Category Archives: Economic Systems

China and its journey to be a superpower

Useful video from DW which looks at China which over 40 Years ago opened up its economy to the rest of the world. Although Chinese President Xi Jinping vowed to press ahead with economic reforms he made it clear that Beijing will not deviate from its one-party system or take orders from any other country. China has a system of market socialism in which the political system of communism exists in parallel with market capitalism and private ownership. The Irish Times Beijing correspondent Clifford Coonan makes some very good points.

Doc Martens – from anti-capitalist punk movement to London Stock Exchange

In the 1970’s Doc Marten boots were a symbol of youth culture, inner rebellion and an essential part of the uniform. However last week the company floated on the London Stock Exchange which sort of sums up the unequal environment that we live in as it seems that everything can be repackaged, commodified and resold – e.g. US housing market and subprime mortgages.

The story of Doc Martens is the story of the financialisation of the global economy. It is a tale of credit cycles, access to capital and a winner-takes-all form of capitalism that undermines our social fabric. The story is a microcosm of much that is problematic with late-stage, 21st-century financial engineering. Some key points about the financialisation of Doc Martens:

  • 1945 -Klaus Märtens a doctor in the German army injured his ankle whole skiing. Designs a better boot.
  • 1947 – now with investor partner Herbert Funck they start to make good sales
  • 1959 – R. Griggs group Ltd (UK shoe manufacturer) bought patent rights
  • 2013 – Griggs family sell the company to private equity company Permira for £300 million
  • 2021 – Permira plans to float Doc Martens at a valuation of $4 billion.

The advantage to firms like Permira is that they can borrow money at virtually 0% interest and deals like this normally involve a small amount of equity, carrying a significant amount of debt.

This means that if the debt-to-equity ratio of the original deal was 90/10, the return on committed equity could be more than 100 times the original cash investment. It is not difficult to see why, at times of very low interest rates, the return to the already wealthy and financially literate goes through the roof. Financial engineering that benefits the extremely rich, converts an everyday shoe company into a gold mine. (We are talking Doc Martens here, not a life-saving Covid vaccine.) David McWilliams

Inequality statistics from the USA:

  • Top 10 per cent of wealthiest families in the US hold 76 per cent of total household wealth.
  • Bottom 50 per cent held just 1 per cent of the nation’s wealth.
  • Top 1 per cent of families account for 40 per cent of all wealth.
  • Between 1979 & 2015, households in the top 1 per cent saw their incomes grow five times as fast as the bottom 90 per cent,
  • Earnings of the top 0.1 per cent grew 15-times faster than the bottom 90 per cent.

In 1941, US supreme court justice Louis Brandeis noted: “We can have democracy in this country, or we can have great wealth concentrated in the hands of a few, but we can’t have both.”

Source: What a Doc Martens boot can teach us about the wealth gap

AS Economics Revision – Transition Economies

With the CIE AS essay paper on Wednesday next week here are some notes on the issues confronting transition economies – this topic is in Unit 1 of the syllabus. What have been the formidable challenges facing eastern European countries (command) embracing capitalism? Here are some thoughts as well as an informative video from the IMF:

  • In planned some goods are provided free but not in a market economy
  • Corruption – widespread in communist countries in eastern Europe – Oligarchs
  • Inflation ↑ – privatised firms began to charge prices that reflected high costs
  • Lack of entrepreneurial experience
  • Rising unemployment as owners of businesses try to make them more efficient.
  • Labour relations – Poor as workers are in a new environment – Job security?
  • Consumer sovereignty – some industries decline/expand
  • Resources – surplus and shortage
  • Self-Interest – fewer merit goods and more demerit goods
  • Time Gap before framework of government controls can be developed
  • Expansion of industry – potentially for greater externalities
  • Old/disabled – vulnerable with the change of government role
  • Welfare system – limited support for unemployed etc. will take time to develop
  • Provision of public services – disruption to police and other public services
  • Moral Hazard – the state insure workers against risks of losing their job

Models of Capitalism – LMEs vs CMEs during COVID-19

The Economist Free Exchange recently ran an article looking at the various taxonomies that are used to categorise models of capitalism. The book entitled “Varieties of Capitalism” (2001), distinguished between liberal market economies (LMEs) and co-ordinated market economies (CMEs).

LMEs’ rely on market mechanisms to allocate resources and determine wages, and on financial markets to allocate capital. E.G. America, Britain and Canada
CMEs, like social organisations such as trade unions, and of bank finance. E.G. Germany, Sweden, Austria and the Netherlands

Western economies tend to sit on a continuum between these two models – below is a table outlining the main criteria each:

Source: Wikipedia

Which system is better during a pandemic?

During the pandemic, CMEs have generally had a more sound strategy for containing the spread of the virus. This may be generated by unity and consistency than by the strength of the intervention that is chosen. Some countries, e.g. Sweden, avoided lockdowns completely but seemed to get a lot of public support and relied on voluntary social distancing. New Zealand implemented a lockdown policy from the outset and relied a lot on contract tracing as well as strict system of managed isolation. LMEs such as the USA and the UK have had a policy which have been on the whole disorganised and not taken the virus seriously.

However in such situations and because of their innovative nature LMEs are more likely to focus on treatments and vaccines.

Of 34 vaccine candidates tracked by the World Health Organisation
CMEs = 4
LMEs = 13
(AstraZeneca, an Anglo-Swedish drugmaker working with Oxford University, straddles both categories).

CMEs are likely to have a lower death count but LMEs seem to hold the upper hand with regard to a vaccines. Maybe a global coalition and co-ordination is needed in future to get the best of both systems.

Source: The Economist – Which is the best market model? 12th September 2020

Ludicrous regulations of the US Airline Industry and Contestable Markets

With Auckland now at COVID-19 Alert Level 3 and schools operating online we continued going through the A2 syllabus and discussed Contestable Markets using Webex. I used this clip from Commanding Heights to show how regulated the US airline industry was during the 1970’s. Regulations meant that major carriers like Pan Am never had to compete with newcomers. However an Englishman named Freddie Laker was determined to break this tradition and set-up Laker airways to compete on trans-atlantic flights. He offered flights at less than half the price of what Pan Am charged. Alfred Kahn was given the task by the then President Jimmy Carter to breakup the Civil Aeronautics Board (the regulatory body) and he wanted a leaner regulatory environment in which the market was free to dictate price. There is a piece in the clip that shows how ludicrous some of the regulations were:

When I got to the Civil Aeronauts Board, the biggest division under me was the division of enforcement – in effect, FBI agents who would go around and seek out secret discounts and then impose fines. We would discipline them. It was illegal to compete in price. That means it was illegal to compete in the discounts you offer travel agents. So we regulated travel agents’ discounts. Internationally, since they couldn’t cut rates, they competed by having more and more sumptuous meals. We actually regulated the size of sandwiches. Alfred Kahn

When the CAB was closed down competition was the rule and the industry had vastly underestimated the demand for air travel at lower prices – a very elastic demand curve – see graph below.

In the A2 course contestable markets is a popular essay question and is usually combined with another market structure.

What is a contestable market?

• One in which there is one firm (or a small number of firms)
• Because of freedom of entry and exit, the firm faces competition and might operate in a way similar to a perfectly competitive firm
• The threat of “hit and run entry” from new firms may be sufficient to keep the industry operating at a competitive price and output
• The key requirement for a contestable market is the absence of sunk costs – i.e. costs that cannot be recovered if a business decides to leave a market
• When sunk costs are high, a market is more likely to produce an price and output similar to monopoly (with the risk of allocative inefficiency and loss of economic welfare)
• A perfectly contestable market occurs only when entry and exit into and out of a market is perfectly costless
• Contestable markets are different from perfect competitive markets
• It is possible for one incumbent firm to dominate the industry
• Each existing firm in the market produces a differentiated product (i.e. goods and services are not perfect substitutes for each other)

There are 3 conditions for market contestability:

• Perfect information and the ability and or legal right to use the best available technology
• Freedom to market / advertise and enter a market
• The absence of sunk costs

• Liberalisation of the US Airline Industry in the 1970’s and the European Airline Market in late 1990s
• Traditional “flag-flying” airlines faced new competition
• Barriers to entry in the industry were lowered (including greater use of leased aircraft)
• New Entrants – easyJet- Ryanair

Market Economy – Mindmap

In lockdown here in NZ but still teaching classes online. Looked at types of economies over the last few days and put together this mindmap. I found it useful to talk through different parts of the mindmap on the computer screen – using Cisco Webex for the online learning.

Adapted from – CIE Economics Revision Guide by Susan Grant

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
I = Business Investment
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’s ghost cities – there needs to be another plan

Below is a very good report from 60 Minutes Australia that gives you an update on China’s ghost cities. Roughly 22 percent of China’s urban housing stock is unoccupied, according to Professor Gan Li, who runs the main nationwide study. That adds up to more than 50 million empty homes, he said. One solution that the government could use is property or vacancy taxes to try to counter the issue, but neither appears imminent and some researchers, including Gan, say what actually counts as vacant could be tricky to determine.

For so long China has relied on major infrastructure projects including building cities to drive growth figures in their economy. Historically China’s economic model was based on export-led growth, massive government injections into the economy and access to cheap money. This is not sustainable and although you can keep blowing up bridges and build cities that nobody lives in at some point it becomes unsustainable. Furthermore since the global financial crisis economies have increased protectionist policies to look after their own economy and this has been followed with by the potential trade war with the USA. Therefore the Chinese government need to refocus the growth of the economy on domestic consumption rather than building things – Gross Fixed Capital Formation. So much more C than I in the GDP Expenditure equation. EG:

GDP = C↑+ I↓+ G + (X-M)

Scandinavian countries most expensive but happy

Another good video here with Tom Chitty from CNBC – outlines why the cost of living is so high in Scandinavia – Norway, Sweden and Denmark. These countries on average have some of the highest tax rates (see graph) in order to fund a large welfare state. Expenditure in social welfare is one of the highest as a % of GDP and eventhough it is very expensive to live in these countries they rank as some of the happiest.