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IGCSE Economics – Division of Labour

Just been doing Division of Labour with my IGCSE class and came across this very good video from Marginal Revolution University.

Division of Labour  is the breakdown of a production process so that each person can specialise in one part of that process and, through skill development and timesaving, workers’ productivity is increased. Adam Smith in The Wealth of Nations pointed out that the making of pins required 18 distinct operations and if one person did them all, approximately 20 pins would be produced each day. However, if ten people carried out some of the operations, then – through a division of labour – upward of 48,00 pins or 4,800 pins per worker would be produced each day.

US – China trade war. Who has the power?

Another PBS video from Paul Solmon about the trade war between the US and China. The trade war hits China more for two reasons:

  1. Trade makes up a much higher proportion of China’s GDP than that of the USA
  2. With the Chinese economy slowing there is a big reliance on the export sector as an employer

The Chinese have certain options (see below) open to them which are discussed in the video below.

  1. Bond dump
  2. Squeezing US firms in China
  3. Pull back on the number of Chinese coming to US for education
  4. Devalue their currency
  5. China might make sweetheart trade deals with other countries leaving out the US

Brexit and the Common Agricultural Policy (CAP)

With the 29th March deadline approaching UK farmers are particularly opposed to a no-deal Brexit; customs hold-ups at the borders could ruin fresh produce. And there is concern that new trade deals with countries like New Zealand could lead to a flood of cheap imports and therefore making it harder for British farmers.

The EU bloc receives receives about 60% of UK food exports with 70% of the UK food imports come from the EU bloc. Lamb and beef exports could face export tariffs of at least 40% if the UK reverted to World Trade Organization rules under a no-deal exit. The UK produces approximately 60% of what is required to feed its population with the remainder being imported. The UK’s £110bn-a-year agriculture and food sector is deeply integrated with Europe relying on the bloc for agricultural subsidies of £3.1bn ($4bn) under the CAP – Common Agricultural Policy. The government has promised to pay the equivalent of the CAP subsidies up to 2022, no one is certain what will happen after that.

What is CAP?

At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector has been known as the common agricultural policy – CAP. The CAP was established under Article Thirty Nine of the Treaty of Rome, and its objectives – the justification for the CAP – are as follows:

1. Raise and maintain farm incomes, through the establishment of high prices for food. Such prices are often in excess of the free market equilibrium. This necessarily means support buying of surpluses and raising tariffs on cheaper imported food to give domestic preference.
2. To reduce the wide flutuations that often occur in the price of agriculutural products due to uncertain supplies.
3. To increase the mobility of resources in farming and to increase the efficiency of all units. To reduce the number of farms and farmers especially in monoculturalistic agriculture.
4. To stimulate increased production to achieve European self sufficiency to satisfy the consumption of food from our own resources.
5. To protect consumers from violent price changes and to guarantee a wide choice in the shop, without shortages.

CAP Intervention Price

An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.

CAP Int Price
Figure 1: The effect of an intervention price on the income of EU farmers.

The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.

Throughout most of its four decades of existence, the CAP has had a very poor public relations image. It is extremely unpopular among consumers, and on a number of occasions it has all but bankrupted the EU.

Airline prices: 2014 – 2018 and dynamic pricing

Another great graphic from The Economist showing the change in the price of an economy class ticket for both short-haul and long-haul flights. Routes longer than 5,000km have generally seen price drops of 30% and 50% on some transatlantic routes.

Reasons for the drop in fares:

  • Fuel costs have come down – 2014 = US$0.81 / litre – 2016 = US$0.22 / litre
  • Increasing long-haul competition from low-cost carriers
  • More fuel efficient planes = lower costs
  • Subsidies to state owned e.g. China
  • Major airline deregulation
  • Airlines have become much better at making more efficient use of their planes – i.e. having them full

Airlines and dynamic pricing

To the average buyer, airline ticket prices appear to fluctuate without reason. But behind the process is actually the science of dynamic pricing, which has less to do with cost and more to do with artificial intelligence. See video below from Tom Chitty of CNBC

Is it time to ‘short’ the Aussie dollar

Although I wrote recently on Australia avoiding the ‘resource curse’ this video from the FT suggests otherwise and that the Aussie Dollar in 2019 is going to be volatile. The slowing down of the Chinese economy accompanied by a trade dispute with the US has meant lower demand for the Aussie Dollar. Imports of commodities, especially iron-ore, have slowed as China recorded significant reduction in exports and imports in December last year – see graph below:

A lot will depend in the US Fed and its interest rate stance and whether with weaker inflationary pressure and a slowing economy there could be a drop in rates which would help the Aussie Dollar. The cother concern is the exposure that commercial banks have in the mortgage market. Housing has long been a favoured investment option in Australia and with the housing market slowing banks could be left exposed with defaults on mortgages. So is it time to dump the Aussie Dollar?

Falling exchange rate – causes and effects.

Turkey’s economy – stuffed

Inflation at 25%, Central Bank interest rates at 24%, Lira down 30% in value since the start of the year. What hope is there for the Turkish economy?

Wages and salaries haven’t kept pace with inflation and the reduction in demand has led to higher unemployment. There is pressure on the central bank to keep interest rates to avoid the lira collapsing. However this makes it expensive for businesses to borrow money and thereby reducing investment and ultimately growth.

No pain no gain – there is no alternative for Turkey other than undertaking painful and unpopular economic reforms. Remember what Reagan said in the 1980’s “If not now, when? If not us, who?”  He was referring to the stagflation conditions in the US economy at the time and how spending your way out of a recession, which had been the previous administration’s policy, didn’t work.

In order to the economy back on track things will need to get worse but President Erdogan has the time on his hands as there is neither parliamentary nor presidential elections in the next five years. This longer period should allow him the time to make painful adjustments without the pressure of elections which usually mean more short-term policies for political gain. Beyond stabilising the lira, which helped to ease the dollar-debt burden weighing on the country’s banks and corporate sectors, the 24 per cent interest rate level the central bank imposed also brought about a long-overdue economic adjustment. A cut in interest rates discourage net inflows of investment from foreigners and the resulting depreciation would accelerate the concerns about financial stability and deteriorating business and consumer confidence. Below is a mind map as to why a rise in the exchange rate maybe useful in reducing inflation.

Why dearer oil impacts developing economies more.

It wasn’t long ago that $100 for a barrel of oil was the norm but with the advent of the shale market the production increased which depressed prices. It was felt that the flexibility of large scale shale production from the USA could act as a stabiliser to global oil prices.

Oil shocks – supply or demand?

Oil shocks are not all the same. They tend to be associated with supply issues caused by conflict or OPEC reducing daily production targets. In the case of an increase in global growth there is the demand side for oil which increases the price. However this doesn’t have a great effect as in such cases the rising cost of imported oil is offset by the increasing export revenue. However today’s increase has a bit of both:

Demand – global consumption has increased as the advanced economies recover after the GFC especially China
Supply – supply constraints in Venezuela from the economic crisis. Also tighter American sanctions on Iran and OPEC producers are not increasing supply with the higher price.

Higher oil prices do squeeze household budgets and therefore reduce demand. Lower prices are expected to act as a stimulus to consumer spending but it can also have negative effects on the petroleum industries.

Emerging economies the impact of higher oil prices

Oil importing emerging economies are badly impacted by higher oil prices:

  • Terms of trade deteriorate as the price of their imports rise relative to their exports
  • Exports pay for fewer imports = importers’ current-account deficits widen.
  • Normally this leads to a depreciation a a country’s currency which makes exports cheaper and imports more expensive.

However this is not the case today. World trade is slowing and with it manufacturing orders therefore higher oil prices make the current account worse which in turn depreciates the exchange rate. For emerging economies who have borrowed from other countries or organisations a weaker exchange rate intensifies the burden of dollar-denominated debt. Companies in emerging economies have borrowed large amounts of money being spurred on by very low interest rates but they earn income in the domestic currency but owe in dollars – a weaker exchange rate means they have to spend more of their local currency to pay off their debt. Therefore indebted borrowers feel the financial squeeze and may reduce investment and layoff workers.

Another problem for emerging economies, as well as higher oil prices, is that central banks are looking to tighten monetary policy (interest rates) with the chance of higher inflation.

Source: The Economist – Crude Awaking – September 29th 2018

Global poverty rates down but challenges still remain

The world attained the first Millennium Development Goal target—to cut the 1990 poverty rate in half by 2015—five years ahead of schedule, in 2010. Despite the progress made in reducing poverty, the number of people living in extreme poverty globally remains unacceptably high. And given global growth forecasts, poverty reduction may not be fast enough to reach the target of ending extreme poverty by 2030.

According to the most recent estimates:

  • 1990 – 36% of the world’s population lived on less than US$1.90 a day
  • 2013 – 11 % of the world’s population lived on less than US$1.90 a day
  • 2015 – 10 % of the world’s population lived on less than US$1.90 a day

Nearly 1.1 billion fewer people are living in extreme poverty than in 1990. In 2015, 736 million people lived on less than $1.90 a day, down from 1.85 billion in 1990.

While poverty rates have declined in all regions, progress has been uneven:

  • East Asia and Pacific (47 million extreme poor)
  • Europe and Central Asia (7 million) have reduced extreme poverty to below 3 percent, achieving the 2030 target.
  • More than half of the extreme poor live in Sub-Saharan Africa. In fact, the number of poor in the region increased by 9 million, with 413 million people living on less than US$1.90 a day in 2015, more than all the other regions combined. If the trend continues, by 2030, nearly 9 out of 10 extreme poor will be in Sub-Saharan Africa.
  • The majority of the global poor live in rural areas, are poorly educated, employed in the agricultural sector, and under 18 years of age.

Challenges

One of the main challenges is that it is becoming very difficult too reach those that are in extreme poverty as they often live in countries that are remote or have internal strife amongst its population. Furthermore access to good schools, health care, electricity, safe water, and other critical services remains elusive for many people, often determined by socioeconomic status, gender, ethnicity, and geography.

Even those that seem to be able to move out of poverty can only do it for a certain period of time as economic shocks, food insecurity and climate change can be their undoing and revert them back into poverty.

Policies

The book ‘The End of Poverty: How we can make it happen in our lifetime’ by Jeffrey Sachs (2005) looks policies to overcome poverty. Although it is an old publication it does have some valid points. However what is imperative is that a one-size fits all policy doesn’t work as all countries have some unique variables that requires a customised approach.

At the most basic level, the key to ending extreme poverty is to enable the poorest of the poor to get their foot on the ladder of development. The development ladder hovers overhead, and the poorest of the poor are stuck beneath it. They lack the minimum amount of capital necessary to get a foothold, and therefore need a boost up to the first rung. The extreme poor lack six major kinds of capital:

  • Human capital: health, nutrition, and skills needed for each person to be economically productive
  • Business capital: the machinery, facilities, motorized transport used in agriculture, industry, and services
  • Infrastructure: roads, power, water and sanitation, airports and seaports, and telecommunications systems, that are critical in-puts into business productivity
  • Natural capital: arable land, healthy soils, biodiversity, and well-functioning ecosystems that provide the environmental services needed by human society
  • Public institutional capital: the commercial law, judicial systems, government services and policing that underpin the peaceful and prosperous division of labor
  • Knowledge capital: the scientific and technological know-how that raises productivity in business output and the promotion of physical and natural capital

Source: The Economist – Espresso

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OECD – GDP per capita – New Zealand falls to 22nd.

New Zealand has enjoyed a high standard of living and solid economic growth in recent years. However, during this period New Zealand has also exhibited a comparatively low level of productivity growth relative to our OECD peers. Broad-based evidence of this can be seen in New Zealand’s Gross Domestic Product (“GDP”) per capita. This metric measures output per New Zealander and is standardised into US Dollars for all countries. On this metric, New Zealand has consistently trailed the United States, Australia, Canada, Great Britain, France, Japan and the OECD average.

In 2017, New Zealand was ranked 22 of 48 countries surveyed by the OECD, compared with 9th place in 1970 and 20th in 1993. Over the last 50 years the world has seen much stronger growth in exports of manufactured products and slower growth in exports of primary products. And New Zealand’s competitive advantage is still in primary products. We are now on the brink of a technological revolution that will alter the way we live and work. The fourth industrial revolution is all about embracing the digital revolution. Our low productivity levels are a bit of a conundrum and the reasons for this are varied and subjective. Source – ANZ Bank

OECD GDP PER CAPITA (2017)

Source: Organisation for Economic Co-operation and Development (“OECD”)