEN PRIVATE AND SOCIAL COSTS

 Externalities create a divergence between the private and social costs of production.

SOCIAL COST = PRIVATE COST + EXTERNAL COST (externality)
  • Private costs are the costs to a ‘firm of producing a good or service and to an individual of consuming a product.
  • External costs are the spill over effects on third parties.
  • Social costs are obtained by adding the private and external costs together. They reflect the total cost to society of an economic decision.

The same concept applies for Private and Social Benefits:

SOCIAL BENEFIT = PRIVATE BENEFIT + EXTERNAL BENEFIT (externality)

Benefits and Costs of building the Three Gorges Dam

Three Gorges dam - Externalities

The biggest benefit that is seen from the dam’s construction is that it produces renewable energy from hydro electricity. The Three Gorges Dam alone can provide China with 10% of its annual energy consumption. Increasing the proportion of hydroelectricity alternative to coal burning plants, will cut their emissions greatly which will help reduce the overall emissions all over the world – carbon emissions will be reduced 100 million tonnes compared to alternative coal generation

A Level Revision: Comparing living standards over time and between countries

National income figures, usually GDP at factor cost, are the man figures used to compare living standards. This is because most countries keep and publish detailed national income data.

However, care has to be taken in using national income figures to compare living standards both over time and between countries. It is important to use GDP at constant prices (i.e. real national income) so that a misleading impression is not given because of the effects of inflation. It is also important to take into account differences in population size. A country with a large population is likely to produce more than a country with a small population. However, this output has to be shared out among more people so living standards are not necessarily higher. This is why economist divide output by population and compare real GDP per capita. Even when adjustments have been made for inflation and differences in population size, national income figures as a measure of living standards have to be interpreted cautiously.

A rise in real GDP per capital may have resulted from an increase in the output of capital goods. In the longer run this will increase productive capacity and result in more consumer goods being produced. However, in the short run people may not feel any benefit from more capital goods being made. An increase in weapons will also increase GDP but, again, may not necessarily improve living standards. If more police are employed and crime is reduced, the quality of people’s lives will be improved. However, if more police are employed to keep pace with rising crime, people will be feeling worse off. So economists have to look not only at the amount of goods and services produced but also at the composition of those goods and why the quantity has changed. In addition, the quality of goods and services produced should be examined. The same quantity could be produced this year as last year or five years ago but if the quality of the output has risen, living standards will have improved.

The distribution of income also has to be taken into account. National income may rise but if it is concentrated in the hands of a few, the living standards of the majority may not rise. See graph below from The Economist showing the Gini coefficient of income inequality.

Gini Coef Nordic

National income figures also fail to take into account some items which affect the quality of people’s lives. A certain amount of economic activity is not declared, either to avoid paying taxes or because it is illegal. If there is an increase in, say, people providing home hairdressing services but not declaring them, people’s living standards may rise, although this increase will not be reflected in the official figures.

Differences in working hours and working conditions are also not taken into account. If output remains constant but working hours fall, people are likely to have a higher quality of life.

National income figures only take into account economic activities for which a payment is made. They do not take into account externalities and non-marketed activities. So, for example, an increase in pollution will reduce living standards while an increase in people decorating the homes of old people, on a voluntary basis, will improve the quality of life of the elderly. Neither of these will be recorded in national income figures.

All of these factors have to be taken into account in using national income figures to make comparisons both over time and between countries. However, some additional factors have to be considered when making international comparisons. Different statistical methods are employed in some countries and the degree of accuracy can vary. Tastes and needs can be different in different countries. For example, people living in a cold climate have to spend more on heating than those in warm countries, merely to enjoy the same standard of living. There is also the problem of selecting a rate of exchange to make the comparison. Exchange rate fluctuate and do not always reflect relative prices in compared using purchasing power parities which compare the cost of a given basket of goods in different countries.

Economics of the Sugar Tax

Celebrity chef Jamie Oliver was delighted with the ‘sugar tax’ that was announced as part of the 2016 Budget in the UK. The tax, which will come in from 2018, could add 8p (17c) to the price of cans of fizzy drinks like Coca-Cola, 7Up and Irn Bru, energy drinks like Red Bull and carton juice drinks like Ribena from 2018. Below is a clip from BBC Newsnight explaining the rationale behind the tax.

 

In economics sugary drinks have a negative externality, (cost to third party) and the tax will make consumers pay some of the external cost.

This higher tax reduces the quantity demanded, raises revenue for government and achieve a more socially efficient level of consumption. The money raised will go towards sport in primary schools. The sugar tax should help to reduce major health issues, such as:

  • obesity and related illnesses
  • diabetes –  in particular type 2 diabetes
  • tooth decay

These external costs are reflected in higher costs imposed on the UK National Health Service (NHS). Poor health also adversely affects work and productivity. Therefore, the social cost of sugar consumption is greater than the private cost of sugar. Remember:

Social Cost = Private Cost + External Cost

This diagram shows the impact of a good with external costs. The free market Quantity is Q1, Price P1. But, the socially efficient level of output is at Q2 (where MPB marginal private  benefit (assuming no externalities of consumption)  = MSC marginal social cost) The solution is to impose a tax which raises the price and reduce the quantity to Q2. Source: Tutor2u

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Coca-Cola use behavioral economics to increase sales

Coke Can 250mlYou may have seen on the shelves beside the standard 375ml Coca-Cola can the 250ml slimline can that Coca-Cola introduced over a year ago. Coca-Cola Amatil has used a clever trick to increase its fizzy drink sales over the past year – it’s putting its products in smaller cans.

There are two reasons for this:

1. We are paying more for less. In some shops the small cans sell for NZ$2.16 each, or NZ$6.50 a litre.

2. When we eat or drink smaller portions, we feel as if we’ve done something virtuous, according to David Just, a professor of behavioural economics at Cornell University who studies consumer food choices.

“If they are left wanting, they may be much more likely to move to a second can, which could be a bad thing for the consumer, but a good thing for Coke.

“If they feel they have done something virtuous, they might feel they have licence to consume more elsewhere, and most often overcompensate.”

Coke are already launch new products that tap into consumers’ desire for low- or no-sugar beverages. For example Coke Life, which the company packages in a green label instead of the usual bright red. To make it sweet Coca-Cola uses a mix of cane sugar and stevia which is up to 150 time sweeter than sugar. Coke Life has about two-thirds of the sugar and kilojoules of regular Coke, and the company hopes it and similar products will lure health-conscious consumers back to fizzy drinks.

But isn’t this familiar to what the tobacco companies did after the link between smoking and cancer was established? They tried to get the consumer to smoke ‘Light’ cigarettes as opposed to not smoking at all. Don’t we have enough sugar in our diet anyway?

Obesity and the growth model

ObesityObesity it turns out is actually good for the economy. More consumption of food, particularly processed food, contributes to more economic growth. Poor health, strangely enough, can be considered an economic bonus. Bad food, too much food and drink, might be tragic in health terms but when it comes to the economy it would seem that obesity pays. But obesity doesn’t pay when it comes to the natural capital of the planet. Some economists have seen this obesity issue as indicative of wider economic, environmental and social problems. They take the economic argument one step further and link obesity to greenhouse gas emissions. Unnecessary over consumption of food is putting pressure on the environment through farming and manufacturing processes and hence contributing to its degradation.

There is proof to support the belief that while economic development is for the most part undoubtedly associated with human health, this is not always the case. The measure of economic growth – GDP – the value of the output of goods and services, does not consider the negative contributions that it might make to an economy. Ten percent of the developed world is made up of drug alcohol and cigarette sales and dealing with all these, medically of course, adds to the GDP and it is ironic that some cigarette manufacturers also produce surgical equipment and therefore making and doubling the benefit for GDP from smoking.

However growth is related to people living longer and this has been apparent with the improvements in healthcare in developed countries over the last century. In the developing world there has been a change from a high presence of infectious diseases to that of persistent illnesses including heart disease, strokes etc and is reflected, in some cases, in a disability for life. According to Garry Egger and Boyd Swinborne obesity is not a disease but a signal. It’s the canary in the coalmine, which should alert us to bigger structural problems in society. There are a number of areas where humans have achieved a peak of success, a sweet spot, but now that very success is turning on us and threatening to unravel centuries of achievement.

On the one hand, economic growth has over centuries led to a steadily improving standard of living, better levels of health and ever increasing life spans. In economic terms this reflects the start of a point of diminishing marginal rates of return from continued investment in the growth model.

Diminishing rates of return for the growth model

Mortality and economic growth data collected on the Swedish economy between 1800 to 2000 has shown the commencement of a diminishing rate of return on economic growth in relation to mortality rates. This coincides, not unexpectedly, with the leveling of improvements in health made from the decrease in infectious diseases associated with development, but with the consequent increase in chronic diseases associated with modern lifestyles, driven as they are by the modern environment. It is this switch, from predominantly infectious disease, to lifestyle-related chronic disease, and the consequent breakdown in the human immune system that differentiates the early from late stages of economic development. Several developing countries, such as China and India, appear to be experiencing this issue of chronic disease and at a more rapid pace because of their levels of GDP. In China for instance more than a quarter of the adult population are overweight or obese, as people add more meat and dairy products to their diet, causing chronic disease. According to a study in the Journal of Health Affairs “we need to find the right investments and regulations to encourage people to adopt a healthy lifestyle, or we risk facing higher rates of death, disease, and disability and the related costs.”

The reverse applies to Cuba where they experienced improved health conditions with the withdrawal of the Soviets in 1989. Over the next decade there was a significant improvement in health:

• Decrease in food intake of 1000 kcal/day average
• Mortality rate decrease by 20%
• Obesity reduced by approximately 50%
• Deaths from heart disease reduced by 35%
• Deaths from stroke reduced by 18%

Final thought
It seems to be apparent that the current economic growth system cannot keep going in perpetuity. As developed economies grow there comes a point where there is a diminishing marginal rate of return on investment in terms of climate change and in particular human health. As Keynes indicated at the Bretton Woods conference in 1944 this current model of economics, ie. growth driven, will need to change in the next 100 years.

References:

Obesity, Chronic Disease, and Economic Growth: A Case for “Big Picture” Prevention by Garry Egger http://www.sage-hindawi.com/journals/apm/2011/149158/

Radio New Zealand – 30-1-11 Interview with Garry Egger

Taxes on fizzy drinks

With the increase in bulging waistlines and the rise in diabetes governments have been implementing taxes on surgary drinks to overcome this negative externality of consumption. The list of governments includes the following countries:

Hungary – in 2011 a tax on products with a high sugar content. The tax was calculated on the turnover of the company and the percentage of sugar per 100g of the product. Hungarian confectioners must pay the health tax on top of a 27% value added tax.

France – in 2012 a tax on all drinks with added sugar or artificial sweetener – US$0.08 per litre.

Mexico – in 2014 a tax on all sugary drinks of US$0.06 per litre. according to The Economist, in 2012 more than 70% of Mexican adults and 34% of 5-11 year olds were overweight and 12% of the population have diabetes which accounted for 14% of deaths in 2009.

Invariably the commercial sector believes that the government should not interfere with the market system and that consumers should be free to decide what to drink and eat. However the effect of a tax can be limited if the retailers absorb all the tax and therefore the price of the drink remains unchanged. Additionally a higher price because of the tax might not lead to any change in consumer behaviour as sugary drinks are very inelastic in nature to them.

Mexico

In some cases the tax has been passed onto the consumer and it has had the desired effect. Coca-Cola’s Mexican bottler, blamed declining sales in 2014 on the price jump that followed the introduction of the tax.  Overall sales of sugary drinks fell by 1.9% in 2014, having increased by an average of 3.2% a year over the three previous years. Some have said that reduced consumption has only saved Mexicans 5 calories a day on average and that the tax is regressive in that it takes more from the lower income groups than their higher income counterparts. Lower incomes were more responsive to the tax cutting their consumption of surgary drinks by 17% within a year of its introduction.

Different levels of tax.

As is the case with Hungary taxes that equate to levels of sugar or salt seem to be more effective with up to 40% of manufacturers adjusting their offending ingredients used. France and Mexico with their flat rate taxes for sugar content give the beverage industry little incentive to make it drinks healthier.

References: 

The Economist – Stopping slurping – November 28th 2015

confectionarynews.com 

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El Niño and Commodity Prices

Below is a very good video from The Economist outlining the effects of the El Niño weather pattern. It was first called El Niño – the boy (Jesus) – by Peruvian fisherman over a century ago because it became noticeable at Christmas time.

In parts of south east Asia, southern Africa and Australia it produces drier-than-average weather and even droughts. Research has shown that El nino tend to reduce global cocoa production by 2.4% which can lead to a price rise of almost 2%.

In South America heavy rain could threaten zinc, nickel and copper supply. Drought in South East Asia could lead to power shortages and higher prices in those countries that rely on hydropower.

Cash on Delivery – a better approach to aid.

Aid RemitForeign aid programmes have been criticised for encouraging dependency and wastefulness amongst developing countries. All too often there is little to show for the spending that has eventuated in these countries. Furthermore there seems to be a mismatch between what donors are prepared to pay for and what recipient countries feel is a priority. Money, in a lot of circumstances, is given to firms who have close links with the government but the end product is not used e.g. schools, roads and other infrastructure. Although donors can be stringent at how the money is spent, it is very difficult to monitor commercial activities in the developing world. For example “The Economist” reported that laying a square meter of road costs the World Bank 50% more in countries where firms report paying bribes above 2% of the value of contracts than ones where such payments are reported to be lower.

In order to combat this donors are now looking at giving aid only if outcomes improve – “Cash on Delivery”. Under this system recipients decide what they would like to develop in their economy and starts to use its own money and existing aid. This has also been referred to as the Stick and Carrot approach.

Coarse Theorem – Ronald Coarse argued that bargaining between parties could produce a mutually beneficial and efficient solution to problems like pollution.

Norway and Liberia
An example of this was the a deal between Liberia and Norway. Norway will give $150m in aid in return for Liberia stopping the destruction of its forests. The stick approach of trying to force Liberia to stop cutting down its trees might give way to a more effective carrot approach by paying Liberia to do so. This makes both sides better off. Liberia still gets the aid and Norway gets to preserve biodiversity and take a small step against climate change.

UK and Ethiopia
The UK has agreed to pay Ethiopia up to US$157 for each extra pupil sitting its school-leaving exam, compared with numbers before then, and another US$157 for each pupil who passed. Two years later nearly 45,000 extra students have taken the exam and 42,000 extra have passed.

I suppose now the onus is on the recipient country to avoid failing which has been the case with some conventional aid programmes where it is easy to proclaim assets as accomplishment.

Neo-Nazis fund anti-Nazi charity

For years neo-Nazi groups have marched through the German town of Wunsiedel in commemoration of Rudolf Hess (Hitler’s deputy) – Hess was buried there until 2011. Residents of the town had observed the march from a distance and have staged counterprotests and filed numerous legal complaints in the past, but this year the group Rechts gegen Rechts — Right against Right — tried a new tactic. For every metre that the ne-Nazis marched, local businesses and residents would donate 10 euro to a non governmental organisation (EXIT Germany) devoted to making it easier for neo-nazis to leave behind their hateful policies. Therefore the 200 neo-Nazis had two choices:

1. Proceed with the march and indirectly donating money to the EXIT Germany initiative
2. Acknowledge defeat and suspend the march.

The neo-Nazis proceeded with their march and therefore contributed to an organisation that was committed to their downfall. Locals provided motivational banners and sustenance so that the neo-Nazis would keep walking – positive externalities for locals? An interesting tactic by EXIT Germany and an effective alternative to counter-demonstrations.