Category: Essentials of Economics: Ch 08

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A modern tragedy of the commons

In many parts of the world, life in the oceans is dying out. The term ‘dead zones’ is used to describe seas that are devoid of marine life. And these zones are growing in size and number.

It’s not just the decline in fish and other marine species that’s worrying environmentalists and many others; it’s a growth in rubbish. Part of this is caused by natural disasters, such as the 2011 Tsunami in Japan that washed huge amounts of debris into the Pacific Ocean. But much of it is caused by rubbish carried down rivers and into the seas, or rubbish jettisoned from ships. The problem is particularly acute in areas of the oceans where currents circulate the rubbish into huge rubbish dumps. There are two such areas either side of Hawaii in the Pacific. Both are vast.

The first article below tells the tale of Newcastle (Australia) yachtsman Ivan Macfadyen. He completed the 2013 Melbourne to Osaka double handed yacht race earlier this year as skipper of his yacht Funnelweb and then went on to bring the yacht home to Australia via America and race the famous Trans-Pac Yacht Race from Los Angeles to Hawaii along the way.

Exactly 10 years before, when [he] had sailed exactly the same course from Melbourne to Osaka, all he’d had to do to catch a fish from the ocean between Brisbane and Japan was throw out a baited line.

“There was not one of the 28 days on that portion of the trip when we didn’t catch a good-sized fish to cook up and eat with some rice,” Macfadyen recalled. But this time, on that whole long leg of sea journey, the total catch was two. No fish. No birds. Hardly a sign of life at all.

After reaching Osaka in Japan, they sailed on to San Francisco via Hawaii.

“After we left Japan, it felt as if the ocean itself was dead,” Macfadyen said. “We hardly saw any living things. We saw one whale, sort of rolling helplessly on the surface with what looked like a big tumour on its head. It was pretty sickening.”

“I’ve done a lot of miles on the ocean in my life and I’m used to seeing turtles, dolphins, sharks and big flurries of feeding birds. But this time, for 3000 nautical miles there was nothing alive to be seen.”

In place of the missing life was garbage in astounding volumes.

As economists, you should readily understand that here we have a case of over-exploited common resources – a Tragedy of the Commons of epic proportions. One ship’s rubbish may make a tiny difference, but when the cost of dumping is near zero and when the oceans are not policed, what is rational for a single ship becomes a disaster when repeated tens of thousands of times by other ships

Again, overfishing is the result of seemingly rational behaviour by crews of individual fishing boats. But as Economics (8th edition) points out on pages 328–30:

Common resources are not owned but are available free of charge to anyone. Examples include the air we breathe and the oceans for fishing. Like public goods, they are non-excludable. For example, fishing boats can take as many fish as they are able from the open seas. There is no ‘owner’ of the fish to stop them. As long as there are plentiful stocks of fish, there is no problem.

But as more people fish the seas, so fish stocks are likely to run down. This is where common resources differ from public goods. There is rivalry. One person’s use of a common resource diminishes the amount available for others. This result is an overuse of common resources. This is why fish stocks in many parts of the world are severely depleted, why virgin forests are disappearing (cut down for timber or firewood), why many roads are so congested and why the atmosphere is becoming so polluted (being used as a common ‘dump’ for emissions). In each case, a resource that is freely available is overused. This has become known as the tragedy of the commons.

… When I use a common resource, I am reducing the amount available for others. I am imposing a cost on other people: an external cost. If I am motivated purely by self-interest, I will not take these external costs into account.

Try doing some research to find out just what has been happening to the state of the oceans in recent years.

Articles

The ocean is broken Newcastle Herald (Australia), Greg Ray (18/10/13)
Our Planet Is Exploding With Ocean Dead Zones Business Insider, Dina Spector (26/6/13)
Health of oceans ‘declining fast’ BBC News, Roger Harrabin (3/10/13)
Chaos in the Oceans Huffington Post, Evaggelos Vallianatos (14/10/13)
Ocean Health Suffers from Overfishing, Index Finds Live Science, TechMedia, Douglas Main (16/10/13)

Information
Dead zone (ecology) Wikipedia
Common Fisheries Policy Wikipedia
Reform of the Common Fisheries Policy Fisheries DG, European Commission
Ocean Health Index OHI

Questions

  1. How does a common resource differ from a public good?
  2. What is the equilibrium use of a common resource? Demonstrate this with a diagram.
  3. What is the socially efficient use of a common resource such as a fishing ground?
  4. In what ways have modern ‘industrial’ methods of fishing compounded the problem of the overuse of fishing grounds?
  5. What criteria, other than social efficiency, could be used to determine the optimal use of a common resource?
  6. Explain how the Common Fisheries Policy of the EU works. Are there any lessons that can be learned by other groups of countries from the experience of the CFP?
  7. Are there any ‘good news’ stories about the state of any of the oceans? If so, to what extent are they the result of deliberate human action?
  8. To what extent is the Internet a common resource?
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Fuelling the Political Playing Field

The cost of living is a contentious issue and is likely to form a key part of the political debate for the next few years. This debate has been fuelled by the latest announcement by SSE of an average rise in consumer energy bills of 8.2%, meaning that an average dual-fuel customer would see its bill rise by £106. With this increase, the expectation is that the other big energy companies will follow suit with their own price rises.

Energy prices are made up of numerous factors, including wholesale prices, investment in infrastructure and innovation, together with government green energy taxes. SSE has put their price hike down to an increase in wholesale prices, but has also passed part of the blame onto the government by suggesting that the price hikes are required to offset the government’s energy taxes. Will Morris, from SSE said:

We’re sorry we have to do this…We’ve done as much as we could to keep prices down, but the reality is that buying wholesale energy in global markets, delivering it to customers’ homes, and government-imposed levies collected through bills – endorsed by all the major parties – all cost more than they did last year.

The price hike has been met with outrage from customers and the government and has provided Ed Miliband with further ammunition against the Coalition’s policies. However, even this announcement has yet to provide the support for Labour’s plans to freeze energy prices, as discussed in the blog Miliband’s freeze. Customers with other energy companies are likely to see similar price rises in the coming months, as SSE’s announcement is only the first of many. A key question is how will the country provide the funding for much needed investment in the energy sector? The funds of the government are certainly not going to be available to provide investment, so the job must pass to the energy companies and in turn the consumers. It is this that is given as a key reason for the price rises.

Investment in the energy infrastructure is essential for the British economy, especially given the lack of investment that we have seen over successive governments – both Labour and Conservative. Furthermore, the government’s green targets are essential and taxation is a key mechanism to meet them. Labour has been criticized for its plans to freeze energy prices, which may jeopardise these targets. The political playing field is always fraught with controversy and it seems that energy prices and thus the cost of living will remain at the centre of it for many months.

More energy price rises expected after SSE increase BBC News (10/10/13)
SSE retail boss blames government for energy price rise The Telegraph, Rebecca Clancy (10/10/13)
A better way to take the heat out of energy prices The Telegraph (11/10/13)
SSE energy price rise stokes political row Financial Times, John Aglionby and Guy Chazan (10/10/13)
Ed Miliband condemns ‘rip-off’ energy firms after SSE 8% price rise The Guardian, Terry Macalister, Angela Monaghan and Rowena Mason (28/9/12)
Coalition parties split over energy companies’ green obligations Independent, Nigel Morris (11/10/13)
Energy price rise: David Cameron defends green subsidies The Guardian, Rowena Mason (10/10/13)
‘Find better deals’ users urged as energy bills soar Daily Echo (11/10/13)
Energy Minister in row over cost of taxes Sky News (10/10/13)
SSE energy price rise ‘a bitter pill for customers’ The Guardian, Angela Monaghan (10/10/13)
Energy firm hikes prices, fuels political row Associated Press (10/10/13)
Only full-scale reform of our energy market will prevent endless price rises The Observer, Phillip Lee (27/10/13)

Questions

  1. In what market structure would you place the energy sector?
  2. Explain how green taxes push up energy bills? Use a diagram to support your answer.
  3. Consider the energy bill of an average household. Using your knowledge and the articles above, allocate the percentage of that bill that is derived from wholesale prices, green taxes, investment in infrastructure and any other factors. Which are the key factors that have risen, which has forced SSE (and others) to push up prices?
  4. Why is investment in energy infrastructure and new forms of fuel essential? How might such investment affect future prices?
  5. Why has Labour’s proposed 20-month price freeze been criticised?
  6. What has happened to energy prices over the past 20 years?
  7. Is there now a call for more government regulation in the energy sector to allay fears of rises in the cost of living adversely affecting the poorest households?
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Who controls the airports?

No matter the product or service, price is always a key factor and never more so than in tough economic times. In most cases, prices are allowed to be determined by the forces of demand and supply, which gives the equilibrium price. However, in some cases, the government may choose to intervene with a price control, for example rent controls and the national minimum wage. Another market where there is also regulation is the airline industry and the Civil Aviation Authority have recently been criticized by Heathrow Airport for its price control plan.

Whenever we go on holiday, the price we pay for an airline ticket will depend in part on the airport we are taking off from and landing at, as they will charge the airline for landing fees, security, terminals etc. Heathrow airport had proposed that annual rises to its tariffs charged to airlines would increase by 4.6% above RPI inflation. However, this plan has been rejected by the CAA, which has said that the annual tariff rise between 2014 and 2018 should not be above the RPI. Though Heathrow are criticizing the CAA about this restriction, it is an improvement from the initial proposal which would have capped price rises at the RPI minus 1.3%.

Controversy has naturally been created, with the CAA arguing that such price controls are needed to keep prices down and thus benefit consumers and retain the competitiveness of Heathrow airport. But, in contrast, Heathrow has argued that such a cap will put its competitive position under pressure and will risk future investment in the UK. But this isn’t the only criticism of the CAA. Airlines aren’t happy with the ruling either, arguing that the CAA has bowed to the pressure of Heathrow. The contrasting positions of the CAA, Heathrow and airlines are evident in the following quotes, firstly from the Chairwoman of the CAA:

The proposals will put an end to over a decade of prices rising faster than inflation at Heathrow. Tackling the upward drift in Heathrow’s prices is essential to safeguard its globally competitive position. The challenge for Heathrow is to maintain high levels of customer service while reducing costs. We are confident this is possible and that our proposals create a positive climate for further capital investment, in the passenger interest.

Secondly, from Heathrow’s Chief Executive:

This proposal is the toughest Heathrow has ever faced. The CAA’s settlement could have serious and far-reaching consequences for passengers and airlines at Heathrow … We want to continue to improve Heathrow for passengers. Instead, the CAA’s proposals risk not only Heathrow’s competitive position but the attractiveness of the UK as a centre for international investment. We will now carefully consider our investment plans before responding fully to the CAA.

And finally from the IAG Chief Executive, who said:

[The CAA] neglected its new primary statutory duty to further the interests of passengers by endorsing a settlement that allows the UK’s monopoly hub to ignore its inefficiencies and over-reward investors by imposing excessive charges … It is a bad day for customers who have been let down by the CAA.

Any price rise from the airports will be passed on to airlines and these in turn will translate into higher prices for customers. However, is there any truth to Heathrow’s claims that investment will be adversely impacted? As costs rise, profit margins and profit will fall, unless the revenue generated can increase. Price controls restrict the amount that prices can rise and thus unless demand increases by a significant margin, profits will decline. With lower profits, there will be less money for investment and arguably the service that customers face will also decline. However, the CAA suggests that Heathrow will be able to cut its costs and thus protect investment into the future, while retaining its competitive position globally by charging lower prices to airlines. This is unlikely to be the end of the journey, but for the moment, the CAA appears to have put its foot down. The following articles consider the battleground between the CAA and Heathrow.

Regulation in the passenger’s interest, support investment and driving competition The Civil Aviation Authority (3/10/13)
Passengers at Heathrow ‘face £1bn fares hike’ Independent, Matthew Beard (4/10/13)
Heathrow airport attacks regulator’s price control plan BBC News (3/10/13)
CAA proposed Heathrow charges rise in line with inflation The Telegraph, Rebecca Clancy (13/10/13)
Passengers face fare increases as Heathrow and Gatwick are allowed to up landing fees Mail Online (3/10/13)
Heathrow and airlines enraged by CAA price proposals The Telegraph, Alistair Osborne (3/10/13)
Heathrow attacks Civil Aviation Authority over airport charges Financial Times, Andrew Parker (3/10/13)
BAA considers life outside Heathrow as CAA backtracks on charges The Guardian, Gwyn Topham (3/10/13)
Heathrow charge plan disappoints all round Wall Street Journal, Peter Evans (3/10/13)

Questions

  1. What is the role of a regulator?
  2. Explain how the price control outlined by the CAA will affect Heathrow.
  3. If Heathrow is unable to cut costs, what is the likely effect? Using a diagram illustrate the impact on profitability if costs (a) can be reduced and (b) cannot be reduced.
  4. Why are the CAA being criticised by airlines and airports?
  5. How will customers be affected by Heathrow’s planned price rises and the CAA’s proposal?
  6. ‘Regulation in the airlines industry is essential to retain competitiveness.’ Evaluate the validity of this statement.
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2020 Tokyo Olympics

The 2020 Olympics has just been awarded to Tokyo, beating Madrid and Istanbul. Concerns over the safety of the games in Tokyo, with the city being perceived as relatively close to the Fukushima nuclear plant, were overcome with the help of an address by the Japanese Prime Minister, Shinzo Abe. So, what are the economic implications of this latest development in the sporting world?

When London was awarded the 2012 Olympic Games, estimates suggested that it would generate a £16.5 billion contribution to GDP. With many new construction projects, there was the inevitable injection of government expenditure. This led to the creation of new jobs and thus successive employment multiplier effects were generated. This is also likely to be true for Tokyo, with current proposals suggesting that ten new permanent sites will be built to host the various sports of the Games. This will undoubtedly generate new jobs and will provide an almost certain boost to the construction industry. This, in turn, will generate further multiplier effects across a multitude of industries and across the rest of the country.

There will also be further economic effects, for example on Japanese investment and stocks and shares, with a boost in confidence and optimism. A Tokyo-based fund manager, Hiroshi Fujumonto, said:

Olympics-related stocks are yet to fully price in the decision, even though they’ve already outperformed … In the short term the entire Japanese share market will get a boost from celebratory buying and expectations for the event’s economic impact.

This was also confirmed by Shinzo Abe, when he commented after the victory was announced that ‘I want to make the Olympics a trigger for sweeping away 15 years of deflation economic shrinkage.’ The Japanese economy has been struggling for many years and this may be the much needed boost to the country’s optimism, infrastructure and economy.

As the world’s third largest economy, this economic boost is also likely to have knock-on effects on other countries across the world, though it is more likely to be the long-term impact that is important here. Just as it was with the London Olympics, the final effect and cost will only be known some years after the Olympics are held, but for now the work will start for Japan.

Olympics 2020: Tokyo wins race to host games BBC Sport (7/9/13)
Tokyo Olympics win seen boosting infrastructure, recovery Bloomberg, Yoshiaki Nohara and Satoshi Kawano (8/9/13)
Tokyo wins bid to host 2020 Olympic Games Telegraph, Ben Rumsby (8/9/13)
Tokyo chosen as ‘safe pair of hands’ to host 2020 Olympics Financial Times, Benedict Mander (8/9/13)
Japanese bid’s passion earns Tokyo the 2020 Olympic Games Guardian, Owen Gibson (7/9/13)
Olympics 2020: Why Tokyo is a ‘safe pair of hands’ to host Games BBC News, David Bond (8/9/13)

Questions

  1. What is the multiplier effect and how is it calculated?
  2. How can the overall economic benefits of the Olympic Games be estimated?
  3. Which industries in Tokyo are likely to be the ones that benefit from the Olympic Games?
  4. Outline a cost–benefit analysis of the Olympic Games.
  5. Why are share prices likely to go up in Japan based on this news? Look at both the demand and supply factors that will affect share prices.
  6. Is it possible that there will be wider multiplier effects on other countries besides Japan?