Category: Essentials of Economics 9e

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A free-trade deal? Not really

According to the Brexit trade agreement (the Trade and Cooperation Agreement (TCA)), trade between the EU and the UK will remain quota and tariff free. ‘Quota free’ means that trade will not be restricted in quantity by the authorities on either side. ‘Tariff free’ means that customs duties will not be collected by the UK authorities on imports from the EU nor by the EU authorities on imports from the UK.

Article ‘GOODS .5: Prohibition of customs duties’ on page 20 of the agreement states that:

Except as otherwise provided for in this Agreement, customs duties on all goods originating in the other Party shall be prohibited.

This free-trade agreement was taken by many people to mean that trade would be unhindered, with no duties being payable. In fact, as many importers and exporters are finding, trade is not as ‘free’ as it was before January 2021. There are four sources of ‘friction’.

Tariffs on goods finished in the UK

This has become a major area of concern for many UK companies. When a good is imported into the UK from outside the EU and then has value added to it by processing, packaging, cleaning, remixing, preserving, refashioning, etc., under ‘rules of origin’ regulations, it can only count as a UK good if sufficient value or weight is added. The proportions vary by product, but generally goods must have approximately 50% UK content (or 80% of the weight of foodstuffs) to qualify for tariff-free access to the EU. For example, for a petrol car, 55% of its value must have been created in either the EU or UK. Thus cars manufactured in the UK which use many parts imported from Japan, China or elsewhere, may not qualify for tariff-free access to the EU.

In other cases, it is simply the question of whether the processing is deemed ‘sufficient’, rather than the imported inputs having a specific weight or value. For example, the grinding of pepper is regarded as a sufficient process and thus ground pepper can be exported from the UK to the EU tariff free. Another example is that of coal briquettes:

The process to transform coal into briquettes (including applying intense pressure) goes beyond the processes listed in ‘insufficient processing’ and so the briquettes can be considered ‘UK originating’ regardless of the originating status of the coal used to produce the briquettes.

In the case of many garments produced in the UK and then sold in retail chains, many of which have branches in both the UK and EU, generally both the weaving and cutting of fabric to make garments, as well as the sewing, must take place in the UK/EU for the garments to be tariff free when exported from the UK to the EU and vice versa.

Precise details of rules of origin are given in the document, The Trade and Cooperation Agreement (TCA): detailed guidance on the rules of origin.

Many UK firms exporting to the EU and EU firms exporting to the UK are finding that their products are now subject to tariffs because of insufficient processing being done in the UK/EU. Indeed, with complex international supply chains, this is a major problem for many importing and exporting companies.

Documentation

Rules of origin require that firms provide documentation itemising what parts of their goods come from outside the UK/EU. Then it has to be determined whether tariffs will be necessary on the finished product. This is time consuming and is an example of the increase in ‘red tape’ about which many firms are complaining. As the Evening Standard article states:

Exporters have to be able to provide evidence to prove the origin of their products’ ingredients. Next year, they will also have to provide suppliers’ declarations too, and EU officials may demand those retrospectively, so exporters need to have them now.

The increased paperwork and checks add to the costs of trade. Some EU companies are stating that they will no longer export to the UK and some UK companies that they will no longer export to the EU, or will have to set up manufacturing plants or distribution hubs in the EU to handle trade within the EU.

Other companies are adding charges to their products to cover the costs. As the Guardian article states:

“We bought a €47 [£42] shelf from Next for our bathroom,” said Thom Basely, who lives in Marseille. “On the morning it was supposed to be delivered we received an ‘import duty/tax’ demand for over €30, like a ransom note. It came as a complete surprise.”

In evidence given to the Treasury Select Committee (Q640) in May 2018, Sir Jon Thompson, then Chief Executive of HMRC, predicted that leaving the single market would involve approximately 200 million extra customs declarations on each side of the UK/EU border at a cost of £32.50 for each one, giving a total extra cost of approximately £6.5bn on each side of the border for companies trading with Europe. Although this was only an estimate, the extra ‘paperwork’ will represent a substantial cost.

VAT

Previously, goods could be imported into the UK without paying VAT in the UK on value added up to that point as VAT had already been collected in the EU. Similarly, goods exported to the EU would already have had VAT paid and hence would only be subject to the tax on additional value added. The UK was part of the EU VAT system and did not have to register for VAT in each EU country.

Now, VAT has to be paid on the goods as they are imported or released from a customs warehouse – similar to a customs duty. This is therefore likely to involve additional administration costs – the same as those with non-EU imports.

Services

The UK is a major exporter of services, including legal, financial, accounting, IT and engineering. It has a positive trade in services balance with the EU, unlike its negative trade in goods balance. Yet, the Brexit deal does not include free trade in services. Some of the barriers to other non-EU countries have been reduced for the UK in the TCA, but UK service providers will still face new barriers which will impose costs. For example, some EU countries will limit the time that businesspeople providing services can stay in their countries to six months in any twelve. Some will not recognise UK qualifications, unlike when the UK was a member of the single market.

The financial services supplied by City of London firms are a major source of export revenue, with about 40% of these revenues coming from the EU. Now outside the single market, these firms have lost their ‘passporting rights’. These allowed such firms to sell their services into the EU without the need for additional regulatory clearance. The alternative now is for such firms to be granted ‘equivalence’ by the EU. This has not yet been negotiated and even if it were, does not cover the full range of financial services. It excludes, for example, banking services such as lending and deposit taking.

Conclusions

Leaving the single market has introduced a range of frictions in trade. These are causing severe problems to some importers and exporters in the short term. Some EU goods are now unavailable in the UK or only so at significantly higher prices. Some exporters are finding that the frictions are too great to make their exports profitable. However, it remains to be seen how quickly accounting and logistical systems can adjust to improve trade flows between the UK and the EU.

But some of these frictions, as itemised above, will remain. According to the law of comparative advantage, these restrictions on trade will lead to a loss of GDP. And these losses will not be spread evenly throughout the UK economy: firms and their employees which rely heavily on UK–EU trade will be particularly hard hit.

Articles

Official documents

Questions

  1. Explain what is meant by ‘rules of origin’.
  2. If something is imported to the UK from outside the UK and then is refashioned in the UK and exported to the EU but, according to the rules of origin has insufficient value added in the UK, does this mean that such as good will be subject to tariffs twice? Explain.
  3. Are tariffs exactly the same as customs duties? Is the distinction made in the Guardian article a correct one?
  4. Is it in the nature of a free-trade deal that it is not the same as a single-market arrangement?
  5. Find out what arrangement Switzerland has with the EU. How does it differ from the UK/EU trade deal?
  6. What are the advantages and disadvantages of the Swiss/EU agreement over the UK/EU one?
  7. Are the frictions in UK–EU trade likely to diminish over time? Explain.
  8. Find out what barriers to trade in services now exist between the UK and EU. How damaging are they to UK services exports?
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Is growing inequality fair?

In a series of five podcasts, broadcast on BBC Radio 4 in the first week of January 2021, Amol Rajan and guests examine different aspects of inequality and consider the concept of fairness.

As the notes to the programme state:

The pandemic brought renewed focus on how we value those who have kept shelves stacked, transport running and the old and sick cared for. So is now the time to bring about a fundamental shift in how our society and economy work?

The first podcast, linked below, examines the distribution of wealth in the UK and how it has changed over time. It looks at how rising property and share prices and a lightly taxed inheritance system have widened inequality of wealth.

It also examines rising inequality of incomes, a problem made worse by rising wealth inequality, the move to zero-hour contracts, gig working and short-term contracts, the lack of social mobility, austerity following the financial crisis of 2007–9 and the lockdowns and restrictions to contain the coronavirus pandemic, with layoffs, people put on furlough and more and more having to turn to food banks.

Is this rising inequality fair? Should fairness be considered entirely in monetary terms, or should it be considered more broadly in social terms? These are issues discussed by the guests. They also look at what policies can be pursued. If the pay of health and care workers, for example, don’t reflect their value to our society, what can be done to increase their pay? If wealth is very unequally distributed, should it be redistributed and how?

The questions below are based directly on the issues covered in the podcast in the order they are discussed.

Podcast

Questions

  1. In what ways has Covid-19 been the great ‘unequaliser’?
  2. What scarring/hysteresis effects are there likely to be from the pandemic?
  3. To what extent is it true that ‘the more your job benefits other people, the less you get paid’?
  4. How has the pandemic affected inter-generational inequality?
  5. How have changes in house prices skewed wealth in the UK over the past decade?
  6. How have changes in the pension system contributed to inter-generational inequality?
  7. How has quantitative easing affected the distribution of wealth?
  8. Why is care work so poorly paid and how can the problem be addressed?
  9. How desirable is the pursuit of wealth?
  10. How would you set about defining ‘fairness’?
  11. Is a mix of taxation and benefits the best means of tackling economic unfairness?
  12. How would you set about deciding an optimum rate of inheritance tax?
  13. How do you account for the growth of in-work poverty?
  14. In what ways could wealth be taxed? What are the advantages and disadvantages of such taxes?
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The UK and the EU: all change, or is it?

At 23:00 on 31 December 2020, the UK withdrew from the European single market. This ended the transition period which followed the UK’s departure from the EU on 31 January 2020. But, with the Trade and Cooperation Agreement (‘the deal’) signed on 30 December, it was agreed that there would be no tariffs or quotas on trade in goods between the UK and the EU.

So what are the new economic relations between the EU and the UK and how will they impact on the UK economy? What new restrictions are there on trade in goods and on the movement of labour and capital? How is trade in services, including financial services, affected? What new agreements, such as on fishing, will replace previous agreements?

What will happen to trade between Northern Ireland and the Republic of Ireland? What will happen to trade between Great Britain and Northern Ireland?

What will happen to regulations over standards of traded products and their production? Will the UK government be able to provide subsidies or other types of support for goods or services exported to the EU? How will disputes about standards and support to companies be resolved?

How will trade with non-EU countries change? If the EU has trade agreements with such countries, do these agreements now apply to trade between the UK and such countries? How free is the UK now to negotiate new trade agreements with non-EU countries? How will the UK’s negotiating strength be affected by its withdrawal from the EU?

Rather than listing the changes here, follow the links below to the articles and assess the nature of the changes and then attempt the questions. The articles represent a balance of views.

What is clear is that these are all big issues and are likely to have a significant impact on the UK economy. Most economists argue that the net effect will be negative on trade and economic growth, but there is huge uncertainty about the magnitude of the effects. Much will depend on how arrangements between the UK and the EU develop over the coming months and years.

Articles

UK and EU documents

Questions

  1. Summarise the main features of the Trade and Cooperation Agreement and how the UK’s new relationship with the EU differs from being a member.
  2. What are the potential economic benefits from being outside the EU?
  3. What are the economic drawbacks for the UK from having left the EU, albeit with the new Trade and Cooperation Agreement?
  4. On balance, do you think that the UK will gain or lose economically from having left the EU? Explain your answer.
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Lockdown – again.  Is it worth it?

Mid-December saw a rapid rise in coronavirus cases in London and the South East and parts of eastern and central southern England. This was due to a new strain of Covid, which is more infectious. In response, the UK government introduced a new tier 4 level of restrictions for these areas from 20 December. These amount to a complete lockdown. The devolved administrations also announced lockdowns. In addition, the Christmas relaxation of rules was tightened across the UK. Households (up to three) were only allowed to get together on Christmas day and not the days either side (or one day between 23 and 27 December in the case of Northern Ireland). Tier 4 residents were not allowed to visit other households even on Christmas day.

The lockdowns aimed to slow the spread of the virus and reduce deaths. But this comes at a considerable short-term economic cost, especially to the retail and leisure sectors, which are required to close while the lockdowns remain in force. In taking the decision to introduce these tougher measures, the four administrations had to weigh up the benefits of reduced deaths and illness and pressure on the NHS against the short-term economic damage. As far a long-term economic damage is concerned, this might be even greater if lockdowns were not imposed and the virus spread more rapidly.

In a blog back in September, we examined the use of cost–benefit analysis (CBA) to aid decision-making about such decisions. The following is an updated version of that blog.

The use of cost–benefit analysis

It is commonplace to use cost–benefit analysis (CBA) in assessing public policies, such as whether to build a new hospital, road or rail line. Various attempts in the past few months have been made to use CBA in assessing policies to reduce the spread of the coronavirus. These have involved weighing up the costs and benefits of national or local lockdowns or other containment measures. But, as with other areas where CBA is used, there are serious problems of measuring costs and benefits and assessing risks. This is particularly problematic where human life is involved and where a value has to be attached to a life saved or lost.

The first step in a CBA is to identify the benefits and costs of the policy.

Identifying the benefits and costs of the lockdown

The benefits of the lockdown include lives saved and a reduction in suffering, not only for those who otherwise would have caught the virus but also for their family and friends. It also includes lives saved from other diseases whose treatment would have been put (even more) on hold if the pandemic had been allowed to rage and more people were hospitalised with the virus. In material terms, there is the benefit of saving in healthcare and medicines and the saving of labour resources. Then there are the environmental gains from less traffic and polluting activities.

On the cost side, there is the decline in output from businesses being shut and people being furloughed or not being able to find work. There is also a cost if schools have to close and children’s education is thereby compromised. Then there is the personal cost to people of being confined to home, a cost that could be great for those in cramped living conditions or in abusive relationships. Over the longer term, there is a cost from people becoming deskilled and firms not investing – so-called scarring effects. Here there are the direct effects and the multiplier effects on the rest of the economy.

Estimating uncertain outcomes

It is difficult enough identifying all the costs and benefits, but many occur in the future and here there is the problem of estimating the probability of their occurrence and their likely magnitude. Just how many lives will be saved from the policy and just how much will the economy be affected? Epidemiological and economic models can help, but there is a huge degree of uncertainty over predictions made about the spread of the disease, especially with a new strain of the virus, and the economic effects, especially over the longer term.

One estimate of the number of lives saved was made by Miles et al. in the NIESR paper linked below. A figure of 440 000 was calculated by subtracting the 60 000 actual excess deaths over the period of the first lockdown (March to June 2020) from a figure of 500 000 lives lost which, according to predictions, would have been the consequence of no lockdown. However, the authors acknowledge that this is likely to be a considerable overestimate because:

It does not account for changes in behaviour that would have occurred without the government lockdown; it does not count future higher deaths from side effects of the lockdown (extra cancer deaths for example); and it does not allow for the fact that some of those ‘saved’ deaths may just have been postponed because when restrictions are eased, and in the absence of a vaccine or of widespread immunity, deaths may pick up again.

Some help in estimating likely outcomes from locking down or not locking down the economy can be gained by comparing countries which have taken different approaches. The final article in the first list below compares the approaches in the UK and Sweden. Sweden had much lighter control measures than the UK and did not impose a lockdown. Using comparisons of the two approaches, the authors estimate that some 20 000 lives were saved by the lockdown – considerably less than the 440 000 estimate.

Estimating the value of a human life

To assess whether the saving of 20 000 lives was ‘worth it’, a value would have to be put on a life saved. Although putting a monetary value on a human life may be repugnant to many people, such calculations are made whenever a project is assessed which either saves or costs lives. As we say in the 10th edition of Economics (page 381):

Some people argue ‘You can’t put a price on a human life: life is priceless.’ But just what are they saying here? Are they saying that life has an infinite value? If so, the project must be carried out whatever the costs, and even if other benefits are zero! Clearly, when evaluating lives saved from the project, a value less than infinity must be given.
 
Other people might argue that human life cannot be treated like other costs and benefits and put into mathematical calculations. But what are these people saying? That the question of lives saved should be excluded from the cost–benefit study? If so, the implication is that life has a zero value! Again this is clearly not the case.

In practice, there are two approaches used to measure the value of a human life.

The first uses the value of a statistical life (VSL). This is based on the amount extra the average person would need to be paid to work in a job where there is a known probability of losing their life. So if people on average needed to be paid an extra £10 000 to work in a job with a 1% chance of losing their life, they would be valuing a life at £1 000 000 (£10 000/0.01). To avoid the obvious problem of young people’s lives being valued the same as old people’s ones, even though a 20 year-old on average will live much longer than a 70 year-old, a more common measure is the value of a statistical life year (VSLY).

A problem with VSL or VSLY measures is that they only take into account the quantity of years of life lost or saved, not the quality.

A second measure rectifies this problem. This is the ‘quality of life adjusted year (QALY)’. This involves giving a value to a year of full health and then reducing it according to how much people’s quality of life is reduced by illness, injury or poverty. The problem with this measure is the moral one that a sick or disabled person’s life is being valued less than the life of a healthy person. But it is usual to make such adjustments when considering medical intervention with limited resources.

One adjustment often made to QALYs or VSLYs is to discount years, so that one year gained would be given the full value and each subsequent year would be discounted by a certain percentage from the previous year – say, 3%. This would give a lower weighting to years in the distant future than years in the near future and hence would reduce the gap in predicted gains from a policy between young and old people.

Cost–effectiveness analysis (CEA)

Even using QALYs, there is still the problem of measuring life and health/sickness. A simpler approach is to use cost–effectiveness analysis (CEA). This takes a social goal, such as reducing the virus production rate (R) below 1 (e.g. to 0.9), and then finding the least-cost way of achieving this. As Mark Carney says in his third Reith Lecture:

As advocated by the economists Nick Stern and Tim Besley, the ideal is to define our core purpose first and then determine the most cost-effective interventions to achieve this goal. Such cost–effectiveness analysis explicitly seeks to achieve society’s values.

Cost–effectiveness analysis can take account of various externalities – as many of the costs will be – by giving them a value. For example, the costs of a lockdown to people in the hospitality sector or to the education of the young could be estimated and included in the costs. The analysis can also take into account issues of fairness by identifying the effects on inequality when certain groups suffer particularly badly from Covid or lockdown policies – groups such as the poor, the elderly and children. Achieving the goal of a specific R for the least cost, including external costs and attaching higher weights on the effects on certain groups then becomes the goal. As Carney says:

R brings public health and economics together. Relaxations of restrictions increase R, with economic, health and social consequences. A strategic approach to Covid is the best combination of policies to achieve the desired level of infection control at minimum economic cost with due respect for inequality, mental health and other social consequences, and calculating those costs then provides guidance when considering different containment strategies. That means paying attention to the impact on measures of fairness, the social returns to education, intergenerational equity and economic dynamism.

Conclusion

Given the uncertainties surrounding the measurement of the number of lives saved and the difficulties of assigning a value to them, and given the difficulties of estimating the economic and social effects of lockdowns, it is not surprising that the conclusions of a cost–benefit analysis, or even a cost–effectiveness analysis of a lockdown will be contentious. But, at least such analysis can help to inform discussion and drive future policy decisions. And a cost–effectiveness analysis can be a practical way of helping politicians reach difficult decisions about life and death and the economy.

Articles (original blog)

Articles (additional)

Questions

  1. What are the arguments for and against putting a monetary value on a life saved?
  2. Are QALYs the best way of measuring lives saved from a policy such as a lockdown?
  3. Compare the relative merits of cost–benefit analysis and cost–effectiveness analysis.
  4. If the outcomes of a lockdown are highly uncertain, does this strengthen or weaken the case for a lockdown? Explain.
  5. What specific problems are there in estimating the number of lives saved by a lockdown?
  6. How might the age distribution of people dying from Covid-19 affect the calculation of the cost of these deaths (or the benefits or avoiding them)?
  7. How might you estimate the costs to people who suffer long-term health effects from having had Covid-19?
  8. What are the arguments for and against using discounting in estimating future QALYs?
  9. The Department of Transport currently uses a figure of £1 958 303 (in 2018 prices) for the value of a life saved from a road safety project. Find out how this is figure derived and comment on it. See Box 12.5 in Economics 10th edition and Accident and casualty costs, Tables RAS60001 and RA60003, (Department of Transport, 2019).
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The magic money forest

The BBC podcast linked below looks at the use of quantitative easing since 2009 and especially the most recent round since the onset of the pandemic.

Although QE was a major contributor to reducing the depth of the recession in 2009–10, it was barely used from 2013 to 2020 (except for a short period in late 2016/early 2017). The Coalition and Conservative governments were keen to get the deficit down. In justifying pay restraint and curbing government expenditure, Prime Ministers David Cameron and Theresa May both argued that there ‘was no magic money tree’.

But with the severely dampening effect of the lockdown measures from March 2020, the government embarked on a large round of expenditure, including the furlough scheme and support for businesses.

The resulting rise in the budget deficit was accompanied by a new round of QE from the beginning of April. The stock of assets purchased by the Bank of England rose from £445 billion (the approximate level it had been since March 2017) to £740 billion by December 2020 and is planned to reach £895 billion by the end of 2021.

So with the effective funding of the government’s deficits by the creation of new money, does this mean that there is indeed a ‘magic money tree’ or, indeed, a ‘magic money forest’? And if so, is it desirable? Is it simply stoking up problems for the future? Or will, as modern monetary theorists maintain, the extra money, if carefully spent, lead to faster growth and a reducing deficit, with low interest rates making it easy to service the debt?

The podcast explores these issues. There is then a longer list of questions than normal relating to the topics raised in the podcast.

Podcast

Questions

  1. Which of the following are stocks and which are flows?
    (a) Money
    (b) Income
    (c) The total amount people save each month
    (d) The money held in savings accounts
    (e) Public-sector net debt
    (f) Public-sector net borrowing
    (g) National income
    (h) Injections into the circular flow of income
    (i) Aggregate demand
    (j) Wealth
  2. How do banks create money?
  3. What is the role of the Debt Management Office in the sale of gilts?
  4. Describe the birth of QE.
  5. Is raising asset prices the best means of stimulating the economy? What are the disadvantages of this form of monetary expansion?
  6. What are the possible exit routes from QE and what problems could occur from reducing the central bank’s stock of assets?
  7. Is the use of QE in the current Covid-19 crisis directly related to fiscal policy? Or is this use of monetary policy simply a means of hitting the inflation target?
  8. What are the disadvantages of having interest rates at ultra-low levels?
  9. Does it matter if the stock of government debt rises substantially if the gilts are at ultra-low fixed interest rates?
  10. What are the intergenerational effects of substantial QE? Does it depend on how debt is financed?
  11. How do the policy recommendations of modern monetary theorists differ from those of more conventional macroeconomists?
  12. In an era of ultra-low interest rates, does fiscal policy have a greater role to play than monetary policy?