Category: Essential Economics for Business: Ch 13

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Shortages in Venezuela – what’s the solution?

A simple model in economics is that of demand and supply. Through the price mechanism, signals are sent between consumers and producers and this interaction results in an equilibrium market price and quantity. However, what happens when the market for a good or service is in disequilibrium?

When a market is in equilibrium, demand equals supply. However, as we discussed in a previous blog concerning baby milk in China (see Milking the economy), markets are not always in equilibrium. If demand exceeds supply, a shortage will emerge and to eliminate this, the price must rise. If, on the other hand, supply exceeds demand, there will be an excess supply and thus the price must fall to restore equilibrium.

The market in question here is toilet paper in Venezuela! A severe shortage of this product has emerged in recent months, with shops running out of supplies. In a bid to relieve this shortage, the country’s Minister of Commerce has received approval for a $79 million credit, which can be used to import this basic product in short supply. Fifty million rolls will be imported to help fill the shortage that has emerged. The shortage is not just a problem for toilet paper, but also across a range of basic consumer goods. The article from Reuters comments that:

The government says the toilet paper shortages, like others, are the results of panicked buying and unscrupulous merchants hoarding the goods to artificially inflate prices.

Opposition critics say the problem is caused by the currency controls, created a decade ago by late socialist leader Hugo Chavez, and years of nationalizations that weakened private industry and left businesses unwilling to invest.

With shortages across a variety of products, the President has begun to work closely with business leaders to address this situation. The following articles consider this basic market, the intervention and consequences.

Venezuela hopes to wipe out toilet paper shortage by importing 50m rolls The Guardian (16/5/13)
Venezuela ends toilet paper shortage BBC News (22/5/13)
With even toilet paper scarce, Venezuelan president warms to business Reuters, Eyanir Chinea (22/5/13)
Toilet paper shortage in Venezuela to end after lawmakers back plans to import 39 million rolls Huffington Post, Sara Nelson (22/5/13)
Venezuela’s toilet paper shortage ended; 3 other basic goods that went scarce in the country International Business Times, Patricia Rey Mallen (22/5/13)

Questions

  1. Using a demand and supply diagram, explain how equilibrium is determined in a free market.
  2. Illustrate the shortage described in the aticles on your above demand and supply diagram. How should the price mechanism adjust?
  3. What types of government intervention have led to the shortages of such basic consumer goods?
  4. How have currency controls created a problem for Venezuela?
  5. With an increase in imported products, what impact might there be on Venezuela’s exchange rate and on its balance of payments?
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Avoiding questions of tax avoidance

If you ask most people whether they like paying tax, the answer would surely be a resounding ‘no’. If asked would you like to pay less tax, most would probably say ‘yes’. Evidence of this can be seen in the behaviour of individuals and of companies, as they aim to reduce their tax bill, through both legal and illegal methods.

Our tax revenues are used for many different things, ranging from the provision of merit goods to the redistribution of income, so for most people they don’t object to paying their way. However, maintaining profitability and increasing disposable income is a key objective for companies and individuals, especially in weak economic times. Some high profile names have received media coverage due to accusations of both tax avoidance and tax evasion. Starbucks, Amazon, Googe and Apple are just some of the big names that have been accused of paying millions of pounds/dollars less in taxation than they should, due to clever (and often legal) methods of avoiding tax.

The problem of tax avoidance has become a bigger issue in recent years with the growth of globalisation. Multinationals have developed to dominate the business world and business/corporation tax rates across the global remain very different. Thus, it is actually relatively easy for companies to reduce their tax burden by locating their headquarters in low tax countries or ensuring that business contracts etc. are signed in these countries. By doing this, any profits are subject to the lower tax rate and are thus such companies are accused of depriving the government of tax revenue. Apple is currently answering questions posed by a US Senate Committee, having been accused of structuring its business to create ‘the holy grail of tax avoidance’.

Many may consider the above and decide that these companies have done little wrong. After all, many schemes aimed at tax avoidance are legal and are often just a clever way of using the system. However, in a business environment dominated by the likes of Google, Apple and Amazon, the impact of tax avoidance may not just be on the government’s coffers. Indeed John McCain, one of the Committee members asked:

…Couldn’t one draw the conclusion that you and Apple have an unfair advantage over domestic based corporations and companies, in other words, smaller companies in this country that don’t have the same ability that you do to locate in Ireland or other countries overseas?

The concern is that with such ability to avoid huge amounts of taxation, large companies will inevitably compete smaller ones out of the market. Local businesses, without the ability to re-locate to other parts of the world, pay their full tax bills, but multinationals legally (in most cases) manage to avoid paying their own share. With a harsh economic climate continuing globally, these large companies that aim to further increase their profitability through such means as tax avoidance will naturally bear the wrath of smaller businesses and individuals that are struggling to get by. It’s likely that this topic will remain in the media for some time. The following articles consider some of the companies accused of participating in tax avoidance schemes and the consequences of doing so.

Is Apple’s tax avoidance rational? BBC News, Robert Peston (21/5/13)
Apple’s Tim Cook defends tax strategy in Senate BBC News (21/5/13)
Senator accuses Apple of ‘highly questionable’ billion-dollar tax avoidance scheme The Guardian, Dominic Rushe (21/5/13)
Apple’s Tim Cook faces tax avoidance questions Sky News (21/5/13)
EU leaders look to end Apple-style tax avoidance schemes Reuters, Luke Baker and Mark John (21/5/13)
Apple Chief Tim Cook defends tax practices and denies avoidance Financial Times, James Politi (21/5/13)
Apple CEO Tim Cook tells Senate: tiny tax bill isn’t our fault, it’s yours Independent, Nikhil Kumar (21/5/13)
Miliband promises action on Google tax avoidance The Telegraph (19/5/13)
Google is cheating British tax payers out of millions…what they are doing is just immoral’: Web giant accused of running ‘scandalous’ tax avoidance scheme by whistleblower Mail Online, Becky Evans (19/5/13)
Multinational CEOs tell David Cameron to rein in tax avoidance rhetoric The Guardian, Simon Bowers, Lawrie Holmes and Rajeev Syal (20/5/13)
Fury at corporate tax avoidance leads to call for a global response The Guardian, Tracy McVeigh (18/5/13)

Questions

  1. What is the difference between tax evasion and tax avoidance? Is it rational to engage in such schemes?
  2. What are tax revenues used for?
  3. Why are multinationals more able to engage in tax avoidance schemes?
  4. Is the problem of tax avoidance a negative consequence of globalisation?
  5. How might the actions of large multinationals who are avoiding paying large amounts of tax affect the competitiveness of the global market place?
  6. Is there justification for a global policy response to combat the issue of tax avoidance?
  7. What are the costs and benefits to a country of having a low rate of corporation tax?
  8. How would a more ‘reasonable’ tax on foreign earnings allow the ‘free movement of capital back to the US’?
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The UK and the single market

A key debate for some months has been the UK’s membership of the European Union. The debate has centred around the desire to return some powers back to the UK, but this has extended into the possibility of a referendum on our membership of the preferential trading area. So, let’s take a step back and consider why any country would want to be a member of a preferential trading area.

Preferential trading areas can be as basic as a free trading area or as advanced as a currency, or even political union. The eurozone is clearly a currency union, but the European Union, of which the UK is a member, is a common market. A common market has no tariffs and quotas between the members, but in addition there are common external tariffs and quotas. The European union also includes the free movement of labour, capital and goods and services. Membership of a preferential trading area therefore creates benefits for the member countries. One such benefit is that of trade creation. Members are able to trade under favourable terms with other members, which yields significant benefits. Countries can specialise in the production of goods/services in which they have a comparative advantage and this enables greater quantities of output to be produced and then traded.

Other benefits include the greater competition created. By engaging in trade, companies are no longer competing just with domestic firms, but with foreign firms as well. This helps to improve efficiency, cut costs and thus lower prices benefiting consumers. However, from a firm’s point of view there are also benefits: they have access to a much wider market in which they can sell their goods without facing tariffs. This creates the potential for economies of scale to be achieved. Were the UK to completely exit the EU, this could be a significant loss for domestic firms and for consumers, who would no longer see the benefits of no tariffs on imported goods. Membership of a preferential trading area also creates benefits in terms of potential technology spillovers and is likely to have a key effect on a country’s bargaining power with the rest of the world. As is a similar argument to membership of a trade union, there is power in numbers.

There are costs of membership of a preferential trading area, but they are typically outweighed by the benefits. However, estimates suggest that the cost of EU regulation is the equivalent of 10% of UK GDP. Furthermore, while the UK certainly does trade with Europe, data suggests that only 13% of our GDP is dependent on such exports. The future is uncertain for the European Union and Britain’s membership. There are numerous options available besides simply leaving this preferential trading area, but they typically have one thing in common. They will create uncertainty and this is something that markets and investors don’t like. Vince Cable warned of this, saying:

There are large numbers of potential investors in the UK, who would bring employment here, who have been warned off because of the uncertainty this is creating.

The impact of the UK’s decision will be significant and not just for those living and working in the economy. The world is no interdependent that when countries exist (or typically enter) a preferential trading area the wider economic effects are significant. While any change in the UK’s relationship with the EU will take many months and years to occur and then further time to have an effect, the uncertainty created by the suggestion of a change in the relationship has already sent waves across the world. The following articles consider the wider single market and the current debate on UK membership.

European Union: if the ‘outs’ get their way, we’ll end up like Ukraine Guardian, Vince Cable (16/5/13)
Conservative MP James Wharton champions bill to guarantee EU referendum Independent, Andrew Grice (16/5/13)
Nick Clegg shifts ground over EU referendum The Guardian, Patrick Wintour (15/5/13)
Cameron tells EU rebels to back referendum law Reuters, Peter Griffiths (16/5/13)
The EU and the UK – the single market BBC Democracy (4/3/13)
Single market dilemmas on Europe BBC News, Stephanie Flanders (14/5/13)
Lord Wolfson: I back the single market – but not at any cost The Telegraph, Lord Wolfson (19/1/13)
EU focuses on returning single market to health Financial Times, James Fontanella-Khan (8/5/13)

Questions

  1. What other examples of preferential trading areas are there? How close are they to the arrangement of the European Union?
  2. In each of the above examples, explain the type of preferential trading area that it is.
  3. What are the benefits and costs of being a member of a preferential trading area such as the EU? How do these differ to being a member of a) a free trade area and (b) a customs union?
  4. What options are open to the UK in terms of re-negotiating its relationship with the EU? In each case, explain how the benefits and costs identified in question 3 would change.
  5. Why is the UK’s decision so important for the global economy? Would it be in the interests of other economies? Explain your answer.
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GDP and development

The link below is to an article by Bill Gates, founder of Microsoft. He argues that per-capita GDP is a poor indicator of development, especially in Sub-Saharan Africa.

The problems with using GDP as an indicator of the level of development of a country are well known and several alternative measures are in common use. Perhaps the best known is the United Nations Development Programme’s Human Development Index (HDI), where countries are given an HDI of between 0 and 1. HDI is the average of three indices based on three sets of variables: (i) life expectancy at birth, (ii) education (a weighted average of (a) the mean years that a 25-year-old person or older has spent in school and (b) the number of years of schooling that a 5-year-old child is expected to have over their lifetime) and (iii) real gross national income (GNY) per capita, measured in US dollars at purchasing-power parity exchange rates (see Box 27.1 in Economics 8th edition for more details).

But although indicators such as this capture more elements of development than simple per-capita GNP or GNY, there are still serious shortcomings. A major problem is the lack of and inaccuracy of statistics, especially when applied to the rural subsistence and informal urban sectors. The problem is recognised and some countries are trying to address the problem (see the second article below), but the problem is huge. As Gates says:

It is clear to me that we need to devote greater resources to getting basic GDP numbers right. … National statistics offices across Africa need more support so that they can obtain and report timelier and more accurate data. Donor governments and international organisations such as the World Bank need to do more to help African authorities produce a clearer picture of their economies. And African policymakers need to be more consistent about demanding better statistics and using them to inform decisions.

Another problem is how you convert data into internationally comparable forms. For example, how are inflation, exchange rates, income distribution, the quality of health provision and education, etc. taken into account?

How GDP understates economic growth The Guardian, Bill Gates (8/5/13)
States’ GDP computation report out soon, says Nigeria statistics bureau Premium Times (Nigeria), Bassey Udo (9/5/13)
Michael Porter Presents New Alternative to GDP: The Social Progress Index (SPI) Triple Pundit, Raz Godelnik (13/4/13)

Questions

  1. By accessing the Human Development Index site, identify which countries have a much higher ranking by HDP than by per capita gross national income. Explain why.
  2. Why is expressing GNY in purchasing-power parity (PPP) terms likely to increase the GNY figures for the poorest countries?
  3. Explain the following quote from the Gates article: ‘I have long believed that GDP understates growth even in rich countries, where its measurement is quite sophisticated, because it is very difficult to compare the value of baskets of goods across different time periods’.
  4. Why is GNY per capita, even when expressed in PPP terms, likely to understate the level of development in subsistence economies?
  5. Explain whether the rate of growth of GNY per capita is likely to understate or overstate the rate of economic development of sub-Saharan African countries?
  6. Why are the challenges of calculating GDP or GNY particularly acute in sub-Saharan Africa?