It’s not been a good week for UK economy. Whilst other major economies look to be exiting their recessions, the UK experienced its 6th quarter of negative growth (UK still in Recession)

Money Supply data gives a rough guide to economic activity. I say rough guide because it can be hard to measure, and often changes in the money supply may be due to different factors such as changes in the way people bank. Another complication is that the Bank of England publish many different versions of the Money Supply; it can be hard to know which one to use.

M4 Money Supply data is published here at the Bank of England

However, one measure of adjusted M4 shows that M4 fell by 0.9pc in September, resulting in an annual fall of 1.7pc . This is the worst figure since comparable statistics began. A sign of the sluggish economic activity

This fall in the Money Supply  has occured despite £160bn of asset purchased by the Bank of England. In theory, creating money to buy illiquid assets should help to boost the Money Supply (see Asset Purchase Scheme and Money Supply) This suggests that the government may need to approve further measures of quantitative easing.

It also suggests that the link between creating money and inflation is complicated.

Related

• Overcoming a Liquidity trap
• Why increasing the money supply creates inflation
• Link between Money Supply and Inflation
• Money Supply data

Readers Question: Why isn’t trade among countries like a game with some winners and some losers?

Often in the political world, trade is seen as a game of tit for tat. e.g. US places tariffs on imports of Chinese chickens, China retaliates by placing tariffs on US cars e.t.c

However, the theory of comparative advantage and free trade suggests, that a country can increase its economic welfare by cutting tariffs – even if these tariff cuts are not reciprocated. In other words cutting tariffs is a win win situation.

The below example shows how reducing import tariffs leads to a net gain in economic welfare for the country (even if others don’t respond by cutting their import tariffs)

Diagram for Trade Creation

• The removal of tariffs leads to lower prices for consumers and an increase in consumer surplus of areas 1 + 2 + 3 + 4
• Imports will increase from Q3-Q2 to Q4-Q1
• The govt will lose tax revenue of area 3
• Domestic firms producing this good will sell less and lose producer surplus equal to area 1
• However overall there will be an increase in economic welfare of 2+4 (1+2+3+4 – (1+3))

However, it is not as simple as this.

There are some losers from free trade.

- Domestic firms protected by tariffs will lose out – these are often politically vocal. They will make more fuss than consumers who benefit from marginally lower prices.

It is true that countries benefit from cutting tariffs, but they would benefit even more if it is part of a mutual tariff reduction, helping to increase exports. Countries may not want to unilaterally cut tariffs, preferring to use them as a bargaining chip in trade negotiations.

Also, free trade can be damaging under certain circumstances. This is especially true for developing countries seeking to diversify their economy.

See:

Disadvantages of Free Trade

Benefits of Free Trade

I think most people have heard of The Dismal Prophecy of Malthus. (though Economics was termed the ‘dismal science’ for different reasons) Writing in the late eighteenth century, T.Malthus argued that the human population was doomed because the population was growing faster than the ability to grow food. He argued the simple equation of rising population and static land mass meant the world would soon be facing a shortage of food, high prices and famine. Malthus saw this as an inevitability. Yet 150 years on, his prophecy’s look ridiculously pessimistic. Despite, rapid population growth, food supply has, until now, more than kept pace with rising demand. In fact, places like the EU were producing so much surplus food we had the much publicised butter mountains and milk lakes e.t.c.

What Malthus failed to appreciate was that food production was not limited to the amount of fertile land. Relatively modest improvements in technology, and farming techniques could significantly boost food production.

Despite frequent dire warnings, since the time of Malthus, the impending  food crisis had never really materialised (with regional exceptions). Yet, just because Malthusian fears have proved wrong in the past, doesn’t meant that it will always be the case.

• Firstly, population growth continues a pace. Every year the global population rises by an estimated 60-70 million people. (another Britain to put it into perspective)
• At the same time, the amount of fertile land is under threat from a combination of global warming and desertification.
• Also the marginal gains from better technology are starting to diminish. Like anything, the use of artificial fertilisers are subject to diminishing returns. There is only so many chemicals you can use before you reach a plateau of rising production.

It is true, that the world’s capacity to produce food is still way off its maximum.

• Many countries such as India and Africa have not yet adopted many of the simplest technologies to improve food production.
• There is also the contentious issue of GM crops. GM food has potentially many problems, but, also the potential to significantly increase crop yields. A real shortage of food, could well make GM food more likely to occur.
• There is also the possibility of the world shifting to a less intensive food diet – a shift from a meat diet to vegetarian diet would require much less resources.
• Also, as food shortages lead to higher prices (as long as government don’t distort markets by subsidising cheap food), there will be greater economic incentives for countries to increase food production.

See also:

• Dealing with food scarcity
• The Real Economic Crisis – Food

Source: ONS

You can view the latest statistics on UK GDP by visiting the Office of National Statistics here

The latests statistics make for depressing reading, with evidence that the UK economy has now been in recession for 6 quarters, making it one of the longest recessions on record. The decline in output was 0.4%, less severe than at the start of the year, but, still bad news.

The continued recession means:

• Unemployment likely to continue to rise
• Higher government borrowing. Tax receipts will remain depressed, and welfare benefits will be higher.
• Prospect for Interest Rates to remain at 0.5% for the foreseeable future.
• Will keep downward pressure on Pound Sterling. This is because the length of the recession increases the likely hood of further quantitative easing (increasing money supply) and low interest rates.

More on Still in Recession and prospects for recovery

Question: Is the growth of Monopoly Power always a bad thing?

In recent years, many industries have seen a growth in monopoly power and market concentration. For example, in the supermarket industry, Tesco’s market share has grown; I believe they now have over 30% of market share. The Merger of Morrison’s and Safeway has also decreased the number of competitors in the market.

The banking sector has seen a significant growth in monopoly power, due to the recent mergers. The merger of Lloyds TSB and HBOS has created a firm with over 30% of the retail banking market. It is a significant reduction in competition, and has created a banking sector with strong monopoly power.

Generally, growth in monopoly power is seen as harmful thing, especially for the consumer. Monopoly power enables firms to:

• Charge higher prices because of the lower levels of competition
• Offers less choice of service and products to consumers.
• Make High profits at the expense of the consumer.
• more disadvantages of monopoly

A growth in Monopoly Power can be beneficial if:

Economies of scale. A larger firm may be able to benefit from lower average costs. Hence consumers may benefit from lower prices

Diagram showing lower average costs.

Higher profits can be used for Research and Development. e.g. drug companies may need high profit to invest in risky research techniques.

Dynamic Monopoly. If the growth in monopoly power occurs due to the success, efficiency and dynamism of the firm this can benefit consumers. For example, Google gained monopoly power through arguably developing the best search engine. Google is not generally considered to be a lethargic, inefficient monopoly like say an old nationalised monopoly like British Rail.

Monopoly Power In Banking.

If we take the banking industry, the problem is that these advantages seem rather feeble. Certainly there are economies of scale in offering a national banking network. But, I would imagine Lloyds TSB have already exploited most of the economies of scale. A further merger does little to benefit from further economies. If it was a merger of two steel firms, which has much higher fixed costs, the economies of scale may be greater. But, I really can’t see consumers getting lower bank charges because of economies of scale.

If two pharmaceutical firms or airplane manufacturers merged, there could be a good case to say they would use their combined profit for reasearch and development. But, it is hard to justify this for the Banking sector. Profit isn’t needed to invest in new products, it will generally go to the shareholders.

So in the case of banking it seems the growth in monopoly power has many of the disadvantages without any of the advantages. In fact, the only real reason it was allowed to go ahead was the fact, it was seen as a less bad alternative to nationalisation at the time.

So although, it was a convenient solution at the time, the effect of more monopoly power will be felt for many years to come.

The important thing to be aware of is that the benefits of greater monopoly power really depends on the industry in question. We have to look at each merger and firm separately.

Definition of disinflation. This is a fall in the inflation rate. It means that the general price level is increasing at a slower rate.

If the inflation rate is already very low, then disinflation could lead to deflation. Deflation is where there is actually a fall in the price level.

For example in the period 1977 -78, we had a period of disinflation, though prices were still rising.

Since the peak in oil prices in early 2008, the UK inflation rate has continued to fall. CPI inflation has now fallen to 1.1%, from a peak of over 5% in 2008.

The worry is that if this disinflation continues, we could see deflation – a negative inflation rate soon.

However, the Bank of England’s recent decision to halt the policy of quantitative easing, suggests they feel the threat of deflation is not too strong and they see signs of economic recovery.

Readers Question: With Oil prices rising towards $100, what are the economic effects of rising oil prices?

Demand for oil is inelastic, therefore the rise in price is good news for producers because they will see an increase in their revenue. Oil importers, however, will experience increased costs of purchasing oil. Because oil is the largest traded commodity, the effects are quite significant. A rising oil price can even shift economic / political power from oil importers to oil exporters.

Current Account

Higher oil prices will lead to an improvement in the current account position of oil exporters like OPEC countries. It will lead to a deterioration in the current account position of oil importers (e.g. Germany, China). Oil exporters will see an increase in foreign currency reserves which they could use to purchase foreign assets. e.g. Arabic countries, such as Saudi Arabia are an important purchaser of US securities.

Inflation

A marked rise in oil prices will contribute to a higher inflation level. This is because transport costs will rise leading to higher prices for many goods. This will be cost push inflation which is quite different to inflation caused by rising aggregate demand / excess growth.

Monetary Policy

Cost push inflation caused by rising oil prices presents a dilemma to policy makers. Higher inflation usually requires higher interest rates to keep inflation on target. But, to reduce inflation may not  be appropriate because output could be well below full employment. Arguably, in early 2008, policy makers gave too much importance to the cost push inflation and too little weight to the impending economic downturn.

Long Term Effects.

In the short term, demand for oil is inelastic. This means a rise in price only causes a small fall in demand. Demand is price inelastic because consumers need oil based products, e.g. their car only runs on petrol. However, in the long term, higher oil prices will encourage consumers to diversify consumption (e.g. buy hydrogen powered cars e.t.c.)

Also, higher oil prices will encourage firms to try and find more oil supplies, even if it is expensive, remote places like the Antarctic.

Related

• A world without Oil
• Higher oil prices and marginal consumption

National Minimum Wage Rates from 1 October 2009

• Workers Aged 16-17  – £3.57
• Workers Aged 18-21 – £4.83
• Workers Aged 22 and over – £5.80

The post which has attracted the most comments is this post on the National Minimum wage for workers aged 16 and 17. It was actually in response to a question of whether a minimum wage for young workers would increase labour market participation. But, most comments have focused on whether it is justified to pay young workers a lower minimum wage than those over 22.

Reasons for Setting A Lower Minimum Wage for  Young Workers

• Young workers have less experience and therefore a lower MRP (Marginal Revenue Product). As they have lower productivity, economic theory dictates a lower wage.
• Young workers may need more training to develop skills and work experience. The costs of training need to be borne by lower wages otherwise the firm couldn’t afford to pay young workers and train them. In a way, this is like the old apprentice scheme where young workers were paid a low wage during their training period.
• If the NMW for 16 year old workers was the same as 22 year old workers. It would be much more difficult for 16 year olds to get a job because firms would rather pay the more experienced workers.
• During a recession, many firms would struggle to pay more than £3.57 for 16 year olds.
• Firms can, of course, pay more than a minimum wage. If they think 16 year olds are doing as good a job as 22 year olds, they could give same wage.

Reasons to Pay Young Workers the Same as Adults

• As many commentators point out, many 16 year old workers are doing the same job as adults. Therefore, if they are doing the same job, it seems unfair to pay a different wage.
• Firms may substitute 16 year olds for 22 year olds. I know of certain fast food restaurants where young workers are given preferential treatment for overtime compared to 22 year old workers. This is because 16 year olds are much cheaper to employ. This makes it more difficult for 22 year old workers to get employment. Arguably, 22 year olds need a job more than 16 year old workers living at home.

Conclusion

It would be really very hard to justify a minimum wage of nearly £6 for 16 year old workers. If this was implemented, firms would be reluctant to employ young people and there would be far few job opportunities.

One issue that may need addressing is the correct implementation of the minimum wage. If some comments are correct, many young workers (e.g. in hairdressing salons) are getting paid far less than the statutory minimum wage.

Related

• National minimum wage
• Why increase in NMW led to higher employment
• Minimum wage for 16 year olds

Readers Comment: I believe if you want to solve the recession then look at footballers.
they earn millions and for what/kicking a ball around!! I think their wages should be cut down to say 75k a year and the remaining money should be used wisely.

This recession illustrates that economic policy often involves making decisions based on economic utility rather than a sense of justice.

For example, the government was right to bail out the banks, even though the incompetent bankers didn’t deserve to be bailed out. (Why we need to bail out banks)

By contrast, the honest car worker who lost his job, probably deserves to keep his job. But, unfortunately, the government can’t subsidise every potential job loss in an economy.

The high wages and economic rent of footballers is a good example of the laws of supply and demand in practice. See Wages of footballers

If the top footballers had their wages cut and the income was distributed to lower paid workers, it may create a small increase in consumption. Even though there is no extra money in the economy, it is likely that low paid workers will have a higher marginal propensity to consume than footballers on over £50,000 a week.

In other words, those earning over £50,000 are likely to save a higher % than workers selling burgers for £15,000 a year. However, the impact on overall aggregate demand would be limited at best.

In a recession, the inequities of income distribution seem more unfair, but, it is not  inequality which directly causes a recession. Nor is solving inequality a solution to the recession. Can a recession be avoided?

This does not mean inequality of income is necessarily good, but, it is not directly related to the problems of a recession.

Interestingly, many professional footballers will be affected by the new 50% income tax band. – Some Premiership players have even threatened moving to countries with lower tax regimes.

Readers Question: In what way or how do the economic growth possible ? Currently technology and infrastructure are growing apart from Europe esp UK to Asia. Financial stability per family is also sinking ! right (esp to white people-majority ) Then where is growth of economy and how it drives UK to a new positive level of growth ? Now a days people forget to save money and remember how to spend the same? Where is the growth ?

The immediate problem facing the UK economy is a large output gap and decline in aggregate demand. To boost economic growth we need to increase aggregate demand. To increase demand the government and monetary authorities have tried.

• Cutting interest rates to 0.5%. Lower interest rates should make borrowing cheaper and increase the disposable income of homeowners with mortgages. This should increase consumer spending
• Cutting tax rates (expansionary fiscal policy) e.g. VAT to 15%. This should increase consumer spending as they have more disposable income and goods are cheaper.
• Quantitative easing. Increasing the money supply by the Bank of England buying assets from banks. In theory, this should improve bank balance sheets and increase bank lending which in turn will boost investment and spending.
• Also, the weak pound has helped boost exports

However, it is difficult to increase consumer spending because:

• After a decade of low savings and high borrowing, consumers have become more risk averse and consumers are now seeking to increase their savings rate. This will limit consumer spending and make growth more sluggish. (see: problem of saving)
• Also, banks are reluctant / unable to lend as they seek to improve their balance sheets. Thus, the low levels of bank lending is a limit to consumer spending and investment.
• Also, falling house prices have reduced consumer wealth and discouraged spending. – If house prices stabilise this may enable consumer spending to rise in the future.
• Also, the tax cuts are likely to expire as the government seeks to reduce the very large budget deficit. In fact, fiscal policy could soon be deflationary which will hold back growth.

In the long term, economic growth will depend on productivity growth and increases in aggregate supply. However, in the short / medium term, growth will be held back by the many factors limiting consumer spending.

I think the growth will come from a period of low interest rates and a continued policy of quantitative easing.

For more detail see: Causes of economic growth