Pearson - Always learning

All your resources for Economics

RSS icon Subscribe | Text size

Articles for the ‘Essentials of Economics 6e: Ch 06’ Category

What does ‘fair play’ mean for the big teams in Europe?

Officials of the Club Financial Control Body (CFCB) of UEFA met on Tuesday 15th April and Wednesday 16th April to decide the fate of a number of European clubs. The job of the CFCB is to implement UEFA’s Financial Fair Play (FFP) rules. Manchester City and Paris Saint-Germain (PSG) are said to be nervously awaiting the outcome of these meetings.

UEFA’s FFP rules apply to teams who want to play in either the Champions League or the Europa League. In order to be eligible to compete in these competitions teams not only have to perform well in their domestic league they also have to obtain a license from UEFA. The application process normally takes place midway through the current season for entry into either the Champions League or Europa League for the following season.

UEFA’s FFP rules cover a broad range of issues such as requirements for clubs to pay taxes, transfer fees and players’ wages on time in order to receive a license. However it is the ‘Break Even’ requirement that has caught the attention of a number of economists. This provision limits the size of the financial losses that team can incur before they become subject to sanctions from UEFA. Some of the stated aims of the policy are to:

- Introduce more discipline and rationality in club football finances
- Encourage clubs to operate on the basis of their own revenues
- Encourage responsible spending for the long-term benefit of football
- Protect the long term viability and sustainability of European club football.

The Royal Economic Society held a special session on the potential impact of the ‘Break Even’ requirement at its annual conference in April of this year.

One key way in which the UEFA rules differ from the rules imposed in the Championship in England is that the financial performance of the clubs is judged over a 2/3 year period rather than just one. The initial assessment period is over 2 seasons – 2011-12 to 2012-13. After this the monitoring period is over 3 seasons. Teams can make an initial loss of €5 million in total over the first two year period but this can increase to a maximum permitted loss €45 million over the two years – approximately £37 million – if the team’s owner is willing to fund this loss out of their own money. Certain categories of expenditure are exempt such as the cost of building a new stadium/stand or spending on youth development and the local community.

Manchester City made a total financial loss of £149 million over the last two seasons, far in excess of the permitted £37million, but these losses are falling which may count in their favour. They made losses of £97.9 million in 2012 and £51.6 million in 2013. Also some of the club’s expenditure will have been on some of the exempted categories so that the actual losses subject to FFP will be lower. Chelsea made a profit of £1.4million in 2011-12 and a loss of £49.4million in 2012-13. Although the losses over the two seasons were greater than £37 million, once adjustments were made for exempted expenditures the club was within the maximum permitted loss so was not subject to a full investigation.

In order to implement its FFP regulations UEFA created the Club Financial Control Body (CFCB). The CFCB has two departments – an investigatory chamber and an adjudicatory chamber. The investigatory chamber does the bulk of the work by investigating the accounts of all the 237 clubs that play in UEFA competitions. It was initially reported that the accounts of 76 clubs were being investigated in some detail because it was thought that they might have failed to meet FFP guidelines. However after further investigations in February it was reported that this number had fallen to below 20 teams. The investigatory panel met on Tuesday 15th April and Wednesday 16th April in order to make its final decisions which will be announced May 5th. The body can choose from one of the four following options in each case:

- Dismiss the case
- Agree a settlement with the club – effectively putting it on probation
- Reprimand and fine the club up to €100,000
- Refer the club to the CFCB adjudicatory chamber

The last option is the most serious as the adjudicatory chamber has the power to issue more serious penalties such as

- A deduction of points from the group stages of UEFA competitions.
- Withholding of revenues from UEFA competitions.
- Restrictions on the number of players that a club can register for participation in UEFA competitions.
- Disqualification from future UEFA competitions.

One issue that concerned UEFA was the possibility that very wealthy team owners might try to artificially inflate the revenues their club’s generate so as to circumvent the rules and make it look as if the team was meeting the FFP guidelines. In particular deals might be struck between other organisations that the club owner has an interest in and the football club at rates far in excess of the normal market level. For example some concerns have been expressed about the nature of the back-dated sponsorship deal of £167 million/year signed by PSG with the Qatar Tourism Authority. PSG are owned by Qatar Sport Investment which itself is a joint venture between the Qatari government and the Qatari Olympic Committee. The CFCB have said that they will analyse these types of deals and adjust club accounts if necessary so that they reflect true market rates.

May 5th could prove to be a very significant day for some of the biggest and most wealthy clubs in Europe.

Webcast
The Economics of “Financial Fair Play” (FFP) in European Soccer (EJ Special Session) Royal Economic Society (7/4/14)

Articles
UEFA probes ‘fewer than 20′ clubs over financial fair play rules Sky Sports, (14/4/14)
Manchester City confident of satisfying Uefa financial fair play rules The Guardian (15/4/14)
Uefa’s Financial Fair Play rules explained The Telegraph (15/4/14)
Man City sweating over sanctions as UEFA prepare to rule over excessive spending Daily Mail (15/4/14)
How Bosman’s lawyer is plotting another football revolution BBC Sport (2/10/13)
Manchester City await fate as Uefa’s financial rules kick in BBC Sport (16/4/14)
Manchester City and Paris Saint-Germain face financial fair play fate The Guardian (14/4/14) .

Questions

  1. In standard economic theory it is assumed that both consumers and producers act rationally. What precisely does this mean?
  2. One of the stated aims of UEFA FFP is to ‘introduce more discipline and rationality in club football finances’. Why might the owners of a football club act in an irrational way?
  3. Consider some of the advantages and disadvantages of assessing the financial performance of a team over 3 years as opposed to 1 year.
  4. One of the major arguments made against the UEFA FFP rules is that they will lead to a ‘fossilisation’ of the existing market i.e. the current top clubs are more likely to maintain their leadership. Explain the logic of this argument in more detail.
  5. Which of the possible sanctions for breaking FFP regulations do you think would hit the clubs the hardest in terms of the revenue they would lose? i.e. Which of the sanctions would they most like to avoid?
Share in top social networks!

How to play fair: The rules of the game for the owners of teams in the Championship.

As Leicester City celebrated promotion to the English Premier League (EPL) last Saturday (5th April) it also became the first club in England that will probably have to pay a new Financial Fair Play (FFP) Tax. This tax is not paid to the government, but is effectively a fine imposed by the English Football League (EFL) on teams who break FFP regulations.

On Tuesday 8th April 2014 representatives from all the Championship clubs met with officials from the English Football League (EFL) in order to discuss the implementation of FFP. It had been reported in February that a number of teams were unhappy about the implementation of the FFP rules and were threatening to take legal action against the league. Unsurprisingly, one of these clubs was rumoured to be Leicester City.

In April 2012, 21 out of the 24 clubs in the Championship agreed on a set of new FFP regulations. These rules place a limit on the size of any financial losses that a team can incur in a given season before punishments, such as a tax, are imposed on them. The English Football League (EFL) stated that the aim of the FFP regulations was to

reduce the levels of losses being incurred at some clubs and, over time, establish a league of financially self-sustaining professional football clubs.

Under the agreed set of rules, all teams in the Championship have to provide a set of annual accounts by 1st December for the previous season: i.e. the first reporting period was in December 2012, when clubs had to submit accounts for 2011–12. No penalties were applied for the first two reporting periods as teams were given time to adjust to the new FFP framework. However sanctions come into effect for the 2013–14 season.

For the 2013–14 season the FFP rules set a threshold of £3 million as the size of the pre-tax financial losses that a team can incur before having to face any sanctions. If a team incurs a pre-tax loss of greater than £3 million but less than £8 million then punishments from the league can be avoided if the team’s owner invests enough money into the club so that the loss is effectively limited to £3 million: i.e. if the club reports a loss of £7 million then the owner would have to invest a minimum of £4 million of his/her own cash to avoid any sanctions.

The club is not allowed to finance the loss by borrowing or adding to the level of the team’s debt. If the owner cannot/refuses to make the investment or the pre-tax loss is greater than £8 million then the team is subject to one of two possible sanctions depending on whether it is promoted or not.

First, if the club is not promoted to the EPL, then it is subject to a transfer ban from the 1st January 2015: i.e. it will be unable to sign new players at the start of the transfer window. The ban remains in place until the club is able to submit financial information that clearly shows that it is meeting the FFP guidelines.

Second, if the club is promoted to the EPL then instead of a transfer embargo it has to pay the FFP Tax. The amount of tax the firm has to pay to the league depends on the size of the financial loss it has incurred. The larger the loss, the greater the tax it has to pay. The marginal rate of tax also increases with the size of the loss.

In order to help illustrate how the tax works it is useful to take a simple example. Leicester city reported a pre-tax loss of £34 million in 2012–13. If the club managed to reduce its pre-tax losses to £15 million in 2013–14 then, given its promotion, it would be subject to the tax. If we also assume that the owners are willing and able to invest £5 million of their own money into the club then the rate of tax the team would have to pay is based on the size of its losses over £8 million in the following way:

1% on losses between £8,000,001 and £8,100,000
20% on losses between £8,100,001 and £8,500,000
40% on losses between £8,500,001 and £9,000,000
60% on losses between £9,000,001 and £13,000,000
80% on losses between £13,000,001 and £18,000,000
100% on any losses over £18,000,000

Therefore with a loss of £15 million the FFP tax that Leicester would have to pay is £4,281,000 (£1,000 + £80,000 + £200,000 + £2.4million + £1.6million). If the club instead made a pre-tax financial loss of £30,000 in the 2013–14 season, then the FFP tax it would have to pay increases to £18,681,000 (£1,000 + £80,000 + £200,000 + £2.4million + £4 million + £12 million).

It was originally agreed that the revenue generated from the FFP tax would be shared equally by the teams in the Championship who managed to meet the FFP regulations. However the EPL objected to this provision and the money will now be donated to charity by the EFL.

Based on the financial results reported in 2012–13, about half the clubs in the Championship would be subject to either a transfer ban or FFP tax in January 2015. It was reported in the press in February that a number of clubs had instructed the solicitors, Brabners, to write to the EFL threatening legal action.

One particular concern was the ability of the clubs in the Championship subject to FFP rules to compete with teams relegated from the EPL. When the original FFP regulations were agreed, the teams relegated from the EPL received parachute payments of £48 million over a 4-year period. Following the record-breaking TV deal to broadcast EPL games, the payments were increased to £59 million for the 2013–14 season.

Following the meeting on Tuesday 8th April a spokesman from the EFL said

Considerable progress was achieved on potential improvements to the current regulations following a constructive debate between the clubs.

It will be interesting to see what changes are finally agreed and the implications they will have for the competitive balance of the league.

Articles
Why Championship clubs are crying foul over financial fair play The Guardian (26/2/14)
Wage bills result in big losses at Leicester City and Nottingham Forest The Guardian (5/3/14)
Financial fair play: Championship clubs make progress on talks BBC Sport (10/4/14)
Financial Fair Play in the Football League The Football League (25/4/12)
Loss leaders – Financial Fair Play Rules When Saturday Comes (25/4/12)
Richard Scudamore: financial fair play rules unsustainable in present form The Guardian (14/3/14)

Questions

  1. To what extent do you think that the implementation of the FFP regulations will either increase or decrease the competitive balance of the Championship?
  2. An article in the magazine ‘When Saturday Comes’ made the following statement “Last season’s champions, QPR, lost £25.4m and would have been handed a ‘tax’ of at least £17.4m based on 2013-14 thresholds”. Explain why this statement is not accurate. What mistake has the author made when trying to calculate the level of FFP tax payable?
  3. Nottingham Forest reported pre-tax financial losses of £17 million in 2012-13. If they made the same losses in 2013-14 and were promoted to the EPL, calculate how much FFP tax they would have to pay under current regulations.
  4. To what extent do you think that the money generated by the FFP tax should be equally distributed between the teams in the Championship who meet the FFP regulations.
  5. Why do you think team owners might need regulations to restrict the level of losses that they can make. Why might sport be different from other sectors?
Share in top social networks!

Pensioner hazard

In his Budget on March 19, the Chancellor of the Exchequer, George Osborne, announced fundamental changes to the way people access their pensions. Previously, many people with pension savings were forced to buy an annuity. These pay a set amount of income per month from retirement for the remainder of a person’s life.

But, with annuity rates (along with other interest rates) being at historically low levels, many pensioners have struggled to make ends meet. Even those whose pension pots did not require them to buy an annuity were limited in the amount they could withdraw each year unless they had other guaranteed income of over £20,000.

Now pensioners will no longer be required to buy an annuity and they will have much greater flexibility in accessing their pensions. As the Treasury website states:

This means that people can choose how they access their defined contribution pension savings; for example they could take all their pension savings as a lump sum, draw them down over time, or buy an annuity.

While many have greeted the news as a liberation of the pensions market, there is also the worry that this has created a moral hazard. When people retire, will they be tempted to blow their savings on foreign travel, a new car or other luxuries? And then, when their pension pot has dwindled and their health is failing, will they then be forced to rely on the state to fund their care?

But even if pensioners resist the urge to go on an immediate spending spree, there are still large risks in giving people the freedom to spend their pension savings as they choose. As the Scotsman article below states:

The risks are all too obvious. Behaviour will change. People who no longer have to buy an annuity will not do so but will then be left with a pile of cash. What to do with it? Spend it? Invest it? There are many new risky choices. But the biggest of all can be summed up in one fact: when we retire our life expectancy continues to grow. For every day we live after 65 it increases by six and a half hours. That’s right – an extra two-and-a-half years every decade.

The glory of an annuity is it pays you an income for every year you live – no matter how long. The problem with cash is that it runs out. Already the respected Institute for Fiscal Studies (IFS) has said that the reform ‘depends on highly uncertain behavioural assumptions about when people take the money’. And that ‘there is a market failure here. There will be losers from this policy’.

We do not have perfect knowledge about how long we will live or even how long we can be expected to live given our circumstances. Many people are likely to suffer from a form of myopia that makes them blind to the future: “We’re likely to be dead before the money has run out”; or “Let’s enjoy ourselves now while we still can”; or “We’ll worry about the future when it comes”.

The point is that there are various market failings in the market for pensions and savings. Will the decisions of the Chancellor have made them better or worse?

Articles
Pension shakeup in budget leaves £14bn annuities industry reeling The Guardian, Patrick Collinson (20/3/14)
Chancellor vows to scrap compulsory annuities in pensions overhaul The Guardian, Patrick Collinson and Harriet Meyer (19/3/14)
Labour backs principle of George Osborne’s pension shakeup The Guardian, Rowena Mason (23/3/14)
Osborne’s pensions overhaul may mean there is little left for future rainy days The Guardian, Phillip Inman (24/3/14)
Let’s celebrate the Chancellor’s bravery on pensions – now perhaps the Government can tackle other mighty vested interests Independent on Sunday, Mary Dejevsky (23/3/14)
A vote-buying Budget The Scotsman, John McTernan (21/3/14)
L&G warns on mis-selling risks of pension changes The Telegraph, Alistair Osborne (26/3/14)
Budget 2014: Pension firms stabilise after £5 billion sell off Interactive Investor, Ceri Jones (20/3/14)

Budget publications
Budget 2014: pensions and saving policies Institute for Fiscal Studies, Carl Emmerson (20/3/14)
Budget 2014: documents HM Treasury (March 2014)
Freedom and choice in pensions HM Treasury (March 2014)

Questions

  1. What market failures are there in the market for pensions?
  2. To what extent will the new measures help to tackle the existing market failures in the pension industry?
  3. Explain the concept of moral hazard. To what extent will the new pension arrangements create a moral hazard?
  4. Who will be the losers from the new arrangements?
  5. Assume that you have a choice of how much to pay into a pension scheme. What is likely to determine how much you will choose to pay?
Share in top social networks!

“Why buy a football club?”, asks Linda Yueh

Footballers in the English Premier League are some of the most highly paid workers in the world. With unique talents and skills and hence a limited supply of labour, together with an insatiable appetite from the British public for football, we would expect to see high wages and a market ripe for investment, with high returns on offer. But, is this case?

The article below is by Linda Yueh, the Chief Business Correspondent for BBC News, and she has looked into the football, asking why on earth buy a football club? Despite the success of the English Premier League in drawing fans, TV and commercial revenues, many teams find it difficult to break even and investing in a team is unlikely to yield much of a return (if any!). Yet, we still see successful businesspeople, especially from abroad, purchasing English football teams.

Many club owners have hugely profitable ventures in other markets and historically only invest their money when they see an opportunity for a high return. But, not in the case of football. A return is unlikely and yet they still invest. So, with positive returns unlikely, what is it about this market that attracts investors? The article by Linda Yueh considers this question.

Article
Why on earth buy a football club? BBC News, Linda Yueh (27/2/14)

Report
Annual Review of Football Finance – Highlights Deloitte, Sports Business Group June 2013

Questions

  1. How can the returns to investment be measured?
  2. How can a company’s operating profit be calculated?
  3. Using a labour market diagram, explain why footballers are paid such a high wage.
  4. Is it monetary or non-monetary factors that seem to explain why businessmen invest in football clubs?
  5. Why are English football clubs typically unprofitable? Should they be?
  6. Which factors can explain the growing financial inequality between clubs in the Premier League and in the divisions below? Is there an argument for government involvement to regulate football?
Share in top social networks!

An above-inflation rise in the NMW

In the blog Effects of raising the minimum
wage
, the policy of an above-inflation rise in the minimum wage was discussed, as this had been advocated by political leaders. Over the past 5 years, the minimum wage has fallen in real terms, but from October 2014, the national minimum wage will increase 19p per hour and this rise will be the first time since 2008 when the increase will be higher than inflation.

The National Minimum Wage is a rate applied to most workers in the UK and is their minimum hourly entitlement. For adults over the age of 21, it will be increased by just over 3% to £6.50. Rises will also occur for 18-20 year olds, though their increase will be lower at 10p and will take the hourly wage to £5.13 an hour, representing a 2% rise. Those aged 16 and 17 will also see a 2% rise, taking their wage up by 7p to £3.79. With inflation currently at 1.9% (as measured by the CPI), these rises outstrip inflation, representing a real increase in the minimum wage. Undoubtedly this is good news for workers receiving the minimum wage, and it is thought that millions of workers will benefit.

Vince Cable said:

The recommendations I have accepted today mean that low-paid workers will enjoy the biggest cash increase in their take home pay since 2008…This will benefit over one million workers on national minimum wage and marks the start of a welcome new phase in minimum wage policy.

While this rise has been praised, there are still suggestions that this minimum wage is too low and does not represent a ‘living wage’. The General Secretary of Unison said:

Across the country people are struggling to make ends meet. The sooner we move to a Living Wage the better. The real winners today will again be payday loan sharks who prey on working people, unable to bridge the financial gap between what they earn and what their families need to survive.


(Click here for a PowerPoint of the above chart.)

The Chancellor eventually wants to increase the minimum wage to £7 per hour, but there will undoubtedly be an impact on businesses of such a rise. Is it also possible that with the national minimum wage being pushed up, unemployment may become a problem once more?

Market wages are determined by the interaction of the demand and supply of labour and when they are in equilibrium, the only unemployment in the economy will be equilibrium unemployment, namely frictional or structural. However, when the wage rate is forced above the equilibrium wage rate, disequilibrium unemployment may develop. At a wage above the equilibrium the supply of labour will exceed the demand for labour and the excess is unemployment.

By increasing the national minimum wage, firms will face higher labour costs and this may discourage them from taking on new workers, but may also force them into laying off existing workers. The impact of the minimum wage on unemployment doesn’t seem to be as pronounced as labour market models suggest, so perhaps the increase in the minimum wage will help the lowest paid families and we won’t observe any adverse effect on businesses and employment. The following articles consider this story.

National minimum wage to rise to £6.50 The Guardian, Rowena Mason (12/3/14)
Minimum wage up to £6.50 an hour BBC News (12/3/14)
Minium wage to increase by 3% to £6.50 an hour Independent, Maria Tadeo (12/3/14)
Minimum wage rise confirmed Fresh Business Thinking, Daniel Hunter (12/3/14)
Ministers approve minimum wage rise London Evening Standard (12/3/14)
Government to accept proposed 3% minimum wage rise The Guardian, Rowena Mason (4/3/14)
Londoners do not believe minimum wage is enough to live on in the capital The Guardian, Press Association (9/3/14)
Minimum wage: The Low Pay Commission backs a 3% increase BBC News (26/2/14)

Questions

  1. Using a diagram, illustrate the impact of raising the national minimum wage in an otherwise perfectly competitive labour market.
  2. How does your answer to question 1 change, if the market is now a monopsony?
  3. To what extent is elasticity relevant when analysing the effects of the national minimum wage on unemployment?
  4. How might an increase in the national minimum wage affect public finances?
  5. Why is an above-inflation increase in the national minimum wage so important?
  6. What is meant by a Living Wage?
  7. What do you think the impact on business and the macroeconomy would be if the minimum wage were raised to a ‘Living Wage’?
Share in top social networks!

Private versus public

Many people are attracted to work in the private sector, with expectations of greater opportunities for promotion, more variation in work and higher salaries. However, according to the Office for National Statistics, it may be that the oft-talked-of pay differential is actually in the opposite direction. Data from the ONS suggests that public sector workers are paid 14.5% more on average than those working in the private sector.

As is the case with the price of a good, the price of labour (that is, the wage rate) is determined by the forces of demand and supply. Many factors influence the wages that individuals are paid and traditional theory leads us to expect higher wages in sectors where there are many firms competing for labour. With the government acting as a monopsony employer, it has the power to force down wages below what we would expect to see in a perfectly competitive labour market. However, the ONS data suggests the opposite. What factors can explain this wage differential?

Jobs in the public sector, on average, require a higher degree of skills. There tend to be entry qualifications, such as possessing a university degree. While this is the case for many private-sector jobs as well, on average it is a greater requirement in the public sector. The skills required therefore help to push up the wages that public-sector workers can demand. Another explanation could be the size of public-sector employers, which allows them to offer higher wages. When the skills, location, job specifications etc. were taken into account, the 14.5% average hourly earnings differential declined to between just 2.2% and 3.1%, still in favour of public-sector workers. It then reversed to give private-sector workers the pay edge, once the size of the employer was taken out.

Further analysis of the data also showed that, while it may pay to be in the public sector when you’re starting out on your career, it pays to be in the private sector as you move up the career ladder. Workers in the bottom 5% of earners will do better in the public sector, while those in the top 5% of earners benefit from private-sector employment. The ONS said:

Looking at the top 5%, in the public sector earnings are greater than £31.49 per hour, while in the private sector, the top 5% earn more than £33.63 per hour… The top 1% of earners in the private sector, at more than £60.21 per hour, earns considerably more than the top 1% of earners in the public sector, at more than £49.65 per hour.

The data from the ONS thus suggest a reversal in the trend of average public-sector pay being higher than private sector pay, once all the relevant factors are taken into account.

This will naturally add to debates about living standards, which are likely to take on a stronger political slant as the next election approaches. It is obviously partly down to the public-sector pay freeze that we saw in 2010 and also to a reversal, at least in part, of the previous trend from 2008, where public-sector pay had been growing faster than private-sector pay. However, depending on the paper you read or the person you listen to, they will offer very different views as to who gets paid more. All you need to do in this case is look at the titles of the newspaper articles written by the Independent and The Telegraph! Whatever the explanation, these new data provide a wealth of information about relative prospects for pay for everyone.

Data
Public and Private Sector Earnings Office for National Statistics (March 2014)
Annual Survey of Hours and Earnings, 2013 Provisional Results Office for National Statistics (December 2013)

Articles
Austerity bites as private sector pay rises above the public sector for the first time since 2010 Independent, Ben Chu (10/3/14)
Public sector workers still better paid despite the cuts The Telegraph, John Bingham (10/3/14)
Public sector hourly pay outstrips private sector pay BBC News (10/3/14)
Public sector workers are biggest losers in UK’s post-recession earnings squeeze The Guardian, Larry Elliott (11/3/14)
New figures go against right-wing claims that public sector workers are grossly overpaid Independent, Ben Chu (10/3/14)
Public sector pay sees biggest shrink on 2010, figures suggest LocalGov, Thomas Bridge (11/3/14)
Public sector staff £2.12 an hour better off The Scotsman, David Maddox (11/3/14)

Questions

  1. Illustrate the way in which wages are determined in a perfectly competitive labour market.
  2. Why does monopsony power tend to push wages down?
  3. Why does working for a large company suggest that you will earn a higher wage on average?
  4. Using the concept of marginal revenue product of labour, explain the way in which higher skills help to push up wages.
  5. How significant are public-sector pay freezes in explaining the differential between public- and private-sector pay?
  6. Why is there a difference between the bottom and top 5% of earners? How does this impact on whether it is more profitable to work in the public or private sector?
Share in top social networks!

WhatsApp Doc?

Facebook has announced that it’s purchasing the messaging company WhatsApp. It is paying $19 billion in cash and shares, a sum that dwarfs other acquisitions of start-up companies in the app market. But what are the reasons for the acquisition and how will it affect users?

WhatsApp was founded less than five years ago and has seen massive growth and now has some 450 million active users, 70% of whom use it daily. This compares with Twitter’s 240 million users. An average of one million new users are signing up to WhatsApp each day. As the Wall Street Journal article, linked below, states:

Even by the get-big-fast standards of Silicon Valley, WhatsApp’s story is remarkable. The company, founded in 2009 by Ukrainian Jan Koum and American Brian Acton, reached 450 million users faster than any company in history, wrote Jim Goetz, a partner at investor Sequoia Capital.

Facebook had fewer than 150 million users after its fourth year, one third that of WhatsApp in the same time period.

Yet, despite its large user base, WhatsApp has just 55 employees, including 32 engineers.

For the user, WhatsApp offers a cheap service (free for the first year and just a 99¢ annual fee thereafter). There are no charges for sending or receiving text, pictures and videos. It operates on all mobile systems and carries no ads. It also offers privacy – once sent, messages are deleted from the company’s servers and are thus not available to government and other agencies trying to track people.

With 450 million current active users, this means that revenue next year will not be much in excess of $450 million. Thus it would seem that unless Facebook changes WhatsApp’s charging system or allows advertising (which it says it won’t) or sees massive further growth, there must have been reasons other than simple extra revenue for the acquisition.

Other possible reasons are investigated in the videos and articles below. One is to restrict competition which threatens Facebook’s own share of the messaging market: competition that has seen young people move away from Facebook, which they see is becoming more of a social media platform for families and all generations, not just for the young.

Videos and podcasts
Facebook pays billions for WhatsApp Messenger smartphone service Deutsche Welle, Manuel Özcerkes (19/2/14)
Facebook’s WhatsApp buy no bargain Reuters, Peter Thal Larsen (20/2/14)
Facebook Agrees To Buy WhatsApp For $19bn Sky News, Greg Milam (20/2/14)
Facebook Eliminates Competitor With WhatsApp Bloomberg TV, Om Malik, David Kirkpatrick and Paul Kedrosky (20/2/14)
Why WhatsApp Makes Perfect Sense for Facebook Bloomberg TV, Om Malik, David Kirkpatrick and Paul Kedrosky (20/2/14)
Facebook buying WhatsApp for $19bn BBC News, Mike Butcher (20/2/14)
Is Facebook’s acquisition of WhatsApp a desperate move? CNBC News, Rob Enderle (19/2/14)
Facebook’s $19bn WhatsApp deal ‘unjustifiable’ BBC Today Programme, Larry Magid (20/2/14)

Articles
Facebook to buy WhatsApp for $19 billion in deal shocker ReutersGerry Shih and Sarah McBride (20/2/14)
Facebook to Pay $19 Billion for WhatsApp Wall Street Journal, Reed Albergotti, Douglas MacMillan and Evelyn M. Rusli (19/2/14)
Facebook to buy WhatsApp for $19bn The Telegraph, Katherine Rushton (19/2/14)
Facebook buys WhatsApp: Mark Zuckerberg explains why The Telegraph (19/2/14)
WhatsApp deal: for Mark Zuckerberg $19bn is cheap to nullify the threat posed by messaging application The Telegraph, Katherine Rushton (20/2/14)
Why did Facebook buy WhatsApp? TechRadar, Matt Swider (20/2/14)
What is WhatsApp? What has Facebook got for $19bn? The Guardian, Alex Hern (20/2/14)
Facebook to buy messaging app WhatsApp for $19bn BBC News (20/2/14)
WhatsApp – is it worth it? BBC News, Rory Cellan-Jones (20/2/14)
Facebook buys WhatsApp: what the analysts say The Telegraph (19/2/14)
Facebook ‘dead and buried’ as teenagers switch to WhatsApp and Snapchat – because they don’t want mum and dad to see their embarrassing pictures Mail Online (27/12/13)
Facebook and WhatsApp: Getting the messages The Economist (22/2/14)

Questions

  1. Are Facebook and WhatsApp substitutes or complements, or neither?
  2. What does Facebook stand to gain from the acquisition of WhatsApp? Is the deal a largely defensive one for Facebook?
  3. Has Facebook paid too much for WhatsApp? What information would help you answer this question?
  4. Would it be a good idea for Facebook to build in the WhatsApp functionality into the main Facebook platform or would it be better to keep the two products separate by keeping WhatsApp as a self contained company?
  5. What effects will the acquisition have on competition in the social media and messaging market? Is this good for the user?
  6. Will the deal attract the attention of Federal competition regulators in the USA? If so, why; if not, why not?
  7. What are the implications for Google and Twitter?
  8. Find out and explain what happened to the Facebook share price after the acquisition was announced.
Share in top social networks!

Quiet Underground; Busy Overground

Getting around London is pretty easy to do. Transport, though often criticized, is very effective in and around London – at least when the Underground is running uninterrupted. However, since 9pm on Tuesday 4th February until the morning of 7th February, the underground will be operating well below full capacity, as strike action affects many workers.

Transport for London has plans to cut many jobs, in particular through the closure of ticket office at all stations. Modernisation to the network is said to be essential, not just to improve the existing system, but also as it is predicted to save £50 million per year. Data suggests that only 3% of transactions involve people using ticket offices and thus the argument is that having offices manned is a waste of money and these workers would be better allocated to manning stations. David Cameron said:

I unreservedly condemn this strike. There is absolutely no justification for a strike. We need a modernised tube line working for the millions of Londoners who use it every day.

Workers on London Underground are naturally concerned about the impact this will have, in particular on their jobs, despite assurances that there will be no compulsory redundancies.

The impact of these strikes on workers in London is clearly evident by any pictures you look at. Buses were over-crowded, despite more than 100 extra being provided, pavements were packed with pedestrians and the roads were full of cyclists. At least the strike action has led to a little more exercise for many people! The disruption to business in London is likely to be relatively large and the loss in revenue due to the action will also be high, estimated by Business leaders to be tens of millions of pounds. It is perhaps for this reason that there is discussion as to whether the underground should be declared an ‘essential service’ as a means of minimising future disruptions.

Discussions have been ongoing between both sides to try to prevent this action and talks are likely to continue in the future. Boris Johnson has declared the strikes as ‘completely pointless’ and both sides have argued that the other has been unwilling to negotiate and discuss the ticket office closures. Boris Johnson said:

A deal is there to be done. I am more than happy to talk to Bob Crow if he calls off the pointless and unnecessary strike.

The impact on London and the economy will only be fully known after the strike action is over, but there are plans for further strikes next week. The greater the disruption the bigger the calls for further strikes on key services, such as the tube, to be prevented. In particular, this may mean new powers to curtail the rights of unions in these types of areas, which will require a minimum service to be provided. The following articles consider the strike action on the London Underground.

Tube strike: London Underground disrupts commuters BBC News (5/2/14)
Boris Johnson apologises for ‘pointless’ tube strike delays The Telegraph (5/2/14)
London hit by travel chaos as Tube staff goes on strike Reuters, Julia Fioretti (5/2/14)
London Underground staff stage 48-hour strike Sky News (5/2/14)
Tube strike disrupts journeys for London commuters The Guardian, Gwyn Topham (5/2/14)
Tube strike 2014: Travel chaos as industrial action over ticket office closures hits underground services in London Independent, Rob Williams (5/2/14)
What’s the tube strike really about? BBC News, Tom Edwards (4/2/14)

Questions

  1. If there is strike action in a labour market, what can we conclude about the market in question in terms of how competitive it is?
  2. If only 3% of transactions take place via ticket offices, is it an efficient use of resources to maintain the presence of ticket offices at every station?
  3. Is industrial action ‘completely pointless’?
  4. What other solutions are there besides strike action to problems of industrial dispute?
  5. What is the role of ACAS in negotiations?
  6. What is the economic impact of the strike on the London Underground? Think about the impact on businesses, revenues, sales and both micro and macro consequences.
  7. Should the tube be seen as an essential service such that strike action by its workers would be restricted?
Share in top social networks!

A 50p top tax rate: more or less money for the government?

The UK Shadow Chancellor, Ed Balls, has announced that, if Labour is returned to power in the next election, it will bring back the 50% top rate of income tax (see also). This will apply to incomes over £150,000.

But will this raise more tax revenue? The question here concerns incentive effects. Will the higher rate of income tax discourage work by those earning £150,000 or encourage tax avoidance or tax evasion, so that the total tax take is reduced? The Conservatives say the answer is yes. The Labour party says no, claiming that there will still be an increase in tax revenue.

The possible effects are summed up in the Laffer curve (see The 50p income tax rate and the Laffer curve). As the previous post stated:

These arguments were put forward in the 1980s by Art Laffer, an adviser to President Reagan. His famous ‘Laffer curve’ (see Economics (8th edition) Box 10.3) illustrated that tax revenues are maximised at a particular tax rate. The idea behind the Laffer curve is very simple. At a tax rate of 0%, tax revenue will be zero – but so too at a rate of 100%, since no-one would work if they had to pay all their income in taxes. As the tax rate rises from 0%, so tax revenue would rise. And so too, as the tax rate falls from 100%, the tax rate would rise. It follows that there will be some tax rate between 0% and 100% that maximises tax revenue.

As Labour is claiming that re-introducing the 50% top rate of income tax will increase tax revenue, the implication is that the economy is to the left of the top of the Laffer curve: that, at current level of income, the curve is still rising.

Work by HMRC, and published in the document The Exchequer effect of the 50 per cent additional rate of income tax, suggested that the previous cut in the top rate from 50% to 45% would cut revenue by around £3.5 billion if there were no incentive effect, but with the extra work that would be generated, the cut would be a mere £100 million. This implies, other things being equal, that a rise in the rate from 45% to 50% would raise only a tiny bit of extra taxes.

However, the HMRC analysis has been criticised and especially its assumptions about the incentive effects on work. Then there is the question of whether a rise in the rate from 45% to 50% would have exactly the reverse effect of a cut from 50% to 45%. And then there is the question of how much HMRC could reduce tax evasion and avoidance.

The following article from the Institute for Fiscal Studies examines the effects. However, the authors conclude that:

… at the moment, the best evidence we have still suggests that raising the top rate of tax would raise little revenue and make, at best, a marginal contribution to reducing the budget deficit an incoming government would face after the next election.

But there is also the question of equity. Putting aside the question of how much revenue would be raised, is it fair to raise the top rate of tax for those on high incomes? Would it make an important contribution to reducing inequality? This normative question lies at the heart of the different views of the world between left and right and is not a question that can be answered by economic analysis.

50p tax – strolling across the summit of the Laffer curve? Institute for Fiscal Studies, Paul Johnson and David Phillips (Jan 2014)

Questions

  1. Distinguish between tax evasion and tax avoidance.
  2. How would it be possible for a rise in tax rates to generated less tax revenue?
  3. Could policies shift the Laffer curve as opposed to merely resulting in a move along the curve?
  4. What is meant by ‘taxable income elasticity (TIE)’? What are its determinants?
  5. Is the taxable income elasticity at the top of the Laffer curve equal to, above or below zero? Explain.
  6. Why did the Office for Budget Responsibility chairman, Robert Chote, conclude that, whatever the precise answer, we were ‘strolling across the summit of the Laffer curve’?
  7. Explain why ‘there is little additional evidence to suggest that a 50p rate would raise more than was estimated by HMRC back in 2012′.
  8. What contribution can economists make to the debate on the desirability of reducing inequality?
Share in top social networks!

Time to leave GDP behind?

GDP is still the most frequently used indicator of a country’s development. When governments target economic growth as a key goal, it is growth in GDP to which they are referring. And they often make the assumption that growth in GDP is a proxy for growth in well-being. But is it time to leave GDP behind as the main indicator of national economic success? This is the question posed in the first of the linked articles below, from the prestigious science journal Nature.

As the article states:

Robert F. Kennedy once said that a country’s gross domestic product (GDP) measures “everything except that which makes life worthwhile”. The metric was developed in the 1930s and 1940s amid the upheaval of the Great Depression and global war. Even before the United Nations began requiring countries to collect data to report national GDP, Simon Kuznets, the metric’s chief architect, had warned against equating its growth with well-being.

GDP measures mainly market transactions. It ignores social costs, environmental impacts and income inequality. If a business used GDP-style accounting, it would aim to maximize gross revenue — even at the expense of profitability, efficiency, sustainability or flexibility. That is hardly smart or sustainable (think Enron). Yet since the end of the Second World War, promoting GDP growth has remained the primary national policy goal in almost every country

So what could replace GDP, or be considered alongside GDP? Should we try to measure happiness? After all, behavioural scientists are getting much better at understanding and measuring the psychology of human well-being (see the blog posts Money can’t buy me love and Happiness economics).

Or should we focus primarily on long-term issues of the sustainability of development? Or should we focus more on the distribution of income or well-being in a world that is becoming increasingly unequal?

Or should measures of well-being involve weighted composite indices involving things such as life-expectancy, education, housing, democratic engagement, leisure time, social mobility, etc. And, if so, how should the weightings of the different indicators be determined? The United Nations Development Programme (UNDP) produces annual Human Development Reports, where countries are ranked according to a Human Development Index. As the UNDP site states:

The breakthrough for the HDI was the creation of a single statistic which was to serve as a frame of reference for both social and economic development. The HDI sets a minimum and a maximum for each dimension, called goalposts, and then shows where each country stands in relation to these goalposts, expressed as a value between 0 and 1.

HDI is a composite of three sets of indicators: education, life expectancy and income (see). The UNDP since 2010 has also produced an Inequality-adjusted HDI (IHDI).

The IHDI will be equal to the HDI value when there is no inequality, but falls below the HDI value as inequality rises. The difference between the HDI and the IHDI represents the ‘loss’ in potential human development due to inequality and can be expressed as a percentage.

You can now build your own HDI for each country on the UNDP site by selecting from the following indicators: health, education, income, inequality, poverty and gender.

The Nature article considers a number of measures of progress and considers their relative merits. The other articles also look at measuring national progress and well-being and at the relationship between income per head and happiness. It is clear that focusing on GDP alone provides too simplistic an approach to measuring development.

Development: Time to leave GDP behind Nature, Robert Costanza, Ida Kubiszewski, Enrico Giovannini, Hunter Lovins, Jacqueline McGlade, Kate E. Pickett, Kristín Vala Ragnarsdóttir, Debra Roberts, Roberto De Vogli and Richard Wilkinson (15/1/14)
The happiness agenda makes for miserable policy The Conversation, Daniel Sage (9/1/14)
Economic view: No matter what the politicians say, GDP is a distorted guide to economic performance and a bad way to measure prosperity Independent, Guy Hands (28/1/14)
Buy buy love The Economist (22/6/13)
Experts confirm that money does buy happiness – but only up to £22,100 Independent, Jamie Merrill (28/11/13)
Can Money Buy Happiness? Scientific American, Sonja Lyubomirsky (10/8/10)
Money can buy happiness The Economist (2/5/13)
Money can buy happiness Hacker News, pyduan (13/1/14)
Can ‘happiness economics’ provide a new framework for development? The Guardian, Christian Kroll (3/9/13)
The 10 Things Economics Can Tell Us About Happiness The Atlantic, Derek Thompson (31/5/12)
Financial crisis hits happiness levels BBC News (3/11/13)
Happiness study finds that UK is passing point of peak life satisfaction The Guardian, Larry Elliott (27/11/13)
How GDP became the figure everyone wanted to watch BBC News, Peter Day (16/4/14)
Economic development can only buy happiness up to a ‘sweet spot’ of $36,000 GDP per person Science Daily (27/11/13)

Questions

  1. What does GDP measure?
  2. How suitable a measure of economic progress is growth in GDP?
  3. How can GDP be adjusted to make it a more suitable measure of economic progress?
  4. What are the advantages of using composite indicators of well-being?
  5. What difficulties are there in measuring well-being using composite indicators?
  6. Assuming there were no measurement problems, what indicators would you include in devising the optimum composite indicator of well-being?
  7. Can money buy happiness?
  8. Why do life satisfaction levels peak at around $36,000 (adjusted for Purchasing Power Parity (PPP))?
Share in top social networks!