For many goods and services, economists argue that relatively unregulated markets often do a pretty good job in delivering desirable outcomes from society’s view point.
However, for these desirable outcomes to occur, certain conditions need to be present. One of these is that all the benefits and costs of consuming and producing the good/service must be experienced/incurred by the buyers and sellers directly involved in the transaction: i.e. there are no externalities. The market can still work effectively if people outside of the transaction are affected (i.e. third parties) but the impact occurs through the price mechanism.
The fast fashion industry
Fast fashion refers to designs and trends that rapidly pass from catwalks and designers to retailers. The clothes sell for low prices and in high quantities. The business model relies on regular purchases and impulse buying. It is particularly popular in the UK where annual clothing consumption per capita is significantly greater than in other European countries – 26.7kg vs 16.7kg in Germany and 14.5kg in Italy. On average, people in the UK have 115 items of clothing. Unsurprisingly, 30 per cent of these garments have not been worn for at least 12 months.
Externalities in fast fashion
There is lots of evidence that the fast fashion market fails to meet the condition of no externalities. Instead, it generates lots of external costs across its whole supply chain that do not affect third parties through the price mechanism. For example:
- Growing cotton requires large amounts of water. Some estimates suggest that on average it takes 10 000 litres of water to cultivate just one kilogram of cotton. As water is a common resource (rival and non-excludable), its use in cotton production can exceed socially desirable levels. This can have serious consequences for both the quantity of drinking and ground water and can lead to previously fertile land being transformed into arid regions that are too dry to support vegetation.
- Growing cotton also uses large amounts of pesticide. Some estimates suggest that 6 per cent of global pesticide production is applied to cotton crops. Extended contact with these chemicals can cause illness and infertility. It also has a negative impact on the long-term productivity of the soil. For example, the chemicals destroy microorganisms, plants and insects and so decrease biodiversity.
- The manufacture of synthetic fibres such as polyester has a smaller negative impact on the use of water and land than the cultivation of a natural fibre such as cotton. However, because it is derived from oil, its manufacture generates more CO2 emissions. One study compared the CO2 emissions from producing the same shirt using polyester and cotton. The former generated 5.5kg whereas the latter produced 2.1kg.
- The waste water from the use of solvents, bleaches and synthetic dyes in the manufacture of textiles/garments often flows untreated into local rivers and water systems. This is especially the case in developing countries. Estimates suggest that this is responsible for between 17 and 20 per cent of industrial global water pollution.
- There are excessive levels of textile waste. This can be split into producer waste and consumer waste. Producer waste consists of 10–15 per cent of the fabric used in the manufacture of garments that ends up on the cutting room floor. It also includes deadstock – unsold and returned garments. For example, Burberry admitted that in 2017 it incinerated £28.6 million of unsold stock. In the same year, UK consumers disposed of 530 000 tonnes of unwanted clothing, shoes, bags and belts. This all went for landfill and incineration.
- Textiles are one of the major sources of microplastic pollution and contribute 35 per cent (190 000 tonnes) of microplastic pollution in the oceans. A 6kg domestic wash can release as many as 700 000 synthetic fibres.
Addressing the externalities
The House of Commons Environmental Audit Committee published a report on the fashion industry in February 2019. One of its key recommendations was that the tax system should be reformed so that it rewards fashion companies that design products with lower environmental impacts.
The UK government has tended to focus on the use of plastic rather than textiles. For example, it introduced a charge for single use carrier bags as well as banning the use of microbeads in rinse-off personal products and plastic straws/stirrers.
In April 2022, a new tax is being introduced in the UK on the plastic packaging of finished goods that is either manufactured in the UK or imported from abroad. The rate, set at £200 per metric tonne, will apply to packaging that contains less than 30 per cent of recycled plastic.
One specific proposal made by the Environmental Audit Committee was for the government to consider extending this new tax to textiles that contain less than 50 per cent recycled polyester. A recent study found that just under 50 per cent of clothes for sale on leading online websites were made entirely from new plastics.
The committee also called for the introduction of an extended producer responsibility scheme. This would make textile businesses responsible for the environmental impact of their products: i.e. they would have to contribute towards the cost of collecting, moving, recycling and disposing of their garments. It could involve the payment of an up-front fee, the size of which would depend on the environmental impact of the product.
In its Waste Prevention Programme for England published in March 2021, the government announced plans to consult with stakeholders about the possibility of introducing an ‘extended producer responsibility scheme’ in the textile industry. The House of Commons Environmental Audit Committee is also carrying out a follow-up inquiry to its 2019 report.
Articles
Government and Parliament documents and reports
Questions
- Using the concepts of rivalry and excludability, define the concept of a common resource.
- Explain the ‘tragedy of the commons’ and how it might apply to the use of water in the cultivation of cotton.
- Draw a diagram to illustrate how negative externalities in consumption and production lead to inefficient levels of output in an unregulated competitive market.
- Using a diagram, explain how imposing a tax on producers of textile products that contain less than 50 per cent recycled polyester could reduce economic inefficiency.
- Explain the potential limitations of using taxation/regulation to address the pollution issues created by the fast fashion sector.
Many of you may have heard of nudge – the idea that governments can help people make better decisions by carefully designing the way a policy is structured and presented. Have you heard of sludge?
The most widely cited example of a nudge is changing a default option. The default option is what happens if you do nothing. For example, when you start a new job, are you automatically enrolled into the pension scheme or do you have to do something (i.e. fill-in an on-line form) to opt-in to the scheme. Changing the default option to one of being automatically enrolled in a scheme seems to have a big impact on the choices people make.
Recently, policy makers have started referring to ‘sludge’. Sludge is the opposite of nudge: i.e. characteristics about design and presentation that make it more difficult for people to make good decisions. Some businesses may use sludge to encourage consumers to spend more on their goods than they ever intended.
One interesting application of sludge is in the design of websites – referred to as Dark Patterns. The following are a number of different categories of dark pattern:
The last example, Forced Continuity, refers to the use of free trial periods and automatic renewal of contracts. Many people sign up for a free trial or special offer with the full intention of cancelling before the account automatically switches to the standard price.
How often do people simply forget or never quite get around to cancelling these deals when the time comes? Some recent evidence comes from a YouGov Survey. Forty-seven percent of respondents to this survey reported having accidently signed up for an annual subscription because they either forgot or were unable to cancel their account. The estimated total cost of unwanted subscriptions per year was £837 million. The same YouGov survey found that one in eight people kept paying for over four months before finally getting around to cancelling.
One business has recently seen an opportunity to help people deal with this problem. Free Trial Surfing is a new App developed by the company, Do Not Pay. It became available via Apple’s App store in September but is not yet compatible with Android devices. It works in the following way.
When customers download the app, they receive a new credit card number and a false name. Although Do Not Pay register the card details to their own business, the customer can use the information to sign up for a free trial of a good or service. In effect, Do Not Pay acts as an intermediary between the firm offering the promotion and the user. Once the free trial period ends, the app automatically cancels the subscription. Importantly, the new credit card details only work when someone signs up for a free trial. Consumers cannot use it to purchase any other products. Obviously one major drawback to the app is that a consumer would have to sign up again with their own personal credit card if they wanted to continue to use the service after the free trial ends. Businesses may also try to block the use of Do Not Pay credit card numbers for their services.
It will be interesting to see if other businesses come up with interesting ways of helping us to deal with sludge.
Articles
Questions
- Give three different examples of nudges.
- What policies do government typically use to change peoples’ behaviour? How do these traditional approaches differ from nudge?
- Identify some biases from behavioural economics that might help to explain why so many people fail to cancel subscriptions once a free trial period ends.
- Choose two other types of dark pattern and explain how they might prevent people from making decisions that maximise their own welfare.
When making a decision, what happens if you do nothing: i.e. take no action? The answer is the default option. There is evidence that changing the default option for the same decision can sometimes have a big impact on the final choices people make. For example, when a person starts a new job, they often have to decide whether to contribute to the company’s pension scheme. The default option is typically for employees not to contribute. They have to do something actively (e.g. fill in an online form) to opt in to the scheme. An alternative is to change the default option so that employees are contributing to the pension. They now have to do something to opt out of the scheme.
Changing the default should have no impact on people who behave in ways that are consistent with the rational choice model in economics. However, research by Madrian and Shea (2001) found that it had a big effect. When employees had to opt-in, 49 per cent enrolled in a company pension. When they had to opt out, the figure increased to 86 per cent.
Other research suggests that defaults can influence the likelihood of getting a flu jab, making healthier food choices, receiving e-mail marketing and choosing certain types of car insurance.
Organ donation
One policy area where the choice of default has become a topical issue is organ donation. In 2017, over 400 people died in the UK because it was impossible to find an appropriate donor. Could changing the default increase the number of donors?
The scheme that operates in England requires people to sign-up to the organ donor register: i.e. they have to opt in. Although 80 per cent of the public support organ donation less than 50 per cent ever get around to signing this register.
Parliament recently approved the Organ Donation Bill and the new law will come into effect in 2020. The default position will change so that people are automatically signed-up for organ donation. If they do not want to donate their organs, they will have to opt out of the register.
In December 2015, the devolved Welsh government introduced a similar scheme. Although it is quite early to give a full assessment of the policy, its impact has been smaller than many people had hoped.
Why have the initial results been disappointing? One potential downside with an opt-out scheme is that it may create greater uncertainty about someone’s true wishes. With an opt-in scheme, a relative takes a deliberate action to indicate their preference to be an organ donor. In England, approximately 10 per cent of families overrule the wishes of a relative who has actively signed the register.
With an opt-out scheme, family members may worry that their relative did not want to donate their organs but never found the time to take their name off the register. In 2017/18, families in Wales overruled the presumed consent of their relatives in 33 per cent of cases.
Some countries, such as Singapore and Austria, operate a ‘hard opt-out’ policy. In these schemes, families cannot overrule and this leads to high organ donor rates. However, this type of policy is unpopular with large sections of the electorate who feel it is over paternalistic.
Forcing people to make a choice
Is it possible to force people to make a choice and so reveal their preferences to others? This is a policy of active choice. For example, the government could make the issuing of a driving licence conditional on a people making a choice about whether or not to sign the organ donor register.
This type of policy has been trialled in the USA with the take up of home delivered prescriptions. For the majority of people, there are clear advantages of choosing to have home delivered prescriptions rather than visiting a pharmacy – it is both cheaper and involves less time/hassle. However, the default option is to visit a pharmacy and one study found that only 6 per cent of people chose home delivered options. With the introduction of active choice, this figure increased to 42 per cent.
Some have argued that it is socially undesirable to force people to make a choice. An alternative is simplified active choice – people can either make a choice or accept the default option.
Articles
Questions
- Explain why changing the default option should have no impact on people who behave in ways that are consistent with the rational choice model in economics.
- What is present bias? How does it differ from simple impatience? Explain how present bias might help to explain the impact of changing the default option.
- What is loss aversion? How does it differ from diminishing marginal utility? Explain how loss aversion might help to explain the impact of changing the default option.
- What are some of the limitations of using defaults in policy-making?
- Is active choice less paternalistic than changing the default option?
- Think of some reasons why someone may not want to make a choice.
On 21st February 2019, the Department for International Trade (DIT) published a document outlining the UK’s progress in negotiating new free trade agreements (FTAs) with a number of non-EU countries. It advises UK firms that FTAs with Turkey and Japan will not be finalised before the official exit day from the European Union – 29th March 2019. Many business groups expressed concern at this news.
The EU has successfully negotiated a number of FTAs. These deals enable all 28 states in the European Union Custom Union (EU-CU), including the UK, to trade at preferential (i.e. lower) tariffs with over 70 non-EU countries. These include Canada, South Korea, Mexico, Israel, Norway, South Africa and Turkey. Research by the CBI estimates that UK exports to these countries were approximately £41bn in 2017 – approximately 13 per cent of all UK exports. In July 2018, the EU signed its largest ever FTA – with Japan. This deal covers 635 million people.
If the UK leaves the European Union without a deal on the 29th March, then it immediately loses membership of the EU-CU. Preferential tariffs will no longer apply to trade between the UK and the non-EU countries which signed the FTAs. Without any new arrangements in place, tariffs and quotas will revert to the non-preferential (i.e. higher) rates outlined in registered schedules with the World Trade Organization.
Given the economic significance of this trade, the UK government has spent the past two years trying to negotiate new FTAs to replace those previously agreed by the EU. For example, on February 11th, the government announced that it had signed a ‘continuity agreement’ with Switzerland covering trade worth £32bn per year. Deals have also been finalised with Chile, Israel, and the Faroe Islands that replicate the terms of the EU agreements. However, government officials informed 30 business groups in early February that it was highly unlikely that most of the new replacement FTAs would be concluded in time for March 29th.
The document published by the DIT on the 21st February confirms this position and describes the current status of most of the new FTAs as:
Engagement ongoing
For both Japan and Turkey, the outlook is more negative. The guidance states:
We will not transition this agreement for exit day.
The head of EU negotiations at the CBI commented that:
We are really concerned that firms could be blindsided by this.
The government stated that it would significantly increase the resources devoted to the trade negotiations and expected to sign more deals over the next couple of weeks.
If the UK leaves the EU on the 29th March with a deal, then it remains in the EU-CU during the 21-month transition period. Trade will still be covered by the 40 existing EU deals. This gives UK officials until the end of December 2020 to conclude a new set of FTAs.
Articles
Government information
Questions
- Using a demand and supply diagram, illustrate the impact of tariffs on imported goods.
- The EU is perhaps the most famous example of a customs union. Find out some other examples.
- Discuss some of the potential disadvantages of free trade.
- Discuss some of the advantages and disadvantages of the UK remaining in the European Union Custom Union.
- What is a ‘registered schedule’ at the World Trade Organization?
Do you want to get drunk this festive season in the most tax efficient way: i.e. minimise the amount of tax you pay for the volume of alcohol that you drink? Do tax rates vary or are all alcoholic drinks taxed in the same or similar way?
The UK government imposes two different types of tax on alcohol. One is a specific or fixed tax per unit, referred to as excise duty or excise tax. This varies depending on the type of alcohol and is the focus of this blog. The other is VAT, which is 20% of the price for all alcoholic drinks. The price on which VAT is based includes the impact of the excise tax.
How does the implementation of excise tax differ between alcoholic drinks? Both the tax rate itself and the unit of output on which it is based vary: i.e. the volume of liquid vs the volume of pure alcohol within the liquid.
For example, with lager, beer and spirits the excise tax depends on the units of alcohol in the drink rather than the number of litres. The tax works in the following way. It is based on the alcohol by volume or ABV of the lager, beer or spirit. This is often displayed on the bottle or can. ABV is the percentage of the drink that is pure alcohol. Therefore, if a one-litre bottle of lager has an ABV of 1%, then 10ml of the bottle contains pure alcohol. Ten millilitres of pure alcohol is one unit of alcohol. If a one litre bottle of lager had an ABV of 5% it contains 5 units of alcohol.
Excise duties on spirits are the simplest of all the alcohol taxes. The rate for 2017/18 is 28.74p for each percentage of ABV or unit of alcohol in a one-litre bottle. Most spirits have an ABV of 40%. This means that there are 40 units of alcohol in a litre bottle and the excise tax payable on that bottle is £11.50 (40 × 28.74p). If a litre bottle had an ABV of 57%, such as Woods Navy Rum, then the excise tax would be or £16.38 (57 × 28.74p). Although the volume of liquid is the same in each case, the excise tax has increased by £4.88 because the alcohol content has increased.
For cider and wine the system is quite different. Within certain bands of alcoholic strength, the excise duty is based on the volume of the drink rather than by its ABV. For example, the excise tax on a litre of cider with an ABV of between 1.2% and 7.5% is 40.38p. This has the effect of reducing the tax rate per unit of alcohol as the alcoholic content of the cider increases (up to a limit of 7.5%). For example, the rate of excise tax per unit of alcohol for a litre bottle of cider with an ABV of 2% is 20.19p (40.38/2) whereas for a litre bottle of cider with an ABV of 7.5% it is just 5.39p (40.38/7.5). Wine is taxed in a similar way. A litre of wine with an ABV of between 5.5% and 15% is taxed at 288.65p per litre.
The excise tax rates per unit of alcohol for different drinks are illustrated below.
|
Drink
|
ABV
|
Excise tax per
unit of alcohol
|
| Beer/lager |
5%
|
19.08p
|
| Beer/lager |
8%
|
24.77p
|
| Spirits |
1-100%
|
28.74p
|
| Wine |
12.5%
|
21.90p
|
| Wine |
15%
|
19.24p
|
| Cider |
5%
|
8.08p
|
| Cider |
7.5%
|
5.39p
|
The table clearly shows that cider with an ABV of 7.5 per cent is by far the most tax effective way of consuming alcohol.
Although this blog is a rather light-hearted look at excise tax, it does help to illustrate the strange anomalies of the system used in the UK. Research by the Institute for Fiscal Studies (IFS) has indicated that heavier drinkers are more likely to switch between different alcoholic products in response to price changes. They also tend to drink products with more units of alcohol in them: i.e. spirits such as whisky and gin. For these reasons, the IFS has suggested that the excise tax rates on cider and spirits should be increased.
In the November budget, the Chancellor announced plans to introduce a new excise tax rate on still cider with an ABV of between 6.9% and 7.5%.
The excise taxes on cider and wine are based on the volume of liquid because of the European Community Directive 92/84/EEC. It will be interesting to see if the government changes this system to one based on alcohol content once the UK had left the European Union.
Articles
Budget 2017 – Why is white cider being taxed more? BBC News (22/11/17)
Is it time for a flat tax on alcohol – health campaigners can drink to that The Telegraph, Christopher Snowdon (15/2/17)
Traditional cider makers say tax on strong brands will hurt their business The Guardian, Rob Davies (22/11/17)
Minimum price would increase cost of 70% of alcohol BBC News (15/12/17)
Designing alcohol taxes IFS, Kate Smith (24/4/17) .
Questions
- Explain the difference between an ad valorem tax and a specific tax.
- Illustrate the impact of an ad valorem tax and a specific tax on a demand and supply diagram.
- What is the excise tax rate per unit of alcohol on a litre bottle of cider with an ABV of 6%?
- What is the economic rationale for imposing excise tax on alcohol?
- How will the external costs of consuming alcohol differ from those of smoking cigarettes? Draw a marginal external cost of consumption curve for both products to illustrate the difference.
- Compare the impact of increasing excise tax rates on cider and spirits with introducing a minimum unit price for alcohol.
- In April 2012 the government in England and Wales imposed a ban on ‘below cost’ pricing of alcohol. Explain how this policy works and what impact you think it has had.
