Category: Economics for Business: 8e Ch 02

Elections are times of peak deception. Political parties have several ways in which they can use data to persuade people to vote for them. At one extreme, they can simply make up ‘facts’ – in other words, they can lie. There have been various examples of such lies in the run-up to the UK general election of 12 December 2019. The linked article below gives some examples. But data can be used in other deceptive ways, short of downright lies.

Politicians can use data in two ways. First, statistics can be used to describe, explain and interpret the past. Second, they can be used as the basis of forecasts of the future effects of policies.

In terms of past data, one of the biggest means of deception is the selective use of data. If you are the party currently in power, you highlight the good news and ignore the bad. You do the reverse if you are currently in opposition. The data may be correct, but selective use of data can give a totally false impression of events.

In terms of forecast data, you highlight those forecasts, or elements of them, that are favourable to you and ignore those that are not.

Politicians rely on people’s willingness to look selectively at data. People want to see ‘evidence’ that reinforces their political views and prejudices. News media know this and happily do the same as politicians, selectively using data favourable to their political leanings. And it’s not just newspapers that do this. There are many online news sites that feed their readers with data supportive of their position. And there are many social media platforms, where people can communicate with people in their political ‘bubble’.

Genuine fact-checking sites can help, as can independent forecasters, such as the Institute for Fiscal Studies. But too many voters would rather only look at evidence, genuine or not, that supports their political point of view.

This can make life hard for economists who seek to explain the world with an open mind, based on a non-biased use of evidence – and hard for economic forecasters, who want to use full and accurate data in their models and to make realistic assumptions, emphasising that their forecasts are only the most likely outcome, not a certainty. As the article states:

Economic forecasts are flawed and their limitations should be acknowledged. But they should not be blindly dismissed as fake facts. And as far as political debate and discourse is concerned, in the long run, the truth may will out.

Article

Questions

  1. Give some specific examples of ways in which politicians misuse data.
  2. Give some specific examples of ways in which politicians misuse the analysis of economists.
  3. Distinguish between positive and normative statements? Should economists make policy recommendations? If so, in what context?
  4. Why are economic forecasts flawed, but why should they not be dismissed as ‘fake facts’?
  5. Examine the manifestos of two political parties and provide a critique of their economic analysis.

Economists are often criticised for making inaccurate forecasts and for making false assumptions. Their analysis is frequently dismissed by politicians when it contradicts their own views.

But is this fair? Have economists responded to the realities of the global economy and to the behaviour of people, firms, institutions and government as they respond to economic circumstances? The answer is a qualified yes.

Behavioural economics is increasingly challenging the simple assumption that people are ‘rational’, in the sense that they maximise their self interest by weighing up the marginal costs and benefits of alternatives open to them. And macroeconomic models are evolving to take account of a range of drivers of global growth and the business cycle.

The linked article and podcast below look at the views of 2019 Nobel Prize-winning economist Esther Duflo. She has challenged some of the traditional assumptions of economics about the nature of rationality and what motivates people. But her work is still very much in the tradition of economists. She examines evidence and sees how people respond to incentives and then derives policy implications from the analysis.

Take the case of the mobility of labour. She examines why people who lose their jobs may not always move to a new one if it’s in a different town. Partly this is for financial reasons – moving is costly and housing may be more expensive where the new job is located. Partly, however, it is for reasons of identity. Many people are attached to where they currently live. They may be reluctant to leave family and friends and familiar surroundings and hope that a new job will turn up – even if it means a cut in wages. This is not irrational; it just means that people are driven by more than simply wages.

Duflo is doing what economists typically do – examining behaviour in the light of evidence. In her case, she is revisiting the concept of rationality to take account of evidence on what motivates people and the way they behave.

In the light of workers’ motivation, she considers the implications for the gains from trade. Is free trade policy necessarily desirable if people lose their jobs because of cheap imports from China and other developing countries where labour costs are low?

The answer is not a clear yes or no, as import-competing industries are only part of the story. If protectionist policies are pursued, other countries may retaliate with protectionist policies themselves. In such cases, people working in the export sector may lose their jobs.

She also looks at how people may respond to a rise or cut in tax rates. Again the answer is not clear cut and an examination of empirical evidence is necessary to devise appropriate policy. Not only is there an income and substitution effect from tax changes, but people are motivated to work by factors other than take-home pay. Likewise, firms are encouraged to invest by factors other than the simple post-tax profitability of investment.

Podcast

Article

Questions

  1. In traditional ‘neoclassical’ economics, what is meant by ‘rationality’ in terms of (a) consumer behaviour; (b) producer behaviour?
  2. How might the concept of rationality be expanded to take into account a whole range of factors other than the direct costs and benefits of a decision?
  3. What is meant by bounded rationality?
  4. What would be the effect on workers’ willingness to work more or fewer hours as a result of a cut in the marginal income tax rate if (a) the income effect was greater than the substitution effect; (b) the substitution effect was greater than the income effect? Would your answers to (a) and (b) be the opposite in the case of a rise in the marginal income tax rate?
  5. Give some arguments that you consider to be legitimate for imposing controls on imports in (a) the short run; (b) the long run. How might you counter these arguments from a free-trade perspective?

A general election has been called in the UK for 12 December. Central to the debates between the parties will be their policy on Brexit.

They range from the Liberal Democrats’, Plaid Cymru’s and Sinn Féin’s policy of cancelling Brexit and remaining in the EU, to the Scottish Nationalists’ and Greens’ policy of halting Brexit while a People’s Vote (another referendum) is held, with the parties campaigning to stay in the EU, to the Conservative Party’s policy of supporting the Withdrawal Agreement and Political Declaration negotiated between the Boris Johnson government and the EU, to the DUP which supports Brexit but not a version which creates a border between Great Britain and Northern Ireland, to the Brexit Party and UKIP which support leaving the EU with no deal (what they call a ‘clean break’) and then negotiating individual trade deals on a country-by-country basis.

The Labour Party also supports a People’s Vote, but only after renegotiating the Withdrawal Agreement and Political Declaration, so that if Brexit took place, the UK would have a close relationship with the single market and remain in a customs union. Also, various laws and regulations on environmental protection and workers’ rights would be retained. The referendum would take place within six months of the election and would be a choice between this new deal and remain.

But what are the economic costs and benefits of these various alternatives? Prior to the June 2016 referendum, the Treasury costed various scenarios. After 15 years, a deal would make UK GDP between 3.4% and 7.8% lower than if it remained in the EU, depending on the nature of the deal. No deal would make GDP between 5.4% and 9.5% lower.

Then in November 2018, the Treasury published analysis of the original deal negotiated by Theresa May in July 2018 (the ‘Chequers deal’). It estimated that GDP would be up to 3.9% lower after 15 years than it would have been if the UK had remained in the EU. In the case of a no-deal Brexit, GDP would be up to 9.3% lower after 15 years.

When asked for Treasury forecasts of the effects of Boris Johnson’s deal, the Chancellor, Sajid Javid, said that the Treasury had not been asked to provide forecasts as the deal was “self-evidently in our economic interest“.

Other forecasters, however, have analysed the effects of the Johnson deal. The National Institute for Economic and Social Research (NIESR), the UK’s longest established independent economic research institute, has estimated the costs of various scenarios, including the Johnson deal, the May deal, a no-deal scenario and also a scenario of continuing uncertainty with no agreement over Brexit. The NIESR estimates that, under the Johnson deal, with a successful free-trade agreement with the EU, in 10 years’ time UK GDP will be 3.5% lower than it would be by remaining in the EU. This represents a cost of £70 billion. The costs would arise from less trade with the EU, lower inward investment, slower growth in productivity and labour shortages from lower migration. These would be offset somewhat by savings on budget contributions to the EU.

Under Theresa May’s deal UK GDP would be 3.0% lower (and thus slightly less costly than Boris Johnson’s deal). Continuing in the current situation with chronic uncertainty about whether the UK would leave or remain would leave the UK 2% worse off after 10 years. In other words, uncertainty would be less damaging than leaving. The costs from the various scenarios would be in addition to the costs that have already occurred – the NIESR estimates that GDP is already 2.5% smaller than it would have been as a result of the 2016 Brexit vote.

Another report also costs the various scenarios. In ‘The economic impact of Boris Johnson’s Brexit proposals’, Professors Anand Menon and Jonathan Portes and a team at The UK in a Changing Europe estimate the effects of a decline in trade, migration and productivity from the various scenarios – again, 10 years after new trading arrangements are in place. According to their analysis, UK GDP would be 4.9%, 6.4% and 8.1% lower with the May deal, the Johnson deal and no deal respectively than it would have been from remaining in the EU.

But how much reliance should we put on such forecasts? How realistic are their assumptions? What other factors could they have taken into account? Look at the two reports and at the articles discussing them and then consider the questions below which are concerned with the nature of economic forecasting.

Articles

Reports

Questions

  1. What are the arguments in favour of the assumptions and analysis of the two recent reports considered in this blog?
  2. What are the arguments against the assumptions and analysis of the two reports?
  3. How useful are forecasts like these, given the inevitable uncertainty surrounding (a) the outcome of negotiations post Brexit and (b) the strength of the global economy?
  4. If it could be demonstrated beyond doubt to everyone that each of the Brexit scenarios meant that UK GDP would be lower than if it remained in the EU, would this prove that the UK should remain in the EU? Explain.
  5. If economic forecasts turn out to be inaccurate, does this mean that economists should abandon forecasting?

There is increasing recognition that the world is facing a climate emergency. Concerns are growing about the damaging effects of global warming on weather patterns, with increasing droughts, forest fires, floods and hurricanes. Ice sheets are melting and glaciers retreating, with consequent rising sea levels. Habitats and livelihoods are being destroyed. And many of the effects seem to be occurring more rapidly than had previously been expected.

Extinction Rebellion has staged protests in many countries; the period from 20 to 27 September saw a worldwide climate strike (see also), with millions of people marching and children leaving school to protest; a Climate Action Summit took place at the United Nations, with a rousing speech by Greta Thunberg, the 16 year-old Swedish activist; the UN’s Intergovernmental Panel on Climate Change (IPCC) has just released a report with evidence showing that the melting of ice sheets and rising sea levels is more rapid than previously thought; at its annual party conference in Brighton, the Labour Party pledged that, in government, it would bring forward the UK’s target for zero net carbon emissions from 2050 to 2030.

Increasingly attention is focusing on what can be done. At first sight, it might seem as if the answer lies solely with climate scientists, environmentalists, technologists, politicians and industry. When the matter is discussed in the media, it is often the environment correspondent, the science correspondent, the political correspondent or the business correspondent who reports on developments in policy. But economics has an absolutely central role to play in both the analysis of the problem and in examining the effectiveness of alternative solutions.

One of the key things that economists do is to examine incentives and how they impact on human behaviour. Indeed, understanding the design and effectiveness of incentives is one of the 15 Threshold Concepts we identify in the Sloman books.

One of the most influential studies of the impact of climate change and means of addressing it was the study back in 2006, The Economics of Climate Change: The Stern Review, led by the economist Sir Nicholas Stern. The Review reflected economists’ arguments that climate change represents a massive failure of markets and of governments too. Firms and individuals can emit greenhouse gases into the atmosphere at no charge to themselves, even though it imposes costs on others. These external costs are possible because the atmosphere is a public good, which is free to exploit.

Part of the solution is to ‘internalise’ these externalities by imposing charges on people and firms for their emissions, such as imposing higher taxes on cars with high exhaust emissions or on coal-fired power stations. This can be done through the tax system, with ‘green’ taxes and charges. Economists study the effectiveness of these and how much they are likely to change people’s behaviour.

Another part of the solution is to subsidise green alternatives, such as solar and wind power, that provide positive environmental externalities. But again, just how responsive will demand be? This again is something that economists study.

Of course, changing human behaviour is not just about raising the prices of activities that create negative environmental externalities and lowering the prices of those that create positive ones. Part of the solution lies in education to make people aware of the environmental impacts of their activities and what can be done about it. The problem here is that there is a lack of information – a classic market failure. Making people aware of the consequences of their actions can play a key part in the economic decisions they make. Economists study the extent that imperfect information distorts decision making and how informed decision making can improve outcomes.

Another part of the solution may be direct government investment in green technologies or the use of legislation to prevent or restrict activities that contribute to global warming. But in each case, economists are well placed to examine the efficacy and the costs and benefits of alternative policies. Economists have the tools to make cost–benefit appraisals.

Economists also study the motivations of people and how they affect their decisions, including decisions about whether or not to take part in activities with high emissions, such air travel, and decisions on ‘green’ activities, such as eating less meat and more vegetables.

If you are starting out on an economics degree, you will soon see that economists are at the centre of the analysis of some of the biggest issues of the day, such as climate change and the environment generally, inequality and poverty, working conditions, the work–life balance, the price of accommodation, the effects of populism and the retreat from global responsibility and, in the UK especially, the effects of Brexit, of whatever form.

Articles

Report

Questions

  1. Explain what is meant by environmental externalities.
  2. Compare the relative merits of carbon taxes and legislation as means of reducing carbon emissions.
  3. If there is a climate emergency, why are most governments unwilling to take the necessary measures to make their countries net carbon neutral within the next few years?
  4. In what ways would you suggest incentivising (a) individuals and (b) firms to reduce carbon emissions? Explain your reasoning.
  5. For what reasons are the burdens of climate changed shared unequally between people across the globe?

Economists were generally in favour of the UK remaining in the EU and highly critical of the policy proposals of Donald Trump. And yet the UK voted to leave the EU and Donald Trump was elected.

People rejected the advice of most economists. Many blamed the failure of most economists to predict the 2007/8 financial crisis and to find solutions to the growing gulf between rich and poor, with the majority stuck on low incomes.

So to what extent are economists to blame for the rise in populism – a wave that could lead to electoral upsets in various European countries? The podcast below brings together economists and politicians from across the political spectrum. It is over an hour long and provides an in-depth discussion of many of the issues and the extent to which economists can provide answers.

Podcast

Should economists share the blame for populism? Guardian Politics Weekly podcast, Heather Stewart, joined by Andrew Lilico, Ann Pettifor, Jonathan Portes, Rachel Reeves and Vince Cable (23/2/17)

Questions

  1. Why has globalisation become a dirty word?
  2. Assess the arguments for and against an open policy towards immigration?
  3. In what positive ways may economists contribute to populism?
  4. Do economists concentrate too much on growth in GDP rather than on its distribution?
  5. Give some examples of ways in which various popular interpretations of economic phenomena may confuse correlation with causality.
  6. Why did the proportions of people who voted for and against Brexit differ considerably from one part of the country to another, from one age group to another and from one social group to another?
  7. In what ways have economists and the subject of economics contributed towards a growth in human welfare?
  8. What are the advantages and disadvantages of the trend for undergraduate economics curricula to become more mathematical (at least until relatively recently)?