Category: Podcasts and Videos
Posted on 31 December 2019 2 January 2020
A gift for the new decade: working less for more!
A lack of productivity growth has been a major problem for the UK economy over the past decade (click here for a PowerPoint of the chart). Is it possible that the new decade may see a pick-up in the growth in output per hour worked?
One possible solution to low productivity growth is to reduce working hours and even to move to a four-day week, but not to reduce total pay. If people work fewer hours, they may well be more productive in the hours they do work. In fact, not only may output per hour increase, but so too may output per worker, despite fewer hours being worked. What is more, the quality of output may increase with people being less tired and more motivated.
Several companies have experimented with a four-day week, including Microsoft in Japan, which employees 2300 workers. It found that, despite a 20% reduction in hours worked, output per hour worked increased by 40%, with total output thereby increasing. Workers were generally happier and more motivated and asked for fewer days off.
And it is not just a question of output: fewer hours can result in lower costs. The effect on costs will depend on the nature of new work patterns, including whether everyone has the same extra day off.
But a four-day week is only one way of cutting working hours for full-time employees. Another is to reduce the length of the working day. The argument is that people may work more efficiently if the standard working day is cut from eight to, say, five hours. As the first Thrive Global article article (linked below) states:
Just because you're at your desk for eight hours doesn't mean you're being productive. Even the best employees probably only accomplish two to three hours of actual work. The five-hour day is about managing human energy more efficiently by working in bursts over a shorter period.
If people have more leisure time, this could provide a boost to the leisure and other industries. According to a Henley Business School study:
An extra day off could have a knock-on effect for the wider society. We found 54% of employees said they would spend their day shopping, meaning a potential boost for the high street, 43% would go to the cinema or theatre and 39% would eat out at restaurants.
What is more, many people would be likely to use the extra time productively, undertaking training, volunteering or other socially useful activities. Also family life is likely to improve, with people spending less time at work and commuting and having more time for their partners, children, other relatives and friends. In addition, people's physical and mental health is likely to improve as they achieve a better work-life balance.
So, should firms be encouraged to reduce hours for full-time workers with no loss of pay? Many firms may need no encouragement at all if they can see from the example of others that it is in their interests. But many firms may find it difficult, especially if their suppliers and/or customers are sticking with 'normal' working hours and want to do business during those hours. But, over time, as more firms move in this direction, so it will become increasingly in the interests of others to follow suit.
In the meantime, should the government introduce incentives (such as tax breaks) or regulations to limit the working week? Indeed, it was part of the Labour manifesto for the December 2019 election that the country should, over time, move to a four-day week. Although this was a long-term goal, it would probably have involved the use of some incentives to encourage employers to move in that direction or the gradual introduction of limits on the number of hours or days per week that people could work in a particular job. It is unlikely that the new Conservative government will introduce any specific measures, but would probably not want to discourage firms from reducing working hours, especially if it is accompanied by increased output per worker.
But despite the gains, there are some problems with reduced working hours. Many small businesses, such as shops, restaurants and firms offering technical support, may not have the flexibility to offer reduced hours, or may find it hard to increase productivity when there is a specific amount of work that needs doing, such as serving customers.
Another problem concerns businesses where the output of individuals is not easy to measure because they are part of a team. Reducing hours or the working week may not make such people work harder if they can 'get way with it'. Not everyone is likely to be motivated by fewer hours to work harder.
Then there is the problem if reduced hours don't work in boosting productivity. It may then be very difficult to reintroduce longer hours.
But, despite these problems, there are many firms where substantial gains in productivity could be made by restructuring work in a way that reduces hours worked. We may see more and more examples as the decade progresses.
The pros and cons of a four day working week
ABC, Life Matters, Hilary Harper, Emma Dawson and Professor Peter McIlveen (25/11/19)
Economics of a four-day working week: research shows it can save businesses mone
The Conversation, Miriam Marra (11/11/19)
Less hours for work, more time on Earth: Why a four-day working week is good for you
Independent, Steve Taylor (16/12/19)
Microsoft Japan Launched A Four-Day Workweek To Much Success: Is This The Key To Attracting Talent In The Tight U.S. Job Market?
Forbes, Jack Kelly (5/11/19)
Will The Five-Hour Work Day Catch On In America?
Forbes, Jack Kelly (28/10/19)
My Company Implemented a 5-Hour Workday — and the Results Have Been Astounding
Thrive Global, Stephan Aarstol (3/10/19)
Why Does a Four-Day Work Week Achieve Better Results?
Thrive Global, Stephanie Lin (16/12/19)
Four-Day Working Week Improves Staff's Mental Health By 87%, Company Finds
Unilad, Niamh Shackleton (10/12/19)
Hull business launches four-day working week as well as your birthday off and 'Beer Fridays'
Hull Live, Phil Winter (5/12/19)
A four-day work week? Sounds nice, but here's the real deal
Sydney Morning Herald, Tony Featherstone (21/11/19)
The four-day debate: Fantasy or feasible?
The Hindu, Business Live, Kamal Karanth (20/11/19)
Finland's ministry of transport floats tech-enabled four-day week
Computer Weekly, Gerard O'Dwyer (20/11/19)
Should You Consider a 4 Day Work Week?
Small Business Trends, Rob Starr (5/12/19)
Four Better or Four Worse
A White Paper from Henley Business School, James Walker and Rita Fontinha (3/7/19)
Four-day Week Pays off for Business
Henley Business School Press Release (3/7/19)
Distinguish between different ways of measuring labour productivity.
Give some examples (from the linked references) of employers which have tried introducing a four-day week or reduced hours for full-time workers. What has been the outcome in each case?
In what ways may reducing working hours reduce a firm's total costs?
What are the advantages and disadvantages of the government imposing (at some point in the future) a maximum working week or a four-day week?
What types of firm might struggle in introducing a four-day week or a substantially reduced number of hours for full-time employees?
What external benefits and costs might arise from a shorter working week?
Tags: Tagsfour-day week, incentives, labour market, labour productivity, motivation, output per hour, output per worker, productivity, working weekPosted in: CategoriesEconomics 10e: Ch 10, Economics 10e: Ch 23, Economics for Business: 8e Ch 14, Economics for Business: 8e Ch 18, Economics for Business: 8e Ch 21, Economics for Business: 8e Ch 31, Essential Economics for Business: Ch 06, Essential Economics for Business: Ch 08, Essential Economics for Business: Ch 11, Essentials of Economics: 8e Ch 07, Essentials of Economics: 8e Ch 12, Podcasts and VideosAuthored by: John Sloman
An inflation make-up mandate
The monetary policy mandates of central banks have an impact on all our lives. While the terminology might not be familiar to many outside economics, their impact is, however, undeniably important. This is because they set out the objectives for the operation of monetary policy. Adjustments to interest rates or the growth of the money supply, which affect us all, reflect the mandate given to the central bank.
Since 1977 the mandate given to the Federal Reserve (the US central bank) by Congress has been to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates. This mandate has become known as the dual mandate because it emphasises both employment and stable prices. Since 2012, the Federal Reserve's Open Market Committee has issued an annual statemenent of its long-run goals. The latest was published in January 2019. Since this time, the Federal Reserve has explicitly set the 'longer-run goal for inflation' at 2 per cent. It has also emphasised that it would be 'concerned' if the inflation rate was persistently above or below this level.
In November 2018 the Federal Reserve began a review of its monetary policy strategy, its tools and how it communicates monetary policy. The review is being conducted within the guidelines that its statutory mandate gives and as well as the longer-term inflation goal of 2 per cent. However, one of the issues being addressed by the review is how the operation of monetary policy can avoid the rate of inflation frequently undershooting 2 per cent, as it has done since the financial crisis of the late 2000s and the introduction of the 2 per cent inflation rate target.
Chart 1 shows the annual rate of consumer price inflation in the US since 1998. It helps to illustrate the concern that low inflation rates can become entrenched. The chart shows that, while the average inflation rate from 1998 to 2008 was 2.7 per cent, from 2009 the average has been only 1.6 per cent. Interestingly, the average since 2012, when the explicit 2 per cent goal was introduced, to the present day is also 1.6 per cent. (Click here to download the PowerPoint chart.)
The concern going forward is that the natural or neutral rate of interest, which is the policy rate at which the rate of inflation is close to its target level and the level of output is close to its potential level, is now lower than in the recent past. Hence, when the next downturn occurs there is likely to be less room for cutting interest rates. Hence, the review is looking, in essence, to future-proof the conduct of monetary policy.
Chart 2 shows the Federal Fund rate since 1998. This is the rate at which commercial banks lend to each other the reserve balances they hold at the Federal Reserve in order to meet their reserve requirements. The Federal Reserve can affect this rate through buying or selling government securities. If it wants to drive up rates, it can sell holdings of government securities and reduce the money supply. If it wants to drive rates down, it can buy government securities and increase the money supply. The effects then ripple through to other interest rates and, in turn, aggregate demand and inflation. (Click here to download a copy of the PowerPoint chart.)
We can see from Chart 2 the dramatic cuts made by the Federal Reserve to interest rates as the financial crisis unfolded. The subsequent 'normalisation' of the Federal Funds rate in the 2010s saw the Federal Funds Rate rise to no higher than between 2.25 and 2.5 per cent. Then in 2019 the Federal Reserve began to cut rates again. This was despite historically-low unemployment rates. In November 2019 the unemployment rate fell to 3.5 per cent, its lowest since 1969. This has helped fuel the argument among some economists and financiers, which we saw earlier, that that the natural (or neutral) interest rate is now lower.
If the natural rate is lower, then this raises concerns about the effectiveness of monetary policy in future economic downturns. In this context, the review is considering ways in which the operation of monetary policy would be able to prevent the rate of inflation consistently undershooting its target. This includes a discussion of how the Fed can prevent inflationary expectations becoming anchored below 2 per cent. This is important because, should they do so, they help to anchor the actual rate of inflation below 2 per cent. One possibility being considered is an inflation make-up strategy. In other words, a period of below-target inflation rates would need to be matched by a period where inflation rates could exceed the 2 per cent target in order that the long-term average of 2 per cent is met.
An inflation make-up policy would work like forward guidance in that people and markets would know know that short-term interest rates would be kept lower for longer. This would then help to force longer-term interest rates lower as well as providing people and businesses with greater certainty that interest rates will be lower for longer. This could help to encourage spending, raise economic growth and prevent inflation from overshooting its target for any extensive period of time.
An inflation make-up strategy would, in part, help to cement the idea that the inflation target is effectively symmetrical and that 2 per cent is not an upper limit for the inflation rate. But, it would do more than that: it would allow the Fed to deliberately exceed the 2 per cent target.
An inflation make-up strategy does raise issues. For example, how would the Fed determine the magnitude of any inflation make-up and for how long would a looser monetary stance be allowed to operate? In other words, would an inflation make-up strategy be determined by a specific rule or formula? Or, would the principle be applied flexibly? Finally, could a simpler alternative be to raise the target rate itself, given the tendency to undershoot the 2 per cent target rate? If so, what should that the rate be?
We should know by the end of 2020 whether the Federal Reserve will adopt, when necessary, an inflation make-up monetary policy.
US Federal Reserve considers letting inflation run above target
Financial Times, Brendan Greeley (2/12/19)
Fed Officials Getting Serious About Strategies for Low Inflation
Bloomberg, Craig Torres and Catarina Saraiva (9/10/19)
Clarida: Lowering Inflation Created New Challenges for Central Banks
The Wall Street Journal, Nick Timiraos (12/11/19)
What do you understand by the monetary policy mandate of a central bank?
Explain the ways in which the monetary policy mandate of the central bank affects our everyday lives.
Why are inflation-rate expectations important in determining actual inflation rates?
Why is the Federal Reserve concerned about its ability to use monetary policy effectively during future economic downturns?
Discuss the economic arguments for and against central banks operating strict inflation-rate targets.
Does the case for adopting an inflation make-up monetary policy mandate show that the argument for inflation-rate targeting has been lost?
What do you understand by the idea of a natural or neutral policy interest rate? Would the actual rate be expected to be above or below this if the rate of inflation was below its target level?
Tags: TagsCentral bank mandates, Expectations of inflation, Federal Reserve, Federal Reserve rate, financial crisis, forward guidance, Inflation make-up policy, Inflation rate, Inflation rate targets, interest rates, monetary policy, Natural rate of interest, Neutral rate of interestPosted in: CategoriesEconomics 10e: Ch 18, Economics 10e: Ch 22, Economics for Business: 8e Ch 28, Economics for Business: 8e Ch 30, Essential Economics for Business: Ch 11, Essentials of Economics: 8e Ch 11, Essentials of Economics: 8e Ch 13, Podcasts and VideosAuthored by: Dean Garratt
Economists and the real world
Economists are often criticised for making inaccurate forecasts and for making false assumptions. Their analysis is frequently dismissed by politicians when it contradicts their own views.
But is this fair? Have economists responded to the realities of the global economy and to the behaviour of people, firms, institutions and government as they respond to economic circumstances? The answer is a qualified yes.
Behavioural economics is increasingly challenging the simple assumption that people are 'rational', in the sense that they maximise their self interest by weighing up the marginal costs and benefits of alternatives open to them. And macroeconomic models are evolving to take account of a range of drivers of global growth and the business cycle.
The linked article and podcast below look at the views of 2019 Nobel Prize-winning economist Esther Duflo. She has challenged some of the traditional assumptions of economics about the nature of rationality and what motivates people. But her work is still very much in the tradition of economists. She examines evidence and sees how people respond to incentives and then derives policy implications from the analysis.
Take the case of the mobility of labour. She examines why people who lose their jobs may not always move to a new one if it's in a different town. Partly this is for financial reasons – moving is costly and housing may be more expensive where the new job is located. Partly, however, it is for reasons of identity. Many people are attached to where they currently live. They may be reluctant to leave family and friends and familiar surroundings and hope that a new job will turn up – even if it means a cut in wages. This is not irrational; it just means that people are driven by more than simply wages.
Duflo is doing what economists typically do – examining behaviour in the light of evidence. In her case, she is revisiting the concept of rationality to take account of evidence on what motivates people and the way they behave.
In the light of workers' motivation, she considers the implications for the gains from trade. Is free trade policy necessarily desirable if people lose their jobs because of cheap imports from China and other developing countries where labour costs are low?
The answer is not a clear yes or no, as import-competing industries are only part of the story. If protectionist policies are pursued, other countries may retaliate with protectionist policies themselves. In such cases, people working in the export sector may lose their jobs.
She also looks at how people may respond to a rise or cut in tax rates. Again the answer is not clear cut and an examination of empirical evidence is necessary to devise appropriate policy. Not only is there an income and substitution effect from tax changes, but people are motivated to work by factors other than take-home pay. Likewise, firms are encouraged to invest by factors other than the simple post-tax profitability of investment.
Trade may not lift a lot of new people out of poverty
Business Matters, BBC, Esther Duflo (6/11/19)
Why economists get things wrong
BBC News, Szu Ping Chan (19/11/19)
In traditional 'neoclassical' economics, what is meant by 'rationality' in terms of (a) consumer behaviour; (b) producer behaviour?
How might the concept of rationality be expanded to take into account a whole range of factors other than the direct costs and benefits of a decision?
What is meant by bounded rationality?
What would be the effect on workers' willingness to work more or fewer hours as a result of a cut in the marginal income tax rate if (a) the income effect was greater than the substitution effect; (b) the substitution effect was greater than the income effect? Would your answers to (a) and (b) be the opposite in the case of a rise in the marginal income tax rate?
Give some arguments that you consider to be legitimate for imposing controls on imports in (a) the short run; (b) the long run. How might you counter these arguments from a free-trade perspective?
Tags: Tagsassumptions, behavioural economics, bounded rationality, Duflo, economic models, free trade, geographical immobiliy, import controls, incentives, income effect, labour mobility, motivation, neoclassical economics, rationality, structural unemployment, substitution effect, tax cuts, tax incentives, trade policyPosted in: CategoriesEconomics 10e: Ch 01, Economics 10e: Ch 02, Economics 10e: Ch 04, Economics 10e: Ch 05, Economics 10e: Ch 09, Economics 10e: Ch 11, Economics 10e: Ch 12, Economics 10e: Ch 15, Economics 10e: Ch 16, Economics 10e: Ch 24, Economics for Business: 8e Ch 02, Economics for Business: 8e Ch 04, Economics for Business: 8e Ch 06, Economics for Business: 8e Ch 07, Economics for Business: 8e Ch 13, Economics for Business: 8e Ch 20, Economics for Business: 8e Ch 24, Economics for Business: 8e Ch 26, Essential Economics for Business: Ch 01, Essential Economics for Business: Ch 02, Essential Economics for Business: Ch 03, Essential Economics for Business: Ch 05, Essential Economics for Business: Ch 10, Essential Economics for Business: Ch 12, Essentials of Economics: 8e Ch 01, Essentials of Economics: 8e Ch 02, Essentials of Economics: 8e Ch 04, Essentials of Economics: 8e Ch 08, Essentials of Economics: 8e Ch 09, Essentials of Economics: 8e Ch 14, Podcasts and VideosAuthored by: John Sloman
Posted on 6 November 2019
Are carbon taxes a solution to the climate emergency?
With the growing recognition of the global climate emergency (see also), attention is being increasingly focused on policies to tackle global warming.
In the October version of its journal, Fiscal Monitor, the IMF argues that carbon taxes can play a major part in meeting the goal of achieving net zero carbon emissions by 2050 or earlier.
As the blog accompanying the journal states:
Global warming has become a clear and present threat. Actions and commitments to date have fallen short. The longer we wait, the greater the loss of life and damage to the world economy. Finance ministers must play a central role to champion and implement fiscal policies to curb climate change. To do so, they should reshape the tax system and fiscal policies to discourage carbon emissions from coal and other polluting fossil fuels.
The effect of a carbon tax on production
The argument is that carbon emissions represent a massive negative externality, where the costs are borne largely by people other than the emitters. Taxes can internalise these externalities. The effect would be to raise the price of carbon-emitting activities and reduce the quantity consumed and hence produced.
The diagram illustrates the argument. It takes the case of carbon emissions from coal-fired electricity generation in a large country. To keep the analysis simple, it is assumed that all electricity in the country is generated from coal-fired power stations and that there are many such power stations, making the market perfectly competitive.
It is assumed that all the benefits from electricity production accrue solely to the consumers of electricity (i.e. there are no external benefits from consumption). Marginal private and marginal social benefits of the production of electricity are thus the same (MPB = MSB). The curve slopes downwards because, with a downward-sloping demand for electricity, higher output results in a lower marginal benefit (diminishing marginal utility).
Competitive market forces, with producers and consumers responding only to private costs and benefits, will result in a market equilibrium at point a in the diagram: i.e. where demand equals supply. The market equilibrium price is P0 while the market equilibrium quantity is Q0. However the presence of external costs in production means that MSC > MPC. In other words, MEC = b – a.
The socially optimal output would be Q* where P = MSB = MSC, achieved at the socially optimal price of P*. This is illustrated at point d and clearly shows how external costs of production in a perfectly competitive market result in overproduction: i.e. Q0 > Q*. From society's point of view, too much electricity is being produced and consumed.
If a carbon tax of d – c is imposed on the electricity producers, it will now be in producers' interests to produce at Q*, where their new private marginal costs (including tax) equals their marginal private benefit.
Assessing the benefits of carbon taxes
The diagram shows the direct effect on production of electricity. With widespread carbon taxes, there would be similar direct effects on other industries that emit carbon, and also on consumers, faced with higher fuel prices. In the UK, for example, there are currently higher taxes on high-emissions vehicles than on low-emissions ones.
However, there are other effects of carbon taxes which contribute to the reduction in carbon emissions over the longer term. First, firms will have an incentive to invest in green energy production, such as wind, solar and hydro. Second, it will encourage R&D in green energy technology. Third, consumers will have an incentive to use less electricity by investing in more efficient appliances and home insulation and making an effort to turn off lights, the TV, computers and so on.
People may object to paying more for electricity, gas and motor fuel, but the tax revenues could be invested in cheaper clean public transport, home insulation and public services generally, such as health and education. This could be part of a policy of redistribution, with the tax revenues being spent on alleviating poverty. Alternatively, other taxes could be cut.
The IMF estimates that to restrict global warming to 2°C (a target seen as too modest by many environmentalists), large emitting countries 'should introduce a carbon tax set to rise quickly to $75 a ton in 2030'.
This would mean household electric bills would go up by 43 per cent cumulatively over the next decade on average – more in countries that still rely heavily on coal in electricity generation, less elsewhere. Gasoline would cost 14 percent more on average.
It gives the example of Sweden, which has a carbon tax of $127 per ton. This has resulted in a 25% reduction in emissions since 1995, while the economy has expanded 75% since then.
Limits of carbon taxes
Although carbon taxes can make a significant contribution to combatting global warming, there are problems with their use.
First, it may be politically popular for governments not to impose them, or raise them, with politicians arguing that they are keen to help 'struggling motorists' or poor people 'struggling to keep their homes warm'. In the UK, successive governments year after year have chosen not to raise road fuel taxes, despite a Fuel Price Escalator (replaced in 2011 by a Fuel Duty Stabiliser) designed to raise fuel taxes each year by more than inflation. Also, governments fear that higher energy prices would raise costs for their country's industries, thereby damaging exports.
Second, it is difficult to measure the marginal external costs of CO2 emissions, which gives ammunition to those arguing to keep taxes low. In such cases it may be prudent, if politically possible, to set carbon taxes quite high.
Third, they should not be seen as a sufficient policy on their own, but as just part of the solution to global warming. Legislation to prevent high emissions can be another powerful tool to prevent activities that have high carbon emissions. Examples include banning high-emission vehicles; a requirement for coal-fired power stations and carbon emitting factories to install CO2 scrubbers (filters); and tougher planning regulations for factories that emit carbon. Education to encourage people to cut their own personal use of fossil fuels is another powerful means of influencing behaviour.
A cap-and-trade system, such as the European Emissions Trading Scheme would be an alternative means of cutting carbon efficiently. It involves setting quotas for emissions and allowing firms which manage to cut emissions to sell their surplus permits to less efficient firms. This puts a price pressure on firms to be more efficient. But the quotas (the 'cap') must be sufficiently tight if emissions are going to be cut to desired levels.
But, despite being just one possible policy, carbon taxes can make a significant contribution to combatting global warming.
Fiscal Policies to Curb Climate Change
IMF blog, Vitor Gaspar, Paolo Mauro, Ian Parry and Catherine Pattillo (10/10/19)
Energy bills will have to rise sharply to avoid climate crisis, says IMF
The Guardian, Larry Elliott (10/10/19)
Huge global carbon tax hike needed in next 10 years to head off climate disaster, says IMF
Independent, Chris Mooney and Andrew Freedman (11/10/19)
World urgently needs to quicken steps to reduce global warming – IMF
Reuters, Lindsay Dunsmuir (10/10/19)
The Case for a Goldilocks Carbon Tax
Forbes, Roger Pielke (13/9/19)
The world needs a massive carbon tax in just 10 years to limit climate change, IMF says
Washington Post, Chris Mooney and Andrew Freedman (10/10/19)
People like the idea of a carbon tax – if the money is put to good use
New Scientist, Michael Le Page (18/9/19)
The IMF thinks carbon taxes will stop the climate crisis. That's a terrible idea.
The Guardian, Kate Aronoff (12/10/19)
The Guardian, Damian Carrington (13/10/19)
How central banks can tackle climate change
Financial Times, The editorial board (31/10/19)
World Economic Forum: Climate change action needed to avoid societal 'collapse' says minister
The National, UAE, Anna Zacharias (3/11/19)
Riots and trade wars: Why carbon taxes will not solve climate crisis
Recharge, Leigh Collins (31/10/19) (Part 1)
The plethora of effective alternatives to carbon pricing
Are these the real reasons why Big Oil wants a carbon tax?
Do we need carbon taxes in an era of cheap renewables?
How to Mitigate Climate Change
IMF Fiscal Monitor, Ian Parry (team leader), Thomas Baunsgaard, William Gbohoui, Raphael Lam, Victor Mylonas, Mehdi Raissi, Alpa Shah and Baoping Shang (October 2019)
Draw a diagram to show how subsidies can lead to the optimum output of green energy.
What are the political problems in introducing or raising carbon taxes? Examine possible solutions to these problems
Choose two policies for reducing carbon emissions other than using carbon taxes? Compare their effectiveness with carbon taxes.
How is game theory relevant to getting international agreement on cutting greenhouse gas emissions? Why is there likely to be a prisoners' dilemma problem in reaching and sticking to such agreements? How might the problem of a prisoners' dilemma be overcome in such circumstances?
Tags: Tagscap-and-trade schemes, carbon emissions, carbon taxes, CO2, coal-fired power stations, electricity industry, emissions trading, environmental economics, environmental externalities, European Emissions Trading Scheme, external costs, global warming, marginal external cost, marginal social costPosted in: CategoriesEconomics 10e: Ch 12, Economics 10e: Ch 13, Economics for Business: 8e Ch 01, Economics for Business: 8e Ch 20, Economics for Business: 8e Ch 22, Essential Economics for Business: Ch 01, Essential Economics for Business: Ch 09, Essentials of Economics: 8e Ch 09, Podcasts and VideosAuthored by: John Sloman
Posted on 4 November 2019 4 November 2019
The costs of alternative Brexit scenarios
A general election has been called in the UK for 12 December. Central to the debates between the parties will be their policy on Brexit.
They range from the Liberal Democrats', Plaid Cymru's and Sinn Féin's policy of cancelling Brexit and remaining in the EU, to the Scottish Nationalists' and Greens' policy of halting Brexit while a People's Vote (another referendum) is held, with the parties campaigning to stay in the EU, to the Conservative Party's policy of supporting the Withdrawal Agreement and Political Declaration negotiated between the Boris Johnson government and the EU, to the DUP which supports Brexit but not a version which creates a border between Great Britain and Northern Ireland, to the Brexit Party and UKIP which support leaving the EU with no deal (what they call a 'clean break') and then negotiating individual trade deals on a country-by-country basis.
The Labour Party also supports a People's Vote, but only after renegotiating the Withdrawal Agreement and Political Declaration, so that if Brexit took place, the UK would have a close relationship with the single market and remain in a customs union. Also, various laws and regulations on environmental protection and workers' rights would be retained. The referendum would take place within six months of the election and would be a choice between this new deal and remain.
But what are the economic costs and benefits of these various alternatives? Prior to the June 2016 referendum, the Treasury costed various scenarios. After 15 years, a deal would make UK GDP between 3.4% and 7.8% lower than if it remained in the EU, depending on the nature of the deal. No deal would make GDP between 5.4% and 9.5% lower.
Then in November 2018, the Treasury published analysis of the original deal negotiated by Theresa May in July 2018 (the 'Chequers deal'). It estimated that GDP would be up to 3.9% lower after 15 years than it would have been if the UK had remained in the EU. In the case of a no-deal Brexit, GDP would be up to 9.3% lower after 15 years.
When asked for Treasury forecasts of the effects of Boris Johnson's deal, the Chancellor, Sajid Javid, said that the Treasury had not been asked to provide forecasts as the deal was "self-evidently in our economic interest".
Other forecasters, however, have analysed the effects of the Johnson deal. The National Institute for Economic and Social Research (NIESR), the UK's longest established independent economic research institute, has estimated the costs of various scenarios, including the Johnson deal, the May deal, a no-deal scenario and also a scenario of continuing uncertainty with no agreement over Brexit. The NIESR estimates that, under the Johnson deal, with a successful free-trade agreement with the EU, in 10 years' time UK GDP will be 3.5% lower than it would be by remaining in the EU. This represents a cost of £70 billion. The costs would arise from less trade with the EU, lower inward investment, slower growth in productivity and labour shortages from lower migration. These would be offset somewhat by savings on budget contributions to the EU.
Under Theresa May's deal UK GDP would be 3.0% lower (and thus slightly less costly than Boris Johnson's deal). Continuing in the current situation with chronic uncertainty about whether the UK would leave or remain would leave the UK 2% worse off after 10 years. In other words, uncertainty would be less damaging than leaving. The costs from the various scenarios would be in addition to the costs that have already occurred – the NIESR estimates that GDP is already 2.5% smaller than it would have been as a result of the 2016 Brexit vote.
Another report also costs the various scenarios. In 'The economic impact of Boris Johnson's Brexit proposals', Professors Anand Menon and Jonathan Portes and a team at The UK in a Changing Europe estimate the effects of a decline in trade, migration and productivity from the various scenarios – again, 10 years after new trading arrangements are in place. According to their analysis, UK GDP would be 4.9%, 6.4% and 8.1% lower with the May deal, the Johnson deal and no deal respectively than it would have been from remaining in the EU.
But how much reliance should we put on such forecasts? How realistic are their assumptions? What other factors could they have taken into account? Look at the two reports and at the articles discussing them and then consider the questions below which are concerned with the nature of economic forecasting.
UK's new Brexit deal worse than continued uncertainty – NIESR
Reuters, David Milliken (30/10/19)
Brexit deal means '£70bn hit to UK by 2029′
BBC News, Faisal Islam (30/10/19)
Boris Johnson's Brexit deal worse for economy than Theresa May's, new analysis shows
Politics Home, Matt Honeycombe-Foster (30/10/19)
Boris Johnson's Brexit deal 'would cost UK economy £70bn'
The Guardian, Richard Partington (30/10/19)
UK economy suffers 'slow puncture' as general election is called
ITV News, Joel Hills (30/10/19)
Boris Johnson's Brexit deal 'would deliver £70bn hit to economy by 2029'
Sky News, Ed Conway (30/10/19)
Boris Johnson's Brexit deal won't cost Britain £70bn by 2029
The Spectator, Ross Clark (30/10/19)
Boris Johnson's Brexit deal would make people worse off than Theresa May's
The Guardian, Anand Menon and Jonathan Portes (13/10/19)
How Boris Johnson's hard Brexit would hit the UK economy
Financial Times, Chris Giles (13/10/19)
Boris Johnson's Brexit deal is worse for the UK economy than Theresa May's, research suggests
CNBC, Elliot Smith (19/10/19)
UK economy 3.5 per cent smaller under latest Brexit deal
NIESR Press Release (29/10/19)
The Economic Impact of Prime Minister Johnson's New Brexit Deal
National Institute Economic Review No. 250, Arno Hantzsche and Garry Young (November 2019)
Brexit Negotiations
NIESR
The economic impact of Boris Johnson's Brexit proposals
The UK in a Changing Europe, Anand Menon, Hanwei Huang, Jonathan Portes, Thomas Sampson, Matt Bevington and Jill Rutter (October 2019)
What are the arguments in favour of the assumptions and analysis of the two recent reports considered in this blog?
What are the arguments against the assumptions and analysis of the two reports?
How useful are forecasts like these, given the inevitable uncertainty surrounding (a) the outcome of negotiations post Brexit and (b) the strength of the global economy?
If it could be demonstrated beyond doubt to everyone that each of the Brexit scenarios meant that UK GDP would be lower than if it remained in the EU, would this prove that the UK should remain in the EU? Explain.
If economic forecasts turn out to be inaccurate, does this mean that economists should abandon forecasting?
Tags: TagsBoris Johnson, Brexit, customs union, economic forecasts, forecasting, free trade areas, Johnson deal, May deal, National Institute for Economic and Social Research, NIESR, no-deal Brexit, People's Vote, Political Declaration, productivity, The UK in a Changing Europe, Theresa May, trade deals, withdrawal agreement, WTO termsPosted in: CategoriesEconomics 10e: Ch 01, Economics 10e: Ch 15, Economics 10e: Ch 24, Economics for Business: 8e Ch 01, Economics for Business: 8e Ch 02, Economics for Business: 8e Ch 25, Economics for Business: 8e Ch 26, Essential Economics for Business: Ch 01, Essential Economics for Business: Ch 12, Essentials of Economics: 8e Ch 01, Essentials of Economics: 8e Ch 14, Podcasts and VideosAuthored by: John Sloman