Pensioners better off, young people worse off

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I often like to tease my parents because they both now both qualify for free bus travel – one of the many ‘perks’ of being ‘old’. Half-jokingly I say they are the lucky generation. Buying a house in the 1960s, enabled a massive increase in wealth. They benefited from an era of full employment and greater relative job security. Neither went to university (so had no student loan to pay off ). But, in those days, a degree wasn’t so necessary (My Dad was last year to train as an accountant without even an A-level) 30 years later, with their mortgage paid off, their outgoings are relatively modest. Yet, despite the relative comfort of this generation, they are still entitled to a whole host of perks and benefits in kind from our ‘generous’ government.

Compare that to the younger generation. Getting on the property ladder is very difficult –  unless you are willing to take on excessive amounts of debt (probably to add to your student loans) The effect is that young people face high rents or high mortgage payments. Amongst young people, unemployment is very high. (18%) Those with jobs still face the harsher realities of the modern workforce – zero hour contracts, greater job insecurity and the very modern development of under-employment.

However, the baby boomers generation is quite politically powerful. Chancellors never seem to lose an opportunity to give more benefits to pensioners – free TV license, free bus pass, winter fuel discount. However, those who face unemployment and declining real wages, will see only rising living costs and little support. The costs of youth unemployment (both economic and social) are exceptionally high, but politically, there seems to be relatively little concern.

A recent report by the IFS show rising income disparity between the generations.

  • The median – or middle – income of the over 60s grew by 2-3% between 2007/08 and 2011/12, continuing a long-term trend.
  • Yet, the median income of people in their 20s fell by 12% over the same period, allowing for inflation. This was the largest fall of any age group, owing to low or frozen wages and high unemployment.
  • According to dept of work and pensions  1 in 6 children now live in poverty.

The decline in pension poverty is very good and signs of social progress. But, maybe we should be giving free bus travel not to pensioners,  but those who are unemployed or seeking a more permanent job.

Benefits in Kind

It is also important to bear in mind that income is only one factor that determines living standards. If you can live rent free (having paid off mortgage) and you also gain other free perks, that gives much greater security and discretionary income than having to pay a fortune for rent and paying off a student loan.

IFS – pensioners income rising faster at BBC

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Internal Devaluation Definition

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Internal Devaluation – where a country seeks to regain competitiveness through lowering wage costs and increasing productivity and not reducing the value of the exchange rate. A devaluation of the currency is a decision to allow a currency, in a fixed or semi-fixed exchange rate, to decrease in value. Devaluing the currency means that the …

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Shock therapy economics

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Shock therapy is the belief that the best way to fix a broken economy is to implement radical changes and introduce new market oriented policies, in one fell swoop whatever the short term cost. Shock therapy is associated with the economist Jeffrey Sachs who advocated free market reforms for Eastern European countries like Poland and Russia in the early 1990s. (Sachs actually disliked term ‘shock therapy’ arguing it was coined by media and makes it sound more painful that it needed to be)

Shock therapy is different to a more gradual approach which seeks to make incremental changes and transition.

Shock therapy generally refers to policies used for making a transition from a Command (state controlled) economy to a mixed economy. However, shock therapy might also refer to

  • Policies to reduce inflation quickly.
  • Policies to reduce budget deficit.
  • Policies to restore competitiveness and reduce current account deficits.

Shock Therapy policies involves

  • Price liberalisation – ending price controls
  • Ending government subsidies
  • Privatisation. Selling state owned industries to the private sector. It is hoped that under private control, firms will have more incentives to be efficient and cut costs.
  • Tightening of fiscal policy – higher tax rates, lower government spending to reduce budget deficit and control inflation.

Benefits of Shock Therapy

  • It is considered a quicker method to overcome economic inefficiency and deal with wasted resources.
  • With firm leadership, people know what to expect and make efforts to deal with the new situation. For example, if you want to control inflation, it is important to change expectations. Sticking to strict anti-inflationary policies, will help bring down inflation expectations and make it easier to achieve.
  • Stretching out economic reform, can prolong the old difficulties.
  • Jeffrey Sachs, a key supporter of shock therapy, argued it was harder to make the leap to a market economy in two stages. Privatisation, price liberalisation and control of inflation are complementary policies.

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Will China challenge the West?

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Readers Question: 1. Does state capitalism as practised in China pose a fundamental challenge to the Western model of liberal-democratic capitalism?

No, I don’t think so. From a political perspective, no matter how economic successful China might be, there will never be any enthusiasm to replicate China’s one party political system. In fact, it is most likely to be the other way around. Increased economic living standards in China are likely to cause increased demand for political and democratic freedom within China; there is already growing resentment at corruption within the state apparatus. It make take a few years or a few decades, but it is China’s political system which will be challenged by its own economic success.

That’s enough on politics, what about the economics? Does China’s growth pose a threat or benefit to the rest of the world?

From an economic perspective, Chinese state capitalism has been successful in creating very high rates of economic growth over the past few decades. Depending on which measure of GDP you use, China is forecast to overtake US economy at some stage (though recent downward revisions to China’s growth may mean it doesn’t occur until the next century. But, nevertheless, the growth of the Chinese economy has been very significant and has many impact on the world economy.

Challenges from Chinese rapid economic growth

Increased price and demand for raw materials. The global recession of 2008-12 was unique in having a period of recession, but rising commodity prices. Usually, when the western economic go into recession, demand for raw materials falls, and therefore the price falls – cushioning the impact of the recession. However, this time, rising demand from China and Asia, meant in the recession, we saw rising commodity prices – making the recession more difficult. Over the medium term, China’s economic growth will put increased pressure on raw materials and push up oil and other commodity prices. There will be greater competition for limited supplies of raw materials

  • However, this will spur the Western economies to increase fuel efficiency and look for alternatives to fossil fuels, which in the long term is desirable.

Environmental challenges. As Chinese GDP grows, there will be rise in greenhouse gases and other environmental costs, making it more challenging to deal with global warming.

  • However, the biggest levels of pollution still come from Western economies.

Global imbalances from high saving rates. In the boom period of 2000-2007, China experienced a large current account surplus. The Chinese kept their currency undervalued through using surplus foreign currency and purchasing US bonds. Arguably, these large capital outflows distorted markets. Artificially pushing down US interest rates contributing to a boom in US lending – and reducing US exports through keeping the dollar overvalued.

  • However, these global imbalances have been significantly reduced in recent years. The Chinese currency has steadily appreciated as the government have tried to contain inflationary pressures. This shows that Chinese growth can evolve from relying on cheap exports to more balanced with a growing middle class willing to spend and buy imports.

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Latvia to join the Euro

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After enduring a deep economic crisis, Latvia are poised to be ‘rewarded’ with membership of the Euro in 2014.

latvia-eu

The Latvian miracle story

It seems a strange that countries are so keen to join the Euro, when membership of the Euro has been a major factor in creating a real depression amongst many Euro countries. Yet, the debate about Latvian joining seems to be from a parallel universe, where the ongoing crisis is neatly forgotten.

Prime Minister Valdis Dombrovskis said that the European Commission (EC) had given the go ahead for Latvia for adopt the euro from early 2014. “Joining the eurozone will foster Latvia’s economic growth for sure,” Mr Dombrovskis said. I’m sure that is what the Greek, Spanish and Portuguese political leaders said when they joined in 2000.

latvia-czech-republic

There is opposition – with many in Latvia concerned about ‘rising prices’ after joining the Euro. But, given the experience of the Eurozone in the past few years, rising prices are likely to be the least of Latvia’s concerns over the next few years.

From an outsiders perspective, it’s hard to understand the attraction of joining the Euro. I think the underlying motive must be a desire to join up with Europe and move away from Russia and the East. Given Latvia’s past, this is understandable. What is unfortunate is that being a good European citizen seems to involve joining an unworkable single currency and monetary policy.

Despite the European obsession with meeting fiscal deficits, there has been much less concern about whether the Eurozone is fundamentally an optimal currency area. An optimal currency area is a geographical area where the benefits of one currency are greater than the downsides. An optimal currency area will need:

  • Strong labour and capital mobility
  • Lack of geographical barriers
  • Fiscal transfers from strong regions to weak ones
  • Similar labour costs and similar inflation rates.
  • The ability to cope with a single monetary policy (interest rate)
  • The ability to retain competitiveness within the fixed exchange rate.

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If the UK had been in the Euro – how would it affect the economy?

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Readers Question: my question is If the UK. had joined the Euro back when it first started would the UK. have benefited like Germany or would we be in the same situation as Greece, Italy, and Spain?

If the UK had joined the Euro from the start in 1999, the UK economy would definitely have been affected in a variety of ways. Firstly, in the Euro we would have a fixed exchange rate, no independent monetary policy, fiscal policy would be severely curtailed, and the UK bond market would have had no intervention from the Central Bank.

In short, we could have expected – a bigger housing boom and bust. A deeper recession in 2009. Rising bond yields in 2010-12, leading to greater austerity. No devaluation and less competitive exports.

Housing Bubble

ECB Interest Rates

The years 2000 to 2007 were relatively stable for the Eurozone and Euro. However, due to stronger growth in the UK, ECB interest rates were lower than the Bank of England interest rates. Between 2003 and early 2005, ECB interest rates were 2%, UK rates were higher at around 4%.

UK base interest rates

If the UK had been in the Euro, we could have seen a bigger asset bubble during the years 2003-06. Lower interest rates would have encouraged more people to enter the housing market, causing an even bigger increase in house prices. These lower interest rates would have caused higher economic growth in the period 2000-07, but at the cost of a bigger credit and housing boom. The UK is particularly sensitive to interest rates because so many homeowners have a variable mortgage.

If house prices had risen faster (04-07), they would have been a bigger fall, post 2008. The fall in house prices post 2008 was a drag on consumer spending and contributed to bank losses. If house prices fell at a great rate, then the financial crash would have been more painful and banks lost even more money.

Response to recession of 2008

The economic and financial crisis of 2008 hit the UK more than most other European economies. This was partly because the UK’s economy has a bigger reliance on banking and finance – sectors adversely affected by the credit crunch. Other European economies, such as Germany also saw a big fall in GDP during 2009, but were able to bounce back from recession quicker than the UK and southern Europe.

eu econ growth

In response to this fall in output, the UK pursued a different monetary and fiscal policy to the rest of Europe. If the UK had been in the Euro, we would not have been able to pursue this independent monetary and fiscal policy.

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Abenomics – a Japanese recovery?

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Abenomics refers to the economic policy of the current Japanese prime minister Shinzō Abe. The aim of the policy is to stimulate strong economic recovery and help the Japanese economy to escape a cycle of deflation, and low growth.

japan economic growth

Can Japan break the cycle of low growth?

The range of policies include:

  1. Expansionary monetary policy (Quantitative easing, negative real interest rates, and an inflation target of 2%)
  2. Expansionary fiscal policy (higher government spending financed by borrowing)
  3. Weakening the value of the Japanese Yen to boost the export sector.
  4. Supply side policies ‘new growth measures’

japan-inflation-60-22

How it is supposed to work

  • Japan has suffered from a prolonged period of deflation or very low inflation. Since early 1997, the GDP deflator (a broad measure of the price level) has declined by 17 per cent. (FT) This deflation has increased the real debt burden of firms, consumers and the government and acted as a continued depressing factor on spending. (See: problems of deflation) By pursuing expansionary monetary policy and targeting higher inflation, they hope to change expectations of inflation and encourage more private sector investment and spending.
  • Expansionary fiscal policy. Fiscal spending will increase by 2% in 2013, increasing the budget deficit to 11.5%. The aim of the expansionary fiscal policy is to make sure that the extra money supply feeds into the real economy. There is concern that quantitative easing alone, just leads to increased bank reserves. But, the extra government spending will provide a direct injection into the economy and provide a stimulus to aggregate demand (AD)
  • Confidence and expectation. An important feature of ‘Abenomics’ is trying to change the economic mood and overcome the prevailing ‘economic defeatism’. Opinion polls suggest that many people are supportive of the attempts to overcome recession. This positive effort and talk of economic recovery is improving business and consumer confidence, and will act as a spur to increase consumer spending and private sector investment.

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