A big expenditure for many households is petrol. The price of petrol is affected by various factors, but the key determinant is what happens in the oil market. When oil prices rise, this pushes up the price of petrol at the pumps. But, when they fall, do petrol prices also fall? That is the question the government is asking.
The price of oil is a key cost of production for companies providing petrol and so when oil prices rise, it shifts the supply curve up to the left and hence prices begin to increase. We also see supply issues developing with political turmoil, fears of war and disruption and they have a similar effect. As such, it is unsurprising that petrol prices rise with concern of supply and rising costs. But, what happens when the opposite occurs? Oil prices have fallen significantly: by a quarter. Yet, prices at the pump have fallen by around 6%. This has caused anger amongst customers and the government is now urging petrol retailers to pass their cost savings from a lower price of oil onto customers. Danny Alexander, Chief Secretary to the Treasury said:
“I believe it’s called the rocket-and-feather effect. The public have a suspicion that when the price of oil rises, pump prices go up like a rocket. But when the price of oil falls, pump prices drift down like a feather … This has been investigated before and no conclusive evidence was found. But even if there were a suspicion it could be true this time it would be an outrage.”
However, critics suggest that tax policy is partly to blame as 63% of the cost of petrol is in the form taxation through fuel duty and VAT. Therefore even if oil prices do fall, the bulk of the price we pay at the pumps is made up of tax revenue for the government. Professor Stephen Glaister, director of the RAC Foundation said:
“It’s a simple story. Before tax we have just about the cheapest petrol and diesel in Europe. After tax we have just about the most expensive … It’s right to keep the pressure on fuel retailers but if drivers want to know what’s behind the high pump prices of recent years all they have to do is follow the trail back to the Treasury … if ministers are serious about reducing fuel prices further then they should cut duty further.”
(Click here for a PowerPoint of the chart.)
However, even taking out the fuel duty and VAT, Arthur Renshaw, an analyst at Experian has said that the actual price of petrol has fallen by 21% since last year. Still, a much bigger decrease than we have seen at the pumps. One further reason for this may be the fact that dollars is the currency in which oil is traded. The pound has been relatively weak, falling by almost 7% over the past few months and hence even though the price of oil has fallen, the effect on UK consumers has been less pronounced.
The big supermarkets have responded to government calls to cut petrol prices, but how much of this cut was influenced by the government and how much was influenced by the actions of the other supermarkets is another story. A typical oligopoly, where interdependence is key, price wars are a constant feature, so even if one supermarket cut petrol prices, this would force others to respond in kind. If such price wars continue, further price cuts may emerge. Furthermore, with oil production still at such high levels, this market may continue to put downward pressure on petrol prices. Certainly good news for consumers – we now just have to wait to see how long it lasts, with key oil producing countries, such as Russia taking a big hit. The following articles consider this story.
Articles
Supermarkets cut fuel prices again The Telegraph, Nick Collins (6/11/14)
Petrol retailers urged to cut prices in line with falling oil costs The Guardian, Terry Macalister (6/11/14)
Supermarkets cut petrol prices after chancellor’s criticism Financial Times, Michael Kavanagh (6/11/14)
Governent ‘watching petrol firms’ Mail Online (6/11/14)
Our horrendous tax rates are the real reason why petrol is still so expensive The Telegraph, Allister Heath (6/11/14)
Osborne ‘expects’ fuel price drop after fall in oil price BBC News (6/11/14)
Danny Alexander tells fuel suppliers to pass on oil price cuts to drivers The Telegraph, Peter Dominiczak (5/11/14)
Further UK fuel cuts expected as pound strengthens The Scotsman, Alastair Dalton (6/11/14)
Data
Spot oil prices Energy Information Administration
Weekly European Brent Spot Price Energy Information Administration (Note: you can also select daily, monthly or annual.)
Annual Statistical Bulletin OPEC
Questions
- Using a supply and demand diagram, illustrate the impact that a fall in the price of oil should have on the price of petrol.
- What is the impact of a tax on petrol?
- Why is petrol a market that is so heavily taxed? You should think about the incidence of taxation in your answer.
- Why does the strength of the pound have an impact on petrol prices in the UK and how much of the oil price is passed onto customers at the pumps?
- Does the structure of the supermarket industry help customers when it comes to the price of petrol? Explain your answer.
- Militant action in some key oil producing countries has caused fears of oil disruption. Why is that oil prices don’t reflect these very big concerns?
Lloyds Banking Group has announced that it plans to reduce its labour force by 9000. Some of this reduction may be achieved by not replacing staff that leave, but some may have to be achieved through redundancies.
The reasons given for the reduction in jobs are technological change and changes in customer practice. More banking services are available online and customers are making more use of these services and less use of branch banking. Also, the increasingly widespread availability of cash machines (ATMs) means that fewer people withdraw cash from branches.
And it’s not just outside branches that technological change is impacting on bank jobs. Much of the work previously done by humans is now done by software programs.
One result is that many bank branches have closed. Lloyds says that the latest planned changes will see 150 fewer branches – 6.7% of its network of 2250.
What’s happening in banking is happening much more widely across modern economies. Online shopping is reducing the need for physical shops. Computers in offices are reducing the need, in many cases, for office staff. More sophisticated machines, often controlled by increasingly sophisticated computers, are replacing jobs in manufacturing.
So is this bad news for employees? It is if you are in one of those industries cutting employment. But new jobs are being created as the economy expands. So if you have a good set of skills and are willing to retrain and possibly move home, it might be relatively easy to find a new, albeit different, job.
As far as total unemployment is concerned, more rapid changes in technology create a rise in frictional and structural unemployment. This can be minimised, however, or even reduced, if there is greater labour mobility. This can be achieved by better training, education and the development of transferable skills in a more adaptive labour force, where people see changing jobs as a ‘normal’ part of a career.
Webcasts
Lloyds Bank cuts 9,000 jobs – but what of the tech future? Channel 4 News, Symeon Brown (28/10/14)
Lloyds Bank confirms 9,000 job losses and branch closures BBC News, Kamal Ahmed (28/10/14)
Article
Lloyds job cuts show the technology axe still swings for white collar workers The Guardian, Phillip Inman (28/10/14)
Reports
Unleashing Aspiration: The Final Report of the Panel on Fair Access to the Professions Cabinet Office (July 2009)
Fair access to professional careers: a progress report Cabinet Office (30/5/12)
Questions
- Is a reduction in banking jobs inevitable? Explain.
- What could banks do to reduce the hardship to employees from a reduction in employment?
- What other industries are likely to see significant job losses resulting from technological progress?
- Distinguish between demand-deficient, real-wage, structural and frictional unemployment. Which of these are an example, or examples, of equilibrium unemployment?
- What policies could the government pursue to reduce (a) frictional unemployment; (b) structural unemployment?
- What types of industry are likely to see an increase in employment and in what areas of these industries?
Following the financial crisis, all sectors of the economy continue to repair their balance sheets. As well as households, non-financial corporations and government, this is true of the banking sector. In part, the repairing and rebalancing of their balance sheets is being brought about by regulatory pressures. The objective is to make banks more resilient to shocks and less susceptible to financial distress.
The need for banks to repair and rebalance their balance sheets is significant because of their systemic importance to the modern-day economy. Financial institutions that are systemically important to national economies are know as SIFIs (systemically important financial institutions) while those of systemic importance to the global economy are know as G-SIFIs or G-SIBs (global systemically important banks). The increasing importance of financial institutions to economic activity is known as financialisation.
One way of measuring the degree of financialisation here in the UK is to consider the aggregate size of the balance sheet of resident UK banks and building societies (including foreign subsidiaries operating here). The chart shows that the balance sheet grew from £2.6 trillion in 1998 Q1 to £8.5 trillion in 2010 Q1. Another way of looking at this is to consider this growth relative to GDP. This reveals that the aggregate balance sheet of banks and building societies grew over this period from 3 times annual GDP to a staggering 5.6 times GDP. (Click here for a PowerPoint of the chart.)
But, now consider the aggregate banking balance sheet in the 2010s. This reveals a shrinking balance sheet. At the end of the second quarter of this year (2014 Q2) it had fallen back to £7.1 trillion or 4 times GDP. As a share of GDP, this was the smallest the aggregate balance sheet had been since 2005 Q1.
Does a shrinking balance sheet matter? This is where the analysis becomes tricky and open to debate. If the smaller size is consistent with a more stable financial system then undoubtedly that is a good thing. But, size is not that all matters. The composition of the balance sheet matters too. This requires an analysis of, among other things, the liquidity of assets (i.e. assets that can be readily turned in a given amount of cash), the reliability of the income flow from assets and the resources available to withstand periods of slow economic growth, including recessions, or periods of financial difficulty.
As we have identified before (see Financialisation: Banks and the economy after the crisis), the financial crisis could herald new norms for the banking system with important implications for the economy. If so, we may need to become accustomed to consistently lower flows of credit and not to the levels that we saw prior to the financial crisis of the late 2000s. However, an alternative view is that we are merely experiencing a pause before the next expansionary phase of the credit cycle. This is consistent with the financial instability hypothesis (see Keeping a Minsky-eye on credit) which argues that credit cycles are an integral part of modern financialised economies. Only time will tell which view will turn out to be right.
Articles
‘Cleaning up bank balance sheets is key’ Irish Examiner, John Walsh (10/10/14)
More action needed at European banks: Fitch Courier Mail, (17/10/14)
Bank lending to small businesses falls by £400m The Telegraph, Rebecca Burn-Callander (20/10/14)
Bank lending to SMEs falls by £400m SME insider, Lindsey Kennedy (21/10/14)
Record world debt could trigger new financial crisis, Geneva report warns The Guardian, Phillip Inman (29/10/14)
RBS shares jump as bank’s bad debts improve The Guardian, Jill Treanor (30/10/14)
Data
Statistical Interactive Database Bank of England
Questions
- Using examples, demonstrate your understanding of financialisation.
- Draw up a list of the alternative ways in which we might measure financialisation.
- What factors are likely to explain the recent reduction in the aggregate balance sheet of resident banks and building societies in the UK?
- How might we go about assessing whether the aggregate level of lending by financial institutions is sustainable?
- How might we go about assessing whether the level of lending by individual financial institutions is sustainable?
- How would reduced flows of credit be expected to impact on the economy both in the short term and in the longer term?
- Are credit cycles inevitable?
- Of what significance are credit cycles in explaining the business cycle?
The latest GDP numbers from the Office for National Statistics contained in Quarterly National Accounts, Q2 2014 show the economy’s output expanded by 0.9 per cent in the second quarter. This follows on the back of a 0.7 per cent increase in output in Q1 2014. The economy’s output is now thought to be 0.7 per cent above its Q1 2008 peak. Yet, the data show very different profiles for the four principal industrial sectors. The service sector appears to be ploughing ahead while the rest (production, construction and agriculture) lag behind.
Chart 1 shows quarterly economic growth since 1980s (click here for a PowerPoint of the chart). It illustrates nicely the inherent volatility of economies – one of the threshold concepts in economics. The average quarterly rate of growth since 1980 has been 0.5 per cent. On the face of it, a quarterly growth number of 0.9 per cent would appear very robust. Of course, this has to been set in the context of the 2008/9 recession. UK output peaked in Q1 2008 (£414.424 billion at 2011 prices). The revised data now show that there followed 5 quarters of declining output (previously, data suggested the duration of the recession was 6 quarters). During this period output shrank 6 per cent (GDP at 2011 prices had fallen by Q2 2009 to £389.388 billion ).
Chart 1 highlights two earlier downturns. First, there is the recession of the early 1980s. We can see the 5-quarter recession that commenced in Q1 1980. By the end of this recession output had shrunk by 4.5 per cent. Second, there is the recession of the early 1990s which commenced in Q3 1990. Again, this recession lasted five quarters. By the time the economy had come out of recession it had shrunk 2.2 per cent.
Consider now Chart 2 (click here for a PowerPoint of the chart). It allows us to analyse more recent events by tracking how industrial output has evolved since 2006. It suggests an unbalanced recovery. From it, we observe that in Q2 2014 service-sector output was 6.5 per cent higher than in Q1 2008. However, a very different picture emerges for the other principal industrial types. Output across the production industries remains 9.7 per cent lower, 9.2 per cent lower in agriculture and 8.9 per cent lower in the construction sector.
In short, the British economy continues to struggle to rebalance its industrial base. The business cycle remains heavily dependent on the service sector.
Articles
UK GDP revised up: what the economists say Guardian, Katie Allen (30/9/14)
UK economy grew 0.9% in second quarter, says ONS BBC News, Katie Allen (9/5/14)
UK GDP: Did the UK economy do well after all? Independent, Ben Chu (30/9/14)
UK economy grew 0.9% Herald, Ian McConnell (1/10/14)
Economy tracker: GDP BBC News (30/9/14).
Data
Quarterly National Accounts, Q2 2014 Dataset Office for National StatisticsQuarterly National Accounts, Q2 2014, Statistical Release Office for National Statistics
Questions
- What is the difference between nominal and real GDP? Which of these helps to track changes in economic output?
- Looking at Chart 1 above, summarise the key patterns in real GDP since the 1980s.
- What is a recession?
- What are some of the problems with the traditional definition of a recession?
- Can a recession occur if nominal GDP is actually rising? Explain your answer.
- What factors lead to economic growth being so variable?
- What factors might explain the very different patterns seen since the late 2000s in the volume of output of the four main industrial sectors?
- What different interpretations could there be of a ‘rebalancing’ of the UK economy?
- What other data might we look at to analyse whether the UK economy is ‘rebalancing’?.
- Produce a short briefing paper exploring the prospects for economic growth in the UK over the next 12 to 18 months.
- What is the difference between GVA and GDP?
- Explain the arguments for and against using GDP as a measure of a country’s economic well-being.
Economic journalists, commentators and politicians have been examining the possible economic effects of a Yes vote in the Scottish independence referendum on 18 September. For an economist, there are two main categories of difficulty in examining the consequences. The first is the positive question of what precisely will be the consequences. The second is 
the normative question of whether the likely effects will be desirable or undesirable and how much so.
The first question is largely one of ‘known unknowns’. This rather strange term was used in 2002 by Donald Rumsfeld, US Secretary of Defense, in the context of intelligence about Iraq. The problem is a general one about forecasting the future. We may know the types of thing that are likely happen, but the magnitude of the outcome cannot be precisely known because there are so many unknowable things that can influence it.
Here are some known issues of Scottish independence, but with unknown consequences (at least in precisely quantifiable terms). The list is certainly not exhaustive and you could probably add more questions yourself to the list.
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Will independence result in lower or higher economic growth in the short and long term? |
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Will there be a currency union, with Scotland and the rest of the UK sharing the pound and a central bank? Or will Scotland merely use the pound outside a currency union? Would it prefer to have its own currency or join the euro over the longer term? |
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What will happen to the sterling exchange rate with the dollar, the euro and various other countries? |
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How will businesses react? Will independence encourage greater inward investment in Scotland or will there be a net capital outflow? And either way, what will be the magnitude of the effect? |
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How will assets, such as oil, be shared between Scotland and the rest of the UK? And how will national debt be apportioned? |
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How big will the transition costs be of moving to an independent Scotland? |
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How will independence impact on Scottish trade (a) with countries outside the UK and (b) with the rest of the UK? |
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What will happen about Scotland’s membership of the EU? Will other EU countries, such as Spain (because of its concerns about independence movements in Catalonia and the Basque country), attempt to block Scotland remaining in or rejoining the EU? |
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What will happen to tax rates in Scotland, with the new Scottish government free to set its own tax rates? |
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What will be the consequences for Scottish pensions and the Scottish pensions industry? |
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What will happen to the distribution of income in Scotland? How might Scottish governments behave in terms of income redistribution and what will be its consequences on output and growth? |
Of course, just because the effects cannot be known with certainty, attempts are constantly being made to quantify the outcomes in the light of the best information available at the time. These are refined as circumstances change and newer data become available.
But forecasts also depend on the assumptions made about the post-referendum decisions of politicians in Scotland, the rest of the UK and in major trading partner countries. It also depends on assumptions about the reactions of businesses. Not surprisingly, both sides of the debate make assumptions favourable to their own case.
Then there is the second category of question. Even if you could quantify the effects, just how desirable would they be? The issue here is one of the weightings given to the various costs and benefits. How would you weight distributional consequences, given that some people will gain or lose more than others? What social discount rate would you apply to future costs and benefits?
Then there are the normative and largely unquantifiable costs and benefits. How would you assess the desirability of political consequences, such as greater independence in decision-making or the break-up of a union dating back over 300 years? But these questions about nationhood are crucial issues for many of the voters.
Articles
Scottish Independence would have Broad Impact on UK Economy NBC News, Catherine Boyle (9/9/14)
Scottish independence: the economic implications The Guardian, Angela Monaghan (7/9/14)
Scottish vote: Experts warn of potential economic impact BBC News, Matthew Wall (9/9/14)
The economics of Scottish independence: A messy divorce The Economist (21/2/14)
Dispute over economic impact of Scottish independence Financial Times, Mure Dickie, Jonathan Guthrie and John Aglionby (28/5/14)
10 economic benefits for a wealthier independent Scotland Michael Gray (6/3/14)
Scottish independence, UK dependency New Economics Foundation (NEF), James Meadway (4/9/14)
Scottish Jobs and the World Economy Scottish Economy Watch, Brian Ashcroft (25/8/14)
Scottish yes vote: what happens to the pound in your pocket? Channel 4 News (9/9/14)
What price Scottish independence? BBC News, Robert Peston (12/9/14)
What price Scottish independence? BBC News, Robert Peston (7/9/14)
Economists can’t tell Scots how to vote BBC News, Robert Peston (16/9/14)
Books and Reports
The Economic Consequences of Scottish Independence Scottish Economic Society and Helmut Schmidt Universität, David Bell, David Eiser and Klaus B Beckmann (eds) (August 2014)
The potential implications of independence for businesses in Scotland Oxford Economics, Weir (April 2014)
Questions
- What is a currency union? What implications would there be for Scotland being in a currency union with the rest of the UK?
- If you could measure the effects of independence over the next ten years, would you treat £1m of benefits or costs occurring in ten years’ time the same as £1m of benefits and costs occurring next year? Explain.
- Is it inevitable that events occurring in the future will at best be known unknowns?
- If you make a statement that something will occur in the future and you turn out to be wrong, was your statement a positive one or a normative one?
- What would be the likely effects of Scottish independence on the current account of the balance of payments (a) for Scotland; (b) for the rest if the UK?
- How does inequality in Scotland compare with that in the rest of the UK and in other countries? Why might Scottish independence lead to a reduction in inequality? (See the chapter on inequality in the book above edited by David Bell, David Eiser and Klaus B Beckmann.)
- One of the problems in assessing the arguments for a Yes vote is uncertainty over what would happen if there was a majority voting No. What might happen in terms of further devolution in the case of a No vote?
- Why is there uncertainty over the amount of national debt that would exist in Scotland if it became independent?
