Author: Catherine Mitchell

Posted on

Health vs the economy: is there a trade off?

Throughout the pandemic, the fight against COVID-19 has often been framed in terms of striking a balance between the health of the public and the health of the economy. This leads to the assumption that a trade-off must exist between these two objectives. Countries, therefore, have to decide between lives and livelihoods. However, one year on since lockdowns swept the globe the evidence suggests that the trade-off between sacrificing lives and sacrificing the economy is not necessarily clear cut.

Controlling the virus

Restrictions such as social distancing and lockdowns were introduced in order to minimise the spread of the virus, prevent hospitals from being overwhelmed, and ultimately save lives. However, as these measures are put in place, schools were closed, businesses and factories stopped operating, and economic activity shrank. This would suggest therefore, that society inevitably faces a trade-off between lost lives versus lost livelihoods.

It could be argued, therefore, that in the short run these interventions create a ‘health–wealth trade-off’. The lockdown restrictions save lives by preventing transmission, but they came at the cost of lost output, income and therefore GDP. This would also imply that the trade-off works in reverse when the lockdown restrictions are eased. As measures are relaxed, the economy can begin to recover but at the cost of an increased threat of the virus spreading again.

What are the costs?

In order to work out if a trade-off exists and what costs are involved, there must be a monetary value placed on human life. While this may seem unethical, governments, civil courts, regulatory bodies and companies do it all the time. The very existence of the life insurance industry is testament to the fact that human lives can be measured in monetary terms. One approach to measuring valuing life, commonly used by economists who conduct cost-benefit analyses, is the ‘value of statistical life’. It measures the loss or gain that arises from changes in the incidence of death, by eliciting people’s willingness to pay for small reductions in the probability of death, or their willingness to accept compensation in exchange for tolerating a small increase in the chance of death. (see the blog Lockdown – again. Is it worth it?)

Take the example of a complete lockdown. The potential number of lives saved can be estimated based on infection and fatality rates estimated from epidemiological models. This can then be multiplied by value of statistical life to compute the monetary value of saved lives. If this number exceeds the economic costs of a complete lockdown, then we know that it is desirable.

The trade-off between lost lives versus the economy is often erroneously viewed as an all-or-nothing choice between complete lockdown versus zero restrictions. However, in reality, there is a continuum in stringency of restrictions and it is not an all-or-nothing comparison.

Death rates vs downturns

In order to explore the existence of this trade-off, we can compare the health and economic impacts of the pandemic in different countries. If such a trade-off exists, then countries with lower death rates should have experienced larger economic downturns. However, when comparing the COVID-19 death rates with GDP data, the result is the opposite: countries that have managed to protect their population’s health in the pandemic have generally also protected their economy too. This suggests that there was never a simple binary trade-off between the two factors. Those countries that experienced the biggest first wave of excess deaths, also had the biggest hits to the economy.

The UK was the hardest hit of similar countries on both measures within the G7 group of industrialised countries. The shape of the recession in the UK from the pandemic and lockdowns was extraordinary and historic. However, it was also unique as there was a very sharp fall followed by a rapid rebound. Over 2020, GDP saw the largest hit in three centuries; larger than any single year of the Great Wars or the 1920s Depression.

Studies of the declines in GDP contradict the idea of a trade-off, showing that countries that suffered the most severe economic downturns, such as Peru, Spain and the UK, were generally among the countries with the highest COVID-19 death rates. There are countries that have experienced the reverse too; Taiwan, South Korea, and Lithuania all experienced modest declines in economic output but have also managed to keep the death rate low.

It should also be noted that some countries that had similar falls in GDP experienced very different death rates from each other. When comparing the USA and Sweden with Denmark and Poland, they all saw similar declines in the economy with contractions of around 8–9%. However, the USA and Sweden recorded 5–10 times more deaths per million. This therefore suggests that there is no clear trade-off between the health of the population and the health of the economy.

There will be many different factors that impact on the death rate for each individual country and by how much the economy has been affected. Such factors will even go beyond the policy decisions that have been made throughout the pandemic about how best to suppress the transmission of the virus. However, from the data available, there is no clear evidence to suggest that a trade-off between the health and the economy exists. If anything, it suggests that the relationship works in the opposite direction.

Save the economy by saving lives

Given the arguments against the existence of the trade-off, it could be argued that in order to limit the economic damage caused by the pandemic, the focus needs to start and end with controlling the spread of the virus. Experiments that have been conducted across the world definitively show that no country can prevent the economic damage without first addressing the pandemic that causes it. Those countries that acted swiftly in implementing harsh measures to control the virus, are now reopening in stages and their economies are growing. Countries such as China, Australia, New Zealand, Iceland, and Singapore, which all invested primarily in swift coronavirus suppression, have effectively eliminated the virus and are seeing their economies begin to grow again.

China, in particular, stands out amongst this group of countries. The Chinese authorities acted very quickly, and firmly, but also the levels of compliance of the population have been very high. However, it could be argued that few countries possess the infrastructure that exists in China to facilitate such high compliance. The fact that the lockdown in China was so effective reduced both losses to the economy and the need for stimulus measures. China is also one of the few countries that have achieved a “V-shaped” recovery. Countries such as Korea, Norway and Finland also appear to have responded relatively well.

Most of the countries that prioritised supporting their economies and resisted, limited, or prematurely curtailed interventions to control the pandemic faced runaway rates of infection and further national lockdowns. The examples of the UK, the USA and Brazil are often quoted, with many arguing that these countries responded too late and too haphazardly. Both have experienced high numbers of deaths.

Conclusion

Discussions around the responses to the pandemic and what appropriate action should be taken have predominately been about how countries can strike the balance between protecting people’s health and protecting the economy. However, from observing the GDP data available there is no clear evidence of a definitive trade-off; rather the relationship between the health and economic impacts of the pandemic goes in the opposite direction. As well as saving lives, countries controlling the outbreak effectively may have adopted the best economic strategy too. It is important to recognise that many factors have affected the death rate and the impact on the economy, and the full impacts of the pandemic are yet to be seen. However, it is by no means clear that the trade-off between greater emphasis on sacrificing lives or sacrificing the economy is as real as has been suggested. If such a trade-off does exist, it is, at best, a weak one.

Articles

Questions

  1. Define and explain the difference between a substitute and complementary good.
  2. Using your answer to question 1, describe the existence of a trade-off.
  3. Discuss the reasons why the trade-off between health and the economy would work in the opposite direction.
Posted on

US tech giants and monopoly power

In recent years, US tech companies have faced increased scrutiny in Washington over their size and power. Despite the big tech firms in America being economically robust, seemingly more so than any other sector, they are also more politically vulnerable. This potential vulnerability is present regardless of the recent election result.

Both the Democrat and Republican parties are thinking critically about monopoly power and antitrust issues, where ‘antitrust’ refers to the outlawing or control of oligopolistic collusion. Despite the varied reasons across different parts of the political spectrum, the increased scrutiny over big tech companies is bipartisan.

Rising monopoly power

Monopoly power occurs when a firm has a dominant position in the market. A pure monopoly is when one firm has a 100% share of the market. A firm might be considered to have monopoly power with more than a 25% market share.

If there is a rise in market concentration, it tends to hurt blue-collar workers, such as those employed in factories, more than everyone else. Research, from the University of Chicago, studied what happens to particular classes of workers when companies increasingly dominate a market and have more power to raise prices. The study found that those workers that make things tend to be left worse off, while the workers who sell, market or design things gain. When companies have more pricing power, they make fewer products and sell each one for a higher profit margin. In that case, it’s far more valuable to a company to be an employee working in so-called expansionary positions, such as marketing, than in production jobs, such as working on a factory line — because there’s less production to be done and more salesmanship.

Monopoly power under Trump Vs Biden

In February, President Trump and his economic team saw no need to rewrite the federal government’s antitrust rules, drawing a battle line with the Democrats on an issue that has increasingly drawn the attention of economists, legal scholars and other academics. In their annual Economic Report of the President, Mr. Trump and his advisers effectively dismissed research that found large American companies increasingly dominate industries like telecommunications and tech, stifling competition and hurting consumers. At the time the Trump administration contended that studies demonstrating a rise in market concentration were flawed and that the rise of large companies may not be a bad thing for consumers.

On page 201, the report reads:

Concentration may be driven by economies of scale and scope that can lower costs for consumers. Also, successful firms tend to grow, and it is important that antitrust enforcement and competition policy not be used to punish firms for their competitive success.

The Trump administration approved some high-profile corporate mergers, such as the merger of Sprint and T-Mobile, while also trying to block others, such as AT&T’s purchase of Time Warner. Mr. Trump’s advisers stated that agencies already had the tools they needed to evaluate mergers and antitrust cases. It lamented that some Americans have come to hold the mistaken, simplistic view that ‘Big Is Bad.’

However, it is likely that such big firms, including the tech giants, would take a hit under the new presidency. President-Elect Joe Biden has pledged to undo the tax cuts introduced by Trump and has vowed to increase corporation tax from 21% to 28%. As part of these tax changes, he has suggested the introduction of a minimum 15% tax for all companies with a revenue of over $100 million. This has now been given the nickname of the ‘Amazon Tax’ and it is clear how it would impact on the big the firms such as Amazon.

This is the opposite of what was probable if Trump were to have been re-elected. It was expected that the US would continue along the path of deregulation and lower taxes for corporates and high-income households, which would have been welcomed by the stock market. However, analysts suggest that the tax changes under Biden would negatively affect the US tech sector, with some analysts maintaining that the banking sector would also be hit.

Antitrust enforcement is often associated with the political left, but the current situation is not so clear-cut. In the past, Silicon Valley has largely avoided any clashes with Washington, even when European regulators have levied fines against the tech giants. European regulators have fined Google a total of $9bn for anticompetitive practices. In 2018 Donald Trump attacked the EU decisions. “I told you so! The European Union just slapped a Five Billion Dollar fine on one of our great companies, Google,” Trump tweeted. “They truly have taken advantage of the US, but not for long!”

However, since then the mood has changed, with Trump and other conservatives joining liberals, including senators Elizabeth Warren and Bernie Sanders, in attacking the dominance of tech firms, including Amazon, Google, Facebook and others. While Democrats have largely stuck to criticising the scale of big tech’s dominance, Republicans, including Trump, have accused the major tech companies of censoring conservative speech.

An antitrust subcommittee of the Democrat-controlled House Judiciary Committee released a 449-page report excoriating the Big Four tech companies, Amazon, Facebook, Apple and Google-owner, Alphabet, for what it calls systematic and continuing abuses of their monopoly power. Recommendations from the report include ways to limit their power, force them out of certain areas of business and even a break-up of some of them.

Democratic lawmakers working on the probe claim that these firms have too much power, and that power must be reined in. But not all Republicans involved agreed with the recommendations. One Republican congressman, Jim Jordan, dismissed the report as “partisan” and said it advanced “radical proposals that would refashion antitrust law in the vision of the far left.” However, others have said they support many of the report’s conclusions about the firms’ anti-competitive tactics, but that remedies proposed by Democrats go too far.

The US tech giants


Amazon is a leading example of the economic strength held by the tech giants. Amazon has produced 12-month revenues of $321bn to October 2020, which in an increase from 2019 and 2018 revenues of $280bn and $233bn respectively. However, Amazon, along with the other big players Apple, Facebook, Google parent Alphabet, and Microsoft, are facing increased government scrutiny.

The US Department of Justice has filed a lawsuit against Google for entrenching itself as the dominant search engine through anti-competitive practices. Google’s complex algorithms, software, and custom-built servers helped make it into one of the world’s richest and most-powerful corporations. It currently dominates the online search market in the USA, accounting for around 80% of search queries. The lawsuit accuses the tech company of abusing its position to maintain an illegal monopoly over search and search advertising. Facebook also faces an antitrust lawsuit from the Federal Trade Commission. It is arguable that the US tech giants are so powerful that they may accomplish the seemingly impossible and unite the two parties, at least on one policy – breaking them up.

If it is correct that the tech giants’ behaviour ultimately damages innovation and exacerbates inequality, it is arguable that such problems have only grown worse with the coronavirus pandemic. Many smaller businesses have succumbed to the economic damage: many have been closed during lockdowns or suffered a decline in sales; many have gone out of business.

The changing patterns in teleworking and retail have accelerated in ways that have made Americans more reliant on technologies produced by a few firms. Shares in the Big Four, along with Microsoft, Netflix, and Tesla, added $291 billion in market value in just one day last week. It could therefore be claimed that the dangers of Big Tech domination are more profound now than they were even a few months ago.

Google’s lawsuit

On 20 October, the Department of Justice — along with eleven state Attorneys General — filed a civil antitrust lawsuit in the U.S. District Court for the District of Columbia to stop Google from unlawfully maintaining monopolies through anticompetitive and exclusionary practices in the search and search advertising markets and to remedy the competitive harms.

This is the most significant legal challenge to a major tech company in decades and comes as US authorities are increasingly critical of the business practices of the major tech companies. The suit alleges that Google is no longer a start-up company with an innovative way to search the emerging internet. Instead Google is being described as a “monopoly gatekeeper for the internet” that has used “pernicious” anticompetitive tactics to maintain and extend its monopolies.

The allegation that Google is unfairly acting as a gatekeeper to the internet is based on the argument that through a series of business agreements, Google has effectively locked out any competition. One of the specific arrangements being challenged is the issue of Google being preloaded on mobile devices. On mobile phones running its Android operating system, Google is preinstalled and cannot be deleted. The company pays billions each year to “secure default status for its general search engine and, in many cases, to specifically prohibit Google’s counterparties from dealing with Google’s competitors,” the suit states. It is argued that this alone forecloses competition for internet search as it denies its rivals to compete effectively and prevent potential innovation.

However, Google has defended its position, calling the lawsuit “deeply flawed”. It has argued that consumers themselves choose to use Google; they do not use it because they are forced to or because they can’t find an alternative search platform. Google also argues that this lawsuit will not be beneficial for consumers. It claims that this will artificially prop up lower-quality search alternatives, increase phone prices, and make it harder for people to get the search services they want to use.

Conclusion

Despite wanting to stop Google from “unlawfully maintaining monopolies in the markets for” search services, advertising, and general search text, the lack of consensus and divergence among the Democrats and Republicans on the antitrust issues remains a major issue to move things forward.

The Democrats want to see the power held by these companies reined in, while the Republicans would rather see targeted antitrust enforcement over onerous and burdensome regulation that kills industry innovation. It is clear that the US government will have to balance its reforms and ideas while making sure not to put the largest companies in the USA at a competitive disadvantage versus their competitors globally.

Articles

Questions

  1. With the aid of a diagram, explain how pricing decisions are made in a monopoly.
  2. What factors influence the degree of monopoly power a company has within an industry?
  3. What are the advantages of a monopoly?
  4. Why would a government want to prevent a monopoly? Discuss the policies a government could implement to do this.
Posted on

Supply and demand: the housing market

For the majority of people, a house (or flat) is the most valuable thing they will ever own.

It is important to understand the role that house prices play in the economy and how much of an impact they have.

The Bank of England monitors changes in the housing market to assess the risks to the financial system and the wider economy. The housing market employs large numbers of people in construction, sales, furniture and fittings, and accounts for a sizeable percentage of the value of GDP. The market is closely linked to consumer spending and therefore is a crucially important sector of the economy.

The concepts of supply and demand can be applied to understand house price changes and the impacts on the economy.

What is the housing market?

The housing market brings together different stakeholders, such as homeowners who are selling their properties, people seeking to buy a property, renters, investors who buy and sell properties solely for investment purposes, contractors, renovators and estate agents, who act as facilitators in the process of buying or selling a property.

In the UK, two-thirds of households own the property in which they live, and the remaining third of households are renters, split fairly equally between private and social renting. We can thus divide people into:

  • Homeowners – either outright owners or with a mortgage;
  • Private renters – people renting from private landlords;
  • Social renters – people renting from local authorities and housing associations.

There are many determinants of demand and supply in the housing market, many of which are related to demographic factors. Such factors include the size of the market, rate of marriages, divorces, and deaths. However, factors such as income, availability of credit, interest rates and consumer preferences are also important.

Why is the housing market important for the economy?

Changes in the housing market are always given such importance due to the relationship house prices have with consumer spending. Changes in house prices and the number of sales affect how much money people have to spend. Given that household spending accounts for two-thirds of Britain’s total economic activity, any changes in consumption is likely to have a major impact on the wider economy. Observing the housing market helps us to assess the overall demand for goods and services.

When house prices increase, those consumers who own their own homes have now become better off as their houses are worth more. This ‘wealth effect’ increases the confidence of homeowners, which in turn increases consumption. Some of these homeowners will decide to acquire additional borrowing against the value of their home. The borrowing is then spent in the economy on goods and services, thereby increasing aggregate demand and GDP.

However, when house prices decline, homeowners lose confidence as their home is now worth less than before. This becomes a major issue if prices have decreased enough to make their house worth less than the remainder of the unpaid mortgage – known as ‘negative equity’. Homeowners will therefore reduce their consumption and will be less likely to undertake any new borrowing.

The vast majority of homeowners will have taken out a mortgage in order to purchase their home. Mortgages are the largest source of debt for households in the UK. More than 70% of household borrowing is mortgage debt. Half of all homeowners who live in the house they own are still paying off their mortgage. Therefore, households might suddenly hold back on their spending during times of uncertainty because they start to worry about repaying their debts. This has a knock-on effect on the rest of economy, and a small problem can suddenly become a big one.

In addition to affecting overall household spending, the buying and selling of houses also affects the economy directly. Housing investment is a small but unpredictable part of total output in the economy. There are two different ways in which the buying and selling of houses impacts GDP.

The first is when a new build is purchased. This directly contributes to GDP through the investment in the land to build the house on, the purchase of materials and the creation of jobs. Once the homeowners move in they also contribute to the local economy: i.e. shopping at local shops.

The second is when an existing home is bought or sold. The purchase of an existing home does not have the same impact on GDP. However, it does still contribute to GDP: i.e. from estate agents’ and solicitors’ fees and removal costs to the purchase of new furniture.

Why house prices change: demand and supply

Demand: the demand for housing can be defined as the quantity of properties that homebuyers are willing and able to buy at a given price in a given time period. Factors affecting the demand for housing include:

  • Real incomes: If real incomes increase the demand for housing increases due to a rise in the standard of living.
  • The cost of a mortgage: If there is a rise in interest rates in the economy, mortgage interest rates are likely to rise too. This makes the cost of financing a loan more expensive and therefore will see a decline in demand.
  • Availability of credit: The more lending banks and building societies are willing to provide, the more people will borrow and spend on housing and hence the higher house prices will be.
  • Economic growth: When the economy is in the recovery and boom stages of the business cycle, wages rise. This will increase the demand for houses.
  • Population: When the population increases or if there is an increase in single-person households, demand for housing increases.
  • Employment/unemployment: The higher the level of unemployment in an economy, the less people will able to afford housing.
  • Confidence: If consumers feel optimistic about the future state of the economy, they will be more likely to go ahead with purchasing a house, thereby increasing demand. House prices tend to rise if people expect to be richer in the future.

Supply: The supply of housing can be defined as the flow of properties available at a given price in a given time period. The supply of housing includes both new-build homes and existing properties. Factors affecting the supply for housing include:

  • Costs of production: The higher the cost of production, the fewer houses are built, reducing the supply of housese coming to the market. Example of costs include: labour costs, land for development and building materials.
  • Government policy: If the government increases taxation and/or reduces subsidies for new house developments, there will be fewer new houses built.
  • Number of construction companies: Depending on their objectives, the more construction companies there are, the more likely there is to be an increase in the supply of housing. The construction industry accounts for around 7% of UK GDP.
  • Technology and innovation: With improved technology and innovation in the construction industry, houses become cheaper and easier to build, thus increasing the supply.
  • Government spending on building new social housing: The government has the ability to influence the supply of housing by increasing spending on new social housing.

Price elasticity of supply

The supply of new housing in the short run is price inelastic. The main reason for this is the time it takes to build a new home. The production of a house can take many months, from the planning process to the project’s completion. Supply also relies on access to a skilled labour force and the availability of certain construction materials.

Because of the inelastic supply, any changes in demand are likely to have a significant effect on price. This is illustrated by the diagram, which shows a larger proportionate increase in price than quantity when demand increases from D1 to D2.

The current UK housing market

Despite the current economic climate and the effects of the lockdown restrictions on consumers, house prices have increased, and sales have now resumed. Rightmove, which advertises 95% of homes for sale, states that the housing market has seen its busiest month in more than 10 years in July. During the summer, the housing market usually sees a lull in activity. However, since the easing of lockdown, there has been a flurry of activity from buyers and sellers. Since July 2019, house prices have increased by 1.7%, according to the Nationwide Building Society.

London estate agency, Hamptons, states that homeowners are now bringing forward their moving plans as the experience of lockdown has encouraged them to seek more space. The mortgage market is also very favourable right now in terms of interest rates, and rental demand is continuing to surge across the UK.

The increase in activity in the market has also been helped by the announcement of a stamp duty ‘holiday’ until March 2021. This sees the threshold above which stamp duty is paid rising from £125 000 to £500 000. Estate agency, Savills, has also seen an increase in the number of new buyers registering with its service, more than double the number registered in July 2019. It is thought that, along with the tax savings from stamp duty, people’s experiences in lockdown have made them evaluate their current living space and reconsider their housing needs.

However, given the that the economy is experiencing its deepest recession on record, there is concern about just how long the market can resist the economic forces pulling prices down.

Historically, a drop in house prices has been both a cause and a consequence of economic recessions. During the 2008 financial crisis, house prices fell by about 30%. As previously mentioned, for the majority of people, a house is the most valuable thing they will ever own and therefore consumers are extremely interested in its value. Consumer confidence is one of the key factors affecting the demand for housing. If consumers feel pessimistic about the future state of the economy, they will be less likely to go ahead with purchasing a house, thereby decreasing demand. Britain’s Office for Budget Responsibility, the country’s fiscal watchdog, forecasts that during this downturn prices will fall 5% this year and 11% in 2021.

Various government schemes put in place to help during lockdown are starting to come to an end. The main one – the furlough scheme, which replaced 80% of eligible workers’ incomes – comes to an end in October. It is forecast that labour market conditions will weaken significantly in the quarters ahead, with unemployment predicted to rise for the rest of the year. If these predictions materialise, it would likely dampen housing activity once again.

Conclusion

Fluctuations in house prices and transactions tend to amplify the volatility of the economic cycle. Therefore, it is crucial that we understand what influences such changes. Understanding how supply and demand factors influence the housing market can enable key stakeholders to make better predictions about future activity and plan accordingly. The current market has seen a growth since the easing of restrictions but there is concern that this has been powered by pent-up demand. Therefore, the outlook for house prices is uncertain and the full effects of an economic downturn are yet to be realised.

Articles

Questions

  1. Explain why the supply of housing is inelastic in the short-term.
  2. Given that the elasticity of housing supply in the UK is low, what policies could be introduced to ensure that house building is more responsive to changes in market demand?
  3. If unemployment does increase as predicted, explain what impact this would have on the demand in the housing market and house prices? Use a supply and demand diagram to aid your answer.
  4. Explain how changes in house prices affect the government’s key macroeconomic objectives.
Posted on

Should the post-Covid-19 recovery be a Green recovery?

Pre-Covid 19, the climate change movement had gathered momentum with climate activist Greta Thunberg regularly in the news and people around the world striking in protest of inadequate government action on the climate crisis. However, now in a world overtaken by the pandemic, climate change is no longer at the centre and appears a more distant threat. The majority of the large climate change events due to take place this year have been delayed and policy announcements are aimed at supporting the current economic hardships. This is not surprising nor debatable, but there is a risk that, as Covid-19 dominates the news, policy and debates for a long time to come, this will overshadow any environmental initiatives that were due to be implemented.

Governments around the globe are navigating their economies through the pandemic and starting to think about the future road to recovery. However, there is an argument that it doesn’t have to be a case of ‘either or’, as there is the potential for policies to address the Covid-19 crisis and climate change at the same time. How policy makers respond now could shape the fight against climate change for the future. One of the lessons from the pandemic is that quick responses to high impact risks are vital to reduce costs. With that in mind, and given the costs of climate change, it is arguable that now is the best time to address its challenges.

Climate change and Covid

It is estimated that there was a total global loss of $3tn caused by natural disasters over the past decade. By 2050, cumulative damages from climate change are predicted to reach $8 trillion, impoverishing the world as a whole by 3% of GDP and the poorest regions by more. Climate activists argue that despite the economic consequences of climate change, the action taken by governments has been insufficient. In 2015, the then Bank of England governor, Mark Carney warned: ‘Once climate change becomes a defining issue for financial stability, it may already be too late.’

However, since the pandemic struck all over the world, there have been positive consequences for the environment. Pollution levels started dropping fast as airlines grounded fleets, car travel came to a stop and industries shut down. With 2.6bn people living under restrictions under their country’s lockdown, there has also been an impact on the environment, not just the spread of the virus. Given that the lockdowns across the world have come at huge social and human costs, is now not the time to ensure that these improvements for the environment are not just temporary but ignite long-term changes?

Given the clear impacts and risks of Covid on peoples’ health, our ability to change our behaviour quickly has been striking. The importance of behaviour change has been brought to the centre and, arguably, it shows that we are capable of change when lives are at risk and are deemed more important than business-as-usual GDP growth. The application to climate change, however, is not as straightforward, as the costs to human lives are often viewed as a future problem.

Global cooperation

Dr Laure de Preux, Assistant Professor of Economics at Imperial College Business School, highlights the important role that cooperation across borders plays in the face of a global crisis like Coronavirus, and how that can be applied to the fight against climate change.

The big challenges the world is facing, including the climate change crisis, can only be dealt with efficiently through international cooperation. We cannot only act individually; the benefits of our actions are multiplied if integrated into a global strategy. In the case of COVID-19, social distancing measures can only be truly effective if they are adopted at a large scale.

World leaders are aware that their economies now face one of the most severe recessions in history as a consequence of the coronavirus restrictions. Governments are going to have to dedicate huge budgets to enable the economic activity to resume again. This presents a unique challenge, but also a massive opportunity for global cooperation. The question to be asked, therefore, is that if these stimulus packages are a one-off chance to transform the economy, how should the government spend it and what should be their focus? Should the recovery policies focus on creating a greener economy?

The European Union unveiled what it is calling the biggest ‘green’ stimulus package in history. Ursula von der Leyen, the European Commission president, told European Parliament members that this issue is about all nations and it is bigger than any one of them. The deputy Prime Minister of Spain, Teresa Ribera, states that there is a greater risk by not acting in this way. She argues that if the recovery is not green, then it will be nothing but a short-cut to solve the current problems rather than a true economic recovery.

It is not just in Europe where the recovery has an environment focus. Joe Biden is believed to be planning a similarly huge green stimulus package for the US. The model echoes the vast investment projects of the New Deal that helped lift America out of the Great Depression in the 1930s.

There are sound economic reasons why politicians see green technology as a prudent investment. Renewable energy is now often cheaper than fossil fuels in large parts of the world and the technologies are proven and can be built at scale today. The argument for renewables providing a pathway for clean future growth is based on the logic of much of manufacturing – the more you produce, the cheaper it gets. However, China does not appear to have similar plans for their recovery. China produces almost a third of the world’s emissions, as much as the USA and the EU combined. At the annual National People’s Congress, there was no indication that the big expansion of coal-fired electricity generation would be reversed, even though it is also expanding the production of renewable energy. China expanded its coal-fired power stations as a key part of its stimulus package after the 2008 financial crisis.

Policy decisions

The UK government receives ongoing pressure from energy companies. The boss of energy giant SSE, Alistair Phillips-Davies has warned that a failure to deal with climate change could eventually have a greater economic impact than coronavirus. SSE wants the UK government to encourage private investment in renewables by giving the green light to big new projects, such as hydrogen and carbon capture plants and boosting electric vehicles. Despite the impacts of climate change not being immediately felt in comparison to Covid-19, Phillips-Davies argues that a failure to deal with climate change could lead to great long-term impacts:

While it is still too early to predict with confidence the full human, social and economic impact of coronavirus, we can say with certainty that significant investment will be needed to rebuild the UK economy in its wake.

It is clear that any pandemic-induced financial decisions made over the next 12 months will shape the global economy for the next decade. The full impact of the virus on climate change will be determined by the world’s stimulus measures adopted post-pandemic. Following the 2008 financial crisis, the energy-intensive stimulus measures that followed, particularly in China, boosted emissions. Therefore, if we are to meet the reduction in emissions target our response needs to be green, helping to shape a sustainable future. Dr Alex Koberle, of the Grantham Institute at Imperial College London, argues that Governments should take time to reflect, learn from past mistakes and redirect development towards a sustainable future.

Shouldn’t growth be given priority?

With 1.6 billion people working in the informal economy worldwide reckoned to be in immediate danger of losing their livelihoods (according to the International Labour Organization), is now the right time to be focusing on the climate? Industries such as airlines and car manufacturing are strategic industries, employing millions of people. Headlines of longer-term environmental targets will be given less importance than headlines of job losses. Recovery relies on the government finding ways to employ lots and lots of people. There is a close relationship between real GDP, employment and energy consumption. Therefore, any policies aimed at reducing greenhouse gas emissions, unless carefully directed, could reduce economic growth and employment for both less and more developed economies. Such policies would increase the cost of conventional energy sharply.

Critics of a green energy policy for recovery argue that investing in renewable energy ignores the adverse effects of reduced investment and higher energy costs in other sectors. By governments prioritising policy to focus on the environment, they could harm the ability of most people to improve their own circumstances, especially given the terrible economic shock caused by the lockdowns.

Conclusion

With the majority of news in recent months providing little joy, there has been at least the positive impact on the environment. However, advocates say it not a cause for celebration and warn that any benefits are likely to be short lived. There have been some positive behavioural impacts but the true test will be what happens in the recovery phase. If the focus is returned to business as usual what happens to the targets actioned prior to Covid-19?

The immediate priority of all governments right now is to control the pandemic and to save lives. As their policy interventions have an impact and economies start to emerge from this crisis, then there is an important debate to be had about how new investments can help create a cleaner, greener recovery. We have learnt from the current pandemic that changes can be made when consequences are imminent, however, climate change is a threat that doesn’t go away, and is arguably just as urgent. Solutions to both crises can be integrated into a coherent response to propel the global economy towards sustainable growth and increased resilience.

Articles

Letter

Questions

  1. Are government attempts to reduce the impact of climate change beneficial or harmful to UK firms?
  2. What policy instruments can the government use to increase economic activity?
  3. How does an increase in investment affect aggregate demand?
  4. What are the costs and benefits of economic growth?
  5. Why can climate change be described as a market failure?
Posted on

Bank of England warns of the severe impact of Covid-19

At its meeting on 6 May, the Bank of England’s Monetary Policy Committee decided to keep Bank Rate at 0.1%. Due to the significant impact of COVID-19 and the measures put in place to try to contain the virus, the MPC voted unanimously to keep Bank Rate the same.

However, it decided not to launch a new stimulus programme, with the committee voting by a majority of 7-2 for the Bank to continue with the current programme of quantitative easing. This involves the purchase of £200 billion of government and sterling non-financial investment-grade corporate bonds, bringing the total stock of bonds held by the Bank to £645 billion.

The Bank forecast that the crisis will put the economy into its deepest recession in 300 years, with output plunging 30 per cent in the first half of the year.

Monetary policy and MPC

Monetary policy is the tool used by the UK’s central bank to influence how much money is in the economy and how much it costs to borrow. The Bank of England’s main monetary policy tools include setting the Bank Rate and quantitative easing (QE). Bank Rate is the interest rate charged to banks when they borrow money from the BoE. QE is the process of creating money digitally to buy corporate and government bonds.

The BoE’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target. Maintaining a low and stable inflation rate is good for the economy and it is the main monetary policy aim. However, the Bank also has to balance this target with the government’s other economic aims of sustaining growth and employment in the economy.

Actions taken by the MPC

It is challenging to respond to severe economic and financial disruption, with the UK economy looking unusually uncertain. Activity has fallen sharply since the beginning of the year and unemployment has risen markedly. The current rate of inflation, measured by the Consumer Price Index (CPI), declined to 1.5% in March and is likely to fall below 1% in the next few months. Household consumption has fallen by around 30% as consumer confidence has declined. Companies’ sales are expected to be around 45% lower than normal and business investment 50% lower.

In the current circumstances, and consistent with the MPC’s remit, monetary policy is aimed at supporting businesses and households through the crisis and limiting any lasting damage to the economy. The Bank has used both main monetary tools to fulfil its mandate and attempt to boost the economy amid the current lockdown. The Bank Rate was reduced to 0.1% in March, the lowest level in the Bank’s 325-year history and the current programme of QE was introduced in March.

What is next?

This extraordinary time has seen the outlook for the all global economies become uncertain. The long-term outcome will depend critically on the evolution of the pandemic, and how governments, households and businesses respond to it. The Bank of England has stated that businesses and households will need to borrow to get through this period and is encouraging banks and building societies to increase their lending. Britain’s banks are warned that if they try to stem losses by restricting lending, they will make the situation worse. The Bank believes that the banks are strong enough to keep lending, which will support the economy and limit losses to themselves.

In the short term, a bleak picture of the UK economy is suggested, with a halving in business investment, a near halving in business sales, a sharp rise in unemployment and households cutting their spending by a third. Despite its forecast that GDP could shrink by 14% for 2020, the Bank of England is forecasting a ‘V’ shaped recovery. In this scenario, the recovery in economic activity, once measures are softened, is predicted to be relatively rapid and inflation rises to around the 2 per cent target. However, this would be after a dip to 0.5% in 2021, before returning to the 2 per cent target the following year.

However, there are some suggestions that the Bank’s forecast for the long-term recovery is too optimistic. Yael Selfin, chief economist at KPMG UK, fears the UK economy could shrink even more sharply than the Bank of England has forecast.

Despite the stark numbers issued by the Bank of England today, additional pressure on the economy is likely. Some social distancing measures are likely to remain in place until we have a vaccine or an effective treatment for the virus, with people also remaining reluctant to socialise and spend. That means recovery is unlikely to start in earnest before sometime next year.

There are also additional factors that could dampen future productivity, such as the impact on supply chains, with ‘just-in-time’ operations potentially being a thing of the past.

There is also the ongoing issue of Brexit. This is a significant downside risk as the probability of a smooth transition to a comprehensive free-trade agreement with the EU in January is relatively small. This will only increase uncertainty for businesses along with the prospect of increased trade frictions next year.

Conclusion

The predictions from the Bank of England are based on many assumptions, one of which is that the economy will only be gradually released from lockdown. Its numbers contain the expectations that consumer and worker behaviour will change significantly, and continue for some time, with forms of voluntary social distancing. On the other hand, Mr Bailey expects the recovery to be much faster than seen with the financial crisis a decade ago. However, again this is based on the assumption that measures put in place from the public health side prevent a second wave of the virus.

It also assumes that the supply-side effects on the economy will be limited in the long run. Many economists disagree, arguing that the ‘scarring effects’ of the lockdown may be substantial. These include lower rates of investment, innovation and start ups and the deskilling effects on labour. They also include the businesses that have gone bankrupt and the dampening effect on consumer and business confidence. Finally, with a large increase in lending to tide firms over the crisis, many will face problems of debt, which will dampen investment.

The Bank of England does recognise these possible scarring effects. Specifically, it warns of the danger of a rise in equilibrium unemployment:

It is possible that the rise in unemployment could prove more persistent than embodied in the scenario, for example if companies are reluctant to hire until they are sure about the robustness of the recovery in demand. It is also possible that any rise in unemployment could lead to an increase in the long‑term equilibrium rate of unemployment. That might happen if the skills of the unemployed do not increase to the same extent as they would if they were working, for example, or even erode over time.

What is certain, however, is that the long-term picture will only become clearer when we start to come out of the crisis. Bailey implied that the Bank is taking a wait-and-see approach for now, waiting on the UK government to shed some light about easing of lockdown measures before taking any further action with regards to QE. The MPC will continue to monitor the situation closely and, consistent with its remit, stands ready to take further action as necessary to support the economy and ensure a sustained return of inflation to the 2% target. Paul Dales, chief UK economist at Capital Economics, suggested that the central bank is signalling that ‘more QE is coming, if not in June, then in August’.

Articles

Bank of England publication

Questions

  1. How could the BoE use monetary policy to boost the economy?
  2. Explain how changes in interest rates affect aggregate demand.
  3. Define and explain quantitative easing (QE).
  4. How might QE help to stimulate economic growth?
  5. How is the pursuit of QE likely to affect the price of government bonds? Explain.
  6. Evaluate the extent to which monetary policy is able to stimulate the economy and achieve price stability.