Category: Essential Economics for Business: Ch 09

At the annual World Economic Forum (WEF) in Davos, Switzerland, world political and business leaders are meeting to discuss pressing economic issues of the day. This year, one of the key themes is climate change and “how to save the planet”.

The approaches of leaders to the climate crisis, however, differ enormously. At the one extreme there are those who deny that emissions have caused climate change, or who reluctantly acknowledge climate change but think that governments need to do nothing and that technological advances in green energy and transport will be sufficient to curb global warming. This has been the approach of President Trump, President Bolsonaro of Brazil and Prime Minister Scott Morrison of Australia. They may claim to support the general goals of reducing greenhouse gases, but are keen to protect their coal and oil industries and, in the case of Brazil, to continue cutting down the Amazon rain forest to support mining, ranching and the growing of crops.

At his speech at the WEF, President Trump said that he supported the initiative to plant one trillion trees worldwide to act as a carbon sink. However, he gave no details of just what the nature of the support would be. Would there be subsidies or tax breaks, for example, for landowners to plant trees? In the meantime, his administration has relaxed regulations to curb air and water pollution. And he has withdrawn the USA from the Paris climate agreement.

Other leaders, urged on by activists, such as Greta Thunberg, have talked about tougher action to tackle emissions. Countries such as Canada, Norway and the EU countries have adopted a number of initiatives. Policies range from taxing emissions, capping/regulating emissions with penalities for those breaching the limits, tradable permits, subsidising green alternatives, setting local emissions targets with incentives for meeting them, investing in green infrastructure such as roadside charging points for electric vehicles, making environmental education part of a national curriculum, investing in public transport, and so on. But, say, activists, only large-scale measures that truly recognise the scale of the climate emergency will be sufficient.

The year starts with climate being addressed at Davos; it ends with the annual Conference of the Parties (COP26) to the United Nations Framework Convention on Climate Change (UNFCCC). This year it will be in Glasgow. There is much hope pinned on this conference, given the growing realisation of the effects of climate change, from bush fires in Australia, to floods in Indonesia and other parts of southeast Asia, to more extreme hurricanes/typhoons, to rapidly melting glaciers and retreating sea ice, to rising sea levels, to crop failures and the displacement of humans and the destruction of wildlife and habitat.

COP25 in Madrid made little progress; it is hoped that COP26 will be much more successful. Sir David Attenborough has warned that the world faces a ‘climate crisis moment’. He hopes that the world will be ready to take much stronger action at COP26.

But there remains the fundamental economic problem of the tragedy of the commons. As long as the atmosphere and other parts of the environment are free to ‘use’ to pollute, and as long as the costs of doing so are borne largely by people other than the direct polluters, the market will fail to provide a solution. Australia’s bush fires can be directly attributed to climate change and climate change is exacerbated by coal-fired power stations. But Australia’s use of coal as a power source is only a tiny contributor to global climate change. Presumably, the Australian government would rather get a ‘free ride’ off other countries’ policies to cut emissions rather than bearing the economic cost of reducing coal-fired generation itself for little gain in terms of reduced global emissions.

However, people are not entirely selfish. Many are willing to make personal sacrifices to lead a more environmentally sustainable life. Many people, for example, are choosing electricity tariffs that are slightly higher but where the electricity is generated with zero carbon emissions. Firms have shown a readiness to respond to demands from their consumers for more sustainable products.

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Questions

  1. Draw a diagram to show how the external costs of carbon emissions cause a more than socially optimal output of products emitting CO2.
  2. What is meant by the ‘tragedy of the commons’? Give some environmental examples.
  3. Discuss possible solutions to the tragedy of the commons.
  4. Why was COP25 generally regarded as a failure?
  5. Identify four possible policies that governments could adopt to reduce carbon emissions and discuss their relative advantages and disadvantages.
  6. Are meetings such as the annual World Economic Forum meetings at Davos of any benefit other than to the politicians attending? Explain.

The online market for food delivery has grown rapidly grown in recent years. Deliveroo was founded in 2013 and has become one of the most recognised brands in this market. It now has a presence in around 100 towns and cities in the UK. In addition to offering customers restaurant cooked meals delivered straight to their homes, Deliveroo also provides a grocery store delivery service, for example in partnership with with the Co-op.

Despite Deliveroo’s strong brand, the market leader in online restaurant delivery is actually Just Eat. Just Eat’s business model is built on it acting as an intermediary between restaurants and consumers who can use Just Eat’s website or app to order take-aways. This is in contrast to Deliveroo which also provides the delivery service. This means that Just Eat’s service is more viable in smaller towns. Deliveroo’s other main rival is Uber Eats.

Having been founded in the UK, Deliveroo has subsequently expanded its operations to around 10 other countries. However, this global expansion resulted in Deliveroo making losses of almost £200m in 2017. In part as a result of these losses, Deliveroo decided to look for new investment and by May 2019 had raised £450m. Deliveroo intends to use this money to fund its continued international expansion and to improve the service it provides. This includes growing its delivery-only kitchens business, which enables it to be less reliant on links with traditional restaurants.

Amazon was one of the big investors in Deliveroo, although the exact amount it invested is unknown. Interestingly, both Amazon and Uber have previously made approaches to buy Deliveroo outright. For Amazon this latest move may be a first step before looking to fully acquire Deliveroo.

Despite this not being a full merger or acquisition, it was still investigated by the UK Competition and Markets Authority (CMA). Its remit allows it also to examine situations where an enterprise gains a ‘material influence over the policy of another’. This was the case with Amazon’s investment which, despite only allowing it to become a minority shareholder, enables it to participate in the management of the company.

Last week the CMA announced that it had completed its initial investigation and that it had concerns about the investment. Andrea Gomes de Silva, CMA Executive Director, stated that:

If the deal were to proceed in its current form, there’s a real risk that it could leave customers, restaurants and grocers facing higher prices and lower quality services as these markets develop. This is because the significant competition which could otherwise exist between Amazon and Deliveroo would be reduced.

The CMA has two specific concerns. Firstly, it is worried that competition in online restaurant delivery will be harmed. Amazon had started competing with Deliveroo in this market in 2016 when it launched Amazon Restaurants. However, it shut this down two years later. The CMA uncovered internal documents from Amazon suggesting that it continued to monitor closely this market. Therefore, the CMA believed that Amazon re-entering the market was a distinct possibility and argued that this would be a substantial boost for competition. The CMA’s concern was that its investment in Deliveroo would make this re-entry less likely.

On the other hand, there is a counterargument to the CMA’s which says that Amazon’s entry through investment, even if only at this time resulting in minority ownership of Deliveroo, could itself boost competition. This is an important trade-off the CMA should take into account.

Secondly, the CMA is worried that Amazon’s investment will also harm competition in online grocery store delivery. Here, Amazon and Deliveroo are two of the leading players in the market. The CMA believes that, as the market grows in the future, competition between the two could intensify. However, the investment in Deliveroo would put this in jeopardy.

At the time of writing, Amazon and Deliveroo have five working days to offer proposals to the CMA to address these competition concerns. It will be interesting to see how they respond to the CMA and whether a full-blown investigation follows. If it does, this may eventually lead to the CMA blocking Amazon’s investment.

POSTSCRIPT: Amazon and Deliveroo did offer a proposal to address the competition concerns and so on 27th December the CMA referred the case for a full-blown investigation.

To be continued.

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Questions

  1. What are the key features of competition in the online market for food delivery?
  2. What are the pros and cons of Just Eat’s business model in comparison with Deliveroo’s?
  3. What are the potential advantages Amazon has over the other players in the online market for food delivery?

The USA has seen many horizontal mergers in recent years. This has turned industries that were once relatively competitive into oligopolies, resulting in lower output and higher prices for consumers.

In Europe, by contrast, many markets are becoming more competitive. The result is that in industries such as mobile phone services, airlines and broadband provision, prices are considerably lower in most European countries than in the USA. As the French economist, Thomas Philippon, states in a Guardian article:

When I landed in Boston in 1999, the United States was the land of free markets. Many goods and services were cheaper than in Europe. Twenty years later, American free markets are becoming a myth.

According to Asher Schechter (see linked article below):

Nearly every American industry has experienced an increase in concentration in the last two decades, to the point where … sectors dominated by two or three firms are not the exception, but the rule.

The result has been an increase in deadweight loss, which, according to research by Bruno Pelligrino, now amounts to some 13.3 per cent of total potential surplus.

Philippon in his research estimates that monopolies and oligopolies “cost the median American household about $300 a month” and deprive “American workers of about $1.25tn of labour income every year”.

One industry considered by the final two linked articles below is housebuilding. Since the US housing and financial crash of 2007–8 many US housebuilders have gone out of business. This has meant that the surviving companies have greater market power. According to Andrew van Dam in the linked Washington Post article below:

They have since built on that advantage, consolidating until many markets are controlled by just a few builders. Their power has exacerbated the country’s affordable-housing crisis, some economists say.

According to research by Luis Quintero and Jacob Cosman:

… this dwindling competition has cost the country approximately 150 000 additional homes a year – all else being equal. With fewer competitors, builders are under less pressure to beat out rival projects, and can time their efforts so that they produce fewer homes while charging higher prices.

Thanks to lobbying of regulators and politicians by businesses and various unfair, but just about legal, practices to exclude rivals, competition policy in the USA has been weak.

In the EU, by contrast, the competition authorities have been more active and tougher. For example, in the airline industry, EU regulators have “encouraged the entry of low-cost competitors by making sure they could get access to takeoff and landing slots.” Politicians from individual EU countries have generally favoured tough EU-wide competition policy to prevent companies from other member states getting an unfair advantage over their own country’s companies.

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Questions

  1. What are the possible advantages and disadvantages of oligopoly compared with markets with many competitors?
  2. How can concentration in an industry be measured?
  3. Why have US markets become more concentrated?
  4. Why have markets in the EU generally become more competitive?
  5. Find out what has happened to levels of concentration in the UK housebuilding market.
  6. What are the possible effects of Brexit on concentration and competition policy in the UK?

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.

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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?