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Posts Tagged ‘zero-sum game’

The negotiation game

Yanis Varoufakis, the new Greek finance minister, is also an economist and an expert in game theory and co-author of Game Theory: a critical text. He is now putting theory into practice.

He wishes to renegotiate the terms of Greece’s debt repayments. He argues not that some of the debt should be written off, but that the terms of the repayment are far too tough.

Greece’s problem, he argues, was wrongly seen as one of a lack of liquidity and hence the Troika (of the EU, the ECB and the IMF) provided a large amount of loans to enable Greece to keep servicing its debts. These loans were conditional on Greece following austerity policies of higher taxes and reduced government expenditure. But this just compounded the problem as seen by Yanis Varoufakis. With a shrinking economy, it has been even more difficult to repay the loans granted by the Troika.

The problem, he argues, is essentially one of insolvency. The solution is to renegotiate the terms of the debt to make it possible to pay. This means reducing the size of the budget surplus that Greece is required to achieve. The Troika is currently demanding a surplus equal to 3% of GDP in 2015 and 4.5% of GDP in 2016.

The Syriza government is also seeking to link repayments to economic growth, by the issue of growth-linked bonds, whose interest rate depends on the rate of economic growth, with a zero rate if there is no growth in real GDP. He is also seeking emergency humanitarian aid

At the centre of the negotiations is a high stake game. On the one hand, Germany and other countries do not want to reduce Greece’s debts or soften their terms. The fear is that this could unleash demands from other highly indebted countries in the eurozone, such as Spain, Portugal and Ireland. Already, Podemos, Spain’s anti-austerity party is rapidly gaining support in Spain. On the other hand, the new Greek government cannot back down in its fundamental demands for easing the terms of its debt repayments.

And the threats on both sides are powerful. The Troika could demand that the original terms are met. If they are not, and Greece defaults, there could be capital flight from Greece (even more than now) and Greece could be forced from the euro. The Greeks would suffer from further falls in income, which would now be denominated in a weak drachma, high inflation and financial chaos. But that could unleash a wave of speculation against other weaker eurozone members and cause a break-up of the currency union. This could seriously harm all members and have large-scale repercussions for the global economy.

So neither side wants Greece to leave the euro. But is it a game of chicken, where if neither side backs down, ‘Grexit’ (Greek exit from the euro) will be the result? Yanis Varoufakis understands the dimensions of the ‘game’ very well. He is well aware of the quote from Keynes, ‘If you owe your bank a hundred pounds, you have a problem. But if you owe a million, it has.’ He will no doubt bring all his gaming skills to play in attempting to reach the best deal for Greece.

Greece’s last minute offer to Brussels changes absolutely nothing The Telegraph, Ambrose Evans-Pritchard (10/2/15)
The next card Yanis Varoufakis will play The Conversation, Partha Gangopadhyay (8/2/15)
Senior European official: ‘The Greeks are digging their own graves’ Business Insider, Mike Bird (10/2/15)
Greece: The Tie That Doesn’t Bind New York Times, Paul Krugman (9/2/15)
Greek finance minister says euro will collapse if Greece exits Reuters, Gavin Jones (8/2/15)
Greece is playing to lose the debt crisis poker game The Guardian, Project Syndicate and Anatole Kaletsky (9/2/15)
Greek markets find sliver of hope Financial Times, Elaine Moore, Kerin Hope and Daniel Dombey (10/2/15)
Greece: What are the options for its future? BBC News, Jamie Robertson (12/2/15)
‘If I weren’t scared, I’d be awfully dangerous’ The Guardian, Helena Smith (13/2/15)
Greek debt crisis: German MPs back bailout extension BBC News (27/2/15)

Questions

  1. Is a deal over the terms of repayment of Greek debt a zero sum game? Explain whether it is or not.
  2. What are Keynes Bisque bonds (or GDP-indexed bonds)? Do a Web search to find out whether they have been used and what their potential advantages and disadvantages are. Are they a good solution for both creditors and Greece in the current situation?
  3. What is meant by a ‘debt swap’? What forms can debt swaps take?
  4. Has Greece played its best cards too early?
  5. Should Greece insist on debt reduction and simply negotiate around the size and terms of that reduction?
  6. Are Greece’s new structural reform proposals likely to find favour with other EU countries and the Troika?
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An end to Greek austerity?

After Syriza’s dramatic victory in the Greek election, it is now seeking to pursue its manifesto promises of renegotiating the terms of Greece’s bailout and bringing an end to austerity policies.

The bailout of €240bn largely involved debt restructuring to give Greeks more time to pay. A ‘haircut’ (reduction) on privately held bonds, estimated to be somewhere between €50bn and €110bn, was more than offset by an increase of €130bn in loans granted by official creditors.

The terms of the bailout negotiated with the ‘Troika’ of the EU Commission, the ECB and the IMF, had forced the previous Greek government to make substantial fiscal adjustments. These have included large-scale cuts in government expenditure (including public-sector wages), increases in taxes, charges and fares, and selling state assets through an extensive programme of privatisation.

Although Greece is now regarded as having achieved a structural budget surplus (a surplus when the economy is operating at potential output: i.e. with a zero output gap), the austerity policies and a decline in inward investment have dampened the economy so much that, until last year, the actual budget deficit and public-sector debt continued to rise as tax revenues plummeted.

Since 2007, GDP has fallen by nearly 27% and the unemployment rate is around 26%. The fall in GDP has made the achievement of a reduction in the debt/GDP ratio that much harder. General government debt has risen from 103% of GDP in 2007 to 176% in 2014, and the budget deficit, although having peaked at 12.2% of GDP in 2013, has only been brought down through huge cuts.

As a report to the European Parliament from the Economic Governance Support Unit argues on page 27:

With less front-loaded fiscal adjustment, the EU-IMF financing envelope for Greece would have needed to expand, in what is already the largest financial assistance programme in percent of GDP in recent global history. On the other hand, a less rapid fiscal adjustment may have helped to preserve some of the productive capacity that, in the course of the adjustment, was destroyed.

The new government, although pledging not to default on debt, is insistent on renegotiating the debt and wants to achieve a high level of rescheduling and debt forgiveness. As the new Prime Minister, Alexis Tsipras, says:

On existing loans, we demand repayment terms that do not cause recession and do not push the people to more despair and poverty. We are not asking for new loans; we cannot keep adding debt to the mountain.

But, just as the Greek government is insistent on renegotiating its debt, so the German government and others in the EU are insisting that Greece sticks to the terms of the bailout and carries on with its current programme of debt reduction. Another haircut, they maintain, is out of the question.

We must wait to see how the negotiations play out. We are in the realms of game theory with various possible threats and promises on either side. It will be interesting to how these threats and promises are deployed.

New Leader in Greece Now Faces Creditors New York Times, Liz Alderman (26/1/15)
Syriza’s historic win puts Greece on collision course with Europe The Guardian, Ian Traynor and Helena Smith (26/1/15)
Greece Q&A: what now for Syriza and EU austerity? The Guardian, Phillip Inman (26/1/15)
Greek elections: Syriza gives eurozone economic headache BBC News, Prof Dimitri Mardas (26/1/15)
How a Syriza government would approach the eurozone The Telegraph, Andrew Lilico (19/1/15)
Australian economists urge Greek debt forgiveness as Syriza election win looks likely ABC News, Michael Janda (26/1/15)
Will Syriza win rock the global economy? CBS News, Nick Barnets (26/1/15)
Syriza should ignore calls to be responsible Irish Times. Paul Krugman (27/1/15)
Syriza Victory in Greek Election Roils European Debate Over Austerity Wall Street Journal, Marcus Walker (25/1/14)
Greece markets hit by debt default fears BBC News (28/1/15)
Why Europe Will Cave to Greece Bloomberg, Clive Crook (29/1/15)
Greece and the euro: Take the money and run The Economist, Buttonwood (28/1/15)
Tanking markets send dire warning to Greece’s new government Fortune, Geoffrey Smith (28/1/15)
The biggest debt write-offs in the history of the world The Telegraph, Mehreen Khan (2/2/15)

Questions

  1. Why has Greek debt continued to rise despite extremely tight fiscal policy?
  2. How is the structural deficit defined? What difficulties arise in trying to measure its size?
  3. Would there have been any way of substantially reducing the Greek budget deficit without driving Greece into a deep recession?
  4. What are the arguments for and against cancelling a large proportion of Greek debt? Is there a moral hazard involved here?
  5. Will the recently announced ECB quantitative easing programme help to reduce Greece’s debt?
  6. Are negotiations about debt forgiveness a zero sum game? Explain.
  7. What are the likely impacts of the Syriza victory on the global economy?
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How does the design of a penalty shoot-out influence the success of the teams involved?

The round robin group stage of the World Cup was recently completed with 16 out of the 32 countries eliminated from the competition – including England, Italy and Spain. The remaining 16 countries progressed to the single game elimination section of the tournament. At the time of writing, the first round of elimination games had been completed with the remaining 8 teams proceeding to the quarter finals of the tournament. Two of these 8 elimination games ended as a draw after extra time. The winner was decided by a penalty shoot-out e.g. Brazil and Costa Rica. Are these shoot-outs just a lottery or are there any factors that significantly influence their outcome?

The penalty shoot-out was first introduced in June 1970 and has become an important part of competitions such as the World Cup and European Championships for national teams and The Champions League, UEFA Cup and FA Cup for club teams. English fans have suffered more than most with victory in only one out of the seven penalty-shoot outs they have been involved in at major tournaments. On average only three out of every five penalties taken were scored. Germany has a very different record. They have won six out of the seven shoot-outs they have participated in and have a scoring rate of 93%. The Czech Republic has an even better record as their players have not missed a single penalty in the three shoot-outs they have been involved in – including beating West Germany in 1976.

Each individual penalty can be thought of as an example of an interdependent or game theoretic situation. The penalty taker (PT) has to choose from one of three different strategies: shoot to the right, shoot to the left or shoot down the middle. The success of the penalty does not just depend on which of these strategies is chosen. It also depends on the choice made by the goalkeeper (GK) i.e. dive to the left, dive to the right or stay where they are.

In the jargon of game theory there is strategic interdependence. It can also be thought of as an example of a simultaneous game. After the ball is struck it takes approximately 0.3 seconds until it hits the back of the net!! Therefore it is impossible for the GK to observe the shot and respond. Instead they simply have to guess which way they think the PT will kick the ball and respond accordingly. The same reasoning applies to the PT. They cannot observe which way the keeper will dive before they strike the ball. A penalty shoot-out is also an example of a zero sum game. If one teams scores they are better off by one goal while the other team is worse off by one goal.

There is also a sequential element to the shoot- outs as in each round one team always follows another. Is there either a first or second mover advantage? Is there any advantage from always shooting first or second? This was a question investigated by some economists who analysed the data from 129 shoot-outs in ten different tournaments taken between June 1970 and June 2003. This cut-off was chosen because up until this point it could be argued that a penalty shoot-out was an example of a truly randomized field experiment. The team that won the coin toss was required to shoot first. Teams were not given a choice of whether to shoot first or second until the rules were amended in June 2003.

The economists found that the teams who took the first shot won in 78 (60.5%) cases while the team that shot second won in only 51 cases (39.5%). This evidence suggests that there is a significant first mover advantage. One explanation for this finding is that there is greater psychological pressure on the PTs who go second in each round of the shoot-off and this has a significantly negative effect on their performance. The researchers also found that in 19 of the 20 shoot-outs they observed after June 2003 the team that won the toss decided to kick first. They concluded that not only is there a first mover advantage, but that teams/players are aware of it.

If there is currently a first mover advantage which provides teams with an unfair advantage then is there anything that the football authorities could do to help reduce the bias? One suggestion is to change the order in which the teams shoot in each round. A similar approach could be taken to that used in tennis in order to determine the order of the server in a tie break.

Imagine a penalty shoot-out between England and Germany. The sequence below provides one possible alternative to the current structure of the contest.

Penalty 1: Germany England
Penalty 2: England Germany
Penalty 3: England Germany
Penalty 4: Germany England
Penalty 5: England Germany
Penalty 6: Germany England

This would involve increasing the number of penalties from 5 to 6 so that both teams get to shoot first in three rounds of the contest. Interestingly the authors also found any first mover advantages fell dramatically if the shoot-outs reached the sudden death stage.

It will be interesting to see if first mover advantages occur in the remaining games in the tournament.

The English Disease – How to handle pressure: lessons from penalty shoot-outs The Economist (14/6/14)
Penalty kick shootouts and the importance of shooting first Soccermetrics Research (3/1/11)
Game Theory Lesson: Man Utd v Chelsea Penalty Shootout Econfix (11/3/14)
World Cup Game Theory – What economics tells us about penalty kicks Slate (24/6/06)
Football penalty shoot-outs are unfair says new research LSE (16/12/10).

Questions

  1. Explain the difference between a sequential and simultaneous game.
  2. Explain how either the penalty taker or goal keeper might attempt to transform the penalty from a simultaneous to a sequential game. (Hint: watch the next time the Brazilian footballer, Neymar, takes a penalty!!!
  3. Give some examples of potential first or second mover advantages in other industries.
  4. What other factors might influence the outcome of a penalty shoot? Is it possible for researchers to obtain any data in order to control for any of the factors you have identified?
  5. Explain the difference between a zero sum game and a non-zero sum game. Give some real world examples of a non-zero sum game.
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Doves from above

With many countries struggling to recover from the depression of the past few years, central banks are considering more and more doveish moves to kick-start lending. But with short-term interest rates in the USA, the UK and Japan close to zero, the scope for further cuts are limited. So what can central banks do?

The first thing that can be done is to adopt a higher inflation target or to accept inflation above target – at least for the time being. This could be accompanied by explicitly targeting GDP growth (real or nominal) or unemployment (see the blog from last December, Rethinking central bank targets).

The second option is to increase quantitative easing. Although in a minority at the last MPC meeting, Mervyn King, the current Bank of England Governor, argued for a further £25 billion of asset purchases (bringing the total to £400bn) (see MPC minutes paragraph 39). It is highly likely that the MPC will agree to further QE at its next meeting in March. In Japan, the new governor of the Bank of Japan is expected to include asset purchases as part of the policy of monetary easing.

The third option is for the central bank to provide finance at below-market rates of interest directly to the banking sector specifically for lending: e.g. to small businesses or for house purchase. The Bank of England’s Funding for Lending Scheme is an example and the Bank is considering extending it to other financial institutions.

One other approach, mooted by the Bank of England’s Deputy Governor before the House of Commons Treasury Select Committee, is for negative interest rates paid on Banks’ reserves in the Bank of England. This would, in effect, be a fee levied on banks for keeping money on deposit. The idea would be to encourage banks to lend the money and not to keep excessive liquidity. As you can see from the chart, three rounds of quantitative easing have led to a huge increase in bank’s reserves at the Bank of England. (Click here for a PowerPoint of the chart.)

The following articles consider these various proposals and whether they will work to stimulate lending and thereby aggregate demand and economic recovery.

Central banks: Brave new words The Economist (23/2/13)
Phoney currency wars The Economist (16/2/13)
Analysis: Global central banks will keep taking it easy Reuters, Alan Wheatley (22/2/13)
Quantitative easing: the markets are struggling with a serious drug habi The Guardian, Larry Elliott (24/2/13)
Negative interest rates idea floated by Bank’s Paul Tucker BBC News (26/2/13)
Bank of England mulls negative interest rates Independent, Ben Chu (26/2/13)
BoE floats extending Funding for Lending to non-banks Mortgage Solutions, Adam Williams (26/2/13)
Funding for Lending Scheme failing to get banks lending Left Foot Forward, James Bloodworth (26/2/13)
Mortgage market boosted by lending schemes, says Redrow BBC News (26/2/13)
Widespread quantitative easing risks ‘QE wars’ and stagnation The Guardian, Nouriel Roubini (28/2/13)

Questions

  1. Consider each of the methods outlined above and their chances of success in stimulating aggregate demand.
  2. Go through each of the methods and consider the problems they are likely to create/have created.
  3. How important is it that monetary policy measures affect people’s expectations?
  4. What effects do the measures have on the distribution of income between borrowers and savers?
  5. What are annuities? How are these affected by policies of monetary easing?
  6. How has actual and anticipated Japanese monetary policy affected the exchange rate of the Japanese yen? How is this likely to affect the Japanese economy?
  7. Explain the sub-heading of the final article above, “When several major central banks pursue QE at the same time, it becomes a zero-sum game”. Do you agree?
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Backing to the edge of the fiscal cliff

At the start of 2013, the USA faces a ‘fiscal cliff’. By this is meant that, without agreement by Congress on new fiscal measures, the USA will be forced into tax rises and expenditure cuts of around $650 billion (over 4% of GDP). This would probably push the economy straight back into recession. This in turn would have a serious dampening effect on the global economy.

But why would fiscal policy be automatically tightened? The first reason is that tax cuts given under the George W. Bush administration during 2001–3 (largely to the rich) are due to expire. Also a temporary cut in payroll taxes and an increase in tax credits given by President Obama are also due to end. These tax increases would form the bulk of the tightening. The average US household would pay an extra $3500 in taxes, reducing after-tax income by around 6%.

The second reason is that various government expenditure programmes are scheduled to be reduced. These reductions in expenditure amount to around $110 billion.

It is likely, however, that Congress will agree to delay or limit the tax increases or expenditure cuts; politicians on both sides want to avoid sending the economy back into recession. But what the agreement will be is not at all clear at this stage.

Republicans are taking a tougher line than Democrats on cutting the budget deficit; they are calling for considerably less restraint in implementing the government expenditure cuts. On the other hand, they are likely to be less willing to raise taxes.

But unless something is done, the consequences for 2013 could be dire. The fiscal cliff edge rapidly approaches.

Articles
Nearly 90 percent of Americans would see taxes rise if ‘fiscal cliff’ hits Washington Post, Lori Montgomery (1/10/12)
Fiscal cliff a serious threat, but unlikely CNN Money, Chris Isidore (1/10/12)
“Fiscal cliff” fears may impede faster job growth Chicago Tribute, Lucia Mutikani (1/10/12)
Avert Fiscal Cliff With Entitlement Cuts, Tax Increases Bloomberg (2/10/12)
‘Fiscal cliff’ to hit 90% of US families Financial Times, James Politi (1/10/12)
Investors don’t want the US to fall off the fiscal cliff The Telegraph, Tom Stevenson (22/9/12)
Gauging the fiscal cliff BBC News, Stephanie Flanders (27/9/12)
The US fiscal cliff – and the fiscal chasm BBC News, Stephanie Flanders (2/10/12)
US fiscal cliff threat fails to galvanise policymakers Guardian Economics blog, Mohamed el-Erian (1/10/12)
Multiplying Europe’s fiscal suicide (technical) The Telegraph, Ambrose Evans-Pritchard (1/10/12)
Q&A: The US fiscal cliff BBC News (7/11/12)
US election: Four more years… of what? BBC News, Stephanie Flanders (7/11/12)

Background
United States fiscal cliff Wikipedia

Questions

  1. Explain what is meant by the ‘fiscal cliff’ and what is its magnitude.
  2. What would be the multiplier implications of the USA ‘falling off the cliff’ both for the USA and for the rest of the world?
  3. What factors determine the size of the government expenditure and tax multipliers? What would be the problems of (a) underestimating and (b) overestimating the size of these multipliers?
  4. How can a fiscal stimulus be reconciled with a policy of reducing the size of the budget deficit as a proportion of GDP over the longer term?
  5. In what ways can the actions of Democrats and Republicans be seen as game playing? What are the possible payoffs and risks to both sides?
  6. Is relying on export growth to bring the world economy out of recession a zero sum game?
  7. Explain which is likely to be more effective in stimulating short- and medium-term economic growth in the USA: fiscal policy or monetary policy.
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A broadcast on game theory

John Von Neumann was a mathematician and one of his many accolades was applying mathematics and his observations of traditional games to create a new discipline – Game Theory. This involves a mathematical approach to decision making whereby different strategies can be assessed. It a tool that not only can be used in Economics, but also can be applied to a broad range of areas and fields of study.

Just as I arrived at work, I was listening to Radio 4 and heard the introduction to the programme In our Time. This one in particular caught my attention because of the name mentioned – Von Neumann, and after arriving in my office I then listened to the discussions surrounding game theory.

The main link is to the discussion from BBC Radio 4, led by Melvyn Bragg, with guests: Ian Stewart, a Professor of Mathematics from the University of Warwick; Andrew Colman, a Professor of Psychology at the University of Leicester and Richard Bradley, a Professor of Philosophy from the LSE. I’ll keep it brief and simply say enjoy!

Podcast
Game Theory (also at) BBC Radio 4, In our Time, Melvyn Bragg (10/5/12) (Programme details)

Articles
Game Theory cannot predict broadcasting future Financial Times, Andrew Edgecliffe-Johnson (4/5/12)
Game Theory, in the real world Phys Org (2/5/12)

Questions

  1. What is game theory? How is mathematics relevant here?
  2. The discussion talks about co-operative and non co-operative games. What is the difference between them?
  3. In the game – walking down the street – draw out the matrix and show whether a Nash equilibrium exists.
  4. Draw out the matrix for the game ‘Rock, Paper, Scissors’. How can game theory be applied to this game? What is the best strategy to win this game? Can there be a winner?
  5. Draw out the matrix for the problem of littering when it is non co-operative. Is there a Nash equilibrium?
  6. What is the Prisoner’s Dilemma? Give some examples of it. Explain why it is an example of a dominant strategy game.
  7. How is game theory relevant to broadcasting? Think about the role of auctions and also the information given in the Financial Times article.
  8. Explain how game theory is relevant to the Cold War.
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Do trade wars loom?

With countries around the globe struggling to recover from recession, many seem to believe that the answer lies in a growth in exports. But how can this be achieved? A simple solution is to lower the exchange rate.

Under a pegged exchange rate, the currency could be devalued. Alternatively, if the country’s inflation is lower than that of other countries, merely leaving the exchange rate pegged at its current level will bring about a real devaluation (in purchasing-power parity terms).

Under a floating exchange rate, one answer would be to lower interest rates. This would involve open market operations to support the lower rate and that would increase the money supply. But with central banks’ interest rates at virtually zero, it is not possible to lower them further. In such circumstances a solution would be a deliberate policy of increasing the money supply through “quantitative easing”. For example, the USA is considering a second round of quantitative easing (known as “QE2″). This would tend to push down the exchange rate of the dollar.

But stimulating exports through devaluation or depreciation is a zero-sum game globally. If currency A depreciates against currency B, currency B necessarily appreciates against currency A. Country A’s gain in exports to Country B are an increase in imports for Country B. It is logically impossible for every currency in the world to depreciate! Yet depreciation is exactly the policy being pursued by countries such as Japan, South Korea and Taiwan, all of which have directly intervened in the currency markets to lower their exchange rates. And, in each case of course, other countries’ currencies have an equivalent appreciation against them.

Economists and politicians in the USA argue that the dollar is fundamentally over valued against the Chinese yuan (or ‘renminbi’ as it is sometimes called). They are calling on China to revalue by far more than the 2% increase since June 2010. But what if China refuses to do so? On 29 September the House of Representatives passed a bill giving the executive branch the authority to impose a wide range of tariffs on imports from China. The bill was passed with a huge majority of 348 to 79.

So is this the start of a trade war? Many in the USA argue that China is already waging such a war by giving subsidies to a wide range of exports. And that war is hotting up. China has just announced that it is imposing traiffs ranging from 50% to 104% on various poultry imports from the USA. And if it is a trade war, will there be any winners? The following articles investigate.

Global recovery’s weakness raises possibility of trade war Guardian, Larry Elliott (4/10/10)
Tension mounts as China and US trade insults over currency Independent, Stephen Foley (1/10/10)
Is the world in a trade war? Time Magazine blogs: The Curious Capitalist, Michael Schuman (29/9/10)
Trade War Is Here – and We’ve Disarmed The Huffington Post, Robert Kuttner (3/10/10)
US House Passes Anti-China Trade War Bill GlobalResearch.ca, Barry Grey (1/10/10)
Currencies the key to market’s next move BBC News, Jamie Robertson (3/10/10)
A Message for China New York Times (30/9/10)
Taking On China New York Times, Paul Krugman (30/9/10)
Krugman Makes Two Powerful Arguments Against “Taking on China” Wall Street Pit, Scott Sumner (2/10/10)
Why the U.S. can’t win a trade war with China The Globe and Mail (Canada), Carl Mortished (4/10/10)
China-Japan trade war looms CTV News (Canada), Mark MacKinnon (23/9/10)
IMF chief’s warning of currency war ‘real threat’ BBC News, interview with Dominique Strauss-Khan, head of the IMF (7/10/10)
Could disputes over currency levels lead to a depression? BBC World Service, interview with Robert Zoellick (8/10/10)
China stands firm over yuan move BBC News, Andrew Walker (9/10/10)
What to do about China’s currency? Washington Post (10/10/10)
How to stop a currency war The Economist (14/10/10)
What’s the currency war about? BBC News, Laurence Knight (23/10/10)
Nominally cheap or really dear? The Economist (4/11/10)

Questions

  1. Why are competitive devaluations globally a zero sum game while global trade wars are a negative sum game?
  2. What are the arguments for and against using tariffs as a means of stimulating recovery?
  3. Why has quantitative easing so far had a more discernible effect on asset prices than on the real economy?
  4. Do a search on “Smoot-Hawley Tariff Act” of 1930 and describe its impact on the global economy in the 1930s. Are there any parallels today?
  5. How is it possible for massive trade surpluses and deficits to persist and yet for individual countries’ exchange rates and overall balance of payments to be in equilibrium?
  6. Are global trade imbalances widening, and if so why?
  7. What would determine the size of the effect on the US balance of trade of an appreciation of the yuan?
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The poverty of riches

The happiness literature has established that, in the developed countries, increasing affluence has not increased well-being in recent decades. We seek an explanation for this in terms of conspicuous consumption, a phenomenon originally identified by Veblen.

This is from the abstract of an article in the Economic Journal, ‘Well-being and Affluence in the Presence of a Veblen Good’ by B. Curtis Eaton and Mukesh Eswaran. The authors argue that while increased affluence of the rich may bring a small amount of extra benefit to them, it actually reduces the well-being of others who crave after things that they cannot afford. As the first article below states:

[The authors] believe their work shows that as a nation becomes wealthier, consumption shifts increasingly to buying status symbols with no intrinsic value – such as lavish jewellery, designer clothes and luxury cars. But they warn: “These goods represent a ‘zero-sum game’ for society: they satisfy the owners, making them appear wealthy, but everyone else is left feeling worse off.”

… There is another downside. As people yearn for more status symbols they have less time or inclination for helping others. This, the authors argue, damages “community and trust”, which are vital to an economy because they ensure the smooth running of society.

But do the super wealthy generate more jobs and more prosperity? Do we need to pay vast salaries and bonuses as incentives for executives to take risks: to invest in new products and processes, and drive technological advance and productivity increases? According to the second article, ‘Too few of the world’s billionaires can claim to be honest-to-God productive entrepreneurs who have enlarged the economic pie by dint of hard work, imagination, risk taking and innovation – although thankfully a useful proportion do populate the list.’

So is the ever widening gap between rich and poor necessary if the economy is to grow? Or is it something of very little value to society, except, perhaps, for the super rich themselves?

Articles
More money makes society miserable, warns report The Observer, Jamie Doward (14/3/10)
Don’t celebrate these billionaires, be horrified by their existence The Observer, Will Hutton (14/3/10)

Data
For the latest Guardian survey of executive pay, see: Executive pay survey, 2009
For data on UK incomes and income distribution, see: Annual Survey of Hours and Earnings (ASHE) Office for National Statistics
For data on the distribution of wealth in the UK, see Distribution of Personal Wealth HM Revenue and Customs

Questions

  1. Explain what is meant by a ‘Veblen good’.
  2. What is meant by the diminishing marginal utility of income? What implications does this have for the effects of income distribution and redistribution on social well-being?
  3. Why may a rise in GDP make society worse off if it is accompanied by growing inequality?
  4. To what extent can marginal productivity theory explain the salaries and other rewards of the wealthy?
  5. Using the data below, examine the extent to which the gap between rich and poor is growing.
  6. Explain why increasing conspicuous consumption by the wealthy might be a zero-sum game for society or even a negative-sum game.
  7. What factors cause a rise in productivity?
  8. How might greater entrepreneurship be encouraged in the UK?
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