Economics help blog – Page 158

Is Austerity Self Defeating?

14 February 202010 January 2015 by Tejvan Pettinger

Question from the Economist. – It is easy to understand the case that European austerity is self-defeating. But it is also easy to see that one cannot run large deficits year after year without limit and that some countries (Greece, Portugal) have exhausted the willingness of private investors to finance them. Is Austerity self-defeating? Austerity …

Expansion of European Union EU

10 March 20208 January 2015 by Tejvan Pettinger

The original European Union (then called the EEC European Economic Council) was composed of 6 founder members. Belgium France Germany Italy Luxembourg Netherlands The EEC came into existence with the Treaty of Rome 1954. Since then the EU has expanded its borders taking in most European Countries. Enlargement has generally been seen as a positive …

The UK recovery compared

29 December 20207 January 2015 by Tejvan Pettinger

I’ve just got back from my Christmas holidays. I spent two weeks in Croatia (the EU’s newest member, 2013). It was very beautiful by the coast, if somewhat cold. Just like students find it hard to write the first essay after a three week holiday, I also struggle to get into the flow of economics …

Missing Markets

14 February 20205 January 2015 by Tejvan Pettinger

A missing market is a type of market failure. A missing market means that there is some obstruction to an efficient free market which would enable a Pareto efficient distribution of resources but for various reasons this market doesn’t exist.

Private label brands

16 February 202018 December 2014 by Tejvan Pettinger

Private label brands (or own brand labels) are products sold by a retailer with its own packing, but manufactured by a third party. For example, Tesco sell ordinary branded items, such as Heinz baked beans, but also sell their own ‘Tesco Value’ baked beans. Tesco will license a manufacturer to produce baked beans and then …

Cigarette tax and smoking rates

16 February 202017 December 2014 by Tejvan Pettinger

In the UK, smoking rates have fallen significantly in the past 40 years. A combination of factors have led to declining smoking rates. Higher tax Health campaigns warning about the dangers of smoking. Regulations to ban smoking in many public areas, making smoking less attractive. Changing social attitudes and decline in the fashionability of smoking. …

Russian economic crisis

18 November 201717 December 2014 by Tejvan Pettinger

With economic sanctions and a plummeting price of oil, the Russian economy is seeing a real economic crisis. The value of the rouble is falling – causing inflation and a decline in living standards. Government tax revenues are falling as oil tax revenues decline. On top of a falling Rouble, the economy faces recession due to declining export revenues, falling real incomes, a collapse in confidence and higher interest rates.

Causes of Russian economic crisis

Oil dependent economy. The Russian economy has done well in recent years from high oil and gas prices. This has led to strong export revenues and government tax revenues. In 2012, the oil and gas sector accounted for 52% of federal tax funds and 70% of exports But, the near 50% in oil prices have caused the economy to suffer. Unfortunately, the strength of the oil industry has meant alternative manufacturing industries remain undeveloped – and unable to benefit from more competitive export prices. The Russian oil economy is an example of the Dutch disease.

Falling oil prices. The oil price has collapsed from $115 a barrel in June 2014 to just above $60 in Dec 2014. Falling oil prices have caused a big fall in export revenue, a fall in real GDP and a fall in government tax revenues.

Economic sanctions. Sanctions imposed by the EU and US since the issues around the Ukraine have damaged the ability of some Russian firms to raise finance. On their own, the sanctions are quite limited in effect, but combined with the timing, they are a big blow to confidence in the Russian economy.

Recession. Due to the 50% devaluation in the Rouble, the price of imported goods has increased, leading to imported inflation. With inflation running at 9%, consumers are seeing a fall in real wages. Wages, pensions and benefits are not keeping up with rising cost of living. This is causing lower spending. The Central Bank faces a difficult dilemma – because of the recession it needs to cut interest rates, but the falling Rouble has caused it to increase interest rates to 17% – to try and protect the value of the Rouble – but, this will further reduce spending and lower growth. (See: effect of higher interest rates). With the oil and gas sector hit, big firms are likely to lay off workers, due to the fall in demand and revenue. This rise in unemployment will exacerbate the recession. It’s a tough combination of factors, which give the government and Central Bank little room for manoeuvre.

russia-rouble-independent

Source: Independent

Falling Rouble. Despite high foreign currency reserves, the Rouble has fallen in value, suggesting investors have lost confidence in the Russian Central Bank, the Russian economy and the Rouble. The problem of the falling confidence in the Rouble, is that it is encouraging capital flight – where Russians seek to protect the value of their wealth by transferring it into other currencies outside Russia. This is a toxic mix – a self-reinforcing cycle of falling Rouble, causing more people to give up on the Rouble.

Question: Why do the costs of living keep going up?

14 February 202016 December 2014 by Tejvan Pettinger

Readers Question: Why do the costs of living keep going up and our wages do not match it?

In recent years, many people have seen the cost of living rising faster than wages. This has led to a fall in real wages – wages increased less than inflation. This effectively means a fall in the number of money consumers have to spend on goods and services, leading to a decline in living standards.

The cost of living measures the price of goods and services that we typically buy. This rise in the cost of living is measured by the inflation rate.
If the inflation rate is higher than our nominal wage growth, then we see a decline in real wages. We are financially worse off.

This is not always the case. In the twentieth century, there was an unprecedented rise in living standards with the average wage of workers significantly increasing – enabling workers to be better off.

Ways to become worse off

Inflation higher than wage growth – falling real wages
Falling wages – and constant prices – leading to falling real wages
Higher taxes, leading to less disposable income – disposable income measures after tax income. Your real wage may increase by 2%, but if income taxes rise 3%, your disposable income will be less.
Higher living costs leading to less discretionary income. If you have to spend more on essential items, such as heating, insurance and travel costs, debt repayments – then the amount of money left over after spending on essentials falls. We say this is a fall in discretionary income (though people may use term disposable income). Again, you will feel worse off because there is less money left over to spend.
Lower benefits. Many low-income people rely on government benefits, such as unemployment insurance, housing benefit or income support. If benefits fall behind inflation, this will create a fall in real income. This will be quite noticeable because people on low income are already stretched and have limited disposable income.

Falling real wages are quite rare in Western Europe since 1945. Typically we have seen positive economic growth and rising real incomes. People are definitely better off than 50 years ago. The graph below shows that since 2008, the rise in living standards has temporarily ended and become negative.

UK real wages

uk-wages-inflation-01-14

It is a similar situation in many other developed economies, such as US and Europe.

Reasons for falling real wages

Negative economic growth. If there is a recession – which means a fall in real GDP – then average incomes are likely to fall. Firms will be cutting wages and / or cutting jobs, therefore there will be a decline in living standards.

However, we can also see falling real wages during economic growth. An interesting feature of this recovery is that despite economic growth (rising real GDP), real incomes are still falling. How can real incomes fall, when there is positive economic growth?