Category: Essential Economics for Business: Ch 01

Short-termism is a problem which has dogged British firms and is part of the explanation of low investment in the UK. Shareholders, many of which are large pension funds and other financial institutions, are more concerned with short-term returns than long-term growth and productivity. Likewise, senior managers’ rewards are often linked to short-term performance rather than the long-term health of the company.

But the stakeholders in companies extend well beyond owners and senior managers. Workers, consumers, suppliers, local residents and the country as a whole are all stakeholders in companies.

So is the current model of capitalism fit for purpose? According to the new May government, workers and consumers should be represented on the boards of major British companies. The Personnel Today article quotes Theresa May as saying:

‘The people who run big businesses are supposed to be accountable to outsiders, to non-executive directors, who are supposed to ask the difficult questions. In practice, they are drawn from the same, narrow social and professional circles as the executive team and – as we have seen time and time again – the scrutiny they provide is just not good enough.

We’re going to change that system – and we’re going to have not just consumers represented on company boards, but workers as well.’

This model is not new. Many countries, such as France and Germany, have had worker representatives on boards for many years. There the focus is often less on short-term profit maximisation and more on the long-term performance of the company in terms of a range of indicators.

Extending this model to stakeholder groups more generally could see companies taking broader social objectives into account. And the number of companies which put corporate social responsibility high on their agenda could increase significantly.

And this approach can ultimately bring better returns to shareholders. As the first The Conversation article below states:

This is something that research into a ‘Relational Company’ model has found – by putting the interests of all stakeholders at the heart of their decision making, companies can become more competitive, stable and successful. Ultimately, this will generate greater returns for shareholders.

While CSR has become mainstream in terms of the public face of some large corporations, it has tended to be one of the first things to be cut when economic growth weakens. The findings from Business in the Community’s 2016 Corporate Responsibility Index suggest that many firms are considering how corporate responsibility can positively affect profits. However, it remains the case that there are still many firms and consumers that care relatively little about the social or natural environment. Indeed, each year, fewer companies take part in the CR Index. In 2016 there were 43 firms; in 2015, 68 firms; in 2014, 97 firms; in 2013, 126 firms.

In addition to promising to give greater voice to stakeholder groups, Mrs May has also said that she intends to curb executive pay. Shareholders will be given binding powers to block executive remuneration packages. But whether shareholders are best placed to do this questionable. If shareholders’ interests are the short-term returns on their investment, then they may well approve of linking executive remuneration to short-term returns rather than on the long-term health of the company or its role in society more generally.

When leaders come to power, they often make promises that are never fulfilled. Time will tell whether the new government will make radical changes to capitalism in the UK or whether a move to greater stakeholder power will remain merely an aspiration.

Articles

Will Theresa May break from Thatcherism and transform business? The Conversation, Arad Reisberg (19/7/16)
Democratise companies to rein in excessive banker bonuses The Conversation, Prem Sikka (14/3/16)
Theresa May promises worker representatives on boards Personnel Today, Rob Moss (11/7/16)
If Theresa May is serious about inequality she’ll ditch Osbornomics The Guardian, Mariana Mazzucato and Michael Jacobs (19/7/16)
Theresa May should beware of imitating the German model Financial Times, Ursula Weidenfeld (12/7/16)

Questions

  1. To what extent is the pursuit of maximum short-term profits in the interests of (a) shareholders; (b) consumers; (c) workers; (d) suppliers; (e) society generally; (f) the environment?
  2. How could British industry be restructured so as to encourage a greater proportion of GDP being devoted to investment?
  3. How would greater flexibility in labour markets affect the perspectives on company performance of worker representatives on boards?
  4. How does worker representation in capitalism work in Germany? What are the advantages and disadvantages of this model? (See the panel in the Personnel Today article and the Financial Times article.)
  5. What do you understand by ‘industrial policy’? How can it be used to increase investment, productivity, growth and the pursuit of broader stakeholder interests?

Before the referendum, economists overwhelmingly argued that the economic case for the UK remaining in the EU was much stronger than that for leaving. They warned of serious economic consequences, both short term and long term, of a Brexit vote. And yet, by a majority of 51.9% to 48.1% of the 72.1% of the electorate who voted, the UK voted to leave the EU.

Does this mean that economists failed to communicate to the electorate? Were the arguments presented poorly or in too academic a way?

Or did people simply not believe the economists’ forecasts, being cynical about the ability of economists to forecast? During the campaign, on several occasions I heard people repeating the joke that economists had successfully predicted five out of the last two recessions!

Did they not believe the data that immigrants from other EU countries to the UK contribute more in taxes they draw in benefits and that overall they make a net positive contribution to output per head? Or perhaps they believed the claims that immigrants imposed a net cost on the economy.

Or were there ‘non-economic’ issues that people found more persuasive, such as questions of sovereignty or national identity? Or was the strain on local resources, such as health services, schools and housing, blamed on immigration itself rather than on a lack of spending on additional resources – the funding for which could have come from the extra GDP generated by the immigration?

Or were there so many lies told by politicians and those with vested interests that people simply didn’t know whom to believe?

Economists will, no doubt, do a lot of soul searching over the coming months. One such economist is Paul Johnson, Director of the Institute for Fiscal Studies, whose article is linked below.

Article
We economists must face the plain truth that the referendum showed our failings Institute for Fiscal Studies newspaper articles. Paul Johnson (28/6/16)

Questions

  1. In what ways could economists have communicated better to the general public during the referendum campaign?
  2. For what reasons may people distrust economists?
  3. Were economists hampered in delivering their message by ‘balanced reporting’?
  4. Comment on Paul Johnson’s statement that, ‘The most politically engaged of us spend decades working out how to tweak tax policy, or labour market policy, or competition policy to deliver small benefits. How many times over would our work have been repaid if we had simply convinced a few more people of the basics?’
  5. Do economists, or at least some of them, need to become more ‘media savvy’?
  6. How could institutions, such as the Royal Economic Society and the Society of Business Economists, do more to help economists collectively to communicate with the general public?
  7. Give some examples of the terminology/jargon we use which might be inappropriate for communicating with the general public. Suggest some alternative terms to the examples you’ve given.

In the following article, Joseph Stiglitz argues that power rather than competition is a better starting point for analysing the working of capitalism. People’s rewards depend less on their marginal product than on their power over labour or capital (or lack of it).

As inequality has widened and concerns about it have grown, the competitive school, viewing individual returns in terms of marginal product, has become increasingly unable to explain how the economy works.

Thus the huge bonuses, often of millions of pounds per year, paid to many CEOs and other senior executives, are more a reflection of their power to set their bonuses, rather than of their contribution to their firms’ profitability. And these excessive rewards are not competed away.

Stiglitz examines how changes in technology and economic structure have led to the increase in power. Firms are more able to erect barriers to entry; network economies give advantages to incumbents; many firms, such as banks, are able to lobby governments to protect their market position; and many governments allow powerful vested interests to remain unchecked in the mistaken belief that market forces will provide the brakes on the accumulation and abuse of power. Monopoly profits persist and there is too little competition to erode them. Inequality deepens.

According to Stiglitz, the rationale for laissez-faire disappears if markets are based on entrenched power and exploitation.

Article

Monopoly’s New Era Chazen Global Insights, Columbia Business School, Joseph Stiglitz (13/5/16)

Questions

  1. What are the barriers to entry that allow rewards for senior executives to grow more rapidly than median wages?
  2. What part have changes in technology played in the increase in inequality?
  3. How are the rewards to senior executives determined?
  4. Provide a critique of Stiglitz’ analysis from the perspective of a proponent of laissez-faire.
  5. If Stiglitz analysis is correct, what policy implications follow from it?
  6. How might markets which are currently dominated by big business be made more competitive?
  7. T0 what extent have the developments outlined by Stiglitz been helped or hindered by globalisation?

In our recent blog constructing growth without production: The UK growth paradox we saw that the provisional estimate of economic growth in the UK in the final quarter of 2015 was 0.5 per cent. This was buoyed by service sector growth of 0.7 per cent. Meanwhile, construction sector output was estimated to have fallen by 0.1 per cent and production in the production industries by 0.2 per cent. The ONS Index of Production released on 11 February suggests the decline in production activity in the final quarter might have been has much as 0.5 per cent further pointing to unbalanced industrial growth.

The production industries today account for about 15 per cent of UK output which is small in comparison to the roughly 79 per cent from service-sector industries. Chart 1 shows the quarterly rate of growth in UK industrial production since the 1980s. (Click here for a PowerPoint of the chart). Over this period the average quarterly rate of growth in industrial output has been a mere 0.1 per cent compared with 0.5 per cent for total economic output and 0.7 per cent for the service sector. As a result, the importance of the production industries as a driver of economic output has declined.

Across 2015 industrial production rose by 1 per cent while the total output of the economy grew by 2.2 per cent. Industrial output comprises four main components. Of these, output from mining and quarrying grew in 2015 by 6.6 per cent, water, sewerage and waste management by 3.1 per cent, electricity, gas, steam and air conditioning by 0.3 per cent, while manufacturing output contracted by 0.2 per cent.

Chart 2 shows the path of industrial output since 2006. (Click here for a PowerPoint of the chart). In particular, it allows us to analyse the effect of the financial crisis and the global economic downturn. Whereas the total output of the economy surpassed its 2008 Q1 peak in 2013 Q2, driven by the service sector, total industrial output in 2015 Q4 remains 9.9 per cent below its 2008 Q1 level. Among its component parts, output in mining and quarrying is 31 per cent lower, electricity, gas, steam and air conditioning output is 12.2 per cent lower and manufacturing 6.5 per cent lower. Only the output of water, sewerage and waste management is greater – some 7.4 per cent higher.

The data point to the industrial composition of UK remaining heavily skewed towards the service sector and, hence, to service-sector industries driving economic growth. A key talking point is the extent to which this matters. On one hand we might point to the deindustrialisation captured by the data. This has had profound implications for certain regions of the United Kingdom and in particular for living standards in certain communities. Industrial change poses challenges for the UK labour force and for policymakers trying to affect the skills of workers needed in a changing economy. It has had a profound impact on the country’s balance of trade in goods: we consistently run a balance of trade deficit in goods. On the other hand we might argue that the UK does services well. We might be said to have a comparative advantage in this area. Whatever, your view point the latest industrial production data show the fragility of UK industrial output.

Data

Index of Production Dataset December 2015 Office for National Statistics
Index of Production, December 2015 Office for National Statistics

Articles
UK industrial production shrank in 2015 Guardian, Phillip Inman (10/2/16)
December UK industrial output falls sharply BBC News, (10/2/16)
Manufacturing output fall dents UK growth hope Sky News, (10/2/16)
Industrial production’s worst monthly fall since 2012 Belfast Trelegraph, Holly Williams (11/2/16)
GDP growth picks up to 0.5% but only the services sector comes to the party Independent, Ben Chu (29/1/16)

Questions

  1. What is meant by industrial production? How does it differ from the economy’s total output?
  2. Would you expect the index of production to be less or more volatile than total output? Explain your answer.
  3. What factors might explain the volatility of industrial production?
  4. Do the different rates of growth across the industrial sectors of the UK matter?
  5. Discuss the economic issues that might arise as the industrial composition of a country changes.
  6. Why is the distinction between nominal and real important when analysing economic growth?

The town of Kilkenny in Ireland has just hosted the sixth annual Kilkenomics festival (Nov 5–8) where economics and comedy meet. The festival brought together comedians and economists to take a look at some of the most pressing economic and social issues, such as the refugee crisis, economic recovery, banking and finance, the growth in inequality, the future of the EU, economic power, the environment and personal behaviour.

With stand-up comedians taking a sideways look at economic issues and top economists having their ideas lampooned, or lampooning them themselves, the festival provided a fun, but useful, reality check for the discipline of economics.

The festival attracted some major names in the field of comedy, economics, journalism and politics. Perhaps the biggest draw was the former finance minister of Greece, Yanis Varoufakis (see also), who opened the festival with a withering attack on the economic model being pursued by Greece’s creditors (the European Commission, the IMF and the ECB).

Much of the comedy was really aimed, not so much at economics and economists, but more at how politicians pursue economic policies and interpret economic models in ways that suit their own political agenda. But still there was no escape for economists. Much of the humour was directed at unrealistic assumptions and unrealistic visions of how economies function.

Thanks to JokEc for the following:

 •  Economics is the only field in which two people can get a Nobel Prize for saying exactly the opposite thing.
 •  If you rearrange the letters in “ECONOMICS”, you get “COMIC NOSE”.
 •  Economics has got so rigorous we’ve all got rigor mortis.
 •  How many economists does it take to change a light bulb?

I’ll leave you to work out the best answer to that last one – there could be many depending on the school of thought.

Videos and podcasts

Kilkenomics Promo – 2015 Kilkenomics on YouTube (23/10/15)
Kilkenomics: Highlights 1 Kilkenomics on YouTube (27/10/15)
Kilkenomics: Highlights 2 Kilkenomics on YouTube (30/10/15)
Kilkenomics 2014 BBC ‘In the Balance’ (9/11/14)

Articles

Kilkenomics launches biggest programme to date Meath Chronicle (1/10/15)
The subversive wonders of Kilkenomics – where economics meets stand-up The Spectator, Liam Halligan (15/11/14)
Guilty as charged: Irish standup festival puts economics in the dock The Guardian, Larry Elliott (8/11/15)
Ireland no paradigm of successful austerity – Varoufakis The Irish Times, Eoin Burke Kennedy (5/11/15)
Economy of sex … how much are your orgasms costing you? Irish Independent, Niamh Horan (8/11/15)

Questions

  1. What is it about economics that gives so much material to comedians?
  2. ‘The worse it gets the funnier it seems because comedy exists with tragedy.’ To what extent is this true of economics as a discipline or simply of the state of the world economists are studying at any one time?
  3. Should assumptions in economics always be realistic? Explain why or why not.
  4. For what types of reason might economists disagree?
  5. Make up an economics joke and test it on your fellow students. Perhaps there ought to be a vote for the funniest and a prize for the winner. What was it about the winning joke that made it the funniest?