This blog discusses economic issues in the news and relates these news items to key economic concepts and theories. Links are given to a range of articles and other relevant material and each blog post finishes with a set of discussion questions.
Late January sees the annual global World Economic Forum meeting of politicians, businesspeople and the great and the good at Davos in Switzerland. Global economic, political, social and environmental issues are discussed and, sometimes, agreements are reached between world leaders. The 2019 meeting was somewhat subdued as worries persist about a global slowdown, Brexit and the trade war between the USA and China. Donald Trump, Xi Jinping, Vladimir Putin and Theresa May were all absent, each having more pressing issues to attend to at home.
There was, however, a feeling that the world economic order is changing, with the rise in populism and with less certainty about the continuance of the model of freer trade and a model of capitalism modified by market intervention. There was also concern about the roles of the three major international institutions set up at the end of World War II: the IMF, the World Bank and the WTO (formerly the GATT). In a key speech, Angela Merkel urged countries not to abandon the world economic order that such institutions help to maintain. The world can only resolve disputes and promote development, she argued, by co-operating and respecting the role of such institutions.
But the role of these institutions has been a topic of controversy for many years and their role has changed somewhat. Originally, the IMF’s role was to support an adjustable peg exchange rate system (the ‘Bretton Woods‘ system) with the US dollar as the international reserve currency. It would lend to countries in balance of payments deficit to allow them to maintain their rate pegged to the dollar unless it was perceived to be a fundamental deficit, in which case they were expected to devalue their currency. The system collapsed in 1971, but the IMF continued to provide short-term, and sometimes longer-term, finance to countries in balance of payments difficulties.
The World Bank was primarily set up to provide development finance to poorer countries. The General Agreement on Tariffs and Trade (GATT) and then the WTO were set up to encourage freer trade and to resolve trade disputes.
However, the institutions were perceived with suspicion by many developing countries and by more left-leaning developed countries, who saw them as part of the ‘Washington consensus’. Loans from the IMF and World Bank were normally contingent on countries pursuing policies of market liberalisation, financial deregulation and privatisation.
Although there has been some movement, especially by the IMF, towards acknowledging market failures and supporting a more broadly-based development, there are still many economists and commentators calling for more radical reform of these institutions. They advocate that the World Bank and IMF should directly support investment – public as well as private – and support the Green New Deal.
How would your life be without the internet? For many of you, this is a question that may be difficult to answer – as the internet has probably been an integral part of your life, probably since a very young age. We use internet infrastructure (broadband, 4G, 5G) to communicate, to shop, to educate ourselves, to keep in touch with each other, to buy and sell goods and services. We use it to seek and find new information, to learn how to cook, to download music, to watch movies. We also use the internet to make fast payments, transfer money between accounts, manage our ISA or our pension fund, set up direct debits and pay our credit-card bills.
I could spend hours writing about all the things that we do over the internet these days, and I would probably never manage to come up with a complete list. Just think about how many hours you spend online every day. Most likely, much of your waking time is spent using internet-based services one way or another (including apps on your phone, streaming on your phone, tablet or your smart TV and similar). If your access to the internet was disrupted, you would certainly feel the difference. What if you just couldn’t afford to have computer or internet access? What effect would that have on your education, your ability to find a job, and your income?
Martin Jenkins, a former homeless man, now entrepreneur, thinks that the magnitude of this effect is rather significant. In fact, he is so convinced about the importance of bringing the internet to poorer households, that he recently founded a company, Neptune, offering low-income households in the Bronx district of New York free access to online education, healthcare and finance portals. His venture was mentioned in a recent (and very interesting) BBC article – a link to which can be found at the end of this blog. But is internet connectivity really that important when it comes to economic and labour market outcomes? And is there a systematic link between economic growth and internet penetration rates?
These are all questions that have been the subject of intensive debate over the last few years, in the context of both developed and developing economies. Indeed, the ‘digital divide’ as it is known (the economic gap between the internet haves and have nots) is not something that concerns only developing countries. According to a recent policy brief published by the New York City Comptroller:
More than one-third (34 percent) of households in the Bronx lack broadband at home, compared to 30 percent in Brooklyn, 26 percent in Queens, 22 percent in Staten Island, and 21 percent in Manhattan.
The report goes on to present data on the percentage of households with internet connection at home by NYC district, and it does not take advanced econometric skills for one to notice that there is a clear link between median district income and broadband access. Wealthier districts (e.g. Manhattan Community District 1 & 2 – Battery Park City, Greenwich Village & Soho PUMA), tend to have a significantly higher share of households with broadband access, than less affluent ones (e.g. NYC-Brooklyn Community District 13 – Brighton Beach & Coney Island PUMA) – 88% of total households compared with 58%.
But, do these large variations in internet connectivity matter? The evidence is mixed. On the one hand, there are several studies that find a clear, strong link between internet penetration and economic growth. Czernich et al (2011), for instance, using data on OECD countries over the period 1996–2007, find that “a 10 percentage point increase in broadband penetration raised annual per capita growth by 0.9–1.5 percentage points”.
Another study by Koutroumpis (2018) examined the effect of rolling out broadband in the UK.
For the UK, the speed increase contributed 1.71% to GDP in total and 0.12% annually. Combining the effect of the adoption and speed changes increased UK GDP by 6.99% cumulatively and 0.49% annually on average”. (pp.10–11)
The evidence is less clear, however, when one tries to estimate the benefits between different types of workers – low and high skilled. In a recent paper, Atasoy (2013) finds that:
gaining access to broadband services in a county is associated with approximately a 1.8 percentage point increase in the employment rate, with larger effects in rural and isolated areas.
But then he adds:
most of the employment gains result from existing firms increasing the scale of their labor demand and from growth in the labor force. These results are consistent with a theoretical model in which broadband technology is complementary to skilled workers, with larger effects among college-educated workers and in industries and occupations that employ more college-educated workers.
Similarly, Forman et al (2009) analyse the effect of business use of advanced internet technology and local variation in US wage growth, over the period 1995–2000. Their findings show that:
Advanced internet technology is associated with larger wage growth in places that were already well off. These are places with highly educated and large urban populations, and concentration of IT-intensive industry. Overall, advanced internet explains over half of the difference in wage growth between these counties and all others.
How important then is internet access as a determinant of growth and economic activity and what role does it have in bridging economic disparities between communities? The answer to this question is most likely ‘very important’ – but less straightforward than one might have assumed.
Consumer and business confidence reflect the sentiment, emotion, or anxiety of consumers and businesses. Confidence surveys therefore try to capture these feelings of optimism or pessimism. They aim to shed light on spending intentions and hence the short-term prospects for private-sector spending. For example, a fall in confidence would be expected to lead to a fall in consumption and investment spending. This is particularly relevant in the UK with the ongoing uncertainty around Brexit. We briefly summarise here current patterns in confidence.
Through the use of surveys attempts are made to measure confidence. One long-standing survey is that conducted for the European Commission. Each month consumers and firms across the European Union are asked a series of questions, the answers to which are used to compile indicators of consumer and business confidence. For instance, consumers are asked about how they expect their financial position to change. They are offered various options such as ‘get a lot better, ‘get a lot worse’ and balances are then calculated on the basis of positive and negative replies.
The chart plots confidence in the UK for consumers and different sectors of business since the mid 1990s. The chart captures the volatility of confidence. This volatility is generally greater amongst businesses than consumers, and especially so in the construction sector. (Click here to download a PowerPoint copy of the chart.)
The chart nicely captures the collapse in confidence during the global financial crisis in the late 2000s. The significant tightening of credit conditions contributed to a significant dampening of aggregate demand which was further propagated (amplified) by the collapse in confidence. Consequently, the economy slid in to recession with national output contracting by 6.3 per cent during the 5 consecutive quarters during which output fell.
To this point, the current weakening of confidence is not of the same magnitude as that of the late 2000s. In January 2009 consumer confidence had fallen to an historic low of -35. Nonetheless, the December 2018 figure for consumer confidence was -9, the lowest figure since July 2016 the month following the EU referendum, and markedly lower than the +8 seen as recently as 2014. The long-term (median) average for the consumer confidence balance is -6.
The weakening in consumer confidence is mirrored by a weakening in confidence in the retail and service sectors. The confidence balances in December 2018 in these two sector both stood at -8 which compares to their longer-term averages of around +5. In contrast, confidence in industry and construction has so far held fairly steady with confidence levels in December 2018 at +8 in industry and at 0 in construction compared to their long-term averages of -4 and -10 respectively.
It will be interesting to see how confidence has been affected by recent events. The glut of stories suggesting that trading conditions were especially difficult for retailers over the Christmas and New Year period is consistent with the weakening confidence already observed amongst consumers and retailers. However, it is unlikely that recent events will have done anything other than to exacerbate the trend for a weakening of confidence of domestic consumers and retailers. Hence, the likelihood is an intensification of caution and prudence.
With the UK parliament in Brexit gridlock, the Labour opposition is calling for a general election. Although its policy over Brexit and a second referendum is causing splits in the party, the Labour party is generally agreed that pubic expenditure on health, education and transport infrastructure needs to increase – that there needs to be an end to fiscal austerity. However, to fund extra public expenditure would require an increase in taxes and/or an increase in government borrowing.
One of the arguments against increasing government borrowing is that it will increase public-sector debt. The desire to get public-sector debt down as a percentage of GDP has been central to both the Coalition and Conservative governments’ economic strategy. Austerity policies have been based on this desire.
But, in the annual presidential address to the American Economics Association, former chief economist at the IMF, Olivier Blanchard, criticised this position. He has argued for several years that cutting government deficits may weaken already weak economies and that this may significantly reduce tax revenues and potential national income, thereby harming recovery and doing long-term economic damage. Indeed, the IMF has criticised excessively tight fiscal policies for this reason.
In his presidential address, he expanded the argument to consider whether an increase in government borrowing will necessarily increase the cost of servicing government debt. When the (nominal) interest rate (r) on government borrowing is below the nominal rate of economic growth (gn), (r < gn), then even if total debt is not reduced, it is likely that the growth in tax revenues will exceed the growth in the cost of servicing the debt. Debt as a proportion of GDP will fall. The forecast nominal growth rate exceeds the 10-year nominal rate on government bonds by 1.3% in the USA, 2.2% in the UK and 1.8% in the eurozone. In fact, with the exception of a short period in the 1980s, nominal growth (gn) has typically exceeded the nominal interest rate on government borrowing (r) for decades.
When r < gn, this then gives scope for increasing government borrowing to fund additional government spending without increasing the debt/GDP ratio. Indeed, if that fiscal expansion increases both actual and potential income, then growth over time could increase, giving even more scope for public investment.
Peterson Institute on YouTube, Olivier Blanchard (4/1/19)
Questions
What do you understand by ‘fiscal illusion’?
What is the justification for reducing government debt as a proportion of GDP?
What are the arguments against reducing government debt as a proportion of GDP?
Explain the significance of the relationship between r and gn for fiscal policy and the levels of government debt, government borrowing and the government debt/GDP ratio.
Under what circumstances would a rise in the budget deficit not lead to a rise in government debt as a proportion of GDP?
Does Blanchard’s analysis suggest that a combination of both loose monetary policy and loose fiscal policy is desirable?
Under Blanchard’s analysis, what would limit the amount that governments should increase spending?
Back in October, we examined the rise in oil prices. We said that, ‘With Brent crude currently at around $85 per barrel, some commentators are predicting the price could reach $100. At the beginning of the year, the price was $67 per barrel; in June last year it was $44. In January 2016, it reached a low of $26.’ In that blog we looked at the causes on both the demand and supply sides of the oil market. On the demand side, the world economy had been growing relatively strongly. On the supply side there had been increasing constraints, such as sanctions on Iran, the turmoil in Venezuela and the failure of shale oil output to expand as much as had been anticipated.
But what a difference a few weeks can make!
Brent crude prices have fallen from $86 per barrel in early October to just over $50 by the end of the year – a fall of 41 per cent. (Click here for a PowerPoint of the chart.) Explanations can again be found on both the demand and supply sides.
On the demand side, global growth is falling and there is concern about a possible recession (see the blog: Is the USA heading for recession?). The Bloomberg article below reports that all three main agencies concerned with the oil market – the U.S. Energy Information Administration, the Paris-based International Energy Agency and OPEC – have trimmed their oil demand growth forecasts for 2019. With lower expected demand, oil companies are beginning to run down stocks and thus require to purchase less crude oil. Fracking (Source: US Bureau of Land Management Environmental Assessment, public domain image)
On the supply side, US shale output has grown rapidly in recent weeks and US output has now reached a record level of 11.7 million barrels per day (mbpd), up from 10.0 mbpd in January 2018, 8.8 mbpd in January 2017 and 5.4 mbpd in January 2010. The USA is now the world’s biggest oil producer, with Russia producing around 11.4 mpbd and Saudi Arabia around 11.1 mpbd.
Total world supply by the end of 2018 of around 102 mbpd is some 2.5 mbpd higher than expected at the beginning of 2018 and around 0.5 mbpd greater than consumption at current prices (the remainder going into storage).
So will oil prices continue to fall? Most analysts expect them to rise somewhat in the near future. Markets may have overcorrected to the gloomy news about global growth. On the supply side, global oil production fell in December by 0.53 mbpd. In addition OPEC and Russia have signed an accord to reduce their joint production by 1.2 mbpd starting this month (January). What is more, US sanctions on Iran have continued to curb its oil exports.
But whatever happens to global growth and oil production, the future price will continue to reflect demand and supply. The difficulty for forecasters is in predicting just what the levels of demand and supply will be in these uncertain times.
There was, however, a feeling that the world economic order is changing, with the rise in populism and with less certainty about the continuance of the model of freer trade and a model of capitalism modified by market intervention. There was also concern about the roles of the three major international institutions set up at the end of World War II: the IMF, the World Bank and the WTO (formerly the GATT). In a key speech, Angela Merkel urged countries not to abandon the world economic order that such institutions help to maintain. The world can only resolve disputes and promote development, she argued, by co-operating and respecting the role of such institutions. 
The World Bank was primarily set up to provide development finance to poorer countries. The General Agreement on Tariffs and Trade (GATT) and then the WTO were set up to encourage freer trade and to resolve trade disputes.
Special Address by Angela Merkel, Federal Chancellor of Germany
How would your life be without the internet? For many of you, this is a question that may be difficult to answer – as the internet has probably been an integral part of your life, probably since a very young age. We use internet infrastructure (broadband, 4G, 5G) to communicate, to shop, to educate ourselves, to keep in touch with each other, to buy and sell goods and services. We use it to seek and find new information, to learn how to cook, to download music, to watch movies. We also use the internet to make fast payments, transfer money between accounts, manage our ISA or our pension fund, set up direct debits and pay our credit-card bills.
Consumer and business confidence reflect the sentiment, emotion, or anxiety of consumers and businesses. Confidence surveys therefore try to capture these feelings of optimism or pessimism. They aim to shed light on spending intentions and hence the short-term prospects for private-sector spending. For example, a fall in confidence would be expected to lead to a fall in consumption and investment spending. This is particularly relevant in the UK with the ongoing uncertainty around Brexit. We briefly summarise here current patterns in confidence. 
The chart plots confidence in the UK for consumers and different sectors of business since the mid 1990s. The chart captures the volatility of confidence. This volatility is generally greater amongst businesses than consumers, and especially so in the construction sector. (Click 
With the UK parliament in Brexit gridlock, the Labour opposition is calling for a general election. Although its policy over Brexit and a second referendum is causing splits in the party, the Labour party is generally agreed that pubic expenditure on health, education and transport infrastructure needs to increase – that there needs to be an end to fiscal austerity. However, to fund extra public expenditure would require an increase in taxes and/or an increase in government borrowing.
Back in October, we examined the 
Brent crude prices have fallen from $86 per barrel in early October to just over $50 by the end of the year – a fall of 41 per cent. (Click 