The Paradox of Aid – dumping in developing countries.

Although a few years old now the video below is a good example of dumping – where the exporting country is able to lower its prices below that of the domestic price in the market it is selling into. Useful to show when teaching barriers to trade.

The U.S. spends approximately $37 billion dollars a year on foreign aid – just under 1% of our federal budget. “The Foreign Aid Paradox” zeroes in on food aid to Haiti and how it affects American farming and shipping interests as well as Haiti’s own agricultural markets. The fact that the US dump rice exports on the Haitian market below the equilibrium price severely affects the revenue of local farmers. Should there be a trade-not-aid strategy for developing countries? Below is a very good video from wetheeconomy

The trade-not-aid strategy is based on the idea that if developing countries were able to trade more freely with wealthy countries, they would have more reliable incomes and they would be much less dependent on external aid to carry out development projects. International trade would raise incomes and living standards as poor countries would be able to export their way to economic development by selling their products to rich countries eager to buy their goods.

Source: http://www.globalization101.org/trade-not-aid/

Low income groups struggle in post Covid-19

From The Economist – very good explanation on the impact of COVID-19 on the entertainment / service sector. Often it is the low income groups that would be severely affected as they tend to work in the service industry especially – also not being able to work from home. As these groups tend to live from pay check to pay check they will struggle to maintain any quality of life. They are unlikely to have savings to call upon and will depend on handouts form the government in the form of unemployment benefit or the wage subsidy. What happens when government support runs out? The video is well worth watching.

King’s College student economics magazine

Click here to view ‘Marginal Utility’ a publication by economics students at King’s College, Auckland. Contents below

  • FUTURE OF THE NEW ZEALAND ECONOMY
  • COVID-19 AND THE AIRLINE INDUSTRY
  • ECONOMICS QUIZ
  • COVID-19 AND DEVELOPING ECONOMIES
  • OPTIONS FOR NEW ZEALAND TOURISM
  • ECONOMICS BOOKSHELF
  • TOILET PAPER HOARDING IN COVID-19
  • ECONOMICS PODCASTS
  • THE PARADOX OF NORWAY
  • FAMOUS ECONOMISTS
  • CROSSWORD

New Zealand Tourism will take a hit.

Tourism accounts for approximately 10% of GDP but the forecast doesn’t look good even with the success of eliminating Covid-19. NZ growth totalled $40.9bn last year of which $16.2bn – 5.8% GDP – came from tourism – see graph below. Tourism also helped the retail and hospitality sectors to the tune of $11.2bn – 4% GDP. But there are a number industries which have been hit hard by the lack of tourism due to Covid-19. The food and beverage industry relies on tourism and it accounts for 24% of the total food and beverage serving services.

Of visitors to New Zealand the three main ones are:

  • Australia – 23%
  • China -13%
  • Rest of Asia – 13%

New Zealand is more exposed to tourism than a lot of other countries; we rely more heavily on this sector for employment, income and GDP. In 2019, 229,566 people were directly employed in tourism (8.4% of the labour force). This is a significant portion of the labour market and is considerably higher than many other countries. It has estimated that 100,000 jobs could be lost in the tourism sector as a result COVID-19 – that is 40% of those employed in the sector. On 22nd April 2020 visitor numbers fell to zero – see graph below – as a result of the border closures. However the lockdown has given the tourism sector the chance to restructure the sector into a more sustainable model and be less reliant on overseas visitors. But the future is very fragile.

Arrivals to New Zealand

Source: ANZ Research – New Zealand Weekly Focus – 25th May 2020

A2 Eco – Indifference curves and GIN

Teaching my A2 class the most complex theory in the A2 CIE Economics course – indifference curves. This year one student has come up with a novel way of remembering the position of the indifference curve when the price of one good falls. The three types of goods that eventuate from a price fall are: Giffen, Inferior and Normal – GIN.

G – Giffen – price falls negative income effect outweighs the positive substitution effect – point L would then be to the left of point J on the graph below.
I – Inferior – price falls positive substitution effect outweighs negative income effect – point L would then be between points J and K
N – Normal good – price falls both income and substitution effect are positive – point L will be to the right of point K – as shown below.

Below is a mindmap on indifference curves explaining all the effects of increasing and decreasing prices on different types of goods.

US dollar under pressure as the reserve currency.

In doing most introductory courses in economics you will have come across the four functions of money which are:

  • Medium of exchange
  • Unit of Account
  • Store of Value
  • Means of deferred payment

Since the Bretton Woods Agreement in 1944 the US dollar was nominated as the world’s reserve currency and ranks highly compared to other currencies in the above functions. As a medium of exchange the US dollar is very prevalent:

  • 60% of the world’s currency reserves are in US dollars
  • 50% of cross-border interbank claims
  • After the GFC, purchases of the US dollar increased significantly – store of value.
  • Around 90% of forex trading involves the US dollar
  • Approximately 40% of the world’s debt is issued in dollars
  • n 2018 banks of Germany, France, and the UK held more liabilities in US dollars than in their own domestic currencies.

So why therefore is there pressure on the US dollar as the reserve currency?

The COVID-19 pandemic has closed borders and will inevitably lead to more regionalised trade, migration and money flows which suggests a greater use of local currencies. However China has made its intention clear that the Yuan should become a more universal currency. Some interesting facts:

  • Deposits in yuan = 1trn yuan = US$144bn
  • Yuan transactions have grown in Taiwan, Singapore, Hong Kong and London.
  • Investment by Chinese firms into Belt and Road project = US$3.75bn which was in yuan
  • China settles 15% of its foreign trade in yuan
  • France settles 20% of its trade with China in yuan
  • 2018 – Shanghai sock market launched yuan-denominated oil futures.
  • The IMF suggest that the ‘yuan bloc’ accounts for 30% of Global GDP – the US$ = 40%

However if the past is anything to go by the US economy has gone through some very turbulent times but the US dollar has remained firm. This suggests that how we perceive the US economy doesn’t seem to relate to the value of its currency.

Source: The Economist – China wants to make the yuan a central-bank favourite
7th May 2020

UK farmers get a double hit: COVID-19 and Brexit

As COVID-19 absorbs most of the headlines worldwide there are other concerns in the UK like Brexit. The farming industry has been impacted by both:

  • COVID-19 – shutdown of the service that serves the farming industry – 1/3 of the lamb market has gone.
  • Brexit – a deal needs to be negotiated with the EU.

Brexit and lamb exports to the EU – when the UK was part of the EU it was part of a custom union where there was no tariff between member states but there was a Common External Tariff (CET) which meant that countries outside the EU have to pay the same tariff when they export into any EU member state. For Britain leaving the EU without a deal has serious consequences for the farming sector. Over 90% of lamb exports in the UK have gone to the EU but with no longer being a member state the industry will no have to pay a CET which will undoubtedly make UK exports more expensive in the EU market. The FT visit a farm in Wales to look at the importance of the Brexit negotiations – a lamb is valued around £80 but if the EU charges the going rate of tariff between 40-80% that would bring up the price of lamb to between £112 – £144 in EU countries. This would make it very hard for farmers to remain financially viable. Furthermore it is not just the farming sector as the UK’s overall trade with the the EU is significant:

2018 – 45% of all UK exports go to the EU – $291bn
2018 – 53% of all UK imports from the EU – $357bn

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 (explained later in the post). The government has promised to pay the equivalent of the CAP subsidies up to 2022, no one is certain what will happen after that. There lies ahead some major challenges in the UK and not just for the farming sector. The video from the FT below is very useful for explaining the impact of trade barriers and CET.

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.


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.

Monopoly power – Luxottica and sunglasses

With summer approaching in the northern hemisphere and the days getting brighter you will be looking to don sunglasses on a more regular basis. Sunglasses come in various styles and brands, eg. Rayban, Oakley, Gucci, Prada, Versace to name but a few,  but can be quite expensive when you consider the so-called competition that is in the market which in theory should driving down the price. Sunglasses these days are reasonably homogeneous in that the frames and materials are very similar and it surprised me that 80% of the major sunglass brands are controlled by Luxottica, in a market that is worth US$28 billion.

Luxottica produced the following brands of sunglasses under their name:

Prada, Chanel, Dolce & Gabbana, Versace, Burberry, Ralph Lauren, Tiffany, Bulgari, Vogue, Persol, Coach, DKNY, Rayban, Oakley, Sunglasses Hut, LensCrafters, Oliver Peoples, Pearle Vision, Target Optical and Sears Optical.

This list of brands is fairly comprehensive and by controlling 80% of the market you have a monopoly and dictate the price consumers have to pay for each specific brand since the industry isn’t competitive. Therefore they are Price Makers. But Luxottica also dictate what goes in the shops as they own Sunglass hut, Oliver peoples and Pearle Vision where consumers shop for sunglasses. This makes it very difficult for a brand outside one that is produced by Luxottica to compete as you can’t get your product into those shops. So not only do they have a monopoly in the production but they also control the distribution of sunglasses. See monopoly graph below.

Although a few years old now, in the clip below from ’60 Minutes’ they mention Oakley’s dilemma when their sunglasses became more popular than those produced by Luxottica. When this happen Luxottica proceeded to hold fewer Oakely sunglasses in their Sunglass Hut shops causing Oakley’s stock to plunge. Then in 2007 Oakley was left with no choice but to merge with Luxottica.

US or China for Post Covid-19 financial dominance

Very informative video from The Economist with Matthieu Favas – Finance Correspondent – talking about the balance of power between the USA and China. The US didn’t show global leadership during the pandemic and China might fill the global vacuum that the US has left on the world stage. China has the second biggest bond market in the world and Covid-19 provided a rigorous test to suggest that people trust Chinese bonds. However there is a distrust of Chinese intentions and remember that Chinese officials covered up the spread of COVID-19.

Labour Market – notes for NCEA Level 2

Wage Rate:- The price of labour as determined by market supply and demand.
The demand for labour is said to be derived demand: – the demand for labour is dependent on the demand for the goods & services produced.
Key factors that affect the quantity of labour supplied:-

  • age of population
  • non-wage factors
  • wages
  • Difficulty in acquiring qualifications – eg. doctors
  • social attitudes to employment
  • discrimination

Change in Demand for labour Change in Supply of labour

Wages
A more realistic version of the market model measures the price of labour in real wages rather than in nominal or money wages. The difference is that nominal wages are the actual dollars that are paid for any job while real wages are a measure of the ability of those dollars (earnings) to buy goods and services. Therefore real wages consider the purchasing power of your income.

Sticky Wages
Actual wages will rise much more easily than they will fall. Labour markets are extremely rigid when it comes to reducing wage levels. Several factors encourage wages to stick at higher levels and so prevent the market from clearing, as shown in ‘Supply and Demand Applications’ and below.

Equilibrium and Real Wages

A = Employed B = Involuntary Unemployment C = Voluntary Unemployment

Some of these factors occur through the natural operation of the labour market.

  • Strong trade unions can operate as ‘monopoly suppliers’ of labour. This keeps wages above the equilibrium equilibrium. Fewer workers are hired.
  • Hiring cheap labour may backfire on employers. This labour may not have the same level of skills as that of the firm’s existing workforce. This will increase costs for the firm if it has to provide too much training. Existing workers therefore hold the balance of power and can demand higher wages.
  • The idea that a job has a certain worth, an intrinsic value regardless of the action of demand and supply, can keep wages above equilibrium.
  • The influence of humanity values can be strong. It is easy to pay less for resources other than labour.

Some factors are imposed on the market by the government.

  • Legislated minimum wages prevent the market from clearing. Although these wages aim to protect the incomes of those in the lower paid jobs, the result is fewer jobs for those same workers.
  • Welfare benefits can be over-generous and this may discourage the unemployed from seeking jobs.