Author: John Sloman

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The benefits of having rich parents and studying economics

Research published by the Institute for Fiscal Studies shows that graduates from wealthier family backgrounds earn significantly more than those from poorer backgrounds. If you compare the 20% of graduates from the richest backgrounds with the remaining 80%, the average earnings gap in 2012/13, 10 years after graduation, was £8000 per year for men and £5300 for women. Even when you take graduates in similar degrees from similar universities, there is still a gap of around 10% between those from richer and those from poorer backgrounds.

The research also shows that in 2012/13, 10 years after graduation, the median earnings for economics graduates was the second highest of any subject (just behind graduates in medicine) and that at the 90th percentile economics graduates had the highest earnings (£93 900 for women and £121 400 for men) of any subject. In fact, graduates in economics were the only males at this percentile earning over £100 000. (Click here for a PowerPoint of the chart.) As the Press Release to the IFS working paper states:

For males, it is estimated that approximately 12% of economics graduates earned above £100 000 some ten years after graduation; by contrast, 6% of those studying medicine or law earned more than £100 000.

For females, it is estimated that approximately 9% of economics graduates earned above £100 000 some ten years after graduation; by contrast, just 1% of those studying medicine and 3% of those studying law did so.

For some subjects, graduates earned little more than non-graduates.

Those studying the creative arts had the lowest earnings, and indeed earned no more on average than non-graduates.

The research also shows that earnings vary substantially by gender and university. For those earning £8000 or more, the median earnings for male graduates 10 years after graduation was £30 000 (compared with £21 000 for non-graduates), whereas for women it was £27 000 (compared with £18 000 for non-graduates).

Earnings are substantially higher for graduates from some universities, such as Oxford, Cambridge and the LSE. “At the other end of the spectrum, there were some institutions (23 for men and 9 for women) where the median graduate earnings were less than those of the median non-graduate ten years on.” Differences in graduate earnings by university tend to compound the difference by students’ family background as those from poorer backgrounds disproportionately attend universities with lower average graduate earnings by discipline.

The following articles consider the findings and their implications for higher education policy

Articles

Graduates from wealthy backgrounds reap earnings benefits Times Higher Education, John Morgan (13/4/16)
Graduate Earnings Guided By Parents’ Wealth, Institute For Fiscal Studies Report Finds Huffington Post, George Bowden (13/4/16)
Graduates from poorer backgrounds earn less than richer peers on same course, major international study finds Independent. Oliver Wright (13/4/16)
Richer students have higher graduate income, study finds The Guardian (13/4/16)
Want a Higher Salary? It Helps If You’re a Man With Rich Parents Bloomberg, Robert Hutton (13/4/16)
Economics graduates are in the money Why Study Economics? Economics in Action blog (15/4/16)

IFS paper
What and where you study matter for graduate earnings – but so does parents’ income IFS Press Release (13/4/16)
How English domiciled graduate earnings vary with gender, institution attended, subject and socio-economic background IFS Working Paper W16/06, Jack Britton, Lorraine Dearden, Neil Shephard and Anna Vignoles (13/4/16)

Data

Free Online Statistics – Students & qualifiers Higher Education Statistics Agency (HESA)
Applications and acceptances for types of higher education course – 2015 UCAS
What do graduates do? Higher Education Careers Services Unit

Questions

  1. For what reasons are graduates from rich backgrounds likely to earn substantially more than graduates from poor backgrounds?
  2. Why are graduates in economics likely to earn more than graduates in other subjects, especially those in the top percentile of earners from any given subject?
  3. How might marginal productivity help to explain the differences in earnings of different graduates?
  4. What are meant by ‘soft skills’. Why may students from richer backgrounds have better soft skills in the context of (a) university admission and (b) getting a job on graduation?
  5. Why are female graduates likely to earn less than male graduates with the same class of degree in the same subject?
  6. What could be done by (a) universities and (b) the government to increase social mobility?
  7. Do you think that the findings of the research have implications for the way students’ study is funded? Explain.
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Avoiding taxes

Tax avoidance has been in the news since the publication of the Panama papers, which show the use of offshore tax havens by rich individuals and companies, partly for tax avoidance, partly for money laundering and other criminal activities – some by corrupt politicians and their associates – and partly to take advantage of lower regulation of financial dealing.

There are many tax havens around the world, including Switzerland, Hong Kong, British overseas territories (such as the British Virgin Islands, the Cayman Islands and Bermuda), Jersey, Singapore and certain US states (such as Arizona, Delaware, Nevada and Wyoming).

Here we focus on tax avoidance. This is the management of tax affairs by individuals or firms so as to avoid or minimise the payment of taxes. Tax avoidance is legal, unlike tax evasion, which is the practice of not declaring taxable income.

In a statement from the White House, directly after the publication of the Panama papers, President Obama spoke about the huge international scale of tax evasion and tax avoidance:

“A lot of it is legal, but that’s exactly the problem. It’s not that [people are] breaking the laws, it’s that the laws are so poorly designed that they allow people, if they’ve got enough lawyers and enough accountants, to wiggle out of responsibilities that ordinary citizens are having to abide by.

Here in the United States, there are loopholes that only wealthy individuals and powerful corporations have access to. They have access to offshore accounts, and they are gaming the system. Middle-class families are not in the same position to do this. In fact, a lot of these loopholes come at the expense of middle-class families, because that lost revenue has to be made up somewhere. Alternatively, it means that we’re not investing as much as we should in schools, in making college more affordable, in putting people back to work rebuilding our roads, our bridges, our infrastructure, creating more opportunities for our children.”

Tax avoidance, whether in tax havens, or through exploiting loopholes in the tax system may be legal. But is it fair?

Various principles of a tax system can be identified. These include:

• Horizontal equity People in the same situation should be treated equally. For example, people earning the same level of income and with the same personal circumstances (e.g. number and type of dependants, size of mortgage, etc.) should pay the same level of income tax.
• Vertical equity Taxes should be ‘fairly’ apportioned between rich and poor. The rich should pay proportionately more taxes than the poor.
• Equity between recipients of government services Under the ‘benefit principle’, it is argued that those who receive the most benefits from government expenditure ought to pay the most in taxes. For example, it can be argued that roads should be paid for from fuel tax.
• Difficulty of evasion and possibly of avoidance If it is desirable to have a given tax, people should not be able to escape paying.
• Non-distortion Taxes alter market signals: taxes on goods and services alter market prices; taxes on income alter wages. They should not do this in an undesirable direction.
• Convenience to the taxpayer Taxes should be certain and clearly understood by taxpayers so that they can calculate their tax liabilities. The method of payment should be straightforward.
• Convenience to the government Tax rates should be simple to adjust and as cheap to collect as possible.
• Minimal disincentive effects Taxes may discourage people from working longer or harder, from saving, from investing or from taking initiative. It is desirable that these disincentives should be kept to a minimum.

Of course, not all these requirements can be met at the same time. One of the most serious conflicts is between vertical equity and the need to keep disincentives to a minimum. The more steeply the rich are taxed, it is argued, the more serious are the disincentive effects on them likely to be (see the blog post from 2012, The 50p income tax rate and the Laffer curve). Another is between vertical equity and equity between recipients of services. Some of the people most in need of government support are the poorest and hence pay the least taxes.

The crucial question is what is regarded as ‘fair’. What is vertically equitable? According to the second article below, people’s preferred tax rates depend on how information is presented. If information is presented on how much tax is paid by the rich, people generally feel that the rich pay too much. If, however, information is presented on how much income people are left with after paying tax, people feel that the rich still have too much and ought to pay more tax.

The majority of people in the UK feel that tax avoidance, although legal, is morally wrong. According to the results of an HMRC survey in 2015, “the majority (63%) of respondents felt that the use of tax avoidance schemes was widespread. However, the majority (61%) also responded that it was never acceptable to use a tax avoidance scheme. The most frequent reason given as to why it was unacceptable was that ‘it is unfair on others who pay their taxes’.”

In making judgements about the fairness of tax, people generally have inaccurate knowledge about the distribution of income, believing that it is more equal than it really is, and about the progressiveness of the tax system, believing that it is more progressive than it really is. Despite this, they want post-tax income distribution to be more equal.

What is more, although people generally disapprove of tax avoidance, it is the system that allows the avoidance of taxes that they want changing. As long as it is possible to avoid taxes, such as giving gifts to children to avoid inheritance tax (as long as the gift is made more than seven years before the person’s death), most people see no reason why they should not do so themselves.

The following articles look at tax avoidance and people’s attitudes towards it. They are all drawn from The Conversation, “an independent source of news and views, sourced from the academic and research community and delivered direct to the public.”.

Articles

Explainer: what are ‘tax havens’? The Conversation, Tommaso Faccio (5/4/16)
When it comes to tax, how do we decide what’s fair? The Conversation, Stian Reimers (8/4/16)
Six things a tax haven expert learned from the Panama Papers The Conversation, Ronen Palan (6/4/16)

Documents
The Panama Papers The International Consortium of Investigative Journalists
Exploring public attitudes to tax avoidance in 2015: HM Revenue and Customs Research Report 401 HMRC, Preena Shah (February 2016)
2010 to 2015 government policy: tax evasion and avoidance HMRC/HM Treasury (8/5/15)

Questions

  1. Distinguish between tax avoidance and tax evasion.
  2. Give some examples of tax avoidance.
  3. Look through the various principles of a tax system and identify any conflicts.
  4. What problems are there in having a highly progressive tax system?
  5. What is a ‘shell company’? How can it be used to avoid and evade taxes?
  6. What are bearer shares and bonds? Why were they abolished in the UK in 2015?
  7. What legitimate reasons may there be for a company or individual using a tax haven?
  8. To what extent might increased transparency in tax affairs discourage individuals and companies from engaging in aggressive tax avoidance?
  9. What light does/can behavioural economics shed on people’s perceptions of fairness?
  10. How might the use of absolute amounts or percentages influence people’s thinking about the fairness of a tax system? What implications does this have for politicians in framing tax policy?
  11. In the principal–agent problem, where the principals are the tax authorities and the agents are taxpayers, why does asymmetric information arise and why is it a problem? How do the tax authorities seek to reduce this problem?
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Global warning

Project Syndicate is an organisation which produces articles on a range of economic, political and social topics written by eminent scholars, political and business leaders, policymakers and civic activists. It then makes these available to news media in more than 150 countries. Here we look at four such articles which assess the outlook for the European and global economies and even that of capitalism itself.

The general tone is one of pessimism. Despite unconventional monetary policies, such as quantitative easing (QE) and negative nominal interest rates, the global recovery is anaemic. As the Nouriel Roubini articles states:

Unconventional monetary policies – entrenched now for almost a decade – have themselves become conventional. And, in view of persistent lacklustre growth and deflation risk in most advanced economies, monetary policymakers will have to continue their lonely fight with a new set of ‘unconventional unconventional’ monetary policies.

Perhaps this will involve supplying additional money directly to consumers and/or business in a so-called ‘helicopter drop’ of money. Perhaps it will be supplying money directly to governments to finance infrastructure projects – a policy dubbed ‘people’s quantitative easing‘. Perhaps it will involve taxing the holding of cash by banks to encourage them to lend.

The Hans-Werner Sinn article looks at some of the consequences of the huge amount of money created through QE and continuing to be created in the eurozone. Although it has not boosted consumption and investment nearly as much as desired, it has caused bubbles in various asset markets. For example, the property market has soared in many countries:

Property markets in Austria, Germany, and Luxembourg have practically exploded throughout the crisis, as a result of banks chasing borrowers with offers of loans at near-zero interest rates, regardless of their creditworthiness.

The German property boom could be reined in with an appropriate jump in interest rates. But, given the ECB’s apparent determination to head in the opposite direction, the bubble will only grow. If it bursts, the effects could be dire for the euro.

The Jean Pisani-Ferry article widens the analysis of the eurozone’s problems. Like Roubini, he considers the possibility of a helicopter drop of money, which “would be functionally equivalent to a direct government transfer to households, financed by central banks’ permanent issuance of money”.

Without such drastic measures he sees consumer and business pessimism (see chart) undermining recovery and making the eurozone vulnerable to global shocks, such as further weakening in China. (Click here for a PowerPoint of the chart.)

Finally, Anatole Kaletsky takes a broad historical view. He starts by saying that “All over the world today, there is a sense of the end of an era, a deep foreboding about the disintegration of previously stable societies.” He argues that the era of ‘leaving things to the market’ is coming to an end. This was an era inspired by the monetarist and supply-side revolutions of the 1960s and 1970s that led to the privatisation and deregulation policies of Reagan, Thatcher and other world leaders.

But if the market cannot cope with the complexities of today’s world, neither can governments.

If the world is too complex and unpredictable for either markets or governments to achieve social objectives, then new systems of checks and balances must be designed so that political decision-making can constrain economic incentives and vice versa. If the world is characterized by ambiguity and unpredictability, then the economic theories of the pre-crisis period – rational expectations, efficient markets, and the neutrality of money – must be revised.

… It is obvious that new technology and the integration of billions of additional workers into global markets have created opportunities that should mean greater prosperity in the decades ahead than before the crisis. Yet ‘responsible’ politicians everywhere warn citizens about a ‘new normal’ of stagnant growth. No wonder voters are up in arms.

His solution has much in common with that of Roubini and Pisani-Ferry. “Money could be printed and distributed directly to citizens. Minimum wages could be raised to reduce inequality. Governments could invest much more in infrastructure and innovation at zero cost. Bank regulation could encourage lending, instead of restricting it.”

So will there be a new era of even more unconventional monetary policy and greater regulation that encourages rather than restricts investment? Read the articles and try answering the questions.

Articles

Unconventional Monetary Policy on Stilts Project Syndicate, Nouriel Roubini (1/4/16)
Europe’s Emerging Bubbles Project Syndicate, Hans-Werner Sinn (28/3/16)
Preparing for Europe’s Next Recession Project Syndicate, Jean Pisani-Ferry (31/3/16)
When Things Fall Apart Project Syndicate, Anatole Kaletsky (31/3/16)

Questions

  1. Explain how a ‘helicopter drop’ of money would work in practice.
  2. Why has growth in the eurozone been so anaemic since the recession of 2009/10?
  3. What is the relationship between tightening the regulations about capital and liquidity requirements of banks and bank lending?
  4. Explain the policies of the different eras identified by Anatole Kaletsky.
  5. Would it be fair to describe the proposals for more unconventional monetary policies as ‘Keynesian’?
  6. If quantitative easing was used to finance government infrastructure investment, what would be the effect on the public-sector deficit and debt?
  7. If the inflation of asset prices is a bubble, what could cause the bubble to burst and what would be the effect on the wider economy?
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Trade wars looming

According to the law of comparative advantage, trade can benefit all countries if they export goods which they can produce at lower opportunity costs than their trading partners. Trade enables all countries to consume beyond their production possibility frontier. What is more, trade can increase competition, which encourages firms to be more efficient.

That trade is beneficial has been generally accepted by governments around the world since the Second World War, with the General Agreement on Tariffs and Trade (GATT) and then the World Trade Organization (WTO) advocating the dismantling of trade barriers. Countries have participated in a series of trade ’rounds’, such as the Uruguay Round (1986–94) and most recently the Doha Round (2001–15). But since the financial crisis of 2008, there has been waning enthusiasm for freer trade and growing calls to protect strategic and/or vulnerable industries. To some extent this mirrors the growth in protection after the Great Depression of the early 1930s as countries sought to boost their own industries.

After some progress in the Doha round talks in Nairobi in December 2015, the talks effectively marked the end of a fourteen-year road for the round (see also). There was a failure to agree on a number of items and chances of resurrecting the talks seem slim.

The classic response to calls for protection is that it can lead to a trade war, with a net loss in global output as less efficient domestic industries are shielded from competition from lower-cost imports. Consumers lose from no longer having access to cheaper imported goods. Trade wars, it is argued, are a negative sum game. Any gains to one country are more than offset by losses elsewhere. In fact, it is likely that all countries will lose.

One argument for protection recognises the efficiency gains from free trade, but argues that current trade is distorted. For example, countries may subsidise the export of products in which they have a comparative disadvantage and dump them on the rest of the world. The WTO recognises this as a legitimate argument for tariffs, if they are used to offset the effect of the subsidies and make import prices more reflective of the cost of production.

But increasingly arguments go beyond this. Industries that are regarded as strategic to a country’s future, such as the steel industry or agriculture, are seen as warranting protection. With protection, investment may flow to such industries, making them more efficient and even gaining a comparative advantage at some point in the future.

Then there is the question of income distribution. Trade with poor countries may help to close the gap somewhat between rich and poor countries. The reason is that poor countries, with an abundance of labour, are likely to have a comparative advantage in labour-intensive products. The demand for exports of such products will help to drive up wages in such countries. However, income distribution within the rich countries may become less equal. Cheap imports from developing countries may depress the wages of unskilled or low-skilled workers in the rich countries.

Another argument concerns the devastation caused to communities by the closure of plants which are major employers. Workers made redundant may find it hard to find alternative employment, especially if their skills are specific to the plant that has closed. At least in the short term, it is argued that such industries warrant protection to allow time for alternative employers to be attracted into the area.

Arguments such as these are being used today in many countries as they struggle with slowing growth in China, a glut of global resources and overcapacity in certain industries.

The steel industry is a case in point. The announcement by Tata Steel that it intends to close the Port Talbot steel works has been met with consternation and calls for protection against subsidised Chinese steel imports. The USA already imposes tariffs of 256% on corrosion-resistant Chinese steel. The EU has proposed raising tariffs on Chinese steel to the full amount of the subsidy, but the UK has blocked this, not wishing to trigger a trade war with China. In the meantime, China has announced the imposition of a tariff of 46% on a particular type of hi-tech steel imported from the EU.

On the other side of the Atlantic, there have been growing protectionist calls from presidential front runners. Donald Trump and Ted Cruz on the Republican side, and Bernie Sanders and now Hilary Clinton on the Democratic side, are opposed to the trade agreement that President Obama has been seeking with the EU – the Transatlantic Trade and Investment Partnership (TTIP). Donald Trump has proposed imposing tariffs of 45% on all Chinese imports.

The following articles look at the growing calls for protection, especially against China, and at the arguments about what should be done to protect the UK and EU steel industry.

Articles

Defiant China slaps steel tariffs on Britain as trade war looms The Telegraph, Ambrose Evans-Pritchard (1/4/16)
China’s soaring steel exports may presage a trade war, The Economist (9/12/15)
Trade, at what price? The Economist (30/3/16)
Free trade in America: Open argument The Economist (2/4/16)
Can the British steel industry be saved? Financial Times (2/4/16)
Steel crisis: UK government plays down China tariff fears BBC News (2/4/16)
The dogmas destroying UK steel also inhibit future economic growth The Observer, WIll Hutton (3/4/16)
UK accused of leading efforts to block limits to Chinese steel dumping The Guardian, Frances Perraudin (1/4/16)
There’s always an excuse to justify suspending free trade – Tata is the latest The Telegraph, Allister Heath (1/4/16)
Can one of the world’s top economies live without making steel? Bloomberg, Thomas Biesheuvel (1/4/16)
Trade policy is no longer just for political nerds: it matters in the UK and US The Guardian, Larry Elliott (27/3/16)
Steel shrivels while Britain’s balance of payments crisis grows The Observer, WIlliam Keegan (3/4/16)
Trump’s tariff plan could boomerang, spark trade wars with China, Mexico Reuters, David Lawder and Roberta Rampton (24/3/16)
Analysis: A Trump trade war could cost the U.S. millions of jobs Daily Herald (Chicago), Jim Tankersley (3/4/16)

Questions

  1. What is meant by the ‘law of comparative advantage’? Does the law imply that countries will always gain from totally free trade?
  2. Demonstrate the gains for each of two countries which choose to trade with each other (see, for example, pages 711–3 in Economics, 9th edition).
  3. What is meant by ‘strategic trade theory’? How would such theory relate to the case of steel production in south Wales?
  4. What are the arguments for and against the EU imposing tariffs on Chinese steel imports equal to the subsidy given by the Chinese government?
  5. Is protectionism always a negative sum game? Explain.
  6. Assess the validity of various arguments for protection.
  7. Why did it prove impossible to complete the Doha round?
  8. What is meant by the ‘Transatlantic Trade and Investment Partnership (TTIP)’? Why is there so much opposition to it?
  9. Are bilateral trade deals, such as the TTIP, the best way of moving forward in reaping the gains from freer trade?
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A soft target for a tax

Back in October, we looked at the growing pressure in the UK for a sugar tax. The issue of childhood obesity was considered by the Parliamentary Health Select Committee and a sugar tax, either on sugar generally, or specifically on soft drinks, was one of the proposals being considered to tackle the problem. The committee studied a report by Public Health England, which stated that:

Research studies and impact data from countries that have already taken action suggest that price increases, such as by taxation, can influence purchasing of sugar sweetened drinks and other high sugar products at least in the short-term with the effect being larger at higher levels of taxation.

In his Budget on 16 March, the Chancellor announced that a tax would be imposed on manufacturers of soft drinks from April 2018. This will be at a rate of 18p per litre on drinks containing between 5g and 8g of sugar per 100ml, such as Dr Pepper, Fanta and Sprite, and 24p per litre for drinks with more than 8g per 100ml, such as Coca-Cola, Pepsi and Red Bull.

Whilst the tax has been welcomed by health campaigners, there are various questions about (a) how effective it is likely to be in reducing childhood obesity; (b) whether it will be enough or whether other measures will be needed; and (c) whether it is likely to raise the £520m in 2018/19, falling to £455m by 2020/21, as predicted by the Treasury: money the government will use for promoting school sport and breakfast clubs.

These questions are all linked. If demand for such drinks is relatively inelastic, the drinks manufacturers will find it easier to pass the tax on to consumers and the government will raise more revenue. However, it will be less effective in cutting sugar consumption and hence in tackling obesity. In other words, there is a trade off between raising revenue and cutting consumption.

This incidence of tax is not easy to predict. Part of the reason is that much of the market is a bilateral oligopoly, with giant drinks manufacturers selling to giant supermarket chains. In such circumstances, the degree to which the tax can be passed on depends on the bargaining strength and skill of both sides. Will the supermarkets be able to put pressure on the manufacturers to absorb the tax themselves and not pass it on in the wholesale price? Or will the demand be such, especially for major brands such as Coca-Cola, that the supermarkets will be willing to accept a higher price from the manufacturers and then pass it on to the consumer?

Then there is the question of the response of the manufacturers. How easy will it be for them to reformulate their drinks to reduce sugar content and yet still retain sales? For example, can they produce a product which tastes like a high sugar drink, but really contains a mix between sugar and artificial sweeteners – effectively a hybrid between a ‘normal’ and a low-cal version? How likely are they to reduce the size of cans, say from 330ml to 300ml, to avoid raising prices?

The success of the tax on soft drinks in cutting sugar consumption depends on whether it is backed up by other policies. The most obvious of these would be to impose a tax on sugar in other products, including cakes, biscuits, low-fat yoghurts, breakfast cereals and desserts, and also many savoury products, such as tinned soups, ready meals and sauces. But there are other policies too. The Public Health England report recommended a national programme to educate people on sugar in foods; reducing price promotions of sugary food and drink; removing confectionery or other sugary foods from end of aisles and till points in supermarkets; setting broader and deeper controls on advertising of high-sugar foods and drinks to children; and reducing the sugar content of the foods we buy through reformulation and portion size reduction.

Articles

Questions

  1. What determines the price elasticity of demand for sugary drinks in general (as opposed to one particular brand)?
  2. How are drinks manufacturers likely to respond to the sugar tax?
  3. How are price elasticity of demand and supply relevant in determining the incidence of the sugar tax between manufacturers and consumers? How is the degree of competition in the market relevant here?
  4. What is meant by a socially optimal allocation of resources?
  5. If the current consumption of sugary drinks is not socially optimal, what categories of market failure are responsible for this?
  6. Will a sugar tax fully tackle these market failures? Explain.
  7. Is a sugar tax progressive, regressive or proportional? Explain.
  8. Assess the argument that the tax on sugar in soft drinks may actually increase the amount that people consume.
  9. The sugar tax can be described as a ‘hypothecated tax’. What does this mean and is it a good idea?
  10. Compare the advantages and disadvantages of a tax on sugar in soft drinks with (a) banning soft drinks with more than a certain amount of sugar per 100ml; (b) a tax on sugar; (c) a tax on sugar in all foods and drinks.