Category: Economics 10e: Ch 05

Long queues at petrol pumps, with many filling stations running out of fuel; fears of shortages of food and various other items in supermarkets; orders by shops and warehouses unfilled or delayed. These have been some of the headlines in the UK in recent days.

The immediate problem is a shortage of over 100 000 lorry drivers, with thousands of drivers from EU countries, who were previously living and working in the UK, having returned to their home countries. Their numbers have not been replaced by British drivers, a problem exacerbated by a decline in HGV tests during the pandemic. Thus the supply of lorry drivers has fallen.

At the same time, as the economy recovers from the COVID-19 pandemic, aggregate demand has risen and with it the demand for lorry drivers.

The shortage is pushing up wages somewhat, but not enough to eliminate the shortage. What is more, the supply of lorry drivers is relatively wage inelastic: a higher wage does not attract many more drivers into the market. Also the demand is also relatively wage inelastic: a higher wage does not do much to dampen the demand for drivers.

But why has this happened? Why has the supply of drivers fallen and why is it inelastic? And what will happen in the coming months? The three main causes are Brexit, COVID-19 and working conditions.

Brexit

With Brexit, many EU workers left the UK, finding life and working conditions more conducive in the EU. Many EU drivers had faced discrimination and felt that they were not welcome in the UK. It has been difficult finding replacement drivers from the EU as the UK’s immigration system, which now applies to the EU as well as other countries, prioritises workers who are classified as high-skilled, and these do not include lorry drivers.

Those EU drivers who do want to stay as UK residents are finding that settled status or visas are not easy to achieve and involve filling in various documents, which can be an onerous and time-consuming process. As the writer of the first linked bog below, who is a Polish worker in the transport industry, states, ‘Would you rather come to Britain and jump through all the hoops, or choose any of the well-paying EU countries, for example, Germany that, if you live in Western Poland, is just a short drive across (virtually non-existent thanks to Schengen) border?’ Another problem is that with EU driving licences: it is harder for potential employers to check on their status and thus they may prefer to employ UK drivers. This, again, puts off EU drivers from seeking to stay in the UK.

Even in the case of EU drivers living in the EU but delivering to the UK there are problems. First there are the dangers for drivers of boarding ferries in France, where people from migrant camps seek to board lorries to get passage to the UK, often threatening drivers. If illegal migrants do succeed in boarding a trailer unseen by the driver, the driver can then be arrested in the UK. According to the Polish blogger, it’s ‘no surprise that I hear more and more drivers who, when taking on new jobs, demand guarantees from their employers that they won’t be sent to the UK’.

Then there is a decline in the system known as ‘cabotage’. This is where an EU driver delivers from the EU to destination A in the UK and takes back a load to the EU from destination B in the UK. To avoid having to travel empty between the two UK destinations, the driver could pick up a load to take from A to B. With a fall in imports and exports from and to the EU following Brexit, there are fewer EU lorries on UK roads. This means that there is now less capacity for transporting loads within the UK.

There has also been a large rise in ‘red tape’ associated with post-Brexit customs checks and border controls. This means that lorries can be held up at ports. This makes it much less attractive for EU haulage companies to export to the UK rather than to other EU countries, where paperwork is minimal. In addition, m many drivers are paid by the length of the journey rather than by the time spent, so delays result in them earning less per hour. Full checks have not been introduced yet. When they are, in January and July next year, the problem will be worse.

Tax changes make it more difficult for drivers to avoid taxes by claiming that they are self employed when they are in reality employees. This too is discouraging drivers from the EU from moving to or staying in the UK since many would now (since April 2021) be paying more tax.

COVID-19

Another contributing factor to the shortage of drivers has been COVID-19 and the government’s response to it. COVID rates are considerably higher in the UK than in most EU countries and, not surprisingly, many EU drivers are afraid to come to the UK.

The pandemic led to fewer HGV driver tests, with 25 000 fewer candidates passing their test in 2020 than in 2019. It takes time to train new drivers and then to test them. However, even if there had been no reduction in HGV drivers passing their tests, there would still be a significant shortage of qualified drivers.

A further problem with the effects of COVID-19 on the economy has been the initial recession and then the bounce back. The sheer size of the bounce back has exacerbated the problem of driver shortages, which otherwise would have been slower to develop, giving the market more time to respond. Real GDP grew by 5.5% from 2021 Q1 to 2021 Q2, giving an annual growth rate of 23.6%. Nevertheless, GDP was still some 3.3% below its 2019 Q3 level.

Pay and working conditions

Working conditions are very poor for many drivers. The following are common complaints:

  • Driving jobs are often very tightly controlled, with computer monitoring and little freedom for the driver. Some cabs have cameras aimed at the drivers so that they can be constantly monitored.
  • Drivers are subject to very stringent health and safety regulations, such as not being allowed to drive longer than a certain time, even when they are queuing in congested traffic. Whilst many of these regulations are desirable to protect both the public’s and the driver’s safety, they can discourage drivers from entering or staying in the industry. And some regulations are hard to justify on safety grounds (see second linked article below, point 13).
  • Just-in-time deliveries at supermarkets, regional distribution centres (warehouses) or factories make timing very important and add considerable stress to drivers who may face abuse if they are late, even though it was not their fault, with their employer perhaps facing a fine. And yet on other occasions they might have to wait a long time to offload if drivers before them have been delayed, and often the conditions in waiting areas are poor with few if any facilities.
  • Drivers often feel a lack of respect from employers, trainers and the general public.
  • Rest and refreshment facilities are often very poor in the UK and generally much worse than in the EU. In the EU, motorway service areas have better parking, toilets, showers and shops. Restaurants are better and cheaper. Dedicated truck stops have supermarkets, laundrettes, showers or even open-air gyms dedicated to making drivers’ lives easier and more pleasant. The UK by contrast often has very poor facilities. Unlike in most EU motorway services, drivers have to pay to park and are faced with poor toilet and eating facilities. ‘Meanwhile, a typical British truck stop is some dusty yard full of potholes on the side of some industrial estate with a portaloo and a “greasy spoon” burger van parked next to it.’
  • Hours are long. Even though driving hours are restricted to 10 hours per day (recently extended to 11 hours), the average working day may be much longer as drivers have to wait at distribution centres, fill in increasing amounts of paperwork and help load or unload their vehicle. Also drivers may have to work variable shifts, which leads to disturbed sleeping patterns.
  • The work is often physically demanding, especially when a large part of the job involves loading and unloading and moving items from the lorry to where the customer wants them.
  • Many vehicles are hard and unpleasant to drive, with leased vehicles often low-spec, dirty, uncomfortable and poorly maintained.
  • Many of the jobs are agency jobs that do not offer stable employment.

Although pay is higher than in some parts of the labour market where there are shortages, such as social care and hospitality, pay per hour is still relatively poor when compared with many industries which have better conditions of employment.

The future

The government is allowing more foreign workers into the UK from this month (October); more training places will be offered for potential drivers and the number of driving tests will increase; the government is also encouraging retired drivers or those who have left driving for other jobs to return to the industry.

However, there are shortages of drivers in other EU countries and so it will be difficult to attract additional drivers to the UK from the EU. What is more, with wages and working conditions remaining poor and the labour market remaining tight in other sectors, it might be hard to fill new training places and encourage workers to return to driving. Also, with the average age of drivers being 55, it is likely that the outflow of workers from driving jobs could be large in the coming years.

Articles

Questions

  1. Why are the supply of and demand for lorry drivers relatively wage inelastic?
  2. Use a marginal productivity diagram to explain the current situation in the market for lorry drivers.
  3. What policy measures could be adopted to increase the supply of lorry drivers? How successful would these be?
  4. Is it ‘rational’ for consumers to ‘panic buy’ fuel and other products in short supply?
  5. Find out why there is a shortage of lorry drivers in the EU. Are any of the explanations similar to those in the UK?
  6. What are the macroeconomic implications of a shortage of lorry drivers and other key workers?

Bubbles

Speculation in markets can lead to wild swings in prices as exuberance drives up prices and
pessimism leads to price crashes. When the rise in price exceeds underlying fundamentals, such as profit, the result is a bubble. And bubbles burst.

There have been many examples of bubbles throughout history. One of the most famous is that of tulips in the 17th century. As Box 2.4 in Essential Economics for Business (6th edition) explains:

Between November 1636 and February 1637, there was a 20-fold increase in the price of tulip bulbs, such that a skilled worker’s annual salary would not even cover the price of one bulb. Some were even worth more than a luxury home! But, only three months later, their price had fallen by 99 per cent. Some traders refused to pay the high price and others began to sell their tulips. Prices began falling. This dampened demand (as tulips were seen to be a poor investment) and encouraged more people to sell their tulips. Soon the price was in freefall, with everyone selling. The bubble had burst .

Another example was the South Sea Bubble of 1720. Here, shares in the South Sea Company, given a monopoly by the British government to trade with South America, increased by 900% before collapsing through a lack of trade.

Another, more recent, example is that of Poseidon. This was an Australian nickel mining company which announced in September 1969 that it had discovered a large seam of nickel at Mount Windarra, WA. What followed was a bubble. The share price rose from $0.80 in mid-1969 to a peak of $280 in February 1970 and then crashed to just a few dollars.

Other examples are the Dotcom bubble of the 1990s, the US housing bubble of the mid-2000s and BitCoin, which has seen more than one bubble.

Bubbles always burst eventually. If you buy at a low price and sell at the peak, you can make a lot of money. But many will get their fingers burnt. Those who come late into the market may pay a high price and, if they are slow to sell, can then make a large loss.

GameStop shares – an unlikely candidate for a bubble

The most recent example of a bubble is GameStop. This is a chain of shops in the USA selling games, consoles and other electronic items. During the pandemic it has struggled, as games consumers have turned to online sellers of consoles and online games. It has been forced to close a number of stores. In July 2020, its share price was around $4. With the general recovery in stock markets, this drifted upwards to just under $20 by 12 January 2021.

Then the bubble began.

Hedge fund shorting

Believing that the GameStop shares were now overvalued and likely to fall, many hedge funds started shorting the shares. Shorting (or ‘short selling’) is where investors borrow shares for a fee and immediately sell them on at the current price, agreeing to return them to the lender on a specified day in the near future (the ‘expiration date’). But as the investors have sold the shares they borrowed, they must now buy them at the current price on or before the expiration date so they can return them to the lenders. If the price falls between the two dates, the investors will gain. For example, if you borrow shares and immediately sell them at a current price of £5 and then by the expiration date the price has fallen to $2 and you buy them back at that price to return them to the lender, you make a £3 profit.

But this is a risky strategy. If the price rises between the two dates, investors will lose – as events were to prove.

The swarm of small investors

Enter the ‘armchair investor’. During lockdown, small-scale amateur investing in shares has become a popular activity, with people seeking to make easy gains from the comfort of their own homes. This has been facilitated by online trading platforms such as Robinhood and Trading212. These are easy and cheap, or even free, to use.

What is more, many users of these sites were also collaborating on social media platforms, such as Reddit. They were encouraging each other to buy shares in GameStop and some other companies. In fact, many of these small investors were seeing it as a battle with large-scale institutional investors, such as hedge funds – a David vs. Goliath battle.

With swarms of small investors buying GameStop, its share price surged. From $20 on 12 January, it doubled in price within two days and had reached $77 by 25 January. The frenzy on Reddit then really gathered pace. The share price peaked at $468 early on 28 January. It then fell to $126 less than two hours later, only to rise again to $354 at the beginning of the next day.

Many large investors who had shorted GameStop shares made big losses. Analytics firm Ortex estimated that hedge funds lost a total of $12.5 billion in January. Many small investors, however, who bought early and sold at the peak made huge gains. Other small investors who got the timing wrong made large losses.

And it was not just GameStop. Social media were buzzing with suggestions about buying shares in other poorly performing companies that large-scale institutional investors were shorting. Another target was silver and silver mines. At one point, silver prices rose by more than 10% on 1 February. However, money invested in silver is huge relative to GameStop and hence small investors were unlikely to shift prices by anything like as much as GameStop shares.

Amidst this turmoil, the US Securities and Exchange Commission (SEC) issued a statement on 29 January. It warned that it was working closely with other regulators and the US stock exchange ‘to ensure that regulated entities uphold their obligations to protect investors and to identify and pursue potential wrongdoing’. It remains to be seen, however, what it can do to curb the concerted activities of small investors. Perhaps, only the experience of bubbles bursting and the severe losses that can result will make small investors think twice about backing failing companies. Some Davids may beat Goliath; others will be defeated.

Articles

Data

Questions

  1. Distinguish between stabilising and destabilising speculation.
  2. Use a demand and supply diagram to illustrate destabilising speculation.
  3. Explain how short selling contributed to the financial crisis of 2007/8 (see Box 2.7 in Economics (10th edition) or Box 3.4 in Essentials of Economics (8th edition)).
  4. Why won’t shares such as GameStop go on rising rapidly in price for ever? What limits the rise?
  5. Find out some other shares that have been trending among small investors. Why were these specific shares targeted?
  6. How has quantitative easing impacted on stock markets? What might be the effect of a winding down of QE or even the use of quantitative tightening?

On 15 March 2019, the ‘Organ Donation (Deemed Consent) Bill’ was passed into law. (See the blog, Organ donations – Changing the default option vs active choice.) The government has just announced that this will come into force on 20 May this year. Under the scheme, ‘adults in England will be considered potential donors unless they chose to opt out or are excluded. The act is known as Max and Keira’s law in honour of a boy who received a heart transplant and the girl who donated it.’

This change from an ‘opt-in’ to an ‘opt-out’ system follows a similar a move in Wales in 2015. Since then, Wales has seen a significant increase in potential donors, with the consent rate rising from 58% to 77%. A similar move in Scotland will come into force in the autumn of this year. The government expects there to be an additional 700 transplant operations per year available for transplant by 2023.

These moves from an opt-in to an opt-out system are consistent with ‘nudge theory’. This maintains that positive reinforcement or making a decision easy for people can persuade them to make a particular choice. They are ‘nudged’ into so doing.

Opting out and nudge theory

In the case of having to opt in to a scheme such as organ donation, people have to make the decision to take part. Many, as a result, do not, partly because they never seem to find the time to do so, even though they might quite like to. With the busy lives people lead, it’s too easy to think, ‘Yes, I’ll do that some time’, but never actually get round to doing it: i.e. they have present bias and hence behave in a time-inconsistent manner.

With an opt-out system, people are automatically signed up to the scheme, but can freely choose to opt out. In the case of the new organ donor schemes in the UK, it is/will be assumed that organs from people killed in an accident who had not opted out could be used for transplants. If you do not want your organs to be used, you have to notify that you are opting out.

It could be the same with charitable giving. Some firms add a small charitable contribution to the price of their products (e.g. airline tickets or utility bills), unless people opt out.

Similarly, under UK pension arrangements introduced from 2012, firms automatically deduct pension contributions from employees’ wages unless they opt out of the scheme. Opt-out pension schemes like this retain between 90 and 95 per cent of employees. Opt-in pension schemes, by contrast, have much lower participation rates of around 60 per cent, even though they are otherwise identical.

This type of ‘nudging’ can improve the welfare of those who make systematic mistakes (i.e. operate in a time-inconsistent manner), while imposing very limited harm on those who act in a time-consistent manner. If it is in the interests of someone to opt out of the scheme, they can easily do so. Policies such as these are an example of what behavioural economists call ‘soft paternalism’.

Articles

Official Information

Questions

  1. Why do opt-out schemes have a higher take up than opt-in ones? Would this apply if people behaved in a time-consistent manner?
  2. 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.
  3. What are the arguments for and against nudging people to make decisions that benefit them or are in the social interest?
  4. Give some example of nudges that are used in public policy or would be a good idea to use. Consider how effective they are likely to be. (You might refer to the work of the Behavioural Insights Team.)
  5. What are the possible drawbacks of presumed consent in organ donation?
  6. What are the arguments for and against paying live people to donate organs, such as a kidney?
  7. How might people be encouraged to behave in the right way during an epidemic, such as corona virus?
  8. To what extent was nudge theory used during the Brexit referendum campaign and in the two subsequent general elections?

How to get the most from your money? This is the question posed by the linked article below. It’s a topic we’ve looked at in previous posts, such as Studies show that money can buy happiness (but only if you spend on experiences), Happiness economics and Peak stuff. This article takes the arguments further.

It suggests that, up to a certain level of income, there is a roughly linear relationship between money and life satisfaction. As poor people have more to spend, so they can begin to escape poverty and the negative features of financial insecurity and a lack of basic necessities, such as food and shelter. They also gain a greater freedom to choose what and when to buy. Beyond a certain level, however, the rate of increase in life satisfaction tends to decline, as does the specific pleasure from additional individual purchases. In economists’ language, the marginal utility of income diminishes.

But the article goes further than this. It suggests that satisfaction or happiness is of two broad types. The first is the general sense of well-being that people get from their life. This tends to be relatively stable for any given person, but will tend to increase as people have more money to spend or have more fulfilling jobs. Of course, there may well be a trade-off between income and job satisfaction. Some people may prefer to take a cut in pay for a more fulfilling job.

The second is the satisfaction or happiness you get from specific experiences. This tends to fluctuate on a day-to-day basis, depending on what you are doing. Here, what you purchase and the use you make of the purchases is a key component.

So what lessons are there for earning and spending money wisely? To start with, it is important to get a good work-life balance. It may be worth trading income for job satisfaction. Here the focus should be on long-term fulfilment, rather than on the short-term happiness from more ‘stuff’. Then it is important to spend money wisely. Here the author identifies three lessons:

The first is to consider buying time. Time-saving purchases, such as dishwashers can help. So too can ‘outsourcing’ activities, such as cleaning, laundry, cooking, DIY or child care, if they give you more time to do other more fulfilling things (but not if you love doing them!).

The second is to spend more money on experiences (as we saw in the post Studies show that money can buy happiness (but only if you spend on experiences). A better TV or car may seem like a wiser investment than more dinners out, holidays or going to concerts. But we quickly adapt to new upgraded ‘stuff’, thereby eliminating any additional satisfaction. Experiences, however, tend to linger in the memory. As Tom Gilovich, a psychology professor at Cornell University, is quoted by the article as saying:

Even though, in a material sense, they [experiences] come and go, they live on in the stories we tell, the relationships we cement, and ultimately in the sense of who we are.

Choosing a more fulfilling but less well-paid job is a form of spending money on experiences.

The third is to give some of your money away, whether to charity or to helping friends or relatives. As Gilovich says:

It’s hard to find a more charming finding than that by giving away money, you not only make someone else happier, you make yourself happier.

Article

Questions

  1. What is meant by ‘diminishing marginal utility of income’? Is the concept consistent with the arguments in the article?
  2. In what sense may it be rational to choose a lower-paid job?
  3. Is ‘happiness’ the same as ‘utility’ as the concept is used by economists?
  4. Does the concept of ‘peak stuff’ apply to all physical products? Explain your answer.
  5. If giving money away makes a person happy, is it truly altruistic for that person to do so? Explain.

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?