Next year a government agreement with insurance companies is set to end. This agreement requires insurance companies to provide cover for homes at a high risk of flooding.
However, in June 2013, this agreement will no longer be in place and this has led to mounting concerns that it will leave thousands of home-owners with the inability either to find or afford home insurance.
The key thing with insurance is that in order for it to be provided privately, certain conditions must hold. The probability of the event occurring must be less than 1 – insurance companies will not insure against certainty. The probability of the event must be known on aggregate to allow insurance companies to calculate premiums. Probabilities must be independent – if one person makes a claim, it should not increase the likelihood of others making claims.
Finally, there should be no adverse selection or moral hazard, both of which derive from asymmetric information. The former occurs where the person taking out the insurance can hide information from the company (i.e. that they are a bad risk) and the latter occurs when the person taking out insurance changes their behaviour once they are insured. Only if these conditions hold or there are easy solutions will the private market provide insurance.
On the demand-side, consumers must be willing to pay for insurance, which provides them with protection against certain contingencies: in this case against the cost of flood damage. Given the choice, rational consumers will only take out an insurance policy if they believe that the value they get from the certainty of knowing they are covered exceeds the cost of paying the insurance premium. However, if the private market fails to offer insurance, because of failures on the supply-side, there will be major gaps in coverage.
Furthermore, even if insurance policies are offered to those at most risk of flooding, the premiums charged by the insurance companies must be high enough to cover the cost of flood damage. For some homeowners, these premiums may be unaffordable, again leading to gaps in coverage.
In light of the agreement coming to an end next year, there is pressure on the government firstly to ensure that insurance cover is available to everyone at affordable prices and secondly to continue to build up flood defences in the most affected areas. Not an easy task given the budget cuts. The following articles provide some of the coverage of the problems of insuring against flood damage.
Articles
200,000 homes ‘at flooding risk’ BBC News (3/1/12)
MPs slam government flood defences Post Online, Chris Wheal (31/1/12)
Flooding: 200,000 houses at risk of being uninsurable The Telegraph (31/1/12)
Flood defences hit by government cuts ‘mismatch’, says MP Guardian, Damian Carrington (31/1/12)
Fears over cash for flood defences The Press Association (31/1/12)
ABI refuses to renew statement of principles for flood insurance Insurance Age, Emmanuel Kenning (31/1/12)
Questions
- Consider the market for insurance against flood damage. Are risks less than one? Explain your answer
- Explain whether or not the risk of flooding is independent.
- Are the problems of moral hazard and adverse selection relevant in the case of home insurance against flood damage?
- If ABI doesn’t put in place another agreement to provide insurance to homeowners at most risk of flooding, what could be the adverse economic consequences?
- Is there an argument for the government stepping in to provide insurance itself?
- Explain why insurance premiums are so much higher for those at most risk of flooding. Is it equitable?
Last October (2011) we considered the case for a Tobin tax: also known as a financial transactions tax (FTT) or a ‘Robin Hood tax’. Since then there have been increased calls for the world to adopt such a tax.
It was promoted by President Sarkozy and supported by many other leaders at the G20 conference in Cannes on 3 and 4 November 2011. It has also been publicly supported by Bill Gates, the Archbishop of Canterbury and the Vatican, as you can see from the video clips and articles below. It is also one of the demands of protesters at St Pauls in London and at other places around the world.
However, the introduction of such a tax is vehemently opposed by many banks and by the US, UK, Canadian and Australian governments, amongst others. In the articles below, we consider the latest arguments that are being used on both sides. With such strong feelings it looks as if the arguments are not going to go away.
Update
On 29 January 2012, French President, Nicolas Sarkozy, announced plans to introduce a 0.1% levy on financial transactions. Naturally, by taking the lead, he hopes that other EU countries will follow suit. The final set of articles consider his move.
What is a Tobin Tax? BBC News, Andrew Walker (2/11/11)
Rowan Williams: St Paul’s protest has ‘triggered awareness’ BBC News (2/11/11)
Bill Gates explains his support for a Tobin tax BBC News (2/11/11)
Robin Hood tax: What is the Tobin tax? BBC Newsnight, Andrew Verity (17/11/11)
Q&A: What is the Tobin Tax on financial trading BBC News (2/11/11)
Head-to-head: the Robin Hood tax BBC News, Gemma Godfrey and Prof Avinash Persaud (9/12/11)
Time for us to challenge the idols of high finance Financial Times, Rowan Williams, Archbishop of Canterbury (1/11/11)
Gates says ‘Robin Hood’ tax has part to play Financial Times, Chris Giles (3/11/11)
Sarkozy Pledges Fight for Transaction Tax Bloomberg, Rebecca Christie and Helene Fouque (4/11/11)
Financial Transaction or Speculation Taxes: Not Quite What They Seem Forbes, Tim Worstall (4/11/11)
Is a Robin Hood Tax the Answer? Forbes, Kelly Phillips Erb (3/11/11)
Bill Nighy takes Robin Hood tax to the G20 Guardian, Patrick Wintour and Larry Elliott (3/11/11)
G20 tax moves disappoint charities Press Association (4/11/11)
Jamaica should support the Robin Hood Tax Jamaica Observer (6/11/11)
World Leaders Need to Agree to the Robin Hood Tax at G20 Huffington Post, Bill Nighy (3/11/11)
Obama, the G20, and the 99 Percent Huffington Post, Jeffrey Sachs (1/11/11)
Now is the moment to bring banks to heel This is Money, Jeffrey Sachs (3/11/11)
Note on financial reform from the Pontifical Council for Justice and Peace The Vatican Today
Tobin Tax would cost £25.5bn and cause job losses says think-tank London loves Business, Rebecca Hobson (4/11/11)
The Spurious Case Against A Financial Transactions Tax – Analysis Eurasia Review, Dean Baker (2/11/11)
Update
Sarkozy Says France to Impose Transaction Tax From August Bloomberg Businessweek, Helene Fouquet and Mark Deen (30/1/12)
Struggling Sarkozy unveils financial transactions tax Sydney Morning Herald, AFP (30/1/12)
Sarkozy announces French financial transaction tax BBC News (30/1/12)
French president announces unilateral financial transaction tax Deutsche Welle Spencer Kimball, Andrew Bowen and Nicole Goebel (30/1/12)
Questions
- What are the main arguments in favour of a financial transactions tax?
- What are the main arguments against a financial transactions tax?
- To what extent is the debate a normative one and to what extent could evidence be used to support one side or the other?
- What would determine the extent to which the tax would be passed on to consumers?
- Would a financial transactions tax impede growth? Explain.
- Would financial intermediation be made more efficient by the imposition of such a tax?
With the fall of communism in eastern Europe between 1989 and 1991, many hailed this as the victory of capitalism.
Even China, which is still governed by the Chinese Communist Party, has embraced the market and accepted growing levels of private ownership of capital. It is only one or two countries, such as North Korea and Cuba, that could be described as communist in the way the term was used to describe the centrally planned economies of eastern Europe before 1990.
But whilst market capitalism seemed to have emerged as the superior system in the 1990s, may are now questioning whether the market capitalism we have today is fit for the 21st century. Today much of the world’s capital in the hands of big business, with financial institutions holding a large proportion of shares in such companies. And the gap between rich and poor is ever widening
The market system of today, is very different from that of 100 years ago. In fact, as John Kay agues in his article “Let’s talk about the market economy” below, it would be wrong to describe it as ‘capitalism’ in the sense the term was used in the debates of the 19th and early 20th centuries. Nonetheless, the term is still used and generally refers to the market system we now have. And it is a market system that many see as failing and unfit for purpose. It is a system that coincided with the bubble of the 1990s and early 2000s, the credit crunch of 2007–9 and the recession of 2008/9, now seeming to return as a double-dip recession
With the political and business leaders of the world meeting at the World Economic Forum at Davos in Switzerland on 25–29 January 2012, a central theme of the forum has been the future of capitalism and whether it’s fit for the 21st century.
Is there a fairer and more compassionate capitalism that can be fostered? This has been a stated objective of all three political parties in the UK recently. Can we avoid another crisis of capitalism as seen in the late 2000s and which still continues today? What is the role of government in regulating the market system? Does the whole capitalist system need restructuring?
It’s becoming increasingly clear that we need to talk about capitalism. The following webcasts and articles do just that.
Webcasts and podcasts
Davos 2012 – TIME Davos Debate on Capitalism< World Economic Forum (25/01/12)
Can capitalism be ‘responsible’? BBC Newsnight, Paul Mason (19/01/12)
Capitalism ‘nothing to do with responsibility’ BBC Newsnight, Eric Hobsbawm (19/01/12)
Are there alternatives to capitalism? BBC Newsnight, Danny Finkelstein, Tristram Hunt and Julie Meyer (19/01/12)
America Beyond Capitalism The Real News on YouTube, Gar Alperovitz (27/12/11)
The future of capitalism CNBC, Warren Buffett and Bill Gates (12/11/09)
Capitalism Hits the Fan (excerpt) YouTube, Richard Wolff (2/1/12)
Panel Discussion “20 years after – Future of capitalism in CEE” Erste Group on YouTube, Andreas Treichl, Janusz Kulik, Jacques Chauvet, and media Adrian Sarbu (24/2/11)
The Future of Capitalism: Constructive Competition or Chaos? YouTube, Nathan Goetting, Tony Nelson, Craig Meurlin and Judd Bruce Bettinghaus (24/1/11)
Capitalism in Crisis Financial Times, Various videos (24/1/11)
Bill Gates: Capitalism a ‘phenomenal system’ BBC Today Programme, Bill Gates talks to Evan Davis (25/1/12)
Capitalism (See also) BBC The Bottom Line, Evan Davis and guests (28/1/12)
Articles
Meddle with the market at your peril Financial Times, Alan Greenspan (25/1/12)
The world’s hunger for public goods Financial Times, Martin Wolf (24/1/12)
When capitalism and corporate self-interest collide JohnKay.com, John Kay (25/1/12)
Let’s talk about the market economy JohnKay.com, John Kay (11/1/12)
A real market economy ensures that greed is good JohnKay.com, John Kay (18/1/12)
Seven ways to fix the system’s flaws Financial Times, Martin Wolf (22/1/12)
To the barricades, British defenders of open markets! The Economist, Bagehot’s Notebook (26/1/12)
Community reaction to doubts about capitalism in Davos CBC News (26/1/12)
Capitalism saw off USSR, now it needs to change or die The National (UAE), Frank Kane (26/1/12)
Words won’t change capitalism. So be daring and do something Observer, Will Hutton (22/1/12)
A political economy fit for purpose: what the UK could learn from Germany Our Kingdom, Alex Keynes (20/1/12)
Debate on State Capitalism The Economist (24/1/12)
Questions
- How has the nature of capitalism changed over recent decades?
- Can capitalism be made more ‘caring’ and, if so, how?
- What do you understand by the term a ‘fair allocation of resources’? Is capitalism fair? Can it be made fairer and, if so, what are the costs of making it so?
- Can greed ever be good?
- How does the ‘Anglo-Saxon’ model of capitalism differ from the European model?
- What do you understand by the term ‘crony capitalism’? Is crony capitalism on the increase?
- John Kay states that “Modern titans derive their authority and influence from their position in a hierarchy, not their ownership of capital.” Explain what this means and what its implications are for making capitalism meet social goals.
- In what ways can governments control markets? Have these instruments and their effectiveness changed in effectiveness over time?
- What are the costs and benefits to society of the increasing globalisation of capital?
- To what extent was the financial crisis and credit crunch the result of a flawed capitalist system and to what extent was it a failure of government intervention?
- Why is it important for the success of capitalism that companies should be allowed to fail? Consider whether this should also apply to banks. How is the concept of moral hazard relevant to your answer?
Is Google’s Android catching up with Apple’s iOS in the market for apps? With Android tablets and smartphones taking an ever larger proportion of the market, you would expect so. In the third quarter of 2011, 53% of smartphone shipments used Google’s Android system, compared with only 15% with iOS.
However, Apple is still ahead of Google in the share of apps downloads. To date, there have been 18 billion downloads from the iOS App Store for iPhone, iPad and iPod Touchs compared with 10 billion downloads of Android apps. But Android downloads are growing faster and are set to overtake those of iOS apps in the coming months. This should be boosted with the new Ice Cream Sandwich Android operating system.
But what about revenues earned from downloads? Here the picture is very different. Android Marketplace has earned around $330 million gross revenue for paid apps. Apple’s App Store, by contrast, has earned over 15 times as much: nearly $5000 million. The reason is that 99% of Android apps are free; the figure for App Store apps is 86%. But why is this so and how can Android earn revenues from its apps? And how can app developers earn revenues from the Android market? The following articles look at the economics of apps.
Android Vs. iPhone: The Economics Of Apps Financial Edge, Manish Sahajwani (6/1/12)
Google has an Amazon problem MSN Money, Jim J. Jubak (25/1/12)
Android and the economics of apps BBC News, Rory Cellan-Jones (7/12/11)
Apple Getting Best Of The Android Vs. iPhone Economics Forbes, Manish Sahajwani (6/1/12)
Fragmentation Is Not The End of Android cek.log, Charlie Kindel (14/1/12)
Questions
- Why are most Android apps free to download?
- What is the business model for (a) developing and (b) offering Android apps?
- How can money be made from free apps?
- What are the long-term strengths and weaknesses in Apple’s apps business model?
- Assess Amazon’s business model for apps for Kindle users.
In the third quarter of 2011, the UK economy grew by 0.6% – nothing to shout about, but at least it was positive. Since then there has been growing concern about the state of the recovery with many commentators widely expecting to see much lower growth in the final quarter of last year.
Today, those commentators were proved right, as official figures released show the UK economy shrank by 0.2%. It doesn’t mean we’re in a recession (that requires 2 successive quarters of negative growth), but if growth doesn’t pick up in quarter 1 of 2012, then ‘Double-Dip Recession’ headlines will fill the front page.
Despite the disappointment that the UK economy has shrunk, the figures were not wholly unexpected, especially given the data released a week or so before, which showed unemployment had risen. Furthermore, with the crisis in the eurozone and many other countries still struggling to mount an economic recovery, there have been few external stimuli for the UK.
Although the fall in growth was larger than expected (0.2% as opposed to the predicted 0.1%), the UK economy is expected to grow throughout 2012. However, the IMF has reduced its forecast annual growth rate from 1.6% to 0.6%. The economic climate for 2012 remains uncertain and much will depend on developments in the eurozone. Further problems could spell trouble, but if there is an improvement in the fortunes of Europe, confidence could return to the markets and economic recovery could be faster. Ian McCafferty, the Chief Economic Adviser of the CBI said:
While the acute fears seen at the end of last year over global demand may be subsiding, 2012 will prove to be a difficult year for UK manufacturing, as the crisis in the eurozone – our biggest export market – has yet to reach any definitive resolution.
Whether or not we do move into a double-dip recession is uncertain and following this latest data, many commentators say it is a 50:50 change; and even then it hinges on many factors. However, even if quarter 1 of 2012 sees negative growth and hence a return to recession for the UK, Chris Williamson from Markit said that ‘there are growing indications that any downturn is likely to be ‘mild and short-lived’. The following articles consider the state of the UK economy.
Unemployment to soar as UK heads back into recession The Telegraph, Philip Aldrick (25/1/12)
UK economy shrinks by 0.2% in last 3 months of 2011 BBC News (25/1/12)
UK GDP: what the economists say Guardian (25/1/12)
UK recession threat: can we dodge the double dip? Citywire, Chris Marshall (25/1/12)
Double-dip recession fears as UK economy shrinks 0.2 percent Independent, Peter Cripps (25/1/12)
PM says ‘no complacency’ on economy Financial Times, Norma Cohen and Elizabeth Rigby (25/1/12)
The UK economy is shrinking. Time to listen to gloom-mongers? Guardian, Phillip Inman (25/1/12)
UK economy shrinks in Q4, raising recession fears The Associated Press (25/1/12)
FTSE CLOSE: Stocks slide as 0.2% GDP fall sparks recession fears; banks among the biggest fallers This is Money (25/1/12)
Sorrell: ‘UK will avoid double-dip recession’ Sky News, Tom Rayner (25/1/12)
Recovery in rehab BBC News, Stephanie Flanders (25/1/12)
Questions
- How is a recession defined? What are the typical characteristics of a recession? (Think about the macroeconomic objectives).
- Which particular sectors of the UK economy were the most severely affected in Q4 of 2011?
- Examine the main causes of the UK’s decline in national output.
- Which of the causes identified in question 3 do you think is the key factor keeping UK national output from growing? Explain your answer.
- Why is there a growing presence of companies from emerging markets in the top 100?
- Why are many commentators suggesting that even if the UK goes into a recession, it is likely to be ‘mild and short-lived’?
- What has happened to stock markets following the release of this latest economic data?
- Evaluate the options open to the Coalition government in stimulating the UK economy. To what extent would your policy solution damage the Coalition’s aim of cutting the UK’s structural budget deficit?
Next year a government agreement with insurance companies is set to end. This agreement requires insurance companies to provide cover for homes at a high risk of flooding.