During the great miner's strike of 1984, the combative leader of the National Union of Mineworkers, Arthur Scargill, claimed the government had a secret plan to let the coal mines close down. The government denied this. They claimed the strike was just a greedy claim by the miners for higher wages. However, 20 years later, Arthur Scargill has in one sense been proved right - the government did allow the coal mines to close down. An industry which once emplyed 500,000 has been allowed to die. But, it also raises the perennial question - Should governments intervene to support declining firms and declining industries?

From a political perspective it is easy to Present a convincing case about the hardship of firms closing down.

1. If Factories close down, it will cause negative externalities to the rest of society. Firstly, unemployment will rise. This causes the government to spend more on unemployment benefits. It causes lower growth in the areas affected by the factory closure. Higher unemployment can also cause more social problems such as crime, vandalism and feelings of alienation. Unemployment also has a terrible personal cost to those affected.
2. The effect of an industry closing down will be felt in particular areas much more than others. Whole villages and towns used to rely on an industry for employment and prosperity. If the mine closed down, unemployment would rise dramatically and effect all areas of the community. It is not just the miners who will be made unemployed; but, the shops and pubs who rely on miners purchasing power.
3. If firms close down, then it reduces the number of firms in the industry. This reduces competition and increases the monopoly power of the existing firms. Therefore, this means in the future consumers could face higher prices and lower quality. However, they may close down because of greater global competition, therefore the markets will remain competitive and it is a mistake for the government to intervene.

In the face of mass unemployment how can the government sit back and allow the firms to close down?

How An Economist Would Respond

1. If you subsidise declining industries you are merely delaying the inevitable.
2. There is a very high cost to the taxpayer, which is often not made clear. The problem is that the cost to the taxpayers is a very small % of the tax burden so they will not make a political fuss. But, those threatened with unemployment will
3. Subsidising declining industries may encourage inefficient firms to remain. A good example, is the UK car industry in the 60s and 70s, the UK car industry lost ground to more efficient firms in Germany and Japan. But, the government couldn't face seeing it's beloved car industry close down, so it felt compelled to support British Leyland. But, this government subsidy did nothing to turn the company around. The government then realised it had committed to supporting a loss making firm and it proved even more difficult to extracate itself from the position.
4. Change is inevitable in a modern economy. There was a time when the coal mines employed 500,000 people; now it is next to nothing. This doesn't mean all these people are unemployed; new jobs are created in supermarkets, computers. If we didn't embrace change, we would still all be living on a farm.

Do economists have no heart?

It is easy to sit back in your ivory tower and talk about the inevitability of change in a modern capitalist economy; but, that is no comfort for the workers who have to experience the unemployment and poverty. It is this attitude that gives capitalism a bad name. So what can be done?

The answer is that the government can intervene to overcome market failure. The government will not try to prop up a declining industry; but, what it can do is make the change to new industries easier. The government can help to regenerate the areas affected by the closure. The government can give training schemes to help the unemployed back to work. It may not happen straight away; but, if you visit former mining communities in the north east and south Wales there has been a regeneration of these areas. Proof that change can be managed, even if it is painful in the short term.

In theory, the unemployed should be able to move to new expanding industries. However, this may be difficult because of geographical immobilities (difficult for workers to move to new areas) and occupational immobilities. The government could intervene to help workers move areas and also learn new skills. This helps to overcome the market failures without subsidising a declining industry.

Related

• Subsidies for positive externalities

Readers Question:. From an economic perspective, provide an explanation of the following quotation: “In an underdeveloped country, don’t drink the water; in a developed country, don’t breathe the air.” (Jonathan Raban, 1976).

I don’t usually answer readers questions on this blog, but, this looked quite interesting.

The first part of the sentence is relatively straightforward. Underdeveloped countries (less developed is the more pc term we use these days) struggle to have sufficient economic resources to provide the basic necessities of life. Even clean drinking water is a luxury many can’t afford.

The more difficult question would be why so many people don’t have access to clean drinking water when the world economy is relatively affluent? According to End Water Poverty 1.1 billion lack access to clean water. Furthermore, the crisis is said to claim the lives of 5,000 children a day. Lack of clean water is said to cost the African economy the equivalent of 5% of GDP every year. Clearly there is an economic and social benefit to improving water supplies and sanitation but there is both a lack of political will and basic resources, especially in rural areas.

In theory, aid from developed countries could help to solve the problem; but, there are several problems.

• AID accounts for a very small % of developed countries GDP
• Even when AID is given, it is often tied aid not focused on the most important projects.
• It is difficult to get aid to work effectively. (Does Aid increase Economic welfare)
  

‘In A Developed Country Don’t Breathe The Air.’

One immediately thinks of China. 20 years ago, the Chinese were famous for everyone cycling - and as a consequence of the low industrialisation hey had relatively good air quality. 20 years of rapid economic expansion in China has led to an unprecedented improvement in living standards; but, at the expense of more pollution, especially from an increasing number of cars.

Thus the economic expansion of China is a mixed blessing. True, some people have more income, but, in some cities it is dangerous to go out running because of the bad air quality. Paula Radcliffe, Britain’s marathon runner was understandably worried about the pollution in China for the Beijing Olympics. In China the problem is also exacerbated by a high population density.

Of course, economic development doesn’t have to lead to worse air quality. Britain introduced strict pollution laws after the great smogs in London of the 1950s. Better technology could lead to pollution free engines.

Even now, we have the potential to improve air quality a lot within developed countries. The problem is an unwillingness to change from polluting energy sources to emission free energy sources. It is a clear case of market failure and highlights the issue that economic growth doesn’t necessarily improve living standards.

If the political will was there, developed countries could have improved GDP but also good air quality. But, who wants to pay higher tax on petrol to subsidise emission free engines?

Does GDP measure economic Development?
Does Economic Growth bring increased happiness?

Should The Government intervene to deal with oil Shortages? The world is facing a rise in the price of oil. Is this an example of market failure? Should we leave the discovery of new energy sources to the free market or is this an issue which requires active government intervention. Given the problems that rising oil prices could cause, it is perhaps surprising governments haven't tried to act earlier.

Are Gas /petrol Prices really falling? - Why Did the US statistics office report Gas prices fell by 4.7% in April, when every American knows that Gas prices have been rising in the past few weeks? This also raises the issue of how accurate and useful government inflation methods actually are. See also: Measuring the real rate of inflation

In the UK, it is the exam season. I have put together a few tips for students who might be revising for economics exams.

• Revision Tips for Exams
• Evaluative essays and thinking like an economist
• Economics Revision Guide
  

What does the future hold for economics? What are the issues which economics will need to face in the coming decades?

Global Poverty.

Despite decades of effort, global poverty seems as intractable as ever. In some countries progress has been made. But, in other countries, especially sub saharan Africa and parts of Asia, people are still dying from malnutrition and preventable diseases. How can increasing affluence in the West be compatible with the extent of poverty that still exists? The problem remains - how to effectively deal with poverty. Does Aid help or hinder? To what extent can the West actually help reduce poverty in other countries?

Environment.

It is difficult to predict changes in the environment. However, there is a consensus that the world is hotting up. If the increase in world temperature continues, it could lead to serious economic problems such as shortage of arable land, shortage of water, migration of people. Can free market economies effectively deal with the externalities of growth? Are we actually willing to take painful measures necessary to deal with the environment?

A Future Without Oil?

It is assumed / hoped that a rise in the price of oil would lead to the development of alternatives. However, alternatives to oil have proved less satisfactory than many hoped. Bio fuels are becoming increasingly contentious in an era of rising food prices. Will economies be able to cope with a situation of rapidly rising oil prices. Can free markets effectively deal with growing shortages of commodities or is this a classic example of market failure. - where the solution will come too late. (finding alternatives to oil)

What is the Objective of Society?

Classical Economics assumes a rather simple objective of profit maximisation and increase output. But, as the environment deteriorates, maybe economics needs to be reoriented away from considering simple financial maximisation. Instead, increases in living standards should be the only objective. However, living standards, which include many more variables other than GDP, are more difficult to evaluate and measure. Economics may have to give increasing importance to normative opinions rather than positive views (positive economics deals with observable facts like GDP per capita).

Will Technology Solve Our Problems?

It is easy to think of the future and see all the problems - environment, global warming, overpopulation, shortage of commodities, rising inequality. However, it is possible to consider an optimistic view. If we consider the potential technological improvements, many of these problems could be solved. In the past we have usually underestimated the potential for future technological innovations. 100 years ago, who could have predicted modern technology would have evolved as it has? The next couple of decades could potentially see technological innovations which will solve our energy needs without a cost to the environment.

To What Extent Can Countries Work Together?

The issue of global warming highlights the importance of countries working together. There is a classic free rider problem to reduce emissions. Everyone wants other countries to reduce their emissions, but, are less keen on reducing their output. Is it possible for the development of a world government / world body with sufficient respect to negotiate and enforce treaties such as Kyoto?

What do you think will happen to future of economics? I would be interested to hear any views from our readers.

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In a recent post, we looked at new developments in economics. These are some issues which used to be a matter of debate importance. But, have gradually faded from view.

Left vs Right

The twentieth century was characterised by a divisive ideological debate between Capitalism and Socialism. In Europe, versions of democratic Socialism was supported by many leading academics. The idea of public ownership vs Private ownership seemed a key issue in economics. The collapse of the Soviet bloc coincided with declining support for Socialist alternatives. This does not mean that people have embraced Capitalism. However, it is rare for people to argue for public ownership as the solution. The left have shifted their focus on reducing inequality through policies other than wholescale structural change in the economy. There has been a growing acceptance that free markets are the least bad solution. The debate comes on how to manage and regulate the free market rather than arguing for its complete replacement.

• But, also there are others who argue Socialism and Capitalism are actually quite similar - they both aim to increase output and material living standards. However, others now argue that increasing output is not the goal of society. They argue the real debate is between Growth vs Environment

Monetarist vs Keynesian

When teaching economics to A Level students, we often provide a simple model suggesting there is a huge gulf between Monetarists and Keynesians. Good students will know that Monetarist think fiscal policy is useful. Inflation can be controlled by the money supply. Keynesians on the other hand believe government intervention can prevent economic downturns.

Empirical evidence has suggested a blurring of the distinction. Monetarist theory has proved very inexact. The relationship between the money supply and inflation is quite weak. The UK effectively abandoned Monetarism after a brief experiment in the 1980s. Keynesian theory on expansionary fiscal policy can sometimes work; data can be found to support both sides of the argument.

Credit Controls

Monetary policy used to involve complex credit controls and regulation of the banking system. For example minimum reserve ratios. You can still find these in old textbooks, but, it is many years since they have been used. Monetary policy tends to involve just changing base interest rates by an independent Central Bank.

A reader recently asked what would stop the dollar devaluing. I answered here There are now signs that the lengthy decline in the Dollar may be over.

• Firstly, the downturn in the US economy, may not be as bad as people feared.
• The dollar is effectively cheap compared to the Euro.
• The Strength of the Euro to Dollar belies weaknesses in the Euro economy
• US current account has shown signs of improvement.

It has to be remembered the extent to which the dollar has already fallen.

More on: What will stop the fall in the Dollar

• Reasons for Fall in Dollar

Economics is an evolving subject. Issues which were once hotly debated gradually fade from view and become insignificant over time. In their place we get new issues rising to the surface. These are some of the important recent development in Economics:

Increased Importance of Globalisation.

Globalisation is a fuzzy term. In a way globalisation has always been with us. Economies have traded with each other for many centuries. Not since Japan in the nineteenth century has a country been able to successfully pursue 'autarky' - self sufficiency. What has changed in recent years is the scope of global integration. Ripples in markets are invariably felt throughout the world. Communication and transport have vastly improved; this has helped give the impression that the world is much smaller and more closely connected. The multinational company is more prevalent than ever before. Globalisation affects many aspects of economics from competition policy to Monetary policy and agricultural policy.

Shifting Balance of Global Economy

In the post war period, the US economy was dominant. The old phrase 'when America sneezes, the rest of the world catches a cold' was very much appropriate. But, America's share of global output and global resources is declining rapidly. In particular, it is the two sleeping giants - India and China who are coming to play an increasingly important role in the global economy. This means we can no longer consider global economics from an Anglo- American perspective. We need to study and evaluate the implications of China and India's development.

Pressure on Commodities.

The world is used to dealing with a situation of abundant supply of raw materials. But, diminishing supply and growing demand threatens to change that. Oil prices are rising, partly due to speculation, but, partly due to the fact demand is simply rising faster than supply. In the short term the price of oil may fall, but, also it may continue to rise. In the long term, the prices of commodities like food, oil and metals could rise much faster than inflation affecting many issues for both developed and developing economies.

Environmental Change.

The past decade has seen recognition that economic development is impacting the environment in a possibly devastating way. In the past, theories of global warming and ecology were seen as fringe topics. Now they are seen as the greatest threats facing society - even if at the moment, we are unable to take effective steps to deal with the problem. In the future, it will be increasingly necessary to deal with environmental change. This challenges fundamental ideas such as the goal of society is to increase GDP. Maybe the goal is not to increase output, but, only increase GDP if the environment is secured.

Rogue Economics

The recent credit crisis, shows how financial deregulation and globalisation has contributed to many new problems, which leave economies vulnerable to financial speculation.
See: Rogue Economics by Loretta Napoleoni

Wealth inequality is far greater than income inequality. yet, wealth is taxed much less than income.

Wealth inequality is greater than income inequality because:

• Wealth can be inherited, income cannot
• The wealthy can accumulate more wealth. e.g. they can use rents and dividends to buy more wealth. i.e. wealth enables income without working. Those on low incomes spend all the income on living, they have no disposable income to accumulate wealth.
• Wealth is taxed much less.

Inheriting wealth requires no effort, no skill; it has hard to argue that you deserve to inherit wealth. Yet, there is a very strong opposition to any tax on inheritance. But, there is another way of looking at the problem? why are people happy to accept a much higher tax on income?

Income tax can create disincentives to work. Corporation tax can discourage firms from investing in a country. But, a wealth tax would not discourage work. We cannot say Inheritance tax would not discourage people to be born.

People often talk about the desirability of equality of opportunity. But, large inheritance is the easiest way to ensure, society starts with unequal opportunities. At the moment we reward wealth and rent without work; but, we tax heavily income and hard work.

The irony is that a wealth tax would effect the richest 1% and richest 10% far more than the rest of society. This is because wealth distribution is more inequitable (The richest 10% own 95% of the nations wealth) most people will be better off by switching the burden of tax from income to wealth. But, when it comes to tax, people rarely act in a rational way. There is an emotive attachment to leaving money without attracting any inheritance tax. But, just because people are emotionally tied to avoiding inheritance tax doesn't mean it should form the basis of economic policy.

By the way, have you ever wondered why there are so many Russian billionaires living around Chelsea? The reason is that the UK doesn't tax people on income earnt elsewhere. Therefore, they can claim UK residency and live pretty much tax free.

I came across this in an Australian Newspaper:

Opposition Treasury Spokesman Malcolm Turnbull says taxes on luxury cars and some alcoholic drinks will drive up prices. Mr Turnbull has called on the Government to explain how the new taxes fitted in with the fight against inflation.

"I ask the Treasurer how can he reduce inflation by increasing prices, what kind of voodoo economics is he peddling?" he said. (ABC News)

It sounds colourful language, but is this really 'Voodoo' economics?

Increasing taxes on luxury cars and alcoholic drinks will cause an increase in the price level. However, this increase in prices is a one off. It will only affect the inflation rate temporarily. Next year, the high prices will be built into the index. Unless the tax increases are repeated next year, the effect of these price rises will fall out of the index.

Often economists look at the 'underlying rate of inflation' which excludes these temporary cost push factors such as tax increases and interest rate changes. The hope is that since they are only a temporary factor they are less cause for concern than an increase in the underlying rate (e.g. caused by rising demand)

Furthermore, it is argued that higher taxes will reduce the discretionary income of consumers and therefore lead to a fall in spending. This reduction in AD will help to reduce inflation (in fact it will reduce underlying core inflation.). Therefore, in theory, higher taxes can reduce inflation, even if they give a temporary boost, to these particular goods.

However.

• It is possible that cost push factors like rising taxes change people's inflation expectations and therefore, the chance of inflation in the future is increased.
• The impact of tax rises on spending is not clear cut. For example, people who buy luxury cars, may simply choose to save less and pay the extra tax without reducing their overall spending. On the other hand, people may reduce demand for luxury goods like cars quite significantly now they are expensive. An economist can never exactly predict the future effects of changes in taxes.
• It depends which effect is greater the increase in price caused by taxes or the decrease in consumer spending
• It depends whether tax increases get passed on. Since demand for alcohol is inelastic, higher taxes will lead to higher prices. But, demand for luxury cars is elastic, therefore, firms may not pass the costs on to consumers but suffer lower profit margins.
  

Conclusion - Is the Politician correct to call this Voodoo Economics?

I would say the attitude of this particular politician is unhelpful. He takes a simplistic view of the situation and seems more interested in creating a good soundbite for the press rather than understanding the economic complexities. However, we have to say, he isn't the first politician to do this.....
Also the media wouldn't be interested in reporting this depth of analysis, they prefer things in black and white.

1. GDP measures National Output.

GDP measures National output using official statistics. However, there are many discrepancies. Suppose you spend £1,000 a year on vegetables. But, then decide to convert your back garden into an allotment growing everything from seed. Your expenditure falls by £1,000 so National Output appears to fall, but you are still consuming the same amount of vegetables. A women may earn £10,000 a year working as a cleaner. When she gets married she continues to do the housework and cleaning, but, she doesn't get paid anything (maybe a little outdated example)

2. GDP per Capita.

Suppose:

• US GDP per capita is $20,000
• GDP per capita in Tanzania is $500
• Therefore, are living standards 40 times better in the US than Tanzania?
  

No, firstly, one dollar in Tanzania will go a lot further than in the US. To rent an apartment in New York may cost $500 a month. In Tanzania a similar apartment may cost $20 a month. This is why economists prefer to use Purchasing Power Parity.
Another issue, is that maybe Tanzania underestimate their GDP because many people are subsistent farmers. i.e. they grow their own food and so do not declare an income. This lifestyle is rare in the US.

Economic Growth Rate in Japan



What Happens to GDP between 1973 and 1985?

• Many students will say, GDP is falling. However, this is wrong, GDP is not falling just increasing at a slower rate.
• I usually test my students with a question like this. On average 85% will get it wrong on the first time. 70 % will get it wrong the second time. Some students can take 9-10 attempts before they will remember the difference between an absolute fall and a fall in the rate of increase.

Here the statistics are not misleading. It is because we are asking a question about something different to what is displayed on the axis. The vertical axis shows GDP growth, but we ask about GDP. This is why there is the potential for being misled if we confuse rates of change with absolute changes.

4. Household incomes have fallen.

Suppose we have a household with a man and a wife earning $26,000 a year. Their combined income for the household is $52,000. If they got divorced there would be 2 households with $26,000 it would appear there is a doubling of households who earn less than $30,000

See also:

• Can We Trust Economic Statistics?
• GDP Per Capita Statistics

The Euro has appreciated significantly against all major currencies. In particular the US dollar has fallen in value to $1 = 1.5 Euro.

Losers from Rising Euro.

• EU exporters who are struggling to remain competitive and maintain export orders.
• EU current account deficit is growing
• Southern Euro members such as Italy and Spain. The strength of the Euro really reflects the strength of the German economy and the weakness of the dollar (The Euro is simply an alternative to the dollar. )
  
• However, the rise of the Euro doesn't reflect the strength of the Italian and Spanish economies. For example, Spain's current account deficit is a massive 9% of GDP. But, Spain can't devalue and it can't cut interest rates. Furthermore, the pain of the high Euro, will be exacerbated by the impending bust in the Spanish Housing Market.

Those who gain from rising Euro.

• Investors in the Euro.
• Europeans going on holiday to US.
• European firms and consumers who import goods and services.
• European tourists going to the US.
• Helps reduce inflationary pressure in the EU. It is providing an incentive for firms
• US industry exporting to the EU. Important because the US economy is slowing down and rising exports are preventing a full blown recession.

See also:

• The Problem with the Euro
• Plural of Euro - Euro or Euros?
• Rising Euro reaches danger levels

In 1991, UK interest rates were 12%. In one crazy week, October, 1992, the government increased interest rates to 15% in a desperate bid to remain in the ERM. Since then interest rates have fallen. Many homeowners have bought houses on the assumption that these kind of interest rates are a thing of the past. If UK or US interest rates returned to these kinds of levels, it would bring real misery to many homeowners. What are the chances for these kind of interest rates to return?

Why Long Term interest rates are likely to Remain Low.

Core Inflation is low.

In 1992, a run away economy caused inflation to reach 10.9%. It was this inflation which cause interest rates to rise. However, core inflation is much lower. At the moment, the MPC are worried about rising inflation (caused by cost push factors) However, CPI inflation is sill close to the 3% upper limit. There was a time when 3% inflation would have been a remarkable achievement. It shows how the goal posts have shifted; people have lower inflation expectations.

Independent Monetary Policy.

There was a time when the government ran monetary policy. There was a temptation for the government to cut interest rates before an election to increase demand and garner popularity with the electorate. This led to boom and bust economic cycles; periods of high inflation and high interest rates followed by recession. Arguably the MPC have done a much better job and seem to avoided these volatile swings in the economic cycle. By maintaining low inflationary growth it has enabled interest to remain permanently low.

Low Inflation expectations.

When inflation is high people expect inflation to be higher next year; firms pass on cost increases; workers demand wage increases. Thus the inflation expectations become self fulfilling. Because inflation expectations are currently low, inflation is unlikely to become a problem in the medium term.

Global inflation is low.

Helped by improved technology and low wage economies like China, global inflation has been lower in the past decade. The UK and US have benefited from this global reduction in inflation.

Why Long Term Interest rates may rise. - Is Inflation really Dead?

Having said all that, there are arguments to suggest that it is too early to talk about the 'death of inflation'. Arguably there is no reason why inflation and higher interest rates couldn't make a return. Some factors include:

Rising Economic Growth

Rising Economic Growth is putting strain on Commodity prices. Already we are seeing rising price of commodities, oil and food. This is due to demand rising faster than supply. As China and India continue to expand at breakneck pace, this problem is likely to exacerbate. This cost push inflation may start to feed through into higher inflation expectations and we could see a resurgence in global inflation.

Chinese / Global inflation is rising.

Ominously Inflation in China has increased to 8%. The era of permanently low priced Chinese good may be at and end. As the economy grows and supply constraints rise, workers will demand rising wages.

Conclusion

In the medium term, I expect inflation and interest rates to remain relatively low. The most beneficial development is the improvement in the trade cycle and the reduction in the boom and bust aspect.

In the longer term it becomes harder to predict cost push inflation factors. It remains to be seen whether supply can keep up with rising global demand. If supply doesn't then it becomes harder to keep inflation low.

Despite falling house prices and the prospect of a slowdown in the economy, the Bank of England kept interest rates unchanged at 5% this May. The main reason for this is:

They are worried about inflation. In particular the rising price of oil and food is causing cost push inflationary factors. Even the CPI (which excludes many housing costs) is getting close to the 3% limit set by the Chancellor. The MPC would be embarrassed to cut rates and then in the same month see inflation rise above the target.

They hope the slowdown may not be as bad as feared. On backward looking statistics such as unemployment and economy growth the economy appears to be doing relatively well; there is no need for panic just yet.

They have cut rates 3 times and this may just be a pause before the next cut in June. If they cut rates too quickly it may give the impression of panic and this may unsettle the markets or at least increase inflation expectations.

Nevertheless with no let up in the shortage of mortgage finance, the situation is only likely to get worse; it may be that in an era of rising inflationary pressure, the government's target of 1-3% could be an unattainable goal and the Government may have to consider changing the inflation target to reflect a deterioration in economic conditions.

The MPC's approach contrasts strongly with that of the Fed. Faced with a housing crash and slowdown in the economy, the Fed cut rates to 2% and the government introduced a tax rebate to stimulate the economy. The American economic situation was less favourable, but, it also shows a willingness to be bolder in staving off a recession and worry less over inflation.

The office of National Statistics suggest that England will soon become the most Crowded place in Europe. Forecasts suggest that the population of the UK will increase by 33 % in the next 50 years as it becomes the most crowded country in Europe.

Estimates for the population are that it will rise from 50 million to 68 million. This gives a population density of 1,349 person for every square mile as opposed to 1,010 for every square mile in the future. Population rises will be focused in the south and south west.

There have been 1.5 million immigrants in the past decade into the UK.

Economic Effects of Rising Population.

Push Up Long Term House Prices.
It may be hard to imagine it at the moment, but, if the population continues to rise, then long term house prices will continue to rise.This may be exacerbated by demographic changes which are encouraging smaller population sizes and the difficulty of building new houses in the UK. Higher house prices reduce the standard of living, especially for younger, first time buyers. It means a higher % of their disposable income goes on mortgage payments or rent. It will also increases intergenerational inequalities.

Pressure on Social Services such as schools and hospitals.
However, if there are more people there will be more tax revenue to pay for more schools and hospitals.

Road congestion.
Road congestion already costs the UK economy over £25bn a year in lost output. Increased population would only make the situation worse. Furthermore, it is difficult to increase the supply of roads; in many cities it is difficult to find space to build more roads.

Higher GDP.
A higher population will increase GDP; although a rising population should, ceteris paribus, not alter GDP per Capita.

Tax Benefits
If the population increases because of immigrants in their 20s and 30s there will be an economic benefit. The UK has an ageing population which places a strain on government finances, they pay less tax and require pensions and health care spending. This ageing population will place a strain on government finances. Young immigrants will help boost tax revenues and help deal with the public sector finances. Media might like to portray immigrants as benefit scroungers' But, the real drain on public finances comes from an ageing population. From the perspective of national finances, immigration is beneficial so long as they are predominantly young. Countries with a declining population like Japan and Germany face a difficult future.

• The effect of Immigration into the UK
• How To Deal With Ageing Population
  

Readers Question: hi If a country face food scarcity what solution should the economist render thanks.

In this post we looked at the reasons behind the food crisis currently affecting the world

These are some possible solutions to a shortage of food, with a look at there relative merits.

1. Food Aid.

If a country is facing a food shortage, the obvious solution is to seek food aid from countries with food surpluses. This can help solve the pressing shortage of food and keep prices down for consumers. However increasing supply of food through aid has its fair share of problems.

• By depressing prices the food aid may deter farmers and the agricultural sector from boosting output and productivity in the long run.
• It is difficult to target food aid effectively.
• Food aid can harm the incomes of farmers in developing world. If the developed world 'dump' surplus food on world markets, the prices of agricultural goods will fall. This will cause a decline in incomes for the poor farmers we are supposed to be helping.

Food aid will benefit countries who are net importers more than those who are net exporters.

2. Free Up Markets.

A market based solution to food shortages would take a different perspective. This would try to free up agricultural markets so that the market mechanism would respond to rising prices by increasing production. For example, free market reforms may involve:

• making it easier to farmers to buy additional land.
• abolition of food controls
• Ending subsidies to certain agricultural groups.

However, although in theory a free market can deal with food shortages, in practice there can be several problems.

• Monopoly power. Landlords may have monopoly power which keep tenant farmers with small inefficient plots of land.
• Takes time to increase supply. To increase supply of food takes at least one year. By the time the market responds to the shortage it may be too late. It could even lead to the cobweb theory. This is when volatile prices escalate. This means that high prices encourage extra supply, so next year prices plummet. Therefore, supply falls drastically causing prices to rise again. Thus due to inelastic supply the market mechanism can be ineffective in dealing with shortages and surpluses.

3. Government Intervention

Subsidise Farming to develop better technology and increase productivity. This could involve

• investment in infrastructure projects.
• Buffer Stocks to stabilise Prices.

However, government intervention in agriculture has a poor track record. Farmers often get attached to receiving large subsidies and it becomes politically difficult to ween farmers away from subsidies (e.g. EU). The secret is for the government to help agriculture indirectly. For example.

• Providing affordable finance / loans so that small farmers can afford to buy new equipment.
• Improving infrastructure to make it easier to export food surpluses.
• Land reclamation schemes / Protection of the environment. e.g. deforestation can lead to soil erosion.

There is a need to distinguish between what needs to be done in the short term and what needs to be done in the long term. In the short term, we need to ensure people have enough food to eat. But, in the long term economists need to work towards a framework where the markets and farmers themselves have sufficient incentives and capabilities to provide enough food.

With Hilary Clinton and John McCain both saying they would cut tax on petrol, tax cuts have become a big issue. Interestingly, Hilary Clinton has been saying that she no longer takes the advice of economists. As I wrote in a previous piece it would be mistake to cut tax on petrol (gas)

To summarise:

1. Other taxes would have to increase or government spending will fall. (Why do people think tax cuts will make them better off?)
2. Help Combat carbon emissions and solve Global Warming
3. Already sales of SUV's and Hummers are declining in America. People are choosing more fuel efficient cars. This will help reduce America's long term dependency on oil. See: High Petrol prices see Americans dump their SUVs at the Independent
   
4. Thanks to Brightstar for this link on a transport review suggesting the benefits of increasing tax on petrol
5. Americans could do with a bit more exercise - help reduce their obesity problem. 50% of car journeys are less than 2 miles.

The price of Petrol in the UK has reached 110p a litre as we mentioned in this post on petrol price.


Many Argue the Government Should Be Cutting the Tax on Petrol, at least during this temporary rise in petrol prices.

Arguments For Cutting Taxes

1. Taxes are placing a burden on consumers disposable income. Fuel prices now account for a high % of people's disposable income creating 'fuel poverty
2. High petrol prices are damaging the Road Haulage Industry at high prices firms are struggling to stay afloat.

Arguments Against Cutting Tax

1. If Petrol tax is cut, the government would have to make up the shortfall elsewhere, by either cutting spending or increasing taxes on other goods / incomes. Cutting petrol tax would not reduce the tax burden but merely shift the tax burden from one place to another.
2. High petrol prices are causing a rise in transport costs. Ultimately, they will lead to higher prices for consumers. Alternatively, people will seek to transport goods by rail, which uses relatively less petrol. Having more goods travel be freight is no bad thing.

Long Term Benefits of Rising Oil Prices

1. Less Congestion. Congestion on UK roads costs the economy over £20 billion a year, higher fuel prices encourage people to find other ways to travel to work. Although demand for petrol is inelastic, the higher prices are reducing the growth in demand for car journeys. If petrol prices were 20% lower, there would be significantly more cars on the road and more congestion as a result.
2. Incentives to Develop Greater Fuel Efficiency. When oil prices shot up in the 1970s, car manufactuers drastically improved engine efficiency. They sought ways to decrease fuel emissions. However, the falling prices in the 1980s and 1990s, saw these incentives evaporate. This led to the rise of high level polluting SUVs and 4*4s. Given the problems of global warming, there are many long term benefits of creating incentives to develop more fuel efficiency.
3. Would Only Delay The Inevitable. Oil prices are rising because of economic fundamentals; demand increasing faster than supply. As supply diminishes the price rise will only get worse. Opec talk of a $200 barrel. Cutting taxes only delays the reality that we need to deal with the reality of expensive oil prices.
   

A Note on American Petrol Prices. American prices are very cheap compared to the rest of the world. The US should be looking to increase prices closer to world levels. Fuel prices around the world

I'm sure there must be a Presidential candidate promising to increase taxes on gas prices so that America can do it's bit to fight the problem of global warming....

Recently, I had a question from a reader - why is the US in recession?

The first thing to bear in mind is that the US is not technically in a recession; in fact at 2.4% annual growth, the US economy appears to be doing relatively well. It certainly seems a long way off an actual recession.

Why is there a perception that the US is in recession, when in fact it isn't?

1. Economic Statistics reflect the past. Growth statistics tend to be backward looking. They reflect economic conditions of the past 6 months, rather than what is going to happen. If you look at other statistics, such as, as the level of planned investment in the economy, the outlook appears more negative.
2. The Worst is Yet to Come. House prices have fallen 12%; but many argue bigger falls are still to come. There is excess supply and demand is still falling. The number of mortgage defaults has been high, but arguably more are still at risk of future mortgage defaults as they remortgage their balloon mortgages.
   
3. The Housing Market is in Recession. The housing market is experiencing particular difficulties. The fall in house prices regularly make headline news and people tend to equate problems in the housing market to the wider economy. The housing market is particularly important because people make the link to their own houses. People tend to remember bad news more than good news. So whilst the housing market is in decline, exports are doing quite well (thanks to declining dollar)
4. Reflationary Monetary and Fiscal Policy. In 2007, the rise in mortgage defaults were mainly caused by rising interest rates. However, since the start of the year, the Fed have aggressively cut rates to 2% from 4.5%, this has largely averted the problem for many with expensive mortgages. The cut in rates tend to boost demand and this has definitely helped shore up the economy. (Although I would doubt future cuts would help any more) The government have also offered a tax rebate in the hope that this will boost consumer spending.
5. Declining Dollar has helped boost Exports. The dollar has fallen substantially against most major currency's. This gives an impression of economic weakness, that people may equate to 'being in a recession'. But, a devaluation actually helps boost demand
   

See also:

• Iraq War and US economy
• Can UK and US avoid recession?